-----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, Sjb0REKoXs7xdhLRvxVnoS8tnWlpE1xhtHPPax3ILuk2Pu8u+MEZ1ludU/QWw01o rKCMTVWcyGuqWp8MJQf6cw== 0000706015-00-000006.txt : 20000516 0000706015-00-000006.hdr.sgml : 20000516 ACCESSION NUMBER: 0000706015-00-000006 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20000331 FILED AS OF DATE: 20000515 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: SEC FILE NUMBER: 000-15997 FILM NUMBER: 632606 BUSINESS ADDRESS: STREET 1: 3565 HARBOR BLVD CITY: COSTA MESA STATE: CA ZIP: 92626 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 March 31, 2000 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 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip code) (714) 327-3400 - -------------------------------------------------------------------------------- (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 May 1, 2000, there were 34,222,977 shares of the Registrant's common stock outstanding. FILENET CORPORATION Index Page Number - -------------------- ------------------------------------------------ ---------- PART I. FINANCIAL INFORMATION Item 1. Consolidated Balance Sheets as of March 31, 2000 (unaudited) and December 31, 1999......... 3 Consolidated Statements of Operations (unaudited) for the three month periods ended March 31, 2000 and 1999....... 4 Consolidated Statements of Comprehensive Operations (unaudited) for the three month periods ended March 31, 2000 and 1999....... 5 Consolidated Statements of Cash Flows (unaudited) for the three month periods ended March 31, 2000 and 1999....... 6 Notes to Consolidated Financial Statements (unaudited).......... 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 PART I. FINANCIAL INFORMATION Item 1. Financial Statements FILENET CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands, except share amounts) March 31, December 31, 2000 1999 --------------- ------------ (Unaudited) ASSETS Current assets: Cash and cash equivalents $ 84,913 $ 71,528 Short-term investments 41,755 31,581 Accounts receivable, net 76,166 72,736 Inventories, net 2,605 3,399 Prepaid expenses and other current assets 8,165 8,080 Deferred income taxes 976 938 ------------ ------------ Total current assets 214,580 188,262 Property, net 39,499 40,593 Long-term investments 2,898 5,542 Deferred income taxes 4,757 4,752 Other assets 1,707 1,743 ------------ ------------ Total assets $ 263,441 $ 240,892 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Acounts payable $ 12,896 $ 16,642 Accrued compensation and benefits 22,447 24,079 Unearned maintenance revenue 21,987 16,286 Income taxes payable 8,287 7,808 Other accrued liabilities 21,384 21,670 ------------ ------------ Total current liabilities 87,001 86,485 Unearned maintenance revenue 6,555 3,949 Stockholders' equity: Preferred stock - $.10 par value; 7,000,000 shares authorized; none issued and outstanding Common stock - $.01 par value; 100,000,000 shares authorized; 35,130,962 and 33,578,642 shares outstanding at March 31, 2000 and December 31, 1999, respectively 164,440 149,779 Retained earnings 29,449 22,981 Accumulated other comprehensive operations (9,437) (7,735) ------------ ------------ 184,452 165,025 Treasury stock, at cost; 1,098,000 shares at March 31, 2000 and December 31, 1999, respectively (14,567) (14,567) ------------ ------------ Total stockholders' equity 169,885 150,458 ------------ ------------ Total liabilities and stockholders' equity $ 263,441 $ 240,892 ============ ============ See accompanying notes to consolidated financial statements. 