================================================================================
FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the transition period from to
Commission File Number 0-15997
FILENET CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 95-3757924
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
3565 Harbor Boulevard, Costa Mesa, California 92626
(Address of principal executive office) (Zip code)
Registrant's telephone number, including area code: (714) 966-3400
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Title of each class Name of each exchange which registered
Common stock, $0.01 par value Nasdaq
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days: Yes [X] No [ ]
Indicate by check mark whether the disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Based on the closing sale price of March 17, 1998, the aggregate market value of
the 14,981,441 shares of voting stock of the Registrant held by nonaffiliates of
the Registrant on such date was $579,631,952. For purposes of such calculation,
only executive officers, board members and beneficial owners of more than 10% of
the Company's outstanding common stock are deemed to be affiliates.
The number of shares outstanding of the Registrant's common stock was 15,145,900
at March 17, 1998.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's definitive proxy statement for its 1998 Annual Meeting
are incorporated by reference into Part III as set forth herein. Portions of
Registrant's Annual Report to Stockholders for the fiscal year ended December
31, 1997 are incorporated by reference into Parts II, III and IV as set forth
herein.
================================================================================
<PAGE>
FILENET CORPORATION
FORM 10-K
For the Year Ended December 31, 1997
INDEX
<TABLE>
PART I Page
<S> <C>
Item 1. Business..............................................................3
Item 2. Properties...........................................................10
Item 3. Legal Proceedings....................................................10
Item 4. Submission of Matters to a Vote of Security Holders..................11
PART II
Item 5. Market for the Registrant's Common Stock and Related
Stockholder Matters..................................................11
Item 6. Selected Financial Data..............................................12
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................13
Item 8. Financial Statements and Supplementary Data..........................13
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.............................................13
PART III
Item 10. Directors and Executive Officers of the Registrant..................13
Item 11. Executive Compensation..............................................13
Item 12. Security Ownership of Certain Beneficial Owners and Management......13
Item 13. Certain Relationships and Related Transactions......................13
PART IV
Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K.....14
Signatures...................................................................19
</TABLE>
2
<PAGE>
PART I
Item 1. Business
GENERAL
FileNET Corporation (FileNET or the Company) develops, markets and services a
family of integrated document management software products designed for managing
information and enhancing enterprise productivity. Additionally, the Company
manufactures and sells a line of 12-inch optical storage and retrieval
libraries. The Company markets its products in more than 60 countries through a
global sales, services and support organization, including its ValueNET(R)
partner program of resellers, system integrators and application developers.
MARKETS AND APPLICATIONS
The Company offers a family of complementary products which enable users to
manage, on an enterprise-wide basis, the storage, processing and workflow for
documents and other unstructured information, including scanned images, faxes,
text, spreadsheets, graphics, drawings, photographs, computer output reports,
voice, and video. The Company's products provide a client server/based document
management architecture that can be implemented on a modular basis and
organizations can choose one, some, or all of the Company's products to build
the system that most effectively meets their needs. The Company's customers are
typically those organizations which have active paper document files, process
significant numbers of electronic documents in their day-to-day operations, or
have complex, mission-critical business processes for a variety of applications
such as mortgage loan servicing, credit card customer service, insurance claims
processing, retirement account management, engineering drawings management, web
based document management, medical records management, personnel records
management, company policies and procedures, accounts payable and receivable,
traffic, property and criminal records. Additionally, the Company's products
address ad hoc business processes at the departmental and workgroup levels to
improve overall enterprise productivity and integrate with industry standard
productivity applications like Microsoft Office, Lotus Notes and Novell
GroupWise.
The Company markets its products in more than 60 countries through a direct
sales force and through its ValueNET(R) partner program consisting of systems
integrators, value-added resellers and distributors. A number of firms,
including Andersen Consulting and American Management Systems, operate as
third-party resellers under the Company's ValueNET(R) program and combine
FileNET products with vertical market-specific value-added services to provide
turnkey solutions and complex systems integration for customers. Other firms
such as Tech Data, Law Cypress, IAI Canada, Image Choice and Paperlink are
distributors of the Company's products selling to hundreds of resellers
throughout the world. The Company also has OEM agreements with other firms
involving the Company's software products.
The Company offers software maintenance service for its products in the United
States and in countries where it has direct international sales operations. The
Company's international resellers offer maintenance in the countries in which
they operate. The Company subcontracts hardware maintenance to Hewlett-Packard
Corporation (HP) and other third parties.
In September 1995, the Company entered into an agreement with SAP AG to deliver
data archiving and document solutions for their client/server-based R/3
enterprise application systems environment as a Complementary Software Partner.
Deliveries of this product commenced in December 1995.
The Company also has porting and licensing agreements with HP and Sun
Microsystems, Inc. (Sun) to co-market versions of FileNET's document imaging and
workflow software products to users of those companies' products. Sales of the
HP based product commenced in December 1993 and the Sun based product in March
1995. In 1996, the Company became a Global Partner with HP's General Systems
Division. In September 1997, the company signed an IBM Market Development
Program Agreement with IBM's Solution Developer Marketing Alliance group to
become an IBM Business Partner.
The Company is a Certified Microsoft Solutions Developer and will continue to
develop and certify products for the Microsoft BackOffice computing environment.
3
<PAGE>
PRODUCTS
SOFTWARE
The following software products are currently being offered by the Company:
Integrated Document Management
In February 1998, the Company introduced the Panagon family of Integrated
Document Management (IDM) software that combines imaging, electronic document
management, and workflow into a unified architecture. The Panagon family of
products includes new desktop and web services software applications being
released by the Company for the first time and a rebranding of existing products
for client and server environments. With Panagon, the Company has created a
software infrastructure that allows companies to capture any type of document
electronically, then quickly and easily access, manage, and integrate the
information with their existing critical business applications throughout the
enterprise. Using Microsoft's Windows Explorer or web browsers familiar to most
business professionals, companies can search the entire enterprise network for
information, retrieve documents of all types, easily work with the information,
and then route it as needed for further review, processing, or decision making.
The new Panagon IDM Desktop range of products are built around Microsoft's
component software architecture (COM) and allow applications to be quickly and
easily developed and tailored to meet an organization's specific requirements.
Panagon IDM Desktop reduces the ongoing cost of ownership through the ability to
easily deploy applications on the Web or in a client/server environment. Cost of
ownership is also reduced through the use of rapid application development (RAD)
techniques and compatibility with industry-standard programming tools such as
Visual Basic, PowerBuilder and more. As a result, it takes less time to develop
customized IDM applications, less time to integrate the software components into
a company and less time to train users.
The Panagon family includes a complete suite of IDM software components that are
built to work together, eliminating integration issues when combining products
from different vendors. Panagon products include:
Panagon IDM Desktop and IDM Web Services are software applications that
offer best-of-class integrated document management for ad hoc query and
access or mission critical applications. Companies can access all
documents stored in enterprise libraries from within a Microsoft
Windows Explorer, Internet browser interface or via a custom
application integrated into line of business systems. Panagon IDM
Desktop delivers "out-of-the-box" integration with Microsoft Windows
environments and productivity applications such as Microsoft Office,
seamlessly managing and viewing more than 200 document formats. Once
located, users can create work processes to include others that need to
share, distribute, or approve, with the built-in workflow and
integrated e-mail features.
Panagon IDM Services is a server based integrated document management
solution incorporating imaging and document services for medium to
large business. IDM Services is the high performance repository system
that integrates with Panagon IDM Desktop and IDM Web Services for
managing all types of documents. IDM Services can be used as both an
imaging and document system together or as separate applications.
Panagon Visual WorkFlo is an enterprise-wide, scalable business process
automation solution that can be used to easily create applications that
reflect the way work processes are performed. It allows managers to
control and modify work processes to meet the needs of a dynamic
business environment, and integrates information flow between software
applications within a company's business processes. Panagon Visual
WorkFlo supports multiple client, server and applications development
environments and integrates with leading business process reengineering
products for reduced implementation time. The product features
object-oriented technology to enhance developer productivity through
reusability of applications and a wide variety of vertical and
horizontal solutions for out-of-the-box functionality.
Panagon Report Manager is a high-performance, client/server computer
output to laser disk (COLD) product that eliminates printing and
distributing computer-generated reports and statements. It
significantly lowers costs and inefficiencies by allowing companies to
index, store, retrieve, view, print, fax, and distribute
computer-generated output on magnetic or optical disk. Panagon Report
Manager is built around industry standards and has an intuitive,
easy-to-use graphical interface with report mining capabilities.
Panagon Capture is an enterprise document capture application that has
a complete set of highly configurable components for capturing
virtually all document types, scanned paper documents, fax, e-mail,
word processing documents, spreadsheets, HTML forms, audio and
video-clips, computer generated reports, and electronic data
4
<PAGE>
interchange (EDI) information-and making them immediately available to
users. Its modular components can be configured to meet simple capture
requirements in distributed environments or enterprise-wide capture
requirements for production operations.
The new Panagon family of products is available to new and existing
customers. New customers will receive the benefits of a more
comprehensive range of integrated document management functions as
opposed to acquiring separate document management technologies from
multiple vendors. Existing customers can deploy new IDM applications
independently or along side existing applications using FileNET
software. Existing customers wanting to take advantage of Panagon's
broader IDM capabilities for applications already deployed can recreate
the existing applications using the IDM development environment.
Document Imaging
FileNET Panagon WorkGroup(TM) software is a midrange document imaging and work
management product based on a subset of the Panagon IDM products combined with
certain prepackaged software applications.
Document Warehouse(TM) for SAP software is a document and data archiving
application certified by SAP, for use with the popular R/3 Enterprise Resource
Planning (ERP) application suite.
The Company's Watermark(R) software products enable users worldwide to exchange,
process and share scanned images, faxes and other electronic documents within
departments and workgroups of large enterprises and throughout midsize and small
business environments. Watermark documents and folders are easily integrated
into existing line-of-business applications and take advantage of the latest
Microsoft operating systems, database technologies and Internet capabilities.
The Watermark family consists of the following products:
Watermark Client software replaces document handling procedures with
integrated electronic processing of scanned images, faxes and other
electronic documents. The software provides easy-to-use tools for
document capturing, filing, viewing, annotation and OCR that
image-enable any OLE- or ODMA- compatible Windows application, such as
e-mail, databases and workflows.
Watermark Server software is used for organizing, storing and
optimizing shared network access to scanned documents, faxes and
electronic files. The software intelligently captures the business
rules governing document security, version control, migration and
storage through easy client-based administration and reporting tools
designed for Microsoft BackOffice.
Watermark DiskExtender software extends the document storage and
retrieval capacity of the Watermark Server by providing Windows NT
services to migrate documents to and from high-density optical media.
Watermark Fax Router software is a fax management solution that
streamlines inbound fax communications with customers, suppliers and
other business partners. The software delivers documents electronically
to the intended recipient and immediately routes for processing. Faxes
are securely managed side-by-side with all other business documents.
Watermark Developer's Toolkit software allows a developer to build
client/server and intranet applications by taking advantage of the full
power and range of Watermark functionality via OLE Objects and ActiveX
Controls specifically designed to simplify application building.
Workflow
Panagon Visual WorkFlo(R) software provides an open, flexible, component
software framework for workflow application development. This product enables
users and ValueNET(R) partners to automate business processes using
object-oriented programming technology, and supports standard tools such as C++,
Visual Basic, PowerBuilder, Microsoft Windows-compatible tools, and FileNET's
other WorkFlo products. All work management functions, including routing,
queuing, exception handling, and management control, are managed by Visual
WorkFlo using standard Windows interfaces and graphical tools.
FileNET Ensemble(TM) is a general purpose workflow tool introduced in 1996 that
automates a wide range of everyday business processes and is integrated with
Microsoft Exchange and Novell GroupWise to enhance these messaging (e-mail)
system products. FileNET markets this product through all of its direct and
indirect sales channels worldwide. Novell markets a version of this software
under the product name "GroupWise Workflow."
5
<PAGE>
Electronic Document Management
The Company's electronic document management software products simplify the
management and maintenance of electronic documents and other unstructured
information, ensuring the right information is always available. Needed
information is readily accessible, providing total manageability and security.
Panagon IDM Document Services is a server software product that enables
electronic document management applications across large enterprise
LANs and WANs. It acts as a network librarian, simplifying the
management and maintenance of all files on the user's network.
@mezzanine(R) is a software product used to organize, protect and
maintain documents published on the World Wide Web. @mezzanine provides
improved organization and access methods to the Web browser and special
document management features such as version control, security and
archiving needed by the Web server.
COLD
The Company's Panagon Report Manager software product stores and retrieves
computer-generated reports to replace the use of printed reports and computer
output to microfiche. It also enables the user to search for specific
information located in one or more reports and extract the information to use
with popular desktop software applications. It is a client/server software
product running on servers using the Microsoft Windows NT Server operating
system and PC workstations running Microsoft Windows. It also integrates with
FileNET's IMS software product to provide large capacity archival storage
capabilities.
HARDWARE
The Company markets an optional integration service, offering customers the
option to purchase complete solutions, including industry standard hardware,
directly from FileNET. The Company also manufactures and markets an optical
storage and retrieval library (OSAR(R)) based on 12-inch optical disk storage
technology.
All named products mentioned in this Form 10-K, other than the Company's named
products, are trademarks or registered trademarks of the respective holder
RESEARCH AND DEVELOPMENT
The Company's research and development activities are focused on software
product development. Research and development expenditures were $39.6 million,
$36.5 million and $24.7 million for the years ended December 31, 1997, 1996, and
1995, respectively. The Company believes that its future success depends upon
its ability to continue to enhance its existing software products and to develop
new software products that satisfactorily meet market needs. Accordingly, the
Company intends to continue to make substantial investments in its research and
development activities.
BACKLOG
The Company typically ships its products within a short period of time after
acceptance of orders, which is common in the computer software industry. The
Company does not consider the level of backlog to be a significant or important
indicator of future revenue or earnings.
SERVICES, SUPPORT AND MANUFACTURING
The Company maintains service and support organizations that provide both
pre-sales and post-sales services in the United States and the foreign countries
where the Company has direct operations.
The Company's integration facilities in Costa Mesa, California and Dublin,
Ireland, conduct software manufacturing, integration, test and quality control.
The Company operates a Response Center in Costa Mesa to provide telephone
technical support to customers who have entered into support agreements with the
Company. The Company is in the process of opening an additional Response Center
in Dublin, Ireland and also plans to open a Response Center for the Asia Pacific
region in Singapore.
6
<PAGE>
EMPLOYEES
As of December 31, 1997, the Company had 1,490 full-time employees of which 343
were employed in research and development; 924 in sales, marketing, professional
services and customer support; 131 in operations; and 92 in finance and
administration. Employees in the Company's German subsidiary are represented by
a labor union. No other employees are represented by labor unions, and the
Company has never experienced a work stoppage. The Company believes that it
enjoys good employee relations.
COMPETITION
The market for the Company's products is highly competitive. The Company's
principal competitors for its various product lines include the following
companies: 1) Workflow and document imaging-- Banctec, Inc., IBM, Keyfile,
Optika, Unisys Corporation, Mosaix, Eastman Software, a Kodak company, 2)
Electronic Document Management--Documentum, IBM, Interleaf, Novasoft, Novell,
Open Text, PC DOCS, and 3) COLD--Computron, IBM and Microbank. Numerous smaller
software vendors also compete in each product area. The Company also experiences
competition from systems integrators who configure hardware and software into
customized systems.
In addition, RDBMS vendors, such as Oracle, Sybase and Informix, may compete
with the Company in the future. Oracle has announced products that compete with
the Company's document management products. It is also possible that new
competitors or alliances among competitors may emerge and rapidly acquire
significant market share. The Company also expects that competition will
increase as a result of software industry consolidations. See "Certain
Considerations - Competition" below.
