-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VUrNF6raddLWdd5dcYLd0m3x3peWHBPRlqC1jKglvfpetgfeV7ARwGu4wqhZFlp1 Sh7uwsukDQzicynO1Ai0jQ== 0000706015-98-000003.txt : 19980401 0000706015-98-000003.hdr.sgml : 19980401 ACCESSION NUMBER: 0000706015-98-000003 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: FILENET CORP CENTRAL INDEX KEY: 0000706015 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER INTEGRATED SYSTEMS DESIGN [7373] IRS NUMBER: 953757924 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-15997 FILM NUMBER: 98580046 BUSINESS ADDRESS: STREET 1: 3565 HARBOR BLVD CITY: COSTA MESA STATE: CA ZIP: 92626 BUSINESS PHONE: 7149663400 MAIL ADDRESS: STREET 1: 3565 HARBOR BLVD CITY: COSTA MESA STATE: CA ZIP: 926261420 10-K 1 FORM 10-K FOR THE FISCAL YEAR ENDED 12/31/97 ================================================================================ FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number 0-15997 FILENET CORPORATION (Exact name of Registrant as specified in its charter) Delaware 95-3757924 (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 3565 Harbor Boulevard, Costa Mesa, California 92626 (Address of principal executive office) (Zip code) Registrant's telephone number, including area code: (714) 966-3400 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Title of each class Name of each exchange which registered Common stock, $0.01 par value Nasdaq Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes [X] No [ ] Indicate by check mark whether the disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] Based on the closing sale price of March 17, 1998, the aggregate market value of the 14,981,441 shares of voting stock of the Registrant held by nonaffiliates of the Registrant on such date was $579,631,952. For purposes of such calculation, only executive officers, board members and beneficial owners of more than 10% of the Company's outstanding common stock are deemed to be affiliates. The number of shares outstanding of the Registrant's common stock was 15,145,900 at March 17, 1998. DOCUMENTS INCORPORATED BY REFERENCE Portions of Registrant's definitive proxy statement for its 1998 Annual Meeting are incorporated by reference into Part III as set forth herein. Portions of Registrant's Annual Report to Stockholders for the fiscal year ended December 31, 1997 are incorporated by reference into Parts II, III and IV as set forth herein. ================================================================================ FILENET CORPORATION FORM 10-K For the Year Ended December 31, 1997 INDEX PART I Page Item 1. Business..............................................................3 Item 2. Properties...........................................................10 Item 3. Legal Proceedings....................................................10 Item 4. Submission of Matters to a Vote of Security Holders..................11 PART II Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters..................................................11 Item 6. Selected Financial Data..............................................12 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations............................................13 Item 8. Financial Statements and Supplementary Data..........................13 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.............................................13 PART III Item 10. Directors and Executive Officers of the Registrant..................13 Item 11. Executive Compensation..............................................13 Item 12. Security Ownership of Certain Beneficial Owners and Management......13 Item 13. Certain Relationships and Related Transactions......................13 PART IV Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K.....14 Signatures...................................................................19
2 PART I Item 1. Business GENERAL FileNET Corporation (FileNET or the Company) develops, markets and services a family of integrated document management software products designed for managing information and enhancing enterprise productivity. Additionally, the Company manufactures and sells a line of 12-inch optical storage and retrieval libraries. The Company markets its products in more than 60 countries through a global sales, services and support organization, including its ValueNET(R) partner program of resellers, system integrators and application developers. MARKETS AND APPLICATIONS The Company offers a family of complementary products which enable users to manage, on an enterprise-wide basis, the storage, processing and workflow for documents and other unstructured information, including scanned images, faxes, text, spreadsheets, graphics, drawings, photographs, computer output reports, voice, and video. The Company's products provide a client server/based document management architecture that can be implemented on a modular basis and organizations can choose one, some, or all of the Company's products to build the system that most effectively meets their needs. The Company's customers are typically those organizations which have active paper document files, process significant numbers of electronic documents in their day-to-day operations, or have complex, mission-critical business processes for a variety of applications such as mortgage loan servicing, credit card customer service, insurance claims processing, retirement account management, engineering drawings management, web based document management, medical records management, personnel records management, company policies and procedures, accounts payable and receivable, traffic, property and criminal records. Additionally, the Company's products address ad hoc business processes at the departmental and workgroup levels to improve overall enterprise productivity and integrate with industry standard productivity applications like Microsoft Office, Lotus Notes and Novell GroupWise. The Company markets its products in more than 60 countries through a direct sales force and through its ValueNET(R) partner program consisting of systems integrators, value-added resellers and distributors. A number of firms, including Andersen Consulting and American Management Systems, operate as third-party resellers under the Company's ValueNET(R) program and combine FileNET products with vertical market-specific value-added services to provide turnkey solutions and complex systems integration for customers. Other firms such as Tech Data, Law Cypress, IAI Canada, Image Choice and Paperlink are distributors of the Company's products selling to hundreds of resellers throughout the world. The Company also has OEM agreements with other firms involving the Company's software products. The Company offers software maintenance service for its products in the United States and in countries where it has direct international sales operations. The Company's international resellers offer maintenance in the countries in which they operate. The Company subcontracts hardware maintenance to Hewlett-Packard Corporation (HP) and other third parties. In September 1995, the Company entered into an agreement with SAP AG to deliver data archiving and document solutions for their client/server-based R/3 enterprise application systems environment as a Complementary Software Partner. Deliveries of this product commenced in December 1995. The Company also has porting and licensing agreements with HP and Sun Microsystems, Inc. (Sun) to co-market versions of FileNET's document imaging and workflow software products to users of those companies' products. Sales of the HP based product commenced in December 1993 and the Sun based product in March 1995. In 1996, the Company became a Global Partner with HP's General Systems Division. In September 1997, the company signed an IBM Market Development Program Agreement with IBM's Solution Developer Marketing Alliance group to become an IBM Business Partner. The Company is a Certified Microsoft Solutions Developer and will continue to develop and certify products for the Microsoft BackOffice computing environment. 3 PRODUCTS SOFTWARE The following software products are currently being offered by the Company: Integrated Document Management In February 1998, the Company introduced the Panagon family of Integrated Document Management (IDM) software that combines imaging, electronic document management, and workflow into a unified architecture. The Panagon family of products includes new desktop and web services software applications being released by the Company for the first time and a rebranding of existing products for client and server environments. With Panagon, the Company has created a software infrastructure that allows companies to capture any type of document electronically, then quickly and easily access, manage, and integrate the information with their existing critical business applications throughout the enterprise. Using Microsoft's Windows Explorer or web browsers familiar to most business professionals, companies can search the entire enterprise network for information, retrieve documents of all types, easily work with the information, and then route it as needed for further review, processing, or decision making. The new Panagon IDM Desktop range of products are built around Microsoft's component software architecture (COM) and allow applications to be quickly and easily developed and tailored to meet an organization's specific requirements. Panagon IDM Desktop reduces the ongoing cost of ownership through the ability to easily deploy applications on the Web or in a client/server environment. Cost of ownership is also reduced through the use of rapid application development (RAD) techniques and compatibility with industry-standard programming tools such as Visual Basic, PowerBuilder and more. As a result, it takes less time to develop customized IDM applications, less time to integrate the software components into a company and less time to train users. The Panagon family includes a complete suite of IDM software components that are built to work together, eliminating integration issues when combining products from different vendors. Panagon products include: Panagon IDM Desktop and IDM Web Services are software applications that offer best-of-class integrated document management for ad hoc query and access or mission critical applications. Companies can access all documents stored in enterprise libraries from within a Microsoft Windows Explorer, Internet browser interface or via a custom application integrated into line of business systems. Panagon IDM Desktop delivers "out-of-the-box" integration with Microsoft Windows environments and productivity applications such as Microsoft Office, seamlessly managing and viewing more than 200 document formats. Once located, users can create work processes to include others that need to share, distribute, or approve, with the built-in workflow and integrated e-mail features. Panagon IDM Services is a server based integrated document management solution incorporating imaging and document services for medium to large business. IDM Services is the high performance repository system that integrates with Panagon IDM Desktop and IDM Web Services for managing all types of documents. IDM Services can be used as both an imaging and document system together or as separate applications. Panagon Visual WorkFlo is an enterprise-wide, scalable business process automation solution that can be used to easily create applications that reflect the way work processes are performed. It allows managers to control and modify work processes to meet the needs of a dynamic business environment, and integrates information flow between software applications within a company's business processes. Panagon Visual WorkFlo supports multiple client, server and applications development environments and integrates with leading business process reengineering products for reduced implementation time. The product features object-oriented technology to enhance developer productivity through reusability of applications and a wide variety of vertical and horizontal solutions for out-of-the-box functionality. Panagon Report Manager is a high-performance, client/server computer output to laser disk (COLD) product that eliminates printing and distributing computer-generated reports and statements. It significantly lowers costs and inefficiencies by allowing companies to index, store, retrieve, view, print, fax, and distribute computer-generated output on magnetic or optical disk. Panagon Report Manager is built around industry standards and has an intuitive, easy-to-use graphical interface with report mining capabilities. Panagon Capture is an enterprise document capture application that has a complete set of highly configurable components for capturing virtually all document types, scanned paper documents, fax, e-mail, word processing documents, spreadsheets, HTML forms, audio and video-clips, computer generated reports, and electronic data 4 interchange (EDI) information-and making them immediately available to users. Its modular components can be configured to meet simple capture requirements in distributed environments or enterprise-wide capture requirements for production operations. The new Panagon family of products is available to new and existing customers. New customers will receive the benefits of a more comprehensive range of integrated document management functions as opposed to acquiring separate document management technologies from multiple vendors. Existing customers can deploy new IDM applications independently or along side existing applications using FileNET software. Existing customers wanting to take advantage of Panagon's broader IDM capabilities for applications already deployed can recreate the existing applications using the IDM development environment. Document Imaging FileNET Panagon WorkGroup(TM) software is a midrange document imaging and work management product based on a subset of the Panagon IDM products combined with certain prepackaged software applications. Document Warehouse(TM) for SAP software is a document and data archiving application certified by SAP, for use with the popular R/3 Enterprise Resource Planning (ERP) application suite. The Company's Watermark(R) software products enable users worldwide to exchange, process and share scanned images, faxes and other electronic documents within departments and workgroups of large enterprises and throughout midsize and small business environments. Watermark documents and folders are easily integrated into existing line-of-business applications and take advantage of the latest Microsoft operating systems, database technologies and Internet capabilities. The Watermark family consists of the following products: Watermark Client software replaces document handling procedures with integrated electronic processing of scanned images, faxes and other electronic documents. The software provides easy-to-use tools for document capturing, filing, viewing, annotation and OCR that image-enable any OLE- or ODMA- compatible Windows application, such as e-mail, databases and workflows. Watermark Server software is used for organizing, storing and optimizing shared network access to scanned documents, faxes and electronic files. The software intelligently captures the business rules governing document security, version control, migration and storage through easy client-based administration and reporting tools designed for Microsoft BackOffice. Watermark DiskExtender software extends the document storage and retrieval capacity of the Watermark Server by providing Windows NT services to migrate documents to and from high-density optical media. Watermark Fax Router software is a fax management solution that streamlines inbound fax communications with customers, suppliers and other business partners. The software delivers documents electronically to the intended recipient and immediately routes for processing. Faxes are securely managed side-by-side with all other business documents. Watermark Developer's Toolkit software allows a developer to build client/server and intranet applications by taking advantage of the full power and range of Watermark functionality via OLE Objects and ActiveX Controls specifically designed to simplify application building. Workflow Panagon Visual WorkFlo(R) software provides an open, flexible, component software framework for workflow application development. This product enables users and ValueNET(R) partners to automate business processes using object-oriented programming technology, and supports standard tools such as C++, Visual Basic, PowerBuilder, Microsoft Windows-compatible tools, and FileNET's other WorkFlo products. All work management functions, including routing, queuing, exception handling, and management control, are managed by Visual WorkFlo using standard Windows interfaces and graphical tools. FileNET Ensemble(TM) is a general purpose workflow tool introduced in 1996 that automates a wide range of everyday business processes and is integrated with Microsoft Exchange and Novell GroupWise to enhance these messaging (e-mail) system products. FileNET markets this product through all of its direct and indirect sales channels worldwide. Novell markets a version of this software under the product name "GroupWise Workflow." 