Back to GetFilings.com

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2004

OR

For the transition period from              to             

Commission File Number: 0-20981

DOCUMENT SCIENCES CORPORATION

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (760) 602-1400

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $.001 par value per share

(Title of Class)

Indicate by check mark whether the registrant (1) has 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

The aggregate market value of the common equity held by non-affiliates computed by reference to the price at which the common equity was last sold at June 30, 2004 was $15,358,344.

As of March 24, 2005, there were 4,113,236 shares of the Registrant’s common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Part III incorporates certain information by reference from Registrant’s definitive proxy statement for its 2005 Annual Meeting of Stockholders to be held on April 28, 2005, which proxy statement is expected to be filed no later than 120 days after the close of Registrant’s fiscal year ended December 31, 2004.

Table of Contents

TABLE OF CONTENTS

Table of Contents

A WARNING ABOUT FORWARD-LOOKING STATEMENTS

We make forward-looking statements in this annual report on Form 10-K that are subject to risks and uncertainties. These forward-looking statements include information about possible or assumed future results of our financial condition, operations, plans, objectives and performance. Additionally, when we use the words “believe,” “expect,” “anticipate,” “estimate” or similar expressions, we are making forward-looking statements. Many possible events or factors could affect our future financial results and performance. This could cause our results or performance to differ materially from those expressed in our forward-looking statements. You should consider these risks when you review this document, along with the following possible events or factors:

Foreseeable risks and uncertainties are described elsewhere in this report and in detail under “Item 1. Business – Risk Factors.” You are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date of this annual report. We undertake no obligation to publicly release the results of any revision of, or otherwise update, the forward-looking statements.

PART I

ITEM 1. BUSINESS

Document Sciences Corporation develops, markets and supports a family of Dynamic Content Publishing software products used primarily for business to customer communications. Dynamic content publishing has become increasingly important as more companies benefit from automating the generation of personalized documents that include the precise assembly and layout of personal financial data, regulated content and in-context one-to-one marketing information. Our products facilitate an important form of communication between organizations and their customers by employing enterprise data assets and business compliance rules to produce high quality, regulated and highly-personalized documents that are ready to print in high-volume or on-demand, to email or to distribute over the web in real-time using HTML or Adobe Systems’ (Adobe) Portable Document Format (PDF^®).

Using modern enterprise-class architecture standards, our new generation xPression^™ product line enables scalable dynamic content publishing solutions across many industries, including insurance, financial services, managed healthcare, government and commercial outsourcing. Our entire product portfolio, including our previous generation Autograph^™ product family, is licensed to approximately 565 customers worldwide who collectively produce over an estimated one billion personalized documents per month, operating on computing environments ranging from traditional enterprise mainframe systems, distributed client/server PC and UNIX configurations, to modern highly-scalable J2EE application server platforms.

Company Formation

We were incorporated in Delaware in October 1991 as a wholly owned subsidiary of Xerox Corporation (Xerox). Following our initial public offering of stock in September 1996, Xerox ownership was reduced to approximately 62%. As a result of our tender offer and our exercise of an option to purchase additional shares from Xerox, in April 2001, Xerox’s ownership interest was reduced to 19.9%, and then on November 18, 2003, we purchased Xerox’s remaining shares in a private transaction.

1

Table of Contents

Available Information

This annual report, and each of our other periodic and current reports, including any amendments thereto, are available, free of charge, on our website at www.docscience.com, as soon as reasonably practical after such material is electronically filed with, or furnished to, the Securities and Exchange Commission. The information contained on our website is not incorporated by reference in this report and should not be considered part of this report. In addition, the Securities and Exchange Commission website, www.sec.gov, contains reports, proxy and information statements and other information about us.

Products

Our new generation xPression product line addresses a major functional area within the growing Enterprise Content Management (ECM) arena: Dynamic Content Publishing. In 2004, we released the second major version of xPression, including our new higher-performance composition engine, and this has resulted in improved xPression sales. In addition, all of our software products can be complemented by our professional services organization, including services provided by our China-based Document Factory, thereby enabling the delivery of cost-effective fully-integrated functional solutions to our worldwide customer base.

We generally license our products for an upfront initial license fee and an annual renewal license and support fee, usually 20% of the initial license fee, which is required for the initial year and subsequent years. We also offer the right to license for perpetual use of our products and, in these cases, annual maintenance agreements are typically charged at 20% of the list price of the initial license fees.

