##### 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: January 31, 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)
 5910 North Central Expressway, Suite 800, Dallas, Texas
    
    75206(Address of principal executive offices)
    
    (Zip Code)
 (214) 891-6500 
  Not applicable 
  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, 10,977,223 shares outstanding as of
March 7, 2005.




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Docucorp International, Inc.
Table of Contents
Quarterly Report on Form 10-Q
January 31, 2005 PagePART I  FINANCIAL INFORMATIONItem 1. Financial Statements (Unaudited)Consolidated Balance Sheets as of January 31, 2005 and July 31, 2004
    
    
    2Interim Consolidated Statements of Operations and Comprehensive
Income for the three and six months ended January 31,
2005 and 2004
    
    
    3Interim Consolidated Statements of Cash Flows for the six months
ended January 31, 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
    
    
    22Item 4. Controls and Procedures
    
    
    23PART II  OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    24Item 4. Submission of Matters to a Vote of Security Holders
    
    
    24Item 6. Exhibits and Reports on Form 8-K
    
    
    25Signatures
    
    
    26Certification Pursuant to Rule 13a-14(a)Certification Pursuant to Rule 13a-14(a)Certification Pursuant to 18 U.S.C. Section 1350Certification Pursuant to 18 U.S.C. Section 1350




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Docucorp International, Inc. 
 Consolidated Balance Sheets
 (In thousands except share and per share amounts)
 (Unaudited)
 January 31,
    
    
    July 31,2005
    
    
    2004AssetsCurrent assets:Cash and cash equivalents
    
    $
    7,886
    
    
    $
    12,336Accounts receivable, net of allowance
of $452 and $375, respectively
    
    
    19,065
    
    
    
    16,752Current portion of deferred taxes
    
    
    112
    
    
    
    112Income tax receivable
    
    
    817
    
    
    
    817Other current assets
    
    
    2,105
    
    
    
    2,461Total current assets
    
    
    29,985
    
    
    
    32,478Property and equipment, net of accumulated depreciation
of $18,383 and $16,664, respectively
    
    
    9,765
    
    
    
    8,073Software development costs, net of accumulated
amortization of $23,883 and $22,096, respectively
    
    
    13,230
    
    
    
    12,269Goodwill, net of accumulated amortization of $4,940
    
    
    9,803
    
    
    
    5,846Identifiable intangibles, net of accumulated amortization
of $12 and $0, respectively
    
    
    928
    
    
    
    0Other assets
    
    
    577
    
    
    
    573Total assets
    
    $
    64,288
    
    
    $
    59,239Liabilities and stockholders equityCurrent liabilities:Accounts payable
    
    $
    1,956
    
    
    $
    1,473Accrued liabilities:Accrued compensation
    
    
    3,079
    
    
    
    2,104Other
    
    
    2,123
    
    
    
    1,783Income taxes payable
    
    
    1,057
    
    
    
    158Current portion of capital lease obligations
    
    
    1,184
    
    
    
    626Current portion of long-term debt
    
    
    3,612
    
    
    
    3,550Deferred revenue
    
    
    11,135
    
    
    
    12,038Total current liabilities
    
    
    24,146
    
    
    
    21,732Deferred taxes
    
    
    4,835
    
    
    
    4,835Long-term capital lease obligations
    
    
    2,706
    
    
    
    1,716Long-term debt
    
    
    5,260
    
    
    
    6,804Other long-term liabilities
    
    
    1,686
    
    
    
    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
    
    
    47,938
    
    
    
    47,350Treasury stock at cost, 5,622,126 and 6,050,429 shares, respectively
    
    
    (31,254
    )
    
    
    (33,635
    )Retained earnings
    
    
    11,665
    
    
    
    9,821Unearned compensation
    
    
    (2,303
    )
    
    
    (402
    )Foreign currency translation adjustment
    
    
    (557
    )
    
    
    (501
    )Total stockholders equity
    
    
    25,655
    
    
    
    22,799Total liabilities and stockholders equity
    
    $
    64,288
    
    
    $
    59,239
 See accompanying notes to interim consolidated financial statements. 2




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Docucorp International, Inc. 
 Interim Consolidated Statements of Operations and Comprehensive Income
 (In thousands except per share amounts)
 (Unaudited)
 Three months ended
    