PATENTS AND LICENSES
The Company holds three patents for its OSAR product which expire August 26,
2003, June 23, 2004 and August 4, 2004, respectively. The Company has also
entered into non-exclusive license arrangements with a number of organizations,
including IBM and Oracle, which permit the Company and its resellers to grant
sublicenses to end users of the Company's systems to use software developed by
these third-party vendors. See "Certain Considerations - Intellectual Property
and Other Proprietary Rights" below.
CERTAIN CONSIDERATIONS
This Annual Report on Form 10-K contains forward-looking statements that involve
risks and uncertainties, including those discussed in the Company's Annual
Report to Stockholders for the year ended December 31, 1997, certain sections of
which are incorporated herein by reference as set forth in Items 7 and 8 of this
report. The actual results that the Company achieves may differ materially from
any forward-looking statements, which reflect management's opinions only as of
the date hereof. The Company undertakes no obligation to revise or publicly
release the results of any revisions to these forward-looking statements.
Readers should carefully review the factors described below and in other
documents the Company files from time to time with the Securities and Exchange
Commission, including its 1997 Annual Report to Stockholders and the Quarterly
Reports on Form 10-Q to be filed by the Company in 1998.
Rapid Technological Change; Product Development The market for the
Company's products is characterized by rapid technological developments,
evolving industry standards, changes in customer requirements and frequent new
product introductions and enhancements. The Company's success will be dependent
upon its ability to enhance its existing products, develop and introduce, in a
timely manner, new products incorporating technological advances and respond to
customer requirements. Specifically, the Company has announced plans to deliver
a new range of desktop software products providing integrated document
management capability for existing and new users. To the extent one or more of
the Company's competitors introduce products that more fully address customer
requirements, the Company's business could be adversely affected. There can be
no assurance that the Company will be successful in developing and marketing
enhancements to its existing products or new products on a timely basis or that
any new or enhanced products will adequately address the changing needs of the
market-place. If the Company is unable to develop and introduce new products or
enhancements to existing products in a timely manner in response to changing
market conditions or customer requirements, the Company's business, financial
condition or results of operations could be adversely affected. From time to
time, the Company or its competitors may announce new products, capabilities or
technologies that have the potential to replace or shorten the life cycles of
the Company's existing products. There can be no assurance that such
announcements will not cause customers to delay their purchasing decisions in
anticipation of such products, resulting in a material adverse effect on the
Company's business, financial condition or results of operations.
Uncertainty of Future Operating Results; Fluctuations in Quarterly
Operating Results Future operating results will depend upon many factors,
including the demand for the Company's products, the effectiveness of the
Company's efforts to continue to integrate various products it has developed or
acquired through acquisition of others and to achieve the desired levels of
7
<PAGE>
sales from such product integration, the level of product and price competition,
the length of the Company's sales cycle, seasonality of individual customer
buying patterns, the size and timing of individual transactions, the delay or
deferral of customer implementations, the budget cycles of the Company's
customers, the timing of new product introductions and product enhancements by
the Company and its competitors, the mix of sales by products, services and
distribution channels, levels of international sales, acquisitions by
competitors, changes in foreign currency exchange rates, the ability of the
Company to develop and market new products and control costs, and general
domestic and international economic and political conditions. Accordingly, the
Company's quarterly results are difficult to predict and revenues and net income
for any one quarter have in the past and may again fall significantly short of
anticipated levels. Additionally, a large percentage of orders for any one
quarter are usually received from customers very late in the quarter and, as a
result, the Company is not able to identify possible revenue and net income
shortfalls to any significant extent until the end of the quarter.
As a result of these factors, revenues and operating results for any
quarter are subject to variation and are not predictable with any significant
degree of accuracy. Therefore, the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as indications of future performance. Moreover, such
factors could cause the Company's operating results in a given quarter to be
below the expectations of public market analysts and investors and the price of
the Company's common stock could be materially adversely affected.
Competition The document imaging, workflow, computer output to laser
disk and document management software markets are highly competitive, and there
are certain competitors of the Company with substantially greater sales,
marketing, development and financial resources. The Company believes that the
competitive factors affecting the market for its products and services include
vendor and product reputation; product quality, performance and price; the
availability of products on multiple platforms; product scalability; product
integration with other enterprise applications; product functionality and
features; product ease of use; and the quality of customer support services and
training. The relative importance of each of these factors depends upon the
specific customer involved. While the Company believes it competes favorably in
each of these areas, there can be no assurance that it will continue to do so.
Moreover, the Company's present or future competitors may be able to develop
products comparable or superior to those offered by the Company, offer lower
price products or adapt more quickly than the Company to new technologies or
evolving customer requirements. Competition is expected to intensify. In order
to be successful in the future, the Company must respond to technological
change, customer requirements and competitors' current products and innovations.
There can be no assurance that the Company will be able to continue to compete
effectively in its market or that future competition will not have a material
adverse effect on its business, financial condition or results of operations. In
addition, current and potential competitors have established or may establish
cooperative relationships among themselves or with third parties to increase the
ability of their products to address the needs of the markets served by the
Company. Accordingly, it is possible that new competitors or alliances among
competitors may emerge and rapidly acquire significant market share. Increased
competition may result in price reductions, reduced gross margins and loss of
market share, any of which could have a material adverse effect on the Company's
business, financial condition or results of operations.
Intellectual Property and Other Proprietary Rights The Company's
success depends, in part, on its ability to protect its proprietary rights to
the technologies used in its principal products. The Company relies on a
combination of copyrights, trademarks, trade secrets, confidentiality procedures
and contractual provisions to protect its proprietary rights. There can be no
assurance that the Company's existing or future copyrights, trademarks, trade
secrets or other intellectual property rights will be of sufficient scope or
strength to provide meaningful protection or commercial advantage to the
Company. FileNET has no software patents. Also, in selling certain of its
products, the Company relies on "shrink wrap" licenses that are not signed by
licensees and, therefore, may be unenforceable under the laws of certain
jurisdictions. In addition, the laws of some foreign countries do not protect
the Company's proprietary rights to the same extent as do the laws of the United
States. There can be no assurance that such factors would not have a material
adverse effect on the Company's business, financial condition or results of
operations. In addition, the Company also relies on certain software that it
licenses from third parties, including software that is integrated with
internally developed software used in the Company's products to perform key
functions. There can be no assurance that such third parties will remain in
business, that they will continue to support their products, that their products
are, or will be, year 2000 compliant, or that their products will otherwise
continue to be available to the Company on commercially reasonable terms. The
loss or inability to maintain any of theses software licenses could result in
delays or reductions in product shipments until equivalent software can be
developed, identified, licensed and integrated, any of which could adversely
affect the Company's business, financial condition or results of operations.
The Company may, from time to time, be notified that it is infringing
certain patent or intellectual property rights of others. Combinations of
technology acquired through past or future acquisitions and the Company's
technology will create new products and technology that may give rise to claims
of infringement. While no actions other than those discussed below are currently
pending against the Company for infringement of patent or other proprietary
rights of third parties, there can be no assurance that third parties will not
initiate infringement actions against the Company in the future. Infringement
actions can result in substantial cost to, and diversion of, resources of the
Company. If the Company were found to infringe upon the rights of others, no
assurance can be given that licenses would be obtainable on acceptable terms or
8
<PAGE>
at all, that significant damages for past infringement would not be assessed or
that further litigation relative to any such licenses or usage would not occur.
The failure to successfully defend any claims or obtain necessary licenses or
other rights, the ultimate disposition of any claims or the advent of litigation
arising out of any claims of infringement, could have a material adverse effect
on the Company's business, financial condition or results of operations.
In October 1994, Wang Laboratories, Inc. (Wang) filed a complaint in
the United States District Court for the District of Massachusetts alleging that
the Company is infringing five patents held by Wang (the FileNET Case). On June
23, 1995, Wang amended its complaint to include an additional related patent. On
July 2, 1996, Wang filed a complaint in the same court alleging that Watermark
Software Inc., formerly a wholly owned subsidiary that was merged into the
Company, is infringing three of the same patents asserted in the initial
complaint (the Watermark Case). On October 9, 1996, Wang withdrew its claim in
the FileNET Case that one of the patents it initially asserted is infringed by
the Company's products that were commercialized before the initial complaint was
filed. Wang reserved the right to assert that patent against the Company's
products commercialized after that date in a separate lawsuit.
In March 1997, Eastman Kodak Company (Kodak) purchased the Wang imaging
business unit that has responsibility for this litigation. The patents in the
suit have been transferred to a Kodak subsidiary, Kodak Limited of England,
which, in turn, has exclusively licensed them to another Kodak subsidiary,
Eastman Software, Inc. in the United States (Eastman). On July 30, 1997, the
Court permitted Eastman and Kodak Limited of England to be substituted in the
litigation in place of Wang.
FileNET has moved for summary judgement on noninfringement as to each
of the five patents in the suit, and for summary judgment of invalidity as to
one of the patents. Eastman moved for summary judgment as to FileNET's
unenforceability defense on one of the patents. A trial date has not been set.
If it should be determined that the patents at issue in the litigation
are valid and are infringed by any of the Company's products, including
Watermark products, the Company will, depending on the product, redesign the
infringing products or seek to obtain a license to market the products. There
can be no assurance that the Company will be able to obtain such a license on
acceptable terms. Based on the Company's analysis of these Eastman patents and
their respective file histories, the Company believes that it has meritorious
defenses to Eastman's claims; however, the ultimate outcome or any resulting
potential loss cannot be determined at this time.
Dependence on Certain Relationships The Company has entered into a
number of co-marketing relationships with other companies such as Microsoft
Corporation, Compaq Computer Corporation, SAP AG, HP and Sun Microsystems, Inc.
There can be no assurance that these companies will not reduce or discontinue
their relationships with, or support of, the Company and its products.
Dependence on Key Management and Technical Personnel The Company's
success depends to a significant degree upon the continued contributions of its
key management, marketing, technical and operational personnel. In general, the
Company does not utilize employment agreements for its key employees. The loss
of the services of one or more key employees could have a material adverse
effect on the Company's operating results. The Company also believes its future
success will depend in large part upon its ability to attract and retain
additional highly skilled management, technical, marketing, product development
and operational personnel. Competition for such personnel, particularly
engineers and other technical personnel, is intense, and there can be no
assurance that the Company will be successful in attracting and retaining such
personnel. In addition, the Company may experience increased compensation costs
in order to attract and retain skilled personnel.
International Sales Historically, the Company has derived more than 30%
of its total revenues from international sales. Six percent of the Company's
1997 revenues were generated in the Asia-Pacific region (including 4% in
Australia). International business is subject to certain risks including varying
technical standards, tariffs and trade barriers, political and economic
instability, reduced protection for intellectual property rights in certain
countries, difficulties in staffing and maintaining foreign operations,
difficulties in managing foreign distributors, potentially adverse tax
consequences, currency exchange fluctuations, the burden of complying with a
wide variety of complex operations, foreign laws, regulations and treaties, and
the possibility of difficulties in collecting accounts receivable. In
particular, the current economic crisis in the Asia Pacific region may limit
future growth or cause a decline in international revenues. There can be no
assurance that any of these factors will not have a material adverse effect on
the Company's business, financial condition or results of operations.
Product Liability Products as complex as those sold by the Company are
susceptible to errors or failures, especially when first introduced or when new
versions are released. The Company's products are often intended for use in
applications that are critical to a customer's business. As a result, the
Company's customers may rely on the effective performance of the software to a
greater extent than the market for software products generally. The Company
conducts extensive product testing to ensure that its products are free of
significant errors and defects. In addition, the Company has designed and tested
the most current versions of its products to be year 2000 compliant. However,
some of the Company's customers are running earlier product versions that are
9
<PAGE>
not year 2000 compliant. Although the Company has been encouraging such
customers to migrate to current product versions, no assurance can be given that
all of them will do so in a timely fashion, if at all. Moreover, the Company
also relies on certain software that it licenses from third parties, including
software that is integrated with internally developed software and is used in
the Company's products to perform key functions. There can be no assurance that
such third-party software will be free of errors and defects or be year 2000
compliant in a timely fashion. Although the Company has not experienced any
material product liability claims to date, there can be no assurance that errors
or defects, whether associated with year 2000 functions or otherwise, will not
result in product liability claims against the Company in the future. The
Company's license agreements with customers typically contain provisions
designed to limit the Company's exposure to potential product liability claims;
however, it is possible that such limitation of liability pro-visions may not be
effective under the laws of certain jurisdictions. Defective products or
releases could result in loss of revenues, increased service and warranty costs
and product liability claims, and could adversely affect the Company's market
penetration and reputation, any of which could have a material adverse effect on
the Company's business, financial condition and results of operations.
Stock Price Volatility The Company believes that a variety of factors
could cause the price of its common stock to fluctuate, perhaps substantially,
including quarter-to-quarter variations in operating results; announcements of
developments related to its business; fluctuations in its order levels; general
conditions in the technology sector or the worldwide economy; announcements of
technological innovations, new products or product enhancements by the Company
or its competitors; key management changes; changes in joint marketing and
development pro-grams; developments relating to patents or other intellectual
property rights or disputes; and developments in the Company's relationships
with its customers, distributors and suppliers. In addition, in recent years,
the stock market in general, and the market for shares of high-technology stocks
in particular, has experienced extreme price fluctuations which have often been
unrelated to the operating performance of affected companies. Such fluctuations
could adversely affect the market price of the Company's common stock.
Item 2. Properties
The Company currently leases 250,000 square feet of office, development and
manufacturing space in Costa Mesa, California and 42,000 square feet of office
and development space in Bellevue, Washington. The Company also leases sales and
support offices in 34 locations in the United States, 13 in Europe, 3 in
Australia, 3 in Canada, and 4 in Asia. The Company believes that the Costa Mesa
and Bellevue facilities will be adequate for the Company's anticipated needs
through 1998.
Item 3. Legal Proceedings
In October 1994, Wang Laboratories, Inc. (Wang) filed a complaint in
the United States District Court for the District of Massachusetts alleging that
the Company is infringing five patents held by Wang (the FileNET Case). On June
23, 1995, Wang amended its complaint to include an additional related patent. On
July 2, 1996, Wang filed a complaint in the same court alleging that Watermark,
formerly a wholly-owned subsidiary that was merged into the Company, is
infringing three of the same patents asserted in the initial complaint (the
Watermark Case). On October 9, 1996, Wang withdrew its claim in the FileNET Case
that one of the patents it initially asserted is infringed by the Company's
products that were commercialized before the initial complaint was filed. Wang
reserved the right to assert that patent against the Company's products
commercialized after that date in a separate lawsuit.
In March 1997, Eastman Kodak Company (Kodak) purchased the Wang imaging
business unit that has responsibility for this litigation. The patents in the
suit have been transferred to a Kodak subsidiary, Kodak Limited of England,
which, in turn, has exclusively licensed them to another Kodak subsidiary,
Eastman Software, Inc. in the United States (Eastman). On July 30, 1997, the
Court permitted Eastman and Kodak Limited of England to be substituted in the
litigation in place of Wang.
FileNET has moved for summary judgement on noninfringement as to each
of the five patents in the suit, and for summary judgment of invalidity as to
one of the patents. Eastman moved for summary judgment as to FileNET's
unenforceability defense on one of the patents. A trial date has not been set.
