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                                    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, 1999

                                       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 of             (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) 327-3400


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 20, 2000, the aggregate market value of
the 33,769,076 shares of voting stock of the Registrant held by nonaffiliates of
the  Registrant  on  such  date  was   $1,046,841,356.   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 34,004,009
at March 20, 2000.


                       DOCUMENTS INCORPORATED BY REFERENCE

Portions of Registrant's  definitive proxy statement for its 2000 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, 1999 are  incorporated  by reference  into Parts II, III and IV as set forth
herein.

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<PAGE>

                               FILENET CORPORATION

                                    FORM 10-K
                      For the Year Ended December 31, 1999


                                      INDEX

                                                                            Page
                                     PART I
Item 1. Business...............................................................2
Item 2. Properties.............................................................9
Item 3. Legal Proceedings......................................................9
Item 4. Submission of Matters to a Vote of Security Holders............. .....10

                                     PART II

Item 5. Market for the Registrant's Common Stock and Related .................11
        Stockholder Matters
Item 6. Selected Financial Data...............................................12
Item 7. Management's Discussion and Analysis of Financial Condition ..........13
        and Results of Operations
Item 8. Financial Statements and Supplementary Data...........................19
Item 9. Changes in and Disagreements with Accountants on Accounting ..........19
        and Financial Matters
                                    PART III

Item 10. Directors and Executive Officers of the Registrant...................19
Item 11. Executive Compensation...............................................19
Item 12. Security Ownership of Certain Beneficial Owners and Management.......19
Item 13. Certain Relationships and Related Transactions.......................20

                                     PART IV

Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K......20
Signatures....................................................................23



                                       1
<PAGE>

                                     PART I


Item 1.    Business

GENERAL

         FileNET Corporation  develops,  markets, and services Web-based content
management  and eBusiness  applications  that help  corporations  and government
organizations  build Intranets,  business-to-business  and  business-to-consumer
portals  to  manage  their   business   information   and  work  processes  more
productively.  Our Panagon(TM) software products allow users to create,  access,
edit, process,  organize, secure, store and archive digital content of all types
for Web-based applications, as well as client/server environments. We also offer
professional  services relative to the implementation of these software products
and 24x7  customer  support.  Additionally,  we  manufacture  and sell a line of
12-inch optical storage and retrieval libraries (OSARs(R)).

Markets and Applications

         We offer a family of  complementary  software  products under the brand
name  Panagon.  These  products  enable users to manage,  on an  enterprise-wide
basis, the storage,  processing and workflow of documents and other unstructured
information that are part of a centralized or distributed  server  repository or
Web site. This content may include scanned images,  faxes,  text,  spreadsheets,
HTML/XML pages, graphics, drawings, photographs, computer output reports, voice,
and  video.  Our  software   products  provide  both   client/server-based   and
Web-centric content management architecture solutions that can be implemented on
a modular  basis.  Organizations  can choose one,  some,  or all of our software
products to build the solution  that most  effectively  meets their  needs.  Our
customers are typically those enterprises that have active paper document files,
process  significant  numbers  of  electronic  documents/transactions  in  their
day-to-day operations, or have complex,  mission-critical business processes for
a variety of applications such as mortgage loan servicing, customer relationship
management,   enterprise   resource   planning,   insurance  claims  processing,
regulatory  compliance,  accounts payable and receivable,  and Web-based content
management.   Additionally,  our  software  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 SAP R/3.

         We market our products in more than 70 countries through a direct sales
force and our ValueNET(R) partner community  consisting of systems  integrators,
value-added  resellers  and  distributors.   More  than  350  firms  operate  as
third-party  resellers  under our  ValueNET  program and  combine  our  software
products with vertical  market-specific  value-added services to provide turnkey
solutions  and  complex  systems  integration  for  customers.  We also have OEM
agreements with other firms involving our software products.

         Our customer  support  operating  segment offers  software  maintenance
service for our products worldwide.  Our professional services operating segment
offers training,  implementation and other technical consulting services to both
end-users of our products and to resellers.  Professional  services are marketed
by our direct sales force and by our resellers.

ProducTS

Software

         Our  Panagon  family of  software  products  help  organizations  build
eBusiness applications by providing electronic process (eProcess) and electronic
content (eContent) management  solutions.  eContent management is the ability to
organize and deliver digital documents,  images,  sounds,  data and all forms of
electronic  content  via the  Web  content  which  is  often  the  result  of an
interactive  business process (new piece-part pricing in an online supply chain,
for example).  eProcess  management  automates  these  processes  using the Web,
incorporating employees and other groups such as business partners and customers
in order to  improve  operating  efficiency  and  increase  sales.  Our  Panagon
software  products are organized  around Panagon Web Services,  the core product

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and development  platform that  integrates with each of the Panagon  products to
build eBusiness  applications.  Through the end of 1999,  Panagon technology has
been used by over 400  companies to manage  eBusiness  processes and millions of
pages of Web content.  The Panagon family  includes a complete suite of software
components  that  are  built to work  together,  mitigating  integration  issues
customers may have when attempting to combine products from different vendors.

         With  Panagon,  we have created a software  infrastructure  that allows
customers  to capture  documents  or digital  information  electronically,  then
access,  manage,  publish and  integrate  the  information  with their  existing
critical  business  applications  throughout the enterprise.  Using  Microsoft's
Windows  Explorer or Netscape Web browsers,  customers can search the enterprise
network for information, retrieve documents and data of all types, work with the
information,  and then route it as needed for  further  review,  processing,  or
decision making.

         The following software products are currently being offered by us:

              Panagon   Web   Services   combines  a   significantly   enhanced,
              full-featured,  Web  browser-based  thin client,  a  comprehensive
              Web-centric  application  development  tool  kit,  and Web  server
              components,  to support  dynamic  eContent  and  complex  eProcess
              business  activities.  The out-of the-box  application  provides a
              complete set of content management  functionality,  allowing users
              to check in,  check out,  search  and  browse,  share,  revise and
              change properties for a Panagon repository document,  all from the
              Web.  The Panagon Web  Services  client  maintains  near-identical
              functionality and look and feel with the Panagon IDM Desktop thick
              client,  including  seamlessly  managing and viewing more than 200
              document  formats  via  a  familiar  Window   Explorer-like   user
              interface.  The Web development  environment features a full suite
              of Active X controls  and supports  most  popular Web  programming
              languages   for   developing   customized,    line   of   business
              applications.

              Panagon  integrated   document   management  (IDM)  Desktop  is  a
              client-level  software  application  which  allows  users to view,
              manage,   revise,   share  and  distribute   documents  across  an
              enterprise  for ad hoc or mission  critical  use,  from  Microsoft
              Windows-based  clients.  Panagon IDM Desktop supports an identical
              set of document access and management  features as the Panagon Web
              Services  thin  client,  including  multiple  levels of  security,
              stored  reusable   search   templates  and  support  for  compound
              documents,  providing greatly improved team  collaboration.  Tight
              integration with industry standard software applications including
              Microsoft  Office 97, Office 2000 and Lotus Notes enables  Panagon
              eContent management directly from within these applications.  With
              the built-in  workflow and integrated  email  features  (including
              with  Microsoft  Outlook),  users can  create  work  processes  to
              include others that need to share, distribute, or approve.

              Panagon  Content  Services  (formerly  Document  Services)  is  an
              enterprise-class   document   repository   system   for   creating
              accessing,    managing,    securing   and   dynamically   updating
              business-critical  electronic documents.  A full-featured back end
              for eContent management,  with Panagon Web Services or IDM Desktop
              client  software  Panagon  Content  Services  manages   electronic
              documents throughout their lifecycle.

              Panagon  Image  Services  is a  high-performance  image and object
              repository  system that  integrates  with Panagon Web Services and
              Panagon IDM Desktop for storing,  managing, and retrieving images,
              documents and  electronic  content of all types from many sources,
              including scanned paper, fax, EDI, and the Web.

              Panagon IDM Services  includes content services and image services
              in  a  single  offering  package  to  allow  customers  to  deploy
              full-featured systems for electronic document lifecycle management
              and image and object storage and  management,  all eContent server
              operations at one time, saving deployment expense and reducing the
              cost of ownership.

              Panagon Visual WorkFlo(R) is an object-oriented, high-transaction,
              scalable business process automation  solution allowing customers,
              partners and internal users to drive critical business  activities
              and personalized content creation. Providing an infrastructure for
              eProcess management,  Panagon Visual WorkFlo can be used to create
              applications  that reflect the way work  processes are  performed,
              and is a  critical  enabling  technology  for  the  automation  of

                                       3
<PAGE>

              business-to-business  eCommerce via the Web. 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 such as Java and integrates
              with leading business process  reengineering  products for reduced
              implementation time.

              Panagon  Report Manager  processes  computer print data streams to
              provide  online  statement  and report  management  for  eBusiness
              applications  that  require  access  to  legacy  data.  It  allows
              organizations   to  index,   store,   access,   mine  and  analyze
              computer-generated  reports and forms such as customer statements,
              claims,  and billing  statements  electronically,  eliminating the
              need for  manual  printing  and  distribution.  Evolving  from its
              computer  output to laser disk (COLD)  background,  Panagon Report
              Manager  provides   significantly   enhanced  eContent  management
              capabilities,   including  a  new  `super  thin'  client  allowing
              authorized users to view Report Manager  processed  statements via
              the Web, requiring none of our software.

              Panagon  Capture  Professional  (formerly  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,  email,  word
              processing documents,  spreadsheets,  HTML, audio and video clips,
              and  images,  making  them  immediately  available  to users.  Its
              modular  components,   substantial  support  for  automated  image
              identification  and  enhancement   capabilities,   and  high-speed
              document  processing to Panagon  Image  Services are optimized for
              high volume, enterprise-wide production capture operations.

              Panagon  Capture  Desktop  is  a  new  capture  application  which
              acquires and processes digital and paper-based  documents into the
              Content Services  repository,  providing an easy-to-use  front end
              for eContent  management.  Panagon  Capture Desktop is designed to
              address the scanning and document  capture needs of  low-to-medium
              volume  environments  of all  types,  particularly  eBusiness  Web
              deployment teams,  small accounting and finance  departments,  and
              engineering groups. Featuring a basic, intuitive interface for all
              scanning and importing  functions,  Panagon  Capture  Desktop also
              includes built-in image enhancement  features and provides support
              for third party software components such as PDF conversion.

              Panagon 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.

               Panagon Web  Publisher  ("PWP") is an important  component of our
               extended Panagon Web Services infrastructure.  PWP simplifies and
               automates Web publishing operations for Internet,  intranet,  and
               extranet Web sites by providing indexing and automatic formatting
               for MS-Word and other native format documents that authors simply
               drag  and drop to the  appropriate  Panagon  Web site  repository
               folder.   It   eliminates   virtually   all  HTML  hand   coding,
               dramatically  reducing  workloads  for Web  masters,  information
               technology  staff, and Web publishers.  Panagon Web Publisher can
               automatically  update  entire  Web  sites  and  on-line  compound
               documents  without manual  intervention,  avoiding  problems with
               broken links and virtually eliminating out-of-date Web documents.
               PWP can be further  extended using Microsoft  Active Server Pages
               (ASPs) to deliver customized Web applications

              Panagon WorkGroup(TM)  software is a midrange document imaging and
              work management  product based on a subset of the Panagon products
              combined   with  certain   pre-packaged   software   applications.
              Watermark(R)  software  products have enabled  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 integrated into
              existing  line-of-business  applications  and  take  advantage  of
              Microsoft  operating  systems and  database  technologies.  We are
              actively  pursuing a  conversion  program to Panagon  products for
              Watermark customers, and will end formal support for the Watermark
              line on March 31, 2000.

                                       4
<PAGE>

Hardware

         We  manufacture  and market an OSAR  library  product  based on 12-inch
optical disk technology and also offer optional  integration  services providing
customers the ability to purchase complete solutions.

         All named  products  mentioned in this Form 10-K,  other than our named
products,  may  reference  trademarks  or  registered  trademarks  owned  by the
respective holder.

RESEARCH AND Development

         Our research and development activities are focused on software product
development.  Research and development  expenditures  were $54.3 million,  $50.1
million and $40.9 million for the years ended December 31, 1999, 1998, and 1997,
respectively.  We believe  that our future  success  depends upon our ability to
continue to enhance our existing  software  products and to develop new software
products  that  satisfactorily  meet  market  needs.  Accordingly,  we intend to
continue to make substantial investments in research and development activities.

BACKLOG

         We  typically  ship our  products  within a short  period of time after
acceptance of orders, which is common in the computer software industry.

Services, Support and manufacturing

         We  maintain  service  and  support  organizations  that  provide  both
pre-sales and post-sales services on a worldwide basis.

         Our customer support group provides software  maintenance and technical
support  services  to  customers  and  resellers  who have  contracted  for such
services.  This service is provided through telephone  response centers in Costa
Mesa, California;  Dublin, Ireland; Sydney, Australia; and Singapore, or through
on-site  visits to customer  sites when  necessary.  Customer  support will also
provide support on a fee-per-service basis for those customers and resellers who
have not entered into a maintenance  contract with us. During 1998, we completed
the process of  transferring  to Hewlett  Packard the  hardware  maintenance  we
previously  provided.  Customers who require  maintenance  of hardware  products
bought from us now contract directly with HP or other service providers for such
service.  Previously,  customers had contracted with us and we subcontracted the
maintenance work to HP.

         Our  professional   services  group  provides  consulting  services  to
customers,  primarily on a time and material basis and training services.  These
services range from management of large-scale implementations of our products to
pre-packaged  standard  services  such as software  installation.  Services  are
provided  by  consultants  employed  directly  by us and  through a  network  of
qualified partners.

         Our facilities in Costa Mesa, California and Dublin,  Ireland,  conduct
software manufacturing, localization, integration, test and quality control.

EMPLOYEES

         As of December 31, 1999, we had 1,693 full-time  employees of which 382
were employed in research and development; 474 in sales, 76 in marketing, 209 in
education and professional  services, 297 in customer support; 95 in operations;
and 160 in administration.  No employees are represented by labor unions, and we
have never  experienced a work stoppage.  We believe that we enjoy good employee
relations.

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<PAGE>

COMPETITION

         The  market  for our  products  is highly  competitive.  Our  principal
competitors  for our 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,  and
Hummingbird 3) COLD - Computron,  IBM and Microbank.  Numerous  smaller software
vendors also compete in each product area. We also experience  competition  from
systems integrators who configure hardware and software into customized systems.

