FORM 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

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


For Quarter Ended: April 30, 2006		Commission File Number: 000-23829

DOCUCORP INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)


Delaware		75-2690838

(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer identification number)


5400 LBJ Freeway, Suite 300, Dallas, Texas		75240

(Address of principal executive offices)		(Zip Code)

(214) 891-6500

(Registrant’s telephone number including area code)

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Large accelerated filer o Accelerated filer þ Non-accelerated filer o

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: Common Stock, $.01 par value, 11,373,785 shares outstanding as of June 5, 2006.

Docucorp International, Inc.
Table of Contents
Quarterly Report on Form 10-Q
April 30, 2006


		Page
PART I — FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)

	Consolidated Balance Sheets as of April 30, 2006 and July 31, 2005	2

	Interim Consolidated Statements of Operations and Comprehensive Income for the three and nine months ended April 30, 2006 and 2005	3

	Interim Consolidated Statements of Cash Flows for the nine months ended April 30, 2006 and 2005	4

	Notes to Interim Consolidated Financial Statements	5

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	24

Item 4.	Controls and Procedures	25

PART II — OTHER INFORMATION

Item 1.	Legal Proceedings	26

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	26

Item 6.	Exhibits	26

Signatures		27
Employment Agreement
Certification Pursuant to Rule 13a-14(a)
Certification Pursuant to Rule 13a-14(a)
Certification Pursuant to 18 U.S.C. Section 1350
Certification Pursuant to 18 U.S.C. Section 1350

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


	April 30,			July 31,
	2006			2005
Assets
Current assets:
Cash and cash equivalents	$	9,915		$	8,381
Accounts receivable, net of allowance of $428 and $293, respectively		17,386			17,132
Current portion of deferred taxes		170			170
Income tax receivable		248			248
Other current assets		2,898			2,559

Total current assets		30,617			28,490

Property and equipment, net of accumulated depreciation of $23,142 and $20,122, respectively		9,208			10,261
Software development costs, net of accumulated amortization of $29,051 and $25,909, respectively		14,225			13,687
Goodwill		9,842			9,842
Identifiable intangibles, net of accumulated amortization of $248 and $113, respectively		772			907
Other assets		446			448

Total assets	$	65,110		$	63,635


Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	3,152		$	2,423
Accrued liabilities:
Accrued compensation		3,671			3,067
Other		1,354			1,491
Income taxes payable		65			403
Current portion of lease obligations		1,542			1,459
Current portion of long-term debt		3,619			3,617
Deferred revenue		12,193			11,479

Total current liabilities		25,596			23,939

Deferred taxes		5,459			5,178
Long-term lease obligations		1,227			2,303
Long-term debt		747			3,462
Other long-term liabilities		1,467			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		46,006			48,035
Treasury stock at cost, 5,290,557 and 5,458,912 shares, respectively		(29,574	)		(30,347	)
Retained earnings		14,536			12,268
Unearned compensation		0			(2,100	)
Foreign currency translation adjustment		(520	)		(493	)

Total stockholders’ equity		30,614			27,529

Total liabilities and stockholders’ equity	$	65,110		$	63,635

See accompanying notes to interim consolidated financial statements.

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


	Three months ended						Nine months ended
	April 30,						April 30,
	2006			2005			2006			2005
Revenues
ASP hosting	$	8,388		$	6,559		$	25,343		$	20,150
Professional services		5,902			5,246			16,735			16,227
License		2,761			2,756			7,287			7,427
Maintenance		5,385			5,218			16,312			15,935

Total revenues		22,436			19,779			65,677			59,739


Cost of revenues
ASP hosting		7,485			6,092			22,591			17,858
Professional services		4,726			4,169			13,114			12,502
License		1,184			1,044			3,511			3,002
Maintenance		329			393			1,029			1,120

Total cost of revenues		13,724			11,698			40,245			34,482


Gross profit		8,712			8,081			25,432			25,257


Operating expenses
Product development		2,284			2,180			6,784			6,404
Sales and marketing		2,700			3,040			7,986			8,817
General and administrative		2,108			2,064			6,273			6,065

Total operating expenses		7,092			7,284			21,043			21,286


Income from operations		1,620			797			4,389			3,971

Interest expense		(84	)		(118	)		(295	)		(442	)
Other income, net		188			82			365			326


Income before income taxes		1,724			761			4,459			3,855
Provision for income taxes		638			293			1,650			1,484


Net income	$	1,086		$	468		$	2,809		$	2,371


Other comprehensive income:
Foreign currency translation adjustment, net of tax		(27	)		(7	)		(27	)		(63	)

Comprehensive income	$	1,059		$	461		$	2,782		$	2,308


Basic net income per share	$	0.10		$	0.04		$	0.26		$	0.22


Weighted average basic shares outstanding		10,856			10,741			10,910			10,609


Diluted net income per share	$	0.09		$	0.04		$	0.24		$	0.21


Weighted average diluted shares outstanding		11,501			11,621			11,504			11,561

See accompanying notes to interim consolidated financial statements.

