FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1996
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: 0-15997
FILENET CORPORATION
State or other jurisdiction of (I.R.S. Employer
incorporation or organization Identification No.)
Delaware 95-3757924
FILENET CORPORATION
3565 Harbor Boulevard
Costa Mesa, CA 92626
(714) 966-3400
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 the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
Title Outstanding
Common stock 15,184,532 as of November 4, 1996
<PAGE>
FILENET CORPORATION
Index
Page
Number
--------
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Balance Sheets
as of September 30, 1996 and December 31, 1995................... 1
Consolidated Statements of Operations for the fiscal quarters
and nine months ended September 30, 1996 and October 1, 1995..... 2
Consolidated Statements of Cash Flows for the nine months ended
September 30, 1996 and October 1, 1995........................... 3
Notes to Consolidated Financial Statements....................... 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................ 7
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................ 13
Item 5. Certain Considerations........................................... 13
Item 6. Exhibits and Reports on Form 8-K................................. 18
SIGNATURE........................................................ 19
INDEX TO EXHIBITS................................................ 20
<PAGE>
Part I. Financial Information
Item 1. Financial Statements
FILENET CORPORATION
Consolidated Balance Sheets
(In thousands, except share amounts)
(Unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
------------ ------------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents................... $ 22,820 $ 43,378
Short-term marketable securities............ 25,623 28,782
------- -------
Total cash and short-term marketable
securities.............................. 48,443 72,160
------- -------
Accounts receivable, net.................... 71,863 53,501
Inventories................................. 8,128 6,620
Prepaid expenses and other.................. 8,152 6,573
Deferred income taxes....................... 3,735 3,735
------- -------
Total current assets............................. 140,321 142,589
------- -------
Net property and equipment....................... 26,979 25,796
Other assets:
Capitalized software, net................... 448 1,226
Long-term marketable securities............. 12,608 18,395
Other....................................... 1,851 1,676
-------- --------
Total other assets............................... 14,907 21,297
------ ------
Total assets..................................... $182,207 $189,682
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................. $ 12,096 $ 16,073
Accrued liabilities:
Compensation............................. 11,943 10,997
Income taxes payable..................... 3,117 2,228
Unearned maintenance revenue............. 7,224 5,761
Royalties................................ 4,565 3,572
Other.................................... 16,284 17,604
-------- --------
Total current liabilities......................... 55,229 56,235
-------- --------
Deferred income taxes............................. 2,340 2,289
Stockholders' equity:
Convertible preferred stock - $.001 par
value; authorized, 39,000,000 shares;
35,232,029 issued and outstanding shares and
1,531,536 common equivalent shares at the
liquidation preference at December 31, 1995. - 19,879
Common stock - $.01 par value; authorized,
100,000,000 shares; issued and outstanding
15,155,596 and 13,254,222 shares at
September 30, 1996 and December 31, 1995,
respectively................................ 124,716 100,719
Retained earnings............................. 4,642 10,518
Other......................................... (152) 42
------- -------
Total 129,206 131,158
Less Treasury shares at cost: 200,000 shares at
September 30, 1996............................... 4,568 -
------- -------
Total stockholders' equity......................... 124,638 131,158
------- -------
Total liabilities and stockholders' equity......... $182,207 $ 189,682
======== =========
</TABLE>
See accompanying notes to consolidated financial statements.
1
<PAGE>
FILENET CORPORATION
Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Fiscal Quarter Ended Nine Months Ended
------------------------ ------------------------
September 30, October 1, September 30, October 1,
1996 1995 1996 1995
------------------------ ------------------------
<S> <C> <C>
Revenue:
Software revenue....... $ 32,999 $ 26,911 $ 103,152 $ 78,668
Service revenue........ 20,462 17,056 57,770 49,022
Hardware revenue....... 11,161 13,131 35,441 33,950
------ ------ ------ ------
Total revenue........... 64,622 57,098 196,363 161,640
------ ------ ------- -------
Costs and expenses:
Cost of software revenue.. 3,520 3,738 12,164 10,929
Cost of service revenue... 13,832 10,234 37,626 31,969
Cost of hardware revenue.. 6,729 7,993 22,326 21,407
Research and development.. 9,104 6,756 26,583 17,458
Selling, general and
administrative........... 27,492 23,339 86,368 67,968
Merger, restructuring and
write-off of purchased
in-process research and
development costs........ - 6,393 16,011 6,393
-------- -------- --------- --------
Total costs and expenses... 60,677 58,453 201,078 156,124
-------- -------- --------- --------
Operating income (loss) 3,945 (1,355) (4,715) 5,516
Other income, net......... 630 711 2,224 2,036
-------- -------- --------- --------
Income (loss) before
income taxes............. 4,575 (644) (2,491) 7,552
Provision for income
taxes.................... 1,144 822 3,385 4,538
--------- --------- ---------- --------
Net income (loss)......... $ 3,431 $ (1,466) $ (5,876) $ 3,014
========= ========= ========== ========
Net income (loss) per
share.................... $ 0.22 $ (0.10) $ (0.39) $ 0.19
========= ========= ========== ========
Weighted average common
and common equivalent
shares outstanding....... 15,560 14,506 14,999 15,757
========= ========= ========= ========
</TABLE>
See accompanying notes to consolidated financial statements.
