Back to GetFilings.com

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the year ended December 31, 2003

or

For the transition period from                      to                     .

Commission File Number ( 0-22292 )

Captiva Software Corporation

(Exact name of registrant as specified in its charter)

10145 Pacific Heights Boulevard

San Diego, CA 92121

(858) 320-1000

(Address, including zip code, and telephone number, including area code, of principal executive offices)

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.01 par value

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [    ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act). Yes              No     X    

The aggregate market value of the voting stock held by non-affiliates of the registrant, as of June 30, 2003, was approximately $38,274,365 (based on the closing price for shares of the registrant’s Common Stock as reported by the Nasdaq National Market on that date). Shares of Common Stock held by each officer, director and holder of 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

The number of shares outstanding of the registrant’s Common Stock, $0.01 par value, as of February 29, 2004 was 10,938,083.

Table of Contents

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A in connection with the registrant’s 2004 Annual Meeting of Stockholders are incorporated herein by reference into Part III of this Report. Such Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the registrant’s year ended December 31, 2003.

Certain exhibits filed with the registrant’s (i) Current Report on Form 8-K filed on March 20, 2002, (ii) Registration Statement on Form S-1, as amended (Registration No. 33-66142), (iii) Current Report on Form 8-K filed on September 24, 1997, (iv) Registration Statement on Form 8-A filed on September 10, 1997 (Registration No. 000-22292), (v) Annual Report on Form 10-K filed on March 29, 2002, (vi) Annual Report on Form 10-K filed on April 2, 2001, (vii) Registration Statement on Form S-4 (Registration No. 333-87106) and (viii) Annual Report on Form 10-K filed on March 31, 2003, are incorporated by reference into Part IV of this Report.

Table of Contents

CAPTIVA SOFTWARE CORPORATION

FORM 10-K

For the Year Ended December 31, 2003

INDEX

Table of Contents

PART I

Forward Looking Statements

This Annual Report on Form 10-K contains forward-looking statements. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of these terms or other words of similar meaning. These statements are only predictions based on information currently available to us. Actual events or results may differ materially. Important factors that may cause actual results to differ materially from the forward-looking statements are described in the section entitled “Risk Factors” in Item 1 of this report and in other risks identified from time to time in our filings with the Securities and Exchange Commission, press releases and other communications.

Although we believe that the estimates and expectations reflected in our forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We assume no obligation to update any of the forward-looking statements contained in this report.

Overview

We are a leading provider of input management solutions designed to manage business critical information from paper, faxed and electronic forms, documents and transactions into the enterprise. Our solutions automate the processing of billions of forms, documents and transactions annually, converting their content into information that is usable in database, document, content, and other information management systems. We believe that our products and services enable organizations to reduce operating costs, obtain higher information accuracy rates, and speed processing times.

Our products offer organizations a cost-effective, accurate, and automated alternative to both manual data entry and electronic data interchange (EDI). These traditional approaches are typically labor intensive, time consuming and costly methods of managing the input of information into the enterprise. Organizations can utilize our products to capture information digitally, extract the meaningful content or data, and apply business rules that ensure the data’s accuracy. Our solutions serve thousands of users in insurance, financial services, business process outsourcing (BPO), government, manufacturing, and other markets. Enterprises that have purchased our products and services include American Express, Blue Cross Blue Shield of Oklahoma, Electronic Data Systems, FileNet, Fujitsu, GEICO, National City Corporation, and Texas Workforce Commission.

In February 2004, we acquired ADP Context Inc. (Context), a business unit of ADP Claims Solutions Group, Inc. and a part of the worldwide Automatic Data Processing, Inc. family of companies, for approximately $5.2 million in cash. Context’s products provide automated solutions to complex medical claims coding, editing and reimbursement challenges in the healthcare industry and allow us to better serve our claims processing customers and expand our reach in the healthcare insurance market.

