**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-K**

**(Mark One)**

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe fiscal year ended July 31, 2006**

**or**

**o**                                 TRANSITIONALREPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe transitional period from            to            **

**CommissionFile Number 00-23829**

**Docucorp International, Inc.**

(Exact name of registrantas specified in its charter)

| **Delaware**                                        |   | **75-2690838**       |
|-----------------------------------------------------|--------|----------------------|
| (State or other  jurisdiction of                    |   | (I.R.S. Employer     |
| incorporation or  organization)                     |   | Identification  No.) |
| **5400 LBJ Freeway, Suite 300, Dallas, Texas** |   | **75240**            |
| (Address of  principal executive offices)           |   | (Zip Code)           |

 

**Registrant’s telephone number,including area code**(214)891-6500

**Securities registered pursuant to Section 12(b) ofthe Act:** None

Securities registered under Section 12(g) ofthe Exchange Act:

**Common Stock, par value$.01 per share**

(Title of class)

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. Yes  o  No  x

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes  o  No  x

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes  x  No  o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer (as defined in Rule 12b-2 of theExchange Act. (check one):
| Large accelerated filer o | Accelerated filer x | Non-accelerated  filer o |
|---------------------------|---------------------|--------------------------|

 

Indicate by check markwhether the registrant is a shell company (as defined by Rule 12b-2of the Exchange Act). Yes  o  No  x

As of October 6, 2006,there were 11,515,843 shares of Common Stock, $.01 par value, of the Registrantoutstanding. The aggregate market value of the voting stock of the Registrantheld by non-affiliates as of the last business day of the second quarter offiscal 2006 approximated $63,435,000.

**DOCUMENTSINCORPORATED BY REFERENCE**

Part IIIof this Annual Report on Form 10-K incorporates by referenceportions of the Registrant’s definitive proxy statement, to be filed with theSecurities and Exchange Commission not later than 120 days after the close ofits fiscal year.

 

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**Docucorp International, Inc.Table of ContentsForm 10-KJuly 31, 2006**
| **Part I.**   |   |                                                                                                                |   |   |
|--------------------|--------|---------------------------------------------------------------------------------------------------------------------|--------|--------|
| Item 1.            |   | Business                                                                                                            |   | 2      |   |
| Item 1A.           |   | Risk Factors                                                                                                        |   | 11     |   |
| Item  1B.          |   | Unresolved  Staff Comments                                                                                          |   | 14     |   |
| Item 2.            |   | Properties                                                                                                          |   | 14     |   |
| Item 3.            |   | Legal  Proceedings                                                                                                  |   | 15     |   |
| Item  4.           |   | Submission  of Matters to a Vote of Security Holders                                                                |   | 15     |   |
| **Part II.**  |   |                                                                                                                |   |   |   |
| Item  5.           |   | Market  for Registrant’s Common Equity, Related Stockholder Matters and Issuer  Purchases of Equity Securities |   | 16     |   |
| Item  6.           |   | Selected  Consolidated Financial Data                                                                               |   | 17     |   |
| Item  7.           |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         |   | 18     |   |
| Item  7A.          |   | Quantitative  and Qualitative Disclosures About Market Risk                                                         |   | 32     |   |
| Item  8.           |   | Financial  Statements and Supplementary Data                                                                        |   | 32     |   |
| Item  9.           |   | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure                               |   | 32     |   |
| Item  9A.          |   | Controls  and Procedures                                                                                            |   | 32     |   |
| Item 9B.           |   | Other  information                                                                                                  |   | 35     |   |
| **Part III.** |   |                                                                                                                |   |   |   |
| Item  10.          |   | Directors  and Executive Officers of the Registrant                                                                 |   | 35     |   |
| Item  11.          |   | Executive  Compensation                                                                                             |   | 35     |   |
| Item  12.          |   | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matter                     |   | 35     |   |
| Item  13.          |   | Certain  Relationships and Related Transactions                                                                     |   | 35     |   |
| Item  14.          |   | Principal  Accounting Fees and Services                                                                             |   | 35     |   |
| **Part IV.**  |   |                                                                                                                |   |   |   |
| Item  15.          |   | Exhibits  and Financial Statement Schedules                                                                         |   | 36     |   |
| Signatures         |   | 38                                                                                                                  |   |

 

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**Part I**

*The disclosures set forth in this report are qualifiedby Item 1A, Risk Factors, and by the section captioned “Forward-LookingStatements” in Item 7, Management’s Discussion and Analysis of FinancialCondition and Results of Operations, as well as other cautionary statements setforth elsewhere in this report.*

**Item1.**                Business

**General**

Docucorp International, Inc. (“Docucorp”)develops, markets and supports Customer Communication Management (“CCM”)solutions via a portfolio of proprietary information software, ApplicationService Provider (“ASP”) hosting and professional services that enablecompanies to create, publish, manage and archive complex, high-volume,individualized information. We support the entire information lifecycle—fromacquisition of the first raw data point to final delivery of personalizedinformation to the customer.

We were created on January 13, 1997 in connectionwith the acquisition of FormMaker Software, Inc. by Image Sciences, Inc.

We are a leading authority in providing dynamicsolutions for acquiring, creating, managing, personalizing, presenting andmarketing information of all kinds. Servicing the entire CCM lifecycle, ourcomprehensive offering supports a wide range of in-house and outsourcedenterprise applications, including customer statements and billings, ElectronicBill Presentment and Payment (“EBPP”), insurance policy production, contentmanagement, correspondence automation, call center fulfillment, wealthmanagement reporting and health care provider directories. Our softwaresolutions support leading hardware platforms, operating systems, printers andimaging systems.

Our ASP hosting service allows customers to outsourcetheir information management to our ASP centers, where our software andfacilities are used to provide processing, print, mail, archival and Internetdelivery of documents. Our ASP offerings include customer statement and billgeneration, EBPP, insurance policy production, health care providerdirectories, disaster recovery and electronic document archival.

Additionally, we provide professional services relatedto our software solutions. Our professional services offerings includeimplementation, integration, training and consulting services.

Operating primarily in four key markets—insurance,utilities, financial services and health care—we now help more than 1,300customers worldwide maximize the value of their enterprise information,reducing costs, increasing productivity, improving customer service, buildingcustomer loyalty and facilitating new revenue opportunities.

We believe we are theleading provider of CCM solutions for the insurance industry. Our insurancecustomer base includes more than half of the 200 largest United Statesinsurance companies, including nine of the top 10 life and health insurancecompanies, nine of the top 10 property and casualty insurance companies andmore than 600 Managing General Agents (MGAs). Many of the largest NorthAmerican utility companies, major international financial servicesinstitutions, and leading health care provider networks use our products andservices.

**Industry Background**

Certain trends have accelerated the need forautomating the process of acquiring, creating, managing, personalizing,presenting and marketing enterprise-wide information. Increased competition inindustries such as insurance, utilities, financial services and health care hascaused companies to focus more closely on enhancing customer relationshipswhile reducing associated operating costs.

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The current economic environment has promptedcustomers and prospects to focus on Return On Investment (“ROI”) when makingpurchasing decisions. In fact, few companies are buying software or servicesunless ROI can be proven. We have succeeded in this competitive economy becausewe believe our customers successfully realize ROI for our solutions. With oursolutions, customers can turn resource-draining manual processes intoelectronic workflows that enable personalized customer communications to beautomatically created, stored and accessed, significantly impacting theircompany’s performance.

Additionally, rapid technological advances in tieredclient/server architecture and the Internet, adoption of Microsoft’s WindowsXPand .NET, emergence of Sun Microsystems’ Java and J2EE, and the acceptance ofevolving XML standards have expanded the benefits that businesses can derivefrom document automation. Process automation and Web-based access and deliveryof information enable our customers to save substantial amounts of time andmoney.

With our solutions,companies are also able to:

·       Reducetime, errors and labor associated with manual processes and input;

·       Eliminatehard copy storage with electronic archiving;

·       Shortendocument preparation time and reduce duplicate data entry by reusing electronicallycaptured and stored data;

·       Reducedelays and processing time by automating document routing and workflow;

·       Improvecustomer satisfaction and loyalty by delivering personalized communicationsacross multiple channels; and

·       Speedcustomer service response time by electronically accessing file information.

The same advances that have enhanced the benefits ofsuch process automation, however, have rendered the development andimplementation of solutions increasingly complex. Consequently, businesses areincreasingly outsourcing some of their needs to skilled and experiencedcompanies like ours that provide ASP hosting services.

Information iscritical to corporations as they endeavor to increase revenue, improve customercommunications and reduce costs. The emergence of call centers has alsoincreased the demand for access to and automation of customer services.Companies can increase revenue by leveraging information through personalizingand producing high-volume, one-to-one documents such as customer statementsthat cross-sell additional products and services. Personalization andpresentation of information enables companies to provide better customerservice by:

·       Presentinginformation in print and over the Internet in more attractive, easier-to-read formats;

·       Deliveringinformation online, allowing for customer self-service;

·       Minimizingthe time it takes to produce and deliver information; and

·       Providingcustomer service personnel with immediate access to electronically archivedinformation.

Our clients are findingthat personalization of customer communications can be a powerful tool forincreasing customer satisfaction. As a result, an increasing number ofcompanies are employing innovative comprehensive CCM processes.

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**Growth Strategy**

Our strategy for growthconsists of the following:

*Leveraging existingcustomer relationships*

We have an installed baseof more than 1,300 customers. Existing customers expanding or upgrading theirCCM solutions provide us with a market for additional software solutions andservices. The majority of our revenue growth is generated from existingcustomers.

*Expansion invertical markets*

It is our belief that weare a leading provider of CCM solutions for the insurance and utilitiesindustries. During fiscal year 2005, we expanded into the health care marketthrough our acquisition of Newbridge. For information regarding thisacquisition see Note 2—Acquisition to the Consolidated Financial Statements. Thehealth care industry, like insurance, utilities and financial services, has anincreasing need for reducing operating costs as well as communicating moreeffectively with their customers. Revenues from the health care industryrepresented 8% and 7% of our total revenues in fiscal years 2006 and 2005,respectively.

*Expandinginternationally*

We continue to expand ourinternational customer base primarily through direct sales and by cultivatingand expanding our European distribution alliances. We currently serve the insurance, financial services andutility markets through our presence in London, the Benelux region,Switzerland, Central and Eastern Europe, Middle East and Africa (“EMEA”) andthe Asia Pacific region.

*Developing andenhancing new technologies*

Our product developmentefforts are focused on developing new solutions as well as enhancing andbroadening our current software solutions. New solutions will continue toemphasize state-of-the-art technologies for Internet-enablement and informationexchange including XML, SOAP, LINUX, Javaand Microsoft.Net. During fiscal 2007, our product development efforts willinclude development of new functionality, integration of existing solutions toprovide information exchange through the Internet, improving the ease of use ofour software products and further development and packaging of applications foruse in vertical industries such as insurance, utilities, financial services andhealth care.

*Pursuingacquisitions and strategic alliances*

We have successfullycompleted four acquisitions since 1997. We will continue to evaluate potentialacquisitions of other companies or technologies to further expand oursolutions, services or market penetration. In addition, as we expand in ourtargeted vertical markets, we intend to enter into additional sales andmarketing strategic alliances in such markets. We believe that new technicalskills, expanded software functionality, a broader client base and an expandedgeographic presence may result from these activities.

*Expanding ASPhosting business*

In fiscal 2000, we adoptedan outsourcing business model which provides hosted software applications on aper transaction basis through our ASP centers. Our ASP hosting offerings allowcustomers to off-load applications and free up resources to concentrate ontheir core competencies and strategic projects. ASP revenues increased 25% infiscal 2006 as compared to fiscal 2005. Our United States based ASP hostingcenters are located in Dallas and Atlanta to meet customer demands as well asoffer off-site backup and 

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disasterrecovery capabilities. During 2006, we began providing ASP hosting services toa customer located in EMEA through a print and fulfillment partner.

**Docucorp Solutions**

We focus on providingenterprise-wide CCM solutions that acquire, create, manage, personalize,present and market information. Customers can purchase these solutions byeither licensing our software for in-house installation or by utilizing thesolutions through our ASP centers on a per transaction basis. We marketsolutions primarily to four vertical markets: insurance, financial services,utilities and health care. Set forth below is a list of representativesolutions that we provide to each of these vertical markets:

*Insurance solutions*

*InsurancePolicy Production**—Enables companies to create, publish, distribute andarchive high volumes of personalized insurance policies, quotes, endorsements,cancellations and renewals.*

*Correspondence**—Allows*insurancerepresentatives to electronically access policies and other critical data toverify coverage, automate and personalize subsequent document packages andcorrespondence.

*PolicyXpressTM**—Provides*insurance companies witha complete library of fully implemented Insurance Service Office (“ISO”)industry standard forms for the Property and Casualty (P&C) marketplace.

*LibraryXpressTM**—Provides*insurance companies withcustomized electronic libraries of ISO industry standard forms for the P&Cmarketplace.

*ContentManagement**—Provides*insurance companies witha single, centralized repository for storing, accessing, annotating, printingand electronically routing all content, including customer data, electronicdocuments, video/audio clips and scanned copies of printed material.

*ImageResourceTM**—Provides*an affordable contentmanagement and workflow solution for the MGA market.

*Electronic BillPresentment & Payment**—Provides***policyholders with the ability to view premium notices andpay premiums online.

*Financial servicessolutions*

*WealthManagement Reporting**—Enables***financialadvisors and customers to electronically access client data from multipleaccounts for review and analysis, while automating and personalizing subsequentconsolidated customer reports and presentations.

*e-forms**—Enables*financialservices companies to establish electronic workflows for form creation, formfill, routing and distribution for both internal and customer-facing forms.

*FinancialStatements**—Enables*financial services andretail finance companies to produce dynamic, personalized statements, whichreflect customer preferences for content and format from numerous data sourcesfor multi-channel distribution, including print, PDF, fax and e-mail.

*FinancialCorrespondence**—Enables*financial services companies to access data electronically toautomate personalized financial correspondence.

*Content Management**—Provides***financial services companies with a single, centralizedrepository for storing, accessing, annotating, printing and electronicallyrouting all content, including customer data, electronic documents, video/audioclips and scanned copies of printed material.

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*Utilities solutions*

*BillPrint**—Allows*utility companies tocross-market and consolidate billing statements for multiple services such asgas, electricity, cable TV, security and the Internet.

*Electronic BillPresentment & Payment**—Enables*companies togive their customers the ability to view and pay their bills online.

*Health caresolutions*

*Webprovider search systems**—Hosts*a secure Website, from which health care plan members can search for provider informationor create provider directories based on geographic proximity.

*Providerdirectories**—Produces*and distributes healthcare provider directories on demand, ensuring the most up-to-date provider dataavailable.

*Enrollment kits**—Creates*customizedpost-enrollment health care kits that can include ID cards, introductionletters, benefit certification pages, group insurance policies, summary plandescriptions, benefit riders and tailored provider directories.

**Docucorp Software Products**

We offer our CCM solutionsthrough a portfolio of scalable, high-performance software applications thataddress each phase of the enterprise-wide information process of acquiring,creating, managing, personalizing, presenting and marketing information. Ourphilosophy of open architecture and support of industry standards enables ourcustomers to select software and hardware from other leading vendors andintegrate them with Docucorp solutions. Software licenses accounted for 11%,13% and 14% of our total revenues in fiscal 2006, 2005 and 2004, respectively. Revenuesrelated to maintenance and support agreements accounted for 25%, 27% and 28% ofour total revenues in fiscal 2006, 2005 and 2004, respectively. Our softwaresolutions are organized into the following four primary categories.

*Acquiring andcreating information*

*Docucreate* products create forms that can be used repeatedly inhigh-volume environments. These software products include editors that createforms and insert fields for run-time variable data insertion. They also producedevice-independent data streams that can be printed, archived and distributedover intranets and the Internet. Specific products include:

*DocucreateWorkstation**—A*Microsoft Windows-based productthat includes a WYSIWYG forms editor, field editors and print drivers necessaryto create and edit both static and dynamic forms that can be output in XeroxMetacode, IBM AFP and other print data streams.

*DocucreateSC (Kofax)**—A*Microsoft Windows-based serverproduct that enables document capture by a Kofax Ascent scanner.

*DocucreateIC**—A*serverproduct available for Microsoft Windows, AIX, LINUX and IBM z/OS platforms,which enables graphic images created by a personal computer or captured byscanner or fax to be incorporated within documents for print on high-speedXerox and IBM printers, or to be published in digital formats over intranetsand the Internet.

*Transall—**An*Extract-Translate-Load(ETL) product that enables companies to rapidly and economically develop intra-applicationcommunication and data exchanges from multiple sources and in multiple formats.

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*Managinginformation*

*Documanage* software delivers full document management andarchival to information-intensive companies. Specific products include:

*DocumanageWorkstation**—A*Microsoft Windows-based viewerthat retrieves indexed documents from the Documanage Server and otherrepositories for viewing, annotating and routing with viewer support of morethan 200 images and print stream formats.

*Documanage Server**—A*server-basedproduct that automaticallyindexes and stores various print data streams and imaging system formats andperforms document management, including check-in/check-out, automated versioncontrol, multi-tier security and annotations. This product runs under MicrosoftWindows, LINUX and AIX, and accepts hundreds of image formats, as well as IBMAFP, Xerox Metacode, Docucorp DCD and line printer data streams.

*Personalizinginformation*

*Documaker,Documaker FP and Docuflex*are powerful, high-volumepublishing engines for personalizing and presenting information. These publishing products perform data merging,content assembly and business rules creation to automate enterprise-wideproduction of applications such as insurance policies and customer statements.These device-independent software products enable individualized printing,archiving and delivery via networks and the Web. Specific products include:

*DocumakerWorkstation**—A*Microsoft Windows-basedapplication that enables device-independent document production, includingautomated and dynamic forms fill, data editing and WYSIWYG viewing ofdocuments.

*DocumakerServer**—A*server-based product forcustomized, business rule-intensive publishing applications that require uniquedocuments, such as insurance policies, customer correspondence, flexible billsand statements. Documaker runs under Microsoft Windows, LINUX, AIX, IBM z/OSand Sun Solaris.

*DocumakerFP**—A***server-based product that personalizes and presentsinformation repeatedly using the same forms in various combinations, such asinsurance policies. Documaker FP runs under Microsoft Windows, AIX and IBMz/OS.

*Docuflex**—An*easy-to-use,powerful publishing engine for dynamically composing highly personalizedbooklets, catalogs, contracts and statements. Docuflex runs under MicrosoftWindows, LINUX, AIX, IBM z/OS and Sun Solaris.

*PPS**—A*MicrosoftWindows-based application designed specifically for MGAs. It provides anefficient and economical insurance policy production solution.

*iDocumaker**—An*Internet basedproduct that web-enables the Documaker suite, allowing users in multiplelocations to view, assemble and maintain documents. Additionally, it providesthe ability to enter data and edit content.

*Presenting andmarketing information*

We can help companies speed business applications tothe Internet, Web-enabling anything from forms fill and publishing to managingand viewing documents. Our solutions are platform-independent and fullyscalable. Specific products include:

*Docupresentment**—A*software product thatbridges the gap between Internet browsers and legacy systems by enabling theviewing of documents in a variety of Internet formats, including PDF, HTML andXML.

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*ElectronicBill Presentment & Payment**—A*software productthat allows companies to deliver and present bills to their customers andcollect payments over the Internet.

*iEntry**—A***software product**that allowsusers to select and complete forms online, creating personalized documents.

*iPPS**—A*software productthat enables insurance companies and their agents to assemble policies and viewinformation via the Internet.

**ProfessionalServices**

We offer a broad range of professional servicesrelated to our software solutions. As of July 31, 2006, we employed 122professional service personnel, who represent one of the largest servicesorganizations in our industry. Our professional services personnel haveexperience across many vertical industries and types of CCM solutions.

A majority of ourprofessional services consulting revenue is derived from implementation andintegration of our software solutions. We also receive professional servicesrevenue from consulting and training. Our professional services group works withclients to develop and define enterprise CCM strategies to meet specificbusiness needs. Training classes are available to assist clients withimplementing and using our applications and are available in standardized andcustomized formats. A majority of our consulting services are related toDocucorp solutions that personalize information. Professional servicesaccounted for 26% of our total revenues in fiscal years 2006 and 2005, and 27%of our total revenues in fiscal year 2004.

**ASP Hosting**

We offer ASP hostingservices that utilize our software to provide processing, print, mail, archivaland Internet delivery of documents for customers who outsource these activities.We operate two ASP hosting centers located in Atlanta and Dallas. We alsoprovide ASP hosting services at a customer facility in Dallas. Using datareceived electronically from customers, the ASP centers employ high-volumeprinters and mail handling equipment to produce insurance policies, utilitystatements, health care directories and other customer mailings, bundle theoutput for bulk mailings and host Internet bill presentation and payment. ASPhosting services accounted for 38%, 34% and 31% of our total revenues in fiscalyears 2006, 2005 and 2004, respectively.

**Product Development**

We have made, and expect to continue to make,substantial investments in research and product development. During fiscal2006, our product development efforts focused on improving the user experienceby enhancing the look and feel and ease of use within the products. We continueto improve our Internet functionality, expandmulti-user development and further develop new applications for theinsurance, utilities, financial services and health care markets.

In March 2006, we announced an agreement withVirtusa Corporation (“Virtusa”), a global software development and IT servicesfirm. As part of the agreement, Virtusa will supplement Docucorp’s full-timedevelopment staff to further enhance the Web-based portal used by Docucorp’sASP customers. In addition, Docucorp plans to leverage Virtusa’s considerablefinancial services expertise to deliver tailor-made, cost-effective businesssolutions to the wealth management market at a more aggressive pace.

We have committedsubstantial resources to product development. As of July 31, 2006, weemployed 102 technical personnel engaged in research, product development andcustomer support activities. The product development process is a cooperativeeffort with our customers and us. Early review of functionality specificationsand product demonstrations allows for the incorporation of customer 

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suggestionsand comments in parallel with management review of the process internally. Wehave a formal planning process for new software solutions, as well as softwareupgrades and maintenance releases, to maximize software quality, ensuretimeliness of releases and meet or exceed our customers’ expectations. Infiscal years 2006, 2005 and 2004, our product development expenditures were$13.9 million, $13.8 million and $13.5 million, respectively.

**Sales and Marketing**

We market our software and services primarily througha direct sales force. We also market our solutions through marketing alliancesand distributors. Our sales resources are organized by the vertical industrymarkets we serve. As of July 31, 2006, we employed 41 sales and marketingrepresentatives, who operate primarily from Dallas, Atlanta and London. Salesrepresentatives are compensated through a combination of base salary andcommission. Distributor relationships are established in the United States,Canada, Europe, South Africa, Australia and Asia.

