-----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, DjtzDK03KJrJK1ZU3J5Mz0UwJlGI/uvqt11H/oXb7pPEFlKkGK/ZzxAYBnYdAfUS fTj1mun2nA/au4hKsN7L1Q== 0000706015-97-000007.txt : 19970520 0000706015-97-000007.hdr.sgml : 19970520 ACCESSION NUMBER: 0000706015-97-000007 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19970331 FILED AS OF DATE: 19970515 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: 97606190 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 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________ to ____________ Commission File Number 0-15997 FILENET CORPORATION (Exact name of registrant as specified in its charter) 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 issuer's classes of common stock, as of the latest practicable date: Title Outstanding Common Stock 15,202,354 as of May 9, 1997 FILENET CORPORATION Index Page Number ------ PART I. FINANCIAL INFORMATION Item 1. Consolidated Balance Sheets as of March 31, 1997 and December 31, 1996...................... 1 Consolidated Statements of Operations for the quarters ended March 31, 1997 and 1996.................. 2 Consolidated Statements of Cash Flows for the quarters ended March 31, 1997 and 1996.................. 3 Notes to Consolidated Financial Statements...................... 4 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition......................................... 7 PART II. OTHER INFORMATION Item 1. Legal Proceedings............................................... 11 Item 5. Certain Considerations.......................................... 12 Item 6. Exhibits and Reports on Form 8-K................................ 15 SIGNATURE....................................................... 16 INDEX TO EXHIBITS............................................... 17 Part I. Financial Information Item 1. Financial Statements. FILENET CORPORATION Consolidated Balance Sheets (In thousands, except share amounts)
March 31, December 31, 1997 1996 --------- ------------ (Unaudited) ASSETS Current assets: Cash and cash equivalents..................... $ 29,308 $ 28,530 Short-term marketable securities.............. 28,610 22,037 ------ ------ Total cash and short-term marketable securities............................... 57,918 50,567 ------ ------ Accounts receivable, net...................... 43,941 75,469 Inventories................................... 7,819 8,794 Prepaid expenses and other.................... 7,409 8,336 Deferred income taxes......................... 6,016 5,641 ----- ----- Total current assets............................... 123,103 148,807 ------- ------- Net property and equipment......................... 28,583 28,329 Long-term marketable securities.................... 13,057 16,705 Other.............................................. 2,103 1,838 ----- ----- Total assets....................................... $166,846 $195,679 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.............................. $ 11,442 $ 16,752 Accrued liabilities: Compensation.............................. 8,796 10,728 Unearned maintenance revenue.............. 4,585 5,554 Royalties................................. 3,343 4,531 Other..................................... 13,315 21,903 ------ ------ Total current liabilities.......................... 41,481 59,468 ------ ------ Deferred income taxes.............................. 3,373 3,405 Stockholders' equity: Common stock - $.01 par value; authorized, 100,000,000 shares; issued and outstanding 15,330,306 and 15,230,566 shares at March 31, 1997 and December 31, 1996, respectively................................ 128,735 127,813 Retained earnings (accumulated deficit)....... (1,546) 7,874 Other......................................... (629) 1,687 ---- ----- 126,560 137,374 Less 200,000 Treasury shares at cost 4,568 4,568 ----- ----- Total stockholders' equity......................... 121,992 132,806 ------- ------- Total liabilities and stockholders' equity......... $166,846 $195,679 ======== ========
See notes to consolidated financial statements. 1 FILENET CORPORATION Consolidated Statements of Operations (In thousands, except per share amounts) (Unaudited)
Quarter Ended -------------------------------- March 31, 1997 March 31, 1996 -------------- -------------- Revenue: Software revenue.......................... $ 22,082 $ 37,118 Service revenue........................... 18,237 17,215 Hardware revenue.......................... 7,243 12,411 ----- ------ Total revenue.................................. 47,562 66,744 ------ ------ Costs and expenses: Cost of software revenue.................. 2,999 3,863 Cost of service revenue................... 13,131 11,450 Cost of hardware revenue.................. 5,329 8,219 Research and development.................. 10,140 8,422 Selling, general and administrative....... 29,766 30,027 Merger, restructuring and write-off of purchased in-process research and development costs........................ - 16,011 ------ ------ Total costs and expenses....................... 61,365 77,992 ------ ------ Operating loss................................. (13,803) (11,248) Other income, net.............................. 721 831 --- --- Loss before income taxes....................... (13,082) (10,417) Provision (benefit) for income taxes........... (3,662) 1,403 ------ ----- Net loss....................................... $ (9,420) $(11,820) ======== ======== Net loss per share............................. $ (0.63) $ (0.79) ======== ======== Weighted average common shares outstanding..... 15,045 14,882 ====== ======
See notes to consolidated financial statements. 2 FILENET CORPORATION Consolidated Statements Of Cash Flows (In thousands) (Unaudited)
Quarter Ended -------------------------------- March 31, 1997 March 31, 1996 -------------- -------------- Cash flows from operating activities: Net loss.................................. $ (9,420) $(11,820) Adjustments to reconcile net loss to net cash provided (used) by operating activities: Write-off of purchased in-process research and development costs....... - 10,011 Depreciation and amortization.......... 3,353 2,872 Provision for losses on accounts receivable........................... 23 110 Changes in operating assets and liabilities, net of acquisition: Accounts receivable.............. 30,090 (11,831) Inventories...................... 1,090 (843) Prepaid expenses................. 617 (1,079) Accounts payable................. (5,108) 184 Accrued liabilities: Compensation................. (1,863) (1,302) Unearned maintenance revenue. (954) 2,155 Royalties.................... (1,188) 24 Other............................ (8,436) 6,560 ------ ----- Net cash provided (used) by operating activities................................... 8,204 (4,959) ----- ------ Cash flows from investing activities: Proceeds from sale of equipment........... 70 2,848 Capital expenditures...................... (4,059) (4,856) Payment for purchase of IFSL.............. - (11,711) Purchase of marketable securities......... (14,215) (6,029) Proceeds from sales and maturity of marketable securities................... 11,260 12,317 ------ ------ Net cash used by investing activities.......... (6,944) (7,431) ------ ------ Cash flows from financing activities: Proceeds from issuance of common stock.... 922 2,456 Effect of exchange rate changes on cash and cash equivalents............................. (1,404) (92) ------ -- Net increase (decrease) in cash and cash equivalents.................................. 778 (10,026) Cash and cash equivalents, beginning of year... 28,530 43,378 ------ ------ Cash and cash equivalents, end of period....... $ 29,308 $ 33,352 ======== ======== Supplemental cash flow information: Interest paid............................. $ 38 $ 108 Income taxes paid......................... $ 718 $ 625
