Back to GetFilings.com
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, 2004
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 of $31.57 on June 30, 2004, the aggregate
market value of the 39,366,950 shares of common stock of the Registrant held by
non-affiliates of the Registrant on such day was $1,242,814,612. For purposes of
such calculation, only executive officers, board members and beneficial owners
of more than 10% of our outstanding common stock are deemed to be affiliates.
The number of shares outstanding of the Registrant's common stock was
40,669,006 at March 14, 2005.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive proxy statement, to be delivered in
connection with the Registrant's 2005 Annual Meeting of Stockholders, are
incorporated by reference into Part III of this Report.
FILENET CORPORATION
2004 ANNUAL REPORT ON FORM 10-K
For the Year Ended December 31, 2004
TABLE OF CONTENTS
Page
PART I
Item 1. Business..............................................................3
Item 2. Properties...........................................................19
Item 3. Legal Proceedings....................................................19
Item 4. Submission of Matters to a Vote of Security Holders..................20
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters..............................................................20
Item 6. Selected Financial Data..............................................21
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................22
Item 7a. Quantitative and Qualitative Disclosures About Market Risk...........39
Item 8. Financial Statements and Supplementary Data..........................41
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.................................................41
Item 9a. Controls and Procedures..............................................41
PART III
Item 10. Directors and Executive Officers of the Registrant..................43
Item 11. Executive Compensation..............................................43
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.........................................43
Item 13. Certain Relationships and Related Transactions......................43
Item 14. Principal Accountant Fees and Services..............................43
PART IV
Item 15. Exhibits, Financial Statement Schedule..............................44
Signatures..........................................................47
2
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, 2004,
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. 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
FileNet Corporation ("FileNet") was incorporated on July 30, 1982. We
develop, market, sell and support a software platform and application
development framework for Enterprise Content Management and Business Process
Management. Enterprise Content Management ("ECM") refers to the broad range of
functions used by organizations including businesses and governmental agencies
to manage all types of content associated with their business processes and to
control and track the information or content that is important to the
organization's operations. This information may be used internally, such as
sales contracts or product diagrams, or externally, such as content provided to
customers through a Web site.
The content our software manages includes, but is not limited to: Web
pages, word processing documents, spreadsheets, HTML, XML, PDF, document images,
email messages and other electronic content. Business Process Management
("BPM"), refers to processing, communicating and gathering information within
the organization and from third parties in order to make appropriate decisions
during a business transaction, such as processing payments or applications for
services or products. Our software offers customers the ability to configure,
design, build and deploy ECM and BPM solutions to meet the needs of their
particular business or organization. These solutions allow customers to manage
content throughout their organizations, and automate and streamline their
critical and everyday decision-making to enhance the performance of their
business.
We operate globally and sell our products and services to our customers
through a direct sales force, system integrators, independent software vendors
and value added resellers. We invest significantly in product development to
improve our existing products and to expand our product offerings. We also offer
professional services for the implementation of our software, as well as 24
hours a day, 7 days a week technical support and services to our customers on a
global basis.
3
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.
Fiscal 2004 Developments and Strategy
During fiscal 2004, we continued our development efforts to enhance and
integrate the capabilities of our FileNet P8 architecture and we focused our
marketing resources on communicating the advantages of this architecture to the
market. FileNet P8 provides our customers with the ability to configure, design,
build and deploy a variety of ECM and BPM solutions to meet a broad range of
content management and business process management needs within a single
scalable framework. Offshore development augments our current development
capacity with a low cost and high quality alternative to internal development.
During fiscal 2003, we acquired the technology of the Shana Corporation that
brought us advanced eForms management technology. During fiscal 2002, we
acquired the technology of eGrail, which brought us advanced Web content
management technology.
FileNet P8 provides the following capabilities:
o ability to run on various operating systems, databases and application
servers;
o a unified architecture for 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 and enterprise application integration capabilities to leverage
a customer's existing applications; and
o enhanced Business Process Management capabilities including process
simulation and analytics allowing customers to optimize business
processes on a real-time basis.
We have packaged our ECM capabilities into eight FileNet suites that
include the Business Process Manager, Content Manager, Web Content Manager,
Image Manager, Forms Manager, Records Manager, Team Collaboration Manager and
Email Manager. Each suite provides specific functionality to meet customer
requirements. When our customers purchase a FileNet suite they have the ability
to add on additional FileNet capabilities as needed, allowing them flexibility
to acquire only the functionality they need. The integration of the suites
allows for a lower total cost of ownership by reducing support costs and
application development times.
We intend to continue to leverage our development capabilities and
substantial worldwide distribution and service network to deliver on our unified
platform strategy. We also intend to continue our strategy of investing in
product enhancements, new product developments, new partnerships, and strategic
acquisitions.
4
Markets and Customers
We believe the FileNet P8 architecture offers our customers the ability to
scale their ECM and BPM solutions to the enterprise-level and offers the
flexibility to manage demanding content challenges, complex business processes,
integration with an organization's existing systems and analysis of content and
related processes to enable an informed approach to improve business
performance. The FileNet P8 architecture is designed to provide our customers
with a way to manage and analyze their enterprise content, which can provide
greater process control and consistency throughout the enterprise.
Our customers include many of the Global 2000 organizations and are
typically those enterprises and government agencies that have complex business
processes that capture, manage, store and share large volumes of electronic
content. As of December 31, 2004, our software has been licensed to more than
four thousand customers worldwide.
Our software provides customers the ability to create solutions that are
effective for a variety of applications such as mortgage loan servicing,
regulatory compliance, customer relationship management, insurance claims
processing, accounts payable and receivable, or for any business operation that
processes significant amounts of electronic content in an organization's
day-to-day operations. Additionally, our software products can address ad hoc
business processes at the enterprise, departmental, and workgroup levels to
improve overall business performance, 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. Furthermore,
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/BPM solutions for customers. Solutions developed from our
software are applicable in a variety of industries, however our key vertical
markets are insurance, financial services, government, manufacturing,
telecommunications, and utilities.
Using our standard software products, customers build applications that
address the requirements unique to their particular business. Very often these
applications can involve a significant change in the way a customer 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
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 of 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
assistance in delivering ECM/BPM solutions.
5
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, gross profits and other information
using the management approach in Note 13 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, and Professional Services and Education. A summary
of our sales by geographic location is incorporated herein by reference in Note
13 of the "Notes to Consolidated Financial Statements" under Item 8, "Financial
Statements and Supplementary Data."
Software Products
FileNet P8
The FileNet P8 architecture offers our customers enterprise-level
scalability and flexibility to handle demanding content challenges, complex
business processes, integration to existing systems, and analysis of content and
related processes to enable an informed approach to improve business
performance. The FileNet P8 architecture provides a framework for functional
expansion to provide enhanced content and process management across an
enterprise through eight pre-packaged suites, each emphasizing a different
aspect of the ECM/BPM solution set, with functions grouped in a logical order
that are designed to meet a customer's individual needs. Each suite can be
implemented by a customer individually, but remains expandable to include all
FileNet ECM and BPM capabilities. Solutions that are developed from FileNet P8
are designed to manage content; allowing organizations to capture, create, use,
analyze, and activate that content in order to make decisions faster and bring
control and consistency to business processes, improve efficiency and address
compliance requirements.
FileNet Suites
Business Process Manager
FileNet Business Process Manager is designed to help 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 suite include:
insurance companies that have automated policy underwriting and claims
processing decisions, 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 to either
make decisions based on automated criteria or direct that information to the
appropriate decision-maker in an efficient and consistent basis. Additionally,
the Business Process Manager suite provides real-time and historical tracking of
processes combined with analysis and simulation capabilities allowing customers
to optimize their processes. This product is standards based, flexible and can
be customized to a wide range of industry requirements.
6
Content Manager
FileNet Content Manager is designed to combine content management with
process management capabilities to help organizations manage complex documents
to control, share, and access critical business information. Content Manager is
designed 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
in 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.
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 large volumes of critical business information
and 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.
Forms Manager
FileNet Forms Manager is designed to provide customers the ability to
design, deploy and process electronic forms (eForms) across their enterprise.
FileNet Forms Manager enables customers to transform cumbersome paper forms into
fully interactive eForms that directly connect to their business applications.
FileNet Forms Manager provides a rich and intuitive design environment that
enables general business users to create, deploy and process eForms and
associated data without extensive Web development or JavaScript experience.
FileNet Forms Manager can integrate with a customer's existing infrastructure to
enable forms to be widely accessible by supporting a variety of operating
systems and browsers. It enables users to view forms in a business process and
supports digital signatures and tracking for audit trails to help in meeting
regulatory compliance requirements.
Records Manager
FileNet Records Manager is designed to support the entire lifecycle of
business records and prove adherence to policy by leveraging FileNet P8's
content and process capabilities to automate and streamline records-based
activities, reduce unnecessary end user participation and support enforcement of
regulatory compliance. FileNet Records Manager's ZeroClick technology is
designed to enforce records management policies at the server technology layer
by setting rules for the correct handling of records. This enables customers to
reduce the potential for user-related error by reducing end-user involvement and
automating the management of business records, helping to ensure best-practice
records management.
Email Manager
FileNet Email Manager is designed to allow organizations with large numbers
of email users to effectively manage email content for improved business
decision-making and adherence to regulatory compliance requirements. FileNet
Email Manager is a server-based email management solution that integrates with
popular corporate email systems like Microsoft Exchange and Lotus Notes mail
servers and desktop applications such as Microsoft Office. FileNet Email Manager
allows organizations to manage email content as a part of a comprehensive
Enterprise Content Management infrastructure. FileNet Email Manager provides the
ability to use captured email content to initiate and play a role in business
processes. In addition, FileNet Email Manager can help simplify and automate the
7
process of capturing email messages as business records to support proof of
compliance as well as easy storage and retrieval of email messages.
Team Collaboration
FileNet Team Collaboration Manager is designed to promote more effective
and efficient group decision-making by removing barriers between people, data
and processes. FileNet Team Collaboration Manager provides the contextual
framework and collaboration tools, including discussion forums, live meetings,
and interactive polls, to enable group members to share information and
participate in processes to facilitate group decision-making. FileNet Team
Collaboration Manager captures all related content and streamlines processes to
promote knowledge exchange and improve decision-making, and enforces
corporate-best practice execution and regulatory compliance. Team collaboration
increases team interaction through the capturing and sharing of ideas, issues
and comments from team members; shortens exception/resolution cycle times with a
complete record of decision-making processes; increases project speed and
provides an audit trail to support decisions.
Web Content Manager
FileNet Web Content Manager is designed to combine Web site development
capabilities with integrated process capabilities for managing the creation,
approval and publication of Web content. FileNet 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 Web content across distributed sites and
provides integrated process management capabilities to help ensure accurate Web
content publication.
FileNet ECM Development Tools
The FileNet P8 architecture includes the following technology for aiding in
the development of ECM and BPM 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 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 Process 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.
FileNet P8 Workplace is an end-user application that provides a Web-based
interface to the FileNet P8 platform. 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. A customizable environment, FileNet P8 Workplace is designed to enable
employees, partners and customers to manage work processes through a simple
interface.
8
Content Provider for FileNet P8 Workplace provides virtual content management
("VCM") access to content stored in third party repositories including content
management repositories from IBM, EMC, and OpenText among others, through the
FileNet P8 Workplace. It is designed to eliminate the need for custom
integrations, which can be expensive, time consuming and require ongoing
maintenance for customers. FileNet's VCM capabilities are provided as a result
of a reseller business agreement with FileNet partner, Venetica, who in October
of 2004 was acquired by IBM.
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 offer developers the
ability 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.
Image Services Resource Adapter ("ISRA") is designed to enable organizations to
connect content stored in the FileNet Image Manager's Image Services repository
to custom J2EE applications. The ISRA delivers the functionality required to
access Image Services content within a J2EE Web application. It was specifically
designed for Image Services customers who have standardized on a Java
development and implementation environment for Web applications.
Portal Integrations provide commonly required content and process functionality
within 3rd party portal products. FileNet provides portal integration for BEA
WebLogic, IBM WebSphere and mySAP portals. Additionally, customers and partners
can create their own portlets using FileNet's Java Application Programming
Interfaces. In addition, FileNet makes available the source code for the
portlets so that customers and partners can modify and extend the capabilities
if desired.
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.
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 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 tool kit, and Web server components, and is designed to
support complex and mission critical ECM and BPM 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 repository, all from a Web browser.
FileNet Content Services is a repository for creating, accessing, managing,
securing, and updating electronic documents and content. Content Services is
designed to allow a business to manage enterprise content from creation, to
secure delivery, to revise and re-use.
9
FileNet WorkFlo Services is FileNet's 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 Application Connector Products are built to provide content management
and business process management integration with leading Enterprise Business
solutions like those from SAP and Siebel.
FileNet Application Connector for SAP R/3 is a document management and data
archiving solution certified by SAP, designed for use with the SAP R/3
Enterprise Resource Planning ("ERP") application suite.
FileNet Application Connector for Siebel 7 provides Siebel certified document
management for use with the Siebel 7 Customer Relationship Management ("CRM")
application.
Customer Support
We operate service and support organizations on a global basis to provide
post-sales services to ensure successful implementation of our products and
customer satisfaction. Due to the highly configurable nature of our software,
our product sales are coupled with contracts for continuing support services.
Our support offering also includes right to new versions.
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.
System engineers deliver support coverage on multiple platforms with 24-hour
call handling. Our 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.
10
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,
implementation, development and other technical services and training services
to our licensed customers and authorized ValueNet Partners. These services are
provided through in-house employees and through a network of qualified partners.
Our worldwide professional services organization offers a comprehensive
methodology to help customers design, install, integrate, customize and deploy
our software. These services range from the management of large-scale
implementations of our products to fixed price standard services such as
software installation and standard implementation packages, but do not include
modifications to the standard software. Our educational curriculum includes
training courses for end users, application developers and system administrators
through online media-based and/or instructor-led training.
Research and Development
The industry in which we compete is subject to rapid technological
developments, evolving industry standards, changes in customer requirements and
competitive new products and features. As a result, our success, in part,
depends on our ability to continue to timely and cost effectively enhance our
existing products and to develop and introduce new products that meet customer
needs while reducing total cost of ownership.
To achieve these objectives we have made and expect to continue to make
substantial investments in research and development, through internal and
offshore development activities, third party licensing agreements and
potentially through technology acquisitions. Our development efforts focus on
our FileNet P8 ECM platform as we continue to develop and enhance our enterprise
content and process management capabilities. The focus of these efforts is to
create functionality in Enterprise Content Management and Business Process
Management technology that provide a richer competitive product offering to our
customers. Expenditures for research and development were $ 78.2 million; $77.1
million and $71.7 million for the years ended December 31, 2004, 2003, and 2002,
respectively.
Additionally, we license and embed third party software that is designed to
expand the functionality of our products through a variety of agreements with
the producers of this software. 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 third party technology that expands our
product line.
Competition
The market for our products is highly competitive and competition will
continue to intensify as the ECM and BPM market consolidates. 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
11
us in the content and process management market. Documentum, a key competitor
in the Content Management market, was acquired by the EMC Corporation, a large
storage technology company, during 2003. EMC is now a competitor offering both
content management and storage management capabilities. 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
approached 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 ongoing software industry consolidations.
We believe that the principal competitive factors affecting the market for
our software products and services include vendor and product reputation;
product quality, performance and price; the availability of software products on
multiple platforms; product scalability; product integration with other
enterprise applications; software functionality and features; software ease of
use; and the quality of professional services, customer support services and
training. The relative importance of each of these factors depends upon the
specific customer involved.
Certain of our competitors 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 and ValueNet are registered trademarks of FileNet. WorkFlo
Services, OSAR, Watermark, Panagon, Acenza, Brightspire, Document Warehouse, and
FileNet Workgroup also are trademarks or registered trademarks of FileNet
Corporation that may be referenced in this Form 10K. All other brands or product
names are trademarks of their respective companies.
Patents
As of December 31, 2004, FileNet Corporation has one issued and nine
pending U.S. patent applications. Our subsidiary, 3565 Acquisition LLC, has one
issued U.S. patent and three pending U.S. patent applications. Another
subsidiary, FileNet Nova Scotia, has one issued U.S. patent and two pending U.S.
patent applications. We have applied for and may in the future apply for patent
protection in foreign countries.
Employees
As of December 31, 2004 we had 1,607 full-time employees, of which 400 were
employed in research and development; 433 in sales; 97 in marketing; 187 in
education and professional services; 258 in customer support; 64 in operations;
and 168 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.
12
Risk Factors That May Affect Future Results
Except for the historical information and discussions contained herein,
statements contained in this Form 10-K may constitute "forward looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. These statements are based on current expectations and assumptions that
involve a number of risks, uncertainties and other factors that could cause
actual results to differ materially from recent results or from our anticipated
future results. We operate in a rapidly changing economic and technological
environment that presents numerous risks. Prospective and existing investors are
strongly urged to carefully consider the various cautionary statements and risks
set forth in this annual report and our other public filings. Many of these
risks are beyond our control and are driven by factors that we cannot predict.
The following discussion highlights some of these risks:
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. 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. Consequently, our prior operating results should not necessarily be
considered indicative of future operating results.
Factors that may cause our operating results to fluctuate, include, but are not
limited to, the following:
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 information technology spending trends;
o the discretionary nature of our customers' budget and purchase cycles
and the absence of long-term customer purchase commitments;
o the size, complexity and timing of individual transactions;
o the length of our sales cycle;
o the level of software sales and price competition;
o the timing of new software introductions and software enhancements by
us and our competitors;
o general domestic and international economic and political conditions;
o seasonality in technology purchases, and
o a significant portion of our expenses are personnel related and fixed
and cannot be adjusted quickly in response to actual or anticipated
revenue trends.
