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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 June 30, 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 1934:
Yes |X| No |_|
As of August 5, 2004, there were 39,424,953 shares of the Registrant's common stock
outstanding.
FILENET CORPORATION
Index
Page
Number
PART I. FINANCIAL INFORMATION.
Item 1. Unaudited Condensed Consolidated Financial Statements ........ 3
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations .................................. 18
Item 3. Quantitative and Qualitative Disclosures about Market Risk..... 37
Item 4. Controls and Procedures........................................ 39
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................. 39
Item 4. Submission of Matters to a Vote of Security Holders............ 39
Item 6. Exhibits and Reports on Form 8-K............................... 40
SIGNATURE ............................................................... 41
INDEX TO EXHIBITS............................................................. 42
2
PART I. FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
FILENET CORPORATION
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
June 30, December 31,
2004 2003
ASSETS
Current assets:
Cash and cash equivalents $ 224,172 $ 203,305
Short-term investments available for sale 57,790 32,286
Accounts receivable, net 33,821 38,096
Prepaid expenses and other current assets 12,879 13,174
Deferred income taxes 3,551 3,551
Total current assets 332,213 290,412
Property, net 25,597 26,922
Long-term investments available for sale 17,544 12,672
Goodwill 25,561 26,170
Intangible assets, net 6,679 7,979
Deferred income taxes 23,231 23,001
Other assets 3,260 4,692
Total assets $ 434,085 $ 391,848
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 11,526 $ 11,006
Accrued compensation and benefits 23,456 27,648
Customer deposits and advances 6,742 5,217
Unearned maintenance revenue 60,288 40,691
Other accrued liabilities 15,455 16,524
Total current liabilities 117,467 101,086
Unearned maintenance revenue and other liabilities 3,208 1,614
Commitments and contingencies (Note 11)
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 254,743 234,025
authorized; 40,464,950 issued and 39,366,950
shares outstanding at June 30, 2004; and
38,906,640 shares issued and 37,808,640 shares
outstanding at December 31, 2003
Retained earnings 70,255 64,098
Accumulated other comprehensive income 2,979 5,592
Treasury stock, at cost; 1,098,000 shares (14,567) (14,567)
Net stockholders' equity 313,410 289,148
Total liabilities and stockholders' equity $ 434,085 $ 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 amounts)
Three Months Ended June 30, Six Months Ended June 30,
2004 2003 2004 2003 .
Revenue:
Software $ 32,677 $ 33,555 $ 74,028 $ 69,077
Customer support 47,072 41,760 92,342 81,156
Professional services and education 14,337 11,802 27,214 23,933
Total revenue 94,086 87,117 193,584 174,166
Costs:
Software 3,128 3,608 6,651 6,616
Customer support 9,942 9,968 20,234 20,539
Professional services and education 11,154 10,335 21,992 21,415
Total cost of revenue 24,224 23,911 48,877 48,570
Gross Profit 69,862 63,206 144,707 125,596
Operating expenses:
Sales and marketing 39,198 34,856 80,759 69,255
Research and development 19,703 19,680 39,805 38,982
General and administrative 9,394 8,326 18,627 16,152
Total operating expenses 68,295 62,862 139,191 124,389
Operating income 1,567 344 5,516 1,207
Other income, net 1,066 1,620 1,993 2,665
Income before income taxes 2,633 1,964 7,509 3,872
Provision for income taxes 474 512 1,352 1,084
Net income $ 2,159 $ 1,452 $ 6,157 $ 2,788
Earnings per share:
Basic $ 0.06 $ 0.04 $ 0.16 $ 0.08
Diluted $ 0.05 $ 0.04 $ 0.15 $ 0.08
Weighted-average shares outstanding:
Basic 38,854 36,173 38,567 36,057
Diluted 41,099 37,296 40,942 36,960
See accompanying notes to unaudited condensed consolidated financial statements.
4
FILENET CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
(In thousands)
Three Months Ended Six Months Ended
June 30, June 30, .
2004 2003 2004 2003 .
Net income $ 2,159 $ 1,452 $ 6,157 $ 2,788
Other comprehensive income (loss):
Foreign currency translation adjustments (1,474) 3,363 (2,388) 5,360
Unrealized losses on securities:
Unrealized holding losses (241) (28) (225) (38)
Total other comprehensive income (loss) (1,715) 3,335 (2,613) 5,322
Comprehensive income $ 444 $ 4,787 $ 3,544 $ 8,110
See accompanying notes to unaudited condensed consolidated financial statements.
5
FILENET CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Six Months Ended
June 30, .
2004 2003 .
