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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, 2004



| ̈ | 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)



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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, 2004, there were 11,918,362 shares of the registrants common stock, par value $0.01, outstanding.



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##### Table of Contents

CAPTIVA SOFTWARE CORPORATION



FORM
10-Q

FOR THE QUARTER ENDED JUNE 30, 2004

INDEX



|                              |  |                                                                                                                                                             |  |         
|----------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------
|                              |  |                                                                                                                                                             |  | Page No.
|PART I. FINANCIAL INFORMATION |  |                                                                                                                                                            
|                              |  |                                                                                                                                                            
|Item 1.                       |  | Financial Statements                                                                                                                                        |  |         
|                              |  |                                                                                                                                                            
|                              |  | Consolidated Condensed Balance Sheets at June 30, 2004 and December 31, 2003 (unaudited)                                                                    |  | 3       
|                              |  |                                                                                                                                                            
|                              |  | Consolidated Condensed Statements of Operations for the Three and Six-Month Periods Ended June 30, 2004 and 2003 (unaudited)                                |  | 4       
|                              |  |                                                                                                                                                            
|                              |  | Consolidated Condensed Statement of Stockholders Equity and Total Comprehensive Income for the Three and Six-Month Periods Ended June 30, 2004 (unaudited) |  | 5       
|                              |  |                                                                                                                                                            
|                              |  | Consolidated Condensed Statements of Cash Flows for the Six-Month Periods Ended June 30, 2004 and 2003 (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                                                                                                  |  | 31      
|                              |  |                                                                                                                                                            
|Item 4.                       |  | Controls and Procedures                                                                                                                                     |  | 31      
|                              | 
|PART II. OTHER INFORMATION    |  |                                                                                                                                                            
|                              |  |                                                                                                                                                            
|Item 1.                       |  | Legal Proceedings                                                                                                                                           |  | 31      
|                              |  |                                                                                                                                                            
|Item 2.                       |  | Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities                                                                            |  | 31      
|                              |  |                                                                                                                                                            
|Item 3.                       |  | Defaults Upon Senior Securities                                                                                                                             |  | 32      
|                              |  |                                                                                                                                                            
|Item 4.                       |  | Submission of Matters to a Vote of Security Holders                                                                                                         |  | 32      
|                              |  |                                                                                                                                                            
|Item 5.                       |  | Other Information                                                                                                                                           |  | 32      
|                              |  |                                                                                                                                                            
|Item 6.                       |  | Exhibits and Reports on Form 8-K                                                                                                                            |  | 33      
|                              | 
|Signatures                    |  | 34                                                                                                                                                         



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##### Table of Contents

PART IFINANCIAL INFORMATION



Item 1Financial Statements



CAPTIVA SOFTWARE CORPORATION



CONSOLIDATED CONDENSED BALANCE SHEETS*

(UNAUDITED)

(IN THOUSANDS)



|                                             |  |              |        |                  |   |       
|-------------------------------------------- |  | ------------ | ------ | ---------------- | - | ------
|                                             |  | June 30,2004 |        | December 31,2003
|ASSETS                                       |  |              |        |                  |   |       
|Current assets:                              |  |              |        |                  |   |       
|Cash and cash equivalents                    |  | $            | 19,156 |                  | $ | 16,038
|Accounts receivable, net                     |  |              | 10,303 |                  |   | 10,780
|Prepaid expenses and other current assets    |  |              | 2,060  |                  |   | 3,314 
|                                             |  |              |        |                  |   |       
|Total current assets                         |  |              | 31,519 |                  |   | 30,132
|Property and equipment, net                  |  |              | 1,203  |                  |   | 924   
|Other assets                                 |  |              | 3,075  |                  |   | 2,354 
|Goodwill                                     |  |              | 10,312 |                  |   | 6,082 
|Other intangible assets, net                 |  |              | 4,434  |                  |   | 3,762 
|                                             |  |              |        |                  |   |       
|Total assets                                 |  | $            | 50,543 |                  | $ | 43,254
|                                             |  |              |        |                  |   |       
|LIABILITIES AND STOCKHOLDERS EQUITY         |  |              |        |                  |   |       
|Current liabilities:                         |  |              |        |                  |   |       
|Accounts payable                             |  | $            | 429    |                  | $ | 891   
|Accrued compensation and related liabilities |  |              | 2,844  |                  |   | 2,793 
|Other liabilities                            |  |              | 3,791  |                  |   | 3,166 
|Deferred revenue                             |  |              | 11,203 |                  |   | 11,264
|                                             |  |              |        |                  |   |       
|Total current liabilities                    |  |              | 18,267 |                  |   | 18,114
|                                             |  |              |        |                  |   |       
|Deferred revenue                             |  |              | 308    |                  |   | 519   
|Other liabilities                            |  |              | 230    |                  |   | 235   
|Commitments                                  |  |              |        |                  |   |       
|Stockholders equity:                        |  |              |        |                  |   |       
|Preferred stock                              |  |              |       |                  |   |      
|Common stock                                 |  |              | 118    |                  |   | 108   
|Additional paid-in capital                   |  |              | 30,206 |                  |   | 24,171
|Retained earnings                            |  |              | 1,376  |                  |   | 38    
|Accumulated other comprehensive income       |  |              | 38     |                  |   | 69    
|                                             |  |              |        |                  |   |       
|Total stockholders equity                   |  |              | 31,738 |                  |   | 24,386
|                                             |  |              |        |                  |   |       
|Total liabilities and stockholders equity   |  | $            | 50,543 |                  | $ | 43,254
|                                             |  |              |        |                  |   |       



*The accompanying notes
are an integral part of these consolidated condensed financial statements.



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CAPTIVA SOFTWARE CORPORATION



CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS*

(UNAUDITED)

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)



|                                                 |  |                            |        |                          |   |        |  |      |        |  |   |        |  
|------------------------------------------------ |  | -------------------------- | ------ | ------------------------ | - | ------ |  | ---- | ------ |  | - | ------ | -
|                                                 |  | Three Months EndedJune 30, |        | Six Months EndedJune 30, |  
|                                                 |  | 2004                       |        | 2003                     |   | 2004   |  | 2003 |       
|Net revenues:                                    |  |                            |        |                          |   |        |  |      |        |  |   |        |  
|Software                                         |  | $                          | 8,426  |                          | $ | 6,779  |  | $    | 15,104 |  | $ | 12,360 |  
|Services                                         |  |                            | 6,891  |                          |   | 5,199  |  |      | 13,808 |  |   | 10,897 |  
|Hardware and other                               |  |                            | 1,485  |                          |   | 1,904  |  |      | 3,752  |  |   | 3,229  |  
|                                                 |  |                            |        |                          |   |        |  |      |        |  |   |        |  
|Total revenues                                   |  |                            | 16,802 |                          |   | 13,882 |  |      | 32,664 |  |   | 26,486 |  
|Cost of revenues:                                |  |                            |        |                          |   |        |  |      |        |  |   |        |  
|Software                                         |  |                            | 1,179  |                          |   | 740    |  |      | 2,025  |  |   | 1,140  |  
|Services                                         |  |                            | 2,524  |                          |   | 2,527  |  |      | 5,171  |  |   | 5,038  |  
|Hardware and other                               |  |                            | 1,229  |                          |   | 1,521  |  |      | 3,053  |  |   | 2,641  |  
|Amortization of purchased intangible assets      |  |                            | 654    |                          |   | 524    |  |      | 1,265  |  |   | 1,048  |  
|                                                 |  |                            |        |                          |   |        |  |      |        |  |   |        |  
|Total cost of revenues                           |  |                            | 5,586  |                          |   | 5,312  |  |      | 11,514 |  |   | 9,867  |  
|                                                 |  |                            |        |                          |   |        |  |      |        |  |   |        |  
|Gross profit                                     |  |                            | 11,216 |                          |   | 8,570  |  |      | 21,150 |  |   | 16,619 |  
|Operating expenses:                              |  |                            |        |                          |   |        |  |      |        |  |   |        |  
|Research and development                         |  |                            | 2,506  |                          |   | 2,114  |  |      | 5,197  |  |   | 4,225  |  
|Sales and marketing                              |  |                            | 5,448  |                          |   | 4,532  |  |      | 10,646 |  |   | 8,894  |  
|General and administrative                       |  |                            | 1,704  |                          |   | 1,436  |  |      | 2,972  |  |   | 2,912  |  
|Merger costs                                     |  |                            |       |                          |   |       |  |      |       |  |   | (44    | )
|Write-off of in-process research and development |  |                            |       |                          |   |       |  |      | 66     |  |   |       |  
|Write-off of withdrawn stock offering costs      |  |                            | 205    |                          |   |       |  |      | 205    |  |   |       |  
|                                                 |  |                            |        |                          |   |        |  |      |        |  |   |        |  
|Total operating expenses                         |  |                            | 9,863  |                          |   | 8,082  |  |      | 19,086 |  |   | 15,987 |  
|                                                 |  |                            |        |                          |   |        |  |      |        |  |   |        |  
|Income from operations                           |  |                            | 1,353  |                          |   | 488    |  |      | 2,064  |  |   | 632    |  
|Other income, net                                |  |                            | 58     |                          |   | 14     |  |      | 129    |  |   | 7      |  
|                                                 |  |                            |        |                          |   |        |  |      |        |  |   |        |  
|Income before income taxes                       |  |                            | 1,411  |                          |   | 502    |  |      | 2,193  |  |   | 639    |  
|Provision for income taxes                       |  |                            | 550    |                          |   | 201    |  |      | 855    |  |   | 256    |  
|                                                 |  |                            |        |                          |   |        |  |      |        |  |   |        |  
|Net income                                       |  | $                          | 861    |                          | $ | 301    |  | $    | 1,338  |  | $ | 383    |  
|                                                 |  |                            |        |                          |   |        |  |      |        |  |   |        |  
|Basic net income per share                       |  | $                          | 0.07   |                          | $ | 0.03   |  | $    | 0.12   |  | $ | 0.04   |  
|                                                 |  |                            |        |                          |   |        |  |      |        |  |   |        |  
|Diluted net income per share                     |  | $                          | 0.07   |                          | $ | 0.03   |  | $    | 0.10   |  | $ | 0.04   |  
|                                                 |  |                            |        |                          |   |        |  |      |        |  |   |        |  
|Basic common equivalent shares                   |  |                            | 11,481 |                          |   | 9,011  |  |      | 11,242 |  |   | 8,936  |  
|                                                 |  |                            |        |                          |   |        |  |      |        |  |   |        |  
|Diluted common equivalent shares                 |  |                            | 13,116 |                          |   | 10,347 |  |      | 13,046 |  |   | 9,820  |  
|                                                 |  |                            |        |                          |   |        |  |      |        |  |   |        |  



*The accompanying notes
are an integral part of these consolidated condensed financial statements.



