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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 June 30, 2003
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: 00-15997
FILENET CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 95-3757924
(State or other jurisdiction of (I.R.S. Employer
corporation or organization Identification No.)
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 |_|
Indicate by check mark whether the Registrant is an accelerated filer as defined in Rule
12b-2 of the Securities Exchange Act of 1943:
Yes |X| No |_|
As of August 12, 2003, there were 36,496,332 shares of the Registrant's common stock
outstanding.
FILENET CORPORATION
Index
Page
Number
PART I. FINANCIAL INFORMATION.......................................... 3
Item 1. Unaudited Condensed Consolidated Financial Statements ........ 3
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations .................................. 20
Item 3. Quantitative and Qualitative Disclosures about Market Risk..... 37
Item 4. Controls and Procedures........................................ 38
PART II. OTHER INFORMATION.............................................. 39
Item 1. Legal Proceedings.............................................. 39
Item 4. Submission of Matters to a Vote of Shareholders................ 39
Item 6. Exhibits and Reports on Form 8-K............................... 40
SIGNATURE ............................................................... 41
INDEX TO EXHIBITS............................................................. 42
2
PART I. FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
FILENET CORPORATION
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
June 30, December 31,
2003 2002
ASSETS
Current assets:
Cash and cash equivalents $ 157,330 $ 130,154
Short-term investments 25,694 29,188
Accounts receivable, net 37,611 44,839
Inventories, net 1,919 2,568
Prepaid expenses and other current assets 15,201 13,317
Deferred income taxes 802 802
Total current assets 238,557 220,868
Property, net 30,883 34,641
Long-term investments 22,814 25,864
Goodwill 24,480 16,907
Intangible assets, net 8,606 3,029
Deferred income taxes 20,048 21,792
Other assets 3,929 4,935
Total assets $ 349,317 $ 328,036
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 7,074 $ 7,706
Customer deposits 4,611 2,962
Accrued compensation and benefits 18,213 20,729
Unearned maintenance revenue 51,348 38,945
Other accrued liabilities 14,237 15,224
Total current liabilities 95,483 85,566
Unearned maintenance revenue and other liabilities 2,584 3,565
Commitments and contingencies (Note 9)
Stockholders' equity:
Preferred stock - $0.10 par value; 7,000,000 shares
authorized; none issued and outstanding
Common stock - $0.01 par value; 100,000,000 shares
authorized; 37,464,825 shares issued and 36,366,825
shares outstanding at June 30, 2003; and
37,014,512 shares issued and 35,916,512 shares
outstanding at December 31, 2002 210,911 206,676
Retained earnings 55,966 53,178
Accumulated other comprehensive loss (1,060) (6,382)
Treasury stock, at cost; 1,098,000 shares (14,567) (14,567)
Net stockholders' equity 251,250 238,905
Total liabilities and stockholders' equity $ 349,317 $ 328,036
See accompanying notes to unaudited condensed consolidated financial statements.
3
FILENET CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Three Months Ended June 30, Six Months Ended June 30,
2003 2002 2003 2002
Revenue:
Software $ 33,555 $ 34,350 $ 69,077 $ 65,590
Customer support 41,164 37,281 79,862 73,844
Professional services and education 11,802 14,491 23,933 30,327
Hardware 596 2,105 1,294 4,707
Total revenue 87,117 88,227 174,166 174,468
Costs:
Software 3,608 2,674 6,616 4,755
Customer support 8,715 9,807 18,484 19,895
Professional services and education 10,335 13,187 21,415 26,642
Hardware 1,253 1,585 2,055 3,510
Total cost of revenue 23,911 27,253 48,570 54,802
Gross Profit 63,206 60,974 125,596 119,666
Operating expenses:
Sales and marketing 34,856 32,761 69,255 65,050
Research and development 19,680 18,924 38,982 36,229
In-process research and development - 400 - 400
General and administrative 8,326 8,605 16,152 16,793
Total operating expenses 62,862 60,690 124,389 118,472
Operating income 344 284 1,207 1,194
Other income, net 1,620 1,921 2,665 2,829
Income before income taxes 1,964 2,205 3,872 4,023
Provision for income taxes 512 471 1,084 925
Net income $ 1,452 $ 1,734 $ 2,788 $ 3,098
Earnings per share:
Basic $ 0.04 $ 0.05 $ 0.08 $ 0.09
Diluted $ 0.04 $ 0.05 $ 0.08 $ 0.08
Weighted-average shares outstanding:
Basic 36,173 35,543 36,057 35,452
Diluted 37,296 36,741 36,960 36,983
See accompanying notes to unaudited condensed consolidated financial statements.
4
FILENET CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
(In thousands)
Three Months Ended Six Months Ended
June 30, June 30, .
2003 2002 2003 2002
Net income $ 1,452 $ 1,734 $ 2,788 $ 3,098
Other comprehensive income:
Foreign currency translation adjustments 3,363 5,401 5,360 4,991
Unrealized gains on securities:
Unrealized holding gains (28) 89 (38) 14
Total other comprehensive income 3,335 5,490 5,322 5,005
Comprehensive income $ 4,787 $ 7,224 $ 8,110 $ 8,103
See accompanying notes to unaudited condensed consolidated financial statements.
5
FILENET CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Six Months Ended
June 30,
2003 2002
Cash flows from operating activities:
Net income $ 2,788 $ 3,098
Adjustments to reconcile net income to net cash
provided by operating activities:
Purchased in-process research and development - 400
Depreciation and amortization 9,937 10,724
Loss on sale of fixed assets 28 10
Provision for doubtful accounts 26 612
Deferred income taxes 1,731 9
Changes in operating assets and liabilities, net of
the effects of acquisition:
Accounts receivable 8,918 15,403)
Inventories 698 458
Prepaid expenses and other current assets 514 (3,969)
Accounts payable (1,188) 2,630
Accrued compensation and benefits 1,633 2,438
Customer deposits and advances (3,363) (983)
Unearned maintenance revenue 9,965 9,845
Income taxes payable (808) 886
Other (2,628) (5,015)
Net cash provided by operating activities 28,251 5,740
Cash flows from investing activities:
Capital expenditures (5,030) (6,506)
Proceeds from sale of property 66 40
Note receivable from officer - (1,900)
Cash paid for acquisition (8,073) (9,359)
Purchases of marketable securities (60,199) (73,497)
Proceeds from sales and maturities of marketable securities 64,305 55,100
Net cash used in investing activities (8,931) (36,122)
Cash flows from financing activities:
Proceeds from issuance of common stock 4,187 3,603
Principal payments on capital lease obligations - (854)
Net cash provided by financing activities 4,187 2,749
Effect of exchange rate changes on cash and cash equivalents 3,669 4,421
Net increase in cash and cash equivalents 27,176 (23,212)
Cash and cash equivalents, beginning of year 130,154 107,502
Cash and cash equivalents, end of period 157,330 84,290
Supplemental cash flow information:
Interest paid 32 51
Income taxes paid $ 2,638 $ 120
See accompanying notes to unaudited condensed consolidated financial statements.
6
FILENET CORPORATION
Notes To Condensed Consolidated Financial Statements
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited interim condensed consolidated financial
statements of FileNet Corporation (the "Company" or "FileNet") reflect all
adjustments (consisting of normal recurring adjustments) necessary to
present fairly the financial position of the Company at June 30, 2003, the
results of its operations, and its comprehensive operations for the three
and six months ended June 30, 2003 and 2002, and its cash flows for the six
months ended June 30, 2003 and 2002. 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 (the "SEC"), although the Company believes that the disclosures
in the condensed consolidated financial statements are adequate to ensure
the information presented is not misleading. These condensed consolidated
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto, contained in the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 2002 filed with
the SEC on March 28, 2003. The results of operations for the interim
periods are not necessarily indicative of the operating results for the
year, or any other future period.
2. RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations," which was effective immediately. SFAS No. 141 requires that
the purchase method of accounting be used for all business combinations
initiated after June 30, 2001 and it eliminated the pooling-of-interests
method. The adoption of this standard did not have a significant impact on
the Company's consolidated financial statements. The Company's acquisition
of certain assets and certain liabilities of eGrail, Inc. in April 2002,
and the acquisition of Shana Corporation in April 2003 were accounted for
in compliance with this pronouncement (See Note 3 for details).
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which the Company adopted January 1, 2002. SFAS No. 142 requires
that goodwill and other intangible assets with indefinite useful lives no
longer be amortized, but instead be tested for impairment at least annually
and written down when impaired. SFAS No. 142 requires purchased intangible
assets other than goodwill to be amortized over their useful lives, unless
these lives are determined to be indefinite. In accordance with this
Standard, the Company does not amortize goodwill and indefinite life
intangible assets but evaluates their carrying value annually or when
events or circumstances indicate that their carrying value may be impaired.
On the first day of July of each year, goodwill will be tested for
impairment by determining if the carrying value of each reporting unit
exceeds its fair value. As of June 30, 2003, no impairment of goodwill has
been recognized. If estimates change, a materially different impairment
conclusion could result. The Company is currently testing for impairment
with results expected by late August 2003.
In August 2001, the FASB issued SFAS No. 144, "Accounting for Impairment or
Disposal of Long-Lived Assets." This Statement addresses financial
accounting and reporting for the impairment of long-lived assets and for
the disposal of long-lived assets and discontinued operations. SFAS No. 144
superseded SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of," and is effective for
fiscal years beginning after December 15, 2001. The adoption of this
Standard on January 1, 2002 did not have a material impact on the Company's
consolidated financial position and results of operations.