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


	Nine months ended
	April 30,
	2006			2005
Cash flows from operating activities
Net income	$	2,809		$	2,371
Adjustments to reconcile net income to net cash provided by operating activities:
Stock-based compensation expense		510			252
Depreciation and amortization		3,193			3,046
Amortization of capitalized software		3,142			2,786
Gain on foreign currency		(108	)		(144	)
Provision for doubtful accounts		122			260
Deferred income taxes		260			0
Tax benefit related to stock option exercises		(620	)		432
Changes in assets and liabilities:
Increase in accounts receivable		(284	)		(88	)
(Increase) decrease in other assets		(323	)		77
Increase (decrease) in accounts payable		718			(960	)
Increase (decrease) in accrued liabilities		443			(228	)
Increase (decrease) in income taxes payable		282			1,031
Increase (decrease) in deferred revenue		682			(867	)
Increase (decrease) in other liabilities		240			(124	)

Total adjustments		8,257			5,473

Net cash provided by operating activities		11,066			7,844


Cash flows from investing activities
Purchase of Newbridge		0			(2,482	)
Proceeds from the sale of property and equipment		70			0
Purchase of property and equipment		(2,066	)		(1,908	)
Capitalized software development costs		(3,680	)		(3,987	)

Net cash used in investing activities		(5,676	)		(8,377	)


Cash flows from financing activities
Principal payments under capital lease obligations		(993	)		(947	)
Principal payments under debt obligations		(2,713	)		(3,873	)
Purchase of treasury stock		(2,357	)		0
Tax benefit related to stock option exercises		620			0
Proceeds from exercise of stock options		1,496			871
Proceeds from stock issued under Employee Stock Purchase Plan		51			102

Net cash used in financing activities		(3,896	)		(3,847	)


Effect of exchange rates on cash flows		40			15


Net increase (decrease) in cash and cash equivalents		1,534			(4,365	)
Cash and cash equivalents at beginning of period		8,381			12,336

Cash and cash equivalents at end of period	$	9,915		$	7,971

See accompanying notes to interim consolidated financial statements.

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

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

The accompanying unaudited interim consolidated financial statements of Docucorp International, Inc. and its wholly owned subsidiaries (“Docucorp” or the “Company”) as of April 30, 2006 and July 31, 2005, and for the three and nine months ended April 30, 2006 and 2005, have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The financial information presented should be read in conjunction with our annual consolidated financial statements for the year ended July 31, 2005. 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 intercompany accounts and transactions have been eliminated in consolidation. Operating results for the three and nine months ended April 30, 2006 are not necessarily indicative of the results to be expected for the year.

Revenue recognition

We derive our revenues from the sale of software licenses, annual software maintenance and support agreements, professional services and application service provider (“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. As a result, we have established VSOE only for the undelivered element(s) included in a multi-element arrangement. 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 unspecified upgrades, updates and enhancements on a when and if available basis, as well as telephone support and bug fixes. Revenue generated from maintenance and support is recognized ratably over the maintenance term of the agreement. We record deferred revenue for maintenance amounts invoiced prior to the performance of the related services.

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

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

Professional services revenue includes implementation, integration, training and consulting services relating to new software license sales and consulting with existing customers to provide additional services. For new software license sales that are sold with installation services, the residual method is applied, whereby the fair value of the services element is deferred along with the fair value of the maintenance and support, with the residual value of the contract recognized as license revenue. The services offered are not essential to the functionality of the software. Professional services revenue is generally billed on a time and material basis and is 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. 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 receivable. Unbilled accounts receivable includes amounts recognized as revenue, primarily software license, for which the payments are not yet due and therefore, have not yet been billed.

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.

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. Software developed for internal use is accounted for in accordance with AICPA Statement of Position No. 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” Depreciation and amortization are computed over the estimated service lives using the straight-line method. Estimated service lives are as follows:


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

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

Software development costs

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

Business combinations and goodwill and intangible assets

Upon acquisition of a business, we allocate the purchase price to tangible assets and liabilities acquired and identifiable intangible assets. Any residual purchase price is recorded as goodwill. The allocation of the purchase price requires management to make significant estimates in determining the fair values of assets acquired and liabilities assumed, especially with respect to intangible assets. These estimates are based on historical experience and information obtained from valuation specialists and the management of the acquired company. These estimates can include, but are not limited to, appraisals by valuation specialists, the cash flows that an asset is expected to generate in the future and the appropriate weighted average cost of capital. Estimates used in determining the fair value of assets acquired and liabilities assumed are inherently uncertain and unpredictable. Unanticipated events and circumstances may occur which may affect the accuracy or validity of such estimates.

In accordance with Financial Accounting Standards Board Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” we assess the impairment of goodwill within our

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

reportable units annually or more often if events or changes in circumstances indicate that the carrying value may not be recoverable. As of April 30, 2006, we have completed our annual impairment analysis and determined no goodwill impairment exists. We assess the impairment of identifiable intangible assets whenever events or changes in circumstances indicate that its carrying amount may not be recoverable.

