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, 1997
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
(Exact name of Registrant as specified in its charter)
Delaware 95-3757924
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3565 Harbor Boulevard
Costa Mesa, CA 92626
(Address of principal executive offices) (Zip code)
(714) 966-3400
(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 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 15,272,020 at November 5, 1997
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FILENET CORPORATION
Index
Page Number
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PART I. FINANCIAL INFORMATION
Item 1. Consolidated Balance Sheets
as of September 30, 1997 and December 31, 1996............. 1
Consolidated Statements of Operations
for the quarters and nine months ended September 30, 1997 2
and 1996...................................................
Consolidated Statements of Cash Flows
for the nine months ended September 30, 1997 and 1996...... 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.......................................... 11
Item 5. Other Information.......................................... 11
Item 6. Exhibits and Reports on Form 8-K........................... 14
SIGNATURE.................................................. 15
INDEX TO EXHIBITS.......................................... 16
<PAGE>
Part I. Financial Information
Item 1. Financial Statements
FILENET CORPORATION
Consolidated Balance Sheets
(In thousands, except share amounts)
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
------------ ------------
ASSETS (Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents................... $ 42,802 $ 28,530
Short-term marketable securities............ 28,648 22,037
------ ------
Total cash and short-term marketable
securities............................... 71,450 50,567
------ ------
Accounts receivable, net.................... 47,720 75,469
Inventories................................. 5,514 8,794
Prepaid expenses and other.................. 7,111 8,336
Deferred income taxes....................... 6,181 5,641
----- -----
Total current assets........................... 137,976 148,807
------- -------
Net property and equipment..................... 26,459 28,329
Long-term marketable securities................ 5,618 16,705
Other.......................................... 848 1,838
--- -----
Total assets................................... $170,901 $195,679
======= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................ $ 12,390 $ 16,752
Accrued liabilities:
Compensation............................. 12,780 10,728
Unearned maintenance revenue............. 7,341 5,554
Royalties................................ 2,502 4,531
Other.................................... 14,031 21,903
------ ------
Total current liabilities...................... 49,044 59,468
------ ------
Deferred income taxes.......................... 3,359 3,405
Stockholders' equity:
Preferred stock - $.10 par value;
authorized, 7,000,000 shares; none
issued and outstanding...................
Common stock - $.01 par value; authorized,
100,000,000 shares; issued and outstanding,
15,513,435 and 15,230,566 shares at
September 30, 1997 and December 31, 1996,
respectively............................. 130,151 127,813
Retained earnings (accumulated deficit)..... (3,509) 7,874
Other....................................... (3,576) 1,687
------ -----
123,066 137,374
Less 200,000 treasury shares at cost........ 4,568 4,568
----- -----
Total stockholders' equity..................... 118,498 132,806
------- -------
Total liabilities and stockholders' equity..... $170,901 $195,679
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
1
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FILENET CORPORATION
Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -------------------
1997 1996 1997 1996
------ ------ ------ ------
<S> <C> <C> <C> <C>
Revenue:
Software revenue............ $ 34,684 $ 32,999 $ 87,841 $103,152
Service revenue............. 23,713 20,462 65,206 57,770
Hardware revenue............. 6,614 11,161 21,976 35,441
----- ------ ------ ------
Total revenue............... 65,011 64,622 175,023 196,363
------ ------ ------- -------
Costs and expenses:
Cost of software revenue..... 4,058 3,520 10,223 12,164
Cost of service revenue..... 14,010 13,832 40,906 37,626
Cost of hardware revenue..... 5,063 6,729 15,230 22,326
Research and development..... 9,613 9,104 29,346 26,583
Selling, general and
administrative............... 30,624 27,492 91,411 86,368
Merger, restructuring and
write-off of purchased
in-process research and
development costs......... 6,000 16,011
------ ------ ----- ------
Total costs and expenses.... 63,368 60,677 193,116 201,078
------- ------- ------- -------
Operating income (loss) 1,643 3,945 (18,093) (4,715)
Other income, net........... 984 630 2,285 2,224
--- --- ----- -----
Income (loss) before income
taxes.......................... 2,627 4,575 (15,808) (2,491)
Provision (benefit) for
income taxes................... 736 1,144 (4,425) 3,385
--- ----- ------ -----
Net income (loss).............. $ 1,891 $ 3,431 $(11,383) $ (5,876)
======== ======== ======== ========
Net income (loss) per share $ 0.12 $ 0.22 $ (0.75) $ (0.39)
======== ======== ======== ========
Weighted average common and
common equivalent shares
outstanding................. 15,615 15,560 15,165 14,999
====== ====== ====== ======
</TABLE>
See accompanying notes to consolidated financial statements.
