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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2004
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ________ to ___________
Commission file number: 00-15997
FILENET CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 95-3757924 .
(State or other jurisdiction of (I.R.S. Employer
corporation or organization Identification No.)
3565 Harbor Boulevard, Costa Mesa, CA 92626
(Address of principal executive offices) (Zip code)
(714) 327-3400 .
(Registrant's telephone number including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the Registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark whether the Registrant is an accelerated filer as defined in Rule
12b-2 of the Securities Exchange Act of 1943:
Yes |X| No |_|
As of May 5, 2004, there were 38,940,147 shares of the Registrant's common stock
outstanding.
FILENET CORPORATION
Index
Page
Number
PART I. FINANCIAL INFORMATION.......................................... 3
Item 1. Unaudited Condensed Consolidated Financial Statements ........ 3
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations .................................. 17
Item 3. Quantitative and Qualitative Disclosures about Market Risk..... 35
Item 4. Controls and Procedures........................................ 37
PART II. OTHER INFORMATION.............................................. 37
Item 1. Legal Proceedings.............................................. 37
Item 6. Exhibits and Reports on Form 8-K............................... 37
SIGNATURE ............................................................... 38
INDEX TO
EXHIBITS ............................................................... 39
2
PART I. FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
FILENET CORPORATION
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
March 31, December 31,
2004 2003
ASSETS
Current assets:
Cash and cash equivalents $ 238,327 $ 203,305
Short-term investments available for sale 33,674 32,286
Accounts receivable, net 33,340 38,096
Prepaid expenses and other current assets 13,511 13,174
Deferred income taxes 3,551 3,551
Total current assets 322,403 290,412
Property, net 25,810 26,922
Long-term investments available for sale 18,983 12,672
Goodwill 25,822 26,170
Intangible assets, net 7,315 7,979
Deferred income taxes 23,040 23,001
Other assets 4,032 4,692
Total assets $ 427,405 $ 391,848
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 10,207 $ 11,006
Accrued compensation and benefits 24,291 27,648
Customer deposits and advances 6,970 5,217
Unearned maintenance revenue 64,861 40,691
Other accrued liabilities 15,397 16,524
Total current liabilities 121,726 101,086
Unearned maintenance revenue and other liabilities 3,204 1,614
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 244,252 234,025
authorized; 39,811,824 issued and 38,713,824
shares outstanding at March 31, 2004; and
38,906,640 shares issued and 37,808,640 shares
outstanding at December 31, 2003
Retained earnings 68,096 64,098
Accumulated other comprehensive income 4,694 5,592
Treasury stock, at cost; 1,098,000 shares (14,567) (14,567)
Net stockholders' equity 302,475 289,148
Total liabilities and stockholders' equity $ 427,405 $ 391,848
See accompanying notes to unaudited condensed consolidated financial statements.
3
FILENET CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Three Months Ended March 31,
2004 2003
Revenue:
Software $ 41,351 $ 35,522
Customer support 45,270 39,396
Professional services and education 12,877 12,131
Total revenue 99,498 87,049
Costs:
Software 3,523 3,008
Customer support 10,292 10,571
Professional services and education 10,838 11,080
Total cost of revenue 24,653 24,659
Gross Profit 74,845 62,390
Operating expenses:
Sales and marketing 41,561 34,399
Research and development 20,102 19,302
General and administrative 9,233 7,826
Total operating expenses 70,896 61,527
Operating income 3,949 863
Other income, net 927 1,045
Income before income taxes 4,876 1,908
Provision for income taxes 878 572
Net income $ 3,998 $ 1,336
Earnings per share:
Basic $ 0 .10 $ 0.04
Diluted $ 0 .10 $ 0.04
Weighted-average shares outstanding:
Basic 38,280 35,942
Diluted 40,785 36,623
See accompanying notes to unaudited condensed consolidated financial statements.
4
FILENET CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
(In thousands)
Three Months Ended
March 31, .
2004 2003
Net income $ 3,998 $ 1,336
Other comprehensive income (loss):
Foreign currency translation adjustments (914) 1,997
Unrealized gain (loss) on securities:
Unrealized holding gain (loss) 16 (10)
Total other comprehensive income (loss) (898) 1,987
Comprehensive income $ 3,100 $ 3,323
See accompanying notes to unaudited condensed consolidated financial statements.
5
FILENET CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Three Months Ended
March 31, .
2004 2003
Cash flows from operating activities:
Net income $ 3,998 $ 1,336
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 4,276 4,907
Loss on sale of property 4 37
Provision for doubtful accounts 6 18
Deferred income taxes (40) (6)
Changes in operating assets and liabilities, net of the
effects of acquisitions:
Accounts receivable 4,551 4,653
Prepaid expenses and other current assets (411) (975)
Accounts payable (756) (1,830)
Accrued compensation and benefits (3,261) 3,034
Customer deposits and advances 1,762 1,048
Unearned maintenance revenue 25,875 15,821
Income taxes payable 1,734 (385)
Other (2,578) (972)
Net cash provided by operating activities $ 35,160 $ 26,686
Cash flows from investing activities:
Capital expenditures (2,726) (2,507)
Proceeds from sale of property 48 68
Purchases of marketable securities (24,910) (28,020)
Proceeds from sales and maturities of marketable securities 17,800 23,655
Net cash used in investing activities $ (9,788) $ (6,804)
Cash flows from financing activities:
Proceeds from issuance of common stock 10,178 530
Net cash provided by financing activities $ 10,178 $ 530
Effect of exchange rate changes on cash and cash equivalents (528) 1,755
Net increase in cash and cash equivalents 35,022 22,167
Cash and cash equivalents, beginning of year 203,305 130,154
Cash and cash equivalents, end of period 238,327 152,321
Supplemental cash flow information:
Interest paid 22 7
Income taxes paid / (refunded) $ (950) $ 950
See Note No. 10 for additional non-cash disclosures stock.
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 March 31, 2004, the
results of its operations, its comprehensive operations and its cash flows
for the three months ended March 31, 2004 and 2003. 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,
2003 filed with the SEC on March 12, 2004. The results of operations for
the interim periods are not necessarily indicative of the operating results
for the year, or any other future period.
Reclassifications. Certain reclassifications have been made to prior-years'
balances to conform to the current-year's presentation.
2. NEW ACCOUNTING PRONOUNCEMENTS
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. With respect to variable interest entities created before January 31,
2003, in December 2003 the FASB issued FIN 46R, which, among other things,
revised the implementation date to the first fiscal years or interim
periods ending after March 15, 2004, with the exception of Special Purpose
Entities ("SPE"). The consolidated requirements apply to all SPE's in the
first fiscal year or interim period ending after December 15, 2003. The
Company has determined that it does not have any SPE's to which these
interpretations apply and has adopted FIN 46R in the first quarter of 2004.
The adoption of FIN 46R did not have a material impact on the Company's
consolidated financial statements.
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;
7
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.
In November 2003, the FASB issued FASB Staff Position (FSP) No. 150-3
which deferred the effective dates for applying certain provisions of SFAS
No. 150 related to mandatorily redeemable financial instruments of certain
nonpublic entities and certain mandatorily redeemable noncontrolling
interests for public and nonpublic entities.
For public entities, SFAS No. 150 is effective for mandatorily
redeemable 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.
For mandatorily redeemable noncontrolling interests that would not
have to be classified as liabilities by a subsidiary under the exception in
paragraph 9 of SFAS No. 150, but would be classified as liabilities by the
parent, the classification and measurement provisions of SFAS No. 150 are
deferred indefinitely. For other mandatorily redeemable noncontrolling
interests that were issued before November 5, 2003, the measurement
provisions of SFAS No. 150 are deferred indefinitely. For those
instruments, the measurement guidance for redeemable shares and
noncontrolling interests in other literature shall apply during the
deferral period.
SFAS No. 150 is to be implemented by reporting the cumulative effect
of a change in accounting principle. The Company does not have financial
instruments with characteristics of both debt and equity and therefore the
adoption of SFAS No. 150 did not have a material impact on the Company's
consolidated financial statements.
3. STOCK BASED COMPENSATION
The Company accounts for stock based awards to employees using the
intrinsic value method in accordance with Accounting Principles Board (APB)
Opinion No. 25, "Accounting for Stock Issued to Employees." The following
table summarizes the Company's net income (loss) and net income (loss) per
share on a pro forma basis had compensation cost for the Company's
stock-based compensation plans been determined based on the provisions of
SFAS No. 123, Accounting for Stock Based Compensation", for the three
months ended March 31, 2004 and 2003.