If it should be determined that the patents at issue in the litigation
are valid and are infringed by any of the Company's products, including
Watermark products, the Company will, depending on the product, redesign the
infringing products or seek to obtain a license to market the products. There
can be no assurance that the Company will be able to obtain such a license on
acceptable terms. Based on the Company's analysis of these Eastman patents and
their respective file histories, the Company believes that it has meritorious
defenses to Eastman's claims; however, the ultimate outcome or any resulting
potential loss cannot be determined at this time.
On December 20, 1996, plaintiff Michael I. Goldman (the Plaintiff) filed a
class action complaint against the Company and certain of its officers and
directors in the Superior Court of California, County of Orange (the State
10
<PAGE>
Action). The action was purportedly filed on behalf of a class of purchasers of
the Company's common stock during the period October 19, 1995 through July 2,
1996. The Plaintiff alleges that the Company and other defendants violated Cal.
Corp. Code ss.ss. 25400 and 25500, Cal. Civ. Code ss.ss. 1709-1710 and Cal. Bus.
& Prof. Code ss.ss. 17200 et seq. in connection with various public statements
made by the Company and certain of its officers and directors during the
putative class period. The complaint seeks unspecified compensatory and punitive
damages, interest, payment of attorney's fees and costs, and equitable or
injunctive relief.
On April 1, 1997, The Plaintiff filed another class action complaint
against the Company and certain of its officers and directors in the United
States District Court for the Central District of California (the Federal
Action). The action purportedly was filed on behalf of the same class of
purchasers of the Company's common stock as the State Action. The allegations
contained in the Federal Action are very similar to the allegations contained in
the State Action, except that the Federal Action asserts claims under Sections
10(b) and 20(a) of the Securities Exchange Act and Rule 10b-5. The complaint
seeks unspecified compensatory damages, interest, attorneys' fees, expert
witness fees, costs and equitable or injunctive relief. On July 2, 1997, the
court granted plaintiff's motion to be appointed "lead plaintiff" under the
Private Securities Litigation Reform Act.
In the Federal Action, defendants have filed a motion to dismiss the
complaint in its entirety. Plaintiff has filed a motion to stay the Federal
Action, in light of the parallel State Action. The court is scheduled to hear
both of these motions during April 1998.
In the State Action, defendants moved to stay the action, in light of the
parallel Federal Action. The trial court granted the motion to stay the action
as to discovery on September 8, 1997. Defendants also demurred and moved to
strike the complaint. The trial court overruled the demurrer and denied the
motion to strike on October 21, 1997. On January 14, 1998, the court entered an
order dismissing with prejudice two of plaintiff's three causes of action: the
claims under Cal. Civ. Code ss.ss. 1709-1710 and Cal. Bus. & Prof. Code ss.ss.
17200 et seq.
On January 30, 1998, the trial court in the State Action granted the
Plaintiff's motion to certify a class composed of persons who bought FileNET
stock in California only between October 19, 1995 and July 2, 1996. This ruling
is subject to revision based on the decisions to be rendered by the California
Supreme Court in Diamond Multimedia Systems, et al. v. Superior Court (Pass) and
StorMedia, Inc., et al. v. Superior Court (Werczberger). The trial court also
denied the Plaintiff's motion to lift the discovery stay.
The Company believes that all of the allegations contained in the
complaints filed in the State and Federal Actions are without merit and intends
to defend the actions vigorously.
The Company, in the normal course of business, is subject to various
other legal matters. While the results of litigation and claims cannot be
predicted with certainty, the Company believes that the final outcome of these
other matters will not have a materially adverse effect on the Company's
consolidated results of operations or financial condition.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters
There is hereby incorporated herein by reference the information appearing
under the caption "Stock Market and Dividend Information," which appears on page
42 of the Registrant's Annual Report to Stockholders for the year ended December
31, 1997 and is filed herewith as Exhibit 13.1.
11
<PAGE>
Item 6. Selected Financial Data
The following table summarizes certain selected financial data:
<TABLE>
<CAPTION>
For Fiscal Years Ended
--------------------------------------------------------------------------------------
Dec. 31, 1997 Dec. 31, 1996 Dec. 31, 1995 Jan. 1, 1995 Jan. 2, 1994
(1997) (1996) (1995) (1994) (1993)
-------------- --------------- ---------------- ------------- -------------
(In thousands, except per share amounts)
Consolidated statements of operations data:
<S> <C> <C> <C> <C> <C>
Revenue:
Software revenue $132,723 $140,659 $116,052 $ 81,102 $ 54,067
Service revenue 89,280 82,118 67,174 60,753 60,933
Hardware revenue 29,422 46,136 46,152 50,480 51,410
------------ ---------- ---------- ---------- ----------
Total revenue 251,425 268,913 229,378 192,335 166,410
Costs and expenses:
Cost of software revenue 14,768 16,464 15,146 12,472 7,831
Cost of service revenue 56,503 53,568 44,277 41,645 42,812
Cost of hardware revenue 20,330 29,633 28,800 30,999 34,116
Research and development 39,575 36,502 24,711 18,274 15,247
Selling, general and administrative 125,122 117,761 96,499 71,267 61,711
Merger, restructuring, write-off of
purchased in-process research and
development and other costs 6,000 16,011 6,393 0 0
------------ ---------- ---------- ---------- ----------
Total costs and expenses 262,298 269,939 215,826 174,657 161,717
------------ ---------- ---------- ---------- ----------
Operating income (loss) (10,873) (1,026) 13,552 17,678 4,693
Other income, net 3,160 2,838 2,780 1,821 333
------------- ---------- ---------- ---------- ----------
Income (loss) before income taxes (7,713) 1,812 16,332 19,499 5,026
Provision (benefit) for income taxes (2,187) 4,456 8,116 5,356 4,760
------------- ----------- ---------- ----------- ----------
Net income (loss) $ (5,526) $ (2,644) $ 8,216 $ 14,143 $ 266
============= =========== ========== =========== ==========
Basic earnings (loss) per share $ (0.36) $ (0.18) $ 0.57 $ 1.04 $ 0.02
Diluted earnings (loss) per share $ (0.36) $ (0.18) $ 0.52 $ 0.95 $ 0.02
Weighted average shares outstanding - basic
15,155 15,007 14,430 13,661 12,567
Weighted average shares outstanding -
diluted 15,155 15,007 15,856 14,834 13,178
Consolidated balance sheet data:
Working capital $ 82,887 $ 89,339 $ 86,354 $ 63,149 $ 47,819
Total assets 179,870 195,679 189,682 152,642 124,986
Long-term debt, excluding current portion 163
Stockholders' equity 118,811 132,806 131,158 101,006 78,383
Certain reclassifications have been made to the prior years' selected
financial data to conform with the current year's presentation.
</TABLE>
12
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
There is hereby incorporated herein by reference the information appearing under
the caption "Management's Discussion and Analysis of Financial Condition and
Results of Operations," which appears on pages 18 through 24 of the Registrant's
Annual Report to Stockholders for the year ended December 31, 1997 and is filed
herewith as Exhibit 13.2.
Item 8. Financial Statements and Supplementary Data
There is hereby incorporated herein by reference the information appearing on
pages 25 through 40 of the Registrant's Annual Report to Stockholders for the
year ended December 31, 1997 and is filed herewith as Exhibit 13.3. The
accompanying Independent Auditors' Report is also incorporated herein by
reference and filed herewith as Exhibit 13.3.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
There is hereby incorporated herein by reference the information appearing under
the caption "Election of Directors," under the caption "Executive Officers of
the Company," and under the caption "Compliance with Securities Laws" of the
Registrant's definitive Proxy Statement for its 1998 Annual Meeting to be filed
with the Securities and Exchange Commission.
Item 11. Executive Compensation
There is hereby incorporated herein by reference the information appearing under
the caption "Executive Compensation" and under the caption "Election of
Directors" of the Registrant's definitive Proxy Statement for its 1998 Annual
Meeting to be filed with the Securities and Exchange Commission.
Item 12. Security Ownership of Certain Beneficial Owners and Management
There is hereby incorporated herein by reference the information appearing under
the caption "Voting Securities and Principal Holders Thereof" of the
Registrant's definitive Proxy Statement for its 1998 Annual Meeting to be filed
with the Securities and Exchange Commission.
Item 13. Certain Relationships and Related Transactions
There is hereby incorporated herein by reference the information appearing under
the caption "Note 12: Related Party Transactions," which appears on page 39 of
the Registrant's Annual Report to Stockholders for the year ended December 31,
1997 and is filed herewith as Exhibit 13.4.
13
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K
(a) Financial statements
1. The list of financial statements contained in the accompanying
Index to Consolidated Financial Statements covered by the
Independent Auditors' Report is herein incorporated by
reference.
2. Financial statement schedule
The listed financial statement schedule contained in the
accompanying Index to Consolidated Financial Statements
covered by the Independent Auditors' Report is herein
incorporated by reference.
3. Exhibits
The list of exhibits contained in the accompanying Index to
Exhibits is herein incorporated by reference.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of 1997.
Index to Consolidated Financial Statements Covered
by Independent Auditors' Report
Item 14(a) (1) and (2)
<TABLE>
<CAPTION>
Page Reference
--------------------------
1997 Annual
Report to
Form 10-K Stockholders
The information under the following captions, which is included in the 1997
Annual Report to Stockholders, is incorporated herein by reference:
<S> <C> <C>
Independent Auditors' Report 40
Consolidated balance sheets at December 31, 1997 and December 31, 1996 25
Consolidated statements of operations for each of the years ended December
31, 1997, 1996 and 1995 26
Consolidated statements of stockholders' equity for each of the years ended
December 31, 1997, 1996 and 1995 27
Consolidated statements of cash flows for each of the years ended December
31, 1997, 1996 and 1995 28
Notes to consolidated financial statements 29
Independent Auditors' Report on Schedule 15
Schedule for each of the three years ended December 31, 1997, 1996
and 1995
II. Valuation and qualifying accounts and reserves 16
</TABLE>
14
<PAGE>
INDEPENDENT AUDITORS' REPORT ON SCHEDULE
To the Stockholders and the Board of Directors
FileNET Corporation
Costa Mesa, California
We have audited the consolidated financial statements of FileNET Corporation and
its subsidiaries as of December 31, 1997 and 1996 and for each of the three
years in the period ended December 31, 1997, and have issued our report thereon
dated February 3, 1998. Such consolidated financial statements and report are
included in your 1997 Annual Report to Stockholders and are incorporated herein
by reference. Our audits also included the financial statement schedule of
FileNET Corporation and its subsidiaries, listed in Item 14. The consolidated
financial statement schedule is the responsibility of the Company's management.
Our responsibility is to express an opinion based on our audits. In our opinion,
such consolidated financial statement schedule, when considered in relation to
the basic consolidated financial statements taken as a whole, presents fairly,
in all material respects, the information set forth therein.
/s/ Deloitte & Touche LLP
February 3, 1998
Costa Mesa, California
15
<PAGE>
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
($ in thousands)
<TABLE>
<CAPTION>
Balance at Additions -
Beginning of Charged to Costs Balance at End
Description Period and Expenses Deductions of Period
- ----------------------------------------- ---------------- -------------------- --------------- ----------------
<S> <C> <C> <C> <C>
Year ended December 31, 1997:
Inventory reserves $ 660 $ 380 $ 710 (1) $ 330
Allowance for doubtful accounts 2,140 350 800 (2) 1,690
Reserve for returned systems 3,185 460 (3) 2,725
Year ended December 31, 1996:
Inventory reserves 573 635 548 (1) 660
Allowance for doubtful accounts 1,540 1,205 605 (2) 2,140
Reserve for returned systems 3,153 32 3,185
Year ended December 31, 1995:
Inventory reserves 651 482 560 (1) 573
Allowance for doubtful accounts 731 857 48 (2) 1,540
Reserve for returned systems 2,747 869 463 (3) 3,153
</TABLE>
- --------------------------
(1) Consists primarily of the write-off of excess/obsolete inventories.
(2) Consists primarily of uncollectible invoice amounts.
(3) Consists primarily of returned systems.
16
<PAGE>
Index to Exhibits
Exhibit
No. Description
- ----- ----------------------------------------------------------------------
3.1* Restated Certificate of Incorporation, as amended(filed as Exhibit 3.1
to Form S-4 filed on January 26, 1996; Registration No.333-00676).
3.1.1* Certificate of Amendment of Restated Certificate of Incorporation
(filed as Exhibit 3.1.1 to Form S-4 filed on January 26, 1996,
Registration No. 333-00676).
3.2* Bylaws (filed as Exhibit 3.2 of the Registrant's registration
statement on Form S-1, Registration No. 33-15004 (the "Form S-1")).
4.1* Form of certificate evidencing Common Stock (filed as Exhibit 4.1 to
the Form S-1, Registration No. 33-15004).
4.2* Rights Agreement, dated as of November 4, 1988 between FileNET
Corporation and the First National Bank of Boston, which includes
the form of Rights Certificate as Exhibit A and the Summary of
Rights to Purchase Common Shares as Exhibit B (filed as Exhibit 4.2
to Form S-4 filed on January 26, 1996; Registration No. 333-00676).
10.1* Second Amended and Restated Credit Agreement (Multicurrency) by and
among the Registrant and Bank of America National Trust and Savings
Association dated June 25, 1997, effective June 1, 1997 (filed as
Exhibit 10.1 to Form 10-Q for the quarter ended June 30, 1997).
10.2* Business Alliance Program Agreement between the Registrant and Oracle
Corporation dated July 1, 1996, as amended by Amendment One thereto
(filed as Exhibit 10.4 to Form 10-QA for the quarter ended June 30,
1996).
10.3* Runtime Sublicense Addendum between the Registrant and Oracle
Corporation dated July 1, 1996, as amended by Amendment One thereto
(filed as Exhibit 10.4 to Form 10-QA for the quarter ended June 30,
1996).
10.4* Full Use and Deployment Sublicense Addendum between the Registrant and
Oracle Corporation dated July 1, 1996, as amended by Amendment One
thereto (filed as Exhibit 10.4 to Form 10-QA for the quarter ended
June 30, 1996).
10.5* Lease between the Registrant and C. J. Segerstrom & Sons for the
headquarters of the Company, dated April 30, 1987 (filed as Exhibit
10.19 to the Form S-1).
10.6* Third Amendment to the Lease between the Registrant and C.J.
Segerstrom & Sons dated April 30, 1987, for additional facilities at
the headquarters of the Company, dated October 1, 1992 (filed as
exhibit 10.7 to Form 10-K filed on April 4, 1997).
10.7* Fifth Amendment to the Lease between the Registrant and C.J.Segerstrom
& Sons dated April 30, 1987, for the extension of the term of the
lease, dated March 28, 1997 (filed as exhibit 10.8 to Form 10-Q for
the quarter ended March 31, 1997).
10.8* 1989 Stock Option Plan for Non-Employee Directors of FileNET
Corporation, as amended by the First Amendment, Second Amendment,
Third Amendment thereto (filed as Exhibit 10.9 to Form S-4 filed on
January 26, 1996; Registration No. 333-00676).
10.9* Amended and Restated 1995 Stock Option Plan of FileNET Corporation as
approved by stockholders at the Registrant's Annual Meeting on May 8,
1996 (filed as Exhibit 99.1 to Form S-8 filed on July 29, 1996).
10.10* Second Amended and Restated Stock Option Plan of FileNET Corporation,
together with the forms of Incentive Stock Option Agreement and
Non-Qualified Stock Option Agreements (filed as Exhibits 4(a), 4(b)and
4(c), respectively, to the Registrant's Registration Statement on Form
S-8, Registration No. 33-48499), and an Amendment thereto (filed as
Exhibit 4(d) to the Registrant's Registration Statement on Form S-8,
Registration No. 33-69920), and the Second Amendment thereto (filed as
Appendix A to the Registrant's Proxy Statement for the Registrant's
1994 Annual Meeting of Stockholders, filed on April 29, 1994).
- --------------------------------------------
* Incorporated herein by reference
17
<PAGE>
Exhibit
No. Description
- -------- ----------------------------------------------------------------------
10.11* Non-Statutory Stock Option Agreement (with Notice of Grant of Stock
Option and Special Addendum) between Registrant and Mr. Lee Roberts
(filed as exhibit 99.17 to Form S-8 on August 20, 1997).
