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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, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 0-15997
FILENET CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 95-3757924
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
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 National Market
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 22, 2001, the aggregate market value of the 30,635,737 shares of voting stock of the
Registrant held by nonaffiliates of the Registrant on such date was $427,062,174. For purposes of such calculation, only executive
officers, board members and beneficial owners of more than 10% of our outstanding common stock are deemed to be affiliates.
The number of shares outstanding of the Registrant's common stock was 35,141,212 at March 22, 2001.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates by reference certain information from the Registrant's definitive proxy statement for the 2001 Annual Meeting.
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FILENET CORPORATION
2000 ANNUAL REPORT ON FORM 10-K
For the Year Ended December 31, 2000
TABLE OF CONTENTS
Page
PART I
Item 1. Business...........................................................................................................2
Item 2. Properties........................................................................................................10
Item 3. Legal Proceedings.................................................................................................10
Item 4. Submission of Matters to a Vote of Security Holders...............................................................11
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters..........................................11
Item 6. Selected Financial Data...........................................................................................12
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.............................13
Item 8. Financial Statements and Supplementary Data.......................................................................20
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..............................20
PART III
Item 10. Directors and Executive Officers of the Registrant...............................................................20
Item 11. Executive Compensation...........................................................................................20
Item 12. Security Ownership of Certain Beneficial Owners and Management...................................................20
Item 13. Certain Relationships and Related Transactions...................................................................20
PART IV
Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K..................................................21
Signatures................................................................................................................23
PART I
Item 1. Business
GENERAL
FileNET Corporation develops, markets, and services eProcess enabled Web Content Management software solutions and packaged
eBusiness applications for selected vertical markets. Our enterprise software solutions enable organizations to improve operational
efficiency and leverage their content resources by delivering efficient, flexible, and scalable eBusiness process solutions. By
linking customers, business partners, suppliers, and employees, our software solutions help organizations increase productivity,
customer satisfaction, and revenue. We also offer professional services for the implementation of these software solutions, as well
as 24 X 7 technical support and services to our customers on a global basis.
MARKET AND CUSTOMERS
We offer a family of core technology software products under the brand name Panagon, as well as packaged eBusiness
applications for specific vertical markets through our Acenza applications family. These products and applications enable users to
automate business processes and manage associated content on an enterprise-wide basis. Our customers consist mostly of Global 2000
organizations, including 70 of the Fortune 100, and are typically those enterprises that 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 those who process significant
amounts of electronic content and transactions in their day-to-day operations. Additionally, our software products address ad hoc
business processes at the enterprise, departmental, and workgroup levels to improve overall enterprise productivity and integrate with
industry-standard productivity and enterprise applications such as Lotus Notes, Microsoft Office, SAP, Siebel, and Vignette.
We market our products in more than 90 countries through a direct sales force and our ValueNET(R) business partner community
consisting of systems integrators, value-added resellers, application development partners, and distributors. More than 350 firms
operate under our ValueNET program and combine our software products with vertical market-specific, value-added services and
applications to provide turnkey solutions for customers. Our solutions are applicable in a wide variety of industries, however,
historically, insurance, finance, government, manufacturing, telecommunications, and utilities have been our key vertical markets.
Our global customer support operation offers software maintenance service for our products worldwide. Our technical
support programs offer a wide range of services including the right to new versions of FileNET software, extended phone support
coverage, on-site technical consultants, technical account management program, and software development kit support. Our professional
services operation offers business and technical consulting services and training to both end-users of our products and to ValueNET
partners. These professional services are marketed by our direct sales force and by our ValueNET business partners, with a focus on
enterprise system implementation and the delivery of eBusiness applications.
PRODUCTS
Software
Our Panagon family of software combines a tightly integrated eProcess and Content Management application development
platform, easy-to-use Web browser interfaces and Application Programming Interfaces ("APIs"), and world-class server technology to
deliver a high-performing, eProcess enabled Web Content Management solution. Our integrated set of products allows an organization to
extend business processes beyond the corporate firewall to link these business processes, the customers and constituents they support,
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and the content they interactively create and manage, all via the Web. Our Panagon software products are built around our Panagon
eProcess Services, our core product and development platform that integrates with each of the Panagon products to build specific
eBusiness applications.
We currently offer the following software products:
Panagon eProcess Services is our next-generation Web-based, business process management product. eProcess Services
enables an organization to create and manage high-transaction, mission-critical business processes in a dynamic Web
environment. Our Web-based user interface, built-in eProcess applets, Web server components, and XML architecture are
easy to use and provide scalable connectivity with employees, business partners, and customers.
Panagon Web Services combines a full-featured, Web browser-based thin client, a comprehensive Web-centric application
development tool kit, and Web server components, to support dynamic and complex eProcess and Web content management
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 content stored in a
Panagon repository, all from the Web.
Panagon Content Services is an enterprise content repository for creating, accessing, managing, securing, and
dynamically updating business-critical electronic documents and content. Content Services allows a business to manage
enterprise information from collaborative creation, to secure delivery, to revise and re-use.
Panagon Web Publisher simplifies and automates Web publishing operations for Internet, extranet, and intranet Web
sites by providing indexing and automatic formatting for Microsoft Word and other native format documents that authors
simply drag and drop to the appropriate Panagon repository folder. It eliminates virtually all HTML coding, dramatically
reducing workloads for Web masters, information technology staff, and Web publishers. 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.
Panagon WorkFlo(R) Services is our high-performance eProcess workflow engine. WorkFlo Services, combined with eProcess
Services, enables customers, partners, and internal users to automate and access critical business processes and
associated content. Panagon WorkFlo Services can be used to create applications that reflect the way business processes
are performed, and is a critical enabling technology for the automation of business-to-business processes via the Web.
It allows organizations to control and modify work processes to meet the needs of a dynamic business environment, and
integrates the flow of information between software applications within a company's business processes. Panagon WorkFlo
Services supports multiple client, server and applications development environments, such as Java and COM, and integrates
with leading business process reengineering products for reduced implementation time.
Panagon Integrated Document Management ("IDM") Desktop is a unified Windows client software application that
allows users to view, manage, revise, share, and distribute content across an enterprise for ad hoc or mission
critical use. IDM Desktop allows users to manage content directly from within the Microsoft Office and Lotus Notes
applications.
Panagon Image Services is an image and object server that allows businesses to manage the high-speed acquisition,
distribution, and access of transactional content and objects of all types.
Panagon Report Manager is an online statement and report management system. Report Manager allows organizations access to
legacy print data streams within eBusiness applications by storing, accessing, mining, and analyzing computer-generated
reports, statements and forms.
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Panagon Capture addresses document and content capture needs. Available in high-volume Capture Professional or small
department Capture Desktop versions, Panagon Capture acquires digital and paper-based content into Image Services or
Content Services for enterprise-wide use and online access.
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.
eBusiness Applications
Our Acenza family of eBusiness applications extends business processes and associated content across the Web in a variety of
vertical industries. Based on our Panagon core technology, Acenza eBusiness applications improve an organization's competitive edge
by streamlining the business processes associated with acquiring and servicing customers and business partners across the Web.
Acenza applications automate core front-office and back-office business processes and systems, externalize these business processes
to the Web, and create and manage associated content using the latest Panagon eProcess and Content Management technology.
We released the following eBusiness applications in 2000:
Acenza for Insurance enables insurance organizations to improve operational efficiency and customer service by
delivering Web-based business process solutions. Acenza for Insurance provides the following capabilities: eliminates
or reduces filing costs; provides efficient and accurate self-service that is customer friendly; improves workers'
efficiency and utilization of their knowledge to reduce processing time and costs; improves customer satisfaction; and
supports the rapid deployment of Web-enabled claims operations, linking customers, agents/brokers, and employees in
shared processes and content.
Acenza Payables streamlines the accounts payable process, allowing accounting staff to handle more purchase
transactions - quickly, easily, and accurately. Invoices presented in paper, fax or electronic form are captured, filed
securely, and routed for data entry and approval automatically. A Web interface allows status checking and approval of
invoices to be deployed cost-effectively across the enterprise and to business partners.
Hardware
We also manufacture and market an Optical Storage And Retrieval ("OSAR") library product based on 12-inch, 30 gigabyte,
optical disk technology for the storage management of business critical content.
RESEARCH AND DEVELOPMEMT
Our research and development activities are primarily focused on software product development. Research and development
expenditures were $57.9 million, $54.3 million and $50.1 million for the years ended December 31, 2000, 1999, and 1998,
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 will ensure future product revenue growth and market leadership. Accordingly, we intend to continue
to make substantial investments in research and development activities in eProcess and Web Content Management technologies.
SERVICES, SUPPORT, AND MANUFACTURING
We operate service and support organizations that provide both pre-sales and post-sales services on a global basis.
Our customer support operation provides software maintenance and technical support services to customers and resellers who
have contracted for such services. We currently operate telephone response centers in Costa Mesa, California; Dublin, Ireland;
Sydney, Australia; and Singapore, and provide extensive online technical support as well as on-site customer visits when necessary.
We also provide support on a fee-per-service basis for those customers and ValueNET partners who have not entered into a maintenance
contract with us.
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Our professional services group provides consulting services to customers, primarily on a time and material basis and
training services. These services range from the management of large-scale implementations of our products to prepackaged standard
services such as software installation. We provide consulting services through in-house employees and through a network of qualified
partners.
Our manufacturing facilities in Costa Mesa, California and Dublin, Ireland, conduct software manufacturing and distribution,
localization, integration, test and quality control.