Autograph to xPression Transition

From its introduction in 2002 through 2004, we have installed our new generation xPression products in over 30 major accounts worldwide – new accounts including competitive installations, as well as previous generation Autograph accounts. These installations validate our ability to migrate Autograph, as well as competitive accounts, to xPression using a scalable and reliable delivery model. We have recently introduced packaged offerings consisting of additional software and services for further facilitating the migration of our existing Autograph customers, as well as from select competitive products, to our xPression product family. During 2005, we anticipate actively marketing these packaged offerings to generate additional account migrations.

Dynamic Content Publishing

Our xPression product line provides dynamic content publishing capabilities on an open J2EE architecture. As such, our xPression products are developed in Java, adhering to J2EE open standards for compatibility with application server platforms such as IBM WebSphere and BEA WebLogic. Our xPression dynamic content publishing components can also be tightly integrated with other enterprise applications to extend the existing capabilities of ECM platforms, customer relationship management (CRM) systems and other enterprise technology assets. The xPression product line is based on open XML standards for open data interchange, and on Unicode text encoding for worldwide language support. These characteristics are attractive to customers seeking inter-operability between their enterprise applications and adherence to open standards.

xPression Server and Client products. The xPression Server manages the robust content creation and document assembly process required in complex, regulated text-intensive documents such as proposals, contracts, policies and customer correspondence. xPression Server supports several client application that provide user interfaces for systems management (xPression Admin), personalized document design (xPression Design), interactive real-time document generation (xPression Response) and collaborative document revision and approval (xPression Revise). Customers can configure their xPression installations with any number of server and client products as required by the application type and performance requirements.

xPression Admin manages all aspects of the xPression configuration including access security, customer data sources and mapping, document production and multi-channel output environments. xPression Admin is designed for use by the system administrators familiar with the overall operating environment. Conversely, xPression Design is designed for non-technical business users responsible for the creation and management of personalized document applications. This is accomplished using a hierarchy of content items that is created and managed using Microsoft Corporation’s (Microsoft) Word^®, the industry-standard authoring and design tool for regulated documents such as contracts and correspondence. The support of open tools such as Microsoft Word enables our customers to redeploy the development and maintenance of applications from their generally higher-cost IT department to the line-of-businesses responsible for the application.

2

Table of Contents

xPression Design manages and tracks the personalized document applications and their content items using a secure multi-user environment that supports powerful user-definable attributes (e.g. language, jurisdiction, affectivity, etc), multi-level revision control, multi-level approval workflows and advanced content searching. xPression Design enables the definition of simple or complex content assembly and business rules that control content selection and personalization based on unique customer data. Once a personalized document application has been created, validated, and approved, xPression Server manages the subsequent document assembly and publishing processes. These can execute in a high volume production mode, or as real-time, on-demand transactions. By leveraging the benefits of application servers, xPression Server is highly-scalable and supports multi-threaded clustered configurations, providing high-volume as well as high-concurrency performance.

xPression Response is a web browser based out-of-the-box client application that enables the on-demand generation of customer correspondence and other documents created using xPression Design. xPression Response features an integrated Java editor that can be used to make additional manual or exception changes to pre-assembled documents. xPression Response also supports web-based change tracking, approval and workflow processes to ensure document integrity and compliance. xPression Response can be integrated with a CRM or other correspondence management or call center system of choice.

xPression Revise provides more sophisticated capabilities for managing complex contract applications that require re-issuance control and a level of collaboration. In 2005, we anticipate introducing additional client product capabilities.

Finally, xPression provides extensible capabilities in the increasingly important areas of integration and connectivity using xPression Framework. Because of its open architecture and its adherence to XML standards, xPression can be tightly integrated with a wide variety of line-of-business applications such as insurance and financial administration systems, business workflow systems, as well as enterprise ECM platforms. To further our capabilities in the connectivity area, we also support web services as well as XML dialects such as the insurance-industry ACORD standard. Furthermore, we enhance our technical connectivity by developing strong partnerships with other open system providers. In 2005, we anticipate introducing additional enterprise connectivity capabilities.

Composition Engine. The xPression product family supports our core CompuSet composition engine, thus enabling and facilitating the migration of existing Autograph applications to xPression. CompuSet automates document composition using data and variable content tagged in a manner conceptually and syntactically similar to HTML or XML, the web tagging standards, and styled using specifications conceptually similar to CSS and XSL, the web styling standards. In a fully automated fashion, CompuSet transforms the tagged data, the style specifications and the variable content into high-quality electronic documents that are assembled and composed at rates in excess of 50 pages per second, depending on the computing platform and document complexity. The document composition features are rich and extensive, including the automatic generation of multi-dimensional dynamic data driven graphics, and the support of full color text and images.

