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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005

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 registrant’s principal executive offices)

Former name, former address and former fiscal year, if changed since last report:

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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No  ¨

As of April 30, 2005, there were 12,436,589 shares of the registrant’s common stock, par value $0.01, outstanding.

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CAPTIVA SOFTWARE CORPORATION

FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2005

INDEX

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PART I – FINANCIAL INFORMATION

Item 1 - Financial Statements

CAPTIVA SOFTWARE CORPORATION

CONSOLIDATED CONDENSED BALANCE SHEETS

(UNAUDITED)

(IN THOUSANDS)

See accompanying notes to consolidated financial statements.

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CAPTIVA SOFTWARE CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(UNAUDITED)

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

See accompanying notes to consolidated financial statements.

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CAPTIVA SOFTWARE CORPORATION

CONSOLIDATED CONDENSED STATEMENT OF STOCKHOLDERS’ EQUITY AND

COMPREHENSIVE INCOME

(UNAUDITED)

(IN THOUSANDS)

See accompanying notes to consolidated financial statements.

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CAPTIVA SOFTWARE CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(IN THOUSANDS)

See accompanying notes to consolidated financial statements.

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CAPTIVA SOFTWARE CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)

Captiva Software Corporation

Captiva Software Corporation (together with its consolidated subsidiaries, referred to herein as we, us, our, and Captiva ) develops, markets, and services input management software that helps automate and manage the capture of external information into an organization’s internal computing systems.

Principles of Consolidation and Basis of Presentation

We have prepared the accompanying unaudited interim condensed consolidated financial statements in accordance with the instructions to Form 10-Q. Consequently, we have not necessarily included in this Quarterly Report on Form 10-Q all information and footnotes required for audited financial statements. In our opinion, the accompanying unaudited interim condensed consolidated financial statements in this Quarterly Report on Form 10-Q reflect all adjustments (consisting only of normal recurring adjustments, except as otherwise indicated) necessary for a fair statement of our financial position and results of operations. These unaudited condensed consolidated financial statements and notes thereto should be read in conjunction with our audited consolidated financial statements and notes thereto presented in our Annual Report on Form 10-K for the fiscal year ended December 31, 2004. The interim financial information contained in this report is not necessarily indicative of the results to be expected for any other interim period or for the entire fiscal year.

The consolidated financial statements include the accounts of Captiva and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. These estimates and assumptions include, but are not limited to, assessing the following: the recoverability of accounts receivable, goodwill, intangible assets and deferred tax assets; the ability to estimate hours in connection with fixed-fee service contracts; and the determination of whether fees are fixed or determinable and collection is probable or reasonably assured.

Stock-Based Compensation

We measure compensation expense for our employee stock-based compensation awards using the intrinsic value method and provide pro forma disclosures of net income and earnings per share as if a fair value method had been applied. Therefore, compensation cost for fixed employee stock awards would be measured as the excess, if any, of the quoted market price of our common stock at the grant date over the amount an employee must pay to acquire the stock, and would be amortized over the related service periods. Under the intrinsic value method, no compensation expense was recognized during the quarters ended March 31, 2005 or 2004.

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CAPTIVA SOFTWARE CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Had compensation cost for our employee stock-based compensation awards been determined based on the fair value method, the amount of employee stock-based compensation cost and our pro forma results for the quarters ended March 31, 2005 and 2004 would have been as follows (in thousands, except per share data):

The pro forma net income and earnings per share amounts for the quarter ended March 31, 2004 have been adjusted from that originally reported, to reflect revisions in our calculation of stock-based employee compensation cost related to purchase rights issued under our employee stock purchase plan, as well as certain tax benefit attributes.

Recent Accounting Pronouncements

On December 16, 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based Payment (SFAS No. 123(R)), which is a revision of SFAS No. 123 (SFAS No. 123), Accounting for Stock-Based Compensation. SFAS No. 123(R) supersedes Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statement of Cash Flows (SFAS No. 95). Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) will require all share-based payments to employees, including grants of employee stock options and other stock-based awards, to be recognized in our statements of operations based on their fair values. Pro forma disclosures, previously allowed by SFAS No. 123, will no longer be an alternative.

Statement No. 123(R) was to be effective for public companies for annual or interim periods beginning after June 15, 2005. However, on April 14, 2005 the U.S. Securities and Exchange Commission announced a deferral of the effective date of SFAS 123(R) for calendar year companies until the beginning of 2006; accordingly, we will be required to adopt SFAS 123(R) on January 1, 2006 (the effective date). We expect to adopt such standard using the modified prospective method, under which compensation cost will be recognized based on the requirements of SFAS No. 123(R) for all share-based awards granted to employees on or after the effective date and based on our original fair value calculations in accordance with SFAS No. 123 for all share-based awards granted to employees prior to the effective date, to the extent that they remain unvested on the effective date. Upon our adoption of SFAS No. 123(R), we anticipate that we will continue to apply the Black-Scholes option pricing model to estimate the fair value of our share-based awards. However, we may elect to use another valuation model as prescribed by SFAS No. 123(R).

As permitted by SFAS No. 123, we currently account for share-based payments to employees using APB Opinion No. 25’s intrinsic value method and, as such, generally do not recognize compensation cost for

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CAPTIVA SOFTWARE CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

employee stock option awards. Accordingly, the adoption of SFAS No. 123(R)’s fair value method will have a significant impact on our results of operations, although it will have no impact on our overall financial position. The impact of adoption of SFAS No. 123(R) cannot be predicted at this time because it will depend on the levels of share-based awards granted by us in the future. SFAS No. 123(R) also requires the benefit of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow, as is currently prescribed by SFAS No. 95. To the extent that we continue to recognize tax benefits upon the exercise or disqualifying disposition of employee stock options, our adoption of SFAS No. 123(R) will reduce our net operating cash flows and increase our net financing cash flows in periods after adoption.