COMPETITION
The market for our products is highly competitive. We compete with a large number of eProcess, Web Content Management,
eBusiness Applications, workflow and document imaging, and electronic document management companies. 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, IBM, Sybase, and Informix, messaging vendors and eCommerce vendors such as Broadvision,
webMethods, and Art Technology Group 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.
We believe that the principal 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.
Certain of our competitors may have greater resources, larger sales and marketing teams, broader product lines and
more experience developing Internet-based software than we do. 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.
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.
EMPLOYEES
As of December 31, 2000, we had 1,754 full-time employees, of which 400 were employed in research and development; 441 in
sales, 87 in marketing, 257 in education and professional services, 308 in customer support; 88 in operations; and 173 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.
RISK FACTORS
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 our financial statements for the year ended December 31, 2000,
certain sections of which are incorporated herein by reference as set forth in Items 7 and 8 of this report. The actual results that
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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 risk factors described below and in other documents we file from time to time with the Securities
and Exchange Commission, including our Quarterly Reports on Form 10-Q to be filed by us in 2001. 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:
We Must Develop and Sell New Products in Order to Keep Up With Rapid Technological Change. The market for our software and
services is characterized by rapid technological developments, evolving industry standards, changes in customer requirements and
frequent new product introductions and enhancements. Our ability to continue to sell products will be dependent upon our ability to
continue to enhance our existing software and services offerings, develop and introduce, in a timely manner, new software products
incorporating technological advances and respond to customer requirements. Our future success also depends, in part, on our ability
to execute on our strategy of developing Web Content Management and business-to-business solutions. This strategy may require us to
develop and maintain relations with technology partners. We may not be successful in maintaining these relationships or in
developing, marketing and releasing new products or new versions of our products that respond to technological developments, evolving
industry standards or changing customer requirements. We may also experience difficulties that could delay or prevent the successful
development, introduction and sale of these enhancements. In addition, these enhancements may not adequately meet the requirements
of the marketplace and may not achieve any significant degree of market acceptance. If we fail to successfully maintain or establish
relationships with technology partners or to execute on our integrated product solution strategy, or if release dates of any future
products or enhancements are delayed, or if these products or enhancements fail to achieve market acceptance when released, our
business operating results and financial condition could be materially harmed. In the past, we have experienced delays in the
release dates of enhancements and new releases to our products and we cannot assure you that we will not experience significant
future delays in product introduction. 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. We cannot assure
you 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, such delays could have a material adverse effect on our business and operating
results.
Our Quarterly Operating Results May Fluctuate in Future Periods. Prior growth rates in our revenue and operating results
should not necessarily be considered indicative of future growth or operating results. Our operating results have fluctuated in the
past and we anticipate our future operating results will continue to fluctuate due to many factors, some of which are largely beyond
our control. These factors, include, but are not limited to, the following:
o the level of software product and price competition;
o the length of our sales cycle;
o variations in the productivity of our sales force;
o seasonality of individual customer buying patterns;
o discretionary nature of our customer's budget and purchase cycles and the absence of long-term customer purchase
commitments;
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o the size, complexity and timing of individual transactions;
o the delay or deferral of customer orders;
o the budget cycles of our customers;
o the timing of new software introductions and software enhancements by us and our competitors;
o the mix of sales by products, software, services and distribution channels;
o the tendency to realize a substantial amount of revenue in the last weeks, or even days, of each quarter;
o acquisitions by competitors;
o our ability to develop and market new software products and control costs;
o the quality of our customer support;
o the level of international sales;
o changes in foreign currency exchange rates, impact of the EURO currency; and
o general domestic and international economic and political conditions.
The decision to implement our products is subject to each customer's resources and budget availability. Our quarterly sales
generally include a mix of medium sized orders, along with several large individual orders, and as a result, the loss or delay of an
individual large order could have a significant impact on our quarterly operating results and revenue. Our operating expenses are
based on projected revenue trends and are generally fixed. Therefore, any shortfall from projected revenue will cause significant
fluctuations in operating results from quarter to quarter. As a result of these factors, revenues and operating results for any
quarter are subject to fluctuations and are not predictable with any significant degree of accuracy. Therefore, we believe that
period-to-period comparisons of our results of operations should not be relied upon as indications of future performance. Moreover,
such factors could cause our operating results in a given quarter to be below the expectations of public market analysts and
investors. In either case, the price of our common stock could decline materially.
The Market in Which We Operate is Highly Competitive. The markets we serve are highly competitive and we expect competition
to intensify. Our future financial performance will depend primarily on the continued growth of the market for our software products
and services as well as the purchase of our products by customers in these markets. If the markets we serve fail to grow or grow
more slowly than we currently anticipate, our business, financial condition and operating results would be harmed. This intensely
competitive market is highly fragmented and rapidly changing and there are certain competitors of ours with substantially greater
sales, marketing, development and financial resources. Our present or future competitors may be able to develop software products
comparable or superior to those offered by us, offer lower priced products or adapt more quickly than we do to new technologies or
evolving customer requirements. In order to be successful in the future, we must respond to technological change, customer
requirements and competitors' current software products and innovations. We cannot assure you that we will be able to continue to
compete effectively in our target markets or that future competition will not have a material adverse effect on our business,
financial condition or results of operations. In addition, current and potential competitors have established or may establish
cooperative relationships among themselves or with third parties to increase the ability of their products to address the needs of
the markets we serve. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire
significant market share. Increased competition may result in price reductions, reduced gross margins and loss of market share, any
of which could have a material adverse effect on our business, financial condition or results of operations.
Protection of Our Intellectual Property and Other Proprietary Rights is Limited and There is Risk of Third-Party Claims of
Infringement. 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
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provisions to protect our proprietary rights in our software products. We cannot assure you that our existing or future copyrights,
trademarks, trade secrets or other intellectual property rights will have sufficient scope or strength to provide meaningful
protection or a commercial advantage to us. We currently 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. Our inability to protect our
intellectual property may have a material adverse effect on our business, financial condition or results of operations.
We may, from time to time, be notified that we are infringing certain patent or intellectual property rights of others.
While there are no material actions, other than those discussed in this report, currently pending against us for infringement of
patent or other proprietary rights of third parties, we cannot assure that third parties will not initiate infringement actions
against us in the future. Combinations of technology acquired through past or future acquisitions and our technology will create new
software products and technology that also may give rise to claims of infringement. Infringement actions can result in substantial
costs and diversion of resources, regardless of the merits of the actions. If we were found to infringe upon the rights of others, we
cannot assure that we could redesign the infringing products or could obtain licenses on acceptable terms, if at all. Additionally,
significant damages for past infringement could be assessed or future litigation relative to any such licenses or usage could occur.
An adverse disposition of any claims or the advent of litigation arising out of any claims of infringement, may have a material
adverse effect on our business, financial condition or results of operations.
We Depend on Certain Strategic Relationships. In order to expand the distribution of our products and broaden our product
offerings, we have established strategic relationships with a number of indirect channel partners and other consultants that provide
marketing and sales opportunities for us. We have entered into key formal and informal agreements with other companies such as
Hewlett-Packard Company, IBM Global Services, Microsoft Corporation, SAP AG, Siebel Systems, Inc, Sun Microsystems, Inc., and Vignette
Corporation. Certain of these agreements do not have minimum purchase requirements and/or are cancelable at will. We cannot assure
you that these companies will not reduce or discontinue their relationships with, or support of, FileNET and our products. Our
failure to maintain these relationships, or to establish new relationships in the future, could harm our business, financial
condition and results of operations.
We currently license certain software from third parties, including software that is integrated with internally developed
software and used in our products to perform key functions. In the past, we have had difficulty renewing certain licenses. The
failure to continue to maintain these licenses would prohibit us from selling certain products. We cannot assure you that such third
parties will remain in business, that they will continue to support their software products or that their software products will
continue to be available to us on acceptable terms. The loss or inability to maintain any of these software licenses could result in
shipment delays or reductions in software shipments until equivalent software can be developed, identified, licensed, and
integrated. This could adversely affect our business, financial condition or results of operations.
We Must Retain and Attract Key Executives and Personnel. Our success depends to a significant degree upon the continued
contributions of our key management, as well as other marketing, technical and operational personnel. 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.
We cannot assure you that in the future we will be successful in attracting and retaining such personnel.
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We are Subject to Many Risks Internationally. Historically, we have derived approximately 30% of our total revenues from
international sales through our worldwide network of subsidiaries and channel partners. International business is subject to certain
risks including, but not limited to, the following:
o tariffs and trade barriers;
o varying technical standards;
o political and economic instability;
o reduced protection for intellectual property rights in certain countries;
o difficulties in staffing and maintaining foreign operations;
o difficulties in managing foreign distributors;
o varying requirements for localized products;
o potentially adverse tax consequences;
o currency restrictions and currency exchange fluctuations including those related to the EURO;
o adoption of the EURO and uncertainties surrounding the EURO conversion;
o the burden of complying with a wide variety of complex foreign laws, regulations and treaties; and
o the possibility of difficulties in collecting accounts receivable, longer payment cycles.
Any of these factors could have a material adverse effect on our business, financial condition or results of operations in
the future.
