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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the year ended December 31, 2004

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     X     No             

The aggregate market value of the voting stock held by non-affiliates of the registrant, as of June 30, 2004, was approximately $93.7 million (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 28, 2005 was 12,382,694.

Table of Contents

CAPTIVA SOFTWARE CORPORATION

FORM 10-K

For the Year Ended December 31, 2004

INDEX

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PART I

Forward Looking Statements

Statements contained in this Annual Report on Form 10-K that are not statements of historical fact should be considered forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the Act). In addition, certain statements in our future filings with the Securities and Exchange Commission (SEC), in press releases, and in oral and written statements made by us or with our approval that are not statements of historical fact constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to: (i) projections of revenue, income or loss, earnings or loss per share, capital structure and other statements concerning future financial performance; (ii) statements of our plans and objectives by our management or Board of Directors, including those relating to products or services; (iii) statements of assumptions underlying such statements; (iv) statements regarding business relationships with vendors, customers or collaborators; and (v) statements regarding products, their characteristics, performance, sales potential or effect in the hands of customers and the development of new products. Words such as “believes,” “anticipates,” “expects,” “intends,” “targeted,” “should,” “potential,” “goals,” “strategy,” and similar expressions generally identify forward-looking statements, but are not the exclusive means of identifying such statements. Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to, those described in the section entitled “Risk Factors,” below. The performance of our business and our securities may be adversely affected by these factors and by other factors common to other businesses and investments, or to the general economy. Forward-looking statements speak only as of the date on which the statements are made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made to reflect the occurrence of unanticipated events or circumstances. Readers should carefully review the disclosures and the risk factors described in this and other documents we file from time to time with the SEC, including our reports on Forms 10-Q and 8-K.

Overview

Captiva Software Corporation (together with its consolidated subsidiaries, the Company, which may also be referred to in this report as we, us, our, and Captiva) is 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 solutions 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 solutions 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, banking, government, business-process outsourcing (BPO), technology and other markets. Enterprises that have purchased our products and services include GEICO, American Express, Citicorp, the U.S. Patent and Trademark Office, the FBI Records Management Division, the Internal Revenue Service, EDS, IBM and Home Depot.

We are a Delaware corporation, formed by 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), pursuant to which ActionPoint acquired all of the capital stock of Old Captiva. In connection with the Merger, Old Captiva became a wholly-owned subsidiary of ActionPoint and ActionPoint changed its name to Captiva Software Corporation.

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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. 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.

More information about us can be found on our principal web site, www.captivasoftware.com. Our Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K, as well as amendments to those reports, are available free of charge through our web site as soon as reasonably practicable after we electronically file them with the SEC. Information on our web site and other information that can be accessed through our web site are not part of this report.

You may read and copy materials that we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. Information on the operation of the Public Reference Room is available by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy statements and other information we file. The address of the SEC website is http://www.sec.gov.

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 captured, classified, extracted, validated, 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 $974 million in 2005.

Current Approaches are Inadequate

Traditional methods for capturing data from paper forms and documents rely principally on 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 (Gartner), an independent information technology research firm, estimates that the amount of time wasted on 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: i) the average document is copied, either physically or electronically, nine to 11 times at a total cost of about $18 per copy; ii) the cost to file each document is about $20; and iii) the cost to find a misfiled document is about $120.

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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 the use of 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 a substantial percentage of all medical claims continue to be submitted on paper forms. The growth in the use of electronic forms and documents and Internet-based transactions is limited by 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 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 collectively 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. We believe 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.

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 expand systems easily should the need arise.

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Ease in Extracting and Exporting Information

Our solutions are able to extract and improve the accuracy of information and export information in multiple formats to almost any information management system. These capabilities allow our customers to deploy and benefit from a single, fully integrated input management platform.

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 invest in developing, testing and deploying a single set of these rules, and 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:

Leveraging 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 line of business 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.

Broadening Our Sales Channels and Expanding Our Markets

In 2004, we derived 39% of our revenues from resellers, systems integrators and distributors. We believe there are significant opportunities to increase sales of our solutions through these channels. We also believe there are significant opportunities to add new cooperative marketing partners and leverage our existing 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 continue expanding in lower volume segments by repackaging and repricing our solutions for these segments. For example, in 2003, we released InputAccel Express to specifically address the lower volume market, and have since entered into distribution agreements for this product with several leading ECM product distributors in Western Europe and Southeast Asia in 2003 and in Latin America in 2004.