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FILENET CORPORATION
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-----------------------------
1997 1996
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net loss....................................... $(11,383) $(5,876)
Adjustments to reconcile net loss to net
cash provided by (used by) operating
activities:
Write-off of purchased in-process
research and development costs............. 10,011
Depreciation and amortization............... 9,947 9,425
Changes in operating assets and
liabilities, net of acquisition:
Accounts receivable...................... 24,090 (18,315)
Inventories.............................. 3,395 (1,454)
Prepaid expenses and other............... 882 (1,788)
Accounts payable......................... (3,888) (3,860)
Accrued liabilities:
Compensation.......................... 2,257 993
Unearned maintenance revenue.......... 1,819 1,287
Royalties............................. (2,029) 989
Other.................................... (6,730) 1,561
------ -----
Net cash provided by (used by) operating
activities..................................... 18,360 (7,027)
------ ------
Cash flows from investing activities:
Proceeds from sale of equipment................ 407 2,823
Capital expenditures........................... (9,184) (12,539)
Payment for purchase of IFSL................... (11,711)
Purchases of marketable securities............. (22,462) (22,037)
Proceeds from sales and maturities of
marketable securities........................ 26,921 30,435
------ ------
Net cash used by investing activities.......... (4,318) (13,029)
------ -------
Cash flows from financing activities:
Common stock repurchased....................... (4,568)
Proceeds from issuance of common stock......... 2,338 4,118
----- -----
Net cash provided by (used by) financing
activities..................................... 2,338 (450)
Effect of exchange rate changes on cash and
cash equivalents.................................. (2,108) (52)
------ ---
Net increase (decrease) in cash and cash
equivalents....................................... 14,272 (20,558)
Cash and cash equivalents, beginning of year...... 28,530 43,378
------ ------
Cash and cash equivalents, end of period.......... $ 42,802 $22,820
======== =======
Supplemental cash flow information:
Interest paid.................................. $ 187 $ 293
Income taxes paid.............................. $ 2,768 $ 2,859
</TABLE>
See accompanying notes to consolidated financial statements.
3
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FILENET CORPORATION
Notes to Consolidated Financial Statements
(Unaudited)
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, 1997
and the results of its operations for the three months and nine months
ended September 30, 1997 and 1996 and its cash flows for the nine months
ended September 30, 1997 and 1996. 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
Results of Operations and Financial Condition contained in the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 1996, and
with the Company's Current Report on Form 8-K, dated April 1, 1997, and
filed by the Company with the SEC on April 1, 1997. 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 third quarter ended September 30, 1997 and
1996, was computed using the weighted average number of common and common
equivalent shares outstanding during the period. Net loss per share for the
nine months ended September 30, 1997 and 1996 was based upon the weighted
average number of actual shares of common stock outstanding.
4. During the second quarter ended June 30, 1997, the Company recognized $6.0
million in restructuring and other charges to consolidate the Watermark
business unit's Burlington, Massachusetts engineering and marketing
functions with those at FileNET's Costa Mesa, California location as well
as reduce headcount in certain other areas of the Company. The
restructuring and other charges consist primarily of severance costs,
write-off of impaired assets, and facility closing costs.