Our Business Will Suffer if Our Software Contains Errors. Software and products as complex as those we sell 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 our software to a greater extent than the market for software products generally. Despite internal testing and testing by current
and potential customers, new products or enhancements may contain undetected errors or performance problems that are discovered only
after a product has been installed and used by customers. Errors or performance problems could cause delays in product introduction
and shipments or could require design modifications, either of which could lead to a loss in or delay in revenue. These problems
could cause a diversion of development resources, harm our reputation or result in increased service or warranty costs, or require
the payment of monetary damages, any of which could harm our business, operating results and financial condition. While our license
agreements with customers typically contain provisions designed to limit our exposure to potential product liability claims, it is
possible that such limitation of liability provisions may not be effective under the laws of certain jurisdictions.
Our Stock Price Has Been and May Continue to Be Volatile. The trading price of our common stock has fluctuated in the past
and is subject to significant fluctuations in response to the following factors, some of which are beyond our control:
o variations in quarterly operating results;
o fluctuations in our order levels;
o changes in earnings estimates by analysts;
o announcements of technological innovations or new products or product enhancements by us or our competitors;
o key management changes;
o changes in joint marketing and development programs;
o developments relating to patents or other intellectual property rights or disputes;
o developments in our relationships with our customers, resellers and suppliers;
o our announcements of significant contracts, acquisitions, strategic partnerships or joint ventures;
o general conditions in the software and computer industries;
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o fluctuations in stock market price and volume, which are particularly common among highly volatile securities
of Internet and software companies; and
o other general economic conditions.
In recent years, the stock market in general, has experienced extreme price and volume fluctuations that have affected the
market price for many companies in industries similar to ours. Some of these fluctuations have been unrelated to the operating
performance of the affected companies. These market fluctuations may decrease the market price of our common stock in the future.
Acquisitions of Companies or Technologies May Result in Disruptions to Our Business and Diversion of Management Attention.
In the past, we have made acquisitions and as part of our business strategy, we frequently evaluate strategic opportunities. We
anticipate that our future growth may depend in part on our ability to identify and acquire complementary businesses, technologies or
product lines. Acquisitions involve significant risks and could divert management's attention from the day-to-day operations of our
ongoing business. Additionally, such acquisitions may include numerous other risks, including, but not limited to the following:
o difficulties in the integration of the operations, products and personnel of the acquired companies;
o the incurrence of debt and amortization expenses related to goodwill and other intangible assets or any other
unforseen adverse accounting treatment;
o liabilities and risks that are not known or identifiable at the time of the acquisition;
o the potential loss of current customers and/or retention of the acquired company's customers; and
o the potential loss of key personnel of the acquired company.
If we fail to successfully manage future acquisitions or fully integrate future acquired businesses, products or
technologies with our existing operations, we may not receive the intended benefits of the acquisition and such acquisitions may harm
our business and financial results.
Item 2. Properties
We currently lease 352,000 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 30 locations in the
United States, 22 in Europe, 2 in Australia, 4 in Canada, and 3 in Asia. We believe that the Costa Mesa and Kirkland facilities will
be adequate for our anticipated needs through 2001.
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 the
Magistrate Judge has ruled on these motions, oral arguments will be heard for the remaining motions in the sequence in which they were
filed. A trial date has not been set.
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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. We cannot assure you 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. As of
December 31, 2000, the Company accrued a $2.5 million liability for potential settlement costs and other expenses.
Subsequent to December 31, 1998, the former shareholders of Saros Corporation filed a demand for mandatory arbitration to
release approximately 375,700 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. The arbitration, scheduled for March 5, 2001 is currently in
progress. 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 2000.
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters
Our common stock is traded on the Nasdaq National Market under the symbol "FILE". The following are the high
and low sale prices from January 1, 1998 through December 31, 2000, as reported by Nasdaq:
High Low
Year Ended December 31, 2000
4th Quarter $ 35.63 $ 15.69
3rd Quarter 21.31 15.00
2nd Quarter 31.06 15.25
1st Quarter 46.81 21.19
Year ended December 31, 1999
4th Quarter $ 26.38 $ 10.00
3rd Quarter 13.69 7.75
2nd Quarter 12.00 6.00
1st Quarter 13.38 6.50
Year ended December 31, 1998
4th Quarter $ 14.00 $3.69
3rd Quarter 32.88 13.50
2nd Quarter 30.13 21.88
1st Quarter 24.50 13.75
The closing price of our common stock at December 31, 2000 was $27.25. The approximate number of stockholders of record on
March 22, 2001, was 556. The closing price of our common stock on that date was $13.94.
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) Fiscal Years Ended December 31,
2000 1999 1998 1997 1996
Consolidated statements of operations data:
Revenue:
Software $ 204,823 $ 183,253 $ 171,153 $ 132,723 $ 140,659
Service 172,772 147,449 115,501 89,280 82,118
Hardware 21,019 16,418 23,579 29,422 46,136
---------- ---------- ---------- ---------- ----------
Total revenue 398,614 347,120 310,233 251,425 268,913
Costs and expenses:
Cost of software revenue 15,544 16,984 16,814 13,416 15,389
Cost of service revenue 100,456 85,686 69,586 54,003 51,068
Cost of hardware revenue 12,430 8,805 13,181 20,330 29,633
---------- ---------- ---------- ---------- ----------
Total cost of revenue 128,430 111,475 99,581 87,749 96,090
Gross profit 270,184 235,645 210,652 163,676 172,823
---------- ---------- ---------- ---------- ----------
Operating expenses:
Research and development 57,914 54,307 50,132 40,927 37,577
Selling, general and administrative 163,165 157,708 161,013 127,622 120,261
Amortization of intangibles 1,776 - - - -
Merger, restructuring,
in-process research and
development, and other costs 2,984 - 2,000 6,000 16,011
---------- ---------- ---------- ---------- ----------
Total operating expenses 225,839 212,015 213,145 174,549 173,849
---------- ---------- ---------- ---------- ----------
Operating income (loss) 44,345 23,630 (2,493) (10,873) (1,026)
Other income, net 5,406 3,409 3,840 3,160 2,838
---------- ---------- ---------- ---------- ----------
Income (loss) before income taxes 49,751 27,039 1,347 (7,713) 1,812
Provision (benefit) for income taxes 11,204 7,362 391 (2,187) 4,456
---------- ---------- ---------- ------------ ----------
Net income (loss) $ 38,547 $ 19,677 $ 956 $ (5,526) $ (2,644)
========== ========== ========== ============ ==========
Earnings (loss) per share:
Basic $ 1.13 $ 0.61 $ 0.03 $ (0.18) $ (0.09)
Diluted $ 1.05 $ 0.59 $ 0.03 $ (0.18) $ (0.09)
Weighted average shares outstanding:
Basic 34,155 32,125 31,083 30,310 30,014
Diluted 36,765 33,360 33,367 30,310 30,014
Consolidated balance sheet data:
Working capital $ 155,483 $ 101,777 $ 67,972 $ 79,091 $ 85,475
Total assets 323,570 240,892 206,822 179,440 192,274
Stockholders' equity 224,957 150,458 130,320 118,811 132,806
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).
RESULTS OF OPERATIONS
The following table sets forth certain consolidated statement of income data as a percentage of total revenue for the
periods indicated:
December 31,
2000 1999 1998
(As a percentage of total revenue)
Revenue:
Software 51.4% 52.8% 55.2%
Customer support 26.4 25.5 22.2
Professional services and education 15.7 15.2 12.1
Hardware 5.3 4.7 7.6
Other 1.2 1.8 2.9
---------- --------- --------
Total Revenue 100.0 100.0 100.0
Cost of revenue:
Software 3.9 4.9 5.4
Customer support 10.5 10.9 10.6
Professional services and education 13.7 12.2 9.5
Hardware 3.1 2.5 4.3
Other 1.0 1.6 2.3
---------- --------- --------
Total cost of revenue 32.2 32.1 32.1
Gross Profit 67.8 67.9 67.9
Operating expenses
Research and development 14.5 15.7 16.2
Selling, general and administrative 41.0 45.4 51.9
Amortization of intangibles, restructuring,
in-process research and development, and
other costs 1.2 - 0.6
---------- --------- --------
Total operating expenses 56.7 61.1 68.7
Operating income (loss) 11.1 6.8 (0.8)
Other income, net 1.4 1.0 1.2
---------- --------- --------
Net income before tax 12.5% 7.8% 0.4%
13
Revenue
Total revenue increased to $398.6 million in 2000 from $347.1 million in 1999 and from $310.2 million in 1998, representing
increases of $51.5 million, or 15%, from 1999 to 2000 and $36.9 million, or 12%, from 1998 to 1999. This increase was largely due to an
increase in our customer base, broader software functionality and new product introductions, and an increased emphasis on professional
services.
Software revenue consists of revenue from the licensing of our software products to customers. Software revenue increased
to $204.8 million in 2000 from $183.3 million in 1999 and from $171.2 million in 1998, representing increases of $21.5 million, or
12%, from 1999 to 2000 and $12.1 million, or 7%, from 1998 to 1999. These increases were primarily attributable to large scale
deployments of our software products, as well as growth in the number of our customers. These expanded deployments were largely the
result of Web-enabled architecture introduced in 1998.
Customer support revenue consists of revenue from software maintenance contracts and "fee for service" revenues. Customer
support revenue increased to $105.4 million in 2000 from $88.6 million in 1999 and from $69.0 million in 1998, representing increases
of $16.8 million, or 19%, from 1999 to 2000, and $19.6, or 28%, from 1998 to 1999. This increase in customer support revenue was
primarily due to the growth in our customer base as a result of new customer sales and sales of additional products to our 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 generally performed on a time and material basis. Professional services and education revenue increased to $62.5
million in 2000 from $52.5 million in 1999 and from $37.4 million in 1998, representing increases of $10.0 million, or 19%, from
1999 to 2000, and $15.1 million, or 40%, from 1998 to 1999. This increase was primarily attributable to an increase in custom
development projects, and to a lesser extent, an increase in sales of prepackaged service offerings, which include both consulting
and training. We plan to continue to focus on expanding our professional services capabilities to support our solutions-oriented
strategy.
