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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period for _____________ to _______________.
Commission File No. 0-15997
FILENET CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 95-3757924
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3565 Harbor Boulevard
Costa Mesa, California 92626
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (714) 327-3400
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, $0.01
par value
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days: Yes [x] No [ ]
Indicate by check mark whether the disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of the Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [x]
Indicate by check mark whether the registrant is an accelerated filer as
defined by Rule 12b-2 of the Securities Exchange Act of 1934: Yes [x] No [ ]
Based on the closing sale price as of June 28, 2002, the aggregate market
value of the 30,973,825 shares of common stock of the Registrant held by
non-affiliates of the Registrant on such day was $449,120,463. For purposes of
such calculation, only executive officers, board members and beneficial owners
of more than 10% of our outstanding common stock are deemed to be affiliates.
The number of shares outstanding on the Registrant's common stock was
35,964,015 at March 25, 2003.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive proxy statement, to be delivered in
connection with the Registrant's 2003 Annual Meeting of Stockholders, are
incorporated by reference into Part III of this Report.
FILENET CORPORATION
2002 ANNUAL REPORT ON FORM 10-K
For the Year Ended December 31, 2002
TABLE OF CONTENTS
Page
PART I
Item 1. Business..............................................................3
Item 2. Properties...........................................................17
Item 3. Legal Proceedings....................................................18
Item 4. Submission of Matters to a Vote of Security Holders..................18
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder
Matters............................................................18
Item 6. Selected Financial Data..............................................19
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations..............................................20
Item 7a. Quantitative and Qualitative Disclosures About Market Risk...........33
Item 8. Financial Statements and Supplementary Data..........................34
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure...............................................34
PART III
Item 10. Directors and Executive Officers of the Registrant..................35
Item 11. Executive Compensation..............................................35
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters.........................................35
Item 13. Certain Relationships and Related Transactions......................35
Item 14. Controls and Procedures.............................................35
PART IV
Item 15. Financial Statement Schedule, Reports on Form 8-K, and Exhibits.....36
Signatures....................................................................39
Certifications................................................................40
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Forward-Looking Statements
In addition to historical information, this Annual Report on Form 10-K
contains forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995, Section 21E of the Securities Exchange Act of
1934, as amended, and Section 27A of the Securities Act of 1933, as amended, and
is subject to the safe harbors created by those sections. These forward-looking
statements involve risks and uncertainties, including those discussed herein and
in the notes to our financial statements for the year ended December 31, 2002,
certain sections of which are incorporated herein by reference as set forth in
Items 7 and 8 of this report. The actual results that we achieve may differ
materially from any forward-looking statements, which reflect management's
opinions only as of the date hereof. We undertake no obligation to revise or
publicly release the results of any revisions to these forward-looking
statements. Readers should carefully review the section entitled "Risk Factors"
and other documents we file from time to time with the Securities and Exchange
Commission, including our Quarterly Reports on Form 10-Q to be filed by us in
2003. Our business, financial condition, operating results and prospects can be
impacted by a number of factors, including but not limited to those set forth in
the section entitled "Risk Factors" and elsewhere in this report, any one of
which could cause our actual results to differ materially from recent results or
from our anticipated future results.
PART I
Item 1. Business
General
FileNet Corporation ("FileNet") was incorporated on July 30, 1982. We
develop, market, sell and support a software platform and framework for
Enterprise Content Management. Enterprise Content Management, or ECM, refers to
the broad range of functions used by organizations of all types, including
businesses and governmental agencies, to control and track the information, or
content, that is important to the organization's operations, whether that
information is used internally, such as sales data or product specifications, or
externally, such as content provided to customers through a Web site. The
content our software manages includes Web pages, word processing documents,
spreadsheets, HTML, XML, PDF, document images, email messages and other
electronic content. ECM also refers to processing, communicating and gathering
information within the organization and from third parties, such as processing
payments or applications for services. Our software offers customers the ability
to configure, design, build and deploy ECM solutions to meet the needs of their
particular business or organization. These solutions allow customers to manage
content throughout their organizations, automate and streamline their business
processes, and provide the broad-spectrum of connectivity needed to support
their critical and everyday decision-making.
We operate globally and sell our products and services to our customers
through a direct sales force, system integrators, resellers and value added
distributors. We invest significantly in product development to improve our
existing products and to increase our product offerings. We also offer
professional services for the implementation of these software solutions, as
well as 24 hours a day, 7 days a week technical support and services to our
customers on a global basis.
Available Information
Our filings with the Securities and Exchange Commission, including our
Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on
Form 8-K and amendments to those filings, pursuant to Sections 13(a) and 15(d)
of the Securities Exchange Act of 1934, are available free of charge at
www.filenet.com, when such reports are available at the Securities and Exchange
Commission Web site.
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Fiscal 2002 Developments and Strategy
During fiscal 2002, we focused our development efforts on enhancing and
integrating the capabilities of our Panagon platform, Brightspire eBusiness
framework, and Acenza applications. Also during the year, we acquired the
technology of eGrail, Inc. that brought us advanced Web Content Management
technology. By combining and enhancing the foregoing technologies we have
introduced FileNet P8 to provide a unified platform and framework for ECM. This
approach is intended to offer our customers the ability to easily configure,
design, build and deploy a variety of enterprise-wide ECM solutions to meet a
broad range of content management needs within a single scalable framework.
With the introduction of the FileNet P8 ECM architecture in early 2003, we
offer the following benefits:
o a single repository for all content types;
o unified object oriented Application Programming Interfaces to facilitate
rapid application development;
o common user and management interface across the entire architecture;
o portal integration to leverage a customer's existing application
(BEA, IBM, Siebel, SAP, Plumtree and
Microsoft's Sharepoint integration will be provided);
o connectivity to customer enterprise applications via an Enterprise
Application Integration capability and Virtual Content Management,
which provides the ability to interact with external content and events;
and
o enhanced Business Process Management capabilities including process
simulation allowing customers to optimize business processes on a
real-time basis.
We have packaged our ECM capabilities into four logical FileNet P8
suites/solutions that include the Business Process Manager, Content Manager, Web
Content Manager and the Image Manager. Each of these ECM suites emphasizes a
different aspect of the ECM framework. When our customers purchase a FileNet P8
solution they have the ability to add-on additional FileNet P8 suite
capabilities to their existing FileNet P8 architecture as needed, allowing them
flexibility to acquire only the functionality they need. This deep integration
allows for a lower total cost of ownership by reducing support costs and
application development times.
We intend to continue to leverage our market leadership, expansive
installed customer base, financial strengths, strong development capabilities,
and substantial worldwide distribution and service network to deliver on our
uniform platform strategy. We also intend to continue our strategy of investing
in product enhancements and introduction through new product developments, new
partnerships, and strategic acquisitions.
Markets and Customers
We believe the FileNet P8 architecture offers our customers the ability to
scale their ECM solutions to the enterprise-level and offers the flexibility to
manage demanding content challenges, complex business processes, and integration
with an organization's existing systems. The FileNet P8 architecture is designed
to provide our customers with a way to manage their enterprise content, which
can provide greater process control and consistency throughout the enterprise.
Our customers include Global 2000 organizations and are typically those
enterprises and government agencies that have complex business
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processes that manage, store, and share large volumes of digital content. As of
December 31, 2002, our software has been licensed to more than 3,800 customers
worldwide.
Our software solutions are effective for a variety of applications such as
mortgage loan servicing, customer relationship management, insurance claims
processing, regulatory compliance, accounts payable and receivable, and for any
business operation that processes significant amounts of electronic information
or content in their day-to-day operations. Additionally, our software products
can address ad hoc business processes at the enterprise, departmental, and
workgroup levels to improve overall enterprise productivity, and can integrate
with industry-standard productivity and enterprise applications such as Lotus
Notes, Microsoft Office, SAP, Siebel, and others.
We market our products in more than 90 countries around the world through a
direct sales force and through our ValueNet business partner program. The
ValueNet program brings together value-added resellers, independent software
vendors, system integrators, consultants and service providers to deliver a
broad range of solutions and services to our customers worldwide. Further, our
strategic alliances with other industry leaders contribute to our efforts in
product development, customer satisfaction, and worldwide market penetration.
More than 250 firms operate under the ValueNet program and combine our software
products with industry-specific, value-added services and applications to
provide turnkey ECM solutions for customers. Our ECM solutions are applicable in
a wide variety of industries. Historically, our key vertical markets are
insurance, financial services, government, manufacturing, telecommunications,
and utilities.
Using our standard software products, customers generally build
applications that address their particular needs. Very often these applications
can involve a significant change in the way a customer organization operates.
Consequently, our sales cycle, or the time from initial customer contact to
completed product sale, can be lengthy, and our quarterly sales typically
include a mix of medium sized sales with a smaller number of large orders. We
typically ship our products within a short period of time after acceptance of
orders, which is common in the computer software industry.
Our global customer support operation offers software maintenance and
technical support services for our products worldwide. These technical support
programs offer a wide range of services including the right to new versions of
the majority of our software, extended phone support coverage, on-site technical
consultants, a technical account management program, and software development
kit support.
Our professional services operation offers business and technical
consulting services and training to both end-users for our products and to
ValueNet partners on our standard software products. These professional services
are marketed by our direct sales force and through the ValueNet business partner
program, with a focus on FileNet centric enterprise system implementation and
the delivery of ECM applications.
Industry Segments and Geographic Information
For the purposes of Statement of Financial Accounting Standards ("SFAS")
No. 131, "Disclosures About Segments of an Enterprise and Related Information,"
we have provided a breakdown of our sales, operating results and other
information using the management approach in Note 16 of the "Notes to
Consolidated Financial Statements" under Item 8, "Financial Statements and
Supplementary Data." Using the management approach, our principle reportable
operating segments include Software, Customer Support, Professional Services and
Education, and Hardware. A summary of our sales by geographic location is
incorporated herein by reference from Note 16 of the "Notes to Consolidated
Financial Statements" under Item 8, "Financial Statements and Supplementary
Data."
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Software Products and Solutions
FileNet P8
Prior to the introduction of the FileNet P8 architecture we marketed our
products under the discreet brand names Panagon, Brightspire, and Acenza.
Additionally, we acquired a Web Content Management product from eGrail, Inc. on
April 2, 2002. We have combined these discrete brands and products into a
uniform architecture known as FileNet P8. The FileNet P8 architecture offers
enterprise-level scalability and flexibility to handle demanding content
challenges, complex business processes, and integration to existing systems that
a customer may have. The FileNet P8 architecture provides a framework for
functional expansion to provide enhanced content and process management across
an enterprise.
FileNet P8 architecture, a standards-based, enterprise application
framework, features four pre-packaged suites, each emphasizing a different
aspect of the ECM solution set, with functions grouped in a logical order that
are designed to meet a customer's individual ECM needs. Each suite can be
implemented by a customer individually, but remains expandable to include all
FileNet P8 ECM capabilities as may be required. FileNet ECM solutions are
designed to manage content; allowing organizations to create, use, and activate
that content in order to make decisions and bring control and consistency to
business processes.
FileNet P8 Suites
Business Process Manager
FileNet Business Process Manager is an ECM solution that we believe helps
organizations increase process performance, reduce cycle times, and improve
productivity by managing the flow of work through automating, streamlining, and
optimizing complex processes associated with business operations. The operations
of many businesses involve gathering information and making decisions based on
that information, and many of these decisions, or the steps leading up to them,
can be automated to increase efficiency and create a more standardized approach
to these decisions throughout the business organization. Examples of customer
business processes that may benefit from our Business Process Manager solution
include insurance companies that have automated policy underwriting decisions
and claims processing, financial services companies that have streamlined the
loan origination and servicing processes, and government agencies that have
automated case management and tax processing functions. The Business Process
Manager can provide an interface for gathering necessary information and either
make decisions based on automated criteria or direct that information to the
appropriate decision-maker in an efficient and consistent basis. This product is
standards based, flexible and can be customized to a wide range of industries.
Content Manager
FileNet Content Manager is an ECM solution that combines content management
with workflow processes to help organizations manage complex documents and
control, share, and access critical business information. Content Manager is
intended to assist with all steps in the content life cycle, from creation and
tracking to storing and controlling access to relevant information. It activates
content by allowing an organization to make content available to the right place
at the right time - to support the business decision-making process at any level
of the organization. The Content Manager's secure and scalable environment
integrates directly with desktop and business applications so business users can
collaborate on the creation and management of content, while controlling access
as necessary.
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Web Content Manager
FileNet Web Content Manager is designed to combine easy-to-use Web site
development capabilities with integrated process capabilities for managing the
creation, approval and publication of Web content and complex documents to
multiple Web sites, in multiple formats, and in multiple languages. The Web
Content Manager allows centralized control of Web site content and appearance
while allowing particular content to be directly created and updated by
organization members without specialized Web expertise, through the use of
controlled templates and other tools. Web Content Manager can control large
amounts of dynamic Web content across globally distributed sites and provides
integrated process management capabilities to help ensure secure and accurate
Web content publication.
Image Manager
FileNet Image Manager is designed to be highly scalable and provides rapid
access for end-users to fixed objects, or content that is not intended to be
modified, such as scanned documents, faxes, email and rich media. It is designed
to securely and permanently store critical business information in a robust and
available environment to safeguard critical content from disaster and misuse
while making it more accessible to thousands of users. Among other applications,
FileNet Image Manager has been used by organizations such as municipal court
systems to scan, track and provide access to important case documents.
FileNet P8 Technology
Each of the FileNet P8 Suites takes advantage of the FileNet P8
architecture, which includes the following technology for aiding in the
development of ECM solutions:
Content Engine provides software services for managing content and other
business-related data, collectively referred to as objects. In addition to
managing documents and any customer defined objects, the Content Engine manages
a broad range of enterprise content including workflow definitions, stored
searches, publishing templates, entry templates, web content management
templates, analytics reports, and simulation scenarios.
Process Engine is the component for design, execution and tracking of processes.
It manages all processes and their associations with documents, data, and
lifecycle information residing in the Content Engine. It also tracks and records
the status of work in progress. The Engine drives processes, associates
information, manages work-to-do, sends notifications, sets milestones, provides
reporting and tracking capabilities, and provides the most up-to-date
information to all participants.
Enterprise Application Integration provides connectors for integrating process
and content with enterprise applications. In addition, FileNet offers an
optional EAI server through an OEM agreement for IBM CrossWorlds InterChange
Server, Connectors, and Collaborations. The connectors provided by FileNet
provide integration with enterprise applications such as SAP R/3, Siebel, and
Clarify as well as technologies such as XML, Web Service, JMS, and MQSeries.
FileNet P8 Workplace is an end-user application that provides a Web-based
interface to FileNet P8. It is designed to allow users to locate business
content, initiate new transactions, check status and track a wide variety of
processes and information across multiple storage locations or systems.
Customizable and platform independent, FileNet P8 Workplace is designed to
enable employees, partners and customers to manage work processes through a
simple interface.
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Web Content Manager ("WCM") is an application that provides web content
management capabilities that leverage the core content and process management
capabilities provided in the platform.
Java2 Platform Enterprise Edition (J2EE) Support provides J2EE application
components and system components that operate in J2EE Platform Products
(application servers) such as BEA WebLogic and IBM WebSphere. In addition,
FileNet applications leverage the J2EE application model to build multi-tier
applications that deliver the scalability, accessibility, and manageability
required by enterprise applications.
Web Application Toolkit provides a framework for developing web applications
that run in a J2EE environment. The toolkit is used by several FileNet P8
applications, including Workplace, Solution Templates, and the Web Content
Manager.
Portal Integrations provide commonly required content and process functionality
within 3rd party portal products. Initially, FileNet is providing a portal
integration for BEA WebLogic Portal. Other portal product integrations will be
provided in the future. However, customers and partners can create their own
portlets using FileNet's Java Application Programming Interfaces. In addition,
FileNet distributes the source code for the Portlets so that customers and
partners can modify and extend the capabilities if desired.
Solution Templates are a set of predefined objects and processes for use in
developing industry specific solutions. Built on the FileNet P8 architecture, a
Solution Template provides working code that can be configured and extended to
build complete applications. A Solution Template is not a turnkey application;
rather, it can be thought of as an application development template. By
providing much of the application's core infrastructure, it can significantly
reduce the length of solution development and deployment cycle.
Initially, FileNet is providing a Case Management Solution Template and Lending
Solution Template. The Case Management Solution Template leverages the Case
Management Application Programming Interfaces to provide generic case processing
functionality. The Lending Solution Template uses the generic Case Management
Solution Template to implement a commercial lending template.
Stand-Alone Products
In addition to the FileNet P8 product suites and development tools the
following FileNet software products are available to our customers as
stand-alone products providing some of the functionality available through the
full FileNet P8 architecture, and were formally available under the Panagon
and/or Brightspire brands.
FileNet eProcess Services is a Web browser-based process management product.
eProcess Services enables an organization to create and manage high-volume,
mission-critical automated business processes in a dynamic Web environment. Our
Web-based user interface, built-in eProcess applications, Web server components,
and XML architecture are easy to use and provide scalable connectivity of
business processes for employees, business partners, and customers.
FileNet Web Services combines a full-featured, Web browser-based client system
that allows access to content without the need to locally download information
or content. FileNet Web Services also combines a comprehensive Web-based
application development toolkit, and Web server components, and is designed to
support complex and mission critical ECM and Business Process Management
activities. This application provides a complete set of content management
functionality, allowing users to check in, check out, search and browse, share,
revise, and change properties for content stored in a FileNet repository, all
from a Web browser.
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FileNet Content Services is a repository for creating, accessing, managing,
securing, and dynamically updating electronic documents and content. Content
Services is designed to allow a business to manage enterprise content from
creation, to secure delivery, to revision and re-use.
FileNet WorkFlo Services is FileNet's high-performance eProcess workflow engine.
WorkFlo Services, combined with eProcess Services, is designed to enable
customers to automate and access critical business processes and associated
content. WorkFlo Services can be used to create applications that reflect the
way business processes are performed within the particular customer's
organization, and is a critical enabling technology for the automation of
business processes via the Web. It allows organizations to control and modify
their work processes to meet their evolving needs, and integrates the flow of
information between software applications within a company's business processes.
WorkFlo Services supports multiple client, server and applications development
environments, such as Java and COM, and integrates with leading business process
re-engineering products for reduced implementation time.
FileNet Integrated Document Management ("IDM") Desktop is a Microsoft Windows
client software application designed to allow users to view, manage, revise,
share, and distribute content across an enterprise for ad hoc or mission
critical use. IDM Desktop allows users to manage content directly from within
Microsoft Office and Lotus Notes applications.
FileNet Image Services is an image and object server designed to allow
businesses to manage the high-speed acquisition, distribution, and access of
content and objects of all types.
FileNet Report Manager is an online statement and report management system.
Report Manager is designed to allow organizations the ability to capture, store
and access legacy print data streams within ECM applications by storing,
accessing, mining, and analyzing computer-generated reports, statements and
forms.
FileNet Capture addresses document and content capture needs. Available in
high-volume Capture Professional or small department Capture Desktop versions,
Capture is designed to acquire digital and paper-based content into FileNet ECM
repositories for enterprise-wide use and online access.
FileNet Document Warehouse for SAP software is a document and data archiving
application certified by SAP, designed for use with the SAP R/3 Enterprise
Resource Planning ("ERP") application suite.
FileNet ECM Applications
Based on our FileNet P8 core technologies, FileNet ECM applications help
streamline the business processes associated with acquiring and servicing
customers and business partners across the Web. FileNet ECM applications can
automate core front office and back-office business processes and systems, make
these business processes available externally through the Web, and create and
manage associated content using the latest FileNet P8 products and technology.
The FileNet product family includes the following ECM applications,
formerly known as Acenza eBusiness applications:
FileNet for Insurance is designed to enable insurance organizations to improve
operational efficiency and customer service by delivering Web-based business
process management solutions. FileNet for Insurance can provide the following
capabilities: eliminates or reduces filing costs; provides efficient and
accurate self-service that is customer friendly; improves workers' efficiency
and utilization of their knowledge to reduce processing time and costs; improves
customer satisfaction; and supports the rapid deployment of Web-enabled claims,
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underwriting and policy administration operations, linking customers,
agents/brokers, and employees in shared processes and content.
FileNet Payables is designed to streamline the accounts payable process,
allowing accounting staff to handle more purchase transactions. Invoices
presented in paper, fax or electronic form can be captured, filed securely, and
routed for data entry and approval automatically. A Web interface allows status
checking and approval of invoices to be deployed cost-effectively across the
enterprise and to business partners.
Hardware
We also manufacture and market an Optical Storage And Retrieval ("OSAR")
library product based on 12-inch, 30 gigabyte, optical disk technology for
storage management of business critical content. Our core business focus is on
software solutions for the management of content, and we would expect hardware
sales to continue to decrease as a percentage of our total revenues.
Services, Support, and Manufacturing
We operate service and support organizations on a global basis to provide
both pre-sales and post-sales services to ensure successful implementation of
our products and customer satisfaction. Due to the highly customizable nature of
our products, many of our product sales are coupled with contracts for
continuing support services.
Our worldwide Customer Service and Support organization provides
comprehensive support capabilities including electronic and real-time phone
support and global call tracking for customers and partners on support programs.
Highly skilled and experienced systems engineers deliver support coverage on
multiple platforms with 24-hour call handling. Our technical Web site offers the
ability to open cases, search our knowledge base and review related status
reports.
Support programs may be customized and enhanced with optional fee-based
services. These options include after hours phone coverage, on-site technical
consultants to assist with upgrades and FileNet product installations, and
FileNet Software Development Kit support for development teams building
applications using our products.
Our manufacturing facilities in Costa Mesa, California and Dublin, Ireland,
conduct software manufacturing and distribution, localization, integration, test
and quality control.
Professional Services and Education
Our worldwide professional services organization provides consulting,
development, architecture and other technical services to our licensed customers
and training services. These services are provided through in-house employees
and through a network of qualified partners. Our worldwide professional services
organization understands the requirements for implementing an ECM solution and
offers a comprehensive methodology to install, integrate, customize and deploy
our solutions. These services range from the management of large-scale
implementations of our products to prepackaged standard services such as
software installation. Our educational curriculum includes training courses for
end users, application developers and system administrators through media-based
and instructor-led training.
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Research and Development
We have made and expect to continue to make substantial investments in
research and development, primarily through internal development activities,
third party licensing agreements and through technology acquisitions. Our
development efforts focus on our unified FileNet P8 ECM architecture as we
continue to develop and improve a complete ECM capability to service all aspects
of our customers' business content needs. Additionally, we license and embed
third party software that enhances the functionality of our products through a
variety of agreements with the producers of this software. Expenditures for
research and development were $71.7 million; $68.8 million and $57.9 million for
the years ended December 31, 2002, 2001, and 2000, respectively.
We expect to continue to look for technology acquisitions that offer us
additional product know-how or domain knowledge where appropriate and will
continue to embed in our products third party products that enhance our product
line. We intend to continue to invest significantly in internal development with
a focus on developing new functionality in Enterprise Content Management and
Business Process Management applications that provide a richer competitive
product offering to our customers.
Our future success depends, in part, on our ability to execute on our
strategy of offering a unified platform and framework for Enterprise Content
Management that gains customer acceptance. This strategy may require us to
develop and maintain relations with technology partners. If we fail to
successfully execute on our integrated product solution strategy or if we fail
to maintain or establish relationships with technology partners, or if release
dates of any future products or enhancements are delayed, or if these products
or enhancements fail to achieve market acceptance when released, our business
operating results and financial condition could be materially harmed. In the
past, we have experienced delays in the release dates of enhancements and new
releases to our products and we cannot assure that we will not experience
significant future delays in product introduction. From time to time, either we
or our competitors may announce new software products, capabilities or
technologies that have the potential to replace or shorten the life cycles of
our existing software products. We cannot assure that announcements of currently
planned or other new software products will not cause customers to delay their
purchasing decisions in anticipation of such software products, and such delays
could have a material adverse effect on our business and operating results.
Competition
The market for our products is highly competitive and competition will
continue to intensify. We compete with a large number of Enterprise Content
Management, Web content management, business process management, workflow,
document imaging, and electronic document management companies. IBM is the
largest company that competes directly with FileNet in the content and process
management market. Documentum is a key competitor in the Content Management
Market. Numerous smaller software vendors also compete in each product area. We
also experience competition from systems integrators who configure hardware and
software into customized systems.
Large infrastructure vendors such as Oracle Corporation and Microsoft
Corporation have developed products or plan to offer products in the content
management market. Software vendors such as Tibco Software, Inc., Savvion, Inc.
and Pegasystems, Inc., each with a different core product foundation, have begun
to approach the business process management market from their individual market
segments and may compete more intensely with us in the future. It is also
possible that new competitors or alliances among competitors may emerge and
rapidly acquire significant market share. We also expect that competition will
increase as a result of software industry consolidations.
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We believe that the principal competitive factors affecting the market for
our software products and services include vendor and product reputation;
product quality, performance and price; the availability of software products on
multiple platforms; product scalability; product integration with other
enterprise applications; software functionality and features; software ease of
use; and the quality of professional services, customer support services and
training. The relative importance of each of these factors depends upon the
specific customer involved.
Certain of our competitors and potential competitors may have greater
resources, larger sales and marketing teams, broader product lines and more
experience developing software than we do. Increased competition may result in
price reductions, reduced gross margins and loss of market share, any of which
could have a material adverse effect on our business, financial condition or
results of operations.
Trademarks
FileNet, WorkFlo Services, ValueNet, OSAR, Watermark, Panagon, Acenza,
Brightspire, Document Warehouse, and FileNet Workgroup are trademarks or
registered trademarks of FileNet Corporation that are referenced in this Form
10K. All other brands or product names are trademarks or registered trademarks
of their respective companies.
Patents and Licenses
As of December 31, 2002, we have four issued U.S. patents and five pending
U.S. patent applications. Our subsidiary, 3565 Acquisition LLC, has one pending
U.S. patent application. We have applied for and may in the future apply for
patent protection in foreign countries. We have also entered into non-exclusive
license arrangements with a number of organizations, including IBM and Oracle,
which permit us and our resellers to grant sublicenses to end-users of our
systems to use software developed by these third party vendors.
Employees
As of December 31, 2002 we had 1,705 full-time employees, of which 430 were
employed in research and development; 458 in sales; 83 in marketing; 235 in
education and professional services; 252 in customer support; 80 in operations;
and 167 in administration. No employees are represented by labor unions, and we
have never experienced a work stoppage. We believe that we enjoy good employee
relations.
Risk Factors
Our business, financial condition, operating results and prospects can be
impacted by a number of factors, including but not limited to those set forth
below and elsewhere in this report, any one of which could cause our actual
results to differ materially from recent results or from our anticipated future
results. Factors that may affect our business, financial condition and results
of operations include:
Our quarterly operating results may fluctuate in future periods and are not
predictable and, as a result, we may fail to meet expectations of investors and
analysts, causing our stock price to fluctuate or decline. Prior growth rates in
our revenue and operating results should not necessarily be considered
indicative of future growth or operating results. Our operating results have
fluctuated in the past and we anticipate our future operating results will
continue to fluctuate due to many factors, some of which are largely beyond our
control.
12
These factors include, but are not limited to, the following:
o the industry-wide slow down in IT spending;
o general domestic and international economic and political conditions;
o the discretionary nature of our customers' budget and purchase cycles
and the absence of long-term customer purchase commitments;
o the tendency to realize a substantial percentage of our revenue in
the last weeks, or even days, of each quarter;
o the potential for delays or deferrals of customer orders;
o the size, complexity and timing of individual transactions;
o changes in foreign currency exchange rates;
o the length of our sales cycle;
o variations in the productivity of our sales force;
o the level of software product sold and price competition;
o the timing of new software introductions and software enhancements
by us and our competitors;
o the mix of sales by products, software, services and distribution
channels;
o project overruns associated with fixed price contracts;
o acquisitions by us and our competitors;
o our ability to develop and market new software products and control
costs;
o the quality of our customer support; and
o the level of international sales.
The decision to implement our products is subject to each customer's
resources and budget availability. Our quarterly sales generally include a mix
of medium sized orders, along with several large individual orders, and as a
result, the loss or delay of an individual large order could have a significant
impact on our quarterly operating results and revenue. Our operating expenses
are based on projected revenue trends and are generally fixed. Therefore, any
shortfall from projected revenue may cause significant fluctuations in operating
results from quarter to quarter. As a result of these factors, revenues and
operating results for any quarter are subject to fluctuations and are not
predictable with any significant degree of accuracy. Therefore, we believe that
period-to-period comparisons of our results of operations should not be relied
upon as indications of future performance. Moreover, such factors could cause
our operating results in a given quarter to be below the expectations of public
market analysts and investors. In either case, the price of our common stock
could decline materially.
The markets in which we operate are highly competitive and we cannot be
sure that we will be able to continue to compete effectively, which could result
in lost market share and reduced revenue. The markets we serve are highly
competitive and we expect competition to intensify. Our future financial
performance will depend primarily on the continued growth of the markets for our
software products and services as well as the purchase of our products by
customers in these markets. If the markets we serve fail to grow or grow more
slowly than we currently anticipate, our business, financial condition and
operating results would be harmed. These intensely competitive markets can
change rapidly. There are multiple competitors of ours and there may be future
competitors, some of which have or may have substantially greater sales,
marketing, development and financial resources. As a consequence, our present or
future competitors may be able to develop software products comparable or
superior to those offered by us, offer lower priced products or adapt more
quickly than we do to new technologies or evolving customer requirements. In
order to be successful in the future, we must respond to technological change,
customer requirements and competitors' current software products and
innovations. We cannot assure that we will be able to continue to compete
effectively in our target markets or that future competition will not have a
material adverse effect on our business, financial condition or results of
operations. In addition, current and potential competitors have established or
13
may establish cooperative relationships among themselves or with third parties
to increase the ability of their products to address the needs of the markets we
serve. Accordingly, it is possible that new competitors or alliances among
competitors may emerge and rapidly acquire significant market share. Increased
competition may result in price reductions, reduced gross margins and loss of
market share that could result in reduced revenue.
We must develop and sell new products to keep up with rapid technological
change in order to achieve future revenue growth and profitability. The market
for our software and services is characterized by rapid technological
developments, evolving industry standards, changes in customer requirements and
frequent new product introductions and enhancements. Our ability to continue to
sell products will be dependent upon our ability to continue to enhance our
existing software and services offerings, develop and introduce, in a timely
manner, new software products incorporating technological advances and respond
to customer requirements. Our future success also depends, in part, on our
ability to execute on our strategy of developing a unified platform and
framework for Enterprise Content Management. This strategy requires us to make
long-term investments and commit significant resources based on our prediction
of new products and services that the market needs and will accept. Our strategy
also requires us to develop and maintain relations with technology partners. We
may not be successful in maintaining these relationships or in developing,
marketing and releasing new products or new versions of our products that
respond to technological developments, evolving industry standards or changing
customer requirements. We may also experience difficulties that could delay or
prevent the successful development, introduction and sale of these products and
enhancements. In addition, these products and enhancements may not adequately
meet the requirements of the marketplace and may not achieve any significant
degree of market acceptance. If we fail to successfully maintain or establish
relationships with technology partners or to execute on our integrated product
solution strategy, or if release dates of any future products or enhancements
are delayed, or if these products or enhancements fail to achieve our prediction
of market acceptance when released, our business operating results and financial
condition could be materially harmed. In the past, we have experienced delays in
the release dates of enhancements and new releases to our products and we cannot
assure that we will not experience significant future delays in product
introduction. From time to time, our competitors or we may announce new software
products, capabilities or technologies that have the potential to replace or
shorten the life cycles of our existing software products. We cannot assure that
announcements of currently planned or other new software products will not cause
customers to delay their purchasing decisions in anticipation of such software
products, and such delays could have a material adverse effect on our sales.
We must effectively manage our new product and services transitions or our
revenue may suffer. If we do not make an effective transition from existing
products and services to our P8 architecture, our revenue may be seriously
harmed. Among the factors that make a smooth transition difficult are delays in
development, variations in pricing, delays in customer purchases in anticipation
of new introductions and customer demand for the new offerings. If we incur
delays in customer purchases or do not accurately estimate the market effects of
new introductions, future demand for our products and services and our revenue
may be seriously harmed.
Protection of our intellectual property and other proprietary rights is
limited, which could result in the use of our technology by competitors or other
third parties. There is risk of third-party claims of infringement, which could
expose us to litigation and other costs. Our success depends, in part, on our
ability to protect our proprietary rights to the technologies used in our
principal products. We rely on a combination of copyrights, trademarks, trade
secrets, patents, confidentiality procedures and contractual provisions to
protect our proprietary rights in our software products. We cannot assure that
our existing or future copyrights, trademarks, trade secrets, patents or other
intellectual property rights will have sufficient scope or strength to provide
meaningful protection or a commercial advantage to us. In addition, the laws of
some foreign countries do not protect our proprietary rights to the same extent,
14
as do the laws of the United States. Any inability to protect our intellectual
property may harm our business and competitive position.
We may, from time to time, be notified that we are infringing certain
patent or intellectual property rights of others. While there are no material
actions currently pending against us for infringement of patent or other
proprietary rights of third parties, we cannot assure that third parties will
not initiate infringement actions against us in the future. Combinations of
technology acquired through past or future acquisitions and our technology will
create new software products and technology that also may give rise to claims of
infringement. Infringement actions can result in substantial costs and diversion
of resources, regardless of the merits of the actions. If we were found to
infringe upon the rights of others, we cannot assure that we could redesign the
infringing products or could obtain licenses on acceptable terms, if at all.
Additionally, significant damages for past infringement could be assessed or
future litigation relative to any such licenses or usage could occur. An adverse
disposition of any claims or the advent of litigation arising out of any claims
of infringement could result in significant costs or reduce our ability to
market any affected products.
We depend on certain strategic relationships in order to license
third-party products and revenue related to these products could be at risk if
we were unable to maintain these relationships. In order to expand the
distribution of our products and broaden our product offerings, we have
established strategic relationships with a number of indirect channel partners
and other consultants that provide marketing and sales opportunities for us. We
have entered into key formal and informal agreements with other companies such
as IBM CrossWorlds, Microsoft Corporation, SAP AG, Siebel Systems Inc, Sun
Microsystems, Inc., BEA, EMC and Verity, Inc. Certain of these agreements have
minimum purchase requirements and/or require prepayments which usage is limited
to a specific timeframe while others do not have minimum purchase requirements
and/or are cancelable at will. We cannot assure that these companies will not
reduce or discontinue their relationships with, or support of, FileNet and our
products. Our failure to maintain these relationships, or to establish new
relationships in the future, could harm our business, financial condition and
results of operations.
We currently license certain software from third parties, including
software that is integrated with internally developed software and used in our
products to perform key functions. In the past, we have had difficulty renewing
certain licenses. The failure to continue to maintain these licenses would
prohibit us from selling certain products. We cannot assure that such third
parties will remain in business, that they will continue to support their
software products or that their software products will continue to be available
to us on acceptable terms. The loss or inability to maintain any of these
software licenses could result in shipment delays or reductions in software
shipments until equivalent software can be developed, identified, licensed, and
integrated. In addition, it is possible that as a consequence of a merger or
acquisition transaction involving one of these third parties, certain
restrictions could be imposed on our business that had not been imposed prior to
the transaction. This could adversely affect our sales.
We must retain and attract key executives and personnel who are essential
to our business, which could result in increased personnel expenses. Our success
depends to a significant degree upon the continued contributions of our key
management, as well as other marketing, technical and operational personnel. The
loss of the services of one or more key employees could have a material adverse
effect on our operating results. We also believe our future success will depend
in large part upon our ability to attract and retain additional highly skilled
management, technical, marketing, product development and operational personnel
and consultants. There is competition for such personnel; particularly software
developers, professional service consultants and other technical personnel, and
pay scales in the software industry have significantly increased. We cannot
assure that in the future we will be successful in attracting and retaining such
personnel.
15
A significant percent of our revenue is derived internationally and we are
subject to many risks internationally, which could put our revenue at risk.
Historically, we have derived approximately 25%-30% of our total revenue from
international sales through our worldwide network of subsidiaries and channel
partners. International business is subject to certain risks including, but not
limited to, the following:
o political and economic instability;
o tariffs and trade barriers;
o varying technical standards;
o reduced protection for intellectual property rights in certain countries;
o difficulties in staffing and maintaining foreign operations;
o difficulties in managing foreign distributors;
o varying requirements for localized products;
o potentially adverse tax consequences;
o currency restrictions and currency exchange fluctuations including those
related to the euro;
o the burden of complying with a wide variety of complex foreign laws,
regulations and treaties;
o the possibility of difficulties in collecting accounts receivable; and
o longer accounts receivable cycles and financial instability among customers.
Any of these factors could reduce the amount of revenue we realize from our
international operations in the future.
If our products contain errors we could incur unplanned expenses and delays
that could result in reduced revenue, lower profits, and harmful publicity.
Software, services and products, as complex as those we sell, are susceptible to
errors or failures, especially when first introduced or deployed. Our software
products are often intended for use in applications that are critical to a
customer's business. As a result, our customers may rely on the effective
performance of our software to a greater extent than the market for software
products generally. Despite internal testing and testing by current and
potential customers, new products or enhancements may contain undetected errors
or performance problems that are discovered only after a product has been
installed and used by customers. Errors or performance problems could cause
delays in product introduction and shipments or could require design
modifications, either of which could lead to a loss in or delay of revenue.
These problems could cause a diversion of development resources, harm our
reputation or result in increased service or warranty costs, or require the
payment of monetary damages. While our license agreements with customers
typically contain provisions designed to limit our exposure to potential product
liability claims, it is possible that such limitation of liability provisions
may not be effective under the laws of certain jurisdictions.
Our stock price has been and may continue to be volatile causing
fluctuations in the market price of our stock, which would impact shareholder
value. The trading price of our common stock has fluctuated in the past and is
subject to significant fluctuations in response to the following factors, among
others, some of which are beyond our control:
o variations in quarterly operating results;
o fluctuations in our order levels;
o changes in earnings estimates by analysts;
o announcements of technological innovations or new products or product
enhancements by us or our competitors;
o key management changes;
o changes in joint marketing and development programs;
o developments relating to patents or other intellectual property rights
or disputes;
16
o developments in our relationships with our customers, resellers and
suppliers;
o our announcements of significant contracts, acquisitions, strategic
partnerships or joint ventures;
o general conditions in the software and computer industries;
o fluctuations in general stock market prices and volume, which are
particularly common among highly volatile securities of Internet and
software companies; and
o other general economic and political conditions.
In recent years, the stock market, in general, has experienced extreme
price and volume fluctuations that have affected the market price for many
companies in industries similar to ours. Some of these fluctuations have been
unrelated to the operating performance of the affected companies. These market
fluctuations may decrease the market price of our common stock in the future.
Acquisitions of companies or technologies may result in disruptions to our
business and diversion of management attention, which could cause our financial
performance to suffer. As part of our business strategy, we frequently evaluate
strategic acquisition opportunities. For example, on April 2, 2002, we acquired
certain assets and assumed certain liabilities of eGrail, Inc., a Web content
management company, for a purchase price of $9.0 million in cash. We anticipate
that our future growth may depend in part on our ability to identify and acquire
complementary businesses, technologies or product lines. Acquisitions involve
significant risks and could divert management's attention from the day-to-day
operations of our ongoing business. Additionally, such acquisitions may include
numerous other risks, including, but not limited to the following:
o difficulties in the integration of the operations, products and personnel
of the acquired companies;
o the incurrence of debt;
o liabilities and risks that are not known or identifiable at the time of
the acquisition;
o difficulties in retaining the acquired company's customer base; and
o the potential loss of key personnel of the acquired company.
If we fail to successfully manage future acquisitions or fully integrate
future acquired businesses, products or technologies with our existing
operations, we may not receive the intended benefits of the acquisitions and
such acquisitions may harm our business and financial results.
We depend on a single source for certain hardware components and revenue
related to these products could be at risk if we were unable to obtain
inventory. Certain components for the Company's proprietary 12-inch OSARs are
available only from a single source. Any inability to obtain components in the
amounts needed on a timely basis could result in delays in product shipments
that could have an adverse effect on the Company's operating results. However,
the Company has qualified and is able to purchase and sell 5 1/4-inch optical
storage and retrieval devices from an alternative source which could be utilized
by the Company's customers in the event of any interruptions in the delivery of
components for the Company's own OSAR product.
Item 2. Properties
We currently lease 336,000 square feet of office, development and
manufacturing space in Costa Mesa, California and 91,000 square feet of office
and development space in Kirkland, Washington. In addition, we lease 24,500
square feet of office and manufacturing space in Dublin, Ireland. We also lease
sales and support offices in 29 locations in the United States, 18 locations in
17
Europe, 3 locations in Australia, 2 locations in Canada, and 4 locations in
Asia. We believe that the Costa Mesa, Dublin and Kirkland facilities will be
adequate for our anticipated development and manufacturing needs through 2003.
Item 3. Legal Proceedings
In the normal course of business, we are subject to ordinary routine
litigation and claims incidental to business. While the results of litigation
and claims cannot be predicted with certainty, we believe that the final outcome
of these matters will not have a materially adverse effect on our consolidated
results of operations or financial conditions.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended December 31, 2002.
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters
Our common stock is traded on the Nasdaq National Market under the symbol
"FILE". The following are the high and low sale prices from January 1, 2001
through December 31, 2002, as reported by Nasdaq:
High Low
Year Ended December 31, 2002
4th Quarter $ 14.23 $ 8.64
3rd Quarter 15.50 10.09
2nd Quarter 17.98 11.35
1st Quarter 23.10 16.01
Year ended December 31, 2001
4th Quarter $ 21.41 $ 9.00
3rd Quarter 14.86 8.95
2nd Quarter 16.23 8.88
1st Quarter 29.13 12.75
The closing price of our common stock at December 31, 2002 was $12.20. The
approximate number of stockholders of record as of March 12, 2003 (record date
for 2003 Annual Meeting of Stockholders) was 518. The closing price of our
common stock on that date was $11.38.
We have not paid any dividends on our common stock. We currently intend to
retain earnings for use in our business and do not anticipate paying cash
dividends in the foreseeable future. We are prohibited from paying cash
dividends under the terms of our line of credit agreement.
18
Item 6. Selected Financial Data
The following table summarizes certain selected financial data and should
be read in conjunction with our consolidated financial statements and the notes
thereto, and Item 7, Management's Discussion and Analysis of Financial Condition
and Results of Operations. The selected consolidated statements of operations
and balance sheet data as of and for each of the five years in the period ended
December 31, 2002 have been derived from our audited financial statements.
(In thousands, except per share amounts)
Fiscal Years Ended December 31, 2002 2001 2000 1999 1998
Consolidated statements ofoperations data:
Revenue:
Software $ 132,508 $ 119,014 $ 204,872 $ 183,316 $ 171,239
Service 206,806 201,568 174,291 148,162 115,833
Hardware 7,703 14,028 21,199 16,630 23,886
Total revenue 347,017 334,610 400,362 348,108 310,958
Cost of revenue:
Cost of software revenue 10,565 7,522 14,643 16,986 16,901
Cost of service revenue 89,016 102,292 101,976 86,377 69,825
Cost of hardware revenue 5,995 10,211 13,559 9,078 13,489
Total cost of revenue 105,576 120,025 130,178 112,441 100,215
Gross profit 241,441 214,585 270,184 235,667 210,743
Operating expenses:
Research and development 71,735 68,838 57,914 54,307 50,132
Selling, general and
administrative 163,765 169,505 164,941 157,730 161,105
Restructuring and in-process
research and development 400 - 2,984 - 2,000
Total operating expenses 235,900 238,343 225,839 212,037 213,237
Operating income (loss) 5,541 (23,758) 44,345 23,630 (2,494)
Other income, net 5,209 2,503 5,406 3,409 3,840
Income (loss) before income taxes 10,750 (21,255) 49,751 27,039 1,346
Provision (benefit) for income
taxes 2,478 (4,633) 11,204 7,362 391
Net income (loss) $ 8,272 $ (16,622) $ 38,547 $ 19,677 $ 955
Earnings (loss) per share:
Basic $ 0.23 $ (0.47) $ 1.13 $ 0.61 $ 0.03
Diluted $ 0.23 $ (0.47) $ 1.05 $ 0.59 $ 0.03
Weighted average shares outstanding:
Basic 35,590 35,117 34,155 32,125 31,827
Diluted 36,709 35,117 36,765 33,360 33,367
Consolidated balance sheet data:
Working capital $ 135,302 $ 144,750 $ 155,483 $ 101,777 $ 67,972
Total assets 328,036 301,639 324,093 243,398 206,822
Stockholders' equity 238,905 215,825 224,957 150,458 130,320
Note: Service revenue and costs include both Customer Support and Professional
Services and Education. Certain reclassifications have been made to the prior
years' selected financial data to conform to the current year's presentation. In
November 2001, the FASB announced Emerging Issues Task Force ("EITF") Topic No.
D-103, "Income Statement Characterization of Reimbursements Received for
Out-of-Pocket Expense Incurred." The EITF required companies to characterize
reimbursements received for out-of-pocket expenses as revenues in the statement
of operations. Application of this EITF required that comparative financial
statements for prior periods be reclassified to comply with the guidance. We
adopted this EITF as of January 1, 2002 and have reclassified our prior-period,
consolidated financial statements to conform to this EITF.
19
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion contains forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995, Section 21E of
the Securities Exchange Act of 1934, as amended, and Section 27A of the
Securities Act of 1933, as amended, and is subject to the safe harbors created
by those sections. These forward-looking statements are subject to a number of
risks and uncertainties that could cause our actual results to differ materially
from those that may be anticipated by such forward-looking statements, which
reflect management's opinions only as of the date hereof. We undertake no
obligation to revise or publicly release the results of any revisions to these
forward-looking statements. Readers should carefully review the risk factors and
various disclosures described in this document and in other documents we file
with the Securities and Exchange Commission that attempt to advise interested
parties of the risks and factors that may affect our business. The following
discussion should be read in conjunction with the Consolidated Financial
Statements and Notes thereto submitted as a separate section of this Form 10-K
(Item 15).
Critical Accounting Policies and Estimates
The consolidated financial statements of FileNet are prepared in conformity
with accounting principles generally accepted in the United States of America.
The consolidated financial statements include our accounts and the accounts of
our wholly owned subsidiaries. All intercompany balances and transactions have
been eliminated. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period. The
significant accounting policies we believe are most critical to aid in fully
understanding and evaluating our reported financial results include the
following:
Revenue Recognition. FileNet accounts for the licensing of software in
accordance with the American Institute of Certified Accountants ("AICPA")
Statement of Position ("SOP") 97-2, "Software Revenue Recognition." We enter
into contracts for the sale of our products and services. The majority of these
contracts relates to single elements and contains standard terms and conditions.
However, there are agreements that contain multiple elements or non-standard
terms and conditions. Contract interpretation is sometimes required to determine
the appropriate accounting, including how the price should be allocated among
the deliverable elements and when to recognize revenue.
Software license revenues generated from sales through direct and indirect
channels, which do not contain multiple elements, are recognized upon shipment
of the related product, if the requirements of SOP 97-2, are met. If the
requirements of SOP 97-2, including evidence of an arrangement, delivery, fixed
or determinable fee, collectibility or vendor specific evidence about the value
of an element are not met at the date of shipment, revenue is not recognized
until these elements are known or resolved. Fees are deemed to be fixed and
determinable for transactions with a set price that is not subject to refund or
adjustment and payment is due within 90 days from the invoice date. Software
license revenue from channel partners is recognized when the product is shipped
and sale by the channel partner to an end-user is confirmed.
For arrangements with multiple elements, we allocate revenue to each
element of a transaction based upon its fair value as determined in reliance on
vendor specific objective evidence. This evidence of fair value for all elements
of an arrangement is based on the normal pricing and discounting practices for
those products and services when sold separately. If fair value of any
undelivered element cannot be determined objectively, we defer the revenue until
all elements are delivered, services have been performed or until fair value can
objectively be determined.
Customer support contracts are renewable on an annual basis and provide
after-sale support for our software, as well as software upgrades under the
20
Company's right to new versions program, on a when-and-if-available basis.
Revenue from post-contract customer support is recognized ratably over the term
of the arrangement, which is typically twelve months.
Professional services revenue consists of consulting and implementation
services provided to end users of our software products and technical consulting
services provided to our resellers. The majority of these consulting engagements
average from one to three months and are generally not essential to the
functionality of the software. Revenue from these services and from training
classes is recognized as such services are delivered and accepted by the
customer. Fixed-price consulting contracts are the exception and because
estimates of costs applicable to these contracts are reasonably dependable,
revenue is recognized using the percentage-of completion method. However,
revenue and profit is subject to revision as the contract progresses and
anticipated losses on fixed-price professional services contracts are recognized
in the period when they become known.
Allowance for Doubtful Accounts and Sales Returns. We evaluate the
creditworthiness of our customers prior to order fulfillment and we perform
ongoing credit evaluations of our customers to adjust credit limits based on
payment history and the customer's current creditworthiness. We constantly
monitor collections from our customers and maintain an allowance for estimated
credit losses that is based on historical experience and on specific customer
collection issues. While credit losses have historically been within our
expectations and the provisions established in our financial statements, we
cannot guarantee that we will continue to experience the same credit loss rates
that we have in the past. Since our revenue recognition policy requires
customers to be creditworthy, our accounts receivable are based on customers
whose payment is reasonably assured. Our accounts receivable are derived from
sales to a wide variety of customers. We do not believe a change in liquidity of
any one customer or our inability to collect from any one customer would have a
material adverse impact on our consolidated financial position. Based on
historical experience, we also maintain a sales return allowance for the
estimated amount of potential returns. While product returns have historically
been minimal and within our expectations and the allowances established by us,
we cannot guarantee that we will continue to experience the same return rates
that we have in the past.
The following table represents the account balances for these provisions
and the changes for each of the periods presented. Deductions to these
provisions are the result of customer bad debt write-offs or product returns.
Additions to the provision are based on estimated credit losses related to
specific customer collection issues and are also based on historical experience.
(In thousands)
Additions
Balance at Charged to Balance
Beginning Revenue and at End
of Period Expenses Deductions of Period
Year ended December 31, 2002:
Allowance for doubtful accounts
and sales returns $ 3,567 1,752 1,087 $ 4,232
Year ended December 31, 2001:
Allowance for doubtful accounts
and sales returns $ 5,518 1,482 3,433 $ 3,567
Year ended December 31, 2000:
Allowance for doubtful accounts
and sales returns $ 4,542 2,280 1,304 $ 5,518
Deferred Income Taxes. Deferred income taxes reflect the net tax effects of
temporary differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes. We
maintain a valuation allowance against a portion of the deferred tax assets due
to uncertainty regarding the future realization based on historical taxable
income, projected future taxable income, and the expected timing of the
21
reversals of existing temporary differences. If we operate at a loss or are
unable to generate sufficient future taxable income we could be required to
increase the valuation allowance against all or a significant portion of our
deferred tax assets which would result in a substantial increase to our
effective tax rate and could result in a material adverse impact on our
consolidated operating results.
Long-Lived Assets. In the first quarter of fiscal 2002, the Company adopted
Statement of Financial Accounting Standards No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"). SFAS No. 144
establishes a single accounting model, based on the framework established in
Statement of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
("SFAS No. 121"), for long-lived assets to be disposed of by sale, and resolves
implementation issues related to SFAS No. 121. The adoption of SFAS No. 144 did
not have a material impact on the Company's operating results or financial
position.
Property, plant and equipment, intangible assets, and capitalized software
costs are recorded at cost less accumulated depreciation or amortization. They
are amortized using the straight-line method over estimated useful lives of
three to six years. The determination of useful lives and whether or not these
assets are impaired involves judgment and are reviewed for impairment whenever
events or circumstances indicate that the carrying amount of such assets may not
be recoverable. We evaluate the carrying value of long-lived assets and certain
identifiable intangible assets for impairment of value based on undiscounted
future cash flows resulting from the use of the asset and its eventual
disposition. While we have not experienced impairment of intangible assets in
prior periods, we cannot guarantee that there will not be impairment in the
future.
Goodwill and Other Intangible Assets. Goodwill is recorded at cost and is
not amortized. In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangible Assets," which we adopted January 1, 2002. SFAS No. 142 requires that
goodwill and other intangible assets with indefinite useful lives no longer be
amortized, but instead be tested for impairment at least annually and written
down when impaired. We periodically evaluate whether events and circumstances
have occurred which indicate that the carrying value of goodwill may not be
recoverable. In accordance with SFAS No. 142, we were required to perform a
two-step transitional impairment review. We completed the first step of this
review by June 30, 2002 with the determination of the fair value of our
reporting units in order to identify whether the fair value of each reporting
unit was less than its carrying amount as of January 1, 2002. In the event that
the fair value of each reporting unit was less than the carrying amount, the
second step of the test was required to determine if the carrying value of
goodwill exceeded the implied value. We determined that we did not have a
transitional impairment of goodwill because the fair value of each reporting
unit exceeded its carrying amount. As of December 31, 2002, no impairment of
goodwill has been recognized. Goodwill will also be tested for impairment in the
manner described above on July 1st of each year or earlier if indicators of
potential impairment exist. If estimates change, a materially different
impairment conclusion could result.
Other Operating Matters
We took selective actions in 2001 to help drive profitability and to reduce
on-going annual expenses. These actions included cost-saving measures, internal
business process changes to improve efficiency and a worldwide workforce
reduction of 158 employees. Workforce reductions occurred during the second and
fourth quarters of 2001 resulting in a total severance charge of $4.5 million.
These severance charges were $897,000 in customer support, $293,000 in
professional services, $331,000 in research and development and $2.9 million in
selling, general and administrative, as discussed below.
22
Overview
FileNet develops, markets, sells and supports a unified platform and
framework for Enterprise Content Management, or ECM, that delivers capabilities
to our customers in a tightly integrated and synchronized offering. This
approach offers our customers the ability to easily configure, design, build and
deploy ECM software and solutions. We operate globally and sell our products and
services to our customers through a direct sales force, system integrators,
resellers and value added distributors. We invest significantly in product
development to improve our existing products and increase our product offerings.
Our revenue growth depends on the overall demand for computer software and
services primarily to corporate and government customers. A difficult
environment for Information Technology ("IT") sales that began in early 2001 and
continued through 2002 caused many customers to delay, downsize or cancel IT
projects, resulting in lower demand and a reduction in our revenues from
software and hardware sales. We do not anticipate market conditions to improve
significantly in the near term. Despite the unpredictability of the current
business environment, we remain focused on our strategy to provide a unified
platform and framework for ECM solutions.
Results Of Operations
The following table sets forth certain consolidated statement of operations
data as a percentage of total revenue for the periods indicated:
(As a percentage of total revenue)
December 31, 2002 2001 2000
Revenue:
Software 38.2% 35.6% 51.2%
Customer support 43.2 39.6 27.5
Professional services and education 16.4 20.6 16.0
Hardware 2.2 4.2 5.3
Total revenue 100.0 100.0 100.0
Cost of revenue:
Software 3.1 2.2 3.7
Customer support 11.1 12.7 11.5
Professional services and education 14.5 17.9 14.0
Hardware 1.7 3.1 3.3
Total cost of revenue 30.4 35.9 32.5
Gross profit 69.6 64.1 67.5
Operating expenses:
Research and development 20.7 20.6 14.5
Selling, general and administrative 47.2 50.6 41.2
In-process research and development 0.1 - 0.8
Total operating expenses 68.0 71.2 56.5
Operating income (loss) 1.6 (7.1) 11.0
Other income, net 1.5 0.7 1.4
Income (loss) before tax 3.1% (6.4)% 12.4%
23
Revenue
Total revenue increased to $347.0 million, or 4% in 2002 from $334.6
million in 2001. From 2000 to 2001, total revenue decreased from $400.4 million,
or 16%. The increase in total revenue from 2001 to 2002 was primarily
attributable to an increase in demand for our software products as well as the
growth in customer support revenue partially offset by lower professional
services and hardware revenue as discussed below. The decrease in total revenue
from 2000 to 2001 was primarily attributable to lower software revenue as a
result of unfavorable economic conditions in 2001 resulting in decreased demand
for our software products partially offset by an increase in customer support
and professional services revenues.
Software. Software revenue consists of fees earned from the licensing of
our software products to customers. Software revenue increased to $132.5 million
in 2002 from $119.0 million in 2001, representing an increase of $13.5 million,
or 11%. From 2000 to 2001, software revenue decreased $85.9 million from $204.9
million, or 42%. The increase in software revenue from 2001 to 2002 was
primarily due to an increase in demand for content management solutions
primarily attributable to broader product offerings in 2002 coupled with a
slightly improved IT spending environment. Additionally, we were successful in
increasing software revenues from our existing customers as they expanded the
use of our products. The decrease from 2000 to 2001 was primarily due to the
significant global economic slowdown in the technology sector that resulted in a
significant reduction in the amount and size of customer orders. Large
enterprise projects were eliminated or replaced by smaller projects as IT
budgets were reduced and delayed in both 2001 and continued in 2002. We expect
that the trend toward smaller projects will continue for the foreseeable future
and we do not anticipate market conditions will improve significantly in the
near term.
Customer Support. Customer support revenue consists of revenue from
software maintenance contracts and "fee for service" revenues and the sale of
spare parts and supplies. Customer support revenue increased to $149.8 million
in 2002 from $132.4 million in 2001, representing an increase of $17.5 million,
or 13%. From 2000 to 2001, customer support revenue increased by $22.1 million
from $110.3 million, or 20%. These increases in customer support revenue reflect
an increase in the overall customer installed base combined with a high rate of
renewal in the existing customer base. Customer support revenue grew more slowly
in 2002 compared to the growth rate in 2001 as a result of the decreased
software revenue in 2001 and 2002. A prolonged economic slowdown will continue
to affect the growth rate of customer support revenue as this revenue stream is
directly related to software revenue fluctuations over time.
Professional Services and Education. Professional services and education
revenue is generated primarily from consulting and implementation services on
our standard products provided to end users of our software products, technical
consulting services provided to our resellers and training services.
Professional services are generally performed on a time and material basis.
Professional services and education revenue decreased to $57.0 million in 2002
from $69.2 million in 2001, representing a decrease of $12.2 million, or 18%.
From 2000 to 2001 professional services and education revenue increased by $5.2
million from $64.0 million, or 8%. The decrease from 2001 to 2002 is reflective
of the economic slow down, particularly in North America, which resulted in
fewer and smaller consulting engagements and increased pricing pressures. The
increase from 2000 to 2001 was primarily attributable to an increase in custom
development projects that carried over from 2000, and to a lesser extent, an
increase in sales of prepackaged service offerings, which included both
consulting and training. A prolonged economic slowdown that causes companies to
delay spending on technology projects will continue to negatively impact these
revenues.
24
Hardware. Hardware revenue is generated primarily from the sale of our
12-inch OSAR libraries. Hardware revenue decreased to $7.7 million in 2002 from
$14.0 million in 2001, representing a decrease of $6.3 million, or 45%. From
2000 to 2001 hardware revenue decreased by $7.2 million from $21.2 million, or
34%. The decline in hardware revenue reflects that hardware is not a strategic
focus for us and we expect hardware revenue to continue to decrease as a percent
of total revenue and in absolute dollars.
International. International revenues accounted for 26% of total revenue,
or $90.0 million, in 2002, 25% of total revenue, or $82.9 million, in 2001, and
28% of total revenue, or $110.1 million, in 2000. The increase in absolute
dollars in 2002 as compared to 2001 resulted primarily from increases in
software revenue and customer support revenue related to an increase in the
overall customer base and a high rate of renewal. The decrease in absolute
dollars in 2001 as compared to 2000 was primarily the result of a significant
reduction in the amount and size of customer orders in Europe and Asia, our
largest international markets, due to a major slowdown in IT spending. We expect
international revenue to continue to represent a significant percentage of total
revenue. However, international revenues will be adversely affected if the U.S.
dollar strengthens against certain major international currencies or if economic
conditions remain weak.
Cost of Revenue
Total cost of revenue decreased to $105.6 million in 2002, from $120.0
million in 2001, representing a decrease of $14.4 million, or 12%. From 2000 to
2001 total cost of revenue decreased by $10.2 million, or 8%. Total cost of
revenue decreased from 2001 to 2002 primarily due to reduced costs in the
service organizations and the hardware component as discussed below. The
decrease in total cost of revenue from 2000 to 2001 is primarily attributable to
lower software and hardware costs that can be directly related to lower software
and hardware revenue, as well as the discontinuation of certain third-party
embedded products.
Software. Cost of software revenue includes royalties paid to third
parties, amortization of acquired technology, media costs, and the cost to
manufacture and distribute software. The cost of software revenue was $10.6
million in 2002, $7.5 million in 2001 and $14.6 million in 2000, representing
8%, 6% and 7% of software revenue, respectively. The increase in cost of
software revenue for 2002 compared to 2001 is primarily the result of a 129%
increase in royalty costs due to increased utilization of new third party
software products in 2002 and the amortization of acquired technology (resulting
from the eGrail acquisition in April 2002) which was $511,000 for 2002 compared
to none in 2001. Cost of software revenue decreased from 2000 to 2001 resulting
from a 69% reduction in royalty cost due to the discontinuation of certain third
party products along with a decrease in royalty costs directly related to the
decrease in revenue. Going forward we anticipate cost of software revenue to
remain comparable to current levels or increase slightly as we continue to
integrate third-party technology with our products.
Customer Support. Cost of customer support revenue includes the cost of
customer support personnel, supplies and spare parts, and the cost of
third-party hardware maintenance. The cost of customer support revenue was $38.6
million in 2002, $42.4 million in 2001 and $45.9 million in 2000, representing
26%, 32%, and 42% of customer support revenue, respectively. Efficiency gains
and headcount reductions in 2001 contributed to the overall reduction in
customer support costs in 2002 as compared to 2001. The decrease in 2001 from
2000 was primarily attributable to a 58% reduction in variable compensation and
personnel costs as well as cost reduction benefits from process improvements
initiated in 2000. Workforce reductions in 2001 resulted in severance costs of
$897,000 that were absorbed by the benefit of ongoing reduced salary and
personnel expenses for 2001 and future periods. Due to increased productivity
and controls over headcount we expect to maintain these cost efficiencies for
the near future.
25
Professional Services and Education. Cost of professional services and
education revenue consists primarily of the costs of professional services
personnel, training personnel, and third-party contractors. The cost of
professional services and education revenue was $50.4 million in 2002, $59.9
million in 2001 and $56.1 million in 2000, representing 89%, 87% and 88% of
professional services and education revenue, respectively. Lower professional
services and education revenue in 2002 resulted in lower costs in absolute
dollars compared to 2001 primarily due to a 38% reduction in the use of
third-party independent consultants, as well as 30% lower variable compensation
expense in 2002. The increase in absolute dollars from 2000 to 2001 was
primarily due to an increase of 16% in personnel costs as a result of average
headcount increases along with a 17% increase in the use of third-party
independent contractors who were needed to complete development projects that
carried over from 2000. Additionally, we recorded a charge of approximately
$293,000 for severance payments in 2001. Expressed as a percentage of revenue,
costs were essentially unchanged from 2000 to 2001. We expect professional
services and education costs as a percentage of professional services and
education revenue to vary from period to period depending on the utilization
rates of internal resources and the mix between internal and external service
providers.
Hardware. Cost of hardware revenue includes the cost of assembling our OSAR
library products, the cost of hardware integration personnel, warranty costs and
distribution costs. The cost of hardware revenue was $6.0 million in 2002, $10.2
million in 2001 and $13.6 million in 2000, representing 78%, 73% and 64% of
hardware revenue, respectively. The year-to-year decreases in absolute dollars
are directly related to decreased hardware revenue. Hardware cost as a percent
of hardware revenue has not decreased proportionally because fixed costs have
not decreased at the same rate as hardware revenue.
Operating Expenses
Research and Development. Research and development expense consists
primarily of personnel costs for software developers, third party contracted
development efforts and related facilities costs. Research and development
expense was $71.7 million in 2002, $68.8 million in 2001 and $57.9 million in
2000, representing 21%, 21% and 15% of total revenue, respectively. The
acquisition of eGrail in 2002 accounted for the majority of the $2.9 million
increase in research and development expenses from 2001 to 2002 primarily due to
additional facility and headcount expenses. The increase in expense from 2000 to
2001 was primarily due to the initiation of extensive development efforts to
enhance existing products with new capabilities and to develop new products.
This initiation resulted in a 15% increase in compensation expense primarily due
to increased numbers of personnel from 400 in fiscal 2000 to 425 in fiscal 2001
as well as a 35% increase in consulting costs due to the expanded use of
contractors. Also included in the 2001 costs were a one-time bonus of $2.0
million related to the Application Partners, Incorporated ("API") acquisition
and severance costs of approximately $331,000.
Our research and development efforts are focused on providing a unified
platform and framework for Enterprise Content Management that deliver
capabilities to our customers in a tightly integrated and synchronized offering.
This approach offers our customers the ability to easily configure, design,
build and deploy ECM solutions. These efforts focus on improvements in Business
Process Management, Content Management, Web Content Management and associated
applications to provide a richer product offering to our customers. We intend to
continue to complement internal development with third party software through
OEM agreements and may execute additional technology acquisitions such as our
eGrail acquisition that took place in April 2002.
New product development underway at eGrail at the time of the acquisition
included the next generation of their Web Content Management product that was in
the early stages of design and only 5% complete at the date of the acquisition.
The cost to complete the project was estimated at approximately $3.0 million to
26
occur over a twelve-month period. As of December 31, 2002 the project is 75%
complete and the Company has incurred approximately $2.9 million of research and
development expenses related to the project. The revised estimate to complete
the project within the estimated timeframe is an additional $1.0 million in
costs.
We intend to continue to invest significantly in internal research and
development. We expect that competition for qualified technical personnel, while
easing due to the global economic slowdown in the short-term, will remain
intense and may result in higher levels of compensation expense for us in the
future. We believe that research and development expenditures, including
compensation of technical personnel, are essential to maintaining our
competitive position and expect these costs to continue to constitute a
significant percentage of total revenue in future periods.
Selling, General and Administrative. Selling, general and administrative
expense consists primarily of salaries, benefits, sales commissions and other
expenses related to the direct and indirect sales force; personnel cost for
marketing and market development programs; personnel costs for finance,
information technology, legal, human resources and general management; and the
cost of outside professional services. Selling, general and administrative
expense was $163.8 million in 2002, $169.5 million in 2001 and $164.9 million in
2000. Selling, general and administrative expense, as a percentage of total
revenue, was 47% in 2002, 51% in 2001 and 41% in 2000. The decrease in absolute
dollars from 2001 to 2002 was primarily due to a 54% reduction in recruitment
expenses, as well as a 10% reduction in sales commission expense. The largest
expense reduction was the elimination of goodwill and assembled workforce
amortization in 2002, which was $3.0 million in 2001 and $1.8 million in 2000.
We ceased amortizing goodwill and assembled workforce as of the beginning of the
first quarter of 2002 in compliance with SFAS No. 142. Assembled workforce no
longer meets the definition of a separately identified intangible asset under
the provisions of SFAS No. 141, "Business Combinations," and the unamortized
balance of $182,000 at December 31, 2001 was reclassified as goodwill at January
1, 2002. The increase in absolute dollars in 2001 from 2000 was primarily due to
overall increased expenses associated with the expansion of sales and marketing
for new product launch programs, a 19% increase in depreciation expense from
capitalized software systems, and a 120% increase in legal fees.
Charges in 2001 for severance of $2.9 million related to workforce
reductions and $218,000 for facility consolidation costs, primarily in sales,
also contributed to the increase in 2001 from 2000. However, these workforce
reductions and facility consolidations led to reduced costs in 2002. We expect
to maintain expense controls over selling, general and administrative costs in
2003. Accordingly, these costs during 2003 should remain relatively consistent
with 2002 as a percentage of sales.
Purchased In-Process Research and Development. Based upon an independent
third-party appraisal determined through established valuation techniques in the
high-tech industry, we allocated approximately $3.0 million to in-process
research and development in connection with our purchase of certain assets from
API in May 2000. The in-process research and development expenses were related
to new product projects that were under development at the date of the
acquisition and were expected to eventually lead to new products but had not yet
established feasibility and for which no future alternative use was identified.
The valuation of the in-process research and development projects was based upon
the discounted expected future net cash flows of the products over their
expected life, reflecting the estimated percent of completion of the projects
and an estimate of the costs to complete the projects. New product development
projects underway at API at the time of the acquisition included Sequis, an
eService application that we estimated to be 88% complete at the date of the
acquisition. The cost to complete the project was estimated at approximately
$300,000 to occur over a three-month period. We incurred approximately $356,000
of research and development expenses related to the project that was 100%
complete as of September 30, 2000.
27
Our eGrail acquisition in April 2002 of certain assets and certain
liabilities resulted in an allocation of $400,000 to in-process research and
development. The allocation was determined through established valuation
techniques in the high-technology industry by an independent third-party
appraiser. In-process research and development was expensed upon acquisition
because technological feasibility had not been established and no future
alternative uses existed. New product development underway at eGrail at the time
of the acquisition included the next generation of their Web Content Management
product that was in the early stages of design and only 5% complete at the date
of the acquisition. The cost to complete the project was estimated at
approximately $3.0 million to occur over a twelve-month period. As of December
31, 2002 the project was 75% complete and the Company has incurred approximately
$2.9 million of research and development expenses related to the project. The
revised estimate to complete the project within the estimated timeframe is an
additional $1.0 million in cost.
Amortization of Goodwill. In connection with our acquisition of certain
assets from API on May 18, 2000, the purchase price amount allocated to goodwill
of $14.6 million was being amortized in operating expenses over a useful life of
five years and assembled workforce of $386,000 was being amortized over a useful
life of three years. We ceased amortizing goodwill and assembled workforce as of
January 1, 2002 as a result of the adoption of SFAS No. 142. Assembled workforce
no longer meets the definition of a separately identified intangible asset under
the provisions of SFAS No. 141, "Business Combinations," and the unamortized
balance of $182,000 at December 31, 2001 was reclassified as goodwill at January
1, 2002. SFAS No. 142 was also effective for business combinations that occurred
after June 30, 2001. Accordingly, goodwill of $5.8 million that was recorded in
April 2002 in connection with the eGrail acquisition is not amortized. We had no
indefinite life intangible assets as of January 1, 2002. We are required to
evaluate the carrying value of goodwill annually or when events or circumstances
indicate that their carrying value may be impaired. In accordance with SFAS No.
142, we were required to perform a two-step transitional impairment review. We
completed the first step of this review by June 30, 2002 with the determination
of the fair value of our reporting units in order to identify whether the fair
value of each reporting unit was less than its carrying amount as of January 1,
2002. In the event that the fair value of each reporting unit was less than the
carrying amount, the second step of the test was required to determine if the
carrying value of goodwill exceeded the implied value. We determined that we did
not have a transitional impairment of goodwill because the fair value of each
reporting unit exceeded its carrying amount. There was no impairment of goodwill
at December 31, 2002. Goodwill will also be tested for impairment in the manner
described above on July 1st of each year or earlier if indicators of potential
impairment exist. If estimates change, a materially different impairment
conclusion could result.
Amortization of Purchased Intangible Assets. Acquired technology of $3.3
million and patents of $24,000 were included in our acquisition of eGrail.
Acquired technology is being amortized over a useful life of five years and
patents are being amortized over a useful life of two years. Amortization
expense for purchased intangible assets was $523,400 for 2002. We determined
that these assets were not impaired at December 31, 2002.
Interest, Other Income and Expenses, Net. Other income, net consists
primarily of interest income earned on our cash and cash equivalents, short and
long-term investments, and other items including foreign exchange gains and
losses, and interest expense. Other income, net of other expenses, was $5.2
million in 2002, $2.5 million in 2001 and $5.4 million in 2000. The increase in
2002 from 2001 was primarily attributable to a net foreign exchange gain of $1.5
million for 2002 when compared to none for 2001 due to a significant weakening
of the dollar against the Euro in 2002. This was offset by lower interest income
of $4.1 million in 2002 compared to $6.2 million in 2001. The weighted average
interest rate earned on cash, cash equivalents and investments during 2002
decreased to 1.98% from 2.49% in 2001. Finally, a $3.5 million litigation
settlement charge included in other expense in 2001 caused other income, net in
2001 to be lower than both 2002 and 2000.
28
Provision for Income Taxes. The provision for income taxes was $2.5 million
in 2002, compared to a benefit of $4.6 million in 2001 and a provision of $11.2
million in 2000. The effective tax rate was 23%, (22%) and 23% for the years
ended December 31, 2002, 2001 and 2000, respectively. The increased tax rate in
2002 was primarily due to the mix of income between domestic and foreign
jurisdictions. FileNet management will continue weighing various evidence
throughout each year to assess the recoverability of its recorded deferred
assets and the need for any valuation allowance against such amounts.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2002, cash and cash equivalents, and investments were
$185.2 million, an increase of $13.0 million from $172.2 million at December 31,
2001.
Cash provided by operating activities in 2002 was $21.4 million and
resulted primarily from net income of $8.3 million, and depreciation and
amortization of $21.6 million. These were partially offset by increased accounts
receivable of $7.8 million resulting from increased revenue in the fourth
quarter of 2002 compared to 2001, an increase of $3.4 million in prepaid
expenses such as prepaid insurance due to higher insurance premiums in 2002 and
increases in prepaid royalty related to the addition of new third party
licensing agreements in 2002, and a decrease in income tax payable of $4.0
million. Cash used in investing activities in 2002 included $10.8 million for
capital expenditures, a $1.9 million note receivable from an officer, and a $9.4
million cash purchase related to the eGrail acquisition in April 2002, partially
offset by $12.0 million net proceeds from the sale of marketable securities.
Financing activities provided cash of $4.7 million primarily from the proceeds
of the issuance of common stock upon exercise of employee stock options under
the stock option and stock purchase plans.
Cash provided by operating activities in 2001 was $42.5 million and
resulted primarily from a substantial decrease in accounts receivable of $51.1
million due to decreased revenue and strong collections in the fourth quarter,
depreciation and amortization expense of $24.4 million, and increases in
unearned maintenance of $9.8 million related to prepaid maintenance contracts,
partially offset by a net loss of $16.6 million, decreases in accounts payable
of $8.2 million resulting from reduced spending, decreases in accrued
compensation and benefits of $8.1 million primarily due to a reduction in
bonuses, and a reduction in federal income tax payable of $5.6 million. Cash
used for investing activities in 2001 was $41.9 million consisting primarily of
capital expenditures of $14.1 million and net purchases of marketable securities
of $28.1 million. Cash provided by financing activities in 2001 was $7.8 million
consisting primarily of proceeds from the issuance of common stock upon exercise
of employee stock options under our stock option and stock purchase plans and
income tax benefit from exercised stock options.
Cash provided by operating activities in 2000 was $55.0 million and
resulted primarily from net income of $38.5 million, an increase in unearned
maintenance revenue related to prepaid maintenance contracts of $7.5 million,
$14.4 million stock option income tax benefit, and depreciation and amortization
expense of $19.8 million, partially offset by increases in accounts receivable
of $19.9 million resulting from increased revenue in the fourth quarter of 2000
compared to the prior year, and increases in prepaid expenses of $4.9 million.
Cash used for investing activities in 2000 totaled $47.8 million, consisting
primarily of capital expenditures of $27.7 million and cash paid for an
acquisition of $20.0 million. Cash provided by financing activities in 2000 was
$24.7 million, consisting primarily of proceeds from the issuance of common
stock upon exercise of employee stock options under our stock option and stock
purchase plans.
29
Our capital expenditures were $10.8 million in 2002, $14.1 million in 2001,
and $27.7 million in 2000. Our primary capital expenditures during these years
were for research and development equipment, demonstration and training
equipment, enhancements to our internal network and business systems, leasehold
improvements on leased property, and furniture. Spending was significantly
reduced in an effort to contain expenses while the company experienced reduced
revenues from the downturn in the economy in 2002 and 2001.
We have a one-year, $5.0 million multi-currency revolving line of credit
that expires on June 27, 2003. Borrowings under the arrangement are unsecured
and bear interest at one hundred and twenty-five basis points over the London
Interbank Offered Rate. A standby letter of credit fee of one hundred and
twenty-five basis points per annum and an annual commitment fee of fifty basis
points is assessed against any undrawn amounts. There were no borrowings
outstanding at December 31, 2002. We are subject to certain financial covenants
that include, but are not limited to, compliance with specific balance sheet
ratios, no two consecutive quarterly losses, an aggregate loan limit to the
officers not to exceed $5.0 million, and a capital expenditure limit under this
line of credit. As of December 31, 2002, we were in compliance with all the
covenants. We are prohibited from paying cash dividends during the term of the
arrangement.
Our principal sources of short and long-term liquidity consist of existing
cash balances and funds generated from future operations. We had total cash and
investments of $185.2 million at December 31, 2002, compared with $172.2 million
at December 31, 2001, and we regularly review our cash funding requirements and
attempt to meet those requirements through a combination of cash on hand and
cash provided by operations. Our ability to increase revenues and generate
profits is subject to numerous risks and uncertainties and any significant
decrease in our revenues or profitability could reduce our operating cash flows
and erode our existing cash balances. During 2001 and continuing into 2002 lower
capital spending in the IT sector resulted in lower revenue for us. No
assurances can be given that this trend will improve or that we will continue to
be able to generate positive operating cash flows or that we will continue to
maintain or grow our existing cash balances. See "Risk Factors".
We believe that our present cash balances, together with internally
generated funds and credit lines, will be sufficient to meet our working capital
and capital expenditures throughout 2003. We anticipate capital expenditures of
approximately $19.1 million in 2003 and we have no long-term debt at December
31, 2002.
Commitments. We lease certain of our facilities under noncancelable
operating lease arrangements that expire at various dates through 2013. We have
certain royalty commitments associated with licensing of third party products
that require minimum payments or contractual prepayments.
The following table summarizes future minimum payments for these
obligations as of December 31, 2002:
(In thousands)
Payments Due by Period
2004- 2006-
Total 2003 2005 2007 Thereafter
Contractual obligations
Operating leases $ 63,604 13,815 22,134 18,840 $ 8,815
Third party licensing contracts 3,810 3,810
Total contractual cash obligations $ 67,414 17,625 22,134 18,840 $ 8,815
We have a $5.0 million line of credit and we have bank guarantees issued in
local currencies in Europe and Asia as discussed in Note 18 of the Notes to
Consolidated Financial Statements.
30
The following table summarizes future minimum commercial commitments for
these obligations as of December 31, 2002:
(In thousands)
Amount of Commitment Expiration Per Period
Total
Amounts 2004- 2006-
Committed 2003 2005 2007 Thereafter
Other commercial commitments:
Lines of Credit $ 5,000 5,000 - - $ -
Secured and unsecured bank
guarantees 1,042 165 459 132 $ 286
Total commercial commitments $ 6,042 5,165 459 132 $ 286
OTHER MATTERS
European Monetary Union. On January 1, 1999, 11 of the 15 member countries of
the European Union established fixed conversion rates between their existing
sovereign currencies and the euro. These countries agreed to adopt the euro as
their common legal currency from that date. The legacy currencies remained legal
tender in these countries as a denomination of the euro between January 1, 1999
and January 1, 2002. Beginning on January 1, 2002, euro-denominated bills and
coins were issued for cash transactions. For a period of up to six months from
that date, both legacy currencies and the euro were legal tender. On or before
July 1, 2002, the participating countries withdrew all legacy currencies and
exclusively used the euro.
We made the necessary changes to our internal business systems to support
transactions denominated in the euro, including establishing euro price lists
for affected countries. We have been transacting in the euro currency since 1999
and have evaluated the impact the euro has had on our financial condition and
results of operations. Based on this evaluation to date, we currently do not
believe that there has been or will be a material impact on our consolidated
financial condition or results of operations as a result of the euro conversion.
Impact of Recently Issued Accounting Pronouncements. In June 2001, the FASB
issued SFAS No. 141, "Business Combinations," which was effective immediately.
SFAS No. 141 requires that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001; and it eliminated the
pooling-of-interests method. The adoption of this standard did not have a
significant impact on our consolidated financial statements. Our April 2002
acquisition of certain assets and certain liabilities of eGrail, Inc. was
accounted for in compliance with this pronouncement (see Note 3 of Notes to
Consolidated Financial Statements).
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which we adopted January 1, 2002. SFAS No. 142 requires that goodwill
and other intangible assets with indefinite useful lives no longer be amortized,
but instead be tested for impairment at least annually and written down when
impaired. SFAS No. 142 requires purchased intangible assets other than goodwill
to be amortized over their useful lives unless these lives are determined to be
indefinite. In accordance with this Standard, we no longer amortize goodwill and
indefinite life intangible assets but evaluate their carrying value annually or
when events or circumstances indicate that their carrying value may be impaired.
Assembled workforce no longer meets the definition of a separately identified
intangible asset under the provisions of SFAS No. 141, Business Combinations,
and the unamortized balance of $182,000 was reclassified as goodwill at January
1, 2002. We ceased amortizing the goodwill balance of $10.1 million from our
2000 acquisition of Applications Partner, Inc. as of January 1, 2002. We had no
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indefinite life intangible assets as of January 1, 2002. In accordance with SFAS
No. 142, we were required to perform a two-step transitional impairment review.
We completed the first step of this review by June 30, 2002 with the
determination of the fair value of our reporting units in order to identify
whether the fair value of each reporting unit was less than its carrying amount
as of January 1, 2002. In the event that the fair value of each reporting unit
was less than the carrying amount, the second step of the test would be required
to determine if the carrying value of goodwill exceeded the implied value. We
determined that we did not have a transitional impairment of goodwill because
the fair value of each reporting unit exceeded its carrying amount. As of
December 31, 2002, no impairment of goodwill has been recognized. Goodwill will
also be tested for impairment in the manner described above on July 1st of each
year or earlier if indicators of potential impairment exist. If estimates
change, a materially different impai