10.12* Non-Statutory Stock Option Agreement (with Notice of Grant of Stock
Option and Special Addendum) between Registrant and Mr. Ron Ercanbrack
(filed as exhibit 99.19 to Form S-8 on August 20, 1997).
10.13* Agreement for the Purchase of IBM products dated December 20, 1991
(filed on May 5, 1992 with the Form 8 amending the Company's Form 10-K
for the fiscal year ended December 31, 1991).
10.14* Amendment #A1011-941003-01 dated September 30, 1994, to the Agreement
for the Purchase of IBM products dated December 20, 1991 (filed as
exhibit 10.12 to form 10-K for the fiscal year ended December 31,
1996).
10.15* Development and Initial Supply Agreement between the Registrant and
Quintar Company dated August 20, 1992 (filed as Exhibit 10.21 to Form
10-K for the year ended January 3, 1993).
10.16* Amendment dated December 22, 1992 to the Development and Initial
Supply Agreement between the Registrant and Quintar Company dated
August 20, 1992 (filed as Exhibit 10.22 to Form 10-K for the year
ended January 3, 1993).
10.17* Product License Agreement between the Registrant and Novell, Inc.
dated May 16, 1995 (filed as Exhibit 10.26 to Form 10-Q for the
quarter ended July 2, 1995).
10.18* Agreement and Plan of Merger between the Registrant and Watermark
Software Inc. dated July 18, 1995 (filed as Exhibit 10.27 to Form 10-Q
for the quarter ended July 2, 1995).
10.19* Agreement and Plan of Merger between the Registrant and Saros
Corporation, as amended, dated January 17, 1996 (filed as Exhibits
2.1, 2.2, 2.3, and 2.4 to Form 8-K on March 13, 1996).
10.20* Stock Purchase Agreement by and Among FileNET Corporation, IFS
Acquisition Corporation, Jawaid Khan and Juergen Goersch dated January
17, 1996 and Amendment 1 to Stock Purchase Agreement dated January 30,
1996 (filed as Exhibit 10.2 to form 10-K for the year ended December
31, 1995).
13.1 Market for the Registrant's Common Stock and Related Stockholder
Matters incorporated by reference to page 42 of the 1997 Annual
Report.
13.2 Management's Discussion and Analysis of Financial Condition and
Results of Operations incorporated by reference to pages 18 through 24
of the 1997 Annual Report.
13.3 Financial Statements incorporated by reference to pages 25 through 40
of the 1997 Annual Report.
13.4 Certain Relationships and Related Transactions incorporated by
reference to page 12 of the 1997 Annual Report.
21.1 List of subsidiaries of Registrant (filed as FileNET Corporation
Subsidiary Information). 23.1 Consent of Deloitte & Touche LLP
(filed as Independent Auditors' Consent).
27 Financial Data Schedule.
- ---------------------------------------------
* Incorporated herein by reference
18
<PAGE>
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FILENET CORPORATION
Date: March 30, 1998 By: /s/ T. J. Smith
------- -----------------------------------
T. J. Smith
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Date: March 30, 1998 By: /s/ T. J. Smith
------- --------------------------------------
T. J. Smith
Chief Executive Officer
(Principal Executive Officer)
Director
Date: March 30, 1998 By: /s/ Lee D. Roberts
------- -------------------------------------
Lee D. Roberts
President and
Chief Operating Officer
Date: March 30, 1998 By: /s/ Mark S. St. Clare
------- -------------------------------------
Mark S. St. Clare
Chief Financial Officer and
Sr. Vice President, Finance
(Principal Financial Officer)
Date: March 30, 1998 By: /s/ Lee M. Kim
------- -------------------------------------
Lee M. Kim
Controller and
Chief Accounting Officer
Date: March 30, 1998 By: /s/ Frederick K. Fluegel
------- -------------------------------------
Frederick K. Fluegel
Director
Date: March 30, 1998 By: /s/ John C. Savage
------- -------------------------------------
John C. Savage
Director
Date: March 30, 1998 By: /s/ William P. Lyons
------- -------------------------------------
William P. Lyons
Director
19
Stock Market and Dividend Information
The Company's common stock is traded in the National Market System (NASDAQ)
under the symbol FILE. The following are the high and low closing prices from
January 2, 1995 through December 31, 1997, as reported by NASDAQ:
High Low
---- ---
1997
4th Quarter $32.63 $16.13
3rd Quarter 20.13 15.50
2nd Quarter 16.63 10.31
1st Quarter 31.75 15.50
1996
4th Quarter $36.13 $26.00
3rd Quarter 35.00 20.63
2nd Quarter 57.88 33.25
1st Quarter 65.25 40.75
1995
4th Quarter $48.75 $38.50
3rd Quarter 50.25 40.25
2nd Quarter 40.38 31.00
1st Quarter 35.50 26.00
The closing price of the Company's common stock on December 31, 1997 was $30.13.
The approximate number of stockholders of record on February 23, 1998, was 838;
the closing price of the Company's common stock on this date was $31.34.
The Company has not paid any dividends on its common stock. The Company
currently intends to retain earnings for use in its business and does not
anticipate paying cash dividends in the foreseeable future. The Company's
ability to pay dividends is limited by the terms of its line of credit
agreement.
42
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Results of Operations The following discussion should be read in
conjunction with the Consolidated Financial Statements and Notes thereto
contained elsewhere in this Annual Report.
Revenue (Dollars in millions)
Percent Percent
1997 change 1996 change 1995
---- ------ ---- ------ ----
Software revenue
Domestic $ 89.7 2% $ 87.6 12% $ 77.9
International 43.0 (19%) 53.1 39% 38.2
---- --- ---- -- ----
Total software revenue $132.7 (6%) $140.7 21% $116.1
Percentage of total revenue 53% 52% 51%
Service revenue
Domestic $ 68.0 11% $ 61.4 29% $ 47.5
International 21.3 3% 20.7 5% 19.7
---- - ---- - ----
Total service revenue $ 89.3 9% $ 82.1 22% $ 67.2
Percentage of total revenue 36% 31% 29%
Hardware revenue
Domestic $ 20.4 (28%) $ 28.3 3% $ 27.4
International 9.0 (49%) 17.8 (5%) 18.7
--- --- ---- -- ----
Total hardware revenue $ 29.4 (36%) $ 46.1 -- $ 46.1
Percentage of total revenue 12% 17% 20%
-- -- --
Total revenue $251.4 (7%) $268.9 17% $229.4
====== == ====== == ======
Software revenue from the licensing of the Company's software products
decreased 6% in 1997 due to a decrease in new domestic orders during the first
quarter of 1997 and a decrease in new international orders for the year, offset
by increased demand experienced domestically during the third and fourth
quarters. The 21% increase in 1996 is attributable to an increase in the volume
of product shipments from the addition of new products and reselling partners
and additional revenue generated through the Company's co-marketing arrangement
with Hewlett-Packard Company (HP). The Company believes software revenue growth
rates for 1997 and 1996 were negatively impacted by difficulties experienced
with integrating the Saros Corporation (Saros) and Watermark Software Inc.
(Watermark) sales organizations into FileNET's sales organization.
Service revenue consists of revenue from software maintenance services,
professional services, training, repairs and supplies. Service revenue increased
9% in 1997 due to an increase in the customer installed base, offset by a
decrease in international professional services revenue and the decrease in
revenue related to the sale and repair of spare parts to HP noted below. The 22%
increase in 1996 was due to the growth of the Company's customer installed base,
an increase in training due primarily to the training of new resellers, and the
recognition of $7.6 million of revenue from the sale and repair of spare parts
in connection with the continued transition of hardware maintenance activities
to HP. There were no such sales in 1995.
Hardware revenue is generated primarily from the sale of 12-inch optical
storage and retrieval libraries (OSAR) and third-party hardware. Hardware
revenue decreased 36% in 1997 due to a decrease in new orders experienced both
domestically and internationally, attributable to the Company's focus on
increasing its higher margin software revenue. The Company expects hardware
revenue to continue to decline in both absolute dollars and as a percentage of
total revenue as it continues to transition its business toward software-related
revenue.
18
<PAGE>
Domestic revenues remained flat in 1997 compared to an increase of $24.5
million, or 16%, in 1996 due to the decrease in hardware revenue noted above and
slower software growth. International revenue decreased $18.3 million, or 20%,
compared with an increase of $15.0 mil-lion, or 20%, in 1996. The decrease in
international revenue in 1997 from 1996 was due to a weakness in European orders
and, to a lesser extent, the strengthening of the U.S. dollar. The increase in
1996 was due to continued growth of software and service revenue offset by the
anticipated decrease in hardware revenue. International revenue as a percentage
of total revenue decreased to 30% in 1997 from 34% in 1996 and 33% in 1995. The
decrease in 1997 is due to the decrease in international revenues noted above.
In the future, the Company expects inter-national revenue to continue to
represent a significant percentage of total revenue as it continues to expand
its operations internationally. However, the current economic crisis in the
Asia-Pacific region could adversely affect international sales. In addition,
international revenues could be adversely affected if the U.S. dollar
strengthens against international currencies.
Cost of Revenue (Dollars in millions)
Percent Percent
1997 change 1996 change 1995
---- ------ ---- ------ ----
Cost of software revenue $14.8 (10%) $16.5 9% $15.1
Percentage of software revenue 11% 12% 13%
Cost of service revenue $56.5 5% $53.6 21% $44.3
Percentage of service revenue 63% 65% 66%
Cost of hardware revenue $20.3 (31%) $29.6 3% $28.8
Percentage of hardware revenue 69% 64% 62%
-- -- --
Cost of total revenue $91.6 (8%) $99.7 13% $88.2
===== == ===== == =====
The cost of software revenue includes royalties paid to third parties and
the cost of software distribution. The cost of software revenue as a percentage
of software revenue decreased to 11% in 1997 from 12% in 1996 and 13% in 1995.
The decrease in 1997 is due to savings related to the consolidation of software
distribution activities. The decrease in 1996 was due to a decrease in the
amount of capitalized software amortized in 1996 and savings related to the
consolidation of software distribution activities.
The cost of service revenue includes software support and professional
services personnel, supplies, and the cost of third-party hardware maintenance.
The cost of service revenue as a percentage of service revenue decreased to 63%
in 1997 from 65% in 1996 and 66% in 1995. The decreases are primarily due to the
transition of hardware maintenance to HP, offset by lower margins associated
with international maintenance.
The cost of hardware revenue includes the Company's cost of OSAR
manufacturing, third-party purchased hardware and the cost of hardware
integration personnel. The cost of hardware revenue as a percentage of hardware
revenue increased to 69% in 1997 from 64% in 1996 and 62% in 1995. The increase
in 1997 is due to a decrease in hardware revenue without a corresponding
decrease in fixed costs related to the Company's hardware manufacturing and
integration activities. The increase in 1996 was due to a less favorable mix
from the Company's OSAR product line and lower margins from third-party
purchased equipment.
Research and Development and Selling, General and Administrative Expenses
(Dollars in millions)
Percent Percent
1997 change 1996 change 1995
---- ------ ---- ------ ----
Research and development $ 39.6 8% $ 36.5 48% $24.7
Percentage of total revenue 16% 14% 11%
Selling, general and administrative $125.1 6% $117.8 22% $96.5
Percentage of total revenue 50% 44% 42%
19
<PAGE>
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Research and development expenses increased 8% in 1997 primarily due to a
general increase in salaries. The 48% increase in 1996 was due to the addition
of development personnel and the related facilities and depreciation expenses to
fund new development activities. Research and development expense in 1995 is
after capitalized software development costs of $1.6 million.
As a percentage of total revenue, research and development expenses
increased to 16% in 1997 from 14% in 1996 and 11% in 1995. The increase in 1997
is due to the decrease in revenue compounded by the increased level of spending.
The increase in 1996 was due to the increase in research and development
personnel to sup-port new development activities without corresponding revenue
growth and a decrease in the amount of capitalized software development costs.
The Company expects that competition for qualified technical personnel will
remain intense for the foreseeable future and may result in higher levels of
compensation expense for the Company. The Company believes that research and
development expenditures, including compensation of technical personnel, are
essential to maintaining its competitive position and expects these costs to
continue to constitute a significant percentage of revenue.
Selling, general and administrative expenses increased 6% in 1997 and 22%
in 1996. The increase in 1997 was due primarily to the Company's continued
international expansion and higher legal costs (see Note 11 of Notes to
Consolidated Financial Statements for a description of legal proceedings). The
increase in 1996 was due primarily to an increase in the number of marketing and
sales support personnel employed internationally as the Company expanded its
international reseller and sales operations and to an increase in commissions
associated with higher revenues. In 1997, selling, general and administrative
expenses as a percentage of total revenue increased to 50% from 44% in 1996 and
42% in 1995 primarily due to increasing expense levels without a corresponding
increase in revenues.
Merger, Restructuring, Write-off of Purchased In-process Research and
Development and Other Costs The $6.0 million in restructuring and other charges
in 1997 represents the costs of consolidating the Watermark business unit's
Burlington, Massachusetts engineering and marketing functions with those at
FileNET's Costa Mesa, California location, as well as a reduction in headcount
in certain other areas of the Company. The restructuring and other charges
include approximately $1.9 million for severance payments for 111 employees,
$2.2 million for the write-off of impaired assets, $0.4 million for facility
closing costs and $1.5 million of other charges.
The $16.0 million merger, restructuring and write-off of purchased
in-process research and development costs in 1996 consisted of $10.0 million for
the write-off of purchased in-process research and development costs related to
the International Financial Systems Ltd. (IFSL) acquisition, $4.2 million in
merger costs related to the Saros acquisition, and $1.8 million in restructuring
costs related to the Saros and Watermark acquisitions. The restructuring charges
represent the costs of consolidating the various companies' sales and
administrative functions and include $1.4 million for severance payments for 30
employees and $0.4 million for the write-off of certain contractual obligations
and other costs.
The $6.4 million merger, restructuring and write-off of purchased
in-process research and development costs in 1995 consisted of a charge for the
buyout of certain Watermark European marketing and manufacturing rights, a
write-off of capitalized research and development expenses for FileNET projects
made redundant by the Watermark acquisition and other direct acquisition-related
fees and expenses.
At December 31, 1997, accrued restructuring and other charges of $3.0
million are included in other accrued liabilities. The Company anticipates that
the remaining restructuring costs will be expended during 1998.
Other Income Other income, net of other expenses, was $3.2 million in 1997
and $2.8 million in both 1996 and 1995. The increase in 1997 is primarily due to
increased interest income on a higher balance of cash and marketable securities.
Provision for Income Taxes The provision for income taxes was a benefit of
$2.2 million in 1997, compared to charges of $4.5 million and $8.1 million
recorded in 1996 and 1995, respectively. The 1997 effective tax rate was (28%).
The Company's 1996 effective tax rate is not meaningful, as the 1996 provision
was impacted by the write-off of purchased in-process research and development
as part of the acquisition of IFSL, with no corresponding tax benefit,
nondeductible costs associated with the Saros merger and earnings generated in
certain international jurisdictions, partially offset by the benefit of tax
losses incurred in the United States. The Company's effective tax rate was 50%
in 1995.