7
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which addresses financial
accounting and reporting for costs associated with exit or disposal
activities and supersedes Emerging Issues Task Force ("EITF") Issue 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." SFAS No. 146 requires that costs associated with exit or
disposal activities be recognized when they are incurred rather than at the
date of a commitment to an exit or disposal plan. SFAS No. 146 also
establishes that the liability should initially be measured and recorded at
fair value. The Company adopted the provisions of SFAS No. 146 for exit or
disposal activities initiated after December 31, 2002. The adoption of the
provisions of SFAS No. 146 in the three and six months ended June 30, 2003
did not have a material impact on the Company's consolidated results of
operations or financial position.
In November 2002, the FASB issued FASB Interpretation No. ("FIN") 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees and Indebtedness of Others," an
interpretation of FASB Statement Nos. 5, 57 and 107, and rescission of FIN
34, "Disclosure of Indirect Guarantees of Indebtedness of Others." FIN 45
elaborates on the disclosures to be made by the guarantor in its interim
and annual financial statements about its obligations under certain
guarantees that it has issued. It also requires that a guarantor recognize,
at the inception of a guarantee, a liability for the fair value of the
obligation undertaken in issuing the guarantee. The provisions related to
recognizing a liability at inception of the guarantee for the fair value of
the guarantor's obligations does not apply to product warranties or to
guarantees accounted for as derivatives. The initial recognition and
measurement provisions of this interpretation are applicable on a
prospective basis to guarantees issued or modified after December 31, 2002,
while the disclosure requirements are effective for financial statements
for interim or annual periods ending after December 15, 2002. The adoption
of the recognition provisions of FIN 45 in the three and six months ended
June 30, 2003 did not have a material impact on the Company's consolidated
results of operations or financial position.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation Transition and Disclosure." This statement amends SFAS No.
123, "Accounting for Stock-Based Compensation," to provide alternative
methods of transition for a voluntary change to the fair value based method
of accounting for stock-based employee compensation. In addition, this
statement amends the disclosure requirements of SFAS No. 123 to require
prominent disclosures in both annual and interim financial statements about
the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The transition guidance and
annual disclosure provisions of SFAS No. 148 are effective for fiscal years
ending after December 15, 2002. The interim disclosure provisions are
effective for financial reports containing financial statements for interim
periods beginning after December 15, 2002. The adoption of SFAS No. 148 did
not have a material impact on the Company's consolidated results of
operations or financial position.
8
The following table summarizes the Company's net income (loss) and net income
(loss) per share on a pro forma basis had compensation cost for the Company's
stock-based compensation plans been determined based on the provisions of SFAS
No. 123, for the three and six months ended June 30, 2003 and 2002:
Three Months Ended Six Months Ended
June 30, June 30,
(In thousands, except per share amounts) 2003 2002 2003 2002
Net income, as reported $ 1,452 $ 1,734 $ 2,788 $ 3,098
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards, net
of related tax effects (2,062) (2,075) (4,101) (4,537)
Pro forma net loss (610) (341) (1,313) (1,439)
Earnings per share:
Basic earnings per share - as reported $ .04 $ .05 $ .08 $ .09
Basic earnings (loss) per share - pro forma (.02) (.01) (.04) (.04)
Diluted earnings per share - as reported .04 .05 .08 .08
Diluted earnings (loss) per share - pro forma $ (.02) $ (.01) $ (.04) $ (.04)
Pro forma compensation cost of shares issued under the Employee Qualified Stock
Purchase Plan is measured based on the discount from market value on the date of
purchase in accordance with SFAS No. 123. For purposes of computing pro forma
net income, we estimate the fair value of each option grant and employee stock
purchase plan right on the date of grant using the Black-Scholes option-pricing
model. The Black-Scholes option-pricing model was developed for use in
estimating the value of traded options that have no vesting restrictions and are
fully transferable, while the options issued by the Company are subject to both
vesting and restrictions on transfer. In addition, option-pricing models require
input of highly subjective assumptions including the expected stock price
volatility. The Company uses projected data for expected volatility and expected
life of its stock options based upon historical data.
The assumptions used to value the option grants and the purchase rights are
stated as follows:
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
Expected life (in years) 2 to 5 2 to 5 2 to 5 2 to 5
Expected volatility 64% 78% 64 - 66% 75 - 78%
Risk free interest rates 1.63 to 4.36% 3.58 to 5.28% 1.63 to 4.76% 2.16 to 5.28%
Expected dividend 0% 0% 0% 0%
9
In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest
Entities." In general, a variable interest entity is a corporation, partnership,
trust, or any other legal structure used for business purposes that either (a)
does not have equity investors with voting rights or (b) has equity investors
that do not provide sufficient financial resources for the entity to support its
activities. FIN 46 requires a variable interest entity to be consolidated by a
company if that company is subject to a majority of the risk of loss from the
variable interest entity's activities or entitled to receive a majority of the
entity's residual returns or both. The consolidation requirements of FIN 46
apply immediately to variable interest entities created after January 31, 2003.
The consolidation requirements apply to older entities in the first fiscal year
or interim period beginning after June 15, 2003. Certain of the disclosure
requirements apply in all financial statements issued after January 31, 2003,
regardless of when the variable interest entity was established. The Company
does not have any variable interest entities as of June 30, 2003. The adoption
of FIN 46 did not have a material impact on the Company's consolidated results
of operations or its financial position.
In April 2003, FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 (1) clarifies under
what circumstances a contract with an initial net investment meets the
characteristic of a derivative discussed in paragraph 6(b) of Statement 133, (2)
clarifies when a derivative contains a financing component, (3) amends the
definition of an underlying derivative to conform it to language used in FIN 45,
and (4) amends certain other existing pronouncements, which will collectively
result in more consistent reporting of contracts as either derivatives or hybrid
instruments. SFAS No. 149 is effective for contracts and hedging relationships
entered into or modified after June 30, 2003. The Company does not believe that
the adoption of SFAS No. 149 will have a material impact on its consolidated
financial statements.
In May 2003, FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both debt and equity and requires
an issuer to classify the following instruments as liabilities in its balance
sheet:
o a financial instrument issued in the form of shares that is
mandatorily redeemable and embodies an unconditional obligation that
requires the issuer to redeem it by transferring its assets at a
specified or determinable date or upon an event that is certain to
occur;
o a financial instrument, other than an outstanding share, that embodies
an obligation to repurchase the issuer's equity shares, or is indexed
to such an obligation, and requires the issuer to settle the
obligation by transferring assets; and
o a financial instrument that embodies an unconditional obligation that
the issuer must settle by issuing a variable number of its equity
shares if the monetary value of the obligation is based solely or
predominantly on (1) a fixed monetary amount, (2) variations in
something other than the fair value of the issuer's equity shares, or
(3) variations inversely related to changes in the fair value of the
issuer's equity shares.
SFAS No. 150 is effective for financial instruments entered into or modified
after May 31, 2003 and is effective for all other financial instruments as of
the first interim period beginning after June 15, 2003. SFAS No. 150 is to be
implemented by reporting the cumulative effect of a change in accounting
principle. The Company does not expect the adoption of SFAS No. 150 to have a
material impact on its consolidated financial statements
Reclassifications. Certain reclassifications have been made to prior-years'
balances to conform to the current-year's presentation.
10
3. ACQUISITIONS
On April 2, 2002, the Company acquired certain assets and assumed certain
liabilities of eGrail, Inc. ("eGrail"), a Web content management company.
This strategic acquisition provides additional Web Content Management
("WCM") software application capabilities that expand the Company's
position in the Enterprise Content Management ("ECM") market, which
contributed to the purchase price that resulted in goodwill. The purchase
price for the acquisition consisted of $9.0 million in cash consideration
and direct acquisition costs of $359,000.
On April 2, 2003, the Company completed a stock purchase acquisition of
Shana Corporation ("Shana"), an electronic forms management company. This
strategic acquisition provides technology and experience to expand the
Company's ECM offering with Enterprise Forms Management capability, which
contributed to the purchase price and resulted in goodwill. The purchase
price for the acquisition consisted of $8.55 million in cash, less $938,000
of acquired cash consideration, plus $184,000 in acquisition expenses and
$277,000 paid for Non-Compete Agreements.
In accordance with SFAS No. 141, "Business Combinations," these
acquisitions were accounted for under the purchase method of accounting.
The purchase price was allocated as follows:
eGrail, Inc. Shana Corp.
April 2, 2002 April 2, 2003
(In thousands)
Net tangible assets $ 581 $ 2,725
Patents 24 -
Acquired technology 3,300 4,000
Technical manuals and design documents - 600
Customer maintenance relationships - 800
In-process research and development 400 -
Non-Compete Agreements - 277
Liabilities assumed (739) (2,494)
Goodwill 5,793 3,103
Total purchase price $ 9,359 $ 9,011
Less cash acquired - (938)
Net cash paid $ 9,359 $ 8,073
The Company allocated the purchase price of these acquisitions based on
fair value. Statement of Financial Accounting Concepts No. 7 defines fair
value as the amount at which an asset (or liability) could be bought or
sold in a current transaction between willing parties, that is, other than
in a forced or liquidation sale.
The valuation of the eGrail assets included $400,000 of in-process research
and development, which was expensed upon acquisition because technological
feasibility had not been established and no future alternative uses,
existed. New product development underway at eGrail at the time of the
acquisition included the next generation of their WCM product that was in
the early stages of design and only 5% complete at the date of the
acquisition. The cost to complete the project was estimated at
approximately $3.0 million to occur over a 12-month period. As of March 31,
2003 the project was complete and the Company incurred approximately $4.8
million of research and development expenses related to the project. The
remaining purchase price was primarily allocated to tangible assets and
goodwill. The acquired technology of $3.3 million was assigned a useful
life of five years and patents of $24,000 were assigned a useful life of
two years. The remaining purchase price of $6.0 million was primarily
allocated to tangible assets and goodwill. Goodwill is tax deductible for
this asset purchase.
