UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended March 31,June 30, 2007

OR

For the transition period from            to            

Commission File Number 000-20981

DOCUMENT SCIENCES CORPORATION

(Exact name of registrant as specified in its charter)

5958 Priestly Drive

Carlsbad, California 92008

(Address of Principal Executive Offices including Zip Code)

(760) 602-1400

(Registrant’sRegistrant's Telephone Number including Area Code)

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

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non- accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ¨    Accelerated filer  ¨    Non-accelerated filer  x

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of May 15,August 2, 2007, there were 4,424,3353,954,413 shares of common stock of the registrant outstanding.

DOCUMENT SCIENCES CORPORATION

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PART I. FINANCIAL INFORMATION

ITEM 1–1—FINANCIAL STATEMENTS (Unaudited)

DOCUMENT SCIENCES CORPORATION

CONSOLIDATED BALANCE SHEETS

Note: The balance sheet at December 31, 2006 has been derived from the audited consolidated financial statements at that date but does not include all of the information and disclosures required by U.S. generally accepted accounting principles for complete financial statements.

See notes to unaudited consolidated financial statements.

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DOCUMENT SCIENCES CORPORATION

CONSOLIDATED INCOME STATEMENTS OF OPERATIONS

(UNAUDITED)

See notes to unaudited consolidated financial statements.

4

DOCUMENT SCIENCES CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

See notes to unaudited consolidated financial statements.

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DOCUMENT SCIENCES CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

March 31,June 30, 2007

Note A—Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States for interim financial statements and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information and disclosures normally included in complete financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the statements include all adjustments necessary, which are of a normal and recurring nature, for the fair presentation of our financial position and of the results of operations and cash flows for the interim periods presented.

Certain prior year amounts have been reclassified to be consistent with the current year presentation. Following a review of the Company’s accounting for the recording of accounts receivable and deferred revenue related to unpaid invoices for renewals of existing annual licenses that were invoiced prior to the commencement of the annual license period, the Company has removed approximately $3,849,000 from accounts receivable and from deferred revenue on its balance sheet. The reduction had no effect on net profit (loss), net profit (loss) per share, or stockholders’ equity for all periods presented.

These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2006, included in Document Sciences Corporation’s Annual Report on Form 10-K filed with the Securities and Exchange Commission. Operating results for the three and six months ended March 31,June 30, 2007 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, 2006.2007. The consolidated balance sheet at December 31, 2006 has been derived from the audited financial statements at that date but does not include all of the information and disclosures required by accounting principles generally accepted in the United States for complete financial statements.

Note B—Revenue Recognition

We derive our revenues principally from the licensing of software, post contract support fees (PCS), and professional services. We recognize revenue in accordance with Statement of Position (SOP) 97-2,Software Revenue Recognition. Although some software is licensed on aWe offer both perpetual basis, the majority of our licenses are currentlyand time-based licenses that are required to be renewed annually. Revenues are recognized when a contract exists, the fee is fixed and determinable, software delivery has occurred and collection of the receivable is deemed probable. Amounts billed or payments received in advance of revenue recognition are recorded as deferred revenue.

If an arrangement includes multiple elements, we allocate the contract amount to the various elements based on vendor-specific objective evidence (VSOE) of fair value, regardless of any separate prices stated within the contracts for each element. We base our VSOE on the price charged when the same element is sold separately. If an undelivered element of the arrangement exists, revenue is deferred based on VSOE of the fair value of the undelivered element. If VSOE 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 use the residual method to recognize revenue when an arrangement includes one or more elements to be delivered at a future date and VSOE of the fair value of all undelivered elements exists.

We recognize fees for annual licensing arrangements ratably over the contract term of twelve months because we are unable to establish VSOE for the license and support elements under this type of bundled arrangement.

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For perpetual license arrangements, VSOE of fair value for ongoing maintenance and support obligations (PCS) is determined based upon the historical, stand-alone renewal rates or pricing. We recognize revenue relating to the perpetual software license arrangements at inception of the arrangement using the residual method as discussed above.

Our contracts do not provide for specific upgrades. In addition, our standard contracts do not provide for rights of return or conditions of acceptance; however, in cases where acceptance criteria are provided, revenue is deferred and not recognized until all conditions are satisfied and written customer acceptance is obtained.

Professional services revenue includes consulting services and training related to our software products. Revenues generated from consulting services and training are recognized as the related services are performed and collectibility is deemed probable, based on VSOE of fair value of the services. VSOE of fair value for professional services is determined based upon the price charged when these services are sold separately. For professional services that are bundled with annual software licenses and are not deemed to be essential to the functionality of the delivered software product, we recognize the entire arrangement fee ratably over the longer of the period over which the professional services are expected to be rendered, or the PCS period, beginning with delivery of the software and commencement of the professional services. In the vast majority of cases, the arrangement fee is recognized ratably over the twelve month PCS period. In certain limited situations where we determine that professional services period is the longer period, upon the end of the PCS term, we recognize license and PCS revenues at that stage (on the residual basis), recognizing the remaining deferred revenue for the unfinished services over the remaining period of such services.

If 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 the phases of our consulting projects are generally not of great duration (2-6 weeks on average), we believe that there are very limited circumstances where materially different amounts would be reported under different conditions or using different assumptions.