The decision to implement our products is subject to each customer's
resources and budget availability. Our quarterly sales generally include a mix
of medium sized orders, along with several large individual orders, and as a
result, the loss or delay of an individual large order could have a significant
impact on our quarterly operating results and revenue. Our operating expenses
are based on projected revenue trends and are generally fixed. Therefore, any
shortfall from projected revenue may cause significant fluctuations in operating
results from quarter to quarter. As a result of these factors, revenue and
operating results for any quarter are subject to fluctuations and are not
predictable with any significant degree of accuracy. Therefore, we believe that
period-to-period comparisons of our results of operations should not be relied
upon as indications of future performance. Moreover, such factors could cause
our operating results in a given quarter to be below the expectations of public
market analysts and investors. In either case, the price of our common stock
could decline materially.
The markets in which we operate are highly competitive and we cannot be
sure that we will be able to continue to compete effectively, which could result
in lost market share and reduced revenue. The markets we serve are highly
competitive and we expect competition to intensify with the consolidation of the
ECM market. We have multiple competitors and there may be future competitors,
13
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.
Other competitive risks include, but are not limited to:
o We anticipate significant future consolidation as the software
industry matures. Large well-established software firms like Oracle,
IBM and Adobe either have entered or may enter our market by adding
content management features to their existing suite of products. In
addition, large hardware or infrastructure firms may enter our market
by acquiring our competitors to pursue revenue growth opportunities;
o Many of our competitors are also our distribution channel partners.
For example, IBM competes with us in the content management market,
but also implements our software solutions through its IBM Global
Services business unit. Our customers may view this type of vertical
integration of software development and system integration
capabilities as a key competitive advantage.
o We cannot predict new competitors entering our market through
acquisitions or other alliances. In order to be successful in the
future, we must respond to technological change, customer requirements
and competitors' current software products and innovations. We may not
be able to compete effectively in our target markets. In addition,
current and potential competitors have established or may establish
cooperative relationships among themselves or with third parties to
increase the ability of their products to address the needs of the
markets we serve. Accordingly, it is possible that new competitors or
alliances among competitors may emerge and rapidly acquire significant
market share. Increased competition may result in price reductions,
reduced gross margins and loss of market share that could result in
reduced revenue.
A significant portion 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 30% of our total revenue from
international sales through our worldwide network of subsidiaries and channel
partners. This contribution percentage will fluctuate quarter to quarter.
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 and requirements for localized products;
o reduced protection for intellectual property rights in certain countries;
o difficulties in staffing and maintaining foreign operations;
o difficulties in managing foreign partners;
o multiple overlapping tax regimes;
o currency restrictions and currency exchange fluctuations;
o the burden of complying with a wide variety of complex foreign laws,
regulations and treaties;
o spreading our management resources to cover multiple countries; or,
o longer collection cycles and higher risk of non-collection and bad
debt expense.
Any of these factors could reduce the amount of revenue we realize from our
international operations in the future.
The market for content management solutions may not grow as we anticipate,
and may decline, and our products may not gain acceptance within this market,
resulting in reduced revenue. Our future financial performance will depend
primarily on the continued growth of the markets for our software products and
services as well as our ability to capture a larger share of those markets. Our
14
primary product offerings address the enterprise content management solutions
market. This market is developing rapidly, and while we believe this market is
growing and will continue to grow, particularly as new regulations are
introduced that focus on controlling the flow of information within
organizations to ensure compliance with disclosure and other obligations, these
markets may not continue to grow as we anticipate, or our products and solutions
may not gain acceptance within these markets. If the markets we serve,
particularly the market for enterprise content management solutions, fail to
grow or grow more slowly than we currently anticipate, or if our products and
solutions do not gain acceptance within these markets, our business, financial
condition and operating results would be harmed.
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. For example, three new product suites that we predict
will address new markets include Records Manager, E-Mail Manager and Team
Collaboration Manager. The Records Manager Suite was released in the third
quarter of 2004 and provides customers with the capability to systematically
apply record management principles to content. E-Mail Manager was released in
late 2004 and allows organizations with large numbers of email users to
effectively manage email content. The Team Collaboration Manager Suite that
enables customers to initiate collaborative tasks at any point in a process is
expected to be available early 2005.
We may not be successful 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 technical difficulties that could delay or prevent the
successful development, introduction, sale and implementation of these products
and enhancements. In the past, we have experienced delays in the release dates
of enhancements and new releases to our products and we may 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. Announcements of currently planned or other new
software products may 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. In addition, our ability to generate revenues from
the sale of customer support, education and professional services is
substantially dependent on our ability to generate new sales of our software
products.
We are dependent upon customers concentrated in a small number of
industries. A significant decline in one of those industries could result in
reduced revenue. Our customers are concentrated in the insurance, financial
services, government, manufacturing, telecommunications and utilities
industries. We may not be successful in obtaining significant new customers in
different industry segments and we expect that sales of our products to
customers in a limited number of industry segments will continue to account for
a large portion of our revenue in the future. If we are not successful at
obtaining significant new customers or if a small number of customers cancel or
delay their orders for our products, then we could fail to meet our revenue
objectives. Consolidation within the financial services and insurance industry
could further reduce our customers and future prospects. As many of our
significant customers are concentrated in a small number of industry segments,
if business conditions in one of those industry segments decline, then orders
for our products from that segment may decrease, which could negatively impact
our business, financial condition and operating results and cause the price of
our common stock to fall.
15
We must devote substantial resources to software development, and we may
not realize revenue from our development efforts for a substantial period of
time. Introducing new products that rapidly address changing market demands
requires a continued high level of investment in research and development. We
expect to invest approximately 19% of annual revenue in research and development
efforts in the near term. The majority of our investment in new and existing
market opportunities is made prior to our ability to generate revenue from these
new opportunities. These investments of money and resources are made based on
our prediction of new products and services that we anticipate the market needs
and will accept. As a result, our operating results could be adversely affected
if our predictions of market demand are incorrect and we are not able to realize
the level of revenues we expect from new products or if that revenue is
significantly delayed due to revenue recognition rules that require new products
be tested in the market to validate pricing and acceptance.
We are increasing our use of third party software developers and may have
difficulty enforcing or managing our agreements with them, which could delay new
product introductions and reduce revenue. To help manage costs, we have
contracted with third party software development companies overseas,
particularly in India, where labor costs are lower, to perform a portion of our
software development of specific products and software localization work. As a
result, we will become increasingly dependent on these third party developers
for continued development and support of several of our key products. If any of
these third party developers were to terminate their relationship with us, our
efforts to develop new products and improve existing products could be
significantly delayed and our ability to provide product support to our
customers could be impaired. In addition, since the majority of these third
party developers are located outside the United States, our ability to enforce
our agreements with them may be limited.
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 do not have employment agreements with any
of the members of our United States-based senior management. We do have
employment contracts with members of our international management that commit
them to a notification period.
We 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
services consultants and other technical personnel. We may not be successful in
attracting and retaining such personnel in the future.
If our products contain errors or performance problems, 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 performance problems, 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
often 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
16
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.
The limitation of liability provisions contained in our license agreements
may not be effective as a result of existing or future federal, state or local
laws or ordinances or unfavorable judicial decisions. Our license agreements
with our customers typically contain provisions designed to limit our exposure
to potential product liability claims. Although product liability claims to date
have been immaterial, the sale and support of our products entails the risk of
such claims, which could be substantial in light of our customers' use of such
products in mission-critical applications. If a claimant brings a product
liability claim against us, it could have a material adverse effect on our
business, results of operations and financial condition. Even if our software is
not at fault, we could suffer material expense and material diversion of
management time in defending any such lawsuits.
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. 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;
o valuations of acquired assets or businesses that are less than
expected; or
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.
Our business is highly automated for the execution of marketing, selling
and technical support functions, and natural disasters that disable these
systems could result in a disruption in our ability to transact business. We
depend on the integrity of our information systems network connectivity to
perform these business functions. Significant business interruption could occur
at our Costa Mesa headquarters facility due to a natural disaster such as an
earthquake, which could cause a prolonged power outage and the inability for key
personnel to perform their job functions.
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. Our existing or future
copyrights, trademarks, trade secrets, patents or other intellectual property
rights may not have sufficient scope or strength to provide meaningful
protection or a commercial advantage to us. Intellectual property rights often
cannot be enforced without engaging in litigation, which involves devotion of
significant resources, can divert management attention and has uncertain
outcomes. In addition, the laws of some foreign countries do not protect our
proprietary rights to the same extent as do the laws of the United States. Any
inability to protect our intellectual property may harm our business and
competitive position.
17
We may, from time to time, be notified that we are infringing certain
patent or intellectual property rights of others, which could expose us to
litigation and other costs. 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 may not be able to redesign the
infringing products to avoid further infringement or obtain necessary licenses
to use the infringed rights on acceptable terms, or 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 broaden the number
of third party platforms with which our products are compatible and the loss of
these relationships could harm our business. In order to broaden the number of
third party platforms with which our products are compatible and thereby broaden
the market opportunities for our products, we have established strategic
relationships with a number of software and hardware platform vendors, including
companies such as BEA Systems Inc., Hewlett-Packard Development Company LP,
Network Appliance, Inc., Sun MicroSystems and Veritas Software Corporation. We
cannot assure that these companies will not reduce or discontinue their
relationships with, or support of, FileNet and our products. If we fail to
maintain these relationships, or to establish new relationships in the future,
it 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. Also, certain of our products include
publicly available software pursuant to open source license agreements. We would
be unable to sell these products if we do not maintain these licenses, which
would result in reduced revenue. 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 until replacement functionality could
be developed, licensed or acquired. 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, licensed or acquired 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.
In addition to our direct sales force, we depend on relationships with
systems integrators, independent software vendors, and value added resellers to
sell our products and services. The loss of a large strategic partner could
affect our ability to sell in a specific segment of the market. We cannot assure
that these channel partners will remain in business or continue to promote or
sell our products or services. The loss or inability to maintain these channel
partner relationships, or our failure to establish new channel partner
relationships in the future, could harm our business, financial condition and
results of operations.
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:
18
o variations in quarterly operating results;
o fluctuations in our order levels;
o announcements of technological innovations or new products or product
enhancements by us or our competitors;
o key management changes;
o changes in accounting regulations;
o changes in joint marketing and development programs;
o developments relating to patents or other intellectual property rights
or disputes;
o developments in our relationships with our customers, resellers and
suppliers;
o our announcements of significant contracts, acquisitions, strategic
partnerships or joint ventures;
o general conditions in the software and computer industries;
o fluctuations in general stock market prices and volume, which are
particularly common among highly volatile securities of Internet and
software companies;
o acquisitions in the past have been primarily cash based transactions.
Future acquisitions may include stock, which could dilute earnings per
share and possibly reduce shareholder value;
o we may not be able to hedge all foreign exchange risk due to the
significant fluctuation of the Euro to the US Dollar and our ability
to predict the mix of sales orders denominated in the Euro at the end
of each fiscal quarter;
o reduced stock value may restrict our access to equity financing to
fund further acquisitions using stock;
o industry analyst opinions may increase our stock price volatility and
reduce shareholder value; 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.
Item 2. Properties
Our headquarters is located in Costa Mesa, California. We currently lease
300,238 square feet of office, development and manufacturing space in Costa
Mesa, California and 69,349 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 and 10,882 square feet of office and
development space in Edmonton, Alberta, Canada. We also lease sales and support
offices in 24 locations in the United States, 17 locations in Europe, 2
locations in Australia, 1 in Canada, and 6 locations in Asia. We believe that
the Costa Mesa, Dublin, Kirkland and Edmonton facilities will be adequate for
our anticipated development and manufacturing needs through 2005.
Item 3. Legal Proceedings
In the normal course of business, we are subject to ordinary routine
litigation and claims incidental to our business. We monitor and assess the
merits and risks of pending legal proceedings. While the results of litigation
and claims cannot be predicted with certainty, based upon our current assessment
we believe that the final outcome of each existing legal proceeding either will
be resolved in our favor or, if resolved against us, will not have a materially
adverse effect on our consolidated results of operations or financial condition.
19
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, 2004.
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, 2003
through December 31, 2004, as reported by NASDAQ:
.
High Low
Year Ended December 31, 2004 .
4th Quarter $28.95 $17.50
3rd Quarter 31.39 16.44
2nd Quarter 32.00 25.80
1st Quarter 30.45 24.19
Year ended December 31, 2003 .
4th Quarter $27.75 $19.50
3rd Quarter 22.65 15.00
2nd Quarter 19.65 10.19
1st Quarter 14.18 10.39
The closing price of our common stock at December 31, 2004 was $25.76. As
of March 14, 2005 (record date for the 2005 Annual Meeting of Stockholders)
there were 454 stockholders of record.
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.
20
Item 6. Selected Financial Data
The following table summarizes 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, 2004 have been derived from our audited financial statements.
(in thousands, except per share amounts)
Fiscal Years Ended December 31, 2004 2003 2002 2001 2000
Consolidated statements of operations data:
Revenue:
Software $ 154,279 $ 149,214 $ 132,508 $ 119,014 $ 204,872
Service 243,279 215,291 214,509 215,596 195,490
Total revenue 397,558 364,505 347,017 334,610 400,362
Cost of revenue:
Cost of software revenue 15,122 13,800 10,565 7,522 14,643
Cost of service revenue 86,943 85,131 95,011 112,503 115,535
Total cost of revenue 102,065 98,931 105,576 120,025 130,178
Gross profit 295,493 265,574 241,441 214,585 270,184
Operating expenses:
Research and development 78,248 77,050 71,735 68,838 57,914
Selling and marketing 159,716 144,975 132,109 136,124 135,513
General and administrative 35,363 32,466 31,656 33,381 29,428
Restructuring and in-process
research and development - - 400 - 2,984
Total operating expenses 273,327 254,491 235,900 238,343 225,839
Operating income (loss) 22,166 11,083 5,541 (23,758) 44,345
Other income, net 5,959 4,084 5,209 2,503 5,406
Income (loss) before income taxes 28,125 15,167 10,750 (21,255) 49,751
Provision (benefit) for income taxes
(1,289) 4,247 2,478 (4,633) 11,204
Net income (loss) $ 29,414 $ 10,920 $ 8,272 $ (16,622) $ 38,547
Earnings (loss) per share:
Basic $ 0.75 $ 0.30 $ 0.23 $ (0.47) $ 1.13
Diluted $ 0.72 $ 0.29 $ 0.23 $ (0.47) $ 1.05
Weighted average shares outstanding:
Basic 39,095 36,532 35,590 35,117 34,155
Diluted 40,994 38,089 36,709 35,117 36,765
Consolidated balance sheet data:
Working capital $ 262,882 $ 189,326 $ 135,302 $ 144,750 $ 155,483
Total assets 493,666 391,848 328,036 301,639 324,093
Stockholders' equity 367,864 289,148 238,905 215,825 224,957
Note: Certain reclassifications have been made to the prior years' selected financial data to conform to the
current year's presentation. Customer support revenue and cost of customer support revenue includes hardware
revenue and cost of hardware revenue that was previously reported separately.
21
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
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 and Exchange Act of
1934, as amended, and Section 27A of the Securities Act of 1933, as amended, and
is subject to the safe harbors created by those sections. Words such as
"anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates,"
"may," "will" and variations of these words or similar expressions are intended
to identify forward-looking statements. In addition, any statements that refer
to expectations, projections or other characterizations of future events or
circumstances, including any underlying assumptions, are forward-looking
statements. These statements are not guarantees of future performance and are
subject to risks, uncertainties and assumptions that are difficult to predict.
Therefore, our actual results could differ materially and adversely from those
expressed in any forward-looking statements as a result of various factors. We
undertake no obligation to revise or publicly release the results of any
revisions to these forward-looking statements. Readers should carefully review
the factors described under the heading "Risk Factors" and in other documents we
file from time to time with the Securities and Exchange Commission. Our filings
with the Securities and Exchange Commission, including our Annual Reports on
Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and
amendments to those filings, pursuant to Sections 13(a) and 15(d) of the
Securities Exchange Act of 1934, are available free of charge at
www.filenet.com, when such reports are available at the Securities and Exchange
Commission Web site.
Overview
We develop, market, sell and support a software platform and framework for
Enterprise Content and Business Process Management. This platform, called
FileNet P8, provides a flexible and scaleable framework for developing solutions
that provide our customers with the ability to manage content throughout their
organizations, and streamline their business processes. Enterprise Content
Management, ("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 contracts or product diagrams, or externally, such as content provided to
customers through a Web site. The content our software manages, commonly called
unstructured content, includes, but is not limited to: Web pages, word
processing documents, spreadsheets, HTML, XML, PDF, document images, email
messages and other electronic content. Our software offers customers the ability
to configure, design, build and deploy ECM solutions to meet the needs of their
particular business or organization.
We generate revenue by selling software licenses, delivering implementation
and education services, and by providing technical support to our customers.
Software revenue consists of fees earned from the licensing of our software
products to our customers. Implementation and education services are sold on a
fee for service basis, and technical support and software maintenance are
provided pursuant to service contracts. Annual fees for software technical
support and software maintenance are received in advance and recognized as
revenue over the duration of the contract.
Earnings results are highly sensitive to fluctuations in revenue. The
nature of our cost structure is essentially fixed - with employee compensation
and benefits being the single largest expense. These expenses represent more
than 50% of our cost structure. Costs associated with variable compensation
expense and third party royalty expenses fluctuate with revenue. Future
profitability is contingent upon revenue growth achieved through continued
investments in internally developed or acquired software technologies that gain
market acceptance.
