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SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission File Number: 0-20981

Document Sciences Corporation

Registrant’s telephone number, including area code:

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

      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 þ          No o

      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.     o

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

      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 28, 2002 was $6,589,084. As of March 24, 2003, there were 3,874,730 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 pursuant to Schedule 14A for its 2003 Annual Meeting of Stockholders to be held on April 29, 2003, which proxy statement will be filed no later than 120 days after the close of Registrant’s fiscal year ended December 31, 2002.

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A WARNING ABOUT FORWARD-LOOKING STATEMENTS

      We make forward-looking statements in this Annual Report 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:

	•	national, international, regional and local economic, competitive and regulatory conditions and developments;
	•	the market for document automation software (currently includes the emerging content processing market);
	•	market acceptance of enhancements to our existing products and introduction of new products;
	•	continued profitability of our professional services;
	•	maintaining our relationships with Xerox Corporation; and
	•	other uncertainties, all of which are difficult to predict and many of which are beyond our control.

      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 the forward-looking statements.

PART I

Item 1.     Business

      Document Sciences Corporation develops, markets and supports a family of document automation software used in high volume print and transactional web-based applications. Document automation has become increasingly important as more companies realize the productivity benefits of automating the generation of personalized documents that include the precise layout of regulated content, personal financial data and in-context, one-to-one marketing information. Document automation, or “content processing”, is becoming recognized as a key component within the emerging Enterprise Content Management (ECM) software market. Our established Autograph document automation software products, as well as our new xPression content processing product family, each enable automated publishing solutions for many industries, including insurance, financial services, managed healthcare, government, telecommunications, manufacturing and commercial print outsourcing. Our software products facilitate an important form of communication between organizations and their customers by employing enterprise database assets and business compliance rules to produce high-quality, highly-personalized regulated documents that are ready to print on demand, to email or to distribute over the web in real-time using HTML or Adobe Systems’ (Adobe) PDF® technology. Our Autograph and xPression software products are licensed to approximately 600 customers worldwide who collectively produce over one billion customized documents per month. Our highly portable Autograph and our new xPression software platforms enable cost-effective, on demand, high volume or real-time transactional publishing that is high quality, in compliance and fully automated. Our software products are compatible with a wide array of popular computing environments from traditional mainframe computer systems, distributed client/server PC and Unix configurations, as well as highly scalable J2EE application server platforms.

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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 has been reduced to 19.9%. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources”.

Products

      Our established Autograph and our new xPression software product families currently address two major functional areas within the emerging ECM arena: Regulated Content Management and Document Publishing, as described below. All of our software products can be complemented by our professional services organization.

      We generally license our products for an upfront initial license fee and an annual renewal license and support fee, usually between 15% and 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, maintenance agreements are charged at between 15% and 20% of the list price of the initial license fees. The list price for a license of CompuSet, our core Autograph product, is currently $90,000 for a mainframe installation and ranges down to $45,000 for a PC NT server installation. The list price for an initial license of xPression, our new product, is currently $200,000 for the IBM WebSphere platform. Additional product options currently range from $3,000 to $50,000. A typical new account sale through our direct channel is currently about $200,000 for software licenses and approximately $75,000 for professional services.

      Our Autograph and xPression regulated content management products provide solutions for the creation, revision and management of document content used in several types of regulated document automation applications. In the Autograph product family, they consist of the Document Library Service (DLS) Server and Client products, DLS eCor and DLSCOM. Unlike other general-purpose content management products, our Autograph DLS products are optimized for highly regulated document applications such as contract and policy production. In xPression, an enhanced version of the equivalent Autograph product functionality is provided through a more open J2EE/ XML architecture that can be integrated with general-purpose content management. As such, the xPression content processing components can coexist with and significantly extend the capabilities of a scalable ECM environment.

      Autograph DLS Server and Clients. DLS Server manages the document content creation process required in complex, regulated text-intensive documents, such as proposals, contracts, policies and customer correspondence. Our DLS products use a client server architecture for accessing data and files stored on a mainframe or on an NT network server. Our DLS Client product manages the text content created with Microsoft Corporation’s (Microsoft) Word® and internally stored in HTML. The DLS text content is tracked and managed in a multi-authoring environment that supports access security, content searching, revision control and approval workflow. In addition to content creation and management, the DLS Client product enables the definition of complex assembly and business rules required for interactive or automated document assembly and composition using Microsoft Word and/or our CompuSet publishing engine. DLS supports criteria-based content selection mechanism for generating a Microsoft Word document or a CompuSet tagged file, based on application volume requirements. The personalized document assembly can occur in a high volume fashion on the server or in a just-in-time, on-demand fashion on the local DLS Client computer.

      Autograph DLS eCor and DLSCOM. DLS eCor and DLSCOM further augment our DLS technology capabilities by providing a rich feature-set that is targeted at enterprise-wide correspondence applications. DLS eCor enables the on-demand generation of customer correspondence through corporate call centers. DLS eCor is web based and features an integrated Java editor that can be used to make additional manual or exception changes to pre-assembled customer correspondence. DLS eCor supports an email-based change

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      XPression Regulated Content Management: Our new xPression product family provides a migration path for the established Autograph DLS product family. XPression is entirely developed in Java, adhering to J2EE open standards for compatibility with application server platforms such as IBM WebSphere. Furthermore, xPression is based around open XML standards for open data and business logic description and interchange. XPression supports all of the capabilities found within the Autograph DLS product line, as well as significantly extends core functionality in the areas of data capture and handling (xPression Admin), document and rules design (xPression Design), interactive real-time document generation (xPression Response), as well as in the areas of integration and connectivity (xPression Framework). In 2002, we released the first version of xPression following the successful completion of our Beta testing during the third and fourth quarters. In 2003, we expect to release additional extensions to our xPression product family.

