FORM 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934

DOCUCORP INTERNATIONAL, INC.

(214) 891-6500

Not applicable

          Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes [X]  No [  ]

          Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes [X]  No [  ]

          Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: Common Stock, $.01 par value, 10,870,503 shares outstanding as of December 2, 2004.

Docucorp International, Inc.
Table of Contents
Quarterly Report on Form 10-Q
October 31, 2004

Docucorp International, Inc.

See accompanying notes to interim consolidated financial statements.

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Docucorp International, Inc.

See accompanying notes to interim consolidated financial statements.

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Docucorp International, Inc.

See accompanying notes to interim consolidated financial statements.

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Docucorp International, Inc.

Note 1 - Basis of presentation and summary of significant accounting policies

The accompanying unaudited interim consolidated financial statements of Docucorp International, Inc. and its wholly owned subsidiaries (“Docucorp” or the “Company”) as of October 31, 2004 and July 31, 2004, and for the three months ended October 31, 2004 and 2003, have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The financial information presented should be read in conjunction with our annual consolidated financial statements for the year ended July 31, 2004. The foregoing unaudited interim consolidated financial statements reflect all adjustments (all of which are of a normal recurring nature), which are, in the opinion of management, necessary for a fair presentation of the results of the interim periods, and include the accounts of Docucorp and our wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Operating results for the three months ended October 31, 2004 are not necessarily indicative of the results to be expected for the year. Certain prior year amounts have been reclassified to conform to the current year presentation.

Revenue recognition

We derive our revenues from the sale of software licenses, annual software maintenance and support agreements, professional services and ASP hosting services. We recognize revenue in accordance with Statement of Position 97-2, “Software Revenue Recognition” and Staff Accounting Bulletin No. 104, “Revenue Recognition” (“SAB 104”). Revenue is recognized when a contract exists, the fee is fixed or determinable, delivery has occurred and collection of the receivable is deemed probable.

We use the residual method to recognize revenue from the sale of software licenses that are bundled with maintenance and support. Under the residual method, the fair value of the undelivered element(s) is deferred and the remaining value of the contract is recognized as revenue. Fair value of an element is based on vendor-specific objective evidence (“VSOE”). VSOE is based on the price charged when the same element is sold separately. We do not generally sell software licenses without selling maintenance and support for the licensed software. Therefore, we have established VSOE only for the undelivered element(s) included in a multi-element arrangement. Specifically, VSOE for maintenance and support is based upon prices customers pay to renew maintenance and support agreements. After expiration of the initial maintenance term, maintenance and support agreements are renewable on an annual basis and include rights to upgrades, when and if available, telephone support, updates, enhancements and bug fixes. Revenue generated from maintenance and support is recognized ratably over the maintenance term of the agreement. We record deferred revenue for maintenance amounts invoiced prior to the performance of the related services.

Our standard software license agreements do not provide for rights of software return and/or conditions of acceptance. However, in the rare case that acceptance criteria are provided, revenue is deferred and not recognized until all acceptance provisions are satisfied. Revenue from software licenses, which include a cancellation clause, is recognized upon expiration of the cancellation period. Revenue related to products still in the testing phase is deferred until formal acceptance of the product by the customer.

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Docucorp International, Inc.
Notes to Interim Consolidated Financial Statements (cont.)
(Unaudited)

Professional services revenue includes implementation, integration, training and consulting services related to our software products. The services offered are not essential to the functionality of the software. Professional services revenue is generally recognized as the services are performed.

Professional services revenue derived from the installation and integration of software packages under a fixed price contract is recognized on a percentage-of-completion basis measured by the relationship of hours worked to total estimated contract hours. We follow this method because reasonably dependable estimates of the revenue and contract hours applicable to various elements of a contract can be made. Since the financial reporting of these contracts depends upon estimates, which are assessed continually during the term of these contracts, recognized revenue and profit are subject to revisions as the contract progresses to completion. Revisions in profit estimates are reflected in the period in which the facts that give rise to the revisions become known. Accordingly, favorable changes in estimates result in additional revenue recognition and net income, and unfavorable changes in estimates result in a reduction of recognized revenue and net income. When estimates indicate that a loss will be incurred on a contract upon completion, a provision for the expected loss is recorded in the period in which the loss becomes evident.