3 FILENET CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) Three Months Ended March 31, ------------------------------------- 2000 1999 ----------------- ---------------- (Unaudited) (Unaudited) Revenue: Software $ 48,112 $ 41,984 Service 39,482 33,427 Hardware 5,208 6,031 ------------ ------------ Total revenue 92,002 81,442 Costs and expenses: Cost of software revenue 4,289 3,961 Cost of service revenue 23,105 20,304 Cost of hardware revenue 2,891 3,166 Research and development 14,138 13,102 Selling, general and administrative 40,946 39,445 ------------ ------------ Total costs and expenses 85,369 79,978 ------------ ------------ Operating income 7,423 1,464 Other income, net 1,192 1,461 ------------ ------------ Income before income taxes 8,625 2,925 Provision for income taxes 2,156 877 ------------ ------------ Net income $ 6,469 $ 2,048 ============ ============ Earnings per share: Basic $ 0.19 $ 0.06 Diluted $ 0.18 $ 0.06 Weighted average shares outstanding: Basic 33,344 31,915 Diluted 36,858 32,554 See accompanying notes to consolidated financial statements. 4 FILENET CORPORATION CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS (In thousands) Three Months Ended March 31, --------------------------------- 2000 1999 ---------------- -------------- (Unaudited) (Unaudited) Net income $ 6,469 $ 2,048 Other comprehensive income (loss): Foreign currency translation adjustments (net of tax benefit of $(1,130) and $(1,769) in 2000 and 1999, respectively (1,695) (2,653) Unrealized losses on securities: Unrealized holding losses arising during period (net of tax effect of $(5) and $(11) in 2000 and 1999, respectively (7) (16) ------------ -------------- Total other comprehensive loss (1,702) (2,669) ------------ -------------- Comprehensive income (loss) $ 4,767 $ (621) ============ ============== See accompanying notes to consolidated financial statements. 5 FILENET CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Three Months Ended March 31, ---------------------------------- 2000 1999 --------------- --------------- (Unaudited) (Unaudited) Cash flows from operating activities: Net income $ 6,469 $ 2,048 Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization 4,311 4,323 Provision for doubtful accounts 63 43 Deferred income taxes 43 15 Changes in operating assets and liabilities, net of acquisition: Accounts receivable (4,833) (492) Inventories 794 703 Prepaid expenses and other current assets (133) 911 Accounts payable (3,659) (8,039) Accrued compensation and benefits (1,457) (3,720) Unearned maintenance revenue 8,405 2,474 Income taxes payable 524 1,333 Other 1,037 6,835 --------------- ------------- Net cash provided by operating activities 11,564 6,434 --------------- ------------- Cash flows from investing activities: Capital expenditures (3,862) (4,220) Proceeds from sale of property 411 37 Purchases of marketable securities (13,028) (16,844) Proceeds from sales and maturities of marketable securities 4,300 5,500 --------------------------------- Net cash used in investing activities (12,179) (15,527) --------------------------------- Cash flows from financing activities: Proceeds from issuance of common stock 14,660 738 --------------- -------------- Net cash provided by financing activities 14,660 738 --------------- -------------- Effect of exchange rate changes on cash and cash equivalents (660) (1,246) --------------- -------------- Net increase (decrease) in cash and cash equivalents 13,385 (9,601) Cash and cash equivalents, beginning of year 71,528 55,820 --------------- -------------- Cash and cash equivalents, end of period $ 84,913 $ 46,219 =============== ============== Supplemental cash flow information: Interest paid $ 11 $ 6 Income taxes paid (refunded) $ 1,736 $ (438) See accompanying notes to consolidated financial statements.
6 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, 2000 and the results of its operations, its comprehensive operations and its cash flows for the three month periods ended March 31, 2000 and 1999. 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, 1999 filed by the Company with the SEC on March 30, 2000. 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, 2000.
