================================================================================
FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934 For the fiscal year ended December 31, 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
(Exact name of Registrant as specified in its charter)
Delaware 95-3757924
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
3565 Harbor Boulevard, Costa Mesa, California 92626
(Address of principal executive office) (Zip code)
Registrant's telephone number, including area code: (714) 966-3400
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Title of each class Name of each exchange which registered
Common stock, $0.01 par value Nasdaq
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days: Yes [X] No [ ]
Indicate by check mark whether the disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Based on the closing sale price of March 21, 1997, the aggregate market value of
the 14,835,635 shares of voting stock of the Registrant held by nonaffiliates of
the Registrant on such date was $237,370,160. For purposes of such calculation,
only executive officers, board members and beneficial owners of more than 10% of
the Company's outstanding common stock are deemed to be affiliates.
The number of shares outstanding of the Registrant's common stock was 15,085,811
at March 21, 1997.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's definitive proxy statement for its 1997 Annual Meeting
are incorporated by reference into Part III as set forth herein. Portions of
Registrant's Annual Report to Stockholders for the fiscal year ended December
31, 1996 are incorporated by reference into Parts II, III and IV as set forth
herein.
================================================================================
<PAGE>
FILENET CORPORATION
FORM 10-K
For the Fiscal Year Ended December 31, 1996
INDEX
<TABLE>
Page
PART I
<S> <C>
Item 1. Business.............................................................................. 3
Item 2. Properties............................................................................ 10
Item 3. Legal Proceedings..................................................................... 10
Item 4. Submission of Matters to a Vote of Security Holders................................... 10
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters.............. 10
Item 6. Selected Financial Data............................................................... 11
Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition. 12
Item 8. Financial Statements and Supplementary Data........................................... 12
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.. 12
PART III
Item 10. Directors and Executive Officers of the Registrant................................... 12
Item 11. Executive Compensation............................................................... 12
Item 12. Security Ownership of Certain Beneficial Owners and Management....................... 12
Item 13. Certain Relationships and Related Transactions....................................... 12
PART IV
Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K...................... 13
Signatures.................................................................................... 18
</TABLE>
2
<PAGE>
PART I
Item 1. Business
GENERAL
FileNet Corporation ("FileNet" or the "Company") develops, markets and services
an open, integrated family of workflow, document-imaging, electronic
document-management and computer output to laser disk ("COLD") client/server
product solutions which control and manage the movement of document images,
data, text and other information throughout an enterprise. In August 1995, the
Company acquired Watermark Software Inc. ("Watermark"), a leader in
document-imaging software for the Microsoft Windows NT platform. In the first
quarter of 1996, the Company acquired Saros Corporation ("Saros"), one of the
leading suppliers of enterprise electronic document-management software, and
International Financial Systems, Ltd. ("IFSL"), whose Greenbar(TM) product is an
innovative COLD software application for archiving computer-generated reports.
The current product line enables FileNet to offer a broad range of software and
support capabilities to customers who are seeking a single vendor to manage
their unstructured business information.
MARKETS AND APPLICATIONS
With its recent acquisitions, the Company now offers a family of complementary
products which will enable users to manage the storage, processing and workflow
for all documents and other unstructured information, including scanned images,
faxes, text, spreadsheets, graphics, drawings, photographs, computer output
reports, voice, and video on an enterprise-wide basis. Because the Company's
products provide an integrated document-management architecture that can be
implemented on a modular basis, organizations can choose one, some, or all of
the Company's products to build the system that most effectively meets their
needs. The Company's products include workflow and document-imaging software for
those organizations which have large, active paper document files, process large
numbers of documents in their day-to-day operations, or have complex,
mission-critical business processes for a variety of applications such as
mortgage loan servicing, credit card customer service, insurance claims
processing, retirement account management, technical document management and
change control, and the management of personnel, accounts payable, traffic,
property and criminal records. Additionally, the Company's products address ad
hoc business processes at the departmental and workgroup levels to improve
overall enterprise productivity.
The Company markets its products through a direct sales force in Australia,
Canada, France, Germany, the United Kingdom and the United States. In addition,
the Company markets in the United States and in 60 other countries through its
Valuenet(R) partner program consisting of systems integrators, resellers and
distributors. A number of firms, including Andersen Consulting and American
Management Systems, operate as third-party resellers under the Company's
ValueNet program and combine FileNet products with vertical market-specific
value-added services to provide turnkey solutions and complex systems
integration for customers. Other firms such as Tech Data, Law Cypress, IAI
Canada, Image Choice and Paperlink are distributors of the Company's products
selling to hundreds of resellers throughout the world. The Company also has OEM
agreements with other firms involving the Company's software and hardware
products.
The Company offers software maintenance service for its products in the United
States and in countries where it has direct international operations. Its
international resellers offer maintenance in the countries they serve. The
Company subcontracts hardware maintenance to Hewlett-Packard Corporation ("HP")
and other third parties.
In June 1995, the Company entered into a joint venture development partnership
and distribution agreement with Novell, Inc. ("Novell") to provide workflow
software components for Novell's Groupwise software product family. A version of
this software is also being marketed by FileNet directly as of November 1996.
In September 1995, the Company entered into an alliance with SAP AG to deliver
data archiving and document solutions for their client/server-based R/3
enterprise application systems environment. Deliveries of this product commenced
in December 1995.
The Company also has porting and licensing agreements with HP and Sun
Microsystems, Inc. ("Sun") to co-market versions of FileNet's document-imaging
and workflow software products to users of those companies' products. Sales of
the HP based product commenced in December 1993 and the Sun based product in
March 1995. In 1996, the Company became a Global Partner with HP's General
Systems Division.
3
<PAGE>
The Company is a Certified Microsoft Solutions Developer and will continue to
develop products for the Microsoft BackOffice computing environment.
PRODUCTS
SOFTWARE
The following software products are currently being offered by the Company:
Document Imaging
The Company's Image Management Services ("IMS") software is used for organizing,
storing and accessing multiple types of information including document images,
data, text, graphics, voice and photographs from different sources. IMS software
currently supports the Microsoft Windows NT Server operating system and the
AIX/6000, HP-UX, and Solaris operating environments which are IBM Corporation's
("IBM"), HP's, and Sun's implementation of the UNIX operating system,
respectively. IMS software operates on high performance servers attached to
Token-Ring, Ethernet and FDDI local area networks utilizing TCP/IP and SPX/IPX
communication protocols.
The Company's WorkForce Desktop(R) Software is a suite of document-imaging and
workflow management products which run on IBM and IBM compatible personal
computers running Microsoft Corporation's ("Microsoft") Windows operating
environments or IBM's OS/2 operating system. The suite provides search and
access features, image viewing, and manipulation capabilities for stored images.
Additionally, the user can develop custom applications for the WorkForce Desktop
products using one of the following software development tools and application
programming interfaces:
WorkFlo(R)--a proprietary application development software product that
enables users to develop business process automation programs by defining
individual processing tasks and process flows using a series of high level
language commands. WorkFlo programs can be easily modified by the user to
respond to new business requirements. In addition, the software enables
users to create standard electronic forms for entering information in
prescribed formats.
WorkFlo Controls--a software development tool that integrates with
Microsoft's Visual Basic programming system to increase productivity when
developing custom document-imaging and workflow applications.
WorkFlo Power Libraries--a software development tool that integrates with
Sybase/Powersoft's PowerBuilder programming system and C language programs
to increase productivity when developing custom document-imaging and
workflow applications.
WorkFlo Application Libraries--a standard application programming interface
layer to FileNet's IMS software for various workstations, network and
application environments including Microsoft Windows, OS/2, Sun Solaris,
HP-UX, and IBM AIX/6000.
The Company's FileNet:WorkGroup(TM) software is a midrange document-imaging and
work management product based on a subset of the above products combined with
certain prepackaged software applications.
The Company's Document Warehouse(TM) for SAP software product is a document and
data archiving application, certified by SAP, for use with the popular R/3
Enterprise Resource Planning (ERP) application suite.
FileNet Image View II(TM) is a client software product introduced in 1996 that
integrates with and accesses documents stored in FileNet's IMS server and the
Watermark Image Server products to enable the use of scanned documents and faxes
with any OLE-compatible Windows application, such as spreadsheets, workflows,
forms, databases, e-mail, etc.
The Company's Watermark(R) software products enable users worldwide to exchange,
process and share scanned images, faxes and other electronic documents within
departments and workgroups of large enterprises and throughout midsize and small
business environments. Watermark documents and folders are easily integrated
into existing line-of-business applications and take advantage of the latest
Microsoft operating systems, database technologies and Internet capabilities.
The Watermark family consists of the following products:
4
<PAGE>
Watermark Client software replaces document handling procedures with
integrated electronic processing of scanned images, faxes and other
electronic documents. The software provides easy-to-use tools for document
capturing, filing, viewing, annotation and OCR that image enable any OLE-
or ODMA- compatible Windows application, such as e-mail, databases and
workflows.
Watermark Image Server software is used for organizing, storing and
optimizing shared network access to scanned documents, faxes and electronic
files. The software intelligently captures the business rules governing
document security, version control, migration and storage through easy
client-based administration and reporting tools designed for Microsoft
Backoffice.
Watermark Hierarchical Storage Manager software extends the document
storage and retrieval capacity of the Watermark Image Server by providing
Windows NT services to migrate documents to and from high-density optical
disks.
Watermark Fax Router software is a fax management solution that streamlines
inbound fax communications with customers, suppliers and other business
partners. The software delivers documents electronically to the intended
recipient and immediately routes for processing. Faxes are securely managed
side-by-side with all other business documents.
Watermark Developer's Toolkit software allows a developer to build
client/server and intranet applications by taking advantage of the full
power and range of Watermark functionality via OLE Objects and ActiveX
Controls specifically designed to simplify application building.
Workflow
The Company's Visual WorkFlo(R) software provides an open, flexible, component
software framework for workflow application development. This product enables
users and ValueNet partners to automate business processes using object-oriented
programming technology, and supports standard tools such as C++, Visual Basic,
PowerBuilder, Microsoft Windows-compatible tools, and FileNet's other WorkFlo
products. All work management functions, including routing, queuing, exception
handling, and management control, are managed by Visual WorkFlo using standard
Windows interfaces and graphical tools.
FileNet Ensemble(TM) is a general purpose workflow tool introduced in 1996 that
automates a wide range of everyday business processes and is integrated with
Microsoft Exchange and Novell Groupwise to enhance these messaging (e-mail)
system products. FileNet markets this product through all of its direct and
indirect sales channels worldwide. A version of this software will be marketed
by Novell starting in 1997 under the product name "Groupwise Workflow."
Electronic Document Management
The Company's Saros(R) software products simplify the management and maintenance
of electronic documents and other unstructured information, ensuring the right
information is always available. Needed information is readily accessible,
providing total manageability and security. The Saros family consists of the
following products:
Saros Mezzanine(R) is a server software product that enables electronic
document management applications across large enterprise LANs and WANs. It
acts as a network librarian, simplifying the management and maintenance of
all files on the user's network.
Saros Document Manager is a client-based ready-to-use document management
system based on Saros Mezzanine. Saros Document Manager provides the user
with tools to create, communicate and control electronic documents.
Saros @mezzanine(TM) is a software product used to organize, protect and
maintain documents published on the World Wide Web. @mezzanine provides
improved organization and access methods to the Web browser and special
document management features such as version control, security and
archiving needed by the Web server.
Saros Document Server for BackOffice is a special version of the Mezzanine
software and is designed expressly for the Microsoft BackOffice server
platform. Saros Document Server for BackOffice takes advantage of the full
power of Microsoft Windows NT Server to create an enterprise-wide
electronic information library.
5
<PAGE>
COLD
The Company's Greenbar software product stores and retrieves computer-generated
reports to replace the use of printed reports and computer output to microfiche.
It also enables the user to search for specific information located in one or
more reports and extract the information to use with popular desktop software
applications. It is a client/server software product running on servers using
the Microsoft Windows NT Server operating system and PC workstations running
Microsoft Windows. It also integrates with FileNet's IMS software product to
provide large capacity archival storage capabilities.
HARDWARE
The Company markets an optional integration service, offering customers the
option to purchase complete solutions, including industry standard hardware,
directly from FileNet. The Company also manufactures and markets an optical
storage and retrieval library (OSAR(R)) based on 12-inch optical disk storage
technology.
All named products mentioned in this Form 10-K, other than the Company's named
products, are trademarks or registered trademarks of the respective holder.
RESEARCH AND DEVELOPMENT
The Company's research and development activities are focused on software
product development. Research and development expenditures were $36.5 million,
$24.7 million and $18.3 million for the fiscal years ended December 31, 1996,
December 31, 1995, and January 1, 1995, respectively. The Company believes that
its future success depends upon its ability to continue to enhance its existing
software products and to develop new software products that satisfactorily meet
market needs. Accordingly, the Company intends to continue to make substantial
investments in its research and development activities.
BACKLOG
The Company typically ships its products within a short period of time after
acceptance of orders, which is common in the computer software industry. The
Company does not consider the level of backlog to be a significant or important
indicator of future revenue or earnings.
SERVICES, SUPPORT AND MANUFACTURING
The Company maintains service and support organizations which provide both
pre-sales and post-sales services in the United States and the foreign countries
where the Company has direct operations.
The Company's integration facilities in Costa Mesa, California and Dublin,
Ireland, conduct software manufacturing, integration, test and quality control.
In those cases in which the customer requests that FileNet provide a turnkey
solution, the Company uses standard products and components which are available
from multiple vendors. Certain parts and components are purchased from sole
sources, including optical disk drives for its OSAR product. The Company is
dependent upon the ability of vendors to deliver these items in accordance with
the Company's specifications and delivery schedules. Scanners, printers,
magnetic disks, memory circuits, frames, panels and harnesses are available from
a number of domestic sources. The failure of certain suppliers to deliver on
schedule could delay or interrupt the Company's delivery of products and thereby
adversely affect the Company's operating results. To date, the Company has not
experienced any delays in deliveries from its suppliers which have had a
material impact on its business.
EMPLOYEES
As of December 31, 1996, the Company had 1,443 full-time employees of which 364
were employed in research and development; 853 in sales, marketing, professional
services and customer support; 96 in operations; and 130 in finance and
administration. Employees in the Company's German subsidiary are represented by
a labor union. No other employees are represented by labor unions, and the
Company has never experienced a work stoppage. The Company believes that it
enjoys good employee relations.
6
<PAGE>
COMPETITION
The market for the Company's products is highly competitive. The Company's
principal competitors for its various product lines include the following
companies: 1) Workflow and document imaging-- Banctec, Inc., IBM, Keyfile,
Optika, Unisys Corporation, Mosaix, Wang Laboratories, Inc., 2) Electronic
Document Management--Documentum, IBM, Interleaf, Novasoft, Novell, Open Text, PC
DOCS, and 3) COLD--Computron, IBM and Microbank. Numerous smaller software
vendors also compete in each product area. The Company also experiences
competition from systems integrators who configure hardware and software into
customized systems.
In addition, RDBMS vendors, such as Oracle, Sybase and Informix, may compete
with the Company in the future. Oracle has announced products that compete with
the Company's document management products. It is also possible that new
competitors or alliances among competitors may emerge and rapidly acquire
significant market share. The Company also expects that competition will
increase as a result of software industry consolidations. To the extent one or
more of the Company's competitors introduce products that more fully address
customer requirements, the Company's business and operating results could be
adversely affected.
PATENTS AND LICENSES
The Company holds three patents for its OSAR product which expire August 26,
2003, June 23, 2004 and August 4, 2004, respectively. The Company has also
entered into non-exclusive license arrangements with a number of organizations,
including IBM and Oracle, which permit the Company and its resellers to grant
sublicenses to end users of the Company's systems to use software developed by
these third-party vendors.
CERTAIN CONSIDERATIONS
This report and the Company's Annual Report to Stockholders for the year ended
December 31, 1996 contains forward-looking statements that involve risks and
uncertainties, including those discussed below and in the Management's
Discussion and Analysis of Financial Condition and Results of Operations section
and Notes to Consolidated Financial Statements in the Company's Annual Report to
Stockholders incorporated herein by reference as set forth in Items 7 and 8 of
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, 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 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
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 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.
7
<PAGE>
Competition. The document imaging, workflow, COLD 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 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 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 January 1997, Wang and Eastman Kodak Company ("Kodak") announced that
they have entered into an agreement under which Kodak will acquire the Wang
business unit that has responsibility for this litigation. The acquisition is
scheduled to close in March-April 1997 and the Company can not 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 ("HP")
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.
8
<PAGE>
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 contracts 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 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. The Company and the acquired companies could
experience difficulties or delays in integrating their respective technologies
or developing and introducing new products. In particular, one of the reasons
for FileNet's acquisition of Saros was the perceived 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.