11
The valuation of Shana resulted in acquired technology, technical manuals
and design documents, and customer maintenance relationships. Since Shana
had recently completed Version 4.1 of its eForms product, there was no in-
process research and development underway at the time of the acquisition.
Shana's technology manuals and design documents are the "roadmaps" for the
eForms technology and will be used by FileNet product development.
Recurring maintenance revenues are expected and estimable for Shana's
customers based on the older and newer versions of eForms technology. The
acquired technology of $4.0 million, the technical manuals and design
documents of $600,000, and the customer maintenance relationships of
$800,000 were assigned a useful life of five years. The remaining purchase
price of $3.6 million was allocated primarily to goodwill. In accordance
with SFAS No. 142, goodwill for both acquisitions will not be amortized but
will be reviewed for impairment on an annual basis in July. (This
evaluation is currently underway with an estimated completion date in late
August.) Although the goodwill stemming from the Shana stock purchase is
non-deductible for Canadian tax purposes, a Section 338(g) election will
result in the reduction of taxable income for U.S. tax purposes on this
transaction.
Actual results of operations of the acquired eGrail business, as well as
assets and liabilities of the acquired eGrail business, are included in the
unaudited condensed consolidated financial statements from the date of
acquisition. The pro forma results of operations data for the six-month
period ended June 30, 2003 and 2002 presented below assumes that the eGrail
acquisition had been made at the beginning of fiscal 2002. The pro forma
data is presented for informational purposes only and is not necessarily
indicative of the results of future operations nor of the actual results
that would have been achieved had the acquisition taken place at the
beginning of fiscal 2002. No pro forma information has been presented for
the Shana acquisition, as the result did not have a material impact on the
financial statements of the company during the reporting period.
Six Months Ended
June 30,
2003 Actual 2002 Pro Forma
(in thousands)
Revenue $ 174,166 $ 175,220
Net income 2,788 1,245
Earnings per share:
Basic $ .08 $ .04
Diluted $ .08 $ .03
4. GOODWILL AND PURCHASED INTANGIBLE ASSETS
In acquisitions accounted for using the purchase method, goodwill is
recorded for the difference, if any, between the aggregate consideration
paid for an acquisition and the fair value of the net tangible and
identified intangible assets acquired. SFAS No. 142 requires a periodic
review of goodwill and indefinite life intangibles for possible impairment.
Intangible assets with definite lives must be amortized over their
estimated useful lives. Shana goodwill and intangible assets were recorded
on our Canadian subsidiary and a portion of the goodwill and intangible
assets for previous acquisitions was allocated to our Ireland subsidiary.
This results in foreign exchange translation fluctuation. The following
table represents the balance of goodwill as of December 31, 2002 and the
changes in goodwill for the six months ended June 30, 2003:
12
Goodwill (in thousands)
Balance as of December 31, 2002 $ 16,907
Goodwill acquired during the period 3,103
Adjustments 3,498
Foreign currency gain 972
Balance as of June 30, 2003 $ 24,480
Other adjustments to goodwill included $1.7 million for the write-off of a
prepaid royalty and the recognition of a $1.7 million deferred tax asset.
Prior to the Shana acquisition, FileNet licensed the eForms technology from
Shana under an agreement that resulted in a prepaid royalty. The remaining
balance of this prepaid royalty fee was considered additional investment in
Shana and was allocated to goodwill. A deferred tax asset was recorded
under purchase accounting for the estimated future tax effects of the
identified intangibles with a corresponding entry to goodwill of $1.7
million.
Acquired technology, technical manuals and design documents, customer
maintenance relationships, non-compete agreements and patents are the
Company's only intangible assets subject to amortization under SFAS No.
142. These assets were recorded in connection with the acquisition of
asstes of eGrail in April 2002 and the acquisition of Shana in April 2003,
and are comprised of the following as of December 31, 2002 and June 30,
2003:
Intangible Assets Subject to Amortization
Foreign
Balance as of December 31, 2002 Accumulated Currency
(in thousands) Gross Amortization Fluctuation Net
Acquired technology and Other Intangibles $ 3,468 $ (532) $ 79 $ 3,015
Non-compete agreements - - - -
Patents 25 (12) 1 14
Total $ 3,493 $ (544) $ 80 $ 3,029
Intangible Assets Subject to Amortization
Foreign
Balance as of June 30, 2003 Accumulated Currency
(in thousands) Gross Amortization Fluctuation Net
Acquired technology and Other Intangibles $ 8,868 $ (1213) $ 673 $ 8,328
Non-compete agreements 277 (29) 24 272
Patents 25 (21) 2 6
Total $ 9,170 $ (1,263) $ 699 $ 8,606
13
Acquired technology, technical manuals and design documents, and customer
maintenance relationships are being amortized over a useful life of five
years, patents are being amortized over a useful life of two years, and the
non-compete agreements are being amortized between two and three years.
Amortization expense for amortizing intangible assets was $494,000 and
$677,000 for the three and six months ended June 30, 2003, and $168,000 for
the three and six months ended June 30, 2002. Estimated future amortization
expense (excluding foreign exchange effect) of purchased intangible assets
as of June 30, 2003 is as follows (in thousands):
Fiscal Year Amount
2003 (remaining 6 months) $ 1,017
2004 2,024
2005 1,990
2006 1,926
2007 1,356
2008 293
Total Amortization Expense $ 8,606
5. EARNINGS PER SHARE
Basic earnings per share are computed by dividing net income for the period
by the weighted-average number of common shares outstanding during the
period. Diluted earnings per share is computed by dividing net income by
the weighted-average number of common shares outstanding plus the dilutive
effect of outstanding stock options and shares issuable under the employee
stock purchase plan using the treasury stock method. The number of dilutive
options excluded from the basic EPS calculation for the three and six
months ended June 30, 2003 were 1,123,000 and 903,000 shares, compared to
1,198,000 and 1,531,000 for the comparable periods in 2002. The following
table sets forth the computation of basic and diluted earnings per share
for the three and six months ended June 30, 2003 and 2002:
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
(in thousands, except per share amounts)
Net Income $ 1,452 $ 1,734 $ 2,788 $ 3,098
Shares used in computing 36,173 35,543 36,057 35,452
basic earnings per share
Dilutive effect of stock plans 1,123 1,198 903 1,531
Shares used in computing
diluted earnings per share 37,296 36,741 36,960 36,983
Earnings per basic share $ 0.04 $ 0.05 $ 0.08 $ 0.09
Earnings per diluted share $ 0.04 $ 0.05 $ 0.08 $ 0.08
14
6. ACCUMULATED OTHER COMPREHENSIVE LOSS
Accumulated other comprehensive loss for the six months ended June 30, 2003
is comprised of the following:
Foreign Unrealized Accumulated
Currency Holding Other
Translation Gain Comprehensive
Adjustment (Loss) (Loss)
(in thousands)
Balance, December 31, 2002 (6,448) 66 (6,382)
Six month period changes 5,360 (38) 5,322
Balance, June 30, 2003 (1,088) 28 (1,060)
7. OPERATING SEGMENT DATA
The Company has prepared operating segment information in accordance with
SFAS No. 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 group, in
deciding how to allocate resources and in assessing performance. The
Company is organized geographically and by line of business. The line of
business management structure is the primary basis upon which financial
performance is assessed and resources allocated.
The Company's reportable operating segments include Software, Customer
Support, Professional Services and Education, and Hardware. The Software
operating segment develops and markets the Company's Enterprise Content,
Business Process and Forms Management software products. The Customer
Support segment provides after-sale support for software, as well as
providing software upgrades when and if available pursuant to the Company's
right to new versions program. The Professional Services and Education
segment provides fee-based implementation and technical services related to
the Company's software products, and also provides training. The Hardware
operating segment manufactures and markets the Company's line of Optical
Storage And Retrieval ("OSAR") libraries.
The financial results of the segments reflect allocation of certain
functional expense categories consistent with the basis and manner in which
Company management internally disaggregates financial information for the
purpose of assisting in making internal operating decisions, which is not
the same as generally accepted accounting principles reporting. The Company
evaluates performance based on stand-alone segment operating results.
Because the Company does not evaluate performance based on the return on
assets at the operating segment level, assets are not tracked internally by
segment. Therefore, segment asset information is not presented.
15
Operating segments data for the three and six months ended June 30, 2003
and 2002 are as follows:
Three months ended Six months ended
June 30, June 30,
(in thousands) 2003 2002 2003 2002
Software
Revenue $ 33,555 $ 34,350 $ 69,077 $ 65,590
Operating loss (16,220) (11,307) (29,221) (22,027)
Customer Support
Revenue $ 41,164 $ 37,281 $ 79,862 $ 73,844
Operating income 17,792 12,710 32,961 24,527
Professional Services and Education
Revenue $ 11,802 $ 14,491 $ 23,933 $ 30,327
Operating loss (566) (1,167) (1,488) (1,500)
Hardware
Revenue $ 596 $ 2,105 $ 1,294 $ 4,707
Operating income (loss) (662) 48 (1,045) 194
Total
Revenue $ 87,117 $ 88,227 $ 174,166 $ 174,468
Operating income 344 284 1,207 1,194
8. STOCK OPTIONS
The following is a summary of stock option transactions regarding all stock
option plans for the three months ended June 30, 2003:
Weighted-Average
Number of Exercise
Options Price
Balance, March 31, 2003 8,735,984 $ 15.10
Granted (weighted-average fair value of $6.95) 128,650 14.61
Exercised (217,710) 9.43
Canceled (59,461) 17.48
Balance, June 30, 2003 8,587,463 $ 15.22
16
The following table summarizes information concerning outstanding and
exercisable stock options at June 30, 2003:
Options Outstanding Options Exercisable
Weighted-Average
Remaining Weighted-Average Weighted-Average
Range of Exercise Number Contractual Exercise Number Exercise
Price Outstanding Life (Years) Price Exercisible Price
1.39 - 9.00 1,585,576 4.39 $ 8.00 1,585,076 $ 8.00
9.17 - 12.86 1,795,037 7.77 11.91 581,627 10.66
12.97 - 14.19 1,687,022 7.85 13.48 735,289 13.61
14.39 - 18.45 1,566,425 7.62 16.69 799,737 16.60
19.53 - 25.28 1,444,781 6.87 22.89 1,137,067 23.02
26.09 - 41.84 508,622 6.02 28.89 432,906 28.97
1.39 - 41.84 8,587,463 6.52 $ 13.51 5,271,702 $ 12.96
Reference Note No. 2 regarding SFAS No. 148, "Accounting for Stock-Based
Compensation Transition and Disclosure."
