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**==================================================================================****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, 2002

                                       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: 00-15997

                               **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) 327-3400                        
          (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 August 12, 2002, there were 35,627,846 shares of the  Registrant's  common
stock outstanding.

**==================================================================================****FILENET CORPORATION**
                                      Index

                                                                           Page
                                                                         Number **PART I.            FINANCIAL INFORMATION**..................................... 3

Item 1.            Condensed Consolidated Financial Statements............... 3

Item 2.            Management's Discussion and Analysis of Financial
                   Condition and Results of Operations   ................... 13

Item 3.            Quantitative and Qualitative Disclosures about........... 24
                   Market Risk

**PART II.           OTHER INFORMATION**........................................ 25

Item 1.            Legal Proceedings........................................ 25

Item 4.            Submssion of Matters to a Vote of Securities Holders..... 25

Item 6.            Exhibits and Reports on Form 8-K......................... 26

**SIGNATURE**          ......................................................... 27

**INDEX TO EXHIBITS**  ......................................................... 28

                                       2
**PART I.  FINANCIAL INFORMATION

Item 1.  Condensed Consolidated Financial Statements

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

                                                             June 30,        December 31,
                                                                2002          2001  **ASSETS**
 Current assets:
   Cash and cash equivalents                            $     84,290        $    107,502
   Short-term investments                                     67,395              64,660
   Accounts receivable, net                                   53,420              36,909
   Inventories, net                                            2,535               2,993
   Prepaid expenses and other current assets                  12,701               9,521
   Deferred income taxes                                       2,779         2,779  
   Total current assets                                      223,120             224,364

 Property, net                                                40,748              44,206
 Long-term investments                                        17,008                   -
 Goodwill                                                     16,581               9,953
 Intangible assets, net                                        3,317                 182
 Deferred income taxes                                        21,436              21,445
 Other assets                                                  5,624         1,489  

     Total assets                                       $    327,834        $    301,639

 **LIABILITIES AND STOCKHOLDERS' EQUITY**
 Current liabilities:
   Accounts payable                                     $     11,102        $      8,282
   Customer deposits                                           3,920               4,848
   Accrued compensation and benefits                          20,814              17,804
   Unearned maintenance revenue                               43,044              30,996
   Income taxes payable                                        4,930               3,999
   Other accrued liabilities                                  11,515        13,685  

   Total current liabilities                                  95,325              79,614

 Unearned maintenance revenue and other
   liabilities                                                 4,978               6,200
 Commitments and contingencies

 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; 36,711,966 shares issued and
     35,613,966 shares outstanding at June 30, 2002; and
     36,389,682 shares issued and 35,291,682 shares
     outstanding at December 31, 2001                        203,129             199,526
   Retained earnings                                          48,004              44,906
   Accumulated other comprehensive loss                       (9,035)       (14,040) 
                                                             242,098             230,392
   Treasury stock, at cost; 1,098,000 shares                 (14,567)       (14,567) 
   Net stockholders' equity                                  227,531        215,825  

     Total liabilities and stockholders' equity         $    327,834   $    301,639  *See accompanying notes to condensed consolidated financial statements.*

                                       3

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

                                         Three Months Ended June 30,       Six Months Ended June 30,        2002        2001        2002        2001  

 Revenue:
   Software                              $  34,350        $  28,788         $  65,590        $  61,531
   Customer Support                         37,281           32,690            73,844           61,829
   Professional services and education      14,491           18,707            30,327           35,934
   Hardware                                  2,105       2,663       4,707       8,048  
   Total revenue                            88,227      82,848     174,468     167,342  

 Costs:
   Software                                  2,510            1,343             4,591            3,383
   Customer Support                          9,807           11,466            19,895           23,452
   Professional services and education      13,187           16,340            26,642           33,331
   Hardware                                  1,585       1,943       3,510       5,474  
   Total cost of revenue                    27,089           31,092            54,638           65,640

     Gross Profit                           61,138           51,756           119,830          101,702

 Operating expenses:
   Research and development                 19,088           19,524            36,393           35,612
   Selling, general and administrative      41,366           43,618            81,843           86,777
   In-process research and development         400           -         400           -  

   Total operating expenses                 60,854           63,142           118,636          122,389

 Operating income (loss)                       284          (11,386)            1,194          (20,687)

 Other income (loss), net                    1,921      (1,836)      2,829        (166) 

 Income (loss) before income taxes           2,205          (13,222)            4,023          (20,853)

 Provision (benefit) for income taxes          471      (2,527)        925      (4,587) 
 Net income (loss)                        $  1,734   $ (10,695)   $  3,098   $ (16,266) 

 Earnings (loss) per share:
   Basic                                  $    0.05       $   (0.30)         $    0.09       $   (0.46)
   Diluted                                $    0.05       $   (0.30)         $    0.08       $   (0.46)

 Weighted average shares outstanding:
   Basic                                     35,543          35,281             35,452          35,139
   Diluted                                   36,741          35,281             36,983          35,139

  *See accompanying notes to condensed consolidated financial statements.*

                                       4
**FILENET CORPORATION**
                               CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS (UNAUDITED)
                                                            (In thousands)

                                           Three Months Ended June 30,    Six Months Ended June 30,       2002       2001       2002       2001  

 Net income (loss)                         $   1,734  $ (10,695) $   3,098  $ (16,266) 

 Other comprehensive income (loss):
   Foreign currency translation
    adjustments 1                              5,401           (1,439)          4,991           (4,628)
 Unrealized gains on securities:
    Unrealized holding gains 2                    89         75         14         91  
 Total other comprehensive income (loss)       5,490     (1,364)     5,005     (4,537) 
 Comprehensive income (loss)                   7,224    (12,059)     8,103    (20,803) 
1  net of tax effect of $3,601 and $(959) for the three  months ended June 30, 2002 and 2001,  respectively
   and  net of tax effect  of  $3,327  and  $(3,085)  for the  six months  ended  June 30, 2002  and  2001,
   respectively

2  net of  tax effect  of  $59 and $50  for the three  months  ended June 30, 2002 and  2001,  respectively
   and net of tax effect of $9 and $61 for the six months ended June 30, 2002 and 2001, respectively

 *See accompanying notes to condensed consolidated financial statements.*

                                       5

**FILENET CORPORATION**
                         CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
                                               (In thousands)

                                                                   Six Months Ended June 30,          2002         2001   **Cash flows from operating activities:**
Net income (loss)                                              $   3,098           $ (16,266)
Adjustments to reconcile net income (loss) to net cash
  provided by operating activities:
    Purchased in-process research and development                    400                    -
    Depreciation and amortization                                 10,724               11,936
    Loss on sale of fixed assets                                      10                  115
    Provision for doubtful accounts                                  612                  611
    Deferred income taxes                                              9                  (27)
    Changes in operating assets and liabilities, net
      of the effects of acquisition:
      Accounts receivable                                        (15,403)              28,604
      Inventories                                                    458                 (453)
      Prepaid expenses and other current assets                   (3,969)                 260
      Accounts payable                                             2,630               (5,252)
      Accrued compensation and benefits                            2,438               (6,420)
      Customer deposits and advances                                (983)               4,823
      Accrued legal fees                                               -                4,022
      Unearned maintenance revenue                                 9,845               14,934
      Income taxes payable                                           886               (8,645)
      Other                                                       (5,015)     (2,457)  
Net cash provided by operating activities                          5,740      25,785   **Cash flows from investing activities:**
Capital expenditures                                              (6,506)              (9,809)
Proceeds from sale of property                                        40                   83
Note receivable from officer                                      (1,900)                   -
Cash paid for acquisition                                         (9,359)                   -
Purchases of marketable securities                               (73,497)             (72,995)
Proceeds from sales and maturities of marketable
  securities                                                      55,100      40,303   
Net cash used in investing activities                            (36,122)    (42,418)  **Cash flows from financing activities:**
Proceeds from issuance of common stock                             3,603                5,510
Principal payments on capital lease obligations                     (854)       (109)  
Net cash provided by financing activities                          2,749       5,401   

Effect of exchange rate changes on cash and cash
  equivalents                                                      4,421      (3,041)  

Net decrease in cash and cash equivalents                        (23,212)             (14,273)
Cash and cash equivalents, beginning of year                     107,502     101,497   
Cash and cash equivalents, end of period                      $   84,290   $  87,224   

Supplemental cash flow information:
Interest paid                                                 $       51   $      12   

Income taxes paid                                             $      120   $   4,097   *See accompanying notes to condensed consolidated financial statements.*

                                       6

                               FILENET CORPORATION
              Notes To Condensed Consolidated Financial Statements
                                   (Unaudited)

1.   BASIS OF PRESENTATION

     The  accompanying   unaudited  interim  condensed   consolidated  financial
     statements  of FileNET  Corporation  (the  "Company")  reflect  adjustments
     (consisting of normal  recurring  adjustments)  necessary to present fairly
     the financial  position of the Company at June 30, 2002, the results of its
     operations  and its  comprehensive  operations for the three and six months
     ended June 30,  2002 and 2001 and its cash  flows for the six months  ended
     June 30,  2002 and  2001.  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
     condensed  consolidated  financial  statements  are  adequate to ensure the
     information  presented  is not  misleading.  These  condensed  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,
     2001 filed with the SEC on March 28, 2002.  The results of  operations  for
     the interim periods are not necessarily indicative of the operating results
     for the year.

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

2.   RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

     In June 1998, the Financial  Accounting  Standards  Board  ("FASB")  issued
     Statement of Financial  Accounting  Standards ("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. SFAS
     133,  as  amended,  established  accounting  and  reporting  standards  for
     derivative instruments including certain derivative instruments embedded in
     other contracts that were not formerly  considered  derivatives and now may
     meet the definition of a derivative.  Additionally,  this standard requires
     all  derivatives  to be reported on the  balance  sheet at fair value.  For
     derivatives  that are  fair  value  hedges,  changes  in the fair  value of
     derivatives  are offset by the  change in fair value of the hedged  assets,
     liabilities,  or  firm  commitments.  The  Company  adopted  this  standard
     effective  January  1, 2001 with no  significant  effect to its  results of
     operations, financial position, or cash flows.

     In June 2001, the FASB issued SFAS No. 141, "Business  Combinations," which
     was effective  immediately.  SFAS No. 141 requires that the purchase method
     of accounting be used for all business  combinations  initiated  after June
     30, 2001; and it eliminated the  pooling-of-interests  method. The adoption
     of this  standard  did  not  have a  significant  impact  on the  Company's
     consolidated financial statements.  The Company's April 2002 acquisition of
     certain assets and certain  liabilities of eGrail,  Inc. has been accounted
     for in compliance with this pronouncement (see Note 3 for details).

     In June 2001, the FASB issued SFAS No. 142,  "Goodwill and Other Intangible
     Assets," which the Company  adopted  January 1, 2002. SFAS No. 142 requires
     that goodwill and other intangible  assets with indefinite  useful lives no
     longer be amortized, but instead be tested for impairment at least annually
     and written down when impaired.  SFAS No. 142 requires purchased intangible
     assets other than  goodwill to be amortized  over their useful lives unless
     these  lives are  determined  to be  indefinite.  In  accordance  with this
     Standard,  the Company no longer  amortizes  goodwill and  indefinite  life
     intangible  assets but  evaluates  their  carrying  value  annually or when
     events or circumstances indicate that their carrying value may be impaired.
     Assembled    workforce    no   longer   meets   the    definition    of   a
     separately-identified  intangible  asset under the  provisions  of SFAS No.
     141, and the balance of $182,000 was reclassified as goodwill at January 1,
     2002. The Company ceased  amortizing the goodwill  balance of $10.1 million
     from its 2000  acquisition of Applications  Partner,  Inc. as of January 1,
     2002. In accordance with SFAS No. 142, the Company is required to perform a
     two-step transitional  impairment review. The first step of this review was
     completed by June 30, 2002 with the  determination of the fair value of the
     Company's  reporting  units in order to identify  whether the fair value of
     each   reporting   unit    is   less   than    its   carrying   amount.  In
     the  event  that the  fair  value of the  reporting  unit is less  than the

                                       7

     carrying amount, the second step of the test would be required to determine
     if the carrying value of goodwill  exceeds the implied  value.  The Company
     determined that it did not have a transitional  impairment of goodwill. The
     Company had no indefinite life intangible  assets as of January 1, 2002. If
     estimates  change,  a  materially  different  impairment  conclusion  could
     result.

     In August 2001, the FASB issued SFAS No. 144, "Accounting for Impairment or
     Disposal  of  Long-Lived   Assets."  This  Statement   addresses  financial
     accounting  and reporting for the  impairment of long-lived  assets and for
     the disposal of long-lived assets and discontinued operations. SFAS No. 144
     superseded  SFAS No. 121,  "Accounting  for the  Impairment  of  Long-Lived
     Assets and for  Long-Lived  Assets to be Disposed Of," and is effective for
     fiscal  years  beginning  after  December  15,  2001.  The adoption of this
     Standard on January 1, 2002 did not have a material impact on the Company's
     financial position and results of operations.

     In November 2001, the FASB  announced  Emerging  Issues Task Force ("EITF")
     Topic No.  D-103,  "Income  Statement  Characterization  of  Reimbursements
     Received for Out-of-Pocket Expense Incurred",  is required to be applied in
     financial  reporting  periods  beginning  after December 15, 2001. The EITF
     requires   companies   to   characterize    reimbursements   received   for
     out-of-pocket   expenses  as  revenues  in  the  statement  of  operations.
     Historically,   the  Company  has  netted   reimbursements   received   for
     out-of-pocket  expenses  against the related  expenses in the  statement of
     operations.  Application of this EITF requires that  comparative  financial
     statements for prior periods be  reclassified  to comply with the guidance.
     The Company  adopted  this EITF as of January 1, 2002 and has  reclassified
     its prior  period  consolidated  financial  statements  to  conform  to the
     current  presentation.  The  adoption  of this EITF did not have a material
     effect on total revenues or gross margin  percentages  and has no impact on
     results of operations as it required an equivalent increase to both revenue
     and cost of revenue. Revenue and cost of revenue for the three months ended
     June 30, 2001  increased by $642,000 and  increased by $1.2 million for the
     six months ended June 30, 2001.

     In July 2002, the FASB issued SFAS 146,  "Accounting  for Costs  Associated
     with Exit or Disposal Activities," which addresses financial accounting and
     reporting  for  costs  associated  with  exit or  disposal  activities  and
     supersedes EITF Issue 94-3,  "Liability  Recognition  for Certain  Employee
     Termination Benefits and Other Costs to Exit an Activity (including Certain
     Costs  Incurred  in  a  Restructuring)."   SFAS  146  requires  that  costs
     associated  with exit or disposal  activities be  recognized  when they are
     incurred  rather  than at the date of a  commitment  to an exit or disposal
     plan.  SFAS 146 also  establishes  that the liability  should  initially be
     measured and recorded at fair value.  The Company will adopt the provisions
     of SFAS 146 for  exit or  disposal  activities  that  are  initiated  after
     December 31, 2002.

3.   ACQUISITIONS

     On April 2, 2002, the Company  acquired  certain assets and assumed certain
     liabilities of eGrail, Inc.  ("eGrail"),  a Web content management company,
     for $9.0 million in cash. This strategic  acquisition  provides  additional
     Web Content  Management  ("WCM")  software  application  capabilities  that
     enhance the Company's position in the Enterprise Content Management ("ECM")
     market.  These  enhancements  are expected to expand our ECM  offerings and
     contributed to the purchase price that resulted in goodwill.  In accordance
     with  SFAS No.  141,  "Business  Combinations,"  the  acquisition  has been
     accounted for under the purchase  method of accounting.  The purchase price
     for eGrail consisted of $9.0 million cash and direct  acquisition  costs of
     $359,000. The purchase price was allocated as follows (in thousands):

             Net tangible assets                             $      581
             Goodwill                                             5,793
             Patents                                                 24
             Acquired technology                                  3,300
             In-process research and development                    400
             Liabilities assumed                                   (739)  $    9,359  

     The amount  allocated to in-process  research and  development and acquired
     technology was determined through established  valuation  techniques in the
     high-technology   industry  by  an   independent   third-party   appraiser.
     In-process  research and development was expensed upon acquisition  because
     technological   feasibility   had  not  been   established  and  no  future
     alternative uses existed. New product development underway at eGrail at the
     time of the  acquisition  included the next generation of their Web Content
     Management  product  that was in the early  stages  of  design  and only 5%
     complete at the date of the  acquisition.  The cost to complete the project

                                       8

     was estimated at  approximately  $3.0 million to occur over a  twelve-month
     period. As of June 30, 2002 the Company has incurred approximately $906,000
     of research and development  expenses related to the project. The remaining
     purchase price was primarily allocated to tangible assets and goodwill. The
     acquired  technology  of $3.3  million  was  assigned a useful life of five
     years and patents of $24,000 were  assigned a useful life of two years.  In
     accordance  with SFAS No. 142,  goodwill  will not be amortized but will be
     reviewed for impairment on an annual basis.  Goodwill is tax deductible for
     this asset purchase.

     Actual  results  of  operations  of eGrail,  as well as certain  assets and
     liabilities  acquired  on April 2,  2002,  are  included  in the  condensed
     consolidated financial statements from the date of acquisition.  Therefore,
     the  Company's  financial  results for the three months ended June 30, 2002
     include the actual results of eGrail for this period. The pro forma results
     of  operations  data for the six month periods ended June 30, 2001 and 2002
     presented  below assume that the acquisition had been made at the beginning
     of fiscal 2001. The pro forma data is presented for informational  purposes
     only and is not necessarily  indicative of the results of future operations
     nor  of  the  actual   results  that  would  have  been  achieved  had  the
     acquisitions taken place at the beginning of fiscal 2001 (in thousands):

                                              Six Months Ended June 30,
                                                  2002       2001   

         Revenue                           $   175,220       $   170,528
         Net Income (Loss)                       1,515           (17,269)
         Earnings (Loss) per share:

            Basic                                 0.04             (0.49)

            Diluted                               0.04             (0.49)

     Alliant Partners acted as financial  advisors to eGrail in this transaction
     and was paid  approximately  $500,000 by eGrail.  John Savage,  a member of
     FileNET's  Board of Directors and the Audit Committee of FileNET's Board of
     Directors,  is  Managing  Partner of  Alliant  Partners  and,  accordingly,
     recused  himself  from  all  discussions  related  to the  transaction  and
     abstained from voting on this transaction.

4.   GOODWILL AND PURCHASED INTANGIBLE ASSETS

     In  acquisitions  accounted  for using the  purchase  method,  goodwill  is
     recorded as the  difference,  if any,  between the aggregate  consideration
     paid  for an  acquisition  and  the  fair  value  of the net  tangible  and
     identified  intangible  assets  acquired.  Statement  No. 142 requires that
     ratable  amortization  of  goodwill  and  indefinite  life  intangibles  be
     replaced  with  periodic  review and  analysis  of  goodwill  for  possible
     impairment.  Intangible  assets with definite  lives must be amortized over
     their  estimated  useful lives. On January 1, 2002 the Company adopted SFAS
     No. 142, and as a result, goodwill is no longer amortized. Summarized below
     are the  effects on net income  (loss)  per share data if the  Company  had
     followed the amortization  provisions of SFAS 142 for all periods presented
     (in thousands, except per share amounts):

                                                              Three Months Ended          Six Months Ended
                                                                   June 30,                   June 30,
                                                            2002      2001      2002      2001  

     Net income (loss):
        As reported                                     $  1,734       $ (10,695)     $  3,098     $ (16,266)
        Add:  goodwill amortization, net of taxes              -       617         -     1,200  

           Adjusted net income (loss)                   $  1,734       $  (10,078)$   3,098    $  (15,066)

     Basic net income (loss) per share:
        As reported                                     $   0.05       $   (0.30)     $   0.09     $   (0.46)
        Add:  goodwill amortization, net of taxes              -      0.02         -      0.03  

           Adjusted basic net income (loss) per
             share                                      $   0.05       $   (0.28) $   0.09     $   (0.43) 

                                       9

     Diluted net income (loss) per share:
        As reported                                     $   0.05       $   (0.30)     $   0.08     $   (0.46)
        Add:  goodwill amortization, net of taxes              -      0.02         -      0.03  

           Adjusted diluted net income (loss) per
             share                                      $   0.05       $   (0.28) $   0.08     $   (0.43) 

     Note:  Goodwill  and  intangible  assets  were  allocated  to  our  Ireland
     subsidiary  and therefore the following  tables reflect  amounts  resulting
     from foreign exchange translation.

     The  following  table  presents  the changes in goodwill  allocated  to the
     reportable segments during the first six months of 2002 (in thousands):

                                     Balance at                                      Foreign     Balance at
                                   December 31,                                     Currency       June 30,
                                           2001      Acquired     Adjustments    Fluctuation           2002  

        Software                      $   4,914     $   3,654        $     90       $    322      $   8,980
        Customer support                  3,271           406              60            215          3,952
        Professional services
         and education                    1,768         1,733              32            116          3,649
        Hardware                              -         -        -        -         - 

          Total                       $   9,953 $   5,793 $    182 $    653 $  16,581 

     The   adjustments   during   the   first  six   months   were  due  to  the
     reclassification of assembled  workforce  intangible to goodwill at January
     1, 2002 as a result of the  adoption  of SFAS 142.  The  acquired  goodwill
     resulted from the acquisition of eGrail in April 2002.

     Acquired  technology and patents are the Company's only  intangible  assets
     subject to amortization under Statement No. 142. These assets were recorded
     in connection  with the April 2002 eGrail  acquisition and are comprised of
     the following as of June 30, 2002 (in thousands):

                                                     Accumulated
                                        Gross   Amortization        Net 

         Acquired technology        $   3,468          $     173     $   3,295
         Patents                           25              3         22  $   3,493      $     176  $   3,317 

     Acquired technology is being amortized over a useful life of five years and
     patents are being  amortized over a useful life of two years.  Amortization
     expense for amortizing  intangible assets was $168,190 for the three months
     ended June 30, 2002 and estimated future  amortization  expense  (excluding
     foreign exchange effect) of purchased intangible assets as of June 30, 2002
     is as follows (in thousands):

                             Fiscal
                               Year            Amount 
          2002 (remaining 6 months)           336,380
                               2003           672,760
                               2004           663,190
                               2005           660,000
                               2006           660,000
                               2007           165,000
                                        $   3,157,330 

                                       10

5.   EARNINGS (LOSS) PER SHARE

     Basic  earnings  (loss) per share is computed by dividing net income (loss)
     for the period by the weighted average number of common shares  outstanding
     during the period.  Diluted  earnings per share is computed by dividing net
     income by the weighted average number of common shares outstanding plus the
     dilutive effect of outstanding  stock options and shares issuable under the
     employee stock purchase plan using the treasury stock method.  The dilutive
     loss  per  share  excludes  these  adjustments,  as  the  impact  would  be
     anitidilutive.  The following table sets forth the computation of basic and
     diluted  earnings (loss) per share for the  three and six months ended June
     30, 2002 and 2001:

      *(In thousands, except per share amounts)*   Three months ended June 30,     Six months ended June 30,             2002           2001           2002             2001  

        Net income (loss)                           $   1,734  $  (10,695)  $   3,098  $ (16,266) 

        Shares used in computing
           basic earnings (loss) per share             35,543         35,281            35,452           35,139
        Dilutive effect of stock plans                  1,198           -       1,531          -  
        Shares used in computing
           diluted earnings (loss) per share           36,741         35,281            36,983           35,139

         Earnings (loss) per basic share            $    0.05     $    (0.30)        $    0.09        $   (0.46)
         Earnings (loss) per diluted share          $    0.05     $    (0.30)        $    0.08        $   (0.46)

6.   ACCUMULATED OTHER COMPREHENSIVE LOSS

     In June  1997,  the FASB  issued  SFAS No.  130,  "Reporting  Comprehensive
     Income." SFAS No. 130 requires  enterprises to report  comprehensive income
     and its components in general-purpose  financial  statements.  SFAS No. 130
     was effective for the Company beginning January 1, 1998.  Accordingly,  the
     Company has prepared  Statements of  Comprehensive  Operations  for the six
     months ended June 30, 2002. Accumulated other comprehensive loss as of June
     30, 2002 is comprised of the following:

                                                       Foreign      Unrealized            Accumulated
                                                      Currency         Holding                  Other
                                                   Translation           Gains          Comprehensive
         *(in thousands)*                           Adjustment         (Losses)            Operations  

            Balance, December 31, 2001            $   (14,079)       $      39           $    (14,040)
            Current period changes                      4,991          14          5,005  
            Balance June 30, 2002                 $    (9,088)  $      53   $     (9,035) 

7.   OPERATING SEGMENT DATA

     The Company has prepared  operating segment  information in accordance with
     SFAS No. 131,  "Disclosures  About  Segments of An  Enterprise  and Related
     Information,"  to report  components  that are  evaluated  regularly by the
     Company's  chief  operating  decision  maker,  or decision making group, in
     deciding  how to  allocate  resources  and in  assessing  performance.  The
     Company is organized  geographically  and by line of business.  The line of
     business  management  structure is the primary  basis upon which  financial
     performance is assessed and resources allocated.

     The Company's  reportable  operating  segments include  Software,  Customer
     Support,  Professional Services and Education,  and Hardware.  The Software
     operating  segment  develops and markets the Company's  Enterprise  Content
     Management and Business Process Management software products.  The Customer
     Support  segment  provides  after-sale  support  for  software,  as well as
     providing software upgrades pursuant to the Company's right to new versions
     program. The Professional Services and Education segment provides fee-based
     implementation  and technical  services  related to the Company's  software

                                       11

     products,  and also  provides  training.  The  Hardware  operating  segment
     manufactures  and  markets  the  Company's  line  of  Optical  Storage  And
     Retrieval ("OSAR") libraries. The financial results of the segments reflect
     allocation of certain  functional  expense  categories  consistent with the
     basis  and  manner in which  Company  management  internally  disaggregates
     financial  information  for the  purpose of  assisting  in making  internal
     operating decisions,  which are not the same as GAAP reporting. The Company
     evaluates  performance  based on  stand-alone  segment  operating  results.
     Because the Company  does not evaluate  performance  based on the return on
     assets at the operating segment level, assets are not tracked internally by
     segment. Therefore, segment asset information is not presented.

     Operating  segments  data for the three and six months  ended June 30, 2002
     and 2001 are as follows:

                                           Three months ended June 30,     Six months ended June 30,
        *In thousands*         2002            2001           2002          2001   
       Software
         Revenue                          $    34,350     $    28,788    $    65,590    $    61,531
         Operating loss                       (12,984)        (19,530)       (25,408)       (34,699)

       Customer Support
         Revenue                          $    37,281     $    32,690    $    73,844    $    61,829
         Operating income                      14,480           9,844         28,145         18,195

       Professional Services and
         Education Revenue                $    14,491     $    18,707    $    30,327    $    35,934
         Operating loss                        (1,234)         (1,306)        (1,679)        (3,777)

       Hardware
         Revenue                          $     2,105     $     2,663    $     4,707    $     8,048
         Operating income (loss)                   22            (394)           136           (406)   

       Total
         Revenue                          $    88,227     $    82,848    $   174,468    $   167,342
         Operating income (loss)                  284         (11,386)         1,194        (20,687)

8.   LEGAL PROCEEDINGS

     In the normal  course of  business,  the  Company  is  subject to  ordinary
     routine  litigation  incidental to the business.  While the results of this
     litigation  cannot be predicted with certainty,  the Company  believes that
     the final  outcome  of these  matters  will not have a  materially  adverse
     effect on its consolidated results of operations or financial condition.

9.   RELATED PARTY TRANSACTIONS

     In  July  2001,  the  Compensation  Committee  of the  Company's  Board  of
     Directors  entered into discussions  with Lee Roberts,  the Company's Chief
     Executive  Officer,  regarding a secured loan by the Company to Mr. Roberts
     to enable him to  purchase  a home in Orange  County,  California.  In July
     2001, the Compensation  Committee forwarded its recommendation to the Board
     to approve, in principle,  a secured loan, in the amount of $1.2 million to
     Mr. Roberts.  In September 2001, the Compensation  Committee  approved,  in
     principle,  an increase  in the  previously  requested  loan amount to $1.9
     million,  subject to review of final loan  documents  and  approval  of the
     Board.  In May 2002,  the  Compensation  Committee  reviewed  proposed loan
     documentation  for  a  secured  loan  to  Mr.  Roberts  and  forwarded  its
     recommendation  to the Board to approve  the loan on the terms set forth in
     the loan  documents.  The loan  documents  provided  that the loan would be
     secured by the real estate purchased by Mr. Roberts.  Subsequently, on June
     5, 2002,  the Board approved the loan documents and the loan. The authority
     to grant such a loan is "grand fathered" under Section 13 of the Securities
     Exchange Act of 1934, as amended by Section 402 of the  Sarbanes-Oxley  Act
     on July 30, 2002.
                                       12

     As of June 30, 2002,  FileNET had an  outstanding  secured note  receivable
     from  Mr.  Roberts  in the  amount  of $1.9  million  that  relates  to the
     above-referenced  loan  and is  included  in other assets on the  condensed
     consolidated  balance  sheet.  The note bears  interest at 2.89% per annum.
     Accrued interest on the principal  balance of this note is payable annually
     beginning  February 15, 2003 and on each February 15th thereafter until the
     entire  principal  balance  becomes due. The entire  outstanding  principal
     balance of this note and any  accrued  interest  is due and  payable at the
     earliest  of (a)  June 7,  2005,  (b) one  year  after  termination  of Mr.
     Roberts' employment by the Company, or (c) ninety (90) days after voluntary
     termination of employment by Mr. Roberts. The difference between the stated
     interest rate of the Note and a fair value interest rate of 7% was recorded
     as a  discount  that is  being  amortized  over  the  term  of the  Note to
     compensation expense using the effective interest method.

10.  FOREIGN CURRENCY TRANSACTIONS

     As of June 30, 2002, we had forward foreign exchange contracts  outstanding
     totaling  approximately  $1,192,809 eight  currencies.  These contracts are
     opened on the last  business  day of the  quarter and mature  within  three
     months.  Accordingly,  the fair value of such contracts is zero at June 30,
     2002.

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

This Quarterly Report on Form 10-Q contains  forward-looking  statements  within
the meaning of the Private Securities Litigation Reform Act of 1995, Section 21E
of the  Securities  Exchange  Act of 1934,  as  amended,  and Section 27A of the
Securities Act of 1933, as amended,  and is subject to the safe harbors  created
by those sections.  These forward-looking  statements are subject to a number of
risks and  uncertainties,  including  those  discussed in "Risk Factors That May
Affect  Future  Results"  below and in the notes to our  consolidated  financial
statements  for the year ended  December  31, 2001.  The actual  results that we
achieve may differ materially from any forward-looking statements, which reflect
management's  opinions only as of the date hereof. We undertake no obligation to
revise or publicly release the results of any revisions to these forward-looking
statements. Readers should carefully review the risk factors described below and
in other  documents we file from time to time with the  Securities  and Exchange
Commission,  including  our Annual Report on Form 10-K for the fiscal year ended
December 31, 2001.

**Overview**

FileNET  Corporation  develops,  markets,  implements  and  services  Enterprise
Content Management ("ECM") and Business Process Management software products and
eBusiness applications and solutions for selected vertical markets. Our software
products enable  organizations  to improve  operational  efficiency and leverage
their  content  resources  through the  delivery  of  efficient,  flexible,  and
scalable  eBusiness process  management  solutions.  We also offer  professional
services and training for the  implementation  of these software  solutions,  as
well as 24 hours a day, seven days a week technical  support and services to our
customers on a global basis.