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CAPTIVA SOFTWARE CORPORATION



CONSOLIDATED CONDENSED STATEMENT OF STOCKHOLDERS EQUITY AND TOTAL COMPREHENSIVE INCOME*

(UNAUDITED)

(IN THOUSANDS)



|                                                            |  |                 |  |        |     |                          |   |                  |  |                                            |       |  |                          |     |   |  |   |        |  
|----------------------------------------------------------- |  | --------------- |  | ------ | --- | ------------------------ | - | ---------------- |  | ------------------------------------------ | ----- |  | ------------------------ | --- | - |  | - | ------ | -
|                                                            |  | Common Stock    |  |        |     |                          |   |                  |  |                                            |       | 
|                                                            |  | Number ofShares |  | Amount |     | AdditionalPaid-inCapital |   | RetainedEarnings |  | AccumulatedOtherComprehensiveIncome (Loss) |       |  | TotalStockholdersEquity |    
|Balance at December 31, 2003                                |  | 10,790          |  | $      | 108 |                          | $ | 24,171           |  | $                                          | 38    |  | $                        | 69  |   |  | $ | 24,386 |  
|Exercise of stock options                                   |  | 512             |  |        | 5   |                          |   | 2,512            |  |                                            |       |  |                          |     |   |  |   | 2,517  |  
|Tax benefit of stock option exercises                       |  |                 |  |        |     |                          |   | 1,077            |  |                                            |       |  |                          |     |   |  |   | 1,077  |  
|Comprehensive income:                                       |  |                 |  |        |     |                          |   |                  |  |                                            |       |  |                          |     |   |  |   |        |  
|Equity adjustment from foreign currencies                   |  |                 |  |        |     |                          |   |                  |  |                                            |       |  |                          | (13 | ) |  |   | (13    | )
|Net income                                                  |  |                 |  |        |     |                          |   |                  |  |                                            | 477   |  |                          |     |   |  |   | 477    |  
|                                                            |  |                 |  |        |     |                          |   |                  |  |                                            |       |  |                          |     |   |  |   |        |  
|Total comprehensive income                                  |  |                 |  |        |     |                          |   |                  |  |                                            |       |  |                          |     |   |  |   | 464    |  
|                                                            |  |                 |  |        |     |                          |   |                  |  |                                            |       |  |                          |     |   |  |   |        |  
|Balance at March 31, 2004                                   |  | 11,302          |  | $      | 113 |                          | $ | 27,760           |  | $                                          | 515   |  | $                        | 56  |   |  | $ | 28,444 |  
|Exercise of stock options                                   |  | 422             |  |        | 4   |                          |   | 1,068            |  |                                            |       |  |                          |     |   |  |   | 1,072  |  
|Issuance of common stock under employee stock purchase plan |  | 116             |  |        | 1   |                          |   | 294              |  |                                            |       |  |                          |     |   |  |   | 295    |  
|Tax benefit of stock option exercises                       |  |                 |  |        |     |                          |   | 1,084            |  |                                            |       |  |                          |     |   |  |   | 1,084  |  
|Comprehensive income:                                       |  |                 |  |        |     |                          |   |                  |  |                                            |       |  |                          |     |   |  |   |        |  
|Equity adjustment from foreign currencies                   |  |                 |  |        |     |                          |   |                  |  |                                            |       |  |                          | (18 | ) |  |   | (18    | )
|Net income                                                  |  |                 |  |        |     |                          |   |                  |  |                                            | 861   |  |                          |     |   |  |   | 861    |  
|                                                            |  |                 |  |        |     |                          |   |                  |  |                                            |       |  |                          |     |   |  |   |        |  
|Total comprehensive income                                  |  |                 |  |        |     |                          |   |                  |  |                                            |       |  |                          |     |   |  |   | 843    |  
|                                                            |  |                 |  |        |     |                          |   |                  |  |                                            |       |  |                          |     |   |  |   |        |  
|Balance at June 30, 2004                                    |  | 11,840          |  | $      | 118 |                          | $ | 30,206           |  | $                                          | 1,376 |  | $                        | 38  |   |  | $ | 31,738 |  
|                                                            |  |                 |  |        |     |                          |   |                  |  |                                            |       |  |                          |     |   |  |   |        |  





*The accompanying notes are an integral part of these consolidated condensed financial statements.



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CAPTIVA SOFTWARE CORPORATION



CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS*

(UNAUDITED)

(IN THOUSANDS)



|                                                                                                |  |                          |        |   |      |   |       |  
|----------------------------------------------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ----- | -
|                                                                                                |  | Six Months EndedJune 30, |       
|                                                                                                |  | 2004                     |        |   | 2003 |  
|Cash flows from operating activities:                                                           |  |                          |        |   |      |   |       |  
|Net income                                                                                      |  | $                        | 1,338  |   |      | $ | 383   |  
|Adjustments to reconcile net income to net cash provided by operating activities:               |  |                          |        |   |      |   |       |  
|Depreciation and amortization                                                                   |  |                          | 1,541  |   |      |   | 1,377 |  
|Deferred income taxes                                                                           |  |                          | (1,307 | ) |      |   | (501  | )
|Tax benefit of stock option exercises                                                           |  |                          | 2,161  |   |      |   |      |  
|Write-off of in-process research and development                                                |  |                          | 66     |   |      |   |      |  
|Changes in operating assets and liabilities, net of effect of acquisition of ADP Context, Inc.: |  |                          |        |   |      |   |       |  
|Accounts receivable                                                                             |  |                          | 1,855  |   |      |   | 1,455 |  
|Other current assets and other assets                                                           |  |                          | 1,168  |   |      |   | (723  | )
|Accounts payable                                                                                |  |                          | (462   | ) |      |   | 290   |  
|Deferred revenue                                                                                |  |                          | (1,736 | ) |      |   | (506  | )
|Other liabilities                                                                               |  |                          | 524    |   |      |   | (382  | )
|                                                                                                |  |                          |        |   |      |   |       |  
|Net cash provided by operating activities:                                                      |  |                          | 5,148  |   |      |   | 1,393 |  
|                                                                                                |  |                          |        |   |      |   |       |  
|Cash flows from investing activities:                                                           |  |                          |        |   |      |   |       |  
|Purchases of property and equipment                                                             |  |                          | (421   | ) |      |   | (229  | )
|Cash used in acquisition of ADP Context, Inc.                                                   |  |                          | (5,343 | ) |      |   |      |  
|Direct costs of acquisition of ADP Context, Inc.                                                |  |                          | (116   | ) |      |   |      |  
|                                                                                                |  |                          |        |   |      |   |       |  
|Net cash used in investing activities:                                                          |  |                          | (5,880 | ) |      |   | (229  | )
|                                                                                                |  |                          |        |   |      |   |       |  
|Cash flows from financing activities:                                                           |  |                          |        |   |      |   |       |  
|Proceeds from issuance of common stock                                                          |  |                          | 3,884  |   |      |   | 837   |  
|Payments on line of credit                                                                      |  |                          |       |   |      |   | (345  | )
|                                                                                                |  |                          |        |   |      |   |       |  
|Net cash provided by financing activities                                                       |  |                          | 3,884  |   |      |   | 492   |  
|                                                                                                |  |                          |        |   |      |   |       |  
|Effect of exchange rate changes on cash                                                         |  |                          | (34    | ) |      |   | 116   |  
|                                                                                                |  |                          |        |   |      |   |       |  
|Net increase in cash and cash equivalents                                                       |  |                          | 3,118  |   |      |   | 1,772 |  
|Cash and cash equivalents at beginning of period                                                |  |                          | 16,038 |   |      |   | 7,453 |  
|                                                                                                |  |                          |        |   |      |   |       |  
|Cash and cash equivalents at end of period                                                      |  | $                        | 19,156 |   |      | $ | 9,225 |  
|                                                                                                |  |                          |        |   |      |   |       |  



*The accompanying notes
are an integral part of these consolidated condensed financial statements.



