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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from -------- to --------.
Commission File Number 0-15997
FILENET CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 95-3757924
(State or other jurisdiction of (I.R.S. Employer Identification No.)
of incorporation or organization)
3565 Harbor Boulevard, Costa Mesa, California 92626
(Address of principal executive office) (Zip code)
Registrant's telephone number, including area code: (714) 327-3400
Securities registered pursuant to Section 12(b) of the Act: None Securities
registered pursuant to Section 12(g) of the Act:
Title of each class Name of each exchange which registered
Common stock, $0.01 par value Nasdaq
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 disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K [X]
Based on the closing sale price of March 20, 2000, the aggregate market value of
the 33,769,076 shares of voting stock of the Registrant held by nonaffiliates of
the Registrant on such date was $1,046,841,356. For purposes of such
calculation, only executive officers, board members and beneficial owners of
more than 10% of the Company's outstanding common stock are deemed to be
affiliates.
The number of shares outstanding of the Registrant's common stock was 34,004,009
at March 20, 2000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's definitive proxy statement for its 2000 Annual Meeting
are incorporated by reference into Part III as set forth herein. Portions of
Registrant's Annual Report to Stockholders for the fiscal year ended December
31, 1999 are incorporated by reference into Parts II, III and IV as set forth
herein.
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FILENET CORPORATION
FORM 10-K
For the Year Ended December 31, 1999
INDEX
Page
PART I
Item 1. Business...............................................................2
Item 2. Properties.............................................................9
Item 3. Legal Proceedings......................................................9
Item 4. Submission of Matters to a Vote of Security Holders............. .....10
PART II
Item 5. Market for the Registrant's Common Stock and Related .................11
Stockholder Matters
Item 6. Selected Financial Data...............................................12
Item 7. Management's Discussion and Analysis of Financial Condition ..........13
and Results of Operations
Item 8. Financial Statements and Supplementary Data...........................19
Item 9. Changes in and Disagreements with Accountants on Accounting ..........19
and Financial Matters
PART III
Item 10. Directors and Executive Officers of the Registrant...................19
Item 11. Executive Compensation...............................................19
Item 12. Security Ownership of Certain Beneficial Owners and Management.......19
Item 13. Certain Relationships and Related Transactions.......................20
PART IV
Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K......20
Signatures....................................................................23
1
PART I
Item 1. Business
GENERAL
FileNET Corporation develops, markets, and services Web-based content
management and eBusiness applications that help corporations and government
organizations build Intranets, business-to-business and business-to-consumer
portals to manage their business information and work processes more
productively. Our Panagon(TM) software products allow users to create, access,
edit, process, organize, secure, store and archive digital content of all types
for Web-based applications, as well as client/server environments. We also offer
professional services relative to the implementation of these software products
and 24x7 customer support. Additionally, we manufacture and sell a line of
12-inch optical storage and retrieval libraries (OSARs(R)).
Markets and Applications
We offer a family of complementary software products under the brand
name Panagon. These products enable users to manage, on an enterprise-wide
basis, the storage, processing and workflow of documents and other unstructured
information that are part of a centralized or distributed server repository or
Web site. This content may include scanned images, faxes, text, spreadsheets,
HTML/XML pages, graphics, drawings, photographs, computer output reports, voice,
and video. Our software products provide both client/server-based and
Web-centric content management architecture solutions that can be implemented on
a modular basis. Organizations can choose one, some, or all of our software
products to build the solution that most effectively meets their needs. Our
customers are typically those enterprises that have active paper document files,
process significant numbers of electronic documents/transactions in their
day-to-day operations, or have complex, mission-critical business processes for
a variety of applications such as mortgage loan servicing, customer relationship
management, enterprise resource planning, insurance claims processing,
regulatory compliance, accounts payable and receivable, and Web-based content
management. Additionally, our software products address ad hoc business
processes at the departmental and workgroup levels to improve overall enterprise
productivity and integrate with industry-standard productivity applications like
Microsoft Office, Lotus Notes, and SAP R/3.
We market our products in more than 70 countries through a direct sales
force and our ValueNET(R) partner community consisting of systems integrators,
value-added resellers and distributors. More than 350 firms operate as
third-party resellers under our ValueNET program and combine our software
products with vertical market-specific value-added services to provide turnkey
solutions and complex systems integration for customers. We also have OEM
agreements with other firms involving our software products.
Our customer support operating segment offers software maintenance
service for our products worldwide. Our professional services operating segment
offers training, implementation and other technical consulting services to both
end-users of our products and to resellers. Professional services are marketed
by our direct sales force and by our resellers.
ProducTS
Software
Our Panagon family of software products help organizations build
eBusiness applications by providing electronic process (eProcess) and electronic
content (eContent) management solutions. eContent management is the ability to
organize and deliver digital documents, images, sounds, data and all forms of
electronic content via the Web content which is often the result of an
interactive business process (new piece-part pricing in an online supply chain,
for example). eProcess management automates these processes using the Web,
incorporating employees and other groups such as business partners and customers
in order to improve operating efficiency and increase sales. Our Panagon
software products are organized around Panagon Web Services, the core product
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and development platform that integrates with each of the Panagon products to
build eBusiness applications. Through the end of 1999, Panagon technology has
been used by over 400 companies to manage eBusiness processes and millions of
pages of Web content. The Panagon family includes a complete suite of software
components that are built to work together, mitigating integration issues
customers may have when attempting to combine products from different vendors.
With Panagon, we have created a software infrastructure that allows
customers to capture documents or digital information electronically, then
access, manage, publish and integrate the information with their existing
critical business applications throughout the enterprise. Using Microsoft's
Windows Explorer or Netscape Web browsers, customers can search the enterprise
network for information, retrieve documents and data of all types, work with the
information, and then route it as needed for further review, processing, or
decision making.
The following software products are currently being offered by us:
Panagon Web Services combines a significantly enhanced,
full-featured, Web browser-based thin client, a comprehensive
Web-centric application development tool kit, and Web server
components, to support dynamic eContent and complex eProcess
business activities. The out-of the-box application provides a
complete set of content management functionality, allowing users
to check in, check out, search and browse, share, revise and
change properties for a Panagon repository document, all from the
Web. The Panagon Web Services client maintains near-identical
functionality and look and feel with the Panagon IDM Desktop thick
client, including seamlessly managing and viewing more than 200
document formats via a familiar Window Explorer-like user
interface. The Web development environment features a full suite
of Active X controls and supports most popular Web programming
languages for developing customized, line of business
applications.
Panagon integrated document management (IDM) Desktop is a
client-level software application which allows users to view,
manage, revise, share and distribute documents across an
enterprise for ad hoc or mission critical use, from Microsoft
Windows-based clients. Panagon IDM Desktop supports an identical
set of document access and management features as the Panagon Web
Services thin client, including multiple levels of security,
stored reusable search templates and support for compound
documents, providing greatly improved team collaboration. Tight
integration with industry standard software applications including
Microsoft Office 97, Office 2000 and Lotus Notes enables Panagon
eContent management directly from within these applications. With
the built-in workflow and integrated email features (including
with Microsoft Outlook), users can create work processes to
include others that need to share, distribute, or approve.
Panagon Content Services (formerly Document Services) is an
enterprise-class document repository system for creating
accessing, managing, securing and dynamically updating
business-critical electronic documents. A full-featured back end
for eContent management, with Panagon Web Services or IDM Desktop
client software Panagon Content Services manages electronic
documents throughout their lifecycle.
Panagon Image Services is a high-performance image and object
repository system that integrates with Panagon Web Services and
Panagon IDM Desktop for storing, managing, and retrieving images,
documents and electronic content of all types from many sources,
including scanned paper, fax, EDI, and the Web.
Panagon IDM Services includes content services and image services
in a single offering package to allow customers to deploy
full-featured systems for electronic document lifecycle management
and image and object storage and management, all eContent server
operations at one time, saving deployment expense and reducing the
cost of ownership.
Panagon Visual WorkFlo(R) is an object-oriented, high-transaction,
scalable business process automation solution allowing customers,
partners and internal users to drive critical business activities
and personalized content creation. Providing an infrastructure for
eProcess management, Panagon Visual WorkFlo can be used to create
applications that reflect the way work processes are performed,
and is a critical enabling technology for the automation of
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business-to-business eCommerce via the Web. It allows managers to
control and modify work processes to meet the needs of a dynamic
business environment, and integrates information flow between
software applications within a company's business processes.
Panagon Visual WorkFlo supports multiple client, server and
applications development environments such as Java and integrates
with leading business process reengineering products for reduced
implementation time.
Panagon Report Manager processes computer print data streams to
provide online statement and report management for eBusiness
applications that require access to legacy data. It allows
organizations to index, store, access, mine and analyze
computer-generated reports and forms such as customer statements,
claims, and billing statements electronically, eliminating the
need for manual printing and distribution. Evolving from its
computer output to laser disk (COLD) background, Panagon Report
Manager provides significantly enhanced eContent management
capabilities, including a new `super thin' client allowing
authorized users to view Report Manager processed statements via
the Web, requiring none of our software.
Panagon Capture Professional (formerly Panagon Capture) is an
enterprise document capture application that has a complete set of
highly-configurable components for capturing virtually all
document types: scanned paper documents, fax, email, word
processing documents, spreadsheets, HTML, audio and video clips,
and images, making them immediately available to users. Its
modular components, substantial support for automated image
identification and enhancement capabilities, and high-speed
document processing to Panagon Image Services are optimized for
high volume, enterprise-wide production capture operations.
Panagon Capture Desktop is a new capture application which
acquires and processes digital and paper-based documents into the
Content Services repository, providing an easy-to-use front end
for eContent management. Panagon Capture Desktop is designed to
address the scanning and document capture needs of low-to-medium
volume environments of all types, particularly eBusiness Web
deployment teams, small accounting and finance departments, and
engineering groups. Featuring a basic, intuitive interface for all
scanning and importing functions, Panagon Capture Desktop also
includes built-in image enhancement features and provides support
for third party software components such as PDF conversion.
Panagon Document Warehouse(TM) for SAP software is a document and
data archiving application certified by SAP, for use with the
popular R/3 Enterprise Resource Planning (ERP) application suite.
Panagon Web Publisher ("PWP") is an important component of our
extended Panagon Web Services infrastructure. PWP simplifies and
automates Web publishing operations for Internet, intranet, and
extranet Web sites by providing indexing and automatic formatting
for MS-Word and other native format documents that authors simply
drag and drop to the appropriate Panagon Web site repository
folder. It eliminates virtually all HTML hand coding,
dramatically reducing workloads for Web masters, information
technology staff, and Web publishers. Panagon Web Publisher can
automatically update entire Web sites and on-line compound
documents without manual intervention, avoiding problems with
broken links and virtually eliminating out-of-date Web documents.
PWP can be further extended using Microsoft Active Server Pages
(ASPs) to deliver customized Web applications
Panagon WorkGroup(TM) software is a midrange document imaging and
work management product based on a subset of the Panagon products
combined with certain pre-packaged software applications.
Watermark(R) software products have enabled users worldwide to
exchange, process and share scanned images, faxes and other
electronic documents within departments and workgroups of large
enterprises and throughout midsize and small business
environments. Watermark documents and folders are integrated into
existing line-of-business applications and take advantage of
Microsoft operating systems and database technologies. We are
actively pursuing a conversion program to Panagon products for
Watermark customers, and will end formal support for the Watermark
line on March 31, 2000.
4
Hardware
We manufacture and market an OSAR library product based on 12-inch
optical disk technology and also offer optional integration services providing
customers the ability to purchase complete solutions.
All named products mentioned in this Form 10-K, other than our named
products, may reference trademarks or registered trademarks owned by the
respective holder.
RESEARCH AND Development
Our research and development activities are focused on software product
development. Research and development expenditures were $54.3 million, $50.1
million and $40.9 million for the years ended December 31, 1999, 1998, and 1997,
respectively. We believe that our future success depends upon our ability to
continue to enhance our existing software products and to develop new software
products that satisfactorily meet market needs. Accordingly, we intend to
continue to make substantial investments in research and development activities.
BACKLOG
We typically ship our products within a short period of time after
acceptance of orders, which is common in the computer software industry.
Services, Support and manufacturing
We maintain service and support organizations that provide both
pre-sales and post-sales services on a worldwide basis.
Our customer support group provides software maintenance and technical
support services to customers and resellers who have contracted for such
services. This service is provided through telephone response centers in Costa
Mesa, California; Dublin, Ireland; Sydney, Australia; and Singapore, or through
on-site visits to customer sites when necessary. Customer support will also
provide support on a fee-per-service basis for those customers and resellers who
have not entered into a maintenance contract with us. During 1998, we completed
the process of transferring to Hewlett Packard the hardware maintenance we
previously provided. Customers who require maintenance of hardware products
bought from us now contract directly with HP or other service providers for such
service. Previously, customers had contracted with us and we subcontracted the
maintenance work to HP.
Our professional services group provides consulting services to
customers, primarily on a time and material basis and training services. These
services range from management of large-scale implementations of our products to
pre-packaged standard services such as software installation. Services are
provided by consultants employed directly by us and through a network of
qualified partners.
Our facilities in Costa Mesa, California and Dublin, Ireland, conduct
software manufacturing, localization, integration, test and quality control.
EMPLOYEES
As of December 31, 1999, we had 1,693 full-time employees of which 382
were employed in research and development; 474 in sales, 76 in marketing, 209 in
education and professional services, 297 in customer support; 95 in operations;
and 160 in administration. No employees are represented by labor unions, and we
have never experienced a work stoppage. We believe that we enjoy good employee
relations.
5
COMPETITION
The market for our products is highly competitive. Our principal
competitors for our various product lines include the following companies: 1)
Workflow and document imaging - Banctec, Inc., IBM, Keyfile, Optika, Unisys
Corporation, Mosaix, Eastman Software (a Kodak company), 2) Electronic Document
Management - Documentum, IBM, Interleaf, Novasoft, Novell, Open Text, and
Hummingbird 3) COLD - Computron, IBM and Microbank. Numerous smaller software
vendors also compete in each product area. We also experience competition from
systems integrators who configure hardware and software into customized systems.
Database vendors such as Oracle, Sybase and Informix, messaging vendors
such as Microsoft and IBM, and Web content vendors such as Broadvision and
Vignette may compete with us in the future. It is also possible that new
competitors or alliances among competitors may emerge and rapidly acquire
significant market share. We also expect that competition will increase as a
result of software industry consolidations. See "Certain Considerations -
Competition" below.
