##### Table of Contents



FORM 10-Q UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549
 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarter Ended: April 30, 2005
    
    Commission File Number: 000-23829
 DOCUCORP INTERNATIONAL, INC.   Delaware
    
    75-2690838(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer
identification number)
 5400 LBJ Freeway, Suite 300, Dallas, Texas
    
    75240(Address of principal executive offices)
    
    (Zip Code)
 (214) 891-6500(Registrants telephone number including area code)
 Not applicable(Former name, former address and former fiscal year, if changed since last report)
 Indicate by check mark whether the registrant (1) 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 þ No o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act). Yes þ No o Indicate the number of shares outstanding of each of the issuers classes of common stock, as
of the latest practicable date: Common Stock, $.01 par value, 11,101,364 shares outstanding as of
June 2, 2005.




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Docucorp International, Inc.
Table of Contents
Quarterly Report on Form 10-Q
April 30, 2005 PagePART I  FINANCIAL INFORMATIONItem 1. Financial Statements (Unaudited)Consolidated Balance Sheets as of April 30, 2005 and July 31, 2004
    
    
    2Interim Consolidated Statements of Operations and Comprehensive
Income for the three and nine months ended April 30,
2005 and 2004
    
    
    3Interim Consolidated Statements of Cash Flows for the nine months
ended April 30, 2005 and 2004
    
    
    4Notes to Interim Consolidated Financial Statements
    
    
    5Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    14Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    24Item 4. Controls and Procedures
    
    
    24PART II  OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    25Item 6. Exhibits
    
    
    25Signatures
    
    
    26Certification Pursuant to Rule 13a-14(a)Certification Pursuant to Rule 13a-14(a)Certification Pursuant to Section 906Certification Pursuant to Section 906




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Docucorp International, Inc. 
 Consolidated Balance Sheets
 (In thousands except share and per share amounts)
 (Unaudited)
 April 30,
    
    
    July 31,2005
    
    
    2004AssetsCurrent assets:Cash and cash equivalents
    
    $
    7,971
    
    
    $
    12,336Accounts receivable, net of allowance
of $462 and $375, respectively
    
    
    17,487
    
    
    
    16,752Current portion of deferred taxes
    
    
    112
    
    
    
    112Income tax receivable
    
    
    817
    
    
    
    817Other current assets
    
    
    2,688
    
    
    
    2,461Total current assets
    
    
    29,075
    
    
    
    32,478Property and equipment, net of accumulated depreciation
of $19,383 and $16,664, respectively
    
    
    9,963
    
    
    
    8,073Software development costs, net of accumulated
amortization of $24,882 and $22,096, respectively
    
    
    13,470
    
    
    
    12,269Goodwill
    
    
    9,738
    
    
    
    5,846Identifiable intangibles, net of accumulated amortization
of $64 and $0, respectively
    
    
    956
    
    
    
    0Other assets
    
    
    554
    
    
    
    573Total assets
    
    $
    63,756
    
    
    $
    59,239Liabilities and stockholders equityCurrent liabilities:Accounts payable
    
    $
    2,063
    
    
    $
    1,473Accrued liabilities:Accrued compensation
    
    
    2,210
    
    
    
    2,104Other
    
    
    1,919
    
    
    
    1,783Income taxes payable
    
    
    1,190
    
    
    
    158Current portion of capital lease obligations
    
    
    1,271
    
    
    
    626Current portion of long-term debt
    
    
    3,616
    
    
    
    3,550Deferred revenue
    
    
    11,283
    
    
    
    12,038Total current liabilities
    
    
    23,552
    
    
    
    21,732Deferred taxes
    
    
    4,835
    
    
    
    4,835Long-term capital lease obligations
    
    
    2,454
    
    
    
    1,716Long-term debt
    
    
    4,371
    
    
    
    6,804Other long-term liabilities
    
    
    1,662
    
    
    
    1,353Commitments and contingenciesStockholders equity:Preferred stock, $0.01 par value, 1,000,000 shares
authorized; none issued
    
    
    0
    
    
    
    0Common stock, $0.01 par value, 50,000,000 shares
authorized; 16,593,849 shares issued
    
    
    166
    
    
    
    166Additional paid-in capital
    
    
    47,959
    
    
    
    47,350Treasury stock at cost, 5,506,385 and 6,050,429 shares, respectively
    
    
    (30,611
    )
    
    
    (33,635
    )Retained earnings
    
    
    12,133
    
    
    
    9,821Unearned compensation
    
    
    (2,201
    )
    
    
    (402
    )Foreign currency translation adjustment
    
    
    (564
    )
    
    
    (501
    )Total stockholders equity
    
    
    26,882
    
    
    
    22,799Total liabilities and stockholders equity
    
    $
    63,756
    
    
    $
    59,239
 See accompanying notes to interim consolidated financial statements. 2




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##### Table of Contents



Docucorp International, Inc. 
 Interim Consolidated Statements of Operations and Comprehensive Income
 (In thousands except per share amounts)
 (Unaudited)
 Three months ended
    
    
    Nine months endedApril 30,
    
    
    April 30,2005
    
    
    2004
    
    
    2005
    
    
    2004RevenuesASP hosting
    
    $
    6,559
    
    
    $
    5,882
    
    
    $
    20,150
    
    
    $
    17,778Professional services
    
    
    5,246
    
    
    
    5,485
    
    
    
    16,227
    
    
    
    15,596License
    
    
    2,756
    
    
    
    1,814
    
    
    
    7,427
    
    
    
    7,606Maintenance
    
    
    5,218
    
    
    
    5,329
    
    
    
    15,935
    
    
    
    16,074Total revenues
    
    
    19,779
    
    
    
    18,510
    
    
    
    59,739
    
    
    
    57,054Cost of revenuesASP hosting
    
    
    6,092
    
    
    
    4,909
    
    
    
    17,858
    
    
    
    14,592Professional services
    
    
    4,169
    
    
    
    4,616
    
    
    
    12,502
    
    
    
    12,924License
    
    
    1,044
    
    
    
    868
    
    
    
    3,002
    
    
    
    2,296Maintenance
    
    
    393
    
    
    
    346
    
    
    
    1,120
    
    
    
    1,023Total cost of revenues
    
    
    11,698
    
    
    
    10,739
    
    
    
    34,482
    
    
    
    30,835Gross profit
    
    
    8,081
    
    
    
    7,771
    
    
    
    25,257
    
    
    
    26,219Operating expensesProduct development
    
    
    2,180
    
    
    
    1,858
    
    
    
    6,404
    
    
    
    6,046Sales and marketing
    
    
    3,040
    
    
    
    2,700
    
    
    
    8,817
    
    
    
    8,339General and administrative
    
    
    2,064
    
    
    
    1,800
    
    
    
    6,065
    
    
    
    5,199Total operating expenses
    
    
    7,284
    
    
    
    6,358
    
    
    
    21,286
    
    
    
    19,584Operating Income
    
    
    797
    
    
    
    1,413
    
    
    
    3,971
    
    
    
    6,635Interest expense
    
    
    (118
    )
    
    
    (149
    )
    
    
    (442
    )
    
    
    (481
    )Other income (expense), net
    
    
    82
    
    
    
    (53
    )
    
    
    326
    
    
    
    280Income before income taxes
    
    
    761
    
    
    
    1,211
    
    
    
    3,855
    
    
    
    6,434Provision for income taxes
    
    
    293
    
    
    
    504
    
    
    
    1,484
    
    
    
    2,671Net income
    
    $
    468
    
    
    $
    707
    
    
    $
    2,371
    
    
    $
    3,763Other comprehensive income:Foreign currency translation adjustment, net of tax
    
    
    (7
    )
    
    
    39
    
    
    
    (63
    )
    
    
    (162
    )Comprehensive income
    
    $
    461
    
    
    $
    746
    
    
    $
    2,308
    
    
    $
    3,601Basic net income per share
    
    $
    0.04
    
    
    $
    0.07
    
    
    $
    0.22
    
    
    $
    0.37Weighted average basic shares outstanding
    
    
    10,741
    
    
    
    10,359
    
    
    
    10,609
    
    
    
    10,050Diluted net income per share
    
    $
    0.04
    
    
    $
    0.06
    
    
    $
    0.21
    
    
    $
    0.33Weighted average diluted shares outstanding
    
    
    11,621
    
    
    
    11,720
    
    
    
    11,561
    
    
    
    11,328
 See accompanying notes to interim consolidated financial statements. 3




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Docucorp International, Inc. 
 Interim Consolidated Statements of Cash Flows
 (In thousands)
 (Unaudited)
 Nine months endedApril 30,2005
    
