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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2005
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ________ to ___________
Commission file number: 00-15997
FILENET CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 95-3757924 .
(State or other jurisdiction of (I.R.S. Employer
corporation or organization Identification No.)
3565 Harbor Boulevard, Costa Mesa, CA 92626
(Address of principal executive offices) (Zip code)
(714) 327-3400 .
(Registrant's telephone number including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the Registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes |X| No |_|
Indicate by check mark whether the Registrant is an accelerated filer as defined in Rule
12b-2 of the Securities Exchange Act of 1943:
Yes |X| No |_|
As of May 9, 2005, there were 40,937,891 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 .................................. 15
Item 3. Quantitative and Qualitative Disclosures about Market Risk..... 35
Item 4. Controls and Procedures........................................ 37
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................. 37
Item 6. Exhibits and Reports on Form 8-K............................... 37
SIGNATURE ............................................................... 38
INDEX TO
EXHIBITS ............................................................... 39
2
PART I. FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
FILENET CORPORATION
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
March 31, December 31,
2005 2004
ASSETS
Current assets:
Cash and cash equivalents $ 235,113 $ 123,217
Short-term investments available for sale 130,680 211,196
Accounts receivable, net 40,198 35,878
Prepaid expenses and other current assets 12,730 12,179
Deferred income taxes 3,681 3,681
Total current assets 422,402 386,151
Property, net 19,918 21,738
Long-term investments available for sale 9,585 14,256
Goodwill 26,896 27,268
Intangible assets, net 5,591 6,188
Deferred income taxes 36,063 36,028
Other assets 2,283 2,037
Total assets $ 522,738 $ 493,666
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 14,153 $ 13,868
Accrued compensation and benefits 27,443 33,674
Customer deposits and advances 8,484 9,007
Unearned maintenance revenue 71,552 47,145
Income tax payable 9,009 5,374
Other accrued liabilities 12,081 14,201
Total current liabilities 142,722 123,269
Unearned maintenance revenue and other liabilities 4,819 2,533
Commitments and contingencies (Note 10)
Stockholders' equity:
Preferred stock - $0.10 par value; 7,000,000 shares
authorized; none issued and outstanding
Common stock - $0.01 par value; 100,000,000 shares
authorized; 41,790,050 issued and 40,692,050
shares outstanding at March 31, 2005; and
41,690,989 shares issued and 40,592,982 shares
outstanding at December 31, 2004 285,813 284,490
Deferred compensation (6,122) (6,530)
Retained earnings 101,784 93,512
Accumulated other comprehensive income 8,289 10,959
Treasury stock, at cost; 1,098,000 shares (14,567) (14,567)
Net stockholders' equity 375,197 367,864
Total liabilities and stockholders' equity $ 522,738 $ 493,666
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
March 31, .
2005 2004 .
Revenue:
Software $ 38,451 $ 41,351
Customer support 48,333 45,270
Professional services and education 13,233 12,877
Total revenue 100,017 99,498
Costs:
Software 2,370 3,523
Customer support 10,526 10,292
Professional services and education 10,384 10,838
Total cost of revenue 23,280 24,653
Gross Profit 76,737 74,845
Operating expenses:
Sales and marketing 38,182 41,561
Research and development 18,630 20,102
General and administrative 9,227 9,233
Total operating expenses 66,039 70,896
Operating income 10,698 3,949
Other income, net 2,028 927
Income before income taxes 12,726 4,876
Provision for income taxes 4,454 878
Net income $ 8,272 $ 3,998
Earnings per share:
Basic $ 0.20 $ 0.10
Diluted $ 0.20 $ 0.10
Weighted-average shares outstanding:
Basic 40,361 38,280
Diluted 41,706 40,785
See accompanying notes to unaudited condensed consolidated financial statements.
4
FILENET CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
(in thousands)
Three Months Ended
March 31, .
2005 2004
Net income $ 8,272 $ 3,998
Other comprehensive loss:
Foreign currency translation adjustments (2,614) (914)
Unrealized gain (loss) on securities:
Unrealized holding gain (loss), net of
taxes (56) 16
Total other comprehensive loss (2,670) (898)
Comprehensive income $ 5,602 $ 3,100
See accompanying notes to unaudited condensed consolidated financial statements.
5
FILENET CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
.
Three months ended March 31, 2005 2004
Cash flows provided by operating activities:
Net income $ 8,272 $ 3,998
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 3,840 4,276
Loss on sale of fixed assets 15 4
Provision for doubtful accounts and sales returns 299 6
Deferred income taxes (35) (40)
Changes in operating assets and liabilities:
Accounts receivable (5,223) 4,551
Prepaid expenses and other current assets (1,193) (411)
Accounts payable 492 (756)
Accrued compensation and benefits (5,893) (3,261)
Customer deposits and advances (518) 1,762
Unearned maintenance revenue 27,122 25,875
Income taxes payable 3,582 1,734
Other (1,426) (1,774)
Net cash provided by operating activities 29,334 35,964
Cash flows provided by (used in) investing activities:
Capital expenditures (1,585) (2,726)
Proceeds from sale of property 2 48
Purchases of marketable securities (283,607) (356,040)
Proceeds from sales and maturities of marketable
securities 368,525 352,825
Net cash provided by (used in) investing activities 83,335 (5,893)
Cash flows provided by financing activities:
Proceeds from issuance of common stock 1,323 10,178
Net cash provided by financing activities 1,323 10,178
Effect of exchange rate changes on cash and cash
equivalents (2,096) (528)
Net increase in cash and cash equivalents 111,896 39,721
Cash and cash equivalents, beginning of period 123,217 100,605
Cash and cash equivalents, end of period $ 235,113 $ 140,326
Supplemental cash flow information:
Interest paid $ 1 $ 22
Income taxes paid / (refunded) $ 892 $ (950)
.
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 and subsidiaries (the "Company" or "FileNet")
reflect all adjustments (consisting of normal recurring adjustments) necessary
to present fairly the financial position of the Company at March 31, 2005, and
the results of its operations, its comprehensive operations and its cash flows
for the three months ended March 31, 2005 and 2004. 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, 2004 filed with the SEC on
March 15, 2005. 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. A portion of the Company's investments consist of
auction rate securities that reset interest rates at auction intervals of 7, 28,
35 or 49 days. These securities are readily saleable at par value on the auction
dates and the carrying value approximates fair value throughout the holding
period. In prior years, auction rate securities that reset or matured in less
than 90 days were included in cash equivalents. In December 2004, the Company
determined such amounts should properly be classified as short-term investments.
As a result, in its 2004 Form 10-K the Company reclassified these amounts for
all periods presented. Additionally, the Company reclassified the accompanying
statement of cash flows for the three months ended March 31, 2004 to remove the
amounts from cash equivalents and record the net purchases or proceeds of
auction rate securities as an investing activity.
2. NEW ACCOUNTING PRONOUNCEMENTS
In March 2004, The FASB issued EITF Issue No. 03-1 (EITF 03-1), "The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments" which provides new guidance for assessing impairment losses on
investments. Additionally, EITF 03-1 includes new disclosure requirements for
investments that are deemed to be temporarily impaired. In September 2004, the
FASB delayed the accounting provisions for EITF 03-1; however, the disclosure
requirements remain effective for annual periods ending after June 15, 2004. The
Company will evaluate the impact of EITF 03-1 once final guidance is issued.
In December 2004, the FASB revised Statement No. 123 (FAS 123R),
"Share-Based Payment," which requires companies to expense the estimated fair
value of employee stock options and similar awards based on the grant-date fair
value of the award. The cost will be recognized over the period during which an
employee is required to provide service in exchange for the award, usually the
vesting period. The accounting provisions of FAS 123R will be effective as of
the beginning of the first fiscal year that begins after June 15, 2005. The
Company will adopt the provisions of FAS 123R on January 1, 2006 using a
modified prospective application. Under the modified prospective application,
FAS 123R will apply to new awards, unvested awards that are outstanding on the
effective date and any awards that are subsequently modified or cancelled.
Compensation expense for outstanding awards for which the requisite service had
not been rendered as of the effective date will be recognized over the remaining
7
service period using the compensation cost calculated for pro forma disclosure
purposes under FAS 123 (Note 3 Stock-Based Compensation). The Company is in the
process of determining how the new method of valuing stock-based compensation as
prescribed in FAS 123R will be applied to valuing stock-based awards granted
after the effective date and the impact the recognition of compensation expense
related to such awards will have on its financial statements.
