-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, CEaNWvwTSTkeeiuFyb3b3haKUMihrwi9wfcLiouQn3+i/aI0/VsEwOiJ8CFji4cP EztyFJziuW8+eAyvo0uZgg== 0000706015-96-000014.txt : 19961118 0000706015-96-000014.hdr.sgml : 19961118 ACCESSION NUMBER: 0000706015-96-000014 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19960930 FILED AS OF DATE: 19961114 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: FILENET CORP CENTRAL INDEX KEY: 0000706015 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER INTEGRATED SYSTEMS DESIGN [7373] IRS NUMBER: 953757924 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-15997 FILM NUMBER: 96662963 BUSINESS ADDRESS: STREET 1: 3565 HARBOR BLVD CITY: COSTA MESA STATE: CA ZIP: 926261420 BUSINESS PHONE: 7149663400 MAIL ADDRESS: STREET 1: 3565 HARBOR BLVD CITY: COSTA MESA STATE: CA ZIP: 926261420 10-Q 1 QUARTERLY REPORT FOR FILENET CORPORATION FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1996 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to ___________ Commission file number: 0-15997 FILENET CORPORATION State or other jurisdiction of (I.R.S. Employer incorporation or organization Identification No.) Delaware 95-3757924 FILENET CORPORATION 3565 Harbor Boulevard Costa Mesa, CA 92626 (714) 966-3400 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ____ Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. Title Outstanding Common stock 15,184,532 as of November 4, 1996 FILENET CORPORATION Index Page Number -------- PART I. FINANCIAL INFORMATION Item 1. Consolidated Balance Sheets as of September 30, 1996 and December 31, 1995................... 1 Consolidated Statements of Operations for the fiscal quarters and nine months ended September 30, 1996 and October 1, 1995..... 2 Consolidated Statements of Cash Flows for the nine months ended September 30, 1996 and October 1, 1995........................... 3 Notes to Consolidated Financial Statements....................... 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........................................ 7 PART II. OTHER INFORMATION Item 1. Legal Proceedings................................................ 13 Item 5. Certain Considerations........................................... 13 Item 6. Exhibits and Reports on Form 8-K................................. 18 SIGNATURE........................................................ 19 INDEX TO EXHIBITS................................................ 20 Part I. Financial Information Item 1. Financial Statements FILENET CORPORATION Consolidated Balance Sheets (In thousands, except share amounts) (Unaudited)
September 30, December 31, 1996 1995 ------------ ------------ ASSETS Current assets: Cash and cash equivalents................... $ 22,820 $ 43,378 Short-term marketable securities............ 25,623 28,782 ------- ------- Total cash and short-term marketable securities.............................. 48,443 72,160 ------- ------- Accounts receivable, net.................... 71,863 53,501 Inventories................................. 8,128 6,620 Prepaid expenses and other.................. 8,152 6,573 Deferred income taxes....................... 3,735 3,735 ------- ------- Total current assets............................. 140,321 142,589 ------- ------- Net property and equipment....................... 26,979 25,796 Other assets: Capitalized software, net................... 448 1,226 Long-term marketable securities............. 12,608 18,395 Other....................................... 1,851 1,676 -------- -------- Total other assets............................... 14,907 21,297 ------ ------ Total assets..................................... $182,207 $189,682 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable............................. $ 12,096 $ 16,073 Accrued liabilities: Compensation............................. 11,943 10,997 Income taxes payable..................... 3,117 2,228 Unearned maintenance revenue............. 7,224 5,761 Royalties................................ 4,565 3,572 Other.................................... 16,284 17,604 -------- -------- Total current liabilities......................... 55,229 56,235 -------- -------- Deferred income taxes............................. 2,340 2,289 Stockholders' equity: Convertible preferred stock - $.001 par value; authorized, 39,000,000 shares; 35,232,029 issued and outstanding shares and 1,531,536 common equivalent shares at the liquidation preference at December 31, 1995. - 19,879 Common stock - $.01 par value; authorized, 100,000,000 shares; issued and outstanding 15,155,596 and 13,254,222 shares at September 30, 1996 and December 31, 1995, respectively................................ 124,716 100,719 Retained earnings............................. 4,642 10,518 Other......................................... (152) 42 ------- ------- Total 129,206 131,158 Less Treasury shares at cost: 200,000 shares at September 30, 1996............................... 4,568 - ------- ------- Total stockholders' equity......................... 124,638 131,158 ------- ------- Total liabilities and stockholders' equity......... $182,207 $ 189,682 ======== =========
See accompanying notes to consolidated financial statements. 1 FILENET CORPORATION Consolidated Statements of Operations (In thousands, except per share amounts) (Unaudited)
Fiscal Quarter Ended Nine Months Ended ------------------------ ------------------------ September 30, October 1, September 30, October 1, 1996 1995 1996 1995 ------------------------ ------------------------ Revenue: Software revenue....... $ 32,999 $ 26,911 $ 103,152 $ 78,668 Service revenue........ 20,462 17,056 57,770 49,022 Hardware revenue....... 11,161 13,131 35,441 33,950 ------ ------ ------ ------ Total revenue........... 64,622 57,098 196,363 161,640 ------ ------ ------- ------- Costs and expenses: Cost of software revenue.. 3,520 3,738 12,164 10,929 Cost of service revenue... 13,832 10,234 37,626 31,969 Cost of hardware revenue.. 6,729 7,993 22,326 21,407 Research and development.. 9,104 6,756 26,583 17,458 Selling, general and administrative........... 27,492 23,339 86,368 67,968 Merger, restructuring and write-off of purchased in-process research and development costs........ - 6,393 16,011 6,393 -------- -------- --------- -------- Total costs and expenses... 60,677 58,453 201,078 156,124 -------- -------- --------- -------- Operating income (loss) 3,945 (1,355) (4,715) 5,516 Other income, net......... 630 711 2,224 2,036 -------- -------- --------- -------- Income (loss) before income taxes............. 4,575 (644) (2,491) 7,552 Provision for income taxes.................... 1,144 822 3,385 4,538 --------- --------- ---------- -------- Net income (loss)......... $ 3,431 $ (1,466) $ (5,876) $ 3,014 ========= ========= ========== ======== Net income (loss) per share.................... $ 0.22 $ (0.10) $ (0.39) $ 0.19 ========= ========= ========== ======== Weighted average common and common equivalent shares outstanding....... 15,560 14,506 14,999 15,757 ========= ========= ========= ========
See accompanying notes to consolidated financial statements. 2 FILENET CORPORATION Consolidated Statements Of Cash Flows (In thousands) (Unaudited)