We work in conjunction with our established VARs,value-added resellers (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.

Note C—Computation of Net Income (Loss) Per Share

We present our net income (loss) per share information in accordance with Statement of Financial Accounting Standards (SFAS) 128,Earnings per Share (EPS). Basic EPS is computed by dividing income or loss available to common stockholders (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Shares issued during the period and shares reacquired during the period are weighted for the portion of the period that they were outstanding. Basic EPS excludes any dilutive effects of options.

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The computation of diluted EPS is similar to the computation of basic EPS, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the common shares underlying outstanding options had been issued. The dilutive effect of outstanding options and warrants has been reflected in EPS by application of the treasury stock method. The treasury stock method recognizes the use of proceeds that could be obtained upon exercise of options and warrants in computing diluted EPS. It assumes that any proceeds would be used to purchase common stock at the average market price during the period. Options and warrants will have a dilutive effect under the treasury stock method only when the average market price of the common stock during the period exceeds the exercise price of the options or warrants. Common stock options to purchase 7,90076,758 and 23,57751,135 shares were excluded from the calculation of weighted-average shares used in determining diluted EPS for the three and six months ended March 31,June 30, 2007, respectively, and 35,455 and 20,577 shares were excluded from the calculation of weighted-average shares used in determining diluted EPS for the three and six months ended June 30, 2006, respectively, as their effect would have been antidilutive.

The following table reconciles the shares used in computing basic and diluted EPS for the periods indicated:

Note D—Bank Line of Credit

In June 2007 we entered into a bank credit agreement that provides us with a senior secured revolving credit facility of up to $6 million through June 2009. Loans under the agreement are expected to initially bear interest at a rate equal to the bank’s prime rate plus 0.75% and will continue to bear interest at that pricing level (subject to a floor of 7.75% on bank’s prime rate) so long as a liquidity ratio threshold (as defined in the agreement) is in effect. If the liquidity ratio threshold is deemed to no longer be in effect and the interest rate applicable to the loans will increase to bank’s prime rate plus 2.0% until we can maintain and meet the defined liquidity ratio for a period of three consecutive months, at which time the interest rate applicable to the loans would return to bank’s prime rate plus 0.75%. In addition, the Company is required to pay an annual loan fee, an unused revolving line facility fee, and an early termination fee if the agreement is terminated prior to its maturity date.

Availability of proceeds under the agreement are subject to a borrowing base formula equal to the lesser of $6 million and an advance rate percentage of 80% of the Company’s eligible billed accounts receivable. The agreement includes a tangible net worth covenant and also contains other customary

terms and conditions, including representations and warranties, affirmative and negative covenants, events of default and indemnity provisions. Such covenants, among other things, could limit the Company’s ability to incur indebtedness, incur liens or other encumbrances, enter into mergers, consolidations and asset sales, engage in transactions with affiliates, pay dividends or other distributions, and change the nature of the business conducted by us. All advances made under the agreement are secured by a first priority security interest in substantially all of our assets.

As of June 30, 2007, no amounts were outstanding under this facility.

Note E—Stockholders’ Equity

Share Repurchase. On August 1, 2006, the Company announced that the Board of Directors had authorized it to repurchase up to $1,000,000 of its common stock in open market or in private transactions, subject to the Company’sCompany's assessment of market conditions and buying opportunities from time to time. As of March 31, 2007, the Companywe had purchased 38,567 shares at an average price of $6.56 per share, including fees and commissions. AsWe terminated the repurchase program as of March 31, 2007.

Tender Offer. On June 21, 2007, we announced the Company has terminated its repurchase program.final results of the modified “Dutch auction” tender offer that we had extended to shareholders on May 17, 2007. We repurchased 424,269 of our common stock at a purchase price of $6.50 per share for an aggregate amount of approximately $2,758,000. In addition, we capitalized transaction costs of approximately $313,000.

Note E—F—Stock-Based Compensation

Stock Plan Activity

Our stock incentive plans provide for the issuance of restricted stock, incentive stock options and non-statutory options to purchase common shares and other awards to eligible employees, officers, directors and consultants. Our 2004 Stock Incentive Plan (the “2004 Plan”) provides for the issuance of up to 900,000 shares. The Compensation Committee, subject to the provisions of the 2004 Plan, determines the terms of the restricted stock and stock option agreements, including vesting requirements. In general, stock grants vest over a four year period. The maximum term of the options granted under the 2004 Plan is ten years. The exercise price of stock options under the 2004 Plan must equal at least the fair market value on the date of grant.

Our previous plans, the 1993 and 1995 Stock Option Plans, have been replaced by the 2004 Plan and no additional awards may be granted thereunder.there under. These plans had provided for the issuance of up to 2,279,250 shares and had been amended to provide for the issuance of an additional 2,100,000 shares. There are no shares subject to outstanding options from the 1993 Plan as of December 31, 2004. The 1995 Plan has options exercisable through January 26, 2014.

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The following table summarizes stock option activity under all our equity incentive plans:

As of March 31,June 30, 2007, the aggregate intrinsic value of outstanding stock options was $6.1$6.4 million.

As of March 31,June 30, 2007, 59,35668,794 shares were available for future issuance.