8
Three Months Ended
March 31,
(In thousands, except per share amounts) 2004 2003
Net income, as reported $ 3,998 $ 1,336
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards, net
of related tax effects (1,547) (2,039)
Pro forma net income (loss) 2,451 (703)
Earnings per share:
Basic earnings per share - as reported $ 0.10 $ 0.04
Basic earnings (loss) per share - pro forma 0.06 (0.02)
Diluted earnings per share - as reported 0.10 0.04
Diluted earnings (loss) per share - pro forma $ 0.06 $ (0.02)
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
March 31,
2004 2003
Expected term (in years) 5.39 5.0
Expected volatility 51% 66%
Risk free interest rates 3.07% 3.61%
Expected dividend 0% 0%
4. ACQUISITIONS
On April 2, 2003, the Company completed a stock purchase acquisition
of 100% 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.
9
In accordance with SFAS No. 141, "Business Combinations," this
acquisition was accounted for under the purchase method of accounting. The
purchase price was allocated as follows:
(In thousands)
Shana Corporation April 2, 2003
Net tangible assets $ 2,725
Goodwill 3,103
Acquired technology 4,000
Technical manuals and design documents 600
Customer maintenance relationships 800
Non-Compete Agreements 277
Liabilities assumed (2,494)
Total purchase price $ 9,011
Less cash acquired (938)
Net cash paid $ 8,073
The Company allocated the purchase price for this acquisition 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 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.
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.
5. GOODWILL AND PURCHASED INTANGIBLE ASSETS
In acquisitions accounted for using the purchase method, goodwill is
recorded as the difference, if any, between the aggregate consideration
paid for an acquisition and the fair value of the net tangible and
identified intangible assets acquired. SFAS No. 142 requires that
amortization of goodwill and indefinite life intangibles be discontinued
and replaced with periodic review and analysis for possible impairment.
Intangible assets with definite lives must be amortized over their
estimated useful lives.
The following table presents the changes in goodwill by reporting
segment during the three months ended March 31, 2004:
10
(In thousands)
Balance at Foreign Balance at
December 31, Currency March 31,
Goodwill by Reporting Segment 2003 Change 2004
Software $ 15,144 $ (203) $ 14,941
Customer Support 5,858 (77) 5,781
Professional Services and Education 5,168 (68) 5,100
Total $ 26,170 $ (348) $ 25,822
Foreign currency change relates to the impact of translation on the
portion of goodwill that was booked to the Company's Ireland and Canada
subsidiaries.
Acquired technology, technical manuals and design documents, customer
maintenance relationships, patents, and non-compete agreements are the
Company's only intangible assets subject to amortization under Statement
No. 142.
Changes in these assets are summarized as follows for the three months
ended March 31, 2004:
(In thousands)
Balance at Foreign Balance at
December 31, Currency March 31,
Intangible Assets 2003 Amortized Change 2004
Acquired technology and other intangibles $ 7,748 $ (459) $ (167) $ 7,122
Non-compete agreements 227 (28) (6) 193
Patents 4 (3) (1) -
Total $ 7,979 $ (490) $ (174) $ 7,315
Acquired technology is being amortized over a useful life of five
years, patents are being amortized over a useful life of two years and
non-compete agreements are being amortized over three years. Amortization
expense for amortizing intangible assets was $527,000 for the three months
ending March 31, 2004 compared to $183,000 for the comparable period in
2003 (excluding foreign exchange effect). Estimated future amortization
expense (excluding foreign exchange effect) of purchased intangible assets
as of March 31, 2004 is as follows:
(In thousands)
Fiscal Year Amount
(Remainder) 2004 $ 1,566
2005 2,056
2006 1,989
2007 1,401
2008 303
$ 7,315
11
6. 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, shares issuable under the
employee stock purchase plan and restricted stock issued to key executive
management using the treasury stock method. The number of anti-dilutive
options excluded from the EPS calculation for the three months ended March
31, 2004 and 2003 were 2,505,000 and 681,000 shares, respectively. The
following table sets forth the computation of basic and diluted earnings
per share for the three months ended March 31, 2004 and 2003:
Three Months Ended
(In thousands, except per share amounts) March 31,
2004 2003
Net Income $ 3,998 $ 1,336
Weighted average common shares outstanding 38,313 35,942
Weighted average common shares of unvested restricted stock* (33) -
Shares used in computing basic earnings per share 38,280 35,942
Earnings per basic share $ .10 $ .04
Shares used in computing basic earnings per share 38,280 35,942
Dilutive effect of stock plan 2,472 681
Dilutive effect of weighted average common shares
of unvested restricted stock 33 -
Shares used in computing diluted earnings per share 40,785 36,623
Earnings per diluted share $ .10 $ .04
* See Note 10 - Restricted Stock
7. ACCUMULATED OTHER COMPREHENSIVE INCOME
Accumulated other comprehensive income for the three months ended
March 31, 2004 is comprised of the following:
(In thousands)
Foreign Unrealized
Currency Holding Accumulated Other
Translation Gain/(Loss) Comprehensive
Adjustment on Securities Income
Balance, December 31, 2003 $ 5,645 $ (53) $ 5,592
Three month period changes (914) 16 (898)
Balance, March 31, 2004 $ 4,731 $ (37) $ 4,694
12
8. OPERATING SEGMENT DATA
The Company has prepared operating 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 for which financial
performance is assessed and resources allocated.
The Company's reportable operating segments effective January 1, 2004
include Software, Customer Support, and Professional Services and
Education. The residual operating activity of the previously reported
Hardware reporting segment has been combined with the Customer Support
reporting segment. This combination is predicated on the reduced scale and
change in the nature of on-going hardware operations. Prior year hardware
amounts have been reclassified into customer service to conform to the new
segment presentation.
The Software operating segment develops, markets, and sells a unified
platform and framework for ECM software and solutions. The Customer Support
segment provides after-sale support for software, as well as providing
software upgrades, on a when and if available basis, under the Company's
right to new versions program. The Customer Support segment also provides
operating supplies and spare parts for the installed base of Optical
Storage and Retrieval ("OSAR") libraries, previously the hardware business.
The Professional Services and Education segment provides fee-based
implementation and technical consulting services related to the Company's
standard products and post-implementation training services.
The accounting policies of the Company's operating segments are the
same as those described in Item 2 - Critical Accounting Policies and
Estimates - except that the disaggregated 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. The Company evaluates performance based on stand-alone
segment operating income. Because the Company does not evaluate performance
based on the return on assets or on interest income at the operating
segment level, assets and interest income are not tracked internally by
segment. Therefore, such information is not presented.
Operating segments data for the three months ended March 31, 2004 and
2003 are as follows:
(In thousands)
Three months ended
March 31,
2004 2003
Software
Revenue $ 41,351 $ 35,522
Operating loss (16,066) (14,747)
Customer Support
Revenue $ 45,270 39,396
Operating income 19,747 16,585
Professional Services and
Education
Revenue $ 12,877 12,131
Operating income (loss) 268 (975)
Total:
Revenue $ 99,498 87,049
Operating income 3,949 863
13
9. STOCK OPTIONS
The following is a summary of stock option transactions regarding all
stock option plans for the three months ended March 31, 2004:
.
Weighted-
Number of Average
Options Exercise Price
Balance, December 31, 2003 7,642,743 $ 16.31
Granted (weighted-average fair value of $11.74) 674,200 28.23
Exercised (772,684) 13.18
Canceled (149,618) 18.93
Balance, March 31, 2004 7,394,641 $ 17.68
The following table summarizes information concerning outstanding and
exercisable stock options at March 31, 2004:
.
Options Outstanding Options Exercisable
Weighted-Average Weighted-Average
Remaining Weighted-Average Exercise
Range of Exercise Number Contractual Exercise Price
Price Outstanding Life (Years) Price Number Exercisable
$ 1.39 - 9.50 940,122 3.64 $ 8.01 934,527 $ 8.00
9.75 - 12.86 1,232,733 7.58 12.32 583,160 11.93
12.97 - 14.19 1,209,276 7.20 13.46 644,523 13.54
14.39 - 18.45 1,266,506 7.11 16.85 767,618 16.93
19.53 - 25.00 1,268,866 6.28 22.82 1,101,309 22.96
25.28 - 41.84 1,477,138 8.19 28.07 493,614 28.76
$ 1.39 - 41.84 7,394,641 6.84 $ 17.68 4,524,751 $ 16.72
10. ISSUANCE OF RESTRICTED STOCK
The Company awarded 132,500 shares of restricted stock to ten members
of the senior management team on March 9, 2004. This award was made under
the 2002 Incentive Award Plan. These shares of restricted stock vest
December 31, 2008, and include a feature that allows the stock to vest on
an accelerated basis provided certain performance targets are achieved.