22
Software
The FileNet P8 architecture provides our customers with enterprise-level
software that is scalable and flexible to handle demanding content challenges
and manage complex business processes. The FileNet P8 architecture provides a
framework for functional expansion to provide enhanced content and process
management across an enterprise through product 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 content and process management capabilities. Solutions and
applications, built by third party partners or our customers on FileNet P8
software, are designed to manage content; allowing organizations to capture,
create, use, and activate that content in order to make decisions faster and
bring control and consistency to business processes, to improve efficiency and
address compliance requirements.
We license our ECM software to companies in the insurance, financial
services, government, manufacturing, telecommunications and utilities
industries, both directly to the end user and through partners. The growth in
software license revenue is affected by the strength of general economic and
business conditions, as well as the competitive position of our software
products. Our enterprise software business is characterized by long sales cycles
and timing of a few large software license transactions that can substantially
affect our operating results. Over the last three years, customers delayed or
limited their technology capital spending compared to spending levels in 2000.
The ability to meet regulatory and compliance requirements has become
increasingly critical for large public enterprises in order to maintain proper
documentation for all key transactions. We believe we are well positioned to
grow our revenue through our software products that address our current and
prospective customers' regulatory compliance and business process improvement
requirements. However, we believe software revenue will continue to be affected
by future economic conditions.
Customer Support
We offer product support on a global basis to provide post-sales services
to ensure successful implementation of our products and customer satisfaction.
Our support offering also includes right to new versions. Our 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. System engineers deliver support coverage on
multiple platforms with 24-hour call handling. Our Web site offers the ability
to open cases, search our knowledge base and review related status reports.
Our customers typically purchase support at the time they acquire new
software licenses and renew their software license support contracts annually
provided their systems are still in service. The growth of support revenue is
influenced by the renewal rate of the existing base and the amount of new
support contracts associated with the sale of new software licenses. We believe
that our customer support revenue will continue to grow as we sell more new
software licenses and our customers continue to renew their product support
contracts.
Professional Services and Education
Our worldwide professional services organization provides consulting,
implementation, development and other technical services and training services
to our licensed customers and authorized ValueNet Partners. These services are
provided by our internal employees and through a network of qualified service
providers hired on a fee for service basis. Our professional services
organization offers a comprehensive methodology to help our customers design,
install, integrate, customize and deploy our products. These services range from
23
the management of large-scale implementations of our products billed on a time
and material basis to short-term fixed price services such as software
installation and implementation packages, but do not include modifications to
the standard software.
Our educational curriculum includes training courses for end users,
application developers and system administrators through media-based and
instructor-led training. The purpose of our education services is to allow our
customers to further enhance the usability of our software products throughout
their enterprise.
Research and Development
We have made and expect to continue to make substantial investments in
research and development, through internal and offshore development activities,
third party licensing agreements and through technology acquisitions. Our
development efforts focus on our FileNet P8 platform as we continue to develop
and enhance our enterprise content and process management capabilities.
Additionally, we license and embed third party software that is designed to
expand the functionality of our products through a variety of agreements with
the producers of this software. We expect research and development to remain a
significant portion of our cost structure in 2005.
Critical Accounting Policies and Estimates
The consolidated financial statements of FileNet are prepared in conformity
with accounting principles generally accepted in the United States of America.
The consolidated financial statements include our accounts and the accounts of
our wholly owned subsidiaries. All intercompany balances and transactions have
been eliminated. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities at the date of the financial statements and
the reported amounts of revenue and expenses during the reporting period.
We continually evaluate our estimates and judgments, including those
related to revenue recognition, valuation of intangible assets, reserves for bad
debt and sales returns and income taxes. We base our estimates on historical and
projected results that we believe are reasonable. These estimates form the basis
for making judgments about the carrying values of assets and liabilities and by
their nature, are subject to an inherent degree of uncertainty. Actual amounts
could differ from our estimates and could have a significant adverse effect on
our operating results and financial position. 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. The nature of our business commonly includes multiple
elements in our arrangements and requires us to make judgments for determining
the timing and the amount of revenue to recognize. These judgments include, but
are not limited to determining the allocation of revenue in multiple element
arrangements based on vendor specific objective evidence and determining the
creditworthiness of a customer to assess the probability of collection of a
transaction.
We derive revenue from the following sources: (1) software, which includes
software licenses, 2) customer support revenues, which include annual
maintenance agreements, and (3) professional services, which include consulting,
implementation and training services.
24
The provisions of Statement of Position No. 97-2, Software Revenue
Recognition, issued by the American Institute of Certified Public Accountants
governs the basis for our software revenue recognition. Accordingly, software
license revenue is recognized when: (1) we enter into a legally binding
arrangement with a customer for the license of software; (2) we deliver the
products; (3) customer payment is deemed fixed or determinable and free of
contingencies or significant uncertainties; and (4) collection is probable. We
must make judgments and estimates to determine whether or not the certainty of
these elements has been met.
Our software license arrangements often include multiple elements that
consist of software, post contract customer support agreements and professional
services such as consulting, implementation and training. We recognize revenue
in multiple element arrangements using the residual method of revenue
recognition in accordance with SOP 98-9. Under the residual method, the fair
value of the undelivered elements is deferred and the remaining portion of the
arrangement fee is allocated to the delivered elements and is recognized as
revenue, assuming all other revenue recognition criteria have been met. If
evidence of fair value for each undelivered element of the arrangement does not
exist, all revenue from the arrangement is recognized when evidence of fair
value is determined or when all elements of the arrangement are delivered.
Vendor specific objective evidence ("VSOE") of fair value for customer
support is determined by reference to the price our customers pay for such
support when sold separately; that is, the renewal rates paid by our customers.
Revenue from customer support contracts is recognized ratably over the term of
the arrangement, which is typically 12 months. VSOE of fair value for
professional services is based upon the established pricing and discounting
practices for those services when sold separately. Historically, we have been
able to establish VSOE for customer support and professional services, but we
may modify our pricing practices in the future, which could result in changes
in, or the inability to support, VSOE of fair value for these undelivered
elements. If this occurs, our future revenue recognition for multi-element
arrangements could differ significantly from our historical results. A majority
of our professional service revenue is derived from time and materials based
contracts that typically range from three months to one year in duration.
Revenue is recognized on such contracts as time is incurred and approved by the
customer. We also provide fixed price pre-packaged services that are one month
or less in duration. Revenue from such short-term fixed price contracts is
recognized upon completion of the work and customer acceptance. Short-term
fixed-price contracts of a repetitive nature are more readily estimable than
long-term contracts. Our ability to make judgments about revenue and cost for
these types of contracts has in the past been accurate. We have little exposure
to cost overruns in professional service engagements as any additional services
are pre-approved by our customers in time and material contracts and our fixed
price contracts are normally very short term in nature and highly estimable.
We use judgment in assessing whether fees are fixed and determinable and
probable of collection at the time of sale. Since customers who have previously
deployed our products somewhere within their enterprise comprise approximately
90% of software sales, our ability to assess the credit-worthiness of a
transaction is supported by the collection history we have with that customer.
In the past our ability to judge the probability of collection has been highly
accurate and we expect that this will continue. Our standard payment terms range
from net 30 to net 90 days. Payments that are due within 90 days are deemed to
be fixed or determinable based on our successful collection history on such
arrangements. To the extent we elect to provide extended payment terms beyond 90
days for competitive or other reasons, revenue is recognized when the amounts
become due. Historically, sales returns and bad debt write-offs have been
insignificant and within management's expectations. However, any adverse changes
in these trends could impact the timing of revenue recognition in the future.
In addition to direct customer sales, we sell through third party channel
partners. Our channel partners do not inventory our software products; rather,
shipments are made only when the partner places an order for a specific end
user. We require our channel partners to provide us with the name and address of
all end users at the time an order is placed and, in many cases, we ship our
25
products directly to the end user. Software license revenue from channel
partners is recognized when an end user is identified, product is delivered
either to a channel partner or to their designated end-user and all other
revenue recognition criteria are met. As our channel partners only purchase our
product for specific end users, we are not subject to channel inventory returns
or price protection issues.
Allowance for Doubtful Accounts and Sales Returns. We make judgments as to
our ability to collect outstanding receivables and provide allowances for the
portion of receivables when collection becomes doubtful. We perform an initial
evaluation of 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
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. 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. Even though we have large
transactions, these tend to be with large, well capitalized and credit worthy
customers. We also maintain a sales returns allowance based on historical return
rates. While we are not legally required to accept sales returns, we have done
so on certain occasions for our customers. Product returns have historically
been minimal and within our expectations. If we elect to accept a higher level
of returns in the future for customer relations or other reasons, our results of
operations could be materially affected. If the historical data we use to
calculate the allowance for doubtful accounts or if estimates do not properly
reflect future returns, then a change in the allowances would be made in the
period in which such a determination is made and results of operations in that
period could be materially affected.
Goodwill and Other Intangible Assets. Our business acquisitions have
resulted in goodwill and other intangible assets. Goodwill is recorded at cost
and is not amortized, but is tested for impairment at least annually and would
be written down if impairment were determined. Effective the first day of July
of each year, goodwill is tested for impairment by determining if the carrying
value of each reporting unit exceeds its fair value. Our reporting units are
consistent with the reportable segments identified in Note 13. We also
periodically evaluate whether events and circumstances have occurred in between
annual testing dates that indicate the carrying value of goodwill may not be
recoverable. We performed an impairment analysis as of July 1, 2004 in
accordance with SFAS 142. The results indicated there was no impairment of
goodwill in any of the three reporting units. As of December 31, 2004, there
have been no indicators of impairment; therefore no interim impairment tests
have been performed.
Identified intangible assets are recorded at cost less accumulated
amortization. These assets are amortized using the straight-line method over
estimated useful lives of three to five years. The determination of useful lives
and whether or not these assets are impaired involves judgment. Long-lived
assets are reviewed for impairment whenever events or circumstances indicate
that the carrying amount of such assets may not be recoverable. We evaluate
these assets for impairment based on estimated undiscounted future cash flows
from these assets. If the carrying value of the assets exceeds the estimated
future undiscounted cash flows, a loss would be recorded for the excess of the
asset's carrying value over the fair value. While we have not experienced
impairment of intangible assets in prior periods, we cannot guarantee that there
will not be impairment in the future.
Determining the fair value of a reporting unit is judgmental in nature and
involves the use of significant estimates and assumptions. These estimates and
assumptions include revenue growth rates and operating margins used to calculate
projected future cash flows, future economic and market conditions, and
determination of appropriate market comparables. We base our fair value
26
estimates on assumptions we believe to be reasonable but that are unpredictable
and uncertain. Actual future results may differ from those estimates. In
addition, we make certain judgments and assumptions in allocating shared assets
and liabilities to determine the carrying values for each of our reporting
units. Future events, such as a significant decrease in our revenue,
profitability or market capitalization, or a change in technology could cause us
to conclude that impairment indicators exist and that goodwill or other
intangible assets associated with our acquisitions are impaired. Any resulting
impairment loss could have an adverse impact on our results of operations.
Income Taxes. We exercise significant judgment in determining our income
tax provision due to transactions, credits and calculations where the ultimate
tax determination is uncertain. Uncertainties arise as a consequence of the
actual source of taxable income between domestic and foreign locations, the
outcome of tax audits and the ultimate utilization of tax credits. Although we
believe our estimates are reasonable, the final tax determination could differ
from our recorded income tax provision and accruals. In such case, we would
adjust the income tax provision in the period in which the facts that give rise
to the revision become known. These adjustments could have a material impact on
our income tax provision and our net income for that period.
We recognize deferred income tax assets and liabilities based upon the
differences between the financial statement carrying amounts and the tax bases
of assets and liabilities. Such deferred income taxes primarily relate to the
timing of the recognition of certain revenue items and the timing of the
deductibility of certain reserves and accruals for income tax purposes. We
regularly review the deferred tax assets for recoverability and establish a
valuation allowance when it is more likely than not that some portion or all of
the deferred tax assets will not be realized. In the current year we concluded
that the valuation allowance associated with domestic NOL's and other temporary
differences should be fully reversed as a result of the current year and
cumulative domestic profits in recent years and future domestic projections.
However, we could be required to record additional valuation allowance against
the deferred tax assets if we are unable to generate sufficient future taxable
income, fail to benefit from our tax planning strategies or if there is a
material change in the actual effective tax rates or time periods within which
the underlying timing differences become taxable or deductible. Increases in the
valuation allowance could have a material adverse impact on our income tax
provision and our net income. Conversely, if we continue to generate profits,
and ultimately determine that it is more likely than not that all or a portion
of the deferred tax assets will be utilized to offset future taxable income (net
of any current year stock option deductions), the remaining valuation allowance
of $15.0 million related to stock option deductions will result in an increase
to additional paid in capital.
27
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, 2004 2003 2002
Revenue:
Software 38.8% 40.9% 38.2%
Customer support 47.3 45.9 45.4
Professional services and education 13.9 13.2 16.4
Total revenue 100.0 100.0 100.0
Cost of revenue:
Software 3.8 3.8 3.1
Customer support 10.6 11.7 12.8
Professional services and education 11.3 11.6 14.5
Total cost of revenue 25.7 27.1 30.4
Gross profit 74.3 72.9 69.6
Operating expenses:
Research and development 19.7 21.1 20.8
Selling and marketing 40.2 39.8 38.1
General and administrative 8.9 8.9 9.1
Total operating expenses 68.8 69.8 68.0
Operating income 5.5 3.1 1.6
Other income, net 1.5 1.1 1.5
Income before tax 7.0% 4.2% 3.1%
Note: Certain reclassifications have been made to the prior years' results
of operations data to conform to the current year's presentation. Customer
support revenue and cost of customer support revenue includes hardware
revenue and cost of hardware revenue that was previously reported
separately.
Revenue
Total revenue increased by 9.1% in 2004 compared to 2003 due to a
combination of service revenue growth of 13.0% and software revenue growth of
3.4%. Total revenue increased by 5.0% in 2003 compared to 2002 due to software
revenue growth of 12.6% and service revenue growth of 0.4%. Total revenue growth
is dependent upon continued software revenue growth accompanied by professional
services growth to implement the software products, and a continued high renewal
rate of maintenance contracts to support the installed base. Service revenue
growth is highly correlated with prior period software revenue growth. Further
discussion of revenue trends with additional explanation is contained below in
each revenue component discussion.
28
Revenue by Geography. The following table sets forth total revenue by
geography and as a percentage of total revenue for the periods indicated:
Revenue by Geography
(in thousands)
% Increase / % Increase /
Year ended December 31, 2004 (decrease) 2003 (decrease) 2002
Total United States Revenue $ 278,177 8.2% $ 257,100 2.2% $ 251,447
Europe, Middle East / Africa 93,972 10.1% 85,339* 9.5% 77,953
Asia / Pacific 15,793 29.8% 12,171 22.7% 9,916
Canada 8,786 10.2% 7,971 42.8% 5,581
Other 830 (56.9)% 1,924* (9.2)% 2,120
Total International Revenue 119,381 11.2% 107,405 12.4% 95,570
Total Revenue $ 397,558 9.1% $ 364,505 5.0% $ 347,017
Revenue as a % of total revenue:
United States Revenue 70% 71% 72%
International Revenue 30% 29% 28%
Total Revenue Contribution 100% 100% 100%
* Note - 2003 revenue for the Middle East Africa Region of $1.5 million was reclassified for
comparability purposes from Other International to Europe, Middle East/Africa to reflect an
organization change that was effective in 2004.
Market acceptance of our P8 products, and continued penetration into our
installed base, accounted for the growth in all our geographic markets.
Revenue generated in the United States has consistently represented
approximately 70% of total revenue for the past three years. International sales
volumes remained consistant for all three years in local currency. The dollar
increase was due to favorable foreign currency rates against the dollar, The
Europe, Middle East, Africa ("EMEA") region is our largest international market
contributing approximately 80% of our international revenue. Asia Pacific is a
much smaller market for FileNet, but produced revenue growth of 59.3% during the
three-year period from 2002 to 2004. We made significant investments in the Asia
Pacific region to support the revenue growth that we believe will continue to
increase in countries such as China and India.
We expect international revenue to continue to represent a significant
percentage of total revenue in the range of 30%. However, international revenues
will be adversely affected if the U.S. dollar strengthens against certain major
international currencies, especially the Euro, or if international economic
conditions remain relatively weak.
29
Revenue by Reporting Segment. The following table sets forth total revenue
by reporting segment and as a percentage of total revenue for the periods
indicated:
Revenue by Reporting Segment
(in thousands)
% Increase / %Increase /
Year ended December 31, 2004 (decrease) 2003 (decrease) 2002
Revenue:
Software $ 154,279 3.4% $ 149,214 12.6% $ 132,508
Customer Support 188,011 12.4% 167,230 6.1% 157,550
Professional Services and
Education 55,268 15.0% 48,061 (15.6)% 56,959
Total Revenue $ 397,558 9.1% $ 364,505 5.0% $ 347,017
Revenue as a % of total revenue:
Software 38.8% 40.9% 38.2%
Customer Support 47.3% 45.9% 45.4%
Professional Services and
Education 13.9% 13.2% 16.4%
Total Revenue Contribution 100.0% 100.0% 100.0%
Note: Certain reclassifications have been made to the prior years' segment information to conform to the
current year's presentation. The residual operating activity of the previously reported Hardware reporting
segment has been incorporated into the Customer Support reporting segment. This reclassification is
predicated on the reduced scale and change in the nature of on-going hardware operations. The only activity
in the Hardware reporting segment is related to supporting legacy customers with spare parts and supplies,
and management no longer reviews the Hardware reporting segment on a stand-alone basis.
