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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------



FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005



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



For The Transition Period From  To



Commission file number 0-22292



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Captiva Software Corporation

(Exact name of Registrant as specified in its charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 77-0104275                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



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 July 31, 2005, there were 12,985,102 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 JUNE 30, 2005

INDEX



|                              |  |                                                                                       |  |                                                                                                                                  |  |        
|----------------------------- |  | ------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------- |  | -------
|                              |  |                                                                                       |  |                                                                                                                                  |  | PageNo.
|PART I. FINANCIAL INFORMATION |  |                                                                                      
|                              |  |                                                                                      
|Item 1.                       |  | Financial Statements                                                                  |  |                                                                                                                                 
|                              |  |                                                                                       | 
|                              |  |                                                                                       |  | Consolidated Condensed Balance Sheets at June 30, 2005 and December 31, 2004 (unaudited)                                         |  | 3      
|                              |  |                                                                                       | 
|                              |  |                                                                                       |  | Consolidated Condensed Statements of Operations for the Quarters and Six-Month Periods Ended June 30, 2005 and 2004 (unaudited)  |  | 4      
|                              |  |                                                                                       | 
|                              |  |                                                                                       |  | Consolidated Condensed Statement of Stockholders Equity and Comprehensive Income for the Period Ended June 30, 2005 (unaudited) |  | 5      
|                              |  |                                                                                       | 
|                              |  |                                                                                       |  | Consolidated Condensed Statements of Cash Flows for the Six-Month Periods Ended June 30, 2005 and 2004 (unaudited)               |  | 6      
|                              |  |                                                                                       | 
|                              |  |                                                                                       |  | Notes to Consolidated Condensed Financial Statements (unaudited)                                                                 |  | 7      
|                              |  |                                                                                      
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 14                                                                                                                              
|                              |  |                                                                                      
|Item 3.                       |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 35                                                                                                                              
|                              |  |                                                                                      
|Item 4.                       |  | Controls and Procedures                                                               |  | 35                                                                                                                              
|                              | 
|PART II. OTHER INFORMATION    |  |                                                                                      
|                              |  |                                                                                      
|Item 1.                       |  | Legal Proceedings                                                                     |  | 36                                                                                                                              
|                              |  |                                                                                      
|Item 2.                       |  | Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 36                                                                                                                              
|                              |  |                                                                                      
|Item 3.                       |  | Defaults Upon Senior Securities                                                       |  | 36                                                                                                                              
|                              |  |                                                                                      
|Item 4.                       |  | Submission of Matters to a Vote of Security Holders                                   |  | 36                                                                                                                              
|                              |  |                                                                                      
|Item 5.                       |  | Other Information                                                                     |  | 36                                                                                                                              
|                              |  |                                                                                      
|Item 6.                       |  | Exhibits                                                                              |  | 37                                                                                                                              
|                              | 
|Signatures                    |  | 38                                                                                   



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PART I  FINANCIAL INFORMATION



Item 1 - Financial Statements



CAPTIVA SOFTWARE CORPORATION

CONSOLIDATED CONDENSED BALANCE SHEETS

(UNAUDITED)

(IN THOUSANDS)



|                                              |  |              |        |   |                  |   |       
|--------------------------------------------- |  | ------------ | ------ | - | ---------------- | - | ------
|                                              |  | June 30,2005 |        |   | December 31,2004
|ASSETS                                        |  |              |        |   |                  |   |       
|Current assets:                               |  |              |        |   |                  |   |       
|Cash and cash equivalents                     |  | $            | 19,954 |   |                  | $ | 27,273
|Accounts receivable, net                      |  |              | 13,962 |   |                  |   | 13,612
|Prepaid expenses and other current assets     |  |              | 2,748  |   |                  |   | 3,301 
|                                              |  |              |        |   |                  |   |       
|Total current assets                          |  |              | 36,664 |   |                  |   | 44,186
|Property and equipment, net                   |  |              | 1,736  |   |                  |   | 1,355 
|Other assets                                  |  |              | 467    |   |                  |   | 1,558 
|Goodwill                                      |  |              | 26,326 |   |                  |   | 10,244
|Intangible assets, net                        |  |              | 7,338  |   |                  |   | 3,197 
|                                              |  |              |        |   |                  |   |       
|Total assets                                  |  | $            | 72,531 |   |                  | $ | 60,540
|                                              |  |              |        |   |                  |   |       
|LIABILITIES AND STOCKHOLDERS EQUITY          |  |              |        |   |                  |   |       
|Current liabilities:                          |  |              |        |   |                  |   |       
|Accounts payable                              |  | $            | 2,586  |   |                  | $ | 1,462 
|Accrued compensation and related liabilities  |  |              | 4,454  |   |                  |   | 3,372 
|Other liabilities                             |  |              | 6,660  |   |                  |   | 4,508 
|Deferred revenue                              |  |              | 14,084 |   |                  |   | 13,296
|                                              |  |              |        |   |                  |   |       
|Total current liabilities                     |  |              | 27,784 |   |                  |   | 22,638
|Deferred revenue                              |  |              | 479    |   |                  |   | 496   
|Other liabilities                             |  |              | 468    |   |                  |   | 359   
|                                              |  |              |        |   |                  |   |       
|Total liabilities                             |  |              | 28,731 |   |                  |   | 23,493
|                                              |  |              |        |   |                  |   |       
|Stockholders equity:                         |  |              |        |   |                  |   |       
|Preferred stock                               |  |              |       |   |                  |   |      
|Common stock                                  |  |              | 129    |   |                  |   | 123   
|Additional paid-in capital                    |  |              | 37,530 |   |                  |   | 32,549
|Retained earnings                             |  |              | 6,809  |   |                  |   | 4,179 
|Accumulated other comprehensive income (loss) |  |              | (668   | ) |                  |   | 196   
|                                              |  |              |        |   |                  |   |       
|Total stockholders equity                    |  |              | 43,800 |   |                  |   | 37,047
|                                              |  |              |        |   |                  |   |       
|Total liabilities and stockholders equity    |  | $            | 72,531 |   |                  | $ | 60,540
|                                              |  |              |        |   |                  |   |       







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)