Hardware revenue is generated primarily from the sale of 12-inch OSARs, spare parts, supplies and third party products.
Hardware revenue increased to $21.0 million in 2000 from $16.4 million in 1999 and decreased from $23.6 million in 1998, representing
an increase of $4.6 million, or 28%, from 1999 to 2000 and a decrease of $7.2, or 31%, from 1998 to 1999. The increase in 2000 was
primarily due to increased demand for 30 gigabyte drives. We believe the 31% decrease in 1999 was partly attributable to reluctance of
customers to deploy new hardware products as a result of Y2K uncertainty. We anticipate hardware revenue will decline as a percentage
of total revenue in 2001.
As a service to our customers, other revenue is generated primarily from the sale of spare parts, supplies and third party
products. Other revenue decreased to $4.9 million in 2000 from $6.3 million in 1999 and decreased from $9.0 million in 1998,
representing a decrease of $1.4 million, or 22%, from 1999 to 2000 and a decrease of $2.7 million, or 30%, from 1998 to 1999. This
decrease in other revenue was primarily due to a decrease in demand for spare parts and the elimination of sales of third party
products. We anticipate other revenue will continue to be a small percentage of total revenue in 2001.
14
International revenues accounted for 28% of total revenue or $110.1 million in 2000, 28% or $98.1 million in 1999, and 32%
or $97.8 million in 1998. A significant portion of international sales are denominated in the local currency of the country where
sold. The strengthening of the U.S. dollar against foreign currencies negatively impacted revenue reported in U.S. dollars in 2000
and to a lesser extent in 1999. Additionally, the lower percentage in 1999 as compared to 1998 was attributable to a weakness in
order levels in the European market as a result of customers and prospective customers concerns over Y2K. We expect international
revenue to continue to represent a significant percentage of total revenue.
Cost of Revenue
Total cost of revenue increased to $128.4 million in 2000 from $111.5 million in 1999 and from $99.6 million in 1998,
representing increases of $16.9 million, or 15%, from 1999 to 2000 and $11.9 million, or 12%, from 1998 to 1999. This increase was
largely due to increases in cost in our service segments offset in part by decreases in software cost.
Cost of software revenue includes royalties paid to third parties, media costs, and the cost to manufacture and distribute
software. The cost of software revenue decreased to $15.5 million in 2000 from $17.0 million in 1999 and from $16.8 million in 1998,
representing 8%, 9% and 10% of software revenue, respectively. The decrease as a percentage of software revenue is primarily
attributable to distribution costs which remained constant while revenue increased, as well as a reduction in royalty costs due to
the unbundling and discontinuation of certain third party products.
Cost of customer support revenue includes customer support personnel, supplies, and the cost of third-party hardware
maintenance. The cost of customer support revenue increased to $41.9 million in 2000 from $38.0 million in 1999 and from $32.8
million in 1998. However, cost as a percentage of customer support revenue decreased to 40% in 2000 compared to 43% in 1999 and 48%
in 1998. The decrease in 2000 and 1999 was primarily attributable to process improvement that allowed growth in the customer base
without a proportional increase in support personnel and cost. 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.
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 increased to $54.6 million in 2000
from $42.1 million in 1999 and from $29.7 million in 1998, representing 87%, 80% and 79% of professional services and education
revenue, respectively. These increases were primarily due to increases in personnel, whose compensation expense was not fully
absorbed by increases in revenue because new professional services personnel require intensive training before they are fully
productive.
Cost of hardware revenue includes the cost of assembling our OSAR library products, the cost of hardware integration
personnel, warranty costs as well as the distribution costs of these products. The cost of hardware revenue increased to $12.4
million in 2000 from $8.8 million in 1999 and decreased from $13.2 million in 1998, representing 59%, 54% and 56% of hardware
revenue, respectively. The increased cost of hardware revenue as a percent of hardware revenue in 2000 was primarily due to
increased warranty cost as compared to the prior two years.
Cost of other revenue includes the cost of supplies, spare parts and third-party products as well as the distribution costs
of these products. The cost of other revenue decreased to $4.0 million in 2000 from $5.6 million in 1999 and from $7.1 million in 1998,
representing 82%, 89% and 79% of other revenue, respectively. The fluctuation in cost of other revenue as a percent of other revenue
is primarily due to a variety of small factors including vendor price variability.
15
Operating Expenses
Research and Development. Research and development expense consists primarily of personnel costs to support product
development. Research and development expense increased to $57.9 million in 2000 from $54.3 million in 1999 and from $50.1 million
in 1998, representing 15%, 16% and 16% of total revenue, respectively. These increases were primarily due to market driven increases
in salaries and recruiting costs as a result of the intense competitive environment for software engineers and an increase in the
rates of contract developers.
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 total revenue.
Selling, General and Administrative. Selling, general and administrative expense increased to $163.2 million in 2000 from
$157.7 million in 1999 and from $161.0 million in 1998. Selling, general and administrative expense, as a percentage of total revenue
was 41% in 2000, 45% in 1999 and 52% in 1998. The decrease as a percent of total revenue is primarily due to cost containment
measures and expense control, along with higher revenue. The increase in absolute dollars is primarily due to performance-based
incentives, recruitment costs for new sales personnel and higher depreciation costs.
Purchased In-Process Research and Development. Based upon an independent third-party appraisal, we allocated
approximately $3.0 million to in-process research and development which was an element of the purchase price of Application Partners,
Incorporated ("API"). The in-process research and development expenses related to new product projects that were under development at
the date of the acquisition and were expected to eventually lead to new products but had not yet established feasibility and for which
no future alternative use was identified. The valuation of the in-process research and development projects was based upon the
discounted expected future net cash flows of the products over their expected life, reflecting the estimated percent of completion of
the projects and an estimate of the costs to complete the projects. New product development projects underway at API at the time of the
acquisition included Sequis, an eService application which we estimated to be 88% complete at the date of the acquisition. The cost to
complete the project was estimated at approximately $300,000 to occur over a three-month period. We incurred approximately
$356,000 of research and development expenses related to the project which was 100% complete as of September 30, 2000.
Amortization of Goodwill and Other Intangibles. In conjunction with our acquisition of API in May 2000, the purchase price
amount allocated to goodwill was $14.6 million, which is being amortized over five years. The purchase price amount allocated to
assembled workforce was $386.000, which is being amortized over three years. Amortization expense in 2000 was $1.8 million.
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, $700,000
for facility closing costs and $200,000 of other charges. Estimated costs approximated actual costs incurred. At December 31,
2000, there were no remaining accrued restructuring and other costs included in other accrued liabilities as all amounts have been paid.
16
Other Income, Net. Other income, net consists primarily of interest income earned on our cash and cash
equivalents, short and long-term investments, and other items including foreign exchange gains and losses, the gain on sale of fixed
assets, other items of income, and interest expense. Other income, net of other expenses, was $5.4 million in 2000, $3.4 million in
1999 and $3.8 million in 1998. The increase in 2000 was primarily attributable to increases in interest income directly related to
higher cash balances, a foreign exchange gain for the year, which was partially offset by increases in other expense related to an
accrual of $2.5 million for a pending legal settlement. The decrease in 1999 was primarily attributable to increased foreign exchange
losses and increased interest expense associated with our foreign currency hedge activities which was partially offset by increases
in interest income.
Provision for Income Taxes. The provision for income taxes was $11.2 million in 2000, compared to $7.4 million in 1999 and
$391,000 in 1998. The effective tax rate was 23%, 27% and 29% for the years ended December 31, 2000, 1999 and 1998,
respectively. The reduced tax rate in 2000 was primarily due to earnings generated in low tax foreign jurisdictions, partially offset
by the generation of domestic taxable income before stock option deductions and utilization of deferred tax assets.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2000, cash and cash equivalents, and investments were $139.5 million, an increase of $30.8 million from
the $108.7 million at December 31, 1999.
Cash provided by operating activities in 2000 was $55.3 million and resulted primarily from an increase in net income, an
increase in unearned maintenance revenue related to prepaid maintenance contracts, additions to net income for depreciation and
amortization expense and income tax benefit from stock options offset by an increase in accounts receivable, an increase in deferred
tax, and an increase in prepaid expenses. Cash used by investing activities in 2000 totaled $48.3 million, consisting primarily of
capital expenditures, cash paid for acquisitions, and the net sale and maturity of marketable securities. Cash provided by financing
activities in 2000 was $24.9 million, consisting primarily of proceeds from the exercise of employee stock options and the issuance
of common stock under the employee and non-employee director stock purchase plan.
Cash provided by operating activities in 1999 was $38.5 million and resulted primarily from an increase in 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 primarily of capital expenditures, proceeds from the sales of equipment, and the net sale
and maturity of marketable securities. Cash provided by financing activities in 1999 was $5.1 million, consisting primarily of
proceeds from the exercise of employee stock options, and the issuance of common stock under 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 in 1998 totaled $23.7 million, consisting of capital expenditures offset by the net sale and
maturity of marketable securities. Cash provided by financing activities in 1998 was $9.1 million, consisting of proceeds from the
exercise of employee stock options, and the issuance of common stock under the employee and non-employee director stock purchase
plan, offset in part by the cost to repurchase common stock.