5. The $16.0 million merger, restructuring and write-off of purchased
in-process research and development costs for the nine months ended
September 30, 1996, consisted of $10.0 million for the write-off of
purchased in-process research and development costs related to the
acquisition of International Financial Systems, Ltd. ("IFSL") and $6.0
million in merger and restructuring costs related to the acquisitions of
Saros Corporation ("Saros") and Watermark Software Inc. ("Watermark").
6. In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share."
Under SFAS 128, the Company will be required to disclose basic earnings per
share and diluted earnings per share for all periods for which an income
statement is presented, which will replace disclosure currently being made
for primary earnings per share and fully diluted earnings per share. SFAS
128 requires adoption for fiscal periods ending after December 15, 1997.
The impact on the Company's earnings per share for the quarter and nine
months ended September 30, 1997 and 1996 is immaterial.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income," and SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." The Company has not yet
determined the impact, if any, of adopting these standards. SFAS 130 and
SFAS 131 are effective for fiscal years beginning after December 15, 1997.
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7. 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,
formerly a wholly-owned subsidiary that was merged into the Company, 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 the Company's products which were
commercialized before the initial complaint was filed. Wang reserved the
right to assert that patent against the Company's 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.
In March 1997, Eastman Kodak Company ("Kodak") purchased the Wang imaging
business unit that has responsibility for this litigation. The patents in
the suit have been transferred to a Kodak subsidiary, Kodak Limited of
England, which in turn has exclusively licensed them to another Kodak
subsidiary, Eastman Software, Inc. in the United States. On July 30, 1997,
the Court permitted Eastman Software, Inc. and Kodak Limited of England to
be substituted in the litigation in place of Wang. The Company cannot
predict what, if any, impact this will have on the litigation.
If it should be determined that the patents at issue in the litigation 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 on acceptable terms.
On December 20, 1996, plaintiff Michael I. Goldman filed a class action
complaint against the Company and certain of its officers and directors in
the Superior Court of California, County of Orange (the "State Action").
The action was purportedly filed on behalf of a class of purchasers of the
Company's common stock during the period October 19, 1995 through July 2,
1996. Plaintiff alleges that the Company and other defendants violated Cal.
Corp. Code Sections 25400 and 25500, Cal. Civ. Code Sections 1709-1710 and
Cal. Bus. & Prof. Code Sections 17200 et seq. in connection with various
public statements made by the Company and certain of its officers and
directors during the putative class period. The complaint seeks unspecified
compensatory and punitive damages, interest, attorneys' fees, expert
witness fees, costs, and equitable or injunctive relief.
On April 1, 1997, plaintiff Michael I. Goldman filed another class action
complaint against the Company and certain of its officers and directors in
the United States District Court for the Central District of California
(the "Federal Action"). The action purportedly was filed on behalf of the
same class of purchasers of the Company's common stock as the State Action.
The allegations contained in the Federal Action are very similar to the
allegations contained in the State Action, except that the Federal Action
asserts claims under Sections 10(b) and 20(a) of the Securities Exchange
Act and Rule 10b-5. The complaint seeks unspecified compensatory damages,
interest, attorneys' fees, expert witness fees, costs and equitable or
injunctive relief. On July 2, 1997, the court granted plaintiff's motion to
be appointed "lead plaintiff" under the Private Securities Litigation
Reform Act.
Defendants have filed a motion to dismiss the complaint in its entirety.
Plaintiff has filed a motion to stay the Federal Action, in light of the
parallel State Action. Both motions are scheduled to be heard by the court
on December 8, 1997.
In the State Action, the case was assigned to the Complex Case Panel of
Judges. Defendants demurred and moved to strike the complaint. The court
overruled the demurrer and denied the motion to strike on October 21, 1997.
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Defendants also moved to stay the action, in light of the parallel federal
case. The court granted the motion to stay the action as to discovery on
September 8, 1997. Plaintiff has filed a motion for class certification
which is scheduled to be heard by the court on December 19, 1997.