These shares are valued at approximately $3.6 million based on the
March 9, 2004 closing price of $27.47 per share. The grant value of $3.6
million is recorded in the equity section of the balance sheet as an
increase in common stock and a contra-equity offset to deferred
compensation. Expense related to the shares is amortized over a five-year
period on a straight-line basis. Additional recognition of expense may be
accelerated if it becomes probable that certain performance targets are
achieved that trigger accelerated vesting of the restricted shares.
Approximately $45,000 of compensation expense was recognized in the three
months ended March 31, 2004.
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11. COMMITMENTS AND CONTINGENCIES
Leases
The Company leases its corporate offices, sales offices, development
and manufacturing facilities, and other equipment under non-cancelable
operating leases, some of which have renewal options and generally provide
for escalation of the annual rental amount. Amounts related to deferred
rent are recorded in other accrued liabilities on the consolidated balance
sheet. Future annual minimum lease payments under all non-cancelable
operating leases with an initial term in excess of one year as of March 31,
2004 were as follows:
(In thousands)
2004 (remaining 9 months) $ 7,988
2005 11,060
2006 10,493
2007 9,617
2008 8,589
2009 6,154
Thereafter 938
Total $ 54,839
Product Warranties
The Company provides a 90-day warranty for its hardware products
against defects in materials and workmanship and for its software products
against substantial nonconformance to the published documentation at time
of delivery. For hardware products the Company accrues warranty costs based
on historical trends in product return rates and the expected material and
labor costs to provide warranty services. For software products, the
Company records the estimated cost of technical support during the warranty
period. A provision for these estimated warranty costs is recorded at the
time of sale or license. If the Company were to experience an increase in
warranty claims compared with historical experience, or costs of servicing
warranty claims were greater than the expectations on which the accrual had
been based, gross margins could be adversely affected.
The following table represents the warranty activity and balance for
the three months ended March 31, 2004 and 2003:
.
(In thousands) 2004 2003
Beginning balance at January 1 $ 479 $ 728
Additions 329 964
Deductions (332) (1,213)
Ending balance at March 31 $ 476 $ 479
Guarantees and Indemnities
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
15
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
domestic and foreign subsidiaries. To provide subsidiary guarantees, the
Company obtains unsecured bank guarantees from local banks. These bank
guarantees totaled an equivalent of approximately $2.5 million as of March
31, 2004. Unsecured bank guarantees increased by $1.2 million during the
three months ended March 31, 2004 for performance guarantees related to
workers compensation liability insurance and a company sponsored sales
event to be held in April 2005. Approximately $1.3 million was issued in
local currency in Europe and Asia, while the balance was issued in the
United States. Approximately $0.6 million of the $2.5 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
as the estimated fair value of these items is de minimis. Also 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 March 31, 2004 is disclosed in this item under the
heading "Product Warranties."
Legal Proceedings
In the normal course of business, the Company is subject to ordinary
routine litigation and claims incidental to its 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.
12. FOREIGN CURRENCY TRANSACTIONS
As of March 31, 2004, the Company had forward foreign exchange
contracts outstanding totaling approximately $5.1 million in 10 currencies.
These contracts were opened on the last business day of the quarter and
mature within three months. Accordingly, the fair value of such contracts
is zero at March 31, 2004.
13. INCOME TAXES
The Company's combined federal, state and foreign annual effective tax
rate for the three months ended March 31, 2004 is 18% compared to 30% for
the comparable period in 2003. 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 and
reductions in the deferred tax valuation allowance. The decreased tax rate
in the three months ended March 31, 2004 was primarily due to the mix of
income earned by domestic operations versus the foreign subsidiaries, and
the partial release of the valuation allowance against income from domestic
operations as net operating loss carryforwards were utilized.
14. 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
16
to Mr. Roberts for $1.9 million to enable him to purchase a home in Orange
County, California. The note bears interest at 2.89% per annum. On June 5,
2002, the Board approved the loan.
Mr. Roberts is current with all payments and obligations of this
agreement. Mr. Roberts made two payments of $37,000 in February 2003 and
$53,000 in February 2004 toward the accrued interest balance in accordance
with the terms and conditions of the loan agreement. Mr. Roberts also made
a payment in December 2003 of approximately $294,000 toward the principal
loan balance of $1.9 million. As of March 31, 2004, FileNet has an
outstanding secured note receivable balance from Mr. Roberts in the amount
approximately of $1.6 million that relates to the above-referenced loan and
is included in other assets on the consolidated balance sheet. The accrued
interest balance as of March 31, 2004 was approximately $9,000. Please
reference Note No, 4 of our December 31, 2003 Report 10-K filing for
additional details of the terms and conditions of this loan.
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
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, 2003. 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 develops and markets software that helps our customers address
their electronic content and business process management requirements.
Electronic content is unstructured data with various object characteristics
and attributes. Electronic or unstructured content includes, but is not
limited to: Web content, forms, word documents and scanned images that are
not easily managed by relational databases. We market these enterprise
software solutions to primarily Global 2000 customers in the banking,
insurance, government, utilities and telecom industries located in North
America, Europe and Asia.
17
Software
The FileNet P8 architecture offers our customers enterprise-level
scalability and flexibility to handle demanding content challenges, complex
business processes, and integration to existing systems. The FileNet P8
architecture provides a framework for functional expansion to provide
enhanced content and process management across an enterprise through five
pre-packaged suites, each emphasizing a different aspect of the ECM
solution set, with functions grouped in a logical order that are designed
to meet a customer's individual ECM needs. Each suite can be implemented by
a customer individually, but remains expandable to include all FileNet ECM
capabilities. FileNet ECM solutions are designed to manage content;
allowing organizations to capture, create, use, and activate that content
in order to make decisions faster and bring control and consistency to
business processes, to improve efficiency and address compliance
requirements.
Services and Support
We operate service and support organizations on a global basis to
provide both pre-sales and post-sales services to ensure successful
implementation of our products and customer satisfaction. Due to the highly
configurable nature of our products, many of our product sales are coupled
with contracts for continuing support services. Our worldwide Customer
Service and Support organization provides comprehensive support
capabilities including electronic and real-time phone support and global
call tracking for customers and partners on support programs. System
engineers deliver support coverage on multiple platforms with 24-hour call
handling. Our Web site offers the ability to open cases, search our
knowledge base and review related status reports. Our manufacturing
facilities in Costa Mesa, California and Dublin, Ireland, conduct software
manufacturing and distribution, localization, integration, test and quality
control.
Professional Services and Education
Our worldwide professional services organization provides consulting,
development, architecture and other technical services and training
services to our licensed customers and authorized ValueNet Partners and
Global System Integrators. These services are provided through in-house
employees and through a network of qualified partners. Our worldwide
professional services organization offers a comprehensive methodology to
architect, install, integrate, customize and deploy our solutions. These
services range from the management of large-scale implementations of our
products to prepackaged standard services such as software installation,
but do not include modifications to the standard software. Our educational
curriculum includes training courses for end users, application developers
and system administrators through media-based and instructor-led training.
Research and Development
We have made and expect to continue to make substantial investments in
research and development, primarily through internal and offshore
development activities, third party licensing agreements and through
technology acquisitions. Our development efforts focus on our unified
FileNet P8 ECM architecture as we continue to develop and enhance our ECM
capabilities. Additionally, we license and embed third party software that
enhances the functionality of our products through a variety of agreements
with the producers of this software.
18
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. Certain of
these contracts relate to single elements and contain standard terms and
conditions, while other agreements contain multiple elements or
non-standard terms and conditions. Contract interpretation is sometimes
required to determine the appropriate accounting, including how the price
should be allocated among the deliverable elements and when to recognize
revenue.
Software license revenue generated from sales through direct and
indirect channels, which do not contain multiple elements, are recognized
upon shipment and passage of title of the related product, if the
requirements of SOP 97-2, are met. If the requirements of SOP 97-2,
including evidence of an arrangement, delivery, fixed or determinable fee,
collectibility or vendor specific evidence about the value of an element
are not met at the date of shipment, revenue is not recognized until these
elements are known or resolved. Fees are deemed to be fixed and
determinable for transactions with a set price that is not subject to
refund or adjustment and payment is due within 90 days from the invoice
date. Software license revenue from channel partners is not recognized
until 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 using the residual method.