Intangible assets, net, consist of the following (in thousands):

Amortization expense related to our intangible assets totaled $0.7 million and $0.6 million during the quarters ended March 31, 2005 and 2004, respectively. Future amortization expense for the remainder of 2005 and for 2006, 2007, and 2008 is expected to be $1.2 million, $0.8 million, $0.3 million, and $0.2 million, respectively, excluding any incremental expense that could result if we consummate future acquisitions.

Basic earnings per share is computed by dividing the net income available to common stockholders by the weighted average number of common shares outstanding for that period. Diluted earnings per share is computed based on the weighted-average number of common shares outstanding as well as potential common shares resulting from the exercise of outstanding stock options when they are dilutive under the treasury stock method. Dilutive securities consisting of 1.1 million and 2.0 million shares related to outstanding stock options are included in the diluted earnings per share calculations for the quarters ended March 31, 2005 and 2004, respectively. Potentially dilutive securities consisting of 0.7 million and 0.2 million shares related to outstanding stock options were excluded from the diluted earnings per share calculations in the quarters ended March 31, 2005 and 2004, because they were anti-dilutive.

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CAPTIVA SOFTWARE CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

We have a single reportable operating segment consisting of the development, marketing and servicing of input management solutions. Our President and Chief Executive Officer utilizes measurements of profitability related to this single operating segment, which are not disaggregated by product or geographical lines, to make primary business decisions and resource allocations.

International operations primarily consist of subsidiary sales operation offices in the United Kingdom, Germany and Australia, as well as a research and development center in Russia, and represent extensions of our core input management business.

Revenues derived from domestic and international sales, which are determined based on our primary selling office locations, were as follows during the quarters ended March 31, 2005 and 2004 (in thousands):

No single customer accounted for 10% or more of our total revenues in the quarters ended March 31, 2005 or 2004.

In February 2005, our Board of Directors approved the acceleration of vesting of certain unvested and “out-of-the-money” stock options previously awarded to employees and officers under our stock option plans. This action affected all unvested options with exercise prices greater than $11.51 on February 9, 2005. As a result of this action, options to purchase approximately 0.5 million shares of our common stock that would have otherwise vested over an approximate 39 month period became fully vested. In connection therewith, all of our affected executive officers have entered into agreements not to sell shares acquired through the exercise of an accelerated option prior to the date on which exercise would have been permitted under the options’ original vesting terms, other than shares sold for payment of taxes resulting from the exercise or in the case of termination of employment. The decision to accelerate the vesting of these options was made primarily to reduce compensation expense that would be recorded in future periods following our adoption of SFAS No. 123(R).

In the ordinary course of business, we are not subject to potential obligations under guarantees that fall within the scope of FIN No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, except for standard indemnification and warranty provisions that are contained within many of our customer license and service agreements and certain vendor agreements, as well as standard indemnification agreements that we have executed with certain of our officers and directors, and give rise only to the disclosure requirements prescribed by FIN No. 45. In addition, under previously existing accounting principles generally accepted in the United States of America, we continue to monitor the conditions that are subject to the guarantees and indemnifications to identify whether it is probable that a loss has occurred, and would recognize any such losses under the guarantees and indemnifications when those losses are estimable.

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CAPTIVA SOFTWARE CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS—(Continued)

(UNAUDITED)

Indemnification and warranty provisions contained within our customer license and service agreements and certain supplier agreements are generally consistent with those prevalent in our industry. The duration of our product warranties generally does not exceed 90 days following delivery or installation of our products. We have not incurred significant obligations under customer indemnification or warranty provisions historically and do not expect to incur significant obligations in the future. Accordingly, we do not maintain accruals for potential customer indemnification or warranty-related obligations. The indemnification agreements that we have executed with certain of our officers and directors would require us to indemnify such officers and directors in certain instances. We have not incurred obligations under these indemnification agreements historically and do not expect to incur significant obligations in the future. Accordingly, we do not maintain accruals for potential officer or director indemnification obligations. The maximum potential amount of future payments that we could be required to make under the indemnification provisions in our customer license and service agreements, and officer and director agreements is unlimited.

We are party to various claims and legal actions arising in the ordinary course of business. We do not believe that any of these claims or actions will result in a material adverse impact to our consolidated results of operations, liquidity or financial condition. However, the amount of the liabilities associated with these claims and actions, if any, cannot be determined with certainty.

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Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

Statements in this Quarterly Report on Form 10-Q that are not strictly historical in nature are forward-looking statements. These statements relate to, among other things, future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of such 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. Risks that may cause actual results to differ materially from the forward-looking statements are described in the section entitled “Risk Factors” in this Quarterly Report on Form 10-Q and identified from time to time in our filings with the Securities and Exchange Commission. Although we believe that the estimates and expectations reflected in the forward-looking statements are reasonable at the time the statements are made, 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 Quarterly Report on Form 10-Q.

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 objective is to extend our position as a leading provider of input management solutions. Key elements of our growth strategy include leveraging our existing customer base, broadening our sales channels and expanding our markets, expanding our international presence, broadening our product offerings and pursuing strategic acquisitions.

Our products offer organizations a cost-effective, accurate and automated alternative to both manual data entry and electronic data interchange. 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.

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.