3. STOCK BASED COMPENSATION
The Company currently 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 and net income 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 ended March 31, 2005 and 2004.
Three Months Ended
March 31, .
(in thousands, except per share amounts) 2005 2004
Net income, as reported $ 8,272 $ 3,998
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards, net
of related tax effects (2,447) (1,547)
Pro forma net income $ 5,825 $ 2,451
Earnings per share:
Basic earnings per share - as reported $ 0.20 $ 0.10
Basic earnings per share - pro forma 0.14 0.06
Diluted earnings per share - as reported $ 0.20 $ 0.10
Diluted earnings per share - pro forma 0.14 0.06
For purposes of computing proforma net income, the Company estimates the
fair value of each option grant and employee stock purchase plan right on the
date of grant using the Black-Scholes option-pricing model. The Black-Scholes
option-pricing model was developed for use in estimating the value of traded
options that have no vesting restrictions and are fully transferable, while the
options issued by the Company are subject to both vesting and restrictions on
transfer. In addition, option-pricing models require input of highly subjective
assumptions including the expected stock price volatility. The Company uses
projected data for expected volatility and 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
March 31, .
2005 2004
Expected life (in years) 5.52 5.39
Expected volatility 72% 51%
Risk free interest rates 3.87% 3.07%
Expected dividend 0% 0%
8
4. GOODWILL AND OTHER INTANGIBLE ASSETS
The Company's business acquisitions have resulted in goodwill and other
intangible assets. Goodwill is recorded at cost and is not amortized, but is
tested for impairment at least annually and would be written down if impairment
were determined. 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. The Company's reporting units are consistent with
the reportable segments identified in Note 7. The Company also periodically
evaluates whether events and circumstances have occurred between annual testing
dates that indicate the carrying value of goodwill may not be recoverable. An
impairment analysis was performed as of July 1, 2004 in accordance with SFAS
142. The results indicated there was no impairment of goodwill in any of the
three reporting units. As of March 31, 2005, there have been no indicators of
impairment; therefore no interim impairment tests have been performed.
The following table presents the changes in goodwill by reporting segment
during the three months ended March 31, 2005:
(in thousands) .
Professional
Customer Services and
Software Support Education Total
Balance, December 31, 2004 $ 15,826 $ 6,003 $ 5,439 $ 27,268
Foreign currency effect (216) (82) (74) (372)
Balance, March 31, 2005 $ 15,610 $ 5,921 $ 5,365 $ 26,896
Foreign currency change relates to the impact of translation on the portion
of goodwill that was recorded on the Company's foreign subsidiaries.
Identified intangible assets are recorded at cost less accumulated
amortization. These assets are amortized using the straight-line method over
estimated useful lives of 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. The Company
evaluates these assets for impairment based on estimated undiscounted future
cash flows from these assets. If the carrying value of the assets exceeds the
estimated future undiscounted cash flows, a loss would be recorded for the
excess of the asset's carrying value over the fair value. While the Company has
not experienced impairment of intangible assets in prior periods, it cannot
guarantee that there will not be impairment in the future. Intangible assets
subject to amortization consist of the following:
(in thousands) .
March 31, 2005 December 31, 2004 .
Gross Accumulated Gross Accumulated
Asset Amortization Net Asset Amortization Net
Acquired technology and
related intangibles $ 10,480 $ (4,970) $ 5,510 $ 10,571 $ (4,496) $ 6,075
Non-compete agreements
and patents 367 (286) 81 367 (254) 113
Total $ 10,847 $ (5,256) $ 5,591 $ 10,938 $ (4,750) $ 6,188
9
Acquired technology and other intangibles are being amortized over a useful
life of five years, and non-compete agreements are being amortized over three
years. Patents were amortized over two years and are fully amortized.
Amortization expense for intangible assets was $553,000 for the three months
ended March 31, 2005 compared to $527,000 for the comparable period in 2004.
Estimated future amortization expense (assuming no foreign exchange effect)
of purchased intangible assets as of March 31, 2005 is as follows:
(in thousands) .
Fiscal Year Amount
(Remainder) 2005 $ 1,633
2006 2,116
2007 1,513
2008 329
$ 5,591
5. EARNINGS PER SHARE
Basic earnings per share are computed by dividing net income for the period
by the weighted-average number of common shares outstanding during the period.
Diluted earnings per share is computed by dividing net income by the
weighted-average number of common shares outstanding plus the dilutive effect of
outstanding stock options, shares issuable under the employee stock purchase
plan and restricted stock issued to key executive management using the treasury
stock method. The number of anti-dilutive options excluded from the EPS
calculation for the three months ended March 31, 2005 and 2004 were 1,345,145
and 2,505,000 shares, respectively. The following table sets forth the
computation of basic and diluted earnings per share for the three months ended
March 31, 2005 and 2004:
Three Months Ended
March 31, .
(in thousands, except per share amounts) 2005 2004
Net Income $ 8,272 $ 3,998
Weighted average common shares
outstanding 40,639 38,413
Unvested restricted stock (278) (133)
Shares used in computing
basic earnings per share 40,361 38,280
Earnings per basic share $ 0.20 $ 0.10
Shares used in computing
basic earnings per share 40,361 38,280
Dilutive effect of stock plans 1,323 2,472
Dilutive effect of weighted average
common shares of unvested
restricted stock 22 33
Shares used in computing
diluted earnings per share 41,706 40,785
Earnings per diluted share $ 0.20 $ 0.10
10
6. ACCUMULATED OTHER COMPREHENSIVE INCOME
Accumulated other comprehensive income, net of taxes, for the three months
ended March 31, 2005 is comprised of the following:
.
Foreign Unrealized
Currency Holding Accumulated Other
Translation Loss on Comprehensive
(in thousands) Adjustment Securities Income
Balance, December 31, 2004 $ 11,235 $ (276) $ 10,959
Three month period changes (2,614) (56) (2,670)
Balance, March 31, 2005 $ 8,621 $ (332) $ 8,289
7. 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 include Software, Customer
Support, and Professional Services and Education. The Software operating segment
develops, markets, and sells a software platform and application framework for
Enterprise Content Management and Business Process Management. 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 Professional Services and Education segment provides
fee-based implementation and technical consulting services related to the
Company's standard products and training services.
The accounting policies of the Company's operating segments are the same as
those for the Company as a whole. The Company evaluates performance based on
stand-alone segment gross profit. The Company does not separately allocate
operating expenses to these segments, nor does it allocate specific assets to
these segments. The Company does not evaluate performance based on the return on
assets or on interest income at the operating segment level. Therefore, segment
information reported includes only revenues, cost of revenues, and gross profit,
as this information is the only information currently provided to the chief
operating decision maker on a segment basis.
11
Operating segment data for the three months ended March 31, 2005 and 2004
is as follows:
Three months ended
March 31,
(in thousands) 2005 2004
Software:
Revenue $ 38,451 $ 41,351
Cost of revenue 2,370 3,523
Gross profit 36,081 37,828
Customer Support:
Revenue $ 48,333 $ 45,270
Cost of revenue 10,526 10,292
Gross profit 37,807 34,978
Professional Services and Education:
Revenue $ 13,233 $ 12,877
Cost of revenue 10,384 10,838
Gross profit 2,849 2,039
Total
Revenue $ 100,017 $ 99,498
Cost of revenue 23,280 24,653
Gross profit 76,737 74,845
8. STOCK OPTIONS
The following is a summary of stock option transactions regarding all stock
option plans for the three months ended March 31, 2005:
Weighted
Average
Number of Excercise
Options Price
Balance, December 31, 2004 6,870,617 $ 19.99
Granted (weighted-average fair value of $13.11) 22,000 23.58
Exercised (99,061) 13.35
Canceled (103,719) 26.38
Balance, March 31, 2005 6,689,837 $ 20.00
12
The following table summarizes information concerning outstanding and
exercisable stock options at March 31, 2005:
.
Options Outstanding Options Exercisable .