PATENTS AND LICENSES
We hold three patents for our OSAR product which expire August 26,
2003, June 23, 2004 and August 4, 2004. We have also entered into non-exclusive
license arrangements with a number of organizations, including IBM and Oracle,
which permit us and our resellers to grant sublicenses to end users of our
systems to use software developed by these third party vendors. See "Certain
Considerations - Intellectual Property and Other Proprietary Rights" below.
CERTAIN CONSIDERATIONS
This Annual Report on Form 10-K contains forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995,
Section 21E of the Securities 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. These forward looking-statements involve risks and
uncertainties, including those discussed below and in the notes to the Annual
Report on Form 10-K for the year ended December 31, 1999, certain sections of
which are incorporated herein by reference as set forth in Items 7 and 8 of this
report. The actual results that we achieve may differ materially from any
forward-looking statements, which reflect management's opinions only as of the
date hereof. We undertake no obligation to revise or publicly release the
results of any revisions to these forward-looking statements. Readers should
carefully review the factors described below 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 1999 and the Quarterly Reports on Form 10-Q to be filed
by us in 2000. 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:
Rapid Technological Change; Product Development. The market for our
software and services is characterized by rapid technological developments,
evolving industry standards, changes in customer requirements and frequent new
product introductions and enhancements. Our continued success will be dependent
upon our ability to continue to enhance our existing software and services
offerings, develop and introduce, in a timely manner, new software products
incorporating technological advances and respond to customer requirements. There
can be no assurance that we will be successful in developing and marketing new
software products and services offerings or enhancements to our existing
software on a timely basis or that any new or enhanced software and services
offerings will adequately address the changing needs of the marketplace. If we
are unable to develop and introduce new software and enhancements or new service
offerings, in a timely manner in response to changing market conditions or
customer requirements, our business and operating results could be adversely
affected. From time to time, we or our competitors may announce new software
products, capabilities or technologies that have the potential to replace or
shorten the life cycles of our existing software products. There can be no
assurance that announcements of currently planned or other new software products
will not cause customers to delay their purchasing decisions in anticipation of
such software products, which could have a material adverse effect on our
business and operating results.
6
Uncertainty of Future Operating Results; Fluctuations in Quarterly
Operating Results. Prior growth rates in our revenue and operating results
should not necessarily be considered indicative of future growth or operating
results. Future operating results will depend upon many factors, including the
demand for our products; the level of software product and price competition;
the length of our sales cycle; variations in the productivity of our sales
force; seasonality of individual customer buying patterns; the size and timing
of individual transactions; the delay or deferral of customer implementations;
the budget cycles of our customers; the timing of new software introductions
and software enhancements by us and our competitors; the mix of sales by
products, software, services and distribution channels; levels of international
sales; acquisitions by competitors; changes in foreign currency exchange rates,
impact of the EURO currency; our ability to develop and market new software
products and control costs; and general domestic and international economic and
political conditions.
As a result of these factors, revenues and operating results for any
quarter are subject to variation and are not predictable with any significant
degree of accuracy. Therefore, we believe that period-to-period comparisons of
our results of operations are not necessarily meaningful and should not be
relied upon as indications of future performance. Moreover, such factors could
cause our operating results in a given quarter to be below the expectations of
public market analysts and investors. In either case, the price of our common
stock could be materially adversely affected.
Competition.The Web content management, integrated document management,
imaging, workflow, computer output to laser disk and electronic document
management software markets are highly competitive, and there are certain
competitors of ours with substantially greater sales, marketing, development and
financial resources. We believe that the competitive factors affecting the
market for our software products and services include vendor and product
reputation; product quality, performance and price; the availability of software
products on multiple platforms; product scalability; product integration with
other enterprise applications; software functionality and features; software
ease of use; and the quality of professional services, customer support services
and training. The relative importance of each of these factors depends upon the
specific customer involved. While we believe we compete favorably in each of
these areas, there can be no assurance that we will continue to do so. Moreover,
our present or future competitors may be able to develop software products
comparable or superior to those offered by us, offer lower price products or
adapt more quickly than we do to new technologies or evolving customer
requirements. Competition is expected to intensify. In order to be successful in
the future, we must respond to technological change, customer requirements and
competitors' current software products and innovations. There can be no
assurance that we will be able to continue to compete effectively in our market
or that future competition will not have a material adverse effect on our
business, financial condition or results of operations. In addition, current and
potential competitors have established or may establish cooperative
relationships among themselves or with third parties to increase the ability of
their products to address the needs of the markets served by us. Accordingly, it
is possible that new competitors or alliances among competitors may emerge and
rapidly acquire significant market share. Increased competition may result in
price reductions, reduced gross margins and loss of market share, any of which
could have a material adverse effect on our business, financial condition or
results of operations.
Intellectual Property and Other Proprietary Rights.Our success depends,
in part, on our ability to protect our proprietary rights to the technologies
used in our principal products. We rely on a combination of copyrights,
trademarks, trade secrets, confidentiality procedures and contractual provisions
to protect our proprietary rights in our software products. There can be no
assurance that our existing or future copyrights, trademarks, trade secrets or
other intellectual property rights will be of sufficient scope or strength to
provide meaningful protection or a commercial advantage to us. We have no
software patents. In addition, the laws of some foreign countries do not protect
our proprietary rights to the same extent as do the laws of the United States.
There can be no assurance that such factors would not have a material adverse
effect on our business, financial condition or results of operations. In
addition, we also rely on certain software that we license from third parties,
including software that is integrated with internally developed software used in
our products to perform key functions. There can be no assurance that such third
parties will remain in business, that they will continue to support their
software products, or that their software products will otherwise continue to be
available to us on commercially reasonable terms. The loss or inability to
maintain any of these software licenses could result in delays or reductions in
software shipments until equivalent software can be developed, identified,
licensed and integrated, which could adversely affect our business, financial
condition or results of operations.
7
We may, from time to time, be notified that we are infringing certain
patent or intellectual property rights of others. Combinations of technology
acquired through past or future acquisitions and our technology will create new
software products and technology that may give rise to claims of infringement.
While no actions other than those discussed below are currently pending against
us for infringement of patent or other proprietary rights of third parties,
there can be no assurance that third parties will not initiate infringement
actions against us in the future. Infringement actions can result in substantial
cost to, and diversion of, resources. If we were found to infringe upon the
rights of others, no assurance can be given that we could redesign the
infringing products or could obtain licenses on acceptable terms or at all, that
significant damages for past infringement would not be assessed or that further
litigation relative to any such licenses or usage would not occur. The failure
to successfully defend any claims or redesign our products or obtain necessary
licenses or other rights, the ultimate disposition of any claims or the advent
of litigation arising out of any claims of infringement, could have a material
adverse effect on our business, financial condition or results of operations.
In October 1994, Wang Laboratories, Inc. (Wang) filed a complaint in
the United States District Court for the District of Massachusetts alleging that
we are infringing five patents held by Wang (the FileNET Case). On June 23,
1995, Wang amended its complaint to include an additional related patent. On
July 2, 1996, Wang filed a complaint in the same court alleging that Watermark
Software Inc., formerly a wholly owned subsidiary that was merged with us, is
infringing three of the same patents asserted in the initial complaint (the
Watermark Case). On October 9, 1996, Wang withdrew its claim in the FileNET Case
that one of the patents it initially asserted is infringed.
In March 1997, Eastman Kodak Company (Kodak) purchased the Wang imaging
business unit that has responsibility for this litigation. On July 30, 1997, the
Court permitted Eastman and Kodak Limited of England to be substituted in the
litigation in place of Wang.
We have moved for summary judgment on noninfringement as to each of the
five patents in the suit, and for summary judgment of invalidity as to one of
the patents. Eastman moved for summary judgment as to our unenforceability
defense on one of the patents. In July 1998, the Magistrate Judge assigned to
the case, heard oral arguments on our motion for summary judgment that U.S.
Patent 4,918,588 is not infringed and is invalid. The Magistrate Judge has not
yet decided these motions. We believe that after he has ruled on these motions,
he will hear oral arguments in the remaining motions in the sequence in which
they were filed. A trial date has not been set.
If it should be determined that the patents at issue in the litigation
are valid and are infringed by any of our products, including Watermark
products, we will, depending on the product, redesign the infringing products or
seek to obtain a license to market the products. There can be no assurance that
we will be able to redesign the infringing products or obtain a license on
acceptable terms. Based on our analysis of these Eastman patents and their
respective file histories, we believe that we have meritorious defenses to
Eastman's claims; however, the ultimate outcome or any resulting potential loss
cannot be determined at this time.
Dependence on Certain Relationships. We have entered into a number of
key relationships with other companies such as Microsoft Corporation, IBM Global
Services, Siebel Systems Inc, SAP AG, Hewlett-Packard Company, and Sun
Microsystems, Inc. There can be no assurance that these companies will not
reduce or discontinue their relationships with, or support of, us and our
products.
Dependence on Key Management and Technical Personnel. Our success
depends to a significant degree upon the continued contributions of our key
management, marketing, technical and operational personnel. In general, we do
not utilize employment agreements for our key employees. The loss of the
services of one or more key employees could have a material adverse effect on
our operating results. We also believe our future success will depend in large
part upon our ability to attract and retain additional highly skilled
management, technical, marketing, product development, operational personnel and
consultants. Competition for such personnel, particularly software developers,
professional service consultants and other technical personnel, is intense, and
pay scales in the software industry have significantly increased. There can be
no assurance that we will be successful in attracting and retaining such
personnel.
8
International Sales. Historically, we have derived approximately thirty
percent of our total revenues from international sales. International business
is subject to certain risks including varying technical standards; tariffs and
trade barriers; political and economic instability; reduced protection for
intellectual property rights in certain countries; difficulties in staffing and
maintaining foreign operations; difficulties in managing foreign distributors;
varying requirements for localized products; potentially adverse tax
consequences; currency exchange fluctuations including those related to the
EURO; the burden of complying with a wide variety of complex foreign laws,
regulations and treaties; and the possibility of difficulties in collecting
accounts receivable. There can be no assurance that any of these factors will
not have a material adverse effect on our business, financial condition or
results of operations.
Product Liability. Software and products as complex as those sold by us
are susceptible to errors or failures, especially when first introduced or when
new versions are released. Our software products are often intended for use in
applications that are critical to a customer's business. As a result, our
customers may rely on the effective performance of the software to a greater
extent than the market for software products generally. We conduct extensive
software testing to ensure that our software is free of significant errors and
defects. In addition, we have designed and tested the most current versions of
our software products to be year 2000 compliant. However, some of our customers
are running earlier software products that are not year 2000 compliant. Although
we have been encouraging such customers to migrate to current software versions,
no assurance can be given that all of them will do so. Moreover, we also rely on
certain software that we license from third parties, including software that is
integrated with internally developed software and is used in our products to
perform key functions. There can be no assurance that such third party software
will be free of errors and defects or be year 2000 compliant. Although we have
not experienced any material product liability claims to date, there can be no
assurance that errors or defects, whether associated with year 2000 functions or
otherwise, will not result in product liability claims against us in the future.
A successful product liability claim brought against us could have a material
adverse effect upon our business, operating results and financial condition. Our
license agreements with customers typically contain provisions designed to limit
our exposure to potential product liability claims. However, it is possible that
such limitation of liability provisions may not be effective under the laws of
certain jurisdictions.
Item 2. Properties
We currently lease 280,000 square feet of office, development and
manufacturing space in Costa Mesa, California and 92,000 square feet of office
and development space in Kirkland, Washington. We also lease sales and support
offices in 27 locations in the United States, 15 in Europe, 3 in Australia, 5 in
Canada, and 4 in Asia. We believe that the Costa Mesa and Kirkland facilities
will be adequate for our anticipated needs through 2000.
Item 3. Legal Proceedings
In October 1994, Wang Laboratories, Inc. (Wang) filed a complaint in
the United States District Court for the District of Massachusetts alleging that
we are infringing five patents held by Wang (the FileNET Case). On June 23,
1995, Wang amended its complaint to include an additional related patent. On
July 2, 1996, Wang filed a complaint in the same court alleging that Watermark
Software Inc., formerly a wholly owned subsidiary that was merged with us, is
infringing three of the same patents asserted in the initial complaint (the
Watermark Case). On October 9, 1996, Wang withdrew its claim in the FileNET Case
that one of the patents it initially asserted is infringed.
In March 1997, Eastman Kodak Company (Kodak) purchased the Wang imaging
business unit that has responsibility for this litigation. On July 30, 1997, the
Court permitted Eastman and Kodak Limited of England to be substituted in the
litigation in place of Wang.
We have moved for summary judgment on noninfringement as to each of the
five patents in the suit, and for summary judgment of invalidity as to one of
the patents. Eastman moved for summary judgment as to our unenforceability
defense on one of the patents. In July 1998, the Magistrate Judge assigned to
the case heard oral arguments on our motion for summary judgment that U.S.
Patent 4,918,588 is not infringed and is invalid. The Magistrate Judge has not
yet decided these motions. We believe that after he has ruled on these motions,
he will hear oral arguments in the remaining motions in the sequence in which
they were filed. A trial date has not been set.
9
If it should be determined that the patents at issue in the litigation
are valid and are infringed by any of our products, including Watermark
products, we will, depending on the product, redesign the infringing products or
seek to obtain a license to market the products. There can be no assurance that
we will be able to successfully redesign the infringing products or obtain a
license on acceptable terms. Based on our analysis of these patents and their
respective file histories, we believe that we have meritorious defenses to these
claims; however, the ultimate outcome or any resulting potential loss cannot be
determined at this time.
On October 27, 1998, plaintiff Thomas P. Nyquist filed a class action
complaint against us and certain of our officers and directors in the United
States District Court for the Central District of California (the Nyquist
Action). The action was purportedly filed on behalf of a class of purchasers of
our common stock during the period April 16, 1998 through October 7, 1998. On
July 22, 1999, defendant filed a motion to dismiss the complaint in its
entirety. On August 19, 1999, the court ordered a stay of the action and removed
defendants' motion to dismiss from the Court's hearing calendar in light of the
pending petition for rehearing and rehearing enbanc in Silicon Graphics Sec.
Litig., Nos. 97-16204, 97-16240, 1999 U.S. App LEXIS 14955 (9th Cir. July 2,
1999). On December 13, 1999, the court entered a Stipulation to Dismiss Entire
Action Without Prejudice.