2
<PAGE>
FILENET CORPORATION
Consolidated Statements Of Cash Flows
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
-----------------------------------
September 30, October 1,
1996 1995
------------------- -------------
<S> <C> <C>
Cash flows from operating activities:
Net Income (loss).................. $ (5,876) $ 3,014
Adjustments to reconcile net
income (loss) to net cash
(used by)provided by operating
activities:
Write-off of capitalized and
purchased in-process research
and development and associated
acquisition costs.............. 10,011 1,393
Depreciation and amortization.... 8,647 7,587
Capitalized software
amortization................... 778 1,800
Provision for losses on accounts
receivable..................... 116 598
Changes in operating assets and
liabilities, net of acquisition:
Accounts receivable.......... (18,478) (9,746)
Inventories.................. (1,508) (2,181)
Prepaid expenses............. (1,579) (3,334)
Accounts payable............. (3,977) 1,669
Accrued liabilities:
Compensation............... 946 (596)
Income taxes payable....... 889 1,621
Unearned maintenance
revenue.................. 1,463 1,534
Royalties.................. 993 1,691
Other...................... 558 1,858
-------- -------
Net cash (used by) provided by operating
activities............................ (7,017) 6,908
-------- -------
Cash flows from investing activities:
Proceeds from sale of equipment.... 3,047 97
Capital expenditures............... (12,825) (9,244)
Capitalized software............... - (1,600)
Payment for purchase of IFSL....... (11,711) -
Purchase of marketable securities.. (22,037) (35,161)
Proceeds from sales and maturity
of marketable securities.......... 30,435 24,950
------ ------
Net cash used by investing activities... (13,091) (20,958)
-------- --------
Cash flows from financing activities:
Debt repayments, net............... - (163)
Common stock repurchased........... (4,568) -
Proceeds from issuance of common
stock............................. 4,118 7,436
-------- --------
Net cash (used by) provided by financing
activities......................... (450) 7,273
-------- --------
Net decrease in cash and cash
equivalents........................ (20,558) (6,777)
Cash and cash equivalents,
beginning of year.................. 43,378 24,950
-------- --------
Cash and cash equivalents,
end of period...................... $ 22,820 $ 18,173
========= =========
Supplemental cash flow information:
Interest paid....................... $ 293 $ 180
Income taxes paid................... $ 2,859 $ 3,229
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
FILENET CORPORATION
Notes To Consolidated Financial Statements
1. In the opinion of the management of FileNet Corporation ("the Company"),
the accompanying unaudited consolidated financial statements reflect
adjustments (consisting of normal recurring adjustments) necessary to
present fairly the financial position of the Company at September 30, 1996
and the results of its operations for the fiscal quarters and nine months
ended September 30, 1996 and October 1, 1995 and its cash flows for the
nine months ended September 30, 1996 and October 1, 1995. Certain
information and footnote disclosures normally included in financial
statements have been condensed or omitted pursuant to rules and regulations
of the Securities and Exchange Commission ("SEC"), although the Company
believes that the disclosures in the consolidated financial statements are
adequate to ensure the information presented is not misleading. These
consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto, and Management's
Discussion and Analysis of Financial Condition and Results of Operations
contained in the Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1995, with the Form S-4 Registration Statement filed by
the Company with the SEC on January 17, 1996, as amended January 24, 1996,
and with the Company's Current Report on Form 8-K, dated March 1, 1996, and
filed by the Company with the SEC on March 13, 1996. The results of
operations for the interim periods are not necessarily indicative of the
operating results for the year.
2. Certain reclassifications have been made to the prior year's consolidated
financial statements to conform with the current year's presentation.
3. Net income per share for the quarter ended September 30, 1996 and for the
nine months ended October 1, 1995 was computed using the weighted average
number of common and common equivalent shares outstanding during the
period. Common equivalent shares include convertible preferred stock and
stock options. Net loss per share for the quarter ended October 1, 1995 and
for the nine months ended September 30, 1996 was based upon the weighted
average number of actual shares of common stock outstanding.
4. On January 30, 1996, the Company purchased all of the outstanding shares of
International Financial Systems Ltd. ("IFSL"), a New York corporation, the
developer of a Computer Output to Laser Disk (COLD) software product for
archiving documents. Pursuant to the Stock Purchase Agreement, the IFSL
stockholders received $11.2 million in cash for all of their IFSL stock.
The acquisition was accounted for as a purchase, and the purchase price was
allocated to net assets of $1.7 million and in-process research and
development costs of $9.5 million. As a result of the acquisition, the
Company recorded a pre-tax charge of approximately $10.0 million for
acquisition costs and the write-off of purchased in-process research and
development costs.
4
<PAGE>
5. On March 1, 1996, FileNet acquired all the outstanding shares of Saros
Corporation ("Saros"), a Washington corporation (the "Saros Acquisition").
The Saros Acquisition was consummated pursuant to an Agreement and Plan of
Merger (the "Saros Merger Agreement") dated January 17, 1996 by and among
Saros, the Company, and FileNet Acquisition Corporation ("Acquisition
Corp."), a Washington corporation and wholly-owned subsidiary of the
Company. Pursuant to the Saros Merger Agreement, Acquisition Corp. was
merged with and into Saros, with Saros surviving as a wholly-owned
subsidiary of the Company. The Saros stockholders received an aggregate of
approximately 1,878,000 shares of the Company's common stock and
approximately 337,000 options to purchase the Company's common stock in
exchange for all of their Saros stock and options. Approximately 188,000 of
the total number of the Company's shares issued to the Saros stockholders
(the "Saros Escrow Shares") were placed in an escrow account upon
consummation of the Saros Acquisition. Pursuant to the escrow agreement
entered into by the Company, the stockholders' agent and the escrow agent,
the Company may recover from the escrow up to the entire amount of Saros
Escrow Shares in the event the Company incurs any loss, expense, liability
or other damages (collectively, "Damages") due to a breach by Saros of any
of its representations, warranties and covenants in the Saros Merger
Agreement in the event Damages exceed $1.0 million in the aggregate. If no
claim for Damages is made by the Company within one year from the date of
the Merger, the Saros Escrow Shares will be released from escrow and
distributed to the Saros stockholders.