See 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 March 31, 1997 and the results of its operations and cash flows for the fiscal quarters ended March 31, 1997 and 1996. Certain information and footnote disclosures normally included in financial statements have been condensed or omitted pursuant to rules and regulations of the Securities and Exchange Commission ("SEC"), although the Company believes that the disclosures in the consolidated financial statements are adequate to ensure the information presented is not misleading. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto, and Management's Discussion and Analysis of Results of Operations and Financial Condition contained in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996, and with the Company's Current Report on Form 8-K, dated April 1, 1997, and filed by the Company with the SEC on April 1, 1997. The results of operations for the interim periods are not necessarily indicative of the operating results for the year. 2. Certain reclassifications have been made to the prior year's consolidated financial statements to conform with the current year's presentation. 3. Net loss per share was based upon the weighted average number of actual shares of common stock outstanding. 4. The $16.0 million merger, restructuring and write-off of purchased in-process research and development costs for the three months ended March 31, 1996, consisted of $10.0 million for the write-off of purchased in-process research and development costs related to the acquisition of International Financial Systems, Ltd. ("IFSL"), $4.2 million in merger costs related to the acquisition of Saros Corporation ("Saros"), and $1.8 million in restructuring costs related to the acquisitions of Saros and Watermark Software, Inc. ("Watermark"). 5. During April 1997 the Company announced a restructuring plan to reduce operating expenses by consolidating the Watermark business unit's Burlington, Massachusetts engineering and marketing functions with those at FileNet's Costa Mesa, California location as well as reduce headcount in certain other areas of the Company. In connection with this plan, the Company plans to record an estimated $6.0 million of restructuring and other charges during the second quarter ended June 30, 1997. The restructuring charge will consist primarily of severance costs, write-off of impaired assets, and facility closing costs. 6. During 1997, the Financial Accounting Standards Board issued Statement No. 128 (SFAS 128), "Earnings Per Share." Under SFAS 128, the Company will be required to disclose basic earnings per share and diluted earnings per share for all periods for which an income statement is presented, which will replace disclosure currently being made for primary earnings per share and fully diluted earnings per share. SFAS 128 requires adoption for fiscal periods ending after December 15, 1997. There is expected to be no impact on primary or fully diluted earnings per share for the three months ended March 31, 1997 and 1996. 4 7. In October 1994, Wang Laboratories, Inc. ("Wang") filed a complaint in the United States District Court for the District of Massachusetts alleging that the Company is infringing five patents held by Wang. On June 23, 1995, Wang amended its complaint to include an additional related patent. On July 2, 1996, Wang filed a complaint in the same court alleging that Watermark, formerly a wholly-owned subsidiary that was merged into the Company, is infringing three of the same patents asserted in the initial complaint. On October 9, 1996, Wang withdrew its claim that one of the patents it initially asserted is infringed by the Company's products which were commercialized before the initial complaint was filed. Wang reserved the right to assert that patent against the Company's products commercialized after that date in a separate lawsuit. Based on the Company's analysis of these Wang patents and their respective file histories, the Company believes that it has meritorious defenses to Wang's claims; however, the ultimate outcome or any resulting potential loss cannot be determined at this time. In March 1997, Eastman Kodak Company ("Kodak") purchased the Wang imaging business unit that has responsibility for this litigation. The patents in the suit have been transferred to a Kodak subsidiary, Kodak Limited of England, which in turn has exclusively licensed them to another Kodak subsidiary, Eastman Software, Inc. in the United States. The Company cannot predict what, if any, impact this will have on the litigation. If it should be determined that the patents at issue in the litigation are valid and are infringed by any of the Company's products, including Watermark products, the Company will, depending on the product, redesign the infringing products or seek to obtain a license to market the products. There can be no assurance that the Company will be able to obtain such a license on acceptable terms. On December 20, 1996, plaintiff Michael I. Goldman filed a class action complaint against the Company and certain of its officers and directors in the Superior Court of California, County of Orange (the "State Action"). The action was purportedly filed on behalf of a class of purchasers of the Company's common stock during the period October 19, 1995 through July 2, 1996. Plaintiff alleges that the Company and other defendants violated Cal. Corp. Code Sections 25400 and 25500, Cal. Civ. Code Sections 1709-1710 and Cal. Bus. & Prof. Code Sections 17200 et seq. in connection with various public statements made by the Company and certain of its officers and directors during the putative class period. The complaint seeks unspecified compensatory and punitive damages, interest, attorneys' fees, expert witness fees, costs, and equitable or injunctive relief. On April 1, 1997, plaintiff Michael I. Goldman filed another class action complaint against the Company and certain of its officers and directors in the United States District Court for the Central District of California (the "Federal Action"). The action purportedly was filed on behalf of the same class of purchasers of the Company's common stock as the State Action. The allegations contained in the Federal Action are very similar to the allegations contained in the State Action, except that the Federal Action asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act and Rule 10b-5. The complaint seeks unspecified compensatory damages, interest, attorneys' fees, expert witness fees, costs and equitable or injunctive relief. The Company has not yet responded to the complaint in the Federal Action. In the State Action, on April 14, 1997, the Company filed a motion to stay all proceedings in light of the filing of the Federal Action by the same plaintiff. This motion was denied without prejudice by the Court on May 13, 1997, and the case was assigned to the Complex Case Panel of Judges. On April 15, 1997, the Company filed a demurrer and motion to strike in the State Action which are scheduled to be heard by the Court on July 1, 1997, but may be delayed in light of the newly assigned judge. Discovery is proceeding in the State Action. 5 The Company believes that all of the allegations contained in the complaints filed in the State and Federal Actions are without merit and intends to defend the actions vigorously. The Company, in the normal course of business, is subject to various other legal matters. While the results of litigation and claims cannot be predicted with certainty, the Company believes that the final outcome of these other matters will not have a materially adverse effect on the Company's consolidated results of operations or financial condition. 6 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition FILENET CORPORATION The following should be read in conjunction with the unaudited consolidated financial statements and notes thereto included in Part I--Item 1 and Certain Considerations in Part II--Item 5 of this Quarterly Report, the audited consolidated financial statements, and notes thereto, and Management's Discussion and Analysis of Results of Operations and Financial Condition contained in the registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1996, and with the Company's Current Report on Form 8-K, dated April 1, 1997, and filed by the Company with the SEC on April 1, 1997. Results of Operations Revenue Domestic and international revenues decreased approximately 29% and 27%, respectively, in the first quarter of 1997, when compared to the corresponding period in 1996. International revenue constituted approximately 32% and 31% of total revenues in the first quarter of 1997 and 1996, respectively. Management expects that the Company's international operations will continue to provide a significant portion of total revenues; however, international revenues could be adversely affected if the U.S. dollar strengthens against international currencies.
(Dollars in millions) First Quarter First Quarter 1997 1996 % Change ------------- ------------- -------- Software revenue $22.1 $37.1 (40%) ................................................................................ Percentage of total revenue 46% 56% ................................................................................ Service revenue $18.3 $17.2 6% ................................................................................ Percentage of total revenue 39% 26% ................................................................................ Hardware revenue $ 7.2 $12.4 (42%) ................................................................................ Percentage of total revenue 15% 18% ................................................................................ Total revenue $47.6 $66.7 (29%) ................................................................................