Subsequent to December 31, 1998, the former shareholders of Saros
Corporation filed a demand for mandatory arbitration to release approximately
two hundred thousand shares of our stock which were held in escrow pursuant to
the Agreement and Plan of Merger dated January 17, 1996 among FileNET
Corporation, FileNET Acquisition Corporation and Saros Corporation and for
damages. We and the Shareholders' Agent had agreed to mediate the matter, but
the Saros Shareholders' Agent cancelled the mediation prior to the scheduled
date and renewed their demand for mandatory arbitration. We believe that we have
meritorious reasons for not releasing the shares and other defenses to the
claims; however, the ultimate or any resulting potential loss cannot be
presently determined.
In the normal course of business, we are subject to various other legal
matters. While the results of litigation and claims cannot be predicted with
certainty, we believe that the final outcome of these other matters will not
have a materially adverse effect on our consolidated results of operations or
financial condition.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the
fourth quarter of fiscal 1999.
10
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters
We believe that a variety of factors could cause the trading price of
our common stock to fluctuate, perhaps substantially, including
quarter-to-quarter variations in operating results; announcements of
developments related to our business; fluctuations in our order levels; general
conditions in the technology sector or the worldwide economy; announcements of
technological innovations, new software products or product enhancements by us
or our competitors; key management changes; changes in joint marketing and
development programs; developments relating to patents or other intellectual
property rights or disputes; and developments in our relationships with our
customers, resellers and suppliers. In addition, in recent years the stock
market in general, and the market for shares of high-technology stocks in
particular, have experienced extreme price fluctuations that have often been
unrelated to the operating performance of affected companies. Such fluctuations
could adversely affect the trading price of our common stock.
Our common stock is traded in the National Market System ("Nasdaq")
under the symbol FILE. The following are the high and low closing prices from
January 1, 1997 through December 31, 1999, as reported by Nasdaq:
High Low
--------------------
1999
4th Quarter $ 25.50 $ 10.38
3rd Quarter 13.38 8.00
2nd Quarter 11.94 6.03
1st Quarter 12.63 6.75
- ---------------------------------------------------------------
1998
4th Quarter $ 12.50 $4.56
3rd Quarter 31.88 14.00
2nd Quarter 29.97 22.81
1st Quarter 24.44 14.89
- ---------------------------------------------------------------
1997
4th Quarter $ 16.32 $8.07
3rd Quarter 10.07 7.75
2nd Quarter 8.32 5.16
1st Quarter 15.88 7.75
The closing price of our common stock on December 31, 1999 was $25.50.
The approximate number of stockholders of record on February 28, 2000, was 673.
The closing price of our common stock on that date was $42.19.
We have not paid any dividends on our common stock. We currently intend
to retain earnings for use in our business and do not anticipate paying cash
dividends in the foreseeable future. Our ability to pay dividends is limited by
the terms of our line of credit agreement.
11
Item 6. Selected Financial Data
The following table summarizes certain selected financial data:
(Dollars in thousands, except per share amounts)
For Fiscal Years Ended
---------------------------------------------------------------------------------------
Dec. 31, 1999 Dec. 31, 1998 Dec. 31, 1997 Dec. 31, 1996 Dec. 31, 1995
(1999) (1998) (1997) (1996) (1995)
-------------- --------------- -------------- -------------- --------------
Consolidated statements of operations data:
Revenue:
Software revenue $ 183,253 $ 171,153 $ 132,723 $ 140,659 $ 116,052
Service revenue 147,449 115,501 89,280 82,118 67,174
Hardware revenue 16,418 23,579 29,422 46,136 46,152
------------ ------------ ------------ ------------ ------------
Total revenue 347,120 310,233 251,425 268,913 229,378
Costs and expenses:
Cost of software revenue 16,984 16,814 13,416 15,389 14,688
Cost of service revenue 85,686 69,586 54,003 51,068 44,277
Cost of hardware revenue 8,805 13,181 20,330 29,633 28,800
Research and development 54,307 50,132 40,927 37,577 25,169
Selling, general and administrative 157,708 161,013 127,622 120,261 96,499
Merger, restructuring, write-off of
purchased in-process research and
development and other costs - 2,000 6,000 16,011 6,393
------------ ------------ ------------ ------------ ------------
Total costs and expenses 323,490 312,726 262,298 269,939 215,826
------------ ------------ ------------ ------------ ------------
Operating income (loss) 23,630 (2,493) (10,873) (1,026) 13,552
Other income, net 3,409 3,840 3,160 2,838 2,780
Income (loss) before income taxes 27,039 1,347 (7,713) 1,812 16,332
Provision (benefit) for income taxes 7,362 391 (2,187) 4,456 8,116
------------ ------------ ------------ ------------ ------------
Net income (loss) $ 19,677 $ 956 $ (5,526) $ (2,644) $ 8,216
------------ ------------ ------------ ------------ ------------
Basic earnings (loss) per share $ 0.61 $ 0.03 $ (0.18) $ (0.09) $ 0.28
Diluted earnings (loss) per share $ 0.59 $ 0.03 $ (0.18) $ (0.09) $ 0.26
Weighted average shares outstanding -
basic 32,125 31,083 30,310 30,014 28,860
Weighted average shares outstanding -
diluted 33,360 33,367 30,310 30,014 31,712
Consolidated balance sheet data:
Working capital $ 101,777 $ 67,722 $ 79,091 $ 85,475 $ 83,797
Total assets 240,892 206,822 179,440 192,274 187,393
Stockholders' equity 150,458 130,320 118,811 132,806 131,158
Certain reclassifications have been made to the prior years' selected financial
data to conform with the current year's presentation.
12
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion should be read in conjunction with the Consolidated
Financial Statements and Notes thereto submitted as a separate section of this
Form 10-K (Item 14).
Revenue
(Dollars in millions)
Percent Percent
December 31, 1999 change 1998 change 1997
---------------------------------------------------------------------------------------------------------------
Software revenue
Domestic $ 124.3 15% $ 107.7 20% $ 89.7
International 59.0 (7%) 63.5 48% 43.0
----------------------------------------------------------
Total software revenue $ 183.3 7% $ 171.2 29% $ 132.7
Percentage of total revenue 53% 55% 53%
Customer support revenue
Domestic $ 71.5 25% $ 57.0 31% $ 43.4
International 20.4 24% 16.5 50% 11.0
----------------------------------------------------------
Total customer support revenue $ 91.9 25% $ 73.5 35% $ 54.4
Percentage of total revenue 26% 24% 22%
Professional services and education revenue
Domestic $ 35.7 46% $ 24.4 43% $ 17.1
International 13.5 59% 8.5 35% 6.3
----------------------------------------------------------
Total professional services and education
revenue $ 49.2 50% $ 32.9 41% $ 23.4
Percentage of total revenue 14% 10% 9%
Hardware revenue
Domestic $ 12.3 (28%) $ 17.1 (16%) $ 20.4
International 4.1 (37%) 6.5 (28%) 9.0
----------------------------------------------------------
Total hardware revenue $ 16.4 (31%) $ 23.6 (20%) $ 29.4
Percentage of total revenue 5% 8% 12%
Other revenue
Domestic $ 5.2 (16%) $ 6.2 (17%) $ 7.5
International 1.1 (61%) 2.8 (30%) 4.0
----------------------------------------------------------
Total other revenue $ 6.3 (30%) $ 9.0 (22%) $ 11.5
Percentage of total revenue 2% 3% 4%
Total revenue
Domestic $ 249.0 17% $ 212.4 19% $ 178.1
International 98.1 0% 97.8 33% 73.3
----------------------------------------------------------
Total Revenue $ 347.1 12% $ 310.2 23% $ 251.4
----------------------------------------------------------
13
The software revenue growth rate increased 7% and 29% in 1999 and 1998,
respectively. The lower growth rate in 1999 as compared to 1998 was a result of
reduced demand for our products due to customer and prospect focus on year 2000
issues. Our international markets were more impacted by these factors than the
U.S. particularly in the second half of the year.
Customer support revenue consists of revenue from software maintenance
contracts and "fee for service" revenues. Customer support revenue increased 25%
and 35% in 1999 and 1998, respectively, due to the growth of our customer base
through new customer sales and sales of new products to the installed base.
Professional services and education revenue is generated primarily from
consulting and implementation services provided to end users of our software
products, technical consulting services provided to our resellers and training
services. Professional services are primarily performed on a time and material
basis. Professional services and education revenue increased 50% and 41% in 1999
and 1998, respectively. This increase was attributable to our efforts to build
our professional services capabilities to support our solutions-oriented
strategy as well as increased demand for our expanded professional services and
education offerings.
Hardware revenue is generated primarily from the sale of 12-inch OSARs.
Hardware revenue decreased 31% and 20% in 1999 and 1998, respectively, due to
expected decreases in new orders attributable to our continued focus on
software-related revenues. We expect hardware revenue to continue to decline as
a percentage of total revenue.
Other revenue is generated from the sale of spare parts, supplies and
"third party" products. Other revenue decreased 30% and 22% in 1999 and 1998,
respectively, due to decreased sales of spare parts and third party products.
International revenue represented 28%, 32% and 29% of total revenues in
1999, 1998 and 1997, respectively. The lower percentage in 1999 was due to a
weakness in order levels in the European market caused by customers' and
prospective customers' concerns over the year 2000 and, to a lesser extent, the
strengthening of the U.S. dollar against foreign currencies. We expect
international revenue to continue to represent a significant percentage of total
revenue. However, international revenues are subject to certain risks including
but not limited to political and economic instability; and currency
fluctuations.
Cost of Revenue
(Dollars in millions)
------------------------------------------------------------------------------------------------------------
Percent Percent
December 31, 1999 Change 1998 Change 1997
------------------------------------------------------------------------------------------------------------
Cost of software revenue $ 17.0 1% $ 16.8 25% $ 13.4
Percentage of software revenue 9% 10% 10%
Cost of customer support revenue $ 39.4 14% $ 34.7 29% $ 26.9
Percentage of customer support revenue 43% 47% 49%
Cost of professional services and education revenue $ 40.6 47% $ 27.7 40% $ 19.8
Percentage of professional services and
education revenue 83% 84% 85%
Cost of hardware revenue $ 8.8 (33%) $ 13.2 (35%) $ 20.3
Percentage of hardware revenue 54% 56% 69%
Cost of other revenue $ 5.6 (22%) $ 7.2 (1%) $ 7.3
Percentage of other revenue 89% 80% 63%
----------------------------------------------------
Cost of total revenue $ 111.4 12% $ 99.6 14% $ 87.7
----------------------------------------------------
The cost of software revenue includes royalties paid to third parties
and the cost of software distribution. The cost of software revenue as a
percentage of software revenue was 9% in 1999 compared to 10% in 1998 and 1997.
The decrease in 1999 is attributable to distribution costs increasing at a lower
rate than revenue.
14
The cost of customer support revenue includes customer support
personnel, supplies, and the cost of third-party hardware maintenance. The cost
of customer support revenue as a percentage of customer support revenue
decreased to 43% in 1999 from 47% in 1998 and 49% in 1997. The decrease in 1999
is attributable to increased revenue with no proportional increase in costs. The
decrease in 1998 was due to the higher proportion of fees for service revenue,
as opposed to contract maintenance revenue, and the transition of high cost
hardware maintenance services to a third party contractor. The decrease in 1997
is primarily due to the transition of hardware maintenance to a third party
contractor, offset by lower margins associated with international maintenance.
The cost of professional services and education revenue consists
primarily of professional services personnel, training personnel and third party
contractors. The cost of professional services and education revenue as a
percentage of revenue decreased to 83% in 1999 from 84% in 1998. This was
primarily due to higher utilization rates as a result of increased revenue.
However, we expect that competition for qualified technical and managerial
personnel for our professional services segment is intense and will remain so
for the foreseeable future. This may result in higher levels of compensation
expense and higher cost of professional services revenue.
The cost of hardware revenue includes the cost of assembling OSARs and
the cost of hardware integration personnel. The cost of hardware revenue as a
percentage of hardware revenue decreased to 54% in 1999 from 56% in 1998 and 69%
in 1997. The decreases are attributable to a reduction in fixed assembly costs
corresponding to decreases in hardware revenue.
The cost of other revenue includes the cost of supplies, spare parts
and "third party" product. The cost of other revenue as a percentage of other
revenue increased to 89% in 1999 from 80% in 1998 and 63% in 1997. The increase
is due to declining revenue with a fixed expense base and sales of higher cost
product.
Research and Development and Selling, General and Administrative Expense
(Dollars in millions)
Percent Percent
December 31, 1999 Change 1998 Change 1997
----------------------------------------------------------------------------------------------
Research and development $ 54.3 8% $ 50.1 22% $ 40.9
Percentage of total revenue 16% 16% 16%
Selling, general and administrative $ 157.7 (2%) $ 161.0 26% $ 127.6
Percentage of total revenue 45% 52% 51%
------------------------------------------------------
Research and development expenses increased 8% in 1999 primarily due to
an increase in salaries. The 22% increase in 1998 was attributable to market
driven increases in salaries and recruiting costs necessitated by the intense
competitive environment for software engineers and an increase in the cost of
contract developers. As a percentage of total revenue, research and development
expenses were 16% in 1999, 1998 and 1997.
We expect that competition for qualified technical personnel will
remain intense for the foreseeable future and may result in higher levels of
compensation expense for us. We believe that research and development
expenditures, including compensation of technical personnel, are essential to
maintaining our competitive position and expect these costs to continue to
constitute a significant percentage of revenue.
Selling, general and administrative expenses decreased 2% in 1999 and
increased 26% in 1998. The decrease in 1999 was due primarily to overall reduced
spending including reduced legal fees and reduced sales training expenses. The
increase in 1998 was due primarily to the expansion of our sales force, an
increase in sales training costs, and an increase in commissions associated with
higher revenue. Selling, general and administrative expenses, as a percentage of
total revenue, were 45% in 1999, 52% in 1998 and 51% in 1997. The decrease from
1998 to 1999 was primarily due to containment of expenses combined with an
increase in revenues.
15
Restructuring and Other Costs. The $2.0 million in restructuring and
other costs in 1998 represents the costs of a reduction in headcount associated
with the restructuring of our sales and marketing operations, as well as costs
of consolidating facilities. The restructuring and other costs include
approximately $1.1 million for severance payments for 54 employees, $0.7 million
for facility closing costs and $0.2 million of other charges.