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Price Outstanding Life (Years) Price Exercisable Price
1.39 - 12.86 1,401,516 5.35 $ 10.99 1,037,972 $ 10.40
12.97 - 16.35 1,117,119 6.24 13.94 812,590 13.90
16.54 - 23.47 1,436,527 6.24 19.87 1,243,331 19.98
23.88 - 26.66 1,125,129 7.32 25.73 521,568 24.74
26.75 - 28.19 1,333,754 8.85 27.77 277,355 27.82
28.42 - 41.84 275,792 4.38 30.09 250,718 30.13
1.39 - 41.84 6,689,837 6.68 $ 20.00 4,143,534 $ 18.13
9. ISSUANCE OF RESTRICTED STOCK
The fair value of restricted stock awards is recorded in the equity section
of the balance sheet as an increase in common stock and a contra-equity offset
to deferred compensation. All restricted stock awards vest over time and certain
awards include a feature that allows the stock to vest on an accelerated basis
provided certain performance targets are achieved. Certain restricted stock
awards are also subject to Change in Control Agreements and/or termination
without cause provisions that could trigger accelerated vesting. Expense related
to the shares is amortized on a straight-line basis over the vesting period.
Recognition of expense may be accelerated if it becomes probable that certain
performance targets will be achieved that trigger accelerated vesting for those
shares that contain the acceleration feature. Approximately $408,000 and $45,500
of compensation expense was recognized for restricted stock awards in the three
months ended March 31, 2005 and 2004, respectively.
10. 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. Rental expense is recorded on a straight-line basis
over the life of the lease and amounts related to deferred rent are recorded in
other accrued liabilities on the consolidated balance sheet. Future annual
minimum lease payments under all non-cancelable operating leases with an initial
term in excess of one year as of March 31, 2005 were as follows:
(in thousands) .
2005 (remaining 9 months) $ 13,987
2006 13,461
2007 11,268
2008 9,786
2009 7,401
2010 6,310
Thereafter 3,029
Total $ 65,242
13
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 $2.8 million as of March 31, 2005.
Approximately $1.4 million was issued in local currency in Europe and Asia,
while the balance was issued in the United States. Approximately $0.5 million of
the $2.8 million is secured by cash deposit.
The Company indemnifies its directors and officers to the maximum extent
permitted under the laws of the State of Delaware.
The Company has not recorded a liability for the guarantees and indemnities
described above in the accompanying consolidated balance sheet as the fair value
of such guarantees and indemnities is considered nominal.
Legal Proceedings
In the normal course of business, the Company is subject to ordinary
routine litigation and claims incidental to its business. The Company monitors
and assesses the merits and risks of pending legal proceedings. While the
results of litigation and claims cannot be predicted with certainty, based upon
its current assessment the Company believes that the final outcome of existing
legal proceedings will either be resolved in its favor or, if resolved against
it, will not have a materially adverse effect on its consolidated results of
operations or financial condition.
11. FOREIGN CURRENCY TRANSACTIONS
The Company is exposed to foreign exchange rate fluctuations due to
intercompany accounts between the U.S. parent company and the foreign
subsidiaries. The Company is also exposed to foreign exchange rate fluctuations
as the financial statements of foreign subsidiaries are translated into U.S.
dollars for consolidation purposes. The Company purchases foreign exchange
contracts to mitigate the effect of exchange gains and losses on recorded
foreign currency denominated monetary assets and liabilities. The Company does
not use foreign exchange contracts for speculative or trading purposes. All
outstanding forward contracts are marked-to-market on a monthly basis with gains
and losses included in other income (expense) in the consolidated statements of
operations. The Company opens new hedge contracts each quarter that will mature
within three months. The counterparties to these contracts are major financial
institutions. The Company uses commercial rating agencies to evaluate the credit
quality of the counterparties and does not anticipate nonperformance by any
counterparties. The Company does not anticipate a material loss resulting from
any credit risks related to any of these institutions.
14
12. INCOME TAXES
The Company's combined federal, state and foreign annual effective tax rate
applied to the three months ended March 31, 2005 was 35% compared to 18% for the
comparable period in 2004. The increased effective tax rate applied to the three
months ended March 31, 2005 was primarily due to i) the mix of income earned by
domestic operations versus the foreign subsidiaries, and ii) the absence of a
valuation allowance reversal that benefited the Company's rate in 2004.
13. RELATED-PARTY-TRANSACTIONS
On June 5, 2002, the Compensation Committee of the Company's Board of
Directors (the "Board") approved a loan to Mr. Roberts for $1.9 million to
enable him to purchase a home in Orange County, California. Mr. Roberts has
repaid this loan in full as of December 10, 2004. Mr. Roberts made total
payments of $2,020,576 including $120,576 in interest and $1,900,000 in
principal.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
In addition to historical information 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 factors described under the heading "Risk Factors" and in other documents we
file from time to time with the Securities and Exchange Commission. 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 for Enterprise
Content and Business Process Management. This platform, called FileNet P8,
provides a flexible and scaleable framework for developing solutions that
provide our customers with the ability to manage content throughout their
organizations, and streamline their business processes. 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 contracts
or product diagrams, or externally, such as content provided to customers
through a Web site. The documents and content our software manages, commonly
called unstructured content, includes, but is not limited to: Web pages, 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.
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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
provided pursuant to service contracts. Annual fees for software technical
support and software maintenance are received in advance and recognized as
revenue over the duration of the contract.
Our earnings results are highly sensitive to fluctuations in revenue. The
nature of our cost structure is essentially fixed, with employee compensation
and benefits being the single largest expense. These expenses represent more
than 50% of our cost structure. Costs associated with variable compensation
expense and third party royalty expenses fluctuate with revenue. Our future
profitability is contingent upon revenue growth achieved through continued
investments in internally developed or acquired software technologies that gain
market acceptance.
Software
The FileNet P8 platform provides our customers with enterprise-level
software that is scalable and flexible to handle demanding content challenges
and manage complex business processes. The FileNet P8 platform provides a
framework for functional expansion to provide enhanced content and process
management across an enterprise through FileNet's product suites; each
emphasizing a different aspect of the ECM solution set, with functions designed
to meet a customer's individual ECM or BPM needs. Each suite can be implemented
by a customer individually, but remains expandable to include additional FileNet
content and process management capabilities. Solutions and applications, built
by third party partners or our customers using FileNet P8 software, are designed
to manage documents and all forms of 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.
We license our ECM software to companies in the insurance, financial
services, government, manufacturing, telecommunications and utilities
industries, both directly to the end user and through partners. The growth in
software license revenue is affected by the strength of general economic and
business conditions, as well as the competitive position of our software
products. Our enterprise software business is characterized by long sales cycles
and timing of a few large software license transactions that can substantially
affect our operating results. In the past several years the economy has shown
slow growth in the software industry resulting in customer delays or limited
spending for technology capital. The ability to meet regulatory and compliance
requirements has become increasingly critical for large public enterprises in
order to maintain proper documentation for all key transactions. We believe we
are well positioned to grow our revenue through our software products that
address our current and prospective customers' regulatory compliance and
business process improvement requirements. However, we believe software revenue
will continue to be affected by future economic conditions.
Customer Support
We offer product support on a global basis to ensure successful
implementation of our products and customer satisfaction. Our support offering
also includes the right to new versions. Our 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.
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Our customers typically purchase support at the time they acquire new
software licenses and renew their software license support contracts annually
provided their systems are still in service. The growth of support revenue is
influenced by the renewal rate of the existing customer base and the amount of
new support contracts associated with the sale of new software licenses. We
believe that our customer support revenue will continue to grow as we sell more
new software licenses and our customers continue to renew their product support
contracts.
Professional Services and Education
Our worldwide professional services organization provides consulting,
implementation, development and other technical services and training services
to our licensed customers and authorized ValueNet Partners. These services are
provided by our internal employees and through a network of qualified service
providers hired on a fee for service basis. Our professional services
organization offers a comprehensive methodology to help our customers design,
install, integrate, customize and deploy our products. These services range from
the management of large-scale implementations of our products billed on a time
and material basis to short-term fixed price services such as software
installation and implementation packages, 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. The purpose of our education services is to allow our
customers to further enhance the usability of our software products throughout
their enterprise.
Research and Development
We have made and expect to continue to make substantial investments in
research and development, through internal and offshore development activities,
third party licensing agreements and through technology acquisitions. Our
development efforts focus on our FileNet P8 platform as we continue to develop
and enhance our enterprise content and process management capabilities.
Additionally, we license and embed third party software that is designed to
expand the functionality of our products through a variety of agreements with
the producers of this software and we intend to increase the number of third
party licensing agreements. We expect research and development to remain a
significant portion of our cost structure throughout 2005.
Critical Accounting Policies and Estimates
The condensed consolidated financial statements of FileNet are prepared in
conformity with accounting principles generally accepted in the United States of
America. The condensed 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.