We intend to increase our distribution channelsthrough marketing, sales and distribution and development relationships withother companies. Formal and informal marketing and development partnershipscurrently exist with Adaptik, AppliedSystems, AscendantOne, ePolicySolutions, CDP Communications Inc. (“CDP”), Fidelity Outsourcing Services,Epic Solutions, Inc., Firstlogic,Fidelity National Financial, Inc., HitachiEurope Limited, Indus, Systems & Software, Virtusa, Lynx WealthManagement Systems, ISO, Kofax, Océ Printing Systems, AMS-RackleySystems, SAP, Xerox, Microsoft, CSC, Longwing Info-Tech Co. Ltd., WRDCLogsys,The Weiland Financial Group, SynTel,LLC, CheckFree and BillMatrix. These relationships provide sales leadsfor our solutions or provide access to certain technological information andresources.

In October 2005, we entered into an agreementwith CDP to sell its printstream comparison application as Docucorp’s Forms Integrity Manager. FormsIntegrity Manager enables companies to automate the comparison and testing ofprint streams by detecting inadvertent changes that may occur when upgradingdocument composition systems and when converting documents.

Our software solutions aregenerally licensed on a perpetual basis. A large portion of our softwarelicense revenue is generated from a small number of relatively largeagreements, which typically range from $100,000 to $400,000. Most customersalso enter into maintenance agreements, which typically provide for annualmaintenance fees ranging from 15% to 30% of current listed license feesdepending upon the vertical market, size of the customer and license fee. Customerswho enter into maintenance agreements are entitled to unspecified softwareupgrades, software problem resolutions and use of our “Hotline” support, whichprovides technical assistance to the software user. We generally chargecustomers for professional services on a time and materials basis, although certainservice assignments are performed on a fixed price basis. ASP hosting servicesare charged primarily on a transaction fee basis.

**Customers**

We generally market tolarge and mid-size organizations that have a need for integrated solutions forthe high-volume production of individualized information. Currently, themajority of our revenues are generated from the insurance industry. In fiscal2006, 57% of our total revenues were derived from the insurance industry. Webelieve that we have the largest installed customer base for insurance policyproduction in the insurance industry, with more than half of the 200 largestUnited States insurance companies using our software and services, includingnine of the 10 largest life and health insurance companies and nine of the 10largest property and casualty insurance companies. For the year ended July 31,2006, 20% of our total revenues were derived from the utilities industry, 14%of our total revenues were derived from the financial services industry and 8%of our total revenues were derived from the 

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healthcare industry. We also have an installed base of customers in the highereducation, telecommunications, transportation and government markets.

**Competition**

The market for enterprise-wide CCM solutions is intenselycompetitive, subject to rapid change and significantly affected by new productintroductions and other market activities of industry participants. We facedirect and indirect competition from a broad range of competitors, many of whomhave greater financial, technical and marketing resources than we do. Ourprincipal competition currently comes from (i) systems developed in-houseby the internal MIS departments of large organizations, (ii) directcompetition from numerous software vendors, including Exstream Software Inc.,Document Sciences Corporation, Pitney Bowes Group 1 Software, Inc.,Thunderhead, ISIS Papyrus Group, Whitehill Technologies Inc., Metavante andMobius Management Systems, Inc. (iii) direct competition fromnumerous outsourcing and ASP vendors, including Xerox XBS, DST Output andRegulus Group. We believe that the principal competitive factors in the CCMsolutions software market are technology, domain knowledge, performance andfunctionality, ease of use, multi-platform offerings, reputation, quality ofcustomer support and service and price. The degree of competition variessignificantly by the solution being offered and the vertical market beingserved.

We may also facecompetition from new entrants into the industry. As the market for CCMsolutions continues to develop, current or potential competitors who haveaccess to significantly greater resources could attempt to enter or increasetheir presence in the market either independently or by acquiring or formingstrategic alliances with our competitors or otherwise increase their focus onthe industry. In addition, current and potential competitors have establishedor may establish cooperative relationships among themselves or with thirdparties to increase the ability of their products to address the needs of ourcurrent and prospective customers.

**Intellectual Property,Trademarks and Proprietary Rights**

We rely primarily on a combination of copyright,distribution software license agreements, trademark and trade secret laws,employee and third-party nondisclosure agreements and other methods tosafeguard our software solutions. Despite these precautions, it may be possiblefor unauthorized third parties to copy certain portions of our solutions orobtain and use information we regard as proprietary. While our competitiveposition may be affected by our ability to protect our proprietary information,we believe that trademark and copyright protections are not material to oursuccess.

Our software solutions are licensed to end-users on a “rightto use” basis pursuant to license agreements. Certain license provisionsprotecting against unauthorized use, copying, transfer and disclosure of thelicensed program may be unenforceable under the laws of certain jurisdictionsand foreign countries. In addition, the laws of some foreign countries do notprotect proprietary rights to the same extent as the laws of the United States.Generally, we distribute our software in object format only and do not provideaccess to the underlying source code.

As the number of software solutions in the industryincreases and the functionality of these solutions further overlap, we believethat software programs will increasingly become subject to infringement claims.Third parties may assert infringement claims against us in the future withrespect to current or future solutions, and in this event could require us toenter into royalty arrangements or result in costly litigation.

We also rely on certainsoftware that we license from third parties, including software that isintegrated with internally developed software and used in our solutions toperform key functions. These third-party software licenses may not continue tobe available to us on commercially reasonable terms and the related softwaremay not continue to be appropriately supported, maintained or enhanced by thelicensors. The loss of licenses to use, or the inability of licensors tosupport, maintain and enhance, any of 

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suchsoftware could result in increased costs, delays or reductions in software shipmentsuntil equivalent software could be developed or licensed and integrated.

**Employees**

As of July 31, 2006,we had 426 employees, of which 122 were engaged in professional services, 102in product development and customer support, 112 in ASP hosting, 41 in salesand marketing and 49 in finance, administration, human resources and internalcomputer systems support. We believe our future success will depend, in part,on our continued ability to attract and retain highly qualified personnel in acompetitive market for experienced and talented software engineers and salesand marketing personnel. None of our employees are represented by a labor unionor are subject to a collective bargaining agreement. We believe that ouremployee relations are strong.

**ITEM 1A.**        RISKFACTORS

Readers are cautioned tocarefully consider the following risk factors. The risks described below shouldnot be considered to be comprehensive and all-inclusive. Additional risks thatwe do not yet know of or that we currently think are immaterial may also impairour business operations. If any events occur that give rise to the followingrisks, our business, financial condition, cash flow or results of operationscould be materially and adversely affected, and as a result, the trading priceof our Common Stock could be materially and adversely impacted. These riskfactors should be read in conjunction with other information set forth in thisreport, including our Consolidated Financial Statements and the related Notes.

*Our results ofoperations are dependent on significant revenues from two industries.*

For the years ended July 31,2006 and 2005, 57% and 58% of our total revenues, respectively, were derivedfrom the insurance industry and 20% and 19% of our total revenues,respectively, were derived from the utilities industry. Our financialperformance and future growth will depend upon our ability to continue tomarket our solutions successfully in the insurance and utilities industries andto enhance and market technologies for distribution in other markets. Weentered the financial services industry during fiscal year 2000, and with theacquisition of Newbridge in fiscal 2005, we added the health care industry. Weplan to expand into additional vertical markets in the future. This will requireus to make substantial software development and distribution channelinvestments. There can be no assurance that we will be able to continuemarketing our solutions successfully in the insurance and utilities industriesor will be able to successfully introduce new or existing solutions into thefinancial services industry or other vertical markets. 

*Our business hasexperienced declines in ASP hosting margins.*

We have experienced asignificant decline in our ASP hosting gross profit percentage. Our grossprofit as a percentage of ASP hosting revenue was 18% during fiscal 2004compared to 10% in fiscal 2006 and 2005. Factors negatively impacting the ASPhosting margins include loss of a significant customer, competitive pricingpressures for both new and renewal business and excess ASP hosting capacity.There is no assurance that we will retain all of our existing ASP hostingclients and the loss of a significant customer would negatively impact our ASPhosting margins. In addition, we may have to offer more competitive pricing towin new business. Further deterioration of, or our inability to improve, ASPhosting margins would reasonably be expected to have a material adverse effecton our financial results.

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*Our operatingresults depend heavily on software license revenue which is difficult toforecast.*

We have experienced, andmay in the future continue to experience, fluctuations in our quarterlyoperating results due to the fact that software sales cycles, from initialevaluation to purchase, vary substantially from customer to customer. Delays inthe sales cycle frequently occur as a result of competition, changes incustomer personnel, overall budget and spending priorities and the economy. A large portion of our software licenserevenue is generated from a small number of relatively large agreementsexecuted in the latter part of a quarter. The timing of such large agreementsis often unpredictable and impacted by events beyond our control, thereforemaking it difficult to forecast software license revenue accurately. Wehave typically operated with little backlog for license revenues because oursoftware solutions are generally shipped soon after orders are received. As aresult, license revenues in any quarter are substantially dependent on ordersbooked and shipped in that quarter. The delay of customer orders for a smallnumber of licenses could adversely affect the license revenues andprofitability for a given fiscal quarter. The failure to achieve such revenuescould have a material adverse effect on our financial results for each suchinterim period.

*We may facedifficulties in attracting and retaining qualified employees.*

We believe that our futuresuccess will depend in large part upon our ability to attract, retain andmotivate highly skilled employees, particularly technical employees. Theemployees that are in highest demand are software programmers, softwaredevelopers, application integrators and information technology consultants.Additionally, maintaining and improving our sales productivity may be impactedby our ability to retain, hire and train effective sales management and directsales personnel. There can be no assurance that we will be able to attract andretain sufficient numbers of highly skilled employees. The loss of a significantnumber of our technical or experienced sales employees could have a materialadverse effect on our business.

*Our operations aredependent upon key management personnel.*

We believe that ourcontinued success depends to a significant extent upon the efforts andabilities of our senior management. In particular, the loss of Michael D.Andereck, our President and Chief Executive Officer, or any of our otherexecutive officers or senior managers, could have a material adverse effect onour business. Currently, Mr. Andereck is performing certain duties of theSenior Vice President of Sales and Marketing in addition to his role asPresident and Chief Executive Officer, which may impede his ability to devoteadequate attention to any of these roles.

*We may not beable to compete favorably in the competitive ccmindustry.*

The market for our CCMsolutions is intensely competitive. We face competition from a broad range ofcompetitors. The competition may have lower cost structures or have greaterfinancial, technical and marketing resources than we do. There can be noassurance that we will be able to compete effectively with such entities.

*Social, politicaland economic risks could adversely affect our business.*

Acts of terrorism havecaused major instability in the United States and other financial markets.Armed hostilities or further acts of terrorism would cause further instabilityin financial markets and could directly impact our financial condition and theresults of our operations. Our business is subject to general economicconditions and fluctuation in corporate spending. Any adverse effect on theeconomy, depending on the magnitude, could have a material adverse effect onour operating results. There can be no assurance as to the future effect ofchanges in social, political and economic conditions on our business orfinancial condition.

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*We are dependent onmeeting the challenges of technological advances in the CCM solutions industry.*

The CCM solutions industryhas experienced and will continue to experience rapid technological advances,changes in customer requirements and frequent new product introductions andenhancements. Development in both software technology and hardware capabilitywill require us to make substantial investments in the development of oursolutions. Any failure to anticipate or respond adequately to technologicaldevelopments and customer requirements, or any significant delays in thedevelopment or introduction of our solutions, could have a material adverseeffect on our operating results. There can be no assurance that our newsolutions or enhancements, which are intended to respond to technologicalchange or evolving customer requirements, will achieve acceptance.

*We may facedifficulties in expanding our operations in international markets.*

The expansion of ourexisting international operations and entry into additional internationalmarkets requires significant management attention and financial resources andwill place additional burdens on our management, administrative, operationaland financial infrastructure. We have not been able to generate consistentearnings in our EMEA operations and have only limited experience inestablishing and managing international operations. We cannot be certain thatour operations in countries outside of North America will produce desiredlevels of revenues or profitability. International expansion may negativelyaffect our operating results because of numerous factors, includingdifficulties in staffing and managing foreign operations; potential losses fromforeign currency fluctuations; seasonal reductions in business activity inEurope; increased financial accounting and reporting burdens; potential adversetax consequences; compliance with a wide variety of complex foreign laws andtreaties; reduced protection for intellectual property rights in some countriesand potential language-specific requirements for software.

*Future businessacquisitions could adversely affect our results of operations.*

We may make acquisitionsin the future. Acquisitions may be difficult to integrate into our business andcould consume significant management and financial resources. There is noassurance that any acquisition will be successful or generate a satisfactoryreturn on investment.

*Our solutions aresubject to the risk of software defects.*

Complex software solutionssuch as ours can contain undetected errors or performance problems. Suchdefects are most frequently found during the period immediately followingintroduction of new solutions or enhancements to existing solutions. Oursolutions have from time to time contained software errors that were discoveredafter commercial introduction. There can be no assurance that performanceproblems or errors will not be discovered in our solutions in the future. Anyfuture software defects discovered after shipment of our solutions, ifmaterial, could result in loss of revenues, customer dissatisfaction and/orpotential product liability.

*Our failure to meetcustomer expectations could result in losses and negative publicity.*

The implementation of ourproducts, which we primarily accomplish through our professional servicesorganization, typically involves working with sophisticated software, computingand communication systems. If our implementation fails to meet our customers’expectations or anticipated milestones in a timely manner, we could experiencethe following: delayed or lost revenues and market share due to customerdissatisfaction; risk the loss of an existing customer; negative publicityregarding us and our products, which could affect our ability to attract newcustomers; expenses associated with providing additional products and customersupport and other resources to a customer at a reduced charge; claims forsubstantial damages against us, regardless of our responsibility for anyfailures; increased insurance 

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costsand diversion of development and management time and resources; and potentialcustomer collection issues.

*Provisions withinour customer agreements that limit our exposure may not protect us fromadditional liability.*

Our agreements withcustomers generally contain provisions designed to limit our exposure topotential claims, such as disclaimers of warranties and limitations onliability for special, consequential, incidental and other indirect damages. Inaddition, our agreements usually cap the amounts recoverable for direct damagesto the amounts paid to us. However, we cannot be sure that these contractualprovisions will protect us from additional liability. Furthermore, our generalliability insurance coverage may not continue to be available on reasonableterms or in sufficient amounts to cover one or more large claims or the insurermay disclaim coverage as to any future claim. The successful assertion of anylarge claim against us could adversely affect our financial position andresults of operations.

*Our intellectualproperty rights may not be adequately protected.*

We rely on a combinationof copyright and trademark laws, employee and third-party nondisclosureagreements and other methods to protect our proprietary rights. Despite theseprecautions, it may be possible for unauthorized third parties to copy certainportions of our solutions or to obtain and use information that we regard asproprietary. There can be no assurance that our efforts will provide meaningfulprotection for our proprietary technology against others who independentlydevelop or otherwise acquire substantially equivalent techniques or gain accessto, misappropriate or disclose our proprietary technology.

**Available Information**

We electronically file ourannual report on Form 10-K, quarterly reports on Form 10-Q,and current reports on Form 8-K with the Securities and ExchangeCommission (“SEC”). Copies of our filings with the SEC may be obtained from ourwebsite at HTTP://WWW.DOCUCORP.COM or at the SEC’s website atHTTP://WWW.SEC.GOV. Access to these filings is free of charge.

**ITEM 1B.**       UNRESOLVEDSTAFF COMMENTS

NONE

**ITEM 2.**                PROPERTIES

We lease approximately 38,900 square feet of officespace in Dallas, Texas, for our corporate headquarters, includingadministrative, sales, marketing, professional services, and productdevelopment personnel. This lease expires May 31, 2015.

We lease approximately 95,100 square feet of officespace in Atlanta, Georgia, which is utilized for administrative, sales,professional services, and product development personnel. The lease for thisspace expires on December 31, 2012. During the fourth quarter of fiscal2006, we abandoned approximately 15,000 square feet of this facility and arecurrently pursuing sublease opportunities.

We lease space for our ASP hosting facility located inAtlanta, Georgia. This facility occupies approximately 24,600 square feet, thelease of which expires on March 31, 2008.

We lease space for our ASP hosting facility located inDallas, Texas. This facility occupies approximately 44,600 square feet, thelease of which expires on March 31, 2010, however there is an earlytermination option on March 31, 2007.

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Our staff in Maryland is located in Silver Spring,Maryland. This facility is principally used for product development activitiesand occupies approximately 10,300 square feet under a lease, which expires December 31,2006. Negotiations are currently taking place to renew the lease on thisfacility.

Our staff in New Hampshire is located in a 5,700square foot facility in Bedford, New Hampshire. The lease for this facilityexpires on December 31, 2009 and is staffed primarily by professionalservices personnel.

We lease space for our European sales and servicesstaff near London, England. This facility occupies approximately 5,400 squarefeet, the lease of which expires on September 27, 2013.

In connection with the acquisition of Newbridge, weassumed two leases for properties in Dallas, Texas. The lease related to Newbridge’sprint and binding facility is for approximately 23,000 square feet and expireson June 30, 2007. The lease for Newbridge’s corporate office, includingadministrative, sales and information services, is for approximately 11,700square feet and expires on March 31, 2007. During the fourth quarter offiscal 2005, as part of our acquisition and integration plan, we vacated thesefacilities.

We believe the existingoffice facilities and additional space available are adequate to meet ourrequirements, and that in any event, suitable additional or alternative spaceadequate to serve our foreseeable needs will be available on commerciallyreasonable terms.

**ITEM 3.**                LEGALPROCEEDINGS

We are occasionallyinvolved in legal proceedings and other claims arising out of our operations inthe normal course of business. As of July 31, 2006, we are involved in adispute with a customer over the scope of professional services to be providedunder a work order. Management does not believe that a loss from this dispute isprobable; however, no assurance can be given that this matter will be settledin our favor. An unfavorable resolution could potentially have a materialimpact on our consolidated financial position and results of operations. Nosuch other claims are expected, individually or in the aggregate, to have amaterial adverse effect on our consolidated financial position and results ofoperations.

**ITEM 4.**                SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

No matter was submitted to a vote of security holders,through the solicitation of proxies or otherwise, during the fourth quarter offiscal 2006.

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**PART II**

**ITEM 5.**                MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES

OurCommon Stock has traded on the NASDAQ National Market under the symbol “DOCC”since April 6, 1998. At October 5, 2006, there were approximately 500holders of record of our Common Stock, although we believe that the number ofbeneficial owners of our Common Stock is substantially greater. The table belowsets forth for the fiscal quarters indicated the high and low trading prices forour Common Stock:

| ** **        | ** ** | **High**   | ** ** | **Low**    | ** ** |
|-------------------|------------|------------|------------|------------|------------|
| **Fiscal 2006:**  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fourth quarter    |       | $          | 8.33       |       | $          | 6.89 |   |
| Third quarter     |       | 8.89       |       | 6.01       |       |
| Second quarter    |       | 6.82       |       | 5.71       |       |
| First quarter     |       | 7.49       |       | 6.05       |       |
| **Fiscal  2005:** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fourth quarter    |       | $          | 8.25       |       | $          | 5.95 |   |
| Third quarter     |       | 10.95      |       | 6.65       |       |
| Second quarter    |       | 10.15      |       | 8.50       |       |
| First quarter     |       | 9.48       |       | 6.84       |       |

 

We intend to retain anyfuture earnings for use in our business and do not intend to pay cash dividendsin the foreseeable future. The payment of future dividends, if any, will be atthe discretion of our Board of Directors, subject to bank consent, and willdepend, among other things, upon future earnings, operations, capitalrequirements, restrictions in future financing agreements, our generalfinancial condition and general business conditions.

**Issuer Purchases ofEquity Securities**

Thefollowing table provides information about our Common Stock repurchases duringthe quarter ended July 31, 2006: 

| **Period**                                   | ** ** | ** ** | ** ** | **Total  number of  shares  purchased** | ** ** | **Average  price paid  per share** | ** ** | **Total number  of shares  purchased as  part of publicly  announced  program** | ** ** | **Maximum  number of  shares that may  yet be  purchased under  the program** | ** ** |
|----------------------------------------------|------------|------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|
| May 1, 2006  – May 31, 2006   |       |       | 0          |                                         |       |                                         | 0          |                                                                                                     |       |                                                                                                        | 0          |   |   |   | 1,000,000 |   |   |
| June 1, 2006  – June 30, 2006 |       |       | 0          |                                         |       |                                         | 0          |                                                                                                     |       |                                                                                                        | 0          |   |   |   | 1,000,000 |   |   |
| July 1, 2006  – July 31, 2006 |       |       | 4,000      |                                         |       |                                         | $          | 7.06                                                                                                     |       |                                                                                                        |       | 4,000 |   |   |   | 996,000 |   |   |
| Total                                        |       |       | 4,000      |                                         |       |                                         | $          | 7.06                                                                                                     |       |                                                                                                        |       | 4,000 |   |   |   | 996,000 |   |   |

 

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**ITEM 6.**                SELECTEDCONSOLIDATED FINANCIAL DATA

Thefollowing selected consolidated financial data for the years ended July 31,2006, 2005, 2004, 2003, and 2002 has been derived from our audited financialstatements. The following data should be read in conjunction with, and isqualified by, reference to our audited financial statements and the notesthereto, included elsewhere in this Form 10-K.

| ** **                                      | ** ** | **Years ended July 31,**                               | ** ** |
|-------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **2006**                                                              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                      | ** ** | **(in thousands, except per share amounts)** | ** ** |
| **Statements of Operations Data:**              |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Total revenues                                  |       | $                                                                     | 88,337     |   | $ | 79,177 |   | $ | 75,670 |   | $ | 74,941 |   | $ | 72,620 |   |
| Operating income                                |       | $                                                                     | 5,012      |   | $ | 4,399 |   | $ | 9,426 |   | $ | 7,256 |   | $ | 9,084 |   |
| Income before  income taxes                     |       | $                                                                     | 5,173      |   | $ | 4,002 |   | $ | 9,191 |   | $ | 7,229 |   | $ | 9,865 |   |
| Net income                                      |       | $                                                                     | 3,220      |   | $ | 2,506 |   | $ | 5,366 |   | $ | 3,945 |   | $ | 5,929 |   |
| Net income per share:                           |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Basic                                           |       | $                                                                     | 0.29       |   | $ | 0.24 |   | $ | 0.53 |   | $ | 0.31 |   | $ | 0.44 |   |
| Diluted                                         |       | $                                                                     | 0.28       |   | $ | 0.22 |   | $ | 0.47 |   | $ | 0.28 |   | $ | 0.40 |   |
| Weighted average number  of shares outstanding: |       |                                                                  |       |   |   |   |   |   |   |   |   |
| Basic                                           |       | 10,923                                                                |       | 10,651 |   | 10,154 |   | 12,780 |   | 13,458 |   |
| Diluted                                         |       | 11,522                                                                |       | 11,526 |   | 11,360 |   | 13,878 |   | 14,883 |   |

 

| ** **                               | ** ** | **July 31,**       | ** ** |
|------------------------------------------|------------|-------------------------|------------|
| ** **                               | ** ** | **2006**                | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                               | ** ** | **(in thousands)** | ** ** |
| **Balance Sheet Data:**                  |       |                    |       |   |   |   |   |   |   |   |   |
| Working capital                          |       | $                       | 4,454      |   | $ | 4,551 |   | $ | 10,746 |   | $ | 3,686 |   | $ | 13,150 |   |
| Total assets                             |       | $                       | 65,309     |   | $ | 63,635 |   | $ | 59,239 |   | $ | 53,440 |   | $ | 55,750 |   |
| Total debt,  including lease obligations |       | $                       | 6,894      |   | $ | 10,841 |   | $ | 12,696 |   | $ | 16,828 |   | $ | -0- |   |
| Stockholders’ equity                |       | $                       | 31,502     |   | $ | 27,529 |   | $ | 22,799 |   | $ | 13,732 |   | $ | 33,064 |   |

 

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**Item7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

**Forward-lookingStatements**

Certain informationcontained herein may include “forward-looking statements” within the meaning ofSection 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended. All statements, other thanstatements of historical facts included herein, are forward-looking statements.Readers are cautioned that any such forward-looking statements are notguarantees of future performance and involve certain risks and uncertainties,which include, but are not limited to, those discussed in the section entitled “Item1A. Risk Factors.” Should one or more of these risks or uncertainties, amongothers as set forth herein, materialize, actual results may vary materiallyfrom those estimated, anticipated or projected. Although we believe that theexpectations reflected by such forward-looking statements are reasonable basedon information currently available to us, no assurance can be given that suchexpectations will prove to have been correct. Cautionary statements identifyingimportant factors that could cause actual results to differ materially from ourexpectations are set forth herein. All forward-looking statements includedherein and all subsequent oral forward-looking statements attributable to us orpersons acting on our behalf are expressly qualified in their entirety by thesecautionary statements.