Our 1997 Employee Stock Purchase Plan provides for the issuance of shares of our common stock, up to a total of 500,000 shares, to eligible employees. The price of the common shares purchased under the Plan is equal to 85% of the fair market value of the common shares on the first or last day of the offering period, whichever is lower. Employees who choose to participate in the Plan can withhold between one and ten percent of their wages. However, an employee can not purchase more than 5,000 shares in any one offering period. This plan terminated on March 31, 2007.

SFAS No. 123

Effective January 1, 2006, we adopted SFAS No. 123(R)Share-Based Payment, which requires the measurement and recognition of compensation expense for all stock-based payment awards made to employees and directors, including employee stock options and employee stock purchases, based on estimated fair values. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) 107No.107 relating to SFAS No. 123(R). We have applied the provisions of SAB No. 107 in our adoption of SFAS No. 123(R).

SFAS No. 123(R) requires companies to estimate the fair value of stock-based payment awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our consolidated income statement. SFAS No. 123(R) supersedes our previous accounting under the provisions of SFAS No. 123,Accounting for Stock-Based Compensation. As permitted by SFAS No. 123, we measured compensation cost for options granted prior to January 1, 2006, in accordance with Accounting Principles Board Opinion (APB) No. 25,Accounting for Stock Issued to Employees, and related interpretations. Accordingly, no accounting recognition was given to stock options granted at fair market value until they are exercised. Upon exercise, net proceeds, including tax benefits realized, are credited to equity.

We adopted SFAS No. 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of our fiscal year 2006. In accordance with the modified prospective transition method, our consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS No. 123(R).

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The following table summarizes stock-based compensation expense related to employee stock options, restricted stock grants and stock purchases for the three and six months ended March 31,June 30, 2007 and 2006, which was allocated as follows:

We use the Black-Scholes option pricing model and the following weighted average assumptions:

In determining fair value, we used the following criteria:

Expected Term.The expected term of options granted represents the period of time that the option is expected to be outstanding. We estimate the expected term of the option grants based on historical exercise patterns that are believed to be representative of future behavior as well as other various factors. When and if applicable we use separate groups of employees that have similar historical exercise behavior for valuation purposes.

Expected Volatility.We estimate our volatility using our historical share price performance over the expected life of the options, which management believes is materially indicative of expectations about expected future volatility.

Risk-Free Interest Rate.We use risk-free interest rates in the Black-Scholes option valuation model that are based on U.S. Treasury zero-coupon issues with a remaining term equal to the expected life of the options.

Dividend Rate.We do not issue dividends on our common stock and do not anticipate paying any cash dividends in the foreseeable future. Therefore, we use an expected dividend yield of zero in the Black-Scholes option valuation model.

Forfeitures. SFAS No. 123R requires companies to estimate forfeitures at the time of grant and revise those estimates in subsequent reporting periods if actual forfeitures differ from those estimates. We use historical data to estimate pre-vesting option forfeitures and record share-based compensation expense only for those awards that are expected to vest. For purposes of calculating pro forma information under SFAS No. 123 for periods prior to the date of adoption of SFAS No. 123R, we accounted for forfeitures as they occurred.

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Nonvested Shares

Stock Options. A summary of the status of our nonvested stock options issued under the plan for the three months ended March 31, 2007 was as follows:

As of March 31,June 30, 2007, there was approximately $147,000$98,000 of total compensation cost related to nonvested share-based compensation arrangements for stock options granted under the plans. That cost is expected to be recognized over a weighted average period of 2.212.01 years. During the threesix months ended March 31,June 30, 2007, we recognized approximately $22,000$52,000 in compensation expense related to nonvested shares.

Restricted Stock. A summary of the status of our nonvested restricted stock issued under the plan for the three months ended March 31, 2007 was as follows:

As of March 31,June 30, 2007, there was approximately $717,000$562,000 of total compensation cost related to nonvested share-based compensation arrangements for restricted stock granted under the plans. That cost is expected to be recognized over a weighted average period of 1.551.44 years. During the threesix months ended March 31,June 30, 2007, we recognized approximately $93,000$216,000 in compensation expense related to nonvested restricted stock.

Note F—G—Income Taxes

In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation (FIN) No. 48,Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109, which clarifies the accounting for income taxes, by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006.

As a result of the adoption of FIN 48, we have recorded no change to retained earnings at January 1, 2007. We had no unrecognized tax benefits that, if recognized, would favorably affect our effective income tax rate in future periods. At March 31,June 30, 2007, we had no unrecognized tax benefits. Our continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense. We had no accrued interest or penalties at January 1, 2007 and no accrued interest or penalties at March 31,June 30, 2007.

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We have not currently completed a study to assess whether a change in control has occurred or whether there have been multiple changes of control since our formation due to the significant complexity and cost associated with such study and the possibility that there could be additional changes in the future. If we experienced a greater than 50 percentage point change or shift in ownership over a 3-year time frame since our formation, utilization of our NOL or R&D credit carryforwards would be subject to an annual limitation under Sections 382 and 383. The annual limitation generally is determined by multiplying the value of our stock at the time of the ownership change (subject to certain adjustments) by the applicable long-term tax-exempt rate. Any limitation may result in expiration of a portion of the NOL or R&D credit carryforwards before utilization. Further, until a study is completed and any limitation known, no amounts are being presented as an uncertain tax position under FIN 48.