Expanding Our International Presence

We derived 20%, 21% and 25% of our revenues from outside the United States in 2004, 2003 and 2002, 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. Additionally, in 2003 we initiated efforts to add resellers and system integrators in most Spanish and Portuguese speaking countries and in 2004 we initiated similar efforts in the Pacific Rim region. We expect to expand our presence in additional international markets and to continue to address local language requirements by localizing our products.

Broadening Our Product Offerings

We intend to continue to develop and introduce new solutions utilizing our proven technologies to enter new markets. Moreover, because we believe that many end-user customers prefer to procure complete sets of software, hardware and integration services from a single source, instead of purchasing these components

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separately from multiple vendors, we believe that we can improve our market position and increase the average selling price of our products by broadening our product offerings to include a variety of software, services and hardware, such as digital scanners and other third-party products, as part of the solutions we provide.

Pursuing Strategic Acquisitions

We believe that strategic acquisitions may allow us to expand our technology offerings, augment our distribution channels, expand our market opportunities or broaden our customer base. We have achieved these objectives through past acquisitions, 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 by 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 2004, 2003 and 2002, software revenues represented 50%, 47% and 57% 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 that is optimized to extract data from structured forms containing fields of data, such as medical claims, new account enrollments, credit applications, tax returns, orders and similar forms. FormWare includes modules for:

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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 configure 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 solution for automating 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 configured through the use of InputAccel’s development environment and Visual Basic Scripting.

Digital Mailroom

Also built on InputAccel, the 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.

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Pixel Products

Pixel software products include:

Context Products

We acquired the Context product line in connection with our February 2004 acquisition of Context. Context products are sold to providers and payers in the health insurance market and include:

Architecture

Our software products consist of 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.

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 of our products are available in German, Spanish, Portuguese and Japanese. We expect to provide additional non-English versions of our product in order to increase our international presence and revenues.

AdvantEDGE Services

Through our AdvantEDGE services program, our professional and technical services staff offers a broad range of services, which we believe 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. During each of 2004, 2003 and 2002, services revenues accounted for 40% of our total revenues.

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 our clients for professional services on either a fixed fee or time and materials cost basis.

Our technical services staff provides maintenance for the resolution of technical inquiries by telephone, e-mail and over the Internet. Our staff also offers a set of regularly scheduled training classes held at our offices and customer sites. We offer several levels of maintenance, the most comprehensive of which provides coverage to

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our customers 24 hours a day, seven days a week. We generally charge for maintenance as a percentage of the related software license fee, 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. During 2004, 2003 and 2002, these products accounted for 10%, 13% and 3% of our total revenues respectively. Substantially all of our hardware and third-party product revenues are generated by our sales of sophisticated, production-level digital scanners manufactured by Kodak and IBML. Based on our current relationships with these vendors as well as their strength in this industry, we believe that we will be able to continue sourcing products from these vendors in the future.

Our Customers

We have licensed our software to over 5,000 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 clients that have licensed our solutions and is representative of our overall customer base:

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No single customer accounted for 10% or more of our total revenues in 2002, 2003 or 2004.

Sales and Marketing

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, with whom we jointly sell products directly to end-user customers, typically develop and market complementary products. 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. During 2004, 2003 and 2002, 39%, 36% and 29%, respectively, of our total revenues were derived from sales to resellers, system integrators and distributors. No single reseller, system integrator or distributor contributed to 10% or more of our total revenues during any of these periods.

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

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relationship marketing programs, seminars, trade shows, speaking engagements and Internet-based marketing. To support our sales efforts, our marketing staff also produces collateral materials such as brochures, data sheets, white papers and provides presentations and demonstrations.

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. In the second quarter of 2004, we established a research and development subsidiary in Russia to supplement our product development efforts.

Our research and development expenditures totaled $9.7 million, $9.0 million and $5.9 million in 2004, 2003 and 2002, respectively.