Nine Months Ended ----------------------------------- September 30, October 1, 1996 1995 ------------------- ------------- Cash flows from operating activities: Net Income (loss).................. $ (5,876) $ 3,014 Adjustments to reconcile net income (loss) to net cash (used by)provided by operating activities: Write-off of capitalized and purchased in-process research and development and associated acquisition costs.............. 10,011 1,393 Depreciation and amortization.... 8,647 7,587 Capitalized software amortization................... 778 1,800 Provision for losses on accounts receivable..................... 116 598 Changes in operating assets and liabilities, net of acquisition: Accounts receivable.......... (18,478) (9,746) Inventories.................. (1,508) (2,181) Prepaid expenses............. (1,579) (3,334) Accounts payable............. (3,977) 1,669 Accrued liabilities: Compensation............... 946 (596) Income taxes payable....... 889 1,621 Unearned maintenance revenue.................. 1,463 1,534 Royalties.................. 993 1,691 Other...................... 558 1,858 -------- ------- Net cash (used by) provided by operating activities............................ (7,017) 6,908 -------- ------- Cash flows from investing activities: Proceeds from sale of equipment.... 3,047 97 Capital expenditures............... (12,825) (9,244) Capitalized software............... - (1,600) Payment for purchase of IFSL....... (11,711) - Purchase of marketable securities.. (22,037) (35,161) Proceeds from sales and maturity of marketable securities.......... 30,435 24,950 ------ ------ Net cash used by investing activities... (13,091) (20,958) -------- -------- Cash flows from financing activities: Debt repayments, net............... - (163) Common stock repurchased........... (4,568) - Proceeds from issuance of common stock............................. 4,118 7,436 -------- -------- Net cash (used by) provided by financing activities......................... (450) 7,273 -------- -------- Net decrease in cash and cash equivalents........................ (20,558) (6,777) Cash and cash equivalents, beginning of year.................. 43,378 24,950 -------- -------- Cash and cash equivalents, end of period...................... $ 22,820 $ 18,173 ========= ========= Supplemental cash flow information: Interest paid....................... $ 293 $ 180 Income taxes paid................... $ 2,859 $ 3,229
See accompanying notes to consolidated financial statements. 3 FILENET CORPORATION Notes To Consolidated Financial Statements 1. In the opinion of the management of FileNet Corporation ("the Company"), the accompanying unaudited consolidated financial statements reflect adjustments (consisting of normal recurring adjustments) necessary to present fairly the financial position of the Company at September 30, 1996 and the results of its operations for the fiscal quarters and nine months ended September 30, 1996 and October 1, 1995 and its cash flows for the nine months ended September 30, 1996 and October 1, 1995. Certain information and footnote disclosures normally included in financial statements have been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission ("SEC"), although the Company believes that the disclosures in the consolidated financial statements are adequate to ensure the information presented is not misleading. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto, and Management's Discussion and Analysis of Financial Condition and Results of Operations contained in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995, with the Form S-4 Registration Statement filed by the Company with the SEC on January 17, 1996, as amended January 24, 1996, and with the Company's Current Report on Form 8-K, dated March 1, 1996, and filed by the Company with the SEC on March 13, 1996. The results of operations for the interim periods are not necessarily indicative of the operating results for the year. 2. Certain reclassifications have been made to the prior year's consolidated financial statements to conform with the current year's presentation. 3. Net income per share for the quarter ended September 30, 1996 and for the nine months ended October 1, 1995 was computed using the weighted average number of common and common equivalent shares outstanding during the period. Common equivalent shares include convertible preferred stock and stock options. Net loss per share for the quarter ended October 1, 1995 and for the nine months ended September 30, 1996 was based upon the weighted average number of actual shares of common stock outstanding. 4. On January 30, 1996, the Company purchased all of the outstanding shares of International Financial Systems Ltd. ("IFSL"), a New York corporation, the developer of a Computer Output to Laser Disk (COLD) software product for archiving documents. Pursuant to the Stock Purchase Agreement, the IFSL stockholders received $11.2 million in cash for all of their IFSL stock. The acquisition was accounted for as a purchase, and the purchase price was allocated to net assets of $1.7 million and in-process research and development costs of $9.5 million. As a result of the acquisition, the Company recorded a pre-tax charge of approximately $10.0 million for acquisition costs and the write-off of purchased in-process research and development costs. 4 5. On March 1, 1996, FileNet acquired all the outstanding shares of Saros Corporation ("Saros"), a Washington corporation (the "Saros Acquisition"). The Saros Acquisition was consummated pursuant to an Agreement and Plan of Merger (the "Saros Merger Agreement") dated January 17, 1996 by and among Saros, the Company, and FileNet Acquisition Corporation ("Acquisition Corp."), a Washington corporation and wholly-owned subsidiary of the Company. Pursuant to the Saros Merger Agreement, Acquisition Corp. was merged with and into Saros, with Saros surviving as a wholly-owned subsidiary of the Company. The Saros stockholders received an aggregate of approximately 1,878,000 shares of the Company's common stock and approximately 337,000 options to purchase the Company's common stock in exchange for all of their Saros stock and options. Approximately 188,000 of the total number of the Company's shares issued to the Saros stockholders (the "Saros Escrow Shares") were placed in an escrow account upon consummation of the Saros Acquisition. Pursuant to the escrow agreement entered into by the Company, the stockholders' agent and the escrow agent, the Company may recover from the escrow up to the entire amount of Saros Escrow Shares in the event the Company incurs any loss, expense, liability or other damages (collectively, "Damages") due to a breach by Saros of any of its representations, warranties and covenants in the Saros Merger Agreement in the event Damages exceed $1.0 million in the aggregate. If no claim for Damages is made by the Company within one year from the date of the Merger, the Saros Escrow Shares will be released from escrow and distributed to the Saros stockholders. The Saros Acquisition was accounted for as a pooling-of-interests for financial reporting purposes. The pooling-of-interests method of accounting is intended to present as a single interest two or more common stockholders' interests which were previously independent; accordingly, the historical financial statements for the periods prior to the acquisition have been restated as though the companies had been combined. Fees and expenses related to the Saros Acquisition and restructuring costs incurred in connection with the consolidation of certain operations of Saros and Watermark Software Inc. ("Watermark"), were $6.0 million. The components of this charge include professional fees, elimination of duplicate facilities, write-off of certain contractual obligations and settlement costs, write-off of certain fixed assets (including redundant hardware and software systems), transition and severance payments to employees and other integration and restructuring costs. 6. During the quarter ended September 30, 1996, Watermark and Saros, formerly wholly-owned subsidiaries of the Company, were merged into the Company. 