Software revenue decreased 40% for the quarter ended March 31, 1997, compared to the same period of 1996. The decrease was due to a weakness in new orders experienced both domestically and internationally. Software revenue as a percentage of total revenue decreased to 46% for the quarter ended March 31, 1997, from 56% in the same quarter last year due to the decrease in software revenue cited above. Service revenue increased 6% for the quarter ended March 31, 1997, compared to the same period of 1996. Service revenue consists of revenue from software and hardware maintenance services provided to the Company's customers and other revenue that includes professional services, training, repairs and supplies. The increase was due to the growth of the Company's installed base and an increase in repairs of spare parts associated with the transition of hardware maintenance to HP and others. The increase was partially offset by a decrease in professional services revenue associated with lower software revenue. Service revenue as a percentage of total revenue increased to 39% for the quarter ended March 31, 1997, from 26% in the same quarter last year due to the current quarter decrease in software and hardware revenue cited herein. 7 Hardware revenue decreased by 42% for the quarter ended March 31, 1997, compared to the same period of 1996 due to similar reasons discussed above for software revenue. Additionally, hardware revenue for 1996 included a number of international sales with significant hardware content. Hardware revenue as a percent of total revenue declined due to the reasons cited above. The Company expects hardware revenue to continue to decrease as a percentage of revenue. Cost of Revenue.
(Dollars in millions) First Quarter First Quarter 1997 1996 % Change ------------- ------------- -------- Cost of software revenue $ 3.0 $ 3.9 (23%) ................................................................................ Percentage of software revenue 14% 11% ................................................................................ Cost of service revenue $13.1 $11.4 15% ................................................................................ Percentage of service revenue 72% 66% ................................................................................ Cost of hardware revenue $ 5.3 $ 8.2 (35%) ................................................................................ Percentage of hardware revenue 74% 66% ................................................................................ Total cost of revenue $21.4 $23.5 9% ................................................................................ Percentage of total revenue 45% 35% ................................................................................
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 increased to 14% for the quarter ended March 31, 1997, from 11% for same period of 1996 due to the decrease in software revenue without a corresponding decrease in fixed costs related to the Company's distribution activities. The cost of service revenue includes software support and professional services personnel, supplies, and the cost of third party hardware maintenance. The cost of service revenue as a percentage of service revenue increased to 72% for the quarter ended March 31, 1997, from 66% for the same period of 1996. The increase in 1997 was primarily due to lower margins experienced internationally. The cost of hardware revenue includes the Company's cost of OSAR manufacturing, third-party purchased hardware, and the cost of hardware integration personnel. The cost of hardware revenue as a percentage of hardware revenue increased to 74% for the quarter ended March 31, 1997, from 66% for the same period of 1996. The increase in 1997 was due to the decrease in hardware revenue without a corresponding decrease in fixed costs related to the Company's hardware integration activities and competitive pricing pressures associated with the hardware market. Operating Expenses.
(Dollars in millions) First Quarter First Quarter 1997 1996 % Change ------------- ------------- -------- Research and development $10.1 $ 8.4 20% ................................................................................ Percentage of total revenue 21% 13% ................................................................................ Selling, general and administrative $29.8 $30.0 (1%) ................................................................................ Percentage of total revenue 63% 45% ................................................................................
8 The Company's research and development expenses increased 20% in 1997 due to the addition of development personnel and related facilities, depreciation expense associated with new capital equipment additions, and a general increase in salaries due to increased demand and competition for engineers. As a percentage of total revenue, research and development expenses increased to 21% for the quarter ended March 31, 1997, from 13% for the same period of 1996 due to a combination of the factors cited above and the decrease in total revenue. Selling, general and administrative expenses as a percentage of total revenue increased to 63% for the quarter ended March 31, 1997, from 45% for the same period of 1996. The increase in 1997 is a consequence of the decrease in revenues cited above. MERGER, RESTRUCTURING AND WRITE-OFF OF PURCHASED IN-PROCESS RESEARCH AND DEVELOPMENT COSTS. The $16.0 million charge for merger, restructuring and write-off of purchased in-process research and development costs for the three months ended March 31, 1996, consisted of $10.0 million for the write-off of purchased in-process research and development costs related to the IFSL acquisition, $4.2 million in merger costs related to the Saros acquisition, and $1.8 million in restructuring costs related to the Saros and Watermark acquisitions. EFFECTIVE TAX RATE. The Company's combined federal, State and foreign annual effective tax rate for the quarter ended March 31, 1997, was 28% compared to 37% for the same period in 1996. The 1996 effective tax rate included non-deductible merger and other costs for the Saros and IFSL acquisitions. The effective tax rate for 1996, exclusive of the merger and other costs, was 25%. The higher effective tax rate in 1997 is attributable to earnings generated in certain foreign jurisdictions. NET LOSS. Net loss for the three months ended March 31, 1997, was $9.4 million or $0.63 per share on 15.0 million weighted average common shares outstanding compared to a net loss of $11.8 million or $0.79 per share on 14.9 million weighted average common shares outstanding for the same period of 1996. The same period of 1996 included after-tax charges for merger, restructuring and write-off of purchased in-process research and development costs of $16.0 million. Income for the three months ended March 31, 1996, before the one-time after-tax charges was $4.2 million or $0.25 per share on 16.6 million weighted average common and common equivalent shares outstanding. FOREIGN CURRENCY FLUCTUATIONS AND INFLATION. The Company's performance can be affected by changes in foreign currency values relative to the U.S. dollar as discussed above in relation to the Company's revenue and operating expenses. The net impact to net income from foreign exchange transactions and hedging activities are immaterial for all periods reported. Management believes that inflation has not had a significant impact on the prices of the Company's products, the cost of its materials, or its operating results for the quarters ended March 31, 1997, and 1996 RECENT EVENT. During April 1997, the Company announced a restructuring plan to reduce operating expenses by consolidating the Watermark business unit's Burlington, Massachusetts engineering and marketing functions with those at FileNet's Costa Mesa, California location as well as reduce headcount in certain other areas of the Company. In connection with this plan, the Company plans to record an estimated $6.0 million of restructuring and other charges during the second quarter ended June 30, 1997. The restructuring charge will consist primarily of severance costs, write-off of impaired assets, and facility closing costs. 