Revenue from our ASP hosting operations is recognized in accordance with SAB 104, generally on a per transaction basis. ASP hosting agreements are generally one-to-five years in duration and provide for monthly billing based on transaction volume or contract minimums, if applicable. Revenue related to the customer’s initial set up and implementation is deferred and subsequently recognized over the expected term of the ASP hosting agreement.

Cash equivalents

We consider all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. Cash equivalents are stated at cost, which approximates fair market value.

Accounts receivable

Accounts receivable is composed of billed and unbilled accounts. Unbilled accounts receivable include amounts that have been recognized as revenue under the percentage-of-completion method or upon execution of the software license contract and shipment of the software, but prior to contractual payment terms.

Allowance for doubtful accounts

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

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Docucorp International, Inc.
Notes to Interim Consolidated Financial Statements (cont.)
(Unaudited)

Property and equipment, depreciation and amortization

Property and equipment are carried at cost, less accumulated depreciation and amortization. Depreciation and amortization are computed over the estimated service lives using the straight-line method. Estimated service lives are as follows:

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

Software development costs

Software development costs are accounted for in accordance with Statement of Financial Accounting Standards No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed.” The guidance above requires the capitalization of certain software development costs, which include salaries and personnel related costs incurred in the development activities, once technological feasibility of the software has been established. Research and development costs incurred prior to the establishment of the technological feasibility of a product are expensed as incurred. The cost of capitalized software is amortized on a straight-line basis over its estimated useful life, generally four to six years, or the ratio of current revenues to current and anticipated revenues from the software, whichever provides the greater amortization.

Goodwill

In accordance with Financial Accounting Standards Board Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets”, we do not amortize goodwill, but rather test it annually for impairment. Goodwill is also reviewed for impairment at other times during the year when events or changes in circumstances indicate that an impairment might be present.

Impairment of long-lived assets

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

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Docucorp International, Inc.
Notes to Interim Consolidated Financial Statements (cont.)
(Unaudited)

Deferred revenue

Deferred revenue relates primarily to maintenance and support agreements that have been invoiced to customers prior to the performance of the related services. Maintenance and support services are generally billed annually in advance for services to be performed over a 12-month period. Maintenance and support provided under an initial software license contract is recorded as deferred revenue based on the VSOE of that maintenance and is recognized over the term of the maintenance and support agreement.

Guarantees

In the ordinary course of business, we include standard indemnification provisions in our customer and distributor agreements. Pursuant to these agreements, we typically indemnify, hold harmless and reimburse the indemnified party for those losses suffered or incurred by the indemnified party arising from any trade secret, trademark, copyright, patent or other intellectual property infringement claim by any third party with respect to our software and services. The term of these indemnification agreements is generally perpetual any time after execution of the agreement. The maximum potential amount of future payments that we could be required to make under these indemnification agreements is unlimited; however, consequential damages are excluded. Since we have never incurred costs to defend lawsuits or settle claims related to these indemnification agreements, we believe the estimated fair value of our obligation under these agreements is minimal. Accordingly, we have no liabilities recorded for these agreements as of October 31, 2004.

We currently provide software product warranties to our customers. The product warranties generally provide that the licensed software shall operate substantially in accordance with the applicable user documentation for a period typically 90 days from delivery. At October 31, 2004, we had no material product warranty liability. From time to time, in order to manage our customer relationships, we incur costs outside of our product warranty program. These costs are expensed as incurred.

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

Translation of foreign currencies

We translate the financial statements of our European subsidiary into U.S. dollars in accordance with Statement of Financial Accounting Standards No. 52, “Foreign Currency Translation”. Assets and liabilities of our European subsidiary, whose functional currency is other than the U.S. dollar, are translated at period-end rates of exchange, and revenues and expenses are translated at average exchange rates prevailing during the period. Foreign currency transaction gains and losses are recognized in income as incurred.

We account for unrealized gains or losses on our foreign currency translation adjustments in accordance with Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income,” which requires the adjustments be accumulated in stockholders’ equity as part of other comprehensive income.

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Docucorp International, Inc.
Notes to Interim Consolidated Financial Statements (cont.)
(Unaudited)

Treasury stock

We account for Treasury Stock using the cost method. Gains on sales of Treasury Stock are credited to Additional Paid-in Capital (“APIC”), losses are charged to APIC to the extent that previous net gains from sales are included therein, otherwise to Retained Earnings.