Note G—H—Acquisition of Certain Assets of CambridgeDocs

On January 29, 2007, we acquired certain assets of CambridgeDocs, a provider of software utilized in document transformation and repurposing. The total cost of the asset acquisition and the subsequent allocation was as follows:

Allocated to assets and liabilities as follows:
Intangible assets acquired		$	420,000
Goodwill			299,548
		$	719,548

Pro forma information has not been reported because of its immaterial amounts.impact.

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, software development 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

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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 derive our revenues principally from the licensing of software, post contract support fees (PCS) and professional services. We recognize revenue in accordance with Statement of Position (SOP) 97-2,Software Revenue Recognition. Although some software is licensed on aWe offer both perpetual basis, the majority of our licenses are currentlyand time-based licenses that are required to be renewed annually. Revenues are recognized when a contract exists, the fee is fixed and determinable, software delivery has occurred and collection of the receivable is deemed probable. Amounts billed or payments received in advance of revenue recognition are recorded as deferred revenue.

If an arrangement includes multiple elements, we allocate the contract amount to the various elements based on vendor-specific objective evidence (VSOE) of fair value, regardless of any separate prices stated within the contracts for each element. We base our VSOE on the price charged when the same element is sold separately. If an undelivered element of the arrangement exists, revenue is deferred based on VSOE of the fair value of the undelivered element. If VSOE 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 use the residual method to recognize revenue when an arrangement includes one or more elements to be delivered at a future date and VSOE of the fair value of all undelivered elements exists.

We recognize fees for annual licensing arrangements ratably over the contract term of twelve months because we are unable to establish VSOE for the license and support elements under this type of bundled arrangement.

For perpetual license arrangements, VSOE of fair value for ongoing maintenance and support obligations (PCS) is determined based upon the historical, stand-alone renewal rates or pricing. We recognize revenue relating to the perpetual software license arrangements at inception of the arrangement using the residual method as discussed above.

Our contracts do not provide for specific upgrades. In addition, our standard contracts do not provide for rights of return or conditions of acceptance; however, in cases where acceptance criteria are provided, revenue is deferred and not recognized until all conditions are satisfied and written customer acceptance is obtained.

Professional services revenue includes consulting services and training related to our software products. Revenues generated from consulting services and training are recognized as the related services are performed and collectibility is deemed probable, based on VSOE of fair value of the services. VSOE of fair value for professional services is determined based upon the price charged when these services are sold separately. For professional services that are bundled with annual software licenses and are not deemed to be essential to the functionality of the delivered software product, we recognize the entire arrangement fee ratably over the longer of the period over which the professional services are expected to be rendered, or the PCS period, beginning with delivery of the software and commencement of the professional services. In the vast majority of cases, the arrangement fee is recognized ratably over the twelve month PCS period. In certain limited situations where we determine that professional services period is the longer period, upon the end of the PCS term, we recognize license and PCS revenues at that stage (on the residual basis), recognizing the remaining deferred revenue for the unfinished services over the remaining period of such services.

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If 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 the phases of our consulting projects are generally not of great duration (2-6 weeks on average), we believe that there are very limited circumstances where materially different amounts would be reported under different conditions or using different assumptions.

We work in conjunction with our established VARs,value-added resellers (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.

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.

Impairment of Goodwill.The value of our goodwill could be impacted by future adverse changes such as declines in our operating results or failure to meet the performance projections included in our forecasts of future operating results. We evaluate these assets on an annual basis or more frequently if indicators of impairment exist. In the process of our annual impairment review, we primarily use a discounted cash flow method to determine the fair value of our assets. Significant management judgment is required in the forecasts of future operating results that are used in the discounted cash flow method of valuation. The estimates we have used are consistent with the plans and estimates that we use to manage our business. It is possible, however, that the plans and estimates used may be incorrect. If our actual results, or the plans and estimates used in future impairment analyses, are lower than the original estimates used to assess the recoverability of these assets, we could incur impairment charges.

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 is made. At the end of each reporting period, we perform a detailed 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.

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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, 2006, we had net deferred tax assets of $5.1 million. Due to the uncertainty of realizing these net deferred tax assets, we have recorded a valuation allowance of $5.1 million. 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. 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 continue to record a valuation allowance against all or a portion of the remaining net deferred tax assets. Examples of future events that might occur which would make the realization of such assets not likely is a lack of taxable income resulting from poor operating results during 2007.

Results of Operations for the Three and Six Months Ended March 31,June 30, 2007 and 2006

The following table shows the percentage of revenues, cost of revenues, operating expenses and other items to total revenues in our consolidated statements of operations for the periods indicated:

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Revenues

Our revenues are divided into two categories based upon the sources from which they are derived: (i) term-based licenses and perpetual licenses and related annual renewal license and support fees, and (ii) services and other revenues. License fees consist primarily of perpetual fees, fees for the first year of use of our products and annual renewal license and PCS fees. Services and other revenues consist of fees for consulting, software outsourcing, 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 through distributors and VARs internationally. The following table summarizes revenues (in thousands) and the percentage change over the previous year for the periods indicated:

Cost of Revenues

Cost of license fees includes amortization of previously capitalized software development costs, costs of third party software, employee related costs for distribution personnel and technical support staff, and product packaging. Costs of services and other consist principally of the employee related costs of our consulting and training staff. The following table summarizes cost of revenues (in thousands) and the percentage change over the previous quarter for the period indicated:

Operating Expenses

Research and development. Research and development expenses consist primarily of the employee related costs of personnel associated with developing new products, enhancing existing products, testing software products, and developing product documentation.