    
    2004Cash flows from operating activitiesNet income
    
    $
    2,371
    
    
    $
    3,763Adjustments to reconcile net income to
net cash provided by operating activities:Depreciation
    
    
    3,046
    
    
    
    2,598Amortization of software development costs
    
    
    2,786
    
    
    
    2,051Provision for doubtful accounts
    
    
    260
    
    
    
    399Tax benefit related to stock option exercises
    
    
    432
    
    
    
    1,785Stock-based compensation expense
    
    
    252
    
    
    
    44Changes in assets and liabilities:Increase in accounts receivable
    
    
    (88
    )
    
    
    (1,824
    )Decrease in income tax receivable
    
    
    0
    
    
    
    1,074Decrease in other assets
    
    
    77
    
    
    
    673Increase (decrease) in accounts payable
    
    
    (960
    )
    
    
    156Decrease in accrued liabilities
    
    
    (228
    )
    
    
    (1,410
    )Increase (decrease) in income taxes payable
    
    
    1,031
    
    
    
    (253
    )Decrease in deferred revenue
    
    
    (867
    )
    
    
    (15
    )Increase (decrease) in other liabilities
    
    
    (124
    )
    
    
    158Total adjustments
    
    
    5,617
    
    
    
    5,436Net cash provided by operating activities
    
    
    7,988
    
    
    
    9,199Cash flows from investing activitiesPurchase of Newbridge Corporation
    
    
    (2,482
    )
    
    
    0Purchase of property and equipment
    
    
    (1,908
    )
    
    
    (1,065
    )Capitalized software development costs
    
    
    (3,987
    )
    
    
    (3,980
    )Net cash used in investing activities
    
    
    (8,377
    )
    
    
    (5,045
    )Cash flows from financing activitiesPrincipal payments under capital lease obligations
    
    
    (947
    )
    
    
    (433
    )Principal payments under debt obligations
    
    
    (3,873
    )
    
    
    (2,662
    )Proceeds from exercise of stock options
    
    
    871
    
    
    
    1,737Proceeds from stock issued under Employee Stock Purchase Plan
    
    
    102
    
    
    
    96Net cash used in financing activities
    
    
    (3,847
    )
    
    
    (1,262
    )Effect of exchange rates on cash flows
    
    
    (129
    )
    
    
    (232
    )Net increase (decrease) in cash and cash equivalents
    
    
    (4,365
    )
    
    
    2,660Cash and cash equivalents at beginning of period
    
    
    12,336
    
    
    
    7,269Cash and cash equivalents at end of period
    
    $
    7,971
    
    
    $
    9,929
 See accompanying notes to interim consolidated financial statements. 4




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Docucorp International, Inc. 
 Notes to Interim Consolidated Financial Statements
 (Unaudited)
 Note 1  Basis of presentation and summary of significant accounting policies The accompanying unaudited interim consolidated financial statements of Docucorp International,
Inc. and its wholly owned subsidiaries (Docucorp or the Company) as of April 30, 2005 and July
31, 2004, and for the three and nine months ended April 30, 2005 and 2004, have been prepared in
accordance with accounting principles generally accepted in the United States for interim financial
information. Accordingly, they do not include all of the information and footnotes required by
generally accepted accounting principles for complete financial statements. The financial
information presented should be read in conjunction with our annual consolidated financial
statements for the year ended July 31, 2004. The foregoing unaudited interim consolidated financial
statements reflect all adjustments (all of which are of a normal recurring nature) which are, in
the opinion of management, necessary for a fair presentation of the results of the interim periods,
and include the accounts of Docucorp and our wholly owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in consolidation. Operating results for
the three and nine months ended April 30, 2005 are not necessarily indicative of the results to be
expected for the year. Certain prior year amounts have been reclassified to conform to the current
year presentation. Revenue recognition We derive our revenues from the sale of software licenses, annual software maintenance and support
agreements, professional services and ASP hosting services. We recognize revenue in accordance with
Statement of Position 97-2, Software Revenue Recognition and Staff Accounting Bulletin No. 104,
Revenue Recognition (SAB 104). Revenue is recognized when a contract exists, the fee is fixed
or determinable, delivery has occurred and collection of the receivable is deemed probable. We use the residual method to recognize revenue from the sale of software licenses that are bundled
with maintenance and support. Under the residual method, the fair value of the undelivered
element(s) is deferred and the remaining value of the contract is recognized as revenue. Fair value
of an element is based on vendor-specific objective evidence (VSOE). VSOE is based on the price
charged when the same element is sold separately. We do not generally sell software licenses
without selling maintenance and support for the licensed software. Therefore, we have established
VSOE only for the undelivered element(s) included in a multi-element arrangement. Specifically,
VSOE for maintenance and support is based upon prices customers pay to renew maintenance and
support agreements. After expiration of the initial maintenance term, maintenance and support
agreements are renewable on an annual basis and include rights to upgrades, when and if available,
telephone support, updates, enhancements and bug fixes. Revenue generated from maintenance and
support is recognized ratably over the maintenance term of the agreement. We record deferred
revenue for maintenance amounts invoiced prior to the performance of the related services. Our standard software license agreements do not provide for rights of software return and/or
conditions of acceptance. However, in the rare case that acceptance criteria are provided, revenue
is deferred and not recognized until all acceptance provisions are satisfied. Revenue from
software licenses, which include a cancellation clause, is recognized upon expiration of the
cancellation period. License revenue related to products still in the testing phase is deferred
until formal acceptance of the product by the customer. Professional services revenue includes implementation, integration, training and consulting
services related to our software products. The services offered are not essential to the
functionality of the software. Professional services revenue is generally recognized as the
services are performed. 5




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Docucorp International, Inc.
Notes to Interim Consolidated Financial Statements (cont.)
(Unaudited) Professional services revenue derived from the installation and integration of software packages
under a fixed price contract is recognized on a percentage-of-completion basis measured by the
relationship of hours worked to total estimated contract hours. We follow this method because
reasonably dependable estimates of the revenue and contract hours applicable to various elements of
a contract can be made. Since the financial reporting of these contracts depends upon estimates,
which are assessed continually during the term of these contracts, recognized revenue and profit
are subject to revisions as the contract progresses to completion. Revisions in profit estimates
are reflected in the period in which the facts that give rise to the revisions become known.
Accordingly, favorable changes in estimates result in additional revenue recognition and net
income, and unfavorable changes in estimates result in a reduction of recognized revenue and net
income. When estimates indicate that a loss will be incurred on a contract upon completion, a
provision for the expected loss is recorded in the period in which the loss becomes evident. Revenue from our ASP hosting operations is recognized in accordance with SAB 104, generally on a
per transaction basis. ASP hosting agreements are generally one-to-five years in duration and
provide for monthly billing based on transaction volume or contract minimums, if applicable.
Revenue related to the customers initial set up and implementation is deferred and subsequently
recognized as professional services revenue over the expected term of the ASP hosting agreement. Cash equivalents We consider all highly liquid investments purchased with an original maturity of six months or less
to be cash equivalents. Cash equivalents are stated at cost, which approximates fair market value. Accounts receivable Accounts receivable is composed of billed and unbilled accounts. Unbilled accounts receivable
include amounts that have been recognized as revenue under the percentage-of-completion method or
upon execution of the software license contract and shipment of the software, but prior to
contractual payment terms. Allowance for doubtful accounts We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of
our customers to make required payments. We take into consideration the current financial
condition of the customers, the specific details of the customer accounts, the age of the
outstanding balance and the current economic environment when assessing the adequacy of the
allowance. If the financial condition of our customers were to deteriorate, resulting in an
impairment of their ability to make payments, additional allowances might be required. Property and equipment, depreciation and amortization Property and equipment are carried at cost, less accumulated depreciation and amortization.
Depreciation and amortization are computed over the estimated service lives using the straight-line
method. Estimated service lives are as follows: 6




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Docucorp International, Inc.
Notes to Interim Consolidated Financial Statements (cont.)
(Unaudited) Leasehold improvements
    
