FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 1998
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ___________
Commission file number: 0-15997
FILENET CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 95-3757924
- ---------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S.Employer Identification No.)
incorporation or organization)
3565 Harbor Boulevard, Costa Mesa, CA 92626
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(Address of principal executive offices) (Zip code)
(714) 966-3400
- ---------------------------------------------------------------------------
(Registrant's telephone number including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
As of April 30, 1998, there were 15,423,222 shares of the Registrant's common
stock outstanding.
<PAGE>
FILENET CORPORATION
Index
Page
Number
- ------------------- ------------------------------------------------ ----------
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Balance Sheets
as of March 31, 1998 and December 31, 1997...................... 3
Consolidated Statements of Operations
for the three months ended March 31, 1998 and 1997.............. 4
Consolidated Statements of Comprehensive Income
for the three months ended March 31, 1998 and 1997.............. 5
Consolidated Statements of Cash Flows
for the three months ended March 31, 1998 and 1997.............. 6
Notes to Consolidated Financial Statements...................... 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................... 10
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................... 17
Item 6. Exhibits and Reports on Form 8-K................................ 17
SIGNATURE....................................................... 18
INDEX TO EXHIBITS............................................... 19
2
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
FILENET CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
------------- -------------
(Unaudited)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents................. $ 53,833 $ 37,344
Short-term marketable securities.......... 11,662 26,600
Accounts receivable, net.................. 62,307 61,283
Inventories............................... 3,078 3,541
Prepaid expenses and other current assets 8,969 8,309
Deferred income taxes..................... 6,142 6,439
-------- ---------
Total current assets...................... 145,991 143,516
Property, net............................... 31,078 27,587
Long-term marketable securities............. 7,879 7,826
Other assets................................ 990 941
---------- ----------
Total assets............................ $ 185,938 $ 179,870
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable......................... $ 17,769 $ 15,003
Accrued compensation..................... 14,249 14,845
Unearned maintenance revenue............. 13,320 8,848
Accrued royalties........................ 2,149 2,743
Other accrued liabilities................ 19,545 19,190
---------- ----------
Total current liabilities.................. 67,032 60,629
Deferred income taxes...................... 433 430
Stockholders' equity:
Preferred stock - $.10 par value; 7,000,000
shares authorized; none issued or out-
standing
Common stock - $.01 par value; 100,000,000
shares authorized; 15,774,626 and 15,560,838
shares outstanding at March 31, 1998 and
December 31, 1997, respectively....... 134,031 130,741
Retained earnings........................ 4,871 2,348
Accumulated other comprehensive income... (5,862) (4,146)
---------- -----------
133,040 128,943
Treasury stock, at cost; 549,000 and
410,000 shares at March 31, 1998 and
December 31, 1997, respectively........ (14,567) (10,132)
---------- -----------
Total stockholders' equity............... 118,473 118,811
---------- -----------
Total liabilities and stockholders'
equity................................. $ 185,938 $ 179,870
========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE>
FILENET CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended March 31,
--------------------------------------
1998 1997
----------------- -----------------
(Unaudited) (Unaudited)
<S> <C> <C>
Revenue:
Software.................... $ 43,247 $ 22,082
Service..................... 23,471 18,237
Hardware.................... 6,891 7,243
---------- ----------
Total revenue................. 73,609 47,562
Costs and expenses:
Cost of software revenue.... 3,686 2,999
Cost of service revenue..... 15,346 13,131
Cost of hardware revenue.... 3,360 5,329
Research and development.... 12,074 10,140
Selling, general and
administrative.............. 36,567 29,766
---------- ----------
Total costs and expenses.... 71,033 61,365
Operating income (loss)....... 2,576 (13,803)
Other income, net............. 979 721
---------- ----------
Income (loss) before income taxes 3,555 (13,082)
Provision (benefit) for income
taxes......................... 1,031 (3,662)
---------- ----------
Net income (loss)............. $ 2,524 $ (9,420)
========== ==========
Earnings (loss) per share:
Basic....................... $ 0.17 $ (0.63)
Diluted..................... $ 0.15 $ (0.63)
Weighted average shares outstanding:
Basic....................... 15,102 15,045
Diluted..................... 16,481 15,045
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
FILENET CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended March 31,
------------------------------
1998 1997
-------------- ------------
(Unaudited) (Unaudited)
<S> <C> <C>
Net income (loss)........................ $ 2,524 $ (9,420)
----------- -----------
Other comprehensive income:
Foreign currency translation
adjustments net of tax benefit of
$701 and $881 in 1998 and 1997,
respectively).......................... (1,716) (2,265)
Unrealized gains (losses) on securities:
Unrealized holding gains (losses)
arising during period (net of tax effect
of $3 and $(32) in 1998 and 1997,
respectively)........................ 5 (51)
Reclassification adjustment for losses
included in net income (net of tax
benefit of $2)....................... (5)
----------- -----------
Total other comprehensive loss........... (1,716) (2,316)
----------- -----------
Comprehensive income (loss).............. $ 808 $ (11,736)
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
FILENET CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended March 31,
--------------------------------------
1998 1997
------------------ -----------------
(Unaudited) (Unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)......................... $ 2,524 $ (9,420)
Adjustments to reconcile net income
(loss) to net cash provided by operating
activities:
Depreciation and amortization......... 3,431 3,353
Provision for doubtful accounts....... 447 23
Deferred income taxes................. 300
Changes in operating assets and
liabilities:
Accounts receivable................. (2,039) 30,090
Inventories......................... 558 1,090
Prepaid expenses and other current
assets.............................. (730) 617
Accounts payable.................... 2,915 (5,108)
Accrued compensation................ (541) (1,863)
Unearned maintenance revenue........ 4,472 (954)
Accrued royalties................... (595) (1,188)
Other............................... 4,052 (8,436)
------------- ------------
Net cash provided by operating activities. 14,794 8,204
------------- ------------
Cash flows from investing activities:
Proceeds from sale of equipment........... 314 70
Capital expenditures...................... (7,436) (4,059)
Purchases of marketable securities........ (14,215)
Proceeds from sales and maturities of
marketable securities..................... 11,345 11,260
------------- ------------
Net cash provided (used) by investing
activities................................ 4,223 (6,944)
------------- ------------
Cash flows from financing activities:
Proceeds from issuance of common stock.... 3,291 922
Common stock repurchased.................. (4,435)
------------- ------------
Net cash provided (used) by financing
activities................................ (1,144) 922
------------- ------------
Effect of exchange rate changes on cash
and cash equivalents..................... (1,384) (1,404)
------------- ------------
Net increase in cash and cash equivalents 16,489 778
Cash and cash equivalents, beginning of year 37,344 28,530
============= ============
Cash and cash equivalents, end of period. $ 53,833 $ 29,308
============= ============
Supplemental cash flow information:
Interest paid............................ $ 8 $ 38
Income taxes paid (refunds received)..... $ (2,066) $ 718
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE>
FILENET CORPORATION
Notes To Consolidated Financial Statements
(Unaudited)
1. In the opinion of the management of FileNET Corporation ("the Company"),
the accompanying unaudited consolidated financial statements reflect
adjustments (consisting of normal recurring adjustments) necessary to
present fairly the financial position of the Company at March 31, 1998 and
the results of its operations, its comprehensive income and its cash flows
for the three months ended March 31, 1998 and 1997. Certain information and
footnote disclosures normally included in financial statements have been
condensed or omitted pursuant to rules and regulations of the Securities
and Exchange Commission ("SEC"), although the Company believes that the
disclosures in the consolidated financial statements are adequate to ensure
the information presented is not misleading. These consolidated financial
statements should be read in conjunction with the consolidated financial
statements and notes thereto, and Management's Discussion and Analysis of
Financial Condition and Results of Operations contained in the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 1997
filed by the Company with the SEC on March 31, 1998. The results of
operations for the interim periods are not necessarily indicative of the
operating results for the year.
2. Certain reclassifications have been made to the prior year's consolidated
financial statements to conform with the current year's presentation.
3. The following table is a reconciliation of the earnings and share amounts
used in the calculation of basic earnings per share and diluted earnings
per share for the three months ended March 31, 1998.
<TABLE>
<CAPTION>
(In thousands, except per share amounts) Net Per Share
Income Shares Amount
------------ ------------ -----------
<S> <C> <C> <C>
Three months ended March 31, 1998:
Basic earnings per share........ $ 2,524 15,102 $ 0.17
Effect of dilutive stock options 1,379
------------ ------------
Diluted earnings per share...... $ 2,524 16,481 $ 0.15
============ ============
</TABLE>
The weighted average number of shares outstanding during the three
months ended March 31, 1997 was 15,045,000. Options to purchase shares of
common stock were outstanding during this period but were not included in
the computation of diluted loss per share as their effect was antidilutive.
4. In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard (SFAS) No. 130, "Reporting
Comprehensive Income." SFAS No. 130 requires enterprises to report
comprehensive income and its components in general-purpose financial
statements. SFAS No. 130 is effective for the Company beginning January 1,
1998. Accordingly, the Company has prepared Statements of Comprehensive
Income for the quarters ended March 31, 1998 and 1997 (restatement of prior
year financial statements is required by SFAS No. 130). Accumulated other
comprehensive income as of March 31, 1998 is comprised of the following:
<TABLE>
<CAPTION>
Accumulated
Unrealized Gain Other
Foreign on Marketable Comprehensive
(In thousands) Currency Items Securities Income
<S> <C> <C> <C>
-------------- ------------- --------------
Balance, December 31, 1997 $ (4,121) $ (25) $ (4,146)
Current period changes (1,716) (1,716)
-------------- ------------- --------------
Balance, March 31, 1998 $ (5,837) $ (25) $ (5,862)
============== ============= ==============
</TABLE>
7
<PAGE>
5. In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information" which is effective for the year
ending December 31, 1998. The Company has not yet determined the impact,
if any, of adopting this standard on its financial statements.
6. 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 (the FileNET
Case). 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 (the Watermark Case). On October 9, 1996,
Wang withdrew its claim in the FileNET Case that one of the patents it
initially asserted is infringed by the Company's products that 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.
In March 1997, Eastman Kodak Company (Kodak) purchased the Wang imaging
business unit that has responsibility for this litigation. The patents
in the suit have been transferred to a Kodak subsidiary, Kodak Limited
of England, which, in turn, has exclusively licensed them to another
Kodak subsidiary, Eastman Software, Inc. in the United States (Eastman).
On July 30, 1997, the court permitted Eastman and Kodak Limited of England
to be substituted in the litigation in place of Wang.
FileNET has moved for summary judgement on noninfringement as to each of
the five patents in the suit, and for summary judgment of invalidity as to
one of the patents. Eastman moved for summary judgment as to FileNET's
unenforceability defense on one of the patents. A trial date has not been
set.
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. Based on the Company's analysis of these
Eastman patents and their respective file histories, the Company believes
that it has meritorious defenses to Eastman's claims; however, the ultimate
outcome or any resulting potential loss cannot be determined at this time.
On December 20, 1996, plaintiff Michael I. Goldman (the Plaintiff) filed a
class actio complaint against the Company and certain of its
officers and directors in the Superior Court of California, County of
Orange (the State Action). The action was purportedly filed on behalf of a
class of purchasers of the Company's common stock during the period October
19, 1995 through July 2, 1996. The Plaintiff alleges that the Company and
other defendants violated Cal. Corp. Code ss.ss. 25400 and 25500, Cal. Civ.
Code ss.ss. 1709-1710 and Cal. Bus. & Prof. Code ss.ss. 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.
On April 1, 1997, the Plaintiff filed another class action complaint
against the Company and certain of its officers and directors in the United
States District Court for the Central District of California (the Federal
Action). The action purportedly was filed on behalf of the same class of
purchasers of the Company's common stock as the State Action. The
allegations contained in the Federal Action are very similar to the
allegations contained in the State Action, except that the Federal Action
asserts claims under Sections 10(b) and 20(a) of the Securities Exchange
Act and Rule 10b-5. The complaint seeks unspecified compensatory damages,
interest, attorneys' fees, expert witness fees, costs and equitable or
injunctive relief. On July 2, 1997, the court granted plaintiff's motion to
be appointed "lead plaintiff" under the Private Securities Litigation
Reform Act.
8
<PAGE>
In the Federal Action, defendants have filed a motion to dismiss the
complaint in its entirety. Plaintiff has filed a motion to stay the Federal
Action, in light of the parallel State Action. The court is scheduled to
hear both of these motions during June 1998.
In the State Action, defendants moved to stay the action, in light of the
parallel Federal Action. The trial court granted the motion to stay the
action as to discovery on September 8, 1997. Defendants also demurred and
moved to strike the complaint. The trial court overruled the demurrer and
denied the motion to strike on October 21, 1997. On January 14, 1998, the
court entered an order dismissing with prejudice two of plaintiff's three
causes of action: the claims under Cal. Civ. Code ss.ss. 1709-1710 and Cal.
Bus. & Prof. Code ss.ss. 17200 et seq.
On January 30, 1998, the trial court in the State Action granted the
Plaintiff's motion to certify a class composed of persons who bought
FileNET stock in California only between October 19, 1995 and July 2, 1996.
This ruling is subject to revision based on the decisions to be rendered by
the California Supreme Court in Diamond Multimedia Systems, et al. v.
Superior Court (Pass) and StorMedia, Inc., et al. v. Superior Court
(Werczberger). The trial court also denied the Plaintiff's motion to lift
the discovery stay.
The Company believes that all of the allegations contained in the
complaints filed in the State and Federal Actions are without merit and
intends to defend the actions vigorously.
The Company, in the normal course of business, is subject to various other
legal matters. While the results of litigation and claims cannot be
predicted with certainty, the Company believes that the final outcome of
these other matters will not have a materially adverse effect on the
Company's consolidated results of operations or financial condition.
9
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following should be read in conjunction with the unaudited consolidated
financial statements and notes thereto included in Part I--Item 1 and Factors
That May Affect Future Results in this item of this Quarterly Report, and with
the audited consolidated financial statements, and notes thereto, and
Management's Discussion and Analysis of Financial Condition and Results of
Operations contained in the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1997.
Results of Operations
Revenue
<TABLE>
<CAPTION>
Quarter Ended March 31,
--------------------------------------------
(Dollars in millions) 1998 1997 Change
<S> <C> <C> <C>
------------- -------------- -----------
Software revenue $ 29.5 $ 13.0 127%
International 13.7 9.0 52%
------------- --------------
Total software revenue $ 43.2 $ 22.0 96%
------------ --------------
Percentage of total
revenue 59% 46%
Service revenue
Domestic $ 16.6 $ 12.3 35%
International 6.9 6.0 15%
------------- --------------
Total service revenue $ 23.5 $ 18.3 28%
------------- --------------
Percentage of total
revenue 32% 39%
Hardware revenue
Domestic $ 5.0 5.2 (4%)
International 1.9 2.1 (10%)
------------- --------------
Total hardware revenue $ 6.9 $ 7.3 (5%)
------------- --------------
Percentage of total
revenue 9% 15%
Total revenue
Domestic $ 51.1 $ 30.5 68%
International 22.5 17.1 32%
============= ==============
Total revenue $ 73.6 $ 47.6 55%
============= ==============
</TABLE>
Software revenue from the licensing of the Company's software products increased
96% for the quarter ended March 31, 1998 over the same period of 1997 due to an
increase in the volume of product shipments, including the Company's Panagon
product line which was released during the quarter. The magnitude of the
increase in revenue over 1997 is partially attributable to weakness in orders
during the first quarter of 1997 and is not indicative of future revenue growth.
Service revenue consists of revenue from software maintenance services,
professional services, training, repairs and supplies. Service revenue increased
by 28% for the quarter ended March 31, 1998 over the same period of 1997. The
increase was attributable to increased maintenance revenue due to the growth of
the Company's installed base.
Hardware revenue is generated primarily from the sale of 12-inch optical storage
and retrieval libraries (OSARs) and third-party hardware. Hardware revenue
decreased by 5% for the quarter ended March 31, 1998 from the same period of
1997 primarily due to a decrease in new orders experienced both domestically and
internationally and the Company's focus on increasing its higher margin software
revenues. The Company expects hardware revenue to continue to decline in both
absolute dollars and as a percentage of total revenues as it continues to
transition its business toward software-related revenue.
10
<PAGE>
International revenues constituted approximately 31% and 36% of total revenues
in the quarters ended March 31, 1998 and 1997, respectively. The decrease is
attributable to the higher level of domestic growth experienced quarter to
quarter. Management expects that the Company's international operations will
continue to account for a significant portion of total revenues. However, the
current economic crisis in the Asia-Pacific region could adversely affect
international revenues. In addition, international revenues could be adversely
affected if the U.S. dollar strengthens against international currencies.
Cost of Revenue
<TABLE>
<CAPTION>
Quarter Ended March 31,
--------------------------
1998 1997 Change
<S> <C> <C> <C>
----------- ----------- ----------
(Dollars in millions)
Cost of software revenue $ 3.7 $ 3.0 23%
Percentage of software revenue 9% 14%
Cost of service revenue $ 15.3 $ 13.1 17%
Percentage of service revenue 65% 72%
Cost of hardware revenue $ 3.4 $ 5.3 (36%)
Percentage of hardware revenue 49% 73%
Total cost of revenue $ 22.4 $ 21.4 5%
Percentage of total revenue 30% 45%
</TABLE>
The cost of software revenue includes royalties paid to third parties and the
cost of software distribution. The cost of software revenue as a percentage of
software revenue for the quarter ended March 31, 1998 decreased to 9% from 14%
for the comparable period in 1997. The decrease was primarily attributable to
the low revenue levels in 1997 without a corresponding decrease in fixed
distribution costs. Also contributing to the decrease was the fact that software
localization costs which were classified as cost of revenue in 1997 have been
classified as research and development in 1998.
The cost of service revenue includes software support and professional services
personnel, supplies, and the cost of third-party hardware maintenance. The cost
of service revenue as a percentage of service revenue for the first quarter of
1998 decreased to 65% from 72% in the same period of 1997. The decrease was
attributable to improved international margins from those experienced in the
first quarter of 1997.
The cost of hardware revenue includes the cost of manufacturing OSARs,
third-party purchased hardware and the cost of hardware integration personnel.
The cost of hardware revenue as a percentage of hardware revenue for the quarter
ended March 31, 1998 decreased to 49% from 73% for the comparable quarter of
1997. This decrease was due to improved product mix and a reduction in fixed
manufacturing costs.
Operating Expenses
<TABLE>
<CAPTION>
Quarter Ended March 31,
------------------------------
1998 1997 Change
<S> <C> <C> <C>
------------- -------------- -----------
(Dollars in millions)
Research and development $ 12.1 $ 10.1 20%
Percentage of total revenue 16% 21%
Selling, general and administrative $ 36.6 $ 29.8 23%
Percentage of total revenue 50% 63%
</TABLE>
Research and development expenses increased 20% for the first quarter of 1998.
The increase was due to a general increase in salaries necessitated by the
intense competitive environment for software engineers; increase in cost of
contract developers; and the inclusion of software localization costs in
research and development in 1998. As a percentage of total revenue, research and
development expenses decreased to 16% in the first quarter of 1998 from 21% in
1997. This decrease is primarily attributable to the effects of the lower
revenue levels in the first quarter of 1997.
11
<PAGE>
The Company expects that competition for qualified technical personnel will
remain intense for the foreseeable future and may result in higher levels of
compensation expense for the Company. The Company believes that research and
development expenditures, including compensation of technical personnel, are
essential to maintaining its competitive position and expects these costs to
continue to constitute a significant percentage of revenues.
Selling, general and administrative expenses increased 23% for the first quarter
of 1998 compared to the same period in 1997. This increase was primarily due to
overall increases in salaries, higher sales incentive compensation due to
increased revenues, and increased marketing program costs. As a percentage of
total revenue, selling, general and administrative expenses decreased to 50% in
1998 from 63% in 1997 primarily due to the lower revenue levels in the first
quarter of 1997.
Provision for Income Taxes. The Company's combined federal, state and foreign
annual effective tax rate for the quarter ended March 31, 1998 was 29% compared
to 28% for the same period in 1997. The increase in the rate is attributable to
a decrease in taxable income generated in lower tax jurisdictions outside of
North America.
Foreign Currency Fluctuations and Inflation. The Company's performance can be
affected by changes in foreign currency values relative to the U.S. dollar in
relation to the Company's revenue and operating expenses. The impact to net
income from foreign exchange transactions and hedging activities is immaterial
for all periods reported. As of March 31, 1998, the Company had forward exchange
contracts outstanding totaling approximately $39 million in 10 currencies. All
of these contracts mature in three months.
Other comprehensive income for the three months ended March 31, 1998 reflects a
$1.7 million increase in the unrealized loss due to foreign currency
translation. This increase was primarily attributable to unrealized losses
associated with the weakening of the Irish currency against the U.S. dollar
during the period.
Management believes that inflation has not had a significant impact on the
prices of the Company's products, the cost of its materials, or its operating
results for the three months ended March 31, 1998 and 1997.
Other Financial Instruments. The Company enters into forward foreign exchange
contracts as a hedge against effects of fluctuating currency exchange rates on
monetary assets and liabilities denominated in currencies other than the
functional currency of the relevant entity. The Company is exposed to market
risk on the forward exchange contracts as a result of changes in foreign
exchange rates; however, the market risk should be offset by changes in the
valuation of the underlying exposures. Gains and losses on these contracts,
which equal the difference between the forward contract rate and the prevailing
market spot rate at the time of valuation, are recognized in the consolidated
statement of operations. The counterparties to these instruments are major
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.
Liquidity and Capital Resources
At March 31, 1998, combined cash, cash equivalents and short- and long-term
marketable securities totaled $73.4 million, an increase of $1.6 million from
the end of 1997. Cash provided by operating activities during the quarter
totaled $14.8 million and resulted primarily from net income; an increase in
accounts payable associated with higher capital expenditures; an increase in
unearned maintenance revenue related to the large volume of renewal billings
which occur during the first quarter; and additions to net income for
depreciation and amortization expense. These operating cash inflows were offset
by an increase in accounts receivable. Cash provided by investing activities
totaled $4.2 million and was a result of sales and maturities of marketable
securities offset by capital expenditures. Cash used by financing activities
totaled $1.1 million and was a result of the repurchase of 139,000 shares of the
Company's common stock offset by proceeds received from the exercise of employee
stock options and purchases under the employee stock purchase plan.
12
<PAGE>
Accounts receivable increased to $62.3 million at March 31, 1998 from $61.3
million at December 31, 1997. Days sales outstanding was 72 days as of March 31,
1998 and December 31, 1997. Current liabilities increased to $67.0 million at
March 31, 1998 from $60.6 million at December 31, 1997. The increase is
primarily a result of increases in deferred maintenance revenue and income taxes
payable offset by decreases in accrued employee benefit costs and accrued
royalties.
The Company has a $20 million unsecured line of credit with a commercial bank.
This line of credit expires in May 1999 and is subject to the maintenance of
certain financial covenants. The Company also has several borrowing arrangements
with foreign banks which expire at various times during 1998 under which the
Company may borrow approximately $2 million. As of March 31, 1998, there were no
borrowings outstanding against any of the Company's credit lines.
During the quarter ended March 31, 1998, the Company repurchased $4.4 million of
its common stock, thereby completing its previously announced $10 million stock
repurchase program.
The Company anticipates that its present cash balances together with internally
generated funds and credit lines will be sufficient to meet its working capital
and capital expenditure needs for at least the next twelve months.
Other Matters
Year 2000. The Company is assessing the internal readiness of its computer
systems for handling the year 2000. The Company expects to implement
successfully the systems and programming changes necessary to address year 2000
issues with respect to its internal systems and does not believe that the cost
of such actions will have a material adverse effect on its financial condition
or results of operations. Although the Company is not aware of any material
operational issue or costs associated with preparing its internal systems for
the year 2000, there can be no assurance that there will not be a delay in, or
increased costs associated with, the implementation of the necessary systems and
changes to address the year 2000 issues, and the Company's inability to
implement such systems and changes could have an adverse effect on future
results of operations.
Environmental Matters. The Company is not aware of any issues related to
environmental matters that have, or are expected to, materially affect its
business.
Factors That May Affect Future Results
The Company's business, financial condition and operating results can be
impacted by a number of factors, including but not limited to those set forth
below and elsewhere in this report, any one of which could cause the Company's
actual results to differ materially from recent results or from the Company's
anticipated future results.
Rapid Technological Change; Product Development. The market for the Company's
products is characterized by rapid technological developments, evolving industry
standards, changes in customer requirements and frequent new product
introductions and enhancements. The Company's continued success will be
dependent upon its ability to continue to enhance its existing products, develop
and introduce, in a timely manner, new products incorporating technological
advances and respond to customer requirements, including without limitation
enhancements to certain specified Company software products to achieve year 2000
compliance. The Company could experience continued difficulties or delays in
developing and introducing new products integrating some or all of the
technologies and products from the acquisitions of Watermark, Saros and IFSL
with the technologies and products from the Company. Delays in or non-completion
of the development of newly integrated products, or lack of market acceptance of
such products, could have an adverse impact on the Company's future results of
operations and result in a failure to realize the anticipated benefits of the
acquisitions. To the extent one or more of the Company's competitors introduce
products that more fully address customer requirements, the Company's business
could be adversely affected. There can be no assurance that the Company will be
13
<PAGE>
successful in developing and marketing enhancements to its existing products or
new products on a timely basis or that any new or enhanced products will
adequately address the changing needs of the marketplace. If the Company is
unable to develop and introduce new products or enhancements to existing
products in a timely manner in response to changing market conditions or
customer requirements including without limitation enhancements to certain
existing software products to achieve year 2000 compliance, the Company's
business and operating results could be adversely affected. From time to time,
the Company or its competitors may announce new products, capabilities or
technologies that have the potential to replace or shorten the life cycles of
the Company's existing products. There can be no assurance that announcements of
currently planned or other new products will not cause customers to delay their
purchasing decisions in anticipation of such products, which could have a
material adverse effect on the Company's business and operating results.
Uncertainty Of Future Operating Results; Fluctuations In Quarterly Operating
Results.Prior growth rates in the Company's revenue and operating results should
not necessarily be considered indicative of future growth or operating results.
Future operating results will depend upon many factors, including the demand for
the Company's products, the effectiveness of the Company's efforts to continue
to integrate various products it has developed or acquired through acquisition
of others and to achieve the desired levels of sales from such product
integration, the level of product and price competition, the length of the
Company's sales cycle, seasonality of individual customer buying patterns, the
size and timing of individual transactions, the delay or deferral of customer
implementations, the budget cycles of the Company's customers, the timing of new
product introductions and product enhancements by the Company and its
competitors, the mix of sales by products, services and distribution channels,
levels of international sales, acquisitions by competitors, changes in foreign
currency exchange rates, the ability of the Company to develop and market new
products and control costs, and general domestic and international economic and
political conditions. As a result of these factors, revenues and operating
results for any quarter are subject to variation and are not predictable with
any significant degree of accuracy.
Therefore, the Company believes that period-to-period comparisons of its results
of operations are not necessarily meaningful and should not be relied upon as
indications of future performance. Moreover, such factors could cause the
Company's operating results in a given quarter to be below the expectations of
public market analysts and investors. In either case, the price of the Company's
common stock could be materially adversely affected.
Competition. The document imaging, workflow, computer output to laser disk and
document management software markets are highly competitive, and there are
certain competitors of the Company with substantially greater sales, marketing,
development and financial resources. The Company believes that the competitive
factors affecting the market for its products and services include vendor and
product reputation; product quality, performance and price; the availability of
products on multiple platforms; product scalability; product integration with
other enterprise applications; product functionality and features; product
ease-of use; and the quality of customer support services and training. The
relative importance of each of these factors depends upon the specific customer
involved. While the Company believes it competes favorably in each of these
areas, there can be no assurance that it will continue to do so. Moreover, the
Company's present or future competitors may be able to develop products
comparable or superior to those offered by the Company, offer lower price
products or adapt more quickly than the Company to new technologies or evolving
customer requirements. Competition is expected to intensify. In order to be
successful in the future, the Company must respond to technological change,
customer requirements and competitors' current products and innovations. There
can be no assurance that it will be able to continue to compete effectively in
its market or that future competition will not have a material adverse effect on
its business, operating results and financial condition.
Intellectual Property And Other Proprietary Rights.The Company's success depends
in part on its ability to protect its proprietary rights to the technologies
used in its principal products. The Company relies on a combination of
copyrights, trademarks, trade secrets, confidentiality procedures and
contractual provisions to protect its proprietary rights. There can be no
assurance that the Company's existing or future copyrights, trademarks, trade
secrets or other intellectual property rights will be of sufficient scope or
strength to provide meaningful protection or commercial advantage to the
Company. FileNET has no software patents. Also, in selling certain of its
14
<PAGE>
products, the Company relies on "shrink wrap" licenses that are not signed by
licensees and, therefore, may be unenforceable under the laws of certain
jurisdictions. In addition, the laws of some foreign countries do not protect
the Company's proprietary rights to the same extent as do the laws of the United
States. There can be no assurance that such factors would not have a material
adverse effect on the Company's business or operating results.
The Company may from time to time be notified that it is infringing certain
patent or intellectual property rights of others. Combinations of technology
acquired through past or future acquisitions and the Company's technology will
create new products and technology that may give rise to claims of infringement.
While no actions other than the ones discussed below are currently pending
against the Company for infringement of patent or other proprietary rights of
third parties, there can be no assurance that third parties will not initiate
infringement actions against the Company in the future. Infringement actions can
result in substantial cost to and diversion of resources of the Company. If the
Company were found to infringe upon the rights of others, no assurance can be
given that licenses would be obtainable on acceptable terms or at all, that
significant damages for past infringement would not be assessed or that further
litigation relative to any such licenses or usage would not occur. The failure
to successfully defend any claims or obtain necessary licenses or other rights,
the ultimate disposition of any claims or the advent of litigation arising out
of any claims of infringement, could have a material adverse effect on the
Company's business, financial condition or results of operations.
In October 1994, Wang filed a complaint in the United States District Court for
the District of Massachusetts alleging that the Company is infringing five
patents held by Wang. On June 23, 1995, Wang amended its complaint to include an
additional related patent. On July 2, 1996, Wang filed a complaint in the same
court alleging that Watermark, formerly a wholly-owned subsidiary that was
merged into the Company, is infringing three of the same patents asserted in the
initial complaint. On October 9, 1996, Wang withdrew its claim that one of the
patents it initially asserted is infringed by the Company's products which were
commercialized before the initial complaint was filed. Wang reserved the right
to assert that patent against the Company's products commercialized after that
date in a separate lawsuit. Based on the Company's analysis of these Wang
patents and their respective file histories, the Company believes that it has
meritorious defenses to Wang's claims; however, the ultimate outcome or any
resulting potential loss cannot be determined at this time.
In March 1997, Eastman Kodak Company ("Kodak") purchased the Wang imaging
business unit that has responsibility for this litigation. The patents in the
suit have been transferred to a Kodak subsidiary, Kodak Limited of England,
which in turn has exclusively licensed them to another Kodak subsidiary, Eastman
Software, Inc. in the United States. On July 30, 1997, the Court permitted
Eastman Software, Inc. and Kodak Limited of England to be substituted in the
litigation in place of Wang. The Company cannot predict what impact, if any,
this will have on the litigation.
If it should be determined that the patents at issue in the litigation are valid
and are infringed by any of the Company's products, including Watermark
products, the Company will, depending on the product, redesign the infringing
products or seek to obtain a license to market the products. There can be no
assurance that the Company will be able to obtain such a license on acceptable
terms.
Dependence On Certain Relationships. The Company has entered into a number of
co-marketing relationships with other companies such as Microsoft Corporation,
Compaq Computer Corporation, SAP AG, Hewlett-Packard Company and Sun
Microsystems, Inc. There can be no assurance that these companies will not
reduce or discontinue their relationships with or support of the Company and its
products.
Dependence On Key Management And Technical Personnel. The Company's success
depends to a significant degree upon the continued contributions of its key
management, marketing, technical and operational personnel. In general, the
Company does not utilize employment agreements for its key employees. The loss
of the services of one or more key employees could have a material adverse
effect on the Company's operating results. The Company also believes its future
success will depend in large part upon its ability to attract and retain
additional highly skilled management, technical, marketing, product development
15
<PAGE>
and operational personnel. Competition for such personnel, particularly
engineers and other technical personnel, is intense, and pay scales in the
Company's industry are increasing. There can be no assurance that the Company
will be successful in attracting and retaining such personnel.
International Sales. Historically, the Company has derived approximately
one-third of its total revenues from international sales. International business
is subject to certain risks including varying technical standards, tariffs and
trade barriers, political and economic instability, reduced protection for
intellectual property rights in certain countries, difficulties in staffing and
maintaining foreign operations, difficulties in managing foreign distributors,
potentially adverse tax consequences, currency exchange fluctuations, the burden
of complying with a wide variety of complex operations, foreign laws,
regulations and treaties and the possibility of difficulties in collecting
accounts receivable. There can be no assurance that any of these factors will
not have a material adverse effect on the Company's business or operating
results.
Product Liability. The Company's license agreements with customers typically
contain provisions designed to limit their exposure to potential product
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 trading 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 trading price of the Company's common stock.
16
<PAGE>
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
See Notes to Consolidated Financial Statements.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits - The list of exhibits contained in the accompanying Index to
Exhibits is herein incorporated by reference. (b) No reports on Form 8-K were
filed during the first quarter of 1998.
17
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FILENET CORPORATION
May 14, 1998 By:______\s\ Mark S. St. Clare__________________
Date Mark S. St. Clare, Chief Financial Officer and
Sr. Vice President, Finance (Principal
Financial Officer)
18
<PAGE>
INDEX TO EXHIBITS
Exhibit No. Description
....................... ........................................................
3.1* Restated Certificate of Incorporation, as amended (filed
as Exhibit 3.1 to Form S-4 filed on January 26, 1996;
Registration No. 333-00676).
3.1.1* Certificate of Amendment of Restated Certificate of
Incorporation (filed as Exhibit 3.1.1 to Form S-4 filed
on January 26, 1996, Registration No.333-00676).
3.2* Bylaws (filed as Exhibit 3.2 of the Registrant's
registration statement on Form S-1, Registration No.
33-15004 (the "Form S-1")).
4.1* Form of certificate evidencing Common Stock (filed as
Exhibit 4.1 to the Form S-1, Registration No. 33-15004).
4.2* Rights Agreement, dated as of November 4, 1988 between
FileNET Corporation and the First National Bank of
Boston, which includes the form of Rights Certificate as
Exhibit A and the Summary of Rights to Purchase Common
Shares as Exhibit B (filed as Exhibit 4.2 to Form S-4
filed on January 26, 1996; Registration No. 333-00676).
10.1* Second Amended and Restated Credit Agreement
(Multicurrency) by and among the Registrant and Bank of
America National Trust and Savings Association dated
June 25, 1997, effective June 1,1997 (filed as Exhibit
10.1 to Form 10-Q for the quarter ended June 30, 1997).
10.2* Business Alliance Program Agreement between the
Registrant and Oracle Corporation dated July 1, 1996, as
amended by Amendment One thereto (filed as Exhibit 10.4
to Form 10-QA for the quarter ended June 30, 1996).
10.3* Runtime Sublicense Addendum between the Registrant and
Oracle Corporation dated July 1, 1996, as amended by
Amendment One thereto (filed as Exhibit 10.4 to Form
10-QA for the quarter ended June 30, 1996).
10.4* Full Use and Deployment Sublicense Addendum between the
Registrant and Oracle Corporation dated July 1, 1996, as
amended by Amendment One thereto (filed as Exhibit 10.4
to Form 10-QA for the quarter ended June 30, 1996).
10.5* Lease between the Registrant and C. J. Segerstrom & Sons
for the headquarters of the Company, dated April 30,1987
(filed as Exhibit 10.19 to the Form S-1).
10.6* Third Amendment to the Lease between the Registrant and
C. J. Segerstrom & Sons dated April 30, 1987, for
additional facilities at the headquarters of the
Company, dated October 1, 1992 (filed as exhibit 10.7 to
Form 10-K filed on April 4, 1997).
10.7* Fifth Amendment to the Lease between the Registrant and
C. J. Segerstrom & Sons dated April 30, 1987, for the
extension of the term of the lease, dated March 28,
1997(filed as exhibit 10.8 to Form 10-Q for the quarter
ended March 31, 1997).
10.8* 1989 Stock Option Plan for Non-Employee Directors of
FileNET Corporation, as amended by the First Amendment,
Second Amendment, Third Amendment thereto (filed as
Exhibit 10.9 to Form S-4 filed on January 26, 1996;
Registration No. 333-00676).
10.9* Amended and Restated 1995 Stock Option Plan of FileNET
Corporation as approved by stockholders at the
Registrant's Annual Meeting on May 8, 1996 (filed as
Exhibit 99.1 to Form S-8 filed on July 29, 1996).
- --------------------------------------------
* Incorporated herein by reference
19
<PAGE>
Exhibit No. Description
....................... ........................................................
10.10* Second Amended and Restated Stock Option Plan of FileNET
Corporation, together with the forms of Incentive Stock
Option Agreement and Non-Qualified Stock Option
Agreements (filed as Exhibits 4(a), 4(b) and 4(c),
respectively, to the Registrant's Registration Statement
on Form S-8, Registration No. 33-48499), and an
Amendment thereto (filed as Exhibit 4(d) to the
Registrant's Registration Statement on Form S-8,
Registration No. 33-69920), and the Second Amendment
thereto (filed as Appendix A to the Registrant's Proxy
Statement for the Registrant's 1994 Annual Meeting of
Stockholders, filed on April 29, 1994).
10.11* Non-Statutory Stock Option Agreement (with Notice of
Grant of Stock Option and Special Addendum) between
Registrant and Mr. Lee Roberts (filed as exhibit 99.17
to Form S-8 on August 20, 1997).
10.12* Non-Statutory Stock Option Agreement (with Notice of
Grant of Stock Option and Special Addendum) between
Registrant and Mr. Ron Ercanbrack (filed as exhibit
99.19 to Form S-8 on August 20, 1997).
10.13* 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).
10.14* Amendment #A1011-941003-01 dated September 30, 1994, to
the Agreement for the Purchase of IBM products dated
December 20, 1991 (filed as exhibit 10.12 to form 10-K
for the fiscal year ended December 31, 1996).
10.15* 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).
10.16* 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).
10.17* 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).
10.18* 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).
10.19* 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).
10.20* Stock Purchase Agreement by and Among FileNET
Corporation, IFS Acquisition Corporation, Jawaid Khan
and Juergen Goersch dated January 17, 1996 and Amendment
1 to Stock Purchase Agreement dated January 30, 1996
(filed as Exhibit 10.2 to form 10-K for the year ended
December 31, 1995).
27 Financial Data Schedule.
- ---------------------------------------------
* Incorporated herein by reference
20
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