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, 20032004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period for _____________ to _______________.
Commission File No. 0-15997
FILENET CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 95-3757924
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3565 Harbor Boulevard
Costa Mesa, California 92626
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (714) 327-3400
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, $0.01
par value
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days: Yes [x] No [ ]
Indicate by check mark whether the disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of the Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [x]
Indicate by check mark whether the registrant is an accelerated filer as
defined by Rule 12b-2 of the Securities Exchange Act of 1934: Yes [x] No [ ]
Based on the closing sale price as of $31.57 on June 30, 2002,2004, the aggregate
market value of the 36,323,17839,366,950 shares of common stock of the Registrant held by
non-affiliates of the Registrant on such day was $653,853,204.$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 onof the Registrant's common stock was
38,535,08740,669,006 at March 12, 2004.14, 2005.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive proxy statement, to be delivered in
connection with the Registrant's 20042005 Annual Meeting of Stockholders, are
incorporated by reference into Part III of this Report.
FILENET CORPORATION
20032004 ANNUAL REPORT ON FORM 10-K
For the Year Ended December 31, 20022004
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..................19Holders..................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..........................40Data..........................41
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.................................................40Disclosure.................................................41
Item 9a. Controls and Procedures..............................................40Procedures..............................................41
PART III
Item 10. Directors and Executive Officers of the Registrant..................41Registrant..................43
Item 11. Executive Compensation..............................................41Compensation..............................................43
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.........................................41Matters.........................................43
Item 13. Certain Relationships and Related Transactions......................41Transactions......................43
Item 14. Principal Accountant Fees and Services..............................41Services..............................43
PART IV
Item 15. Exhibits, Financial Statement Schedule, Reports on Form 8-K, and Exhibits.....42
Signatures....................................................................46Schedule..............................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, 2003,2004,
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 1.1 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 or ECM,("ECM") refers to the broad range of
functions used by organizations of all types, 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, whether thatoperations. This information ismay be used internally, such as
sales datacontracts or product specifications,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. ECM alsoBusiness 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.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
business processes, and provide the broad-spectrum
of connectivity needed to support their critical and everyday decision-making.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, resellersindependent software vendors
and value added distributors.resellers. We invest significantly in product development to
improve our existing products and to increaseexpand our product offerings. We also offer
professional services for the implementation of theseour software, solutions, 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.
3
Fiscal 20032004 Developments and Strategy
During fiscal 2003,2004, we focusedcontinued our development efforts on enhancingto enhance and
integratingintegrate the capabilities of our FileNet P8 architecture and bringingwe focused our
marketing resources on communicating the advantages of this architecture to the
market. FileNet P8 provides our customers with the ability to easily 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. Also during the year, we acquired the technology of
the Shana Corporation and ramped up our third party offshore development
efforts. The Shana acquisition brought us advanced eForms management technology. 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.
During fiscal 2000, we acquired the
technology of Application Partners Incorporated, which brought us eService
applications technology.
With the introduction of the FileNet P8 ECM architecture in early 2003, we
provideprovides 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;
o connectivity to customer enterprise applications via an Enterprise
Application Integration capability and FileNet Virtual Content
Management, which provides the ability to interact with external
content and events; 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 fiveeight FileNet suites that
include the Business Process Manager, Content Manager, Web Content Manager,
Image Manager, Forms Manager, Records Manager, Team Collaboration Manager and
FormsEmail Manager. Each suite provides specific functionality to meet customer
requirements. When our customers purchase a FileNet ECM solutionsuite they have the ability
to add-onadd 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.
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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,
and integration with an organization's existing systems.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 digitalelectronic
content. As of December 31, 2003,2004, our software has been licensed to more than
4,000four 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, regulatory compliance, accounts payable and receivable, andor for any
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business operation that
processes significant amounts of electronic information
or content in theiran 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 enterprise productivity,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 ECMECM/BPM solutions for customers. Our FileNet ECM solutionsSolutions 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 generally build applications that
address the requirements unique to their particular needs.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
the delivery of ECM applications.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, operating resultsgross profits and other information
using the management approach in Note 1613 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, and Hardware.Education. A summary
of our sales by geographic location is incorporated herein by reference in Note
1613 of the "Notes to Consolidated Financial Statements" under Item 8, "Financial
Statements and Supplementary Data."
5
Software Products
and SolutionsFileNet P8
The FileNet P8 architecture offers our customers enterprise-level
scalability and flexibility to handle demanding content challenges, complex
business processes, and integration to existing systems.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 fiveeight pre-packaged suites, each emphasizing a different
aspect of the ECMECM/BPM 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 ECM and BPM capabilities. Solutions that are developed from FileNet ECM
solutionsP8
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, to improve efficiency and address
compliance requirements.
FileNet Suites
Business Process Manager
FileNet Business Process Manager is an ECM solution that 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 solutionsuite 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 andto 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.
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Content Manager
FileNet Content Manager is an ECM solution that combinesdesigned 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.
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Web Content Manager
FileNet Web Content Manager is designed to combine easy-to-use Web site
development capabilities with integrated process capabilities for managing the
creation, approval and publication of Web content and complex documents to
multiple Web sites, in multiple formats, and in multiple languages. The Web
Content Manager allows centralized control of Web site content and appearance
while allowing particular content to be directly created and updated by
organization members without specialized Web expertise, through the use of
controlled templates and other tools. Web Content Manager can control large
amounts of dynamic Web content across globally distributed sites and provides
integrated process management capabilities to help ensure secure and accurate
Web content publication.
Image Manager
FileNet Image Manager is designed to be highly scalable and provides rapid
access for end-users to fixed objects, or content that is not intended to be
modified, such as scanned documents, faxes, email and rich media. It is designed
to securely and permanently store 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 integratescan 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 TechnologyDevelopment 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.
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Enterprise Application Integration provides connectors for integrating process
and content with enterprise applications. In addition, FileNet offers an
optional EAI server through an OEM agreement for IBM Websphere InterChange
Server, Adaptors and Collaborations. The connectors provided by FileNet provide
integration with enterprise applications such as SAP R/3, Siebel, and Clarify as
well as technologies such as XML, Web Service, JMS, and MQSeries.
FileNet P8 Workplace is an end-user application that provides a Web-based
interface to the FileNet P8.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.
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Content Provider for FileNet P8 Workplace provides virtual content management
(VCM)("VCM") access to content stored in third party repositories including content
management repositories from IBM, EMC/Documentum,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.
Web Content Manager ("WCM") is an application that provides Web content
management capabilities that leverage the core content and process management
capabilities providedVenetica, who in the platform.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 distributesmakes available the source code for the
portlets so that customers and partners can modify and extend the capabilities
if desired.Solution Templates are a set of predefined objects and processes for use in
developing industry specific solutions. Built on the FileNet P8 architecture, a
Solution Template provides working code that can be configured and extended to
build complete applications. A Solution Template is not a turnkey application;
rather, it can be thought of as an application development template. By
providing much of the application's core infrastructure, it can reduce the
length of the solution development and deployment cycle.
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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 that provide some of the functionality available through
the full FileNet P8 architecture, and were formally available under the Panagon
and/or Brightspire brands.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 Business Process ManagementBPM activities. This application
provides a complete set of content management functionality, allowing users to
check in, check out, search and browse, share, revise, and change properties for
content stored in a FileNet repository, all from a Web browser.
FileNet Content ServiceServicess 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 revisionrevise and re-use.
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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.
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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 software is a document management and data
archiving applicationsolution certified by SAP, designed for use with the SAP R/3
Enterprise Resource Planning ("ERP") application suite.
HardwareFileNet Application Connector for Siebel 7 We also manufacture and market an Optical Storage And Retrievalprovides Siebel certified document
management for use with the Siebel 7 Customer Relationship Management ("OSAR"CRM")
library product based on 12-inch, 30 gigabyte, and optical disk technology for
storage management of business critical content. Hardware is no longer a
strategic focus for the Company.application.
Services,Customer Support and Manufacturing
We operate service and support organizations on a global basis to provide
both pre-sales and
post-sales services to ensure successful implementation of our products and
customer satisfaction. Due to the highly configurable nature of our products, many ofsoftware,
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.
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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 architecture and other technical services and training services
to our licensed customers and authorized ValueNet Partners and Global System
Integrators.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 architect,help customers design, install, integrate, customize and deploy
our solutions.software. These services range from the management of large-scale
implementations of our products to prepackagedfixed 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 andand/or instructor-led training.
Research and Development
WeThe 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, primarily through internal and
offshore development activities, third party licensing agreements and
potentially through technology acquisitions. Our development efforts focus on
our unified FileNet P8 ECM 10
architectureplatform as we continue to develop and enhance our ECMenterprise
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 enhancesis designed to
expand the functionality of our products through a variety of agreements with
the producers of this software. Expenditures for research and development were $77.0 million;
$71.7 million and $68.8 million for the years ended December 31, 2003, 2002, and
2001, respectively. We expect to continue to look for technology
acquisitions that offer us additional product know-how or domain knowledge where
appropriate and will continue to embed third party technology that enhancesexpands our
product line. We
intend to continue to invest significantly in internal and offshore development
with a focus on developing new functionality in Enterprise Content Management
and Business Process Management technology that provide a richer competitive
product offering to our customers.
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
FileNet11
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 becomesis now a
FileNet 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, ValueNet, 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.
11
Patents and Licenses
As of December 31, 2003,2004, FileNet Corporation has fourone issued and sevennine
pending U.S. patents.patent applications. Our subsidiary, 3565 Acquisition LLC, has one
issued U.S. patent and onethree pending U.S. patent application.applications. Another
subsidiary, Shana
Corporation,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.
We have also entered into non-exclusive license arrangements with a number
of organizations, including IBM, Verity, Stellent and Oracle that permit our
resellers and us to grant sublicenses and provide support to end-users of our
systems to use software developed by these third party vendors.
Employees
As of December 31, 20032004 we had 1,7201,607 full-time employees, of which 456400 were
employed in research and development; 436433 in sales; 11397 in marketing; 210187 in
education and professional services; 261258 in customer support; 6864 in operations;
and 176168 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.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 whichthat may cause our operating results to fluctuate, include, but are not
limited to, the following:
o IT spending trends;
o general domestic and international economic and political conditions;
o the discretionary nature of our customers' budget and purchase cycles
and the absence of long-term customer purchase commitments;
o the tendency to realize a substantial percentage of our revenue in the
last weeks, or even days, of each quarter;
o the potential for delays or deferrals of customer orders;
o 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;
12
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;
or,o general domestic and international economic and political conditions;
o seasonality in technology purchases.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.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
2003, EMC
Corporation, a data storageaddition, large hardware company, acquired one of our
competitors, Documentum. Other large, well-capitalized hardwareor 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. ThisOur customers may view this type of vertical
integration of software development and system integration
capabilities may be viewed by our
customers as a key competitive advantage;advantage.
o Some of our competitors are also our key technology suppliers. For
example, IBM's Crossworlds business unit supplies a key technology for
our business process management software. Our inability to license
future releases of key technology from these competitive vendors could
limit the technical capabilities of our products. 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
13
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 28%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 distributors;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.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 new and emerging market forenterprise content management solutions.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, there can be no assurance that these
markets willmay not continue to grow as we anticipate, or that our products and solutions
willmay 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 execute on our strategy of offering a unified platform and
framework for Enterprise Content Management that gains customer acceptance or
our revenue may suffer. This strategy may require us to develop and maintain
relations with technology partners. If we fail to successfully execute on our
integrated product solution strategy or if we fail to maintain or establish
relationships with technology partners, or if release dates of any future
products or enhancements are delayed, or if these products or enhancements fail
to achieve market acceptance when released, our business operating results and
financial condition could be materially harmed. In the past, we have experienced
delays in the release dates of enhancements and new releases to our products and
we cannot assure that we will not experience significant future delays in
product introduction. From time to time, either our competitors or we may
announce new software products, capabilities or technologies that have the
potential to replace or shorten the life cycles of our existing software
products. We cannot assure that announcements of currently planned or other new
software products will not cause customers to delay their purchasing decisions
in anticipation of such software products, and such delays could have a material
adverse effect on our business and operating results.
14
We must develop and sell new products to keep up with rapid technological
change in order to achieve future revenue growth and profitability.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. In addition, our abilityFor 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 generate revenues from the
salesystematically
apply record management principles to content. E-Mail Manager was released in
late 2004 and allows organizations with large numbers of customer support, education and professional servicesemail 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
substantially
dependent on our abilityexpected to generate new sales of our software products.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 saleimplementation 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 cannot assure that we will notmay experience
significant future delays in product introduction. From time to time, our
competitors or we may announce new software products, capabilities or
technologies that have the potential to replace or shorten the life cycles of
our existing software products. We cannot assure that announcementsAnnouncements of currently planned or other new
software products will notmay 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.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 a
limited number of
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 business and
our prospects could be harmed.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.time. Introducing new products that rapidly address changing market demands
requires a continued high level of investment in research and development. OurWe
expect to invest approximately 19% of annual revenue in research and development
expenses were $77.0 million, or 21% of total revenue,
for 2003 and $ 71.7 million, or 21% of total revenue, for 2002.efforts in the near term. The majority of our investment in new and existing
market opportunities must beis made prior to our ability to generate revenue from these
new opportunities. These investments of money and resources must beare 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.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.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 an increasinga portion of our
software development of specific products and software localization work. As a
result,
15
we will become increasingly dependent on these third party developers
for continued development and maintenancesupport 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.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 cannot assure that in the
future we willmay not be successful in
attracting and retaining such personnel.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.publicity. Software, services and products, as complex as
those we sell, are susceptible to errors or failures,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
mayoften 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.suffer. As part of our business strategy, we frequently evaluate
strategic acquisition opportunities. For example, we recently completed the
acquisitions of eGrail and Shana. 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.
16
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.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.parties. There is risk of third-party claims of infringement, which could
expose us to litigation and other costs. Our success depends, in part, on our
ability to protect our proprietary rights to the technologies used in our
principal products. We rely on a combination of copyrights, trademarks, trade
secrets, patents, confidentiality procedures and contractual provisions to
protect our proprietary rights in our software products. We cannot assure that
ourOur existing or future
copyrights, trademarks, trade secrets, patents or other intellectual property
rights willmay 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.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 cannot assure that we couldmay not be able to redesign the
infringing products to avoid further infringement or that we could 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 license
third-partybroaden the number
of third party platforms with which our products are compatible and revenue related tothe loss of
these productsrelationships could be at risk if
we were unable to maintain these relationships.harm our business. In order to expandbroaden the distributionnumber of
third party platforms with which our products are compatible and thereby broaden
the market opportunities for our product offerings,products, we have established strategic
relationships with a number of indirect channel partnerssoftware and other consultants that provide marketing and sales opportunities for us. We
have entered into key formal and informal agreements with otherhardware platform vendors, including
companies such as IBM CrossWorlds, Microsoft Corporation, SAP AG, Siebel Systems Inc, Sun
Microsystems, Inc., BEA Systems Inc., EMC Corporation, ILOG Corporation,
Arbortext,Hewlett-Packard Development Company LP,
Network Appliance, Inc., Venetica CorporationSun MicroSystems and Verity, Inc. Certain of these
agreements have minimum purchase requirements and/or require prepayments which
usage is limited to a specific timeframe, while others do not have minimum
purchase requirements and/or are cancelable at will.Veritas Software Corporation. We
cannot assure that these companies will not reduce or discontinue their
relationships with, or support of, FileNet and our products. Our failureIf 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.
17
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 thesesthese products if we do not maintain these licenses, which
would result in reduced revenue.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.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, identified, 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.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 EPSearnings 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.
18
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 91,12869,349 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 10,00010,882 square feet of office and
development space in Edmonton, Alberta, Canada. We also lease sales and support
offices in 2924 locations in the United States, 1817 locations in Europe, 32
locations in Australia, 2 other locations1 in Canada, and 46 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 2004.2005.
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 litigation and claims matterslegal 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 conditions.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, 2003.
19
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, 20022003
through December 31, 2003,2004, as reported by NASDAQ:
.High Low
Year Ended December 31, 20032004 .
4th Quarter $ 27.75 $ 19.50$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
Year ended December 31, 2002
4th Quarter $ 14.23 $ 8.64
3rd Quarter 15.50 10.09
2nd Quarter 17.98 11.35
1st Quarter 23.10 16.01 The closing price of our common stock at December 31, 20032004 was $27.08.$25.76. As
of March 12, 2004 we estimate that there will be approximately 475 stockholders
of record on March 16, 200414, 2005 (record date for 2004the 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, 20032004 have been derived from our audited financial statements.
(Perin thousands, except per share amounts)
Fiscal Years Ended December 31, 2004 2003 2002 2001 2000 1999
Consolidated statements of operations data:
Revenue:
Software $ 154,279 $ 149,214 $ 132,508 $ 119,014 $ 204,872
$ 183,316 Service 212,833 206,806 201,568 174,291 148,162
Hardware 2,458 7,703 14,028 21,199 16,630243,279 215,291 214,509 215,596 195,490
Total revenue 397,558 364,505 347,017 334,610 400,362 348,108
Cost of revenue:
Cost of software revenue 15,122 13,800 10,565 7,522 14,643
16,986 Cost of service revenue 81,462 89,016 102,292 101,976 86,377
Cost of hardware revenue 3,669 5,995 10,211 13,559 9,07886,943 85,131 95,011 112,503 115,535
Total cost of revenue 102,065 98,931 105,576 120,025 130,178 112,441
Gross profit 295,493 265,574 241,441 214,585 270,184 235,667
Operating expenses:
Research and development 78,248 77,050 71,735 68,838 57,914
54,307
Selling and marketing 159,716 144,975 132,109 136,124 135,513
133,374
General and administrative 35,363 32,466 31,656 33,381 29,428 24,356
Restructuring and in-process
research and development - - 400 - 2,984 -
Total operating expenses 273,327 254,491 235,900 238,343 225,839 212,037
Operating income (loss) 22,166 11,083 5,541 (23,758) 44,345
23,630
Other income, net 5,959 4,084 5,209 2,503 5,406 3,409
Income (loss) before income taxes 28,125 15,167 10,750 (21,255) 49,751
27,039
Provision (benefit) for income taxes (1,289) 4,247 2,478 (4,633) 11,204 7,362
Net income (loss) $ 29,414 $ 10,920 $ 8,272 $ (16,622) $ 38,547 $ 19,677
Earnings (loss) per share:
Basic $ 0.75 $ 0.30 $ 0.23 $ (0.47) $ 1.13
0.61
Diluted $ 0.72 $ 0.29 $ 0.23 $ (0.47) $ 1.05 0.59
Weighted average shares outstanding:
Basic 39,095 36,532 35,590 35,117 34,155
32,125
Diluted 40,994 38,089 36,709 35,117 36,765 33,360
Consolidated balance sheet data:
Working capital $ 262,882 $ 189,326 $ 135,302 $ 144,750 $ 155,483
$ 101,777
Total assets 493,666 391,848 328,036 301,639 324,093
243,398
Stockholders' equity 367,864 289,148 238,905 215,825 224,957 150,458
Note: Service revenue and costs include both Customer Support and Professional
Services and Education. Certain reclassifications have been made to the prior years' selected financial data to conform to the
current year's presentation. In
November 2001, the FASB announced Emerging Issues Task Force ("EITF") Topic No.
D-103, "Income Statement CharacterizationCustomer support revenue and cost of Reimbursements Received for
Out-of-Pocket Expense Incurred." The EITF required companies to characterize
reimbursements received for out-of-pocket expenses as revenues in the statementcustomer support revenue includes hardware
revenue and cost of operations. Application of this EITF requiredhardware revenue that comparative financial
statements for prior periods be reclassified to comply with the guidance. We
adopted this EITF as of January 1, 2002 and have reclassified our prior-period,
consolidated financial statements to conform to this EITF.was previously reported separately.
21
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
ThisIn 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 estimates.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.Recognition FileNet accounts. The nature of our business commonly includes multiple
elements in our arrangements and requires us to make judgments for determining
the licensingtiming 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, in
accordance withwhich 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
("AICPA")
Statement of Position ("SOP") 97-2, "Software Revenue Recognition." Wegoverns the basis for our software revenue recognition. Accordingly, software
license revenue is recognized when: (1) we enter into contractsa legally binding
arrangement with a customer for the salelicense of our products and services. The majority of these
contracts relate to single elements and contain standard terms and conditions.
However, there are agreements that contain multiple elements or non-standard
terms and conditions. Contract interpretationsoftware; (2) we deliver the
products; (3) customer payment is sometimes required to determine
the appropriate accounting, including how the price should be allocated among
the deliverable elements and when to recognize revenue.
Software license revenue generated from sales through direct and indirect
channels, which do not contain multiple elements, are recognized upon shipment
and passage of title of the related product, if the requirements of SOP 97-2,
are met. If the requirements of SOP 97-2, including evidence of an arrangement,
delivery,deemed fixed or determinable fee, collectibilityand free of
contingencies or vendor specific evidence
aboutsignificant 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 an element are not met at the dateundelivered elements is deferred and the remaining portion of shipment, revenuethe
arrangement fee is not recognized until theseallocated to the delivered elements are known or resolved. Fees are deemed to be
fixed and determinable for transactions with a set price that is not subject to
refund or adjustment and payment is due within 90 days from the invoice date.
Software license revenue from channel partners is recognized when the product is
shipped and sale by the channel partner to a specified end user is confirmed.
22
For arrangements with multiple elements, we allocateas
revenue, to each
element of a transaction based upon its fair value as determined in reliance on
vendor specific objective evidence. Thisassuming 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 anthe arrangement are delivered.
Vendor specific objective evidence ("VSOE") of fair value for customer
support is based ondetermined by reference to the normal pricing and discounting practicesprice our customers pay for those products and servicessuch
support when sold separately. If fair value of any
undelivered element cannot be determined objectively, we deferseparately; that is, the revenue until
all elements are delivered, services have been performed or until fair value can
objectively be determined.
Customer support contracts are renewable on an annual basis and provide
after-sale support forrenewal rates paid by our software, as well as software upgrades under our
right to new versions program, on a when-and-if-available basis.customers.
Revenue from post-contract customer support contracts is recognized ratably over the term of
the arrangement, which is typically 12 months. ProfessionalVSOE 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 consists of consulting and implementation
services provided to end usersrecognition for multi-element
arrangements could differ significantly from our historical results. A majority
of our software productsprofessional service revenue is derived from time and technical consulting
services providedmaterials based
contracts that typically range from three months to our resellers. Consulting engagements average from one to
three months.year in duration.
Revenue from these services and from training classes is recognized on such contracts as such services are deliveredtime is incurred and acceptedapproved 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 usingwhen the percentage-of-completion methodamounts
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 fixed-price
consulting contracts. However,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 profitall other
revenue recognition criteria are met. As our channel partners only purchase our
product for specific end users, we are not subject to revision as the
contract progresses and anticipated losses on fixed-price professional services
contracts are recognized in the period when they become known. Professional
services are not required for the software to function. We do not make changes
to the standard software code in the field.channel inventory returns
or price protection issues.
Allowance for Doubtful Accounts and Sales Returns.Returns. We evaluatemake 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. Since our revenue recognition policy requires
customers to be creditworthy, our accounts receivable are based on customers
whose payment is reasonably assured. Our accounts receivable are derived from sales to a
wide variety of customers.
The following table represents the account balances for these provisions
and the changes for each of the periods presented. Deductions to these
provisions are the result of customer bad debt write-offs or product returns.
Additions to the provision are based on estimated credit losses related to
specific customer collection issues and are also based on historical experience.
(In thousands)Additions
Balance at Charged to Balance
Beginning Revenue and at Endof Period Expenses Deductions of PeriodYear ended December 31, 2003:
Allowance for doubtful accounts
and sales returns $ 4,232 $ 653 $ 968 $ 3,917
Year ended December 31, 2002:
Allowance for doubtful accounts
and sales returns $ 3,567 $ 1,752 $ 1,087 $ 4,232
Year ended December 31, 2001:
Allowance for doubtful accounts
and sales returns $ 5,518 $ 1,482 $ 3,433 $ 3,567
23
We do not believe a change in liquidity of any one
customer or our inability to collect from any one customer would have a material
adverse impact on our consolidated financial position. Based on historical experience,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
allowancerates. While we are not legally required to accept sales returns, we have done
so on certain occasions for the estimated amount of returns. While
productour customers. Product returns have historically
been minimal and within our expectations andexpectations. 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 established by us, we cannot guarantee that we will continue to
experience the same return rates that we havewould be made in the
past.period in which such a determination is made and results of operations in that
period could be materially affected.
Goodwill and Other Intangible Assets.Assets. Our business acquisitions have
resulted in goodwill and other intangible assets. Goodwill is recorded at cost
and is not amortized. In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets," which we adopted January 1, 2002. SFAS No. 142 requires that
goodwill and other intangible assets with indefinite useful lives no longer be
amortized, but instead beis tested for impairment at least annually and would
be written down when impaired. Onif 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 whichin between
annual testing dates that indicate that the carrying value of goodwill may not be
recoverable. We engaged an independent valuation firm to determine
the business enterprise value for each of our three reporting units and to
performperformed an impairment analysis as of July 1, 20032004 in
accordance with SFAS 142. The analysisresults indicated there was no impairment of
goodwill in any of the three reporting units. As of December 31, 2003,2004, there
have been no indicators of impairment; therefore no interim impairment of goodwill hastests
have been recognized. If estimates change, a materially different impairment conclusion
could result.
Long-Lived Assets. Property, plant and equipment,performed.
Identified intangible assets and
capitalized software costs are recorded at cost less accumulated
depreciation or
amortization. TheyThese assets are amortized using the straight-line method over
estimated useful lives of generally three to five years. The determination of useful lives
and whether or not these assets are impaired involves judgment andjudgment. 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 long-livedthe assets and certain identifiable intangible assets for impairment of
value based onexceeds the estimated
future undiscounted future cash flows, resulting froma loss would be recorded for the useexcess of the
asset and its eventual disposition.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.
Deferred Income Taxes.Taxes Deferred. We exercise significant judgment in determining our income
taxes reflecttax 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 effects of
temporaryassets and liabilities based upon the
differences between the financial statement carrying amounts and the tax bases
of assets and liabilities for
financial reporting purposesliabilities. Such deferred income taxes primarily relate to the
timing of the recognition of certain revenue items and the amounts usedtiming of the
deductibility of certain reserves and accruals for income tax purposes. We
maintainregularly review the deferred tax assets for recoverability and establish a
valuation allowance against awhen it is more likely than not that some portion or all of
the deferred tax asset
(related toassets will not be realized. In the current year we concluded
that the valuation allowance associated with domestic operations) due to uncertainty regarding the future
realization based on historical taxable income, projected future taxable income,NOL's and the expected timingother temporary
differences should be fully reversed as a result of the reversals of existing temporary differences. Ifcurrent year and
cumulative domestic profits in recent years and future domestic projections.