On February 1, 2004, we acquired Context. 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. The results of operations of Context are included in our 2004 results of operations beginning on February 1, 2004.

Our business has historically been subject to some seasonality, principally as it relates to software license revenues. Our first quarters have generally been our weakest in terms of software license sales volume while our fourth quarters have generally been our strongest. We believe that this seasonality is attributable primarily to information technology spending budgets and related purchasing patterns of our customers, and would expect this trend to continue in future periods.

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Results of Operations

The following table sets forth, in absolute dollars and as a percentage of total revenues, certain statement of operations data for the quarters ended March 31, 2005 and 2004:

Quarter Ended March 31, 2005 compared to Quarter Ended March 31, 2004

Revenues

Our total revenues increased 11% to $17.6 million in the quarter ended March 31, 2005 from $15.9 million in the quarter ended March 31, 2004.

Our software revenues increased 32% to $8.8 million in the quarter ended March 31, 2005 from $6.7 million in the quarter ended March 31, 2004. Software revenues accounted for 50% and 42% of total revenues in the quarters ended March 31, 2005 and 2004, respectively. The increase in software revenues in absolute dollars and as a percentage of total revenues was attributable primarily to strong software license sales execution by our direct sales force and channel partners domestically.

Our service revenues increased 7% to $7.4 million in the quarter ended March 31, 2005 from $6.9 million in the quarter ended March 31, 2004. Service revenues accounted for 42% and 44% of total revenues in the quarters

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ended March 31, 2005 and 2004, respectively. The increase in service revenues in absolute dollars was attributable primarily to an increase in maintenance revenues resulting from a growing installed base of customers, most of who purchase and renew ongoing maintenance and support. The decrease in service revenues as a percentage of total revenues was attributable primarily to the increase in software revenues.

Our hardware and other revenues decreased 38% to $1.4 million in the quarter ended March 31, 2005 from $2.3 million in the quarter ended March 31, 2004. Hardware and other revenues accounted for 8% and 14% of total revenues in the quarters ended March 31, 2005 and 2004, respectively. The decrease in hardware and other revenues in absolute dollars and as a percentage of total revenues resulted primarily from a decrease in digital scanner sales quarter over quarter.

International revenues totaled $2.8 million and $3.0 million in the quarters ended March 31, 2005 and 2004, respectively, representing 16% and 19% of total revenues in each of these quarters.

Gross Profit

Gross profit increased 22% to $12.1 million in the quarter ended March 31, 2005 from $9.9 million in the quarter ended March 31, 2004. Gross profit as a percentage of total revenues increased to 69% in the quarter ended March 31, 2005 from 63% in the quarter ended March 31, 2004. The increase in absolute dollars and as a percentage of total revenue was attributable primarily to the increase in software revenues, which have higher margins than service and hardware revenues. The decrease in hardware and other revenues, which have lower gross margins than software and service revenues, and economies of scale gained by leveraging existing maintenance infrastructure to support higher maintenance revenues also contributed to the gross profit percentage increase.

Research and Development

Research and development expenses decreased 10% to $2.4 million in the quarter ended March 31, 2005 from $2.7 million in the quarter ended March 31, 2004. As a percentage of total revenues, research and development expenses decreased to 14% in the quarter ended March 31, 2005 from 17% in the quarter ended March 31, 2004. The decrease in absolute dollars and as a percentage of total revenue was attributable primarily to a decrease in software localization costs related to the timing of certain localized software release development efforts, and to our utilization of lower cost research and development personnel in Russia to supplement our product development efforts beginning in the second quarter of 2004.

Sales and Marketing

Sales and marketing expenses increased 12% to $5.8 million in the quarter ended March 31, 2005 from $5.2 million in the quarter ended March 31, 2004. As a percentage of total revenues, sales and marketing expenses remained consistent at 33% in the quarters ended March 31, 2005 and 2004. The increase in absolute dollars was attributable primarily to increased direct sales costs, including commissions, and to a lesser degree the expansion of our sales force and related labor cost increases.

General and Administrative

General and administrative expenses increased 51% to $1.9 million in the quarter ended March 31, 2005 from $1.3 million in the quarter ended March 31, 2004. As a percentage of total revenues, general and administrative expenses increased to 11% in the quarter ended March 31, 2005 from 8% in the quarter ended March 31, 2004. The increase in absolute dollars and as a percentage of total revenues was attributable primarily to an increase in professional service fees, including audit and consulting fees, relating to our Sarbanes-Oxley Act compliance initiatives in the quarter ended March 31, 2005 and to the non-recurring recovery of a receivable balance during the quarter ended March 31, 2004.

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Provision for Income Taxes

Our effective tax rate for the quarter ended March 31, 2005 was 40.4%, as compared to an effective tax rate of 39.0% in the quarter ended March 31, 2004. The increase in our effective tax rate quarter over quarter is attributable primarily to the impact of lower revenues and profitability from our foreign operations. The provision for income taxes during interim quarterly reporting periods is based on our estimates of the effective tax rates for the respective full fiscal year.

Liquidity and Capital Resources

Our working capital increased from $21.5 million at December 31, 2004 to $23.8 million at March 31, 2005. The $2.3 million increase in working capital consisted of a $5.5 million increase in cash and cash equivalents, partially offset by a $3.7 million decrease in accounts receivable, net, a $0.4 million decrease in prepaid and other current assets, a $0.8 million increase in deferred revenue, and a $1.7 million combined decrease in other current liabilities. The increase in cash and cash equivalents was attributable primarily to $5.5 million in net cash provided by operating activities. The decrease in accounts receivable, net, was attributable primarily to a reduction in our days-sales-outstanding in accounts receivable, which decreased from 60 days at December 31, 2004 to 51 days at March 31, 2005. The increase in deferred revenue was attributable primarily to the addition of deferred maintenance revenues associated with the growth of our software maintenance subscriber base. The decrease in other current liabilities was attributable primarily to a decrease in accounts payable to third-party hardware vendors and a decrease in accrued third-party royalties.