7. In July 1996, the Company's Board of Directors authorized the Company to repurchase up to 200,000 shares of its common stock. As of September 30, 1996, the Company had purchased 200,000 shares at an aggregate cost of approximately $4.6 million. 5 8. In October 1994, Wang Laboratories, Inc. ("Wang") filed a complaint in the United States District Court for the District of Massachusetts alleging that the Company is infringing five patents held by Wang. On June 23, 1995, Wang amended its complaint to include an additional related patent. On July 2, 1996, Wang filed a complaint in the same court alleging that Watermark is infringing three of the same patents asserted in the initial complaint. On October 9, 1996, Wang withdrew its claim that one of the patents it initially asserted is infringed by FileNet products which were commercialized before the initial complaint was filed. Wang reserved the right to assert that patent against FileNet products commercialized after that date in a separate lawsuit. Based on the Company's analysis of these Wang patents and their respective file histories, the Company believes that it has meritorious defenses to Wang's claims; however, the ultimate outcome or any resulting potential loss cannot be determined at this time. If it should be determined that Wang's patents are valid and are infringed by any of the Company's products, including Watermark products, the Company will, depending on the product, redesign the infringing products or seek to obtain a license to market the products. The Company, in the normal course of business, is subject to various other legal matters. While the results of litigation and claims cannot be predicted with certainty, the Company believes that the final outcome of these other matters will not have a materially adverse effect on the Company's consolidated results of operations or financial condition. 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations FILENET CORPORATION The following should be read in conjunction with the unaudited consolidated financial statements and notes thereto included in Part I--Item 1 of this Quarterly Report, the audited consolidated financial statements, and notes thereto, and Management's Discussion and Analysis of Financial Condition and Results of Operations contained in the registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1995, the Form S-4 Registration Statement filed by the Company with the SEC on January 17, 1996, as amended January 24, 1996, and with the Company's Current Report on Form 8-K, dated March 1, 1996, and filed by the Company with the SEC on March 13, 1996. Results of Operations Factors That May Affect Future Results. Future operating results will depend upon many factors, including the demand for the Company's products, the level of price competition, the length of the Company's sales cycle, seasonality of individual customer buying patterns, the size and timing of individual transactions, possible delays or deferrals of customer implementations, the budget cycles of the Company's customers, the timing of new product introductions and product enhancements by the Company and its competitors, the mix of sales by products and distribution channels, the level of international sales, acquisitions by competitors, changes in foreign currency exchange rates, the ability of the Company to develop and market new products and control costs, and general domestic and international economic and political conditions. As a result of these factors, revenue and operating results for any quarter may fluctuate significantly. Therefore, the Company believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. The Company's marketplace continues to be highly competitive. Other companies offer lower priced products which in some applications compete with FileNet products. Additionally, major computer suppliers and software companies offer new competitive document-image, workflow and document management products. The Company continues to experience competitive pricing pressures in all phases of its operations and expects competition will continue to increase. The market for the Company's products is characterized by rapid technological developments, evolving industry standards, swift changes in customer requirements and frequent new product introductions and enhancements. The Company's continued success is dependent upon its ability to enhance its existing products and to develop and introduce, in a timely manner, new products incorporating technological advances which meet customer requirements. To the extent one or more of the Company's competitors introduce products that more fully address customer requirements, the Company's business could be adversely affected. The Company has entered into a number of significant co-marketing relationships with companies such as Hewlett-Packard Company and Sun Microsystems, Inc. There can be no assurance that these companies will not 7 reduce or discontinue their relationship with or support of the Company and its products. Disruption of these relationships could have a material adverse effect on the Company's business and operating results. The Company derives approximately one-third of its total revenue from international sales. Its international business is subject to certain risks including varying technical standards, tariffs and trade barriers, political and economic instability, reduced protection for intellectual property rights in certain countries, difficulties in staffing and maintaining foreign operations, difficulties in managing foreign distributors, potentially adverse tax consequences, foreign currency fluctuations, the burden of complying with a wide variety of complex foreign laws, regulations and treaties and the possibility of difficulties in collecting accounts receivable. The Company acquired Watermark in August 1995 and Saros and IFSL in early 1996. These acquisitions have presented and continue to present the Company with numerous challenges, including the effective assimilation of the operations, technologies and personnel. While the company believes it is taking the appropriate steps to effectively integrate these operations, difficulties in the integration have had and could continue to have a negative impact on the Company's overall financial results. The Company believes that any of the above factors could have an adverse effect on the Company's business and cause fluctuation in the Company's operating results, perhaps substantially. In addition, in recent years the stock market in general, and the market for shares of high technology stocks in particular, have experienced extreme fluctuations which have often been unrelated to operating performance. Such fluctuations could adversely affect the market price of FileNet's common stock. Revenue. Domestic revenues increased 29% in the third quarter and 24% for the first nine months of fiscal 1996 while international revenues decreased 12% in the third quarter and increased 16% for the first nine months of fiscal 1996, when compared to the corresponding periods in fiscal 1995. International revenues constituted approximately 30% and 39% of total revenues in the third quarters of fiscal 1996 and 1995, respectively, and 32% and 33% of total revenues in the first nine months of fiscal 1996 and 1995, respectively. Management expects that the Company's international operations will continue to provide a significant portion of total revenues. However, international revenues could be adversely affected if the U.S. dollar strengthens against international currencies.