9
<PAGE>
Item 2. Properties
The Company currently leases 250,000 square feet of office, development and
manufacturing space in Costa Mesa, California; 42,000 square feet of office and
development space in Bellevue, Washington; 12,500 square feet of office and
development space in Burlington, Massachusetts. The Company also leases sales
and support offices in 41 locations in the United States, 13 in Europe, 2 in
Australia, 3 in Canada, and 3 in Asia. The Company believes that the Costa Mesa,
Bellevue and Burlington facilities will be adequate for the Company's
anticipated needs through 1997.
Item 3. 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, 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 January 1997, Wang and Kodak announced that they have entered into an
agreement under which Kodak will acquire the Wang business unit that has
responsibility for this litigation. The acquisition is scheduled to close in
March-April 1997 and 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 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, payment of attorney's
fees and costs, and equitable or injunctive relief; however, at this time it is
not possible to determine the potential liability, if any. The Company has not
yet responded to the complaint. The Company believes the complaint is without
merit and intends to defend the action 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.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters
There is hereby incorporated herein by reference the information appearing under
the caption "Stock Market and Dividend Information," which appears on page 42 of
the Registrant's Annual Report to Stockholders for the year ended December 31,
1996 and is filed herewith as Exhibit 13.1.
10
<PAGE>
Item 6. Selected Financial Data 1
The following table summarizes certain selected financial data:
<TABLE>
<CAPTION>
For Fiscal Years Ended
--------------------------------------------------------------------------------------
Dec. 31, 1996 Dec. 31, 1995 Jan. 1, 1995 Jan. 2, 1994 Jan. 3, 1993
---------------- ---------------- --------------- ---------------- ---------------
(1996) (1995) (1994) (1993) (1992)
------ ------ ------ ------ ------
(In thousands, except per share amounts)
Consolidated statements of operations data:
<S> <C> <C> <C> <C> <C>
Revenue:
Software revenue $140,659 $116,052 $ 81,102 $ 54,067 $ 34,089
Service revenue 82,118 67,174 60,753 60,933 45,803
Hardware revenue 46,136 46,152 50,480 51,410 62,608
---------------------------------- ---------------- ----------------- ----------------
Total revenue 268,913 229,378 192,335 166,410 142,500
Costs and expenses:
Cost of software revenue 16,464 15,146 12,472 7,831 6,324
Cost of service revenue 53,568 44,277 41,645 42,812 36,650
Cost of hardware revenue 29,633 28,800 30,999 34,116 28,330
Research and development 36,502 24,711 18,274 15,247 15,142
Selling, general and administrative 117,761 96,499 71,267 61,711 59,277
Merger, restructuring and write-off of
purchased in-process research and
development costs 16,011 6,393 -- -- 10,044
--------------------------------------------------------------------------------------
Total costs and expenses 269,939 215,826 174,657 161,717 155,767
--------------------------------------------------------------------------------------
Operating income (loss) (1,026) 13,552 17,678 4,693 (13,267)
Other income 2,838 2,780 1,821 333 348
--------------------------------------------------------------------------------------
Income (loss) before income taxes 1,812 16,332 19,499 5,026 (12,919)
Provision (benefit) for income taxes 4,456 8,116 5,356 4,760 (1,827)
--------------------------------------------------------------------------------------
Net income (loss) $ (2,644) $ 8,216 $ 14,143 $ 266 $(11,092)
================= ================= ================ ================= ===============
Net income (loss) per share $ (0.18) $ 0.52 $ 0.95 $ 0.02 $ (0.95)
Weighted average common and common
equivalent shares outstanding 15,007* 15,856 14,834 13,178 11,705*
*Excludes common share equivalents
Consolidated balance sheet data:
Working capital $ 89,339 $ 86,354 $ 63,149 $ 47,819 $ 46,292
Total assets 195,679 189,682 152,642 124,986 104,350
Long-term debt, excluding
current portion -- -- -- 163 68
Stockholders' equity 132,806 131,158 101,006 78,383 71,346
</TABLE>
1 All historical data has been restated to reflect the acquisition of Saros
Corporation on March 1, 1996 which was accounted for as a pooling of interests.
Certain reclassifications have been made to the prior years' selected
financial data to conform with the current year's presentation.
11
<PAGE>
Item 7. Management's Discussion and Analysis of Results of Operations and
Financial Condition
There is hereby incorporated herein by reference the information appearing under
the caption "Management's Discussion and Analysis of Results of Operations and
Financial Condition," which appears on pages 18 through 24 of the Registrant's
Annual Report to Stockholders for the year ended December 31, 1996 and is filed
herewith as Exhibit 13.2.
Item 8. Financial Statements and Supplementary Data
There is hereby incorporated herein by reference the information appearing on
pages 25 through 39 of the Registrant's Annual Report to Stockholders for the
year ended December 31, 1996 and is filed herewith as Exhibit 13.3. The
accompanying Independent Auditors' Report is also incorporated herein by
reference and filed herewith as Exhibit 13.3.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
There is hereby incorporated herein by reference the information appearing under
the caption "Election of Directors," under the caption "Executive Officers of
the Company," and under the caption "Compliance with Securities Laws" of the
Registrant's definitive Proxy Statement for its 1997 Annual Meeting to be filed
with the Securities and Exchange Commission.
Item 11. Executive Compensation
There is hereby incorporated herein by reference the information appearing under
the caption "Executive Compensation" and under the caption "Election of
Directors" of the Registrant's definitive Proxy Statement for its 1997 Annual
Meeting to be filed with the Securities and Exchange Commission.
Item 12. Security Ownership of Certain Beneficial Owners and Management
There is hereby incorporated herein by reference the information appearing under
the caption "Voting Securities and Principal Holders Thereof" of the
Registrant's definitive Proxy Statement for its 1997 Annual Meeting to be filed
with the Securities and Exchange Commission.
Item 13. Certain Relationships and Related Transactions
There is hereby incorporated herein by reference the information appearing under
the caption "Note 11: Related Party Transaction," which appears on page 38 of
the Registrant's Annual Report to Stockholders for the year ended December 31,
1996 and is filed herewith as part of Exhibit 13.4.
12
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K
(a) Financial statements
1. The list of financial statements contained in the accompanying
Index to Consolidated Financial Statements covered by the
Independent Auditors' Report is herein incorporated by reference.
2. Financial statement schedule
The listed financial statement schedule contained in the
accompanying Index to Consolidated Financial Statements covered
by the Independent Auditors' Report is herein incorporated by
reference.
3. Exhibits
The list of exhibits contained in the accompanying Index to
Exhibits is herein incorporated by reference.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of fiscal
1996.
Index to Consolidated Financial Statements Covered
by Independent Auditors' Report
Item 14(a) (1) and (2)
<TABLE>
<CAPTION>
Page Reference
---------------------------
1996 Annual
Report to
Form 10-K Stockholders
The information under the following captions, which is included in the 1996
Annual Report to Stockholders, is incorporated herein by reference:
<S> <C> <C>
Independent Auditors' Report 39
Consolidated balance sheets at December 31, 1996 and December 31, 1995 25
Consolidated statements of operations for each of the years ended
December 31, 1996, December 31, 1995 and January 1, 1995 26
Consolidated statements of stockholders' equity for each of the years ended
December 31, 1996, December 31, 1995 and January 1, 1995 27
Consolidated statements of cash flows for each of the years ended
December 31, 1996, December 31, 1995 and January 1, 1995 28
Notes to consolidated financial statements 29
Independent Auditors' Report on Schedule 14
Schedule for each of the three years ended December 31, 1996,
December 31, 1995 and January 1, 1995
II. Valuation and qualifying accounts and reserves 15
</TABLE>
13
<PAGE>
INDEPENDENT AUDITORS' REPORT ON SCHEDULE
To the Stockholders and the Board of Directors of FileNet Corporation:
We have audited the consolidated financial statements of FileNet Corporation and
its subsidiaries as of December 31, 1996 and 1995 and for each of the three
years in the period ended December 31, 1996, and have issued our report thereon
dated February 10, 1997. Such consolidated financial statements and report are
included in your 1996 Annual Report to Stockholders and are incorporated herein
by reference. Our audits also included the consolidated financial statement
schedule of FileNet Corporation and its subsidiaries, listed in Item 14. The
consolidated financial statement schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion based on our audits. In
our opinion, such consolidated financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
/s/ Deloitte & Touche LLP
February 10, 1997
Costa Mesa, California
14
<PAGE>
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
($ in thousands)
<TABLE>
<CAPTION>
Balance at Additions-
Beginning of Charged to Costs Balance at End
Description Period and Expenses Deductions of Period
- ----------------------------------- ----------------------------------------------------------------------
<S> <C> <C> <C> <C>
Year ended January 1, 1995:
Inventory reserves $ 771 $ 532 $ 652 (1) $ 651
Allowance for doubtful accounts 562 222 53 (2) 731
Reserve for returned systems 3,418 489 1,160 (3) 2,747
Year ended December 31, 1995:
Inventory reserves 651 482 560 (1) 573
Allowance for doubtful accounts 731 857 48 (2) 1,540
Reserve for returned systems 2,747 869 463 3,153
Year ended December 31, 1996:
Inventory reserves 573 635 548 (1) 660
Allowance for doubtful accounts 1,540 1,205 605 (2) 2,140
Reserve for returned systems 3,153 32 - 3,185
</TABLE>
(1) Consists primarily of the write-off of excess/obsolete inventories.
(2) Consists primarily of uncollectible invoice amounts.
(3) Includes an amount attributable to the resolution of a specific customer
dispute. Such amount was recognized in revenue in 1994.
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* 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 Waiver and Second Amendment dated December 18, 1996, to the Amended
and Restated Credit Agreement (Multicurrency) by and among the
Registrant and Bank of America National Trust and Savings Association
dated August 8, 1995.
10.3* 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).
10.4* 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).
10.5* 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).
10.6* 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).
10.7 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.
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).
- --------------------------------------------
* Incorporated herein by reference
16
<PAGE>
Exhibit No. Description
- ----------------------- --------------------------------------------------------
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.
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).
13.1 Market for the Registrant's Common Stock and Related Stockholder
Matters incorporated by reference to page 42 of the 1996 Annual
Report.
13.2 Management's Discussion and Analysis of Results of Operations and
Financial Condition incorporated by reference to pages 18 through 24
of the 1996 Annual Report.
13.3 Financial Statements incorporated by reference to pages 25 through 39
of the 1996 Annual Report.
13.4 Certain Relationships and Related Transactions incorporated by
reference to page 38 of the 1996 Annual Report.
21.1 List of subsidiaries of Registrant (filed as FileNet Corporation
Subsidiary Information).
23.1 Consent of Deloitte & Touche LLP (filed as Independent Auditors'
Consent).
27 Financial Data Schedule
- ---------------------------------------------
* Incorporated herein by reference
17
<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
Date: April 2, 1997 By: /s/ T. J. Smith
--------------------------------------------
T. J. Smith
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Date: April 2, 1997 By: /s/ T. J. Smith
--------------------------------------------
T. J. Smith
President
(Principal Executive Officer) Director
Date: April 2, 1997 By: /s/ Mark S. St. Clare
--------------------------------------------
Mark S. St. Clare
Chief Financial Officer and
Sr. Vice President, Finance
(Principal Financial Officer)
Date: April 2, 1997 By: /s/ William R. Hughes
--------------------------------------------
William R. Hughes
Chief Accounting Officer and Controller
Date: April 2, 1997 By: /s/ Frederick K. Fluegel
--------------------------------------------
Frederick K. Fluegel
Director
Date: April 2, 1997 By: /s/ J. Burgess Jamieson
--------------------------------------------
J. Burgess Jamieson
Director
Date: April 2, 1997 By: /s/ John C. Savage
--------------------------------------------
John C. Savage
Director
Date: April 2, 1997 By: /s/ William P. Lyons
--------------------------------------------
William P. Lyons
Director
18
<PAGE>
WAIVER AND SECOND AMENDMENT TO CREDIT AGREEMENT
THIS WAIVER AND SECOND AMENDMENT TO AMENDED AND RESTATED CREDIT AGREEMENT
("Waiver and Amendment"), dated as of December 18 , 1996, is entered into by and
between FILENET CORPORATION (the "Borrower") and BANK OF AMERICA NATIONAL TRUST
AND SAVINGS ASSOCIATION (the "Bank").
RECITALS
A. The Bank and the Borrower are parties to an Amended and Restated Credit
Agreement (Multicurrency) dated as of August 8,1995, effective as of May 1,
1995, as amended by that Waiver and Amendment to Credit Agreement dated as of
July 11, 1996 (as so amended, the "Credit Agreement"), pursuant to which the
Bank has extended certain credit facilities to the Borrower.
B. The Borrower has reported to the Bank the existence of an Event of
Default under the Credit Agreement. The Borrower has requested that the Bank
waive such Event of Default and agree to an amendment to the Credit Agreement.
C. The Bank is willing to waive such Event of Default under the Credit
Agreement, and to amend the Credit Agreement, subject to the terms and
conditions of this Waiver and Amendment.
NOW, THEREFORE, for valuable consideration, the receipt and adequacy of
which are hereby acknowledged, the parties hereto hereby agree as follows:
1. Defined Terms. Unless otherwise defined herein, capitalized terms used
herein shall have the meanings, if any, assigned to them in the Credit
Agreement.
2. Default and Waiver.
(a) For purposes of this Waiver and Amendment, the "Existing Default"
shall mean the Event of Default existing on this date under Section 8.01(c)
of the Credit Agreement as a consequence of a breach of the negative
covenant set forth at Section 7.13 of the Credit Agreement solely for the
quarter ended September 30, 1996.
(b) Subject to and upon the terms and conditions hereof, the Bank
hereby waives the Existing Default.
(c) Nothing contained herein shall be deemed a waiver of (or otherwise
affect the Bank's ability to enforce) any other default or Event of
Default, including without limitation (i) any default or Event of Default
as may now or hereafter exist and arise from or otherwise be related to
1
<PAGE>
the Existing Default (including without limitation any cross-default
arising under the Credit Agreement by virtue of any matters resulting from
the Existing Default), and (ii) any default or Event of Default arising at
any time after the Effective Date and which is the same as the Existing
Default.
3. Amendments to Credit Agreement.
(a) Section 7.13 of the Credit Agreement shall be amended and restated in
its entirety so as to read as follows:
"7.13 Tangible Net Worth. The Borrower shall not permit at any time on a
consolidated basis its Tangible Net Worth to be less than $115,000,000 plus
the sum of (i) 75% of net income after income taxes (without subtracting
losses) earned in each quarterly accounting period commencing after
September 30, 1996, (ii) the net proceeds from any equity securities issued
after September 30, 1996, and (iii) any increase in stockholders' equity
resulting from the conversion of debt securities to equity securities after
September 30, 1996."
(b) Schedule 2 to the Compliance Certificate shall be amended and
restated in its entirety so as to read as in the schedule attached hereto
as Schedule 2.
4. Representations and Warranties. The Borrower hereby represents and
warrants to the Bank as follows:
(a) Other than the Existing Default, no Default or Event of Default
has occurred and is continuing.
(b) The execution, delivery and performance by the Borrower of this
Waiver and Amendment have been duly authorized by all necessary corporate
and other action and do not and will not require any registration with,
consent or approval of, notice to or action by, any person (including any
governmental authority) in order to be effective and enforceable. The
Credit Agreement as amended by this Waiver and Amendment constitutes the
legal, valid and binding obligations of the Borrower, enforceable against
it in accordance with its respective terms. without defense, counterclaim
or offset.
(c) Subject to the Existing Default, all representations and
warranties of the Borrower contained in the Credit Agreement are true and
correct.
(d) The Borrower is entering into this Waiver and Amendment on the
basis of its own investigation and for its own reasons, without reliance
upon the Bank or any other person.
2
<PAGE>
5. Effective Date. This Waiver and Amendment will become effective as of
the date first above written (the "Effective Date"), provided that each of the
following conditions precedent are satisfied.
(a) The Bank has received from the Borrower a duly executed original
(or, if elected by the Bank, an executed facsimile copy) of this Waiver and
Amendment; and
(b) All representations and warranties contained herein are true and
correct as of the Effective Date.
6. Reservation of Rights. The Borrower acknowledges and agrees that neither
the Bank's forbearance in exercising its rights and remedies in connection with
the Existing Default, nor the execution and delivery by the Bank of this Waiver
and Amendment, shall be deemed (i) to create a course of dealing or otherwise
obligate the Bank to forbear or execute similar waivers under the same or
similar circumstances in the future, or (ii) to waive, relinquish or impair any
right of the Bank to receive any indemnity or similar payment from any person or
entity as a result of any matter arising from or relating to the Existing
Default.
7. Miscellaneous.
(a) Except as herein expressly amended, all terms, covenants and
provisions of the Credit Agreement are and shall remain in full force and
effect and all references therein to such Credit Agreement shall henceforth
refer to the Credit Agreement as amended by this Waiver and Amendment. This
Waiver and Amendment shall be deemed incorporated into, and a part of, the
Credit Agreement.
(b) This Waiver and Amendment shall be binding upon and inure to the
benefit of the parties hereto and thereto and their respective successors
and assigns. No third party beneficiaries are intended in connection with
this Waiver and Amendment.