The Company currently anticipates that its effective tax rate for 1998 will
be approximately 30%. However, the actual tax rate may differ due to a variety
of factors including the geographical mix of revenues and the ability to use
certain deferred tax assets.
20
<PAGE>
Foreign Currency Fluctuations and Inflation The Company's performance can
be affected by changes in foreign currency values relative to the U.S. dollar,
as discussed above, in relation to the Company's revenue and operating expenses.
The impact to net income from foreign exchange transactions and hedging
activities is immaterial for all periods reported. The foreign currency
translation adjustment included in stockholders' equity decreased $5.8 million
during 1997 over 1996 due primarily to the weakness of the Irish currency
against the U.S. dollar applied to the Company's net assets in Ireland.
Management believes that inflation has not had a significant impact on the
prices of the Company's products, the cost of its materials, or its operating
results during 1995 through 1997.
Financial Condition
Liquidity and Capital Resources As of December 31, 1997, combined cash,
cash equivalents, and marketable securities (short and long-term) were $71.8
million, an increase of $4.5 million from the $67.3 million at the end of 1996.
Cash provided by operating activities in 1997 was $24.8 million. Cash used
by the net loss for the year was offset by lower accounts receivable balances
associated with a lower average days sales outstanding, lower inventories
associated with the Company's decrease in hardware revenue and additions to net
income for depreciation and amortization. Cash used by investing activities
totaled $11.3 million, consisting of capital expenditures offset by the net sale
and maturity of marketable securities. Cash used by financing activities was
$2.6 million and was the result of the repurchase of common stock offset by
proceeds from the issuance of common stock in connection with the exercise of
employee stock options and the employee stock purchase plan.
Cash used by operating activities in 1996 was $1.8 million. The balance is
primarily due to a net loss and the effect of higher accounts receivable
balances associated with higher revenue and higher average days sales
outstanding, offset in part by the non-cash additions to net income for
write-off of capitalized and purchased in-process research and development
costs, depreciation and amortization of capitalized software. Cash used by
investing activities totaled $16.7 million, consisting of capital expenditures
and the purchase of IFSL, offset by proceeds from the sale of equipment and the
net sale and maturity of marketable securities. Net cash provided by financing
activities was $2.6 million and was the result of proceeds from the issuance of
common stock and stock option income tax benefits, offset by the repurchase of
common stock.
The Company's capital expenditures were $14.3 million in 1997, $17.9
million in 1996, and $14.7 million in 1995. The Company's primary capital
equipment expenditures are for research and development, demonstration and
training equipment and enhancements to its internal business systems. The
Company anticipates that it will acquire approximately $18.0 million of capital
equipment in 1998. During the first quarter of 1998, the Company repurchased
$4.4 million of its common stock, thereby completing its previously announced
$10 million stock repurchase program. The Company anticipates that its present
cash balances, together with internally-generated funds and credit lines, will
be sufficient to meet its working capital and capital expenditure needs
throughout 1998.
Other Matters
Year 2000 The Company is assessing the internal readiness of its computer
systems for handling the year 2000. The Company expects to implement
successfully the systems and programming changes necessary to address year 2000
issues with respect to its internal systems and does not believe that the cost
of such actions will have a material adverse effect on its financial condition
or results of operations. Although the Company is not aware of any material
operational issues or costs associated with preparing its internal systems for
the year 2000, there can be no assurance that there will not be a delay in, or
increased costs associated with, the implementation of the necessary systems and
changes to address the year 2000 issues, and the Company's inability to
implement such systems and changes could have an adverse effect on future
results of operations.
Recent Accounting Pronouncements In 1997, SFAS No. 130, "Reporting
Comprehensive Income" and SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," were issued and are effective for fiscal
years beginning after December 15, 1997. In October 1997, the AICPA issued SOP
97-2, "Software Revenue Recognition," which supersedes SOP 91-1. The provisions
of SOP 97-2 are effective for fiscal years beginning after December 15, 1997.
The Company is reviewing the impact of these pronouncements on its financial
statements.
Environmental Matters The Company is not aware of any issues related to
environmental matters that have, or are expected to materially affect its
business.
21
<PAGE>
Management's Discussion and Analysis of Financial Condition and
Results of Operations
Certain Considerations
This Annual Report contains forward-looking statements that involve risks
and uncertainties, including those discussed below and in the Notes to
Consolidated Financial Statements. The actual results that the Company achieves
may differ materially from any forward-looking statements, which reflect
management's opinions only as of the date hereof. The Company undertakes no
obligation to revise or publicly release the results of any revisions to these
forward-looking statements. Readers should carefully review the factors
described below and in other documents the Company files from time to time with
the Securities and Exchange Commission, including its Annual Report on Form 10-K
for 1997 and the Quarterly Reports on Form 10-Q to be filed by the Company in
1998. Factors that may affect the Company's business, financial condition and
results of operations include:
Rapid Technological Change; Product Development The market for the
Company's products is characterized by rapid technological developments,
evolving industry standards, changes in customer requirements and frequent new
product introductions and enhancements. The Company's success will be dependent
upon its ability to enhance its existing products, develop and introduce, in a
timely manner, new products incorporating technological advances and respond to
customer requirements. Specifically, the Company has announced plans to deliver
a new range of desktop software products providing integrated document
management capability for existing and new users. To the extent one or more of
the Company's competitors introduce products that more fully address customer
requirements, the Company's business could be adversely affected. There can be
no assurance that the Company will be successful in developing and marketing
enhancements to its existing products or new products on a timely basis or that
any new or enhanced products will adequately address the changing needs of the
market-place. If the Company is unable to develop and introduce new products or
enhancements to existing products in a timely manner in response to changing
market conditions or customer requirements, the Company's business, financial
condition or results of operations could be adversely affected. From time to
time, the Company or its competitors may announce new products, capabilities or
technologies that have the potential to replace or shorten the life cycles of
the Company's existing products. There can be no assurance that such
announcements will not cause customers to delay their purchasing decisions in
anticipation of such products, resulting in a material adverse effect on the
Company's business, financial condition or results of operations.
Uncertainty of Future Operating Results; Fluctuations in Quarterly
Operating Results Future operating results will depend upon many factors,
including the demand for the Company's products, the effectiveness of the
Company's efforts to continue to integrate various products it has developed or
acquired through acquisition of others and to achieve the desired levels of
sales from such product integration, the level of product and price competition,
the length of the Company's sales cycle, seasonality of individual customer
buying patterns, the size and timing of individual transactions, the delay or
deferral of customer implementations, the budget cycles of the Company's
customers, the timing of new product introductions and product enhancements by
the Company and its competitors, the mix of sales by products, services and
distribution channels, levels of international sales, acquisitions by
competitors, changes in foreign currency exchange rates, the ability of the
Company to develop and market new products and control costs, and general
domestic and international economic and political conditions. Accordingly, the
Company's quarterly results are difficult to predict and revenues and net income
for any one quarter have in the past and may again fall significantly short of
anticipated levels. Additionally, a large percentage of orders for any one
quarter are usually received from customers very late in the quarter and, as a
result, the Company is not able to identify possible revenue and net income
shortfalls to any significant extent until the end of the quarter.
As a result of these factors, revenues and operating results for any
quarter are subject to variation and are not predictable with any significant
degree of accuracy. Therefore, the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as indications of future performance. Moreover, such
factors could cause the Company's operating results in a given quarter to be
below the expectations of public market analysts and investors and the price of
the Company's common stock could be materially adversely affected.
Competition The document imaging, workflow, computer output to laser disk
and document management software markets are highly competitive, and there are
certain competitors of the Company with substantially greater sales, marketing,
development and financial resources. The Company believes that the competitive
factors affecting the market for its products and services include vendor and
product reputation; product quality, performance and price; the availability of
products on multiple platforms; product scalability; product integration with
other enterprise applications; product functionality and features; product ease
of use; and the quality of customer support services and training. The relative
importance of each of these factors depends upon the specific customer involved.
While the Company believes it competes favorably in each of these areas, there
can be no assurance that it will continue to do so. Moreover, the Company's
present or future competitors may be able
22
<PAGE>
to develop products comparable or superior to those offered by the Company,
offer lower price products or adapt more quickly than the Company to new
technologies or evolving customer requirements. Competition is expected to
intensify. In order to be successful in the future, the Company must respond to
technological change, customer requirements and competitors' current products
and innovations. There can be no assurance that the Company will be able to
continue to compete effectively in its market or that future competition will
not have a material adverse effect on its business, financial condition or
results of operations. In addition, current and potential competitors have
established or may establish cooperative relationships among themselves or with
third parties to increase the ability of their products to address the needs of
the markets served by the Company. Accordingly, it is possible that new
competitors or alliances among competitors may emerge and rapidly acquire
significant market share. Increased competition may result in price reductions,
reduced gross margins and loss of market share, any of which could have a
material adverse effect on the Company's business, financial condition or
results of operations.
Intellectual Property and Other Proprietary Rights The Company's success
depends, in part, on its ability to protect its proprietary rights to the
technologies used in its principal products. The Company relies on a combination
of copyrights, trademarks, trade secrets, confidentiality procedures and
contractual provisions to protect its proprietary rights. There can be no
assurance that the Company's existing or future copyrights, trademarks, trade
secrets or other intellectual property rights will be of sufficient scope or
strength to provide meaningful protection or commercial advantage to the
Company. FileNET has no software patents. Also, in selling certain of its
products, the Company relies on "shrink wrap" licenses that are not signed by
licensees and, therefore, may be unenforceable under the laws of certain
jurisdictions. In addition, the laws of some foreign countries do not protect
the Company's proprietary rights to the same extent as do the laws of the United
States. There can be no assurance that such factors would not have a material
adverse effect on the Company's business, financial condition or results of
operations. In addition, the Company also relies on certain software that it
licenses from third parties, including software that is integrated with
internally developed software used in the Company's products to perform key
functions. There can be no assurance that such third parties will remain in
business, that they will continue to support their products, that their products
are, or will be, year 2000 compliant, or that their products will otherwise
continue to be available to the Company on commercially reasonable terms. The
loss or inability to maintain any of theses software licenses could result in
delays or reductions in product shipments until equivalent software can be
developed, identified, licensed and integrated, any of which could adversely
affect the Company's business, financial condition or results of operations.
The Company may, from time to time, be notified that it is infringing
certain patent or intellectual property rights of others. Combinations of
technology acquired through past or future acquisitions and the Company's
technology will create new products and technology that may give rise to claims
of infringement. While no actions other than those discussed below are currently
pending against the Company for infringement of patent or other proprietary
rights of third parties, there can be no assurance that third parties will not
initiate infringement actions against the Company in the future. Infringement
actions can result in substantial cost to, and diversion of, resources of the
Company. If the Company were found to infringe upon the rights of others, no
assurance can be given that licenses would be obtainable on acceptable terms or
at all, that significant damages for past infringement would not be assessed or
that further litigation relative to any such licenses or usage would not occur.
The failure to successfully defend any claims or obtain necessary licenses or
other rights, the ultimate disposition of any claims or the advent of litigation
arising out of any claims of infringement, could have a material adverse effect
on the Company's business, financial condition or results of operations.
In October 1994, Wang Laboratories, Inc. (Wang) filed a complaint in the
United States District Court for the District of Massachusetts alleging that the
Company is infringing five patents held by Wang (the FileNET Case). On June 23,
1995, Wang amended its complaint to include an additional related patent. On
July 2, 1996, Wang filed a complaint in the same court alleging that Watermark
Software Inc., formerly a wholly owned subsidiary that was merged into the
Company, is infringing three of the same patents asserted in the initial
complaint (the Watermark Case). On October 9, 1996, Wang withdrew its claim in
the FileNET Case that one of the patents it initially asserted is infringed by
the Company's products that were commercialized before the initial complaint was
filed. Wang reserved the right to assert that patent against the Company's
products commercialized after that date in a separate lawsuit.
In March 1997, Eastman Kodak Company (Kodak) purchased the Wang imaging
business unit that has responsibility for this litigation. The patents in the
suit have been transferred to a Kodak subsidiary, Kodak Limited of England,
which, in turn, has exclusively licensed them to another Kodak subsidiary,
Eastman Software, Inc. in the United States (Eastman). On July 30, 1997, the
Court permitted Eastman and Kodak Limited of England to be substituted in the
litigation in place of Wang.
FileNET has moved for summary judgement on noninfringement as to each of
the five patents in the suit, and for summary judgment of invalidity as to one
of the patents. Eastman moved for summary judgment as to FileNET's
unenforceability defense on one of the patents. A trial date has not been set.
If it should be determined that the patents at issue in the litigation are
valid and are infringed by any of the Company's products, including Watermark
products, the Company will, depending on the product, redesign the infringing
products or seek to obtain a license to market the
23
<PAGE>
Management's Discussion and Analysis of Financial Condition and Results of
Operations
products. There can be no assurance that the Company will be able to obtain such
a license on acceptable terms. Based on the Company's analysis of these Eastman
patents and their respective file histories, the Company believes that it has
meritorious defenses to Eastman's claims; however, the ultimate outcome or any
resulting potential loss cannot be determined at this time.
Dependence on Certain Relationships The Company has entered into a number
of co-marketing relationships with other companies such as Microsoft
Corporation, Compaq Computer Corporation, SAP AG, HP and Sun Microsystems, Inc.
There can be no assurance that these companies will not reduce or discontinue
their relationships with, or support of, the Company and its products.
Dependence on Key Management and Technical Personnel The Company's success
depends to a significant degree upon the continued contributions of its key
management, marketing, technical and operational personnel. In general, the
Company does not utilize employment agreements for its key employees. The loss
of the services of one or more key employees could have a material adverse
effect on the Company's operating results. The Company also believes its future
success will depend in large part upon its ability to attract and retain
additional highly skilled management, technical, marketing, product development
and operational personnel. Competition for such personnel, particularly
engineers and other technical personnel, is intense, and there can be no
assurance that the Company will be successful in attracting and retaining such
personnel. In addition, the Company may experience increased compensation costs
in order to attract and retain skilled personnel.
International Sales Historically, the Company has derived more than 30% of
its total revenues from international sales. Six percent of the Company's 1997
revenues were generated in the Asia-Pacific region (including 4% in Australia).
International business is subject to certain risks including varying technical
standards, tariffs and trade barriers, political and economic instability,
reduced protection for intellectual property rights in certain countries,
difficulties in staffing and maintaining foreign operations, difficulties in
managing foreign distributors, potentially adverse tax consequences, currency
exchange fluctuations, the burden of complying with a wide variety of complex
operations, foreign laws, regulations and treaties, and the possibility of
difficulties in collecting accounts receivable. In particular, the current
economic crisis in the Asia Pacific region may limit future growth or cause a
decline in international revenues. There can be no assurance that any of these
factors will not have a material adverse effect on the Company's business,
financial condition or results of operations.
Product Liability Products as complex as those sold by the Company are
susceptible to errors or failures, especially when first introduced or when new
versions are released. The Company's products are often intended for use in
applications that are critical to a customer's business. As a result, the
Company's customers may rely on the effective performance of the software to a
greater extent than the market for software products generally. The Company
conducts extensive product testing to ensure that its products are free of
significant errors and defects. In addition, the Company has designed and tested
the most current versions of its products to be year 2000 compliant. However,
some of the Company's customers are running earlier product versions that are
not year 2000 compliant. Although the Company has been encouraging such
customers to migrate to current product versions, no assurance can be given that
all of them will do so in a timely fashion, if at all. Moreover, the Company
also relies on certain software that it licenses from third parties, including
software that is integrated with internally developed software and is used in
the Company's products to perform key functions. There can be no assurance that
such third-party software will be free of errors and defects or be year 2000
compliant in a timely fashion. Although the Company has not experienced any
material product liability claims to date, there can be no assurance that errors
or defects, whether associated with year 2000 functions or otherwise, will not
result in product liability claims against the Company in the future. The
Company's license agreements with customers typically contain provisions
designed to limit the Company's exposure to potential product liability claims;
however, it is possible that such limitation of liability pro-visions may not be
effective under the laws of certain jurisdictions. Defective products or
releases could result in loss of revenues, increased service and warranty costs
and product liability claims, and could adversely affect the Company's market
penetration and reputation, any of which could have a material adverse effect on
the Company's business, financial condition and results of operations.