However, we operate at a loss orcould be required to record additional valuation allowance against
the deferred tax assets if we are unable to generate sufficient future taxable
income, we could be requiredfail to increasebenefit 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 against all or a
significant portion of our deferred tax assets, which would result in a
substantial increase to our effective tax rate and could result inhave a material adverse impact on our operating results.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 remaining deferred tax assets will be utilized to offset future taxable income (net
of any current year stock option deductions), the remaining valuation allowance
could be decreased or eliminated all
together, thereby resultingof $15.0 million related to stock option deductions will result in a substantial temporary decrease to our effective
tax rate and an increase
to additional paid-inpaid in capital.
The Company is currently
assessing its valuation allowance related to our deferred tax assets. As of
December 31, 2003, we have a net tax deferred asset of approximately $26.6
million and valuation allowance of approximately $24.3 million. We will continue
weighing various factors throughout the year to assess the need for any
valuation allowance. Recoverability of the deferred tax assets is dependent on
continued profitability from operations. Should our level of profitability
continue as expected, we would likely remove the entire valuation allowance in
2004. We would realize a one-time, non-cash benefit by decreasing our tax
expense (causing an increase in earnings) by approximately $10.0 million to
$14.0 million. Additionally, we would record a non-cash charge to increase
additional reported paid-in capital by approximately $9.0 million.
2427
Research and Development Costs. We expense research and development costs
as incurred. No amounts are required to be capitalized in accordance with SFAS
No. 86, "Accounting for the Costs of Computer Software to Be Sold, Leased, or
Otherwise Marketed," because our software is substantially completed
concurrently with the establishment of technological feasibility.
Overview
FileNet develops and markets software that helps our customers address
their electronic content and business process management requirements.
Electronic content is unstructured data with various object characteristics and
attributes. Electronic content includes, but is not limited to: Web content,
forms, word documents and scanned images that are not easily managed by
relational databases. We market these enterprise software solutions to primarily
Global 2000 customers in the banking, insurance, government, utilities and
telecom industries located in North America, Europe and Asia.
We have experienced a turbulent business environment during the last three
years. During this period we have witnessed dramatically reduced spending on
information technology. Only during the last half of 2003 have we seen
accelerated spending on information technology from our customers. We derive
approximately seventy two percent of our revenue from the United States market
and approximately twenty eight percent from international markets. The U.S.
economy is showing early indications of moderate expansion while growth in
Europe remains sluggish. Growth in Asia is expanding rapidly - but represents a
much smaller base of business for us compared to the United States market. We
operate in an international economy and are subject to the inherent risks of
foreign exchange, regulatory compliance, intellectual property infringement and
interest rate risk. We believe the electronic content management market will
out-perform average information technology spending based on industry analysts'
opinions and our own customers' statements regarding their IT investment
priorities in the next several years.
There was a significant consolidation in the electronic content management
market space during 2003. Several competitors that previously offered only point
solutions to specific content management problems now provide a suite of
solutions rendering them as more viable competitors to us. These competitors
must now integrate these various point solutions, based on several different
technologies, into an application that a prospective customer could consider
deploying on an enterprise-wide basis. We have taken a different approach by
focusing primarily on internal development to provide an integrated solution. We
have, however, acquired certain specific third party technologies that enhance
our products' capabilities. For example, we acquired and integrated Web content
and electronic forms technologies into our FileNet P8 framework during 2002 and
2003.
We face several challenges in executing our strategy of growth and
profitability in the future. Our strategy is to:
o Leverage the investment we have made in research and development
through increased software license sales,
o Continue to sell our software to customers who will deploy multiple
applications across their enterprises based on the FileNet P8
architecture,
o Manage our research and development expenditures through a balanced
approach of internal development, offshore development, and third
party licensing and technology acquisitions,
o Increase our marketing and sales productivity to effectively and
efficiently address each vertical market and each account segment, and
o Maintain high customer satisfaction levels to ensure continued renewal
of maintenance contracts.
25
We believe we are well positioned for continued growth and profitability if
we can execute our business strategy.
Results Of Operations
The following table sets forth certain consolidated statement of operations
data as a percentage of total revenue for the periods indicated:
(Asas a percentage of total revenue)
December 31, 2004 2003 2002 2001
Revenue:
Software 38.8% 40.9% 38.2%
35.6%
Customer support 45.2 43.2 39.647.3 45.9 45.4
Professional services and education 13.9 13.2 16.4 20.6
Hardware 0.7 2.2 4.2
Total revenue 100.0 100.0 100.0
Cost of revenue:
Software 3.8 3.8 3.1 2.2
Customer support 10.7 11.1 12.710.6 11.7 12.8
Professional services and education 11.3 11.6 14.5 17.9
Hardware 1.0 1.7 3.1
Total cost of revenue 25.7 27.1 30.4
35.9
Gross profit 74.3 72.9 69.6 64.1
Operating expenses:
Research and development 19.7 21.1 20.8 20.6
Selling and marketing 40.2 39.8 38.1 40.6
General and administrative 8.9 8.9 9.1 10.0
Total operating expenses 68.8 69.8 68.0
71.2
Operating income (loss)5.5 3.1 1.6
(7.1)
Other income, net 1.5 1.1 1.5 0.7
Income (loss) before tax 7.0% 4.2% 3.1% (6.4)%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
As more fully discussed below, totalTotal 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 3.7% in 2002 comparedprofessional
services growth to 2001. The increase in total
revenue during both of these periods is primarily attributable to an increase in
demand for ourimplement the software products, as well asand 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
customer supporteach revenue partially offset by lower professional services and hardware revenue.
26component discussion.
28
Revenue by Geography.Geography. The following table sets forth total revenue by
geography and as a percentage of total revenue for the periods indicated:
Revenue by Geography
(Inin thousands)
% Increase/Increase / % Increase/Increase /
Year ended December 31, 2004(decrease)2003 decrease(decrease) 2002decrease2001
Total United States Revenue $ 278,177 8.2% $ 257,100 2.2% $ 251,447
2.7% $ 244,902
Europe, 83,817 7.5%Middle East / Africa 93,972 10.1% 85,339* 9.5% 77,953 8.1% 72,117
Asia / Pacific 15,793 29.8% 12,171 22.7% 9,916
24.4% 7,968
Canada 8,786 10.2% 7,971 42.8% 5,581
(17.8%) 6,787
Other 3,446830 62.5%(56.9)% 2,120 1,924* (25.2%)(9.2)% 2,8362,120
Total International Revenue 119,381 11.2% 107,405 12.4% 95,570
6.5% 89,708
Total Revenue $ 397,558 9.1% $ 364,505 5.0% $$ 347,017
3.7% $ 334,610 Revenue as a % of total revenue:
United States Revenue 70% 71% 72%
73%
International Revenue 30% 29% 28% 27%
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 revenue representsto 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 29%70% of total revenue and
grew more rapidly than domestic revenuefor the past three years. International sales
volumes remained consistant for all three years in both 2003 and 2002.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
and total revenues in Europe grew by 16% during the
period from 2001 to 2003.contributing approximately 80% of our international revenue. Asia Pacific is a
much smaller market for FileNet, but produced revenue growth of 53%59.3% during the
three-year period from 20012002 to 2003.2004. 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.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.
2729
Revenue by Reporting Segment.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
(Inin thousands)
% Increase/% Increase/Increase / %Increase /
Year ended December 31, 2004(decrease)2003 (Decrease)(decrease) 2002 (Decrease)2001.
Revenue:
Software $ 154,279 3.4% $ 149,214 12.6% $ 132,508
11.3% $ 119,014
Customer Support 164,772 10.0 149,847 13.2 132,382188,011 12.4% 167,230 6.1% 157,550
Professional Services and
Education 55,268 15.0% 48,061 (15.6) 56,959 (17.7) 69,186
Hardware% 2,458 (68.0) 7,703 (45.1) 14,02856,959
Total Revenue $ 397,558 9.1% $ 364,505 5.0% $ 347,017
3.7% $ 334,610Revenue as a % of total revenue:
Software 38.8% 40.9% 38.2%
35.6%
Customer Support 45.2 43.2 39.647.3% 45.9% 45.4%
Professional Services and
Education 13.2 16.4 20.6
Hardware .7 13.9% 2.2 13.2% 4.2 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. 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 2002,2002. Our P8 platform
and by 11.3%associated products were announced early in 2002 compared to 2001. The increase2003. We attribute the growth in
software revenue duringin both periods was primarily due2004 and 2003 to an increasemarket 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 demand
for enterprise content management2004
and business process management solutions.
Additionally, our existing customers primarily drove thisthe demand in our key vertical industries of banking,financial services,
insurance, telecommunications, manufacturing, government and government.utilities. We saw
these customers increase usage of our products to expand existing applications
and to create new applications ofthroughout their enterprise with our software. We
believe the IT spending environment has improved during the past two fiscal
years and more significantly during the last half of 2003 as we have experienced the return of larger software deployments by some
of our customers. We believe these trends will continue in 20042005 with a moderate,
but steady improvement in IT spending on enterprise content management and
business process management software.software as large enterprises look for software that
supports key business applications and solves regulatory and compliance
requirements related to managing content.
Customer Support.Support. Customer support revenue consists of revenue from
software maintenance contracts, "fee for service" revenuesbillings and the sale of
hardware spare parts and supplies. MaintenanceSupport 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 10.0%12.4% in
2004 compared to 2003 and by 6.1% in 2003 compared to 2002 and by 13.2% in 2002 compared to 2001.2002. 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 20032004 and 20022003
compared to the growth rate in previous years as a result of reduced software
sales growth in 20012002 and 20022003 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
maintenancesupport contracts, as our customers tend to deploy mission critical applications
using our software to manage content.
Professional Services and Education.Education. Professional services and education
revenue is generated primarily fromearned by providing consulting and implementation services to end userscustomers 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 28
generallyusually performed on a time and
material basis. Professional servicesbasis and education revenue decreased by 15.6% in 2003 compared to 2002 and by 17.7% in
2002 compared to 2001. The decrease during the last two years is reflective of
the economic slow down that began in 2001, resulting in fewer and smaller
consulting engagements and increased pricing pressures.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 yearsperiods - particularly new customer
sales. Professional services revenue was strongdecreased in 2001 as a result2003 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 strong software sales in 2000
to new customers. However, with the decline in software revenue in 2001,partners for professional services revenue in 2002 started to decrease and this trend
continued into 2003. Another contributing factor to theservices. The decrease in professional services and
education revenue for the past two years is thatalso affected by software revenue that has been
characterized by repeat purchases for additional software licenses that do not
require large-scale professional services engagements.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 20042005 based on the software revenue trends we experienced
during the last half of 2003.
Hardware. Hardware revenue is generated primarily2004, with strong dependency on new system sales to
generate the professional services and education demand from the sale of our 12-inch OSAR libraries. Hardware revenue decreased by 68.1% in 2003 compared to
2002 and by 45.1% in 2002 compared to 2001. The decline in hardware revenue
reflects that hardware is not a strategic focus for us.
customers.
Cost of Revenue
Cost of Revenue by Reporting Segment.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
(Inin thousands)
% Increase/Increase / % Increase/Increase /
Year ended December 31,2004(decrease) 2003 (Decrease)(decrease) 2002 (Decrease)2001
Cost of revenue:
Software $ 15,122 9.6% $ 13,800 30.6% $ 10,565
40.5% $ 7,522
Customer Support 39,116 1.3 38,608 (8.9) 42,39641,989 (1.9)% 42,785 (4.1)% 44,603
Professional Services and
Education 44,954 6.2% 42,346 (16.0) 50,408 (15.8) 59,896
Hardware% 3,669 (38.8) 5,995 (41.3) 10,21150,408
Total Cost of Revenue $ 102,065 3.2% $ 98,931 (6.3)% $ 105,576
(12.0)Cost of revenue as a % $ 120,025of
segment revenue:
Software 9.8% 9.2% 8.0%
6.3%
Customer Support 23.7 25.8 32.022.3% 25.6% 28.3%
Professional Services and
88.1 88.5 86.6
Education Hardware 115.0 77.8 72.881.3% 88.1% 88.5%
Total Cost of Revenue as a
% of Segment Revenue 25.7% 27.1% 30.4% 35.9%
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.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
percentpercentage of software revenue increased by 1.2% in 2003 compared to 2002 and by 1.7%grew 1.8 percentage points from 8.0% in 2002 compared
to
2001.9.8% 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 software revenue during both periods is
primarily the resultapproximately
$2.0 million in each of an2003 and 2004 and a $960,000 increase in royalty costs dueamortization
expense in 2003 related to increased
utilization of new third party software products and the amortization of acquired technology resulting
from the eGrail acquisition in April 2002 and the 29
Shana acquisition in April
2002.2003. Going forward we anticipate cost of software revenue to be approximately 10%range between
8%-10% of costrevenue. Future acquisitions resulting in additional acquired
technology and future integration of revenue as we continue to integrate
third-partyadditional third party technology with our
products.products would result in increased software cost, but we would expect such
increase to be offset by increased revenue.
Customer Support. Cost 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 percentpercentage of customer support
revenue has decreased by 2.0% in 2003 compared to
2002 and by 6.2%from 28.3% in 2002 compared to 2001. These reductions22.3% in cost2004. The combination of
increased customer support revenue are attributablealong with relatively flat customer support
cost in all three years resulted in a lowered percent of cost in relation to
employee reductions and efficiency
improvementsrevenue. 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 delivery of technical support.hardware function, has ranged
from 252 employees in 2002 to 259 in 2004. We expect the cost of customer
support revenue to remain at approximately 25%range between 21%-24% of customer support revenue for the
near future.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.Education. Cost of professional services and
education revenue consists primarily 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 professionalexpense 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 asincreased 15% when comparing
2004 to 2003, while costs increased at a percentlower rate of professional6.2% due to improved
utilization of internal resources. Professional services and education revenue
and cost both decreased by 0.4%at the same level in 2003 compared to 2002 and
increased by 1.9%maintaining
cost at approximately 88% of revenue for both years. We believe our headcount in
2002 compared to 2001. The reduction in the use of external
third party independent consultants and lower variable compensation for internal
employees contributed to maintaining essentially flat operating costs as a
percent of professional services and education segment allows for revenue during both periods.growth
without adding additional resources. We expect professional services and
education costs as a percentage of professional services and education revenue
to vary from periodrange between 80%-82% in the near-term assuming professional services and
education revenue continues to period depending on the
utilization rates of internal resources and the mix between internal and
external service providers.grow.
32
Hardware. Cost of hardware revenue includes the cost of assembling our OSAR
library products, the cost of hardware integration personnel, warranty costs and
distribution costs. The cost of hardware revenue decreased by 38.8% in 2003
compared to 2002 and decreased by 41.3% in 2002 compared to 2001. The
year-to-year decreases in absolute dollars are directly related to decreased
hardware revenue. Hardware cost as a percent of hardware revenue has not
decreased proportionally because fixed costs have not decreased at the same rate
as hardware revenue. Hardware is no longer a strategic focus for us.
Operating ExpensesTotal Operating Expenses.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 / % Increase/Increase /
Year ended December 31,2004(decrease)2003 (Decrease) (decrease)2002 (Decrease) 2001
Operating expense:
Research and Development $ 78,248 1.6% $ 77,050 7.4% $ 71,735
4.2% $ 68,838
Marketing and Sales 159,716 10.2% 144,975 9.79.7% 132,109 (2.9) 136,124
General and Administrative 35,363 8.9% 32,466 2.62.6% 31,656 (5.2) 33,381
In-process R and D - - 400 - .
Total Operating Expenses $ 273,327 7.4% $ 254,491 7.9% $ 235,900
(1.0)Operating expense as a % $ 238,343of
total revenue:
Research and Development 19.7% 21.1% 20.8% 20.6%20.7%
Marketing and Sales 39.8 38.1 40.640.2% 39.8% 38.1%
General and Administrative 8.9 9.1 10.08.9% 8.9% 9.1%
Operating Expense as a % of
Revenue 68.8% 69.8% 68.0% 71.2%
30
Research and Development. Our research and development efforts are focusedfocus on enhancingour
FileNet P8 architecture as we continue to develop and maintainingexpand our ECM and BPM
capabilities. The focus of these efforts is to create functionality in
Enterprise Content Management capabilities
within the FileNet P8 product line. These efforts focus on existing products and
developing additional capabilities to our FileNet P8 platform and suites such as Business Process Management Web Content Management, Records Management, Team
Collaboration and other capabilities.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 electronicselectronic forms capabilities into our
products. During 2002 we acquired eGrail to integrate their web content
management capabilities into our products.
(See Note 3 to the Notes to the
Consolidated Financial Statements.)
Our research and development expense consists primarily of personnel costs for
software developers; third party contracted development efforts and related
facilities costs. Research and development expense increased by 1.6% in 2004
compared to 2003 and by 7.4% in 2003 compared to 2002 and by 4.2% in 2002 compared to 2001.2002. 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 and 425 in 2001.to 2003. The majority of the $5.3$1.2 million increase in research and2004
is attributable to our expanded offshore development expensesprogram 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 the acquisition of Shana, the full
year cost of the eGrail development team, extensive investment development
efforts to enhance content management with new capabilities and increased
offshore development expense. Increased numbers of26 additional
internal employees resultedin North America resulting in higher compensation, benefits
and relocation costs of $3.0 million, increased facility related toexpenses of
33
$0.5 million associated with the integration of the eGrail and Shana
acquisitions in April of 2002 and 2003, respectively.
The majorityrespectively, and increased consulting
expense of the $2.9$1.5 million increaseassociated with offshore development through contractors
in research and development expenses
from 2001India.
We intend to 2002 is primarily attributable to the acquisition of eGrail that
resulted in additional facility and employee expenses. This acquisition resulted
in an increase in compensation expense primarily due to increased numbers of
personnel as well as an increase in consulting costs due to the expanded use of
contractors.
We intendcontinue 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 developerper-developer cost through the use of offshore resources.
However, in the near term some duplicate expenses will be incurred aswe do not plan on expanding our development
programs are transitioned touse of offshore
developers. Offshore development costs for
the 12 months ended December 31, 2003 was $3.1 million compared to $1.3 million
for 2002.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 be at
approximately 21%range
between 18%-20% of revenue assuming revenue growth in the near-term.near-term, and will
gradually decrease on a percentage basis as revenue increases.
Selling and Marketing.Marketing. We sell our products through a direct sales force
and our indirect channel sales partners. Our selling and marketing expense
consists primarily 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 by10.2% in 2004 compared to 2003 and
increased 9.7% in 2003 compared to 2002
and decreased by 2.9% in 2002 compared to 2001.2002. The number of sales and marketing
employees in 2004 was 530 compared to 549 in 2003 compared toand 541 in 2002. MarketingDuring this
two-year period, marketing personnel increased by 3014 employees while sales
personnel decreased by 22 employees,
yielding the net increase of 8 employees during 2003.25 employees. This shift in sales and marketing capacity
was predicated on our customer engagement initiative, which
31
we implementedresulted in 2002 and 2003. This initiative prescribed 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. Travel,million in 2003 compared to 2002. In 2003 travel, training,
recruitment and marketing
programs increased $3.6 million from 2002 related to the FileNet P8 product
release that was announced in 2003 accounted for the balancefirst quarter of the increase. The decrease in absolute dollars
from 2001 to 2002 was primarily due to a 54% reduction in recruitment expenses,
as well as a 10% reduction in sales commission expense. Charges in 2001 for
severance of $2.9 million related to workforce reductions and $218,000 for
facility consolidation costs, primarily in sales, also contributed to the higher
costs in 2001 compared to 2002 and led to reduced costs in 2002.2003.
We expect selling and marketing expense to remain at approximately 40%range between 38%-40% of revenue
in the near-term.near-term, depending on revenue growth.
General and Administrative.Administrative. Our general and administrative expense consists
primarily
of salaries, benefits, and other expenses related to personnel costs for
finance, information technology, legal, human resources and general management;management,
and the cost of outside professional services.
34
General and administrative expense increased slightlyby 8.9% in 2004 compared to
2003 and increased by 2.6% in 2003 compared to 20022002. The number of general and
decreased by 5.2%administrative employees in 20022004 was 168 compared to 2001. General176 in 2003 and administrative expenses remained relatively stable when comparing167 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 2001 - primarily as a resultlegal fees associated with compliance with other sections
of expense controls.the Sarbanes-Oxley Act.
We expect general and administrative expense to remain at approximately 9%range between 8%-10% of
total revenue in the near-term.near-term, depending on revenue growth.
Purchased In-Process Research and Development.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 bywith 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.
New product development underway at eGrail at
the time of the acquisition included the next generation of their Web Content
Management product that was in the early stages of design and only 5% complete
at the date of the acquisition. The cost to complete the project was estimated
at approximately $3.0 million to occur over a twelve-month period. However,
actual costs upon 100% completion at March 31, 2003 were $4.7 million. There was
no in-process research and development expense during 2001.
Amortization of Goodwill. There was no amortization of goodwill expense
during 2003 and 2002 as we ceased amortizing goodwill and assembled workforce
beginning January 1, 2002 based on the adoption of SFAS No. 142. In connection
with our acquisition of certain assets from API on May 18, 2000, the purchase
price amount allocated to goodwill of $14.6 million was being amortized in
operating expenses over a useful life of five years and assembled workforce of
$386,000 was being amortized over a useful life of three years. Assembled
workforce no longer meets the definition of a separately identified intangible
asset under the provisions of SFAS No. 141, "Business Combinations," and the
un-amortized balance of $182,000 at December 31, 2001 was reclassified as
goodwill at January 1, 2002. SFAS No. 142 was also effective for business
combinations that occurred after June 30, 2001. Accordingly, goodwill of $5.8
32
million that was recorded in April 2002 in connection with the eGrail
acquisition and goodwill of $3.6 million that was recorded in April 2003 in
connection with the Shana acquisition is not amortized.
SFAS No. 142 requires that goodwill and other intangible assets with
indefinite useful lives no longer be amortized, but instead be tested for
impairment at least annually and written down when impaired. In accordance with
this standard, we do not amortize goodwill and indefinite life intangible assets
but evaluate their carrying value annually or when events or circumstances
indicate that their carrying value may be impaired. As of 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. We engaged an independent
valuation firm to determine the business enterprise value for each of our three
reporting units and to perform an impairment analysis as of July 1, 2003 in
accordance with SFAS 142. The analysis indicated there was no impairment of
goodwill in any of the three reporting units. As of December 31, 2003, no
impairment of goodwill has been recognized. If estimates change, a materially
different impairment conclusion could result.
Amortization of Purchased Intangible Assets. The April 2002 purchase of
eGrail assets resulted in intangible assets comprised of acquired technology of
$3.3 million and patents of $24,000, with assigned useful lives of five years
and two years, respectively. The April 2003 purchase of Shana resulted in $5.7
million of intangible assets; comprised of acquired technology of $4.0 million,
customer maintenance relationships of $800,000, technology manuals and design
documents of $600,000 and non-compete agreements of $277,000. All intangible
assets for the Shana acquisition were assigned a useful life of five years.
Non-compete agreements with former executives of Shana were assigned a useful
life of between two and three years. We determined that these assets were not
impaired at December 31, 2003. Amortization of patents are reported as research
and development expense, amortization of non-compete agreements are reported as
general and administrative expense, while acquired technology, customer
maintenance relationships and technical manuals and design documents are
reported as cost of revenue.
Interest, Other Income, and Expenses, Net.Net. Other income, net consists
primarily of interest income earned on
our cash, and cash equivalents short and
long-term investments, and other items including foreign
exchange gains and losses and interest expense.losses. Other income, net of other expenses, was $6.0 million
in 2004, $4.1 million in 2003 and $5.2 million in 20022002. 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 $2.5 millioninvestment amounts
and a higher weighted-average interest rate. The weighted average interest rate
earned on cash, cash equivalents and investments was 2.21% in 2001.2004, 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 significantcontinued 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.
The weighted average interest rate earned on cash, cash equivalents and
investments was 1.39% in 2003, 1.98% in 2002 and 2.49% in 2001. Other expense in
2001 included a $3.5 million litigation settlement charge.
Provision for Income Taxes.Taxes. The benefit for income taxes was ($1.3) million
in 2004, compared to a provision for income taxes wasof $4.2 million in 2003 compared toand of
$2.5 million in 2002, and a benefit of $4.6 million in
2001.2002. The effective tax rate was (5%), 28%, 23% and (22%)23% for the
years ended December 31, 2004, 2003 2002 and 2001,2002, respectively. The increaseddecreased tax
rate in 20032004 was
primarily 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 income earnedour 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 domestic group versustiming of large enterprise transactions,
seasonality of economic activity in Europe, and to some degree the foreign subsidiaries. Astiming 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 FiscalQuarter Quarter Quarter Quarter Year
Year ended December 31, 2003, we have a net tax deferred asset
(related to domestic operations) of approximately $26.6 million and a valuation
allowance of approximately $24.3 million. The Company is currently assessing its
valuation allowance related to our deferred tax assets. Recoverability of the
deferred tax assets is dependent on continued profitability from operations.
Should our level of profitability continue as expected, we would likely remove
the entire valuation allowance in 2004. We would realize a one-time, non-cash
benefit by decreasing our tax expense (causing an increase in earnings) by
approximately $10.0 million to $14.0 million. Additionally, we would record a
non-cash charge to increase additional reported paid in capital by approximately
$9.0 million.
33
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, 2003,2004, cash and cash equivalents and investments were
$248.3$348.7 million, an increase of $63.1$100.4 million from $185.2$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 was $52.2and $21.6 million and
resulted primarilyin 2002. Our cash
from depreciation and amortization of $19.4 million, net
income of $10.9 million, decreasedoperations is also impacted by changes in working capital accounts. Changes
in accounts receivable of $8.8 million and increased accrued compensation and benefits of $5.3 million.unearned revenue have typically had the largest
impact on our cash flows. The days sales outstanding metric, decreased to thirty-sixwhich is calculated
by dividing quarter-end accounts receivable by average daily sales for the
quarter, was 31 days, by40 days and 47 days as of December 31, 2004, 2003 and 2002
respectively. We believe that we will continue to generate cash from
forty-seven days at December 31, 200236
unearned revenues but expect increases in cash due to strong collections. Accrued
compensationdeclines in accounts
receivable to lessen. We attempt to structure our sales contracts to require a
majority of payments in 30 days or less, and benefits increased dueall payments in 90 days or less. To
the extent that competitive pressures require us to increased variable compensation
associated with higherextend 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. CashThis 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 infor investing activities was $88.5 million in 2004, $64.2
million in 2003 was
$10.3and $27.0 million in 2002. Capital spending has been fairly
consistent and resulted primarily fromunder 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 capital expenditures,acquisitions. Excess cash from operations is invested in high
quality debt instruments and an $8.1 millionsecurities, and the timing of purchases and
maturities of investments could result in significant short-term fluctuations in
net cash purchaseused 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 Shana acquisitionnature
of our investment policy, all such investments are available in April
2003, partially offsetthe short term
if needed for any reason.