    Lesser of usefullife or life of leaseComputer equipment
    
    4-5 yearsFurniture and fixtures
    
    5 yearsEquipment under capital leases
    
    Lesser of usefullife or life of lease
 Repairs and maintenance are expensed as incurred. Major renewals and betterments are capitalized
and depreciated over the assets remaining estimated service lives. Upon retirement or sale of an
asset, the cost and accumulated depreciation are removed from the accounts with any resulting gain
or loss included in income. Software development costs Software development costs are accounted for in accordance with Statement of Financial Accounting
Standards No. 86, Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed (SFAS 86). SFAS 86 requires the capitalization of certain software development costs,
which include salaries and personnel related costs incurred in the development activities, once
technological feasibility of the software has been established. Research and development costs
incurred prior to the establishment of the technological feasibility of a product are expensed as
incurred. The cost of capitalized software is amortized on a straight-line basis to cost of license
revenue over its estimated useful life, generally four to six years, or the ratio of current
revenues to current and anticipated revenues from the software, whichever provides the greater
amortization. Business combinations and goodwill and intangible assets Upon acquisition of a business, we allocate the purchase price to intangible assets and liabilities
acquired and identifiable intangible assets. Any residual purchase price is recorded as goodwill.
The allocation of the purchase price requires management to make significant estimates in
determining the fair values of assets acquired and liabilities assumed, especially with respect to
intangible assets. These estimates are based on historical experience and information obtained
from valuation specialists and the management from the acquired company. These estimates can
include, but are not limited to, appraisals by valuation specialists, the cash flows that an asset
is expected to generate in the future and the appropriate weighted average cost of capital.
Estimates used in determining the fair value of assets acquired and liabilities assumed are
inherently uncertain and unpredictable. Unanticipated events and circumstances may occur which may
affect the accuracy or validity of such estimates. In accordance with Financial Accounting Standards Board Statement of Financial Accounting Standards
No. 142, Goodwill and Other Intangible Assets, we assess the impairment of goodwill within our
reportable units annually, or more often if events or changes in circumstances indicate that the
carrying value may not be recoverable. As of April 30, 2005, we completed our annual impairment
analysis and determined no goodwill impairment exists. We assess the impairment of identifiable
intangible assets whenever events or changes in circumstances indicate that its carrying amount may
not be recoverable. Impairment of long-lived assets We have evaluated our long-lived assets for impairment, and will continue to do so as events or
changes in circumstances indicate that the carrying value of such assets may not be fully
recoverable. If facts or 7




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Docucorp International, Inc.
Notes to Interim Consolidated Financial Statements (cont.)
(Unaudited) circumstances support the possibility of impairment, we prepare a projection of future operating
cash flows, undiscounted and without interest. If based on this projection we do not expect to
recover our carrying cost, an impairment loss equal to the difference between the fair value of the
asset and its carrying value will be recognized in operating income. Deferred revenue Deferred revenue relates primarily to maintenance and support agreements that have been invoiced to
customers prior to the performance of the related services. Maintenance and support services are
generally billed annually in advance for services to be performed over a twelve month period.
Maintenance and support provided under an initial software license contract is recorded as deferred
revenue based on the VSOE of that maintenance and is recognized over the term of the associated
agreement. Guarantees In the ordinary course of business, we include standard indemnification provisions in our customer
and distributor agreements. Pursuant to these agreements, we typically indemnify, hold harmless
and reimburse the indemnified party for those losses suffered or incurred by the indemnified party
arising from any trade secret, trademark, copyright, patent or other intellectual property
infringement claim by any third party with respect to our software and services. The term of these
indemnification agreements is generally perpetual any time after execution of the agreement. The
maximum potential amount of future payments that we could be required to make under these
indemnification agreements is unlimited; however, consequential damages are excluded. Since we
have never incurred costs to defend lawsuits or settle claims related to these indemnification
agreements, we believe the estimated fair value of our obligation under these agreements is
minimal. Accordingly, we have no liabilities recorded for these agreements as of April 30, 2005. We currently provide software product warranties to our customers. The product warranties
generally provide that the licensed software shall operate substantially in accordance with the
applicable user documentation for a period typically 90 days from delivery. At April 30, 2005, we
had no material product warranty liability. From time to time, in order to manage our customer
relationships, we incur costs outside of our product warranty program. These costs are expensed as
incurred. We have agreements in place with our directors and officers whereby we indemnify them for certain
events or occurrences while the officer or director is, or was, serving at our request in such
capacity. The maximum potential amount of future payments we could be required to make under these
indemnification agreements is unlimited; however, we have a director and officer insurance policy
that may enable us to recover a portion of any future amounts paid. Translation of foreign currencies We translate the financial statements of our European subsidiary into U.S. dollars in accordance
with Statement of Financial Accounting Standards No. 52, Foreign Currency Translation. Assets and
liabilities of our European subsidiary, whose functional currency is other than the U.S. dollar,
are translated at period-end rates of exchange, and revenues and expenses are translated at average
exchange rates prevailing during the period. Gains and losses on foreign currency transactions and
the translation of our intercompany loan to a consolidated foreign subsidiary are recognized in
other income as incurred. 8




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Docucorp International, Inc.
Notes to Interim Consolidated Financial Statements (cont.)
(Unaudited) We account for unrealized gains or losses on our foreign currency translation adjustments in
accordance with Statement of Financial Accounting Standards No. 130, Reporting Comprehensive
Income, which requires the adjustments be accumulated in stockholders equity as part of other
comprehensive income. Treasury stock We account for Treasury Stock using the cost method. Gains on sales of Treasury Stock are credited
to Additional Paid-in Capital (APIC), losses are charged to APIC to the extent that previous net
gains from sales are included therein, otherwise to Retained Earnings. Income taxes Income taxes are accounted for under the asset and liability method. Deferred tax assets and
liabilities are recognized for the estimated future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates for
the year in which those temporary differences are expected to be recovered or settled. Valuation
allowances are established when necessary to reduce deferred tax assets to the amounts more likely
than not to be realized. Net income per share Our basic and diluted net income per share is computed in accordance with Statement of Financial
Accounting Standards No. 128, Earnings Per Share. Basic net income per share is computed using
the weighted average number of common shares outstanding. Diluted net income per share is computed
using the weighted average number of common shares outstanding and the assumed exercise of stock
options and unvested restricted stock awards, using the treasury stock method. The treasury stock
method recognizes the use of proceeds that could be obtained upon exercise of options and the
assumed proceeds on unvested restricted stock in computing diluted net income per share. It assumes
that any proceeds would be used to purchase common stock at the average market price during the
period. Options and unvested restricted stock will have a dilutive effect under the treasury stock
method only when the average market price of common stock during the period exceeds the exercise
price of the options or calculated exercise price of the unvested restricted stock. Following is a
reconciliation of the shares used in computing basic and diluted net income per share for the
periods indicated (in thousands): Three months ended
    
    
    Nine months endedApril 30,
    
    
    April 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Shares used in computing basic
net income per share
    
    
    10,741
    
    
    
    10,359
    
    
    
    10,609
    
    
    
    10,050Dilutive effect of stock options
and unvested restricted stock
    
    
    880
    
    
    
    1,361
    
    
    
    952
    
    
    
    1,278Shares used in computing diluted
net income per share
    
    
    11,621
    
    
    
    11,720
    
    
    
    11,561
    
    
    
    11,328
 At April 30, 2005 and 2004, options to purchase 50,000 shares of Common Stock at average exercise
prices of $13.50 per share were anti-dilutive and not included in the computation of diluted net
income per share, because the options exercise prices were greater than the average market price
of the Common Stock for the period. 9




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Docucorp International, Inc.
Notes to Interim Consolidated Financial Statements (cont.)
(Unaudited) Stock-based compensation We provide equity incentives to our employees and directors by means of non-qualified stock options
and restricted stock awards issued from the 1997 Equity Compensation Plan (the Plan). In
addition, we granted restricted stock awards outside of the Plan in connection with our acquisition
of Newbridge Corporation. We account for stock-based compensation under the recognition and
measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued
to Employees (APB 25) and related Interpretations. For the periods presented, stock-based
compensation cost related to options is not reflected in net income, as all options granted under
the Plan had an exercise price equal to the market value of the underlying Common Stock on the date
of grant. We have implemented the disclosure-only provisions of Statement of Financial Accounting
Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123) and Statement of
Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation Transition and
Disclosure. The following table illustrates the pro forma effect on net income and net income per
share as if we had applied the fair value recognition provisions of SFAS 123 (in thousands except
per share amounts): Three months ended
    
    
    Nine months endedApril 30,
    
    
    April 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Net income as reported
    
    $
    468
    
    
    $
    707
    
    
    $
    2,371
    
    
    $
    3,763Plus,
stock-based
compensation
expense
included in
reported
income, net of
tax
    
    
    55
    
    
    
    4
    
    
    
    155
    
    
    
    26Less,
stock-based
compensation
expense under
fair value
based methods,
net of tax
    
    
    (246
    )
    
    
    (240
    )
    
    
    (728
    )
    