The Company believes that all of the allegations contained in the
complaints filed in the State and Federal Actions are without merit and
intends to defend the actions vigorously.
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 Operation
The following should be read in conjunction with the unaudited consolidated
financial statements and notes thereto included in Part I--Item 1 and Certain
Considerations in Part II--Item 5 of this Quarterly Report, the audited
consolidated financial statements, and notes thereto, and Management's
Discussion and Analysis of Results of Operations and Financial Condition
contained in the registrant's Annual Report on Form 10-K for the fiscal year
ended December 31, 1996, and with the Company's Current Report on Form 8-K filed
by the Company with the SEC on April 1, 1997.
Results of Operations
Revenue.
(In Millions) Third Quarter % Nine Months %
1997 1996 Change 1997 1996 Change
-------------------------------------------------
Software revenue $34.7 $33.0 5% $ 87.8 $103.2 (15%)
Percentage of total revenue 53% 51% 50% 53%
Service revenue $23.7 $20.4 16% $ 65.2 $ 57.8 13%
Percentage of total revenue 37% 32% 37% 29%
Hardware revenue $ 6.6 $11.2 (41%) $ 22.0 $ 35.4 (38%)
Percentage of total revenue 10% 17% 13% 18%
Total revenue $65.0 $64.6 1% $175.0 $196.4 (11%)
Software revenue increased 5% for the quarter ended September 30, 1997 over the
same period of 1996 due to an increase in the volume of product shipments.
Software revenue decreased 15% for the nine months ended September 30, 1997 over
the same period of 1996 due to a decrease in new domestic orders during the
first quarter of 1997 and a decrease in new international orders during the
first and second quarters of 1997.
Service revenue increased by 16% and 13% for the quarter and nine months ended
September 30, 1997, respectively, over the same periods of 1996. Service revenue
consists of revenue from software maintenance services provided to the Company's
customers and other revenue that includes professional services, training,
repairs and supplies. The increase was due to the growth of the Company's
installed base. Service revenue as a percentage of total revenue increased to
37% for the quarter and nine months ended September 30, 1997, compared to 32%
and 29% over the same period of 1996 due to the decrease in hardware revenue
noted below.
Hardware revenue decreased by 41% and 38% for the quarter and nine months ended
September 30, 1997 over the same periods of 1996 primarily due to a decrease in
new orders experienced both domestically and internationally and the Company's
focus on increasing its higher margin software revenues.
International revenues constituted approximately 32% and 30% of total revenues
in the third quarters of fiscal 1997 and 1996, respectively, and 29% and 32% of
total revenues for the nine months ended September 30, 1997 and 1996,
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.
7
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Cost of Revenue.
(In Millions) Third Quarter % Nine Months %
1997 1996 Change 1997 1996 Change
------------------------------------------
Cost of software revenue $ 4.0 $ 3.5 14% $10.2 $12.2 (16%)
As a percentage of software revenue 12% 11% 12% 12%
Cost of service revenue $14.0 $13.8 1% $40.9 $37.6 9%
As a percentage of service revenue 59% 68% 63% 65%
Cost of hardware revenue $ 5.1 $ 6.7 (24%) $15.2 $22.3 (32%)
As a percentage of hardware revenue 77% 60% 69% 63%
Total cost of revenue $23.1 $24.0 (4%) $66.3 $72.1 (8%)
As a percentage of total revenue 36% 37% 38% 37%
The cost of software revenue includes royalties paid to third parties and the
cost of software distribution. The cost of software revenue as a percentage of
software revenue for the quarter and nine months ended September 30, 1997
remained comparable to the same periods in 1996.
The cost of service revenue includes software support and professional services
personnel, supplies, and the cost of third party hardware maintenance. The cost
of service revenue as a percentage of service revenue for the third quarter of
1997 decreased to 59% from 68% in the same period of 1996 due to the lower
margins experienced internationally in 1996 as a result of the transition of
hardware maintenance activities to Hewlett Packard Company.