9. COMMITMENTS AND CONTINGENCIES
Leases
The Company leases its corporate offices, sales offices, development and
manufacturing facilities, and other equipment under non-cancelable
operating leases, some of which have renewal options and generally provide
for escalation of the annual rental amount. Amounts related to deferred
rent are recorded in other accrued liabilities on the consolidated balance
sheet. Future annual minimum lease payments under all non-cancelable
operating leases with an initial term in excess of one year as of June 30,
2003 were as follows:
(in thousands)
2003 (remaining 6 months) $ 5,407
2004 12,553
2005 10,871
2006 10,004
2007 9,101
2008 7,370
Thereafter 6,732
Total $ 62,038
Product Warranties
The Company provides a 90-day warranty for its hardware products against
defects in materials and workmanship and for its software products against
substantial nonconformance to the published documentation at time of
delivery. For hardware products the Company accrues warranty costs based on
historical trends in product return rates and the expected material and
labor costs to provide warranty services. For software products, the
Company records the estimated cost of technical support during the warranty
period. A provision for these estimated warranty costs is recorded at the
17
time of sale or license. If the Company were to experience an increase in
warranty claims compared with historical experience, or costs of servicing
warranty claims were greater than the expectations on which the accrual had
been based, gross margins could be adversely affected.
The following table represents the warranty activity and balance for the
six months ended June 30, 2003 and 2002:
(in thousands) 2003 2002
Beginning balance at January 1 $ 728 $ 772
Additions 396 543
Deductions (636) (647)
Ending balance at June 30 $ 488 $ 668
Guarantees and Indemnities
In November 2002, the FASB issued FIN 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." The initial recognition and initial measurement
provisions apply on a prospective basis to guarantees issued or modified
after December 15, 2002. The disclosure requirements are effective for
financial statements of interim and annual periods ending after December
15, 2002.
The Company has made guarantees and indemnifications, under which it may be
required to make payments to a guaranteed or indemnified party, in relation
to certain transactions. In connection with the sales of its products, the
Company provides intellectual property indemnities to its customers.
Guarantees and indemnities to customers in connection with product sales
and service generally are subject to limits based upon the amount of the
related product sales or service. Payment by the Company is conditioned
upon the other party filing a claim pursuant to the terms and conditions of
the agreement. The Company may challenge this claim and may also have
recourse against third parties for certain payments made by the Company.
Predicting the maximum potential future payment under these agreements is
not possible due to the unique facts and circumstances involved with each
agreement. Historically, the Company has made no payments under these
agreements. The fair value of guarantees issued during the six months ended
June 30, 2003 is insignificant.
In connection with certain facility leases and other performance
guarantees, the Company has guaranteed payments on behalf of some of its
subsidiaries. To provide subsidiary guarantees, the Company obtains
unsecured bank guarantees from local banks. These bank guarantees totaled
an equivalent of approximately $1.3 million issued in local currency in
Europe and Asia as of June 30, 2003. Approximately $0.4 million of the $1.3
million is secured by cash deposit.
The Company indemnifies its directors and officers to the maximum extent
permitted under the laws of the State of Delaware.
There have been no modifications or new guarantees issued during the first
half of fiscal year 2003. The Company has not recorded a liability for the
guarantees and indemnities described above in the accompanying consolidated
balance sheet and the maximum amount of potential future payments under
such guarantees and indemnities is not determinable, other than as
described above. The Company's product warranty liability as of June 30,
2003 is disclosed in this item under the heading "Product Warranties."
18
10. LEGAL PROCEEDINGS
In the normal course of business, the Company is subject to ordinary
routine litigation and claims incidental to business. While the results of
litigation and claims cannot be predicted with certainty, management
believes that the final outcome of these matters will not have a materially
adverse effect on the Company's consolidated results of operations or
financial condition.
11. FOREIGN CURRENCY TRANSACTIONS
As of June 30, 2003, the Company had forward foreign exchange contracts
outstanding totaling approximately $ 2.1 million in 10 currencies. These
contracts were opened on the last business day of the quarter and mature
within three months. Accordingly, the fair value of such contracts is zero
at June 30, 2003.
12. RELATED-PARTY TRANSACTIONS
In July 2001, the Compensation Committee of the Company's Board of
Directors (the "Board") entered into discussions with Lee Roberts, the
Company's Chief Executive Officer, regarding a secured loan by the Company
to Mr. Roberts to enable him to purchase a home in Orange County,
California. In July 2001, the Compensation Committee forwarded its
recommendation to the Board to approve, in principle, a secured loan, in
the amount of $1.2 million to Mr. Roberts. In September 2001, the
Compensation Committee approved, in principle, an increase in the
previously requested loan amount to $1.9 million, subject to review of
final loan documents and approval of the Board. In May 2002, the
Compensation Committee reviewed proposed loan documentation for a secured
loan to Mr. Roberts and forwarded its recommendation to the Board to
approve the loan on the terms set forth in the loan documents. The loan
documents provided that the loan would be secured by the real estate
purchased by Mr. Roberts. Subsequently, on June 5, 2002, the Board approved
the loan documents and the loan. As of June 30, 2003, FileNet has an
outstanding secured note receivable from Mr. Roberts in the amount of $1.9
million that relates to the above-referenced loan and is included in other
assets on the consolidated balance sheet. The note bears interest at 2.89%
per annum. Accrued interest on the principal balance of this note is
payable annually beginning February 15, 2003 and on each February 15th
thereafter until the entire principal balance becomes due. Accrued interest
as of June 30, 2003 was approximately $21,000. The entire outstanding
principal balance of this note and any accrued interest is due and payable
at the earliest of (a) June 7, 2005, (b) one year after termination of Mr.
Roberts' employment by the Company, or (c) ninety (90) days after voluntary
termination of employment by Mr. Roberts. Imputed interest for the
difference between the stated interest rate of the note and a fair value
interest rate of 7% was recorded as compensation expense and a discount
that is being amortized over the term of the note to interest income using
the effective interest method. The loan to Mr. Roberts is permitted under
Section 13 of the Securities Exchange Act of 1934, as amended by Section
402 of the Sarbanes-Oxley Act on July 30, 2002, because it was outstanding
on that date. However, its terms cannot be renewed or materially modified
in the future.
John Savage, a member of FileNet's Board of Directors and the Audit
Committee of FileNet's Board of Directors, is Managing Partner of Alliant
Partners, who acted as financial advisor to eGrail in connection with our
acquisition of assets from eGrail and was paid approximately $500,000 by
eGrail. Accordingly, John Savage recused himself from all discussions
related to the acquisition between FileNet and eGrail and abstained from
voting on the transaction.
19
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Quarterly Report on Form 10-Q contains forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995, Section 21E
of the Securities and Exchange Act of 1934, as amended, and Section 27A of the
Securities Act of 1933, as amended, and is subject to the safe harbors created
by those sections. Words such as "anticipates," "expects," "intends," "plans,"
"believes," "seeks," "estimates," "may," "will" and variations of these words or
similar expressions are intended to identify forward-looking statements. In
addition, any statements that refer to expectations, projections or other
characterizations of future events or circumstances, including any underlying
assumptions, are forward-looking statements. These statements are not guarantees
of future performance and are subject to risks, uncertainties and assumptions
that are difficult to predict. Therefore, our actual results could differ
materially and adversely from those expressed in any forward-looking statements
as a result of various factors. We undertake no obligation to revise or publicly
release the results of any revisions to these forward-looking statements.
Readers should carefully review the risk factors described below under the
heading "Risk Factors That May Affect Future Results" and in other documents we
file from time to time with the Securities and Exchange Commission, including
our Annual Report on Form 10-K for the fiscal year ended December 31, 2002. Our
filings with the Securities and Exchange Commission, including our Annual
Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form
8-K and amendments to those filings, pursuant to Sections 13(a) and 15(d) of the
Securities Exchange Act of 1934, are available free of charge at
www.filenet.com, when such reports are available at the Securities and Exchange
Commission Web site.
Overview
FileNet Corporation develops, markets, sells and supports Enterprise Content
Management ("ECM") software to enable organizations to improve operational
efficiency and leverage their content, process and connectivity resources to
make decisions faster. In the first quarter of 2003, we introduced FileNet P8,
our new architecture that provides a unified platform and framework for ECM. The
FileNet P8 architecture is designed to provide an integrated solution for our
customers to easily configure, design, build and deploy a variety of
enterprise-wide ECM applications to meet a broad range of content management
needs within a single scalable framework. We also offer professional services
and training for the implementation of these software solutions, as well as 24
hours a day, seven days a week technical support and services to our customers
on a global basis.