    
    (735
    )Pro forma net income
    
    $
    277
    
    
    $
    471
    
    
    $
    1,798
    
    
    $
    3,054Net income per share:As reportedBasic
    
    $
    0.04
    
    
    $
    0.07
    
    
    $
    0.22
    
    
    $
    0.37Diluted
    
    $
    0.04
    
    
    $
    0.06
    
    
    $
    0.21
    
    
    $
    0.33Pro formaBasic
    
    $
    0.03
    
    
    $
    0.04
    
    
    $
    0.17
    
    
    $
    0.30Diluted
    
    $
    0.02
    
    
    $
    0.04
    
    
    $
    0.16
    
    
    $
    0.26
 In August 2004, the Compensation Committee of the Board of Directors granted 112,500 shares of
restricted stock to certain executive officers and directors. Based on the market value of our
Common Stock at the date of grant, this restricted stock grant was valued at approximately
$821,000. The restricted stock vests over five years with 50% and 100% acceleration of cumulative
vesting in the first two years if specific performance goals are attained. The first accelerated
vesting measurement date is on July 31, 2005. The value of the restricted stock grant is being
recognized as compensation expense ratably over the vesting period. In connection with the acquisition of the assets of Newbridge Corporation, which include
the capital stock of Newbridge Information Services, Inc. and Matrix Digital Technologies, Inc.
(collectively Newbridge), we entered into employment agreements with several key employees of
Newbridge. As a part of these agreements, the Compensation Committee of our Board of Directors
granted an aggregate of 175,000 shares 10




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##### Table of Contents



Docucorp International, Inc.
Notes to Interim Consolidated Financial Statements (cont.)
(Unaudited) of restricted stock to those key Newbridge employees. Based on the market value of our Common Stock
at the date of acquisition, this restricted stock grant was valued at $1.4 million. The restricted
shares vest over seven years with 33%, 67% and 100% acceleration of cumulative vesting in the first
three years if certain financial performance goals are achieved by Newbridge. The first
accelerated vesting measurement date is on July 31, 2005. The value of the restricted stock grant
is being recognized as compensation expense ratably over the vesting period. Management estimates The preparation of our financial statements, in accordance 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 and the reported amounts of revenues and expenses at the date of the financial
statements. On an ongoing basis, management evaluates its estimates and judgments. Actual results
could differ from those estimates. Certain accounting policies require higher degrees of
judgment than others in their application. The following accounting policies require significant
estimates: revenue recognition, accounts receivable and allowance for doubtful accounts, fair value
of acquired intangible assets and goodwill, impairment of long-lived assets, software development
costs and income taxes. Advertising costs We expense advertising costs as incurred. Royalty costs We incur royalty fees associated with the licensing of certain software products. These fees vary
based upon the terms of the royalty agreement. Note 2  Acquisition On September 24, 2004, we acquired the assets of Newbridge Corporation, which include the capital
stock of Newbridge Information Services, Inc. and Matrix Digital Technologies, Inc. Newbridge is a
leading information services company for the health care market. Newbridge composes, produces and
distributes provider directories, ID cards and policy kits, as well as provides health care
provider information over the Internet. Operating results of Newbridge are primarily included in
the ASP hosting segment of our financial statements from the effective date of the acquisition. The purchase price for the transaction was approximately $3.9 million, comprised of approximately
$2.6 million paid in cash and $1.3 million of net liabilities assumed. During the three months
ended April 30, 2005, we completed the purchase price allocation, which consists of assets acquired
of approximately $5.0 million, including $1.0 million for the acquired customer relationships,
liabilities assumed of approximately $6.4 million and goodwill of approximately $3.9 million. The acquisition is not considered material to our results of operations; therefore no pro forma
information is presented. 11




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##### Table of Contents



Docucorp International, Inc.
Notes to Interim Consolidated Financial Statements (cont.)
(Unaudited) Note 3  Business segments As set forth in the criteria of Statement of Financial Accounting Standards No. 131, Disclosures
about Segments of an Enterprise and Related Information, we are organized into two reportable
segments: Software and ASP. The Software segment consists of initial software license sales,
professional services consulting derived from implementation and integration of our software
products and continued customer support and maintenance of the software products. The ASP segment
provides processing, print, mail, archival and Internet delivery of documents for customers who
outsource these activities. The table below presents information about reported segments for the
three and nine months ended April 30, 2005 and 2004 (in thousands): Three months ended
    
    
    Nine months endedApril 30,
    
    
    April 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Revenues:Software
    
    $
    13,220
    
    
    $
    12,628
    
    
    $
    39,589
    
    
    $
    39,276ASP
    
    
    6,559
    
    
    
    5,882
    
    
    
    20,150
    
    
    
    17,778Total revenues
    
    $
    19,779
    
    
    $
    18,510
    
    
    $
    59,739
    
    
    $
    57,054Software gross profit, net of
product development costs
    
    $
    5,434
    
    
    $
    4,940
    
    
    $
    16,561
    
    
    $
    16,987ASP gross profit
    
    
    467
    
    
    
    973
    
    
    
    2,292
    
    
    
    3,186Sales and marketing
    
    
    (3,040
    )
    
    
    (2,700
    )
    
    
    (8,817
    )
    
    
    (8,339
    )General and administrative
    
    
    (2,064
    )
    
    
    (1,800
    )
    
    
    (6,065
    )
    
    
    (5,199
    )Total operating income
    
    $
    797
    
    
    $
    1,413
    
    
    $
    3,971
    
    
    $
    6,635
 Note 4  Commitments and contingencies During the quarter, the Internal Revenue Service (IRS) completed its examination of our tax year
ended July 31, 2002 and issued a notice of proposed adjustment for transfer pricing issues
impacting intercompany interest and royalty income. These proposed adjustments would increase our
U.S. taxable income for 2002 and could result in additional exposure to other open tax years. We
vigorously disagree with the proposed adjustments and intend to aggressively contest these matters
through applicable IRS and judicial processes, as appropriate. Accordingly, we have filed a written
protest to these proposed adjustments thereby requesting an appeals conference with the IRS Office
of Appeals. As of April 30, 2005, we concluded that the potential loss was not probable. With
respect to the tax year under audit, the potential exposure ranges between $0 and $340,000,
excluding interest and penalties. Assurance can not be given that these tax matters will be
resolved in our favor in view of the inherent uncertainties involved in settlement initiatives and
tax proceedings. An unfavorable resolution of these tax matters may have a material adverse impact
on our consolidated financial position and results of operations. Note 5  Recently issued accounting guidance The American Jobs Creation Act of 2004 (the Act) was signed into law on October 22, 2004. The Act
contains numerous amendments and additions to the U.S. corporate income tax rules. Among other
things, the Act will provide a deduction with respect to income from certain U.S. manufacturing
activities and will 12




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Docucorp International, Inc.
Notes to Interim Consolidated Financial Statements (cont.)
(Unaudited) provide a reduced tax upon certain repatriated foreign earnings. We are continuing to evaluate the
Act and its financial impact pending further guidance to be provided by the U.S. Treasury
Department. In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting
Standards No. 123R, Share-Based Payment (SFAS 123R), which is a revision to SFAS 123. SFAS
123R requires employee stock based compensation awards to be accounted for under the fair value
method and eliminates the ability to account for these instruments under the intrinsic value method
prescribed by APB 25. SFAS 123R requires the use of an option pricing model for estimating fair
value, which is then recognized as compensation expense over the service periods. SFAS 123R is
effective for fiscal periods beginning after June 15, 2005. We will be required to adopt SFAS 123R
beginning August 1, 2005 for new awards of stock-based compensation granted after that date and for
unvested awards outstanding at that date. Compensation expense for the unvested awards
will be measured based on the fair value of the awards as previously calculated in preparing pro
forma disclosures in accordance with the provisions of SFAS 123. We are in the process of
determining the impact of the requirements of SFAS 123R. In March 2005, the Securities Exchange Commission (SEC) issued Staff Accounting Bulletin No. 107,
Share-Based Payment (SAB 107). SAB 107 provides the SECs view on the interaction between SFAS
123R and certain SEC rules and regulations. Specifically, SAB 107 provides guidance on share-based
payment transactions with non-employees, valuation methods, accounting for certain redeemable
financial instruments issued under share-based payment arrangements, the classification of
compensation expense, non GAAP financial measures, capitalization of compensation costs related to
share-based payments arrangements, the accounting for income tax effects of share-based payment
arrangements upon adoption of SFAS 123R, the modification of employee share options prior to
adoption of SFAS 123R and disclosures in Managements Discussion and Analysis subsequent to
adoption of SFAS 123R. The adoption of SAB 107 will not have a material impact on our
implementation of SFAS 123R. 13