Software. Software revenue consists of fees earned from the licensing of
our software products to our customers. Software revenue increased by 3.4% in
2004 compared to 2003, and by 12.6% in 2003 compared to 2002. Our P8 platform
and associated products were announced early in 2003. We attribute the growth in
software revenue in both 2004 and 2003 to market acceptance for these new
products.
Sales to customers who have previously deployed our products somewhere
within their enterprise comprised approximately 90% of software revenue in 2004
and drove the demand in our key vertical industries of financial services,
insurance, telecommunications, manufacturing, government and utilities. We saw
these customers increase usage of our products to expand existing applications
and to create new applications throughout their enterprise with our software. We
believe the IT spending environment has improved during the past two fiscal
years as we have experienced the return of larger software deployments by some
of our customers. We believe these trends will continue in 2005 with a moderate,
but steady improvement in IT spending on enterprise content management and
business process management software as large enterprises look for software that
supports key business applications and solves regulatory and compliance
requirements related to managing content.
Customer Support. Customer support revenue consists of revenue from
software maintenance contracts, "fee for service" billings and the sale of
hardware spare parts and supplies. Support contracts entitle our customers to
receive technical support, bug fixes and upgrades to new versions of software
releases when and if available. Customer support revenue increased by 12.4% in
2004 compared to 2003 and by 6.1% in 2003 compared to 2002. These increases in
customer support revenue reflect an increase in our overall customer installed
base combined with a high rate of renewal in the existing customer base.
Customer support revenue is directly related to the sale of software licenses in
prior periods. Customer support revenue grew more slowly in both 2004 and 2003
compared to the growth rate in previous years as a result of reduced software
sales growth in 2002 and 2003 and software support pricing pressure. A prolonged
economic slowdown negatively affects the growth rate of customer support revenue
as this revenue stream is directly related to software revenue growth over time.
30
However, we believe we will continue to experience a high rate of renewal on
support contracts, as our customers tend to deploy mission critical applications
using our software to manage content.
Professional Services and Education. Professional services and education
revenue is earned by providing consulting services to customers for the design,
implementation, deployment, upgrade and migration of our software products,
technical consulting services provided to our resellers, and training services.
No modifications are made to our standard base product code once the software
has been sold. Professional services are usually performed on a time and
material basis and are also generated from short-term fixed price offerings.
Professional services revenue and education revenue is dependent on the level
and the nature of software sales in prior periods - particularly new customer
sales. Professional services revenue decreased in 2003 compared to 2002 and then
recovered in 2004 to the 2002 levels. We experienced fewer and smaller
consulting engagements and increased pricing pressures in the past two years.
Competitive pricing pressures have led to higher discounts and an increased use
of partners for professional services. The decrease in professional services and
education revenue is also affected by software revenue that has been
characterized by repeat purchases for additional software licenses that do not
require large-scale professional services engagements but rather smaller
engagements and a lesser need for customer training classes. We believe we will
experience a moderate, but steady improvement in professional services and
education revenue in 2005 based on the software revenue trends we experienced
during the last half of 2004, with strong dependency on new system sales to
generate the professional services and education demand from our customers.
Cost of Revenue
Cost of Revenue by Reporting Segment. The following table sets forth total
cost of revenue by reporting segment and as a percentage of total cost of
revenue by reporting segment for the periods indicated:
Cost of Revenue by Reporting Segment
Cost of Revenue by Reporting Segment
(in thousands)
% Increase / % Increase /
Year ended December 31, 2004 (decrease) 2003 (decrease) 2002
Cost of revenue:
Software $ 15,122 9.6% $ 13,800 30.6% $ 10,565
Customer Support 41,989 (1.9)% 42,785 (4.1)% 44,603
Professional Services and
Education 44,954 6.2% 42,346 (16.0)% 50,408
Total Cost of Revenue $ 102,065 3.2% $ 98,931 (6.3)% $ 105,576
Cost of revenue as a % of
segment revenue:
Software 9.8% 9.2% 8.0%
Customer Support 22.3% 25.6% 28.3%
Professional Services and
Education 81.3% 88.1% 88.5%
Total Cost of Revenue as a
% of Segment Revenue 25.7% 27.1% 30.4%
Note: Certain reclassifications have been made to the prior years' segment information to conform to the
current year's presentation. The residual operating activity of the previously reported Hardware reporting
segment has been incorporated into the Customer Support reporting segment. This reclassification is
predicated on the reduced scale and change in the nature of on-going hardware operations. The only activity
in the Hardware reporting segment is related to supporting legacy customers with spare parts and supplies,
and management no longer reviews the Hardware reporting segment on a stand-alone basis.
31
Software. Cost of software revenue includes royalties paid to third parties
for technology embedded in our products to enhance features and functionality,
referral fees, amortization of acquired technology, media costs, and the cost to
manufacture and distribute software. The cost of software revenue as a
percentage of software revenue grew 1.8 percentage points from 8.0% in 2002 to
9.8% in 2004, resulting from higher costs not being offset by a corresponding
growth in revenue. The increase in software cost over the period from 2002 to
2004 resulted from increased third party fees and royalties of approximately
$2.0 million in each of 2003 and 2004 and a $960,000 increase in amortization
expense in 2003 related to the amortization of acquired technology resulting
from the eGrail acquisition in April 2002 and the Shana acquisition in April
2003. Going forward we anticipate cost of software revenue to range between
8%-10% of revenue. Future acquisitions resulting in additional acquired
technology and future integration of additional third party technology with our
products would result in increased software cost, but we would expect such
increase to be offset by increased revenue.
Customer Support. The cost of customer support revenue includes the cost of
customer support personnel, facility and technology infrastructure expenses in
our call centers, and costs of supplies and hardware spare parts. As disclosed
previously, the residual operating activity of the previously reported hardware
business segment has been combined with the customer support reporting segment.
We do not sell hardware to new customers. We provide spare parts and supplies as
an accommodation to our customers who purchased FileNet hardware in prior years.
We view this as a service to our customers.
The cost of customer support revenue as a percentage of customer support
revenue has decreased from 28.3% in 2002 to 22.3% in 2004. The combination of
increased customer support revenue along with relatively flat customer support
cost in all three years resulted in a lowered percent of cost in relation to
revenue. The decrease in cost as a percent of revenue was improved by our
reduction in hardware revenues each year, which were a high cost, low margin
segment. Customer support headcount, excluding the hardware function, has ranged
from 252 employees in 2002 to 259 in 2004. We expect the cost of customer
support revenue to range between 21%-24% of customer support revenue for the
near future as long as customer support revenue continues to grow at a higher
rate than costs. We believe the current cost structure and number of personnel
in the customer support organization will be sufficient to support projected
revenue growth.
Professional Services and Education. Cost of professional services and
education revenue consists of the costs of professional services personnel,
training personnel, and third-party contractors. The increase in 2004 compared
to 2003 is due to increased third-party contractor expense of $4.3 million,
partially offset by decreased facility and depreciation expense of $1.4 million
along with continued cost control in a number of expense areas. The decrease in
cost from 2002 to 2003 resulted from the reduced usage of third-party
contractors of $3.9 million and lower personnel costs of $2.5 million. These
decreases were predicated on the decreased revenue level during this period.
Professional services and education revenue increased 15% when comparing
2004 to 2003, while costs increased at a lower rate of 6.2% due to improved
utilization of internal resources. Professional services and education revenue
and cost both decreased at the same level in 2003 compared to 2002 maintaining
cost at approximately 88% of revenue for both years. We believe our headcount in
the professional services and education segment allows for revenue growth
without adding additional resources. We expect professional services and
education costs as a percentage of professional services and education revenue
to range between 80%-82% in the near-term assuming professional services and
education revenue continues to grow.
32
Operating Expenses
Total Operating Expenses. The following table sets forth total operating
expense by function and as a percentage of total revenue for the periods
indicated:
Operating Expenses
(in thousands)
% Increase / % Increase /
Year ended December 31, 2004 (decrease) 2003 (decrease) 2002
Operating expense:
Research and Development $ 78,248 1.6% $ 77,050 7.4% $ 71,735
Marketing and Sales 159,716 10.2% 144,975 9.7% 132,109
General and Administrative 35,363 8.9% 32,466 2.6% 31,656
In-process R and D - - 400 .
Total Operating Expenses $ 273,327 7.4% $ 254,491 7.9% $ 235,900
Operating expense as a % of
total revenue:
Research and Development 19.7% 21.1% 20.7%
Marketing and Sales 40.2% 39.8% 38.1%
General and Administrative 8.9% 8.9% 9.1%
Operating Expense as a % of
Revenue 68.8% 69.8% 68.0%
Research and Development. Our research and development efforts focus on our
FileNet P8 architecture as we continue to develop and expand our ECM and BPM
capabilities. The focus of these efforts is to create functionality in
Enterprise Content Management and Business Process Management technology that
provide a richer competitive product offering to our customers.
We seek to achieve our development objectives through both internal and
external resources, and by obtaining third party technology to enhance product
capabilities through licensing agreements and acquisitions. During 2002 we
initiated a program involving contracted offshore development in lower labor
cost countries. During 2003 we expanded this offshore development effort to
include both product sustainment and product development activities. We have
also historically acquired companies to obtain their technology. During 2003 we
acquired Shana to integrate their electronic forms capabilities into our
products. During 2002 we acquired eGrail to integrate their web content
management capabilities into our products.
Our research and development expense consists of personnel costs for
software developers; third party contracted development efforts and related
facilities costs. Research and development expense increased by 1.6% in 2004
compared to 2003 and by 7.4% in 2003 compared to 2002. The number of research
and development personnel was 400 in 2004, 456 in 2003 and 430 in 2002. We had
an average of 93 contract workers in India throughout 2004 compared to an
average of 52 contract workers in India in 2003.
Research and development expense increased $1.2 million from 2003 to 2004
and increased $5.3 million from 2002 to 2003. The $1.2 million increase in 2004
is attributable to our expanded offshore development program with contractors in
India, which represented a $3.2 million expense increase that was partially
offset by reduced compensation expense of $1.7 million in North America. The
$4.9 million increase from 2002 to 2003 is attributable to 26 additional
internal employees in North America resulting in higher compensation, benefits
and relocation costs of $3.0 million, increased facility related expenses of
33
$0.5 million associated with the integration of the eGrail and Shana
acquisitions in April of 2002 and 2003, respectively, and increased consulting
expense of $1.5 million associated with offshore development through contractors
in India.
We intend to continue to complement internal development with offshore
development as well as with third-party software through OEM agreements and may
execute additional technology acquisitions. Over time, we believe we will be
able to lower our per-developer cost through the use of offshore resources.
However, in the near term we do not plan on expanding our use of offshore
contract labor. We believe that research and development expenditures, including
compensation of technical personnel, are essential to maintaining our
competitive position. We expect research and development expense to range
between 18%-20% of revenue assuming revenue growth in the near-term, and will
gradually decrease on a percentage basis as revenue increases.
Selling and Marketing. We sell our products through a direct sales force
and our indirect channel sales partners. Our selling and marketing expense
consists of salaries, benefits, sales commissions and other expenses related to
the direct and indirect sales force and personnel cost for marketing and market
development programs.
Selling and marketing expense increased 10.2% in 2004 compared to 2003 and
increased 9.7% in 2003 compared to 2002. The number of sales and marketing
employees in 2004 was 530 compared to 549 in 2003 and 541 in 2002. During this
two-year period, marketing personnel increased by 14 employees while sales
personnel decreased by 25 employees. This shift in sales and marketing capacity
resulted in a smaller direct sales force, with increased channel partner
business and increased marketing personnel with deep vertical industry knowledge
and demand generation capabilities.
The increase in sales and marketing expense was $14.7 million from 2003 to
2004. Personnel related expenses including salaries and benefits increased $7.9
million year over year due to a higher salary mix despite a reduction in
headcount. Higher total revenue in 2004 resulted in incremental commission
expense of $4.9 million in 2004 compared to 2003. Additionally, travel expense
increased $2.1 million in 2004 compared to 2003 due to a new sales coverage
model where resources were deployed by account rather than geography and due to
generally higher business activity. This resulted in increased travel both in
volume and distances.
The increase in sales and marketing expense of $12.9 million from 2002 to
2003 reflects a higher salary mix as well as higher variable compensation
associated with higher revenue in 2003 compared to 2002. Personnel related
expenses including salaries and benefits increased $4.6 million year over year.
Higher software revenue in 2003 resulted in higher commission expense of $3.4
million in 2003 compared to 2002. In 2003 travel, training, and marketing
programs increased $3.6 million from 2002 related to the FileNet P8 product
release that was announced in the first quarter of 2003.
We expect selling and marketing expense to range between 38%-40% of revenue
in the near-term, depending on revenue growth.
General and Administrative. Our general and administrative expense consists
of salaries, benefits, and other expenses related to personnel costs for
finance, information technology, legal, human resources and general management,
and the cost of outside professional services.
34
General and administrative expense increased by 8.9% in 2004 compared to
2003 and increased by 2.6% in 2003 compared to 2002. The number of general and
administrative employees in 2004 was 168 compared to 176 in 2003 and 167 in
2002. The $2.9 million increase in absolute dollars in 2004 compared to 2003 was
attributable to increased personnel expense of $1.8 million that included merit
increases, increased bonuses and the addition of restricted stock expense.
Increased consulting expense and accounting fees of $1.1 million associated with
our efforts to achieve compliance with Section 404 of the Sarbanes-Oxley Act by
December 31, 2004 also contributed to the increase in 2004. Essentially all of
the $0.8 million increase in 2003 compared to 2002 was attributable to increased
consulting expense and legal fees associated with compliance with other sections
of the Sarbanes-Oxley Act.
We expect general and administrative expense to range between 8%-10% of
total revenue in the near-term, depending on revenue growth.
Purchased In-Process Research and Development. There were no acquisitions
during 2004 and there was no in-process research and development expense
associated with our April 2003 acquisition of Shana. Our eGrail acquisition in
April 2002 of certain assets and certain liabilities of eGrail resulted in an
allocation of $400,000 to in-process research and development. The allocation
was determined by management through established valuation techniques in the
high-technology industry with the assistance of 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.
Other Income, Net. Other income, net consists of interest income earned on
our cash, cash equivalents and investments, and other items including foreign
exchange gains and losses. Other income, net of other expenses, was $6.0 million
in 2004, $4.1 million in 2003 and $5.2 million in 2002. The increase in 2004
compared to 2003 was due almost entirely to an increase in interest income of
$1.9 million based on increased cash, cash equivalents and investment amounts
and a higher weighted-average interest rate. The weighted average interest rate
earned on cash, cash equivalents and investments was 2.21% in 2004, 1.39% in
2003 and 1.98% in 2002. The overall decrease in 2003 from 2002 of $1.1 million
was primarily attributable to a lower net foreign exchange gain of approximately
$700,000 due to a continued weakening of the dollar against the Euro in 2003,
and reduced interest income of approximately $400,000 due to a lower
weighted-average interest rate in 2003 compared to 2002.
Provision for Income Taxes. The benefit for income taxes was ($1.3) million
in 2004, compared to a provision for income taxes of $4.2 million in 2003 and of
$2.5 million in 2002. The effective tax rate was (5%), 28%, and 23% for the
years ended December 31, 2004, 2003 and 2002, respectively. The decreased tax
rate in 2004 was due to the benefit of $13.5 million from the reversal of the
valuation allowance associated with domestic net operating loss carryforwards
and other temporary differences. Subsequent to the reversal of the valuation
allowance, we expect our on-going effective tax rate to range between 30%-40%.
These rates, however, can fluctuate outside our expectations depending upon the
mix of our profits between domestic and lower taxed foreign locations.
Quarterly Results of Operations
Quarterly revenues and expenses have historically been affected by a
variety of factors, including the timing of large enterprise transactions,
seasonality of economic activity in Europe, and to some degree the timing of
budget approvals in the government sector. Historically, the fourth quarter is
our highest quarter and we expect these trends to continue in 2005.
35
The following table sets forth selected unaudited quarterly information for
our 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, 2004:
Revenue $ 99,498 $ 94,086 $ 96,488 $ 107,486 $ 397,558
Gross profit 74,845 69,862 71,358 79,428 295,493
Income before income taxes 4,876 2,633 7,756 12,860 28,125
Net income 3,998 2,159 6,360 16,897 29,414
Basic earnings per share 0.10 0.06 0.16 0.42 0.75
Diluted earnings per share 0.10 0.05 0.16 0.41 0.72
Year ended December 31, 2003:
Revenue $ 87,049 $ 87,117 $ 89,389 $ 100,950 $ 364,505
Gross profit 62,390 63,206 64,516 75,462 265,574
Income before income taxes 1,908 1,964 3,453 7,842 15,167
Net income 1,336 1,452 2,486 5,646 10,920
Basic earnings per share 0.04 0.04 0.07 0.15 0.30
Diluted earnings per share 0.04 0.04 0.06 0.14 0.29
Liquidity And Capital Resources
As of December 31, 2004, cash and cash equivalents and investments were
$348.7 million, an increase of $100.4 million from $248.3 million at December
31, 2003. Cash, cash equivalents and investments include $266.9 million in the
United States and $81.8 million held by our foreign subsidiaries. Cash and cash
equivalents consist of high quality and highly liquid investments in short-term
money market funds, United States government agency discount notes, and
Corporate Notes. Cash equivalent investments include instruments with original
maturities of 90 days or less. Short-term investments include auction-rate
securities and instruments with maturities of greater than 90 days and less than
365 days. Long-term investments consist of high grade corporate and government
securities with maturities greater than 12 months and less than three years.