The Saros Acquisition was accounted for as a pooling-of-interests for
financial reporting purposes. The pooling-of-interests method of accounting
is intended to present as a single interest two or more common
stockholders' interests which were previously independent; accordingly, the
historical financial statements for the periods prior to the acquisition
have been restated as though the companies had been combined. Fees and
expenses related to the Saros Acquisition and restructuring costs incurred
in connection with the consolidation of certain operations of Saros and
Watermark Software Inc. ("Watermark"), were $6.0 million. The components of
this charge include professional fees, elimination of duplicate facilities,
write-off of certain contractual obligations and settlement costs,
write-off of certain fixed assets (including redundant hardware and
software systems), transition and severance payments to employees and other
integration and restructuring costs.
6. During the quarter ended September 30, 1996, Watermark and Saros, formerly
wholly-owned subsidiaries of the Company, were merged into the Company.
7. In July 1996, the Company's Board of Directors authorized the Company to
repurchase up to 200,000 shares of its common stock. As of September 30,
1996, the Company had purchased 200,000 shares at an aggregate cost of
approximately $4.6 million.
5
<PAGE>
8. In October 1994, Wang Laboratories, Inc. ("Wang") filed a complaint in the
United States District Court for the District of Massachusetts alleging
that the Company is infringing five patents held by Wang. On June 23, 1995,
Wang amended its complaint to include an additional related patent. On July
2, 1996, Wang filed a complaint in the same court alleging that Watermark
is infringing three of the same patents asserted in the initial complaint.
On October 9, 1996, Wang withdrew its claim that one of the patents it
initially asserted is infringed by FileNet products which were
commercialized before the initial complaint was filed. Wang reserved the
right to assert that patent against FileNet products commercialized after
that date in a separate lawsuit. Based on the Company's analysis of these
Wang patents and their respective file histories, the Company believes that
it has meritorious defenses to Wang's claims; however, the ultimate outcome
or any resulting potential loss cannot be determined at this time. If it
should be determined that Wang's patents are valid and are infringed by any
of the Company's products, including Watermark products, the Company will,
depending on the product, redesign the infringing products or seek to
obtain a license to market the products.
The Company, in the normal course of business, is subject to various
other legal matters. While the results of litigation and claims cannot be
predicted with certainty, the Company believes that the final outcome of
these other matters will not have a materially adverse effect on the
Company's consolidated results of operations or financial condition.
6
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
FILENET CORPORATION
The following should be read in conjunction with the unaudited consolidated
financial statements and notes thereto included in Part I--Item 1 of this
Quarterly Report, the audited consolidated financial statements, and notes
thereto, and Management's Discussion and Analysis of Financial Condition and
Results of Operations contained in the registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1995, the Form S-4 Registration Statement
filed by the Company with the SEC on January 17, 1996, as amended January 24,
1996, and with the Company's Current Report on Form 8-K, dated March 1, 1996,
and filed by the Company with the SEC on March 13, 1996.
Results of Operations
Factors That May Affect Future Results. Future operating results will
depend upon many factors, including the demand for the Company's products, the
level of price competition, the length of the Company's sales cycle, seasonality
of individual customer buying patterns, the size and timing of individual
transactions, possible delays or deferrals of customer implementations, the
budget cycles of the Company's customers, the timing of new product
introductions and product enhancements by the Company and its competitors, the
mix of sales by products and distribution channels, the level of international
sales, acquisitions by competitors, changes in foreign currency exchange rates,
the ability of the Company to develop and market new products and control costs,
and general domestic and international economic and political conditions. As a
result of these factors, revenue and operating results for any quarter may
fluctuate significantly. Therefore, the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as indications of future performance.
The Company's marketplace continues to be highly competitive. Other
companies offer lower priced products which in some applications compete with
FileNet products. Additionally, major computer suppliers and software companies
offer new competitive document-image, workflow and document management products.
The Company continues to experience competitive pricing pressures in all phases
of its operations and expects competition will continue to increase.
The market for the Company's products is characterized by rapid
technological developments, evolving industry standards, swift changes in
customer requirements and frequent new product introductions and enhancements.
The Company's continued success is dependent upon its ability to enhance its
existing products and to develop and introduce, in a timely manner, new products
incorporating technological advances which meet customer requirements. To the
extent one or more of the Company's competitors introduce products that more
fully address customer requirements, the Company's business could be adversely
affected.
The Company has entered into a number of significant co-marketing
relationships with companies such as Hewlett-Packard Company and Sun
Microsystems, Inc. There can be no assurance that these companies will not
7
<PAGE>
reduce or discontinue their relationship with or support of the Company and its
products. Disruption of these relationships could have a material adverse effect
on the Company's business and operating results.
The Company derives approximately one-third of its total revenue from
international sales. Its international business is subject to certain risks
including varying technical standards, tariffs and trade barriers, political and
economic instability, reduced protection for intellectual property rights in
certain countries, difficulties in staffing and maintaining foreign operations,
difficulties in managing foreign distributors, potentially adverse tax
consequences, foreign currency fluctuations, the burden of complying with a wide
variety of complex foreign laws, regulations and treaties and the possibility of
difficulties in collecting accounts receivable.
The Company acquired Watermark in August 1995 and Saros and IFSL in early
1996. These acquisitions have presented and continue to present the Company with
numerous challenges, including the effective assimilation of the operations,
technologies and personnel. While the company believes it is taking the
appropriate steps to effectively integrate these operations, difficulties in the
integration have had and could continue to have a negative impact on the
Company's overall financial results.
The Company believes that any of the above factors could have an adverse
effect on the Company's business and cause fluctuation in the Company's
operating results, perhaps substantially. In addition, in recent years the stock
market in general, and the market for shares of high technology stocks in
particular, have experienced extreme fluctuations which have often been
unrelated to operating performance. Such fluctuations could adversely affect the
market price of FileNet's common stock.