      Document Composition. CompuSet software automates content assembly and document composition using corporate data and variable content. CompuSet consists of a rule-based language and a robust composition engine that provides high-speed content assembly and composition of complex personalized documents at a high level of quality. Corporate data and variable content are marked with CompuSet tags that, in turn, are defined in logically separate CompuSet style specifications. The CompuSet tags are conceptually and syntactically similar to HTML or XML tags, the current web standards for content tagging, and the CompuSet style specifications are conceptually similar to CSS and XSL, the current web standards for style definition. Without requiring any real-time user interaction, 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 configuration and the complexity of the document. 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 assembly and composition process can be optimized for print, email and/or web presentation media for multi-channel distribution.

      Document Output Processing. The CompuSet Emitters transform CompuSet generated output into a number of popular Page Description Languages, or 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 finished documents. The Emitters also condition the PDLs for transport over a variety of high-speed printing interfaces and for support of various finishing devices. The PDL formats currently supported are Xerox Metacode, International Business Machines Corporation’s (IBM) AFPDS®, Hewlett-Packard Company’s PCL® and Adobe’s PostScript® and Portable Document Format (PDF). Output Processing extends the Emitters by enabling inline output stream manipulation including stream splitting, merging, resequencing, 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. This part of the Autograph architecture is extensible and new Emitters can be developed as necessary. In 2002, several additional Emitter extensions were released, including support for Xerox’s popular VIPP specification, enabling high-volume full-color production on Xerox DocuColor and iGen product lines.

      Autograph Rapid Application Development Tools. The Visual CompuSet Professional Edition (VCPro) application development tools run on Microsoft Windows® and simplify variable document application design and prototyping. Visual CompuSet supports all of the composition features of the NT, Unix and mainframe CompuSet production engines to ensure exact design for all supported production platforms, and includes a variety of content Importer, Merge, Font and Emitter tools necessary for basic application development. The content Importers accept externally generated document content, including text and forms,

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      XPression Document Publishing: As with Autograph, our new xPression product family is fully compatible with our core CompuSet, Emitter and Output Processing products. However, and rather than using the Autograph VCPro application development tools, xPression Design is integrated with Microsoft Word, the industry-standard authoring and design tool for regulated documents such as contracts and correspondence. Furthermore, xPression Design has been designed to integrate with other XML-compatible industry-standard tools planned to be supported in the future. In 2002, we began the design and development of a new Java-based composition engine. The design of the new composition engine incorporates the majority of the features available in the established CompuSet engine as well as significant extensions in the areas of complex multi-frame page layout, Unicode multi-language support including support for double-byte Asian languages and scalable multi-threaded performance. The new composition engine will support high-volume print applications as well as real-time transactional eBusiness applications. During 2003, we plan on releasing the first versions of our new xPression composition engine.

      Our products are usually licensed initially for a single document automation application. Regulated content applications such as policies and contracts are typically implemented using our Autograph DLS products whereas statement applications are typically implemented using our Autograph VCPro products, in each case driving document production through the CompuSet products. A growing number of customers are enterprise. Our xPression product family is targeted at customers that require universal content processing services on an open, standardized, enterprise-wide basis.

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 document automation applications. Professional services include on-site software installation, customer training programs, telephone support programs and consulting services. 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. Our consulting services can also be provided in conjunction with our system integration (SI) partners. In addition to consulting services, we provide introductory and advanced-level education classes in Autograph and xPression products at our headquarters in San Diego, our offices in Milwaukee and Washington DC and at customer sites. We believe that the use of our professional services enables customers to deploy our document automation products more rapidly and effectively. The professional services and support organizations employed a staff of 40 as of December 31, 2002.

Sales and Marketing

      Our sales and marketing organization targets vertical industry markets that require document automation and 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 the United States and Canada to provide optimal coverage. Outside of North America, we distribute our

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      We intend 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 IBM, Xerox, American Management Systems Inc. and Edgewater Technology Inc. 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 Siebel Systems, Inc., FileNet and Oracle, Inc. We participate in joint marketing events with our key partners whenever appropriate and feasible. Furthermore, we actively market our products and solutions at major trade shows, through focused regional seminars and through a variety of web marketing mechanisms, including webinars.

Research and Development

      We are continuing to enhance our web functionality across all of our major product offerings. We engage customers in a formal requirements analysis that is based on the Quality Function Deployment (QFD) process, which is a formal procedure for interviewing customers, identifying their needs and prioritizing specific product features. As a result, we have identified a number of customer requirements for the production of regulated, electronic documents of the future. Our major development initiatives in 2003 address several of these key requirements as brought to our attention through our ongoing QFD process.

      In general, our product development strategy is based on delivering document automation solutions for specific types of documents in one or more vertical markets or industries. A cross-functional team that includes a representative from each discipline in the company 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. We also employ iterative and rapid prototyping development methodologies.

      Our recent offerings continue to build on the Autograph family of products. These well-established products are maintained by teams that respond to customer requests for defect corrections and feature enhancements. By building on our existing products, we maximize our reuse of existing software and our expertise and we enable our Autograph customers to purchase these new offerings as upgrades to their existing product configurations.

      The xPression product offerings are being developed as components that 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 large systems integrators and other channels. By offering application migration paths wherever possible we enable our Autograph customers to purchase our new xPression offerings. We have a two-year, $3.1 million agreement with Objectiva Software Solutions, Inc. (Objectiva) to provide us development services in connection with our development of xPression.

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

      We expect to continue enhancing our existing products and to develop future new products, particularly as they relate to multi-channel content automation applications. Our research and development expenditures have grown substantially since our inception. Such expenditures, not including amounts capitalized, were $5.3 million, $5.9 million and $7.0 million in 2000, 2001 and 2002, respectively. Our development organization

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Competition

      The market for document automation 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 document automation processes to our document automation software. We also face competition from DocuCorp International, Inc. and InSystems Technologies, Inc., in the insurance industry; Metavante in banking and financial services; Group 1 Software, Inc. and Exstream Software, Inc. in commercial direct mailing and marketing, as well as 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.

      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 document automation 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 document automation 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, identified, licensed and integrated, which would adversely affect our business, operating results and financial condition.