Income taxes

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

Net income per share

Our basic and diluted net income per share is computed in accordance with Statement of Financial Accounting Standards No. 128, “Earnings Per Share”. Basic net income per share is computed using the weighted average number of common shares outstanding. Diluted net income per share is computed using the weighted average number of common shares outstanding and the assumed exercise of stock options and warrants and restricted stock awards, using the treasury stock method. Following is a reconciliation of the shares used in computing basic and diluted net income per share for the periods indicated (in thousands):

At October 31, 2004 and 2003, options to purchase 50,000 and 390,000 shares of Common Stock at average exercise prices of $13.50 and $8.13 per share, respectively, were anti-dilutive and not included in the computation of diluted net income per share, because the options’ exercise prices were greater than the average market price of the Common Stock for the period.

Stock-based compensation

We provide equity incentives to our employees and directors by means of non-qualified stock options and restricted stock awards issued from the 1997 Equity Compensation Plan (the “Plan”). In addition, we granted restricted stock awards outside of the Plan in connection with our recent acquisition. We account for stock-based compensation under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and related Interpretations. For the periods presented, stock-based compensation cost related to options is not reflected in net income, as all options granted under the Plan had an exercise price equal to the market value of the underlying Common Stock on the date of grant. We have implemented the disclosure-only

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Docucorp International, Inc.
Notes to Interim Consolidated Financial Statements (cont.)
(Unaudited)

provisions of SFAS 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) and SFAS 148, “Accounting for Stock-Based Compensation Transition and Disclosure.” The following table illustrates the pro forma effect on net income and net income per share as if we had applied the fair value recognition provisions of SFAS 123 (in thousands except per share amounts):

In August 2004, the Compensation Committee of the Board of Directors granted 112,500 shares of restricted stock to certain executive officers and directors. Based on the market value of our Common Stock at the date of grant, this restricted stock grant was valued at approximately $821,000. The restricted stock vests over five years with 50% and 100% acceleration of cumulative vesting in the first two years if specific performance goals are attained. The value of the restricted stock grant is being recognized as compensation expense ratably over the vesting period.

In connection with the acquisition of the assets of Newbridge Corporation, which include the capital stock of Newbridge Information Services, Inc. and Matrix Digital Technologies, Inc. (collectively (“Newbridge”), we entered into employment agreements with several key employees of Newbridge. As a part of these agreements, the Compensation Committee of our Board of Directors granted an aggregate of 175,000 shares of restricted stock to those key Newbridge employees. Based on the market value of our Common Stock at the date of acquisition, this restricted stock grant was valued at $1.4 million. The restricted shares vest over seven years with 33%, 67% and 100% acceleration of cumulative vesting in the first three years if certain financial performance goals are achieved by Newbridge. The value of the restricted stock grant is being recognized as compensation expense ratably over the vesting period.

Management estimates

The preparation of our financial statements, in accordance with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities and the

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Docucorp International, Inc.
Notes to Interim Consolidated Financial Statements (cont.)
(Unaudited)

reported amounts of revenues and expenses at the date of the financial statements. Actual results could differ from those estimates. Certain accounting policies require higher degrees of judgment than others in their application. The following accounting policies require significant estimates: accounts receivable and allowance for doubtful accounts, impairment of long-lived assets and income taxes.

Advertising costs

We expense advertising costs as incurred.

Royalty costs

We incur royalty fees associated with the licensing of certain software products. These fees vary based upon the terms of the royalty agreement.

Note 2 - Acquisition

On September 24, 2004, we acquired the assets and assumed certain liabilities of Newbridge Corporation, which include the capital stock of Newbridge Information Services, Inc. and Matrix Digital Technologies, Inc. Newbridge is a leading information services company for the health care market. Newbridge composes, produces and distributes provider directories, ID cards and policy kits, as well as provides health care provider information over the Internet. The purchase price for the Newbridge assets was approximately $2.6 million, including a 10% holdback, and was funded from cash on hand.

Operating results of Newbridge are included in the ASP hosting segment of our financial statements from the effective date of the acquisition. Our consolidated balance sheet as of October 31, 2004 reflects the preliminary allocation of the purchase price to the assets acquired and liabilities assumed at the date of acquisition. The preliminary allocation includes assets acquired of approximately $5.9 million, liabilities assumed of approximately $5.9 million and goodwill of approximately $2.6 million. Additional analysis is being performed with regards to the fair value of acquired assets and liabilities. As a result, the purchase price allocation and goodwill may be adjusted in future periods.

The acquisition is not considered material to our results of operations; therefore no pro forma information is presented.