Net cash provided by $ 6.5 million net proceeds from the sale of marketable
securities. Financingfinancing activities provided cash of $21.3 million primarilyresults from the proceeds of
the issuance of common stock upon exercise ofrelated to employee stock options under the stock option plans and employee stock purchase
plans. Cash provided by operating activities in 2002 was $21.4As previously noted, the cash generated from this activity increased to
$36.1 million and
resulted primarily from net income of $8.3 million, and depreciation and
amortization of $21.6 million. These were partially offset by increased accounts
receivable of $7.8 million resulting from increased revenue in the fourth
quarter of 2002 compared to 2001, an increase of $3.4 million in prepaid
expenses such as prepaid insurance due to higher insurance premiums in 2002 and
increases in prepaid royalty related to the addition of new third party
licensing agreements in 2002, and a decrease in income tax payable of $4.0
million. Cash used in investing activities in 2002 included $10.8 million for
capital expenditures, a $1.9 million note receivable from an officer, and a $9.4
million cash purchase related to the eGrail acquisition in April 2002, partially
offset by $12.0 million net proceeds from the sale of marketable securities.
Financing activities provided cash of $4.7 million primarily from the proceeds
of the issuance of common stock upon exercise of employee stock options under
the stock option and stock purchase plans.
Cash provided by operating activities in 2001 was $42.5 million and
resulted primarily from a substantial decrease in accounts receivable of $51.1
million due to decreased revenue and strong collections in the fourth quarter,
depreciation and amortization expense of $24.4 million, and increases in
unearned maintenance of $9.8 million related to prepaid maintenance contracts,
partially offset by a net loss of $16.6 million, decreases in accounts payable
of $8.2 million resulting from reduced spending, decreases in accrued
compensation and benefits of $8.1 million primarily due to a reduction in
bonuses, and a reduction in federal income tax payable of $5.6 million. Cash
used for investing activities in 2001 was $41.9 million consisting primarily of
capital expenditures of $14.1 million and net purchases of marketable securities
of $28.1 million. Cash provided by financing activities in 2001 was $7.8 million
consisting primarily of proceeds from the issuance of common stock upon exercise
of employee stock options under our stock option and stock purchase plans and
income tax benefit from exercised stock options.
Our capital expenditures were $9.2$21.3 million in 2003 $10.8and $4.7 million in 20022002. 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 $14.1 millioncash equivalents held in
2001. Our primary capital expenditures during theseforeign currency resulted in net cash inflows in all three years were for researchas the Euro and
development equipment, demonstration and training
equipment, enhancements to our internal network and business systems, leasehold
improvements on leased property, and furniture. Spending was significantly
reduced in an effort to contain expenses whileother currencies progressively strengthened against the company experienced reduced
revenues from the downturn in the economy and reduced information technology
spending during the period 2001 to 2003. We anticipate capital expenditures of
approximately $12.0 million in 2004.dollar.
We have no long-term debt atborrowing arrangements as of December 31, 2003.
34
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 levelcost of usagecarrying the line did not
justify the costlevel of carrying the line.usage. We believe we will behave been able to meet escrow funding requirementsneeds through our
existing bank relationships in the United States and internationally.
Our principal sources of short and long-term liquidity consist of existing
cash balances and funds generated from future operations. We had total cash and
investments of $248.3 million at December 31, 2003, compared to $185.2 million
at December 31, 2002. We regularly review our cash funding requirements and
attempt to meet our cash requirements through a combination of cash on hand and
cash provided by operations. Our ability to increase revenues and generate
profits is subject to numerous risks and uncertainties and any significant
decrease in our revenues or profitability could reduce our operating cash flows
and erode our existing cash balances. During 2001, 2002 and continuing into 2003
lower capital spending in the IT sector resulted in lower revenue for us. While
the economy showed signs of improved IT spending during the last two quarters of
2003, no assurances can be given that this trend will continue or that we will
continue to be able to generate positive operating cash flows or that we will
continue to maintain or grow our existing cash balances.
We believe that our present cash balances, together with internally
generated funds, will be sufficient to meet our working capital and capital
expenditures throughout 2004.2005. See "Risk Factors".
Commitments.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, 2003:2004:
37
(In thousands)in thousands)
Payments Due by Period .
Total 2004 2005-2006 2007-20082005 2006-2007 2008-2009 Thereafter
Contractual obligations:
Operating leases $ 57,18655,646 $ 12,51812,265 $ 20,60622,161 $ 17,51415,435 $ 6,5485,785
Third party licensing contracts 2,130 2,1303,032 3,032 - - -
Third party development contracts 2,140 1,127 1,0134,155 2,775 1,380 - - .
Total contractual cash obligations $ 61,45662,833 $ 15,77518,072 $ 21,61923,541 $ 17,51415,435 $ 6,5485,785
We have bank guarantees issued in local currencies in Europe and Asia as
discussed in Note 1815 of the Notes to Consolidated Financial Statements. The
following table summarizes future minimum commercial commitments for these
obligations as of December 31, 2003:2004:
(Inin thousands)
Amount of Commitment Expiration Per Period .
Total
Amounts Committed 2004 2005-2006 2007-2008 Thereafter 2006- 2008-
Other commercial commitments: Committed 2005 2007 2009 Therafter .
Secured and unsecured bank
$guarantees 1,627,657 $ 355,7562,555 $ 924,7361,506 $ 23,465877 $ 323,700172 $ - guarantees.
Total commercial commitments $ 1,627,657 $ 355,7562,555 $ 924,7361,506 $ 23,465877 $ 323,700172 $ - 35
.
OTHER MATTERS
Environmental Matters.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 June 2001,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 issued SFASdelayed 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. 141, "Business Combinations,123 (FAS 123R),
"Share-Based Payment," which was effective immediately. SFAS No. 141 requires thatcompanies to expense the purchase method of
accounting be used for all business combinations initiated after June 30, 2001
and it eliminated the pooling-of-interests method. The adoption of this standard
did not have a significant impact on our consolidated financial statements. Our
April 2002 acquisition of certain assets and certain liabilities of eGrail, Inc.
and our April 2003 acquisition of Shana Corporation were accounted for in
compliance with this pronouncement (See Note No. 3 to the Notes to the Audited
Consolidated Financial Statements for details).
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which we adopted January 1, 2002. SFAS No. 142 requires that goodwill
and other intangible assets with indefinite useful lives no longer be amortized,
but instead be tested for impairment at least annually and written down when
impaired. SFAS No. 142 requires purchased intangible assets other than goodwill
to be amortized over their useful lives, unless these lives are determined to be
indefinite. In accordance with this standard, we do not amortize goodwill and
indefinite life intangible assets but evaluate their carrying value annually or
when events or circumstances indicate that their carrying value may be impaired.
As of the first day of July of each year, goodwill is tested for impairment by
determining if the carryingestimated fair
value of each reporting unit exceeds its fair value.
We engaged an independent valuation firm to assist us in determining the
business enterprise value for each of our three reporting unitsemployee stock options and to perform
an impairment analysis as of July 1, 2003 in accordance with SFAS 142. The
analysis indicated there was no impairment of goodwill in any of the three
reporting units. As of December 31, 2003, no impairment of goodwill has been
recognized. If estimates change, a materially different impairment conclusion
could result.
In August 2001, the FASB issued SFAS No. 144, "Accounting for Impairment or
Disposal of Long-Lived Assets." This statement addresses financial accounting
and reporting for the impairment of long-lived assets and for the disposal of
long-lived assets and discontinued operations. SFAS No. 144 superseded SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of," and is effective for fiscal years beginning after
December 15, 2001. The adoption of this standard did not have a material impact
on our consolidated financial statements.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which addresses financial
accounting and reporting for costs associated with exit or disposal activities
and supersedes EITF Issue 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." SFAS No. 146 requires that costs associated
with exit or disposal activities be recognized when they are incurred rather
than at the date of a commitment to an exit or disposal plan. SFAS No. 146 also
establishes that the liability should initially be measured and recorded at fair
value. We adopted the provisions of SFAS No. 146 for exit or disposal activities
initiated after December 31, 2002. The adoption of this standard did not have a
material impact on our consolidated financial statements.
36
In November 2002, the FASB issued FIN 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others," an interpretation of FASB Statement Nos. 5, 57 and 107,
and rescission of FIN 34, "Disclosure of Indirect Guarantees of Indebtedness of
Others." FIN 45 elaboratessimilar awards based on the disclosures to be made by the guarantor in its
interim and annual financial statements about its obligations under certain
guarantees that it has issued. It also requires that a guarantor recognize, at
the inception of a guarantee, a liability for thegrant-date fair
value of the obligation
undertakenaward. The cost will be recognized over the period during which an
employee is required to provide service in issuingexchange for the guarantee.award, usually the
vesting period. The accounting provisions related to recognizing a
liability at inceptionof FAS 123R will be effective as of
the guarantee for the fair value of the guarantor's
obligations do not apply to product warranties or to guarantees accounted for as
derivatives. The initial recognition and measurement provisions of this
interpretation are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002, while the disclosure requirements are
effective for financial statements for interim or annual periods ending after
December 15, 2002. The adoption of the recognition of provisions of FIN 45 in
the period ended December 31, 2003 did not have a material impact on our
consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation Transition and Disclosure," an amendment of SFAS No. 123. This
statement amends SFAS No. 123, "Accounting for Stock-Based Compensation," to
provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, this statement amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The transition guidance and
annual disclosure provisions of SFAS No. 148 are effective for fiscal years
ending after December 15, 2002. The interim disclosure provisions are effective
for financial reports containing financial statements for interim periods
beginning after December 15, 2002. The adoption of SFAS No. 148 did not have a
material impact on our consolidated financial statements.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities." In general, a variable interest entity is a corporation,
partnership, trust, or any other legal structure used for business purposes that
either (a) does not have equity investors with voting rights or (b) has equity
investors that do not provide sufficient financial resources for the entity to
support its activities. FIN 46 requires a variable interest entity to be
consolidated by a company if that company is subject to a majority of the risk
of loss from the variable interest entity's activities or entitled to receive a
majority of the entity's residual returns or both. The consolidation
requirements of FIN 46 apply immediately to variable interest entities created
after January 31, 2003. With respect to variable interest entities created
before January 31, 2003, in December 2003 the FASB issued FIN 46R, which, among
other things, revised the implementation date to the first fiscal years or
interim periods ending after March 15, 2004, with the exception of Special
Purpose Entities ("SPE"). The consolidated requirements apply to all SPE's in
the first fiscal year or interim period ending after December 15, 2003. We have
determined that we do not have any SPE's to which these interpretations apply;
we will adopt FIN 46R in the first quarter of 2004. We believe the adoption of
FIN 46R will not have a material impact on our consolidated financial
statements.
In April 2003, FASB issued SFAS No. 149, "Amendment of Statement No. 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 (1) clarifies under
what circumstances a contract with an initial net investment meets the
characteristic of a derivative discussed in paragraph 6(b) of Statement No. 133,
(2) clarifies when a derivative contains a financing component, (3) amends the
definition of an underlying derivative to conform it to language used in FIN 45,
and (4) amends certain other existing pronouncements, which will collectively
result in more consistent reporting of contracts as either derivatives or hybrid
instruments. SFAS No. 149 is effective for contracts and hedging relationships
entered into or modified after June 30, 2003. The adoption of SFAS No. 149 did
not have a material impact on our consolidated financial statements.
37
In May 2003, FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both debt and equity and requires
an issuer to classify the following instruments as liabilities in its balance
sheet:
o a financial instrument issued in the form of shares that is
mandatorily redeemable and embodies an unconditional obligation that
requires the issuer to redeem it by transferring its assets at a
specified or determinable date or upon an event that is certain to
occur;
o a financial instrument, other than an outstanding share, that embodies
an obligation to repurchase the issuer's equity shares, or is indexed
to such an obligation, and requires the issuer to settle the
obligation by transferring assets; and
o a financial instrument that embodies an unconditional obligation that
the issuer must settle by issuing a variable number of its equity
shares if the monetary value of the obligation is based solely or
predominantly on (1) a fixed monetary amount, (2) variations in
something other than the fair value of the issuer's equity shares, or
(3) variations inversely related to changes in the fair value of the
issuer's equity shares.
In November 2003, the FASB issued FASB Staff Position (FSP) No. 150-3 which
deferred the effective dates for applying certain provisions of SFAS No. 150
related to mandatorily redeemable financial instruments of certain nonpublic
entities and certain mandatorily redeemable noncontrolling interests for public
and nonpublic entities.
For public entities, SFAS No. 150 is effective for mandatorily redeemable
financial instruments entered into or modified after May 31, 2003 and is
effective for all other financial instruments as of the first interim or annual reporting period beginningthat begins after
June 15, 2003.
For mandatorily redeemable noncontrolling interests that would not have to
be classified as liabilities by a subsidiary under2005. We will adopt the exception in paragraph 9
of SFAS No. 150, but would be classified as liabilities by the parent, the
classification and measurement provisions of SFAS No. 150FAS 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 deferred
indefinitely. For other mandatorily redeemable noncontrolling interestsoutstanding on the
effective date and any awards that were issued before November 5, 2003,are subsequently modified or cancelled.
Compensation expense for outstanding awards for which the measurement provisionsrequisite service had
not been rendered as of SFAS No. 150the 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 deferred indefinitely. For those instruments,in the measurement guidance for
redeemable sharesprocess
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 noncontrolling interests in other literature shall apply
during the deferral period.
SFAS No. 150 isimpact the recognition of compensation expense
related to be implemented by reporting the cumulative effect of a
change in accounting principle. We do not believe the adoption of SFAS No. 150such awards will have a material impact on our consolidated financial statements.
Inflation.Inflation Management believes. 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, 2003.
38
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
primarily to
our investment portfolio. We have not used derivative financial instruments in
our investment portfolio. We place our investments with high-quality issuers
and, by policy, limit the amount of credit exposure to any one issuer. We
protect and preserve our invested funds by limiting default, market and
reinvestment risk. Our investments in marketable securities consist
primarily of
high-grade corporate and government securities with maturities of less than
three years. Investments purchased with an original maturity of three months or
less are considered to be cash equivalents. We classify all of our investments
as available-for-sale. Available-for-sale securities are carried at fair value,
with unrealized gains and losses, net of tax, reported in a separate component
of stockholders' equity. Average maturity of our investment portfolio is
2.8approximately 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, 20032004 and 2002,2003, 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, 20032004 and 2002.2003.
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 and
approximately $231,000 at December 31, 2002.2003. 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 and
approximately $460,000 at December 31, 2002.2003.
39
The following table provides information about our investment portfolio at
December 31, 2003:2004:
(Inin thousands)
Estimated Fair
Debt Securities Cost Fair Value
Debt Securities
Due in one year or less:
Short-term munis-taxable $ 8,313120,725 $ 8,324120,725
Corporate 8,442 8,44015,724 15,682
Governments/Agencies 15,526 15,52275,087 74,789
Total due in one year 32,281 32,286$ 211,536 $ 211,196
Due in one to three years:
Corporate 2,189 2,182
Government/Agencies 10,500 10,49014,364 14,256
Total due in one to three years 12,689 12,67214,364 14,256
Grand total $ 44,970 $ 44,958225,900 $ 225,452
39
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 primarilyin an effort to hedge
amounts due fromagainst the effects of fluctuating currency exchange rates on monetary assets
and the net assets of selected subsidiariesliabilities denominated in foreign currencies other than the functional currency of
the relevant entity (mainly in Europe and Asia Pacific) against fluctuations in
exchange rates.. We have not entered
into forward foreign exchange contracts for speculative or trading purposes. Our
accounting policies for these contracts are based on our designation of the
contracts as hedging transactions. The criteria
we use for designating a contract as a hedge include the contract's
effectiveness in risk reduction and one-to-one matching of derivative
instruments to underlying transactions. Gains and losses on foreign exchange
contracts are recognized in income in the same period as gains and losses on the
underlying transactions. If an underlying hedged transaction were terminated
earlier than initially anticipated, the offsetting gain or loss on the related
forward foreign exchange contract would be recognized in income in the same
period. In addition, since we enter into forward contracts only as a hedge, any
change in currency rates would not result in any material net gain or loss, as
any gain or loss on the underlying foreign currency denominated balance would be
offset by the gain or loss on the forward contract.occur.
Our forward contracts
generally have an original maturity of three months. As of December 31, 2003, we
had forward foreign exchange contracts outstanding totaling approximately
$185,000 in ten currencies. These contracts
were opened on the last business day of the quarter and mature within three months.thus had a nominal fair
value as of December 31, 2004.
Cumulative other comprehensive income increased from a lossgain of $6.4$5.6 million
in 2002,during 2003, to a gain of $5.6$11.0 million at the end of 2003,during 2004, due primarily to $12.0
million of unrealized foreign
currency translation gains of $5.4 million resulting from the strengthening of
the Euro against the U.S. dollar during 2003.2004.
40
Item 8. Financial Statements and Supplementary Data
The consolidated financial statements for the years ended December 31,
2004, 2003 2002 and 20012002 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
The Company maintainsConclusion 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 the Company'sour Exchange Act reports isare
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 the Company'sour management, including itsour
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
40
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, 2003,2004, the end of the period covered by this report, an
evaluation was carried out under the supervision and with the participation of
the Company'sour management, including the Company'sour Chief Executive Officer and the Company'sour Chief Financial
Officer, of the effectiveness of the design and operation of the Company'sour disclosure
controls and procedures as required by SECSecurities Exchange Act of 1934 Rule 13a
- - 15(b). Based on the foregoing, the Company'sour Chief Executive Officer and Chief Financial
Officer concluded that the Company'sour disclosure controls and procedures were effective at
the reasonable assurance level. There has been no change in the Company'sour internal
controls over financial reporting during the Company'sour most recent fiscal quarter and year ending
December 31, 2003 that has
materially affected, or is reasonably likely to materially affect, the Company'sour 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 20042005 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 20042005 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 20042005 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
20042005 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 "Fees Billed to Us by Deloitte"Principal Accountant Fees and Touche LLP in 2003"Services" of our definitive Proxy
Statement for our 20042005 Annual Meeting to be filed with the Securities and
exchangeExchange Commission.
4143
PART IV
Item 15. Exhibits, Financial Statement Schedule and Reports on Form 8-K
(a) Report of Independent Auditors' Report,Registered Public Accounting Firm, FinancialStatements and Financial Statement ScheduleSchedule
Page
Report of Independent Auditors' ReportRegistered Public Accounting Firm F-2
Consolidated Balance Sheets at December 31, 20032004 and December 31, 20022003 F-3
Consolidated Statements of Operations for each of the three years in
the period ended December 31, 20032004 F-4
Consolidated Statements of Comprehensive Operations for each of the
three years in the period ended December 31, 20032004 F-5
Consolidated Statements of Stockholders' Equity for each of the three
years in the period ended December 31, 20032004 F-6
Consolidated Statements of Cash Flows for each of the three years in
the period ended December 31, 20032004 F-7
Notes to Consolidated Financial Statements F-8
Independent Auditors' Report on Schedule F-37
Schedule II. Valuation and Qualifying Accounts and Reserves S-1
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter ended December
31, 2003.
4244
(c) Exhibits
The following exhibits are filed herewith or incorporated by reference:
Exhibit No. Exhibit Description
3.1* Restated Certificate of Incorporation, as amended (filed as Exhibit 3.1 to Registrant's Form S-4
filed on January 26, 1996; Registration No. 333-00676).
3.1.1* Certificate of Amendment of Restated Certificate of Incorporation (filed as Exhibit 3.1.1 to
Registrant's Form S-4 filed on January 26, 1996, Registration No. 333-00676).
3.2* Bylaws (filed as Exhibit 3.2 of the Registrant's registration statement on Form S-1, Registration
No. 33-15004).
4.1* Form of certificate evidencing Common Stock (filed as Exhibit 4.1 to Registrant's registration
statement on Form S-1, Registration No. 33-15004).
4.2* Rights Agreement, dated as of November 4, 1988 between FileNet Corporation and the First National
Bank of Boston, which includes the form of Rights Certificate as Exhibit A and the Summary of Rights
to Purchase Common Shares as Exhibit B (filed as Exhibit 4.2 to Registrant's registration statement
on Form S-4 filed on January 26, 1996; Registration No. 333-00676).
4.3* Amendment One dated July 31, 1998 and Amendment Two dated November 9, 1998 to Rights Agreement dated
as of November 4, 1988 between FileNet Corporation and BANKBOSTON, N.A. formerly known as The First
National Bank of Boston (filed as Exhibit 4.3 to Registrant's registration statement on Form 10-Q for
the quarter ended September 30, 1998).
4.4* Amendment Three dated November 30, 2001 to Rights Agreement dated as of November 4, 1988 between
FileNet Corporation and Equiserve Trust Company, N.A., successors to BANKBOSTON, N.A. (filed as
Exhibit 4.4 to Registrant's Annual Report on Form 10-K filed for the year ended December 31, 2001).
10.1* Second Amended and Restated Credit Agreement (Multi-currency) by and
between the Registrant and Bank of America National Trust and Savings
Association dated June 30, 1999, effective June 30, 1999 (filed as
Exhibit 10.1 to Registrant's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1999) as amended by a Waiver and First
Amendment to Credit Agreement dated as of June 29, 2001 and by a
letter amendment dated as of April 5, 2002.
10.1.1* Waiver and First Amendment to Credit Agreement (Multi-currency) by
and among the Registrant and Bank of America, N.A., formerly known as
Bank of America National Trust and Savings Association, dated June 29,
2001, effective June 29, 2001 (filed as Exhibit 10.1 to Registrant's
Annual Report on Form 10-K filed for the year ended December 31,
2001).
10.1.2* Letter amendment dated as of April 5, 2002 and Third Amendment to
Credit Agreement (Multi-currency) by and between the Registrant and
Bank of America, N.A., dated as of June 28, 2002 (filed as Exhibit
10.1.2 to Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 2002).
10.2*+ Amended and Restated 1995 Stock Option Plan of FileNet (filed as Exhibit 99.1 to Registrant's
registration statement on Form S-8 filed on October 15, 2001; Registration No. 333-71598).
10.2.1*+ 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(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).
43
10.5*+ Non-Statutory Stock Option Agreement (with Notice of Grant of Stock
Option and Special Addendum) between Registrant and Mr. Ron Ercanbrack
(filed as Exhibit 99.19 to Registrant's registration statement
on Form S-8 filed on August 20, 1997).
10.6*+ Amended and Restated FileNet Corporation 1998 Employee Stock Purchase Plan (filed as Appendix B to
Registrant's Definitive Proxy Statement on Schedule 14A, for the Registrant's 2002 Annual Meeting of
Stockholders, filed on April 18, 2002).
10.7*+ FileNet Corporation International Employee Stock Purchase Plan (filed as Appendix C to Registrant's
Definitive Proxy Statement on Schedule 14A, for the Registrant's 2002 Annual Meeting of Stockholders,
filed on April 18, 2002).
10.8* Lease between the Registrant and C. J. Segerstrom and Sons for the headquarters of the Company, dated
September 1, 1999 (filed as Exhibit 10.23 to Registrant's registration statement on Form 10-Q for the
quarter ended September 30, 1999).
10.9* Asset Purchase Agreement between the Registrant and Application
Partners, Inc. dated May 18, 2000 (filed as Exhibit 10.24 to
Registrant's Form 10-Q for the quarter ended June 30, 2000).
10.10*+ Written Compensation Agreement and Non-Statutory Stock Option Agreement (with Notice of Grant of
Stock Option and Special Addendum) between Registrant and Mr. Sam Auriemma (filed as Exhibit 99.1 and
99.2 to Registrant's registration statement on Form S-8, filed on April 20, 2001; Registration No.
333-59274).
10.11* Asset Purchase Agreement dated April 2, 2002 by and between 3565 Acquisition Corporation and eGrail,
Inc. (filed as Exhibit 10.1 to Registrant's Current Report on Form 8-K, filed on April 12, 2002).
10.12*+ Secured Promissory Note between Registrant and Mr. Lee D. Roberts dated June 14, 2002 ((filed as
Exhibit 10.12 to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2002).
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).
44
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+ Non-Statutory10.20*+ Form of Restricted Stock Option Agreement between Registrant and Mr.
Kenneth F. Fitzpatrick.
14 Code of Conductcertain 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 Auditors' consentRegistered 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, Michael W. Harris,
William J.
Kreidler, Chas W. Kunkelmann, Philip Rugani, Daniel S. Whelan, Franz X. Zihlmann, Ms. Katharina M. Mueller and Ms. Audrey N.
Schaeffer. Mr. Kenneth F. Fitzpatrick entered in aAmended and Restated Letter Agreement dated September 2, 2003 onwith substantially the same terms and conditions.
45conditions
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 12, 200415, 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 12, 200415, 2005 /s/ Lee D. Roberts .
Lee D. Roberts
Chief Executive Officer and
Chairman of the Board
(Principal Executive Officer)
March 12, 200415, 2005 /s/ Sam M. Auriemma .
Sam M Auriemma,
Chief Financial Officer and Senior Vice
President, Finance (Principal Financial
and Accounting Officer)
March 12, 200415, 2005 /s/ Theodore J. Smith .
Theodore J. Smith
Director
March 12, 200415, 2005 /s/ L. George Klaus .
L. George Klaus
Director
March 12, 200415, 2005 /s/ William P. Lyons
William P. Lyons
Director
March 12, 2004 /s/ John C. Savage .
John C. Savage
Director
March 12, 200415, 2005 /s/ Roger S. Siboni .
Roger S. Siboni
Director
4647
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 Auditors' ReportRegistered Public Accounting Firm F-2
Consolidated Balance Sheets at December 31, 20032004 and December 31, 20022003 F-3
Consolidated Statements of Operations for each of the three years in the
period ended December 31, 20032004 F-4
Consolidated Statements of Comprehensive Operations for each of the
three years in the period ended December 31, 20032004 F-5
Consolidated Statements of Stockholders' Equity for each of the three years
in the period ended December 31, 20032004 F-6
Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 20032004 F-7
Notes to Consolidated Financial Statements F-8
Independent Auditors' Report on Schedule F-37
Schedule II. Valuation and Qualifying Accounts and Reserves S-1
F-1
REPORT OF INDEPENDENT AUDITORS' REPORTREGISTERED 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 its subsidiaries (the Company)"Company") as of December 31, 20032004 and 2002,2003,
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, 2003.2004. Our audits also included the financial statement
schedule listed in the Index at Item 15(a). These consolidated financial statements and the
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these consolidatedthe financial statements and the
financial statement schedule based on our audits.
We conducted our audits in accordance with auditingthe standards generally accepted
inof the United States of America.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
its
subsidiaries as of December 31, 20032004 and 2002,2003, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2003,2004, in conformity with accounting principles generally accepted
in the United States of America. As discussedAlso, in Note 2our opinion, such financial statement
schedule, when considered in relation to the basic consolidated financial
statements the Company
changed its method of accounting for goodwill and other intangible assetstaken as a resultwhole, presents fairly, in all material respects, the
information set forth therein.