Our two major sources of cash, as more fully discussed below, have been
cash generated from operations and cash generated from financing activities.
Cash flows from operations was $70.0 million in 2004, $52.2 million in 2003 and
$21.4 million in 2002. Cash provided by financing activities was $36.1 million
in 2004, $21.3 million in 2003 and $4.7 million in 2002.
Net income is a primary source of cash from operating activities. Net
income was $29.4 million, $10.9 million and $8.3 million in 2004, 2003 and 2002,
respectively. Depreciation and amortization added to net income to provide cash
from operating activities - although the amount has declined each year due to
tight budgetary control over capital spending. Depreciation and amortization was
$16.4 million in 2004, $19.4 million in 2003 and $21.6 million in 2002. Our cash
from operations is also impacted by changes in working capital accounts. Changes
in accounts receivable and unearned revenue have typically had the largest
impact on our cash flows. The days sales outstanding metric, which is calculated
by dividing quarter-end accounts receivable by average daily sales for the
quarter, was 31 days, 40 days and 47 days as of December 31, 2004, 2003 and 2002
respectively. We believe that we will continue to generate cash from
36
unearned revenues but expect increases in cash due to declines in accounts
receivable to lessen. We attempt to structure our sales contracts to require a
majority of payments in 30 days or less, and all payments in 90 days or less. To
the extent that competitive pressures require us to extend our terms, it would
result in a decrease to our operating cash flows. Our annual customer support
agreements are typically prepaid at the beginning of the support period,
resulting in a large cash inflow and a corresponding increase in deferred
revenue. This has historically resulted in significant cash inflows in the first
quarter, when the largest portion of our support agreements renews. We expect
this trend to continue in the future.
Net cash used for investing activities was $88.5 million in 2004, $64.2
million in 2003 and $27.0 million in 2002. Capital spending has been fairly
consistent and under tight budgetary control and accounted for net cash used of
$9.4 million in 2004, $9.2 million in 2003 and $10.8 million in 2002. We do not
expect capital expenditure levels in 2005 to differ significantly from the level
of the past few years. Significant changes in cash from investing activities
have resulted from the purchase and sale of investments and, to a lesser extent,
cash paid for acquisitions. Excess cash from operations is invested in high
quality debt instruments and securities, and the timing of purchases and
maturities of investments could result in significant short-term fluctuations in
net cash used or generated from investing activities. As long as we continue to
generate excess cash, we expect to invest such amounts and thus continue to show
a net use of cash related to investing activities. However, based on the nature
of our investment policy, all such investments are available in the short term
if needed for any reason.
Net cash provided by financing activities results from the proceeds of
common stock related to employee stock option plans and employee stock purchase
plans. As previously noted, the cash generated from this activity increased to
$36.1 million from $21.3 million in 2003 and $4.7 million in 2002. Stock prices
favorably influenced this activity. As long as our stock price is greater than
the exercise price of outstanding stock options, we expect to continue to
generate cash from option exercises.
The effect of exchange rate changes on cash and cash equivalents held in
foreign currency resulted in net cash inflows in all three years as the Euro and
other currencies progressively strengthened against the dollar.
We have no borrowing arrangements as of December 31, 2004. On June 27, 2003
our $5.0 million multi-currency revolving line of credit expired in accordance
with its terms and was not renewed because the cost of carrying the line did not
justify the level of usage. We have been able to meet escrow needs through
existing bank relationships in the United States and internationally.
We believe that our present cash balances, together with internally
generated funds, will be sufficient to meet our working capital and capital
expenditures throughout 2005. See "Risk Factors".
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. We have contract
commitments associated with third party development agreements. The following
table summarizes future minimum payments for these obligations as of December
31, 2004:
37
(in thousands)
Payments Due by Period .
Total 2005 2006-2007 2008-2009 Thereafter
Contractual obligations:
Operating leases $ 55,646 $ 12,265 $ 22,161 $ 15,435 $ 5,785
Third party licensing contracts 3,032 3,032 - - -
Third party development contracts 4,155 2,775 1,380 - - .
Total contractual cash obligations $ 62,833 $ 18,072 $ 23,541 $ 15,435 $ 5,785
We have bank guarantees issued in local currencies in Europe and Asia as
discussed in Note 15 of the Notes to Consolidated Financial Statements. The
following table summarizes future minimum commercial commitments for these
obligations as of December 31, 2004:
(in thousands)
Amount of Commitment Expiration Per Period .
Total
Amounts 2006- 2008-
Other commercial commitments: Committed 2005 2007 2009 Therafter .
Secured and unsecured bank
guarantees $ 2,555 $ 1,506 $ 877 $ 172 $ - .
Total commercial commitments $ 2,555 $ 1,506 $ 877 $ 172 $ - .
OTHER MATTERS
Environmental Matters. We are not aware of any issues related to
environmental matters that have, or are expected to have, a material effect on
our business.
Impact of Recently Issued Accounting Pronouncements
NEW ACCOUNTING PRONOUNCEMENTS
In March 2004, The FASB issued EITF Issue No. 03-1 (EITF 03-1), "The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments" which provides new guidance for assessing impairment losses on
investments. Additionally, EITF 03-1 includes new disclosure requirements for
investments that are deemed to be temporarily impaired. In September 2004, the
FASB delayed the accounting provisions for EITF 03-1; however the disclosure
requirements remain effective for annual periods ending after June 15, 2004. We
will evaluate the impact of EITF 03-1 once final guidance is issued.
In December 2004, the FASB revised Statement No. 123 (FAS 123R),
"Share-Based Payment," which requires companies to expense the estimated fair
value of employee stock options and similar awards based on the grant-date fair
value of the award. The cost will be recognized over the period during which an
employee is required to provide service in exchange for the award, usually the
vesting period. The accounting provisions of FAS 123R will be effective as of
the beginning of the first interim or annual reporting period that begins after
June 15, 2005. We will adopt the provisions of FAS 123R on July 1, 2005 using a
38
modified prospective application. Under the modified prospective application,
FAS 123R, will apply to new awards, unvested awards that are outstanding on the
effective date and any awards that are subsequently modified or cancelled.
Compensation expense for outstanding awards for which the requisite service had
not been rendered as of the effective date will be recognized over the remaining
service period using the compensation cost calculated for pro forma disclosure
purposes under FAS 123 (Note 2 Stock-Based Compensation). We are in the process
of determining how the new method of valuing stock-based compensation as
prescribed in FAS 123R will be applied to valuing stock-based awards granted
after the effective date and the impact the recognition of compensation expense
related to such awards will have on our financial statements.
Inflation. We believe 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, 2004.
Item 7a. Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Risk
Our exposure to market rate risk for changes in interest rates relates to
our investment portfolio. We have not used derivative financial instruments in
our investment portfolio. We place our investments with high-quality issuers
and, by policy, limit the amount of credit exposure to any one issuer. We
protect and preserve our invested funds by limiting default, market and
reinvestment risk. Our investments in marketable securities consist of
high-grade corporate and government securities with maturities of less than
three years. Investments purchased with an original maturity of three months or
less are considered to be cash equivalents. We classify all of our investments
as available-for-sale. Available-for-sale securities are carried at fair value,
with unrealized gains and losses, net of tax, reported in a separate component
of stockholders' equity. Average maturity of our investment portfolio is
approximately 3 months; therefore, the movement of interest rates should not
have a material impact on our balance sheet or income statement.
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, 2004 and 2003, 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, 2004 and 2003.
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 $323,000 at December 31, 2004 and
approximately $194,000 at December 31, 2003. 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 $645,000 at December 31, 2004 and
approximately $388,000 at December 31, 2003.
39
The following table provides information about our investment portfolio at
December 31, 2004:
(in thousands)
Estimated
Debt Securities Cost Fair Value
Due in one year or less:
Short-term munis-taxable $ 120,725 $ 120,725
Corporate 15,724 15,682
Governments/Agencies 75,087 74,789
Total due in one year $ 211,536 $ 211,196
Due in one to three years:
Government/Agencies 14,364 14,256
Total due in one to three years 14,364 14,256
Grand total $ 225,900 $ 225,452
Actual maturities may differ from contractual maturities because the issuer
of the securities may have the right to repurchase such securities. We classify
short-term investments in current assets, as all such investments are available
for current operations.
Foreign Currency Fluctuations
Our performance can be affected by changes in foreign currency values
relative to the U.S. dollar in relation to our revenue and operating expenses.
We have entered into forward foreign exchange contracts in an effort to 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 (mainly in Europe and Asia Pacific). 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. Gains and losses on foreign exchange
contracts are recognized in income in the same period as gains and losses occur.
Our forward contracts have an original maturity of three months. These contracts
were opened on the last business day of the quarter and thus had a nominal fair
value as of December 31, 2004.
Cumulative other comprehensive income increased from a gain of $5.6 million
during 2003, to a gain of $11.0 million during 2004, due to unrealized foreign
currency translation gains of $5.4 million resulting from the strengthening of
the Euro against the U.S. dollar during 2004.
40
Item 8. Financial Statements and Supplementary Data
The consolidated financial statements for the years ended December 31,
2004, 2003 and 2002 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.
Item 9a. Controls and Procedures
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure
that information required to be disclosed in our Exchange Act reports are
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission'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
for timely decisions regarding required disclosure. In designing and evaluating
the disclosure controls and procedures, management recognizes that any controls
and procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and in
reaching a reasonable level of assurance, management necessarily was required to
apply its judgment in evaluating the cost-benefit relationship of possible
controls and procedures.
As of December 31, 2004, the end of the period covered by this report, an
evaluation was carried out under the supervision and with the participation of
our management, including our Chief Executive Officer and our Chief Financial
Officer, of the effectiveness of the design and operation of our disclosure
controls and procedures as required by Securities Exchange Act of 1934 Rule 13a
- - 15(b). Based on the foregoing, our Chief Executive Officer and Chief Financial
Officer concluded that our disclosure controls and procedures were effective at
the reasonable assurance level. There has been no change in our internal
controls over financial reporting during our most recent fiscal quarter that has
materially affected, or is reasonably likely to materially affect, our internal
controls over financial reporting
Management's Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate
internal control over financial reporting; as such term is defined in the
Securities Exchange Act of 1934 Rules 13a-15(f). Under the supervision of our
management, including our principal executive officer and principal financial
officer, we conducted an evaluation of our internal controls over financial
reporting. We based our evaluation on the framework in Internal Control -
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). Based on our evaluation under the framework in
Internal Control - Integrated Framework, management has concluded that our
internal control over financial reporting was effective as of December 31, 2004.
Our management's assessment of the effectiveness of our internal control
over financial reporting as of December 31, 2004 has been audited by Deloitte
and Touche LLP, an independent registered public accounting firm that also
audited our financial statements, as stated in their report which is included
herein.
41
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of
FileNet Corporation
Costa Mesa, California
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control Over Financial Reporting, that FileNet
Corporation and subsidiaries (the "Company") maintained effective internal
control over financial reporting as of December 31, 2004, based on criteria
established in Internal Control--Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. The Company's management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on management's
assessment and an opinion on the effectiveness of the Company's internal control
over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management's assessment, testing
and evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinions.
A company's internal control over financial reporting is a process designed
by, or under the supervision of, the company's principal executive and principal
financial officers, or persons performing similar functions, and effected by the
company's board of directors, management, and other personnel to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial
reporting, including the possibility of collusion or improper management
override of controls, material misstatements due to error or fraud may not be
prevented or detected on a timely basis. Also, projections of any evaluation of
the effectiveness of the internal control over financial reporting to future
periods are subject to the risk that the controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
In our opinion, management's assessment that the Company maintained
effective internal control over financial reporting as of December 31, 2004, is
fairly stated, in all material respects, based on the criteria established in
Internal Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Also in our opinion, the Company
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2004, based on the criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated financial
statements and financial statement schedule as of and for the year ended
December 31, 2004 of the Company and our report dated March 11, 2005 expressed
an unqualified opinion on those financial statements and the financial statement
schedule.
/s/ Deloitte and Touche LLP
Deloitte and Touche LLP
Costa Mesa, California
March 11, 2005
42
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," under the caption "Section 16(a) Beneficial Ownership Reporting
Compliance" and under the caption "Code of Ethics" of our definitive Proxy
Statement for our 2005 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 2005 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 2005 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
2005 Annual Meeting to be filed with the Securities and Exchange Commission.
Item 14. Principal Accountant Fees and Services
We hereby incorporate by reference the information appearing under the
caption "Principal Accountant Fees and Services" of our definitive Proxy
Statement for our 2005 Annual Meeting to be filed with the Securities and
Exchange Commission.
43
PART IV
Item 15. Exhibits, Financial Statement Schedule
(a) Report of Independent Registered Public Accounting Firm, Financial
Statements and Financial Statement Schedule
Page
Report of Independent Registered Public Accounting Firm F-2
Consolidated Balance Sheets at December 31, 2004 and December 31, 2003 F-3
Consolidated Statements of Operations for each of the three years in
the period ended December 31, 2004 F-4
Consolidated Statements of Comprehensive Operations for each of the
three years in the period ended December 31, 2004 F-5
Consolidated Statements of Stockholders' Equity for each of the three
years in the period ended December 31, 2004 F-6
Consolidated Statements of Cash Flows for each of the three years in
the period ended December 31, 2004 F-7
Notes to Consolidated Financial Statements F-8
Schedule II. Valuation and Qualifying Accounts and Reserves S-1
44
(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).
10.2*+ 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).
10.2.1*+ Amendment to the 1995 Stock Option Plan approved by Registrant's Board of Directors dated May 7, 2003
(filed as Exhibit 10.2.1 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30,
2003).
10.2.2*+ Amended Form of 1995 Executive Officer Stock Option Agreement (filed as Exhibit 10.2.2 to
Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003).
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).
10.6*+ 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).
10.10*+ 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).
45
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).
10.14.3*+ Amendment to the 2002 Incentive Award Plan dated May 7, 2003 (filed as Exhibit 10.14.3 to
Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2003).
10.14.4*+ Amended and Restated 2002 Incentive Award Plan of FileNet Corporation, (filed on April 1, 2004 as
Appendix B of Registrant's Definitive Proxy Statement for its 2004 Annual Meeting of Stockholders).
10.15* Stock Purchase Agreement dated April 2, 2003 by and among Registrant, FileNet Nova Scotia
Corporation, Shana Corporation and certain Sellers (filed as Exhibit 10.15 to Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2003).
10.15.1* Escrow Agreement dated April 2, 2003 by and among FileNet Nova Scotia Corporation, certain Sellers
and Bennett Jones LLP (filed as Exhibit 10.15.1 to Registrant's Quarterly Report on Form 10-Q for the
quarter ended June 30, 2003).
10.16*+ Amended and Restated Letter Agreement dated May 15, 2003 by and between Registrant and Lee D.
Roberts, Chief Executive Officer (filed as Exhibit 10.16+ to Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 2003).
10.17*+ Form of Amended and Restated Letter Agreement, dated May 15, 2003, by and between Registrant and the
Chief Financial Officer and President (filed as Exhibit 10.17 to Registrant's Quarterly Report on
Form 10-Q for the quarter ended June 30, 2003)(1).
10.18*+ Form of Amended and Restated Letter Agreement by and among Registrant and certain Executive Officers
(filed as Exhibit 10.18 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30,
2003).(2)
10.19*+ CEO Severance Agreement together with Addendum II to Stock Option Agreement between Registrant and
Mr. Lee D. Roberts (filed as Exhibit 10.19 to Registrant's Quarterly Report on Form 10-Q for the
quarter ended June 30, 2003).
10.20*+ Form of Restricted Stock Agreement between Registrant and certain Executive Officers (filed as Exhibit
10.21 to Registrant's Quarterly report on form 10-Q for the quarter ended March 31, 2004).
21.1 List of subsidiaries of Registrant (filed as FileNet Corporation Subsidiary Information).
23.1 Consent of Independent Registered Public Accounting Firm
31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act
31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act
32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act
32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act
________________________________________________________________________________________________________________
* Incorporated herein by reference + Management contract, compensatory plan or arrangement
(1) Amended and Restated Letter Agreement, dated May 15, 2003 was entered into by and between Registrant
and Messrs. Sam Auriemma, Chief Financial Officer and Ron L. Ercanbrack, President
(2) Amended and Restated Letter Agreement, dated May 15, 2003 was entered into by and between Registrant
and Messrs. Martyn D. Christian, David D. Despard, Frederick P. Dillon, Karl J. Doyle, William J.
Kreidler, Chas W. Kunkelmann, Philip Rugani, Daniel S. Whelan, Franz X. Zihlmann, and Ms. Audrey N.
Schaeffer. Amended and Restated Letter Agreement with substantially the same terms and conditions
was entered into between Registrant and Philip C. Maynard dated August 30, 2004, and L. Kim
Poindexter dated January 1, 2005.
46
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 15, 2005 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 15, 2005 /s/ Lee D. Roberts .
Lee D. Roberts
Chief Executive Officer and
Chairman of the Board
(Principal Executive Officer)
March 15, 2005 /s/ Sam M. Auriemma .
Sam M Auriemma,
Chief Financial Officer and Senior Vice
President, Finance (Principal Financial
and Accounting Officer)
March 15, 2005 /s/ Theodore J. Smith .
Theodore J. Smith
Director
March 15, 2005 /s/ L. George Klaus .
L. George Klaus
Director
March 15, 2005 /s/ John C. Savage .
John C. Savage
Director
March 15, 2005 /s/ Roger S. Siboni .
Roger S. Siboni
Director
47
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
Report of Independent Registered Public Accounting Firm F-2
Consolidated Balance Sheets at December 31, 2004 and December 31, 2003 F-3
Consolidated Statements of Operations for each of the three years in the
period ended December 31, 2004 F-4
Consolidated Statements of Comprehensive Operations for each of the
three years in the period ended December 31, 2004 F-5
Consolidated Statements of Stockholders' Equity for each of the three years
in the period ended December 31, 2004 F-6
Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 2004 F-7
Notes to Consolidated Financial Statements F-8
Schedule II. Valuation and Qualifying Accounts and Reserves S-1
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and the Board of Directors of
FileNet Corporation:
We have audited the accompanying consolidated balance sheets of FileNet
Corporation and subsidiaries (the "Company") as of December 31, 2004 and 2003,
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, 2004. Our audits also included the financial statement
schedule listed in the Index at Item 15(a). These financial statements and the
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on the financial statements and the
financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). 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
subsidiaries as of December 31, 2004 and 2003, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2004, in conformity with accounting principles generally accepted
in the United States of America. Also, in our opinion, such 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.
We have also audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the effectiveness of the
Company's internal control over financial reporting as of December 31, 2004,
based on Internal Control--Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission, and our report dated March
11, 2005 expressed an unqualified opinion on management's assessment of the
effectiveness of the Company's internal control over financial reporting and an
unqualified opinion on the effectiveness of the Company's internal control over
financial reporting.
/s/ Deloitte and Touche LLP
Deloitte and Touche LLP
Costa Mesa, California
March 11, 2005
F-2
CONSOLIDATED BALANCE SHEETS
ASSETS
(in thousands, except share and per share amounts)
December 31, 2004 2003
Current assets:
Cash and cash equivalents $ 123,217 $ 100,605
Short-term investments 211,196 134,986
Accounts receivable, net of allowances for doubtful accounts
and sales returns of $3,835 and $3,917 at December 31,
2004 and 2003, respectively 35,878 38,096
Prepaid expenses and other current assets 12,179 13,174
Deferred income taxes 3,681 3,551
Total current assets 386,151 290,412
Property, net 21,738 26,922
Long-term investments 14,256 12,672
Goodwill 27,268 26,170
Intangible assets, net of accumulated amortization of $4,750 and
$2,386 at December 31, 2004 and 2003, respectively 6,188 7,979
Deferred income taxes 36,028 23,001
Other assets 2,037 4,692
Total assets $ 493,666 $ 391,848
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 13,868 $ 11,006
Accrued compensation and benefits 33,674 27,648
Customer deposits and advances 9,007 5,217
Unearned customer support revenue 47,145 40,691
Income tax payable 5,374 1,492
Other accrued liabilities 14,201 15,032
Total current liabilities 123,269 101,086
Unearned customer support revenue 2,533 1,614
Commitments and contingencies (Notes 9, 14 and 15)
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;
41,690,989 shares issued and 40,592,989 shares outstanding at
December 31, 2004; and 38,906,640 shares issued and
37,808,640 shares outstanding at December 31, 2003 284,490 234,025
Deferred compensation (6,530) -
Retained earnings 93,512 64,098
Accumulated other comprehensive income 10,959 5,592
Treasury stock, at cost; 1,098,000 shares at 382,431 303,715
December 31, 2004 and 2003 (14,567) (14,567)
Net stockholders' equity 367,864 289,148
Total liabilities and stockholders' equity $ 493,666 $ 391,848
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, 2004 2003 2002
Revenue:
Software $ 154,279 $ 149,214 $ 132,508
Customer support 188,011 167,230 157,550
Professional services and education 55,268 48,061 56,959
Total revenue 397,558 364,505 347,017
Cost of revenue:
Cost of software 15,122 13,800 10,565
Cost of customer support 41,989 42,785 44,603
Cost of professional services and education revenue 44,954 42,346 50,408
Total cost of revenues 102,065 98,931 105,576
Gross profit 295,493 265,574 241,441
Operating expenses:
Research and development 78,248 77,050 71,735
Selling and marketing 159,716 144,975 132,109
General and administrative 35,363 32,466 31,656
In-process research and development - - 400
Total operating expenses 273,327 254,491 235,900
Operating income 22,166 11,083 5,541
Other income, net 5,959 4,084 5,209
Income before income taxes 28,125 15,167 10,750
Provision (benefit) for income taxes (1,289) 4,247 2,478
Net income $ 29,414 $ 10,920 $ 8,272
Earnings per share:
Basic $ .75 $ .30 $ .23
Diluted $ .72 $ .29 $ .23
Weighted average shares outstanding:
Basic 39,095 36,532 35,590
Diluted 40,994 38,089 36,709
See accompanying Notes to Consolidated Financial Statements
F-4
CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
(in thousands)
Year Ended December 31, 2004 2003 2002
Net income $ 29,414 $ 10,920 $ 8,272
Other comprehensive income:
Foreign currency translation
adjustments 5,590 12,093 7,631
Unrealized holding gains (losses) on
available-for-sale securities, net of tax (223) (119) 27
Other comprehensive income 5,367 11,974 7,658
Comprehensive income $ 34,781 $ 22,894 $ 15,930
See accompanying Notes to Consolidated Financial Statements
F-5
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
Accumulated
Common Other
Stock Deferred Retained Comprehensive Treasury Stock
Shares Amount Compensation Earnings Operations Shares Amount Total
Balances at January 1, 2002 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
benefit 685 685
Common stock issued under the
Employee Qualified Stock
Purchase Plan 339 3,712 3,712
Foreign currency translation
adjustment 7,631 7,631
Unrealized holding gains on
available-for-sale-securities 27 27
Net income 8,272 8,272
Balances at December 31, 2002 37,015 $ 206,676 $ - $ 53,178 $ (6,382) $ (1,098) $ (14,567) $ 238,905
Stock options exercised 1,553 17,569 17,569
Stock option income tax
benefit 5,865 5,865
Common stock issued under
the Employee Qualified Stock
Purchase Plan 339 3,788 3,788
Non-employee stock
compensation 127 127
Foreign currency translation
adjustment 12,093 12,093
Unrealized holding gains on
available-for-sale-securities (119) (119)
Net income 10,920 10,920
Balances at December 31, 2003 39,907 $ 234,025 $ - $ 64,098 $ 5,592 $ (1,098) $ (14,567) $ 289,148
Stock options exercised 2,271 30,669 30,669
Stock option income tax
benefit 7,087 7,087
Common stock issued under
the Employee Qualified Stock
Purchase Plan 236 5,445 5,445
Non-employee stock
compensation 4 4
Restricted stock granted 277 7,260 (6,530) 730
Foreign currency translation
adjustment 5,590 5,590
Unrealized holding gains on
available-for-sale-securities (223) (223)
Net income 29,414 29,414
Balances at December 31, 2004 41,691 $ 284,490 $ (6,530) $ 93,512 $ 10,959 $ (1,098) $ (14,567) $ 367,864
See accompanying Notes to Consolidated Financial Statements
F-6
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31, 2004 2003 2002
Cash flows provided by operating activities:
Net income $ 29,414 $ 10,920 $ 8,272
Adjustments to reconcile net income to net cash
provided by operating activities:
Purchased in-process research and development - 400
Depreciation and amortization 16,350 19,378 21,588
Loss on sale of fixed assets 426 27 47
Provision for doubtful accounts and sales returns 1,108 653 1,752
Deferred income taxes (13,158) (3,956) 1,629
Stock option income tax benefit 7,087 5,865 685
Changes in operating assets and liabilities, net of
effects of acquisition:
Accounts receivable 1,918 8,835 (7,818)
Prepaid expenses and other current assets 920 3,723 (3,000)
Accounts payable 2,502 2,325 (940)
Accrued compensation and benefits 5,301 5,309 2,101
Customer deposits and advances 3,774 2,198 (1,895)
Unearned customer support revenue 6,855 (2,276) 4,651
Income taxes payable 3,898 2,349 (3,966)
Other assets and liabilities 3,625 (3,183) (2,066)
Net cash provided by operating activities 70,020 52,167 21,440
Cash flows used for investing activities:
Capital expenditures (9,435) (9,177) (10,825)
Proceeds from sale of property 106 135 66
Note receivable - 294 (1,900)
Cash paid for acquisitions, net of cash acquired - (8,073) (9,359)
Purchases of investments (131,360) (141,668) (151,578)
Proceeds from sales and maturities of investments 52,225 94,305 146,571
Net cash used in investing activities (88,464) (64,184) (27,025)
Cash flows provided by financing activities:
Proceeds from issuance of common stock 36,114 21,357 6,465
Principal payments on capital lease obligations - (16) (1,799)
Net cash provided by financing activities 36,114 21,341 4,666
Effect of exchange rate changes on cash and cash
equivalents 4,942 9,927 6,521
Net increase in cash and cash equivalents 22,612 19,251 5,602
Cash and cash equivalents, beginning of year 100,605 81,354 75,752
Cash and cash equivalents, end of year $ 123,217 $ 100,605 $ 81,354
Supplemental cash flow information:
Interest paid $ 38 $ 48 $ 100
Income taxes paid $ 349 $ 3,050 $ $4,301
See Note 4 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 framework for Enterprise Content Management ("ECM") software that
delivers capabilities in a tightly integrated offering. 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 value added resellers, system integrators and independent
software vendors.
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, contingencies and income
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. Gains and losses from
foreign currency transactions are included in other income, net. Transaction
gains incurred during the years ended December 31, 2004, 2003 and 2002 were
approximately $890,000, $700,000, and $1.5 million, 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 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. During 2004 the Company changed the classification of certian
securitites from cash equivalents to short-term investments and reclassified
prior years to the current year's presentation (Note 7).
Investments. The Company's investments consist of marketable 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 16).
Fair Value of Financial Instruments. The recorded amounts of financial
assets and liabilities at December 31, 2004 and 2003, 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.
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 economic lives of the improvements or the term of the related
lease (Note 8).
Long-Lived Assets. The Company accounts for the impairment and disposition
of long-lived assets in accordance with SFAS No. 144, "Accounting for Impairment
or Disposal of Long-Lived Assets." 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 from future cash flows. Based on the
Company's most recent analysis, the Company believes there is no impairment at
December 31, 2004.
Goodwill. SFAS No. 142, "Goodwill and Other Intangible Assets," requires
that goodwill and other intangible assets with indefinite useful lives be tested
for impairment annually or when events or changes in circumstances indicate that
the carrying amount of these assets may not be recoverable. In accordance with
SFAS No. 142, the Company does not amortize goodwill, but performs the required
two-step impairment review each year. Step one of this review determines whether
the fair value of each reporting unit is less than its carrying amount as of the
measurement date. In the event that the fair value of each reporting unit was
less than the carrying amount, step two of the test would be required to
determine if the carrying value of goodwill exceeded the implied value. The
Company performed an impairment analysis as of July 1, 2004 in accordance with
SFAS 142. The analysis indicated there was no impairment of goodwill in any of
the reporting segments. As of December 31, 2004, no impairment of goodwill has
been recognized. If estimates change, a materially different impairment
conclusion could result.
F-9
Revenue Recognition. The Company derives revenues from the following
sources: (1) software, which includes software licenses, 2) customer support
revenues, which include annual support agreements, and (3) professional
services, which include consulting, implementation and training services.
The basis for software revenue recognition is governed by the provisions of
Statement of Position No. 97-2, Software Revenue Recognition, issued by the
American Institute of Certified Public Accountants. Accordingly, software
license revenue is recognized when: (1) the Company enters into a legally
binding arrangement with a customer for the license of software; (2) the Company
delivers the products; (3) customer payment is deemed fixed or determinable and
free of contingencies or significant uncertainties; and (4) collection is
probable.
The Company's software license arrangements include multiple elements,
including software, postcontract customer support agreements and professional
services such as consulting, implementation and training. We recognize revenue
in multiple element arrangements using the residual method of revenue
recognition in accordance with SOP 98-9. Under the residual method, the fair
value of the undelivered elements is deferred and the remaining portion of the
arrangement fee is allocated to the delivered elements and is recognized as
revenue, assuming all other revenue recognition criteria have been met. If
evidence of fair value for each undelivered element of the arrangement does not
exist, all revenue from the arrangement is recognized when evidence of fair
value is determined or when all elements of the arrangement are delivered.
Vendor specific objective evidence ("VSOE") of fair value for customer
support is determined by reference to the price the Company's customers pay for
such support when sold separately; that is, the renewal rates offered to
customers. Revenue from customer support contracts is recognized ratably over
the term of the arrangement, which is typically 12 months.
VSOE of fair value for professional services is based upon the established
pricing and discounting practices for those services when sold separately. The
Company's professional service revenue is derived primarily from time and
materials based contracts that typically range from 3 months to 1 year in
duration. Revenue is recognized on such contracts as time is incurred and
approved by the customer. The Company may also provide fixed fee quotes in some
contracts. Nearly all fixed price contracts are 1 month or less in duration.
Revenue from such short term fixed price contracts is recognized upon completion
of the work and customer acceptance. Professional services are not required for
the software to function and the Company does not make changes to the standard
software code in the field.
The Company assesses whether fees are fixed or determinable at the time of
sale. Standard payment terms range from net 30 to net 90 days. Payments that are
due within 90 days are deemed to be fixed or determinable based on the Company's
successful collection history on such arrangements. To the extent the Company
elects to provide extended payment terms beyond 90 days for competitive or other
reasons, revenue is recognized when the amounts become due.
In addition to direct customer sales, the Company sells through third party
channel partners. The Company's channel partners do not inventory the Company's
software products; rather, shipments are made only when the partner places an
order for a specific end user. The Company requires its channel partners to
provide the Company with the name and address of all end users at the time an
order is placed and, in many cases, the Company ships its product directly to
the end user. Thus, software license revenue from channel partners is recognized
when an end user is identified, product is delivered either to a channel partner
or to their designated end-user and all other revenue recognition criteria are
met.
F-10
Product Warranty. The Company provides a 90-day warranty for its software
products against substantial non-conformance to the published documentation at
the time of delivery. The incremental cost of services performed under warranty
obligations has historically not been significant.
Research and Development Costs. We expense research and development costs
as incurred. The Company does not consider its new products or new versions to
be technologically feasible until all design specifications for functionality,
features and technical performance are completed and all uncertainties related
to identified high-risk development issues are resolved. Once all high-risk
development issues are resolved and the program design is finalized, the
products have historically been considered ready for general release. As a
result, no amounts are required to be capitalized in accordance with SFAS No.
86, "Accounting for the Costs of Computer Software to Be Sold, Leased, or
Otherwise Marketed," because no significant costs are incurred subsequent to 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
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 12).
Earnings Per Share. Basic earnings per share are 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. (Note 5).
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."
The following table summarizes the Company's net income and earnings 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:"
F-11
(In thousands, except per share amounts)
December 31, 2004 2003 2002
Net income, as reported $ 29,414 $ 10,920 $ 8,272
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (7,821) (7,429) (8,735)
Pro forma net income (loss) $ 21,593 $ 3,491 $ (463)
Earnings per share:
Basic earnings per share - as reported $ 0.75 $ 0.30 $ 0.23
Basic earnings (loss) per share - pro forma $ 0.55 $ 0.10 $ (0.01)
Diluted earnings per share - as reported $ 0.72 $ 0.29 $ 0.23
Diluted earnings (loss) per share - pro forma $ 0.53 $ 0.09 $ (0.01)
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 2004, 2003 and 2002:
______________________________________________________________________________________________________
2004 2003 2002
Expected volatility 76% 58% 68%
Risk-free interest rates 3.07% - 3.72% 1.63% - 4.76% 2.0% to 4.61%
Expected life (years) 5.46 5.56 5.60
Dividend 0% 0% 0%
Pro forma compensation cost also includes the fair value of awards issued
under the Employee Stock Purchase Plan.
Recently Issued Accounting Pronouncements
Note 3. New Accounting Pronouncements
In March 2004, The FASB issued EITF Issue No. 03-1 (EITF 03-1), "The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments" which provides new guidance for assessing impairment losses on
investments. Additionally, EITF 03-1 includes new disclosure requirements for
investments that are deemed to be temporarily impaired. In September 2004, the
FASB delayed the accounting provisions for EITF 03-1; however the disclosure
requirements remain effective for annual periods ending after June 15, 2004. The
Company will evaluate the impact of EITF 03-1 once final guidance is issued.
In December 2004, the FASB revised Statement No. 123 (FAS 123R),
"Share-Based Payment," which requires companies to expense the estimated fair
value of employee stock options and similar awards based on the grant-date fair
value of the award. The cost will be recognized over the period during which an
employee is required to provide service in exchange for the award, usually the
vesting period. The accounting provisions of FAS 123R will be effective as of
the beginning of the first interim or annual reporting period that begins after
F-12
June 15, 2005. The Company will adopt the provisions of FAS 123R on July 1, 2005
using a modified prospective application. Under the modified prospective
application, FAS 123R, will apply to new awards, unvested awards that are
outstanding on the effective date and any awards that are subsequently modified
or cancelled. Compensation expense for outstanding awards for which the
requisite service had not been rendered as of the effective date will be
recognized over the remaining service period using the compensation cost
calculated for pro forma disclosure purposes under FAS 123 (Note 2 Stock-Based
Compensation). The Company is in the process of determining how the new method
of valuing stock-based compensation as prescribed in FAS 123R will be applied
to valuing stock-based awards granted after the effective date and the impact
the recognition of compensation expense related to such awards will have
on its financial statements.
Reclassifications. Certain reclassifications have been made to prior-years'
balances to conform to the current year's presentation (see Note 7 and Note 13).