Revenue.
Domestic revenues increased 29% in the third quarter and 24% for the first
nine months of fiscal 1996 while international revenues decreased 12% in the
third quarter and increased 16% for the first nine months of fiscal 1996, when
compared to the corresponding periods in fiscal 1995. International revenues
constituted approximately 30% and 39% of total revenues in the third quarters of
fiscal 1996 and 1995, respectively, and 32% and 33% of total revenues in the
first nine months of fiscal 1996 and 1995, respectively. Management expects that
the Company's international operations will continue to provide a significant
portion of total revenues. However, international revenues could be adversely
affected if the U.S. dollar strengthens against international currencies.
<TABLE>
<CAPTION>
(In Millions) ------Third Quarter----- -------Nine Months------
% %
1996 1995 Change 1996 1995 Change
<S> <C> <C> <C> <C> <C> <C>
Software revenue $33.0 $26.9 23% $103.2 $ 78.7 31%
............................ ........................ ........................
Percentage of total revenue 51% 47% 53% 49%
............................ ........................ ........................
Service revenue 20.4 17.1 19% 57.8 49.0 18%
............................ ....................... ........................
Percentage of total revenue 32% 30% 29% 30%
............................ ........................ ........................
Hardware revenue 11.2 13.1 (15%) 35.4 33.9 4%
............................ ........................ ........................
Percentage of total revenue 17% 23% 18% 21%
............................ ........................ ........................
Total revenue $64.6 $57.1 13% $196.4 $161.6 22%
............................ ........................ ........................
</TABLE>
8
<PAGE>
Software revenue growth in the third quarter of 1996 compared to the same
period of 1995 was 23% and is due to an increase in the volume of product
shipments from the Company, additional revenue generated through the Company's
co-marketing arrangement with Hewlett-Packard Company, and the addition of new
products, reselling partners and direct sales force.
Service revenue increased by 19% for the quarter ended September 30, 1996
compared to the same period of 1995. Service revenue consists of revenue from
software and hardware maintenance services provided to the Company's customer
installed base and other revenue that includes professional services, training
and supplies. The increase was due to the growth of the Company's installed base
and the recognition of $2.5 million of revenue from the sale and repair of spare
parts in connection with the continued transition of hardware maintenance
activities to Hewlett Packard Company. The Company anticipates recognizing an
additional $2.0 million from spare parts sales for the quarter ended December
31, 1996. Such spare parts sales are not expected to be significant in 1997.
Hardware revenue decreased by 15% for the quarter ended September 30, 1996
compared to the same period of 1995. Hardware revenue as a percent of total
revenue declined, a trend which the Company expects will continue as it focuses
on increasing its higher margin software revenues.
For the nine months ended September 30, 1996, total revenue increased by 22% to
$196.4 million over the same period in 1995. Software and service revenue
increased by 31% and 18%, respectively, due to the reasons cited above.
Hardware revenue increased 4%, and as expected, decreased as a percent of
total revenue to 18% compared to 21% for the same period last year.
Cost of Revenue.
<TABLE>
<CAPTION>
(In Millions) ----Third Quarter---- ----Nine Months-----
% %
1996 1995 Change 1996 1995 Change
<S> <C> <C> <C> <C> <C> <C>
Cost of software revenue $ 3.5 $ 3.7 (5%) $12.2 $10.9 12%
.................................... ..................... ....................
As a percentage of software revenue 11% 14% 12% 14%
.................................... ..................... ....................
Cost of service revenue 13.8 10.2 35% 37.6 32.0 18%
.................................... ..................... ....................
As a percentage of service revenue 68% 60% 65% 65%
.................................... ..................... ....................
Cost of hardware revenue 6.7 8.0 (16%) 22.3 21.4 4%
.................................... ..................... ....................
As a percentage of hardware revenue 60% 61% 63% 63%
.................................... ..................... ....................
Total cost of revenue $24.0 $21.9 10% $72.1 $64.3 12%
.................................... ..................... ....................
As a percentage of total revenue 37% 38% 37% 40%
.................................... ..................... ....................
</TABLE>
The cost of software revenue includes royalties paid to third parties,
amortization of capitalized software and the cost of software distribution.
The 3% decrease in the cost of software revenue as a percentage of software
revenue for the quarter ended September 30, 1996 as compared to the same
period of 1995 is primarily attributable to a favorable product mix and the
savings related to consolidation of software distribution activities.
9
<PAGE>
The cost of service revenue includes the cost attributable to maintenance and
providing professional services. The cost of service revenue as a percentage of
service revenue increased by 8% in the third quarter of 1996 from the same
period of 1995 primarily due to lower margins associated with international
maintenance as a result of the continued transition of hardware maintenance
activities to Hewlett Packard Company.
The cost of hardware revenue includes the Company's cost of OSAR manufacturing,
third-party purchased hardware and the cost of hardware integration personnel
and related benefits and facilities expenses. The cost of hardware revenue as a
percentage of hardware revenue for the third quarter of 1996 decreased to 60%
from 61% in the same period of 1995 primarily due to a lower percentage of sales
of third-party purchased hardware.
For the nine months ended September 30, 1996, the cost of software revenue as a
percentage of software revenue decreased to 12% from 14% for the same period
last year due to the reasons cited above as well as lower amortization of
capitalized software expenses. The cost of service revenue as a percentage of
service revenue and the cost of hardware revenue as a percentage of hardware
revenue remained comparable for the first nine months of 1996 compared to the
same period in 1995.
Operating Expenses.
<TABLE>
<CAPTION>
(In Millions) ----Third Quarter---- ----Nine Months-----
% %
1996 1995 Change 1996 1995 Change
<S> <C> <C> <C> <C> <C> <C>
Research and development $ 9.1 $ 6.8 34% $26.6 $17.5 52%
................................... ..................... ....................