         Database vendors such as Oracle, Sybase and Informix, messaging vendors
such as Microsoft  and IBM,  and Web content  vendors  such as  Broadvision  and
Vignette  may  compete  with us in the  future.  It is also  possible  that  new
competitors  or  alliances  among  competitors  may emerge and  rapidly  acquire
significant  market share.  We also expect that  competition  will increase as a
result of  software  industry  consolidations.  See  "Certain  Considerations  -
Competition" below.

PATENTS AND LICENSES

         We hold three  patents for our OSAR  product  which  expire  August 26,
2003, June 23, 2004 and August 4, 2004. We have also entered into  non-exclusive
license  arrangements with a number of organizations,  including IBM and Oracle,
which  permit  us and our  resellers  to grant  sublicenses  to end users of our
systems to use  software  developed by these third party  vendors.  See "Certain
Considerations - Intellectual Property and Other Proprietary Rights" below.

CERTAIN CONSIDERATIONS

         This Annual  Report on Form 10-K  contains  forward-looking  statements
within the  meaning of the  Private  Securities  Litigation  Reform Act of 1995,
Section 21E of the  Securities  Exchange Act of 1934, as amended and Section 27A
of the  Securities  Act of 1933, as amended,  and is subject to the safe harbors
created by those sections.  These forward  looking-statements  involve risks and
uncertainties,  including  those  discussed below and in the notes to the Annual
Report on Form 10-K for the year ended  December 31, 1999,  certain  sections of
which are incorporated herein by reference as set forth in Items 7 and 8 of this
report.  The actual  results  that we achieve  may  differ  materially  from any
forward-looking  statements,  which reflect management's opinions only as of the
date  hereof.  We  undertake  no  obligation  to revise or publicly  release the
results of any revisions to these  forward-looking  statements.  Readers  should
carefully review the factors described below and in other documents we file from
time to time with the Securities and Exchange  Commission,  including our Annual
Report on Form 10-K for 1999 and the Quarterly  Reports on Form 10-Q to be filed
by  us in  2000.  Our  business,  financial  condition,  operating  results  and
prospects  can be impacted by a number of factors,  including but not limited to
those set forth below and elsewhere in this report, any one of which could cause
our  actual  results  to  differ  materially  from  recent  results  or from our
anticipated  future  results.  Factors that may affect our  business,  financial
condition and results of operations include:

         Rapid  Technological Change; Product Development.   The  market for our
software  and services is  characterized  by rapid  technological  developments,
evolving industry standards,  changes in customer  requirements and frequent new
product introductions and enhancements.  Our continued success will be dependent
upon our  ability to  continue to enhance our  existing  software  and  services
offerings,  develop and  introduce,  in a timely manner,  new software  products
incorporating technological advances and respond to customer requirements. There
can be no assurance  that we will be successful in developing  and marketing new
software  products  and  services  offerings  or  enhancements  to our  existing
software on a timely  basis or that any new or enhanced  software  and  services
offerings will adequately  address the changing needs of the marketplace.  If we
are unable to develop and introduce new software and enhancements or new service
offerings,  in a timely  manner in  response to changing  market  conditions  or
customer  requirements,  our business and  operating  results could be adversely
affected.  From time to time,  we or our  competitors  may announce new software
products,  capabilities  or  technologies  that have the potential to replace or
shorten  the life  cycles of our  existing  software  products.  There can be no
assurance that announcements of currently planned or other new software products
will not cause customers to delay their purchasing  decisions in anticipation of
such  software  products,  which  could  have a material  adverse  effect on our
business and operating results.

                                       6
<PAGE>

         Uncertainty  of Future  Operating  Results;  Fluctuations  in Quarterly
Operating Results.  Prior  growth  rates  in our  revenue and  operating results
should  not  necessarily be considered  indicative of future growth or operating
results. Future operating results  will  depend upon many factors, including the
demand for our products;  the level of  software product and  price competition;
the  length  of  our sales  cycle;  variations in the  productivity of our sales
force;  seasonality of individual customer buying patterns;  the size and timing
of  individual transactions; the delay or deferral of customer  implementations;
the  budget cycles of our  customers;  the timing of new software  introductions
and  software  enhancements  by us  and  our competitors;  the  mix of  sales by
products, software, services and distribution channels;  levels of international
sales; acquisitions by competitors;  changes in foreign currency exchange rates,
impact of the  EURO currency;  our ability to  develop  and market new  software
products and control costs;  and general domestic and international economic and
political conditions.

         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, we believe that period-to-period  comparisons of
our  results of  operations  are not  necessarily  meaningful  and should not be
relied upon as indications of future performance.  Moreover,  such factors could
cause our operating  results in a given quarter to be below the  expectations of
public market  analysts and  investors.  In either case, the price of our common
stock could be materially adversely affected.

         Competition.The Web content management, integrated document management,
imaging,  workflow,  computer  output  to  laser  disk and  electronic  document
management  software  markets  are  highly  competitive,  and there are  certain
competitors of ours with substantially greater sales, marketing, development and
financial  resources.  We believe that the  competitive  factors  affecting  the
market for our  software  products  and  services  include  vendor  and  product
reputation; product quality, performance and price; the availability of software
products on multiple platforms;  product  scalability;  product integration with
other enterprise  applications;  software  functionality and features;  software
ease of use; and the quality of professional services, customer support services
and training.  The relative importance of each of these factors depends upon the
specific  customer  involved.  While we believe we compete  favorably in each of
these areas, there can be no assurance that we will continue to do so. Moreover,
our  present  or future  competitors  may be able to develop  software  products
comparable  or superior to those  offered by us,  offer lower price  products or
adapt  more  quickly  than  we do  to  new  technologies  or  evolving  customer
requirements. Competition is expected to intensify. In order to be successful in
the future, we must respond to technological  change,  customer requirements and
competitors'  current  software  products  and  innovations.  There  can  be  no
assurance that we will be able to continue to compete  effectively in our market
or that  future  competition  will not have a  material  adverse  effect  on our
business, financial condition or results of operations. In addition, current and
potential   competitors   have   established   or  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 us. 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 our business,  financial  condition or
results of operations.

         Intellectual Property and Other Proprietary Rights.Our success depends,
in part, on our ability to protect our  proprietary  rights to the  technologies
used  in our  principal  products.  We  rely  on a  combination  of  copyrights,
trademarks, trade secrets, confidentiality procedures and contractual provisions
to protect our  proprietary  rights in our  software  products.  There can be no
assurance that our existing or future copyrights,  trademarks,  trade secrets or
other  intellectual  property rights will be of sufficient  scope or strength to
provide  meaningful  protection  or a  commercial  advantage  to us.  We have no
software patents. In addition, the laws of some foreign countries do not protect
our  proprietary  rights to the same extent as do the laws of the United States.
There can be no assurance  that such factors  would not have a material  adverse
effect on our  business,  financial  condition  or  results  of  operations.  In
addition,  we also rely on certain  software that we license from third parties,
including software that is integrated with internally developed software used in
our 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
software products, or that their software products will otherwise continue to be
available  to us on  commercially  reasonable  terms.  The loss or  inability to
maintain any of these software  licenses could result in delays or reductions in
software  shipments  until  equivalent  software can be  developed,  identified,
licensed and integrated,  which could adversely  affect our business,  financial
condition or results of operations.

                                       7
<PAGE>

         We may, from time to time, be notified that we are  infringing  certain
patent or  intellectual  property  rights of others.  Combinations of technology
acquired through past or future  acquisitions and our technology will create new
software  products and technology that may give rise to claims of  infringement.
While no actions other than those discussed below are currently  pending against
us 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 us in the future. Infringement actions can result in substantial
cost to, and  diversion  of,  resources.  If we were found to infringe  upon the
rights  of  others,  no  assurance  can be  given  that we  could  redesign  the
infringing products or could obtain licenses 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 redesign our products 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 our 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
we are  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 with us, 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.

         In March 1997, Eastman Kodak Company (Kodak) purchased the Wang imaging
business unit that has responsibility for this litigation. On July 30, 1997, the
Court  permitted  Eastman and Kodak Limited of England to be  substituted in the
litigation in place of Wang.

         We have moved for summary judgment 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 our  unenforceability
defense on one of the patents.  In July 1998, the  Magistrate  Judge assigned to
the case,  heard oral  arguments  on our motion for summary  judgment  that U.S.
Patent  4,918,588 is not infringed and is invalid.  The Magistrate Judge has not
yet decided these motions.  We believe that after he has ruled on these motions,
he will hear oral  arguments in the  remaining  motions in the sequence in which
they were filed. 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 our  products,  including  Watermark
products, we 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
we will be able to  redesign  the  infringing  products  or obtain a license  on
acceptable  terms.  Based on our  analysis  of these  Eastman  patents and their
respective  file  histories,  we believe  that we have  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.   We have entered into a number of
key relationships with other companies such as Microsoft Corporation, IBM Global
Services,   Siebel  Systems  Inc,  SAP  AG,  Hewlett-Packard  Company,  and  Sun
Microsystems,  Inc.  There can be no  assurance  that these  companies  will not
reduce or  discontinue  their  relationships  with,  or  support  of, us and our
products.

         Dependence on Key Management and Technical Personnel.      Our  success
depends to a  significant  degree upon the  continued  contributions  of our key
management,  marketing,  technical and operational personnel.  In general, we do
not  utilize  employment  agreements  for our  key  employees.  The  loss of the
services of one or more key employees  could have a material  adverse  effect on
our operating  results.  We also believe our future success will depend in large
part  upon  our  ability  to  attract  and  retain   additional  highly  skilled
management, technical, marketing, product development, operational personnel and
consultants.  Competition for such personnel,  particularly software developers,
professional service consultants and other technical personnel,  is intense, and
pay scales in the software industry have significantly  increased.  There can be
no  assurance  that we will be  successful  in  attracting  and  retaining  such
personnel.

                                       8
<PAGE>

         International Sales. Historically, we have derived approximately thirty
percent of our total revenues from international sales.  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;
varying   requirements   for  localized   products;   potentially   adverse  tax
consequences;  currency  exchange  fluctuations  including  those related to the
EURO;  the burden of  complying  with a wide  variety of complex  foreign  laws,
regulations  and treaties;  and the  possibility of  difficulties  in collecting
accounts  receivable.  There can be no assurance  that any of these factors will
not have a material  adverse  effect on our  business,  financial  condition  or
results of operations.

         Product Liability. Software and products as complex as those sold by us
are susceptible to errors or failures,  especially when first introduced or when
new versions are released.  Our software  products are often intended for use in
applications  that are  critical  to a  customer's  business.  As a result,  our
customers  may rely on the  effective  performance  of the software to a greater
extent than the market for software  products  generally.  We conduct  extensive
software  testing to ensure that our software is free of significant  errors and
defects.  In addition,  we have designed and tested the most current versions of
our software products to be year 2000 compliant.  However, some of our customers
are running earlier software products that are not year 2000 compliant. Although
we have been encouraging such customers to migrate to current software versions,
no assurance can be given that all of them will do so. Moreover, we also rely on
certain software that we license from third parties,  including software that is
integrated  with  internally  developed  software and is used in our 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.  Although we have
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 us in the future.
A successful  product  liability  claim brought against us could have a material
adverse effect upon our business, operating results and financial condition. Our
license agreements with customers typically contain provisions designed to limit
our exposure to potential product liability claims. However, it is possible that
such  limitation of liability  provisions may not be effective under the laws of
certain jurisdictions.

Item 2.     Properties

         We  currently  lease  280,000  square feet of office,  development  and
manufacturing  space in Costa Mesa,  California and 92,000 square feet of office
and development space in Kirkland,  Washington.  We also lease sales and support
offices in 27 locations in the United States, 15 in Europe, 3 in Australia, 5 in
Canada,  and 4 in Asia.  We believe that the Costa Mesa and Kirkland  facilities
will be adequate for our anticipated needs through 2000.

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
we are  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 with us, 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.

         In March 1997, Eastman Kodak Company (Kodak) purchased the Wang imaging
business unit that has responsibility for this litigation. On July 30, 1997, the
Court  permitted  Eastman and Kodak Limited of England to be  substituted in the
litigation in place of Wang.

         We have moved for summary judgment 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 our  unenforceability
defense on one of the patents.  In July 1998, the  Magistrate  Judge assigned to
the case heard oral  arguments  on our motion  for  summary  judgment  that U.S.
Patent  4,918,588 is not infringed and is invalid.  The Magistrate Judge has not
yet decided these motions.  We believe that after he has ruled on these motions,
he will hear oral  arguments in the  remaining  motions in the sequence in which
they were filed. A trial date has not been set.

                                       9
<PAGE>

        If it should be determined  that the patents at issue in the  litigation
are  valid  and  are  infringed  by  any of our  products,  including  Watermark
products, we 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
we will be able to  successfully  redesign the  infringing  products or obtain a
license on  acceptable  terms.  Based on our analysis of these patents and their
respective file histories, we believe that we have meritorious defenses to these
claims;  however, the ultimate outcome or any resulting potential loss cannot be
determined at this time.

         On October 27, 1998,  plaintiff  Thomas P. Nyquist filed a class action
complaint  against us and certain of our  officers  and  directors in the United
States  District  Court for the Central  District  of  California  (the  Nyquist
Action).  The action was purportedly filed on behalf of a class of purchasers of
our common stock during the period  April 16, 1998 through  October 7, 1998.  On
July 22,  1999,  defendant  filed a  motion  to  dismiss  the  complaint  in its
entirety. On August 19, 1999, the court ordered a stay of the action and removed
defendants'  motion to dismiss from the Court's hearing calendar in light of the
pending  petition for rehearing and  rehearing  enbanc in Silicon  Graphics Sec.
Litig.,  Nos.  97-16204,  97-16240,  1999 U.S. App LEXIS 14955 (9th Cir. July 2,
1999).  On December 13, 1999,  the court entered a Stipulation to Dismiss Entire
Action Without Prejudice.

         Subsequent  to December  31,  1998,  the former  shareholders  of Saros
Corporation  filed a demand for mandatory  arbitration to release  approximately
two hundred  thousand  shares of our stock which were held in escrow pursuant to
the  Agreement  and  Plan  of  Merger  dated  January  17,  1996  among  FileNET
Corporation,  FileNET  Acquisition  Corporation  and Saros  Corporation  and for
damages.  We and the Shareholders'  Agent had agreed to mediate the matter,  but
the Saros  Shareholders'  Agent  cancelled the mediation  prior to the scheduled
date and renewed their demand for mandatory arbitration. We believe that we have
meritorious  reasons  for not  releasing  the shares and other  defenses  to the
claims;  however,  the  ultimate  or any  resulting  potential  loss  cannot  be
presently determined.

         In the normal course of business, we are subject to various other legal
matters.  While the results of litigation  and claims  cannot be predicted  with
certainty,  we believe  that the final  outcome of these other  matters will not
have a materially  adverse effect on our  consolidated  results of operations or
financial condition.

Item 4.     Submission of Matters to a Vote of Security Holders

         No matters  were  submitted  to a vote of security  holders  during the
fourth quarter of fiscal 1999.

                                       10

<PAGE>

                                     PART II

Item 5.     Market  for  the  Registrant's  Common Stock and Related Stockholder
            Matters

         We believe that a variety of factors  could cause the trading  price of
our   common   stock   to   fluctuate,    perhaps    substantially,    including
quarter-to-quarter   variations   in   operating   results;   announcements   of
developments related to our business;  fluctuations in our order levels; general
conditions in the technology sector or the worldwide  economy;  announcements of
technological  innovations,  new software products or product enhancements by us
or our  competitors;  key  management  changes;  changes in joint  marketing and
development  programs;  developments  relating to patents or other  intellectual
property  rights or disputes;  and  developments in our  relationships  with our
customers,  resellers  and  suppliers.  In  addition,  in recent years the stock
market in  general,  and the  market  for  shares of  high-technology  stocks in
particular,  have experienced  extreme price  fluctuations  that have often been
unrelated to the operating performance of affected companies.  Such fluctuations
could adversely affect the trading price of our common stock.

         Our 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 1, 1997 through December 31, 1999, as reported by Nasdaq:

                                               High        Low
                                           --------------------
1999
   4th Quarter                              $ 25.50    $ 10.38
   3rd Quarter                                13.38       8.00
   2nd Quarter                                11.94       6.03
   1st Quarter                                12.63       6.75
---------------------------------------------------------------
1998
   4th Quarter                              $ 12.50      $4.56
   3rd Quarter                                31.88      14.00
   2nd Quarter                                29.97      22.81
   1st Quarter                                24.44      14.89
---------------------------------------------------------------
1997
   4th Quarter                              $ 16.32      $8.07
   3rd Quarter                                10.07       7.75
   2nd Quarter                                 8.32       5.16
   1st Quarter                                15.88       7.75

         The closing  price of our common stock on December 31, 1999 was $25.50.
The approximate  number of stockholders of record on February 28, 2000, was 673.
The closing price of our common stock on that date was $42.19.

         We have not paid any dividends on our common stock. We currently intend
to retain  earnings for use in our business  and do not  anticipate  paying cash
dividends in the foreseeable  future. Our ability to pay dividends is limited by
the terms of our line of credit agreement.

                                       11

<PAGE>


Item 6.     Selected Financial Data

         The following table summarizes certain selected financial data:
<TABLE>
<CAPTION>

                                                                                    (Dollars in thousands, except per share amounts)
                                                                         For Fiscal Years Ended
                                             ---------------------------------------------------------------------------------------
                                             Dec. 31, 1999    Dec. 31, 1998      Dec. 31, 1997    Dec. 31, 1996     Dec. 31, 1995
                                                 (1999)           (1998)             (1997)           (1996)            (1995)
                                             --------------   ---------------    --------------   --------------    --------------
<S>                                            <C>              <C>                <C>              <C>              <C>
Consolidated statements of operations data:
Revenue:
     Software revenue                          $   183,253      $   171,153        $   132,723      $   140,659      $   116,052
     Service revenue                               147,449          115,501             89,280           82,118           67,174
     Hardware revenue                               16,418           23,579             29,422           46,136           46,152
                                               ------------     ------------       ------------     ------------     ------------
            Total revenue                          347,120          310,233            251,425          268,913          229,378

Costs and expenses:
     Cost of software revenue                       16,984           16,814             13,416           15,389           14,688
     Cost of service revenue                        85,686           69,586             54,003           51,068           44,277
     Cost of hardware revenue                        8,805           13,181             20,330           29,633           28,800
     Research and development                       54,307           50,132             40,927           37,577           25,169
     Selling, general and administrative           157,708          161,013            127,622          120,261           96,499
     Merger, restructuring, write-off of
        purchased in-process research and
        development and other costs                      -            2,000              6,000           16,011            6,393
                                               ------------     ------------       ------------     ------------     ------------
         Total costs and expenses                  323,490          312,726            262,298          269,939          215,826

                                               ------------     ------------       ------------     ------------     ------------
Operating income (loss)                             23,630           (2,493)           (10,873)          (1,026)          13,552

     Other income, net                               3,409            3,840              3,160            2,838            2,780

Income (loss) before income taxes                   27,039            1,347             (7,713)           1,812           16,332

     Provision (benefit) for income taxes            7,362              391             (2,187)           4,456            8,116

                                               ------------     ------------       ------------     ------------     ------------
Net income (loss)                              $    19,677      $       956        $    (5,526)     $    (2,644)     $     8,216
                                               ------------     ------------       ------------     ------------     ------------

Basic earnings (loss) per share                $     0.61       $     0.03         $    (0.18)      $    (0.09)      $     0.28
Diluted earnings (loss) per share              $     0.59       $     0.03         $    (0.18)      $    (0.09)      $     0.26

Weighted average shares outstanding -
        basic                                       32,125           31,083             30,310           30,014           28,860
Weighted average shares outstanding -
        diluted                                     33,360           33,367             30,310           30,014           31,712

Consolidated balance sheet data:

Working capital                                $   101,777      $    67,722        $    79,091      $    85,475      $    83,797
Total assets                                       240,892          206,822            179,440          192,274          187,393
Stockholders' equity                               150,458          130,320            118,811          132,806          131,158

</TABLE>
Certain  reclassifications have been made to the prior years' selected financial
data to conform with the current year's presentation.

                                       12
<PAGE>


Item 7.     Management's  Discussion  and  Analysis of  Financial  Condition and
            Results of Operations

The following  discussion  should be read in conjunction  with the  Consolidated
Financial  Statements and Notes thereto  submitted as a separate section of this
Form 10-K (Item 14).

         Revenue
<TABLE>
<CAPTION>

                                                                                                 (Dollars in millions)
                                                                           Percent                 Percent
        December 31,                                             1999       change        1998      change        1997
        ---------------------------------------------------------------------------------------------------------------
<S>                                                          <C>             <C>       <C>           <C>       <C>
        Software revenue
               Domestic                                       $ 124.3          15%     $ 107.7         20%     $  89.7
               International                                     59.0          (7%)       63.5         48%        43.0
                                                             ----------------------------------------------------------
               Total software revenue                         $ 183.3           7%     $ 171.2         29%     $ 132.7
                   Percentage of total revenue                     53%                      55%                     53%

        Customer support revenue
               Domestic                                       $  71.5          25%     $  57.0         31%     $  43.4
               International                                     20.4          24%        16.5         50%        11.0
                                                             ----------------------------------------------------------
               Total customer support revenue                 $  91.9          25%     $  73.5         35%     $  54.4
                   Percentage of total revenue                     26%                      24%                     22%

        Professional services and education revenue
               Domestic                                       $  35.7          46%     $  24.4         43%     $  17.1
               International                                     13.5          59%         8.5         35%         6.3
                                                             ----------------------------------------------------------
               Total professional services and education
               revenue                                        $  49.2          50%     $  32.9         41%     $  23.4
                   Percentage of total revenue                     14%                      10%                      9%

        Hardware revenue
               Domestic                                       $  12.3        (28%)     $  17.1       (16%)     $  20.4
               International                                      4.1        (37%)         6.5       (28%)         9.0
                                                             ----------------------------------------------------------
               Total hardware revenue                         $  16.4        (31%)     $  23.6       (20%)     $  29.4
                   Percentage of total revenue                      5%                       8%                     12%

        Other revenue
               Domestic                                       $   5.2        (16%)     $   6.2       (17%)     $   7.5
               International                                      1.1        (61%)         2.8       (30%)         4.0
                                                             ----------------------------------------------------------
               Total other revenue                            $   6.3        (30%)     $   9.0       (22%)     $  11.5
                   Percentage of total revenue                      2%                       3%                      4%

        Total revenue
               Domestic                                       $ 249.0          17%     $ 212.4         19%     $ 178.1
               International                                     98.1           0%        97.8         33%        73.3
                                                             ----------------------------------------------------------
               Total Revenue                                  $ 347.1          12%     $ 310.2         23%     $ 251.4
                                                             ----------------------------------------------------------
</TABLE>
                                       13
<PAGE>

         The software revenue growth rate increased 7% and 29% in 1999 and 1998,
respectively.  The lower growth rate in 1999 as compared to 1998 was a result of
reduced  demand for our products due to customer and prospect focus on year 2000
issues.  Our international  markets were more impacted by these factors than the
U.S. particularly in the second half of the year.

         Customer support revenue consists of revenue from software  maintenance
contracts and "fee for service" revenues. Customer support revenue increased 25%
and 35% in 1999 and 1998,  respectively,  due to the growth of our customer base
through new customer sales and sales of new products to the installed base.

         Professional services and education revenue is generated primarily from
consulting  and  implementation  services  provided to end users of our software
products,  technical  consulting services provided to our resellers and training
services.  Professional  services are primarily performed on a time and material
basis. Professional services and education revenue increased 50% and 41% in 1999
and 1998,  respectively.  This increase was attributable to our efforts to build
our  professional  services  capabilities  to  support  our   solutions-oriented
strategy as well as increased demand for our expanded  professional services and
education offerings.

         Hardware revenue is generated primarily from the sale of 12-inch OSARs.
Hardware revenue  decreased 31% and 20% in 1999 and 1998,  respectively,  due to
expected  decreases  in new  orders  attributable  to  our  continued  focus  on
software-related  revenues. We expect hardware revenue to continue to decline as
a percentage of total revenue.

         Other revenue is generated  from the sale of spare parts,  supplies and
"third party"  products.  Other revenue  decreased 30% and 22% in 1999 and 1998,
respectively, due to decreased sales of spare parts and third party products.

         International revenue represented 28%, 32% and 29% of total revenues in
1999,  1998 and 1997,  respectively.  The lower  percentage in 1999 was due to a
weakness  in order  levels  in the  European  market  caused by  customers'  and
prospective  customers' concerns over the year 2000 and, to a lesser extent, the
strengthening  of  the  U.S.  dollar  against  foreign  currencies.   We  expect
international revenue to continue to represent a significant percentage of total
revenue. However,  international revenues are subject to certain risks including
but  not  limited  to   political   and  economic   instability;   and  currency
fluctuations.

         Cost of Revenue
<TABLE>
<CAPTION>

                                                                                           (Dollars in millions)
    ------------------------------------------------------------------------------------------------------------
                                                                       Percent              Percent
    December 31,                                                1999    Change       1998    Change       1997
    ------------------------------------------------------------------------------------------------------------
<S>                                                         <C>           <C>     <C>          <C>      <C>

    Cost of software revenue                                 $  17.0        1%    $  16.8       25%     $  13.4
                Percentage of software revenue                     9%                  10%                   10%
    Cost of customer support revenue                         $  39.4       14%    $  34.7       29%     $  26.9
                Percentage of customer support revenue            43%                  47%                   49%
    Cost of professional services and education revenue      $  40.6       47%    $  27.7       40%     $  19.8
                Percentage of professional services and
                education revenue                                 83%                  84%                   85%
    Cost of hardware revenue                                 $   8.8      (33%)   $  13.2      (35%)    $  20.3
                Percentage of hardware revenue                    54%                  56%                   69%
    Cost of other revenue                                    $   5.6      (22%)   $   7.2       (1%)    $   7.3
                Percentage of other revenue                       89%                  80%                   63%
                                                            ----------------------------------------------------
    Cost of total revenue                                    $ 111.4       12%    $  99.6       14%     $  87.7
                                                            ----------------------------------------------------
</TABLE>

         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 was 9% in 1999 compared to 10% in 1998 and 1997.
The decrease in 1999 is attributable to distribution costs increasing at a lower
rate than revenue.

                                       14
<PAGE>

         The  cost  of  customer  support  revenue  includes   customer  support
personnel,  supplies, and the cost of third-party hardware maintenance. The cost
of  customer  support  revenue  as a  percentage  of  customer  support  revenue
decreased to 43% in 1999 from 47% in 1998 and 49% in 1997.  The decrease in 1999
is attributable to increased revenue with no proportional increase in costs. The
decrease in 1998 was due to the higher  proportion of fees for service  revenue,
as opposed to contract  maintenance  revenue,  and the  transition  of high cost
hardware maintenance services to a third party contractor.  The decrease in 1997
is primarily  due to the  transition  of hardware  maintenance  to a third party
contractor, offset by lower margins associated with international maintenance.

         The  cost of  professional  services  and  education  revenue  consists
primarily of professional services personnel, training personnel and third party
contractors.  The cost of  professional  services  and  education  revenue  as a
percentage  of  revenue  decreased  to 83% in 1999  from 84% in  1998.  This was
primarily  due to higher  utilization  rates as a result of  increased  revenue.
However,  we expect that  competition  for qualified  technical  and  managerial
personnel for our  professional  services  segment is intense and will remain so
for the  foreseeable  future.  This may result in higher levels of  compensation
expense and higher cost of professional services revenue.

         The cost of hardware  revenue includes the cost of assembling OSARs and
the cost of hardware  integration  personnel.  The cost of hardware revenue as a
percentage of hardware revenue decreased to 54% in 1999 from 56% in 1998 and 69%
in 1997. The decreases are  attributable  to a reduction in fixed assembly costs
corresponding to decreases in hardware revenue.

         The cost of other  revenue  includes the cost of supplies,  spare parts
and "third  party"  product.  The cost of other revenue as a percentage of other
revenue  increased to 89% in 1999 from 80% in 1998 and 63% in 1997. The increase
is due to declining  revenue with a fixed  expense base and sales of higher cost
product.

        Research and Development and Selling, General and Administrative Expense
<TABLE>
<CAPTION>
                                                                                    (Dollars in millions)
                                                            Percent                Percent
          December 31,                               1999    Change        1998     Change         1997
          ----------------------------------------------------------------------------------------------
<S>                                               <C>          <C>      <C>            <C>      <C>

          Research and development                $  54.3        8%     $  50.1        22%      $  40.9
                    Percentage of total revenue        16%                   16%                     16%
          Selling, general and administrative     $ 157.7      (2%)     $ 161.0        26%      $ 127.6
                    Percentage of total revenue        45%                   52%                     51%
                                                  ------------------------------------------------------
</TABLE>

         Research and development expenses increased 8% in 1999 primarily due to
an increase in  salaries.  The 22% increase in 1998 was  attributable  to market
driven  increases in salaries and recruiting  costs  necessitated by the intense
competitive  environment  for software  engineers and an increase in the cost of
contract developers.  As a percentage of total revenue, research and development
expenses were 16% in 1999, 1998 and 1997.

         We expect that  competition  for  qualified  technical  personnel  will
remain  intense for the  foreseeable  future and may result in higher  levels of
compensation   expense  for  us.  We  believe  that  research  and   development
expenditures,  including  compensation of technical personnel,  are essential to
maintaining  our  competitive  position  and expect  these  costs to continue to
constitute a significant percentage of revenue.

         Selling,  general and administrative  expenses decreased 2% in 1999 and
increased 26% in 1998. The decrease in 1999 was due primarily to overall reduced
spending including reduced legal fees and reduced sales training  expenses.  The
increase in 1998 was due  primarily  to the  expansion  of our sales  force,  an
increase in sales training costs, and an increase in commissions associated with
higher revenue. Selling, general and administrative expenses, as a percentage of
total revenue,  were 45% in 1999, 52% in 1998 and 51% in 1997. The decrease from
1998 to 1999 was  primarily  due to  containment  of expenses  combined  with an
increase in revenues.

                                       15
<PAGE>

         Restructuring  and Other Costs. The $2.0  million in  restructuring and
other costs in 1998 represents the costs of a reduction in headcount  associated
with the restructuring of our sales and marketing  operations,  as well as costs
of  consolidating   facilities.   The  restructuring  and  other  costs  include
approximately $1.1 million for severance payments for 54 employees, $0.7 million
for facility closing costs and $0.2 million of other charges.

         The $6.0 million in  restructuring  and other costs in 1997 represented
the  costs  of   consolidating   the  Watermark   business  unit's   Burlington,
Massachusetts  engineering and marketing functions with those at our Costa Mesa,
California location,  as well as a reduction in headcount in certain other areas
of the company.  The  restructuring and other costs include  approximately  $2.2
million for severance payments for 111 employees, $2.2 million for the write-off
of assets  impaired by the  decision to  restructure,  $0.4 million for facility
closing costs, $0.4 million for equipment lease cancellations,  $0.3 million for
cancellation of third party development  contracts,  $0.2 million related to the
withdrawal  of  certain  products  from the  market  and $0.3  million  of other
charges.

         At December 31, 1999,  the remaining  accrued  restructuring  and other
costs of $0.5 million are included in other accrued  liabilities.  We anticipate
that the remaining restructuring costs will be expended during 2000 .

         Other Income. Interest and other income  consists primarily of interest
income earned on our cash and cash equivalents, short and long-term investments,
and other items including foreign exchange gains and losses, the gain on sale of
fixed assets,  other items of income and interest expense.  Other income, net of
other expenses,  was $3.4 million in 1999, $3.8 million and $3.2 million in 1998
and 1997,  respectively.  The  decrease in 1999 was  attributable  to  increased
foreign  exchange  losses and increased  interest  expense  associated  with our
foreign  currency  hedge  activities  partially  offset by increases in interest
income.  The increase in 1998 over 1997 was  primarily  due to a decrease in our
foreign exchange losses.

         Provision for Income Taxes. The provision for income taxes was a charge
of $7.4  million in 1999,  compared to a charge of $0.4 million and a benefit of
$2.2 million recorded in 1998 and 1997, respectively. The effective tax rate was
27%,  29%  and  28% in the  years  ended  December  31,  1999,  1998  and  1997,
respectively.  The reduction in 1999 was due to our utilization of net operating
loss carryforwards.

         Quantitative and Qualitative Disclosures about Market Risk.     We  are
exposed to a variety of risks, including changes in interest rates affecting the
return on investments and foreign currency fluctuations. In the normal course of
business,  we employ established  policies and procedures to manage our exposure
to fluctuations in interest rates and foreign currency values.

         Interest Rate Risk. Our  exposure  to market  rate risk for  changes in
interest rates relates primarily to our investment  portfolio.  We have not used
derivative  financial  instruments  in our  investment  portfolio.  We place our
investments with high-quality issuers and, by policy, limit the amount of credit
exposure  to any one issuer.  We protect  and  preserve  our  invested  funds by
limiting  default,  market and reinvestment  risk. Our investments in marketable
securities consist primarily of high-grade  corporate and government  securities
with maturities of less than three years. Investments purchased with an original
maturity  of three  months or less are  considered  to be cash  equivalents.  We
classify  all  of  our  investments  as  available-for-sale.  Available-for-sale
securities are carried at fair value,  with unrealized gains and losses,  net of
tax, reported in a separate component of stockholder's equity.

         Foreign Currency Risk.  We have entered into forward  foreign  exchange
contracts  primarily  to hedge  amounts  due from and the net assets of selected
subsidiaries  denominated  in  foreign  currencies  (mainly  in Europe  and Asia
Pacific)  against  fluctuations  in exchange  rates.  We have not  entered  into
forward  foreign  exchange  contracts for speculative or trading  purposes.  Our
accounting  policies for these  contracts  are based on our  designation  of the
contracts  as  hedging  transactions.  The  criteria  we use for  designating  a
contract as a hedge include the contract's  effectiveness  in risk reduction and
one-to-one matching of derivative instruments to underlying transactions.  Gains
and losses on foreign  exchange  contracts are  recognized in income in the same
period as gains and  losses on the  underlying  transactions.  If an  underlying
hedged  transaction  is  terminated  earlier  than  initially  anticipated,  the
offsetting gain or loss on the related forward foreign  exchange  contract would
be  recognized  in income in the same period.  In addition,  since we enter into
forward contracts only as a hedge, any change in currency rates would not result

                                       16
<PAGE>

in any material net gain or loss, as any gain or loss on the underlying  foreign
currency  denominated balance would be offset by the gain or loss on the forward
contract.  Our forward  contracts  generally have an original  maturity of three
months.  The total notional  values of forward  contracts  purchased and forward
contracts  sold were $15.9 million and $17.0  million,  respectively.  We do not
expect gains or losses on these contracts to have a material impact on financial
results (see Note 15 to the consolidated financial statements).

         Management  believes that inflation has not had a significant impact on
the price of our products,  the cost of our materials,  or our operating results
for the three years ended December 31, 1999.

FINANCIAL CONDITION

         Liquidity and Capital Resources.   As  of  December 31, 1999,  combined
cash,  cash  equivalents,  and  investments  (short and long-term)  were  $108.7
million, an increase of $26.6 million from the $82.1 million at the end of 1998.

         Cash  provided by operating  activities  in 1999 was $38.0  million and
resulted primarily from net income, an increase in unearned  maintenance revenue
related  to  prepaid  maintenance   contracts,   additions  to  net  income  for
depreciation  and  amortization  expense  offset  by  an  increase  in  accounts
receivable and a decrease in accounts payable. Cash used by investing activities
totaled $25.4 million,  consisting of capital expenditures,  proceeds from sales
and the net sale  and  maturity  of  marketable  securities.  Cash  provided  by
financing  activities was $5.5 million consisting primarily of proceeds from the
issuance of common  stock in  connection  with the  exercise  of employee  stock
options and the employee and non-employee director stock purchase plan.

         Cash provided by operating activities in 1998 was $33.3 million and was
comprised primarily of additions to net income for depreciation and amortization
expense and increases in accounts payable,  accrued  compensation,  and unearned
maintenance  revenue.  Cash used by investing  activities totaled $23.7 million,
consisting  of  capital  expenditures  offset  by the net sale and  maturity  of
marketable  securities.  Cash provided by financing  activities was $9.1 million
consisting  of proceeds  from  issuance of common stock in  connection  with the
exercise of employee  stock options and the employee and  non-employee  director
stock purchase plan, offset by the cost to repurchase common stock.

         Cash provided by operating  activities in 1997 was $24.7 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 our 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 and non-employee director stock options and the employee stock purchase
plan.

         Our capital  expenditures  were $22.4 million in 1999, $32.5 million in
1998,   and  $14.3  million  in  1997.  We  anticipate   that  we  will  acquire
approximately  $27.0 million of capital  equipment in 2000. Our primary  capital
expenditures  are for  research and  development  equipment,  demonstration  and
training  equipment,  enhancements to our internal network and business systems,
leasehold improvements on leased property,  and furniture.  The increase in 1998
capital expenditures over the levels of the prior two years was due primarily to
large internal information  technology  infrastructure and systems projects,  as
well as expenditures incurred to improve and furnish our new office in Kirkland,
Washington. During the first quarter of 1998, we repurchased $4.4 million of our
common  stock.  We  repurchased  $10.1 million of our common stock in 1997 for a
total of $14.5 million in treasury stock.

         We   anticipate   that  our  present  cash   balances,   together  with
internally-generated  funds and credit  lines,  will be  sufficient  to meet our
working capital and capital expenditure needs throughout 2000.

                                       17
<PAGE>

OTHER MATTERS

         Year 2000.  In 1997, we implemented a year 2000 Integrity  Program (the
Program) to ensure that our computer  software  products  and internal  business
systems would function  properly in the year 2000 and thereafter.  Since January
1, 2000,  we have not  experienced  any problems  with our software  products or
internal  business systems to properly manage and manipulate data related to the
year 2000.

         All new generations of our software products were released as year 2000
compliant.  However,  not all our software products were year 2000 compliant and
we did not make them so.  Accordingly,  upgraded year 2000 compliant versions of
such software  products were made available to customers and resellers who would
then bear the  responsibility  for installing the upgraded  software  product in
order to make their  systems year 2000  compliant.  Some of our  customers  were
running  software  product  versions that were not year 2000 compliant.  We have
been encouraging such customers to migrate to current software product versions.
All customers were kept informed of the release of year 2000  compliant  updates
and  upgrades  via our  readiness  disclosure  statement  on our Web  site.  The
inability of any of our software products to properly manage and manipulate data
in  the  year  2000  and  beyond  could  result  in  increased  costs,  customer
satisfaction issues, potential lawsuits and other costs and liabilities, as well
as  customers  being  unable  to run  software  licensed  from us and  incurring
significant  costs  from  the  resultant  business  interruption.  We  spent  an
estimated $1.6 million on year 2000 software  product related  projects  through
December 31, 1999. We formed a rapid  response team as part of customer  support
that responded to problems during the year 2000 date change period.  We spent an
estimated $0.1 million during the year 2000 date change timeframe.

         We  communicated  with  significant  third  party  vendors of  computer
software  with which our systems  interface or upon which our software  products
depend. Such third party vendors delivered year 2000 versions or guaranteed that
their current computer  software was year 2000 compliant.  In the event that our
customers  have year 2000 related  problems with such third party  software,  we
have  been  assured  that the third  party  will  remediate  their own year 2000
issues.

         The Program also  included a review of all internal IT systems for year
2000  compliance.  Our significant  business  systems  (financial,  operational,
marketing,  customer  support,  etc.) were reviewed and were either already year
2000 compliant or were upgraded and/or replaced so as to be year 2000 tested and
compliant by October 31, 1999. All of the hardware and software  deployed in our
technical  infrastructure was either fully year 2000 tested and compliant or had
been replaced with year 2000  compliant  components by October 31, 1999. We also
evaluated IT related environmental systems (heating, air conditioning, security,
etc.) and made all such  systems  year  2000  compliant  by  October  31,  1999.
Business  teams  monitored the critical  systems,  and service  centers to react
immediately  to facilitate  repairs at the end of the year 1999.  Data retention
and  recovery  procedures  were in place for critical  business  data to provide
back-ups  with  on-site and off-site  data copies.  Our cost to fund solely year
2000 compliant projects was $1.1 million through December 31, 1999.

         The EURO Conversion.  On January 1, 1999,  eleven of the fifteen member
countries of the European Union established fixed conversion rates between their
existing sovereign currencies and the EURO. These countries have agreed to adopt
the EURO as their  common  legal  currency  from that date.  The EURO  trades on
currency exchanges and is available for non-cash  transactions.  These countries
will issue sovereign debt exclusively in EURO and will re-denominate outstanding
sovereign debt.  Effective on this date, these countries no longer control their
own monetary  policies by directing  independent  interest  rates for the legacy
currencies.  Instead,  the authority to direct monetary policy,  including money
supply  and  official  interest  rates for the  EURO,  is  exercised  by the new
European Central Bank.

         The legacy  currencies  are  scheduled  to remain legal tender in these
countries as a denomination  of the EURO between  January 1, 1999 and January 1,
2002 (the "transition period"). During the transition period, public and private
parties may pay for goods and services  using  either the EURO or the  country's
legacy currency on a "no compulsion, no prohibition" basis. However,  conversion
rates no longer will be computed  directly from one legacy  currency to another.
Instead, a "triangulation" process will be applied whereby an amount denominated

                                       18
<PAGE>

in one legacy  currency  first will be converted  into an amount  denominated in
EURO,  and the resultant  EURO-denominated  amount is converted  into the second
legacy currency.

         We have made the necessary  changes to our internal business systems to
support transactions  denominated in the EURO, including establishing EURO price
lists for effected countries. We are in the process of evaluating the impact the
conversion  to the EURO will have on our  financial  condition  and  results  of
operations.  Based on this  evaluation to date, we currently do not believe that
there  will be a  material  impact on our  financial  condition  or  results  of
operations as a result of the EURO  conversion,  except that we cannot currently
assess the impact that a common EURO-based price list will have on how we market
our products in Europe nor the impact, if any, on revenues generated in Europe.

         Recent Accounting Pronouncements. In June 1998 the Financial Accounting
Standards  Board  ("FASB")  issued,  SFAS No. 133,  "Accounting  for  Derivative
Instruments and Hedging  Activities".  SFAS No. 133 as amended, is effective for
fiscal  years  beginning  after June 15, 2000 and will  require us to record all
derivatives on the balance sheet at fair value. For derivatives that are hedges,
changes  in the fair value of  derivatives  will be offset by the change in fair
value of the hedged assets,  liabilities,  or firm  commitments.  We believe the
impact  of  adopting  this  standard  will not be  material  to our  results  of
operations or equity.

         Environmental  Matters  We are  not  aware  of any  issues  related  to
environmental  matters that have, or are expected to have, a material  affect on
our business.


Item 8.     Financial Statements and Supplementary Data

         The consolidated  financial statements for the years ended December 31,
1999,  1998 and 1997 are  incorporated  herein by reference  and  submitted as a
separate section of this Form 10-K. (See Item 14).

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 our 2000
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 our
2000 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 our 2000 Annual Meeting to be
filed with the Securities and Exchange Commission.

                                       19
<PAGE>

Item 13.    Certain Relationships and Related Transactions

         This  information  is included as set forth under the caption "Note 14:
Related Party Transactions," contained in this Form 10-K in Item 14, page F-22.


                                     PART IV


Item 14.    Exhibits, Financial Statement Schedule, and Reports on Form 8-K
<TABLE>
<CAPTION>
(a)      Independent Auditors' Report, Financial Statements and Financial Statement Schedule
<S>                                                                                              <C>
                                                                                                 Page
         Independent Auditors' Report............................................................F-3
         Consolidated balance sheets at December 31, 1999 and December 31, 1998..................F-4
         Consolidated statements of operations for each of the years ended
                  December 31, 1999, 1998 and 1997...............................................F-5
         Consolidated statements of comprehensive operations for each of the years
                  ended December 31, 1999, 1998 and 1997.........................................F-6
         Consolidated statements of stockholders' equity for each of the years ended
                  December 31, 1999, 1998 and 1997...............................................F-7
         Consolidated statements of cash flows for each of the years ended
                  December 31, 1999, 1998 and 1997...............................................F-8
         Notes to consolidated financial statements..............................................F-9
         Independent Auditors' Report on Schedule................................................F-24
         Schedule II.  Valuation and Qualifying Accounts and Reserves............................S-1

(b)      Reports on Form 8-K

         No reports on Form 8-K were filed during the fourth quarter of 1999.


                                       20
<PAGE>

(c)      Exhibits

         The following exhibits are filed herewith or incorporated by reference:

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).

4.3* Amendment One dated July 31, 1998 and Amendment Two dated  November 9, 1998
     to Rights  Agreements  between  FileNET  Corporation  and  BANKBOSTON  N.A.
     formerly  known as The First  National Bank of Boston (filed as Exhibit 4.3
     to Form 10-Q for the quarter ended September 30, 1998).

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 30, 1999, effective June 30, 1999 (filed as Exhibit 10.1 to Form
     10-Q for the quarter ended June 30, 1999).

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).

10.3.1*  Runtime   Sublicense   Addendum   between  the  Registrant  and  Oracle
     Corporation  dated July 1, 1996; as amended by  Amendments  Two through Six
     thereto  (filed  as  Exhibit  10.3.1  to Form  10-Q for the  quarter  ended
     September 30, 1998).

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  (filed as Exhibit
     99.1 to Form S-8 filed on October 29, 1999; Registration No. 333-89983).

                                       21
<PAGE>

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).

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  our 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* Amendment 2 dated  December  18,  1998 to the Product  License  Agreement
     between  the  Registrant  and  Novell,  Inc.  dated May 16,  1995 (filed as
     exhibit 10.17 to form 10-K/A for the year ended December 31, 1998).

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).

10.21* Amended and Restated  FileNET  Corporation  1998 Employee  Stock Purchase
     Plan  (filed as  Exhibit  99.15 to Form S-8,  filed on  October  29,  1999;
     Registration No. 333-89983).

10.22* FileNET Corporation International Employee Stock Purchase Plan. (filed as
     Exhibit  99.16 to Form S-8,  filed on October 29,  1999;  Registration  No.
     333-89983).

10.23*  Lease  between  the  Registrant  and C.  J.  Segerstrom  & Sons  for the
     headquarters  of the  Company,  dated  September  1, 1999 (filed as Exhibit
     10.23 to Form 10Q for the quarter ended September 30, 1999).

21.1 List of subsidiaries of Registrant (filed as FileNET Corporation Subsidiary
     Information).

23.1 Independent Auditor's consent (see page 24).

27.0 Financial Data Schedule.

* Incorporated herein by reference

                                       22
<PAGE>





SIGNATURES

         Pursuant to the  requirements  of the Securities  Exchange Act of 1934,
the  Registrant  has duly  caused  this report to be signed on its behalf by the
undersigned thereunto duly authorized.

                                     FILENET CORPORATION



Date: March 30, 2000        By:   /s/      Lee D. Roberts
                                  -------- -------------------------------------
                                           Lee D. Roberts
                                           President and 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, 2000         By:  /s/      Lee D. Roberts
                                  -------- -------------------------------------
                                           Lee D. Roberts
                                           President and Chief Executive Officer
                                          (Principal Executive Officer) Director

Date: March 30, 2000         By:  /s/      Brian A. Colbeck
                                  -------- -------------------------------------
                                           Brian A. Colbeck
                                           VP, Controller and Chief Accounting
                                           Officer

Date:  March 30, 2000        By:  /s/      Theodore J. Smith
                                  -------- -------------------------------------
                                           Theodore J. Smith
                                           Chairman of the Board

Date: March 30, 2000         By:  /s/      L. George Klaus
                                  -------- -------------------------------------
                                           L. George Klaus
                                           Director

Date: March 30, 2000         By:  /s/      William P. Lyons
                                  -------- -------------------------------------
                                           William P. Lyons
                                           Director

Date: March 30, 2000         By:  /s/      John C. Savage
                                  -------- -------------------------------------
                                           John C. Savage
                                           Director

Date: March 30, 2000         By:  /s/      Roger S. Siboni
                                  -------- -------------------------------------
                                           Roger S. Siboni
                                           Director


                                       23

<PAGE>


                               FILENET CORPORATION


                        CONSOLIDATED FINANCIAL STATEMENTS





              For the Years Ended December 31, 1999, 1998 and 1997



                                      with



                          Independent Auditors' Report




                                      F-1

<PAGE>




                               FILENET CORPORATION

                        CONSOLIDATED FINANCIAL STATEMENTS

              For the Years Ended December 31, 1999, 1998 and 1997

                                    Contents


  Independent Auditors' Report..............................................F-3
  Audited Consolidated Financial Statements:
     Consolidated Balance Sheets............................................F-4
     Consolidated Statements of Operations..................................F-5
     Consolidated Statements of Comprehensive Operations....................F-6
     Consolidated Statements of Stockholders' Equity........................F-7
     Consolidated Statements of Cash Flows..................................F-8
  Notes to consolidated financial statements................................F-9
   Independent Auditors' Report on Schedule.................................F-24




                                      F-2
<PAGE>


INDEPENDENT AUDITORS' REPORT


To the Stockholders and the Board of Directors of FileNET Corporation:


We  have  audited  the  accompanying  consolidated  balance  sheets  of  FileNET
Corporation and its subsidiaries (the Company) as of December 31, 1999 and 1998,
and the related consolidated statements of operations, comprehensive operations,
stockholders'  equity and cash  flows for each of the three  years in the period
ended December 31, 1999. 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 auditing standards generally accepted
in the  United  States of  America.  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,  1999  and  1998,  and the  results  of their
operations  and their cash flows for each of the three years in the period ended
December 31, 1999, in conformity with accounting  principles  generally accepted
in the United States of America.


/s/ DELOITTE & TOUCHE LLP


Costa Mesa, California
January 25, 2000


                                      F-3

<PAGE>


                           CONSOLIDATED BALANCE SHEETS

                       (Dollar in thousands, except share and per share amounts)
                                                      --------------------------
 Decemebr 31,                                              1999          1998
                                                      --------------------------
 ASSETS
 Current assets:
   Cash and cash equivalents                           $   71,528    $   55,820
   Short-term investments                                  31,581        15,484
   Accounts receivable, net of allowances
   for doubtful accounts and sales
   allowances of $4,542 and $4,382 at
   Decemebr 31, 1999 and 1998, respectively                72,736        61,636
   Inventories, net                                         3,399         2,419
   Prepaid expenses and other current assets                8,080         8,865
   Deferred income taxes                                      938             -
                                                      ------------   -----------
   Total current assets                                   188,262       144,224
 Property, net                                             40,593        44,177
 Long-term investments                                      5,542        10,885
 Deferred income taxes                                      4,752         6,385
 Other assets                                               1,743         1,151
                                                      ------------   -----------
     Total assets                                     $   240,892    $  206,822
                                                      ============   ===========

 LIABILITIES AND STOCKHOLDERS' EQUITY
 Current liabilities:
   Accounts payable                                   $    16,642    $   21,022
   Accrued compensation and benefits                       24,079        22,165
   Unearned maintenance revenue                            16,286        10,988
   Income tax payable                                       7,808         3,618
   Deferred income taxes                                      -             942
   Other accrued liabilities                               21,670        17,517
                                                      ------------   -----------
   Total current liabilities                               86,485        76,252

 Unearned maintenance revenue                               3,949           250

Committments and contingencies (Notes 2, 8 and 13)

 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
     33,578,642 and 32,924,950 shares issued and
     outstanding at December 31, 1999 and 1998,
     respectively                                         149,779       144,242
   Retained earnings                                       22,981         3,304
   Accumulated other comprehensive loss                    (7,735)       (2,659)
                                                      ------------   -----------
                                                          165,025       144,887
   Treasury stock, at cost; 1,098,000 shares at
     December 31, 1999 and 1998                           (14,567)      (14,567)
                                                      ------------   -----------
   Total stockholders' equity                             150,458       130,320
                                                      ------------   -----------

     Total liabilities and stockholders' equity       $   240,892    $  206,822
                                                      ============     =========
See accompanying Notes to Consolidated Financial Statements
</TABLE>
                                       F-4
<PAGE>


                      CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                            (Dollars in thousands, except per share amounts)
Year Ended December 31,                             1999              1998            1997
--------------------------------------------------------------------------------------------
<S>                                             <C>              <C>               <C>
Revenue:
  Software                                      $ 183,253        $ 171,153         $ 132,723
  Service                                         147,449          115,501            89,280
  Hardware                                         16,418           23,579            29,422
                                                ---------------------------------------------
  Total revenue                                   347,120          310,233           251,425
                                                ---------------------------------------------

Costs and expenses:
  Cost of software revenue                         16,984           16,814            13,416
  Cost of service revenue                          85,686           69,586            54,003
  Cost of hardware revenue                          8,805           13,181            20,330
  Research and development                         54,307           50,132            40,927
  Selling, general and administrative             157,708          161,013           127,622
  Restructuring and other costs                         -            2,000             6,000
                                                ---------------------------------------------
  Total costs and expenses                        323,490          312,726           262,298
                                                ---------------------------------------------

Operating income (loss)                            23,630           (2,493)          (10,873)

Other income, net                                   3,409            3,840             3,160
                                                ---------------------------------------------

Income (loss) before income taxes                  27,039            1,347            (7,713)

Provision (benefit) for income taxes                7,362              391            (2,187)
                                                ---------------------------------------------

Net income (loss)                               $  19,677        $     956         $  (5,526)
                                                =============================================

Earnings (loss) per share:
  Basic                                         $    0.61        $    0.03         $   (0.18)
                                                =============================================
  Diluted                                       $    0.59        $    0.03         $   (0.18)
                                                =============================================

Weighted average shares outstanding-basic          32,125           31,083            30,310
                                                =============================================
Weighted average shares outstanding-diluted        33,360           33,367            30,310
                                                =============================================

See accompanying Notes to Consolidated Financial Statements
</TABLE>
                                       F-5
<PAGE>



                        STATEMENT OF COMPREHENSIVE OPERATIONS

                                                         (Dollars in thousands)
 Year Ended December 31,                     1999         1998          1997
----------------------------------------------------  -----------   ------------

 Net income (loss)                        $  19,677    $     956     $  (5,526)
                                         -----------  -----------   ------------

 Other comprehensive income (loss):
  Foreign currency translation
      adjustments, net of tax               (4,970)        1,455        (5,809)
  Unrealized holding gains (losses) on
      available for sale securities,          (106)           32           (24)
      net of tax
                                         -----------  -----------   ------------
  Other comprehensive income (loss)         (5,076)        1,487        (5,833)
                                         -----------  -----------   ------------

 Comprehensive income (loss)              $  14,601    $   2,443     $ (11,359)
                                         ===========  ===========   ============

See accompanying Notes to Consolidated Financial Statements

                                       F-6
<PAGE>

                                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                                                                                      (In thousands)
                                                                                   Accumulated
                                                                                         Other
                                                    Common Stock       Retained   Comprehensive      Treasury Stock
                                                Shares      Amount     Earnings      Operations     Shares      Amount       Total
------------------------------------------    ---------------------   ----------  --------------  ---------------------  -----------
<S>                                             <C>      <C>           <C>         <C>              <C>      <C>          <C>
 Balances at January 1, 1997                    30,462   $ 127,813     $  7,874     $  1,687         (400)   $ (4,568)    $ 132,806
 Stock options exercised                           484       1,721                                                            1,721
 Common stock issued under the
  Employee Qualified Stock Purchase Plan           176       1,207                                                            1,207
 Repurchase of treasury shares at cost                                                               (420)     (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                  31,122     130,741        2,348       (4,146)        (820)    (10,132)      118,811
 Stock options exercised                         1,642      12,078                                                           12,078
 Common stock issued under the
  Employee Qualified Stock Purchase Plan           161       1,423                                                            1,423
 Repurchase of treasury shares at cost                                                               (278)     (4,435)       (4,435)
 Foreign currency translation adjustment                                               1,455                                  1,455
 Net income                                                                 956                                                 956
 Other                                                                                    32                                     32
                                              ----------------------- ------------ --------------- --------------------  -----------
 Balances at December 31, 1998                  32,925     144,242        3,304       (2,659)       (1,098)   (14,567)      130,320
 Stock options exercised                           315       2,466                                                            2,466
 Stock option income tax benefit                               477                                                              477
 Common stock issued under the
  Employee Qualified Stock Purchase Plan           339       2,594                                                            2,594
 Foreign currency translation adjustment                                              (4,970)                                (4,970)
 Net income                                                              19,677                                              19,677
 Other                                                                                  (106)                                  (106)
                                              ----------------------- ------------ --------------- --------------------  -----------
 Balances at December 31, 1999                   33,579  $ 149,779     $ 22,981       (7,735)       (1,098)  $ (14,567)   $ 150,458
                                              ----------------------- ------------ --------------- --------------------  -----------
See accompanying Notes to Consolidated Financial Statements
</TABLE>

                                       F-7
<PAGE>

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
                                                                                     (Dollars in thousands
Year Ended December 31,                                              1999             1998            1997
-----------------------------------------------------------------------------------------------------------
<S>                                                             <C>             <C>              <C>
Cash flows from operating activities:
Net income (loss)                                                $ 19,677         $    956        $ (5,526)
Adjustments to reconcile net income (loss) to net cash
  provided by  operating activities:
    Depreciation and amortization                                  17,316           15,360          13,193
    Provision for doubtful accounts                                   612            1,041             350
    Deferred income taxes                                            (247)             566          (3,773)
    Changes in operating assets and liabilities:
      Accounts receivable                                        (14,979)            (573)           9,365
      Inventories                                                   (980)            1,121           5,368
      Prepaid expenses and other current assets                       603             (609)           (539)
      Accounts payable                                             (4,102)           5,905          (1,273)
      Accrued compensation & benefits                               2,486            4,820           4,721
      Unearned maintenance revenue                                  9,046            2,408           3,327
      Income tax payable                                            4,051            2,323          (1,533)
      Other                                                         4,514              (60)            985
                                                                ----------      -----------      ----------
Net cash provided by operating activities                          37,997           33,258          24,665
                                                                ----------      -----------      ----------

Cash flows from investing activities:
Capital expenditures                                              (22,432)         (32,474)        (14,266)
Proceeds from sale of property                                      8,028              478             264
Purchases of marketable securities                                (51,669)         (34,536)        (30,274)
Proceeds from sales and maturities of marketable securities        40,670           42,843          32,946
                                                                ----------      -----------      ----------
Net cash used in investing activities                             (25,403)         (23,689)        (11,330)
                                                                ----------      -----------      ----------

Cash flows from financing activities:
Proceeds from issuance of common stock                              5,060           13,501           2,928
Common stock repurchased                                                -           (4,435)         (5,564)
Stock option income tax benefits                                      477                -               -
                                                                ----------      -----------      ----------
Net cash provided by (used in) financing activities                 5,537            9,066         (2,636)

Effect of exchange rate changes on cash and cash equivalents       (2,423)            (159)         (1,885)
                                                                ----------      -----------      ----------

Net increase in cash and cash equivalents                          15,708           18,476           8,814
Cash and cash equivalents, beginning of year                       55,820           37,344          28,530
                                                                ----------      -----------      ----------
Cash and cash equivalents, end of year                           $ 71,528         $ 55,820        $ 37,344
                                                                ==========      ===========      ==========

Supplemental cash flow information:
Interest paid                                                    $    221         $     25        $    201
Income taxes paid (refunded)                                     $    671         $  (2,119)      $  3,050
 See accompanying Notes to Consolidated Financial Statements.
</TABLE>

                                       F-8
<PAGE>

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1     Summary of Significant Accounting Policies

         Nature of Operations. FileNET  Corporation  ("the  Company")  develops,
markets,    implements   and   services   an   open,    integrated,    Web   and
client/server-based  family of Web content  management  and document  management
software  products  designed for managing  information and enhancing  enterprise
productivity. Additionally, the Company manufactures and sells a line of 12-inch
OSARs.  The Company  markets its products to a broad range of industries in more
than 70  countries  through a global  sales,  service 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 the Company's wholly owned subsidiaries. All
intercompany balances and transactions have been eliminated.

         Use of Estimates. The preparation of financial statements in conformity
with accounting  principles  generally  accepted in the United States of America
requires  management to make estimates and assumptions  that affect the reported
amounts of assets and  liabilities  and disclosure of contingent  liabilities at
the date of the financial  statements  and the reported  amounts of revenues and
expenses  during the reporting  period.  Actual  results could differ from those
estimates.

         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 (Note 6).

         Other Financial Instruments.   The Company enters into forward  foreign
exchange  contracts  as a hedge  against  the  effects of  fluctuating  currency
exchange  rates on monetary  assets and  liabilities  denominated  in currencies
other than the  functional  currency  of the  relevant  entity.  The  Company is
exposed to market risk on the forward foreign exchange  contracts as a result of
changes in foreign exchange rates;  however, the market risk should be offset by
changes in the valuation of the underlying exposures.  Gains and losses on these
contracts,  which equal the difference between the forward contract rate and the
prevailing  market spot rate at the time of  valuation,  are  recognized  in the
consolidated statements of operations. The counterparties to these contracts are
major financial  institutions.  The Company uses  commercial  rating agencies to
evaluate  the  credit  quality  of the  counterparties.  The  Company  does  not
anticipate a material loss  resulting  from credit risks related to any of these
institutions (Note 15).

         Fair Value of Financial Instruments. The recorded  amounts of financial
assets and liabilities at December 31, 1999 and 1998, 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 (Note 7). 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  its  foreign  subsidiaries  using  the  local  currency  as the
functional currency. Assets and liabilities of these subsidiaries are translated
at the exchange rate on the balance sheet date. Revenues, costs and expenses are
translated  at the rates of  exchange  prevailing  during the year.  Translation
adjustments  resulting from this process are included in  stockholders'  equity.
Gains and losses  from  foreign  currency  transactions  are  included  in other
income, net.

                                      F-9
<PAGE>

         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 (Note 8).

         Research and Development. The Company expenses research and development
costs as incurred.  No amounts are required to be capitalized in accordance with
Statement of Financial  Accounting  Standards (SFAS) No. 86, "Accounting for the
Costs of Computer  Software to be Sold,  Leased,  or Otherwise  Marketed," as of
December  31,  1999  and  1998  because  software  is  substantially   completed
concurrently with the establishment of technological feasibility.

         Revenue Recognition.  Software revenue is generally recognized when the
software product is delivered to the customer or reseller in accordance with the
American Institute of Certified Public Accountants (AICPA) Statement of Position
(SOP) 97-2, "Software Revenue  Recognition,  as amended." The Company recognizes
other revenue at the time of product  delivery and accrues any remaining  costs,
including insignificant vendor obligations.  Revenue from post-contract customer
support  is  recognized  ratably  over the term of the  contract.  Revenue  from
professional  services is recognized as such services are delivered and accepted
by the customer.

         Product Warranty.  The  Company  provides  a 90 day  warranty  for  its
hardware  products  against  defects in materials  and  workmanship  and for its
software   products  against   substantial   nonconformance   to  the  published
specifications. A provision for estimated warranty costs is recorded at the time
of sale or license 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.
Valuation  allowance is established to reduce  deferred tax assets if it is more
likely than not that such deferred tax assets will not be realized (Note 11).

         Earnings (Loss) Per Share.  Basic earnings (loss) per share is computed
using the  weighted  average  number of common  shares  outstanding  during  the
reporting  period.  Diluted  earnings  (loss)  per share is  computed  using the
weighted average number of common shares  outstanding and the dilutive effect of
potential common shares outstanding (Note 4).

         Supplier Concentrations.    Certain   components   for  the   Company's
proprietary 12-inch OSARs are available only from a single source. Any inability
to obtain  components  in the amounts  needed on a timely  basis could result in
delays in product  shipments which could have an 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  (APB)  Opinion  No.  25,  "Accounting  for  Stock  Issued  to
Employees" (Note 10).

         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.

         Comprehensive Income.  In June 1997, the Financial Accounting Standards
Board (FASB) issued SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130
requires  enterprises  to report  comprehensive  income  and its  components  in
general-purpose financial statements. SFAS No. 130 was effective for the Company
beginning January 1, 1998.

                                      F-10
<PAGE>

         Segment Disclosures. In 1998, the FASB issued, and the Company adopted,
SFAS  No.  131,  "Disclosures  about  Segments  of  an  Enterprise  and  Related
Information." SFAS No. 131 establishes standards for reporting information about
operating  segments  and  related   disclosures  about  products  and  services,
geographic areas and major customers (Note 12).

         Recent Accounting Pronouncements.    In June 1998, the FSAB issued SFAS
No. 133,  "Accounting for  Derivative Instruments and Hedging Activities."  SFAS
No. 133, as amended, is effective for fiscal years beginning after June 15, 2000
and  will require the  Company to record all derivatives on the balance sheet at
fair value.  For  derivatives  that  are  hedges,  changes in the  fair value of
derivatives  will be  offset  by the  change in fair value of the hedged assets,
liabilities, or  firm commitments.  The Company believes the  impact of adopting
this standard will not be material to its results of operations or equity.

         Stock  Split.  On May 15, 1998,  the  Board  of  Directors  declared  a
two-for-one stock split of the Company's common stock, effected in the form of a
100% stock  dividend paid on June 12, 1998 to  shareholders  of record as of May
29, 1998. All agreements  concerning stock options and other commitments payable
in shares of its common stock provide for the issuance of additional  shares due
to the  declaration of the stock split.  All references  throughout  this annual
report relating to number of shares,  per share amounts,  stock option data, and
market price of common stock have been restated for the stock split.

         Reclassifications.   Certain  reclassifications   have   been  made  to
prior-years' balances to conform to current year's presentation.


Note 2     Acquisitions

         In March 1996,  the Company  acquired  Saros  Corporation  ("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 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 million were expensed in the first quarter of 1996.  Subsequent
to December 31, 1998, the former  shareholders have filed a demand for mandatory
arbitration  to release  approximately  0.2  million  shares  which were held in
Escrow pursuant to the Agreement and Plan of Merger and for damages. The Company
believes that it has meritorious  reasons for not releasing the shares and other
defenses to the claims, however, the ultimate outcome or any resulting potential
loss cannot be presently determined.


Note 3     Restructuring and Other Costs

         The $2.0 million in  restructuring  and other costs in 1998  represents
the costs of a reduction in headcount  associated with the  restructuring of the
Company's  sales and  marketing  operations,  as well as costs of  consolidating
facilities. The restructuring and other costs include approximately $1.1 million
for severance payments for 54 employees, $0.7 million for facility closing costs
and $0.2 million of other charges.

         The $6.0 million in  restructuring  and other costs in 1997 represented
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 costs include  approximately
$2.2  million for  severance  payments for 111  employees,  $2.2 million for the
write-off of assets  impaired by the decision to  restructure,  $0.4 million for
facility  closing costs,  $0.4 million for equipment lease  cancellations,  $0.3
million for  cancellation  of third party  development  contracts,  $0.2 million
related to the  withdrawal of certain  products from the market and $0.3 million
of other charges.

         At December 31, 1999,  the remaining  accrued  restructuring  and other
costs of $0.5 million are  included in other  accrued  liabilities.  The Company
anticipates that the remaining restructuring costs will be expended during 2000.

                                      F-11
<PAGE>

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.

<TABLE>
<CAPTION>
                                               (In thousands, except per share amounts)
                                                     Net                      Per Share
                                                   Income          Shares       Amount
---------------------------------------------------------------------------------------
<S>                                            <C>                 <C>         <C>
Year ended December 31, 1997
Basic (loss) per share                           $ (5,526)         30,310      $ (0.18)
Effect of dilutive stock options                                        -
                                               ----------------------------------------
Diluted (loss) per share                         $ (5,526)         30,310      $ (0.18)
                                               ----------------------------------------

Year ended December 31, 1998
Basic earnings per share                         $    956          31,083      $  0.03
Effect of dilutive stock options                                    2,284
                                               ----------------------------------------
Diluted earnings per share                       $    956         33,367       $  0.03
                                               ----------------------------------------

Year ended December 31, 1999
Basic earnings per share                         $  19,677         32,125      $  0.61
Effect of dilutive stock options                                    1,235
                                               ----------------------------------------
Diluted earnings per share                       $  19,677         33,360      $  0.59
                                               ========================================
</TABLE>

         Options to  purchase shares of  common stock  in 1997  were outstanding
during the year  but were not included in the  computation  of  diluted loss per
share as their effect was anti-dilutive (see Note 10).


Note 5     Other Comprehensive Operations

         Accumulated other comprehensive  operations for each of the three years
in the period ended December 31, 1999, is comprised of the following:

                                                         (Dollars in thousands)
                                                  Unrealized        Accumulated
                                   Foreign        Gain(Loss)              Other
                                  Currency     on Marketable      Comprehensive
                                     Items        Securities             Income
--------------------------------------------------------------------------------
Balance, January 1, 1997       $    1,686             $    1        $     1,687
   Current Period Changes
    (Net of tax of $(3,873)
    and $(16), prospectively)      (5,809)               (24)            (5,833)
                               -------------------------------------------------

Balance, December 31, 1997         (4,123)               (23)            (4,146)
   Current Period Changes
    (Net of tax of $970 and         1,455                 32              1,487
    $21, prospectively)        -------------------------------------------------

Balance, December 31, 1998         (2,668)                  9            (2,659)
   Current Period Changes
    (Net of tax of $(3,313)
    and $(71), prospectively)      (4,970)              (106)            (5,076)
                               -------------------------------------------------
Balance, December 31, 1999      $  (7,638)          $    (97)        $   (7,735)
                               =================================================

                                      F-12
<PAGE>

Note 6     Investment Securities Available for Sale

         The Company's  investments in marketable  securities consists primarily
of high-grade  corporate and government  securities with maturities of less than
three years.  Investments purchased with an original maturity of three months or
less are  considered  to be cash  equivalents.  The following  table  summarizes
investment securities available for sale as of December 31:

                                                 (Dollars in thousands)
Investment securities available for sale:       1999              1998
-----------------------------------------------------------------------
  Cost                                     $  37,282         $  26,361
  Gross unrealized gains                           -                 8
  Gross unrealized losses                      (159)                 -
                                          -----------------------------
  Estimated fair value                     $  37,123         $  26,369
                                          =============================


         There were no realized  gains or losses for the year ended December 31,
1999. For the year ended December 31, 1998, there was a realized gain of $6,600.
Unrealized holding gains and losses on investments,  net of tax, are included in
accumulated other comprehensive  operations in stockholders'  equity at December
31, 1999 and 1998, and were $(97,000) and $9,000, respectively.

         The  contractual  maturities  of  investments  at December 31, 1999 and
1998, are shown below. Actual maturities may differ from contractual  maturities
because  the  issuer of the  securities  may have the right to  repurchase  such
securities.  The Company classifies short-term  investments in current assets as
all such investments are available for current operations.

<TABLE>
<CAPTION>
                                                                            (Dollars in thousands)
                                               1999                               1998
                                  -----------------------------   --------------------------------
                                                    Estimated                          Estimated
                                       Cost        Fair Value             Cost        Fair Value
                                  -----------------------------   --------------------------------
<S>                               <C>                <C>          <C>                   <C>
Debt Securities:
  Due in one year or less           $ 31,690         $ 31,581         $ 15,476          $ 15,484
  Due in one to three years            5,592            5,542           10,885            10,885
                                  -----------------------------   --------------------------------
                                    $ 37,202         $ 37,123         $ 26,361          $ 26,369
                                  =============================   ================================
</TABLE>

Note 7     Inventories

         Inventories,  net of reserves,  consisted of the  following at December
31:
                                          (Dollars in thousands)
                                           1999            1998
                                      --------------------------
Raw materials                          $  1,895        $  1,676
Work-in-process                           1,067             580
Finished goods                              437             163
                                      --------------------------
Total                                  $  3,399        $  2,419
                                      ==========================



                                      F-13
<PAGE>

Note 8     Property and Leases

         Property consisted of the following at December 31:
                                                    (Dollars in thousands)
                                                     1999             1998
                                         ----------------------------------

Machinery, equipment and software              $  101,712        $  95,793
Furniture and fixtures                             12,812           12,376
Leasehold improvements                             14,998           11,796
                                         ----------------------------------
                                                  129,522          119,965
Less accumulated depreciation
and amortization                                  (88,929)         (75,788)
                                         ----------------------------------
Property, net                                   $  40,593        $  44,177
                                         ==================================

         At  December  31,  1999,  there  was  no  impairment  in the  value  of
long-lived  assets  based on  management's  estimated  undiscounted  future cash
flows.

         The Company leases its corporate offices, 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.  Amounts  related  to  deferred  rent are  recorded  in  accrued
liabilities on the balance sheet.

         Expenses related to operating leases were $15.4 million, $11.3 million,
and  $10.8  million  for the  years  ended  December  31,  1999,  1998 and 1997,
respectively.  The following  table  summarizes  future  minimum lease  payments
required under operating leases at December 31:

                                            (Dollars in thousands)
                      --------------------------------------------
                      2000                            $    17,413
                      2001                                 14,043
                      2002                                  9,471
                      2003                                  8,002
                      2004                                  6,701
                      Thereafter                            8,410
                                                     -------------
                      Total                           $    64,040
                                                     =============

         The Company  continues to invest in  technology  equipment and software
for information systems infrastructure and telecommunications. These investments
have been funded  through  operating  leases and cash  purchases.  In 1999,  the
Company  entered  into  sale  leaseback  commitments  for  previously  purchased
technology  equipment and software with a net book value of $7.3 million.  These
leases are  classified  as  operating  leases and the gain of  $437,000 is being
recognized over the leaseback periods.


Note 9     Borrowing Arrangements

         The Company has a $20 million commercial line of credit that expires in
June 2001.  Borrowings  under the arrangement are unsecured and bear interest at
one hundred  basis points over the London  Interbank  Offered Rate. A commitment
fee of fifteen basis points is assessed against any undrawn amounts.

         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, 1999. There were no borrowings
outstanding at December 31, 1999 and 1998.

                                      F-14

<PAGE>

Note 10    Stockholders' Equity

         Shareholder Rights Plan   In  October  1988,  the  Company  declared  a
dividend of one common stock purchase right for each outstanding share of common
stock.  As amended in July and November of 1998, a right may be exercised  under
certain circumstances to purchase one share of common stock at an exercise price
of $87.50,  subject  to certain  anti-dilution  adjustments.  The rights  become
exercisable if and when a person (or group of affiliated or associated  persons)
acquires  15% or more of FileNET's  outstanding  common  stock,  or announces an
offer that would result in such person acquiring 15% or more of FileNET's common
stock. After the rights become  exercisable,  each right will entitle its holder
to buy a number of shares of  FileNET's  common  stock  having a market value of
twice the exercise price of the rights. After the rights become exercisable,  if
FileNET is a party to certain  merger or business  combination  transactions  or
transfer 50% or more of its assets or earnings  power (as  defined),  each right
will  entitle  its  holder to buy a number  of  shares  of  common  stock of the
acquiring or surviving  entity having a market value of twice the exercise price
of the right. The rights expire November 17, 2008 and may be redeemed by FileNET
at one cent per right at any time up to ten days  after a person  has  announced
that they have acquired 15% 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 420,000 shares at an
aggregate  cost of $5.6 million.  During the first quarter of 1998,  the Company
repurchased  278,000  shares of its common  stock at an  aggregate  cost of $4.4
million, thereby completing the stock repurchase program.

         Employee Stock Purchase Plans.  In May 1998,  FileNET  adopted the 1998
Employee Stock Purchase Plan and the International  Employee Stock Purchase Plan
(the Purchase  Plans).  A total of 300,000 shares were authorized to be added to
the remaining share reserve under the predecessor 1988 Employee  Qualified Stock
Purchase Plan so that the total share reserve for the Purchase Plans would be no
more  than  400,000  shares.  In  May  1999,  shareholders  approved  adding  an
additional 300,000 shares to the reserve. Under the terms of the Purchase Plans,
common stock may be offered in successive six-month offering periods to eligible
employees  of the Company at 85% of the market  price of the common stock at the
beginning or end of the offering period,  whichever is lower. The Purchase Plans
cover  substantially all employees of the Company.  Eligible employees may elect
to have a portion of their salary  withheld for the purpose of making  purchases
under the Purchase  Plans.  Each  participant is limited in any plan year to the
acquisition of that number of shares that have an aggregate fair market value of
not more than  $25,000.  There are no charges or credits to income in connection
with the Purchase Plans.  At December 31, 1999,  $864,000 had been withheld from
employees'  salaries  pursuant to the  Purchase  Plans for the current  offering
period,  which  expires on April 30, 2000.  At December 31, 1999,  approximately
353,162 shares remained available for future issuance.

         Stock Option Plans.  In April 1986,  the Company adopted the 1986 Stock
Option Plan (the 1986 Plan).  Under the amended terms of the 1986 Plan,  options
to purchase  6,500,000  shares of the  Company's  common stock were reserved for
issuance to employees,  officers and directors.  Options to purchase 322,757 and
463,422 common shares were exercisable  under the 1986 Plan at December 31, 1999
and 1998,  respectively.  In May  1995,  the 1986  Plan was  terminated  and the
remaining  reserve of 140,098 shares was transferred  into the 1995 Stock Option
Plan. 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  5,600,000 shares
of the Company's common stock were reserved for issuance to employees,  officers
and  directors.  This  reserve was added to the 140,098  shares of common  stock
transferred  from the 1986 Plan.  Outstanding  options  under the 1986 Plan will
continue to be governed by the  provisions of the  agreements  evidencing  those

                                      F-15
<PAGE>

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, 1999,  1,973,060  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. On October 21, 1999, the
Plan's  Discretionary  Option Program was amended to change the vesting schedule
of all options granted from that date forward to vest twenty-five  percent (25%)
of the option shares after twelve (12) months of service from the grant date and
the balance of the options to vest in thirty-six (36)  successive  equal monthly
installments upon completion of each additional month of service thereafter.  As
of December 31, 1999, 2,151,121 options were exercisable under the 1995 Plan. At
the December 14, 1999  meeting,  the Board  established  a Special  Stock Option
Committee  consisting of Lee D. Roberts,  President and Chief Executive Officer,
which  is  authorized  to grant  options  up to  20,000  shares  to  non-officer
employees.

         Prior to their merger with FileNET, Saros and Watermark Software,  Inc.
had adopted  stock  option  plans.  These plans were  assumed by the Company and
outstanding  options  were  converted  into  options to purchase an aggregate of
975,976 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, 1999, a total of 29,107
options were outstanding and 29,107 were exercisable under these plans.

         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 140,000  shares at prices ranging from $5.75
to $16.35 per share were  granted from  December  18, 1989 to May 24,  1995.  At
December  31,  1999,  options to  purchase  25,200  shares of common  stock were
exercisable.  This plan was terminated in May 1995 with respect to future option
grants.  Future  grants to  non-employee  directors  are to be granted under the
provisions  of the 1995 Plan.  On May 15,  1998,  the  shareholders  approved an
Amendment  to  the  1995  Plan  for  the  Automatic   Option  Grant  Program  to
non-employee  directors to increase the initial option to purchase 25,000 shares
of  FileNET  common  stock at fair  market  value  on the  date of grant  and an
additional 7,000 shares of FileNET common stock at fair market value on the date
of grant every year following the initial grant,  provided such person continued
to be a director at such time.

         In August 1997,  the Company filed a Form S-8 with the  Securities  and
Exchange  Commission  registering a Non-Statutory  Stock Option Grant of 600,000
shares,  dated  May 22,  1997,  to the  Company's  current  President  and Chief
Operating  Officer and a  Non-Statutory  Stock Option  Grant of 160,000  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,
1999,  230,000 options were  exercisable  related to these  Non-Statutory  Stock
Option Grants and 150,000 had been exercised to date.

On July 11,  1997,  the  Company  approved a stock  option  cancellation/regrant
program which allowed  reporting  officers and employees,  but not  non-employee
directors,  to exchange  outstanding options with an exercise price greater than
$9.00 for new options. Outstanding options of 3,105,050 shares were canceled and
regranted at $9.00 per share, the market value on July 11, 1997. Under the stock
option  cancellation/regrant  program,  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

                                      F-16
<PAGE>

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.

         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, 1997                              5,601,766         $11.11
  Granted (weighted average fair value of $4.13)       5,602,098          $9.33
  Exercised                                             (483,408)         $3.56
  Canceled                                            (3,930,238)        $13.48
                                                     ------------
Balances, December 31, 1997                            6,790,218          $8.81
  Granted (weighted average fair value of $7.41)       2,166,520         $13.43
  Exercised                                           (1,641,758)         $7.51
  Canceled                                              (597,838)        $10.86
                                                     ------------
Balances December 31, 1998                             6,717,142         $10.47
  Granted (weighted average fair value of $ 6.72)      1,427,371         $12.12
  Exercised                                             (314,798)         $7.84
  Canceled                                              (710,422)        $10.97
                                                     ------------
Balances, December 31, 1999                            7,119,293         $10.87
                                                     ============


         The  following  table  summarizes   information   concerning  currently
outstanding and exercisable options:
<TABLE>
<CAPTION>

                                      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
---------------------------------------------------------------------------------------------------------------
<S>                         <C>                     <C>           <C>             <C>                   <C>
$0.71 to $7.16                1,697,016             7.51          $  6.50             688,960          $  6.25
$7.19 to $8.94                  690,259             7.68             8.23             225,826             7.81
$9.00                         1,854,293             7.53             9.00           1,162,202             9.00
$9.17 to $12.16               1,439,530             8.85            10.58             247,515            10.29
$12.25 to $29.00              1,438,195             8.40            20.00             433,682            18.53
                            -----------------------------------------------------------------------------------
$0.71 to $29.00               7,119,293             7.98          $ 10.87           2,758,185          $  9.83
                            ============                                          ============
</TABLE>

         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 during the years ended December 31, 1999,  1998
and 1997,  as the exercise  price  equaled the fair market value of the stock at
the date of grant.


                                      F-17
<PAGE>

         The following table  summarizes the Company's net income (loss) and net
income  (loss)  per share on a pro forma  basis  had  compensation  cost for the
Company's stock-based compensation plans been determined based on the provisions
of SFAS No. 123, "Accounting for Stock-Based Compensation":

<TABLE>
<CAPTION>
                                                    (Dollars in thousands, except per share amounts)

                                                             1999             1998             1997
----------------------------------------------------------------------------------------------------
<S>                                                     <C>               <C>            <C>
 Net income (loss) - as reported                        $  19,677         $    956       $  (5,526)
 Net income (loss) - pro forma                              3,027           (6,915)        (12,497)
 Diluted earnings (loss) per share - as reported             0.59             0.03           (0.18)
 Diluted earnings (loss) per share - pro forma               0.39            (0.21)          (0.41)
</TABLE>

         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 1999, 1998 and 1997;  expected  volatility of 75%
for 1999 and 1998,  and 60% for 1997;  risk-free  interest rates of 5.1% to 6.1%
for 1999, 5.4% to 5.5% for 1998, and 5.3% to 5.6% for 1997; and an expected life
of one year from the vest date.  Pro forma  compensation  cost of shares  issued
under the  Employee  Qualified  Stock  Purchase  Plan is  measured  based on the
discount from market value on the date of purchase in  accordance  with SFAS No.
123.


Note 11     Income Taxes

         The provision (benefit) for income taxes at December 31, 1999, 1998 and
1997, consists of the following:

                                                          (Dollars in thousands)
 Year ended December 31,                 1999            1998              1997
 ------------------------       --------------    ------------        ----------
 Current:
      Federal                        $ 3,148           $ (405)         $    785
      State                            1,137               32               (40)
      Foreign                          3,411              198               841
 Deferred:
      Federal                             74              (20)           (1,963)
      State                             (476)              40            (1,168)
      Foreign                             68              546              (642)
                                   -----------     -----------        ----------
 Total provision                     $ 7,362           $  391          $ (2,187)
                                   ===========     ===========        ==========

         The  valuation  allowance  decreased by $3.2 million for the year ended
December  31,  1999,  as a  result  of the  utilization  of net  operating  loss
carryforwards.  Whereas,  the valuation  allowance increased by $9.9 million and
$1.4 million  during the years ended  December 31, 1998 and 1997,  respectively,
due to the  generation  of net  operating  losses and research  and  development
credits.

         A reconciliation of the Company's effective tax rate (benefit) compared
to the statutory Federal tax rate is as follows:

Years ended December 31,                              1999       1998      1997
-------------------------------------------------- --------   --------   -------
Income taxes (benefit) at statutory Federal rate       35%        35%      (35%)
State taxes (benefit), net of Federal benefit           3          5        (6)
Unbenefited/utilized domestic losses                  (14)       153         0
Foreign tax rate differential/unbenefited losses        3       (163)       11
Other                                                   0         (1)        2
                                                   --------   --------   -------
Total                                                  27%        29%      (28%)
                                                   ========   ========   =======

                                      F-18
<PAGE>

         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, 1999 and 1998, are as
follows:
                                                      (Dollars in thousands)
Year ended December 31,                            1999                1998
--------------------------------------------------------- ------------------
Deferred taxes:
     Foreign loss carryforwards                $    130            $  1,768
     Domestic loss carryforwards                 15,191              22,540
     Tax credit carryforwards                     8,251               6,934
     Accrued expenses                             2,786               1,874
     Sales returns and allowance reserves           808                 982
     Deferred revenue                             4,110               (491)
     Capitalized software                             -               (319)
     Depreciable assets                           1,655               1,070
     Residual U.S. tax on foreign earnings       (4,521)             (4,504)
     Other                                       (1,592)                (37)
                                              -----------         ----------
Total                                            26,818              29,817
                                              -----------         ----------
Valuation allowance                             (21,128)            (24,374)
                                              -----------         ----------
Net deferred tax asset                         $  5,690            $  5,443
                                              ===========         ==========

         The Company has $44.7  million  domestic  federal  net  operating  loss
carryforwards  which  can be  utilized  to reduce  future  taxable  income.  Any
unutilized  net operating  loss  carryforward  will begin  expiring in 2011. The
Company has an $8.3 million tax credit  carryforward which will expire beginning
in 2002.  Approximately $8.1 million of the valuation  allowance is attributable
to the potential tax benefit of stock option  transactions that will be credited
directly to additional paid-in capital if realized.

         At  December  31,  1999,  the Company  had Dutch,  French and  Austrian
subsidiary tax loss carryforwards  relating to its foreign subsidiary operations
of $0.2 million, $0.2 million, and $9,000, respectively.  The Dutch and Austrian
tax loss carryforwards have no expiration.  French losses of $62,000 will expire
in 2002.

         The Company has not  provided any  residual  U.S. tax on  approximately
$14.5 million of a portion of the Company's foreign  subsidiaries  undistributed
earnings, as the Company intends to indefinitely reinvest such earnings.


Note 12     Operating Segment and Geographic Information

         The Company has prepared  operating  segment  information in accordance
with SFAS No. 131,  "Disclosures  About  Segments of An  Enterprise  and Related
Information," to report components that are evaluated regularly by the Company's
chief  operating  decision  maker,  or decision making group, in deciding how to
allocate  resources and in assessing  performance.  The  operating  segments are
managed  separately  because each segment  represents a strategic  business unit
that offers different products or services.

The Company's reportable operating segments include Software, Hardware, Customer
Support, and Professional Services and Education. The Software operating segment
develops and markets the Company's line of web content management and integrated
document management  software.  The Hardware operating segment  manufactures and
markets the  Company's  line of OSAR  libraries.  The Customer  Support  segment
provides after-sale support for both software and hardware products,  as well as

                                      F-19
<PAGE>

providing  software  upgrades under the Company's right to new versions program.
The   Professional   Services   and   Education   segment   provides   fee-based
implementation  and technical  services  related to the  Company's  products and
provides training.

         The  accounting  policies of the Company's  operating  segments are the
same as those described in Note 1- Summary of Significant  Accounting Policies -
except  that  the  disaggregated  financial  results  of  the  segments  reflect
allocation of certain functional  expense  categories  consistent with the basis
and  manner  in which  Company  management  internally  disaggregates  financial
information for the purpose of assisting in making internal operating decisions.
The Company evaluates performance based on stand-alone segment operating income.
Because the Company does not evaluate  performance based on the return on assets
at the operating  segment level,  assets are not tracked  internally by segment.
Therefore, segment asset information is not presented.

         Operating segment data for the three years ended December 31, 1999, was
as follows:

<TABLE>
<CAPTION>
                                                                                                         (Dollars in thousands)
                                                                                    Professional
                                                                         Customer   Services and
                                             Software      Hardware       Support      Education          Other   Consolidated
--------------------------------------------------------------------------------------------------------------------------------
<S>                                         <C>            <C>           <C>           <C>            <C>            <C>
 Year Ended December 31, 1999
 Revenue                                    $ 183,253      $ 16,418      $ 91,917      $  49,283      $   6,249      $ 347,120
 Depreciation and amortization                  9,555           504         4,655          2,576             26         17,316
 Operating income before
   other income                                 1,096         1,911        19,386          1,107            130         23,630
 Assets                                                                                                                240,892
 Capital expenditures                          11,001           468         7,986          2,908             69         22,432

 Year Ended December 31, 1998
 Revenue                                    $ 171,153      $ 23,579      $ 73,524      $  32,967      $   9,010      $ 310,233
 Depreciation and amortization                  9,061           652         3,906          1,603            138         15,360
 Operating income (loss) before
   other income                               (17,023)        1,807        12,023            776            (76)        (2,493)
 Assets                                                                                                                206,822
 Capital expenditures                          19,383         1,118         8,341          3,387            245         32,474

 Year Ended December 31, 1997
Year Ended December 31, 1997
 Revenue                                    $ 132,723       $ 29,422     $ 54,417      $  23,413      $  11,450      $ 251,425
 Depreciation and amortization                  7,582            971        2,926          1,465            249         13,193
 Operating income (loss) before
   other income                               (19,779)           107        7,035           (518)         2,282        (10,873)
 Assets                                                                                                                179,440
 Capital expenditures                           8,462            864        3,155          1,650            135         14,266

</TABLE>

                                      F-20
<PAGE>


         Revenue is attributed to geographic  areas based on the location of the
entity to which the  products or services  were sold.  The  operation in Ireland
functions as a manufacturing and service center for non-United States customers.
An  allocation of its assets among the  geographic  segments is not prepared for
management reporting. Information concerning principal geographic areas in which
the Company operates was as follows:

<TABLE>
<CAPTION>
                                                                                   (Dollars in thousands)
Year ended December 31,                      1999                   1998                     1997
---------------------------------------------------------------------------------------------------------
                                    Revenue      Assets     Revenue       Assets     Revenue      Assets
                                -------------------------------------------------------------------------
<S>                             <C>           <C>         <C>          <C>         <C>         <C>
North America:
   United States                  $ 240,607   $ 171,483   $ 205,797    $ 142,471   $ 170,116   $ 123,681
   Canada                             8,430       6,442       6,669        1,869       8,027       2,263
                                -------------------------------------------------------------------------
   Total Domestic                   249,037     177,925     212,466      144,340     178,143     125,944

Europe:
   France                             8,540       5,119       7,516        5,562       6,961       2,481
   Germany                           23,888       6,279      30,675       14,450      21,665       9,100
   United Kingdom                    20,148      12,085      20,882        9,800      16,838       8,007
   Ireland                                -      21,645           -       23,551           -      29,411
   Other Europe                      22,498       9,831      19,373        4,172       9,358         961
                                -------------------------------------------------------------------------
   Total Europe                      75,074      54,959      78,446       57,535      54,822      49,960

Asia Pacific                         17,144       7,951      10,058        4,782      13,892       3,494

All other                             5,865          57       9,263          165       4,568          42
                                -------------------------------------------------------------------------
Totals                            $ 347,120   $ 240,892   $ 310,233    $ 206,822   $ 251,425   $ 179,440
                                =========================================================================
</TABLE>

Note 13     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
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.

         In March 1997,  Eastman  Kodak  Company  ("Kodak")  purchased  the Wang
imaging business unit that has responsibility  for this litigation.  On July 30,
1997, the Court permitted Eastman and Kodak Limited of England to be substituted
in the litigation in place of Wang.

         The  Company has moved for summary  judgment 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 the Company's
unenforceability  defense on one of the patents.  In July 1998,  the  Magistrate
Judge  assigned to the case heard oral  arguments  on the  Company's  motion for
summary judgment that U.S. Patent 4,918,588 is not infringed and is invalid. The
Magistrate  Judge has not yet decided these motions.  The Company  believes that
after  he has  ruled  on these  motions,  he will  hear  oral  arguments  in the
remaining motions in the sequence in which they were filed. A trial date has not
yet 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

                                      F-21
<PAGE>

products  or seek to obtain a license  to market the  products.  There can be no
assurance that the Company will be able to successfully  redesign the infringing
products  or  obtain a  license  on  acceptable  terms.  Based on the  Company's
analysis  of these  patents and their  respective  file  histories,  the Company
believes that it has meritorious defenses to these claims; however, the ultimate
outcome or any resulting potential loss cannot be determined at this time.

         On October 27, 1998,  plaintiff  Thomas P. Nyquist filed a 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 Nyquist
Action).  The action was purportedly filed on behalf of a class of purchasers of
the Company's  common stock during the period April 16, 1998 through  October 7,
1998. On July 22, 1999, defendant filed a motion to dismiss the complaint in its
entirety. On August 19, 1999, the court ordered a stay of the action and removed
defendants'  motion to dismiss from the Court's hearing calendar in light of the
pending  petition for rehearing and  rehearing  enbanc in Silicon  Graphics Sec.
Litig.,  Nos.  97-16204,  97-16240,  1999 U.S. App LEXIS 14955 (9th Cir. July 2,
1999).  On December 13, 1999,  the court entered a Stipulation to Dismiss Entire
Action Without Prejudice.

         Subsequent to December 31, 1998, the former shareholders of Saros filed
a demand for mandatory arbitration to release approximately two hundred thousand
shares of FileNET stock which were held in escrow  pursuant to the Agreement and
Plan of Merger  dated  January 17,  1996,  among  FileNET  Corporation,  FileNET
Acquisition  Corporation,  and  Saros,  and for  damages.  The  Company  and the
Shareholders'   Agent  had  agreed  to  mediate  the   matter,   but  the  Saros
Shareholders'  Agent  cancelled  the mediation  prior to the scheduled  date and
renewed their demand for mandatory arbitration. The Company believes that it has
meritorious  reasons  for not  releasing  the shares and other  defenses  to the
claims;  however,  the  ultimate  or any  resulting  potential  loss  cannot  be
presently determined.

         In the normal  course of  business,  the  Company 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  material  adverse  effect  on  the  Company's
consolidated results of operations or financial condition.


Note 14     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.


Note 15     Other Financial Instruments

         The  following  table  summarizes  the  notional  amounts,   which  are
equivalent  to  the  fair  market  value,  of  the  Company's  foreign  currency
agreements  entered  into on December  31, 1999 and 1998,  all maturing in three
months:

<TABLE>
<CAPTION>

   At December 31,                         1999                                                1998
  -----------------  ---------------------------------------------------    -----------------------------------------------
                        Notional            Notional         Unrealized          Notional       Notional        Unrealized
                         Amount              Amount            Gains              Amount         Amount            Gains
                       Purchased              Sold            (Losses)          Purchased         Sold           (Losses)
                     ---------------------------------------------------    -----------------------------------------------
  <S>                <C>                 <C>               <C>              <C>               <C>              <C>
   European            $ 14,450,375      $  9,738,547      $  (105,298)         $ 11,238      $  (8,488)       $      0
   Australian                     0         4,772,150          (58,492)                0         (2,938)              0
   Asian                  1,432,765           406,696           (1,070)              929              0               0
   Canadian                       0         2,113,223          (19,683)                0           (522)              0
                     ---------------------------------------------------    -----------------------------------------------
   Total               $ 15,883,140      $ 17,030,616      $  (184,543)        $  12,167      $ (11,948)       $      0
                     ===================================================    ===============================================
</TABLE>

                                      F-22
<PAGE>

Note 16     Quarterly Financial Information (Unaudited)

<TABLE>
<CAPTION>
                                                                       (Dollars in thousands, except per share amounts)
                                                           First         Second        Third        Fourth       Fiscal
                                                         Quarter        Quarter      Quarter       Quarter         Year
------------------------------------------------------------------------------------------------------------------------
<S>                                                   <C>             <C>          <C>           <C>          <C>
Year ended December 31, 1999:
    Revenue                                            $  81,442      $  86,089    $  85,532     $  94,057    $ 347,120
    Income before income taxes                             2,925          5,563        6,633        11,918       27,039
    Net income                                             2,048          3,894        4,643         9,092       19,677
    Basic earnings per share                                0.06           0.12         0.14          0.28         0.61
    Diluted earnings per share                              0.06           0.12         0.14          0.28         0.59

Year ended December 31, 1998:
    Revenue                                            $  73,609      $  80,372    $  71,152     $  85,100    $ 310,233
    Income (loss) before income taxes                      3,555          6,528       (8,143)         (593)*       1,347
    Net income (loss)                                      2,524          4,635       (5,779)         (424)         956
    Basic earnings (loss) per share                         0.08           0.15        (0.18)        (0.01)        0.03
    Diluted earnings (loss) per share                       0.08           0.14        (0.18)        (0.01)        0.03

*Includes pre tax charges of $2.0 million in the fourth quarter of 1998 for restructuring and other costs.

</TABLE>

                                      F-23
<PAGE>




INDEPENDENT AUDITORS' REPORT ON SCHEDULE



To the Stockholders and the Board of Directors
FileNET Corporation
Costa Mesa, California


We have audited the consolidated financial statements of FileNET Corporation and
its subsidiaries (the Company) as of December 31, 1999 and 1998, and for each of
the three  years in the period  ended  December  31,  1999,  and have issued our
report thereon dated January 25, 2000. Such  consolidated  financial  statements
and report are included  elsewhere in this Form 10-K.  Our audits also  included
the financial  statement  schedule of FileNET  Corporation and its subsidiaries,
listed  in Item  14.  This  consolidated  financial  statement  schedule  is the
responsibility of the Company's management.  Our responsibility is to express an
opinion  based  on our  audits.  In our  opinion,  such  consolidated  financial
statement  schedule,  when  considered  in  relation  to the basic  consolidated
financial  statements  taken  as a  whole,  presents  fairly,  in  all  material
respects, the information set forth therein.



/s/ DELOITTE & TOUCHE LLP

Costa Mesa, California
January 25, 2000

                                      F-24


<PAGE>


                                   SCHEDULE II

                 VALUATION AND QUALIFYING ACCOUNTS AND RESERVES

<TABLE>
<CAPTION>
                                                                                          (Dollars in thousands)
                                                  Balance at           Additions                         Balance
                                                   Beginning    Charged to Costs                          at End
                                                   of Period        and Expenses     Deductions        of Period
-----------------------------------------------------------------------------------------------------------------
<S>                                                 <C>                    <C>           <C>            <C>
Year ended December 31, 1999:
     Inventory reserves                             $    401                 335           410(1)       $    326
     Allowance for doubtful accounts                $  2,063                 612           463(2)       $  2,212
     Reserve for sales allowances                   $  2,319               1,160         1,155(3)       $  2,330
Year ended December 31, 1998:
     Inventory reserves                             $    330                 381           310(1)       $    401
     Allowance for doubtful accounts                $  1,690               1,041           668(2)       $  2,063
     Reserve for sales allowances                   $  2,725                  52           458(3)       $  2,319
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 sales allowances                   $  3,185                   0           460(3)       $  2,725

(1) Consists primarily of the write-off of excess/obsolete inventories.
(2) Consists primarily of uncollectible customer invoice amounts.
(3) Consists primarily of sales allowances.
</TABLE>
                                      S-1