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
(Registrant’s telephone number including area code)

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 [   ] No [ X ]

     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, 10,442,901 shares outstanding as of March 15, 2004.

Table of Contents

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

Docucorp International, Inc.
Consolidated Balance Sheets
(In thousands except share and per share amounts)
(Unaudited)

See accompanying notes to interim consolidated financial statements.

2

Docucorp International, Inc.
Interim Consolidated Statements of Operations and Comprehensive Income
(In thousands except per share amounts)
(Unaudited)

See accompanying notes to interim consolidated financial statements.

3

Docucorp International, Inc.
Interim Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)

See accompanying notes to interim consolidated financial statements.

4

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

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

The accompanying unaudited interim consolidated financial statements of Docucorp International, Inc. and its wholly owned subsidiaries (“Docucorp” or the “Company”) for the three and six month periods ended January 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, 2003. The foregoing unaudited interim consolidated financial statements reflect all adjustments (all of which are of a normal recurring nature), which are, in the opinion of management, necessary for a fair presentation of the results of the interim periods, and include the accounts of Docucorp and our wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Operating results for the three and six months ended January 31, 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 portion of the arrangement fee 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 the price a customer pays to renew its maintenance and support agreement. 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.

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

Included in accounts receivable are unbilled amounts, which 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.

Fixed assets, 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:

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

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 either Statement of Financial Accounting Standards No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed,” or with AICPA Statement of Position No. 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” For software to be sold, after the technological feasibility of the software has been established, material software development costs, which include salaries and personnel-related costs incurred in the development activities are capitalized. 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”, effective August 1, 2001, we no longer amortize goodwill, but rather test it annually for impairment. Goodwill is also reviewed for impairment at other times during each 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.

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

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

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 agreement.

Guarantees

We enter into standard indemnification agreements in our ordinary course of business. Pursuant to these agreements, we typically indemnify, hold harmless and agree to reimburse the indemnified party for those losses suffered or incurred by the indemnified party arising from any trade secrets, trademark, copyright, patent or other intellectual property infringement claim by any third party with respect to our software and services. The term of these indemnification agreements is generally perpetual any time after execution of the agreement. The maximum potential amount of future payments that we could be required to make under these indemnification agreements is unlimited; however, consequential damages are excluded. Since we have never incurred costs to defend lawsuits or settle claims related to these indemnification agreements, we believe the estimated fair value of our obligation under these agreements is minimal. Accordingly, we have no liabilities recorded for these agreements as of January 31, 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 January 31, 2004 we had no material product warranty liability, as we have historically not experienced material warranty claims. 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 year-end rates of exchange, and revenues and expenses are translated at average exchange rates prevailing during the year. 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.

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. As of July 31, 2003, the cumulative net

8

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

difference between the average Treasury Stock purchase price per share and the option exercise price of approximately $2.9 million has been reclassified from APIC 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.

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”). 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 provisions of SFAS 123, “Accounting for Stock-Based Compensation” 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 November 2003, the Compensation Committee of the Board of Directors granted 55,000 shares of restricted stock to certain executives. Based on the market value of our Common Stock, the restricted stock grant was valued at approximately $450,000. The restricted stock vests over seven years with acceleration of cumulative vesting to 25%, 50% and 100% in the first three years if specific performance

9

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

goals are attained. Compensation expense related to the restricted stock grant is being recognized ratably over the vesting period.

Net income per share

Our basic and diluted net income per share are 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. The following is a reconciliation of the shares used in computing basic and diluted net income per share for the periods indicated (in thousands):

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

Management estimates

The preparation of our financial statements, in accordance with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses at the date of the financial statements. Actual results could differ from those estimates.

Advertising costs

We expense advertising costs as incurred.

Note 2 – 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

10

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

support and maintenance of the software products. The ASP segment provides processing, print, mail, archival and Internet delivery of documents for customers who outsource these activities. The table below presents information about reported segments for the three and six months ended January 31, 2004 and 2003 (in thousands):

Note 3 – Recently issued accounting pronouncements

In December 2003, the Securities Exchange Commission (“SEC”) issued Staff Accounting Bulletin 104, “Revenue Recognition” (“SAB 104”). SAB 104 updates existing Staff Accounting Bulletin Topic 13, “Revenue Recognition” to be consistent with recently issued guidance, primarily Emerging Issues Task Force Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” The adoption of SAB 104 did not have a material impact on our consolidated financial statements.

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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, 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 is a software-driven hybrid company. We have developed core software technology that can be used as a primary competitive advantage to offer additional products and services. We are able to leverage our software applications to offer Application Service Provider (“ASP”) hosting and professional services. This business model creates significant barriers to competition, drives higher margins and generates diverse and recurring revenue streams. We continue to pursue our long-term strategy to be the leading provider of software and services that enable companies to create, publish, manage and archive complex, high-volume, individualized information.

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, 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, disaster recovery and electronic document archival.

Operating in three key markets, insurance, utilities and financial services