|
|

|                                                 |  |                        |        |                          |   |        |  |      |        |  |   |       
|------------------------------------------------ |  | ---------------------- | ------ | ------------------------ | - | ------ |  | ---- | ------ |  | - | ------
|                                                 |  | Quarter Ended June 30, |        | Six Months EndedJune 30,
|                                                 |  | 2005                   |        | 2004                     |   | 2005   |  | 2004
|Net revenues:                                    |  |                        |        |                          |   |        |  |      |        |  |   |       
|Software                                         |  | $                      | 10,795 |                          | $ | 8,426  |  | $    | 19,619 |  | $ | 15,104
|Services                                         |  |                        | 7,850  |                          |   | 6,891  |  |      | 15,219 |  |   | 13,808
|Hardware and other                               |  |                        | 1,545  |                          |   | 1,485  |  |      | 2,946  |  |   | 3,752 
|                                                 |  |                        |        |                          |   |        |  |      |        |  |   |       
|Total revenues                                   |  |                        | 20,190 |                          |   | 16,802 |  |      | 37,784 |  |   | 32,664
|                                                 |  |                        |        |                          |   |        |  |      |        |  |   |       
|Cost of revenues:                                |  |                        |        |                          |   |        |  |      |        |  |   |       
|Software                                         |  |                        | 1,024  |                          |   | 1,179  |  |      | 2,235  |  |   | 2,025 
|Services                                         |  |                        | 2,824  |                          |   | 2,524  |  |      | 5,421  |  |   | 5,171 
|Hardware and other                               |  |                        | 1,205  |                          |   | 1,229  |  |      | 2,256  |  |   | 3,053 
|Amortization of purchased intangible assets      |  |                        | 746    |                          |   | 654    |  |      | 1,403  |  |   | 1,265 
|                                                 |  |                        |        |                          |   |        |  |      |        |  |   |       
|Total cost of revenues                           |  |                        | 5,799  |                          |   | 5,586  |  |      | 11,315 |  |   | 11,514
|                                                 |  |                        |        |                          |   |        |  |      |        |  |   |       
|Gross profit                                     |  |                        | 14,391 |                          |   | 11,216 |  |      | 26,469 |  |   | 21,150
|                                                 |  |                        |        |                          |   |        |  |      |        |  |   |       
|Operating expenses:                              |  |                        |        |                          |   |        |  |      |        |  |   |       
|Research and development                         |  |                        | 2,830  |                          |   | 2,506  |  |      | 5,241  |  |   | 5,197 
|Sales and marketing                              |  |                        | 6,524  |                          |   | 5,448  |  |      | 12,341 |  |   | 10,646
|General and administrative                       |  |                        | 2,450  |                          |   | 1,704  |  |      | 4,366  |  |   | 2,972 
|Acquisition and restructuring charges            |  |                        | 429    |                          |   |       |  |      | 429    |  |   |      
|Write-off of in-process research and development |  |                        | 110    |                          |   |       |  |      | 110    |  |   | 66    
|Write-off of withdrawn stock offering costs      |  |                        |       |                          |   | 205    |  |      |       |  |   | 205   
|                                                 |  |                        |        |                          |   |        |  |      |        |  |   |       
|Total operating expenses                         |  |                        | 12,343 |                          |   | 9,863  |  |      | 22,487 |  |   | 19,086
|                                                 |  |                        |        |                          |   |        |  |      |        |  |   |       
|Income from operations                           |  |                        | 2,048  |                          |   | 1,353  |  |      | 3,982  |  |   | 2,064 
|Interest and other income, net                   |  |                        | 136    |                          |   | 58     |  |      | 267    |  |   | 129   
|                                                 |  |                        |        |                          |   |        |  |      |        |  |   |       
|Income before income taxes                       |  |                        | 2,184  |                          |   | 1,411  |  |      | 4,249  |  |   | 2,193 
|Provision for income taxes                       |  |                        | 784    |                          |   | 550    |  |      | 1,619  |  |   | 855   
|                                                 |  |                        |        |                          |   |        |  |      |        |  |   |       
|Net income                                       |  | $                      | 1,400  |                          | $ | 861    |  | $    | 2,630  |  | $ | 1,338 
|                                                 |  |                        |        |                          |   |        |  |      |        |  |   |       
|Earnings per share:                              |  |                        |        |                          |   |        |  |      |        |  |   |       
|Basic                                            |  | $                      | 0.11   |                          | $ | 0.07   |  | $    | 0.21   |  | $ | 0.12  
|                                                 |  |                        |        |                          |   |        |  |      |        |  |   |       
|Diluted                                          |  | $                      | 0.10   |                          | $ | 0.07   |  | $    | 0.19   |  | $ | 0.10  
|                                                 |  |                        |        |                          |   |        |  |      |        |  |   |       
|Shares used in computing earnings per share:     |  |                        |        |                          |   |        |  |      |        |  |   |       
|Basic                                            |  |                        | 12,549 |                          |   | 11,481 |  |      | 12,450 |  |   | 11,242
|                                                 |  |                        |        |                          |   |        |  |      |        |  |   |       
|Diluted                                          |  |                        | 13,644 |                          |   | 13,116 |  |      | 13,537 |  |   | 13,046
|                                                 |  |                        |        |                          |   |        |  |      |        |  |   |       







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)



|                                                               |  |              |  |                          |     |                  |   |                                            |  |   |                          |  |   |                     |   |  |   |        |   |  |   |       |  
|-------------------------------------------------------------- |  | ------------ |  | ------------------------ | --- | ---------------- | - | ------------------------------------------ |  | - | ------------------------ |  | - | ------------------- | - |  | - | ------ | - |  | - | ----- | -
|                                                               |  | Common Stock |  | AdditionalPaid-inCapital |     | RetainedEarnings |   | AccumulatedOtherComprehensiveIncome (Loss) |  |   | TotalStockholdersEquity |  |   | ComprehensiveIncome |  
|                                                               |  | Shares       |  | Par Value                |     |                  |   |                                            | 
|Balance at December 31, 2004                                   |  | 12,294       |  | $                        | 123 |                  | $ | 32,549                                     |  | $ | 4,179                    |  | $ | 196                 |   |  | $ | 37,047 |   |  |   |       |  
|Common stock issued under:                                     |  |              |  |                          |     |                  |   |                                            |  |   |                          |  |   |                     |   |  |   |        |   |  |   |       |  
|Stock option plans                                             |  | 310          |  |                          | 3   |                  |   | 887                                        |  |   |                          |  |   |                     |   |  |   | 890    |   |  |   |       |  
|Employee stock purchase plan                                   |  | 64           |  |                          | 1   |                  |   | 464                                        |  |   |                          |  |   |                     |   |  |   | 465    |   |  |   |       |  
|Common stock issued in conjunction with the acquisition of SWT |  | 179          |  |                          | 2   |                  |   | 2,181                                      |  |   |                          |  |   |                     |   |  |   | 2,183  |   |  |   |       |  
|Stock compensation expense                                     |  |              |  |                          |     |                  |   | 323                                        |  |   |                          |  |   |                     |   |  |   | 323    |   |  |   |       |  
|Tax benefit from stock option exercises                        |  |              |  |                          |     |                  |   | 1,126                                      |  |   |                          |  |   |                     |   |  |   | 1,126  |   |  |   |       |  
|Net income                                                     |  |              |  |                          |     |                  |   |                                            |  |   | 2,630                    |  |   |                     |   |  |   | 2,630  |   |  |   | 2,630 |  
|Cumulative translation adjustments                             |  |              |  |                          |     |                  |   |                                            |  |   |                          |  |   | (864                | ) |  |   | (864   | ) |  |   | (864  | )
|                                                               |  |              |  |                          |     |                  |   |                                            |  |   |                          |  |   |                     |   |  |   |        |   |  |   |       |  
|Balance at June 30, 2005                                       |  | 12,847       |  | $                        | 129 |                  | $ | 37,530                                     |  | $ | 6,809                    |  | $ | (668                | ) |  | $ | 43,800 |   |  | $ | 1,766 |  
|                                                               |  |              |  |                          |     |                  |   |                                            |  |   |                          |  |   |                     |   |  |   |        |   |  |   |       |  









See accompanying notes to consolidated financial statements.



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CAPTIVA SOFTWARE CORPORATION

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(IN THOUSANDS)



|                                                                                  |  |                          |         |   |      |   |        |  
|--------------------------------------------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------ | -
|                                                                                  |  | Six Months EndedJune 30, |        
|                                                                                  |  | 2005                     |         |   | 2004 |  
|Cash flows from operating activities:                                             |  |                          |         |   |      |   |        |  
|Net income                                                                        |  | $                        | 2,630   |   |      | $ | 1,338  |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                          |         |   |      |   |        |  
|Depreciation and amortization                                                     |  |                          | 1,732   |   |      |   | 1,541  |  
|Tax benefit from stock option exercises                                           |  |                          | 1,126   |   |      |   | 2,161  |  
|Deferred income taxes                                                             |  |                          |        |   |      |   | (1,307 | )
|Stock compensation expense                                                        |  |                          | 323     |   |      |   |       |  
|Write-off of in-process research and development                                  |  |                          | 110     |   |      |   | 66     |  
|Changes in operating assets and liabilities, net of effect of acquisitions:       |  |                          |         |   |      |   |        |  
|Accounts receivable                                                               |  |                          | 1,673   |   |      |   | 1,855  |  
|Prepaid expenses and other current assets                                         |  |                          | 985     |   |      |   | 1,168  |  
|Accounts payable                                                                  |  |                          | (1,470  | ) |      |   | (462   | )
|Deferred revenue                                                                  |  |                          | (277    | ) |      |   | (1,736 | )
|Other liabilities                                                                 |  |                          | 963     |   |      |   | 524    |  
|                                                                                  |  |                          |         |   |      |   |        |  
|Net cash provided by operating activities:                                        |  |                          | 7,795   |   |      |   | 5,148  |  
|                                                                                  |  |                          |         |   |      |   |        |  
|Cash flows from investing activities:                                             |  |                          |         |   |      |   |        |  
|Purchases of property and equipment                                               |  |                          | (390    | ) |      |   | (421   | )
|Cash paid to acquire SWT, net of cash acquired                                    |  |                          | (15,768 | ) |      |   |       |  
|Cash paid to acquire Context                                                      |  |                          |        |   |      |   | (5,459 | )
|                                                                                  |  |                          |         |   |      |   |        |  
|Net cash used in investing activities:                                            |  |                          | (16,158 | ) |      |   | (5,880 | )
|                                                                                  |  |                          |         |   |      |   |        |  
|Cash flows from financing activities:                                             |  |                          |         |   |      |   |        |  
|Repayment of SWT debt obligations                                                 |  |                          | (108    | ) |      |   |       |  
|Proceeds from issuance of common stock                                            |  |                          | 1,355   |   |      |   | 3,884  |  
|                                                                                  |  |                          |         |   |      |   |        |  
|Net cash provided by financing activities                                         |  |                          | 1,247   |   |      |   | 3,884  |  
|                                                                                  |  |                          |         |   |      |   |        |  
|Effect of exchange rate changes on cash                                           |  |                          | (203    | ) |      |   | (34    | )
|                                                                                  |  |                          |         |   |      |   |        |  
|Net increase (decrease) in cash and cash equivalents                              |  |                          | (7,319  | ) |      |   | 3,118  |  
|Cash and cash equivalents at beginning of period                                  |  |                          | 27,273  |   |      |   | 16,038 |  
|                                                                                  |  |                          |         |   |      |   |        |  
|Cash and cash equivalents at end of period                                        |  | $                        | 19,954  |   |      | $ | 19,156 |  
|                                                                                  |  |                          |         |   |      |   |        |  
|Non-cash financing activities:                                                    |  |                          |         |   |      |   |        |  
|Issuance of common stock in SWT acquisition                                       |  | $                        | (2,183  | ) |      | $ |       |  