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. Despite our precautions, it may be possible for competitors or users to copy or reproduce aspects of our software or to obtain information that we regard as trade secrets. In addition, the laws of some foreign countries do not protect proprietary rights to the same extent as do the laws of the United States.

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:

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

We believe that our principal competitors are:

Personnel

As of December 31, 2004, we had 316 employees worldwide, including 112 in sales and marketing, 70 in professional and technical services, 94 in research and development and 40 employees in finance and administration. Our employees are not represented by a labor union or subject to a collective bargaining agreement, and we believe that our employee relations are generally 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. In addition to those we describe below, risks and uncertainties that are not presently known to us or that we currently believe are immaterial may also impair our business operations. See “Forward-Looking Statements” above. If any of the following risks occur, our business could be harmed, the price of our common stock could decline and you may 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 our 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 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 do not undertake any 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 is likely to decline significantly.

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

We typically operate with little or no software order backlog because our 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 tends to be 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 are relatively fixed in the short term. If revenue levels are below expectations, our operating results could be harmed.

Our future success depends on our key management, sales and marketing, professional services, technical support and research and development personnel, whose knowledge of our business and technical expertise would be difficult to replace.

Our products and technologies are complex, and we are substantially dependent upon the continued service of existing key management, sales and marketing, professional services, technical support and research and development personnel. All of these key employees are employees “at will” and can resign at any time. The loss of the services of one or more of these key employees could slow product development processes or sales and marketing efforts or otherwise harm our business.

A significant aspect of our ability to attract and retain highly qualified employees is the equity compensation that we offer, typically in the form of stock options. In December 2004, the Financial Accounting Standards Board issued Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (for further discussion regarding this pronouncement, refer to Recent Accounting Pronouncements in Item 7 of this Report). As a result, beginning on July 1, 2005, we will be required to include in our statements of operations compensation expense relating to the issuance of employee stock options. As a result, we may decide to issue fewer stock options and may be impaired in our efforts to attract and retain necessary personnel.

If we fail to recruit and retain a significant number of qualified technical personnel, we may not be able to develop, introduce or enhance products on a timely basis.

We require the services of a substantial number of qualified professional services, technical support and research and development personnel. The market for these highly skilled employees is characterized by intense competition, which is heightened by their high level of mobility. These factors make it particularly difficult to attract and retain the qualified technical personnel we require. We have experienced, and may continue to experience, difficulty in hiring and retaining highly skilled employees with appropriate technical qualifications.

If we are unable to recruit and retain a sufficient number of technical personnel with the skills required for existing and future products, we may not be able to complete development of, or upgrade or enhance, our products in a timely manner. Even if we are able to expand our staff of qualified technical personnel, they may require greater than expected compensation packages that would increase operating expenses.

We have a long sales cycle, and our products and services require a sophisticated sales effort, so we cannot predict when expected sales will occur and we may experience unexpected delays in sales despite expending significant sales resources.

Given the high average selling price and the cost and time required to implement our products and services, 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 products and services requires us to educate potential customers on the uses and benefits of our products and services. As a result, our products and services have a long sales cycle, which can take three to six months or more. Consequently, we have difficulty predicting the quarter in which sales to expected customers may occur. The sales of our products and services are also subject to delays from the lengthy budgeting, approval

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and competitive evaluation processes of our customers, which typically accompany significant capital expenditures.

Our products and services require a sophisticated sales effort targeted at senior management of our prospective customers. New employees 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 and extremely competitive, with no one company having a significant market share. We expect that competition in this 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 we do, 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 current or 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. 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 greater 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.

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/or loss of market share, any of which could harm our revenues, business and operating results.

If the market for input management software does not grow, our revenues are unlikely to grow.

The market for input management software has had limited growth in recent years. 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 variations in the future. If the market for input management products grows more slowly than we anticipate or not at all, our revenues are unlikely to grow and our operating results will suffer.

We currently depend on repeat business for a substantial portion of our revenues and our business and operating results may be harmed if we fail to increase our customer base in the future.

Currently, a significant 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 line of business basis or for limited form or

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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 our revenues from new customers 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 will be 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 will be harmed.

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

We expect to release a number of new products and enhancements to existing products in the future and anticipate that a portion of our product revenue growth will come from these new releases. If we experience material delays in introducing new products or product 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 int