Stock Price Volatility The Company believes that a variety of factors could
cause the price of its common stock to fluctuate, perhaps substantially,
including quarter-to-quarter variations in operating results; announcements of
developments related to its business; fluctuations in its order levels; general
conditions in the technology sector or the worldwide economy; announcements of
technological innovations, new products or product enhancements by the Company
or its competitors; key management changes; changes in joint marketing and
development pro-grams; developments relating to patents or other intellectual
property rights or disputes; and developments in the Company's relationships
with its customers, distributors and suppliers. In addition, in recent years,
the stock market in general, and the market for shares of high-technology stocks
in particular, has experienced extreme price fluctuations which have often been
unrelated to the operating performance of affected companies. Such fluctuations
could adversely affect the market price of the Company's common stock.
24
Consolidated Balance Sheets
December 31,
(In thousands, except share and per share amounts) 1997 1996
- -------------------------------------------------- ---- ----
Assets
Current assets:
Cash and cash equivalents $ 37,344 $ 28,530
Short-term marketable securities 26,600 22,037
Accounts receivable, net of allowances for doubtful
accounts and sales returns of $4,415 and $5,325 at
December 31, 1997 and 1996, respectively 61,283 75,469
Inventories 3,541 8,794
Prepaid expenses and other current assets 8,309 8,336
Deferred income taxes 6,439 5,641
----- -----
Total current assets 143,516 148,807
Property, net 27,587 28,329
Long-term marketable securities 7,826 16,705
Other assets 941 1,838
--- -----
Total assets $179,870 $195,679
======== ========
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 15,003 $ 16,752
Accrued compensation 14,845 10,728
Unearned maintenance revenue 8,848 5,554
Accrued royalties 2,743 4,531
Other accrued liabilities 19,190 21,903
------ ------
Total current liabilities 60,629 59,468
Deferred income taxes 430 3,405
Stockholders' equity:
Preferred stock-$.10 par value, 7,000,000 shares authorized;
none issued and outstanding
Common stock-$.01 par value, 100,000,000 shares authorized;
15,560,838 and 15,230,566 shares issued and outstanding
at December 31, 1997 and 1996, respectively 130,741 127,813
Retained earnings 2,348 7,874
Currency translation adjustment and other (4,146) 1,687
------ -----
128,943 137,374
Treasury stock at cost: 410,000 and 200,000 shares at
December 31, 1997 and 1996, respectively 10,132 4,568
------ -----
Total stockholders' equity 118,811 132,806
Total liabilities and stockholders' equity $179,870 $195,679
See accompanying Notes to Consolidated Financial Statements.
25
<PAGE>
Consolidated Statements of Operations
Year ended December 31,
(In thousands, except per share amounts) 1997 1996 1995
- ---------------------------------------- ---- ---- ----
Revenue
Software revenue $132,723 $140,659 $116,052
Service revenue 89,280 82,118 67,174
Hardware revenue 29,422 46,136 46,152
------ ------ ------
Total revenue 251,425 268,913 229,378
Costs and expenses
Cost of software revenue 14,768 16,464 15,146
Cost of service revenue 56,503 53,568 44,277
Cost of hardware revenue 20,330 29,633 28,800
Research and development 39,575 36,502 24,711
Selling, general and administrative 125,122 117,761 96,499
Merger, restructuring, write-off of purchased
in-process research and development and other
costs 6,000 16,011 6,393
----- ------ -----
Total costs and expenses 262,298 269,939 215,826
------- ------- -------
Operating income (loss) (10,873) (1,026) 13,552
Other income, net 3,160 2,838 2,780
----- ----- -----
Income (loss) before income taxes (7,713) 1,812 16,332
Provision (benefit) for income taxes (2,187) 4,456 8,116
------ ----- -----
Net income (loss) $ (5,526) $ (2,644) $ 8,216
======== ======== =======
Basic earnings (loss) per share $ (0.36) $ (0.18) $ 0.57
Diluted earnings (loss) per share $ (0.36) $ (0.18) $ 0.52
Weighted average shares outstanding - basic 15,155 15,007 14,430
Weighted average shares outstanding - diluted 15,155 15,007 15,856
See accompanying Notes to Consolidated Financial Statements.
26
<PAGE>
Consolidated Statements of Stockholders' Equity
(In thousands)
<TABLE>
<CAPTION>
Currency
Convertible Translation
preferred stock Common stock Retained Adjustment Treasury stock
Shares Amount Shares Amount earnings Other Shares Amount Total
------ -------- ------ -------- -------- ----------- ------ -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances at January 2, 1995 1,532 $ 19,879 11,420 $ 78,778 $ 2,302 $ 47 $101,006
Stock options exercised 542 7,471 7,471
Stock option income
tax benefits 3,722 3,722
Common stock issued under the
Employee Qualified Stock
Purchase Plan 35 814 814
Exercise of Saros warrants 195 2,235 2,235
Conversion of Watermark
redeemable convertible
preferred stock to FileNET
common stock 1,062 7,699 8 7,707
Foreign currency translation
adjustment (53) (53)
Net income 8,216 8,216
Other 40 40
------ -------- ------ -------- -------- ----------- ------ -------- --------
Balances at December 31, 1995 1,532 19,879 13,254 100,719 10,518 42 131,158
Stock options exercised 398 3,330 3,330
Stock option income
tax benefits 2,606 2,606
Common stock issued under
the Employee Qualified
Stock Purchase Plan 38 1,028 1,028
Exercise of Saros warrants 9 251 251
Conversion of Saros
convertible preferred
stock to FileNET
common stock (1,532) (19,879) 1,532 19,879
Repurchase of treasury
shares at cost (200) $(4,568) (4,568)
Foreign currency translation
adjustment 1,671 1,671
Net loss (2,644) (2,644)
Other (26) (26)
------ -------- ------ -------- -------- ----------- ------ -------- --------
Balances at December 31, 1996 15,231 127,813 7,874 1,687 (200) (4,568) 132,806
Stock options exercised 242 1,721 1,721
Common stock issued under the
Employee Qualified Stock
Purchase Plan 88 1,207 1,207
Repurchase of treasury
shares at cost (210) (5,564) (5,564)
Foreign currency translation
adjustment (5,809) (5,809)
Net loss (5,526) (5,526)
Other (24) (24)
------ -------- ------ -------- -------- ----------- ------ -------- --------
Balances at December 31, 1997 15,561 $130,741 $ 2,348 $(4,146) (410) $(10,132) $118,811
====== ======== ====== ======== ======== ============ ======= ========= ========
See accompanying Notes to Consolidated Financial Statements.
</TABLE>
27
<PAGE>
Consolidated Statements of Cash Flows
Year ended December 31,
(In thousands) 1997 1996 1995
- -------------- ---- ---- ----
Cash flows from operating activities:
Net income (loss) $ (5,526) $ (2,644) $ 8,216
Adjustments to reconcile net income (loss) to net
cash provided by (used for) operating activities:
Write-off of capitalized and purchased
in-process research and development costs 10,011 1,393
Depreciation and amortization 13,289 13,049 12,075
Provision for doubtful accounts 350 1,205 857
Deferred income taxes (3,773) (790) 196
Changes in operating assets and liabilities,
net of effect of business acquisition:
Accounts receivable 9,365 (21,921) (10,722)
Inventories 5,368 (2,161) (1,464)
Prepaid expenses and other current assets (539) (1,764) (2,497)
Accounts payable (1,273) 639 4,683
Accrued compensation 4,380 (270) 2,689
Unearned maintenance revenue 3,327 (207) 1,864
Accrued royalties (1,788) 959 1,125
Other 1,581 2,099 6,271
----- ----- -----
Net cash provided by (used for) operating activities 24,761 (1,795) 24,686
------ ------ ------
Cash flows from investing activities:
Proceeds from sale of property 264 3,304 393
Capital expenditures (14,266) (17,866) (14,692)
Capitalized software development costs (1,600)
Payment for purchase of IFSL, net of assets
acquired (10,011)
Purchases of marketable securities (30,274) (32,092) (49,815)
Proceeds from sales and maturities of
marketable securities 32,946 39,990 45,402
------ ------ ------
Net cash used for investing activities (11,330) (16,675) (20,312)
------- ------- -------
Cash flows from financing activities:
Debt repayments, net (163)
Proceeds from issuance of common stock 2,928 4,609 10,520
Common stock repurchased (5,564) (4,568)
Stock option income tax benefits 2,606 3,722
----- ----- -----
Net cash provided by (used for) financing activities (2,636) 2,647 14,079
------ ----- ------
Effect of exchange rate changes on cash and cash
equivalents (1,981) 975 (25)
------ --- ---
Net increase (decrease) in cash and cash equivalents 8,814 (14,848) 18,428
Cash and cash equivalents, beginning of year 28,530 43,378 24,950
------ ------ ------
Cash and cash equivalents, end of year $ 37,344 $ 28,530 $ 43,378
======== ======== ========
Supplemental cash flow information
Interest paid $ 201 $ 443 $ 229
Income taxes paid $ 3,050 $ 3,236 $ 3,527
See accompanying Notes to Consolidated Financial Statements.
28
<PAGE>
Notes to Consolidated Financial Statements
Note 1
Summary of Significant Accounting Policies
Nature of Operations FileNET Corporation develops, markets and services an
open, integrated, client/server-based family of document management software
products designed for managing information and enhancing enterprise
productivity. Additionally, the Company manufactures and sells a line of 12-inch
optical storage and retrieval libraries (OSARs). The Company markets its
products to a broad range of industries in more than 60 countries through a
global sales, services and support organization, including its ValueNET partner
program of resellers, system integrators and application developers.
Principles of Consolidation The consolidated financial statements include
the accounts of FileNET and its wholly-owned subsidiaries. All intercompany
balances and transactions have been eliminated.
Use of Estimates The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Investments The Company's investments in marketable securities consist
primarily of high-grade corporate and government securities with maturities of
less than three years. Investments purchased with an original maturity of three
months or less are considered to be cash equivalents. The Company classifies all
of its investments as available-for-sale. Available-for-sale securities are
carried at fair value, with unrealized gains and losses, net of tax, reported in
a separate component of stockholders' equity.
Other Financial Instruments The Company enters into forward foreign
exchange contracts as a hedge against the effects of fluctuating currency
exchange rates on monetary assets and liabilities denominated in currencies
other than the functional currency of the relevant entity. The Company is
exposed to market risk on the forward exchange contracts as a result of changes
in foreign exchange rates; however, the market risk should be offset by changes
in the valuation of the underlying exposures. Gains and losses on these
contracts, which equal the difference between the forward contract rate and the
prevailing market spot rate at the time of valuation, are recognized in the
consolidated statements of operations. The counterparties to these instruments
are major financial institutions. The Company uses commercial rating agencies to
evaluate the credit quality of the counterparties. The Company does not
anticipate a loss resulting from credit risk related to any of these
institutions (see Note 13).
Fair Value of Financial Instruments The recorded amounts of financial
assets and liabilities at December 31, 1997 and 1996 approximate fair value due
to the relatively short period of time between origination of the instruments
and their expected realization.
Inventories Inventories are stated at the lower of first-in, first-out cost
or market (see Note 5). The Company regularly monitors inventories for excess or
obsolete items and makes any necessary adjustments at each balance sheet date.
Foreign Currency Translation The Company measures the financial statements
for the Company's 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. Translation adjustments
resulting from this process are included in stockholders' equity. Revenues,
costs and expenses are translated at the rates of exchange prevailing during the
year. Gains and losses from foreign currency transactions are included in other
income.
Property Property is stated at cost. Depreciation is computed using the
straight-line method over the estimated useful lives of the related assets,
generally three to five years. Leasehold improvements are amortized over the
shorter of the estimated useful lives of the improvements or the term of the
related lease (see Note 6).
Research and Development The Company expenses research and development
costs as incurred. Statement of Financial Accounting Standards (SFAS) No. 86,
"Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise
Marketed" does not materially affect the Company. The Company did capitalize
certain software development costs up to and including the second quarter of
1995. The Company amortized the remaining capitalized software development costs
during 1996. Amortization expense was $1.2 million and $1.8 million for the
years ended December 31, 1996 and 1995, respectively.
29
<PAGE>
Notes to Consolidated Financial Statements
Revenue Recognition Software revenue is generally recognized when product
is delivered to the customer in accordance with the American Institute of
Certified Public Accountants (AICPA) Statement of Position (SOP) 91-1, "Software
Revenue Recognition." The Company recognizes other revenue at the time of
product delivery and accrues any remaining costs, including insignificant vendor
obligations. Revenue from service and post-contract customer support is
recognized ratably over the term of the contract.
Product Warranty The Company provides a warranty for its products against
defects in materials and workmanship. A provision for estimated warranty costs
is recorded at the time of sale and periodically adjusted to reflect actual
experience.
Income Taxes The provision for incomes taxes is determined in accordance
with SFAS No. 109, "Accounting for Income Taxes." Deferred tax assets and
liabilities arise from temporary differences between the tax bases of assets and
liabilities and their reported amounts in the consolidated financial statements
that will result in taxable or deductible amounts in future years (see Note 9).
Earnings (Loss) Per Share Beginning in 1997, the Company computes earnings
or loss per share in accordance with SFAS No. 128, "Earnings Per Share."
Earnings (loss) per share for all prior years have been restated to conform to
SFAS No. 128. Earnings (loss) per share is computed using the weighted average
number of common shares outstanding during the reporting period. Earnings (loss)
per share assuming dilution is computed using the weighted average number of
common shares outstanding and the dilutive effect of potential common shares
out-standing (see Note 4).
Supplier Concentrations Certain components for the Company's proprietary
12-inch OSARs are available from a limited number of sources. Any inability to
obtain components in the amounts needed on a timely basis could result in
short-term delays in product shipments which could have a material adverse
effect on the Company's operating results. The Company has qualified and is
selling 5 1/4 -inch optical storage and retrieval devices from an alternative
source which could be utilized by the Company's customers in the event of any
interruptions in the delivery of components for the Company's own OSAR product.
Stock-based Compensation The Company accounts for stock-based awards to
employees using the intrinsic value method in accordance with Accounting
Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to
Employees" (see Note 8).
Long-Lived Assets The Company accounts for the impairment and disposition
of long-lived assets in accordance with SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." In
accordance with SFAS No. 121, long-lived assets to be held are reviewed for
events or changes in circumstances that indicate that their carrying value may
not be recoverable.
Recent Accounting Pronouncements In 1997, SFAS No. 130, "Reporting
Comprehensive Income" and SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information," were issued and are effective for fiscal
years beginning after December 15, 1997. In October 1997, the AICPA issued SOP
97-2, "Software Revenue Recognition," which supersedes SOP 91-1. The provisions
of SOP 97-2 are effective for fiscal years beginning after December 15, 1997.
The Company is reviewing the impact of these pronouncements on its financial
statements.
Reclassifications Certain reclassifications have been made to prior-years'
balances to conform to current year's presentation.