Critical Accounting Policies and Estimates
The consolidated financial statements of FileNet are prepared in conformity with
accounting principles generally accepted in the United States of America. The
consolidated financial statements include our accounts and the accounts of our
wholly owned subsidiaries. All intercompany balances and transactions have been
eliminated. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period. Actual
amounts could differ from estimates. The significant accounting policies we
believe are most critical to aid in fully understanding and evaluating our
reported financial results include the following:
20
Revenue Recognition. FileNet accounts for the licensing of software in
accordance with the American Institute of Certified Accountants ("AICPA")
Statement of Position ("SOP") 97-2, "Software Revenue Recognition." We enter
into contracts for the sale of our products and services. The majority of these
contracts relate to single elements and contain standard terms and conditions.
However, there are agreements that contain multiple elements or non-standard
terms and conditions. Contract interpretation is sometimes required to determine
the appropriate accounting, including how the price should be allocated among
the deliverable elements and when to recognize revenue.
Software license revenue generated from sales through direct and indirect
channels, which do not contain multiple elements, are recognized upon shipment
and passage of title of the related product, if the requirements of SOP 97-2,
are met. If the requirements of SOP 97-2, including evidence of an arrangement,
delivery, fixed or determinable fee, collectibility or vendor specific evidence
about the value of an element are not met at the date of shipment, revenue is
not recognized until these elements are known or resolved. Fees are deemed to be
fixed and determinable for transactions with a set price that is not subject to
refund or adjustment and payment is due within 90 days from the invoice date.
Software license revenue from channel partners is recognized when the product is
shipped and sale by the channel partner to a specified end user is confirmed.
For arrangements with multiple elements, we allocate revenue to each element of
a transaction based upon its fair value as determined in reliance on vendor
specific objective evidence. This evidence of fair value for all elements of an
arrangement is based on the normal pricing and discounting practices for those
products and services when sold separately. If fair value of any undelivered
element cannot be determined objectively, we defer the revenue until all
elements are delivered, services have been performed or until fair value can
objectively be determined.
Customer support contracts are renewable on an annual basis and provide
after-sale support for our software, as well as software upgrades under the
Company's right to new versions program, on a when-and-if-available basis.
Revenue from post-contract customer support is recognized ratably over the term
of the arrangement, which is typically 12 months.
Professional services revenue consists of consulting and implementation services
provided to end users of our software products and technical consulting services
provided to our resellers. Consulting engagements average from one to three
months. We do not make changes to the standard software code in the field.
Revenue from these services and from training classes is recognized as such
services are delivered and accepted by the customer. Revenue and cost is
recognized using the percentage-of-completion method for fixed-price consulting
contracts. However, revenue and profit are subject to revision as the contract
progresses and anticipated losses on fixed-price professional services contracts
are recognized in the period when they become known.
Allowance for Doubtful Accounts and Sales Returns. We evaluate the
creditworthiness of our customers prior to order fulfillment, and we perform
ongoing credit evaluations of our customers to adjust credit limits based on
payment history and the customer's current creditworthiness. We constantly
monitor collections from our customers and maintain an allowance for estimated
credit losses that is based on historical experience and on specific customer
collection issues. While credit losses have historically been within our
expectations and the provisions established in our financial statements, we
cannot guarantee that we will continue to experience the same credit loss rates
that we have in the past. Since our revenue recognition policy requires
customers to be creditworthy, our accounts receivable are based on customers
whose payment is reasonably assured. Our accounts receivable are derived from
sales to a wide variety of customers.
We do not believe a change in liquidity of any one customer or our inability to
collect from any one customer would have a material adverse impact on our
consolidated financial position. Based on historical experience, we also
maintain a sales return allowance for the estimated amount of potential returns.
21
While product returns have historically been minimal and within our expectations
and the allowances established by us, we cannot guarantee that we will continue
to experience the same return rates that we have in the past.
Goodwill and Other Intangible Assets. Goodwill is recorded at cost and is not
amortized. In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets," which we adopted January 1, 2002. SFAS No. 142 requires that
goodwill and other intangible assets with indefinite useful lives no longer be
amortized, but instead be tested for impairment at least annually and written
down when impaired. On the first day of July of each year, goodwill will be
tested for impairment by determining if the carrying value of each reporting
unit exceeds its fair value. We also periodically evaluate whether events and
circumstances have occurred which indicate that the carrying value of goodwill
may not be recoverable. As of June 30, 2003, no impairment of goodwill has been
recognized. If estimates change, a materially different impairment conclusion
could result.
Long-Lived Assets. Property, plant and equipment, intangible assets, and
capitalized software costs are recorded at cost less accumulated depreciation or
amortization. They are amortized using the straight-line method over estimated
useful lives of generally three to six years. The determination of useful lives
and whether or not these assets are impaired involves judgment and are reviewed
for impairment whenever events or circumstances indicate that the carrying
amount of such assets may not be recoverable. We evaluate the carrying value of
long-lived assets and certain identifiable intangible assets for impairment of
value based on undiscounted future cash flows resulting from the use of the
asset and its eventual disposition. While we have not experienced impairment of
intangible assets in prior periods, we cannot guarantee that there will not be
impairment in the future.
Deferred Income Taxes. Deferred income taxes reflect the net tax effects of
temporary differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes. We
maintain a valuation allowance against a portion of the deferred tax asset due
to uncertainty regarding the future realization based on historical taxable
income, projected future taxable income, and the expected timing of the
reversals of existing temporary differences. If we operate at a loss or are
unable to generate sufficient future taxable income we could be required to
increase the valuation allowance against all or a significant portion of our
deferred tax assets which would result in a substantial increase to our
effective tax rate and could result in a material adverse impact on our
operating results. Conversely, if the Company continues to generate profits and
ultimately determines that it is more likely than not that all or a portion of
the remaining deferred tax assets will be utilized to offset future taxable
income, the valuation allowance could be decreased or eliminated all together,
thereby resulting in a substantial decrease to our effective tax rate and an
increase to additional paid in capital.
Research and Development Costs. We expense research and development costs as
incurred. No amounts are required to be capitalized in accordance with SFAS No.
86, "Accounting for the Costs of Computer Software to be Sold, Leased, or
Otherwise Marketed," because our software is substantially completed
concurrently with the establishment of technological feasibility.
22
Results of Operations
The following table sets forth certain consolidated statements of operations
data as a percentage of total revenue for the periods indicated:
Three Months Ended Six Months Ended
June 30, June 30,
2003 2002 2003 2002
Revenue:
Software 38.5% 38.9% 39.7% 37.6%
Customer support 47.3 42.3 45.9 42.3
Professional services and education 13.5 16.4 13.7 17.4
Hardware .7 2.4 .7 2.7
Total Revenue 100.0 100.0 100.0 100.0
Cost of revenue:
Software 4.1 3.0 3.8 2.7
Customer support 10.0 11.1 10.6 11.4
Professional services and education 11.9 15.0 12.3 15.3
Hardware 1.4 1.8 1.2 2.0
Total cost of revenue 27.4 30.9 27.9 31.4
Gross Profit 72.6 69.1 72.1 68.6
Operating expenses:
Sales and marketing 40.0 37.1 39.8 37.3
Research and development 22.6 21.4 22.4 20.8
In-process research and development - .5 - .2
General and administrative 9.6 9.8 9.2 9.6
Total operating expenses 72.2 68.8 71.4 67.9
Operating income .4 .3 .7 .7
Other income, net 1.9 2.2 1.5 1.6
Income before income tax 2.3% 2.5% 2.2% 2.3%
23
Revenue
Total revenue for the three months ended June 30, 2003 was $87.1 million
compared to $88.2 million for the three months ended June 30, 2002, a decrease
of $1.1 million, or 1%. Total revenue for the six months ended June 30, 2003 was
$174.2 million compared to $174.5 million for the six months ended June 30,
2002, a decrease of $0.3 million or less than 1%. International revenue for the
three and six months ended June 30, 2003 was 34% and 33% of total revenue,
compared to 27% and 28% for the three and six months ended June 30, 2002. As
more fully discussed and explained below, total revenue remained essentially the
same between comparable six-month periods as increases in software and customer
support revenue were offset by decreases in professional services and hardware
revenue. The unchanged revenue level during the first half of 2003, as compared
to the same period in 2002, is indicative of the continuing difficult
information technology-spending environment.
Software: Software revenue consists of fees earned from the licensing of our
software products to customers. Software revenue decreased $0.8 million, or 2%,
to $33.6 million for the three months ended June 30, 2003, from $34.4 million
for the three months ended June 30, 2002. Software revenue increased $3.5
million, or 5%, to $69.1 million for the six months ended June 30, 2003, from
$65.6 million for the three months ended June 30, 2002. Software revenue
represented 39% of total revenue for the three months ended June 30, 2003 and
for the comparable period of 2002. Software revenue represented 40% of total
revenue for the six months ended June 30, 2003 compared to 38% for the
comparable period of 2002.
Software revenue for the three months ended June 30, 2003 was comparable to the
same period in 2002 and software revenue for the six months ended June 30, 2003
increased 5% compared to the six months ended June 30, 2002. Some of the factors
contributing to this increase include a slight increase in our average selling
price and further penetration of our existing customer base. We believe that
enterprise content management will continue to be a corporate priority over the
immediate term. The current economic environment is still very uncertain
however, and any reduction in information technology spending could have a
negative effect on our software revenue growth.