Impairment of long-lived assets

We have evaluated our long-lived assets for impairment, and will continue to do so as events or changes in circumstances indicate that the carrying value of such assets may not be fully recoverable. If facts or 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 and support provided under an initial software license contract is recorded as deferred revenue based on the VSOE of that maintenance, and is recognized over the term of the associated agreement.

Guarantees

In the ordinary course of business, we include standard indemnification provisions in our customer and distributor agreements. Pursuant to these agreements, we typically indemnify, hold harmless and reimburse the indemnified party for those losses suffered or incurred by the indemnified party arising from any trade secret, trademark, copyright, patent or other intellectual property infringement claim by any third party with respect to our software and services. The term of these indemnification agreements is generally perpetual upon 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 generally excluded. Since we have never incurred costs to defend lawsuits or settle claims related to these indemnification agreements, we believe the estimated fair value of our obligation under these agreements is minimal. Accordingly, we have no liabilities recorded for these agreements as of April 30, 2006.

We currently provide software product warranties to our customers. The product warranties generally provide that the licensed software shall operate substantially in accordance with the applicable user documentation for a period typically 90 days from delivery. At April 30, 2006, we had no material product warranty liability.

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.

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

Translation of foreign currencies

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

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

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 gains from sales are included therein, otherwise to Retained Earnings.

On February 14, 2006, we repurchased 392,841 shares of our Common Stock in a private transaction. The purchase price was $6.00 per share and was funded with available cash on hand. The purchase represented approximately 3.5% of our outstanding common stock on February 14, 2006. Since inception of our stock repurchase program in fiscal 1999, we have repurchased approximately 9,759,000 shares of stock at an average purchase price of $5.39. Our Board of Directors believes the repurchase program is an appropriate means of increasing shareholder value.

Income taxes

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

Net income per share

Our basic and diluted net income per share is computed in accordance with Statement of Financial Accounting Standards No. 128, “Earnings Per Share.” Basic net income per share is computed using the weighted average number of common shares outstanding. Diluted net income per share is computed using the weighted average number of common shares outstanding and the assumed exercise of stock options and unvested restricted stock awards, using the treasury stock method. The treasury stock method recognizes the use of proceeds that could be obtained upon exercise of options and the assumed proceeds on unvested restricted stock in computing diluted net income per share. It assumes that any proceeds would be used to purchase common stock at the average market price during the period. Options and unvested restricted stock have a dilutive effect under the treasury stock method only when the average market price of common stock during the period exceeds the exercise price of the options or calculated

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

exercise price of the unvested restricted stock. Following is a reconciliation of the shares used in computing basic and diluted net income per share for the periods indicated (in thousands):

Three months ended

Nine months ended

April 30,

2006

2005

2006

2005

Shares used in computing basic net income per share

10,856

10,741

10,910

10,609

Dilutive effect of stock options and unvested restricted stock

645

880

594

952

Shares used in computing diluted net income per share

11,501

11,621

11,504

11,561

At April 30, 2006 and 2005, options to purchase 50,000 shares of Common Stock at average exercise prices of $13.50 per share were anti-dilutive and not included in the computation of diluted net income per share, because the stock options’ exercise prices were greater than the average market price of the Common Stock for the period.

Stock-based compensation

In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (“SFAS 123R”). SFAS 123R requires employee stock-based compensation awards to be accounted for under the fair value method and eliminates the ability to account for these instruments under the intrinsic value method prescribed by APB 25. SFAS 123R is effective for fiscal periods beginning after June 15, 2005. We adopted SFAS 123R on a modified prospective basis beginning August 1, 2005 for stock-based compensation awards granted after that date or for unvested awards outstanding at that date. For the nine months ended April 30, 2006, no stock-based compensation expense related to stock options was recorded with the adoption of SFAS 123R, since all outstanding stock options were fully vested at July 31, 2005 and no stock options have been granted during fiscal 2006. Stock-based compensation expense of $510,000 and $252,000 for the nine months ended April 30, 2006 and 2005, respectively, relates to restricted stock grants. Tax benefits from stock option exercises of $620,000 for the nine months ended April 30, 2006 were reflected as an outflow from operating activities and an inflow from financing activities in the Consolidated Statement of Cash Flows. In the comparable prior year period, the tax benefits from stock option exercises of $432,000 were reflected as a cash inflow to cash provided by operating activities.

Prior to August 1, 2005, we accounted 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 periods prior to August 1, 2005, 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. 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):

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


	Three months ended			Nine months ended
	April 30, 2005			April 30, 2005
Net income as reported	$	468		$	2,371
Less, stock-based compensation expense under fair value based methods, net of tax benefit of $120 and $358, respectively		(191	)		(573	)

Pro forma net income	$	277		$	1,798


Net income per share:
As reported
Basic	$	0.04		$	0.22

Diluted	$	0.04		$	0.21

Pro forma
Basic	$	0.03		$	0.17

Diluted	$	0.02		$	0.16

In August 2005, the Compensation Committee of the Board of Directors granted 108,500 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 $758,000. The restricted stock vests ratably over five years. The value of the restricted stock grant is being recognized as compensation expense ratably over the vesting period.