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 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. 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. Professional
services are not required for the software to function. We do not make
changes to the standard software code in the field.
19
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
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 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. Goodwill and other intangible assets with indefinite
useful lives are 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. 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 March 31, 2004, there
have been no indicators of impairment, and no impairment of goodwill has
been recognized. If estimates change, a materially different impairment
conclusion could result.
Long-Lived Assets. Property, plant and equipment and intangible assets
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 five 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. If impairment were
indicated, we would be required to write the related assets down to their
fair values. 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 (related to domestic operations) 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 continue to generate profits and
ultimately determine 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.
20
We are continually assessing the valuation allowance related to our
deferred tax assets. As of March 31, 2004, we have a net tax deferred asset
of approximately $26.6 million and valuation allowance of approximately
$24.3 million. We will continue weighing various factors throughout the
year to assess the need for any valuation allowance. Recoverability of the
deferred tax assets is dependent on continued profitability from
operations, as well as the geographic region generating the profits. Should
our level of profitability continue as expected, we would likely remove the
entire valuation allowance later in 2004. We would realize a one-time,
non-cash benefit by decreasing our tax expense (causing an increase in
earnings) by approximately $10.0 million to $12.0 million. Additionally, we
would record a non-cash charge to increase additional reported
paid-in-capital by approximately $9.0 million.
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.
21
Results of Operations
The following table sets forth certain consolidated statements of
operations data as a percentage of total revenue for the periods indicated:
Three Months Ended March 31,
2004 2003
Revenue:
Software 41.6% 40.8%
Customer support 45.5 45.3
Professional services and education 12.9 13.9
Total revenue 100.0 100.0
Cost of revenue:
Software 3.5 3.5
Customer support 10.4 12.1
Professional services and education 10.9 12.7
Total cost of revenue 24.8 28.3
Gross Profit 75.2 71.7
Operating expenses:
Sales and marketing 41.8 39.5
Research and development 20.2 22.2
General and administrative 9.2 9.0
Total operating expenses 71.2 70.7
Operating income 4.0 1.0
Other income, net 0.9 1.2
Income before income tax 4.9% 2.2%
22
Revenue
As more fully discussed below, total revenue increased by 14.3% in the
quarter ended March 31, 2004 compared to the same period in 2003. The
increase in total revenue during this period is primarily attributable to
the increased demand for our software products and customer support. We
believe that the demand for our software and services is due to an increase
in the growth of unstructured content within our coustomer base. Our
products enable customers to manage this content and use it in their
business processes.
Revenue by Geography. The following table sets forth total revenue by
geography and as a percentage of total revenue for the periods indicated:
Revenue by Geography
(In thousands)
% Increase/
Three months ended March 31, 2004 2003 Decrease
Total United States Revenue $ 68,000 $ 59,457 14.4%
Europe, Middle East and Africa 25,317 22,134 14.4%
Canada, Latin America and Asia 6,181 5,458 11.4%
Total International Revenue 31,498 27,592 14.2%
Total Revenue $ 99,498 $ 87,049 14.3%
United States Revenue 68.3% 68.3% -
International Revenue 31.7% 31.7% - .
Total Revenue Contribution 100.0% 100.0%
International revenue represented 31.7% of total revenue and increased
at nearly the same rate as domestic revenue during this period as compared
to the same period in 2003. We believe the same content management factors
mentioned above drive international revenue growth and are not regional in
nature. We expect international revenue to continue to represent a
significant percentage of total revenue. However, international revenues
will be adversely affected if the U.S. dollar strengthens against certain
major international currencies or if international economic conditions
remain relatively weak.
Revenue by Reporting Segment. The following table sets forth total
revenue by reporting segment and as a percentage of total revenue for the
periods indicated:
Revenue by Reporting Segment
(In thousands)
% Increase/
Three months ending March 31, 2004 2003 (Decrease)
Software $ 41,351 $ 35,522 16.4%
Customer Support 45,270 39,396 14.9%
Professional Services and Education 12,877 12,131 6.1%
Total Revenue $ 99,498 $ 87,049 14.3%
Software 41.6% 40.8% .8%
Customer Support 45.5% 45.3% .2%
Professional Services and Education 12.9% 13.9% (1.0%)
Total Revenue Contribution 100.0% 100.0%
23
Software. Software revenue consists of fees earned from the licensing
of our software products to our customers. Software revenue increased by
16.4% in the first three months of 2004 compared to the same period in
2003. The increase in software revenue during this period was primarily due
to an increase in demand for enterprise content management solutions driven
by the growth in unstructured content in our customer base. Customers in
our key vertical industries of banking, insurance, government and telecom
continued to purchase new systems and add-on licenses to existing systems
to help them manage content and records. We believe IT spending on
enterprise content management and business process management software will
show steady improvement throughout 2004.
Customer Support. Customer support revenue consists of revenue from
software maintenance contracts, "fee for service" revenues and the sale of
Optical Storage and Retrieval ("OSAR") libraries, spare parts and supplies.
Maintenance contracts entitle our customers to receive technical support,
enhancements and upgrades to new versions of software releases when and if
available. Customer support revenue increased by 14.9% in the first three
months ended March 31, 2004 compared to the same period in 2003. Customer
support revenue is generated from new maintenance contracts for new system
sales, and from the renewal of existing maintenance contracts for
previously sold software licenses on installed systems. We have
historically experienced a high contract maintenance renewal rate, but are
continuing to experience pricing pressures from our customers during
contract negotiation and renewal. Accordingly, the rate of software revenue
growth may not directly translate into the same growth for customer support
revenue.
Professional Services and Education. Professional services and
education revenue is generated from consulting and implementation services
to end users of our software products, technical consulting services
provided to our resellers, and training services. No modifications are made
to our standard base product code once the software has been sold.
Professional services and education revenue increased by 6.1% in the three
months ended March 31, 2004 compared to the same period in 2003. Increases
in professional services revenue growth typically lags behind software
revenue growth by 90 to 180 days as our customers implement their content
management projects that include consulting and training services.
Furthermore, professional services revenue is dependent on the level and
the nature of software sales in prior periods. Professional services
revenue grow more rapidly when new customers purchase new systems for a
large-scale implementation - as opposed to existing customers purchasing
add-on licenses for installed systems. A significant majority of our
software sales during the last twelve months have been to existing
customers. We believe we will experience a moderate, but steady improvement
in professional services and education revenue during the balance 2004
based on the software revenue trends we experienced during the last half of
2003 and the first quarter of 2004.
Cost of Revenue
Cost of Revenue by Reporting Segment. The following table sets forth
total cost of revenue by reporting segment and as a percentage of revenue
by reporting segment for the periods indicated:
Cost of Revenue by Reporting Segment
(In thousands)
% Increase/
Three months ending March 31, 2004 2003 (Decrease)
Software $ 3,523 $ 3,008 17.1%
Customer Support 10,292 10,570 (2.6%)
Professional Services and Education 10,838 11,081 (2.2%)
Total Cost of Revenue $ 24,653 $ 24,659 0%
Software 8.5% 8.5% 0%
Customer Support 22.7% 26.8% (4.1%)
Professional Services and Education 84.2% 91.3% (7.1%)
Total Cost of Revenue as a % of Revenue 24.8% 28.3% (3.5%)
24
Software. Cost of software revenue includes royalties paid to third
parties for technology embedded in our products to enhance features and
functionality, amortization of acquired technology, media costs, and the
cost to manufacture and distribute software. The cost of software revenue
as a percent of software revenue was unchanged in the three months ended
March 31, 2004 compared to the same period in 2003. The increase in
absolute cost of software revenue during this period is primarily due to an
increase in royalty costs based on higher revenues and a higher mix of
products sold that contain third party software products. This cost will
fluctuate period to period based on the mix of products sold. The
amortization of acquired technology resulting from the Shana acquisition in
April 2003 is another cost element that has increased the absolute cost of
software revenue. Going forward we anticipate cost of software revenue to
increase slightly to approximately 10% of software revenue as we continue
to integrate third-party technology with our products.
Customer Support. Cost of customer support revenue includes the cost
of customer support personnel, facility and technology infrastructure
expenses in our call centers, supplies and spare parts. The cost of
customer support revenue in absolute dollars was relatively unchanged year
over year. However, the cost of customer support revenue as a percent of
customer support revenue decreased by 4.1% in the first three months ended
March 31, 2004 compared to the same period in 2003. This reduction in cost
of customer support revenue is attributable to efficiency improvements in
the delivery of technical support, which allows for increased revenue
without a comparable increase in expense. We expect the cost of customer
support revenue to average approximately 25% of customer support revenue
for the near future.