We have also audited, in accordance with the standards of adopting Statementthe Public
Company Accounting Oversight Board (United States), the effectiveness of Financial Accounting Standards No. 142, Goodwillthe
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 Other Intangible Assets, effective January 1, 2002.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
February 24, 2004March 11, 2005
F-2
CONSOLIDATED BALANCE SHEETS
ASSETS
(Inin thousands, except share and per share amounts)
December 31, 2004 2003 2002
Current assets:
Cash and cash equivalents $ 203,305123,217 $ 130,154100,605
Short-term investments 32,286 29,188211,196 134,986
Accounts receivable, net of allowances for doubtful accounts
and sales returns of $3,917$3,835 and $4,232$3,917 at December 31,
2004 and 2003, and 2002, respectively 35,878 38,096 44,839
Inventories, net 528 2,568
Prepaid expenses and other current assets 12,646 13,31712,179 13,174
Deferred income taxes 3,681 3,551 802
Total current assets 386,151 290,412 220,868
Property, net 21,738 26,922 34,641
Long-term investments 14,256 12,672
25,864
Goodwill 27,268 26,170 16,907
Intangible assets, net of accumulated amortization of $1,842$4,750 and
$544$2,386 at December 31, 2004 and 2003, and 2002, respectively 6,188 7,979 3,029
Deferred income taxes 36,028 23,001
21,792
Other assets 2,037 4,692 4,935
Total assets $ 391,848493,666 $ 328,036391,848
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 11,00613,868 $ 7,70611,006
Accrued compensation and benefits 33,674 27,648 20,729
Customer deposits and advances 9,007 5,217
2,962
Unearned maintenancecustomer support revenue 47,145 40,691
38,945Income tax payable 5,374 1,492
Other accrued liabilities 16,524 15,22414,201 15,032
Total current liabilities 123,269 101,086
85,566
Unearned maintenancecustomer support revenue 2,533 1,614 3,565
Commitments and contingencies (Notes 10, 179, 14 and 18)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; and 37,014,512 shares issued and
35,916,512 shares outstanding at December 31, 20022003 284,490 234,025
206,676Deferred compensation (6,530) -
Retained earnings 93,512 64,098 53,178
Accumulated other comprehensive income (loss)10,959 5,592 (6,382)
303,715 253,472
Treasury stock, at cost; 1,098,000 shares at 382,431 303,715
December 31, 20032004 and 20022003 (14,567) (14,567)
Net stockholders' equity 367,864 289,148 238,905
Total liabilities and stockholders' equity $ 391,848493,666 $ 328,036391,848
See accompanying Notes to Consolidated Financial Statements
F-3
CONSOLIDATED STATEMENTS OF OPERATIONS
(Inin thousands, except share and per share amounts)
Year Ended December 31, 2004 2003 2002 2001
Revenue:
Software $ 154,279 $ 149,214 $ 132,508
$ 119,014
Customer support 164,772 149,847 132,382188,011 167,230 157,550
Professional services and education 55,268 48,061 56,959 69,186
Hardware 2,458 7,703 14,028
Total revenue 397,558 364,505 347,017 334,610
Cost of revenue:
Cost of software revenue15,122 13,800 10,565 7,522
Cost of customer support revenue 39,116 38,608 42,39641,989 42,785 44,603
Cost of professional services and education revenue 44,954 42,346 50,408 59,896
Cost of hardware revenue 3,669 5,995 10,211
Total cost of revenues 102,065 98,931 105,576 120,025
Gross profit 295,493 265,574 241,441 214,585
Operating expenses:
Research and development 78,248 77,050 71,735 68,838
Selling and marketing 159,716 144,975 132,109 136,124
General and administrative 35,363 32,466 31,656 33,381
In-process research and development - - 400 - .
Total operating expenses 273,327 254,491 235,900 238,343
Operating income (loss)22,166 11,083 5,541 (23,758)
Other income, net 5,959 4,084 5,209 2,503
Income (loss) before income taxes 28,125 15,167 10,750 (21,255)
Provision (benefit) for income taxes (1,289) 4,247 2,478 (4,633)
Net income (loss) $ 29,414 $ 10,920 $ 8,272 $ (16,622)
Earnings (loss) per share:
Basic $ .75 $ .30 $ .23
Diluted $ (0.47)
Diluted.72 $ .29 $ .23 $ (0.47)
Weighted average shares outstanding:
Basic 39,095 36,532 35,590
35,117
Diluted 40,994 38,089 36,709 35,117
See accompanying Notes to Consolidated Financial Statements
F-4
CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
(Inin thousands)
Year Ended December 31, 2004 2003 2002 2001
Net income (loss)$ 29,414 $ 10,920 $ 8,272 $ (16,622)
Other comprehensive income (loss):income:
Foreign currency translation
adjustments 5,590 12,093 7,631 (3,056)
Unrealized holding gains (losses) on
available-for-sale securities, net of tax (223) (119) 27 77
Other comprehensive income (loss)5,367 11,974 7,658 (2,979)
Comprehensive income (loss)$ 34,781 $ 22,894 $ 15,930 $ (19,601)
See accompanying Notes to Consolidated Financial Statements
F-5
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Inin thousands)
Accumulated
Common Other
Common Stock Deferred Retained Comprehensive Treasury Stock
Shares Amount Compensation Earnings Operations Shares Amount Total
Balances at January 1, 2001 35,941 $ 189,057 $ 61,528 $ (11,061) (1,098) $(14,567) $ 224,957
Stock options exercised 486 4,722 4,722
Stock option income tax 1,749 1,749
benefit
Common stock issued under the
Employee Qualified Stock
Purchase Plan 339 3,998 3,998
Cancelled and retired escrow
shares issued in business
combinations (376)
Foreign currency translation
adjustment (3,056) (3,056)
Net (loss) (16,622) (16,622)
Unrealized holding gains on
available-for-sale-securities 77 77 .
Balances at December 31, 20012002 36,390 $ 199,526 $ - $ 44,906 $ (14,040) $ (1,098) $(14,567)$ (14,567) $ 215,825
Stock options exercised 286 2,753 2,753
Stock option income tax
benefit 685 685
benefit
Common stock issued under the
Employee Qualified Stock
Purchase Plan 339 3,712 3,712
Foreign currency translation
adjustment 7,631 7,631
Unrealized holding gains on
available-for-sale-securities 27 27
Net income 8,272 8,272 Unrealized holding gains on
available-for-sale-securities 27 27 .
Balances at December 31, 2002 37,015 $ 206,676 $ - $ 53,178 $ (6,382) $ (1,098) $(14,567)$ (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
Net income 10,920 10,920
Unrealized holding gains on
available-for-sale-securities (119) (119)
Non-employee stock
compensation valuation 127 127 Net income 10,920 10,920.
Balances at December 31, 2003 38,90739,907 $ 234,025 $ - $ 64,098 $ 5,592 $ (1,098) $(14,567)$ (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
(Inin thousands)
Year Ended December 31, 2004 2003 2002 2001
Cash flows provided by operating activities:
Net income (loss)$ 29,414 $ 10,920 $ 8,272
$ (16,622)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Purchased in-process research and development - 400
-
Depreciation and amortization 16,350 19,378 21,588 24,349
Loss on sale of fixed assets 426 27 47 264
Provision for doubtful accounts and sales returns 1,108 653 1,752 1,482
Deferred income taxes (13,158) (3,956) 1,629 (8,286)
Stock option income tax benefit 7,087 5,865 685 1,749
Changes in operating assets and liabilities, net of
effects of acquisitions:acquisition:
Accounts receivable 1,918 8,835 (7,818) 51,128
Inventories 2,075 425 405
Prepaid expenses and other current assets 1,648 (3,425) 185920 3,723 (3,000)
Accounts payable 2,502 2,325 (940) (8,236)
Accrued compensation and benefits 5,301 5,309 2,101 (8,119)
Customer deposits and advances 3,774 2,198 (1,895)
2,936
Unearned maintenancecustomer support revenue 6,855 (2,276) 4,651 9,842
Income taxes payable 3,898 2,349 (3,966) (5,559)
Other assets and liabilities 3,625 (3,183) (2,066) (3,044)
Net cash provided by operating activities 70,020 52,167 21,440 42,474
Cash flows used for investing activities:
Capital expenditures (9,435) (9,177) (10,825) (14,075)
Proceeds from sale of property 106 135 66
329
Note receivable - 294 (1,900) -
Cash paid for acquisitions, net of cash acquired - (8,073) (9,359) -
Purchases of investments (87,768) (134,528) (148,570)(131,360) (141,668) (151,578)
Proceeds from sales and maturities of investments 52,225 94,305 146,571 120,433
Net cash used in investing activities (10,284) (9,975) (41,883)(88,464) (64,184) (27,025)
Cash flows provided by financing activities:
Proceeds from issuance of common stock 36,114 21,357 6,465 8,720
Principal payments on capital lease obligations - (16) (1,799) (935)
Net cash provided by financing activities 36,114 21,341 4,666 7,785
Effect of exchange rate changes on cash and cash
equivalents 4,942 9,927 6,521 (2,371)
equivalents .
Net increase in cash and cash equivalents 73,151 22,652 6,00522,612 19,251 5,602
Cash and cash equivalents, beginning of year 130,154 107,502 101,497100,605 81,354 75,752
Cash and cash equivalents, end of year $ 203,305123,217 $ 130,154100,605 $ 107,50281,354
Supplemental cash flow information:
Interest paid $ 38 $ 48 $ 100 $ 92
Income taxes paid $ 349 $ 3,050 $ 4,301 $ 7,045$4,301
See Note 134 for non-cash investing and financing activities .
See accompanying Notes to Consolidated Financial Statements
F-7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 Nature of Operations
FileNet Corporation ("FileNet" or "the Company") develops, markets, sells
and supports a unified platform and framework for Enterprise Content Management ("ECM") software and solutions that
delivers capabilities in a tightly integrated and synchronized offering. 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 application developers.independent
software vendors.
Note 2 Summary of Significant Accounting Policies
Basis of Presentation.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.Estimates. The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates. Estimates are used for, but not limited to, the accounting for the
allowance for doubtful accounts and sales returns, inventory allowances,
warranty costs, contingencies and income
taxes.
Foreign Currency Translation.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 and losses incurred during the years ended December 31, 2004, 2003 and 2002 and
2001 were
a gain of approximately $890,000, $700,000, a gain ofand $1.5 million, and a loss
of approximately $13,000, respectively.
Cash Equivalents.Equivalents. Investments purchased with an original maturity of three
months or less are considered to be cash equivalents and are stated at cost,
which approximates fair value. Cash equivalents generally consist of cash, time deposits,
commercial paper, U.S. government and U.S. government agencies instruments,
money market funds and other money market instruments. The Company invests its
excess cash only in investment AAA grade money market instruments from companies
in a variety of industries and, therefore, believes that it bears minimal
principal risk. 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.Investments. The Company's investments consist of marketable securities,
primarily high-grade
corporate and government securities with maturities of less than three years.
The Company classifies all of its investments as available-for-sale.
Available-for-sale securities are carried at fair value, with unrealized gains
and losses, net of tax, reported in a separate component of stockholders' equity
(Note 7).
F-8
Other Financial Instruments.Instruments. The Company enters into forward foreign
exchange contracts as a hedge against the effects of fluctuating currency
exchange rates on monetary assets and liabilities denominated in currencies
other than the functional currency of the relevant entity. The Company is
exposed to market risk on the forward foreign exchange contracts as a result of
changes in foreign exchange rates; however, the market risk should be offset by
changes in the valuation of the underlying exposures. Gains and losses on these
contracts, which equal the difference between the forward contract rate and the
prevailing market spot rate at the time of valuation, are recognized in the
consolidated statements of operations. These contracts mature every three months
at the end of each quarter. The Company opens new hedge contracts on the last
business day of each quarter that will mature at the end of the following
quarter. The counterparties to these contracts are major financial institutions.
The Company uses commercial rating agencies to evaluate the credit quality of
the counterparties and does not anticipate nonperformance by any counterparties.
The Company does not anticipate a material loss resulting from credit risks
related to any of these institutions (Note 19)16).
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for
Derivative Instruments and Hedging Activities." SFAS No. 133 as amended, is
effective for fiscal years beginning after June 15, 2000. SFAS No. 133, as
amended, established accounting and reporting standards for derivative
instruments including certain derivative instruments embedded in other contracts
that were not formerly considered derivatives and may now meet the definition of
a derivative. Additionally, this standard required the Company to record all
derivatives on the balance sheet at fair value. For derivatives that qualify for
hedge accounting, changes in the fair value of derivatives are offset by the
change in fair value of the hedged assets, liabilities, or firm commitments as
appropriate for cash flow and fair value hedges. The Company adopted this
standard effective January 1, 2001, and it has had no significant effect on the
Company's consolidated results of operations, financial position, or cash flows.
Fair Value of Financial Instruments.Instruments. The recorded amounts of financial
assets and liabilities at December 31, 20032004 and 2002,2003, approximate fair value due
to the relatively short period of time between origination of the instruments
and their expected realization.
Accounts Receivable.Receivable. The Company evaluates the creditworthiness of its
customers prior to order fulfillment and regularly adjusts credit limits based
upon ongoing credit evaluations of a customer's payment history and current
creditworthiness. An allowance for estimated credit losses is maintained and
such losses have been within management's expectations and the provisions
established.
Inventories.Property Inventories are stated at the lower of first-in, first-out,
cost, or market (Note 8). The Company regularly monitors inventories for excess
or obsolete items and makes any necessary adjustments at each balance sheet
date.
Property. Property is stated at cost. Depreciation is computed using the
straight-line method over the estimated useful lives of the related assets,
generally three to five years. Leasehold improvements are amortized over the
shorter of the estimated usefuleconomic lives of the improvements or the term of the related
lease (Note 9)8).
Long-Lived Assets.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,Assets." which the Company adopted effective January
1, 2002. In accordance with SFAS No. 144, long-lived
assets are reviewed for events or changes in circumstances that indicate that
their carrying value may not be recoverable.recoverable from future cash flows. Based on the
Company's most recent analysis, the Company believes there is no impairment at
December 31, 2003.
F-9
2004.
Change in Accounting for Goodwill.Goodwill Prior to the adoption of. SFAS No. 142, "Goodwill and Other Intangible Assets," requires
that goodwill arising from our API
acquisition that took place on May 18, 2000, was amortized on a straight-line
basis over five years and assembled workforce was amortized on a straight-line
basis over three years (Note 3). The Company adopted SFAS No. 142 on January 1,
2002. As a result, assembled workforce no longer meets the definition of a
separately identified intangible asset under the provisions of SFAS No. 142, and
the un-amortized balance of $182,000 was reclassified as goodwill at January 1,
2002. In accordance with this Standard, the Company ceased amortizing the
goodwill balance of $10.1 million from its 2000 acquisition of Applications
Partner, Inc. as of January 1, 2002 and there were no other indefinite life intangible assets aswith indefinite useful lives be tested
for impairment annually or when events or changes in circumstances indicate that
the carrying amount of January 1, 2002. Goodwill of $5.8 million resulting from
the acquisition of eGrail in April 2002 and goodwill of $3.1 million resulting
from the acquisition of Shana in April 2003 is alsothese assets may not being amortized.be recoverable. In accordance with
SFAS No. 142, the Company isdoes not amortize goodwill, but performs the required
to perform a
two-step transitional 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, the step two of the test would be required to
determine if the carrying value of goodwill exceeded the implied value. The
Company engaged an independent valuation firm to assist
management in determining the business enterprise value for each of its
reporting segments and to performperformed an impairment analysis as of July 1, 20032004 in accordance with
SFAS 142. The analysis indicated there was no impairment of goodwill in any of
the reporting segments. As of December 31, 2003,2004, no impairment of goodwill has
been recognized. If estimates change, a materially different impairment
conclusion could result.
Summarized below areF-9
Revenue Recognition. The Company derives revenues from the effects on net income (loss) per share data iffollowing
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
Company had followed the non-amortization provisions of
SFAS No.142 for all
periods presented (in thousands, except per share amounts):
Year ended December 31,2003 2002 2001
Net income (loss):
As reported $ 10,920 $ 8,272 $ (16,622)
Add: goodwill and assembled
workforce
amortization, netStatement of taxes - - 1,619 .
Adjusted net income (loss) $ 10,920 $ 8,272 $ (15,003)
Basic net income (loss) per share:
As reported $ 0.30 $ 0.23 $ (0.47)
Add: goodwill and assembled workforce
amortization, net of taxes - - 0.04 .
Adjusted basic net income (loss) per share $ 0.30 $ 0.23 $ (0.43)
Diluted net income (loss) per share:
As reported $ 0.29 $ 0.23 $ (0.47)
Add: goodwill and assembled workforce
amortization, net of taxes - - 0.04 .
Adjusted diluted net income (loss) per share $ 0.29 $ 0.23 $ (0.43)
F-10
Intangible Assets. The acquisition of eGrail in April 2002 and Shana in
April 2003 resulted in intangible assets. Acquired technology, technical manuals
and design documents, and customer relationships were assigned a useful life of
five years and amortized on a straight-line basis as a cost of software revenue.
Non-compete agreements have a useful life of three years and are amortized on a
straight-line basis as a cost of software revenue. Patents were assigned a
useful life of two years and amortized on a straight-line basis as an operating
expense.
Position No. 97-2, Software Revenue Recognition. The Company accounts for the licensing of software in
accordance withRecognition, issued by the
American Institute of Certified Accountants ("AICPA")
Statement of Position ("SOP") 97-2, "Software Revenue Recognition." We enterPublic Accountants. Accordingly, software
license revenue is recognized when: (1) the Company enters into contractsa legally
binding arrangement with a customer for the salelicense of our products and services. The majority of these
contracts relate to single elements and contain standard terms and conditions.
However, there are agreements that contain multiple elements or non-standard
terms and conditions. Contract interpretationsoftware; (2) the Company
delivers the products; (3) customer payment is sometimes required to determine
the appropriate accounting, including how the price should be allocated among
the deliverable elements and when to recognize revenue.
Software license revenue generated from sales through direct and indirect
channels, which do not contain multiple elements, are recognized upon shipment
and passage of title of the related product, if the requirements of SOP 97-2,
are met. If the requirements of SOP 97-2, including evidence of an arrangement,
delivery,deemed fixed or determinable fee, collectibilityand
free of contingencies or vendor specific evidence
aboutsignificant 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 an element are not met at the dateundelivered elements is deferred and the remaining portion of shipment, revenuethe
arrangement fee is not recognized until theseallocated to the delivered elements are known or resolved. Fees are deemed to be
fixed and determinable for transactions with a set price that is not subject to
refund or adjustment and payment is due within 90 days from the invoice date.
Software license revenue from channel partners is recognized when the product is
shipped and sale by the channel partner to a specified end user is confirmed.
For arrangements with multiple elements, we allocateas
revenue, to each
element of a transaction based upon its fair value as determined in reliance on
vendor specific objective evidence. Thisassuming 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 anthe arrangement are delivered.
Vendor specific objective evidence ("VSOE") of fair value for customer
support is based ondetermined by reference to the normal pricing and discounting practicesprice the Company's customers pay for
those products and servicessuch support when sold separately. If fair value of any
undelivered element cannot be determined objectively,separately; that is, the Company defers the
revenue until all elements are delivered, services have been performed or until
fair value can objectively be determined.
Customer support contracts are renewable on an annual basis and provide
after-sale support for the Company's software, as well as software upgrades
under its rightrenewal rates offered to
new versions program, on a when-and-if-available basis.customers. Revenue from post-contract 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 revenue consists of consultingare not required for
the software to function and implementation
services provided to end users of our software products and technical consulting
services provided to our resellers. Consulting engagements average from one to
three months. Thethe Company does not make changes to the standard
software code in the field.
RevenueThe Company assesses whether fees are fixed or determinable at the time of
sale. Standard payment terms range from these services and from training classesnet 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 as such serviceswhen 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 deliveredmade 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 accepted byaddress of all end users at the customer. Revenuetime an
order is placed and, costin many cases, the Company ships its product directly to
the end user. Thus, software license revenue from channel partners is recognized
using the percentage-of-completion method for fixed-price consulting
contracts. However,when an end user is identified, product is delivered either to a channel partner
or to their designated end-user and all other revenue and profitrecognition criteria are
subject to revision as the contract
progresses and anticipated losses on fixed-price professional services contracts
are recognized in the period when they become known.met.
F-10
Product Warranty.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 and hardware products against defects in materials and
workmanship. A provision for estimateddelivery. The incremental cost of services performed under warranty
costs is recorded at the time of
sale or license and the related liability is periodically adjusted to reflect
actual experience (Note 11).
F-11
obligations has historically not been significant.
Research and Development.Development Costs The Company expenses. We expense research and development costs
as incurred. NoThe 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 software is substantially completed concurrently
withno significant costs are incurred subsequent to the
establishment of technological feasibility.
Income Taxes.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 15)12).
Earnings (Loss) Per Share.Share. Basic earnings (loss) per share isare computed using the
weighted average number of common shares outstanding during the reporting
period. Diluted earnings per share is computed using the weighted average number
of common shares outstanding plus the dilutive effect of outstanding stock
options and shares issuable under the employee stock purchase plan using the
treasury stock method. Diluted loss per share excludes these
adjustments, as the impact would be antidilutive (Note 5).
Supplier Concentrations. Hardware is no longer a strategic reporting
segment for the Company. The dependence on suppliers is limited to Optical
Storage and Retrieval (OSAR) devices that generate minimal revenue to the
Company.
Stock-Based Compensation.Compensation. The Company accounts for stock-based awards to
employees using the intrinsic value method in accordance with Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees."
No stock-based compensation expense was recorded in the consolidated
statements of operations for the years ended December 31, 2003, 2002 and 2001.
The following table summarizes the Company's net income (loss) and net
income (loss)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 2001
Net income, (loss), as reported $ 29,414 $ 10,920 $ 8,272 $ (16,622)
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) (12,381)
Pro forma net income (loss) $ 21,593 $ 3,491 $ (463) $ (29,003)
Earnings per share:
Basic earnings (loss) per share - as reported $ 0.75 $ 0.30 $ 0.23 $ (0.47)
Basic earnings (loss) per share - pro forma $ 0.55 $ 0.10 $ (0.01)
$ (0.83)
Diluted earnings (loss) per share - as reported $ 0.72 $ 0.29 $ 0.23 $ (0.47)
Diluted earnings (loss) per share - pro forma $ 0.53 $ 0.09 $ (0.01) $ (0.83)
F-12
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 and 2001:
.
2003 2002 2001 .
Expected volatility 76% 58% 68% 78%
Risk-free interest rates 3.07% - 3.72% 1.63% - 4.76% 2.0% to 4.61%
3.6% to 5.3%
Expected life from vest date (years) 1 1 15.46 5.56 5.60
Dividend 0% 0% 0% .
Pro forma compensation cost also includes the fair value of sharesawards issued
under the Employee Qualified
Stock Purchase Plan is measured based on the discount from market value on the
date of purchase in accordance with SFAS No. 123.Plan.
Recently Issued Accounting Pronouncements
Note 3. New Accounting PronouncementsIn June 2001,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 issued SFASdelayed 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. 141, "Business Combinations,123 (FAS 123R),
"Share-Based Payment," which was effective immediately. SFAS No. 141 requires thatcompanies to expense the purchase methodestimated fair
value of accounting be used for all business combinations initiated after June 30, 2001employee stock options and it eliminated the pooling-of-interests method. The adoption of this standard
did not have a significant impactsimilar awards based on the Company's consolidated financial
statements. The Company's April 2002 acquisition of certain assets and certain
liabilities of eGrail, Inc. and the Company's April 2003 acquisition of Shana
Corporation were accounted for in compliance with this pronouncement (See Note
No. 3 to the Notes to the Audited Consolidated Financial Statements for
details).
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which we adopted January 1, 2002. SFAS No. 142 requires that goodwill
and other intangible assets with indefinite useful lives no longer be amortized,
but instead be tested for impairment at least annually and written down when
impaired. SFAS No. 142 requires purchased intangible assets other than goodwill
to be amortized over their useful lives, unless these lives are determined to be
indefinite. In accordance with this standard, the Company does not amortize
goodwill and indefinite life intangible assets but evaluates their carrying
value annually or when events or circumstances indicate that their carrying
value may be impaired. As of 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. The Company engaged an independent valuation firm
to determine the business enterprise value for each of our reporting segments
and to perform an impairment analysis as of July 1, 2003 in accordance with SFAS
142. The analysis indicated there was no impairment of goodwill in any of the
reporting units. As of December 31, 2003, no impairment of goodwill has been
recognized. If estimates change, a materially different impairment conclusion
could result.
In August 2001, the FASB issued SFAS No. 144, "Accounting for Impairment or
Disposal of Long-Lived Assets." This statement addresses financial accounting
and reporting for the impairment of long-lived assets and for the disposal of
long-lived assets and discontinued operations. SFAS No. 144 superseded SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of," and is effective for fiscal years beginning after
December 15, 2001. The adoption of this standard did not have a material impact
on the Company's consolidated financial statements.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which addresses financial
accounting and reporting for costs associated with exit or disposal activities
and supersedes EITF Issue 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." SFAS No. 146 requires that costs associated
F-13
with exit or disposal activities be recognized when they are incurred rather
than at the date of a commitment to an exit or disposal plan. SFAS No. 146 also
establishes that the liability should initially be measured and recorded at fair
value. The Company adopted the provisions of SFAS No. 146 for exit or disposal
activities initiated after December 31, 2002. The adoption of this standard did
not have a material impact on the Company's consolidated financial statements.
In November 2002, the FASB issued FIN 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others," an interpretation of FASB Statement Nos. 5, 57 and 107,
and rescission of FIN 34, "Disclosure of Indirect Guarantees of Indebtedness of
Others." FIN 45 elaborates on the disclosures to be made by the guarantor in its
interim and annual financial statements about its obligations under certain
guarantees that it has issued. It also requires that a guarantor recognize, at
the inception of a guarantee, a liability for thegrant-date fair
value of the obligation
undertakenaward. The cost will be recognized over the period during which an
employee is required to provide service in issuingexchange for the guarantee.award, usually the
vesting period. The accounting provisions related to recognizing a
liability at inceptionof FAS 123R will be effective as of
the guarantee for the fair value of the guarantor's
obligations does not apply to product warranties or to guarantees accounted for
as derivatives. The initial recognition and measurement provisions of this
interpretation are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002, while the disclosure requirements are
effective for financial statements for interim or annual periods ending after
December 15, 2002. The adoption of the recognition of provisions of FIN 45 in
the period ended December 31, 2003 did not have a material impact on the
Company's consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," an amendment of SFAS No. 123. This
statement amends SFAS No. 123, "Accounting for Stock-Based Compensation," to
provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, this statement amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The transition guidance and
annual disclosure provisions of SFAS No. 148 are effective for fiscal years
ending after December 15, 2002. The interim disclosure provisions are effective
for financial reports containing financial statements for interim periods
beginning after December 15, 2002. The adoption of SFAS No. 148 did not have a
material impact on the Company's consolidated financial statements.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities." In general, a variable interest entity is a corporation,
partnership, trust, or any other legal structure used for business purposes that
either (a) does not have equity investors with voting rights or (b) has equity
investors that do not provide sufficient financial resources for the entity to
support its activities. FIN 46 requires a variable interest entity to be
consolidated by a company if that company is subject to a majority of the risk
of loss from the variable interest entity's activities or entitled to receive a
majority of the entity's residual returns or both. The consolidation
requirements of FIN 46 apply immediately to variable interest entities created
after January 31, 2003. With respect to variable interest entities created
before January 31, 2003, in December 2003 the FASB issued FIN 46R, which, among
other things, revised the implementation date to the first fiscal years or
interim periods ending after March 15, 2004, with the exception of Special
Purpose Entities ("SPE"). The consolidated requirements apply to all SPE's in
the first fiscal year or interim period ending after December 15, 2003. As the
Company has determined that it does not have any SPE's to which these
interpretations apply, the Company will adopt FIN 46R in the first quarter of
2004. The Company believes the adoption of FIN 46R will not have a material
impact on its consolidated financial statements.