Selling and marketing. Selling and marketing expenses consist primarily of salaries, commissions, marketing programs, and related costs for pre- and post-sales activity.costs.

General and administrative. General and administrative expenses consist of employee related costs for finance, administration, information technology and human resources, allowance for doubtful accounts, and general corporate management expenses, including public company expenses, director expenses, legal fees, and accounting fees.

The following table summarizes operating expenses (in thousands) and the percentage change over the previous year for the periods indicated:

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Other items

Interest and other income, net. Interest and other income, net, is composed of interest income from cash and cash equivalents and proceeds from short-term investment disposals, offset by interest expense related to capital leases and proceeds from disposals of fixed assets.

Provision for income taxes. Provision for income taxes reflects 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.

Three and six months ended March 31,June 30, 2007 compared to the three and six months ended March 31,June 30, 2006

The slight decrease in2007 second quarter and six months to date license fee revenue in the first quarter of 2007 from thegrew 46% and 22%, respectively over comparable 2006 period amounts. Geographically, the growth in license revenues was primarily due to lower initialdriven by our North American sales ofoperations which contributed several new contracts in the quarter, as well as a significant enterprise opportunity with an existing customer. Continued growth in our software products, somewhat offset by higherannual license fees and post contract support revenue.fees also contributed to the period over period growth.

First

Second quarter and year-to-date 2007 services and other revenues increased 22%by 8% and 14%, respectively over firstsecond quarter and year-to-date 2006 amounts. The majority of the increase was from the delivery of implementation and other services to customers who have licensed our xPression software. ConsultingIncreased consulting services provided by our Objectiva subsidiary also contributed to the quarterly increase.period over period increases.

The 6% decrease8% increase in license fees cost of revenue in the firstsecond quarter of 2007 was primarily due to a decrease in personnel and personnel related costs as staff was transferred to our research and development efforts, offset by an increase of approximately $60,000 in software royaltiesroyalties. Year-to-date costs were flat.

2007 second quarter and other product costs.

Servicesyear-to-date services and other cost of revenues in the first quarter of 2007 increased by 3%9% and 6% respectively over the first quarter ofcomparable 2006 periods due to an increase in staff and personnel related costs and management required to execute onservice existing projects.

The 43% increase in first2007 second quarter 2007and year-to-date research and development costsexpenses increased by 22% and 32%, respectively over the comparable quarter in 2006 wasperiods. These increases were primarily due to an increaseincreases in personnel costs related to staff transferred from our customer support group and to our Objectiva Chinese operation necessaryand were required to support additional development and enhancement of our xPression product line, as well as our more mature Autograph product line. ResearchAt June 30, 2007, research and development staff totals were 136 professionals at March 31, 2007employee headcount has increased by approximately 30% compared to 110 employees at March 31, 2006.June 30, 2006 totals, largely in our Objectiva Chinese operation. In addition, costs associated with our acquisition of CambridgeDocs contributed to the increase.

The 30% increase in first quarter 2007 sellingSelling and marketing expenses for the three and six month periods ended June 30, 2007, increased significantly over the comparable 2006 amounts – by approximately $1.2 million, or 52% in the second quarter and by approximately $1.9 million, or 41% for the year-to-date period. Once again, the increase was substantially as a result of increased staffing, primarily due toin the inside and outside sales groups. These increases in salary andcreated additional personnel related costs partially offset by a decrease in commissions, which accounted for approximately $344,000, or 17%and travel and entertainment expenses. Contributing to the second quarter increase and to a lesser extent to the year-to date increase were higher commission expenses related to higher sales bookings. Advertising, trade show advertising and promotionconsulting expenses which accounted for approximately $187,000, or 9% increase.also increased quarter over quarter and year over year.

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First2007 second quarter 2007and year-to-date general and administrative expenses increased by 26%approximately $250,000 or 24% and by approximately $500,000 or 25%, respectively over the comparable 2006 periods. Approximately $150,000 of these amounts was related to an increase in our bad debt expense. Increased staffing and associated costs contributed to the period over period increases, as did increased consulting expenses.

2007 second quarter and were primarily driven by salary and personnel related expense increases of approximately $123,000, taxes of approximately $39,000, and costs associated with being a publicly traded company of $62,000.

Interestyear-to-date interest and other income, net, in the first quarter of 2007 increased by approximately $26,000 over the comparable 2006 quarterperiods due to higher interest income due to higher interest rates on invested cash balances.

The first quarterquarterly provisions for income taxes in 2007 and 2006 relate to foreign taxes.

Trends and 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 and services, the level of product and price competition, the length of our sales cycle, the size, elements and timing of individual software arrangements, 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, the renewal rates for our annual software licenses, 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 license fee revenues depend on when orders are received from and shipped to customers; however, because of our revenue recognition policies, our customers’ implementation schedules and the complexity of the implementation process, revenue from some software shipments may not be recognized in the same quarter as the shipment occurs. The timing of receipt of these license fees is also difficult to predict because of the length of our sales cycle. ForAutograph products, our sales cycle is typically three to nine months from initial contact. ForxPression products, our sales cycle is typically nine months to over one year from 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.