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations Certain information contained herein may include forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended. All statements, other than statements of historical facts included in
this Form 10-Q, are forward-looking statements. The Company does not undertake any obligation to
update forward-looking statements excepts as required by law. Such statements are subject to
certain risks and uncertainties, which include, but are not limited to, the economy, dependence
upon the insurance and utilities industries, technological advances, attraction and retention of
technical employees, affect of business acquisitions, fluctuations in operating results and the
other risk factors and cautionary statements listed from time to time in the Companys periodic
reports filed with the Securities and Exchange Commission. All forward-looking statements included
in this Form 10-Q and all subsequent oral forward-looking statements attributable to the Company or
persons acting on its behalf are expressly qualified in their entirety by these cautionary
statements. Overview Docucorp International, Inc. (Docucorp) develops, markets and supports a portfolio of proprietary
information software, application service provider (ASP) hosting and professional services that
enables companies to create, publish, manage and archive complex, high-volume, individualized
information. We support the entire information life cycle  from acquisition of the first raw data
point to final delivery of personalized information to the customer. Our software products support leading hardware platforms, operating systems, printers and imaging
systems. These products are designed to personalize, produce and manage documents such as insurance
policies, utility statements, telephone bills, bank and mutual fund statements, invoices, provider
directories, correspondence, bills of lading and other customer-oriented documents. Our ASP
offerings include customer statement and bill generation, electronic bill presentment and payment,
insurance policy production, provider directory generation, disaster recovery and electronic
document archival. Operating in four key markets, insurance, utilities, financial services and health care, we
currently have an installed base of more than 1,300 customers worldwide. More than half of the 200
largest United States insurance companies use our software products and services, including nine of
the top 10 life and health insurance companies, nine of the top 10 property and casualty insurance
companies and more than 500 managing general agents (MGAs). Many of the largest North American
health care, utility companies and major international financial services institutions use our
products and services. We derive our revenues from ASP hosting fees, professional services fees, software license fees and
recurring maintenance fees related to our software products. ASP hosting revenue consists of
transactional fees earned from customers who outsource the production of customer statements,
insurance policies and provider directories. Professional services revenue includes fees for
implementation, integration, training and consulting services. Software license revenue is
generally derived from the sale of perpetual licenses of software products. Maintenance revenue
consists primarily of annual software maintenance and support agreements. As set forth in the criteria of Statement of Financial Accounting Standards No. 131, Disclosures
about Segments of an Enterprise and Related Information (SFAS 131), we are organized into two
reportable segments: Software and ASP. The Software segment consists of initial software license
sales, professional services consulting derived from implementation and integration of our software
products and continued customer support and maintenance of the software products. The ASP segment
provides processing, print, mail, archival and internet delivery of documents for customers who
outsource these activities. 14




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##### Table of Contents



Our operating results are strongly tied to software license revenue. Software license sales have a
high margin and ultimately drive additional professional services and maintenance revenues. A large
portion of our software license revenue is generated from a small number of relatively large
agreements executed in the latter half of a quarter. The timing of such large agreements is often
unpredictable and impacted by events beyond our control, therefore making it difficult to forecast
software license revenue effectively. Due to the nature of our software license sales, revenues and
profits may vary from quarter to quarter. During the third quarter, we focused on increasing sales and the effectiveness of our sales
organization. License revenue for the three months ended April 30, 2005 of $2.8 million increased
significantly compared with the same period of the prior fiscal year. Much of the success in
license revenue is attributable to sales generated by our European subsidiary. For the three months
ended April 30, 2005, the performance of our European subsidiary resulted in an operating profit
for the second consecutive quarter and record revenue in both license revenue of $854,000 and total
revenue of $1.9 million. On September 24, 2004, we completed the acquisition of Newbridge, a leading information services
company for the health care market. Operating results of Newbridge are primarily reflected in our
ASP hosting segment from the date of acquisition. Full integration of Newbridge with our Dallas ASP
center is scheduled to occur during the first quarter of our next fiscal year. Our ASP hosting revenue grew 12% for the three months ended April 30, 2005 due primarily to revenue
generated by the acquisition of Newbridge, partially offset by a decrease in revenue from existing
ASP customers. The decline in revenue from existing customers is primarily due to the roll off of
certain accounts over the last 12 months as a result of a distributor being acquired and lower
rates on renewing accounts due to competitive pricing pressures. The decrease in revenue from
existing customers and lower utilization of equipment, facilities and personnel, have negatively
impacted the gross margins achieved from our ASP segment during the current year. Subsequent to the
end of the third quarter, we signed a significant contract with Capgemini Energy to serve as their
print bill provider. Revenue generated from this contact will begin during our fourth quarter of
fiscal 2005. We estimate that annual revenue from this contract will be approximately $3.5 million. Going forward, business and market uncertainties may affect results. For a discussion of key
factors that could impact results, please refer to the section entitled Risk Factors in our
Annual Report on Form 10-K for the year ended July 31, 2004. Critical Accounting Policies and Estimates The accompanying Managements Discussion and Analysis of Financial Condition and Results of
Operations is based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States of America (GAAP).
The preparation of these financial statements requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities at the date of the financial statements,
and the reported amounts of revenues and expenses during the reported period. We base our
estimates and assumptions on historical experiences and various other factors that are believed to
be reasonable under the circumstances. These estimates and assumptions are evaluated on an ongoing
basis. Actual results may differ from previously estimated amounts under different assumptions or
conditions. The following critical accounting policies, which involve significant judgments and
estimates, are used in the preparation of our consolidated financial statements: Revenue recognition We derive our revenues from the sale of software licenses, annual software maintenance and support
agreements, professional services and ASP hosting services. We recognize revenue in accordance with
Statement of Position 97-2, Software Revenue Recognition, and Staff Accounting Bulletin No. 104, 15




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##### Table of Contents



Revenue Recognition (SAB 104). Revenue is recognized when a contract exists, the fee is fixed
or determinable, delivery has occurred and collection of the receivable is deemed probable. We use the residual method to recognize revenue from the sale of software licenses that are bundled
with maintenance and support. Under the residual method, the fair value of the undelivered
element(s) is deferred and the remaining value of the contract is recognized as revenue. Fair value
of an element is based on vendor-specific objective evidence (VSOE). VSOE is based on the price
charged when the same element is sold separately. We do not generally sell software licenses
without selling maintenance and support for the licensed software. Therefore, we have established
VSOE only for the undelivered element(s) included in a multi-element arrangement. Specifically,
VSOE for maintenance and support is based upon prices customers pay to renew maintenance and
support agreements. After expiration of the initial maintenance term, maintenance and support
agreements are renewable on an annual basis and include rights to upgrades, when and if available,
telephone support, updates, enhancements and bug fixes. Revenue generated from maintenance and
support is recognized ratably over the maintenance term of the agreement. We record deferred
revenue for maintenance amounts invoiced prior to the performance of the related services. Our standard software license agreements do not provide for rights of software return and/or
conditions of acceptance. However, in the rare case that acceptance criteria are provided, revenue
is deferred and not recognized until all acceptance provisions are satisfied. Revenue from
software licenses, which include a cancellation clause, is recognized upon expiration of the
cancellation period. License revenue related to products still in the testing phase is deferred
until formal acceptance of the product by the customer. Professional services revenue includes implementation, integration, training and consulting
services related to our software products. The services offered are not essential to the
functionality of the software sold. Professional services revenue is generally recognized as the
services are performed. Professional services revenue derived from the installation and integration of software packages
under a fixed price contract is recognized on a percentage-of-completion basis measured by the
relationship of hours worked to total estimated contract hours. We follow this method because
reasonably dependable estimates of the revenue and contract hours applicable to various elements of
a contract can be made. Since the financial reporting of these contracts depends upon estimates,
which are assessed continually during the term of these contracts, recognized revenue and profit
are subject to revisions as the contract progresses to completion. Revisions in profit estimates
are reflected in the period in which the facts that give rise to the revisions become known.
Accordingly, favorable changes in estimates result in additional revenue recognition and net
income, and unfavorable changes in estimates result in a reduction of recognized revenue and net
income. When estimates indicate that a loss will be incurred on a contract upon completion, a
provision for the expected loss is recorded in the period in which the loss becomes evident. Revenue from our ASP hosting operations is recognized in accordance with SAB 104, generally on a
per transaction basis. ASP hosting agreements are generally one-to-five years in duration and
provide for monthly billing based on transaction volume or contract minimums, if applicable.
Revenue related to the customers initial set up and implementation is deferred and subsequently
recognized as professional services revenue over the expected term of the ASP hosting agreement. Allowance for doubtful accounts We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of
our customers to make required payments. We take into consideration the current financial
condition of our customers, the specific details of the customer accounts, the age of the
outstanding balance and the current economic environment when assessing the adequacy of the
allowance. If the financial condition 16




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##### Table of Contents



of our customers were to deteriorate, resulting in an impairment of their ability to make payments,
additional allowances might be required. Software development costs Software development costs are accounted for in accordance with Statement of Financial Accounting
Standards No. 86, Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed (SFAS 86). SFAS 86 requires the capitalization of certain software development costs
once technological feasibility is established. The capitalized costs are then amortized on a
straight-line basis over the estimated product life, or on the ratio of current revenues to total
projected product revenues, whichever provides the greater amortization. Management periodically
assesses the realizability of software development costs when events and circumstances indicate a
potential decline in value. Business combinations Upon acquisition of a business, we allocate the purchase price to intangible assets and liabilities
acquired and identifiable intangible assets. Any residual purchase price is recorded as goodwill.
The allocation of the purchase price requires management to make significant estimates in
determining the fair values of assets acquired and liabilities assumed, especially with respect to
intangible assets. These estimates are based on historical experience and information obtained
from valuation specialists and the management from the acquired company. These estimates can
include, but are not limited to, appraisals by valuation specialists, the cash flows that an asset
is expected to generate in the future and the appropriate weighted average cost of capital.
Estimates used in determining the fair value of assets acquired and liabilities assumed are
inherently uncertain and unpredictable. Unanticipated events and circumstances may occur which may
affect the accuracy or validity of such estimates Valuation of long-lived and intangible assets and goodwill We recognize an impairment charge associated with our long-lived assets, including property and
equipment, goodwill and other intangible assets whenever we determine that recovery of such
long-lived asset is not probable. Such determination is made in accordance with the applicable
GAAP requirement associated with the long-lived asset, and is based upon, among other things,
estimates of the amount of future net cash flows to be generated by the long-lived asset and
estimates of the current fair value of the asset. Adverse changes in future net cash flows or fair
value could result in the inability to recover the carrying value of the long-lived asset, thereby
requiring an impairment charge to be recognized. We perform an impairment analysis in accordance
with Statement of Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets,
annually and whenever events and circumstances indicate that an impairment might be present. Deferred taxes and valuation allowance We recognize deferred tax assets and liabilities based on the differences between the financial
statement carrying amounts and the tax bases of the assets and liabilities. In assessing the
realizability of deferred tax assets, management considers whether it is more likely than not that
some portion or all of the deferred tax assets will not be realized. The ultimate realization of
deferred tax assets is dependent upon generation of future taxable income during the periods in
which those temporary differences become deductible. Management considers the scheduled reversal of
deferred tax liabilities, projected future taxable income, and tax planning strategies in making
this assessment. It is possible that in the future we may change our estimate of the amount of the
deferred income tax assets that will more likely than not be realized, which will result in an
adjustment to the valuation allowance that would either increase or decrease, as applicable,
reported net income in the period such change in estimate was made. 17




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##### Table of Contents



Translation of foreign currency We translate the financial statements of our European subsidiary into U.S. dollars in accordance
with Statement of Financial Accounting Standards No. 52, Foreign Currency Translation. Assets and
liabilities of our European subsidiary, whose functional currency is other than the U.S. dollar,
are translated at period-end rates of exchange, and revenues and expenses are translated at average
exchange rates prevailing during the period. Gains and losses on foreign currency transactions and
the translation of our intercompany loan to a consolidated foreign subsidiary are recognized in
other income as incurred. We account for unrealized gains or losses on our foreign currency translation adjustments in
accordance with Statement of Financial Accounting Standards No. 130, Reporting Comprehensive
Income, which requires adjustments to be accumulated in stockholders equity as part of other
comprehensive income. Currently, we do not engage in foreign currency hedging activities. Historical Operating Results The following table sets forth selected unaudited interim consolidated statements of operations
data expressed as a percentage of total revenues for the periods indicated: Three months ended
    
    
    Nine months endedApril 30,
    
    
    April 30,2005
    
    
    2004
    
    
    2005
    
    
    2004RevenuesASP hosting
    
    
    33
    %
    
    
    32
    %
    
    
    34
    %
    
    
    31
    %Professional services
    
    
    27
    
    
    
    29
    
    
    
    27
    
    
    
    28License
    
    
    14
    
    
    
    10
    
    
    
    12
    
    
    
    13Maintenance
    
    
    26
    
    
    
    29
    
    
    
    27
    
    
    
    28Total revenues
    
    
    100
    
    
    
    100
    
    
    
    100
    
    
    
    100Cost of revenuesASP hosting
    
    
    31
    
    
    
    26
    
    
    
    30
    
    
    
    26Professional services
    
    
    21
    
    
    
    25
    
    
    
    21
    
    
    
    22License
    
    
    5
    
    
    
    5
    
    
    
    5
    
    
    
    4Maintenance
    
    
    2
    
    
    
    2
    
    
    
    2
    
    
    
    2Total cost of revenues
    
    
    59
    
    
    
    58
    
    
    
    58
    
    
    
    54Gross Profit
    
    
    41
    
    
    
    42
    
    
    
    42
    
    
    
    46Operating expensesProduct development
    
    
    11
    
    
    
    10
    
    
    
    10
    
    
    
    10Sales and marketing
    
    
    15
    
    
    
    14
    
    
    
    15
    
    
    
    15General and administrative
    
    
    11
    
    
    
    10
    
    
    
    10
    
    
    
    9Total operating expenses
    
    
    37
    
    
    
    34
    
    
    
    35
    
    
    
    34Operating income
    
    
    4
    
    
    
    8
    
    
    
    7
    
    
    
    12Interest expense
    
    
    (1
    )
    
    
    (1
    )
    
    
    (1
    )
    
    
    (1
    )Other income, net
    
    
    1
    
    
    
    0
    
    
    
    0
    
    
    
    1Income before income taxes
    
    
    4
    
    
    
    7
    
    
    
    6
    
    
    
    12Provision for income taxes
    
    
    2
    
    
    
    3
    
    
    
    2
    
    
    
    5Net income
    
    
    2
    %
    
    
    4
    %
    
    
    4
    %
    
    
    7
    %
 18




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##### Table of Contents



Comparative analysis of results for the three and nine months ended April 30, 2005 and 2004 Revenues Total revenues increased 7% and 5% for the three and nine months ended April 30, 2005,
respectively. ASP hosting revenue increased 12%, or $677,000, and 13%, or $2.4 million, for the
three and nine months ended April 30, 2005, respectively. The increase in ASP hosting revenue is
primarily due to revenue generated by recently acquired Newbridge of $1.6 million and $4.4 million
for the three and nine months ended April 30, 2005, respectively. The increase in ASP revenue is
partially offset by a decrease in revenue from existing customers as certain accounts rolled off
over the last 12 months as a result of a distributor being acquired and lower rates on renewing
accounts due to competitive pricing pressures. For the three months ended April 30, 2005,
professional services revenue decreased 4% or $239,000 primarily due to prior year revenue of
$147,000 generated in the third quarter of fiscal 2004 related to attendee fees from our March 2004
bi-annual users conference and a decrease of $180,000 related to the prior year recognition of
deferred revenues on previously completed projects. These declines were partially offset by an
increase in professional service revenues derived from service engagements during the current
quarter. For the nine months ended April 30, 2005, professional services revenue increased 4%, or
$631,000, due largely to a 25% increase in revenue generated by our European operations. License
revenue increased 52% or $942,000 and decreased 2%, or $179,000 for the three and nine months ended
April 30, 2005, respectively. The increase during the current quarter was primarily attributed to
record license revenue in our European operations of $854,000. For the three and nine months ended
April 30, 2005, maintenance revenue decreased $111,000, or 2% and $139,000 or 1%, respectively. The
slight decrease in maintenance revenue is due to certain legacy customers consolidating multiple
licenses when upgrading to enterprise-wide versions of our latest technology. Backlog for our products and services was approximately $51.2 million as of April 30, 2005, of
which approximately $24.5 million is scheduled to be satisfied within one year. Backlog is
primarily composed of maintenance revenue for ongoing maintenance and support, software
implementation and consulting services and ASP hosting services. Maintenance contracts may
generally be terminated upon 30 to 60 days notice; however, we have not historically experienced
material cancellations of such contracts. Software implementation and consulting services backlog
is principally performed under time and material agreements, of which some have cancellation
provisions. The estimated future revenues with respect to software implementation and consulting
services are based on managements estimate of revenues over the remaining life of the respective
contracts. ASP hosting agreements generally have one-to-five year terms and provide that fees are
charged on a per transaction basis. Estimated future revenues with respect to ASP hosting services
are based on contractual monthly minimums multiplied by the remaining term of the respective
contract. Cost of revenues Cost of ASP hosting revenue.Cost of ASP hosting revenue is comprised primarily of salary and
personnel related costs, facility and equipment costs and postage and supplies expense related to
our ASP hosting centers. Cost of ASP hosting revenue increased 24% to $6.1 million for the three
months ended April 30, 2005, and increased 22% to $17.9 million for the nine months ended April 30,
2005. These increases are primarily due to the operating expenses associated with Newbridge of $1.6
million and $4.3 million for the three and nine months ended April 30, 2005, respectively. For the
three months ended April 30, 2005 and 2004, cost of ASP hosting revenue represented 93% and 83% of
ASP hosting revenue, respectively. For the nine months ended April 30, 2005 and 2004, cost of ASP
hosting revenue represented 89% and 82% of ASP hosting revenue, respectively. The increase in cost
as a percentage of ASP revenue is primarily due to a decrease in revenue from existing customers
primarily due to the roll off of certain accounts over the last 12 months as a result of a
distributor being acquired, lower rates on 19