Management estimates

The preparation of our financial statements, in accordance with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses at the date of the financial statements. On an ongoing basis, management evaluates its estimates and judgments. Actual results could differ from those estimates. Certain accounting policies require higher degrees of judgment than others in their application. The following accounting policies require significant estimates: revenue recognition, accounts receivable and allowance for doubtful accounts, fair value of acquired intangible assets and goodwill, impairment of long-lived assets, software development costs and income taxes.

Advertising costs

We expense advertising costs as incurred.

Royalty costs

We incur royalty costs associated with the licensing of certain software products. These fees vary based upon the terms of the royalty agreement. Royalty expense is recognized in the same period that the revenue is earned for the sale of the associated products, or ratably over the term of the royalty fee.

Recently issued accounting guidance

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

the period ended April 30, 2006, we are continuing to evaluate the deduction for certain manufacturing activities, which may impact our future consolidated financial statements. The reduction in tax associated with repatriated foreign earnings will not have an impact on our future consolidated financial statements.

Statement of Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections” (“SFAS 154”), which replaces Accounting Principals Board Opinions No. 20 “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements — An Amendment of APB Opinion No. 28,” was issued in May 2005. SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. Specifically, this statement requires “retrospective application” of the direct effect for a voluntary change in accounting principle to prior periods’ financial statements, if it is practicable to do so. SFAS 154 also strictly redefines the term “restatement” to mean the correction of an error by revising previously issued financial statements. SFAS 154 replaces APB No. 20, which requires that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. Unless adopted early, SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.

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 hosting. The Software segment consists of software license sales, professional services consulting related to our software products and continued customer support and maintenance of the software products. The ASP hosting segment provides processing, print, mail, archival and Internet delivery of documents for customers who outsource these activities. The table below presents information about reported segments for the three and nine months ended April 30, 2006 and 2005 (in thousands):


	Three months ended						Nine months ended
	April 30,						April 30,
	2006			2005			2006			2005
Revenues:
Software	$	14,048		$	13,220		$	40,334		$	39,589
ASP hosting		8,388			6,559			25,343			20,150

Total revenues	$	22,436		$	19,779		$	65,677		$	59,739


Software gross profit, net of product development costs	$	5,525		$	5,434		$	15,896		$	16,561
ASP hosting gross profit		903			467			2,752			2,292
Sales and marketing		(2,700	)		(3,040	)		(7,986	)		(8,817	)
General and administrative		(2,108	)		(2,064	)		(6,273	)		(6,065	)

Total operating income	$	1,620		$	797		$	4,389		$	3,971

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

Note 3 — Commitments and contingencies

During fiscal 2005, the Internal Revenue Service (“IRS”) completed its examination of the tax year ended July 31, 2002 and issued a notice of proposed adjustment for transfer pricing issues impacting intercompany interest and royalty income. In October 2005, the IRS also completed its examination of our tax year ended July 31, 2000 and issued a notice of proposed adjustment for the 2000 tax year based on similar issues identified for 2002. These proposed adjustments could increase our U.S. taxable income for tax years 2002 and 2000. With respect to the tax years under audit, the potential exposure ranges between $0 and $448,000, excluding interest and penalties. We vigorously disagree with the proposed adjustments and are aggressively contesting these matters through applicable IRS and judicial processes, as appropriate. We have filed a written protest to these proposed adjustments, thereby requesting an appeals conference with the IRS Office of Appeals. As of April 30, 2006, we concluded that the potential loss was not probable and no amounts have been provided for these items in the accompanying financial statements.

Assurance cannot be given that these tax matters will be resolved in our favor in view of the inherent uncertainties involved in settlement initiatives and tax proceedings. Further, an unfavorable settlement may result in additional exposure for other open tax years. An unfavorable resolution of these tax matters may also have a material adverse impact on our consolidated financial position and results of operations.


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, effect of business acquisitions, fluctuations in operating results and the other risk factors and cautionary statements included 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 Customer Communication Management (CCM) solutions via a portfolio of proprietary information software, application service provider hosting (“ASP”) and professional services that enable companies to create, publish, manage and archive complex, high-volume, individualized information. We support the entire information lifecycle — 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, health care provider directories, correspondence, bills of lading and other customer-oriented documents. Our ASP hosting offerings include customer statement and bill generation, electronic bill presentment and payment, insurance policy production, health care 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 600 managing general agents. Many of the largest North American health care and utility companies, as well as 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 production of customer statements, insurance policies, utility statements, health care provider directories, disaster recovery and electronic document archival. Professional services revenue includes fees for implementation, integration, training and consulting services. Software license revenue is generally derived from the sale of perpetual licenses of software products. Maintenance revenue consists primarily of annual software maintenance and support agreements.

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

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.