(In Millions) ------Third Quarter----- -------Nine Months------ % % 1996 1995 Change 1996 1995 Change Software revenue $33.0 $26.9 23% $103.2 $ 78.7 31% ............................ ........................ ........................ Percentage of total revenue 51% 47% 53% 49% ............................ ........................ ........................ Service revenue 20.4 17.1 19% 57.8 49.0 18% ............................ ....................... ........................ Percentage of total revenue 32% 30% 29% 30% ............................ ........................ ........................ Hardware revenue 11.2 13.1 (15%) 35.4 33.9 4% ............................ ........................ ........................ Percentage of total revenue 17% 23% 18% 21% ............................ ........................ ........................ Total revenue $64.6 $57.1 13% $196.4 $161.6 22% ............................ ........................ ........................
8 Software revenue growth in the third quarter of 1996 compared to the same period of 1995 was 23% and is due to an increase in the volume of product shipments from the Company, additional revenue generated through the Company's co-marketing arrangement with Hewlett-Packard Company, and the addition of new products, reselling partners and direct sales force. Service revenue increased by 19% for the quarter ended September 30, 1996 compared to the same period of 1995. Service revenue consists of revenue from software and hardware maintenance services provided to the Company's customer installed base and other revenue that includes professional services, training and supplies. The increase was due to the growth of the Company's installed base and the recognition of $2.5 million of revenue from the sale and repair of spare parts in connection with the continued transition of hardware maintenance activities to Hewlett Packard Company. The Company anticipates recognizing an additional $2.0 million from spare parts sales for the quarter ended December 31, 1996. Such spare parts sales are not expected to be significant in 1997. Hardware revenue decreased by 15% for the quarter ended September 30, 1996 compared to the same period of 1995. Hardware revenue as a percent of total revenue declined, a trend which the Company expects will continue as it focuses on increasing its higher margin software revenues. For the nine months ended September 30, 1996, total revenue increased by 22% to $196.4 million over the same period in 1995. Software and service revenue increased by 31% and 18%, respectively, due to the reasons cited above. Hardware revenue increased 4%, and as expected, decreased as a percent of total revenue to 18% compared to 21% for the same period last year. Cost of Revenue.
(In Millions) ----Third Quarter---- ----Nine Months----- % % 1996 1995 Change 1996 1995 Change Cost of software revenue $ 3.5 $ 3.7 (5%) $12.2 $10.9 12% .................................... ..................... .................... As a percentage of software revenue 11% 14% 12% 14% .................................... ..................... .................... Cost of service revenue 13.8 10.2 35% 37.6 32.0 18% .................................... ..................... .................... As a percentage of service revenue 68% 60% 65% 65% .................................... ..................... .................... Cost of hardware revenue 6.7 8.0 (16%) 22.3 21.4 4% .................................... ..................... .................... As a percentage of hardware revenue 60% 61% 63% 63% .................................... ..................... .................... Total cost of revenue $24.0 $21.9 10% $72.1 $64.3 12% .................................... ..................... .................... As a percentage of total revenue 37% 38% 37% 40% .................................... ..................... ....................
The cost of software revenue includes royalties paid to third parties, amortization of capitalized software and the cost of software distribution. The 3% decrease in the cost of software revenue as a percentage of software revenue for the quarter ended September 30, 1996 as compared to the same period of 1995 is primarily attributable to a favorable product mix and the savings related to consolidation of software distribution activities. 9 The cost of service revenue includes the cost attributable to maintenance and providing professional services. The cost of service revenue as a percentage of service revenue increased by 8% in the third quarter of 1996 from the same period of 1995 primarily due to lower margins associated with international maintenance as a result of the continued transition of hardware maintenance activities to Hewlett Packard Company. The cost of hardware revenue includes the Company's cost of OSAR manufacturing, third-party purchased hardware and the cost of hardware integration personnel and related benefits and facilities expenses. The cost of hardware revenue as a percentage of hardware revenue for the third quarter of 1996 decreased to 60% from 61% in the same period of 1995 primarily due to a lower percentage of sales of third-party purchased hardware. For the nine months ended September 30, 1996, the cost of software revenue as a percentage of software revenue decreased to 12% from 14% for the same period last year due to the reasons cited above as well as lower amortization of capitalized software expenses. The cost of service revenue as a percentage of service revenue and the cost of hardware revenue as a percentage of hardware revenue remained comparable for the first nine months of 1996 compared to the same period in 1995. Operating Expenses.