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Liquidity and Capital Resources

Our sources of cash are derived primarily from operations and sales and maturities of short-term investments. We currently do not have any debt from borrowed money. Our short-term investments are invested in U.S. government agency obligations and high quality commercial paper. In June 2007, we entered into a bank credit agreement which provides us with a senior secured revolving credit facility of up to $6 million through June 2009 as discussed in Note E in the Notes to the Unaudited Consolidated Financial Statements. As of June 30, 2007, no amounts were outstanding under this facility.

On June 21, 2007, we announced the final results of the modified “Dutch auction” tender offer that we had extended to shareholders on May 17, 2007. We repurchased 424,269 shares of our Common Stock at a purchase price of $6.50 per share for an aggregate amount of approximately $2,758,000. In addition, we capitalized transaction costs of approximately $313,000.

We believe that our existing cash balances, the availability of borrowings under our bank line of credit, 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. In this regard, a portion of our cash could be used to acquire or invest in complementary businesses or products or to obtain the right to use complementary technologies. We have no material current understandings, commitments or agreements with respect to any acquisition in whole of other businesses, products or technologies.

At March 31,June 30, 2007, we had approximately $7.9$2.4 million in cash, cash equivalents and short-term investments. This is a decrease of approximately $808,000$4.7 million from our December 31, 2006 balance. The

decrease during the quarterthis six month period was mainly due the payment of approximately $3.1 million related the tender offer discussed in Note E in the Notes to the Unaudited Consolidated Financial Statements. Additionally, the loss for the quarter,six month period and the cash used in the asset purchase of CambridgeDocs the decrease(also discussed in accrued compensation relatedNote E) contributed to the paymentreduction in cash balances as of year-end commissions and bonuses, partially offset by collections of accounts receivable.

We have no significant capital spending or purchase commitments other than normal purchase commitments and commitments under facilities and equipment leases.June 30, 2007.

We have no significant capital spending or purchase commitments other than normal purchase commitments and commitments under facilities and equipment leases. The following information shows future minimum rental payments required in the aggregate and for each of the five succeeding fiscal years:

Forward-looking Statements

We make forward-looking statements in this quarterly report on Form 10-Q 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:

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Our actual results could differ materially from those discussed herein due to a number of factors, including those set forth in this discussion, under “Certain Factors Affecting Document Sciences Corporation” and other risks detailed from time to time in our SEC reports. In addition, the discussion of our results of operations should be read in conjunction with the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2006 Annual Report on Form 10-K for the fiscal year ended December 31, 2006 and in reports we file with the Securities and Exchange Commission. You are cautioned not to place undue reliance on these forward-lookingforward-

looking statements, which reflect management’smanagement's analysis only as of the date of this annual report. Except as required by law, we undertake no obligation to publicly release the results of any revision of, or otherwise update, the forward-looking statements.

Certain Factors Affecting Document Sciences Corporation

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

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

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

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

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

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

Our future business, operating results and financial condition 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. OurAutographfamily 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 newer products, such as xPressoandxPression, or enhancements to existing products will adequately meet the requirements of the marketplace or achieve market acceptance. Moreover, delays in our commercial shipments of new products or enhancements may result in client dissatisfaction and a delay or loss of product revenues. In addition, 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.

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 could 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.

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

The licensing of our software products is often an enterprise-wide decision by prospective customers and generally involves a sales cycle of three months to more than one year in order to educate these prospective customers regarding the use and benefits of our products, often requiring us to expend considerable financial and personnel resources without any assurance that revenue will be realized. In addition, the implementation of our products by customers involves a significant commitment of their resources over an extended period of time and is commonly associated with substantial customer business process reengineering efforts. Sales of our enterprise-widexPression product line often involve many participants in the corporate decision-making process. Additionally, we have experienced and may, from time to time, continue to experience defects in our software which cause implementation problems and affect our revenues and our sales cycle. For these and other reasons, our sales cycles and customer implementation periods are subject to a number of significant delays over which we may have little or no control. Any delay in the sale or customer implementation of a limited number of license transactions could have a material adverse effect on our business and results of operations and cause our operating results to vary significantly from quarter to quarter.

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

We currently have a variety of contractual and informal relationships with Xerox and affiliates of Xerox, including a cooperative marketing agreement, a transfer and license agreement and various distribution agreements. We rely on these relationships and agreements for a significant portion of our total revenues. Revenues derived from relationships with Xerox and affiliates of Xerox accounted for approximately $888,000$1.7 million and $929,000$1.7 million for the threesix months ended March 31,June 30, 2007 and 2006, respectively, representing 11%9% and 12%11% of our total revenues, respectively.

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

There can be no assurance that existing and potential customers will continue to do business with us because of these relationships or our historical ties with Xerox and its affiliates. Xerox has strategic alliances and other business relationships with other companies who supply software and services used in high volume electronic publishing applications and who now are, or in the future may become, our competitors. There can be no assurance that Xerox or one of its affiliated companies will not engage in a 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.