The $6.0 million in restructuring and other costs in 1997 represented
the costs of consolidating the Watermark business unit's Burlington,
Massachusetts engineering and marketing functions with those at our Costa Mesa,
California location, as well as a reduction in headcount in certain other areas
of the company. The restructuring and other costs include approximately $2.2
million for severance payments for 111 employees, $2.2 million for the write-off
of assets impaired by the decision to restructure, $0.4 million for facility
closing costs, $0.4 million for equipment lease cancellations, $0.3 million for
cancellation of third party development contracts, $0.2 million related to the
withdrawal of certain products from the market and $0.3 million of other
charges.
At December 31, 1999, the remaining accrued restructuring and other
costs of $0.5 million are included in other accrued liabilities. We anticipate
that the remaining restructuring costs will be expended during 2000 .
Other Income. Interest and other income 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 on sale of
fixed assets, other items of income and interest expense. Other income, net of
other expenses, was $3.4 million in 1999, $3.8 million and $3.2 million in 1998
and 1997, respectively. The decrease in 1999 was attributable to increased
foreign exchange losses and increased interest expense associated with our
foreign currency hedge activities partially offset by increases in interest
income. The increase in 1998 over 1997 was primarily due to a decrease in our
foreign exchange losses.
Provision for Income Taxes. The provision for income taxes was a charge
of $7.4 million in 1999, compared to a charge of $0.4 million and a benefit of
$2.2 million recorded in 1998 and 1997, respectively. The effective tax rate was
27%, 29% and 28% in the years ended December 31, 1999, 1998 and 1997,
respectively. The reduction in 1999 was due to our utilization of net operating
loss carryforwards.
Quantitative and Qualitative Disclosures about Market Risk. We are
exposed to a variety of risks, including changes in interest rates affecting the
return on investments and foreign currency fluctuations. In the normal course of
business, we employ established policies and procedures to manage our exposure
to fluctuations in interest rates and foreign currency values.
Interest Rate Risk. Our exposure to market rate risk for changes in
interest rates relates primarily to our investment portfolio. We have not used
derivative financial instruments in our investment portfolio. We place our
investments with high-quality issuers and, by policy, limit the amount of credit
exposure to any one issuer. We protect and preserve our invested funds by
limiting default, market and reinvestment risk. Our investments in marketable
securities consist primarily of high-grade corporate and government securities
with maturities of less than three years. Investments purchased with an original
maturity of three months or less are considered to be cash equivalents. We
classify all of our investments as available-for-sale. Available-for-sale
securities are carried at fair value, with unrealized gains and losses, net of
tax, reported in a separate component of stockholder's equity.
Foreign Currency Risk. We have entered into forward foreign exchange
contracts primarily to hedge amounts due from and the net assets of selected
subsidiaries denominated in foreign currencies (mainly in Europe and Asia
Pacific) against fluctuations in exchange rates. We have not entered into
forward foreign exchange contracts for speculative or trading purposes. Our
accounting policies for these contracts are based on our designation of the
contracts as hedging transactions. The criteria we use for designating a
contract as a hedge include the contract's effectiveness in risk reduction and
one-to-one matching of derivative instruments to underlying transactions. Gains
and losses on foreign exchange contracts are recognized in income in the same
period as gains and losses on the underlying transactions. If an underlying
hedged transaction is terminated earlier than initially anticipated, the
offsetting gain or loss on the related forward foreign exchange contract would
be recognized in income in the same period. In addition, since we enter into
forward contracts only as a hedge, any change in currency rates would not result
16
in any material net gain or loss, as any gain or loss on the underlying foreign
currency denominated balance would be offset by the gain or loss on the forward
contract. Our forward contracts generally have an original maturity of three
months. The total notional values of forward contracts purchased and forward
contracts sold were $15.9 million and $17.0 million, respectively. We do not
expect gains or losses on these contracts to have a material impact on financial
results (see Note 15 to the consolidated financial statements).
Management believes that inflation has not had a significant impact on
the price of our products, the cost of our materials, or our operating results
for the three years ended December 31, 1999.
FINANCIAL CONDITION
Liquidity and Capital Resources. As of December 31, 1999, combined
cash, cash equivalents, and investments (short and long-term) were $108.7
million, an increase of $26.6 million from the $82.1 million at the end of 1998.
Cash provided by operating activities in 1999 was $38.0 million and
resulted primarily from net income, an increase in unearned maintenance revenue
related to prepaid maintenance contracts, additions to net income for
depreciation and amortization expense offset by an increase in accounts
receivable and a decrease in accounts payable. Cash used by investing activities
totaled $25.4 million, consisting of capital expenditures, proceeds from sales
and the net sale and maturity of marketable securities. Cash provided by
financing activities was $5.5 million consisting primarily of proceeds from the
issuance of common stock in connection with the exercise of employee stock
options and the employee and non-employee director stock purchase plan.
Cash provided by operating activities in 1998 was $33.3 million and was
comprised primarily of additions to net income for depreciation and amortization
expense and increases in accounts payable, accrued compensation, and unearned
maintenance revenue. Cash used by investing activities totaled $23.7 million,
consisting of capital expenditures offset by the net sale and maturity of
marketable securities. Cash provided by financing activities was $9.1 million
consisting of proceeds from issuance of common stock in connection with the
exercise of employee stock options and the employee and non-employee director
stock purchase plan, offset by the cost to repurchase common stock.
Cash provided by operating activities in 1997 was $24.7 million. Cash
used by the net loss for the year was offset by lower accounts receivable
balances associated with a lower average days sales outstanding, lower
inventories associated with our decrease in hardware revenue and additions to
net income for depreciation and amortization. Cash used by investing activities
totaled $11.3 million, consisting of capital expenditures offset by the net sale
and maturity of marketable securities. Cash used by financing activities was
$2.6 million and was the result of the repurchase of common stock offset by
proceeds from the issuance of common stock in connection with the exercise of
employee and non-employee director stock options and the employee stock purchase
plan.
Our capital expenditures were $22.4 million in 1999, $32.5 million in
1998, and $14.3 million in 1997. We anticipate that we will acquire
approximately $27.0 million of capital equipment in 2000. Our primary capital
expenditures are for research and development equipment, demonstration and
training equipment, enhancements to our internal network and business systems,
leasehold improvements on leased property, and furniture. The increase in 1998
capital expenditures over the levels of the prior two years was due primarily to
large internal information technology infrastructure and systems projects, as
well as expenditures incurred to improve and furnish our new office in Kirkland,
Washington. During the first quarter of 1998, we repurchased $4.4 million of our
common stock. We repurchased $10.1 million of our common stock in 1997 for a
total of $14.5 million in treasury stock.
We anticipate that our present cash balances, together with
internally-generated funds and credit lines, will be sufficient to meet our
working capital and capital expenditure needs throughout 2000.
17
OTHER MATTERS
Year 2000. In 1997, we implemented a year 2000 Integrity Program (the
Program) to ensure that our computer software products and internal business
systems would function properly in the year 2000 and thereafter. Since January
1, 2000, we have not experienced any problems with our software products or
internal business systems to properly manage and manipulate data related to the
year 2000.
All new generations of our software products were released as year 2000
compliant. However, not all our software products were year 2000 compliant and
we did not make them so. Accordingly, upgraded year 2000 compliant versions of
such software products were made available to customers and resellers who would
then bear the responsibility for installing the upgraded software product in
order to make their systems year 2000 compliant. Some of our customers were
running software product versions that were not year 2000 compliant. We have
been encouraging such customers to migrate to current software product versions.
All customers were kept informed of the release of year 2000 compliant updates
and upgrades via our readiness disclosure statement on our Web site. The
inability of any of our software products to properly manage and manipulate data
in the year 2000 and beyond could result in increased costs, customer
satisfaction issues, potential lawsuits and other costs and liabilities, as well
as customers being unable to run software licensed from us and incurring
significant costs from the resultant business interruption. We spent an
estimated $1.6 million on year 2000 software product related projects through
December 31, 1999. We formed a rapid response team as part of customer support
that responded to problems during the year 2000 date change period. We spent an
estimated $0.1 million during the year 2000 date change timeframe.
We communicated with significant third party vendors of computer
software with which our systems interface or upon which our software products
depend. Such third party vendors delivered year 2000 versions or guaranteed that
their current computer software was year 2000 compliant. In the event that our
customers have year 2000 related problems with such third party software, we
have been assured that the third party will remediate their own year 2000
issues.
The Program also included a review of all internal IT systems for year
2000 compliance. Our significant business systems (financial, operational,
marketing, customer support, etc.) were reviewed and were either already year
2000 compliant or were upgraded and/or replaced so as to be year 2000 tested and
compliant by October 31, 1999. All of the hardware and software deployed in our
technical infrastructure was either fully year 2000 tested and compliant or had
been replaced with year 2000 compliant components by October 31, 1999. We also
evaluated IT related environmental systems (heating, air conditioning, security,
etc.) and made all such systems year 2000 compliant by October 31, 1999.
Business teams monitored the critical systems, and service centers to react
immediately to facilitate repairs at the end of the year 1999. Data retention
and recovery procedures were in place for critical business data to provide
back-ups with on-site and off-site data copies. Our cost to fund solely year
2000 compliant projects was $1.1 million through December 31, 1999.
The EURO Conversion. On January 1, 1999, eleven of the fifteen member
countries of the European Union established fixed conversion rates between their
existing sovereign currencies and the EURO. These countries have agreed to adopt
the EURO as their common legal currency from that date. The EURO trades on
currency exchanges and is available for non-cash transactions. These countries
will issue sovereign debt exclusively in EURO and will re-denominate outstanding
sovereign debt. Effective on this date, these countries no longer control their
own monetary policies by directing independent interest rates for the legacy
currencies. Instead, the authority to direct monetary policy, including money
supply and official interest rates for the EURO, is exercised by the new
European Central Bank.
The legacy currencies are scheduled to remain legal tender in these
countries as a denomination of the EURO between January 1, 1999 and January 1,
2002 (the "transition period"). During the transition period, public and private
parties may pay for goods and services using either the EURO or the country's
legacy currency on a "no compulsion, no prohibition" basis. However, conversion
rates no longer will be computed directly from one legacy currency to another.
Instead, a "triangulation" process will be applied whereby an amount denominated
18
in one legacy currency first will be converted into an amount denominated in
EURO, and the resultant EURO-denominated amount is converted into the second
legacy currency.
We have made the necessary changes to our internal business systems to
support transactions denominated in the EURO, including establishing EURO price
lists for effected countries. We are in the process of evaluating the impact the
conversion to the EURO will have on our financial condition and results of
operations. Based on this evaluation to date, we currently do not believe that
there will be a material impact on our financial condition or results of
operations as a result of the EURO conversion, except that we cannot currently
assess the impact that a common EURO-based price list will have on how we market
our products in Europe nor the impact, if any, on revenues generated in Europe.
Recent Accounting Pronouncements. In June 1998 the Financial Accounting
Standards Board ("FASB") issued, SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133 as amended, is effective for
fiscal years beginning after June 15, 2000 and will require us to record all
derivatives on the balance sheet at fair value. For derivatives that are hedges,
changes in the fair value of derivatives will be offset by the change in fair
value of the hedged assets, liabilities, or firm commitments. We believe the
impact of adopting this standard will not be material to our results of
operations or equity.
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.
Item 8. Financial Statements and Supplementary Data
The consolidated financial statements for the years ended December 31,
1999, 1998 and 1997 are incorporated herein by reference and submitted as a
separate section of this Form 10-K. (See Item 14).
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
There is hereby incorporated herein by reference the information
appearing under the caption "Election of Directors," under the caption
"Executive Officers of the Company," and under the caption "Compliance with
Securities Laws" of the Registrant's definitive Proxy Statement for our 2000
Annual Meeting to be filed with the Securities and Exchange Commission.
Item 11. Executive Compensation
There is hereby incorporated herein by reference the information
appearing under the caption "Executive Compensation" and under the caption
"Election of Directors" of the Registrant's definitive Proxy Statement for our
2000 Annual Meeting to be filed with the Securities and Exchange Commission.
Item 12. Security Ownership of Certain Beneficial Owners and Management
There is hereby incorporated herein by reference the information
appearing under the caption "Voting Securities and Principal Holders Thereof" of
the Registrant's definitive Proxy Statement for our 2000 Annual Meeting to be
filed with the Securities and Exchange Commission.
19
Item 13. Certain Relationships and Related Transactions
This information is included as set forth under the caption "Note 14:
Related Party Transactions," contained in this Form 10-K in Item 14, page F-22.
PART IV
Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K
(a) Independent Auditors' Report, Financial Statements and Financial Statement Schedule
Page
Independent Auditors' Report............................................................F-3
Consolidated balance sheets at December 31, 1999 and December 31, 1998..................F-4
Consolidated statements of operations for each of the years ended
December 31, 1999, 1998 and 1997...............................................F-5
Consolidated statements of comprehensive operations for each of the years
ended December 31, 1999, 1998 and 1997.........................................F-6
Consolidated statements of stockholders' equity for each of the years ended
December 31, 1999, 1998 and 1997...............................................F-7
Consolidated statements of cash flows for each of the years ended
December 31, 1999, 1998 and 1997...............................................F-8
Notes to consolidated financial statements..............................................F-9
Independent Auditors' Report on Schedule................................................F-24
Schedule II. Valuation and Qualifying Accounts and Reserves............................S-1
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of 1999.
20
(c) Exhibits
The following exhibits are filed herewith or incorporated by reference:
3.1* Restated Certificate of Incorporation, as amended (filed as Exhibit 3.1 to
Form S-4 filed on January 26, 1996; Registration No. 333-00676).
3.1.1* Certificate of Amendment of Restated Certificate of Incorporation (filed
as Exhibit 3.1.1 to Form S-4 filed on January 26, 1996, Registration No.
333-00676).
3.2* Bylaws (filed as Exhibit 3.2 of the Registrant's registration statement on
Form S-1, Registration No. 33-15004 (the "Form S-1")).
4.1* Form of certificate evidencing Common Stock (filed as Exhibit 4.1 to the
Form S-1, Registration No. 33-15004).
4.2* Rights Agreement, dated as of November 4, 1988 between FileNET Corporation
and the First National Bank of Boston, which includes the form of Rights
Certificate as Exhibit A and the Summary of Rights to Purchase Common
Shares as Exhibit B (filed as Exhibit 4.2 to Form S-4 filed on January 26,
1996; Registration No. 333-00676).
4.3* Amendment One dated July 31, 1998 and Amendment Two dated November 9, 1998
to Rights Agreements between FileNET Corporation and BANKBOSTON N.A.
formerly known as The First National Bank of Boston (filed as Exhibit 4.3
to Form 10-Q for the quarter ended September 30, 1998).