(c) This Waiver and Amendment shall be governed by and construed in
accordance with the law of the State of California.
(d) This Waiver and Amendment may be executed in any number of
counterparts, each of which shall be deemed an original, but all such
counterparts together shall constitute but one and the same instrument.
Each of the parties hereto understands and agrees that this document
3
<PAGE>
(and any other document required herein) may be delivered by any party
thereto either in the form of an executed original or an executed original
sent by facsimile transmission to be followed promptly by mailing of a hard
copy original, and that receipt by the Bank of a facsimile transmitted
document purportedly bearing the signature of the Borrower shall bind the
Borrower, with the same force and effect as the delivery of a hard copy
original. Any failure by the Bank to receive the hard copy executed
original of such document shall not diminish the binding effect of receipt
of the facsimile transmitted executed original of such document which hard
copy page was not received by the Bank.
(e) This Waiver and Amendment, together with the Credit Agreement,
contains the entire and exclusive agreement of the parties hereto with
reference to the matters discussed herein and therein. This Waiver and
Amendment supersedes all prior drafts and communications with respect
thereto. This Waiver and Amendment may not be amended except in accordance
with the provisions of Section 9.05 of the Credit Agreement.
(f) If any term or provision of this Waiver and Amendment shall be
deemed prohibited by or invalid under any applicable law, such provision
shall be invalidated without affecting the remaining provisions of this
Waiver and Amendment or the Credit Agreement, respectively.
(g) The Borrower covenants to pay to or reimburse the Bank at cost,
upon demand, for all reasonable costs and expenses (including allocated
costs of in-house counsel) incurred in connection with the development,
preparation, negotiation, execution and delivery of this Waiver and
Amendment and the administration of the Existing Default.
4
<PAGE>
IN WITNESS WHEREOF, the parties hereto have executed and delivered this
Waiver and Amendment as of the date first above written.
FILENET CORDORATION
By: /s/ Mark S. St. Clare
Typed Name: Mark S. St. Clare
Title: Chief Financial Officer
By: /s/ William R. Hughes
Typed Name: William R. Hughes
Title: Controller/Chief Accounting Officer
BANK OF AMERICA NATIONAL TRUST
AND SAVINGS ASSOCIATION
By: /s/ John Cinderey
Typed Name: John Cinderey
Title: Managing Director
5
<PAGE>
Date: , 199
For the fiscal quarter/year
ended , 199
SCHEDULE 2
to Compliance Certificate
Actual Required/Permitted
------ ------------------
1. Section 7.01(d) Other Bank Borrowings
by Subsidiaries
Indebtedness of Subsidiaries for
borrowed money from other bank Not to exceed $5,000,000
2. Section 7.01(e) Purchase Money
Obligations and Section 7.02 purchase
Money Liens
Purchase money obligations and
related liens Not to exceed $10,000,000
3. Section 7.03 Capital Assets
Obligations for the acquisition of
fixed or capital assets during
current fiscal year Not to exceed $25,000,000
4. Section 7.07(d) Sale and Leaseback
Financing under sale and leaseback
agreements of fixed or capital assets Not to exceed $5,000,000
A11 amounts determined on a consolidated basis.
1
<PAGE>
Actual Required/Permitted
------ ------------------
5. Section 7.11 Quick Ratio
A. (i) cash
(ii) net accounts receivable
(iii) short-term cash
investments
(iv) investment grade marketable
securities not classified
as long- term investments
(v) long-term investments in
compliance with the
Investment Guidelines (not
to exceed $25,000.000)
(i) + (ii) + (iii) + (iv) + (v) =
B. Current liabilities (including
all funded and unfunded
obligations under the credit
Agreement and other Credit
Documents, including undrawn
amounts (or the Equivalent Amount
thereof) of all letters of credit
and Bank Guaranties and drawn and
unreimbursed obligations with
respect thereto
A
= B = Not less than 1.75 to 1.00
2
<PAGE>
Actual Required/Permitted
------ ------------------
6. Section 7.l2 Total Liabilities to
Total Net Worth
the ratio of
A. total liabilities (including all
funded and unfunded obligations
under the Credit Agreement and
other Credit Documents. including
undrawn amounts (or the
Equivalent Amount thereof) of all
letters of credit and Bank
Guaranties and drawn and
unreimbursed obligations with
respect thereto
B. Tangible Net Worth
the difference of:
(i) gross book value of
assets
less
(ii) goodwill, patents, trademarks, trade names,
organization expense, capitalized software,
treasury stock, unamortized debt
discount and expense, deferred charges, and
other like intangibles, monies due from
affiliates, officers, directors. or
shareholders of the Borrower or any of its
Subsidiaries. and value placed on any leasehold
(other than leasehold improvements)
less
(iii)applicable reserves
less
(iv) all liabilities
(including accrued and deferred income taxes)
(i) - (ii) - (iii) - (iv) =
A =
B Not greater than 0.75 to 1.00
3
<PAGE>
Actual Required/Permitted
------ ------------------
7. Section 7.13 Tangible Net Worth
Tangible Net Worth (from 6 above) Not less than the sum of:
A.$115,000,000 $115,000,000
plus
B.75% of net income
after taxes (with-out
subtracting losses)for
each fiscal quarter
commencing after 9/30/96
plus
C.100% of net proceeds
from the issuance of
any equity securities
issued after 9/30/96
plus
D.100% of any increase
in shareholders' equity
from conversion of debt
to equity after 9/30/96
= A + B + C + D =
8. Section 7.24 Consecutive Quarterly
Losses: Losses in One Quarter
A. (i) Net (after tax) income
(loss) for fiscal quarter
reported on Not in excess of ($5,000,000)
(ii) Operating income (loss) for
fiscal quarter reported on Not in excess of ($5,000.000)
B. (i) Net (after tax) income
(loss) immediately
preceding fiscal quarter
(ii) Net (after tax) income
(loss) for fiscal quarter If (i) is a loss, (ii) shall
reported on not be a loss.
C. (i) Operating income (loss) for
the immediately preceding
fiscal quarter
(ii) Operating income (loss) for If (i) is a loss, (ii) shall not be
fiscal quarter reported on a loss.
4
THIRD AMENDMENT TO LEASE
THIS THIRD AMENDMENT TO LEASE (the "Amendment") is made and entered into as
this 1st day of October, 1992, by and between C. J. SEGERSTROM & SONS, a general
partnership, hereinafter called "Landlord," and FILENET CORPORATION, a
California corporation, hereinafter called "Tenant," with respect to the
following:
RECITALS
A. Landlord is the landlord and Tenant is the tenant pursuant to that
certain High Technology/Research and Development Lease dated July 23, 1986, as
amended by a certain letter agreement dated July 2, 1987 (collectively; the
"Original Lease"). The Original Lease covers certain premises consisting of a
total of approximately 120,000 square feet of Rentable Area located in two
buildings, of approximately 60,000 square feet each ("Buildings 1 and 2")
located at the Northwest corner of Harbor Boulevard and Scenic Avenue in that
certain business park known as Harbor Gateway Business Center (the "Center"), in
the City of Costa Mesa, State of California and more particularly described in
the Original Lease.
B. Landlord and Tenant have also entered into that certain Option:
Agreement dated and executed July 23, 1986, as amended by certain letter
agreements dated, respectively, June 23, 1987, March 15, 1988, and May 23, 1988
(collectively; the "Option Agreement"). By means of the Option Agreement,
Landlord and Tenant amended the Original Lease to add to the Premises certain
additional premises consisting of approximately 50,000 square feet located in a
single building denominated as High-Tech 3 ("Building 3") and located in the
Center. Buildings 1, 2 and 3 are herein referred to, collectively, as the
"Premises," and the Original Lease and the Option Agreement are sometimes
referred to herein, collectively, as the "Lease."
C. Tenant desires to amend the Original Lease to add to the Premises
another additional building located within the Center, commonly known as 1535
Scenic Avenue and consisting of approximately 60,000 square feet of Rentable
Area ("Building 14"), as more particularly shown on Exhibit "A" attached hereto.
Landlord is willing to so amend the Original Lease, but only upon the terms and
conditions set forth in this Amendment.
AGREEMENT
IN CONSIDERATION OF the foregoing recitals and the promises and covenants
contained in this Amendment, Landlord and Tenant agree as follows:
1. Leasing of Building 14. Landlord hereby leases to Tenant, and Tenant
hereby hires from Landlord, Building 14 upon all of the terms of the Original
Lease, as modified by this Amendment.
2. Terms of Leasing. Tenant shall hold and occupy Building 14 as part of
the Premises upon all of the terms and conditions of the Original Lease, except
that:
(a) The term of the Lease with respect to Building 14 shall commence on
July 1, 1993 (the "Building 14 Commencement Date"), and thereafter shall be
coterminous with the term of the Lease with respect to Building 3. Tenant shall
also have the option to extend the term of the Lease with respect to Building
14. Such option shall be upon the terms set forth in paragraph 4(b)(xi) of the
Option Agreement and Section 48.1 of the Original Lease, and the additional term
for Building 14 shall be
<PAGE>
coterminous with the additional term for Building 3. From and after the Building
14 Commencement Date, Tenant and Landlord shall each observe and perform all of
their respective obligations pursuant to the Lease, as hereby amended, with
respect to Building 14, including, without limitation, the payment of Basic
Annual Rent and Additional Rent.
Landlord and Tenant contemplate that Landlord will deliver possession of
Building 14 to Tenant and Tenant will commence occupancy of Building 14 on July
1, 1993, the Building 14 Commencement Date. In no event shall Tenant be required
to pay Basic Annual Rent or Additional Rent with respect to Building 14 for any
period prior to July 1, 1993, notwithstanding any delivery of possession of
Building 14 to Tenant prior to the Building 14 Commencement Date.
Notwithstanding the foregoing Tenant shall have a license (the "License")
to enter Building 14 prior to the Building 14 Commencement Date. Such License
shall be upon the following terms:
(i) The License shall extend for the period from April 1, 1993 through June
30 1993.
(ii) Entry pursuant to the License may be made at any time during normal
business hours (8 a.m.. to 5:30 p.m., Monday through Friday, legal holidays
excepted). For this purpose, Tenant shall not retain a key to Building 14.
Rather, access shall be afforded by Landlord's management or security personnel
upon request to Landlord's management office at the Center. Such request may be
made in person or by telephone.
(iii) Entry pursuant to the License shall be for any purpose reasonably
related to Tenant's occupancy of Building 14 following the Building 14
Commencement Date, including but not limited to measurement of areas to be
occupied, inspection of Building 14 and the equipment located therein or
thereon, installation of furniture, furnishings, equipment and operating systems
(such as telephone, security and fire), replacement of existing signage with
respect to Building 14 and installation of tenant improvements.
(iv) Entry pursuant to the License is limited to Tenant, its employees and
to third parties retained by Tenant for the purposes specified in clause (iii)
above and designated in writing by Tenant to Landlord. As between Landlord and
Tenant, all persons entering Building 14 at the request of Tenant shall be
deemed agents of Tenant, and Tenant shall be solely responsible for the safety
of and actions of such persons. In no event shall Landlord have any
responsibility for such persons or any liability to them, and Tenant shall
indemnify. defend and hold Landlord harmless from and against all claims by any
such persons for damages (including punitive damages, costs and attorneys fees)
resulting from injury, death or property damage arising out of such entry.
(v) Any work in or on Building 14 performed by or for Tenant pursuant to
the License shall be the sole responsibility of Tenant as to performance and
payment of costs and shall comply with Articles 9 and 12 of the Original Lease,
all applicable provisions of Exhibit "D" thereto and all applicable requirements
of all governmental authorities having jurisdiction of Building 14. Such
requirements shall include the prior written approval of Landlord when required
by the Original Lease.
(vi) The insurance required by Sections 15.1, 15.2 and 15,3 of the Original
Lease shall extend to any entry pursuant to the License and all activities by or
on behalf of Tenant in or about Building 14. In addition, the indemnification
and exculpation provisions contained in Sections 15.4, 15.5 and 15,6 of the
Original Lease shall extend to any such entry and any such activities.
2
<PAGE>
(vii) As used in this License, all references to Building 14 shall include
the Permanent Building 14 Parking Area, as defined in subparagraph (g) below.
(viii) In the event that Tenant fails to perform any of its obligations
pursuant to clauses (v) and (vi) above with respect to the License, and such
failure continues for ten (10) days after delivery of written notice from
Landlord to Tenant, Landlord may immediately terminate the License upon written
notice to Tenant, with such termination to be effective upon receipt by Tenant
of Landlord's notice of termination. In addition, if Tenant fails to perform any
of its obligations pursuant to the License, Landlord shall have the right to
perform such obligations for Tenant's account pursuant to Article 33 of the
Original Lease, but without requirement of further notice and a grace period
pursuant to Article 19 of the Original Lease.
(b) Notwithstanding anything to the contrary in this Amendment and except
as provided in this subparagraph (b), Tenant accepts Building 14 "AS IS". Tenant
acknowledges that, except as provided to the contrary in clause (ii) below,
Landlord shall have no responsibility, either as to performance or payment of
costs, to remodel or renovate Building 14 or the Permanent Building 14 Parking
Area for Tenant use. Any remodel, renovation or improvement to Building 14 or
the Permanent Building 14 Parking Area undertaken by Tenant shall be completed
in accordance with the terms and conditions of paragraphs 5, 6 and 8 of Exhibit
"D" to the Original Lease and notwithstanding anything to the contrary therein,
all such work shall be completed at Tenant's sole cost and expense.
Without limiting the generality of the foregoing:
(i) Landlord represents and warrants to Tenant that, to the knowledge of
Landlord, no hazardous, toxic carcinogenic, reproductive toxic, corrosive,
reactive or ignitable substances, wastes or materials, as defined in any
applicable federal, state or local law or regulation promulgated thereunder,
including, without limitation, petroleum (including crude oil or any fraction
thereof), asbestos or asbestos-containing materials and polychlorinated
byphenyls (PCB's), collectively, "Substances," are incorporated into Building 14
or-any other improvements or facilities located on the Permanent Building 14
Parking Area. Tenant acknowledges and accepts that Landlord has not conducted
any investigation or testing for the purposes of making the foregoing
representation and warranty. Rather, Landlord makes such representation and
warranty solely on the basis of Landlord's construction of Building 14 and the
Permanent Building 14 Parking Area and its continuous ownership thereof since
such construction. The foregoing representation and warranty shall not extend to
any Substances incorporated into, brought into or maintained in or upon Building
14 or the Permanent Building 14 Parking Area by Emulex Corporation ("Emulex"),
the existing tenant of Building 14 and the Permanent Building 14 Parking Area.
(ii) Prior to execution and delivery of this Amendment, Landlord, Tenant
and Emulex have mutually inspected Building 14 and on the basis of such
inspection, Landlord and Emulex have compiled a list of maintenance and repair
work with respect to Building 14 to be performed by Emulex prior to delivery of
possession of Building 14 to Landlord. A copy of such list u attached to this
Amendment as Exhibit "B." Landlord shall use its best efforts to cause Emulex to
perform all work specified on such list (the "Repair List"). Except for (A) the
performance of the work specified on the Repair List, (B) normal wear and tear
and (C) removal by Emulex of all signage and all personal property and fixtures
not permanently attached to Building 14 other than the FF&E, as defined in
paragraph 4 below, upon delivery of possession of Building 14 to Tenant,
Building 14 shall be in the same condition as on the date of the inspection
described herein.
3
<PAGE>
(iii) As described in paragraph 4 below, Tenant shall purchase directly
from Emulex certain FF&E located in Building 14. Tenant may, during the period
from surrender of possession of Building 14 by Emulex to Landlord and the
Building 14 Commencement Date, desire to leave the FF&E in place in Building 14.
Landlord consents to such storage arrangement by Tenant. Such storage shall be
without requirement of payment of rent or any other amount to Landlord However,
Tenant shall be solely responsible for all such FF&E, including security of the
same and maintenance of insurance upon the FF&E. Except for intentional acts and
negligence of Landlord, Landlord shall have no responsibility with respect to
the FF&E. Without limiting the generality of the foregoing Landlord shall have
no responsibility to provide special security for, maintenance of or insurance
with respect to the FF&E. By its signature hereto, Tenant releases and forever
discharges Landlord from any and all such responsibilities and/or liability and
irrevocably waives any and all claims against Landlord its partners, agents and
employees arising out of or resulting from any loss, theft, damage or
destruction to or of the FF&E, or any of it while stored in Building 14 pursuant
to this clause (iii), except for intentional acts and negligence of Landlord.
(c) The provisions of the Option Agreement, other than paragraph 4(b)(xi)
thereof shall have no application with respect to Building 14.
(d) The provisions of Sections 2.2, 2.4. 3.5, 48.1(c) and Articles 38 and
41 of the Original Lease shall have no application with respect to Building 14.
The provisions of Exhibit "D" to the Original Lease, other than paragraphs 5, 6
and 8 thereof, shall have no application to Building 14.