We continually evaluate our estimates and judgments, including those
related to revenue recognition, valuation of intangible assets, reserves for bad
debt and sales returns and income taxes. We base our estimates on historical and
projected results that we believe are reasonable. These estimates form the basis
for making judgments about the carrying values of assets and liabilities and by
their nature, are subject to an inherent degree of uncertainty. Actual amounts
could differ from our estimates and could have a significant adverse effect on
our operating results and financial position. The significant accounting
policies we believe are most critical to aid in fully understanding and
evaluating our reported financial results include the following:
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Revenue Recognition. The nature of our business commonly includes multiple
elements in our arrangements and requires us to make judgments for determining
the timing and the amount of revenue to recognize. These judgments include, but
are not limited to, determining the allocation of revenue in multiple element
arrangements based on vendor specific objective evidence and determining the
creditworthiness of a customer to assess the probability of collection of a
transaction.
We derive revenue from the following sources: (1) software, which includes
software licenses, (2) customer support revenues, which include annual
maintenance agreements, and (3) professional services, which include consulting,
implementation and training services.
The provisions of Statement of Position No. 97-2, Software Revenue
Recognition, issued by the American Institute of Certified Public Accountants,
governs the basis for our software revenue recognition. Accordingly, software
license revenue is recognized when: (1) we enter into a legally binding
arrangement with a customer for the license of software; (2) we deliver the
products; (3) customer payment is deemed fixed or determinable and free of
contingencies or significant uncertainties; and (4) collection is probable. We
must make judgments and estimates to determine whether or not the certainty of
these elements has been met.
Our software license arrangements often include multiple elements that
consist of software, post- contract customer support agreements and professional
services such as consulting, implementation and training. We recognize revenue
in multiple element arrangements using the residual method of revenue
recognition in accordance with SOP 98-9. Under the residual method, the fair
value of the undelivered elements is deferred and the remaining portion of the
arrangement fee is allocated to the delivered elements and is recognized as
revenue, assuming all other revenue recognition criteria have been met. If
evidence of fair value for each undelivered element of the arrangement does not
exist, all revenue from the arrangement is recognized when evidence of fair
value is determined or when all elements of the arrangement are delivered.
Vendor specific objective evidence ("VSOE") of fair value for customer
support is determined by reference to the price our customers pay for such
support when sold separately; that is, the renewal rates paid by our customers.
Revenue from customer support contracts is recognized ratably over the term of
the arrangement, which is typically 12 months. VSOE of fair value for
professional services is based upon the established pricing and discounting
practices for those services when sold separately. Historically, we have been
able to establish VSOE for customer support and professional services, but we
may modify our pricing practices in the future, which could result in changes
in, or the inability to support, VSOE of fair value for these undelivered
elements. If this occurs, our future revenue recognition for multi-element
arrangements could differ significantly from our historical results. A majority
of our professional service revenue is derived from time and materials based
contracts that typically range from three months to one year in duration.
Revenue is recognized on such contracts as time is incurred and approved by the
customer. We also provide fixed price pre-packaged services that are one month
or less in duration. Revenue from such short-term fixed price contracts is
recognized upon completion of the work and customer acceptance. Short-term
fixed-price contracts of a repetitive nature are more readily estimable than
long-term contracts. Our ability to make judgments about revenue and cost for
these types of contracts has in the past been accurate. We have limited exposure
to cost overruns in professional service engagements as any additional services
are pre-approved by our customers in time and material contracts and our fixed
price contracts are normally very short term in nature and highly estimable.
We use judgment in assessing whether fees are fixed and determinable and
probable of collection at the time of sale. Since customers who have previously
deployed our products somewhere within their enterprise comprise approximately
90% of software sales, our ability to assess the credit-worthiness of a
transaction is supported by the collection history we have with that customer.
In the past our ability to judge the probability of collection has been highly
accurate and we expect that this will continue. Our standard payment terms range
from net 30 to net 90 days. Payments that are due within 90 days are deemed to
be fixed or determinable based on our successful collection history on such
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arrangements. To the extent we elect to provide extended payment terms beyond 90
days for competitive or other reasons, revenue is recognized when the amounts
become due. Historically, sales returns and bad debt write-offs have been
insignificant and within management's expectations. However, any adverse changes
in these trends could impact the timing of revenue recognition in the future.
In addition to direct customer sales, we sell through third party channel
partners. Our channel partners do not inventory our software products; rather,
shipments are made only when the partner places an order for a specific end
user. We require our channel partners to provide us with the name and address of
all end users at the time an order is placed and, in many cases, we ship our
products directly to the end user. Software license revenue from channel
partners is recognized when an end user is identified, product is delivered
either to a channel partner or to their designated end-user and all other
revenue recognition criteria are met. As our channel partners only purchase our
product for specific end users, we are not subject to channel inventory returns
or price protection issues.
Allowance for Doubtful Accounts and Sales Returns. We make judgments as to
our ability to collect outstanding receivables and provide allowances for the
portion of receivables when collection becomes doubtful. We perform an initial
evaluation of 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. 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. Even though we have large
transactions, these tend to be with large, well capitalized and credit worthy
customers. We also maintain a sales returns allowance based on historical return
rates. While we are not legally required to accept sales returns, we have done
so on certain occasions for our customers. Product returns have historically
been minimal and within our expectations. If we elect to accept a higher level
of returns in the future for customer relations or other reasons, our results of
operations could be materially affected. If the historical data we use to
calculate the allowance for doubtful accounts or if estimates do not properly
reflect future returns, then a change in the allowances would be made in the
period in which such a determination is made and results of operations in that
period could be materially affected.
Goodwill and Other Intangible Assets. Our business acquisitions have
resulted in goodwill and other intangible assets. Goodwill is recorded at cost
and is not amortized, but is tested for impairment at least annually and would
be written down if impairment were determined. 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. Our reporting units are
consistent with the reportable segments identified in Note 7. We also
periodically evaluate whether events and circumstances have occurred between
annual testing dates that indicate the carrying value of goodwill may not be
recoverable. We performed an impairment analysis as of July 1, 2004 in
accordance with SFAS 142. The results indicated there was no impairment of
goodwill in any of the three reporting units. As of March 31, 2005, there have
been no indicators of impairment; therefore no interim impairment tests have
been performed.
Identified intangible assets are recorded at cost less accumulated
amortization. These assets are amortized using the straight-line method over
estimated useful lives of 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
these assets for impairment based on estimated undiscounted future cash flows
from these assets. If the carrying value of the assets exceeds the estimated
future undiscounted cash flows, a loss would be recorded for the excess of the
asset's carrying value over the fair value. While we have not experienced
impairment of intangible assets in prior periods, we cannot guarantee that there
will not be impairment in the future.
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Determining the fair value of a reporting unit is judgmental in nature and
involves the use of significant estimates and assumptions. These estimates and
assumptions include revenue growth rates and operating margins used to calculate
projected future cash flows, future economic and market conditions, and
determination of appropriate market comparables. We base our fair value
estimates on assumptions we believe to be reasonable but that are unpredictable
and uncertain. Actual future results may differ from those estimates. In
addition, we make certain judgments and assumptions in allocating shared assets
and liabilities to determine the carrying values for each of our reporting
units. Future events, such as a significant decrease in our revenue,
profitability or market capitalization, or a change in technology could cause us
to conclude that impairment indicators exist and that goodwill or other
intangible assets associated with our acquisitions are impaired. Any resulting
impairment loss could have an adverse impact on our results of operations.
Income Taxes. We exercise significant judgment in determining our income
tax provision due to transactions, credits and calculations where the ultimate
tax determination is uncertain. Uncertainties arise as a consequence of the
actual source of taxable income between domestic and foreign locations, the
outcome of tax audits and the ultimate utilization of tax credits. Although we
believe our estimates are reasonable, the final tax determination could differ
from our recorded income tax provision and accruals. In such case, we would
adjust the income tax provision in the period in which the facts that give rise
to the revision become known. These adjustments could have a material impact on
our income tax provision and our net income for that period.
We recognize deferred income tax assets and liabilities based upon the
differences between the financial statement carrying amounts and the tax bases
of assets and liabilities. Such deferred income taxes primarily relate to the
timing of the recognition of certain revenue items and the timing of the
deductibility of certain reserves and accruals for income tax purposes. We
regularly review the deferred tax assets for recoverability and establish a
valuation allowance when it is more likely than not that some portion or all of
the deferred tax assets will not be realized. In 2004 we concluded that the
valuation allowance associated with domestic NOL's and other temporary
differences should be fully reversed as a result of the cumulative domestic
profits in recent years and future domestic projections. However, we could be
required to record additional valuation allowance against the deferred tax
assets if we are unable to generate sufficient future taxable income, fail to
benefit from our tax planning strategies or if there is a material change in the
actual effective tax rates or time periods within which the underlying timing
differences become taxable or deductible. Increases in the valuation allowance
could have a material adverse impact on our income tax provision and our net
income. The remaining portion of the valuation allowance of $15 million related
to stock option deductions will result in an increase to additional paid in
capital should the Company generate sufficient taxable income in future years to
utilize the net operating loss carryforwards recorded as a deferred tax asset.