Professional Services and Education. Cost of professional services and
education revenue consists primarily of the costs of professional services
personnel, training personnel, and third-party contractors. The cost of
professional services and education revenue, as a percent of professional
services and education revenue, decreased by 7.1% in the first three months
ended March 31, 2004 as compared to the same period in 2003. A reduced
employee headcount and lower variable employee compensation contributed to
maintaining reduced operating costs on slightly increased professional
services and education revenue during the period. 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 internal and
external service providers.
Operating Expenses
Total Operating Expenses. The following table sets forth total
operating expense by function and as a percentage of total revenue for the
periods indicated:
Operating Expenses
% Increase/
Three months ending March 31, 2004 2003 (Decrease)
Research and Development $ 20,102 $ 19,302 4.1%
Marketing and Sales 41,561 34,399 20.8%
General and Administrative 9,233 7,826 18.0%
Total Operating Expenses $ 70,896 $ 61,527 15.2%
Research and Development 20.2% 22.2% (2.0%)
Marketing and Sales 41.8% 39.5% 2.3%
General and Administrative 9.3% 9.0% .3%
Operating Expense as a % of Revenue 71.3% 70.7% .6%
25
Research and Development. Our research and development efforts are focused
on enhancing and maintaining our Enterprise Content Management capabilities
within the FileNet P8 product line. These efforts focus on existing products and
developing additional capabilities for our FileNet P8 platform and suites such
as Business Process Management, Web Content Management, Records Management, Team
Collaboration and other capabilities.
Our research and development expense consists primarily of personnel costs
for software developers; third party contracted development efforts and related
facilities costs. Research and development expense increased by 4.1% in the
three months ended March 31, 2004 compared to the same period in 2003. The
number of research and development personnel was 452 on March 31, 2004 compared
to 455 on March 31, 2003.
The majority of the $800,000 increase in research and development expenses
during the three months ended March 31, 2004 compared to the same period in 2003
is attributable to increased offshore development expense partially offset by
reduced internal employee expense. We currently have 91 contractors in India
developing software compared to 35 contractors one year ago. We believe we will
be able to lower our per-developer cost through the use of offshore resources,
however in the near term, some duplicate expenses will be incurred as our
development programs are transitioned to these offshore development resources.
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 19% of revenue
for 2004.
Selling and Marketing. We sell our products through a direct sales force
and our indirect channel sales partners. The majority of our selling and
marketing expense is salaries, benefits, sales commissions and other expenses
related to the direct and indirect sales force, and personnel cost for marketing
and market development programs. Selling and marketing expense increased by
20.8% or $7.2 million, in the three months ended March 31, 2004 compared to the
same period in 2003. Approximately $5.2 million of the increase is attributable
to higher salaries and benefits along with higher variable compensation
generated by higher revenue. The total number of sales and marketing personnel
increased by 25 employees, at a higher salary mix, from 557 to 582 when
comparing March 31, 2004 to the same period in 2003. We expect selling and
marketing expense to remain at approximately 41% of revenue in the near-term.
General and Administrative. Our general and administrative expense consists
primarily of salaries, benefits, and other expenses related to personnel costs
for finance, information technology, legal, human resources and general
management and the cost of outside professional services. General and
administrative expense increased 18% in the three months ended March 31, 2004
compared to the same period in 2003. The increase in general and administrative
expense of $1.4 million between the comparative periods reflects higher salary
costs due to increased headcount as well as increased legal and accounting fees
associated with recently mandated compliance regulations and cancellation of a
facility lease. We expect general and administrative expense to remain at
approximately 9% of revenue in the near-term.
Interest, Other Income and Expenses, 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 and interest expense. Other income, net of other expenses, was $927,000
for the three months ended March 31, 2004 compared to $1.0 million during the
same period in 2003. The weighted average interest rate earned on cash, cash
equivalents and investments was 1.36% during the three months ended March 31,
2004 compared to 1.48% for the same period in 2003.
26
Provision for Income Taxes. Our combined federal, state and foreign annual
effective tax rate for the three months ended March 31, 2004 is 18% compared to
30% for the comparable period in 2003. 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 and
reductions in our deferred tax valuation allowance. The decreased tax rate in
the three months ended March 31, 2004 was primarily due to the mix of income
earned by our domestic operations versus the foreign subsidiaries, and the
partial release of the valuation allowance against income from domestic
operations as net operating loss carryforwards were utilized.
Liquidity and Capital Resources
At March 31, 2004, combined cash, cash equivalents and investments totaled
$291.0 million, an increase of $42.7 million from December 31, 2003.
Cash provided by operating activities during the three months ended March
31, 2004 totaled $35.2 million and resulted primarily from: an increase in
unearned maintenance revenue related to prepaid maintenance contracts of $25.9
million; a decrease in accounts receivable of $2.9 million; depreciation and
amortization expense of $4.3 million; and net income of $4.0 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.
Cash provided by financing activities totaled $10.2 million and was a
result of proceeds received from the exercise of employee stock options and
stock purchases under the employee stock purchase plan. Cash used in investing
activities was $9.8 million for the purchase of marketable securities.
Contractual cash obligations of significance include non-cancelable
operating leases for our corporate offices, sales offices, development and
manufacturing facilities and other equipment, some of which have renewal options
and generally provide for escalation of the annual rental amount. (See Note No.
11 to the Notes to Unaudited Condensed Consolidated Financial Statements for
additional details.)
We believe that our present cash balances together with internally
generated funds 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 (expense) 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 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.
27
New Accounting Pronouncements
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. With respect to variable interest entities created
before January 31, 2003, in December 2003 the FASB issued FIN 46R, which, among
other things, revised the implementation date to the first fiscal years or
interim periods ending after March 15, 2004, with the exception of Special
Purpose Entities ("SPE"). The consolidated requirements apply to all SPE's in
the first fiscal year or interim period ending after December 15, 2003. We have
determined that we do not have any SPE's to which these interpretations apply;
and have adopted FIN 46R in the first quarter of 2004. The adoption of FIN 46R
did not have a material impact on our consolidated financial statements.
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.
In November 2003, the FASB issued FASB Staff Position (FSP) No. 150-3 which
deferred the effective dates for applying certain provisions of SFAS No. 150
related to mandatorily redeemable financial instruments of certain nonpublic
entities and certain mandatorily redeemable noncontrolling interests for public
and nonpublic entities.
For public entities, SFAS No. 150 is effective for mandatorily redeemable
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.
For mandatorily redeemable noncontrolling interests that would not have to
be classified as liabilities by a subsidiary under the exception in paragraph 9
of SFAS No. 150, but would be classified as liabilities by the parent, the
classification and measurement provisions of SFAS No. 150 are deferred
indefinitely. For other mandatorily redeemable noncontrolling interests that
were issued before November 5, 2003, the measurement provisions of SFAS No. 150
are deferred indefinitely. For those instruments, the measurement guidance for
redeemable shares and noncontrolling interests in other literature shall apply
during the deferral period.
28
SFAS No. 150 is to be implemented by reporting the cumulative effect of a
change in accounting principle. We do not have financial instruments with
characteristics of both debt and equity and therefore, the adoption of SFAS No.
150 did not have a material impact on our consolidated financial statements.
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 annual 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 IT spending trends;
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 sales and price competition;
o the timing of new software introductions and software enhancements by
us and our competitors; or,
o seasonality in technology purchases.
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.
29
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 with the consolidation of the
ECM market. 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. In 2003, EMC
Corporation, a data storage hardware company, acquired one of our
competitors, Documentum. Other large, well-capitalized hardware firms
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 its IBM
Global Services business unit. Our customers may view this type of
vertical integration of software development and system integration
capabilities as a key competitive advantage.
Our inability to license future releases of 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.
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. This contribution percentage will fluctuate quarter to quarter.
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.
30
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,
resulting in reduced revenue. 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 must execute on our strategy of offering a unified platform and
framework for Enterprise Content Management that gains customer acceptance or
our revenue may suffer. This strategy may require us to develop and maintain
relations with technology partners. If we fail to successfully execute on our
integrated product solution strategy or if we fail to maintain or establish
relationships with technology partners, or if release dates of any future
products or enhancements are delayed, or if these products or enhancements fail
to achieve market acceptance when released, our business operating results and
financial condition could be materially harmed. In the past, we have experienced
delays in the release dates of enhancements and new releases to our products and
we cannot assure that we will not experience significant future delays in
product introduction. From time to time, either our competitors or we may
announce new software products, capabilities or technologies that have the
potential to replace or shorten the life cycles of our existing software
products. We cannot assure that announcements of currently planned or other new
software products will not cause customers to delay their purchasing decisions
in anticipation of such software products, and such delays could have a material
adverse effect on our business and operating results.