(In Millions) ----Third Quarter---- ----Nine Months----- % % 1996 1995 Change 1996 1995 Change Research and development $ 9.1 $ 6.8 34% $26.6 $17.5 52% ................................... ..................... .................... As a percentage of total revenue 14% 12% 14% 11% ................................... ..................... .................... Selling, general and administrative $27.5 $23.3 18% $86.4 $68.0 27% ................................... ..................... .................... As a percentage of total revenue 43% 41% 44% 42% ................................... ..................... ....................
Research and Development. Research and development expenses increased by 34% in the third quarter of 1996 over the same quarter last year due to the addition of development personnel and related facilities and depreciation expenses associated with new development activities. As a percentage of total revenue, research and development expenses increased to 14% from 12% for the same period last year due to the reasons cited above, and the Saros and Watermark business units research and development expenses growing more rapidly than corresponding revenue. For the nine months ended September 30, 1996, research and development expenses increased by 52% over the same period of 1995 due to the reasons cited above as well as a reduction in capitalized software development costs. As a percentage of total revenue, research and development costs increased to 14% compared to 11% for the same period last year. Selling, General and Administrative. Selling, general and administrative expenses increased by 18% for the third quarter of 1996 compared to the same period in 1995. The increase in 1996 was primarily due to the addition of marketing and sales support personnel. As a percentage of total revenue, selling, general and administrative expenses increased to 43% from 41% for the 10 same period last year primarily due to the reasons cited above. For the nine months ended September 30, 1996, selling, general and administrative expenses increased by 27% over the same period of 1995 for the same reasons cited above. As a percentage of total revenue, selling, general and administrative expenses increased to 44% compared to 42% for the same period last year. Merger, Restructuring and Write-off of Purchased In-process Research and Development Costs. Merger, restructuring and write-off of purchased in-process research and development costs for the nine months ended September 30, 1996, consist of a $10.0 million charge for the write-off of purchased in-process research and development and acquisition costs related to the IFSL purchase, $6.0 million for fees and expenses related to the Saros Acquisition and restructuring costs in connection with the consolidation of certain operations of Saros and Watermark. Merger and other costs for the third quarter and nine months ended October 1, 1995 consist of a charge for the buyout of certain Watermark European marketing and manufacturing rights, a write-off of capitalized research and development expenses for FileNet projects made redundant by the Watermark acquisition, and other direct acquisition related fees and expenses. Interest and Other Income. Other income, net of other expenses, decreased in the third quarter to $.6 million from $.7 million in the same quarter last year. For the nine months ended September 30, 1996, other income, net of other expenses, increased to $2.2 million from $2.0 million over the comparable period in 1995. Effective Tax Rate. Non-deductible merger and other costs in the first quarter of 1996 increased the estimated annual effective tax rate to 72% from 45% previously estimated for 1996. The effect of the increased tax rate was recorded in the first quarter. The effective rate for 1996 of 72% compares to 35% for 1995. The 1995 effective tax rate included the non-deductible merger costs for the Watermark acquisition and preacquisition net operating losses incurred by Watermark for which the Company did not receive a current year benefit. Net Income. Net income for the third quarter ended September 30, 1996 was $3.4 million or $0.22 per share compared to a net loss of $1.5 million or $0.10 per share for the same quarter in 1995. For the nine months ended September 30, 1996, net loss was $5.9 million or $0.39 per share compared to net income of $3.0 million or $0.19 per share in 1995. Before merger, restructuring and write-off of purchased in-process research and development costs of $16.0 million and $5.0 million, after tax for 1996 and 1995 respectively, net income for the nine months ended September 30, 1996, was $10.1 million or $0.62 per share on approximately 16.2 million weighted average common and common equivalent shares, compared to $8.0 million or $0.51 cents per share on 15.8 million weighted average common and common equivalent shares for the same period of 1995. 11 Liquidity and Capital Resources As of September 30, 1996, combined cash, cash equivalents and short- and long-term marketable securities totaled $61.1 million, down from $90.6 million for the fiscal year ended December 31, 1995. For the nine months ended September 30, 1996, net cash used by operating activities was $7.0 million, primarily resulting from an increase in accounts receivable. Net cash used by investing activities totaled $13.1 million, consisting of the purchase of IFSL of $11.7 million, capital expenditures of $12.8 million, $8.4 million in net proceeds from marketable securities and $3.0 million in proceeds from the sale of equipment. Net cash used by financing activities was $.5 million, consisting of the net effect of the repurchase of common stock and the proceeds from the exercise of employee stock options. The Company has an unsecured line of credit of $20 million available from a commercial bank. This line of credit expires in April 1997 and is subject to the maintenance of certain financial covenants. The Company also has several borrowing arrangements with foreign banks which expire at various times throughout 1996 pursuant to which the Company may borrow up to approximately $2 million. As of September 30, 1996, there were no borrowings against these credit lines. The Company anticipates that its present cash balances together with internally generated funds and credit lines (which are expected to be renewed or replaced) will be sufficient to meet its working capital and capital expenditure needs for at least the next 12 months. - -------------------------------------------------------------------------------- This quarterly report on form 10-Q contains forward-looking statements that involve risks and uncertainties, including those discussed below, in "Management's Discussion and Analysis of Financial Condition and Results of Operations", the "Notes to Consolidated Financial Statements" contained herein, and elsewhere in this report. The actual results that the Company achieves may differ materially from any forward-looking statements due to such risks and uncertainties. - -------------------------------------------------------------------------------- 12 Part II. Other Information Item 1. Legal Proceedings. In October 1994, Wang filed a complaint in the United States District Court for the District of Massachusetts alleging that the Company is infringing five patents held by Wang. On June 23, 1995, Wang amended its complaint to include an