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Results of Operations
The following table sets forth certain consolidated statements of
operations data as a percentage of total revenue for the periods indicated:
Three Months Ended
March 31,
2005 2004
Revenue:
Software 38.5 % 41.6 %
Customer support 48.3 45.5
Professional services and education 13.2 12.9
Total Revenue 100.0 100.0
Cost of revenue:
Software 2.4 3.5
Customer support 10.5 10.4
Professional services and education 10.4 10.9
Total cost of revenue 23.3 24.8
Gross Profit 76.7 75.2
Operating expenses:
Sales and marketing 38.2 41.8
Research and development 18.6 20.2
General and administrative 9.2 9.2
Total operating expenses 66.0 71.2
Operating income 10.7 4.0
Other income, net 2.0 0.9
Income before income tax 12.7 % 4.9 %
Revenue
Total revenue in the quarter ended March 31, 2005 compared to the same
period in 2004 was virtually unchanged with an increase of less than half a
percentage point. Our software segment showed a 7.0% decline in revenue year
over year. Fluctuation in software revenue is attributable to the timing of one
or a few large enterprise transactions when comparing quarters. Revenue in our
service segments increased when comparing the first quarter of 2005 to the first
quarter of 2004. A high rate of renewal in our customer support segment and an
increase in professional services and education revenue offset the decrease in
software revenue.
Revenue by Geography. The following table sets forth total revenue by
geography and as a percentage of total revenue for the periods indicated:
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Revenue by Geography
Three Months Ended
March 31, .
% Increase/
(in thousands) 2005 2004 decrease
$ Total Revenue
Total United States Revenue $ 68,597 $ 68,000 0.9%
Europe, Middle East and Africa 25,538 25,317 0.9%
Canada, Latin America and Asia 5,882 6,181 (4.8%)
Total International Revenue 31,420 31,498 (0.2%)
Total Revenue $ 100,017 $ 99,498 0.5%
% of Total Revenue
United States Revenue 68.6 % 68.3 %
International Revenue 31.4 % 31.7 %
Total Revenue Contribution 100.0 % 100.0 %
Revenue generated in the United States grew by 0.9% in the first three
months of 2005 compared to the same period in 2004. This increase during the
three-month period is primarily due to the increase in service revenue.
International revenue represented approximately 31.4% of total revenue in the
first three months of 2005 compared to approximately 31.7% for the same three
months in 2004. The factors driving software license and service revenue changes
will be more fully discussed in the Revenue by Reporting Segment section below.
We believe that process improvement and content management requirements are
global in nature and international customers also view our products as essential
to solving their business and content problems. Revenue growth in the long term
appears to be non-regional in nature, but is subject to periodic fluctuations
depending on transaction size and timing. Furthermore, international revenues
will be adversely affected if the U.S. dollar strengthens against certain major
international currencies or if international economic conditions weaken.
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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
March 31, .
% Increase/
(in thousands) 2005 2004 (decrease)
$ Total Revenue
Software $ 38,451 $ 41,351 (7.0%)
Customer Support 48,333 45,270 6.8%
Professional Services and
Education 13,233 12,877 2.8%
Total Revenue $ 100,017 $ 99,498 0.5%
% of Total Revenue
Software 38.5% 41.6% (3.1%)
Customer Support 48.3% 45.5% 2.8%
Professional Services
and Education 13.2% 12.9% 0.3%
Total Revenue
Contribution 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 7.0% in
the three-month period ended March 31, 2005 compared to the same period in 2004.
As we have seen in prior quarters, fluctuation in buying patterns and the number
of large enterprise transactions that close in any particular quarter can affect
our level of software sales quarter to quarter. One customer accounted for 9% of
total revenue in the first quarter of 2004. There were no individually
significant sales of this size in the first quarter 2005, which accounts for the
year-to-year decrease. This buying behavior creates an environment that is
unpredictable and we believe this will continue in the near term. In the longer
term we believe spending on enterprise content management and business process
management software will be a priority as companies look to automate regulatory
and compliance requirements. Additionally, we believe there will be increased
demand for our ECM products driven by the need for large organizations to manage
their unstructured content.
Customer Support. Customer support revenue consists of revenue from
software maintenance contracts, time and material revenues and the sale of 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. Time and material revenue is derived from
services provided to the customer that are not included in their maintenance
contract entitlements. Customer support revenue is generated from new
maintenance contracts for current year software sales and from the renewal of
existing maintenance contracts for previously sold software licenses on
installed systems. Customer support revenue increased by 6.8% in the three-month
period ended March 31, 2005 compared to the same period in 2004. 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 correlate to
the same growth for customer support revenue experienced in the past.
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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 2.8% in the three months ended March 31, 2005 compared to
the same period in 2004. 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 and education revenue we experienced in
the first three months of 2005 compared to the same period in 2004 was primarily
attributable to the increase in P8 software license sales. Based on software
revenue sales for the past year 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
March 31, .
% Increase/
(in thousands) 2005 2004 (decrease)
$ Total Cost of Revenue
Software $ 2,370 $ 3,523 (32.7%)
Customer Support 10,526 10,292 2.3%
Professional Services and
Education 10,384 10,838 (4.2%)
Total Cost of Revenue $ 23,280 $ 24,653 (5.6%)
% Total Cost of Revenue
Software 6.2% 8.5% (2.3%)
Customer Support 21.8% 22.7% (0.9%)
Professional Services and
Education 78.5% 84.2% (5.7%)
Total Cost of Revenue as a %
of Revenue 23.3% 24.8% (1.5%)
Software. Cost of software revenue includes royalties paid to third parties
for technology used in our products to enhance features and functionality,
referral fees, amortization of acquired technology, media costs, and the cost to
manufacture and distribute software. The cost of software revenue in absolute
dollars decreased by 32.7% when comparing the three months ended March 31, 2005
to the same three months in 2004. The cost of software revenue as a percent of
software revenue decreased 2.3 percentage points in the three-month period
comparison. Costs will fluctuate period to period based on the mix of products
sold containing third party royalties and fees. A majority of the current
quarter decrease is due to royalty costs being $0.9 million less than the prior
year quarter. However, we anticipate continuing to integrate third party
technology with our software which could lower our margins in the future by
several percentage points from current levels. Going forward we anticipate the
cost of software revenue to be approximately 8%-10% of software revenue.
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Customer Support. Cost of customer support revenue includes the cost of
compensation and benefits paid to 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 0.7 percentage points in the three months ended March 31,
2005 compared to the same period in 2004. The cost of customer support revenue
in absolute dollars increased $0.2 million in these comparable periods due to
minor increases in variable compensation, third-party maintenance and a variety
of other expense items. The reduction in cost of customer support revenue, as a
percentage of the revenue is attributable to efficiencies in the delivery of
technical support, which allows for increased revenue without a comparable
increase in cost. We expect the cost of customer support revenue to remain at
approximately 21%-24% 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 5.7 percentage points in the three
months ended March 31, 2005 as compared to the same period in 2004. This
decrease in cost of professional services and education revenue as a percent of
professional services and education revenue is primarily attributable to lower
costs associated with reduced employee headcount resulting in $0.5 million in
lower benefit costs and lower variable employee compensation. In the near-term
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, but to average in a
range between 80%-82% of revenue.
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
March 31, .
% Increase/
(in thousands) 2005 2004 (decrease)
$ Total Operating Expenses
Research and Development $ 18,630 $ 20,102 (7.3%)
Marketing and Sales 38,182 41,561 (8.1%)
General and Administrative 9,227 9,233 (0.1%)
Total Operating Expenses $ 66,039 $ 70,896 (6.9%)
% Total Operating Expenses
Research and Development 18.6% 20.2% (1.6%)
Marketing and Sales 38.2% 41.8% (3.6%)
General and Administrative 9.2% 9.3% (0.1%)
Operating Expense as a % of
Revenue 66.0% 71.3% (5.3%)
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Research and Development. Our research and development efforts are focused
on enhancing and maintaining our Enterprise Content Management capabilities. Our
efforts focus on our product suites including Business Process Manager, Content
Manager, Image Manager, Email Manager, Records Manager, Forms Manager, Team
Collaboration Manager, Web Content Manager and other capabilities.