As a percentage of total revenue 14% 12% 14% 11%
................................... ..................... ....................
Selling, general and administrative $27.5 $23.3 18% $86.4 $68.0 27%
................................... ..................... ....................
As a percentage of total revenue 43% 41% 44% 42%
................................... ..................... ....................
</TABLE>
Research and Development. Research and development expenses increased by 34% in
the third quarter of 1996 over the same quarter last year due to the addition of
development personnel and related facilities and depreciation expenses
associated with new development activities. As a percentage of total revenue,
research and development expenses increased to 14% from 12% for the same period
last year due to the reasons cited above, and the Saros and Watermark business
units research and development expenses growing more rapidly than corresponding
revenue.
For the nine months ended September 30, 1996, research and development expenses
increased by 52% over the same period of 1995 due to the reasons cited above as
well as a reduction in capitalized software development costs. As a percentage
of total revenue, research and development costs increased to 14% compared to
11% for the same period last year.
Selling, General and Administrative. Selling, general and administrative
expenses increased by 18% for the third quarter of 1996 compared to the same
period in 1995. The increase in 1996 was primarily due to the addition of
marketing and sales support personnel. As a percentage of total revenue,
selling, general and administrative expenses increased to 43% from 41% for the
10
<PAGE>
same period last year primarily due to the reasons cited above.
For the nine months ended September 30, 1996, selling, general and
administrative expenses increased by 27% over the same period of 1995 for the
same reasons cited above. As a percentage of total revenue, selling, general and
administrative expenses increased to 44% compared to 42% for the same period
last year.
Merger, Restructuring and Write-off of Purchased In-process Research and
Development Costs. Merger, restructuring and write-off of purchased in-process
research and development costs for the nine months ended September 30, 1996,
consist of a $10.0 million charge for the write-off of purchased in-process
research and development and acquisition costs related to the IFSL purchase,
$6.0 million for fees and expenses related to the Saros Acquisition and
restructuring costs in connection with the consolidation of certain operations
of Saros and Watermark. Merger and other costs for the third quarter and nine
months ended October 1, 1995 consist of a charge for the buyout of certain
Watermark European marketing and manufacturing rights, a write-off of
capitalized research and development expenses for FileNet projects made
redundant by the Watermark acquisition, and other direct acquisition related
fees and expenses.
Interest and Other Income. Other income, net of other expenses, decreased in the
third quarter to $.6 million from $.7 million in the same quarter last year. For
the nine months ended September 30, 1996, other income, net of other expenses,
increased to $2.2 million from $2.0 million over the comparable period in 1995.
Effective Tax Rate. Non-deductible merger and other costs in the first quarter
of 1996 increased the estimated annual effective tax rate to 72% from 45%
previously estimated for 1996. The effect of the increased tax rate was recorded
in the first quarter. The effective rate for 1996 of 72% compares to 35% for
1995. The 1995 effective tax rate included the non-deductible merger costs for
the Watermark acquisition and preacquisition net operating losses incurred by
Watermark for which the Company did not receive a current year benefit.
Net Income. Net income for the third quarter ended September 30, 1996 was $3.4
million or $0.22 per share compared to a net loss of $1.5 million or $0.10 per
share for the same quarter in 1995. For the nine months ended September 30,
1996, net loss was $5.9 million or $0.39 per share compared to net income of
$3.0 million or $0.19 per share in 1995. Before merger, restructuring and
write-off of purchased in-process research and development costs of $16.0
million and $5.0 million, after tax for 1996 and 1995 respectively, net income
for the nine months ended September 30, 1996, was $10.1 million or $0.62 per
share on approximately 16.2 million weighted average common and common
equivalent shares, compared to $8.0 million or $0.51 cents per share on 15.8
million weighted average common and common equivalent shares for the same period
of 1995.
11
<PAGE>
Liquidity and Capital Resources
As of September 30, 1996, combined cash, cash equivalents and short- and
long-term marketable securities totaled $61.1 million, down from $90.6 million
for the fiscal year ended December 31, 1995. For the nine months ended September
30, 1996, net cash used by operating activities was $7.0 million, primarily
resulting from an increase in accounts receivable. Net cash used by investing
activities totaled $13.1 million, consisting of the purchase of IFSL of $11.7
million, capital expenditures of $12.8 million, $8.4 million in net proceeds
from marketable securities and $3.0 million in proceeds from the sale of
equipment. Net cash used by financing activities was $.5 million, consisting of
the net effect of the repurchase of common stock and the proceeds from the
exercise of employee stock options.
The Company has an unsecured line of credit of $20 million available from a
commercial bank. This line of credit expires in April 1997 and is subject to the
maintenance of certain financial covenants. The Company also has several
borrowing arrangements with foreign banks which expire at various times
throughout 1996 pursuant to which the Company may borrow up to approximately $2
million. As of September 30, 1996, there were no borrowings against these credit
lines.
The Company anticipates that its present cash balances together with internally
generated funds and credit lines (which are expected to be renewed or replaced)
will be sufficient to meet its working capital and capital expenditure needs for
at least the next 12 months.
- --------------------------------------------------------------------------------
This quarterly report on form 10-Q contains forward-looking statements that
involve risks and uncertainties, including those discussed below, in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", the "Notes to Consolidated Financial Statements" contained herein,
and elsewhere in this report. The actual results that the Company achieves may
differ materially from any forward-looking statements due to such risks and
uncertainties.
- --------------------------------------------------------------------------------
12
<PAGE>
Part II. Other Information
Item 1. Legal Proceedings.