F-14
In April 2003, FASB issued SFAS No. 149, "Amendment of Statement No. 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 (1) clarifies under
what circumstances a contract with an initial net investment meets the
characteristic of a derivative discussed in paragraph 6(b) of Statement No. 133,
(2) clarifies when a derivative contains a financing component, (3) amends the
definition of an underlying derivative to conform it to language used in FIN 45,
and (4) amends certain other existing pronouncements, which will collectively
result in more consistent reporting of contracts as either derivatives or hybrid
instruments. SFAS No. 149 is effective for contracts and hedging relationships
entered into or modified after June 30, 2003. The adoption of SFAS No. 149 did
not have a material impact on the Company's consolidated financial statements.
In May 2003, FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both debt and equity and requires
an issuer to classify the following instruments as liabilities in its balance
sheet:
o a financial instrument issued in the form of shares that is
mandatorily redeemable and embodies an unconditional obligation that
requires the issuer to redeem it by transferring its assets at a
specified or determinable date or upon an event that is certain to
occur;
o a financial instrument, other than an outstanding share, that embodies
an obligation to repurchase the issuer's equity shares, or is indexed
to such an obligation, and requires the issuer to settle the
obligation by transferring assets; and
o a financial instrument that embodies an unconditional obligation that
the issuer must settle by issuing a variable number of its equity
shares if the monetary value of the obligation is based solely or
predominantly on (1) a fixed monetary amount, (2) variations in
something other than the fair value of the issuer's equity shares, or
(3) variations inversely related to changes in the fair value of the
issuer's equity shares.
In November 2003, the FASB issued FASB Staff Position (FSP) No. 150-3 which
deferred the effective dates for applying certain provisions of SFAS No. 150
related to mandatorily redeemable financial instruments of certain nonpublic
entities and certain mandatorily redeemable noncontrolling interests for public
and nonpublic entities.
For public entities, SFAS No. 150 is effective for mandatorily redeemable
financial instruments entered into or modified after May 31, 2003 and is
effective for all other financial instruments as of the first interim or annual reporting period beginningthat begins after
F-12
June 15, 2003.
For mandatorily redeemable noncontrolling interests that would not have to
be classified as liabilities by a subsidiary under2005. The Company will adopt the exception in paragraph 9
of SFAS No. 150, but would be classified as liabilities by the parent, the
classification and measurement provisions of SFAS No. 150FAS 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
deferred
indefinitely. For other mandatorily redeemable noncontrolling interestsoutstanding on the effective date and any awards that were issued before November 5, 2003,are subsequently modified
or cancelled. Compensation expense for outstanding awards for which the
measurement provisionsrequisite service had not been rendered as of SFAS No. 150
are deferred indefinitely. For those instruments, the measurement guidanceeffective date will be
recognized over the remaining service period using the compensation cost
calculated for redeemable shares and noncontrolling interests in other literature shall apply
during the deferral period.
SFAS No. 150 is to be implemented by reporting the cumulative effect of a
change in accounting principle.pro forma disclosure purposes under FAS 123 (Note 2 Stock-Based
Compensation). The Company does not believeis in the adoptionprocess of SFAS No. 150determining 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
a material impact on its consolidated financial statements.
Reclassifications.Reclassifications. Certain reclassifications have been made to prior-years'
balances to conform to the current year's presentation.
F-15
presentation (see Note 7 and Note 13).
Note 34. 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.
(In thousands) April 2, 2002 April 2, 2003 .
Net tangible assets $ 581 $ 2,725
Patents 24 -
Goodwill 5,793 3,1037,235
Acquired technology 3,300 4,000
Technical manuals and design documents - 600
Customer maintenancesupport 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 WCMWeb 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
primarily allocated to tangible assets and goodwill. Goodwill of $5.8 million was tax
deductible for this asset purchase.
F-16
The acquisition of Shana resulted in acquired technology, technical manuals
and design documents, and customer maintenancesupport 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
maintenancesupport revenues arewere 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 maintenancesupport relationships of $800,000 were assigned a useful life of five
years. The remaining purchase price of $3.6$7.2 million was allocated primarily
to goodwill.
In accordance with SFAS No. 142, goodwill for both the eGrail and Shana
acquisitions will not be amortized and was reviewed for impairment as part of
the annual analysis performed in July 2003. (See Note 4.) Goodwill from these
acquisitions was not impaired at December 31, 2003.
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 reductiondeductibility of taxable
incomegoodwill and other intangibles for U.S. tax
purposes on this transaction. Goodwill is tax deductible for
the eGrail asset purchase.
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 reporting period.periods presented.
(in thousands)
December 31,2003 Actual 2002 Pro Forma
(unaudited)
Revenue $ 364,505 $ 347,769
Net income 10,920 6,425
Earnings per share:
Basic $ 0.30 $ 0.18
Diluted $ 0.29 $ 0.17
Note 4 Related-Party Transactions
In July 2001, the Compensation Committee of the Company's Board of
Directors ("the Board") entered into discussions with Lee Roberts, the Company's
Chief Executive Officer, regarding a secured loan by the Company to Mr. Roberts
to enable him to purchase a home in Orange County, California. In July 2001, the
Compensation Committee forwarded its recommendation to the Board to approve, in
principle, a secured loan, in the amount of $1.2 million to Mr. Roberts. In
September 2001, the Compensation Committee approved, in principle, an increase
in the previously requested loan amount to $1.9 million, subject to review of
final loan documents and approval of the Board. In May 2002, the Compensation
Committee reviewed proposed loan documentation for a secured loan to Mr. Roberts
and forwarded its recommendation to the Board to approve the loan on the terms
set forth in the loan documents. The loan documents provided that the loan would
be secured by the real estate purchased by Mr. Roberts. Subsequently, on June 5,
2002, the Board approved the loan documents and the loan. The loan to Mr.
Roberts is permitted under Section 13 of the Securities Exchange Act of 1934, as
amended by Section 402 of the Sarbanes-Oxley Act on July 30, 2002, because it
was outstanding on July 30, 2002. However, its terms cannot be renewed or
materially modified in the future. The note bears interest at 2.89% per annum.
F-17F-14
Accrued interest on the principal balance of this note is payable annually
beginning February 15, 2003 and on each February 15th thereafter until the
entire principal balance becomes due. The entire outstanding principal balance
of this note and any accrued interest is due and payable at the earliest of (a)
June 7, 2005, (b) one year after termination of Mr. Roberts' employment by the
Company, or (c) ninety (90) days after voluntary termination of employment by
Mr. Roberts. Imputed interest for the difference between the stated interest
rate of the note and a fair value interest rate of 7% was recorded as
compensation expense and a discount that is being amortized over the term of the
note to interest income using the effective interest method.
Mr. Roberts made a payment in February 2003 of approximately $37,000 toward
the accrued interest balance in accordance with the terms and conditions of the
loan agreement. Mr. Roberts also made a payment in December 2003 of
approximately $294,000 toward the principal loan balance of $1.9 million. As of
December 31, 2003, FileNet has an outstanding secured note receivable balance
from Mr. Roberts in the amount approximately of $1.6 million that relates to the
above-referenced loan and is included in other assets on the consolidated
balance sheet. The accrued interest balance as of December 31, 2003 was
approximately $48,000.
John Savage, a member of the Board and the Audit Committee of the Board, is
Managing Partner of Alliant Partners, which acted as financial advisor to eGrail
in connection with our acquisition of assets from eGrail and was paid
approximately $500,000 by eGrail. Accordingly, John Savage recused himself from
all discussions related to the acquisition of eGrail assets by the Company and
abstained from voting on the transaction.
Note 5 Earnings (Loss) Per Share
Basic earnings per share are computed by dividing net income for the period
by the weighted-average number of common shares outstanding during the period.
Diluted earnings per share is computed by dividing net income by the
weighted-average number of common shares outstanding plus the dilutive effect of
outstanding stock options, shares available for issue under the employee stock
purchase plan and restricted stock issued to key executive management using the
treasury stock method. The number of anti-dilutive options excluded from the
earnings per share calculation for 2004, 2003 and 2002 was 1,943,014, 596,517
and 6,044,213 shares, respectively. The number of unvested restricted stock
excluded from shares used in computing basic earnings per share was 175,000
shares for 2004. The number of unvested restricted stock included in computing
diluted earnings per share was 17,141 shares for 2004. The following table is a
reconciliation of the earnings (loss) and share amounts used in the calculation of
basic earnings (loss) per share and diluted earnings (loss) per share.
share (Inin thousands, except
per share amounts):
_______________________________________________
2004 2003 2002Net Income (loss)$ 29,414 $ 10,920 $ 8,272
Shares Per Share AmountYear ended December 31, 2003:
Basicused in computing
basic earnings per share $ 10,92039,095 36,532 $ 0.30
Effect35,590
Dilutive effect of dilutive stock options -plans 1,899 1,557 -
Diluted1,119
Shares used in computing
diluted earnings per share 40,994 38,089 36,709
Earnings per basic share $ 10,920 38,0890.75 $ 0.30 $ 0.23
Earnings per diluted share $ 0.72 $ 0.29Year ended December 31, 2002:
Basic (loss) per share $ 8,272 35,590 $ 0.23
Effect of dilutive stock options - 1,119 -
Diluted (loss) per share $ 8,272 36,709 $ 0.23
Year ended December 31, 2001:
Basic earnings per share $ (16,622) 35,117 $ (0.47)
*Effect of dilutive stock options - - - Diluted earnings per share $ (16,622) 35,117 $ (0.47)*Note - Options to purchase 3,284,849 shares of common stock in fiscal 2001
were outstanding during the year but were not included in the computation
of diluted income per share as their effect was antidilutive (See Note 14).
F-18
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:
(Inin 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, December 31, 2001 (14,079) 39 (14,040)
Current Period Changes (3,056) 77 (2,979)
Balance, January 1, 20012002 $ (11,023)(14,079) $ (38)39 $ (11,061)(14,040)
F-15
Note 7 Investment Securities Available for SaleAvailable-for-Sale
The Company's investments in marketable securities consist primarily of high-grade
corporate and government securities with maturities of less than three years.
Investments purchased with an original maturity of three months or less are
considered to be cash equivalents. The following table summarizes investment
securities available for sale as of December 31:
(Inin thousands)
Investment securities available foravailable-for-sale sale: 2004 2003 2002
Cost $ 44,970225,900 $ 54,945
Gross unrealized gains - 107
147,670
Gross unrealized losses (448) (12) -
Estimated fair value $ 44,958225,452 $ 55,052147,658
There were no significant realized gains or losses for the years ended
December 31, 2004, 2003 2002 and 2001.2002. Unrealized holding gains and losses on
investments, net of tax, are included in accumulated other comprehensive
operations in stockholders' equity at December 31, 20032004 and 2002,2003, and were a
$53,000cumulative loss of $276,000 and a $66,000 gain,$53,000, respectively. The change year over year
was an unrealized loss of $119,000,$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 tax.
F-19
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, 20032004 and 20022003 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.
(Inin thousands)
2004 2003 2002 .
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 $ 8,313120,725 $ 8,324- $ 4,227120,725 $ 4,232
Commercial paper - - - -111,013 11 $ 111,024
Corporate 15,724 (42) 15,682 8,442 (2) 8,440 4,659 4,681
Governments/Agencies 75,087 (298) 74,789 15,526 (4) 15,522 20,244 20,275
Total 32,281 32,286 29,130 29,188211,536 (340) 211,196 134,981 5 134,986
Due in one to three years:
Short-term munis-taxable - - 2,315 2,329
Commercial paperCorporate - - - -
Corporate 2,189 (7) 2,182
- -
Government/Governments/Agencies 14,364 (108) 14,256 10,500 (10) 10,490 23,500 23,535
Total 14,364 (108) 14,256 12,689 (17) 12,672 25,815 25,864
Grand Total $ 44,970225,900 $ 44,958(448) $ 54,945225,452 $ 55,052147,670 $ (12) $ 147,658
F-16
Note 8Inventories
Inventories consisted of the following at December 31:
(In thousands)2003 2002
Raw materials $ 102 $ 1,538
Work-in-process - 979
Finished goods 426 51 Total $ 528 $ 2,568 Note 9 Property
Property consisted of the following at December 31:
(Inin thousands)
2004 2003 2002
Machinery, equipmentEquipment and software $ 127,265116,669 $ 118,723127,265
Furniture and fixtures 14,025 14,350 13,213
Leasehold improvements 23,752 24,344 23,416
Total property 154,446 165,959 155,352
Less accumulated depreciation and amortization (132,708) (139,037) (120,711)
Property, net $ 21,738 $ 26,922 $ 34,641
F-20
Note 109 Leases and Commitments
The Company leases its corporate offices, sales offices, development and
manufacturing facilities, and other equipment under non-cancelable operating leases,
some of which have renewal options and generallymay 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 $16.0 million and
$17.5$16.0 million for the years ended December 31, 2004, 2003 2002 and 2001,2002,
respectively. The following table summarizes future minimum lease payments
required under operating leases at December 31, 2003:2004:
(Inin thousands)
20042005 $ 12,518
2005 10,57912,265
2006 10,02712,030
2007 9,28210,131
2008 8,2328,570
2009 6,865
Thereafter 6,548 5,785
Total $ 57,186 55,646
The Company continues to invest in technology equipment and software for
research and development and for information systems infrastructure and
telecommunications. These investments have been funded through operating leases,
capital leases and cash purchases. In July 2001, the Company converted its
outstanding leases associated with these investments into an eighteen-month
capital lease with a value of $2.6 million. No future lease commitments are
required under this lease at December 31, 2003.
The Company licenses certain software from third parties with contractual
arrangements that require future payment obligations. These obligations were
$2.1 million, $3.8At December 31, 2004 this
obligation was $3.0 million and $3.4 million at December 31, 2003, 2002 and 2001,
respectively, and werewas due the following year. The Company entered
into a development contract with a third party vendor during 2003. The obligation was
$2.1 million atAt December
31, 2003.2004 the Company had an obligation to pay $4.2 million under this contract.
Note 11 Product Warranty
The Company provides a 90-day warranty for its hardware products against
defects in materials and workmanship and for its software products against
substantial nonconformance to the published documentation at time of delivery.
For hardware products the Company accrues warranty costs based on historical
trends in product return rates and the expected material and labor costs to
provide warranty services. For software products, the Company records the
estimated cost of technical support during the warranty period. A provision for
these estimated warranty costs is recorded at the time of sale or license. If
the Company were to experience an increase in warranty claims compared with our
historical experience, or costs of servicing warranty claims were greater than
the expectations on which the accrual had been based, gross margins could be
adversely affected.
F-21
The following table represents the warranty activity and balances for the
periods shown (in thousands):
.
Balance at Balance at
Beginning Endof Period Additions Deductions of Period.
Year ended December 31, 2003:
Warranty reserves $ 728 964 1,213 $ 479
Year ended December 31, 2002:
Warranty reserves 772 1,146 1,190 728
Year ended December 31, 2001:
Warranty reserves $ 764 1,801 1,793 $ 772 .
Note 12 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 requires that amortization of goodwill and indefinite life intangibles be discontinuedare
not amortized but rather reviewed and replaced with periodic review
and analysisanalyzed for possible impairment at least
annually or when circumstances occur that indicate the carrying value of
goodwill for possible impairment.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. On January
1, 2002 the Company adopted SFAS No. 142, and as a result, goodwill is no longer
amortized. Summarized below are the effects on net income (loss) per share data
if the Company had followed the non-amortization provisions of SFAS No.142 for
all periods presented (in thousands, except per share amounts):
Year ended December 31,2003 2002 2001
Net income (loss):
As reported $ 10,920 $ 8,272 $ (16,622)
Add: goodwill and assembled
workforce
amortization, net of taxes - - 1,619 .
Adjusted net income (loss) $ 10,920 $ 8,272 $ (15,003)
Basic net income (loss) per share:
As reported $ 0.30 $ 0.23 $ (0.47)
Add: goodwill and assembled workforce
amortization, net of taxes - - 0.04 .
Adjusted basic net income (loss) per share $ 0.30 $ 0.23 $ (0.43)
Diluted net income (loss) per share:
As reported $ 0.29 $ 0.23 $ (0.47)
Add: goodwill and assembled workforce
amortization, net of taxes - - 0.04 .
Adjusted diluted net income (loss) per share $ 0.29 $ 0.23 $ (0.43)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.
F-22
The following table presents the changes in goodwill by reporting segment
during 2003, 20022004 and 2001(2003:
(in thousands):
.
Balance at Foreign Balance at
Beginning Currency EndProfessional
Customer Services and
of Period Acquired Amortized Adjustments Gain of PeriodSoftware Support Education Total
Year endedBalance, 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, 2003:2003 $ 16,90715,190 $ 3,1035,761 $ - $ 4,132 $ 2,0285,219 $ 26,170
Software 9,187 2,070 - 2,756 1,177 15,190
Customer Support 3,962 580 - 773 446 5,761
Professional Services and Education 3,758 453 - 603 405 5,219
Year endedForeign currency effect 636 242 220 1,098 Balance, December 31, 2002:2004 $ 9,95315,826 $ 5,7936,003 $ -5,439 $ 182 $ 979 $ 16,907
Software 4,914 3,654 - 90 529 9,187
Customer Support 3,271 406 - 60 225 3,962
Professional Services and Education 1,768 1,733 - 32 225 3,758
Year ended December 31, 2001: $ 13,146 $ - $ (3,193) $ - $ - $ 9,95327,268
Goodwill acquired during 2003 was due to the Shana acquisition in April
2003. Adjustments to goodwill in 2003 included $1.7 million for the write-off of
a prepaid royalty and the recognition of a $2.3 million deferred tax asset.
Prior to the Shana acquisition, FileNet licensed the eForms technology from
Shana under an agreement that resulted in a prepaid royalty. The remaining
balance of this prepaid royalty fee was considered additional investment in
Shana and was allocated to goodwill. A deferred tax asset was recorded under
purchase accounting for the estimated future tax effects of the identified
intangibles with a corresponding entry to goodwill of $1.7 million. A portion of
the Shana goodwill was allocated to the Company's subsidiaries in Ireland and
Canada resulting in foreign currency gain and loss exposure. Goodwill acquired
during 2002 was due to the eGrail acquisition in April 2002. Adjustments to
goodwill in 2002 included a reclassification of the assembled workforce
intangible to goodwill at January 1, 2002 as a result of the adoption of SFAS
142. A portion of the eGrail goodwill was booked to the Company's subsidiaries
in Ireland resulting in foreign currency gain and loss exposure. Goodwill
acquired in 2000 due to the API acquisition amortized by approximately $3.1
million during 2001 before the Company adopted SFAS 142 on January 1, 2002. All
goodwill due to the API acquisition was allocated to the U.S. subsidiary.
Acquired technology, technical manuals and design documents, customer
maintenancesupport relationships, patents and non-compete agreements are the Company's only
intangible assets subject to amortization under Statement No. 142.
F-23
These assets
were recorded in connection with the April 2002 eGrail acquisition and the April
2003 Shana acquisition, and are comprised of the following as offollowing:
(in thousands)December 31, 2004 December 31, 2003 (in thousands):
.
Balance at Foreign Balance at
Beginning Currency EndGross Accumulated Gross Accumulated
of Period Acquired Amortized Gain of PeriodAsset Amortization Net Asset Amortization Net Total year ended December 31, 2003: $ 3,029 $ 5,677 $ (1,842) $ 1,115 $ 7,979
Acquired technology and other
intangibles 3,015 5,400 (1,739) 1,072$ 10,571 (4,496) $ 6,075 $ 10,020 (2,272) $ 7,748
Non-compete agreements - 277338 (225) 113 317 (90) 40 227
Patents 14 29 (29) - (13) 328 (24) 4 Total year ended December 31, 2002:$ -10,938 (4,750) $ 3,3256,188 $ (544)10,365 (2,386) $ 248 $ 3,029
Acquired technology and other intangibles - 3,300 (532) 247 3,015
Non-compete agreements - - - - -
Patents - 25 (12) 1 14
Total year ended December 31, 2001: $ - $ - $ - $ - $ -7,979
Acquired technology is being amortized over a useful life of five years,
patents are beingwere 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 and $523,000 for 2002
(excluding foreign exchange effect).2003.
Estimated future amortization expense
(excluding foreign exchange effect) of purchased intangible assets as of
December 31, 20032004 is as follows (in(in thousands):
Fiscal Year Amount
20042005 $ 2,128
2005 2,0912,207
2006 2,0232,134
2007 1,4281,517
2008 309
Thereafter -330
$ 7,9796,188
Note 13 Borrowing Arrangements
On June 27, 2003 the Company's $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. The Company
believes it will be able to meet escrow needs through existing bank
relationships in the United States and internationally.
F-24F-18
Note 1411 Stockholders' EquitEquityy
Shareholder Rights Plan.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 a person hasit is announced that they have acquired 15% or more of FileNet's common stock.stock has been
acquired.
Treasury Stock.Restricted Stock In 1997,. During 2004 the BoardCompany awarded restricted stock to
certain members of Directors authorized,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 AccelerationDate 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 business and market conditions,performance targets will be achieved that trigger accelerated vesting
for those shares that contain the purchaseacceleration feature. Approximately $730,000
of up to $10.0 million ofcompensation expense was recognized in the Company's outstanding common stock. During the yeartwelve-month period ended December
31, 1997,
the number of shares purchased under this authorization was 420,000 shares at an
aggregate cost of $5.6 million. During the first quarter of 1998, the Company
repurchased 278,000 shares of its common2004, for these restricted stock at an aggregate cost of $4.4
million, thereby completing the stock repurchase program.awards with no acceleration.
F-19
Employee Stock Purchase Plans.Plans. In May 1998, FileNet adopted the 1998
Employee Stock Purchase Plan and the International Employee Stock Purchase Plan
(the "Purchase Plans"). AAs of December 31, 2004, a total of 300,0002,432,278 shares werehad
been authorized to be added to
the remaining share reserve under the predecessor 1988 Employee Qualified Stock
Purchase Plan so that the total share reserve forincluded in the Purchase Plans would be no
more than 400,000 shares. In May 2001, shareholders approved adding an
additional 300,000 shares to the reserve. In addition, in May 2002, shareholders
approved an additional 1,100,000 shares to the reserve.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. There areDuring 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, 2003, $846,3782004, $775,804 had been
withheld from employees' salaries pursuant to the Purchase Plans for the current
offering period, which expires on April 30, 2004.2005. At December 31, 2003,2004,
approximately 795,198559,015 shares remained available for future issuance.
Stock Option Plans.Plans. In April 1986, the Company adopted the 1986 Stock
Option Plan (the "1986 Plan"). Under the amended terms of the 1986 Plan, options
to purchase 6,500,000 shares of the Company's common stock were reserved for
issuance to employees, officers and directors. Options to purchase 18,110 common
shares were exercisable under the 1986 Plan at December 31, 2003. In May 1995, the 1986 Plan was
terminated as to future grants and the remaining reserve of 140,098 shares was
transferred into the 1995 Stock Option Plan ("1995 Plan"). Outstanding options
under the 1986 Plan will continue to be governed by the provisions of agreements
evidencing those grants. No common shares remain
available for future grants under the 1986 Plan. Options granted under the 1986 Plan were either
incentive stock options or nonqualified stock options and became exercisable in
20% annual installments beginning one year after the date of grant and expire no
later than ten years plus one day from the date of grant.
F-25
The exercise price of
the incentive stock options and nonqualified options were not to be less than
100% and 85%, respectively, of the fair market value of the Company's common
stock at the date of grant. To the extent any outstanding options under the 1986
Plan terminate or expire prior to exercise, the shares subject to those
unexercised options will be available for subsequent option grant pursuant to
the provisions of the 1995 Plan.
In May 1995, the Company adopted the 1995 Plan. Under the amended terms of
the 1995 Plan, options to purchase 8,350,000 shares of the Company's common
stock were reserved for issuance to employees, officers and directors. This
reserve was added to the 140,098 shares of common stock transferred from the
1986 Plan. Options
granted under the 1995 Plan's Discretionary Option Grant Program for employees
and the Automatic Option Grant Program for directors have an exercise price per
share of 100% of the fair market value per share on the grant date and become
exercisable in 25% annual installments beginning one year from the date of
grant. On October 21, 1999, the Plan's Discretionary Option Program was amended
to change the vesting schedule of all options granted from that date forward to
vest twenty-five percent (25%) of the option shares after twelve (12) months of
service from the grant date and the balance of the options to vest in thirty-six
(36) successive equal monthly installments upon completion of each additional
month of service thereafter. OnIn May 7, 2003, the Plan was amended to prohibit,
without prior stockholder approval, the repricing,re-pricing, replacement or regrantingre-granting
through cancellation or lowering the option exercise price of any outstanding
options granted under the Plan. As of December 31, 2003, 4,223,0032004, there are 3,277,230
options were 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, 2003,2004, a total of 2,9771,778 options were
outstanding and exercisable under the Saros Plan. No shares remain outstanding
or exercisable under the Watermark Plan.
Future grants to non-employeeNon-employee directors are to be granted under the
provisions of the 1995 Plan or the 2002 Incentive Award Plan. On May 15, 1998,
the shareholders approved an amendment to the 1995 Plan for the Automatic Option
Grant Program to non-employee directors to increase the initial option to purchase 25,000
shares of FileNet common stock at fair market value on the date of grant and an
additional 7,00010,000 shares of FileNet common stock at fair market value on the
date of grant every year following the initial grant, provided such person
continued to be a director at such time.
In August 1997, the Company filed a Form S-8 with the Securities and
Exchange Commission registering a Non-Statutory Stock Option Grant of 600,000
shares, dated May 22, 1997, to the Company's current Chief Executive Officer and
a Non-Statutory Stock Option Grant of 160,000 shares, dated June 18, 1997, to
the Company's current President. In April 2001, the Company filed a Form S-8
with the Securities and Exchange Commission registering a Non-Statutory Stock
Option Grant of 140,000 shares, dated September 13, 2000, to the Company's
current Chief Financial Officer. Such grants were in accordance with employment
agreements entered into by the Company and the grantees. 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
termination of the employment of the Chief Marketing Officer). The non-statutory
options granted prior to October 21, 1999 have an exercise price per share of
100% of the fair market value per share on the date of grant and vest in 25%
installments beginning one year from the date of grant and will expire no later
than ten years from the date of grant. The non-statutory options granted after
October 21, 1999 have an exercise price per share of 100% of the fair market
value per share on the date of grant and vest in installments with 25%
exercisable after twelve months of service and the balance exercisable in
F-26
thirty-six (36) successive equal monthly installments upon completion of each
additional month of service thereafter and will expire no later than ten years
after the grant date. As of December 31, 2003, 459,532 options were exercisable
related to these Non-Statutory Stock Option Grants and 414,218 had been
exercised to date.