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renewing accounts and lower utilization of equipment, facilities and personnel. The variable
components of cost of ASP hosting revenue are expected to increase as ASP hosting revenue
increases. Cost of professional services revenue.Cost of professional services revenue consists of costs
incurred in providing implementation, integration, training and consulting services. Cost of
professional services revenue decreased $447,000, or 10% for the three months ended April 30, 2005,
and decreased $422,000 or 3% for the nine months ended April 30, 2005. The decrease in cost of
professional services revenue is primarily due to costs of $387,000 associated with our bi-annual
user group conference held in March 2004. For the three months ended April 30, 2005 and 2004, cost
of professional services revenue represented 79% and 84% of professional services revenue,
respectively. For the nine months ended April 30, 2005 and 2004, cost of professional services
revenue represented 77% and 83% of professional services revenue, respectively. The decrease in
costs as a percentage of professional services revenue is primarily due to improved staff
utilization, an increase in average billing rates and the user group conference held in the prior
year. We expect the cost of professional services revenue to increase as professional services
activities and revenue increase both domestically and internationally. Cost of license revenue.Cost of license revenue includes amortization of capitalized software
development costs and royalties paid to third parties. For the three and nine months ended April
30, 2005, cost of license revenue increased 20% and 31%, respectively, primarily due to additional
amortization expense related to new products introduced to the marketplace during the last twelve
months. For the three months ended April 30, 2005 and 2004, cost of license revenue represented 38%
and 48% of license revenue, respectively. This decrease in cost as a percentage of license revenue
is primarily due to an increase in license revenue. For the nine months ended April 30, 2005 and
2004, cost of license revenue represented 40% and 30% of license revenue, respectively. This
increase in costs as a percentage of license revenue is due to an increase in amortization expense.
We anticipate cost of license revenue to increase as amortization of capitalized development costs
increases as new products become generally available. Cost of maintenance revenue.Cost of maintenance revenue consists of costs incurred in providing
customer telephone and online support. Cost of maintenance revenue increased 14% to $393,000 for
the three months ended April 30, 2005, and increased 9% to $1.1 million for the nine months ended
April 30, 2005, primarily due to an increase in customer support costs from our European
subsidiary. For both the three months ended April 30, 2005 and 2004, cost of maintenance revenue
represented 8% and 7% of maintenance revenue, respectively. For the nine months ended April 30,
2005 and 2004, cost of maintenance revenue represented 7% and 6% of maintenance revenue,
respectively. The cost of maintenance revenue is expected to increase as salaries and personnel
related costs increase due to annual merit raises and extending customer support hours to
accommodate certain international customers. Operating expenses Product development.Product development expense consists primarily of costs associated with
developing new products prior to establishing technological feasibility, enhancing existing
products, testing software products and developing product documentation. Product development
expenses increased 17% to $2.2 million for the three months ended April 30, 2005, primarily due to
a reduction in software capitalization as a result of our efforts to release new products in the
prior year. Product development costs increased 6%, to $6.4 million, for the nine months ended
April 30, 2005, primarily due to increased salary and personnel related costs. Sales and marketing. Sales and marketing expense consists primarily of salaries and personnel
related costs, incentive compensation and costs associated with marketing programs. For the three
and nine months ended April 30, 2005, sales and marketing expense increased $340,000, or 13%, and
$478,000, or 20




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6%, respectively. These increases are primarily due to increased salary and personnel related costs
and an increase in incentive compensation due to increased license revenue. General and administrative. General and administrative expense consists of costs for accounting,
human resources, legal, information technology and outside legal, accounting and other services.
General and administrative expense increased $264,000, or 15%, and $866,000, or 17%, for the three
and nine months ended April 30, 2005, respectively, primarily due to costs associated with
Sarbanes-Oxley compliance and costs associated with the relocation of the corporate headquarters
facility. In April 2005, we commenced a lease for our new corporate headquarters which has an
aggregate commitment of $7.0 million over a ten year period. Our former headquarter facility lease
terminated at the end of April 2005. Interest expense Interest expense decreased $31,000 and $39,000 for the three and nine months ended April 30, 2005,
respectively, due to payment of term loan principle during the last twelve months of $3.5 million,
partially offset by increased interest attributed to the assumption of capital leases from the
Newbridge acquisition. Other income (expense), net Other income, net increased $135,000 and $46,000 for the three and nine months ended April 30,
2005, respectively, primarily due to an increase in gains associated with fluctuations of foreign
currency exchange rates during the current quarter and increased interest income during the nine
month period of the current year. Provision for income taxes The effective tax rate for both the three and nine months ended April 30, 2005 was 38.5%. The
effective tax rate for both the three and nine months ended April 30, 2004 was 41.5%. In fiscal
2004, the rates differ from the federal statutory rate due primarily to losses generated by our
European subsidiary, for which we did not recognize a tax benefit. The decrease in the effective
rate from the prior year is primarily due to the improved performance of our European subsidiary. During the quarter, the IRS completed its examination of our tax year July 31, 2002 and issued a
notice of proposed adjustment for transfer pricing issues impacting intercompany interest and
royalty income. These proposed adjustments would increase our U.S. taxable income for 2002 and
could result in additional exposure to other open tax years. We vigorously disagree with the
proposed adjustments and intend to aggressively contest these matters through applicable IRS and
judicial procedures, as appropriate. Accordingly, we have filed a written protest to these proposed
adjustments thereby requesting an appeals conference with the IRS Office of Appeals. As of April
30, 2005, we concluded that the potential loss was not probable. With respect to the tax year under
audit, the potential exposure ranges between $0 and $340,000, excluding penalties and interest.
Assurance can not be given that these tax matters will be resolved in our favor in view of the
inherent uncertainties involved in settlement initiatives and tax proceedings. An unfavorable
resolution of these tax matters may have a material adverse impact on our consolidated financial
position and results of operations. Net income Net income decreased approximately 34% and 37% for the three and nine months ended April 30, 2005,
respectively. This decrease is primarily due to a decrease in margins in our ASP segment and an
increase in operating expenses for the three and nine months ended April 30, 2005. 21