In October 1994, Wang filed a complaint in the United States District
Court for the District of Massachusetts alleging that the Company is
infringing five patents held by Wang. On June 23, 1995, Wang amended
its complaint to include an additional related patent. On July 2,
1996, Wang filed a complaint in the same court alleging that Watermark
is infringing three of the same patents asserted in the initial
complaint. On October 9, 1996, Wang withdrew its claim that one of the
patents it initially asserted is infringed by FileNet products which
were commercialized before the initial complaint was filed. Wang
reserved the right to assert that patent against FileNet products
commercialized after that date in a separate lawsuit. Based on the
Company's analysis of these Wang patents and their respective file
histories, the Company believes that it has meritorious defenses to
Wang's claims; however, the ultimate outcome or any resulting
potential loss cannot be determined at this time. If it should be
determined that Wang's patents are valid and are infringed by any of
the Company's products, including Watermark products, the Company
will, depending on the product, redesign the infringing products or
seek to obtain a license to market the products. There can be no
assurance that the Company will be able to obtain such a license from
Wang on acceptable terms.
The Company, in the normal course of business, is subject to various
other legal matters. While the results of litigation and claims cannot
be predicted with certainty, the Company believes that the final
outcome of these other matters will not have a materially adverse
effect on the Company's consolidated results of operations or
financial condition.
Item 5. Certain Considerations.
This quarterly report on form 10-Q contains forward-looking statements
that involve risks and uncertainties, including those discussed below,
in "Management's Discussion and Analysis of Financial Condition and
Results of Operations", the "Notes to Consolidated Financial
Statements" contained herein, and elsewhere in this report. The actual
results that the Company achieves may differ materially from any
forward-looking statements due to such risks and uncertainties. All
such factors should be considered by investors in the Company.
RAPID TECHNOLOGICAL CHANGE; PRODUCT DEVELOPMENT. The market for the
Company's products is characterized by rapid technological
developments, evolving industry standards, swift changes in customer
requirements and frequent new product introductions and enhancements.
The Company's continued success will be dependent upon its ability to
continue to enhance its existing products, develop and introduce in a
timely manner new products incorporating technological advances and
respond to customer requirements. To the extent one or more of the
Company's competitors introduce products that more fully address
customer requirements, the Company's business could be adversely
affected. There can be no assurance that the Company will be
13
<PAGE>
successful in developing and marketing enhancements to its existing
products or new products on a timely basis or that any new or enhanced
products will adequately address the changing needs of the
marketplace. If the Company is unable to develop and introduce new
products or enhancements to existing products in a timely manner in
response to changing market conditions or customer requirements, the
Company's business and operating results could be adversely affected.
From time to time, the Company or its competitors may announce new
products, capabilities or technologies that have the potential to
replace or shorten the life cycles of the Company's existing products.
There can be no assurance that announcements of currently planned or
other new products will not cause customers to delay their purchasing
decisions in anticipation of such products, which could have a
material adverse effect on the Company's business and operating
results.
UNCERTAINTY OF FUTURE OPERATING RESULTS; FLUCTUATIONS IN QUARTERLY
OPERATING RESULTS. Prior growth rates in the Company's revenue and
operating results should not necessarily be considered indicative of
future growth, or of future operating results. Future operating
results will depend upon many factors, including the demand for the
Company's products, the effectiveness of the Company's efforts to
continue to integrate the recent acquisitions and achieve the desired
levels of product sales from such acquisitions, the level of product
and price competition, the length of the Company's sales cycle,
seasonality of individual customer buying patterns, the size and
timing of individual transactions, the delay or deferral of customer
implementations, the budget cycles of the Company's customers, the
timing of new product introductions and product enhancements by the
Company and its competitors, the mix of sales by products, services
and distribution channels, levels of international sales, acquisitions
by competitors, changes in foreign currency exchange rates, the
ability of the Company to develop and market new products and control
costs, and general domestic and international economic and political
conditions. As a result of these factors, revenues and operating
results for any quarter are subject to variation, and the Company
believes that period-to-period comparisons of its results of
operations are not necessarily meaningful and should not be relied
upon as indications of future performance.
COMPETITION. The imaging, workflow, computer output to laser disk
software and document management software markets are highly
competitive, and there are certain competitors of the Company with
substantially greater sales, marketing, development and financial
resources. The Company believes that the competitive factors affecting
the market for its products and services include vendor and product
reputation; product quality, performance and price; the availability
of products on multiple platforms; product scalability; product
integration with other enterprise applications; product functionality
and features; product ease-of use; and the quality of customer support
services and training. The relative importance of each of these
factors depends upon the specific customer involved. While the Company
believes it competes favorably in each of these areas, there can be no
assurance that it will continue to do so. Moreover, the Company's
present or future competitors may be able to develop products
comparable or superior to those offered by the Company, offer lower
price products or adapt more quickly than the Company to new
14
<PAGE>
technologies or evolving customer requirements. Competition is
expected to intensify. In order to be successful in the future, the
Company must respond to technological change, customer requirements
and competitors current products and innovations. There can be no
assurance that it will be able to continue to compete effectively in
its market or that future competition will not have a material adverse
effect on its business, operating results and financial condition.