Cash flows from operating activities:
Net income $ 6,157 $ 2,788
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 8,338 9,937
Loss on sale of property 12 28
Provision for doubtful accounts 31 26
Deferred income taxes (230) 1,731
Changes in operating assets and liabilities,
net of the effects of acquisitions:
Accounts receivable 3,848 8,918
Prepaid expenses and other current assets 252 1,212
Accounts payable 606 (1,188)
Accrued compensation and benefits (3,959) 1,633
Customer deposits and advances 1,540 (3,363)
Unearned maintenance revenue 21,536 9,965
Income taxes payable 2,127 (808)
Other $ (1,127) $ (2,628)
Net cash provided by operating activities $ 39,131 $ 28,251
Cash flows from investing activities:
Capital expenditures (6,137) (5,030)
Proceeds from sale of property 52 66
Note receivable 331 -
Cash paid for acquisition - (8,073)
Purchases of marketable securities (60,904) (60,199)
Proceeds from sales and maturities of marketable
securities 29,715 64,305
Net cash used in investing activities $ (36,943) $ (8,931)
Cash flows from financing activities:
Proceeds from issuance of common stock 20,481 4,187
Net cash provided by financing activities $ 20,481 $ 4,187
Effect of exchange rate changes on cash and cash
equivalents (1,802) 3,669
Net increase in cash and cash equivalents $ 20,867 $ 27,176
Cash and cash equivalents, beginning of year 203,305 130,154
Cash and cash equivalents, end of period $ 224,172 $ 157,330
Supplemental cash flow information:
Interest paid $ 25 $ 32
Income taxes paid/(refunded) $ (798) $ 2,638
_____________________________________
See Notes 4 and 10 for additional non-cash disclosures.
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 June 30, 2004, the
results of its operations, its comprehensive operations and its cash flows
for the three and six months ended June 30, 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. The adoption of FIN 46R in 2004 has not had 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 has not had 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 and
six months ended June 30, 2004 and 2003.
8
Three Months Ended Six Months Ended
June 30, June 30, .
(In thousands, except per share amounts) 2004 2003 2004 2003 .
Net income, as reported $ 2,159 $ 1,452 $ 6,157 $ 2,788
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards, net
of related tax effects (2,137) (2,062) (3,676) (4,101)
Pro forma net income (loss) $ 22 $ (610) $ 2,481 $ (1,313)
Earnings (loss) per share:
Basic earnings per share - as reported $ .06 $ .04 $ .16 $ .08
Basic earnings (loss) per share - pro forma .00 (.02) .07 (.04)
Diluted earnings per share - as reported .05 .04 .15 .08
Diluted earnings (loss) per share - pro forma $ .00 $ (.02) $ .06 $ (.04)
For purposes of computing proforma net income (loss), 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 estimates the 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 Six Months Ended
June 30, June 30, .
2004 2003 2004 2003 .
Expected life (in years) 5.28 5.0 5.28 5.0
Expected volatility 67% 64% 51% - 67% 66%
Risk free interest rates 3.72% 3.31% 3.40% 3.56%
Expected dividend 0% 0% 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 provided technology and experience to
expand the Company's Electronic Content Management ("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 by treating goodwill as tax deductible
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. Goodwill and indefinite life
intangibles are not amortized, but are reviewed at least annually 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 six months ended June 30, 2004:
10
.
(In thousands) Balance at Foreign Balance at
December 31, Currency June 30,
Goodwill by Reporting Segment 2003 Change 2004 .
Software $ 15,144 $ (353) $ 14,791
Customer Support 5,858 (136) 5,722
Professional Services and
Education 5,168 (120) 5,048
Total $ 26,170 $ (609) $ 25,561
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.
Intangible assets subject to amortization consist of the following:
June 30, 2004 December 31, 2003 .
(In thousands) Gross Accumulated Gross Accumulated
Intangible Assets Asset Amortization Net Asset Amortization Net .
Acquired technology and
other intangibles $ 9,700 (3,181) $ 6,519 $ 10,020 (2,272) $ 7,748
Non-compete agreements 304 (144) 160 317 (90) 227
Patents 28 (28) - 28 (24) 4
Total $ 10,032 (3,353) $ 6,679 $ 10,365 (2,386) $ 7,979
Acquired technology is being amortized over a useful life of five
years, patents with a two year life are fully armortized and non-compete
agreements are being amortized over three years. Amortization expense for
intangible assets was $513,000 for the three months ended June 30, 2004
compared to $494,000 for the comparable period in 2003. Amortization
expense for amortizing intangible assets was $1,040,000 for the six months
ended June 30, 2004 compared to $677,000 for the comparable period in 2003.
Estimated future amortization expense (excluding foreign exchange
effect) of purchased intangible assets as of June 30, 2004 is as follows:
(In thousands) .
Fiscal Year Amount .
(Remainder) 2004 $ 1,028
2005 2,024
2006 1,958
2007 1,373
2008 296
$ 6,679
11
6. EARNINGS PER SHARE
Basic earnings per share is 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 and six-month
period ended June 30, 2004 were 2,245,812 and 2,375,506 shares, compared to
1,123,000 and 903,000 for the comparable periods in 2003. The following
table sets forth the computation of basic and diluted earnings per share
for the three and six-month period ended June 30, 2004 and 2003:
Three Months Ended Six Months Ended
June 30, June 30, .