We must develop and sell new products to keep up with rapid technological
change in order to achieve future revenue growth and profitability. The market
for our software and services is characterized by rapid technological
developments, evolving industry standards, changes in customer requirements and
frequent new product introductions and enhancements. Our ability to continue to
sell products will be dependent upon our ability to continue to enhance our
existing software and services offerings, develop and introduce, in a timely
manner, new software products incorporating technological advances and respond
to customer requirements. For example, two new products that we predict will
address new markets will be made available in the second half of this year. Team
Collaboration Manager suite that enables customers to initiate collaborative
tasks at any point in a process and Records Manager Suite that systematically
applies record management principles to content are both expected to be
available in the second half of this year. We may not be successful in
developing, marketing and releasing these 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. 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.
31
We are dependent upon customers concentrated in a small number of
industries. A significant decline in one of those industries could result in
reduced revenue. 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 we could fail to
meet our revenue objectives. 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. We
expect to invest approximately 20% of annual revenue in research and development
efforts in the near term. 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 due to revenue recognition rules that require new products
be tested in the market to validate pricing and acceptance.
We are increasing our use of third party software developers and may have
difficulty enforcing or managing our agreements with them, which could delay new
product introductions and reduce revenue. To help manage costs, we have
contracted with third party software development companies overseas,
particularly in India, where labor costs are lower, to perform an increasing
portion of our software development and software localization 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
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.
32
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.
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.
33
We may, from time to time, be notified that we are infringing certain
patent or intellectual property rights of others, which could expose us to
litigation and other costs. 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 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
timeframe, while others do not have minimum purchase requirements and/or are
cancelable at will. We cannot assure that these companies will not reduce or
discontinue their relationships with, or support of, FileNet and our products.
Our failure to maintain these relationships, or to establish new relationships
in the future, could harm our business, financial condition and results of
operations.
We currently license certain software from third parties, including
software that is integrated with internally developed software and used in our
products to perform key functions. We would be unable to sell theses products if
we do not maintain these licenses, which would result in reduced revenue. 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.
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;
34
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 76 days; therefore, the movement of interest rates should not have a material
impact on our balance sheet or income statement.
At any time, a significant increase/decrease in interest rates will have an
impact on the fair market value and interest earnings of our investment
portfolio. We do not currently hedge this interest rate exposure. We have
performed a sensitivity analysis as of March 31, 2004 and 2003, using a modeling
technique that measures the change in the fair values arising from a
hypothetical 50 basis points and 100 basis points adverse movement in the levels
of interest rates across the entire yield curve, which are representative of
historical movements in the Federal Funds Rate with all other variables held
constant. The analysis covers our investment and is based on the
weighted-average maturity of our investments as of March 31, 2004 and 2003. 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 $223,000 at March 31, 2004 and
approximately $286,000 at March 31, 2003. 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 $446,000 at March 31, 2004 and
approximately $573,000 at March 31, 2003.
35
The following table provides information about our cash equivalents and our
investment portfolio at March 31, 2004 (dollars in thousands):
Estimated Fair
(In thousands Cost Value
Debt Securities
Due in one year or less:
Short-term munis-taxable $ 6,286 $ 6,291
Corporate 13,358 13,357
Governments/Agencies 14,022 14,026
Total due in one year 33,666 33,674
Due in one to three years:
Corporate 2,157 2,155
Government/Agencies 16,821 16,828
Total due in three years 18,978 18,983
Grand total $ 52,644 $ 52,657
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 March 31, 2004, we
had forward foreign exchange contracts outstanding totaling approximately $5.1
million in ten currencies. These contracts were opened on the last business day
of the quarter and mature within three months.
Cumulative other comprehensive income decreased by $898,000 for the three
months ended March 31, 2004 due to unrealized foreign currency translation
losses resulting from the weakening of the Euro against the U.S. dollar during
the period.
Management believes that inflation has not had a significant impact on the
prices of our products, the cost of our materials, or our operating results for
the three months ended March 31, 2004.
36
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 March 31, 2004, 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 11 to Consolidated Financial Statements.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
The list of exhibits contained in the accompanying Index to Exhibits
is herein incorporated by reference.
(b) Reports on Form 8-K
On April 22, 2004 FileNet furnished a report on Form 8-K under Item 12
announcing its financial results for the quarter ended March 31, 2004.
37
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FILENET CORPORATION
May 7, 2004 By: /s/ Sam M. Auriemma
Date Sam M. Auriemma, Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer, Authorized Signatory)
38
Index to Exhibits
Exhibit No. Exhibit Description
3.1* Restated Certificate of Incorporation, as amended (filed as Exhibit 3.1 to Registrant's Form S-4
filed on January 26, 1996; Registration No. 333-00676).
3.1.1* Certificate of Amendment of Restated Certificate of Incorporation (filed as Exhibit 3.1.1 to
Registrant's Form S-4 filed on January 26, 1996, Registration No. 333-00676).
3.2* Bylaws (filed as Exhibit 3.2 of the Registrant's registration statement on Form S-1, 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, 2001 to Rights Agreement dated as of November 4, 1988 between
FileNet Corporation and Equiserve Trust Company, N.A., successors to BANKBOSTON, N.A. (filed as
Exhibit 4.4 to Registrant's Annual Report on Form 10-K filed for the year ended December 31, 2001).
10.2*+ Amended and Restated 1995 Stock Option Plan of FileNet (filed as Exhibit 99.1 to Registrant's
registration statement on Form S-8 filed on October 15, 2001; Registration No. 333-71598).
10.2.1*+ 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).
10.6*+ 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).
10.10*+ Written Compensation Agreement and Non-Statutory Stock Option Agreement (with Notice of Grant of
Stock Option and Special Addendum) between Registrant and Mr. Sam Auriemma (filed as Exhibit 99.1 and
99.2 to Registrant's registration statement on Form S-8, filed on April 20, 2001; Registration No.
333-59274).
10.11* Asset Purchase Agreement dated April 2, 2002 by and between 3565 Acquisition Corporation and eGrail,
Inc. (filed as Exhibit 10.1 to Registrant's Current Report on Form 8-K, filed on April 12, 2002).
10.12*+ Secured Promissory Note between Registrant and Mr. Lee D. Roberts dated June 14, 2002 (filed as
Exhibit 10.12 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
39
10.13*+ Option Exchange Agreement between Registrant and Mr. Ron L. Ercanbrack, dated May 22, 2002, together
with form of Incentive Stock Option Agreement and Grant Notice (filed as Exhibit 10.13 to
Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
10.14*+ The 2002 Incentive Award Plan, as approved by stockholders at the Registrant's Annual Meeting on May
22, 2002, together with the forms of Incentive Option Agreement and Non-Qualified Stock Option
Agreement for Independent Directors (filed as Exhibit 10.14 to Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 2002).
10.14.1*+ Amended Form of 2002 Incentive Award Plan Incentive Option Agreement with Notice of Grant of Stock
Option (filed as Exhibit 10.14.1 to Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2002).
10.14.2*+ Amended Form of 2002 Incentive Award Plan Non-Qualified Stock Option Agreement for Independent
Directors with Notice of Grant of Stock Option (filed as Exhibit 10.14.2 to Registrant's Quarterly
Report on Form 10-Q for the quarter ended 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 10.16 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.
10.21 Form of Restricted Stock Agreement between Registrant and certain Executive Officers (filed as Exhibit
10.21 to Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2004).
14* Code of Conduct (filed as Exhibit 14 to Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act
32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act
32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act
.
* 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.
40
Exhibit 10.21
RESTRICTED STOCK AGREEMENT
THIS RESTRICTED STOCK AGREEMENT (the "Agreement") is made by and between
FileNet Corporation, a Delaware corporation (the "Company"), and
_______________, ("Holder"), effective as of ________________, 2004 ("Grant
Date").
WHEREAS, the Company wishes to award to Holder shares of Common Stock
subject to certain Restrictions (as defined below), which award is granted under
the 2002 Incentive Award Plan of FileNet Corporation, as amended and/or restated
from time to time (the "Plan"); and
WHEREAS, the Committee appointed to administer the Plan has determined that
it would be to the advantage and best interest of the Company and its
stockholders to issue the Restricted Shares provided for herein to Holder as an
inducement to enter into or remain in the service of the Company and as an
incentive for increased efforts during such service.