Customer Support: Customer support revenue consists of revenue from software
maintenance contracts, "fee for service" revenue and the sale of spare parts and
supplies. Customer support revenue increased $3.9 million, or 10%, to $41.2
million for the three months ended June 30, 2003 from $37.3 million for the
three months ended June 30, 2002. Customer support revenue increased $6.1
million, or 8%, to $79.9 million for the six months ended June 30, 2003 from
$73.8 million for the six months ended June 30, 2002. Customer support revenue
represented 47% of total revenue for the three months ended June 30, 2003
compared to 42% for the comparable period of 2002. Customer support revenue
represented 46% of total revenue for the six months ended June 30, 2003 compared
to 42% for the comparable period of 2002.
The increase in customer support revenue was primarily due to the growth in our
base of customers who receive ongoing maintenance as a result of new and add-on
customer software sales made during the reporting period. Additionally, the
Company has experienced a high rate of renewal on maintenance contracts from its
customer base. However, over time the growth rate for customer support revenue
is dependent on the Company's success in achieving software revenue growth. The
occurrence of a prolonged economic slowdown, or other factors that negatively
impact software revenue growth, would result in a reduced future growth rate for
customer support revenue.
Professional Services and Education: 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 provided to end users and resellers.
24
Professional services are performed on a time and material basis or fixed price
contract. Professional services and education revenue decreased $2.7 million, or
19%, to $11.8 million for the three months ended June 30, 2003 from $14.5
million for the three months ended June 30, 2002. Professional services and
education revenue decreased $6.4 million, or 21%, to $23.9 million for the six
months ended June 30, 2003 from $30.3 million for the six months ended June 30,
2002. Professional services and education revenue represented 14% of total
revenue for the three months ended June 30, 2003 compared to 16% for the
comparable period in 2002. Professional services and education revenue
represented 14% of total revenue for the six months ended June 30, 2003 compared
to 17% for the comparable period in 2002.
Professional services revenue is dependent on the level and the nature of
software sales over time. Generally, software sales for new system
implementations will generate larger professional service consulting engagements
than sales of additional licenses to existing customer installations. In recent
quarters, we have experienced relatively level software revenue characterized by
repeat purchases for additional software licenses with fewer large-scale
software installations. These factors have adversely impacted professional
services revenue resulting in fewer and smaller consulting engagements. The
aforementioned, coupled with pricing pressures, have reduced professional
services and education revenue, and we do not expect a significant improvement
in the near future.
Hardware: Hardware revenue is generated primarily from the sale of 12-inch
Optical Storage And Retrieval ("OSAR") libraries. Hardware revenue decreased
$1.5 million, or 72%, to $0.6 million for the three months ended June 30, 2003
from $2.1 million for the three months ended June 30, 2002. Hardware revenue
decreased $3.4 million, or 73%, to $1.3 million for the six months ended June
30, 2003 from $4.7 million for the six months ended June 30, 2002. Hardware
revenue represented slightly less than 1% of total revenue for the three months
ended June 30, 2003, compared to 2% for the comparable period of 2002. Hardware
revenue represented less than 1% of total revenue for the six months ended June
30, 2003, compared to 3% for the comparable period of 2002. The decline in
hardware revenue reflects that hardware is not a strategic focus for us, and we
expect hardware revenue to continue to decrease in the future.
Cost of Revenue
Total cost of revenue decreased $3.4 million, or 12%, to $23.9 million for the
three months ended June 30, 2003, from $27.3 million for the comparable period
in 2002. Total cost of revenue decreased $6.2 million, or 11%, to $48.6 million
for the six months ended June 30, 2003, from $54.8 million for the comparable
period in 2002. The decrease for the three and six month comparisons is
primarily due to the decrease in the cost of professional services and education
revenue and hardware revenue as more fully discussed below.
Software: Cost of software revenue includes royalties paid to third parties,
amortization expense for acquired technology and other intangible assets,
partner commissions, software media costs, and the cost to manufacture and
distribute software. The cost of software revenue increased $0.9 million, or
35%, to $3.6 million for the three months ended June 30, 2003 from $2.7 million
for the three months ended June 30, 2002. The cost of software revenue increased
$1.8 million, or 39%, to $6.6 million for the six months ended June 30, 2003
from $4.8 million for the six months ended June 30, 2002. The costs of software
revenue represented 11% and 8% of the related software revenue for the three
months ended June 30, 2003 and June 30, 2002, respectively. The costs of
software revenue represented 10% and 7% of the related software revenue for the
six months ended June 30, 2003 and June 30, 2002, respectively.
The increase in software cost of revenue for the three and six-month periods of
2003, as compared to the same periods in 2002, is due primarily to higher
partner commission expense and the additional amortization expense of acquired
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technology and other intangible assets associated with the acquisition of assets
from eGrail in April 2002 and the stock of Shana in April 2003. We anticipate cost
of software revenue as a percentage of software revenue to remain comparable to
historical levels in future periods, however additional technology acquisitions
or unexpected increases in third party royalty costs could increase software
cost of revenue in the future.
Customer Support: Cost of customer support revenue includes costs of customer
support personnel, cost of supplies and spare parts, and the cost of third-party
hardware maintenance. The cost of customer support revenue decreased $1.1
million, or 11%, to $8.7 million for the three months ended June 30, 2003 from
$9.8 million for the three months ended June 30, 2002. The cost of customer
support revenue decreased $1.4 million, or 7%, to $18.5 million for the six
months ended June 30, 2003 from $19.9 million for the six months ended June 30,
2002. These costs represented 21% and 26% of the related customer support
revenue for the three months ended June 30, 2003 and 2002, respectively. These
costs represented 23% and 27% of the related customer support revenue for the
six months ended June 30, 2003 and 2002, respectively.
The decrease in cost of customer support revenue for the three and six months
ended June 30, 2003 compared to the same period in 2002 is primarily
attributable to lower variable compensation expense and lower supplies cost. The
decrease in cost of customer support revenue as a percentage of customer support
revenue was primarily due to automation and process improvements that allowed
growth in the customer and revenue base without a proportional increase in
support personnel and cost. Going forward, we expect customer support cost of
revenue to remain relatively stable in the near term.
Professional Services and Education: Cost of professional services and education
revenue consists primarily of costs of professional services personnel, training
personnel, and third-party independent consultants. The cost of professional
services and education revenue decreased $2.9 million, or 22%, to $10.3 million
for the three months ended June 30, 2003 from $13.2 million for the three months
ended June 30, 2002. The cost of professional services and education revenue
decreased $5.2 million, or 20%, to $21.4 million for the six months ended June
30, 2003 from $26.6 million for the six months ended June 30, 2002. These costs
represented 88% and 91% of the related professional services and education
revenue for the three months ended June 30, 2003 and 2002, respectively. These
costs represented 89% and 88% of the related professional services and education
revenue for the six months ended June 30, 2003 and 2002, respectively.
The decrease in cost of professional services and education revenue in 2003
compared to 2002 was primarily attributable to a reduction in the use of
third-party independent consultants, as well as lower variable compensation
expense; all directly related to the decrease in professional services and
education revenue. We expect professional services and education costs as a
percentage of professional services and education revenue to vary from period to
period, depending on the utilization rates of internal resources and the mix
between the use of internal resources and third-party independent consultants.
Hardware: Cost of hardware revenue includes the cost of assembling and
distributing our OSAR library products, the cost of hardware integration
personnel, and warranty costs. The cost of hardware revenue decreased $0.3
million, or 21%, to $1.3 million for the three months ended June 30, 2003 from
$1.6 million for the three months ended June 30, 2002. The cost of hardware
revenue decreased $1.4 million, or 41%, to $2.1 million for the six months ended
June 30, 2003 from $3.5 million for the six months ended June 30, 2002. These
costs represented 210% and 75% of the related hardware revenue for the three
months ended June 30, 2003 and 2002, respectively. These costs represented 159%
and 75% of the related hardware revenue for the six months ended June 30, 2003
and 2002, respectively.
The decrease in costs of revenue is directly related to the decrease in sales of
OSAR library products. The increase in costs as a percentage of sales reflects
the fixed operating costs relative to reduced sales volume. As we have discussed
previously, this operating segment is not a strategic focus for us.
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Operating Expenses
Research and Development: Research and development expense primarily consists of
costs of personnel to support product development. Research and development
expense increased $0.8 million to $19.7 million, or 4%, for the three months
ended June 30, 2003 from $18.9 million for the three months ended June 30, 2002,
and represented 23% and 21% of total revenue for these respective periods.
Research and development expense increased $2.7 million to $39.0 million, or 8%,
for the six months ended June 30, 2003 from $36.3 million for the six months
ended June 30, 2002, and represented 22% and 21% of total revenue for these
respective periods. The increase year over year in the first half of 2003 is
primarily the result of increased headcount resulting in higher compensation,
benefits and relocation costs related to the eGrail and Shana acquisitions in
April of 2002 and 2003, respectively. This increase was partially offset by a
decrease in variable compensation expense. Research and development headcount
for the three and six month periods ending June 2003 was 455 and 472, compared
to 430 and 461 for the same periods in 2002, respectively. We expect research
and development expense to be at approximately 22% of revenue in the near-term
due to the continuing enhancement of ECM capabilities.
Our research and development efforts are focused on enhancing our ECM
capabilities within the FileNet P8 product line and maintaining legacy products.
These efforts will focus on enhancements to our FileNet P8 platform, Business
Process Management, Web Content Management and the development of integrated
records management and other capabilities. We intend to complement internal
development with third-party software through OEM agreements and may execute
additional technology acquisitions. We expect that competition for qualified
technical personnel will remain intense and may result in higher levels of
compensation expense for us in the future. We believe that research and
development expenditures, including compensation of technical personnel, are
essential to maintaining our competitive position and expect these costs will
continue to constitute a higher than normal percentage of total revenue, as
compared to our competitors, in the near term.