(In thousands, except per share amounts) 2004 2003 2004 2003 .
Net Income $ 2,159 $ 1,452 $ 6,157 $ 2,788
Shares used in computing 38,853 36,173 38,567 36,057
basic earnings per share
Dilutive effect of stock plans 2,246 1,123 2,376 903
Shares used in computing
diluted earnings per share 41,099 37,296 40,943 36,960
Earnings per basic share $ 0.06 $ 0.04 $ 0.16 $ 0.08
Earnings per diluted share $ 0.05 $ 0.04 $ 0.15 $ 0.08
7. ACCUMULATED OTHER COMPREHENSIVE INCOME
Accumulated other comprehensive income for the six months ended June
30, 2004 is comprised of the following:
.
Foreign Unrealized
Currency Holding Accumulated Other
Translation Loss on Comprehensive
(In thousands) Adjustment Securities Income .
Balance, December 31, 2003 $ 5,645 $ (53) $ 5,592
Six month period changes (2,388) (225) (2,613)
Balance, June 30, 2004 $ 3,257 $ (278) $ 2,979
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. There have been no new hardware sales; only spare parts
and supplies. 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, the remaining portion of the
previous 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.
13
Operating segments data for the three and six months ended June 30,
2004 and 2003 are as follows:
Three months ended Six months ended
(In thousands) June 30, June 30, .
2004 2003 2004 2003 .
Software
Revenue $ 32,677 $ 33,555 $ 74,028 $ 69,077
Operating loss (22,739) (16,220) (38,600) (29,221)
Customer Support
Revenue $ 47,072 $ 41,760 $ 92,342 $ 81,156
Operating income 22,906 17,130 42,460 31,916
Professional Services and
Education
Revenue $ 14,337 $ 11,802 $ 27,214 $ 23,933
Operating income (loss) 1400 (566) 1,656 (1,488)
Total
Revenue $ 94,086 $ 87,117 $ 193,584 $ 174,166
Operating income 1,567 344 5,516 1,207
9. STOCK OPTIONS
The following is a summary of stock option transactions regarding all
stock option plans for the three months ended June 30, 2004:
.
Weighted
Number of Average
Options Exercise Price .
Balance, March 31, 2004 7,394,641 $ 17.68
Granted (weighted-average fair value of $13.91) 161,000 27.23
Exercised (532,668) 14.22
Canceled (66,977) 19.79
Balance, June 30, 2004 6,955,996 $ 18.08
14
The following table summarizes information concerning outstanding and
exercisable stock options at June 30, 2004:
.
Options Outstanding Options Exercisable .
Weighted
Average
Remaining Weighted Average Weighted Average
Range of Exercise Number Contractual Exercise Number Exercise
Price Outstanding Life (Years) Price Exercisable Price
$ 1.39 - 9.50 806,105 3.43 $ 8.01 801,524 $ 7.99
9.75 - 12.86 1,134,584 7.38 12.35 561,575 11.99
12.97 - 14.19 1,105,559 6.93 13.47 636,666 13.54
14.39 - 18.45 1,113,864 6.91 16.90 732,553 16.90
19.53 - 25.00 1,201,436 6.03 22.84 1,082,147 22.98
25.28 - 41.84 1,594,448 8.09 27.99 482,153 28.81
$ 1.39 - 41.84 6,955,996 6.72 $ 18.08 4,296,618 $ 16.97
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 were 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 on a straight-line
basis through December 31, 2008. Recognition of expense may be accelerated
if it becomes probable that certain performance targets will be achieved
that trigger accelerated vesting of the restricted shares. Approximately
$188,407 and $233,956 of compensation expense were recognized in the three
and six-month periods ended June 30, 2004, with no acceleration.
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 June 30,
2004 were as follows:
15
(In thousands) .
2004 (remaining 6 months) $ 6,295
2005 8,514
2006 10,882
2007 9,920
2008 8,670
2009 6,322
Thereafter 5,844
Total $ 56,447
Product Warranties
The Company provides a 90-day warranty for its software products
against substantial nonconformance to the published documentation at time
of delivery. 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. A
small warranty is reserved for non-software products. 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 accrual for the six months
ended June 30, 2004 and 2003:
(In thousands) 2004 2003 .
Beginning balance at January 1 $ 479 $ 728
Additions 578 396
Deductions (693) (636)
Ending balance at June 30 $ 364 $ 488
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
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 June
30, 2004. Approximately $1.5 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.
16
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 June 30, 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 June 30, 2004, the Company had forward foreign exchange
contracts outstanding totaling approximately $1.4 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 June 30, 2004.