Our research and development expense consists primarily of personnel costs
for internal software development; third party contracted development resources,
and related facilities costs. Research and development expense decreased 7.3% in
the three months ended March 31, 2005 compared to the same period in 2004 due
primarily to lower internal personnel and facility expense of $1.5 million
resulting from decreased headcount. The number of internal research and
development personnel was 401 on March 31, 2005 compared to 452 on March 31,
2004. We currently have 94 contract workers in India developing software
compared to 99 one year ago. This reduction resulted in a decrease in research
and development expense as a percent of revenue by 1.6 percentage points for the
three months ended March 31, 2005 compared to the same period in 2004. Offshore
development cost remained constant at approximately $2.0 million for the
comparable periods. We intend to modestly increase research and development
headcount in the short term to invest in adding functionality to our Filenet P8
platform, increase support for industry standards, and extend the scalability,
manageability, and openness of the Filenet P8 architecture. 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 range between 18%-20% of revenue assuming
revenue growth in 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 decreased by 3.6 percentage points for the three months ended March 31,
2005 compared to the same period in 2004. In absolute dollars selling and
marketing expense decreased by 8.1% for the three months ended March 31, 2005
compared to the same period in 2004. Approximately $1.9 million of the decrease
in absolute dollars was attributable to reduced compensation and benefits
resulting from lower headcount. Headcount was 534 as of March 31, 2005 compared
to 582 as of March 31, 2004. Reduced spending in programs, travel, and the
annual sales kickoff meeting held in the first quarter accounted for the balance
of the decrease. We expect expense levels in future quarters to reflect
incremental hiring in sales and increased marketing program expense related to
lead generation and brand awareness and we expect selling and marketing expense
to range between 38%-40% 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 and in absolute dollars remained
constant in the three months ended March 31, 2005 compared to the same period in
2004. We expect general and administrative expense to range between 8%-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 realized foreign
exchange gains and losses and interest expense. Other income, net of other
expenses, was $2.0 million for the three months ended March 31, 2005 compared to
$1.1 million during the three months ended March 31, 2004. Interest income
increased $0.9 million in the first quarter of 2005 compared to the first
quarter in 2004. This increase is attributable to a higher cash balance and a
higher weighted average interest rate earned on cash, cash equivalents and
investments which was 2.44% during the three months ended March 31, 2005
compared to 1.48% for the same period in 2004.
26
Provision for Income Taxes. Our combined federal, state and foreign annual
effective tax rate applied to the three months ended March 31, 2005 was 35%,
compared to 18% for the comparable period in 2004. The increased effective tax
rate applied to the three months ended March 31, 2005 was primarily due to i)
the mix of income earned by domestic operations versus the foreign subsidiaries,
and ii) the absence of a valuation allowance reversal that benefited our rate in
2004.
Liquidity and Capital Resources
As of March 31, 2005, cash and cash equivalents and investments were $375.4
million, an increase of $26.7 million from $348.7 million at December 31, 2004.
Cash, cash equivalents and investments include $299.3 million in the United
States and $76.1 million held by our foreign subsidiaries. Cash and cash
equivalents consist of high quality and highly liquid investments in short-term
money market funds, United States government agency discount notes, and
corporate notes. Cash equivalent investments include instruments with original
maturities of 90 days or less. Short-term investments include investment
instruments with maturities of greater than 90 days and less than 365 days as
well as auction rate securities that reset interest rates at auction intervals
ranging from 7, 28, 35, or 49 days. Long-term investments consist of high grade
corporate and government securities with maturities greater than 12 months and
less than three years.
Our two major sources of cash in the past two fiscal years have been cash
generated from operations and cash generated from financing activities. The
amount of these sources can fluctuate depending on operational activities and
stock price as more fully discussed below. Cash flow from operations was $29.3
million for the three months ended March 31, 2005 compared to $36.0 million for
the same three months in 2004. Cash provided by financing activities was $1.3
million in the three months ended March 31, 2005 compared to $10.2 million for
the same period in 2004.
Net income is a primary source of cash from operating activities. Net
income was $8.3 million and $4.0 million for the three months ended March 31,
2005 and 2004, respectively. Depreciation and amortization added to net income
to provide cash from operating activities - although the amount has declined
year to year due to tight budgetary control over capital spending. Depreciation
and amortization was $3.8 million in the first quarter of 2005 down from $4.3
million in the first quarter of 2004. Our cash from operations is also impacted
by changes in working capital accounts. Changes in accounts receivable and
unearned revenue have typically had the largest impact on our cash flows. The
days sales outstanding metric, which is calculated by dividing quarter-end
accounts receivable by average daily sales for the quarter, was 36 days at March
31, 2005 compared to 30 days at of March 31, 2004. We attempt to structure our
sales contracts to require a majority of payments in 30 days or less, and all
payments in 90 days or less. To the extent that competitive pressures require us
to extend our terms, it would result in a decrease to our operating cash flows.
Our annual customer support agreements are typically prepaid at the beginning of
the support period, resulting in a large cash inflow and a corresponding
increase in unearned maintenance revenue. This has historically resulted in
significant cash inflows in the first quarter, when the largest portion of our
support agreements renews. This trend continued in the first quarter of 2005.
Net cash generated from investing activities was $83.3 million compared to
net cash used in investing activities of $5.9 million in the three months ended
March 31, 2005 and 2004, respectively. Capital spending has been fairly
consistent and under tight budgetary control and accounted for net cash used of
$1.6 million in the first quarter of 2005 and $2.7 million in the first quarter
of 2004. We do not expect capital expenditure levels in 2005 to differ
significantly from the level of the past year. Significant changes in cash from
investing activities have resulted from the purchase and sale of investments.
Excess cash from operations is invested in high quality debt instruments and
securities, and the timing of purchases and maturities of investments could
result in significant short-term fluctuations in net cash used or generated from
investing activities. During the first quarter of 2005, most auction-rate
securities were sold which resulted in an increase in cash and cash equivalents
and at the same time generated the large increase from proceeds from the sale of
marketable securities that is reflected in the first quarter of 2005. As we
27
continue to generate excess cash, we expect to invest such amounts in marketable
securities and thus continue to show a net use of cash related to investing
activities. However, based on the nature of our investment policy, all such
investments are available in the short term if needed for any reason.
Net cash provided by financing activities results from the proceeds of
common stock related to employee stock option plans and employee stock purchase
plans. Cash generated from this activity was $1.3 million for the three months
ended March 31, 2005 compared to $10.2 million for the same period in 2004.
Stock prices unfavorably influenced this activity in the first quarter of 2005
with a lower stock price compared to the first quarter of 2004. When our stock
price is greater than the exercise price of outstanding stock options, we expect
to generate cash from option exercises.
The effect of exchange rate changes on cash and cash equivalents held in
foreign currency had the effect of decreasing net cash in the two periods as the
Euro and other currencies weakened against the dollar in those two quarters.
We have no borrowing arrangements as of March 31, 2005. We believe that our
present cash balances, together with internally generated funds, will be
sufficient to meet our working capital and capital expenditures throughout 2005.
See "Risk Factors".
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 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.
New Accounting Pronouncements
In March 2004, The FASB issued EITF Issue No. 03-1 (EITF 03-1), "The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments" which provides new guidance for assessing impairment losses on
investments. Additionally, EITF 03-1 includes new disclosure requirements for
investments that are deemed to be temporarily impaired. In September 2004, the
FASB delayed the accounting provisions for EITF 03-1; however the disclosure
requirements remain effective for annual periods ending after June 15, 2004. We
will evaluate the impact of EITF 03-1 once final guidance is issued.
In December 2004, the FASB revised Statement No. 123 (FAS 123R),
"Share-Based Payment," which requires companies to expense the estimated fair
value of employee stock options and similar awards based on the grant-date fair
value of the award. The cost will be recognized over the period during which an
employee is required to provide service in exchange for the award, usually the
vesting period. The accounting provisions of FAS 123R will be effective as of
the beginning of the first fiscal year that begins after June 15, 2005. We will
adopt the provisions of FAS 123R on January 1, 2006 using a modified prospective
application. Under the modified prospective application, FAS 123R, will apply to
new awards, unvested awards that are outstanding on the effective date and any
awards that are subsequently modified or cancelled. Compensation expense for
outstanding awards for which the requisite service had not been rendered as of
the effective date will be recognized over the remaining service period using
28
the compensation cost calculated for pro forma disclosure purposes under FAS 123
(Note 3 Stock-Based Compensation). We are in the process of determining how the
new method of valuing stock-based compensation as prescribed in FAS 123R will be
applied to valuing stock-based awards granted after the effective date and the
impact the recognition of compensation expense related to such awards will have
on our financial statements.