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Customers

      We derived 17% of our revenues through Xerox and its affiliates in 2002. 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, 2002, we had 127 employees including 40 in professional services, 39 in sales and marketing, 36 in research and development and 12 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 the Annual Report under the heading “Notes to Consolidated Financial Statements — 3. Segment Information” and is incorporated herein by reference.

Recent Developments

      On February 10, 2003, we announced that we received approval from the Nasdaq Listing Qualifications department to transfer listing of our common stock from the Nasdaq National Market to the Nasdaq SmallCap Market. The transfer became effective at the opening of business on February 18, 2003.

      We applied to transfer to the Nasdaq SmallCap Market due to a change in a maintenance listing standard of the Nasdaq National Market from one based on Net Tangible Assets to one based on Stockholders’ Equity. In April 2001, we repurchased $14 million worth of its shares via a self-tender offer. This repurchase, which reduced our stockholders’ equity on the balance sheet by $14 million, was undertaken when the maintenance listing standard for the Nasdaq National Market required $4 million of Net Tangible Assets, with which we were in compliance. In November 2002, the Nasdaq National Market replaced the Net Tangible Assets listing standard with a minimum requirement of $10 million of Stockholders’ Equity. A consequence of our share repurchase, undertaken over a year earlier when the Net Tangible Assets listing standard was in place, is that our stockholders’ equity fell short of the Nasdaq National Market’s new Stockholder’s Equity listing standard.

      For more information regarding the transfer of listing of our common stock to the Nasdaq SmallCap Market, please see our Current Report on Form 8-K filed with the Securities and Exchange Commission on February 18, 2003.

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 all or part of your investment.

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

	•	the demand for our products;
	•	the level of product and price competition we face;
	•	the length of our sales cycle;
	•	the size and timing of individual license transactions;
	•	the delay or deferral of customer implementations;
	•	the budget cycles of our customers;
	•	our success in expanding our direct sales force or indirect distribution channels;
	•	the timing of our new product introductions and enhancements, as well as those of our competitors;
	•	our mix of products and services;
	•	our level of international sales;
	•	the activities of and acquisitions by our competitors;
	•	our timing of new hires;
	•	changes in foreign currency exchange rates;
	•	our ability to develop and market new products and to control costs; and
	•	general domestic and international economic conditions.

      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 in implementing some of our software, 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. If such expenses precede increased revenues, our operating results would 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 some future quarter may fall below the expectations of public market analysts and investors. If this occurs, the price of our common stock would likely be materially adversely affected.

      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 $5.2 million, $4.1 million and $4.0 million in 2000, 2001 and 2002, respectively, representing 23%, 19% and 17% of our total revenues, respectively.

      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. Though we intend to continue and further develop our existing relationships with Xerox, our strategy is to continue to lessen our dependence

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      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.

      We rely on a combination of copyright and trademark laws, trade secrets, confidentiality procedures and contractual provisions to protect our proprietary rights. Despite these precautions, 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, software piracy can be expected 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.

      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.

      We intend to optimize our worldwide sales and distribution channels by focusing on key target industry market segments where our current and planned products enjoy a significant competitive advantage and a current, high market demand. We also plan on leveraging our existing relationships with Xerox, IBM Corporation and their channels and affiliates 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. In addition, we intend to form additional partnerships with system integrators and consultants in order to broaden our capacity to deliver complete document automation solutions that incorporate significant services content, while also maintaining our core domain expertise. We cannot assure you that we will be able to successfully optimize 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.

      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 document automation applications. This strategy is dependent on retaining and hiring professionals to perform these consulting

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      The market for our document automation products is intensely competitive. We face competition from a broad range of competitors, some 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., Metavante Corporation, Group 1 Software, Inc., Exstream Software, Inc. and InSystems Technologies, Inc. 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.

      Our future business, operating results and financial condition will depend 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 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 new products and product enhancements will adequately meet the requirements of the marketplace or achieve market acceptance. 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.

      The licensing of our software products is often an enterprise-wide decision by prospective customers and generally involves a sales cycle of three to twelve months 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. For these and other reasons, our sales and customer implementation cycles 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.

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      We derived 70% and 23% of our initial license revenues from our CompuSet and DLS product lines in 2002, 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 continue to depend significantly on the successful development, introduction and customer acceptance of new and enhanced versions of our CompuSet and DLS software and related products.

      Licenses to end users in the insurance, finance and print service industries in the United States accounted for 90%, 97% and 97% of initial license revenues in 2000, 2001 and 2002, respectively. Our future success will depend on our ability to continue to successfully market our products in these and other industries. We cannot assure you that we will continue to be successful in developing and marketing CompuSet and DLS products and related services. Our failure to do so would have a material adverse effect on our business, operating results and financial condition.

      Our revenues from export sales, including sales through our foreign subsidiary, accounted for 28%, 21% and 23% of our total revenues in 2000, 2001 and 2002, respectively.

      Our wholly owned subsidiary, Document Sciences Europe, markets and supports our products in Europe, for which they receive an agent fee. We license our products in Europe through VAR’s and to a much lesser extent, direct sales. Our VARs are principally Xerox affiliates who re-market our products. Revenues generated by the activities of this subsidiary were $3.9 million, $2.7 million and $3.2 million in 2000, 2001 and 2002, respectively.

      In Australia, Canada and Brazil, we distribute our products through Fuji Xerox Co., Xerox Canada, Ltd. and Xerox do Brazil, Ltd., respectively. Revenues generated by these Xerox affiliates were $2.4 million, $2.1 million and $1.7 million in 2000, 2001 and 2002, 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:

	•	currency fluctuations;
	•	unexpected changes in regulatory requirements;
	•	tariffs and other trade barriers;
	•	our limited experience in localizing products for foreign countries;
	•	lack of acceptance of our localized products in foreign countries;
	•	longer accounts receivable payment cycles;
	•	difficulties in managing our international operations;
	•	potentially adverse tax consequences including restrictions on the repatriation of earnings; and
	•	the burdens of complying with a wide variety of foreign laws.