**Overview**

Docucorp develops, markets and supports CCM solutionsvia a portfolio of proprietary information software, ASP hosting andprofessional services that enable companies to create, publish, manage andarchive complex, high-volume, individualized information. We support the entireinformation lifecycle—from acquisition of the first raw data point to finaldelivery of personalized information to the customer.

Our software products support leading hardwareplatforms, operating systems, printers and imaging systems. These products aredesigned to personalize, produce and manage documents such as insurancepolicies, utility statements, telephone bills, bank and mutual fund statements,invoices, health care provider directories, correspondence, bills of lading andother customer-oriented documents. Our ASP offerings include customer statementand bill generation, electronic bill presentment and payment, insurance policyproduction, provider directory generation, disaster recovery and electronicdocument archival.

Operating in four key vertical markets, insurance,utilities, financial services and health care, we currently have an installedbase of more than 1,300 customers worldwide. More than half of the 200 largestUnited States insurance companies use our software products and services,including nine of the top 10 life and health insurance companies, nine of thetop 10 property and casualty insurance companies and more than 600 MGAs. Manyof the largest North American health care, utility companies and majorinternational financial services institutions use our products and services.

We derive our revenues from ASP hosting fees,professional services fees, software license fees and recurring maintenancefees related to our software products. ASP hosting revenue consists oftransactional fees earned from customers who outsource production of customerstatements, insurance policies, utility statements, health care providerdirectories, disaster recovery and electronic document archival. Professionalservices revenue includes fees for implementation, integration, training andconsulting services. Software license revenue is generally derived from thesale of perpetual licenses of software products. Maintenance revenue consistsprimarily of annual software maintenance and support agreements.

Our operating results are strongly tied to softwarelicense revenue. Software license sales have a high margin and ultimately driveadditional professional services and maintenance revenues. A large portion ofour software license revenue is generated from a small number of relativelylarge agreements executed in 

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the latter part of aquarter. The timing of such large agreements is often unpredictable andimpacted by events beyond our control, therefore making it difficult toforecast software license revenue accurately. Due to the nature of our softwarelicense sales, revenues and profits may vary from quarter to quarter.

For the year ended July 31, 2006, total revenueincreased 12% to $88.3 million, net income increased 28% to $3.2 million andearnings per diluted share increased from $0.22 in the prior year to $0.28 inthe current year. During fiscal 2006 revenue has grown for four consecutivequarters despite a smaller sales force than we had in the previous fiscal year,and without a Senior Sales and Marketing VP managing the sales and marketingorganization. In addition, net income for the year ended July 31, 2006 wasadversely impacted by $1.1 million in non-cash lease abandonment charges thatwere primarily for the abandonment of excess office space at our Atlanta, Georgia,office facility. This charge reduced earnings per diluted share by $0.06.

In September 2004, we completed the acquisitionof Newbridge, a leading information services company for the health caremarket. Operating results of Newbridge are primarily reflected in our ASPhosting segment from the date of acquisition. Full integration of Newbridgewith our Dallas ASP center was completed during the fourth quarter of fiscal2005. Our revenue growth in the current year benefited from the Newbridgeacquisition and the addition of a large ASP utilities outsourcing contract withCapgemini Energy (“Capgemini”) that was signed in the fourth quarter of theprior fiscal year. Our current year increase of 25% in ASP hosting revenuereflects the impact of a full year of operations for both of the Newbridge andCapgemini additions, as well as, revenue expansion from an existing utilitycustomer that expanded its business processing during the current year.

Our operating results were also favorably impacted byimproved utilization of our professional services staff that resulted in a 2%improvement in the gross profit percentage on revenues from professionalservices for the year ended July 31, 2006. This includes fees and expensesassociated with our bi-annual user conference, DocuGroup, which reducedearnings per diluted shares by $0.01 and reduced our gross profit percentage onrevenues from professional services from 24% to 23% in the current year. Grossprofit as a percentage of maintenance revenue also improved 1% due to increasedmaintenance revenue and lower costs of providing maintenance support during thecurrent year. Our license revenue was relatively flat when compared with theprior year and our cost of license revenue increased 20% due to higher softwareamortization and third party royalty costs resulting in lower gross profit fromlicense revenue. However, the lower gross profit from license revenue wasoffset by lower sales and marketing costs for the year ended July 31,2006.

In addition to the increased revenue and gross profit,our profitability for the year ended July 31, 2006 benefited from lowerinterest expense and favorable foreign currency changes during the currentyear.

Revenue from our EMEAoperations improved 2% in fiscal 2006; however, EMEA operating results declinedapproximately $420,000 for the year ended July 31, 2006, which wasprimarily attributed to increased salaries and related personnel costs as wecontinue to invest for expansion in the EMEA market.

Ourfinancial position remains strong with $9.8 million of cash on hand andavailable borrowings under our revolving credit facility of $20.0 million at July 31,2006.

**Critical AccountingPolicies and Estimates**

The accompanying “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” isbased upon our consolidated financial statements, which have been prepared inaccordance with accounting principles generally accepted in the United Statesof America (“GAAP”). The preparation of these financial statements requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities at the date of the financial statements, and thereported amounts of revenues and expenses during the reported period. We baseour estimates and assumptions on historical 

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experiencesand various other factors that are believed to be reasonable under thecircumstances. These estimates and assumptions are evaluated on an ongoingbasis. Actual results may differ from previously estimated amounts due to differentassumptions or conditions. The following critical accounting policies, whichinvolve significant judgments and estimates, are used in the preparation of ourconsolidated financial statements:

*Revenue recognition*

We derive our revenues from the sale of softwarelicenses, annual software maintenance and support agreements, professionalservices and ASP hosting services. We recognize revenue in accordance withStatement of Position 97-2, “Software Revenue Recognition” and StaffAccounting Bulletin No. 104, “Revenue Recognition” (“SAB 104”). Revenue isrecognized when a contract exists, the fee is fixed or determinable, deliveryhas occurred and collection of the receivable is deemed probable.

We use the residual method to recognize revenue fromthe sale of software licenses that are bundled with maintenance and support.Under the residual method, the fair value of the undelivered element(s) isdeferred and the remaining value of the contract is recognized as revenue. Fairvalue 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. Wedo not generally sell software licenses without selling maintenance and supportfor the licensed software. As a result, we have established VSOE only for theundelivered element(s) included in a multi-element arrangement. VSOE formaintenance and support is based upon prices customers pay to renew maintenanceand support agreements. After expiration of the initial maintenance term, maintenanceand support agreements are renewable on an annual basis and include rights tounspecified upgrades, updates and enhancements on a when and if availablebasis, as well as telephone support and bug fixes. Revenue generated frommaintenance and support is recognized ratably over the maintenance term of theagreement. We record deferred revenue for maintenance amounts invoiced prior tothe performance of the related services.

Our standard software license agreements do notprovide for rights of software return and/or conditions of acceptance. However,in the rare case that acceptance criteria are provided, revenue is deferred andnot recognized until all acceptance provisions are satisfied. Revenue fromsoftware licenses which include a cancellation clause is recognized uponexpiration of the cancellation period. License revenue related to productsstill in the testing phase is deferred until formal acceptance of the productby the customer.

Professional services revenue includes implementation,integration, training and consulting services relating to new software licensesales and consulting with existing customers to provide additional services.For new software license sales that are sold with installation services, theresidual method is applied, whereby the fair value of the services element isdeferred along with the fair value of the maintenance and support, with theresidual value of the contract recognized as license revenue. The servicesoffered are not essential to the functionality of the software. Professionalservices revenue is generally billed on a time and material basis and isrecognized as the services are performed.

Professional services revenue derived from theinstallation and integration of software packages under a fixed price contractis recognized on a percentage-of-completion basis measured by the relationshipof hours worked to total estimated contract hours. We follow this methodbecause reasonably dependable estimates of the revenue and contract hoursapplicable to various elements of a contract can be made. Since the financialreporting of these contracts depends upon estimates which are assessedcontinually during the term of these contracts, recognized revenue and profitare subject to revisions as the contract progresses to completion. Revisions inprofit estimates are reflected in the period in which the facts that give riseto the revisions become known. Accordingly, favorable changes in estimatesresult in additional revenue recognition and net income, and unfavorable changesin estimates result in a reduction of 

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recognized revenue and netincome. When estimates indicate that a loss will be incurred on a contract uponcompletion, a provision for the expected loss is recorded in the period inwhich the loss becomes evident.

Revenue from our ASPhosting operations is recognized in accordance with SAB 104, generally on a pertransaction basis. ASP hosting agreements are generally one to five years induration and provide for monthly billing based on transaction volume or contractminimums. Revenue related to the customer’s initial set up and implementationis deferred and subsequently recognized over the expected term of the ASPhosting agreement.

*Allowance fordoubtful accounts*

We maintain an allowancefor doubtful accounts for estimated losses resulting from the inability of ourcustomers to make required payments. We take into consideration the currentfinancial condition of our customers, the specific details of the customeraccounts, the age of the outstanding balance and the current economicenvironment when assessing the adequacy of the allowance. If the financialcondition of our customers were to deteriorate, resulting in an impairment oftheir ability to make payments, additional allowances might be required.

*Software developmentcosts*

Software development costsare accounted for in accordance with Statement of Financial AccountingStandards No. 86, “Accounting for the Costs of Computer Software to beSold, Leased or Otherwise Marketed” (“SFAS 86”). SFAS 86 requires the capitalizationof certain software development costs once technological feasibility isestablished. The capitalized costs are then amortized on a straight-line basisover the estimated product life, or on the ratio of current revenues to totalprojected product revenues, whichever provides the greater amortization.Management periodically assesses the realizability of software developmentcosts when events and circumstances indicate a potential decline in value.

*Businesscombinations*

Upon acquisition of a business,we allocate the purchase price to tangible assets and liabilities acquired andidentifiable intangible assets. Any residual purchase price is recorded asgoodwill. The allocation of the purchase price requires management to makesignificant estimates in determining the fair values of assets acquired andliabilities assumed, especially with respect to intangible assets. Theseestimates are based on historical experience and information obtained fromvaluation specialists and the management from the acquired company. Theseestimates can include, but are not limited to, appraisals by valuationspecialists, the cash flows that an asset is expected to generate in the futureand the appropriate weighted average cost of capital. Estimates used in determiningthe fair value of assets acquired and liabilities assumed are inherentlyuncertain and unpredictable. Unanticipated events and circumstances may occurwhich may affect the accuracy or validity of such estimates.

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*Valuation oflong-lived and intangible assets and goodwill*

We recognize an impairmentcharge associated with our long-lived assets, including property and equipment,goodwill and other intangible assets whenever we determine that recovery ofsuch long-lived assets is not probable. Such determination is made inaccordance with the applicable GAAP requirement associated with the long-livedasset, and is based upon, among other things, estimates of the amount of futurenet cash flows to be generated by the long-lived asset and estimates of thecurrent fair value of the asset. Adverse changes in future net cash flows orfair value could result in the inability to recover the carrying value of thelong-lived asset, thereby requiring an impairment charge to be recognized. Weperform an impairment analysis in accordance with Statement of FinancialAccounting Standard No. 142, “Goodwill and Other Intangible Assets,”annually, during the third quarter, and whenever events and circumstancesindicate that an impairment might be present. Our impairment analysis for ourexisting goodwill utilizes various assumptions and factors to estimate futurecash flows to determine the fair value of the business. No impairment chargewas recognized during the fiscal year 2006; however, if our estimates of cashflows or other factors adversely change, an impairment charge might be recordedin the future.

*Deferred taxes andvaluation allowance*

We recognize deferred taxassets and liabilities based on the differences between the financial statementcarrying amounts and the tax bases of the assets and liabilities. In assessingthe realizability of deferred tax assets, management considers whether it ismore likely than not that some portion or all of the deferred tax assets willnot be realized. It is possible that in the future we may change our estimateof the amount of the deferred income tax assets that will more likely than notbe realized, which will result in an adjustment to the valuation allowance thatwould either increase or decrease, as applicable, reported net income in theperiod such change in estimate was made.

*Translation offoreign currency*

We translate the financial statements of our Europeansubsidiary into U.S. dollars in accordance with Statement of FinancialAccounting Standards No. 52, “Foreign Currency Translation.” Assets andliabilities of our European subsidiary, whose functional currency is other thanthe U.S. dollar, are translated at period-end rates of exchange, and revenuesand expenses are translated at average exchange rates prevailing during theperiod. Gains and losses on foreign currency transactions and the translationof our intercompany loan to a consolidated foreign subsidiary are recognized inother income as incurred.

We account for unrealized gains or losses on ourforeign currency translation adjustments in accordance with Statement ofFinancial Accounting Standards No. 130, “Reporting Comprehensive Income,”which requires adjustments to be accumulated in stockholders’ equity as part ofother comprehensive income. Currently, we do not engage in foreign currencyhedging activities.

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**HistoricalOperating Results for the Years Ended July 31, 2006, 2005 and 2004**

Thefollowing table sets forth for the periods indicated selected consolidatedstatements of operations data. The information presented below, expressed indollars and as a percentage of total revenues for the periods indicated, hasbeen derived from our consolidated financial statements (dollars in thousands).

| ** **                                     | ** ** | **Years ended July 31,** | ** ** |
|------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                     | ** ** | **2006**                                | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Revenues**                                   |       |                                    |       |   |   |   |   |
| ASP hosting                                    | ** ** | **$**                                   | **33,884** |   | $ | 27,002 |   | $ | 23,332 |   |
| Professional services                          | ** ** | **22,562**                              |       | 20,966 |   | 20,637 |   |
| License                                        | ** ** | **9,961**                               |       | 10,063 |   | 10,480 |   |
| Maintenance                                    | ** ** | **21,930**                              |       | 21,146 |   | 21,221 |   |
| Total revenues                                 | ** ** | **$**                                   | **88,337** |   | $ | 79,177 |   | $ | 75,670 |   |
| **Percentage  relationship to total revenues** |       |                                    |       |   |   |   |   |
| **Revenues**                                   |       |                                    |       |   |   |   |   |
| ASP hosting                                    | ** ** | **38**                                  | **%**      | 34 | % | 31 | % |
| Professional services                          | ** ** | **26**                                  |       | 26 |   | 27 |   |
| License                                        | ** ** | **11**                                  |       | 13 |   | 14 |   |
| Maintenance                                    | ** ** | **25**                                  |       | 27 |   | 28 |   |
| Total revenues                                 | ** ** | **100**                                 |       | 100 |   | 100 |   |
| **Cost of revenues**                           |       |                                    |       |   |   |   |   |
| ASP hosting                                    | ** ** | **34**                                  |       | 31 |   | 25 |   |
| Professional services                          | ** ** | **20**                                  |       | 21 |   | 23 |   |
| License                                        | ** ** | **6**                                   |       | 5 |   | 4 |   |
| Maintenance                                    | ** ** | **1**                                   |       | 2 |   | 2 |   |
| Total cost of revenues                         | ** ** | **61**                                  |       | 59 |   | 54 |   |
| Gross profit                                   | ** ** | **39**                                  |       | 41 |   | 46 |   |
| Operating expenses                             |       |                                    |       |   |   |   |   |
| Product development                            | ** ** | **10**                                  |       | 11 |   | 10 |   |
| Sales and marketing                            | ** ** | **12**                                  |       | 15 |   | 15 |   |
| General and administrative                     | ** ** | **10**                                  |       | 10 |   | 9 |   |
| Loss on lease abandonment                      | ** ** | **1**                                   |       | 0 |   | 0 |   |
| Total operating expenses                       | ** ** | **33**                                  |       | 36 |   | 34 |   |
| Operating income                               | ** ** | **6**                                   |       | 5 |   | 12 |   |
| Other income, net                              | ** ** | **0**                                   |       | 0 |   | 0 |   |
| Income before  income taxes                    | ** ** | **6**                                   |       | 5 |   | 12 |   |
| Provision for  income taxes                    | ** ** | **2**                                   |       | 2 |   | 5 |   |
| Net income                                     | ** ** | **4**                                   | **%**      | 3 | % | 7 | % |

 

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**ComparativeAnalysis of Results for the Fiscal Years Ended July 31, 2006 and 2005**

*Revenues*

Thefollowing table summarizes revenues (in thousands) and the percent change overthe prior year: 

| ** **             | ** ** | **Year ended July 31,** | ** ** |
|------------------------|------------|----------------------------------------|------------|
| ** **             | ** ** | **2006**                               | ** ** | **2005** | ** ** | **% change** | ** ** |
| ASP hosting            | ** ** | **$**                                  | **33,884** |   | $ | 27,002 |   |   | 25 | % |   |
| Professional  services | ** ** | **22,562**                             |       | 20,966 |   |   | 8 |   |   |
| License                | ** ** | **9,961**                              |       | 10,063 |   |   | (1 | ) |   |
| Maintenance            | ** ** | **21,930**                             |       | 21,146 |   |   | 4 |   |   |
| Total revenues         | ** ** | **$**                                  | **88,337** |   | $ | 79,177 |   |   | 12 | % |   |

 

For the year ended July 31, 2006, total revenuesincreased approximately $9.2 million, or 12%, when compared to the prior yeardue to increases in ASP hosting, professional services and maintenancerevenues. ASP hosting revenue grew 25%, or $6.9 million, when compared to theprior year. Approximately 51% of the increase in ASP hosting revenue wasattributed to two customers that expanded their business through merger andacquisition, thereby increasing their processing needs, during the currentyear. In addition, revenue from the Capgemini contract, which began during thefourth quarter of the prior fiscal year, represented 31% of the increase in ASPhosting revenue during the current fiscal year. The ASP hosting revenuegenerated by Newbridge, which was acquired during the first quarter of theprior fiscal year, represented 14% of the increase in ASP hosting revenue.These increases were partially offset by a 19% decrease in ASP hosting revenuefrom an existing customer with accounts that continued to roll off during theyear because this customer was acquired during fiscal 2004 by a company withprint facilities of its own. Professional services revenue increased 8%, or$1.6 million, during the current fiscal year. This improvement was largelyattributed to an increase in billable work performed primarily associated withnew license revenue from customers in the insurance industry. Additionally, 10%of the professional services revenue growth was from EMEA and 10% of theimprovement was attributed to revenue from DocuGroup, our bi-annual userconference, which was held in March of fiscal 2006. Maintenance revenueimproved 4%, or $784,000, primarily due to maintenance agreements associatedwith new license sales, and license revenue of $10.0 million was relativelyunchanged when compared to the prior year.

Backlog for our productsand services was $57.4 million as of July 31, 2006, of which $29.8 millionis scheduled to be satisfied within one year. Backlog has declined slightlywhen compared to $57.9 million at July 31, 2005. Backlog is primarilycomposed of recurring maintenance revenue for ongoing maintenance and support,software implementation and consulting services and ASP hosting services.Maintenance agreements generally have an initial non-cancelable term of up tothree years and may generally be terminated after the initial term upon 30 to60 days’ written notice. Software implementation and consulting services areprincipally performed under time and material agreements, of which some havecancellation provisions. The estimated future revenues with respect to softwareimplementation and consulting are based on management’s estimate of revenuesover the remaining life of the respective contract. ASP hosting agreementsgenerally have one to five year terms and generally provide that fees arecharged on a per transaction basis. Estimated future revenues of ASP hostingservices are based on contractual monthly minimums multiplied by the remainingterm of the respective contract or management’s estimate of revenues over theremaining life of the respective contract.

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*Cost of revenues*

Thefollowing table summarizes cost of revenues (in thousands) and the percentchange over the prior year: 

| ** **             | ** ** | **Year ended July 31,** | ** ** |
|------------------------|------------|----------------------------------------|------------|
| ** **             | ** ** | **2006**                               | ** ** | **2005** | ** ** | **% change** | ** ** |
| ASP hosting            | ** ** | **$**                                  | **30,354** |   | $ | 24,195 |   |   | 25 | % |   |
| Professional  services | ** ** | **17,434**                             |       | 16,563 |   |   | 5 |   |   |
| License                | ** ** | **5,030**                              |       | 4,199 |   |   | 20 |   |   |
| Maintenance            | ** ** | **1,322**                              |       | 1,524 |   |   | (13 | ) |   |
| Total cost of revenues | ** ** | **$**                                  | **54,140** |   | $ | 46,481 |   |   | 16 | % |   |

 

*Costof ASP hosting revenue.*   Cost of ASP hostingrevenue is composed primarily of salary and personnel related costs, facilityand equipment costs and postage and supplies expense related to our ASP hostingcenters. For the year ended July 31, 2006, cost of ASP hosting revenueincreased 25%, or $6.2 million. The increase in ASP hosting expense during thecurrent year was caused by a 53% increase in postage and supplies cost and a13% increase in compensation costs. These increases in costs were a result of a25% increase in our ASP business. For fiscal 2006 and 2005, cost of ASP hostingrevenue was 90% of ASP hosting revenue. Cost as a percentage of ASP hostingrevenue was unchanged despite a 25%increase in ASP hosting revenue. This was primarily due to the continued rolloff of accounts from a high margin ASP customer that was acquired during fiscal2004 by a company with print facilities of its own. The loss of this highermargin account offset the incremental profits associated with the increased ASPhosting revenue, resulting in cost of ASP hosting revenue as a percentage ofASP hosting revenue to remain unchanged. We expect the variablecomponents of cost of ASP hosting revenue will continue to increase as ASPhosting revenue increases.