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

The market for dynamic content publishing products is intensely competitive. We face competition from a broad range of competitors, many of whom have greater financial, technical and marketing resources than we do. Our principal competition currently comes from systems developed in-house by the internal IS departments of large organizations and direct competition from numerous software vendors, including

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Docucorp International, Inc., InSystems Technologies, Inc., Group 1 Software, Inc., Exstream Software, Inc. and Metavante Corporation. We believe that the principal competitive factors affecting our market include product performance and functionality, ease of use, scalability, operating across multiple computer and operating system platforms, product and company reputation, client service and support and price. Although we believe that 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 or new solutions introduced by existing competitors or by new competitors entering the market.

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

We derived a substantial percentage of our license revenue from two product lines in 20062007 and 2005.2006. As a result, factors that may adversely impact the pricing of or demand for these products, such as competition from other products, negative publicity or obsolescence of the hardware or software

environments in which our products run, could have a material adverse effect on our business, operating results and financial condition. Our financial performance will depend significantly on the successful development, introduction and customer acceptance of new and enhanced versions of ourxPression software andxPresso software, as well as continued customer acceptance of CompuSet, DLS and related products.

Revenues from end users in the insurance industry accounted for 39% and 44% of total revenues for the threesix months ended March 31,June 30, 2007 and 2006. Our future success will depend on our ability to continue to successfully market our products in the insurance industry, as well as the finance and print services industries, and introduce their use in new industries. Our failure to do so could have a material adverse effect on our business, operating results and financial condition.

Inaccurate sales forecasts and/or revenue projections could cause improper planning and budgeting of our resources.

Our revenues, and particularly our new software license revenues, are difficult to forecast, and as a result our quarterly operating results can fluctuate substantially. We use a “pipeline” system, a common industry practice, to forecast sales and trends in our business. In particular, our sales personnel monitor the status of all proposals and estimate when a customer will make a purchase decision and the dollar amount of the sale. These estimates are aggregated periodically to generate a sales pipeline. Our pipeline estimates can prove to be unreliable both in a particular quarter and over a longer period of time, in part because the “conversion rate” of the pipeline into contracts can be very difficult to estimate. A variation in the conversion rate, or in the pipeline itself, could cause us to plan or budget incorrectly and adversely affect our business or results of operations. While this sales estimation process provides us with some guidance in business planning, it is based on estimates only and is therefore subject to numerous risks and uncertainties. Because a substantial portion of our new software license revenue contracts are completed in the latter part of a quarter, and our cost structure is largely fixed in the short term, revenue shortfalls tend to have a disproportionately negative impact on our profitability. A delay in even a small number of large new software license transactions could cause our quarterly new software licenses revenues to fall significantly short of our predictions.

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Our growth is dependent upon successfully focusing our distribution channels.

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

Our products may suffer from defects or errors.

Software products, as complex as those we offer, may contain undetected defects or errors when first introduced or as new versions are released. As a result, depending on the severity of the defect or error, we could in the future forego or delay recognition of revenues as a result of these errors or defects. In

addition, our products are typically intended for use in applications that may be critical to a customer’scustomer's business. As a result, we expect that our customers and potential customers have a greater aversion and sensitivity to product defects than the general market for software products. We experienced defects in connection with the introduction of ourxPression product line in 2004, and believe that we have addressed this problem, but we cannot assure you that, despite our testing, as well as testing by current and potential customers, additional errors will not be found in our existing products or new products or releases. Defects discovered after the commencement of commercial shipments, can result in loss of revenue, delay in market acceptance, diversion of our development resources, damage to our reputation and/or increased service and warranty costs.

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

We are continuing our focus on the consulting services component of our professional services to assist customers in the planning and implementation of enterprise-wide, mission-critical dynamic content publishing applications. This strategy is dependent on hiring and retaining qualified professional staff to perform these consulting services. Our business, operating results and financial condition could be materially adversely affected if we are unsuccessful in developing and retaining our professional services workforce.

We may be exposed to risks associated with international operations.

Our revenues from export sales accounted for 27%18% and 16%13% of our total revenues for the three months ended March 31,June 30, 2007 and 2006, respectively, and 22% and 14% of our total revenues for the six months ended June 30, 2007 and 2006, respectively.

We license our products in Europe through value-added resellers (VARs) and to a much lesser extent, direct sales. Revenues generated by these activities were $1.2 million$827,000 and $742,000$731,000 for the three months ended March 31,June 30, 2007 and 2006, respectively, and $2.0 million and $1.5 million for the six months ended June 30, 2007 and 2006, respectively.

In Australia, Canada and Latin America, our products are distributed and/or supported by Xerox affiliates and also by direct sale in Canada. In China, our products are distributed and/or supported by our subsidiary, Objectiva. Revenues generated in these regions were $1.0$1.2 million and $469,000$369,000 for the three months ended March 31,June 30, 2007 and 2006, respectively, and $2.2 million and $838,000 for the six months ended June 30, 2007 and 2006, respectively.

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In order to successfully expand export sales, we must increase our international presence in select countries, 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.

Our international business activities could also be adversely impacted by losing the services of key VARs, difficulties in managing our international operations, our limited experience in localizing products for foreign countries resulting in a lack of acceptance of these localized products, longer payment cycles for accounts receivable, currency fluctuations, unexpected adverse changes in regulatory requirements and tariffs, imposition of additional trade barriers and restrictions, potentially adverse tax consequences including restrictions on the repatriation of earnings, and the burdens of complying with a wide variety of foreign laws.