The cost of hardware revenue includes the Company's cost of manufacturing
optical storage and retrieval libraries ("OSAR"), third-party purchased hardware
and the cost of hardware integration personnel. The cost of hardware revenue as
a percentage of hardware revenue increased to 77% and 69% for the quarter and
nine months ended September 30, 1997, respectively, compared to 60% and 63% over
the same periods of 1996 due to the decrease in hardware revenue without a
corresponding decrease in fixed costs related to the Company's hardware
manufacturing and integration activities.
Operating Expenses.
(In Millions) Third Quarter % Nine Months %
1997 1996 Change 1997 1996 Change
-------------------------------------------
Research and development $ 9.6 $ 9.1 6% $29.3 $26.6 10%
As a percentage of total revenue 15% 14% 17% 14%
Selling, general and administrative $30.6 $27.5 11% $91.4 $86.4 6%
As a percentage of total revenue 47% 43% 52% 44%
Research and development expenses increased 6% for the third quarter of 1997 due
to a general increase in salaries necessitated by the intense competitive
environment for engineers in the software industry. As a percentage of total
revenue, research and development costs remained consistent for the third
quarter of 1997 compared to the same period of 1996.
For the nine month period ended September 30, 1997, research and development
expenses increased 10% over the same period of 1996 due to the reasons cited
above. As a percentage of total revenue, research and development costs
increased to 17% compared to 14% for the same period last year due to the
reasons cited above and the decrease in orders experienced during the first six
months of 1997. The Company expects that competition for qualified technical
personnel will remain intense for the foreseeable future and may result in
higher levels of compensation expense for the Company. The Company believes that
research and development expenditures, including compensation of technical
personnel, are essential to maintaining its competitive position and expects
these costs to continue to constitute a significant percentage of revenues.
Selling, general and administrative expenses increased 11% for the third quarter
of 1997 compared to the same period in 1996 due to the Company's continued
international expansion and higher legal costs as a result of the legal
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proceedings discussed in the Notes to Consolidated Financial Statements. As a
percentage of total revenue, selling, general and administrative expenses
increased to 47% from 43% for the same period last year primarily due to the
reasons cited above.
For the nine month period ended September 30, 1997, selling, general and
administrative expenses increased 6% over the same period of 1996 for the same
reasons cited above. As a percentage of total revenue, selling, general and
administrative expenses increased to 52% compared to 44% for the same period
last year due to the reasons cited above and the decrease in orders experienced
during the first six months of 1997.
MERGER, RESTRUCTURING AND WRITE-OFF OF PURCHASED IN-PROCESS RESEARCH AND
DEVELOPMENT COSTS. Restructuring and other charges of $6 million for the nine
months ended September 30, 1997, are related to the consolidation of the
Watermark business unit's Burlington, Massachusetts engineering and marketing
functions with those at FileNET's Costa Mesa, California location as well as a
reduction in headcount in certain other areas of the Company. The restructuring
charge consists primarily of severance costs, write-off of impaired assets, and
facility closing costs.
Merger, restructuring and write-off of purchased in-process research and
development costs for the nine months ended September 30, 1996, consisted of
$10.0 million for the write-off of purchased in-process research and development
costs related to the acquisition of IFSL and $6.0 million in merger and
restructuring costs related to the acquisitions of Saros and Watermark.
EFFECTIVE TAX RATE. The Company's combined federal, state and foreign annual
effective tax rate for the quarter ended September 30, 1997 was 28% compared to
45% for the same period in 1996. The 1996 effective tax rate reflected
non-deductible merger and other costs for the Saros and IFSL acquisitions. The
effective tax rate for 1996, exclusive of the non-deductible merger and other
costs, was 25%. The higher effective tax rate in 1997 is attributable to
earnings generated in certain foreign jurisdictions.