The composition process is further optimized for print, email and/or web media for multi-channel distribution. CompuSet supports a number of popular Page Description Languages (PDLs) for subsequent printing, electronic distribution and/or archive storage for future retrieval and viewing. These PDLs provide device-specific instructions for rendering text, forms, images and graphics into printable streams or into electronic documents. Output processing capabilities include inline output stream manipulation for splitting, merging, re-sequencing, sorting, bundling and bar coding. These features are necessary for postal optimization, for the support of finishing equipment without further post-processing and for multi-channel applications that require both print and electronic (email) distribution. The PDL formats currently supported are Xerox Metacode, International Business Machines Corporation’s (IBM) AFPDS®, Hewlett-Packard Company’s PCL® and Adobe’s PostScript®, including Xerox VIPP extensions for high-volume full-color production on Xerox DocuColor and iGen product lines, and well as Adobe PDF.

In 2004, we introduced xPression Publish, our new Java-based composition engine, as part of xPression 2.0. The design of the new composition engine incorporates the majority of features available in our CompuSet engine, as well as significant extensions in the areas of multi-frame page layout, multi-language support including support for double-byte Asian languages and scalable multi-threaded performance. The new xPression Publish engine supports higher volume print applications as well as higher throughput real-time transactional eBusiness applications. In 2005,

3

Table of Contents

we plan on further enhancing this engine, including providing incremental Output Processing functionality. We also anticipate introducing new application design tools that take full advantage of the capabilities of our new publishing engine.

Professional Services

In addition to our software products, we provide a comprehensive suite of professional services that can assist customers in the implementation of mission-critical dynamic content publishing applications. Professional services include on-site software installation, consulting services, customer training programs and telephone support programs. Our consulting services are currently focused on assisting in the sale of high margin initial software licenses by providing project management, requirements analysis, application design and development services. The capacity of our domestic professional services has been extended through the use of our cost effective China-based Document Factory team.

Our consulting services can be also provided in conjunction with our system integration partners. In addition to consulting services, we provide introductory and advanced-level education classes for our xPression and Autograph products at our headquarters in San Diego, our office in Milwaukee and at customer sites. We believe that the use of our professional services enables customers to deploy our dynamic content publishing products more rapidly and more cost-effectively. In 2005, we anticipate putting incremental emphasis on the delivery of professional services in support of our packaged xPression migration offerings.

Development Outsourcing Services

In addition to our software products and professional services, we also provide cost effective development outsourcing services through our subsidiary’s, Objectiva Software Solutions Inc. (Objectiva), software engineering team based in Beijing, China. These software engineering services include project management, design and architecture, prototyping, coding, testing and productizing. Our Objectiva software engineering team has achieved CMM Level 3 certification, a recognized global standard for quality service delivery, as well as other vendor specific recognitions such as Microsoft MVP certified engineers. In 2005, we anticipate continued investment and growth in our core Objectiva software engineering outsourcing services.

Sales and Marketing

Our sales and marketing organization targets markets that require dynamic content publishing, including high volume, high quality document personalization. We currently license our products using a combination of direct sales and alternative channels. In North America, we market our products primarily through a direct sales force that manages our existing base of corporate accounts, as well as targets new accounts in select market segments. Our sales account executives are provided with pre-sales technical support through qualified solution analysts. Account executives and solution analysts are located throughout North America to provide optimal coverage. Outside of North America, we distribute our software products through value added resellers (VARs) in Australia, South America and Asia. Our subsidiary, Document Sciences Europe, markets our products in Europe, Africa and the Middle East by providing VAR channel management and support and by defining European market and product requirements.

We are continuing to increase both our product offerings and markets through joint marketing, sales and distribution and development relationships with other major companies. Current relationships include formal and informal marketing and sales alliances with EMC Corporation, Computer Science Corporation (CSC), Edgewater Technology Inc., IBM Inc. and Xerox Global Services. These relationships provide qualified sales leads for our products and extend our sales coverage and networking capabilities. In addition, we also support partner relationships with complementary technology companies such as EMC Documentum and FileNet, Inc. as well as numerous insurance admin system vendors such as Fiserv, Harlosh, Solcorp and Worldgroup. We participate in joint marketing events with our key partners whenever appropriate and feasible. Furthermore, we actively market our products and solutions at industry focused trade shows, through focused regional seminars and through a variety of web marketing mechanisms, including webinars.