additional related patent. On July 2, 1996, Wang filed a complaint in the same court alleging that Watermark is infringing three of the same patents asserted in the initial complaint. On October 9, 1996, Wang withdrew its claim that one of the patents it initially asserted is infringed by FileNet products which were commercialized before the initial complaint was filed. Wang reserved the right to assert that patent against FileNet products commercialized after that date in a separate lawsuit. Based on the Company's analysis of these Wang patents and their respective file histories, the Company believes that it has meritorious defenses to Wang's claims; however, the ultimate outcome or any resulting potential loss cannot be determined at this time. If it should be determined that Wang's patents are valid and are infringed by any of the Company's products, including Watermark products, the Company will, depending on the product, redesign the infringing products or seek to obtain a license to market the products. There can be no assurance that the Company will be able to obtain such a license from Wang on acceptable terms. The Company, in the normal course of business, is subject to various other legal matters. While the results of litigation and claims cannot be predicted with certainty, the Company believes that the final outcome of these other matters will not have a materially adverse effect on the Company's consolidated results of operations or financial condition. Item 5. Certain Considerations. This quarterly report on form 10-Q contains forward-looking statements that involve risks and uncertainties, including those discussed below, in "Management's Discussion and Analysis of Financial Condition and Results of Operations", the "Notes to Consolidated Financial Statements" contained herein, and elsewhere in this report. The actual results that the Company achieves may differ materially from any forward-looking statements due to such risks and uncertainties. All such factors should be considered by investors in the Company. RAPID TECHNOLOGICAL CHANGE; PRODUCT DEVELOPMENT. The market for the Company's products is characterized by rapid technological developments, evolving industry standards, swift changes in customer requirements and frequent new product introductions and enhancements. The Company's continued success will be dependent upon its ability to continue to enhance its existing products, develop and introduce in a timely manner new products incorporating technological advances and respond to customer requirements. To the extent one or more of the Company's competitors introduce products that more fully address customer requirements, the Company's business could be adversely affected. There can be no assurance that the Company will be 13 successful in developing and marketing enhancements to its existing products or new products on a timely basis or that any new or enhanced products will adequately address the changing needs of the marketplace. If the Company is unable to develop and introduce new products or enhancements to existing products in a timely manner in response to changing market conditions or customer requirements, the Company's business and operating results could be adversely affected. From time to time, the Company or its competitors may announce new products, capabilities or technologies that have the potential to replace or shorten the life cycles of the Company's existing products. There can be no assurance that announcements of currently planned or other new products will not cause customers to delay their purchasing decisions in anticipation of such products, which could have a material adverse effect on the Company's business and operating results. UNCERTAINTY OF FUTURE OPERATING RESULTS; FLUCTUATIONS IN QUARTERLY OPERATING RESULTS. Prior growth rates in the Company's revenue and operating results should not necessarily be considered indicative of future growth, or of future operating results. Future operating results will depend upon many factors, including the demand for the Company's products, the effectiveness of the Company's efforts to continue to integrate the recent acquisitions and achieve the desired levels of product sales from such acquisitions, the level of product and price competition, the length of the Company's sales cycle, seasonality of individual customer buying patterns, the size and timing of individual transactions, the delay or deferral of customer implementations, the budget cycles of the Company's customers, the timing of new product introductions and product enhancements by the Company and its competitors, the mix of sales by products, services and distribution channels, levels of international sales, acquisitions by competitors, changes in foreign currency exchange rates, the ability of the Company to develop and market new products and control costs, and general domestic and international economic and political conditions. As a result of these factors, revenues and operating results for any quarter are subject to variation, and the Company believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. COMPETITION. The imaging, workflow, computer output to laser disk software and document management software markets are highly competitive, and there are certain competitors of the Company with substantially greater sales, marketing, development and financial resources. The Company believes that the competitive factors affecting the market for its products and services include vendor and product reputation; product quality, performance and price; the availability of products on multiple platforms; product scalability; product integration with other enterprise applications; product functionality and features; product ease-of use; and the quality of customer support services and training. The relative importance of each of these factors depends upon the specific customer involved. While the Company believes it competes favorably in each of these areas, there can be no assurance that it will continue to do so. Moreover, the Company's present or future competitors may be able to develop products comparable or superior to those offered by the Company, offer lower price products or adapt more quickly than the Company to new 14 technologies or evolving customer requirements. Competition is expected to intensify. In order to be successful in the future, the Company must respond to technological change, customer requirements and competitors current products and innovations. There can be no assurance that it will be able to continue to compete effectively in its market or that future competition will not have a material adverse effect on its business, operating results and financial condition. INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS. The Company's success depends in part on its ability to protect its proprietary rights to the technologies used in its principal products. The Company relies on a combination of copyrights, trademarks, trade secrets, confidentiality procedures and contractual provisions to protect its proprietary rights. There can be no assurance that the Company's existing or future copyrights, trademarks, trade secrets or other intellectual property rights will be of sufficient scope or strength to provide meaningful protection or commercial advantage to the Company. FileNet has no software patents. Also, in selling certain of its products, the