Three Months ended March 31, (In thousands, except per share amounts) 2000 1999 ------------- -------------- Net Income $ 6,469 $ 2,048 ============= ============== Weighted average basic shares outstanding 33,344 31,915 Effect of dilutive stock options 3,514 639 ------------- -------------- Weighted average diluted shares outstanding 36,858 32,554 ============= ============== Basic earnings per share $ 0.19 $ 0.06 Diluted earnings per share $ 0.18 $ 0.06
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 was effective for the Company beginning January 1, 1998. Accordingly, the Company has prepared Statements of Comprehensive Operations for the three month period ended March 31, 2000. Accumulated other comprehensive operations as of March 31, 2000 is comprised of the following: Accumulated Foreign Currency Unrealized Other Translation Holding Comprehensive (In thousands) Adjustment Gains (Losses) Operations -------------- ----------------- -------------- Balance, December 31, 1999 $ (7,638) $ (97) $ (7,735) Current period changes (1,695) (7) (1,702) -------------- ----------------- -------------- Balance, March 31, 2000 $ (9,333) $ (104) $ (9,437) ============== ================= ============== 5. The Company has prepared operating segment information in accordance with SFAS 131, "Disclosures about Segments of an Enterprise and Related Information", to report components that are evaluated regularly by the Company's chief operating decision-maker, or decision making groups, in deciding how to allocate resources and in assessing performance. The operating segments are managed separately because each segment represents a strategic business unit that offers different products or services. The results of the segments reflect allocation of certain functional expense categories consistent with its internal reporting which is not the same as GAAP reporting. 7 Operating segments data for the three month periods ended March 31, 2000 and 1999 is as follows: Three Months Ended March 31, -------------------------------- In thousands 2000 1999 ------------- -------------- Software Revenue $ 48,112 $ 41,984 Loss before other income (280) (3,664) Customer Support Revenue $ 24,846 $ 19,893 Income before other income 7,262 4,377 Professional Services and education Revenue $ 13,402 $ 11,394 Income (loss) before other income (57) 64 Hardware Revenue $ 5,208 $ 6,031 Income before other income 407 522 Other Revenue $ 1,234 $ 2,140 Income before other income 101 165 Total Revenue $ 92,802 $ 81,442 Income before other income $ 7,433 $ 1,464 Included in software revenue is $13.4 million related to Web based product for the three months period ended March 31, 2000. 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 Software, Inc., 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. In March 1997, Eastman Kodak Company ("Kodak") purchased the Wang imaging business unit that has responsibility for this litigation. On July 30, 1997, the Court permitted Eastman and Kodak Limited of England to be substituted in the litigation in place of Wang. The Company has moved for summary judgment 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 the Company's unenforceability defense on one of the patents. In July 1998, the Magistrate Judge assigned to the case heard oral arguments on the Company's motion for summary judgment that U.S. Patent 4,918,588 is not infringed and is invalid. The Magistrate Judge has not yet decided these motions. The Company believes that after he has ruled on these motions, he will hear oral arguments in the remaining motions in the sequence in which they were filed. A trial date has not yet 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 successfully redesign the infringing products or obtain a license on acceptable terms. Based on the Company's analysis of these patents and their respective file histories, the Company believes that it has meritorious defenses to these claims; however, the ultimate outcome or any resulting potential loss cannot be determined at this time. 8 Subsequent to December 31, 1998, the former shareholders of Saros filed a demand for mandatory arbitration to release approximately two hundred thousand shares of FileNET stock which were held in escrow pursuant to the Agreement and Plan of Merger dated January 17, 1996, among FileNET Corporation, FileNET Acquisition Corporation, and Saros, and for damages. The Company and the Shareholders' Agent had agreed to mediate the matter, but the Saros Shareholders' Agent canceled the mediation prior to the scheduled date and renewed their demand for mandatory arbitration. The Company believes that it has meritorious reasons for not releasing the shares and other defenses to the claims; however, the ultimate or any resulting potential loss cannot be presently determined. In the normal course of business, the Company 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 material adverse effect on the Company's consolidated results of operations or financial condition. 9 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 Item 2 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 our Annual Report on Form 10-K for the fiscal year ended December 31, 1999. Results of Operations Revenue