17
Our capital expenditures were $28.2 million in 2000, $22.4 million in 1999, and $32.5 million in 1998. Our primary capital
expenditures during these years were 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 capital
expenditures in 1998 over the levels in 1999 and 2000 was primarily due 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 anticipate that our present cash balances, together with internally generated funds and credit lines, will be sufficient
to meet our working capital and capital expenditures throughout 2001, which are anticipated to be approximately $37.0 million.
OTHER MATTERS
European Monetary Union. On January 1, 1999, 11 of the 15 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. 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 will remain legal tender in these countries as a denomination of the EURO between January 1, 1999 and
January 1, 2002. During this 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 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 interim changes to our internal business systems to support transactions denominated in the EURO,
including establishing EURO price lists for affected countries. In 2001 we will complete the system changes required to fully
implement EURO reporting requirements. We have evaluated the impact the conversion to the EURO will have on our financial condition
and results of operations. Based on this evaluation to date, we currently do not believe that there will be a material impact on our
financial condition or results of operations as a result of the EURO conversion.
Recent Accounting Pronouncements. In December 1999, Staff Accounting Bulletin ("SAB") No. 101 was issued to provide
staff's views in applying generally accepted accounting principles to revenue recognition in financial statements. SAB 101 is
effective no later than the fourth fiscal quarter of fiscal years beginning after December 15, 1999. We adopted this statement and
evaluated the impact of this bulletin on our consolidated financial statements and believe it did not and will not have a material
impact on our results of operations or equity.
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("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. SFAS 133, as amended, establishes accounting and reporting standards for derivative instruments
including certain derivative instruments embedded in other contracts that were not formerly considered derivatives and now may meet the
18
definition of a derivative. Additionally, this standard 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 have adopted this standard effective January 1, 2001 and have evaluated the impact
of adopting this statement on the consolidated financials statements and believe it will not be material to the results of our
operations, financial position, or cash flows.
In March 2000, the FASB issued Interpretation No. 44 of Accounting Principles Board Opinion No. 25, "Accounting for Certain
Transactions Involving Stock Compensation," which, among other things, addressed accounting consequences of a modification that reduces
the exercise price of a fixed stock option award (otherwise known as repricing). If the exercise price of a fixed stock option award
is reduced, the award must be accounted for as variable price stock plan from the date of the modification to the date the award is
exercised, is forfeited, or expires unexercised. The exercise price of an option award has been reduced if the fair value of the
consideration required to be paid by the grantee upon exercise is less than or potentially less than the fair value of the
consideration that was required to be paid pursuant to the award's original terms. The requirements about modifications to fixed
stock option awards that directly or indirectly reduce the exercise price of an award apply to modifications made after December
15, 1998, and will be applied prospectively as of July 1, 2000. The adoption of this interpretation did not impact our
consolidated financial statements.
Item 7a. 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
19
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 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 in 2000 were $25.4 million and $16.4 million, respectively. We do not
expect gains or losses on these contracts to have a material impact on financial results (see Note 14 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 each of the three years ended December 31, 2000.
Item 8. Financial Statements and Supplementary Data
The consolidated financial statements for the years ended December 31, 2000, 1999 and 1998 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
We hereby incorporate by reference the information appearing under the caption "Election of Directors," under the caption
"Executive Officers of the Company," and under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" of the
Registrant's definitive Proxy Statement for our 2001 Annual Meeting to be filed with the Securities and Exchange Commission.
Item 11. Executive Compensation
We hereby incorporate 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 2001 Annual Meeting to be filed with the
Securities and Exchange Commission.
Item 12. Security Ownership of Certain Beneficial Owners and Management
We hereby incorporate by reference the information appearing under the caption "Voting Securities and Principal Holders
Thereof" of the Registrant's definitive Proxy Statement for our 2001 Annual Meeting to be filed with the Securities and Exchange
Commission.
Item 13. Certain Relationships and Related Transactions
None
20
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, 2000 and December 31, 1999....................................F-4
Consolidated Statements of Income for each of the years ended
December 31, 2000, 1999 and 1998.................................................................F-5
Consolidated Statements of Comprehensive Income for each of the years
ended December 31, 2000, 1999 and 1998...........................................................F-6
Consolidated Statements of Stockholders' Equity for each of the years ended
December 31, 2000, 1999 and 1998.................................................................F-7
Consolidated Statements of Cash Flows for each of the years ended
December 31, 2000, 1999 and 1998.................................................................F-8
Notes to Consolidated Financial Statements................................................................F-9
Independent Auditors' Report on Schedule..................................................................F-26
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 ended December 31, 2000.
(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).
21
10.5* Lease between the Registrant and C. J. Segerstrom and 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 and 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 and 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).
10.10* Second Amended and Restated Stock Option Plan of FileNET Corporation, together with the forms of
Incentive Stock Option Agreement and Non-Qualified Stock Option Agreements (filed as Exhibits
4(a), 4(b) and 4(c), respectively, to the Registrant's Registration Statement on Form S-8,
Registration No. 33-48499), and an Amendment thereto (filed as Exhibit 4(d) to the Registrant's
Registration Statement on Form S-8, Registration No. 33-69920), and the Second Amendment thereto
(filed as Appendix A to the Registrant's Proxy Statement for the Registrant's 1994 Annual Meeting
of Stockholders, filed on April 29, 1994).
10.11* Non-Statutory Stock Option Agreement (with Notice of Grant of Stock Option and Special Addendum)
between Registrant and Mr. Lee Roberts (filed as exhibit 99.17 to Form S-8 on August 20, 1997).
10.12* Non-Statutory Stock Option Agreement (with Notice of Grant of Stock Option and Special Addendum)
between Registrant and Mr. Ron Ercanbrack (filed as exhibit 99.19 to Form S-8 on August 20, 1997).
10.18* Agreement and Plan of Merger between the Registrant and Watermark Software Inc. dated July 18,
1995 (filed as Exhibit 10.27 to Form 10-Q for the quarter ended July 2, 1995).
10.19* Agreement and Plan of Merger between the Registrant and Saros Corporation, as amended, dated
January 17, 1996 (filed as Exhibits 2.1, 2.2, 2.3, and 2.4 to Form 8-K on March 13, 1996).
10.20* Stock Purchase Agreement by 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 99.2
to Form S-8, filed on August 8, 2000; Registration No. 333-43254).
10.22* FileNET Corporation International Employee Stock Purchase Plan (filed as Exhibit 99.3 to Form
S-8, filed on August 8, 2000; Registration No. 333-43254).
10.23* Lease between the Registrant and C. J. Segerstrom and 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 Auditors' consent (see page 24).
* 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 27, 2001 By: /s/ Lee D. Roberts
Lee D. Roberts
Chief Executive Officer and
Chairman of the Board
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 27, 2001 By: /s/ Lee D. Roberts
Lee D. Roberts
Chief Executive Officer and
Chairman of the Board
Date: March 27, 2001 By: /s/ Sam M. Auriemma
Sam M Auriemma,
Chief Financial Officer and
Senior Vice President, Finance
(Principal Financial and
Accounting Officer)
Date: March 27, 2001 By: /s/ Theodore J. Smith
Theodore J. Smith
Director
Date: March 27, 2001 By: /s/ L. George Klaus
L. George Klaus
Director
Date: March 27, 2001 By: /s/ William P. Lyons
William P. Lyons
Director
Date: March 27, 2001 By: /s/ John C. Savage
John C. Savage
Director
Date: March 27, 2001 By: /s/ Roger S. Siboni
Roger S. Siboni
Director
23
Exhibit 23.1
Independent Auditors' Consent
We consent to the incorporation by reference in Registration Statements No. 33-90454, 33-96076, 33-80899, 333-02194, 333-09075,
333-34031, 333-66997, 333-89983, 333-43254 and 333-43254 of FileNET Corporation on Form S-8 of our reports dated January 23, 2001,
appearing in this Annual Report on Form 10-K of FileNET Corporation for the fiscal year ended December 31, 2000.
/s/ DELOITTE and TOUCHE LLP
Costa Mesa, California
March 27, 2001
24
FILENET CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2000, 1999 and 1998
with
Independent Auditors' Report
F-1
FILENET CORPORATION
CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 2000, 1999 and 1998
Contents
Independent Auditors' Report..............................................................................F-3
Audited Consolidated Financial Statements:
Consolidated Balance Sheets............................................................................F-4
Consolidated Statements of Income......................................................................F-5
Consolidated Statements of Comprehensive Income........................................................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-26
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, 2000 and 1999, and the related consolidated statements of income, comprehensive income, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2000. 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, 2000 and 1999, and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United
States of America.