10.1*Second Amended and Restated Credit Agreement (Multicurrency) by and among
the Registrant and Bank of America National Trust and Savings Association
dated June 30, 1999, effective June 30, 1999 (filed as Exhibit 10.1 to Form
10-Q for the quarter ended June 30, 1999).
10.2*Business Alliance Program Agreement between the Registrant and Oracle
Corporation dated July 1, 1996, as amended by Amendment One thereto (filed
as Exhibit 10.4 to Form 10-QA for the quarter ended June 30, 1996).
10.3*Runtime Sublicense Addendum between the Registrant and Oracle Corporation
dated July 1, 1996, as amended by Amendment One thereto (filed as Exhibit
10.4 to Form 10-QA for the quarter ended June 30, 1996).
10.3.1* Runtime Sublicense Addendum between the Registrant and Oracle
Corporation dated July 1, 1996; as amended by Amendments Two through Six
thereto (filed as Exhibit 10.3.1 to Form 10-Q for the quarter ended
September 30, 1998).
10.4*Full Use and Deployment Sublicense Addendum between the Registrant and
Oracle Corporation dated July 1, 1996, as amended by Amendment One thereto
(filed as Exhibit 10.4 to Form 10-QA for the quarter ended June 30, 1996).
10.5*Lease between the Registrant and C. J. Segerstrom & Sons for the
headquarters of the Company, dated April 30, 1987 (filed as Exhibit 10.19
to the Form S-1).
10.6*Third Amendment to the Lease between the Registrant and C. J. Segerstrom &
Sons dated April 30, 1987, for additional facilities at the headquarters of
the Company, dated October 1, 1992 (filed as exhibit 10.7 to Form 10-K
filed on April 4, 1997).
10.7*Fifth Amendment to the Lease between the Registrant and C. J. Segerstrom &
Sons dated April 30, 1987, for the extension of the term of the lease,
dated March 28, 1997 (filed as exhibit 10.8 to Form 10-Q for the quarter
ended March 31, 1997).
10.8*1989 Stock Option Plan for Non-Employee Directors of FileNET Corporation,
as amended by the First Amendment, Second Amendment, Third Amendment
thereto (filed as Exhibit 10.9 to Form S-4 filed on January 26, 1996;
Registration No. 333-00676).
10.9*Amended and Restated 1995 Stock Option Plan of FileNET (filed as Exhibit
99.1 to Form S-8 filed on October 29, 1999; Registration No. 333-89983).
21
10.10* Second Amended and Restated Stock Option Plan of FileNET Corporation,
together with the forms of Incentive Stock Option Agreement and
Non-Qualified Stock Option Agreements (filed as Exhibits 4(a), 4(b) and
4(c), respectively, to the Registrant's Registration Statement on Form S-8,
Registration No. 33-48499), and an Amendment thereto (filed as Exhibit 4(d)
to the Registrant's Registration Statement on Form S-8, Registration No.
33-69920), and the Second Amendment thereto (filed as Appendix A to the
Registrant's Proxy Statement for the Registrant's 1994 Annual Meeting of
Stockholders, filed on April 29, 1994).
10.11* Non-Statutory Stock Option Agreement (with Notice of Grant of Stock
Option and Special Addendum) between Registrant and Mr. Lee Roberts (filed
as exhibit 99.17 to Form S-8 on August 20, 1997).
10.12* Non-Statutory Stock Option Agreement (with Notice of Grant of Stock
Option and Special Addendum) between Registrant and Mr. Ron Ercanbrack
(filed as exhibit 99.19 to Form S-8 on August 20, 1997).
10.13* Agreement for the Purchase of IBM products dated December 20, 1991 (filed
on May 5, 1992 with the Form 8 amending our Form 10-K for the fiscal year
ended December 31, 1991).
10.14* Amendment #A1011-941003-01 dated September 30, 1994, to the Agreement for
the Purchase of IBM products dated December 20, 1991 (filed as exhibit
10.12 to form 10-K for the fiscal year ended December 31, 1996).
10.15* Development and Initial Supply Agreement between the Registrant and
Quintar Company dated August 20, 1992 (filed as Exhibit 10.21 to Form 10-K
for the year ended January 3, 1993).
10.16* Amendment dated December 22, 1992 to the Development and Initial Supply
Agreement between the Registrant and Quintar Company dated August 20, 1992
(filed as Exhibit 10.22 to Form 10-K for the year ended January 3, 1993).
10.17* Amendment 2 dated December 18, 1998 to the Product License Agreement
between the Registrant and Novell, Inc. dated May 16, 1995 (filed as
exhibit 10.17 to form 10-K/A for the year ended December 31, 1998).
10.18* Agreement and Plan of Merger between the Registrant and Watermark
Software Inc. dated July 18, 1995 (filed as Exhibit 10.27 to Form 10-Q for
the quarter ended July 2, 1995).
10.19* Agreement and Plan of Merger between the Registrant and Saros
Corporation, as amended, dated January 17, 1996 (filed as Exhibits 2.1,
2.2, 2.3, and 2.4 to Form 8-K on March 13, 1996).
10.20* Stock Purchase Agreement by and Among FileNET Corporation, IFS
Acquisition Corporation, Jawaid Khan and Juergen Goersch dated January 17,
1996 and Amendment 1 to Stock Purchase Agreement dated January 30, 1996
(filed as Exhibit 10.2 to form 10-K for the year ended December 31, 1995).
10.21* Amended and Restated FileNET Corporation 1998 Employee Stock Purchase
Plan (filed as Exhibit 99.15 to Form S-8, filed on October 29, 1999;
Registration No. 333-89983).
10.22* FileNET Corporation International Employee Stock Purchase Plan. (filed as
Exhibit 99.16 to Form S-8, filed on October 29, 1999; Registration No.
333-89983).
10.23* Lease between the Registrant and C. J. Segerstrom & Sons for the
headquarters of the Company, dated September 1, 1999 (filed as Exhibit
10.23 to Form 10Q for the quarter ended September 30, 1999).
21.1 List of subsidiaries of Registrant (filed as FileNET Corporation Subsidiary
Information).
23.1 Independent Auditor's consent (see page 24).
27.0 Financial Data Schedule.
* Incorporated herein by reference
22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FILENET CORPORATION
Date: March 30, 2000 By: /s/ Lee D. Roberts
-------- -------------------------------------
Lee D. Roberts
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Date: March 30, 2000 By: /s/ Lee D. Roberts
-------- -------------------------------------
Lee D. Roberts
President and Chief Executive Officer
(Principal Executive Officer) Director
Date: March 30, 2000 By: /s/ Brian A. Colbeck
-------- -------------------------------------
Brian A. Colbeck
VP, Controller and Chief Accounting
Officer
Date: March 30, 2000 By: /s/ Theodore J. Smith
-------- -------------------------------------
Theodore J. Smith
Chairman of the Board
Date: March 30, 2000 By: /s/ L. George Klaus
-------- -------------------------------------
L. George Klaus
Director
Date: March 30, 2000 By: /s/ William P. Lyons
-------- -------------------------------------
William P. Lyons
Director
Date: March 30, 2000 By: /s/ John C. Savage
-------- -------------------------------------
John C. Savage
Director
Date: March 30, 2000 By: /s/ Roger S. Siboni
-------- -------------------------------------
Roger S. Siboni
Director
23
FILENET CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1999, 1998 and 1997
with
Independent Auditors' Report
F-1
FILENET CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1999, 1998 and 1997
Contents
Independent Auditors' Report..............................................F-3
Audited Consolidated Financial Statements:
Consolidated Balance Sheets............................................F-4
Consolidated Statements of Operations..................................F-5
Consolidated Statements of Comprehensive Operations....................F-6
Consolidated Statements of Stockholders' Equity........................F-7
Consolidated Statements of Cash Flows..................................F-8
Notes to consolidated financial statements................................F-9
Independent Auditors' Report on Schedule.................................F-24
F-2
INDEPENDENT AUDITORS' REPORT
To the Stockholders and the Board of Directors of FileNET Corporation:
We have audited the accompanying consolidated balance sheets of FileNET
Corporation and its subsidiaries (the Company) as of December 31, 1999 and 1998,
and the related consolidated statements of operations, comprehensive operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1999. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of FileNET Corporation and its
subsidiaries as of December 31, 1999 and 1998, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States of America.
/s/ DELOITTE & TOUCHE LLP
Costa Mesa, California
January 25, 2000
F-3
CONSOLIDATED BALANCE SHEETS
(Dollar in thousands, except share and per share amounts)
--------------------------
Decemebr 31, 1999 1998
--------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 71,528 $ 55,820
Short-term investments 31,581 15,484
Accounts receivable, net of allowances
for doubtful accounts and sales
allowances of $4,542 and $4,382 at
Decemebr 31, 1999 and 1998, respectively 72,736 61,636
Inventories, net 3,399 2,419
Prepaid expenses and other current assets 8,080 8,865
Deferred income taxes 938 -
------------ -----------
Total current assets 188,262 144,224
Property, net 40,593 44,177
Long-term investments 5,542 10,885
Deferred income taxes 4,752 6,385
Other assets 1,743 1,151
------------ -----------
Total assets $ 240,892 $ 206,822
============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 16,642 $ 21,022
Accrued compensation and benefits 24,079 22,165
Unearned maintenance revenue 16,286 10,988
Income tax payable 7,808 3,618
Deferred income taxes - 942
Other accrued liabilities 21,670 17,517
------------ -----------
Total current liabilities 86,485 76,252
Unearned maintenance revenue 3,949 250
Committments and contingencies (Notes 2, 8 and 13)
Stockholders' equity:
Preferred stock - $.10 par value; 7,000,000 shares
authorized; none issued and outstanding
Common stock, $.01 par value; 100,000,000 shares
33,578,642 and 32,924,950 shares issued and
outstanding at December 31, 1999 and 1998,
respectively 149,779 144,242
Retained earnings 22,981 3,304
Accumulated other comprehensive loss (7,735) (2,659)
------------ -----------
165,025 144,887
Treasury stock, at cost; 1,098,000 shares at
December 31, 1999 and 1998 (14,567) (14,567)
------------ -----------
Total stockholders' equity 150,458 130,320
------------ -----------
Total liabilities and stockholders' equity $ 240,892 $ 206,822
============ =========
See accompanying Notes to Consolidated Financial Statements
F-4
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share amounts)
Year Ended December 31, 1999 1998 1997
- --------------------------------------------------------------------------------------------
Revenue:
Software $ 183,253 $ 171,153 $ 132,723
Service 147,449 115,501 89,280
Hardware 16,418 23,579 29,422
---------------------------------------------
Total revenue 347,120 310,233 251,425
---------------------------------------------
Costs and expenses:
Cost of software revenue 16,984 16,814 13,416
Cost of service revenue 85,686 69,586 54,003
Cost of hardware revenue 8,805 13,181 20,330
Research and development 54,307 50,132 40,927
Selling, general and administrative 157,708 161,013 127,622
Restructuring and other costs - 2,000 6,000
---------------------------------------------
Total costs and expenses 323,490 312,726 262,298
---------------------------------------------
Operating income (loss) 23,630 (2,493) (10,873)
Other income, net 3,409 3,840 3,160
---------------------------------------------
Income (loss) before income taxes 27,039 1,347 (7,713)
Provision (benefit) for income taxes 7,362 391 (2,187)
---------------------------------------------
Net income (loss) $ 19,677 $ 956 $ (5,526)
=============================================
Earnings (loss) per share:
Basic $ 0.61 $ 0.03 $ (0.18)
=============================================
Diluted $ 0.59 $ 0.03 $ (0.18)
=============================================
Weighted average shares outstanding-basic 32,125 31,083 30,310
=============================================
Weighted average shares outstanding-diluted 33,360 33,367 30,310
=============================================
See accompanying Notes to Consolidated Financial Statements
F-5
STATEMENT OF COMPREHENSIVE OPERATIONS
(Dollars in thousands)
Year Ended December 31, 1999 1998 1997
- ---------------------------------------------------- ----------- ------------
Net income (loss) $ 19,677 $ 956 $ (5,526)
----------- ----------- ------------
Other comprehensive income (loss):
Foreign currency translation
adjustments, net of tax (4,970) 1,455 (5,809)
Unrealized holding gains (losses) on
available for sale securities, (106) 32 (24)
net of tax
----------- ----------- ------------
Other comprehensive income (loss) (5,076) 1,487 (5,833)
----------- ----------- ------------
Comprehensive income (loss) $ 14,601 $ 2,443 $ (11,359)
=========== =========== ============
See accompanying Notes to Consolidated Financial Statements
F-6
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)
Accumulated
Other
Common Stock Retained Comprehensive Treasury Stock
Shares Amount Earnings Operations Shares Amount Total
- ------------------------------------------ --------------------- ---------- -------------- --------------------- -----------
Balances at January 1, 1997 30,462 $ 127,813 $ 7,874 $ 1,687 (400) $ (4,568) $ 132,806
Stock options exercised 484 1,721 1,721
Common stock issued under the
Employee Qualified Stock Purchase Plan 176 1,207 1,207
Repurchase of treasury shares at cost (420) (5,564) (5,564)
Foreign currency translation adjustment (5,809) (5,809)
Net loss (5,526) (5,526)
Other (24) (24)
----------------------- ------------ --------------- -------------------- -----------
Balances at December 31, 1997 31,122 130,741 2,348 (4,146) (820) (10,132) 118,811
Stock options exercised 1,642 12,078 12,078
Common stock issued under the
Employee Qualified Stock Purchase Plan 161 1,423 1,423
Repurchase of treasury shares at cost (278) (4,435) (4,435)
Foreign currency translation adjustment 1,455 1,455
Net income 956 956
Other 32 32
----------------------- ------------ --------------- -------------------- -----------
Balances at December 31, 1998 32,925 144,242 3,304 (2,659) (1,098) (14,567) 130,320
Stock options exercised 315 2,466 2,466
Stock option income tax benefit 477 477
Common stock issued under the
Employee Qualified Stock Purchase Plan 339 2,594 2,594
Foreign currency translation adjustment (4,970) (4,970)
Net income 19,677 19,677
Other (106) (106)
----------------------- ------------ --------------- -------------------- -----------
Balances at December 31, 1999 33,579 $ 149,779 $ 22,981 (7,735) (1,098) $ (14,567) $ 150,458
----------------------- ------------ --------------- -------------------- -----------
See accompanying Notes to Consolidated Financial Statements
F-7
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands
Year Ended December 31, 1999 1998 1997
- -----------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income (loss) $ 19,677 $ 956 $ (5,526)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 17,316 15,360 13,193
Provision for doubtful accounts 612 1,041 350
Deferred income taxes (247) 566 (3,773)
Changes in operating assets and liabilities:
Accounts receivable (14,979) (573) 9,365
Inventories (980) 1,121 5,368
Prepaid expenses and other current assets 603 (609) (539)
Accounts payable (4,102) 5,905 (1,273)
Accrued compensation & benefits 2,486 4,820 4,721
Unearned maintenance revenue 9,046 2,408 3,327
Income tax payable 4,051 2,323 (1,533)
Other 4,514 (60) 985
---------- ----------- ----------
Net cash provided by operating activities 37,997 33,258 24,665
---------- ----------- ----------
Cash flows from investing activities:
Capital expenditures (22,432) (32,474) (14,266)
Proceeds from sale of property 8,028 478 264
Purchases of marketable securities (51,669) (34,536) (30,274)
Proceeds from sales and maturities of marketable securities 40,670 42,843 32,946
---------- ----------- ----------
Net cash used in investing activities (25,403) (23,689) (11,330)
---------- ----------- ----------
Cash flows from financing activities:
Proceeds from issuance of common stock 5,060 13,501 2,928
Common stock repurchased - (4,435) (5,564)
Stock option income tax benefits 477 - -
---------- ----------- ----------
Net cash provided by (used in) financing activities 5,537 9,066 (2,636)
Effect of exchange rate changes on cash and cash equivalents (2,423) (159) (1,885)
---------- ----------- ----------
Net increase in cash and cash equivalents 15,708 18,476 8,814
Cash and cash equivalents, beginning of year 55,820 37,344 28,530
---------- ----------- ----------
Cash and cash equivalents, end of year $ 71,528 $ 55,820 $ 37,344
========== =========== ==========
Supplemental cash flow information:
Interest paid $ 221 $ 25 $ 201
Income taxes paid (refunded) $ 671 $ (2,119) $ 3,050
See accompanying Notes to Consolidated Financial Statements.