Sales and Marketing: Sales and marketing expense consists primarily of salaries
and benefits, sales commissions and other expenses related to the direct and
indirect sales force, various marketing expenses and the cost of other market
development programs. Sales and marketing expense increased $2.1 million to
$34.9 million, or 6%, for the three months ended June 30, 2003 from $32.8
million for the three months ended June 30, 2002, and represented 40% and 37% of
total revenue for these respective periods. Sales and marketing expense
increased $4.2 million to $ 69.3 million, or 6%, for the six months ended June
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30, 2003 from $65.1 million for the six months ended June 30, 2002, and
represented 40% and 37% of total revenue for these respective periods.
The increase in 2003 was primarily due to investment in our sales and marketing
capabilities that include targeted contact and campaign management for specific
industries, and channel partner development expenses associated with the launch
of our FileNet P8 ECM product that occurred in the first half of 2003. This
increase was partially offset by reduced commissions and variable compensation
expense. We expect marketing and sales expense to be at approximately 39% of
revenue in the near-term due to the continuing investment in demand generation
capabilities for targeted customers through our direct and indirect sales
channels.
General and Administrative: General and administrative expense consists
primarily of personnel costs for finance, information technology, legal, human
resources and general management, and the cost of outside professional services.
General and administrative expense decreased $0.3 million to $8.3 million, or
3%, for the three months ended June 30, 2003 from $8.6 million for the three
months ended June 30, 2002, and represented 10% of total revenue for these
respective periods. General and administrative expense decreased $0.6 million to
$16.2 million, or 4%, for the six months ended June 30, 2003 from $16.8 million
for the six months ended June 30, 2002, and represented 10% of total revenue for
these respective periods.
The decrease in the first six months of 2003 compared to first six months of
2002 was primarily due to on-going cost containment efforts and reduced variable
compensation expense. We expect general and administrative expenses to remain at
approximately 10% of revenue for the near term.
Amortization of Purchased Intangible Assets
The April 2002 purchase of eGrail assets resulted in intangible assets comprised
of acquired technology of $3.3 million and patents of $24,000 with assigned
useful lives of five years and two years, respectively. The April 2003 purchase
of Shana resulted in $5.7 million of intangible assets; comprised of acquired
technology of $4.0 million, customer maintenance relationships of $800,000 and
technology manuals and design documents of $600,000. All intangible assets for
this acquisition were assigned a useful life of five years. Non-compete
agreements with former executives of Shana were valued at $277,000 and were
assigned a useful life of between two and three years.
Amortization of acquired technology, and technical manuals and design documents
are recorded on a straight-line basis as a cost of software revenue. Customer
maintenance relationships are amortized on a straight-line basis as cost of
customer support revenue. Amortization of patents and Covenants Not to Compete
are recorded on a straight-line basis as an operating expense. Amortization
expense was approximately $494,000 and $ 677,000 for the three and six months
ended June 30, 2003, respectively, for all intangible assets. Amortization
expense was approximately $168,000 for the three and six months ended June 30,
2002, respectively, for all intangible assets. We determined that these assets
were not impaired at June 30, 2003.
Other Income, Net
Other income, net, consists primarily of interest income earned on our cash and
cash equivalents, short and long-term investments, and other items including
foreign exchange gains and losses, the gain (loss) on sale of fixed assets, and
interest expense. Other income, net was $1.6 million for the three months ended
June 30, 2003 compared to other income, net of $1.9 million for the three months
ended June 30, 2002. Other income, net was $2.7 million for the six months ended
June 30, 2003 compared to other income, net of $2.8 million for the six months
ended June 30, 2002. Other income was essentially unchanged between comparable
periods as foreign exchange gains were offset with reduced investment earnings.
Income Taxes
Our combined federal, state and foreign annual effective tax rate for the three
months ended June 30, 2003, is 26% compared to 21% for the comparable period in
2002. The combined federal, state and foreign annual effective tax rate for the
six months ended June 30, 2003, is 28% compared to 23% for the comparable period
in 2002. The increased tax rate in 2003 was primarily due to the mix of income
earned by the domestic group versus the foreign subsidiaries. FileNet management
will continue weighing various factors throughout the year to assess the
recoverability of its recorded deferred assets and the need for any valuation
allowance against such amounts. Any adjustment to the valuation allowance could
affect both additional paid in capital and the effective tax rate in subsequent
quarters.
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Liquidity and Capital Resources
At June 30, 2003, combined cash, cash equivalents and investments totaled $205.8
million, an increase of $20.6 million from December 31, 2002.
Cash provided by operating activities during the six months ended June 30, 2003
totaled $28.3 million and resulted primarily from: an increase in unearned
maintenance revenue related to prepaid maintenance contracts of $10.0 million,
additions to net income for depreciation and amortization expense of $9.9
million, net income of $2.8 million, and a decrease in accounts receivable of
$8.9 million, partially offset by a decrease of $3.4 million in customer
deposits and advances. The increase in unearned maintenance revenue is primarily
the result of the growth in our base of annual support contracts resulting from
new customer sales and sales of additional products to the existing base.
Additionally, a significant number of maintenance contracts renew early in the
year and are amortized ratably throughout the year resulting in a lower balance
in unearned maintenance by December 31.
For the six months ended June 30, 2003 cash used for investing activities
totaled $8.9 million and included: capital expenditures of $5.0 million, and
$8.1 million for the acquisition of Shana, offset by net proceeds of the sales
of marketable securities of $4.1 million.
Cash provided by financing activities totaled $4.2 million and was a result of
proceeds received from the exercise of employee stock options and stock
purchases under the employee stock purchase plan.
We had a $5.0 million multi-currency revolving line of credit. On June 27, 2003,
this credit facility expired in accordance with its terms and was not renewed
because the cost of carrying the line did not justify the level of usage. We
will be able to meet our bank guarantee needs through our existing bank
relationships in the United States and internationally.
Contractual cash obligations of significance include operating leases for our
corporate offices, sales offices, development and manufacturing facilities, and
other equipment under non-cancelable operating leases, some of which have
renewal options and generally provide for escalation of the annual rental
amount. (See Note 9 to the Notes to Unaudited Condensed Consolidated Financial
Statements for additional details.)
We believe 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 12 months.
Other Financial Instruments
We conduct business on a global basis in several currencies. Accordingly, we are
exposed to movements in foreign currency exchange rates. We enter into forward
foreign exchange contracts to minimize the short-term impact of currency
fluctuations on monetary assets and liabilities denominated in currencies other
than the functional currency of the relevant entity. We do not enter into
foreign exchange forward contracts for trading purposes. 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 as
other income in the consolidated statements of operations. We open new hedge
contracts on the last business day of each quarter that will mature at the end
of the following quarter. The counterparties to these contracts are major
financial institutions. We use commercial rating agencies to evaluate the credit
quality of the counterparties and do not anticipate nonperformance by any
counterparties. We do not anticipate a material loss resulting from any credit
risks related to any of these institutions.
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Recently Adopted Accounting Pronouncements
In June 2001, the FASB issued SFAS No. 141, "Business Combinations," which was
effective immediately. SFAS No. 141 requires that the purchase method of
accounting be used for all business combinations initiated after June 30, 2001
and it eliminated the pooling-of-interests method. The adoption of this standard
did not have a significant impact on our consolidated financial statements. Our
April 2002 acquisition of certain assets and certain liabilities of eGrail, Inc.
and our April 2003 acquisition of Shana Corporation were accounted for in
compliance with this pronouncement (See Note 3 for details).
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which we adopted January 1, 2002. SFAS No. 142 requires that goodwill
and other intangible assets with indefinite useful lives no longer be amortized,
but instead be tested for impairment at least annually and written down when
impaired. SFAS No. 142 requires purchased intangible assets other than goodwill
to be amortized over their useful lives, unless these lives are determined to be
indefinite. In accordance with this standard, we do not amortize goodwill and
indefinite life intangible assets but evaluate their carrying value annually or
when events or circumstances indicate that their carrying value may be impaired.
On the first day of July of each year, goodwill will be tested for impairment by
determining if the carrying value of each reporting unit exceeds its fair value.
As of June 30, 2003, no impairment of goodwill has been recognized. If estimates
change, a materially different impairment conclusion could result.
In August 2001, the FASB issued SFAS No. 144, "Accounting for Impairment or
Disposal of Long-Lived Assets." This statement addresses financial accounting
and reporting for the impairment of long-lived assets and for the disposal of
long-lived assets and discontinued operations. SFAS No. 144 superseded SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of," and is effective for fiscal years beginning after
December 15, 2001. The adoption of this standard did not have a material impact
on our consolidated financial position and results of operations.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which addresses financial accounting and
reporting for costs associated with exit or disposal activities and supersedes
EITF Issue 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)." SFAS No. 146 requires that costs associated with exit or
disposal activities be recognized when they are incurred rather than at the date
of a commitment to an exit or disposal plan. SFAS No. 146 also establishes that
the liability should initially be measured and recorded at fair value. We
adopted the provisions of SFAS No. 146 for exit or disposal activities initiated
after December 31, 2002. The adoption of this standard did not have a material
impact on our consolidated financial position and results of operations.
In November 2002, the FASB issued FIN 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees and Indebtedness of
Others," an interpretation of FASB Statement Nos. 5, 57 and 107, and rescission
of FIN 34, "Disclosure of Indirect Guarantees of Indebtedness of Others." FIN 45
elaborates on the disclosures to be made by the guarantor in its interim and
annual financial statements about its obligations under certain guarantees that
it has issued. It also requires that a guarantor recognize, at the inception of
a guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. The provisions related to recognizing a liability at
inception of the guarantee for the fair value of the guarantor's obligations
does not apply to product warranties or to guarantees accounted for as
derivatives. The initial recognition and measurement provisions of this
interpretation are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002, while the disclosure requirements are
effective for financial statements for interim or annual periods ending after
December 15, 2002. The adoption of the recognition of provisions of FIN 45 in
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the three and six months ended June 30, 2003 did not have a material impact on
our consolidated results of operations or financial position.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation Transition and Disclosure," an amendment of SFAS No. 123. This
statement amends SFAS No. 123, "Accounting for Stock-Based Compensation," to
provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, this statement amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The transition guidance and
annual disclosure provisions of SFAS No. 148 are effective for fiscal years
ending after December 15, 2002. The interim disclosure provisions are effective
for financial reports containing financial statements for interim periods
beginning after December 15, 2002. The adoption of SFAS No. 148 did not have a
material impact on our consolidated results of operations or financial position.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest
Entities." In general, a variable interest entity is a corporation, partnership,
trust, or any other legal structure used for business purposes that either (a)
does not have equity investors with voting rights or (b) has equity investors
that do not provide sufficient financial resources for the entity to support its
activities. FIN 46 requires a variable interest entity to be consolidated by a
company if that company is subject to a majority of the risk of loss from the
variable interest entity's activities or entitled to receive a majority of the
entity's residual returns or both. The consolidation requirements of FIN 46
apply immediately to variable interest entities created after January 31, 2003.
The consolidation requirements apply to older entities in the first fiscal year
or interim period beginning after June 15, 2003. Certain of the disclosure
requirements apply in all financial statements issued after January 31, 2003,
regardless of when the variable interest entity was established. We do not have
any variable interest entities as of June 30, 2003. The adoption of FIN 46 did
not have a material impact on our consolidated results of operations or our
financial position.
In April 2003, FASB issued SFAS No. 149, "Amendment of Statement No. 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 (1) clarifies under
what circumstances a contract with an initial net investment meets the
characteristic of a derivative discussed in paragraph 6(b) of Statement No. 133,
(2) clarifies when a derivative contains a financing component, (3) amends the
definition of an underlying derivative to conform it to language used in FIN 45,
and (4) amends certain other existing pronouncements, which will collectively
result in more consistent reporting of contracts as either derivatives or hybrid
instruments. SFAS No. 149 is effective for contracts and hedging relationships
entered into or modified after June 30, 2003. We do not believe that the
adoption of SFAS No. 149 will have a material impact on our consolidated
financial statements.
In May 2003, FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both debt and equity and requires
an issuer to classify the following instruments as liabilities in its balance
sheet:
o a financial instrument issued in the form of shares that is
mandatorily redeemable and embodies an unconditional obligation that
requires the issuer to redeem it by transferring its assets at a
specified or determinable date or upon an event that is certain to
occur;
o a financial instrument, other than an outstanding share, that embodies
an obligation to repurchase the issuer's equity shares, or is indexed
to such an obligation, and requires the issuer to settle the
obligation by transferring assets; and
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o a financial instrument that embodies an unconditional obligation that
the issuer must settle by issuing a variable number of its equity
shares if the monetary value of the obligation is based solely or
predominantly on (1) a fixed monetary amount, (2) variations in
something other than the fair value of the issuer's equity shares, or
(3) variations inversely related to changes in the fair value of the
issuer's equity shares.
SFAS No. 150 is effective for financial instruments entered into or modified
after May 31, 2003 and is effective for all other financial instruments as of
the first interim period beginning after June 15, 2003. SFAS No. 150 is to be
implemented by reporting the cumulative effect of a change in accounting
principle. We do not expect the adoption of SFAS No. 150 to have a material
impact on our consolidated financial statements
Other Matters
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.
Risk 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. Factors that may affect our business, financial condition and results
of operations include:
Our quarterly operating results may fluctuate in future periods and are not
predictable and, as a result, we may fail to meet expectations of investors and
analysts, causing our stock price to fluctuate or decline. Prior operating
results should not necessarily be considered indicative of future operating
results. Our operating results have fluctuated in the past and we anticipate our
future operating results will continue to fluctuate due to many factors, some of
which are largely beyond our control.
These factors include, but are not limited to, the following:
o the industry-wide slow down in IT spending;
o general domestic and international economic and political conditions;
o the discretionary nature of our customers' budget and purchase cycles and
the absence of long-term customer purchase commitments;
o the tendency to realize a substantial percentage of our revenue in the
last weeks, or even days, of each quarter;
o the potential for delays or deferrals of customer orders;
o the size, complexity and timing of individual transactions;
o changes in foreign currency exchange rates;
o the length of our sales cycle;
o variations in the productivity of our sales force;
o the level of software product sold and price competition;
o the timing of new software introductions and software enhancements by us
and our competitors;
o the mix of sales by products, software, services and distribution channels;
o project overruns associated with fixed price contracts;
o acquisitions by us and our competitors;
o our ability to develop and market new software products and control costs;
o the quality of our customer support; or
o the level of international sales.
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The decision to implement our products is subject to each customer's
resources and budget availability. Our quarterly sales generally include a mix
of medium sized orders, along with several large individual orders, and as a
result, the loss or delay of an individual large order could have a significant
impact on our quarterly operating results and revenue. Our operating expenses
are based on projected revenue trends and are generally fixed. Therefore, any
shortfall from projected revenue may cause significant fluctuations in operating
results from quarter to quarter. As a result of these factors, revenue and
operating results for any quarter are subject to fluctuations and are not
predictable with any significant degree of accuracy. Therefore, we believe that
period-to-period comparisons of our results of operations 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 decline materially.
The markets in which we operate are highly competitive and we cannot be
sure that we will be able to continue to compete effectively, which could result
in lost market share and reduced revenue. The markets we serve are highly
competitive and we expect competition to intensify. Our future financial
performance will depend primarily on the continued growth of the markets for our
software products and services as well as the purchase of our products by
customers in these markets. If the markets we serve fail to grow or grow more
slowly than we currently anticipate, our business, financial condition and
operating results would be harmed. These intensely competitive markets can
change rapidly. We have multiple competitors and there may be future
competitors, some of which have or may have substantially greater sales,
marketing, development and financial resources. As a consequence, our present or
future competitors may be able to develop software products comparable or
superior to those offered by us, offer lower priced products or adapt more
quickly than we do to new technologies or evolving customer requirements. We
cannot predict new competitors entering our market through acquisitions or other
alliances. In order to be successful in the future, we must respond to
technological change, customer requirements and competitors' current software
products and innovations. We cannot assure that we will be able to continue to
compete effectively in our target markets 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 we serve. 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 that could result in reduced revenue.
We must develop and sell new products to keep up with rapid technological
change in order to achieve future revenue growth and profitability. 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 ability to continue to
sell products 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. Our future success also depends, in part, on our
ability to execute on our strategy of delivering a unified platform and
framework for Enterprise Content Management. This strategy requires us to make
long-term investments and commit significant resources based on our prediction
of new products and services that the market needs and will accept. Our strategy
also requires us to develop and maintain relations with technology partners. We
may not be successful in maintaining these relationships or in developing,
marketing and releasing new products or new versions of our products that
respond to technological developments, evolving industry standards or changing
customer requirements. We may also experience difficulties that could delay or
prevent the successful development, introduction and sale of these products and
enhancements. In addition, these products and enhancements may not adequately
meet the requirements of the marketplace and may not achieve any significant
degree of market acceptance. If we fail to successfully maintain or establish
relationships with technology partners or to execute on our integrated product
solution strategy, or if release dates of any future products or enhancements
are delayed, or if these products or enhancements fail to achieve our prediction
of market acceptance when released, our business operating results and financial
condition could be materially harmed. In the past, we have experienced delays in
33
the release dates of enhancements and new releases to our products and we cannot
assure that we will not experience significant future delays in product
introduction. From time to time, our competitors or we may announce new software
products, capabilities or technologies that have the potential to replace or
shorten the life cycles of our existing software products. We cannot assure 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, and such delays could have a material adverse effect on our sales.
We must effectively manage our new product and services transitions or our
revenue may suffer. If we do not make an effective transition from existing
products and services to our FileNet P8 architecture, our revenue may be
seriously harmed. Among the factors that make a smooth transition difficult are
delays in development, variations in pricing, delays in customer purchases in
anticipation of new introductions and customer demand for the new offerings. If
we incur delays in customer purchases or do not accurately estimate the market
effects of new introductions, future demand for our products and services and
our revenue may be seriously harmed.
Protection of our intellectual property and other proprietary rights is
limited, which could result in the use of our technology by competitors or other
third parties. There is risk of third-party claims of infringement, which could
expose us to litigation and other costs. 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, patents, confidentiality procedures and contractual provisions to
protect our proprietary rights in our software products. We cannot assure that
our existing or future copyrights, trademarks, trade secrets, patents or other
intellectual property rights will have sufficient scope or strength to provide
meaningful protection or a commercial advantage to us. 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. Any inability to protect our intellectual
property may harm our business and competitive position.
We may, from time to time, be notified that we are infringing certain
patent or intellectual property rights of others. While there are no material
actions currently pending against us for infringement of patent or other
proprietary rights of third parties, we cannot assure that third parties will
not initiate infringement actions against us in the future. Combinations of
technology acquired through past or future acquisitions and our technology will
create new software products and technology that also may give rise to claims of
infringement. Infringement actions can result in substantial costs and diversion
of resources, regardless of the merits of the actions. If we were found to
infringe upon the rights of others, we cannot assure that we could redesign the
infringing products or could obtain licenses on acceptable terms, if at all.
Additionally, significant da