Company relies on "shrink wrap" licenses that are not signed by licensees and, therefore, may be unenforceable under the laws of certain jurisdictions. In addition, the laws of some foreign countries do not protect the Company's proprietary rights to the same extent as do the laws of the United States. There can be no assurance that such factors would not have a material adverse effect on the Company's business or operating results. The Company may from time to time be notified that it is infringing certain patent or intellectual property rights of others. Combinations of technology acquired through past or future acquisitions and the Company's technology will create new products and technology which may give rise to claims of infringement. While no actions other than the ones discussed below are currently pending against the Company for infringement of patent or other proprietary rights of third parties, there can be no assurance that third parties will not initiate infringement actions against the Company in the future. Infringement actions can result in substantial cost to and diversion of resources of the Company. If the Company were found to infringe upon the rights of others, no assurance can be given that licenses would be obtainable on acceptable terms or at all, that significant damages for past infringement would not be assessed or that further litigation relative to any such licenses or usage would not occur. The failure to successfully defend any claims or obtain necessary licenses or other rights, the ultimate disposition of any claims or the advent of litigation arising out of any claims of infringement, could have a material adverse effect on the Company's business, financial condition or results of operations. In October 1994, Wang filed a complaint in the United States District Court for the District of Massachusetts alleging that the Company is infringing five patents held by Wang. On June 23, 1995, Wang amended its complaint to include an additional related patent. On July 2, 1996, Wang filed a complaint in the same court alleging that Watermark is infringing three of the same patents asserted in the initial complaint. On October 9, 1996, Wang withdrew its claim that one of the patents it initially asserted is infringed by FileNet products which were commercialized before the initial complaint was filed. Wang reserved the right to assert that patent against FileNet products commercialized after that date in a separate lawsuit. Based on the 15 Company's analysis of these Wang patents and their respective file histories, the Company believes that it has meritorious defenses to Wang's claims; however, the ultimate outcome or any resulting potential loss cannot be determined at this time. If it should be determined that Wang's patents are valid and are infringed by any of the Company's products, including Watermark products, the Company will, depending on the product, redesign the infringing products or seek to obtain a license to market the products. There can be no assurance that the Company will be able to obtain such a license from Wang on acceptable terms. DEPENDENCE ON CERTAIN RELATIONSHIPS. The Company has entered into a number of co-marketing relationships with other companies such as Microsoft Corporation, Compaq Computer Corporation, SAP AG, Hewlett-Packard Company and Sun Microsystems, Inc. There can be no assurance that these companies will not reduce or discontinue their relationships with or support of the Company and its products. Disruption of these relationships could have a material adverse effect on the Company's business and operating results. DEPENDENCE ON KEY MANAGEMENT AND TECHNICAL PERSONNEL. The Company's success depends to a significant degree upon the continued contributions of its key management, marketing, technical and operational personnel, including members of senior management and technical personnel of acquired companies. The Company has no agreements providing for the employment of any of its key employees or any fixed term and the Company's key employees may voluntarily terminate their employment with the Company at any time. The loss of the services of one or more key employees, including key employees of acquired companies, could have a material adverse effect on the Company's operating results. The Company also believes its future success will depend in large part upon its ability to attract and retain additional highly skilled management, technical, marketing, product development and operational personnel. Competition for such personnel is intense, and there can be no assurance that the Company will be successful in attracting and retaining such personnel. INTERNATIONAL SALES. Historically, the Company has derived approximately one-third of its total revenues from international sales. International business is subject to certain risks including varying technical standards, tariffs and trade barriers, political and economic instability, reduced protection for intellectual property rights in certain countries, difficulties in staffing and maintaining foreign operations, difficulties in managing foreign distributors, potentially adverse tax consequences, currency exchange fluctuations, the burden of complying with a wide variety of complex operations, foreign laws, regulations and treaties and the possibility of difficulties in collecting accounts receivable. There can be no assurance that any of these factors will not have a material adverse effect on the Company's business or operating results. ACQUISITION-RELATED RISKS. The Company recently completed the acquisitions of Watermark, Saros and IFSL. These recent acquisitions by the Company have presented and will continue to present it with 16 numerous challenges, including difficulties in the assimilation of the operations, technologies and products of the acquired companies and managing separate geographic operations. The challenges have absorbed and may continue to absorb significant management attention that would otherwise be available for the ongoing development of the Company's business. If the Company's management does not respond to these challenges effectively, the Company's results of operations could be adversely affected. Moreover, there can be no assurance that the anticipated benefits of the acquisitions will be realized. FileNet and the acquired companies could experience difficulties or delays in integrating their respective technologies or developing and introducing new products. In particular, FileNet's interest in Saros is in part based on the Company's evaluation of the market potential for Saros' new products including the recently announced @mezzanine and Saros Document Server for BackOffice which have yet to be proven in the marketplace, as well as other products currently under development. Delays in or non-completion of the development of these new products, or lack of market acceptance of such products, could have an adverse impact on the Company's future results of operations and result in a failure to realize anticipated benefits of the acquisitions. PRODUCT LIABILITY. The Company's license agreements with customers typically contain provisions designed to limit their exposure to potential product liability claims. However, it is possible that such limitation of liability provisions may not be effective under the laws of certain jurisdictions. Although the Company has not experienced any product liability claims to date, the sale and support of products by them may entail the risk of such claims, and there can be no assurance that the Company will not be subject to such claims in the future. A successful product liability claim brought against the Company could have a material adverse effect upon the Company's business, operating results and financial condition. STOCK PRICE VOLATILITY. The Company believes that a variety of factors could cause the price of its common stock to fluctuate, perhaps substantially, including quarter to quarter variations in operating results; announcements of developments related to its business; fluctuations in its order levels; general conditions in the technology sector or the worldwide economy; announcements of technological innovations, new products or product enhancements by the Company or its competitors; key management changes; changes in joint marketing and development programs; developments relating to patents or other intellectual property rights or disputes; and developments in the Company's relationships with its customers, distributors and suppliers. In addition, in recent years the stock market in general, and the market for shares of high technology stocks in particular, has experienced extreme price fluctuations which have often been unrelated to the operating performance of affected companies. Such fluctuations could adversely affect the market price of the Company's Common Stock. 17 Item 6. Exhibits and Reports on Form 8-K 1. Exhibits The list of exhibits contained in the accompanying Index to Exhibits is herein incorporated by reference. 2. No reports on Form-8K were filed during the third quarter of fiscal 1996. 18 Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FILENET CORPORATION By:/s/ Mark S. St. Clare ------------------- Mark S. St. Clare Chief Financial Officer and Sr. Vice President, Finance (Principal Financial Officer) Date: November 13, 1996 19 Index to Exhibits Exhibit No. Description - ----------- ----------------------------------------------------------------- 4.1* Form of certificate evidencing Common Stock (filed as Exhibit 4.1 to the Form S-1, Registration No. 33-15004). 4.2* Rights Agreement, dated as of November 4, 1988 between FileNet Corporation and the First National Bank of Boston, which includes the form of Rights Certificate as Exhibit A and the Summary of Rights to Purchase Common Shares as Exhibit B (filed as Exhibit 4.2 to Form S-4 filed on January 26, 1996; Registration No. 333-00676). 10.1* Amended and Restated Credit Agreement (Multicurrency) by and among the Registrant and Bank of America National Trust and Savings Association dated August 8, 1995, effective May 1, 1995 (filed as Exhibit 10.1 to Form 10-Q for the quarter ended July 2, 1995). 10.2* Substitution Agreement between the Registrant and AT&T Technologies, Inc. dated October 23, 1984 (filed as Exhibit 10.9 to the Form S-1). 10.3* Sublicensing Agreement between the Registrant and AT&T Technologies, Inc. dated October 23, 1984 (filed as Exhibit 10.9 to the Form S-1). 10.4* Business Alliance Program Agreement between the Registrant and Oracle Corporation dated July 1, 1996, as amended by Amendment One thereto (filed as Exhibit 10.4 to Form 10-QA for the quarter ended June 30, 1996). 10.5* Runtime Sublicense Addendum between the Registrant and Oracle Corporation dated July 1, 1996, as amended by Amendment One thereto (filed as Exhibit 10.4 to Form 10-QA for the quarter ended June 30, 1996). 10.6* Full Use and Deployment Sublicense Addendum between the Registrant and Oracle Corporation dated July 1, 1996, as amended by Amendment One thereto (filed as Exhibit 10.4 to Form 10-QA for the quarter ended June 30, 1996). 10.7* Lease between the Registrant and C. J. Segerstrom & Sons for the headquarters of the Company, dated April 30, 1987 (filed as Exhibit 10.19 to the Form S-1). 10.8* 1989 Stock Option Plan for Non-Employee Directors of FileNet Corporation, as amended by the First Amendment, Second Amendment, Third Amendment thereto (filed as Exhibit 10.9 to Form S-4 filed on January 26, 1996; Registration No. 333-00676). 10.9* Amended and Restated 1995 Stock Option Plan of FileNet Corporation as approved by stockholders at the Registrant's Annual Meeting on May 8, 1996 (filed as Exhibit 99.1 to Form S-8 filed on July 29, 1996). 10.10* Second Amended and Restated Stock Option Plan of FileNet Corporation, together with the forms of Incentive Stock Option Agreement and Non-Qualified Stock Option Agreements (filed as Exhibits 4(a), 4(b) and 4(c), respectively, to the Registrant's registration statement on Form S-8, Registration No. 33-48499), and an Amendment thereto (filed as Exhibit 4(d) to the Registrant's registration statement on Form S-8, Registration No. 33-69920), and the Second Amendment thereto (filed as Appendix A to the Registrant's Proxy Statement for the Registrant's 1994 Annual Meeting of Stockholders, filed on April 29, 1994). 10.11* Agreement for the Purchase of IBM products dated December 20, 1991 (filed on May 5, 1992 with the Form 8 amending the Company's Form 10-K for the fiscal year ended December 31, 1991). 10.12* Software License Agreement between the Registrant and Mentat, Inc. dated December 11, 1991 (filed on May 5, 1992 with the Form 8 amending the Company's Form 10-K for the fiscal year ended December 31, 1991). 10.13* Development and Initial Supply Agreement between the Registrant and Quintar Company dated August 20, 1992 (filed as Exhibit 10.21 to Form 10-K for the year ended January 3, 1993). - -------------------------------------------------- * Incorporated herein by reference 20 Exhibit No. Description - ----------- ----------------------------------------------------------------- 10.14* Amendment dated December 22, 1992 to the Development and Initial Supply Agreement between the Registrant and Quintar Company dated August 20, 1992 (filed as Exhibit 10.22 to Form 10-K for the year ended January 3, 1993). 10.15* Memorandum of Agreement effective June 30, 1994 between the Registrant and Ing. C. Olivetti & C. S.p.A. (filed as Exhibit 10.24 to Form 10-Q for the quarter ended October 2, 1994). 10.16* Product License Agreement between the Registrant and Novell, Inc. dated May 16, 1995 (filed as Exhibit 10.26 to Form 10-Q for the quarter ended July 2, 1995). 10.17* Agreement and Plan of Merger between the Registrant and Watermark Software Inc. dated July 18, 1995 (filed as Exhibit 10.27 to Form 10-Q for the quarter ended July 2, 1995). 10.18* Agreement and Plan of Merger between the Registrant and Saros Corporation, as amended, dated January 17, 1996 (filed as Exhibits 2.1, 2.2, 2.3, and 2.4 to Form 8-K on March 13, 1996). 10.19* Stock Purchase Agreement by and Among FileNet Corporation, IFS Acquisition Corporation, Jawaid Khan and Juergen Goersch dated January 17, 1996 and Amendment 1 to Stock Purchase Agreement dated January 30, 1996 (filed as Exhibit 10.20 to form 10-K for the year ended December 31, 1995). 27. Financial Data Schedule. - ------------------------------------------------- * Incorporated herein by reference 21 EX-27 2 FINANCIAL DATA SCHEDULE
5 1,000 9-MOS Dec-31-1996 Sep-30-1996 22,820 25,623 71,863 0 8,128 140,321 78,147 51,168 182,207 55,229 0 0 0 120,148 (152) 182,207 196,363 196,363 34,490 72,116 128,962 0 0 (2,491) (3,385) (5,876) 0 0 0 (5,876) (0.39) (0.39)
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