In May 2002, the Company adopted the 2002 Incentive Award Plan (the "2002
Plan"). Under the terms ofIn 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 purchase 1,400,0004,800,000 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 the Company's common stock were reserved for issuanceoption awards to key employees,
consultants and
independent directors of which only 140,000 shares may be
issued as restricted stock. In May 2003, stockholders approved an additional
1,400,000 sharesfrom 7,000 to 10,000 shares; and extending the reserve.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,first; second,
third and fourth anniversary provided the director continues as an independent
director on each such anniversary. Additionally, on May 7, 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, 2003, 281,6932004, there were 477,773
options were 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 option plansoptions is as follows:
__________________________________________________________________________________________________
Number of Weighted Average
Options Exercise Price
Balances, January 1, 2001 6,356,092 $ 14.64
Granted (weighted average fair value of $9.30) 2,442,985 16.88
Exercised (485,270) 9.74
Cancelled (303,354) 16.45 Balances, December 31, 20012002 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 $ 16.3216.31
Granted (weighted average fair value of $13.71) 1,843,100 27.08
Exercised (2,270,666) 13.47
Cancelled (344,530) 19.35
F-27
Balances, December 31, 2004 6,870,617 $ 19.99
The following table summarizes information concerning currently outstanding and
exercisable options:
.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 to- 11.09 702,447 3.63 $ 9.00 1,106,956 3.849.12 685,646 $ 7.96 1,106,706 $ 7.96
$ 9.17 to $ 12.86 1,478,378 7.51 12.06 712,799 11.41
$ 12.97 to $ 14.19 1,374,288 7.39 13.47 698,056 13.56
$ 14.39 to $9.10
11.13 - 13.38 1,422,005 7.13 13.04 780,716 13.09
13.39 - 18.45 1,399,093 7.30 16.80 824,038 16.85
$ 19.53 to $ 23.94 1,363,854 6.76 22.50 1,062,763 22.761,149,815 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
$ 24.88 to $ 29.00 - 41.84 920,144 6.91 27.60 580,953 28.15219,100 4.94 30.74 187,600 30.95
$ 1.39 to- 41.84 6,870,617 6.88 $ 41.84 7,642,713 6.7119.99 3,953,563 $ 16.32 4,985,315 $ 16.2117.89
F-22
Note 12 Income TaxesThe Company accountsprovision (benefit) for its stock-based compensation plans in accordance
with APB No. 25 and related interpretations. Stock-based compensation expense
was recorded for only one non-employee contractor working in the United Kingdom
during 2003. No stock-based compensation expense was recorded in the
consolidated statements of operationsincome taxes for the years ended December 31,
20022004, 2003 and 2001, respectively.
The following table summarizes the Company's net income (loss) and net
income (loss) per share on a pro forma basis had compensation cost for the
Company's stock-based compensation plans been determined based on the provisions
of SFAS No. 123, "Accounting for Stock-Based Compensation:"
.
(In thousands, except per share amounts)2003 2002 2001.
Net income (loss), as reported $ 10,920 $ 8,272 $ (16,622)
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards, net
of related tax effects (7,429) (8,735) (12,381)
Pro forma net income (loss) 3,491 (463) (29,003)
Earnings per share:
Basic earnings (loss) per share - as reported $ .30 $ 0.23 $ (0.47)
Basic earnings (loss) per share - pro forma $ .10 $ (0.01) $ (0.83)
Diluted earnings (loss) per share - as reported $ .29 $ 0.23 $ (0.47)
Diluted earnings (loss) per share - pro forma $ .09 $ (0.01) $ (0.83)
F-28
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 2003, 2002 and 2001:
.
2003 2002 2001.
Volatility Factor 58% 68% 78%
Risk-free Interest Date 1.63% - 4.76% 2.0% - 4.60% 3.6% - 5.3%
Expected Life from Vest Date (years) 1 1 1
Dividend 0% 0% 0% .
Pro forma compensation cost of shares issued under the Employee Qualified
Stock Purchase Plan is measured based on the discount from market value on the
date of purchase in accordance with SFAS No. 123.
Retirement of Shares. In September 2001, 375,700 shares were cancelled and
retired as part of a litigation settlement (Note 17).
Note 15 Income Taxes
The provision for income taxes at December 31, 2003, 2002 and 2001 consists of the following:
(Inin thousands)
Year ended December 31, 2004 2003 2002 2001
Current:
Federal $ 7,044 $ 7,428 $ (2,126)
$ (324)
State 2,048 885 235
1,261
Foreign 2,777 1,825 2,740
2,716
Deferred:
Federal (7,021) (4,520) 1,276
(4,550)
State (5,351) (1,371) 353
(3,736) Foreign (786) - - - .
Total provision (benefit) $ (1,289) $ 4,247 $ 2,478 $ (4,633)
Income (loss) before income taxes consists of the following components:
(Inin thousands)
Year ended December 31,, 2004 2003 2002 2001
United States $ 24,864 $ 9,272 $ (307)
$ (17,442)
Foreign 3,261 5,895 11,057 (3,813)
Total $ 28,125 $ 15,167 $ 10,750 $ (21,255)
F-29
A reconciliation of the provision (benefit) for income taxes at the federalFederal
statutory rate compared to the Company's effective tax rate is as follows:
______________________________________________________________________________________
.
Year ended December 31, 2004 2003 2002 2001 .
Income taxes (benefit), at statutory federal rate 35% 35% (35)%35%
State taxes (benefit), net of federal benefit (8) (2) 3 (7)
Tax rate differential on foreign earnings 3 (1) (10)
13
Change in domestic valuation allowance ( 36) - - 6
R and D Credit (3) (7) (7)
(3)
Other 4 3 2 4 .
Total (5%) 28% 23% (22)%
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The income tax effectssignificant
components of these temporary differences representing significant portionsconsisted of the deferred
taxes atfollowing as of
December 31, 2004 and 2003, and 2002 are as follows:respectively:
F-23
(Inin thousands)
Year ended December 31, 2004 2003 2002 .
Deferred taxes:
Loss carryforwards $ 20,25427,939 $ 23,39120,254
Tax credit carryforwards 20,478 15,980 11,408
Accrued expenses 3,369 3,608 3,321
Sales returns and allowance reserves 405 405
Deferred revenue 6,275 10,209 4,035
Depreciable assets and amortizable assets 3,792 4,060 5,996
Other (4,841) (3,667) (2,122)
Total 57,417 50,849 46,434
Valuation allowance (17,708) (24,297) (23,840)
Net deferred tax asset $ 39,709 $ 26,552 $ 22,594 .
Recoverability of the existing net deferred tax assets is dependent on the
continued Federal and foreign profitability from operations. The Company
maintainsregularly evaluates its net deferred tax assets for recoverability and
establishes a valuation allowance against the domesticwhen it is more likely than not that some
portion or all of the net deferred tax asset due to uncertainty regarding the future realization and
after weighing all available evidence.assets will not be realized. The net
increase (decrease) in the total valuation allowance was ($6,589,000), $457,000
$(844,000) and $1,316,000($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 2001, respectively.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, 2003,2004, the Company has a net tax
deferred assetremaining valuation allowance relates
to stock option deductions of approximately $26.6$15 million and a valuation allowancenet operating loss
carryforwards specific to certain foreign tax jurisdictions of approximately
$24.3$2.7 million. The Company will continue weighing various factors throughout the yearin future years
to assess the need for any additional changes in its valuation allowance. Recoverability of the deferred tax assets is dependent on continued
profitability from operations. Should
the Company's levelCompany realize increased domestic profitability (net of profitability
continue as expected, it would likely removeany current year
stock option deductions) and anticipate a continuation of this trend, any
decrease in the entire valuation allowance in
2004. The Companyrelated to stock option deductions would
realize a one-time, non-cash benefit by decreasing its
tax expense (causingresult in an increase in earnings) by approximately $10.0 million to $14.0 million. Additionally, the Company would record a non-cash charge to
increase additional reported paid-in capital by approximately $9.0 million.
F-30
The net deferred asset at December 31, 2003, includes a $2.3 million
deferred tax liability recorded in the purchase accounting entries for the April
2003 Shana stock acquisition.stockholders' equity.
The Company has $50.1 million domestic federalFederal net operating loss carryforwards that can be utilizedavailable
to reduceoffset future taxable income. Any
unutilizedincome totaling $64.9 million and domestic tax credits
of $20.2 million as of December 31, 2004. The domestic Federal net operating
loss carryforwardcarryforwards will begin expiring in 2013. The
Company has $15.9 millionexpire at various dates from 2013 through 2024, and the
domestic tax credit carryforwards thatcredits will begin expiring in
2004.expire at various dates from 2005 through 2024. At
December 31, 2003,2004, the Company had French, Canadian, Irish Swedish and Austrian tax loss carryforwards
relating to its foreign subsidiary operations that total approximately $4.2$11.0
million that will begin expiring in 2005.
Nowhich have unlimited carry forward periods.
The Company has made no provision has been made for federalU.S. income taxes or state incomeforeign
withholding taxes on the unremitted earnings of the Company'sits foreign subsidiaries, (cumulative $63.7
million at December 31, 2003) sinceas these amounts
are considered permanently reinvested outside the Company plans to indefinitely reinvest
all such earnings offshore.United States. At December 31,
2003,2004, the cumulative amount of undistributed earnings was approximately $63.9
million, and the unrecognized deferred tax liability for these earnings was
approximately $24.4$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 1613 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 reportable operating segmentsreporting units are the same as the lines of business and
include Software, Hardware, Customer Support, and Professional Services and Education. The
Software operating segment develops, markets, and sells a unifiedsoftware platform and
application development framework for ECM softwareEnterprise Content Management and solutions. The Hardware operating segment manufactures and
markets the Company's line of OSAR libraries.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 post-implementation
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 - except
that the disaggregated financial results of the segments reflect allocation of
certain functional expense categories consistent with the basis and manner in
which Company management internally disaggregates financial information for the
purpose of assisting in making internal operating decisions.Policies. The
Company evaluates performance based on stand-alone segment gross profit. The
Company does not separately allocate operating income. Because theexpenses 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, assetslevel. Therefore, segment information reported includes only
revenues, cost of revenues, and interest incomegross profit, as this information and the
geographic information described below are not tracked internally by segment. Therefore, suchthe only information is not presented.
F-31currently
provided to the chief operating decision maker on a segment basis.
F-25
Operating segment data for the three years ended December 31, 2003, was2004, is as
follows:
(Inin thousands)
Professional
Customer Services and
Software Support Education Hardware ConsolidatedConsulted
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 10,314 295,493Year Ended December 31, 2003
Revenue $ 149,214 $ 164,772167,230 $ 48,061 $ 2,458 $ 364,505
Depreciation and amortization 10,725 5,724 2,827 102 19,378
Operating (loss) income (58,409) 70,780 (542) (746) 11,083
Assets - - - - 391,848Cost of Revenue Capital expenditures 5,196 2,844 1,107 30 9,177 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 $ 149,847157,550 $ 56,959 $ 7,703 $ 347,017
Depreciation and amortization 10,215 7,527 3,550 296 21,588
Operating (loss) income (51,413) 60,258 (3,212) (92) 5,541
Assets - - - - 328,036Cost of Revenue Capital expenditures 5,146 3,881 1,601 197 10,825 10,565 44,603 50,408 105,576
Year Ended December 31, 2001
Revenue $ 119,014 $ 132,382 $ 69,186 $ 14,028 $ 334,610
Depreciation and amortization 10,835 8,540 4,377 597 24,349
Operating income (59,296) 39,336 (3,259) (539) (23,758)
Assets - - - - 301,639Gross Profit Capital expenditures 7,077 4,161 2,477 360 14,075 121,943 112,947 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 wasis as
follows:
(Inin thousands)
Year ended December 31, 2004 2003 2002 2001 .
Revenue Assets Revenue Assets Revenue Assets
North America:
United States $ 278,177 $ 372,918 $ 257,100 $ 283,073 $ 251,447 $ 251,928
$ 244,902 $ 234,408
Canada 8,786 22,611 7,971 22,627 5,581 5,398 6,787 6,143
Total North America 286,963 395,529 265,071 305,700 257,028 257,326
251,689 240,551
Europe:
France 8,252 1,793 6,166 2,111 6,593 2,086
7,800 1,753
Germany 28,882 4,001 29,074 6,985 22,174 3,632
19,565 5,920
United Kingdom 21,250 29,845 18,930 20,810 22,950 18,145
16,851 18,275
Ireland - 46,019 - 39,742 - 37,114
- 26,925
Other Europe 29,64735,588 5,640 31,169 5,954 26,236 4,902 27,901 5,320
Total Europe 83,81793,972 87,298 85,339 75,602 77,953 65,879
72,117 58,193
Asia Pacific 15,793 10,839 12,171 10,546 9,916 4,831
7,968 2,895
All other 3,446830 - 1,924 - 2,120 - 2,836 - .
Totals $ 397,558 $ 493,666 $ 364,505 $ 391,848 $ 347,017 $ 328,036 $ 334,610 $ 301,639
F-32F-26
Note 1714 Litigation
In October 1994, Wang Laboratories, Inc. ("Wang") filed a complaint in the
United States District Court for the District of Massachusetts alleging that the
Company was infringing five patents held by Wang (the "FileNet Case"). On June
23, 1995, Wang amended its complaint to include an additional related patent. On
July 2, 1996, Wang filed a complaint in the same court alleging that Watermark
Software Inc., a former wholly owned subsidiary of FileNet that was merged with
the Company, was infringing three patents held by Wang (the "Watermark Case").
On October 9, 1996, Wang withdrew its claim in the FileNet Case that one of the
patents it initially asserted was infringed.
On January 8, 1997, the court stayed the Watermark Case, subject to limited
exceptions for certain discovery. The products at issue in the Watermark Case
were phased out as of December 31, 1999. In March 1997, Eastman Kodak Company
purchased the Wang imaging business unit that had responsibility for this
litigation. On July 30, 1997, the court permitted Eastman Software and Kodak
Limited of England to be substituted in the FileNet Case in place of Wang. On
April 24, 2001, the court permitted Eastman Software and Kodak Limited to be
substituted in the Watermark case in place of Wang.
On August 10, 2000, Eastman Kodak Company, Eastman Software and eiStream
WMS, Inc. ("eiStream") entered into an Asset Purchase and Sale Agreement
("APA"), under which eiStream acquired some, but not all, of the assets of
Eastman Software.
Effective June 30, 2001, the Company and Eastman Kodak Company, the parent
of Eastman Software, entered into an agreement that settled the FileNet Case. In
accordance with that settlement agreement, the parties filed on July 5, 2001, a
stipulation dismissing the FileNet Case.
On September 19, 2001, eiStream filed a complaint against Eastman Kodak
Company and Eastman Software in the United States District Court for the
district of Dallas County (the "eiStream Case"). eiStream sought, among other
things, a declaratory judgment that pursuant to the terms of the APA, eiStream
owns the Watermark Case and has the right to pursue claims in the Watermark Case
regarding Watermark products sold prior to the phase out in December 1999 and
that Eastman Kodak Company was required to obtain eiStream's consent prior to
settling the FileNet Case.
On October 15, 2001, Eastman Kodak Company filed its answer to eiStream's
complaint in which Eastman Kodak Company claimed ownership of the Watermark
Case, denied that the APA gave eiStream ownership of the Watermark Case, and
stated that eiStream's claim that its consent was necessary prior to settling
the FileNet Case was barred by principles of equitable estoppel.
Also on October 15, 2001, Eastman Kodak Company moved to abate the eiStream
Case because the previously filed Watermark Case raises issues inherently
related with issues raised in the eiStream Case and because certain necessary
and indispensable parties were not properly joined in the eiStream Case.
On October 31, 2001, Eastman Kodak Company moved for leave to amend the
original complaint filed in the Watermark Case to add eiStream as a party, to
add the correct Eastman Kodak Company entities as plaintiffs and to add a
declaratory judgment count seeking a judgment that Eastman Kodak Company, not
eiStream, owns the Watermark Case.
In November 2001, Eastman Kodak Company and eiStream amended the APA and
resolved all their disputes regarding Eastman Kodak Company's right to settle
the FileNet Case and the Watermark Case. Effective November 15, 2001, eiStream
agreed that the June 30, 2001 agreement between the Company and Eastman Kodak
F-33
Company which settled the FileNet Case is in accordance with the APA, as
amended, and that the Company and Eastman Kodak Company may dismiss the
Watermark Case with prejudice.
Effective November 15, 2001, the Company and Eastman Kodak Company entered
into an agreement that settled the Watermark Case. In accordance with that
settlement agreement and the amended APA between Eastman Kodak Company and
eiStream, the parties to the Watermark Case filed on November 16, 2001 a
stipulation dismissing that case with prejudice. A stipulation of non-suit with
prejudice was filed in the eiStream Case on November 19, 2001.
Subsequent to December 31, 1998, the former shareholders of Saros
Corporation, a former wholly owned subsidiary of FileNet that was merged with
the Company, filed a demand for mandatory arbitration to release approximately
375,700 shares of the Company's stock which were held in escrow pursuant to the
Agreement and Plan of Merger dated January 17, 1996 among FileNET Corporation,
FileNet Acquisition Corporation and Saros Corporation and for damages. The
Company and the agent for the former Saros Shareholders ("Shareholders' Agent")
had agreed to mediate the matter, but the Shareholders' Agent cancelled the
mediation prior to the scheduled date and renewed the demand for mandatory
arbitration. A binding arbitration proceeding took place during the period March
5, 2001 through March 23, 2001. On April 24, 2001 the arbitrators issued an
interim decision denying all claims asserted by the Shareholders' Agent against
the Company, sustaining all claims asserted by the Company, and awarding all of
the shares of stock held in escrow to the Company. On June 7, 2001 the
arbitrators issued a final award that reiterated the principal rulings set forth
in the interim decision and awarded all of the stock held in the escrow to the
Company. The final award further determined that the escrowed shares provide the
exclusive source for the Company's recovery of its attorneys' fees and costs
from the former stockholders of Saros. These shares were cancelled and retired
when the Company received the certificates from the escrow agent in September
2001.
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 existing litigation and claims cannot be predicted with certainty, based upon
its current assessment the Company believes that the final outcome of these matterseach
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 conditions.condition.
Note 18 15 Guarantees and Indemnifications
In November 2002, the FASB issued FIN 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." The initial recognition and initial measurement
provisions apply on a prospective basis to guarantees issued or modified after
December 15, 2002. The disclosure requirements are effective for financial
statements of interim and annual periods ending after December 15, 2002.
The Company has made guarantees and indemnifications, under which it may be
required to make payments to a guaranteed or indemnified party, in relation to
certain transactions. In connection with the sales of its products, the Company
provides intellectual property indemnities to its customers. Guarantees and
indemnities to customers in connection with product sales and service generally
are subject to limits based upon the amount of the related product sales or
service. Payment by the Company is conditioned upon the other party filing a
claim pursuant to the terms and conditions of the agreement. The Company may
challenge this claim and may also have recourse against third parties for
certain payments made by the Company. Predicting the maximum potential future
payment under these agreements is not possible due to the unique facts and
circumstances involved with each agreement. Historically, the Company has made
no payments under these agreements.
F-34
In connection with certain facility leases and other performance
guarantees, the Company has guaranteed payments on behalf of some of its
subsidiaries. To provide subsidiary guarantees, the Company obtains unsecured
bank guarantees from local banks. These bank guarantees totaled an equivalent of
approximately $1.6$2.6 million issued in local currency in Europe and Asia as of
December 31, 2003. Approximately $587,000 of the $1.6 million is secured by cash
deposit.2004. Furthermore, the Company has signed an indemnity letter as a
performance guarantee to a certain customer in Europe in local currency
equivalent to $180,000approximately $200,000 as of December 31, 2003.2004.
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.
The Company's product warranty
liability as of December 31, 2003 is disclosed in this footnote under the
heading "Product Warranties."
Note 1916 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, 20032004 and 2002:2003. 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 2002 .
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
$ 16,721,200 $ 4,128,147
Australian - - - 116,072
47,149 -
Asian 1,292,685 (226,688) 1,791,763 - 1,648,157 -
Canadian - (5,785,124) - 7,878,703 574,604 - .
Total $ 23,838,927 $ (22,867,115) $ 19,698,828 $ 19,883,474 $ 18,991,110 $ 4,128,147
The following table summarizes the amounts due to (from) the Company for
realized gains (losses) on the Company's foreign exchange contracts closed on
December 31, 2003 and 2002 that were $656,210 and $952,917, respectively. The
actual settlement with the banks occurs in January of the following year.
.
At December 31,2003 2002.
European $ 984,788 $ 962,247
Australian (16,573) (12,531)
Asian 5,800 8,747
Canadian (317,805) (5,546)Total $ 656,210 $ 952,917 .
F-35
Note 20 Quarterly Financial Information (Unaudited)
The following table sets forth selected unaudited quarterly information for
the Company's last eight fiscal quarters. This information has been prepared on
the same basis as the Consolidated Financial Statements and all necessary
adjustments (which consisted only of normal recurring adjustments) have been
included in the amounts stated below to present fairly the results of such
periods when read in conjunction with the Consolidated Financial Statements and
related notes included elsewhere herein.
(In thousands, except per share amounts)First Second Third Fourth FiscalQuarter Quarter Quarter Quarter YearYear 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
Year ended December 31, 2002:
Revenue $ 86,241 $ 88,227 $ 83,102 $ 89,447 $ 347,017
Gross profit 58,692 60,974 58,316 63,459 241,441
Income (loss) before income taxes 1,818 2,205 1,804 4,923 10,750
Net income (loss) 1,364 1,734 1,389 3,785 8,272
Basic earnings (loss) per share 0.04 0.05 0.04 0.11 0.23
Diluted earnings (loss) per share 0.04 0.05 0.04 0.10 0.23
Note 2117 Subsequent EventsRelated-Party Transactions
The Company awarded 560,800 stock options with an option price of $28.19 to
301 employees during Q1 2004. This grant was made underOn June 5, 2002, the 2002 Incentive Award
Plan. These shares vest over a four-year period and will be reported in
accordance with APB 25 and FASB 123. This transaction is unaudited. The Company
also awarded 132,500 shares of restricted stock to ten membersCompensation Committee of the senior
management team during the first quarter of 2004 under the 2002 Incentive Award
Plan. These shares of restricted stock vest over five years after the grant date
and include a feature that allows the stock to vest on an accelerated basis
provided certain performance targets are achieved. These restricted stock awards
will be reported in accordance with ABP 25 and FASB 123. This transaction is
unaudited.
F-36
INDEPENDENT AUDITORS' REPORT ON SCHEDULE
Stockholders and theCompany's Board of
Directors FileNet Corporation
Costa Mesa, California
We have audited the consolidated balance sheets of FileNet Corporation and its
subsidiaries (the Company)"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 31, 200310, 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 thewas paid approximately $500,000 by eGrail. Accordingly, John Savage
recused himself from all discussions related
consolidated statements of operations, comprehensive operations, stockholders'
equity and cash flows for each of the three years in the period ended December
31, 2003, and have issued our report thereon dated February 24, 2004 (which
report expresses an unqualified opinion and includes an explanatory paragraph
referring to a change in method of accounting for goodwill and other intangible
assets in 2002). Such consolidated financial statements and reports are included
elsewhere in this Form 10-K. Our audits also included the financial statement
schedule of FileNet Corporation and its subsidiaries, listed in Item 15. This
consolidated financial statement schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion based on our audits. In
our opinion, such consolidated financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects,acquisition of eGrail assets
by the information set forth therein.
/s/ DeloitteCompany and Touche LLP
Deloitte and Touche LLP
Costa Mesa, California
February 24, 2004
F-37abstained from voting on the transaction.
F-28
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(Inin 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
Year ended December 31, 2001:
Inventory reserves $ 234 26 72 $ 188
Allowance for doubtful accounts
and sales returns $ 5,518 1,482 3,433 $ 3,567 S-1
EXHIBIT INDEX
Exhibit NumberNo. Exhibit Title
14 Code of Conduct
21.1 List of subsidiariesSubsidiaries of Registrant (filed as FileNet
Corporation Subsidiary Information)
23.1 Consent of Independent Auditors' ConsentRegistered Public Accounting Firm
31.1 Section 302 Certification of Chief Executive Officer
31.2 Section 302Certification of Chief Executive Officer
32.1 Certification of Chief Financial Officer
32.1 Section 906 Certification of Chief Executive Officer
32.2 Section 906 Certification of Chief Financial Officer
EX-14
[cover page]
[FileNet logo]
It's in Every Decision We Make
Our Values and Standards
of Business ConductExhibit 21.1
TABLE OF CONTENTS
I Message to Employees
II Our Values
III Commitments and Responsibilities
IV Standards of Business Conduct
1) Responsible Care
2) Workplace Conduct
3) Gifts and Entertainment
4) Business Information
5) Employment Practices
6) Marketing Practices
7) Working with Government Agencies
8) International Business
V Reporting Concerns and Violations
VI Employee Resources
2
Dear Fellow Employees:
Our company has a proud heritage and, more importantly, a very promising
future. A key component of our success and who we are as a company is based on
Our Values and Standards of Business Conduct. These principles, which are
outlined in this document, represent our core beliefs.
Much change has occurred in our industry over the past decade, and we can
expect that change will continue. In addition to the challenge of change and the
need to satisfy a diverse and demanding customer base, we are faced with
increasingly complex laws and regulations. Adding to our challenge are the
diverse social and cultural norms we face in serving our global customers. Given
this and our desire to achieve success in every decision we make-- in an open
and honest manner, it is important that we formally codify our values and
standards for conducting business.
Please take the time to study this document. The information provides a
good roadmap for sound business practices. In cases where you have questions or
concerns, there is a section directing you to available resources to get
answers.
Our goal is to address issues before they become problems. By doing this
well, we will fulfill the promise of our future - a company that can always be
counted on to do the right thing and one that generates long-term growth and
prosperity for all those connected to us - our employees, customers, partners,
communities and shareholders.
Sincerely,
/s/ Lee D. Roberts
Lee D. Roberts
Chairman and Chief Executive Officer
3
II Our Values
FileNet's values are rooted in the company's history and the enduring principles
of fairness, honesty and integrity. As employees, we share different religious,
cultural, social, and ethnic backgrounds. We also share certain standards of
behavior that are universally accepted as fundamental to a healthy and
productive society.
At FileNet, we believe these standards of behavior are encompassed in our four
key values.
1) Corporate and Community Citizenship
Integrity is doing what is right...each and every day...open, honest and
trustworthy.
Integrity is placing our principles of uncompromising ethics before profits and
personal ambition, never cutting corners, and always making business decisions
that balance our competitive instincts with our ethical obligations. We want to
be a global provider recognized for integrity, professionalism, and meeting the
highest standards of behavior.
FileNet, along with its employees, is very active in contributing time and
resources to various communities around the world. From regionally organized
charitable giving activities to local need sponsorships, FileNet employees will
continue to strive to positively contribute to the communities in which we work
and live.