13. INCOME TAXES
The Company's combined federal, state and foreign annual effective tax
rate for the three months ended June 30, 2004 is 18% compared to 26% for
the comparable period in 2003. The Company's combined federal, state and
foreign annual effective tax rate for the six months ended June 30, 2004 is
18% compared to 28% 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 with lower tax rates and reductions in the domestic
deferred tax valuation allowance as net operating loss carryforwards were
utilized. The decreased tax rate in six months ended June 30, 2004 was
primarily due to the mix of income earned by domestic operations versus the
foreign subsidiaries.
The Company is continually assessing the valuation allowance related
to its deferred tax assets. As of June 30, 2004, the Company has a net tax
deferred asset of approximately $26.6 million and valuation allowance of
approximately $24.3 million. The Company 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 the Company's level of domestic profitability continue
at the current rate, it would likely remove the entire valuation allowance
later in 2004. A one-time, non-cash benefit would be realized by decreasing
tax expense (causing an increase in earnings) by approximately $7.0 million
to $9.0 million. Additionally, a non-cash increase to additional
paid-in-capital of approximately $9.0 million would be recorded.
17
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
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
two payments in December 2003 and June 2004 of approximately $294,000 and
$331,000, respectively, toward the principal loan balance of $1.9 million.
As of June 30, 2004, the outstanding balance on the secured note receivable
from Mr. Roberts is approximately $1.275 million and is included in other
assets on the consolidated balance sheet. The accrued interest balance as
of June 30, 2004 was approximately $22,000. 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
We develop, market, sell and support a software platform and framework
for Enterprise Content Management. Enterprise Content Management, or ECM,
refers to the broad range of functions used by organizations of all types,
including businesses and governmental agencies, to control and track the
information, or content, that is important to the organization's
operations, whether that information is used internally, such as sales data
or product specifications, or externally, such as content provided to
customers through a Web site. The content our software manages, commonly
called unstructured content, includes, but is not limited to: Web pages,
18
word processing documents, spreadsheets, HTML, XML, PDF, document images,
email messages and other electronic content. Our software offers customers
the ability to configure, design, build and deploy ECM solutions to meet
the needs of their particular business or organization. These solutions
allow customers to manage content throughout their organizations, automate
and streamline their business processes, and provide the broad-spectrum of
connectivity needed to support their critical and everyday decision making.
We generate revenue by selling software licenses, delivering
implementation and education services, and by providing technical support
to our customers. Software revenue consists of fees earned from the
licensing of our software products to our customers. Implementation and
education services are sold on a fee for service basis, and technical
support and software maintenance are generally provided pursuant to service
contracts of a one-year duration. Annual fees for software technical
support and software maintenance are generally received in advance and
recognized as revenue over the duration of the contract. Since our
operations are not capital or equipment intensive, and cost of goods sold
is relatively small, employee compensation is the largest single operating
expense for FileNet. Future profitability is contingent upon strategic
investments in internally developed or acquired software technologies that
are accepted by the market and result in software license and service
revenue. This investment is the key factor in achieving our long-term
business strategy.
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
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
19
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.
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 and 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 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.
20
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. Professional services are not required for the
software to function. We do not make changes to the standard software code
in the field.
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. Goodwill is recorded at cost and is not amortized. Goodwill
is tested for impairment at least annually and written down when impaired.
Effective 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 in between annual testing dates that indicate
the carrying value of goodwill may not be recoverable. We performed an
impairment analysis as of July 1, 2003 in accordance with SFAS 142. The
results indicated there was no impairment of goodwill in any of the three
reporting units. As of June 30, 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. Long-lived
assets 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.
21
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.
We are continually assessing the valuation allowance related to our
deferred tax assets. As of June 30, 2004, we have a net tax deferred asset
of approximately $26.8 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 domestic profitability continue at the current rate, 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 $7.0 million to $9.0 million.
Additionally, we would record a non-cash increase to additional
paid-in-capital of 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.
22
Results of Operations
The following table sets forth certain consolidated statements of
operations data as a percentage of total revenue for the periods indicated:
Three Months Ended Six Months Ended
June 30, June 30, .
2004 2003 2004 2003 .
Revenue:
Software 34.8% 38.5% 38.2% 39.7%
Customer support 50.0 48.0 47.7 46.6
Professional services and education 15.2 13.5 14.1 13.7
Total Revenue 100.0 100.0 100.0 100.0
Cost of revenue:
Software 3.3 4.1 3.4 3.8
Customer support 10.5 11.4 10.4 11.8
Professional services and education 11.9 11.9 11.4 12.3
Total cost of revenue 25.7 27.4 25.2 27.9
Gross Profit 74.3 72.6 74.8 72.1
Operating expenses:
Sales and marketing 41.7 40.0 41.7 39.8
Research and development 20.9 22.6 20.6 22.4
General and administrative 10.0 9.6 9.6 9.2
Total operating expenses 72.6 72.2 71.9 71.4
Operating income 1.7 .4 2.9 .7
Other income, net 1.1 1.9 1.0 1.5
Income before income tax 2.8% 2.3% 3.9% 2.2%
23
Revenue
As more fully discussed below, total revenue increased by 8.0% in the
quarter ended June 30, 2004 compared to the same period in 2003 and
increased 11.1% in the six-month period ended June 30, 2004 compared to the
same period in 2003. We believe that the increase in total revenue is
attributable to an increase in the growth of unstructured content within
our customer base creating a demand for our products and services to manage
this content and automate it for use 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
Three Months Ended Six Months Ended
June 30, June 30, .