Captiva Software Corporation resulted from the merger of ActionPoint, Inc., a Delaware corporation (ActionPoint), with Captiva Software Corporation, a California corporation (Old Captiva), in the third quarter of 2002 (the Merger). In this transaction, Captiva Software Corporation became a wholly owned subsidiary of ActionPoint, and ActionPoint changed its name to Captiva Software Corporation and remained a Delaware Corporation.

Our principal executive offices are located at 10145 Pacific Heights Boulevard, San Diego, California 92121, our telephone number is (858) 320-1000 and our Internet website address is www.captivasoftware.com. We were incorporated in California in January 1986 and were reincorporated in Delaware in September 1993. Our filings with the Securities and Exchange Commission (SEC), including our Annual Report on Form 10-K, quarterly

1

Table of Contents

reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports, are available free of charge through the investor relations section of our Internet website as soon as reasonably practicable after being filed with or furnished to the SEC.

Industry Background

The Input Management Problem

Enormous quantities of printed and electronic information flow into businesses, government agencies and other organizations on a daily basis. Most of this information comes from customers, suppliers, employees and other third parties conducting transactions or corresponding with the organization through the use of paper and electronic forms and documents such as letters, resumes, new account enrollments, credit applications, tax returns, invoices, legal briefs, and regulatory filings.

Pertinent information from these forms and documents must be extracted, perfected, formatted and exported to an organization’s information management systems as cost effectively, accurately and quickly as possible. Processing delays, incorrect or invalid data and inefficient methods can adversely impact an organization’s revenues, operating expenses and interactions with customers, suppliers and employees. According to Strategy Partners, a consultancy firm specializing in enterprise content management (ECM), the input management software market is expected to exceed $1.2 billion in 2004.

Current Approaches are Inadequate

Traditional methods for capturing data from paper forms and documents rely principally upon manual data entry. According to Harvey Spencer Associates, a consultancy firm specializing in ECM, organizations in the United States spend $15 billion a year manually keying data from forms alone. Organizations generally perform this work internally or outsource it to BPO firms. But both approaches have inherent problems. Organizations performing this work internally usually distribute it on a departmental basis, where highly paid knowledge workers manually key data directly into information management systems with minimal data validation and low productivity rates. The accuracy of the information and processing times usually suffer, and costs incurred from both erroneous data and poorly utilized human resources are high.

Gartner Group, an independent information technology research firm, estimates that the amount of time wasted on these document management tasks is significant and increasing. In 1997, Gartner estimated that knowledge workers spent about eight hours per week or 20% of their time on document management tasks. In 2003, Gartner increased this estimate to between 12 and 16 hours per week or 30% and 40% of their time. Additional data gathered by Gartner indicated that:

BPO firms that specialize in performing this type of work typically achieve higher productivity rates at a lower cost. However, unpredictable data accuracy and turnaround times as well as an overall loss of control impede adoption, particularly for confidential or time sensitive forms and documents and for government agencies sensitive to the increased outsourcing of jobs to offshore firms.

Alternative approaches to manually capturing data include electronic data interchange (EDI), electronic forms and documents and, more recently, Internet applications. Each of these approaches also has inherent problems and limitations. EDI is difficult to implement and has been adopted in only a few vertical markets, such as medical claims processing. We believe approximately 60% of all medical claims continue to be submitted on paper forms. The growth in use of electronic forms and documents and Internet-based transactions is limited by

2

Table of Contents

user concerns about the security of transactions, the absence of a standard data exchange format and the limited acceptance of legally binding, digital signatures.

These alternative input management methods frequently have minimal data validation capabilities, are incapable of capturing data from paper forms and documents, and require substantial custom application development and maintenance. Gartner Group estimates that, for every dollar spent on Internet applications, organizations should expect to spend from $5 to $20 on services, principally for the integration of Internet applications with existing information management systems.

As the volume of forms and documents continues to grow, many organizations processing paper and electronic forms and documents are seeking a more comprehensive solution to address their input management problems. We believe there is a significant opportunity to help organizations automate their input management processes, reduce operating costs, obtain higher information accuracy rates and speed processing times.