See accompanying notes to consolidated financial statements.



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CAPTIVA SOFTWARE CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)



1.    Nature of Business



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 results of operations of Captivas wholly owned subsidiary SWT SA (SWT) have been
included commencing May 27, 2005, the effective date of the acquisition.



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 in connection with revenue recognition..



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 or six months ended June 30, 2005 or 2004 related to new awards. Refer to Note 7 for a discussion of compensation expense recorded as a result of an award modification.



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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 and six months ended June 30, 2005 and 2004 would have been as follows (in thousands, except per share data):



|                                                                                    |  |                       |       |   |                          |   |      |      |  |   |        |   |  |   |        |  
|----------------------------------------------------------------------------------- |  | --------------------- | ----- | - | ------------------------ | - | ---- | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                                    |  | Quarter EndedJune 30, |       |   | Six Months EndedJune 30, |  
|                                                                                    |  | 2005                  |       |   | 2004                     |   |      | 2005 |  |   | 2004   |  
|Net income as reported                                                              |  | $                     | 1,400 |   |                          | $ | 861  |      |  | $ | 2,630  |   |  | $ | 1,338  |  
|Stock-based employee compensation cost, net of tax, utilizing the fair value method |  |                       | (609  | ) |                          |   | (657 | )    |  |   | (2,340 | ) |  |   | (1,234 | )
|                                                                                    |  |                       |       |   |                          |   |      |      |  |   |        |   |  |   |        |  
|                                                                                    |  |                       |       |  
|Pro forma net income                                                                |  |                       | 791   |   |                          |   | 204  |      |  |   | 290    |   |  |   | 104    |  
|                                                                                    |  |                       |       |   |                          |   |      |      |  |   |        |   |  |   |        |  
|                                                                                    |  |                       |       |  
|Earnings per share as reported:                                                     |  |                       |       |   |                          |   |      |      |  |   |        |   |  |   |        |  
|Basic                                                                               |  | $                     | 0.11  |   |                          | $ | 0.07 |      |  | $ | 0.21   |   |  | $ | 0.12   |  
|                                                                                    |  |                       |       |   |                          |   |      |      |  |   |        |   |  |   |        |  
|Diluted                                                                             |  | $                     | 0.10  |   |                          | $ | 0.07 |      |  | $ | 0.19   |   |  | $ | 0.10   |  
|                                                                                    |  |                       |       |   |                          |   |      |      |  |   |        |   |  |   |        |  
|Pro forma earnings per share:                                                       |  |                       |       |   |                          |   |      |      |  |   |        |   |  |   |        |  
|Basic                                                                               |  | $                     | 0.06  |   |                          | $ | 0.02 |      |  | $ | 0.02   |   |  | $ | 0.01   |  
|                                                                                    |  |                       |       |   |                          |   |      |      |  |   |        |   |  |   |        |  
|Diluted                                                                             |  | $                     | 0.06  |   |                          | $ | 0.02 |      |  | $ | 0.02   |   |  | $ | 0.01   |  
|                                                                                    |  |                       |       |   |                          |   |      |      |  |   |        |   |  |   |        |  



The pro forma net income and earnings
per share amounts for the quarter and six months ended June 30, 2004 have been adjusted from that originally reported (pro forma net income of $0.1 million for each of the quarter and six months ended June 30, 2004, and pro forma basic and diluted
earnings per share of $0.01 for each of the quarter and six months ended June 30, 2004), 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).



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##### Table of Contents

CAPTIVA SOFTWARE CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS(Continued)

(UNAUDITED)



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.



2.    Intangible Assets



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



|                                     |  |                     |        |                         |   |        |                   |  |   |      
|------------------------------------ |  | ------------------- | ------ | ----------------------- | - | ------ | ----------------- |  | - | -----
|                                     |  | GrossCarryingAmount |        | AccumulatedAmortization |   |        | NetCarryingAmount
|June 30, 2005:                       |  |                     |        |                         |   |        |                   |  |   |      
|Completed technology                 |  | $                   | 8,743  |                         | $ | (5,608 | )                 |  | $ | 3,135
|Customer contracts and relationships |  |                     | 4,621  |                         |   | (949   | )                 |  |   | 3,672
|Trademarks and trade names           |  |                     | 853    |                         |   | (424   | )                 |  |   | 429  
|Patents                              |  |                     | 163    |                         |   | (61    | )                 |  |   | 102  
|                                     |  |                     |        |                         |   |        |                   |  |   |      
|                                     |  | $                   | 14,380 |                         | $ | (7,042 | )                 |  | $ | 7,338
|                                     |  |                     |        |                         |   |        |                   |  |   |      
|December 31, 2004:                   |  |                     |        |                         |   |        |                   |  |   |      
|Completed technology                 |  | $                   | 6,371  |                         | $ | (4,518 | )                 |  | $ | 1,853
|Customer contracts and relationships |  |                     | 1,536  |                         |   | (733   | )                 |  |   | 803  
|Trademarks and trade names           |  |                     | 766    |                         |   | (344   | )                 |  |   | 422  
|Patents                              |  |                     | 163    |                         |   | (44    | )                 |  |   | 119  
|                                     |  |                     |        |                         |   |        |                   |  |   |      
|                                     |  | $                   | 8,836  |                         | $ | (5,639 | )                 |  | $ | 3,197
|                                     |  |                     |        |                         |   |        |                   |  |   |      



Amortization expense related to our
intangible assets totaled $0.7 million and $1.4 million during the quarter and six months ended June 30, 2005, respectively, and $0.7 million and $1.3 million during the quarter and six months ended June 30, 2004, respectively. Future amortization
expense for the remainder of 2005 and for 2006, 2007, 2008, and 2009 is expected to be $1.1 million, $1.8 million, $1.3 million, $1.2 million, and $0.7 million respectively, excluding any incremental expense that could result if we consummate future
acquisitions.



3.    Computation of Earnings Per Share



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 shares related to outstanding stock options are included in the diluted earnings per share
calculations for the quarter and six months ended June 30, 2005. Dilutive securities consisting of 1.6 million and 1.8 million shares related to outstanding stock options are included in the diluted earnings per share calculations for the quarter
and six months ended June 30, 2004, respectively. Potentially dilutive securities consisting of 0.4 million and 0.7 million shares related to outstanding stock options were excluded from the



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CAPTIVA SOFTWARE CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS(Continued)

(UNAUDITED)



diluted earnings per share calculations in the quarter and six months ended June 30, 2005, respectively, and 0.7 million and 0.5 million shares for the
quarter and six months ended June 30, 2004, respectively, because they were anti-dilutive.



4.    Acquisition of SWT SA



On May 27, 2005, we consummated our acquisition of SWT SA, a privately held France-based provider of automatic data extraction and intelligent document capture solutions and technology, pursuant to a definitive purchase agreement dated May
10, 2005. The acquisition was consummated principally to expand our geographic presence into new markets, particularly in France, and to add synergistic technologies that we expect to leverage into our products, direct and indirect sales channels
and customer base. We paid approximately $17.7 million in cash and issued approximately 179,000 shares of our common stock to SWT shareholders to purchase all of the outstanding share capital of SWT. Of the total cash consideration, we deposited
approximately $1.9 million into an escrow account to secure potential future indemnification obligations of the primary selling shareholder.



We accounted for this transaction using the purchase method of accounting. Results of operations of SWT have been included in our results prospectively from May 27, 2005.



Our estimate of the total purchase price of SWT is summarized as follows (in
thousands):



|                                              |  |   |       
|--------------------------------------------- |  | - | ------
|Total cash consideration                      |  | $ | 17,679
|Captiva common stock issued                   |  |   | 2,183 
|Estimated acquisition-related costs           |  |   | 1,717 
|                                              |  |   |       
|Total estimated purchase price of acquisition |  | $ | 21,579
|                                              |  |   |       



The total estimated purchase price was
preliminarily allocated as follows (in thousands):



|                                              |  |   |        |  
|--------------------------------------------- |  | - | ------ | -
|Tangible assets                               |  | $ | 4,787  |  
|Goodwill                                      |  |   | 16,668 |  
|Intangible assets:                            |  |   |        |  
|Completed technology                          |  |   | 2,460  |  
|In-process research and development           |  |   | 110    |  
|Customer contracts and relationships          |  |   | 3,200  |  
|Trademarks and trade names                    |  |   | 90     |  
|Tangible liabilities                          |  |   | (4,543 | )
|Deferred tax liabilities, net                 |  |   | (1,193 | )
|                                              |  |   |        |  
|Total estimated purchase price of acquisition |  | $ | 21,579 |  
|                                              |  |   |        |  



The assumed value of the Captiva
common stock issued in the acquisition was calculated based on the average closing price of Captivas common stock for the five day period beginning two days before and ending two days after the public announcement of the acquisition.



The preliminary allocation of the purchase price is pending completion of
several elements, including our determination of certain deferred tax and other tax attributes existing as of the purchase date. We do not expect future adjustments to the purchase price to be material. However, there may be material adjustments to
the allocation of the purchase price.



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CAPTIVA SOFTWARE CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS(Continued)

(UNAUDITED)



The completed technology, in-process research and development, customer contracts and relationships and trademarks
and trade names were valued utilizing discounted cash flow models based on forecasts of future revenues and expenses related to the intangible assets, utilizing discount rates of 20%, 25%, 18-20% and 18%, respectively.



The acquired intangible assets have a weighted average estimated useful life of approximately
six years and will be amortized using the straight-line method over their estimated useful lives as follows: completed technology  four years; customer contracts and relationships  eight years; and trademarks and trade names  two
years. In connection with the acquisition, we wrote-off acquired in-process research and development totaling $0.1 million, which was recorded as an immediate charge to operations. None of the goodwill related to this acquisition is deductible for
tax purposes.



The following table summarizes unaudited pro forma statement of
operations data as if our acquisition of SWT had occurred on January 1, 2004 (unaudited; in thousands, except per share data):



|                           |  |                        |        |                          |   |        |  |      |        |  |   |       
|-------------------------- |  | ---------------------- | ------ | ------------------------ | - | ------ |  | ---- | ------ |  | - | ------
|                           |  | Quarter Ended June 30, |        | Six Months EndedJune 30,
|                           |  | 2005                   |        | 2004                     |   | 2005   |  | 2004
|Revenues                   |  | $                      | 21,410 |                          | $ | 18,165 |  | $    | 41,078 |  | $ | 36,157
|Net income                 |  |                        | 677    |                          |   | 140    |  |      | 986    |  |   | 207   
|Basic earnings per share   |  | $                      | 0.05   |                          | $ | 0.01   |  | $    | 0.08   |  | $ | 0.02  
|Diluted earnings per share |  |                        | 0.05   |                          |   | 0.01   |  |      | 0.07   |  |   | 0.02  



These unaudited pro forma results are
not necessarily indicative of those that would have actually occurred had the acquisition taken place on January 1, 2004.



SWT Debt Obligations



In connection with the acquisition of SWT, we assumed debt obligations consisting of a small business term loan, ANVAR subsidy advances and COFACE advances amounting to $0.1 million, $0.3 million and $0.3 million,
respectively. ANVAR is a French organization that provides research and development subsidies to finance corporate development projects. Under the terms of the ANVAR loan subsidies, repayment is required only upon the success of defined research
projects. If the projects are not deemed successful as per the project definitions, the subsidy loans are forgiven. COFACE is an affiliate of a French banking organization that provides advances to corporations for foreign expansion via insurance
contracts that are designated to cover foreign losses resulting from French product exportation. Under the terms of the COFACE contracts, repayment of the advances may be forgiven if foreign expansion results do not achieve certain defined financial
levels. In June 2005, repayments under SWT debt obligations amounted to $0.1 million. SWT debt obligations and scheduled repayment dates as of June 30, 2005 are as follows (in thousands):



|                                                                                                                         |  |                           |    
|------------------------------------------------------------------------------------------------------------------------ |  | ------------------------- | ---
|                                                                                                                         |  | Liability atJune 30, 2005
|Small business term loans (payable in quarterly installments, including interest accrued at 4.4%, through February 2008) |  | $                         | 114
|ANVAR subsidy (payable in installments of $121 and $60 in September 2005 and September 2006, respectively)               |  |                           | 181
|COFACE advances ($220 payable in 2005 and $64 payable in 2006)                                                           |  |                           | 284
|                                                                                                                         |  |                           |    
|                                                                                                                         |  | $                         | 579
|                                                                                                                         |  |                           |    



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CAPTIVA SOFTWARE CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS(Continued)

(UNAUDITED)



Of SWTs total debt obligations, $451 and $128 has been included in other current liabilities and other
non-current liabilities, respectively, in the accompanying condensed consolidated balance sheet at June 30, 2005.



5.     Acquisition and Restructuring Charges



During the quarter ended June 30, 2005, in connection with our acquisition of SWT, we adopted a restructuring plan that included a reduction of our workforce and office
space made redundant by the acquisition. In connection with this plan, we recorded a charge to operations of $0.3 million which consisted of a 0.1 million charge related to a reduction in our workforce, consisting primarily of employee severance
costs, and a $0.2 million charge related to the accrual of estimated net future facility lease costs related to a vacated office lease. All of these charges represent future cash charges. As of June 30, 2005, the accruals relating to the workforce
charge and the facility lease charge amounted to $0.1 million and $0.2 million, respectively.



Additionally, during the quarter ended June 30, 2005, we recorded non-recurring acquisition charges totaling $0.1, which consisted principally of internal acquisition-related travel costs that preceded the
acquisition.



6.    Segment Information



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 offices in France, the United Kingdom, Germany, Spain 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 and six months ended June 30, 2005 and 2004, respectively (in thousands):



|                         |  |                        |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|------------------------ |  | ---------------------- | ------ | - | ------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                         |  | Quarter Ended June 30, |        |   | Six Months EndedJune 30, |  
|                         |  | 2005                   |        |   | 2004                     |   |        | 2005 |  |   | 2004   |  
|Domestic (United States) |  | $                      | 13,878 |   |                          | $ | 12,937 |      |  | $ | 28,575 |   |  | $ | 25,788 |  
|% of total               |  |                        | 69     | % |                          |   | 77     | %    |  |   | 76     | % |  |   | 79     | %
|International            |  | $                      | 6,312  |   |                          | $ | 3,865  |      |  | $ | 9,209  |   |  | $ | 6,876  |  
|% of total               |  |                        | 31     | % |                          |   | 23     | %    |  |   | 24     | % |  |   | 21     | %



No single customer accounted for 10%
or more of our total revenues during the quarters or six months ended June 30, 2005 or 2004.



7.    Stock Option Award Modifications



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



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CAPTIVA SOFTWARE CORPORATION

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS(Continued)

(UNAUDITED)



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 May 2005, our Board of Directors approved an extension of the exercise period of certain stock options held by a former director. In connection with this award
modification, we recorded a stock compensation charge of $0.3 million, which represented the intrinsic value of the options at the date of modification. This charge is included in general and administrative expense during the quarter and six months
ended June 30, 2005.



8.    Guarantees



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. We continue to monitor the conditions that are subject to these 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.



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.



9.    Contingencies



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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##### Table of Contents

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 May 27, 2005, we consummated our acquisition of SWT, a privately held France-based provider of automatic data extraction and intelligent
document capture solutions and technology. The results of operations of SWT are included in our 2005 results of operations beginning on May 27, 2005.