Our Objectiva software engineering and professional services team of 251288 employees are located in two facilities in China. We are subject to a variety of risks associated with conducting operations in China, including those related to general economic conditions, regulatory changes, political unrest and potential reduced protection for our intellectual property rights. In addition to facing the difficulty of managing a large offshore organization, we must comply with a variety of laws and regulations, including trade restrictions, local labor ordinances, changes in tariff rates and import and export licensing requirements. Our success depends, in part, on our ability to anticipate these risks and manage these difficulties.

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

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

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

Furthermore, the market for dynamic content publishing of electronic documents designed for use with the Internet, intranets and commercial on-line services has only recently begun to develop, and the success of our products designed for this market will depend in part on their compatibility with these elements. Since the increased commercial use of the Internet, intranets and commercial on-line services is difficult to predict and 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.

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Our ability to manage future change could affect our business.

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

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

Our future performance depends in significant part upon the continued service of our key technical, sales and senior management personnel. The loss of the services of one or more of our executive officers could have a material adverse effect on our business, operating results and financial condition. Our future

success also depends on our continuing ability to attract and retain highly qualified product development, sales and management personnel. Competition for such personnel is intense, and there can be no assurance that we will be able to retain our key employees or that we will be able to attract or retain other highly qualified product development, sales and managerial personnel in the future.

Our business is dependent upon successfully protecting our proprietary rights.

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

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, companies hire employees from competitors, and the functionality of products in different industry segments overlaps. Any such claims, with or without merit, could be time consuming, result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements. Such royalty or licensing agreements, if required, may not be available on terms acceptable to us or at all, which could have a material adverse effect upon our business, operating results and financial condition.

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

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

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Integration of potential business or technology acquisitions may be difficult.

If we acquire complementary businesses, products or technologies instead of developing them ourselves, we may be unable to successfully integrate an acquired business, product or technology in a cost-effective and non-disruptive manner. Integrating any business, product or technology that we acquire could be expensive and time-consuming, disrupt our ongoing business and distract company management. In addition, in order to finance any acquisition, we might need to raise additional funds through public or private equity or debt financings. In that event, we could be forced to obtain financing on less than favorable terms which, in the case of equity financing, may result in dilution to our stockholders. If we are unable to integrate any acquired entities, products or technologies effectively, our business, operating results and financial condition could be materially adversely affected. In addition, under certain circumstances, amortization of assets or charges resulting from the costs of acquisitions could have a negative impact on our reported operating results and financial condition.

Enacted and proposed changes in securities laws and regulations are likely to increase our costs.

The Sarbanes-Oxley Act of 2002 and the rules subsequently implemented by the SEC and the NASD have imposed various new requirements on public companies, including requiring changes in corporate governance practices. Our management and other personnel will need to continue to devote a substantial amount of time to comply with these requirements. Moreover, these rules and regulations have increased our annual legal and financial compliance costs, have made some activities more time-consuming and costly, and could expose us to additional liability. In addition, these rules and regulations may make retention and recruitment of qualified persons to serve on our board of directors or executive management team more difficult.

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

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. Our primary foreign currency risk exposures are related to U.S. Dollar to Euro and U.S. Dollar to Chinese Yuan conversions. Our subsidiary in China conducts business primarily in the Chinese Yuan. 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 the Euro would not materially adversely affect expected second quarter 2007 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 effect 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. 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 March 31,June 30, 2007. Declines in interest rates over time will, however, reduce our interest income.

We are also exposed to interest rate risk in connection with borrowings under our bank line of credit, which bear interest at a rate equal to either (i) the bank’s prime rate plus 0.75% (subject to a floor of 7.75% on bank’s prime rate) or (ii) the to bank’s prime rate plus 2.0% if we fail to maintain a predefined liquidity ratio. For variable rate debt, interest rate changes generally do not affect the fair market value of the underlying debt, but do impact future earnings and cash flows, assuming other factors are held constant.

ITEM 4.

CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

We have established and currently maintain disclosure controls and other procedures designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified by the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. In designing and evaluating our disclosure controls and procedures, management recognized that any control or procedure, no matter how well designed and functioning, can provide only reasonable, but not absolute assurance of achieving the desired control objectives. In reaching a reasonable level of assurance, management applied its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Additionally, the design of any system of controls is partially based upon certain assumptions of the likelihood of future events, and there can be no assurance that any design will achieve its stated goals under all potential future conditions. Over time, controls may become inadequate because of changing conditions, or the degree of compliance with policies and procedures may deteriorate. Consequently, because of the inherent limitations of a cost-effective control system, misstatements due to error or fraud may occur and not be detected

As of the end of the period covered by this quarterly report on Form 10-Q, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures. That evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting him to material information relating to Document Sciences required to be included in our periodic SEC filings.

Changes in Internal Control over Financial Reporting

We have made no change in our internal control over financial reporting during the most recent fiscal quarter covered by this quarterly report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

We are not involved in any material legal proceedings.

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The following table provides information about purchases by the Company during the fiscal quarter ended March 31, 2007 of equity securities that are registered by the Company pursuant to Section 12 of the Securities Exchange Act of 1934, as amended.