Our Solutions

Our products and services, which we refer to together as our “solutions”, allow our customers to realize the following benefits:

An Input Management Process That is Cost Effective, Accurate and Timely

By automating previously manual processes, our solutions enable our customers to capture information from multiple sources in a more cost effective, accurate and timely manner than otherwise possible. Our customers achieve lower operating costs, higher information accuracy rates and faster processing times. These benefits can increase our customers’ revenues, reduce their expenses, accelerate their business processes and help improve their relationships with customers, suppliers and employees. We believe our solutions typically provide a 12 to 18 month return on investment (ROI) through reduced manual data entry costs alone, and also improve the quality and timeliness of information, which further increases the ROI.

Rapid Implementation Timeframes

Our products utilize graphically oriented, easy to use, development modules that enable rapid application development, testing and deployment. We also offer professional services to assist customers with these tasks or to perform them entirely on their behalf. Our solutions allow our customers to reduce implementation costs and shorten implementation timeframes.

A Highly Flexible, Open and Scalable System

Our products provide a modular platform using an open architecture that is scalable from a single personal computer to large, multi-user networks processing from several hundred to hundreds of thousands of forms and documents per day. This allows our customers to configure systems and supplement our solutions with third-party software and hardware in order to meet unique requirements and easily expand systems should the need arise.

Ease in Extracting and Exporting Information

Our solutions are able to extract and improve the accuracy of information from paper, faxed and scanned forms and documents, electronic forms and electronic data in an EDI or an eXtensible Markup Language (XML) format. Our solutions also provide the ability to export information in multiple formats, including XML, to almost any information management system, including those from Documentum, FileNet, IBM, OpenText and SAP. These capabilities allow our customers to deploy and benefit from a single, fully integrated input management platform as opposed, for example, to separate systems for document capture, forms processing and electronic data streams.

3

Table of Contents

The Application of Uniform Business Rules to All Sources of Information

Our solutions are able to consistently apply a configurable set of business rules to all forms and documents entering the organization throughout the input management process, regardless of their origin or format. This allows organizations to make a one-time investment in developing, testing and deploying these rules, and it allows the forms and documents to be automatically verified and properly routed.

Growth Strategy

Our objective is to extend our position as a leading provider of input management solutions. Key elements of this strategy include:

Leverage Our Existing Customer Base

We believe significant opportunities exist to expand the use of our solutions in our existing customer base. Our customers generally start by deploying our solutions on a departmental basis or for limited form or document types. Satisfaction with these initial deployments can lead to a broader or enterprise-wide adoption of our solutions.

Leverage and Expand Our Sales Channels and Markets

In 2003 we derived 36% of our revenues from resellers, system integrators and distributors. We believe there are significant opportunities to increase sales of our solutions through resellers, system integrators and distributors. We also believe there are significant opportunities to both add new cooperative marketing partners and leverage our existing cooperative marketing partners, who typically develop and market complementary products but do not actually resell our products.

We have historically focused our sales and marketing efforts on large organizations, which typically require the ability to process large volumes of forms and documents through scalable input management solutions. Our solutions are, however, flexible enough to serve the full spectrum of market needs, and we intend to expand into lower volume segments by repackaging and repricing our solutions for these segments. In 2003 we released InputAccel Express to specifically address the lower volume market and we announced a distribution agreement for this product with Headway Technology Group, a leading imaging products distributor in Western Europe. In 2004 we announced a distribution agreement for this product with Scientific Digital Business Group, a leading imaging products distributor in Southeast Asia.

Expand International Presence

We derived 21%, 25% and 30% of our revenues from outside the United States in 2003, 2002 and 2001, respectively. We believe there are significant opportunities to increase sales of our solutions in international markets. We believe the size and presence of our subsidiaries in the United Kingdom, Germany and Australia will improve our competitiveness in those countries. In 2003, we initiated efforts to add resellers and system integrators in Spanish and Portuguese speaking countries. In 2004, we initiated similar efforts in the Pacific Rim. We expect to expand our presence in additional international markets and to continue to address local language requirements by localizing our products.

