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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period for _____________ to _______________.
Commission File No. 0-15997
FILENET CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 95-3757924
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3565 Harbor Boulevard
Costa Mesa, California 92626
(Address of principal executive offices) (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: Common Stock, $0.01
par value
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]
Indicate by check mark whether the registrant is an accelerated filer as
defined by Rule 12b-2 of the Securities Exchange Act of 1934: Yes [x] No [ ]
Based on the closing sale price as of June 28, 2002, the aggregate market
value of the 30,973,825 shares of common stock of the Registrant held by
non-affiliates of the Registrant on such day was $449,120,463. 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 on the Registrant's common stock was
35,964,015 at March 25, 2003.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive proxy statement, to be delivered in
connection with the Registrant's 2003 Annual Meeting of Stockholders, are
incorporated by reference into Part III of this Report.
FILENET CORPORATION
2002 ANNUAL REPORT ON FORM 10-K
For the Year Ended December 31, 2002
TABLE OF CONTENTS
Page
PART I
Item 1. Business..............................................................3
Item 2. Properties...........................................................17
Item 3. Legal Proceedings....................................................18
Item 4. Submission of Matters to a Vote of Security Holders..................18
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters............................................................18
Item 6. Selected Financial Data..............................................19
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations..............................................20
Item 7a. Quantitative and Qualitative Disclosures About Market Risk...........33
Item 8. Financial Statements and Supplementary Data..........................34
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure...............................................34
PART III
Item 10. Directors and Executive Officers of the Registrant..................35
Item 11. Executive Compensation..............................................35
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.........................................35
Item 13. Certain Relationships and Related Transactions......................35
Item 14. Controls and Procedures.............................................35
PART IV
Item 15. Financial Statement Schedule, Reports on Form 8-K, and Exhibits.....36
Signatures....................................................................39
Certifications................................................................40
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Forward-Looking Statements
In addition to historical information, 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 herein and
in the notes to our financial statements for the year ended December 31, 2002,
certain sections of which are incorporated herein by reference as set forth in
Items 7 and 8 of this report. The actual results that we achieve may differ
materially from any forward-looking statements, which reflect management's
opinions only as of the date hereof. We undertake no obligation to revise or
publicly release the results of any revisions to these forward-looking
statements. Readers should carefully review the section entitled "Risk Factors"
and 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
2003. Our business, financial condition, operating results and prospects can be
impacted by a number of factors, including but not limited to those set forth in
the section entitled "Risk Factors" 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.
PART I
Item 1. Business
General
FileNet Corporation ("FileNet") was incorporated on July 30, 1982. We
develop, market, sell and support a software platform and framework for
Enterprise Content Management. Enterprise Content Management, or ECM, refers to
the broad range of functions used by organizations of all types, including
businesses and governmental agencies, to control and track the information, or
content, that is important to the organization's operations, whether that
information is used internally, such as sales data or product specifications, or
externally, such as content provided to customers through a Web site. The
content our software manages includes Web pages, word processing documents,
spreadsheets, HTML, XML, PDF, document images, email messages and other
electronic content. ECM also refers to processing, communicating and gathering
information within the organization and from third parties, such as processing
payments or applications for services. Our software offers customers the ability
to configure, design, build and deploy ECM solutions to meet the needs of their
particular business or organization. These solutions allow customers to manage
content throughout their organizations, automate and streamline their business
processes, and provide the broad-spectrum of connectivity needed to support
their critical and everyday decision-making.
We operate globally and sell our products and services to our customers
through a direct sales force, system integrators, resellers and value added
distributors. We invest significantly in product development to improve our
existing products and to increase our product offerings. We also offer
professional services for the implementation of these software solutions, as
well as 24 hours a day, 7 days a week technical support and services to our
customers on a global basis.
Available Information
Our filings with the Securities and Exchange Commission, including our
Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on
Form 8-K and amendments to those filings, pursuant to Sections 13(a) and 15(d)
of the Securities Exchange Act of 1934, are available free of charge at
www.filenet.com, when such reports are available at the Securities and Exchange
Commission Web site.
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Fiscal 2002 Developments and Strategy
During fiscal 2002, we focused our development efforts on enhancing and
integrating the capabilities of our Panagon platform, Brightspire eBusiness
framework, and Acenza applications. Also during the year, we acquired the
technology of eGrail, Inc. that brought us advanced Web Content Management
technology. By combining and enhancing the foregoing technologies we have
introduced FileNet P8 to provide a unified platform and framework for ECM. This
approach is intended to offer our customers the ability to easily configure,
design, build and deploy a variety of enterprise-wide ECM solutions to meet a
broad range of content management needs within a single scalable framework.
With the introduction of the FileNet P8 ECM architecture in early 2003, we
offer the following benefits:
o a single repository for all content types;
o unified object oriented Application Programming Interfaces to facilitate
rapid application development;
o common user and management interface across the entire architecture;
o portal integration to leverage a customer's existing application
(BEA, IBM, Siebel, SAP, Plumtree and
Microsoft's Sharepoint integration will be provided);
o connectivity to customer enterprise applications via an Enterprise
Application Integration capability and Virtual Content Management,
which provides the ability to interact with external content and events;
and
o enhanced Business Process Management capabilities including process
simulation allowing customers to optimize business processes on a
real-time basis.
We have packaged our ECM capabilities into four logical FileNet P8
suites/solutions that include the Business Process Manager, Content Manager, Web
Content Manager and the Image Manager. Each of these ECM suites emphasizes a
different aspect of the ECM framework. When our customers purchase a FileNet P8
solution they have the ability to add-on additional FileNet P8 suite
capabilities to their existing FileNet P8 architecture as needed, allowing them
flexibility to acquire only the functionality they need. This deep integration
allows for a lower total cost of ownership by reducing support costs and
application development times.
We intend to continue to leverage our market leadership, expansive
installed customer base, financial strengths, strong development capabilities,
and substantial worldwide distribution and service network to deliver on our
uniform platform strategy. We also intend to continue our strategy of investing
in product enhancements and introduction through new product developments, new
partnerships, and strategic acquisitions.
Markets and Customers
We believe the FileNet P8 architecture offers our customers the ability to
scale their ECM solutions to the enterprise-level and offers the flexibility to
manage demanding content challenges, complex business processes, and integration
with an organization's existing systems. The FileNet P8 architecture is designed
to provide our customers with a way to manage their enterprise content, which
can provide greater process control and consistency throughout the enterprise.
Our customers include Global 2000 organizations and are typically those
enterprises and government agencies that have complex business
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processes that manage, store, and share large volumes of digital content. As of
December 31, 2002, our software has been licensed to more than 3,800 customers
worldwide.
Our software solutions are effective for a variety of applications such as
mortgage loan servicing, customer relationship management, insurance claims
processing, regulatory compliance, accounts payable and receivable, and for any
business operation that processes significant amounts of electronic information
or content in their day-to-day operations. Additionally, our software products
can address ad hoc business processes at the enterprise, departmental, and
workgroup levels to improve overall enterprise productivity, and can integrate
with industry-standard productivity and enterprise applications such as Lotus
Notes, Microsoft Office, SAP, Siebel, and others.
We market our products in more than 90 countries around the world through a
direct sales force and through our ValueNet business partner program. The
ValueNet program brings together value-added resellers, independent software
vendors, system integrators, consultants and service providers to deliver a
broad range of solutions and services to our customers worldwide. Further, our
strategic alliances with other industry leaders contribute to our efforts in
product development, customer satisfaction, and worldwide market penetration.
More than 250 firms operate under the ValueNet program and combine our software
products with industry-specific, value-added services and applications to
provide turnkey ECM solutions for customers. Our ECM solutions are applicable in
a wide variety of industries. Historically, our key vertical markets are
insurance, financial services, government, manufacturing, telecommunications,
and utilities.
Using our standard software products, customers generally build
applications that address their particular needs. Very often these applications
can involve a significant change in the way a customer organization operates.
Consequently, our sales cycle, or the time from initial customer contact to
completed product sale, can be lengthy, and our quarterly sales typically
include a mix of medium sized sales with a smaller number of large orders. We
typically ship our products within a short period of time after acceptance of
orders, which is common in the computer software industry.
Our global customer support operation offers software maintenance and
technical support services for our products worldwide. These technical support
programs offer a wide range of services including the right to new versions of
the majority of our software, extended phone support coverage, on-site technical
consultants, a 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 for our products and to
ValueNet partners on our standard software products. These professional services
are marketed by our direct sales force and through the ValueNet business partner
program, with a focus on FileNet centric enterprise system implementation and
the delivery of ECM applications.
Industry Segments and Geographic Information
For the purposes of Statement of Financial Accounting Standards ("SFAS")
No. 131, "Disclosures About Segments of an Enterprise and Related Information,"
we have provided a breakdown of our sales, operating results and other
information using the management approach in Note 16 of the "Notes to
Consolidated Financial Statements" under Item 8, "Financial Statements and
Supplementary Data." Using the management approach, our principle reportable
operating segments include Software, Customer Support, Professional Services and
Education, and Hardware. A summary of our sales by geographic location is
incorporated herein by reference from Note 16 of the "Notes to Consolidated
Financial Statements" under Item 8, "Financial Statements and Supplementary
Data."
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Software Products and Solutions
FileNet P8
Prior to the introduction of the FileNet P8 architecture we marketed our
products under the discreet brand names Panagon, Brightspire, and Acenza.
Additionally, we acquired a Web Content Management product from eGrail, Inc. on
April 2, 2002. We have combined these discrete brands and products into a
uniform architecture known as FileNet P8. The FileNet P8 architecture offers
enterprise-level scalability and flexibility to handle demanding content
challenges, complex business processes, and integration to existing systems that
a customer may have. The FileNet P8 architecture provides a framework for
functional expansion to provide enhanced content and process management across
an enterprise.
FileNet P8 architecture, a standards-based, enterprise application
framework, features four pre-packaged suites, each emphasizing a different
aspect of the ECM solution set, with functions grouped in a logical order that
are designed to meet a customer's individual ECM needs. Each suite can be
implemented by a customer individually, but remains expandable to include all
FileNet P8 ECM capabilities as may be required. FileNet ECM solutions are
designed to manage content; allowing organizations to create, use, and activate
that content in order to make decisions and bring control and consistency to
business processes.
FileNet P8 Suites
Business Process Manager
FileNet Business Process Manager is an ECM solution that we believe helps
organizations increase process performance, reduce cycle times, and improve
productivity by managing the flow of work through automating, streamlining, and
optimizing complex processes associated with business operations. The operations
of many businesses involve gathering information and making decisions based on
that information, and many of these decisions, or the steps leading up to them,
can be automated to increase efficiency and create a more standardized approach
to these decisions throughout the business organization. Examples of customer
business processes that may benefit from our Business Process Manager solution
include insurance companies that have automated policy underwriting decisions
and claims processing, financial services companies that have streamlined the
loan origination and servicing processes, and government agencies that have
automated case management and tax processing functions. The Business Process
Manager can provide an interface for gathering necessary information and either
make decisions based on automated criteria or direct that information to the
appropriate decision-maker in an efficient and consistent basis. This product is
standards based, flexible and can be customized to a wide range of industries.
Content Manager
FileNet Content Manager is an ECM solution that combines content management
with workflow processes to help organizations manage complex documents and
control, share, and access critical business information. Content Manager is
intended to assist with all steps in the content life cycle, from creation and
tracking to storing and controlling access to relevant information. It activates
content by allowing an organization to make content available to the right place
at the right time - to support the business decision-making process at any level
of the organization. The Content Manager's secure and scalable environment
integrates directly with desktop and business applications so business users can
collaborate on the creation and management of content, while controlling access
as necessary.
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Web Content Manager
FileNet Web Content Manager is designed to combine easy-to-use Web site
development capabilities with integrated process capabilities for managing the
creation, approval and publication of Web content and complex documents to
multiple Web sites, in multiple formats, and in multiple languages. The Web
Content Manager allows centralized control of Web site content and appearance
while allowing particular content to be directly created and updated by
organization members without specialized Web expertise, through the use of
controlled templates and other tools. Web Content Manager can control large
amounts of dynamic Web content across globally distributed sites and provides
integrated process management capabilities to help ensure secure and accurate
Web content publication.
Image Manager
FileNet Image Manager is designed to be highly scalable and provides rapid
access for end-users to fixed objects, or content that is not intended to be
modified, such as scanned documents, faxes, email and rich media. It is designed
to securely and permanently store critical business information in a robust and
available environment to safeguard critical content from disaster and misuse
while making it more accessible to thousands of users. Among other applications,
FileNet Image Manager has been used by organizations such as municipal court
systems to scan, track and provide access to important case documents.
FileNet P8 Technology
Each of the FileNet P8 Suites takes advantage of the FileNet P8
architecture, which includes the following technology for aiding in the
development of ECM solutions:
Content Engine provides software services for managing content and other
business-related data, collectively referred to as objects. In addition to
managing documents and any customer defined objects, the Content Engine manages
a broad range of enterprise content including workflow definitions, stored
searches, publishing templates, entry templates, web content management
templates, analytics reports, and simulation scenarios.
Process Engine is the component for design, execution and tracking of processes.
It manages all processes and their associations with documents, data, and
lifecycle information residing in the Content Engine. It also tracks and records
the status of work in progress. The Engine drives processes, associates
information, manages work-to-do, sends notifications, sets milestones, provides
reporting and tracking capabilities, and provides the most up-to-date
information to all participants.
Enterprise Application Integration provides connectors for integrating process
and content with enterprise applications. In addition, FileNet offers an
optional EAI server through an OEM agreement for IBM CrossWorlds InterChange
Server, Connectors, and Collaborations. The connectors provided by FileNet
provide integration with enterprise applications such as SAP R/3, Siebel, and
Clarify as well as technologies such as XML, Web Service, JMS, and MQSeries.
FileNet P8 Workplace is an end-user application that provides a Web-based
interface to FileNet P8. It is designed to allow users to locate business
content, initiate new transactions, check status and track a wide variety of
processes and information across multiple storage locations or systems.
Customizable and platform independent, FileNet P8 Workplace is designed to
enable employees, partners and customers to manage work processes through a
simple interface.
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Web Content Manager ("WCM") is an application that provides web content
management capabilities that leverage the core content and process management
capabilities provided in the platform.
Java2 Platform Enterprise Edition (J2EE) Support provides J2EE application
components and system components that operate in J2EE Platform Products
(application servers) such as BEA WebLogic and IBM WebSphere. In addition,
FileNet applications leverage the J2EE application model to build multi-tier
applications that deliver the scalability, accessibility, and manageability
required by enterprise applications.
Web Application Toolkit provides a framework for developing web applications
that run in a J2EE environment. The toolkit is used by several FileNet P8
applications, including Workplace, Solution Templates, and the Web Content
Manager.
Portal Integrations provide commonly required content and process functionality
within 3rd party portal products. Initially, FileNet is providing a portal
integration for BEA WebLogic Portal. Other portal product integrations will be
provided in the future. However, customers and partners can create their own
portlets using FileNet's Java Application Programming Interfaces. In addition,
FileNet distributes the source code for the Portlets so that customers and
partners can modify and extend the capabilities if desired.
Solution Templates are a set of predefined objects and processes for use in
developing industry specific solutions. Built on the FileNet P8 architecture, a
Solution Template provides working code that can be configured and extended to
build complete applications. A Solution Template is not a turnkey application;
rather, it can be thought of as an application development template. By
providing much of the application's core infrastructure, it can significantly
reduce the length of solution development and deployment cycle.
Initially, FileNet is providing a Case Management Solution Template and Lending
Solution Template. The Case Management Solution Template leverages the Case
Management Application Programming Interfaces to provide generic case processing
functionality. The Lending Solution Template uses the generic Case Management
Solution Template to implement a commercial lending template.
Stand-Alone Products
In addition to the FileNet P8 product suites and development tools the
following FileNet software products are available to our customers as
stand-alone products providing some of the functionality available through the
full FileNet P8 architecture, and were formally available under the Panagon
and/or Brightspire brands.
FileNet eProcess Services is a Web browser-based process management product.
eProcess Services enables an organization to create and manage high-volume,
mission-critical automated business processes in a dynamic Web environment. Our
Web-based user interface, built-in eProcess applications, Web server components,
and XML architecture are easy to use and provide scalable connectivity of
business processes for employees, business partners, and customers.
FileNet Web Services combines a full-featured, Web browser-based client system
that allows access to content without the need to locally download information
or content. FileNet Web Services also combines a comprehensive Web-based
application development toolkit, and Web server components, and is designed to
support complex and mission critical ECM and Business Process Management
activities. This 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 FileNet repository, all
from a Web browser.
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FileNet Content Services is a repository for creating, accessing, managing,
securing, and dynamically updating electronic documents and content. Content
Services is designed to allow a business to manage enterprise content from
creation, to secure delivery, to revision and re-use.
FileNet WorkFlo Services is FileNet's high-performance eProcess workflow engine.
WorkFlo Services, combined with eProcess Services, is designed to enable
customers to automate and access critical business processes and associated
content. WorkFlo Services can be used to create applications that reflect the
way business processes are performed within the particular customer's
organization, and is a critical enabling technology for the automation of
business processes via the Web. It allows organizations to control and modify
their work processes to meet their evolving needs, and integrates the flow of
information between software applications within a company's business processes.
WorkFlo Services supports multiple client, server and applications development
environments, such as Java and COM, and integrates with leading business process
re-engineering products for reduced implementation time.
FileNet Integrated Document Management ("IDM") Desktop is a Microsoft Windows
client software application designed to allow 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
Microsoft Office and Lotus Notes applications.
FileNet Image Services is an image and object server designed to allow
businesses to manage the high-speed acquisition, distribution, and access of
content and objects of all types.
FileNet Report Manager is an online statement and report management system.
Report Manager is designed to allow organizations the ability to capture, store
and access legacy print data streams within ECM applications by storing,
accessing, mining, and analyzing computer-generated reports, statements and
forms.
FileNet Capture addresses document and content capture needs. Available in
high-volume Capture Professional or small department Capture Desktop versions,
Capture is designed to acquire digital and paper-based content into FileNet ECM
repositories for enterprise-wide use and online access.
FileNet Document Warehouse for SAP software is a document and data archiving
application certified by SAP, designed for use with the SAP R/3 Enterprise
Resource Planning ("ERP") application suite.
FileNet ECM Applications
Based on our FileNet P8 core technologies, FileNet ECM applications help
streamline the business processes associated with acquiring and servicing
customers and business partners across the Web. FileNet ECM applications can
automate core front office and back-office business processes and systems, make
these business processes available externally through the Web, and create and
manage associated content using the latest FileNet P8 products and technology.
The FileNet product family includes the following ECM applications,
formerly known as Acenza eBusiness applications:
FileNet for Insurance is designed to enable insurance organizations to improve
operational efficiency and customer service by delivering Web-based business
process management solutions. FileNet for Insurance can provide 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,
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underwriting and policy administration operations, linking customers,
agents/brokers, and employees in shared processes and content.