We have continued to focus on improving profitability during fiscal 2006. We have achieved improvements in revenues and operating results during the first nine months of fiscal 2006 when compared to the same period during fiscal 2005. Our revenues have grown by 10% and our net income has improved 18% during this time period. Much of this improvement is associated with the 26% increase in revenues and 20% improvement in gross margin generated by our ASP hosting business and from a 2% increase in revenues and 3% increase in margin from our maintenance activity. Also, during the first nine months of the current fiscal year, we have been able to generally maintain our license revenues while reducing our sales and marketing expense by 9% when compared to the same period of the prior year. In addition, we held our bi-annual user conference, Docugroup, during the quarter ending April 30, 2006. The cost of hosting Docugroup reduced earnings per diluted share by $.02 in the current year and reduced our professional services margin percentage on professional services revenue for the nine months of fiscal 2006 from 24% to 22% compared to 23% achieved during the comparable period of the prior year. We will continue to direct our efforts to improving profitability and increasing revenues; however, there can be no assurance that our recent results are indicative of future performance.

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, 2005.

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 periods. 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 made 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.

and support for the licensed software. As a result, we have established VSOE only for the undelivered element(s) included in a multi-element arrangement. 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 unspecified upgrades, updates and enhancements on a when and if available basis, as well as telephone support 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.

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.

Software development costs

Software development costs are accounted for in accordance with Statement of Financial Accounting Standards No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed” (“SFAS 86”). SFAS 86 requires the capitalization of certain software development costs once technological feasibility is established. The capitalized costs are then amortized on a straight-line basis over the estimated product life, or on the ratio of current revenues to total projected product revenues, whichever provides the greater amortization. Management periodically assesses the realizability of software development costs when events and circumstances indicate a potential decline in value.

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.

Business combinations

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 assets 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, during the third fiscal quarter, and whenever events and circumstances indicate that impairment might be present. During the current quarter, we performed our annual impairment analysis for our existing goodwill by utilizing various assumptions and factors to estimate future cash flows to determine the fair value of the applicable business. We determined from our analysis that no impairment exists; however, if our estimates of cash flow or other factors adversely change, an impairment charge might be recorded in the future.

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

Historical Operating Results

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


	Three months ended						Nine months ended
	April 30,						April 30,
	2006			2005			2006			2005
Revenues
ASP hosting		38	%		33	%		39	%		34	%
Professional services		26			27			25			27
License		12			14			11			12
Maintenance		24			26			25			27

Total revenues		100			100			100			100


Cost of revenues
ASP hosting		33			31			34			30
Professional services		21			21			20			21
License		5			5			5			5
Maintenance		2			2			2			2

Total cost of revenues		61			59			61			58


Gross Profit		39			41			39			42


Operating expenses
Product development		10			11			10			10
Sales and marketing		12			15			12			15
General and administrative		10			11			10			10

Total operating expenses		32			37			32			35


Operating income		7			4			7			7
Interest expense		0			(1	)		(1	)		(1	)
Other income, net		1			1			1			0


Income before income taxes		8			4			7			6
Provision for income taxes		3			2			3			2


Net income		5	%		2	%		4	%		4	%

Comparative analysis of results for the three and nine months ended April 30, 2006 and 2005

Revenues

The following table summarizes revenues (in thousands) and the percent change over the same period of the prior year:


	Three months ended							Nine months ended
	April 30,							April 30,
	2006		2005		% change			2006		2005		% change
ASP hosting	$	8,388	$	6,559		28	%	$	25,343	$	20,150		26	%
Professional services		5,902		5,246		13			16,735		16,227		3
License		2,761		2,756		0			7,287		7,427		(2	)
Maintenance		5,385		5,218		3			16,312		15,935		2

Total revenues	$	22,436	$	19,779		13	%	$	65,677	$	59,739		10	%

Total revenues increased 13% and 10% for the three and nine months ended April 30, 2006, respectively, primarily due to the increase in ASP revenue. ASP revenue increased 28% and 26% for the three and nine months ended April 30, 2006, respectively. The addition of the Capgemini contract during the fourth quarter of fiscal 2005 accounted for 30% and 33%, respectively, of these ASP increases. Further, an existing utility customer expanded its business processing which represented 37% and 36% of the increase in the ASP revenue for the three and nine months ended April 30, 2006, respectively. Professional services revenue increased 13% and 3% for the three and nine months ended April 30, 2006. For the increase in professional services revenue during the three and nine months ended April 30, 2006, 70% and 67%, respectively, of this increase was attributed to an increase in billable work performed and 25% of the three month increase and 33% of the nine month increase was attributed to attendee fees from our bi-annual Docugroup conference that was held in March of 2006. Maintenance revenue also contributed to the growth in revenues, increasing 3% and 2%, for the three and nine months ended April 30, 2006, respectively. License revenue was unchanged for the three months ended April 30, 2006, while on a year-to-date basis; license revenue decreased 2% when compared to the same period of the prior year.