/s/ DELOITTE and TOUCHE LLP
Costa Mesa, California
January 23, 2001
F-3
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share and per share amounts)
December 31, 2000 1999
ASSETS
Current assets:
Cash and cash equivalents $ 101,497 $ 71,528
Short-term investments 36,960 31,581
Accounts receivable, net of allowances for doubtful accounts
and sales allowances of $5,518 and $4,542 at December 31,
2000 and 1999, respectively 90,166 72,736
Inventories, net 3,393 3,399
Prepaid expenses and other current assets 9,682 8,080
Deferred income taxes 5,660 938
------------------ ------------------
Total current assets 247,358 188,262
Property, net 49,757 40,593
Long-term investments 999 5,542
Intangible assets, net of accumulated amortization of $1,811 at
December 31, 2000 13,457 -
Deferred income taxes 10,278 4,752
Other assets 1,721 1,743
------------------ ------------------
Total assets $ 323,570 $ 240,892
================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 16,638 $ 16,642
Accrued compensation and benefits 26,245 24,079
Unearned maintenance revenue 20,892 16,286
Income tax payable 9,679 7,808
Other accrued liabilities 18,421 21,670
------------------ ------------------
Total current liabilities 91,875 86,485
Unearned maintenance revenue 6,738 3,949
Commitments 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 authorized;
35,940,876 shares issued and 34,842,876 shares outstanding at
December 31, 2000; and 33,578,642 shares issued and
32,480,642 shares outstanding at December 31, 1999 189,057 149,779
Retained earnings 61,528 22,981
Accumulated other comprehensive loss (11,061) (7,735)
------------------ ------------------
239,524 165,025
Treasury stock, at cost; 1,098,000 shares at
December 31, 2000 and 1999 (14,567) (14,567)
------------------ ------------------
Total stockholders' equity 224,957 150,458
------------------ ------------------
Total liabilities and stockholders' equity $ 323,570 $ 240,892
================== ==================
See accompanying Notes to Consolidated Financial Statements
F-4
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share amounts)
Year Ended December 31, 2000 1999 1998
Revenue:
Software $ 204,823 $ 183,253 $ 171,153
Service 172,772 147,449 115,501
Hardware 21,019 16,418 23,579
--------------------------------------------------
Total revenue 398,614 347,120 310,233
--------------------------------------------------
Costs:
Cost of software revenue 15,544 16,984 16,814
Cost of service revenue 100,456 85,686 69,586
Cost of hardware revenue 12,430 8,805 13,181
--------------------------------------------------
Total cost of revenues 128,430 111,475 99,581
--------------------------------------------------
Gross profit 270,184 235,645 210,652
--------------------------------------------------
Operating expenses:
Research and development 57,914 54,307 50,132
Selling, general and administrative 163,165 157,708 161,013
Amortization of goodwill and other intangibles 1,776 - -
Restructuring, and in-process research and development 2,984 - 2,000
--------------------------------------------------
Total operating expenses 225,839 212,015 213,145
--------------------------------------------------
Operating income (loss) 44,345 23,630 (2,493)
Other income, net 5,406 3,409 3,840
--------------------------------------------------
Income before income taxes 49,751 27,039 1,347
Provision for income taxes 11,204 7,362 391
--------------------------------------------------
Net income $ 38,547 $ 19,677 $ 956
==================================================
Earnings per share:
Basic $ 1.13 $ 0.61 $ 0.03
Diluted $ 1.05 $ 0.59 $ 0.03
Weighted average shares outstanding
Basic 34,155 32,125 31,083
Diluted 36,765 33,360 33,367
See accompanying Notes to Consolidated Financial Statements
F-5
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
Year Ended December 31, 2000 1999 1998
Net income $ 38,547 $ 19,677 $ 956
--------------------------------------------------
Other comprehensive income (loss):
Foreign currency translation
Adjustments, net of tax (3,385) (4,970) 1,455
Unrealized holding gains (losses) on
available-for-sale securities, net of 59 (106) 32
tax --------------------------------------------------
Other comprehensive income (loss) (3,326) (5,076) 1,487
--------------------------------------------------
Comprehensive income $ 35,221 $ 14,601 $ 2,443
--------------------------------------------------
See accompanying Notes to Consolidated Financial Statements
F-6
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Accumulated
Other
Common Stock Retained Comprehensive Treasury Stock
(In thousands) Shares Amount Earnings Operations Shares Amount Total
Balances at January 1, 1998 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
Stock options exercised 2,081 19,981 19,981
Stock option income tax benefit 14,408 14,408
Common stock issued under the
Employee Qualified Stock Purchase Plan 281 4,889 4,889
Foreign currency translation adjustment (3,385) (3,385)
Net income 38,547 38,547
Other 59 59
------------------------- ------------ --------------- ----------------------- ------------
Balances at December 31, 2000 35,941 $ 189,057 $ 61,528 $ (11,061) (1,098) $ (14,567) $ 224,957
===========================================================================================
See accompanying Notes to Consolidated Financial Statements
F-7
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Year Ended December 31, 2000 1999 1998
Cash flows from operating activities:
Net income $ 38,547 $ 19,677 $ 956
Adjustments to reconcile net income to net cash
provided by operating activities:
Purchased in-process research and development 2,984 - -
Depreciation and amortization 19,827 17,316 15,360
Provision for doubtful accounts 1,389 612 1,041
Deferred income taxes (10,248) (247) 566
Stock option income tax benefit 14,408 477 -
Changes in operating assets and liabilities net of effects of
business acquisition:
Accounts receivable (21,000) (14,979) (573)
Inventories 6 (980) 1,121
Prepaid expenses and other current assets (4,897) 603 (609)
Accounts payable 155 (4,102) 5,905
Accrued compensation and benefits 2,582 2,486 4,820
Unearned maintenance revenue 7,530 9,046 2,408
Income tax payable 2,040 4,051 2,323
Other 1,962 4,514 (60)
-------------------------------------------------
Net cash provided by operating activities 55,285 38,474 33,258
-------------------------------------------------
Cash flows from investing activities:
Capital expenditures (28,155) (22,432) (32,474)
Proceeds from sale of property 427 8,028 478
Cash paid for acquisitions, net of cash acquired (20,000) - -
Purchases of marketable securities (40,442) (51,669) (34,536)
Proceeds from sales and maturities of marketable securities 39,901 40,670 42,843
-------------------------------------------------
Net cash used in investing activities (48,269) (25,403) (23,689)
-------------------------------------------------
Cash flows from financing activities:
Proceeds from issuance of common stock 24,870 5,060 13,501
Common stock repurchased - - (4,435)
-------------------------------------------------
Net cash provided by financing activities 24,870 5,060 9,066
-------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents (1,917) (2,423) (159)
-------------------------------------------------
Net increase in cash and cash equivalents 29,969 15,708 18,476
Cash and cash equivalents, beginning of year 71,528 55,820 37,344
-------------------------------------------------
Cash and cash equivalents, end of year $ 101,497 $ 71,528 $ 55,820
=================================================
Supplemental cash flow information:
Interest paid $ 69 $ 221 $ 25
Income taxes paid (refunded) $ 6,996 $ 671 $ (2,119)
-------------------------------------------------
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 eProcess and Content Management software products designed for managing information and
enhancing enterprise productivity. Additionally, the Company manufactures and sells a line of 12-inch, 30 gigabyte Optical Storage and
Retrieval Libraries ("OSARs"). The Company markets its products to a broad range of industries in more than 90 countries through a
global sales, service and support organization, including its ValueNET business partner program of resellers, system integrators and
application developers.
Basis of Presentation. The accompanying consolidated financial statements have been prepared in accordance with accounting
principles generally accepted in the United States. The consolidated financial statements include the accounts of the Company and
its 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.
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.
Cash Equivalents. Investments purchased with an original maturity of three months or less are considered to be cash
equivalents.
Investments. The Company's investments in marketable securities consist primarily of high-grade corporate and government
securities with maturities of less than three years. 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
F-9
financial institutions. The Company uses commercial rating agencies to evaluate the credit quality of the counterparties and does not
anticipate nonperformance by any counterparties. The Company does not anticipate a material loss resulting from credit risks related
to any of these institutions (Note 14).
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("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. SFAS 133, as amended, establishes accounting and reporting standards for derivative instruments including certain
derivative instruments embedded in other contracts that were not formerly considered derivatives and may now meet the definition of a
derivative. Additionally, this standard 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 has adopted this standard effective January 1, 2001 and has evaluated the impact of
adopting this statement on the consolidated financial statements and believes it will not be material to results of operations,
financial position, or cash flows of the Company .
Fair Value of Financial Instruments. The recorded amounts of financial assets and liabilities at December 31, 2000 and
1999, 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.
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).
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. Based on the Company's most recent analysis, the Company believes there is no impairment at December 31, 2000.
Research and Development. The Company expenses research and development costs as incurred. No amounts are required to be
capitalized in accordance with SFAS No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed,"
as of December 31, 2000 and 1999 because software is substantially completed concurrently with the establishment of technological
feasibility.
F-10
Goodwill and Assembled Workforce. Goodwill arising from acquisitions is amortized on a straight-line basis over five years
and assembled workforce is amortized on a straight-line basis over three years (Note 2). The Company evaluates the carrying value of
goodwill and assembled workforce for impairment of value based on undiscounted future cash flows. Based on the Company's most recent
analysis, the Company believes there is no impairment at December 31, 2000.
Revenue Recognition. Revenues from sales of software licenses, which generally do not contain multiple elements, are
recognized upon shipment of the related product if the requirements of Statement of Position ("SOP") 97-2, as amended, are met. If
the requirements of SOP 97-2, including evidence of an arrangement, delivery, fixed or determinable fee, collectibility or
vendor-specific evidence about the value of an element are not met at the date of shipment, revenue recognition is deferred until
such elements are known or resolved. 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 Per Share Basic earnings per share is computed using the weighted average number of common shares outstanding
during the reporting period. Diluted earnings 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).