4

Table of Contents

Research and Development

We continue to enhance our product offerings, engaging key customers and prospects to identify requirements and to prioritize specific product features. We also engage industry and technology analysts, and key partners to understand existing market trends, new target markets, and overall technology directions. Our 2005 development roadmap addresses key requirements for tight integration into emerging ECM Enterprise Reference Architecture (ERA) models, as well as new target markets identified through our ongoing planning process.

In general, our product development strategy is based on delivering dynamic content publishing solutions for specific types of document applications in one or more vertical markets or industries, or in identifying more horizontal applications that can be sold across many market segments. A cross-functional team is responsible for delivering each focused offering. We use a documented business planning and product delivery process to guide our product development and delivery activities throughout the year. We also employ rapid prototyping to validate new product concepts, and agile development methodologies to be responsive in a rapidly-evolving technology environment.

During 2004, we acquired Objectiva, a China-based development outsourcing company that provided us with cost-effective software development capabilities. The acquisition of Objectiva has significantly increased our software development capacity, including our ability to respond more rapidly to unanticipated requirements driven by new technologies, new partnerships, or new business opportunities.

Our recent xPression 2.0 release continues to build on our xPression family of products. These product offerings adhere to open standards for large-scale systems integration such as J2EE and XML. By developing products using open standards we can expand the delivery of our products through and with large systems integrators and other channels. By offering application migration paths wherever possible we also enable our Autograph customers to purchase and migrate to our newer xPression offerings.

We continue to maintain and enhance our Autograph product line for operation on traditional platforms such as mainframe environments. These well-established products, including DLS and VC Pro, are maintained by teams that respond to customer requests for defect corrections and feature enhancements. These products are proven and feature rich, and we do not anticipate the need to significantly enhance them during 2005.

We expect to continue enhancing our existing product portfolio and to develop new products, particularly as they relate to multi-channel applications, including electronic (email) distribution and web portals. Our development expenditures continue to be a major focus of our resources. Such expenditures, not including amounts capitalized, were $7.0 million, $6.3 million and $5.8 million in 2002, 2003 and 2004, respectively.

We can make no assurance that we will be successful in developing, introducing and marketing new products on a timely and cost-effective basis, if at all, or that such new products will achieve market acceptance. See “Risk Factors – Our growth depends on market acceptance of our existing products, enhancements to existing products and our introduction of new products.”

Competition

The market for dynamic content publishing products is intensely competitive, subject to rapid change and significantly affected by new product introductions and other market activities of industry participants. Our software products are targeted at document intensive organizations that require the ability to produce large quantities of personalized documents in paper or electronic form. We face direct and indirect competition from a broad range of competitors who offer a variety of products and solutions to our current and potential customers. Our principal competition currently comes from systems developed in-house by the internal MIS departments of large organizations where there is a reluctance to commit the time and effort necessary to convert their existing dynamic content publishing processes to our dynamic content publishing software.

We also face competition from DocuCorp International, Inc. and InSystems Technologies, Inc. in the insurance industry; Metavante in banking and financial services; Pitney Bowes Group 1 Software, Inc.; Exstream Software, Inc. and numerous other smaller competitors. Several of our competitors have longer operating histories, significantly greater financial, technical and marketing resources, greater name recognition and a larger installed base of customers than we do. We believe that the principal competitive factors affecting our market include product performance and functionality, ease of use, scalability, operating across multiple computer and operating system platforms, product and company reputation, client service and support and price.

5

Table of Contents

It is also possible that we will face competition from new competitors. These include large independent software companies offering personal computer-based application software solutions, such as Microsoft and Adobe, and from large corporations providing database and content management software solutions, such as Oracle Corporation. In addition, Xerox or IBM, either directly or through affiliated entities, could become large competitors. Moreover, as the market for dynamic content publishing software develops, a number of these or other companies with significantly greater resources than ours could attempt to enter or increase their presence in the dynamic content publishing market by either acquiring or forming strategic alliances with our competitors or by increasing their focus on the industry. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the ability of their products to address the needs of our current and prospective customers. It is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. Increased competition may result in price reductions, reduced gross margins and loss of market share, any of which could have a material adverse effect on our business, operating results and financial condition.