Cost of revenues

The following table summarizes cost of revenues (in thousands) and the percent change over the same period of the prior year:


	Three months ended							Nine months ended
	April 30,							April 30,
	2006		2005		% change			2006		2005		% change
ASP hosting	$	7,485	$	6,092		23	%	$	22,591	$	17,858		27	%
Professional services		4,726		4,169		13			13,114		12,502		5
License		1,184		1,044		13			3,511		3,002		17
Maintenance		329		393		(16	)		1,029		1,120		(8	)

Total cost of revenues	$	13,724	$	11,698		17	%	$	40,245	$	34,482		17	%

Cost of ASP hosting revenue. Cost of ASP revenue is comprised primarily of salary and personnel related costs, facility and equipment costs and postage and supplies expense related to our ASP centers. The increase in cost for the three and nine months ended April 30, 2006 was primarily due to an increase in variable costs associated with the increase in ASP revenue. For the three months ended April 30, 2006 and 2005, cost of ASP revenue represented 89% and 93% of ASP revenue, respectively. This decrease in

cost as a percentage of ASP revenue was primarily due to increased ASP revenue. For both the nine months ended April 30, 2006 and 2005, cost of ASP revenue represented 89% of ASP revenue. For the nine month period, ASP revenues improved 26% despite a 5% decline in ASP revenue caused by the loss of a customer that was acquired by a company with print facilities of their own during fiscal 2004 that resulted in the roll off of certain higher margin accounts. The loss of these higher margin accounts offset the incremental profits associated with the increased ASP revenue, resulting in cost of ASP revenue as a percentage of ASP revenue remaining unchanged. The increase in hosting expense during the current year was caused by a 51% increase in postage and supplies cost and a 17% increase in compensation related costs largely attributed to the September 24, 2004 acquisition of Newbridge. The variable components of cost of ASP revenue are expected to increase as ASP revenue increases.

Cost of professional services revenue. Cost of professional services revenue consists of costs incurred in providing implementation, integration, training and consulting services. Cost of professional services revenue increased 13% and 5% for the three and nine months ended April 30, 2006, respectively, when compared with the comparable periods of the prior fiscal year. For the three months ended April 30, 2006 and 2005, cost of professional services revenue represented 80% and 79% of professional services revenue, respectively. For the nine months ended April 30, 2006 and 2005, cost of professional services revenue represented 78% and 77% of professional services revenue, respectively. These increases during the three and nine months ended April 30, 2006, in costs as a percentage of professional services revenue were primarily due to the impact of our bi-annual Docugroup conference that was held in March 2006. If fees and expenses associated with the bi-annual Docugroup conference were excluded from revenue and cost of professional services, our professional services cost as a percentage of professional services would be 75% for the three months ended April 30, 2006, and 76% for the nine months ended April 30, 2006. The improvement in cost as a percentage of professional services revenue, excluding Docugroup, was primarily attributed to improved staff utilization in the current year. We expect cost of professional services revenue to increase as professional services activities and revenue increase.

Cost of license revenue. Cost of license revenue includes amortization of capitalized software development costs and royalties paid to third parties. For the three and nine months ended April 30, 2006, cost of license revenue increased 13% and 17%, respectively, when compared to the comparable periods of the prior fiscal year. The increase in the current quarter is primarily caused by an increase in royalty costs associated with increased license revenue from the new Forms Integrity Manager product that was made available in the current year. The increase for the nine month period is primarily due to additional amortization expense related to new products introduced to the marketplace during the last twelve months. For the three months ended April 30, 2006 and 2005, cost of license revenue represented 43% and 38% of license revenue, respectively. This increase in costs as a percentage of license revenue was primarily due to the increase in royalty expense for sales of the Forms Integrity Manager product during the current quarter. For the nine months ended April 30, 2006 and 2005, cost of license revenue represented 48% and 40% of license revenue, respectively. This increase in costs as a percentage of license revenue was primarily due to a 13% increase in amortization expense and a 72% increase in royalties paid to third parties. We anticipate cost of license revenue to increase as amortization of capitalized development costs increases as new products become generally available and as sales of products with associated royalties increase.

Cost of maintenance revenue. Cost of maintenance revenue consists of costs incurred in providing customer telephone and online support. Cost of maintenance revenue decreased 16% or $64,000, and 8% or $91,000, for the three and nine months ended April 30, 2006 and 2005, respectively. For the three months ended April 30, 2006 and 2005, cost of maintenance revenue represented 6% and 8%, respectively, of maintenance revenue. For the nine months ended April 30, 2006 and 2005, cost of maintenance revenue represented 6% and 7%, respectively, of maintenance revenue. 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

The following table summarizes operating expenses (in thousands) and the percent change over the same period of the prior year:


	Three months ended							Nine months ended
	April 30,							April 30,
	2006		2005		% change			2006		2005		% change
Product development	$	2,284	$	2,180		5	%	$	6,784	$	6,404		6	%
Sales and marketing		2,700		3,040		(11	)		7,986		8,817		(9	)
General and administrative		2,108		2,064		2			6,273		6,065		3

Total operating expenses	$	7,092	$	7,284		(3	)%	$	21,043	$	21,286		(1	)%

Product development. Product development expense consists primarily of costs associated with developing new products prior to establishing technological feasibility, enhancing existing products, testing software products and developing product documentation. Product development expenses increased 5% and 6% for the three and nine months ended April 30, 2006, respectively, as compared to the comparable periods of the prior fiscal year, primarily due to an increase in incentive compensation.