Other Matters
Environmental Matters. We are not aware of any issues related to
environmental matters that have, or are expected to have, a material affect on
our business.
Risk Factors That May Affect Future Results
Except for the historical information and discussions contained herein,
statements contained in this Form 10-Q may constitute "forward looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. These statements are based on current expectations and assumptions that
involve a number of risks, uncertainties and other factors that could cause
actual results to differ materially from recent results or from our anticipated
future results. We operate in a rapidly changing economic and technological
environment that presents numerous risks. Prospective and existing investors are
strongly urged to carefully consider the various cautionary statements and risks
set forth in this 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 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 information technology spending trends;
o the discretionary nature of our customers' budget and purchase cycles
and the absence of long-term customer purchase commitments;
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;
o general domestic and international economic and political conditions;
o seasonality in technology purchases, and
o a significant portion of our expenses are personnel related and fixed
and cannot be adjusted quickly in response to actual or anticipated
revenue trends.
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
29
upon as indications of future performance. Moreover, such factors could cause
our operating results in a given quarter to be below the expectations of public
market analysts and investors. In either case, the price of our common stock
could decline materially.
The markets in which we operate are highly competitive and we cannot be
sure that we will be able to continue to compete effectively, which could result
in lost market share and reduced revenue. The markets we serve are highly
competitive and we expect competition to intensify 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 EMC either have entered or may enter our market by adding
content management features to their existing suite of products. In
addition, large hardware or infrastructure 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 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 partners;
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.
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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 enterprise 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 our products and solutions
may not 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 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, three new product suites that we predict
can address new markets include Records Manager, E-Mail Manager and Team
Collaboration Manager. The Records Manager Suite was released in the third
quarter of 2004 and provides customers with the capability to systematically
apply records management principles to content. E-Mail Manager was released in
late 2004 and allows organizations with large numbers of email users to
effectively manage email content. The Team Collaboration Manager Suite was
released during the first quarter of 2005 and is designed to enable customers to
initiate collaborative tasks at any point in a process.
We may not be successful in developing, marketing and releasing new
products or new versions of our products that respond to technological
developments, evolving industry standards or changing customer requirements. We
may also experience technical difficulties that could delay or prevent the
successful development, introduction, sale and implementation 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.
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.
31
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 19% of annual revenue in research and development
efforts in the near term. The majority of our investment in new and existing
market opportunities is made prior to our ability to generate revenue from these
new opportunities. These investments of money and resources are made based on
our prediction of new products and services that we anticipate 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 a portion of our
software development of specific products and software localization work. As a
result, we will become increasingly dependent on these third party developers
for continued development and support 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.
If our products contain errors or performance problems, 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 performance problems, 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
often 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.
32
The limitation of liability provisions contained in our license agreements
may not be effective as a result of existing or future federal, state or local
laws or ordinances or unfavorable judicial decisions. Our license agreements
with our customers typically contain provisions designed to limit our exposure
to potential product liability claims. Although product liability claims to date
have been immaterial, the sale and support of our products entails the risk of
such claims, which could be substantial in light of our customers' use of such
products in mission-critical applications. If a claimant brings a product
liability claim against us, it could have a material adverse effect on our
business, results of operations and financial condition. Even if our software is
not at fault, we could suffer material expense and material diversion of
management time in defending any such lawsuits.
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, and natural disasters that disable these
systems could result in a disruption in our ability to transact business. We
depend on the integrity of our information systems network connectivity to
perform these business functions. While mitigating measures have been put in
place, significant business interruption could occur at our Costa Mesa
headquarters facility due to a natural disaster such as an 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.
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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 broaden the number
of third party platforms with which our products are compatible and the loss of
these relationships could harm our business. In order to broaden the number of
third party platforms with which our products are compatible and thereby broaden
the market opportunities for our products, we have established strategic
relationships with a number of software and hardware platform vendors, including
companies such as BEA Systems Inc., Hewlett-Packard Development Company LP,
Network Appliance, Inc., Sun MicroSystems and Veritas Software Corporation. 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,
it 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. Also, certain of our products include
publicly available software pursuant to open source license agreements. We would
be unable to sell these 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 until replacement functionality could
be developed, licensed or acquired. 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, licensed or acquired 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.
In addition to our direct sales force, we depend on relationships with
systems integrators, independent software vendors, and value added resellers to
sell our products and services. The loss of a large strategic partner could
affect our ability to sell in a specific segment of the market. We cannot assure
that these channel partners will remain in business or continue to promote or
sell our products or services. The loss or inability to maintain these channel
partner relationships, or our failure to establish new channel partner
relationships in the future, could harm our business, financial condition and
results of operations.
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:
34
o variations in quarterly operating results;
o fluctuations in our order levels;
o announcements of technological innovations or new products or product
enhancements by us or our competitors;
o key management changes;
o changes in accounting regulations;
o changes in joint marketing and development programs;
o developments relating to patents or other intellectual property rights
or disputes;
o developments in our relationships with our customers, resellers and
suppliers;
o our announcements of significant contracts, acquisitions, strategic
partnerships or joint ventures;
o general conditions in the software and computer industries;
o fluctuations in general stock market prices and volume, which are
particularly common among highly volatile securities of Internet and
software companies;
o acquisitions in the past have been primarily cash based transactions.
Future acquisitions may include stock, which could dilute earnings per
share 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 except for auction-rate
securities that are considered as short term investments for any maturities less
than 365 days. 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. The average maturity of our investment portfolio is 78 days; therefore,
the movement of interest rates should not have a material impact on our balance
sheet or income statement.
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.
At any time, a significant increase/decrease in interest rates will have an
impact on the fair market value and interest earnings of our investment
portfolio. We do not currently hedge this interest rate exposure. We have
performed a sensitivity analysis as of March 31, 2005 and 2004, 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
35
constant. The analysis covers our investment and is based on the
weighted-average maturity of our investments as of March 31, 2005 and 2004. 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 $314,000 at March 31, 2005 and
approximately $223,000 at March 31, 2004. 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 $629,000 at March 31, 2005 and
approximately $446,000 at March 31, 2004.
The following table provides information about our investment portfolio at
March 31, 2005:
.
Unrealized Estimated
(in thousands) Cost Gain/(Loss) Fair Value
Debt Securities
Due in one year or less:
Short-term munis-taxable $ 7,500 $ - $ 7,500
Corporate 7,091 (27) 7,064
Governments/Agencies 116,525 (409) 116,116
Total due in one year 131,116 (436) 130,680
Due in one to three years:
Government/Agencies 9,687 (102) 9,585
Total due in three years 9,687 (102) 9,585
Grand total $ 140,803 $ (538) $ 140,265
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 in an effort to hedge
against the effects of fluctuating currency exchange rates on monetary assets
and liabilities denominated in currencies other than the functional currency of
the relevant entity (mainly in Europe and Asia Pacific). 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. Gains and losses on foreign exchange
contracts are recognized in income in the same period as the gains and losses
occur. Our forward contracts have an original maturity of three months. These
contracts were closed on the last business day of the quarter ending March 31,
2005 and as such there were no outstanding forward contracts as of March 31,
2005.
Cumulative other comprehensive income decreased $2.7 million during the
three-month period ended March 31, 2005 due to unrealized foreign currency
translation loss of $2.6 million resulting from the weakening of the Euro
against the U.S. dollar the first three months of 2005.
Management believes that inflation has not had a significant impact on the
prices of our products, the cost of our materials, or our operating results for
the three months ended March 31, 2005.
36
Item 4. Controls and Procedures
Conclusion regarding the effectiveness of disclosure controls and
procedures. We maintain disclosure controls and procedures that are designed to
ensure that information required to be disclosed in our Securities Exchange Act
of 1934 (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 March 31, 2005, 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 Securities Exchange Act of 1934 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.
Changes in internal control over financial reporting. 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 10 to Condensed Consolidated Financial Statements.
Item 6. Exhibits
The list of exhibits contained in the accompanying Index to Exhibits is
herein incorporated by reference.
37
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FILENET CORPORATION
May 10, 2005 By: /s/ Sam M. Auriemma .
Date Sam M. Auriemma, Executive Vice President and
Chief Financial Officer
(Principal Financial and Accounting Officer,
Authorized Signatory)
38
Index to Exhibits
Exhibit No. Exhibit Description
3.1* Restated Certificate of Incorporation, as amended (filed as Exhibit 3.1 to Registrant's Form S-4
filed on January 26, 1996; Registration No. 333-00676).
3.1.1* Certificate of Amendment of Restated Certificate of Incorporation (filed as Exhibit 3.1.1 to
Registrant's Form S-4 filed on January 26, 1996, Registration No. 333-00676).
3.2* Bylaws (filed as Exhibit 3.2 of the Registrant's registration statement on Form S-1, Registration
No. 33-15004).
4.1* Form of certificate evidencing Common Stock (filed as Exhibit 4.1 to Registrant's registration
statement on Form S-1, Registration No. 33-15004).
4.2* Rights Agreement, dated as of November 4, 1988 between FileNet Corporation and the First National
Bank of Boston, which includes the form of Rights Certificate as Exhibit A and the Summary of Rights
to Purchase Common Shares as Exhibit B (filed as Exhibit 4.2 to Registrant's registration statement
on Form S-4 filed on January 26, 1996; Registration No. 333-00676).
4.3* Amendment One dated July 31, 1998 and Amendment Two dated November 9, 1998 to Rights Agreement dated
as of November 4, 1988 between FileNet Corporation and BANKBOSTON, N.A. formerly known as The First
National Bank of Boston (filed as Exhibit 4.3 to Registrant's registration statement on Form 10-Q
for the quarter ended September 30, 1998).
4.4* Amendment Three dated November 30, 2001 to Rights Agreement dated as of November 4, 1988 between
FileNet Corporation and Equiserve Trust Company, N.A., successors to BANKBOSTON, N.A. (filed as
Exhibit 4.4 to Registrant's Annual Report on Form 10-K filed for the year ended December 31, 2001).
10.2*+ Amended and Restated 1995 Stock Option Plan of FileNet (filed as Exhibit 99.1 to Registrant's
registration statement on Form S-8 filed on October 15, 2001; Registration No. 333-71598).
10.2.1*+ Amendment to the 1995 Stock Option Plan approved by Registrant's Board of Directors dated May 7,
2003 (filed as Exhibit 10.2.1 to Registrant's Quarterly Report on Form 10-Q for the quarter ended
June 30, 2003).
10.2.2*+ Amended Form of 1995 Executive Officer Stock Option Agreement (filed as Exhibit 10.2.2 to
Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003).
10.3*+ Second Amended and Restated 1986 Stock Option Plan of FileNet Corporation, together with the forms
of Incentive Stock Option Agreement and Non-Qualified Stock Option Agreement (filed as Exhibits
4(a), 4(b) and 4(c), respectively, to the Registrant's registration statement on Form S-8,
Registration No. 33-48499), the first Amendment thereto (filed as Exhibit 4(d) to the Registrant's
registration statement on Form S-8, Registration No. 33-69920), and the Second Amendment thereto
(filed as Appendix A to the Registrant's Proxy Statement for the Registrant's 1994 Annual Meeting of
Stockholders, filed on April 29, 1994).
10.4*+ Non-Statutory Stock Option Agreement (with Notice of Grant of Stock Option and Special Addendum)
between Registrant and Mr. Lee Roberts (filed as Exhibit 99.17 to Registrant's registration
statement on Form S-8 filed on August 20, 1997).
10.6*+ Amended and Restated FileNet Corporation 1998 Employee Stock Purchase Plan (filed as Appendix B to
Registrant's Definitive Proxy Statement on Schedule 14A, for the Registrant's 2002 Annual Meeting of
Stockholders, filed on April 18, 2002).
10.6.1*+ Amendment No. 1 to the FileNet Corporation Amended and Restated 1998 Employee Stock Purchase Plan
(filed as exhibit 10.6.1 to Registrant's Current Report of Form 8-K filed on April 11, 2005).
10.6.2*+ Revised Amendment No. 1 to the FileNet Corporation Amended and Restated 1998 Employee Stock Purchase
Plan (filed as exhibit 10.6.2 to Registrant's Current Report of Form 8-K filed on April 21, 2005).
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).
10.7.1*+ Amendment No. 1 to the FileNet Corporation Amended and Restated International Employee Stock
Purchase Plan (filed as exhibit 10.7.1 to Registrant's Current Report of Form 8-K filed on April 11,
2005).
10.7.2*+ Revised Amendment No. 1 to the FileNet Corporation Amended and Restated International Employee Stock
Purchase Plan (filed as exhibit 10.7.2 to Registrant's Current Report of Form 8-K filed on April 21,
2005).
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).
39
10.10*+ Written Compensation Agreement and Non-Statutory Stock Option Agreement (with Notice of Grant of
Stock Option and Special Addendum) between Registrant and Mr. Sam Auriemma (filed as Exhibit 99.1
and 99.2 to Registrant's registration statement on Form S-8, filed on April 20, 2001; Registration
No. 333-59274).
10.11* Asset Purchase Agreement dated April 2, 2002 by and between 3565 Acquisition Corporation and eGrail,
Inc. (filed as Exhibit 10.1 to Registrant's Current Report on Form 8-K, filed on April 12, 2002).
10.12*+ Secured Promissory Note between Registrant and Mr. Lee D. Roberts dated June 14, 2002 (filed as
Exhibit 10.12 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
10.13*+ Option Exchange Agreement between Registrant and Mr. Ron L. Ercanbrack, dated May 22, 2002, together
with form of Incentive Stock Option Agreement and Grant Notice (filed as Exhibit 10.13 to
Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
10.14*+ The 2002 Incentive Award Plan, as approved by stockholders at the Registrant's Annual Meeting on May
22, 2002, together with the forms of Incentive Option Agreement and Non-Qualified Stock Option
Agreement for Independent Directors (filed as Exhibit 10.14 to Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 2002).
10.14.1*+ Amended Form of 2002 Incentive Award Plan Incentive Option Agreement with Notice of Grant of Stock
Option (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, William J. Kreidler,
Chas W. Kunkelmann, Philip Rugani, Daniel S. Whelan, Franz X. Zihlmann, and Ms. Audrey N. Schaeffer.
Amended and Restated Letter Agreement with substantially the same terms and conditions was entered into
between Registrant and Philip C. Maynard dated August 30, 2004, and L. Kim Poindexter dated January 1,
2005.
40
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)) and internal control over financial
reporting (as defined in Exchange Act Rules 13-a-15(f) and 15d-15(f)) 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) designed such internal control and procedures, or caused such
internal control over financial reporting to be designed under our
supervision, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting
principles;
c) 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
d) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal quarter in the case
of an annual report) that has materially affected, or is reasonably likely
to materially affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
control over financial reporting.
Date: May 10, 2005
/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)) and internal control over financial
reporting (as defined in Exchange Act Rules 13-a-15(f) and 15d-15(f)) 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) designed such internal control and procedures, or caused such
internal control over financial reporting to be designed under our
supervision, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting
principles;
c) 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
d) disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's most
recent fiscal quarter (the registrant's fourth fiscal quarter in the case
of an annual report) that has materially affected, or is reasonably likely
to materially affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to record,
process, summarize and report financial information; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
control over financial reporting.
Date: May 10, 2005
/s/ Sam M. Auriemma .
Sam M. Auriemma
Chief Financial Officer
2
Exhibit 32.1
Certification of Chief Executive Officer
Certification Pursuant To 18 U.S.C. Section 1350,
Created by Section 906
of The Sarbanes-Oxley Act of 2002
The undersigned officer of FileNET Corporation (the "Company"), hereby
certifies, to such officer's knowledge, that:
(i) the accompanying Quarterly Report on Form 10-Q of the Company for the
fiscal period ended March 31, 2005 (the "Report") fully complies with the
requirements of Section 13(a) or Section 15(d), as applicable, of the Securities
Exchange Act of 1934, as amended; and
(ii) the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
Dated: May 10, 2005
/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 March 31, 2005 (the "Report") fully complies with the
requirements of Section 13(a) or Section 15(d), as applicable, of the Securities
Exchange Act of 1934, as amended; and
(ii) the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
Dated: May 10, 2005
/s/ Sam M. Auriemma .
Sam M. Auriemma
Senior Vice President and
Chief Financial Officer
(Principal Financial Officer)