*Costof professional services revenue.*   Cost ofprofessional services revenue consists primarily of salary and personnelrelated costs incurred in providing implementation, integration, training andconsulting services. For the year ended July 31, 2006, cost ofprofessional services revenue increased $871,000, or 5%. Costs associated withour bi-annual user group conference held in March 2006 and higher traveland living costs accounted for 51% and 33%, respectively, of the increase incost of professional services revenue. For the years ended July 31, 2006and 2005, cost of professional services revenue represented 77% and 79% ofprofessional services revenue, respectively. Excluding the revenues andexpenses associated with DocuGroup, the bi-annual user conference, the cost ofprofessional services would have been 76% of professional services revenue inthe current year. The decrease in costs as a percentage of professionalservices revenue was primarily due to improved staff utilization. We expect thecost of professional services revenue to increase as professional servicesactivities and revenue increase both domestically and internationally.

*Costof license revenue.**  *Cost oflicense revenue includes amortization of capitalized software development costsand royalties paid to third parties. For fiscal 2006, cost of license revenueincreased 20% to $5.0 million. Of this increase, 67% is due to additionalsoftware amortization expense primarily related to new products introduced tothe marketplace during the past two years. The remaining 33% of the increase isattributed to increased third party royalties, primarily due to sales of thenew Forms Integrity Manager product during the year ended July 31, 2006. Thesecost increases caused the cost of license revenue as a percentage of licenserevenue to increase to 51% during the current year compared to 42% for theprior year. We anticipate cost of license revenue to increase as amortizationof capitalized development costs increases for new products when they becomegenerally available and if sales of products requiring third party royaltiescontinue to increase.

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*Cost of maintenancerevenue.**  *Costof maintenance revenue consists primarily of salary and personnel related costsincurred in providing customer telephone and online support. Cost ofmaintenance revenue decreased 13%, or approximately $202,000, for the yearended July 31, 2006, primarily due to a reduction in maintenance staffingduring fiscal 2006 that was enabled by a lower demand for support of our maturelegacy products. For the years ended July 31, 2006 and 2005, cost ofmaintenance revenue represented 6% and 7% of maintenance revenue, respectively.The cost of maintenance revenue is expected to increase as salaries andpersonnel related costs increase due to annual merit raises and as we extendcustomer support hours to accommodate our customers’ request for extended hoursof coverage.

*Operating expenses*

Thefollowing table summarizes operating expenses (in thousands) and the percentchange over the prior year: 

| ** **                 | ** ** | **Year ended July 31,** | ** ** |
|----------------------------|------------|----------------------------------------|------------|
| ** **                 | ** ** | **2006**                               | ** ** | **2005** | ** ** | **% change** | ** ** |
| Product  development       | ** ** | **$**                                  | **8,964**  |   | $ | 8,555 |   |   | 5 | % |   |
| Sales and  marketing       | ** ** | **10,776**                             |       | 11,781 |   |   | (9 | ) |   |
| General and administrative | ** ** | **8,345**                              |       | 7,961 |   |   | 5 |   |   |
| Loss on lease  abandonment | ** ** | **1,100**                              |       | 0 |   |   | 100 |   |   |
| Total operating  expenses  | ** ** | **$**                                  | **29,185** |   | $ | 28,297 |   |   | 3 | % |   |

 

*Productdevelopment.**  *Productdevelopment expense consists primarily of salary and personnel related costsassociated with developing new products prior to establishing technologicalfeasibility, enhancing existing products, testing software products anddeveloping product documentation. For the year ended July 31, 2006,product development expense increased 5% to $9.0 million, primarily due to anincrease in incentive compensation as certain performance goals and bonus planincentives were achieved.

*Salesand marketing.*   Sales and marketing expenseconsists primarily of salaries and personnel related costs, incentivecompensation and costs associated with marketing programs. For the year ended July 31,2006, sales and marketing expense decreased $1.0 million, or 9%, primarily dueto a decrease in salaries and personnel related costs as a result of areduction in staffing levels within our sales organization.

*Generaland administrative.*   General and administrativeexpense consists primarily of salary and personnel related costs foraccounting, human resources, legal and information technology, as well asoutside legal, accounting and other services. General and administrativeexpense increased 5% to $8.4 million for the year ended July 31, 2006.This increase is primarily due to an increase in incentive compensation ascertain bonus plan incentives were achieved during fiscal 2006.

*Losson lease abandonment.*   The loss on leaseabandonment was primarily for the abandonment of excess space at our officefacility in Atlanta, Georgia. In fiscal 2002, we entered into an operatinglease agreement which required us to take 15,154 sq. ft. of additional officespace for future lease expansion. During the fourth quarter of fiscal 2006,based on changes in our business, we determined that we no longer intended toutilize this extra space and we began pursuing opportunities to sublease thisspace in an effort to reduce the continuing net cash expense for this facility.As a result, a non-cash charge of approximately $1.0 million was recognizedduring the fourth quarter of fiscal 2006 based on the discounted value of theremaining lease obligation through December 2012, net of an anticipatedrecovery from estimated sublease activity. At July 31, 2006, approximately$1.0 million was included in our liability for lease obligations.

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During fiscal 2005, we recorded as part of ourpurchase price allocation an abandoned facility provision of approximately$462,000 associated with abandoning Newbridge’s corporate headquarters andprint center. During the year ended July 31, 2006, an additional $74,000was recorded for this abandonment. At July 31, 2006, the remainingliability was approximately $237,000 and will be paid in fiscal 2007. Thisbalance was included in our liability for lease obligations.

Our total obligationsunder operating leases that relate to abandoned facilities are $1.3 million atJuly 31, 2006.

*Interest expense*

Interest expense iscomposed of interest incurred on our debt obligations and capital leases. Forthe year ended July 31, 2006, interest expense decreased $195,000,primarily due to repayments of our principal balance on our bank term note. 

*Other income, net*

Other income, net,increased $363,000 for the year ended July 31, 2006, primarily due tofavorable fluctuations on foreign currency exchange rates and a $155,000increase in interest income primarily attributed to increased interest ratesduring the current year. For the year ended July 31, 2006, our foreigncurrency exchange rate gain was $174,000, as compared to a foreign currencyexchange rate loss of $34,000 for the year ended July 31, 2005.

*Provision forincome taxes*

The effective tax rate forthe years ended July 31, 2006 and 2005 was 38% and 37%, respectively. Theincrease in the effective rate from the prior year is primarily due to currentyear operating losses in EMEA, for which we did not recognize a tax benefit. Weused a portion of our net operating loss carryforwards to offset our currenttax liability for the years ended July 31, 2006 and 2005.

**ComparativeAnalysis of Results for the Fiscal Years Ended July 31, 2005 and 2004**

*Revenues*

Thefollowing table summarizes revenues (in thousands) and the percent change overthe prior year: 

| ** **             | ** ** | **Year ended July 31,** | ** ** |
|------------------------|------------|----------------------------------------|------------|
| ** **             | ** ** | **2005**                               | ** ** | **2004** | ** ** | **% change** | ** ** |
| ASP hosting            |       | $                                      | 27,002     |   | $ | 23,332 |   |   | 16 | % |   |
| Professional  services |       | 20,966                                 |       | 20,637 |   |   | 2 |   |   |
| License                |       | 10,063                                 |       | 10,480 |   |   | (4 | ) |   |
| Maintenance            |       | 21,146                                 |       | 21,221 |   |   | 0 |   |   |
| Total revenues         |       | $                                      | 79,177     |   | $ | 75,670 |   |   | 5 | % |   |

 

For the year ended July 31,2005, total revenues increased approximately $3.5 million or 5%, due primarilyto an increase in ASP hosting revenue and professional services revenue,partially offset by a decrease in license revenue. ASP hosting revenue grew16%, or $3.7 million, when compared to the prior year, primarily due to theaddition of revenue related to the acquisition of Newbridge of $5.9 million andrevenue of approximately $400,000 generated by a large outsourcing contractwhich was signed during the fourth quarter with Capgemini. Partially offsettingthese increases was a decline of approximately $1.2 million in ASP hostingrevenue from an existing customer with multiple accounts that rolled off overthe last 12 months as this customer was acquired by a company with its ownprint facilities. Lower pricing on renewing accounts due to competitive pricingpressures also resulted in a reduction to ASP hosting 

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revenueof approximately $450,000. Professional services revenue increased 2%, or$329,000, due largely to an increase in revenue generated by our EMEAprofessional services operations of approximately $230,000 and an 8%improvement in billing rates for our domestic professional services. Licenserevenue of $10.1 million declined 4% for the year ended July 31, 2005, asa result of a 17% decline in license sales in North America, largely offset bya $1.2 million increase in license revenue in EMEA. Maintenance revenuedecreased approximately $75,000 in fiscal 2005 due to certain legacy customersconsolidating multiple existing licenses when upgrading to enterprise-wideversions of our latest technology.

*Cost of revenues*

Thefollowing table summarizes cost of revenues (in thousands) and the percentchange over the prior year: 

| ** **              | ** ** | **Year ended July 31,** | ** ** |
|-------------------------|------------|----------------------------------------|------------|
| ** **              | ** ** | **2005**                               | ** ** | **2004** | ** ** | **% change** | ** ** |
| ASP hosting             |       | $                                      | 24,195     |   | $ | 19,023 |   |   | 27 | % |   |
| Professional  services  |       | 16,563                                 |       | 16,985 |   |   | (2 | ) |   |
| License                 |       | 4,199                                  |       | 3,232 |   |   | 30 |   |   |
| Maintenance             |       | 1,524                                  |       | 1,340 |   |   | 14 |   |   |
| Total cost of  revenues |       | $                                      | 46,481     |   | $ | 40,580 |   |   | 15 | % |   |

 

*Costof ASP hosting revenue.*   For the year ended July 31,2005, cost of ASP hosting revenue increased 27%, or $5.2 million, primarily dueto the operating expenses associated with Newbridge of $5.6 million. For fiscal2005 and 2004, cost of ASP hosting revenue represented 90% and 82% of ASPhosting revenue, respectively. The increase in cost as a percentage of ASPrevenue is due primarily to a decreasein revenue from an existing customer with multiple accounts, which rolled offover the last 12 months as a result of this customer being acquired by acompany with its own print facilities and lower pricing on renewing accounts.Additionally, expenses of approximately $600,000 to integrate Newbridge intoour expanded Dallas hosting center adversely impacted our margins.

*Costof professional services revenue.*   For the yearended July 31, 2005, cost of professional services revenue decreased$422,000, or 2%. This decline is primarily due to costs associated with ourbi-annual user group conference held in March 2004. For the years ended July 31,2005 and 2004, cost of professional services revenue represented 79% and 82% ofprofessional services revenue, respectively. The decrease in costs as apercentage of professional services revenue is primarily due to a 3%improvement in staff utilization, an 8% increase in average billing rates and areduction of approximately $400,000 for costs associated with the user groupconference held in the prior year.

*Costof license revenue.**  *Forfiscal 2005, cost of license revenue increased 30% to $4.2 million. Theincrease is primarily due to additional amortization expense of approximately$1.0 million related to new products introduced to the marketplace duringfiscal 2005.

*Cost of maintenancerevenue.**  *Costof maintenance revenue increased 14%, or approximately $184,000, for the yearended July 31, 2005, primarily due to an increase in customer supportcosts from our EMEA operations. For the years ended July 31, 2005 and2004, cost of maintenance revenue represented 7% and 6% of maintenance revenue,respectively.

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*Operating expenses*

Thefollowing table summarizes operating expenses (in thousands) and the percentchange over the prior year: 

| ** **                  | ** ** | **Year ended July 31,** | ** ** |
|-----------------------------|------------|----------------------------------------|------------|
| ** **                  | ** ** | **2005**                               | ** ** | **2004** | ** ** | **% change** | ** ** |
| Product  development        |       | $                                      | 8,555      |   | $ | 7,974 |   |   | 7 | % |   |
| Sales and  marketing        |       | 11,781                                 |       | 11,167 |   |   | 5 |   |   |
| General and  administrative |       | 7,961                                  |       | 6,523 |   |   | 22 |   |   |
| Total operating  expenses   |       | $                                      | 28,297     |   | $ | 25,664 |   |   | 10 | % |   |

 

*Productdevelopment.*   For the year ended July 31,2005, product development expense increased 7% to $8.6 million, primarily dueto an increase in salary and personnel related costs associated with additionsto our product development staff.

*Salesand marketing.*   For the year ended July 31,2005, sales and marketing expense increased approximately $614,000, or 5%,primarily due to increased salary and personnel related costs.

*General andadministrative.*   General and administrativeexpense increased 22%, or approximately $1.4 million, for the year ended July 31,2005. This increase is primarily due to costs associated with Sarbanes-Oxleycompliance of approximately $675,000 and increased salary and personnel relatedcosts of approximately $370,000.

*Interest expense*

For the year ended July 31,2005, interest expense decreased $50,000, as interest expense on our bank termnote and capital leases decreased approximately $185,000 due to lower principalbalances. This decrease was partially offset by additional interest expense ofapproximately $135,000 attributed to the assumption of capital leases from theNewbridge acquisition.

*Other income, net*

Other income, net,decreased $212,000 for the year ended July 31, 2005, primarily due tolosses incurred on foreign currency exchange rates in the current year,partially offset by an increase in interest income of $119,000 due to improvedinterest rates. For the year ended July 31, 2005, our foreign currencyexchange rate loss was $34,000, as compared to a foreign currency exchange rategain of $297,000 for the year ended July 31, 2004.

*Provision forincome taxes*

The effective tax rate forthe years ended July 31, 2005 and 2004 was 37% and 42%, respectively.During fiscal 2004, the rates differ from the federal statutory rate dueprimarily to losses generated by our EMEA operations, for which we did notrecognize a tax benefit. The decrease in the effective rate from the prior yearis primarily due to the improved performance of our EMEA operations. We used aportion of our net operating loss carryforwards to offset our current taxliability for the years ended July 31, 2005 and 2004.

**Liquidity andCapital Resources**

At July 31, 2006, our principal sources ofliquidity consisted of cash and cash equivalents of $9.8 million and ourrevolving credit facility of $20.0 million. Cash and cash equivalents for theyear ended July 31, 2006, increased $1.4 million from $8.4 million at July 31,2005, despite $2.4 million of cash used to acquire our Common Stock and $1.8million paid for income taxes during the current year.

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During the year ended July 31, 2006, we generated$14.8 million in cash flows from operating activities compared to $12.0 millionfor the year ended July 31, 2005. The increase over the prior year wasprimarily a result of improved operating results and changes in other workingcapital accounts. Significant changes in assets and liabilities for the yearended July 31, 2006 that impacted cash flows from operating activitiesinclude an increase in accounts payable of $885,000 due to the timing of cashdisbursements in the ordinary course of business and an increase of $775,000 inaccrued expenses largely attributed to an increase in personnel incentive costsas certain performance goals and bonus plan incentives were achieved duringfiscal 2006. In addition, we have focused attention on accelerating thecollection of accounts receivable. As a result, our days sales outstanding haveimproved by 12 days for the year ended July 31, 2006.

During the years ended July 31, 2006 and 2005,cash used in investing activities was $8.4 million and $10.9 million,respectively. This decrease is primarily due to the use of $2.5 million in theprior year for the purchase of Newbridge. Cash used for the purchase ofproperty and equipment was $3.5 million and $3.2 million for the years ended July 31,2006 and 2005, respectively. Property and equipment purchased during fiscal2006 was primarily for ASP equipment while prior year expenditures wereprimarily for the relocation of our corporate headquarters, expansion of ourDallas ASP center for the integration of the Newbridge operations and purchasesof equipment primarily used in our ASP operations. Cash used in the investmentof capitalized software development costs was $5.0 million and $5.2 million forthe years ended July 31, 2006 and 2005, respectively.

Cash used in financing activities was $5.0 million foreach of the years ended July 31, 2006 and 2005. During the year ended July 31,2006, cash used in financing activities primarily related to payments under ourbank term note of $3.6 million and payments under capital lease obligations of$1.5 million. In addition, we repurchased 396,841 shares of our Common Stockfor $2.4 million during the current year. These uses of cash were partiallyoffset by $1.7 million of proceeds from the exercise of stock options. For theyear ended July 31, 2005, cash used in financing activities primarilyrelated to repayments of our bank term note of $3.6 million, principal paymentsmade under the assumed debt obligations of Newbridge of $1.2 million andpayments under capital lease obligations of $1.4 million, partially offset byproceeds received from the exercise of stock options of $1.0 million.

In December 2002, we entered into various capitallease arrangements for the rental of computer equipment at our ASP hostingfacilities in the aggregate amount of $3.2 million. The lease agreementsrequire monthly payments of principal and interest of approximately $65,000 andexpire in December 2007. For each of the years ended July 31, 2006and 2005, we made payments of $777,000 related to these leases.

With the acquisition of Newbridge in September 2004,we assumed several capital lease obligations in the aggregate amount of $2.3million. These leases require monthly payments of principal and interest of$51,000. The Newbridge leases expire at varying dates over the next two years.For the years ended July 31, 2006 and 2005, we made payments of $622,000and $759,000, respectively, under these leases.

On June 3, 2003, we repurchased 3.1 millionshares of our Common Stock along with warrants to purchase approximately161,000 shares of Common Stock from Safeguard Scientifics, Inc (“Safeguard”)and a former officer of Safeguard for $5.95 per share. In connection with therepurchase, we entered into a $14.2 million bank term note, of which $3.3million is outstanding at July 31, 2006. The bank note bears interest at afixed annual rate of 3.32% and is repayable in equal monthly installments overfour years.

As of July 31, 2006, we had approximately 5.2million shares of treasury stock at an average per share cost of $5.59. In March 2006,we amended the stock repurchase program to authorize the repurchase of up to1.0 million additional shares of Common Stock. At July 31, 2006, 4,000shares have been repurchased under the amended program. Since inception of ourstock repurchase program in fiscal 1999, we have repurchased approximately 9.8million shares of our Common Stock at an average purchase price of $5.39. 

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Our Board of Directorsbelieves the repurchase program is an appropriate means of increasingshareholder value.

During June 2006, the revolving bank creditfacility was amended to increase the maximum credit amount from $10.0 millionto $20.0 million, and extended the maturity date to November 1, 2009.  The credit facility bears interest at the bank’sprime rate less 100 basis points or LIBOR rate of interest plus 150 basispoints, and is collateralized by substantially all of our assets. Under thecredit facility and our bank note, we are required to maintain certainfinancial and non-financial covenants. As of July 31, 2006, there were noborrowings under the revolving bank credit facility. Based on the financialcovenants, availability of funds under our revolving bank credit facility was $20.0 million at July 31, 2006.

Our liquidity needs are expected to arise primarilyfrom the repayment of debt, payments of obligations under capital leases,funding the continued software development activities, potential purchases ofour Common Stock, enhancement and support of our software offerings and salesand marketing costs associated with expansion in new vertical and internationalmarkets. A portion of our cash or borrowings under our revolving creditfacility could be used to acquire complementary businesses or obtain the rightto use complementary technologies.

Our liquidity could be negatively impacted by adecrease in demand for our products, which are subject to rapid technologychanges, reduction in capital expenditures by our customers and intensecompetition, among other factors. Operating leases are our only off balancesheet arrangements.

Wecurrently anticipate that existing cash and cash equivalents, together withcash generated from operations and available borrowings under our creditfacility, will be sufficient to satisfy our operating cash needs for the next12 months. The following is a schedule of our future contractual cashobligations as of July 31, 2006 (in thousands):

| ** **                            | ** ** | **Total** | ** ** | **Less than  1 year** | ** ** | **2 - 3 years** | ** ** | **4 - 5 years** | ** ** | **After  5 years** | ** ** |
|---------------------------------------|------------|-----------|------------|---------------------------------|------------|--------------------------------|------------|----------------------|------------|-------------------------|------------|
| Operating leases                      |       | $         | 25,424     |                            |       | $                              | 4,057      |                 |       |                    | $          | 7,383 |   |   |   | $ | 7,125 |   |   | $ | 6,859 |   |
| Capital lease  obligations            |       | 2,258     |       |                            | 1,351      |                           |       |                 | 907        |                    |       |   | 0 |   |   | 0 |   |
| Debt obligations,  including interest |       | 3,521     |       |                            | 3,378      |                           |       |                 | 143        |                    |       |   | 0 |   |   | 0 |   |
| Total contractual cash  obligations   |       | $         | 31,203     |                            |       | $                              | 8,786      |                 |       |                    | $          | 8,433 |   |   |   | $ | 7,125 |   |   | $ | 6,859 |   |

 

**Recently issued accountingguidance**

In July 2006, the Financial Accounting StandardsBoard (“FASB”) issued FASB Interpretation No. 48, “Accounting forUncertainty in Income Taxes - an interpretation of FASB Statement No. 109”(“FIN 48”), which prescribes accounting for and disclosure of uncertainty intax positions. FIN 48 defines the criteria that must be met for the benefits ofa tax position to be recognized. The provisions of FIN 48 are effective forfiscal years beginning after December 15, 2006, which is our fiscal 2008.We are evaluating the potential impact of this interpretation on our futureresults of operations and financial condition.

On September 13, 2006, the Securities andExchange Commission issued Staff Accounting Bulletin No. 108, “Consideringthe Effects of Prior Year Misstatements When Quantifying Misstatements inCurrent Year Financial Statements” (“SAB 108”), which provides interpretiveguidance on how the effects of the carryover or reversal of prior yearmisstatements should be considered in quantifying a current year misstatement.The guidance is applicable for our fiscal 2008. We do not believe SAB 108 willhave a material impact on our consolidated financial statements.

From time to time, newaccounting pronouncements are issued by the FASB or other standard settingbodies which we adopt as of the specified effective date. Unless otherwisediscussed, we believe the impact of recently issued standards which are not yeteffective will not have a material impact on our consolidated financialstatements upon adoption.