Sales and marketing. Sales and marketing expense consists primarily of salaries and personnel related costs, incentive compensation and costs associated with marketing programs. For the three and nine months ended April 30, 2006, sales and marketing expense decreased 11% and 9%, respectively, as compared to the comparable periods of the prior fiscal year, primarily due to a decrease in salaries and personnel related costs as a result of a reduction in staffing levels within our sales organization.

General and administrative. General and administrative expense consists primarily of costs for accounting, human resources, legal, information technology and outside legal, accounting and other services. General and administrative expense increased 2% and 3% for the three and nine months ended April 30, 2006, respectively, mainly due to an increase in management incentive compensation.

Interest expense

Interest expense consists of interest incurred on our term note and capital leases. For the three and nine months ended April 30, 2006, interest expense decreased $34,000, and $147,000, respectively, due to lower debt balances resulting from scheduled payments over the last twelve months.

Other income, net

Other income, net consists primarily of interest income and foreign exchange rate gains or losses. Other income, net increased $106,000 for the three months ended April 30, 2006, versus the three months ended April 30, 2005, primarily due to fluctuations in the foreign exchange rate. Other income, net increased $39,000 for the nine months ended April 30, 2006, versus the nine months ended April 30, 2005, primarily due to increased interest income caused by increased interest rates in the current year.

Provision for income taxes

The effective tax rate for both the three and nine months ended April 30, 2006 and 2005 was 37% and 38.5%, respectively. For the current year, the rate differs from the federal statutory rate due primarily to the state tax accrual rate and certain recurring permanent differences. We expect our effective rate for fiscal 2006 to be consistent with the annual effective rate for fiscal 2005.

intercompany interest and royalty income. In October 2005, the IRS also completed its examination of our tax year ended July 31, 2000 and issued a notice of proposed adjustment for the 2000 tax year based on similar issues identified for 2002. These proposed adjustments could increase our U.S. taxable income for tax years 2002 and 2000. With respect to the tax years under audit, the potential exposure ranges between $0 and $448,000, excluding interest and penalties. We vigorously disagree with the proposed adjustments and are aggressively contesting these matters through applicable IRS and judicial processes, as appropriate. We have filed a written protest to these proposed adjustments thereby requesting an appeals conference with the IRS Office of Appeals. As of April 30, 2006, we concluded that the potential loss was not probable and no amounts have been provided for these items in the accompanying financial statements.

Liquidity and Capital Resources

At April 30, 2006, our principal sources of liquidity consisted of cash and cash equivalents of $9.9 million and our $10 million revolving credit facility. Cash and cash equivalents for the nine months ended April 30, 2006, increased $1.5 million from $8.4 million at July 31, 2005, primarily due to our operating results for the current year and improved working capital management, partially offset by debt repayment and stock repurchases.

Cash provided by operating activities was $11.1 million and $7.8 million for the nine months ended April 30, 2006 and 2005, respectively. Significant changes in assets and liabilities for the nine months ended April 30, 2006 that impacted cash flow from operations include an increase in accounts payable of $718,000 due to the timing of cash disbursements in the ordinary course of business and an increase in deferred revenue of $682,000 due primarily to the billing of annual maintenance and support for calendar year contracts. In addition, we have focused attention on accelerating the collection of accounts receivable. As a result, our days sales outstanding have improved by 10 days for the nine months ended April 30, 2006.

During the nine months ended April 30, 2006 and 2005, cash used in investing activities was $5.7 million and $8.4 million, respectively. For the nine months ended April 30, 2006 and 2005, cash used for the purchase of property and equipment was $2.1 million and $1.9 million, respectively. During the current year, 80% of our purchases of property and equipment have been for facility expansion and equipment to be utilized in our ASP operations. Cash used in the investment of capitalized software development costs was $3.7 million and $4.0 million for the nine months ended April 30, 2006 and 2005, respectively.

Cash used in financing activities was $3.9 million and $3.8 million for the nine months ended April 30, 2006 and 2005, respectively. Cash used in financing activities during the nine months ended April 30, 2006, primarily related to payments under our bank note of $2.7 million and payments under capital lease obligations of $1.0 million. On February 14, 2006, we repurchased 392,841 shares of our Common Stock in a private transaction for $2.4 million. These payments were partially offset in the current year by $1.5 million in proceeds received from the exercise of stock options. The $3.8 million of cash used in financing activities during the nine months ended April 30, 2005, primarily related to payments under our bank note of $2.7 million, principal payments made under the assumed debt obligations of Newbridge of $1.2 million and payments under capital lease obligations of $947,000, partially offset by proceeds received from the exercise of stock options of $871,000.