Our primary method for funding operations and growth has been through cash flows generated from operations. Net cash provided by operating activities increased from $3.1 million in the quarter ended March 31, 2004 to $5.5 million in the quarter ended March 31, 2005. The increase was attributable primarily to an increase in income before non-cash charges, including depreciation and amortization and the tax benefit from stock option exercises, along with the favorable impact on cash of other net working capital changes, as described above.

Net cash used in investing activities decreased from $5.4 million in the quarter ended March 31, 2004 to $0.1 million in the quarter ended March 31, 2005. The decrease was attributable primarily to the use of $5.3 million in cash to acquire Context during the quarter ended March 31, 2004.

Net cash provided by financing activities decreased from $2.5 million in the quarter ended March 31, 2004 to $0.2 million in the quarter ended March 31, 2005. Net cash provided by financing activities related exclusively to proceeds from stock option exercises in both periods. The decrease resulted from lower stock option exercise activity in the first quarter of 2005 as compared to the first quarter of 2004.

We are party to a credit agreement with a bank that provides for a revolving line of credit through August 2005. Borrowings under the credit agreement are limited to the lesser of $3.0 million or 80% of eligible accounts receivable, as defined, and bear interest at the bank’s prime rate plus 0.5%. Borrowings under this agreement are secured by substantially all of our assets. At March 31, 2005, there were no outstanding amounts borrowed under this credit agreement. The credit agreement restricts us from paying dividends on our common stock, conducting merger and acquisition activities, or otherwise effecting material changes to our business without the express written consent of the bank, and also stipulates various financial covenants that include, but are not limited to, minimum monthly working capital and quarterly earnings levels. At March 31, 2005, we were in compliance with all covenants prescribed by this credit agreement.

As of March 31, 2005, we had $32.7 million in cash and cash equivalents. We believe that these balances, anticipated future cash flows from operating and financing activities and, as necessary, borrowings under our credit agreement, will be sufficient to fund our working and other capital requirements over the course of the next twelve months and for the foreseeable future. We may, however, seek additional equity or debt financing to fund further expansion, including potential future acquisitions of technologies or businesses. There can be no assurance that additional financing will be available on terms favorable to us, or at all.

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Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources.

Critical Accounting Policies and Estimates

We prepare our consolidated financial statements in conformity with U.S. generally accepted accounting principles. These accounting principles require management to make certain judgments and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. We periodically evaluate our estimates including, but not limited to, those relating to revenue recognition, our allowance for doubtful accounts, goodwill and other intangible assets resulting from business acquisitions and income taxes. We base our estimates on historical experience and various other assumptions that we believe to be reasonable based on the specific circumstances, the results of which form the basis for making judgments about the carrying value of certain assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

We believe the following critical accounting policies involve the most significant judgments and estimates used in the preparation of our consolidated financial statements:

Revenue Recognition

Our revenue is generated primarily from three sources: (i) software revenues, consisting primarily of software license revenue, subscription revenue and royalty revenue, (ii) service revenues, consisting primarily of software maintenance and support revenue, training revenue and professional service revenues and (iii) hardware and other revenues, consisting primarily of revenues related to our sale of digital scanners.

Software license revenue is recognized upon shipment provided that persuasive evidence of an arrangement exists, fees are fixed or determinable and collection is probable. Revenue under software subscription arrangements is recognized ratably over the term of the arrangements. Royalty revenue is recognized when our resellers ship or pre-purchase rights to ship products incorporating our software, provided that the above revenue recognition criteria are met, specifically ensuring that our resellers’ obligations to us are non-cancelable and are not subject to any acceptance or rights of return. In instances where we rely on reporting from our resellers to substantiate revenues earned based on usage and other factors, we do not recognize revenues until corroborative evidence is reported to us by the reseller, assuming that all other revenue recognition criteria are met. The timing of royalty reporting by our resellers, which is generally one quarter in arrears, has historically been consistent period to period.

We use the residual method to recognize revenue when an arrangement includes one or more elements to be delivered at a future date and vendor-specific objective evidence of the fair value of all undelivered elements exists. Vendor-specific objective evidence of fair value for ongoing maintenance and support obligations is determined based upon separate sales of renewals to customers or upon substantive renewal rates quoted in the agreements. Vendor-specific objective evidence of fair value for professional services is determined based on the pricing of these services when sold separately to other customers. Under the residual method, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is recognized as revenue. If evidence of the fair value of one or more undelivered elements does not exist, the revenue is deferred and recognized when delivery of those elements occurs or when fair value can be established.

When software licenses are sold together with professional services, license fees are recognized upon delivery provided that the above revenue recognition criteria are met, payment of the license fees is not dependent upon

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the performance of the services, and the services do not provide significant customization or modification of the software products and are not essential to the functionality of the software that was delivered. For arrangements with services that do not meet this criteria, the license and related service revenues are recognized using contract accounting as described below.