**Significant Accounting Policies**

We prepare the consolidated  financial  statements of FileNET in conformity with
accounting  principles  generally accepted in the United States of America.  The
consolidated  financial  statements include our accounts and the accounts of our
wholly-owned subsidiaries.  All intercompany balances and transactions have been
eliminated.   The  preparation  of  financial   statements  in  conformity  with
accounting  principles  generally  accepted  in the  United  States  of  America
requires  management to make estimates and assumptions  that affect the reported
amounts of assets and  liabilities  at the date of the financial  statements and
the reported amounts of revenues and expenses during the reporting  period.  The
significant  accounting  policies we believe  are most  critical to aid in fully
understanding  and  evaluating  our  reported   financial  results  include  the
following:

***Revenue Recognition.***  Revenues  from  sales of software  licenses  sold  through
direct and  indirect  channels,  which do not  contain  multiple  elements,  are
recognized upon shipment of the related product if the requirements of Statement
of Position ("SOP") 97-2, as amended,  are met. If the requirements of SOP 97-2,
including  evidence of an  arrangement,  delivery,  fixed or  determinable  fee,
collectibility or vendor specific evidence about the value of an element are not
met at the date of shipment,  revenue is not recognized  until such elements are
known  or  resolved.  Software  license  revenue  for  arrangements  to  deliver
unspecified  additional  software  products in the future is recognized  ratably
over the term of the arrangement,  beginning with the initial shipment.  Revenue
from  post-contract  customer support is recognized ratably over the term of the
contract. Revenue from professional services and education is recognized as such
services are  delivered  and  accepted by the  customer.  Anticipated  losses on

                                       13

fixed-price  contracts are  recognized in the period when they become known.  We
recognize other revenue at the time of product delivery and accrue any remaining
costs, including vendor obligations. Based on historical experience, we maintain
a sales return  allowance for the estimated amount of potential  returns.  While
such returns have  historically  been minimal and within our expectations of the
allowances established,  we cannot guarantee that we will continue to experience
the same return rates that we have in the past.

***Accounts Receivable.***  We evaluate the creditworthiness of our customers prior to
order fulfillment and we perform ongoing credit  evaluations of our customers to
adjust  credit  limits  based on  payment  history  and the  customer's  current
creditworthiness.  We monitor  collections  from our  customers  and  maintain a
provision for estimated credit losses that is based on historical experience and
on  specific  customer   collection  issues.   While  such  credit  losses  have
historically  been within our  expectations and the provisions  established,  we
cannot  guarantee that we will continue to experience the same credit loss rates
that we  have  in the  past.  Since  our  revenue  recognition  policy  requires
customers to be  creditworthy,  our accounts  receivable  are based on customers
whose payment is reasonably  assured.  Our accounts  receivable are derived from
sales to a wide variety of customers. We do not believe a change in liquidity of
any one customer or our inability to collect from any one customer  would have a
material adverse impact on our financial position.

***Deferred Income Taxes.***  Deferred  income  taxes  reflect  the net tax effects of
temporary differences between the carrying amounts of assets and liabilities for
financial  reporting  purposes and the amounts used for income tax purposes.  We
maintain a valuation  allowance  against a portion of the deferred tax asset due
to  uncertainty  regarding the future  realization  based on historical  taxable
income,  projected  future  taxable  income,  and  the  expected  timing  of the
reversals  of  existing  temporary  differences.  If we operate at a loss or are
unable to  generate  sufficient  future  taxable  income we could be required to
increase the valuation  allowance  against all or a  significant  portion of our
deferred  tax  assets  which  would  result  in a  substantial  increase  to our
effective  tax rate  and  could  result  in a  material  adverse  impact  on our
operating results.

***Accounting for Impairment or Disposal of Long-Lived  Assets.***  We account for the
impairment and disposition of long-lived assets in accordance with the Statement
of  Financial  Accounting  Standards  ("SFAS")  No.  144,  "Accounting  for  the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." In
accordance  with SFAS No. 144,  long-lived  assets to be held are  reviewed  for
events or changes in  circumstances  that indicate that their carrying value may
not be  recoverable.  In August 2001, the Financial  Accounting  Standards Board
("FASB")  issued  SFAS No.  144,  "Accounting  for  Impairment  or  Disposal  of
Long-Lived Assets." This statement addresses financial  accounting and reporting
for the  impairment  of  long-lived  assets and for the  disposal of  long-lived
assets.  SFAS No. 144 superseded SFAS No. 121, and is effective for fiscal years
beginning  after December 15, 2001. We evaluate the carrying value of intangible
assets for impairment of value based on  undiscounted  future cash flows,  which
are subject to change.  While we have not  experienced  impairment of intangible
assets in prior periods,  we cannot  guarantee that there will not be impairment
in the future.

***Research and Development Costs.***  We expense  research and  development  costs as
incurred.  No amounts are required to be capitalized in accordance with SFAS No.
86,  "Accounting  for the Costs of  Computer  Software  to be Sold,  Leased,  or
Otherwise   Marketed,"   because  our   software  is   substantially   completed
concurrently with the establishment of technological feasibility.

**Results of Operations**

The  following  table sets forth certain  consolidated  statements of operations
data as a percentage of total revenue for the periods indicated:

                                                 Three months ended June 30,        Six months ended June 30,       2002            2001        2002             2001   
Revenue:
   Software                                           38.9 %          34.7 %          37.6 %           36.8 %
   Customer support                                   42.3            39.5            42.3             36.9
   Professional services and
    education                                         16.4            22.6            17.4             21.5
   Hardware                                            2.4       3.2       2.7       4.8  
Total Revenue                                        100.0           100.0           100.0            100.0

                                       14

Cost of revenue:
   Software                                            2.8             1.6             2.6              2.0
   Customer support                                   11.1            13.8            11.4             14.0
   Professional services and
    education                                         15.0            19.7            15.3             19.9
   Hardware                                            1.8       2.4       2.0       3.3  
      Total cost of revenue                           30.7      37.5      31.3      39.2  

Gross Profit                                          69.3      62.5      68.7      60.8  

Operating expenses
Research and development                              21.6            23.6            20.9             21.3
Selling, general and administrative                   46.9            52.6            46.9             51.9
In-process research and development                    0.5         -       0.2         -  
      Total operating expenses                        69.0            76.2            68.0             73.2

Operating income (loss)                                0.3           (13.7)            0.7            (12.4)
Other income, net                                      2.2      (2.2)      1.6      (0.1) 
Income (loss) before income tax                        2.5 %   (15.9)%     2.3 %   (12.5)%**Revenue**

Total  revenue  was $88.2  million  for the three  months  ended  June 30,  2002
compared to $82.8 million for the three months ended June 30, 2001, representing
an increase of $5.4 million, or 6%. Total revenue was $174.5 million for the six
months  ended June 30,  2002 and $167.3  million for the  comparable  six months
ended June 30, 2001,  representing  an increase of $7.2 million,  or 4%. As more
fully discussed below, the increase in total revenue was primarily  attributable
to an increase in software  and customer  support  revenue  partially  offset by
lower professional services and education revenue.

Software  revenue  consists of fees earned from the  licensing  of our  software
products to customers.  Software revenue  increased by 19%, or $5.6 million,  to
$34.4  million for the three months  ended June 30, 2002 from $28.8  million for
the three months ended June 30, 2001;  and increased by 7%, or $4.1 million,  to
$65.6  million for the six months ended June 30, 2002 from $61.5 million for the
six months  ended June 30, 2001.  Software  revenue  represented  38.9% of total
revenue  for the three  months  ended June 30,  2002  compared  to 34.7% for the
comparable  period of 2001, and represented  37.6% of total revenues for the six
months ended June 30, 2002 compared to 36.8% for the comparable  period of 2001.
Compared to 2001, the increases in software revenue in 2002 are primarily due to
increased  revenue from channel partners across most  geographies.  While we saw
signs of potential  improvement  in customer  spending in the second  quarter of
2002, we are not currently  able to assess the likely trend of software  revenue
in future periods due to the continued slowdown in IT spending.

Customer  support  revenue   consists  of  revenue  from  software   maintenance
contracts,  "fee for service" revenues and the sale of spare parts and supplies.
Customer support revenue increased by 14%, or $4.6 million, to $37.3 million for
the three  months  ended June 30, 2002 from $32.7  million for the three  months
ended June 30, 2001;  and increased by 19%, or $12.0  million,  to $73.9 million
for the six months  ended June 30,  2002 from $61.9  million  for the six months
ended June 30, 2001. Customer support revenue represented 42.3% of total revenue
for the three  months ended June 30, 2002  compared to 39.5% for the  comparable
period of 2001; and represented 42.3% of total revenues for the six months ended
June 30, 2002 compared to 36.9% for the comparable  period of 2001. The increase
in  customer  support  revenue  was  primarily  due to the growth in our base of
customers who receive ongoing  maintenance as a result of new customer sales and
sales of  additional  products to our  installed  base along with a high rate of
renewal on the existing base.  However,  the occurrence of a prolonged  economic
slowdown that continues to reduce software  revenue will result in a decrease in
the future growth rate of customer support revenue.

Professional   services  and  education  revenue  is  generated  primarily  from
consulting  and  implementation  services  provided to end users of our software
products,  technical  consulting services provided to our resellers and training
services  provided  to  end  users  and  resellers.  Professional  services  are
generally  performed on a time and  material  basis.  Professional  services and
education  revenue  decreased by 22%, or $4.2 million,  to $14.5 million for the
three months  ended June 30, 2002 from $18.7  million for the three months ended
June 30, 2001;  and decreased by 16%, or $5.6 million,  to $30.3 million for the

                                       15

six months  ended June 30,  2002  compared to $35.9  million for the  comparable
period of 2001. Professional services and education revenue represented 16.4% of
total revenue for the three months ended June 30, 2002 compared to 22.6% for the
comparable  period in 2001, and represented  17.4% of total revenues for the six
months ended June 30, 2002 compared to 21.5% for the comparable  period of 2001.
Professional  services and education  revenue  generally  reflects the trends in
software  revenue that  occurred two to three  quarters  prior.  The decrease in
professional  services and  education  revenue in 2002 compared to 2001 resulted
primarily  from  decreased  software  revenue  that  occurred  in 2001  due to a
slowdown in IT spending.  A prolonged  economic  slow down,  which  continues to
negatively affect software revenue, will most likely continue to have a negative
impact on professional services and education revenue.

Hardware revenue is generated primarily from the sale of 12-inch Optical Storage
and Retrieval  ("OSAR")  libraries.  Hardware revenue  decreased by 21%, or $0.6
million,  to $2.1  million  for the three  months  ended June 30, 2002 from $2.7
million for the three months  ended June 30, 2001 and  decreased by 42%, or $3.4
million, to $4.7 million for the six months ended June 30, 2002 compared to $8.1
million for the comparable period of 2001.  Hardware revenue represented 2.4% of
total  revenue for the three months ended June 30, 2002 compared to 3.2% for the
comparable  period of 2001, and  represented  2.7% of total revenues for the six
months ended June 30, 2002 compared to 4.8% for the  comparable  period of 2001.
Hardware  is not a  strategic  focus for us and we expect  hardware  revenue  to
continue to decrease as a percent of total revenue.

International  revenue accounted for 27% of total revenue, or $23.7 million, for
the three months ended June 30, 2002 and 22% of total revenue, or $18.1 million,
for the  three  months  ended  June 30,  2001,  and  accounted  for 27% of total
revenue,  or $46.8 million,  for the six months ended June 30, 2002, and 27%, or
$44.6 million, for the comparable period of 2001. This increase in international
sales for the first six months in 2002 of $2.2  million is primarily a result of
increased sales to our channel partners.

**Cost of Revenue**

Total cost of revenue decreased to $27.1 million for the three months ended June
30,  2002  from  $31.1  million  for the  three  months  ended  June  30,  2001,
representing  a decrease of $4.0 million,  or 13%. For the six months ended June
30, 2002,  total cost of revenue  decreased to $54.6  million from $65.6 million
for the comparable period in 2002,  representing a decrease of $11.0 million, or
17%. This decrease is primarily due to decreases in the cost of customer support
revenue and professional  services and education revenue as discussed more fully
below.

Cost of software  revenue  includes  royalties  paid to third  parties,  partner
commissions,  software media costs,  and the cost to manufacture  and distribute
software.  The cost of software revenue increased by 92% to $2.5 million for the
three  months  ended June 30, 2002 from $1.3  million for the three months ended
June 30,  2001,  and  increased  by 35% to $4.6 million for the six months ended
June 30, 2002 from $3.4 million for the six months  ended June 30,  2001.  These
costs  represented  7% and 5% of the  related  software  revenue for each of the
three and six months ended June 30, 2002 and 2001, respectively. These increases
in absolute  dollars are  primarily  the result of increased  use of third party
software  products  resulting  in  higher  royalty  fees and  increased  partner
commissions  as a consequence  of increased  channel  revenue.  Going forward we
anticipate cost of software  revenue as a percent of software  revenue to remain
comparable to current levels.

Cost of customer support revenue  includes costs of customer support  personnel,
cost of  supplies  and  spare  parts,  and  the  cost  of  third-party  hardware
maintenance.  The cost of  customer  support  revenue  decreased  by 15% to $9.8
million  for the three  months  ended June 30,  2002 from $11.5  million for the
three months ended June 30, 2001;  and decreased by 15% to $19.9 million for the
six months ended June 30, 2002 from $23.5  million for the six months ended June
30, 2001.  These costs  represented 26% and 35% of the related  customer support
revenue for the three months ended June 30, 2002 and 2001, respectively; and 27%
and 38% of the related  customer  support  revenue for the six months ended June
30, 2002 and 2001,  respectively.  The decrease in absolute dollars is primarily
attributable to lower  compensation cost as a result of a reduction in workforce
in 2001. The decrease as a percentage of customer  support  revenue is primarily
attributable to automation and process  improvements  that allowed growth in the
customer  base,  which  generated  increased  revenue,  without  a  proportional
increase  in  support  personnel  and  cost.  We  expect  these  costs to remain
relatively stable in absolute dollars for the foreseeable future.

Cost of professional  services and education revenue consists primarily of costs
of  professional  services  personnel,   training  personnel,   and  third-party
independent consultants. The cost of professional services and education revenue
decreased by 19% to $13.2  million for the three months ended June 30, 2002 from
$16.3 million for the three months ended June 30, 2001;  and decreased by 20% to
$26.6  million for the six months ended June 30, 2002 from $33.3 million for the
six months  ended June 30,  2001.  These  costs  represented  91% and 87% of the

                                       16

related  professional  services and education revenue for the three months ended
June  30,  2002  and  2001,  respectively;  and  88%  and  93%  of  the  related
professional  services and  education  revenue for the six months ended June 30,
2002 and 2001,  respectively.  The  decrease in absolute  dollars was  primarily
attributable  to a reduction in the use of higher cost  third-party  independent
consultants and reduced variable compensation as a result of lower 2002 revenues
discussed  above.  We expect  professional  services  and  education  costs as a
percentage of professional services and education revenue to vary from period to
period  depending on the  utilization  rates of internal  resources  and the mix
between internal and third party independent consultants.

Cost of hardware  revenue  includes the cost of assembling and  distributing our
OSAR library products, the cost of hardware integration personnel,  and warranty
costs.  The cost of hardware  revenue  decreased  by 18% to $1.6 million for the
three  months  ended June 30, 2002 from $1.9  million for the three months ended
June 30,  2001;  and  decreased  by 36% to $3.5 million for the six months ended
June 30, 2002 from $5.5 million for the six months  ended June 30,  2001.  These
costs  represented  75% and 73% of the  related  hardware  revenue for the three
months  ended  June 30,  2002  and  2001,  respectively;  and 75% and 68% of the
related  hardware  revenue  for the six  months  ended  June 30,  2002 and 2001,
respectively.  The  decrease  in  absolute  dollars is  directly  related to the
decrease in sales of OSAR  library  products.  The  increase in cost of hardware
revenue as a percentage  of hardware  revenue was  primarily  due to  unabsorbed
fixed costs.

**Operating Expenses**

Research and  development  expense  primarily  consists of costs of personnel to
support product development. Research and development expense decreased by 2% to
$19.1  million for the three months  ended June 30, 2002 from $19.5  million for
the three  months  ended June 30,  2001,  and  represented  22% and 24% of total
revenue for these respective periods. Research and development expense increased
2% to $36.4  million for the six months  ended June 30, 2002 from $35.6  million
for the six months ended June 30, 2001, and represented 21% of total revenue for
these  respective  periods.  Excluding  the impact of one-time  charges in 2001,
explained  below,  and the added  charges  in 2002 more fully  explained  below,
expenses  increased in  the three and six-month periods ended June 30, 2002 over
the  comparable  periods in 2001 primarily due to increased  headcount  expense.
Expenses for the period ended June 30, 2001 included a one-time bonus payment of
$2.0  million  related  to  the  Applications   Partners   Incorporated  ("API")
acquisition.  The  eGrail  acquisition,  which was  completed  on April 2, 2002,
contributed  approximately  $1.5  million of  additional  expenses,  including a
one-time  charge  of  $400,000  for  in-process  research  and  development  and
amortization  of purchased  intangible  assets of $168,000,  in the three months
ended June 30, 2002.

Our  research  and  development  efforts  are  focused  on  developing  our  ECM
capabilities.  These  efforts  will focus on  improvements  in Business  Process
Management,   Content   Management,   Web  Content   Management  and  associated
applications to provide a richer competitive  product offering to our customers.
We intend to compliment  internal  development with third party software through
OEM agreements and may execute additional technology  acquisitions.  New product
development  underway at eGrail at the time of the acquisition included the next
generation of their Web Content  Management product that was in the early stages
of  design  and only 5%  complete  at the date of the  acquisition.  The cost to
complete the project was estimated at approximately $3.0 million to occur over a
twelve-month period. As of June 30, 2002 the Company has incurred  approximately
$906,000 of research and development expenses related to the project.

We expect that competition for qualified technical  personnel,  while easing due
to  the  global  economic  slowdown  in  the  short-term,  will  remain  intense
thereafter and may result in higher levels of compensation expense for us in the
future.  We  believe  that  research  and  development  expenditures,  including
compensation   of  technical   personnel,   are  essential  to  maintaining  our
competitive  position  and expect  these  costs will  continue to  constitute  a
significant percentage of total revenue.

Selling,  general and  administrative  expense  consists  primarily of salaries,
benefits,  sales  commissions  and other  expenses  related  to the  direct  and
in-direct  sales force;  various  marketing  expenses;  the cost of other market
development  programs;  personnel  costs for  finance,  information  technology,
legal,  human  resources  and  general  management;  and  the  cost  of  outside
professional services.  Selling, general and administrative expense decreased by
5% to $41.4  million for the three months ended June 30, 2002 from $43.6 million
for the three months ended June 30, 2001, and  represented  47% and 53% of total
revenues  for these  respective  periods.  Selling,  general and  administrative
expense  decreased  6% to $81.8  million for the six months  ended June 30, 2002
from $86.8 million for the six months ended June 30, 2001, and  represented  47%
and 52% of total revenue for these respective  periods.  These decreases in 2002
were primarily due to a reduction in headcount  during 2001 resulting in overall
reduced  personnel costs,  lower recruitment and training expense in addition to
decreased   marketing   development   expense.   The   elimination  of  goodwill
amortization,  which was $1.5  million for the six months  ended June 30,  2001,
also contributed to this decrease (see  "Amortization of Goodwill and Intangible
Assets" below).

                                       17

We expect operating  expenses to remain at or above these current levels for the
foreseeable future as a result of continued development of our ECM capabilities.

**Amortization of Goodwill and Identifiable Intangible Assets**

In connection  with our  acquisition of certain assets from API on May 18, 2000,
the  purchase  price  amount  allocated  to goodwill of $14.6  million was being
amortized  over a useful life of five years and assembled  workforce of $386,000
was being amortized over a useful life of three years.  These amortization costs
were  recorded  in  selling,  general  and  administrative  expense.  We  ceased
amortizing  goodwill and  assembled  workforce as of the  beginning of the first
quarter of 2002 in  compliance  with SFAS No. 142. In  contrast,  we  recognized
$762,000 of  amortization  expense in the three  months  ended June 30, 2001 and
$1.5  million of  amortization  expense in the six months  ended June 30,  2001.
Assembled  workforce no longer meets the  definition of a  separately-identified
intangible asset under the provisions of SFAS No. 141, "Business  Combinations,"
and the balance of  $182,000  was  reclassified  as goodwill at January 1, 2002.
SFAS No. 142 is effective  for new business  combinations  that occur after June
30, 2001. Accordingly,  goodwill of $5.8 million that was recorded in April 2002
in  connection  with  the  eGrail  acquisition  will not be  amortized.  We will
evaluate the carrying value of goodwill annually or when events or circumstances
indicate that their carrying value may be impaired.  In accordance with SFAS No.
142, we are required to perform a two-step  transitional  impairment  review. We
completed the first step of this review by June 30, 2002 with the  determination
of the fair value of our reporting  units in order to identify  whether the fair
value of each reporting unit is less than its carrying amount. In the event that
the fair  value of the  reporting  unit is less than the  carrying  amount,  the
second step of the test would be required to determine if the carrying  value of
goodwill  exceeds  the  implied  value.  We  determined  that we did not  have a
transitional impairment of goodwill. We had no indefinite life intangible assets
as of January 1, 2002. If estimates  change, a materially  different  impairment
conclusion could result.

**Other Income, Net**

Other income,  net consists  primarily of interest income earned on our cash and
cash  equivalents,  short and long-term  investments,  and other items including
foreign exchange gains and losses,  the gain (loss) on sale of fixed assets, and
interest expense.  Other income, net was $1.9 million for the three months ended
June 30, 2002  compared to other loss,  net of $1.8 million for the three months
ended June 30, 2001.  Other  income,  net for the six months ended June 30, 2002
was $2.8  million  compared to other loss,  net of $166,000  for the  comparable
six-month  period in 2001. The loss in 2001 was due to a one-time charge of $4.0
million for a legal  settlement that was recorded in the second quarter of 2001.
Included  in other  income,  net in the second  quarter of 2002 is a net gain on
foreign  exchange  of $1.1  million  related  to the  strengthening  of the euro
against the U.S. dollar during the quarter.

**Income Taxes**

Our combined federal,  state and foreign annual effective tax rate for the three
months ended June 30, 2002, is 21% compared to 19% for the comparable  period in
2001. The combined federal,  state and foreign annual effective tax rate for the
six months ended June 30, 2002, is 23% compared to 22% for the comparable period
in 2001.  FileNET  management will continue weighing various factors  throughout
the year to assess the  recoverability  of its recorded  deferred assets and the
need for any valuation  allowance  against such amounts.  Any  adjustment to the
valuation allowance could affect the effective tax rate in subsequent quarters.

**Liquidity and Capital Resources**

At June 30, 2002, combined cash, cash equivalents and investments totaled $168.7
million,  a decrease of $3.5 million from  December 31, 2001.  Cash  provided by
operating  activities  during the six months  ended June 30, 2002  totaled  $5.7
million and resulted primarily from an increase in unearned  maintenance revenue
related to prepaid maintenance  contracts,  an increase in accounts payable, net
income and additions to net income for depreciation  and  amortization  expense,
offset by increases in accounts  receivable and an increase in prepaid expenses.
Cash used for investing  activities  totaled $36.1 million and included  capital
expenditures of $6.5 million, a $1.9 million note receivable from officer,  $9.4
million for the eGrail acquisition,  and net purchases of marketable  securities
of $18.4 million. Cash provided by financing activities totaled $2.7 million and
was a result of proceeds  received  from the exercise of employee  stock options
and stock purchases under the employee stock purchase plan offset by payments on
capital  lease  obligations.  Exchange  rate changes  during the second  quarter
provided an increase in cash of $4.4 million

Accounts  receivable  increased  to $53.4  million  at June 30,  2002 from $36.9
million at December 31, 2001. This increase is primarily a result of higher days
sales outstanding due to slightly slower overall collections.

                                       18

Current  liabilities  increased  to $95.3  million  at June 30,  2002 from $79.6
million at December 31, 2001.  This increase in current  liabilities  from $31.0
million at December  31, 2001 to $43.0  million at June 30, 2002 is  primarily a
result of a significant  increase in unearned maintenance revenue due to a large
portion of our customer  base  renewing  their annual  maintenance  in the first
quarter of 2002.

We have a $5.0 million  multi-currency  revolving line of credit available until
June 27, 2003.  Borrowings under the arrangement are unsecured and bear interest
at one hundred and twenty-five  basis points over the London  Interbank  Offered
Rate. A standby letter of credit fee of one hundred and twenty five basis points
per annum and a  commitment  fee of fifty basis  points is assessed  against any
undrawn amounts.  There were no borrowings  outstanding at June 30, 2002. We are
subject to certain  financial  covenants  that include,  but are not limited to,
compliance  with specific  balance sheet ratios,  no two  consecutive  quarterly
losses, an aggregate loan limit to the officers not to exceed $5.0 million,  and
a capital  expenditure  limit under this line of credit. As of June 30, 2002, we
were in compliance with all covenants.

We expect  capital  expenditures  to be slightly  above  current  levels for the
remainder of 2002.  We anticipate  that our present cash balances  together with
internally  generated  funds and  credit  lines will be  sufficient  to meet our
working  capital  and  capital  expenditure  needs for at least the next  twelve
months.

**Other Financial Instruments**

We enter into forward foreign exchange  contracts as a hedge against the effects
of  fluctuating  currency  exchange  rates on  monetary  assets and  liabilities
denominated  in currencies  other than the  functional  currency of the relevant
entity.  We are 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.  These contracts  mature every three
months  at the end of each  quarter.  We open new  hedge  contracts  on the last
business  day of each  quarter  that  will  mature  at the end of the  following
quarter. The counterparties to these contracts are major financial institutions.
We use  commercial  rating  agencies  to  evaluate  the  credit  quality  of the
counterparties and do not anticipate nonperformance by any counterparties. We do
not anticipate a material loss resulting from any credit risks related to any of
these institutions.

**Recent Accounting Pronouncements**

In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial  Accounting  Standards ("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.  SFAS 133, as amended,  established
accounting and reporting standards for derivative  instruments including certain
derivative  instruments  embedded  in other  contracts  that  were not  formerly
considered  derivatives  and  now  may  meet  the  definition  of a  derivative.
Additionally,  this  standard  requires  all  derivatives  to be reported on the
balance sheet at fair value. For derivatives that are fair value hedges, changes
in the fair value of  derivatives  are offset by the change in fair value of the
hedged  assets,  liabilities,  or firm  commitments.  We adopted  this  standard
effective January 1, 2001 and it has had no significant effect on our results of
operations, financial position, or cash flows.

In June 2001, the FASB issued SFAS No. 141, "Business  Combinations,"  which was
effective  immediately.  SFAS No.  141  requires  that the  purchase  method  of
accounting be used for all business combinations  initiated after June 30, 2001;
and it eliminated the pooling-of-interests method. The adoption of this standard
did not have a significant impact on our consolidated financial statements.  Our
April 2002  acquisition of certain  assets of eGrail,  Inc. was accounted for in
compliance with this pronouncement (see Note 3 for details).

In June 2001,  the FASB  issued  SFAS No. 142,  "Goodwill  and Other  Intangible
Assets," which we adopted  January 1, 2002.  SFAS No. 142 requires that goodwill
and other intangible assets with indefinite useful lives no longer be amortized,
but instead be tested for  impairment  at least  annually  and written down when
impaired.  SFAS No. 142 requires purchased intangible assets other than goodwill
to be amortized  over their useful live unless these lives are  determined to be
indefinite. In accordance with this Standard, we no longer amortize goodwill and
indefinite life intangible  assets but evaluate their carrying value annually or
when events or circumstances indicate that their carrying value may be impaired.
Assembled  workforce no longer meets the  definition of a  separately-identified
intangible  asset under the provisions of SFAS No. 141,  Business  Combinations,
and the balance of $182,000 was  reclassified as goodwill at January 1, 2002. We
ceased   amortizing  the  goodwill  balance  of  $10.1  million  from  our  2000
acquisition  of  Applications  Partner Inc. as of January 1, 2002. In accordance
with SFAS No. 142, we are required to perform a two-step transitional impairment
review.  We  completed  the first step of this  review by June 30, 2002 with the

                                       19

determination  of the fair  value of our  reporting  units in order to  identify
whether the fair value of each reporting unit is less than its carrying  amount.
In the event that the fair value of the reporting unit is less than the carrying
amount,  the  second  step of the test would be  required  to  determine  if the
carrying value of goodwill  exceeds the implied value. We determined that we did
not have a  transitional  impairment  of  goodwill.  We had no  indefinite  life
intangible  assets as of January 1, 2002.  If  estimates  change,  a  materially
different impairment conclusion could result.

In August 2001,  the FASB issued SFAS No. 144,  "Accounting  for  Impairment  or
Disposal of Long-Lived Assets." This Statement  addresses  financial  accounting
and  reporting for the  impairment of long-lived  assets and for the disposal of
long-lived assets and discontinued operations.  SFAS No. 144 superseded SFAS No.
121,  "Accounting  for the  Impairment of Long-Lived  Assets and for  Long-Lived
Assets to be Disposed  Of," and is effective  for fiscal years  beginning  after
December 15, 2001. The adoption of this Standard on January 1, 2002 did not have
a material impact on our financial position and results of operations.

In November 2001, the FASB announced  Emerging  Issues Task Force ("EITF") Topic
No. D-103,  "Income Statement  Characterization  of Reimbursements  Received for
Out-of-Pocket  Expense  Incurred",  is  required  to  be  applied  in  financial
reporting periods beginning after December 15, 2001. The EITF requires companies
to characterize  reimbursements  received for out-of-pocket expenses as revenues
in the  statement of  operations.  Historically,  we have netted  reimbursements
received  for  out-of-pocket  expenses  against  the  related  expenses  in  the
statement of  operations.  Application  of this EITF requires  that  comparative
financial  statements  for prior  periods  be  reclassified  to comply  with the
guidance.  We adopted this EITF as of January 1, 2002 and have  reclassified our
prior  period  consolidated  financial  statements  to  conform  to the  current
presentation.  The adoption of this EITF did not have a material effect on total
revenues or gross margin  percentages and has no impact on results of operations
as it  required  an  equivalent  increase  to both  revenue and cost of revenue.
Revenue and cost of revenue for the three months  ended June 30, 2001  increased
by $642,000  and  increased  by $1.2  million for the six months  ended June 30,
2001.

In July 2002, the FASB issued SFAS 146,  "Accounting  for Costs  Associated with
Exit or Disposal Activities," which addresses financial accounting and reporting
for costs associated with exit or disposal  activities and supersedes EITF Issue
94-3, "Liability Recognition for Certain Employee Termination Benefits and Other
Costs  to  Exit  an   Activity   (including   Certain   Costs   Incurred   in  a
Restructuring)."  SFAS 146 requires that costs  associated with exit or disposal
activities  be  recognized  when they are incurred  rather than at the date of a
commitment  to an exit or  disposal  plan.  SFAS 146 also  establishes  that the
liability should initially be measured and recorded at fair value. We will adopt
the  provisions of SFAS 146 for exit or disposal  activities  that are initiated
after December 31, 2002.

**Other Matters*****European  Monetary Union.***  On January 1, 1999, 11 of the 15 member  countries of
the European Union  established  fixed  conversion  rates between their existing
sovereign  currencies and the euro.  These countries agreed to adopt the euro as
their common legal currency from that date. The legacy currencies remained legal
tender in these  countries as a denomination of the euro between January 1, 1999
and January 1, 2002.  Beginning on January 1, 2002,  euro-denominated  bills and
coins are now  issued  for cash  transactions.  For a period of up to six months
from this date, both legacy  currencies and the euro were legal tender.  By July
1, 2002, the participating  countries withdrew all legacy currencies and now use
the euro.

We have made the necessary  changes to our internal  business systems to support
transactions  denominated in the euro,  including  establishing euro price lists
for affected countries. We have been transacting in the euro currency since 1999
and have  evaluated the impact the euro has had on our  financial  condition and
results of  operations.  Based on this  evaluation  to date, we currently do not
believe  that  there  has been or will be a  material  impact  on our  financial
condition or results of operations as a result of the euro conversion.

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

                                       20
**Risk Factors That May Affect Future Results**

Our  business,  financial  condition,  operating  results and  prospects  can be
impacted  by a number of factors,  including  but not limited to those set forth
below and  elsewhere  in this  report,  any one of which  could cause our actual
results to differ materially from recent results or from our anticipated  future
results.  Factors that may affect our business,  financial condition and results
of operations include:

***Our  quarterly  operating  results may  fluctuate in future  periods and are not
predictable and, as a result,  we may fail to meet expectations of investors and
analysts, causing our stock price to fluctuate or decline.*** Prior growth rates in
our  revenue  and  operating   results  should  not  necessarily  be  considered
indicative of future  growth or operating  results.  Our operating  results have
fluctuated  in the past and we  anticipate  our future  operating  results  will
continue to fluctuate due to many factors,  some of which are largely beyond our
control. These factors include, but are not limited to, the following:

     o        the industry-wide slow down in IT spending;
     o        general domestic and international economic and political
              conditions;
     o        the discretionary nature of our customers' budget and purchase
              cycles and the absence of long-term customer purchase
              commitments;
     o        the tendency to realize a substantial percentage of our revenue
              in the last weeks, or even days, of each quarter;
     o        the potential for delays or deferrals of customer orders;
     o        the budget cycles of our customers;
     o        the size, complexity and timing of individual transactions;
     o        changes in foreign currency exchange rates and the impact of
              the euro currency;
     o        the length of our sales cycle;
     o        variations in the productivity of our sales force;
     o        the level of software product sold and price competition;
     o        the timing of new software introductions and software enhancements
              by us and our competitors;
     o        the mix of sales by products, software, services and distribution
              channels;
     o        project overruns associated with fixed-price contracts;
     o        acquisitions by us and our competitors;
     o        our ability to develop and market new software products and
              control costs;
     o        the quality of our customer support; and
     o        the level of international sales.

The decision to implement our products is subject to each  customer's  resources
and budget  availability.  Our quarterly sales generally include a mix of medium
sized orders,  along with several large individual  orders, and as a result, the
loss or delay of an individual  large order could have a  significant  impact on
our quarterly operating results and revenue. Our operating expenses are based on
projected revenue trends and are generally fixed. Therefore,  any shortfall from
projected revenue may cause  significant  fluctuations in operating results from
quarter to quarter. As a result of these factors, revenues and operating results
for any quarter are subject to  fluctuations  and are not  predictable  with any
significant  degree of accuracy.  Therefore,  we believe  that  period-to-period
comparisons  of  our  results  of  operations  should  not  be  relied  upon  as
indications  of future  performance.  Moreover,  such  factors  could  cause our
operating  results  in a given  quarter to be below the  expectations  of public
market  analysts and  investors.  In either case,  the price of our common stock
could decline materially.

***The  markets in which we operate  are highly  competitive  and we cannot be sure
that we will be able to continue to compete  effectively,  which could result in
lost  market  share  and  reduced  revenue.***  The  markets  we serve  are  highly
competitive  and we  expect  competition  to  intensify.  Our  future  financial
performance will depend primarily on the continued growth of the markets for our
software  products  and  services  as well as the  purchase  of our  products by
customers  in these  markets.  If the markets we serve fail to grow or grow more
slowly than we currently  anticipate,  our  business,  financial  condition  and
operating  results  would be harmed.  These  intensely  competitive  markets are
highly fragmented and rapidly changing and there are certain competitors of ours
with  substantially   greater  sales,   marketing,   development  and  financial
resources.  Our present or future  competitors  may be able to develop  software
products  comparable  or superior  to those  offered by us,  offer lower  priced
products  or adapt  more  quickly  than we do to new  technologies  or  evolving
customer requirements.  In order to be successful in the future, we must respond
to technological change, customer requirements and competitors' current software
products and  innovations.  We cannot assure that we will be able to continue to
compete  effectively in our target markets or that future  competition  will not
have a material adverse effect on our business,  financial  condition or results
of operations.  In addition,  current and potential competitors have established
or may  establish  cooperative  relationships  among  themselves  or with  third

                                       21

parties to increase  the  ability of their  products to address the needs of the
markets we serve. Accordingly,  it is possible that new competitors or alliances
among  competitors  may emerge and rapidly  acquire  significant  market  share.
Increased competition may result in price reductions,  reduced gross margins and
loss of market share,  any of which could have a material  adverse effect on our
business, financial condition and results of operations.

***We must develop and sell new products to keep up with rapid technological change
in order to achieve future revenue growth and profitability.***  The market for our
software  and services is  characterized  by rapid  technological  developments,
evolving industry standards,  changes in customer  requirements and frequent new
product introductions and enhancements. Our ability to continue to sell products
will be dependent upon our ability to continue to enhance our existing  software
and services offerings,  develop and introduce, in a timely manner, new software
products   incorporating   technological   advances   and  respond  to  customer
requirements.  Our future  success  also  depends,  in part,  on our  ability to
execute  on  our  strategy  of  developing  a  framework  for  Business  Process
Management solutions for the ECM market. This strategy may require us to develop
and maintain  relations with  technology  partners.  We may not be successful in
maintaining  these  relationships or in developing,  marketing and releasing new
products  or  new  versions  of  our  products  that  respond  to  technological
developments,  evolving industry standards or changing customer requirements. We
may also  experience  difficulties  that could delay or prevent  the  successful
development,  introduction  and  sale of these  products  and  enhancements.  In
addition,   these  products  and   enhancements  may  not  adequately  meet  the
requirements of the  marketplace  and may not achieve any significant  degree of
market   acceptance.   If  we  fail  to   successfully   maintain  or  establish
relationships  with technology  partners or to execute on our integrated product
solution  strategy,  or if release dates of any future  products or enhancements
are  delayed,  or if these  products  or  enhancements  fail to  achieve  market
acceptance when released, our business operating results and financial condition
could be  materially  harmed.  In the past,  we have  experienced  delays in the
release  dates of  enhancements  and new  releases to our products and we cannot
assure  that we  will  not  experience  significant  future  delays  in  product
introduction. From time to time, our competitors or we may announce new software
products,  capabilities  or  technologies  that have the potential to replace or
shorten the life cycles of our existing software products. We cannot assure that
announcements of currently planned or other new software products will not cause
customers to delay their  purchasing  decisions in anticipation of such software
products,  and such delays could have a material  adverse effect on our business
and operating results.

***Protection of our intellectual property and other proprietary rights is limited,
which could result in the use of our  technology by  competitors  or other third
parties. There is risk of third-party claims of infringement, which could expose
us to litigation and other costs.***   Our success depends, in part, on our ability
to protect our  proprietary  rights to the  technologies  used in our  principal
products.  We rely on a combination  of copyrights,  trademarks,  trade secrets,
patents,  confidentiality  procedures and contractual  provisions to protect our
proprietary rights in our software products.  We cannot assure that our existing
or future  copyrights, trademarks,  trade secrets, patents or other intellectual
property  rights will have  sufficient  scope or strength to provide  meaningful
protection  or a  commercial  advantage  to us.  In  addition,  the laws of some
foreign  countries do not protect our proprietary  rights to the same extent, as
do the laws of the United  States.  Our  inability  to protect our  intellectual
property may have a material adverse effect on our business, financial condition
and results of operations.

We may, from time to time, be notified that we are infringing  certain patent or
intellectual  property  rights of others.  While there are no  material  actions
currently  pending against us for  infringement  of patent or other  proprietary
rights of third  parties,  we cannot assure that third parties will not initiate
infringement  actions  against  us in the  future.  Combinations  of  technology
acquired through past or future  acquisitions and our technology will create new
software  products  and  technology  that  also  may  give  rise  to  claims  of
infringement. Infringement actions can result in substantial costs and diversion
of  resources,  regardless  of the  merits of the  actions.  If we were found to
infringe upon the rights of others,  we cannot assure that we could redesign the
infringing  products or could obtain  licenses on acceptable  terms,  if at all.
Additionally,  significant  damages for past  infringement  could be assessed or
future litigation relative to any such licenses or usage could occur. An adverse
disposition of any claims or the advent of litigation  arising out of any claims
of infringement  may have a material  adverse effect on our business,  financial
condition and results of operations.

***We depend on certain  strategic  relationships  in order to  license third-party
products  and  revenue  related  to these  products  could be at risk if we were
unable to maintain these  relationships.***  In order to expand the distribution of
our products and broaden our product  offerings,  we have established  strategic
relationships  with a number of indirect channel partners and other  consultants
that provide marketing and sales  opportunities for us. We have entered into key
formal and  informal  agreements  with other  companies such as IBM Crossworlds,
Microsoft Corporation, SAP AG, Siebel Systems Inc, Sun Microsystems,  Inc., BEA,
and  Verity,  Inc.  Certain of these  agreements  do not have  minimum  purchase
requirements  and/or  are  cancelable  at will.  We  cannot  assure  that  these
companies will not reduce or discontinue  their  relationships  with, or support
of, FileNET and our products. Our failure to maintain these relationships, or to
establish new  relationships in the future,  could harm our business,  financial
condition and results of operations.

                                       22

We currently  license certain  software from third parties,  including  software
that is integrated with internally  developed  software and used in our products
to perform key functions.  In the past, we have had difficulty  renewing certain
licenses.  The failure to continue to maintain  these licenses would prohibit us
from selling  certain  products.  We cannot  assure that such third parties will
remain in business,  that they will continue to support their software  products
or  that  their  software  products  will  continue  to  be  available  to us on
acceptable  terms.  The loss or  inability  to  maintain  any of these  software
licenses  could result in shipment  delays or reductions  in software  shipments
until  equivalent  software  can  be  developed,   identified,   licensed,   and
integrated.  This could adversely  affect our business,  financial  condition or
results of operations.

***We must retain and attract key executives and personnel who are essential to our
business,  which  could  result in  increased  personnel  expenses.***  Our success
depends to a  significant  degree upon the  continued  contributions  of our key
management, as well as other marketing, technical and operational personnel. The
loss of the services of one or more key employees could have a material  adverse
effect on our operating results.  We also believe our future success will depend
in large part upon our ability to attract and retain  additional  highly skilled
management,  technical, marketing, product development and operational personnel
and consultants. There is competition for such personnel,  particularly software
developers,  professional service consultants and other technical personnel, and
pay scales in the software  industry  have  significantly  increased.  We cannot
assure that in the future we will be successful in attracting and retaining such
personnel.

***A  significant  percent of our  revenue is  derived  internationally  and we are
subject  to many risks  internationally,  which  could put our  revenue at risk.***
Historically,  we have derived  approximately  25%-30% of our total revenue from
international  sales through our worldwide  network of subsidiaries  and channel
partners.  International business is subject to certain risks including, but not
limited to, the following:

     o        tariffs and trade barriers;
     o        varying technical standards;
     o        political and economic instability;
     o        reduced protection for intellectual property rights in certain
              countries;
     o        difficulties in staffing and maintaining foreign operations;
     o        difficulties in managing foreign distributors;
     o        varying requirements for localized products;
     o        potentially adverse tax consequences;
     o        currency restrictions and currency exchange fluctuations including
              those related to the euro;
     o        the burden of complying with a wide variety of complex foreign
              laws, regulations and treaties;
     o        the possibility of difficulties in collecting accounts receivable;
              and
     o        longer payment cycles.

Any of these  factors  could have a  material  adverse  effect on our  business,
financial condition or results of operations in the future.

***If our software  contains  errors we could incur  unplanned  expenses and delays
which could  result in reduced  revenue,  lower  profits and harmful  publicity.***
Software and products as complex as those we sell are  susceptible  to errors or
failures,  especially  when first  introduced or when new versions are released.
Our  software  products  are often  intended  for use in  applications  that are
critical to a customer's  business.  As a result,  our customers may rely on the
effective  performance  of our software to a greater  extent than the market for
software products generally. Despite internal testing and testing by current and
potential customers,  new products or enhancements may contain undetected errors
or  performance  problems  that are  discovered  only  after a product  has been
installed  and used by customers.  Errors or  performance  problems  could cause
delays  in  product   introduction   and  shipments  or  could  require   design
modifications,  either  of which  could  lead to a loss in or delay of  revenue.
These  problems  could  cause a diversion  of  development  resources,  harm our
reputation  or result in  increased  service or warranty  costs,  or require the
payment of monetary  damages,  any of which could harm our  business,  operating
results and financial  condition.  While our license  agreements  with customers
typically contain provisions designed to limit our exposure to potential product
liability  claims,  it is possible that such limitation of liability  provisions
may not be effective under the laws of certain jurisdictions.

***Our stock price has been and may continue to be volatile causing fluctuations in
the market price of our stock, which would impact shareholder value.*** The trading
price  of our  common  stock  has  fluctuated  in the  past  and is  subject  to
significant  fluctuations  in response to the following  factors,  among others,
some of which are beyond our control:

     o        variations in quarterly operating results;
     o        fluctuations in our order levels;

                                       23

     o        changes in earnings estimates by analysts;
     o        announcements of technological innovations or new products or
              product enhancements by us or our competitors;
     o        key management changes;
     o        changes in joint marketing and development programs;
     o        developments relating to patents or other intellectual property
              rights or disputes;
     o        developments in our relationships with our customers, resellers
              and suppliers;
     o        our announcements of significant contracts, acquisitions,
              strategic partnerships or joint ventures;
     o        general conditions in the software and computer industries;
     o        fluctuations in general stock market prices and volume, which
              are particularly common among highly volatile securities of
              Internet and software companies; and
     o        other general economic and political conditions.

In recent years, the stock market, in general, has experienced extreme price and
volume  fluctuations  that have affected the market price for many  companies in
industries  similar to ours. Some of these  fluctuations  have been unrelated to
the operating  performance of the affected companies.  These market fluctuations
may decrease the market price of our common stock in the future.

***Acquisitions  of  companies or  technologies  may result in  disruptions  to our
business and diversion of management attention,  which could cause our financial
performance to suffer.*** As part of our business strategy,  we frequently evaluate
strategic acquisition opportunities.  For example, on April 2, 2002, we acquired
certain assets and assumed  certain  liabilities of eGrail,  Inc., a Web content
management company,  for a purchase price of $9.0 million in cash. We anticipate
that our future growth may depend in part on our ability to identify and acquire
complementary  businesses,  technologies or product lines.  Acquisitions involve
significant  risks and could divert  management's  attention from the day-to-day
operations of our ongoing business.  Additionally, such acquisitions may include
numerous other risks, including, but not limited to the following:

     o        difficulties in the integration of the operations, products and
              personnel of the acquired companies;
     o        the incurrence of debt;
     o        liabilities and risks that are not known or identifiable at the
              time of the acquisition;
     o        difficulties in retaining the acquired company's customer base;
              and
     o        the potential loss of key personnel of the acquired company.

If we fail to successfully  manage future acquisitions or fully integrate future
acquired businesses,  products or technologies with our existing operations,  we
may not receive the intended  benefits of the acquisitions and such acquisitions
may harm our business and financial results.

**Item 3.  Quantitative and Qualitative Disclosures about Market Risk****Interest Rate Risk**

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

The following table provides information about our cash and cash equivalents and
our investment portfolio at June 30, 2002 (dollars in thousands):

                                                                          Weighted
                                                                           Average
     Portfolio                                            Balance            Yield   
     Cash and Equivalents-Domestic                    $    30,542             1.81 %
     Cash and Equivalents-International                    46,269             3.05 %
     Short Term Municipals - Taxable                       10,881             2.05 %

                                       24

     Commercial Paper                                       6,045             1.87 %
     Corporate                                              8,462             2.43 %
     Governments/Agencies                                  66,494             2.50 %
       Total                                                                  2.47 %
                                                      $   168,693  **Foreign Currency Fluctuations and Inflation**

Our 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.
As of June 30,  2002,  we had forward  foreign  exchange  contracts  outstanding
totaling  approximately  $1,192,809  in eight  currencies.  These  contracts are
opened on the last business day of the quarter and mature within three months.

Cumulative  other  comprehensive  loss decreased $5.0 million for the six months
ended  June 30,  2002  due to  unrealized  foreign  currency  translation  gains
resulting from the  strengthening of the euro against the U.S. dollar during the
second quarter of 2002.

Management  believes  that  inflation  has not had a  significant  impact on the
prices of our products, the cost of our materials,  or our operating results for
the three and six months ended June 30, 2002 and 2001.

**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 2002  Annual  Meeting of  Stockholders  of the Company was held at 9:00
     a.m. on May 22, 2002, in Costa Mesa, California.

(b)  At the annual meeting,  the following six  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                   31,395,051                350,011
      William P. Lyons                  31,395,305                349,757
      Lee D. Roberts                    31,390,443                354,619
      John C. Savage                    31,407,971                337,091
      Roger S. Siboni                   30,550,236              1,194,826
      Theodore J. Smith                 31,307,695                437,367

(c)  The Company's  stockholders  were asked to approve the 2002 Incentive Award
     Plan pursuant to which an aggregate of 1,400,000  shares would be available
     for issuance  hereunder.  This proposal was approved in accordance with the
     following vote of stockholders:

                                                                          **Broker****Votes For            Votes Against         Abstentions           Non-Votes**
      17,875,173               5,706,252              66,770           8,096,867

(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  1,100,000  shares.  This proposal was approved in accordance
     with the following vote of stockholders:

                                                                          **Broker****Votes For            Votes Against         Abstentions           Non-Votes**
     21,948,564                1,635,177              64,424           8,096,897

                                       25

(e)  The Company's  stockholders were asked to ratify the Company's  appointment
     of Deloitte and Touche LLP as  independent  accountants  of the Company for
     the fiscal year ending  December  31, 2002.  This  proposal was approved in
     accordance with the following vote of stockholders:

    **Votes For           Votes Against         Abstentions**
      30,957,296                 743,428              44,338

**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)  Reports on Form 8-K
     On April 12,  2002,  the  Registrant  filed a report on
     Form 8-K relating to the  Registrant's  acquisition  of certain  assets and
     certain  liabilities of eGrail,  Inc., which report was amended on June 11,
     2002.

                                       26
**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 14, 2002 
Date
                           By:      /s/  Sam M. Auriemma                         
                                  Sam M. Auriemma, Senior Vice President, Finance
                                  (Principal Financial and Accounting Officer)
                                  and Chief Financial Officer

                                       27

**Index to Exhibits****Exhibit
  No.      Exhibit Description**

 3.1*      Restated Certificate of Incorporation,  as amended *(filed as Exhibit 3.1 to
           Registrant's 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 Registrant's 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, filed on July 21, 1987; Registration No. 33-15004).*

 4.1*      Form of certificate evidencing Common Stock *(filed as Exhibit 4.1 to
           Registrant's registration statement on Form S-1, filed on July 21, 1987;
           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 Registrant's registration statement on
           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 Agreement dated as of November 4, 1988 between FileNET Corporation and
           BANKBOSTON,  N.A. formerly known as The First National Bank of Boston *(filed
           as Exhibit 4.3 to Registrant's Quarterly Report on Form 10-Q for the quarter
           ended September 30, 1998).*

4.4*       Amendment Three dated November 30, 2001 to Rights Agreement dated as of
           November 4, 1988 between FileNET Corporation and Equiserve Trust Company,  N.A.,
           successors to BANKBOSTON,  N.A. *(filed as Exhibit 4.4 to Registrant's Annual
           Report on Form 10-K filed for the year ended  December  31, 2001).*

10.1*      Second Amended and Restated Credit Agreement  (Multi-currency)  by and between
           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 Registrant's
           Quarterly  Report on Form 10-Q for the quarter ended June 30, 1999)* as amended
           by a Waiver and First  Amendment to Credit  Agreement  dated as of June 29, 2001
           and by a letter amendment dated as of April 5, 2002.

10.1.1*    Waiver and First  Amendment to Credit  Agreement  (Multi-currency)  by and
           between the Registrant and Bank of America, N.A., formerly known as Bank of
           America National Trust and Savings Association, dated June 29, 2001, effective
           June 29, 2001 *(filed as Exhibit 10.1 to Registrant's Annual Report on Form 10-K
           filed for the year ended December 31, 2001).*

10.1.2     Letter amendment dated as of April 5, 2002 and Third Amendment to Credit
           Agreement (Multi-currency) by and between the Registrant and Bank of
           America, N.A., dated as of June 28, 2002.

10.2*+     Amended and Restated 1995 Stock Option Plan of FileNET *(filed as Exhibit 99.1
           to Registrant's registration statement on Form  S-8 filed on October 15, 2001;
           Registration No. 333-71598).*

10.3*+     Second Amended and Restated 1986 Stock Option Plan of FileNET Corporation,
           together with the forms of Incentive Stock Option Agreement and Non-Qualified
           Stock Option Agreement (*filed as Exhibits 4(a), 4(b) and 4(c), respectively,
           to the Registrant's registration statement on Form S-8, filed on June 10, 1992;
           Registration No. 33-48499)*, the first Amendment thereto *(filed as Exhibit 4(d)
           to the Registrant's registration statement on Form S-8, filed on October 4, 1993;
           Registration No. 33-69920)*, and the Second Amendment thereto *(filed as
           Appendix A to the Registrant's Definitive Proxy Statement on Schedule 14A for
           the Registrant's 1994 Annual Meeting of Stockholders, filed on April 29, 1994).*

10.4*+     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  Registrant's registration statement on Form S-8 filed on August 20, 1997).*

10.5*+     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 Registrant's registration statement on Form S-8 filed on
           August 20, 1997).*

10.6*+     Amended and Restated FileNET Corporation 1998 Employee Stock Purchase Plan
          *(filed as Appendix B to  Registrant's  Definitive  Proxy Statement on Schedule
           14A, for the Registrant's 2002 Annual Meeting of Stockholders, filed on
           April 18, 2002).*

10.7*+     FileNET Corporation International Employee Stock Purchase Plan (*filed as
           Appendix C to Registrant's Definitive Proxy Statement on Schedule 14A,for the
           Registrant's 2002 Annual Meeting of Stockholders, filed on April 18, 2002).*

                                       28

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

10.9*      Asset Purchase Agreement between the Registrant and Application Partners, Inc.
           dated May 18, 2000 *(filed as Exhibit 10.24 to Registrant's Quarterly Report on
           Form 10-Q for the quarter ended June 30, 2000).*

10.10*+    Written Compensation Agreement and Non-Statutory Stock Option Agreement(with
           Notice of Grant of Stock Option and Special Addendum) between Registrant and
           Mr. Sam Auriemma *(filed as Exhibit 99.1 and 99.2 to Registrant's registration
           statement on Form S-8, filed on April 20, 2001; Registration No. 333-59274).*

10.11*     Asset Purchase Agreement, dated April 2, 2002 by and between 3565 Acquisition
           Corporation and eGrail, Inc. *(filed as Exhibit 10.1 to Registrant's Current
           Report on Form 8-K, filed on April 12, 2002).*

10.12      Secured Promissory Note between Registrant and Mr. Lee D Roberts, dated
           June 14, 2002.

10.13      Option Exchange Agreement between Registrant and Mr. Ron L. Ercanbrack, dated
           May 22, 2002, together with form of Incentive Stock Option Agreement and Grant
           Notice.

10.14      The 2002 Incentive Award Plan, as approved by stockholders at the Registrant's
           Annual Meeting on May 22, 2002, together with the forms of Incentive  Option
           Agreement and Non-Qualified Stock Option Agreement for Independent Directors.

           ** Incorporated herein by reference
           + Management contract, compensatory plan or arrangement*

                                       29
**EXHIBIT 10.1.2

                          [Bank of America Letterhead]**
                            [Office of Kevin McMahon]

April 10, 2002

Ms. Behshid Amini-Rad
Manager Treasury Operations
Filenet Corporation
3565 Harbor Blvd.
Costa Mesa, CA  92626-1420

         Re: Extension of Bank Guarantee

Dear Behshid:

     At  your  request,  Bank  of  America,  N.A.,  did  not  send a  notice  of
non-renewal  which could have been sent April 5, 2002,  with  respect to Bank of
America's Guarantee #851271 issued to Engels-Hollandse  Beleggingstrust  N.V. as
beneficiary (the "Guarantee") on July 6, 2000 in the amount of EUR 106,000.  The
consequence of not sending that notice was to permit the automatic  extension of
the expiry date of the Guarantee from July 6, 2002, to July 6, 2003.

     The  Guarantee  was issued  pursuant to that  certain  Amended and Restated
Credit  Agreement  (Multicurrency)  dated as of June 30,  1999,  as amended by a
Waiver and First  Amendment to Credit  Agreement  dated as of June 29, 2001 (the
"Credit  Agreement")  to which we are both  parties.  Section  2.06(b)(i) of the
Credit  Agreement states that each Bank Guarantee shall expire no later than the
Final  Maturity  date  which in  respect of Bank  Guarantees  is June 28,  2003.
Notwithstanding  Section  2.06(b)(i) Bank of America  permitted the extension of
the  Guarantee to July 6, 2003,  at your  request,  and both Bank of America and
Filenet  Corporation  agree that Section  2.06(b)(i) of the Credit  Agreement is
hereby  amended  solely  to  permit  the  extension  of the  expiry  date of the
Guarantee to July 6, 2003.  Except as amended hereby,  all terms,  covenants and
provisions of the Credit Agreement are and shall remain in full force and effect
and constitute the legal, valid and binding  obligations of Filenet  Corporation
enforceable against it in accordance with its terms.

[Official 2000-2004 Olympic Sponsor logo]

page 2

     Please  confirm your  acknowledgement  and  agreement  to the  foregoing by
countersigning and returning a copy of this letter. As always, we are pleased to
assist you.

                                                  Very truly yours,

                                                  **Bank of America, N.A.**

Acknowledged and agreed:
**Filenet Corporation**
                                                  By:    */s/ Kevin M. McMahon*

By:    */s/ Sam M. Auriemma*             Name:    Kevin M. McMahon         

Name:    Sam M. Auriemma                          Title:   Managing Director        

Title:   Sr. Vice President and CFO  

By:    */s/ Lee D. Roberts*

Name:    Lee D. Roberts              

Title:   Chairman and CEO            

Date:  April ___, 2002

**THIRD AMENDMENT TO CREDIT AGREEMENT**

     THIS THIRD AMENDMENT TO CREDIT  AGREEMENT (this  "Amendment"),  dated as of
June  28,  2002,  is  entered  into  by and  between  FILENET  CORPORATION  (the
"Company") and BANK OF AMERICA, N. A. (the "Bank").

                                    **RECITALS**

     A.   The Bank and the Company are parties to an Amended and Restated Credit
          Agreement  (Multicurrency)  dated as of June 30, 1999, as amended by a
          Waiver and First  Amendment to Credit  Agreement  dated as of June 29,
          2001 and by a letter  amendment dated as of April 5, 2002 (the "Credit
          Agreement")  pursuant to which the Bank has  extended  certain  credit
          facilities to the Company and certain Acceptable Subsidiaries.

     B.   The Company has requested that the Bank agree to certain amendments of
          the Credit Agreement.

     C.   The Bank is  willing  to amend the  Credit  Agreement,  subject to the
          terms and conditions of this Amendment.

     NOW,  THEREFORE,  for valuable  consideration,  the receipt and adequacy of
which are hereby acknowledged, the parties hereto hereby agree as follows:

     1.   **Defined Terms**. Unless otherwise defined herein, capitalized terms used
          herein shall have the meanings, if any, assigned to them in the Credit
          Agreement.

     2.   **Amendments to Credit Agreement**.  The Credit Agreement shall be amended
          as follows:

          (a)  Section  1.01 of the  Credit  Agreement  shall be  amended at the
               defined term  "Availability  Period" by replacing  the date "June
               28, 2002" with "June 27, 2003."

          (b)  Section  1.01 of the  Credit  Agreement  shall be  amended at the
               defined term "Final  Maturity Date" by amending such defined term
               in its entirety to read as follows:

          **"Final Maturity Date"**: (a) in respect of any Advances,  June 27, 2003;
               (b) in respect of any standby  letters of credit,  June 27, 2004;
               and (c) in respect of any Bank Guaranties, June 27, 2004.

          (c)  Section  2.02(b)  of the  Credit  Agreement  shall be  amended by
               replacing the amount "1.20%" with the amount "1.25%."

          (d)  Section  2.04(d)  of the  Credit  Agreement  shall be  amended by
               replacing the amount "0.85%" with the amount "1.25%."

                                       1

          (e)  Section  2.09  of  the  Credit  Agreement  shall  be  amended  by
               replacing the amount "0.25%" with "0.50%."

     3.   **Representations and Warranties**.   The  Company  hereby  represents and
          warrants to the Bank as follows:

          (a)  No Default or Event of Default has occurred and is continuing.

          (b)  The  execution,  delivery and  performance by the Company of this
               Amendment  have been duly  authorized by all necessary  corporate
               and other action and do not and will not require any registration
               with,  consent or approval of, notice to or action by, any person
               or entity  (including any governmental  authority) in order to be
               effective  and  enforceable.  The Credit  Agreement as amended by
               this  Amendment   constitutes   the  legal,   valid  and  binding
               obligations of the Company,  enforceable against it in accordance
               with its  respective  terms,  without  defense,  counterclaim  or
               offset.

          (c)  All  representations  and warranties of the Company  contained in
               the Credit  Agreement  are true and correct on and as of the date
               hereof.

          (d)  The Company is entering  into this  Amendment on the basis of its
               own investigation and for its own reasons,  without reliance upon
               the Bank or any other person or entity.

     4.   **Effective Date**.  This Amendment  will become  effective the date first
          above written (the "Effective Date"), provided:

          (a)  The Bank has received from the Company a duly  executed  original
               (or, if elected by the Bank, an executed  facsimile copy) of this
               Amendment.

          (b)  The Bank has  received  from the  Company a copy of a  resolution
               passed by the board of directors of such  corporation,  certified
               by the Secretary or an Assistant Secretary of such corporation as
               being in full force and effect on the Effective Date, authorizing
               the execution,  delivery and performance of this Amendment, along
               with an incumbency certificate.

          (c)  All representations and warranties  contained herein are true and
               correct as of the Effective Date.

          (d)  The Bank has  received  from the  Company  the  amount of $5,000,
               representing  payment in full of a non-refundable  amendment fee,
               which amount the Company covenants to pay to the Bank on demand.

     5.   **Reservation of Rights**.   The  Company  acknowledges  and   agrees  the
          execution  and  delivery  by the Bank of this  Amendment  shall not be
          deemed to create a course of dealing or otherwise obligate the Bank to
          enter  into   amendments   under  the  same,   similar  or  any  other
          circumstances in the future.

                                       2

     6.   **Miscellaneous**.

          (a)  Except as herein  expressly  amended,  all terms,  covenants  and
               provisions  of the Credit  Agreement are and shall remain in full
               force and  effect  and all  references  therein  and in the other
               Credit  Documents to such Credit Agreement shall henceforth refer
               to the  Credit  Agreement  as  amended  by this  Amendment.  This
               Amendment shall be deemed  incorporated  into, and a part of, the
               Credit Agreement. This Amendment is a Credit Document.

          (b)  This Amendment  shall be binding upon and inure to the benefit of
               the  parties  hereto  and  to  the  Credit  Agreement  and  their
               respective  successors and assigns.  No third party beneficiaries
               are intended in connection with this Amendment.

          (c)  This  Amendment  shall be governed by and construed in accordance
               with the law of the State of California.

          (d)  This  Amendment  may be executed  in any number of  counterparts,
               each  of  which  shall  be  deemed  an  original,  but  all  such
               counterparts  together  shall  constitute  but one  and the  same
               instrument.  Each of the parties  hereto  understands  and agrees
               that this document (and any other document  required  herein) may
               be  delivered  by any  party  thereto  either  in the  form of an
               executed  original  or an  executed  original  sent by  facsimile
               transmission  to be  followed  promptly by mailing of a hard copy
               original, and that receipt by the Bank of a facsimile transmitted
               document  purportedly  bearing the signature of the Company shall
               bind the Company,  with the same force and effect as the delivery
               of a hard copy  original.  Any failure by the Bank to receive the
               hard copy executed  original of such document  shall not diminish
               the  binding  effect  of  receipt  of the  facsimile  transmitted
               executed  original of such document  which hard copy page was not
               received by the Bank,  and the Bank is hereby  authorized to make
               sufficient  photocopies thereof to assemble complete counterparty
               documents.

          (e)  This Amendment,  together with the Credit Agreement, contains the
               entire  and  exclusive  agreement  of  the  parties  hereto  with
               reference  to the  matters  discussed  herein and  therein.  This
               Amendment  supersedes  all prior drafts and  communications  with
               respect  thereto.  This  Amendment  may not be amended  except in
               accordance  with the  provisions  of  Section  9.05 of the Credit
               Agreement.

          (f)  If any  term or  provision  of this  Amendment  shall  be  deemed
               prohibited by or invalid under any applicable law, such provision
               shall be invalidated  without affecting the remaining  provisions
               of this Amendment or the Credit Agreement, respectively.

                                       3

     IN WITNESS  WHEREOF,  the parties  hereto have executed and delivered  this
Amendment as of the date first above written.

                                         **FILENET CORPORATION**

                                         By: 
                                         Name: 
                                         Title: 

                                         By: 
                                         Name: 
                                         Title: **BANK OF AMERICA, N.A.**

                                         By: 
                                         Name: 
                                         Title: 

                                       4

**EXHIBIT 10.12

                             SECURED PROMISSORY NOTE

$1,900,000                                                Costa Mesa, California
                                                                   June 14, 2002**

     FOR VALUE RECEIVED,  the undersigned,  Lee D. Roberts  ("Roberts"),  hereby
promises to pay to the order of FileNET Corporation ("Payee"), the principal sum
of One Million Nine Hundred Thousand Dollars ($1,900,000), or so much thereof as
may be outstanding  under this Note,  with interest on the unpaid  principal sum
owing  hereunder at the rate of 2.89% per annum  accruing  from the date hereof,
all payable in the manner and at the time or times provided below, together with
all other  amounts  due Payee  under this Note and the Deed of Trust (as defined
below).

     Interest  shall  accrue  from  the  date  hereof.  All  interest  shall  be
calculated  based upon a 365 day year and  charged  on the basis of actual  days
elapsed.

     Accrued  interest  on the  principal  balance  of this  Note  shall be paid
annually  beginning February 15, 2003 and on each February 15th thereafter until
the entire principal  balance becomes due as provided in the next sentence.  The
entire outstanding  principal balance of this Note (and any accrued interest) is
due and payable at the earlier of (a) the second year plus 359 days  anniversary
of the date of this Note,  (b) one year after  termination  by Payee of Roberts'
employment with Payee,  or (c) ninety (90) days after  termination by Roberts of
his employment with Payee.  Any other amounts due and unpaid under this Note and
the Deed of Trust  shall be due and  payable  within  ten (10)  days of  written
demand  therefore.  Except as may  otherwise  be specified by Payee from time to
time, all payments  hereunder  shall be paid to Payee at 3565 Harbor  Boulevard,
Costa Mesa, California 92626.

     Should  Roberts  sell,  convey,  transfer,  lease,  dispose  of or  further
encumber the  Property (as defined in the Deed of Trust) or any portion  thereof
(whether voluntarily or involuntarily),  then Payee shall have the right, at its
option, to declare all sums secured hereby immediately due and payable.

     This Note is secured by a Deed of Trust  With  Assignment  of Rents of even
date herewith (the "Deed of Trust").

     Roberts  shall have the right to prepay the whole or any part of the unpaid
principal balance of this Note at any time without the payment of any additional
consideration therefore so long as such payment is accompanied by the payment of
all accrued and unpaid interest, if any.

     If any  installment  of principal  and interest is not made within five (5)
days of the date due, or if any other amount owing  hereunder is not made within
the aforementioned ten (10) day period after demand therefore,  then such amount
shall bear interest at the lesser rate of (a) ten and one-half  percent  (10.5%)
per annum or (b) the highest rate permissible  under applicable law,  commencing
on the first day after the amount becomes  delinquent and continuing  until such
amount is paid in full.

     If Roberts  exercises any FileNET stock options prior to the payment of all
principal and interest under this Note (whether or not due), fifty percent (50%)
of the net proceeds  from such exercise of stock options will be paid by Roberts
to Payee and shall be applied against the principal outstanding under this Note.

     This Note has been executed and delivered in the State of California and is
to be governed by and construed  according to the laws  thereof.  Time is of the
essence with respect to every provision hereof.

     All payments  hereunder  shall be made in lawful money of the United States
of America.  In the event of any action or  proceeding  instituted to enforce or
construe any provision of this Note or the Deed of Trust, or as a consequence of
any default under this Note or the Deed of Trust,  the prevailing party shall be
entitled  to  recover  from the  losing  party all of its  costs  and  expenses,
including,  without limitation, court costs, all costs of appeals and reasonable
attorneys' fees.

     No previous  waiver and no failure or delay by Payee in acting with respect
to the terms of this Note or the Deed of Trust shall  constitute a waiver of any
breach,  default,  or failure of condition under this Note, the Deed of Trust or
the obligations  secured thereby. A waiver of any term of this Note, the Deed of
Trust or of any of the  obligations  secured thereby must be made in writing and
shall be limited to the express written terms of such waiver.

     All agreements  between the undersigned and Payee are expressly  limited so
that in no contingency or event whatsoever,  whether by reason of advancement of
the proceeds hereof,  acceleration of maturity of the unpaid  principal  balance
hereof,  or otherwise,  shall the amount paid or agreed to be paid to the holder
hereof  for the use,  forbearance  or  detention  of the  money  to be  advanced
hereunder  exceed the highest lawful rate  permissible  under  applicable  usury
laws.  If,  from any  circumstances  whatsoever,  fulfillment  of any  provision
hereof,  the Deed of Trust securing this Note or any other agreement referred to
herein,  at the time  performance of such provision  shall be due, shall involve
transcending the limit of validity  prescribed by law which a court of competent
jurisdiction may deem applicable  hereto,  then ipso facto, the obligation to be
fulfilled  shall  be  reduced  to the  limit of such  validity,  and if from any
circumstances  the holder  hereof shall ever receive as interest an amount which
would  exceed the highest  lawful  rate,  such amount  which would be  excessive
interest shall be applied to the reduction of the unpaid  principal  balance due
hereunder and not to the payment of interest. This provision shall control every
other provision of all agreements between the undersigned and the holder hereof.

     Roberts and Payee acknowledge that each party and its counsel have reviewed
and approved  this Note and that the normal rule of  construction  to the effect
that any ambiguities are to be resolved  against the drafting party shall not be
employed  in the  interpretation  of this  Note or any  amendments  or  exhibits
hereto.

                                       2

     Executed as of the date first written above.

                                            LEE D. ROBERTS:

                                           */s/ Lee D. Roberts*
                                            Lee D. Roberts

                                       3

**EXHIBIT 10.13****OPTION EXCHANGE AGREEMENT**

     This Option  Exchange  Agreement (the  "Agreement") is made effective as of
May 22, 2002 by and between FileNET  Corporation,  a Delaware  corporation  (the
"Company"),  and Ron L. Ercanbrack ("Executive").  The Company and Executive are
referred  to  herein,  individually  as a  "party"  and,  collectively,  as  the
"Parties."

                                    **Recitals**

     WHEREAS,  the  Compensation  Committee  (the  "Committee")  of the Board of
Directors of the Company granted to Executive on February 23, 2000, an option to
purchase 100,000 shares (the "2000 Option Shares") of the Company's Common Stock
("Common Stock") at an exercise price of $35.16 per share;

     WHEREAS,   the  2000  Option   Shares  have  an  exercise   price  that  is
significantly  higher  than the current  market  price of the  Company's  common
stock;

     WHEREAS, the Committee believes that the 2000 Option Shares are unlikely to
be exercised in the foreseeable future, which does not serve the purpose of such
options to promote the  long-term  success of the  Company  and the  creation of
stockholder  value by  encouraging  employees  to focus on  critical  long-range
objectives,   encouraging   the  attraction  and  retention  of  employees  with
exceptional qualifications and linking employees' interests directly to those of
stockholders through increased stock ownership;

     WHEREAS,  the Committee  and Executive  believe that the 2000 Option shares
fail to provide Executive with a meaningful incentive to extend his best efforts
on  behalf  of the  Company  and its  stockholders,  and  that it is in the best
interests of the Company and its stockholders to encourage  maximum  performance
by Executive at this time;

     WHEREAS,  the Committee has determined that it is advisable and in the best
interests  of the  Company and its  stockholders  to  institute  a stock  option
exchange with  Executive to provide him with the benefit of owning  options that
over time may have a greater  potential  to  increase  in value,  create  better
performance incentives for Executive and thereby maximize stockholder value;

     WHEREAS,  the Executive and the Company  desire to terminate and cancel the
out-of-the  money 2000 Option Shares effective as of May 22, 2002, such that the
2000 Option Shares shall not at any time be deemed  outstanding or  exercisable,
in exchange for new options to be granted during the thirty day period beginning
on the first business day that is at least six months and one day from this date
of option cancellation; and

     WHEREAS, the Committee and Executive desire to enter into this Agreement to
set forth the terms and  conditions of the 2000 Option Shares  cancellation  and
exchange.
**Agreement**

     In consideration of the foregoing  recitals and the mutual  representations
warranties,  covenants  and  agreements  contained  herein,  and other  good and
valuable  consideration,  the  receipt  and  sufficiency  of  which  are  hereby
acknowledged,  the Company and  Executive,  intending  to be legally  bound,  do
hereby agree as follows:

     1.   Cancellation  of the 2000  Option  Shares.  Executive  and the Company
          hereby mutually  consent and agree to cancel the out-of-the money 2000
          Option  Shares  effective  as of May  22,  2002,  such  that as of and
          following  such date,  the 2000 Option Shares shall not at any time be
          deemed outstanding or exercisable.

     2.   Replacement Option Grant. In exchange for the cancellation of the 2000
          Option   Shares,   as  provided  in  Section  1  hereof,   subject  to
          satisfaction of the conditions for Replacement  Option grant set forth
          in Section 3 hereof,  the Company agrees to grant  Executive an option
          to purchase 100,000 shares of Common Stock (the "Replacement  Option")
          under the Company's  1995 Stock Option Plan, as amended,  (the "Plan")
          on a date  selected  by the  Committee  that is during  the thirty day
          period beginning on the first business day that is at least six months
          and one day from this date of  cancellation  of the 2000 Option Shares
          (i.e.,  during the thirty day period  beginning on November 25, 2002).
          Certain of the material terms of the  Replacement  Option grant are as
          follows:

          a.   The  exercise  price for the  Replacement  Option shall equal the
               average  of the  high  and low  selling  price  per  share of the
               Company's common stock on the Nasdaq National Market on the grant
               date for the Replacement Option;

          b.   The Replacement  Option shall commence vesting on the Replacement
               Option grant date and will vest as to  twenty-five  percent (25%)
               of the shares subject to the  Replacement  Option on the one year
               anniversary  of the  Replacement  Option  grant date and 1/36 per
               each  month  after the one year  anniversary  of the  Replacement
               Option grant date until the Replacement Option is fully vested on
               the fourth anniversary of the Replacement Option grant date;

          c.   The Replacement  Option will be designated a non-qualified  stock
               option,  and will  have a term of ten years  following  the grant
               date for the Replacement  Option,  subject to earlier termination
               upon the  happening of certain  events as specified in the option
               agreement and Plan; and

          d.   The  Replacement  Option  shall be  evidenced  by,  and  shall be
               subject to all of the terms and conditions  contained in, a stock
               option  agreement,  substantially  in the form attached hereto as
               Exhibit A, which will be executed by the Company and Executive at
               or about the time of the grant of the Replacement Option.

                                       2

     3.   Conditions to Grant of Replacement Option. The Company's obligation to
          grant  the  Replacement  Option  is  subject  to  satisfaction  of the
          following conditions:

          a.   Executive shall continue to serve as an executive  officer of the
               Company from the date hereof through and including the grant date
               for the Replacement Option; and

          b.   The grant of the Replacement  Option shall not be in violation of
               any applicable law, rule or order.

          In  addition,  the Company is reserving  the right,  in the event of a
          merger, tender offer,  exchange offer or similar transaction,  to take
          any actions the Company deems  necessary or  appropriate to complete a
          transaction  that the Company's Board of Directors  believes is in the
          best interest of the Company and its stockholders.  This could include
          terminating  Executive's  right to receive the Replacement  Option. If
          the Company  terminates  Executive's  right to receive the Replacement
          Option in  connection  with such a  transaction,  Executive  would not
          receive  options to purchase  securities  of the acquiror or any other
          consideration for the canceled 2000 Option Shares.

     4.   Executive's Understandings. Executive understands and agrees:

          a.   THE EXCHANGE OF OPTIONS  CONTEMPLATED  BY THIS AGREEMENT  CARRIES
               CONSIDERABLE  RISK FOR EXECUTIVE,  AND THERE ARE NO GUARANTEES OF
               THE  COMPANY'S  FUTURE STOCK  PERFORMANCE  OR THE PRICE OF COMMON
               STOCK ON THE  REPLACEMENT  GRANT DATE. The Company's  stock price
               could  increase  (or  decrease)  and the  exercise  price  of the
               Replacement  Option  could be higher (or lower) than the exercise
               price of the 2000 Option  Shares.  The  advisability  of entering
               into this Agreement  depends  largely on Executive's  assumptions
               about  the  future   overall   economic   environment,   and  the
               performance  of the  stock  markets,  the  Common  Stock  and the
               Company's business. Executive is informed and knowledgeable about
               the  Company's  business,   properties,  results  of  operations,
               condition (financial or otherwise), prospects and proposals;

          b.   Executive  will  receive no vesting  credit  with  respect to the
               cancelled  2000  Option  Shares  between  the date hereof and the
               Replacement  Option  grant date,  a period which will be at least
               six months and one day;

          c.   Executive is responsible  for consulting his own tax advisor with
               respect to the federal,  state and local tax consequences of this
               Agreement;

          d.   The Company  will not grant any new options to  Executive  for at
               least six  months  and one day after the date of this  Agreement;
               and

                                       3

          e.   This   Agreement  does  not  constitute  an  offer  of  continued
               employment,  and does not  interfere  with or restrict in any way
               the rights of the Company,  which are hereby expressly  reserved,
               to discharge Executive at any time with or without good cause.

     5.   Successors and Assigns. This Agreement shall be binding upon and inure
          to the  benefit  of and  be  enforceable  by  the  Parties  and  their
          respective  successors  and assigns.  Notwithstanding  the  foregoing,
          neither this Agreement nor any rights hereunder may be assigned by any
          Party without the prior written consent of the other Parties.

     6.   Governing  Law.  The  Parties  agree  that  this  Agreement  shall  be
          construed  and enforced in  accordance  with the internal  laws of the
          State of California.

     7.   Acknowledgement.  The Parties  acknowledge  that this Agreement is not
          entered into in consideration of any promise, commitment,  expectation
          or  agreement  to  provide  Executive  with  any  form  of  additional
          consideration, including any future stock options.

                            *[SIGNATURE PAGE FOLLOWS]*

                                       4

     IN WITNESS WHEREOF,  this Agreement has been duly executed and delivered as
of the date first written above.

                                                **Executive***/s/ Ron L. Ercanbrack*

                                                Ron L. Ercanbrack

                                                FileNET Corporation

                                                */s/ Lee D. Roberts*

                                                By:      Lee D. Roberts
                                                Title:   Chief Executive Officer

                                       5
**EXHIBIT A****STOCK OPTION AGREEMENT AND GRANT NOTICE****EMPLOYEE AND CONSULTANTS****October 21, 1999****FILENET CORPORATION****STOCK OPTION AGREEMENT****RECITALS**

     The Board has adopted the Plan for the purpose of retaining the services of
selected Employees,  non-employee members of the Board and consultants and other
independent  advisors who provide  services to the Corporation (or any Parent or
Subsidiary).

     A.   Optionee  is to render  valuable  services  to the  Corporation  (or a
          Parent or Subsidiary), and this Agreement is executed pursuant to, and
          is intended to carry out the purposes of, the Plan in connection  with
          the Corporation's grant of an option to Optionee.

     B.   All  capitalized  terms  in this  Agreement  shall  have  the  meaning
          assigned to them in the attached Appendix.

          NOW, THEREFORE, it is hereby agreed as follows:

          1.   **Grant of Option**. The Corporation hereby grants to Optionee, as of
               the Grant Date,  an option to purchase up to the number of Option
               Shares specified in the Grant Notice.  The Option Shares shall be
               purchasable from time to time during the option term specified in
               Paragraph 2 at the Exercise Price.

          2.   **Option Term**.  This  option  shall  have  a term of ten (10) years
               measured from the Grant Date and shall accordingly  expire at the
               close  of  business  on  the  Expiration   Date,   unless  sooner
               terminated in accordance with Paragraph 5 or 6.

          3.   **Limited Transferability**.    This   option    shall   be   neither
               transferable  nor assignable by Optionee other than by will or by
               the laws of descent and distribution  following  Optionee's death
               and  may  be  exercised,  during  Optionee's  lifetime,  only  by
               Optionee.  However,  if this option is designated a Non-Qualified
               Option in the Grant  Notice,  then this option may be assigned in
               whole or in part during  Optionee's  lifetime in accordance  with
               the terms of a Qualified  Domestic  Relations Order. The assigned
               portion  shall be  exercisable  only by the person or persons who
               acquire a  proprietary  interest  in the option  pursuant to such
               Qualified  Domestic  Relations Order. The terms applicable to the
               assigned  portion  shall be the same as those in effect  for this
               option  immediately  prior to such  assignment  and  shall be set
               forth  in such  documents  issued  to the  assignee  as the  Plan
               Administrator may deem appropriate.

          4.   **Dates of Exercise**.  This option shall become  exercisable for the
               Option  Shares  in a  series  of  one  or  more  installments  as
               specified in the Grant Notice. As the option becomes  exercisable
               for one or more of those  installments,  the  installments  shall
               accumulate  and  the  option  shall  remain  exercisable  for the
               accumulated  installments  until  the  Expiration  Date or sooner
               termination of the option term under Paragraph 5 or 6.

          5.   **Cessation of Service**.   The option term  specified in Paragraph 2
               shall  terminate (and this option shall cease to be  outstanding)
               prior  to  the  Expiration  Date  should  any  of  the  following
               provisions become applicable:

                                       6

               (i)  Should  Optionee  cease to remain in Service  for any reason
                    (other than death or Permanent Disability) while this option
                    is  outstanding,  then Optionee shall have a period of three
                    (3) months  (commencing  with the date of such  cessation of
                    Service)  during which to exercise  this  option,  but in no
                    event shall this option be exercisable at any time after the
                    Expiration Date.

               (ii) Should Optionee die while this option is  outstanding,  then
                    the  personal  representative  of  Optionee's  estate or the
                    person or persons to whom the option is transferred pursuant
                    to Optionee's will or in accordance with the laws of descent
                    and  distribution  shall  have the  right to  exercise  this
                    option.  Such right shall lapse and this option  shall cease
                    to be outstanding  upon the earlier of (i) the expiration of
                    the  twelve  (12)  month  period  measured  from the date of
                    Optionee's death or (ii) the Expiration Date.

               (iii)Should Optionee   cease   Service  by  reason  of  Permanent
                    Disability  while this option is outstanding,  then Optionee
                    shall have a period of twelve (12) months  (commencing  with
                    the  date of such  cessation  of  Service)  during  which to
                    exercise  this  option.  In no event  shall  this  option be
                    exercisable at any time after the Expiration Date.

               (iv) Should Optionee's Service be terminated for Misconduct, then
                    this option shall terminate  immediately and cease to remain
                    outstanding.

               (v)  During the applicable  post-Service  exercise  period,  this
                    option may not be exercised in the  aggregate  for more than
                    the  number  of  Option  Shares  for  which  the  option  is
                    exercisable at the time of Optionee's  cessation of Service.
                    Upon the expiration of such exercise  period or (if earlier)
                    upon the Expiration  Date,  this option shall  terminate and
                    cease to be outstanding  for any  exercisable  Option Shares
                    for which the option has not been exercised.  However,  this
                    option  shall,  immediately  upon  Optionee's  cessation  of
                    Service,  terminate and cease to be outstanding with respect
                    to any Option  Shares for which the option is not  otherwise
                    at that time exercisable.

          6.   **Special Acceleration of Option**.

               (i)  This  option,  to the  extent  outstanding  at the time of a
                    Corporate  Transaction but not otherwise fully  exercisable,
                    shall  automatically  accelerate  so that this option shall,
                    immediately  prior to the  effective  date of the  Corporate
                    Transaction, become exercisable for all of the Option Shares
                    at the time subject to this option and may be exercised  for
                    any or all of those Option Shares as fully-vested  shares of
                    Common Stock. No such acceleration of this option,  however,
                    shall  occur if and to the  extent:  (i) this  option is, in
                    connection  with the  Corporate  Transaction,  either  to be
                    assumed by the successor  corporation (or parent thereof) or
                    to be replaced with a comparable  option to purchase  shares
                    of the capital stock of the successor corporation (or parent
                    thereof) or (ii) this  option is to be replaced  with a cash
                    incentive   program  of  the  successor   corporation  which
                    preserves  the spread  existing on the Option  Shares at the
                    time of the  Corporate  Transaction  (the excess of the Fair
                    Market  Value  of such  Option  Shares  over  the  aggregate
                    Exercise  Price  payable for those  shares) and provides for
                    subsequent  pay-out in accordance  with the option  exercise
                    schedule set forth in the Grant Notice. The determination of
                    option  comparability  under clause (i) shall be made by the
                    Plan  Administrator,  and such determination shall be final,
                    binding and conclusive.

               (ii) Immediately following the Corporate Transaction, this option
                    shall terminate and cease to be  outstanding,  except to the
                    extent  assumed  by the  successor  corporation  (or  parent
                    thereof) in connection with the Corporate Transaction.

               (iii)If this  option is assumed in  connection  with a  Corporate
                    Transaction,   then  this  option  shall  be   appropriately
                    adjusted,  immediately after such Corporate Transaction,  to
                    apply to the number and class of securities which would have
                    been issuable to Optionee in  consummation of such Corporate
                    Transaction had the option been exercised  immediately prior
                    to such Corporate Transaction,  and appropriate  adjustments
                    shall  also be  made to the  Exercise  Price,  provided  the
                    aggregate Exercise Price shall remain the same.

                                       7

               (iv) This Agreement  shall not in any way affect the right of the
                    Corporation to adjust,  reclassify,  reorganize or otherwise
                    change  its  capital  or  business  structure  or to  merge,
                    consolidate,  dissolve, liquidate or sell or transfer all or
                    any part of its business or assets.

          7.   **Adjustment in Option Shares**.   Should  any  change be made to the
               Common  Stock by  reason  of any  stock  split,  stock  dividend,
               recapitalization,  combination  of shares,  exchange of shares or
               other change  affecting the  outstanding  Common Stock as a class
               without the Corporation's  receipt of consideration,  appropriate
               adjustments  shall  be made to (i) the  number  and/or  class  of
               securities subject to this option, (ii) the minimum number and/or
               class of securities for which this option must be exercised,  and
               (iii) the  Exercise  Price in order to  reflect  such  change and
               thereby preclude a dilution or enlargement of benefits hereunder.

          8.   **Stockholder Rights**.  The holder of this option  shall not have any
               stockholder  rights with respect to the Option  Shares until such
               person shall have  exercised the option,  paid the Exercise Price
               and become a holder of record of the purchased  shares.

          9.   **Manner of Exercising Option**.

               (i)  In order to exercise  this option with respect to all or any
                    part of the Option  Shares  for which this  option is at the
                    time  exercisable,  Optionee (or any other person or persons
                    exercising the option) must take the following actions:

               (ii) Execute and deliver to the  Corporation a Notice of Exercise
                    for the  number of  Option  Shares  for which the  option is
                    exercised.

               (iii)Pay the aggregate  Exercise  Price for the purchased  shares
                    in one or more of the following forms:

                    (A)  cash or check made payable to the Corporation;

                    (B)  a promissory note payable to the Corporation,  but only
                         to the extent  authorized by the Plan  Administrator in
                         accordance with Paragraph 13;

                    (C)  shares of Common  Stock held by Optionee  (or any other
                         person  or  persons  exercising  the  option)  for  the
                         requisite  period  necessary  to avoid a charge  to the
                         Corporation's earnings for financial reporting purposes
                         and valued at Fair Market Value on the  Exercise  Date;
                         or

                    (D)  through  a  special  sale  and   remittance   procedure
                         pursuant  to which  Optionee  (or any  other  person or
                         persons   exercising  the  option)  shall  concurrently
                         provide  irrevocable  written  instructions  (a)  to  a
                         Corporation-designated  brokerage  firm to  effect  the
                         immediate sale of the purchased shares and remit to the
                         Corporation,  out of the sale proceeds available on the
                         settlement   date,   sufficient   funds  to  cover  the
                         aggregate  Exercise  Price  payable  for the  purchased
                         shares  plus all  applicable  Federal,  state and local
                         income and employment  taxes required to be withheld by
                         the  Corporation  by reason of such exercise and (b) to
                         the  Corporation  to deliver the  certificates  for the
                         purchased  shares  directly to such  brokerage  firm in
                         order to complete the sale.

                         Except to the extent the sale and remittance  procedure
                         is  utilized  in  connection  with the option exercise,
                         payment of the Exercise Price must accompany the Notice
                         of Exercise.

               (iv) Furnish to the Corporation  appropriate  documentation  that
                    the person or persons  exercising  the option (if other than
                    Optionee) have the right to exercise this option.

                                       8

               (v)  Make  appropriate  arrangements  with  the  Corporation  (or
                    Parent or  Subsidiary  employing or retaining  Optionee) for
                    the satisfaction of all Federal,  state and local income and
                    employment tax  withholding  requirements  applicable to the
                    option exercise, if the Option is designated a Non-Qualified
                    Option in the Grant Notice.

               (vi) As  soon  as  practical   after  the  Exercise   Date,   the
                    Corporation  shall issue to or on behalf of Optionee (or any
                    other   person  or  persons   exercising   this   option)  a
                    certificate for the purchased Option Shares.

               (vii)In no event may this option be exercised for any  fractional
                    shares.

          10.  **Compliance with Laws and Regulations**.

               (i)  The  exercise of this option and the  issuance of the Option
                    Shares upon such exercise  shall be subject to compliance by
                    the   Corporation   and   Optionee   with   all   applicable
                    requirements of law relating thereto and with all applicable
                    regulations  of any stock  exchange (or the Nasdaq  National
                    Market,  if  applicable)  on which the  Common  Stock may be
                    listed  for  trading  at  the  time  of  such  exercise  and
                    issuance.

               (ii) The inability of the Corporation to obtain approval from any
                    regulatory body having  authority  deemed by the Corporation
                    to be  necessary  to the  lawful  issuance  and  sale of any
                    Common  Stock  pursuant  to this  option  shall  relieve the
                    Corporation   of  any   liability   with   respect   to  the
                    non-issuance  or sale of the  Common  Stock as to which such
                    approval  shall not have  been  obtained.  The  Corporation,
                    however,  shall  use its best  efforts  to  obtain  all such
                    approvals.

          11.  **Successors and Assigns**.  Except to the extent otherwise  provided
               in  Paragraphs 3 and 6, the  provisions of this  Agreement  shall
               inure to the benefit of, and be binding upon, the Corporation and
               its successors and assigns and Optionee,  Optionee's  assigns and
               the legal  representatives,  heirs  and  legatees  of  Optionee's
               estate.

          12.  **Notices**.  Any notice  required  to be given or  delivered  to the
               Corporation under the terms of this Agreement shall be in writing
               and  addressed  to the  Corporation  at its  principal  corporate
               offices. Any notice required to be given or delivered to Optionee
               shall be in writing  and  addressed  to  Optionee  at the address
               indicated  below  Optionee's  signature line on the Grant Notice.
               All notices shall be deemed  effective upon personal  delivery or
               upon  deposit in the U.S.  mail,  postage  prepaid  and  properly
               addressed to the party to be notified.

          13.  **Financing**. The Plan Administrator may, in its absolute discretion
               and without any  obligation to do so, permit  Optionee to pay the
               Exercise  Price for the  purchased  Option Shares by delivering a
               promissory note payable to the Corporation. The terms of any such
               promissory  note  (including the interest rate, the  requirements
               for collateral  and the terms of repayment)  shall be established
               by the Plan Administrator in its sole discretion.(1/)

          14.  **Excess  Shares**.  If the Option Shares  covered by this  Agreement
               exceed,  as of the  Grant  Date,  the  number of shares of Common
               Stock which may without stockholder  approval be issued under the
               Plan,  then this option shall be void with respect to such excess
               shares, unless stockholder approval of an amendment  sufficiently
               increasing  the number of shares of Common Stock  issuable  under
               the Plan is obtained in  accordance  with the  provisions  of the
               Plan.

          15.  ****Construction****.  This Agreement and the option evidenced hereby are
               made and  granted  pursuant  to the Plan and are in all  respects
               limited by and subject to the terms of the Plan. All decisions of
               the Plan  Administrator  with  respect to any  question  or issue
               arising under the Plan or this Agreement  shall be conclusive and
               binding on all persons having an interest in this option.

(1/) Payment of the  Exercise  Price by  promissory  note may,  under  currently
proposed  Treasury  Regulations,  result in the loss of  incentive  stock option
treatment under the Federal tax laws.

                                       9

          16.  **Governing Law**. The interpretation, performance and enforcement of
               this  Agreement  shall be  governed  by the laws of the  State of
               California without resort to that State's conflict-of-laws rules.

          17.  **Leave of Absence**.  The following  provisions shall apply upon the
               Optionee's commencement of an authorized leave of absence:

               (i)  The exercise schedule in effect under the Grant Notice shall
                    be frozen as of the first day of the authorized  leave,  and
                    the option shall not become  exercisable  for any additional
                    installments of the Option Shares during the period Optionee
                    remains on such leave.

               (ii) Should  Optionee  resume active Employee status within sixty
                    (60)  days  after the start  date of the  authorized  leave,
                    Optionee  shall,  for purposes of the exercise  schedule set
                    forth in the Grant Notice,  receive  Service  credit for the
                    entire  period of such leave.  If  Optionee  does not resume
                    active  Employee  status within such sixty (60) day periods,
                    then no Service  credit shall be given for the period of the
                    leave.

               (iii)If the option is designated as an Incentive  Stock Option in
                    the Grant Notice,  then the following  additional  provision
                    shall apply:

                    (A)  If the leave of absence  continues for more than ninety
                         (90) days, then the option shall automatically  convert
                         to a non-qualified option under the federal tax laws on
                         the ninety-first  (91st) day of such leave,  unless the
                         Optionee's   reemployment   rights  are  guaranteed  by
                         statute or by  written  agreement.  Following  any such
                         conversion of the option,  all subsequent  exercises of
                         such   option,   whether   effected   before  or  after
                         Optionee's  return to  active  Employee  status,  shall
                         result  in  an  immediate   taxable   event,   and  the
                         Corporation  shall be required to collect from Optionee
                         the  federal,  state and local  income  and  employment
                         withholding taxes applicable to such exercise.

               (iv) In no event shall this  option  become  exercisable  for any
                    additional Option Shares or otherwise remain  outstanding if
                    Optionee  does  not  resume  Employee  status  prior  to the
                    Expiration Date of the option term.

                                       10

**APPENDIX**

     The following definitions shall be in effect under the Agreement:

          A.   **Agreement** shall mean this Stock Option Agreement.

          B.   **Board** shall mean the Corporation's Board of Directors.

          C.   **Code** shall mean the Internal Revenue Code of 1986, as amended.

          D.   **Common Stock** shall mean the Corporation's common stock.

          E.   **Corporate Transaction**   shall   mean   either  of  the  following
               stockholder-approved  transactions  to which the Corporation is a
               party:

               (i)  a merger or  consolidation  in which  securities  possessing
                    more than fifty percent (50%) of the total  combined  voting
                    power  of  the  Corporation's   outstanding  securities  are
                    transferred  to a  person  or  persons  different  from  the
                    persons holding those securities  immediately  prior to such
                    transaction, or

               (ii) the  sale,   transfer  or  other   disposition   of  all  or
                    substantially  all of the  Corporation's  assets in complete
                    liquidation or dissolution of the Corporation.

          F.   **Corporation**  shall   mean   FileNET   Corporation,   a  Delaware
               corporation.

          G.   **Domestic Relations Order** shall mean any judgment, decree or order
               (including  approval of a property  settlement  agreement)  which
               provides  or  otherwise  conveys,  pursuant to  applicable  State
               domestic  relations laws  (including  community  property  laws),
               marital  property  rights to any  spouse or former  spouse of the
               Optionee.

          H.   **Employee**  shall  mean an  individual  who is in the employ of the
               Corporation (or any Parent or Subsidiary), subject to the control
               and  direction of the  employer  entity as to both the work to be
               performed and the manner and method of performance.

          I.   **Exercise Date** shall mean  the date on which the option shall have
               been exercised in accordance with Paragraph 9 of the Agreement.

          J.   **Exercise Price**  shall  mean   the  exercise  price  per  share as
               specified in the Grant Notice.

          K.   **Expiration Date** shall mean the  date on which the option  expires
               as specified in the Grant Notice.

          L.   **Fair Market Value** per share of Common Stock on any relevant  date
               shall be determined in accordance with the following provisions:

               (v)(i)    If the Common Stock is at the time traded on the Nasdaq
                    National  Market,  then the Fair  Market  Value shall be the
                    average  of the high and low  selling  prices  per  share of
                    Common  Stock on the date in  question,  as such  prices are
                    reported by the National  Association of Securities  Dealers
                    on the Nasdaq  National Market or any successor  system.  If
                    there are no selling  prices  quoted for the Common Stock on
                    the date in  question,  then the Fair Market  Value shall be
                    the average of the high and low  selling  prices on the last
                    preceding date for which such quotations exist.

               (vi)(ii)  If the Common  Stock is at the time listed on any Stock
                    Exchange,  then the Fair  Market  Value shall be the average
                    high and low selling prices per share of Common Stock on the
                    date in question  on the Stock  Exchange  determined  by the
                    Plan  Administrator  to be the primary market for the Common
                    Stock, as such prices are officially quoted in the composite
                    tape of  transactions  on such  exchange.  If  there  are no
                    selling  prices  quoted for the Common  Stock on the date in
                    question, then the Fair Market Value shall be the average of
                    the high and low selling  prices on the last  preceding date
                    for which such quotations exist.

          M.   **Grant Date**  shall  mean  the  date of  grant  of  the  option  as
               specified in the Grant Notice.

          N.   **Grant Notice**  shall  mean  the  Notice  of Grant of Stock  Option
               accompanying  the Agreement,  pursuant to which Optionee has been
               informed of the basic terms of the option evidenced hereby.

          O.   **Incentive Option**  shall   mean   an  option  that  satisfies  the
               requirements of Code Section 422.

          P.   **Misconduct**  shall  mean  the  commission  of any  act  of  fraud,
               embezzlement or dishonesty by Optionee,  any  unauthorized use or
               disclosure  by  Optionee  of  confidential  information  or trade
               secrets of the Corporation (or any Parent or Subsidiary),  or any
               other intentional  misconduct by Optionee adversely affecting the
               business  or  affairs  of  the  Corporation  (or  any  Parent  or
               Subsidiary) in a material manner. The foregoing  definition shall
               not be deemed to be inclusive of all the acts or omissions  which
               the  Corporation  (or any Parent or  Subsidiary)  may consider as
               grounds for the  dismissal  or discharge of Optionee or any other
               individual  in the Service of the  Corporation  (or any Parent or
               Subsidiary).

          Q.   **Non-Qualified Option** shall mean an option not intended to satisfy
               the requirements of Code Section 422.

          R.   **Notice of Exercise**  shall mean the  written  notice of the option
               exercise  on the  form  provided  by  the  Corporation  for  such
               purpose.

          S.   **Option Shares**  shall  mean the  number of shares of Common  Stock
               subject to the option as specified in the Grant Notice.

          T.   **Optionee**  shall  mean the person to whom the option is granted as
               specified in the Grant Notice.

          U.   **Parent** shall mean any corporation (other than the Corporation) in
               an unbroken chain of  corporations  ending with the  Corporation,
               provided each  corporation  in the unbroken chain (other than the
               Corporation)  owns,  at  the  time  of the  determination,  stock
               possessing  fifty  percent  (50%) or more of the  total  combined
               voting  power  of all  classes  of  stock  in  one  of the  other
               corporations in such chain.

          V.   **Permanent Disability**  shall  mean the  inability  of  Optionee to
               engage  in any  substantial  gainful  activity  by  reason of any
               medically  determinable  physical or mental  impairment  which is
               expected  to result in death or has lasted or can be  expected to
               last for a continuous period of twelve (12) months or more.

          W.   **Plan** shall mean the Corporation's 1995 Stock Option Plan.

          X.   **Plan Administrator**  shall mean either the Board or a committee of
               Board  members,  to the  extent  the  committee  is at  the  time
               responsible for the administration of the Plan.

          Y.   **Qualified Domestic Relations Order**    shall   mean   a   Domestic
               Relations   Order   which   substantially   complies   with   the
               requirements of Code Section 414(p). The Plan Administrator shall
               have  the  sole  discretion  to  determine   whether  a  Domestic
               Relations Order is a Qualified Domestic Relations Order.

          Z.   **Service** shall mean the Optionee's performance of services for the
               Corporation  (or any Parent or  Subsidiary) in the capacity of an
               Employee,  a  non-employee  member of the board of directors or a
               consultant or independent advisor.

          AA.  **Stock Exchange** shall mean  the American Stock Exchange or the New
               York Stock Exchange.

          BB.  **Subsidiary**   shall   mean  any   corporation   (other   than  the
               Corporation) in an unbroken chain of corporations  beginning with
               the Corporation,  provided each corporation  (other than the last
               corporation)  in the  unbroken  chain  owns,  at the  time of the
               determination,  stock  possessing  fifty percent (50%) or more of
               the total combined voting power of all classes of stock in one of
               the other corporations in such chain.

**FileNET Corporation ID: 95-3757924

                                                Notice of Grant of Stock Options
                                                            and Option Agreement****Ron L. Ercanbrack                                Option Number:****10 Le Conte                                      Plan:                       95****Laguna Niguel, CA  92677                         ID:**

Effective __/__/02 been granted a Non-Qualified  Option to buy 100,000 shares of
FileNET Corporation (the Company) stock at $x.xx per share.

The total option price of the shares granted is $xxx,xxx.xx.

Shares in each period will become fully vested on the date shown.

    **Shares        Vest Type                    Full Vest            Expiration**

     25,000        On First Anniversary           __/__/03           __ /__ /12
                   of Grant Date

     75,000        1/36 Monthly                   __/__/06            __/ __/12
                   commencing

By your signature and the Company's  signature  below, you and the Company agree
that these options are granted under and governed by the terms and conditions of
the 1995  FileNET  Corporation  Stock  Option  Plan as  amended  and the  Option
Agreement,  all of which are located and may be accessed via FileNET's Intranet,
now.

 FileNET Corporation                      Date

 Ron L. Ercanbrack

**Exhibit 10.14****THE 2002 INCENTIVE AWARD PLAN

                                       OF

                               FILENET CORPORATION**

     FileNET Corporation, a Delaware corporation, has adopted the 2002 Incentive
Award  Plan of  FileNET  Corporation,  (the  "Plan"),  effective  May  22,  2002
("Effective Date"), for the benefit of its eligible  employees,  consultants and
directors.

     The purposes of the Plan are as follows:

     (1) To provide an  additional  incentive for  directors,  key Employees and
Consultants (as such terms are defined below) to further the growth, development
and  financial  success of the  Company by  personally  benefiting  through  the
ownership  of  Company  stock  and/or  rights  which   recognize   such  growth,
development and financial success.

     (2) To enable the Company to obtain and retain the  services of  directors,
key Employees and Consultants  considered essential to the long range success of
the Company by offering them an  opportunity  to own stock in the Company and/or
rights which will reflect the growth,  development and financial  success of the
Company.

                                   **ARTICLE I.
                                   DEFINITIONS**

     Wherever  the  following  terms  are used in the Plan they  shall  have the
meanings specified below,  unless the context clearly indicates  otherwise.  The
singular pronoun shall include the plural where the context so indicates.

     1.1.  "Administrator"  shall  mean the entity  that  conducts  the  general
administration   of  the  Plan  as  provided  herein.   With  reference  to  the
administration  of the Plan with  respect  to  Options  granted  to  Independent
Directors,  the term "Administrator" shall refer to the Board. With reference to
the  administration  of the Plan  with  respect  to any  other  Award,  the term
"Administrator"  shall refer to the Committee,  unless the Board has assumed the
authority for  administration  of the Plan generally as provided in Section 10.1
or the Committee has delegated its authority to administer  the Plan as provided
in Section  10.5,  in which events  "Administrator"  shall refer to the Board or
such delegated sub-committee, as applicable.

     1.2.  "Award" shall mean an Option, a Restricted Stock award, a Performance
Award,  a Dividend  Equivalents  award,  a Deferred Stock award, a Stock Payment
award or a Stock  Appreciation  Right which may be awarded or granted  under the
Plan (collectively, "Awards").

     1.3.  "Award Agreement"  shall  mean  a written  agreement  executed  by an
authorized officer of the Company and the Holder, which shall contain such terms
and conditions with respect to an Award as the  Administrator  shall  determine,
consistent with the Plan.

     1.4.  "Award Limit" shall mean 400,000 shares of Common Stock,  as adjusted
pursuant  to Section  11.3;  provided,  however,  that  solely  with  respect to
Performance  Awards granted  pursuant to Section 8.2(b),  Award Limit shall mean
Seven Hundred Fifty Thousand Dollars ($750,000).

     1.5. "Board" shall mean the Board of Directors of the Company.

     1.6.  "Change in Control"  shall mean  a change in ownership  or control of
the Company effected through any of the following transactions:

                                       1

          (a) Any person or related group of persons  (other than the Company or
     a person that, prior to such transaction,  directly or indirectly controls,
     is controlled by, or is under common control with, the Company) directly or
     indirectly acquires beneficial  ownership (within the meaning of Rule 13d-3
     under the Exchange Act) of securities possessing more than 50% of the total
     combined voting power of the Company's outstanding securities pursuant to a
     tender or exchange offer made directly to the Company's  stockholders which
     the Board does not recommend such stockholders accept; or

          (b) There is a change in the composition of the Board over a period of
     36  consecutive  months (or less) such that a majority of the Board members
     (rounded up to the nearest whole number)  ceases,  by reason of one or more
     proxy  contests  for the  election of Board  members,  to be  comprised  of
     individuals who either (i) have been Board members  continuously  since the
     beginning  of such  period,  or (ii) have been  elected  or  nominated  for
     election as Board members  during such period by at least a majority of the
     Board members  described in clause (i) who were still in office at the time
     such election or nomination was approved by the Board; or

     1.7. "Code" shall mean the Internal Revenue Code of 1986, as amended.

     1.8.  "Committee"  shall mean the  Compensation  Committee of the Board, or
another committee or subcommittee of the Board, appointed as provided in Section
10.1.

     1.9.  "Common Stock" shall mean the common stock of the Company,  par value
$0.01 per share.

     1.10. "Company" shall mean FileNET Corporation, a Delaware corporation.

     1.11. "Consultant" shall mean any consultant or adviser if:

          (a) The  consultant  or  adviser  renders  bona fide  services  to the
     Company;

          (b) The  services  rendered  by the  consultant  or adviser are not in
     connection  with  the  offer  or sale of  securities  in a  capital-raising
     transaction and do not directly or indirectly  promote or maintain a market
     for the Company's securities; and

          (c) The  consultant or adviser is a natural  person who has contracted
     directly with the Company to render such services.

     1.12. "Corporate Transaction" shall mean:

          (a) The  stockholders of the Company approve a merger or consolidation
     of the Company with any other  corporation (or other entity),  other than a
     merger or consolidation  which would result in the voting securities of the
     Company  outstanding  immediately  prior  thereto  continuing  to represent
     (either  by  remaining  outstanding  or  by  being  converted  into  voting
     securities  of the surviving  entity) more than 50% of the combined  voting
     power of the voting  securities  of the  Company or such  surviving  entity
     outstanding  immediately  after  such  merger or  consolidation;  provided,
     however,   that  a  merger  or   consolidation   effected  to  implement  a
     recapitalization of the Company (or similar transaction) in which no person
     acquires more than 25% of the combined  voting power of the Company's  then
     outstanding securities shall not constitute a Change in Control; or

          (b)  The  stockholders  of the  Company  approve  a plan  of  complete
     liquidation  of the Company or an agreement for the sale or  disposition by
     the Company of all or substantially all of the Company's assets.]

     1.13.  "Deferred Stock"  shall mean Common Stock awarded under Article VIII
of the Plan.

     1.14. "Director" shall mean a member of the Board.

                                       2

     1.15.  "Dividend Equivalent"  shall  mean a right to receive the equivalent
value (in cash or Common Stock) of dividends paid on Common Stock, awarded under
Article VIII of the Plan.

     1.16. "DRO" shall mean a domestic relations order as defined by the Code or
Title I of the Employee  Retirement Income Security Act of 1974, as amended,  or
the rules thereunder.

     1.17. "Effective Date" shall mean May 22, 2002.

     1.18.  "Employee"  shall mean any officer or other  employee (as defined in
accordance  with  Section  3401(c)  of  the  Code)  of  the  Company,  or of any
corporation that is a Subsidiary.

     1.19.  "Exchange Act" shall mean the  Securities  Exchange  Act of 1934, as
amended.

     1.20.  "Fair Market Value"  of a share of  Common  Stock as of a given date
shall be (a) the average of the high and low selling prices of a share of Common
Stock on the  principal  exchange or the Nasdaq  Stock Market on which shares of
Common Stock are then  trading,  if any (or as reported on any  composite  index
which  includes such  principal  exchange),  on such date, or if shares were not
traded on such date,  then on the next preceding date on which a trade occurred,
or (b) if Common Stock is not traded on an exchange or the Nasdaq Stock  Market,
but is quoted on Nasdaq or a  successor  quotation  system,  the  average of the
closing representative bid and asked prices for the Common Stock on such date as
reported by Nasdaq or such successor quotation system, or (c) if Common Stock is
not  publicly  traded on an  exchange  and not  quoted on Nasdaq or a  successor
quotation  system,  the  Fair  Market  Value  of a  share  of  Common  Stock  as
established by the Administrator acting in good faith.

     1.21.  "Holder"  shall  mean a person  who has been  granted  or awarded an
Award.

     1.22.  "Incentive Stock Option"  shall mean an option which conforms to the
applicable  provisions  of Section 422 of the Code and which is designated as an
Incentive Stock Option by the Administrator.

     1.23. "Independent Director" shall mean a member of the Board who is not an
Employee of the Company.

     1.24.  "Non-Qualified  Stock  Option"  shall  mean  an  Option  that is not
designated as an Incentive Stock Option by the Administrator.

     1.25.  "Option"  shall mean a stock option  granted under Article IV of the
Plan.  An  Option   granted   under  the  Plan  shall,   as  determined  by  the
Administrator,  be either a  Non-Qualified  Stock Option or an  Incentive  Stock
Option;  provided,  however,  that Options granted to Independent  Directors and
Consultants shall be Non-Qualified Stock Options.

     1.26.  "Performance Award"  shall  mean a cash bonus,  stock bonus or other
performance  or  incentive  award  that is  paid  in  cash,  Common  Stock  or a
combination of both, awarded under Article VIII of the Plan.

     1.27.  "Performance Criteria"  shall mean the following  business  criteria
with respect to the Company,  any Subsidiary or any division or operating  unit:
(a) net income,  (b) pre-tax income,  (c) operating  income,  (d) cash flow, (e)
earnings  per share,  (f) return on equity,  (g) return on  invested  capital or
assets,  (h)  cost  reductions  or  savings,  (i)  funds  from  operations,  (j)
appreciation  in the fair market value of Common Stock,  and (k) earnings before
any  one or  more of the  following  items:  interest,  taxes,  depreciation  or
amortization each as determined in accordance with generally accepted accounting
principles or subject to such  adjustments  as may be specified by the Committee
with respect to a Performance Award.

     1.28. "Permanent Disability"  shall mean, for purposes of Awards granted to
Independent  Directors,  the inability of the Holder to perform his usual duties
as a Board  member by reason of any  medically  determinable  physical or mental
impairment expected to result in death or to be of continuous duration of twelve
months or more.

     1.29.   "Plan"  shall  mean  the  2002  Incentive  Award  Plan  of  FileNET
Corporation, as amended and/or restated from time to time.

                                       3

     1.30.  "Restricted Stock" shall mean Common Stock awarded under Article VII
of the Plan.

     1.31.  "Rule 16b-3" shall mean  Rule 16b-3  promulgated  under the Exchange
Act, as such Rule may be amended from time to time.

     1.32.  "Section 162(m) Participant" shall  mean any key Employee designated
by the Administrator as a key Employee whose compensation for the fiscal year in
which the key Employee is so  designated  or a future fiscal year may be subject
to the limit on deductible compensation imposed by Section 162(m) of the Code.

     1.33. "Securities Act" shall mean the Securities Act of 1933, as amended.

     1.34.  "Stock Appreciation Right" shall mean  a  stock  appreciation  right
granted under Article IX of the Plan.

     1.35.  "Stock Payment"  shall  mean  (a) a payment in the form of shares of
Common  Stock,  or (b) an option  or other  right to  purchase  shares of Common
Stock, as part of a deferred  compensation  arrangement,  made in lieu of all or
any portion of the compensation,  including without limitation,  salary, bonuses
and  commissions,  that would  otherwise  become  payable to a key  Employee  or
Consultant in cash, awarded under Article VIII of the Plan.

     1.36.  "Subsidiary"  shall mean any  corporation  in an  unbroken  chain of
corporations  beginning with the Company if each of the corporations  other than
the last  corporation  in the unbroken  chain then owns stock  possessing  fifty
percent (50%) or more of the total combined voting power of all classes of stock
in one of the other corporations in such chain.

     1.37.  "Substitute Award" shall mean an Option granted under this Plan upon
the assumption of, or in substitution for,  outstanding equity awards previously
granted by a company or other entity in connection with a corporate transaction,
such as a merger,  combination,  consolidation  or  acquisition  of  property or
stock; provided,  however, that in no event shall the term "Substitute Award" be
construed  to refer to an award made in  connection  with the  cancellation  and
repricing of an Option.

     1.38.  "Termination of Consultancy" shall mean the time when the engagement
of a Holder as a Consultant to the Company or a Subsidiary is terminated for any
reason,  with or without  cause,  including,  but not by way of  limitation,  by
resignation,  discharge,  death or retirement,  but excluding terminations where
there is a  simultaneous  commencement  of  employment  with the  Company or any
Subsidiary. The Administrator,  in its absolute discretion,  shall determine the
effect of all matters and  questions  relating to  Termination  of  Consultancy,
including,  but not by way of limitation,  the question of whether a Termination
of  Consultancy  resulted from a discharge for good cause,  and all questions of
whether a particular leave of absence  constitutes a Termination of Consultancy.
Notwithstanding  any other  provision of the Plan, the Company or any Subsidiary
has an absolute and  unrestricted  right to terminate a Consultant's  service at
any time for any reason whatsoever,  with or without cause, except to the extent
expressly provided otherwise in writing.

     1.39.  "Termination of Directorship"  shall mean the time when a Holder who
is an Independent  Director  ceases to be a Director for any reason,  including,
but not by way of  limitation,  a  termination  by  resignation,  failure  to be
elected,  death or retirement.  The Board, in its sole and absolute  discretion,
shall determine the effect of all matters and questions  relating to Termination
of Directorship with respect to Independent Directors.

     1.40.   "Termination of Employment"    shall   mean   the   time  when  the
employee-employer   relationship  between  a  Holder  and  the  Company  or  any
Subsidiary is terminated for any reason, with or without cause,  including,  but
not by way of  limitation,  a  termination  by  resignation,  discharge,  death,
disability  or  retirement;  but  excluding  (a)  terminations  where there is a
simultaneous reemployment or continuing employment of a Holder by the Company or
any Subsidiary,  (b) at the discretion of the Administrator,  terminations which
result in a temporary severance of the employee-employer  relationship,  and (c)
at the discretion of the  Administrator,  terminations which are followed by the
simultaneous  establishment  of a  consulting  relationship  by the Company or a
Subsidiary  with  the  former  employee.  The  Administrator,  in  its  absolute
discretion,  shall determine the effect of all matters and questions relating to
Termination of Employment, including, but not by way of limitation, the question

                                       4

of whether a Termination of Employment resulted from a discharge for good cause,
and all  questions  of  whether a  particular  leave of  absence  constitutes  a
Termination of Employment;  provided,  however,  that, with respect to Incentive
Stock  Options,   unless  otherwise  determined  by  the  Administrator  in  its
discretion,  a leave  of  absence,  change  in  status  from an  employee  to an
independent  contractor  or other change in the  employee-employer  relationship
shall  constitute a Termination of Employment  if, and to the extent that,  such
leave of absence, change in status or other change interrupts employment for the
purposes of Section  422(a)(2) of the Code and the then  applicable  regulations
and revenue rulings under said Section.

                                  **ARTICLE II.
                             SHARES SUBJECT TO PLAN**

     2.1. Shares Subject to Plan.

          (a) The  shares  of stock  subject  to Awards  shall be Common  Stock,
     initially  shares of the Company's  Common Stock.  Subject to adjustment as
     provided in Section 11.3, the aggregate  number of such shares which may be
     issued  upon  exercise of such  Options or rights or upon any other  Awards
     under  the  Plan  shall  not  exceed  One  Million  Four  Hundred  Thousand
     (1,400,000)  shares,  and the aggregate number of shares that may be issued
     as  Restricted  Stock  shall not  exceed  One  Hundred  and Forty  Thousand
     (140,000) shares. The shares of Common Stock issuable upon exercise of such
     Options  or  rights  or upon any  other  Awards  may be  either  previously
     authorized but unissued shares or treasury shares.

          (b) The  maximum  number of  shares  which  may be  subject  to Awards
     granted  under the Plan to any  individual  in any calendar  year shall not
     exceed the Award Limit.

     2.2 Add-back of Options and Other Awards.  If any Option, or other right to
acquire shares of Common Stock under any other Award under the Plan,  expires or
is canceled without having been fully exercised,  or is exercised in whole or in
part for cash as  permitted  by the Plan,  the number of shares  subject to such
Option  or other  right  but as to which  such  Option  or other  right  was not
exercised  prior  to its  expiration,  cancellation  or  exercise  may  again be
optioned,  granted or awarded  hereunder,  subject to the limitations of Section
2.1.  Furthermore,  any shares subject to Awards which are adjusted  pursuant to
Section 11.3 and become  exercisable  with respect to shares of stock of another
corporation shall be considered cancelled and may again be optioned,  granted or
awarded  hereunder,  subject to the limitations of Section 2.1. Shares of Common
Stock which are  delivered  by the Holder or  withheld  by the Company  upon the
exercise of any Award under the Plan,  in payment of the exercise  price thereof
or tax withholding thereon, may again be optioned, granted or awarded hereunder,
subject to the limitations of Section 2.1. If any shares of Restricted Stock are
surrendered by the Holder or repurchased by the Company  pursuant to Section 7.4
or 7.5 hereof, such shares may again be optioned,  granted or awarded hereunder,
subject to the  limitations  of Section 2.1.  Notwithstanding  the provisions of
this Section  2.2, no shares of Common  Stock may again be optioned,  granted or
awarded if such action would cause an Incentive  Stock Option to fail to qualify
as an incentive stock option under Section 422 of the Code.

                                  **ARTICLE III.
                               GRANTING OF AWARDS**

     3.1. Award Agreement.  Each Award shall be evidenced by an Award Agreement.
Award  Agreements  evidencing  Awards  intended to qualify as  performance-based
compensation as described in Section 162(m)(4)(C) of the Code shall contain such
terms and  conditions as may be necessary to meet the  applicable  provisions of
Section 162(m) of the Code. Award Agreements  evidencing Incentive Stock Options
shall  contain  such  terms  and  conditions  as may be  necessary  to meet  the
applicable provisions of Section 422 of the Code.

     3.2. Provisions Applicable to Section 162(m) Participants.

          (a) The  Administrator,  in its discretion,  may determine  whether an
     Award is to qualify  as  performance-based  compensation  as  described  in
     Section 162(m)(4)(C) of the Code.

                                       5

          (b)  Notwithstanding  anything  in  the  Plan  to  the  contrary,  the
     Administrator  may  grant  any  Award  to  a  Section  162(m)  Participant,
     including  Restricted  Stock the  restrictions  with respect to which lapse
     upon the attainment of  performance  goals which are related to one or more
     of  the  Performance  Criteria  and  any  performance  or  incentive  award
     described in Article VIII that vests or becomes exercisable or payable upon
     the attainment of performance goals which are related to one or more of the
     Performance Criteria.

          (c) To the  extent  necessary  to  comply  with the  performance-based
     compensation requirements of Section 162(m)(4)(C) of the Code, with respect
     to any Award  granted  under  Articles VII and VIII which may be granted to
     one or more  Section  162(m)  Participants,  no later than ninety (90) days
     following  the  commencement  of any fiscal  year in  question or any other
     designated fiscal period or period of service (or such other time as may be
     required or permitted  by Section  162(m) of the Code),  the  Administrator
     shall, in writing,  (i) designate one or more Section 162(m)  Participants,
     (ii) select the Performance Criteria applicable to the fiscal year or other
     designated fiscal period or period of service,  (iii) establish the various
     performance  targets,  in terms of an objective  formula or  standard,  and
     amounts of such Awards, as applicable,  which may be earned for such fiscal
     year or other  designated  fiscal  period or period  of  service,  and (iv)
     specify the relationship  between Performance  Criteria and the performance
     targets and the amounts of such Awards, as applicable, to be earned by each
     Section 162(m)  Participant for such fiscal year or other designated fiscal
     period or period of service.  Following the  completion of each fiscal year
     or other designated  fiscal period or period of service,  the Administrator
     shall certify in writing  whether the applicable  performance  targets have
     been  achieved for such fiscal year or other  designated  fiscal  period or
     period of service.  In  determining  the amount earned by a Section  162(m)
     Participant,  the Administrator  shall have the right to reduce (but not to
     increase) the amount  payable at a given level of  performance to take into
     account  additional factors that the Administrator may deem relevant to the
     assessment of individual  or corporate  performance  for the fiscal year or
     other designated fiscal period or period of service.

          (d)  Furthermore,  notwithstanding  any other provision of the Plan or
     any Award which is granted to a Section 162(m)  Participant and is intended
     to  qualify  as  performance-based  compensation  as  described  in Section
     162(m)(4)(C) of the Code shall be subject to any additional limitations set
     forth in Section  162(m) of the Code  (including  any  amendment to Section
     162(m) of the Code) or any  regulations or rulings issued  thereunder  that
     are requirements for  qualification  as  performance-based  compensation as
     described in Section 162(m)(4)(C) of the Code, and the Plan shall be deemed
     amended to the extent necessary to conform to such requirements.

     3.3.  Limitations Applicable  to Section 16 Persons.   Notwithstanding  any
other  provision of the Plan,  the Plan, and any Award granted or awarded to any
individual  who is then  subject  to Section 16 of the  Exchange  Act,  shall be
subject to any additional limitations set forth in any applicable exemptive rule
under Section 16 of the Exchange Act  (including  any amendment to Rule 16b-3 of
the Exchange Act) that are  requirements  for the  application of such exemptive
rule. To the extent  permitted by applicable law, the Plan and Awards granted or
awarded  hereunder shall be deemed amended to the extent necessary to conform to
such applicable exemptive rule.

     3.4. Consideration.  In consideration of the granting of an Award under the
Plan, the Holder shall agree, in the Award Agreement, to remain in the employ of
(or to consult for or to serve as an Independent Director of, as applicable) the
Company  or any  Subsidiary  for a period of at least one year (or such  shorter
period as may be fixed in the Award Agreement or by action of the  Administrator
following  grant of the Award) after the Award is granted (or, in the case of an
Independent  Director,  until the next  annual  meeting of  stockholders  of the
Company).

     3.5.  At-Will Employment.  Nothing  in the Plan  or in any Award  Agreement
hereunder  shall  confer upon any Holder any right to continue in the employ of,
or as a Consultant for, the Company or any  Subsidiary,  or as a director of the
Company,  or shall  interfere  with or  restrict  in any way the  rights  of the
Company and any Subsidiary,  which are hereby expressly  reserved,  to discharge
any Holder at any time for any reason whatsoever,  with or without cause, except
to the extent expressly  provided  otherwise in a written  employment  agreement
between the Holder and the Company and any Subsidiary.

                                       6
**ARTICLE IV.
                        GRANTING OF OPTIONS TO EMPLOYEES,
                      CONSULTANTS AND INDEPENDENT DIRECTORS**

     4.1. Eligibility.  Any Employee or Consultant selected by the Administrator
pursuant to Section  4.4(a)(i)  shall be eligible to be granted an Option.  Each
Independent  Director of the Company shall be eligible to be granted  Options at
the times and in the manner set forth in Section 4.5.

     4.2.  Disqualification  for Stock  Ownership.  No person  may be granted an
Incentive Stock Option under the Plan if such person,  at the time the Incentive
Stock  Option  is  granted,  owns  stock  possessing  more than 10% of the total
combined  voting  power  of all  classes  of stock  of the  Company  or any then
existing  Subsidiary or parent corporation (within the meaning of Section 422 of
the  Code)  unless  such  Incentive  Stock  Option  conforms  to the  applicable
provisions of Section 422 of the Code.

     4.3.  Qualification  of Incentive Stock Options.  No Incentive Stock Option
shall be granted to any person who is not an Employee.

     4.4. Granting of Options to Employees and Consultants.

          (a) The  Administrator  shall  from  time  to  time,  in its  absolute
     discretion, and subject to applicable limitations of the Plan:

               (i) Determine  which  Employees are key Employees and select from
          among  the  key  Employees  or  Consultants  (including  Employees  or
          Consultants who have  previously  received Awards under the Plan) such
          of them as in its opinion should be granted Options;

               (ii) Subject to the Award Limit,  determine  the number of shares
          to be subject to such Options granted to the selected key Employees or
          Consultants;

               (iii) Subject to Section 4.3,  determine whether such Options are
          to be  Incentive  Stock  Options or  Non-Qualified  Stock  Options and
          whether such Options are to qualify as performance-based  compensation
          as described in Section 162(m)(4)(C) of the Code; and

               (iv)   Determine  the  terms  and  conditions  of  such  Options,
          consistent  with the  Plan;  provided,  however,  that the  terms  and
          conditions  of  Options  intended  to  qualify  as   performance-based
          compensation  as described in Section  162(m)(4)(C)  of the Code shall
          include,  but not be limited to, such terms and  conditions  as may be
          necessary to meet the  applicable  provisions of Section 162(m) of the
          Code.

          (b) Upon the  selection of a key Employee or  Consultant to be granted
     an Option, the Administrator shall instruct the Secretary of the Company to
     issue the Option and may impose such  conditions on the grant of the Option
     as it deems appropriate.

          (c) Any Incentive  Stock Option granted under the Plan may be modified
     by the  Administrator,  with the consent of the Holder,  to disqualify such
     Option from  treatment as an "incentive  stock option" under Section 422 of
     the Code.

     4.5.  Automatic  Granting of Options to Independent  Directors.  During the
term of the Plan, each person who is an Independent Director as of the Effective
Date automatically shall be granted an Option to purchase 7,000 shares of Common
Stock  (subject to  adjustment  as provided in Section 11.3) on the date of each
annual meeting of stockholders at which the Independent Director is reelected to
the Board,  commencing with the 2002 Annual Meeting of Stockholders.  During the
term of the Plan,  a person who is  initially  elected or appointed to the Board
after the Effective Date and who is an Independent  Director at the time of such
initial election or appointment  automatically shall be granted (x) an Option to
purchase  25,000  shares of Common Stock  (subject to  adjustment as provided in
Section 11.3) on the date of such initial  election or  appointment,  and (y) an
Option to  purchase  7,000  shares of Common  Stock  (subject to  adjustment  as
provided  in Section  11.3) on the date of each annual  meeting of  stockholders

                                       7

after such initial election or appointment, at which the Independent Director is
reelected to the Board,  provided such  individual  has served as an Independent
Director  for at least six months  prior to the date of such  annual  meeting of
stockholders.  Members  of the  Board  who  are  employees  of the  Company  who
subsequently retire from the Company and remain on the Board will not receive an
initial  Option grant pursuant to clause (x) of the preceding  sentence,  but to
the extent that they are otherwise eligible, will receive, after retirement from
employment with the Company, Options as described in clause (y) of the preceding
sentence. Certain material terms of the Options granted pursuant to this Section
4.5 are set forth in Section 5.4. All the foregoing Option grants  authorized by
this Section 4.5 are subject to stockholder approval of the Plan.

     4.6. Discretionary Granting of Options to Independent Directors.  The Board
may from time to time,  in its absolute  discretion,  and subject to  applicable
limitations of the Plan:

          (a) Select from among the Independent Directors (including Independent
     Directors who have previously received Options under the Plan) such of them
     as in its opinion should be granted Options;

          (b) Subject to the Award Limit,  determine  the number of shares to be
     subject to such Options granted to the selected Independent Directors;

          (c) Subject to the  provisions  of Article 5,  determine the terms and
     conditions of such Options, consistent with the Plan.

     4.7. Options in Lieu of Cash Compensation. Options may be granted under the
Plan to Employees and  Consultants in lieu of cash bonuses which would otherwise
be payable to such Employees and  Consultants  and to  Independent  Directors in
lieu of  directors'  fees which would  otherwise be payable to such  Independent
Directors,  pursuant to such policies which may be adopted by the  Administrator
from time to time.

                                   **ARTICLE V.
                                TERMS OF OPTIONS**

     5.1 Option Price.  The price per share of the shares subject to each Option
granted  to  Employees  and  Consultants  shall  be set  by  the  Administrator;
provided,  however, that such price shall be no less than 85% of the Fair Market
Value of a share of Common Stock on the date the Option is granted and:

          (a) In the case of Options  intended  to qualify as  performance-based
     compensation  as described in Section  162(m)(4)(C) of the Code, such price
     shall not be less than 100% of the Fair  Market  Value of a share of Common
     Stock on the date the Option is granted;

          (b) In the case of  Incentive  Stock  Options  such price shall not be
     less than 100% of the Fair Market  Value of a share of Common  Stock on the
     date the Option is granted (or the date the Option is modified, extended or
     renewed for purposes of Section 424(h) of the Code);

          (c) In the case of Incentive  Stock  Options  granted to an individual
     then owning  (within  the meaning of Section  424(d) of the Code) more than
     10% of the  total  combined  voting  power of all  classes  of stock of the
     Company or any Subsidiary or parent corporation thereof (within the meaning
     of Section 422 of the Code),  such price shall not be less than 110% of the
     Fair  Market  Value of a share of  Common  Stock on the date the  Option is
     granted  (or the date the  Option is  modified,  extended  or  renewed  for
     purposes of Section 424(h) of the Code).

     5.2 Option Term. The term of an Option granted to an Employee or consultant
shall be set by the Administrator in its discretion;  provided,  however,  that,
the term shall not be more than ten years  from the date the Option is  granted,
or five  years  from the date the  Incentive  Stock  Option  is  granted  if the
Incentive  Stock  Option is granted to an  individual  then  owning  (within the
meaning  of  Section  424(d)  of the Code)  more than 10% of the total  combined
voting power of all classes of stock of the Company or any  Subsidiary or parent
corporation  thereof (within the meaning of Section 422 of the Code).  Except as
limited by  requirements  of Section 422 of the Code and regulations and rulings
thereunder  applicable to Incentive Stock Options,  the Administrator may extend

                                       8

the  term of any  outstanding  Option  in  connection  with any  Termination  of
Employment or Termination of Consultancy of the Holder,  or amend any other term
or condition of such Option relating to such a termination.

     5.3 Option Vesting.

          (a) The  period  during  which the right to  exercise,  in whole or in
     part, an Option granted to an Employee or a Consultant  vests in the Holder
     shall be set by the  Administrator and the Administrator may determine that
     an Option may not be exercised  in whole or in part for a specified  period
     after  it  is  granted.   At  any  time  after  grant  of  an  Option,  the
     Administrator  may,  in its sole and  absolute  discretion  and  subject to
     whatever  terms and  conditions  it selects,  accelerate  the period during
     which an Option granted to an Employee or Consultant vests.

          (b) No portion of an Option granted to an Employee or Consultant which
     is   unexercisable   at   Termination   of  Employment  or  Termination  of
     Consultancy, as applicable, shall thereafter become exercisable,  except as
     may  be  otherwise  provided  by the  Administrator  either  in  the  Award
     Agreement  or by action  of the  Administrator  following  the grant of the
     Option.

          (c) To the extent that the  aggregate  Fair Market Value of stock with
     respect to which  "incentive  stock options" (within the meaning of Section
     422 of the Code,  but  without  regard to  Section  422(d) of the Code) are
     exercisable  for the first time by a Holder during any calendar year (under
     the Plan and all other  incentive stock option plans of the Company and any
     parent or subsidiary corporation,  within the meaning of Section 422 of the
     Code) of the Company,  exceeds  $100,000,  such Options shall be treated as
     Non-Qualified  Stock  Options to the extent  required by Section 422 of the
     Code.  The rule set forth in the  preceding  sentence  shall be  applied by
     taking  Options into account in the order in which they were  granted.  For
     purposes of this  Section  5.3(c),  the Fair Market Value of stock shall be
     determined as of the time the Option with respect to such stock is granted.

     5.4  Terms  of  Options  Automatically  Granted  to  Independent  DirectorsPursuant to Section 4.5. Options granted to an Independent  Director pursuant to
Section 4.5 shall be subject to the following terms and conditions:

          (a) The  exercise  price per share shall equal 100% of the Fair Market
     Value of a share of Common Stock on the date the Option is granted.

          (b)  The  Options  shall  become   exercisable  in  cumulative  annual
     installments  of 25% on  each  of  the  first,  second,  third  and  fourth
     anniversaries  of the date of Option grant,  except that any Option granted
     to an  Independent  Director shall become  immediately  exercisable in full
     upon the Termination of Directorship  due to death or Permanent  Disability
     of the Independent Director.

          (c)  Subject to Section  6.6,  the term of each  Option  granted to an
     Independent  Director  shall be ten  years  from the  date  the  Option  is
     granted.

          (d) No portion of an Option which is  unexercisable  at Termination of
     Directorship shall thereafter become exercisable.

          (e) Each vested  Option may be exercised  until the earlier of (i) the
     expiration of the Option term or (ii) 12 months  following the  Independent
     Director's cessation of service on the Board for any reason.

     5.5 Substitute Awards.  Notwithstanding  the  foregoing  provisions of this
Article V to the contrary,  in the case of an Option that is a Substitute Award,
the price per share of the shares  subject  to such  Option may be less than the
Fair Market Value per share on the date of grant, provided, that the excess of:

          (a) The  aggregate  Fair Market Value (as of the date such  Substitute
     Award is granted) of the shares subject to the Substitute Award; over

                                       9

          (b) The aggregate exercise price thereof;

          does not exceed the excess of:

          (c) The  aggregate  fair  market  value  (as of the  time  immediately
     preceding the transaction  giving rise to the Substitute  Award,  such fair
     market value to be  determined by the  Administrator)  of the shares of the
     predecessor  entity that were subject to the grant  assumed or  substituted
     for by the Company; over

          (d) The aggregate exercise price of such shares.

                                   **ARTICLE VI.
                               EXERCISE OF OPTIONS**

     6.1. Partial Exercise.  An exercisable  Option may be exercised in whole or
in part.  However, an Option shall not be exercisable with respect to fractional
shares and the  Administrator  may require that,  by the terms of the Option,  a
partial exercise be with respect to a minimum number of shares.

     6.2. Manner of Exercise. All or a portion of an exercisable Option shall be
deemed  exercised  upon delivery of all of the following to the Secretary of the
Company or his or her office:

          (a) A notice  complying with the applicable  rules  established by the
     Administrator stating that the Option, or a portion thereof, is exercised.

          (b) Such  representations  and documents as the Administrator,  in its
     absolute discretion, deems necessary or advisable to effect compliance with
     all  applicable  provisions of the  Securities Act and any other federal or
     state  securities  laws  or  regulations.  The  Administrator  may,  in its
     absolute  discretion,  also  take  whatever  additional  actions  it  deems
     appropriate  to  effect  such  compliance  including,  without  limitation,
     placing legends on share certificates and issuing  stop-transfer notices to
     agents and registrars;

          (c) In the  event  that the  Option  shall be  exercised  pursuant  to
     Section  11.1 by any person or persons  other than the Holder,  appropriate
     proof of the right of such person or persons to exercise the Option; and

          (d) Full  cash  payment  to the of the  Company  for the  shares  with
     respect to which the Option, or portion thereof, is exercised. However, the
     Administrator may, in its discretion, (i) allow a delay in payment up to 30
     days from the date the Option, or portion thereof, is exercised; (ii) allow
     payment,  in whole or in part,  through  the  delivery  of shares of Common
     Stock  which have been owned by the  Holder for at least six  months,  duly
     endorsed  for  transfer to the Company with a Fair Market Value on the date
     of  delivery  equal  to the  aggregate  exercise  price  of the  Option  or
     exercised  portion  thereof;  (iii)  allow  payment,  in  whole or in part,
     through the surrender of shares of Common Stock then issuable upon exercise
     of the Option  having a Fair  Market  Value on the date of Option  exercise
     equal to the aggregate  exercise  price of the Option or exercised  portion
     thereof;  (iv) allow payment,  in whole or in part, through the delivery of
     property of any kind which constitutes good and valuable consideration; (v)
     allow payment, in whole or in part, through the delivery of a full recourse
     promissory  note bearing  interest (at no less than such rate as shall then
     preclude the  imputation of interest  under the Code) and payable upon such
     terms as may be prescribed by the  Administrator;  (vi) allow  payment,  in
     whole or in part,  through  the  delivery  of a notice  that the Holder has
     placed a market sell order with a broker  with  respect to shares of Common
     Stock then issuable  upon  exercise of the Option,  and that the broker has
     been  directed to pay a sufficient  portion of the net proceeds of the sale
     to  the   Company   in   satisfaction   of  the  Option   exercise   price,
     provided  that payment of such  proceeds is then made to the Company
     upon   settlement  of  such  sale;  or  (vii)  allow  payment  through  any
     combination of the  consideration  provided in the foregoing  subparagraphs
     (ii),  (iii),  (iv),  (v) and (vi). In the case of a promissory  note,  the
     Administrator  may also prescribe the form of such note and the security to
     be given for such note.

                                       10

     The Option may not be exercised,  however, by delivery of a promissory note
     or by a loan from the Company when or where such loan or other extension of
     credit is prohibited by law.

     6.3. Conditions to Issuance of Stock Certificates. The Company shall not be
required to issue or deliver any certificate or certificates for shares of stock
purchased  upon  the  exercise  of  any  Option  or  portion  thereof  prior  to
fulfillment of all of the following conditions:

          (a) The admission of such shares to listing on all stock  exchanges on
     which such class of stock is then listed;

          (b) The completion of any registration or other  qualification of such
     shares under any state or federal law, or under the rulings or  regulations
     of  the  Securities  and  Exchange  Commission  or any  other  governmental
     regulatory body which the Administrator  shall, in its absolute discretion,
     deem necessary or advisable;

          (c) The obtaining of any approval or other clearance from any state or
     federal  governmental agency which the Administrator shall, in its absolute
     discretion, determine to be necessary or advisable;

          (d) The lapse of such reasonable period of time following the exercise
     of the  Option as the  Administrator  may  establish  from time to time for
     reasons of administrative convenience; and

          (e) The  receipt  by the  Company  of full  payment  for such  shares,
     including  payment  of  any  applicable   withholding  tax,  which  in  the
     discretion of the Administrator may be in the form of consideration used by
     the Holder to pay for such shares under Section 6.2(d).

     6.4.  Rights as Stockholders.   Holders  shall not be,  nor have any of the
rights or privileges  of,  stockholders  of the Company in respect of any shares
purchasable  upon  the  exercise  of any  part of an  Option  unless  and  until
certificates  representing  such  shares have been issued by the Company to such
Holders.

     6.5.  Ownership and Transfer Restrictions.   The   Administrator,  in   its
absolute  discretion,   may  impose  such  restrictions  on  the  ownership  and
transferability  of the shares  purchasable upon the exercise of an Option as it
deems  appropriate.  Any such  restriction  shall be set forth in the respective
Award  Agreement  and may be referred  to on the  certificates  evidencing  such
shares.  The Holder shall give the Company  prompt notice of any  disposition of
shares of Common Stock acquired by exercise of an Incentive  Stock Option within
(a) two  years  from the date of  granting  (including  the date the  Option  is
modified,  extended or renewed for purposes of Section  424(h) of the Code) such
Option to such Holder, or (b) one year after the transfer of such shares to such
Holder.

     6.6.  Limitations on Exercise of Options Granted to Independent  Directors.
No Option granted to an  Independent  Director may be exercised to any extent by
anyone after the first to occur of the following events:

          (a) The  expiration  of twelve  months  from the date of the  Holder's
     Termination of Directorship; or

          (b) The expiration of ten years from the date the Option was granted.

     6.7. Additional Limitations on Exercise of Options. Holders may be required
to comply with any timing or other  restrictions  with respect to the settlement
or  exercise  of an Option,  including  a  window-period  limitation,  as may be
imposed in the discretion of the Administrator.

                                       11
**ARTICLE VII.
                            AWARD OF RESTRICTED STOCK**

     7.1.  Eligibility.  Subject  to the Award  Limit,  Restricted  Stock may be
awarded to any Employee who the  Administrator  determines  is a key Employee or
any Consultant who the Administrator determines should receive such an Award.

     7.2. Award of Restricted Stock.

          (a)  The  Administrator  may  from  time  to  time,  in  its  absolute
     discretion:

               (i) Determine  which  Employees are key Employees and select from
          among  the  key  Employees  or  Consultants  (including  Employees  or
          Consultants who have previously  received other awards under the Plan)
          such of them as in its opinion should be awarded Restricted Stock; and

               (ii)  Determine the purchase  price,  if any, and other terms and
          conditions  applicable to such Restricted  Stock,  consistent with the
          Plan.

          (b) The Administrator  shall establish the purchase price, if any, and
     form of payment for Restricted Stock; provided, however, that such purchase
     price  shall  be no less  than  the par  value  of the  Common  Stock to be
     purchased,  unless  otherwise  permitted  by  applicable  state law. In all
     cases,  legal   consideration  shall  be  required  for  each  issuance  of
     Restricted Stock.

          (c) Upon the  selection of a key Employee or  Consultant to be awarded
     Restricted  Stock,  the  Administrator  shall instruct the Secretary of the
     Company to issue such  Restricted  Stock and may impose such  conditions on
     the issuance of such Restricted Stock as it deems appropriate.

     7.3. Rights as Stockholders.  Subject to  Section 7.4, upon delivery of the
shares of  Restricted  Stock to the escrow  holder  pursuant to Section 7.6, the
Holder  shall have,  unless  otherwise  provided by the  Administrator,  all the
rights of a stockholder with respect to said shares, subject to the restrictions
in his or her Award Agreement,  including the right to receive all dividends and
other distributions paid or made with respect to the shares; provided,  however,
that in the discretion of the  Administrator,  any  extraordinary  distributions
with respect to the Common Stock shall be subject to the  restrictions set forth
in Section 7.4.

     7.4.  Restriction.  All shares of  Restricted  Stock  issued under the Plan
(including  any shares  received by holders  thereof  with  respect to shares of
Restricted Stock as a result of stock dividends,  stock splits or any other form
of recapitalization)  shall, in the terms of each individual Award Agreement, be
subject  to  such  restrictions  as  the  Administrator  shall  provide,   which
restrictions may include,  without  limitation,  restrictions  concerning voting
rights and transferability and restrictions based on duration of employment with
the Company, Company performance and individual performance;  provided, however,
that,  unless the  Administrator  otherwise  provides  in the terms of the Award
Agreement or otherwise, no share of Restricted Stock granted to a person subject
to  Section  16 of the  Exchange  Act  shall  be  sold,  assigned  or  otherwise
transferred  until at least six months and one day have elapsed from the date on
which the Restricted Stock was issued, and provided,  further, that, except with
respect to shares of Restricted Stock granted to Section 162(m) Participants and
intended to be  "performance-based"  compensation  under  Section  162(m) of the
Code, by action taken after the Restricted  Stock is issued,  the  Administrator
may, on such terms and conditions as it may determine to be appropriate,  remove
any or all of the  restrictions  imposed  by the terms of the  Award  Agreement.
Restricted  Stock  may not be sold or  encumbered  until  all  restrictions  are
terminated or expire.

     If no consideration was paid by the Holder upon issuance, a Holder's rights
in unvested  Restricted  Stock shall lapse,  and such Restricted  Stock shall be
surrendered to the Company without consideration, upon Termination of Employment
or, if applicable,  upon Termination of Consultancy with the Company;  provided,
however,  that the Administrator in its sole and absolute discretion may provide
that such rights  shall not lapse in the event of a  Termination  of  Employment
following a "change of  ownership  or  control"  (within the meaning of Treasury
Regulation Section 1.162-27(e)(2)(v) or any successor regulation thereto) of the
Company or because  of the  Holder's  death or  disability;  provided,  further,

                                       12

except with  respect to shares of  Restricted  Stock  granted to Section  162(m)
Participants,  the Administrator in its sole and absolute discretion may provide
that no such lapse or  surrender  shall occur in the event of a  Termination  of
Employment,  or a  Termination  of  Consultancy,  without cause or following any
Change in Control of the  Company or  because  of the  Holder's  retirement,  or
otherwise.

     7.5. Repurchase of Restricted Stock. The Administrator shall provide in the
terms of each  individual  Award Agreement that the Company shall have the right
to repurchase from the Holder the Restricted  Stock then subject to restrictions
under the Award  Agreement  immediately  upon a Termination of Employment or, if
applicable,  upon a  Termination  of  Consultancy  between  the  Holder  and the
Company,  at a cash  price per share  equal to the price  paid by the Holder for
such Restricted Stock; provided, however, that the Administrator in its sole and
absolute  discretion may provide that no such right of repurchase shall exist in
the event of a  Termination  of  Employment  following a "change of ownership or
control" (within the meaning of Treasury Regulation Section 1.162-27(e)(2)(v) or
any  successor  regulation  thereto) of the  Company or because of the  Holder's
death or disability;  provided,  further, that, except with respect to shares of
Restricted Stock granted to Section 162(m)  Participants,  the  Administrator in
its sole and absolute  discretion  may provide that no such right of  repurchase
shall exist in the event of a Termination  of  Employment  or a  Termination  of
Consultancy  without  cause or following any Change in Control of the Company or
because of the Holder's retirement, or otherwise.

     7.6.  Escrow.  The  Secretary of the Company or such other escrow holder as
the  Administrator may appoint shall retain physical custody of each certificate
representing  Restricted Stock until all of the  restrictions  imposed under the
Award Agreement with respect to the shares evidenced by such certificate  expire
or shall have been removed.

     7.7. Legend.  In order to enforce the  restrictions  imposed upon shares of
Restricted Stock hereunder, the Administrator shall cause a legend or legends to
be placed on certificates  representing  all shares of Restricted Stock that are
still subject to restrictions  under Award  Agreements,  which legend or legends
shall make appropriate reference to the conditions imposed thereby.

     7.8.  Section 83(b) Election.  If a Holder  makes an election under Section
83(b) of the Code, or any successor section thereto, to be taxed with respect to
the Restricted  Stock as of the date of transfer of the Restricted  Stock rather
than as of the date or dates upon which the Holder  would  otherwise  be taxable
under  Section  83(a) of the  Code,  the  Holder  shall  deliver  a copy of such
election to the Company immediately after filing such election with the Internal
Revenue Service.

                                  **ARTICLE VIII.
    PERFORMANCE AWARDS, DIVIDEND EQUIVALENTS, DEFERRED STOCK, STOCK PAYMENTS**

     8.1.  Eligibility.  Subject  to the Award  Limit,  one or more  Performance
Awards, Dividend Equivalents, awards of Deferred Stock and/or Stock Payments may
be granted to any Employee whom the  Administrator  determines is a key Employee
or any  Consultant  whom the  Administrator  determines  should  receive such an
Award.

     8.2. Performance Awards.

          (a) Any key Employee or Consultant  selected by the  Administrator may
     be granted one or more  Performance  Awards.  The value of such Performance
     Awards  may be linked  to any one or more of the  Performance  Criteria  or
     other  specific   performance   criteria  determined   appropriate  by  the
     Administrator, in each case on a specified date or dates or over any period
     or periods determined by the Administrator.  In making such determinations,
     the  Administrator  shall  consider  (among such other  factors as it deems
     relevant  in  light  of the  specific  type of  award)  the  contributions,
     responsibilities  and other  compensation of the particular key Employee or
     Consultant.

          (b) Without  limiting  Section  8.2(a),  the  Administrator  may grant
     Performance  Awards to any 162(m)  Participant  in the form of a cash bonus
     payable  upon the  attainment  of  objective  performance  goals  which are
     established  by  the  Administrator  and  relate  to  one  or  more  of the
     Performance Criteria, in each case on a specified date or dates or over any
     period or periods determined by the Administrator. Any such bonuses paid to
     162(m)  Participants  shall be based upon  objectively  determinable  bonus

                                       13

     formulas  established in accordance with the provisions of Section 3.2. The
     maximum  amount of any  Performance  Award payable to a 162(m)  Participant
     under this Section  8.2(b) shall not exceed the Award Limit with respect to
     any  calendar  year  of the  Company.  Unless  otherwise  specified  by the
     Administrator at the time of grant,  the Performance  Criteria payable to a
     Section  162(m)  Participant  shall be determined on the basis of generally
     accepted accounting principles.

     8.3. Dividend Equivalents.

          (a) Any key Employee or Consultant  selected by the  Administrator may
     be granted Dividend  Equivalents based on the dividends  declared on Common
     Stock,  to be  credited  as of dividend  payment  dates,  during the period
     between the date a Stock Appreciation Right,  Deferred Stock or Performance
     Award is  granted,  and the date such Stock  Appreciation  Right,  Deferred
     Stock or Performance Award is exercised, vests or expires, as determined by
     the Administrator.  Such Dividend Equivalents shall be converted to cash or
     additional  shares of  Common  Stock by such  formula  and at such time and
     subject to such limitations as may be determined by the Administrator.

          (b) Any Holder of an Option who is an Employee or Consultant  selected
     by the  Administrator  may be  granted  Dividend  Equivalents  based on the
     dividends  declared on Common Stock, to be credited as of dividend  payment
     dates,  during the period  between the date an Option is  granted,  and the
     date such Option is  exercised,  vests or  expires,  as  determined  by the
     Administrator.  Such  Dividend  Equivalents  shall be  converted to cash or
     additional  shares of  Common  Stock by such  formula  and at such time and
     subject to such limitations as may be determined by the Administrator.

          (c) Any Holder of an Option who is an Independent Director selected by
     the  Board  may be  granted  Dividend  Equivalents  based on the  dividends
     declared on Common  Stock,  to be credited  as of dividend  payment  dates,
     during the period  between  the date an Option is granted and the date such
     Option is exercised,  vests or expires,  as  determined by the Board.  Such
     Dividend  Equivalents  shall be converted to cash or  additional  shares of
     Common  Stock  by  such  formula  and at  such  time  and  subject  to such
     limitations as may be determined by the Board.

          (d) Dividend  Equivalents  granted with respect to Options intended to
     be qualified performance-based  compensation for purposes of Section 162(m)
     of the  Code  shall be  payable,  with  respect  to  pre-exercise  periods,
     regardless of whether such Option is subsequently exercised.

     8.4. Stock Payments.  Any   key  Employee  or  Consultant  selected  by the
Administrator  may receive Stock Payments in the manner  determined from time to
time by the  Administrator.  The  number of shares  shall be  determined  by the
Administrator  and may be based upon the Performance  Criteria or other specific
performance criteria determined appropriate by the Administrator,  determined on
the date such Stock Payment is made or on any date thereafter.

     8.5.  Deferred Stock.  Any  key  Employee  or  Consultant  selected  by the
Administrator may be granted an award of Deferred Stock in the manner determined
from time to time by the  Administrator.  The number of shares of Deferred Stock
shall be determined by the  Administrator  and may be linked to the  Performance
Criteria or other specific  performance criteria determined to be appropriate by
the Administrator,  in each case on a specified date or dates or over any period
or periods determined by the  Administrator.  Common Stock underlying a Deferred
Stock  award  will not be issued  until the  Deferred  Stock  award has  vested,
pursuant to a vesting schedule or performance criteria set by the Administrator.
Unless otherwise provided by the Administrator, a Holder of Deferred Stock shall
have no rights as a Company  stockholder  with  respect to such  Deferred  Stock
until  such time as the Award has vested and the  Common  Stock  underlying  the
Award has been issued.

     8.6. Term. The term of a Performance Award,  Dividend Equivalent,  award of
Deferred  Stock and/or Stock  Payment shall be set by the  Administrator  in its
discretion.

                                       14

     8.7.  Exercise or Purchase Price.   The  Administrator  may  establish  the
exercise or purchase price of a Performance  Award,  shares of Deferred Stock or
shares received as a Stock Payment; provided, however, that such price shall not
be less  than  the par  value  of a share  of  Common  Stock,  unless  otherwise
permitted by applicable state law.

     8.8. Exercise Upon Termination of Employment, Termination of Consultancy orTermination of Directorship.  A Performance Award, Dividend Equivalent, award of
Deferred  Stock and/or Stock  Payment is  exercisable  or payable only while the
Holder is an  Employee,  Consultant  or  Independent  Director,  as  applicable;
provided,  however,  that the Administrator in its sole and absolute  discretion
may provide that the Performance Award,  Dividend Equivalent,  award of Deferred
Stock and/or Stock Payment may be exercised or paid  subsequent to a Termination
of Employment  following a "change of control or ownership"  (within the meaning
of  Section  1.162-27(e)(2)(v)  or  any  successor  regulation  thereto)  of the
Company;  provided,  further,  that except with  respect to  Performance  Awards
granted  to  Section  162(m)  Participants,  the  Administrator  in its sole and
absolute discretion may provide that Performance Awards may be exercised or paid
following a Termination of Employment or a Termination  of  Consultancy  without
cause,  or  following  a Change in  Control  of the  Company,  or because of the
Holder's retirement, death or disability, or otherwise.

     8.9. Form of Payment. Payment of the amount determined under Section 8.2 or
8.3  above  shall be in cash,  in  Common  Stock or a  combination  of both,  as
determined  by the  Administrator.  To the extent any payment under this Article
VIII is effected in Common Stock,  it shall be made subject to  satisfaction  of
all provisions of Section 6.3.

                                   **ARTICLE IX.
                            STOCK APPRECIATION RIGHTS**

     9.1. Grant of Stock Appreciation Rights.  A Stock Appreciation Right may be
granted to any key Employee or Consultant selected by the Administrator. A Stock
Appreciation Right may be granted (a) in connection and simultaneously  with the
grant of an Option,  (b) with respect to a  previously  granted  Option,  or (c)
independent of an Option.  A Stock  Appreciation  Right shall be subject to such
terms and conditions not inconsistent with the Plan as the  Administrator  shall
impose and shall be evidenced by an Award Agreement.

     9.2. Coupled Stock Appreciation Rights.

          (a) A Coupled Stock  Appreciation Right ("CSAR") shall be related to a
     particular  Option and shall be exercisable only when and to the extent the
     related Option is exercisable.

          (b) A CSAR may be granted to the Holder for no more than the number of
     shares subject to the  simultaneously or previously granted Option to which
     it is coupled.

          (c) A CSAR  shall  entitle  the Holder (or other  person  entitled  to
     exercise  the Option  pursuant  to the Plan) to  surrender  to the  Company
     unexercised  a portion  of the  Option to which  the CSAR  relates  (to the
     extent  then  exercisable  pursuant  to its terms) and to receive  from the
     Company in  exchange  therefor  an amount  determined  by  multiplying  the
     difference  obtained by subtracting the Option exercise price from the Fair
     Market Value of a share of Common Stock on the date of exercise of the CSAR
     by the  number of shares of Common  Stock  with  respect  to which the CSAR
     shall have been exercised, subject to any limitations the Administrator may
     impose.

     9.3. Independent Stock Appreciation Rights.

          (a)  An  Independent  Stock   Appreciation  Right  ("ISAR")  shall  be
     unrelated to any Option and shall have a term set by the Administrator.  An
     ISAR shall be exercisable in such  installments  as the  Administrator  may
     determine. An ISAR shall cover such number of shares of Common Stock as the
     Administrator   may   determine;   provided,   however,   that  unless  the
     Administrator  otherwise provides in the terms of the ISAR or otherwise, no
     ISAR granted to a person subject to Section 16 of the Exchange Act shall be

                                       15

     exercisable until at least six months have elapsed from (but excluding) the
     date on which the  Option  was  granted.  The  exercise  price per share of
     Common  Stock  subject to each ISAR shall be set by the  Administrator.  An
     ISAR is  exercisable  only while the Holder is an Employee  or  Consultant;
     provided,  that  the  Administrator  may  determine  that  the  ISAR may be
     exercised  subsequent  to  Termination  of  Employment  or  Termination  of
     Consultancy without cause, or following a Change in Control of the Company,
     or because of the Holder's retirement, death or disability, or otherwise.

          (b) An ISAR shall  entitle  the Holder (or other  person  entitled  to
     exercise  the ISAR  pursuant  to the Plan) to  exercise  all or a specified
     portion of the ISAR (to the extent then exercisable  pursuant to its terms)
     and to receive from the Company an amount  determined  by  multiplying  the
     difference obtained by subtracting the exercise price per share of the ISAR
     from  the Fair  Market  Value  of a share  of  Common  Stock on the date of
     exercise of the ISAR by the number of shares of Common  Stock with  respect
     to which the ISAR shall have been exercised, subject to any limitations the
     Administrator may impose.

     9.4. Payment and Limitations on Exercise.

          (a) Payment of the amounts  determined under Section 9.2(c) and 9.3(b)
     above shall be in cash,  in Common Stock (based on its Fair Market Value as
     of the date the Stock  Appreciation Right is exercised) or a combination of
     both,  as determined  by the  Administrator.  To the extent such payment is
     effected in Common  Stock it shall be made subject to  satisfaction  of all
     provisions of Section 6.3 above pertaining to Options.

          (b)  Holders of Stock  Appreciation  Rights may be  required to comply
     with any timing or other  restrictions  with respect to the  settlement  or
     exercise  of  a  Stock  Appreciation   Right,   including  a  window-period
     limitation, as may be imposed in the discretion of the Administrator.

                                   **ARTICLE X.
                                 ADMINISTRATION**

     10.1.  Compensation  Committee.  The  Compensation  Committee  (or  another
committee or a subcommittee of the Board assuming the functions of the Committee
under the  Plan)  shall  consist  solely  of two or more  Independent  Directors
appointed by and holding  office at the  pleasure of the Board,  each of whom is
both a  "non-employee  director"  as  defined  by  Rule  16b-3  and an  "outside
director" for purposes of Section  162(m) of the Code.  Appointment of Committee
members shall be effective upon acceptance of appointment. Committee members may
resign at any time by delivering  written notice to the Board.  Vacancies in the
Committee may be filled by the Board. In its absolute discretion,  the Board may
at any time and from time to time  exercise any and all rights and duties of the
Committee  under the Plan except with respect to matters  which under Rule 16b-3
or Section 162(m) of the Code, or any  regulations  or rules issued  thereunder,
are  required  to be  determined  in  the  sole  discretion  of  the  Committee.
Notwithstanding  the  foregoing,  the full  Board,  acting by a majority  of its
members in office,  shall  conduct the general  administration  of the Plan with
respect to Awards granted to Independent Directors.

     10.2. Duties and Powers of the Administrator.   It shall be the duty of the
Administrator  to conduct the general  administration  of the Plan in accordance
with its  provisions.  The  Administrator  shall have the power to interpret the
Plan and the Award Agreements,  and to adopt such rules for the  administration,
interpretation  and  application  of the Plan as are  consistent  therewith,  to
interpret,  amend or revoke  any such  rules  and to amend  any Award  Agreement
provided that the rights or  obligations  of the Holder of the Award that is the
subject of any such Award Agreement are not affected  adversely.  Any such grant
or award under the Plan need not be the same with  respect to each  Holder.  Any
such  interpretations and rules with respect to Incentive Stock Options shall be
consistent with the provisions of Section 422 of the Code.

     10.3. Majority Rule; Unanimous Written Consent. The Administrator shall act
by a majority  of its  members in  attendance  at a meeting at which a quorum is
present or by a memorandum or other written  instrument signed by all members of
the Administrator.

                                       16

     10.4. Compensation; Professional Assistance; Good Faith Actions. Members of
the Administrator shall receive such compensation, if any, for their services as
members as may be determined by the Board. All expenses and  liabilities,  which
members of the Administrator  incur in connection with the administration of the
Plan, shall be borne by the Company. The Administrator may, with the approval of
the Board, employ attorneys,  consultants,  accountants,  appraisers, brokers or
other persons.  The  Administrator,  the Company and the Company's  officers and
Directors  shall be entitled to rely upon the advice,  opinions or valuations of
any such persons.  All actions taken and all  interpretations and determinations
made by the  Administrator or the Board in good faith shall be final and binding
upon all Holders,  the Company and all other interested  persons.  No members of
the   Administrator  or  Board  shall  be  personally  liable  for  any  action,
determination or  interpretation  made in good faith with respect to the Plan or
Awards,  and all  members  of the  Administrator  and the  Board  shall be fully
protected  by the  Company  in  respect  of any such  action,  determination  or
interpretation.

     10.5.  Delegation of Authority to Grant Awards. The Committee may, but need
not,  delegate  from time to time some or all of its  authority  to grant Awards
under  the  Plan  and  administer  the  Plan as to such  Awards  to a  committee
consisting of one or more members of the Committee or of one or more officers of
the  Company;  provided,  however,  that  the  Committee  may not  delegate  its
authority to grant Awards to individuals  (a) who are subject on the date of the
grant to the  reporting  rules under  Section 16(a) of the Exchange Act, (b) who
are Section 162(m) Participants,  or (c) who are officers of the Company who are
delegated authority by the Committee  hereunder.  Any delegation hereunder shall
be subject to the  restrictions  and limits that the Committee  specifies at the
time of such  delegation  of  authority  and may be rescinded at any time by the
Committee.  At all times, any committee  appointed under this Section 10.5 shall
serve in such capacity at the pleasure of the Committee.

                                   **ARTICLE XI.
                            MISCELLANEOUS PROVISIONS**

     11.1. Transferability of Awards.

          (a) Except as provided in Section 11.1(b):

               (i) No Award  under the Plan may be sold,  pledged,  assigned  or
          transferred  in any  manner  other than by will or the laws of descent
          and  distribution  or,  subject to the  consent of the  Administrator,
          pursuant to a DRO, unless and until such Award has been exercised,  or
          the  shares   underlying   such  Award  have  been  issued,   and  all
          restrictions applicable to such shares have lapsed.

               (ii) No Award or  interest or right  therein  shall be liable for
          the  debts,  contracts  or  engagements  of the  Holder  or his or her
          successors in interest or shall be subject to disposition by transfer,
          alienation, anticipation, pledge, encumbrance, assignment or any other
          means  whether such  disposition  be voluntary  or  involuntary  or by
          operation of law by judgment,  levy,  attachment,  garnishment  or any
          other legal or equitable proceedings (including  bankruptcy),  and any
          attempted disposition thereof shall be null and void and of no effect,
          except  to the  extent  that  such  disposition  is  permitted  by the
          preceding sentence.

               (iii)  During  the  lifetime  of the  Holder,  only he or she may
          exercise an Option or other Award (or any portion  thereof) granted to
          him or her  under the Plan,  unless it has been  disposed  of with the
          consent of the Administrator pursuant to a DRO. After the death of the
          Holder, any exercisable portion of an Option or other Award may, prior
          to the time when such portion becomes  unexercisable under the Plan or
          the applicable  Award  Agreement,  be exercised by his or her personal
          representative  or by any person empowered to do so under the deceased
          Holder's  will or  under  the  then  applicable  laws of  descent  and
          distribution.

          (b) Notwithstanding  Section 11.1(a),  the Administrator,  in its sole
     discretion,  may  determine to permit a Holder to transfer an Option to any
     one or more  Permitted  Transferees  (as  defined  below),  subject  to the
     following terms and conditions:

                                       17

               (i) an Option transferred to a Permitted  Transferee shall not be
          assignable or transferable by the Permitted  Transferee  other than by
          will or the laws of descent and distribution;  (ii) an Option which is
          transferred to a Permitted  Transferee shall continue to be subject to
          all the terms  and  conditions  of the  Option  as  applicable  to the
          original  Holder  (other  than the  ability  to further  transfer  the
          Option); and

               (iii) the Holder and the Permitted  Transferee  shall execute any
          and all documents requested by the Administrator,  including,  without
          limitation  documents to (A) confirm the status of the transferee as a
          Permitted  Transferee,  (B) satisfy any  requirements for an exemption
          for the transfer under  applicable  federal and state  securities laws
          and (C) evidence the transfer.

               For  purposes of this  Section  11.1(b),  "Permitted  Transferee"
          shall  mean,  with  respect  to  a  Holder,   any  child,   stepchild,
          grandchild,  parent, stepparent,  grandparent,  spouse, former spouse,
          sibling,  niece,  nephew,  mother-in-law,  father-in-law,  son-in-law,
          daughter-in-law,  brother-in-law, or sister-in-law, including adoptive
          relationships, any person sharing the Holder's household (other than a
          tenant or  employee),  a trust in which these  persons (or the Holder)
          control the management of assets,  and any other entity in which these
          persons  (or the  Holder)  own more than  fifty  percent of the voting
          interests,  or  any  other  transferee  specifically  approved  by the
          Administrator  after  taking into  account any state or federal tax or
          securities laws applicable to transferable Options."

     11.2. Amendment, Suspension or Termination of the Plan. Except as otherwise
provided in this Section  11.2,  the Plan may be wholly or partially  amended or
otherwise modified,  suspended or terminated at any time or from time to time by
the Administrator. However, without approval of the Company's stockholders given
within 12 months before or after the action by the  Administrator,  no action of
the Administrator  may, except as provided in Section 11.3,  increase the limits
imposed in Section 2.1 on the maximum number of shares which may be issued under
the Plan. No amendment, suspension or termination of the Plan shall, without the
consent of the Holder, alter or impair any rights or obligations under any Award
theretofore  granted or awarded,  unless the Award itself otherwise expressly so
provides. No Awards may be granted or awarded during any period of suspension or
after termination of the Plan, and in no event may any Incentive Stock Option be
granted under the Plan after the first to occur of the following events:

          (a) The  expiration  of ten years from the date the Plan is adopted by
     the Board; or

          (b) The  expiration of ten years from the date the Plan is approved by
     the Company's stockholders under Section 11.4.

     11.3.  Changes in Common  Stock or Assets of the  Company,  Acquisition  orLiquidation of the Company and Other Corporate Events.

          (a) Subject to Section  11.3(e),  in the event that the  Administrator
     determines that any dividend or other distribution  (whether in the form of
     cash, Common Stock, other securities or other property),  recapitalization,
     reclassification, stock split, reverse stock split, reorganization, merger,
     consolidation,  split-up, spin-off, combination,  repurchase,  liquidation,
     dissolution,  or sale,  transfer,  exchange or other  disposition of all or
     substantially all of the assets of the Company, or exchange of Common Stock
     or other securities of the Company, issuance of warrants or other rights to
     purchase Common Stock or other securities of the Company,  or other similar
     corporate  transaction or event, in the  Administrator's  sole  discretion,
     affects  the Common  Stock such that an  adjustment  is  determined  by the
     Administrator to be appropriate in order to prevent dilution or enlargement
     of the benefits or potential  benefits  intended to be made available under
     the Plan or with respect to an Award, then the Administrator shall, in such
     manner as it may deem equitable, adjust any or all of:

               (i) The  number  and kind of  shares  of  Common  Stock (or other
          securities or property) with respect to which Awards may be granted or
          awarded (including, but not limited to, adjustments of the limitations
          in Section 2.1 on the maximum  number and kind of shares  which may be
          issued and adjustments of the Award Limit);

                                       18

               (ii) The  number  and kind of shares  of  Common  Stock (or other
          securities or property) subject to outstanding Awards; and

               (iii) The grant or exercise price with respect to any Award.

          (b)  Subject  to  Section  11.3(c)  and  11.3(e),  in the event of any
     transaction or event described in Section  11.3(a),  any Change in Control,
     any Corporate  Transaction or any unusual or  nonrecurring  transactions or
     events  affecting  the  Company,  any  affiliate  of  the  Company,  or the
     financial  statements  of the  Company or any  affiliate,  or of changes in
     applicable laws, regulations or accounting  principles,  the Administrator,
     in its sole and absolute discretion, and on such terms and conditions as it
     deems  appropriate,  either by the  terms of the  Award or by action  taken
     prior  to  the   occurrence  of  such   transaction  or  event  and  either
     automatically or upon the Holder's  request,  is hereby  authorized to take
     any  one or  more  of the  following  actions  whenever  the  Administrator
     determines that such action is appropriate in order to prevent  dilution or
     enlargement  of the  benefits  or  potential  benefits  intended to be made
     available  under the Plan or with  respect to any Award under the Plan,  to
     facilitate such transactions or events or to give effect to such changes in
     laws, regulations or principles:

               (i) To provide  for either the  purchase of any such Award for an
          amount of cash equal to the amount that could have been  attained upon
          the exercise of such Award or realization  of the Holder's  rights had
          such Award been  currently  exercisable  or payable or fully vested or
          the  replacement of such Award with other rights or property  selected
          by the Administrator in its sole discretion;

               (ii) To provide  that the Award  cannot  vest,  be  exercised  or
          become payable after such event;

               (iii) To provide that such Award shall be  exercisable  as to all
          shares covered  thereby,  notwithstanding  anything to the contrary in
          Section 5.3 or 5.4 or the provisions of such Award;

               (iv) To provide  that such Award be assumed by the  successor  or
          survivor  corporation,  or a parent or subsidiary thereof, or shall be
          substituted  for by similar  options,  rights or awards  covering  the
          stock  of the  successor  or  survivor  corporation,  or a  parent  or
          subsidiary thereof, with appropriate  adjustments as to the number and
          kind of shares and prices; and

               (v) To make  adjustments  in the  number  and type of  shares  of
          Common Stock (or other securities or property)  subject to outstanding
          Awards, and in the number and kind of outstanding  Restricted Stock or
          Deferred  Stock and/or in the terms and  conditions of (including  the
          grant or exercise price),  and the criteria  included in,  outstanding
          options, rights and awards and options, rights and awards which may be
          granted in the future.

               (vi) To provide  that,  for a  specified  period of time prior to
          such event,  the  restrictions  imposed under an Award  Agreement upon
          some or all  shares  of  Restricted  Stock or  Deferred  Stock  may be
          terminated,  and, in the case of Restricted  Stock, some or all shares
          of such Restricted  Stock may cease to be subject to repurchase  under
          Section 7.5 or forfeiture under Section 7.4 after such event.

          (c) In the event of a Change in  Control  or a  Corporate  Transaction
     each Option granted to an  Independent  Director shall be exercisable as to
     all shares  covered  thereby upon such Change in Control or during the five
     days immediately  preceding the consummation of such Corporate  Transaction
     and subject to such consummation,  notwithstanding anything to the contrary
     in Section 5.4 or the vesting  schedule of such Options.  In the event of a
     Change in Control,  each Option  granted to an  Independent  Director shall
     remain exercisable for such fully-vested option shares until the expiration
     or sooner  termination  of the  Option  term.  In the event of a  Corporate
     Transaction,  to the extent that the Board does not have the ability  under
     Rule 16b-3 to take or to refrain from taking the discretionary  actions set
     forth in Section  11.3(b)(ii)  above,  no Option  granted to an Independent
     Director may be exercised following such Corporate  Transaction unless such

                                       19

     Option is, in connection with such Corporate Transaction, either assumed by
     the successor or survivor  corporation (or parent or subsidiary thereof) or
     replaced  with a  comparable  right with  respect to shares of the  capital
     stock of the  successor or survivor  corporation  (or parent or  subsidiary
     thereof).

          (d) Subject to Sections 11.3(e),  3.2 and 3.3, the Administrator  may,
     in its discretion,  include such further  provisions and limitations in any
     Award,  agreement or certificate,  as it may deem equitable and in the best
     interests of the Company.

          (e) With  respect  to  Awards  which are  granted  to  Section  162(m)
     Participants and are intended to qualify as performance-based  compensation
     under  Section  162(m)(4)(C),  no  adjustment  or action  described in this
     Section 11.3 or in any other  provision of the Plan shall be  authorized to
     the extent that such adjustment or action would cause such Award to fail to
     so qualify under Section 162(m)(4)(C), or any successor provisions thereto.
     No  adjustment  or action  described  in this  Section 11.3 or in any other
     provision  of the  Plan  shall  be  authorized  to  the  extent  that  such
     adjustment or action would cause the Plan to violate  Section  422(b)(1) of
     the Code. Furthermore,  no such adjustment or action shall be authorized to
     the extent such  adjustment or action would result in  short-swing  profits
     liability  under  Section 16 or violate the  exemptive  conditions  of Rule
     16b-3 unless the  Administrator  determines that the Award is not to comply
     with such  exemptive  conditions.  The  number  of  shares of Common  Stock
     subject to any Award shall always be rounded to the next whole number.

          (f) The  existence  of the Plan,  the Award  Agreement  and the Awards
     granted  hereunder  shall not  affect or  restrict  in any way the right or
     power  of the  Company  or the  shareholders  of the  Company  to  make  or
     authorize any adjustment, recapitalization,  reorganization or other change
     in  the  Company's  capital  structure  or  its  business,  any  merger  or
     consolidation of the Company, any issue of stock or of options, warrants or
     rights  to  purchase  stock or of  bonds,  debentures,  preferred  or prior
     preference  stocks  whose rights are superior to or affect the Common Stock
     or the rights thereof or which are  convertible  into or  exchangeable  for
     Common Stock, or the dissolution or liquidation of the company, or any sale
     or  transfer  of all or any part of its  assets or  business,  or any other
     corporate act or proceeding, whether of a similar character or otherwise.

     11.4. Approval of Plan by Stockholders.  The Plan will be submitted for the
approval of the  Company's  stockholders  within 12 months after the date of the
Board's initial adoption of the Plan.  Awards may be granted or awarded prior to
such  stockholder  approval,  provided that such Awards shall not be exercisable
nor shall such  Awards  vest prior to the time when the Plan is  approved by the
stockholders,  and provided  further that if such approval has not been obtained
at the end of said twelve-month period, all Awards previously granted or awarded
under the Plan  shall  thereupon  be  canceled  and  become  null and  void.  In
addition,  if the Board  determines  that  Awards  other  than  Options or Stock
Appreciation  Rights which may be granted to Section 162(m)  Participants should
continue  to be  eligible  to qualify as  performance-based  compensation  under
Section  162(m)(4)(C) of the Code, the Performance Criteria must be disclosed to
and approved by the Company's  stockholders no later than the first  stockholder
meeting that occurs in the fifth year  following the year in which the Company's
stockholders previously approved the Performance Criteria.

     11.5. Tax Withholding.  The Company shall be entitled to require payment in
cash or  deduction  from other  compensation  payable to each Holder of any sums
required by federal,  state or local tax law to be withheld  with respect to the
issuance,  vesting,  exercise or payment of any Award. The  Administrator may in
its  discretion  and in  satisfaction  of the foregoing  requirement  allow such
Holder to elect to have the Company  withhold  shares of Common Stock  otherwise
issuable under such Award (or allow the return of shares of Common Stock) having
a Fair Market Value equal to the sums  required to be withheld.  Notwithstanding
any other  provision of the Plan, the number of shares of Common Stock which may
be withheld  with respect to the issuance,  vesting,  exercise or payment of any
Award (or which may be  repurchased  from the  Holder of such  Award  within six
months  after such shares of Common  Stock were  acquired by the Holder from the
Company) in order to satisfy the  Holder's  federal and state income and payroll
tax liabilities  with respect to the issuance,  vesting,  exercise or payment of
the Award  shall be  limited to the  number of shares  which have a Fair  Market
Value on the date of withholding or repurchase  equal to the aggregate amount of
such liabilities  based on the minimum  statutory  withholding rates for federal
and state tax  income and  payroll  tax  purposes  that are  applicable  to such
supplemental taxable income.

                                       20

     11.6. Loans. The Administrator  may, in its discretion,  extend one or more
loans to key  Employees in  connection  with the exercise or receipt of an Award
granted  or awarded  under the Plan,  or the  issuance  of  Restricted  Stock or
Deferred Stock awarded under the Plan. The terms and conditions of any such loan
shall be set by the Administrator.

     11.7. Forfeiture Provisions. Pursuant to its general authority to determine
the terms and conditions  applicable to Awards under the Plan, the Administrator
shall have the right to provide,  in the terms of Awards made under the Plan, or
to require a Holder to agree by  separate  written  instrument,  that (a)(i) any
proceeds, gains or other economic benefit actually or constructively received by
the Holder upon any  receipt or  exercise  of the Award,  or upon the receipt or
resale of any Common Stock  underlying  the Award,  must be paid to the Company,
and (ii) the Award  shall  terminate  and any  unexercised  portion of the Award
(whether  or not  vested)  shall  be  forfeited,  if  (b)(i)  a  Termination  of
Employment,  Termination of Consultancy  or Termination of  Directorship  occurs
prior to a specified date, or within a specified time period  following  receipt
or exercise of the Award,  or (ii) the Holder at any time, or during a specified
time period,  engages in any activity in competition with the Company,  or which
is inimical,  contrary or harmful to the  interests  of the Company,  as further
defined  by the  Administrator  or (iii)  the  Holder  incurs a  Termination  of
Employment, Termination of Consultancy or Termination of Directorship for cause.

     11.8.  Effect of Plan Upon Options and Compensation Plans.  The adoption of
the Plan shall not affect any other  compensation  or incentive  plans in effect
for the Company or any  Subsidiary.  Nothing in the Plan shall be  construed  to
limit the right of the Company (a) to establish any other forms of incentives or
compensation  for  Employees,  Directors  or  Consultants  of the Company or any
Subsidiary,  or (b) to  grant  or  assume  options  or other  rights  or  awards
otherwise than under the Plan in connection  with any proper  corporate  purpose
including  but not by way of  limitation,  the grant or assumption of options in
connection with the acquisition by purchase,  lease,  merger,  consolidation  or
otherwise,  of the business,  stock or assets of any  corporation,  partnership,
limited liability company, firm or association.

     11.9.  Compliance with Laws. The Plan, the granting and vesting of Awards
under the Plan and the  issuance  and delivery of shares of Common Stock and the
payment of money under the Plan or under Awards granted or awarded hereunder are
subject to  compliance  with all  applicable  federal and state laws,  rules and
regulations  (including but not limited to state and federal  securities law and
federal margin requirements) and to such approvals by any listing, regulatory or
governmental  authority  as may, in the opinion of counsel for the  Company,  be
necessary or advisable in connection  therewith.  Any securities delivered under
the Plan shall be subject to such  restrictions,  and the person  acquiring such
securities  shall,  if  requested by the Company,  provide such  assurances  and
representations to the Company as the Company may deem necessary or desirable to
assure  compliance  with  all  applicable  legal  requirements.  To  the  extent
permitted by applicable  law, the Plan and Awards  granted or awarded  hereunder
shall be deemed amended to the extent  necessary to conform to such laws,  rules
and regulations.

     11.10. Titles.  Titles are provided herein for convenience only and are not
to serve as a basis for interpretation or construction of the Plan.

     11.11.  Governing Law.  The Plan  and  any  agreements  hereunder  shall be
administered,  interpreted  and enforced under the internal laws of the State of
California without regard to conflicts of laws thereof.

                                      * * *

     I hereby  certify that the foregoing  Plan was duly adopted by the Board of
Directors of  FileNet Corporation  on March 28, 2002.  I hereby certify that the
foregoing Plan was approved by the  stockholders  of FileNet  Corporation on May
22, 2002.

          Executed on this ____ day of May 2002.

                                                 
                                                 Secretary

                                       21

                                                            Effective as of 2002

                             **STOCK OPTION AGREEMENT

                              TERMS AND CONDITIONS**

     These *Terms and Conditions* constitute a part of the Stock Option Agreement,
dated as of the date set forth on the *Signature  Page to Stock Option  Agreement
Terms and  Conditions*  made a part hereof  (the  "Signature  Page"),  concerning
certain  Options  granted  by  FileNET   Corporation,   a  Delaware  corporation
hereinafter  referred  to as  "Company,"  to the  employee  of the Company (or a
Subsidiary of the Company) listed on the Signature Page, hereinafter referred to
as   "Optionee."   These  Terms  and  Conditions  and  the  Signature  Page  are
collectively referred to as the "Agreement."

     WHEREAS,  the Company  wishes to afford the  Optionee  the  opportunity  to
purchase shares of its $0.01 par value Common Stock;

     WHEREAS,  the Company wishes to carry out The 2002 Incentive  Award Plan of
FileNET  Corporation,  as the same may be amended from time to time (the "Plan")
(the terms of which are hereby incorporated by reference and made a part of this
Agreement); and

     WHEREAS,  the Administrator  under the Plan has determined that it would be
to the advantage and best interest of the Company and its  stockholders to grant
the Option provided for herein to the Optionee as an inducement to enter into or
remain in the  service of the Company or a  Subsidiary  of the Company and as an
incentive for increased efforts during such service, and has advised the Company
thereof and instructed the undersigned officers to issue said Option.

     NOW,  THEREFORE,  in consideration of the mutual covenants herein contained
and  other  good  and  valuable  consideration,   receipt  of  which  is  hereby
acknowledged, the parties hereto do hereby agree as follows:

                                    **ARTICLE I.****DEFINITIONS**

     Whenever the following  terms are used in this  Agreement,  they shall have
the  meaning  specified  below  unless  the  context  clearly  indicates  to the
contrary.  The masculine pronoun shall include the feminine and neuter,  and the
singular the plural, where the context so indicates.  Capitalized terms used but
not defined in this Agreement  shall have the meaning  ascribed to such terms in
the Plan.

Section 1.1.Cause

     "Cause" shall mean: (i) Optionee's  commission of any act of theft,  fraud,
embezzlement or dishonesty; or (ii) Optionee's willful or intentional misconduct
adversely affecting the business or affairs of the Company or any Subsidiary; or
(iv) Optionee's  unauthorized  use or disclosure of confidential  information or
trade secrets of the Company or any Subsidiary.  The foregoing  definition shall

not be deemed to be inclusive  of all acts or omissions  that the Company or any
Subsidiary  may  consider  as grounds  for the  dismissal  or  discharge  of any
Optionee.

                                   **ARTICLE II.****GRANT OF OPTION**Section 2.1.Grant of Option

     Effective  as of the date set  forth on the  Signature  Page,  the  Company
irrevocably grants to the Optionee the option to purchase any part or all of the
aggregate  number of shares of its Common Stock set forth on the Signature Page,
all upon the terms and conditions set forth in this Agreement (the "Option").

Section 2.2.Purchase Price

     The purchase  price of the shares of Common Stock  covered by the Option is
set forth on the Signature Page, and shall not be subject to commission or other
charge.

Section 2.3.Consideration to Company

     In  consideration  of the  granting  of this  Option  by the  Company,  the
Optionee agrees to render faithful and efficient  services to the Company or its
any  Subsidiary,  with such  duties and  responsibilities  as the Company or any
Subsidiary  shall from time to time prescribe,  for a period of at least one (1)
year from the date this Option is granted.

                                  **ARTICLE III.****PERIOD OF EXERCISABILITY**Section 3.1.  Commencement of Exercisability

     The Option shall become exercisable in the time and manner set forth on the
Signature  Page.  Except as otherwise may be provided by the  Administrator,  no
portion of the Option that is  unexercisable  at Termination of Employment shall
thereafter become exercisable.

Section 3.2.Duration of Exercisability

     The  installments  provided  for in Section 3.1 are  cumulative.  Each such
installment  that  becomes  exercisable  pursuant  to Section  3.1 shall  remain
exercisable until it becomes unexercisable under Section 3.3.

Section 3.3.Expiration of Option

     Except to the extent  otherwise  set forth in the Severance  Agreement,  if
applicable,  the Option may not be  exercised  to any extent by anyone after the
first to occur of the following events:

                                       2

     (a)  The expiration of ten (10) years from the date the Option was granted,
          as set forth on the Signature Page;

     (b)  The time of the Optionee's Termination of Employment for Cause;

     (c)  The  expiration  of three (3) months  from the date of the  Optionee's
          Termination of Employment by reason of his retirement,  resignation or
          termination of his employment not for Cause,  unless the Optionee dies
          within said three-month period;

     (d)  The  expiration  of one (1)  year  from  the  date  of the  Optionee's
          Termination of Employment by reason of his disability;

     (e)  The expiration of one (1) year from the date of the Optionee's  death;
          or

     (f)  The effective  date of a Corporate  Transaction,  unless the successor
          corporation  or a parent or subsidiary  of the  successor  corporation
          assumes or  substitutes  the Option as  described  in Section  3.5. At
          least  fifteen  (15) days prior to the  effective  date of a Corporate
          Transaction  as to which  the  successor  corporation  or a parent  or
          subsidiary of the successor  corporation does not assume or substitute
          the Option,  the Administrator  shall give the Optionee notice of such
          event if the Option has then neither been fully  exercised  nor become
          unexercisable under this Section 3.3.

Section 3.4.Special Tax Consequences

     The  Optionee  acknowledges  that,  to the extent that the  aggregate  fair
market value of stock with respect to which  "incentive  stock options"  (within
the meaning of Section 422 of the Code,  but without regard to Section 422(d) of
the Code),  including all or such portion of the Option  elected by the Optionee
to be treated as an incentive  stock option,  are exercisable for the first time
by the Optionee during any calendar year (under the Plan and all other incentive
stock option  plans of the Company and any  Subsidiary  of the Company)  exceeds
$100,000, such options shall be treated for all purposes as not qualifying under
Section  422 of  the  Code  and  therefore  shall  be  subject  to  taxation  as
non-qualified  options.  The Optionee  further  acknowledges  that the rules set
forth in the preceding  sentence shall be applied by taking options into account
in the order in which they were granted.  For purposes of these rules,  the fair
market value of stock shall be determined as of the time the option with respect
to such stock option is granted.

Section 3.5.Acceleration of Option

     (a)  This  Option,  to the extent  outstanding  at the time of a  Corporate
          Transaction, but not otherwise fully exercisable,  shall automatically
          accelerate  so  that  this  Option  shall,  immediately  prior  to the
          effective date of the Corporate  Transaction,  become  exercisable for
          all of the Option Shares at the time subject to this Option and may be
          exercised for any or all of those Option Shares as fully-vested shares
          of Common Stock. No such acceleration of this Option,  however,  shall
          occur if and to the  extent  this  Option is, in  connection  with the
          Corporate Transaction:  (i) to be assumed by the successor corporation
          (or  parent  or  subsidiary  thereof)  or to  be  substituted  with  a
          comparable  right to purchase  or receive,  for each share of optioned
          stock  subject  to the  Option  immediately  prior  to  the  Corporate
          Transaction,   the  consideration   (whether  stock,  cash,  or  other

                                       3

          securities  or  property)  received in the  Corporate  Transaction  by
          holders of Common Stock for each share held on the  effective  date of
          the transaction;  or (ii) to be replaced with a cash incentive program
          of the successor corporation which preserves the spread exiting on the
          Option shares at the time of the Corporate  Transaction (the excess of
          the  Fair  Market  Value of such  Option  shares  over  the  aggregate
          exercise price payable for those shares,  appropriately  adjusted) and
          provides for subsequent pay-out in accordance with the Option exercise
          schedule.  The determination of Option  comparability under clause (i)
          shall be made by the Plan Administrator,  and such determination shall
          be final, binding and conclusive.