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Liquidity and Capital Resources At April 30, 2005, our principal sources of liquidity consisted of cash and cash equivalents of
$8.0 million and our revolving credit facility, which had available borrowings of $10.0 million.
Cash and cash equivalents for the nine months ended April 30, 2005, decreased $4.4 million from
$12.3 million at July 31, 2004, primarily as a result of cash used in the Newbridge acquisition. Cash provided by operating activities was $8.0 million and $9.2 million for the nine months ended
April 30, 2005 and 2004, respectively. Significant changes in assets and liabilities for the nine
months ended April 30, 2005 that impacted cash flow from operations include an decrease in accounts
payable of $1.0 million, of which approximately $0.9 million related primarily to payments on past
due accounts acquired from Newbridge and an increase in income taxes payable of $1.0 million due to
the timing of quarterly federal tax payments. During the nine months ended April 30, 2005 and 2004, cash used in investing activities was $8.4
million and $5.0 million, respectively. For the nine months ended April 30, 2005, we used $2.5
million, net of cash received of $115,000, for the purchase of Newbridge. Cash used for the
purchase of property and equipment was $1.9 million and $1.1 million for the nine months ended
April 30, 2005 and 2004, respectively. The increase in purchases is primarily due to purchases
associated with the new corporate headquarters and expansion of our Dallas ASP center in order to
integrate the Newbridge operations. Cash used in the investment of capitalized software
development costs was $4.0 million for the nine months ended April 30, 2005 and 2004. Cash used in financing activities was $3.8 million and $1.3 million for the nine months ended April
30, 2005 and 2004, respectively. Cash used in financing activities during the nine months ended
April 30, 2005, primarily related to payments under our bank note of $2.7 million, principal
payments made under the assumed debt obligations of Newbridge of $1.2 million and payments under
capital lease obligations of $947,000, partially offset by proceeds received from the exercise of
stock options of $871,000. The $1.3 million of cash used in financing activities during the nine
months ended April 30, 2004, related to the payments made under our bank note of $2.7 million and
capital lease obligations of $433,000, partially offset by proceeds received from the exercise of
stock options of $1.7 million. As of April 30, 2005, we held approximately 5,506,000 shares of treasury stock at an average per
share cost of $5.56. Since inception of our stock repurchase program in fiscal 1999, we have
repurchased approximately 9,366,000 shares of stock at an average purchase price of $5.37. Our
Board of Directors believes the repurchase program is an appropriate means of increasing
shareholder value. Working capital was $5.5 million at April 30, 2005, compared with $10.7 million at July 31, 2004.
The decrease in working capital of $5.2 million is primarily due to cash expenditures aggregating
approximately $4.6 million to purchase Newbridge and make payments on their outstanding and past
due liabilities and debt obligations. In June 2003, we repurchased approximately 3.1 million shares of our Common Stock along with
warrants to purchase an additional 161,000 shares of Common Stock from Safeguard Scientifics, Inc.
(Safeguard) and a former officer of Safeguard for $5.95 per share. In connection with the
repurchase, we entered into a $14.2 million term note with Comerica Bank. The bank note bears
interest at a fixed annual rate of 3.32% and is repayable in equal monthly installments over four
years. At April 30, 2005, the outstanding balance on our bank note was $7.7 million, of which $3.6
million is due within one year. At April 30, 2005, we had a $10.0 million revolving credit facility from Comerica Bank, which
expires on August 31, 2006. The credit facility bears interest at the banks prime rate less 100
basis points or LIBOR rate of interest plus 150 basis points, and is collateralized by
substantially all of our assets. As of April 30, 2005, there were no borrowings under this credit
facility. Under our bank note and credit facility, we are required to maintain certain financial
and non-financial covenants. 22




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Our liquidity needs are expected to arise primarily from the repayment of debt, obligations under
capital leases, funding the continued development, enhancement and support of our software
offerings and sales and marketing costs associated with expansion in new vertical and international
markets. A portion of our cash or borrowings under our revolving credit facility could be used to
acquire complementary businesses or obtain the right to use complementary technologies. Our liquidity could be negatively impacted by a decrease in demand for our products, which are
subject to rapid technology changes, reduction in capital expenditures by our customers and intense
competition, among other factors. Operating leases and purchase obligations related to services
agreements are our only off balance sheet arrangements. We currently anticipate that existing cash and cash equivalents, together with cash generated from
operations and available borrowings under our credit facility, will be sufficient to satisfy our
operating cash needs for the foreseeable future. Recently issued accounting guidance The American Jobs Creation Act of 2004 (the Act) was signed into law on October 22, 2004. The Act
contains numerous amendments and additions to the U.S. corporate income tax rules. Among other
things, the Act will provide a deduction with respect to income from certain U.S. manufacturing
activities and will provide a reduced tax upon certain repatriated foreign earnings. We are
continuing to evaluate the Act and its financial impact pending further guidance to be provided by
the U.S. Treasury Department. In December 2004, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 123R, Share-Based Payment (SFAS 123R), which is a revision to SFAS
123. SFAS 123R requires employee stock based compensation awards to be accounted for under the
fair value method and eliminates the ability to account for these instruments under the intrinsic
value method prescribed by APB 25. SFAS 123R requires the use of an option pricing model for
estimating fair value, which is then recognized as compensation expense over the service periods.
SFAS 123R is effective for fiscal periods beginning after June 15, 2005. We will be required to
adopt SFAS 123R beginning August 1, 2005 for new awards of stock-based compensation granted after
that date and for unvested awards outstanding at that date. Compensation expense for the
unvested awards will be measured based on the fair value of the awards as previously calculated in
preparing pro forma disclosures in accordance with the provisions of SFAS 123. We are in the
process of determining the impact of the requirements of SFAS 123R. In March 2005, the Securities Exchange Commission (SEC) issued Staff Accounting Bulletin No. 107,
Share-Based Payment (SAB 107). SAB 107 provides the SECs view on the interaction between SFAS
123R and certain SEC rules and regulations. Specifically, SAB 107 provides guidance on share-based
payment transactions with non-employees, valuation methods, accounting for certain redeemable
financial instruments issued under share-based payment arrangements, the classification of
compensation expense, non GAAP financial measures, capitalization of compensation costs related to
share-based payments arrangements, the accounting for income tax effects of share-based payment
arrangements upon adoption of SFAS 123R, the modification of employee share options prior to
adoption of SFAS 123R and disclosures in Managements Discussion and Analysis subsequent to
adoption of SFAS 123R. The adoption of SAB 107 will not have a material impact on our
implementation of SFAS 123R. 23




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Item 3. Quantitative and Qualitative Disclosures About Market Risk We have no derivative financial instruments. We invest our cash and cash equivalents in investment
grade, highly liquid investments, consisting of money market instruments and commercial paper. We
have a fixed rate debt instrument of $7.7 million as of April 30, 2005. We are exposed to market risk arising from changes in foreign currency exchange rates as a result
of selling our products and services outside the U.S. (principally Europe). A portion of our sales
generated from our non-U.S. operations are denominated in currencies other than the U.S. dollar,
principally British pounds. Consequently, the translated U.S. dollar value of Docucorps non-U.S.
sales, operating results and cash flows are subject to currency exchange rate fluctuations, which
may favorably or unfavorably impact reported earnings and may affect comparability of
period-to-period operating results. For the three months ended April 30, 2005 and 2004, 9% and 6%, respectively, of our revenues were
denominated in British pounds. For the nine months ended April 30, 2005 and 2004, 8% and 6%,
respectively, of our revenues were denominated in British pounds. For the three and nine
months ended April 30, 2005 and 2004, 9% of our costs of revenue and operating expenses were
denominated in British pounds. Historically, transactional gains and losses from the effect of
fluctuations in currency exchange rates have not had a material impact on our operations; however,
there can be no guarantees that it will not have a material impact in the future. The exposure to
fluctuations in currency exchange rates will increase as we expand our operations outside the U.S. 
 Item 4. Controls and Procedures Our management, with participation of our President and Chief Executive Officer and Senior Vice
President, Finance and Administration (Principal Financial Officer) evaluated the effectiveness
of our disclosure controls and procedures (as defined in Rule 13a-15 of the Securities Exchange Act
of 1934) as of the end of the period covered by this report. The evaluation included the subsidiary, Newbridge, which we acquired on September 24, 2004. Since
the acquisition of Newbridge, we have focused on analyzing and implementing changes in their
procedures and controls to determine their effectiveness and to make them consistent with, and
integrate them into, our disclosure controls and procedures. We continue to analyze Newbridges
procedures and controls and expect to make additional changes in those procedures and controls in
the future. We performed additional procedures to review Newbridges accounting records and
substantiate the financial information of Newbridge included in this report. Based upon that evaluation, the President and Chief Executive Officer and Principal Financial
Officer concluded that our disclosure controls and procedures, as of April 30, 2005, were designed
and are functioning effectively to provide reasonable assurance that the information required to be
disclosed by Docucorp in reports filed under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in the SECs rules and forms.
There were no significant changes in our internal controls or in other factors that could
significantly affect these controls that occurred during the period covered by this report.
However, we are continuing to analyze, and expect to make changes in, the controls and procedures
in place at Newbridge, our recently acquired subsidiary. Section 404 of the Sarbanes-Oxley Act requires management to provide an assessment of the
effectiveness of our internal control over financial reporting as of July 31, 2005, the end of our
fiscal year. We are in the process of performing the system and process documentation, evaluation
and testing necessary to make our assessment. We have not completed this process or its assessment.
In the process of evaluation and testing, we may identify deficiencies that will require
remediation. 24




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PART II  OTHER INFORMATION 
 Item 1. Legal Proceedings We are occasionally involved in legal proceedings and other claims arising out of our operations in
the normal course of business. No such claims are expected, individually or in the aggregate, to
have a material adverse effect on our consolidated financial statements. 
 Item 6. Exhibits  31.1 
    Certification pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.  31.2 
    Certification pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.  32.1 
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes  Oxley Act of 2002.  32.2 
    Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes  Oxley Act of 2002. 25




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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. Docucorp International, Inc.(Registrant)/s/ Michael D. Andereck
    
    
    Date
    June 7,
2005Michael D. AndereckPresident and Chief Executive Officer
 26