9 Liquidity and Capital Resources As of March 31, 1997, combined cash, cash equivalents and short- and long-term marketable securities totaled $71.0 million, an increase of $3.7 million from $67.3 million at the end of 1996. The increase is primarily a result of cash generated by operating activities of $8.2 million, and to a lesser extent through the exercise of employee stock options of $.9 million. This increase was partially offset by capital expenditures of $4.1 million and net purchase of marketable securities of $3.0 million. Accounts receivable decreased to $43.9 million at March 31, 1997 from $75.5 million at December 31, 1996. Days sales outstanding decreased to 84 days as of March 31, 1997 compared to 95 days as of December 31, 1996. Current liabilities decreased to $41.5 million at March 31, 1997 from $59.5 million at December 31, 1996. The decrease is primarily a result of a decrease in accounts payable and lower accrued sales commissions, royalties and other expenses as a result of lower revenue. The Company has an unsecured line of credit of $20 million available from a commercial bank. This line of credit expires in 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 1997 pursuant to which the Company may borrow up to approximately $2 million. As of March 31, 1997, 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; however, the Company expects cash balances to decline during the year as a result of the net loss for the quarter ended March 31, 1997, and the expected restructuring charge during the second quarter of 1997. 10 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, formerly a wholly-owned subsidiary that was merged into the Company, is infringing three of the same patents asserted in the initial complaint. On October 9, 1996, Wang withdrew its claim that one of the patents it initially asserted is infringed by the Company's products which were commercialized before the initial complaint was filed. Wang reserved the right to assert that patent against the Company's products commercialized after that date in a separate lawsuit. Based on the Company's analysis of these Wang patents and their respective file histories, the Company believes that it has meritorious defenses to Wang's claims; however, the ultimate outcome or any resulting potential loss cannot be determined at this time. In March 1997, Kodak purchased the Wang imaging business unit that has responsibility for this litigation. The patents in the suit have been transferred to a Kodak subsidiary, Kodak Limited of England, which in turn has exclusively licensed them to another Kodak subsidiary, Eastman Software, Inc. in the United States. The Company cannot predict what, if any, impact this will have on the litigation. If it should be determined that the patents at issue in the litigation are valid and are infringed by any of the Company's products, including Watermark products, the Company will, depending on the product, redesign the infringing products or seek to obtain a license to market the products. There can be no assurance that the Company will be able to obtain such a license on acceptable terms. On December 20, 1996, plaintiff Michael I. Goldman filed a class action complaint against the Company and certain of its officers and directors in the Superior Court of California, County of Orange (the "State Action"). The action was purportedly filed on behalf of a class of purchasers of the Company's common stock during the period October 19, 1995 through July 2, 1996. Plaintiff alleges that the Company and other defendants violated Cal. Corp. Code Sections 25400 and 25500, Cal. Civ. Code Sections 1709-1710 and Cal. Bus. & Prof. Code Sections 17200 et seq. in connection with various public statements made by the Company and certain of its officers and directors during the putative class period. The complaint seeks unspecified compensatory and punitive damages, interest, attorneys' fees, expert witness fees, costs, and equitable or injunctive relief. On April 1, 1997, plaintiff Michael I. Goldman filed another class action complaint against the Company and certain of its officers and directors in the United States District Court for the Central District of California (the "Federal Action"). The action purportedly was filed on behalf of the same class of purchasers of the Company's common stock as the State Action. The allegations contained in the Federal Action are very similar to the allegations contained in the State Action, except that the Federal Action asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act and Rule 10b-5. The complaint seeks unspecified compensatory damages, interest, attorneys' fees, expert witness fees, costs and equitable or injunctive relief. The Company has not yet responded to the complaint in the Federal Action. In the State Action, on April 14, 1997, the Company filed a motion to stay all proceedings in light of the filing of the Federal Action by the same plaintiff. This motion was denied without prejudice by the Court on May 13, 1997, and the case was assigned to the Complex Case Panel of Judges. On April 15, 1997, the Company filed a demurrer and motion to strike in the State Action which are scheduled to be heard by the Court on July 1, 1997, but may be delayed in light of the newly assigned judge. Discovery is proceeding in the State Action. 11 The Company believes that all of the allegations contained in the complaints filed in the State and Federal Actions are without merit and intends to defend the actions vigorously. The Company, in the normal course of business, is subject to various other legal matters. While the results of litigation and claims cannot be predicted with certainty, the Company believes that the final outcome of these other matters will not have a materially adverse effect on the Company's consolidated results of operations or financial condition. Item 5. Certain Considerations. This quarterly report on form 10-Q contains forward-looking statements that involve risks and uncertainties, including those discussed below and in the Management's Discussion and Analysis of Results of Operations and Financial Condition section and Notes to Consolidated Financial Statements in the Company's Annual Report to Stockholders. The actual results that the Company achieves may differ materially from any forward-looking statements due to such risks and uncertainties. All such factors should be considered by investors in the Company. RAPID TECHNOLOGICAL CHANGE; PRODUCT DEVELOPMENT. The market for the Company's products is characterized by rapid technological developments, evolving industry standards, changes in customer requirements and frequent new product introductions and enhancements. The Company's continued success will be dependent upon its ability to continue to enhance its existing products, develop and introduce, in a timely manner, new products incorporating technological advances and respond to customer requirements. To the extent one or more of the Company's competitors introduce products that more fully address customer requirements, the Company's business could be adversely affected. There can be no assurance that the Company will be successful in developing and marketing enhancements to its existing products or new products on a timely basis or that any new or enhanced products will adequately address the changing needs of the marketplace. If the Company is unable to develop and introduce new products or enhancements to existing products in a timely manner in response to changing market conditions or customer requirements, the Company's business and operating results could be adversely affected. From time to time, the Company or its competitors may announce new products, capabilities or technologies that have the potential to replace or shorten the life cycles of the Company's existing products. There can be no assurance that announcements of currently planned or other new products will not cause customers to delay their purchasing decisions in anticipation of such products, which could have a material adverse effect on the Company's business and operating results. UNCERTAINTY OF FUTURE OPERATING RESULTS; FLUCTUATIONS IN QUARTERLY OPERATING RESULTS. Prior growth rates in the Company's revenue and operating results should not necessarily be considered indicative of future growth or operating results. Future operating results will depend upon many factors, including the demand for the Company's products, the effectiveness of the Company's efforts to continue to integrate various products it has developed or acquired through acquisition of others and to achieve the desired levels of sales from such product integration, the level of product and price competition, the length of the Company's sales cycle, seasonality of individual customer buying patterns, the size and timing of individual transactions, the delay or deferral of customer implementations, the budget cycles of the Company's customers, the timing of new product introductions and product enhancements by the Company and its competitors, the mix of sales by products, services and distribution channels, levels of international sales, acquisitions by competitors, changes in foreign currency exchange rates, the ability of the Company to develop and market new products and control costs, and general domestic and international economic and political conditions. As a result of these factors, revenues and operating results for any quarter are subject to variation and are not 12 predictable with any significant degree of accuracy. Therefore, the Company believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. Moreover, such factors could cause the Company's operating results in a given quarter to be below the expectations of public market analysts and investors. In either case, the price of the Company's common stock could be materially adversely affected. COMPETITION. The document imaging, workflow, COLD and document management software markets are highly competitive, and there are certain competitors of the Company with substantially greater sales, marketing, development and financial resources. The Company believes that the competitive factors affecting the market for its products and services include vendor and product reputation; product quality, performance and price; the availability of products on multiple platforms; product scalability; product integration with other enterprise applications; product functionality and features; product ease-of use; and the quality of customer support services and training. The relative importance of each of these factors depends upon the specific customer involved. While the Company believes it competes favorably in each of these areas, there can be no assurance that it will continue to do so. Moreover, the Company's present or future competitors may be able to develop products comparable or superior to those offered by the Company, offer lower price products or adapt more quickly than the Company to new technologies or evolving customer requirements. Competition is expected to intensify. In order to be successful in the future, the Company must respond to technological change, customer requirements and competitors' current products and innovations. There can be no assurance that it will be able to continue to compete effectively in its market or that future competition will not have a material adverse effect on its business, operating results and financial condition. INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS. The Company's success depends in part on its ability to protect its proprietary rights to the technologies used in its principal products. The Company relies on a combination of copyrights, trademarks, trade secrets, confidentiality procedures and contractual provisions to protect its proprietary rights. There can be no assurance that the Company's existing or future copyrights, trademarks, trade secrets or other intellectual property rights will be of sufficient scope or strength to provide meaningful protection or commercial advantage to the Company. FileNet has no software patents. Also, in selling certain of its products, the Company relies on "shrink wrap" licenses that are not signed by licensees and, therefore, may be unenforceable under the laws of certain jurisdictions. In addition, the laws of some foreign countries do not protect the Company's proprietary rights to the same extent as do the laws of the United States. There can be no assurance that such factors would not have a material adverse effect on the Company's business or operating results. The Company may from time to time be notified that it is infringing certain patent or intellectual property rights of others. Combinations of technology acquired through past or future acquisitions and the Company's technology will create new products and technology which may give rise to claims of infringement. While no actions other than the ones discussed below are currently pending against the Company for infringement of patent or other proprietary rights of third parties, there can be no assurance that third parties will not initiate infringement actions against the Company in the future. Infringement actions can result in substantial cost to and diversion of resources of the Company. If the Company were found to infringe upon the rights of others, no assurance can be given that licenses would be obtainable on acceptable terms or at all, that significant damages for past infringement would not be assessed or that further litigation relative to any such licenses or usage would not occur. The failure to successfully defend any claims or obtain necessary licenses or other rights, the ultimate disposition of any claims or the advent of litigation arising out of any claims of infringement, could have a material adverse effect on the Company's business, financial condition or results of operations. 13 In October 1994, Wang filed a complaint in the United States District Court for the District of Massachusetts alleging that the Company is infringing five patents held by Wang. On June 23, 1995, Wang amended its complaint to include an additional related patent. On July 2, 1996, Wang filed a complaint in the same court alleging that Watermark, formerly a wholly-owned subsidiary that was merged into the Company, is infringing three of the same patents asserted in the initial complaint. On October 9, 1996, Wang withdrew its claim that one of the patents it initially asserted is infringed by the Company's products which were commercialized before the initial complaint was filed. Wang reserved the right to assert that patent against the Company's products commercialized after that date in a separate lawsuit. Based on the Company's analysis of these Wang patents and their respective file histories, the Company believes that it has meritorious defenses to Wang's claims; however, the ultimate outcome or any resulting potential loss cannot be determined at this time. In March 1997, Kodak purchased the Wang imaging business unit that has responsibility for this litigation. The patents in the suit have been transferred to a Kodak subsidiary, Kodak Limited of England, which in turn has exclusively licensed them to another Kodak subsidiary, Eastman Software, Inc. in the United States. The Company cannot predict what, if any, impact this will have on the litigation. If it should be determined that the patents at issue in the litigation are valid and are infringed by any of the Company's products, including Watermark products, the Company will, depending on the product, redesign the infringing products or seek to obtain a license to market the products. There can be no assurance that the Company will be able to obtain such a license on acceptable terms. DEPENDENCE ON CERTAIN RELATIONSHIPS. The Company has entered into a number of co-marketing relationships with other companies such as Microsoft Corporation, Compaq Computer Corporation, SAP AG, HP and Sun Microsystems, Inc. There can be no assurance that these companies will not reduce or discontinue their relationships with or support of the Company and its products. Disruption of these relationships could have a material adverse effect on the Company's business and operating results. DEPENDENCE ON KEY MANAGEMENT AND TECHNICAL PERSONNEL. The Company's success depends to a significant degree upon the continued contributions of its key management, marketing, technical and operational personnel, including members of senior management and technical personnel of acquired companies. The Company has no agreements providing for the employment of any of its key employees or any fixed term contracts and the Company's key employees may voluntarily terminate their employment with the Company at any time. The loss of the services of one or more key employees 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. 14 ACQUISITION-RELATED RISKS. The acquisitions of Watermark, Saros and IFSL have presented and will continue to present the Company with numerous challenges, including difficulties in the assimilation of the operations, technologies and products of the acquired companies and managing separate geographic operations. The challenges have absorbed and may continue to absorb significant management attention that would otherwise be available for the ongoing development of the Company's business. If the Company's management does not respond to these challenges effectively, the Company's results of operations could be adversely affected. Moreover, there can be no assurance that the anticipated benefits of the acquisitions will be realized. The Company and the acquired companies could experience difficulties or delays in integrating their respective technologies or developing and introducing new products. In particular, one of the reasons for FileNet's acquisition of Saros was the perceived market potential for Saros' new products, including the recently announced @mezzanine and Saros Document Server for BackOffice, which have yet to be proven in the marketplace, as well as other products currently under development. Delays in or non-completion of the development of these new products, or lack of market acceptance of such products, could have an adverse impact on the Company's future results of operations and result in a failure to realize anticipated benefits of the acquisitions. PRODUCT LIABILITY. The Company's license agreements with customers typically contain provisions designed to limit their exposure to potential product liability claims. However, it is possible that such limitation of liability provisions may not be effective under the laws of certain jurisdictions. Although the Company has not experienced any product liability claims to date, the sale and support of products by them may entail the risk of such claims, and there can be no assurance that the Company will not be subject to such claims in the future. A successful product liability claim brought against the Company could have a material adverse effect upon the Company's business, operating results and financial condition. STOCK PRICE VOLATILITY. The Company believes that a variety of factors could cause the price of its common stock to fluctuate, perhaps substantially, including quarter-to-quarter variations in operating results; announcements of developments related to its business; fluctuations in its order levels; general conditions in the technology sector or the worldwide economy; announcements of technological innovations, new products or product enhancements by the Company or its competitors; key management changes; changes in joint marketing and development programs; developments relating to patents or other intellectual property rights or disputes; and developments in the Company's relationships with its customers, distributors and suppliers. In addition, in recent years the stock market in general, and the market for shares of high technology stocks in particular, has experienced extreme price fluctuations which have often been unrelated to the operating performance of affected companies. Such fluctuations could adversely affect the market price of the Company's common stock. 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-8K were filed during the first quarter of fiscal 1997. 15 FILENET CORPORATION Signature Pursuant to the requirement 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: May 14, 1997 16 Index to Exhibits Exhibit No. Description - ------- ---------------------------------------------------------------------- 3.1* Restated Certificate of Incorporation, as amended (filed as Exhibit 3.1 to Form S-4 filed on January 26, 1996; Registration No. 333-00676). 3.1.1* Certificate of Amendment of Restated Certificate of Incorporation (filed as Exhibit 3.1.1 to Form S-4 filed on January 26, 1996, Registration No. 333-00676). 3.2* Bylaws (filed as Exhibit 3.2 of the Registrant's registration statement on Form S-1, Registration No. 33-15004 (the "Form S-1")). 4.1* Form of certificate evidencing Common Stock (filed as Exhibit 4.1 to the Form S-1, Registration No. 33-15004). 4.2* Rights Agreement, dated as of November 4, 1988 between FileNet Corporation and the First National Bank of Boston, which includes the form of Rights Certificate as Exhibit A and the Summary of Rights to Purchase Common Shares as Exhibit B (filed as Exhibit 4.2 to Form S-4 filed on January 26, 1996; Registration No. 333-00676). 10.1* Amended and Restated Credit Agreement (Multicurrency) by and among the Registrant and Bank of America National Trust and Savings Association dated August 8, 1995, effective May 1, 1995 (filed as Exhibit 10.1 to Form 10-Q for the quarter ended July 2, 1995). 10.2* Waiver and Second Amendment dated December 18, 1996, to the Amended and Restated Credit Agreement (Multicurrency) by and among the Registrant and Bank of America National Trust and Savings Association dated August 8, 1995 (filed as exhibit 10.2 to Form 10-K filed on April 4, 1997). 10.3* Business Alliance Program Agreement between the Registrant and Oracle Corporation dated July 1, 1996, as amended by Amendment One thereto (filed as Exhibit 10.4 to Form 10-QA for the quarter ended June 30, 1996). 10.4* Runtime Sublicense Addendum between the Registrant and Oracle Corporation dated July 1, 1996, as amended by Amendment One thereto (filed as Exhibit 10.4 to Form 10-QA for the quarter ended June 30, 1996). 10.5* Full Use and Deployment Sublicense Addendum between the Registrant and Oracle Corporation dated July 1, 1996, as amended by Amendment One thereto (filed as Exhibit 10.4 to Form 10-QA for the quarter ended June 30, 1996). 10.6* Lease between the Registrant and C. J. Segerstrom & Sons for the headquarters of the Company, dated April 30, 1987 (filed as Exhibit 10.19 to the Form S-1). 10.7* Third Amendment to the Lease between the Registrant and C. J. Segerstrom & Sons dated April 30, 1987, for additional facilities at the headquarters of the Company, dated October 1, 1992 (filed as exhibit 10.7 to Form 10-K filed on April 4, 1997). 10.8 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. 10.9* 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). 10.10* Amended and Restated 1995 Stock Option Plan of FileNet Corporation as approved by stockholders at the Registrant's Annual Meeting on May 8, 1996 (filed as Exhibit 99.1 to Form S-8 filed on July 29, 1996). - -------------------------------------------- * Incorporated herein by reference 17 Exhibit No. Description - ------- ---------------------------------------------------------------------- 10.11* 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). 10.12* 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). 10.13* Amendment #A1011-941003-01 dated September 30, 1994, to the Agreement for the Purchase of IBM products dated December 20, 1991(filed as exhibit 10.12 to Form 10-K filed on April 4, 1997). 10.14* Development and Initial Supply Agreement between the Registrant and Quintar Company dated August 20, 1992 (filed as Exhibit 10.21 to Form 10-K for the year ended January 3, 1993). 10.15* 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). 10.16* 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 10.2 to form 10-K for the year ended December 31, 1995). 27 Financial Data Schedule - --------------------------------------------- * Incorporated herein by reference 18 EX-10.8 2 AMENDMENT TO LEASE FIFTH AMENDMENT TO LEASE THIS FIFTH AMENDMENT TO LEASE (the "Amendment") is made and entered into as of the 28th day of March, 1997 by and between C. J. SEGERSTROM & SONS, a California general partnership ("Landlord"), and FILENET CORPORATION, a California corporation ("Tenant"), with respect to the following: RECITALS A. Landlord is the landlord and Tenant is the tenant pursuant to a certain High Technology/Research and Development Lease dated July 23, 1986 (the "Original Lease"). The Original Lease has been modified or supplemented by the following instruments: (1) Letter dated July 23, 1986 (the "First Letter"); (2) Option agreement dated July 23, 1986 (the "Option Agreement"); (3) Letter agreement dated June 23, 1987 (the. "Second Letter"); (4) Letter agreement dated July 2, 1987 (the "Third Letter"); (5) Letter agreement dated March 15, 1988 (the "Fourth Letter"); (6) Letter agreement dated May 23, 1988 (the "Fifth Letter"); (7) Third amendment to lease dated October 1, 1992 (the "Third Amendment"); and (8) Fourth Amendment to lease dated December 1, 1992 (the "Fourth Amendment"). The Original Lease, First through Fifth Letters, Third Amendment and Fourth Amendment are herein, collectively, referred to as the "Lease." B. Pursuant to the Lease, Tenant holds and occupies four complete buildings located at Harbor Gateway Business Center, in Costa Mesa, California (the "Center"), which four buildings (each a "Building" herein) are more particularly described as follows: (1) "Building 1" - 3565 Harbor Boulevard, consisting of approximately 60,000 square feet of Rentable Area; (2) "Building 2" - 1540 Scenic Avenue, consisting of approximately 60,000 square feet of Rentable Area; (3) "Building 3" - 1550 Scenic Avenue, consisting of approximately 50,000 square feet of Rentable Area; and (4) "Building 14" - 1535 Scenic Avenue, consisting of approximately 60,000 square feet of Rentable Area. C. The term of the Lease as to Building 1 and Building 2 expires during 1998. Tenant has options to extend the Lease as to each such Building. Landlord and Tenant desire to enter into this Amendment to reflect the exercise of such options as to Building 1 and Building 2 and to modify and set forth the terms and provisions upon which Tenant shall continue to hold and occupy Building 1 and Building 2. AGREEMENT IN CONSIDERATION OF the foregoing recitals and the mutual covenants set forth herein, Landlord and Tenant agree as follows: 1. Extension of Term. (a) The current term of the Lease as to Building 1 expires on April 30, 1998. Tenant has exercised its option to extend as to such Building, and such term shall be extended for the period from May 1, 1998 through April 30, 2003 (the "Building 1 Extended Term"). (b) The term of the Lease as to Building 2 expires on January 31, 1998. Tenant has exercised its option to extend as to such Building, and such term shall be extended for the period from February 1, 1998 through April 30, 2003 (the "Building 2 Extended Term"). (c) The term of the Lease as to Building 3 and Building 14. expires on May 31, 2000 and shall not be affected by this Amendment. (d) Tenant has the option to extend the term of the Lease for an additional five (5) years with respect to each of the Buildings 3 and 14. Such option shall remain as currently written in the Lease with respect to Building 3 and Building 14 (i.e., five (5) years from and after June 1, 2000). With respect to Building 1 and Building 2, the option terms resulting from Tenant's exercise as of its options shall be as set forth in this Amendment. 