NET INCOME. Net income for the third quarter ended September 30, 1997 was $1.9
million, or 12 cents per share on 15.6 million weighted average common and
common equivalent shares compared to $3.4 million or 22 cents per share on 15.6
million weighted average common and common equivalent shares. Excluding
restructuring and other charges net of related tax benefit, the Company had a
net loss for the nine months ended September 30, 1997 of $7.1 million, or 47
cents per share, on 15.2 million weighted average common shares outstanding
compared to income of $10.1 million, or 62 cents per share, on 16.5 million
weighted average common and common equivalent shares for the same period last
year.
Including all restructuring and other charges, FileNET had a net loss for the
nine months ended September 30, 1997, of $11.4 million, or 75 cents per share on
15.2 million weighted average shares outstanding compared with a net loss of
$5.9 million, or 39 cents per share on 15.0 million weighted average shares
outstanding for the same period last year.
FOREIGN CURRENCY FLUCTUATIONS AND INFLATION. The Company's performance can be
affected by changes in foreign currency values relative to the U.S. dollar in
relation to the Company's revenue and operating expenses. The net impact to net
income from foreign exchange transactions and hedging activities is immaterial
for all periods reported. Management believes that inflation has not had a
significant impact on the prices of the Company's products, the cost of its
materials, or its operating results for the quarters ended September 30, 1997,
and 1996.
OTHER FINANCIAL INSTRUMENTS. The Company enters into forward foreign exchange
contracts as a hedge against effects of fluctuating currency exchange rates on
monetary assets and liabilities denominated in currencies other than the
functional currency of the relevant entity. The Company is exposed to market
risk on the forward exchange contracts as a result of changes in foreign
exchange rates; however, the market risk should be offset by changes in the
valuation of the underlying exposures. 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 in the consolidated
statement of operations. The counterparties to these instruments are major
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financial institutions. The Company uses commercial rating agencies to evaluate
the credit quality of the counterparties, and the Company does not anticipate a
loss resulting from any credit risk of these institutions. The unrealized gains
and losses from these contracts were immaterial at both September 30, 1997 and
September 30, 1996.
Liquidity and Capital Resources
As of September 30, 1997, combined cash, cash equivalents and short- and
long-term marketable securities totaled $77.1 million, an increase of $9.8
million from $67.3 million at the end of 1996. The increase is primarily a
result of cash provided by operating activities of $18.4 and proceeds from
issuance of common stock of $2.3 million offset by capital expenditures of $9.2
million.
Accounts receivable decreased to $47.7 million at September 30, 1997 from $75.5
million at December 31, 1996. Days sales outstanding decreased to 67 days as of
September 30, 1997 compared to 95 days as of December 31, 1996. Current
liabilities decreased to $49.0 million at September 30, 1997 from $59.5 million
at December 31, 1996. The decrease is primarily a result of a decrease in
accounts payable and lower accrued royalties and other expense as a result of
lower revenue.
The Company has an unsecured line of credit of $20 million available from a
commercial bank. This line of credit expires in May 1999 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 1997 pursuant to which the Company may borrow up to approximately $2
million. As of September 30, 1997, there were no borrowings outstanding against
any of the Company's credit lines.
The Company anticipates that its present cash balances together with internally
generated funds and credit lines will be sufficient to meet its working capital
and capital expenditure needs for at least the next twelve months. On October
21, 1997 the Company announced that the Board of Directors has authorized the
Company to repurchase up to $10 million of its currently outstanding common
stock. Such repurchases may occur from time to time at prevailing market prices,
through open market or unsolicited negotiated transactions, depending upon
market conditions.
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Part II. Other Information
Item 1. Legal Proceedings
See Notes to Consolidated Financial Statements.
Item 5. Other Information
Certain Considerations.