Note 4. Acquisitions
On April 2, 2002, the Company acquired certain assets and assumed certain
liabilities of eGrail, Inc. ("eGrail"), a Web content management company. This
strategic acquisition provides additional Web Content Management ("WCM")
software application capabilities that expand the Company's position in the
Enterprise Content Management ("ECM") market, which contributed to the purchase
price that resulted in goodwill. The purchase price for the acquisition
consisted of $9.0 million in cash consideration and direct acquisition costs of
$359,000.
On April 2, 2003, the Company completed a stock purchase acquisition of
Shana Corporation ("Shana"), an electronic forms management company. This
strategic acquisition provides technology and experience to expand the Company's
ECM offering with Enterprise Forms Management capability, which contributed to
the purchase price and resulted in goodwill. The purchase price for the
acquisition consisted of $8.55 million in cash consideration, less $938,000 of
acquired cash, plus $184,000 in acquisition expenses and $277,000 paid for
Non-Compete Agreements. The Company had previously invested in licensing Shana's
technology, and the book value of the investment as of the acquisition date was
included as purchase consideration.
In accordance with SFAS No. 141, "Business Combinations," these
acquisitions were accounted for under the purchase method of accounting. The
purchase price was allocated as follows:
(in thousands)
eGrail, Inc. Shana Corp.
April 2, 2002 April 2, 2003
Net tangible assets $ 581 $ 2,725
Patents 24 -
Goodwill 5,793 7,235
Acquired technology 3,300 4,000
Technical manuals and design documents - 600
Customer support relationships - 800
In-process research and development 400 -
Non-Compete Agreements - 277
Liabilities assumed (739) (2,494)
Previous investment in Shana technology - (1,756)
Deferred tax liability - (2,376)
Total cash purchase price $ 9,359 $ 9,011
Less cash acquired - (938)
Net cash paid $ 9,359 $ 8,073
F-13
The Company allocated the purchase price for these acquisitions based on
fair value. Statement of Financial Accounting Concepts No. 7 defines fair value
as the amount at which an asset (or liability) could be bought or sold in a
current transaction between willing parties, that is, other than in a forced or
liquidation sale.
The valuation of the eGrail assets included $400,000 of in-process research
and development, which was expensed upon acquisition because technological
feasibility had not been established and no future alternative uses existed. New
product development underway at eGrail at the time of the acquisition included
the next generation of their 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 12-month period. As of March 31, 2003 the project was 100% complete
and the Company incurred approximately $4.8 million of research and development
expenses related to the project. The acquired technology of $3.3 million was
assigned a useful life of five years and patents of $24,000 were assigned a
useful life of two years. The remaining purchase price of $6.0 million was
allocated to tangible assets and goodwill. Goodwill of $5.8 million was tax
deductible for this asset purchase.
The acquisition of Shana resulted in acquired technology, technical manuals
and design documents, and customer support relationships. Since Shana had
recently completed Version 4.1 of its eForms product, there was no in-process
research and development underway at the time of the acquisition. Shana's
technology manuals and design documents are the "roadmaps" for the eForms
technology and will be used by FileNet in its product development. Recurring
support revenues were expected and estimable for Shana's customers based on the
older and newer versions of eForms technology. The acquired technology of $4.0
million, the technical manuals and design documents of $600,000, and the
customer support relationships of $800,000 were assigned a useful life of five
years. The remaining purchase price of $7.2 million was allocated to goodwill.
Although the goodwill stemming from the Shana stock purchase is non-deductible
for Canadian tax purposes, the Company made a Section 338(g) election that will
result in the deductibility of goodwill and other intangibles for U.S. tax
purposes on this transaction.
Actual results of operations of the acquired eGrail business, as well as
assets and liabilities of the acquired eGrail business, are included in the
audited consolidated financial statements from the date of acquisition. The pro
forma results of operations data for 2002 presented below assume that the eGrail
acquisition had been made at the beginning of fiscal 2002. The pro forma data is
presented for informational purposes only and is not necessarily indicative of
the results of future operations nor of the actual results that would have been
achieved had the acquisition taken place at the beginning of fiscal 2002. No pro
forma information has been presented for the Shana acquisition, as the result
did not have a material impact on the financial statements of the Company during
the periods presented.
(in thousands)
2002 Pro Forma
(unaudited)
Revenue $ 347,769
Net income 6,425
Earnings per share:
Basic $ 0.18
Diluted $ 0.17
F-14
Note 5 Earnings Per Share
Basic earnings per share are computed by dividing net income for the period
by the weighted-average number of common shares outstanding during the period.
Diluted earnings per share is computed by dividing net income by the
weighted-average number of common shares outstanding plus the dilutive effect of
outstanding stock options, shares available for issue under the employee stock
purchase plan and restricted stock issued to key executive management using the
treasury stock method. The number of anti-dilutive options excluded from the
earnings per share calculation for 2004, 2003 and 2002 was 1,943,014, 596,517
and 6,044,213 shares, respectively. The number of unvested restricted stock
excluded from shares used in computing basic earnings per share was 175,000
shares for 2004. The number of unvested restricted stock included in computing
diluted earnings per share was 17,141 shares for 2004. The following table is a
reconciliation of the earnings and share amounts used in the calculation of
basic earnings per share and diluted earnings per share (in thousands, except
per share amounts):
_______________________________________________
2004 2003 2002
Net Income $ 29,414 $ 10,920 $ 8,272
Shares used in computing
basic earnings per share 39,095 36,532 35,590
Dilutive effect of stock plans 1,899 1,557 1,119
Shares used in computing
diluted earnings per share 40,994 38,089 36,709
Earnings per basic share $ 0.75 $ 0.30 $ 0.23
Earnings per diluted share $ 0.72 $ 0.29 $ 0.23
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, December 31, 2004 $ 11,235 $ (276) $ 10,959
Current Period Changes 5,590 (223) 5,367
Balance, December 31, 2003 $ 5,645 $ (53) $ 5,592
Current Period Changes 12,093 (119) 11,974
Balance, December 31, 2002 $ (6,448) $ 66 $ (6,382)
Current Period Changes 7,631 27 7,658
Balance, January 1, 2002 $ (14,079) $ 39 $ (14,040)
F-15
Note 7 Investment Securities Available-for-Sale
The Company's investments in marketable securities consist 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 sale: 2004 2003
Cost $ 225,900 $ 147,670
Gross unrealized losses (448) (12)
Estimated fair value $ 225,452 $ 147,658
There were no significant realized gains or losses for the years ended
December 31, 2004, 2003 and 2002. Unrealized holding gains and losses on
investments, net of tax, are included in accumulated other comprehensive
operations in stockholders' equity at December 31, 2004 and 2003, and were a
cumulative loss of $276,000 and $53,000, respectively. The change year over year
was an unrealized loss of $223,000.
A portion of the Company's investments consist of auction rate securities
that reset interest rates at auction intervals ranging from 7, 28, 35 or 49
days. These securities are readily saleable at par value on the auction dates
and the carrying value approximates fair value throughout the holding period. In
prior years, auction rate securities were included in cash equivalents. In 2004,
the Company determined such amounts should properly be classified as short-term
investments. As a result, the Company has reclassified $102.7 million in the
fiscal 2003 consolidated balance sheet from cash and cash equivalents to
short-term investments to conform to the current year presentation.
Additionally, the Company reclassified prior years' statements of cash flows to
remove the amounts from cash equivalents and record the net purchases of auction
rate securities of $53.9 million and $17.1 million for fiscal 2003 and 2002,
respectively, as an investing activity.
The contractual maturities of investments at December 31, 2004 and 2003 are
shown below. Actual maturities may differ from contractual maturities because
the issuer of the securities may have the right to repurchase such securities.
The Company classifies short-term investments in current assets, as all such
investments are available for current operations.
(in thousands)
2004 2003 .
Unrealized Estimated Unrealized Estimated
Cost Gain/(Loss) Fair Value Cost Gain/(Loss) Fair Value
Debt Securities
Due in one year or less:
Short-term munis-taxable $ 120,725 $ - $ 120,725 $ 111,013 11 $ 111,024
Corporate 15,724 (42) 15,682 8,442 (2) 8,440
Governments/Agencies 75,087 (298) 74,789 15,526 (4) 15,522
Total 211,536 (340) 211,196 134,981 5 134,986
Due in one to three years:
Corporate - - - 2,189 (7) 2,182
Governments/Agencies 14,364 (108) 14,256 10,500 (10) 10,490
Total 14,364 (108) 14,256 12,689 (17) 12,672
Grand Total $ 225,900 $ (448) $ 225,452 $ 147,670 $ (12) $ 147,658
F-16
Note 8 Property
Property consisted of the following at December 31:
(in thousands)
2004 2003
Equipment and software $ 116,669 $ 127,265
Furniture and fixtures 14,025 14,350
Leasehold improvements 23,752 24,344
Total property 154,446 165,959
Less accumulated depreciation and amortization (132,708) (139,037)
Property, net $ 21,738 $ 26,922
Note 9 Leases and Commitments
The Company leases its corporate offices, sales offices, development and
manufacturing facilities, and equipment under non-cancelable operating leases,
some of which have renewal options and may 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 $13.2 million; $13.8 million and
$16.0 million for the years ended December 31, 2004, 2003 and 2002,
respectively. The following table summarizes future minimum lease payments
required under operating leases at December 31, 2004:
(in thousands)
2005 $ 12,265
2006 12,030
2007 10,131
2008 8,570
2009 6,865
Thereafter 5,785
Total $ 55,646
The Company licenses certain software from third parties with contractual
arrangements that require future payment obligations. At December 31, 2004 this
obligation was $3.0 million and was due the following year. The Company entered
into a development contract with a third party vendor during 2003. At December
31, 2004 the Company had an obligation to pay $4.2 million under this contract.
Note 10 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. Under SFAS No. 142 goodwill and indefinite life intangibles are
not amortized but rather reviewed and analyzed for possible impairment at least
annually or when circumstances occur that indicate the carrying value of
goodwill may not be recoverable. Goodwill was not impaired at December 31, 2004.
Intangible assets with definite lives must be amortized over their estimated
useful lives. A portion of goodwill and intangible assets were allocated to the
F-17
Company's Ireland subsidiary and therefore the two following tables reflect
amounts resulting from foreign exchange translation.
The following table presents the changes in goodwill by reporting segment
during 2004 and 2003:
(in thousands)
Professional
Customer Services and
Software Support Education Total
Balance, January 1, 2003 $ 9,187 $ 3,962 $ 3,758 $ 16,907
Acquired 4,826 1,353 1,056 7,235
Foreign currency effect 1,177 446 405 2,028
Balance, December 31, 2003 $ 15,190 $ 5,761 $ 5,219 $ 26,170
Foreign currency effect 636 242 220 1,098
Balance, December 31, 2004 $ 15,826 $ 6,003 $ 5,439 $ 27,268
Acquired technology, technical manuals and design documents, customer
support relationships, patents and non-compete agreements 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 the April
2003 Shana acquisition, and are comprised of the following:
(in thousands)
December 31, 2004 December 31, 2003 .
Gross Accumulated Gross Accumulated
Asset Amortization Net Asset Amortization Net
Acquired technology and other
intangibles $ 10,571 (4,496) $ 6,075 $ 10,020 (2,272) $ 7,748
Non-compete agreements 338 (225) 113 317 (90) 227
Patents 29 (29) - 28 (24) 4
Total $ 10,938 (4,750) $ 6,188 $ 10,365 (2,386) $ 7,979
Acquired technology is being amortized over a useful life of five years,
patents were amortized over a useful life of two years and non-compete
agreements are being amortized over three years. Amortization expense for
amortizing intangible assets was $2,109,000 for 2004 and $1,695,000 for 2003.
Estimated future amortization expense of purchased intangible assets as of
December 31, 2004 is as follows (in thousands):
Fiscal Year Amount
2005 $ 2,207
2006 2,134
2007 1,517
2008 330
$ 6,188
F-18
Note 11 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) acquire 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 it is announced that 15% or more of FileNet's common stock has been
acquired.
Restricted Stock. During 2004 the Company awarded restricted stock to
certain members of senior management and members of the product development
team. All of these awards were made under the 2002 Incentive Award Plan. The
fair value of the restricted stock award is recorded in the equity section of
the balance sheet as an increase in common stock and a contra-equity offset to
deferred compensation. All restricted stock awards vest over time and certain
awards include a feature that allows the stock to vest on an accelerated basis
providing certain performance targets are achieved. Certain restricted stock
awards are also subject to Change in Control Agreements and/or termination
without cause provisions that could trigger accelerated vesting. Expense related
to the shares is amortized on a straight-line basis over the vesting period.
The following table summarizes the awards of restricted stock during 2004:
_____________________________________________________________________________________________________________________
Performance
Vesting
Issuance Shares Share Share Acceleration
Date Recipients Issued Price Valuation Vesting Schedule Feature
12/15/2004 Executive Management 25% annually
(Nine members) 105,000 $ 26.640 $ 2,797,200 over four years No
08/30/2004 Chief Legal Officer 15,000 $ 20.275 $ 304,125 12/31/2008 Yes
07/14/2004 Product Development 25% annually
(Eight members) 25,000 $ 20.760 $ 519,000 over four years No
03/09/2004 Executive Management
(Ten members) 132,500 $ 27.470 $ 3,639,775 12/31/2008 Yes
Totals 277,500 $7,260,100 .
Recognition of expense may be accelerated if it becomes probable that
certain performance targets will be achieved that trigger accelerated vesting
for those shares that contain the acceleration feature. Approximately $730,000
of compensation expense was recognized in the twelve-month period ended December
31, 2004, for these restricted stock awards with no acceleration.
F-19
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"). As of December 31, 2004, a total of 2,432,278 shares had
been authorized to be included in the Purchase Plans. 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. During the past three fiscal years
there were no charges or credits to income in connection with the Purchase
Plans. During 2004, 2003 and 2002 the shares issued under the Purchase Plans
were 236,183, 339,236, and 338,716 at a weighted average fair value of $8.91,
$4.40 and $4.72 per share, respectively. At December 31, 2004, $775,804 had been
withheld from employees' salaries pursuant to the Purchase Plans for the current
offering period, which expires on April 30, 2005. At December 31, 2004,
approximately 559,015 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. 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. 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. 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. In May 2003, the Plan was amended to prohibit,
without prior stockholder approval, the re-pricing, replacement or re-granting
through cancellation or lowering the option exercise price of any outstanding
options granted under the Plan. As of December 31, 2004, there are 3,277,230
options exercisable and 278,059 options available for future issuance 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
F-20
subsequent option grant. At December 31, 2004, a total of 1,778 options were
outstanding and exercisable under the Saros Plan. No shares remain outstanding
or exercisable under the Watermark Plan.
Non-employee directors are granted an initial option to purchase 25,000
shares of FileNet common stock at fair market value on the date of grant and an
additional 10,000 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 May 2002, the Company adopted the 2002 Incentive Award Plan (the "2002
Plan"). In May 2003, the 2002 Plan was amended to prohibit, without prior
stockholder approval, the re-pricing, replacement or re-granting through
cancellation or lowering the option exercise price of any outstanding options
granted under the Plan. In May of 2004, the 2002 Plan was amended and restated,
with stockholder approval. These amendments included: increasing the available
shares by 2,000,000 shares from 2,800,000 to 4,800,000 shares; increasing the
number of shares that may be awarded as restricted stock, restricted stock
units, deferred stock, performance awards and stock payments from 140,000 to
700,000 shares; increasing the annual automatic grant of stock option awards to
independent directors from 7,000 to 10,000 shares; and extending the Plan
termination date to February 24, 2014. 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 (36) 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, 2004, there were 477,773
options exercisable and 1,313,507 available for future issuance under the 2002
Plan.
The Company has also granted certain options outside of its shareholder
approved stock option plans. In August 1997, the Company made a Non-Statutory
Stock Option Grant of 600,000 shares, dated May 1997, to the Company's current
Chief Executive Officer and made a Non-Statutory Stock Option Grant of 160,000
shares, dated June 1997, to the Company's current President. In April 2001, the
Company made a Non-Statutory Stock Option Grant of 140,000 shares, dated
September 2000, to the Company's current Chief Financial Officer. Such grants
were in accordance with hiring such persons and the employment agreements
entered into by the Company and the grantees. In September 2003, the Company's
Chief Marketing Officer was granted a Non-Statutory Stock Option Grant of
100,000 shares. These options were subsequently cancelled in March 2004 upon the
termination of employment of the Chief Marketing Officer. All non-plan grants
were made with an exercise price equal to 100% of the fair market value per
share on the date of grant and expire no later than ten years from the date of
grant and all such grants were fully vested as of December 31, 2004. All of
these options were also amended in May 2003 to prohibit repricing. As of
December 31, 2004, there were 196,782 options exercisable related to these
Non-Statutory Stock Option Grants and 703,218 had been exercised to date.