Broaden Product Offerings

We intend to continue to develop and introduce new solutions that utilize our proven technologies and allow us to enter new markets. For example, in 2001 we released ClaimPack, in 2003 we introduced InputAccel Express and in 2004 we introduced Digital Mailroom. All of these products build upon our pre-existing technology and have allowed us to enter new markets.

According to IDC, an independent information technology research firm, end-users are willing to pay a single vendor source 10% to 15% more for a complete solution that includes software, hardware and integration

4

Table of Contents

services than they would if they obtained these components separately from multiple vendors. We believe that we can extend our position and increase our average selling price by offering a variety of software, services, and hardware, including digital scanners and other third-party products as part of the solutions we provide.

Pursue Strategic Acquisitions

We believe acquisitions of complementary technologies may allow us to expand our product offerings, augment our distribution channels, expand our market opportunities or broaden our customer base. We have acquired technology in the past to achieve these objectives and may in the future evaluate and pursue similar opportunities.

Our Products and Services

Our products and services enable enterprises to manage business critical information from paper, faxed, and electronic forms, documents and transactions. Our solutions automate the processing of billions of forms, documents and transactions annually, converting their contents into information that is usable in database, document, content, and other information management systems.

Software

Our customers are usually required to capture large amounts of information within short timeframes in order to meet inflexible deadlines on a regular basis. We have optimized our software products to provide this level of system performance and availability. Our software products are generally licensed on either a per server, per user or per concurrent user basis, with the server-based processes typically being configured to support only a specified form or document throughput rate. In 2003, 2002 and 2001, software revenues were approximately 47%, 57% and 68% of our total revenues, respectively.

FormWare

FormWare is comprised of a set of modules that work in conjunction with one another to capture data from paper, faxed and scanned forms and documents, Internet forms and electronic data in an EDI or XML format. It is a forms processing platform optimized to extract data from structured forms containing fielded data, such as medical claims, new account enrollments, credit applications, tax returns, orders and similar forms. It includes modules for:

5

Table of Contents

ClaimPack

Built on FormWare, ClaimPack is an automated medical claims processing solution for the healthcare industry that is able to capture critical information from paper-based claim forms (including HCFA and UB92 forms). It speeds deployment times by providing a standard packaged application while maintaining the ability to customize applications through the use of FormWare’s integrated development environment and VBA.

InputAccel

InputAccel is comprised of a set of modules that work in conjunction with one another to capture content from paper, faxed and scanned forms and documents and electronic data sources. It is a document capture platform optimized to extract content from unstructured documents, such as correspondence, resumes, regulatory filings, litigation materials, drug test reports and similar documents. It includes modules for:

FormWare and InputAccel are fully integrated with one another and can be licensed separately or together.

InputAccel Express

Based on InputAccel, InputAccel Express is a repackaged and repriced version of InputAccel designed for the mid-market segment of the input management market. Completely upgradeable to InputAccel, InputAccel Express is more of a packaged solution for departmental or lower volume users who need to quickly and easily transform paper forms and documents into more usable electronic content.

InputAccel for Invoices

Built on InputAccel, InputAccel for Invoices is a product for accounts payable departments that is designed to capture critical information from invoices. Like ClaimPack, it speeds deployment times by providing a standard packaged application, but can be customized through the use of InputAccel’s development environment and VB Scripting. InputAccel for Invoices was released in the first quarter of 2004.

Digital Mailroom

Also built on InputAccel, Digital Mailroom is a solution for the automated classification and routing of digitized images of inbound mail and electronic communications. It provides a single point of entry and centralized processing that is able to automatically recognize and route forms and documents to the appropriate department or person for processing, while providing full auditing and tracking capabilities. Digital Mailroom was released in the first quarter of 2004.