      A portion of our business is conducted in currencies other than the U.S. Dollar, primarily the Euro. Although exchange rate fluctuations have not had a significant impact on us, fluctuations in the value of the

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      The market for document automation software is intensely competitive, highly fragmented and subject to rapid change. We cannot assure you that the market for document automation software will 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 document automation software market fails to develop or 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 document automation 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 this market.

      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 future performance depends in significant part upon the continued service of our key technical, sales and senior management personnel. Only our President and Chief Executive Officer and Chief Scientist have signed employment agreements with us. 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, assimilate or retain other highly qualified product development, sales and managerial personnel in the future.

      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.

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      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. Although our business has not been adversely affected by any such errors to date, we cannot assure you that, despite our testing and testing by current and potential customers, errors will not be found in our products or releases. If these errors are discovered after the commencement of commercial shipments, it could result in any of the following:

	•	loss of revenue or delay in market acceptance;
	•	diversion of our development resources;
	•	damage to our reputation; or
	•	increased service and warranty costs.

      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. Our subsidiary in France occupies approximately 2,200 square feet of office space with a renewable lease expiring on April 15, 2004. In addition, our regional office in Milwaukee, Wisconsin occupies approximately 7,500 square feet of office space pursuant to a lease expiring on June 30, 2003. Sales representatives and field technical support personnel operate from their homes. 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 21, 2003, 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 2002.

PART II

      Our common stock is presently traded on The Nasdaq SmallCap under the symbol “DOCX.” Until February 18, 2003, our common stock was traded on The Nasdaq National Market System. The following table sets forth the range of high and low sales prices of our common stock for the periods indicated, as

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      We had 3,874,730 shares outstanding and 106 record holders of our common stock as of March 24, 2003. We did not make any sales of unregistered stock in 2000, 2001 or 2002. We have not paid dividends on our common stock and do not anticipate paying dividends in the foreseeable future.

Item 6.     Selected Financial Data

      The following table presents selected financial data of Document Sciences Corporation. This historical data should be read in conjunction with the Consolidated Financial Statements and the related notes thereto in Item 8 and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7. The drop in working capital from 2000 to 2001 was due to our tender offer completed in April 2001 where we purchased 6,000,000 shares of our outstanding common stock for $2.00 per share.

      Except for the historical information, the following discussion contains forward-looking statements that are subject to risks and uncertainties. Actual results may differ substantially from those described below, including those risks described in the section entitled, “Business — Risk Factors,” and elsewhere in this Annual Report. Our discussion and analysis of the financial condition and results of operations of Document Sciences and its subsidiary should be read in conjunction with the consolidated financial statements and related notes.

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Critical Accounting Policies

      Our discussion and analysis of the financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates and judgments, including those related to revenue recognition, computer software costs, allowance for doubtful accounts and valuation allowance for net deferred tax assets. We base our estimates on historical and anticipated results and trends and on assumptions that we believe are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. By their nature, estimates are subject to an inherent degree of uncertainty. Actual results may differ from our estimates. We believe that the following critical accounting policies and assumptions may involve a higher degree of judgment and complexity than others.

      Revenue Recognition. We recognize revenue in accordance with Statement of Position (SOP) 97-2, Software Revenue Recognition, and Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial Statements. Initial license fees are recognized when a contract exists, the fee is fixed and determinable, software delivery has occurred and collection of the receivable is deemed probable. We use the residual method to recognize revenue for all of our license models. Our contracts specifically state the amount of initial and annual license fees due for each type of software licensed. If an undelivered element of the arrangement exists under the license arrangement, revenue is deferred based on vendor-specific objective evidence of the fair value of the undelivered element. If vendor-specific objective evidence of fair value does not exist for all undelivered elements, all revenue is deferred until sufficient evidence exists or all elements have been delivered. We recognize revenue on transactions with payment terms greater than 30 days but less than twelve months from the contract date, if we have a history of successfully collecting from the specific customer without providing concessions. Amounts billed or payments received in advance of revenue recognition are recorded as deferred revenue.

      We work in conjunction with our established VARs, with whom we have formal contracts defining the rights and obligations of the parties, to license software to end-users. We license software to our VARs, less a discount, from a fixed price list. We require a binding purchase order as evidence of an unconditional order by an end user from our VARs, with no rights of return or acceptance. License revenue from our VARs is recognized when software is licensed to an end user.

      Annual renewal license and support fees (ALF) are recognized ratably over the contract period. Included in our ALF are unspecified maintenance releases. Our contracts do not provide for specific upgrades. Our standard contracts do not provide for rights of return or conditions of acceptance; however, in the rare case that acceptance criteria are provided, revenue is deferred and not recognized until all conditions are satisfied and written customer acceptance is obtained. We believe this approach to revenue recognition, when acceptance criteria exist, would not result in materially different amounts being reported under different conditions or using different assumptions.

      Revenues generated from consulting services are recognized as the related services are performed and collectibility is deemed probable. However, when such consulting services are deemed to be essential to the functionality of the delivered software product, revenue from the entire arrangement is recognized on a percentage of completion method or not until the contract is completed in accordance with SOP 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts, and Accounting Research Bulletin (ARB) No. 45, Long-Term Construction-Type Contracts. We measure progress under the percentage of completion method, depending on how the contract language is written, either by using the percentage of total project hours completed or by the completion of phases in the consulting project. Because (i) the phases of our consulting projects are generally not of great duration (2-6 weeks on average) and (ii) we have a variety of projects progressing at the same time, we believe that there are very limited circumstances where materially different amounts would be reported under different conditions or using different assumptions.

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      We consider our anticipated revenue levels when making decisions about our operating expenses. 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. Since revenue may not be recognized in the same quarter as when shipment occurs and if such fixed expenses are incurred before we recognize revenues for these shipments, our operating results would be materially adversely affected.

      Software Development Costs. In accordance with Statement of Financial Accounting Standards (SFAS) No. 86, Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed, costs incurred in the research and development of new software products and significant enhancements to existing software products are expensed as incurred until technological feasibility of the product has been established. After technological feasibility has been established, direct production costs, including programming and testing, are capitalized until general release of the product.

      Capitalized costs of software to be sold, licensed or otherwise marketed are amortized using the greater of the amount computed using the ratio of current period product revenues to estimated total product revenues or the straight-line method over the remaining estimated economic lives of the products. It is possible that estimated total product revenues, the estimated economic life of the product, or both, will be reduced in the future. As a result, the carrying amount of capitalized software costs may be reduced in the future, which could cause our operating results in future periods to be adversely affected.

      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. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required which would result in an additional general and administrative expense in the period such determination was made. At the end of each reporting period, we perform a rigorous review of outstanding balances by customer and invoice. We utilize statistical and account specific analysis to determine the adequacy of our reserve, as well as comparing balances to historical losses. If our assumptions or analysis are incorrect, our operating results for future periods may be adversely affected.

      Deferred Income Taxes. Deferred income taxes reflect the net effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. At December 31, 2002, we had net deferred tax assets of $2.0 million. Due to the uncertainty of realizing a portion of these net deferred tax assets, we have maintained a valuation allowance of $1.6 million for net deferred tax assets. Such uncertainty primarily relates to the potential for future taxable income as well as loss carryforwards and tax credits expiring in 2018 and 2012, respectively. In addition, pursuant to Sections 382 and 383 of the Internal Revenue Code, annual use of our net operating loss carryforwards may be limited in the event of a cumulative change in ownership of more than 50% within a three-year period. No valuation allowance has been recorded to offset the remaining $305,000 of net deferred tax assets as we have determined that it is more likely than not that these assets will be realized during the year ending December 31, 2003. We will continue to assess the likelihood of realization of such assets; however, if future events occur which do not make the realization of such assets more likely than not, we will record a valuation allowance against all or a portion of these net deferred tax assets. An example of a future event that may occur which would make the realization of such assets not likely is a lack of taxable income resulting from poor operating results.

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Results of Operations for the Years Ended December 31, 2000, 2001 and 2002

      The following table sets forth, for the periods indicated, certain financial data as a percentage of total revenues:

      Total revenues were $22.6 million, $22.1 million and $23.1 million in 2000, 2001 and 2002, respectively, representing a decrease of 2% from 2000 to 2001 and an increase of 5% from 2001 to 2002. Our revenues are divided into three categories based upon the sources from which they are derived: initial license fees, annual renewal license and support fees, and services and other revenues. Initial license fees consist primarily of upfront license fees for the first year of use of our products. Annual renewal license and support fees consist of license fees for the initial and continued use and support of our licensed products. Services and other revenues consist of fees for consulting, application development and training services performed by us as well as miscellaneous other operational revenues.

      We sell our products principally through our direct sales force domestically, and internationally through distributors and VARs. Revenues from export sales and sales through our foreign subsidiary were $6.3 million, $4.7 million and $5.3 million in 2000, 2001 and 2002, respectively, representing a decrease of 25% from 2000 to 2001 and an increase of 13% from 2001 to 2002. Revenue from export sales were 28%, 21% and 23% of total revenues in 2000, 2001 and 2002, respectively. The increase from 2001 to 2002 was the result of higher revenues in Europe and Canada, offset by lower revenues in Brazil. The decrease from 2000 to 2001 was the result of lower initial license fees in all regions.

      We have entered into distributorship agreements with various Xerox foreign affiliates to remarket our products internationally. Our revenues from these agreements were $4.7 million, $3.7 million and $3.6 million

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      Initial license fees. Initial license fees were $10.3 million, $8.2 million and $9.6 million in 2000, 2001 and 2002, respectively, representing a decrease of 20% from 2000 to 2001 and an increase of 17% from 2001 to 2002. The increase in 2002 was due to higher sales in the United States, Canada and Europe, as well as the release of our new product, xPression. Additionally, 2002 initial license fees have benefited from several contracts where customers extended their relationship with us following the expiration of their three-year contracts. Such contract extensions totaled $2.4 million. Because we have de-emphasized three-year term agreements, it is expected that the revenue from such extensions will decline significantly in 2003. The decrease in 2001 was largely the result of fewer sales and fewer new customers from our foreign resellers.

      The components of initial license fees consist of the following:

      Annual renewal license and support fees. Annual renewal license fees were $8.6 million, $8.7 million and $9.6 million in 2000, 2001 and 2002, respectively, representing increases of 1% from 2000 to 2001 and 10% from 2001 to 2002. The increase in 2002 was due to increases in our base of licensed software and in our list prices. The increase in 2001 was due to an increase in our installed base of users offset by the impact of discontinuing support for certain products and platforms.

      Services and other. Revenues from services and other were $3.7 million, $5.2 million and $3.9 million in 2000, 2001 and 2002, respectively, representing an increase of 41% from 2000 to 2001 and a decrease of 25% from 2001 to 2002. The decrease in 2002 was largely due to customer delays in initiating contracted projects, as well as the mix of software being licensed that requires fewer services. The increase in 2001 was due to the delivery of consulting services needed to implement new product sales made during the fourth quarter of 2000 as well as significant follow-on services to existing customers.

      Cost of initial license fees. Costs of initial license fees were $1.6 million, $1.5 million and $1.6 million in 2000, 2001 and 2002, respectively, representing 16%, 18% and 17% of initial license fees in 2000, 2001 and 2002, respectively. Cost of initial license fees includes amortization of previously capitalized software development costs, costs of third party software, employment costs for distribution personnel and product packaging. The increase in 2002 compared to 2001 was primarily the result of higher sales and an increase in the amortization of software. The decrease in 2001 compared to 2000 was due to lower sales and a decrease in the amortization of software.

      Cost of annual renewal license and support fees. Costs of annual license fees were $1.3 million, $1.5 million and $1.5 million in 2000, 2001 and 2002, respectively, representing 15%, 17% and 16% of annual license fees in 2000, 2001 and 2002, respectively. Costs of annual renewal license fees consist principally of the employment-related costs for our technical support staff. Due to increased efficiencies, we were able to keep a steady headcount in 2002 compared to 2001. The increase in 2001 compared to 2000 was due to additional technical support personnel to support our increasing customer base.

      Cost of services and other. Costs of services and other were $2.5 million, $3.0 million and $2.6 million in 2000, 2001 and 2002, respectively, representing 68%, 58% and 67% of services and other revenue in 2000, 2001

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      Research and development. Research and development expenses were $4.2 million, $5.2 million and $5.5 million in 2000, 2001 and 2002, respectively, representing increases of 24% from 2000 to 2001 and 6% from 2001 to 2002. Research and development expenses consist primarily of the employment-related costs of personnel associated with developing new products, enhancing existing products, testing software products and developing product documentation. We anticipate that we will continue to direct significant resources to the development and enhancement of our products. In connection with a development services and referral agreement effective January 16, 2002, we have a two-year, $3.1 million agreement with Objectiva to provide us development services in connection with our new product, xPression. In 2002, Objectiva performed approximately 50% of the services of this agreement and we paid them $1.6 million.

      We capitalized software development costs of $1.2 million, $717,000 and $1.6 million in 2000, 2001 and 2002, respectively. The increase between 2002 and 2001 was mainly due to development costs of our new product, xPression. The decrease between 2001 and 2000 was due to timing of technological feasibility. Capitalized software development costs mainly include payroll related costs and consulting fees paid to Objectiva in relation to the development of xPression. The amount of software development costs to be capitalized in the future may change if the time between the establishment of technological feasibility of a product and its general release changes.

      Selling and marketing. Selling and marketing expenses were $8.4 million, $7.2 million and $7.8 million in 2000, 2001 and 2002, respectively, representing a decrease of 14% from 2000 to 2001 and an increase of 8% from 2001 to 2002. Selling and marketing expenses consist primarily of salaries, commissions, marketing programs and related costs for pre- and post-sales activity. The increase in 2002 was primarily due to increased personnel costs, as well as higher trade show and travel costs. The decrease in 2001 was primarily due to fewer personnel and decreased commissions due to decreased initial license fees.

      General and administrative. General and administrative expenses were $5.0 million, $3.4 million and $3.0 million in 2000, 2001 and 2002, respectively, representing decreases of 32% from 2000 to 2001 and 12% from 2001 to 2002. General and administrative expenses consist of employment-related costs for finance, administration and human resources, allowance for doubtful accounts and general corporate management expenses, including legal and audit fees. These decreases were primarily due to decreased personnel and outside consultant costs.

      Other income (expense). Other income (expense) is composed of interest income from cash and cash equivalents and short-term investments offset by interest expense related to notes to Xerox and losses on disposal of fixed assets. Other income was $961,000, $281,000 and $93,900 in 2000, 2001 and 2002, respectively. The decrease in 2002 was the result of less interest income due lower cash balances following the $2.5 million debt payment in February and lower interest rates. The decrease in 2001 was the result of less interest income following a large decrease in our cash balances as a result of our tender offer which was completed in April 2001.

      Provision (benefit) for income taxes. As a result of releasing a portion of our previously recorded valuation allowance on net deferred tax assets, we have recorded a $290,000 benefit for income taxes in the year ended December 31, 2002. We will continue to assess the likelihood of realization of our tax credits and other net deferred tax assets. If future events occur that do not make the realization of such assets more likely than not, a valuation allowance will be established against all or a portion of the net deferred tax assets. The provision for income taxes for 2000 and 2001 was for taxes under the alternative minimum tax.

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Factors That May Affect Future Operating Results

      Our total revenues and operating results can vary, sometimes substantially, from quarter to quarter and are expected to vary significantly in the future. Our revenues and operating results are difficult to forecast. Future results will depend upon many factors, including the demand for our products, the level of product and price competition, the length of our sales cycle, the size and timing of individual license transactions, the delay or deferral of customer implementations, the budget cycles of our customers, our success in expanding our direct sales force and indirect distribution channels, the timing of new product introductions and product enhancements by us and our competitors, the mix of products and services sold, levels of international sales, activities of and acquisitions by competitors, the timing of new hires, changes in foreign currency exchange rates, our ability to develop and market new products, controlling costs and general domestic and international economic conditions. In addition, our sales generally reflect a relatively high amount of revenue per order, and, therefore, the loss or delay of individual orders could have a significant impact on our revenues and quarterly operating results. In addition, a significant amount of our revenues occur predominantly in the third month of each fiscal quarter and tend to be concentrated in the latter half of that third month.

      Our software products generally are shipped as orders are received. As a result, initial license fees in any quarter are substantially dependent on orders booked and shipped in that quarter. The timing of receipt of initial license fees is difficult to predict because of the length of our sales cycle, typically three to twelve months from the initial contact. Because our operating expenses are based on anticipated revenue trends and because a high percentage of our expenses are relatively fixed, a delay in the recognition of revenue from a limited number of initial license transactions could cause significant variations in operating results from quarter to quarter and could result in losses. To the extent such expenses precede, or are not subsequently followed by, increased revenues, our operating results could be materially adversely affected.

      Due to the foregoing factors, revenues and operating results for any quarter are subject to significant variation, and we believe that period-to-period comparisons are not necessarily meaningful and should not be relied upon as indications of future performance.

Liquidity and Capital Resources

      At December 31, 2002, we had $8.6 million in cash, cash equivalents and short-term investments. This is a decrease of $0.3 million from December 31, 2001. In February 2002, we paid $2.5 million to Xerox to retire debt pursuant to our 2001 tender offer.

      Net cash provided by operating activities increased 33% to $4.0 million for the year ended December 31, 2002 from $3.0 million for the year ended December 31, 2001. This increase is due largely to a favorable change in operating assets and liabilities.