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 may be
attributable to one or more of the following factors: i) when businesses feel comfortable spending their information technology budgets, ii) the impact that the Sarbanes-Oxley Act has had on the timing of new information technology deployments, and
iii) sales commission plans based on calendar year achievement levels.



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##### Table of Contents

Results of Operations



The following tables set forth, in absolute dollars and as a percentage of total revenues, certain statement of operations data for the quarters and six months ended June
30, 2005 and 2004:



|                                                 |  |                        |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|------------------------------------------------ |  | ---------------------- | ------ | --------------------- | - | ------ | ---------------------- | --- | ---- | -------------------------------- | --- | - |  | - | ----- | - |  | ---- | --
|                                                 |  | Quarter Ended June 30, |        | Percentage ofRevenues |   |        | Period-to-PeriodChange |     |      | Period-to-PeriodPercentageChange |    
|                                                 |  | 2005                   |        | 2004                  |   | 2005   |                        |     | 2004 |                                  |     |  
|                                                 |  | (In thousands)         |        |                       |   |        |                        |     |      | (In thousands)                   |     |   |  |  
|Net revenues:                                    |  |                        |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|Software                                         |  | $                      | 10,795 |                       | $ | 8,426  |                        | 53  | %    |                                  | 50  | % |  | $ | 2,369 |   |  | 28   | % 
|Services                                         |  |                        | 7,850  |                       |   | 6,891  |                        | 39  | %    |                                  | 41  | % |  |   | 959   |   |  | 14   | % 
|Hardware and other                               |  |                        | 1,545  |                       |   | 1,485  |                        | 8   | %    |                                  | 9   | % |  |   | 60    |   |  | 4    | % 
|                                                 |  |                        |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|Total revenues                                   |  |                        | 20,190 |                       |   | 16,802 |                        | 100 | %    |                                  | 100 | % |  |   | 3,388 |   |  | 20   | % 
|                                                 |  |                        |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|                                                 |  |                        |        |                       |   |       
|Cost of revenues:                                |  |                        |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|Software                                         |  |                        | 1,024  |                       |   | 1,179  |                        | 5   | %    |                                  | 7   | % |  |   | (155  | ) |  | (13  | )%
|Services                                         |  |                        | 2,824  |                       |   | 2,524  |                        | 14  | %    |                                  | 15  | % |  |   | 300   |   |  | 12   | % 
|Hardware and other                               |  |                        | 1,205  |                       |   | 1,229  |                        | 6   | %    |                                  | 7   | % |  |   | (24   | ) |  | (2   | )%
|Amortization of purchased intangibles            |  |                        | 746    |                       |   | 654    |                        | 4   | %    |                                  | 4   | % |  |   | 92    |   |  | 14   | % 
|                                                 |  |                        |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|Total cost of revenues                           |  |                        | 5,799  |                       |   | 5,586  |                        | 29  | %    |                                  | 33  | % |  |   | 213   |   |  | 4    | % 
|                                                 |  |                        |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|                                                 |  |                        |        |                       |   |       
|Gross profit                                     |  |                        | 14,391 |                       |   | 11,216 |                        | 71  | %    |                                  | 67  | % |  |   | 3,175 |   |  | 28   | % 
|                                                 |  |                        |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|Operating expenses:                              |  |                        |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|Research and development                         |  |                        | 2,830  |                       |   | 2,506  |                        | 14  | %    |                                  | 15  | % |  |   | 324   |   |  | 13   | % 
|Sales and marketing                              |  |                        | 6,524  |                       |   | 5,448  |                        | 32  | %    |                                  | 32  | % |  |   | 1,076 |   |  | 20   | % 
|General and administrative                       |  |                        | 2,450  |                       |   | 1,704  |                        | 12  | %    |                                  | 10  | % |  |   | 746   |   |  | 44   | % 
|Acquisition and restructuring charges            |  |                        | 429    |                       |   |       |                        | 2   | %    |                                  |    |   |  |   | 429   |   |  |     |   
|Write-off of in-process research and development |  |                        | 110    |                       |   |       |                        | 1   | %    |                                  |    |   |  |   | 110   |   |  |     |   
|Write-off of withdrawn stock offering costs      |  |                        |       |                       |   | 205    |                        |    |      |                                  | 1   | % |  |   | (205  | ) |  | (100 | )%
|                                                 |  |                        |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|Total operating expenses                         |  |                        | 12,343 |                       |   | 9,863  |                        | 61  | %    |                                  | 59  | % |  |   | 2,480 |   |  | 25   | % 
|                                                 |  |                        |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|                                                 |  |                        |        |                       |   |       
|Income from operations                           |  |                        | 2,048  |                       |   | 1,353  |                        | 10  | %    |                                  | 8   | % |  |   | 695   |   |  | 51   | % 
|Interest and other income, net                   |  |                        | 136    |                       |   | 58     |                        | 1   | %    |                                  |    |   |  |   | 78    |   |  | 134  | % 
|                                                 |  |                        |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|Income before income taxes                       |  |                        | 2,184  |                       |   | 1,411  |                        | 11  | %    |                                  | 8   | % |  |   | 773   |   |  | 55   | % 
|Provision for income taxes                       |  |                        | 784    |                       |   | 550    |                        | 4   | %    |                                  | 3   | % |  |   | 234   |   |  | 43   | % 
|                                                 |  |                        |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|Net income                                       |  | $                      | 1,400  |                       | $ | 861    |                        | 7   | %    |                                  | 5   | % |  |   | 539   |   |  | 63   | % 
|                                                 |  |                        |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   



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|                                                 |  |                           |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|------------------------------------------------ |  | ------------------------- | ------ | --------------------- | - | ------ | ---------------------- | --- | ---- | -------------------------------- | --- | - |  | - | ----- | - |  | ---- | --
|                                                 |  | Six Months Ended June 30, |        | Percentage ofRevenues |   |        | Period-to-PeriodChange |     |      | Period-to-PeriodPercentageChange |    
|                                                 |  | 2005                      |        | 2004                  |   | 2005   |                        |     | 2004 |                                  |     |  
|                                                 |  | (In thousands)            |        |                       |   |        |                        |     |      | (In thousands)                   |     |   |  |  
|Net revenues:                                    |  |                           |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|Software                                         |  | $                         | 19,619 |                       | $ | 15,104 |                        | 52  | %    |                                  | 46  | % |  | $ | 4,515 |   |  | 30   | % 
|Services                                         |  |                           | 15,219 |                       |   | 13,808 |                        | 40  | %    |                                  | 42  | % |  |   | 1,411 |   |  | 10   | % 
|Hardware and other                               |  |                           | 2,946  |                       |   | 3,752  |                        | 8   | %    |                                  | 11  | % |  |   | (806  | ) |  | (21  | %)
|                                                 |  |                           |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|Total revenues                                   |  |                           | 37,784 |                       |   | 32,664 |                        | 100 | %    |                                  | 100 | % |  |   | 5,120 |   |  | 16   | % 
|                                                 |  |                           |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|                                                 |  |                           |        |                       |   |       
|Cost of revenues:                                |  |                           |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|Software                                         |  |                           | 2,235  |                       |   | 2,025  |                        | 6   | %    |                                  | 6   | % |  |   | 210   |   |  | 10   | % 
|Services                                         |  |                           | 5,421  |                       |   | 5,171  |                        | 14  | %    |                                  | 16  | % |  |   | 250   |   |  | 5    | % 
|Hardware and other                               |  |                           | 2,256  |                       |   | 3,053  |                        | 6   | %    |                                  | 9   | % |  |   | (797  | ) |  | (26  | %)
|Amortization of purchased intangibles            |  |                           | 1,403  |                       |   | 1,265  |                        | 4   | %    |                                  | 4   | % |  |   | 138   |   |  | 11   | % 
|                                                 |  |                           |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|Total cost of revenues                           |  |                           | 11,315 |                       |   | 11,514 |                        | 30  | %    |                                  | 35  | % |  |   | (199  | ) |  | (2   | %)
|                                                 |  |                           |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|                                                 |  |                           |        |                       |   |       
|Gross profit                                     |  |                           | 26,469 |                       |   | 21,150 |                        | 70  | %    |                                  | 65  | % |  |   | 5,319 |   |  | 25   | % 
|                                                 |  |                           |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|Operating expenses:                              |  |                           |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|Research and development                         |  |                           | 5,241  |                       |   | 5,197  |                        | 14  | %    |                                  | 16  | % |  |   | 44    |   |  | 1    | % 
|Sales and marketing                              |  |                           | 12,341 |                       |   | 10,646 |                        | 33  | %    |                                  | 33  | % |  |   | 1,695 |   |  | 16   | % 
|General and administrative                       |  |                           | 4,366  |                       |   | 2,972  |                        | 12  | %    |                                  | 9   | % |  |   | 1,394 |   |  | 47   | % 
|Acquisition and restructuring charges            |  |                           | 429    |                       |   |       |                        | 1   | %    |                                  |    |   |  |   | 429   |   |  |     |   
|Write-off of in-process research and development |  |                           | 110    |                       |   | 66     |                        |    |      |                                  |    |   |  |   | 44    |   |  | 67   | % 
|Write-off of withdrawn stock offering costs      |  |                           |       |                       |   | 205    |                        |    |      |                                  | 1   | % |  |   | (205  | ) |  | (100 | %)
|                                                 |  |                           |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|Total operating expenses                         |  |                           | 22,487 |                       |   | 19,086 |                        | 60  | %    |                                  | 58  | % |  |   | 3,401 |   |  | 18   | % 
|                                                 |  |                           |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|                                                 |  |                           |        |                       |   |       
|Income from operations                           |  |                           | 3,982  |                       |   | 2,064  |                        | 11  | %    |                                  | 6   | % |  |   | 1,918 |   |  | 93   | % 
|Interest and other income, net                   |  |                           | 267    |                       |   | 129    |                        | 1   | %    |                                  |    |   |  |   | 138   |   |  | 107  | % 
|                                                 |  |                           |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|Income before income taxes                       |  |                           | 4,249  |                       |   | 2,193  |                        | 11  | %    |                                  | 7   | % |  |   | 2,056 |   |  | 94   | % 
|Provision for income taxes                       |  |                           | 1,619  |                       |   | 855    |                        | 4   | %    |                                  | 3   | % |  |   | 764   |   |  | 89   | % 
|                                                 |  |                           |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   
|Net income                                       |  | $                         | 2,630  |                       | $ | 1,338  |                        | 7   | %    |                                  | 4   | % |  |   | 1,292 |   |  | 97   | % 
|                                                 |  |                           |        |                       |   |        |                        |     |      |                                  |     |   |  |   |       |   |  |      |   



Quarter Ended June 30, 2005
compared to Quarter Ended June 30, 2004



Revenues



Our total revenues increased 20% to $20.2 million in the quarter ended June 30, 2005 from
$16.8 million in the quarter ended June 30, 2004.



Our software revenues
increased 28% to $10.8 million in the quarter ended June 30, 2005 from $8.4 million in the quarter ended June 30, 2004. Software revenues accounted for 53% and 50% of total revenues in the quarters ended June 30, 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 and also to an increase in
international revenues resulting primarily from our acquisition of SWT.



Our
service revenues increased 14% to $7.9 million in the quarter ended June 30, 2005 from $6.9 million in the quarter ended June 30, 2004. Service revenues accounted for 39% and 41% of total revenues in the quarters ended June 30, 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



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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 increased 4% to
$1.5 million in the quarter ended June 30, 2005 from $1.5 million in the quarter ended June 30, 2004. Hardware and other revenues accounted for 8% and 9% of total revenues in the quarters ended June 30, 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 $6.3 million and $3.9 million in the quarters ended June 30, 2005 and 2004, respectively, representing 31%
and 23% of total revenues in each of these quarters.



Gross Profit



Gross profit increased 28% to $14.4 million in the quarter ended June 30,
2005 from $11.2 million in the quarter ended June 30, 2004. Gross profit as a percentage of total revenues increased to 71% in the quarter ended June 30, 2005 from 67% in the quarter ended June 30, 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, and to higher margins on our software sales due to a lower royalty component mix in the
software we sold. The 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 increased 13% to $2.8 million in the quarter ended June
30, 2005 from $2.5 million in the quarter ended June 30, 2004. As a percentage of total revenues, research and development expenses decreased to 14% in the quarter ended June 30, 2005 from 15% in the quarter ended June 30, 2004. The increase in
absolute dollars was attributable primarily to an increase in research and development personnel in our Russia product development office and as a result of our SWT acquisition. The decrease as a percentage of total revenue was attributable
primarily to cost benefits gained through the expanded utilization of lower cost research and development personnel in Russia to supplement our product development efforts.



Sales and Marketing



Sales and marketing expenses increased 20% to $6.5 million in the quarter ended June 30, 2005 from $5.4 million in the quarter ended June 30, 2004. As a percentage of
total revenues, sales and marketing expenses remained consistent at 32% in the quarters ended June 30, 2005 and 2004. The increase in absolute dollars was attributable primarily to the expansion of our sales organization and related labor cost
increases, including those related to SWT, an increase sales commission expense and an increase in tradeshow expenditures.



General and Administrative



General and administrative expenses increased 44% to $2.5 million in the quarter ended June 30, 2005 from $1.7 million in the quarter ended June 30, 2004. As a percentage
of total revenues, general and administrative expenses increased to 12% in the quarter ended June 30, 2005 from 10% in the quarter ended June 30, 2004. The increase in absolute dollars and as a percentage of total revenue was attributable primarily
to an increase in headcount related to the expansion of our operations, including those related to SWT, and to the recognition of a stock compensation charge related to the modification of a former directors stock option awards in the quarter
ended June 30, 2005.



Acquisition and Restructuring Charges



During the quarter ended June 30, 2005, in connection with our acquisition of SWT, we
recognized expenses totaling $0.4 million which consisted of a $0.3 million restructuring charge that resulted from a reduction of our workforce and office space made redundant by the acquisition and $0.1 million in internal acquisition-related
travel expenses that preceded the acquisition.



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In-Process Research and Development



In connection with our acquisition of SWT in the quarter ended June 30, 2005, we recorded $0.1 million charge related to acquired in-process
research and development. No in-process research and development charge was recorded in the quarter ended June 30, 2004.



Provision for Income Taxes



Our tax rate for the quarter ended June 30, 2005 was 35.9%, as compared to a tax rate of 39.0% in the quarter ended June 30, 2004. 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. During the quarter ended June 30, 2005, we revised our estimates of foreign taxable income, which is taxed at lower
statutory rates than domestic income, as a percentage of estimated total taxable income in 2005. This revision had the impact of reducing our estimate of the 2005 effective tax rate from 40.4% to 38.1%, and resulted in an adjusted net tax rate of
35.9% for the quarter ended June 30, 2005.



Six Months Ended June 30,
2005 compared to the Six Months Ended June 30, 2004



Revenues



Our total revenues increased 16% to $37.8 million in the six months ended
June 30, 2005 from $32.7 million in the six months ended June 30, 2004.



Our
software revenues increased 30% to $19.6 million in the six months ended June 30, 2005 from $15.1 million in the six months ended June 30, 2004. Software revenues accounted for 52% and 46% of total revenues in the six months ended June 30, 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 10% to $15.2 million in the six months ended
June 30, 2005 from $13.8 million in the six months ended June 30, 2004. Service revenues accounted for 40% and 42% of total revenues in the six months ended June 30, 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 21% to $2.9 million in the six months ended June 30, 2005 from $3.8 million in the six months ended June 30, 2004. Hardware and other revenues accounted for 8% and 11% of total revenues in the six months ended
June 30, 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 period over period.



International revenues totaled $9.2 million and $6.9 million in the six months ended June 30,
2005 and 2004, respectively, representing 24% and 21% in the six months ended June 30, 2005 and 2004, respectively.



Gross Profit



Gross profit increased 25% to $26.5 million in the six months ended June 30, 2005 from $21.2 million in the six months ended June 30, 2004. Gross profit as a percentage of total revenues increased to 70% in the six
months ended June 30, 2005 from 65% in the six months ended June 30, 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



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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
totaled $5.2 million in both the six months ended June 30, 2005 and 2004. As a percentage of total revenues, research and development expenses decreased to 14% in the six months ended June 30, 2005 from 16% in the six months ended June 30, 2004. The
decrease as a percentage of total revenue was attributable primarily to cost benefits gained through the 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 16% to $12.3 million in the six months ended June 30,
2005 from $10.6 million in the six months ended June 30, 2004. As a percentage of total revenues, sales and marketing expenses remained consistent at 33% in the six months ended June 30, 2005 and 2004. The increase in absolute dollars was
attributable primarily to an increase sales commission expense, the expansion of our sales organization and related labor cost increases, and an increase in tradeshow expenditures.



General and Administrative



General and administrative expenses increased 47% to $4.4 million in the six months ended June 30, 2005 from $3.0 million in the six months ended June 30, 2004. As a
percentage of total revenues, general and administrative expenses increased to 12% in the six months ended June 30, 2005 from 9% in the six months ended June 30, 2004. The increase in absolute dollars and as a percentage of revenue was attributable
primarily to an increase in professional service fees, including audit and consulting fees, relating to our first year Sarbanes-Oxley Act compliance initiatives that were completed in the first quarter of 2005, an increase in headcount related to
the expansion of our operations, and the recognition of a stock compensation charge related to the modification of a former directors stock option awards in the six months ended June 30, 2005.



Acquisition and Restructuring Charges



During the six months ended June 30, 2005, in connection with our acquisition of SWT, we
recognized expenses totaling $0.4 million which consisted of a $0.3 million restructuring charge that resulted from a reduction of our workforce and office space made redundant by the acquisition and $0.1 million in internal acquisition-related
travel expenses that preceded the acquisition.



In-Process Research and
Development



In connection with our acquisition of SWT in the six months
ended June 30, 2005, we recorded $0.1 million charge related to acquired in-process research and development. In connection with our acquisition of Context in the six months ended June 30, 2004, we recorded $0.1 million charge related to acquired
in-process research and development.



Provision for Income Taxes



Our effective tax rate for the six months ended June 30, 2005 was 38.1%,
as compared to an effective tax rate of 39.0% in the six months ended June 30, 2004. 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.
The decrease in our effective tax rate is attributable primarily to revised estimates of foreign taxable income, which is taxed at lower statutory rates than domestic income, as a percentage of total estimated taxable income in 2005.



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Liquidity and Capital Resources



Our working capital decreased from $21.5 million at December 31, 2004 to $8.9 million at June 30, 2005. The $12.6 million decrease in
working capital consisted of a $7.3 million decrease in cash and cash equivalents, a $0.5 million decrease in prepaid and other current assets, a $0.8 million increase in deferred revenue, and a $4.4 million combined increase in other current
liabilities, partially offset by a $0.4 million increase in accounts receivable, net. The decrease in cash and cash equivalents was attributable primarily to our acquisition of SWT. The increase in deferred revenue was attributable primarily to the
addition of deferred maintenance revenues recorded in connection with our acquisition of SWT. The increase in other current liabilities was attributable primarily to an increase in accrued liabilities related to SWT, including accrued acquisition
costs.



Our primary method for funding operations and growth has been through
cash flows generated from operations. Net cash provided by operating activities increased from $5.1 million in the six months ended June 30, 2004 to $7.8 million in the six months ended June 30, 2005. The increase was attributable primarily to an
increase in income before non-cash charges, including depreciation and amortization, the tax benefit from stock option exercises, stock compensation expense, and the write-off of in-process research and development.



Net cash used in investing activities increased from $5.9 million in the six months ended
June 30, 2004 to $16.2 million in the six months ended June 30, 2005. The increase was attributable primarily to the use of $15.8 million in cash, net of cash acquired, to acquire SWT during the six months ended June 30, 2005.



Net cash provided by financing activities decreased from $3.9 million in the six months ended
June 30, 2004 to $1.2 million in the six months ended June 30, 2005. Net cash provided by financing activities related primarily to proceeds from the exercise of common stock options and the sale of common stock under our employee stock purchase
plan in both periods. The decrease resulted from lower stock option exercise activity and lower sales of common stock under our employee stock purchase plan in the six months ended June 30, 2005 as compared to the six months ended June 30, 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 June 30, 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 June 30, 2005, we were in compliance with all covenants prescribed by this credit agreement.



We assumed $0.7 million in debt obligations in connection with our acquisition of SWT that included a small business term loan, ANVAR subsidy advances and COFACE
advances. ANVAR is a French organization that provides research and development subsidies to finance corporate development projects. COFACE is an affiliate of a French banking organization that provides advances to corporations for foreign expansion
via insurance contracts that are designated to cover foreign losses resulting from French product exportation. At June 30, 2005, our total liability under these obligations amounted to $0.6 million, $0.4 million of which is payable during the second
half of 2005 and the remainder of which is primarily payable in 2006.



As of
June 30, 2005, we had $20.0 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 are 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



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creditworthiness and changes in our customer payment cycles. Material differences may result in the amount and 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 2005, 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:



| |  | fluctuations in the size and timing of significant orders;
|- |  | ----------------------------------------------------------



| |  | possible delays in recognizing software licensing revenues;
|- |  | -----------------------------------------------------------



| |  | the fact that a large portion of our orders are generally booked late in each quarter, increasing the risk that orders anticipated to close in the quarter might not close;
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | uncertainty in the budgeting cycles of customers;
|- |  | -------------------------------------------------



| |  | the timing of introduction of new or enhanced products; and
|- |  | -----------------------------------------------------------



| |  | general economic and political conditions.
|- |  | ------------------------------------------



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.



We may not realize the benefits we expect from the
acquisition of SWT.



The integration of SWTs business into Captiva
may be time consuming and expensive, and may disrupt our business. After the acquisition, we will need to overcome significant challenges in order to realize any benefits or



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synergies from the acquisition. These challenges include the timely, efficient and successful execution of a number of post-transaction integration
activities, including:



| |  | integrating the technologies of the two companies;
|- |  | --------------------------------------------------



| |  | entering markets in which we have no or limited prior experience;
|- |  | -----------------------------------------------------------------



| |  | successfully completing the development of SWTs technology and developing commercial products based on that technology;
|- |  | ------------------------------------------------------------------------------------------------------------------------



| |  | retaining and assimilating the key personnel of SWT;
|- |  | ----------------------------------------------------



| |  | attracting additional customers for products based on SWTs technology;
|- |  | -----------------------------------------------------------------------



| |  | implementing and maintaining uniform standards, controls, processes, procedures, policies and information systems; and
|- |  | ----------------------------------------------------------------------------------------------------------------------



| |  | managing expenses of any undisclosed or potential legal liability of SWT.
|- |  | -------------------------------------------------------------------------



The process of integrating operations and technology could cause an interruption of, or loss of momentum in, the activities of one or more of our businesses and the loss
of key personnel. The diversion of managements attention and any delays or difficulties encountered in connection with the acquisition and the integration of SWTs technology could have an adverse effect on our business, results of
operations or financial condition. We may not succeed in addressing these risks or any other problems encountered in connection with the transaction. The inability to successfully integrate the technology and personnel of SWT, or any significant
delay in achieving integration, could have an adverse effect on us and, as a result, on the market price of our common stock.



Acquisitions could prove difficult to integrate, disrupt our business, dilute stockholder value and strain our resources.



As part of our business strategy, we intend to continue to enter new markets and to expand
our presence in existing markets by acquiring companies that allow us to increase our product offerings, augment our distribution channels, expand our market opportunities or broaden our customer base. Acquisitions, including most recently our
acquisition of SWT, are accompanied by the risks commonly encountered in acquisitions of businesses, which include:



| |  | the financial and strategic goals for the acquired and combined business may not be achieved;
|- |  | ---------------------------------------------------------------------------------------------



| |  | the possibility that we will pay more than the acquired companies or assets are worth;
|- |  | --------------------------------------------------------------------------------------



| |  | the difficulty of assimilating the operations and personnel of the acquired businesses;
|- |  | ---------------------------------------------------------------------------------------



| |  | challenges in retaining customers of the acquired business, and customer dissatisfaction or performance problems with the acquired business post acquisition;
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the potential product liability associated with the sale of the acquired companies products;
|- |  | ---------------------------------------------------------------------------------------------



| |  | the potential disruption of our ongoing business;
|- |  | -------------------------------------------------



| |  | the potential dilution of our existing stockholders and earnings per share;
|- |  | ---------------------------------------------------------------------------



| |  | unanticipated liabilities, legal risks and costs;
|- |  | -------------------------------------------------



| |  | the distraction of management from our ongoing business;
|- |  | --------------------------------------------------------



| |  | the impairment of relationships with employees and customers as a result of any integration of new management personnel;
|- |  | ------------------------------------------------------------------------------------------------------------------------



| |  | The possibility that the acquired companies do not ultimately achieve the strategic purposes intended; and
|- |  | ----------------------------------------------------------------------------------------------------------



| |  | Other unanticipated events or circumstances.
|- |  | --------------------------------------------



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Acquisitions also frequently result in recording of goodwill and other intangible assets, which are subject to potential
impairments in the future that could harm our operating results. In addition, if we finance acquisitions by issuing convertible debt or equity securities, our existing stockholders may be diluted. Such dilution could adversely affect the market
price of our stock. It is also possible that at some point in the future we may decide to enter new markets, thus subjecting ourselves to new risks associated with those markets. Acquisitions of businesses having a significant presence outside the
U.S., such as SWT, will increase our relative exposure to the risks of conducting operations in international markets. If we fail to achieve the anticipated benefits of any acquisitions we complete, our business, operating results, financial
condition and prospects may be impaired.