F-8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 Summary of Significant Accounting Policies
Nature of Operations. FileNET Corporation ("the Company") develops,
markets, implements and services an open, integrated, Web and
client/server-based family of Web content management and document management
software products designed for managing information and enhancing enterprise
productivity. Additionally, the Company manufactures and sells a line of 12-inch
OSARs. The Company markets its products to a broad range of industries in more
than 70 countries through a global sales, service and support organization,
including its ValueNET partner program of resellers, system integrators and
application developers.
Principles of Consolidation. The consolidated financial statements
include the accounts of FileNET and the Company's wholly owned subsidiaries. All
intercompany balances and transactions have been eliminated.
Use of Estimates. 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 and disclosure of contingent liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Investments. The Company's investments in marketable securities consist
primarily of high-grade corporate and government securities with maturities of
less than three years. Investments purchased with an original maturity of three
months or less are considered to be cash equivalents. The Company classifies all
of its investments as available-for-sale. Available-for-sale securities are
carried at fair value, with unrealized gains and losses, net of tax, reported in
a separate component of stockholders' equity (Note 6).
Other Financial Instruments. The Company enters into forward foreign
exchange contracts as a hedge against the effects of fluctuating currency
exchange rates on monetary assets and liabilities denominated in currencies
other than the functional currency of the relevant entity. The Company is
exposed to market risk on the forward foreign exchange contracts as a result of
changes in foreign exchange rates; however, the market risk should be offset by
changes in the valuation of the underlying exposures. Gains and losses on these
contracts, which equal the difference between the forward contract rate and the
prevailing market spot rate at the time of valuation, are recognized in the
consolidated statements of operations. The counterparties to these contracts are
major financial institutions. The Company uses commercial rating agencies to
evaluate the credit quality of the counterparties. The Company does not
anticipate a material loss resulting from credit risks related to any of these
institutions (Note 15).
Fair Value of Financial Instruments. The recorded amounts of financial
assets and liabilities at December 31, 1999 and 1998, approximate fair value due
to the relatively short period of time between origination of the instruments
and their expected realization.
Inventories. Inventories are stated at the lower of first-in, first-out
cost or market (Note 7). The Company regularly monitors inventories for excess
or obsolete items and makes any necessary adjustments at each balance sheet
date.
Foreign Currency Translation. The Company measures the financial
statements for its foreign subsidiaries using the local currency as the
functional currency. Assets and liabilities of these subsidiaries are translated
at the exchange rate on the balance sheet date. Revenues, costs and expenses are
translated at the rates of exchange prevailing during the year. Translation
adjustments resulting from this process are included in stockholders' equity.
Gains and losses from foreign currency transactions are included in other
income, net.
F-9
Property. Property is stated at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the related assets,
generally three to five years. Leasehold improvements are amortized over the
shorter of the estimated useful lives of the improvements or the term of the
related lease (Note 8).
Research and Development. The Company expenses research and development
costs as incurred. No amounts are required to be capitalized in accordance with
Statement of Financial Accounting Standards (SFAS) No. 86, "Accounting for the
Costs of Computer Software to be Sold, Leased, or Otherwise Marketed," as of
December 31, 1999 and 1998 because software is substantially completed
concurrently with the establishment of technological feasibility.
Revenue Recognition. Software revenue is generally recognized when the
software product is delivered to the customer or reseller in accordance with the
American Institute of Certified Public Accountants (AICPA) Statement of Position
(SOP) 97-2, "Software Revenue Recognition, as amended." The Company recognizes
other revenue at the time of product delivery and accrues any remaining costs,
including insignificant vendor obligations. Revenue from post-contract customer
support is recognized ratably over the term of the contract. Revenue from
professional services is recognized as such services are delivered and accepted
by the customer.
Product Warranty. 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
specifications. A provision for estimated warranty costs is recorded at the time
of sale or license and periodically adjusted to reflect actual experience.
Income Taxes. The provision for incomes taxes is determined in
accordance with SFAS No. 109, "Accounting for Income Taxes." Deferred tax assets
and liabilities arise from temporary differences between the tax bases of assets
and liabilities and their reported amounts in the consolidated financial
statements that will result in taxable or deductible amounts in future years.
Valuation allowance is established to reduce deferred tax assets if it is more
likely than not that such deferred tax assets will not be realized (Note 11).
Earnings (Loss) Per Share. Basic earnings (loss) per share is computed
using the weighted average number of common shares outstanding during the
reporting period. Diluted earnings (loss) per share is computed using the
weighted average number of common shares outstanding and the dilutive effect of
potential common shares outstanding (Note 4).
Supplier Concentrations. Certain components for the Company's
proprietary 12-inch OSARs are available only from a single source. Any inability
to obtain components in the amounts needed on a timely basis could result in
delays in product shipments which could have an adverse effect on the Company's
operating results. The Company has qualified and is selling 5 1/4-inch optical
storage and retrieval devices from an alternative source which could be utilized
by the Company's customers in the event of any interruptions in the delivery of
components for the Company's own OSAR product.
Stock-Based Compensation. The Company accounts for stock-based awards
to employees using the intrinsic value method in accordance with Accounting
Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to
Employees" (Note 10).
Long-Lived Assets. The Company accounts for the impairment and
disposition of long-lived assets in accordance with SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of." In accordance with SFAS No. 121, long-lived assets to be held are reviewed
for events or changes in circumstances that indicate that their carrying value
may not be recoverable.
Comprehensive Income. In June 1997, the Financial Accounting Standards
Board (FASB) issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130
requires enterprises to report comprehensive income and its components in
general-purpose financial statements. SFAS No. 130 was effective for the Company
beginning January 1, 1998.
F-10
Segment Disclosures. In 1998, the FASB issued, and the Company adopted,
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information." SFAS No. 131 establishes standards for reporting information about
operating segments and related disclosures about products and services,
geographic areas and major customers (Note 12).
Recent Accounting Pronouncements. In June 1998, the FSAB issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS
No. 133, as amended, is effective for fiscal years beginning after June 15, 2000
and will require the Company to record all derivatives on the balance sheet at
fair value. For derivatives that are hedges, changes in the fair value of
derivatives will be offset by the change in fair value of the hedged assets,
liabilities, or firm commitments. The Company believes the impact of adopting
this standard will not be material to its results of operations or equity.
Stock Split. On May 15, 1998, the Board of Directors declared a
two-for-one stock split of the Company's common stock, effected in the form of a
100% stock dividend paid on June 12, 1998 to shareholders of record as of May
29, 1998. All agreements concerning stock options and other commitments payable
in shares of its common stock provide for the issuance of additional shares due
to the declaration of the stock split. All references throughout this annual
report relating to number of shares, per share amounts, stock option data, and
market price of common stock have been restated for the stock split.
Reclassifications. Certain reclassifications have been made to
prior-years' balances to conform to current year's presentation.
Note 2 Acquisitions
In March 1996, the Company acquired Saros Corporation ("Saros") by
issuing approximately 1.9 million shares of FileNET common stock and
approximately 337,000 options to purchase FileNET common stock in exchange for
all outstanding Saros stock and options. The transaction was accounted for as a
pooling-of-interests for financial reporting purposes. Fees and expenses
aggregating $4.2 million were expensed in the first quarter of 1996. Subsequent
to December 31, 1998, the former shareholders have filed a demand for mandatory
arbitration to release approximately 0.2 million shares which were held in
Escrow pursuant to the Agreement and Plan of Merger and for damages. The Company
believes that it has meritorious reasons for not releasing the shares and other
defenses to the claims, however, the ultimate outcome or any resulting potential
loss cannot be presently determined.
Note 3 Restructuring and Other Costs
The $2.0 million in restructuring and other costs in 1998 represents
the costs of a reduction in headcount associated with the restructuring of the
Company's sales and marketing operations, as well as costs of consolidating
facilities. The restructuring and other costs include approximately $1.1 million
for severance payments for 54 employees, $0.7 million for facility closing costs
and $0.2 million of other charges.
The $6.0 million in restructuring and other costs in 1997 represented
the costs of consolidating the Watermark business unit's Burlington,
Massachusetts engineering and marketing functions with those at FileNET's Costa
Mesa, California location, as well as a reduction in headcount in certain other
areas of the Company. The restructuring and other costs include approximately
$2.2 million for severance payments for 111 employees, $2.2 million for the
write-off of assets impaired by the decision to restructure, $0.4 million for
facility closing costs, $0.4 million for equipment lease cancellations, $0.3
million for cancellation of third party development contracts, $0.2 million
related to the withdrawal of certain products from the market and $0.3 million
of other charges.
At December 31, 1999, the remaining accrued restructuring and other
costs of $0.5 million are included in other accrued liabilities. The Company
anticipates that the remaining restructuring costs will be expended during 2000.
F-11
Note 4 Earnings (Loss) Per Share
The following table is a reconciliation of the earnings and share
amounts used in the calculation of basic earnings (loss) per share and diluted
earnings (loss) per share.
(In thousands, except per share amounts)
Net Per Share
Income Shares Amount
- ---------------------------------------------------------------------------------------
Year ended December 31, 1997
Basic (loss) per share $ (5,526) 30,310 $ (0.18)
Effect of dilutive stock options -
----------------------------------------
Diluted (loss) per share $ (5,526) 30,310 $ (0.18)
----------------------------------------
Year ended December 31, 1998
Basic earnings per share $ 956 31,083 $ 0.03
Effect of dilutive stock options 2,284
----------------------------------------
Diluted earnings per share $ 956 33,367 $ 0.03
----------------------------------------
Year ended December 31, 1999
Basic earnings per share $ 19,677 32,125 $ 0.61
Effect of dilutive stock options 1,235
----------------------------------------
Diluted earnings per share $ 19,677 33,360 $ 0.59
========================================
Options to purchase shares of common stock in 1997 were outstanding
during the year but were not included in the computation of diluted loss per
share as their effect was anti-dilutive (see Note 10).
Note 5 Other Comprehensive Operations
Accumulated other comprehensive operations for each of the three years
in the period ended December 31, 1999, is comprised of the following:
(Dollars in thousands)
Unrealized Accumulated
Foreign Gain(Loss) Other
Currency on Marketable Comprehensive
Items Securities Income
- --------------------------------------------------------------------------------
Balance, January 1, 1997 $ 1,686 $ 1 $ 1,687
Current Period Changes
(Net of tax of $(3,873)
and $(16), prospectively) (5,809) (24) (5,833)
-------------------------------------------------
Balance, December 31, 1997 (4,123) (23) (4,146)
Current Period Changes
(Net of tax of $970 and 1,455 32 1,487
$21, prospectively) -------------------------------------------------
Balance, December 31, 1998 (2,668) 9 (2,659)
Current Period Changes
(Net of tax of $(3,313)
and $(71), prospectively) (4,970) (106) (5,076)
-------------------------------------------------
Balance, December 31, 1999 $ (7,638) $ (97) $ (7,735)
=================================================
F-12
Note 6 Investment Securities Available for Sale
The Company's investments in marketable securities consists primarily
of high-grade corporate and government securities with maturities of less than
three years. Investments purchased with an original maturity of three months or
less are considered to be cash equivalents. The following table summarizes
investment securities available for sale as of December 31:
(Dollars in thousands)
Investment securities available for sale: 1999 1998
- -----------------------------------------------------------------------
Cost $ 37,282 $ 26,361
Gross unrealized gains - 8
Gross unrealized losses (159) -
-----------------------------
Estimated fair value $ 37,123 $ 26,369
=============================
There were no realized gains or losses for the year ended December 31,
1999. For the year ended December 31, 1998, there was a realized gain of $6,600.
Unrealized holding gains and losses on investments, net of tax, are included in
accumulated other comprehensive operations in stockholders' equity at December
31, 1999 and 1998, and were $(97,000) and $9,000, respectively.
The contractual maturities of investments at December 31, 1999 and
1998, are shown below. Actual maturities may differ from contractual maturities
because the issuer of the securities may have the right to repurchase such
securities. The Company classifies short-term investments in current assets as
all such investments are available for current operations.