FileNet Payables is designed to streamline the accounts payable process,
allowing accounting staff to handle more purchase transactions. Invoices
presented in paper, fax or electronic form can be 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
storage management of business critical content. Our core business focus is on
software solutions for the management of content, and we would expect hardware
sales to continue to decrease as a percentage of our total revenues.
Services, Support, and Manufacturing
We operate service and support organizations on a global basis to provide
both pre-sales and post-sales services to ensure successful implementation of
our products and customer satisfaction. Due to the highly customizable nature of
our products, many of our product sales are coupled with contracts for
continuing support services.
Our worldwide Customer Service and Support organization provides
comprehensive support capabilities including electronic and real-time phone
support and global call tracking for customers and partners on support programs.
Highly skilled and experienced systems engineers deliver support coverage on
multiple platforms with 24-hour call handling. Our technical Web site offers the
ability to open cases, search our knowledge base and review related status
reports.
Support programs may be customized and enhanced with optional fee-based
services. These options include after hours phone coverage, on-site technical
consultants to assist with upgrades and FileNet product installations, and
FileNet Software Development Kit support for development teams building
applications using our products.
Our manufacturing facilities in Costa Mesa, California and Dublin, Ireland,
conduct software manufacturing and distribution, localization, integration, test
and quality control.
Professional Services and Education
Our worldwide professional services organization provides consulting,
development, architecture and other technical services to our licensed customers
and training services. These services are provided through in-house employees
and through a network of qualified partners. Our worldwide professional services
organization understands the requirements for implementing an ECM solution and
offers a comprehensive methodology to install, integrate, customize and deploy
our solutions. These services range from the management of large-scale
implementations of our products to prepackaged standard services such as
software installation. Our educational curriculum includes training courses for
end users, application developers and system administrators through media-based
and instructor-led training.
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Research and Development
We have made and expect to continue to make substantial investments in
research and development, primarily through internal development activities,
third party licensing agreements and through technology acquisitions. Our
development efforts focus on our unified FileNet P8 ECM architecture as we
continue to develop and improve a complete ECM capability to service all aspects
of our customers' business content needs. Additionally, we license and embed
third party software that enhances the functionality of our products through a
variety of agreements with the producers of this software. Expenditures for
research and development were $71.7 million; $68.8 million and $57.9 million for
the years ended December 31, 2002, 2001, and 2000, respectively.
We expect to continue to look for technology acquisitions that offer us
additional product know-how or domain knowledge where appropriate and will
continue to embed in our products third party products that enhance our product
line. We intend to continue to invest significantly in internal development with
a focus on developing new functionality in Enterprise Content Management and
Business Process Management applications that provide a richer competitive
product offering to our customers.
Our future success depends, in part, on our ability to execute on our
strategy of offering a unified platform and framework for Enterprise Content
Management that gains customer acceptance. This strategy may require us to
develop and maintain relations with technology partners. If we fail to
successfully execute on our integrated product solution strategy or if we fail
to maintain or establish relationships with technology partners, 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 that we will not experience
significant future delays in product introduction. From time to time, either 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 that announcements of currently
planned or other new software products will not cause customers to delay their
purchasing decisions in anticipation of such software products, and such delays
could have a material adverse effect on our business and operating results.
Competition
The market for our products is highly competitive and competition will
continue to intensify. We compete with a large number of Enterprise Content
Management, Web content management, business process management, workflow,
document imaging, and electronic document management companies. IBM is the
largest company that competes directly with FileNet in the content and process
management market. Documentum is a key competitor in the Content Management
Market. 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.
Large infrastructure vendors such as Oracle Corporation and Microsoft
Corporation have developed products or plan to offer products in the content
management market. Software vendors such as Tibco Software, Inc., Savvion, Inc.
and Pegasystems, Inc., each with a different core product foundation, have begun
to approach the business process management market from their individual market
segments and may compete more intensely 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.
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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 and potential competitors may have greater
resources, larger sales and marketing teams, broader product lines and more
experience developing 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.
Trademarks
FileNet, WorkFlo Services, ValueNet, OSAR, Watermark, Panagon, Acenza,
Brightspire, Document Warehouse, and FileNet Workgroup are trademarks or
registered trademarks of FileNet Corporation that are referenced in this Form
10K. All other brands or product names are trademarks or registered trademarks
of their respective companies.
Patents and Licenses
As of December 31, 2002, we have four issued U.S. patents and five pending
U.S. patent applications. Our subsidiary, 3565 Acquisition LLC, has one pending
U.S. patent application. We have applied for and may in the future apply for
patent protection in foreign countries. 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, 2002 we had 1,705 full-time employees, of which 430 were
employed in research and development; 458 in sales; 83 in marketing; 235 in
education and professional services; 252 in customer support; 80 in operations;
and 167 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
Our business, financial condition, operating results and prospects can be
impacted by a number of factors, including but not limited to those set forth
below and elsewhere in this report, any one of which could cause our actual
results to differ materially from recent results or from our anticipated future
results. Factors that may affect our business, financial condition and results
of operations include:
Our quarterly operating results may fluctuate in future periods and are not
predictable and, as a result, we may fail to meet expectations of investors and
analysts, causing our stock price to fluctuate or decline. Prior 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.
12
These factors include, but are not limited to, the following:
o the industry-wide slow down in IT spending;
o general domestic and international economic and political conditions;
o the discretionary nature of our customers' budget and purchase cycles
and the absence of long-term customer purchase commitments;
o the tendency to realize a substantial percentage of our revenue in
the last weeks, or even days, of each quarter;
o the potential for delays or deferrals of customer orders;
o the size, complexity and timing of individual transactions;
o changes in foreign currency exchange rates;
o the length of our sales cycle;
o variations in the productivity of our sales force;
o the level of software product sold and price competition;
o the timing of new software introductions and software enhancements
by us and our competitors;
o the mix of sales by products, software, services and distribution
channels;
o project overruns associated with fixed price contracts;
o acquisitions by us and our competitors;
o our ability to develop and market new software products and control
costs;
o the quality of our customer support; and
o the level of international sales.
The decision to implement our products is subject to each customer's
resources and budget availability. Our quarterly sales generally include a mix
of medium sized orders, along with several large individual orders, and as a
result, the loss or delay of an individual large order could have a significant
impact on our quarterly operating results and revenue. Our operating expenses
are based on projected revenue trends and are generally fixed. Therefore, any
shortfall from projected revenue may cause significant fluctuations in operating
results from quarter to quarter. As a result of these factors, 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 markets in which we operate are highly competitive and we cannot be
sure that we will be able to continue to compete effectively, which could result
in lost market share and reduced revenue. The markets we serve are highly
competitive and we expect competition to intensify. Our future financial
performance will depend primarily on the continued growth of the markets for our
software products and services as well as the purchase of our products by
customers in these markets. If the markets we serve fail to grow or grow more
slowly than we currently anticipate, our business, financial condition and
operating results would be harmed. These intensely competitive markets can
change rapidly. There are multiple competitors of ours and there may be future
competitors, some of which have or may have substantially greater sales,
marketing, development and financial resources. As a consequence, our present or
future competitors may be able to develop software products comparable or
superior to those offered by us, offer lower priced products or adapt more
quickly than we do to new technologies or evolving customer requirements. In
order to be successful in the future, we must respond to technological change,
customer requirements and competitors' current software products and
innovations. We cannot assure that we will be able to continue to compete
effectively in our target markets or that future competition will not have a
material adverse effect on our business, financial condition or results of
operations. In addition, current and potential competitors have established or
13
may establish cooperative relationships among themselves or with third parties
to increase the ability of their products to address the needs of the markets we
serve. Accordingly, it is possible that new competitors or alliances among
competitors may emerge and rapidly acquire significant market share. Increased
competition may result in price reductions, reduced gross margins and loss of
market share that could result in reduced revenue.
We must develop and sell new products to keep up with rapid technological
change in order to achieve future revenue growth and profitability. The market
for our software and services is characterized by rapid technological
developments, evolving industry standards, changes in customer requirements and
frequent new product introductions and enhancements. Our ability to continue to
sell products will be dependent upon our ability to continue to enhance our
existing software and services offerings, develop and introduce, in a timely
manner, new software products incorporating technological advances and respond
to customer requirements. Our future success also depends, in part, on our
ability to execute on our strategy of developing a unified platform and
framework for Enterprise Content Management. This strategy requires us to make
long-term investments and commit significant resources based on our prediction
of new products and services that the market needs and will accept. Our strategy
also requires us to develop and maintain relations with technology partners. We
may not be successful in maintaining these relationships or in developing,
marketing and releasing new products or new versions of our products that
respond to technological developments, evolving industry standards or changing
customer requirements. We may also experience difficulties that could delay or
prevent the successful development, introduction and sale of these products and
enhancements. In addition, these products and enhancements may not adequately
meet the requirements of the marketplace and may not achieve any significant
degree of market acceptance. If we fail to successfully maintain or establish
relationships with technology partners or to execute on our integrated product
solution strategy, or if release dates of any future products or enhancements
are delayed, or if these products or enhancements fail to achieve our prediction
of market acceptance when released, our business operating results and financial
condition could be materially harmed. In the past, we have experienced delays in
the release dates of enhancements and new releases to our products and we cannot
assure that we will not experience significant future delays in product
introduction. From time to time, our competitors or we may announce new software
products, capabilities or technologies that have the potential to replace or
shorten the life cycles of our existing software products. We cannot assure that
announcements of currently planned or other new software products will not cause
customers to delay their purchasing decisions in anticipation of such software
products, and such delays could have a material adverse effect on our sales.
We must effectively manage our new product and services transitions or our
revenue may suffer. If we do not make an effective transition from existing
products and services to our P8 architecture, our revenue may be seriously
harmed. Among the factors that make a smooth transition difficult are delays in
development, variations in pricing, delays in customer purchases in anticipation
of new introductions and customer demand for the new offerings. If we incur
delays in customer purchases or do not accurately estimate the market effects of
new introductions, future demand for our products and services and our revenue
may be seriously harmed.
Protection of our intellectual property and other proprietary rights is
limited, which could result in the use of our technology by competitors or other
third parties. There is risk of third-party claims of infringement, which could
expose us to litigation and other costs. Our success depends, in part, on our
ability to protect our proprietary rights to the technologies used in our
principal products. We rely on a combination of copyrights, trademarks, trade
secrets, patents, confidentiality procedures and contractual provisions to
protect our proprietary rights in our software products. We cannot assure that
our existing or future copyrights, trademarks, trade secrets, patents or other
intellectual property rights will have sufficient scope or strength to provide
meaningful protection or a commercial advantage to us. In addition, the laws of
some foreign countries do not protect our proprietary rights to the same extent,
14
as do the laws of the United States. Any inability to protect our intellectual
property may harm our business and competitive position.
We may, from time to time, be notified that we are infringing certain
patent or intellectual property rights of others. While there are no material
actions currently pending against us for infringement of patent or other
proprietary rights of third parties, we cannot assure that third parties will
not initiate infringement actions against us in the future. Combinations of
technology acquired through past or future acquisitions and our technology will
create new software products and technology that also may give rise to claims of
infringement. Infringement actions can result in substantial costs and diversion
of resources, regardless of the merits of the actions. If we were found to
infringe upon the rights of others, we cannot assure that we could redesign the
infringing products or could obtain licenses on acceptable terms, if at all.
Additionally, significant 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 could result in significant costs or reduce our ability to
market any affected products.
We depend on certain strategic relationships in order to license
third-party products and revenue related to these products could be at risk if
we were unable to maintain these 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 IBM CrossWorlds, Microsoft Corporation, SAP AG, Siebel Systems Inc, Sun
Microsystems, Inc., BEA, EMC and Verity, Inc. Certain of these agreements have
minimum purchase requirements and/or require prepayments which usage is limited
to a specific timeframe while others do not have minimum purchase requirements
and/or are cancelable at will. We cannot assure 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 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. In addition, it is possible that as a consequence of a merger or
acquisition transaction involving one of these third parties, certain
restrictions could be imposed on our business that had not been imposed prior to
the transaction. This could adversely affect our sales.
We must retain and attract key executives and personnel who are essential
to our business, which could result in increased personnel expenses. 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 and operational personnel
and consultants. There is competition for such personnel; particularly software
developers, professional service consultants and other technical personnel, and
pay scales in the software industry have significantly increased. We cannot
assure that in the future we will be successful in attracting and retaining such
personnel.
15
A significant percent of our revenue is derived internationally and we are
subject to many risks internationally, which could put our revenue at risk.
Historically, we have derived approximately 25%-30% of our total revenue 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 political and economic instability;
o tariffs and trade barriers;
o varying technical standards;
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 the burden of complying with a wide variety of complex foreign laws,
regulations and treaties;
o the possibility of difficulties in collecting accounts receivable; and
o longer accounts receivable cycles and financial instability among customers.
Any of these factors could reduce the amount of revenue we realize from our
international operations in the future.
If our products contain errors we could incur unplanned expenses and delays
that could result in reduced revenue, lower profits, and harmful publicity.
Software, services and products, as complex as those we sell, are susceptible to
errors or failures, especially when first introduced or deployed. 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 of 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. 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 causing
fluctuations in the market price of our stock, which would impact shareholder
value. The trading price of our common stock has fluctuated in the past and is
subject to significant fluctuations in response to the following factors, among
others, 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;
16
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;
o fluctuations in general stock market prices and volume, which are
particularly common among highly volatile securities of Internet and
software companies; and
o other general economic and political 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, which could cause our financial
performance to suffer. As part of our business strategy, we frequently evaluate
strategic acquisition opportunities. For example, on April 2, 2002, we acquired
certain assets and assumed certain liabilities of eGrail, Inc., a Web content
management company, for a purchase price of $9.0 million in cash. 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;
o liabilities and risks that are not known or identifiable at the time of
the acquisition;
o difficulties in retaining the acquired company's customer base; 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 acquisitions and
such acquisitions may harm our business and financial results.
We depend on a single source for certain hardware components and revenue
related to these products could be at risk if we were unable to obtain
inventory. 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
that could have an adverse effect on the Company's operating results. However,
the Company has qualified and is able to purchase and sell 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.
Item 2. Properties
We currently lease 336,000 square feet of office, development and
manufacturing space in Costa Mesa, California and 91,000 square feet of office
and development space in Kirkland, Washington. In addition, we lease 24,500
square feet of office and manufacturing space in Dublin, Ireland. We also lease
sales and support offices in 29 locations in the United States, 18 locations in
17
Europe, 3 locations in Australia, 2 locations in Canada, and 4 locations in
Asia. We believe that the Costa Mesa, Dublin and Kirkland facilities will be
adequate for our anticipated development and manufacturing needs through 2003.
Item 3. Legal Proceedings
In the normal course of business, we are subject to ordinary routine
litigation and claims incidental to business. While the results of litigation
and claims cannot be predicted with certainty, we believe that the final outcome
of these matters will not have a materially adverse effect on our consolidated
results of operations or financial conditions.
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 the fiscal year ended December 31, 2002.
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, 2001
through December 31, 2002, as reported by Nasdaq:
High Low
Year Ended December 31, 2002
4th Quarter $ 14.23 $ 8.64
3rd Quarter 15.50 10.09
2nd Quarter 17.98 11.35
1st Quarter 23.10 16.01
Year ended December 31, 2001
4th Quarter $ 21.41 $ 9.00
3rd Quarter 14.86 8.95
2nd Quarter 16.23 8.88
1st Quarter 29.13 12.75
The closing price of our common stock at December 31, 2002 was $12.20. The
approximate number of stockholders of record as of March 12, 2003 (record date
for 2003 Annual Meeting of Stockholders) was 518. The closing price of our
common stock on that date was $11.38.
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. We are prohibited from paying cash
dividends under the terms of our line of credit agreement.
18
Item 6. Selected Financial Data
The following table summarizes certain selected financial data and should
be read in conjunction with our consolidated financial statements and the notes
thereto, and Item 7, Management's Discussion and Analysis of Financial Condition
and Results of Operations. The selected consolidated statements of operations
and balance sheet data as of and for each of the five years in the period ended
December 31, 2002 have been derived from our audited financial statements.
(In thousands, except per share amounts)
Fiscal Years Ended December 31, 2002 2001 2000 1999 1998
Consolidated statements ofoperations data:
Revenue:
Software $ 132,508 $ 119,014 $ 204,872 $ 183,316 $ 171,239
Service 206,806 201,568 174,291 148,162 115,833
Hardware 7,703 14,028 21,199 16,630 23,886
Total revenue 347,017 334,610 400,362 348,108 310,958
Cost of revenue:
Cost of software revenue 10,565 7,522 14,643 16,986 16,901
Cost of service revenue 89,016 102,292 101,976 86,377 69,825
Cost of hardware revenue 5,995 10,211 13,559 9,078 13,489
Total cost of revenue 105,576 120,025 130,178 112,441 100,215
Gross profit 241,441 214,585 270,184 235,667 210,743
Operating expenses:
Research and development 71,735 68,838 57,914 54,307 50,132
Selling, general and
administrative 163,765 169,505 164,941 157,730 161,105
Restructuring and in-process
research and development 400 - 2,984 - 2,000
Total operating expenses 235,900 238,343 225,839 212,037 213,237
Operating income (loss) 5,541 (23,758) 44,345 23,630 (2,494)
Other income, net 5,209 2,503 5,406 3,409 3,840
Income (loss) before income taxes 10,750 (21,255) 49,751 27,039 1,346
Provision (benefit) for income
taxes 2,478 (4,633) 11,204 7,362 391
Net income (loss) $ 8,272 $ (16,622) $ 38,547 $ 19,677 $ 955
Earnings (loss) per share:
Basic $ 0.23 $ (0.47) $ 1.13 $ 0.61 $ 0.03
Diluted $ 0.23 $ (0.47) $ 1.05 $ 0.59 $ 0.03
Weighted average shares outstanding:
Basic 35,590 35,117 34,155 32,125 31,827
Diluted 36,709 35,117 36,765 33,360 33,367
Consolidated balance sheet data:
Working capital $ 135,302 $ 144,750 $ 155,483 $ 101,777 $ 67,972
Total assets 328,036 301,639 324,093 243,398 206,822
Stockholders' equity 238,905 215,825 224,957 150,458 130,320
Note: Service revenue and costs include both Customer Support and Professional
Services and Education. Certain reclassifications have been made to the prior
years' selected financial data to conform to the current year's presentation. In
November 2001, the FASB announced Emerging Issues Task Force ("EITF") Topic No.
D-103, "Income Statement Characterization of Reimbursements Received for
Out-of-Pocket Expense Incurred." The EITF required companies to characterize
reimbursements received for out-of-pocket expenses as revenues in the statement
of operations. Application of this EITF required that comparative financial
statements for prior periods be reclassified to comply with the guidance. We
adopted this EITF as of January 1, 2002 and have reclassified our prior-period,
consolidated financial statements to conform to this EITF.