Service revenues include software maintenance and support revenues, training revenues and professional service revenues. Revenues from software maintenance and support agreements are recognized on a straight-line basis over the term of the support period, generally twelve months. The majority of our software maintenance and support agreements provide technical support as well as unspecified software product upgrades and releases when and if made available by us during the term of the support period. We provide training, consulting and software integration services under both hourly-based time and materials and fixed-priced contracts. Revenues from these services are generally recognized as the services are performed. For fixed-price service contracts, we apply the percentage-of-completion method of contract accounting to determine progress towards completion, which requires the use of estimates. In such instances, management is required to estimate the input measures, generally based on hours incurred to date compared to total estimated hours of the project. Adjustments to estimates are made in the period in which the facts requiring such revisions become known and, accordingly, recognized revenues and profits are subject to revisions as the contract progresses to completion. Estimated losses, if any, are recorded in the period in which current estimates of total contract revenue and contract costs indicate a loss. If substantive uncertainty related to customer acceptance of services exists, we apply the completed contract method of accounting and defer the associated revenue until the contract is completed.

Revenue related to the sale of hardware and other products, which we typically procure from third-party vendors and resell to our customers for use with our software solutions, is recognized upon delivery provided that persuasive evidence of an arrangement exists, the selling price is fixed or determinable and collectibility is reasonably assured. Hardware and other product revenues is generally recognized on a gross basis because: (i) we are the primary obligor in our customer arrangements; (ii) we assume inventory, credit and collection risk with respect to these products; and (iii) we have latitude in establishing the price of such products with our customers. In instances where these criteria are not met, we would recognize revenue on a net, or commission basis.

If at the outset of an arrangement we determine that the arrangement fee is not fixed or determinable, revenue is deferred until the arrangement fee becomes due. If at the outset of an arrangement we determine that collectibility is not probable, revenue is deferred until the earlier of when collectibility becomes probable or the receipt of payment. If an arrangement provides for customer acceptance, revenue is not recognized until the earlier of receipt of customer acceptance or expiration of the acceptance period.

Deferred revenue is primarily comprised of undelivered maintenance services and to a lesser degree hardware and other products delivered but not yet accepted.

The determination of whether fees are fixed or determinable and whether collection is probable or reasonably assured involves the use of assumptions. We evaluate contract terms and customer information to ensure that these criteria are met prior to our recognition of revenues. Additionally, our accounting for fixed-price service contracts using the percentage-of-completion method of contract accounting involves the use of estimates. We have not experienced significant variances between our assumptions and estimates and actual results in the past, and anticipate that we will be able to continue to make reasonable assumptions and estimates in the future. However, differences in our assumptions and estimates could result in changes to the amount and timing of revenue recognition in any period.

Allowance for Doubtful Accounts

We make estimates regarding the collectibility of our accounts receivable. When we evaluate the adequacy of our allowance for doubtful accounts, we analyze specific accounts receivable balances, historical bad debts, customer creditworthiness and changes in our customer payment cycles. Material differences may result in the amount and

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timing of expenses for any period if we were to make different judgments or utilize different estimates. If the financial condition of our customers deteriorates resulting in an impairment of their ability to make payments, additional allowances might be required. We have not experienced significant variances in the past between our estimated and actual doubtful accounts and anticipate that we will be able to continue to make reasonable estimates in the future. If for some reason we did not reasonably estimate the amount of our doubtful accounts in the future, it could have a material impact on our consolidated results of operations.

Business Acquisitions; Valuation of Goodwill and Other Intangible Assets

Our business acquisitions typically result in the recognition of goodwill and other intangible assets, and in certain cases non-recurring charges associated with the write-off of in-process research and development (IPR&D), which affect the amount of current and future period charges and amortization expenses. Goodwill represents the excess of the purchase price over the fair value of net assets acquired, including identified intangible assets, in connection with our business combinations accounted for by the purchase method of accounting. We amortize our definite-lived intangible assets using the straight-line method over their estimated useful lives, while IPR&D is recorded as a non-recurring charge on the acquisition date. Goodwill is not amortized, but rather is periodically assessed for impairment.

The determination of the value of these components of a business combination, as well as associated asset useful lives, requires management to make various estimates and assumptions. Critical estimates in valuing intangible assets may include but are not limited to: future expected cash flows from product sales and services, maintenance agreements, consulting contracts, customer contracts, and acquired developed technologies and patents or trademarks; expected costs to develop the IPR&D into commercially viable products and estimating cash flows from the projects when completed; the acquired company’s brand awareness and market position, as well as assumptions about the period of time the acquired products and services will continue to be used in our product portfolio; and discount rates. Management’s estimates of fair value and useful lives are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. Unanticipated events and circumstances may occur and assumptions may change. Estimates using different assumptions could also produce significantly different results.

We continually review the events and circumstances related to our financial performance and economic environment for factors that would provide evidence of the impairment of our intangible assets. When impairment indicators are identified with respect to our previously recorded intangible assets, we test for impairment using undiscounted cash flows. If such tests indicate impairment, we measure the impairment as the difference between the carrying value of the asset and the fair value of the asset, which is measured using discounted cash flows. Significant management judgment is required in forecasting of future operating results, which are used in the preparation of the projected discounted cash flows and should different conditions prevail, material write downs of net intangible assets and other long-lived assets could occur. We periodically review the estimated remaining useful lives of our acquired intangible assets. A reduction in our estimate of remaining useful lives, if any, could result in increased amortization expense in future periods.

We test goodwill for impairment at least annually during the second quarter of each year and more frequently if impairment indicators are identified. In connection with our most recent annual impairment testing date in the second quarter of 2004, we determined that there was no impairment. The timing and frequency of our goodwill impairment test is based on an ongoing assessment of events and circumstances that would more than likely reduce the fair value of our business below its carrying value. We will continue to monitor our goodwill balance and conduct formal tests on at least an annual basis or earlier when impairment indicators are present. There are various assumptions and estimates underlying the determination of an impairment loss, and estimates using different, but reasonable assumptions could produce significantly different results. Therefore, the timing and recognition of impairment losses by us in the future, if any, may be highly dependent upon our estimates and assumptions.