(Dollars in thousands)
1999 1998
----------------------------- --------------------------------
Estimated Estimated
Cost Fair Value Cost Fair Value
----------------------------- --------------------------------
Debt Securities:
Due in one year or less $ 31,690 $ 31,581 $ 15,476 $ 15,484
Due in one to three years 5,592 5,542 10,885 10,885
----------------------------- --------------------------------
$ 37,202 $ 37,123 $ 26,361 $ 26,369
============================= ================================
Note 7 Inventories
Inventories, net of reserves, consisted of the following at December
31:
(Dollars in thousands)
1999 1998
--------------------------
Raw materials $ 1,895 $ 1,676
Work-in-process 1,067 580
Finished goods 437 163
--------------------------
Total $ 3,399 $ 2,419
==========================
F-13
Note 8 Property and Leases
Property consisted of the following at December 31:
(Dollars in thousands)
1999 1998
----------------------------------
Machinery, equipment and software $ 101,712 $ 95,793
Furniture and fixtures 12,812 12,376
Leasehold improvements 14,998 11,796
----------------------------------
129,522 119,965
Less accumulated depreciation
and amortization (88,929) (75,788)
----------------------------------
Property, net $ 40,593 $ 44,177
==================================
At December 31, 1999, there was no impairment in the value of
long-lived assets based on management's estimated undiscounted future cash
flows.
The Company leases its corporate offices, sales offices, manufacturing
facilities, and other equipment under noncancelable 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 accrued
liabilities on the balance sheet.
Expenses related to operating leases were $15.4 million, $11.3 million,
and $10.8 million for the years ended December 31, 1999, 1998 and 1997,
respectively. The following table summarizes future minimum lease payments
required under operating leases at December 31:
(Dollars in thousands)
--------------------------------------------
2000 $ 17,413
2001 14,043
2002 9,471
2003 8,002
2004 6,701
Thereafter 8,410
-------------
Total $ 64,040
=============
The Company continues to invest in technology equipment and software
for information systems infrastructure and telecommunications. These investments
have been funded through operating leases and cash purchases. In 1999, the
Company entered into sale leaseback commitments for previously purchased
technology equipment and software with a net book value of $7.3 million. These
leases are classified as operating leases and the gain of $437,000 is being
recognized over the leaseback periods.
Note 9 Borrowing Arrangements
The Company has a $20 million commercial line of credit that expires in
June 2001. Borrowings under the arrangement are unsecured and bear interest at
one hundred basis points over the London Interbank Offered Rate. A commitment
fee of fifteen basis points is assessed against any undrawn amounts.
The Company is restricted from paying dividends during the term of the
arrangement and, under the arrangement, must comply with certain covenants,
including quarterly and annual profitability covenants. The Company was in
compliance with such covenants as of December 31, 1999. There were no borrowings
outstanding at December 31, 1999 and 1998.
F-14
Note 10 Stockholders' Equity
Shareholder Rights Plan In October 1988, the Company declared a
dividend of one common stock purchase right for each outstanding share of common
stock. As amended in July and November of 1998, a right may be exercised under
certain circumstances to purchase one share of common stock at an exercise price
of $87.50, subject to certain anti-dilution adjustments. The rights become
exercisable if and when a person (or group of affiliated or associated persons)
acquires 15% or more of FileNET's outstanding common stock, or announces an
offer that would result in such person acquiring 15% or more of FileNET's common
stock. After the rights become exercisable, each right will entitle its holder
to buy a number of shares of FileNET's common stock having a market value of
twice the exercise price of the rights. After the rights become exercisable, if
FileNET is a party to certain merger or business combination transactions or
transfer 50% or more of its assets or earnings power (as defined), each right
will entitle its holder to buy a number of shares of common stock of the
acquiring or surviving entity having a market value of twice the exercise price
of the right. The rights expire November 17, 2008 and may be redeemed by FileNET
at one cent per right at any time up to ten days after a person has announced
that they have acquired 15% or more of FileNET's common stock.
Treasury Stock. In 1997, the Board of Directors authorized, subject to
certain business and market conditions, the purchase of up to $10 million of the
Company's outstanding common stock. During the year ended December 31, 1997, the
number of shares purchased under this authorization was 420,000 shares at an
aggregate cost of $5.6 million. During the first quarter of 1998, the Company
repurchased 278,000 shares of its common stock at an aggregate cost of $4.4
million, thereby completing the stock repurchase program.
Employee Stock Purchase Plans. In May 1998, FileNET adopted the 1998
Employee Stock Purchase Plan and the International Employee Stock Purchase Plan
(the Purchase Plans). A total of 300,000 shares were authorized to be added to
the remaining share reserve under the predecessor 1988 Employee Qualified Stock
Purchase Plan so that the total share reserve for the Purchase Plans would be no
more than 400,000 shares. In May 1999, shareholders approved adding an
additional 300,000 shares to the reserve. Under the terms of the Purchase Plans,
common stock may be offered in successive six-month offering periods to eligible
employees of the Company at 85% of the market price of the common stock at the
beginning or end of the offering period, whichever is lower. The Purchase Plans
cover substantially all employees of the Company. Eligible employees may elect
to have a portion of their salary withheld for the purpose of making purchases
under the Purchase Plans. Each participant is limited in any plan year to the
acquisition of that number of shares that have an aggregate fair market value of
not more than $25,000. There are no charges or credits to income in connection
with the Purchase Plans. At December 31, 1999, $864,000 had been withheld from
employees' salaries pursuant to the Purchase Plans for the current offering
period, which expires on April 30, 2000. At December 31, 1999, approximately
353,162 shares remained available for future issuance.
Stock Option Plans. In April 1986, the Company adopted the 1986 Stock
Option Plan (the 1986 Plan). Under the amended terms of the 1986 Plan, options
to purchase 6,500,000 shares of the Company's common stock were reserved for
issuance to employees, officers and directors. Options to purchase 322,757 and
463,422 common shares were exercisable under the 1986 Plan at December 31, 1999
and 1998, respectively. In May 1995, the 1986 Plan was terminated and the
remaining reserve of 140,098 shares was transferred into the 1995 Stock Option
Plan. No common shares remain available for future grants under the 1986 Plan.
Options granted were either incentive stock options or nonqualified stock
options. Options granted become exercisable in 20% annual installments beginning
one year after the date of grant, as determined by the Board of Directors, and
expire no later than ten years plus one day from the date of grant. The exercise
price of the incentive stock options and nonqualified options were not to be
less than 100% and 85%, respectively, of the fair market value of the Company's
common stock at the date of grant.
In May 1995, the Company adopted the 1995 Stock Option Plan (the 1995 Plan).
Under the amended terms of the 1995 Plan, options to purchase 5,600,000 shares
of the Company's common stock were reserved for issuance to employees, officers
and directors. This reserve was added to the 140,098 shares of common stock
transferred from the 1986 Plan. Outstanding options under the 1986 Plan will
continue to be governed by the provisions of the agreements evidencing those
F-15
grants. To the extent any of those outstanding options terminate or expire prior
to exercise, the shares subject to those unexercised options will be available
for subsequent option grant pursuant to the provisions of the 1995 Plan. As of
December 31, 1999, 1,973,060 options of the 1986 Plan had been terminated and
were made available under the 1995 Plan. Options granted under the 1995 Plan's
Discretionary Option Grant Program for employees and the Automatic Option Grant
Program for directors have an exercise price per share of 100% of the fair
market value per share on the grant date and become exercisable in 25% annual
installments beginning one year from the date of grant. On October 21, 1999, the
Plan's Discretionary Option Program was amended to change the vesting schedule
of all options granted from that date forward to vest twenty-five percent (25%)
of the option shares after twelve (12) months of service from the grant date and
the balance of the options to vest in thirty-six (36) successive equal monthly
installments upon completion of each additional month of service thereafter. As
of December 31, 1999, 2,151,121 options were exercisable under the 1995 Plan. At
the December 14, 1999 meeting, the Board established a Special Stock Option
Committee consisting of Lee D. Roberts, President and Chief Executive Officer,
which is authorized to grant options up to 20,000 shares to non-officer
employees.
Prior to their merger with FileNET, Saros and Watermark Software, Inc.
had adopted stock option plans. These plans were assumed by the Company and
outstanding options were converted into options to purchase an aggregate of
975,976 shares of FileNET common stock. Outstanding options under the plans will
continue to be governed by the provisions of the agreements evidencing those
grants. To the extent any of those outstanding options terminate or expire prior
to exercise, the shares subject to those unexercised options will not be
available for subsequent option grant. At December 31, 1999, a total of 29,107
options were outstanding and 29,107 were exercisable under these plans.
In December 1989, the Company adopted the 1989 Stock Option Plan for
Non-Employee Directors (the Directors' Plan). Under the terms of the Directors'
Plan, as amended, each FileNET director who was not an employee was
automatically granted an initial option to purchase 10,000 shares of FileNET's
common stock at its fair market value on the date of grant and was granted an
additional option to purchase 3,500 shares every year following the initial
grant, provided such person continued to be a director at such time. Options
granted under the plan vested at the rate of 20% per year from the grant date.
Options to purchase an aggregate of 140,000 shares at prices ranging from $5.75
to $16.35 per share were granted from December 18, 1989 to May 24, 1995. At
December 31, 1999, options to purchase 25,200 shares of common stock were
exercisable. This plan was terminated in May 1995 with respect to future option
grants. Future grants to non-employee directors are to be granted under the
provisions of the 1995 Plan. On May 15, 1998, the shareholders approved an
Amendment to the 1995 Plan for the Automatic Option Grant Program to
non-employee directors to increase the initial option to purchase 25,000 shares
of FileNET common stock at fair market value on the date of grant and an
additional 7,000 shares of FileNET common stock at fair market value on the date
of grant every year following the initial grant, provided such person continued
to be a director at such time.
In August 1997, the Company filed a Form S-8 with the Securities and
Exchange Commission registering a Non-Statutory Stock Option Grant of 600,000
shares, dated May 22, 1997, to the Company's current President and Chief
Operating Officer and a Non-Statutory Stock Option Grant of 160,000 shares,
dated June 18, 1997, to the Company's Senior Vice President, Worldwide Sales.
Such grants were in accordance with employment agreements entered into by the
Company and the grantees. Options granted have an exercise price per share of
100% of the fair market value per share on the date of grant and become
exercisable in 25% installments beginning one year from the date of grant and
will expire no later than ten years from the date of grant. As of December 31,
1999, 230,000 options were exercisable related to these Non-Statutory Stock
Option Grants and 150,000 had been exercised to date.
On July 11, 1997, the Company approved a stock option cancellation/regrant
program which allowed reporting officers and employees, but not non-employee
directors, to exchange outstanding options with an exercise price greater than
$9.00 for new options. Outstanding options of 3,105,050 shares were canceled and
regranted at $9.00 per share, the market value on July 11, 1997. Under the stock
option cancellation/regrant program, the regranted options are considered
granted on July 11, 1997. The regranted options retained the exercisable status
of the canceled options with the following exceptions. The exercise date for the
regranted options related to canceled options that would have been exercisable
as of July 11, 1997 was extended six months to January 11, 1998. For the
F-16
reporting officers, as defined in Section 16 of the Securities Exchange Act of
1934, as amended (the Act), the exercise date of regranted options related to
canceled options which would have been exercisable on July 11, 1997, was
extended twelve months to July 11, 1998. The prospective exercise dates for the
remaining regranted options related to canceled options that were not
exercisable as of July 11, 1997, were extended six months from the original
exercise date.
Information regarding the stock option plans, after giving retroactive
effect to the conversions of the Watermark and Saros stock options on their
original grant dates, is as follows:
Weighted
Average
Number of Exercise
Options Price
------------ -----------
Balances, January 1, 1997 5,601,766 $11.11
Granted (weighted average fair value of $4.13) 5,602,098 $9.33
Exercised (483,408) $3.56
Canceled (3,930,238) $13.48
------------
Balances, December 31, 1997 6,790,218 $8.81
Granted (weighted average fair value of $7.41) 2,166,520 $13.43
Exercised (1,641,758) $7.51
Canceled (597,838) $10.86
------------
Balances December 31, 1998 6,717,142 $10.47
Granted (weighted average fair value of $ 6.72) 1,427,371 $12.12
Exercised (314,798) $7.84
Canceled (710,422) $10.97
------------
Balances, December 31, 1999 7,119,293 $10.87
============
The following table summarizes information concerning currently
outstanding and exercisable options:
Options Outstanding Options Exercisable
--------------------------------------------------- ----------------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Price Outstanding Life Price Exercisable Price
- ---------------------------------------------------------------------------------------------------------------
$0.71 to $7.16 1,697,016 7.51 $ 6.50 688,960 $ 6.25
$7.19 to $8.94 690,259 7.68 8.23 225,826 7.81
$9.00 1,854,293 7.53 9.00 1,162,202 9.00
$9.17 to $12.16 1,439,530 8.85 10.58 247,515 10.29
$12.25 to $29.00 1,438,195 8.40 20.00 433,682 18.53
-----------------------------------------------------------------------------------
$0.71 to $29.00 7,119,293 7.98 $ 10.87 2,758,185 $ 9.83
============ ============
The Company accounts for its stock-based compensation plans in
accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees,"
and related interpretations. No compensation expense has been recognized for its
stock-based compensation plans during the years ended December 31, 1999, 1998
and 1997, as the exercise price equaled the fair market value of the stock at
the date of grant.
F-17
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, "Accounting for Stock-Based Compensation":
(Dollars in thousands, except per share amounts)
1999 1998 1997
- ----------------------------------------------------------------------------------------------------
Net income (loss) - as reported $ 19,677 $ 956 $ (5,526)
Net income (loss) - pro forma 3,027 (6,915) (12,497)
Diluted earnings (loss) per share - as reported 0.59 0.03 (0.18)
Diluted earnings (loss) per share - pro forma 0.39 (0.21) (0.41)
The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in 1999, 1998 and 1997; expected volatility of 75%
for 1999 and 1998, and 60% for 1997; risk-free interest rates of 5.1% to 6.1%
for 1999, 5.4% to 5.5% for 1998, and 5.3% to 5.6% for 1997; and an expected life
of one year from the vest date. 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.
Note 11 Income Taxes
The provision (benefit) for income taxes at December 31, 1999, 1998 and
1997, consists of the following:
(Dollars in thousands)
Year ended December 31, 1999 1998 1997
------------------------ -------------- ------------ ----------
Current:
Federal $ 3,148 $ (405) $ 785
State 1,137 32 (40)
Foreign 3,411 198 841
Deferred:
Federal 74 (20) (1,963)
State (476) 40 (1,168)
Foreign 68 546 (642)
----------- ----------- ----------
Total provision $ 7,362 $ 391 $ (2,187)
=========== =========== ==========
The valuation allowance decreased by $3.2 million for the year ended
December 31, 1999, as a result of the utilization of net operating loss
carryforwards. Whereas, the valuation allowance increased by $9.9 million and
$1.4 million during the years ended December 31, 1998 and 1997, respectively,
due to the generation of net operating losses and research and development
credits.
A reconciliation of the Company's effective tax rate (benefit) compared
to the statutory Federal tax rate is as follows:
Years ended December 31, 1999 1998 1997
- -------------------------------------------------- -------- -------- -------
Income taxes (benefit) at statutory Federal rate 35% 35% (35%)
State taxes (benefit), net of Federal benefit 3 5 (6)
Unbenefited/utilized domestic losses (14) 153 0
Foreign tax rate differential/unbenefited losses 3 (163) 11
Other 0 (1) 2
-------- -------- -------
Total 27% 29% (28%)
======== ======== =======
F-18
The Company provides deferred income taxes for temporary differences
between assets and liabilities recognized for financial reporting and income tax
purposes. The income tax effects of these temporary differences representing
significant portions of the deferred taxes at December 31, 1999 and 1998, are as
follows:
(Dollars in thousands)
Year ended December 31, 1999 1998
- --------------------------------------------------------- ------------------
Deferred taxes:
Foreign loss carryforwards $ 130 $ 1,768
Domestic loss carryforwards 15,191 22,540
Tax credit carryforwards 8,251 6,934
Accrued expenses 2,786 1,874
Sales returns and allowance reserves 808 982
Deferred revenue 4,110 (491)
Capitalized software - (319)
Depreciable assets 1,655 1,070
Residual U.S. tax on foreign earnings (4,521) (4,504)
Other (1,592) (37)
----------- ----------
Total 26,818 29,817
----------- ----------
Valuation allowance (21,128) (24,374)
----------- ----------
Net deferred tax asset $ 5,690 $ 5,443
=========== ==========
The Company has $44.7 million domestic federal net operating loss
carryforwards which can be utilized to reduce future taxable income. Any
unutilized net operating loss carryforward will begin expiring in 2011. The
Company has an $8.3 million tax credit carryforward which will expire beginning
in 2002. Approximately $8.1 million of the valuation allowance is attributable
to the potential tax benefit of stock option transactions that will be credited
directly to additional paid-in capital if realized.
At December 31, 1999, the Company had Dutch, French and Austrian
subsidiary tax loss carryforwards relating to its foreign subsidiary operations
of $0.2 million, $0.2 million, and $9,000, respectively. The Dutch and Austrian
tax loss carryforwards have no expiration. French losses of $62,000 will expire
in 2002.
The Company has not provided any residual U.S. tax on approximately
$14.5 million of a portion of the Company's foreign subsidiaries undistributed
earnings, as the Company intends to indefinitely reinvest such earnings.
Note 12 Operating Segment and Geographic Information
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 operating segments are
managed separately because each segment represents a strategic business unit
that offers different products or services.
The Company's reportable operating segments include Software, Hardware, Customer
Support, and Professional Services and Education. The Software operating segment
develops and markets the Company's line of web content management and integrated
document management software. The Hardware operating segment manufactures and
markets the Company's line of OSAR libraries. The Customer Support segment
provides after-sale support for both software and hardware products, as well as
F-19
providing software upgrades under 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 products and
provides training.
The accounting policies of the Company's operating segments are the
same as those described in Note 1- Summary of Significant Accounting Policies -
except that the disaggregated 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.
The Company evaluates performance based on stand-alone segment operating income.
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.
Operating segment data for the three years ended December 31, 1999, was
as follows:
(Dollars in thousands)
Professional
Customer Services and
Software Hardware Support Education Other Consolidated
- --------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 1999
Revenue $ 183,253 $ 16,418 $ 91,917 $ 49,283 $ 6,249 $ 347,120
Depreciation and amortization 9,555 504 4,655 2,576 26 17,316
Operating income before
other income 1,096 1,911 19,386 1,107 130 23,630
Assets 240,892
Capital expenditures 11,001 468 7,986 2,908 69 22,432
Year Ended December 31, 1998
Revenue $ 171,153 $ 23,579 $ 73,524 $ 32,967 $ 9,010 $ 310,233
Depreciation and amortization 9,061 652 3,906 1,603 138 15,360
Operating income (loss) before
other income (17,023) 1,807 12,023 776 (76) (2,493)
Assets 206,822
Capital expenditures 19,383 1,118 8,341 3,387 245 32,474
Year Ended December 31, 1997
Year Ended December 31, 1997
Revenue $ 132,723 $ 29,422 $ 54,417 $ 23,413 $ 11,450 $ 251,425
Depreciation and amortization 7,582 971 2,926 1,465 249 13,193
Operating income (loss) before
other income (19,779) 107 7,035 (518) 2,282 (10,873)
Assets 179,440
Capital expenditures 8,462 864 3,155 1,650 135 14,266
F-20
Revenue is attributed to geographic areas based on the location of the
entity to which the products or services were sold. The operation in Ireland
functions as a manufacturing and service center for non-United States customers.
An allocation of its assets among the geographic segments is not prepared for
management reporting. Information concerning principal geographic areas in which
the Company operates was as follows:
(Dollars in thousands)
Year ended December 31, 1999 1998 1997
- ---------------------------------------------------------------------------------------------------------
Revenue Assets Revenue Assets Revenue Assets
-------------------------------------------------------------------------
North America:
United States $ 240,607 $ 171,483 $ 205,797 $ 142,471 $ 170,116 $ 123,681
Canada 8,430 6,442 6,669 1,869 8,027 2,263
-------------------------------------------------------------------------
Total Domestic 249,037 177,925 212,466 144,340 178,143 125,944
Europe:
France 8,540 5,119 7,516 5,562 6,961 2,481
Germany 23,888 6,279 30,675 14,450 21,665 9,100
United Kingdom 20,148 12,085 20,882 9,800 16,838 8,007
Ireland - 21,645 - 23,551 - 29,411
Other Europe 22,498 9,831 19,373 4,172 9,358 961
-------------------------------------------------------------------------
Total Europe 75,074 54,959 78,446 57,535 54,822 49,960
Asia Pacific 17,144 7,951 10,058 4,782 13,892 3,494
All other 5,865 57 9,263 165 4,568 42
-------------------------------------------------------------------------
Totals $ 347,120 $ 240,892 $ 310,233 $ 206,822 $ 251,425 $ 179,440
=========================================================================
Note 13 Contingencies
In October 1994, Wang Laboratories, Inc. ("Wang") filed a complaint in
the United States District Court for the District of Massachusetts alleging that
the Company is infringing five patents held by Wang (the FileNET Case). On June
23, 1995, Wang amended its complaint to include an additional related patent. On
July 2, 1996, Wang filed a complaint in the same court alleging that Watermark
Software, Inc., formerly a wholly owned subsidiary that was merged into the
Company, is infringing three of the same patents asserted in the initial
complaint (the Watermark Case). On October 9, 1996, Wang withdrew its claim in
the FileNET Case that one of the patents it initially asserted is infringed.
In March 1997, Eastman Kodak Company ("Kodak") purchased the Wang
imaging business unit that has responsibility for this litigation. On July 30,
1997, the Court permitted Eastman and Kodak Limited of England to be substituted
in the litigation in place of Wang.
The Company has moved for summary judgment on noninfringement as to
each of the five patents in the suit, and for summary judgment of invalidity as
to one of the patents. Eastman moved for summary judgment as to the Company's
unenforceability defense on one of the patents. In July 1998, the Magistrate
Judge assigned to the case heard oral arguments on the Company's motion for
summary judgment that U.S. Patent 4,918,588 is not infringed and is invalid. The
Magistrate Judge has not yet decided these motions. The Company believes that
after he has ruled on these motions, he will hear oral arguments in the
remaining motions in the sequence in which they were filed. A trial date has not
yet been set.
If it should be determined that the patents at issue in the litigation are valid
and are infringed by any of the Company's products, including Watermark
products, the Company will, depending on the product, redesign the infringing
F-21
products or seek to obtain a license to market the products. There can be no
assurance that the Company will be able to successfully redesign the infringing
products or obtain a license on acceptable terms. Based on the Company's
analysis of these patents and their respective file histories, the Company
believes that it has meritorious defenses to these claims; however, the ultimate
outcome or any resulting potential loss cannot be determined at this time.
On October 27, 1998, plaintiff Thomas P. Nyquist filed a class action
complaint against the Company and certain of its officers and directors in the
United States District Court for the Central District of California (the Nyquist
Action). The action was purportedly filed on behalf of a class of purchasers of
the Company's common stock during the period April 16, 1998 through October 7,
1998. On July 22, 1999, defendant filed a motion to dismiss the complaint in its
entirety. On August 19, 1999, the court ordered a stay of the action and removed
defendants' motion to dismiss from the Court's hearing calendar in light of the
pending petition for rehearing and rehearing enbanc in Silicon Graphics Sec.
Litig., Nos. 97-16204, 97-16240, 1999 U.S. App LEXIS 14955 (9th Cir. July 2,
1999). On December 13, 1999, the court entered a Stipulation to Dismiss Entire
Action Without Prejudice.
Subsequent to December 31, 1998, the former shareholders of Saros filed
a demand for mandatory arbitration to release approximately two hundred thousand
shares of FileNET stock which were held in escrow pursuant to the Agreement and
Plan of Merger dated January 17, 1996, among FileNET Corporation, FileNET
Acquisition Corporation, and Saros, and for damages. The Company and the
Shareholders' Agent had agreed to mediate the matter, but the Saros
Shareholders' Agent cancelled the mediation prior to the scheduled date and
renewed their demand for mandatory arbitration. The Company believes that it has
meritorious reasons for not releasing the shares and other defenses to the
claims; however, the ultimate or any resulting potential loss cannot be
presently determined.
In the normal course of business, the Company is subject to various
other legal matters. While the results of litigation and claims cannot be
predicted with certainty, the Company believes that the final outcome of these
other matters will not have a material adverse effect on the Company's
consolidated results of operations or financial condition.
Note 14 Related-Party Transactions
The Company entered into a two-year agreement on May 20, 1997, to
employ its new President and Chief Operating Officer. Under the terms of the
agreement, the Company agreed to reimburse the officer for legal costs in
defending a lawsuit from the officer's former employer. The case was settled and
the total cost to the Company was charged to compensation expense in 1997.
Note 15 Other Financial Instruments
The following table summarizes the notional amounts, which are
equivalent to the fair market value, of the Company's foreign currency
agreements entered into on December 31, 1999 and 1998, all maturing in three
months:
At December 31, 1999 1998
----------------- --------------------------------------------------- -----------------------------------------------
Notional Notional Unrealized Notional Notional Unrealized
Amount Amount Gains Amount Amount Gains
Purchased Sold (Losses) Purchased Sold (Losses)
--------------------------------------------------- -----------------------------------------------
European $ 14,450,375 $ 9,738,547 $ (105,298) $ 11,238 $ (8,488) $ 0
Australian 0 4,772,150 (58,492) 0 (2,938) 0
Asian 1,432,765 406,696 (1,070) 929 0 0
Canadian 0 2,113,223 (19,683) 0 (522) 0
--------------------------------------------------- -----------------------------------------------
Total $ 15,883,140 $ 17,030,616 $ (184,543) $ 12,167 $ (11,948) $ 0
=================================================== ===============================================
F-22
Note 16 Quarterly Financial Information (Unaudited)
(Dollars in thousands, except per share amounts)
First Second Third Fourth Fiscal
Quarter Quarter Quarter Quarter Year
- ------------------------------------------------------------------------------------------------------------------------
Year ended December 31, 1999:
Revenue $ 81,442 $ 86,089 $ 85,532 $ 94,057 $ 347,120
Income before income taxes 2,925 5,563 6,633 11,918 27,039
Net income 2,048 3,894 4,643 9,092 19,677
Basic earnings per share 0.06 0.12 0.14 0.28 0.61
Diluted earnings per share 0.06 0.12 0.14 0.28 0.59
Year ended December 31, 1998:
Revenue $ 73,609 $ 80,372 $ 71,152 $ 85,100 $ 310,233
Income (loss) before income taxes 3,555 6,528 (8,143) (593)* 1,347
Net income (loss) 2,524 4,635 (5,779) (424) 956
Basic earnings (loss) per share 0.08 0.15 (0.18) (0.01) 0.03
Diluted earnings (loss) per share 0.08 0.14 (0.18) (0.01) 0.03
*Includes pre tax charges of $2.0 million in the fourth quarter of 1998 for restructuring and other costs.
F-23
INDEPENDENT AUDITORS' REPORT ON SCHEDULE
To the Stockholders and the Board of Directors
FileNET Corporation
Costa Mesa, California
We have audited the consolidated financial statements of FileNET Corporation and
its subsidiaries (the Company) as of December 31, 1999 and 1998, and for each of
the three years in the period ended December 31, 1999, and have issued our
report thereon dated January 25, 2000. Such consolidated financial statements
and report are included elsewhere in this Form 10-K. Our audits also included
the financial statement schedule of FileNET Corporation and its subsidiaries,
listed in Item 14. This consolidated financial statement schedule is the
responsibility of the Company's management. Our responsibility is to express an
opinion based on our audits. In our opinion, such consolidated financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
/s/ DELOITTE & TOUCHE LLP
Costa Mesa, California
January 25, 2000
F-24
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(Dollars in thousands)
Balance at Additions Balance
Beginning Charged to Costs at End
of Period and Expenses Deductions of Period
- -----------------------------------------------------------------------------------------------------------------
Year ended December 31, 1999:
Inventory reserves $ 401 335 410(1) $ 326
Allowance for doubtful accounts $ 2,063 612 463(2) $ 2,212
Reserve for sales allowances $ 2,319 1,160 1,155(3) $ 2,330
Year ended December 31, 1998:
Inventory reserves $ 330 381 310(1) $ 401
Allowance for doubtful accounts $ 1,690 1,041 668(2) $ 2,063
Reserve for sales allowances $ 2,725 52 458(3) $ 2,319
Year ended December 31, 1997:
Inventory reserves $ 660 380 710(1) $ 330
Allowance for doubtful accounts $ 2,140 350 800(2) $ 1,690
Reserve for sales allowances $ 3,185 0 460(3) $ 2,725
(1) Consists primarily of the write-off of excess/obsolete inventories.
(2) Consists primarily of uncollectible customer invoice amounts.
(3) Consists primarily of sales allowances.
S-1