FileNet's diverse global employee population is the cornerstone of our community
outreach philosophy. With interests and involvement in a wide variety of
programs, FileNet employees help shape FileNet's philanthropic participation.
The FileNet Community Outreach Program focuses on improving the lives of people
in our own neighborhoods around the world. FileNet's Community Outreach Program
supports health and wellness of all people, the education of youth, and the
promotion of arts and culture.
2) Technological Leadership
Technological leadership through innovation is how we deliver value to our
customers, providing the most innovative and effective solutions for their
needs. Being the global leader in our market is achieved by a relentless cycle
of continuous improvement and innovation, guided by deep technical knowledge and
intimate awareness of our customers' needs. Change is our ally; not our enemy.
3) Customer Focus
Customer success is essential to our long-term prosperity.
At FileNet, we work hard to provide our customers with superior value in our
products and our services. Our goal is to communicate openly and honestly with
our customers, understand and anticipate their needs and, wherever possible,
exceed their expectations. We measure our success by how we contribute to our
customers' success.
4) Respect for the Individual
Employees are our greatest assets.
We value the health, safety and well being of each and every individual in our
offices and in all of the communities where we live and work. We strive to
create a positive work environment and build respect for the value of each
individual and their contributions to the team. We seek to provide our employees
with opportunities for professional development and advancement, and we
recognize that their hard work and commitment to excellence determine our
future.
4
III Commitments and Responsibilities
FileNet's Values and Standards of Business Conduct apply to all of our
directors, officers and employees, wherever they are located and whether they
work at FileNet on a full- or part-time basis. They apply equally to our
business relationships inside and outside of the company and to any independent
agents, consultants or contractors working on behalf of FileNet Corporation.
Our Values and Standards of Business Conduct work in tandem with the policies
and procedures of our company and with all applicable worldwide laws and
regulations. These Values and Standards of Business Conduct should be considered
minimum standards. Where differences exist because of local customs, norms, laws
or regulations, we ask our board members, officers, and employees to use the
highest standard of behavior or most restrictive law that applies.
Company Responsibilities
FileNet will seek to provide a work environment where high standards of ethical
behavior are recognized and practiced. In order to accomplish this goal, FileNet
will:
o Ensure that every employee, agent, consultant or representative
working on behalf of FileNet is aware of, understands, and lives up to
our Values and Standards of Business Conduct;
o Provide employees with appropriate training on our Values and
Standards of Business Conduct, policies and procedures and relevant
laws and regulations; and
o Provide safe and confidential resources for employees to seek advice
on proper workplace conduct and to report issues and concerns.
Management Responsibilities
Managers have a special responsibility to set an example by exhibiting the
highest standards of behavior. They must also:
o Ensure that each employee under his or her supervisor knows and
understands our Values and Standards of Business Conduct and relevant
company policies and procedures and how to apply them;
o Demonstrate in words and deeds a commitment to FileNet's Values and
Standards of Business Conduct;
o Make sure employees understand that results are never more important
than ethical business conduct and compliance with policies and
procedures, laws and regulations;
o Encourage employees to seek advice or help without fear of
retaliation;
o Provide appropriate resources to answer employee questions; and
o Make themselves approachable and available to all employees.
Employee and Board Responsibilities
FileNet employees and Board members are expected to comply with both the letter
and the spirit of our Values and Standards of Business Conduct, company policies
and procedures and the laws and regulations that govern our business. We ask
each employee and Board member to:
o Read and understand our Values and Standards of Business Conduct;
o Live by our Values and Standards of Business Conduct and company
policies and procedures and encourage fellow employees to do the same;
abide by all applicable FileNet policies and procedures and applicable
government laws and regulations;
o Be alert to any situations that could violate our Values and Standards
of Business Conduct or policies; and
o Report suspected violations, issues or concerns to your manager or any
of the resources identified in the Employee Resources
section.
5
Employees are not expected to know the answer to each and every business
question or how to apply company requirements to complex and sometimes confusing
business situations. Employees are expected to seek advice or clarification
promptly when uncertain about proper actions or practices. Remember, when in
doubt, ask for help!
Employees may report questions or concerns to their manager, local HR
Representative, company legal counsel, the Compliance and Risk Management
Officer ("CRMO") or any other resource made available at a particular location.
Waivers of our Values and Standards of Business Conduct
Waivers of our Values and Standards of Business Conduct will be granted on a
case-by-case basis and only in extraordinary circumstances. Waivers of our
Values and Standards of Business Conduct for employees may be made only by an
executive officer of FileNet at the request and with the concurrence of the
Legal Department. Any waiver of our Values and Standards of Business Conduct for
our directors, executive officers or other principal officers may be made only
by our Board of Directors or the appropriate committee of our Board of Directors
and will be promptly disclosed to the public.
IV Standards of Business Conduct1. Responsible Care
FileNet is committed to excellence in health, safety and the environment. Our
commitment is embodied not only in our compliance with all safety and
environmental laws and regulations in the geographical areas in which we
operate, but also in our recognition of the value of our employees and others
our business affects.
All FileNet operations are to be conducted in a manner that protects the health
and safety of our employees and all people in the communities where it operates.
It is FileNet policy to:
o Recognize and reduce or eliminate unacceptable risk to the health and
safety of our employees and to our shared environment.
o Design and construct new facilities and upgrade or modify current
facilities to ensure they conform to current environmental, health and
safety standards.
o Conserve energy and protect the environment through prudent use of
recyclable resources in preference to non-recyclable resources.
Each FileNet employee is responsible for supporting FileNet 's commitment to
environmental excellence. Employees must:
o Use appropriate personal care and awareness for their safety and the
safety of others.
o Find out from their managers what safety or environmental requirements
apply to their present or new job and how to follow those requirements
without deviation.
2. Workplace ConductA. Open Communication
Open and honest communication is one of the cornerstones of a productive
business environment. At FileNet, we put a premium on communication that
encourages new ideas and participation at all levels of the organization.
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Every FileNet employee is encouraged to contribute. We can all suggest changes
and refinements to our business practices that result in better products,
reduced costs, or enhanced service to our customers.
Effective communication is a product of listening as well as talking. FileNet
employees are encouraged to listen first, then ask questions, discuss options
and make informed decisions that incorporate appropriate input from all
applicable organizational units.
We must all work diligently to create an environment where asking questions and
challenging the status quo is encouraged and recognized by working together with
trust.
B. Giving Recognition and Credit Appropriately and Frequently
It is FileNet's practice to provide equal employment opportunity to all
qualified persons, and to recruit, hire, train, promote and compensate persons
in all jobs without regard to any protected class status.
Individuals will be upgraded and promoted on the basis of their ability, skill,
experience and contribution to FileNet's success. When making promotion
decisions, the supervisors directly involved, as well as other appropriate
officials, verify that all promotions are based on valid occupational
qualifications.
FileNet is committed to supporting the individual development of its employees.
Employee development consists of clearly defining career goals, and creating and
implementing a plan designed to achieve those goals while meeting department and
company objectives.
FileNet values certain skills and behaviors of all employees in the performance
of their job. These behaviors are incorporated into the performance appraisals
and are the foundation of FileNet employee development classes. Core behaviors
include communication, initiative, innovation, job knowledge, and teamwork.
There may also be additional job behaviors, which are tailored to meet specific
job requirements.
C. Conflict of Interest
A conflict of interest can occur when outside activities or personal interests
interfere or appear to interfere with your ability to objectively perform your
job or act in the best interests of FileNet. All financial, business, and other
activities, both inside and outside your job, must be lawful and free of
conflicts or even the suggestion of a conflict with your responsibilities as a
FileNet employee.
Employees are encouraged to participate in professional organizations and
community activities, but your participation must not jeopardize FileNet 's
reputation or distract you from the performance of your job. If you wish to
pursue a second job or participate in an outside business venture, you must
ensure that your engagement in such activity does not create a conflict of
interest with FileNet's business.
Examples of conflicts of interest include:
o Outside Employment. No employee may be employed by, serve as a
director of, or provide any services to a company that is a
significant customer, supplier or competitor of FileNet.
o Financial Interests. No employee may have a significant financial
interest (ownership or otherwise) in any company that is a significant
customer, supplier or competitor of FileNet. A "significant financial
interest" means (i) ownership of greater than 1% of the equity or 5%
of the assets of a significant customer, supplier or competitor.
o Service on Boards and Committees. No employee should serve on a board
of directors or trustees or on a committee of any entity whose
interests reasonably could be expected to conflict with those of
FileNet. Employees must obtain prior approval from the Legal
Department before accepting any such board or committee positions.
o Relatives and Personal Relationships. Employees may not supervise a
relative and determine his or her promotions or pay raises. Employees
may not hire a supplier managed by a close relative or friend.
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o Improper Personal Benefits. No employee may obtain discounts or
personal gifts from actual or potential suppliers or customers with a
cumulative value in excess of $150 USD from any one vendor of FileNet
in a rolling twelve month period. No employee may obtain improper
personal benefits or favors because of his or her position with
FileNet. Please see Gifts and Entertainment for additional guidelines
in this area.
o Loans or Other Financial Transactions. No employee may obtain loans or
guarantees of personal obligations from, or enter into any other
personal financial transaction with, any company that is a significant
customer, supplier or competitor of FileNet. This guideline does not
prohibit arms-length transactions with recognized banks or other
financial institutions.
Even if you believe there will be no conflict, you should check with your
manager before accepting a second job or engaging in an outside business
venture. Depending on the nature of the work, you may be required to seek prior
written approval from your manager.
Family Members and Work
The actions of family members outside the workplace may also give rise to
conflicts of interest because they may influence an employee's objectivity in
making decisions on behalf of FileNet. For example, it is a conflict of interest
if a family member is employed by, or has a significant financial interest in, a
company that is a significant customer, supplier or competitor of FileNet. It is
also a conflict of interest if a family member obtains loans or guarantees of
personal obligations from, or enters into any other personal financial
transaction with, any company that is a significant customer, supplier or
competitor of FileNet. Similarly, receipt of improper personal benefits or
favors by family members creates a conflict of interest.
Employees should report to a manager any situation involving family members that
reasonably could be expected to give rise to a conflict of interest. Managers
will contact the Legal Department to discuss appropriate measures, if any that
should be taken to mitigate the potential conflict of interest. If a member of
an employee's family is an employee of, or has a significant financial interest
in, a company that is a significant customer, supplier or competitor of FileNet,
the employee will be prohibited from participating in business decisions with
respect to that company. It is also inappropriate for an employee to discuss
FileNet's confidential information with members of his or her family that have
such conflicting interests.
D. Inside Information and Securities Trading
Many FileNet employees have access to non-public or "inside" information about
FileNet or other companies that is not available to people outside the company.
Examples of inside information include plans for mergers, new marketing
strategies, financial results before publicly disseminated, or other business
dealings.
Securities laws and FileNet policy prohibit employees from using inside
information gained through working at FileNet to influence their own or anyone
else's investment decisions regarding FileNet or any other company with which we
do business. Employees should be careful not to knowingly or unintentionally
pass on inside information to anyone, including family and friends, who could
then innocently or intentionally disclose the information to others.
E. Product Quality
The integrity and quality of our products and services is fundamental to the
reputation of our company and the ultimate success of our businesses. Employees
must ensure that FileNet products and services conform to all applicable laws,
regulations, specifications, test procedures or any other contractual
requirements.
FileNet employees must never:
o Falsify, alter or distort any inspection or test documentation or
software
o Improperly or erroneously record inspection or test results
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o Falsely certify or state that required inspections or tests were
performed or that test documentation is available o Mislead any
customer's representative
o Use incomplete or improper inspection or testing protocols or
procedures
F. Relationships with Subcontractors and Suppliers
At FileNet, supplier relationships are managed in a fair, equitable and ethical
manner consistent with our Values and Standards of Business Conduct and all
applicable laws and regulations.
FileNet provides, wherever practical, a competitive opportunity for suppliers to
earn a share of our purchases, and we enlist their active support in ensuring
that we meet customer expectations regarding quality, cost and delivery.
At FileNet, decisions to hire a subcontractor or source materials from a
particular vendor or supplier are made on the basis of objective criteria such
as quality, reliability, technical excellence, price, delivery, service and
maintenance of adequate sources of supply. Purchasing decisions must never be
made on the basis of personal relationships and friendships or the opportunity
for any inappropriate benefit.
All FileNet, employees must respect the terms of supplier contracts and
licensing agreements and maintain open, honest dialogue consistent with good
business practices. Employees must also safeguard all information received from
a subcontractor or supplier, including pricing, technology or proprietary design
information, and not disclose it to anyone outside of FileNet without the
supplier's or vendor's written permission.
G. Use of Company Resources
It is the responsibility of each FileNet employee to protect and preserve the
company's resources. Company resources include such things as company time,
materials, supplies, equipment, information, electronic mail and computer
systems. These resources are provided to employees to fulfill company goals and
purposes. Any personal, community, or charitable use of these or other company
resources must be approved by your manager.
FileNet has a policy governing the use of company resources. In all cases where
usage is permitted, the rule of reason applies.
Personal use that is excessive or violates other company policies is prohibited
unless managerial approval is received in advance of use. Some examples include:
o Excessive phone calling or faxing long-distance
o Extensive photocopying
o Copying computer software programs (except as authorized by licensing
agreements)
o Bringing office supplies home (other than for business use)
o Driving or using a company vehicle, tools, equipment, or other company
assets without authorization
o Using electronic networks, including the Internet, except as
authorized by local policy
In addition, any use of FileNet resources for any inappropriate benefit is
strictly forbidden.
FileNet employees should report any improper use of company resources to their
manager or the CRMO. By limiting company resources to business purposes,
employees assist in FileNet's continuous efforts to control costs.
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3. Gifts and EntertainmentA. Non-Government Customers and Suppliers
FileNet purchases products and services on the basis of quality, price and
reliability. In turn, we expect our customers to purchase FileNet products and
services on the same basis. Giving and receiving gifts and entertainment can
potentially affect the independence of our judgment and that of our customers.
Each employee who is not involved in government contracting may infrequently
accept or offer gifts, not to exceed a cumulative value of $150 USD from any one
vendor in any rolling twelve month period, which is reasonable in connection
with business relationships. When offering gifts, FileNet employees should
confirm with the intended recipient that the offer does not violate the business
standards of his or her own company. There may also be situations in which an
expensive gift item may be presented in recognition of a special event or
milestone that involves a business relationship. The test of reason requires
judgment with respect to both frequency as well as cost, and must have prior
approval from the appropriate level of management. Routine upgrades (e.g., hotel
and airline upgrades) and other common perks that are generally available to a
vendor's qualified customers are not considered gifts for purposes of our Values
and Standards of Business Conduct.
The following gifts are not permitted to be made or accepted by FileNet
employees:
o Gifts in cash, cash equivalents or securities of any amount. Cash
equivalents are coupons or certificates redeemable for cash. Excluded
from this definition are gift certificates that are redeemable for
goods and services or meals as long as the cumulative value does not
exceed $150 USD in any twelve month rolling period.
o Payment for commercial transportation, lodging or other travel
expenses, unless you are traveling as part of a group hosted by a
supplier or customer representative, the trip is business related, and
the payment is reported in advance to management.
Infrequently, employees may offer and accept meals and entertainment in
connection with business relationships that are reasonable and appropriate.
Usually, these situations involve group events attended by FileNet and other
company representatives, and the item is provided to all attendees.
B. Government Customers
Gifts and entertainment to officials and employees of the governments of the
U.S. and other countries are highly regulated and often prohibited. FileNet
employees and its agents may not provide or accept any gifts or entertainment to
any government employee or official unless you have specific knowledge that they
are permissible under FileNet policies and applicable laws and regulations.
4. Business InformationA. Books, Records and Communications
Each FileNet employee is responsible for the integrity and accuracy of business
documents, communications and financial records. These records serve as a basis
for managing our business and are important in meeting our obligations to
suppliers, distributors, government regulators, investors, creditors, and our
customers.
All financial information must reflect actual transactions and conform to
generally accepted accounting principles. FileNet maintains a system of internal
controls to assure appropriate authorization, recording and accountability of
the company's assets. When employees are asked to respond to requests by
internal auditors, legal staff, independent accountants, and special counsel,
responses must be complete and truthful. Employees must include all relevant
information, even if the request does not specifically ask that you do so.
10
It is a violation of FileNet's Values and Standards of Business Conduct to alter
or falsify information on any record or document, to intentionally make a false
or exaggerated claim to anyone, including our competitors, or to mislead
customers about our products or those of our competitors Further, destroying or
concealing any records that are required to be maintained, is prohibited.
Business documents and records are retained in accordance with the law and our
company record retention policies. Documents include paper documents, voice
mail, and computer-based information such as Email, computer files on disk or
tape, and any other medium that contains information about the organization or
its business activities. Employees are prohibited from tampering with these
documents or removing or destroying them prior to the dates specified in our
retention policies.
B. Accuracy of Financial Reports and Other Public Communications
We are a public company and are required to report our financial results and a
great deal of financial and other information about our business to the public
and the Securities and Exchange Commission. We are also subject to various
securities laws and regulations. It is our policy to promptly disclose accurate
and complete information regarding FileNet's business, financial condition and
results of operations. Inaccurate, incomplete or untimely reporting will not be
tolerated and can severely damage FileNet and cause legal liability.
Employees should be alert and promptly report evidence of improper financial
reporting. Retaliation against employees who report or supply information about
a concern is strictly prohibited. Examples of suspicious activities that should
be reported include:
o Financial results that seem inconsistent with the performance of
underlying business transactions;
o Inaccurate FileNet records, such as overstated expense reports, or
erroneous time sheets or invoices;
o Transactions that do not seem to have a good business purpose; and
o Requests to circumvent ordinary review and approval procedures.
FileNet's senior financial officers and other employees working in the
Accounting Department have a special responsibility to ensure that all of our
financial disclosures are full, fair, accurate, timely and understandable. These
employees must understand and strictly comply with generally accepted accounting
principles as adopted by FileNet and all standards, laws and regulations for
accounting and financial reporting of transactions, estimates and forecasts.
C. Public Communications and Regulation FDPublic Communications Generally
FileNet places a high value on its credibility and reputation in the community.
What is written or said about FileNet in the news media and investment community
directly impacts our reputation, positively or negatively. It is our policy to
provide timely, accurate and complete information in response to public requests
(media, analysts, etc.), consistent with our obligations to maintain the
confidentiality of competitive and proprietary information and to prevent
selective disclosure of market-sensitive financial data. To ensure compliance
with this policy, all news media or other public requests for information
regarding FileNet should be directed to FileNet's Corporate Communications
Department. The Corporate Communications Department will work with you and the
appropriate personnel to evaluate and coordinate a response to the request.
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Compliance with Regulation FD
In connection with its public communications, FileNet is required to comply with
a rule under the federal securities laws referred to as Regulation FD (which
stands for "fair disclosure"). Regulation FD provides that, when we disclose
material, non-public information about FileNet to securities market
professionals or stockholders (where it is reasonably foreseeable that the
stockholders will trade on the information), we must also disclose the
information to the public. "Securities market professionals" generally include
analysts, institutional investors and other investment advisors.
To ensure compliance with Regulation FD, we have designated the following
officials as "Company Spokespersons":
o Sam Auriemma, Chief Financial Officer
o Tom Hennessey, Director, Corporate Communications
o Lee Roberts, Chief Executive Officer and Chairman of the Board
o Greg Witter, Director, Investor Relations
Only Company Spokespersons are authorized to disclose information about FileNet
in response to requests from securities market professionals or stockholders. If
you receive a request for information from any securities market professionals
or stockholders, promptly contact the Investor Relations Department to
coordinate a response to such request.
D. Confidential Information
Other than our employees, the most valuable asset of FileNet is intangible - our
intellectual property - including our trade secrets and confidential
information. FileNet employees must guard intangible assets and confidential
information even more carefully than our company's physical assets.
Employees must not discuss with any unauthorized person inside or outside of the
company any information that is confidential and not publicly available.
Examples of such confidential information include:
o Undisclosed financial and earnings reports
o Sales forecast, pipeline and other customer relationship information
(e.g. contained on daVinci, SAP, etc.)
o Confidential product performance information
o New product offerings
o Merger, acquisition, divestiture, or business plans
o Classified information
o Procurement plans
o Capital requirements
o Personnel information or changes
o Confidential technical data
o Marketing, pricing, or service strategies
o Business negotiations
o Business costs and volumes
o Supplier and subcontractor information
o Proprietary computer software
Employees should be cautious about discussing business matters with authorized
FileNet employees in the presence of, or within hearing distance of,
unauthorized personnel. This includes family and friends, who may inadvertently
disclose confidential information to others.
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E. Intellectual Property
Intellectual property laws provide an incentive for the creative efforts and
research and development that support innovation. Intellectual property consists
of tangible products of the mind such as: abstract concepts, information,
symbols, computer code, business processes and other expressions that are
protected by law. The protection provided by these laws makes it feasible for
companies like FileNet to invest in the commercialization of new ideas and
processes.
When you joined FileNet, you signed a Proprietary Rights and Inventions
agreement under which you, as an employee of FileNet, assumed specific
obligations relating to intellectual property as well as the treatment of
confidential information. Among other things in the agreement, you assign to
FileNet all of your right, title, and interest in intellectual property you
develop when you are employed in certain capacities, such as a managerial,
technical, product planning, programming, scientific or other professional
capacity. The intellectual property you assign includes such things as ideas,
inventions, computer programs and documents which relate to the company's actual
or anticipated business, research or development or that are suggested by, or
result from, work or tasks you perform for, or on behalf of, FileNet. Subject to
the laws of each country, this obligation applies no matter where or when - at
work or after hours - such intellectual property is created. That intellectual
property must be reported to the company, and the property must be protected
like any other proprietary information of the company. However, if you believe
that your idea, invention, computer program, or other material neither falls
within the area of the company's actual or anticipated business interests, nor
resulted from, nor was suggested by, any of your work assignments in FileNet,
you should discuss it with the Legal Department. Throughout your FileNet
employment, you should seek advice and direction from the Legal Department
before you file for a patent and provide the Legal Department with copies of any
patent you have applied for or obtained.
At FileNet, we must vigorously protect our own intellectual property rights as
well as the rights of others. Intellectual property rights include patents,
copyrights, trademarks, and trade secrets. They also include software programs
created by FileNet and by other companies that are copyrighted or otherwise
restricted, and designs for products.
To protect our own property rights, FileNet employees should fully document
product development research and use appropriate FileNet trademark and copyright
notices on all correspondence, articles, manuals or other papers. Employees
should also avoid disclosing proprietary and confidential information outside of
FileNet unless there is a clear business purpose and the recipient has signed a
confidentiality agreement.
F. Information Owned by Others
Other organizations, like FileNet, and some individuals have intellectual
property, including confidential information, they want to protect. They are
sometimes willing to disclose and allow others to use their proprietary
information for a particular purpose. If you receive another party's proprietary
information, you must proceed with caution to prevent any accusations that
FileNet misappropriated or misused the information. Examples of such
confidential information include:
o Key customer information contained on FileNet systems (e.g. SAP,
Siebel, PeopleSoft CMS)
o Information gathered in conjunction with customer satisfaction/loyalty
surveys
o Information gathered in connection with our Customer Engagement
Initiative (CEI)
o Information disclosed to FileNet pursuant to a non-disclosure or
confidentiality agreement
G. Receiving Information That May Be Confidential or Have Restrictions on
Use
To avoid the risk of FileNet being accused of misappropriating or misusing
someone's confidential or restricted information, there are certain steps you
must take before receiving such information. The receipt of confidential or
restricted information (whether oral, visual or written) must not take place
13
until the terms of its use have been approved by senior management or formally
agreed to by FileNet and the other party in a written agreement approved by
FileNet legal counsel. Furthermore, unless otherwise delegated, an appropriate
company executive must approve the receipt of another's confidential or
restricted information. Once another party's confidential or restricted
information is properly in your hands, you must not use, copy, distribute or
disclose that information unless you do so in accordance with the terms of the
agreement.
In any case, do not take the status of information for granted. If you have
information in your possession that you believe may be confidential to a third
party or may have restrictions on its use, you should consult immediately with
the company's Legal Department.
H. Acquiring Software
Special care should be taken in acquiring software from others. As intellectual
property, software is protected by copyright, and may also be protected by
patent or trade secret laws. Software includes computer programs in "beta" or
finished form, databases and related documentation. The software may be on
CD-ROMs or diskettes or it may reside on electronic online bulletin boards or
databases. Before you accept software, access software or data on a network, or
accept a license agreement, you must follow established procedures which may
include a review with FileNet legal counsel. The terms and conditions of any
license agreement - such as provisions not to copy or distribute programs - must
also be strictly followed. If you acquire software for your personally owned
equipment, you should not copy any part of such software in any development work
you do for FileNet, place such software on any company-owned computer system, or
generally bring such software onto company premises. This includes any copies of
software which reside on any electronic online bulletin boards or databases.
To avoid infringing on the intellectual property rights of others, FileNet
employees may not:
o Make unauthorized copies of software or photocopy magazine/journal
articles or other publications
o Hire a competitor's employee to obtain that competitor's trade secrets
o Affix another's trademark to goods without authorization
o Fail to remove another's trademark when the goods or parts are
remanufactured
o Utilize other companies' software or parts of it in the design of
FileNet programs without a license or other right to do so
If FileNet or its employees want or need to use the intellectual property
belonging to someone else, we must obtain a license to use the property or
purchase the outright ownership of the property. In the case of property rights
with an expiration date, such as patents, FileNet employees must be sure that
this date has passed if licensing or outright purchase is not feasible.
If there is a question of ownership or license rights to software, you should
consult your manager before you distribute the software in FileNet through any
distribution channel, including electronic channels such as the intranet or
email. Your manager may consult the Legal Department. It is your responsibility
to make sure that all third party software you are using is appropriately
licensed and that you use it only in accordance with the terms of its license.
I. Using Trademarks
FileNet and many other companies have trademarks - words, names, symbols or
devices - that are used to identify and distinguish the company's products. Some
trademarks are registered in the U.S. Patent and Trademark Office; others are
not. For example, FileNet is a registered trademark of FileNet Corporation,
indicated by a "(R)". There are other trademarks of FileNet which are not
registered, designated, for example, by the symbol "(TM)". There may be
additional or different trademark designations outside of the U.S.
In all countries, it is important that you properly acknowledge and use FileNet
trademarks and the trademarks of other companies. Specifically, you should
always ensure that the trademark is spelled correctly and written the way the
owner of the trademark writes it. You should not use the trademark as a generic
14
name and should not use the trademark only as an adjective. Also, you should
indicate the first time the trademark is mentioned in a publication that it is a
trademark of FileNet.
You should consult the Director of Corporate Communications or the Legal
Department if you have questions on the proper use of a trademark.
J. Computer Networks and Information
FileNet's computer networks and our information resources include FileNet's
electronic mail and messaging systems, our internal Intranet and the use of the
following external computer-based services when accessed through FileNet's
systems:
o External, third party electronic mail and messaging systems
o The public Internet
o The World Wide Web
o Third party, computer-based online services
o Electronic bulletin board systems
Use of FileNet information networks and resources is both a necessity and a
privilege. Employees with access to our networks are responsible for using the
highest standards of corporate and social behavior in all of their usage and
communications. Employees who use FileNet 's networks from remote locations
(e.g. home or other non-FileNet locations) are subject to the same standards of
use as are employees who use FileNet networks on company premises.
FileNet computer networks are for legitimate, company-related business purposes
only. Limited personal use may be acceptable if such use is authorized by the
employee's specific work location and does not interfere with the performance of
the employee's normal job responsibilities.
Employees may not use FileNet's resources for any of the following:
o Soliciting for commercial, charitable, religious or political causes
o Sending chain mail letters or broadcast personal messages
o Sending inappropriate, offensive or disruptive messages
o Gaining unauthorized access to databases or information sources at
FileNet or any other site
o Damaging computer equipment, software or data
o Interfering with or disrupting network users, services or equipment
The following activities are highly inappropriate and strictly forbidden. In
certain situations, they may also be illegal and subject FileNet and the
individual(s) involved to litigation and possible civil and/or criminal
sanctions.
o Sexually-related or pornographic messages or material
o Violent or hate-related messages or material
o Bigoted, racist or other offensive messages aimed at a particular
group or individual
o Malicious, libelous or slanderous messages or material
o Subversive or other messages or material related to illegal activities
FileNet reserves the right to periodically monitor, access and disclose the
contents of company computer systems and networks and to block access to
non-business related Internet sites. Employees who inappropriately misuse
FileNet resources are subject to discipline including possible termination of
employment.
15
K. Requests for Information and Contacts with the Press, Analysts, the
Government and Others
FileNet's business activities are monitored by reporters, consultants and
securities analysts. You should not initiate contact with these individuals or
groups or respond to their inquiries without authorization. Refer them to the
Director of Corporate Communications.
Similarly, if you receive a request for information on FileNet's business from
an attorney, investigator or law enforcement official, government officials or
agencies, you should refer the request to FileNet's Legal Department, with the
exception of routine employment verifications or garnishments, which should be
referred to the Human Resources Department.
5. Employment PracticesA. Diversity and Equal Employment Opportunity
One of FileNet 's strengths is the diversity of its employees. FileNet is
committed to maintaining a diverse workforce, where employees are hired,
retained, trained, compensated, disciplined, and promoted based on
non-discriminatory principles.
International employment laws prohibit employment discrimination based on race,
color, religion, sex, sexual orientation, age, national or social origin,
language, property, birth, political or other opinion, citizenship status,
veteran status, disability or other status protected by law. FileNet is
committed to providing an equal opportunity work environment in full compliance
with these laws.
All FileNet employees need to be treated with fairness and respect. Accordingly,
employees must avoid jokes and actions or statements about individuals or groups
that may be interpreted as discriminatory or harassing or which stereotype any
group of individuals. Managers have a special responsibility to consistently
adhere to and apply FileNet 's policies regarding equal employment and
harassment and to fairly and accurately document all personnel actions and be
able to show non-discriminatory reasons for taking personnel actions.
B. Harassment and Workplace Violence
FileNet is committed to a workplace environment where employees are treated with
dignity, fairness and respect. Every employee has the right to work in an
atmosphere that provides equal employment opportunities and is free of
discriminatory practices and illegal harassment. Therefore, any form of illegal
harassment or any other illegal conduct that interferes with an individual's
work performance or creates an intimidating, hostile, or offensive work
environment, is absolutely prohibited and will not be tolerated.
Harassment takes many forms. It may target an individual's race, sex, religion,
color, national origin, age, mental or physical disability or sexual
orientation. It may also target a person who is speaking out against illegal
discrimination or participating in proceedings under anti-discrimination laws.
Harassment also includes incidents of workplace violence such as assault and
intimidation. If you are in immediate danger, do not hesitate to call 911 in the
U.S. or your local emergency number outside the U.S. Assault may be verbal, or
physical, such as pushing or even tossing someone materials that are too heavy
to catch. Intimidation can range from threatening body language to threatening
letters. Employees are prohibited from any act of violence or intimidation and
may not possess firearms, other weapons, explosive devices or dangerous
materials in the workplace or outside the workplace, if job related.
Harassment between co-workers, between managers and employees, and between
customers, contractors or vendors and employees, is strictly prohibited and
violations will result in disciplinary action up to and including termination of
employment. In some cases, there could be legal implications involving fines and
other civil or criminal penalties against the person who is harassing another.
16
As an employee, you or a coworker may at some time be confronted with harassment
or intimidation. If so, it is important that you tell the offending person to
stop the unwanted behavior as soon as it occurs. Remain calm and if the
situation warrants, remove yourself from the presence of the individual. It is
critical that you immediately report the behavior to your manager, your
Department Head, any manager, or the Human Resources Department. Allegations of
harassment and intimidation are taken seriously and will be promptly
investigated. FileNet will take immediate steps to prevent and correct any
instances of illegal harassment in the workplace or in settings in which
employees may find themselves in connection with their employment.
C. Employee Information
FileNet is committed to protecting employee personal data required to facilitate
the employment relationship. FileNet has adopted and integrated into its
business processes the eight key principles of employee data protection
advocated by governing authorities in Europe, North America and Asia.
1. FileNet will process all employee personal data fairly and lawfully.
2. FileNet will collect employee personal data for specified, explicit
and legitimate purposes.
3. FileNet will ensure employee personal data is adequate, relevant and
not excessive for the purpose for which the data was collected and
processed.
4. FileNet will ensure employee personal data is accurate, complete and
timely for the purpose it was collected and processed.
5. FileNet will not keep employee personal data longer than necessary for
the purpose the data was originally collected.
6. FileNet will allow employees to review, correct and object to the
processing of personal data. FileNet will also disclose the recipients
of personal data, except as required by law.
7. FileNet will take appropriate organizational and technical measures to
ensure employee personal data is not subject to unauthorized
processing.
8. FileNet will ensure employee personal data will not be transferred to
a second or third country unless that country has an adequate level of
protection.
Sensitive Data
FileNet will not collect or process sensitive data without the data subjects'
explicit consent in accordance with the law. Sensitive data includes any
information that could reveal racial or ethnic origin, political opinions,
religious or philosophical beliefs, trade union membership, and the health and
sex life of the data subject. This may include the family name or birthplace
that may reveal racial or ethnic origin, and the benefits elections and claims
that may indicate a health condition or sexual preference.
Technology
FileNet has implemented a global repository based on state of the art technology
to process employee personal data, job data and compensation data. Multiple
levels of security have been implemented to protect employee personal data by
restricting access and preventing unauthorized processing. Users must login to
the wide area network located behind the corporate firewall to access the
application. Network access requires a user login and password that is encrypted
during transmission over the wide area network. A separate login and password is
required to access specific applications. Pre-defined roles are established for
all users, which limits what personal data they can view. Permissions lists
within the application limit users to what type of personal data they can view.
Row level security limits users to which employees' personal data they can view.
Table level security prevents users from running queries to circumvent the
permissions list and row level security on personal data they are not permitted
to view. FileNet maintains multiple automated and manual interfaces with other
systems operated by related third parties providing benefits and payroll
services. Transport mechanisms to these providers utilize dedicated access,
encryption technology and passwords to ensure employee personal data is
protected. Contractual terms and conditions contained in formal service
agreements with these providers obligates them to maintain adequate levels of
protection for employee personal data processed on internal systems maintained
by the service provider.
17
Personal items, messages or information that you consider private should not be
placed or kept anywhere in the FileNet workplace, such as in telephone systems,
office systems, electronic files, desks, credenzas, lockers, or offices. FileNet
management has the right to access those areas and any other company furnished
facilities. Additionally, in order to protect its employees and assets, we may
ask to search an employee's personal property, including briefcases and bags,
located on or being removed from FileNet locations. The employee is expected to
cooperate with such a request. Employees, however, should not access another
employee's work space, including electronic files, without prior approval from
the employee or management.
D. Employee Health and Safety
Workplace health and safety requirements are established by law. International
laws require all employers to furnish a workplace free of recognized hazards.
FileNet is committed to complying with these standards and closely monitors its
workplaces to determine if equipment, machinery and facilities meet specified
safety standards and that safety and health hazards are adequately addressed
through appropriate work practices and procedures. FileNet acts expeditiously to
eliminate or control employee exposure to any new or inadequately addressed
safety or health hazards.
In addition, FileNet:
o Provides employees with proper tools and training
o Provides and enforces the use by all employees of appropriate personal
protective equipment
o Provides immediate and appropriate medical attention to employees
where needed
o Does not ask or allow any employee to bypass an established safety
practice or procedure
o Does not ask or allow any employee to disable, tamper with, or defeat
any safety device on equipment or machinery.
Safety is everyone's responsibility. All FileNet employees must help to create a
safe work environment and clearly understand their role in following proper
procedures. Employees should promptly report at risk behaviors or unsafe
conditions to their safety officer, their manager or any of the other resources
listed in the Employee Resource section.
E. Alcohol and Substance Abuse
Alcohol, illegal drugs, and abuse of prescription medicines have no place in the
workplace and are inconsistent with a safe and productive work environment. With
the exception of moderate and prudent alcohol consumption during legitimate
business entertainment, FileNet employees and employees of contractors are
prohibited from using, consuming, distributing or possessing alcohol or illegal
substances, while working, operating FileNet property (including company
vehicles) or engaging in FileNet business. In addition, no FileNet employee or
any employee of a contractor may report to work or perform any job duties while
under the influence of alcohol or any illegal substance. Alcohol and substance
abuse by an employee can endanger the employee's safety, the safety of other
employees, and the community.
FileNet will offer assistance to employees who develop problems related to
alcohol or substance abuse before the abuse results in harm to others, impairs
their job performance or renders them unemployable. Employees who refuse to
participate in an appropriate treatment program may be subject to discipline
including discharge.
Where appropriate and allowable by law, FileNet may institute drug-testing
programs to assure that employees in certain safety-sensitive jobs, or during
post-accident investigations, comply with our alcohol and substance abuse
policies.
18
F. Leaving FileNet
If you leave the company for any reason, including retirement, you must return
all FileNet property, including documents and media which contain FileNet
proprietary information, and you may not disclose or use company proprietary
information, including confidential information. Also, the company's ownership
of intellectual property that you created while you were a FileNet employee
continues after you leave the company.
G. Hiring of Former Government Employees
Federal laws restrict FileNet's ability to hire employees who were recent
government employees involved in the awarding or administration of FileNet
contracts. Employees should contact the Human Resources Department before having
any formal or informal discussions with current or former government employees
about the possibility of working for FileNet.
6. Marketing PracticesA. Antitrust and Unfair Trade Practices
FileNet will compete vigorously for business in all of the markets where we
operate, but only in strict compliance with our Values and Standards of Business
Conduct and all applicable policies, trade laws and regulations.
The U.S. and many other nations have antitrust and other trade laws and
regulations designed to promote free and fair competition. U.S. antitrust laws
may apply to FileNet 's activities in other countries whenever they have an
impact on U.S. or domestic or foreign commerce. A violation of U.S. and/or
foreign laws and regulations may result in serious criminal and civil sanctions
for both corporations and individuals.
FileNet employees should understand the basic requirements of the antitrust laws
that apply to their business activities and should not propose or enter into any
agreements or understandings with competitors, customers, distributors and
suppliers, whether formal or informal, written or unwritten, concerning:
o Prices or credit terms
o Costs
o Profits or profit margins
o Allocations of markets, orders, or customers
o Limits on production or sales volume
o Distribution methods or allocations
o Production capacity
o Sales territories
o Agreements to refuse to do business with suppliers and competitors
o Group boycotts of suppliers and competitors
FileNet employees must review with the Legal Department any activities or
agreements that might raise antitrust issues. Employees should consult with the
Legal Department before proposing or entering into any agreements or
understandings that:
o Obligate a supplier or customer to conduct business with FileNet
before FileNet will purchase or sell to it
o Restrict a customer's choices in using or reselling a FileNet product
or service
o Require a customer to purchase one FileNet product or service as a
condition to purchasing another FileNet product or service
o Restrict any party's freedom to conduct business with or produce or
provide any product or service with any other party
o Restrict the freedom of a licensee or licensor of any patent,
copyright, or licensing arrangement
19
B. Competitive Information
Learning about our competitors is good business practice, but it must be done
fairly and ethically and in compliance with all applicable U.S. federal, state
and foreign laws and regulations.
FileNet employees should seek competitive information only when there is a
reasonable belief that both the receipt and the use of the information is
lawful. Competitive information includes anything related to the competitive
environment or to a competitor's products, services, markets, pricing or
business plans. Competitive information may be tangible or intangible and vary
in format depending on how it is stored, compiled, or otherwise documented
(e.g., electronically, graphically, photographically or in writing.)
Competitive information that is drawn from published sources or that is
otherwise widely available is known as "public information" and may be acquired
and used lawfully. FileNet employees may lawfully gain access to or use
proprietary information belonging to competitors under the following
circumstances:
o By deriving information from public sources
o By observing items in public use and deriving information from such
use
o By obtaining a license to use the information
o By purchasing the outright ownership of the information
o By lawfully obtaining product samples and deriving information through
reverse engineering of the product
Employees must never try to obtain or be willing to accept improperly obtained
non-public information about competitors. FileNet employees may never:
o Obtain proprietary information by means of theft, bribery or
misrepresentation
o Hire a competitor's employee for purposes of improperly obtaining
competitive information
o Induce or coerce a person to provide competitive information in
exchange for gifts, job offers, or the withholding of the same
o Copy, duplicate, draw, photograph or otherwise convey someone else's
proprietary information
o Knowingly be in a restricted area of a party's premises without
authorization
o Obtain product samples without authorization from the owner
o Gather information from a competitor through invasive means (e.g.,
wiretapping, "hacking into" a computer system)
o Obtain proprietary information accidentally misplaced or left in an
unsecured place or medium
o Employ an intelligence-gathering firm to collect proprietary
competitive data while misrepresenting themselves or the purpose of
the data collection
C. Trade Controls and Export Restrictions
The United States uses international trade controls to protect our national
security, the domestic economy, and to promote foreign policy. These controls
are embodied in various laws and regulations that affect international
transactions including exports and re-exports of products, technology and
software, imports, and foreign boycotts that the United States does not
sanction.
FileNet employees must fully comply with the laws, regulations and public policy
of the United States. Our policy prohibits any international transaction that is
not authorized by an applicable regulation, export or re-export license or
approval. Contact the Legal Department for details of these regulations.
Also prohibited are unauthorized transactions with:
o Embargoed countries and individuals or entities listed on the U.S.
government debarred parties lists
o Arms proliferation-related end users or parties named on the
Department of Commerce's Entity List
o Any party known or believed to be acting in violation of U.S. or
foreign laws and regulations
o Parties who refuse to do business with or discriminate against another
country or entity in support of an unsanctioned foreign boycott (i.e.
a boycott not sanctioned by the U.S. government)
20
7. Working With Government Agencies
When working with government agencies and officials from any country, FileNet
employees must be aware of unique laws, regulations, and policies governing our
actions. Conduct that is acceptable in the private sector may violate
governmental procurement laws or regulations. Violations can result in harsh
consequences such as fines, penalties, debarment or suspension from competing
for government contracts, and even criminal prosecution of the company or
individual employees.
FileNet employees must uphold both the letter and the spirit of all FileNet
policies and applicable procurement laws governing our business relationships
with government agencies. Employees must also require that all consultants,
agents, independent contractors, subcontract labor and any other individual
working for FileNet on a government project or contract agree to comply with the
same.
A. Proprietary and Source Selection Information
Government procurement laws and regulations prohibit the solicitation,
possession, or use of proprietary or source selection information.
"Proprietary" information includes confidential information of a competitor such
as cost or pricing data or other information submitted by the contractor to the
government as part of a bid or proposal. This information is often marked with
words such as "proprietary," "protected," or "confidential." FileNet employees
must not solicit, receive, or use this information. If you believe that
proprietary information has been revealed to you, you must immediately report
the incident to your manager or the Legal Department.
"Source selection" information includes government-sensitive information and
documents such as source selection plans, technical evaluation plans, government
evaluations of proposals, competitive range and source selection determinations,
competitors' bid prices (prior to bid opening), and competitors' proposal prices
(prior to contract award). FileNet employees must not solicit, receive, or use
this type of information.
If you believe that source selection information has been revealed to you, you
must immediately report the incident to your manager or the Legal Department.
B. Protection of Classified Information
FileNet employees must follow all security regulations of the U.S. Government
and any other government with jurisdiction over FileNet operations in a
particular country. These regulations cover such things as plant and office
security and the proper handling of classified information.
Access to classified information is restricted to only those individuals with
appropriate government security clearance and a valid need to know. Unauthorized
possession, use, disclosure, or transmission of classified information
constitutes a violation of FileNet 's security agreement with the government and
may be punishable by fines and imprisonment.
Employees must report actual or potential security violations immediately to the
facility security administrator or an authorized designee.
C. Product Quality and Substitution
The integrity and quality of FileNet's products are of the utmost importance.
FileNet employees must ensure that all FileNet products meet contract
requirements for design, manufacture, materials, testing and any other relevant
specifications.
FileNet employees must avoid:
o Unauthorized substitutions of materials, substandard or nonconforming
parts
o Altering, falsifying or distorting inspection or test documentation or
software
21
o Improperly or erroneously recording inspection or test results
o Falsely certifying or stating that required inspections or tests were
performed
o Falsely certifying or stating that required inspection or test
documentation is available
o Using incomplete or improper inspection or testing protocols or
procedures
Any waivers, deviations, change orders, or similar approvals relative to a
government contract must be secured before delivery.
D. Anti-Kickback Act of 1986
Under the Anti-Kickback Act, a government contractor or subcontractor cannot
give or receive anything of value that is intended to result in favorable
treatment.
FileNet employees involved in government procurement work must be careful to
avoid actual or potential conflicts of interest. Do not give or accept anything
of value without checking with your manager. You may also be required to
periodically certify that you have not violated the Anti-Kickback Act and gift
bans, and that you do not know of any other employee who may have violated these
laws.
E. Other Limitations
Many laws, regulations, and policies control government procurements. The
following list is not exhaustive, and you should consult with your manager or
the Legal Department before beginning any contact with government customers.
Among other things, procurement laws and regulations require:
o Accurate and complete tracking and billing of all labor and material
costs
o Faithful and strict conformity to all contract specifications and
requirements
o Full compliance with the Truth in Negotiations Act, including the
proper submission of "cost or pricing data"
o Precise and accurate accounting of research and development costs
according to government rules
o Adherence to any testing, inspection, or quality assurance
requirements, including full cooperation with any government inspector
o Avoidance of any fraudulent demands for payment of money or the
transfer of property that could potentially violate the False Claims
Act, such as presenting a voucher while knowing the goods have not
been inspected or accepted
o Accurate and complete records relating in any way to government
contracts including, but not limited to, production records, equipment
logs, inspection records, testing records, time cards, and invoices
8. International BusinessA. International Customs, Laws and Regulations
We must be aware that many of the countries in which we do business have
different laws and customs. Employees who engage in international business are
responsible for knowing and complying with both the laws and regulations of the
countries in which those businesses operate and the U.S. laws and regulations
that apply outside U.S. borders. For example, the Foreign Corrupt Practices Act,
as well as the laws of most other countries, prohibits giving anything of value
to foreign government officials or their families to influence decisions.
FileNet will strictly comply with all such laws.
In some situations, U.S. law may conflict with local customs or local law may be
more restrictive than U.S. laws or company policy. If you ever encounter this,
follow the more restrictive law, custom, or policy. Contact the Legal Department
for further information and guidance.
22
B. Agents, Consultants and Third Party Representatives
The acts of FileNet's agents, consultants, independent contractors and
representatives to facilitate company business are generally considered the acts
of FileNet. Accordingly, FileNet cannot use agents or representatives to do
indirectly what we could not do directly. FileNet employees, agents, and
representatives must abide by all laws in spite of customs, cultural norms, or
competitive pressures that suggest otherwise.
It is incumbent on all FileNet employees to exercise due diligence when
selecting a third party to represent FileNet. When selecting a third party,
consider the following:
o Hire only reputable, qualified individuals or firms
o Seek the assistance of your Legal Department in making adequate
background checks and verifying business credentials
o Make sure that compensation is reasonable for the services to be
provided
o Seek the assistance of your Legal Department and management if you
spot a "red flag"
Some "red flags" to consider are:
o Third parties with family or other relationships that could influence
the buying decision
o Independent contractors or consultants with a reputation for bribes
o A sales representative or agent who approaches you near the award of a
contract and indicates a "special arrangement" with an official
o A customer who suggests that a FileNet bid be made through a specific
agent or representative
C. The Foreign Corrupt Practices Act
The Foreign Corrupt Practices Act (FCPA) makes it a crime for FileNet, or any of
its subsidiaries, agents, or employees to directly or indirectly offer or pay a
bribe to a foreign official. The term "foreign official" refers to any person
acting in an official capacity on behalf of a foreign government, agency,
department or instrumentality, a foreign government-owned corporation or a
foreign political party. The term also applies to any candidate for foreign
political office.
If FileNet cannot obtain a contract without paying a bribe, FileNet employees
should report the matter to their manager and the Legal Department and walk away
from the deal. FileNet 's reputation for integrity is more important than the
profit from any contract.
Employees should be alert to a possible FCPA violation if any of the following
occur:
o Unexplained large expenses on a Travel and Entertainment Expense
Report
o An agent demanding a higher than normal commission for a transaction
o Any agent or salesperson who says they are working with a government
official to give FileNet the contract
o A request that a commission be made in cash, in another name, or in a
third country
D. Political Activities and Contributions
As a company, FileNet will not make any contributions to political parties,
candidates, or public officials, except as permitted by federal, state, or local
laws. Contributions made by individual employees, agents, or representatives
will not be reimbursed directly or indirectly by FileNet, even when made in the
company's name.
FileNet does not permit employees to use company time or resources for political
activities. This prohibition includes using telephones, email, faxes, and
photocopying machines, as well as soliciting contributions. No FileNet employee
is permitted to pressure another employee or supplier to make a political
contribution, volunteer for a political activity, or attend a political event.
23
E. Following the Standards
Most employees will follow FileNet's Values and Standards of Business Conduct
voluntarily and with commitment. In the event that an employee violates our
Values and Standards of Business Conduct, company policies and procedures or any
of the laws and regulations that govern our business, FileNet will take
immediate and appropriate action.
Depending on the nature, severity, and frequency of an employee's violation,
FileNet will take appropriate disciplinary actions up to and including
termination, claims for reimbursement of losses or damages, and civil legal
action or criminal prosecution. Discipline will be handled fairly and
consistently.
V Reporting Concerns and Violations
Employees are obligated to promptly report any problems or concerns or any
potential or actual violation of our Values and Standards of Business Conduct.
FileNet recognizes that the decision to report a concern or problem is not
always easy, nor is there always one right answer. Usually, the first place to
go with questions or concerns is your manager. However, if your manager does not
answer the question or address the problem to your satisfaction, you should
contact your department head, the Human Resources department, or the CRMO. If a
concern relates to a law or regulation governing our business, you may also
contact FileNet's Legal Department.
FileNet employees at all levels are prohibited from taking retribution against
anyone for reporting or supplying information or cooperating in an investigation
about a concern. Any FileNet employee who retaliates against other employees for
reporting problems will be subject to discipline, including potential
termination of employment. This policy applies even if an allegation was made in
good faith but appears ultimately to be groundless. On the other hand, any
employee who deliberately makes a false accusation with the sole purpose of
harming or retaliating against another employee will be subject to disciplinary
action.
Concerns specifically regarding accounting, internal accounting controls or
auditing matters may be directed to the FileNet Ethics Line. This service is a
toll-free telephone line and website dedicated solely to responding to employee,
shareholder and other parties' concerns regarding FileNet's financial practices.
All contacts with the Ethics Line are centrally received by an independent
third-party service, and will remain anonymous unless the reporter chooses to
identify him or herself. This service is multilingual and available 24 hours a
day, seven days a week.
Understanding and acting upon any issues that exist regarding financial,
accounting and/or audit matters is an essential component of FileNet's ability
to take action and ensure the highest levels of financial integrity. 24
VI Employee ResourcesFileNet Ethics Line: (24 Hour Confidential Telephone and Internet Reporting)
Call Toll-Free in the United States: 1-866-493-1850
International Callers: 1-866-737-6850
Call ATandT for your local dialing guide or access code, or you may look up your
dialing guide on the Internet at:
http://www.business.att.com/ then dial 1-866-737-6850 collect after the dialing
or access code.
Or you may use the Internet by entering www.ethicspoint.com to make your report.
Corporate Compliance and Risk Management Officer (CRMO):
Karina Page
1-714-327-5870
Email: kpage@FileNet.comCorporate Human Resources:
Audrey Schaeffer
Vice President, Worldwide Human Resources
1-714-327-3434
Email: aschaeffer@FileNet.comCorporate Legal Department:
Katharina Mueller
Vice President and General Counsel
1-714-327-7802
Email: kmueller@FileNet.com
25
EX-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 BV (The Netherlands)
FileNet Corporation Korea
FileNet Corporation, Pty. Ltd (Australia)
FileNet France S.A.R.L.
FileNet GesmbH (Austria) (?)
FileNet GmbH (Germany)
FileNet Hong Kong Limited
FileNet Iberia, S.L. (Spain)
FileNet Italy, S.R.L.
FileNet Japan
FileNet Limited (United Kingdom)
FileNet Nova Scotia Corporation
FileNet Poland Sp.zo.o
FileNet (Proprietary) Limited (South Africa)
(?)FileNet Shared Services Centre Ireland Limited
FileNet Sweden AB
FileNet Switzerland(Switzerland) GmbH
Shana Corporation (Canada)
Shana Corporation U.S.A.
SPMM,Inc.
EX-23.1
Exhibit 23.1
CONSENT OF INDEPENDENT AUDITORS' CONSENTREGISTERED 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
333-107012
of FileNet Corporation333-116883 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 dated February 24, 2004 (such
report expresses an unqualified opinion and includes an explanatory paragraph
referring to a change in methodon the effectiveness of accounting for goodwill and other intangible
assets in 2002),internal control over financial
reporting, appearing in this Annual Report on Form 10-K of FileNet Corporation
for the year ended December 31, 2003.2004.
/s/ Deloitte and Touche LLP
Deloitte and Touche LLP
Costa Mesa, California
March 12, 200411, 2005
EX-31.1
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;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;evalution; and
c)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 12, 200415, 2005
/s/ Lee D. Roberts .Lee D. Roberts
Chief Executive OfficerExhibit 31.2
EX-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;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
c)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 12, 200415, 2005
/s/ Sam M. Auriemma .Sam M. Auriemma
Chief Financial Officer
2
EX-32.1
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 FileNETFileNet 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, 20032004 (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 12, 200315, 2005
/s/ Lee D. Roberts.
Lee D. Roberts
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
EX-32.2
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 FileNETFileNet 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, 20032004 (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 12, 200315, 2005
/s/ Sam M. Auriemma.
Sam M. Auriemma
SeniorExecutive Vice President and
Chief Financial Officer
(Principal Financial Officer)