Three Months Ended March 31, ----------------------------- (Dollars in millions) 2000 1999 Change ------------- ------------- ---------- Software revenue Domestic $ 31.9 $ 26.8 19% International 16.2 15.2 7% --------- ---------- Total software revenue $ 48.1 $ 42.0 15% --------- ---------- Percentage of total revenue 52% 52% Customer support revenue Domestic $ 19.2 $ 15.8 22% International 5.7 4.1 39% --------- ---------- Total customer support reven $ 24.9 $ 19.9 25% --------- ---------- Percentage of total revenue 27% 24% Professional Services and education revenue Domestic $ 10.3 $ 7.8 32% International 3.1 3.5 (11%) --------- ---------- Total professional services and education $ 13.4 $ 11.3 19% revenue --------- ---------- Percentage of total revenue 14% 14% Hardware revenue Domestic $ 4.3 $ 4.8 (10%) International 0.9 1.2 (25%) --------- ---------- Total hardware revenue $ 5.2 $ 6.0 (13%) --------- ---------- Percentage of total revenue 6% 7% Other revenue Domestic $ 1.1 $ 1.8 (39%) International 0.1 0.4 (75%) --------- ---------- Total other revenue $ 1.2 $ 2.2 (45%) --------- ---------- Percentage of total revenue 1% 3% Total revenue Domestic $ 66.8 $ 57.0 17% International 26.0 24.4 7% --------- ---------- Total revenue $ 92.8 $ 81.4 14% --------- ----------
Software revenue from the licensing of our software products increased 15% for the quarter ended March 31, 2000 over the comparable period of 1999 due to an increase in the volume of web content management product shipments both domestically and internationally. 10 Customer support revenue consists of revenue from maintenance contracts and "fee for service" revenues. Customer support revenue increased 25% for the quarter ended March 31, 2000 over the same period of 1999 attributable to increased maintenance revenue due to the growth of our installed licenses along with renewals from the existing customer base. Professional services and education revenue is generated primarily from consulting and implementation services provided to end users of our software products, technical consulting services provided to our resellers, and training services. Such services are primarily performed on a time and material basis. Professional services and education revenue increased 19% for the quarter ended March 31, 2000 over the same period of 1999 and is a result of our efforts to build our professional services capabilities to support our solution-oriented strategy as well as increased demand for our expanded services offerings. Hardware revenue is generated primarily from the sale of 12-inch optical storage and retrieval libraries (OSAR). Hardware revenue decreased by 13% for the quarter ended March 31, 2000 from the comparable period of 1999 due to expected decreases in new orders attributable to our continued focus on software-related revenues. Hardware revenue is expected to continue to decline as a percentage of total revenue. Other revenue is generated from the sale of spare parts, supplies and third party products. Other revenue decreased 45% for the quarter ended March 31, 2000 from the comparable period of 1999 with diminished demand for spares and expected decreased orders for third party product. International revenue represented 28% and 30% of total revenues in the quarter ended March 31, 2000 and 1999, respectively. Management expects that international operations will continue to account for a significant portion of total revenues. However, international revenues are subject to certain risks including but not limited to political and economic instability and currency fluctuation. Cost of Revenue
Three Months Ended March 31, ------------------------------------------ (Dollars in millions) 2000 1999 Change ------------- ------------- -------------- Cost of software revenue $ 4.3 $ 3.9 10% Percentage of software revenue 9% 9% Cost of customer support revenue $ 10.6 $ 8.9 19% Percentage of customer support revenue 43% 45% Cost of professional services and education revenue $ 11.5 $ 9.6 20% Percentage of professional services and education revenue 86% 85% Cost of hardware revenue $ 2.9 $ 3.2 (9%) Percentage of hardware and other revenue 56% 53% Cost of other revenue $ 1.0 $ 1.8 (44%) Percentage of other revenue 83% 82% Total cost of revenue $ 30.3 $ 27.4 11% Percentage of total revenue 33% 34%
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 remained constant at 9% for the quarters ended March 31, 2000 and 1999. The cost of customer support revenue includes customer support personnel, supplies, and the cost of third party hardware maintenance. The cost of customer support revenue as a percentage of customer support revenue for the quarter ended March 31, 2000 decreased to 43% from 45% in the same period of 1999. The decrease is attributable to increased revenue with no proportional increase in cost. The cost of professional services and education revenue consists primarily of professional services personnel, training personnel and third party contractors. The cost of professional services and education revenue as a percentage of professional services and education revenue for the quarter ended March 31, 2000 increased to 86% from 85% in the same period of 1999 due to the continued investment not completely offset by increased revenue. 11 The cost of hardware revenue includes the cost of manufacturing OSARs, and the cost of hardware integration personnel. The cost of hardware revenue as a percentage of hardware revenue for the quarter ended March 31, 2000 increased to 56% from 53% for the comparable period of 1999. The increase is due to lower revenue without a proportional decrease in manufacturing costs. The cost of other revenue includes the cost of supplies, spare parts and third party product. The cost of other revenue as a percentage of other revenue for the three months ended March 31, 2000 increased to 83% from 82% in the same period of 1999 due to the low margin nature of this business segment. Operating Expenses Three Months Ended March 31, ---------------------------------------- (Dollars in millions) 2000 1999 Change ------------- ------------ ----------- Research and development $ 14.1 $ 13.1 8% Percentage of total revenue 15% 16% Selling, general and administrative $ 