In December 2002, we entered into various capital lease arrangements for the rental of computer equipment at our ASP hosting facilities in the aggregate amount of $3.2 million. The lease agreements

require monthly payments of principal and interest of approximately $65,000 and expire in December 2007.

With the acquisition of Newbridge in September 2004, we assumed several capital lease obligations in the aggregate amount of $2.3 million. These leases require monthly payments of principal and interest of approximately $52,000 and expire at varying dates over the next three years.

On June 3, 2003, we repurchased 3.1 million shares of our Common Stock along with warrants to purchase approximately 161,000 of additional shares of Common Stock from Safeguard Scientifics, Inc. (“Safeguard”) and a former officer of Safeguard for $5.95 per share. In connection with the repurchase, we entered into a $14.2 million bank term note, of which $4.1 million was outstanding at April 30, 2006. The bank term note bears interest at a fixed annual rate of 3.32% and is repayable in equal monthly installments over four years.

As of April 30, 2006, we held approximately 5,291,000 shares of treasury stock at an average per share cost of $5.59. Since inception of our stock repurchase program in fiscal 1999, including the purchase on February 14, 2006, we have repurchased approximately 9,759,000 shares of stock at an average purchase price of $5.39. On March 23, 2006, we announced that we are implementing a new stock repurchase program that authorizes the repurchase of up to one million additional shares of Common Stock. Our Board of Directors believes the repurchase program is an appropriate means of increasing shareholder value.

Working capital was $5.0 million at April 30, 2006, compared with $4.6 million at July 31, 2005. The increase in working capital of $470,000 is primarily due to an increase in current assets of $2.1 million, mainly due to increased cash, partially offset by an increase in current liabilities of $1.7 million, primarily related to an increase in accounts payable of $729,000 and an increase of $714,000 deferred revenue primarily attributed to an increase in deferred maintenance revenue.

At April 30, 2006, we had a $10 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. To date there have been no borrowings under this credit facility. Under our bank term note and revolving credit facility, we are required to maintain certain financial and non-financial covenants. Based on the financial covenants, availability of funds under our revolving credit facility was approximately $4.1 million at April 30, 2006.

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, as well as supporting our existing operations. In addition to providing potential working capital, a portion of our cash or borrowings under our revolving credit facility could be used to acquire complementary businesses, obtain the right to use complementary technologies or repurchase our Common Stock.

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 next 12 months.

Recently issued accounting guidance

The American Jobs Creation Act of 2004 (the “Act”) was signed into law on October 22, 2004. The Act provides a deduction with respect to income from certain U.S. manufacturing activities and provides a reduced tax upon certain repatriated foreign earnings. Although the provisions of the Act did not impact the period ended April 30, 2005, we are continuing to evaluate the deduction for certain manufacturing activities, which may impact our future consolidated financial statements. The reduction in tax associated with repatriated foreign earnings will not have an impact on our future consolidated financial statements.

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 $4.1 million as of April 30, 2006.

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 our 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 each of the three months ended April 30, 2006 and 2005, 9% of our revenues and 9% of our cost of revenues and operating expenses were denominated in British pounds. For the nine month periods ended April 30, 2006 and 2005, 7% and 8%, respectively, of our revenues were denominated in British pounds. For the nine month periods ended April 30, 2006 and 2005, 8% and 9%, respectively, of our cost of revenues and operating expenses were denominated in British pounds. Historically, transactional gains and losses from the effect of fluctuations in currency exchange rates have not had a material impact on our operations; however, there can be no guarantees that it will not have a material impact in the future. The exposure to fluctuations in currency exchange rates will increase as we expand our operations outside the U.S.

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures

Our management, with participation of our Principal Executive Officer and Principal Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based on this evaluation, the Principal Executive Officer and Principal Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective as defined in Rule 13a-15(e) and 15d-15(e).

Internal control over financial reporting

There were no changes in our internal control over financial reporting during the period ended April 30, 2006, that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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 2. Unregistered Sales of Equity Securities and Use of Proceeds

Shares repurchased activity during the third quarter of fiscal 2006 was as follows:

Total number

Maximum

of shares

number of

purchased as

shares that may

Total number

Average

part of publicly

yet be purchased

of shares

price paid

announced

under the

Period

purchased

per share

program

February 1, 2006 - February 28, 2006 (1)

392,841

6.00

392,841

March 1, 2006 to April 30, 2006 (2)

1,000,000

Total

392,841

6.00

392,841

1,000,000


(1)		On February 14, 2006 repurchased 392,841 common shares for $2.4 million.

(2)		Announced March 23, 2006 authorization of repurchase up to one million common shares of stock.

Item 6. Exhibits


10.1	—	Employment Agreement between J. Robert Gary and the Registrant dated May 1, 2006.
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.

SIGNATURES

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


Docucorp International, Inc. (Registrant)
/s/ Michael D. Andereck Michael D. Andereck President and Chief Executive Officer	Date	June 8, 2006

DOCUCORP INTERNATIONAL INC 10-Q