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CAPTIVA SOFTWARE CORPORATION



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(UNAUDITED)



1.    Basis of Preparation and Accounting Policies



Unaudited Interim Financial Information



In this document, we, our, us and the
Company refer to Captiva Software Corporation, formerly known as ActionPoint, Inc., and its subsidiaries, unless the context otherwise requires. The accompanying unaudited interim consolidated condensed financial statements of the
Company have been prepared in accordance with generally accepted accounting principles for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. The December 31, 2003 balance sheet data
was derived from audited financial statements contained in the Companys 2003 Annual Report on Form 10-K but does not include all disclosures required by accounting principles generally accepted in the United States of America.



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 date of the
financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates.



In the opinion of management, the unaudited consolidated condensed financial statements for the three and six-month periods ended June 30, 2004 and 2003
include all adjustments necessary to present fairly the financial information set forth herein, consisting only of normal recurring adjustments except for the write-off of withdrawn stock offering costs as discussed below and the purchase accounting
entries for the Companys acquisition of ADP Context, Inc. as discussed in Note 2. These consolidated condensed financial statements and notes hereto should be read in conjunction with the audited financial statements and notes thereto included
in our Annual Report on Form 10-K for the year ended December 31, 2003. The results of operations for the interim periods presented in this quarterly report on Form 10-Q are not necessarily indicative of the results to be expected for any other
interim period or the entire fiscal year and should not be relied upon as such.



Revenue Recognition



Revenue is generated primarily from three sources: (i) software, which is primarily software license revenue, software subscription license revenue, which includes subscriptions to information databases, and royalty revenue, (ii) services,
which includes software license maintenance fees, training and professional services revenue and (iii) hardware and other products, which were primarily sales of digital scanners in the three and six months ended June 30, 2004 and 2003. Software
license revenue is recognized upon shipment provided that persuasive evidence of an arrangement exists, fees are fixed or determinable, collection is probable and no significant undelivered obligations remain. Software subscription license revenue
is recognized over the term of the license, generally twelve months. Royalty revenue is recognized when partners ship or pre-purchase rights to ship products incorporating the Companys software, provided collection of such revenue is
determined to be probable and the Company has no further obligations. Services revenue is recognized ratably over the period of the maintenance contract or as the services are provided. Payments for maintenance fees are generally made in advance and
are non-refundable. Revenue for hardware and other products is recognized when the following criteria are met: (i) persuasive evidence of an arrangement exists; (ii) delivery of the products and/or services has occurred; (iii) the selling price is
fixed or determinable and (iv) collectibility is reasonably assured.



For arrangements with multiple elements (e.g., delivered and undelivered products, maintenance and other services), the Company allocates revenue to each element of the arrangement based on the fair value of the undelivered elements, which
is specific to the Company, using the residual value method. The fair values for



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CAPTIVA SOFTWARE CORPORATION



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS(Continued)

(UNAUDITED)



ongoing maintenance and support obligations are based upon separate sales of renewals to customers or upon substantive renewal rates quoted in the
agreements. The fair values for services, such as training or consulting, are based upon prices of these services when sold separately to other customers. Deferred revenue is primarily comprised of undelivered maintenance services and in some cases
hardware and other products delivered but not yet accepted. When software licenses are sold with professional services and such services are deemed essential to the functionality of the software, combined software and service revenue is recognized
as the services are performed. When software licenses are sold with professional services and such services are not considered essential to the functionality of the software, software revenue is recognized when the above criteria are met and service
revenue is recognized as the services are performed.



Intangible Assets



Goodwill represents the
excess of purchase price and related costs over the value assigned to the net tangible and identifiable intangible assets of businesses acquired. Goodwill is not amortized but is tested at least annually for impairment. Other intangible assets are
amortized on a straight-line basis over their estimated useful lives, ranging from less than one year to five years.



The determination of the fair value of certain acquired assets and liabilities is subjective in nature and often involves the use of significant estimates
and assumptions. Determining the fair values and useful lives of intangible assets especially requires the exercise of judgment. While there are a number of different generally accepted valuation methods to estimate the value of intangible assets
acquired, the Company primarily used the discounted cash flow method. This method requires significant management judgment to forecast the future operating results used in the analysis. In addition, other significant estimates are required, such as
residual growth rates and discount factors. The estimates that the Company has used are consistent with the plans and estimates that the Company uses to manage its business, based on available historical information and industry averages. The
judgments made in determining the estimated useful lives assigned to each class of assets acquired can also significantly affect the Companys net operating results. Amortization of purchased intangibles is expected to be $2.6 million, $1.9
million, $0.7 million, $0.3 million and $0.2 million for the years ending December 31, 2004, 2005, 2006, 2007 and 2008 and thereafter, respectively.



In addition, the value of the Companys intangible assets, including goodwill, is subject to future impairments if the Company experiences declines
in operating results or negative industry or economic trends or if the Companys future performance is below the Companys projections and estimates.



Valuation of Goodwill



The Company assesses the impairment of goodwill whenever events or changes in circumstances indicate that the carrying value may not be recoverable.
Impairment is reviewed at least annually.



Important factors
that could trigger an impairment, include the following:



| |  | significant underperformance relative to historical or projected future operating results;
| | - | ------------------------------------------------------------------------------------------



| |  | significant changes in the manner of the Companys use of the acquired assets or the strategy for the Companys overall business;
| | - | ---------------------------------------------------------------------------------------------------------------------------------



| |  | significant negative industry or economic trends;
| | - | -------------------------------------------------



| |  | significant decline in the Companys stock price for a sustained period; and
| | - | ----------------------------------------------------------------------------



| |  | decreased market capitalization relative to net book value.
| | - | -----------------------------------------------------------



8



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CAPTIVA SOFTWARE CORPORATION



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS(Continued)

(UNAUDITED)



When there is an indication that the carrying value of goodwill may not be recoverable based upon the
existence of one or more of the above indicators, an impairment loss would be recognized if the carrying amount exceeds its fair value. The Company performed its annual impairment review during the quarter ended June 30, 2004 and determined there
was no impairment.



Offering Costs



On April 12, 2004, the Company filed a registration statement (the
Registration Statement) with the Securities and Exchange Commission (SEC) to register shares of the Companys common stock in preparation for an underwritten public offering. In May 2004, the Company decided not to proceed with the underwritten
public offering, withdrew this Registration Statement and wrote off $0.2 million of costs incurred in the registration process and initially deferred in connection with the anticipated offering.



Stock-Based Compensation



The Company has elected to utilize the intrinsic value method to account for
its employee stock option plans. When the exercise price of the Companys employee stock options equals the fair value price of the underlying stock on the date of grant, no compensation expense is recognized in the Companys financial
statements. Compensation expense for options granted to non-employees is determined in accordance with Statement of Financial Accounting Standards (SFAS) No. 123 and Emerging Issues Task Force (EITF) No. 96-18 as the fair value of the
consideration received or the fair value of the equity instruments issued, whichever is more reliably measured. Deferred charges for options granted to non-employees are periodically remeasured as the underlying options vest.



Had compensation cost for the Companys stock-based compensation to
employees been determined based on the fair value method, the amount of stock-based employee compensation cost and the Companys pro forma results would have been as indicated below (in thousands, except per share data):



|                                                                                         |  |                            |           |   |                           |   |           |      |  |   |           |   |  |   |           |  
|---------------------------------------------------------------------------------------- |  | -------------------------- | --------- | - | ------------------------- | - | --------- | ---- |  | - | --------- | - |  | - | --------- | -
|                                                                                         |  | Three Months EndedJune 30, |           |   | Six Months Ended June 30, |  
|                                                                                         |  | 2004                       |           |   | 2003                      |   |           | 2004 |  |   | 2003      |  
|Net income as reported                                                                   |  | $                          | 861       |   |                           | $ | 301       |      |  | $ | 1,338     |   |  | $ | 383       |  
|Stock-based employee compensation cost, net of tax, utilizing the intrinsic value method |  |                            |          |   |                           |   |          |      |  |   |          |   |  |   |          |  
|Stock-based employee compensation cost, net of tax, utilizing the fair value method      |  |                            | (726      | ) |                           |   | (146      | )    |  |   | (1,228    | ) |  |   | (334      | )
|                                                                                         |  |                            |           |   |                           |   |           |      |  |   |           |   |  |   |           |  
|Pro forma net income under SFAS No. 123                                                  |  | $                          | 135       |   |                           | $ | 155       |      |  | $ | 110       |   |  | $ | 49        |  
|                                                                                         |  |                            |           |   |                           |   |           |      |  |   |           |   |  |   |           |  
|Pro forma basic net income per share under SFAS No. 123                                  |  | $                          | 0.01      |   |                           | $ | 0.02      |      |  | $ | 0.01      |   |  | $ | 0.01      |  
|                                                                                         |  |                            |           |   |                           |   |           |      |  |   |           |   |  |   |           |  
|Pro forma diluted net income per share under SFAS No. 123                                |  | $                          | 0.01      |   |                           | $ | 0.01      |      |  | $ | 0.01      |   |  | $ | 0.00      |  
|                                                                                         |  |                            |           |   |                           |   |           |      |  |   |           |   |  |   |           |  
|Black-Scholes option pricing model assumptions:                                          |  |                            |           |   |                           |   |           |      |  |   |           |   |  |   |           |  
|Risk-free interest rate                                                                  |  |                            | 3.0       | % |                           |   | 2.0       | %    |  |   | 2.4       | % |  |   | 2.0       | %
|Expected life                                                                            |  |                            | 3.5 years |   |                           |   | 3.5 years |      |  |   | 3.5 years |   |  |   | 3.5 years |  
|Expected volatility                                                                      |  |                            | 100       | % |                           |   | 100       | %    |  |   | 100       | % |  |   | 100       | %
|Expected dividend yield                                                                  |  |                            | 0         | % |                           |   | 0         | %    |  |   | 0         | % |  |   | 0         | %



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CAPTIVA SOFTWARE CORPORATION



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS(Continued)

(UNAUDITED)



Reclassifications



Certain prior period items have been reclassified to conform with the current periods presentation. These
reclassifications had no impact on total assets, net revenues, operating income or net income as previously reported.