2 Rent. (a) During the current term of the Lease as to Buildings 1, 2, 3 and 14, Tenant shall continue to pay Basic Annual Rent at the rates provided for or determined pursuant to the Lease as to each such Building and shall pay all additional rent provided for in the Lease with respect to each such Building. 2 (b) During the Building 1 Extended Term and the Building 2 Extended Term, Basic Annual Rent for each Building shall be as follows: (i) For the period from the commencement date of each Extended Term through the end of the thirtieth (30th) month of each Extended Term, Basic Annual Rent shall be at the rate of $1.10 per square foot of Rentable Area of each Building. (ii) Effective at the commencement of the thirty-first (31st) month of the Building 1 Extended Term and the commencement of the thirty-first (31st) month of the Building 2 Extended Term, Basic Annual Rent for the relevant Building (i.e., Building 1 or Building 2) shall be increased in the manner provided in Section 3.4 of the Original Lease. For the purpose of the increases provided for in this clause (ii), the following shall pertain: (A) The "Index" for purposes of such adjustments shall be the "Consumer Price Index of Urban Wage Earners and Clerical Workers (Revised Series), Los Angeles-Anaheim-Riverside Average (1982-1984=100), subgroup all items." (B) The Index published as of the calendar month immediately preceding the commencement date of the relevant Extended Term shall be considered the "Base." (C) In no event shall the Basic Annual Rent for either Building after such adjustment exceed one hundred ten percent (110%) of the Basic Annual Rent immediately prior to such adjustment, and in no event shall there be any decrease in the Basic Annual Rent for either Building. In addition, during the Building 1 Extended Term and the Building 2 Extended Term, Tenant shall pay all additional rent provided for in the Lease with respect to each of Building 1 and Building 2. (c) Subject to the provisions of paragraph 4 below, Tenant shall receive monthly abatements or credits with respect to Basic Annual Rent for the months of June and November, 1997 and June and November, 1998. Each such monthly credit or abatement shall be in the amount of $93,750. Such credits shall be applied by simply reducing the aggregate Basic Annual Rent payable by Tenant for such months with respect to all four Buildings pursuant to the Lease. 3 Parking. Currently, Tenant has the right, under the Lease, to the non-exclusive use of the following numbers of Allocated Parking Spaces at the Center with respect to each Building: Building 1 212 spaces Building 2 172 spaces Building 3 200 spaces Building 14 240 spaces 3 Such Allocated Parking Spaces are on a non-exclusive basis in the Parking Areas of the Center Effective upon the effective date of this Amendment, as provided in paragraph 9 below, Tenant shall have the right to use, on a non-exclusive basis, an additional 76 Allocated Parking Spaces (the "New Allocated Spaces"). The New Allocated Spaces shall be located in that portion of the Parking Areas of the Center indicated by hatching on Exhibit "A" attached hereto. For the purposes of this paragraph, it is understood and agreed that: (a) The New Allocated Spaces shall be allocated 18 spaces to Building 1 (for a total of 230 Allocated Parking Spaces) and 58 spaces to Building 2 (for a total of 230 Allocated Parking Spaces). (b) The New Allocated Spaces are, like the balance of the Allocated Parking Spaces with respect to the Buildings, only the right to use, in common with other tenants of the Center, a specified number of parking spaces and do not give to Tenant the exclusive right to use any particular parking spaces in the Center. (c) The provisions of this paragraph shall supplement paragraph 44.1 of the Original Lease, as previously amended, and shall supersede and replace all inconsistent prior iterations thereof. 4. Permanent Improvements by Tenant. In consideration for the Basic Annual Rent abatement provided for in paragraph 2(c) above, Tenant covenants to spend, prior to the expiration of the Extended Terms as to Building 1 and Building 2, not less than $375,000 on permanent improvements to Building 1 and Building 2 (Tenant's Improvement Work"). In connection with Tenant's Improvement Work, Landlord and Tenant agree that: (a) "Permanent improvements" shall mean work which is permanently attached to the structure, shell or interior components of Building 1 and/or Building 2, and includes permanent decorative improvements such as paint, wall coverings, floor tile and ceilings. Permanent improvements shall not include furniture, furnishings and removable fixtures and equipment. (b) Tenant's Improvement Work shall be allocated between Building 1 and Building 2 (or performed all in one Building) as selected by Tenant, and there is no minimum amount which Tenant is required to spend for permanent improvements as to either such Building. (c) Tenant's Improvement Work shall be in accordance with Article 9 of the Original Lease, including the requirement to obtain Landlord's prior written consent with respect thereto as and when required by such Article 9. (d) Promptly upon completion of Tenant's Improvement Work, or any portion thereof with a cost of $l0,000 or more, Tenant shall furnish to Landlord copies of paid invoices, paid statements or other documentary evidence reasonably satisfactory to Landlord evidencing the amount spent by Tenant and that such amount reflects the cost of permanent improvements to 4 Building 1 and/or Building 2. In addition, upon completion of any Tenant's Improvement Work which changes the physical layout of Building 1 and/or Building 2, Tenant shall deliver to Landlord a copy of "as built" plans and specifications with respect to such Tenant's Improvement Work. (e) If Tenant fails to spend the amount required by this paragraph for permanent improvements and/or to furnish documentary evidence thereof to Landlord pursuant to subparagraph (d) above by the expiration of the Building 1 Extended Term, Tenant shall pay to Landlord, as additional rent pursuant to the Lease, an amount equal to (a) $375,000 less (b) the aggregate cost of Tenant's Improvement Work actually performed by Tenant with respect to Building 1 and/or Building 2 as to which Tenant has furnished to Landlord the documentary evidence required by subparagraph (d) above. Such payment ("Tenant's Reimbursement") shall be due and payable in full within ten (10) days after the expiration of the Building 1 Extended Term, and failure of Tenant to pay Tenant's Reimbursement in full within such period shall entitle Landlord to exercise all remedies available to a landlord against a tenant pursuant to a written lease for non-payment of rent, including but not limited to those set forth in Article 20 of the Original Lease. 5. Other Terms and Conditions. During the Building 1 Extended Term and the Building 2 Extended Term, Tenant shall hold and occupy Building 1 and Building 2 upon all of the terms and conditions of the Lease, except that: (a) Basic Lease Provisions 5, 6 and 13, Sections 2.1, 2.2, 2.3, 2.4, 3.5, Articles 32 and 41 and Sections 47.9, 48.1 and Exhibit "D" to the Original Lease shall have no application to Building 1 and Building 2 during the Building 1 Extended Term and the Building 2 Extended Term. (b) Those provisions of the Lease which are superseded by or inconsistent with the provisions of this Amendment shall not apply to Building 1 or Building 2 during the Building 1 Extended Term and the Building 2 Extended Term. In the event of any inconsistency between the provisions of the Lease and the provisions of this Amendment, the provisions of this Amendment shall control with respect to Building 1 and Building 2 during the Building 1 Extended Term and the Building 2 Extended Term. 6. First Offer Rights. During the term of the Lease, including the Building 1 Extended Term and the Building 2 Extended Term, Tenant shall have a right of first offer with respect to each of the following buildings at the Center: (A) Hr-B: 70,000 square feet of Rentable Area and currently occupied by Q-Logic ("HT-B"); (B) Hr-A: 54,910 square feet of Rentable Area and currently occupied by Emulex ("HT-A") (C) HT-15: 82,106 square feet of Rentable Area and currently occupied by PacifiCare ("HT-15"). 