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS. The Company's
success depends in part on its ability to protect its proprietary
rights to the technologies used in its principal products. The Company
relies on a combination of copyrights, trademarks, trade secrets,
confidentiality procedures and contractual provisions to protect its
proprietary rights. There can be no assurance that the Company's
existing or future copyrights, trademarks, trade secrets or other
intellectual property rights will be of sufficient scope or strength
to provide meaningful protection or commercial advantage to the
Company. FileNet has no software patents. Also, in selling certain of
its products, the Company relies on "shrink wrap" licenses that are
not signed by licensees and, therefore, may be unenforceable under the
laws of certain jurisdictions. In addition, the laws of some foreign
countries do not protect the Company's proprietary rights to the same
extent as do the laws of the United States. There can be no assurance
that such factors would not have a material adverse effect on the
Company's business or operating results. The Company may from time to
time be notified that it is infringing certain patent or intellectual
property rights of others. Combinations of technology acquired through
past or future acquisitions and the Company's technology will create
new products and technology which may give rise to claims of
infringement. While no actions other than the ones discussed below are
currently pending against the Company for infringement of patent or
other proprietary rights of third parties, there can be no assurance
that third parties will not initiate infringement actions against the
Company in the future. Infringement actions can result in substantial
cost to and diversion of resources of the Company. If the Company were
found to infringe upon the rights of others, no assurance can be given
that licenses would be obtainable on acceptable terms or at all, that
significant damages for past infringement would not be assessed or
that further litigation relative to any such licenses or usage would
not occur. The failure to successfully defend any claims or obtain
necessary licenses or other rights, the ultimate disposition of any
claims or the advent of litigation arising out of any claims of
infringement, could have a material adverse effect on the Company's
business, financial condition or results of operations.
In October 1994, Wang filed a complaint in the United States District
Court for the District of Massachusetts alleging that the Company is
infringing five patents held by Wang. On June 23, 1995, Wang amended
its complaint to include an additional related patent. On July 2,
1996, Wang filed a complaint in the same court alleging that Watermark
is infringing three of the same patents asserted in the initial
complaint. On October 9, 1996, Wang withdrew its claim that one of the
patents it initially asserted is infringed by FileNet products which
were commercialized before the initial complaint was filed. Wang
reserved the right to assert that patent against FileNet products
commercialized after that date in a separate lawsuit. Based on the
15
<PAGE>
Company's analysis of these Wang patents and their respective file
histories, the Company believes that it has meritorious defenses to
Wang's claims; however, the ultimate outcome or any resulting
potential loss cannot be determined at this time. If it should be
determined that Wang's patents are valid and are infringed by any of
the Company's products, including Watermark products, the Company
will, depending on the product, redesign the infringing products or
seek to obtain a license to market the products. There can be no
assurance that the Company will be able to obtain such a license from
Wang on acceptable terms.
DEPENDENCE ON CERTAIN RELATIONSHIPS. The Company has entered into a
number of co-marketing relationships with other companies such as
Microsoft Corporation, Compaq Computer Corporation, SAP AG,
Hewlett-Packard Company and Sun Microsystems, Inc. There can be no
assurance that these companies will not reduce or discontinue their
relationships with or support of the Company and its products.
Disruption of these relationships could have a material adverse effect
on the Company's business and operating results.
DEPENDENCE ON KEY MANAGEMENT AND TECHNICAL PERSONNEL. The Company's
success depends to a significant degree upon the continued
contributions of its key management, marketing, technical and
operational personnel, including members of senior management and
technical personnel of acquired companies. The Company has no
agreements providing for the employment of any of its key employees or
any fixed term and the Company's key employees may voluntarily
terminate their employment with the Company at any time. The loss of
the services of one or more key employees, including key employees of
acquired companies, could have a material adverse effect on the
Company's operating results. The Company also believes its future
success will depend in large part upon its ability to attract and
retain additional highly skilled management, technical, marketing,
product development and operational personnel. Competition for such
personnel is intense, and there can be no assurance that the Company
will be successful in attracting and retaining such personnel.
INTERNATIONAL SALES. Historically, the Company has derived
approximately one-third of its total revenues from international
sales. International business is subject to certain risks including
varying technical standards, tariffs and trade barriers, political and
economic instability, reduced protection for intellectual property
rights in certain countries, difficulties in staffing and maintaining
foreign operations, difficulties in managing foreign distributors,
potentially adverse tax consequences, currency exchange fluctuations,
the burden of complying with a wide variety of complex operations,
foreign laws, regulations and treaties and the possibility of
difficulties in collecting accounts receivable. There can be no
assurance that any of these factors will not have a material adverse
effect on the Company's business or operating results.
ACQUISITION-RELATED RISKS. The Company recently completed the
acquisitions of Watermark, Saros and IFSL. These recent acquisitions
by the Company have presented and will continue to present it with
16
<PAGE>
numerous challenges, including difficulties in the assimilation of the
operations, technologies and products of the acquired companies and
managing separate geographic operations. The challenges have absorbed
and may continue to absorb significant management attention that would
otherwise be available for the ongoing development of the Company's
business. If the Company's management does not respond to these
challenges effectively, the Company's results of operations could be
adversely affected. Moreover, there can be no assurance that the
anticipated benefits of the acquisitions will be realized. FileNet and
the acquired companies could experience difficulties or delays in
integrating their respective technologies or developing and
introducing new products. In particular, FileNet's interest in Saros
is in part based on the Company's evaluation of the market potential
for Saros' new products including the recently announced @mezzanine
and Saros Document Server for BackOffice which have yet to be proven
in the marketplace, as well as other products currently under
development. Delays in or non-completion of the development of these
new products, or lack of market acceptance of such products, could
have an adverse impact on the Company's future results of operations
and result in a failure to realize anticipated benefits of the
acquisitions.
PRODUCT LIABILITY. The Company's license agreements with customers
typically contain provisions designed to limit their exposure to
potential product liability claims. However, it is possible that such
limitation of liability provisions may not be effective under the laws
of certain jurisdictions. Although the Company has not experienced any
product liability claims to date, the sale and support of products by
them may entail the risk of such claims, and there can be no assurance
that the Company will not be subject to such claims in the future. A
successful product liability claim brought against the Company could
have a material adverse effect upon the Company's business, operating
results and financial condition.