F-11
Recent Accounting Pronouncements In December 1999, Staff Accounting Bulletin ("SAB") No. 101 was issued to provide
staff's views in applying generally accepted accounting principles to revenue recognition in financial statements. SAB 101 is
effective no later than the fourth fiscal quarter of fiscal years beginning after December 15, 1999. The Company has adopted this
statement and evaluated the impact on the consolidated financial statements and believes it did not and will not have a material
impact on its results of operations or equity.
In June 1998 the 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. SFAS 133, as amended, establishes accounting and
reporting standards for derivative instruments including certain derivative instruments embedded in other contracts that were not
formerly considered derivatives and now may meet the definition of a derivative. Additionally, this standard 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 has
adopted this standard effective January 1, 2001 and has evaluated the impact of adopting this statement on the consolidated financials
statements and believes it will not be material to results of operations, financial position, or cash flows of the Company .
In March 2000, the FASB issued Interpretation No. 44 of Accounting Principles Board Opinion No. 25, Accounting for Certain
Transactions Involving Stock Compensation, which, among other things, addressed accounting consequences of a modification that
reduces the exercise price of a fixed stock option award (otherwise known as repricing). If the exercise price of a fixed stock
option award is reduced, the award must be accounted for as variable price stock plan from the date of the modification to the date
the award is exercised, is forfeited, or expires unexercised. The exercise price of an option award has been reduced if the fair
value of the consideration required to be paid by the grantee upon exercise is less than or potentially less than the fair value of the
consideration that was required to be paid pursuant to the award's original terms. The requirements about modifications to fixed
stock option awards that directly or indirectly reduce the exercise price of an award apply to modifications made after December
15, 1998, and will be applied prospectively as of July 1, 2000. The adoption of this interpretation did not impact the
Company's consolidated financial statements.
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 the current year's
presentation.
F-12
Note 2 Acquisitions
On May 18, 2000, the Company acquired certain assets from Application Partners, Incorporated ("API") for $20.0 million. The
acquisition was accounted for as an asset purchase and the purchase price was allocated as follows (in thousands):
Assembled workforce $ 386
Goodwill 14,552
In-process research and development 2,984
Prepaid expense 2,000
Fixed assets 78
--------------
Total purchase price $ 20,000
==============
The amount allocated to assembled workforce is being amortized over an estimated useful life of three years. The
amount allocated to goodwill is being amortized over an estimated useful life of five years. Additionally, retention payments of
$2.0 million were recorded as a prepaid asset and will be expensed in 2001 based upon defined future employment requirements.
Based upon an independent third party appraisal, the Company allocated approximately $3.0 million to in-process research and
development which was an element of the purchase price. The in-process research and development expenses related to new product
projects that were under development at the date of the acquisition and were expected to eventually lead to new products but had not
yet established feasibility and for which no future alternative use was identified. The valuation of the in-process research and
development projects was based upon the discounted expected future net cash flows of the products over their expected life,
reflecting the estimated percent of completion of the projects and an estimate of the costs to complete the projects. New product
development projects underway at API at the time of the acquisition included Sequis, an eService application which the Company
estimated to be 88% complete at the date of the acquisition. The cost to complete the project was estimated at approximately $300,000
to occur over a three-month period. The Company incurred approximately $356,000 of research and development expenses related to the
project which was 100% complete as of September 30, 2000.
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, $700,000 for facility closing costs
and $200,000 of other charges. Estimated costs approximated actual costs incurred. At December 31, 2000 there were no remaining
accrued restructuring and other costs included in other accrued liabilities as all amounts have been paid.
F-13
Note 4 Earnings Per Share
The following table is a reconciliation of the earnings and share amounts used in the calculation of basic earnings per
share and diluted earnings per share.
(Dollars in thousands, except per share amounts)
Net Per Share
Income Shares Amount
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
=======================================
Year ended December 31, 2000:
Basic earnings per share $ 38,547 34,155 $ 1.13
Effect of dilutive stock options 2,610
----------------------------------------
Diluted earnings per share $ 38,547 36,765 $ 1.05
========================================
Options to purchase 654,000, 1,417,000 and 351,000 shares of common stock in 2000, 1999, and 1998, respectively, were
outstanding during the year but were not included in the computation of diluted income per share as their effect was antidilutive
(Note 10).
Note 5 Other Comprehensive Operations
Accumulated other comprehensive operations for each of the three years in the period ended December 31, 2000, is comprised
of the following:
(Dollars in thousands)
Foreign Accumulated
Currency Unrealized Other
Translation Holding Comprehensive
Adjustment Gains (Losses) Operations
Balance, January 1, 1998 $ (4,123) $ (23) $ (4,146)
Current Period Changes
(Net of tax of $970 and $21, respectively) 1,455 32 1,487
-----------------------------------------------
Balance, December 31, 1998 (2,668) 9 (2,659)
Current Period Changes
(Net of tax of $3,313 and $71, respectively) (4,970) (106) (5,076)
------------------------------------------------
Balance, December 31, 1999 (7,638) (97) (7,735)
Current Period Changes
(Net of tax of $2,257 and $39, respectively) (3,385) 59 (3,326)
------------------------------------------------
Balance, December 31, 2000 (11,023) (38) (11,061)
================================================
F-14
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: 2000 1999
Cost $ 37,937 $ 37,282
Gross unrealized gains 30 -
Gross unrealized losses (8) (159)
------------------------------------
Estimated fair value $ 37,959 $ 37,123
====================================
There were no realized gains or losses for the year ended December 31, 2000 and 1999. Unrealized holding gains and losses
on investments, net of tax, are included in accumulated other comprehensive operations in stockholders' equity at December 31, 2000
and 1999, and were $(38,000) and $(97,000), respectively.
The contractual maturities of investments at December 31, 2000 and 1999, 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)
2000 1999
Estimated Estimated
Cost Fair Value Cost Fair Value
Debt Securities:
Due in one year or less:
Short-term munis-taxable $ 1,000 $ 1,000 $ - $ -
Commercial paper 6,670 6,662 499 499
Corporate 26,780 26,798 28,200 28,097
Governments/Agencies 2,500 2,500 2,991 2,985
Due in one to three years:
Corporate 987 999 5,592 5,542
----------------------------- ----------------------------
Total $ 37,937 $ 37,959 $ 37,282 $ 37,123
============================= ============================
F-15
Note 7 Inventories
Inventories, net of reserves, consisted of the following at December 31:
(Dollars in thousands)
2000 1999
Raw materials $ 1,989 $ 1,895
Work-in-process 1,065 1,067
Finished goods 339 437
-------------------------------
Total $ 3,393 $ 3,399
===============================
Note 8 Property and Leases
Property consisted of the following at December 31:
(Dollars in thousands)
2000 1999
Machinery, equipment and software $ 117,880 $ 101,712
Furniture and fixtures 13,689 12,812
Leasehold improvements 21,596 14,998
---------------------------------
153,165 129,522
Less accumulated depreciation and amortization (103,408) (88,929)
---------------------------------
Property, net $ 49,757 $ 40,593
=================================
The Company leases its corporate offices, sales offices, development and 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 $18.3 million, $15.4 million, and $11.3 million for the years ended December 31,
2000, 1999 and 1998, respectively. The following table summarizes future minimum lease payments required under operating leases at
December 31:
(Dollars in thousands)
2001 $ 16,593
2002 11,766
2003 10,468
2004 8,757
2005 7,869
Thereafter 9,121
--------------
Total $ 64,574
==============
The Company continues to invest in technology equipment and software for information systems infrastructure and
telecommunications. These investments have been funded through operating leases, capital leases, and cash purchases. In 2000, the
Company entered into sale leaseback commitments for previously purchased technology equipment and software with a net book value of
$0.4 million. These leases are classified as capital leases. 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.
F-16
Note 9 Borrowing Arrangements
The Company has a two year, $20 million multi-currency revolving 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 twenty 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, 2000. There were no borrowings outstanding at December 31, 2000 and 1999.
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. In
addition, in May 2000, shareholders approved an additional 340,000 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
F-17
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, 2000, $1,045,000 had been withheld from employees' salaries pursuant to the Purchase Plans for the current
offering period, which expires on April 30, 2001. At December 31, 2000, approximately 412,386 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 137,980 common shares were exercisable under the 1986 Plan at December 31, 2000. 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 6,950,000 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 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, 2000, 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, 2000, 1,836,293 options were exercisable under the 1995 Plan.
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, 2000, a total of 8,991 options were outstanding and 8,991
were exercisable under these plans.
F-18
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, 2000,
options to purchase 7,000 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 Chief Executive Officer and a Non-Statutory Stock Option
Grant of 160,000 shares, dated June 18, 1997, to the Company's current President. In September 2000, the company's Chief Financial
Officer was granted a Non-Statutory Stock Option Grant of 140,000 shares. 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, 2000, 246,782 options were exercisable related to these Non-Statutory
Stock Option Grants and 323,218 had been exercised to date.
Information regarding all stock option plans is as follows:
Weighted
Average
Number of Exercise
Options Price
Balances, January 1, 1998 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
Granted (weighted average fair value of $12.50) 2,161,995 21.67
Exercised (2,081,458) 9.31
Canceled (843,738) 13.87
-------------------
Balances, December 31, 2000 6,356,092 $ 14.64
===================
F-19
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
$1.39 to $8.88 1,342,810 6.86 $ 7.27 657,765 $ 7.06
$9.00 to $9.17 1,146,618 6.77 9.03 796,668 9.02
$9.19 to $16.35 1,306,393 7.74 12.30 544,184 12.97
$16.75 to $23.94 1,787,496 9.29 19.24 107,679 22.68
$24.88 to $41.84 772,775 8.61 29.12 130,750 27.85
--------------------------------------------------------------------------------------
$1.39 to $41.84 6,356,092 7.92 $ 14.64 2,237,046 $ 11.16
=============== =============
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. In July 2000, the vesting of 75,625 shares were accelerated and immediately
exercised in connection with the resignation of one of the Company's officers. The transaction was recorded as compensation expense
with an increase in paid in common stock of $581,000.