Patents, Licenses and Proprietary Rights

Our success is dependent, in part, on our ability to protect our proprietary technology. We rely primarily on a combination of copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect our proprietary rights. We seek to protect our software, documentation and other written materials under trade secret and copyright laws. However, these afford only limited protection. We presently have no patents or patent applications pending. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. See “Risk Factors – Our growth is dependent upon successfully protecting our proprietary rights.”

In addition, we also rely on certain software that we license from third parties, including software that is integrated with internally developed software and used in our products to perform key functions. There can be no assurances that such firms will remain in business, that they will continue to support their products or that their products will otherwise continue to be available to us on commercially reasonable terms. The loss or inability to maintain any of these software licenses could result in delays or reductions in product shipments until equivalent software can be developed, licensed and integrated, which would adversely affect our business, operating results and financial condition.

Customers

We derived 17%, 21% and 16% of our revenues through Xerox and its affiliates in 2002, 2003 and 2004, respectively. As a result, discontinuation of agreements and other business transactions that may adversely impact our relationship with Xerox could have a material adverse effect on our business, operating results and financial condition.

Employees

As of December 31, 2004, we had 231 employees including 80 in professional services and customer support, 35 in sales and marketing, 94 in research and development and 22 in finance and administration. None of our employees are represented by labor unions. We have experienced no work stoppages and believe our relationship with our employees is good. Competition for qualified personnel in the industry in which we compete is intense. We believe that our future success will depend in part on our continued ability to attract, hire and retain qualified personnel.

Financial Information about Segments and Geographic Areas

The information regarding revenues and operating profit by reportable segments and revenues from unaffiliated customers by geographic region is set forth at the end of this annual report under the heading “Notes to Consolidated Financial Statements – 3. Geographic Information” and is incorporated herein by reference.

6

Table of Contents

Risk Factors

The following is a discussion of certain factors that currently impact or may impact our business, operating results and/or financial condition. Anyone making an investment decision with respect to our common stock or other securities is cautioned to carefully consider these factors. If any of the following risks actually occur, our business, results of future operations and financial condition could be materially adversely affected. In such case, the trading price of our common stock could decline and you may lose part or all of your investment.

Our quarterly results fluctuate significantly and we may not be able to grow our business.

Our total revenues and operating results can vary, sometimes substantially, from quarter to quarter, and we expect them to vary significantly in the future. Additionally, our revenues and operating results are difficult to forecast, and our future results will depend upon many factors, including the following:

Our initial license fee revenues mainly depend on when orders are received and shipped. However, because of our sales model, our customers’ implementation schedule and the complexity of the implementation process, revenue from some software shipments may not be recognized in the same quarter as the shipment occurs. Our operating expenses are primarily based on anticipated revenue levels. Since a high percentage of those expenses are relatively fixed, a delay in the recognition of revenue from license transactions could cause significant variations in operating results from quarter to quarter, and we may sustain losses as a result. To the extent such expenses precede, and/or are not subsequently followed by, increased revenues, our operating results could be materially adversely affected.

As a result of these factors, results from operations for any quarter are subject to significant variation, and we believe that period-to-period comparisons of our results of operations are not necessarily meaningful. Accordingly, you should not rely upon them as an indication of our future performance. Furthermore, our operating results in future quarters may fall below the expectations of market analysts and investors. If this occurs, the price of our common stock would likely be materially adversely affected.

Our growth depends on market acceptance of our existing products, enhancements to existing products and our introduction of new products.

Our future business, operating results and financial condition depends upon market acceptance of our existing products, as well as our ability to respond to emerging industry standards and practices and to develop new products that address the future needs of our target markets. Our Autograph family of products has been applied mainly to document automation applications producing paper-based documents. We have started to extend our core technology to the Internet, intranets and commercial on-line services. However, we cannot assure you that we will be successful

7

Table of Contents

in developing, introducing and marketing new products or product enhancements, including new products or the extension of existing products for the Internet, intranets and commercial on-line services, on a timely and cost effective basis, if at all. In addition, we cannot assure you that our newer products, such as xPression, or enhancements to existing products will adequately meet the requirements of the marketplace or achieve market acceptance. Moreover, delays in our commercial shipments of new products or enhancements may result in client dissatisfaction and a delay or loss of product revenues.

If for technological or other reasons we are unable to develop and introduce new products or enhancements of existing products in a timely manner in response to changing market conditions or client requirements, then our business, operating results and financial condition will be materially adversely affected. In addition, we cannot assure you that our existing products, new products or new versions of our existing products will achieve market acceptance. In order to provide our customers with integrated product solutions, our future success will also depend in part upon our ability to maintain and enhance relationships with our technology partners.