41.0 $ 39.4 4% Percentage of total revenue 44% 48% Research and development expenses increased 8% for the first quarter of 2000 due to a general increase in compensation of technical personnel. As a percentage of total revenue, research and development expenses were at 15% for the three-month period ended March 31, 2000 as compared to 16% for the same period in 1999. We expect that competition for qualified technical personnel will remain intense for the foreseeable future and may result in higher levels of compensation expense. We believe that research and development expenditures, including compensation of technical personnel, are essential to maintaining our competitive position and expect these costs to continue to constitute a significant percentage of revenues. Selling, general and administrative expenses increased 4% for the first quarter of 2000. The increase was primarily due to overall increases in compensation partially offset by reduced spending in all other expense areas. As a percentage of total revenue, selling, general and administrative expenses decreased to 44% in the first quarter of 2000 from 48% in the same quarter of 1999 due to expense levels growing at a lower rate than revenue. Provision for Income Taxes. The combined federal, state and foreign annual effective tax rate for the quarter ended March 31, 2000 was 25% compared to 30% for the comparable period in 1999. The decrease in the rate is attributable to an increase in the taxable income generated in lower tax jurisdictions outside of North America along with the utilization of net operating loss carryforwards. Foreign Currency Fluctuations and Inflation. Our 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, 2000, we had forward exchange contracts outstanding totaling approximately $2.4 million in 9 currencies. All of these contracts mature in three months. Other comprehensive loss for the three months ended March 31, 2000 reflects an increase of $1.7 in the unrealized loss due to foreign currency translation. This increase was primarily attributable to unrealized losses associated with the weakening of the Euro currency against the U.S. dollar during the period. Management believes that inflation has not had a significant impact on the prices of its products, the cost of its materials, or its operating results for the three months ended March 31, 2000 and 1999. Other Financial Instruments. We enter into forward foreign exchange contracts as a hedge against the effects of fluctuating currency exchange rates on monetary assets and liabilities denominated in currencies other than the functional currency of the relevant entity. We are 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 contracts are major financial institutions. We use commercial rating agencies to evaluate the credit quality of the counterparties. We do not anticipate a material loss resulting from any credit risks related to any of these institutions. 12 Liquidity and Capital Resources At March 31, 2000, combined cash, cash equivalents and investments totaled $129.6 million, an increase of $20.9 million from the end of 1999. Cash provided by operating activities during the three months ended March 31, 2000 totaled $11.6 million and resulted primarily from net income; an increase in unearned maintenance revenue related to prepaid maintenance contracts; and additions to net income for depreciation and amortization expense offset by decreases in accounts payable and increases in accounts receivable. Cash used in investing activities totaled $12.2 million and was a result of capital expenditures and purchases of marketable securities offset by sales and maturities of marketable securities. Cash provided by financing activities totaled $14.7 million and was a result of proceeds received from the exercise of employee stock options. Accounts receivable increased to $76.2 million at March 31, 2000 from $72.7 million at December 31, 1999. Days sales outstanding increased to 75 days as of March 31, 2000 from 70 days as of December 31, 1999. Current liabilities increased to $87.0 million at March 31, 2000 from $86.5 million at December 31, 1999. The increase in current liabilities is primarily a result of increases in unearned maintenance revenue and income taxes payable, offset by decreases in accounts payable, and accrued compensation and benefits. We have a $20 million commercial line of credit that expires in June 2001. Borrowings under the arrangement are unsecured and bear interest at one hundred basis points over the London Interbank Offered Rate. A commitment fee of fifteen basis points is assessed against any undrawn amounts. As of March 31, 2000, there were no borrowings outstanding against the credit line. We anticipate that our present cash balances together with internally generated funds and credit lines will be sufficient to meet our working capital and capital expenditure needs for at least the next twelve months. Recent Accounting Pronouncements In March 1998, the American Institute of Certified Public Accountants issued SOP No. 98-1, "Accounting for Costs of Computer Software Developed or Obtained for Internal Use". We adopted SOP No. 98-1 effective January 1, 1999 with no significant effect on our results of operations and financial condition. In June 1998, the Financial Accounting Standards Board ("FASB") issued, SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS No. 133 as amended, is effective for fiscal years beginning after June 15, 2000 and will require us to record all derivatives on the balance sheet at fair value. For derivatives that are hedges, changes in the fair value of derivatives will be offset by the change in fair value of the hedged assets, liabilities, or firm commitments. We believe the impact of adopting this standard will not be material to our results of operations or equity. Other Matters Year 2000. In 1997, we implemented a year 2000 Integrity Program to ensure that our computer software products and internal business systems would function properly in year 2000 and thereafter. Since January 1, 2000 we have not experienced any problems with our software products or internal business systems to properly manage and manipulate data related to the year 2000. All new generations of our software products are released as year 2000 compliant. The EURO Conversion. On January 1, 1999, eleven of the fifteen member countries of the European Union established fixed conversion rates between their existing sovereign currencies and the EURO. These countries have agreed to adopt the EURO as their common legal currency from that date. The EURO trades on currency exchanges and is available for non-cash transactions. These countries will issue sovereign debt exclusively in EURO and will re-denominate outstanding sovereign debt. Effective on this date, these countries no longer control their own monetary policies by directing independent interest rates for the legacy currencies. Instead, the authority to direct monetary policy, including money supply and official interest rates for the EURO, is exercised by the new European Central Bank. The legacy currencies are scheduled to remain legal tender in these countries as a denomination of the EURO between January 1, 1999 and January 1, 2002 (the "transition period"). During the transition period, public and private parties may pay for goods and services using either the EURO or the country's legacy currency on a "no compulsion, no prohibition" basis. However, conversion rates 13 no longer will be computed directly from one legacy currency to another. Instead, a "triangulation" process will be applied whereby an amount denominated in one legacy currency first will be converted into an amount denominated in EURO, and the resultant EURO-denominated amount is converted into the second legacy currency. We have made the necessary changes to our internal business systems to support transactions denominated in the EURO, including establishing EURO price lists for effected countries. We have evaluated the impact the conversion to the EURO will have on our financial condition and results of operations. Based on this evaluation to date, we currently do not believe that there will be a material impact on our financial condition or results of operations as a result of the EURO conversion, except that we cannot currently assess the impact that a common EURO-based price list will have on how we market our products in Europe nor the impact, if any, on revenues generated in Europe. Environmental Matters. We are not aware of any issues related to environmental matters that have, or are expected to have, a material affect on our business. Factors That May Affect Future Results Our business, financial condition, operating results and prospects 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 our actual results to differ materially from recent results or from our anticipated future results. Rapid Technological Change; Product Development. The market for our software and services is characterized by rapid technological developments, evolving industry standards, changes in customer requirements and frequent new product introductions and enhancements. Our continued success will be dependent upon our ability to continue to enhance our existing software and services offerings, develop and introduce, in a timely manner, new software products incorporating technological advances and respond to customer requirements. There can be no assurance that we will be successful in developing and marketing new software products and services offerings or enhancements to our existing software on a timely basis or that any new or enhanced software and services offerings will adequately address the changing needs of the marketplace. If we are unable to develop and introduce new software and enhancements or new service offerings, in a timely manner in response to changing market conditions or customer requirements, our business and operating results could be adversely affected. From time to time, we or our competitors may announce new software products, capabilities or technologies that have the potential to replace or shorten the life cycles of our existing software products. There can be no assurance that announcements of currently planned or other new software products will not cause customers to delay their purchasing decisions in anticipation of such software products, which could have a material adverse effect on our business and operating results. Uncertainty of Future Operating Results; Fluctuations in Quarterly Operating Results. Prior growth rates in our 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 our products; the level of software product and price competition; the length of our sales cycle; variations in the productivity of our sales force; seasonality of individual customer buying patterns; the size and timing of individual transactions; the delay or deferral of customer implementations; the budget cycles of our customers; the timing of new software introductions and software enhancements by us and our competitors; the mix of sales by products, software, services and distribution channels; levels of international sales; acquisitions by competitors; changes in foreign currency exchange rates, impact of the EURO currency; our ability to develop and market new software 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, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. Moreover, such