F-21
Information regarding all stock options is as follows:
__________________________________________________________________________________________________
Number of Weighted Average
Options Exercise Price
Balances, January 1, 2002 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
Granted (weighted average fair value of $9.33) 799,100 19.97
Exercised (1,552,892) 11.31
Cancelled (309,811) 17.21
Balances, December 31, 2003 7,642,713 $ 16.31
Granted (weighted average fair value of $13.71) 1,843,100 27.08
Exercised (2,270,666) 13.47
Cancelled (344,530) 19.35
Balances, December 31, 2004 6,870,617 $ 19.99
The following table summarizes information concerning outstanding and
exercisable options at December 31, 2004:
______________________________________________________________________________________________________
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 - 11.09 702,447 3.63 $ 9.12 685,646 $ 9.10
11.13 - 13.38 1,422,005 7.13 13.04 780,716 13.09
13.39 - 18.45 1,149,815 6.35 16.27 887,383 16.45
18.75 - 25.00 1,153,709 5.77 22.59 1,043,702 22.83
25.28 - 28.74 2,223,541 8.79 27.39 368,516 27.27
29.00 - 41.84 219,100 4.94 30.74 187,600 30.95
$ 1.39 - 41.84 6,870,617 6.88 $ 19.99 3,953,563 $ 17.89
F-22
Note 12 Income Taxes
The provision (benefit) for income taxes for the years ended December 31,
2004, 2003 and 2002 consists of the following:
(in thousands)
Year ended December 31, 2004 2003 2002
Current:
Federal $ 7,044 $ 7,428 $ (2,126)
State 2,048 885 235
Foreign 2,777 1,825 2,740
Deferred:
Federal (7,021) (4,520) 1,276
State (5,351) (1,371) 353
Foreign (786) - - .
Total provision (benefit) $ (1,289) $ 4,247 $ 2,478
Income (loss) before income taxes consists of the following components:
(in thousands)
Year ended December 31, 2004 2003 2002
United States $ 24,864 $ 9,272 $ (307)
Foreign 3,261 5,895 11,057
Total $ 28,125 $ 15,167 $ 10,750
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, 2004 2003 2002
Income taxes (benefit), at statutory federal rate 35% 35% 35%
State taxes (benefit), net of federal benefit (8) (2) 3
Tax rate differential on foreign earnings 3 (1) (10)
Change in domestic valuation allowance ( 36) - -
R and D Credit (3) (7) (7)
Other 4 3 2
Total (5%) 28% 23%
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 significant
components of these temporary differences consisted of the following as of
December 31, 2004 and 2003, respectively:
F-23
(in thousands)
Year ended December 31, 2004 2003 .
Deferred taxes:
Loss carryforwards $ 27,939 $ 20,254
Tax credit carryforwards 20,478 15,980
Accrued expenses 3,369 3,608
Sales returns and allowance reserves 405 405
Deferred revenue 6,275 10,209
Depreciable assets and amortizable assets 3,792 4,060
Other (4,841) (3,667)
Total 57,417 50,849
Valuation allowance (17,708) (24,297)
Net deferred tax asset $ 39,709 $ 26,552 .
Recoverability of the existing net deferred tax assets is dependent on the
continued Federal and foreign profitability from operations. The Company
regularly evaluates its net deferred tax assets for recoverability and
establishes a valuation allowance when it is more likely than not that some
portion or all of the net deferred tax assets will not be realized. The net
increase (decrease) in the total valuation allowance was ($6,589,000), $457,000
and ($844,000) during 2004, 2003 and 2002, respectively. The 2004 net decrease
includes a benefit of $13.5 million from the reversal of the valuation allowance
related to domestic net operating loss carryforwards and other temporary
differences as a result of the current year domestic profits and projections of
future domestic profitability. This decrease was partially offset by an increase
in valuation allowance of $1.6 million associated with foreign net operating
loss carryforwards and $6.0 million related to current year stock option
deductions. As of December 31, 2004, the remaining valuation allowance relates
to stock option deductions of approximately $15 million and net operating loss
carryforwards specific to certain foreign tax jurisdictions of approximately
$2.7 million. The Company will continue weighing various factors in future years
to assess the need for any additional changes in its valuation allowance. Should
the Company realize increased domestic profitability (net of any current year
stock option deductions) and anticipate a continuation of this trend, any
decrease in the valuation allowance related to stock option deductions would
result in an increase to stockholders' equity.
The Company has domestic Federal net operating loss carryforwards available
to offset future taxable income totaling $64.9 million and domestic tax credits
of $20.2 million as of December 31, 2004. The domestic Federal net operating
loss carryforwards will expire at various dates from 2013 through 2024, and the
domestic tax credits will expire at various dates from 2005 through 2024. At
December 31, 2004, the Company had Irish and Austrian tax loss carryforwards
relating to its foreign subsidiary operations that total approximately $11.0
million which have unlimited carry forward periods.
The Company has made no provision for U.S. income taxes or foreign
withholding taxes on the earnings of its foreign subsidiaries, as these amounts
are considered permanently reinvested outside the United States. At December 31,
2004, the cumulative amount of undistributed earnings was approximately $63.9
million, and the unrecognized deferred tax liability for these earnings was
approximately $24.5 million.
F-24
Income tax returns filed by the Company are currently under examination by
the Internal Revenue Service as well as certain state and foreign governments.
The Company regularly assesses the likelihood of adverse outcomes resulting from
current or future examinations to determine the adequacy of its provision for
income taxes. The Company accrues for tax contingencies based upon its best
estimate of the taxes it expects to pay. These estimates are updated over time
as more definitive information becomes available or upon the completion of tax
audits. Although the outcome of tax audits are always uncertain, based upon
currently available information, Management believes that the ultimate outcome
of ongoing and future audits will not have a material effect on the Company's
financial position, cash flows or overall trends in results of operations.
The American Jobs Creation Act of 2004 (the "Act"), enacted on October 22,
2004, makes a number of significant changes to the income tax laws, which may
affect the Company in future years. The main tax incentives affecting the
Company include the new deduction for qualifying domestic production activities
and the one time repatriation of foreign earnings subject to an effective tax
rate of 5.25%. Management is currently evaluating the impact of these and any
other changes made by the Act and, as such, the effects of such changes cannot
be quantified at this time.
Note 13 Operating Segment and Geographic Information
The Company has prepared operating segment information in accordance with
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," to report components that are evaluated regularly by the Company's
chief operating decision maker, or decision making group, in deciding how to
allocate resources and in assessing performance. The Company is organized
geographically and by line of business. The line of business management
structure is the primary basis for which financial performance is assessed and
resources allocated.
Certain reclassifications have been made to the prior years' segment
information to conform to the current year's presentation. The residual
operating activity of the previously reported Hardware reporting segment has
been incorporated into the Customer Support reporting segment. This
reclassification is predicated on the reduced scale and change in the nature of
on-going hardware operations. The only activity in the Hardware reporting
segment is related to supporting legacy customers with spare parts and supplies,
and management no longer reviews the Hardware reporting segment on a stand-alone
basis.
The Company's reporting units are the same as the lines of business and
include Software, Customer Support, and Professional Services and Education. The
Software operating segment develops, markets, and sells a software platform and
application development framework for Enterprise Content Management and Business
Process Management. 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 Customer Support segment also provides operating
supplies and spare parts for the installed base of Optical Storage and Retrieval
("OSAR") libraries, the remaining portion of the previous hardware business. The
Professional Services and Education segment provides fee-based implementation
and technical consulting services related to the Company's standard products and
training services.
The accounting policies of the Company's operating segments are the same as
those described in Note 2 - Summary of Significant Accounting Policies. The
Company evaluates performance based on stand-alone segment gross profit. The
Company does not separately allocate operating expenses to these segments, nor
does it allocate specific assets to these segments. The Company does not
evaluate performance based on the return on assets or on interest income at the
operating segment level. Therefore, segment information reported includes only
revenues, cost of revenues, and gross profit, as this information and the
geographic information described below are the only information currently
provided to the chief operating decision maker on a segment basis.
F-25
Operating segment data for the three years ended December 31, 2004, is as
follows:
(in thousands)
Professional
Customer Services and
Software Support Education Consulted
Year Ended December 31, 2004
Revenue $ 154,279 $ 188,011 $ 55,268 $ 397,558
Cost of Revenue 15,122 41,989 44,954 102,065
Gross Profit 139,157 146,022 10,314 295,493
Year Ended December 31, 2003
Revenue $ 149,214 $ 167,230 $ 48,061 $ 364,505
Cost of Revenue 13,800 42,785 42,346 98,931
Gross Profit 135,414 124,445 5,715 265,574
Year Ended December 31, 2002
Revenue $ 132,508 $ 157,550 $ 56,959 $ 347,017
Cost of Revenue 10,565 44,603 50,408 105,576
Gross Profit 121,943 112,947 6,551 241,441
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 and
non-Latin America customers. An allocation of its assets among the geographic
segments is not prepared for management reporting. All other geographic
locations include South America, the Middle East and Africa. Information
concerning principal geographic areas in which the Company operates is as
follows:
(in thousands)
Year ended December 31, 2004 2003 2002 .
Revenue Assets Revenue Assets Revenue Assets
North America:
United States $ 278,177 $ 372,918 $ 257,100 $ 283,073 $ 251,447 $ 251,928
Canada 8,786 22,611 7,971 22,627 5,581 5,398
Total North America 286,963 395,529 265,071 305,700 257,028 257,326
Europe:
France 8,252 1,793 6,166 2,111 6,593 2,086
Germany 28,882 4,001 29,074 6,985 22,174 3,632
United Kingdom 21,250 29,845 18,930 20,810 22,950 18,145
Ireland - 46,019 - 39,742 - 37,114
Other Europe 35,588 5,640 31,169 5,954 26,236 4,902
Total Europe 93,972 87,298 85,339 75,602 77,953 65,879
Asia Pacific 15,793 10,839 12,171 10,546 9,916 4,831
All other 830 - 1,924 - 2,120 - .
Totals $ 397,558 $ 493,666 $ 364,505 $ 391,848 $ 347,017 $ 328,036
F-26
Note 14 Litigation
In the normal course of business, the Company is subject to ordinary
routine litigation and claims incidental to our business. The Company monitors
and assesses the merits and risks of pending legal proceedings. While the
results of litigation and claims cannot be predicted with certainty, based upon
its current assessment the Company believes that the final outcome of each
existing legal proceeding either will be resolved in its favor or, if resolved
against it, will not have a materially adverse effect on its consolidated
results of operations or financial condition.
Note 15 Guarantees and Indemnifications
The Company has made guarantees and indemnifications, under which it may be
required to make payments to a guaranteed or indemnified party, in relation to
certain transactions. In connection with the sales of its products, the Company
provides intellectual property indemnities to its customers. Guarantees and
indemnities to customers in connection with product sales and service generally
are subject to limits based upon the amount of the related product sales or
service. Payment by the Company is conditioned upon the other party filing a
claim pursuant to the terms and conditions of the agreement. The Company may
challenge this claim and may also have recourse against third parties for
certain payments made by the Company. Predicting the maximum potential future
payment under these agreements is not possible due to the unique facts and
circumstances involved with each agreement. Historically, the Company has made
no payments under these agreements.
In connection with certain facility leases and other performance
guarantees, the Company has guaranteed payments on behalf of some of its
subsidiaries. To provide subsidiary guarantees, the Company obtains unsecured
bank guarantees from local banks. These bank guarantees totaled an equivalent of
approximately $2.6 million issued in local currency in Europe and Asia as of
December 31, 2004. Furthermore, the Company has signed an indemnity letter as a
performance guarantee to a certain customer in Europe in local currency
equivalent to approximately $200,000 as of December 31, 2004.
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 a liability for the guarantees and indemnities
described above in the accompanying consolidated balance sheet and the maximum
amount of potential future payments under such guarantees and indemnities is not
determinable, other than as described above.
Note 16 Other Financial Instruments
The Company enters into forward foreign exchange contracts on the last
business day of each quarter - with all contracts maturing in three months.
The following table summarizes the notional amounts of the Company's
foreign currency agreements entered into on December 31, 2004 and 2003. There is
no fair value of such agreements at December 31 as they were entered into on the
last day of the year.
F-27
________________________________________________________________________________________
At December 31, 2004 2003
Notional Notional Notional Notional
Amount Amount Amount Amount
Purchased Sold Purchased Sold
European $ 22,546,242 $ (16,855,303) $ 17,907,065 $ 11,888,699
Australian - - - 116,072
Asian 1,292,685 (226,688) 1,791,763 -
Canadian - (5,785,124) - 7,878,703 .
Total $ 23,838,927 $ (22,867,115) $ 19,698,828 $ 19,883,474
Note 17 Related-Party Transactions
On June 5, 2002, the Compensation Committee of the Company's Board of
Directors (the "Board") approved a loan to Mr. Roberts for $1.9 million to
enable him to purchase a home in Orange County, California. Mr. Roberts has
repaid this loan in full as of December 10, 2004. Mr. Roberts made total
payments of $2,020,576 including $120,576 in interest and $1,900,000 in
principal.
John Savage, a member of the Board and the Audit Committee of the Board, is
Managing Partner of Alliant Partners. Alliant Partners acted as financial
advisor to eGrail in connection with our acquisition of assets from eGrail in
2002 and was paid approximately $500,000 by eGrail. Accordingly, John Savage
recused himself from all discussions related to the acquisition of eGrail assets
by the Company and abstained from voting on the transaction.
F-28
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, 2004:
Inventory reserves $ 250 - 250 $ -
Allowance for doubtful accounts
and sales returns $ 3,917 1,108 1,190 $ 3,835
Year ended December 31, 2003:
Inventory reserves $ 301 547 598 $ 250
Allowance for doubtful accounts
and sales returns $ 4,232 653 968 $ 3,917
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
S-1
EXHIBIT INDEX
Exhibit No. Exhibit Title
21.1 List of Subsidiaries of Registrant (filed as FileNet
Corporation Subsidiary Information)
23.1 Consent of Independent Registered Public Accounting Firm
31.1 Certification of Chief Executive Officer
31.2 Certification of Chief Executive Officer
32.1 Certification of Chief Financial Officer
32.2 Certification of Chief Financial Officer
Exhibit 21.1
LIST OF SUBSIDIARIES OF REGISTRANT
3565 Acquisition, LLC
FileNet BV (The Netherlands)
FileNet Canada, Inc.
FileNet Company Limited (Ireland)
FileNet Corporation Asia Pacific Pte. Ltd. (Singapore)
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 Nova Scotia Corporation
FileNet Poland Sp.zo.o
FileNet (Proprietary) Limited (South Africa)
FileNet Shared Services Centre Ireland Limited
FileNet Sweden AB
FileNet (Switzerland) GmbH
Shana Corporation U.S.A.
SPMM,Inc.
Exhibit 23.1
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
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, 333-96713, 333-107012 and
333-116883 on Form S-8 of our reports dated March 11, 2005 relating to the
financial statements and financial statements schedule of FileNet Corporation
and management's report on the effectiveness of internal control over financial
reporting, appearing in this Annual Report on Form 10-K of FileNet Corporation
for the year ended December 31, 2004.
/s/ Deloitte and Touche LLP
Deloitte and Touche LLP
Costa Mesa, California
March 11, 2005
Exhibit 31.1
Certification of Chief Executive Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Lee D. Roberts, certify that:
1. I have reviewed this annual report on Form 10-K of FileNet Corporation (the
"registrant");
2. Based on my knowledge, this 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 report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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 report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial
reporting (as defined in Exchange Act Rules 13-a-15(f) and 15d-15(f)) for the
registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;
b) designed such internal control over financial reporting, or caused such
internal control over financial reporting to be designed under our supervision,
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles;
c) evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evalution; and
d) disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent
fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual
report) that has materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
Date: March 15, 2005
/s/ Lee D. Roberts .
Lee D. Roberts
Chief Executive Officer
Exhibit 31.2
Certification of Chief Financial Officer
Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
I, Sam M. Auriemma, certify that:
1. I have reviewed this annual report on Form 10-K of FileNet Corporation (the
"registrant");
2. Based on my knowledge, this 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 report;
3. Based on my knowledge, the financial statements, and other financial
information included in this 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 report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial
reporting (as defined in Exchange Act Rules 13-a-15(f) and 15d-15(f)) for the
registrant and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision, 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 report is being prepared;
b) designed such internal control over financial reporting, or caused such
internal control over financial reporting to be designed under our supervision,
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles;
c) evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the effectiveness
of the disclosure controls and procedures, as of the end of the period covered
by this report based on such evaluation; and
d) disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent
fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual
report) that has materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation of internal control over financial reporting, to the
registrant's auditors and the audit committee of the registrant's board of
directors (or persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control over
financial reporting.
Date: March 15, 2005
/s/ Sam M. Auriemma .
Sam M. Auriemma
Chief Financial Officer
Exhibit 32.1
Certification of Chief Executive Officer
Certification Pursuant To 18 U.S.C. Section 1350
Created by Section 906
of The Sarbanes-Oxley Act of 2002
The undersigned officer of FileNet Corporation (the "Company"), hereby
certifies, to such officer's knowledge, that:
(i) the accompanying Annual Report on Form 10-K of the Company for the
fiscal period ended December 31, 2004 (the "Report") fully complies with the
requirements of Section 13(a) or Section 15(d), as applicable, of the Securities
Exchange Act of 1934, as amended; and
(ii) the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
Dated: March 15, 2005
/s/ Lee D. Roberts .
Lee D. Roberts
Chairman of the Board and
Chief Executive Officer
Exhibit 32.2
Certification of Chief Financial Officer
Certification Pursuant To 18 U.S.C. Section 1350,
Created by Section 906
of The Sarbanes-Oxley Act of 2002
The undersigned officer of FileNet Corporation (the "Company"), hereby
certifies, to such officer's knowledge, that:
(i) the accompanying Annual Report on Form 10-K of the Company for the
fiscal period ended December 31, 2004 (the "Report") fully complies with the
requirements of Section 13(a) or Section 15(d), as applicable, of the Securities
Exchange Act of 1934, as amended; and
(ii) the information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
Dated: March 15, 2005
/s/ Sam M. Auriemma .
Sam M. Auriemma
Executive Vice President
Chief Financial Officer
(Principal Financial Officer)