5 Electronic Document Management The Company's electronic document management software products simplify the management and maintenance of electronic documents and other unstructured information, ensuring the right information is always available. Needed information is readily accessible, providing total manageability and security. Panagon IDM Document Services is a server software product that enables electronic document management applications across large enterprise LANs and WANs. It acts as a network librarian, simplifying the management and maintenance of all files on the user's network. @mezzanine(R) is a software product used to organize, protect and maintain documents published on the World Wide Web. @mezzanine provides improved organization and access methods to the Web browser and special document management features such as version control, security and archiving needed by the Web server. COLD The Company's Panagon Report Manager software product stores and retrieves computer-generated reports to replace the use of printed reports and computer output to microfiche. It also enables the user to search for specific information located in one or more reports and extract the information to use with popular desktop software applications. It is a client/server software product running on servers using the Microsoft Windows NT Server operating system and PC workstations running Microsoft Windows. It also integrates with FileNET's IMS software product to provide large capacity archival storage capabilities. HARDWARE The Company markets an optional integration service, offering customers the option to purchase complete solutions, including industry standard hardware, directly from FileNET. The Company also manufactures and markets an optical storage and retrieval library (OSAR(R)) based on 12-inch optical disk storage technology. All named products mentioned in this Form 10-K, other than the Company's named products, are trademarks or registered trademarks of the respective holder RESEARCH AND DEVELOPMENT The Company's research and development activities are focused on software product development. Research and development expenditures were $39.6 million, $36.5 million and $24.7 million for the years ended December 31, 1997, 1996, and 1995, respectively. The Company believes that its future success depends upon its ability to continue to enhance its existing software products and to develop new software products that satisfactorily meet market needs. Accordingly, the Company intends to continue to make substantial investments in its research and development activities. BACKLOG The Company typically ships its products within a short period of time after acceptance of orders, which is common in the computer software industry. The Company does not consider the level of backlog to be a significant or important indicator of future revenue or earnings. SERVICES, SUPPORT AND MANUFACTURING The Company maintains service and support organizations that provide both pre-sales and post-sales services in the United States and the foreign countries where the Company has direct operations. The Company's integration facilities in Costa Mesa, California and Dublin, Ireland, conduct software manufacturing, integration, test and quality control. The Company operates a Response Center in Costa Mesa to provide telephone technical support to customers who have entered into support agreements with the Company. The Company is in the process of opening an additional Response Center in Dublin, Ireland and also plans to open a Response Center for the Asia Pacific region in Singapore. 6 EMPLOYEES As of December 31, 1997, the Company had 1,490 full-time employees of which 343 were employed in research and development; 924 in sales, marketing, professional services and customer support; 131 in operations; and 92 in finance and administration. Employees in the Company's German subsidiary are represented by a labor union. No other employees are represented by labor unions, and the Company has never experienced a work stoppage. The Company believes that it enjoys good employee relations. COMPETITION The market for the Company's products is highly competitive. The Company's principal competitors for its various product lines include the following companies: 1) Workflow and document imaging-- Banctec, Inc., IBM, Keyfile, Optika, Unisys Corporation, Mosaix, Eastman Software, a Kodak company, 2) Electronic Document Management--Documentum, IBM, Interleaf, Novasoft, Novell, Open Text, PC DOCS, and 3) COLD--Computron, IBM and Microbank. Numerous smaller software vendors also compete in each product area. The Company also experiences competition from systems integrators who configure hardware and software into customized systems. In addition, RDBMS vendors, such as Oracle, Sybase and Informix, may compete with the Company in the future. Oracle has announced products that compete with the Company's document management products. It is also possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. The Company also expects that competition will increase as a result of software industry consolidations. See "Certain Considerations - Competition" below. PATENTS AND LICENSES The Company holds three patents for its OSAR product which expire August 26, 2003, June 23, 2004 and August 4, 2004, respectively. The Company has also entered into non-exclusive license arrangements with a number of organizations, including IBM and Oracle, which permit the Company and its resellers to grant sublicenses to end users of the Company's systems to use software developed by these third-party vendors. See "Certain Considerations - Intellectual Property and Other Proprietary Rights" below. CERTAIN CONSIDERATIONS This Annual Report on Form 10-K contains forward-looking statements that involve risks and uncertainties, including those discussed in the Company's Annual Report to Stockholders for the year ended December 31, 1997, certain sections of which are incorporated herein by reference as set forth in Items 7 and 8 of this report. The actual results that the Company achieves may differ materially from any forward-looking statements, which reflect management's opinions only as of the date hereof. The Company undertakes no obligation to revise or publicly release the results of any revisions to these forward-looking statements. Readers should carefully review the factors described below and in other documents the Company files from time to time with the Securities and Exchange Commission, including its 1997 Annual Report to Stockholders and the Quarterly Reports on Form 10-Q to be filed by the Company in 1998. Rapid Technological Change; Product Development The market for the Company's products is characterized by rapid technological developments, evolving industry standards, changes in customer requirements and frequent new product introductions and enhancements. The Company's success will be dependent upon its ability to enhance its existing products, develop and introduce, in a timely manner, new products incorporating technological advances and respond to customer requirements. Specifically, the Company has announced plans to deliver a new range of desktop software products providing integrated document management capability for existing and new users. To the extent one or more of the Company's competitors introduce products that more fully address customer requirements, the Company's business could be adversely affected. There can be no assurance that the Company will be successful in developing and marketing enhancements to its existing products or new products on a timely basis or that any new or enhanced products will adequately address the changing needs of the market-place. If the Company is unable to develop and introduce new products or enhancements to existing products in a timely manner in response to changing market conditions or customer requirements, the Company's business, financial condition or results of operations could be adversely affected. From time to time, the Company or its competitors may announce new products, capabilities or technologies that have the potential to replace or shorten the life cycles of the Company's existing products. There can be no assurance that such announcements will not cause customers to delay their purchasing decisions in anticipation of such products, resulting in a material adverse effect on the Company's business, financial condition or results of operations. Uncertainty of Future Operating Results; Fluctuations in Quarterly Operating Results Future operating results will depend upon many factors, including the demand for the Company's products, the effectiveness of the Company's efforts to continue to integrate various products it has developed or acquired through acquisition of others and to achieve the desired levels of 7 sales from such product integration, the level of product and price competition, the length of the Company's sales cycle, seasonality of individual customer buying patterns, the size and timing of individual transactions, the delay or deferral of customer implementations, the budget cycles of the Company's customers, the timing of new product introductions and product enhancements by the Company and its competitors, the mix of sales by products, services and distribution channels, levels of international sales, acquisitions by competitors, changes in foreign currency exchange rates, the ability of the Company to develop and market new products and control costs, and general domestic and international economic and political conditions. Accordingly, the Company's quarterly results are difficult to predict and revenues and net income for any one quarter have in the past and may again fall significantly short of anticipated levels. Additionally, a large percentage of orders for any one quarter are usually received from customers very late in the quarter and, as a result, the Company is not able to identify possible revenue and net income shortfalls to any significant extent until the end of the quarter. As a result of these factors, revenues and operating results for any quarter are subject to variation and are not predictable with any significant degree of accuracy. Therefore, the Company believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. Moreover, such factors could cause the Company's operating results in a given quarter to be below the expectations of public market analysts and investors and the price of the Company's common stock could be materially adversely affected. Competition The document imaging, workflow, computer output to laser disk and document management software markets are highly competitive, and there are certain competitors of the Company with substantially greater sales, marketing, development and financial resources. The Company believes that the competitive factors affecting the market for its products and services include vendor and product reputation; product quality, performance and price; the availability of products on multiple platforms; product scalability; product integration with other enterprise applications; product functionality and features; product ease of use; and the quality of customer support services and training. The relative importance of each of these factors depends upon the specific customer involved. While the Company believes it competes favorably in each of these areas, there can be no assurance that it will continue to do so. Moreover, the Company's present or future competitors may be able to develop products comparable or superior to those offered by the Company, offer lower price products or adapt more quickly than the Company to new technologies or evolving customer requirements. Competition is expected to intensify. In order to be successful in the future, the Company must respond to technological change, customer requirements and competitors' current products and innovations. There can be no assurance that the Company will be able to continue to compete effectively in its market or that future competition will not have a material adverse effect on its business, financial condition or results of operations. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address the needs of the markets served by the Company. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. Increased competition may result in price reductions, reduced gross margins and loss of market share, any of which could have a material adverse effect on the Company's business, financial condition or results of operations. Intellectual Property and Other Proprietary Rights The Company's success depends, in part, on its ability to protect its proprietary rights to the technologies used in its principal products. The Company relies on a combination of copyrights, trademarks, trade secrets, confidentiality procedures and contractual provisions to protect its proprietary rights. There can be no assurance that the Company's existing or future copyrights, trademarks, trade secrets or other intellectual property rights will be of sufficient scope or strength to provide meaningful protection or commercial advantage to the Company. FileNET has no software patents. Also, in selling certain of its products, the Company relies on "shrink wrap" licenses that are not signed by licensees and, therefore, may be unenforceable under the laws of certain jurisdictions. In addition, the laws of some foreign countries do not protect the Company's proprietary rights to the same extent as do the laws of the United States. There can be no assurance that such factors would not have a material adverse effect on the Company's business, financial condition or results of operations. In addition, the Company also relies on certain software that it licenses from third parties, including software that is integrated with internally developed software used in the Company's products to perform key functions. There can be no assurance that such third parties will remain in business, that they will continue to support their products, that their products are, or will be, year 2000 compliant, or that their products will otherwise continue to be available to the Company on commercially reasonable terms. The loss or inability to maintain any of theses software licenses could result in delays or reductions in product shipments until equivalent software can be developed, identified, licensed and integrated, any of which could adversely affect the Company's business, financial condition or results of operations. The Company may, from time to time, be notified that it is infringing certain patent or intellectual property rights of others. Combinations of technology acquired through past or future acquisitions and the Company's technology will create new products and technology that may give rise to claims of infringement. While no actions other than those discussed below are currently pending against the Company for infringement of patent or other proprietary rights of third parties, there can be no assurance that third parties will not initiate infringement actions against the Company in the future. Infringement actions can result in substantial cost to, and diversion of, resources of the Company. If the Company were found to infringe upon the rights of others, no assurance can be given that licenses would be obtainable on acceptable terms or 8 at all, that significant damages for past infringement would not be assessed or that further litigation relative to any such licenses or usage would not occur. The failure to successfully defend any claims or obtain necessary licenses or other rights, the ultimate disposition of any claims or the advent of litigation arising out of any claims of infringement, could have a material adverse effect on the Company's business, financial condition or results of operations. In October 1994, Wang Laboratories, Inc. (Wang) filed a complaint in the United States District Court for the District of Massachusetts alleging that the Company is infringing five patents held by Wang (the FileNET Case). On June 23, 1995, Wang amended its complaint to include an additional related patent. On July 2, 1996, Wang filed a complaint in the same court alleging that Watermark Software Inc., formerly a wholly owned subsidiary that was merged into the Company, is infringing three of the same patents asserted in the initial complaint (the Watermark Case). On October 9, 1996, Wang withdrew its claim in the FileNET Case that one of the patents it initially asserted is infringed by the Company's products that were commercialized before the initial complaint was filed. Wang reserved the right to assert that patent against the Company's products commercialized after that date in a separate lawsuit. In March 1997, Eastman Kodak Company (Kodak) purchased the Wang imaging business unit that has responsibility for this litigation. The patents in the suit have been transferred to a Kodak subsidiary, Kodak Limited of England, which, in turn, has exclusively licensed them to another Kodak subsidiary, Eastman Software, Inc. in the United States (Eastman). On July 30, 1997, the Court permitted Eastman and Kodak Limited of England to be substituted in the litigation in place of Wang. FileNET has moved for summary judgement on noninfringement as to each of the five patents in the suit, and for summary judgment of invalidity as to one of the patents. Eastman moved for summary judgment as to FileNET's unenforceability defense on one of the patents. A trial date has not been set. If it should be determined that the patents at issue in the litigation are valid and are infringed by any of the Company's products, including Watermark products, the Company will, depending on the product, redesign the infringing products or seek to obtain a license to market the products. There can be no assurance that the Company will be able to obtain such a license on acceptable terms. Based on the Company's analysis of these Eastman patents and their respective file histories, the Company believes that it has meritorious defenses to Eastman's claims; however, the ultimate outcome or any resulting potential loss cannot be determined at this time. Dependence on Certain Relationships The Company has entered into a number of co-marketing relationships with other companies such as Microsoft Corporation, Compaq Computer Corporation, SAP AG, HP and Sun Microsystems, Inc. There can be no assurance that these companies will not reduce or discontinue their relationships with, or support of, the Company and its products. Dependence on Key Management and Technical Personnel The Company's success depends to a significant degree upon the continued contributions of its key management, marketing, technical and operational personnel. In general, the Company does not utilize employment agreements for its key employees. The loss of the services of one or more key employees could have a material adverse effect on the Company's operating results. The Company also believes its future success will depend in large part upon its ability to attract and retain additional highly skilled management, technical, marketing, product development and operational personnel. Competition for such personnel, particularly engineers and other technical personnel, is intense, and there can be no assurance that the Company will be successful in attracting and retaining such personnel. In addition, the Company may experience increased compensation costs in order to attract and retain skilled personnel. International Sales Historically, the Company has derived more than 30% of its total revenues from international sales. Six percent of the Company's 1997 revenues were generated in the Asia-Pacific region (including 4% in Australia). International business is subject to certain risks including varying technical standards, tariffs and trade barriers, political and economic instability, reduced protection for intellectual property rights in certain countries, difficulties in staffing and maintaining foreign operations, difficulties in managing foreign distributors, potentially adverse tax consequences, currency exchange fluctuations, the burden of complying with a wide variety of complex operations, foreign laws, regulations and treaties, and the possibility of difficulties in collecting accounts receivable. In particular, the current economic crisis in the Asia Pacific region may limit future growth or cause a decline in international revenues. There can be no assurance that any of these factors will not have a material adverse effect on the Company's business, financial condition or results of operations. Product Liability Products as complex as those sold by the Company are susceptible to errors or failures, especially when first introduced or when new versions are released. The Company's products are often intended for use in applications that are critical to a customer's business. As a result, the Company's customers may rely on the effective performance of the software to a greater extent than the market for software products generally. The Company conducts extensive product testing to ensure that its products are free of significant errors and defects. In addition, the Company has designed and tested the most current versions of its products to be year 2000 compliant. However, some of the Company's customers are running earlier product versions that are 9 not year 2000 compliant. Although the Company has been encouraging such customers to migrate to current product versions, no assurance can be given that all of them will do so in a timely fashion, if at all. Moreover, the Company also relies on certain software that it licenses from third parties, including software that is integrated with internally developed software and is used in the Company's products to perform key functions. There can be no assurance that such third-party software will be free of errors and defects or be year 2000 compliant in a timely fashion. Although the Company has not experienced any material product liability claims to date, there can be no assurance that errors or defects, whether associated with year 2000 functions or otherwise, will not result in product liability claims against the Company in the future. The Company's license agreements with customers typically contain provisions designed to limit the Company's exposure to potential product liability claims; however, it is possible that such limitation of liability pro-visions may not be effective under the laws of certain jurisdictions. Defective products or releases could result in loss of revenues, increased service and warranty costs and product liability claims, and could adversely affect the Company's market penetration and reputation, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. Stock Price Volatility The Company believes that a variety of factors could cause the price of its common stock to fluctuate, perhaps substantially, including quarter-to-quarter variations in operating results; announcements of developments related to its business; fluctuations in its order levels; general conditions in the technology sector or the worldwide economy; announcements of technological innovations, new products or product enhancements by the Company or its competitors; key management changes; changes in joint marketing and development pro-grams; developments relating to patents or other intellectual property rights or disputes; and developments in the Company's relationships with its customers, distributors and suppliers. In addition, in recent years, the stock market in general, and the market for shares of high-technology stocks in particular, has experienced extreme price fluctuations which have often been unrelated to the operating performance of affected companies. Such fluctuations could adversely affect the market price of the Company's common stock. Item 2. Properties The Company currently leases 250,000 square feet of office, development and manufacturing space in Costa Mesa, California and 42,000 square feet of office and development space in Bellevue, Washington. The Company also leases sales and support offices in 34 locations in the United States, 13 in Europe, 3 in Australia, 3 in Canada, and 4 in Asia. The Company believes that the Costa Mesa and Bellevue facilities will be adequate for the Company's anticipated needs through 1998. Item 3. Legal Proceedings In October 1994, Wang Laboratories, Inc. (Wang) filed a complaint in the United States District Court for the District of Massachusetts alleging that the Company is infringing five patents held by Wang (the FileNET Case). On June 23, 1995, Wang amended its complaint to include an additional related patent. On July 2, 1996, Wang filed a complaint in the same court alleging that Watermark, formerly a wholly-owned subsidiary that was merged into the Company, is infringing three of the same patents asserted in the initial complaint (the Watermark Case). On October 9, 1996, Wang withdrew its claim in the FileNET Case that one of the patents it initially asserted is infringed by the Company's products that were commercialized before the initial complaint was filed. Wang reserved the right to assert that patent against the Company's products commercialized after that date in a separate lawsuit. In March 1997, Eastman Kodak Company (Kodak) purchased the Wang imaging business unit that has responsibility for this litigation. The patents in the suit have been transferred to a Kodak subsidiary, Kodak Limited of England, which, in turn, has exclusively licensed them to another Kodak subsidiary, Eastman Software, Inc. in the United States (Eastman). On July 30, 1997, the Court permitted Eastman and Kodak Limited of England to be substituted in the litigation in place of Wang. FileNET has moved for summary judgement on noninfringement as to each of the five patents in the suit, and for summary judgment of invalidity as to one of the patents. Eastman moved for summary judgment as to FileNET's unenforceability defense on one of the patents. A trial date has not been set. If it should be determined that the patents at issue in the litigation are valid and are infringed by any of the Company's products, including Watermark products, the Company will, depending on the product, redesign the infringing products or seek to obtain a license to market the products. There can be no assurance that the Company will be able to obtain such a license on acceptable terms. Based on the Company's analysis of these Eastman patents and their respective file histories, the Company believes that it has meritorious defenses to Eastman's claims; however, the ultimate outcome or any resulting potential loss cannot be determined at this time. On December 20, 1996, plaintiff Michael I. Goldman (the Plaintiff) filed a class action complaint against the Company and certain of its officers and directors in the Superior Court of California, County of Orange (the State 10 Action). The action was purportedly filed on behalf of a class of purchasers of the Company's common stock during the period October 19, 1995 through July 2, 1996. The Plaintiff alleges that the Company and other defendants violated Cal. Corp. Code ss.ss. 25400 and 25500, Cal. Civ. Code ss.ss. 1709-1710 and Cal. Bus. & Prof. Code ss.ss. 17200 et seq. in connection with various public statements made by the Company and certain of its officers and directors during the putative class period. The complaint seeks unspecified compensatory and punitive damages, interest, payment of attorney's fees and costs, and equitable or injunctive relief. On April 1, 1997, The Plaintiff filed another class action complaint against the Company and certain of its officers and directors in the United States District Court for the Central District of California (the Federal Action). The action purportedly was filed on behalf of the same class of purchasers of the Company's common stock as the State Action. The allegations contained in the Federal Action are very similar to the allegations contained in the State Action, except that the Federal Action asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act and Rule 10b-5. The complaint seeks unspecified compensatory damages, interest, attorneys' fees, expert witness fees, costs and equitable or injunctive relief. On July 2, 1997, the court granted plaintiff's motion to be appointed "lead plaintiff" under the Private Securities Litigation Reform Act. In the Federal Action, defendants have filed a motion to dismiss the complaint in its entirety. Plaintiff has filed a motion to stay the Federal Action, in light of the parallel State Action. The court is scheduled to hear both of these motions during April 1998. In the State Action, defendants moved to stay the action, in light of the parallel Federal Action. The trial court granted the motion to stay the action as to discovery on September 8, 1997. Defendants also demurred and moved to strike the complaint. The trial court overruled the demurrer and denied the motion to strike on October 21, 1997. On January 14, 1998, the court entered an order dismissing with prejudice two of plaintiff's three causes of action: the claims under Cal. Civ. Code ss.ss. 1709-1710 and Cal. Bus. & Prof. Code ss.ss. 17200 et seq. On January 30, 1998, the trial court in the State Action granted the Plaintiff's motion to certify a class composed of persons who bought FileNET stock in California only between October 19, 1995 and July 2, 1996. This ruling is subject to revision based on the decisions to be rendered by the California Supreme Court in Diamond Multimedia Systems, et al. v. Superior Court (Pass) and StorMedia, Inc., et al. v. Superior Court (Werczberger). The trial court also denied the Plaintiff's motion to lift the discovery stay. The Company believes that all of the allegations contained in the complaints filed in the State and Federal Actions are without merit and intends to defend the actions vigorously. The Company, in the normal course of business, is subject to various other legal matters. While the results of litigation and claims cannot be predicted with certainty, the Company believes that the final outcome of these other matters will not have a materially adverse effect on the Company's consolidated results of operations or financial condition. Item 4. Submission of Matters to a Vote of Security Holders None. PART II Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters There is hereby incorporated herein by reference the information appearing under the caption "Stock Market and Dividend Information," which appears on page 42 of the Registrant's Annual Report to Stockholders for the year ended December 31, 1997 and is filed herewith as Exhibit 13.1. 11 Item 6. Selected Financial Data The following table summarizes certain selected financial data:
For Fiscal Years Ended -------------------------------------------------------------------------------------- Dec. 31, 1997 Dec. 31, 1996 Dec. 31, 1995 Jan. 1, 1995 Jan. 2, 1994 (1997) (1996) (1995) (1994) (1993) -------------- --------------- ---------------- ------------- ------------- (In thousands, except per share amounts) Consolidated statements of operations data: Revenue: Software revenue $132,723 $140,659 $116,052 $ 81,102 $ 54,067 Service revenue 89,280 82,118 67,174 60,753 60,933 Hardware revenue 29,422 46,136 46,152 50,480 51,410 ------------ ---------- ---------- ---------- ---------- Total revenue 251,425 268,913 229,378 192,335 166,410 Costs and expenses: Cost of software revenue 14,768 16,464 15,146 12,472 7,831 Cost of service revenue 56,503 53,568 44,277 41,645 42,812 Cost of hardware revenue 20,330 29,633 28,800 30,999 34,116 Research and development 39,575 36,502 24,711 18,274 15,247 Selling, general and administrative 125,122 117,761 96,499 71,267 61,711 Merger, restructuring, write-off of purchased in-process research and development and other costs 6,000 16,011 6,393 0 0 ------------ ---------- ---------- ---------- ---------- Total costs and expenses 262,298 269,939 215,826 174,657 161,717 ------------ ---------- ---------- ---------- ---------- Operating income (loss) (10,873) (1,026) 13,552 17,678 4,693 Other income, net 3,160 2,838 2,780 1,821 333 ------------- ---------- ---------- ---------- ---------- Income (loss) before income taxes (7,713) 1,812 16,332 19,499 5,026 Provision (benefit) for income taxes (2,187) 4,456 8,116 5,356 4,760 ------------- ----------- ---------- ----------- ---------- Net income (loss) $ (5,526) $ (2,644) $ 8,216 $ 14,143 $ 266 ============= =========== ========== =========== ========== Basic earnings (loss) per share $ (0.36) $ (0.18) $ 0.57 $ 1.04 $ 0.02 Diluted earnings (loss) per share $ (0.36) $ (0.18) $ 0.52 $ 0.95 $ 0.02 Weighted average shares outstanding - basic 15,155 15,007 14,430 13,661 12,567 Weighted average shares outstanding - diluted 15,155 15,007 15,856 14,834 13,178 Consolidated balance sheet data: Working capital $ 82,887 $ 89,339 $ 86,354 $ 63,149 $ 47,819 Total assets 179,870 195,679 189,682 152,642 124,986 Long-term debt, excluding current portion 163 Stockholders' equity 118,811 132,806 131,158 101,006 78,383 Certain reclassifications have been made to the prior years' selected financial data to conform with the current year's presentation.
12 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations There is hereby incorporated herein by reference the information appearing under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations," which appears on pages 18 through 24 of the Registrant's Annual Report to Stockholders for the year ended December 31, 1997 and is filed herewith as Exhibit 13.2. Item 8. Financial Statements and Supplementary Data There is hereby incorporated herein by reference the information appearing on pages 25 through 40 of the Registrant's Annual Report to Stockholders for the year ended December 31, 1997 and is filed herewith as Exhibit 13.3. The accompanying Independent Auditors' Report is also incorporated herein by reference and filed herewith as Exhibit 13.3. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. PART III Item 10. Directors and Executive Officers of the Registrant There is hereby incorporated herein by reference the information appearing under the caption "Election of Directors," under the caption "Executive Officers of the Company," and under the caption "Compliance with Securities Laws" of the Registrant's definitive Proxy Statement for its 1998 Annual Meeting to be filed with the Securities and Exchange Commission. Item 11. Executive Compensation There is hereby incorporated herein by reference the information appearing under the caption "Executive Compensation" and under the caption "Election of Directors" of the Registrant's definitive Proxy Statement for its 1998 Annual Meeting to be filed with the Securities and Exchange Commission. Item 12. Security Ownership of Certain Beneficial Owners and Management There is hereby incorporated herein by reference the information appearing under the caption "Voting Securities and Principal Holders Thereof" of the Registrant's definitive Proxy Statement for its 1998 Annual Meeting to be filed with the Securities and Exchange Commission. Item 13. Certain Relationships and Related Transactions There is hereby incorporated herein by reference the information appearing under the caption "Note 12: Related Party Transactions," which appears on page 39 of the Registrant's Annual Report to Stockholders for the year ended December 31, 1997 and is filed herewith as Exhibit 13.4. 13 PART IV Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K (a) Financial statements 1. The list of financial statements contained in the accompanying Index to Consolidated Financial Statements covered by the Independent Auditors' Report is herein incorporated by reference. 2. Financial statement schedule The listed financial statement schedule contained in the accompanying Index to Consolidated Financial Statements covered by the Independent Auditors' Report is herein incorporated by reference. 3. Exhibits The list of exhibits contained in the accompanying Index to Exhibits is herein incorporated by reference. (b) Reports on Form 8-K No reports on Form 8-K were filed during the fourth quarter of 1997. Index to Consolidated Financial Statements Covered by Independent Auditors' Report Item 14(a) (1) and (2)
Page Reference -------------------------- 1997 Annual Report to Form 10-K Stockholders The information under the following captions, which is included in the 1997 Annual Report to Stockholders, is incorporated herein by reference: Independent Auditors' Report 40 Consolidated balance sheets at December 31, 1997 and December 31, 1996 25 Consolidated statements of operations for each of the years ended December 31, 1997, 1996 and 1995 26 Consolidated statements of stockholders' equity for each of the years ended December 31, 1997, 1996 and 1995 27 Consolidated statements of cash flows for each of the years ended December 31, 1997, 1996 and 1995 28 Notes to consolidated financial statements 29 Independent Auditors' Report on Schedule 15 Schedule for each of the three years ended December 31, 1997, 1996 and 1995 II. Valuation and qualifying accounts and reserves 16
14 INDEPENDENT AUDITORS' REPORT ON SCHEDULE To the Stockholders and the Board of Directors FileNET Corporation Costa Mesa, California We have audited the consolidated financial statements of FileNET Corporation and its subsidiaries as of December 31, 1997 and 1996 and for each of the three years in the period ended December 31, 1997, and have issued our report thereon dated February 3, 1998. Such consolidated financial statements and report are included in your 1997 Annual Report to Stockholders and are incorporated herein by reference. Our audits also included the financial statement schedule of FileNET Corporation and its subsidiaries, listed in Item 14. The consolidated financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/ Deloitte & Touche LLP February 3, 1998 Costa Mesa, California 15 SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS ($ in thousands)
Balance at Additions - Beginning of Charged to Costs Balance at End Description Period and Expenses Deductions of Period - ----------------------------------------- ---------------- -------------------- --------------- ---------------- Year ended December 31, 1997: Inventory reserves $ 660 $ 380 $ 710 (1) $ 330 Allowance for doubtful accounts 2,140 350 800 (2) 1,690 Reserve for returned systems 3,185 460 (3) 2,725 Year ended December 31, 1996: Inventory reserves 573 635 548 (1) 660 Allowance for doubtful accounts 1,540 1,205 605 (2) 2,140 Reserve for returned systems 3,153 32 3,185 Year ended December 31, 1995: Inventory reserves 651 482 560 (1) 573 Allowance for doubtful accounts 731 857 48 (2) 1,540 Reserve for returned systems 2,747 869 463 (3) 3,153
- -------------------------- (1) Consists primarily of the write-off of excess/obsolete inventories. (2) Consists primarily of uncollectible invoice amounts. (3) Consists primarily of returned systems. 16 Index to Exhibits Exhibit No. Description - ----- ---------------------------------------------------------------------- 3.1* Restated Certificate of Incorporation, as amended(filed as Exhibit 3.1 to Form S-4 filed on January 26, 1996; Registration No.333-00676). 3.1.1* Certificate of Amendment of Restated Certificate of Incorporation (filed as Exhibit 3.1.1 to Form S-4 filed on January 26, 1996, Registration No. 333-00676). 3.2* Bylaws (filed as Exhibit 3.2 of the Registrant's registration statement on Form S-1, Registration No. 33-15004 (the "Form S-1")). 4.1* Form of certificate evidencing Common Stock (filed as Exhibit 4.1 to the Form S-1, Registration No. 33-15004). 4.2* Rights Agreement, dated as of November 4, 1988 between FileNET Corporation and the First National Bank of Boston, which includes the form of Rights Certificate as Exhibit A and the Summary of Rights to Purchase Common Shares as Exhibit B (filed as Exhibit 4.2 to Form S-4 filed on January 26, 1996; Registration No. 333-00676). 10.1* Second Amended and Restated Credit Agreement (Multicurrency) by and among the Registrant and Bank of America National Trust and Savings Association dated June 25, 1997, effective June 1, 1997 (filed as Exhibit 10.1 to Form 10-Q for the quarter ended June 30, 1997). 10.2* Business Alliance Program Agreement between the Registrant and Oracle Corporation dated July 1, 1996, as amended by Amendment One thereto (filed as Exhibit 10.4 to Form 10-QA for the quarter ended June 30, 1996). 10.3* Runtime Sublicense Addendum between the Registrant and Oracle Corporation dated July 1, 1996, as amended by Amendment One thereto (filed as Exhibit 10.4 to Form 10-QA for the quarter ended June 30, 1996). 10.4* Full Use and Deployment Sublicense Addendum between the Registrant and Oracle Corporation dated July 1, 1996, as amended by Amendment One thereto (filed as Exhibit 10.4 to Form 10-QA for the quarter ended June 30, 1996). 10.5* Lease between the Registrant and C. J. Segerstrom & Sons for the headquarters of the Company, dated April 30, 1987 (filed as Exhibit 10.19 to the Form S-1). 10.6* Third Amendment to the Lease between the Registrant and C.J. Segerstrom & Sons dated April 30, 1987, for additional facilities at the headquarters of the Company, dated October 1, 1992 (filed as exhibit 10.7 to Form 10-K filed on April 4, 1997). 10.7* Fifth Amendment to the Lease between the Registrant and C.J.Segerstrom & Sons dated April 30, 1987, for the extension of the term of the lease, dated March 28, 1997 (filed as exhibit 10.8 to Form 10-Q for the quarter ended March 31, 1997). 10.8* 1989 Stock Option Plan for Non-Employee Directors of FileNET Corporation, as amended by the First Amendment, Second Amendment, Third Amendment thereto (filed as Exhibit 10.9 to Form S-4 filed on January 26, 1996; Registration No. 333-00676). 10.9* Amended and Restated 1995 Stock Option Plan of FileNET Corporation as approved by stockholders at the Registrant's Annual Meeting on May 8, 1996 (filed as Exhibit 99.1 to Form S-8 filed on July 29, 1996). 10.10* Second Amended and Restated Stock Option Plan of FileNET Corporation, together with the forms of Incentive Stock Option Agreement and Non-Qualified Stock Option Agreements (filed as Exhibits 4(a), 4(b)and 4(c), respectively, to the Registrant's Registration Statement on Form S-8, Registration No. 33-48499), and an Amendment thereto (filed as Exhibit 4(d) to the Registrant's Registration Statement on Form S-8, Registration No. 33-69920), and the Second Amendment thereto (filed as Appendix A to the Registrant's Proxy Statement for the Registrant's 1994 Annual Meeting of Stockholders, filed on April 29, 1994). - -------------------------------------------- * Incorporated herein by reference 17 Exhibit No. Description - -------- ---------------------------------------------------------------------- 10.11* Non-Statutory Stock Option Agreement (with Notice of Grant of Stock Option and Special Addendum) between Registrant and Mr. Lee Roberts (filed as exhibit 99.17 to Form S-8 on August 20, 1997). 10.12* Non-Statutory Stock Option Agreement (with Notice of Grant of Stock Option and Special Addendum) between Registrant and Mr. Ron Ercanbrack (filed as exhibit 99.19 to Form S-8 on August 20, 1997). 10.13* Agreement for the Purchase of IBM products dated December 20, 1991 (filed on May 5, 1992 with the Form 8 amending the Company's Form 10-K for the fiscal year ended December 31, 1991). 10.14* Amendment #A1011-941003-01 dated September 30, 1994, to the Agreement for the Purchase of IBM products dated December 20, 1991 (filed as exhibit 10.12 to form 10-K for the fiscal year ended December 31, 1996). 10.15* Development and Initial Supply Agreement between the Registrant and Quintar Company dated August 20, 1992 (filed as Exhibit 10.21 to Form 10-K for the year ended January 3, 1993). 10.16* Amendment dated December 22, 1992 to the Development and Initial Supply Agreement between the Registrant and Quintar Company dated August 20, 1992 (filed as Exhibit 10.22 to Form 10-K for the year ended January 3, 1993). 10.17* Product License Agreement between the Registrant and Novell, Inc. dated May 16, 1995 (filed as Exhibit 10.26 to Form 10-Q for the quarter ended July 2, 1995). 10.18* Agreement and Plan of Merger between the Registrant and Watermark Software Inc. dated July 18, 1995 (filed as Exhibit 10.27 to Form 10-Q for the quarter ended July 2, 1995). 10.19* Agreement and Plan of Merger between the Registrant and Saros Corporation, as amended, dated January 17, 1996 (filed as Exhibits 2.1, 2.2, 2.3, and 2.4 to Form 8-K on March 13, 1996). 10.20* Stock Purchase Agreement by and Among FileNET Corporation, IFS Acquisition Corporation, Jawaid Khan and Juergen Goersch dated January 17, 1996 and Amendment 1 to Stock Purchase Agreement dated January 30, 1996 (filed as Exhibit 10.2 to form 10-K for the year ended December 31, 1995). 13.1 Market for the Registrant's Common Stock and Related Stockholder Matters incorporated by reference to page 42 of the 1997 Annual Report. 13.2 Management's Discussion and Analysis of Financial Condition and Results of Operations incorporated by reference to pages 18 through 24 of the 1997 Annual Report. 13.3 Financial Statements incorporated by reference to pages 25 through 40 of the 1997 Annual Report. 13.4 Certain Relationships and Related Transactions incorporated by reference to page 12 of the 1997 Annual Report. 21.1 List of subsidiaries of Registrant (filed as FileNET Corporation Subsidiary Information). 23.1 Consent of Deloitte & Touche LLP (filed as Independent Auditors' Consent). 27 Financial Data Schedule. - --------------------------------------------- * Incorporated herein by reference 18 Signatures Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FILENET CORPORATION Date: March 30, 1998 By: /s/ T. J. Smith ------- ----------------------------------- T. J. Smith Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Date: March 30, 1998 By: /s/ T. J. Smith ------- -------------------------------------- T. J. Smith Chief Executive Officer (Principal Executive Officer) Director Date: March 30, 1998 By: /s/ Lee D. Roberts ------- ------------------------------------- Lee D. Roberts President and Chief Operating Officer Date: March 30, 1998 By: /s/ Mark S. St. Clare ------- ------------------------------------- Mark S. St. Clare Chief Financial Officer and Sr. Vice President, Finance (Principal Financial Officer) Date: March 30, 1998 By: /s/ Lee M. Kim ------- ------------------------------------- Lee M. Kim Controller and Chief Accounting Officer Date: March 30, 1998 By: /s/ Frederick K. Fluegel ------- ------------------------------------- Frederick K. Fluegel Director Date: March 30, 1998 By: /s/ John C. Savage ------- ------------------------------------- John C. Savage Director Date: March 30, 1998 By: /s/ William P. Lyons ------- ------------------------------------- William P. Lyons Director 19 EX-13.1 2 MARKET FOR THE REGISTRANT'S COMMON STOCK Stock Market and Dividend Information The Company's common stock is traded in the National Market System (NASDAQ) under the symbol FILE. The following are the high and low closing prices from January 2, 1995 through December 31, 1997, as reported by NASDAQ: High Low ---- --- 1997 4th Quarter $32.63 $16.13 3rd Quarter 20.13 15.50 2nd Quarter 16.63 10.31 1st Quarter 31.75 15.50 1996 4th Quarter $36.13 $26.00 3rd Quarter 35.00 20.63 2nd Quarter 57.88 33.25 1st Quarter 65.25 40.75 1995 4th Quarter $48.75 $38.50 3rd Quarter 50.25 40.25 2nd Quarter 40.38 31.00 1st Quarter 35.50 26.00 The closing price of the Company's common stock on December 31, 1997 was $30.13. The approximate number of stockholders of record on February 23, 1998, was 838; the closing price of the Company's common stock on this date was $31.34. The Company has not paid any dividends on its common stock. The Company currently intends to retain earnings for use in its business and does not anticipate paying cash dividends in the foreseeable future. The Company's ability to pay dividends is limited by the terms of its line of credit agreement. 42 EX-13.2 3 MANAGEMENT'S DISCUSSION AND ANALYSIS Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto contained elsewhere in this Annual Report. Revenue (Dollars in millions) Percent Percent 1997 change 1996 change 1995 ---- ------ ---- ------ ---- Software revenue Domestic $ 89.7 2% $ 87.6 12% $ 77.9 International 43.0 (19%) 53.1 39% 38.2 ---- --- ---- -- ---- Total software revenue $132.7 (6%) $140.7 21% $116.1 Percentage of total revenue 53% 52% 51% Service revenue Domestic $ 68.0 11% $ 61.4 29% $ 47.5 International 21.3 3% 20.7 5% 19.7 ---- - ---- - ---- Total service revenue $ 89.3 9% $ 82.1 22% $ 67.2 Percentage of total revenue 36% 31% 29% Hardware revenue Domestic $ 20.4 (28%) $ 28.3 3% $ 27.4 International 9.0 (49%) 17.8 (5%) 18.7 --- --- ---- -- ---- Total hardware revenue $ 29.4 (36%) $ 46.1 -- $ 46.1 Percentage of total revenue 12% 17% 20% -- -- -- Total revenue $251.4 (7%) $268.9 17% $229.4 ====== == ====== == ====== Software revenue from the licensing of the Company's software products decreased 6% in 1997 due to a decrease in new domestic orders during the first quarter of 1997 and a decrease in new international orders for the year, offset by increased demand experienced domestically during the third and fourth quarters. The 21% increase in 1996 is attributable to an increase in the volume of product shipments from the addition of new products and reselling partners and additional revenue generated through the Company's co-marketing arrangement with Hewlett-Packard Company (HP). The Company believes software revenue growth rates for 1997 and 1996 were negatively impacted by difficulties experienced with integrating the Saros Corporation (Saros) and Watermark Software Inc. (Watermark) sales organizations into FileNET's sales organization. Service revenue consists of revenue from software maintenance services, professional services, training, repairs and supplies. Service revenue increased 9% in 1997 due to an increase in the customer installed base, offset by a decrease in international professional services revenue and the decrease in revenue related to the sale and repair of spare parts to HP noted below. The 22% increase in 1996 was due to the growth of the Company's customer installed base, an increase in training due primarily to the training of new resellers, and the recognition of $7.6 million of revenue from the sale and repair of spare parts in connection with the continued transition of hardware maintenance activities to HP. There were no such sales in 1995. Hardware revenue is generated primarily from the sale of 12-inch optical storage and retrieval libraries (OSAR) and third-party hardware. Hardware revenue decreased 36% in 1997 due to a decrease in new orders experienced both domestically and internationally, attributable to the Company's focus on increasing its higher margin software revenue. The Company expects hardware revenue to continue to decline in both absolute dollars and as a percentage of total revenue as it continues to transition its business toward software-related revenue. 18 Domestic revenues remained flat in 1997 compared to an increase of $24.5 million, or 16%, in 1996 due to the decrease in hardware revenue noted above and slower software growth. International revenue decreased $18.3 million, or 20%, compared with an increase of $15.0 mil-lion, or 20%, in 1996. The decrease in international revenue in 1997 from 1996 was due to a weakness in European orders and, to a lesser extent, the strengthening of the U.S. dollar. The increase in 1996 was due to continued growth of software and service revenue offset by the anticipated decrease in hardware revenue. International revenue as a percentage of total revenue decreased to 30% in 1997 from 34% in 1996 and 33% in 1995. The decrease in 1997 is due to the decrease in international revenues noted above. In the future, the Company expects inter-national revenue to continue to represent a significant percentage of total revenue as it continues to expand its operations internationally. However, the current economic crisis in the Asia-Pacific region could adversely affect international sales. In addition, international revenues could be adversely affected if the U.S. dollar strengthens against international currencies. Cost of Revenue (Dollars in millions) Percent Percent 1997 change 1996 change 1995 ---- ------ ---- ------ ---- Cost of software revenue $14.8 (10%) $16.5 9% $15.1 Percentage of software revenue 11% 12% 13% Cost of service revenue $56.5 5% $53.6 21% $44.3 Percentage of service revenue 63% 65% 66% Cost of hardware revenue $20.3 (31%) $29.6 3% $28.8 Percentage of hardware revenue 69% 64% 62% -- -- -- Cost of total revenue $91.6 (8%) $99.7 13% $88.2 ===== == ===== == ===== The cost of software revenue includes royalties paid to third parties and the cost of software distribution. The cost of software revenue as a percentage of software revenue decreased to 11% in 1997 from 12% in 1996 and 13% in 1995. The decrease in 1997 is due to savings related to the consolidation of software distribution activities. The decrease in 1996 was due to a decrease in the amount of capitalized software amortized in 1996 and savings related to the consolidation of software distribution activities. The cost of service revenue includes software support and professional services personnel, supplies, and the cost of third-party hardware maintenance. The cost of service revenue as a percentage of service revenue decreased to 63% in 1997 from 65% in 1996 and 66% in 1995. The decreases are primarily due to the transition of hardware maintenance to HP, offset by lower margins associated with international maintenance. The cost of hardware revenue includes the Company's cost of OSAR manufacturing, third-party purchased hardware and the cost of hardware integration personnel. The cost of hardware revenue as a percentage of hardware revenue increased to 69% in 1997 from 64% in 1996 and 62% in 1995. The increase in 1997 is due to a decrease in hardware revenue without a corresponding decrease in fixed costs related to the Company's hardware manufacturing and integration activities. The increase in 1996 was due to a less favorable mix from the Company's OSAR product line and lower margins from third-party purchased equipment. Research and Development and Selling, General and Administrative Expenses (Dollars in millions) Percent Percent 1997 change 1996 change 1995 ---- ------ ---- ------ ---- Research and development $ 39.6 8% $ 36.5 48% $24.7 Percentage of total revenue 16% 14% 11% Selling, general and administrative $125.1 6% $117.8 22% $96.5 Percentage of total revenue 50% 44% 42% 19 Management's Discussion and Analysis of Financial Condition and Results of Operations Research and development expenses increased 8% in 1997 primarily due to a general increase in salaries. The 48% increase in 1996 was due to the addition of development personnel and the related facilities and depreciation expenses to fund new development activities. Research and development expense in 1995 is after capitalized software development costs of $1.6 million. As a percentage of total revenue, research and development expenses increased to 16% in 1997 from 14% in 1996 and 11% in 1995. The increase in 1997 is due to the decrease in revenue compounded by the increased level of spending. The increase in 1996 was due to the increase in research and development personnel to sup-port new development activities without corresponding revenue growth and a decrease in the amount of capitalized software development costs. The Company expects that competition for qualified technical personnel will remain intense for the foreseeable future and may result in higher levels of compensation expense for the Company. The Company believes that research and development expenditures, including compensation of technical personnel, are essential to maintaining its competitive position and expects these costs to continue to constitute a significant percentage of revenue. Selling, general and administrative expenses increased 6% in 1997 and 22% in 1996. The increase in 1997 was due primarily to the Company's continued international expansion and higher legal costs (see Note 11 of Notes to Consolidated Financial Statements for a description of legal proceedings). The increase in 1996 was due primarily to an increase in the number of marketing and sales support personnel employed internationally as the Company expanded its international reseller and sales operations and to an increase in commissions associated with higher revenues. In 1997, selling, general and administrative expenses as a percentage of total revenue increased to 50% from 44% in 1996 and 42% in 1995 primarily due to increasing expense levels without a corresponding increase in revenues. Merger, Restructuring, Write-off of Purchased In-process Research and Development and Other Costs The $6.0 million in restructuring and other charges in 1997 represents the costs of consolidating the Watermark business unit's Burlington, Massachusetts engineering and marketing functions with those at FileNET's Costa Mesa, California location, as well as a reduction in headcount in certain other areas of the Company. The restructuring and other charges include approximately $1.9 million for severance payments for 111 employees, $2.2 million for the write-off of impaired assets, $0.4 million for facility closing costs and $1.5 million of other charges. The $16.0 million merger, restructuring and write-off of purchased in-process research and development costs in 1996 consisted of $10.0 million for the write-off of purchased in-process research and development costs related to the International Financial Systems Ltd. (IFSL) acquisition, $4.2 million in merger costs related to the Saros acquisition, and $1.8 million in restructuring costs related to the Saros and Watermark acquisitions. The restructuring charges represent the costs of consolidating the various companies' sales and administrative functions and include $1.4 million for severance payments for 30 employees and $0.4 million for the write-off of certain contractual obligations and other costs. The $6.4 million merger, restructuring and write-off of purchased in-process research and development costs in 1995 consisted of a charge for the buyout of certain Watermark European marketing and manufacturing rights, a write-off of capitalized research and development expenses for FileNET projects made redundant by the Watermark acquisition and other direct acquisition-related fees and expenses. At December 31, 1997, accrued restructuring and other charges of $3.0 million are included in other accrued liabilities. The Company anticipates that the remaining restructuring costs will be expended during 1998. Other Income Other income, net of other expenses, was $3.2 million in 1997 and $2.8 million in both 1996 and 1995. The increase in 1997 is primarily due to increased interest income on a higher balance of cash and marketable securities. Provision for Income Taxes The provision for income taxes was a benefit of $2.2 million in 1997, compared to charges of $4.5 million and $8.1 million recorded in 1996 and 1995, respectively. The 1997 effective tax rate was (28%). The Company's 1996 effective tax rate is not meaningful, as the 1996 provision was impacted by the write-off of purchased in-process research and development as part of the acquisition of IFSL, with no corresponding tax benefit, nondeductible costs associated with the Saros merger and earnings generated in certain international jurisdictions, partially offset by the benefit of tax losses incurred in the United States. The Company's effective tax rate was 50% in 1995. The Company currently anticipates that its effective tax rate for 1998 will be approximately 30%. However, the actual tax rate may differ due to a variety of factors including the geographical mix of revenues and the ability to use certain deferred tax assets. 20 Foreign Currency Fluctuations and Inflation The Company's performance can be affected by changes in foreign currency values relative to the U.S. dollar, as discussed above, in relation to the Company's revenue and operating expenses. The impact to net income from foreign exchange transactions and hedging activities is immaterial for all periods reported. The foreign currency translation adjustment included in stockholders' equity decreased $5.8 million during 1997 over 1996 due primarily to the weakness of the Irish currency against the U.S. dollar applied to the Company's net assets in Ireland. Management believes that inflation has not had a significant impact on the prices of the Company's products, the cost of its materials, or its operating results during 1995 through 1997. Financial Condition Liquidity and Capital Resources As of December 31, 1997, combined cash, cash equivalents, and marketable securities (short and long-term) were $71.8 million, an increase of $4.5 million from the $67.3 million at the end of 1996. Cash provided by operating activities in 1997 was $24.8 million. Cash used by the net loss for the year was offset by lower accounts receivable balances associated with a lower average days sales outstanding, lower inventories associated with the Company's decrease in hardware revenue and additions to net income for depreciation and amortization. Cash used by investing activities totaled $11.3 million, consisting of capital expenditures offset by the net sale and maturity of marketable securities. Cash used by financing activities was $2.6 million and was the result of the repurchase of common stock offset by proceeds from the issuance of common stock in connection with the exercise of employee stock options and the employee stock purchase plan. Cash used by operating activities in 1996 was $1.8 million. The balance is primarily due to a net loss and the effect of higher accounts receivable balances associated with higher revenue and higher average days sales outstanding, offset in part by the non-cash additions to net income for write-off of capitalized and purchased in-process research and development costs, depreciation and amortization of capitalized software. Cash used by investing activities totaled $16.7 million, consisting of capital expenditures and the purchase of IFSL, offset by proceeds from the sale of equipment and the net sale and maturity of marketable securities. Net cash provided by financing activities was $2.6 million and was the result of proceeds from the issuance of common stock and stock option income tax benefits, offset by the repurchase of common stock. The Company's capital expenditures were $14.3 million in 1997, $17.9 million in 1996, and $14.7 million in 1995. The Company's primary capital equipment expenditures are for research and development, demonstration and training equipment and enhancements to its internal business systems. The Company anticipates that it will acquire approximately $18.0 million of capital equipment in 1998. During the first quarter of 1998, the Company repurchased $4.4 million of its common stock, thereby completing its previously announced $10 million stock repurchase program. The Company anticipates that its present cash balances, together with internally-generated funds and credit lines, will be sufficient to meet its working capital and capital expenditure needs throughout 1998. Other Matters Year 2000 The Company is assessing the internal readiness of its computer systems for handling the year 2000. The Company expects to implement successfully the systems and programming changes necessary to address year 2000 issues with respect to its internal systems and does not believe that the cost of such actions will have a material adverse effect on its financial condition or results of operations. Although the Company is not aware of any material operational issues or costs associated with preparing its internal systems for the year 2000, there can be no assurance that there will not be a delay in, or increased costs associated with, the implementation of the necessary systems and changes to address the year 2000 issues, and the Company's inability to implement such systems and changes could have an adverse effect on future results of operations. Recent Accounting Pronouncements In 1997, SFAS No. 130, "Reporting Comprehensive Income" and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," were issued and are effective for fiscal years beginning after December 15, 1997. In October 1997, the AICPA issued SOP 97-2, "Software Revenue Recognition," which supersedes SOP 91-1. The provisions of SOP 97-2 are effective for fiscal years beginning after December 15, 1997. The Company is reviewing the impact of these pronouncements on its financial statements. Environmental Matters The Company is not aware of any issues related to environmental matters that have, or are expected to materially affect its business. 21 Management's Discussion and Analysis of Financial Condition and Results of Operations Certain Considerations This Annual Report contains forward-looking statements that involve risks and uncertainties, including those discussed below and in the Notes to Consolidated Financial Statements. The actual results that the Company achieves may differ materially from any forward-looking statements, which reflect management's opinions only as of the date hereof. The Company undertakes no obligation to revise or publicly release the results of any revisions to these forward-looking statements. Readers should carefully review the factors described below and in other documents the Company files from time to time with the Securities and Exchange Commission, including its Annual Report on Form 10-K for 1997 and the Quarterly Reports on Form 10-Q to be filed by the Company in 1998. Factors that may affect the Company's business, financial condition and results of operations include: Rapid Technological Change; Product Development The market for the Company's products is characterized by rapid technological developments, evolving industry standards, changes in customer requirements and frequent new product introductions and enhancements. The Company's success will be dependent upon its ability to enhance its existing products, develop and introduce, in a timely manner, new products incorporating technological advances and respond to customer requirements. Specifically, the Company has announced plans to deliver a new range of desktop software products providing integrated document management capability for existing and new users. To the extent one or more of the Company's competitors introduce products that more fully address customer requirements, the Company's business could be adversely affected. There can be no assurance that the Company will be successful in developing and marketing enhancements to its existing products or new products on a timely basis or that any new or enhanced products will adequately address the changing needs of the market-place. If the Company is unable to develop and introduce new products or enhancements to existing products in a timely manner in response to changing market conditions or customer requirements, the Company's business, financial condition or results of operations could be adversely affected. From time to time, the Company or its competitors may announce new products, capabilities or technologies that have the potential to replace or shorten the life cycles of the Company's existing products. There can be no assurance that such announcements will not cause customers to delay their purchasing decisions in anticipation of such products, resulting in a material adverse effect on the Company's business, financial condition or results of operations. Uncertainty of Future Operating Results; Fluctuations in Quarterly Operating Results Future operating results will depend upon many factors, including the demand for the Company's products, the effectiveness of the Company's efforts to continue to integrate various products it has developed or acquired through acquisition of others and to achieve the desired levels of sales from such product integration, the level of product and price competition, the length of the Company's sales cycle, seasonality of individual customer buying patterns, the size and timing of individual transactions, the delay or deferral of customer implementations, the budget cycles of the Company's customers, the timing of new product introductions and product enhancements by the Company and its competitors, the mix of sales by products, services and distribution channels, levels of international sales, acquisitions by competitors, changes in foreign currency exchange rates, the ability of the Company to develop and market new products and control costs, and general domestic and international economic and political conditions. Accordingly, the Company's quarterly results are difficult to predict and revenues and net income for any one quarter have in the past and may again fall significantly short of anticipated levels. Additionally, a large percentage of orders for any one quarter are usually received from customers very late in the quarter and, as a result, the Company is not able to identify possible revenue and net income shortfalls to any significant extent until the end of the quarter. As a result of these factors, revenues and operating results for any quarter are subject to variation and are not predictable with any significant degree of accuracy. Therefore, the Company believes that period-to-period comparisons of its results of operations are not necessarily meaningful and should not be relied upon as indications of future performance. Moreover, such factors could cause the Company's operating results in a given quarter to be below the expectations of public market analysts and investors and the price of the Company's common stock could be materially adversely affected. Competition The document imaging, workflow, computer output to laser disk and document management software markets are highly competitive, and there are certain competitors of the Company with substantially greater sales, marketing, development and financial resources. The Company believes that the competitive factors affecting the market for its products and services include vendor and product reputation; product quality, performance and price; the availability of products on multiple platforms; product scalability; product integration with other enterprise applications; product functionality and features; product ease of use; and the quality of customer support services and training. The relative importance of each of these factors depends upon the specific customer involved. While the Company believes it competes favorably in each of these areas, there can be no assurance that it will continue to do so. Moreover, the Company's present or future competitors may be able 22 to develop products comparable or superior to those offered by the Company, offer lower price products or adapt more quickly than the Company to new technologies or evolving customer requirements. Competition is expected to intensify. In order to be successful in the future, the Company must respond to technological change, customer requirements and competitors' current products and innovations. There can be no assurance that the Company will be able to continue to compete effectively in its market or that future competition will not have a material adverse effect on its business, financial condition or results of operations. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address the needs of the markets served by the Company. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. Increased competition may result in price reductions, reduced gross margins and loss of market share, any of which could have a material adverse effect on the Company's business, financial condition or results of operations. Intellectual Property and Other Proprietary Rights The Company's success depends, in part, on its ability to protect its proprietary rights to the technologies used in its principal products. The Company relies on a combination of copyrights, trademarks, trade secrets, confidentiality procedures and contractual provisions to protect its proprietary rights. There can be no assurance that the Company's existing or future copyrights, trademarks, trade secrets or other intellectual property rights will be of sufficient scope or strength to provide meaningful protection or commercial advantage to the Company. FileNET has no software patents. Also, in selling certain of its products, the Company relies on "shrink wrap" licenses that are not signed by licensees and, therefore, may be unenforceable under the laws of certain jurisdictions. In addition, the laws of some foreign countries do not protect the Company's proprietary rights to the same extent as do the laws of the United States. There can be no assurance that such factors would not have a material adverse effect on the Company's business, financial condition or results of operations. In addition, the Company also relies on certain software that it licenses from third parties, including software that is integrated with internally developed software used in the Company's products to perform key functions. There can be no assurance that such third parties will remain in business, that they will continue to support their products, that their products are, or will be, year 2000 compliant, or that their products will otherwise continue to be available to the Company on commercially reasonable terms. The loss or inability to maintain any of theses software licenses could result in delays or reductions in product shipments until equivalent software can be developed, identified, licensed and integrated, any of which could adversely affect the Company's business, financial condition or results of operations. The Company may, from time to time, be notified that it is infringing certain patent or intellectual property rights of others. Combinations of technology acquired through past or future acquisitions and the Company's technology will create new products and technology that may give rise to claims of infringement. While no actions other than those discussed below are currently pending against the Company for infringement of patent or other proprietary rights of third parties, there can be no assurance that third parties will not initiate infringement actions against the Company in the future. Infringement actions can result in substantial cost to, and diversion of, resources of the Company. If the Company were found to infringe upon the rights of others, no assurance can be given that licenses would be obtainable on acceptable terms or at all, that significant damages for past infringement would not be assessed or that further litigation relative to any such licenses or usage would not occur. The failure to successfully defend any claims or obtain necessary licenses or other rights, the ultimate disposition of any claims or the advent of litigation arising out of any claims of infringement, could have a material adverse effect on the Company's business, financial condition or results of operations. In October 1994, Wang Laboratories, Inc. (Wang) filed a complaint in the United States District Court for the District of Massachusetts alleging that the Company is infringing five patents held by Wang (the FileNET Case). On June 23, 1995, Wang amended its complaint to include an additional related patent. On July 2, 1996, Wang filed a complaint in the same court alleging that Watermark Software Inc., formerly a wholly owned subsidiary that was merged into the Company, is infringing three of the same patents asserted in the initial complaint (the Watermark Case). On October 9, 1996, Wang withdrew its claim in the FileNET Case that one of the patents it initially asserted is infringed by the Company's products that were commercialized before the initial complaint was filed. Wang reserved the right to assert that patent against the Company's products commercialized after that date in a separate lawsuit. In March 1997, Eastman Kodak Company (Kodak) purchased the Wang imaging business unit that has responsibility for this litigation. The patents in the suit have been transferred to a Kodak subsidiary, Kodak Limited of England, which, in turn, has exclusively licensed them to another Kodak subsidiary, Eastman Software, Inc. in the United States (Eastman). On July 30, 1997, the Court permitted Eastman and Kodak Limited of England to be substituted in the litigation in place of Wang. FileNET has moved for summary judgement on noninfringement as to each of the five patents in the suit, and for summary judgment of invalidity as to one of the patents. Eastman moved for summary judgment as to FileNET's unenforceability defense on one of the patents. A trial date has not been set. If it should be determined that the patents at issue in the litigation are valid and are infringed by any of the Company's products, including Watermark products, the Company will, depending on the product, redesign the infringing products or seek to obtain a license to market the 23 Management's Discussion and Analysis of Financial Condition and Results of Operations products. There can be no assurance that the Company will be able to obtain such a license on acceptable terms. Based on the Company's analysis of these Eastman patents and their respective file histories, the Company believes that it has meritorious defenses to Eastman's claims; however, the ultimate outcome or any resulting potential loss cannot be determined at this time. Dependence on Certain Relationships The Company has entered into a number of co-marketing relationships with other companies such as Microsoft Corporation, Compaq Computer Corporation, SAP AG, HP and Sun Microsystems, Inc. There can be no assurance that these companies will not reduce or discontinue their relationships with, or support of, the Company and its products. Dependence on Key Management and Technical Personnel The Company's success depends to a significant degree upon the continued contributions of its key management, marketing, technical and operational personnel. In general, the Company does not utilize employment agreements for its key employees. The loss of the services of one or more key employees could have a material adverse effect on the Company's operating results. The Company also believes its future success will depend in large part upon its ability to attract and retain additional highly skilled management, technical, marketing, product development and operational personnel. Competition for such personnel, particularly engineers and other technical personnel, is intense, and there can be no assurance that the Company will be successful in attracting and retaining such personnel. In addition, the Company may experience increased compensation costs in order to attract and retain skilled personnel. International Sales Historically, the Company has derived more than 30% of its total revenues from international sales. Six percent of the Company's 1997 revenues were generated in the Asia-Pacific region (including 4% in Australia). International business is subject to certain risks including varying technical standards, tariffs and trade barriers, political and economic instability, reduced protection for intellectual property rights in certain countries, difficulties in staffing and maintaining foreign operations, difficulties in managing foreign distributors, potentially adverse tax consequences, currency exchange fluctuations, the burden of complying with a wide variety of complex operations, foreign laws, regulations and treaties, and the possibility of difficulties in collecting accounts receivable. In particular, the current economic crisis in the Asia Pacific region may limit future growth or cause a decline in international revenues. There can be no assurance that any of these factors will not have a material adverse effect on the Company's business, financial condition or results of operations. Product Liability Products as complex as those sold by the Company are susceptible to errors or failures, especially when first introduced or when new versions are released. The Company's products are often intended for use in applications that are critical to a customer's business. As a result, the Company's customers may rely on the effective performance of the software to a greater extent than the market for software products generally. The Company conducts extensive product testing to ensure that its products are free of significant errors and defects. In addition, the Company has designed and tested the most current versions of its products to be year 2000 compliant. However, some of the Company's customers are running earlier product versions that are not year 2000 compliant. Although the Company has been encouraging such customers to migrate to current product versions, no assurance can be given that all of them will do so in a timely fashion, if at all. Moreover, the Company also relies on certain software that it licenses from third parties, including software that is integrated with internally developed software and is used in the Company's products to perform key functions. There can be no assurance that such third-party software will be free of errors and defects or be year 2000 compliant in a timely fashion. Although the Company has not experienced any material product liability claims to date, there can be no assurance that errors or defects, whether associated with year 2000 functions or otherwise, will not result in product liability claims against the Company in the future. The Company's license agreements with customers typically contain provisions designed to limit the Company's exposure to potential product liability claims; however, it is possible that such limitation of liability pro-visions may not be effective under the laws of certain jurisdictions. Defective products or releases could result in loss of revenues, increased service and warranty costs and product liability claims, and could adversely affect the Company's market penetration and reputation, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. Stock Price Volatility The Company believes that a variety of factors could cause the price of its common stock to fluctuate, perhaps substantially, including quarter-to-quarter variations in operating results; announcements of developments related to its business; fluctuations in its order levels; general conditions in the technology sector or the worldwide economy; announcements of technological innovations, new products or product enhancements by the Company or its competitors; key management changes; changes in joint marketing and development pro-grams; developments relating to patents or other intellectual property rights or disputes; and developments in the Company's relationships with its customers, distributors and suppliers. In addition, in recent years, the stock market in general, and the market for shares of high-technology stocks in particular, has experienced extreme price fluctuations which have often been unrelated to the operating performance of affected companies. Such fluctuations could adversely affect the market price of the Company's common stock. 24 EX-13.3 4 FINANCIAL STATEMENTS Consolidated Balance Sheets December 31, (In thousands, except share and per share amounts) 1997 1996 - -------------------------------------------------- ---- ---- Assets Current assets: Cash and cash equivalents $ 37,344 $ 28,530 Short-term marketable securities 26,600 22,037 Accounts receivable, net of allowances for doubtful accounts and sales returns of $4,415 and $5,325 at December 31, 1997 and 1996, respectively 61,283 75,469 Inventories 3,541 8,794 Prepaid expenses and other current assets 8,309 8,336 Deferred income taxes 6,439 5,641 ----- ----- Total current assets 143,516 148,807 Property, net 27,587 28,329 Long-term marketable securities 7,826 16,705 Other assets 941 1,838 --- ----- Total assets $179,870 $195,679 ======== ======== Liabilities and stockholders' equity Current liabilities: Accounts payable $ 15,003 $ 16,752 Accrued compensation 14,845 10,728 Unearned maintenance revenue 8,848 5,554 Accrued royalties 2,743 4,531 Other accrued liabilities 19,190 21,903 ------ ------ Total current liabilities 60,629 59,468 Deferred income taxes 430 3,405 Stockholders' equity: Preferred stock-$.10 par value, 7,000,000 shares authorized; none issued and outstanding Common stock-$.01 par value, 100,000,000 shares authorized; 15,560,838 and 15,230,566 shares issued and outstanding at December 31, 1997 and 1996, respectively 130,741 127,813 Retained earnings 2,348 7,874 Currency translation adjustment and other (4,146) 1,687 ------ ----- 128,943 137,374 Treasury stock at cost: 410,000 and 200,000 shares at December 31, 1997 and 1996, respectively 10,132 4,568 ------ ----- Total stockholders' equity 118,811 132,806 Total liabilities and stockholders' equity $179,870 $195,679 See accompanying Notes to Consolidated Financial Statements. 25 Consolidated Statements of Operations Year ended December 31, (In thousands, except per share amounts) 1997 1996 1995 - ---------------------------------------- ---- ---- ---- Revenue Software revenue $132,723 $140,659 $116,052 Service revenue 89,280 82,118 67,174 Hardware revenue 29,422 46,136 46,152 ------ ------ ------ Total revenue 251,425 268,913 229,378 Costs and expenses Cost of software revenue 14,768 16,464 15,146 Cost of service revenue 56,503 53,568 44,277 Cost of hardware revenue 20,330 29,633 28,800 Research and development 39,575 36,502 24,711 Selling, general and administrative 125,122 117,761 96,499 Merger, restructuring, write-off of purchased in-process research and development and other costs 6,000 16,011 6,393 ----- ------ ----- Total costs and expenses 262,298 269,939 215,826 ------- ------- ------- Operating income (loss) (10,873) (1,026) 13,552 Other income, net 3,160 2,838 2,780 ----- ----- ----- Income (loss) before income taxes (7,713) 1,812 16,332 Provision (benefit) for income taxes (2,187) 4,456 8,116 ------ ----- ----- Net income (loss) $ (5,526) $ (2,644) $ 8,216 ======== ======== ======= Basic earnings (loss) per share $ (0.36) $ (0.18) $ 0.57 Diluted earnings (loss) per share $ (0.36) $ (0.18) $ 0.52 Weighted average shares outstanding - basic 15,155 15,007 14,430 Weighted average shares outstanding - diluted 15,155 15,007 15,856 See accompanying Notes to Consolidated Financial Statements. 26 Consolidated Statements of Stockholders' Equity (In thousands)
Currency Convertible Translation preferred stock Common stock Retained Adjustment Treasury stock Shares Amount Shares Amount earnings Other Shares Amount Total ------ -------- ------ -------- -------- ----------- ------ -------- -------- Balances at January 2, 1995 1,532 $ 19,879 11,420 $ 78,778 $ 2,302 $ 47 $101,006 Stock options exercised 542 7,471 7,471 Stock option income tax benefits 3,722 3,722 Common stock issued under the Employee Qualified Stock Purchase Plan 35 814 814 Exercise of Saros warrants 195 2,235 2,235 Conversion of Watermark redeemable convertible preferred stock to FileNET common stock 1,062 7,699 8 7,707 Foreign currency translation adjustment (53) (53) Net income 8,216 8,216 Other 40 40 ------ -------- ------ -------- -------- ----------- ------ -------- -------- Balances at December 31, 1995 1,532 19,879 13,254 100,719 10,518 42 131,158 Stock options exercised 398 3,330 3,330 Stock option income tax benefits 2,606 2,606 Common stock issued under the Employee Qualified Stock Purchase Plan 38 1,028 1,028 Exercise of Saros warrants 9 251 251 Conversion of Saros convertible preferred stock to FileNET common stock (1,532) (19,879) 1,532 19,879 Repurchase of treasury shares at cost (200) $(4,568) (4,568) Foreign currency translation adjustment 1,671 1,671 Net loss (2,644) (2,644) Other (26) (26) ------ -------- ------ -------- -------- ----------- ------ -------- -------- Balances at December 31, 1996 15,231 127,813 7,874 1,687 (200) (4,568) 132,806 Stock options exercised 242 1,721 1,721 Common stock issued under the Employee Qualified Stock Purchase Plan 88 1,207 1,207 Repurchase of treasury shares at cost (210) (5,564) (5,564) Foreign currency translation adjustment (5,809) (5,809) Net loss (5,526) (5,526) Other (24) (24) ------ -------- ------ -------- -------- ----------- ------ -------- -------- Balances at December 31, 1997 15,561 $130,741 $ 2,348 $(4,146) (410) $(10,132) $118,811 ====== ======== ====== ======== ======== ============ ======= ========= ======== See accompanying Notes to Consolidated Financial Statements.
27 Consolidated Statements of Cash Flows Year ended December 31, (In thousands) 1997 1996 1995 - -------------- ---- ---- ---- Cash flows from operating activities: Net income (loss) $ (5,526) $ (2,644) $ 8,216 Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities: Write-off of capitalized and purchased in-process research and development costs 10,011 1,393 Depreciation and amortization 13,289 13,049 12,075 Provision for doubtful accounts 350 1,205 857 Deferred income taxes (3,773) (790) 196 Changes in operating assets and liabilities, net of effect of business acquisition: Accounts receivable 9,365 (21,921) (10,722) Inventories 5,368 (2,161) (1,464) Prepaid expenses and other current assets (539) (1,764) (2,497) Accounts payable (1,273) 639 4,683 Accrued compensation 4,380 (270) 2,689 Unearned maintenance revenue 3,327 (207) 1,864 Accrued royalties (1,788) 959 1,125 Other 1,581 2,099 6,271 ----- ----- ----- Net cash provided by (used for) operating activities 24,761 (1,795) 24,686 ------ ------ ------ Cash flows from investing activities: Proceeds from sale of property 264 3,304 393 Capital expenditures (14,266) (17,866) (14,692) Capitalized software development costs (1,600) Payment for purchase of IFSL, net of assets acquired (10,011) Purchases of marketable securities (30,274) (32,092) (49,815) Proceeds from sales and maturities of marketable securities 32,946 39,990 45,402 ------ ------ ------ Net cash used for investing activities (11,330) (16,675) (20,312) ------- ------- ------- Cash flows from financing activities: Debt repayments, net (163) Proceeds from issuance of common stock 2,928 4,609 10,520 Common stock repurchased (5,564) (4,568) Stock option income tax benefits 2,606 3,722 ----- ----- ----- Net cash provided by (used for) financing activities (2,636) 2,647 14,079 ------ ----- ------ Effect of exchange rate changes on cash and cash equivalents (1,981) 975 (25) ------ --- --- Net increase (decrease) in cash and cash equivalents 8,814 (14,848) 18,428 Cash and cash equivalents, beginning of year 28,530 43,378 24,950 ------ ------ ------ Cash and cash equivalents, end of year $ 37,344 $ 28,530 $ 43,378 ======== ======== ======== Supplemental cash flow information Interest paid $ 201 $ 443 $ 229 Income taxes paid $ 3,050 $ 3,236 $ 3,527 See accompanying Notes to Consolidated Financial Statements. 28 Notes to Consolidated Financial Statements Note 1 Summary of Significant Accounting Policies Nature of Operations FileNET Corporation develops, markets and services an open, integrated, client/server-based family of document management software products designed for managing information and enhancing enterprise productivity. Additionally, the Company manufactures and sells a line of 12-inch optical storage and retrieval libraries (OSARs). The Company markets its products to a broad range of industries in more than 60 countries through a global sales, services and support organization, including its ValueNET partner program of resellers, system integrators and application developers. Principles of Consolidation The consolidated financial statements include the accounts of FileNET and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Investments The Company's investments in marketable securities consist primarily of high-grade corporate and government securities with maturities of less than three years. Investments purchased with an original maturity of three months or less are considered to be cash equivalents. The Company classifies all of its investments as available-for-sale. Available-for-sale securities are carried at fair value, with unrealized gains and losses, net of tax, reported in a separate component of stockholders' equity. Other Financial Instruments The Company enters into forward foreign exchange contracts as a hedge against the effects of fluctuating currency exchange rates on monetary assets and liabilities denominated in currencies other than the functional currency of the relevant entity. The Company is exposed to market risk on the forward exchange contracts as a result of changes in foreign exchange rates; however, the market risk should be offset by changes in the valuation of the underlying exposures. Gains and losses on these contracts, which equal the difference between the forward contract rate and the prevailing market spot rate at the time of valuation, are recognized in the consolidated statements of operations. The counterparties to these instruments are major financial institutions. The Company uses commercial rating agencies to evaluate the credit quality of the counterparties. The Company does not anticipate a loss resulting from credit risk related to any of these institutions (see Note 13). Fair Value of Financial Instruments The recorded amounts of financial assets and liabilities at December 31, 1997 and 1996 approximate fair value due to the relatively short period of time between origination of the instruments and their expected realization. Inventories Inventories are stated at the lower of first-in, first-out cost or market (see Note 5). The Company regularly monitors inventories for excess or obsolete items and makes any necessary adjustments at each balance sheet date. Foreign Currency Translation The Company measures the financial statements for the Company's foreign subsidiaries using the local currency as the functional currency. Assets and liabilities of these subsidiaries are translated at the exchange rate on the balance sheet date. Translation adjustments resulting from this process are included in stockholders' equity. Revenues, costs and expenses are translated at the rates of exchange prevailing during the year. Gains and losses from foreign currency transactions are included in other income. Property Property is stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets, generally three to five years. Leasehold improvements are amortized over the shorter of the estimated useful lives of the improvements or the term of the related lease (see Note 6). Research and Development The Company expenses research and development costs as incurred. Statement of Financial Accounting Standards (SFAS) No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed" does not materially affect the Company. The Company did capitalize certain software development costs up to and including the second quarter of 1995. The Company amortized the remaining capitalized software development costs during 1996. Amortization expense was $1.2 million and $1.8 million for the years ended December 31, 1996 and 1995, respectively. 29 Notes to Consolidated Financial Statements Revenue Recognition Software revenue is generally recognized when product is delivered to the customer in accordance with the American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 91-1, "Software Revenue Recognition." The Company recognizes other revenue at the time of product delivery and accrues any remaining costs, including insignificant vendor obligations. Revenue from service and post-contract customer support is recognized ratably over the term of the contract. Product Warranty The Company provides a warranty for its products against defects in materials and workmanship. A provision for estimated warranty costs is recorded at the time of sale and periodically adjusted to reflect actual experience. Income Taxes The provision for incomes taxes is determined in accordance with SFAS No. 109, "Accounting for Income Taxes." Deferred tax assets and liabilities arise from temporary differences between the tax bases of assets and liabilities and their reported amounts in the consolidated financial statements that will result in taxable or deductible amounts in future years (see Note 9). Earnings (Loss) Per Share Beginning in 1997, the Company computes earnings or loss per share in accordance with SFAS No. 128, "Earnings Per Share." Earnings (loss) per share for all prior years have been restated to conform to SFAS No. 128. Earnings (loss) per share is computed using the weighted average number of common shares outstanding during the reporting period. Earnings (loss) per share assuming dilution is computed using the weighted average number of common shares outstanding and the dilutive effect of potential common shares out-standing (see Note 4). Supplier Concentrations Certain components for the Company's proprietary 12-inch OSARs are available from a limited number of sources. Any inability to obtain components in the amounts needed on a timely basis could result in short-term delays in product shipments which could have a material adverse effect on the Company's operating results. The Company has qualified and is selling 5 1/4 -inch optical storage and retrieval devices from an alternative source which could be utilized by the Company's customers in the event of any interruptions in the delivery of components for the Company's own OSAR product. Stock-based Compensation The Company accounts for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees" (see Note 8). Long-Lived Assets The Company accounts for the impairment and disposition of long-lived assets in accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." In accordance with SFAS No. 121, long-lived assets to be held are reviewed for events or changes in circumstances that indicate that their carrying value may not be recoverable. Recent Accounting Pronouncements In 1997, SFAS No. 130, "Reporting Comprehensive Income" and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," were issued and are effective for fiscal years beginning after December 15, 1997. In October 1997, the AICPA issued SOP 97-2, "Software Revenue Recognition," which supersedes SOP 91-1. The provisions of SOP 97-2 are effective for fiscal years beginning after December 15, 1997. The Company is reviewing the impact of these pronouncements on its financial statements. Reclassifications Certain reclassifications have been made to prior-years' balances to conform to current year's presentation. Note 2 Acquisitions Acquisition of Saros Corporation In March 1996, the Company acquired Saros by issuing approximately 1.9 million shares of FileNET common stock and approximately 337,000 options to purchase FileNET common stock in exchange for all of the outstanding Saros stock and options. The transaction was accounted for as a pooling-of-interests for financial reporting purposes. Fees and expenses aggregating $4.2 mil-lion were expensed in the first quarter of 1996. 30 Acquisition of International Financial Systems Ltd. In January 1996, the Company purchased for cash all of the outstanding shares of IFSL, the developer of a computer output to laser disk (COLD) software product for archiving documents. The acquisition was accounted for as a purchase for financial reporting purposes. The purchase price was allocated to net assets of $1.7 million and purchased in-process research and development costs of $10.0 million. The purchased in-process research and development costs were written off at the time of acquisition. Acquisition of Watermark Software Inc. In August 1995, the Company acquired Watermark by issuing approximately 1.3 million shares of FileNET common stock and approximately 152,000 options to purchase FileNET common stock in exchange for all of the outstanding Watermark stock and options. The transaction was accounted for as a pooling-of-interests for financial reporting purposes. Fees and expenses aggregating $6.4 million were expensed in the third quarter of 1995. Included in these fees and expenses is the write-off of $1.4 million of capitalized research and development costs for FileNET projects made redundant by the Watermark acquisition. Note 3 Restructuring and Other Costs The $6.0 million in restructuring and other charge in 1997 represents the costs of consolidating the Watermark business unit's Burlington, Massachusetts engineering and marketing functions with those at FileNET's Costa Mesa, California location, as well as a reduction in head-count in certain other areas of the Company. The restructuring and other charges include approximately $1.9 million for severance payments for 111 employees, $2.2 million for the write-off of impaired assets, $0.4 million for facility closing costs and $1.5 million of other charges. At December 31, 1997, accrued restructuring and other charges of $3.0 million are included in other accrued liabilities. The Company anticipates that the remaining restructuring costs will be paid during 1998. Note 4 Earnings (Loss) Per Share The following table is a reconciliation of the earnings and share amounts used in the calculation of basic earnings (loss) per share and diluted earnings (loss) per share. Such calculations include the effect of the conversion of the then outstanding shares of Watermark's redeemable convertible preferred stock and Saros' convertible preferred stock into FileNET common stock, which occurred upon completion of the related acquisitions (see Notes 2 and 8): Net Per-Share (In thousands, except per share amounts) Income Shares Amount - ---------------------------------------- ------ ------ ------ Year ended December 31, 1995 Basic earnings per share $8,216 14,430 $0.57 Effect of dilutive stock options 1,426 ----- ----- ---- Diluted earnings per share $8,216 15,856 $0.52 ====== ====== ===== The weighted average number of shares outstanding for 1997 and 1996 was 15,154,563 and 15,007,233 respectively. Options to purchase shares of common stock in 1997 and 1996 were outstanding during the year but were not included in the computation of diluted loss per share, as their effect was antidilutive (see Note 8). Note 5 Inventories Inventories consisted of the following at December 31: (In thousands) 1997 1996 - -------------- ---- ---- Raw materials $1,831 $2,606 Work-in-process 950 2,648 Finished goods 760 3,540 --- ----- Total $3,541 $8,794 ====== ====== 31 Notes to Consolidated Financial Statements Note 6 Property and Leases Property consisted of the following at December 31: (In thousands) 1997 1996 - -------------- ---- ---- Machinery, equipment and software $ 74,981 $ 66,404 Furniture and fixtures 8,808 9,242 Leasehold improvements 5,238 5,120 ----- ----- Total 89,027 80,766 Less accumulated depreciation and amortization (61,440) (52,437) ------- ------- Property, net $ 27,587 $ 28,329 ======== ======== The Company leases its corporate office, sales offices, manufacturing facilities, and other equipment under noncancelable operating leases, some of which have renewal options and generally provide for escalation of the annual rental amount. Expenses related to operating leases were $10.8 million, $9.6 million, and $9.3 million for the years ended December 31, 1997, 1996 and 1995, respectively. The following table summarizes future minimum lease payments required under operating leases: (In thousands) - -------------- 1998 $11,046 1999 10,211 2000 8,518 2001 7,117 2002 6,480 Thereafter 7,711 ----- Total $51,083 ======= Note 7 Borrowing Arrangements The Company has a $20 million commercial line of credit that expires in May 1999. Borrowings under the arrangement are unsecured and bear interest at the bank's prime rate. The Company is restricted from paying dividends during the term of the arrangement and, under the arrangement, must comply with certain covenants, including quarterly and annual profitability covenants. The Company was in compliance with such covenants as of December 31, 1997. The Company has four additional borrowing arrangements with foreign banks, which expire at various times during 1998, under which the Company may borrow approximately $2 million. Borrowings under these arrangements bear interest at the various banks' prime rates plus 0.75% to 1.5%. Of the $2 million available, approximately $1 million may be borrowed on an unsecured basis, while the remaining $1 million is collateralized by cash deposits with the bank. There were no borrowings outstanding under any of the arrangements at December 31, 1997 and 1996. Interest expense was $263,000, $443,000 and $288,000 for the years ended December 31, 1997, 1996 and 1995, respectively. Note 8 Stockholders' Equity Shareholder Rights Plan In October 1988, FileNET declared a dividend of one common stock purchase right for each outstanding share of common stock. Under certain circumstances, a right may be exercised to purchase one share of common stock at an exercise price of $55, subject to certain antidilution adjustments. The rights become exercisable if and when a person (or group of affiliated or associated persons) acquires 25% or more of FileNET's outstanding common stock, or announces an offer that would result in such person acquiring 30% or more 32 of FileNET's common stock. After the rights become exercisable, each right will entitle its holder to buy a number of shares of FileNET's common stock having a market value of twice the exercise price of the rights. After the rights become exercisable, if FileNET is a party to certain merger or business combination transactions or transfers 50% or more of its assets or earnings power (as defined), each right will entitle its holder to buy a number of shares of common stock of the acquiring or surviving entity having a market value of twice the exercise price of the right. The rights expire November 17, 1998 and may be redeemed by FileNET at one cent per right at any time before a person has acquired 25% or more of FileNET's common stock. Treasury Stock In 1997, the Board of Directors authorized, subject to certain business and market conditions, the purchase of up to $10 million of the Company's outstanding common stock. During the year ended December 31, 1997, the number of shares purchased under this authorization was 210,000 shares at an aggregate cost of $5.6 million. During the first quarter of 1998, the Company repurchased $4.4 million of its common stock, thereby completing the stock repurchase program. In 1996, the Board of Directors authorized, subject to certain business and market conditions, the purchase of up to 200,000 shares of the Company's common stock. The purchases under this authorization were completed during 1996 at an aggregate cost of $4.6 million. Employee Qualified Stock Purchase Plan In March 1988, FileNET adopted the 1988 Employee Qualified Stock Purchase Plan (the Purchase Plan). A total of 600,000 shares of common stock are reserved for purchases under the Purchase Plan as amended. Under the terms of the Purchase Plan, common stock may be offered in successive six-month offering periods to eligible employees of the Company at 85% of the market price of the common stock at the beginning or end of the offering period, whichever is lower. The Purchase Plan covers substantially all domestic employees of the Company. Eligible employees may elect to have a portion of their salaries withheld for the purpose of making purchases under the Purchase Plan. Each participant is limited in any plan year to the acquisition of that number of shares that have an aggregate fair market value of not more than $25,000. There are no charges or credits to income in connection with the Purchase Plan. At December 31, 1997, $360,850 had been withheld from employees' salaries pursuant to the Purchase Plan for the current offering period, which expires on March 31, 1998. At December 31, 1997, approximately 126,897 shares remained available for future issuance. Stock Option Plans In April 1986, the Company adopted the 1986 Stock Option Plan (the 1986 Plan). Under the amended terms of the 1986 Plan, options to purchase 3,250,000 shares of the Company's common stock were reserved for issuance to employees, officers and directors. Options to purchase 541,415 and 821,548 common shares were exercisable at December 31, 1997 and December 31, 1996, respectively. In May 1995, the 1986 Plan was terminated and the remaining reserve of 70,049 shares was transferred into the 1995 Stock Option Plan and no common shares remain available for future grants under the 1986 Plan. Options granted were either incentive stock options or nonqualified stock options. Options granted become exercisable in 20% annual installments beginning one year after the date of grant, as determined by the Board of Directors, and expire no later than ten years plus one day from the date of grant. The exercise price of the incentive stock options and nonqualified options were not to be less than 100% and 85%, respectively, of the fair market value of the Company's common stock at the date of grant. In May 1995, the Company adopted the 1995 Stock Option Plan (the 1995 Plan). Under the amended terms of the 1995 Plan, options to purchase 1,600,000 shares of the Company's common stock were reserved for issuance to employees, officers and directors. This reserve was added to the 70,049 shares of common stock transferred from the 1986 Plan. Outstanding options under the 1986 Plan will continue to be governed by the provisions of the agreements evidencing those grants. To the extent any of those outstanding options terminate or expire prior to exercise, the shares subject to those unexercised options will be available for subsequent option grant pursuant to the provisions of the 1995 Plan. As of December 31, 1997, 960,867 options of the 1986 Plan had been terminated and were made available under the 1995 Plan. Options granted under the 1995 Plan's Discretionary Option Grant Program for employees and the Automatic Option Grant Program for directors have an exercise price per share of 100% of the fair market value per share on the grant date and become exercisable in 25% annual installments beginning one year from the date of grant. As of December 31, 1997, 10,186 options were exercisable under the 1995 Plan. Prior to their merger into FileNET, Saros and Watermark had adopted stock option plans. These plans were assumed by the Company and outstanding options were converted into options to purchase an aggregate of 487,988 shares of FileNET common stock. Outstanding options under the plans will continue to be governed by the provisions of the agreements evidencing those grants. To the extent any of those outstanding options terminate or expire prior to exercise, the shares subject to those unexercised options will not be available for subsequent option grant. At December 31, 1997, a total of 43,250 options were outstanding and 30,543 were exercisable. 33 Notes to Consolidated Financial Statements In December 1989, the Company adopted the 1989 Stock Option Plan for Non-Employee Directors (the Directors' Plan). Under the terms of the Directors' Plan, as amended, each FileNET director who was not an employee was automatically granted an initial option to purchase 10,000 shares of FileNET's common stock at its fair market value on the date of grant and was granted an additional option to purchase 3,500 shares every year following the initial grant, provided such person continued to be a director at such time. Options granted under the plan vested at the rate of 20% per year from the grant date. Options to purchase an aggregate of 70,000 shares at prices ranging from $11.50 to $32.69 per share were granted from December 18, 1989 to May 24, 1995. At December 31, 1997, options to purchase 23,700 shares of common stock were exercisable and 23,200 have been exercised to date. This plan was terminated in May 1995 with respect to future option grants. Future grants to nonemployee directors are granted under the provisions of the 1995 Plan. In August 1997, the Company filed a Form S-8 with the Securities and Exchange Commission, registering a Non-Statutory Stock Option Grant of 300,000 shares, dated May 22, 1997, to the Company's President and Chief Operating Officer and a Non-Statutory Stock Option Grant of 80,000 shares, dated June 18, 1997, to the Company's Senior Vice President, Worldwide Sales. Such grants were in accordance with employment agreements entered into by the Company and the grantees. Options granted have an exercise price per share of 100% of the fair market value per share on the date of grant and become exercisable in 25% installments beginning one year from the date of grant and will expire no later than ten years from the date of grant. As of December 31, 1997, no options were exercisable related to these Non-Statutory Stock Option Grants. On July 11, 1997, the Company approved a stock option cancellation/regrant program which allowed employees, excluding nonemployee directors, to exchange outstanding options with an exercise price greater than $18.00 for new options. Outstanding options of 1,552,525 shares were canceled and regranted at $18.00 per share, the current market value on July 11, 1997. Under the stock option cancellation/regrant pro-gram, the regranted options are considered granted on July 11, 1997. The regranted options retained the exercisable status of the canceled options with the following exceptions. The exercise date for the regranted options related to canceled options that would have been exercisable as of July 11, 1997 was extended six months to January 11, 1998. For the reporting officers as defined in Section 16 of the Securities Exchange Act of 1934, as amended (the Act) the exercise date of regranted options related to canceled options which would have been exercisable on July 11, 1997 was extended twelve months to July 11, 1998. The prospective exercise dates for the remaining regranted options related to canceled options that were not exercisable as of July 11, 1997, were extended six months from the original exercise date. On August 8, 1996, the Company approved a stock option cancellation/regrant program which allowed employees, excluding all directors and reporting officers as defined in Section 16 of the Act, to exchange options with an exercise price greater than $26.00 for new options. Outstanding options of 530,571 shares were canceled and regranted at $26.00 per share, the current market value on August 8, 1996. Under the stock option cancellation/regrant program, the regranted options were considered granted on August 8, 1996 and are exercisable prospectively in accordance with the provisions of the agreements evidencing those grants. Information regarding the stock option plans, after giving retroactive effect to the conversions of the Watermark and Saros stock options on their original grant dates, is as follows: Weighted Average Number of Exercise Options Price ------- ----- Balances, January 1, 1995 