factors could cause our operating results in a given quarter to be below the expectations of public market analysts and investors. In either case, the price of our common stock could be materially adversely affected. Competition. The Web content management, integrated document management, imaging, workflow, computer output to laser disk and electronic document management software markets are highly competitive, and there are certain 14 competitors of ours with substantially greater sales, marketing, development and financial resources. We believe that the competitive factors affecting the market for our software products and services include vendor and product reputation; product quality, performance and price; the availability of software products on multiple platforms; product scalability; product integration with other enterprise applications; software functionality and features; software ease of use; and the quality of professional services, customer support services and training. The relative importance of each of these factors depends upon the specific customer involved. While we believe we compete favorably in each of these areas, there can be no assurance that we will continue to do so. Moreover, our present or future competitors may be able to develop software products comparable or superior to those offered by us, offer lower price products or adapt more quickly than we do to new technologies or evolving customer requirements. Competition is expected to intensify. In order to be successful in the future, we must respond to technological change, customer requirements and competitors' current software products and innovations. There can be no assurance that we will be able to continue to compete effectively in our market or that future competition will not have a material adverse effect on our business, financial condition or results of operations. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address the needs of the markets served by us. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. Increased competition may result in price reductions, reduced gross margins and loss of market share, any of which could have a material adverse effect on our business, financial condition or results of operations. Intellectual Property and other Proprietary Rights. Our success depends, in part, on our ability to protect our proprietary rights to the technologies used in our principal products. We rely on a combination of copyrights, trademarks, trade secrets, confidentiality procedures and contractual provisions to protect our proprietary rights in our software products. There can be no assurance that our existing or future copyrights, trademarks, trade secrets or other intellectual property rights will be of sufficient scope or strength to provide meaningful protection or a commercial advantage to us. We have no software patents. In addition, the laws of some foreign countries do not protect our 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 our business, financial condition or results of operations. In addition, we also rely on certain software that we license from third parties, including software that is integrated with internally developed software used in our products to perform key functions. There can be no assurance that such third parties will remain in business, that they will continue to support their software products, or that their software products will otherwise continue to be available to us on commercially reasonable terms. The loss or inability to maintain any of these software licenses could result in delays or reductions in software shipments until equivalent software can be developed, identified, licensed and integrated, which could adversely affect our business, financial condition or results of operations. We may, from time to time, be notified that we are infringing certain patent or intellectual property rights of others. Combinations of technology acquired through past or future acquisitions and our technology will create new software products and technology that may give rise to claims of infringement. While no actions other than those discussed in Item I, Note 7, herein, are currently pending against us 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 us in the future. Infringement actions can result in substantial cost to, and diversion of, resources. If we were found to infringe upon the rights of others, no assurance can be given that we could redesign the infringing products or could obtain licenses 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 redesign our products 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 our business, financial condition or results of operations. Dependence on Certain Relationships. We have entered into a number of key relationships with other companies such as Microsoft Corporation, IBM Global Services, Siebel Systems Inc, 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, us and our products. Dependence on Key Management and Technical Personnel. Our success depends to a significant degree upon the continued contributions of our key management, marketing, technical and operational personnel. In general, we do not utilize employment agreements for our key employees. The loss of the services of one or more key employees could have a material adverse effect on our operating results. We also believe our future success will depend in large part upon our ability to attract and retain additional highly skilled management, technical, 15 marketing, product development, operational personnel and consultants. Competition for such personnel, particularly software developers, professional service consultants and other technical personnel, is intense, and pay scales in the