% Increase/ % Increase/
(In thousands) 2004 2003 decrease 2004 2003 decrease .
Total United States Revenue $ 66,288 $ 57,708 14.9% $ 134,288 $ 117,165 14.6%
Europe, Middle East and Africa 22,225 23,521 (5.5%) 47,542 45,655 4.1%
Canada, Latin America and Asia 5,573 5,888 (5.3%) 11,754 11,346 3.6%
Total International Revenue 27,798 29,409 (5.5%) 59,296 57,001 4.0%
Total Revenue $ 94,086 $ 87,117 8.0% $ 193,584 $ 174,166 11.1%
United States Revenue 70.5% 66.2% 69.4% 67.3%
International Revenue 29.5% 33.8% 30.6% 32.7%
Total Revenue Contribution 100.0% 100.0% 100.0% 100.0%
Revenue generated in the United States grew by 14.6% in the first six
months of 2004 compared to the same period in 2003 and by 14.9% in the
second quarter of 2004 over the comparable prior year quarter. As more
fully discussed below, this increase is primarily due to the increase in
service revenue. The revenue growth in the United States was partially
offset by reduced international revenue in the second quarter of 2004
compared to the same quarter a year ago. International revenue represented
approximately 31% of total revenue in the first six months of 2004 compared
to approximately 33% for the same six months in 2003. We believe the same
content management factors mentioned above drive international revenue
growth in the long term and are not regional in nature, but are subject to
minor periodic fluctuations like those experienced in the second quarter of
2004. We expect international revenue to continue to represent a
significant opportunity for us. However, international revenues will be
adversely affected if the U.S. dollar strengthens against certain major
international currencies or if international economic conditions weaken.
24
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
Three Months Ended Six Months Ended
June 30, June 30, .
% Increase/ % Increase/
(In thousands) 2004 2003 (decrease) 2004 2003 (decrease) .
Software $ 32,677 $ 33,555 (2.6%) $ 74,028 $ 69,077 7.2%
Customer Support 47,072 41,760 12.7% 92,342 81,156 13.8%
Professional Services and
Education 14,337 11,802 21.5% 27,214 23,933 13.7%
Total Revenue $ 94,086 $ 87,117 8.0% $ 193,584 $ 174,166 11.1%
Software 34.7% 38.5% (3.8)% 38.2% 39.7% (1.4)%
Customer Support 50.0% 47.9% 2.1% 47.7% 46.6% 1.1%
Professional Services and
Education 15.3% 13.6% 1.7% 14.1% 13.7% 0.3%
Total Revenue Contribution 100.0% 100.0% 100.0% 100.0%
Software. Software revenue consists of fees earned from the licensing
of our software products to our customers. Software revenue decreased by
2.6% in the three-month period ended June 30, 2004, compared to the same
period in 2003, primarily attributable to a small decrease in demand for
our software products during the second quarter of 2004 and delays in some
customer procurement cycles. However, due to higher software revenue in the
first quarter of 2004, software revenue increased by 7.2% in the six-month
period ended June 30, 2004 compared to the same period in 2003. We believe
spending on enterprise content management and business process management
software will be a priority in the near term, but is subject to customer
buying patterns that can fluctuate. In the long-term we believe there will
be increased demand for our ECM products that is driven by the need for
large organizations to manage unstructured content
Customer Support. Customer support revenue consists of revenue from
software maintenance contracts, time and material 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 12.7% in the three-month
period ended June 30, 2004 compared to the same period in 2003 and
increased 13.8% in the six-month period ended June 30, 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 and continue to see this same high level of renewal, but are
continuing to encounter pricing pressures from our customers during
contract negotiation and renewal. Accordingly, the rate of software revenue
growth may not directly result in the same growth for customer support
revenue experienced in the past.
25
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 21.5% in the three
month period ended June 30, 2004 compared to the same period in 2003 and
13.7% in the six-month period ended June 30, 2004 compared to the same
period in 2003. Professional services revenue is dependent on the level and
the nature of software sales in prior periods. Professional services
revenue grows more rapidly when customers purchase new systems for a large
scale implementation or purchase our FileNet P8 product to replace legacy
systems, as opposed to existing customers purchasing add-on licenses for
installed systems. The increase in professional services revenue we
experienced in the first six months of 2004 compared to the same period in
2003 was primarily attributable to an increased demand for consulting
services to existing customers that migrate their custom applications to
the new FileNet P8 platform. Based on software revenue sales for the past
two quarters we do not believe the level of demand for professional
services and education services will change significantly from current
levels.
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
Three Months Ended Six Months Ended
June 30, June 30,
% Increase/ % Increase/
(In thousands) 2004 2003 (decrease) 2004 2003 (decrease)
Software $ 3,128 $ 3,608 (13.3)% $ 6,651 $ 6,616 0.5%
Customer Support 9,942 9,968 (0.3)% 20,234 20,539 (1.5)%
Professional Services and
Education 11,154 10,335 7.9% 21,992 21,415 2.7%
Total Cost of Revenue $ 24,224 $ 23,911 1.3% $ 48,877 $ 48,570 0.6%
Software 9.6% 10.8% (1.2)% 9.0% 9.6% (0.6)%
Customer Support 21.1% 23.9% (2.7)% 21.9% 25.3% (3.4)%
Professional Services and
Education 77.8% 87.6% (9.8)% 80.8% 89.5% (8.7)%
Total Cost of Revenue
as a % of Revenue 25.7% 27.5% 25.2% 25.9%
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
in absolute dollars decreased 13.3% when comparing the three months ended
June 30, 2004 to the same three months in 2003 and the six month comparison
for these two years resulted in a slight 0.5% increase. The cost of
software revenue as a percent of software revenue decreased 1.2 percentage
points and 0.6 percentage points in the three and six-month periods ended
June 30, 2004, compared to the same periods in 2003. While these costs will
fluctuate period to period based on the mix of products sold containing
third party product, our royalty costs have decreased due to more favorable
royalty rates that have been negotiated during the renewal process over the
past year. However, going forward we anticipate the cost of software
revenue to increase slightly to approximately 10% of software revenue as we
continue to integrate third-party technology with our products.
26
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 as a percent of customer support revenue decreased
by 2.7 percentage points and 3.4 percentage points in the three and
six-month periods ended June 30, 2004 compared to the same periods in 2003.
The cost of customer support revenue in absolute dollars also decreased in
these comparable periods. This reduction in cost of customer support
revenue, as a percentage of the revenue and in absolute dollars 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 remain fairly
constant as a percent 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 9.8 percentage points and 8.7
percentage points in the three and six-month periods ended June 30, 2004 as
compared to the same periods in 2003. This decrease in cost of professional
services and education revenue as a percent of professional services and
education revenue is primarily attributable to higher professional services
and education revenue in 2004 compared to 2003, along with lower costs
associated with reduced employee headcount and lower variable employee
compensation. 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,
the level of revenue 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
Three Months Ended Six Months Ended
June 30, June 30, .
% Increase/ % Increase/
(In thousands) 2004 2003 (decrease) 2004 2003 (decrease) .
Research and Development $ 19,703 $ 19,680 0.1% $ 39,805 $ 38,982 2.1%
Marketing and Sales 39,198 34,856 12.5% 80,759 69,255 16.6%
General and Administrative 9,394 8,326 12.8% 18,627 16,152 15.3%
Total Operating Expenses $ 68,295 $ 62,862 8.6% $ 139,191 $ 124,389 11.9%
Research and Development 20.9% 22.6% (1.6)% 20.6% 22.4% (1.8)%
Marketing and Sales 41.7% 40.0% 1.7% 41.7% 39.8% 2.0%
General and Administrative 10.0% 9.6% 0.4% 9.6% 9.3% 0.3%
Operating Expense as a % of
Revenue 72.6% 72.2% 71.9% 71.4%
27
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 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 internal software developers; third party contracted development resources
and related facilities costs. Research and development expense was approximately
the same in the three and six-month periods ended June 30, 2004 compared to the
same periods in 2003. However, this quarter the expense mix changed with lower
internal personnel costs and higher offshore development expense. The number of
internal research and development personnel was 446 on June 30, 2004 compared to
472 on June 30, 2003. We currently have 94 contract workers in India developing
software compared to 48 one year ago.
Research and development expense decreased as a percent of revenue by 1.6
percentage points and 1.8 percentage points for the three and six months ended
June 30, 2004 compared to the same periods in 2003. This decrease is primarily
attributable to increased revenue levels without a corresponding expense
increase due to lower internal personnel and facility expense resulting from the
decreased headcount that more than offset the increased offshore development
expense. We believe we will be able to further decrease our per-developer cost
through the expanded 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 20% of revenue for the near term.
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 as a percent of
revenue increased by 1.7 percentage points and 2.0 percentage points for the
three and six-months ended June 30, 2004 compared to the same period in 2003. In
absolute dollars selling and marketing expense increased by 12.5% and 16.5% for
the three and six-months ended June 30, 2004. Approximately $9.3 million of the
year to date increase is attributable to organizational changes that resulted in
higher salaries, higher variable compensation and associated benefits.
Additionally, we experienced higher travel expense and we granted merit
increases in 2004. 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 as a percent of revenue increased 0.4 percentage points
and 0.3 percentage points in the three and six-month periods ended June 30, 2004
compared to the same periods in 2003. In absolute dollars general and
administrative expenses increased 12.8% and 15.3% in the three and six-month
periods ended June 30, 2004 compared to the same periods in 2003. The increases
in general and administrative expense between the comparative periods reflects
higher salary costs and benefits due to increased headcount as well as increased
legal and accounting fees associated with compliance to recently mandated
corporate governance regulations. We expect general and administrative expense
to remain at approximately 10% of revenue in the near-term.
Other Income, Net. Other income, net consists primarily of interest income
earned on our cash and investments, and other items including foreign exchange
gains and losses and interest expense. Other income, net of other expenses, was
$1,066,500 and $1,993,500 for the three and six-month periods ended June 30,
2004 compared to $1,619,500 and $2,664,900 during for the three and six-month
periods ended June 30, 2003. We experienced a foreign exchange gain of
approximately $748,000 in the second quarter of 2003 that did not reoccur in
2004. The weighted average interest rate earned on cash, cash equivalents and
investments was 1.60% during the six months ended June 30, 2004 compared to
1.43% for the same period in 2003.
28
Provision for Income Taxes. Our combined federal, state and foreign annual
effective tax rate for the three and six-month periods ended June 30, 2004 is
18% compared to 26% and 28% for the comparable periods 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 with lower tax rates and reductions in our domestic deferred
tax valuation allowance. The decreased tax rate in the three and six-month
period ended June 30, 2004 was primarily due to the mix of income earned by our
domestic operations versus the foreign subsidiaries.
Liquidity and Capital Resources
At June 30, 2004, combined cash, cash equivalents and investments totaled
$299.5 million, an increase of $51.3 million and $8.5 million from December 31,
2003 and March 31, 2004, respectively.
Cash provided by operating activities during the six month period ended
June 30, 2004 totaled $39.1 million and resulted primarily from: an increase in
unearned maintenance revenue related to prepaid maintenance contracts of $21.5
million; a decrease in customer receivables of $3.8 million; depreciation and
amortization expense of $8.3 million; and net income of $6.2 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 $20.5 million and was a
result of proceeds received from the exercise of employee stock options and
stock purchases under the employee stock purchase plan.
Net cash used in investing activities was $36.9 million comprised of $31.2
million for the purchase of marketable securities in excess of proceeds and $6.1
million for capital expenditures.
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.
29
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.
The adoption of FIN 46R in 2004 has not had 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.
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 has not had a material impact on our consolidated financial statements.
30
Other Matters
Environmental Matters. We are not aware of any issues related to
environmental matters that have, or are expected to have, a material affect on
our business.
Risk Factors That May Affect Future Results
Except for the historical information and discussions contained herein,
statements contained in this Form 10-Q may constitute "forward looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. These statements are based on current expectations and assumptions that
involve a number of risks, uncertainties and other factors that could cause
actual results to differ materially from recent results or from our anticipated
future results. We operate in a rapidly changing economic and technological
environment that presents numerous risks. Prospective and existing investors are
strongly urged to carefully consider the various cautionary statements and risks
set forth in this quarterly report and our other public filings. Many of these
risks are beyond our control and are driven by factors that we cannot predict.
The following discussion highlights some of these risks:
Our quarterly operating results may fluctuate in future periods and are not
predictable and, as a result, we may fail to meet expectations of investors and
analysts, causing our stock price to fluctuate or decline. Our operating results
have fluctuated in the past and we anticipate our future operating results will
continue to fluctuate due to many factors, some of which are largely beyond our
control. Consequently, our prior operating results should not necessarily be
considered indicative of future operating results.
Factors that may cause our operating results to fluctuate, include, but are
not limited to, the following:
o Information Technology 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.
31
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 addition, large
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.
o 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.
32
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 content management solutions market. 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, these markets may not 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.
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 may
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. Announcements of currently planned or other new
software products may 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.
33
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
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 may not be successful in
attracting and retaining such personnel in the future.
34
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. 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. Our existing or future
copyrights, trademarks, trade secrets, patents or other intellectual property
rights may not 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.
35
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 may not be able to redesign the
infringing products to avoid further infringement or 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.
If we fail 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;
o developments in our relationships with our customers, resellers and
suppliers;
o our announcements of significant contracts, acquisitions, strategic
partnerships or joint ventures;
36
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 105 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 June 30, 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 June 30, 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 $323,000 at June 30, 2004 and
approximately $249,000 at June 30, 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 $646,000 at June 30, 2004 and
approximately $498,000 at June 30, 2003.
37
The following table provides information about our investment portfolio at
June 30, 2004:
.
(In thousands) Cost Estimated Fair Value .
Debt Securities
Due in one year or less:
Short-term munis-taxable $ 2,500 $ 2,500
Corporate 15,089 15,049
Governments/Agencies 40,412 40,241
Total due in one year 58,001 57,790
Due in one to three years:
Government/Agencies 17,710 17,544
Total due in three years 17,710 17,544
Grand total $ 75,711 $ 75,334
Actual maturities may differ from contractual maturities because the issuer
of the securities may have the right to repurchase such securities. We classify
investments maturing in less than one year in current assets and investments
maturing greater than one year are classified as long-term investments.
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 June 30, 2004, we had
forward foreign exchange contracts outstanding totaling approximately $1.4
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 $1.7 million and $2.6
million for the three and six-month period ended June 30, 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 and six-month period ended June 30, 2004.
38
Item 4. Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure
that information required to be disclosed in our Exchange Act reports are
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 our management, including our
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 June 30, 2004, the end of the quarter covered by this report, an
evaluation was carried out under the supervision and with the participation of
our management, including our Chief Executive Officer and our Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures as required by SEC Rule 13a - 15(b). Based on the
foregoing, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures were effective at the reasonable
assurance level.
There has been no change in our internal controls over financial
reporting during our most recent fiscal quarter that has materially
affected, or is reasonably likely to materially affect, our internal
controls over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
See Note 11 to Consolidated Financial Statements.
Item 4. Submission of Matters to a Vote of Security Holders
(a) We held our 2004 Annual Meeting of Stockholders at 9:00 a.m. on May 7,
2004, in Costa Mesa, California.
(b) At the annual meeting, the following six individuals were elected to
our Board of Directors, constituting all members of the Board of
Directors:
Nominee Affirmative Votes Votes Withheld .
L. George Klaus 33,724,578 1,968,962
William P. Lyons 33,070,456 2,623,084
Lee D. Roberts 34,048,575 1,644,965
John C. Savage 33,721,603 1,971,937
Roger S. Siboni 32,958,270 2,735,270
Theodore J. Smith 25,734,661 9,958,879
(c) Our stockholders were asked to approve an amendment and restatement of
our 2002 Incentive Award Plan which (i) increases the number of shares
of Common Stock available for issuance there under by an additional
2,000,000 shares, from 2,800,000 to 4,800,000 shares; (ii) increases
the number shares that may be awarded as Restricted Stock, Restricted
Stock Units, Deferred Stock, Performance Awards and Stock Payments
from 140,000 shares to 700,000 shares, an increase of 560,000 shares;
(iii) increases the number of shares automatically granted annually to
independent directors from 7,000 to 10,000 shares; and (iv)
establishes a termination date for the Plan of February 24, 2014.
39
This proposal was approved in accordance with the following vote of
stockholders:
Votes For Votes Against Abstentions
20,215,589 10,077,309 27,865
Our stockholders were asked to ratify the appointment of Deloitte and
Touche LLP as our independent accountants for the fiscal year ending December
31, 2004. This proposal was approved in accordance with the following vote
of stockholders:
Votes For Votes Against Abstentions
35,017,179 656,257 20,104
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
1) The list of exhibits contained in the accompanying Index to
Exhibits is herein incorporated by reference.
(b) Reports on Form 8-K:
1) On July 7, 2004 FileNet furnished a report on Form 8-K under Item
12 announcing its preliminary financial results for the quarter
ended June 30, 2004.
2) On July 19, 2004 FileNet furnished a report on Form 8-K under
Item 12 announcing its financial results for the quarter ended
June 30, 2004.
40
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FILENET CORPORATION
August 5, 2004 By: /s/ Sam M. Auriemma .
Date Sam M. Auriemma, Executive Vice President
and Chief Financial Officer
(Principal Financial and Accounting Officer,
Authorized Signatory)
41
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).
42
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).
10.14.4*+ Amended and Restated 2002 Incentive Award Plan of FileNet Corporation, (filed on April 1, 2004 as
Appendix B of Registrant's Definitive Proxy Statement for its 2004 Annual Meeting of Stockholders.
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*+ 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).
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.
43
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: August 6, 2004
/s/ Lee D. Roberts .
Lee D. Roberts
Chief Executive Officer
Exhibit 31.2
Certification of Chief Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Sam M. Auriemma, certify that:
1. I have reviewed this quarterly report on Form 10-Q of FileNet Corporation;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, to
ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based on such evaluation; and
c) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal quarter in the case
of an annual report) that has materially affected, or is reasonably likely
to materially affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
control over financial reporting.
Date: August 6, 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 June 30, 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: August 6, 2004
/s/ Lee D. Roberts .
Lee D. Roberts
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
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 June 30, 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: August 6, 2004
/s/ Sam M. Auriemma .
Sam M. Auriemma
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer)