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 September 30, 1999

                                       OR

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

For the transition period from ________ to ___________

                         Commission file number: 0-15997

                               FILENET CORPORATION
             (Exact name of Registrant as specified in its charter)

          Delaware                                      95-3757924
----------------------------------         -------------------------------------
(State or other jurisdiction of             (I.R.S. Employer Identification No.)
 incorporation or organization)

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

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


Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the  preceding 12 months (or for such  shorter  period that the  registrant  was
required  to file  such  reports),  and  (2) has  been  subject  to such  filing
requirements for the past 90 days. Yes |X| No |_|

As of October 31, 1999, there were 32,378,691 shares of the Registrant's  common
stock outstanding.



<PAGE>


                               FILENET CORPORATION
                                      Index


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

PART I.  FINANCIAL INFORMATION

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

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

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

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

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

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

PART II  OTHER INFORMATION

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

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

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

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


                                       2

<PAGE>

PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

                                      FILENET CORPORATION
                                  CONSOLIDATED BALANCE SHEETS
                             (In thousands, except share amounts)
<TABLE>
<CAPTION>

                                                          September 30,    December 31,
                                                             1999              1998
                                                         --------------    -------------
                                                           (unaudited)
<S>                                                      <C>              <C>
 ASSETS
 Current assets:
   Cash and cash equivalents                              $   55,053       $   55,820
   Short-term marketable securities                           12,742           15,484
   Accounts receivable, net                                   74,698           61,636
   Inventories                                                 3,609            2,419
   Prepaid expenses and other current assets                   8,003            8,865
                                                         ------------     ------------

   Total current assets                                      154,105          144,224

 Property, net                                                39,514           44,177
 Long-term marketable securities                              28,600           10,885
 Deferred income taxes                                         6,427            6,385
 Other assets                                                  1,658            1,151
                                                         ------------     ------------
     Total assets                                         $  230,304       $  206,822
                                                         ============     ============
LIABILITIES AND STOCKHOLDERS' EQUITY
 Current liabilities:
   Accounts payable                                       $   15,248       $   21,022
   Accrued compensation and benefits                          22,548           22,165
   Unearned maintenance revenue                               22,453           11,238
   Federal income tax payable                                  7,398            3,618
   Deferred income taxes                                       1,008              942
   Other accrued liabilities                                  21,272           17,517
                                                         ------------     ------------
   Total current liabilities                              $   89,927       $   76,502


 Stockholders' equity:
   Preferred stock - $.10 par value; 7,000,000
     shares authorized; none issued and outstanding
   Common stock - $.01 par value; 100,000,000 shares
     authorized; 33,281,235 and 32,924,950 shares
     issued and outstanding at September 30, 1999
     and December 31, 1998                                   146,900          144,242
   Retained earnings                                          13,889            3,304
   Accumulated other comprehensive                            (5,845)          (2,659)
   Treasury stock, at cost; 1,098,000 shares at
     September 30, 1999 and December 31, 1998                (14,567)         (14,567)
                                                         ------------     -=-----------
   Total stockholders' equity                                140,377          130,320
                                                         ------------     -------------
   Total liabilities and stockholders' equity             $  230,304       $  206,822
                                                         ============     =============
See accompanying notes to consolidated financial statements.
</TABLE>
                                       3
<PAGE>

                                                FILENET CORPORATION
                                       CONSOLIDATED STATEMENTS OF OPERATIONS
                                       (In thousands, except per share data)
<TABLE>
<CAPTION>

                                                   Three Months Ended                 Nine Months Ended
                                                     September 30,                      September 30,
                                          ---------------------------------------------------------------------
                                                1999             1998               1999            1998
                                          ----------------- ----------------   --------------- ----------------
                                            (Unaudited)       (Unaudited)       (Unaudited)      (Unaudited)
<S>                                       <C>                <C>                <C>            <C>
 Revenue:
   Software                                   $   43,055       $  36,128        $  133,690       $  123,778
   Service                                        38,174          29,763           105,494           82,701
   Hardware                                        4,303           5,261            13,879           18,654
                                          ---------------    -------------      ------------   --------------
   Total revenue                                  85,532          71,152           253,063          225,133
                                          ---------------    -------------      ------------   --------------

 Costs and expenses:
   Cost of software revenue                       3,137            4,850            11,761           12,801
   Cost of service revenue                       21,731           17,612            62,550           48,925
   Cost of hardware revenue                       2,410            3,043             7,443            9,641
   Research and development                      13,752           12,915            40,088           36,809
   Selling, general and
     administrative                              38,735           41,977           118,926          118,129
                                          ---------------    -------------      ------------   --------------

  Total costs and expenses                       79,765           80,397           240,768         226,305
                                          ---------------    -------------      ------------   --------------

 Operating income (loss)                          5,767           (9,245)           12,295           (1,172)

 Other income, net                                  866            1,102             2,826            3,112
                                          ---------------    -------------      ------------   --------------

 Income (loss) before income taxes                6,633           (8,143)           15,121            1,940

 Provision (benefit) for income taxes             1,990           (2,364)            4,536              560
                                          ---------------    -------------      ------------   --------------

 Net income (loss)                            $   4,643        $  (5,779)        $  10,585       $    1,380
                                          ===============    =============      ============   ==============

 Earnings (loss) per share:
   Basic                                      $    0.14        $   (0.18)        $    0.33       $     0.04
   Diluted                                    $    0.14        $   (0.18)        $    0.32       $     0.04

 Weighted average shares outstanding:
   Basic                                         32,160           31,526            32,047           30,843
   Diluted                                       33,192           31,526            32,770           33,733

See accompanying notes to consolidated financial statements.

</TABLE>
                                       4
<PAGE>


                                             FILENET CORPORATION
                             CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
                                               (In thousands)

<TABLE>
<CAPTION>
                                                Three Months Ended September 30,    Nine Months Ended September 30,
                                               ---------------------------------------------------------------------
                                                    1999            1998                 1999             1998
                                               --------------- ---------------     ----------------- ---------------
                                                (Unaudited)     (Unaudited)          (Unaudited)      (Unaudited)

<S>                                            <C>             <C>                   <C>             <C>
 Net income (loss)                             $    4,643      $   (5,779)           $   10,585      $    1,380
                                               ------------    ------------          --------------  ---------------

 Other comprehensive income (loss):
   Foreign currency translation adjustments1        1,239           2,238                (3,116)          1,581

   Unrealized gains (losses) on securities:
     Unrealized holding gains (losses)2                10              37                   (70)             49
                                               --------------- ---------------     ----------------- ---------------
 Total other comprehensive income (loss)            1,249           2,275                (3,186)          1,630
                                               --------------- ---------------     ----------------- ---------------

 Comprehensive income (loss)                   $    5,892       $  (3,504)           $    7,399      $    3,010
                                               =============== ===============     ================= ===============
</TABLE>

1 net of tax effect of $826 and $1,492 for the three months ended  September 30,
1999 and 1998, respectively and net of tax effect of ($2,077) and $1,054 for the
nine months ended September 30, 1999 and 1998, respectively

2 net of tax effect of $7 and $25 for the three months ended  September 30, 1999
and  1998,  respectively  and net of tax  effect  of ($47)  and $33 for the nine
months ended September 30, 1999 and 1998, respectively

See accompanying notes to consolidated financial statements.

                                       5
<PAGE>

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

                                                                  Nine Months Ended
                                                                    September 30,
                                                       -----------------------------------------
                                                               1999                   1998
                                                       --------------------    -----------------
                                                            (Unaudited)           (Unaudited)
<S>                                                        <C>                   <C>
 Cash flows from operating activities:
 Net income                                                 $    10,585           $   1,380
 Adjustments to reconcile net loss to net cash
  provided by (used by) operating activities:
     Depreciation and amortization                               12,969              11,090
     Provision for doubtful accounts                                252                 694
     Deferred income taxes                                           25                 598
     Changes in operating assets and liabilities:
       Accounts receivable                                      (15,209)               (388)
       Inventories                                               (1,190)                511
       Prepaid expenses and other current assets                    729                (714)
       Accounts payable                                          (5,583)              1,463
       Accrued compensation and benefits                            702                 983
       Unearned maintenance revenue                              11,221               4,652
       Federal income tax payable                                 3,657               2,325
       Other                                                      3,521                (626)
                                                           --------------        -------------
 Net cash provided by (used by) operating activities             21,679              21,968
                                                           --------------        -------------

 Cash flows from investing activities:
 Proceeds from sale of equipment                                  5,826                 446
 Capital expenditures                                           (14,480)            (21,117)
 Purchases of marketable securities                             (44,560)            (25,601)
 Proceeds from sales and maturities of marketable
  securities                                                     29,600              37,044
                                                           --------------        -------------
 Net cash used by investing activities                          (23,614)             (9,228)
                                                           --------------        -------------

 Cash flows from financing activities:
 Proceeds from issuance of common stock                           2,659              12,827
 Common stock repurchased                                             -              (4,435)
                                                           --------------        -------------
 Net cash provided by financing activities                        2,659               8,392
                                                           --------------        -------------

 Effect of exchange rate changes on cash and cash
  equivalents                                                    (1,491)                613
                                                           --------------        -------------
 Net decrease (increase) in cash and cash equivalents              (767)             21,745
 Cash and cash equivalents, beginning of year                    55,820              37,344
                                                           --------------        -------------
 Cash and cash equivalents, end of period                   $    55,053           $  59,089
                                                           ==============        =============

 Supplemental cash flow information:
 Interest paid                                                       11         $        67
 Income taxes paid (refunded)                                        97         $      (281)

See accompanying notes to consolidated financial statements.

</TABLE>


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

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

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

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

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

<TABLE>
<CAPTION>
                                                                Weighted     Per Share
     (In thousands, except per share amounts)    Net Income      Shares        Amount
                                                -----------   -----------   ------------
      <S>                                       <C>           <C>              <C>
      Three months ended September 30, 1999
              Basic earnings per share           $   4,643    $   32,160       $ 0.14
              Effect of dilutive stock options           -         1,032
                                                -----------   -----------
              Diluted earnings per share         $   4,643    $   33,192       $ 0.14
                                                ===========   ===========

      Nine months ended September 30, 1999
              Basic earnings per share           $  10,585    $   32,047       $ 0.33
              Effect of dilutive stock options           -           723
                                                -----------   -----------
              Diluted earnings per share         $  10,585        32,770       $ 0.32
                                                ===========   ===========
</TABLE>

5.       In June 1997, the Financial  Accounting  Standards  Board (FASB) issued
         Statement of Financial  Accounting  Standard (SFAS) No. 130, "Reporting
         Comprehensive  Income."  SFAS No. 130  requires  enterprises  to report
         comprehensive  income and its components in  general-purpose  financial
         statements.  SFAS  No.  130 was  effective  for the  Company  beginning
         January 1, 1998.  Accordingly,  the Company has  prepared  Consolidated
         Statements  of  Comprehensive  Operations  for the three and nine month
         periods  ended   September  30,  1999  and  1998.   Accumulated   other
         comprehensive  operations  as of September 30, 1999 is comprised of the
         following:

<TABLE>
<CAPTION>
                                                                         Accumulated
                                 Foreign Currency      Unrealized           Other
                                   Translation          Holding         Comprehensive
(In thousands)                      Adjustment       Gains (Losses)       Operations
                                 -----------------  -----------------  ----------------
 <S>                             <C>                <C>                <C>
 Balance, December 31, 1998       $       (2,667)    $           8      $    (2,659)
 Current period changes                   (3,116)              (70)          (3,186)
                                 -----------------  -----------------  ----------------
 Balance, September 30, 1999      $       (5,783)    $         (62)          (5,845)
                                 =================  =================  ================
</TABLE>
                                       7
<PAGE>

6.       The Company has prepared  operating  segment  information in accordance
         with SFAS 131, "Disclosures About Segments of an Enterprise and Related
         Information",  to report components that are evaluated regularly by the
         Company's chief operating  decision-makers  in deciding how to allocate
         resources  and in assessing  performance.  The  operating  segments are
         managed separately because each segment represents a strategic business
         unit that offers  different  products or  services.  The results of the
         segments reflect  allocation of certain  functional  expense categories
         consistent  with its internal  reporting  which is not the same as GAAP
         reporting.

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

<TABLE>
<CAPTION>

                                                   Three Months Ended              Nine Months Ended
                                                     September 30,                   September 30,
        In thousands                                   1999           1998           1999           1998
                                              ----------------------------- -----------------------------
       <S>                                           <C>           <C>            <C>            <C>

       Software
         Revenue                                     43,055         36,128        133,690        123,778
         Operating income (loss)                        577        (12,485)        (2,182)       (12,164)

       Customer Support
         Revenue                                     24,284         19,425         64,335         52,286
         Operating income                             4,477          3,217         11,988          7,680

       Professional Services and Education
         Revenue                                     12,571          8,064         35,977         23,562
         Operating income (loss)                        348          (291)            533            363

       Hardware
         Revenue                                      4,303          5,261         13,879         18,654
         Operating income                               438            199          1,714          2,130

       Other
         Revenue                                      1,319          2,274          5,182          6,853
         Operating income (loss)                       (73)            115            242            819

       Total
         Revenue                                     85,532         71,152        253,063        225,133
         Operating income (loss)                      5,767        (9,245)         12,295        (1,172)

</TABLE>

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

8.   In October 1994,  Wang  Laboratories,  Inc. (Wang) filed a complaint in the
     United States  District  Court for the District of  Massachusetts  alleging
     that the  Company is  infringing  five  patents  held by Wang (the  FileNET
     Case).  On June  23,  1995,  Wang  amended  its  complaint  to  include  an
     additional  related patent.  On July 2, 1996, Wang filed a complaint in the
     same court alleging that Watermark  Software Inc.,  formerly a wholly owned
     subsidiary  that was merged into the Company,  is  infringing  three of the
     same patents  asserted in the initial  complaint (the Watermark  Case).  On
     October 9, 1996,  Wang  withdrew  its claim in the FileNET Case that one of
     the patents it  initially  asserted is  infringed.  In March 1997,  Eastman
     Kodak Company  (Kodak)  purchased  the Wang imaging  business unit that has

                                       8
<PAGE>

     responsibility  for this litigation.  On July 30, 1997, the Court permitted
     Eastman and Kodak Limited of England to be substituted in the litigation in
     place of Wang.

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

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

     On October 27,  1998,  plaintiff  Thomas P.  Nyquist  filed a class  action
     complaint  against the Company and certain of its officers and directors in
     the United  States  District  Court for the Central  District of California
     (the Nyquist Action). The action was purportedly filed on behalf of a class
     of  purchasers  of the  Company's  common stock during the period April 16,
     1998 through  October 7, 1998. The plaintiff  alleges claims under Sections
     10(b) and 20(a) of the Securities Exchange Act and Rule 10b-5 in connection
     with  various  public  statements  made by the  Company  and certain of its
     officers and  directors  during the putative  class  period.  The complaint
     seeks unspecified compensatory damages,  interest,  attorneys' fees, expert
     witness fees and costs. The court has appointed the lead plaintiff and lead
     plaintiffs'  counsel  and  consolidated  all  actions.  On July  22,  1999,
     defendant  filed a motion to dismiss  the  complaint  in its  entirely.  On
     August  19,  1999,  the court  ordered  a stay of the  action  and  removed
     defendants' motion to dismiss from the Court's hearing calendar in light of
     the pending petition for rehearing and rehearing enbanc in Silicon Graphics
     Sec. Litig., Nos. 97-16204,  97-16240,  1999 U.S. App LEXIS 14955 (9th Cir.
     July 2, 1999). The Company  believes that all of the allegations  contained
     in the Nyquist  Action are without  merit and intends to defend the actions
     vigorously;  however,  the ultimate outcome or any resulting potential loss
     cannot be determined at this time.

     Subsequent  to  December  31,  1998,  the  former   shareholders  of  Saros
     Corporation   filed  a  demand  for   mandatory   arbitration   to  release
     approximately two-hundred thousand shares of the Company's stock which were
     held in escrow  pursuant to the  Agreement and Plan of Merger dated January
     17, 1996 among FileNET  Corporation,  FileNET  Acquisition  Corporation and
     Saros  Corporation  and for damages.  In August  1999,  the Company and the
     Shareholders'  Agent agreed to mediate the matter.  The date for  mediation
     has been set for  December  16,  1999.  The  Company  believes  that it has
     meritorious  reasons for not releasing the shares and other defenses to the
     claims;  however,  the ultimate or any resulting  potential  loss cannot be
     presently determined.

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

                                       9

<PAGE>

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

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

Results of Operations

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

 Software revenue
   Domestic                                 $  27.1     $  22.2         22%       $  86.8    $  78.4          11%
   International                                                        14%                                    4%
                                               15.9        13.9                      46.9       45.3
                                        ------------   ---------                ----------   ---------
                                        ------------   ---------                ----------   ---------
   Total software revenue                   $  43.0     $  36.1         19%       $ 133.7    $ 123.7           8%
                                        ------------   ---------                ----------   ---------
     Percentage of total revenue                50%         51%                        53%       55%

 Customer Support
   Domestic                                 $  18.9     $  15.1         25%       $   50.2   $   40.8         23%
   International                                                        26%                                   23%
                                                5.4         4.3                       14.1       11.5
                                          ----------   ---------                ----------   ---------
   Total customer support revenue           $  24.3     $  19.4         25%       $   64.3   $   52.3         23%
                                          ----------   ---------                ----------   ---------
     Percentage of total revenue                28%         27%                        26%        23%

 Professional Services and Education
   Domestic                                 $   8.9     $   6.1         46%       $   25.9   $   17.4         49%
   International                                3.7         2.0         85%           10.1        6.2         63%
                                          ----------   ---------                ----------   ---------
   Total professional services and
     education revenue                     $   12.6     $   8.1         56%       $   36.0   $   23.6         53%
                                          ----------   ---------                ----------   ---------
     Percentage of total revenue                15%         11%                        14%        11%

 Hardware revenue
   Domestic                                 $   3.3     $   4.1       (20%)       $   10.4   $   13.6        (24%)
   International                                1.0         1.2       (17%)            3.4        5.0        (32%)
                                          ----------   ---------                ----------   ---------
   Total hardware revenue                   $   4.3     $   5.3       (19%)       $   13.8   $   18.6        (26%)
                                          ----------   ---------                -----------  ---------
     Percentage of total revenue                 5%          8%                         5%         8%

 Other revenue
   Domestic                                 $   1.1     $   1.4       (21%)       $    4.2   $    4.7        (11%)
   International                                0.2         0.9       (78%)            1.0        2.2        (55%)
                                          ----------   ---------                -----------  ---------
   Total other revenue                      $   1.3     $   2.3       (43%)       $    5.2   $    6.9        (25%)
                                          ----------   ---------                -----------  ---------
     Percentage of total revenue                 2%          3%                         2%         3%

 Total revenue
   Domestic                                 $  59.3     $  48.9         21%       $  177.5   $  154.9         15%
   International                               26.2        22.3         17%           75.5       70.2          8%
                                          ----------   ---------                -----------  ---------
   Total revenue                            $  85.5     $  71.2         20%       $  253.0   $  225.1         12%
                                          ==========   =========                ===========  =========
</TABLE>

Software revenue from the licensing of the Company's software products increased
19% and 8% for the three and nine month periods,  respectively,  ended September
30, 1999 over the  comparable  periods of 1998.  The  increases  were  primarily
attributable  to an increase in the volume of product  shipments  to new Panagon
customers .  Additionally,  Panagon  add-on  revenue is  beginning to offset the

                                       10
<PAGE>

decline in legacy add-on  revenue that the Company had been  experiencing  since
the introduction of its new products early 1998.

Customer support revenue consists of revenue from maintenance contracts and "fee
for service"  revenues.  Customer support revenue  increased 25% and 23% for the
three and nine month periods,  respectively,  ended  September 30, 1999 over the
comparable  periods  of 1998.  The  increases  were  attributable  to  increased
maintenance revenue due to the growth of the Company's installed base as well as
an increase in fee for services revenue.

Professional  services and education revenue consists of revenue from consulting
and  implementation  services  provided to end users of the  Company's  software
products,  technical consulting services provided to the Company's resellers and
training  services.  Consulting  services are primarily  performed on a time and
material basis.  Professional  services and education  revenue increased 56% and
53% for the three and nine month periods, respectively, ended September 30, 1999
over the  comparable  periods of 1998 due to increased  demand for the Company's
expanded professional services and education offerings.

Hardware revenue is generated primarily from the sale of 12-inch optical storage
and retrieval  libraries  (OSAR).  Hardware revenue decreased by 19% and 26% for
the three and nine month periods,  respectively,  ended  September 30, 1999 over
the comparable periods of 1998. This decrease is the result of a decrease in new
orders  experienced  both  domestically  and  internationally  due to customers'
ordering competitive products.  The Company expects hardware revenue to continue
to decline in both absolute dollars and as a percentage of total revenue.

Other  revenue is generated  from the sale of spare  parts,  supplies and "third
party"  products.  Other  revenue  decreased  43% and 25% for the three and nine
month  periods,  respectively,  ended  September  30, 1999  compared to the same
periods  in 1998 due to  decreased  sales  of  spare  parts  and  "third  party"
products; diretly related to decreased hardware sales.

International  revenues  were 31% of total  revenues in the three month  periods
ended  September  30, 1999 and 1998,  respectively.  For the nine month  periods
ended September 30, 1999 and 1998 international revenues constituted 30% and 31%
of  total  revenues,   respectively.   Management  expects  that  the  Company's
international  operations will continue to account for a significant  portion of
total  revenues.  International  revenues are subject to certain risks including
but  not  limited  to   political   and  economic   instability;   and  currency
fluctuations. See "Factors That May Affect Future Results" below.

Cost of Revenue
<TABLE>
<CAPTION>
                                           Three Months Ended September 30,        Nine Months Ended September 30,
                                        --------------------------------------  ------------------------------------
 (Dollars in millions)                        1999         1998     % Change         1999         1998    % Change
                                        --------------------------------------  ------------------------------------
 <S>                                       <C>          <C>             <C>       <C>          <C>             <C>
 Cost of software revenue                  $  3.2       $   4.8         (33%)     $  11.8      $  12.8          (8%)
  Percentage of software revenue                7%          13%                        9%          10

 Cost of customer support revenue          $  10.1      $   8.8          15%      $  28.0      $  24.9          12%
  Percentage of customer support
    revenue                                    42%          45%                       44%         48%

 Cost of professional services  and
    education revenue                      $  10.3      $   7.0          47%      $  30.0      $  18.9          59%
  Percentage of professional services
     and education revenue                     82%          86%                       83%          80%

 Cost of hardware revenue                  $   2.4      $   3.1         (23%)     $   7.4      $   9.7         (24%)
  Percentage of hardware revenue               56%          58%                       54%          52%

 Cost of other revenue                     $   1.3      $   1.9         (32%)     $   4.5      $   5.2         (13%)
Percentage of other revenue                   100%          83%                       87%          75%

 Total cost of revenue                     $  27.3      $  25.6           7%      $  81.7      $  71.5          14%
  Percentage of total revenue                  32%          36%                       32%          32%
</TABLE>

The cost of software  revenue  includes  royalties paid to third parties and the
cost of software  distribution.  The cost of software revenue as a percentage of

                                       11
<PAGE>
software  revenue  decreased to 7% from 13% in the same period of 1998. The cost
of software revenue for the nine month period ended September 30, 1999 decreased
to 9% from 10% for the comparable  period of 1998. The decrease is  attributable
to a favorable product mix with lower royalty costs.

The cost of  customer  support  revenue  includes  customer  support  personnel,
supplies, and the cost of third party hardware maintenance. The cost of customer
support revenue as a percentage of customer  support revenue for the three month
period ended  September 30, 1999 decreased to 42% from 45% in the same period of
1998.  The cost of  customer  support  revenue for the nine month  period  ended
September 30, 1999 decreased to 44% from 48% for the comparable  period of 1998.
The decrease is attributable to increased revenue with no proportional  increase
in costs.

The cost of professional  services and education  revenue consists  primarily of
professional  services and training personnel and third party  contractors.  The
cost  of  professional  services  and  education  revenue  as  a  percentage  of
professional  services  and  education  revenue for the three month period ended
September  30, 1999  decreased to 82% from 86% for the same period of 1998.  The
cost of  professional  services and education  revenue for the nine month period
ended September 30, 1999 increased to 83% from 80% for the comparable  period of
1998.  The nine month increase is due to the addition of  professional  services
management  personnel to support the Company's  announced strategy of increasing
its focus on delivering new  professional  services  products as compared to the
comparable  period of 1998.  The  decrease  for the three  month  period  ending
September  30,  1999  compared  to the same  three  months in 1998 is due to the
higher growth of revenue than costs.

The cost of hardware revenue  includes the cost of manufacturing  OSARs, and the
cost of  hardware  integration  personnel.  The cost of  hardware  revenue  as a
percentage  of hardware  revenue for the three month period ended  September 30,
1999  decreased to 56% from 58% for the  comparable  period of 1998. The cost of
hardware  revenue as a percentage of hardware  revenue for the nine month period
ended September 30, 1999 increased to 54% from 52% for the comparable  period of
1998. The increase is due to lower revenue without a  corresponding  decrease in
fixed manufacturing costs.

The cost of other revenue  includes the cost of supplies, spare parts and "third
party"  product.  The cost of other revenue as a percentage of other revenue for
the three months  ended  September  30, 1999  increased to 100% from 83% for the
comparable  period of 1998.  The cost of other  revenue as a percentage of other
revenue for the nine month period ended September 30, 1999 increased to 87% from
75% for the comparable  period of 1998. The increase is due to declining revenue
with a fixed expense base.

Operating Expenses

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

 Research and development           $  13.8     $  12.9           7%         $  40.1      $ 36.8          9%
  Percentage of total revenue           16%         18%                         16%         16%

 Selling, general and
    administrative                  $  38.7     $  42.0          (8%)        $ 118.9      $ 118.1         1%
  Percentage of total revenue           45%         59%                          47%         52%
</TABLE>

Research  and  development  expenses  increased 7% and 9% for the three and nine
month periods ended September 30, 1999, respectively, compared to the comparable
periods  of 1998.  The  increases  in  absolute  dollars  were due to a  general
increase in salaries  necessitated  by the intense  competitive  environment for
software  engineers  and an  increase in the use of  contract  developers.  As a
percentage of total revenue,  research and development  expenses were at 16% and
18% for the three month period ended  September 30, 1999 and 1998,  respectively
and  16%  for  the  nine  month  period  ended  September  30,  1999  and  1998,
respectively.

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

Selling,  general and  administrative  expenses decreased 8% for the three month
period ended September 30 1999,  compared to the comparable  period of 1998. The
                                      12
<PAGE>

decrease  was  primarily  due to  overall  reduced  spending  including  reduced
consulting  related to internal  information  systems  development  projects and
reduced  legal fees.  As a percentage  of total  revenue,  selling,  general and
administrative  expenses  decreased  to 45% for the three  months  period  ended
September 30, 1999 from 59% for the  comparable  period of 1998 primarily due to
the higher  revenue  levels in 1999 and  containment  of all expenses  including
salaries, rent and travel and entertainment.

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

Foreign Currency  Fluctuations and Inflation.  The Company's  performance can be
affected by changes in foreign  currency  values  relative to the U.S. dollar in
relation to the  Company's  revenue and  operating  expenses.  The impact to net
income from foreign exchange  transactions and hedging  activities is immaterial
for all periods  reported.  As of September  30,  1999,  the Company had forward
exchange  contracts  outstanding  totaling  approximately  $6.9  million in nine
currencies. All of these contracts mature in three months.

Other comprehensive  income of $1.2 million for the three months ended September
30, 1999 is primarily  attributable  to  unrealized  gains  associated  with the
strengthening  of the Euro currency  against the U.S. dollar during the quarter.
Other comprehensive loss of $3.2 million for the nine months ended September 30,
1999  is  primarily  attributable  to  unrealized  losses  associated  with  the
weakening of the Euro currency against the U.S. dollar from the beginning of the
year.

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

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

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

Liquidity and Capital Resources

At September 30 1999,  combined cash, cash  equivalents and short- and long-term
marketable  securities  totaled $96.4 million,  an increase of $14.2million from
the end of 1998.  Cash provided by operating  activities  during the nine months
ended  September 30, 1999 totaled $21.7 million and resulted  primarily from net
income;  an increase in unearned  maintenance  revenue related to annual renewal
billings; an increase in other accrued liabilities;  and additions to net income
for  depreciation  and  amortization  expense  offset by  decreases  in accounts
payable and increases in accounts receivable.  Cash used by investing activities
totaled $23.6 million and was a result of capital  expenditures and purchases of
marketable  securities offset by sales and maturities of marketable  securities.
Cash provided by financing  activities  totaled $2.7 million and was a result of
proceeds received from the exercise of employee stock options.

Accounts receivable  increased to $74.7 million at September 30, 1999 from $61.6
million at December 31, 1998. Days sales outstanding  increased to 79 days as of
September  30,  1999  from  66  days  as of  December  31,  1998  due to  slower
collections  in the  European  market.  Days sales  outstanding  were 79 days at
September 30, 1998. Current liabilities  increased to $89.9 million at September
30, 1999 from $76.5 million at December 31, 1998. The increase in current

                                       13
<PAGE>

liabilities is primarily a result of increases in unearned  maintenance  revenue
and accrued taxes, offset by decreases in accounts payable.

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

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

Other Matters

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

The  Program,  as it relates to the  software  products  licensed to  customers,
includes year 2000 compliance  testing and certification of all current software
products.  All  new  generations  of the  Company's  software  products  will be
released as year 2000  compliant.  Not all software  products of the Company are
year 2000 compliant and the Company does not plan to make them so.  Accordingly,
upgraded year 2000 compliant  versions of such software  products are being made
available to customers and resellers who will then bear the  responsibility  for
installing  the upgraded  software  product in order to make their  systems year
2000 compliant.  Some of the Company's  customers are running  software  product
versions that are not year 2000 compliant. The Company has been encouraging such
customers to migrate to current software product  versions.  It is possible that
the Company may experience increased expenses in addressing migration issues for
such customers. The Company's customer support organization is in the process of
completing its program,  Customer  Service Profile 2000, to review the status of
each Company product currently  installed at a customer location and to schedule
upgrades according to the customer's  requirements and support programs. It also
provided the diagnostics  used in such program to its resellers for their use at
their customer locations. Customers who have support agreements with the Company
have  been  directly  informed  as to  whether  or not the  particular  software
products  they have  installed are year 2000  compliant.  All customers are kept
informed of the release of year 2000  compliant  updates  and  upgrades  via the
Company's readiness  disclosure  statement on its Web site. The inability of any
of the Company's software products to properly manage and manipulate data in the
year 2000  could  result in  increased  warranty  costs,  customer  satisfaction
issues, potential lawsuits and other costs and liabilities, as well as customers
being unable to run software licensed from the Company and incurring significant
costs from the resultant  business  interruption.  The Company has implemented a
contingency plan for certain legacy software  products which provides an upgrade
path to current year 2000 compliant  versions of the Company's software products
with similar  functionality.  The Company has spent an estimated $1.4 million on
year 2000 product related projects  through  September 30, 1999. The expense for
year 2000 product related projects is estimated to be approximately $0.3 million
for the remainder of 1999.  The Company is forming a rapid response team as part
of customer  support  that will  respond to  problems  during the year 2000 date
change period. The Company estimates these expenses at $0.1 million.

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

The  Program  also  includes a review of all  internal  IT systems for year 2000
compliance. The Company's significant business systems (financial,  operational,
marketing,  customer support,  etc.) have been reviewed and are either currently
year 2000  compliant  or were  upgraded  and/or  replaced  so as to be year 2000
tested and  compliant  by October 31,  1999.  All of the  hardware  and software
deployed in the  Company's  technical  infrastructure  is either fully year 2000

                                       14
<PAGE>

tested and compliant or has been replaced with year 2000 compliant components by
October  31,  1999.  The  Company is also  evaluating  IT related  environmental
systems  (heating,  air  conditioning,  security,  etc.)  and has  made all such
systems year 2000  compliant by October 31, 1999.  To the extent  possible,  the
Company  has  developed  and  implemented  contingency  plans  designed to allow
continued  operation in the event of failure of the Company's or third  parties'
systems.  Contingency  plans  have been  developed  in  certain  key  areas,  in
particular finance,  sales, IT and customer service to ensure that any potential
business  interruptions  caused  by the year  2000  issue  are  mitigated.  Such
contingency plans include  identification of alternative  sources for processing
data and managing customer support issues. Business teams will be monitoring the
critical systems, and service centers to react immediately to facilitate repairs
at the end of the year 1999.  Data retention and recovery  procedures will be in
place for critical  business data to provide  back-ups with on-site and off-site
data copies. For those business,  infrastructure and environmental  systems that
are to be upgraded in order to achieve year 2000  compliance,  the majority were
already scheduled for upgrade for other business reasons.  The Company's cost to
fund solely year 2000 compliance projects has been $.8 million through September
30,  1999.   The  expense  to  complete   these  projects  is  estimated  to  be
approximately  $0.1 million for the  remainder of 1999.  Although the Company is
not aware of any material  operational issues or costs associated with preparing
its software  products and internal  systems for the year 2000,  there can be no
assurance that there will not be a delay in, or increased costs associated with,
the implementation of the necessary systems and changes to address the year 2000
issue.

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

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

Factors That May Affect Future Results

The Company's business, financial condition, operating results and prospects can
be impacted by a number of factors, including but not limited to those set forth
below and  elsewhere in this report,  any one of which could cause the Company's
actual  results to differ  materially  from recent results or from the Company's
anticipated future results.

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

Uncertainty of Future  Operating  Results;  Fluctuations in Quarterly  Operating
Results.  Prior  growth rates in the  Company's  revenue and  operating  results
should not  necessarily  be considered  indicative of future growth or operating
results.  Future operating results will depend upon many factors,  including the
demand for the Company's products; the effectiveness of the Company's efforts to
continue to  integrate  various  software it has  developed  or acquired  and to

                                       15
<PAGE>

achieve the desired level of sales from such software integration;  the level of
product  and  price  competition;  the  length  of the  Company's  sales  cycle;
improvements in the  productivity  of the Company's sales force;  seasonality of
individual  customer  buying  patterns;   the  size  and  timing  of  individual
transactions;  the delay or  deferral of  customer  implementations;  the budget
cycles of the Company's customers;  the timing of new software introductions and
software  enhancements by the Company and its  competitors;  the mix of sales by
products,  software, services and distribution channels; levels of international
sales; acquisitions by competitors;  changes in foreign currency exchange rates,
impact of the EURO  currency;  the  ability of the Company to develop and market
new software  products and control costs; and general domestic and international
economic and political  conditions.  Demand for the Company's  software products
could be adversely impacted to the extent customers and potential  customers are
temporarily  distracted by their year 2000 remediation efforts, as such products
compete for  information  technology  (IT) resources that have been diverted for
such  remedial   efforts  which  may  have  higher  priority  than  ordering  or
implementing the Company's software products.

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

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

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

The Company may, from time to time,  be notified  that it is infringing  certain
patent or  intellectual  property  rights of others.  Combinations of technology

                                       16
<PAGE>

acquired through past or future  acquisitions and the Company's  technology will
create new  software  products  and  technology  that may give rise to claims of
infringement.  While no actions other than those  discussed  below are currently
pending  against  the Company for  infringement  of patent or other  proprietary
rights of third  parties,  there can be no assurance that third parties will not
initiate  infringement  actions against the Company in the future.  Infringement
actions can result in  substantial  cost to, and diversion of,  resources of the
Company.  If the Company  were found to infringe  upon the rights of others,  no
assurance can be given that the Company could redesign the  infringing  products
or could obtain licenses on acceptable terms or at all, that significant damages
for past infringement would not be assessed or that further litigation  relative
to any such  licenses  or usage  would not occur.  The  failure to  successfully
defend any claims or redesign its products or obtain necessary licenses or other
rights,  the  ultimate  disposition  of any claims or the  advent of  litigation
arising out of any claims of infringement,  could have a material adverse effect
on the Company's business, financial condition or results of operations.

In October 1994, Wang Laboratories,  Inc. (Wang) filed a complaint in the United
States  District  Court for the  District  of  Massachusetts  alleging  that the
Company is infringing  five patents held by Wang (the FileNET Case). On June 23,
1995,  Wang amended its complaint to include an additional  related  patent.  On
July 2, 1996,  Wang filed a complaint in the same court  alleging that Watermark
Software  Inc.,  formerly a wholly  owned  subsidiary  that was merged  into the
Company,  is  infringing  three  of the same  patents  asserted  in the  initial
complaint (the Watermark  Case).  On October 9, 1996, Wang withdrew its claim in
the FileNET Case that one of the patents it initially asserted is infringed.  In
March 1997,  Eastman Kodak Company (Kodak)  purchased the Wang imaging  business
unit that has  responsibility  for this litigation.  On July 30, 1997, the Court
permitted  Eastman  and  Kodak  Limited  of  England  to be  substituted  in the
litigation in place of Wang.

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

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

Dependence  on Certain  Relationships.  The Company has entered into a number of
key relationships with other companies such as Microsoft Corporation, IBM Global
Services, SAP AG, Hewlett-Packard Company, and Sun Microsystems,  Inc. There can
be no  assurance  that  these  companies  will not reduce or  discontinue  their
relationships with, or support of, the Company and its products.

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

International  Sales.  Historically,   the  Company  has  derived  approximately
one-third of its total revenues from international sales. International business
is subject to certain risks including varying technical  standards;  tariffs and
trade  barriers;  political and economic  instability;  reduced  protection  for
intellectual property rights in certain countries;  difficulties in staffing and
maintaining foreign operations;  difficulties in managing foreign  distributors;

                                       17
<PAGE>

varying   requirements   for  localized   products;   potentially   adverse  tax
consequences;  currency  exchange  fluctuations  including  those related to the
EURO;  the burden of  complying  with a wide  variety of complex  foreign  laws,
regulations  and treaties;  and the  possibility of  difficulties  in collecting
accounts  receivable.  There can be no assurance  that any of these factors will
not  have a  material  adverse  effect  on  the  Company's  business,  financial
condition or results of operations.

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

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

                                       18
<PAGE>


PART II.  OTHER INFORMATION

Item 1.  Legal Proceedings

See Notes to Consolidated Financial Statements.


Item 6.  Exhibits and Reports on Form 8-K

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

                                       19
<PAGE>


                                    SIGNATURE

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

                                  FILENET CORPORATION


November xx, 1999                     /s/ Mark S. St. Clare
Date
                                  By: Mark S. St. Clare, Chief Financial Officer
                                      and Sr. Vice President, Finance
                                      (Principal Financial Officer)






                                       20

<PAGE>
                                INDEX TO EXHIBITS

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

  3.1*              Restated Certificate of Incorporation,  as amended (filed as
                    Exhibit  3.1  to  Form  S-4  filed  on  January  26,   1996;
                    Registration No. 333-00676).

  3.1.1*            Certificate   of  Amendment  of  Restated   Certificate   of
                    Incorporation  (filed as Exhibit  3.1.1 to Form S-4 filed on
                    January 26, 1996, Registration No. 333-00676).

  3.2*              Bylaws   (filed   as   Exhibit   3.2  of  the   Registrant's
                    registration   statement  on  Form  S-1,   Registration  No.
                    33-15004 (the "Form S-1")).