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Income Taxes

We use the asset and liability approach to account for income taxes. This methodology recognizes deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax base of assets and liabilities and operating loss and tax credit carryforwards. As necessary, we record a valuation allowance to reduce deferred tax assets to an amount that more likely than not will be realized. We consider future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, which requires the use of estimates. Although we believe that our estimates are reasonable, there is no assurance that a valuation allowance will not need to be established or, if previously established, will not need to be increased to cover additional deferred tax assets that may not be realizable, and such a determination could have a material adverse impact on our income tax provision and results of operations in the period in which such determination is made. In addition, the calculation of tax liabilities also involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws, including those in international jurisdictions. Resolution of these uncertainties in a manner inconsistent with management’s expectations could also have a material impact on our income tax provision and results of operations in the period in which such determination is made.

Recent Accounting Pronouncements

On December 16, 2004, the FASB issued SFAS No. 123(R), which is a revision of SFAS No. 123. SFAS No. 123(R) supersedes APB Opinion No. 25 and amends SFAS No. 95. Generally, the approach in SFAS No. 123(R) is similar to the approach described in SFAS No. 123. However, SFAS No. 123(R) will require all share-based payments to employees, including grants of employee stock options and other stock-based awards, to be recognized in our statements of operations based on their fair values. Pro forma disclosures, previously allowed by SFAS No. 123, will no longer be an alternative.

Statement No. 123(R) was to be effective for public companies for annual or interim periods beginning after June 15, 2005. However, on April 14, 2005 the U.S. Securities and Exchange Commission announced a deferral of the effective date of SFAS 123(R) for calendar year companies until the beginning of 2006; accordingly, we will be required to adopt SFAS 123(R) on the effective date, January 1, 2006. We expect to adopt such standard using the modified prospective method, under which compensation cost will be recognized based on the requirements of SFAS No. 123(R) for all share-based awards granted to employees on or after the effective date and based on our original fair value calculations in accordance with SFAS No. 123 for all share-based awards granted to employees prior to the effective date, to the extent that they remain unvested on the effective date. Upon our adoption of SFAS No. 123(R), we anticipate that we will continue to apply the Black-Scholes option pricing model to estimate the fair value of our share-based awards. However, we may elect to use another valuation model as prescribed by SFAS No. 123(R).

As permitted by SFAS No. 123, we currently account for share-based payments to employees using APB Opinion No. 25’s intrinsic value method and, as such, generally do not recognize compensation cost for employee stock option awards. Accordingly, the adoption of SFAS No. 123(R)’s fair value method will have a significant impact on our results of operations, although it will have no impact on our overall financial position. The impact of adoption of SFAS No. 123(R) cannot be predicted at this time because it will depend on the levels of share-based awards granted by us in the future. SFAS No. 123(R) also requires the benefit of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow, as is currently prescribed by SFAS No. 95. To the extent that we continue to recognize tax benefits upon the exercise or disqualifying disposition of employee stock options, our adoption of SFAS No. 123(R) will reduce our net operating cash flows and increase our net financing cash flows in periods after adoption.

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Risk Factors

You should carefully consider the following risk factors and all other information contained in this Quarterly Report on Form 10-Q. 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.

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 tend 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

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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 FASB issued SFAS No. 123(R). In April 2005, the U.S. Securities and Exchange Commission announced a deferral of the effective date of this pronouncement for calendar year companies until the beginning of 2006. Accordingly, beginning on January 1, 2006, 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 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

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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 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.

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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 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, 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 product enhancements. We may fail to develop and market on a timely and cost-effective basis new products or 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 markets.

One element of our strategy involves applying our technology in new applications for additional markets. To be successful in expanding our sales in new 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 additional markets, we may not achieve desired sales growth.

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

We have been profitable since 2003. However, we have incurred net losses as recently as 2002 as well as in prior periods. 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.

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. 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 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 errors in certain products

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after they were released to the market. In addition, our products are combined with complex products developed by other vendors. As a result, should problems occur, it may be difficult to identify the source or sources of the problems. Defects and errors or the perception of defects and errors, found in current versions, new versions or enhancements of these products after commencement of commercial shipments may result in:

The occurrence of any one or more of these factors could harm our operating results and financial condition.

If we cannot manage and expand our international operations or respond to changing regulatory conditions in international markets, our revenues may not increase and our business and results of operations could be harmed.

We currently have international operations, including offices in the United Kingdom, Germany, Australia and Russia. During the quarters ended March 31, 2005 and 2004, international sales represented 16% and 19% of our revenues, respectively. We anticipate that international sales will increase as a percentage of our revenues and that, for the foreseeable future, a significant portion of our revenues will be derived from sources outside the United States. We intend to continue to expand sales and support operations internationally. We could enter additional international markets, which would require significant management time and financial resources and which, in turn, could adversely affect our operating margins and earnings. To expand international sales, we may establish additional international operations, expand international sales channels, management and support organizations, hire additional personnel, customize our products for local markets, recruit additional international resellers and attempt to increase the productivity of existing international resellers. If we are unable to do any of the foregoing in a timely and cost-effective manner, our international sales growth, if any, will be limited, and our business, operating results and financial condition may be harmed. Even if we are able to expand international operations successfully, we may not be able to maintain or increase international market demand for our products. Our international operations are generally subject to a number of risks, including:

The majority of our international revenues and costs are denominated in foreign currencies. Although we do not currently undertake foreign exchange hedging transactions to reduce foreign currency transaction exposure, we

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may do so in the future. However, we do not have any plans to eliminate all foreign currency transaction exposure. Foreign currency exchange rate fluctuations and other risks associated with international operations could increase our costs, which, in turn, could harm our business. If we are unable to expand and manage our international operations effectively, our business would be harmed.