Note 2
Acquisitions
Acquisition of Saros Corporation In March 1996, the Company acquired Saros
by issuing approximately 1.9 million shares of FileNET common stock and
approximately 337,000 options to purchase FileNET common stock in exchange for
all of the outstanding Saros stock and options. The transaction was accounted
for as a pooling-of-interests for financial reporting purposes. Fees and
expenses aggregating $4.2 mil-lion were expensed in the first quarter of 1996.
30
<PAGE>
Acquisition of International Financial Systems Ltd. In January 1996, the
Company purchased for cash all of the outstanding shares of IFSL, the developer
of a computer output to laser disk (COLD) software product for archiving
documents. The acquisition was accounted for as a purchase for financial
reporting purposes. The purchase price was allocated to net assets of $1.7
million and purchased in-process research and development costs of $10.0
million. The purchased in-process research and development costs were written
off at the time of acquisition.
Acquisition of Watermark Software Inc. In August 1995, the Company acquired
Watermark by issuing approximately 1.3 million shares of FileNET common stock
and approximately 152,000 options to purchase FileNET common stock in exchange
for all of the outstanding Watermark stock and options. The transaction was
accounted for as a pooling-of-interests for financial reporting purposes. Fees
and expenses aggregating $6.4 million were expensed in the third quarter of
1995. Included in these fees and expenses is the write-off of $1.4 million of
capitalized research and development costs for FileNET projects made redundant
by the Watermark acquisition.
Note 3
Restructuring and Other Costs
The $6.0 million in restructuring and other charge in 1997 represents the
costs of consolidating the Watermark business unit's Burlington, Massachusetts
engineering and marketing functions with those at FileNET's Costa Mesa,
California location, as well as a reduction in head-count in certain other areas
of the Company. The restructuring and other charges include approximately $1.9
million for severance payments for 111 employees, $2.2 million for the write-off
of impaired assets, $0.4 million for facility closing costs and $1.5 million of
other charges.
At December 31, 1997, accrued restructuring and other charges of $3.0
million are included in other accrued liabilities. The Company anticipates that
the remaining restructuring costs will be paid during 1998.
Note 4
Earnings (Loss) Per Share
The following table is a reconciliation of the earnings and share amounts
used in the calculation of basic earnings (loss) per share and diluted earnings
(loss) per share. Such calculations include the effect of the conversion of the
then outstanding shares of Watermark's redeemable convertible preferred stock
and Saros' convertible preferred stock into FileNET common stock, which occurred
upon completion of the related acquisitions (see Notes 2 and 8):
Net Per-Share
(In thousands, except per share amounts) Income Shares Amount
- ---------------------------------------- ------ ------ ------
Year ended December 31, 1995
Basic earnings per share $8,216 14,430 $0.57
Effect of dilutive stock options 1,426
----- ----- ----
Diluted earnings per share $8,216 15,856 $0.52
====== ====== =====
The weighted average number of shares outstanding for 1997 and 1996 was
15,154,563 and 15,007,233 respectively. Options to purchase shares of common
stock in 1997 and 1996 were outstanding during the year but were not included in
the computation of diluted loss per share, as their effect was antidilutive (see
Note 8).
Note 5
Inventories
Inventories consisted of the following at December 31:
(In thousands) 1997 1996
- -------------- ---- ----
Raw materials $1,831 $2,606
Work-in-process 950 2,648
Finished goods 760 3,540
--- -----
Total $3,541 $8,794
====== ======
31
<PAGE>
Notes to Consolidated Financial Statements
Note 6
Property and Leases
Property consisted of the following at December 31:
(In thousands) 1997 1996
- -------------- ---- ----
Machinery, equipment and software $ 74,981 $ 66,404
Furniture and fixtures 8,808 9,242
Leasehold improvements 5,238 5,120
----- -----
Total 89,027 80,766
Less accumulated depreciation and amortization (61,440) (52,437)
------- -------
Property, net $ 27,587 $ 28,329
======== ========
The Company leases its corporate office, sales offices, manufacturing
facilities, and other equipment under noncancelable operating leases, some of
which have renewal options and generally provide for escalation of the annual
rental amount.
Expenses related to operating leases were $10.8 million, $9.6 million, and
$9.3 million for the years ended December 31, 1997, 1996 and 1995, respectively.
The following table summarizes future minimum lease payments required under
operating leases:
(In thousands)
- --------------
1998 $11,046
1999 10,211
2000 8,518
2001 7,117
2002 6,480
Thereafter 7,711
-----
Total $51,083
=======
Note 7
Borrowing Arrangements
The Company has a $20 million commercial line of credit that expires in May
1999. Borrowings under the arrangement are unsecured and bear interest at the
bank's prime rate. The Company is restricted from paying dividends during the
term of the arrangement and, under the arrangement, must comply with certain
covenants, including quarterly and annual profitability covenants. The Company
was in compliance with such covenants as of December 31, 1997.
The Company has four additional borrowing arrangements with foreign banks,
which expire at various times during 1998, under which the Company may borrow
approximately $2 million. Borrowings under these arrangements bear interest at
the various banks' prime rates plus 0.75% to 1.5%. Of the $2 million available,
approximately $1 million may be borrowed on an unsecured basis, while the
remaining $1 million is collateralized by cash deposits with the bank.
There were no borrowings outstanding under any of the arrangements at
December 31, 1997 and 1996.
Interest expense was $263,000, $443,000 and $288,000 for the years ended
December 31, 1997, 1996 and 1995, respectively.
Note 8
Stockholders' Equity
Shareholder Rights Plan In October 1988, FileNET declared a dividend of one
common stock purchase right for each outstanding share of common stock. Under
certain circumstances, a right may be exercised to purchase one share of common
stock at an exercise price of $55, subject to certain antidilution adjustments.
The rights become exercisable if and when a person (or group of affiliated or
associated persons) acquires 25% or more of FileNET's outstanding common stock,
or announces an offer that would result in such person acquiring 30% or more
32
<PAGE>
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, 1998 and may be
redeemed by FileNET at one cent per right at any time before a person has
acquired 25% or more of FileNET's common stock.
Treasury Stock In 1997, the Board of Directors authorized, subject to
certain business and market conditions, the purchase of up to $10 million of the
Company's outstanding common stock. During the year ended December 31, 1997, the
number of shares purchased under this authorization was 210,000 shares at an
aggregate cost of $5.6 million. During the first quarter of 1998, the Company
repurchased $4.4 million of its common stock, thereby completing the stock
repurchase program.
In 1996, the Board of Directors authorized, subject to certain business and
market conditions, the purchase of up to 200,000 shares of the Company's common
stock. The purchases under this authorization were completed during 1996 at an
aggregate cost of $4.6 million.
Employee Qualified Stock Purchase Plan In March 1988, FileNET adopted the
1988 Employee Qualified Stock Purchase Plan (the Purchase Plan). A total of
600,000 shares of common stock are reserved for purchases under the Purchase
Plan as amended. Under the terms of the Purchase Plan, 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 Plan covers
substantially all domestic employees of the Company. Eligible employees may
elect to have a portion of their salaries withheld for the purpose of making
purchases under the Purchase Plan. Each participant is limited in any plan year
to the acquisition of that number of shares that have an aggregate fair market
value of not more than $25,000. There are no charges or credits to income in
connection with the Purchase Plan. At December 31, 1997, $360,850 had been
withheld from employees' salaries pursuant to the Purchase Plan for the current
offering period, which expires on March 31, 1998. At December 31, 1997,
approximately 126,897 shares remained available for future issuance.
Stock Option Plans In April 1986, the Company adopted the 1986 Stock Option
Plan (the 1986 Plan). Under the amended terms of the 1986 Plan, options to
purchase 3,250,000 shares of the Company's common stock were reserved for
issuance to employees, officers and directors. Options to purchase 541,415 and
821,548 common shares were exercisable at December 31, 1997 and December 31,
1996, respectively. In May 1995, the 1986 Plan was terminated and the remaining
reserve of 70,049 shares was transferred into the 1995 Stock Option Plan and no
common shares remain available for future grants under the 1986 Plan. Options
granted were either incentive stock options or nonqualified stock options.
Options granted become exercisable in 20% annual installments beginning one year
after the date of grant, as determined by the Board of Directors, and expire no
later than ten years plus one day from the date of grant. The exercise price of
the incentive stock options and nonqualified options were not to be less than
100% and 85%, respectively, of the fair market value of the Company's common
stock at the date of grant.
In May 1995, the Company adopted the 1995 Stock Option Plan (the 1995
Plan). Under the amended terms of the 1995 Plan, options to purchase 1,600,000
shares of the Company's common stock were reserved for issuance to employees,
officers and directors. This reserve was added to the 70,049 shares of common
stock transferred from the 1986 Plan. Outstanding options under the 1986 Plan
will continue to be governed by the provisions of the agreements evidencing
those grants. To the extent any of those outstanding options terminate or expire
prior to exercise, the shares subject to those unexercised options will be
available for subsequent option grant pursuant to the provisions of the 1995
Plan. As of December 31, 1997, 960,867 options of the 1986 Plan had been
terminated and were made available under the 1995 Plan. Options granted under
the 1995 Plan's Discretionary Option Grant Program for employees and the
Automatic Option Grant Program for directors have an exercise price per share of
100% of the fair market value per share on the grant date and become exercisable
in 25% annual installments beginning one year from the date of grant. As of
December 31, 1997, 10,186 options were exercisable under the 1995 Plan.
Prior to their merger into FileNET, Saros and Watermark had adopted stock
option plans. These plans were assumed by the Company and outstanding options
were converted into options to purchase an aggregate of 487,988 shares of
FileNET common stock. Outstanding options under the plans will continue to be
governed by the provisions of the agreements evidencing those grants. To the
extent any of those outstanding options terminate or expire prior to exercise,
the shares subject to those unexercised options will not be available for
subsequent option grant. At December 31, 1997, a total of 43,250 options were
outstanding and 30,543 were exercisable.
33
<PAGE>
Notes to Consolidated Financial Statements
In December 1989, the Company adopted the 1989 Stock Option Plan for
Non-Employee Directors (the Directors' Plan). Under the terms of the Directors'
Plan, as amended, each FileNET director who was not an employee was
automatically granted an initial option to purchase 10,000 shares of FileNET's
common stock at its fair market value on the date of grant and was granted an
additional option to purchase 3,500 shares every year following the initial
grant, provided such person continued to be a director at such time. Options
granted under the plan vested at the rate of 20% per year from the grant date.
Options to purchase an aggregate of 70,000 shares at prices ranging from $11.50
to $32.69 per share were granted from December 18, 1989 to May 24, 1995. At
December 31, 1997, options to purchase 23,700 shares of common stock were
exercisable and 23,200 have been exercised to date. This plan was terminated in
May 1995 with respect to future option grants. Future grants to nonemployee
directors are granted under the provisions of the 1995 Plan.
In August 1997, the Company filed a Form S-8 with the Securities and
Exchange Commission, registering a Non-Statutory Stock Option Grant of 300,000
shares, dated May 22, 1997, to the Company's President and Chief Operating
Officer and a Non-Statutory Stock Option Grant of 80,000 shares, dated June 18,
1997, to the Company's Senior Vice President, Worldwide Sales. Such grants were
in accordance with employment agreements entered into by the Company and the
grantees. Options granted have an exercise price per share of 100% of the fair
market value per share on the date of grant and become exercisable in 25%
installments beginning one year from the date of grant and will expire no later
than ten years from the date of grant. As of December 31, 1997, no options were
exercisable related to these Non-Statutory Stock Option Grants.
On July 11, 1997, the Company approved a stock option cancellation/regrant
program which allowed employees, excluding nonemployee directors, to exchange
outstanding options with an exercise price greater than $18.00 for new options.
Outstanding options of 1,552,525 shares were canceled and regranted at $18.00
per share, the current market value on July 11, 1997. Under the stock option
cancellation/regrant pro-gram, the regranted options are considered granted on
July 11, 1997. The regranted options retained the exercisable status of the
canceled options with the following exceptions. The exercise date for the
regranted options related to canceled options that would have been exercisable
as of July 11, 1997 was extended six months to January 11, 1998. For the
reporting officers as defined in Section 16 of the Securities Exchange Act of
1934, as amended (the Act) the exercise date of regranted options related to
canceled options which would have been exercisable on July 11, 1997 was extended
twelve months to July 11, 1998. The prospective exercise dates for the remaining
regranted options related to canceled options that were not exercisable as of
July 11, 1997, were extended six months from the original exercise date.
On August 8, 1996, the Company approved a stock option cancellation/regrant
program which allowed employees, excluding all directors and reporting officers
as defined in Section 16 of the Act, to exchange options with an exercise price
greater than $26.00 for new options. Outstanding options of 530,571 shares were
canceled and regranted at $26.00 per share, the current market value on August
8, 1996. Under the stock option cancellation/regrant program, the regranted
options were considered granted on August 8, 1996 and are exercisable
prospectively in accordance with the provisions of the agreements evidencing
those grants.
Information regarding the stock option plans, after giving retroactive
effect to the conversions of the Watermark and Saros stock options on their
original grant dates, is as follows:
Weighted
Average
Number of Exercise
Options Price
------- -----
Balances, January 1, 1995 2,604,174 $15.27
Granted (Weighted average fair value of $14.68) 771,674 $30.41
Exercised (542,142) $13.78
Canceled (130,597) $19.51
-------- ------
Balances, December 31, 1995 2,703,109 $19.68
Granted (Weighted average fair value of $14.96) 1,362,418 $36.65
Exercised (398,041) $ 8.37
Canceled (866,603) $43.34
-------- ------
Balances, December 31, 1996 2,800,883 $22.22
Granted (Weighted average fair value of $8.26) 2,801,049 $18.66
Exercised (241,704) $ 7.12
Canceled (1,965,119) $26.96
---------- ------
Balances, December 31, 1997 3,395,109 $17.62
=== ==== ========= ======
34
<PAGE>
The following table summarizes information concerning currently outstanding
and exercisable options:
Options Outstanding Options Exercisable
------------------------------------ ---------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Price Outstanding Life Price Exercisable Price
- -------------- ----------- ---- ----- ----------- -----
$ 0.93 - $15.06 987,899 7.05 $12.48 346,807 $ 9.69
$15.13 - $17.87 199,798 5.15 $16.04 149,598 $15.79
$18.00 - $18.00 1,603,512 9.51 $18.00 2,084 $18.00
$18.38 - $53.50 603,900 8.67 $26.02 107,855 $20.97
------- ---- ------ ------- ------
$ 0.93 - $53.50 3,395,109 8.39 $17.62 606,344 $13.23
========= ==== ====== ======= ======
The Company accounts for its stock-based compensation plans in accordance
with APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related
interpretations. No compensation expense has been recognized for its stock-based
compensation plans. 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 123, "Accounting for Stock-Based Compensation":
Year ended December 31,
(In thousands, except per share amounts) 1997 1996 1995
- ------------------------------------------- ---- ---- ----
Net income (loss) - as reported $(5,526) $(2,644) $8,216
Net income (loss) - pro forma (12,497) (7,320) 7,273
Diluted earnings (loss) per share - as reported (0.36) (0.18) 0.52
Diluted earnings (loss) per share - pro forma (0.82) (0.49) 0.46
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 1997, 1996 and 1995; expected volatility of 60%;
risk-free interest rates of 5.3% to 5.6% for 1997 and 5.8% to 6.9% for 1996 and
1995; and an expected life of 1 year from vest date. Pro forma compensation cost
of options granted under the Employee Qualified Stock Purchase Plan is measured
based on the discount from market value.