      Net cash used in investing activities was $2.5 million for the year ended December 31, 2002. Net cash provided by investing activities was $7.3 million for the year ended December 31, 2001. Cash used in investing activities for the year ended December 31, 2002 related primarily to the capitalization of computer software costs and net purchases of short-term investments. Cash provided by investing activities for the year ended December 31, 2001 related primarily to proceeds received from our 2001 sale of short-term investments in preparation for payments made in April 2001 in connection with our tender offer in which we purchased 6,000,000 shares of our common stock for $12 million.

      Net cash used in financing activities decreased 80% to $2.4 million for the year ended December 31, 2002 from $11.9 million for the year ended December 31, 2001. Cash used in financing activities for the year ended December 31, 2002 related primarily to the payment of notes to Xerox pursuant to our 2001 tender offer. Cash used in financing activities for the year ended December 31, 2001 reflected the cash portion of our 2001 tender offer.

      We believe that our existing cash balances and anticipated cash flows from operations will be sufficient to meet our anticipated cash needs for working capital and capital expenditures at least through the next twelve months. However, if there were a decrease in customer demand for our products, our availability of funds would be reduced. A portion of our remaining cash could be used to acquire or invest in complementary

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      As of December 31, 2001 and 2002, we did not have any other relationships with unconsolidated entities or financial partners, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

Recently Issued Accounting Standards

      In December 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure — an Amendment of FASB Statement No. 123. This statement amends SFAS No. 123 “Accounting for Stock-Based Compensation” to provide alternative methods of voluntarily transitioning to the fair value based method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure requirements of SFAS No. 123 to require disclosure of the method used to account for stock-based employee compensation and the effect of the method on reported results in both annual and interim financial statements. The disclosure provisions will be effective for us beginning with our year ended December 31, 2003. We have not yet completed the final evaluation of the options presented by SFAS No. 148. However, within this fiscal year, we expect to reach a determination of whether and, if so, when to change our existing accounting for stock-based compensation to the fair value method in accordance with the transition alternatives of SFAS No. 148.

      In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal. SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). The principal difference between SFAS No. 146 and Issue 94-3 relates to SFAS No. 146’s requirements for recognition of a liability for a cost associated with an exit or disposal activity. SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost as generally defined in Issue 94-3 was recognized at the date of an entity’s commitment to an exit plan. The provisions of SFAS No. 146 are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. We will adopt SFAS No. 146 effective January 1, 2003. We do not expect that the adoption of SFAS No. 146 will have a material impact on our financial statements.

Item 7A.     Quantitative and Qualitative Disclosures About Market Risk

Foreign Currency Exchange Risk

      Our earnings and cash flows are subject to fluctuations due to changes in foreign currency exchange rates. To a certain extent, foreign currency exchange rate movements also affect our competitive position, as exchange rate changes may affect business practices and/or pricing strategies on non-U.S. based competitors. The primary foreign currency risk exposure is related to U.S. Dollar to Euro conversions. Considering the anticipated cash flows from firm sales commitments and anticipated sales for the next quarter, a hypothetical 10% weakening of the U.S. Dollar relative to all other currencies would not materially adversely affect expected first quarter 2003 earnings or cash flows. This analysis is dependent on actual export sales during the next quarter occurring within 90% of budgeted forecasts. The effect of the hypothetical change in exchange rates ignores the affect this movement may have on other variables including competitive risk. If it were possible to quantify this competitive impact, the results could well be different than the sensitivity effects described above. In addition, it is unlikely that all currencies would uniformly strengthen or weaken relative to the U.S. Dollar. In reality, some currencies may weaken while others may strengthen. Each month, we review our position for expected currency exchange rate movements.

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Interest Rate Risk

      We are exposed to changes in interest rates primarily from our short-term available-for-sale investments. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of our interest sensitive financial instruments at December 31, 2002. Declines in interest rates over time will, however, reduce our interest income.

Item 8.     Financial Statements and Supplementary Data

      The financial statements and supplementary data required by this item are set forth at the end of this Annual Report on Form 10-K beginning on page F-1 and is incorporated into this item by reference.

Item 9.     Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

      None.

PART III

Item 10.     Directors and Executive Officers of the Registrant

      The information required by this item concerning our directors and certain information regarding our executive officers is incorporated by reference to the information set forth in the sections entitled “Election of Directors — Nominees,” “Compensation of Executive Officers” and “Section 16(a) Beneficial Ownership Reporting Compliance” in our Proxy Statement for the 2003 Annual Meeting of Stockholders.

Executive Officers of Document Sciences

      The executive officers of Document Sciences and their ages, as of March 24, 2003, are as follows:

      John L. McGannon has served as President and Chief Executive Officer since January 2001 and Chief Financial Officer since December 1999. He has also served as Vice President, Chief Administrative Officer and Controller since joining Document Sciences in September 1998. From June 1997 through August 1998, Mr. McGannon served as the Manager of Financial Analysis and Planning for Simulation Sciences, Inc., a California-based software developer for the oil and chemical engineering industries. Mr. McGannon worked for Chevron Corporation from 1988 to 1997 in a variety of financial management positions. Mr. McGannon holds a BA degree from Stanford University and an MBA from Carnegie Mellon University.

      Daniel J. Fregeau has served as Executive Vice President since January 2001. From 1998 to 2001, he served as Vice President of Worldwide Sales and Business Development, from 1997 to 1998, he served as Vice President, Business Development, from 1994 to 1997, he served as Vice President, Marketing and from 1992 to 1994, he served as Vice President, Sales. Prior to joining Document Sciences, Mr. Fregeau was Marketing Manager for the Networking Division of Sears Business Centers, San Diego, from 1990 to 1992. Mr. Fregeau was a founder and principal of MicroAge in San Diego from 1988 to 1990. From 1982 to 1988, Mr. Fregeau held several positions with Xerox Corporation’s Electronic Publishing Business Unit including Manager of Systems Engineering and Integration, Technical Program Manager and Project Manager. While at Xerox,

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      J. Douglas Pike has served as Vice President, Worldwide Sales since January 2001. He had previously served as Director of U.S. Sales and Area Sales Manager since joining Document Sciences in January 1995. From 1990 to 1994, Mr. Pike was employed by Xerox Corporation to provide digital printing solutions to major accounts in the insurance and finance industries. Mr. Pike also worked for Unisys Corporation for seven years providing custom software application and database solutions as an account executive. Mr. Pike holds a B.S. degree in Industrial Technology from the State University of New York.