Longer than expected sales cycles and implementation periods have and may continue to affect our revenues and operating results.

The licensing of our software products is often an enterprise-wide decision by prospective customers and generally involves a sales cycle of three months to more than one year in order to educate our prospective customers regarding the use and benefits of our products. In addition, the implementation of our products by customers involves a significant commitment of their resources over an extended period of time and is commonly associated with substantial customer business process reengineering efforts. Sales of our enterprise-wide xPression product line often involve many participants in the corporate decision-making process. Additionally, we have experienced and may, from time to time, continue to experience defects in our software which cause implementation problems and affect our sales and our sales cycle. For these and other reasons, our sales cycles and customer implementation periods are subject to a number of significant delays over which we have little or no control. Any delay in the sale or customer implementation of a limited number of license transactions could have a material adverse effect on our business and results of operations and cause our operating results to vary significantly from quarter to quarter.

We currently derive a significant portion of our revenues through Xerox.

We currently have a variety of contractual and informal relationships with Xerox and affiliates of Xerox, including a cooperative marketing agreement, a transfer and license agreement and various distribution agreements. We rely on these relationships and agreements for a significant portion of our total revenues. Revenues derived from relationships with Xerox and affiliates of Xerox accounted for approximately $4.0 million, $4.3 million and $3.8 million in 2002, 2003 and 2004, respectively, representing 17%, 21% and 16% of our total revenues, respectively.

In November 2003, we paid $2.7 million to Xerox to repurchase the remaining 740,024 shares of Document Sciences’ common stock owned by Xerox. Since Xerox no longer has an equity interest in us, there may be less incentive in continuing to do business with us at the same level. Though we intend to continue our existing relationships with Xerox, our strategy has been, and continues to be, to lessen our dependence on Xerox. However, there can be no assurance that we will be able to do so and, because of our current level of dependence on Xerox, there can be no assurance that our plans to become more independent will not adversely affect our business, results of operations and financial condition. Our failure to maintain these relationships or to establish new relationships in the future could have a material adverse effect on our business, operating results and financial condition.

There can be no assurance that existing and potential customers will continue to do business with us because of these relationships or our historical ties with Xerox and its affiliates. Xerox has strategic alliances and other business relationships with other companies who supply software and services used in high volume electronic publishing applications and who now are, or in the future may become, our competitors. There can be no assurance that Xerox or one of its affiliated companies will not engage in business that directly competes with us. In addition, Xerox has ongoing internal development activities that could in the future lead to products that compete with us. Xerox could in the future expand these relationships or enter into additional ones, and as a result our business could be materially adversely affected.

8

Table of Contents

Our growth depends on our ability to compete successfully against current and future competitors.

The market for our dynamic content publishing products is intensely competitive. We face competition from a broad range of competitors, many of whom have greater financial, technical and marketing resources than we do. Our principal competition currently comes from systems developed in-house by the internal MIS departments of large organizations and direct competition from numerous software vendors, including Docucorp International, Inc., InSystems Technologies, Inc., Group 1 Software, Inc., Exstream Software, Inc. and Metavante Corporation. We believe that the principal competitive factors affecting our market include product performance and functionality, ease of use, scalability, operating across multiple computer and operating system platforms, product and company reputation, client service and support and price. Although we believe we currently compete favorably with respect to such factors, we can not assure you that we will be able to maintain our competitive position against current and future competitors, especially those with greater financial, technical and marketing resources than us, or that we will be successful in the face of increasing competition from new products, new solutions introduced by existing competitors or by new companies entering the market.

The success of our recent acquisition depends on successful integration.

We may not be able to successfully integrate Objectiva’s operations, personnel or products or we may incur unanticipated costs with the integration of Objectiva into Document Sciences. The acquisition of Objectiva could result in the diversion of capital and management’s attention away from other business issues and opportunities. In addition, our acquisition may not be successful in achieving our desired strategic objectives which could cause our business to suffer. If we fail to successfully integrate this acquisition, our business could be materially adversely affected.

Our operating results are substantially dependent on sales of a small number of products in highly concentrated industries.

We derived 45%, 42% and 13% of our initial license revenues from our CompuSet, xPression and DLS product lines in 2004, respectively. As a result, factors that may adversely impact the pricing of or demand for these products, such as competition from other products, negative publicity or obsolescence of the hardware or software environments in which our products run, could have a material adverse effect on our business, operating results and financial condition. Our financial performance will depend significantly on the successful development, introduction and customer acceptance of new and enhanced versions of our xPression software, as well as continued customer acceptance of CompuSet, DLS and related products.