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)
2000 1999 1998
Net income - as reported $38,547 $19,677 $956
Net income (loss) - pro forma 29,740 3,027 (6,915)
Diluted earnings per share - as reported 1.05 0.59 0.03
Diluted earnings (loss) per share - pro forma 0.81 0.39 (0.21)
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 2000, 1999 and 1998; expected volatility of 80% for 2000 and 75% for 1999
and 1998; risk-free interest rates of 6.1% to 6.5% for 2000, 5.1% to 6.1% for 1999, and 5.4% to 5.5% for 1998; 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 for income taxes at December 31, 2000, 1999 and 1998, consists of the following:
(Dollars in thousands)
Year ended December 31, 2000 1999 1998
Current:
Federal $ 12,758 $ 3,148 $ (405)
State 1,121 1,137 32
Foreign 7,573 3,411 198
Deferred:
Federal (11,286) 74 (20)
State 1,038 (476) 40
Foreign - 68 546
----------- -------------- ------------
Total provision $ 11,204 $ 7,362 $ 391
=========== ============== ============
F-20
A reconciliation of the provision (benefit) for income taxes at the federal statutory rate compared to the Company's
effective tax rate is as follows:
(Dollars in thousands)
Year ended December 31, 2000 1999 1998
Income taxes (benefit), at statutory Federal rate 35% 35% 35%
State taxes (benefit), net of Federal benefit 3 3 5
Tax rate differential on foreign earnings (15) 3 (163)
Change in valuation allowance (3) (14) 153
Return to Provision 2 - -
Other 1 - (1)
--------- --------- --------
Total 23% 27% 29%
========= ========= ========
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used for income tax purposes. The income tax effects of these temporary
differences representing significant portions of the deferred taxes at December 31, 2000 and 1999, are as follows:
(Dollars in thousands)
Year ended December 31, 2000 1999
Deferred taxes:
Loss carryforwards $ 14,782 $ 15,321
Tax credit carryforwards 9,072 8,251
Accrued expenses 5,122 2,786
Sales returns and allowance reserves 810 808
Deferred revenue 5,727 4,110
Depreciable assets and amortizable assets 3,673 1,655
Deferred tax on foreign earnings - (4,521)
Other 120 (1,592)
------------ -----------
Total 39,306 26,818
------------ -----------
Valuation allowance (23,368) (21,128)
------------ -----------
Net deferred tax asset $ 15,938 $ 5,690
============ ===========
The Company maintains a valuation allowance against a portion of the deferred tax asset due to uncertainty regarding the
future realization weighing all available evidence. Approximately $9.1 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. The net
increase (decrease) in the total valuation allowance was $2,240,000 $(3,246,000) and $9,922,000 during 2000, 1999 and 1998,
respectively.
The Company has $42.7 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 $9.1 million tax credit
carryforwards which will begin expiring in 2002.
At December 31, 2000, the Company had Dutch, French and Austrian subsidiary tax loss carryforwards relating to its foreign
subsidiary operations which total approximately $640,000; the majority of which have no expiration.
No provision has been made for federal or state income taxes on the unremitted earnings of the Company's foreign
subsidiaries (cumulative $ 63.9 million at December 31, 2000) since the Company plans to indefinitely reinvest all such earnings
offshore. At December 31, 2000, the unrecognized deferred tax liability for these earnings was approximately $24.5 million.
The Company's federal tax returns have been examined by the Internal Revenue Service ("IRS") for all years through 1996. The
IRS is currently examining the Company's U.S. income tax returns for 1997 and 1998. Management does not believe that the outcome of
these matters will have a material adverse effect on the Company's consolidated results of operations or consolidated financial
position.
F-21
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 Company is organized
geographically and by line of business. The line of business management structure is the primary basis for which financial performance
is assessed and resources allocated.
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 eProcess enabled Web Content Management software
solutions and eBusiness applications. The Hardware operating segment manufactures and markets the Company's line of OSAR libraries.
The Customer Support segment provides after-sale support for software, as well as 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, 2000, was as follows:
(Dollars in thousands)
Professional
Customer Services and
Software Hardware Support Education Other Consolidated
Year Ended December 31, 2000
Revenue $ 204,823 $ 21,019 $ 105,320 $ 62,465 $ 4,987 $ 398,614
Operating income 14,801 1,630 28,652 (1,344) 606 44,345
Assets 323,570
Capital expenditures 12,404 702 10,073 4,932 44 28,155
Year Ended December 31, 1999
Revenue $ 183,253 $ 16,418 $ 88,568 $ 52,631 $ 6,250 $ 347,120
Operating income 3,116 1,554 16,539 2,291 130 23,630
Assets 240,892
Capital expenditures 11,001 467 7,974 2,921 69 22,432
Year Ended December 31, 1998
Revenue $ 171,153 $ 23,579 $ 69,017 $ 37,474 $ 9,010 $ 310,233
Operating income (loss) (15,346) 1,872 10,539 (452) 894 (2,493)
Assets 206,822
Capital expenditures 19,383 1,118 8,341 3,387 245 32,474
F-22
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. All other geographic locations include South America,
the Middle East and Africa. Information concerning principal geographic areas in which the Company operates was as follows:
(Dollars in thousands)
Year ended December 31, 2000 1999 1998 .
Revenue Assets Revenue Assets Revenue Assets
North America:
United States $ 280,563 $ 231,450 $ 240,607 $ 171,483 $ 205,797 $ 142,471
Canada 7,925 6,055 8,430 6,442 6,669 1,869
----------------------------------------------------------------------------------
Total North America 288,488 237,505 249,037 177,925 212,466 144,340
Europe:
France 7,153 2,328 8,540 5,119 7,516 5,562
Germany 26,909 10,037 23,888 6,279 30,675 14,450
United Kingdom 23,867 18,680 20,148 12,085 20,882 9,800
Ireland - 42,989 - 21,645 - 23,551
Other Europe 33,806 7,857 22,498 9,831 19,373 4,172
----------------------------------------------------------------------------------
Total Europe 91,735 81,891 75,074 54,959 78,446 57,535
Asia Pacific 12,966 4,046 17,144 7,951 10,058 4,782
All other 5,425 128 5,865 57 9,263 165
----------------------------------------------------------------------------------
Totals $ 398,614 $ 323,570 $ 347,120 $ 240,892 $ 310,233 $ 206,822
==================================================================================
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
F-23
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 the Magistrate Judge has ruled on these motions, oral arguments will be heard for the remaining motions in
the sequence in which they were filed. A trial date has not yet been set.
If it should be determined that the patents at issue in the litigation are valid and are infringed by any of the Company's
products, including Watermark products, the Company will, depending on the product, redesign the infringing products or seek to
obtain a license to market the products. The Company cannot assure you that it 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. As of December 31, 2000, the Company accrued a $2.5 million liability for
potential settlement costs and other expenses.
Subsequent to December 31, 1998, the former shareholders of Saros filed a demand for mandatory arbitration to release
approximately 375,700 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 arbitration, scheduled for March 5, 2001 is currently in progress. 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 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, 2000 and 1999, all maturing in three months:
At December 31, 2000 1999 .
Notional Notional Unrealized Notional Notional Unrealized
Amount Amount Gains Amount Amount Gains
Purchased Sold (Losses) Purchased Sold (Losses)
European $ 24,465,981 $ 12,951,412 $ 702,629 $ 14,450,375 $ 9,738,547 $ (105,298)
Australian - 1,871,011 (72,711) - 4,772,150 (58,492)
Asian 934,246 - (10,359) 1,432,765 406,696 (1,070)
Canadian - 1,594,546 16,917 - 2,113,223 (19,683)
--------------------------------------------------------------------------------------------------------
Total $ 25,400,227 $ 16,416,969 $ 636,476 $ 15,883,140 $17,030,616 $ (184,543)
========================================================================================================
F-24
Note 15 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, 2000:
Revenue $ 92,802 $ 95,079 $ 99,145 $ 111,588 $ 398,614
Income before income taxes 8,625 9,002 13,087 19,037 49,751
Net income 6,469 7,022 10,208 14,848 38,547
Basic earnings per share 0.19 0.21 0.30 0.43 1.13
Diluted earnings per share 0.18 0.19 0.28 0.40 1.05
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
F-25
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,
2000 and 1999, and for each of the three years in the period ended December 31, 2000, and have issued our report thereon dated
January 23, 2001. 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 and TOUCHE LLP
Costa Mesa, California
January 23, 2001
F-26
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, 2000:
Inventory reserves $ 326 - 92 $ 234
Allowance for doubtful accounts
and sales reserves $ 4,542 2,280 1,304 $ 5,518
Year ended December 31, 1999:
Inventory reserves $ 401 335 410 $ 326
Allowance for doubtful accounts
and sales reserves $ 4,382 1,778 1,618 $ 4,542
Year ended December 31, 1998:
Inventory reserves $ 330 381 310 $ 401
Allowance for doubtful accounts
and sales reserves $ 4,415 1,093 1,126 $ 4,382
S-1