software industry have significantly increased. There can be no assurance that we will be successful in attracting and retaining such personnel. International Sales. Historically, we have derived approximately thirty percent of our 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; varying requirements for localized products; potentially adverse tax consequences; currency exchange fluctuations including those related to the EURO; the burden of complying with a wide variety of complex 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 our business, financial condition or results of operations. Product Liability. Software and products as complex as those sold by us are susceptible to errors or failures, especially when first introduced or when new versions are released. Our software products are often intended for use in applications that are critical to a customer's business. As a result, our customers may rely on the effective performance of the software to a greater extent than the market for software products generally. We conduct extensive software testing to ensure that our software is free of significant errors and defects. In addition, we have designed and tested the most current versions of our software products to be year 2000 compliant. However, some of our customers are running earlier software products that are not year 2000 compliant. Although we have been encouraging such customers to migrate to current software versions, no assurance can be given that all of them will do so. Moreover, we also rely on certain software that we license from third parties, including software that is integrated with internally developed software and is used in our products to perform key functions. There can be no assurance that such third party software will be free of errors and defects or be year 2000 compliant. Although we have not experienced any material product liability claims to date, there can be no assurance that errors or defects, whether associated with year 2000 functions or otherwise, will not result in product liability claims against us in the future. A successful product liability claim brought against us could have a material adverse effect upon our business, operating results and financial condition. Our license agreements with customers typically contain provisions designed to limit our 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. Stock Price Volatility. We believe that a variety of factors could cause the trading price of our common stock to fluctuate, perhaps substantially, including quarter-to-quarter variations in operating results; announcements of developments related to our business; fluctuations in our order levels; general conditions in the technology sector or the worldwide economy; announcements of technological innovations, new software products or product enhancements by us or our 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 our relationships with our customers, resellers and suppliers. In addition, in recent years the stock market in general, and the market for shares of high-technology stocks in particular, have experienced extreme price fluctuations that have often been unrelated to the operating performance of affected companies. Such fluctuations could adversely affect the trading price of our common stock. 16 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 2000. 17 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 15, 2000 By:______________/s/_______________________ - ------------- Date Lee D. Roberts, President and Chief Executive Officer (Principal Executive Officer) 18 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). 4.3* Amendment One dated July 31, 1998 and Amendment Two dated November 9, 1998 to Rights Agreements between FileNET Corporation and BANKBOSTON N.A. formerly known as The First National Bank of Boston (filed as Exhibit 4.3 to Form 10-Q for the quarter ended September 30, 1998). 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 30, 1999, effective June 30, 1999 (filed as Exhibit 10.1 to Form 10-Q for the quarter ended June 30, 1999). 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). 10.3.1* Runtime Sublicense Addendum between the Registrant and Oracle Corporation dated July 1, 1996; as amended by Amendments Two through Six thereto (filed as Exhibit 10.3.1 to Form 10-Q for the quarter ended September 30, 1998). 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 (filed as Exhibit 99.1 to Form S-8 filed on October 29, 1999; Registration No. 333-89983). - ---------------------------------------------- * Incorporated herein by reference 19 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). 10.18* 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 a nd 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). 10.21* Amended and Restated FileNET Corporation 1998 Employee Stock Purchase Plan (filed as Exhibit 99.15 to Form S-8, filed on October 29, 1999; Registration No. 333-89983). 10.22* FileNET Corporation International Employee Stock Purchase Plan. (filed as Exhibit 99.16 to Form S-8, filed on October 29, 1999; Registration No. 333-89983). 10.23* Lease between the Registrant and C. J. Segerstrom & Sons for the headquarters of the Company, dated September 1, 1999 (filed as Exhibit 10.23 to Form 10Q for the quarter ended September 30, 1999). 27 Financial Data Schedule. - ----------------------------------------------- * Incorporated herein by reference 20 EX-27 2 FINANCIAL DATA SCHEDULE
5 1000 3-MOS Dec-31-1998 Mar-31-1999 84,913 41,755 76,166 0 2,605 214,580 131,961 (92,462) 263,441 87,001 0 0 0 149,873 20,012 263,441 53,320 92,802 7,180 30,285 55,084 0 0 8,625 2,156 6,469 0 0 0 6,469 .19 .18
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