  4.1*              Form  of  certificate  evidencing  Common  Stock  (filed  as
                    Exhibit 4.1 to the Form S-1, Registration No. 33-15004).

  4.2*              Rights  Agreement,  dated as of  November  4,  1988  between
                    FileNET  Corporation  and the First National Bank of Boston,
                    which  includes the form of Rights  Certificate as Exhibit A
                    and the  Summary  of Rights  to  Purchase  Common  Shares as
                    Exhibit B (filed as Exhibit 4.2 to Form S-4 filed on January
                    26, 1996; Registration No. 333-00676).

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

 10.1*              Amended and Restated Credit Agreement (Multicurrency) by and
                    among the Registrant and Bank of America  National Trust and
                    Savings  Association  dated June 30,  1999,  effective  June
                    30,1999  (filed as Exhibit 10.1 to Form 10-Q for the quarter
                    ended June 30, 1999).

 10.2*              Business  Alliance Program  Agreement between the Registrant
                    and Oracle  Corporation  dated  July 1, 1996,  as amended by
                    Amendment  One thereto  (filed as Exhibit 10.4 to Form 10-QA
                    for the quarter ended June 30, 1996).

 10.3*              Runtime  Sublicense  Addendum  between  the  Registrant  and
                    Oracle  Corporation  dated  July  1,  1996;  as  amended  by
                    Amendment  One thereto  (filed as Exhibit 10.4 to Form 10-QA
                    for the quarter ended June 30, 1996).

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

 10.4*              Full Use and  Deployment  Sublicense  Addendum  between  the
                    Registrant  and Oracle  Corporation  dated July 1, 1996,  as
                    amended by Amendment  One thereto  (filed as Exhibit 10.4 to
                    Form 10-QA for the quarter ended June 30, 1996).

 10.5*              Lease between the Registrant and C. J. Segerstrom & Sons for
                    the headquarters of the Company, dated April 30, 1987 (filed
                    as Exhibit 10.19 to the Form S-1).

 10.6*              Third  Amendment to the Lease between the  Registrant and C.
                    J.  Segerstrom & Sons dated April 30, 1987,  for  additional
                    facilities at the headquarters of the Company, dated October
                    1, 1992  (filed as Exhibit  10.7 to Form 10-K filed on April
                    4, 1997).

 10.7*              Fifth  Amendment to the Lease between the  Registrant and C.
                    J. Segerstrom & Sons dated April 30, 1987, for the extension
                    of the term of the lease,  dated  March 28,  1997  (filed as
                    Exhibit  10.8 to Form 10-Q for the  quarter  ended March 31,
                    1997).

 10.8*              1989 Stock Option Plan for Non-Employee Directors of FileNET
                    Corporation,  as  amended  by the  First  Amendment,  Second
                    Amendment, Third Amendment thereto (filed as Exhibit 10.9 to
                    Form  S-4  filed  on  January  26,  1996;  Registration  No.
                    333-00676).

 10.9*              Amended  and  Restated  1995  Stock  Option  Plan of FileNET
                    (filed  as  Exhibit  99.1 to Form S-8 filed on  October  29,
                    1999; Registration No. 333-89983).

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

                                       21
<PAGE>

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

 10.10*             Second  Amended and  Restated  Stock  Option Plan of FileNET
                    Corporation,  together  with the  forms of  Incentive  Stock
                    Option Agreement and  Non-Qualified  Stock Option Agreements
                    (filed as Exhibits 4(a), 4(b) and 4(c), respectively, to the
                    Registrant's    Registration    Statement   on   Form   S-8,
                    Registration No. 33-48499),  and an Amendment thereto (filed
                    as Exhibit 4(d) to the Registrant's  Registration  Statement
                    on Form S-8,  Registration  No.  33-69920),  and the  Second
                    Amendment  thereto (filed as Appendix A to the  Registrant's
                    Proxy Statement for the Registrant's  1994 Annual Meeting of
                    Stockholders, filed on April 29, 1994).

 10.11*             Non-Statutory  Stock Option  Agreement (with Notice of Grant
                    of Stock Option and Special Addendum) between Registrant and
                    Mr.  Lee  Roberts  (filed  as  Exhibit  99.17 to Form S-8 on
                    August 20, 1997).

 10.12*             Non-Statutory  Stock Option  Agreement (with Notice of Grant
                    of Stock Option and Special Addendum) between Registrant and
                    Mr. Ron  Ercanbrack  (filed as Exhibit  99.19 to Form S-8 on
                    August 20, 1997).

 10.13*             Agreement  for the Purchase of IBM products  dated  December
                    20, 1991 (filed on May 5, 1992 with the Form 8 amending  the
                    Company's  Form 10-K for the fiscal year ended  December 31,
                    1991).

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

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

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

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

 10.18*             Agreement  and Plan of Merger  between  the  Registrant  and
                    Watermark  Software  Inc.  dated  July 18,  1995  (filed  as
                    Exhibit  10.27 to Form 10-Q for the  quarter  ended  July 2,
                    1995).

 10.19*             Agreement  and Plan of Merger  between  the  Registrant  and
                    Saros Corporation, as amended, dated January 17, 1996 (filed
                    as Exhibits  2.1, 2.2, 2.3, and 2.4 to Form 8-K on March 13,
                    1996).

 10.20*             Stock Purchase  Agreement by and Among FileNET  Corporation,
                    IFS Acquisition Corporation, Jawaid Khan and Juergen Goersch
                    dated  January  17, 1996 and  Amendment 1 to Stock  Purchase
                    Agreement  dated  January 30, 1996 (filed as Exhibit 10.2 to
                    Form 10-K for the year ended December 31, 1995).

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

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

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

 27                 Financial Data Schedule.

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

                                       22