    
    Six months endedJanuary 31,
    
    
    January 31,2005
    
    
    2004
    
    
    2005
    
    
    2004RevenuesASP hosting
    
    $
    7,541
    
    
    $
    6,139
    
    
    $
    13,591
    
    
    $
    11,897Professional services
    
    
    5,573
    
    
    
    4,967
    
    
    
    10,981
    
    
    
    10,110License
    
    
    1,702
    
    
    
    3,125
    
    
    
    4,671
    
    
    
    5,792Maintenance
    
    
    5,479
    
    
    
    5,408
    
    
    
    10,717
    
    
    
    10,745Total revenues
    
    
    20,295
    
    
    
    19,639
    
    
    
    39,960
    
    
    
    38,544Cost of revenuesASP hosting
    
    
    6,730
    
    
    
    5,003
    
    
    
    11,767
    
    
    
    9,683Professional services
    
    
    4,153
    
    
    
    4,209
    
    
    
    8,332
    
    
    
    8,309License
    
    
    1,017
    
    
    
    702
    
    
    
    1,958
    
    
    
    1,428Maintenance
    
    
    382
    
    
    
    363
    
    
    
    727
    
    
    
    677Total cost of revenues
    
    
    12,282
    
    
    
    10,277
    
    
    
    22,784
    
    
    
    20,097Gross profit
    
    
    8,013
    
    
    
    9,362
    
    
    
    17,176
    
    
    
    18,447Operating expensesProduct development
    
    
    2,220
    
    
    
    2,127
    
    
    
    4,224
    
    
    
    4,188Sales and marketing
    
    
    2,878
    
    
    
    2,804
    
    
    
    5,777
    
    
    
    5,639General and administrative
    
    
    2,063
    
    
    
    1,712
    
    
    
    4,002
    
    
    
    3,398Total operating expenses
    
    
    7,161
    
    
    
    6,643
    
    
    
    14,003
    
    
    
    13,225Income from operations
    
    
    852
    
    
    
    2,719
    
    
    
    3,173
    
    
    
    5,222Interest expense
    
    
    (172
    )
    
    
    (159
    )
    
    
    (323
    )
    
    
    (332
    )Other income, net
    
    
    125
    
    
    
    187
    
    
    
    244
    
    
    
    334Income before income taxes
    
    
    805
    
    
    
    2,747
    
    
    
    3,094
    
    
    
    5,224Provision for income taxes
    
    
    309
    
    
    
    1,140
    
    
    
    1,191
    
    
    
    2,168Net income
    
    $
    496
    
    
    $
    1,607
    
    
    $
    1,903
    
    
    $
    3,056Other comprehensive income:Foreign currency translation adjustment, net of tax
    
    
    (45
    )
    
    
    (135
    )
    
    
    (56
    )
    
    
    (201
    )Comprehensive income
    
    $
    451
    
    
    $
    1,472
    
    
    $
    1,847
    
    
    $
    2,855Basic net income per share
    
    $
    0.05
    
    
    $
    0.16
    
    
    $
    0.18
    
    
    $
    0.31Weighted average basic shares outstanding
    
    
    10,580
    
    
    
    9,964
    
    
    
    10,543
    
    
    
    9,895Diluted net income per share
    
    $
    0.04
    
    
    $
    0.14
    
    
    $
    0.17
    
    
    $
    0.27Weighted average diluted shares outstanding
    
    
    11,626
    
    
    
    11,359
    
    
    
    11,531
    
    
    
    11,132
 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)
 Six months endedJanuary 31,2005
    
    
    2004Cash flows from operating activitiesNet income
    
    $
    1,903
    
    
    $
    3,056Adjustments to reconcile net income to
net cash provided by operating activities:Depreciation and amortization
    
    
    2,001
    
    
    
    1,748Amortization of software development costs
    
    
    1,787
    
    
    
    1,306Provision for doubtful accounts
    
    
    145
    
    
    
    185Stock-based compensation expense
    
    
    163
    
    
    
    38Tax benefit related to stock option exercises
    
    
    292
    
    
    
    781Changes in assets and liabilities:Increase in accounts receivable
    
    
    (1,596
    )
    
    
    (3,331
    )Decrease in income tax receivable
    
    
    0
    
    
    
    1,074Decrease in other assets
    
    
    634
    
    
    
    797Decrease in accounts payable
    
    
    (1,064
    )
    
    
    (343
    )Increase (decrease) in accrued liabilities
    
    
    852
    
    
    
    (353
    )Increase in income taxes payable
    
    
    899
    
    
    
    249Decrease in deferred revenue
    
    
    (983
    )
    
    
    (317
    )Increase (decrease) in other liabilities
    
    
    (125
    )
    
    
    221Total adjustments
    
    
    3,005
    
    
    
    2,055Net cash provided by operating activities
    
    
    4,908
    
    
    
    5,111Cash flows from investing activitiesPurchase of Newbridge Corporation
    
    
    (2,495
    )
    
    
    0Purchase of property and equipment
    
    
    (911
    )
    
    
    (601
    )Capitalized software development costs
    
    
    (2,748
    )
    
    
    (2,453
    )Net cash used in investing activities
    
    
    (6,154
    )
    
    
    (3,054
    )Cash flows from financing activitiesPrincipal payments under capital lease obligations
    
    
    (557
    )
    
    
    (287
    )Principal payments under debt obligations
    
    
    (2,975
    )
    
    
    (1,775
    )Proceeds from exercise of stock options
    
    
    338
    
    
    
    774Proceeds from stock issued under Employee Stock Purchase Plan
    
    
    102
    
    
    
    96Net cash used in financing activities
    
    
    (3,092
    )
    
    
    (1,192
    )Effect of exchange rates on cash flows
    
    
    (112
    )
    
    
    (250
    )Net increase (decrease) in cash and cash equivalents
    
    
    (4,450
    )
    
    
    615Cash and cash equivalents at beginning of period
    
    
    12,336
    
    
    
    7,269Cash and cash equivalents at end of period
    
    $
    7,886
    
    
    $
    7,884
 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 January 31, 2005 and
July 31, 2004, and for the three and six months ended January 31, 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 six months ended January 31, 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. Revenue related to products still in the testing phase is deferred until
formal acceptance of the product by the customer. 5




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Docucorp International, Inc.
Notes to Interim Consolidated Financial Statements (cont.)
(Unaudited) 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. 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 over the expected term of the ASP hosting agreement. Cash equivalents We consider all highly liquid investments purchased with an original maturity of three 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. 6




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Docucorp International, Inc.
Notes to Interim Consolidated Financial Statements (cont.)
(Unaudited) 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: Leasehold improvements
    
    Lesser of useful life or life of leaseComputer equipment
    
    4-5 yearsFurniture and fixtures
    
    5 yearsEquipment under capital leases
    
    Lesser of useful life 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 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. Goodwill In accordance with Financial Accounting Standards Board Statement of Financial Accounting Standards
No. 142, Goodwill and Other Intangible Assets, we do not amortize goodwill, but rather test it
annually for impairment. Goodwill is also reviewed for impairment at other times during the year
when events or changes in circumstances indicate that an impairment might be present. 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 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. 7




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Docucorp International, Inc.
Notes to Interim Consolidated Financial Statements (cont.)
(Unaudited) 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 maintenance
and support 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 January 31, 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 January 31, 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. 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. 8




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Docucorp International, Inc.
Notes to Interim Consolidated Financial Statements (cont.)
(Unaudited) 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
    
    
    Six months endedJanuary 31,
    
    
    January 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Shares used in computing basic
net income per share
    
    
    10,580
    
    
    
    9,964
    
    
    
    10,543
    
    
    
    9,895Dilutive effect of stock options
and unvested restricted stock
    
    
    1,046
    
    
    
    1,395
    
    
    
    988
    
    
    
    1,237Shares used in computing diluted
net income per share
    
    
    11,626
    
    
    
    11,359
    
    
    
    11,531
    
    
    
    11,132
 At January 31, 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
    
    
    Six months endedJanuary 31,
    
    
    January 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Net income as reported
    
    $
    496
    
    
    $
    1,607
    
    
    $
    1,903
    
    
    $
    3,056Plus,
stock-based
compensation
expense
included in
reported
income, net of
tax
    
    
    62
    
    
    
    20
    
    
    
    100
    
    
    
    22Less,
stock-based
compensation
expense under
fair value
based methods,
net of tax
    
    
    (263
    )
    
    
    (257
    )
    
    
    (502
    )
    
    
    (495
    )Pro forma net income
    
    $
    295
    
    
    $
    1,370
    
    
    $
    1,501
    
    
    $
    2,583Net income per share:As reportedBasic
    
    $
    0.05
    
    
    $
    0.16
    
    
    $
    0.18
    
    
    $
    0.31Diluted
    
    $
    0.04
    
    
    $
    0.14
    
    
    $
    0.17
    
    
    $
    0.27Pro formaBasic
    
    $
    0.03
    
    
    $
    0.14
    
    
    $
    0.14
    
    
    $
    0.26Diluted
    
    $
    0.03
    
    
    $
    0.12
    
    
    $
    0.13
    
    
    $
    0.23
 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 value of the
restricted stock grant is being recognized as compensation expense ratably over the vesting period. As of January 31, 2005, the performance
goals were not attained. 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 10




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Docucorp International, Inc.
Notes to Interim Consolidated Financial Statements (cont.)
(Unaudited) of 175,000 shares 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 value of the restricted stock grant is being recognized as
compensation expense ratably over the vesting period. As of January 31, 2005, the performance goals
were not attained. 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. 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: accounts receivable and allowance for doubtful
accounts, impairment of long-lived assets 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 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 $4.0 million, comprised of approximately
$2.6 million paid in cash and $1.4 million of net liabilities assumed. During the three months
ended January 31, 2005, we completed the initial appraisals of the acquired tangible and intangible
assets, and finalized lease negotiations to expand our Dallas ASP center in order to relocate the
personnel and operating activities of Newbridge to that facility. These events resulted in the recording of an acquired intangible asset
of $940,000, a decrease of $1.9 million in the value previously allocated to property and equipment
and the recording of a relocation liability of $475,000, resulting in a net increase to goodwill of
$1.4 million. The allocation of purchase consideration is not completed as the valuation of the
intangible assets has not been finalized. We expect to complete the purchase price allocation in
the three months ended April 30, 2005. 11




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Docucorp International, Inc.
Notes to Interim Consolidated Financial Statements (cont.)
(Unaudited) The acquisition is not considered material to our results of operations; therefore no pro forma
information is presented. 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 six months ended January 31, 2005 and 2004 (in thousands): Three months ended
    
    
    Six months endedJanuary 31,
    
    
    January 31,2005
    
    
    2004
    
    
    2005
    
    
    2004Revenues:Software
    
    $
    12,754
    
    
    $
    13,500
    
    
    $
    26,369
    
    
    $
    26,647ASP
    
    
    7,541
    
    
    
    6,139
    
    
    
    13,591
    
    
    
    11,897Total revenues
    
    $
    20,295
    
    
    $
    19,639
    
    
    $
    39,960
    
    
    $
    38,544Software gross profit, net of
product development costs
    
    $
    4,982
    
    
    $
    6,099
    
    
    $
    11,128
    
    
    $
    12,045ASP gross profit
    
    
    811
    
    
    
    1,136
    
    
    
    1,824
    
    
    
    2,214Sales and marketing
    
    
    (2,878
    )
    
    
    (2,804
    )
    
    
    (5,777
    )
    
    
    (5,639
    )General and administrative
    
    
    (2,063
    )
    
    
    (1,712
    )
    
    
    (4,002
    )
    
    
    (3,398
    )Total operating income
    
    $
    852
    
    
    $
    2,719
    
    
    $
    3,173
    
    
    $
    5,222
 Note 4  Commitments and contingencies Our U. S. tax return for the year ended July 31, 2002 is currently under examination by the
Internal Revenue Service. 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 court and tax
proceedings. We intend to vigorously defend our tax positions and to aggressively contest these
matters through applicable IRS and judicial procedures, as appropriate. As of January 31, 2005, we
could not reasonably estimate the tax and related penalties and interest exposure related to these
examinations. An unfavorable resolution of these
tax matters may have a material adverse impact on our consolidated financial position and result of
operations. Note 5  Recently issued accounting pronouncements In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting
Standards No. 123R, Shares-Based Payments (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 12




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Docucorp International, Inc.
Notes to Interim Consolidated Financial Statements
(Unaudited) 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 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. 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 . 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. 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 and 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 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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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. 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 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 fourth quarter of our current fiscal year. For the three months ended January 31, 2005, license revenue of $1.7 million decreased
significantly compared with the same period of fiscal year 2004. The decrease is primarily
attributable to weak software license sales in North America. The decrease in license revenue
negatively impacted our operating margin and profitability. The growth in ASP hosting revenue of 23% for the three month ended January 31, 2005, is primarily
attributable to revenue generated by Newbridge, partially offset by a decrease in existing ASP
revenue. In addition, the increase in cost of ASP hosting revenue for the three and six months
ended January 31, 2005, is due primarily to costs incurred by Newbridge. For the three months and six months ended January 31, 2005, professional services revenue increased
12% and 9%, respectively. The increase in professional services revenue was driven by revenue
increases in both North America and Europe. In addition, professional services margin increased
from 15.3 % to 25.5% for the three months ended January 31, 2005, and from 17.8% to 24.1% for the
six months ended January 31, 2005. We have improved both our utilization and average billing rates
for professional services staff. For the three months ended January 31, 2005, our European subsidiary generated license revenue of
$526,000, total revenue of $1.6 million and achieved a minimal profit for the quarter. 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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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. 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 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. 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. 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. 17




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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
    
    
    Six months endedJanuary 31,
    
    
    January 31,2005
    
    
    2004
    
    
    2005
    
    
    2004RevenuesASP hosting
    
    
    37
    %
    
    
    31
    %
    
    
    34
    %
    
    
    31
    %Professional services
    
    
    28
    
    
    
    25
    
    
    
    27
    
    
    
    26License
    
    
    8
    
    
    
    16
    
    
    
    12
    
    
    
    15Maintenance
    
    
    27
    
    
    
    28
    
    
    
    27
    
    
    
    28Total revenues
    
    
    100
    
    
    
    100
    
    
    
    100
    
    
    
    100Cost of revenuesASP hosting
    
    
    33
    
    
    
    25
    
    
    
    29
    
    
    
    25Professional services
    
    
    21
    
    
    
    21
    
    
    
    21
    
    
    
    21License
    
    
    5
    
    
    
    4
    
    
    
    5
    
    
    
    4Maintenance
    
    
    2
    
    
    
    2
    
    
    
    2
    
    
    
    2Total cost of revenues
    
    
    61
    
    
    
    52
    
    
    
    57
    
    
    
    52Gross Profit
    
    
    39
    
    
    
    48
    
    
    
    43
    
    
    
    48Operating expensesProduct development
    
    
    11
    
    
    
    11
    
    
    
    11
    
    
    
    11Sales and marketing
    
    
    14
    
    
    
    14
    
    
    
    14
    
    
    
    14General and administrative
    
    
    10
    
    
    
    9
    
    
    
    10
    
    
    
    9Total operating expenses
    
    
    35
    
    
    
    34
    
    
    
    35
    
    
    
    34Operating income
    
    
    4
    
    
    
    14
    
    
    
    8
    
    
    
    14Interest expense
    
    
    (1
    )
    
    
    (1
    )
    
    
    (1
    )
    
    
    (1
    )Other income, net
    
    
    1
    
    
    
    1
    
    
    
    1
    
    
    
    1Income before income taxes
    
    
    4
    
    
    
    14
    
    
    
    8
    
    
    
    14Provision for income taxes
    
    
    2
    
    
    
    6
    
    
    
    3
    
    
    
    6Net income
    
    
    2
    %
    
    
    8
    %
    
    
    5
    %
    
    
    8
    %
 Comparative analysis of results for the three and six months ended January 31, 2005 and 2004 Revenues Total revenues increased 3% and 4% for the three and six months ended January 31, 2005,
respectively. ASP hosting revenue increased 23%, or $1.4 million, and 14%, or $1.7 million, for the
three and six months ended January 31, 2005, respectively. The increase in ASP hosting revenue is
primarily due to revenue generated by recently acquired Newbridge, partially offset by a decrease
in revenue from existing customers. For the three and six months ended January 31, 2005,
professional services revenue increased 12%, or $606,000, and 9%, or $871,000, respectively, due
primarily to an increase in utilization of our professional services personnel and an increase in
our average billing rate. License revenue decreased 46%, or $1.4 million, and 19%, or $1.1 million,
for the three and six months ended 18




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January 31, 2005, respectively, due to fewer software license
sales in North America. For the three months ended January 31, 2005, maintenance revenue increased
$71,000, or 1%. Maintenance revenue decreased $28,000 for the six months ended January 31, 2005 due
to certain legacy customers consolidating multiple licenses when upgrading to enterprise-wide versions of our latest technology. This decrease was offset for the
three months ended January 31, 2005 by maintenance revenue generated primarily from new software
license sales. Backlog for our products and services was approximately $50.8 million as of January 31, 2005, of
which approximately $24.9 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 35% to $6.7 million for the three
months ended January 31, 2005, and increased 22% to $11.8 million for the six months ended January
31, 2005. These increases are primarily due to the operating expenses associated with Newbridge.
For the three months ended January 31, 2005 and 2004, cost of ASP hosting revenue represented 89%
and 81% of ASP hosting revenue, respectively. For the six months ended January 31, 2005 and 2004,
cost of ASP hosting revenue represented 87% and 81% of ASP hosting revenue, respectively. The
increase in cost as a percentage of ASP revenue is primarily due to the currently lower margins
associated with Newbridge and the decline in ASP hosting revenue from existing customers. 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 $56,000, or 1% for the three months ended January 31, 2005,
and increased $23,000 for the six months ended January 31, 2005. For the three months ended
January 31, 2005 and 2004, cost of professional services revenue represented 75% and 85% of
professional services revenue, respectively. For the six months ended January 31, 2005 and 2004,
cost of professional services revenue represented 76% and 82% of professional services revenue,
respectively. The decrease in costs as a percentage of professional services revenue is primarily
due to improved staff utilization and an increase in average billing rates. We expect 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 six months ended January
31, 2005, cost of license revenue increased 45% and 37%, respectively, primarily due to the
addition of amortization expense related to new products introduced to the marketplace during the
last twelve months. For the three months ended January 31, 2005 and 2004, cost of license revenue
represented 60% and 22% of license revenue, respectively. For the six months ended January 31,
2005 and 2004, cost of license revenue represented 42% and 25% of license revenue, respectively.
The increase in costs as a 19




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percentage of license revenue is due to the decrease in license revenue
during the second quarter and the 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 5% to $382,000 for the
three months ended January 31, 2005, and increased 7% to $727,000 for the six months ended January
31, 2005, due primarily to an increase in customer support costs from our European subsidiary. For
both the three months ended January 31, 2005 and 2004, cost of maintenance revenue represented 7%
of maintenance revenue. For the six months ended January 31, 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 4% to $2.2 million for the three months ended January 31, 2005, and increased
1%, or $36,000, for the six months ended January 31, 2005. The increase is primarily due to an
increase in salary and personnel related costs, partially offset by an increase in capitalization
of software development 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 six months ended January 31, 2005, sales and marketing expense increased $74,000, or 3%, and
$138,000, or 2%, respectively. This increase is primarily due to an increase in salary and
personnel related costs, partially offset by a decrease in incentive compensation. 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 $351,000, or 20%, and $604,000, or 18%, for the three
and six months ended January 31, 2005, respectively. The increase is primarily due to an increase
in accounting and auditing fees associated with Sarbanes-Oxley compliance. Interest expense Interest expense increased $13,000 for the three months ended January 31, 2005, due to the
assumption of capital leases from Newbridge. For the six months ended January 31, 2005, interest
expense decreased $9,000 due to a decrease in interest expense on our term note with Comerica Bank
due to principal payments made over the last twelve months. Other income, net Other income, net decreased $62,000 and $90,000 for the three and six months ended January 31,
2005, respectively, primarily due to a decrease in gains associated with fluctuations of foreign
currency exchange rates. Provision for income taxes The effective tax rate for both the three and six months ended January 31, 2005 was 38.5%. The
effective tax rate for both the three and six months ended January 31, 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 20




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which we do not currently 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. Net income Net income decreased approximately 69% and 38% for the three and six months ended January 31, 2005,
respectively. This decrease is primarily due to a decrease in software license revenue and an
increase in general and administrative costs for the three and six months ended January 31, 2005. Liquidity and Capital Resources At January 31, 2005, our principal sources of liquidity consisted of cash and cash equivalents of
$7.9 million and our revolving credit facility, which had available borrowings of $10 million. Cash
and cash equivalents for the six months ended January 31, 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 $4.9 million and $5.1 million for the six months ended
January 31, 2005 and 2004, respectively. Significant changes in assets and liabilities for the six
months ended January 31, 2005 that impacted cash flow from operations include an increase in
accounts receivable of $1.6 million and a decrease in accounts payable of $1.1 million, of which
approximately $0.9 million related primarily to past due payments made on the assumed payables of
Newbridge. During the six months ended January 31, 2005 and 2004, cash used in investing activities was $6.2
million and $3.1 million, respectively. For the six months ended January 31, 2005, we used $2.5
million, net of cash received of $100,000, for the purchase of Newbridge. Cash used for the
purchase of property and equipment was $911,000 and $601,000 for the six months ended January 31,
2005 and 2004, respectively. Cash used in the investment of capitalized software development costs
was $2.7 million and $2.5 million for the six months ended January 31, 2005 and 2004, respectively. Cash used in financing activities was $3.1 million and $1.2 million for the six months ended
January 31, 2005 and 2004, respectively. Cash used in financing activities during the six months
ended January 31, 2005, primarily related to payments under our bank note of $1.8 million,
principal payments made under the assumed debt obligations of Newbridge of $1.2 million and
payments under capital lease obligations of $557,000. The $1.2 million of cash used in financing
activities during the six months ended January 31, 2004, related to the payments made under our
bank note of $1.8 million and capital lease obligations of $287,000, partially offset by proceeds
received from the exercise of stock options of $774,000. As of January 31, 2005, we held approximately 5,622,000 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 $5.8 million at January 31, 2005, compared with $10.7 million at July 31, 2004.
The decrease in working capital of $4.9 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 January 31, 2005, the outstanding balance on our bank note was $8.6 million, of which
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At January 31, 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 January 31, 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. 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 pronouncements In December 2004, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 123R, Shares-Based Payments (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 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. 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. 
 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 $8.6 million as of January 31, 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 22




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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 January 31, 2005 and 2004, 8% and 7%, respectively, of our revenues were
denominated in British pounds. For the three months ended January 31, 2005 and 2004, 8% and 9%,
respectively, of our cost of revenues and operating expenses were denominated in British
pounds. For the six months ended January 31, 2005 and 2004, 7% and 6%, respectively, of
our revenues and 8% and 9%, respectively, of our cost of revenues 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 12a-15(e) 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 January 31, 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. 23




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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 4. Submission of Matters to a Vote of Security Holders We held our Annual Meeting of Stockholders on December 7, 2004. At this meeting, the stockholders
voted in favor of electing as directors the six nominees named in the Proxy Statement dated October
21, 2004 and ratifying the selection of PricewaterhouseCoopers LLP as its independent registered
public accounting firm for the 2005 fiscal year. Also at this meeting, the stockholders voted in
favor of amending the 1997 Equity Compensation Plan to increase the number of shares of Common
Stock issuable pursuant to awards under the plan from 3,800,000 to 4,500,000 shares, of which a
maximum of 1,000,000 shares may be used for grants of restricted stock, SARs and performance units.
The number of votes cast for each item was as follows:  I.
    Election of Directors For
    
    
    Against
    
    
    WithheldMilledge A. Hart, III
    
    
    9,122,901
    
    
    
    220,085
    
    
    
    280,474Michael D. Andereck
    
    
    9,342,036
    
    
    
    950
    
    
    
    280,474Anshoo S. Gupta
    
    
    9,301,717
    
    
    
    41,269
    
    
    
    280,474John D. Loewenberg
    
    
    9,125,927
    
    
    
    217,059
    
    
    
    280,474George F. Raymond
    
    
    9,342,212
    
    
    
    774
    
    
    
    280,474Arthur R. Spector
    
    
    9,094,247
    
    
    
    248,739
    
    
    
    280,474
  II.
    Ratification of selection of PricewaterhouseCoopers LLP as Independent Registered Public
Accounting Firm For
    
    Against
    
    Withheld9,522,244
    
    82,124
    
    19,092
 III. Amendment to the 1997 Equity Compensation Plan For
    
    Against
    
    Withheld4,222,780
    
    2,331,806
    
    44,940
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Item 6. Exhibits and Reports on Form 8-K (a)
    
    Exhibits31.1 
    
    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.(b)
    
    Reports on Form 8-K.On November 19, 2004, the Company filed a Current Report on Form 8-K announcing its
results of operations for the three months ended October 31, 2004.
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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 March 11, 2005Michael D. AndereckPresident and Chief Executive Officer
 26