Failure to further develop and sustain our indirect sales channels could limit or prevent future growth.

Our strategy for future growth depends in part on our ability to increase sales through our indirect sales channels. We have a limited number of distribution relationships for our products with distributors, systems integrators and other resellers, and we may not be able to maintain our existing relationships or form new or successful relationships. Competitors may have existing relationships with various distributors, systems integrators and other resellers that could make it difficult for us to form new relationships in some cases. If our indirect sales channels do not continue to grow, our ability to generate revenues may be harmed.

Our current agreements with our indirect sales channels typically do not prevent these companies from selling products of other companies, including products that may compete with our products, and they do not generally require these companies to purchase minimum quantities of our products. Some of these relationships are governed by agreements that can be terminated by either party with little or no prior notice. These indirect sales channels could give higher priority to the products of other companies or to their own products than they give to our products. The loss of, or significant reduction in, sales volume from any of our current or future indirect sales channels as a result of any of these or other factors could harm our revenues and operating results.

If we are unable to protect our intellectual property, our business may be harmed.

Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. Monitoring unauthorized use of our products is difficult, and we cannot be certain that the steps we have taken will prevent misappropriation of our technology, particularly in countries where the laws may not protect our proprietary rights as fully as in the United States.

We have begun performing significant research and development outside of the United States, where intellectual property protection is less stringent than in the United States. In addition, our competitors might independently develop similar technology, duplicate our products or circumvent any patents or other intellectual property rights that we may have. Due to rapid technological change in our market, we believe the various legal protections available for our intellectual property are of limited value. Instead, we seek to establish and maintain a technology leadership position by leveraging the technological and creative skills of our personnel to create new products and enhancements to existing products.

We depend upon software that we license from and products provided by third parties, the loss of which could increase our expenses or even harm our ability to deliver our products to customers.

We rely upon certain software licensed from third parties, including software that is integrated with our internally developed software and used in our products to perform key functions. There can be no assurance that these technology licenses will not infringe the proprietary rights of others or will continue to be available to us on commercially reasonable terms, if at all. The loss of or inability to maintain any of these software licenses could result in shipment delays or reductions until equivalent software could be developed, identified, licensed and integrated. Delays of this type could materially adversely affect our business, operating results and financial condition.

In addition, we derive a significant portion of our revenues from reselling third-party products, primarily digital scanners. These third-party products may not continue to meet industry standards or be available to us on commercially reasonable terms if at all, in which case our operating results and financial condition would be harmed. In addition, we have little control over the quality of these third-party products other than our decisions as to which products to resell.

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If we are subject to a claim that we infringe a third party’s intellectual property, our operating results could suffer.

Substantial litigation regarding intellectual property rights and brand names exists in the software industry. We expect that software product developers increasingly will be subject to infringement claims as the number of products and competitors in our industry grows and the functionality of products in related industries overlaps. Third parties, some with far greater financial resources than ours, may claim infringement of their intellectual property rights by our products.

Any claim of this type, with or without merit, could:

If we are required to enter into royalty or licensing agreements to resolve an infringement claim, we may not be able to enter into those agreements on favorable terms. A successful claim of product infringement against us, or failure or inability either to license the infringed or similar technology or to develop alternative technology on a timely basis could harm our operating results, financial condition or liquidity.

If we are unable to continue to implement and improve financial and managerial controls and continue to improve our reporting systems and procedures, we may not be able to manage growth effectively and our operating results may be harmed.

Growth will place a significant strain on our management, information systems and resources. In order to manage this growth effectively, we will need to continue to improve our financial and managerial controls and our reporting systems and procedures. Any inability of our management to integrate employees, products, technology advances and customer service into our operations and to eliminate unnecessary duplication may have a materially adverse effect on our business, financial condition and results of operations.

If we are unable to build awareness of our brands, we may not be able to compete effectively against competitors with greater name recognition and our sales could be adversely affected.

If we are unable to economically achieve and maintain a leading position in input management software or to promote and maintain our brands; our business, results of operations and financial condition could suffer. In order to attract and retain customers and to promote and maintain our brands, we may be required to increase our marketing and advertising budget or increase our other sales expenses. There can be no assurance that our efforts will be sufficient or that we will be successful in attracting and retaining customers or promoting our brands.

Most of our revenues are currently derived from sales of and services associated with four software product lines. If demand for these product lines declines or fails to grow as expected, our revenues will be harmed.

We derive substantially all of our revenues from our FormWare, Input Accel, Pixel and Context product lines. Our future operating results will depend heavily upon continued and widespread market acceptance for these

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product lines and enhancements to these products. A decline in the demand for any of these product lines as a result of competition, technological change or other factors may cause our revenues to decrease.

We may not be successful in our efforts to integrate acquisitions.

Our failure to manage risks associated with acquisitions could harm our business. A component of our business strategy is to enter new markets and to expand our presence in existing markets by acquiring complementary technologies that allow us to increase our product offerings, augment our distribution channels, expand our market opportunities or broaden our customer base. For example, we acquired Context in February 2004. Acquisitions involve a number of risks, including:

In the past, we have depended heavily on service revenues to increase overall revenues, and we may not be able to sustain the existing levels of profitability of this part of our business.