5 HT-B, HT-A and HT-15 are each herein referred to as a "First Offer Building" and are collectively referred to as the "First Offer Buildings." Such right of first offer shall be on the following terms and conditions: (a) If a First Offer Building becomes available for lease, as defined below, Landlord shall in writing notify Tenant of such availability and of the terms upon which Landlord is prepared to lease such First Offer Building to Tenant or a third party. Such written notice shall contain the information set forth in subparagraph (b) below. As used herein, the term "available for lease" means that the current lease for such First Offer Building expires without an agreed extension or renewal or is terminated by court order or mutual agreement. A First Offer Building shall not be deemed to be "available for lease" upon expiration of the existing lease term with respect thereto if the tenant of such building continues in occupancy pursuant to an option set forth in such lease or an agreed extension or renewal of the existing lease term. (b) The notice to be provided by Landlord to Tenant as to a First Offer Building which becomes available for lease during the term of the Lease shall: (i) Identify the First Offer Building; (ii) Specify the approximate date upon which such First Offer Building became or will become available for lease; (iii) Set forth the rent and term for which or on which Landlord proposes to offer such First Offer Building for lease, the Allocated Parking Spaces with respect to such First Offer Building with an identification of any such Allocated Parking Spaces, if any, which are for the exclusive use of the Tenant of the First Offer Building and whether such First Offer Building is offered "AS IS" or with any renovation work or tenant allowance by Landlord; and (iv) Set forth any other business terms which are specific to Landlord's proposed leasing of such First Offer Building. (c) Tenant may accept Landlord's offer to lease a particular First Offer Building only by unequivocal written notice of acceptance delivered to Landlord within ten (10) business days after Tenant's receipt of Landlord's written notice of availability and leasing terms as to such First Offer Building. To be effective, such notice must be delivered within such ten (10) business day period and shall not after, amend or supplement any of the terms set forth in Landlord's offer notice. (d) If Tenant timely and properly accepts Landlord's offer as to a First Offer Building in the manner provided in subparagraph (c) above, Landlord shall promptly prepare and Landlord and Tenant shall execute and deliver an amendment to the Lease adding such First Offer Building to the Premises pursuant to the Lease. Tenant shall hold and occupy such First Offer Building upon the terms set forth in Landlord's offer notice and upon those provisions of the Lease which are not inconsistent with the terms set forth in Landlord's offer notice. 6 (e) If Tenant fails to timely and properly accept Landlord's offer as to a particular First Offer Building, Tenant shall have no further rights with respect to such First Offer Building, and Landlord shall be free to offer such First Offer Building to third parties on the terms set forth in Landlord's offer notice and to enter into a lease of such building upon such terms as are agreed by Landlord and any third party. Neither failure of Tenant to timely and properly accept Landlord's offer as to a particular First Offer Building nor acceptance of such offer and addition of a particular First Offer Building to the Premises pursuant to the Lease shall affect Tenant's rights pursuant to this paragraph with respect to any other First Offer Building which thereafter becomes available for lease. (f) Notwithstanding anything to the contrary contained in this paragraph, in no event shall Landlord be required to offer to Tenant a First Offer Building during any period during which Tenant is in default pursuant to the Lease. Moreover, nothing herein shall require Landlord to hold such First Offer Building off the market for leasing to third parties pending a cure by Tenant of a default pursuant to the Lease. In the event that Landlord receives a third party offer to lease a First Offer Building during any period of Tenant default pursuant to the Lease, Landlord shall be free to accept such offer and enter into a lease of such building with a third party upon such terms and conditions as are acceptable to Landlord and such third party. (g) Landlord and Tenant acknowledge and agree that the rights afforded to Tenant pursuant to this paragraph are unusual and are not generally afforded by Landlord to tenants of the Center. Landlord shall use reasonable efforts to honor the rights granted to Tenant pursuant to this paragraph. However, if Landlord inadvertently neglects to provide to Tenant an offer notice with respect to a First Offer Building which becomes available for lease, such failure shall not constitute a default by Landlord pursuant to the Lease or entitle Tenant to any damages, rental abatement or other remedy on account of such failure and Tenant shall have no right to terminate the Lease on account of such failure. 7. No Brokers. The first sentence of Article 38 of the Original Lease shall have no application with respect to this Amendment (i.e., there is no broker entitled to a commission with respect to this Amendment). The representations and covenants contained in the second and third sentences of such Article shall apply with respect to this Amendment. For the purpose of such covenants, payment shall not be a condition precedent to recovery upon such indemnification provisions. Each such indemnification provision shall include a covenant by the indemnifying party to defend the indemnified party against all claims from which indemnification is available pursuant to such provision with legal counsel selected by the insurance carrier for the indemnifying party or otherwise reasonably acceptable to the indemnified party. 8. Lender Approval. Landlord and Tenant acknowledge and agree that the continued effectiveness of this Amendment is subject to the approval of this Amendment by Teachers Insurance and Annuity Association, Landlord's lender with respect to the Center ("Lender"). Promptly upon the last execution and delivery of this Amendment by Tenant and Landlord, Landlord shall submit this Amendment to Lender with a request for approval hereof by Lender in writing. Thereafter, Landlord shall use reasonable efforts to obtain the approval of Lender to this 7 Amendment as promptly as practicable. Promptly upon receipt of such approval from Lender, Landlord shall so notify Tenant and shall furnish a copy of any written approval to Tenant. In the event that Landlord is unable to obtain the approval of Lender to this Amendment within fifty (50) days after Tenant's execution and delivery of this Amendment, either party shall have the right to terminate this Amendment. Such right shall be exercised by either party by written notice to the other given at any time after the expiration of such fifty (50) day period and prior to Landlord's notice to Tenant as to such approval. If the parties are entitled to terminate this Amendment and either party exercises such right, then (a) this Amendment shall terminate upon the date of receipt of such notice of termination by the recipient party, (b) each party shall bear its own costs and fees incurred in the preparation and negotiation of this Amendment, (c) neither party shall have any further rights or obligations pursuant to this Amendment and (d) the Lease shall remain in full force and effect without regard to this Amendment. 9. Effective Date. Subject to the provisions of paragraph 8 above, this Amendment shall be effective as of March 28, 1997, notwithstanding any later execution and delivery of this Amendment by Landlord and/or Tenant. 10. Counterparts. This Amendment may be executed in two (2) or more counterparts, each of which shall be deemed an original but all of which together shall constitute a single instrument. It shall not be necessary for Landlord and Tenant to execute the same counterpart(s) of this Amendment for this Amendment to become effective. 11. Defined Terms. All terms used in this Amendment with initial capital letters and not defined herein shall have the meanings given to such terms in the Lease. 12. Lease in Effect. Landlord and Tenant acknowledge and agree that the Lease, as hereby amended and extended, remains in full force and effect in accordance with its terms. 8 IN WITNESS WHEREOF, Landlord and Tenant have executed this Fifth Amendment to Lease to be effective as provided in paragraph 9 above. FILENET CORPORATION, a California C.J. SEGERSTROM & SONS, a California corporation general partnership By __________________________ By ________________________________ Managing Partner Title: __________________________ By ________________________________ Managing Partner Dated: __________________________ Dated: ________________________________ "Tenant" "Landlord" Attachment: Exhibit "A" - Location of New Allocated Spaces 9 EX-27 3 FINANCIAL DATA SCHEDULE
5 1,000 3-MOS Dec-31-1997 Mar-31-1997 29,308 28,610 43,941 0 7,819 123,103 83,754 55,171 166,846 41,481 0 0 0 124,167 (2,175) 166,846 29,325 47,562 8,328 21,459 39,906 0 0 (13,082) 3,662 (9,420) 0 0 0 (9,420) (0.63) (0.63)
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