31

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**ITEM 7A.**        QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

**We have no derivative financialinstruments. We invest our cash and cash equivalents in investment-grade,highly liquid investments, consisting of money market instruments andcommercial paper. We have fixed rate debt instruments of $3.5 million as of July31, 2006. For further discussion see Note 6 to the Consolidated Financial Statements.**

**We are exposed to market riskarising from changes in foreign currency exchange rates as a result of sellingour products and services outside the U.S. (principally Europe). A portion ofour sales generated from our non-U.S. operations are denominated in currenciesother than the U.S. dollar, principally britishpounds. consequently, thetranslated u.s. dollar value ofour non-U.S. sales and operating results are subject to currency exchange ratefluctuations which may favorably or unfavorably impact reported earningsand may affect comparability of period-to-period operating results.**

For the year ended july 31, 2006 and 2005, 7% and 8%,respectively, of our revenues were denominated in british pounds. For each of the years ended july 31, 2006 and 2005, 8% of our costsof revenue and operating expenses were denominated in British pounds. Historically,the effect of fluctuations in currency exchange rates has not had a materialimpact on our operations on an annual basis; however, there can be no guaranteesthat it will not have a material impact in the future. The exposure tofluctuations in currency exchange rates will increase as we expand operationsoutside the United States.

**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

The financial statements andsupplementary data required by this item are set forth at the end of thisannual report on Form 10-K beginning on page F-1 and areincorporated into this item by reference.

**ITEM 9.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

**ITEM 9A.**        CONTROLSAND PROCEDURES

*Management’sEvaluation of Disclosure Controls and Procedures*

Our management, withparticipation of our Principal Executive Officer and Principal FinancialOfficer, evaluated the effectiveness of our disclosure controls and procedures(as defined in Rule 13a-15(e) and 15d-15(e) of theSecurities Exchange Act of 1934) as of the end of the period covered by thisreport. Based on this evaluation, the Principal Executive Officer and PrincipalFinancial Officer concluded that, as of the end of the period covered by thisreport, our disclosure controls and procedures were effective as defined in Rule 13a-15(e) and15d-15(e).

*Management’s Reporton Internal Control over Financial Reporting*

Management is responsible for establishing andmaintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) underthe Securities Exchange Act of 1934. Our internal control over financialreporting is designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

32

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Management has evaluated the effectiveness of ourinternal control over financial reporting as of July 31, 2006 using thecriteria set forth in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission. Based on this evaluation, management has concluded that,as of July 31, 2006, our internal control over financial reporting waseffective.

Management’s assessment ofthe effectiveness of our internal control over financial reporting as of July 31,2006, has been audited by Grant Thornton LLP, the independent registered publicaccounting firm who also audited our consolidated financial statements. Theirreport appears immediately following this report.

*Changes in InternalControl over Financial Reporting*

There were no changes in our internal control overfinancial reporting during the period ended July 31, 2006, that materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.

33

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**Reportof Independent Registered Public Accounting Firm**

The Board of Directors andStockholdersDocucorp International, Inc. and Subsidiaries

We have audited management’sassessment, included in the accompanying Management’s Report on InternalControl over Financial Reporting, that Docucorp International, Inc. andSubsidiaries (the “Company”) maintained effective internal control overfinancial reporting as of July 31, 2006, based on criteria established in *Internal Control—Integrated Framework* issued by theCommittee of Sponsoring Organizations of the Treadway Commission (“COSO”). TheCompany’s management is responsible for maintaining effective internal controlover financial reporting and for its assessment of the effectiveness ofinternal control over financial reporting. Our responsibility is to express anopinion on management’s assessment and an opinion on the effectiveness of theCompany’s internal control over financial reporting based on our audit.

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether effective internal control overfinancial reporting was maintained in all material respects. Our audit includedobtaining an understanding of internal control over financial reporting,evaluating management’s assessment, testing and evaluating the design andoperating effectiveness of internal control, and performing such other proceduresas we considered necessary in the circumstances. We believe that our auditprovides a reasonable basis for our opinions.

A company’s internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial statements for external purposes in accordance with generallyaccepted accounting principles. A company’s internal control over financialreporting includes those policies and procedures that (1) pertain to themaintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

In our opinion, management’sassessment that the Company maintained effective internal control overfinancial reporting as of July 31, 2006, is fairly stated, in all materialrespects, based on criteria established in COSO. Also, in our opinion, theCompany maintained, in all material respects, effective internal control overfinancial reporting as of July 31, 2006, based on criteria established inCOSO.

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated balance sheets of the company as of July 31,2006, and the related consolidated statements of operations and comprehensiveincome, stockholders’ equity, and cash flows for the year ended July 31,2006, and our report dated October 11, 2006, expressed an unqualifiedopinion on those financial statements.

/s/ Grant Thornton LLPDallas, TexasOctober 11, 2006

34

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**ITEM 9B.**       OTHERINFORMATION

None

**Part III**

Part III of thisAnnual Report on Form 10-K incorporates by reference portions of theRegistrant’s definitive proxy statement, to be filed with the Securities andExchange Commission not later than 120 days after the close of its fiscalyear; provided that if such proxy statement is not filed with the Commission insuch 120-day period, an amendment to this Form 10-K shall befiled no later than the end of the 120-day period.

**Item10.**         Directors and Executive Officers of theRegistrant

Information with respect to Directors of Docucorp isset forth in the Proxy Statement (to be filed on or before October 28,2006) under the heading “Directors and Executive Officers,” which informationis incorporated herein by reference. Information required by Item 405 ofRegulation S-K is set forth in the Proxy Statement under the heading “Section 16(a) BeneficialOwnership Reporting Compliance,” which information is incorporated herein byreference.

We have adopted a code ofethics that applies to our Chief Executive Officer and our Senior FinancialOfficers. Our code of ethics may be viewed at and obtained, free of charge,from our Internet website: http://www.docucorp.com.

**Item11.**         Executive Compensation

Information with respectto executive compensation is set forth in the Proxy Statement (to be filed onor before October 28, 2006) under the heading “Executive Compensation,”which information is incorporated herein by reference.

**Item12.**         Security Ownership of Certain BeneficialOwners and Management AND RELATED STOCKHOLDER MATTER

Information with respectto security ownership of certain beneficial owners and management and relatedstockholder matter is set forth in the Proxy Statement (to be filed on orbefore October 28, 2006) under the heading “Beneficial Ownership of CommonStock,” which information is incorporated herein by reference.

**Item13.**         Certain Relationships and Related Transactions

Information with respectto certain relationships and related transactions is set forth in the ProxyStatement (to be filed on or before October 28, 2006) under the heading “CertainRelationships and Related Transactions,” which information is incorporatedherein by reference.

**Item14.**         Principal accounting fees and services

Information with respectto principal accounting fees and services is set forth in the Proxy Statement(to be filed on or before October 28, 2006) under the heading “Fees Paidto, and Independence of, Auditors,” which information is incorporated herein byreference.

35

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**Part IV**

**Item15.**         Exhibits and Financial Statement Schedules

(a)           Thefollowing is a list of the consolidated financial statements, which areincluded in this Form 10-K.

1.                *Financial Statements*:   The financial statements,related notes thereto and the Reports of Independent Registered PublicAccounting Firms required hereunder are set forth at the end of this AnnualReport beginning on page F-1.

2.                *Financial Statement Schedule*:   The following financialstatement schedule for the fiscal years ended July 31, 2006, 2005 and 2004is filed as part of this Form 10-K beginning on page 40 andshould be read in conjunction with our consolidated financial statements andrelated notes thereto.

·        ScheduleII—Valuation and Qualifying Accounts

Schedules otherthan those listed above have been omitted since they are either not required,not applicable or the information is otherwise included.

(b)          Exhibits:
| 3.1   |   | Certificate of Incorporation. (filed as exhibit 3.1  to the Company’s Registration Statement on Form S-4 No. 333-22225  and incorporated herein by reference)                                                                                     |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.2   |   | Bylaws. (filed as  exhibit 99.1 to the Company’s August 18, 2005 Form 8-K and  incorporated herein by reference)                                                                                                                                  |
| 10.1  |   | Credit Agreement between  the Registrant and Comerica Bank-Texas (filed as exhibit 10 to the Company’s  Form 10-Q for the period ended April 30, 2002 and  incorporated herein by reference)                                                      |
| 10.2  |   | Employment Agreement  between Michael D. Andereck and the Registrant dated January 15, 1997.  (filed as exhibit 10.2 to the Company’s Registration Statement on Form S-4  No. 333-22225 and incorporated herein by reference)                |
| 10.3  |   | 1997 Equity Compensation  Plan. (filed as exhibit 10.3 to the Company’s 1997 Annual Report on  Form 10-K and incorporated herein by reference)                                                                                                         |
| 10.4  |   | Asset Purchase Agreement  dated as of September 24, 2004 between Newbridge Corporation and  Docucorp International, Inc. (filed as exhibit 10.4 to the Company’s  2004 Annual Report on Form 10-K and incorporated herein by  reference)     |
| 10.5  |   | Form of Restricted  Stock Agreement dated August 22, 2005 between certain executive officers  and Docucorp International Inc. (filed as exhibit 10.5 to the Company’s 2005  Annual Report on Form 10-K and incorporated herein by reference) |
| 10.6  |   | Employment Agreement  between J. Robert Gary and the Registrant dated May 1, 2006 (filed as  exhibit 10.1 to the Company’s Form 10-Q for the period ended  April 30, 2006 and incorporated herein by reference)                              |
| 10.7  |   | Fourth Amendment to  Credit Agreement (filed as exhibit 00.1 to the Company June 15, 2006  Form 8-K and incorporated herein by reference)                                                                                                              |
| 10.8  |   | Form of Bonus Plan  for Executive Officers (filed as exhibit 10.1 to the Company August 4,  2006 Form 8-K and incorporated herein by reference)                                                                                                   |
| 21.1  |   | Subsidiaries of the  Registrant (filed as exhibit 21.1 to the Company’s 2005 Annual Report on  Form 10-K and incorporated herein by reference)                                                                                                         |
| 23.1* |   | Consent of Grant  Thornton LLP, Independent Registered Public Accounting Firm                                                                                                                                                                                    |

36

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| 23.2* |   | Consent of  PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm                                              |
|-------|--------|------------------------------------------------------------------------------------------------------------------------------------|
| 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 |

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                 * Filed herewith.

37

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized, in the City of Dallas,State of Texas.
| DOCUCORP INTERNATIONAL, INC.                  |   |   |                  |
|----------------------------------------------------|--------|--------|-----------------------|
| (Registrant)                                       |   |   |                  |
| /s/ MICHAEL D. ANDERECK                            |   | Date   | October 11, 2006 |   |
| Michael D. Andereck                                |   |   |                  |
| *President, Chief Executive Officer, and Director* |   |   |                  |

 

38

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**POWEROF ATTORNEY AND SIGNATURES**

We, the undersigned officers and directors of DocucorpInternational, Inc., hereby severally constitute and appoint Michael D.Andereck, our true and lawful attorney, with full power to sign for us in ournames in the capacities indicated below, amendments to this report, andgenerally to do all things in our names and on our behalf in such capacities toenable Docucorp International, Inc. to comply with the provisions of theSecurities Exchange Act of 1934, as amended, and all requirements of the Securitiesand Exchange Commission.

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.
| /s/ MICHAEL D. ANDERECK               |     |   | Date   | October 11, 2006 |   |
|---------------------------------------|----------|--------|--------|-----------------------|--------|
| Michael D. Andereck                   |     |   |   |                  |
| *President, Chief Executive Officer,* | * * |   |   |                  |
| *and Director*                        | * * |   |   |                  |
| *(Principal Executive Officer)*       |     |   |   |                  |
| /s/ J. ROBERT GARY                    |     |   | Date   | October 11, 2006 |   |
| J. Robert Gary                        |     |   |   |                  |
| *Senior Vice President, Finance*      | * * |   |   |                  |
| *And Administration*                  | * * |   |   |                  |
| *(Principal Financial Officer)*       |     |   |   |                  |
| /s/ MILLEDGE A. HART, III        |     |   | Date   | October 11, 2006 |   |
| Milledge A. Hart, III            |     |   |   |                  |
| *Chairman of the Board*               | * * |   |   |                  |
| /s/ ANSHOO S. GUPTA                   |     |   | Date   | October 11, 2006 |   |
| Anshoo S. Gupta                       |     |   |   |                  |
| *Director*                            | * * |   |   |                  |
| /s/ JOHN D. LOEWENBERG                |     |   | Date   | October 11, 2006 |   |
| John D. Loewenberg                    |     |   |   |                  |
| *Director*                            | * * |   |   |                  |
| /s/ GEORGE F. RAYMOND                 |     |   | Date   | October 11, 2006 |   |
| George F. Raymond                     | * * |   |   |                  |
| *Director*                            |     |   |   |                  |
| /s/ ARTHUR R. SPECTOR                 |     |   | Date   | October 11, 2006 |   |
| Arthur R. Spector                     |     |   |   |                  |
| *Director*                            | * * |   |   |                  |
| /s/ ED L. HOLCOMB                     |     |   | Date   | October 11, 2006 |   |
| Ed L. Holcomb                         |     |   |   |                  |
| *Controller*                          | * * |   |   |                  |
| *(Principal Accounting Officer)*      | * * |   |   |                  |

 

39

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**Valuation andQualifying AccountsYears ended July 31, 2006, 2005 and 2004Schedule II**

| **Description**                                  | ** ** | ** ** | ** ** | **Balance at  Beginning  of Period** | ** ** | **Charged to  Costs and  Expenses** | ** ** | **Deductions(a)** | ** ** | **Balance at  End of Period** | ** ** |
|--------------------------------------------------|------------|------------|------------|------------------------------------------------|------------|-----------------------------------------------|------------|-------------------|------------|----------------------------------------------|------------|
| 2006                                             |       |       |       |                                           |       |                                          |       |              |       |                                         |       |   |   |   |   |
| Allowance for doubtful accounts                  |       | $          | 292,571    |                                           |       | $                                             | 201,056    |              |       |                                         | $          | (14,856 | ) |   |   | $ | 478,771 |   |   |
| Valuation allowance against deferred tax assets  |       | $          | 2,796,004  |                                           |       | $                                             | 115,930    |              |       |                                         | $          | -0- |   |   |   | $ | 2,911,934 |   |   |
| 2005                                             |       |       |       |                                           |       |                                          |       |              |       |                                         |       |   |   |   |   |
| Allowance for doubtful accounts                  |       | $          | 375,000    |                                           |       | $                                             | 166,257    |              |       |                                         | $          | (248,686 | ) |   |   | $ | 292,571 |   |   |
| Valuation allowance against deferred tax assets  |       | $          | 2,792,105  |                                           |       | $                                             | 3,899      |              |       |                                         | $          | -0- |   |   |   | $ | 2,796,004 |   |   |
| 2004                                             |       |       |       |                                           |       |                                          |       |              |       |                                         |       |   |   |   |   |
| Allowance for doubtful accounts                  |       | $          | 562,159    |                                           |       | $                                             | 145,139    |              |       |                                         | $          | (332,298 | ) |   |   | $ | 375,000 |   |   |
| Valuation  allowance against deferred tax assets |       | $          | 2,432,566  |                                           |       | $                                             | 359,539    |              |       |                                         | $          | -0- |   |   |   | $ | 2,792,105 |   |   |

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        (a) Deductions from the allowance for doubtful accounts relate to theutilization of the valuation and qualifying accounts for specific items forwhich they were established in the accounts receivable account.

40

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**DOCUCORPINTERNATIONAL, INC.INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**
| Reports of Independent  Registered Public Accounting Firms      |   | F-2 |
|-----------------------------------------------------------------|--------|-----|
| Consolidated Balance Sheets                                     |   | F-4 |
| Consolidated Statements of  Operations and Comprehensive Income |   | F-5 |
| Consolidated Statements of  Cash Flow                           |   | F-6 |
| Consolidated Statements of  Stockholders’ Equity           |   | F-7 |
| Notes to Consolidated  Financial Statements                     |   | F-8 |

 

F-1

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**Report ofIndependent Registered Public Accounting Firm**

To the Board of Directors and Stockholdersof Docucorp International, Inc.:

We have audited the accompanying consolidated balancesheet of Docucorp International, Inc. and Subsidiaries as of July 31,2006, and the related consolidated statements of operations and comprehensiveincome, stockholders’ equity, and cash flows for the year then ended. Thesefinancial statements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred toabove present fairly, in all material respects, the consolidated financialposition of Docucorp International, Inc. and Subsidiaries as of July 31,2006, and the consolidated results of their operations and their consolidatedcash flows for the year then ended in conformity with accounting principlesgenerally accepted in the United States of America.

We have also audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theeffectiveness of Docucorp International, Inc. and Subsidiaries’ internalcontrol over financial reporting as of July 31, 2006, based on criteriaestablished in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commissionand our report dated October 11, 2006, expressed an unqualified opinion onmanagement’s assessment of the effectiveness of internal control over financialreporting and an unqualified opinion on the effectiveness of internal controlover financial reporting.

Our audit was conductedfor the purpose of forming an opinion on the basic financial statements takenas a whole. Schedule II is presented for purposes of additional analysis and isnot a required part of the basic financial statements. This schedule has beensubjected to the auditing procedures applied in the audit of the basicfinancial statements and, in our opinion, is fairly stated in all materialrespects in relation to the basic financial statements taken as a whole.

/s/ Grant Thornton LLP

Dallas, TexasOctober 11, 2006

F-2

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**Report ofIndependent Registered Public Accounting Firm**

To the Board of Directors and Stockholdersof Docucorp International, Inc.:

In our opinion, theconsolidated****balance sheet as of July 31,2005****and the related consolidatedstatements of operations and comprehensive income, of cash flows, andstockholders’ equity for the years ended July 31, 2005 and 2004 listed inthe index appearing under Item 15 (a)(1) present fairly, in all materialrespects, the financial position of Docucorp International, Inc. and itssubsidiaries at July 31, 2005, and the results of their operations andtheir****cash flows for the years endedJuly 31, 2005 and 2004, in conformity with accounting principles generallyaccepted in the United States of America. In addition, in our opinion, thefinancial statement schedule listed in the index appearing under Item 15 (a)(2) presentsfairly, in all material respects the information set forth therein when read inconjunction with the related consolidated financial statements. These financialstatements and financial statement schedule are the responsibility of theCompany’s management. Our responsibility is to express an opinion on thesefinancial statements and financial statement schedule based on our audits. Weconducted our audits of these statements in accordance with the standards ofthe Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, and evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

/s/ PricewaterhouseCoopers LLP

Dallas, TexasOctober 11, 2005, except for Note 7,as to which the date is October 11, 2006

F-3

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**Docucorp International, Inc.Consolidated Balance SheetsJuly 31, 2006 and 2005(in thousands, except share and per share amounts)**

| ** **                                                                                        | ** ** | **2006**    | ** ** | **2005**   | ** ** |
|---------------------------------------------------------------------------------------------------|------------|-------------|------------|------------|------------|
| **Assets**                                                                                        | ** ** | ** **  | ** ** | ** ** | ** ** |
| Current assets:                                                                                   |       |        |       |       |       |
| Cash and cash equivalents                                                                         | ** ** | **$**       | **9,829**  |       | $          | 8,381 |   |
| Accounts receivable, net of allowance of $479 and  $293, respectively                             | ** ** | **16,918**  |       | 17,132     |       |
| Current portion of deferred taxes                                                                 | ** ** | **363**     |       | 170        |       |
| Income tax receivable                                                                             | ** ** | **248**     |       | 248        |       |
| Other current assets                                                                              | ** ** | **2,905**   |       | 2,559      |       |
| Total current assets                                                                              | ** ** | **30,263**  |       | 28,490     |       |
| Property and equipment, net of accumulated  depreciation of $24,156 and $20,122, respectively     | ** ** | **9,674**   |       | 10,261     |       |
| Software development costs, net of accumulated amortization  of $30,274 and $25,909, respectively | ** ** | **14,301**  |       | 13,687     |       |
| Goodwill                                                                                          | ** ** | **9,842**   |       | 9,842      |       |
| Identifiable intangible, net of accumulated  amortization of $290 and $113, respectively          | ** ** | **730**     |       | 907        |       |
| Other assets                                                                                      | ** ** | **499**     |       | 448        |       |
| Total assets                                                                                      | ** ** | **$**       | **65,309** |       | $          | 63,635 |   |
| **Liabilities  and stockholders’ equity**                                                    | ** ** | ** **  | ** ** | ** ** | ** ** |
| Current liabilities:                                                                              |       |        |       |       |       |
| Accounts payable                                                                                  | ** ** | **$**       | **3,322**  |       | $          | 2,423 |   |
| Accrued  liabilities:                                                                             |       |        |       |       |       |
| Accrued compensation                                                                              | ** ** | **3,453**   |       | 3,067      |       |
| Other                                                                                             | ** ** | **1,625**   |       | 1,491      |       |
| Income taxes payable                                                                              | ** ** | **531**     |       | 403        |       |
| Current portion of lease obligations                                                              | ** ** | **1,845**   |       | 1,459      |       |
| Current portion of long-term debt                                                                 | ** ** | **3,324**   |       | 3,617      |       |
| Deferred revenue                                                                                  | ** ** | **11,709**  |       | 11,479     |       |
| Total current liabilities                                                                         | ** ** | **25,809**  |       | 23,939     |       |
| Deferred taxes                                                                                    | ** ** | **4,772**   |       | 5,178      |       |
| Long-term lease obligations                                                                       | ** ** | **1,588**   |       | 2,303      |       |
| Long-term debt                                                                                    | ** ** | **137**     |       | 3,462      |       |
| Other long-term liabilities                                                                       | ** ** | **1,501**   |       | 1,224      |       |
| Commitments and contingencies                                                                     |       |        |       |       |       |
| Stockholders’ equity:                                                                        |       |        |       |       |       |
| Preferred stock, $0.01 par value, 1,000,000 shares authorized;  none issued                       | ** ** | **0**       |       | 0          |       |
| Common stock, $0.01 par value, 50,000,000 shares authorized;  16,593,849 shares issued            | ** ** | **166**     |       | 166        |       |
| Additional paid-in capital                                                                        | ** ** | **45,915**  |       | 48,035     |       |
| Treasury stock at cost, 5,185,109 and 5,458,912  shares, respectively                             | ** ** | **(28,991** | **)**      | (30,347    | )          |
| Retained earnings                                                                                 | ** ** | **14,948**  |       | 12,268     |       |
| Unearned compensation                                                                             | ** ** | **0**       |       | (2,100     | )          |
| Foreign currency translation adjustment                                                           | ** ** | **(536**    | **)**      | (493       | )          |
| Total stockholders’ equity                                                                   | ** ** | **31,502**  |       | 27,529     |       |
| Total liabilities  and stockholders’ equity                                                  | ** ** | **$**       | **65,309** |       | $          | 63,635 |   |

 

See accompanying notes to consolidated financial statements.

F-4

----

**DocucorpInternational, Inc.**

**ConsolidatedStatements of Operations and**

**ComprehensiveIncome**

**For the Years Ended July 31, 2006, 2005 and 2004(in thousands, except per share amounts)**

| ** **                                          | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|-----------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| **Revenues**                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ASP hosting                                         | ** ** | **$**      | **33,884** |       | $          | 27,002     |       | $ | 23,332 |   |
| Professional services                               | ** ** | **22,562** |       | 20,966     |       | 20,637     |       |
| License                                             | ** ** | **9,961**  |       | 10,063     |       | 10,480     |       |
| Maintenance                                         | ** ** | **21,930** |       | 21,146     |       | 21,221     |       |
| Total revenues                                      | ** ** | **88,337** |       | 79,177     |       | 75,670     |       |
| **Cost of  revenues**                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ASP hosting                                         | ** ** | **30,354** |       | 24,195     |       | 19,023     |       |
| Professional services                               | ** ** | **17,434** |       | 16,563     |       | 16,985     |       |
| License                                             | ** ** | **5,030**  |       | 4,199      |       | 3,232      |       |
| Maintenance                                         | ** ** | **1,322**  |       | 1,524      |       | 1,340      |       |
| Total cost of revenues                              | ** ** | **54,140** |       | 46,481     |       | 40,580     |       |
| Gross profit                                        | ** ** | **34,197** |       | 32,696     |       | 35,090     |       |
| **Operating  expenses**                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Product development                                 | ** ** | **8,964**  |       | 8,555      |       | 7,974      |       |
| Sales and marketing                                 | ** ** | **10,776** |       | 11,781     |       | 11,167     |       |
| General and administrative                          | ** ** | **8,345**  |       | 7,961      |       | 6,523      |       |
| Loss on lease abandonment                           | ** ** | **1,100**  |       | 0          |       | 0          |       |
| Total operating expenses                            | ** ** | **29,185** |       | 28,297     |       | 25,664     |       |
| Operating income                                    | ** ** | **5,012**  |       | 4,399      |       | 9,426      |       |
| Interest expense                                    | ** ** | **(375**   | **)**      | (570       | )          | (620       | )          |
| Other income, net                                   | ** ** | **536**    |       | 173        |       | 385        |       |
| Income before income taxes                          | ** ** | **5,173**  |       | 4,002      |       | 9,191      |       |
| Provision for  income taxes                         | ** ** | **1,953**  |       | 1,496      |       | 3,825      |       |
| Net income                                          | ** ** | **$**      | **3,220**  |       | $          | 2,506      |       | $ | 5,366 |   |
| Other  comprehensive income:                        |       |       |       |       |       |       |       |
| Foreign currency translation adjustment, net of tax | ** ** | **(43**    | **)**      | 8          |       | (200       | )          |
| Comprehensive  income                               | ** ** | **$**      | **3,177**  |       | $          | 2,514      |       | $ | 5,166 |   |
| Basic net income per share                          | ** ** | **$**      | **0.29**   |       | $          | 0.24       |       | $ | 0.53 |   |
| Weighted average basic shares outstanding           | ** ** | **10,923** |       | 10,651     |       | 10,154     |       |
| Diluted net income per share                        | ** ** | **$**      | **0.28**   |       | $          | 0.22       |       | $ | 0.47 |   |
| Weighted average  diluted shares outstanding        | ** ** | **11,522** |       | 11,526     |       | 11,360     |       |

 

See accompanying notes to consolidated financial statements.

F-5

----

**Docucorp International, Inc.Consolidated Statements of Cash FlowsFor the Years Ended July 31, 2006, 2005 and 2004(in thousands)**

| ** **                                                                                     | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| **Cash flows from operating activities**                                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                                     | ** ** | **$**      | **3,220**  |       | $          | 2,506      |       | $ | 5,366 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities:             |       |       |       |       |       |       |       |
| Stock-based compensation  expense                                                              | ** ** | **697**    |       | 577        |       | 48         |       |
| Depreciation and  amortization                                                                 | ** ** | **4,242**  |       | 4,089      |       | 3,455      |       |
| Amortization of  capitalized software                                                          | ** ** | **4,365**  |       | 3,813      |       | 2,830      |       |
| Loss on lease abandonment                                                                      | ** ** | **1,100**  |       | 0          |       | 0          |       |
| Loss (gain) on foreign  currency                                                               | ** ** | **(167**   | **)**      | 125        |       | (266       | )          |
| Provision for doubtful  accounts                                                               | ** ** | **201**    |       | 166        |       | 145        |       |
| Deferred income taxes                                                                          | ** ** | **(208**   | **)**      | 285        |       | 2,803      |       |
| Tax benefit related to  stock option exercises                                                 | ** ** | **(674**   | **)**      | 466        |       | 1,860      |       |
| Changes in operating assets and liabilities:                                                   |       |       |       |       |       |       |       |
| Accounts receivable                                                                            | ** ** | **134**    |       | 146        |       | (715       | )          |
| Income tax receivable                                                                          | ** ** | **0**      |       | 569        |       | 257        |       |
| Other assets                                                                                   | ** ** | **(377**   | **)**      | 284        |       | 553        |       |
| Accounts payable                                                                               | ** ** | **885**    |       | (574       | )          | (185       | )          |
| Accrued liabilities                                                                            | ** ** | **775**    |       | (54        | )          | (1,150     | )          |
| Income taxes payable                                                                           | ** ** | **411**    |       | 245        |       | (265       | )          |
| Deferred revenue                                                                               | ** ** | **185**    |       | (613       | )          | (517       | )          |
| Net cash provided by  operating activities                                                     | ** ** | **14,789** |       | 12,030     |       | 14,219     |       |
| **Cash flows from investing activities**                                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Purchase of Newbridge                                                                          | ** ** | **0**      |       | (2,482     | )          | 0          |       |
| Proceeds from sale of  property and equipment                                                  | ** ** | **70**     |       | 0          |       | 0          |       |
| Purchase of property and  equipment                                                            | ** ** | **(3,532** | **)**      | (3,223     | )          | (1,464     | )          |
| Capitalized software  development costs                                                        | ** ** | **(4,979** | **)**      | (5,231     | )          | (5,532     | )          |
| Net cash used in  investing activities                                                         | ** ** | **(8,441** | **)**      | (10,936    | )          | (6,996     | )          |
| **Cash flows from financing activities**                                                       | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Principal payments under  lease obligations                                                    | ** ** | **(1,452** | **)**      | (1,355     | )          | (582       | )          |
| Principal payments under  debt obligations                                                     | ** ** | **(3,618** | **)**      | (4,781     | )          | (3,550     | )          |
| Purchase of treasury  stock                                                                    | ** ** | **(2,385** | **)**      | 0          |       | 0          |       |
| Tax benefit related to  stock option exercises                                                 | ** ** | **674**    |       | 0          |       | 0          |       |
| Proceeds from exercise  of options                                                             | ** ** | **1,708**  |       | 964        |       | 1,802      |       |
| Proceeds from stock  issued to employees under Employee Stock Purchase Plan (“ESPP”) | ** ** | **102**    |       | 209        |       | 191        |       |
| Net cash used in  financing activities                                                         | ** ** | **(4,971** | **)**      | (4,963     | )          | (2,139     | )          |
| Effect of exchange rates  on cash flows                                                        | ** ** | **71**     |       | (86        | )          | (17        | )          |
| Net increase (decrease)  in cash and cash equivalents                                          | ** ** | **1,448**  |       | (3,955     | )          | 5,067      |       |
| Cash and cash  equivalents at beginning of year                                                | ** ** | **8,381**  |       | 12,336     |       | 7,269      |       |
| Cash and cash equivalents at end of year                                                       | ** ** | **$**      | **9,829**  |       | $          | 8,381      |       | $ | 12,336 |   |

See supplementalactivities disclosed in Notes 5, 6 and 8.

See accompanying notes to consolidated financial statements.

F-6

----

**Docucorp International, Inc.Consolidated Statements of Stockholders’ EquityFor the Years Ended July 31, 2006, 2005 and 2004(in thousands, except share amounts)**

| ** **                                                                 | ** ** | **Common  Stock** | ** ** | **Additional  paid-in  capital** | ** ** | **Treasury  Stock** | ** ** | **Retained  Earnings** | ** ** | **Unearned  compensation** | ** ** | **Foreign  currency  translation  adjustment** | ** ** | **Total**   | ** ** |       |
|----------------------------------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|---------------------|------------|------------------------|------------|----------------------------|------------|------------------------------------------------|------------|-------------|------------|------------|
| Balance at  July 31, 2003                                             |       |              | $          | 166                              |       |                |       | 45,466                 |       |                       |       | (37,865                                        | )          |        |       | 6,266      |   |   |   | $ | 0 |   |   |   | (301 | ) |   | 13,732 |   |
| Exercise of stock  options to purchase 676,047 shares of Common Stock |       |              |       |                             |       |                | (145       | )                      |       |                       | 3,758      |                                           |       |        | (1,811     | )          |   |   |   |   |   |   |   |   |   | 1,802 |   |
| Issuance of 55,000  shares of Restricted Stock                             |       |              |       |                             |       |                | 145        |                   |       |                       | 305        |                                           |       |        |       |       |   |   | (450 | ) |   |   |   |   |   | 0 |   |
| Issuance of 29,898  shares of Common Stock to employees under ESPP    |       |              |       |                             |       |                | 24         |                   |       |                       | 167        |                                           |       |        |       |       |   |   |   |   |   |   |   |   |   | 191 |   |
| Stock based  compensation                                                  |       |              |       |                             |       |                |       |                   |       |                       |       |                                           |       |        |       |       |   |   | 48 |   |   |   |   |   |   | 48 |   |
| Tax benefit from  stock option exercises                                   |       |              |       |                             |       |                | 1,860      |                   |       |                       |       |                                           |       |        |       |       |   |   |   |   |   |   |   |   |   | 1,860 |   |
| Foreign currency  translation adjustment                                   |       |              |       |                             |       |                |       |                   |       |                       |       |                                           |       |        |       |       |   |   |   |   |   |   | (200 | ) |   | (200 | ) |
| Net income                                                                 |       |              |       |                             |       |                |       |                   |       |                       |       |                                           |       |        | 5,366      |       |   |   |   |   |   |   |   |   |   | 5,366 |   |
| Balance at  July 31, 2004                                             |       |              | 166        |                             |       |                | 47,350     |                   |       |                       | (33,635    | )                                              |       |        | 9,821      |       |   |   | (402 | ) |   |   | (501 | ) |   | 22,799 |   |
| Exercise of stock  options to purchase 277,379 shares of Common Stock      |       |              |       |                             |       |                | (519       | )                      |       |                       | 1,542      |                                           |       |        | (59        | )          |   |   |   |   |   |   |   |   |   | 964 |   |
| Issuance of  268,357 shares of Restricted Stock                            |       |              |       |                             |       |                | 568        |                   |       |                       | 1,492      |                                           |       |        |       |       |   |   | (2,060 | ) |   |   |   |   |   | 0 |   |
| Issuance of 31,116  shares of Common Stock to employees under ESPP    |       |              |       |                             |       |                | 36         |                   |       |                       | 173        |                                           |       |        |       |       |   |   |   |   |   |   |   |   |   | 209 |   |
| Issuance of 14,665  shares of Common Stock                            |       |              |       |                             |       |                | 39         |                   |       |                       | 81         |                                           |       |        |       |       |   |   | (120 | ) |   |   |   |   |   | 0 |   |
| Stock based  compensation                                                  |       |              |       |                             |       |                | 95         |                   |       |                       |       |                                           |       |        |       |       |   |   | 482 |   |   |   |   |   |   | 577 |   |
| Tax benefit from  stock option exercises                                   |       |              |       |                             |       |                | 466        |                   |       |                       |       |                                           |       |        |       |       |   |   |   |   |   |   |   |   |   | 466 |   |
| Foreign currency  translation adjustment                                   |       |              |       |                             |       |                |       |                   |       |                       |       |                                           |       |        |       |       |   |   |   |   |   |   | 8 |   |   | 8 |   |
| Net income                                                                 |       |              |       |                             |       |                |       |                   |       |                       |       |                                           |       |        | 2,506      |       |   |   |   |   |   |   |   |   |   | 2,506 |   |
| Balance at  July 31, 2005                                             |       |              | 166        |                             |       |                | 48,035     |                   |       |                       | (30,347    | )                                              |       |        | 12,268     |       |   |   | (2,100 | ) |   |   | (493 | ) |   | 27,529 |   |
| Adoption of FAS  123R                                                      |       |              |       |                             | ** ** | ** **          | **(2,100** | **)**                  | ** ** | ** **                 | ** ** |                                           | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | **2,100** |   | ** ** | ** ** | ** ** | ** ** | ** ** | **0** | ** ** |
| Exercise of stock  options to purchase 478,703 shares of Common Stock | ** ** | ** **        | ** ** |                             | ** ** | ** **          | **(424**   | **)**                  | ** ** | ** **                 | **2,672**  |                                           | ** ** | ** **  | **(540**   | **)**      | ** ** | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** | ** ** | **1,708** | ** ** |
| Issuance of  158,500 shares of Restricted Stock                            | ** ** | ** **        | ** ** |                             | ** ** | ** **          | **(883**   | **)**                  | ** ** | ** **                 | **883**    |                                           | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** | ** ** | **0** | ** ** |
| Issuance of 15,527  shares of Common Stock to employees under ESPP    | ** ** | ** **        | ** ** |                             | ** ** | ** **          | **15**     | ** **             | ** ** | ** **                 | **87**     |                                           | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** | ** ** | **102** | ** ** |
| Issuance of 17,914  shares of Common Stock                            | ** ** | ** **        | ** ** |                             | ** ** | ** **          | **(99**    | **)**                  | ** ** | ** **                 | **99**     |                                           | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** | ** ** | **0** | ** ** |
| Stock based  compensation                                                  | ** ** | ** **        | ** ** |                             | ** ** | ** **          | **697**    | ** **             | ** ** | ** **                 | ** ** |                                           | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** | ** ** | **697** | ** ** |
| Purchase of  396,841 shares of Treasury Stock                              | ** ** | ** **        | ** ** |                             | ** ** | ** **          | ** ** | ** **             | ** ** | ** **                 | **(2,385** | )                                              | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** | ** ** | **(2,385** | **)** |
| Tax benefit from  stock option exercises                                   | ** ** | ** **        | ** ** |                             | ** ** | ** **          | **674**    | ** **             | ** ** | ** **                 | ** ** |                                           | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** | ** ** | **674** | ** ** |
| Foreign currency  translation adjustment                                   | ** ** | ** **        | ** ** |                             | ** ** | ** **          | ** ** | ** **             | ** ** | ** **                 | ** ** |                                           | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** | **(43** | **)** | ** ** | **(43** | **)** |
| Net income                                                                 | ** ** | ** **        | ** ** |                             | ** ** | ** **          | ** ** | ** **             | ** ** | ** **                 | ** ** |                                           | ** ** | ** **  | **3,220**  | ** ** | ** ** | ** ** | ** ** |   | ** ** | ** ** | ** ** | ** ** | ** ** | **3,220** | ** ** |
| Balance at  July 31, 2006                                             | ** ** | ** **        | **$**      | **166**                          |       | ** **          | ** ** | **$**                  | **45,915** | ** **                 | ** ** | ** **                                     | **$**      | **(28,991** | )          | ** ** | ** ** | **$** | **14,948** | ** ** | ** ** | ** ** | **$** | **0** |   | ** ** | ** ** | **$** | **(536** | **)** | ** ** | **$** | **31,502** | ** ** |
|                                                                            |            |                   |            |                                  |            |                     |            |                        |            |                            |            |                                                |            |             |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

See accompanying notes to consolidated financial statements.

F-7

----

**Notes to Consolidated Financial Statements**

**Note 1—Basis of presentation and summary ofsignificant accounting policies**

Docucorp International, Inc. (“Docucorp”), aDelaware corporation, was organized on January 13, 1997 in connection withthe acquisition of FormMaker Software, Inc. (“FormMaker”) by ImageSciences, Inc (“Image Sciences”). The accompanying consolidated financialstatements include the accounts of Docucorp and our wholly owned subsidiaries,Image Sciences, FormMaker, EZPower Systems, Maitland Software, NewbridgeInformation Services, Matrix Digital Technologies and Docucorp Europe Ltd. Allintercompany accounts and transactions have been eliminated in consolidation.We operate primarily in the United States, Canada and Europe.

We develop, market andsupport Customer Communication Management (“CCM”) solutions via a portfolio ofproprietary information software, application service provider (“ASP”) hostingand professional services that enable companies to create, publish, manage andarchive complex, high-volume, individualized information. We support the entireinformation life cycle—from acquisition of the first raw data point to finaldelivery of personalized information to the customer. The majority of ourbusiness is currently derived from companies in the insurance industry.

*Revenue recognition*

We derive our revenues from the sale of softwarelicenses, annual software maintenance and support agreements, professionalservices and ASP hosting services. We recognize revenue in accordance withStatement of Position 97-2, “Software Revenue Recognition” and StaffAccounting Bulletin No. 104, “Revenue Recognition” (“SAB 104”). Revenue isrecognized when a contract exists, the fee is fixed or determinable, deliveryhas occurred and collection of the receivable is deemed probable.

We use the residual method to recognize revenue fromthe sale of software licenses that are bundled with maintenance and support.Under the residual method, the fair value of the undelivered element(s) isdeferred and the remaining value of the contract is recognized as revenue. Fairvalue 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. Wedo not generally sell software licenses without selling maintenance and supportfor the licensed software. As a result, we have established VSOE only for theundelivered element(s) included in a multi-element arrangement. VSOE formaintenance and support is based upon prices customers pay to renew maintenanceand support agreements. After expiration of the initial maintenance term,maintenance and support agreements are renewable on an annual basis and includerights to unspecified upgrades, updates and enhancements on a when and ifavailable basis, as well as telephone support and bug fixes. Revenue generatedfrom maintenance and support is recognized ratably over the maintenance term ofthe agreement. We record deferred revenue for maintenance amounts invoicedprior to the performance of the related services.

Our standard software license agreements do notprovide for rights of software return and/or conditions of acceptance. However,in the rare case that acceptance criteria are provided, revenue is deferred andnot recognized until all acceptance provisions are satisfied. Revenue from softwarelicenses which include a cancellation clause is recognized upon expiration ofthe cancellation period. License revenue related to products still in thetesting phase is deferred until formal acceptance of the product by thecustomer.

Professional services revenue includes implementation,integration, training and consulting services relating to new software licensesales and consulting with existing customers to provide additional services.For new software license sales that are sold with installation services, theresidual method is applied, whereby the fair value of the services element isdeferred along with the fair value of the maintenance and 

F-8

----

**Notes to Consolidated Financial Statements (Continued)**

support, with the residualvalue of the contract recognized as license revenue. The services offered arenot essential to the functionality of the software. Professional servicesrevenue is generally billed on a time and material basis and is recognized asthe services are performed.

Professional services revenue derived from theinstallation and integration of software packages under a fixed price contractis recognized on a percentage-of-completion basis measured by the relationshipof hours worked to total estimated contract hours. We follow this methodbecause reasonably dependable estimates of the revenue and contract hoursapplicable to various elements of a contract can be made. Since the financialreporting of these contracts depends upon estimates which are assessedcontinually during the term of these contracts, recognized revenue and profitare subject to revisions as the contract progresses to completion. Revisions inprofit estimates are reflected in the period in which the facts that give riseto the revisions become known. Accordingly, favorable changes in estimatesresult in additional revenue recognition and net income, and unfavorablechanges in estimates result in a reduction of recognized revenue and netincome. When estimates indicate that a loss will be incurred on a contract uponcompletion, a provision for the expected loss is recorded in the period inwhich the loss becomes evident.

Revenue from our ASPhosting operations is recognized in accordance with SAB 104, generally on a pertransaction basis. ASP hosting agreements are generally one to five years induration and provide for monthly billing based on transaction volume orcontract minimums. Revenue related to the customer’s initial set up andimplementation is deferred and subsequently recognized over the expected termof the ASP hosting agreement.

*Cash equivalents*

We consider all highlyliquid investments purchased with an original maturity of three months or lessto be cash equivalents. Cash equivalents are stated at cost, which approximatesfair market value.

*Accounts receivable*

Accountsreceivable is composed of billed and unbilled accounts receivable. Unbilledaccounts receivable includes amounts recognized as revenue, primarily softwarelicense, for which the payments are not yet due and therefore, have not yetbeen billed. Accounts receivable consists of the following at July 31 (inthousands):

| ** ** | ** ** | **2006**  | ** ** | **2005** | ** ** |
|------------|------------|-----------|------------|----------|------------|
| Trade      | ** ** | **$**     | **15,246** |     | $          | 15,421 |   |
| Unbilled   | ** ** | **2,026** |       | 1,850    |       |
| Other      | ** ** | **125**   |       | 154      |       |
|       | ** ** | **$**     | **17,397** |     | $          | 17,425 |   |

 

*Allowance fordoubtful accounts*

We maintain an allowance for doubtful accounts forestimated losses resulting from the inability of our customers to make requiredpayments. We take into consideration the current financial condition of thecustomers, the specific details of the customer accounts, the age of theoutstanding balance and the current economic environment when assessing theadequacy of the allowance. If the financial condition of our customers were todeteriorate, resulting in an impairment of their ability to make payments,additional allowances might be required.

F-9

----

**Notes to Consolidated Financial Statements (Continued)**

Thefollowing are the changes in the allowance for doubtful accounts during theyears ended July 31 (in thousands):

| ** **                                      | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Balance at  beginning of period                 | ** ** | **$**    | **293**    |     | $          | 375      |       | $ | 562 |   |
| Provision for uncollectible accounts receivable | ** ** | **201**  |       | 166      |       | 145      |       |
| Losses sustained, net of recoveries             | ** ** | **(15**  | **)**      | (248     | )          | (332     | )          |
| Balance at end of period                        | ** ** | **$**    | **479**    |     | $          | 293      |       | $ | 375 |   |

 

*Fair value offinancial instruments*

Our financial instruments consist primarily of cash,cash equivalents, accounts receivable, accounts payable, accrued liabilities,bank term note and Newbridge debt. The current carrying amount of theseinstruments approximates fair market value due to the relatively short periodof time to maturity for these instruments. The fair market value of our bankterm note and Newbridge debt approximate their carrying values based uponcurrent market rates of interest.

Statement of FinancialAccounting Standards No. 133, “Accounting for Derivative Instruments andHedging Activities” (“SFAS 133”), requires all derivative instruments berecorded on the balance sheet at fair value. Currently, we do not holdderivative instruments or engage in hedging activities.

*Property andequipment, depreciation and amortization*

Propertyand equipment are carried at cost, less accumulated depreciation andamortization. Software developed for internal use is accounted for inaccordance with AICPA Statement of Position No. 98-1, “Accountingfor the Costs of Computer Software Developed or Obtained for Internal Use.”Depreciation and amortization are computed over the estimated service livesusing the straight-line method. Amortization of assets recorded under capitalleases was $828,000 for the year ended July 31, 2006 and is included indepreciation expense. Cumulative amortization on capital leases wasapproximately $2.7 million as of July 31, 2006. Estimated service livesare as follows:

| Leasehold  improvements         |   | Lesser of useful  life or lease term |
|---------------------------------|--------|--------------------------------------|
| Computer  equipment             |   | 4-5 years                            |
| Furniture and  fixtures         |   | 5 years                              |
| Equipment under  capital leases |   | Lesser of useful  life or lease term |

 

Costs related to repairsand maintenance are expensed as incurred. Major renewals and betterments arecapitalized and depreciated over the assets’ remaining estimated service lives.Upon retirement or sale of an asset, the cost and accumulated depreciation areremoved from the accounts with any resulting gain or loss included in income.

*Softwaredevelopment costs*

Software development costsare accounted for in accordance with Statement of Financial AccountingStandards No. 86, “Accounting for the Costs of Computer Software to beSold, Leased or Otherwise Marketed” (“SFAS 86”). SFAS 86 requires thecapitalization of certain software development costs, which include salariesand personnel related costs incurred in the development activities, oncetechnological feasibility of the software has been established. Research anddevelopment costs incurred prior to the establishment of the technologicalfeasibility of a product are expensed as incurred and are included in 

F-10

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**Notes to Consolidated Financial Statements (Continued)**

productdevelopment expense. The cost of capitalized software is amortized on astraight-line basis to cost of license revenue over its estimated useful life,generally three to six years, or the ratio of current revenues to current andanticipated revenues from the software, whichever provides the greateramortization.

*Businesscombinations and goodwill and intangible assets*

Upon acquisition of a business, we allocate thepurchase price to tangible assets and liabilities acquired and identifiableintangible assets. Any residual purchase price is recorded as goodwill. Theallocation of the purchase price requires management to make significantestimates in determining the fair values of assets acquired and liabilitiesassumed, especially with respect to intangible assets. These estimates arebased on historical experience and information obtained from valuationspecialists and the management from the acquired company. These estimates caninclude, but are not limited to, appraisals by valuation specialists, the cashflows that an asset is expected to generate in the future and the appropriateweighted average cost of capital. Estimates used in determining the fair valueof assets acquired and liabilities assumed are inherently uncertain andunpredictable. Unanticipated events and circumstances may occur which mayaffect the accuracy or validity of such estimates.

In accordance withFinancial Accounting Standards Board Statement of Financial AccountingStandards No. 142, “Goodwill and Other Intangible Assets,” we assess theimpairment of goodwill within our reporting units annually, during the thirdquarter, or more often if events or changes in circumstances indicate that thecarrying value may not be recoverable. For the year ended July 31, 2006,there was no impairment of goodwill. We assess the impairment of identifiable intangibleassets whenever events or changes in circumstances indicate that their carryingamount may not be recoverable.

*Impairment oflong-lived assets*

We have evaluated ourlong-lived assets for impairment, and will continue to do so as events orchanges in circumstances indicate that the carrying value of such assets maynot be fully recoverable. If facts or circumstances support the possibility ofimpairment, we prepare a projection of future operating cash flows,undiscounted and without interest. If based on this projection we do not expectto recover our carrying cost, an impairment loss equal to the differencebetween the fair value of the asset and its carrying value will be recognizedin operating income.

*Deferred revenue*

Deferred revenue relates primarilyto maintenance and support agreements that have been invoiced to customersprior to the performance of the related services. Maintenance and supportservices are generally billed annually in advance for services to be performedover a 12 month period. Maintenance and support provided under an initialsoftware license contract is recorded as deferred revenue based on the VSOE ofthat maintenance, and is recognized over the term of the associated agreement.

*Guarantees*

In the ordinary course of business, we includestandard indemnification provisions in our customer and distributor agreements.Pursuant to these agreements, we typically indemnify, hold harmless andreimburse the indemnified party for those losses suffered or incurred by theindemnified party arising from any trade secret, trademark, copyright, patentor other intellectual property infringement claim by any third party withrespect to our software and services. The term of these indemnificationagreements is generally perpetual. The maximum potential amount of futurepayments that we could be required to 

F-11

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**Notes to Consolidated Financial Statements (Continued)**

make under theseindemnification agreements is unlimited; however, we have never incurred coststo defend lawsuits or settle claims related to these indemnificationagreements. We believe the estimated fair value of our obligation under theseagreements is minimal. Accordingly, we have no liabilities recorded for theseagreements as of July 31, 2006 and 2005.

We currently provide software product warranties toour customers. The product warranties generally provide that the licensedsoftware will operate substantially in accordance with the applicable userdocumentation for a period typically 90 days from delivery. At July 31,2006 and 2005, we did not have material product warranty liabilities.

We have agreements inplace with our directors and officers whereby we indemnify them for certainevents or occurrences while the officer or director is, or was, serving at ourrequest in such capacity. The maximum potential amount of future payments wecould be required to make under these indemnification agreements is unlimited;however, we have a director and officer insurance policy that may enable us torecover a portion of any future amounts paid.

*Translation offoreign currencies*

We translate the financialstatements of our European subsidiary into U.S. dollars in accordance withStatement of Financial Accounting Standards No. 52, “Foreign CurrencyTranslation.” Assets and liabilities of our European subsidiary, whosefunctional currency is other than the U.S. dollar, are translated at period-endrates of exchange, and revenues and expenses are translated at average exchangerates prevailing during the period. Gains and losses on foreign currencytransactions and the translation of our intercompany loan to a consolidatedforeign subsidiary are recognized in other income as incurred. All othertranslation adjustments are reflected in stockholders’ equity as part of othercomprehensive 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”), and losses are charged to APIC to the extent that previous net gainsfrom sales are included therein, otherwise to Retained Earnings. Shares of ourCommon Stock are issued from our treasury shares as stock options are exercisedand restricted shares are granted.

In February 2006, werepurchased 392,841 shares of our Common Stock in a private transaction. Thepurchase price was $6.00 per share and was funded with available cash on hand.In March 2006, we amended the stock repurchase program to authorize therepurchase of up to one million additional shares of Common Stock. AtJuly 31, 2006, 4,000 shares have been repurchased under the amended plan.Since inception of our stock repurchase program in fiscal 1999, we haverepurchased approximately 9,763,000 shares of stock at an average purchaseprice of $5.39.

*Income taxes*

Income taxes are accountedfor under the asset and liability method. Deferred tax assets and liabilitiesare recognized for the estimated future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases. Deferred tax assets andliabilities are measured using enacted tax rates for the year in which thosetemporary differences are expected to be recovered or settled. Valuationallowances are established when necessary to reduce deferred tax assets to theamounts more likely than not to be realized.

F-12

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**Notes to Consolidated Financial Statements (Continued)**

*Net income pershare*

Ourbasic and diluted net income per share is computed in accordance with Statementof Financial Accounting Standards No. 128, “Earnings Per Share.”  Basic net income per share is computed usingthe weighted average number of common shares outstanding. Diluted net incomeper share is computed using the weighted average number of common sharesoutstanding and the assumed exercise of stock options and unvested restrictedstock awards, using the treasury stock method. The treasury stock methodrecognizes the use of proceeds that could be obtained upon exercise of optionsand the unrecognized compensation on unvested restricted stock in computingdiluted net income per share. It assumes that any proceeds would be used topurchase common stock at the average market price during the period. Optionsand unvested restricted stock will have a dilutive effect under the treasurystock method only when the average market price of common stock during theperiod exceeds the exercise price of the options or the average price computedfrom the unamortized compensation associated with unvested restricted stock.Following is a reconciliation of the shares used in computing basic and dilutednet income per share for the years ended July 31 (in thousands):

| ** **                                                      | ** ** | **2006**   | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Shares used in  computing basic net income per share            | ** ** | **10,923** |       | 10,651   |       | 10,154   |       |
| Dilutive effect  of stock options and unvested restricted stock | ** ** | **599**    |       | 875      |       | 1,206    |       |
| Shares used in  computing diluted net income per share          | ** ** | **11,522** |       | 11,526   |       | 11,360   |       |

 

At July 31, 2006,options to purchase approximately 50,000 shares of Common Stock at an averageexercise price of $13.50 per share were anti-dilutive and not included in thecomputation of diluted net income per share, because the options’ exercise pricewas greater than the average market price of the Common Stock for the period.At July 31, 2005 and 2004, there were approximately 348,000 and 50,000anti-dilutive options to purchase Common Stock at an average exercise price of$8.23 and $13.50 per share, respectively.

*Stock-basedcompensation*

In December 2004, the Financial AccountingStandards Board issued Statement of Financial Accounting Standards No. 123(revised), “Share-Based Payment” (“SFAS 123R”). SFAS 123R requires employeestock-based compensation awards to be accounted for under the fair value methodand eliminates the ability to account for these instruments under the intrinsicvalue method prescribed by Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees” (“APB 25”). We adopted SFAS 123R on a modifiedprospective basis beginning August 1, 2005 for stock-based compensationawards granted after that date and for unvested awards outstanding at thatdate. With the adoption of SFAS 123R, we reclassified $2.1 million for unearnedcompensation on restricted stock grants to additional paid in capital. Inaddition, we followed the transition method for calculating the excess taxbenefits available to absorb any future tax deficiencies that will berecognized subsequent to the adoption of SFAS 123R (the “APIC Pool”). Taxdeficiencies arise when actual tax benefits realized upon the exercise of stockoptions are less than the recorded tax benefit. We determined our APIC poolutilizing the alternative transition method.

In July 2005, the Compensation Committee of ourBoard of Directors approved the full vesting of all options then outstandingwith vesting dates occurring after July 31, 2005. This action was taken toreduce the expense related to unvested stock option awards under SFAS 123R. Thevesting of approximately 451,000 options to approximately 130 option holderswas accelerated, of which approximately 

F-13

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**Notes to Consolidated Financial Statements (Continued)**

137,000 options hadan exercise price greater than our closing stock price on the modificationdate. Under the guidance of APB 25 and the Financial Accounting Standard BoardInterpretation No. 44, the accelerated vesting resulted in a stock-basedcompensation charge of approximately $100,000, which is included in our resultsfor the year ended July 31, 2005.

For the year ended July 31, 2006, no stock-basedcompensation expense related to stock options was recorded with the adoption ofSFAS 123R, since all outstanding stock options were fully vested at July 31,2005 and no stock options were granted during fiscal 2006. Stock-basedcompensation expense of $697,000, $577,000 and $48,000 for the years ended July 31,2006, 2005 and 2004, respectively, relates to restricted stock grants and theaccelerated vesting of stock options in fiscal 2005. Tax benefits from stockoption exercises of $674,000 for the year ended July 31, 2006 werereflected as an outflow from operating activities and an inflow from financingactivities in the Consolidated Statement of Cash Flows. For the years ended July 31,2005 and 2004, the tax benefits from stock option exercises of $466,000 and$1.9 million were reflected as a cash inflow to cash provided by operatingactivities.

Priorto August 1, 2005, we accounted for stock-based compensation under therecognition and measurement principles of APB 25 and related Interpretations.For periods prior to August 1, 2005, stock-based compensation cost relatedto options is not reflected in net income, as all options granted had anexercise price equal to the market value of the underlying Common Stock on thedate of grant. The following table illustrates the pro forma effect on netincome and net income per share for the years ended July 31 as if we hadapplied the fair value recognition provisions of SFAS 123 (in thousands exceptper share amounts):

| ** **                                                                                                          | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Net income as  reported                                                                                             |       | $        | 2,506      |     | $          | 5,366 |   |
| Less, stock-based compensation expense under fair  value based methods, net of tax of $489k and $670k, respectively |       | (818     | )          | (945     | )          |
| Pro forma net  income                                                                                               |       | $        | 1,688      |     | $          | 4,421 |   |
| Net income per  share:                                                                                              |       |     |       |     |       |
| As reported                                                                                                         |       |     |       |     |       |
| Basic                                                                                                               | ** ** | **$**    | **0.24**   |     | $          | 0.53 |   |
| Diluted                                                                                                             | ** ** | **$**    | **0.22**   |     | $          | 0.47 |   |
| Pro forma                                                                                                           |       |     |       |     |       |
| Basic                                                                                                               | ** ** | **$**    | **0.16**   |     | $          | 0.44 |   |
| Diluted                                                                                                             | ** ** | **$**    | **0.15**   |     | $          | 0.39 |   |

 

There were no optionsgranted during the years ended July 31, 2006 and 2005. The weightedaverage fair value of options granted during the year ended July 31, 2004was $3.41 per option. The fair value of our stock-based awards to employees wasestimated using the Black-Scholes option pricing model with the followingweighted average assumptions used for grants in 2004: risk-free interest rateof 3.18%; no expected dividend yield; expected life of 4.50 years, andvolatility of 62.8%. The Black-Scholes model was not developed for use invaluing employee stock options, but was developed for use in estimating thefair value of traded options that have no vesting restrictions and are fullytransferable. In addition, it requires the use of subjective assumptionsincluding expectations of future dividends and stock price volatility. Suchassumptions are only used for making the required fair value estimate andshould not be considered as indicators of future dividend policy or stock priceappreciation. Because changes in the subjective assumptions can materiallyaffect the fair value estimate, and because employee stock options have 

F-14

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**Notes to Consolidated Financial Statements (Continued)**

characteristicssignificantly different from those of traded options, the use of theBlack-Scholes option-pricing model may not provide a reliable estimate of thefair value of employee stock options.

*Managementestimates*

The preparation of ourfinancial statements, in accordance with accounting principles generallyaccepted in the United States of America, requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities, anddisclosure of contingent assets and liabilities and the reported amounts ofrevenues and expenses at the date of the financial statements. On an ongoingbasis, management evaluates its estimates and judgments. Actual results coulddiffer from those estimates. Certain accounting policies require higher degreesof judgment than others in their application. The following accounting policiesrequire significant estimates: revenue recognition, accounts receivable andallowance for doubtful accounts, fair value of acquired intangible assets andgoodwill, impairment of long-lived assets, software development costs andincome taxes.

*Advertising costs*

We expense advertisingcosts as incurred. Advertising expense for each of the years ended July 31,2006, 2005 and 2004 was $1.2 million.

*Royalty costs*

We incur royalty costsassociated with the licensing of certain software products. These fees varybased upon the terms of the royalty agreement. Royalty costs for the yearsended July 31, 2006, 2005 and 2004, were approximately $665,000, $386,000and $423,000, respectively.

*Recently issuedaccounting guidance*

In July 2006, the Financial Accounting StandardsBoard (“FASB”) issued FASB Interpretation No. 48, “Accounting forUncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (“FIN48”), which prescribes accounting for and disclosure of uncertainty in taxpositions. FIN 48 defines the criteria that must be met for the benefits of atax position to be recognized. The provisions of FIN 48 are effective forfiscal years beginning after December 15, 2006, which is our fiscal 2008.We are evaluating the potential impact of this interpretation on our futureresults of operations and financial condition.

On September 13, 2006, the Securities andExchange Commission issued Staff Accounting Bulletin No. 108 “Consideringthe Effects of Prior Year Misstatements When Quantifying Misstatements inCurrent Year Financial Statements” (“SAB 108”), which provides interpretiveguidance on how the effects of the carryover or reversal of prior yearmisstatements should be considered in quantifying a current year misstatement.The guidance is applicable for our fiscal 2008. We do not believe SAB 108 willhave a material impact on our consolidated financial statements.

From time to time, newaccounting pronouncements are issued by the FASB or other standard settingbodies which we adopt as of the specified effective date. Unless otherwisediscussed, we believe the impact of recently issued standards which are not yeteffective will not have a material impact on our consolidated financialstatements upon adoption.

F-15

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**Notes to Consolidated Financial Statements (Continued)**

**Note 2—Acquisition**

On September 24, 2004, we acquired the assets ofNewbridge Corporation, which include the capital stock of Newbridge InformationServices, Inc. and Matrix Digital Technologies, Inc. (collectively,“Newbridge”). Newbridge is a leading information services company for thehealth care market. Newbridge composes, produces and distributes health careprovider directories, ID cards and policy kits, as well as provides health careprovider information over the Internet. Operating results of Newbridge areprimarily included in the ASP hosting segment of our financial statements fromthe effective date of the acquisition.

The purchase price for the transaction wasapproximately $4.0 million, comprised of approximately $2.6 million paid incash and $1.4 million of net liabilities assumed. The purchase price allocationconsists of assets acquired of approximately $5.1 million, including $1.0million for the acquired customer relationships, liabilities assumed ofapproximately $6.5 million and goodwill of approximately $4.0 million. Duringfiscal 2005, we paid approximately $2.0 million of debt obligations and pastdue liabilities.

The acquired customerrelationships have an estimated useful life of 10 years and are being amortizedon the basis of projected future cash flow. Amortization expense for thisidentifiable intangible asset was $177,000 and $113,000 for the years ended July 31,2006 and 2005, respectively. Estimated aggregate future amortization expensefor this asset in future fiscal years are as follows (in thousands):

| ** **            | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **Thereafter** | ** ** |
|-----------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|
| Amortization  expense |       | $        | 163        |     | $          | 153      |       | $        | 128        |     |       | $              | 95         |   |   |   | $ | 69 |   |   |   | $ | 122 |   |   |
|                       |            |          |            |          |            |          |            |          |            |          |            |                |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

The acquisition ofNewbridge is not considered material to our results of operations; therefore nopro forma information is presented.

**Note 3—Property andequipment**

Propertyand equipment balances at July 31, 2006 and 2005 are as follows (inthousands):

| ** **                     | ** ** | **2006**    | ** ** | **2005** | ** ** |
|--------------------------------|------------|-------------|------------|----------|------------|
| Computer  equipment            | ** ** | **$**       | **24,293** |     | $          | 21,011 |   |
| Furniture and  fixtures        | ** ** | **3,481**   |       | 3,516    |       |
| Leasehold improvements         | ** ** | **2,242**   |       | 1,939    |       |
| Equipment under  capital lease | ** ** | **3,814**   |       | 3,917    |       |
|                           | ** ** | **33,830**  |       | 30,383   |       |
| Less accumulated  depreciation | ** ** | **(24,156** | **)**      | (20,122  | )          |
|                           | ** ** | **$**       | **9,674**  |     | $          | 10,261 |   |

 

**Note 4—Loss onlease abandonment**

The loss on lease abandonment was primarily for theabandonment of excess space at our office facility in Atlanta, Georgia. Infiscal 2002, we entered into an operating lease agreement which required us totake 15,154 sq. ft. of additional office space for future lease expansion. Duringthe fourth quarter of fiscal 2006, based on changes in our business, wedetermined that we no longer intended to utilize this extra space and we beganpursuing opportunities to sublease this space in an effort to reduce thecontinuing net cash expense for this facility. As a result, a non-cash chargeof approximately $1.0 million was recognized during the fourth quarter offiscal 2006 based on the discounted value of the remaining 

F-16

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**Notes to Consolidated Financial Statements (Continued)**

lease obligation through December 2012,net of an anticipated recovery from estimated sublease activity. At July 31,2006, approximately $1.0 million was included in our liability for leaseobligations.

During fiscal 2005, we recorded as part of ourpurchase price allocation an abandoned facility provision of approximately$462,000 associated with abandoning Newbridge’s corporate headquarters andprint center. During the year ended July 31, 2006, an additional $74,000was recorded for this abandonment. At July 31, 2006, the remainingliability of approximately $237,000 was included in our liability for leaseobligations and will be paid in fiscal 2007.

Our total obligationsunder operating leases that relate to abandoned facilities are $1.3 million at July 31,2006.

**Note 5—Commitmentsand contingencies**

In December 2002, we entered into various capitallease arrangements for computer equipment at our ASP hosting facilities in theaggregate amount of $3.2 million. The lease agreements require monthly paymentsof principal and interest of approximately $65,000. These leases bear interestat various rates averaging 7.3% and expire in December 2007.

In connection with the acquisition of Newbridge on September 24,2004, we assumed numerous capital lease agreements for equipment in theaggregate amount of $2.3 million. Monthly payments of principal and interest onthese leases are approximately $51,000. The Newbridge leases have a 4.5%effective interest rate and expire at various dates over the next two years.

Other equipment leases and our obligation under leasesfor office space are treated as operating leases and the rentals are expensedas incurred. Rent expense on these operating leases for each of the years endedJuly 31, 2006, 2005, and 2004 was $4.3 million, $4.4 million and $3.9million, respectively. Generally, our leases provide for renewals for various periodsat stipulated rates.

Operating leases includes obligations for abandonedfacility leases. Future minimum lease obligations on leases in effect atJuly 31, 2006 are as follows (in thousands):

| ** **                                     | ** ** | **Capital  leases** | ** ** | **Operating  leases** | ** ** | **Total** | ** ** |
|------------------------------------------------|------------|---------------------|------------|-----------------------|------------|-----------|------------|
| 2007                                           |       | $                   | 1,351      |                  |       | $         | 4,057      |   |   | $ | 5,408 |   |
| 2008                                           |       | 815                 |       |                  | 3,736      |      |       | 4,551 |   |
| 2009                                           |       | 92                  |       |                  | 3,647      |      |       | 3,739 |   |
| 2010                                           |       | 0                   |       |                  | 3,588      |      |       | 3,588 |   |
| 2011                                           |       | 0                   |       |                  | 3,537      |      |       | 3,537 |   |
| Thereafter                                     |       | 0                   |       |                  | 6,859      |      |       | 6,859 |   |
| Minimum lease  payments                        |       | 2,258               |       |                  | 25,424     |      |       | 27,682 |   |
| Less interest                                  |       | (112                | )          |                  | 0          |      |       | (112 | ) |
|                                           |       | $                   | 2,146      |                  |       | $         | 25,424     |   |   | $ | 27,570 |   |
| Current portion of obligations under leases    |       | $                   | 1,258      |                  |       | $         | 587        |   |   | $ | 1,845 |   |
| Long-term portion  of obligations under leases |       | 888                 |       |                  | 700        |      |       | 1,588 |   |
| Total obligation under  leases                 |       | $                   | 2,146      |                  |       | $         | 1,287      |   |   | $ | 3,433 |   |

 

We are occasionallyinvolved in legal proceedings and other claims arising out of our operations inthe normal course of business. As of July 31, 2006, we are involved in adispute with a customer over the scope of professional services to be providedunder a work order. Management does not believe that a loss from 

F-17

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**Notes to Consolidated Financial Statements (Continued)**

thisdispute is probable; however, no assurance can be given that this matter willbe settled in our favor. An unfavorable resolution could potentially have amaterial impact on our consolidated financial position and results ofoperations. No such other claims are expected, individually or in theaggregate, to have a material adverse effect on our consolidated financialposition and results of operations.

**Note 6—**Debt

At July 31, 2006, we had a $20.0 million revolvingcredit facility, which expires on November 1, 2009. The credit facilitybears interest at the bank’s prime rate less 100 basis points or LIBOR rate ofinterest plus 150 basis points. As of July 31, 2006, there were noborrowings under this credit facility.

On June 3, 2003, we repurchased approximately 3.1million shares of our Common Stock along with warrants to purchaseapproximately 161,000 shares of our Common Stock from Safeguard Scientifics, Inc.(“Safeguard”) and a former officer of Safeguard for $5.95 per share. Inconnection with the repurchase, we entered into a $14.2 million bank term note.The bank note bears interest at a fixed annual rate of 3.32% and is repayablein equal monthly installments over four years. The outstanding balance of the banknote at July 31, 2006 was $3.3 million and is due during fiscal 2007.Under the credit facility and bank note, we are required to maintain certainfinancial and non-financial covenants. The credit facility and bank note arecollateralized by substantially all of our assets.

In connection with the acquisition of Newbridge on September 24,2004, we assumed approximately $1.5 million of certain debt obligations. At July 31,2006, the remaining outstanding balance of these obligations was $207,000,which is payable in equal monthly installments through May 2009 and bearsinterest at 4.5 %.

For the years ended July 31, 2006, 2005 and 2004,we made cash payments for interest on our bank note, capital lease and otherinterest bearing obligations in the aggregate amount of approximately $386,000,$581,000 and $610,000, respectively.

Long-termdebt consists of the following at July 31, 2006 and 2005 (in thousands): 

| ** **                    | ** ** | **2006**   | ** ** | **2005** | ** ** |
|-------------------------------|------------|------------|------------|----------|------------|
| Bank term note                | ** ** | **$**      | **3,254**  |     | $          | 6,804 |   |
| Newbridge debt                | ** ** | **207**    |       | 275      |       |
| Less current  portion of debt | ** ** | **(3,324** | **)**      | (3,617   | )          |
|                          | ** ** | **$**      | **137**    |     | $          | 3,462 |   |

 

**Note 7—Stockholders’equity**

*Preferred stock*

We have authorized 1.0million shares of Preferred Stock, which our Board of Directors may issue withsuch preferences and rights as it may designate. At July 31, 2006 and2005, there were no issued or outstanding shares of Preferred Stock.

*Employee stockpurchase plan*

During the year ended July 31,1998, we adopted the ESPP, which allowed eligible employees to elect tocontribute up to 15% of their regular compensation through payroll deductions,toward the purchase of our Common Stock at 85% of the fair market value. Thepurchase price of Common Stock was based on the fair market value as of eitherthe date the right was granted (first day of each semi-annual period), or 

F-18

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**Notes to Consolidated Financial Statements (Continued)**

the dateit was exercised (last day of the semi-annual period), whichever had the lowerfair market value. During the year ended July 31, 2005, we amended theESSP to allow the purchase of Common Stock at 95% of the fair market value atthe exercise date. An aggregate of 600,000 shares of Common Stock has beenreserved for issuance upon purchases pursuant to the stock purchase plan. At July 31,2006 and 2005, we have issued approximately 462,000 and 447,000 shares underthe plan, respectively.

*Equity Compensation*

We provide equityincentives to employees and directors by means of non-qualified stock optionsand restricted stock awards, which historically have been provided undervarious stock option plans. We now issue options and restricted stock awardsfrom the 1997 Equity Compensation Plan (the “Plan”). In addition, we grantedrestricted stock awards outside of the Plan in connection with our acquisitionof Newbridge. As of July 31, 2006, under the Plan, we have reserved 4.5million shares for issuance of Common Stock pursuant to awards, of which amaximum of 1.0 million shares may be used for grants of restricted stock, SARsand performance units. At July 31, 2006, approximately 768,000 shares wereavailable for issuance of Common Stock awards, of which a maximum of 653,000shares may be used for grants of restricted stock, SARs and performance units.

*Stock Options*

Stockoptions generally vest over a period of four to five years. We may grantnon-qualified stock options at an option price per share determined by theBoard of Directors; however, the option price per share shall be equal to orgreater than the fair market value on the date of grant. Options generallyexpire 10 years from the date of grant. All stock options outstanding at July 31,2006 and 2005 were fully vested. Activity under all plans is summarized asfollows (in thousands except per share amounts):

| ** **                     | ** ** | **Outstanding  options** | ** ** | **Weighted  average  exercise price** | ** ** |
|--------------------------------|------------|--------------------------|------------|--------------------------------------------|------------|
| Balance at  July 31, 2003 |       |                     | 3,432      |                                       |       |   | $ | 3.97 |   |   |
| Granted                        |       |                     | 285        |                                       |       |   | 6.44 |   |   |
| Exercised                      |       |                     | (676       | )                                          |       |   | 2.64 |   |   |
| Expired                        |       |                     | (24        | )                                          |       |   | 4.07 |   |   |
| Balance at  July 31, 2004 |       |                     | 3,017      |                                       |       |   | $ | 4.50 |   |   |
| Granted                        |       |                     | 0          |                                       |       |   | — |   |   |
| Exercised                      |       |                     | (277       | )                                          |       |   | 3.48 |   |   |
| Expired                        |       |                     | (99        | )                                          |       |   | 4.83 |   |   |
| Balance at  July 31, 2005 |       |                     | 2,641      |                                       |       |   | $ | 4.60 |   |   |
| Granted                        | ** ** | ** **               | **0**      | ** **                                 | ** ** | ** ** | **—** |   |   |
| Exercised                      | ** ** | ** **               | **(479**   | **)**                                      | ** ** | ** ** | **3.57** |   |   |
| Expired                        | ** ** | ** **               | **(58**    | **)**                                      | ** ** | ** ** | **7.05** |   |   |
| Balance at July 31,  2006 | ** ** | ** **               | **2,104**  | ** **                                 | ** ** | ** ** | **$** | **4.76** |   |   |

 

F-19

----

**Notes to Consolidated Financial Statements (Continued)**

Thefollowing table summarizes information about employee stock options outstandingat July 31, 2006 (in thousands except per share amounts and remaininglife):

| ** **                                  | ** ** | **Options Outstanding and Exercisable** | ** ** |
|---------------------------------------------|------------|--------------------------------------------------------|------------|
| **Range of exercise prices** | ** ** | ** **                                             | ** ** | **Number  outstanding** | ** ** | **Weighted  average  exercise price** | ** ** | **Weighted average  remaining life  (years)** | ** ** |
| $2.59 to $3.97                              |       |                                                   | 1,129      |   |   |   | $ | 3.51 |   |   |   | 3.80 |   |   |
| $4.25 to $5.91                              |       |                                                   | 483        |   |   |   | $ | 4.85 |   |   |   | 3.51 |   |   |
| $6.40 to $7.34                              |       |                                                   | 442        |   |   |   | $ | 6.88 |   |   |   | 6.66 |   |   |
| $13.50                                      |       |                                                   | 50         |   |   |   | $ | 13.50 |   |   |   | 6.00 |   |   |
|                                             |            |                                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The total intrinsic value of options exercised in theyears ended July 31, 2006, 2005 and 2004 was approximately $1.9 million,$1.3 million, and $5.7 million, respectively. The total intrinsic value ofunexercised options at July 31, 2006 was approximately $5.9 million.

Subsequent toJuly 31, 2006, the Compensation Committee of the Board of Directorsgranted 75,000 stock options with an exercise price of $7.85, which equaled thefair market value on the date of grant. These options vest ratably over a fiveyear period.

*Restricted stock*

Sharesof restricted stock have been granted to certain key employees and directors.Restrictions lapse as the shares vest, generally over five to seven years. Incertain cases, vesting is accelerated if specified performance measures areachieved. During the vesting period, holders of the restricted shares havevoting rights, but the shares may not be sold, assigned, transferred, pledgedor otherwise encumbered. Unvested shares are forfeited on termination ofemployment. Changes in restricted stock for the years ended July 31, 2006 and2005 were as follows: 

| ** **                                  | ** ** | **Shares  (in thousands)** | ** ** | **Weighted average  grant date fair value  per share** | ** ** |
|---------------------------------------------|------------|---------------------------------|------------|---------------------------------------------------------------------------------|------------|
| Nonvested balance  as of July 31, 2004 |       |                            | 55         |                                                                            |       |   | $ | 8.19 |   |   |
| Granted                                     |       |                            | 287        |                                                                            |       |   | 7.67 |   |   |
| Vested                                      |       |                            | (27        | )                                                                               |       |   | 7.55 |   |   |
| Forfeited                                   |       |                            | (19        | )                                                                               |       |   | 7.54 |   |   |
| Nonvested balance  as of July 31, 2005 |       |                            | 296        |                                                                            |       |   | $ | 7.78 |   |   |
| Granted                                     |       |                            | 159        |                                                                            |       |   | 7.31 |   |   |
| Vested                                      |       |                            | (74        | )                                                                               |       |   | 7.50 |   |   |
| Forfeited                                   |       |                            | 0          |                                                                            |       |   | 0 |   |   |
| Nonvested balance as of  July 31, 2006 |       |                            | 381        |                                                                            |       |   | $ | 7.64 |   |   |

 

The total fair value ofshares vested in 2006 and 2005 was $504,000 and $205,000, respectively. At July 31,2006, unrecognized compensation expense related to nonvested restricted stocktotaled approximately $2.7 million and will be recognized over a weightedaverage period of 4.3 years. Subsequent to July 31, 2006, the CompensationCommittee of the Board of Directors granted 100,000 shares of restricted stockto certain executive officers. Based on the market value of our Common Stock,these restricted stock grants were valued at approximately $750,000. Therestricted stock vests ratably over five years. Compensation expense related tothe restricted stock grant is being recognized ratably over the vesting period.

F-20

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**Notes to Consolidated Financial Statements (Continued)**

**Note 8—Income taxes**

Pretaxincome from continuing operations for the years ended July 31 consisted ofthe following (in thousands): 

| ** **                   | ** ** | **2006**   | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Income (loss) before  taxes: | ** ** | ** ** |       |     |       |     |       |
| Domestic                     | ** ** | **$**      | **5,560**  |     | $          | 4,015    |       | $ | 10,390 |   |
| Foreign                      | ** ** | **(387**   | **)**      | (13      | )          | (1,199   | )          |
|                         | ** ** | **$**      | **5,173**  |     | $          | 4,002    |       | $ | 9,191 |   |

 

Theprovision for income taxes charged to operations was as follows for the yearsended July 31 (in thousands):

| ** **               | ** ** | **2006**   | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------|------------|------------|------------|----------|------------|----------|------------|
| Current tax expense:     | ** ** | ** ** |       |     |       |     |       |
| U.S. federal             | ** ** | **$**      | **1,901**  |     | $          | 1,085    |       | $ | 916 |   |
| State, local and foreign | ** ** | **260**    |       | 126      |       | 106      |       |
| Total current            | ** ** | **2,161**  |       | 1,211    |       | 1,022    |       |
| Deferred tax expense:    | ** ** | ** ** |       |     |       |     |       |
| U.S. federal             | ** ** | **(162**   | **)**      | 255      |       | 2,512    |       |
| State, local and foreign | ** ** | **(46**    | **)**      | 30       |       | 291      |       |
| Total deferred           | ** ** | **(208**   | **)**      | 285      |       | 2,803    |       |
| Total provision          | ** ** | **$**      | **1,953**  |     | $          | 1,496    |       | $ | 3,825 |   |

 

Theprovision for income taxes differs from the amount of income taxes determinedby applying the applicable U.S. statutory federal income tax rate to pre-taxincome as a result of the following differences for the years ended July 31(in thousands):

| ** **                                    | ** ** | **2006**   | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Statutory U.S.  tax expense                   | ** ** | **$**      | **1,759**  |     | $          | 1,361    |       | $ | 3,125 |   |
| Increase (decrease) in  rates resulting from: | ** ** | ** ** |       |     |       |     |       |
| Permanent differences                         | ** ** | **46**     |       | 30       |       | 30       |       |
| State and local taxes (net)                   | ** ** | **141**    |       | 102      |       | 262      |       |
| Valuation allowance                           | ** ** | **116**    |       | 3        |       | 360      |       |
| Tax credits                                   | ** ** | **(125**   | **)**      | 0        |       | 0        |       |
| Other                                         | ** ** | **16**     |       | 0        |       | 48       |       |
| Provision for income  taxes                   | ** ** | **$**      | **1,953**  |     | $          | 1,496    |       | $ | 3,825 |   |

 

F-21

----

**Notes to Consolidated Financial Statements (Continued)**

Deferredtax assets (liabilities) are composed of the following at July 31 (inthousands):

| ** **                                                               | ** ** | **2006**   | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Gross deferred tax  assets:                                              | ** ** | ** ** |       |     |       |     |       |
| Deferred revenue                                                         | ** ** | **$**      | **27**     |     | $          | 153      |       | $ | 210 |   |
| Loss carryforwards                                                       | ** ** | **3,237**  |       | 2,803    |       | 3,069    |       |
| Tax credit carryforwards                                                 | ** ** | **0**      |       | 235      |       | 235      |       |
| Accounts receivable allowance                                            | ** ** | **115**    |       | 61       |       | 81       |       |
| Deferred lease costs                                                     | ** ** | **379**    |       | 357      |       | 310      |       |
| Compensation expense related to stock options and  restricted stock | ** ** | **58**     |       | 122      |       | 58       |       |
| Lease abandonment                                                        | ** ** | **417**    |       | 0        |       | 0        |       |
| Other                                                                    | ** ** | **390**    |       | 366      |       | 371      |       |
|                                                                     | ** ** | **4,623**  |       | 4,097    |       | 4,334    |       |
| Gross deferred tax  liabilities:                                         | ** ** | ** ** |       |     |       |     |       |
| Property and equipment                                                   | ** ** | **(111**   | **)**      | (590     | )          | (1,189   | )          |
| Capitalized software                                                     | ** ** | **(5,393** | **)**      | (5,136   | )          | (4,572   | )          |
| Other                                                                    | ** ** | **(616**   | **)**      | (583     | )          | (504     | )          |
|                                                                     | ** ** | **(6,120** | **)**      | (6,309   | )          | (6,265   | )          |
| Net                                                                      | ** ** | **(1,497** | **)**      | (2,212   | )          | (1,931   | )          |
| Less valuation allowance                                                 | ** ** | **(2,912** | **)**      | (2,796   | )          | (2,792   | )          |
| Net deferred tax  liability                                              | ** ** | **$**      | **(4,409** | **)**    | $          | (5,008   | )          | $ | (4,723 | ) |

 

At July 31, 2006, we had net operating losscarryforwards for federal income tax purposes of approximately $2.0 millionthat generally expire in the years ending 2012 through 2018. Due to ownershipchanges, a portion of our federal net operating loss and tax creditcarryforwards are subject to an annual cumulative limitation. In any one year,approximately $205,000 of carryforwards may be utilized. We also had a foreignnet operating loss carryforward of approximately $7.0 million. A valuationallowance against the entire foreign net operating loss carryforward has beenestablished, as the realizability of this asset is uncertain. The increase inthe valuation allowance in fiscal 2006 was related to an increase in theforeign net operating loss carryforwards.

At July 31, 2006, 2005 and 2004, $800,000 of thevaluation allowance is related to deferred tax assets for which subsequentlyrecognized tax benefits, if any, will be allocated to reduce goodwill.

Federal, state and foreign income taxes paymentsduring the years ended July 31, 2006, 2005 and 2004 were approximately$1.8 million, $178,000, and $262,000, respectively.

The Internal Revenue Service (“IRS”) has completedtheir examination of our tax years ended July 31, 2002 and 2000 and issueda notice of proposed adjustment for transfer pricing issues impactingintercompany interest and royalty income. Although these proposed adjustmentswould increase our U.S. taxable income for these tax years, we vigorouslydisagree with the proposed adjustments and are aggressively contesting thesematters through applicable IRS and judicial processes, as appropriate. We havefiled a written protest to these proposed adjustments thereby requesting anappeals conference with the IRS Office of Appeals. As of July 31, 2006, weconcluded that the potential loss was not probable. With respect to the taxyears under audit, the potential exposure ranges between $0 and $443,000,excluding interest and penalties.

F-22

----

**Notes to Consolidated Financial Statements (Continued)**

Assurance cannot be giventhat these tax matters will be resolved in our favor in view of the inherentuncertainties involved in settlement initiatives and tax proceedings. Further,an unfavorable settlement may result in additional exposure for other open taxyears. An unfavorable resolution of these tax matters may also have a materialadverse impact on our consolidated financial position and results ofoperations.

**Note 9—Retirementplan**

We maintain adiscretionary defined contribution 401(k) plan, as defined by the UnitedStates Internal Revenue Code, which allows participants to contribute apercentage of their compensation. The plan also allows for a discretionarymatching contribution by us as determined by our Board of Directors. Currently,we match an amount not to exceed 50% of the first 6% of the employee’scompensation contributed as an elective deferral. Our matching contributionsfor the years ended July 31, 2006, 2005 and 2004 were approximately$755,000, $741,000 and $648,000, respectively.

**Note 10—Businesssegment and geographic information**

As set forth in the criteria of Statement of FinancialAccounting Standards No. 131, “Disclosures about Segments of an Enterpriseand Related Information” (“SFAS 131”), we are organized into two reportablesegments: Software and ASP. The Software segment consists of initial softwarelicense sales, professional services consulting relating to our softwareproducts and continued customer support and maintenance of the softwareproducts. The ASP segment provides processing, print, mail, archival andInternet delivery of documents for customers who outsource these activities.

The accounting policies of the segments are the sameas those described in Note 1. Sales between segments are insignificant. Corporateexpenses related to our corporate offices are allocated to the segments. Othergeneral and administrative expenses are not allocated to the segments.

We report information regarding operating segments onthe basis used internally by management to evaluate segment performance. Segmentsare based on products and services provided. Management evaluates performancebased on revenues and operating income. We do not track operating results bysegment below the operating income line nor do we track assets, depreciationand amortization by segment.

Thetable below presents information about reported segments for the years ended July 31(in thousands): 

| ** **                                               | ** ** | **2006**    | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------------|------------|-------------|------------|----------|------------|----------|------------|
| Revenues:                                                | ** ** | ** **  |       |     |       |     |       |
| Software                                                 | ** ** | **$**       | **54,453** |     | $          | 52,175   |       | $ | 52,338 |   |
| ASP hosting                                              | ** ** | **33,884**  |       | 27,002   |       | 23,332   |       |
| Total revenues                                           | ** ** | **$**       | **88,337** |     | $          | 79,177   |       | $ | 75,670 |   |
| Software gross  profit, net of product development costs | ** ** | **$**       | **21,703** |     | $          | 21,334   |       | $ | 22,807 |   |
| ASP hosting gross  profit                                | ** ** | **3,530**   |       | 2,807    |       | 4,309    |       |
| Sales and  marketing                                     | ** ** | **(10,776** | **)**      | (11,781  | )          | (11,167  | )          |
| General and  administrative                              | ** ** | **(8,345**  | **)**      | (7,961   | )          | (6,523   | )          |
| Loss on lease  abandonment                               | ** ** | **(1,100**  | **)**      | 0        |       | 0        |       |
| Consolidated  operating income                           | ** ** | **$**       | **5,012**  |     | $          | 4,399    |       | $ | 9,426 |   |

 

F-23

----

**Notes to Consolidated Financial Statements (Continued)**

Revenueis attributed to the country in which the sales originated (i.e., where thelegal subsidiary is domiciled). Our two geographic areas are North America andEMEA. Long-lived assets consist of net property plant and equipment, goodwill,capitalized software development costs and other intangibles. The followingtable presents sales and long-lived asset information by geographic area as ofand for the years ended July 31 (in thousands):  

| ** **               | ** ** | **2006**   | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------|------------|------------|------------|----------|------------|----------|------------|
| Revenues:                | ** ** | ** ** |       |     |       |     |       |
| North America            | ** ** | **$**      | **81,791** |     | $          | 72,775   |       | $ | 70,673 |   |
| EMEA                     | ** ** | **6,546**  |       | 6,402    |       | 4,997    |       |
| Total revenues           | ** ** | **$**      | **88,337** |     | $          | 79,177   |       | $ | 75,670 |   |
| Long-lived assets:       | ** ** | ** ** |       |     |       |     |       |
| North America            | ** ** | **$**      | **34,534** |     | $          | 34,760   |       | $ | 26,269 |   |
| EMEA                     | ** ** | **512**    |       | 385      |       | 492      |       |
| Total long-lived  assets | ** ** | **$**      | **35,046** |     | $          | 35,145   |       | $ | 26,761 |   |

 

**Note 11—Quarterly financial information (unaudited)**

| ** **             | ** ** | **First  quarter**                                                    | ** ** | **Second  quarter** | ** ** | **Third  quarter** | ** ** | **Fourth  quarter** | ** ** |
|------------------------|------------|-----------------------------------------------------------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|
| ** **             | ** ** | **(in thousands, except per share amounts)** | ** ** |
| **2006:**              | ** ** | ** **                                                            | ** ** | ** **          | ** ** | ** **         | ** ** | ** **          | ** ** |
| Total revenues         | ** ** | **$**                                                                 | **20,818** | ** **          | **$**      | **22,424**         | ** ** | **$**               | **22,436** | ** ** | **$** | **22,659** | ** ** |
| Gross profit           | ** ** | **7,791**                                                             | ** ** | **8,929**           | ** ** | **8,712**          | ** ** | **8,765**           | ** ** |
| Operating income       | ** ** | **875**                                                               | ** ** | **1,894**           | ** ** | **1,620**          | ** ** | **623**             | ** ** |
| Net income             | ** ** | **546**                                                               | ** ** | **1,176**           | ** ** | **1,086**          | ** ** | **412**             | ** ** |
| Net income per  share: |       |                                                                  |       |                |       |               |       |                |       |
| Basic                  | ** ** | **$**                                                                 | **0.05**   | ** **          | **$**      | **0.11**           | ** ** | **$**               | **0.10**   | ** ** | **$** | **0.04** | ** ** |
| Diluted                | ** ** | **$**                                                                 | **0.05**   | ** **          | **$**      | **0.10**           | ** ** | **$**               | **0.09**   | ** ** | **$** | **0.04** | ** ** |
| 2005:                  |       |                                                                  |       |                |       |               |       |                |       |
| Total revenues         |       | $                                                                     | 19,665     |                | $          | 20,296             |       | $                   | 19,779     |   | $ | 19,437 |   |
| Gross profit           |       | 9,163                                                                 |       | 8,014               |       | 8,081              |       | 7,438               |       |
| Operating income       |       | 2,321                                                                 |       | 853                 |       | 797                |       | 428                 |       |
| Net income             |       | 1,407                                                                 |       | 496                 |       | 468                |       | 135                 |       |
| Net income per  share: |       |                                                                  |       |                |       |               |       |                |       |
| Basic                  |       | $                                                                     | 0.13       |                | $          | 0.05               |       | $                   | 0.04       |   | $ | 0.01 |   |
| Diluted                |       | $                                                                     | 0.12       |                | $          | 0.04               |       | $                   | 0.04       |   | $ | 0.01 |   |

 

**Net income per share calculationsfor each period are based on the weighted average number of shares outstandingin each period; therefore, the sum of the net income per share amounts for thequarters does not necessarily equal the year-to-date net income per shareamounts.**

F-24

----