6

Table of Contents

Pixel Products

Pixel software products include:

Context Products

We acquired the Context products on February 1, 2004 through the acquisition of ADP Context, Inc., a business unit of ADP Claims Solutions Group, Inc. and a part of the worldwide Automatic Data Processing, Inc. family of companies. Context products are sold to providers and payers in the health insurance market and include:

Architecture

Our software products are sophisticated 32 bit applications for use on standalone personal computers and client-server platforms using Microsoft Windows software at the desktop and Microsoft Server software on file servers. Many of our software products include modules that function as servers, which means that their resources can be shared by multiple users and that additional modules can be added as required to address more complex processing or greater throughput requirements. All of our software products use Microsoft SQL Server or a highly optimized proprietary file system to maintain higher throughput rates.

Most of our software products use complex queuing algorithms to ensure subsecond response times and minimize the number of system calls required to complete various tasks. All of our software products are available in English; some are available in localized German, Spanish, Portuguese and Japanese versions. We expect to provide additional localized versions in order to increase our international presence and revenues.

AdvantEDGE Services

We offer a variety of services through our AdvantEDGE services program. We believe that this allows us to better address the implementation and support needs of our customers, resellers and system integrators and achieve a greater level of customer satisfaction. This program includes a broad range of services provided by our professional and technical services staff, which consisted of 69 employees as of December 31, 2003. In 2003, 2002 and 2001, services revenues were approximately 40%, 40% and 32% of our total revenues, respectively.

Our professional services staff provides project management, functional and detailed specification preparation, application development, form redesign, system configuration, testing, installation and application specific training services to our customers. While our resellers and system integrators can and do provide these services to their customers, they frequently ask us to provide these services to their customers on a subcontract basis. We generally charge for professional services on a fixed fee basis for projects utilizing mutually agreed upon functional and detailed specifications and on a time and materials basis for other projects.

7

Table of Contents

Our technical services staff provides maintenance for the resolution of technical inquiries by telephone, email and over the Internet, and a set of regularly scheduled training classes held at our offices and customer sites. We offer several levels of maintenance, with the most comprehensive covering 24 hours a day, seven days a week. We generally charge for maintenance as a percentage of the related software license fee that varies, depending upon the related level of service and other factors, and classroom training on a per attendee basis.

Hardware and Other Products

As part of our solutions, we offer digital scanners and other third-party products. In 2003 these accounted for approximately 13% of our total revenues, with substantially all of these amounts being attributable to the sale of sophisticated, production level digital scanners manufactured by Kodak and IBML. We had a backlog of digital scanner revenues of approximately $4.3 million and $2.2 million at December 31, 2003 and 2002, respectively.

Our Customers

As of December 31, 2003 we had licensed our software to over 2,000 customers. Our solutions are designed to address input management needs in a broad range of industries, including insurance, financial services, banking, technology, government, BPO, and other markets. The following is a partial list of our customers and are representative of our overall customer base:

8

Table of Contents

In 2003, no single customer accounted for more than 10% of our total revenues.

Sales, Marketing and Business Development

We reach our customers through our direct sales force, our cooperative marketing partners and a network of resellers, system integrators and distributors, collectively “channels”. Our cooperative marketing partners typically develop and market complementary products, and we jointly sell directly to end-user customers. We have established relationships with resellers, system integrators and distributors that deliver our solutions to multiple markets. We believe our ability to work with and through these diverse and sometimes competing channels represents a significant competitive advantage. These channels currently offer our solutions in the United States, Western Europe, the Pacific Rim and Spanish and Portuguese speaking countries.

Our resellers, system integrators and distributors include American Management Systems, Crowe Chizek, Documentum (an EMC company), DST Technologies, EDS, Headway Technology Group (an Acal company), IBM Deutschland, IKON Image Systems Solutions, ImageScan, Integrated Document Technologies, Nissho Electronics Corporation, Open Text and Unisys. Our cooperative marketing partners include Eastman Kodak, FileNet, Fujitsu, Hyland Software, IBM, IBML, Information Management Resources (IMR), Interwoven and SAP.