Note 3 - Business segments

As set forth in the criteria of Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information,” we are organized into two reportable segments: Software and ASP. The Software segment consists of initial software license sales, professional services consulting derived from implementation and integration of our software products and continued customer support and maintenance of the software products. The ASP segment provides processing, print, mail, archival and Internet delivery of documents for customers who outsource these activities. The table below presents information about reported segments for the three months ended October 31, 2004 and 2003 (in thousands):

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Docucorp International, Inc.
Notes to Interim Consolidated Financial Statements (cont.)
(Unaudited)

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Certain information contained herein may include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical facts included in this Form 10-Q, are forward-looking statements. Such statements are subject to certain risks and uncertainties, which include, but are not limited to, the economy, dependence upon the insurance and utilities industries, technological advances, attraction and retention of technical employees, affect of business acquisitions, fluctuations in operating results and the other risk factors and cautionary statements listed from time to time in the Company’s periodic reports filed with the Securities and Exchange Commission. All forward-looking statements included in this Form 10-Q and all subsequent oral forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by these cautionary statements.

Overview

Docucorp International, Inc. (“Docucorp”) develops, markets and supports a portfolio of proprietary information software, application service provider (“ASP”) hosting and professional services that enables companies to create, publish, manage and archive complex, high-volume, individualized information. We support the entire information life cycle — from acquisition of the first raw data point to final delivery of personalized information to the customer.

Our software products support leading hardware platforms, operating systems, printers and imaging systems. These products are designed to personalize, produce and manage documents such as insurance policies, utility statements, telephone bills, bank and mutual fund statements, invoices, provider directories, correspondence, bills of lading and other customer-oriented documents. Our ASP offerings include customer statement and bill generation, electronic bill presentment and payment, insurance policy production, provider directory generation, disaster recovery and electronic document archival.

Operating in four key markets, insurance, utilities, financial services and health care, we currently have an installed base of more than 1,300 customers worldwide. More than half of the 200 largest United States insurance companies use our software products and services, including nine of the top 10 life and health insurance companies, nine of the top 10 property and casualty insurance companies and more than 500 managing general agents (MGAs). Many of the largest North American health care and utility companies and major international financial services institutions use our products and services.

We derive our revenues from ASP hosting fees, professional services fees, software license fees and recurring maintenance fees related to our software products. ASP hosting revenue consists of transactional fees earned from customers who outsource the production of customer statements, insurance policies and provider directories. Professional services revenue includes fees for implementation, integration, training and consulting services. Software license revenue is generally derived from perpetual licenses of software products. Maintenance revenue consists primarily of annual software maintenance and support agreements.

As set forth in the criteria of Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS 131”), we are organized into two reportable segments: Software and ASP. The Software segment consists of initial software license sales, professional services consulting derived from implementation and integration of our software products and continued customer support and maintenance of the software products. The ASP segment provides processing, print, mail, archival and Internet delivery of documents for customers who outsource these activities.

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Our operating results are strongly tied to software license revenue. Software license sales have a high margin and ultimately drive additional professional services and maintenance revenues. A large portion of our software license revenue is generated from a small number of relatively large agreements executed in the latter half of a quarter. The timing of such large agreements is often unpredictable and impacted by events beyond our control, therefore making it difficult to forecast software license revenue effectively. Due to the nature of our software license sales, revenues and profits may vary from quarter to quarter.

During the three months ended October 31, 2004, we completed the acquisition of Newbridge, a leading information services company for the health care market. Operating results of Newbridge are reflected in our ASP hosting segment from the date of acquisition, September 24, 2004. In addition to facilitating our entry into the health care market, we believe that Newbridge will contribute to our future growth and profitability.

License revenue for the three months ended October 31, 2004 increased 11% to $3.0 million primarily due to two significant license sales in the financial services market. Over the past year we have made changes to our financial services sales force and have now seen two consecutive quarters of revenue growth within this market.

For the three months ended October 31, 2004, revenues from our European subsidiary increased 31% compared to the same period of the prior year and the European operating loss was reduced. These improved results are still below our expectation, and European operations continue to be an area requiring improvement.

Going forward, business and market uncertainties may affect results. For a discussion of key factors that could impact results, please refer to the section entitled “Risk Factors” in our Annual Report on Form 10-K for the year ended July 31, 2004.

Critical Accounting Policies and Estimates

The accompanying “Management’s Discussion and Analysis of Financial Condition and Results of Operations” is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reported period. We base our estimates and assumptions on historical experiences and various other factors that are believed to be reasonable under the circumstances. These estimates and assumptions are evaluated on an ongoing basis. Actual results may differ from previously estimated amounts under different assumptions or conditions. The following critical accounting policies, which involve significant judgments and estimates, are used in the preparation of our consolidated financial statements:

Revenue recognition

We derive our revenues from the sale of software licenses, annual software maintenance and support agreements, professional services and ASP hosting services. We recognize revenue in accordance with Statement of Position 97-2, “Software Revenue Recognition”, and Staff Accounting Bulletin No. 104, “Revenue Recognition” (“SAB 104”). Revenue is recognized when a contract exists, the fee is fixed or determinable, delivery has occurred and collection of the receivable is deemed probable.

We use the residual method to recognize revenue from the sale of software licenses that are bundled with maintenance and support. Under the residual method, the fair value of the undelivered element(s) is deferred and the remaining value of the contract is recognized as revenue. Fair value of an element is based on vendor-specific objective evidence (“VSOE”). VSOE is based on the price charged when the same element is sold separately. We do not generally sell software licenses without selling maintenance

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and support for the licensed software. Therefore, we have established VSOE only for the undelivered element(s) included in a multi-element arrangement. Specifically, VSOE for maintenance and support is based upon prices customers pay to renew maintenance and support agreements. After expiration of the initial maintenance term, maintenance and support agreements are renewable on an annual basis and include rights to upgrades, when and if available, telephone support, updates, enhancements and bug fixes. Revenue generated from maintenance and support is recognized ratably over the maintenance term of the agreement. We record deferred revenue for maintenance amounts invoiced prior to the performance of the related services.

Our standard software license agreements do not provide for rights of software return and/or conditions of acceptance. However, in the rare case that acceptance criteria are provided, revenue is deferred and not recognized until all acceptance provisions are satisfied. Revenue from software licenses, which include a cancellation clause, is recognized upon expiration of the cancellation period. Revenue related to products still in the testing phase is deferred until formal acceptance of the product by the customer.

Professional services revenue includes implementation, integration, training and consulting services related to our software products. The services offered are not essential to the functionality of the software sold. Professional services revenue is generally recognized as the services are performed.

Professional services revenue derived from the installation and integration of software packages under a fixed price contract is recognized on a percentage-of-completion basis measured by the relationship of hours worked to total estimated contract hours. We follow this method because reasonably dependable estimates of the revenue and contract hours applicable to various elements of a contract can be made. Since the financial reporting of these contracts depends upon estimates, which are assessed continually during the term of these contracts, recognized revenue and profit are subject to revisions as the contract progresses to completion. Revisions in profit estimates are reflected in the period in which the facts that give rise to the revisions become known. Accordingly, favorable changes in estimates result in additional revenue recognition and net income, and unfavorable changes in estimates result in a reduction of recognized revenue and net income. When estimates indicate that a loss will be incurred on a contract upon completion, a provision for the expected loss is recorded in the period in which the loss becomes evident.

Revenue from our ASP hosting operations is recognized in accordance with SAB 104, generally on a per transaction basis. ASP hosting agreements are generally one-to-five years in duration and provide for monthly billing based on transaction volume or contract minimums, if applicable. Revenue related to the customer’s initial set up and implementation is deferred and subsequently recognized over the expected term of the ASP hosting agreement.

Allowance for doubtful accounts

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

Software development costs

Software development costs are accounted for in accordance with Statement of Financial Accounting Standards No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed.” The guidance above requires the capitalization of certain software development costs once technological feasibility is established. The capitalized costs are then amortized on a straight-line basis over the estimated product life, or on the ratio of current revenues to total projected product revenues,

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whichever provides the greater amortization. Management periodically assesses the realizability of software development costs when events and circumstances indicate a potential decline in value.

Valuation of long-lived and intangible assets and goodwill

We recognize an impairment charge associated with our long-lived assets, including property and equipment, goodwill and other intangible assets whenever we determine that recovery of such long-lived asset is not probable. Such determination is made in accordance with the applicable GAAP requirement associated with the long-lived asset, and is based upon, among other things, estimates of the amount of future net cash flows to be generated by the long-lived asset and estimates of the current fair value of the asset. Adverse changes in future net cash flows or fair value could result in the inability to recover the carrying value of the long-lived asset, thereby requiring an impairment charge to be recognized. We perform an impairment analysis in accordance with Statement of Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets,” annually and whenever events and circumstances indicate that an impairment might be present.