(e) All references to the term "Building" or "Buildings" in the Original
Lease, when referring to Buildings 1 and/or 2 generically shall be construed to
refer to Building 3 and Building 14 to the extent, in each such case, that such
a reference is capable of reasonable application to Building 3 and Building 14.
(f) Any provisions of the Lease superseded by or inconsistent with the
provisions of this Amendment shall have no application with respect to Building
14.
(g) Tenant's Allocated Parking Spaces with respect to Building 14 shall be
240 spaces. Tenant shall be entitled to use such Allocated Parking Spaces, in
common with others, in the Parking Area for the Center, as defined in Article 44
of the Original Lease. Tenant's use of its Allocated Parking Spaces shall be
subject to the terms and provisions of Article 44 of the Original Lease. Without
limiting the generality of the foregoing, Landlord and Tenant agree and
acknowledge that:
(i) The primary parking area currently designated for Building 14 (the
"Current Building 14 Parking Area") is the area depicted on Exhibit "C" attached
hereto with single hatching. As described in clause (iv) below and paragraph
5(e) below, Landlord will cause Emulex to exchange with Tenant that portion of
the Building B parking area located to the east of Building 14 ("Exchange Area
No. 1") for that portion of the Current Building 14 Parking Area located to the
west of Building B ("Exchange Area No. 2"). Exchange Area No. 1 and Exchange
Area No. 2 are depicted and designated on Exhibit "C' attached hereto. The
Building 14 parking area resulting from such exchange is herein referred to as
the "Permanent Building 14 Parking Area" Tenant's primary or principal parking
area for Building 14 shall be the Permanent Building 14 Parking Area. Tenant's
Allocated Spaces shall not, however, be limited to the Permanent Building 14
Parking Area, and Tenant may, subject to the provisions of Article 44 of the
Original Lease and clause (ii) below, utilize for purposes of its Allocated
Parking Spaces the Parking Area for the Center.
4
<PAGE>
(ii) Those spaces identified with cross-hatching on Exhibit "C," other than
Exchange Area No. 1, and Exchange Area No. 2 are or shall be exclusive to the
tenants of Buildings A, B and High-Tech 15. Tenant and its employees shall not
be entitled to park in such areas.
(iii) The Permanent Building 14 Parking Area is subject to the provisions
of that certain Reciprocal Parking Agreement, Amendment No. 8 to Lease with
Emulex Corporation and Notice of Deletion of Territory as to Declaration as to
Easements, Restrictions add Common Facilities for Harbor Gateway Center, dated
May 25, 1984, by and among Citibank N.A., Ticor Title Insurance Company of
California, Landlord and Emulex (the "Parking Agreement"). As provided in
paragraph 5(e) below, Tenant shall cooperate with Landlord (and Emulex) to amend
and restate the Parking Agreement to, among other things, modify the Parking
Agreement to reflect the exchange of Exchange Area No. 1 and Exchange Area No. 2
as provided in clause (i) above.
(iv) There is currently located, approximately at the location depicted
with an "x" on Exhibit "B," a vehicle entry barrier maintained by Emulex and
which prevents entry to a portion of the Current Building 14 Parking Area except
through a guarded gate located at the southerly end of Building A. Emulex shall
not relocate such entry barrier and Tenant shall not use the portion of the
Current Building 14 Parking Area now protected by such vehicle entry barrier.
Rather, Landlord shall cause Emulex to effect the exchange of parking areas
provided for in clause (i) above. In addition, Landlord, Tenant and Emulex shall
as a part of the refinancing provided for in Paragraph 6 below, use reasonable
efforts to cause the Parking Agreement to be amended to create the Permanent
Building 14 Parking Area by recognition of the exchange to be effected pursuant
to clause (i) above.
(h) Tenant shall not be required to make any additional security deposit
with respect to Building 14, but the existing security deposit under the
Original Lease shall apply to the leasing of Building 14 in addition to the
leasing of Buildings 1, 2 and 3.
(i) Upon the Effective Date of this Amendment, as defined in paragraph 6
below, Tenant shall deposit with Landlord the sum of $49,200 as the first
month's Basic Annual Rent due hereunder with respect to Building 14, which sum
shall be applied by Landlord, without interest, to the first monthly installment
of Basic Annual Rent due hereunder with respect to Building 14.
(j) Tenant shall use and occupy Building 14 only for the purposes of a
corporate headquarters, corporate offices, general offices uses and research and
development activities.
(k) From and after the Building 14 Commencement Date, Tenant's monthly
Proportionate Share of Common Facilities Expenses, as defined and determined in
accordance with Exhibit "B" to the Original Lease, shall be determined by
including the Allocated Parking Spaces for Building 14. In other words, from and
after the Building 14 Commencement Date, Tenant's Proportionate Share of Common
Facilities Expenses shall be determined using the Allocated Parking Spaces for
all of Buildings 1, 2, 3 and 14. Expressed as a percentage, Tenant's
Proportionate Share of Common Facilities Expenses for the Center shall be 42.2%,
determined by dividing Tenant's aggregate of 824 allocated Parking Spaces by
1,952 total Allocated Parking Spaces in the Center of tenants who contribute to
Common Facilities Expenses. As of the Building 14 Commencement Date, Tenant's
Allocated Parking Spaces, by Building, shall be as follows:
5
<PAGE>
Building Allocated Spaces
-------- ----------------
1 212
2 172
3 200
14 240
It is understood and acknowledged that the 1,952 Allocated Spaces in the
Center of tenants who contribute to Common Facilities Expenses are less than all
Allocated Spaces in the Center. Landlord represents and warrants to Tenant that
all tenants with allocated Spaces in the Center who do not contribute to Common
Facilities Expenses either (i) maintain and operate their own Allocated Spaces,
including direct payment of real property taxes and other expenses of
maintaining and operating such allocated Spaces or (ii) pay rent to Landlord on
a so-called "gross" basis which includes an allocated portion of the expenses of
operating and maintaining the allocated Spaces of such tenants, which such
allocated portion is applied by Landlord to expenses of operating and
maintaining Allocated Spaces in the Canter. During the term of the Lease, all
leases of space in the Center shall provide either that (A) the tenants pursuant
to such leases shall pay a Proportionate Share of Common Facilities Expenses for
the Center determined in the same manner as provided in Exhibit "B" to the
Original Lease or (B) such tenants shall pay, directly or indirectly, the
expenses of maintaining and operating their allocated Spaces in one of the
manners provided in clauses (i) and (ii) of this subparagraph.
3. Rent.
(a) From and after the Building 14 Commencement Date, Tenant shall pay, as
Basic Annual Rent with respect to Building 14, the sum of $9.84 per square foot
of Rentable Area ($590,400) triple net, per year, payable in equal monthly
installments of $49,200 ($0.82 per square foot of Rentable Area)concurrently
with Tenant's monthly installments of Basic Annual Rent for the balance of the
Premises, without deduction or offset. Basic Annual Rent shall be paid at the
times and in the manner provided in Section 3.1 of the Original Lease
(b) The Basic Annual Rent payable with respect to Building 14 shall be
adjusted in the manner provided in Section 3.4 of the Original Lease, except
that, (i) the term "Adjustment Date" as applied to the Basic Annual Rent payable
with respect to Building 14 shall mean July 1, 1995, and again on April 30,
1997, (ii) as to Building 14, in no event shall the Basic Annual Rent as to
Building 14 be increased on any such Adjustment Date to more than eight percent
(8%) per year of the Basic Annual Rent with respect to Building 14 in effect
immediately prior to such adjustment and (iii) for the purpose of the
adjustments to the Basic Annual Rent with respect to Building 14, the phrase
"twenty-five (25) multiplied by "appearing in the third sentence of Section 3.4
of the Original Lease shall not be applicable. For the purposes of clause (ii)
of this subparagraph, if the number of months in the period from the Building 14
Commencement Date to the first Adjustment Date or the period from the first
Adjustment Date to the second Adjustment Date, as the case may be, is not evenly
divisible by twelve (12), then the percentage increase at the end of such period
shall be equal to eight percent (8%) for each full year in such period plus for
the partial year in such period, a percentage equal to eight (8) times a
fraction whose numerator is the number of months in the partial year and whose
denominator is twelve (12).
4. Furniture. Fixtures and Equipment. Landlord and Tenant acknowledge and
agree that Building 14 has been previously built-out by Landlord, and that all
permanently attached improvements in Building 14 are the property of Landlord.
Concurrently with Tenant's execution of this Amendment, Tenant shall enter into
an
6
<PAGE>
agreement with Emulex to acquire directly from Emulex certain fixtures,
furniture and equipment (the "FF&E') of Emulex currently located in Building 14.
A list of the FF&E to be so acquired is attached hereto as Exhibit "D". Such
list has been compiled by Tenant and Emulex, and Landlord has no responsibility
for the compilation of such list and makes no representation or warranty as to
the accuracy or completeness of such list. Such agreement shall be the sole
responsibility of Tenant, and Landlord shall have no responsibility, either as
to performance or payment, with respect to the FF&E, payment therefor or
delivery thereof. Landlord shall have no claim to the FF&E or any proceeds
thereof, and title to the FF&E shall be conveyed to Tenant by Emulex in such
manner and using such instruments as shall be agreed upon by Tenant and Emulex
5. Representations and Covenants.
(a) Zoning. Landlord represents and warrants to Tenant that Building 14 is
zoned, as of the date hereof, in a manner which permits the use of Building 14
as specifically permitted by paragraph 2(j) above and that no variance or
special use permit is required for the use of Building 14 as specifically
permitted by paragraph 2(j) above or, if any special use permit has been
granted, such special use permit is still in effect and will apply to Tenant's
use of Building 14 as specifically permitted by paragraph 2(j) above.
(b) Use. Landlord represents and warrants to Tenant that the use of
Building 14 as specifically permitted by paragraph 2 (j) above complies with the
Declaration as to Easements, Restrictions and Common Facility Provisions for
Harbor Gateway Center dated July 31, 1981, executed by Landlord and recorded in
the Office of the Orange County Recorder.
(c) Brokers. Landlord and tenant each represents w~ and covenants to the
other that such warranting party shall defend, indemnify and hold harmless the
other party from and against any and all claims, costs, losses, expenses,
damages, actions and Muses of action incurred in any claim or action instituted
by any broker, agent or finder, including, but not limited to, CB Commercial
Real Estate Group, Inc., claiming under the warranting party with respect to
Building 14. Landlord and Tenant agree that payment shall not be a condition
precedent to recovery upon the foregoing indemnification provisions.
(d) Schematics and As-Built Drawings. Prior to the Building 14 Commencement
Date, Landlord shall provide to Tenant one copy of all existing schematic
drawings and as-built drawings in Landlord's possession with respect to Building
14. However, Landlord makes no representations or warranties as to the accuracy
or completeness of any items supplied to Tenant pursuant to the provisions of
this subparagraph.
(e) Cooperation, Tenant recognizes that Landlord is in the process of
refinancing certain property within the Center with Teachers Insurance and
Annuity Association of America ('Teachers"), including Building 14, and that the
Permanent Parking Area for Building 14 is subject to existing restrictions as
contained within the Parking Agreement. Tenant will take all action as may
reasonably be necessary for Landlord to obtain refinancing approval from
Teachers with respect to Building 14, and to amend and restate the Parking
Agreement to, among other things, (i) substitute Tenant for Emulex as to the
Permanent Building 14 Parking Area, (ii) terminate all rights of Emulex as to
the Permanent Building 14 Parking Area, (iii) amend and restate the Parking
Agreement to eliminate therefrom those portions superseded by the passage of
time or various construction or development of the property described in the
Parking Agreement and (iv) eliminate the Current Building 14
7
<PAGE>
Parking Area and create the Permanent Building 14 Parking Area by giving
effect to and recognizing the exchange of Exchange Area No. 1 for Exchange Area
No. 2 provided for in paragraph 2(g) above. Such amendment to and restatement of
the Parking Agreement shall be consistent with the parking rights granted to
Tenant with respect to Building 14 pursuant to this Amendment. Such amendment to
and restatement of the Parking Agreement shall be at no cost or liability to
Tenant other than Tenant's own attorneys' fees and costs, and no such amendment
and restatement shall effect any changes to the business terms embodied in this
Amendment with respect to Tenant's use of Building 14 and the Permanent Building
14 Parking Area. In addition, in connection with such refinancing, Landlord
shall use reasonable efforts to obtain from Teachers s subordination agreement,
in recordable form and in the form attached hereto as Exhibit "E," with
appropriate references to the refinancing documents executed by Landlord and
Teachers. Nothing contained herein shall, however, be deemed to constitute a
representation, warranty or covenant by Landlord to the effect that (i) Landlord
shall. be able to obtain such subordination agreement from Teachers or (ii)
Landlord shall be able to obtain such subordination agreement by any particular
date or within any particular time.
6. Contingencies. The effectiveness of this Amendment is expressly
contingent upon each of the following:
(a) Landlord's review and approval of Tenant's current audited financial
statements (including consolidated balance sheets, consolidated statements of
operations and consolidated statements of cash flows) for Tenant's fiscal year
ended December 31, 1991, and for the interim period ended June 30 1992.
Accordingly, Tenant shall deliver to Landlord the foregoing financial statements
on or before October 16, 1992, and Landlord shall approve or disapprove such
financial statements by written notice to Tenant given within ten (10) days
after Landlord's receipt of such statements. Landlord's failure to approve or
disapprove such statements in such manner and within such time shall be deemed
approval thereof;
(b) Approval by Teachers, on or before November 15, 1992 (the 'Target
Date"), of the terms of this Amendment and the agreement described in
subparagraph (d) below.
(c) Delivery by Teachers to Landlord on or before the Target Date of an
executed letter providing, in substance, that Teachers' commitment to refinance
the existing Teachers financing upon Building 14 and other portions of the
Center on the terms and conditions set forth in Teachers' commitment letter
dated August 20, 1992 remains in effect without modification notwithstanding
this Amendment and the agreement provided for in subparagraph (d) below;
(d) The execution and delivery by Emulex and Landlord, on or before the
Target Date, of an agreement, on terms and conditions mutually satisfactory to
Landlord and Emulex, providing, among other things, for the termination of
Emulex' existing lease (as to Building 14 and the Building 14 Parking Area only)
on or before March 31, 1993 and delivery by Emulex to Landlord of possession of
Building 14 and the Building 14 Parking Area on or before March 31, 1993;
(e) Delivery, on or before the Target Date, of a letter executed by an
appropriate official of the City of Costa Mesa providing in substance, that (i)
the existing zoning for Building 14 permits Tenant's use thereof as specified in
paragraph 2(j) above and (ii) no additional permits are required to permit the
use of Building 14 as specified in paragraph 2 (j) above;
8
<PAGE>
(f) Execution and delivery by Tenant and Emulex, on or before the Target
Date, of an agreement covering the transfer of the FF&E as provided in paragraph
4 above and in form and substance satisfactory to Tenant and Emulex.
(g) Review and approval by Tenant of the Parking Agreement. Such approval
shall be deemed given unless, on or before October 14 1992 Tenant notifies
Landlord in writing of the portion(s) of the Parking Agreement which Tenant
disapproves.
In the event that (i) the contingencies set forth in subparagraphs (b)
through (d) above shall fail to occur within the time periods specified therein
or (ii) Landlord disapproves of Tenant's financial statements within the time
and in the manner set forth in subparagraph (a) above, then Landlord shall have
the option to terminate this Amendment by written notice to Tenant given (A) as
to subparagraph (a) above, by delivery to Tenant of Landlord's notice of
disapproval (B) as to subparagraphs (b), (c) and (d) above, on or before
November 15, 1992. Similarly, if (x) either or both of the conditions set forth
in subparagraphs (e) and (f) above shall fail to occur on or before the Target
Date or (y) Tenant disapproves the Parking Agreement, then Tenant shall have the
right to terminate this Amendment by written notice to Landlord given (C) as to
subparagraphs (e) and (f) above, on or before the Target Date and (D) as to
subparagraph (g) above by delivery to Landlord of Tenant's written notice of
disapproval.
If either party has the right to terminate this Amendment and does so
within the times and in the manner set forth herein:
(1) this Amendment shall terminate on the date of the addressee's receipt
of the notice of termination given by the other party;
(2) each party shall bear its own costs and fees incurred in the
negotiation and preparation of this Amendment and in performing its respective
obligations hereunder through the date of such termination; and
(3) all amounts deposited by Tenant with Landlord pursuant to this
Amendment shall be returned to Tenant and neither party shall have any further
obligation to the other with respect to Building 14 or the Permanent Building 14
Parking Area. Any termination hereunder shall not have any effect on Landlord's
and Tenant's obligations to one another pursuant to the Lease. Pending any
termination of this Amendment as provided herein, Landlord and Tenant each agree
to diligently pursue their respective obligations hereunder.
As soon as any of the conditions contained herein are met, the party
entitled to terminate on the basis of failure of such condition shall promptly
notify the other party of the satisfaction of such condition. The date on which
such notice is received as to the last condition to be satisfied shall be the
effective date (the "Effective Date") of this Amendment.
7. Other Matters. Landlord and Tenant further agree that:
(a) Notwithstanding anything to the contrary contained in the Original
Lease, upon the expiration or any earlier termination of the Lease with respect
to Building 14, reasonable wear and tear shall be excepted from the condition in
which Tenant is required to deliver possession of Building 14 to Landlord.
(b) By their signatures hereto, Landlord and Tenant confirm the following
information with respect to Buildings 1, 2, 3 and 14:
9
<PAGE>
(i) Building 1 - Commencement Date is November 1, 1987 and expiration date
is April 30 1998; one five (5) year option (May 1, 1998 through April 30 2003)
exercisable upon not more than 15 and not less than 12 months prior written
notice to Landlord.
(ii) Building 2 - Commencement Date is August 1, 1987 and expiration date
is January 31, 1998; one five (5) year option (February 1, 1998 through January
31, 2003) exercisable upon not more than 15 and not less than 12 months prior
written notice to Landlord.
(iii) Building 3 - Commencement Date is June 1, 1990 and expiration date is
May 31, 2000; one five (5) year option (June 1, 2000 to May 31, 2005)
exercisable upon not more than 15 and not less than 12 months prior written
notice to Landlord.
(iv) Building 14 - Commencement Date is July 1, 1993 and expiration date is
May 31, 2000; one five (5) year option (June 1, 2000 to May 31, 2005)
exercisable upon not more than 15 and not less than 12 months prior written
notice to Landlord.
(c) There currently exists a free standing concrete sign monument located
at the entrance to the Permanent Building 14 Parking Area from Scenic Drive (the
"monument"). Such Monument is currently occupied by a sign erected by Emulex.
Tenant agrees that, from and after the Target Date, Tenant shall acquire from
Emulex all rights in and to the use of the Monument and that the sign thereon
shall be redesigned to reflect thereon the name of Tenant only. The removal of
the existing Emulex sign, the design and fabrication of Tenant's sign, and all
costs and expenses with respect to such removal, design, construction and
installation, shall be the sole responsibility of Tenant and Emulex, and Tenant
indemnifies and holds Landlord harmless with respect to any claims or liability
with respect thereto. Tenant shall obtain or cause to be obtained all necessary
permits and approvals for the modified signage from the governmental agency
having jurisdiction. Landlord shall have the right to approve such replacement
signage in accordance with its rights under the Lease.
(d) Landlord and Tenant acknowledge that Tenant may, at some date in the
future, desire to consolidate some or all operations currently conducted in
Buildings 1, 2, 3 and 14 into a single, larger building and may approach
Landlord with a proposal to construct for and lease to Tenant a building in the
Center, or in or on any other property owned or controlled by Landlord or an
affiliate of Landlord, with a Rentable Area of 150,000 to 200,000 or more square
feet. Landlord agrees, upon any such proposal by Tenant, to consider such
proposal. For the purposes of this subparagraph, Landlord and Tenant acknowledge
and agree that:
(i) Nothing contained in this subparagraph shall be deemed or construed to
require Tenant to present any such proposal to Landlord, or to require Tenant to
remain in the Center beyond the several expiration dates in the Lease (and any
option terms as to which Tenant timely and properly exercises its options).
(ii) Nothing contained in this subparagraph shall be deemed or construed to
require Landlord to accept any proposal made by Tenant, to make any,
counterproposal to Tenant or to permit Tenant to remain in the Canter beyond the
several expiration dates in the Lease (and any option terms as to which Tenant
timely and properly exercises its options).
(iii) In determining whether to make or accept any such proposal or
counter-proposal, each party shall be free to take into account any fact or
10
<PAGE>
factor which such party deems relevant to its decision, including but not
limited to the availability of land in the Center or elsewhere, alternative
space available to Tenant, the cost of construction of any such building. the
rent payable with respect to any such building and with respect to alternative
available space, any other leasing goals or plans of Landlord with respect to
the Center or other property of Landlord or its affiliates, the ability of
Landlord (or its affiliates) to obtain construction and/or permanent financing
with respect to any new building to be constructed for Tenant and the impact of
any total or partial lease termination pursuant to clause (iv) below upon any
financing then existing and encumbering Buildings 1, 2, 3 and/or 14.
(iv) In connection with any proposal or counter-proposal of the type
described in this subparagraph, one element thereof shall be the termination of
the Lease, if then existing, as to each building covered thereby surrendered by
Tenant to Landlord in connection with Tenant's relocation to the new building
constructed by Landlord or its affiliate for Tenant.
(v) Nothing contained in this subparagraph shall be deemed or construed to
create or grant to either party any option, put, call, right of first refusal or
right of first offer. There shall be no right to recover damages on account of
any alleged "breach" of the provisions of this subparagraph and no right to
specific performance or injunctive relief on account of any such alleged
"breach" or threatened "breach."
8. Defined Terms. All terms used in this Amendment with initial capital
letters and not defined herein shall have the meanings given to such terms in
the Original Lease.
9. Lease in Effect. Landlord and Tenant acknowledge and agree that the
Lease, as hereby amended and modified, remains in full force and effect in
accordance with its terms.
IN WITNESS WHEREOF, Landlord and Tenant have executed this Third Amendment
to Lease as of the day and year first above written.
FILENET CORPORATION, C. J. SEGERSTROM & SONS,
a California corporation a general partnership
By _____________________, By_________________
Managing Partner
Title Sr. VP Operations
By_________________
By ____________________ Managing Partner
Title __________________ "Landlord"
'Tenant"
11
Amendment #A1011-941003-01
IBM Agreement #A1011
This is amendment #A1011-941003-01 to IBM/FileNet agreement #A1101dated 12/20/91
between IBM Corporation and FileNet Corporation effective 02/21/92. The parties
agree to amend the agreement by adding a new Section 4.6 below.
4.6 Buyer will have the option to extend this agreement for two additional
one-year scheduling periods, (sixth and seventh scheduling periods), by
notifying IBM in writing at least six months prior to expiration of the
fifth scheduling period, subject to approval by IBM and subject to
agreement by the parties as to duration, Products, prices, discounts and
other terms and conditions.
FileNet
/s/William Kreidler /s/Luciano J. Bifano
- ------------------- --------------------
Sam Rossiter Lucian J. Bifano
Director, Purchasing/Planning Division Director, OEM and
FileNet Corporation Technology Licensing, IBM Risc
System/6000 Division
October 3 1994 September 30, 1994
Date: Date:
Stock Market and Dividend Information
The Company's common stock is traded in the National Market System
("Nasdaq") under the symbol FILE. The following are the high and low closing
prices from January 1, 1994 through December 31, 1996 as reported by Nasdaq:
High Low
1994
1st Quarter $28.75 $20.75
2nd Quarter 28.00 15.69
3rd Quarter 24.50 17.75
4th Quarter 27.00 22.25
1995
1st Quarter $35.50 $26.00
2nd Quarter 40.38 31.00
3rd Quarter 50.25 40.25
4th Quarter 48.75 38.50
1996
1st Quarter $65.25 $40.75
2nd Quarter 57.88 33.25
3rd Quarter 35.00 20.63
4th Quarter 36.13 26.00
The closing price of the Company's common stock on December 31, 1996 was
$32.00. The approximate number of stockholders of record on March 7, 1997 was
817; the closing price of the Company's common stock on this date was $20.00.
The Company has not paid any dividends on its common stock. The Company
currently intends to retain earnings for use in its business and does not
anticipate paying cash dividends in the foreseeable future. The Company's
ability to pay dividends is limited by the terms of its line of credit
agreement.
Management's Discussion and Analysis of Results of Operations and Financial
Condition
Results of Operations The following discussion should be read in
conjunction with the Consolidated Financial Statements and Notes thereto for
FileNet Corporation ("FileNet" or the "Company") contained elsewhere herein.
On March 1, 1996, the Company acquired all the outstanding shares of Saros
Corporation ("Saros"). The merger was accounted for as a pooling-of-interests
for financial reporting purposes. The historical financial statements for the
periods prior to the merger are restated as though the companies had been
combined. The Saros stockholders received an aggregate of approximately 2.2
million shares and options to purchase the Company's common stock in exchange
for all of their Saros common stock and options (see Note 2 to Notes to
Consolidated Financial Statements for information related to the acquisition).
Factors That May Affect Future Operating Results and Financial Condition
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. 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, 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.
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 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.
The document imaging, workflow, computer output to laser disk ("COLD") 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.
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
<PAGE>
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 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 Software Inc.
("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 January 1997, Wang and Eastman Kodak Company ("Kodak") announced that
they have entered into an agreement under which Kodak will acquire the Wang
business unit that has responsibility for this litigation. The acquisition is
scheduled to close in March-April 1997 and the Company can not 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.
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 ("HP") 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.
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 contracts 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.
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.
The Company recently completed the acquisitions of Watermark, Saros and
International Financial Systems Ltd. ("IFSL"). These recent acquisitions by the
Company have presented and will continue to present it with 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
<PAGE>
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. The Company and the acquired companies could
experience difficulties or delays in integrating their respective technologies
or developing and introducing new products. In particular, one of the reasons
for FileNet's acquisition of Saros was the perceived 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.
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.
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.
Revenue As shown below, the Company derived 52% of its 1996 revenue from
the licensing of the Company's software products compared to 51% in 1995 and 42%
in 1994. Service revenue consisting 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 increased to
31% of total revenue, compared to 29% in 1995 and 32% in 1994. Hardware revenue
consisting primarily of 12-inch optical storage and retrieval libraries ("OSAR")
and third-party server hardware represented 17% of total revenue compared to 20%
in 1995 and 26% in 1994.
<TABLE>
<CAPTION>
Percent Percent
(Dollars in millions) 1996 change 1995 change 1994
<S> <C> <C> <C> <C> <C>
Software revenue $140.7 21% $116.1 43% $ 81.1
As a percentage of total revenue 52% 51% 42%
Service revenue $ 82.1 22% $ 67.2 11% $ 60.7
As a percentage of total revenue 31% 29% 32%
Hardware revenue $ 46.1 - $ 46.1 (9%) $ 50.5
As a percentage of total revenue 17% 20% 26%
------------------------------------------
Total revenue $268.9 17% $229.4 19% $192.3
==========================================
</TABLE>
Total revenue increased 17% in 1996 and 19% in 1995. Software revenue
increased in 1996 and 1995 from an increase in the volume of product shipments
from the addition of new products and reselling partners and additional revenue
generated through the Company's co-marketing arrangement with HP. The Company
believes the software revenue growth rate for 1996 was negatively impacted by
difficulties experienced with integrating the Saros and Watermark selling
efforts and personnel into FileNet's sales organization.
Service revenue increased 22% in 1996 compared to 11% in 1995. The increase
in service revenue in 1996 was due to the growth of the Company's customer
installed base, an increase in training due primarily to the training of new
resellers, and the recognition of $7.6 million of revenue from the sale and
repair of spare parts in connection with the continued transition of hardware
maintenance activities to HP. There were no such sales in 1995 and 1994, and
future sales to HP are not expected to be significant in 1997. Growth in service
revenue in 1995 was lower due to the impact of the Company's decision in 1994 to
begin outsourcing its hardware maintenance to HP and others. By the end of 1995,
all worldwide hardware maintenance was being performed by third parties. In
spite of this, service revenue increased in 1995 due to the growth of the
Company's installed base and an increase in the volume of international
consulting contracts.
<PAGE>
Hardware revenue remained flat in 1996 compared to a 9% decline in 1995.
Despite stronger than expected OSAR sales in 1996 which contributed to the
consistency of hardware revenue between 1996 and 1995, the Company expects
hardware revenue to continue to decline in both absolute dollars and as a
percentage of total revenue as the Company focuses on increasing its higher
margin software revenue.
The Company sells its products through its direct sales force in Australia,
Canada, France, Germany, the United Kingdom and the United States; and
indirectly in the United States and in 60 countries internationally through
ValueNet partners, resellers, and OEMs. Domestic and international revenue by
source are shown in the following table (revenue is attributed to the customer's
location):
<TABLE>
<CAPTION>
Percent Percent
(Dollars in millions) 1996 change 1995 change 1994
<S> <C> <C> <C> <C> <C>
Domestic
Software revenue $ 87.6 12% $ 77.9 46% $ 53.5
Service revenue 61.4 29% 47.5 7% 44.6
Hardware revenue 28.3 3% 27.4 (19%) 34.0
------------------------------------------
Domestic revenue $177.3 16% $152.8 16% $132.1
As a percentage of total revenue 66% 67% 69%
International
Software revenue $ 53.1 39% $ 38.2 38% $ 27.6
Service revenue 20.7 5% 19.7 22% 16.1
Hardware revenue 17.8 (5%) 18.7 13% 16.5
------------------------------------------
International revenue $ 91.6 20% $76.6 27% $ 60.2
As a percentage of total revenue 34% 33% 31%
------------------------------------------
Total revenue $268.9 17% $229.4 19% $192.3
==========================================
</TABLE>
Total domestic revenue increased 16% in 1996 and 1995. Domestic software
revenue increased 12% in 1996 compared to 46% in 1995 due to the reasons cited
above. Domestic service revenue increased 29% in 1996 compared to 7% in 1995.
The increase in service revenue for 1996 was positively impacted by the repair
and sale of spare parts to HP discussed above. Domestic hardware revenue
increased 3% in 1996 compared to a 19% decline in 1995 due to stronger than
expected sales of the Company's OSAR products. As a percentage of total revenue,
domestic revenue decreased to 66% in 1996 from 67% in 1995 and 69% in 1994. This
trend is expected to continue as the Company continues to expand its operations
internationally.
Total international revenue increased 20% in 1996 and 27% in 1995.
International software revenue increased 39% in 1996, remaining fairly constant
with the 38% increase in 1995. Service revenue increased 5% in 1996 and 22% in
1995. The growth in international service revenue slowed due to the impact of
hardware maintenance outsourcing partially offset by an increase in the
international customer installed base. International hardware revenue decreased
5% in 1996 as expected. International revenue as a percentage of total revenue
increased to 34% in 1996 from 33% in 1995 and 31% in 1994.
Cost of Revenue Cost of revenue as a percentage of revenue is shown in the
table below for each of the last three years:
<TABLE>
<CAPTION>
Percent Percent
(Dollars in millions) 1996 change 1995 change 1994
<S> <C> <C> <C> <C> <C>
Cost of software revenue $16.5 9% $15.1 21% $12.5
As a percentage of software revenue 12% 13% 15%
Cost of service revenue $53.6 21% $44.3 6% $41.6
As a percentage of service revenue 65% 66% 69%
Cost of hardware revenue $29.6 3% $28.8 (7%) $31.0
As a percentage of hardware revenue 64% 62% 61%
-----------------------------------------
Cost of total revenue $99.7 13% $88.2 4% $85.1
=========================================
</TABLE>
The cost of software revenue includes royalties paid to third parties,
amortization of capitalized software and the cost of manufacturing and
distributing software. In 1996 and 1995, the cost of software revenue increased
9% and 21%, respectively, over the previous year due to the increased volume of
software revenue. The cost of software revenue as a percentage of software
revenue decreased to 12% in 1996 from 13% in 1995 and 15% in 1994 due to a
decrease in the amount of capitalized software amortized and savings related to
the consolidation of software manufacturing and distributing activities.
<PAGE>
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 increased 21% in 1996 and 6% in 1995 due to an
increase in software support and professional services personnel to support the
increase in the Company's installed base. The cost of service revenue as a
percentage of service revenue decreased to 65% in 1996 from 66% in 1995 and 69%
in 1994. The decrease in 1996 was the result of the sale and repair of spare
parts at favorable margins in connection with the continued transition of
hardware maintenance activities to HP, offset by lower margins associated with
international maintenance. The decrease in 1995 was the result of improved
efficiencies in the Company's international professional services and customer
support operations.
The cost of hardware revenue includes the Company's cost of OSAR
manufacturing, third-party purchased hardware and the cost of hardware
integration personnel. The cost of hardware revenue as a percentage of hardware
revenue has remained relatively consistent at 64% in 1996, 62% in 1995 and 61%
in 1994. The slight increase in 1996 was due to a less favorable mix from the
Company's OSAR product line and lower margins from third party purchased
equipment.
Operating Expenses
<TABLE>
<CAPTION>
Percent Percent
(Dollars in millions) 1996 change 1995 change 1994
<S> <C> <C> <C> <C> <C>
Research and development $ 36.5 48% $24.7 35% $18.3
As a percentage of total revenue 14% 11% 10%
Selling, general and administrative $117.8 22% $96.5 35% $71.3
As a percentage of total revenue 44% 42% 37%
</TABLE>
The Company's research and development expenses increased 48% in 1996 and
35% in 1995 due to the addition of development personnel and the related
facilities and depreciation expenses to fund new development activities.
Research and development expenses reported in the above table are after
capitalized software development costs of $1.6 million in 1995 and $3.2 million
in 1994. As a percentage of total revenue, research and development expenses
increased to 14% in 1996 from 11% in 1995 and 10% in 1994. The increase in 1996
was due to the increase in research and development personnel to support new
development activities without the corresponding expected revenue growth, and a
decrease in the amount of capitalized software development costs. The increase
in 1995 was due to a decrease in the amount of capitalized software development
costs.
Selling, general and administrative expenses increased 22% in 1996 and 35%
in 1995. The increase in 1996 was due primarily to an increase in the number of
marketing and sales support personnel employed internationally as the Company
expanded its international reseller and sales operations and to an increase in
commissions associated with higher revenues. The increase in 1995 was a result
of international expansion, increased commissions, an adverse effect of foreign
currency fluctuations on international expenses, the costs associated with
implementing a new corporate business information system and higher costs for
Watermark in relation to revenue due to its early stage of operations. In 1996,
selling, general and administrative expenses as a percentage of total revenue
increased to 44% from 42% in 1995 and 37% in 1994 primarily due to the reasons
cited above.
Geographic Information The operating loss from the United States operations
was $18.6 million in 1996 compared to operating income of $0.4 million in 1995
and $14.4 million in 1994. The decrease in 1996 and 1995 was due to merger,
restructuring and write-off of purchased in-process research and development
costs and the increase in corporate research and development and general
administrative expenses. Operating income from European operations, including
the income from all international software sales, increased to $17.7 million in
1996 from $12.6 million in 1995 and $3.1 million in 1994. Operating income for
other international operations increased to $1.7 million in 1996 from $0.6
million in 1995 and $0.2 million in 1994 (see Note 9 to Notes to Consolidated
Financial Statements for information related to the operating results of the
Company's various geographic locations).
Merger, Restructuring and Write-off of Purchased In-process Research and
Development Costs The $16.0 million merger, restructuring and write-off of
purchased in-process research and development costs in 1996 consisted of $10.0
million for the write-off of purchased in-process research and development costs
related to the IFSL acquisition, $4.2 million in merger costs related to the
Saros acquisition, and $1.8 million in restructuring costs related to the Saros
and Watermark acquisitions. The restructuring charge represents the costs of
consolidating the various companies' sales and administrative functions and
includes $1.4 million for severance payments for 30 employees and $0.4 million
for the write-off of certain contractual obligations and professional fees. At
December 31, 1996, accrued restructuring costs of $1.3 million is included in
other accrued liabilities. The Company anticipates that the remaining
restructuring costs will be expended during 1997 (see Note 2 to Notes to
Consolidated Financial Statements for information related to the acquisitions of
Watermark, Saros and IFSL).
<PAGE>
The $6.4 million merger, restructuring and write-off of purchased
in-process research and development costs in 1995 consisted 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.
Other Income Other income, net of other expenses, was $2.8 million in both
1996 and 1995 and $1.8 million in 1994. The increase in 1995 was primarily due
to increased interest income on a higher balance of cash and marketable
securities.
Provision for Income Taxes The provision for income taxes was a charge of
$4.5 million in 1996, down from $8.1 million and $5.4 million recorded in 1995
and 1994, respectively. The Company's effective tax rate was 50% in 1995 and 27%
in 1994. The 1996 effective tax rate is not meaningful. The 1996 provision is
impacted from expensing the purchased in-process research and development as
part of the acquisition of IFSL with no corresponding tax benefit, nondeductible
one-time costs associated with the Saros merger and a result of earnings
generated in certain international jurisdictions, partially offset by the
benefit of tax losses incurred in the United States.
The Company currently anticipates that the effective tax rate for 1997 will
be approximately 28%. However, the actual tax rate may differ due to a variety
of factors including the geographical mix of revenues and the ability to use
certain deferred tax assets.
Net Income (Loss) In 1996, the Company reported a net loss of $2.6 million,
or $0.18 per share, on 15.0 million shares outstanding compared to net income of
$8.2 million, or $0.52 per share, on 15.9 million weighted average common and
common equivalent shares outstanding in 1995 and $14.1 million, or $0.95 per
share, on 14.8 million weighted average common and common equivalent shares
outstanding in 1994. Income before one-time after-tax charges for merger,
restructuring and write-off of purchased in-process research and development
costs of $16.0 million and $5.0 million for 1996 and 1995, respectively, was
$13.4 million, or $0.83 per share, on 16.1 million weighted average common and
common equivalent shares outstanding in 1996, compared to $13.2 million, or
$0.83 per share, on 15.9 million weighted average common and common equivalent
shares outstanding in 1995. The 1994 net income per share figure includes $0.12
per share due to a deferred revenue transaction related to the settlement of a
customer dispute.
Foreign Currency Fluctuations and Inflation The Company's performance can
be affected by changes in foreign currency values relative to the U.S. dollar as
discussed above in relation to the Company's revenue and operating expenses. The
net impact to net income from foreign exchange transactions and hedging
activities are immaterial for all periods reported. The foreign currency
translation adjustment included in stockholders' equity increased $1.7 million
during 1996 over 1995 due primarily to the strength of the Irish currency
against the U.S. dollar applied to the Company's net assets in Ireland.
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 during 1994 through 1996.
Liquidity and Capital Resources As of December 31, 1996, combined cash,
cash equivalents, and marketable securities (short- and long-term) were $67.3
million, a decrease of $23.3 million from the $90.6 million at the end of 1995.
Cash used by operating activities in 1996 was $1.8 million. The balance is
primarily due to a net loss and the effect of higher accounts receivable
balances associated with higher revenue and higher average sales days
outstanding offset in part by the noncash additions to net loss for the
write-off of capitalized and purchased in-process research and development
costs, depreciation, and amortization of capitalized software. Cash used by
investing activities totaled $16.7 million, consisting of capital expenditures
and the purchase of IFSL (see Note 2 to Notes to Consolidated Financial
Statements for information related to the Company's purchase of IFSL), offset by
proceeds from the sale of equipment and the net sale and maturity of marketable
securities. Net cash provided by financing activities was $2.6 million and was
the result of proceeds from the issuance of common stock and stock option income
tax benefits offset by the repurchase of common stock.
Cash provided by operating activities in 1995 was $24.7 million. The
balance is primarily due to net income and the noncash additions to net income
for the write-off of capitalized and purchased in-process research and
development costs, depreciation, and amortization of capitalized software. Cash
used by investing activities totaled $20.3 million, consisting of capital
expenditures, capitalized software and a net purchase of marketable securities.
Net cash provided by financing activities in 1995 was $14.1 million consisting
of proceeds from the issuance of common stock and stock option income tax
benefits.
The Company's capital expenditures were $17.9 million in 1996, $14.7
million in 1995, and $11.0 million in 1994. The Company's primary capital
equipment expenditures are for research and development costs, demonstration and
training equipment and enhancements to its internal business systems. The
Company anticipates that it will acquire approximately $20 million of capital
equipment in 1997. The Company also 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 throughout 1997 (see Note
5 to Notes to Consolidated Financial Statements for information related to the
Company's credit facilities).
<PAGE>
OTHER MATTERS On March 7, 1994, the Company's Board of Directors resolved
to dissolve FileNet S.A., its French subsidiary. The Company is now marketing
and supporting its products and customers in France through a branch of the U.S.
corporation. The dissolution of FileNet S.A. resulted in a U.S. tax benefit in
1994 of approximately $2.1 million due to the utilization of losses previously
sustained by its French subsidiary.
The Company is not aware of any issues related to environmental concerns
that have or are expected to materially affect its business.
- --------------------------------------------------------------------------------
This annual report contains forward-looking statements that involve risks
and uncertainties, including, but not limited to, those discussed in
"Management's Discussion and Analysis of Results of Operations and Financial
Condition - Factors That May Affect Future Operating Results and Financial
Condition" in this annual report and those discussed in "Business - Certain
Considerations" in the Company's annual report on Form 10-K for the year ended
December 31, 1996. The actual results that the Company achieves may differ
materially from any forward-looking statements due to such risks and
uncertainties.
- --------------------------------------------------------------------------------
Consolidated Balance Sheets
(In thousands, except share amounts)
<TABLE>
<CAPTION>
At December 31, 1996 and December 31, 1995 1996 1995
Assets -------- --------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 28,530 $ 43,378
Short-term marketable securities 22,037 28,782
-------- --------
Total cash and short-term marketable securities 50,567 72,160
Accounts receivable (net of allowance for doubtful
accounts of $2,140 and $1,540 at December 31, 1996
and December 31, 1995, respectively) 75,469 53,501
Inventories 8,794 6,620
Prepaid expenses and other 8,336 6,573
Deferred income taxes 5,641 3,735
-------- --------
Total current assets 148,807 142,589
-------- --------
Property, net 28,329 25,796
Capitalized software, net - 1,226
Long-term marketable securities 16,705 18,395
Other 1,838 1,676
-------- --------
Total assets $195,679 $189,682
======== ========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 16,752 $ 16,073
Accrued liabilities:
Compensation 10,728 10,997
Income taxes payable 2,152 2,228
Unearned maintenance revenue 5,554 5,761
Royalties 4,531 3,572
Other 19,751 17,604
-------- --------
Total current liabilities 59,468 56,235
-------- --------
Deferred income taxes 3,405 2,289
Stockholders' equity:
Convertible preferred stock - $.001 par value;
authorized, 39,000,000 shares; 35,232,029 issued
and outstanding shares and 1,531,485 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, 15,230,566 and 13,254,222
shares at December 31, 1996 and December 31, 1995,
respectively 127,813 100,719
Retained earnings 7,874 10,518
Other 1,687 42
-------- --------
137,374 131,158
Less 200,000 Treasury shares at cost 4,568 -
-------- --------
Total stockholders' equity 132,806 131,158
-------- --------
Total liabilities and stockholders' equity $195,679 $189,682
======== ========
</TABLE>
See notes to consolidated financial statements.
<PAGE>
Consolidated Statements of Operations
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Years ended December 31, 1996, December 31, 1995
and January 1, 1995 1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Revenue
Software revenue $140,659 $116,052 $ 81,102
Service revenue 82,118 67,174 60,753
Hardware revenue 46,136 46,152 50,480
-------- -------- --------
Total revenue 268,913 229,378 192,335
-------- -------- --------
Costs and expenses
Cost of software revenue 16,464 15,146 12,472
Cost of service revenue 53,568 44,277 41,645
Cost of hardware revenue 29,633 28,800 30,999
Research and development 36,502 24,711 18,274
Selling, general and administrative 117,761 96,499 71,267
Merger, restructuring and write-off of purchased
in-process research and development costs 16,011 6,393 -
-------- -------- --------
Total costs and expenses 269,939 215,826 174,657
-------- -------- --------
Operating income (loss) (1,026) 13,552 17,678
Other income 2,838 2,780 1,821
-------- -------- --------
Income before income taxes 1,812 16,332 19,499
Provision for income taxes 4,456 8,116 5,356
-------- -------- --------
Net income (loss) $ (2,644) $ 8,216 $ 14,143
======== ======== ========
Net income (loss) per share $ (0.18) $ 0.52 $ 0.95
======== ======== ========
Weighted average common and common equivalent
shares outstanding 15,007 15,856 14,834
======== ======== ========
</TABLE>
See notes to consolidated financial statements.
<PAGE>
Consolidated Statements of Stockholders' Equity
(In thousands, except share amounts)
<TABLE>
<CAPTION>
Convertible
Common stock preferred stock Retained Treasury stock
Shares Amount Shares Amount earnings Shares Amount Other Total
---------- -------- --------- -------- --------- --------- -------- ------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances,
January 2, 1994 11,710,614 $ 73,518 1,357,656 $ 16,895 $(11,841) - $ - $ (189) $ 78,383
Stock options exercised 325,882 3,512 3,512
Income tax benefit from
the exercise or disposition
of stock options 1,142 1,142
Common stock issued under
the Employee Qualified
Stock Purchase Plan 43,222 658 658
Preferred stock
issued by Saros 173,829 2,984 2,984
Watermark common stock
converted to redeemable
preferred stock (659,606)
Accretion to liquidation value
of Watermark redeemable
preferred stock (52) (52)
Foreign currency translation
adjustment 234 234
Net income 14,143 14,143
Other 2 2
---------- -------- --------- -------- --------- --------- -------- ------- ---------
Balances,
January 1, 1995 11,420,112 78,778 1,531,485 19,879 2,302 - - 47 101,006
Stock options exercised 542,142 7,471 7,471
Income tax benefit from the
exercise or disposition of
stock options 3,722 3,722
Common stock issued under
the Employee Qualified
Stock Purchase Plan 35,235 814 814
Proceeds from exercise of
Saros warrants 194,421 2,235 2,235
Conversion of Watermark
redeemable convertible
preferred stock to FileNet
common stock 1,062,312 7,699 8 7,707
Foreign currency translation
adjustment (53) (53)
Net income 8,216 8,216
Other 40 40
---------- -------- --------- -------- --------- --------- -------- ------- ---------
Balances,
December 31, 1995 13,254,222 100,719 1,531,485 19,879 10,518 - - 42 131,158
Stock options exercised 398,041 3,330 3,330
Income tax benefit from the
exercise or disposition of
stock options 2,606 2,606
Common stock issued under
the Employee Qualified
Stock Purchase Plan 37,693 1,028 1,028
Proceeds from exercise of
Saros warrants 9,125 251 251
Conversion of Saros
convertible preferred stock
to FileNet common stock 1,531,485 19,879 (1,531,485) (19,879) -
Repurchase of treasury
shares at cost (200,000) (4,568) (4,568)
Foreign currency translation
adjustment 1,671 1,671
Net loss (2,644) (2,644)
Other (26) (26)
---------- -------- --------- -------- --------- --------- -------- ------- ---------
Balances,
December 31, 1996 15,230,566 $127,813 - $ - $ 7,874 (200,000) $(4,568) $1,687 $132,806
========== ======== ========= ======== ========= ========= ======== ======= =========
</TABLE>
See notes to consolidated financial statements.
<PAGE>
Consolidated Statements of Cash Flows
(In thousands)
<TABLE>
<CAPTION>
Years ended December 31, 1996, December 31, 1995
and January 1, 1995 1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities
Net income (loss) $ (2,644) $ 8,216 $ 14,143
Adjustments to reconcile net income (loss) to net
cash provided by operating activities
Write-off of capitalized and purchased in-process
research and development costs 10,011 1,393 -
Depreciation and amortization 11,823 10,275 8,531
Software amortization 1,226 1,800 3,600
Provision for losses on accounts receivable 591 809 134
Deferred taxes (780) 196 440
Changes in operating assets and liabilities,
net of effect of business acquisition
Accounts receivable (21,307) (10,674) (5,044)
Inventories (2,161) (1,464) 2,115
Prepaid expenses and other (1,764) (2,497) 101
Accounts payable 639 4,683 1,434
Accrued liabilities
Compensation (270) 2,689 2,380
Income taxes payable (174) 537 (1,907)
Unearned maintenance revenue (207) 1,864 16
Royalties 959 1,125 687
Other 2,263 5,734 796
Net cash provided (used) by operating activities (1,795) 24,686 27,426
Cash flows from investing activities
Capital expenditures (17,866) (14,692) (11,033)
Proceeds from sale of property 3,304 393 946
Capitalized software - (1,600) (3,200)
Payment for purchase of IFSL, net of
assets acquired (10,011) - -
Purchase of marketable securities (32,092) (49,815) (45,346)
Proceeds from sale and maturity of
marketable securities 39,990 45,402 24,036
Net cash used by investing activities (16,675) (20,312) (34,597)
Cash flows from financing activities
Debt repayments, net - (163) (650)
Short-term bank borrowings, net - - (2,855)
Proceeds from notes receivable from stockholders - - 1,250
Proceeds from issuance of convertible preferred
and common stock 4,609 10,520 11,084
Common stock repurchased (4,568) - -
Stock option income tax benefits 2,606 3,722 1,142
Net cash provided by financing activities 2,647 14,079 9,971
Effect of exchange rate changes on cash and
cash equivalents 975 (25) (6)
Net increase (decrease) in cash and
cash equivalents (14,848) 18,428 2,794
Cash and cash equivalents, beginning of year 43,378 24,950 22,156
Cash and cash equivalents, end of year $ 28,530 $ 43,378 $ 24,950
Supplemental cash flow information
Interest paid $ 443 $ 229 $ 194
Income taxes paid $ 3,236 $ 3,527 $ 5,286
</TABLE>
See notes to consolidated financial statements.
<PAGE>
Notes to Consolidated Financial Statements
Note 1: Summary of Significant Accounting Practices
Nature of Operations FileNet Corporation ("FileNet" or the "Company")
develops, markets and services an open, integrated family of workflow,
document-imaging, electronic document-management and computer output to laser
disk ("COLD") client/server software solutions. The Company's software products
manage and control the movement of document images, data, text and other
information throughout an enterprise. Software from FileNet enables
organizations in industries, such as banking and financial services, insurance,
manufacturing, services, telecommunications and healthcare and in all levels of
government worldwide, to maximize enterprise productivity. Additionally, the
Company manufactures a line of 12-inch optical storage and retrieval libraries
(OSARs). The Company markets its products through a direct sales force in
Australia, Canada, France, Germany, the United Kingdom ("UK"), and the United
States. In addition, the Company markets through ValueNet partners, resellers
and OEMs in both the United States and international markets.
Consolidation The consolidated financial statements include the accounts of
FileNet and its wholly-owned subsidiaries. All intercompany balances and
transactions have been eliminated. Watermark Software Inc. ("Watermark") and
Saros Corporation ("Saros"), formerly wholly-owned subsidiaries of FileNet, were
merged into FileNet on July 25, 1996 and August 26, 1996, respectively (see Note
2).
Year End The Company changed its fiscal year end to December 31 beginning
in fiscal 1996. The Company's year end had been the Sunday closest to December
31. Fiscal 1995 ended on December 31, 1995, and fiscal 1994 ended on January 1,
1995.
Investments The Company accounts for investments in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for
Certain Investments and Equity Securities." The Company's investments consist
primarily of high-grade corporate and government securities with maturities of
less than three years and considers investments purchased with an original
maturity of three months or less to be cash equivalents. The Company classifies
all of its investments as available-for-sale. Available-for-sale securities are
carried at fair value, with the unrealized gains and losses, net of tax,
reported in a separate component of stockholders' equity. Realized and
unrealized gains and losses on available-for-sale securities were immaterial.
Other Financial Instruments Effective January 2, 1995, the Company adopted
the provisions of SFAS No. 119, "Disclosure about Derivative Financial
Instruments and Fair Value of 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 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.
At December 31, 1996 and December 31, 1995, the Company had forward
currency sales contracts open in 10 currencies with a notional amount of $59.6
million and 7 currencies with a notional amount of $27.1 million, respectively;
all having maturities within three months. The unrealized gains and losses from
these contracts were immaterial at both December 31, 1996 and December 31, 1995.
Fair Value of Financial Instruments The recorded amounts of assets and
liabilities at December 31, 1996 and December 31, 1995 approximate fair value in
accordance with SFAS No. 107, "Disclosures About Fair Value of Financial
Instruments" due to the relatively short period of time between origination of
the instruments and their expected realization.
Inventories Inventories are stated at the lower of first-in, first-out cost
or market (see Note 3). The Company regularly monitors inventory for excess or
obsolete items and makes any necessary adjustments at each balance sheet date.
Foreign Currency Translation In accordance with SFAS No. 52, "Foreign
Currency Translation," the Company measures the financial statements for the
Company's foreign subsidiaries using the local currency as the functional
currency. Assets and liabilities of these subsidiaries are translated at the
exchange rate on the balance sheet date. Translation adjustments resulting from
this process are included in equity. Revenues, costs and expenses are translated
at the rates of exchange prevailing during the year. Gains and losses from
foreign currency transactions are included in "other income."
Property Property is stated at cost. Depreciation is computed using the
straight-line method over the estimated useful lives of the related assets,
generally three to five years. Leasehold improvements are amortized over the
shorter of the estimated useful lives of the improvements or the term of the
related lease (see Note 4).
<PAGE>
Research and Development The Company expenses research and development
costs as incurred. SFAS No. 86, "Accounting for the Costs of Computer Software
to Be Sold, Leased, or Otherwise Marketed," does not materially affect the
Company. The Company did capitalize certain software development costs up to and
including the second quarter of 1995. Capitalization was $1.6 million for the
year ended December 31, 1995 and $3.2 million for the year ended January 1,
1995. The Company amortized the remaining capitalized software, net of
accumulated amortization during 1996. Capitalized software net of accumulated
amortization was amortized over the expected life of the related products,
estimated to be one year commencing upon the delivery of the related product.
Amortization expense was $1.2 million, $1.8 million, and $3.6 million for the
years ended December 31, 1996, December 31, 1995, and January 1, 1995,
respectively.
Included in 1996 merger, restructuring and write-off of purchased
in-process research and development costs is the write-off of $10.0 million of
in-process research and development costs related to the purchase of
International Financial Systems, Ltd. ("IFSL"). Included in 1995 merger,
restructuring and write-off of purchased in-process research and development
costs is the write-off of $1.4 million of capitalized research and development
expenses for FileNet projects made redundant by the Watermark acquisition (see
Note 2).
Revenue Recognition Revenue from software and hardware sales related to the
Company's electronic document-management, document-imaging and workflow software
products is generally recognized when the product is delivered to the customer
in accordance with the American Institute of Certified Public Accountants
Statement of Position 91-1, "Software Revenue Recognition." The Company
recognizes other revenue at the time of product delivery and accrues any
remaining costs, including insignificant vendor obligations. Revenue from
service and post-contract customer support is recognized ratably over the term
of the contract.
Product Warranty The Company provides a warranty for its products against
defects in materials and workmanship. A provision for estimated warranty costs
is recorded at the time of sale and periodically adjusted to reflect actual
experience.
Income Taxes The Company accounts for income taxes under the provisions of
SFAS No. 109, "Accounting for Income Taxes" (see Note 7).
Net Income (Loss) Per Share Net loss per share for the year ended December
31, 1996 was computed using the weighted average number of actual common shares
outstanding. Net income per share for the years ended December 31, 1995 and
January 1, 1995 were computed based on the weighted average number of common
shares and dilutive common equivalent shares outstanding after the effect of the
conversion of the then outstanding shares of Watermark's redeemable convertible
preferred stock and Saros' convertible preferred stock into common stock, which
conversion occurred upon completion of the acquisitions (see Notes 2 and 6).
Use of Estimates The preparation of financial statements in conformity with
generally accepted accounting principles necessarily requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from these estimates.
Supplier Concentrations Certain components for the Company's proprietary
12-inch OSARs are available from a limited number of sources. Any inability to
obtain components in the amounts needed on a timely basis could result in
short-term delays in product shipments which could have a material adverse
effect on the Company's operating results and financial condition. The Company
has qualified and is selling 51/4-inch optical storage and retrieval devices
from an alternative company which could be utilized by the Company's customers
in the event of any interruptions in the delivery of components for the
Company's own OSAR product.
Stock-based Compensation The Company accounts for stock-based awards to
employees using the intrinsic value method in accordance with Accounting
Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to
Employees."
Long-Lived Assets The Company accounts for the impairment and disposition
of long-lived assets in accordance with SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." In
accordance with SFAS No. 121, long-lived assets to be held are reviewed for
events or changes in circumstances which indicate that their carrying value may
not be recoverable.
Reclassifications Certain reclassifications have been made to the prior
years' balances to conform with the current year's presentation.
<PAGE>
Note 2: Acquisitions
Acquisition of Saros Corporation On March 1, 1996, FileNet acquired all the
outstanding shares of 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 1.9 million 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. The Company believes it has
certain claims for damages and intends to make a claim against all or a portion
of the Saros Escrow Shares.
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. Saros Acquisition fees and expenses
aggregating $4.2 million were expensed in the first quarter of 1996. Included in
the charges are professional fees, write-off of certain contractual obligations
and settlement costs, write-off of certain fixed assets (including redundant
hardware and software systems) and other integration costs.
Net revenue, net income (loss) and net income (loss) per share of the
companies for the years ended December 31, 1995 and January 1, 1995 are as
follows:
<TABLE>
<CAPTION>
(In thousands, except per share amounts) 1995 1994
<S> <C> <C>
Net revenue
FileNet $215,477 $176,924
Saros 13,901 15,411
-------- --------
Combined $229,378 $192,335
======== ========
Net income (loss)
FileNet $ 14,830 $ 13,263
Saros (6,614) 880
-------- --------
Combined $ 8,216 $ 14,143
======== ========
Net income (loss) per share
FileNet $ 0.94 $ 0.89
Saros (0.42) 0.06
-------- --------
Combined $ 0.52 $ 0.95
======== ========
</TABLE>
Acquisition of International Financial Systems, Ltd. On January 30, 1996,
the Company purchased for cash all of the outstanding shares of IFSL, the
developer of a COLD software product for archiving documents. 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 $10.0
million.
Acquisition of Watermark Software Inc. In August 1995, the Company acquired
Watermark by issuing approximately 1.3 million shares of FileNet common stock in
exchange for all of the outstanding shares of Watermark. The transaction was
accounted for as a pooling-of-interests for financial reporting purposes. Fees
and expenses of $6.4 million before tax, related to the merger and consolidation
of the two companies, were expensed in the third quarter of 1995.
Restructuring Costs The Company incurred a $1.8 million restructuring
charge in the first quarter of 1996. At December 31, 1996, accrued restructuring
costs of $1.3 million is included in other accrued liabilities. The Company
anticipates that the remaining restructuring costs will be paid during 1997.
<PAGE>
Note 3: Inventories Inventories consist of the following at December 31,
1996 and December 31, 1995:
<TABLE>
<CAPTION>
(In thousands) 1996 1995
<S> <C> <C>
Raw materials $2,606 $3,418
Work-in-process 2,648 1,147
Finished goods 3,540 2,055
------ ------
Total $8,794 $6,620
====== ======
</TABLE>
Note 4: Property and Leases Property consists of the following at December
31, 1996 and December 31, 1995:
<TABLE>
<CAPTION>
(In thousands) 1996 1995
<S> <C> <C>
Machinery, equipment and software $ 66,404 $ 67,115
Furniture and fixtures 9,242 7,541
Leasehold improvements 5,120 3,502
-------- --------
Total 80,766 78,158
Less accumulated depreciation and amortization (52,437) (52,362)
-------- --------
Property, net $ 28,329 $ 25,796
======== ========
</TABLE>
The Company leases its corporate office, sales offices, manufacturing
facilities, and other equipment under noncancelable operating leases, some of
which have renewal options and generally provide for escalation of the annual
rental amount.
Expenses related to operating leases were $9.6 million, $9.3 million, and
$8.1 million during the years ended December 31, 1996, December 31, 1995, and
January 1, 1995, respectively. The following table summarizes future minimum
lease payments required under operating leases:
<TABLE>
<CAPTION>
Fiscal year (In thousands)
<S> <C>
1997 $10,171
1998 7,290
1999 4,843
2000 2,884
2001 1,532
Thereafter 1,713
-------
Total $28,433
=======
</TABLE>
Note 5: Borrowing Arrangements The Company has a $20 million commercial
line of credit which expires in April 1997. Borrowings under the arrangement are
unsecured and bear interest at the bank's prime rate. The Company is restricted
from paying dividends during the term of the arrangement and, under the
arrangement, must comply with certain covenants, including quarterly and annual
profitability covenants. The Company was in compliance with such covenants as of
December 31, 1996 after consideration of a waiver received related to the
purchase of treasury shares. The Company expects to renew or replace the line of
credit under a similar arrangement in 1997.
The Company has four additional borrowing arrangements with foreign banks,
which expire at various times during 1997, under which the Company may borrow up
to approximately $2 million. Borrowings under these arrangements bear interest
at the various banks' prime rates plus 0.75% to 1.5%. Of the $2 million
approximately $1 million may be borrowed on an unsecured basis, while the
remaining $1 million is collateralized by cash deposits with the bank.
There were no borrowings outstanding under any of the arrangements at
December 31, 1996 and December 31, 1995. Interest expense was $443,000, $288,000
and $193,000 for the years ended December 31, 1996, December 31, 1995, and
January 1, 1995, respectively.
<PAGE>
Note 6: Stockholders' Equity In October 1988, FileNet declared a dividend
of one common stock purchase right for each outstanding share of common stock.
Under certain circumstances, a right may be exercised to purchase one share of
common stock at an exercise price of $55, subject to certain antidilution
adjustments. The rights become exercisable if and when a person (or group of
affiliated or associated persons) acquires 25% or more of FileNet's outstanding
common stock, or announces an offer that would result in such person acquiring
30% or more of FileNet's common stock. After the rights become exercisable, each
right will entitle its holder to buy a number of shares of FileNet's common
stock having a market value of twice the exercise price of the rights. After the
rights become exercisable, if FileNet is a party to certain merger or business
combination transactions or transfers 50% or more of its assets or earnings
power (as defined), each right will entitle its holder to buy a number of shares
of common stock of the acquiring or surviving entity having a market value of
twice the exercise price of the right. The rights expire November 17, 1998 and
may be redeemed by FileNet at one cent per right at any time before a person has
acquired 25% or more of FileNet's common stock.
Treasury Stock During 1996, the Company purchased 200,000 shares of its
common stock at an aggregate cost of $4.6 million.
Employee Qualified Stock Purchase Plan In March 1988, FileNet adopted the
1988 Employee Qualified Stock Purchase Plan and reserved 450,000 shares of its
common stock for purchases under the plan. Under the terms of the plan, options
to purchase common stock may be granted in successive six-month offering periods
to eligible employees of the Company at 85% of the lower of the market price of
the common stock at the date of grant or at the date of exercise. The plan
covers substantially all domestic employees of the Company. Each participant is
limited in any plan year to the acquisition of that number of shares which have
an aggregate fair market value of not more than $25,000. There are no charges or
credits to income in connection with the plan. At December 31, 1996, $341,000
had been withheld from employees pursuant to the plan to exercise options to
purchase common stock at the lower of $21.25 per share or 85% of the fair market
value of common stock at March 31, 1997.
Stock Option Plans In November 1983, the Company adopted the 1983 Incentive
Stock Option Plan under which options to purchase an aggregate of 400,000 shares
of the Company's common stock were granted to officers and employees. There were
no options exercisable as of December 31, 1996. Options to purchase 1,850 common
shares were exercisable as of December 31, 1995. This plan was terminated in
March 1988 with respect to future option grants. Options granted became
exercisable in 20% installments beginning one year from the date of grant and
expired ten years from the date of grant. The exercise price of all options
granted was the fair market value of the common stock at the date of grant.
In April 1986, the Company adopted the 1986 Stock Option Plan. Under the
amended terms of the 1986 plan, options to purchase 3,250,000 shares of the
Company's common stock were available for issuance to employees, officers, and
directors. Options to purchase 821,548 and 666,791 common shares were
exercisable at December 31, 1996 and December 31, 1995, respectively. In May
1995, the 1986 plan was terminated and the remaining reserve of 70,049 shares
was rolled into the 1995 Stock Option Plan and no common shares are available
for future grants under the 1986 plan. Options granted are either incentive
stock options or non-qualified stock options. Options granted become exercisable
in 20% installments beginning one year after the date of grant, as determined by
the Board of Directors, and expire no later than ten years plus one day from the
date of grant. The exercise price of the incentive stock options and
non-qualified options may not be less than 100% and 85%, respectively, of the
fair market value of the Company's common stock at the date of grant.
In May 1995, the Company adopted the 1995 Stock Option Plan and reserved
350,000 shares of common stock for issuance under the terms of the Plan. This
reserve was added to the 70,049 shares of common stock then available under the
1986 Stock Option Plan (the "Predecessor Plan"). Outstanding options under the
Predecessor Plan will continue to be governed by the provisions of the
agreements evidencing those grants. To the extent any of those outstanding
options terminate or expire prior to exercise, the shares subject to those
unexercised options will be available for subsequent option grant pursuant to
the provisions of the 1995 Plan. As of December 31, 1996, 309,130 options of the
Predecessor Plan had been terminated and were rolled into the 1995 Plan. Options
granted under the Plan's Discretionary Option Grant Program for employees and
the Automatic Option Grant Program for directors have an exercise price per
share of 100% of the fair market value per share on the grant date and become
exercisable in 25% installments beginning one year from the date of grant. As of
December 31, 1996, 1,867,915 options had been granted (including 530,571 under
the cancellation/regrant program discussed below) and 52,173 options were
exercisable under the Plan.
<PAGE>
Prior to the merger, Watermark had adopted the 1993 Stock Incentive Plan.
The Watermark Plan was assumed by FileNet and outstanding options under the
Watermark Plan were converted into options to purchase an aggregate of 151,075
shares of FileNet's common stock at a price equivalent (after conversion) to the
original grant price (which was not less than the estimated fair value of
Watermark common stock at the grant date). Outstanding options under the
Watermark Plan will continue to be governed by the provisions of the agreements
evidencing those grants. To the extent any of those outstanding options
terminate or expire prior to exercise, the shares subject to those unexercised
options will not be available for subsequent option grant. Options granted
become exercisable in 20% installments one year from date of grant and in
additional 5% installments for each full three-month period thereafter. At
December 31, 1996, a total of 30,813 options were outstanding and 15,808 were
exercisable.
Prior to the merger, Saros had adopted the 1988 Restated Stock Option Plan.
The Saros Plan was assumed by FileNet and outstanding options under the Saros
Plan were converted into options to purchase an aggregate of 336,913 shares of
FileNet's common stock at a price equivalent (after conversion) to the original
grant price (which was not less than the estimated fair value of Saros common
stock at the grant date). Outstanding options under the Saros Plan will continue
to be governed by the provisions of the agreements evidencing those grants. To
the extent any of those outstanding options terminate or expire prior to
exercise, the shares subject to those unexercised options will not be available
for subsequent option grant. Options granted may be either incentive stock
options or non-qualified stock options and are exercisable over a period of four
years. The initial option granted to the optionee becomes exercisable on the
ninth month of the anniversary date of hire at a rate of 18.75% and each month
thereafter at the rate of 2.0833%. Options granted following the initial option
grant become exercisable at the rate of 2.0833% for each month from grant date.
At December 31, 1996, a total of 183,922 shares were outstanding and 135,344
were exercisable.
In December 1989, the Company adopted the 1989 Stock Option Plan for
Non-Employee Directors. Under the terms of the plan, as amended, each FileNet
director who was not an employee was automatically granted an initial option to
purchase 10,000 shares of FileNet's common stock at its fair market value on the
date of grant and was granted an additional option to purchase 3,500 shares
every year following the initial grant, provided such person continued to be a
director at such time. Options granted under the plan vested at the rate of 20%
per year from the grant date. Options to purchase an aggregate of 70,000 shares
at prices ranging from $11.50 to $32.69 per share were granted from December 18,
1989 to May 24, 1995. At December 31, 1996, options to purchase 26,000 shares of
common stock were exercisable and 20,000 have been exercised to date. This plan
was terminated in May 1995 with respect to future option grants. Future grants
to non-employee directors are granted under the provisions of the 1995 Stock
Option Plan.
On August 8, 1996 the Company approved a stock option cancellation/regrant
program (the "Program") which allowed employees, excluding all directors and
reporting officers defined in Section 16 of the Securities Exchange Act of 1934
as amended, to exchange options with an exercise price greater than $26.00 for
new options. Outstanding options of 530,571 shares were canceled and regranted
at $26.00 per share, the current market value on August 8, 1996. Under the
Program, the regranted options are considered granted on August 8, 1996 and are
exercisable prospectively in accordance with the provisions of the agreements
evidencing those grants.
Information regarding the stock option plans, after giving retroactive
effect to the conversions of the Watermark and Saros stock options on their
original grant dates, is as follows:
<TABLE>
<CAPTION>
Number of Weighted average
options exercise price
<S> <C> <C>
Balances, January 2, 1994 2,355,386 $13.03
Granted 729,433 $20.84
Exercised (325,882) $10.80
Canceled (154,763) $16.07
---------- ------
Balances, January 1, 1995 2,604,174 $15.27
Granted (weighted average fair value of $14.68) 771,674 $30.41
Exercised (542,142) $13.78
Canceled (130,597) $19.51
---------- ------
Balances, December 31, 1995 2,703,109 $19.68
Granted (weighted average fair value of $14.96) 1,362,418 $36.65
Exercised (398,041) $ 8.37
Canceled (866,603) $43.34
---------- ------
Balances, December 31, 1996 2,800,883 $22.22
========== ======
</TABLE>
<PAGE>
The following table summarizes information concerning currently outstanding
and exercisable options:
<TABLE>
<CAPTION>
Options outstanding Options exercisable
----------------------------------------------- -----------------------------
Weighted average
Range of exercise Number remaining Weighted average Number Weighted average
prices outstanding contractual life exercise price exercisable exercise price
<S> <C> <C> <C> <C> <C>
$ 0.06 - $20.00 1,054,328 5.69 $11.75 717,600 $11.11
$20.00 - $30.00 1,256,083 8.49 $24.96 255,465 $23.23
$30.00 - $40.00 295,922 8.95 $34.34 37,348 $32.29
$40.00 - $50.00 164,550 8.95 $40.83 41,700 $40.87
$50.00 - $64.42 30,000 9.34 $54.08 - -
--------- ---------
$ 0.06 - $64.42 2,800,883 1,052,113
========= =========
</TABLE>
As discussed in Note 1, the Company continues to apply APB No. 25,
"Accounting for Stock Issued to Employees," and related interpretations in
accounting for its plans. Accordingly, no compensation expense has been
recognized for its stock-based compensation plans. Had compensation cost for the
Company's stock-based compensation plans been determined based on the fair
market value at the grant dates for awards under those plans consistent with the
method of SFAS No. 123, "Accounting for Stock-Based Compensation," the Company's
net income (loss) and net income (loss) per share would have changed to the
pro forma amounts indicated below:
<TABLE>
<CAPTION>
(In thousands, except per share amounts) 1996 1995
<S> <C> <C>
Net income (loss) - as reported $(2,644) $8,216
Net income (loss) - pro forma (7,320) 7,273
Net income (loss) per share - as reported (0.18) 0.52
Net income (loss) per share - pro forma (0.49) 0.46
</TABLE>
The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in 1996 and 1995: expected volatility of 60%,
risk-free interest rates of 5.9% to 6.9%, and an expected life of 1 year from
vest date. Pro forma compensation cost of options granted under the Employee
Qualified Stock Purchase Plan is measured based on the discount from market
value.
Watermark Common and Redeemable Convertible Preferred Stock On August 18,
1995, Watermark's capitalization consisted of common stock and Series A through
C of Redeemable Convertible Preferred Stock ("Watermark Preferred Stock"). In
May 1994, Watermark converted certain then outstanding common stock into
Watermark Preferred Stock in connection with a financing. Upon conversion of the
outstanding shares of Watermark Preferred Stock, the preferred stockholders were
entitled to receive from Watermark the then current liquidation amount per share
of Watermark Preferred Stock as stated in the Watermark Articles of
Incorporation.
Saros Common and Convertible Preferred Stock On March 1, 1996, Saros'
capitalization consisted of common stock and Series A through E Convertible
Preferred Stock ("Saros Preferred Stock"). The Saros Preferred Stock gave
certain rights to the holders, was noncumulative, and was convertible, at the
option of the holder, into an equal number of shares of common stock. Each share
of Saros Preferred Stock had voting rights equivalent to those of the common
shareholders and a conversion right that allowed them to convert outstanding
shares of Saros Preferred Stock into common stock. Upon conversion of the
outstanding shares of Saros Preferred Stock, the preferred stockholders were
entitled to receive from Saros the liquidation amount ranging from $.33 to
$1.875 per share.
Note 7: Income Taxes The provision for income taxes consists of the
following:
<TABLE>
<CAPTION>
(In thousands)
Years ended December 31, 1996, December 31, 1995
and January 1, 1995 1996 1995 1994
<S> <C> <C> <C>
Current:
Federal $2,930 $4,017 $3,200
State 75 867 514
Foreign 2,241 2,458 1,202
Deferred:
Federal (772) 834 441
State (18) (60) (1)
------ ------ ------
Total provision $4,456 $8,116 $5,356
====== ====== ======
</TABLE>
<PAGE>
A reconciliation of the Company's effective tax rate compared to the
statutory federal tax rate is as follows:
<TABLE>
<CAPTION>
Years ended December 31, 1996, December 31, 1995
and January 1, 1995 1996 1995 1994
<S> <C> <C> <C>
Income taxes at statutory federal rate 35% 35% 35%
State taxes, net of federal benefit 4 5 2
Unbenefited/utilized domestic losses 42 21 2
Foreign tax rate differential/unbenefited losses (130) (14) (13)
Non-deductible acquisition costs 291 5 -
Other 4 (2) 1
---- --- ---
Total 246% 50% 27%
==== === ===
</TABLE>
The Company provides deferred income taxes for temporary differences
between assets and liabilities recognized for financial reporting and income tax
purposes. The income tax effects of these temporary differences representing
significant portions of the deferred taxes at December 31, 1996 and December 31,
1995 are as follows:
<TABLE>
<CAPTION>
(In thousands)
Years ended December 31, 1996 and December 31, 1995 1996 1995
<S> <C> <C>
Deferred taxes:
Foreign loss carryforwards $ 1,445 $ 975
Domestic loss carryforwards 9,198 9,479
Tax credit carryforwards 1,954 1,579
Accrued expenses 1,745 1,851
Inventory reserves 241 232
Sales returns and allowance reserves 1,359 1,169
Capitalized software (206) (783)
Depreciable assets 802 (131)
Residual U.S. tax on foreign earnings (3,710) (2,027)
Other 2,420 2,105
------ ------
Total 15,248 14,449
------ ------
Valuation allowance (13,012) (13,003)
------ ------
Net deferred tax asset $ 2,236 $ 1,446
======== =========
</TABLE>
The Company has an approximate $27 million loss carryforward related to
Watermark and Saros which can be used to reduce future taxable income. Sections
382 and 383 of the Internal Revenue Code of 1986 place certain limitations on
the use of these acquired losses. A maximum of $18 million of the net operating
loss carryforward can be utilized in 1997, and if not utilized, will
carryforward to 1998 and subsequent years. The remaining $9 million of the net
operating loss carryforward will be available in 1998 and, if not utilized, will
carryforward to subsequent years. Any net operating loss carryforward not
utilized will begin expiring in 2004. The Company has an approximate $2 million
tax credit carryforward which will expire beginning in 2004. Utilization of the
loss and credit carryforwards will result in a reduction of income tax expense.
A valuation allowance has been established for 100% of the net deferred tax
assets related to Watermark and Saros.
The Company has not provided any residual U.S. tax on approximately $15
million of a portion of the Company's foreign subsidiaries' undistributed
earnings as the Company intends to indefinitely reinvest such earnings.
At December 31, 1996, the Company had Dutch, UK and French subsidiary tax
loss carryforwards relating to its foreign subsidiary operations of $1.8
million, $1.8 million and $0.7 million, respectively, as well as other
immaterial foreign tax loss carryforwards. The Dutch and UK tax loss
carryforwards have no expiration. The French losses will begin to expire in
1997. Valuation allowances have been established for 100% of the foreign tax
loss carryforwards.
Note 8: Development Contracts The Company has entered into development
contracts in 1996 and prior years with third parties under which the Company
receives funding for certain development activities. Cumulatively through
December 31, 1996, $5.6 million of expenses related to the development
activities had been funded under this arrangement. The Company has also incurred
aggregate royalty expenses of $3.8 million through December 31, 1996 to one of
the third parties based on shipments of the related products.
<PAGE>
Note 9: Geographical Information
<TABLE>
<CAPTION>
(In thousands)
Years ended December 31, 1996, December 31, 1995
and January 1, 1995 1996 1995 1994
<S> <C> <C> <C>
Revenue
United States*
Customers $174,618 $155,728 $137,420
Intercompany 23,355 14,597 14,180
-------- -------- --------
Total 197,973 170,325 151,600
Europe*
Customers 83,786 67,916 49,725
Intercompany 15,815 11,448 6,825
-------- -------- --------
Total 99,601 79,364 56,550
Other
Customers 10,509 5,734 5,190
Intercompany 1,794 2,086 496
-------- -------- --------
Total 12,303 7,820 5,686
Eliminations (40,964) (28,131) (21,501)
-------- -------- --------
Total revenue $268,913 $229,378 $192,335
======== ======== ========
Operating income (loss)
United States** $(18,588) $ 369 $ 14,408
Europe** 17,680 12,589 3,051
Other 1,691 629 234
Eliminations (1,809) (35) (15)
-------- -------- --------
Total operating income (loss) $ (1,026) $ 13,552 $ 17,678
======== ======== ========
Assets
United States $132,781 $151,929 $123,716
Europe 56,971 38,993 31,278
Other 6,043 2,672 3,124
Eliminations (116) (3,912) (5,476)
-------- -------- --------
Total assets $195,679 $189,682 $152,642
======== ======== ========
</TABLE>
*U.S. revenue includes hardware sales to third-party international resellers.
European revenue includes software sales to all third-party international
resellers.
**U.S. operating income includes $16.0 million in 1996 and $3.9 million in 1995
for merger, restructuring and write-off of purchased in-process research and
development costs and European operating income includes $2.5 million for merger
and other costs in 1995. For all years presented, U.S. operating income (loss)
includes certain corporate expenses such as research and development, marketing
communications and corporate administration and European and other operating
income includes international headquarters expenses.
Note 10: Contingencies 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 January 1997, Wang and Eastman Kodak Company ("Kodak") announced that
they have entered into an agreement under which Kodak will acquire the Wang
business unit that has responsibility for this litigation. The acquisition is
scheduled to close in March-April 1997 and 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.
<PAGE>
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 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, payment of attorney's
fees and costs, and equitable or injunctive relief; however, at this time it is
not possible to determine the potential liability, if any. The Company has not
yet responded to the complaint. The Company believes the complaint is without
merit and intends to defend the action 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.
Note 11: Related Party Transaction Watermark originally entered into a
republishing and distribution agreement with a UK company (the "Distributor")
which provided the Distributor with exclusive distribution rights of Watermark's
products in defined territories. The Chief Executive Officer of the Distributor
is the brother of Watermark's then President and Chief Executive Officer. During
1995, Watermark elected to purchase the portion of the Distributor's business
related to selling Watermark's products at a negotiated price of $2.5 million
which is included in merger and other costs in 1995.
Note 12: Quarterly Financial Information (Unaudited)
<TABLE>
<CAPTION>
(In thousands, except per share amounts)
Year ended December 31, 1996 First Second Third Fourth Fiscal
quarter* quarter quarter* quarter year
<S> <C> <C> <C> <C> <C>
Revenue $66,744 $64,997 $64,622 $72,550 $268,913
Income (loss) before income taxes (10,417) 3,351 4,575 4,303 1,812
Net income (loss) (11,820) 2,513 3,431 3,232 (2,644)
Net income (loss) per share $ (0.79) $ 0.15 $ 0.22 $ 0.20 $ (0.18)
Year ended December 31, 1995
Revenue $48,421 $56,121 $57,098 $67,738 $229,378
Income (loss) before income taxes 4,842 3,354 (644) 8,780 16,332
Net income (loss) 3,149 1,331 (1,466) 5,202 8,216
Net income (loss) per share $ 0.20 $ 0.09 $ (0.10) $ 0.32 $ 0.52
</TABLE>
*Includes a one-time after-tax charge of $16.0 million in the first quarter of
1996 and $5.0 million in the third quarter of 1995 for merger, restructuring and
write-off of purchased in-process research and development costs.
<PAGE>
Independent Auditors' Report
To the Stockholders and Board of Directors of FileNet Corporation:
We have audited the accompanying consolidated balance sheets of FileNet
Corporation and its subsidiaries as of December 31, 1996 and December 31, 1995,
and the related consolidated statements of operations, stockholders' equity, and
cash flows for the years ended December 31, 1996, December 31, 1995, and January
1, 1995. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of FileNet Corporation and its
subsidiaries as of December 31, 1996 and December 31, 1995 and the results of
their operations and their cash flows for the years ended December 31, 1996,
December 31, 1995, and January 1, 1995 in conformity with generally accepted
accounting principles.
/S/ Deloitte & Touche LLP
February 10, 1997
Costa Mesa, California
Note 11: Related Party Transaction Watermark originally entered into a
republishing and distribution agreement with a UK company (the "Distributor")
which provided the Distributor with exclusive distribution rights of Watermark's
products in defined territories. The Chief Executive Officer of the Distributor
is the brother of Watermark's then President and Chief Executive Officer. During
1995, Watermark elected to purchase the portion of the Distributor's business
related to selling Watermark's products at a negotiated price of $2.5 million
which is included in merger and other costs in 1995.
FILENET CORPORATION SUBSIDIARY INFORMATION
FileNet International Corporation (Virgin Islands)
FileNet Corporation International (Delaware)
FileNet Limited (United Kingdom)
FileNet Canada, Inc.
FileNet Company Limited (Ireland)
FileNet GmbH (Germany)
FileNet Corporation Europe, EURL (France)
FileNet Corporation, Pty. Ltd. (Australia)
FileNet KK (Japan)
FileNet Asia Pacific, Pte. Ltd. (Singapore)
International Financial Systems Limited (New York)
Exhibit 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement Numbers
33-90454, 33-96076, 33-80899, 333-02194 and 333-09075 on Form S-8 of our report
dated February 10, 1997 appearing in and incorporated by reference in the Annual
Report on Form 10-K of FileNet Corporation for the fiscal year ended December
31, 1996.
/s/ Deloitte & Touche LLP
Costa Mesa, California
March 25, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> Year
<FISCAL-YEAR-END> Dec-31-1996
<PERIOD-END> Dec-31-1996
<CASH> 28,530
<SECURITIES> 22,037
<RECEIVABLES> 75,469
<ALLOWANCES> 0
<INVENTORY> 8,794
<CURRENT-ASSETS> 148,807
<PP&E> 80,766
<DEPRECIATION> 52,437
<TOTAL-ASSETS> 195,679
<CURRENT-LIABILITIES> 59,468
<BONDS> 0
0
0
<COMMON> 123,245
<OTHER-SE> 9,561
<TOTAL-LIABILITY-AND-EQUITY> 195,679
<SALES> 186,795
<TOTAL-REVENUES> 268,913
<CGS> 46,097
<TOTAL-COSTS> 99,665
<OTHER-EXPENSES> 170,274
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,812
<INCOME-TAX> 4,456
<INCOME-CONTINUING> (2,644)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,644)
<EPS-PRIMARY> (0.18)
<EPS-DILUTED> (0.18)
</TABLE>