Many of our customers enter into professional services and maintenance agreements, which together comprise a significant portion of our revenues. Service revenues represented 42% and 44% of our total revenues during the quarters ended March 31, 2005 and 2004, respectively. The level of service revenues in the future will depend largely upon growing our professional services group and ongoing renewals of customer maintenance contracts by our installed customer base. Our professional services revenues could decline if third-party organizations such as systems integrators compete for the installation or servicing of our products. In addition, our customer maintenance contracts might be reduced in size or scope or might not be renewed in the future.

We are subject to the effects of general economic and geopolitical conditions.

Our business is subject to the effects of general economic conditions and, in particular, market conditions in the industries that we serve. Recent political turmoil in many parts of the world, including terrorist and military actions, may put pressure on global economic conditions. Our customers’ decisions to purchase our products are discretionary and subject to their internal budget and purchasing processes, which may be affected by the above factors. If economic conditions deteriorate, our business and operating results are likely to be adversely impacted.

Accounting charges resulting from mergers and acquisitions will continue to have a negative effect on earnings over future quarters.

As a result of the Merger and our acquisition of Context, we have recorded substantial goodwill and intangible assets. These non-cash charges will negatively affect earnings during these amortization periods, which could have a negative effect on our stock price. Additionally, we are required to test our goodwill for impairment at least annually, and more often if impairment indicators arise, and to review our intangible assets for impairment if indicators of impairment are present. In the event that we determine that our goodwill or intangible assets have become impaired, we would be required to recognize a non-cash charge that would negatively impact earnings in the impairment period, which could also have a negative effect on our stock price.

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Provisions in our charter documents, Delaware law and our stockholder rights plan may have anti-takeover effects that could discourage or prevent a change in control, which may depress our stock price.

Provisions in our certificate of incorporation and bylaws and our stockholder rights plan may discourage, delay or prevent a merger or acquisition of us that the majority of our stockholders may consider favorable. Provisions of our certificate of incorporation and bylaws:

The terms of our stockholder rights plan are set forth in the rights agreement entered into by us and the rights agent. The rights granted pursuant to the rights agreement may cause substantial dilution to any party that attempts to acquire us or our stock on terms that our board of directors determines are not in the best interests of our stockholders and therefore may have anti-takeover effects. Certain provisions of Delaware law also may discourage, delay or prevent a party from acquiring or merging with us, which may cause the market price of our common stock to decline.

We may incur increased costs as a result of recently enacted and proposed changes in laws and regulations relating to corporate governance matters and public disclosure.

Recently enacted and proposed changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002, rules adopted or proposed by the Securities and Exchange Commission (SEC) and by the Nasdaq National Market, and new accounting pronouncements will have resulted in increased costs to us as we have evaluated the implications of these laws, regulations and standards and responded to their requirements. To maintain high standards of corporate governance and public disclosure, we intend to invest all reasonable necessary resources to comply with evolving and increasingly complex and stringent standards. This investment has resulted in increased general and administrative expenses and a diversion of management time and attention from strategic revenue generating and cost management activities.

If we fail to maintain effective internal control over financial reporting, we may be required to make additional public disclosures related to our internal control deficiencies and our management may not be able to conclude that our internal control over financial reporting is effective in future periods.

Although we believe our existing internal controls over financial reporting are effective, there is no assurance that we will meet the certification requirements at the end of any reporting period, which could result in inclusion of a negative attestation report of our independent registered public accounting firm in our subsequent annual report and cause a decline in our stock price.

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Item 3 – Quantitative and Qualitative Disclosures About Market Risk.

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. We maintain an investment policy that is intended to ensure the safety and preservation of our invested funds by limiting default risk, market risk and reinvestment risk. Our investment policy allows us to invest in high credit quality securities such as money market funds, debt instruments of the United States government and its agencies and high quality corporate issuers. To date, our investments of excess cash have principally consisted of bank money market accounts. We do not currently use, nor have we historically used, derivative financial instruments to manage or reduce market risk. At March 31, 2005, our cash and cash equivalents totaled $32.7 million, and consisted primarily of cash and money market accounts in banks with an original maturity of 90 days or less at the time of purchase. We do not maintain any marketable equity or debt security or other investment instruments at March 31, 2005.

We have operations internationally and, as a result, are subject to various risks, including foreign currency risks. We have not entered into foreign currency contracts for purposes of hedging or speculation. To date, we have not realized any significant gains or losses from transactions denominated in foreign currencies. During the quarter ended March 31, 2005, 16% of our sales and 15% of our operating expenses were denominated in currencies other than the United States dollar. These foreign currencies are primarily British Pounds, Euros, Russian Roubles and Australian dollars. Additionally, substantially all of the receivables and payables of our international subsidiaries are denominated in their respective local currencies.

Item 4 – Controls and Procedures

An evaluation regarding the effectiveness of our disclosure controls and procedures as of March 31, 2005, the end of the period covered by this report, was performed under the supervision and with the participation of management, including the Chief Executive Officer (CEO) and Chief Financial Officer (CFO). Based on that evaluation, management, including the CEO and CFO, concluded that our disclosure controls and procedures were effective as of March 31, 2005. No change in our internal control over financial reporting was identified in connection with the evaluation mentioned above that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II – OTHER INFORMATION

We are subject to various legal proceedings from time to time in the ordinary course of business, none of which is required to be disclosed under this Item 1 of Part II.

None.

None.

None.

None.

a. Exhibits

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SIGNATURES

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

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