2.    Acquisition of ADP Context, Inc.



On February 1, 2004, the Company completed the acquisition of ADP Context, Inc., an Illinois corporation (Context). The Context products complement the
Companys existing ClaimPack product line and enhance the Companys product offerings to its claim processing customers. The Context product line also allows the Company to extend its reach into the provider side of the healthcare market.
The acquisition was effected in accordance with a stock purchase agreement dated as of February 1, 2004 by and among the Company, ADP Integrated Medical Solutions, a Delaware corporation (ADP), and ADP Claims Solutions Group, Inc. (CSG), pursuant to
which the Company purchased all of the issued and outstanding capital stock of Context from ADP and paid to ADP approximately $5.3 million in immediately available cash (including a final cash payment of approximately $0.2 million which was paid to
ADP in the second quarter of 2004). The sole source of the cash consideration the Company paid in the acquisition was the Companys cash and cash equivalents. There were no material relationships between the Company or any of the Companys
affiliates, directors or officers, on the one hand, and ADP or CSG, on the other hand, at the time of the acquisition.



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



|                                             |  |   |        |  
|-------------------------------------------- |  | - | ------ | -
|Identified intangibles                       |  | $ | 1,936  |  
|Goodwill                                     |  |   | 4,230  |  
|In-process research and development          |  |   | 66     |  
|Current assets                               |  |   | 1,452  |  
|Non-current assets                           |  |   | 133    |  
|Current liabilities                          |  |   | (1,778 | )
|Non-current liabilities                      |  |   | (580   | )
|Direct acquisition and equity issuance costs |  |   | (116   | )
|                                             |  |   |        |  
|Total consideration                          |  | $ | 5,343  |  
|                                             |  |   |        |  



In connection with the
acquisition, the Company wrote off the purchased in-process research and development of $0.1 million, which was charged to operations in the three months ended March 31, 2004. The results of operations of Context are included in the six months ended
June 30, 2004 starting from February 1, 2004, the date of acquisition. If the acquisition had occurred on January 1, 2003, pro forma financial information would have been as follows (in thousands, except per share information):



|                             |  |                            |        |                          |   |        |  |      |        |  |   |       
|---------------------------- |  | -------------------------- | ------ | ------------------------ | - | ------ |  | ---- | ------ |  | - | ------
|                             |  | Three Months EndedJune 30, |        | Six Months EndedJune 30,
|                             |  | (Actual) 2004              |        | 2003                     |   | 2004   |  | 2003
|Net revenues                 |  | $                          | 16,802 |                          | $ | 15,073 |  | $    | 33,097 |  | $ | 29,054
|Net income                   |  |                            | 861    |                          |   | 357    |  |      | 1,305  |  |   | 591   
|Basic net income per share   |  |                            | 0.07   |                          |   | 0.04   |  |      | 0.12   |  |   | 0.07  
|Diluted net income per share |  |                            | 0.07   |                          |   | 0.03   |  |      | 0.10   |  |   | 0.06  



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CAPTIVA SOFTWARE CORPORATION



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS(Continued)

(UNAUDITED)



3.    Composition of Certain Balance Sheet Captions (in thousands)



|                                               |  |              |        |   |                  |   |        |  
|---------------------------------------------- |  | ------------ | ------ | - | ---------------- | - | ------ | -
|                                               |  | June 30,2004 |        |   | December 31,2003 |  
|Accounts receivable, net:                      |  |              |        |   |                  |   |        |  
|Accounts receivable                            |  | $            | 11,021 |   |                  | $ | 11,556 |  
|Allowance for doubtful accounts                |  |              | (718   | ) |                  |   | (776   | )
|                                               |  |              |        |   |                  |   |        |  
|                                               |  | $            | 10,303 |   |                  | $ | 10,780 |  
|                                               |  |              |        |   |                  |   |        |  
|Prepaid expenses and other current assets:     |  |              |        |   |                  |   |        |  
|Purchased equipment inventory                  |  | $            | 6      |   |                  | $ | 1,258  |  
|Deferred taxes                                 |  |              | 689    |   |                  |   | 794    |  
|Other                                          |  |              | 1,365  |   |                  |   | 1,262  |  
|                                               |  |              |        |   |                  |   |        |  
|                                               |  | $            | 2,060  |   |                  | $ | 3,314  |  
|                                               |  |              |        |   |                  |   |        |  
|Property and equipment, net:                   |  |              |        |   |                  |   |        |  
|Office equipment and machinery                 |  | $            | 2,805  |   |                  | $ | 2,738  |  
|Computer software                              |  |              | 957    |   |                  |   | 914    |  
|Leasehold improvements                         |  |              | 121    |   |                  |   | 561    |  
|                                               |  |              |        |   |                  |   |        |  
|                                               |  |              | 3,883  |   |                  |   | 4,213  |  
|Less accumulated depreciation and amortization |  |              | (2,680 | ) |                  |   | (3,289 | )
|                                               |  |              |        |   |                  |   |        |  
|                                               |  | $            | 1,203  |   |                  | $ | 924    |  
|                                               |  |              |        |   |                  |   |        |  
|Other assets:                                  |  |              |        |   |                  |   |        |  
|Deferred taxes                                 |  | $            | 2,769  |   |                  | $ | 2,104  |  
|Other                                          |  |              | 306    |   |                  |   | 250    |  
|                                               |  |              |        |   |                  |   |        |  
|                                               |  | $            | 3,075  |   |                  | $ | 2,354  |  
|                                               |  |              |        |   |                  |   |        |  
|Accrued compensation and related liabilities:  |  |              |        |   |                  |   |        |  
|Accrued vacation                               |  | $            | 1,404  |   |                  | $ | 1,118  |  
|Other                                          |  |              | 1,440  |   |                  |   | 1,675  |  
|                                               |  |              |        |   |                  |   |        |  
|                                               |  | $            | 2,844  |   |                  | $ | 2,793  |  
|                                               |  |              |        |   |                  |   |        |  



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CAPTIVA SOFTWARE CORPORATION



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS(Continued)

(UNAUDITED)



|                              |  |                     |       |                         |   |        |                   |  |   |      
|----------------------------- |  | ------------------- | ----- | ----------------------- | - | ------ | ----------------- |  | - | -----
|                              |  | GrossCarryingAmount |       | AccumulatedAmortization |   |        | NetCarryingAmount
|Intangible assets, net:       |  |                     |       |                         |   |        |                   |  |   |      
|June 30, 2004:                |  |                     |       |                         |   |        |                   |  |   |      
|Existing technology           |  | $                   | 5,820 |                         | $ | (3,215 | )                 |  | $ | 2,605
|Tradename and trademarks      |  |                     | 766   |                         |   | (268   | )                 |  |   | 498  
|Core technology               |  |                     | 551   |                         |   | (264   | )                 |  |   | 287  
|Maintenance agreements        |  |                     | 479   |                         |   | (306   | )                 |  |   | 173  
|Channel partner relationships |  |                     | 148   |                         |   | (77    | )                 |  |   | 71   
|Customer lists                |  |                     | 810   |                         |   | (67    | )                 |  |   | 743  
|Patents                       |  |                     | 92    |                         |   | (35    | )                 |  |   | 57   
|                              |  |                     |       |                         |   |        |                   |  |   |      
|                              |  | $                   | 8,666 |                         | $ | (4,232 | )                 |  | $ | 4,434
|                              |  |                     |       |                         |   |        |                   |  |   |      
|December 31, 2003:            |  |                     |       |                         |   |        |                   |  |   |      
|Existing technology           |  | $                   | 4,813 |                         | $ | (2,273 | )                 |  | $ | 2,540
|Tradename and trademarks      |  |                     | 679   |                         |   | (193   | )                 |  |   | 486  
|Core technology               |  |                     | 551   |                         |   | (195   | )                 |  |   | 356  
|Maintenance agreements        |  |                     | 479   |                         |   | (226   | )                 |  |   | 253  
|Channel partner relationships |  |                     | 116   |                         |   | (55    | )                 |  |   | 61   
|Patents                       |  |                     | 92    |                         |   | (26    | )                 |  |   | 66   
|                              |  |                     |       |                         |   |        |                   |  |   |      
|                              |  | $                   | 6,730 |                         | $ | (2,968 | )                 |  | $ | 3,762
|                              |  |                     |       |                         |   |        |                   |  |   |      



4.    Computation of Net Income Per Share



Basic net income 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 net income per share is computed
giving effect to all dilutive potential common shares that were outstanding during the period. Dilutive potential common shares consist of incremental common shares issuable upon exercise of stock options and warrants.



Dilutive securities include options subject to vesting on an
as-if-converted-to-common stock basis. Dilutive securities of 1.6 million shares and 1.8 million shares are included in the diluted earnings per share calculation for the three and six months ended June 30, 2004, respectively. Dilutive securities of
1.3 million shares and 0.9 million shares are included in the diluted earnings per share calculation for the three and six months ended June 30, 2003, respectively. Potentially dilutive securities totaling 0.7 million shares and 0.5 million shares
for the three and six months ended June 30, 2004, respectively, and 1.0 million shares and 2.0 million shares for the three and six months ended June 30, 2003, respectively, were excluded from basic and diluted earnings per share because of their
anti-dilutive effect.



5.    Comprehensive Income



Comprehensive income consists of the following components
(in thousands):



|                                        |  |                           |     |   |                         |   |     |      |  |   |       |   |  |   |    
|--------------------------------------- |  | ------------------------- | --- | - | ----------------------- | - | --- | ---- |  | - | ----- | - |  | - | ---
|                                        |  | Three MonthsEndedJune 30, |     |   | Six MonthsEndedJune 30,
|                                        |  | 2004                      |     |   | 2003                    |   |     | 2004 |  |   | 2003 
|Foreign currency translation adjustment |  | $                         | (18 | ) |                         | $ | (55 | )    |  | $ | (31   | ) |  | $ | 13 
|Net income as reported                  |  |                           | 861 |   |                         |   | 301 |      |  |   | 1,338 |   |  |   | 383
|                                        |  |                           |     |   |                         |   |     |      |  |   |       |   |  |   |    
|Total comprehensive income              |  | $                         | 843 |   |                         | $ | 246 |      |  | $ | 1,307 |   |  | $ | 396
|                                        |  |                           |     |   |                         |   |     |      |  |   |       |   |  |   |    



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CAPTIVA SOFTWARE CORPORATION



NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS(Continued)

(UNAUDITED)



6.    Line of Credit



The Company has a bank line of credit that will expire in August 2004. On June 30, 2004, there was no outstanding principal
balance under the line of credit. Borrowings under the line of credit are limited to the lesser of $3.0 million or 80% of eligible accounts receivable. Any outstanding balances under the line of credit would bear interest at the banks prime
rate plus 0.5%. The line of credit is collateralized by all assets of the Company. The Company is restricted from paying dividends under the terms of the line of credit. The line of credit includes various financial covenants related to the
Companys operating results. As of June 30, 2004 the Company was in compliance with all loan covenants.



7.    Income Taxes



The provision for income taxes for interim periods is based on estimated effective income tax rates for the year. The Companys estimated effective tax rate for 2004 is 39%, which was applied to the results for
the three and six months ended June 30, 2004. The Companys estimated effective income tax rate for 2004 differs from the U.S. federal statutory rate of 34% primarily due to state income taxes. The Companys estimated effective tax rate
for the three and six months ended June 30, 2003 was 40%.



8.    Business Segments and Geographic Reporting



The Company has a single reportable segment consisting of the development, marketing and servicing of input management software. Management uses one measurement of profitability and does not disaggregate its business
for internal reporting. Operations outside the United States primarily consist of sales offices of the Companys subsidiaries in the United Kingdom, Germany and Australia, which are responsible for sales to international customers. The
international subsidiaries do not carry any significant tangible long-lived assets, and the total assets of the Companys international subsidiaries were not significant for any period presented.



The following table presents revenue derived from domestic and international
sales, based on location of customer for the three and six months ended June 30, 2004 and 2003, respectively (in thousands, except percentage data):



|                                 |  |                            |        |   |                          |   |        |      |  |   |        |   |  |   |        |  
|-------------------------------- |  | -------------------------- | ------ | - | ------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                 |  | Three Months EndedJune 30, |        |   | Six Months EndedJune 30, |  
|                                 |  | 2004                       |        |   | 2003                     |   |        | 2004 |  |   | 2003   |  
|United States and Canada         |  | $                          | 12,937 |   |                          | $ | 10,376 |      |  | $ | 25,788 |   |  | $ | 20,401 |  
|% of total                       |  |                            | 77     | % |                          |   | 75     | %    |  |   | 79     | % |  |   | 77     | %
|International (excluding Canada) |  | $                          | 3,865  |   |                          | $ | 3,506  |      |  | $ | 6,876  |   |  | $ | 6,085  |  
|% of total                       |  |                            | 23     | % |                          |   | 25     | %    |  |   | 21     | % |  |   | 23     | %



9.    Guarantees



The
Company provides indemnifications of varying scope to customers against claims of intellectual property infringement made by third parties arising from the use of the Companys products. To date, the Company has not encountered material costs
as a result of such obligations and has not accrued any liabilities related to such indemnifications in its financial statements.



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Item 2Managements Discussion and Analysis of Financial Condition and Results of Operations



Forward-Looking Statements



This Quarterly Report on Form 10-Q contains forward-looking statements. These statements relate to future events or our future financial performance.
In some cases, you can identify forward-looking statements by 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, press releases and other communications.



Although we believe that the estimates and expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results,
levels of activity, performance or achievements. We assume no obligation to update any of the forward-looking statements contained in this 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 (EDI). These traditional approaches are typically labor intensive, time consuming and costly methods of managing the input of information
into the enterprise. Organizations can utilize our products to capture information digitally, extract the meaningful content or data, and apply business rules that ensure the datas accuracy.



In the three and six months ended June 30, 2004, our revenues increased to
$16.8 million and $32.7 million, respectively, from $13.9 million and $26.5 million in the three and six months ended June 30, 2003, respectively. In addition, in the three and six months ended June 30, 2004, our net income increased to $0.9 million
and $1.3 million, respectively, from $0.3 million and $0.4 million in the three and six months ended June 30, 2003, respectively.



On July 31, 2002, ActionPoint, Inc. merged with Captiva Software Corporation, a California corporation. As a result of this transaction, Old Captiva
became a wholly-owned subsidiary of ActionPoint, and ActionPoint changed its name to Captiva Software Corporation and remained a Delaware corporation.



On February 1, 2004, we completed the acquisition of all of the issued and outstanding capital stock of Context for approximately $5.2 million of cash
derived from our existing cash and cash equivalents. We made a final cash payment of approximately $0.2 million in the second quarter of 2004. Under generally accepted accounting principles, the results of operations of Context are included in our
results of operations for the six months ended June 30, 2004 starting from February 1, 2004. The Context products complement our existing ClaimPack product line and enhance our product offerings to our claim processing customers. The Context product
line also allows us to extend our reach into the provider side of the healthcare market. We are not planning to make significant changes to Contexts cost structure, and we expect both our consolidated revenues and expenses to increase in the
future as a result of this acquisition.



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Critical Accounting Policies and Estimates



A critical accounting policy is one that is both important to the portrayal of a companys financial condition or
results of operations and requires significant judgment or complex estimation processes. We believe that the following accounting policies fit this definition:



Revenue Recognition



Our revenue is generated primarily from three sources: (i) software, primarily software license revenue, software subscription license revenue, which
includes subscriptions to information databases, and royalty revenue, (ii) services, including software license maintenance fees, training fees and professional services revenue and (iii) hardware and other products, primarily sales of digital
scanners in the three and six months ended June 30, 2004 and 2003. Software license revenue is recognized upon shipment provided that persuasive evidence of an arrangement exists, fees are fixed or determinable, collection is probable and no
significant undelivered obligations remain. Software subscription license revenue is recognized over the term of the license, generally twelve months. Royalty revenue is recognized when our resellers ship or pre-purchase rights to ship products
incorporating our software, provided collection of the revenue is determined to be probable and we have no further obligations. Services revenue is recognized ratably over the period of the maintenance contract or as the services are provided.
Payments for maintenance fees are generally made in advance and are non-refundable. Revenue for hardware and other products is recognized when the following criteria are met: (i) persuasive evidence of an arrangement exists; (ii) delivery of the
products and/or services has occurred; (iii) the selling price is fixed or determinable and (iv) collectibility is reasonably assured.



For arrangements with multiple elements (e.g., delivered and undelivered products, maintenance and other services), we allocate revenue to each element of
the arrangement based on the fair value of the undelivered elements, which is specific to us, using the residual value method. The fair values for ongoing maintenance and support obligations are based upon separate sales of renewals to customers or
upon substantive renewal rates quoted in the agreements. The fair values for services, such as training or consulting, are based upon prices of these services when sold separately to other customers. Deferred revenue is primarily comprised of
undelivered maintenance services and in some cases hardware and other products delivered but not yet accepted. When software licenses are sold with professional services and those services are deemed essential to the functionality of the software,
combined software and service revenue is recognized as the services are performed. When software licenses are sold with professional services and those services are not considered essential to the functionality of the software, software revenue is
recognized when the above criteria are met and service revenue is recognized as the services are performed.



Intangible Assets



Goodwill represents the excess of purchase price and related costs over the value assigned to the net tangible and identifiable intangible assets of businesses acquired. Goodwill is not amortized, but is tested at least annually for
impairment. Other intangible assets are amortized on a straight-line basis over their estimated useful lives, ranging from less than one year to five years.



The determination of the fair value of certain acquired assets and liabilities is subjective in nature and often involves the use of significant estimates
and assumptions. Determining the fair values and useful lives of intangible assets especially requires the exercise of judgment. While there are a number of different generally accepted valuation methods to estimate the value of intangible assets
acquired, we primarily used the discounted cash flow method. This method requires significant management judgment in forecasting the future operating results used in the analysis. This method also requires other significant estimates, such as
residual growth rates and discount factors. The estimates we have used are consistent with the plans and estimates that we use to manage our business, based on available historical information and industry averages. The judgments made in determining
the estimated useful lives assigned to each class of assets acquired can significantly affect our net



15



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##### Table of Contents

operating results. Amortization of purchased intangibles is expected to be $2.6 million, $1.9 million, $0.7 million, $0.3 million and $0.2 million for
the years ending December 31, 2004, 2005, 2006, 2007 and 2008 and thereafter, respectively.



In addition, the value of our intangible assets, including goodwill, is subject to future impairment if we experience declines in operating results or negative industry or economic trends or if our future performance
is below our projections and estimates.



Valuation of Goodwill



We assess the impairment of goodwill whenever events
or changes in circumstances indicate that the carrying value may not be recoverable. Impairment is reviewed at least annually.



Factors we consider important that could trigger an impairment include the following:



| |  | significant underperformance relative to historical or projected future operating results;
| | - | ------------------------------------------------------------------------------------------



| |  | significant changes in the manner of our use of the acquired assets or the strategy for our overall business;
| | - | -------------------------------------------------------------------------------------------------------------



| |  | significant negative industry or economic trends;
| | - | -------------------------------------------------



| |  | significant declines in our stock price for a sustained period; and
| | - | -------------------------------------------------------------------



| |  | decreased market capitalization relative to our net book value.
| | - | ---------------------------------------------------------------



If there were an indication that the carrying value of goodwill might not be recoverable based upon the existence of one or more of the above indicators,
we would recognize an impairment loss if the carrying value exceeds its fair value. We performed our annual impairment review during the quarter ended June 30, 2004 and determined there was no impairment.



Income Tax Valuation Allowance



On a quarterly basis, management evaluates the realizability of our net
deferred tax assets and assesses the need for a valuation allowance. Realization of our net deferred tax assets is dependent on our ability to generate sufficient future taxable income. The amount of the net deferred tax assets actually realized
could vary if there are differences in the timing or amount of future reversals of existing deferred tax liabilities or changes in the actual amounts of future taxable income. If we do not generate our forecasted taxable income, we may be required
to establish a valuation allowance against all or part of our net deferred tax assets based upon applicable accounting criteria. To the extent we establish a valuation allowance, an expense will be recorded within the provision for income taxes line
in our Statement of Operations. As of June 30, 2004, management has determined that it is more likely than not that our net deferred tax assets will be realized based on forecasted taxable income.



Results of Operations



Three Months Ended June 30, 2004 and 2003



Revenues



Total revenues increased 21% in the three months ended June 30, 2004 to $16.8 million from $13.9 million in the three months ended June 30, 2003.



Our software revenues increased 24% in the three months ended
June 30, 2004 to $8.4 million from $6.8 million in the three months ended June 30, 2003. As a percentage of total revenues, software revenues accounted for 50% in the three months ended June 30, 2004 and 49% in the three months ended June 30, 2003.
The increase in software revenues in absolute terms was attributable to both the acquisition of Context and an increase in sales



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of non-Context products. The increase in software revenues as a percentage of total revenues was primarily attributable to the increase in software revenues
in absolute terms and the decrease in hardware and other revenues in absolute terms and as a percentage of total revenues in the three months ended June 30, 2004 compared to the three months ended June 30, 2003.



Our service revenues increased 33% in the three months ended June 30, 2004 to
$6.9 million from $5.2 million in the three months ended June 30, 2003. As a percentage of total revenues, services accounted for 41% in the three months ended June 30, 2004 and 37% in the three months ended June 30, 2003. The increase in service
revenues in absolute terms reflects both a growing installed base of customers, most of which purchase ongoing software maintenance support, and a growth in professional services revenues in the three months ended June 30, 2004 compared to the three
months ended June 30, 2003. The increase in service revenues as a percentage of total revenues was primarily attributable to the increase in service revenues in absolute terms and the decrease in hardware and other revenues in absolute terms and as
a percentage of total revenues in the three months ended June 30, 2004.



Our hardware and other revenues decreased 22% in the three months ended June 30, 2004 to $1.5 million from $1.9 million in the three months ended June 30, 2003. As a percentage of total revenues, hardware and other revenues accounted for 9%
in the three months ended June 30, 2004 and 14% in the three months ended June 30, 2003. The decrease in hardware and other revenues in absolute terms and as a percentage of total revenues reflects a decrease in sales of digital scanners.



Gross Profit



Gross profit increased 31% in the three months ended June 30, 2004 to $11.2
million from $8.6 million in the three months ended June 30, 2003. Gross profit as a percentage of total revenues increased to 67% in the three months ended June 30, 2004 from 62% in the three months ended June 30, 2003. The increase in gross profit
as a percentage of total revenues was due to a combination of the decrease in hardware and other revenues, which have lower gross margins than software and service revenues, and a leveraging of our existing professional services and maintenance
support services infrastructure which kept services cost of revenues for the three months ended June 30, 2004 consistent with the three months ended June 30, 2003, while services revenues increased 33% in the three months ended June 30, 2004
compared to the three months ended June 30, 2003.



Research
and Development



Research and development expenses
increased 19% in the three months ended June 30, 2004 to $2.5 million from $2.1 million in the three months ended June 30, 2003. As a percentage of total revenues, research and development expenses were 15% in both the three months ended June 30,
2004 and 2003. The increase in research and development expenses in absolute terms was primarily attributable to the acquisition of Context which resulted in increases in headcount and related labor costs. The consistency in research and development
expenses as a percentage of total revenues was due to the increase in absolute terms being offset by the increase in total revenues in the three months ended June 30, 2004 compared to the three months ended June 30, 2003. We expect research and
development expenses to continue to increase in absolute terms in 2004 as we continue to expand our research and development staff to support the development of new products and enhancements to current products.



Sales and Marketing



Sales and marketing expenses increased 20% in the three months ended June
30, 2004 to $5.4 million from $4.5 million in the three months ended June 30, 2003. As a percentage of total revenues, sales and marketing expenses were 32% in the three months ended June 30, 2004 and 33% in the three months ended June 30, 2003. The
increase in sales and marketing expenses in absolute terms was due to an expansion of our sales force and higher commissions and related sales costs resulting from the growth in revenues, partially offset by $0.2 million



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of expenses incurred in the second quarter of 2003 related to a large trade show that took place in the first quarter of 2004 instead of in the second
quarter of 2004. The expansion of our sales force includes the Context sales force acquired in the first quarter of 2004. The decrease in sales and marketing expenses as a percentage of total revenues was due to the increase in absolute terms being
more than offset by the increase in total revenues in the three months ended June 30, 2004 compared to the three months ended June 30, 2003. We expect sales expenses to continue to increase in absolute terms in 2004 as we continue to add to our
sales force and experience continued revenue growth.



General and Administrative



General and
administrative expenses increased 19% in the three months ended June 30, 2004 to $1.7 million from $1.4 million in June 30, 2003. As a percentage of total revenues, general and administrative expenses were 10% in both the three months ended June 30,
2004 and 2003. The increase in general and administrative expenses in absolute terms was primarily due to the acquisition of Context which resulted in increases in headcount and related labor costs in the three months ended June 30, 2004 compared to
the three months ended June 30, 2003. The consistency in general and administrative expenses as a percentage of total revenues was due to the increase in absolute terms being offset by the increase in total revenues in the three months ended June
30, 2004 compared to the three months ended June 30, 2003.



Write-off of Withdrawn Stock Offering Costs



On April 12, 2004, we filed a Registration Statement with the Securities and Exchange Commission (SEC) to register shares of our common stock in preparation for an underwritten public offering. In May 2004, the Company decided not to
proceed with the underwritten public offering, withdrew this Registration Statement and wrote off $0.2 million of costs incurred in the registration process and initially deferred in connection with the anticipated offering.



Provision for Income Taxes



In the three months ended June 30, 2004, we recorded a tax provision of $0.6
million, which represented an effective tax rate of 39%. In the three months ended June 30, 2003, we recorded a tax provision of $0.2 million, which represented an effective tax rate of 40%.



Six Months Ended June 30, 2004 and 2003



Revenues



Total revenues increased 23% in the six months ended June 30, 2004 to $32.7
million from $26.5 million in the six months ended June 30, 2003.



Our software revenues increased 22% in the six months ended June 30, 2004 to $15.1 million from $12.4 million in the six months ended June 30, 2003. As a percentage of total revenues, software revenues accounted for 46% in the six months
ended June 30, 2004 and 47% in the six months ended June 30, 2003. The increase in software revenues in absolute terms was attributable to the acquisition of Context and an increase in sales of non-Context products. The decrease in software revenues
as a percentage of total revenues was primarily attributable to the increase in service revenues as a percentage of total revenues in the six months ended June 30, 2004.



Our service revenues increased 27% in the six months ended June 30, 2004 to $13.8 million from $10.9 million in the six
months ended June 30, 2003. As a percentage of total revenues, services accounted for 42% in the six months ended June 30, 2004 and 41% in the six months ended June 30, 2003. The increase in service revenues in absolute terms and as a percentage of
total revenues reflects both a growing installed base of customers, most of which purchase ongoing software maintenance support, and a growth in professional services revenues in the six months ended June 30, 2004 compared to the six months ended
June 30, 2003.



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Our hardware and other revenues increased 16% in the six months ended June 30, 2004 to $3.8 million from
$3.2 million in the six months ended June 30, 2003. As a percentage of total revenues, hardware and other revenues accounted for 11% in the six months ended June 30, 2004 and 12% in the six months ended June 30, 2003. The increase in hardware and
other revenues in absolute terms reflects an increase in sales of digital scanners. The decrease in hardware and other revenues as a percentage of total revenues is due to the higher software and services revenues in the six months ended June 30,
2004 compared to the six months ended June 30, 2003.



Gross
Profit



Gross profit increased 27% in the six months ended
June 30, 2004 to $21.2 million from $16.6 million in the six months ended June 30, 2003. Gross profit as a percentage of total revenues increased to 65% in the six months ended June 30, 2004 from 63% in the three months ended June 30, 2003. The
increase in gross profit as a percentage of total revenues was due to a leveraging of our existing professional services and maintenance support services infrastructure which kept services cost of revenues for the six months ended June 30, 2004
consistent with the six months ended June 30, 2003, while services revenues increased 27% in the six months ended June 30, 2004 compared to the six months ended June 30, 2003. This increase was partially offset by both an increase in hardware and
other revenues, which have lower gross margins than software and service revenues, and an increase in intangibles amortization of approximately $0.2 million in the six months ended June 30, 2004 compared to the six months ended June 30, 2003 related
to the Context acquisition



Research and Development



Research and development expenses increased 23% in the
six months ended June 30, 2004 to $5.2 million from $4.2 million in the six months ended June 30, 2003. As a percentage of total revenues, research and development expenses were 16% in both the six months ended June 30, 2004 and 2003. The increase
in research and development expenses in absolute terms was primarily attributable to the acquisition of Context which resulted in increases in headcount and related labor costs and was also attributable to an increase of approximately $0.2 million
related to localizing products for international markets. The consistency in research and development expenses as a percentage of total revenues was due to the increase in absolute terms being offset by the increase in total revenues in the six
months ended June 30, 2004 compared to the six months ended June 30, 2003. We expect research and development expenses to continue to increase in absolute terms in 2004 as we continue to expand our research and development staff to support the
development of new products and enhancements to current products.



Sales and Marketing



Sales and marketing
expenses increased 20% in the six months ended June 30, 2004 to $10.6 million from $8.9 million in the six months ended June 30, 2003. As a percentage of total revenues, sales and marketing expenses were 33% in the six months ended June 30, 2004 and
34% in the six months ended June 30, 2003. The increase in sales and marketing expenses in absolute terms was due to an expansion of our sales force and higher commissions and related sales costs resulting from the growth in revenues. The expansion
of our sales force includes the Context sales force acquired in the first quarter of 2004. The decrease in sales and marketing expenses as a percentage of total revenues was due to the increase in absolute terms being more than offset by the
increase in total revenues in the six months ended June 30, 2004 compared to the six months ended June 30, 2003. We expect sales expenses to continue to increase in absolute terms in 2004 as we continue to expand our sales force and experience
continued revenue growth.



General and Administrative



General and administrative expenses increased 2% in the
six months ended June 30, 2004 to $3.0 million from $2.9 million in the six months ended June 30, 2003. As a percentage of total revenues, general and



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administrative expenses decreased to 9% in the six months ended June 30, 2004 from 11% in the six months ended June 30, 2003. The increase in general and
administrative expenses in absolute terms was primarily due to the acquisition of Context which resulted in increases in headcount and related labor costs in the six months ended June 30, 2004 compared to the six months ended June 30, 2003,
partially offset by a decrease in professional fees of $0.1 million in the six months ended June 30, 2004 compared to the six months ended June 30, 2003. The decrease in general and administrative expenses as a percentage of total revenues was due
to the increase in absolute terms being more than offset by the increase in total revenues in the six months ended June 30, 2004 compared to the six months ended June 30, 2003.



Merger Costs



Merger costs relate to the merger of ActionPoint, Inc. and Old Captiva. In the six months ended June 30, 2003, we recorded sublease receipts in excess of
estimated receipts of $44,000 related to an excess lease obligation recorded upon the merger.



Write-off of Withdrawn Stock Offering Costs



On April 12, 2004, we filed a Registration Statement with the SEC to register shares of our common stock in preparation for an underwritten public offering. In May 2004, the Company decided not to proceed with the
underwritten public offering, withdrew this Registration Statement and wrote off $0.2 million of costs incurred in the registration process and initially deferred in connection with the anticipated offering.



Provision for Income Taxes



In the six months ended June 30, 2004, we recorded a tax provision of $0.9
million, which represented an effective tax rate of 39%. In the six months ended June 30, 2003, we recorded a tax provision of $0.3 million, which represented an effective tax rate of 40%.



Liquidity and Capital Resources



At June 30, 2004, we had cash and cash equivalents of $19.2 million,
compared to $16.0 million at December 31, 2003. In the six months ended June 30, 2004 we completed the acquisition of all of the issued and outstanding capital of Context for $5.5 million in cash derived from our existing cash and cash equivalents.
The $5.5 million included $0.1 million of direct costs of the Context acquisition.



Net cash provided by operating activities was $5.1 million in the six months ended June 30, 2004 and $1.4 million in the six months ended June 30, 2003. The net cash provided by operating activities in the six months
ended June 30, 2004 was primarily attributable to net income of $1.3 million, depreciation and amortization of $1.5 million, and a decrease in other current assets and other assets of $1.2 million, offset by net decreases in liabilities and deferred
revenue of $1.7 million. In addition, the tax benefit of $2.2 million related to stock option deductions had a positive effect on our net cash provided by operating activities and could continue to have a positive effect if stock options continue to
be exercised.



Net cash used in investing activities was $5.9
million in the six months ended June 30, 2004 and $0.2 million in the six months ended June 30, 2003. The increase in net cash used in investing activities in the six months ended June 30, 2004 compared to the six months ended June 30, 2003 was
primarily attributable to the $5.5 million used in the acquisition of Context.



Net cash provided by financing activities was $3.9 million in the six months ended June 30, 2004 compared to net cash provided by financing activities of $0.5 million in the six months ended June 30, 2003. The
increase in net cash provided by financing activities in the six months ended June 30, 2004 compared to the six months ended June 30, 2003 was primarily attributable to the $3.1 million increase in proceeds from the exercise of common stock
options and the sale of common stock under our employee stock purchase plan period over period. In the



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future, we expect to generate further net cash from financing activities from the sale of common stock under our employee stock purchase plan and the
exercise of stock options.



We have a bank line of credit that
will expire in August 2004. On June 30, 2004, there was no outstanding principal balance under the line of credit. Borrowings under the line of credit are limited to the lesser of $3.0 million or 80% of eligible accounts receivable. Any outstanding
balances under the line of credit would bear interest at the banks prime rate plus 0.5%. The line of credit is secured by all assets of the Company. The line of credit restricts us from paying dividends on our common stock. The line of credit
also includes various financial covenants related to our operating results. As of June 30, 2004, we were in compliance with all loan covenants. We expect to renew the line of credit prior to its expiration, however, there is no assurance that we
will be able to do so on comparable terms or at all.



Our
principal sources of liquidity are cash and cash equivalents, as well as expected cash flows from operations and the line of credit. We may also continue to receive and use proceeds from the sale of common stock under our employee stock purchase
plan and the exercise of stock options. We believe that our cash, cash equivalents and cash flows from operations will be sufficient to meet our liquidity and capital requirements for at least the next 12 months. We may, however, seek additional
equity or debt financing to fund further expansion. There can be no assurance that additional financing will be available on terms favorable to us or at all.



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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;
| | - | --------------------------------------------------------------------------------------



| |  | 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
future performance. In addition, we may from time to time provide estimates of our future performance. For example, we typically estimate that the first quarter of each year is our weakest quarter and the fourth quarter of each year is our strongest
quarter. Estimates are inherently uncertain, and actual results are likely to deviate, perhaps substantially, from our estimates as a result of the many risks and uncertainties in our business, including, but not limited to, those set forth in these
risk factors. We 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 currently operate with virtually no software order backlog because our software products are shipped shortly after orders are received. This fact makes software revenues in any quarter substantially dependent on
orders booked and shipped throughout that quarter. In addition, a large portion of our orders tend to be booked late in each quarter and we obtain a significant portion of our revenues from indirect sales channels over which we have little control.
The combination of these factors makes our revenues difficult to predict from period to period. Expense levels are based to a significant extent on expectations of future revenues and are relatively fixed in the short term. If revenue levels are
below expectations, our operating results could be harmed.



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



Our products and technologies are complex, and we are substantially dependent
upon the continued service of existing key management, sales and marketing, professional services, technical support and research and



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development personnel. All of these key employees are employees at will and can resign at any time. The loss of the services of one or more of
these key employees could slow product development processes or sales and marketing efforts or otherwise harm our business.



A significant aspect of our ability to attract and retain highly qualified employees is the equity compensation that we offer, typically in the form of
stock options. Bills are currently pending before Congress, and the Financial Accounting Standards Board has issued an Exposure Draft, that would require companies to include in their 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.



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



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



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



The input management software industry is currently fragmented and extremely
competitive, with no one company having a significant market share. We expect that competition in this industry will intensify in the future. The market for forms processing and document capture solutions is very competitive and subject to rapid
change. In addition, because there are relatively low barriers to entry into the software market, we may encounter 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



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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 through particular reseller
partners. Accordingly, new competitors or competitive cooperative relationships may emerge and rapidly gain significant market share. Contributing to these challenges, our industry is subject to consolidation, which could subject us to competition
with larger companies offering integrated solutions and a 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 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 need to increase our customer base to grow 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 departmental basis or for limited form or document types. These customers may not choose to purchase additional licenses to expand their use of our products. If this occurs, or if existing customers fail to renew services
or maintenance contracts, then our revenues from new customers may not be sufficient to offset this and enable us to sustain our current revenue levels.



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



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



We currently expect to release a number of new products and enhancements to existing products in 2004 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 only recently become profitable, with net income of $1.3 million for
the six months ended June 30, 2004 and $2.6 million for the year ended December 31, 2003. We incurred a net loss of $0.5 million in 2002 and $1.9 million in 2001. Given the competitive and evolving nature of the industry in which we operate, we may
not be able to sustain or increase profitability on a quarterly or annual basis, which would likely cause our stock price to decline.



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



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



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



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



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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 end-user 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 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 and Australia. For the six months ended June 30, 2004 and
2003, international sales represented approximately 21% and 23% 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 channel 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;
| | - | ---------------------------------------------------------------------



| |  | 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,



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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 systems integrators and other resellers, and we may not be able to maintain our
existing relationships or form new relationships. Competitors may have existing relationships with various 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. In particular, we are planning to begin
performing significant research and development outside of the United States, where intellectual property protection is less stringent than in the United States. In addition, our competitors might independently develop similar technology, duplicate
our products or circumvent any patents or other intellectual property rights that we may have. Due to rapid technological change in our market, we believe the various legal protections available for our intellectual property are of limited value.
Instead, we seek to establish and maintain a technology leadership position by leveraging the technological and creative skills of our personnel to create new products and enhancements to existing products.



We depend upon software that we license from and products provided by third parties, the
loss of which could harm our revenues.



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 have recently derived 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 or at all, in which case our operating results and financial condition would be harmed. In addition, we
have little control over the quality of these third-party products other than our decisions as to which products to resell.



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



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



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.



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. Development and awareness of our brands will depend largely on our success in increasing our customer base. In order to attract and retain customers and to promote and maintain our brands
in response to competitive pressures, 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. Failure in this regard could harm our business and results of operations.



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



Historically, we have derived substantially all of our revenues from the FormWare, InputAccel and PixTools product lines. Our future operating
results will depend heavily upon continued and widespread market acceptance for the FormWare, InputAccel and PixTools product lines and enhancements to those products. A decline in the demand for any of these product lines as a result of
competition, technological change or other factors may cause our revenues to decrease.



We may not be successful in our efforts to identify, execute or integrate acquisitions.



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



| |  | diversion of managements attention;
| | - | ------------------------------------



| |  | difficulty in integrating and absorbing the acquired business and its employees, corporate culture, managerial systems and processes, technology, products and services;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | failure to retain key personnel and employee turnover;
| | - | ------------------------------------------------------



| |  | challenges in retaining customers of the acquired business and customer dissatisfaction or performance problems with an acquired firm;
| | - | --------------------------------------------------------------------------------------------------------------------------------------



| |  | assumption of unknown liabilities;
| | - | ----------------------------------



| |  | dilutive issuances of securities or use of debt or limited cash;
| | - | ----------------------------------------------------------------



| |  | goodwill and potential impairment charges;
| | - | ------------------------------------------



| |  | write-offs and amortization expenses; and
| | - | -----------------------------------------



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



We may be unable to meet our future working capital requirements, which could harm our business.



We could experience negative cash flow from operations in the future and could require substantial working capital to fund
our business. We cannot be certain that financing will be available to us on favorable terms if and when required, or at all.



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



Many of our customers enter into
professional services and maintenance agreements, which together comprise a significant portion of our revenues. Service revenues represented 42% and 41% of our total revenues for the six months ended June 30, 2004 and 2003, respectively. The level
of service revenues in the future will depend largely upon growing our professional services group and ongoing renewals of customer maintenance contracts by our growing 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



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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.



Our
business resulted from the July 2002 merger of ActionPoint, Inc. and Old Captiva. This merger resulted in our recording approximately $13.0 million of goodwill and other intangible assets. In addition, we acquired Context in February 2004 that
resulted in our recording approximately $6.2 million of goodwill and other intangible assets. We expect amortization of purchased intangibles, which is included as part of our cost of revenues, to be $2.6 million, $1.9 million, $0.7 million, $0.3
million and $0.2 million for the years ending December 31, 2004, 2005, 2006, 2007 and 2008 and thereafter, respectively. These non-cash charges will negatively affect earnings during these amortization periods, which could 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;
| | - | --------------------------------------------------------



| |  | 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 the 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 SEC and by the Nasdaq National Market and new accounting pronouncements will result in increased costs to us as we evaluate the implications of these laws, regulations and standards and respond 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 standards. This investment may result in increased general and administrative expenses and a
diversion of management time and attention from strategic revenue generating and cost management activities. In addition, these new laws and regulations could make it more difficult or more costly for us to obtain certain types of insurance,
including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more
difficult for us to attract and retain qualified persons to serve on our board of directors, on our board committees or as executive officers. We are presently evaluating and monitoring developments with respect to these laws and regulations and
cannot predict or estimate the amount or timing of additional costs we may incur to respond to their requirements.



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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 market risk, default risk and reinvestment risk. We do not currently use, nor have we historically used, derivative financial instruments to manage or reduce market risk. We
mitigate default risk for our investments by investing in high credit quality securities such as debt instruments of the United States government and its agencies and high quality corporate issuers, as well as money market funds. Our investment
portfolio includes only marketable securities with active secondary or resale markets to ensure portfolio liquidity and maintains a prudent amount of diversification. As of June 30, 2004, we had approximately $19.2 million in cash and cash
equivalents.



We have significant international operations 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 gain or loss from transactions
denominated in foreign currencies. For the six months ended June 30, 2004, approximately 21% of our sales and approximately 16% of our operating expenses were denominated in currencies other than our functional currency, the United States dollar.
These foreign currencies were primarily British pounds, Euros 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



We maintain controls and procedures, which have been designed to ensure that material information related to Captiva Software Corporation, including its consolidated subsidiaries, is made known to management on a timely and consistent
basis. In response to recent legislation and proposed regulations, we have been reviewing our internal control structure and have established a disclosure committee, which consists of certain members of our management. Although we believe our
existing disclosure controls and procedures are effective and enable us to comply with our disclosure obligations, the review and documentation of our internal control structure is a process that will continue to evolve.



As of the end of the period covered by this report, the disclosure committee
carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer, Mr. Bish, and Chief Financial Officer, Mr. Russo, of the effectiveness of the design and operation of our
disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, Mr. Bish and Mr. Russo concluded that our disclosure controls and procedures are effective in causing material
information relating to us to be collected, communicated and analyzed by management on a timely basis and disclosed in a timely manner in compliance with SEC disclosure obligations.



Changes in Controls and Procedures



There was no change in our internal controls that occurred during the period covered by this report that has materially affected, or is reasonably likely
to affect, our internal controls over financial reporting.



PART IIOTHER INFORMATION



Item 1.    Legal Proceedings



None.



Item 2.    Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities



None.



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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, 2004 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 Captiva Software Corporations 2004 Equity Incentive Plan, which amends and restates Captiva Software Corporations 2003 New Executive Recruitment Stock Option Plan and increases the aggregate number of shares of common stock
authorized for issuance under the plan by 500,000 shares.



3. To ratify the selection by the Audit Committee of the Board of Directors of PricewaterhouseCoopers LLP as independent registered public accounting firm of Captiva Software Corporation for its fiscal year ending
December 31, 2004.



The results were as follows:



|                   |  |            |  |                   |  |           |  |                
|------------------ |  | ---------- |  | ----------------- |  | --------- |  | ---------------
|                   |  | For        |  | WithheldAuthority |  | Abstained |  | BrokerNon-Votes
|Proposal 1         |  |            |  |                   |  |           |  |                
|                   |  |            |  |                  
|Patrick L. Edsell  |  | 9,838,700  |  | 457,737           |  | 0         |  | 0              
|                   |  |            |  |                  
|Reynolds C. Bish   |  | 9,971,301  |  | 325,136           |  | 0         |  | 0              
|                   |  |            |  |                  
|James Berglund     |  | 9,967,267  |  | 329,170           |  | 0         |  | 0              
|                   |  |            |  |                  
|Mel S. Lavitt      |  | 9,856,100  |  | 440,337           |  | 0         |  | 0              
|                   |  |            |  |                  
|Jeffrey J. Lenches |  | 9,855,100  |  | 441,337           |  | 0         |  | 0              
|                   |  |            |  |                  
|Bruce Silver       |  | 9,978,667  |  | 317,770           |  | 0         |  | 0              
|                   |  |            |  |                  
|                   |  | For        |  | Against           |  | Abstained |  | BrokerNon-Votes
|                   |  |            |  |                  
|Proposal 2         |  | 3,532,169  |  | 3,867,186         |  | 107,975   |  | 2,789,107      
|                   |  |            |  |                  
|Proposal 3         |  | 10,264,662 |  | 22,530            |  | 9,245     |  | 0              



A more detailed
discussion of each matter is included in Captiva Software Corporations Proxy Statement for the 2004 Annual Meeting of Stockholders.



Item 5.    Other Information



None.



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Item 6.    Exhibits and Reports on Form 8-K



a. Exhibits



|              |  |                                                                                                                                                   
|------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description                                                                                                                                       
|10.1          |  | The registrants 2003 Recruitment Equity Incentive Plan (amends and restates the registrants 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.



b. Reports on Form 8-K



We filed a Current Report on Form 8-K on April 22, 2004 to
furnish disclosure of our unaudited financial information for the first quarter of 2004.



We filed a Current Report on Form 8-K on June 4, 2004 to disclose the departure of our Chief Technology Officer.



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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/s/    REYNOLDS C.
BISHReynolds C. Bish Chief Executive Officer/s/    RICK E.
RUSSORick E. Russo Chief Financial Officer




Date: August 6, 2004



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