NOW, THEREFORE, in consideration of past services and of the mutual
covenants herein contained, and such other good and valuable consideration,
receipt of which is hereby acknowledged, the parties hereto do hereby agree as
follows:
ARTICLE I.
DEFINITIONS
Whenever the following terms are used in this Agreement they shall have the
meaning specified below unless the context clearly indicates to the contrary.
The masculine pronoun shall include the feminine and neuter, and the singular
the plural, where the context so indicates. All capitalized terms used herein
without definition shall have the meaning ascribed to such terms in the Plan.
Section 1.1 - Cause
"Cause" shall have the meaning set forth in the Holder's CIC Letter
Agreement.
Section 1.2 - Change in Control
"Change in Control" shall have the meaning set forth in the Holder's CIC
Letter Agreement.
Section 1.3 - CIC Letter Agreement
"CIC Letter Agreement" shall mean that certain letter agreement between
Holder and the Company dated May 15, 2003 pursuant to which the Company has
agreed to provide Holder with certain payments and benefits following a Change
in Control, as the same agreement may be amended, supplemented or restated from
time to time.
Section 1.4 - Good Reason
"Good Reason" shall have the meaning set forth in the Holder's CIC Letter
Agreement.
Section 1.5 - Involuntary Termination
"Involuntary Termination" shall have the meaning set forth in the Holder's
CIC Letter Agreement.
Section 1.6 - Restricted Shares
"Restricted Shares" shall mean the shares of Common Stock granted under
this Agreement that are subject to Restrictions.
Section 1.7 - Restrictions
"Restrictions" shall mean the vesting requirements set forth in Sections
3.1 and 3.4, the forfeiture rights set forth in Section 3.2 and the restrictions
on sale or other transfer set forth in Section 3.3.
Section 1.8 - Termination of Service
"Termination of Service" shall mean termination of Holder's employment with
the Company (and any of its subsidiaries) for any reason, or termination of
Holder's service with the Company (and any of its subsidiaries) as a consultant
for any reason. The Committee, in its absolute discretion, shall determine the
effect of all matters and questions relating to a Termination of Service,
including without limitation whether a Termination of Service has occurred, and
whether the Termination of Service was for Cause, for Good Reason or was an
Involuntary Termination.
ARTICLE II.
ISSUANCE OF RESTRICTED SHARES
Section 2.1 - Issuance of Restricted Shares
In consideration of the past services rendered to the Company and for other
good and valuable consideration, on the Grant Date the Company agrees to and
does hereby issue to Holder ___________ (____) Restricted Shares (i.e., shares
of Common Stock subject to the Restrictions and other conditions set forth in
this Agreement).
Section 2.2 - No Right to Continued Employment
Nothing in this Agreement or in the Plan shall confer upon Holder any right
to continue in the employ of the Company, or as a consultant to the Company, or
shall interfere with or restrict in any way the rights of the Company, which are
hereby expressly reserved, to discharge Holder at any time for any reason
Page 2
whatsoever, with or without cause, except to the extent expressly provided
otherwise in writing.
Section 2.3 - Adjustments in Restricted Shares
The Committee may adjust the Restricted Shares in accordance with the
provisions of Section 11 of the Plan.
ARTICLE III.
RESTRICTIONS
Section 3.1 - Vesting and Lapse of Restrictions
(a) Subject to Section 3.4 concerning accelerated vesting under specified
circumstances, all unvested Restricted Shares shall vest in full and all
Restrictions shall lapse on December 31, 2008, conditioned only upon Holder's
continued employment or service with the Company through such date.
(b) By resolution, the Committee may, on such terms and conditions as it
deems appropriate, remove any or all of the Restrictions (including without
limitation, the Committee may accelerate vesting) at any time or from time to
time.
Section 3.2 Forfeiture of Restricted Shares - Termination of Service
Except as provided in Section 3.4(b), upon a Termination of Service of
Holder, all Restricted Shares outstanding as of such Termination of Service
shall be automatically forfeited and cancelled effective as of such Termination
of Service, without payment to Holder, and Holder shall not have any further
rights or entitlements to the Restricted Shares or under this Agreement.
Section 3.3 - Restriction on Transfer of Restricted Shares
Holder shall not sell, exchange, transfer, alienate, hypothecate, pledge,
encumber or assign any Restricted Shares (or any rights with respect thereto),
that have not vested and have not had their Restrictions lapse pursuant to
Section 3.1 or 3.4 hereof. Neither the Restricted Shares nor any interest or
right therein or part thereof shall be liable for the debts, contracts, or
engagements of Holder 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.
Section 3.4 - Acceleration of Vesting and Lapse of Restrictions
(a) The Restricted Shares shall vest and the Restrictions thereon shall
lapse in such amount, based upon the Company's annual performance compared to
certain performance criteria targets, as set forth below. For purposes of this
Agreement, "performance criteria" shall mean the Company's annual operating
Page 3
income divided by the Company's annual revenue, for each of fiscal 2004, 2005,
2006 and 2007, determined in accordance with generally acceptable accounting
principals consistently applied.
Fiscal Year Performance Criteria Target Percent Vesting
2004 8% or greater 33.3% of original grant
2005 10% or greater 33.3% of original grant
2006 12% or greater 33.3% of original grant
2007 12% or greater 33.3% of original grant
Within 90 days following the end of each fiscal year, commencing with the
fiscal year ending December 31, 2004 and continuing until the earlier of the
fiscal year ending December 31, 2007 or the earlier full vesting of the
Restricted Shares, the Chief Financial Officer of the Company will determine the
Company's actual performance under the performance criteria. Within such 90-day
period and on a date that is within the Company's open window for trading in
Company securities, the Committee will review the CFO's determinations and
certify in writing the extent of the Company's actual performance compared to
the performance criteria targets. In the event (i) the Company's actual
performance under the performance criteria equal or exceed the applicable
performance criteria target specified above for such fiscal period and (ii) the
Holder was employed by the Company as of the last day of the fiscal period for
which such performance criteria was measured, then 33% of the original number of
Restricted Shares (rounded up to the nearest whole number of shares,) or if less
the remaining unvested shares, shall vest; the Committee shall certify the
number of Restricted Shares, if any, that so vest. The date upon which the
Committee makes this certification is referred to as the "Early Vesting Date."
Upon the Early Vesting Date, and provided that the Holder has continued to be
employed by the Company through and including the end of the fiscal year for
which such performance criteria targets were met, the Holder will have a right
to the number of shares that so vested, as certified by the Committee, free and
clear of any Restrictions. In no event, however, will the Holder vest in more
than the original number of Restricted Shares issued hereunder and set forth in
Section 1.6.
(b) In the event of a Termination of Service by reason of an Involuntary
Termination or Holder's resignation for Good Reason that occurs within eighteen
(18) months following a Change in Control, then all unvested Restricted Shares
shall vest in full and the Restrictions thereon shall lapse in full effective
upon such Termination of Service, and Section 3.2 shall be not be applicable.
Section 3.5 - Escrow
(a) The Secretary of the Company or any other person designated by the
Committee as escrow agent shall retain physical custody of any certificates
representing the Restricted Shares until and to the extent (i) such Restricted
Shares have vested and all Restrictions have been removed or lapsed as to such
shares under this Agreement, or (ii) such shares have been forfeited or
cancelled pursuant to Section 3.2. To ensure the delivery of Holder's Restricted
Shares upon forfeiture, Holder hereby appoints the Secretary of the Company or
any other designated escrow agent as Holder's attorney-in-fact to assign and
Page 4
transfer unto the Company (or such designee), such Restricted Shares, if any,
pursuant to Section 3.2.
(b) The Secretary, or other escrow agent, shall not be liable for any act
he or she may do or omit to do with respect to holding the Restricted Shares in
escrow and while acting in good faith and in the exercise of his or her
judgment.
Section 3.6 - Legend
The share certificate or other evidence of the Restricted Shares issued
hereunder may at the discretion of the Company be endorsed with or subject to
the following legend (in addition to any legend required under applicable state
securities laws):
THE SECURITIES REPRESENTED BY THIS CERTIFICATE ARE SUBJECT TO CERTAIN
RESTRICTIONS ON TRANSFER AND FORFEITURES AS SET FORTH IN A RESTRICTED STOCK
AGREEMENT BETWEEN THE COMPANY AND THE STOCKHOLDER, A COPY OF WHICH IS ON
FILE WITH THE SECRETARY OF THE ISSUER, AND SUCH SHARES MAY NOT BE, DIRECTLY
OR INDIRECTLY, OFFERED, TRANSFERRED, SOLD, ASSIGNED, PLEDGED, HYPOTHECATED
OR OTHERWISE DISPOSED OF UNDER ANY CIRCUMSTANCES, EXCEPT PURSUANT TO THE
PROVISIONS OF SUCH AGREEMENT.
Section 3.7 - Vested Shares without Restrictions
(a) As and to the extent the Restricted Shares vest in accordance with the
terms of this Agreement, the Restrictions on such shares shall lapse and, and
subject to compliance with Section 3.7(b), such vested shares of Common Stock
shall be delivered to the Holder or for the benefit of his or her account
without the legend referenced in Section 3.6. Such vested shares shall cease to
be considered Restricted Shares subject to the terms and conditions of this
Agreement, and shall be shares of Common Stock of the Company free of all
Restrictions.
(b) Notwithstanding the foregoing, vested shares shall not be delivered to
the Holder or for the benefit of or to his account unless and until the Holder
shall have paid to the Company in cash or made provisions for payment through
withholding against income, the full amount of all federal and state (or
applicable foreign) withholding or other employment taxes applicable to the
taxable income of the Holder resulting from the grant of the Restricted Shares
or the lapse or removal of the Restrictions.
Section 3.8 - Restrictions on New Shares and Distributions
In the event of any dividend or other distribution (including ordinary cash
dividends, and whether in the form of Common Stock, other securities, or other
property), recapitalization, reclassification, stock split, reverse stock split,
reorganization, merger, consolidation, split-off, spin-off, combination,
purchase, liquidation, dissolution, or sale, transfer, exchange or other
disposition of all or substantially all of the assets of the Company, or
exchange of Common Stock or other securities of the Company, or issuance of
warrants or other rights to purchase Common Stock or other securities of the
Company, or other similar transaction or event, is paid, issued, exchanged or
Page 5
distributed in respect of Restricted Shares, such new or additional or different
shares or securities or property (including cash) which are attributable to
Holder in his capacity as the owner of the Restricted Shares, shall be
considered to be Restricted Shares and shall be subject to all of the
Restrictions, unless the Committee shall, in its discretion, otherwise provide.
ARTICLE IV.
MISCELLANEOUS
Section 4.1 - Administration
The Committee shall have the power to interpret the Plan and this Agreement
and to adopt such rules for the administration, interpretation and application
of the Plan as are consistent therewith and to interpret, amend 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 Holder, 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 Plan or the Restricted Shares. 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 the Plan and 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 4.2 - Conditions to Issuance of Stock
The Restricted Shares may be either previously authorized but unissued
shares or issued shares which have then been reacquired by the Company. Such
shares shall be fully paid and nonassessable. The Company shall not be required
to issue or deliver any shares of stock pursuant to this Agreement prior to
fulfillment of all of the following conditions:
(i) The admission of such shares to listing on all stock exchanges on
which such class of stock is then listed, if applicable; and
(ii) The completion of any registration or other qualification of such
shares under any state or federal law or under rulings or regulations
of the Securities and Exchange Commission or of any other governmental
regulatory body, if applicable, or the receipt of further
representations from Holder as to investment intent or completion of
other actions necessary to perfect exemptions, as the Committee shall,
in its absolute discretion, deem necessary or advisable; and
(iii) 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
Page 6
(iv) The lapse of such reasonable period of time as the Committee may from
time to time establish for reasons of administrative convenience; and
(v) The receipt by the Company of payment of any applicable withholding
tax.
Section 4.3 - Rights as Stockholder
Holder shall have all the rights of a stockholder with respect to the
Restricted Shares, including the right to vote and receive all dividends or
other distributions paid or made with respect to the Restricted Shares, subject
to Section 3.8; provided, however, that in the discretion of the Committee, any
extraordinary distributions with respect to the Common Stock may be released
from the Restrictions.
Section 4.4 - Withholding Tax
Holder agrees that in the event the issuance of the Restricted Shares or
the expiration or removal of Restrictions thereon results in the Holder's
realization of income which for federal, state or local income tax purposes is,
in the opinion for the Company, subject to withholding of tax at source by the
Company, the Holder will pay to the Company an amount equal to such withholding
tax or the Company may withhold such amount from the Holder's salary or from
dividends deposited with the Company with respect to the Restricted Stock.
Section 4.5 - Section 83(b) Election
If the Holder makes an election under Section 83(b) of the Internal Revenue
Code of 1986, as amended (the "Code") to be taxed with respect to all or any
portion of the Restricted Shares as of the date of issuance of the Restricted
Shares rather than as of the date or dates upon which the Holder would otherwise
be taxable under Section 83(a) of the Code, the Holder shall deliver a copy of
such election to the Company promptly after filing such election with the
Internal Revenue Service. Section 83(b) elections must be filed with the
Internal Revenue Service within 30 days following the Grant Date.
Section 4.6 - Notices
Any notice to be given by Holder under the terms of this Agreement shall be
addressed to the Secretary or his or her office. Any notice to be given to
Holder shall be addressed to him at the address given beneath his signature
hereto. By a notice given pursuant to this Section, either party may hereafter
designate a different address for notices to be given to him. Any notice which
is required to be given to Holder shall, if Holder is then deceased, be given to
Holder's personal representative if such representative has previously informed
the Company of his or her status and address by written notice under this
Section. Any notice shall be deemed duly given when enclosed in a properly
sealed envelope addressed as aforesaid, deposited (with postage prepaid) in a
post office or branch post office regularly maintained by the United States
Postal Service or when delivered to a courier that guarantees overnight
delivery.
Page 7
Section 4.7 - Titles
Titles are provided herein for convenience only and are not to serve as a
basis for interpretation or construction of this Agreement.
Section 4.8 - Construction
This Agreement shall be administered, interpreted and enforced under the
internal laws of the state of California. The terms of any change in control,
employment or severance agreement, to the extent such other agreement provides
benefits that are in addition to or greater than those provided in this
Agreement, shall supersede and control over the terms of this Agreement.
Section 4.9 - Conformity to Securities Laws
Holder acknowledges that the Plan and this Agreement are intended to
conform to the extent necessary with all provisions of all applicable federal
and state laws, rules and regulations and to such approvals by any listing,
regulatory or other governmental authority as may, in the opinion of counsel for
the Company, be necessary or advisable in connection therewith. Notwithstanding
anything herein to the contrary, the Plan shall be administered, and the
Restricted Shares is granted, only in such a manner as to conform to such laws,
rules and regulations. To the extent permitted by applicable law, the Plan, this
Agreement and the Restricted Shares shall be deemed amended to the extent
necessary to conform to such laws, rules and regulations.
Section 4.10 - Amendments
This Agreement and the Plan may be amended without the consent of Holder
provided that such amendment would not alter, terminate, impair or adversely
affect any rights of Holder under this Agreement.
[Signature Page Follows]
Page 8
IN WITNESS WHEREOF, this Agreement has been executed and delivered by the
parties hereto.
FILENET CORPORATION,
a Delaware corporation
By___________________________________
Title________________________________
HOLDER
_____________________________________
(Name of Holder)
_____________________________________
Address
_____________________________________
City, States Zip
Holder's Taxpayer Identification Number: ________________________
Page 9
FileNet Corporation
R E S T R I C T E D S T O C K A W A R D S
Name Grant Date Shares
Auriemma, Sam M. 3-9-04 15,000
Christian, Martyn 3-9-04 10,000
Ercanbrack, Ron L 3-9-04 15,000
Roberts, Lee D. 3-9-04 30,000
Zihlmann, Franz X. 3-9-04 10,000
Page 10
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: May 7, 2004
/s/ Lee D. Roberts .
Lee D. Roberts
Chief Executive Officer
1
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: May 7, 2004
/s/ Sam M. Auriemma .
Sam M. Auriemma
Chief Financial Officer
2
Exhibit 32.1
Certification of Chief Executive Officer
Certification Pursuant To 18 U.S.C. Section 1350,
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 March 31, 2004 (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: May 7, 2004
/s/ Lee D. Roberts .
Lee D. Roberts
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
1
Exhibit 32.2
Certification of Chief Financial Officer
Certification Pursuant To 18 U.S.C. Section 1350,
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 March 31, 2004 (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: May 7, 2004
/s/ Sam M. Auriemma .
Sam M. Auriemma
Senior Vice President and
Chief Financial Officer
(Principal Financial Officer)
2