STOCK PRICE VOLATILITY. The Company believes that a variety of factors
could cause the price of its common stock to fluctuate, perhaps
substantially, including quarter to quarter variations in operating
results; announcements of developments related to its business;
fluctuations in its order levels; general conditions in the technology
sector or the worldwide economy; announcements of technological
innovations, new products or product enhancements by the Company or
its competitors; key management changes; changes in joint marketing
and development programs; developments relating to patents or other
intellectual property rights or disputes; and developments in the
Company's relationships with its customers, distributors and
suppliers. In addition, in recent years the stock market in general,
and the market for shares of high technology stocks in particular, has
experienced extreme price fluctuations which have often been unrelated
to the operating performance of affected companies. Such fluctuations
could adversely affect the market price of the Company's Common Stock.
17
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
1. Exhibits
The list of exhibits contained in the accompanying Index to Exhibits
is herein incorporated by reference.
2. No reports on Form-8K were filed during the third quarter of fiscal 1996.
18
<PAGE>
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
By:/s/ Mark S. St. Clare
-------------------
Mark S. St. Clare
Chief Financial Officer and Sr. Vice President, Finance
(Principal Financial Officer)
Date: November 13, 1996
19
<PAGE>
Index to Exhibits
Exhibit No. Description
- ----------- -----------------------------------------------------------------
4.1* Form of certificate evidencing Common Stock (filed as Exhibit 4.1
to the 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 Form S-4 filed on January 26, 1996; Registration No.
333-00676).
10.1* Amended and Restated Credit Agreement (Multicurrency) by and
among the Registrant and Bank of America National Trust and
Savings Association dated August 8, 1995, effective May 1, 1995
(filed as Exhibit 10.1 to Form 10-Q for the quarter ended July 2,
1995).
10.2* Substitution Agreement between the Registrant and AT&T
Technologies, Inc. dated October 23, 1984 (filed as Exhibit 10.9
to the Form S-1).
10.3* Sublicensing Agreement between the Registrant and AT&T
Technologies, Inc. dated October 23, 1984 (filed as Exhibit 10.9
to the Form S-1).
10.4* Business Alliance Program Agreement between the Registrant and
Oracle Corporation dated July 1, 1996, as amended by Amendment
One thereto (filed as Exhibit 10.4 to Form 10-QA for the quarter
ended June 30, 1996).
10.5* Runtime Sublicense Addendum between the Registrant and Oracle
Corporation dated July 1, 1996, as amended by Amendment One
thereto (filed as Exhibit 10.4 to Form 10-QA for the quarter
ended June 30, 1996).
10.6* Full Use and Deployment Sublicense Addendum between the
Registrant and Oracle Corporation dated July 1, 1996, as amended
by Amendment One thereto (filed as Exhibit 10.4 to Form 10-QA for
the quarter ended June 30, 1996).
10.7* Lease between the Registrant and C. J. Segerstrom & Sons for the
headquarters of the Company, dated April 30, 1987 (filed as
Exhibit 10.19 to the Form S-1).
10.8* 1989 Stock Option Plan for Non-Employee Directors of FileNet
Corporation, as amended by the First Amendment, Second Amendment,
Third Amendment thereto (filed as Exhibit 10.9 to Form S-4 filed
on January 26, 1996; Registration No. 333-00676).
10.9* Amended and Restated 1995 Stock Option Plan of FileNet
Corporation as approved by stockholders at the Registrant's
Annual Meeting on May 8, 1996 (filed as Exhibit 99.1 to Form S-8
filed on July 29, 1996).
10.10* Second Amended and Restated Stock Option Plan of FileNet
Corporation, together with the forms of Incentive Stock Option
Agreement and Non-Qualified Stock Option Agreements (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),
and an 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).
10.11* Agreement for the Purchase of IBM products dated December 20,
1991 (filed on May 5, 1992 with the Form 8 amending the Company's
Form 10-K for the fiscal year ended December 31, 1991).
10.12* Software License Agreement between the Registrant and Mentat,
Inc. dated December 11, 1991 (filed on May 5, 1992 with the Form
8 amending the Company's Form 10-K for the fiscal year ended
December 31, 1991).
10.13* Development and Initial Supply Agreement between the Registrant
and Quintar Company dated August 20, 1992 (filed as Exhibit 10.21
to Form 10-K for the year ended January 3, 1993).
- --------------------------------------------------
* Incorporated herein by reference
20
<PAGE>
Exhibit No. Description
- ----------- -----------------------------------------------------------------
10.14* Amendment dated December 22, 1992 to the Development and
Initial Supply Agreement between the Registrant and Quintar
Company dated August 20, 1992 (filed as Exhibit 10.22 to Form
10-K for the year ended January 3, 1993).
10.15* Memorandum of Agreement effective June 30, 1994 between the
Registrant and Ing. C. Olivetti & C. S.p.A. (filed as Exhibit
10.24 to Form 10-Q for the quarter ended October 2, 1994).
10.16* Product License Agreement between the Registrant and Novell,
Inc. dated May 16, 1995 (filed as Exhibit 10.26 to Form 10-Q for
the quarter ended July 2, 1995).
10.17* Agreement and Plan of Merger between the Registrant and
Watermark Software Inc. dated July 18, 1995 (filed as Exhibit
10.27 to Form 10-Q for the quarter ended July 2, 1995).
10.18* Agreement and Plan of Merger between the Registrant and Saros
Corporation, as amended, dated January 17, 1996 (filed as
Exhibits 2.1, 2.2, 2.3, and 2.4 to Form 8-K on March 13, 1996).
10.19* Stock Purchase Agreement by and Among FileNet Corporation, IFS
Acquisition Corporation, Jawaid Khan and Juergen Goersch dated
January 17, 1996 and Amendment 1 to Stock Purchase Agreement
dated January 30, 1996 (filed as Exhibit 10.20 to form 10-K for
the year ended December 31, 1995).
27. Financial Data Schedule.
- -------------------------------------------------
* Incorporated herein by reference
21
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