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 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.



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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 document types. These customers may not
choose to purchase additional licenses to expand their use of our



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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 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.



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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 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:



| |  | loss of customers;
|- |  | ------------------



| |  | warranty claims;
|- |  | ----------------



| |  | damage to brand reputation;
|- |  | ---------------------------



| |  | delay in market acceptance of current and future products; and
|- |  | --------------------------------------------------------------



| |  | diversion of development and engineering resources.
|- |  | ---------------------------------------------------



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, Russia, France, and Spain. During the quarters ended June 30, 2005 and 2004, international sales represented 31%
and 23% of our revenues, respectively, and during the six months ended June 30, 2005 and 2004, international sales represented 24% and 21% 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:



| |  | costs of and other difficulties in customizing products for foreign countries;
|- |  | ------------------------------------------------------------------------------



| |  | costs and challenges of educating customers and developing brand awareness in new local markets;
|- |  | ------------------------------------------------------------------------------------------------



| |  | protectionist laws and business practices favoring local competition;
|- |  | ---------------------------------------------------------------------



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| |  | greater seasonal reductions in business activity;
|- |  | -------------------------------------------------



| |  | greater difficulty or delay in accounts receivable collection;
|- |  | --------------------------------------------------------------



| |  | difficulties in staffing and managing international operations and in establishing and managing sales channels;
|- |  | ---------------------------------------------------------------------------------------------------------------



| |  | foreign and United States taxation issues;
|- |  | ------------------------------------------



| |  | regulatory uncertainties in international countries;
|- |  | ----------------------------------------------------



| |  | foreign currency exchange rate fluctuations; and
|- |  | ------------------------------------------------



| |  | political and economic instability.
|- |  | -----------------------------------



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 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.



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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.



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:



| |  | be time consuming to defend;
|- |  | ----------------------------



| |  | result in costly litigation;
|- |  | ----------------------------



| |  | divert managements attention and resources;
|- |  | --------------------------------------------



| |  | cause product shipment delays;
|- |  | ------------------------------



| |  | require us to redesign products;
|- |  | --------------------------------



| |  | require us to enter into royalty or licensing agreements; or
|- |  | ------------------------------------------------------------



| |  | cause others to seek indemnity from us.
|- |  | ---------------------------------------



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.



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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 five 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, SWT, Pixel
and Context product lines. Our future operating results will depend heavily upon continued and widespread market acceptance for these 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.



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 39% and 41% of our total revenues during the quarters ended June 30, 2005 and 2004, respectively, and 40% and 42% of our total revenues during the six months ended
June 30, 2005 and 2004. 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 and SWT, 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.



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:



| |  | prohibit cumulative voting in the election of directors;
|- |  | --------------------------------------------------------



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| |  | eliminate the ability of stockholders to call special meetings; and
|- |  | -------------------------------------------------------------------



| |  | establish advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted on by stockholders at stockholder meetings.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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 control over financial reporting is 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 June
30, 2005, our cash and cash equivalents totaled $20.0 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 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 June 30, 2005, 23% of our sales and 22% of our operating expenses were denominated in currencies other than the United States dollar. During the six months ended June 30, 2005, 19% of our sales and 19% 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 June 30, 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 June 30, 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



Item 1.    Legal Proceedings



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.



Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds



On May 27, 2005, we issued 179,498 shares of Captiva common stock in connection with our acquisition of SWT. The issuance of shares was exempt from registration under the
Securities Act of 1933, as amended, pursuant to Regulation S thereof, on the basis that the transaction did not involve a public offering.



Item 3.    Defaults Upon Senior Securities



None.



Item 4.    Submission of Matters to a Vote of Security Holders



The annual meeting of the stockholders of Captiva Software Corporation was held on May 26, 2005 to vote on the following proposals:



1. To elect directors to serve for the ensuing year and until their successors are elected.



2. To approve an increase in the aggregate number of shares of common stock
authorized for issuance under our Amended and Restated 1993 Stock Option/Stock Issuance Plan by 1,000,000 shares.



3. To ratify the selection by the Audit Committee of the Board of Directors of PricewaterhouseCoopers LLP as the independent registered public accounting firm of Captiva
Software Corporation for its fiscal year ending December 31, 2005.



The results
were as follows:



|                   |  |            |  |                    |  |           |  |                
|------------------ |  | ---------- |  | ------------------ |  | --------- |  | ---------------
|                   |  | For        |  | Withheld Authority |  | Abstained |  | BrokerNon-Votes
|Proposal 1         |  |            |  |                    |  |           |  |                
|Reynolds C. Bish   |  | 11,112,538 |  | 437,883            |  |          |  |               
|Joe A. Rose        |  | 10,947,193 |  | 603,228            |  |          |  |               
|Patrick L. Edsell  |  | 11,120,253 |  | 430,168            |  |          |  |               
|                   |  |            |  |                   
|Bruce Silver       |  | 11,120,253 |  | 430,168            |  |          |  |               
|                   |  |            |  |                   
|Jeffrey J. Lenches |  | 10,949,686 |  | 600,735            |  |          |  |               
|Mel S. Lavitt      |  | 10,949,786 |  | 600,635            |  |          |  |               
|                   |  |            |  |                   
|                   |  | For        |  | Against            |  | Abstained |  | BrokerNon-Votes
|Proposal 2         |  | 6,930,319  |  | 1,759,229          |  | 8,857     |  | 2,852,016      
|Proposal 3         |  | 11,483,715 |  | 56,549             |  | 10,157    |  |               



A more detailed discussion of each
matter is included in Captiva Software Corporations Proxy Statement for the 2005 Annual Meeting of Stockholders.



Item 5.    Other Information



None.



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|Item 6. | Exhibits
|------- | --------



a. Exhibits



|              |  |                                                                                                                                                                                                                   
|------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                                                                                       
|2.1           |  | Agreement for the Sale, Purchase and Exchange of Shares in SWT SA between Certain Shareholders of SWT, Captiva Software Corporation and Captiva Software France EURL dated May 10,
2005.                          
|2.2           |  | Amendment Number 1 to the Agreement for the Sale, Purchase and Exchange of Shares in SWT SA between Certain Shareholders of SWT, Captiva Software Corporation and Captiva Software France EURL
dated May 27, 2005.
|10.1          |  | Addendum  France, to the registrants Amended and Restated 1993 Stock Option Plan/Stock Issuance Plan and 2003 New Executive Recruitment Stock Option Plan                                                       
|31.1          |  | Certification by Chief Executive Officer Pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a).                                                                                                       
|31.2          |  | Certification by Chief Financial Officer Pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a).                                                                                                       
|32.1          |  | Certification by Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                
|32.2          |  | Certification by Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                



Certain schedules are omitted from the
Agreement for the Sale, Purchase and Exchange of Shares in SWT SA between Certain Shareholders of SWT, Captiva Software Corporation and Captiva Software France EURL dated May 10, 2005 filed as Exhibit 2,1 and the Amendment Number 1 to the Agreement
for the Sale, Purchase and Exchange of Shares in SWT SA between Certain Shareholders of SWT, Captiva Software Corporation and Captiva Software France EURL dated May 27, 2005; however, the Company will furnish supplementally a copy of any omitted
schedule to the Securities and Exchange Commission upon request.



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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.



|                     |  |                             
|-------------------- |  | ----------------------------
|                     |  | CAPTIVA SOFTWARE CORPORATION
|                     | 
|Date: August 9, 2005 |  | /s/ REYNOLDS C. BISH        
|                     |  | Reynolds C. Bish            
|                     |  | Chief Executive Officer     
|                     | 
|                     |  | /s/ RICK E. RUSSO           
|                     |  | Rick E. Russo               
|                     |  | Chief Financial Officer     



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