19
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion 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 are subject to a number of
risks and uncertainties that could cause our actual results to differ materially
from those that may be anticipated by such 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 and
various disclosures described in this document and in other documents we file
with the Securities and Exchange Commission that attempt to advise interested
parties of the risks and factors that may affect our business. 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 15).
Critical Accounting Policies and Estimates
The consolidated financial statements of FileNet are prepared in conformity
with accounting principles generally accepted in the United States of America.
The consolidated financial statements include our accounts and the accounts of
our wholly owned subsidiaries. All intercompany balances and transactions have
been eliminated. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period. The
significant accounting policies we believe are most critical to aid in fully
understanding and evaluating our reported financial results include the
following:
Revenue Recognition. FileNet accounts for the licensing of software in
accordance with the American Institute of Certified Accountants ("AICPA")
Statement of Position ("SOP") 97-2, "Software Revenue Recognition." We enter
into contracts for the sale of our products and services. The majority of these
contracts relates to single elements and contains standard terms and conditions.
However, there are agreements that contain multiple elements or non-standard
terms and conditions. Contract interpretation is sometimes required to determine
the appropriate accounting, including how the price should be allocated among
the deliverable elements and when to recognize revenue.
Software license revenues generated from sales through direct and indirect
channels, which do not contain multiple elements, are recognized upon shipment
of the related product, if the requirements of SOP 97-2, are met. If the
requirements of SOP 97-2, including evidence of an arrangement, delivery, fixed
or determinable fee, collectibility or vendor specific evidence about the value
of an element are not met at the date of shipment, revenue is not recognized
until these elements are known or resolved. Fees are deemed to be fixed and
determinable for transactions with a set price that is not subject to refund or
adjustment and payment is due within 90 days from the invoice date. Software
license revenue from channel partners is recognized when the product is shipped
and sale by the channel partner to an end-user is confirmed.
For arrangements with multiple elements, we allocate revenue to each
element of a transaction based upon its fair value as determined in reliance on
vendor specific objective evidence. This evidence of fair value for all elements
of an arrangement is based on the normal pricing and discounting practices for
those products and services when sold separately. If fair value of any
undelivered element cannot be determined objectively, we defer the revenue until
all elements are delivered, services have been performed or until fair value can
objectively be determined.
Customer support contracts are renewable on an annual basis and provide
after-sale support for our software, as well as software upgrades under the
20
Company's right to new versions program, on a when-and-if-available basis.
Revenue from post-contract customer support is recognized ratably over the term
of the arrangement, which is typically twelve months.
Professional services revenue consists of consulting and implementation
services provided to end users of our software products and technical consulting
services provided to our resellers. The majority of these consulting engagements
average from one to three months and are generally not essential to the
functionality of the software. Revenue from these services and from training
classes is recognized as such services are delivered and accepted by the
customer. Fixed-price consulting contracts are the exception and because
estimates of costs applicable to these contracts are reasonably dependable,
revenue is recognized using the percentage-of completion method. However,
revenue and profit is subject to revision as the contract progresses and
anticipated losses on fixed-price professional services contracts are recognized
in the period when they become known.
Allowance for Doubtful Accounts and Sales Returns. We evaluate the
creditworthiness of our customers prior to order fulfillment and we perform
ongoing credit evaluations of our customers to adjust credit limits based on
payment history and the customer's current creditworthiness. We constantly
monitor collections from our customers and maintain an allowance for estimated
credit losses that is based on historical experience and on specific customer
collection issues. While credit losses have historically been within our
expectations and the provisions established in our financial statements, we
cannot guarantee that we will continue to experience the same credit loss rates
that we have in the past. Since our revenue recognition policy requires
customers to be creditworthy, our accounts receivable are based on customers
whose payment is reasonably assured. Our accounts receivable are derived from
sales to a wide variety of customers. We do not believe a change in liquidity of
any one customer or our inability to collect from any one customer would have a
material adverse impact on our consolidated financial position. Based on
historical experience, we also maintain a sales return allowance for the
estimated amount of potential returns. While product returns have historically
been minimal and within our expectations and the allowances established by us,
we cannot guarantee that we will continue to experience the same return rates
that we have in the past.
The following table represents the account balances for these provisions
and the changes for each of the periods presented. Deductions to these
provisions are the result of customer bad debt write-offs or product returns.
Additions to the provision are based on estimated credit losses related to
specific customer collection issues and are also based on historical experience.
(In thousands)
Additions
Balance at Charged to Balance
Beginning Revenue and at End
of Period Expenses Deductions of Period
Year ended December 31, 2002:
Allowance for doubtful accounts
and sales returns $ 3,567 1,752 1,087 $ 4,232
Year ended December 31, 2001:
Allowance for doubtful accounts
and sales returns $ 5,518 1,482 3,433 $ 3,567
Year ended December 31, 2000:
Allowance for doubtful accounts
and sales returns $ 4,542 2,280 1,304 $ 5,518
Deferred Income Taxes. Deferred income taxes reflect the net tax effects of
temporary differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes. We
maintain a valuation allowance against a portion of the deferred tax assets due
to uncertainty regarding the future realization based on historical taxable
income, projected future taxable income, and the expected timing of the
21
reversals of existing temporary differences. If we operate at a loss or are
unable to generate sufficient future taxable income we could be required to
increase the valuation allowance against all or a significant portion of our
deferred tax assets which would result in a substantial increase to our
effective tax rate and could result in a material adverse impact on our
consolidated operating results.
Long-Lived Assets. In the first quarter of fiscal 2002, the Company adopted
Statement of Financial Accounting Standards No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"). SFAS No. 144
establishes a single accounting model, based on the framework established in
Statement of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
("SFAS No. 121"), for long-lived assets to be disposed of by sale, and resolves
implementation issues related to SFAS No. 121. The adoption of SFAS No. 144 did
not have a material impact on the Company's operating results or financial
position.
Property, plant and equipment, intangible assets, and capitalized software
costs are recorded at cost less accumulated depreciation or amortization. They
are amortized using the straight-line method over estimated useful lives of
three to six years. The determination of useful lives and whether or not these
assets are impaired involves judgment and are reviewed for impairment whenever
events or circumstances indicate that the carrying amount of such assets may not
be recoverable. We evaluate the carrying value of long-lived assets and certain
identifiable intangible assets for impairment of value based on undiscounted
future cash flows resulting from the use of the asset and its eventual
disposition. While we have not experienced impairment of intangible assets in
prior periods, we cannot guarantee that there will not be impairment in the
future.
Goodwill and Other Intangible Assets. Goodwill is recorded at cost and is
not amortized. In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets," which we adopted January 1, 2002. SFAS No. 142 requires that
goodwill and other intangible assets with indefinite useful lives no longer be
amortized, but instead be tested for impairment at least annually and written
down when impaired. We periodically evaluate whether events and circumstances
have occurred which indicate that the carrying value of goodwill may not be
recoverable. In accordance with SFAS No. 142, we were required to perform a
two-step transitional impairment review. We completed the first step of this
review by June 30, 2002 with the determination of the fair value of our
reporting units in order to identify whether the fair value of each reporting
unit was less than its carrying amount as of January 1, 2002. In the event that
the fair value of each reporting unit was less than the carrying amount, the
second step of the test was required to determine if the carrying value of
goodwill exceeded the implied value. We determined that we did not have a
transitional impairment of goodwill because the fair value of each reporting
unit exceeded its carrying amount. As of December 31, 2002, no impairment of
goodwill has been recognized. Goodwill will also be tested for impairment in the
manner described above on July 1st of each year or earlier if indicators of
potential impairment exist. If estimates change, a materially different
impairment conclusion could result.
Other Operating Matters
We took selective actions in 2001 to help drive profitability and to reduce
on-going annual expenses. These actions included cost-saving measures, internal
business process changes to improve efficiency and a worldwide workforce
reduction of 158 employees. Workforce reductions occurred during the second and
fourth quarters of 2001 resulting in a total severance charge of $4.5 million.
These severance charges were $897,000 in customer support, $293,000 in
professional services, $331,000 in research and development and $2.9 million in
selling, general and administrative, as discussed below.
22
Overview
FileNet develops, markets, sells and supports a unified platform and
framework for Enterprise Content Management, or ECM, that delivers capabilities
to our customers in a tightly integrated and synchronized offering. This
approach offers our customers the ability to easily configure, design, build and
deploy ECM software and solutions. We operate globally and sell our products and
services to our customers through a direct sales force, system integrators,
resellers and value added distributors. We invest significantly in product
development to improve our existing products and increase our product offerings.
Our revenue growth depends on the overall demand for computer software and
services primarily to corporate and government customers. A difficult
environment for Information Technology ("IT") sales that began in early 2001 and
continued through 2002 caused many customers to delay, downsize or cancel IT
projects, resulting in lower demand and a reduction in our revenues from
software and hardware sales. We do not anticipate market conditions to improve
significantly in the near term. Despite the unpredictability of the current
business environment, we remain focused on our strategy to provide a unified
platform and framework for ECM solutions.
Results Of Operations
The following table sets forth certain consolidated statement of operations
data as a percentage of total revenue for the periods indicated:
(As a percentage of total revenue)
December 31, 2002 2001 2000
Revenue:
Software 38.2% 35.6% 51.2%
Customer support 43.2 39.6 27.5
Professional services and education 16.4 20.6 16.0
Hardware 2.2 4.2 5.3
Total revenue 100.0 100.0 100.0
Cost of revenue:
Software 3.1 2.2 3.7
Customer support 11.1 12.7 11.5
Professional services and education 14.5 17.9 14.0
Hardware 1.7 3.1 3.3
Total cost of revenue 30.4 35.9 32.5
Gross profit 69.6 64.1 67.5
Operating expenses:
Research and development 20.7 20.6 14.5
Selling, general and administrative 47.2 50.6 41.2
In-process research and development 0.1 - 0.8
Total operating expenses 68.0 71.2 56.5
Operating income (loss) 1.6 (7.1) 11.0
Other income, net 1.5 0.7 1.4
Income (loss) before tax 3.1% (6.4)% 12.4%
23
Revenue
Total revenue increased to $347.0 million, or 4% in 2002 from $334.6
million in 2001. From 2000 to 2001, total revenue decreased from $400.4 million,
or 16%. The increase in total revenue from 2001 to 2002 was primarily
attributable to an increase in demand for our software products as well as the
growth in customer support revenue partially offset by lower professional
services and hardware revenue as discussed below. The decrease in total revenue
from 2000 to 2001 was primarily attributable to lower software revenue as a
result of unfavorable economic conditions in 2001 resulting in decreased demand
for our software products partially offset by an increase in customer support
and professional services revenues.
Software. Software revenue consists of fees earned from the licensing of
our software products to customers. Software revenue increased to $132.5 million
in 2002 from $119.0 million in 2001, representing an increase of $13.5 million,
or 11%. From 2000 to 2001, software revenue decreased $85.9 million from $204.9
million, or 42%. The increase in software revenue from 2001 to 2002 was
primarily due to an increase in demand for content management solutions
primarily attributable to broader product offerings in 2002 coupled with a
slightly improved IT spending environment. Additionally, we were successful in
increasing software revenues from our existing customers as they expanded the
use of our products. The decrease from 2000 to 2001 was primarily due to the
significant global economic slowdown in the technology sector that resulted in a
significant reduction in the amount and size of customer orders. Large
enterprise projects were eliminated or replaced by smaller projects as IT
budgets were reduced and delayed in both 2001 and continued in 2002. We expect
that the trend toward smaller projects will continue for the foreseeable future
and we do not anticipate market conditions will improve significantly in the
near term.
Customer Support. Customer support revenue consists of revenue from
software maintenance contracts and "fee for service" revenues and the sale of
spare parts and supplies. Customer support revenue increased to $149.8 million
in 2002 from $132.4 million in 2001, representing an increase of $17.5 million,
or 13%. From 2000 to 2001, customer support revenue increased by $22.1 million
from $110.3 million, or 20%. These increases in customer support revenue reflect
an increase in the overall customer installed base combined with a high rate of
renewal in the existing customer base. Customer support revenue grew more slowly
in 2002 compared to the growth rate in 2001 as a result of the decreased
software revenue in 2001 and 2002. A prolonged economic slowdown will continue
to affect the growth rate of customer support revenue as this revenue stream is
directly related to software revenue fluctuations over time.
Professional Services and Education. Professional services and education
revenue is generated primarily from consulting and implementation services on
our standard products 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 decreased to $57.0 million in 2002
from $69.2 million in 2001, representing a decrease of $12.2 million, or 18%.
From 2000 to 2001 professional services and education revenue increased by $5.2
million from $64.0 million, or 8%. The decrease from 2001 to 2002 is reflective
of the economic slow down, particularly in North America, which resulted in
fewer and smaller consulting engagements and increased pricing pressures. The
increase from 2000 to 2001 was primarily attributable to an increase in custom
development projects that carried over from 2000, and to a lesser extent, an
increase in sales of prepackaged service offerings, which included both
consulting and training. A prolonged economic slowdown that causes companies to
delay spending on technology projects will continue to negatively impact these
revenues.
24
Hardware. Hardware revenue is generated primarily from the sale of our
12-inch OSAR libraries. Hardware revenue decreased to $7.7 million in 2002 from
$14.0 million in 2001, representing a decrease of $6.3 million, or 45%. From
2000 to 2001 hardware revenue decreased by $7.2 million from $21.2 million, or
34%. The decline in hardware revenue reflects that hardware is not a strategic
focus for us and we expect hardware revenue to continue to decrease as a percent
of total revenue and in absolute dollars.
International. International revenues accounted for 26% of total revenue,
or $90.0 million, in 2002, 25% of total revenue, or $82.9 million, in 2001, and
28% of total revenue, or $110.1 million, in 2000. The increase in absolute
dollars in 2002 as compared to 2001 resulted primarily from increases in
software revenue and customer support revenue related to an increase in the
overall customer base and a high rate of renewal. The decrease in absolute
dollars in 2001 as compared to 2000 was primarily the result of a significant
reduction in the amount and size of customer orders in Europe and Asia, our
largest international markets, due to a major slowdown in IT spending. We expect
international revenue to continue to represent a significant percentage of total
revenue. However, international revenues will be adversely affected if the U.S.
dollar strengthens against certain major international currencies or if economic
conditions remain weak.
Cost of Revenue
Total cost of revenue decreased to $105.6 million in 2002, from $120.0
million in 2001, representing a decrease of $14.4 million, or 12%. From 2000 to
2001 total cost of revenue decreased by $10.2 million, or 8%. Total cost of
revenue decreased from 2001 to 2002 primarily due to reduced costs in the
service organizations and the hardware component as discussed below. The
decrease in total cost of revenue from 2000 to 2001 is primarily attributable to
lower software and hardware costs that can be directly related to lower software
and hardware revenue, as well as the discontinuation of certain third-party
embedded products.
Software. Cost of software revenue includes royalties paid to third
parties, amortization of acquired technology, media costs, and the cost to
manufacture and distribute software. The cost of software revenue was $10.6
million in 2002, $7.5 million in 2001 and $14.6 million in 2000, representing
8%, 6% and 7% of software revenue, respectively. The increase in cost of
software revenue for 2002 compared to 2001 is primarily the result of a 129%
increase in royalty costs due to increased utilization of new third party
software products in 2002 and the amortization of acquired technology (resulting
from the eGrail acquisition in April 2002) which was $511,000 for 2002 compared
to none in 2001. Cost of software revenue decreased from 2000 to 2001 resulting
from a 69% reduction in royalty cost due to the discontinuation of certain third
party products along with a decrease in royalty costs directly related to the
decrease in revenue. Going forward we anticipate cost of software revenue to
remain comparable to current levels or increase slightly as we continue to
integrate third-party technology with our products.
Customer Support. Cost of customer support revenue includes the cost of
customer support personnel, supplies and spare parts, and the cost of
third-party hardware maintenance. The cost of customer support revenue was $38.6
million in 2002, $42.4 million in 2001 and $45.9 million in 2000, representing
26%, 32%, and 42% of customer support revenue, respectively. Efficiency gains
and headcount reductions in 2001 contributed to the overall reduction in
customer support costs in 2002 as compared to 2001. The decrease in 2001 from
2000 was primarily attributable to a 58% reduction in variable compensation and
personnel costs as well as cost reduction benefits from process improvements
initiated in 2000. Workforce reductions in 2001 resulted in severance costs of
$897,000 that were absorbed by the benefit of ongoing reduced salary and
personnel expenses for 2001 and future periods. Due to increased productivity
and controls over headcount we expect to maintain these cost efficiencies for
the near future.
25
Professional Services and Education. Cost of professional services and
education revenue consists primarily of the costs of professional services
personnel, training personnel, and third-party contractors. The cost of
professional services and education revenue was $50.4 million in 2002, $59.9
million in 2001 and $56.1 million in 2000, representing 89%, 87% and 88% of
professional services and education revenue, respectively. Lower professional
services and education revenue in 2002 resulted in lower costs in absolute
dollars compared to 2001 primarily due to a 38% reduction in the use of
third-party independent consultants, as well as 30% lower variable compensation
expense in 2002. The increase in absolute dollars from 2000 to 2001 was
primarily due to an increase of 16% in personnel costs as a result of average
headcount increases along with a 17% increase in the use of third-party
independent contractors who were needed to complete development projects that
carried over from 2000. Additionally, we recorded a charge of approximately
$293,000 for severance payments in 2001. Expressed as a percentage of revenue,
costs were essentially unchanged from 2000 to 2001. We expect professional
services and education costs as a percentage of professional services and
education revenue to vary from period to period depending on the utilization
rates of internal resources and the mix between internal and external service
providers.
Hardware. Cost of hardware revenue includes the cost of assembling our OSAR
library products, the cost of hardware integration personnel, warranty costs and
distribution costs. The cost of hardware revenue was $6.0 million in 2002, $10.2
million in 2001 and $13.6 million in 2000, representing 78%, 73% and 64% of
hardware revenue, respectively. The year-to-year decreases in absolute dollars
are directly related to decreased hardware revenue. Hardware cost as a percent
of hardware revenue has not decreased proportionally because fixed costs have
not decreased at the same rate as hardware revenue.
Operating Expenses
Research and Development. Research and development expense consists
primarily of personnel costs for software developers, third party contracted
development efforts and related facilities costs. Research and development
expense was $71.7 million in 2002, $68.8 million in 2001 and $57.9 million in
2000, representing 21%, 21% and 15% of total revenue, respectively. The
acquisition of eGrail in 2002 accounted for the majority of the $2.9 million
increase in research and development expenses from 2001 to 2002 primarily due to
additional facility and headcount expenses. The increase in expense from 2000 to
2001 was primarily due to the initiation of extensive development efforts to
enhance existing products with new capabilities and to develop new products.
This initiation resulted in a 15% increase in compensation expense primarily due
to increased numbers of personnel from 400 in fiscal 2000 to 425 in fiscal 2001
as well as a 35% increase in consulting costs due to the expanded use of
contractors. Also included in the 2001 costs were a one-time bonus of $2.0
million related to the Application Partners, Incorporated ("API") acquisition
and severance costs of approximately $331,000.
Our research and development efforts are focused on providing a unified
platform and framework for Enterprise Content Management that deliver
capabilities to our customers in a tightly integrated and synchronized offering.
This approach offers our customers the ability to easily configure, design,
build and deploy ECM solutions. These efforts focus on improvements in Business
Process Management, Content Management, Web Content Management and associated
applications to provide a richer product offering to our customers. We intend to
continue to complement internal development with third party software through
OEM agreements and may execute additional technology acquisitions such as our
eGrail acquisition that took place in April 2002.
New product development underway at eGrail at the time of the acquisition
included the next generation of their Web Content Management product that was in
the early stages of design and only 5% complete at the date of the acquisition.
The cost to complete the project was estimated at approximately $3.0 million to
26
occur over a twelve-month period. As of December 31, 2002 the project is 75%
complete and the Company has incurred approximately $2.9 million of research and
development expenses related to the project. The revised estimate to complete
the project within the estimated timeframe is an additional $1.0 million in
costs.
We intend to continue to invest significantly in internal research and
development. We expect that competition for qualified technical personnel, while
easing due to the global economic slowdown in the short-term, will remain
intense and may result in higher levels of compensation expense for us in the
future. We believe that research and development expenditures, including
compensation of technical personnel, are essential to maintaining our
competitive position and expect these costs to continue to constitute a
significant percentage of total revenue in future periods.
Selling, General and Administrative. Selling, general and administrative
expense consists primarily of salaries, benefits, sales commissions and other
expenses related to the direct and indirect sales force; personnel cost for
marketing and market development programs; personnel costs for finance,
information technology, legal, human resources and general management; and the
cost of outside professional services. Selling, general and administrative
expense was $163.8 million in 2002, $169.5 million in 2001 and $164.9 million in
2000. Selling, general and administrative expense, as a percentage of total
revenue, was 47% in 2002, 51% in 2001 and 41% in 2000. The decrease in absolute
dollars from 2001 to 2002 was primarily due to a 54% reduction in recruitment
expenses, as well as a 10% reduction in sales commission expense. The largest
expense reduction was the elimination of goodwill and assembled workforce
amortization in 2002, which was $3.0 million in 2001 and $1.8 million in 2000.
We ceased amortizing goodwill and assembled workforce as of the beginning of the
first quarter of 2002 in compliance with SFAS No. 142. Assembled workforce no
longer meets the definition of a separately identified intangible asset under
the provisions of SFAS No. 141, "Business Combinations," and the unamortized
balance of $182,000 at December 31, 2001 was reclassified as goodwill at January
1, 2002. The increase in absolute dollars in 2001 from 2000 was primarily due to
overall increased expenses associated with the expansion of sales and marketing
for new product launch programs, a 19% increase in depreciation expense from
capitalized software systems, and a 120% increase in legal fees.
Charges in 2001 for severance of $2.9 million related to workforce
reductions and $218,000 for facility consolidation costs, primarily in sales,
also contributed to the increase in 2001 from 2000. However, these workforce
reductions and facility consolidations led to reduced costs in 2002. We expect
to maintain expense controls over selling, general and administrative costs in
2003. Accordingly, these costs during 2003 should remain relatively consistent
with 2002 as a percentage of sales.
Purchased In-Process Research and Development. Based upon an independent
third-party appraisal determined through established valuation techniques in the
high-tech industry, we allocated approximately $3.0 million to in-process
research and development in connection with our purchase of certain assets from
API in May 2000. The in-process research and development expenses were 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 that 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 that was 100%
complete as of September 30, 2000.
27
Our eGrail acquisition in April 2002 of certain assets and certain
liabilities resulted in an allocation of $400,000 to in-process research and
development. The allocation was determined through established valuation
techniques in the high-technology industry by an independent third-party
appraiser. In-process research and development was expensed upon acquisition
because technological feasibility had not been established and no future
alternative uses existed. New product development underway at eGrail at the time
of the acquisition included the next generation of their Web Content Management
product that was in the early stages of design and only 5% complete at the date
of the acquisition. The cost to complete the project was estimated at
approximately $3.0 million to occur over a twelve-month period. As of December
31, 2002 the project was 75% complete and the Company has incurred approximately
$2.9 million of research and development expenses related to the project. The
revised estimate to complete the project within the estimated timeframe is an
additional $1.0 million in cost.
Amortization of Goodwill. In connection with our acquisition of certain
assets from API on May 18, 2000, the purchase price amount allocated to goodwill
of $14.6 million was being amortized in operating expenses over a useful life of
five years and assembled workforce of $386,000 was being amortized over a useful
life of three years. We ceased amortizing goodwill and assembled workforce as of
January 1, 2002 as a result of the adoption of SFAS No. 142. Assembled workforce
no longer meets the definition of a separately identified intangible asset under
the provisions of SFAS No. 141, "Business Combinations," and the unamortized
balance of $182,000 at December 31, 2001 was reclassified as goodwill at January
1, 2002. SFAS No. 142 was also effective for business combinations that occurred
after June 30, 2001. Accordingly, goodwill of $5.8 million that was recorded in
April 2002 in connection with the eGrail acquisition is not amortized. We had no
indefinite life intangible assets as of January 1, 2002. We are required to
evaluate the carrying value of goodwill annually or when events or circumstances
indicate that their carrying value may be impaired. In accordance with SFAS No.
142, we were required to perform a two-step transitional impairment review. We
completed the first step of this review by June 30, 2002 with the determination
of the fair value of our reporting units in order to identify whether the fair
value of each reporting unit was less than its carrying amount as of January 1,
2002. In the event that the fair value of each reporting unit was less than the
carrying amount, the second step of the test was required to determine if the
carrying value of goodwill exceeded the implied value. We determined that we did
not have a transitional impairment of goodwill because the fair value of each
reporting unit exceeded its carrying amount. There was no impairment of goodwill
at December 31, 2002. Goodwill will also be tested for impairment in the manner
described above on July 1st of each year or earlier if indicators of potential
impairment exist. If estimates change, a materially different impairment
conclusion could result.
Amortization of Purchased Intangible Assets. Acquired technology of $3.3
million and patents of $24,000 were included in our acquisition of eGrail.
Acquired technology is being amortized over a useful life of five years and
patents are being amortized over a useful life of two years. Amortization
expense for purchased intangible assets was $523,400 for 2002. We determined
that these assets were not impaired at December 31, 2002.
Interest, Other Income and Expenses, 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, and interest expense. Other income, net of other expenses, was $5.2
million in 2002, $2.5 million in 2001 and $5.4 million in 2000. The increase in
2002 from 2001 was primarily attributable to a net foreign exchange gain of $1.5
million for 2002 when compared to none for 2001 due to a significant weakening
of the dollar against the Euro in 2002. This was offset by lower interest income
of $4.1 million in 2002 compared to $6.2 million in 2001. The weighted average
interest rate earned on cash, cash equivalents and investments during 2002
decreased to 1.98% from 2.49% in 2001. Finally, a $3.5 million litigation
settlement charge included in other expense in 2001 caused other income, net in
2001 to be lower than both 2002 and 2000.
28
Provision for Income Taxes. The provision for income taxes was $2.5 million
in 2002, compared to a benefit of $4.6 million in 2001 and a provision of $11.2
million in 2000. The effective tax rate was 23%, (22%) and 23% for the years
ended December 31, 2002, 2001 and 2000, respectively. The increased tax rate in
2002 was primarily due to the mix of income between domestic and foreign
jurisdictions. FileNet management will continue weighing various evidence
throughout each year to assess the recoverability of its recorded deferred
assets and the need for any valuation allowance against such amounts.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2002, cash and cash equivalents, and investments were
$185.2 million, an increase of $13.0 million from $172.2 million at December 31,
2001.
Cash provided by operating activities in 2002 was $21.4 million and
resulted primarily from net income of $8.3 million, and depreciation and
amortization of $21.6 million. These were partially offset by increased accounts
receivable of $7.8 million resulting from increased revenue in the fourth
quarter of 2002 compared to 2001, an increase of $3.4 million in prepaid
expenses such as prepaid insurance due to higher insurance premiums in 2002 and
increases in prepaid royalty related to the addition of new third party
licensing agreements in 2002, and a decrease in income tax payable of $4.0
million. Cash used in investing activities in 2002 included $10.8 million for
capital expenditures, a $1.9 million note receivable from an officer, and a $9.4
million cash purchase related to the eGrail acquisition in April 2002, partially
offset by $12.0 million net proceeds from the sale of marketable securities.
Financing activities provided cash of $4.7 million primarily from the proceeds
of the issuance of common stock upon exercise of employee stock options under
the stock option and stock purchase plans.
Cash provided by operating activities in 2001 was $42.5 million and
resulted primarily from a substantial decrease in accounts receivable of $51.1
million due to decreased revenue and strong collections in the fourth quarter,
depreciation and amortization expense of $24.4 million, and increases in
unearned maintenance of $9.8 million related to prepaid maintenance contracts,
partially offset by a net loss of $16.6 million, decreases in accounts payable
of $8.2 million resulting from reduced spending, decreases in accrued
compensation and benefits of $8.1 million primarily due to a reduction in
bonuses, and a reduction in federal income tax payable of $5.6 million. Cash
used for investing activities in 2001 was $41.9 million consisting primarily of
capital expenditures of $14.1 million and net purchases of marketable securities
of $28.1 million. Cash provided by financing activities in 2001 was $7.8 million
consisting primarily of proceeds from the issuance of common stock upon exercise
of employee stock options under our stock option and stock purchase plans and
income tax benefit from exercised stock options.
Cash provided by operating activities in 2000 was $55.0 million and
resulted primarily from net income of $38.5 million, an increase in unearned
maintenance revenue related to prepaid maintenance contracts of $7.5 million,
$14.4 million stock option income tax benefit, and depreciation and amortization
expense of $19.8 million, partially offset by increases in accounts receivable
of $19.9 million resulting from increased revenue in the fourth quarter of 2000
compared to the prior year, and increases in prepaid expenses of $4.9 million.
Cash used for investing activities in 2000 totaled $47.8 million, consisting
primarily of capital expenditures of $27.7 million and cash paid for an
acquisition of $20.0 million. Cash provided by financing activities in 2000 was
$24.7 million, consisting primarily of proceeds from the issuance of common
stock upon exercise of employee stock options under our stock option and stock
purchase plans.
29
Our capital expenditures were $10.8 million in 2002, $14.1 million in 2001,
and $27.7 million in 2000. 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. Spending was significantly
reduced in an effort to contain expenses while the company experienced reduced
revenues from the downturn in the economy in 2002 and 2001.
We have a one-year, $5.0 million multi-currency revolving line of credit
that expires on June 27, 2003. Borrowings under the arrangement are unsecured
and bear interest at one hundred and twenty-five basis points over the London
Interbank Offered Rate. A standby letter of credit fee of one hundred and
twenty-five basis points per annum and an annual commitment fee of fifty basis
points is assessed against any undrawn amounts. There were no borrowings
outstanding at December 31, 2002. We are subject to certain financial covenants
that include, but are not limited to, compliance with specific balance sheet
ratios, no two consecutive quarterly losses, an aggregate loan limit to the
officers not to exceed $5.0 million, and a capital expenditure limit under this
line of credit. As of December 31, 2002, we were in compliance with all the
covenants. We are prohibited from paying cash dividends during the term of the
arrangement.
Our principal sources of short and long-term liquidity consist of existing
cash balances and funds generated from future operations. We had total cash and
investments of $185.2 million at December 31, 2002, compared with $172.2 million
at December 31, 2001, and we regularly review our cash funding requirements and
attempt to meet those requirements through a combination of cash on hand and
cash provided by operations. Our ability to increase revenues and generate
profits is subject to numerous risks and uncertainties and any significant
decrease in our revenues or profitability could reduce our operating cash flows
and erode our existing cash balances. During 2001 and continuing into 2002 lower
capital spending in the IT sector resulted in lower revenue for us. No
assurances can be given that this trend will improve or that we will continue to
be able to generate positive operating cash flows or that we will continue to
maintain or grow our existing cash balances. See "Risk Factors".
We believe that our present cash balances, together with internally
generated funds and credit lines, will be sufficient to meet our working capital
and capital expenditures throughout 2003. We anticipate capital expenditures of
approximately $19.1 million in 2003 and we have no long-term debt at December
31, 2002.
Commitments. We lease certain of our facilities under noncancelable
operating lease arrangements that expire at various dates through 2013. We have
certain royalty commitments associated with licensing of third party products
that require minimum payments or contractual prepayments.
The following table summarizes future minimum payments for these
obligations as of December 31, 2002:
(In thousands)
Payments Due by Period
2004- 2006-
Total 2003 2005 2007 Thereafter
Contractual obligations
Operating leases $ 63,604 13,815 22,134 18,840 $ 8,815
Third party licensing contracts 3,810 3,810
Total contractual cash obligations $ 67,414 17,625 22,134 18,840 $ 8,815
We have a $5.0 million line of credit and we have bank guarantees issued in
local currencies in Europe and Asia as discussed in Note 18 of the Notes to
Consolidated Financial Statements.
30
The following table summarizes future minimum commercial commitments for
these obligations as of December 31, 2002:
(In thousands)
Amount of Commitment Expiration Per Period
Total
Amounts 2004- 2006-
Committed 2003 2005 2007 Thereafter
Other commercial commitments:
Lines of Credit $ 5,000 5,000 - - $ -
Secured and unsecured bank
guarantees 1,042 165 459 132 $ 286
Total commercial commitments $ 6,042 5,165 459 132 $ 286
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 agreed to adopt the euro as
their common legal currency from that date. The legacy currencies remained legal
tender in these countries as a denomination of the euro between January 1, 1999
and January 1, 2002. Beginning on January 1, 2002, euro-denominated bills and
coins were issued for cash transactions. For a period of up to six months from
that date, both legacy currencies and the euro were legal tender. On or before
July 1, 2002, the participating countries withdrew all legacy currencies and
exclusively used the euro.
We made the necessary changes to our internal business systems to support
transactions denominated in the euro, including establishing euro price lists
for affected countries. We have been transacting in the euro currency since 1999
and have evaluated the impact the euro has had on our financial condition and
results of operations. Based on this evaluation to date, we currently do not
believe that there has been or will be a material impact on our consolidated
financial condition or results of operations as a result of the euro conversion.
Impact of Recently Issued Accounting Pronouncements. In June 2001, the FASB
issued SFAS No. 141, "Business Combinations," which was effective immediately.
SFAS No. 141 requires that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001; and it eliminated the
pooling-of-interests method. The adoption of this standard did not have a
significant impact on our consolidated financial statements. Our April 2002
acquisition of certain assets and certain liabilities of eGrail, Inc. was
accounted for in compliance with this pronouncement (see Note 3 of Notes to
Consolidated Financial Statements).
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which we adopted January 1, 2002. SFAS No. 142 requires that goodwill
and other intangible assets with indefinite useful lives no longer be amortized,
but instead be tested for impairment at least annually and written down when
impaired. SFAS No. 142 requires purchased intangible assets other than goodwill
to be amortized over their useful lives unless these lives are determined to be
indefinite. In accordance with this Standard, we no longer amortize goodwill and
indefinite life intangible assets but evaluate their carrying value annually or
when events or circumstances indicate that their carrying value may be impaired.
Assembled workforce no longer meets the definition of a separately identified
intangible asset under the provisions of SFAS No. 141, Business Combinations,
and the unamortized balance of $182,000 was reclassified as goodwill at January
1, 2002. We ceased amortizing the goodwill balance of $10.1 million from our
2000 acquisition of Applications Partner, Inc. as of January 1, 2002. We had no
31
indefinite life intangible assets as of January 1, 2002. In accordance with SFAS
No. 142, we were required to perform a two-step transitional impairment review.
We completed the first step of this review by June 30, 2002 with the
determination of the fair value of our reporting units in order to identify
whether the fair value of each reporting unit was less than its carrying amount
as of January 1, 2002. In the event that the fair value of each reporting unit
was less than the carrying amount, the second step of the test would be required
to determine if the carrying value of goodwill exceeded the implied value. We
determined that we did not have a transitional impairment of goodwill because
the fair value of each reporting unit exceeded its carrying amount. As of
December 31, 2002, no impairment of goodwill has been recognized. Goodwill will
also be tested for impairment in the manner described above on July 1st of each
year or earlier if indicators of potential impairment exist. If estimates
change, a materially different impairment conclusion could result.
In August 2001, the FASB issued SFAS No. 144, "Accounting for Impairment or
Disposal of Long-Lived Assets." This Statement addresses financial accounting
and reporting for the impairment of long-lived assets and for the disposal of
long-lived assets and discontinued operations. SFAS No. 144 superseded SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of," and is effective for fiscal years beginning after
December 15, 2001. The adoption of this Standard on January 1, 2002 did not have
a material impact on our financial position and results of operations.
In November 2001, the FASB announced Emerging Issues Task Force ("EITF")
Topic No. D-103, "Income Statement Characterization of Reimbursements Received
for Out-of-Pocket Expense Incurred," is required to be applied in financial
reporting periods beginning after December 15, 2001. The EITF requires companies
to characterize reimbursements received for out-of-pocket expenses as revenues
in the statement of operations. Historically, we have netted reimbursements
received for out-of-pocket expenses against the related expenses in the
statement of operations. Application of this EITF requires that comparative
financial statements for prior periods be reclassified to comply with the
guidance. We adopted this EITF as of January 1, 2002 and have reclassified our
prior-period, consolidated financial statements to conform to the current
presentation. These reclassifications resulted in increased revenue and cost of
revenue of $2.1 million and $1.7 million for the twelve months ended December
31, 2001 and 2000, respectively. The adoption of this EITF did not have a
material effect on total revenues or gross margin percentages and has no impact
on results of operations as it required an equivalent increase to both revenue
and cost of revenue. Comparable amounts for 2002 are not available as
out-of-pocket expenses are characterized as revenue upon invoicing.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which addresses financial
accounting and reporting for costs associated with exit or disposal activities
and supersedes EITF Issue 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." SFAS 146 requires that costs associated
with exit or disposal activities be recognized when they are incurred rather
than at the date of a commitment to an exit or disposal plan. SFAS No. 146 also
establishes that the liability should initially be measured and recorded at fair
value. We will adopt the provisions of SFAS No. 146 for exit or disposal
activities that are initiated after December 31, 2002.
In November 2002, the FASB issued Interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees and Indebtedness of Others," an interpretation of FASB
Statements No. 5, 57 and 107, and rescission of FIN No. 34, "Disclosure of
Indirect Guarantees of Indebtedness of Others." FIN 45 elaborates on the
disclosures to be made by the guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It
also requires that a guarantor recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. The provisions related to recognizing a liability at inception of the
32
guarantee for the fair value of the guarantor's obligations does not apply to
product warranties or to guarantees accounted for as derivatives. The initial
recognition and measurement provisions of this interpretation are applicable on
a prospective basis to guarantees issued or modified after December 31, 2002
while the disclosure requirements are effective for financial statements for
interim or annual periods ending after December 15, 2002. Our disclosure of
guarantees is included in Note 18 of the "Notes to Consolidated Financial
Statements." We believe the adoption of this interpretation will not have a
material impact on our consolidated results of operations or financial position.
In December 2002, the FASB Issued SFAS No. 148, "Accounting for Stock-Based
Compensation Transition and Disclosure," an amendment of SFAS No. 123. This
statement amends SFAS No. 123, "Accounting for Stock-Based Compensation," to
provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, this Statement amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The transition guidance and
annual disclosure provisions of SFAS No. 148 are effective for fiscal years ending after
December 15, 2002. The interim disclosure provisions are effective for financial
reports containing financial statements for interim periods beginning after
Decemebr 15, 2002. The adoption of SFAS No. 148 did not have a material impact
on our consolidated results of operations or financial position.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities." In general, a variable interest entity is a corporation,
partnership, trust, or any other legal structure used for business purposes that
either (a) does not have equity investors with voting rights or (b) has equity
investors that do not provide sufficient financial resources for the entity to
support its activities. FIN 46 requires a variable interest entity to be
consolidated by a company if that company is subject to a majority of the risk
of loss from the variable interest entity's activities or entitled to receive a
majority of the entity's residual returns or both. The consolidation
requirements of FIN 46 apply immediately to variable interest entities created
after January 31, 2003. The consolidation requirements apply to older entities
in the first fiscal year or interim period beginning after June 15, 2003.
Certain of the disclosure requirements apply in all financial statements issued
after January 31, 2003, regardless of when the variable interest entity was
established. We did not have any variable interest entities as of December 31,
2002. We are currently evaluating the provisions of the Interpretation, but
believe its adoption will not have a material impact on our consolidated results
of operations or our financial position.
Inflation. 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 any of the three years ended December 31, 2002.
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, we 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 fixed interest
33
rates and 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 stockholders' equity.
At any time, a significant increase/decrease in interest rates will have an
impact on the fair market value and interest earnings of our investment
portfolio. We do not currently hedge this interest rate exposure. We have
performed a sensitivity analysis as of December 31, 2002 and 2001, using a
modeling technique that measures the change in the fair values arising from a
hypothetical 50 basis points and 100 basis points adverse movement in the levels
of interest rates across the entire yield curve, which are representative of
historical movements in the Federal Funds Rate with all other variables held
constant. The analysis covers our investment and is based on the weighted
average maturity of our investments as of December 31, 2002 and 2001. The
sensitivity analysis indicated that a hypothetical 50 basis points adverse
movement in interest rates would result in a loss in the fair values of our
investment instruments of approximately $231,000 at December 31, 2002 and
approximately $188,000 at December 31, 2001. Similarly a hypothetical 100 basis
points adverse movement in interest rates would result in a loss in the fair
values of our investments of approximately $460,000 at December 31, 2002 and
approximately $377,000 at December 31, 2001.
Foreign Currency Risk. Our performance can be affected by changes in foreign
currency values relative to the U.S. dollar in relation to the Company's revenue
and operating expenses. We have entered into forward foreign exchange contracts
primarily to hedge amounts due from and the net assets of selected subsidiaries
denominated in foreign currencies (mainly in Europe and Asia Pacific) against
fluctuations in exchange rates. We have not entered into forward foreign
exchange contracts for speculative or trading purposes. Our accounting policies
for these contracts are based on our designation of the contracts as hedging
transactions. The criteria we use for designating a contract as a hedge include
the contract's effectiveness in risk reduction and one-to-one matching of
derivative instruments to underlying transactions. Gains and losses on foreign
exchange contracts are recognized in income in the same period as gains and
losses on the underlying transactions. If an underlying hedged transaction is
terminated earlier than initially anticipated, the offsetting gain or loss on
the related forward foreign exchange contract would be recognized in income in
the same period. In addition, since we enter into forward contracts only as a
hedge, any change in currency rates would not result 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
2002 were $19.0 million and $4.1 million, respectively. We do not expect gains
or losses on these contracts to have a material impact on our consolidated
financial results (see Note 19).
Item 8. Financial Statements and Supplementary Data
The consolidated financial statements for the years ended December 31,
2002, 2001 and 2000 are incorporated herein by reference and submitted as a
separate section of this Form 10-K. (See Item 15).
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
34
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 our definitive Proxy Statement for our 2003 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 our definitive Proxy Statement for our 2003 Annual Meeting to be filed with
the Securities and Exchange Commission.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
We hereby incorporate by reference the information appearing under the
caption "Voting Securities and Principal Holders Thereof" and "Equity
Compensation Plans" of our definitive Proxy Statement for our 2003 Annual
Meeting to be filed with the Securities and Exchange Commission.
Item 13. Certain Relationships and Related Transactions
We hereby incorporate by reference the information appearing under the
caption "Related Party Transactions" of our definitive Proxy Statement for our
2003 Annual Meeting to be filed with the Securities and Exchange Commission.
Item 14. Controls and Procedures
(a) We maintain disclosure controls and procedures that are designed to
ensure that information required to be disclosed in our reports under
the Securities Exchange Act of 1934 is recorded, processed, summarized
and reported within the time periods specified in the SEC's rules and
forms, and that such information is accumulated and communicated to
our management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure. In designing and evaluating the disclosure
controls and procedures, management recognized that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and
management necessarily was required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and
procedures.
Within 90 days prior to the date of this report, we carried out an
evaluation, under the supervision and with the participation of our
management, including our Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures. Based on the foregoing, our Chief
Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures were effective.
(b) There were no significant changes in our internal controls or in other
factors that could significantly affect our internal controls
subsequent to the date of the evaluation. No significant deficiencies
or material weaknesses were detected in our internal controls, and,
therefore, no corrective actions were taken.
35
PART IV
Item 15. 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-2
Consolidated Balance Sheets at December 31, 2002 and December 31,
2001 F-3
Consolidated Statements of Operations for each of the three years
in the period ended December 31, 2002 F-4
Consolidated Statements of Comprehensive Operations for each of
the three years in the period ended December 31, 2002 F-5
Consolidated Statements of Stockholders' Equity for each of the
three years in the period ended December 31, 2002 F-6
Consolidated Statements of Cash Flows for each of the three years
in the period ended December 31, 2002 F-7
Notes to Consolidated Financial Statements F-8
Independent Auditors' Report on Schedule F-33
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, 2002.
36
(c) Exhibits
The following exhibits are filed herewith or incorporated by reference:
Exhibit No. Exhibit Description
3.1* Restated Certificate of Incorporation, as amended (filed as Exhibit 3.1 to
Registrant's 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 Registrant's 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).
4.1* Form of certificate evidencing Common Stock (filed as Exhibit 4.1 to
Registrant's registration statement on 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 Registrant's registration statement on 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 Agreement dated as of November 4, 1988 between FileNet Corporation and
BANKBOSTON, N.A.formerly known as The First National Bank of Boston (filed
as Exhibit 4.3 to Registrant's registration statement on Form 10-Q for the
quarter ended September 30, 1998).
4.4* Amendment Three dated November 30, 2001 to Rights Agreement dated as of
November 4, 1988 between FileNet Corporation and Equiserve Trust Company,
N.A., successors to BANKBOSTON, N.A. (filed as Exhibit 4.4 to Registrant's
Annual Report on Form 10-K filed for the year ended December 31, 2001).
10.1* Second Amended and Restated Credit Agreement (Multi-currency) by and between
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 Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1999) as amended
by a Waiver and First Amendment to Credit Agreement dated as of June 29, 2001
and by a letter amendment dated as of April 5, 2002.
10.1.1* Waiver and First Amendment to Credit Agreement (Multi-currency) by and among
the Registrant and Bank of America, N.A., formerly known as Bank of America
National Trust and Savings Association, dated June 29, 2001, effective June 29,
2001 (filed as Exhibit 10/1 to Registrant's Annual Report on Form 10-K filed
for the year ended December 31, 2001).
10.1.2* Letter amendment dated as of April 5, 2002 and Third Amendment to Credit Agreement
(Multi-currency) by and between the Registrant and Bank of America, N.A., dated as
of June 28, 2002 (filed as Exhibit 10.1.2 to Registrant's Quarterly Report on
Form 10-Q for the quarter ended June 30, 2002).
10.2*+ Amended and Restated 1995 Stock Option Plan of FileNet (filed as Exhibit 99.1
to Registrant's registration statement on Form S-8 filed on October 15, 2001;
Registration No. 333-71598).
10.3*+ Second Amended and Restated 1986 Stock Option Plan of FileNet Corporation,
together with the forms of Incentive Stock Option Agreement and Non-Qualified
Stock Option Agreement (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),
the first 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).
10.4*+ 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 Registrant's registration statement on Form S-8 filed on August 20, 1997).
10.5*+ 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 Registrant's registration statement on Form S-8 filed on August 20, 1997).
37
10.6*+ Amended and Restated FileNet Corporation 1998 Employee Stock Purchase Plan
(filed as Appendix B to Registrant's Definitive Proxy Statement on Schedule 14A,
for the Registrant's 2002 Annual Meeting of Stockholders, filed on April 18, 2002).
10.7*+ FileNet Corporation International Employee Stock Purchase Plan (filed as
Appendix C to Registrant's Definitive Proxy Statement on Schedule 14A, for the
Registrant's 2002 Annual Meeting of Stockholders, filed on April 18, 2002).
10.8* 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 Registrant's
registration statement on Form 10-Q for the quarter ended September 30, 1999).
10.9* Asset Purchase Agreement between the Registrant and Application Partners, Inc.
dated May 18, 2000 (filed as Exhibit 10.24 to Registrant's Form 10-Q for the
quarter ended June 30, 2000).
10.10*+ Written Compensation Agreement and Non-Statutory Stock Option Agreement (with
Notice of Grant of Stock Option and Special Addendum) between Registrant and
Mr. Sam Auriemma (filed as Exhibit 99.1 and 99.2 to Registrant's registration
statement on Form S-8, filed on April 20, 2001; Registration No. 333-59274).
10.11* Asset Purchase Agreement dated April 2, 2002 by and between 3565 Acquisition
Corporation and eGrail, Inc.(filed as Exhibit 10.1 to Registrant's Current
Report on Form 8-K, filed on April 12, 2002).
10.12*+ Secured Promissory Note between Registrant and Mr. Lee D. Roberts dated
June 14, 2002 (filed as Exhibit 10.12 to Registrant's Quarterly Report on
Form 10-Q for the quarter ended June 30, 2002).
10.13*+ Option Exchange Agreement between Registrant and Mr. Ron L. Ercanbrack, dated
May 22, 2002, together with form of Incentive Stock Option Agreement and Grant
Notice (filed as Exhibit 10.13 to Registrant's Quarterly Report on Form 10-Q
for the quarter ended June 30, 2002).
10.14*+ The 2002 Incentive Award Plan, as approved by stockholders at the Registrant's
Annual Meeting on May 22, 2002, together with the forms of Incentive Option
Agreement and Non-Qualified Stock Option Agreement for Independent Directors
(filed as Exhibit 10.14 to Registrant's Quarterly Report on Form 10-Q for the
quarter ended June 30, 2002).
10.14.1*+ Amended Form of 2002 Incentive Award Plan Incentive Option Agreement with Notice
of Grant of Stock Option (filed as Exhibit 10.14.1 to Registrant's Quarterly
Report on Form 10-Q for the quarter ended September 30, 2002).
10.14.2*+ Amended Form of 2002 Incentive Award Plan Non-Qualified Stock Option Agreement
for Independent Directors with Notice of Grant of Stock Option (filed as
Exhibit 10.14.2 to Registrant's Quarterly Report on Form 10-Q for the quarter
ended September 30, 2002).
21.1 List of subsidiaries of Registrant (filed as FileNet Corporation Subsidiary
Information).
23.1 Independent Auditors' consent
* Incorporated herein by reference
+ Management contract, compensatory plan or arrangement
38
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 28, 2003 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 SIGNATURE AND TITLE
March 28, 2003 /s/ Lee D. Roberts
Lee D. Roberts
Chief Executive Officer and
Chairman of the Board (Principal Executive Officer)
March 28, 2003 /s/ Sam M. Auriemma
Sam M Auriemma,
Chief Financial Officer and Senior Vice
President, Finance (Principal Financial
and Accounting Officer)
March 28, 2003 /s/ Theodore J. Smith
Theodore J. Smith
Director
March 28, 2003 /s/ L. George Klaus
L. George Klaus
Director
March 28, 2003 /s/ William P. Lyons
William P. Lyons
Director
March 28, 2003 /s/ John C. Savage
John C. Savage
Director
March 28, 2003 /s/ Roger S. Siboni
Roger S. Siboni
Director
39
CERTIFICATIONS
I, Lee D. Roberts, Chief Executive Officer, certify that:
1. I have reviewed this annual report on Form 10-K of FileNet Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 28, 2003
/s/ Lee D. Roberts
Lee D. Roberts
Chief Executive Officer
40
I, Sam M. Auriemma, Chief Financial Officer, certify that:
1. I have reviewed this annual report on Form 10-K of FileNet Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 28, 2003
/s/ Sam M. Auriemma
Sam M. Auriemma
Chief Financial Officer
41
Index to Consolidated Financial Statements
As required under Item 8, Financial Statements and Supplementary Data, FileNet
Corporation's consolidated financial statements are provided in this separate
section as follows:
Page
Independent Auditors' Report F-2
Consolidated Balance Sheets at December 31, 2002 and December 31, 2001 F-3
Consolidated Statements of Operations for each of the three years in the
period ended December 31, 2002 F-4
Consolidated Statements of Comprehensive Operations for each of the
three years in the period ended December 31, 2002 F-5
Consolidated Statements of Stockholders' Equity for each of the three years
in the period ended December 31, 2002 F-6
Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 2002 F-7
Notes to Consolidated Financial Statements F-8
Independent Auditors' Report on Schedule F-33
Schedule II. Valuation and Qualifying Accounts and Reserves S-1
F-1
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, 2002 and 2001,
and the related consolidated statements of operations, comprehensive operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 2002. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated 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, 2002 and 2001, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2002, in conformity with accounting principles generally accepted
in the United States of America.
As discussed in Note 2 to the consolidated financial statements, the Company
changed its method of accounting for goodwill and other intangible assets as a
result of adopting Statement of Financial Accounting Standards No. 142, Goodwill
and Other Intangible Assets, effective January 1, 2002.
/s/ DELOITTE and TOUCHE LLP
Costa Mesa, California
January 29, 2003
F-2
CONSOLIDATED BALANCE SHEETS
ASSETS
(In thousands, except share and per share amounts)
December 31, 2002 2001
Current assets:
Cash and cash equivalents $ 130,154 $ 107,502
Short-term investments 29,188 64,660
Accounts receivable, net of allowances for doubtful accounts
and sales returns of $4,232 and $3,567 at December 31,
2002 and 2001, respectively 44,839 36,909
Inventories, net 2,568 2,993
Prepaid expenses and other current assets 13,317 9,521
Deferred income taxes 802 2,779
Total current assets 220,868 224,364
Property, net 34,641 44,206
Long-term investments 25,864 -
Goodwill 16,907 9,953
Intangible assets, net of accumulated amortization of $544 and
$204 at December 31, 2002 and 2001, respectively 3,029 182
Deferred income taxes 21,792 21,445
Other assets 4,935 1,489
Total assets $ 328,036 $ 301,639
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 7,706 $ 8,282
Accrued compensation and benefits 20,729 17,804
Customer deposits and advances 2,962 4,848
Unearned maintenance revenue 38,945 30,996
Income taxes payable - 3,999
Other accrued liabilities 15,224 13,685
Total current liabilities 85,566 79,614
Unearned maintenance revenue 3,565 6,200
Commitments and contingencies (Notes 10, 17 and 18)
Stockholders' equity:
Preferred stock, $0.10 par value; 7,000,000 shares
authorized; none issued and outstanding
Common stock, $0.01 par value; 100,000,000 shares authorized;
37,014,512 shares issued and 35,916,512 shares outstanding at
December 31, 2002; and 36,389,682 shares issued and
35,291,682 shares outstanding at December 31, 2001 206,676 199,526
Retained earnings 53,178 44,906
Accumulated other comprehensive loss (6,382) (14,040)
253,472 230,392
Treasury stock, at cost; 1,098,000 shares at
December 31, 2002 and 2001 (14,567) (14,567)
Net stockholders' equity 238,905 215,825
Total liabilities and stockholders' equity $ 328,036 $ 301,639
See accompanying Notes to Consolidated Financial Statements
F-3
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share amounts)
Year Ended December 31, 2002 2001 2000
Revenue:
Software $ 132,508 $ 119,014 $ 204,872
Customer support 149,847 132,382 110,306
Professional services and education 56,959 69,186 63,985
Hardware 7,703 14,028 21,199
Total revenue 347,017 334,610 400,362
Cost of revenue:
Cost of software revenue 10,565 7,522 14,643
Cost of customer support revenue 38,608 42,396 45,876
Cost of professional services and education 50,408 59,896 56,100
revenue
Cost of hardware revenue 5,995 10,211 13,559
Total cost of revenues 105,576 120,025 130,178
Gross profit 241,441 214,585 270,184
Operating expenses:
Research and development 71,735 68,838 57,914
Selling, general and administrative 163,765 169,505 164,941
In-process research and development 400 - 2,984
Total operating expenses 235,900 238,343 225,839
Operating income (loss) 5,541 (23,758) 44,345
Other income , net 5,209 2,503 5,406
Income (loss) before income taxes 10,750 (21,255) 49,751
Provision (benefit) for income taxes 2,478 (4,633) 11,204
Net income (loss) $ 8,272 $ (16,622) $ 38,547
Earnings (loss) per share:
Basic $ .23 $ (0.47) $ 1.13
Diluted $ .23 $ (0.47) $ 1.05
Weighted average shares outstanding:
Basic 35,590 35,117 34,155
Diluted 36,709 35,117 36,765
See accompanying Notes to Consolidated Financial Statements
F-4
CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
(In thousands)
Year Ended December 31, 2002 2001 2000
Net income (loss) $ 8,272 $ (16,622) $ 38,547
Other comprehensive income (loss):
Foreign currency translation
adjustments 7,631 (3,056) (3,385)
Unrealized holding gains (losses) on
available-for-sale securities, net of tax 27 77 59
Other comprehensive income (loss) 7,658 (2,979) (3,326)
Comprehensive income (loss) $ 15,930 $ (19,601) $ 35,221
See accompanying Notes to Consolidated Financial Statements
F-5
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)
Accumulated
Other
Common Stock Retained Comprehensive Treasury Stock
Shares Amount Earnings Operations Shares Amount Total
Balances at January 1, 2000 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
Unrealized holding gains on
available-for-sale securities 59 59
Balances at December 31, 2000 35,941 $ 189,057 $ 61,528 $(11,061) (1,098) $(14,567) $ 224,957
Stock options exercised 486 4,722 4,722
Stock option income tax 1,749 1,749
benefit
Common stock issued under the
Employee Qualified Stock
Purchase Plan 339 3,998 3,998
Cancelled and retired escrow
shares issued in business (376)
combinations
Foreign currency translation
adjustment (3,056) (3,056)
Net (loss) (16,622) (16,622)
Unrealized holding gains on
available-for-sale-securities 77 77
Balances at December 31, 2001 36,390 $ 199,526 $ 44,906 $(14,040) (1,098) $(14,567) $ 215,825
Stock options exercised 286 2,753 2,753
Stock option income tax 685 685
benefit
Common stock issued under the
Employee Qualified Stock
Purchase Plan 339 3,712 3,712
Foreign currency translation
adjustment 7,631 7,631
Net income 8,272 8,272
Unrealized holding gains on
available-for-sale-securities 27 27
Balances at December 31, 2002 37,015 $ 206,676 $ 53,178 $ (6,382) (1,098) $(14,567) $ 238,905
See accompanying Notes to Consolidated Financial Statements
F-6
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Ended December 31, 2002 2001 2000
Cash flows provided by operating activities:
Net income (loss) $ 8,272 $ (16,622) $ 38,547
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Purchased in-process research and development 400 - 2,984
Depreciation and amortization 21,588 24,349 19,827
Loss on sale of fixed assets 47 264 107
Provision for doubtful accounts and sales returns 1,752 1,482 2,280
Deferred income taxes 1,629 (8,286) (10,248)
Stock option income tax benefit 685 1,749 14,408
Changes in operating assets and liabilities net of
effects of acquisitions:
Accounts receivable (7,818) 51,128 (19,908)
Inventories 425 405 6
Prepaid expenses and other current assets (3,425) 185 (4,897)
Accounts payable (940) (8,236) 155
Accrued compensation and benefits 2,101 (8,119) 2,582
Customer deposits and advances (1,895) 2,936 (3,267)
Unearned maintenance revenue 4,651 9,842 7,530
Income taxes payable (3,966) (5,559) 2,040
Other assets and liabilities (2,066) (3,044) 2,899
Net cash provided by operating activities 21,440 42,474 55,045
Cash flows used for investing activities:
Capital expenditures (10,825) (14,075) (27,721)
Proceeds from sale of property 66 329 427
Note receivable (1,900) - -
Cash paid for acquisitions, net of cash acquired (9,359) - (20,000)
Purchases of investments (134,528) (148,570) (40,442)
Proceeds from sales and maturities of investments 146,571 120,433 39,901
Net cash used in investing activities (9,975) (41,883) (47,835)
Cash flows provided by financing activities:
Proceeds from issuance of common stock 6,465 8,720 24,870
Principal payments on capital lease obligations (1,799) (935) (194)
Net cash provided by financing activities 4,666 7,785 24,676
Effect of exchange rate changes on cash and cash
equivalents 6,521 (2,371) (1,917)
Net increase in cash and cash equivalents 22,652 6,005 29,969
Cash and cash equivalents, beginning of year 107,502 101,497 71,528
Cash and cash equivalents, end of year $ 130,154 $ 107,502 $ 101,497
Supplemental cash flow information:
Interest paid $ 100 $ 92 $ 69
Income taxes paid $ 4,301 $ 7,045 $ 6,996
See Note 13 for non-cash investing and financing
activities
See accompanying Notes to Consolidated Financial Statements
F-7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 Nature of Operations
FileNet Corporation ("FileNet" or "the Company") develops, markets, sells
and supports a unified platform and framework for Enterprise Content Management
("ECM") software and solutions that delivers capabilities in a tightly
integrated and synchronized offering. 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.
Note 2 Summary of Significant Accounting Policies
Basis of Presentation. The accompanying consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States of America. 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. Estimates are used for, but not limited to, the accounting for the
allowance for doubtful accounts and sales returns, inventory allowances,
warranty costs, contingencies and taxes.
Foreign Currency Translation. The Company measures the financial statements
of 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. A cumulative translation
gain of $208,337 was transferred from cumulative translation adjustments and
included in determining net loss for 2001 as a result of the liquidation of an
investment in a foreign entity. Gains and losses from foreign currency
transactions are included in other income, net. Transaction gains and losses
incurred during the years ended December 31, 2002, 2001 and 2000 were a gain of
$1.5 million, a loss of $13,250, and a gain of $315,975, respectively.
Cash Equivalents. Investments purchased with an original maturity of three
months or less are considered to be cash equivalents and are stated at cost,
which approximates fair value. Cash equivalents generally consist of cash, time
deposits, commercial paper, U.S. government and U.S. government agencies
instruments, money market funds and other money market instruments. The Company
invests its excess cash only in investment AAA grade money market instruments
from companies in a variety of industries and, therefore, believes that it bears
minimal principal risk.
Investments. The Company's investments consist of marketable securities,
primarily 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 7).
F-8
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. These contracts mature every three months
at the end of each quarter. The Company opens new hedge contracts on the last
business day of each quarter that will mature at the end of the following
quarter. The counterparties to these contracts are major financial institutions.
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 19).
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 No. 133, as
amended, established 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 required the Company to record all
derivatives on the balance sheet at fair value. For derivatives that qualify for
hedge accounting, changes in the fair value of derivatives are offset by the
change in fair value of the hedged assets, liabilities, or firm commitments as
appropriate for cash flow and fair value hedges. The Company adopted this
standard effective January 1, 2001, and it has had no significant effect on the
Company's consolidated results of operations, financial position, or cash flows.
Fair Value of Financial Instruments. The recorded amounts of financial
assets and liabilities at December 31, 2002 and 2001, approximate fair value due
to the relatively short period of time between origination of the instruments
and their expected realization.
Accounts Receivable. The Company evaluates the creditworthiness of its
customers prior to order fulfillment and regularly adjusts credit limits based
upon ongoing credit evaluations of a customer's payment history and current
creditworthiness. An allowance for estimated credit losses is maintained and
such losses have been within management's expectations and the provisions
established.
Inventories. Inventories are stated at the lower of first-in, first-out,
cost, or market (Note 8). 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 9).
Long-Lived Assets. The Company accounts for the impairment and disposition
of long-lived assets in accordance with SFAS No. 144, "Accounting for Impairment
or Disposal of Long-Lived Assets," which the Company adopted effective January
1, 2002. In accordance with SFAS No. 144, long-lived assets 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, 2002.
F-9
Change In Accounting for Goodwill. Prior to the adoption of SFAS No. 142,
"Goodwill and Other Intangible Assets," goodwill arising from our API
acquisition that took place on May 18, 2000, was amortized on a straight-line
basis over five years and assembled workforce was amortized on a straight-line
basis over three years (Note 3). The Company adopted SFAS No. 142 on January 1,
2002. As a result, assembled workforce no longer meets the definition of a
separately identified intangible asset under the provisions of SFAS No. 142, and
the unamortized balance of $182,000 was reclassified as goodwill at January 1,
2002. In accordance with this Standard, the Company ceased amortizing the
goodwill balance of $10.1 million from its 2000 acquisition of Applications
Partner, Inc. as of January 1, 2002 and there were no indefinite life intangible
assets as of January 1, 2002. Goodwill of $5.8 million resulting from the
acquisition of eGrail in April 2002 is also not being amortized. In accordance
with SFAS No. 142, the Company was required to perform a two-step transitional
impairment review. The first step of this review was completed by June 30, 2002
with the determination of the fair value of the Company's reporting units in
order to identify whether the fair value of each reporting unit was less than
its carrying amount as of January 1, 2002. In the event that the fair value of
each reporting unit was less than the carrying amount, the second step of the
test would be required to determine if the carrying value of goodwill exceeded
the implied value. The Company determined that it did not have a transitional
impairment of goodwill because the fair value of each reporting unit exceeded
its carrying amount. As of December 31, 2002, no impairment of goodwill has been
recognized. Goodwill will also be tested for impairment in the manner described
above on July 1st of each year or earlier if indicators of potential impairment
exist. If estimates change, a materially different impairment conclusion could
result (Note 12).
Intangible Assets. Acquired technology resulting from the asset purchase of
eGrail in April 2002 was assigned a useful life of five years and patents were
assigned a useful life of two years. Amortization of acquired technology is
recorded on a straight-line basis as a cost of software revenue and amortization
of patents is recorded on a straight-line basis as an operating expense.
Revenue Recognition. Revenues from sales of software licenses sold through
direct and indirect channels, 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 and 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. For arrangements with multiple elements, revenue
is allocated to each element of a transaction based upon its fair value as
determined in reliance on vendor specific objective evidence. Revenue from
post-contract customer support is recognized ratably over the term of the
arrangement, which is typically twelve months. Revenue from professional
services and training is recognized as such services are delivered and accepted
by the customer. Anticipated losses on fixed-price professional services
contracts are recognized in the period when they become known.
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 documentation at
time of delivery. A provision for estimated warranty costs is recorded at the
time of sale or license and periodically adjusted to reflect actual experience
(Note 11).
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, 2002 and 2001 because software is
substantially completed concurrently with the establishment of technological
feasibility.
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
F-10
liabilities and their reported amounts in the consolidated financial statements
that will result in taxable or deductible amounts in future years. A 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 15).
Earnings (Loss) Per Share. Basic earnings (loss) per share is computed
using the weighted average number of common shares outstanding during the
reporting period. Diluted earnings per share is computed using the weighted
average number of common shares outstanding plus the dilutive effect of
outstanding stock options and shares issuable under the employee stock purchase
plan using the treasury stock method. Diluted loss per share excludes these
adjustments as the impact would be antidilutive (Note 5).
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 that could have an adverse effect on the Company's
consolidated operating results. However, the Company has qualified and is able
to purchase and sell 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". No Stock-based compensation expense was recorded in the consolidated
statements of operations for the years ended December 31, 2002 and 2001,
respectively.
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:"
(In thousands, except per share amounts) 2002 2001 2000
Net income (loss), as reported $ 8,272 $ (16,622) $ 38,547
Deduct: Total stock-based employee
compensation expense determined under
fair value method for all awards, net
of related tax effects (8,735) (12,381) (8,807)
Pro forma net income (loss) $ (463) $ (29,003) $ 29,740
Earnings per share:
Basic earnings (loss) per share - as reported $ 0.23 $ (0.47) $ 1.13
Basic earnings (loss) per share - pro forma $ (0.01) $ (0.83) $ 0.87
Diluted earnings (loss) per share - as reported $ 0.23 $ (0.47) $ 1.05
Pro forma earnings (loss) per share - as reported $ (0.01) $ (0.83) $ 0.81
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 2002, 2001 and 2000; expected volatility of 68%
F-11
for 2002, 78% for 2001 and 80% for 2000; risk-free interest rates of 2.0% to
4.61% for 2002, 3.6% to 5.3% for 2001, and 6.1% to 6.5% for 2000; 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.
Recently Issued Accounting Pronouncements. In June 2001, the FASB issued
SFAS No. 141, "Business Combinations," which was effective immediately. SFAS No.
141 requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001 and it eliminated the
pooling-of-interests method. The adoption of this standard did not have a
significant impact on the Company's consolidated financial statements. The
Company's April 2002 acquisition of certain assets and certain liabilities of
eGrail, Inc. was accounted for in compliance with this pronouncement (Note 3).
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which the Company adopted January 1, 2002. SFAS No. 142 requires that
goodwill and other intangible assets with indefinite useful lives no longer be
amortized, but instead be tested for impairment at least annually and written
down when impaired. SFAS No. 142 requires purchased intangible assets other than
goodwill to be amortized over their useful lives unless these lives are
determined to be indefinite. In accordance with this Standard, the Company no
longer amortizes goodwill and indefinite life intangible assets but evaluates
their carrying value annually or when events or circumstances indicate that
their carrying value may be impaired. Assembled workforce no longer meets the
definition of a separately identified intangible asset under the provisions of
SFAS No. 141, and the unamortized balance of $182,000 was reclassified as
goodwill at January 1, 2002. The Company ceased amortizing the goodwill balance
of $10.1 million from its 2000 acquisition of Applications Partner, Inc. as of
January 1, 2002. The Company had no indefinite life intangible assets as of
January 1, 2002. In accordance with SFAS No. 142, the Company was required to
perform a two-step transitional impairment review. The first step of this review
was completed by June 30, 2002 with the determination of the fair value of the
Company's reporting units in order to identify whether the fair value of each
reporting unit was less than its carrying amount as of January 1, 2002. In the
event that the fair value of each reporting unit was less than the carrying
amount, the second step of the test would be required to determine if the
carrying value of goodwill exceeded the implied value. The Company determined
that it did not have a transitional impairment of goodwill because the fair
value of each reporting unit exceeded its carrying amount. As of December 31,
2002, no impairment of goodwill has been recognized. Goodwill will also be
tested for impairment in the manner described above on July 1st of each year or
earlier if indicators of potential impairment exist. If estimates change, a
materially different impairment conclusion could result.
In August 2001, the FASB issued SFAS No. 144, "Accounting for Impairment or
Disposal of Long-Lived Assets." This Statement addresses financial accounting
and reporting for the impairment of long-lived assets and for the disposal of
long-lived assets and discontinued operations. SFAS No. 144 superseded SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of," and is effective for fiscal years beginning after
December 15, 2001. The adoption of this Standard on January 1, 2002 did not have
a material impact on the Company's consolidated financial position and results
of operations.
In November 2001, the FASB announced Emerging Issues Task Force ("EITF")
Topic No. D-103, "Income Statement Characterization of Reimbursements Received
for Out-of-Pocket Expense Incurred", which is required to be applied in
financial reporting periods beginning after December 15, 2001. The EITF requires
companies to characterize reimbursements received for out-of-pocket expenses as
revenues in the consolidated statement of operations. Historically, the Company
has netted reimbursements received for out-of-pocket expenses against the
related expenses in the statement of operations. Application of this EITF
requires that comparative financial statements for prior periods be reclassified
F-12
to comply with the guidance. The Company adopted this EITF as of January 1, 2002
and has reclassified its prior-period, consolidated financial statements to
conform to the current presentation. These reclassifications resulted in
increased revenue and cost of revenue of $2.1 million and $1.7 million for the
twelve months ended December 31, 2001 and 2000, respectively. The adoption of
this EITF did not have a material effect on total revenues or gross margin
percentages and has no impact on consolidated results of operations, as it
required an equivalent increase to both revenue and cost of revenue. Comparable
amounts for 2002 are not available as out-of-pocket expenses are characterized
as revenue upon invoicing.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which addresses financial
accounting and reporting for costs associated with exit or disposal activities
and supersedes EITF Issue 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." SFAS No. 146 requires that costs associated
with exit or disposal activities be recognized when they are incurred rather
than at the date of a commitment to an exit or disposal plan. SFAS No. 146 also
establishes that the liability should initially be measured and recorded at fair
value. The Company will adopt the provisions of SFAS No. 146 for exit or
disposal activities that are initiated after December 31, 2002.
In November 2002, the FASB issued Interpretation ("FIN") No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees and Indebtedness of Others," an interpretation of FASB
Statements No. 5, 57 and 107, and rescission of FIN No. 34, "Disclosure of
Indirect Guarantees of Indebtedness of Others." FIN No. 45 elaborates on the
disclosures to be made by the guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued. It
also requires that a guarantor recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken in issuing the
guarantee. The provisions related to recognizing a liability at inception of the
guarantee for the fair value of the guarantor's obligations does not apply to
product warranties or to guarantees accounted for as derivatives. The initial
recognition and measurement provisions of this interpretation are applicable on
a prospective basis to guarantees issued or modified after December 31, 2002
while the disclosure requirements are effective for financial statements for
interim or annual periods ending after December 15, 2002. See Note 18 for
disclosure of guarantees. The Company believes the adoption of such
interpretation will not have a material impact on its consolidated results of
operations or financial position.
In December 2002, the FASB Issued SFAS No. 148, "Accounting for Stock-Based
Compensation Transition and Disclosure," an amendment of SFAS No. 123. This
statement amends SFAS No. 123, "Accounting for Stock-Based Compensation," to
provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, this Statement amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The transition guidance and
annual disclosure provisions of SFAS No. 148 are effective for fiscal years
ending after December 15, 2002. The interim disclosure provisions are effective
for financial reports containing financial statements for interim periods
beginning after December 15, 2002. The adoption of SFAS No. 148 did not have a
material impact on the Company's consolidated results of operations or financial
position.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities." In general, a variable interest entity is a corporation,
partnership, trust, or any other legal structure used for business purposes that
either (a) does not have equity investors with voting rights or (b) has equity
F-13
investors that do not provide sufficient financial resources for the entity to
support its activities. FIN 46 requires a variable interest entity to be
consolidated by a company if that company is subject to a majority of the risk
of loss from the variable interest entity's activities or entitled to receive a
majority of the entity's residual returns or both. The consolidation
requirements of FIN 46 apply immediately to variable interest entities created
after January 31, 2003. The consolidation requirements apply to older entities
in the first fiscal year or interim period beginning after June 15, 2003.
Certain of the disclosure requirements apply in all financial statements issued
after January 31, 2003, regardless of when the variable interest entity was
established. The Company did not have any variable interest entities as of
December 31, 2002. The Company is currently evaluating the provisions of the
interpretation, but believes its adoption will not have a material impact on its
consolidated results of operations or its financial position.
Reclassifications. Certain reclassifications have been made to prior-years'
balances to conform to the current year's presentation.
Note 3 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
Property 78
Total purchase price $ 20,000
The amount allocated to assembled workforce was being amortized over an
estimated useful life of three years. The amount allocated to goodwill was being
amortized over an estimated useful life of five years and with the adoption of
SFAS No. 142, the Company ceased amortizing these assets as of January 1, 2002.
Additionally, retention payments of $2.0 million were recorded as a prepaid
asset and were expensed when paid in 2001 based upon defined employment
requirements.
Based upon an independent third-party appraisal, the Company allocated
approximately $3.0 million to in-process research and development that was an
element of the purchase price and was expensed upon acquisition. These
in-process research and development expenses were 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 that 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.
On April 2, 2002, the Company acquired certain assets and assumed certain
liabilities of eGrail, Inc. ("eGrail"), a Web content management company, for
$9.0 million in cash. This strategic acquisition provides additional Web Content
Management ("WCM") software application capabilities that expands the Company's
position in the Enterprise Content Management ("ECM") market and contributed to
F-14
the purchase price that resulted in goodwill. In accordance with SFAS No. 141,
"Business Combinations," the acquisition has been accounted for under the
purchase method of accounting. The purchase price for eGrail consisted of $9.0
million cash and direct acquisition costs of $359,000. The purchase price was
allocated as follows (in thousands):
Net tangible assets $ 581
Goodwill 5,793
Patents 24
Acquired technology 3,300
In-process research and development 400
Liabilities assumed (739)
$ 9,359
The amount allocated to in-process research and development and acquired
technology was determined through established valuation techniques in the
high-technology industry by an independent third-party appraiser. In-process
research and development was expensed upon acquisition because technological
feasibility had not been established and no future alternative uses existed. New
product development underway at eGrail at the time of the acquisition included
the next generation of their Web Content Management product that was in the
early stages of design and only 5% complete at the date of the acquisition. The
cost to complete the project was estimated at approximately $3.0 million to
occur over a twelve-month period. As of December 31, 2002 the Company has
incurred approximately $2.9 million of research and development expenses related
to the project and estimates an additional $1.0 million in cost to complete the
project within the original estimated time period. The remaining purchase price
was primarily allocated to tangible assets and goodwill. The acquired technology
of $3.3 million was assigned a useful life of five years and patents of $24,000
were assigned a useful life of two years. In accordance with SFAS No. 142,
goodwill will not be amortized but will be reviewed for impairment on an annual
basis.
Goodwill from these acquisitions was not impaired at December 31, 2002.
Goodwill is tax deductible for these asset purchases.
F-15
Note 4 Related-Party Transactions
In July 2001, the Compensation Committee of the Company's Board of
Directors ("the Board") entered into discussions with Lee Roberts, the Company's
Chief Executive Officer, regarding a secured loan by the Company to Mr. Roberts
to enable him to purchase a home in Orange County, California. In July 2001, the
Compensation Committee forwarded its recommendation to the Board to approve, in
principle, a secured loan, in the amount of $1.2 million to Mr. Roberts. In
September 2001, the Compensation Committee approved, in principle, an increase
in the previously requested loan amount to $1.9 million, subject to review of
final loan documents and approval of the Board. In May 2002, the Compensation
Committee reviewed proposed loan documentation for a secured loan to Mr. Roberts
and forwarded its recommendation to the Board to approve the loan on the terms
set forth in the loan documents. The loan documents provided that the loan would
be secured by the real estate purchased by Mr. Roberts. Subsequently, on June 5,
2002, the Board approved the loan documents and the loan. As of December 31,
2002, FileNet has an outstanding secured note receivable from Mr. Roberts in the
amount of $1.9 million that relates to the above-referenced loan and is included
in other assets on the consolidated balance sheet. The note bears interest at
2.89% per annum. Accrued interest on the principal balance of this note is
payable annually beginning February 15, 2003 and on each February 15th
thereafter until the entire principal balance becomes due. The entire
outstanding principal balance of this note and any accrued interest is due and
payable at the earliest of (a) June 7, 2005, (b) one year after termination of
Mr. Roberts' employment by the Company, or (c) ninety (90) days after voluntary
termination of employment by Mr. Roberts. Imputed interest for the difference
between the stated interest rate of the note and a fair value interest rate of
7% was recorded as compensation expense and a discount that is being amortized
over the term of the note to interest income using the effective interest
method. The loan to Mr. Roberts is permitted under Section 13 of the Securities
Exchange Act of 1934 as amended by Section 402 of the Sarbanes-Oxley Act on July
30, 2002 because it was outstanding on that date. However, its terms cannot be
renewed or materially modified in the future.
John Savage, a member of FileNet's Board of Directors and the Audit
Committee of FileNet's Board of Directors, is Managing Partner of Alliant
Partners, who acted as financial advisors to eGrail and was paid approximately
$500,000 by eGrail. Accordingly, John Savage recused himself from all
discussions related to the acquisition between FileNet and eGrail and abstained
from voting on the transaction.
Note 5 Earnings (Loss) Per Share
The following table is a reconciliation of the earnings (loss) and share
amounts used in the calculation of basic earnings (loss) per share and diluted
earnings (loss) per share.
(In thousands, except per share amounts)
Net Per Share
Income (loss) Shares Amount
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
Year ended December 31, 2001:
Basic (loss) per share $ (16,622) 35,117 $ (0.47)
Effect of dilutive stock options - -
Diluted (loss) per share $ (16,622) 35,117 $ (0.47)
Year ended December 31, 2002:
Basic earnings per share $ 8,272 35,590 $ 0.23
Effect of dilutive stock options - 1,119
Diluted earnings per share $ 8,272 36,709 $ 0.23
F-16
Options to purchase 3,284,849 shares of common stock in fiscal 2001 were
outstanding during the year but were not included in the computation of diluted
income per share as their effect was antidilutive (Note 14).
Note 6 Accumulated Other Comprehensive Operations
Accumulated other comprehensive operations for each of the three years in
the period ended December 31 are comprised of the following:
(In thousands)
Foreign Accumulated
Currency Unrealized Other
Translation Holding Comprehensive
Adjustment Gains (Losses) Operations
Balance, January 1, 2000 $ (7,638) $ (97) $ (7,735)
Current Period Changes (3,385) 59 (3,326)
Balance, December 31, 2000 (11,023) (38) (11,061)
Current Period Changes (3,056) 77 (2,979)
Balance, December 31, 2001 (14,079) 39 (14,040)
Current Period Changes 7,631 27 7,658
Balance, December 31, 2002 $ (6,448) $ 66 $ (6,382)
Note 7 Investment Securities Available for Sale
The Company's investments in marketable securities consist primarily of
high-grade corporate and government securities with maturities of less than
three years. Investments purchased with an original maturity of three months or
less are considered to be cash equivalents. The following table summarizes
investment securities available for sale as of December 31:
(In thousands)
Investment securities available for sale: 2002 2001
Cost $ 54,945 $ 64,597
Gross unrealized gains 107 87
Gross unrealized losses - (24)
Estimated fair value $ 55,052 $ 64,660
There were no significant realized gains or losses for the years ended
December 31, 2002 and December 31, 2001. Unrealized holding gains and losses on
investments, net of tax, are included in accumulated other comprehensive
operations in stockholders' equity at December 31, 2002 and 2001, and were a
$66,000 gain and a $39,000 gain, respectively. The change year over year was an
unrealized gain of $27,000, net of tax.
The contractual maturities of investments at December 31, 2002 and 2001 are
shown below. Actual maturities may differ from contractual maturities because
the issuer of the securities may have the right to repurchase such securities.
F-17
The Company classifies short-term investments in current assets, as all
such investments are available for current operations.
(In thousands)
2002 2001
Estimated Estimated
Cost Fair Value Cost Fair Value
Debt Securities
Due in one year or less:
Short-term munis-taxable $ 4,227 $ 4,232 $ 3,297 $ 3,278
Commercial paper - - 3,485 3,486
Corporate 4,659 4,681 10,832 10,855
Governments/Agencies 20,244 20,275 46,983 47,041
Total 29,130 29,188 64,597 64,660
Due in one to three years:
Short-term munis-taxable 2,315 2,329 - -
Commercial paper - - - -
Corporate - - - -
Government/Agencies 23,500 23,535 - -
Total 25,815 25,864 - -
Grand Total $ 54,945 $ 55,052 $ 64,597 $ 64,660
Note 8 Inventories
Inventories consisted of the following at December 31:
(In thousands)
2002 2001
Raw materials $ 1,538 $ 1,872
Work-in-process 979 788
Finished goods 51 333
Total $ 2,568 $ 2,993
Note 9 Property
Property consisted of the following at December 31:
(In thousands)
2002 2001
Machinery, equipment and software $ 118,723 $ 121,815
Furniture and fixtures 13,213 13,611
Leasehold improvements 23,416 22,058
Total property 155,352 157,484
Less accumulated depreciation and amortization (120,711) (113,278)
Property, net $ 34,641 $ 44,206
F-18
Note 10 Leases and Commitments
The Company leases its corporate offices, sales offices, development and
manufacturing facilities, and other equipment under non-cancelable operating
leases, some of which have renewal options and generally provide for escalation
of the annual rental amount. Amounts related to deferred rent are recorded in
other accrued liabilities on the consolidated balance sheet.
Expenses related to operating leases were $16.0 million, $17.5 million, and
$18.3 million for the years ended December 31, 2002, 2001 and 2000,
respectively. The following table summarizes future minimum lease payments
required under operating leases at December 31, 2002:
(In thousands)
2003 $ 13,815
2004 11,861
2005 10,273
2006 9,552
2007 9,288
Thereafter 8,815
Total $ 63,604
The Company continues to invest in technology equipment and software for
research and development and for information systems infrastructure and
telecommunications. These investments have been funded through operating leases,
capital leases, cash purchases and sale leaseback transactions, including a sale
leaseback commitment of $433,400 in 2000 related to previously purchased
technology equipment and software. In July 2001, the Company converted its
outstanding leases associated with these investments into an eighteen-month
capital lease with a value of $2.6 million. No future lease commitments are
required under this lease at December 31, 2002.
The Company licenses certain software from third parties with contractual
arrangements that require future payment obligations. These obligations were
$3.8 million, $3.4 million and $4.7 million at December 31, 2002, 2001 and 2000,
respectively, and were due the following year.
Note 11 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 documentation at time of delivery.
For hardware products the Company accrues warranty costs based on historical
trends in product return rates and the expected material and labor costs to
provide warranty services. For software products, the Company records the
estimated cost of technical support during the warranty period. A provision for
these estimated warranty costs is recorded at the time of sale or license. If
the Company were to experience an increase in warranty claims compared with our
historical experience, or costs of servicing warranty claims were greater than
the expectations on which the accrual had been based, gross margins could be
adversely affected.
F-19
The following table represents the warranty activity and balances for the
periods shown (in thousands):
Balance at Balance at
Beginning End
of Period Additions Deductions of Period
Year ended December 31, 2002
Warranty reserves $ 772 1,146 1,190 $ 728
Year ended December 31, 2001:
Warranty reserves 764 1,801 1,793 772
Year ended December 31, 2000:
Warranty reserves $ 554 2,579 2,369 $ 764
Note 12 Goodwill and Purchased Intangible Assets
In acquisitions accounted for using the purchase method, goodwill is
recorded as the difference, if any, between the aggregate consideration paid for
an acquisition and the fair value of the net tangible and identified intangible
assets acquired. SFAS No. 142 requires that amortization of goodwill and
indefinite life intangibles be discontinued and replaced with periodic review
and analysis of goodwill for possible impairment. Intangible assets with
definite lives must be amortized over their estimated useful lives. On January
1, 2002 the Company adopted SFAS No. 142, and as a result, goodwill is no longer
amortized. Summarized below are the effects on net income (loss) per share data
if the Company had followed the non-amortization provisions of SFAS No.142 for
all periods presented (in thousands, except per share amounts):
Year ended December 31, 2002 2001 2000
Net income (loss):
As reported $ 8,272 $ (16,622) $ 38,547
Add: goodwill and assembled workforce
amortization, net of taxes - 1,619 1,346
Adjusted net income (loss) $ 8,272 $ (15,003) $ 39,893
Basic net income (loss) per share:
As reported $ 0.23 $ (0.47) $ 1.13
Add: goodwill and assembled workforce
amortization, net of taxes - 0.04 0.04
Adjusted basic net income (loss) per share $ 0.23 $ (0.43) $ 1.17
Diluted net income (loss) per share:
As reported $ 0.23 $ (0.47) $ 1.05
Add: goodwill and assembled workforce
amortization, net of taxes - 0.04 0.04
Adjusted diluted net income (loss) per share $ 0.23 $ (0.43) $ 1.09
A portion of goodwill and intangible assets were allocated to our Ireland
subsidiary and therefore the following tables reflect amounts resulting from
foreign exchange translation.
F-20
The following table presents the changes in goodwill allocated to the
reportable segments (in thousands):
Balance at Foreign Balance at
December 31, Currency December 31,
2001 Acquired Adjustments Fluctuation 2002
Software $ 4,914 $ 3,654 $ 90 $ 483 $ 9,141
Customer support 3,271 406 60 322 4,059
Professional Services and
Education 1,768 1,733 32 174 3,707
Hardware - - - - -
Total $ 9,953 $ 5,793 $ 182 $ 979 $ 16,907
The acquired goodwill resulted from the acquisition of eGrail in April
2002. The adjustments were due to the reclassification of the assembled
workforce intangible to goodwill at January 1, 2002 as a result of the adoption
of SFAS No. 142.
Acquired technology and patents are the Company's only intangible assets
subject to amortization under Statement No. 142. These assets were recorded in
connection with the April 2002 eGrail acquisition and are comprised of the
following as of December 31, 2002 (in thousands):
Foreign
Accumulated Currency
Gross Amortization Fluctuation Net
Acquired technology $ 3,468 $ (532) $ 79 $ 3,015
Patents 25 (12) 1 14
$ 3,493 $ (544) $ 80 $ 3,029
Acquired technology is being amortized over a useful life of five years and
patents are being amortized over a useful life of two years. Amortization
expense for amortizing intangible assets was $523,400 for 2002 and estimated
future amortization expense (excluding foreign exchange effect) of purchased
intangible assets as of December 31, 2002 is as follows (in thousands):
Fiscal Year Amount
2003 $ 720
2004 712
2005 709
2006 709
2007 179
$ 3,029
F-21
Note 13 Borrowing Arrangements
The Company has a one-year, $5.0 million multi-currency revolving line of
credit that expires June 27, 2003. Borrowings under the arrangement are
unsecured and bear interest at one hundred and twenty-five basis points over the
London Interbank Offered Rate. A standby letter of credit fee of one hundred and
twenty-five basis points per annum and an annual commitment fee of fifty basis
points are 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 financial
covenants, including quarterly and annual profitability covenants. As of
December 31, 2002 the Company was in compliance with all covenants. There were
no borrowings outstanding at December 31, 2002 and 2001.
Note 14 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. 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 transfers 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 $10.0 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 2001, shareholders approved adding an
additional 300,000 shares to the reserve. In addition, in May 2002, shareholders
approved an additional 1,100,000 shares to the reserve. Under the terms of the
Purchase Plans, common stock may be offered in successive six-month offering
periods to eligible employees of the Company at 85% of the market price of the
common stock at the beginning or end of the offering period, whichever is lower.
The Purchase Plans cover substantially all employees of the Company. Eligible
employees may elect to have a portion of their salary withheld for the purpose
of making purchases under the Purchase Plans. Each participant is limited in any
plan year to the acquisition of that number of shares that have an aggregate
fair market value of not more than $25,000. There are no charges or credits to
F-22
income in connection with the Purchase Plans. At December 31, 2002, $960,269 had
been withheld from employees' salaries pursuant to the Purchase Plans for the
current offering period, which expires on April 30, 2003. At December 31, 2002,
approximately 1,134,434 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 80,740 common
shares were exercisable under the 1986 Plan at December 31, 2002. In May 1995,
the 1986 Plan was terminated as to future grants and the remaining reserve of
140,098 shares was transferred into the 1995 Stock Option Plan ("1995 Plan").
Outstanding options under the 1986 Plan will continue to be governed by the
provisions of agreements evidencing those grants. No common shares remain
available for future grants under the 1986 Plan. Options granted under the 1986
Plan were either incentive stock options or nonqualified stock options and
became exercisable in 20% annual installments beginning one year after the date
of grant 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. To the extent any outstanding
options under the 1986 Plan 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.
In May 1995, the Company adopted the 1995 Plan. Under the amended terms of
the 1995 Plan, options to purchase 8,350,000 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. 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, 2002,
4,388,466 options were exercisable under the 1995 Plan.
Prior to their merger with FileNet in March 1996 and August 1995,
respectively, Saros and Watermark Software, Inc. had adopted stock option plans.
The Company assumed the Saros Plan and the Watermark Plan and outstanding
options were converted into options to purchase an aggregate of 975,976 shares
of FileNet common stock. Outstanding options under these 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, 2002, a total of 7,789 options were
outstanding and exercisable under the Saros Plan. No shares remain outstanding
or exercisable under the Watermark Plan.
Future grants to non-employee directors are to be granted under the
provisions of the 1995 Plan or the 2002 Incentive Award 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
F-23
the Company's current President. In April 2001, the Company filed a Form S-8
with the Securities and Exchange Commission registering a Non-Statutory Stock
Option Grant of 140,000 shares, dated September 13, 2000, to the Company's
current Chief Financial Officer. Such grants were in accordance with employment
agreements entered into by the Company and the grantees. The non-statutory
options granted prior to October 21, 1999 have an exercise price per share of
100% of the fair market value per share on the date of grant and vest in 25%
installments beginning one year from the date of grant and will expire no later
than ten years from the date of grant. The non-statutory options granted after
October 21, 1999 have an exercise price per share of 100% of the fair market
value per share on the date of grant and vest in installments with 25%
exercisable after twelve months of service and the balance exercisable in
thirty-six successive equal monthly installments upon completion of each
additional month of service thereafter and will expire no later than ten years
after the grant date. As of December 31, 2002, 474,532 options were exercisable
related to these Non-Statutory Stock Option Grants and 364,218 had been
exercised to date.
In May 2002, the Company adopted the 2002 Incentive Award Plan (the "2002
Plan"). Under the terms of the 2002 Plan, options to purchase 1,400,000 shares
of the Company's common stock were reserved for issuance to key employees,
consultants and independent directors, of which only 140,000 shares may be
issued as restricted stock. Options granted under the 2002 Plan for independent
directors, consultants and key employees have an exercise price per share of
100% of the fair market value per share on the grant date. Options for key
employees and consultants become exercisable as to 25% of the option shares
after twelve months of service from the grant date and the balance of the
options in thirty-six successive equal monthly installments upon completion of
each additional month of service thereafter. Options for independent directors
become exercisable as to 25% per year on each of the first, second, third and
fourth anniversary provided the director continues as an independent director on
each such anniversary. As of December 31, 2002, 1,250,930 options had been
granted and no options were exercisable under the 2002 Plan.
Information regarding all stock option plans is as follows:
Number of Weighted Average
Options Exercise Price
Balances, January 1, 2000 7,119,293 $ 10.87
Granted (weighted average fair value of $12.50) 2,161,995 21.67
Exercised (2,081,458) 9.31
Cancelled (843,738) 13.87
Balances, December 31, 2000 6,356,092 $ 14.64
Granted (weighted average fair value of $9.30) 2,442,985 16.88
Exercised (485,270) 9.74
Cancelled (303,354) 16.45
Balances, December 31, 2001 8,010,453 $ 15.56
Granted (weighted average fair value of $7.02) 1,559,230 13.63
Exercised (286,114) 9.56
Cancelled (577,253) 21.42
Balances, December 31, 2002 8,706,316 $ 15.12
F-24
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 (Years) Price Exercisable Price
$1.39 to $9.00 1,767,190 4.81 $ 7.95 1,719,850 $ 7.93
$9.17 to $12.86 1,738,495 8.08 11.85 640,804 10.66
$12.97 to $15.16 1,823,134 8.28 13.56 691,670 13.73
$15.17 to $21.13 1,751,764 7.87 17.69 794,527 17.81
$21.38 to $41.84 1,625,733 7.06 25.41 1,104,676 25.75
$1.39 to $41.84 8,706,316 7.22 $ 15.12 4,951,527 $ 14.65
The Company accounts for its stock-based compensation plans in accordance
with APB No. 25 and related interpretations. In July 2000, the vesting of
options to purchase 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
stockholders equity of $581,000. No stock-based compensation expense was
recorded in the consolidated statements of operations for the years ended
December 31, 2002 and 2001, respectively.
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:"
(In thousands, except per share amounts) 2002 2001 2000
Net income (loss), as reported $ 8,272 $ (16,622) $ 38,547
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards, net
of related tax effects (8,735) (12,381) (8,807)
Pro forma net income (loss) $ (463) $ (29,003) $ 29,740
Earnings per share:
Basic earnings (loss) per share - as reported $ 0.23 $ (0.47) $ 1.13
Basic earnings (loss) per share - pro forma $ (0.01) $ (0.83) $ 0.87
Diluted earnings (loss) per share - as reported $ 0.23 $ (0.47) $ 1.05
Diluted earnings (loss) per share - pro forma $ (0.01) $ (0.83) $ 0.81
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 2002, 2001 and 2000; expected volatility of 68%
for 2002, 78% for 2001 and 80% for 2000; risk-free interest rates of 2.0% to
F-25
4.61% for 2002, 3.6% to 5.3% for 2001, and 6.1% to 6.5% for 2000; 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.
Retirement of Shares. In September 2001, 375,700 shares were cancelled and
retired as part of a litigation settlement (Note 17).
Note 15 Income Taxes
The provision for income taxes at December 31, 2002, 2001 and 2000 consists
of the following:
(In thousands)
Year ended December 31, 2002 2001 2000
Current:
Federal $ (2,126) $ (324) $ 12,758
State 235 1,261 1,121
Foreign 2,740 2,716 7,573
Deferred:
Federal 1,276 (4,550) (11,286)
State 353 (3,736) 1,038
Foreign - - -
Total provision (benefit) $ 2,478 $ (4,633) $ 11,204
Income (loss) before income taxes consists of the following components:
(In thousands)
Year ended December 31, 2002 2001 2000
United States $ (307) $ (17,442) $ 20,556
Foreign 11,057 (3,813) 29,195
Total $ 10,750 $ (21,255) $ 49,751
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:
Year ended December 31, 2002 2001 2000
Income taxes (benefit), at statutory federal rate 35% (35)% 35%
State taxes (benefit), net of federal benefit 3 (7) 3
Tax rate differential on foreign earnings (10) 13 (15)
Change in valuation allowance - 6 (3)
R and D Credit (7) (3) -
Other 2 4 3
Total 23% (22)% 23%
F-26
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, 2002 and 2001 are as follows:
(In thousands)
Year ended December 31, 2002 2001
Deferred taxes:
Loss carryforwards $ 23,391 $ 25,075
Tax credit carryforwards 11,408 10,368
Accrued expenses 3,321 3,478
Sales returns and allowance reserves 405 324
Deferred revenue 4,035 6,291
Depreciable assets and amortizable assets 5,996 4,860
Other (2,122) (1,488)
Total 46,434 48,908
Valuation allowance (23,840) (24,684)
Net deferred tax asset $ 22,594 $ 24,224
The Company maintains a valuation allowance against a portion of the
deferred tax asset due to uncertainty regarding the future realization and after
weighing all available evidence. Approximately $9.0 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
$(844,000), $1,316,000, and $2,240,000 during 2002, 2001, and 2000,
respectively.
The Company has $60.1 million domestic federal net operating loss
carryforwards that can be utilized to reduce future taxable income. Any
unutilized net operating loss carryforward will begin expiring in 2011. The
Company has $11.4 million tax credit carryforwards that will begin expiring in
2003.
At December 31, 2002, the Company had French, Irish, Japanese and Austrian
tax loss carryforwards relating to its foreign subsidiary operations that total
approximately $14.3 million; 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 $61.0
million at December 31, 2002) since the Company plans to indefinitely reinvest
all such earnings offshore. At December 31, 2002, the unrecognized deferred tax
liability for these earnings was approximately $23.4 million.
Note 16 Operating Segment and Geographic Information
The Company has prepared operating 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
F-27
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, markets, and sells a unified platform and framework
for ECM software and solutions. 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 consulting
services related to the Company's standard products and provides training.
The accounting policies of the Company's operating segments are the same as
those described in Note 2- 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 or on
interest income at the operating segment level, assets and interest income are
not tracked internally by segment. Therefore, such information is not presented.
Operating segment data for the three years ended December 31, 2002, was as
follows:
(In thousands)
Professional
Customer Services and
Software Support Education Hardware Consolidated
Year Ended December 31, 2002
Revenue $ 132,508 $ 149,847 $ 56,959 $ 7,703 $ 347,017
Depreciation and amortization 10,215 7,527 3,550 296 21,588
Operating (loss) income (51,413) 60,258 (3,212) (92) 5,541
Assets - - - - 328,036
Capital expenditures 5,146 3,881 1,601 197 10,825
Year Ended December 31, 2001
Revenue $ 119,014 $ 132,382 $ 69,186 $ 14,028 $ 334,610
Depreciation and amortization 10,835 8,540 4,377 597 24,349
Operating (loss) income (59,296) 39,336 (3,259) (539) (23,758)
Assets - - - - 301,639
Capital expenditures 7,077 4,161 2,477 360 14,075
Year Ended December 31, 2000
Revenue $ 204,872 $ 110,306 $ 63,985 $ 21,199 $ 400,362
Depreciation and amortization 10,288 6,049 3,051 439 19,827
Operating income 14,979 29,351 (1,531) 1,546 44,345
Assets - - - - 324,093
Capital expenditures 12,149 9,938 4,932 702 27,721
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
F-28
Middle East and Africa. Information concerning principal geographic areas in
which the Company operates was as follows:
(In thousands)
Year ended December 31, 2002 2001 2000
Revenue Assets Revenue Assets Revenue Assets
North America:
United States $ 251,447 $ 251,928 $ 244,902 $ 234,408 $ 282,311 $ 231,973
Canada 5,581 5,398 6,787 6,143 7,925 6,055
Total North America 257,028 257,326 251,689 240,551 290,236 238,028
Europe:
France 6,593 2,086 7,800 1,753 7,153 2,328
Germany 22,174 3,632 19,565 5,920 26,909 10,038
United Kingdom 22,950 18,145 16,851 18,275 23,867 18,680
Ireland - 37,114 - 26,925 - 42,989
Other Europe 26,236 4,902 27,901 5,320 33,806 7,851
Total Europe 77,953 65,879 72,117 58,193 91,735 81,886
Asia Pacific 9,916 4,831 7,968 2,895 12,966 4,046
All other 2,120 - 2,836 - 5,425 133
Totals $ 347,017 $ 328,036 $ 334,610 $ 301,639 $ 400,362 $ 324,093
Note 17 Litigation
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 was 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., a former wholly-owned subsidiary of FileNet that was merged with
the Company, was infringing three patents held by Wang (the "Watermark Case").
On October 9, 1996, Wang withdrew its claim in the FileNet Case that one of the
patents it initially asserted was infringed.
On January 8, 1997, the court stayed the Watermark Case, subject to limited
exceptions for certain discovery. The products at issue in the Watermark Case
were phased out as of December 31, 1999. In March 1997, Eastman Kodak Company
purchased the Wang imaging business unit that had responsibility for this
litigation. On July 30, 1997, the court permitted Eastman Software and Kodak
Limited of England to be substituted in the FileNet Case in place of Wang. On
April 24, 2001, the court permitted Eastman Software and Kodak Limited to be
substituted in the Watermark case in place of Wang.
On August 10, 2000, Eastman Kodak Company, Eastman Software and eiStream
WMS, Inc. ("eiStream") entered into an Asset Purchase and Sale Agreement
("APA"), under which eiStream acquired some, but not all, of the assets of
Eastman Software.
Effective June 30, 2001, the Company and Eastman Kodak Company, the parent
of Eastman Software entered into an agreement that settled the FileNet Case. In
accordance with that settlement agreement, the parties filed on July 5, 2001, a
stipulation dismissing the FileNet Case.
On September 19, 2001, eiStream filed a complaint against Eastman Kodak
Company and Eastman Software in the United States District Court for the
district of Dallas County (the "eiStream Case"). eiStream sought, among other
F-29
things, a declaratory judgment that pursuant to the terms of the APA, eiStream
owns the Watermark Case and has the right to pursue claims in the Watermark Case
regarding Watermark products sold prior to the phase out in December 1999 and
that Eastman Kodak Company was required to obtain eiStream's consent prior to
settling the FileNet Case.
On October 15, 2001, Eastman Kodak Company filed its answer to eiStream's
complaint in which Eastman Kodak Company claimed ownership of the Watermark
Case, denied that the APA gave eiStream ownership of the Watermark Case, and
stated that eiStream's claim that its consent was necessary prior to settling
the FileNet Case was barred by principles of equitable estoppel.
Also on October 15, 2001, Eastman Kodak Company moved to abate the eiStream
Case because the previously filed Watermark Case raises issues inherently
related with issues raised in the eiStream Case and because certain necessary
and indispensable parties were not properly joined in the eiStream Case.
On October 31, 2001, Eastman Kodak Company moved for leave to amend the
original complaint filed in the Watermark Case to add eiStream as a party, to
add the correct Eastman Kodak Company entities as plaintiffs and to add a
declaratory judgment count seeking a judgment that Eastman Kodak Company, not
eiStream, owns the Watermark Case.
In November 2001, Eastman Kodak Company and eiStream amended the APA and
resolved all their disputes regarding Eastman Kodak Company's right to settle
the FileNet Case and the Watermark Case. Effective November 15, 2001, eiStream
agreed that the June 30, 2001 agreement between the Company and Eastman Kodak
Company which settled the FileNet Case is in accordance with the APA, as
amended, and that the Company and Eastman Kodak Company may dismiss the
Watermark Case with prejudice.
Effective November 15, 2001, the Company and Eastman Kodak Company entered
into an agreement that settled the Watermark Case. In accordance with that
settlement agreement and the amended APA between Eastman Kodak Company and
eiStream, the parties to the Watermark Case filed on November 16, 2001 a
stipulation dismissing that case with prejudice. A stipulation of non-suit with
prejudice was filed in the eiStream Case on November 19, 2001.
Subsequent to December 31, 1998, the former shareholders of Saros
Corporation, a former wholly-owned subsidiary of FileNet that was merged with
the Company, filed a demand for mandatory arbitration to release approximately
375,700 shares of the Company's 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. The
Company and the agent for the former Saros Shareholders ("Shareholders' Agent")
had agreed to mediate the matter, but the Shareholders' Agent cancelled the
mediation prior to the scheduled date and renewed the demand for mandatory
arbitration. A binding arbitration proceeding took place during the period March
5, 2001 through March 23, 2001. On April 24, 2001 the arbitrators issued an
interim decision denying all claims asserted by the Shareholders' Agent against
the Company, sustaining all claims asserted by the Company, and awarding all of
the shares of stock held in escrow to the Company. On June 7, 2001 the
arbitrators issued a final award that reiterated the principal rulings set forth
in the interim decision and awarded all of the stock held in the escrow to the
Company. The final award further determined that the escrowed shares provide the
exclusive source for the Company's recovery of its attorneys' fees and costs
from the former stockholders of Saros. These shares were cancelled and retired
when the Company received the certificates from the escrow agent in September
2001.
F-30
In the normal course of business, the Company is subject to ordinary
routine litigation and claims incidental to business. While the results of
litigation and claims cannot be predicted with certainty, the Company believes
that the final outcome of these matters will not have a materially adverse
effect on its consolidated results of operations or financial conditions.
Note 18 Guarantees and Indemnifications
In November 2002, the FASB issued FIN 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." FIN 45 elaborates on the existing disclosure
requirements for most guarantees, including loan guarantees such as standby
letters of credit. It also clarifies that at the time a company issues a
guarantee, the company must recognize an initial liability for the fair value,
or market value, of the obligations it assumes under the guarantee and must
disclose that information in its interim and annual financial statements. The
provisions related to recognizing a liability at inception of the guarantee for
the fair value of the guarantor's obligations does not apply to product
warranties, guarantees accounted for as derivatives or to guarantees between
parents and subsidiaries under common control. The initial recognition and
initial measurement provisions apply on a prospective basis to guarantees issued
or modified after December 15, 2002. The disclosure requirements are effective
for financial statements of interim and annual periods ending after December 15,
2002.
The Company has made guarantees and indemnifications, under which it may be
required to make payments to a guaranteed or indemnified party, in relation to
certain transactions. In connection with the sales of its products, the Company
provides intellectual property indemnities to its customers. Guarantees and
indemnities to customers in connection with product sales and service generally
are subject to limits based upon the amount of the related product sales or
service. In connection with certain facility leases, the Company has guaranteed
payments on behalf of some of its subsidiaries. To provide subsidiary
guarantees, the Company either uses its $5.0 million line of credit as
collateral to unconditionally guarantee the performance of locally denominated
bank guarantees or it obtains both secured and unsecured bank guarantees from
local banks. These bank guarantees totaled an equivalent of approximately $1.0
million issued in local currency in Europe and Asia as of December 31, 2002. The
Company indemnifies its directors and officers to the maximum extent permitted
under the laws of the State of Delaware. The Company has not recorded any
liability for these guarantees and indemnities in the accompanying consolidated
balance sheet and the maximum amount of potential future payments under such
guarantees and indemnities is not determinable, other than as described above.
The Company's product warranty provision reflects management's best
estimate of probable liability under its product warranties. The warranty for
hardware products is based on historical trends in product return rates and the
expected material and labor costs to provide warranty services and for software
products warranty is based on the estimated cost of technical support during the
warranty period. The balance of these liabilities as of December 31, 2002 is
provided in Note 11.
Note 19 Other Financial Instruments
The Company enters into forward foreign exchange contracts on the last
business day of each quarter, all maturing in three months. Accordingly, the
fair value of such contracts is zero at December 31, 2002 and 2001.
F-31
The following table summarizes the notional amounts of the Company's foreign
currency agreements entered into on December 31, 2002 and 2001:
At December 31, 2002 2001
Notional Notional Notional Notional
Amount Amount Amount Amount
Purchased Sold Purchased Sold
European $ 16,721,200 $ 4,128,147 $ 22,646,890 $ 10,929,345
Australian 47,149 - - 444,911
Asian 1,648,157 - 1,040,327 -
Canadian 574,604 - - 1,473,194
Total $ 18,991,110 $ 4,128,147 $ 23,687,217 $ 12,847,450
The following table summarizes the amounts due to (from) the Company for
realized gains (losses) on the Company's foreign exchange contracts closed on
December 31, 2002 and 2001 that were $952,917 and $(787,551), respectively. The
actual settlement with the banks occurs in January of the following year.
At December 31, 2002 2001
European $ 962,247 $ (718,420)
Australian (12,531) (24,829)
Asian 8,747 (40,864)
Canadian (5,546) (3,438)
Total $ 952,917 $ (787,551)
Note 20 Quarterly Financial Information (Unaudited)
The following table sets forth selected unaudited quarterly information for
the Company's last eight fiscal quarters. This information has been prepared on
the same basis as the Consolidated Financial Statements and all necessary
adjustments (which consisted only of normal recurring adjustments) have been
included in the amounts stated below to present fairly the results of such
periods when read in conjunction with the Consolidated Financial Statements and
related notes included elsewhere herein.
(In thousands, except per share amounts)
First Second Third Fourth Fiscal
Quarter Quarter Quarter Quarter Year
Year ended December 31, 2002:
Revenue $ 86,241 $ 88,227 $ 83,102 $ 89,447 $ 347,017
Gross profit 58,692 60,974 58,316 63,459 241,441
Income before income taxes 1,818 2,205 1,804 4,923 10,750
Net income 1,364 1,734 1,389 3,785 8,272
Basic earnings per share 0.04 0.05 0.04 0.11 0.23
Diluted earnings per share 0.04 0.05 0.04 0.10 0.23
Year ended December 31, 2001:
Revenue $ 84,494 $ 82,848 $ 80,581 $ 86,687 $ 334,610
Gross profit 49,946 51,756 52,696 60,187 214,585
Income (loss) before income taxes (7,631) (13,222) (2,856) 2,454 (21,255)
Net income (loss) (5,571) (10,695) (2,228) 1,872 (16,622)
Basic earnings (loss) per share (0.16) (0.30) (0.06) 0.05 (0.47)
Diluted earnings (loss) per share (0.16) (0.30) (0.06) 0.05 (0.47)
F-32
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, 2002 and 2001, and for each of
the three years in the period ended December 31, 2002, and have issued our
report thereon dated January 29, 2003 (which report expresses an unqualified
opinion and includes an explanatory paragraph referring to a change in method of
accounting for goodwill and other intangible assets in 2002). Such consolidated
financial statements and report is included elsewhere in this Form 10-K. Our
audits also included the financial statement schedule of FileNet Corporation and
its subsidiaries, listed in Item 15. 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 29, 2003
F-33
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(In thousands)
Additions
Balance at Charged to Balance
Beginning Revenue and at End
of Period Expenses Deductions of Period
Year ended December 31, 2002:
Inventory reserves $ 188 139 26 $ 301
Allowance for doubtful accounts
and sales returns $ 3,567 1,752 1,087 $ 4,232
Year ended December 31, 2001:
Inventory reserves $ 234 26 72 $ 188
Allowance for doubtful accounts
and sales returns $ 5,518 1,482 3,433 $ 3,567
Year ended December 31, 2000:
Inventory reserves $ 326 - 92 $ 234
Allowance for doubtful accounts
and sales returns $ 4,542 2,280 1,304 $ 5,518
S-1
EXHIBIT INDEX
Exhibit Number Exhibit Title
21.1 List of subsidiaries of Registrant (filed as FileNet
Corporation Subsidiary Information)
23.1 Independent Auditors' Consent
99.1 Certifications pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
EX-21.1
LIST OF SUBSIDIARIES OF REGISTRANT
FileNet Canada, Inc.
FileNet Company Limited (Ireland)
FileNet Corporation Asia Pacific Pte. Ltd. (Singapore)
FileNet Corporation BV (The Netherlands)
FileNet Corporation Korea
FileNet Corporation, Pty. Ltd (Australia)
FileNet France S.A.R.L.
FileNet GesmbH (Austria)
FileNet GmbH (Germany)
FileNet Hong Kong Limited
FileNet Iberia, S.L. (Spain)
FileNet Italy, S.R.L.
FileNet Japan
FileNet Limited (United Kingdom)
FileNet Poland Sp.zo.o
FileNet (Proprietary) Limited (South Africa)
FileNet Sweden AB
FileNet Switzerland GmbH
EX-23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement Nos.
33-90454, 33-96076, 33-80899, 333-02194, 333-09075, 333-34031, 333-66997,
333-89983, 333-43254, 333-59274, 333-71598, 333-96711 and 333-96713 of FileNet
Corporation on Form S-8 of our reports dated January 29, 2003 (such report
expresses an unqualified opinion and explanatory paragraph referring to a change
in method of accounting for goodwill and other intangible assets in 2002),
appearing in this Annual Report on Form 10-K of FileNet Corporation for the year
ended December 31, 2002.
/s/ DELOITTE and TOUCHE LLP
Deloitte and Touche LLP
Costa Mesa, California
March 28, 2003