      Lisa L. Sutrick has served as Vice President, Product Planning and Development since January 2002. She had previously served in the capacities of Director of Product Planning and Development, Director of Product Marketing, Product Marketing Manager for Document Library Services and Program Manager in Development since joining Document Sciences in May 1997. From 1987 to 1997, Ms. Sutrick worked for Data Retrieval Corporation, a Wisconsin software company purchased by Document Sciences in May 1997, in a variety of customer focused software development positions. Ms. Sutrick holds a B.S. degree in Applied Mathematics from the University of Wisconsin, Stout.

      Executive officers are appointed by the Board of Directors and serve at the discretion of the Board. There are no family relationships among any directors or executive officers of Document Sciences.

      The information required by this item regarding executive compensation is incorporated by reference to the information set forth in the sections entitled “Executive Officer Compensation” and “Compensation of Directors” in our Proxy Statement for the 2003 Annual Meeting of Stockholders.

      The information required by this item regarding security ownership of certain beneficial owners and management is incorporated by reference to the information set forth in the section entitled “Security Ownership of Management and Certain Beneficial Owners” in our Proxy Statement for the 2003 Annual Meeting of Stockholders.

      The information required by this item regarding certain relationships and related transactions is incorporated by reference to the information set forth in the section entitled “Certain Transactions” in our Proxy Statement for the 2003 Annual Meeting of Stockholders.

      (a) Under the supervision and with the participation of our management, including our principal executive officer/ principal financial officer, we conducted an evaluation of the effectiveness of design and operation of our disclosure controls and procedures, as such term is defined under Rule 13a-14(c) promulgated under the Securities Exchange Act of 1934, as amended, within 90 days prior to the filing date of this Annual Report. Based on his evaluation, our principal executive officer/ principal financial officer concluded that our disclosure controls and procedures are effective as of the evaluation date.

      (b) There have been no significant changes (including corrective actions with regard to significant deficiencies or material weaknesses) in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referenced in paragraph (a) above.

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PART IV

      (a) The following documents are filed as part of this Form 10-K:

	1. Financial Statements. The financial statements, related notes thereto and the Report of Independent Auditors required hereunder are set forth at the end of this Annual Report beginning on page F-1.
	2. Financial Statement Schedule. The following financial statement schedule for the fiscal years ended December 31, 2000, 2001 and 2002 is filed as part of this Form 10-K beginning on page S-1 and should be read in conjunction with our consolidated financial statements and related notes thereto.

	Schedules other than those listed above have been omitted since they are either not required, not applicable or the information is otherwise included.
	3. Exhibits. See Item 15(c) below.

      (b) Reports on Form 8-K. No reports on Form 8-K were filed by us during the fiscal quarter ended December 31, 2002.

      (c) Exhibits. The exhibits listed on the accompanying index to exhibits immediately following the financial statement schedules are filed as part of, or incorporated by reference into, this Form 10-K.

      (d) Financial Statement Schedules. See Item 15(a) above.

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SIGNATURES

      Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.

	DOCUMENT SCIENCES CORPORATION

	By:	/s/ JOHN L. MCGANNON

	John L. McGannon
	President and Chief Executive Officer

Dated: March 24, 2003

POWER OF ATTORNEY

      KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints John L. McGannon his attorney-in-fact, with full power of substitution, for him in any and all capacities, to sign any and all amendments to this Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that said attorney-in-fact or his substitute, may do or cause to be done by virtue hereof.

      Pursuant to the requirements of the Securities Exchange Act of 1934, this Form 10-K has been signed below by the following persons on behalf of the Registrant on March 24, 2003 in the capacities indicated:

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CERTIFICATION

PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, John L. McGannon, certify that:

      1. I have reviewed this Annual Report on Form 10-K of Document Sciences Corporation;

      2. Based on my knowledge, this Annual Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Annual Report;

      3. Based on my knowledge, the financial statements, and other financial information included in this Annual Report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this Annual Report;

      4. I am responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

	(a) Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to me by others within those entities, particularly during the period in which this Annual Report is being prepared;
	(b) Evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this Annual Report (the “Evaluation Date”); and
	(c) Presented in this Annual Report my conclusions about the effectiveness of the disclosure controls and procedures based on my evaluation as of the Evaluation Date;

      5. I have disclosed, based on my most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

	(a) All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
	(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

      6. I have indicated in this Annual Report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of my most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

	/s/ JOHN L. MCGANNON
	John L. McGannon
	President, Chief Executive Officer and
	Chief Financial Officer

Date: March 24, 2003

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DOCUMENT SCIENCES CORPORATION

ANNUAL REPORT ON FORM 10-K

(1)	Previously filed as exhibits to Registration Statement on Form S-1 Registration Number 333-06344.
(2)	Indicates management compensatory plan, contract or arrangement.
(3)	Previously filed as exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1997.

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(4)	Previously filed as exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1998.
(5)	Previously filed as exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000.
(6)	Previously filed as exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.
(7)	Filed herewith.

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DOCUMENT SCIENCES CORPORATION

F-1

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REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders

      We have audited the accompanying consolidated balance sheets of Document Sciences Corporation (the “Company”) as of December 31, 2001 and 2002, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2002. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

      We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

      In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Document Sciences Corporation at December 31, 2001 and 2002, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

      As discussed in Note 1 to the consolidated financial statements, Document Sciences Corporation changed its method of accounting for purchased goodwill and other intangible assets in accordance with Statement of Financial Accounting Standards No. 142 during the first quarter of fiscal 2002.

	ERNST & YOUNG LLP

San Diego, California

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DOCUMENT SCIENCES CORPORATION

See accompanying notes.

F-3

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DOCUMENT SCIENCES CORPORATION

See accompanying notes.

F-4

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DOCUMENT SCIENCES CORPORATION