Deferred taxes and valuation allowance

We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of the assets and liabilities. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. It is possible that in the future we may change our estimate of the amount of the deferred income tax assets that will more likely than not be realized, which will result in an adjustment to the valuation allowance that would either increase or decrease, as applicable, reported net income in the period such change in estimate was made.

Translation of foreign currency

We translate the financial statements of our European subsidiary into U.S. dollars in accordance with Statement of Financial Accounting Standards No. 52, “Foreign Currency Translation.” Assets and liabilities of our European subsidiary, whose functional currency is other than the U.S. dollar, are translated at period-end rates of exchange, and revenues and expenses are translated at average exchange rates prevailing during the period. Foreign currency transaction gains and losses are recognized in income as incurred.

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

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Historical Operating Results

The following table sets forth selected unaudited interim consolidated statements of operations data expressed as a percentage of total revenues for the periods indicated:

Comparative analysis of quarterly results for the three months ended October 31, 2004 and 2003

Revenues

Total revenues increased 4%, or $760,000, for the three months ended October 31, 2004, due to increases in ASP hosting revenue, professional services revenue and license revenue, partially offset by a decrease in maintenance revenue. ASP hosting revenue of $6.1 million increased 5% for the three months ended October 31, 2004, primarily due to revenue generated by recently acquired Newbridge, partially offset by a decrease in revenue from existing customers. For the three months ended October 31, 2004,

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professional services revenue increased 5%, or $265,000, due primarily to an increase in revenue generated from our European operations. For the three months ended October 31, 2004, license revenue increased 11%, or $302,000, due primarily to an increase in executed software license agreements in the financial services market. Maintenance revenue of $5.2 million decreased $100,000 for the three months ended October 31, 2004, as a result of consolidation that has occurred within the insurance industry. During the last twelve months, certain legacy customers consolidated multiple license and maintenance agreements while up-grading to enterprise-wide versions of our latest technologies, resulting in less annual maintenance fees for those customers.

Cost of revenues

Cost of ASP hosting revenue. Cost of ASP hosting revenue is comprised primarily of salary and personnel related costs, facility and equipment costs and postage and supplies expense related to our ASP hosting centers. Cost of ASP hosting revenue of $5.0 million increased 8% for the three months ended October 31, 2004, primarily due to the operating expenses associated with Newbridge. For the three months ended October 31, 2004 and 2003, cost of ASP hosting revenue represented 83% and 81% of ASP hosting revenue, respectively. The increase in cost as a percentage of ASP revenue is primarily due to the decline in ASP hosting revenue from existing customers, and the currently lower margins associated with Newbridge. Cost of ASP hosting revenue is expected to increase as ASP hosting revenue increases.

Cost of professional services revenue. Cost of professional services revenue consists of costs incurred in providing implementation, integration, training and consulting services. For the three months ended October 31, 2004, cost of professional services revenue increased 2%, due primarily to a decrease in capitalization of development work performed by professional services personnel related to Policy Xpress, our new pre-packaged product offering for the insurance industry. For the three months ended October 31, 2004 and 2003, cost of professional services revenue represented 77% and 80% of professional services revenues, respectively. The decrease in costs as a percentage of professional services revenues is primarily due to improved staff utilization in our European operations. We expect cost of professional services revenue to increase as professional services revenue increases.

Cost of license revenue. Cost of license revenue includes amortization of capitalized software development costs and royalties paid to third parties. For the three months ended October 31, 2004, cost of license revenue increased 29% to $940,000, primarily due to the addition of amortization expense related to the Policy Xpress product. For the three months ended October 31, 2004 and 2003, cost of license revenue represented 32% and 27% of license revenue, respectively. We anticipate cost of license revenue to increase as amortization of capitalized development costs increase due to new products become generally available.

Cost of maintenance revenue. Cost of maintenance revenue consists of costs incurred in providing customer telephone and online support. Cost of maintenance revenue increased 10%, or $32,000, for the three months ended October 31, 2004, due primarily to an increase in salaries and personnel related costs and contract labor. For the three months ended October 31, 2004 and 2003, cost of maintenance revenue represented approximately 7% and 6% of maintenance revenue, respectively. The cost of maintenance revenue is expected to increase as salaries and personnel related costs increase due to annual merit raises and extending customer support hours to accommodate certain international customers.

Operating expenses

Product development. Product development expense consists primarily of costs associated with developing new products prior to establishing technological feasibility, enhancing existing products, testing software products and developing product documentation. For the three months ended October

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31, 2004, product development expense decreased 3% to $2.0 million, primarily due to an increase in capitalization of software development costs, partially offset by an increase in salaries and personnel related costs.

Sales and marketing. Sales and marketing expense consists primarily of salaries and personnel related costs, incentive compensation and costs associated with marketing programs. For the three months ended October 31, 2004, sales and marketing expense increased $64,000, or 2%, primarily due to an increase in salaries and personnel related costs.

General and administrative. General and administrative expense consists of costs for accounting, human resources, legal, information technology and outside legal, accounting and other services. General and administrative expense increased 15% to $1.9 million for the three months ended October 31, 2004, primarily due to costs associated with the Newbridge acquisition and an increase in outside accounting, tax and director fees.

Interest expense

For the three months ended October 31, 2004, interest expense decreased $22,000, primarily due to principal payments made on our outstanding bank debt over the past twelve months.

Other income (expense), net

Other income (expense), net decreased $28,000 for the three months ended October 31, 2004, primarily due to a decrease in gains on foreign currency of $54,000, partially offset by an increase in interest income of $26,000.

Provision for income taxes

The effective tax rate for the three months ended October 31, 2004 and 2003 was 38.5% and 41.5%, respectively. The rates differ from the federal statutory rate due primarily to losses generated by our European subsidiary, for which we do not currently recognize a tax benefit. The decrease in the effective rate from the prior year is primarily due to the improved performance of our European subsidiary.

Net income

Net income decreased 3%, or $42,000, to $1.4 million for the three months ended October 31, 2004.

Liquidity and Capital Resources

At October 31, 2004, our principal sources of liquidity consisted of cash and cash equivalents of $8.0 million and our revolving credit facility, which had available borrowings of $10 million. Cash and cash equivalents for the three months ended October 31, 2004, decreased $4.3 million from $12.3 million at July 31, 2004, primarily as a result of the Newbridge acquisition.

Cash provided by operating activities was $2.2 million and $1.5 million for the three months ended October 31, 2004 and 2003, respectively. Significant changes in assets and liabilities for the three months ended October 31, 2004 that impacted cash flow from operations include the decrease in deferred revenue and accounts payable of $1.8 million and $1.4 million, respectively, and the increase in accrued liabilities of $1.7 million.

During the three months ended October 31, 2004 and 2003, cash used in investing activities was $4.2 million and $1.8 million, respectively. For the three months ended October 31, 2004, we used $2.5 million for the purchases of Newbridge, net of cash received. Cash used for the purchase of property and equipment was $199,000 and $420,000 for the three months ended October 31, 2004 and 2003,

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respectively. Cash used in the investment of capitalized software development costs was $1.5 million and $1.4 million for the three months ended October 31, 2004 and 2003, respectively.

Cash used in financing activities was $2.3 million and $795,000 for the three months ended October 31, 2004 and 2003, respectively. Cash used in financing activities during the three months ended October 31, 2004, primarily related to principal payments made under the assumed debt obligations of Newbridge of $1.2 million, payments under our bank note of $887,000 and payments under capital lease obligations of $291,000. The $795,000 of cash used in financing activities during the three months ended October 31, 2003, related to the payments made under our bank note of $887,000 and capital lease obligations of $143,000, partially offset by proceeds received from the exercise of stock options of $235,000.

As of October 31, 2004, we held approximately 5,735,000 shares of treasury stock at an average per share cost of $5.56. Since inception of our stock repurchase program in fiscal 1999, we have repurchased approximately 9,366,000 shares of stock at an average purchase price of $5.37. Our Board of Directors believes the repurchase program is an appropriate means of increasing shareholder value.

Working capital was $5.6 million at October 31, 2004, compared with $10.7 million at July 31, 2004. The decrease in working capital of $5.1 million is primarily due to cash expenditures aggregating approximately $4.5 million to purchase Newbridge and make payments on their outstanding and past due liabilities and debt obligations.

In June 2003, we entered into a $14.2 million term note with Comerica Bank. The bank note bears interest at a fixed annual rate of 3.32% and is repayable in equal monthly installments over four years. At October 31, 2004, the outstanding balance on our bank note was $9.5 million, of which $3.6 million is due within one year.

At October 31, 2004, we had a $10.0 million revolving credit facility from Comerica Bank, which expires on August 31, 2006. The credit facility bears interest at the bank’s prime rate less 100 basis points or LIBOR rate of interest plus 150 basis points, and is collateralized by substantially all of our assets. As of October 31, 2004, there were no borrowings under this credit facility. Under our bank note and credit facility, we are required to maintain certain financial and non-financial covenants.

Our liquidity needs are expected to arise primarily from the repayment of debt, obligations under capital leases, funding the continued development, enhancement and support of our software offerings and sales and marketing costs associated with expansion in new vertical and international markets. A portion of our cash or borrowings under our revolving credit facility could be used to acquire complementary businesses or obtain the right to use complementary technologies.

Our liquidity could be negatively impacted by a decrease in demand for our products, which are subject to rapid technology changes, reduction in capital expenditures by our customers and intense competition, among other factors. Operating leases and purchase obligations related to services agreements are our only off balance sheet arrangements.

We currently anticipate that existing cash and cash equivalents, together with cash generated from operations and available borrowings under our credit facility, will be sufficient to satisfy our operating cash needs for the foreseeable future.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

We have no derivative financial instruments. We invest our cash and cash equivalents in investment grade, highly liquid investments, consisting of money market instruments and commercial paper. We have a fixed rate debt instrument of $9.5 million as of October 31, 2004.

We are exposed to market risk arising from changes in foreign currency exchange rates as a result of selling our products and services outside the U.S. (principally Europe). A portion of our sales generated from our non-U.S. operations are denominated in currencies other than the U.S. dollar, principally British pounds. Consequently, the translated U.S. dollar value of Docucorp’s non-U.S. sales, operating results and cash flows are subject to currency exchange rate fluctuations, which may favorably or unfavorably impact reported earnings and may affect comparability of period-to-period operating results.

For the three months ended October 31, 2004 and 2003, 7% and 5%, respectively, of our revenues were denominated in British pounds. For both the three months ended October 31, 2004 and 2003, 13% of our operating expenses were denominated in British pounds. Historically, transactional gains and losses from the effect of fluctuations in currency exchange rates has not had a material impact on our operations; however, there can be no guarantees that it will not have a material impact in the future. The exposure to fluctuations in currency exchange rates will increase as we expand our operations outside the U.S.

Item 4. Controls and Procedures

Our management, with participation of our President and Chief Executive Officer and Senior Vice President, Finance and Administration (“Principal Financial Officer”) evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 12a-15(e) of the Securities Exchange Act of 1934) as of the end of the period covered by this report.

The evaluation included the subsidiary, Newbridge, which we acquired on September 24, 2004. Since the acquisition of Newbridge, we have focused on analyzing and implementing changes in their procedures and controls to determine their effectiveness and to make them consistent with, and integrate them into, our disclosure controls and procedures. We continue to analyze Newbridge’s procedures and controls and expect to make additional changes in those procedures and controls in the future. We performed additional procedures to review Newbridge’s accounting records and substantiate the financial information of Newbridge included in this report.

Based upon that evaluation, the President and Chief Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures, as of October 31, 2004, were designed and are functioning effectively to provide reasonable assurance that the information required to be disclosed by Docucorp in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. There were no significant changes in our internal controls or in other factors that could significantly affect these controls that occurred during the period covered by this report. However, we are continuing to analyze, and expect to make changes in, the controls and procedures in place at Newbridge, our recently acquired subsidiary.

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PART II - OTHER INFORMATION

Item 1. Legal Proceedings

We are occasionally involved in legal proceedings and other claims arising out of our operations in the normal course of business. No such claims are expected, individually or in the aggregate, to have a material adverse effect on our consolidated financial statements.

Item 6. Exhibits and Reports on Form 8-K

(a)

Exhibits

	31.1		- Certification pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.
	31.2		- Certification pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934.
	32.1		- Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002.
	32.2		- Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes - Oxley Act of 2002.

(b)

Reports on Form 8-K.

On September 7, 2004, the Company filed a Current Report on Form 8-K announcing its results of operations for the year ended July 31, 2004.

On September 27, 2004, the Company filed a Current Report on Form 8-K announcing the material definitive agreement to acquire the assets of Newbridge Corporation.

On October 8, 2004, the Company filed a Current Report on Form 8-K announcing the execution of the Third Amendment to Credit Agreement with Comerica Bank.

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SIGNATURES

          Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

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