This quarterly report on form 10-Q contains forward-looking statements that
involve risks and uncertainties, including those discussed below and in the
Management's Discussion and Analysis of Results of Operations and Financial
Condition section and Notes to Consolidated Financial Statements in the
Company's Annual Report to Stockholders. 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, 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,
including without limitation enhancements to certain specified Company
software products to achieve year 2000 compliance. The Company could
experience continued difficulties or delays in developing and introducing
new products integrating some or all of the technologies and products from
the acquisitions of Watermark, Saros and IFSL with the technologies and
products from the Company. Delays in or non-completion of the development of
newly integrated 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 the anticipated benefits of the
acquisitions. 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 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 including without
limitation enhancements to certain existing software products to achieve
year 2000 compliance, 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
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 various products it has developed
or acquired through acquisition of others and to achieve the desired levels
of sales from such product integration, 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
11
<PAGE>
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 are not
predictable with any significant degree of accuracy.
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. Moreover, such factors
could cause the Company's operating results in a given quarter to be below
the expectations of public market analysts and investors. In either case,
the price of the Company's common stock could be materially adversely
affected.
COMPETITION. The document imaging, workflow, computer output to laser disk
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 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 that 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.
12
<PAGE>
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, formerly a
wholly-owned subsidiary that was merged into the Company, 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 the Company's products which were commercialized before the
initial complaint was filed. Wang reserved the right to assert that patent
against the Company's 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.
In March 1997, Eastman Kodak Company ("Kodak") purchased the Wang imaging
business unit that has responsibility for this litigation. The patents in
the suit have been transferred to a Kodak subsidiary, Kodak Limited of
England, which in turn has exclusively licensed them to another Kodak
subsidiary, Eastman Software, Inc. in the United States. On July 30, 1997,
the Court permitted Eastman Software, Inc. and Kodak Limited of England to
be substituted in the litigation in place of Wang. The Company cannot
predict what, if any, impact this will have on the litigation.
If it should be determined that the patents at issue in the litigation 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 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.
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. In general, the
Company does not utilize employment agreements for its key employees. The
loss of the services of one or more key employees 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, particularly engineers and other technical personnel, is
intense, and pay scales in the Company's industry are increasing. 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.
PRODUCT LIABILITY. The Company's license agreements with customers
typically contain provisions designed to limit their exposure to potential
product
13
<PAGE>
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.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits. The list of exhibits contained in the accompanying Index to
Exhibits is herein incorporated by reference.
(b) No reports on Form 8-K were filed during the third quarter of 1997.
14
<PAGE>
SIGNATURES
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 14, 1997
15
<PAGE>
Index to Exhibits
Exhibit
No. Description
- ------- ----------------------------------------------------------------------
3.1* Restated Certificate of Incorporation, as amended (filed as Exhibit
3.1 to 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 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 (the "Form S-1")).
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* Second Amended and Restated Credit Agreement (Multicurrency) by and
among the Registrant and Bank of America National Trust and Savings
Association dated June 25, 1997, effective June 1, 1997 (filed as
Exhibit 10.1 to Form 10-Q for the quarter ended June 30, 1997).
10.2* 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).
10.3* 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).
10.4* 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).
10.5* 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).
10.6* Third Amendment to the Lease between the Registrant and C. J.
Segerstrom & Sons dated April 30, 1987, for additional facilities at
the headquarters of the Company, dated October 1, 1992 (filed as
exhibit 10.7 to Form 10-K filed on April 4, 1997).
10.7* Fifth Amendment to the Lease between the Registrant and C. J.
Segerstrom & Sons dated April 30, 1987, for the extension of the term
of the lease, dated March 28, 1997(filed as exhibit 10.8 to Form 10-Q
for the quarter ended March 31, 1997).
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).
- --------------------------------------------
* Incorporated herein by reference
16
<PAGE>
Exhibit
No. Description
- ------- ----------------------------------------------------------------------
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* Amendment #A1011-941003-01 dated September 30, 1994, to the
Agreement for the Purchase of IBM products dated December 20,
1991(filed as exhibit 10.12 to Form 10-K filed on April 4, 1997).
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).
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* 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).
10.16* 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).
10.17* 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).
10.18* 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 10.2 to form 10-K for the year ended December
31, 1995).
27 Financial Data Schedule
- ---------------------------------------------
* Incorporated herein by reference
17
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