2,604,174 $15.27 Granted (Weighted average fair value of $14.68) 771,674 $30.41 Exercised (542,142) $13.78 Canceled (130,597) $19.51 -------- ------ Balances, December 31, 1995 2,703,109 $19.68 Granted (Weighted average fair value of $14.96) 1,362,418 $36.65 Exercised (398,041) $ 8.37 Canceled (866,603) $43.34 -------- ------ Balances, December 31, 1996 2,800,883 $22.22 Granted (Weighted average fair value of $8.26) 2,801,049 $18.66 Exercised (241,704) $ 7.12 Canceled (1,965,119) $26.96 ---------- ------ Balances, December 31, 1997 3,395,109 $17.62 === ==== ========= ====== 34 The following table summarizes information concerning currently outstanding and exercisable options: Options Outstanding Options Exercisable ------------------------------------ --------------------- Weighted Average Weighted Weighted Remaining Average Average Range of Number Contractual Exercise Number Exercise Exercise Price Outstanding Life Price Exercisable Price - -------------- ----------- ---- ----- ----------- ----- $ 0.93 - $15.06 987,899 7.05 $12.48 346,807 $ 9.69 $15.13 - $17.87 199,798 5.15 $16.04 149,598 $15.79 $18.00 - $18.00 1,603,512 9.51 $18.00 2,084 $18.00 $18.38 - $53.50 603,900 8.67 $26.02 107,855 $20.97 ------- ---- ------ ------- ------ $ 0.93 - $53.50 3,395,109 8.39 $17.62 606,344 $13.23 ========= ==== ====== ======= ====== The Company accounts for its stock-based compensation plans in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. No compensation expense has been recognized for its stock-based compensation plans. The following table summarizes the Company's net income (loss) and net income (loss) per share on a pro forma basis had compensation cost for the Company's stock-based compensation plans been determined based on the provisions of SFAS 123, "Accounting for Stock-Based Compensation": Year ended December 31, (In thousands, except per share amounts) 1997 1996 1995 - ------------------------------------------- ---- ---- ---- Net income (loss) - as reported $(5,526) $(2,644) $8,216 Net income (loss) - pro forma (12,497) (7,320) 7,273 Diluted earnings (loss) per share - as reported (0.36) (0.18) 0.52 Diluted earnings (loss) per share - pro forma (0.82) (0.49) 0.46 The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in 1997, 1996 and 1995; expected volatility of 60%; risk-free interest rates of 5.3% to 5.6% for 1997 and 5.8% to 6.9% for 1996 and 1995; and an expected life of 1 year from vest date. Pro forma compensation cost of options granted under the Employee Qualified Stock Purchase Plan is measured based on the discount from market value. Note 9 Income Taxes The provision (benefit) for income taxes consists of the following: Year ended December 31, (In thousands) 1997 1996 1995 - --------------- ---- ---- ---- Current: Federal $ 785 $2,930 $4,017 State (40) 75 867 Foreign 841 2,241 2,458 Deferred: Federal (1,963) (772) 834 State (1,168) (18) (60) Foreign (642) ---- ---- ---- Total provision (benefit) for income taxes $(2,187) $4,456 $8,116 ======= ====== ====== The valuation allowance increased by $1.4 million, $9,000 and $3.5 million in the years ended December 31, 1997, 1996 and 1995, respectively. 35 Notes to Consolidated Financial Statements A reconciliation of the Company's effective tax rate compared to the statutory Federal tax rate is as follows: Year ended December 31, 1997 1996 1995 ---- ---- ---- Income taxes (benefit) at statutory Federal rate (35%) 35% 35% State taxes (benefit), net of Federal benefit (6) 4 5 Unbenefited/utilized domestic losses 42 21 Foreign tax rate differential/unbenefited losses 11 (130) (14) Non-deductible acquisition costs 291 5 Other 2 4 (2) - - -- Total (28%) 246% 50% === === == The Company provides deferred income taxes for temporary differences between assets and liabilities recognized for financial reporting and income tax purposes. The income tax effects of these temporary differences representing significant portions of the deferred taxes at December 31, 1997 and 1996 are as follows: Year ended December 31, (In thousands) 1997 1996 - -------------- ---- ---- Foreign loss carryforwards $ 2,788 $ 1,445 Domestic loss carryforwards 11,928 9,198 Tax credit carryforwards 3,159 1,954 Accrued expenses 2,954 1,745 Sales returns and allowance reserves 1,111 1,359 Capitalized software (272) (206) Depreciable assets 857 802 Residual U.S. tax on foreign earnings (4,027) (3,710) Other 1,963 2,661 ----- ----- Total 20,461 15,248 Valuation allowance (14,452) (13,012) ------- ------- Net deferred tax asset $ 6,009 $ 2,236 ======== ======== The Company has $35.1 million of domestic net operating loss carryforwards, which can be utilized to reduce future taxable income. Any net operating loss carryforwards not utilized will begin expiring in 2004. The Company has a $3.2 million tax credit carryforward, which will expire beginning in 2004. Utilization of $1.1 million of the loss carryforward arising from the tax benefit related to the exercise of nonqualified stock options will be recorded to stockholders' equity when utilized. At December 31, 1997, the Company had Dutch, United Kingdom, French and German subsidiary tax loss carryforwards relating to its foreign subsidiary operations of $1.7 million, $1.6 million, $1.9 million and $3.0 million, respectively. The Dutch, United Kingdom and German tax loss carryforwards have no expiration. French losses of $0.2 million will expire in 1998. The Company has not provided any residual U.S. tax on approximately $16.1 million of the Company's foreign subsidiaries undistributed earnings, as the Company intends to indefinitely reinvest such earnings. 36 Note 10 Geographical Information Year ended December 31, (In thousands) 1997 1996 1995 - --------------- ---- ---- ---- Revenue United States* Customers $173,588 $174,618 $155,728 Intercompany 20,690 23,355 14,597 ------ ------ ------ Total 194,278 197,973 170,325 Europe* Customers 68,247 83,786 67,916 Intercompany 21,547 15,815 11,448 ------ ------ ------ Total 89,794 99,601 79,364 Other Customers 9,590 10,509 5,734 Intercompany 3,479 1,794 2,086 ----- ----- ----- Total 13,069 12,303 7,820 Eliminations (45,716) (40,964) (28,131) ------- ------- ------- Total revenue $251,425 $268,913 $229,378 -------- -------- -------- Operating income (loss) United States** $ (6,730) $(18,588) $ 369 Europe** (2,999) 17,680 12,589 Other 669 1,691 629 Eliminations (1,813) (1,809) (35) ------ ------ --- Total operating income (loss) $(10,873) $ (1,026) $ 13,552 -------- -------- -------- Assets United States $125,091 $132,781 $151,929 Europe 49,822 56,971 38,993 Other 5,054 6,043 2,672 Eliminations (97) (116) (3,912) --- ---- ------ Total assets $179,870 $195,679 $189,682 ======== ======== ======== *U.S. revenue includes hardware sales to third-party international resellers. European revenue includes software sales to third-party international resellers. **U.S. operating income includes $4.3 million, $16.0 million and $3.9 million in 1997, 1996 and 1995, respectively, for merger, restructuring and write-off of purchased in-process research and development costs. European operating income includes $1.5 million and $2.5 million for restructuring, merger and other costs in 1997 and 1995, respectively. Other operating income includes $.2 million for restructuring and other costs in 1997. For all years presented, U.S. operating income (loss) includes certain corporate expenses such as research and development, marketing communications and corporate administration, and European and other operating income includes international headquarters expenses. 37 Notes to Consolidated Financial Statements Note 11 Contingencies In October 1994, Wang Laboratories, Inc. (Wang) filed a complaint in the United States District Court for the District of Massachusetts alleging that the Company is infringing five patents held by Wang (the FileNET Case). On June 23, 1995, Wang amended its complaint to include an additional related patent. On July 2, 1996, Wang filed a complaint in the same court alleging that Watermark, formerly a wholly-owned subsidiary that was merged into the Company, is infringing three of the same patents asserted in the initial complaint (the Watermark Case). On October 9, 1996, Wang withdrew its claim in the FileNET Case that one of the patents it initially asserted is infringed by the Company's products that were commercialized before the initial complaint was filed. Wang reserved the right to assert that patent against the Company's products commercialized after that date in a separate lawsuit. In March 1997, Eastman Kodak Company (Kodak) purchased the Wang imaging business unit that has responsibility for this litigation. The patents in the suit have been transferred to a Kodak subsidiary, Kodak Limited of England, which, in turn, has exclusively licensed them to another Kodak subsidiary, Eastman Software, Inc. in the United States (Eastman). On July 30, 1997, the Court permitted Eastman and Kodak Limited of England to be substituted in the litigation in place of Wang. FileNET has moved for summary judgement on noninfringement as to each of the five patents in the suit, and for summary judgment of invalidity as to one of the patents. Eastman moved for summary judgment as to FileNET's unenforceability defense on one of the patents. A trial date has not been set. If it should be determined that the patents at issue in the litigation are valid and are infringed by any of the Company's products, including Watermark products, the Company will, depending on the product, redesign the infringing products or seek to obtain a license to market the products. There can be no assurance that the Company will be able to obtain such a license on acceptable terms. Based on the Company's analysis of these Eastman patents and their respective file histories, the Company believes that it has meritorious defenses to Eastman's claims; however, the ultimate outcome or any resulting potential loss cannot be determined at this time. On December 20, 1996, plaintiff Michael I. Goldman (the Plaintiff) filed a class action complaint against the Company and certain of its officers and directors in the Superior Court of California, County of Orange (the State Action). The action was purportedly filed on behalf of a class of purchasers of the Company's common stock during the period October 19, 1995 through July 2, 1996. The Plaintiff alleges that the Company and other defendants violated Cal. Corp. Code ss.ss. 25400 and 25500, Cal. Civ. Code ss.ss. 1709-1710 and Cal. Bus. & Prof. Code ss.ss. 17200 et seq. in connection with various public statements made by the Company and certain of its officers and directors during the putative class period. The complaint seeks unspecified compensatory and punitive damages, interest, payment of attorney's fees and costs, and equitable or injunctive relief. On April 1, 1997, The Plaintiff filed another class action complaint against the Company and certain of its officers and directors in the United States District Court for the Central District of California (the Federal Action). The action purportedly was filed on behalf of the same class of purchasers of the Company's common stock as the State Action. The allegations contained in the Federal Action are very similar to the allegations contained in the State Action, except that the Federal Action asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act and Rule 10b-5. The complaint seeks unspecified compensatory damages, interest, attorneys' fees, expert witness fees, costs and equitable or injunctive relief. On July 2, 1997, the court granted plaintiff's motion to be appointed "lead plaintiff" under the Private Securities Litigation Reform Act. In the Federal Action, defendants have filed a motion to dismiss the complaint in its entirety. Plaintiff has filed a motion to stay the Federal Action, in light of the parallel State Action. The court is scheduled to hear both of these motions during March 1998. In the State Action, defendants moved to stay the action, in light of the parallel Federal Action. The trial court granted the motion to stay the action as to discovery on September 8, 1997. Defendants also demurred and moved to strike the complaint. The trial court overruled the demurrer and denied the motion to strike on October 21, 1997. On January 14, 1998, the court entered an order dismissing with prejudice two of plaintiff's three causes of action: the claims under Cal. Civ. Code ss.ss. 1709-1710 and Cal. Bus. & Prof. Code ss.ss. 17200 et seq. On January 30, 1998, the trial court in the State Action granted the Plaintiff's motion to certify a class composed of persons who bought FileNET stock in California only between October 19, 1995 and July 2, 1996. This ruling is subject to revision based on the decisions to be rendered by the California Supreme Court in Diamond Multimedia Systems, et al. v. Superior Court (Pass) and StorMedia, Inc., et al. v. Superior Court (Werczberger). The trial court also denied the Plaintiff's motion to lift the discovery stay. The Company believes that all of the allegations contained in the complaints filed in the State and Federal Actions are without merit and intends to defend the actions vigorously. 38 The Company, in the normal course of business, is subject to various other legal matters. While the results of litigation and claims cannot be predicted with certainty, the Company believes that the final outcome of these other matters will not have a materially adverse effect on the Company's consolidated results of operations or financial condition. Note 12 Related Party Transactions The Company entered into a two-year agreement on May 20, 1997, to employ its new President and Chief Operating Officer. Under the terms of the agreement, the Company agreed to reimburse the officer for legal costs in defending a lawsuit from the officer's former employer. The case was settled and the total cost to the Company was charged to compensation expense in 1997. Watermark originally entered into a republishing and distribution agreement with a UK company (the Distributor) which provided the Distributor with exclusive distribution rights of Watermark's products in defined territories. The Chief Executive Officer of the Distributor is the brother of Watermark's then President and Chief Executive Officer. During 1995, Watermark elected to purchase the portion of the Distributor's business related to selling Watermark's products at a negotiated price of $2.5 million that is included in merger and other costs in 1995. Note 13 Other Financial Instruments The following table summarizes the notional amount, which is equivalent to the fair market value, of the Company's foreign currency agreements entered into on December 31, 1997 and 1996, all maturing in three months: At December 31, (In thousands) 1997 1996 - -------------- ---- ---- Australian Dollar $ 4,299 $ 5,110 British Pound 11,586 17,070 Canadian Dollar 1,014 3,409 French Franc 5,247 5,118 German Mark 14,651 19,532 Irish Punt 602 6,902 Japanese Yen 330 266 Netherland Guilder 3,689 2,152 Singapore Dollar 368 82 --- -- Total $41,786 $59,641 ======= ======= Note 14 Quarterly Financial Information (Unaudited) (In thousands, First Second Third Fourth Fiscal except per share amounts) Quarter Quarter Quarter Quarter Year - ------------------------- ------- ------- ------- ------- ---- Year ended December 31, 1997 Revenue $ 47,562 $62,450 $65,011 $76,402 $251,425 Income (loss) before income taxes (13,082) (5,353) * 2,627 8,095 (7,713) Net income (loss) (9,420) (3,854) * 1,891 5,857 (5,526) Basic earnings (loss) per share (0.63) (0.25) 0.12 0.39 (0.36) Diluted earnings (loss) per share (0.63) (0.25) 0.12 0.36 (0.36) Year ended December 31, 1996 Revenue $ 66,744 $64,997 $64,622 $72,550 $268,913 Income (loss) before income taxes (10,417) * 3,351 4,575 4,303 1,812 Net income (loss) (11,820) * 2,513 3,431 3,232 (2,644) Basic earnings (loss) per share (0.79) 0.17 0.23 0.22 (0.18) Diluted earnings (loss) per share (0.79) 0.15 0.22 0.20 (0.18) *Includes charges of $6.0 million in the second quarter of 1997 and $16.0 million in the first quarter of 1996 for merger, restructuring, write-off of purchased in-process research and development and other costs. 39 Independent Auditors' Report To the Stockholders and the Board of Directors FileNET Corporation We have audited the accompanying consolidated balance sheets of FileNET Corporation and its subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of FileNET Corporation and its subsidiaries as of December 31, 1997 and 1996 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. February 3, 1998 Costa Mesa, California EX-13.4 5 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Note 12 Related Party Transactions The Company entered into a two-year agreement on May 20, 1997, to employ its new President and Chief Operating Officer. Under the terms of the agreement, the Company agreed to reimburse the officer for legal costs in defending a lawsuit from the officer's former employer. The case was settled and the total cost to the Company was charged to compensation expense in 1997. Watermark originally entered into a republishing and distribution agreement with a UK company (the Distributor) which provided the Distributor with exclusive distribution rights of Watermark's products in defined territories. The Chief Executive Officer of the Distributor is the brother of Watermark's then President and Chief Executive Officer. During 1995, Watermark elected to purchase the portion of the Distributor's business related to selling Watermark's products at a negotiated price of $2.5 million that is included in merger and other costs in 1995. EX-21.1 6 LIST OF SUBSIDIARIES OF REGISTRANT FileNET Asia Pacific, Pte. Ltd. (Singapore) FileNET BV (The Netherlands) FileNET Canada, Inc. (Canada) FileNET Company Limited (Ireland) FileNET Corporation Europe, EURL (France) FileNET Corporation, Pty. Ltd. (Australia) FileNET GmbH (Germany) FileNET Hong Kong Limited (Hong Kong) FileNET Iberia, S.L. (Spain) FileNET International Corporation (U.S. Virgin Islands) FileNET Corporation Korea (Korea) FileNET Nihon (K.K.) (Japan) FileNET Limited (England) FileNET Corporation Italy (Italy) FileNET Corporation International (Delaware) EX-23.1 7 AUDITORS' CONSENT EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statements No. 33-90454, 33-96076, 33-80899, 333-02194, 333-09075 and 333-34031 on Form S-8 of our reports dated February 3, 1998 appearing in and incorporated by reference in the Annual Report on Form 10-K of FileNET Corporation for the fiscal year ended December 31, 1997. Costa Mesa, California March 26, 1998 EX-27 8 FINANCIAL DATA SCHEDULE
5 1,000 Year Dec-31-1997 Dec-31-1997 37,344 26,600 61,283 0 3,541 143,516 89,027 61,440 179,870 60,629 0 0 0 120,609 (1,798) 179,870 162,145 251,425 35,098 91,601 170,697 0 0 (7,713) (2,187) (5,526) 0 0 0 (5,526) (0.36) (0.36)
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