     (b)  Immediately  following  the Corporate  Transaction,  this Option shall
          terminate and cease to be outstanding, except to the extent assumed or
          substituted  by the  successor  corporation  (or parent or  subsidiary
          thereof) in connection with the Corporate Transaction.

     (c)  If  this  Option  is  assumed  in   connection   with  the   Corporate
          Transaction,   then  this  Option  shall  be  appropriately  adjusted,
          immediately after such Corporate  Transaction,  to apply to the number
          of and class of  securities  which  would have been  isssuable  to the
          Optionee in consummation of such Corporate  Transaction had the Option
          been exercised  immediately prior to such Corporate  Transaction,  and
          appropriate  adjustments  shall  also be made to the  exercise  price;
          provided, that the aggregate exercise price shall remain the same.

     (d)  This  Agreement  shall  not  in  any  way  affect  the  right  of  the
          Corporation to adjust, reclassify,  reorganize or otherwise change its
          capital or  business  structure  or to merge,  consolidate,  dissolve,
          liquidate  or sell or  transfer  all or any  part of its  business  or
          assets.

                                   **ARTICLE IV.****EXERCISE OF OPTION**Section 4.1.  Person Eligible to Exercise

     (a)  Except as  provided  in Section  4.1(b),  during the  lifetime  of the
          Optionee,  only he or she may  exercise  the  Option  (or any  portion
          thereof),  unless  it has been  disposed  of with the  consent  of the
          Committee  pursuant  to a DRO.  After the death of the  Optionee,  any
          exercisable  portion  of the Option  may,  prior to the time when such
          portion becomes  unexercisable  under Section 3.3, be exercised by his
          or her  personal  representative  or by any person  empowered to do so
          under the deceased  Optionee's  will or under the then applicable laws
          of descent and distribution.

     (b)  Notwithstanding Section 4.1(a), with the consent of the Administrator,
          the  Optionee  may  transfer  the Option to any one or more  Permitted
          Transferees, subject to the following terms and conditions:

          (i)   the  Option  shall  not be  assignable  or  transferable  by the
                Permitted  Transferee other  than by will or the laws of descent
                and distribution;

                                       4

          (ii)  the  Option  shall continue  to be  subject to all the terms and
                conditions of the Option as  applicable  to the Optionee  (other
                than the ability to further transfer the Option); and

          (iii) the Optionee and  the  Permitted Transferee  execute any and all
                documents requested  by the  Administrator,  including,  without
                limitation documents to (A) confirm the status of the transferee
                as a Permitted Transferee,  (B) satisfy any  requirements for an
                exemption  for the transfer under  applicable  federal and state
                securities laws and (C) evidence the transfer.

Section 4.2.Partial Exercise

     (a)  Any  exercisable  portion of the Option or the entire Option,  if then
          wholly  exercisable,  may be exercised in whole or in part at any time
          prior  to  the  time  when  the  Option  or  portion  thereof  becomes
          unexercisable under Section 3.3.

Section 4.3.      Manner of Exercise

     The Option, or any exercisable portion thereof,  may be exercised solely by
delivery to the  Secretary of the Company or his office of all of the  following
prior to the time when the Option or such portion  becomes  unexercisable  under
Section 3.3:

     (a)  Notice in writing  signed by the  Optionee  or the other  person  then
          entitled to exercise the Option or portion, stating that the Option or
          portion  is  thereby   exercised,   such  notice  complying  with  all
          applicable rules established by the Administrator;

     (b)  Full  payment  (in cash) for the  shares  with  respect  to which such
          Option or portion is exercised; or

          (i)   With the consent of the  Administrator, a delay in payment of up
                to 30 days  from the date the  Option,  or  portion  thereof, is
                exercised; or

          (ii)  With  the consent  of  the  Administrator,  (A)  shares  of  the
                Company's Common  Stock owned by the  Optionee  for at least six
                months, duly  endorsed for transfer to the Company,  with a Fair
                Market  Value on the  date of delivery  equal  to the  aggregate
                exercise  price of the Option  or exercised portion thereof,  or
                (B)  shares  of the  Company's  Common  Stock  issuable  to  the
                Optionee  upon exercise  of the Option, with a Fair Market Value
                on the date of  exercise of the Option or  any  portion  thereof
                equal  to  the  aggregate  exercise  price  of  the  Option   or
                exercised  portion thereof; or

          (iii) With the  consent  of  the   Administrator,   a  full   recourse
                promissory  note  bearing interest (at no less than such rate as
                shall then preclude the imputation of interest under the Code or
                successor  provision) and  payable  upon  such  terms  as may be
                prescribed by the  Administrator.  The  Administrator  may  also
                prescribe the form of such note and the security to be given for
                such note. The Option may not be exercised, however, by delivery
                of a promissory note or by a loan from the Company when or where
                such loan or other extension of credit is prohibited by law;  or

                                       5

          (iv)  With  the  consent  of  the  Administrator, property of any kind
                which constitutes good and valuable consideration; or

          (v)   With the consent of the Administrator, a notice that the Optionee
                has  placed a market  sell order  with a broker  with  respect to
                shares of the Company's  Common Stock then issuable upon exercise
                of the  Option,  and that the broker has been  directed  to pay a
                sufficient portion of the net proceeds of the sale to the Company
                in satisfaction of the Option exercise price; or

          (vi)  With the consent of the  Administrator,  any combination  of the
                consideration provided in the foregoing subparagraphs (i), (ii),
                (iii), (iv) and (v);

     (c)  A  bona  fide  written   representation  and  agreement,   in  a  form
          satisfactory  to the  Administrator,  signed by the  Optionee or other
          person then entitled to exercise such Option or portion,  stating that
          the  shares of stock  are  being  acquired  for his own  account,  for
          investment  and without  any  present  intention  of  distributing  or
          reselling said shares or any of them except as may be permitted  under
          the  Securities  Act  and  then   applicable   rules  and  regulations
          thereunder,  and that the  Optionee or other  person then  entitled to
          exercise such Option or portion will indemnify the Company against and
          hold it free and harmless from any loss, damage,  expense or liability
          resulting to the Company if any sale or  distribution of the shares by
          such person is contrary to the  representation  and agreement referred
          to above.  The  Administrator  may, in its absolute  discretion,  take
          whatever  additional  actions  it  deems  appropriate  to  insure  the
          observance and performance of such representation and agreement and to
          effect  compliance  with the  Securities  Act and any other federal or
          state securities laws or regulations.  Without limiting the generality
          of the foregoing,  the Administrator may require an opinion of counsel
          acceptable to it to the effect that any subsequent  transfer of shares
          acquired on an Option  exercise does not violate the  Securities  Act,
          and  may  issue  stop-transfer  orders  covering  such  shares.  Share
          certificates  evidencing stock issued on exercise of this Option shall
          bear  an  appropriate  legend  referring  to the  provisions  of  this
          subsection (c) and the agreements herein.  The written  representation
          and agreement referred to in the first sentence of this subsection (c)
          shall, however, not be required if the shares to be issued pursuant to
          such exercise have been registered  under the Securities Act, and such
          registration is then effective in respect of such shares;

     (d)  Full  payment to the Company (or  Subsidiary  employer) of all amounts
          which,  under  federal,  state or local  tax law,  it is  required  to
          withhold upon exercise of the Option,  which,  with the consent of the
          Administrator,  may be in the form of shares of the  Company's  Common
          Stock issuable to the Optionee upon exercise of the Option with a Fair
          Market  Value on the date of  exercise  of the  Option or any  portion
          thereof equal to the sums required to be withheld, may be used to make
          all or part of such  payment;  provided  that the  number of shares of
          Common  Stock  which may be  withheld  with  respect to the  issuance,
          vesting,   exercise  or  payment  of  any  Option  (or  which  may  be
          repurchased  from the Optionee of such Option  within six months after
          such shares of Common  Stock were  acquired by the  Optionee  from the
          Company) in order to satisfy the  Optionee's  federal and state income
          and payroll tax  liabilities  with respect to the  issuance,  vesting,
          exercise  or payment  of the Option  shall be limited to the number of
          shares  which have a Fair Market Value on the date of  withholding  or
          repurchase equal to the aggregate amount of such liabilities  based on

                                       6

          the  minimum  statutory  withholding  rates for  federal and state tax
          income  and  payroll  tax  purposes   that  are   applicable  to  such
          supplemental taxable income; and

     (e)  In the event the  Option or portion  shall be  exercised  pursuant  to
          Section  4.1 by  any  person  or  persons  other  than  the  Optionee,
          appropriate  proof of the right of such  person or persons to exercise
          the Option.

Section 4.4.Conditions to Issuance of Stock Certificates

     The shares of stock  deliverable  upon the  exercise of the Option,  or any
portion  thereof,  may be either  previously  authorized but unissued  shares or
issued shares that have then been  reacquired by the Company.  Such shares shall
be fully paid and  nonassessable.  The Company shall not be required to issue or
deliver any certificate or  certificates  for shares of stock purchased upon the
exercise of the Option or portion  thereof  prior to  fulfillment  of all of the
following conditions:

     (a)  The  admission  of such  shares to listing on all stock  exchanges  on
          which such class of stock is then listed;

     (b)  The  completion of any  registration  or other  qualification  of such
          shares under any state or federal law or under rulings or  regulations
          of the Securities and Exchange Commission or of any other governmental
          regulatory  body,  which  the  Administrator  shall,  in its  absolute
          discretion, deem necessary or advisable;

     (c)  The  obtaining  of any approval or other  clearance  from any state or
          federal  governmental  agency which the  Administrator  shall,  in its
          absolute discretion, determine to be necessary or advisable;

     (d)  The receipt by the Company (or  Subsidiary  employer)  of full payment
          for  such  shares,  including  payment  of all  amounts  which,  under
          federal,  state or local tax law,  it is  required  to  withhold  upon
          exercise of the Option; and

     (e)  The lapse of such reasonable  period of time following the exercise of
          the Option as the  Administrator  may from time to time  establish for
          reasons of administrative convenience.

Section 4.5.Rights as Stockholder

     The  holder  of the  Option  shall  not be,  nor have any of the  rights or
privileges of, a stockholder of the Company in respect of any shares purchasable
upon the  exercise  of any part of the  Option  unless  and  until  certificates
representing such shares shall have been issued by the Company to such holder.

                                       7
**ARTICLE V.****OTHER PROVISIONS**Section 5.1.Administration

     The  Administrator  shall  have the  power to  interpret  the Plan and this
Agreement  and to adopt such rules for the  administration,  interpretation  and
application of the Plan as are  consistent  therewith and to interpret or revoke
any such rules.  All actions taken and all  interpretations  and  determinations
made by the  Administrator  in good faith  shall be final and  binding  upon the
Optionee,  the  Company  and all  other  interested  persons.  No  member of the
Administrator  shall be  personally  liable  for any  action,  determination  or
interpretation made in good faith with respect to the Plan or the Option. In its
absolute  discretion,  the Board may at any time and from time to time  exercise
any and all rights and duties of the  Administrator  under this Plan except with
respect to matters which under Rule 16b-3 or Section  162(m) of the Code, or any
regulations  or rules issued  thereunder,  are required to be  determined in the
sole discretion of the Administrator.

Section 5.2.Option Not Transferable

     Except as provided in Section  4.1(b),  neither the Option nor any interest
or right  therein or part  thereof  shall be liable for the debts,  contracts or
engagements of the Optionee or his successors in interest or shall be subject to
disposition  by  transfer,   alienation,   anticipation,   pledge,  encumbrance,
assignment  or  any  other  means  whether  such  disposition  be  voluntary  or
involuntary or by operation of law by judgment, levy, attachment, garnishment or
any  other  legal  or  equitable  proceedings  (including  bankruptcy),  and any
attempted disposition thereof shall be null and void and of no effect; provided,
however,  that this  Section 5.2 shall not prevent  transfers  by will or by the
applicable  laws of  descent  and  distribution  or,  with  the  consent  of the
Committee, pursuant to a DRO.

Section 5.3.Shares to Be Reserved

     The Company  shall at all times  during the term of the Option  reserve and
keep  available  such number of shares of stock as will be sufficient to satisfy
the requirements of this Agreement.

                                       8
Section 5.4.Notices

     Any notice to be given  under the terms of this  Agreement  to the  Company
shall be addressed to the Company in care of its Secretary, and any notice to be
given to the Optionee shall be addressed to him at the address given beneath his
signature  hereto.  By a notice given pursuant to this Section 5.4, either party
may hereafter  designate a different address for notices to be given to him. Any
notice that is required to be given to the  Optionee  shall,  if the Optionee is
then  deceased,  be  given to the  Optionee's  personal  representative  if such
representative has previously  informed the Company of his status and address by
written  notice  under this  Section  5.4. Any notice shall be deemed duly given
when enclosed in a properly sealed  envelope or wrapper  addressed as aforesaid,
deposited  (with  postage  prepaid)  in a post  office  or  branch  post  office
regularly maintained by the United States Postal Service.

Section 5.5.Titles

     Titles are provided herein for  convenience  only and are not to serve as a
basis for interpretation or construction of this Agreement.

Section 5.6.Construction

     This Agreement  shall be  administered,  interpreted and enforced under the
          laws of the State of California.

Section 5.7.Conformity to Securities Laws

     The Optionee  acknowledges that the Plan and this Agreement are intended to
conform to the extent  necessary  with all  provisions of the Securities Act and
the  Exchange  Act and any and all  regulations  and  rules  promulgated  by the
Securities and Exchange Commission thereunder, including without limitation Rule
16b-3.  Notwithstanding  anything  herein  to the  contrary,  the Plan  shall be
administered,  and the Option is granted  and may be  exercised,  only in such a
manner  as to  conform  to such  laws,  rules  and  regulations.  To the  extent
permitted by applicable law, the Plan and this Agreement shall be deemed amended
to the extent necessary to conform to such laws, rules and regulations.

Section 5.8.More Favorable Terms of Severance Programs Take Precedemnce

     To the extent the terms and conditions contained in any severance or change
in control program,  plan or agreement,  or any employment  agreement,  with the
Optionee provide more favorable terms for the Option then those set forth herein
(including without limitation terms regarding  accelerated  vesting and extended
exercise  periods),  the more favorable terms of any such severance or change in
control program, plan or agreement or any employment agreement with the Optionee
will control.

                                       9
**Signature Page to the Stock Option Agreement Terms and Conditions

                          THE 2002 INCENTIVE AWARD PLAN
                             OF FILENET CORPORATION**

                   3565 Harbor Boulevard, Costa Mesa, CA 92626

[First_Name] [Middle_Name] [Last_Name]                          [Address_Line_1]
                                                                [Address_Line_2]
                                                                [Address_Line_3]
Optionee's Tax ID #: [Extra_Field_1]                   [City] [State] [Zip_Code]

Effective  ____________________  (the "Grant  Date"),  you have been  granted an
Option  to  buy an  aggregate  of  [Shares_Granted]  shares  of Common  Stock of
FileNET  Corporation at an  exercise price per share  of  $[Option_Price].  This
Option expires on _________________.*

This Option will vest and become  exercisable  in  increments  on the  following
dates:

Twenty-five  percent  (25%) of the shares of Common Stock  subject to the Option
(rounded  down to the next whole number of shares) shall vest one year after the
Grant Date,  and 1/36th of the shares of Common  Stock  subject to the Option on
the date of grant  (rounded  down to the next whole number of shares) shall vest
on the first day of each full month thereafter,  so that all of the Shares shall
be  vested on the first day of the  thirty-sixth  (36th)  month  after the Grant
Date.

*This  Option will not vest and the  expiration  date will be sooner than shown
under certain circumstances, including your Termination from Employment. See the
Stock Option Agreement Terms and Conditions.

**Type of Option**

(TM)    Non-qualified option
(TM)    Incentive stock option (subject to the maximum number
        permitted by the Code) and non-qualified option as
        to all other shares.

You and the Company  agree that these  Options are granted under and governed by
the terms and  conditions of the Stock Option  Agreement  Terms and  Conditions,
which together with this Signature Page, are a binding agreement,  and the Plan.
You  acknowledge  that you have read and understand  the Stock Option  Agreement
Terms and Conditions, this Signature Page, and the Plan, and that you understand
the  terms  and  conditions  of your  Option  grant,  including  the  provisions
governing the vesting and termination of your Options,  the exercise procedures,
and the other restrictions contained therein.

FILENET CORPORATION                                 OPTIONEE

By:                                                 [First_Name] [Last_Name]

Its:

**FILENET CORPORATION
                      NON-QUALIFIED STOCK OPTION AGREEMENT
                            FOR INDEPENDENT DIRECTORS

                              TERMS AND CONDITIONS**

     These *Terms and Conditions* constitute a part of the Stock Option Agreement,
dated as of the date set forth on the *Signature  Page to Stock Option  Agreement
Terms and  Conditions*  made a part hereof  (the  "Signature  Page"),  concerning
certain  Options  granted  by  FileNET   Corporation,   a  Delaware  corporation
hereinafter  referred to as  "Corporation,"  to the director of the  Corporation
listed on the Signature Page, hereinafter referred to as "Optionee." These Terms
and  Conditions  and the  Signature  Page are  collectively  referred  to as the
"Agreement."

     Recitals

     WHEREAS,  the Corporation wishes to carry out The 2002 Incentive Award Plan
of  FileNET  Corporation,  as the same may be  amended  from  time to time  (the
"Plan"), the terms of which are hereby incorporated by reference and made a part
of this Agreement; and

     WHEREAS, in order to provide such directors with a meaningful  incentive to
continue to serve as members of the  Corporation's  Board, the Plan provides for
the automatic  grant to the  Corporation's  Independent  Directors of Options to
purchase the Corporation's common stock over the period of such director's Board
service to the Corporation; and

     WHEREAS, the Optionee is an Independent Director of the Corporation;

     WHEREAS,  all  capitalized  terms in this Agreement  shall have the meaning
assigned to them in the Plan.

     Agreement

     NOW,  THEREFORE,  in consideration of the mutual covenants herein contained
and  other  good  and  valuable  consideration,   receipt  of  which  is  hereby
acknowledged, the parties hereto do hereby agree as follows:

     1. Grant of Option.  The Corporation hereby irrevocable grants to Optionee,
as of the grant date  specified  on the  Signature  Page (the "Grant  Date"),  a
Non-Qualified Option to purchase up to the number of shares of the Corporation's
Common Stock,  par value $0.01 per share,  specified on the Signature  Page (the
"Option"). The exercise price per share of Common Stock subject to the Option is
set  forth  on the  Signature  Page,  which is the  average  of the high and low
selling  price per share of Common Stock as of the Option Grant Date,  and shall
not be subject to commission or other charge.

     2. Vesting.

          (a)  The Option shall vest 25% per year on each of the first,  second,
               third and fourth  anniversary of the Option Grant Date,  provided
               the Optionee  continues as an  Independent  Director on each such
               anniversary.

          (b)  Notwithstanding the foregoing:

               (i)  in the event of Termination of Directorship  due to death or
                    Permanent Disability,  the Option shall become automatically
                    100%  vested  and  exercisable  in full  upon  such  date of
                    Termination of Directorship; and

               (ii) in  the  event  of  a  Change  in   Control   or   Corporate
                    Transaction,  the Option  shall  become  automatically  100%
                    vested and  exercisable  in full upon such Change in Control
                    or upon the fifth day immediately preceding the consummation
                    of such Corporate Transaction.

          (c)  In no event  shall  any  portion  of the  Option  vest  following
               Optionee's Termination of Directorship.

          (d)  The  vesting  installments  provided  for in this  Section  2 are
               cumulative.  Each such installment that becomes exercisable shall
               remain  exercisable  until the Option terminates or expires under
               Section 3.

     3.   Option Term and Exercise Period.

          (a)  The Option shall have a term of ten (10) years  measured from the
               Option  Grant  Date and  shall  accordingly  expire,  and  become
               unexercisable  at the close of business on the Option  expiration
               date  specified  on  the  Signature  Page,   subject  to  earlier
               termination in accordance with the following paragraph (b).

          (b)  The Option shall terminate and may not be exercised to any extent
               by anyone as of the first to occur of the following events:

               (i)  The expiration of ten (10) years from the Option Grant Date;
                    or

               (ii)  The  expiration  of twelve (12) months from the date of the
                     Optionee's Termination of Directorship for any reason.

               (iii) The effective date of a Corporate  Transaction,  unless the
                     Board  waives  this  provision  in  connection   with  such
                     transaction and such waiver is consistent  with Rule 16b-3,
                     or unless the Option is, in connection with such  Corporate
                     Transaction,  either  assumed by the successor  or survivor
                     corporation  (or parent or subsidiary  thereof) or replaced
                     with  a  comparable right  with  respect  to  share  of the
                     capital stock of the successor or survivor corporation  (or
                     parent or subsidiary thereof).

                                       2

          (c)  Upon the Termination of  Directorship,  the portion of the Option
               representing  shares  that  are not at  that  time  vested  shall
               immediately terminate and cease to be outstanding.

     4.   Limited Transferability.

          (a)  Except as may be permitted  pursuant to paragraph (b) below,  the
               Option shall be neither  transferable  nor assignable by Optionee
               other than by will or by the laws of descent and distribution and
               may be exercised  during  Optionee's  lifetime  only by Optionee.
               After the death of the Optionee,  any exercisable  portion of the
               Option may,  prior to the time when such portion  terminates  and
               becomes unexercisable under Section 3, be exercised by his or her
               personal representative or by any person empowered to do so under
               the deceased Optionee's will or under the then applicable laws of
               descent and distribution.

          (b)  Notwithstanding  paragraph (a) above,  the Option may be assigned
               in whole or in part during Optionee's  lifetime to the Optionee's
               spouse  in  accordance  with the  terms of a DRO,  and,  with the
               consent of the  Administrator,  the  Optionee  may  transfer  the
               Option to any one or more Permitted  Transferees,  subject to the
               following terms and conditions:

               (i)   the Option shall not be assignable or  transferable  by the
                     Permitted  Transferee  or such spouse other than by will or
                     the laws of descent and distribution;

               (ii)  the  Option  shall  continue to be subject to all the terms
                     and conditions of the Option as applicable to the  Optionee
                     (other  than the  ability  to further transfer the Option);
                     and

               (iii) the Optionee and the Permitted  Transferee  or such spouse,
                     as  applicable,   shall  execute   any  and  all  documents
                     requested   by   the  Administrator,   including,   without
                     limitation  documents  to  (A) confirm  the  status  of the
                     transferee as a Permitted Transferee or the validity of the
                     DRO, (B) satisfy any requirements for an exemption  for the
                     transfer  under applicable  federal  and  state  securities
                     laws,  and  (C) evidence the transfer.

     5.   Corporate Transaction.  In the event of a Corporate Transaction,  that
          portion of the Option  representing  shares  that are not then  vested
          shall automatically become 100% vested so that the Option shall, as of
          five days prior to the effective date of such  Corporate  Transaction,
          become exercisable in full. Effective as of the Corporate Transaction,
          this Option shall terminate and cease to be exercisable, except to the
          extent the Option is assumed by the successor or survivor  corporation
          (or parent or subsidiary  thereof) or replaced with a comparable right
          with  respect  to  share of the  capital  stock  of the  successor  or
          survivor  corporation  (or  parent  or  subsidiary  thereof)  in  such
          Corporate  Transaction,  or unless the Board waives this  provision in
          connection  with  such  Corporate   Transaction  and  such  waiver  is
          consistent with Rule 16b-3.

                                       3

     6.   Change in Control.  In the event of a Change in Control,  that portion
          of  the  Option   representing   shares  that  are  not  vested  shall
          automatically  become 100% vested so that the Option shall,  as of the
          effective date of such Change in Control, become exercisable in full.

     7.   Manner of Exercising Option.

          (a)  Any vested  portion of the Option or the entire  Option,  if then
               100% vested and exercisable, may be exercised in whole or in part
               at any time prior to the time when the Option or portion  thereof
               terminates or expires and becomes  unexercisable under Section 3.
               The Option may be exercised for whole shares only.

          (b)  In order to  exercise  all or any  portion of the vested  Option,
               Optionee  (or any other  person or persons  permitted to exercise
               the Option under this Agreement) must take the following actions:

               (i)   Execute and deliver to the Corporation a notice of exercise
                     for the vested portion of the Option being  exercised, such
                     notice  complying with all applicable rules  established by
                     the Administrator;

               (ii)  Pay the aggregate  exercise  price and applicable  Federal,
                     state   and  local  tax   withholding  obligation  for  the
                     purchased shares in one or more of the following forms:

                    (A)  cash or check made payable to the Corporation; or

                    (B)  through  a  special  sale  and   remittance   procedure
                         pursuant  to which  Optionee  (or any  other  permitted
                         person)  shall  provide  to  a   Corporation-designated
                         brokerage  firm an  irrevocable  market  sell  order to
                         effect  the sale of the  purchased  shares and remit to
                         the Corporation,  out of the sale proceeds available on
                         the  settlement  date,  sufficient  funds to cover  the
                         aggregate exercise price and applicable taxes.

               (iii) With the prior consent of the Administrator,  the aggregate
                     exercise price and applicable Federal,  state and local tax
                     withholding obligation for the purchased shares may also be
                     paid in one or more of the following forms:

                    (A)  shares of Common  Stock held by Optionee  (or any other
                         permitted  person) for at least six months, or issuable
                         upon exercise of the Option,  and valued at Fair Market
                         Value on the exercise date, or

                    (B)  with any other form of  consideration  permitted by the
                         Plan.

               (iv)  Furnish to the Corporation  appropriate  documentation that
                     the person or persons exercising  the Option (if other than
                     Optionee) have the right to exercise this Option.

                                       4

     8.   Compliance with Laws and Regulations.

     The shares of stock  deliverable  upon the  exercise of the Option,  or any
portion  thereof,  may be either  previously  authorized but unissued  shares or
issued shares which have then been  reacquired by the  Corporation.  Such shares
shall be fully paid and nonassessable.  The Corporation shall not be required to
issue or deliver any certificate or  certificates  for shares of stock purchased
upon the exercise of the Option or portion  thereof prior to  fulfillment of all
of the following conditions:

          (a)  The admission of such shares to listing on all stock exchanges on
               which such class of stock is then listed;

          (b)  The completion of any registration or other qualification of such
               shares  under  any  state  or  federal  law or under  rulings  or
               regulations of the  Securities and Exchange  Commission or of any
               other governmental regulatory body, which the Board shall, in its
               absolute discretion, deem necessary or advisable;

          (c)  The obtaining of any approval or other  clearance  from any state
               or federal  governmental  agency  which the Board  shall,  in its
               absolute discretion, determine to be necessary or advisable;

          (d)  The receipt by the  Corporation  of full payment for such shares,
               including payment of all amounts which,  under federal,  state or
               local tax law, it is required  to withhold  upon  exercise of the
               Option; and

          (e)  The  lapse  of  such  reasonable  period  of time  following  the
               exercise  of the  Option  as the  Board  may  from  time  to time
               establish for reasons of administrative convenience.

     9.   Stockholder  Rights.  The  holder  of the  Option  shall  not have any
          stockholder  rights  with  respect  to  the  shares  of  Common  Stock
          purchasable  upon  exercise of the Option until such person shall have
          exercised the Option,  paid the exercise price and  applicable  taxes,
          satisfies  all other  conditions  of  exercise  and become a holder of
          record of the purchased shares.

     10.  Adjustment in Option Shares.

          (a)  Should any  change be made to the  Common  Stock by reason of any
               stock split,  stock  dividend,  recapitalization,  combination of
               shares,   exchange  of  shares  or  other  change  affecting  the
               outstanding  Common  Stock as a class  without the  Corporation's
               receipt  of  consideration,  or  in  the  event  of  a  Corporate
               Transaction or Change in Control,  appropriate  adjustments shall
               be made to (i) the number and/or class of  securities  subject to
               this Option and (ii) the exercise  price in order to reflect such
               change and thereby preclude a dilution or enlargement of benefits
               hereunder.

          (b)  This  Agreement  shall  not in any way  affect  the  right of the
               Corporation to adjust, reclassify, reorganize or otherwise change

                                       5

               its  capital  or  business  structure  or to merge,  consolidate,
               dissolve,  liquidate  or sell or transfer  all or any part of its
               business or assets.

     11.  Successors and Assigns.  The provisions of this Agreement  shall inure
          to the  benefit  of,  and be binding  upon,  the  Corporation  and its
          successors and assigns and Optionee,  Optionee's assigns and the legal
          representatives, heirs and legatees of Optionee's estate.

     12.  Notices.  Any  notice  required  to  be  given  or  delivered  to  the
          Corporation  under the terms of this Agreement shall be in writing and
          addressed to the Corporation at its principal  corporate offices.  Any
          notice  required  to be given or  delivered  to  Optionee  shall be in
          writing and  addressed  to Optionee  at the address  indicated  on the
          Signature  Page.  All notices shall be deemed  effective upon personal
          delivery  or upon  deposit  in the  U.S.  mail,  postage  prepaid  and
          properly addressed to the party to be notified.

     13.  Construction.  This Agreement and the Option evidenced hereby are made
          and granted  pursuant to the automatic  Option grant program in effect
          under the Plan and are in all  respects  limited by and subject to the
          applicable terms of the Plan.

     14.  Governing Law. The interpretation, performance and enforcement of this
          Agreement  shall be  governed  by the laws of the State of  California
          without resort to that State's conflict-of-laws rules.

     15.  Conformity to Securities Laws. The Optionee acknowledges that the Plan
          and this  Agreement  are  intended to conform to the extent  necessary
          with all provisions of the Securities Act and the Exchange Act and any
          and all  regulations  and  rules  promulgated  by the  Securities  and
          Exchange  Commission  thereunder,  including  without  limitation Rule
          16b-3. Notwithstanding anything herein to the contrary, the Plan shall
          be administered,  and the Option is granted and may be exercised, only
          in such a manner as to conform to such laws, rules and regulations. To
          the extent  permitted by applicable  law, the Plan and this  Agreement
          shall be deemed  amended  to the extent  necessary  to conform to such
          laws, rules and regulations.

                                       6
**SIGNATURE PAGE TO THE
                              INDEPENDENT DIRECTOR
                   STOCK OPTION AGREEMENT TERMS AND CONDITIONS

                         THE 2002 INCENTIVE AWARD PLAN
                             OF FILENET CORPORATION**

                   3565 Harbor Boulevard, Costa Mesa, CA 92626

[First_Name] [Middle_Name] [Last_Name]                          [Address_Line_1]
                                                                [Address_Line_2]
                                                                [Address_Line_3]
Optionee's Tax ID #: [Extra_Field_1]                   [City] [State] [Zip_Code]

Effective  ____________________  (the  "Grant  Date"),  you have been  granted a
Non-qualified  Stock Option to buy an aggregate  of  [Shares_Granted]  shares of
Common  Stock  of  FileNET  Corporation  at  an  exercise  price  per  share  of
$[Option_Price]. This Option expires on _________________.*

*This  Option will not vest and the  expiration  date  will be sooner than shown
under certain circumstances, including your Termination from Directorship.   See
the Stock Option Agreement Terms and Conditions.

You and the Company  agree that these  Options are granted under and governed by
the terms and  conditions of the Stock Option  Agreement  Terms and  Conditions,
which together with this Signature Page, are a binding agreement,  and the Plan.
You  acknowledge  that you have read and understand  the Stock Option  Agreement
Terms and Conditions, this Signature Page, and the Plan, and that you understand
the  terms  and  conditions  of your  Option  grant,  including  the  provisions
governing the vesting and termination of your Options,  the exercise procedures,
and the other restrictions contained therein.

FILENET CORPORATION                                 OPTIONEE

By:                                                 [First_Name] [Last_Name]

Its:
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