Note 9
Income Taxes
The provision (benefit) for income taxes consists of the following:
Year ended December 31,
(In thousands) 1997 1996 1995
- --------------- ---- ---- ----
Current:
Federal $ 785 $2,930 $4,017
State (40) 75 867
Foreign 841 2,241 2,458
Deferred:
Federal (1,963) (772) 834
State (1,168) (18) (60)
Foreign (642)
---- ---- ----
Total provision (benefit) for income taxes $(2,187) $4,456 $8,116
======= ====== ======
The valuation allowance increased by $1.4 million, $9,000 and $3.5 million
in the years ended December 31, 1997, 1996 and 1995, respectively.
35
<PAGE>
Notes to Consolidated Financial Statements
A reconciliation of the Company's effective tax rate compared to the
statutory Federal tax rate is as follows:
Year ended December 31,
1997 1996 1995
---- ---- ----
Income taxes (benefit) at statutory Federal rate (35%) 35% 35%
State taxes (benefit), net of Federal benefit (6) 4 5
Unbenefited/utilized domestic losses 42 21
Foreign tax rate differential/unbenefited losses 11 (130) (14)
Non-deductible acquisition costs 291 5
Other 2 4 (2)
- - --
Total (28%) 246% 50%
=== === ==
The Company provides deferred income taxes for temporary differences
between assets and liabilities recognized for financial reporting and income tax
purposes. The income tax effects of these temporary differences representing
significant portions of the deferred taxes at December 31, 1997 and 1996 are as
follows:
Year ended December 31,
(In thousands) 1997 1996
- -------------- ---- ----
Foreign loss carryforwards $ 2,788 $ 1,445
Domestic loss carryforwards 11,928 9,198
Tax credit carryforwards 3,159 1,954
Accrued expenses 2,954 1,745
Sales returns and allowance reserves 1,111 1,359
Capitalized software (272) (206)
Depreciable assets 857 802
Residual U.S. tax on foreign earnings (4,027) (3,710)
Other 1,963 2,661
----- -----
Total 20,461 15,248
Valuation allowance (14,452) (13,012)
------- -------
Net deferred tax asset $ 6,009 $ 2,236
======== ========
The Company has $35.1 million of domestic net operating loss carryforwards,
which can be utilized to reduce future taxable income. Any net operating loss
carryforwards not utilized will begin expiring in 2004. The Company has a $3.2
million tax credit carryforward, which will expire beginning in 2004.
Utilization of $1.1 million of the loss carryforward arising from the tax
benefit related to the exercise of nonqualified stock options will be recorded
to stockholders' equity when utilized.
At December 31, 1997, the Company had Dutch, United Kingdom, French and
German subsidiary tax loss carryforwards relating to its foreign subsidiary
operations of $1.7 million, $1.6 million, $1.9 million and $3.0 million,
respectively. The Dutch, United Kingdom and German tax loss carryforwards have
no expiration. French losses of $0.2 million will expire in 1998.
The Company has not provided any residual U.S. tax on approximately $16.1
million of the Company's foreign subsidiaries undistributed earnings, as the
Company intends to indefinitely reinvest such earnings.
36
<PAGE>
Note 10
Geographical Information
Year ended December 31,
(In thousands) 1997 1996 1995
- --------------- ---- ---- ----
Revenue
United States*
Customers $173,588 $174,618 $155,728
Intercompany 20,690 23,355 14,597
------ ------ ------
Total 194,278 197,973 170,325
Europe*
Customers 68,247 83,786 67,916
Intercompany 21,547 15,815 11,448
------ ------ ------
Total 89,794 99,601 79,364
Other
Customers 9,590 10,509 5,734
Intercompany 3,479 1,794 2,086
----- ----- -----
Total 13,069 12,303 7,820
Eliminations (45,716) (40,964) (28,131)
------- ------- -------
Total revenue $251,425 $268,913 $229,378
-------- -------- --------
Operating income (loss)
United States** $ (6,730) $(18,588) $ 369
Europe** (2,999) 17,680 12,589
Other 669 1,691 629
Eliminations (1,813) (1,809) (35)
------ ------ ---
Total operating income (loss) $(10,873) $ (1,026) $ 13,552
-------- -------- --------
Assets
United States $125,091 $132,781 $151,929
Europe 49,822 56,971 38,993
Other 5,054 6,043 2,672
Eliminations (97) (116) (3,912)
--- ---- ------
Total assets $179,870 $195,679 $189,682
======== ======== ========
*U.S. revenue includes hardware sales to third-party international resellers.
European revenue includes software sales to third-party international resellers.
**U.S. operating income includes $4.3 million, $16.0 million and $3.9 million in
1997, 1996 and 1995, respectively, for merger, restructuring and write-off of
purchased in-process research and development costs. European operating income
includes $1.5 million and $2.5 million for restructuring, merger and other costs
in 1997 and 1995, respectively. Other operating income includes $.2 million for
restructuring and other costs in 1997. For all years presented, U.S. operating
income (loss) includes certain corporate expenses such as research and
development, marketing communications and corporate administration, and European
and other operating income includes international headquarters expenses.
37
<PAGE>
Notes to Consolidated Financial Statements
Note 11
Contingencies
In October 1994, Wang Laboratories, Inc. (Wang) filed a complaint in the
United States District Court for the District of Massachusetts alleging that the
Company is infringing five patents held by Wang (the FileNET Case). On June 23,
1995, Wang amended its complaint to include an additional related patent. On
July 2, 1996, Wang filed a complaint in the same court alleging that Watermark,
formerly a wholly-owned subsidiary that was merged into the Company, is
infringing three of the same patents asserted in the initial complaint (the
Watermark Case). On October 9, 1996, Wang withdrew its claim in the FileNET Case
that one of the patents it initially asserted is infringed by the Company's
products that were commercialized before the initial complaint was filed. Wang
reserved the right to assert that patent against the Company's products
commercialized after that date in a separate lawsuit.
In March 1997, Eastman Kodak Company (Kodak) purchased the Wang imaging
business unit that has responsibility for this litigation. The patents in the
suit have been transferred to a Kodak subsidiary, Kodak Limited of England,
which, in turn, has exclusively licensed them to another Kodak subsidiary,
Eastman Software, Inc. in the United States (Eastman). On July 30, 1997, the
Court permitted Eastman and Kodak Limited of England to be substituted in the
litigation in place of Wang.
FileNET has moved for summary judgement on noninfringement as to each of
the five patents in the suit, and for summary judgment of invalidity as to one
of the patents. Eastman moved for summary judgment as to FileNET's
unenforceability defense on one of the patents. A trial date has not been set.
If it should be determined that the patents at issue in the litigation are
valid and are infringed by any of the Company's products, including Watermark
products, the Company will, depending on the product, redesign the infringing
products or seek to obtain a license to market the products. There can be no
assurance that the Company will be able to obtain such a license on acceptable
terms. Based on the Company's analysis of these Eastman patents and their
respective file histories, the Company believes that it has meritorious defenses
to Eastman's claims; however, the ultimate outcome or any resulting potential
loss cannot be determined at this time.
On December 20, 1996, plaintiff Michael I. Goldman (the Plaintiff) filed a
class action complaint against the Company and certain of its officers and
directors in the Superior Court of California, County of Orange (the State
Action). The action was purportedly filed on behalf of a class of purchasers of
the Company's common stock during the period October 19, 1995 through July 2,
1996. The Plaintiff alleges that the Company and other defendants violated Cal.
Corp. Code ss.ss. 25400 and 25500, Cal. Civ. Code ss.ss. 1709-1710 and Cal. Bus.
& Prof. Code ss.ss. 17200 et seq. in connection with various public statements
made by the Company and certain of its officers and directors during the
putative class period. The complaint seeks unspecified compensatory and punitive
damages, interest, payment of attorney's fees and costs, and equitable or
injunctive relief.
On April 1, 1997, The Plaintiff filed another class action complaint
against the Company and certain of its officers and directors in the United
States District Court for the Central District of California (the Federal
Action). The action purportedly was filed on behalf of the same class of
purchasers of the Company's common stock as the State Action. The allegations
contained in the Federal Action are very similar to the allegations contained in
the State Action, except that the Federal Action asserts claims under Sections
10(b) and 20(a) of the Securities Exchange Act and Rule 10b-5. The complaint
seeks unspecified compensatory damages, interest, attorneys' fees, expert
witness fees, costs and equitable or injunctive relief. On July 2, 1997, the
court granted plaintiff's motion to be appointed "lead plaintiff" under the
Private Securities Litigation Reform Act.
In the Federal Action, defendants have filed a motion to dismiss the
complaint in its entirety. Plaintiff has filed a motion to stay the Federal
Action, in light of the parallel State Action. The court is scheduled to hear
both of these motions during March 1998.
In the State Action, defendants moved to stay the action, in light of the
parallel Federal Action. The trial court granted the motion to stay the action
as to discovery on September 8, 1997. Defendants also demurred and moved to
strike the complaint. The trial court overruled the demurrer and denied the
motion to strike on October 21, 1997. On January 14, 1998, the court entered an
order dismissing with prejudice two of plaintiff's three causes of action: the
claims under Cal. Civ. Code ss.ss. 1709-1710 and Cal. Bus. & Prof. Code ss.ss.
17200 et seq.
On January 30, 1998, the trial court in the State Action granted the
Plaintiff's motion to certify a class composed of persons who bought FileNET
stock in California only between October 19, 1995 and July 2, 1996. This ruling
is subject to revision based on the decisions to be rendered by the California
Supreme Court in Diamond Multimedia Systems, et al. v. Superior Court (Pass) and
StorMedia, Inc., et al. v. Superior Court (Werczberger). The trial court also
denied the Plaintiff's motion to lift the discovery stay.
The Company believes that all of the allegations contained in the
complaints filed in the State and Federal Actions are without merit and intends
to defend the actions vigorously.
38
<PAGE>
The Company, in the normal course of business, is subject to various other
legal matters. While the results of litigation and claims cannot be predicted
with certainty, the Company believes that the final outcome of these other
matters will not have a materially adverse effect on the Company's consolidated
results of operations or financial condition.
Note 12
Related Party Transactions
The Company entered into a two-year agreement on May 20, 1997, to employ
its new President and Chief Operating Officer. Under the terms of the agreement,
the Company agreed to reimburse the officer for legal costs in defending a
lawsuit from the officer's former employer. The case was settled and the total
cost to the Company was charged to compensation expense in 1997.
Watermark originally entered into a republishing and distribution agreement
with a UK company (the Distributor) which provided the Distributor with
exclusive distribution rights of Watermark's products in defined territories.
The Chief Executive Officer of the Distributor is the brother of Watermark's
then President and Chief Executive Officer. During 1995, Watermark elected to
purchase the portion of the Distributor's business related to selling
Watermark's products at a negotiated price of $2.5 million that is included in
merger and other costs in 1995.
Note 13
Other Financial Instruments
The following table summarizes the notional amount, which is equivalent to
the fair market value, of the Company's foreign currency agreements entered into
on December 31, 1997 and 1996, all maturing in three months:
At December 31,
(In thousands) 1997 1996
- -------------- ---- ----
Australian Dollar $ 4,299 $ 5,110
British Pound 11,586 17,070
Canadian Dollar 1,014 3,409
French Franc 5,247 5,118
German Mark 14,651 19,532
Irish Punt 602 6,902
Japanese Yen 330 266
Netherland Guilder 3,689 2,152
Singapore Dollar 368 82
--- --
Total $41,786 $59,641
======= =======
Note 14
Quarterly Financial Information (Unaudited)
(In thousands, First Second Third Fourth Fiscal
except per share amounts) Quarter Quarter Quarter Quarter Year
- ------------------------- ------- ------- ------- ------- ----
Year ended December 31, 1997
Revenue $ 47,562 $62,450 $65,011 $76,402 $251,425
Income (loss) before income taxes (13,082) (5,353) * 2,627 8,095 (7,713)
Net income (loss) (9,420) (3,854) * 1,891 5,857 (5,526)
Basic earnings (loss) per share (0.63) (0.25) 0.12 0.39 (0.36)
Diluted earnings (loss) per share (0.63) (0.25) 0.12 0.36 (0.36)
Year ended December 31, 1996
Revenue $ 66,744 $64,997 $64,622 $72,550 $268,913
Income (loss) before income taxes (10,417) * 3,351 4,575 4,303 1,812
Net income (loss) (11,820) * 2,513 3,431 3,232 (2,644)
Basic earnings (loss) per share (0.79) 0.17 0.23 0.22 (0.18)
Diluted earnings (loss) per share (0.79) 0.15 0.22 0.20 (0.18)
*Includes charges of $6.0 million in the second quarter of 1997 and $16.0
million in the first quarter of 1996 for merger, restructuring, write-off of
purchased in-process research and development and other costs.
39
<PAGE>
Independent Auditors' Report
To the Stockholders and the Board of Directors
FileNET Corporation
We have audited the accompanying consolidated balance sheets of FileNET
Corporation and its subsidiaries as of December 31, 1997 and 1996, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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, 1997 and 1996 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997 in conformity with generally accepted accounting principles.
February 3, 1998
Costa Mesa, California
Note 12
Related Party Transactions
The Company entered into a two-year agreement on May 20, 1997, to employ
its new President and Chief Operating Officer. Under the terms of the agreement,
the Company agreed to reimburse the officer for legal costs in defending a
lawsuit from the officer's former employer. The case was settled and the total
cost to the Company was charged to compensation expense in 1997.
Watermark originally entered into a republishing and distribution agreement
with a UK company (the Distributor) which provided the Distributor with
exclusive distribution rights of Watermark's products in defined territories.
The Chief Executive Officer of the Distributor is the brother of Watermark's
then President and Chief Executive Officer. During 1995, Watermark elected to
purchase the portion of the Distributor's business related to selling
Watermark's products at a negotiated price of $2.5 million that is included in
merger and other costs in 1995.
FileNET Asia Pacific, Pte. Ltd. (Singapore)
FileNET BV (The Netherlands)
FileNET Canada, Inc. (Canada)
FileNET Company Limited (Ireland)
FileNET Corporation Europe, EURL (France)
FileNET Corporation, Pty. Ltd. (Australia)
FileNET GmbH (Germany)
FileNET Hong Kong Limited (Hong Kong)
FileNET Iberia, S.L. (Spain)
FileNET International Corporation (U.S. Virgin Islands)
FileNET Corporation Korea (Korea)
FileNET Nihon (K.K.) (Japan)
FileNET Limited (England)
FileNET Corporation Italy (Italy)
FileNET Corporation International (Delaware)
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statements No.
33-90454, 33-96076, 33-80899, 333-02194, 333-09075 and 333-34031 on Form S-8 of
our reports dated February 3, 1998 appearing in and incorporated by reference in
the Annual Report on Form 10-K of FileNET Corporation for the fiscal year ended
December 31, 1997.
Costa Mesa, California
March 26, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> Year
<FISCAL-YEAR-END> Dec-31-1997
<PERIOD-END> Dec-31-1997
<CASH> 37,344
<SECURITIES> 26,600
<RECEIVABLES> 61,283
<ALLOWANCES> 0
<INVENTORY> 3,541
<CURRENT-ASSETS> 143,516
<PP&E> 89,027
<DEPRECIATION> 61,440
<TOTAL-ASSETS> 179,870
<CURRENT-LIABILITIES> 60,629
<BONDS> 0
0
0
<COMMON> 120,609
<OTHER-SE> (1,798)
<TOTAL-LIABILITY-AND-EQUITY> 179,870
<SALES> 162,145
<TOTAL-REVENUES> 251,425
<CGS> 35,098
<TOTAL-COSTS> 91,601
<OTHER-EXPENSES> 170,697
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (7,713)
<INCOME-TAX> (2,187)
<INCOME-CONTINUING> (5,526)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,526)
<EPS-PRIMARY> (0.36)
<EPS-DILUTED> (0.36)
</TABLE>