Licenses to end users in the insurance, finance and print service industries in the United States accounted for 70%, 20% and 6% of initial license revenues in 2004, respectively. Our future success will depend on our ability to continue to successfully market our products in these and other industries. Our failure to do so would have a material adverse effect on our business, operating results and financial condition.

Our growth is dependent upon successfully focusing our distribution channels.

To grow our business, we must streamline our worldwide sales and distribution channels by focusing on key target industry market segments where our current and planned products can enjoy a significant competitive advantage and high market demand. We also must leverage our existing relationships with Xerox and other partners by launching targeted joint marketing and value added reseller programs and by introducing new product offerings that are optimized for selected target markets and marketing channels. Additionally, we must form additional partnerships with system integrators and consultants in order to broaden our capacity to deliver complete dynamic content publishing solutions that incorporate significant services content, while also maintaining our core domain expertise. We cannot assure you that we will be able to successfully streamline and focus our worldwide channels, leverage our existing relationships or form new alliances. If we fail to do so, it will have a material adverse effect on our business, operating results and financial condition.

Our products may suffer from defects or errors.

Software products as complex as those we offer, may contain undetected defects or errors when first introduced or as new versions are released. As a result, we could in the future lose or delay recognition of revenues as a result of software errors or defects. In addition, our products are typically intended for use in applications that may be critical to a customer’s business. As a result, we expect that our customers and potential customers have a greater sensitivity to product defects than the general market for software products. We have experienced defects in connection with the

9

Table of Contents

introduction of our xPression product line and we have worked to address this problem, but we cannot assure you that, despite our testing as well as testing by current and potential customers, errors will not be found in our existing products or new products or releases. Defects discovered after the commencement of commercial shipments, can result in any of the following:

Maintaining our professional services expertise is necessary for our future growth.

We are continuing our focus on the consulting services component of our professional services to assist customers in the planning and implementation of enterprise-wide, mission-critical dynamic content publishing applications. This strategy is dependent on retaining and hiring professionals to perform these consulting services. Should we be unable to maintain the necessary services workforce, our business and financial condition could be materially adversely affected.

We are exposed to risks associated with international operations.

Our revenues from export sales accounted for 23%, 27% and 23% of our total revenues in 2002, 2003 and 2004, respectively.

We license our products in Europe through VARs and to a much lesser extent, direct sales. Revenues generated by these activities were $3.2 million, $3.2 million and $3.4 million in 2002, 2003 and 2004, respectively.

Our wholly owned subsidiary, Objectiva, develops, markets and supports our products in Asia. As of December 31, 2004, they had 110 employees.

In Australia, Canada and Latin America, our products are distributed and/or supported by Xerox affiliates and also by direct sale in Canada. In China, our products are distributed and/or supported by our subsidiary, Objectiva. Revenues generated in these regions were $2.1 million, $2.3 million and $2.0 million in 2002, 2003 and 2004, respectively.

In order to successfully expand export sales, we must establish additional foreign operations, hire additional personnel and develop relationships with additional international resellers. If we are unable to do so in a timely manner, our growth in international export sales could be limited, and our business, operating results and financial condition could be materially adversely affected. In addition, we cannot assure you that we will be able to maintain or increase international market demand for our products.

Additional risks inherent in our international business activities include:

10

Table of Contents

A portion of our business is conducted in currencies other than the U.S. Dollar, primarily the Euro and the Chinese Yuan. Although exchange rate fluctuations have not had a significant impact on us, fluctuations in the value of the currencies in which we conduct our business relative to the U.S. Dollar could cause currency transaction gains and losses in future periods. We do not currently engage in currency hedging transactions, and we cannot assure you that fluctuations in currency exchange rates in the future will not have a material adverse impact on our international revenues and our business, operating results and financial condition.

Our business is dependent on the market for dynamic content publishing software.

The market for dynamic content publishing software is intensely competitive, highly fragmented and subject to rapid change. We cannot assure you that the market for dynamic content publishing software will continue to grow or that, if it does grow, organizations will adopt our products. We have spent, and intend to continue to spend, significant resources educating potential customers about the benefits of our products. However, we cannot assure you that such expenditures will enable our products to achieve further market acceptance, and if the dynamic content publishing software market develops more slowly than we currently anticipate, our business, operating results and financial condition would be materially adversely affected.

