FORM 10-Q

                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549

(Mark One)

|X|  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

For the quarterly period ended June 30, 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.)
  incorporation or organization)

              3565 Harbor Boulevard, Costa Mesa, CA 92626
------------------------------------------------------------------------
          (Address of principal executive offices) (Zip code)

                            (714) 966-3400
------------------------------------------------------------------------
          (Registrant's telephone number including area code)


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 |_|

As of July 30, 1999,  there were 32,252,283 shares of  the  Registrant's  common
stock outstanding.



<PAGE>


                               FILENET CORPORATION
                                      Index


                                                                         Page
                                                                        Number
-------- ------------------------------------------------------------ ----------

PART I.   FINANCIAL INFORMATION

Item 1.   Consolidated Balance Sheets
          as of  June 30, 1999 (unaudited) and December 31, 1998.........  3

          Consolidated Statements of Operations (unaudited)
          for the three and six month periods ended June 30,
          1999 and 1998..................................................  4

          Consolidated Statements of Comprehensive Operations
          (unaudited)for the three and six month periods ended
          June 30, 1999 and 1998.........................................  5

          Consolidated Statements of Cash Flows (unaudited)
          for the three and six month periods ended June 30, 1999
          and 1998.......................................................  6

          Notes to Consolidated Financial Statements (unaudited).........  7

Item 2.   Management's Discussion and Analysis of Financial
          Condition and Results of Operations............................ 10

PART II.  OTHER INFORMATION

Item 1.   Legal Proceedings.............................................. 19

Item 4.   Submission of Matters to a Vote of Security Holders............ 19

Item 5.   Other Information.............................................. 19

Item 6.   Exhibits and Reports on Form 8-K............................... 19

          SIGNATURE...................................................... 20

          INDEX TO EXHIBITS.............................................. 21


                                       2
<PAGE>


PART I.  FINANCIAL INFORMATION
Item 1.  Financial Statements

                               FILENET CORPORATION
                           CONSOLIDATED BALANCE SHEETS
                      (In thousands, except share amounts)

                                                 June 30,          December 31,
                                                   1999               1998
                                              ---------------    ---------------
                                               (Unaudited)
 ASSETS
 Current assets:
   Cash and cash equivalents                      $  57,496       $  55,820
   Short-term marketable securities                  14,415          15,484
   Accounts receivable, net                          67,512          61,636
   Inventories                                        3,115           2,419
   Prepaid expenses and other current assets          7,731           8,865
                                                ------------    ------------
     Total current assets                           150,269         144,224

 Property, net                                       42,302          44,177
 Long-term marketable securities                     22,370          10,885
 Deferred income taxes                                6,433           6,385
 Other assets                                         1,401           1,151
                                                ------------    ------------
     Total assets                                $  222,775      $  206,822
                                                ============    ============

 LIABILITIES AND STOCKHOLDERS' EQUITY
 Current liabilities:
   Accounts payable                               $  15,048       $  21,022
   Accrued compensation and benefits                 22,456          22,165
   Unearned maintenance revenue                      21,830          11,238
   Federal income tax payable                         5,454           3,618
   Deferred income taxes                                953             942
   Other accrued liabilities                         22,868          17,517
                                                ------------    ------------
      Total current liabilities                      88,609          76,502

 Stockholders' equity:
   Preferred stock - $.10 par value;
     7,000,000 shares authorized; none
     issued and outstanding Common stock -
     $.01 par value; 100,000,000 shares
     authorized; 33,240,573 and 32,924,950
     shares outstanding at June 30, 1999 and
     December 31, 1998, respectively                146,581         144,242
   Retained earnings                                  9,246           3,304
   Accumulated other comprehensive operations        (7,094)         (2,659)
                                                ------------    -------------
                                                    148,733         144,887
   Treasury stock, at cost; 1,098,000 shares
   at June 30, 1999 and December 31, 1998
   respectively                                     (14,567)        (14,567)
                                                ------------    -------------
   Total stockholders' equity                       134,166         130,320
                                                ------------    -------------
   Total liabilities and stockholders'
     equity                                     $   222,775      $  206,822
                                                ============    =============

See accompanying notes to consolidated financial statements.

                                       3
<PAGE>

                                         FILENET CORPORATION
                                CONSOLIDATED STATEMENTS OF OPERATIONS
                                (In thousands, except per share data)

<TABLE>
<CAPTION>

                                   Three Months Ended June 30,            Six Months Ended June 30,
                                 --------------------------------      --------------------------------
                                     1999              1998                 1999             1998
                                 --------------   ---------------      ---------------   --------------
                                  (Unaudited)       (Unaudited)         (Unaudited)       (Unaudited)

<S>                              <C>              <C>                  <C>               <C>
Revenue:
   Software                      $   48,651       $    44,403          $    90,635       $   87,650
   Service                           33,893            29,467               67,320           52,938
   Hardware                           3,545             6,502                9,576           13,393
                                 -----------      ------------         ------------      ------------
   Total revenue                     86,089            80,372              167,531          153,981
                                 -----------      ------------         ------------      ------------
 Costs and expenses:
   Cost of software revenue           4,663             4,265                8,624            7,951
   Cost of service revenue           20,515            16,967               40,819           31,313
   Cost of hardware revenue           1,867             3,238                5,033            6,598
   Research and development          13,234            11,820               26,336           23,894
   Selling, general and
     administrative                  40,746            38,585               80,191           76,152
                                 -----------      ------------         ------------      ------------
   Total costs and expenses          81,025            74,875              161,003          145,908
                                 -----------      ------------         ------------      ------------
 Operating income                     5,064             5,497                6,528            8,073
 Other income, net                      499             1,031                1,960            2,010
                                 -----------      ------------         ------------      ------------
 Income before income taxes           5,563             6,528                8,488           10,083
 Provision for income taxes           1,669             1,893                2,546            2,924
                                 -----------      ------------         ------------      ------------
 Net income                      $    3,894       $     4,635          $     5,942       $    7,159
                                 ===========      ============         ============      ============
 Earnings per share:
   Basic                         $     0.12       $      0.15          $      0.19       $     0.23
   Diluted                       $     0.12       $      0.14          $      0.18       $     0.21

 Weighted average shares
   outstanding:
   Basic                             32,066            30,801               31,990           30,501
   Diluted                           32,563            34,097               32,558           33,530

See accompanying notes to consolidated financial statements.
</TABLE>
                                                    4
<PAGE>



                                             FILENET CORPORATION
                             CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
                                               (In thousands)



<TABLE>
<CAPTION>

                                                 Three Months Ended June 30,             Six Months ended June 30,
                                               --------------------------------      --------------------------------
                                                   1999              1998                1999              1998
                                               --------------   ---------------      --------------   ---------------
                                                (Unaudited)      (Unaudited)          (Unaudited)      (Unaudited)
<S>                                            <C>              <C>                  <C>              <C>

 Net income                                    $       3,894    $        4,635       $       5,942    $        7,159
                                               --------------   ---------------      --------------   ---------------

 Other comprehensive income(loss):
   Foreign currency translation
     adjustments-1                                    (1,702)            1,064              (4,355)             (657)


 Unrealized gains (losses) on securities:
    Unrealized holding gains (losses)-2                  (64)                7                 (80)               12

                                               --------------   ---------------      --------------   ---------------
 Total other comprehensive income (loss)              (1,766)            1,071              (4,435)             (645)
                                               --------------   ---------------      --------------   ---------------

 Comprehensive income                          $       2,128    $        5,706       $       1,507    $        6,514
                                               ==============   ===============      ==============   ===============

---------------------------------------------------------------------------------
1 net of tax effect of $1,135 and $(709) for the three months ended June 30, 1999
  and 1998,  respectively  and net of tax  benefit of $2,903 and $438 for the six
  months ended June 30, 1999 and 1998, respectively

2 net of tax effect of $43 and $(5) for the three  months ended June 30, 1999 and
  1998,  respectively  and net of tax  effect of $53 and $(8) for the six  months
  ended June 30, 1999 and 1998, respectively

See accompanying notes to consolidated financial statements.

</TABLE>
                                                       5
<PAGE>



                                            FILENET CORPORATION
                                   CONSOLIDATED STATEMENTS OF CASH FLOWS
                                               (In thousands)
<TABLE>
<CAPTION>

                                                                       Six Months Ended June 30,
                                                                  ------------------------------------
                                                                       1999                1998
                                                                  ----------------    ----------------
<S>                                                              <C>                  <C>
 Cash flows from operating activities:
 Net income                                                       $     5,942         $     7,159
 Adjustments to reconcile net loss to net cash provided by
   operating activities:
     Depreciation and amortization                                      8,688               7,109
     Provision for doubtful accounts                                      202                 377
     Deferred income taxes                                                 59                 575
     Changes in operating assets and liabilities:
       Accounts receivable                                             (9,263)             (9,325)
       Inventories                                                       (695)                386
       Prepaid expenses and other current assets                          783                 764
       Accounts payable                                                (5,687)              1,201
       Accrued compensation and benefits                                  734               2,551
       Unearned maintenance revenue                                    10,682               6,665
       Federal income tax payable                                       1,845               4,782
       Other                                                            7,737              (4,552)
                                                                  -------------       -------------
 Net cash provided by operating activities                             21,027              17,692
                                                                  -------------       -------------
 Cash flows from investing activities:
 Proceeds from sale of equipment                                        1,313                 422
 Capital expenditures                                                  (8,898)            (13,586)
 Purchases of marketable securities                                   (28,048)            (21,065)
 Proceeds from sales and maturities of marketable securities           15,600              24,113
                                                                  -------------       -------------
  Net cash used by investing activities                               (20,033)            (10,116)
                                                                  -------------       -------------

 Cash flows from financing activities:
 Proceeds from issuance of common stock                                 2,340               9,740
 Common stock repurchased                                                   -              (4,435)
                                                                  -------------       -------------
 Net cash provided by financing activities                              2,340               5,305
                                                                  -------------       -------------
 Effect of exchange rate changes on cash and cash equivalents          (1,658)               (124)
                                                                  -------------       -------------

 Net increase in cash and cash equivalents                              1,676              12,757
 Cash and cash equivalents, beginning of year                          55,820              37,344
                                                                  -------------      --------------
 Cash and cash equivalents, end of period                         $    57,496         $    50,101
                                                                  =============      ==============
 Supplemental cash flow information:
 Interest paid                                                    $         9         $        60
 Income taxes paid                                                $        46         $       516

See accompanying notes to consolidated financial statements.

</TABLE>
                                                     6
<PAGE>
                               FILENET CORPORATION
                   Notes To Consolidated Financial Statements
                                   (Unaudited)

1.   In the opinion of the management of FileNET  Corporation  ("the  Company"),
     the  accompanying   unaudited  consolidated  financial  statements  reflect
     adjustments  (consisting  of normal  recurring  adjustments)  necessary  to
     present  fairly the financial  position of the Company at June 30, 1999 and
     the results of its operations,  its  comprehensive  operations and its cash
     flows for the three and six month  periods  ended  June 30,  1999 and 1998.
     Certain information and footnote disclosures normally included in financial
     statements have been condensed or omitted pursuant to rules and regulations
     of the Securities  and Exchange  Commission  ("SEC"),  although the Company
     believes that the disclosures in the consolidated  financial statements are
     adequate  to ensure the  information  presented  is not  misleading.  These
     consolidated  financial  statements  should be read in conjunction with the
     consolidated  financial  statements  and notes  thereto,  and  Management's
     Discussion  and Analysis of Financial  Condition  and Results of Operations
     contained in the  Company's  Annual Report on Form 10-K for the fiscal year
     ended December 31, 1998 and the Company's Quarterly Report on form 10-Q for
     the quarter ended March 31, 1999. The results of operations for the interim
     periods are not  necessarily  indicative of the  operating  results for the
     year.

2.   In May 1998, the Company effected a two-for-one  split of its common stock.
     All references in the consolidated financial statements to number of shares
     and per share amounts of the  Company's  common stock have been restated to
     reflect the split.

3.   Certain  reclassifications  have been made to the prior year's consolidated
     financial statements to conform with the current year's presentation.

4.   The following table is a  reconciliation  of the earnings and share amounts
     used in the  calculation of basic  earnings per share and diluted  earnings
     per share for the three and six month period ended June 30, 1999.

<TABLE>
<CAPTION>
                                                                            Per Share
     (In thousands, except per share           Net Income        Shares       Amount
        amounts)                              ---------------------------------------
     <S>                                     <C>            <C>                <C>
     Three months ended June 30, 1999
       Basic earning per share                 $    3,894       32,066         $ 0.12
       Effect of dilutive stock options                            497
                                              ------------  -----------
       Diluted earnings per share              $    3,894       32,563         $ 0.12
                                              ============  ===========

     Six months ended June 30, 1999
       Basic earning per share                 $    5,942       31,990         $ 0.19
       Effect of dilutive stock options                            568
                                              ------------  -----------
       Diluted earnings per share              $    5,942       32,558         $ 0.18
                                              ============  ===========
</TABLE>

5.   In June 1997,  the  Financial  Accounting  Standards  Board  (FASB)  issued
     Statement  of  Financial  Accounting  Standard  (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.  Accordingly,  the Company has prepared  Consolidated  Statements  of
     Comprehensive  Operations for the three and six month period ended June 30,
     1999 and 1998.  Accumulated other  comprehensive  operations as of June 30,
     1999 is comprised of the following:

<TABLE>
<CAPTION>
                                                                         Accumulated
                                 Foreign Currency      Unrealized           Other
                                   Translation          Holding         Comprehensive
(In thousands)                      Adjustment       Gains (Losses)       Operations
                                 -----------------  -----------------  -----------------
<S>                               <C>                <C>                <C>

 Balance, December 31, 1998       $     (2,667)      $            8     $       (2,659)
 Current period changes                 (4,355)                 (80)            (4,435)
                                 -----------------  -----------------  -----------------
 Balance, June 30, 1999           $     (7,022)      $          (72)    $       (7,094)
                                 =================  =================  =================
</TABLE>
                                       7
<PAGE>

6.   The Company has prepared  operating segment  information in accordance with
     SFAS 131 to report components that are evaluated regularly by the Company's
     chief operating  decision-makers  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  results  of the  segments  reflect
     allocation of certain  functional  expense  categories  consistent with its
     internal reporting which is not the same as GAAP reporting.

     Operating  segments data for the three and six month periods ended June 30,
     1999 compared to the same periods for 1998 is as follows:

<TABLE>
<CAPTION>
                                      Three months ended June 30,     Six months ended June 30,
      In thousands                          1999            1998           1999           1998
     <S>                                <C>             <C>            <C>            <C>
                                      ---------------------------     -------------------------
     Software
       Revenue                          $ 48,651        $ 44,403       $ 90,635       $ 87,650
       Operating income (loss)               931             286        (2,759)            321

     Customer Support
       Revenue                          $ 20,506        $ 16,999       $ 40,051       $ 32,861
       Operating income                    3,588           2,839          7,510          4,463

     Professional Services and
      Education
       Revenue                         $  11,665        $  9,555       $ 23,406       $ 15,498
       Operating income (loss)               (2)             878            185            654

     Hardware
       Revenue                          $  3,545        $  6,502       $  9,576       $ 13,393
       Operating income                      397             959          1,277          1,931

     Other
       Revenue                          $  1,722        $  2,913       $  3,863       $  4,579
       Operating income                      150             535            315            704

     Total
       Revenue                          $ 86,089        $ 80,372      $ 167,531      $ 153,981
       Operating income                    5,064           5,497          6,528          8,073
</TABLE>

7.   In June 1998,  the 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 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.  The Company
     will continue to evaluate the early adoption of this pronouncement.

8.   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.

                                       8
<PAGE>

     The Company has moved for summary judgement on  noninfringement  as to each
     of the five patents in the suit, and for summary  judgment of invalidity as
     to one  of the  patents.  Eastman  moved  for  summary  judgment  as to 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  judgement 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 been set.

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

     On 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. The plaintiff  alleges claims under Sections
     10(b) and 20(a) of the Securities Exchange Act and Rule 10b-5 in connection
     with  various  public  statements  made by the  Company  and certain of its
     officers and  directors  during the putative  class  period.  The complaint
     seeks unspecified compensatory damages,  interest,  attorneys' fees, expert
     witness fees and costs. The court has appointed the lead plaintiff and lead
     plaintiffs'  counsel  and  consolidated  all  actions.  On July  22,  1999,
     defendant  filed a motion to dismiss the  complaint  in its  entirely.  The
     Company  believes  that all of the  allegations  contained  in the  Nyquist
     Action are  without  merit and  intends to defend the  actions  vigorously;
     however,  the ultimate  outcome or any resulting  potential  loss cannot be
     determined at this time.

     Subsequent  to  December  31,  1998,  the  former   shareholders  of  Saros
     Corporation   filed  a  demand  for   mandatory   arbitration   to  release
     approximately  0.2 million shares of the Company's stock which were held in
     escrow  pursuant to the Agreement and Plan of Merger dated January 17, 1996
     among  FileNET  Corporation,  FileNET  Acquisition  Corporation  and  Saros
     Corporation   and  for  damages.   In  August  1999, the  Company  and  the
     Shareholders'  Agent agreed to mediate the matter.  The date for  mediation
     has not been set. Nonwithstanding the foregoing, each party has selected an
     arbitrator  and agreed upon a third neutral  arbitrator in connection  with
     arbitration.  A date for arbitration,  if needed,  willnot be set until the
     mediation   process  is  completed.   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.

     The Company, in the normal course of business,  is subject to various other
     legal  matters.  While the  results  of  litigation  and  claims  cannot be
     predicted with  certainty,  the Company  believes that the final outcome of
     these  other  matters  will not have a  materially  adverse  effect  on the
     Company's consolidated results of operations or financial condition.















                                       9

<PAGE>

Item 2. Management's  Discussion and Analysis of Financial Condition and Results
        of Operations

The following  should be read in  conjunction  with the  unaudited  consolidated
financial  statements and notes thereto  included in Part I--Item 1 and "Factors
That May Affect Future Results" in this item of this Quarterly Report,  and with
the  audited   consolidated   financial   statements  and  notes  thereto,   and
Management's  Discussion  and  Analysis of  Financial  Condition  and Results of
Operations  contained in the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1998.

Results of Operations

Revenue
<TABLE>
<CAPTION>
                                            Three Months Ended June 30,             Six Months Ended June 30,
                                        ------------------------------------   -----------------------------------
 (Dollars in millions)                     1999         1998      % Change        1999        1998      % Change
                                        ------------ -----------  ----------   ------------ ---------- -----------
<S>                                     <C>          <C>            <C>         <C>          <C>            <C>

 Software revenue
   Domestic                                 $  32.9     $  26.7       23%         $ 59.7     $ 56.2          6%
   International                                                     (11%)                                  (1%)
                                               15.8        17.7                     31.0       31.4
                                        ------------ -----------                ------------ ----------
   Total software revenue                   $  48.7     $  44.4       10%         $ 90.7     $ 87.6          4%
                                        ------------ -----------                ------------ ----------
    Percentage of total revenue                 57%         55%                      54%        57%

 Customer Support
   Domestic                                 $  16.2     $  13.3       22%         $ 31.3     $ 25.7         22%
   International                                4.3         3.7       16%            8.7        7.2         21%
                                        ------------ -----------                ------------ ----------
   Total customer support revenue           $  20.5     $  17.0       21%         $ 40.0     $ 32.9         22%
                                        ------------ -----------                ------------ ----------
     Percentage of total revenue                24%         21%                      24%        21%

 Professional Services and Education
   Domestic                                 $   8.5      $  7.6       12%         $ 17.0     $ 11.3         50%
   International                                3.2         1.9       68%            6.4        4.2         52%
                                        ------------ -----------                ------------ ----------
   Total professional services and
     education revenue                     $   11.7      $  9.5       23%         $ 23.4     $ 15.5         51%
                                        ------------ -----------                ------------ ----------
     Percentage of total revenue                 13%         12%                     14%        10%

 Hardware revenue
   Domestic                                 $   2.3      $  4.6      (50%)         $  7.1     $  9.6       (26%)
   International                                1.2         1.9      (37%)            2.4        3.8       (37%)
                                        ------------ -----------                ------------ ----------
   Total hardware revenue                   $   3.5      $  6.5      (46%)         $  9.5     $ 13.4       (29%)
                                        ------------ -----------                ------------ ----------
     Percentage of total revenue                  4%          8%                       6%        9%

 Other revenue
   Domestic                                 $   1.3      $  2.0      (35%)         $  3.1     $  3.3        (6%)
   International                                0.4         1.0      (60%)            0.8        1.3       (38%)
                                        ------------ -----------                 ------------ ----------
   Total other revenue                      $   1.7      $  3.0      (43%)         $  3.9     $  4.6       (15%)
                                        ------------ -----------                ------------ ----------
     Percentage of total revenue                 2%          4%                        2%        3%
                                        ------------ -----------                ------------ ----------

 Total revenue
   Domestic                                 $  61.2     $  54.2       13%          $118.2    $ 106.1         11%
   International                               24.9        26.2       (5%)           49.3       47.9          3%
                                        ------------ -----------                ------------ ----------
   Total revenue                            $  86.1     $  80.4        7%          $167.5    $ 154.0          9%
                                        ============ ===========                ============ ==========
</TABLE>

Software revenue from the licensing of the Company's software products increased
10% and 4% for the three and six month  periods,  respectively,  ended  June 30,
1999  over  the  comparable  periods  of  1998.  The  increases  were  primarily
attributable to an increase in the volume of domestic  product  shipments to new
Panagon customers.

                                       10
<PAGE>

Customer support revenue consists of revenue from maintenance contracts and "fee
for service"  revenues.  Customer support revenue  increased 21% and 22% for the
three  and six  month  period,  respectively,  ended  June  30,  1999  over  the
comparable  periods  of 1998.  The  increases  were  attributable  to  increased
maintenance revenue due to the growth of the Company's installed base.

Professional  services and education revenue consists of revenue from consulting
and  implementation  services  provided to end users of the  Company's  software
products,  technical consulting services provided to the Company's resellers and
training  services.  Consulting  services are primarily  performed on a time and
material basis.  Professional  services and education  revenue increased 23% and
50% for the three and six month period,  respectively,  ended June 30, 1999 over
the  comparable  periods  of 1998  due to  increased  demand  for the  Company's
expanded professional services and education offerings.

Hardware revenue is generated primarily from the sale of 12-inch optical storage
and retrieval  libraries  (OSAR).  Hardware revenue decreased by 46% and 29% for
the three and six  month  period,  respectively,  ended  June 30,  1999 over the
comparable  periods of 1998.  This  decrease  is the result of a decrease in new
orders  experienced  both  domestically  and  internationally  due to customers'
ordering competitive products.  The Company expects hardware revenue to continue
to decline in both absolute dollars and as a percentage of total revenue.

Other  revenue is generated  from the sale of spare parts,  supplies and "third-
party" products. Other revenue decreased 43% and 15% for the three and six month
period,  respectively,  ended June 30, 1999 compared to the same periods in 1998
due to decreased sales of spare parts.

International  revenues were  approximately 29% and 33% of total revenues in the
three  month  periods  ended June 30, 1999 and 1998,  respectively.  For the six
month period ended June 30, 1999 and 1998 international revenues constituted 29%
and 31% of total revenues,  respectively.  The decreases are attributable to the
softening  of  non-European  markets.  Management  expects  that  the  Company's
international  operations will continue to account for a significant  portion of
total  revenues.  International  revenues are subject to certain risks including
but  not  limited  to   political   and  economic   instability;   and  currency
fluctuations. See "Factors That May Affect Future Results" below.

Cost of Revenue
<TABLE>
<CAPTION>
                                             Three Months Ended June 30,             Six Months Ended June 30,
                                        --------------------------------------  ------------------------------------
 (Dollars in millions)                        1999         1998     % Change         1999         1998    % Change
                                        --------------------------------------  ------------------------------------
<S>                                         <C>          <C>          <C>          <C>          <C>          <C>
 Cost of software revenue                   $  4.7       $  4.3          9%        $  8.6       $  8.0           8%
  Percentage of software revenue                10%          10%                        9%           9%

 Cost of customer support revenue           $  9.2       $  8.0         15%        $ 17.9       $ 16.1          11%
  Percentage of customer support
    revenue                                     45%          47%                       45%          49%

 Cost of professional services  and
    education revenue                       $  9.9       $  7.0         41%        $ 19.7      $  11.9          66%
  Percentage of professional services
     and education revenue                      85%          74%                       85%          77%

 Cost of hardware revenue                   $  1.8       $  3.2       (44%)        $  5.0       $  6.6        (24%)
  Percentage of hardware revenue                51%          49%                       53%          49%

 Cost of other revenue                      $  1.4       $  2.0       (30%)       $  3.2       $  3.3          (3%)
Percentage of other revenue                     82%          67%                       82%          72%

 Total cost of revenue                     $  27.0      $  24.5         10%        $ 54.4       $ 45.9          19%
  Percentage of total revenue                   31%          30%                       32%          30%
</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  remained  constant at 10% for the three months ended June 30,
1999 and 1998 and 9% for the six months ended June 30, 1999 and 1998.

                                       11
<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 for the three month
period ended June 30, 1999 decreased to 45% from 47% in the same period of 1998.
The cost of customer  support  revenue for the six month  period  ended June 30,
1999 decreased to 45% from 49% for the  comparable  period of 1998. The decrease
is  attributable  to cost  savings  realized  through the  consolidation  of the
Company's European operations.

The cost of professional  services and education  revenue consists  primarily of
professional  services and training personnel and third party  contractors.  The
cost  of  professional  services  and  education  revenue  as  a  percentage  of
professional  services  and  education  revenue for the three month period ended
June 30, 1999 increased to 85% from 74% for the same period of 1998. The cost of
professional  services and education revenue for the six month period ended June
30,  1999  increased  to 85% from 77% for the  comparable  period  of 1998.  The
increase is due to the addition of professional services management personnel to
support the Company's  announced  strategy of increasing its focus on delivering
new professional services products.

The cost of hardware revenue  includes the cost of manufacturing  OSARs, and the
cost of  hardware  integration  personnel.  The cost of  hardware  revenue  as a
percentage  of hardware  revenue for the three month  period ended June 30, 1999
increased  to 51%  from  49% for the  comparable  period  of  1998.  The cost of
hardware  revenue as a percentage  of hardware  revenue for the six month period
ended June 30, 1999 increased to 53% from 49% for the comparable period of 1998.
The increase is due to lower revenue without a  corresponding  decrease in fixed
manufacturing costs.

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 for
the  three  months  ended  June  30,  1999  increased  to 82%  from  67% for the
comparable  period of 1998.  The cost of other  revenue as a percentage of other
revenue for the six month period  ended June 30, 1999  increased to 82% from 72%
for the comparable  period of 1998. The increase is due to the selling of higher
cost product in 1999 compared to 1998.

Operating Expenses
<TABLE>
<CAPTION>
                                       Three Months Ended June 30,                Six Months Ended June 30,
                                   -------------------------------------    ------------------------------------
 (Dollars in millions)                   1999        1998     % Change           1999        1998     % Change
                                   -----------------------   -----------    ----------------------   -----------
<S>                                   <C>         <C>             <C>          <C>         <C>            <C>
 Research and development             $  13.2     $  11.8         12%          $ 26.3      $ 23.9         10%
  Percentage of total revenue              15%         15%                         16%         16%

 Selling, general and
    administrative                    $  40.8     $  38.6          6%          $ 80.2      $ 76.1          5%
  Percentage of total revenue              47%         48%                         48%         49%
</TABLE>

Research and  development  expenses  increased 12% and 10% for the three and six
month  periods  ended June 30, 1999,  respectively,  compared to the  comparable
periods  of 1998.  The  increases  in  absolute  dollars  were due to a  general
increase  in  salaries  and  recruiting   costs   necessitated  by  the  intense
competitive  environment  for software  engineers  and an increase in the use of
contract developers.  As a percentage of total revenue, research and development
expenses  were at 15% for the three month  period  ended June 30, 1999 and 1998,
respectively  and 16% for the six month  period  ended  June 30,  1999 and 1998,
respectively.

The Company  expects that  competition  for qualified  technical  personnel will
remain  intense for the  foreseeable  future and may result in higher  levels of
compensation  expense for the Company.  The Company  believes  that research and
development  expenditures,  including  compensation of technical personnel,  are
essential to  maintaining  its  competitive  position and expects these costs to
continue to constitute a significant percentage of revenues.

Selling,  general and administrative  expenses increased 6% and 5% for the three
and six month periods ended June 30 1999,  compared to the comparable periods of
1998. The increase was primarily due to overall increases in salaries, increased
sales  development  and  training  costs  and  consulting   related  to  systems
development  projects.  As a percentage of total revenue,  selling,  general and
administrative  expenses  decreased to 48% for the six months  period ended June
30, 1999 from 49% for the comparable  period of 1998 primarily due to the higher
revenue levels in 1999.

                                       12
<PAGE>

Provision for Income Taxes. The Company's  combined  federal,  state and foreign
annual  effective  tax rate for the for the three and six months  ended June 30,
1999,  respectively was 30% compared to 29% for the comparable  periods in 1998.
The  increase  in the rate is  attributable  to a  decrease  in  taxable  income
generated in lower tax jurisdictions outside of North America.

Foreign Currency  Fluctuations and Inflation.  The Company's  performance can be
affected by changes in foreign  currency  values  relative to the U.S. dollar in
relation to the  Company's  revenue and  operating  expenses.  The impact to net
income from foreign exchange  transactions and hedging  activities is immaterial
for all periods reported.  As of June 30, 1999, the Company had forward exchange
contracts outstanding totaling  approximately $1.2 million in 8 currencies.  All
of these contracts mature in three months.

Other comprehensive loss reflects an increase of $1.7 for the three months ended
June 30, 1999 and an increase of $4.4 for the six months  ended June 30, 1999 in
the  unrealized  loss due to foreign  currency  translation.  This  increase was
primarily attributable to unrealized losses associated with the weakening of the
Euro currency against the U.S. dollar during the periods.

Management  believes  that  inflation  has not had a  significant  impact on the
prices of the Company's  products,  the cost of its materials,  or its operating
results for the three and six months ended June 30, 1999 and 1998.

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

In June  1998,  the  FASB  issued  SFAS  No.  133,  "Accounting  for  Derivative
Instruments  and Hedging  Activities."  As amended,  SFAS 133, 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.  The Company will continue to evaluate the
early adoption of this pronouncement.

Liquidity and Capital Resources

At June 30 1999,  combined  cash,  cash  equivalents  and short-  and  long-term
marketable  securities totaled $94.3 million,  an increase of $12.1 million from
the end of 1998.  Cash  provided by operating  activities  during the six months
ended June 30, 1999  totaled  $21.0  million  and  resulted  primarily  from net
income;  an increase in unearned  maintenance  revenue related to annual renewal
billings; an increase in other accrued liabilities;  and additions to net income
for  depreciation  and  amortization  expense  offset by  decreases  in accounts
payable and increase in accounts  receivable.  Cash used by investing activities
totaled $20.0 million and was a result of capital  expenditures and purchases of
marketable  securities offset by sales and maturities of marketable  securities.
Cash provided by financing  activities  totaled $2.3 million and was a result of
proceeds received from the exercise of employee stock options.

Accounts  receivable  increased  to $67.5  million  at June 30,  1999 from $61.6
million at December 31, 1998. Days sales outstanding  increased to 71 days as of
June  30,  1999  from 66 days  as of  December  31,  1998.  Current  liabilities
increased to $88.6  million at June 30, 1999 from $76.5  million at December 31,
1998. The increase in current  liabilities is primarily a result of increases in
unearned  maintenance  revenue,  accrued royalties and accrued taxes,  offset by
decreases in accounts payable.

The Company has a $20 million  unsecured  line of credit with a commercial  bank
that expires in June 2001 and is subject to the maintenance of certain financial
covenants. As of June 30, 1999, there were no borrowings outstanding against the
Company's  credit line and the Company was in compliance  with all the covenants
of the line.

The Company  anticipates that its present cash balances together with internally
generated  funds and credit lines will be sufficient to meet its working capital
and capital expenditure needs for at least the next twelve months.

                                       13
<PAGE>

Other Matters

Year 2000.  With the  approach  of the year 2000,  the Company  recognized  that
significant issues could arise in connection with the computer software products
it  licenses  and the  internal  business  systems  which are  essential  to its
operations.  In 1997, the Company implemented a year 2000 Integrity Program (the
Program) to ensure that the Company's  computer  software  products and internal
business systems will function properly in the year 2000 and thereafter.

The  Program,  as it relates to the  software  products  licensed to  customers,
includes year 2000 compliance  testing and certification of all current software
products.  All  new  generations  of the  Company's  software  products  will be
released as year 2000  compliant.  Not all software  products of the Company are
year 2000 compliant and the Company does not plan to make them so.  Accordingly,
upgraded year 2000 compliant  versions of such software  products are being made
available to customers and resellers who will then bear the  responsibility  for
installing  the upgraded  software  product in order to make their  systems year
2000 compliant.  Some of the Company's  customers are running  software  product
versions that are not year 2000 compliant. The Company has been encouraging such
customers to migrate to current software product  versions.  It is possible that
the Company may experience increased expenses in addressing migration issues for
such customers. The Company's customer support organization is in the process of
completing its program,  Customer  Service Profile 2000, to review the status of
each Company product currently  installed at a customer location and to schedule
upgrades according to the customer's  requirements and support programs. It also
provided the diagnostics used in such program to its resellers for their use at
their customer locations. Customers who have support agreements with the Company
have  been  directly  informed  as to  whether  or not the  particular  software
products  they have  installed are year 2000  compliant.  All customers are kept
informed of the release of year 2000  compliant  updates  and  upgrades  via the
Company's readiness  disclosure  statement on its Web site. The inability of any
of the Company's software products to properly manage and manipulate data in the
year 2000  could  result in  increased  warranty  costs,  customer  satisfaction
issues, potential lawsuits and other costs and liabilities, as well as customers
being unable to run software licensed from the Company and incurring significant
costs from the resultant  business  interruption.  The Company has implemented a
contingency plan for certain legacy software  products which provides an upgrade
path to current year 2000 compliant  versions of the Company's software products
with similar  functionality.  The Company has spent an estimated $1.2 million on
year 2000 product related  projects  through June 30, 1999. The expense for year
2000 product related projects is estimated to be  approximately  $.4 million for
the remainder of 1999.  The Company is forming a rapid  response team as part of
customer  support that will respond to problems during the year 2000 date change
period. The Company estimates these expenses at $.1 million.

The Company has communicated  with significant  third party  vendors of computer
software with which the Company's  systems interface or upon which the Company's
software  products  depend.  Such  third party  vendors have delivered year 2000
versions  or  guaranteed  that  its  current  computer  software  is  year  2000
compliant.  In the event that  customers  of the Company  have year 2000 related
problems with such  third party  software,  the ompany has been assured that the
third party  will remediate  their own year 2000 issues.  Although the Company's
compliance  testing utilizes the embedded  third party  software as an essential
part of its software being tested, the Program does not include certification of
third party software which is incorporated in the Company's software products or
customer-developed  applications  which run on the Company's  software products.
Customers and third party vendors will remain directly responsible for year 2000
compliance testing of their software.

The  Program  also  includes a review of all  internal  IT systems for year 2000
compliance. The Company's significant business systems (financial,  operational,
marketing,  customer support,  etc.) have been reviewed and are either currently
year 2000  compliant or will be 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 the  Company's  technical  infrastructure  is either fully year 2000
tested and  compliant or is scheduled  to be replaced  with year 2000  compliant
components  by October  31,  1999.  The  Company is also  evaluating  IT related
environmental systems (heating, air conditioning, security, etc.) and intends to
make all such  systems year 2000  compliant  by October 31, 1999.  To the extent
possible,  the Company will develop and execute  contingency  plans  designed to
allow  continued  operation  in the event of failure of the  Company's  or third
parties' systems by October 31, 1999.  Contingency  plans are being developed in
certain key areas,  in particular  finance,  sales,  IT and customer  service to
ensure that any potential business  interruptions  caused by the year 2000 issue
are mitigated.  Such contingency plans may include identification of alternative
sources for processing data and managing customer support issues. Business teams
will  be  monitoring  the  critical  systems,   and  service  centers  to  react
immediately  to facilitate  repairs at the end of the year 1999.  Data retention
and recovery  procedures will be in place for critical  business data to provide
back-ups   with  on-site  and  off-site   data  copies.   For  those   business,

                                       14
<PAGE>

infrastructure  and  environmental  systems  that are to be upgraded in order to
achieve year 2000  compliance,  the majority were already  scheduled for upgrade
for  other  business  reasons.  The  Company's  cost to fund  solely  year  2000
compliance  projects has been $0.4 million through June 30, 1999. The expense to
complete  these projects is estimated to be  approximately  $0.7 million for the
remainder of 1999. Although the Company is not aware of any material operational
issues or costs  associated  with  preparing its software  products and internal
systems for the year 2000,  there can be no  assurance  that there will not be a
delay  in,  or  increased  costs  associated  with,  the  implementation  of the
necessary systems and changes to address the year 2000 issue.

The  foregoing  statements  are based upon  management's  best  estimates at the
present  time,  which were  derived  utilizing  numerous  assumptions  of future
events,  including the continued availability of certain resources,  third party
modification  plans and other  factors.  There can be no  guarantee  that  these
estimates will be achieved and actual results could differ materially from those
anticipated.  Specific  factors  that  might  cause  such  material  differences
include,  but are not limited to, the nature and amount of programming  required
to upgrade or replace  each of the  affected  programs,  and the  success of the
Company's external customers, resellers, and vendors and suppliers in addressing
the year 2000 issue.

Environmental  Matters.  The  Company  is not  aware of any  issues  related  to
environmental  matters  that have,  or are expected  to,  materially  affect its
business.

Factors That May Affect Future Results

The Company's 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 the Company's
actual  results to differ  materially  from recent results or from the Company's
anticipated future results.

Rapid Technological  Change;  Product Development.  The market for the Company's
software  and products is  characterized  by rapid  technological  developments,
evolving industry standards,  changes in customer  requirements and frequent new
product introductions and enhancements.  The Company's continued success will be
dependent upon its ability to continue to enhance its existing software, develop
and  introduce,   in  a  timely  manner,  new  software  products  incorporating
technological advances and respond to customer  requirements,  including without
limitation  enhancements  to certain  specified  Company  software  products  to
achieve year 2000 compliance. There can be no assurance that the Company will be
successful in developing and marketing new software  products or enhancements to
its  existing  software on a timely  basis or that any new or enhanced  software
will adequately address the changing needs of the marketplace. If the Company is
unable to develop  and  introduce  new  software  or  enhancements  to  existing
software  in a timely  manner in  response  to  changing  market  conditions  or
customer  requirements,  including  without  limitation  enhancements to certain
existing  software  products  to achieve  year 2000  compliance,  the  Company's
business and operating results could be adversely  affected.  From time to time,
the Company or its  competitors  may  announce  new  products,  capabilities  or
technologies  that have the  potential  to replace or shorten the life cycles of
the Company's existing products. There can be no assurance that announcements of
currently  planned or other new products will not cause customers to delay their
purchasing  decisions  in  anticipation  of such  products,  which  could have a
material adverse effect on the Company's business and operating results.

Uncertainty of Future  Operating  Results;  Fluctuations in Quarterly  Operating
Results.  Prior  growth rates in the  Company's  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 the Company's products; the effectiveness of the Company's efforts to
continue to  integrate  various  software it has  developed  or acquired  and to
achieve the desired level of sales from such software integration;  the level of
product  and  price  competition;  the  length  of the  Company's  sales  cycle;
improvements in the  productivity  of the Company's 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 the Company's customers;  the timing of new software introductions and
software  enhancements by the Company and its  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;  the  ability of the Company to develop and market
new software  products and control costs; and general domestic and international
economic and political  conditions.  Demand for the Company's  software products
could be adversely impacted to the extent customers and potential  customers are

                                       15
<PAGE>

temporarily  distracted by their year 2000 remediation efforts, as such products
compete for  information  technology  (IT) resources that have been diverted for
such  remedial   efforts  which  may  have  higher  priority  than  ordering  or
implementing the Company's software products.

As a result of these factors, revenues and operating results for any quarter are
subject to variation  and are not  predictable  with any  significant  degree of
accuracy.  Therefore, the Company believes that period-to-period  comparisons of
its  results of  operations  are not  necessarily  meaningful  and should not be
relied upon as indications of future performance.  Moreover,  such factors could
cause  the  Company's  operating  results  in a given  quarter  to be below  the
expectations of public market analysts and investors.  In either case, the price
of the Company's common stock could be materially adversely affected.

Competition.  The 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 the  Company  with
substantially greater sales, marketing, development and financial resources. The
Company  believes  that the  competitive  factors  affecting  the market for its
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 customer  support  services and  training.  The relative
importance of each of these factors depends upon the specific customer involved.
While the Company believes it competes  favorably in each of these areas,  there
can be no assurance  that it will  continue to do so.  Moreover,  the  Company's
present  or  future  competitors  may  be  able  to  develop  software  products
comparable  or  superior  to those  offered by the  Company,  offer  lower price
products or adapt more quickly than the Company to new  technologies or evolving
customer  requirements.  Competition  is expected to  intensify.  In order to be
successful  in the future,  the Company  must respond to  technological  change,
customer   requirements   and  competitors'   current   software   products  and
innovations. There can be no assurance that the Company will be able to continue
to compete  effectively in its market or that future competition will not have a
material  adverse  effect on its  business,  financial  condition  or results of
operations.  In addition,  current and potential competitors have established or
may establish  cooperative  relationships among themselves or with third parties
to increase  the  ability of their  products to address the needs of the markets
served by the  Company.  Accordingly,  it is possible  that new  competitors  or
alliances among  competitors may emerge and rapidly acquire  significant  market
share.  Increased  competition  may result in price  reductions,  reduced  gross
margins and loss of market  share,  any of which  could have a material  adverse
effect on the Company's business, financial condition or results of operations.

Intellectual  Property  and other  Proprietary  Rights.  The  Company's  success
depends,  in part,  on its  ability to  protect  its  proprietary  rights to the
technologies used in its principal products. The Company relies on a combination
of  copyrights,   trademarks,  trade  secrets,  confidentiality  procedures  and
contractual  provisions  to  protect  its  proprietary  rights  in its  software
products.  There  can be no  assurance  that the  Company's  existing  or future
copyrights, trademarks, trade secrets or other intellectual property rights will
be of  sufficient  scope or  strength  to  provide  meaningful  protection  or a
commercial advantage to the Company. The Company has no software patents.  Also,
in selling certain of its products, the Company relies on "shrink wrap" licenses
that are not signed by licensees and, therefore,  may be unenforceable under the
laws of certain  jurisdictions.  In addition, the laws of some foreign countries
do not protect  the  Company's  proprietary  rights to the same extent as do the
laws of the United States. There can be no assurance that such factors would not
have a material adverse effect on the Company's business, financial condition or
results of operations.  In addition, the Company also relies on certain software
that it licenses from third parties,  including software that is integrated with
internally  developed  software  used in the  Company's  products to perform key
functions.  There can be no  assurance  that such third  parties  will remain in
business, that they will continue to support their software products, that their
products are, or will be, year 2000 compliant,  or that their software  products
will  otherwise  continue  to  be  available  to  the  Company  on  commercially
reasonable  terms.  The loss or  inability  to maintain  any of theses  software
licenses  could  result in delays or  reductions  in  software  shipments  until
equivalent software can be developed, identified, licensed and integrated, which
could adversely affect the Company's business, financial condition or results of
operations.

The Company may, from time to time,  be notified  that it is infringing  certain
patent or  intellectual  property  rights of others.  Combinations of technology
acquired through past or future  acquisitions and the Company's  technology will
create new  software  products  and  technology  that may give rise to claims of
infringement.  While no actions other than those  discussed  below are currently
pending  against  the Company for  infringement  of patent or other  proprietary
rights of third  parties,  there can be no assurance that third parties will not
initiate  infringement  actions against the Company in the future.  Infringement
actions can result in  substantial  cost to, and diversion of,  resources of the
Company.  If the Company  were found to infringe  upon the rights of others,  no
assurance can be given that the Company could redesign the  infringing  products

                                       16
<PAGE>

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 its 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 the Company's business, financial condition or results of operations.

In October 1994, Wang Laboratories,  Inc. (Wang) filed a complaint in the United
States  District  Court for the  District  of  Massachusetts  alleging  that the
Company is infringing  five patents held by Wang (the FileNET Case). On June 23,
1995,  Wang amended its complaint to include an additional  related  patent.  On
July 2, 1996,  Wang filed a complaint in the same court  alleging that Watermark
Software  Inc.,  formerly a wholly  owned  subsidiary  that was merged  into the
Company,  is  infringing  three  of the same  patents  asserted  in the  initial
complaint (the Watermark  Case).  On October 9, 1996, Wang withdrew its claim in
the FileNET Case that one of the patents it initially asserted is infringed.  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 judgement on noninfringement as to each of the
five patents in the suit,  and for summary  judgment of  invalidity as to one of
the  patents.   Eastman   moved  for  summary   judgment  as  to  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  judgement 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
been set.

If it should be determined that the patents at issue in the litigation are valid
and  are  infringed  by any  of  the  Company's  products,  including  Watermark
products,  the Company will,  depending on the product,  redesign the infringing
products  or seek to obtain a license  to market the  products.  There can be no
assurance that the Company will be able to redesign the  infringing  products or
obtain a license on acceptable terms.  Based on the Company's  analysis of these
Eastman patents and their  respective file histories,  the Company believes that
it has meritorious  defenses to Eastman's claims;  however, the ultimate outcome
or any resulting potential loss cannot be determined at this time.

Dependence  on Certain  Relationships.  The Company has entered into a number of
key relationships with other companies such as Microsoft Corporation, IBM Global
Services, 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, the Company and its products.

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

International  Sales.  Historically,   the  Company  has  derived  approximately
one-third of its 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
beginning  in 1999;  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 the  Company's  business,
financial condition or results of operations.

                                       17
<PAGE>

Product Liability. Software and products as complex as those sold by the Company
are susceptible to errors or failures,  especially when first introduced or when
new versions are released.  The Company's  software  products are often intended
for use in applications that are critical to a customer's business. As a result,
the Company's customers may rely on the effective performance of the software to
a greater extent than the market for software  products  generally.  The Company
conducts  extensive  software  testing to ensure  that its  software  is free of
significant errors and defects. In addition, the Company has designed and tested
the most current  versions of its software  products to be year 2000  compliant.
However,  some of the Company's  customers are running earlier software products
that are not year 2000 compliant. Although the Company has been encouraging such
customers to migrate to current  software  versions,  no assurance  can be given
that  all of them  will do so in a  timely  fashion,  if at all.  Moreover,  the
Company also relies on certain  software  that it licenses  from third  parties,
including software that is integrated with internally  developed software and is
used in the  Company's  products  to  perform  key  functions.  There  can be no
assurance that such  third party  software will be free of errors and defects or
be year  2000  compliant  in a timely  fashion.  Although  the  Company  has not
experienced  any  material  product  liability  claims to date,  there can be no
assurance that errors or defects, whether associated with year 2000 functions or
otherwise,  will not result in product  liability  claims against the Company in
the future.  A successful  product  liability  claim brought against the Company
could have a material  adverse  effect upon the  Company's  business,  operating
results and financial condition. The Company's license agreements with customers
typically contain provisions designed to limit its 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.

Stock Price  Volatility.  The Company  believes  that a variety of factors could
cause the trading price of its common stock to fluctuate, perhaps substantially,
including quarter-to-quarter  variations in operating results;  announcements of
developments related to its business;  fluctuations in its order levels; general
conditions in the technology sector or the worldwide  economy;  announcements of
technological innovations,  new software products or product enhancements by the
Company or its 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 the Company's  relationships
with its 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 the Company's common stock.



                                       18
<PAGE>


PART II.  OTHER INFORMATION

Item 1.  Legal Proceedings

See Notes to Consolidated Financial Statements.

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

(a)  The 1999  Annual  Meeting of  Stockholders  of the Company was held at 9:00
     a.m. on May 20, 1999, in Costa Mesa, California.

(b)  At the annual meeting,  the following seven individuals were elected to the
     Company's  Board of  Directors,  constituting  all  members of the Board of
     Directors:

      Nominee                 Affirmative Votes        Votes Withheld
      ----------------------- ------------------------ -------------------------
      L. George Klaus         27,678,276               583,248
      ----------------------- ------------------------ -------------------------
      William P. Lyons        27,644,776               616,748
      ----------------------- ------------------------ -------------------------
      Lee D. Roberts          27,628,603               632,921
      ----------------------- ------------------------ -------------------------
      John C. Savage          27,641,703               619,821
      ----------------------- ------------------------ -------------------------
      Roger S. Siboni         27,645,960               615,564
      ----------------------- ------------------------ -------------------------
      Theodore J. Smith       27,632,916               628,608
      ----------------------- ------------------------ -------------------------
      Carolyn M. Ticknor      27,641,403               620,121
      ----------------------- ------------------------ -------------------------

(c)  The  Company's  stockholders  were  asked to approve  an  amendment  to the
     Company's  1995 Stock  Option Plan (the "1995 Plan") to increase the number
     of shares of Common  Stock  issuable  under the 1995 Plan by an  additional
     1,200,000  shares.  This  proposal  was  approved  in  accordance  with the
     following vote of stockholders:

                                                               Broker
     Votes For          Votes Against       Abstentions        Non-Votes
     ------------------ ------------------- ------------------ -----------------
     23,986,483         3,997,198           277,843            0
     ------------------ ------------------- ------------------ -----------------

(d)  The Company's  stockholders  were asked to approve an amendment to the 1998
     Employee  Stock  Purchase Plan (the "1998  Purchase  Plan") to increase the
     number of shares of Common Stock  issuable  under the 1998 Purchase Plan by
     an additional 300,000 shares.  This  proposal  was approved  in  accordance
     with the  following  vote of stockholders:

                                                               Broker
     Votes For          Votes Against       Abstentions        Non-Votes
     ------------------ ------------------- ------------------ -----------------
     27,100,893         887,427             273,204            0
     ------------------ ------------------- ------------------ -----------------


Item 5.  Other Information

On May 28, 1999,  Carolyn M. Ticknor  voluntarily  tendered her  resignation  as
Director of the Company which was accepted by the Board. Her resignation was not
due to any disagreement  with the Company relating to the Company's  operations,
policies or practices.

Item 6.  Exhibits and Reports on Form 8-K

(a)  Exhibits - The list of  exhibits  contained  in the  accompanying  Index to
Exhibits is herein  incorporated  by reference.  (b) No reports on Form 8-K were
filed during the second quarter of 1999.

                                       19
<PAGE>


                                    SIGNATURE

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

August 13, 1999                By:______________/s/_____________________________
Date                              Mark S. St. Clare, Chief Financial Officer and
                                  Sr. Vice President, Finance
                                  (Principal Financial Officer)






                                       20
<PAGE>
                                INDEX TO EXHIBITS
Exhibit
  No.       Description
----------- --------------------------------------------------------------------
3.1*        Restated Certificate of  Incorporation,  as amended (filed as Exhibi
            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        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  Sublicens   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  f 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 November 9, 1998; Registration No.
            333-66997).

---------------------------------------------
* Incorporated herein by reference

                                       21
<PAGE>

Exhibit
   No.      Description
----------- --------------------------------------------------------------------

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  the  Company's  Form
            10-K for the fiscal year ended December 31, 1991).

10.14*      Amendment  #A1011-941003-01   dated   September  30,  1994,  to  the
            Agreement for the  Purchase of  IBM products dated December 20, 1991
            (filed  as  Exhibit  10.12  to  Form 10-K for the  fiscal year ended
            December 31, 1996).

10.15*      Development  and Initial  Supply  Agreement  between the  Registrant
            and Quintar Company dated August 20, 1992 (filed as Exhibit 10.21 to
            Form 10-K for the year ended January 3, 1993).

10.16*      Amendment  dated  December 22, 1992  to the  Development and Initial
            Supply  Agreement  between  the Registrant and Quintar Company dated
            August 20, 1992  (filed as  Exhibit 10.22  to Form 10-K for the year
            ended January 3, 1993).

10.17*      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
            November  9,  1998;  Registration  No.  333-66997).  10.22*  FileNET
            Corporation  International  Employee  Stock Purchase Plan. (filed as
            Exhibit 99.16 to  Form S-8,  filed on November 9, 1998; Registration
            No. 333-66997).

27          Financial Data Schedule.

-----------------------------------------------
* Incorporated herein by reference


                                       22