Our marketing strategy uses a variety of programs to build awareness of input management problems, our solutions and our brand name. We use a broad mix of programs to accomplish these goals, including market research, product and strategy updates with industry analysts, public relations activities, direct mail and relationship marketing programs, seminars, trade shows, speaking engagements and Internet-based marketing. To support our selling efforts, our marketing staff also produces collateral materials such as brochures, data sheets, white papers, presentations and demonstrations.

9

Table of Contents

As of December 31, 2003, our sales, marketing and business development staff consisted of 97 employees. In 2003 approximately 36% of our total revenues came from resellers, system integrators and distributors, but none of these parties accounted for more than 10% of our total revenues.

We intend to aggressively expand our sales and marketing activities, increase the number of our resellers, system integrators, distributors and cooperative marketing partners and devote significant resources to accomplishing these objectives.

Research and Development

We believe our future success depends in large part on our ability to enhance our current products, develop new products, maintain technological competitiveness, implement emerging standards and satisfy an evolving range of customer requirements for existing and new input management problems. Our research and development employees are responsible for achieving these objectives, and we have and intend to continue to devote substantial resources to these efforts.

We have assembled a team of skilled software development, quality assurance and documentation engineers with substantial industry experience and believe they represent a significant competitive advantage. This team includes many individuals who have previously worked together in other organizations where they developed alternative input management products.

Our research and development expenditures were approximately $9.0 million, $5.9 million and $4.9 million in 2003, 2002 and 2001, respectively. As of December 31, 2003, our research and development staff consisted of 65 employees. All research and development expenditures are expensed as incurred.

Intellectual Property

We have invested and will continue to invest significantly in the development of proprietary technology and information, and we believe our success and ability to compete is dependent on our ability to protect this intellectual property. We rely on a combination of patent, trademark, trade secret and copyright laws and confidentiality, non-disclosure and other contractual arrangements to protect these rights.

Our customers’ use of our software products is governed by shrink-wrap or executed license agreements. We also enter into written agreements with each of our resellers, system integrators and distributors governing the licensing of our software products. In addition, we seek to avoid disclosure of our proprietary technology and information by requiring each of our employees and others with access to our intellectual property to execute confidentiality and/or non-disclosure agreements with us. We protect our software products, documentation and other written materials under trade secret and copyright laws. All of these measures afford only limited protection.

Competition

The market for our products is highly competitive, evolving and subject to rapid technological change. We believe the principal competitive factors in the input management market are:

10

Table of Contents

We believe we compare favorably with our competitors with respect to the above factors.

Our principal competitors are:

Employees

As of December 31, 2003, we had 266 employees. This included 97 employees in sales, marketing and business development; 69 employees in professional and technical services; 65 employees in research and development; and 35 employees in finance and administration. Our acquisition of Context on February 1, 2004 added 34 employees. Our employees are not represented by a labor union or subject to a collective bargaining agreement, and we believe that our employee relations are good.

Risk Factors

You should carefully consider the following risk factors and all other information contained in this Annual Report on Form 10-K. Investing in our common stock involves a high degree of risk. Risks and uncertainties, in addition to those we describe below, that are not presently known to us or that we currently believe are immaterial may also impair our business operations. If any of the following risks occur, our business could be harmed, the price of our common stock could decline and you could lose all or part of your investment.

Because of the unpredictability and variability of revenues from our products, we may not accurately forecast revenues or match expenses to revenues, which could harm quarterly operating results and cause volatility or declines in our stock price.

Our quarterly revenues, expenses and operating results have varied significantly in the past, and our quarterly revenues, expenses and operating results may fluctuate significantly from period to period in the future due to a variety of factors, including:

We believe that comparisons of quarterly operating results will not necessarily be meaningful and should not be relied upon as the sole measure of our future performance. In addition, we may from time to time provide estimates of our future performance. For example, we typically estimate that the first quarter of each year is our weakest quarter and the fourth quarter of each year is our strongest quarter. Estimates are inherently uncertain and actual results are likely to deviate, perhaps substantially, from our estimates as a result of the many risks and uncertainties in our business, including, but not limited to, those set forth in these risk factors. We undertake no duty to update estimates if given. Our operating results in one or more future quarters may fail to meet the expectations of securities analysts or investors. If this occurs, the trading price of our stock could decline significantly.

11

Table of Contents

If we fail to rapidly reduce expenses in the event our revenues unexpectedly decline, our results may be harmed.

We currently operate with virtually no software order backlog because software products are shipped shortly after orders are received. This fact makes software revenues in any quarter substantially dependent on orders booked and shipped throughout that quarter. In addition, a large portion of our orders are generally booked late in each quarter and we obtain a significant portion of our revenues from indirect sales channels over which we have little control. The combination of these factors makes our revenues difficult to predict from period to period. Expense levels are based to a significant extent on expectations of future revenues and therefore are relatively fixed in the short term. In particular, we increased hiring and product development expenses in the fourth quarter of 2003 in anticipation of an improving economic environment. We expect to continue these higher levels of expenses and, if revenue levels are below expectations, our operating results are likely to be harmed because only small portions of our expenses vary directly with revenues.

We have a long sales cycle and our solutions require a sophisticated sales effort.

Given the high average selling price and the cost and time to implement our solutions, a customer’s decision to license our products typically involves a significant commitment of resources and is influenced by the customer’s budget cycles and internal approval procedures for IT purchases. In addition, selling our solutions requires us to educate potential customers on our solutions’ uses and benefits. As a result, our solutions have a long sales cycle, which can take from three to six months or more. Consequently, we face difficulty predicting the quarter in which sales to expected customers may occur. The sale of our solutions is also subject to delays from the lengthy budgeting, approval and competitive evaluation processes of our customers that typically accompany significant capital expenditures.

Our solutions require a sophisticated sales effort targeted at senior management of our prospective customers. New hires in our sales department require extensive training and typically take at least six months to achieve full productivity. There is no assurance that new sales representatives will ultimately become productive. If we were to lose qualified and productive sales personnel, our revenues could be adversely impacted.

We may not be able to compete successfully against current and potential competitors.

The input management software industry is currently fragmented, with no one company having a significant market share. We expect that competition in the input management software industry will intensify in the future. The market for forms processing and document capture solutions is very competitive and subject to rapid change. In addition, because there are relatively low barriers to entry into the software market, we may encounter additional competition from both established and emerging companies. Our current competitors could be acquired by larger companies and could become more formidable competitors. Many potential competitors have longer operating histories and significantly greater financial, technical, marketing and other resources than ours, in addition to significantly greater name recognition and a larger installed base of customers. As a result, these potential competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements or to devote greater resources to the development, promotion and sale of competitive products than we can. There is also a substantial risk that announcements of competing products by potential competitors could result in the delay or postponement of customer orders in anticipation of the introduction of the competitors’ new products.

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 customer needs. These cooperative relationships may limit our ability to sell our products through particular reseller partners. Accordingly, new competitors or competitive cooperative relationships may emerge and rapidly gain significant market share. Contributing to these challenges, our industry is subject to consolidation, which could subject us to competition with larger companies offering integrated solutions and a wider breadth of products. Potential competitors may bundle their products or incorporate additional components into existing products in a manner that discourages users from purchasing our products.

12

Table of Contents

Increased competition as a result of any combination of the above factors is likely to result in price reductions, fewer customer orders, reduced margins and loss of market share, any of which could harm our revenues, business and operating results.

We have incurred losses in the past and we may incur losses in the future.

We have only recently become profitable with net income of $2.6 million for the year ended December 31, 2003. We incurred a net loss of $0.5 million and $1.9 million for the years ended December 31, 2002 and 2001, respectively. Given the competitive and evolving nature of the industry in which we operate, we may not be able to sustain or increase profitability on a quarterly or annual basis, which would likely cause our stock price to decline.

If the market for input management software does not grow, our revenues may not grow.

The market for input management software is fragmented and extremely competitive and in recent years has had limited, if any, growth. In addition, the concept of input management software is not widely understood in the marketplace. We have spent, and intend to continue to spend, considerable resources educating potential customers about our software products and the input management market in general. These expenditures may fail to achieve any broadening of the market or additional degree of market acceptance for our products. The rate at which organizations have adopted our products has varied significantly in the past, and we expect to continue to experience such variations in the future. If the market for input management products grows more slowly than we anticipate or not at all, our revenues will not grow and our operating results will suffer.

We currently depend on repeat business for a substantial portion of our revenues, and need to increase our customer base to grow in the future.

Currently, a significant and increasing portion of our revenues is generated from existing customers. Many of our customers initially make a limited purchase of our products and services on a departmental basis or for limited form or document types. These customers may not choose to purchase additional licenses to expand their use of our products. If this occurs, or if existing customers fail to renew services or maintenance contracts, then new customer revenue may not be sufficient to offset this and enable us to sustain our current revenue levels.

Conversely, a significant factor in our ability to grow our revenues in the future is our ability to expand our customer base. We believe our ability to grow depends in part on our ability to expand into the “mid-market” segment of the input management market. Some of our competitors are more established in this segment of the market, and price is a more significant factor in the mid-market segment than the ability of our products to handle large volumes of documents. We have recently released products that address this market segment, and it is uncertain whether and to what extent these products will be successful and to what extent price-driven competition will erode our margins. If we are unsuccessful in expanding into the mid-market segment, or otherwise fail to increase our customer base, our business and operating results would be harmed.

If we are unable to respond in an effective and timely manner to technological change and new products in the industry, our revenues and operating results will suffer.

We currently expect to release a number of new products and enhancements to existing products in 2004 and anticipate that a substantial portion of our product revenue growth will come from these new releases. If we experience material delays in introducing new products and enhancements, our customers may forego the use of our products and use those of our competitors. The market for input management is characterized by rapid technological change, frequent new product introductions and enhancements, uncertain product life cycles, changes in customer demands and evolving industry standards. The introduction of products embodying new technologies and the emergence of new industry standards can render existing products obsolete and unmarketable. Our future success will depend upon our ability to continue to enhance our current products while developing and introducing new products on a timely basis that keep pace with technological developments and satisfy increasingly sophisticated customer requirements. As a result of the complexities inherent in our software,

13

Table of Contents

new products and product enhancements can require long development and testing periods. Significant delays in the general availability of these new releases or significant problems in the installation or implementation of these new releases could harm our operating results and financial condition. We have experienced delays in the past in the release of new products and new product enhancements. We may fail to develop and market on a timely and cost effective basis new products or new product enhancements that respond to technological change, evolving industry standards or customer requirements. We may also experience difficulties that could delay or prevent the successful development, introduction or marketing of our products or reduce the likelihood that our new products and product enhancements will achieve market acceptance. Any such failures or difficulties would harm our business and operating results.

We may not be successful in expanding into new vertical markets.

One element of our strategy involves applying our technology in new applications for new vertical markets. To be successful in expanding our sales in new vertical markets, we will need to develop additional expertise in these markets. We may be required to hire new employees with expertise in new target markets in order to compete effectively in those markets. If we are not successful in growing our sales in other vertical markets, we may not achieve desired sales growth.

We could be subject to potential product liability claims and third-party litigation related to our products and services, and as a result our operating results might suffer.

Our products are used in connection with critical business functions and may result in significant liability claims if they do not work properly. Limitation of liability provisions included in our license agreements may not sufficiently protect us from product liability claims because of limitations in existing or future laws or unfavorable judicial decisions. Although we have not experienced any material product liability claims in the past, the sale and support of our products may give rise to claims in the future that may be substantial in light of the use of those products in business-critical applications. Liability claims could require expenditure of significant time and money in litigation or payment of significant damages.

Software defects could also damage our reputation, causing a loss of customers and resulting in significant costs.

Our software products are complex and may contain errors or defects, particularly when first introduced or when new versions or enhancements are released. In the past, we have discovered software err