In addition, the commercial market for dynamic content publishing of electronic documents designed for use with the Internet, intranets and commercial on-line services has only recently begun to develop, and the success of our products designed for this market will depend in part on their compatibility with such services. It is difficult to predict whether the demand for related products and services would increase or decrease in the future. Since the increased commercial use of the Internet, intranets and commercial on-line services could require substantial modification and customization of certain of our products and services as well as the introduction of new products and services, we cannot assure you that we will be able to effectively or successfully compete in the future in this market.

Our ability to manage future change will affect our business.

Our ability to compete effectively and to manage future change will require us to continue to improve our financial and management controls, reporting systems and procedures on a timely basis and to expand, train and manage our work force. We cannot assure you that we will be able to do so successfully. Our failure to do so could have a material adverse effect on our business, operating results and financial condition.

Our executive officers and certain key personnel are critical to our business, and these officers and key personnel may not remain with us in the future.

Our future performance depends in significant part upon the continued service of our key technical, sales and senior management personnel. The loss of the services of one or more of our executive officers could have a material adverse effect on our business, operating results and financial condition. Our future success also depends on our continuing ability to attract and retain highly qualified product development, sales and management personnel. Competition for such personnel is intense, and there can be no assurance that we will be able to retain our key employees or that we will be able to attract or retain other highly qualified product development, sales and managerial personnel in the future.

Our business is dependent upon successfully protecting our proprietary rights.

We rely on a combination of copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect our proprietary rights. Despite these protective measures, it may be possible for unauthorized third parties to copy portions of our products or use information we consider proprietary. Policing unauthorized use of our products is difficult and, while we are unable to determine the extent to which piracy of our software products exists, we expect software piracy to be a persistent problem. In addition, the laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of the United States. We cannot assure you that our means of protecting our proprietary rights will be adequate or that our competitors will not independently develop similar technology.

11

Table of Contents

We are not aware of any infringement of our products upon the proprietary rights of third parties. However, we cannot assure you that third parties will not claim infringement by us with respect to current or future products. We expect that software product developers will increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and the functionality of products in different industry segments overlaps. Any such claims, with or without merit, could be time consuming, result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all, which could have a material adverse effect upon our business, operating results and financial condition.

Our failure to adequately limit our exposure to product liability claims may adversely affect us.

Our license agreements with our customers typically contain provisions designed to limit our exposure to potential product liability claims. However, it is possible that the limitation of liability provisions contained in our license agreements may not be effective under the laws of certain jurisdictions. Although we have not experienced any product liability claims to date, sale and support of our products may entail the risk of such claims in the future. A successful product liability claim brought against us or a claim arising as a result of our professional services could have a material adverse effect upon our business, operating results and financial condition.

If any of these events occur, it would have a material adverse effect upon our business, operating results and financial condition.

ITEM 2. PROPERTIES

We lease approximately 21,300 square feet for our principal administrative, sales, marketing, training and research and development facility in Carlsbad, California. This lease expires on February 28, 2005 and has been extended two additional months. We have signed a new lease for a new building in Carlsbad for approximately 17,100 square feet that will expire June 15, 2011. Our regional office in Milwaukee, Wisconsin occupies approximately 3,400 square feet of office space pursuant to a lease expiring on October 31, 2008. Our subsidiary in France occupies approximately 2,200 square feet of office space with a lease expiring on April 15, 2005. In addition, our subsidiary in China occupies approximately 12,000 square feet of office space expiring May 20, 2009. Sales representatives and field technical support personnel operate from their homes. We believe that the current properties that we lease are adequate for our current needs.

ITEM 3. LEGAL PROCEEDINGS

In the ordinary course of business, we may become involved in legal proceedings from time to time. As of March 24, 2005, we were not a party, nor was our property subject, to any material pending legal proceedings.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth quarter of fiscal year 2004.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is presently traded on The Nasdaq SmallCap Market under the symbol “DOCX.” The following table sets forth the range of high and low sales prices of our common stock for the periods indicated, as reported on The Nasdaq National Market System. Such quotations represent inter-dealer prices without retail markup, markdown or commission and may not necessarily represent actual transactions.

12

Table of Contents

We had 4,113,236 shares outstanding and 105 record holders of our common stock as of March 24, 2005. Historically, we have not paid dividends on our common stock and do not anticipate paying dividends in the foreseeable future.

The following table provides information about purchases of equity securities by us or affiliated purchases during the quarter ended December 31, 2004: