<PAGE>   1
 
================================================================================
 
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
 
                                   FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
    OF 1934
 
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
 
                                       OR
 
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
    ACT OF 1934
 
             FOR THE TRANSITION PERIOD FROM           TO
 
                        COMMISSION FILE NUMBER: 0-20981
 
                         DOCUMENT SCIENCES CORPORATION
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
<TABLE>
<S>                                             <C>
                    DELAWARE                                       33-0485994
        (STATE OR OTHER JURISDICTION OF                         (I.R.S. EMPLOYER
         INCORPORATION OR ORGANIZATION)                       IDENTIFICATION NO.)
 
  6333 GREENWICH DRIVE, SAN DIEGO, CALIFORNIA                        92122
    (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)                       (ZIP CODE)
</TABLE>
 
       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (619) 625-2000
                            ------------------------
 
        SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
 
                    COMMON STOCK, $.001 PAR VALUE PER SHARE
                                (TITLE OF CLASS)
 
     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.  Yes [X]  No [ ]
 
     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.  [ ]
 
     As of March 11, 1997, there were 10,730,590 shares of the Registrant's
Common Stock outstanding and the aggregate market value of such shares held by
non-affiliates of the Registrant (based upon the closing sale price of such
shares on the Nasdaq National Market on March 11, 1997) was approximately
$14,428,643. Shares of Common Stock held by each executive officer and director
and by each entity that owns 5% or more of the outstanding Common Stock have
been excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive determination
for other purposes.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
     Certain sections of the Registrant's Annual Report to Stockholders for the
fiscal year ended December 31, 1996 are incorporated by reference in Part II of
this Form 10-K to the extent stated herein. Also, certain sections of the
Registrant's definitive Proxy Statement for the 1997 Annual Meeting of
Stockholders to be held on April 25, 1997 are incorporated by reference in Part
III of this Form 10-K to the extent stated herein.
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<PAGE>   2
 
                                     PART I
 
ITEM 1.  BUSINESS.
 
     This item contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934. Actual results could differ materially from those projected in the
forward-looking statements as a result of the factors set forth in "Certain
Additional Business Risks" below, the section of Item 7 -- Management's
Discussion and Analysis of Financial Condition and Results of Operations
entitled "Factors Affecting Future Results" and elsewhere in this Report.
 
     Document Sciences Corporation (the "Company") develops, markets and
supports a family of document automation software products and services used in
high volume electronic publishing applications. Document automation has become
increasingly important as more companies realize the benefits of automating the
high volume production of individually customized documents that require the
precise layout of information such as financial data, marketing text and graphs.
Autograph, the Company's document automation software architecture, enables
personalized and customized publishing solutions for many industries including
insurance, managed healthcare, financial services, telecommunications,
manufacturing/distribution, government and commercial print services. The
Company's products enable an important form of communication between
organizations and customers by employing enterprise database assets to produce
high-quality documents that are ready to print on demand and distribute in high
volume. Additionally, the Company's core technology is being applied to provide
electronic document automation solutions for the Internet, intranets and
commercial on-line services. CompuSet, Autograph's flagship product, is licensed
by approximately 500 customers worldwide who collectively produce an estimated
one billion customized pages per month. The fully portable Autograph platform
enables cost-effective, just-in-time, on-demand, high volume publishing that is
fully automated, capable of quality document composition, and flexible for
end-user customization. The Company's products are used in a wide array of
computing environments from client/server to large computer systems.
 
PRODUCTS
 
     The Company's software products are included in its Autograph architecture,
which currently addresses three major functional areas: Document Composition and
Assembly, Document Management, and Document Viewing, as described below. All of
the Company's software products can be complemented by Professional Services.
 
     The list price for an initial license fee for CompuSet, the Company's core
product, is currently $65,000 for an initial mainframe installation and ranges
down to $35,000 for an initial single PC; options currently range from $1,000 to
$50,000. The Company licenses its products for one year, after which an annual
renewal fee, usually in an amount equal to 15% of the initial license fee, is
required for continued use. A typical new sale is currently about $75,000 for
software licenses and approximately $25,000 for professional services.
 
     Document Composition and Assembly
 
     Composition and Assembly.  CompuSet, the Company's flagship product,
automates document composition and assembly using data and information in
corporate databases. It is the Company's core technology. CompuSet software
consists of a rule-based language and a composition engine that provide high
speed composition and assembly of complex documents with high typographic and
aesthetic levels of quality. Information content is marked with CompuSet tags
which, in turn, are defined in logically separate style specifications. Without
requiring real-time user interaction, the composition engine then transforms the
tagged data and information into finished electronic documents that can be
composed and assembled at rates in excess of 50 pages per second, depending on
computing configuration and complexity of the document. Document construction
facilities are extensive, including the full support of dynamic data driven
graphics generation. CompuSet operates on a range of computers and operating
systems including mainframes, workstations, network servers and personal
computers.
 
     Data Capture and Setup.  Data capture and setup products include CompuPrep
and a number of Importers, and prepare data and information for subsequent
composition and assembly by CompuSet.
 
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CompuPrep is an optional tool that enables users to capture and tag raw data and
information from a variety of sources, including corporate databases, for
subsequent processing by CompuSet. It is a high level language that describes
the data environment, related data processing and the tagging instructions for
CompuSet. Importers accept externally generated document objects, including
text, static graphics and scanned images, and convert them into formats
compatible with CompuSet. The Importers support Adobe PostScript, Xerox Metacode
and TIFF standard for scanned images.
 
     Document Output and Merge.  Emitters transform CompuSet's output into a
number of popular Page Description Languages (PDLs) for printing and viewing.
The PDLs provide instructions for rendering text, forms, bitmaps, and graphics
into documents. The PDL formats currently supported are Xerox Metacode, IBM
AFPDS, Adobe PostScript, HP PCLV, Xerox Escape Sequences (XES), Xerox Interpress
(DocuTech) and generic line printers. This part of the architecture is
extensible and new Emitters can be provided as required. For example, the
Company expects to provide support for PDF from Adobe during 1997.
 
     Application Development Tools.  CompuSeries applications development tools
run on Microsoft Windows and simplify document design and application
prototyping. CompuSeries currently consists of several modules. CompuSpec is a
tool for defining document formatting rules. Formatting specifications which are
selected from a menu are associated with tags which are referenced in the
document data. The results of the selected formatting specifications are
visually displayed in a preview window. CompuBuild uses a PC version of
CompuSet, combined with an editor to manipulate the tagged document data.
CompuBuild supports all the dynamic functions and features of the CompuSet
production engine. CompuMerge is a tool used to specify the placement of
variable data into fixed document components such as in form-fill applications.
CompuView Proof is a document proofing tool used to preview the document layout
on the computer screen prior to printing. These tools were integrated into a
single Windows application, called CompuSeries II. Recently, the Company
announced it will OEM JetForm(R) Corporation's JetForm Design product as well as
the JetForm production print drivers for Metacode, DocuPrint and AFP printers,
and will integrate it with CompuSeries II.
 
     Document Management
 
     Document Management tools provide client/server solutions for the creation,
revision and management of document components used in the Company's document
automation solutions. They consist of the Document Library Service (DLS) and
Desktop Document Manager (DDM). DLS manages the document component creation
process required by complex variable documents. In addition, DLS can be used to
define complex assembly rules required for interactive or fully automated
document composition and assembly with CompuSet. DLS uses a client/server
architecture for accessing data and files on a mainframe or network server.
Desktop Document Manager (DDM) is the client component of DLS and manages text
objects created with Microsoft Word. Text objects are tracked and managed in a
multi-author environment by providing access security, revision control and
approval levels. DDM also provides a criteria-based document object selection
capability for customized or personalized documents. These criteria are then
used by DLS to generate a CompuSet-ready tagged data file. The customized or
personalized document assembly can be directed to occur in a high-volume fashion
on the server or in a just-in-time, on-demand fashion on the local DDM PC.
 
     Document Viewing
 
     Document Viewing enables on-line viewing and archiving of electronic
documents produced by document automation applications. It consists of the
Document Viewing Service (DVS) and CompuView. DVS uses a client/server
architecture for the creation and access of electronic document files. DVS is
available for a variety of mainframe, Unix and PC platforms. The electronic
document files are generated in a format called CCIF, which is optimized for
fast, memory-efficient viewing, transport and storage. CCIF files can then be
viewed by CompuView. CCIF files consist of three major components: a PDL
rendition of the pages for WYSIWYG viewing; various indices for locating
documents; and reusable document elements. CCIF files can also be distributed,
archived or printed through document distribution and archiving systems offered
by third party software developers that have integrated CompuView. CompuView is
a Windows application for viewing CCIF files. The view of the document is
virtually identical to the printed document. CompuView may
 
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<PAGE>   4
 
also be integrated with third party document retrieval systems. The Company
introduced the DVS in October 1995.
 
     The Company is considering possible future Internet extensions, some of
which are not currently under active development. The Company believes that its
core technology can be extended to the Internet, intranets and commercial online
services and has recently begun initial development activity in this area,
although there can be no assurance that such development activity will result in
commercially successful products. See "Business -- Research and Development."
 
PROFESSIONAL SERVICES
 
     In addition to its software products, the Company provides a comprehensive
suite of services which can assist customers in the implementation of enterprise
wide and mission critical document automation applications. Professional
Services include on-site software installation, customer training programs,
telephone support programs and consulting services. Consulting services are
currently focusing on assisting in the sale of high margin initial software
licenses by providing project management and application development.
Eventually, the Company intends to expand Professional Services to include
document design, systems design and integration. In addition to consulting
services, the Company currently offers introductory-level customer education,
which is bundled with CompuSet initial licenses. Additional and advanced classes
are provided for additional fees at the Company's headquarters in San Diego and
at customer sites. The Company offers advanced and specialized customer
education in response to the unique needs of certain customers. The Company
believes that expanded Professional Services enables customers to deploy the
Company's document automation products more rapidly and effectively, and assist
the Company in the development of new products and provide recurring revenue.
The Professional Services and support organizations employed a staff of 43 as of
December 31, 1996.
 
SALES AND MARKETING
 
     The Company's sales and marketing organization targets vertical industry
segments that require document automation and high volume document
personalization and customization. The Company currently licenses its products
using a combination of direct sales and alternate channels. In the United
States, the Company markets its products through a direct sales force. Sales
representatives are provided with pre-sales technical support by regional
application specialists. Sales representatives and the regional application
specialists are located in Atlanta, Chicago, Cleveland, Dallas, Minneapolis, New
York City, Pittsburgh, Richmond, Raleigh, Sacramento, Orange County, CA, San
Antonio, San Diego, San Francisco, Seattle and Washington, D.C. The Company
distributes its products through VAR relationships with Xerox Canada, Limited in
Canada and Fuji Xerox Co., Ltd. in Australia. The Company's subsidiary, Document
Sciences Europe, markets and supports the Company's products in Europe by
providing channel management, technical support, consulting and training
services, and defining European market and product requirements. The Company
licenses its products in Europe through VARs and, to a lesser extent, direct
sales. The VARs are principally Rank Xerox Ltd. and other Xerox affiliates who
remarket the Company's products. The Company's revenues from export transactions
with Xerox affiliates were $1.3 million, $3.1 million and $2.9 million in 1994,
1995 and 1996, respectively. The sales, marketing, consulting and customer
support organization employed a staff of 79 as of December 31, 1996.
 
     The Company intends to expand its sales and marketing organization to
provide direct sales and support services throughout the world. Such planned
expansion will occur by first addressing the unique product requirements of a
region followed by developing indirect sales channels to market in the region.
As the Company is able to increase its market presence, it may then augment its
alternate channels with a direct sales capability.
 
     In addition, the Company intends to increase both its product offerings and
markets through marketing, sales and distribution and development relationships
with other companies. Current relationships include formal and informal
marketing and sales alliances with Xerox, IBM, Siemens Nixdorf, Computer
Associates, New Dimension, RSD, Data/Ware Development, Data Retrieval and
JetForm Corporation. These relation-
 
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<PAGE>   5
 
ships provide sales leads for the Company's products and have extended the
Company's sales coverage and networking capabilities.
 
RESEARCH AND DEVELOPMENT
 
     In general, the Company's strategy is to build products that augment and
extend the document composition and assembly capabilities of its core products.
Initially, product development investments were primarily focused on completing
the Autograph architecture, which included delivering products for document
viewing as well as adding support for additional print environments. In
addition, there was a substantial investment in product maintenance and in
software integration, testing, and documentation. The Company supplements its
product development efforts by reviewing customer feedback on existing products
and working with customers and potential customers to anticipate future product
needs.
 
     To date, the Company's Autograph architecture has been applied mainly to
document automation applications producing paper based documents. The Company
believes that its core technology can be extended to provide document automation
for the Internet, intranets, and commercial on-line services. The short-term
strategy is to engage this emerging opportunity with two complementary
initiatives. First, the Company intends to work closely to define product
requirements with existing customers, many of whom have expressed interest in
using the Internet in their document automation solutions. Second, the Company
intends to develop incremental extensions to Autograph which can be incorporated
by current customers into existing document automation products provided by the
Company. The Company believes that its core technology can be extended to the
Internet, intranets and commercial on-line services, and has only recently begun
initial development activity in this area. There can be no assurance that the
Company will be successful in developing, introducing and marketing new products
on a timely and cost-effective basis, if at all, or that new products will
achieve market acceptance.
 
     The development organization is composed of self-directed teams, in which
representatives from various disciplines within the Company collectively take
responsibility for the development and delivery of each new feature or product.
The development process includes early review of prototypes and demonstrations
to incorporate customer feedback and provide an opportunity for management
review. A formal sequence of project phases organizes the development and review
process for each team. The Company has a formal release planning process for an
annual maintenance release, and delivers interim versions as needed to support
its customers. The development organization maintains a database of all customer
and internal requests which forms the basis for release planning.
 
     The Company expects to continue to enhance its existing products and to
develop new products, particularly as they relate to electronic publishing
applications. Research and development expenditures have grown substantially
since the Company's inception. Such expenditures were $1.0 million in 1994, $1.7
million in 1995 and $2.3 million in 1996. These amounts do not include product
support activities. The development organization has grown from 15 people in
1994, to 22 in 1995 and 32 in 1996. The Company employs independent contractors
as needed to supplement the permanent development staff.
 
COMPETITION
 
     The market for the Company's document automation products is intensely
competitive, subject to rapid change and significantly affected by new product
introductions and other market activities of industry participants. The
Company's software products are targeted at document intensive organizations
that require the ability to produce large quantities of customized and
personalized documents in paper or electronic form. The Company faces direct and
indirect competition from a broad range of competitors who offer a variety of
products and solutions to the Company's current and potential customers. The
Company's principal competition currently comes from (i) systems developed
in-house by the internal MIS departments of large organizations, (ii) direct
competition in a number of its vertical markets, including Image Sciences, which
is partially owned by Xerox, and FormMaker Software, Inc. in the insurance
industry, M&I Data Services, Inc. in banking and financial services and Group 1
Software, Inc. in commercial direct mailing, and (iii) direct competitors such
as IBM's Direct Composition Facility (DCF) and Group 1's recently introduced
DOC1
 
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product. The Company faces market resistance from the large installed base of
legacy systems because of the reluctance of these customers to commit the time
and effort necessary to convert their document automation processes to the
Company's document automation software. Several of the Company's competitors
have longer operating histories, significantly greater financial, technical,
marketing and other resources than the Company, greater name recognition and a
larger installed base of customers.
 
     It is also possible that the Company will face competition from new
competitors. These include large independent software companies offering
personal computer-based application software solutions, such as Microsoft
Corporation and Adobe Corporation, and from large corporations providing
database management software solutions, such as Oracle Corporation. In addition,
Xerox, either directly or through affiliated entities, could compete with the
Company. Moreover, as the market for document automation software develops, a
number of these or other companies with significantly greater resources than the
Company could attempt to enter or increase their presence in the Company's
market either independently or by acquiring or forming strategic alliances with
competitors of the Company or to otherwise increase 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 the Company's current and
prospective customers, and 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 the
Company's business, operating results and financial condition. There can be no
assurance that the Company will be able to compete successfully against current
or future competitors or that competitive pressures faced by the Company will
not materially adversely affect its business, operating results and financial
condition.
 
     The Company believes that the principal competitive factors affecting its
market include products performance and functionality, ease of use, scalability,
operation across multiple computer and operating system platforms, product and
company reputation, client service and support, and price. Although the Company
believes that it currently competes favorably with respect to such factors,
there can be no assurance that the Company will be able to maintain its
competitive position against current and future competitors or that the Company
will be successful in the face of increasing competition from new products or
solutions introduced by existing competitors or by new companies entering the
market. Further, there can be no assurance that the Company can maintain its
position against current and future competitors, especially those with greater
financial, marketing, service, support, technical and other resources than the
Company.
 
PATENTS AND PROPRIETARY RIGHTS
 
     The Company's success is dependent, in part, on its ability to protect its
proprietary technology. The Company relies primarily on a combination of
copyright and trademark laws, trade secrets, confidentiality procedures and
contractual provisions to protect its proprietary rights. The Company seeks to
protect its software, documentation and other written materials under trade
secret and copyright laws, which afford only limited protection. The Company
presently has no patents or patent applications pending. Despite the Company's
efforts to protect its proprietary rights, unauthorized parties may attempt to
copy aspects of the Company's products or to obtain and use information that the
Company regards as proprietary.
 
     Policing unauthorized use of the Company's products is difficult, and while
the Company is unable to determine the extent to which piracy of its software
products exists, software piracy can be expected to be a persistent problem. In
addition, the laws of some foreign countries do not protect the Company's
proprietary rights to as great an extent as do the laws of the United States.
There can be no assurance that the Company's means of protecting its proprietary
rights will be adequate or that the Company's competitors will not independently
develop similar technology. The Company is not aware that any of its products
infringes the proprietary rights of third parties. There can be no assurance,
however, that third parties will not claim infringement by the Company with
respect to current or future products. The Company expects that software product
developers will increasingly be subject to infringement claims as the number of
products and competitors in the Company's 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 the Company to enter into
royalty or licensing agreements.
 
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Such royalty or licensing agreements, if required, may not be available on terms
acceptable to the Company or at all, which could have a material adverse effect
upon the Company's business, operating results and financial condition.
 
     In addition, the Company also relies on certain software that it licenses
from third parties, including software that is integrated with internally
developed software and used in the Company's 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 the Company 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 the
Company's business, operating results and financial condition.
 
EMPLOYEES
 
     As of December 31, 1996 the Company had 126 employees including 79 in
sales, marketing, consulting and customer support, 32 in research and
development, and 15 in finance and administration. None of the Company's
employees is represented by a labor union. The Company has experienced no work
stoppages and believes its relationship with its employees is good. Competition
for qualified personnel in the industry in which the Company competes is
intensive. The Company believes that its future success will depend in part on
its continued ability to attract, hire, and retain qualified personnel.
 
CERTAIN ADDITIONAL BUSINESS RISKS
 
     The Company's business, financial condition and operating results may be
impacted by a number of factors, including but not limited to those set forth
below, any one of which could cause the Company's actual results to vary
materially from recent results or from the Company's anticipated future results.
 
     Limited Operating History.  The Company was incorporated in October 1991 as
a wholly-owned subsidiary of Xerox, and Xerox currently owns approximately 63%
of the Company's outstanding shares of Common Stock. The Company's limited
operating history makes the prediction of future operating results difficult,
and the Company's operating history during prior periods cannot necessarily be
regarded as indicative of the Company's prospects as an independent company,
especially in light of the Company's investments in sales, marketing,
professional services and development infrastructure. Accordingly, although the
Company has experienced revenue growth in recent years, there can be no
assurance that the Company will sustain such growth in revenues, if any, or that
the Company will remain profitable on a quarterly or annual basis.
 
     Uncertainty of Future Operating Results; Fluctuations in Quarterly
Operating Results.  The Company's total revenues and operating results can vary,
sometimes substantially, from quarter to quarter and are expected to vary
significantly in the future. The Company's revenues and operating results are
difficult to forecast. Future results will depend upon many factors, including
the demand for the Company's products, the level of product and price
competition, the length of the Company's sales cycle, the size and timing of
individual license transactions, the delay or deferral of customer
implementations, the budget cycles of the Company's customers, the level of
commissions on the sale of Xerox printers under the strategic marketing alliance
between the Company and Xerox, the Company's success in expanding its direct
sales force and indirect distribution channels, the timing of new product
introductions and product enhancements by the Company and its 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, the ability of the Company to develop and market new
products and control costs and general domestic and international economic
conditions. In addition, the Company's sales generally reflect a relatively high
amount of revenues per order, and the loss or delay of individual orders,
therefore, could have a significant impact on the revenues and quarterly
operating results of the Company. Moreover, the timing of license revenue is
difficult to predict because of the length of the Company's sales cycle, which
is typically three to twelve months from the initial customer contact.
 
     The Company's initial software license products generally are shipped as
orders are received. As a result, initial license fee revenues are substantially
dependent on orders booked and shipped in that quarter. Because
 
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the Company's operating expenses are based on anticipated revenue levels and
because a high percentage of the Company's expenses are relatively fixed, a
delay in the recognition of revenue from a limited number of license
transactions could cause significant variations in operating results from
quarter to quarter and could result in losses. To the extent such expenses
precede increased revenues, the Company's operating results would be materially
adversely affected.
 
     The Company's business has experienced and is expected to continue to
experience seasonality, in part due to customer purchasing patterns and the
Company's expense patterns. The Company believes that fourth quarter revenues
are positively impacted by year-end capital purchases by large corporate
customers and strong fourth quarter sales of printers by Xerox (which may
generate sales of the Company's products), as well as the Company's sales
compensation plans. As reflected in the fourth quarter of 1996, these seasonal
factors have historically resulted in fourth quarter revenues being
substantially higher than revenues in the preceding three quarters, as well as
being higher than revenues in each of the first two quarters of the next year.
In addition, a significant amount of the Company's revenues occur predominantly
in the third month of each fiscal quarter and tend to be concentrated in the
latter half of the third month.
 
     As a result of these factors, revenues for any quarter are subject to
significant variation, and the Company believes that period-to-period
comparisons of its results of operations are not necessarily meaningful and
should not be relied upon as indications of future performance. Furthermore, due
to all of the foregoing factors, it is likely that in some future quarter the
Company's operating results will be below the expectations of public market
analysts and investors. In such event, the price of the Company's Common Stock
would likely be materially adversely affected. See "Expansion of Sales and
Distribution Channels" below, and "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
 
     Control by Xerox.  Xerox owns approximately 63% of the outstanding shares
of Common Stock of the Company. Xerox has not expressed to the Company any
present intention to sell additional shares of the Company's Common Stock
following completion of the offering. Consequently, Xerox will control the
Company, be able to elect the entire Board of Directors of the Company and
continue to have significant input into the Company's operations. In addition,
Xerox will be able to determine the outcome of all corporate actions requiring
stockholder approval, including potential mergers, acquisitions, consolidations
and sales of all or substantially all of the assets of the Company. The voting
power of Xerox could have the effect of delaying or preventing a change in
control of the Company, and may prevent or discourage tender offers for the
Company's Common Stock at a premium price by another person or entity. At
present, Xerox affiliates hold three of the six seats on the Company's Board of
Directors. See "Reliance on Relationships with Xerox; Lack of Independent Sales
and Marketing Channels" below.
 
     Reliance on Relationships with Xerox; Lack of Independent Sales and
Marketing Channels.  The Company currently has a variety of contractual and
informal relationships with Xerox and affiliates of Xerox, including a Strategic
Marketing Alliance Agreement, a Transfer and License Agreement and various
distribution agreements. The Company relies on these relationships and
agreements for a significant portion of its total revenues. In 1994, 1995 and
1996, total revenues derived from relationships with Xerox and affiliates of
Xerox accounted for approximately $1.9 million, $3.9 million and $4.2 million,
representing 27%, 37% and 28% of the Company's total revenues, respectively. In
addition, through December 31, 1995 substantially all of the Company's domestic
license revenues were dependent on sales leads generated as a result of the
Company's relationship with Xerox and a substantial portion of the Company's
international revenues were made through distributors and distribution channels
affiliated with Xerox. Further, the commissions received by the Company from
sales of Xerox printers under the strategic marketing alliance, which were
$490,400, $752,000 and $1.4 million in 1994, 1995 and 1996, respectively, have
little or no associated costs, have contributed a substantial portion of the
Company's income from operations and net income for certain prior operating
periods, have had a high degree of inconsistency from quarter to quarter and are
difficult to estimate. Failure to continue to receive such commissions would
have a material adverse effect on the Company's business, operating results and
financial condition. Although neither Xerox nor its affiliated entities has
expressed to the Company any intention to terminate their respective agreements
with the Company, these agreements generally may be terminated on no more than
90 days' notice. Accordingly, there can be no assurance that Xerox or its
affiliates will continue these relationships or, if they do, that they will be
on terms
 
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favorable to the Company. Furthermore, there can be no assurance that existing
and potential customers will not be deterred by the existence of these
relationships or by the historical ties between the Company and Xerox and its
affiliates. Though the Company intends to continue its existing relationships
with Xerox, the Company's strategy is to lessen its dependence on Xerox.
However, there can be no assurance that the Company will be able to do so and,
because of the Company's current level of dependence on Xerox, there can be no
assurance that the Company's transition to a more independent company will not
adversely affect its business, financial condition or results of operations. The
failure by the Company to maintain these relationships, particularly with Xerox
and its affiliates, or to establish new relationships in the future, could have
a material adverse effect on the Company's business, operating results and
financial condition. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations," and "Expansion of Sales and Distribution
Channels" below.
 
     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 or in the future may be a competitor of the
Company. Xerox could in the future expand these relationships or enter into
additional ones, and as a result the Company's business could be materially
adversely affected. There can be no assurance that Xerox or one of its
affiliated companies will not engage in business directly competitive with the
Company. In addition, Xerox has on-going internal development activities which
could in the future lead to products that compete with the Company.
 
     Expansion of Sales and Distribution Channels.  The Company has
substantially increased expenditures in support of its strategy to expand its
global marketing, sales and customer support infrastructure in order to expand
the market for the Company's products by providing direct sales and support
services and increased channel distribution throughout the major markets of the
world. Through this expansion, the Company hopes to lessen its dependence on
Xerox and certain Xerox affiliates. In addition, the Company intends to increase
both its product offerings and markets through marketing, sales and distribution
and development relationships with other companies. The Company intends to
increase the number of these strategic relationships as well as form alliances
with system integrators and consultants. Whether the Company can successfully
generate its own sales leads, introduce new products and enter into new markets
will depend on its ability to expand its direct sales and support services,
expand its indirect channel distribution, and increase its relationships and
alliances with other companies. As a result of its planned expansion, the
Company has and will continue to incur significant costs to build such corporate
infrastructure ahead of anticipated revenues, and any failure to achieve growth
in revenues in excess of increased expenses would have a material adverse affect
on the Company's business, operating results and financial condition. There can
be no assurance that the Company will be able to successfully expand its direct
sales and support services force, expand its indirect channel distribution, or
establish or maintain successful third party relationships. Any failure to do so
will have a material adverse effect on the Company's business, operating results
and financial condition. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
 
     Dependence on Success of New Products and Expansion of Professional
Services.  The Company's Autograph architecture has been applied mainly to
document automation applications producing paper based documents. The Company
believes its core technology can be extended to address applications requiring
the delivery of customized and personalized electronic documents over electronic
networks such as the Internet, intranets or commercial on-line services.
 
     The Company began shipping Document Viewing Service (DVS), an optional
on-line viewer for electronic documents produced by document automation
application in October 1995. Document Library Services (DLS), an optional
document management tool, was released for general availability in September
1996. Prior to September 1996, DLS was in a limited release, with certain
configurations still in beta testing. Revenues for DVS were $1.26 million in
1996. Revenues for DLS were $1.0 million in 1996. Revenues for DVS and DLS were
insignificant in 1995.
 
     In addition, the Company is increasing its focus on the consulting services
component of its Professional Services to assist customers in the planning and
implementation of enterprise-wide, mission critical document automation
applications. The Company has directed a significant amount of its product
development
 
                                        9
<PAGE>   10
 
expenditures to the on-going development of DVS and DLS and plans to devote a
significant amount of future sales and marketing resources to the full
commercial introduction of DVS and DLS.
 
     The Company believes that the long-term growth of license and service
revenue will be dependent, in part, upon the success of DVS, DLS and the
expansion of Professional Services. The Company has limited experience in
developing new products. Because of such limited experience, there can be no
assurance that DVS and DLS will not require substantial software enhancements or
modifications to satisfy performance requirements of clients or to correct
design defects. Further, there can be no assurance that the Company will be
successful in expanding its consulting services as part of its Professional
Services. If clients experience significant problems with implementation of the
software or are otherwise dissatisfied with the functionality or performance of
DVS and DLS, or if DVS or DLS fails to achieve market acceptance for any reason,
or if the Company fails to successfully expand its Professional Services, the
Company's business, operating results and financial condition will be materially
adversely affected.
 
     Lengthy Sales and Implementation Cycles.  The license of the Company's
software products is often an enterprise-wide decision by prospective customers
and generally requires the Company to engage in a lengthy sales cycle, typically
between three and twelve months, to provide a significant level of education to
prospective customers regarding the use and benefits of the Company's products.
In addition, the implementation of the Company's products by customers involves
a significant commitment of resources by such customers over an extended period
of time, and is commonly associated with substantial customer business process
reengineering efforts. For these and other reasons, the sales and customer
implementation cycles are subject to a number of significant delays over which
the Company has little or no control. Delay in the sale or customer
implementation of a limited number of license transactions could have a material
adverse effect on the Company's business and results of operations and cause the
Company's operating results to vary significantly from quarter to quarter. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
 
     Product Concentration.  The Company derived 73.9% of its initial license
revenues from licenses of CompuSet and related CompuSet option products in 1996.
Initial license fees from DVS and DLS comprised 14.7% and 11.4%, respectively,
in 1996. As a result, factors adversely affecting the pricing of or demand for
CompuSet and related products, such as competition from other products, negative
publicity or obsolesce of the hardware or software environments in which the
Company's products run, could have a material adverse effect on the Company's
business, operating results and financial condition. The Company's financial
performance will continue to depend, in significant part, on the successful
development, introduction and customer acceptance of new and enhanced versions
of the CompuSet software and related products. There can be no assurance that
the Company will continue to be successful in developing and marketing CompuSet
products and related services. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
 
     Industry Concentration.  Licenses to end users in the insurance and
commercial print services industries for 1994, 1995 and 1996 accounted for 65%,
61% and 55%, respectively, of total revenues. The future success of the Company
will depend on its ability to continue to successfully market its products in
such industries, and to successfully market its products in other industries.
The failure of the Company to do so would have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
 
     Dependence on New Products and Product Enhancements.  The Company's future
business, operating results and financial condition will continue to depend upon
its ability to develop new products that address the future needs of its target
markets and to respond to emerging industry standards and practices. The Company
believes that its core technology can be extended to the Internet, intranets and
commercial on-line services, and has only recently begun initial development
activity in this area. There can be no assurance that the Company 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, or that its new products and product enhancements
will adequately meet the requirements of the marketplace or achieve market
acceptance. Delays in the
 
                                       10
<PAGE>   11
 
commencement of commercial shipments of new products or enhancements, including
DVS and DLS, may result in client dissatisfaction and delay or loss of product
revenues. If the Company is unable, for technological or other reasons, to
develop and introduce new products or enhancements of existing products in a
timely manner in response to changing market conditions or client requirements,
or if new products or new versions of existing products do not achieve market
acceptance, the Company's business, operating results and financial condition
will be materially adversely affected. In order to provide its customers with
integrated product solutions, the Company's future success will also depend in
part upon its ability to maintain and enhance relationships with its technology
partners, such as Computer Associates and Data Retrieval. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
 
     International Operations.  Revenues from export sales, including sales
through its foreign subsidiary accounted for 26%, 42% and 34% of the Company's
total revenues in 1994, 1995 and 1996, respectively. The Company's wholly owned
subsidiary, Document Sciences Europe, markets and supports the Company's
products in Europe. The Company licenses its products in Europe through value
added resellers and to a lesser extent, direct sales. The value added resellers
are principally Xerox affiliates who re-market the Company's products. In
Australia and Canada, the Company distributes its products through Fuji Xerox
Co., Ltd. and Xerox Canada, Limited, respectively. Revenues generated by these
Xerox affiliates were $1.3 million, $3.1 million and $2.9 million in 1994, 1995
and the 1996, respectively. In 1994 and 1995, a substantial portion of the
Company's revenues from export sales were generated through entities affiliated
with Xerox. In order to successfully expand export sales, the Company must
establish additional foreign operations, hire additional personnel and develop
relationships with additional international resellers. To the extent that the
Company is unable to do so in a timely manner, the Company's growth, if any, in
international export sales will be limited, and the Company's business,
operating results and financial condition could be materially adversely
affected. In addition, there can be no assurance that the Company will be able
to maintain or increase international market demand for its products. Additional
risks inherent in the Company's international business activities generally
include currency fluctuations, unexpected changes in regulatory requirements,
tariffs and other trade barriers, costs of and the Company's limited experience
in localizing products for foreign countries, lack of acceptance of localized
products in foreign countries, longer accounts receivable payment cycles,
difficulties in managing 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 the
Company's business is conducted in currencies other than the U.S. dollar,
primarily the French franc. Although to date exchange rate fluctuations have not
had a significant impact on the Company, fluctuations in the value of the
currencies in which the Company conducts its business relative to the U.S.
dollar could cause currency transaction gains and losses in future periods. The
Company does not currently engage in currency hedging transactions, and there
can be no assurance that fluctuations in the currency exchange rates in the
future will not have a material adverse impact on international revenues and
thus the Company's business, operating results or financial condition. There can
be no assurance that such factors will not have a material adverse effect on the
Company's future international operations and, consequently, the Company's
results of operations. See "Control by Xerox" above and "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
 
     Dependence on Emerging Markets for Document Automation Software.  The
market for document automation software is relatively new, intensely
competitive, highly fragmented, underdeveloped and subject to rapid change.
Marketing and sales techniques in the document automation software marketplace,
as well as the bases for competition, are not well established. There can be no
assurance that the market for document automation software will develop or that,
if it does develop, organizations will adopt the Company's products. The Company
has spent, and intends to continue to spend, significant resources educating
potential customers about the benefits of its products. However, there can be no
assurance that such expenditures will enable the Company's products to achieve
further market acceptance, and if the document automation software market fails
to develop or develops more slowly than the Company currently anticipates, the
Company's business, operating results and financial condition would be
materially adversely affected. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
 
                                       11
<PAGE>   12
 
     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 the Company's
products designed for this market will depend, in part, on their compatibility
with such services. It is difficult to predict with any assurance whether the
Internet, intranets and commercial on-line services will prove to be a viable
commercial marketplace or whether the demand for related products and services
will 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 the Company's products
and services and the introduction of new products and services, there can be no
assurance that the Company will be able to effectively or successfully compete
in this emerging market.
 
     Management of Change; Dependence Upon Key Personnel.  The Company has
recently experienced a period of growth in total revenues. The Company's ability
to compete effectively and to manage future change will require the Company to
continue to improve its financial and management controls, reporting systems and
procedures on a timely basis and to expand, train and manage its employee work
force. There can be no assurance that the Company will be able to do so
successfully. The Company's failure to do so could have a material adverse
effect on the Company's business, operating results and financial condition. The
Company's future performance depends in significant part upon the continued
service of its key technical, sales and senior management personnel, none of
whom are parties to employment agreements with the Company. The loss of the
services of one or more of the Company's executive officers could have a
material adverse effect on the Company's business, operating results and
financial condition. The Company's future success also depends on its continuing
ability to attract and retain highly-qualified product development, sales and
managerial personnel. Competition for such personnel is intense, and there can
be no assurance that the Company will be able to retain its key employees or
that it will be able to attract, assimilate or retain other highly qualified
product development, sales and managerial personnel in the future. See "Control
by Xerox" above.
 
     Product Liability.  The Company's license agreements with its customers
typically contain provisions designed to limit the Company's exposure to
potential product liability claims. However, it is possible that the limitation
of liability provisions contained in the Company's license agreements may not be
effective under the laws of certain jurisdictions. Although the Company has not
experienced any product liability claims to date, the sale and support of
products by the Company may entail the risk of such claims, and there can be no
assurance that the Company will not be subject to such claims in the future. A
successful product liability claim or claim arising as a result of professional
services rendered by the Company brought against the Company could have a
material adverse effect upon the Company's business, operating results and
financial condition.
 
     Risk of Product Defects.  Software products as complex as those offered by
the Company, particularly the Company's new DVS and DLS products, may contain
undetected defects or errors when first introduced or as new versions are
released. As a result, the Company could in the future lose or delay recognition
of revenues as a result of software errors or defects. In addition, the
Company's products are typically intended for use in applications that may be
critical to a customer's business. As a result, the Company expects that its
customers and potential customers have a greater sensitivity to product defects
than the market for software products generally. Although the Company's business
has not been adversely affected by any such errors to date, there can be no
assurance that, despite testing by the Company and by current and potential
customers, errors will not be found in new products or releases after
commencement of commercial shipments, resulting in loss of revenue or delay in
market acceptance, diversion of development resources, damage to the Company's
reputation, or increased service and warranty costs, any of which would have a
material adverse effect upon the Company's business, operating results and
financial condition.
 
ITEM 2.  PROPERTIES.
 
     The Company's principal administrative, sales, marketing, training, and
research and development facilities occupy approximately 15,000 square feet in
San Diego, California, pursuant to a lease which expires on January 31, 2000.
The Company recently signed an amendment to the lease of facilities in San
Diego, which expands the square footage to 33,102 and extends the expiration
date to February 28, 2002, on essentially the same terms. In addition, the
Company's subsidiary in France occupies approximately 3,500
 
                                       12
<PAGE>   13
 
square feet of office space with a renewable lease expiring in February 1999.
Sales representatives and field technical support personnel operate from their
homes.
 
ITEM 3.  LEGAL PROCEEDINGS.
 
     The Company is not a party, nor is its 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 1996.
 
     Executive Officers of the Company
 
     The executive officers of the Company and their ages, as of March 1, 1997
are as follows:
 
<TABLE>
<CAPTION>
               NAME                    AGE                         POSITION
-----------------------------------    ---     ------------------------------------------------
<S>                                    <C>     <C>
Tony N. Domit......................    59      President, Chief Executive Office and Director
Barbara E. Amantea.................    52      Vice President, Chief Financial Officer,
                                               Treasurer and Secretary
Thomas Anthony.....................    61      Vice President, Sales
Peter L. Bradshaw..................    41      Vice President, Development
Daniel J. Fregeau..................    40      Vice President, Marketing
</TABLE>
 
     Tony N. Domit, a Company founder, has served as President, Chief Executive
Officer and Director since the Company's inception in October 1991. Previously,
he was an Executive Consultant with Xerox Technology Ventures. From 1990 to
1991, Mr. Domit was President and CEO of Advanced Workstations Products, Inc., a
wholly-owned Xerox subsidiary. Prior to AWPI, Mr. Domit was employed by Xerox
Corporation for 22 years in a variety of Vice Presidential and managerial
positions, primarily in the areas of product development and marketing. His
Xerox-related experiences were in that company's electronic printing,
publishing, workstation and networking businesses. Prior to Xerox, Mr. Domit was
an engineer with Scientific Data Systems, Ampex Computer Products, and Litton
Industries. Mr. Domit is a director of DataWorks Corporation.
 
     Barbara E. Amantea has served as Vice President, Chief Financial Officer,
Treasurer and Assistant Secretary since the Company's inception in 1991. Prior
to the formation of the Company, Ms. Amantea served for nine months as a
financial consultant with Xerox Technology Ventures. From 1990 to 1991, Ms.
Amantea was Chief Financial Officer of Advanced Workstation Products, Inc., a
wholly-owned subsidiary of Xerox Corporation. From 1988 to 1990, Ms. Amantea was
Chief Financial Officer of Segue Software, Inc., a provider of automated testing
software. From 1977 to 1987, Ms. Amantea was Controller and Corporate Secretary
to Interactive Systems Corporation, a developer and supplier of UNIX operating
systems, which was subsequently acquired by Kodak Corporation.
 
     Daniel J. Fregeau has served as Vice President, Marketing since 1994. From
1992 to 1994, Mr. Fregeau served as Vice President, Sales for the Company. Prior
to joining the Company, 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, Mr.
Fregeau designed and directed the development of several publishing products and
was a key contributor to the launch of the XICS (now CompuSet) product in the
U.S. and Canada.
 
     Thomas Anthony has served as Vice President, Sales since June 1994. Prior
to joining the Company, Mr. Anthony was Executive Vice President, Marketing and
Sales for Innovatech, Inc. from 1992 to 1994, Acer America from 1990 to 1992,
Sweda International from 1987 to 1990, and Frame Technologies from 1986 to 1987.
Mr. Anthony was Vice President, Sales for Altos Computer Systems from 1983 to
1986 and Vice
 
                                       13
<PAGE>   14
 
President Marketing and Sales from 1979 to 1983 for Onyx Systems. Prior to Onyx,
Mr. Anthony was with National Semiconductor as a Vice President and founder of
the Datachecker Systems Business Unit.
 
     Peter L. Bradshaw has served as Vice President of Development since March,
1994. Prior to joining the Company, Mr. Bradshaw was manager of the Application
Software Team at Xerox from 1989 to 1994, where he was responsible for
integrating high volume printers with application software. From 1982 to 1989,
Mr. Bradshaw worked in Xerox' Workstation Business Unit where he managed the
development team responsible for the graphical user interface for the 6085
Workstation. From 1977 to 1980, Mr. Bradshaw was at Bell Telephone Laboratories
in system development.
 
     Executive officers of the Company 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 the Company.
 
                                    PART II
 
ITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
 
     The information required by this item is incorporated by reference to the
inside back cover of the Company's 1996 Annual Report to Stockholders.
 
ITEM 6.  SELECTED FINANCIAL DATA.
 
     The information required by this item is incorporated by reference to page
1 of the Company's 1996 Annual Report to Stockholders.
 
ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS.
 
     In addition to historical information, this annual report on Form 10-K
contains forward-looking statements that involve risks and uncertainties. The
Company's actual results could differ materially from those discussed herein.
Factors that could cause or contribute to such differences include, but are not
limited to, those discussed herein as well as those discussed in "Certain
Additional Business Risks" on pages 7 through 12. Readers are cautioned not to
place undue reliance on these forward-looking statements, and the Company
undertakes no obligation to publicly release the results of any revision to
these forward-looking statements which may be made to reflect events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
 
OVERVIEW
 
     Document Sciences Corporation develops, markets and supports a family of
document automation software and services used in high volume electronic
publishing applications. The Company was incorporated in Delaware in October
1991 as a wholly-owned subsidiary of Xerox Corporation ("Xerox"), and following
the Company's initial public offering of stock in September 1996, Xerox
ownership was reduced to approximately 63%.
 
INITIAL PUBLIC OFFERING
 
     In September 1996, the Company completed an initial public offering ("IPO")
in which 2,645,000 shares of its Common Stock were sold, including 462,500
shares which were sold by certain selling stockholders, at $12.00 per share. The
IPO generated net proceeds to the Company of approximately $23.33 million.
 
                                       14
<PAGE>   15
 
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
 
     Revenues
 
     Total revenues were $15.3 million, $10.5 million and $7.2 million in 1996,
1995 and 1994, respectively, representing increases of 46% from 1995 to 1996 and
47% from 1994 to 1995. The Company's 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 are comprised principally of license fees for the first year of use
of the Company's products by end user customers. Annual renewal license and
support fees are comprised principally of mandatory fees paid by customers
annually for continued use and support of the licensed products. Services and
other revenues are comprised principally of fees for consulting, application
development and training services performed by the Company as well as fees
received from Xerox in connection with the sale of certain Xerox printer
products. The Company recognizes revenue in accordance with AICPA Statement of
Position on Software Revenue Recognition No. 91-1. Initial license revenue is
recognized upon shipment of the product to customers if no significant Company
obligations remain and collection of the receivable is deemed probable. The
portion of the initial license revenue which represents the software support for
the first year is deferred and recognized ratably over the contract period.
Revenues from commissions paid by Xerox in connection with the sale of Xerox
printer products are recognized upon installation of the printer products.
Revenues generated from consulting and training services are recognized as the
related services are performed.
 
     The growth of total revenue in each year was due primarily to increased
numbers of initial software license customers and growth in services and other
revenue, and to the expansion of the Company's sales force and product
consultants.
 
     The Company sells its products principally through a direct sales force
domestically, and internationally principally through distributors and value
added resellers ("VARS") and, to a lesser extent, through its direct sales
force. Revenues from export sales and sales through the Company's foreign
subsidiary were $5.2 million, $4.4 million and $1.9 million in 1996, 1995 and
1994, respectively, representing increases of 18% from 1995 to 1996 and 132%
from 1994 to 1995. The growth in export sales from 1994 to 1995 was due
primarily to expansion of the value added reseller channel in Europe. The growth
in export sales from 1995 to 1996 was the result of new customers licensing the
Company's products. Revenue from export sales were 34%, 42% and 26% of total
revenue for the 1996, 1995 and 1994, respectively. The increase in export sales
as a percentage of total revenue in 1995 relative to 1994 was the result of
establishing a subsidiary in Europe to focus on serving the European market. In
1996, export revenue declined as a percentage of total revenue principally
because of reduced sales in Australia and Canada.
 
     The Company and Xerox maintain a strategic marketing alliance agreement
under which the parties have agreed to pay each other fees on referrals that
lead to the successful licensing or sales of each other's products. The
Company's revenues from the strategic marketing alliance, principally
commissions from sales of Xerox printers, were $1.4 million, $752,000 and
$490,400 for 1996, 1995 and 1994, respectively. These commissions were 9% of
total revenue in 1996 and 7% of total revenue in 1995 and 1994. Failure to
continue to receive such commissions would have a material adverse effect on the
Company's business, operating results and financial condition.
 
     The Company has entered into distributorship agreements with various Xerox
foreign affiliates to remarket the Company's products internationally. The
Company's revenues from such distributorship agreements relating to the
licensing, maintenance and support of the Company's products were $2.9 million,
$3.1 million and $1.3 million in 1996, 1995 and 1994, respectively. The decrease
in revenues from Xerox foreign affiliates in 1996 relative to 1995 was the
result of reduced sales by affiliates in Australia and Canada. Revenues from
affiliates in Europe increased 3% from 1996 to 1995.
 
     Initial license fees.  Initial license fee revenues were $8.6 million, $6.3
million and $4.4 million in 1996, 1995 and 1994, respectively, representing
increases of 36% from 1995 to 1996 and 42% from 1994 to 1995. Initial license
revenues as a percentage of total revenue were 56%, 60% and 62%, in 1996, 1995
and 1994, respectively. The growth in initial license revenues in each period
was attributable to increases in both the size
 
                                       15
<PAGE>   16
 
of licensing transactions and the number of new customers. To a lesser extent,
growth in 1996 was the result of introduction of the Company's new products,
Document Viewing Services and Document Library Services.
 
     Annual renewal license and support fees.  Revenues from annual renewal
licenses were $2.4 million, $1.9 million and $1.5 million for 1996, 1995 and
1994, respectively, representing increases of 25% from 1995 to 1996 and 28% from
1994 to 1995. The increase in both periods was principally due to the increase
in the installed base of users of the Company's software products. As a
percentage of total revenue, annual renewal license and support fees were 16%,
18% and 21% in 1996, 1995 and 1994, respectively. The decrease of annual renewal
license and support fees as a percentage of total revenue resulted from the
greater rate of increase in revenue derived from initial license fees and
services and other.
 
     Services and other.  Revenues from services and other were $4.3 million,
$2.3 million and $1.2 million in 1996, 1995 and 1994, respectively, representing
increases of 90% from 1995 to 1996 and 86% from 1994 to 1995. The increase in
each period was principally due to the increased number of new customer licenses
of the Company's software generating increased demand for services as well as
the increasing scope of professional services offered, and the increase in
commissions from $752,000 to $1.4 million from 1995 to 1996 and $490,400 to
$752,000 from 1994 to 1995, respectively, under the strategic marketing alliance
for the sale of Xerox printer products. Revenues from services and other were
28%, 22% and 17% of total revenues in 1996, 1995 and 1994, respectively.
 
     Cost of Revenues
 
     Cost of initial license fees.  Cost of initial license revenues were
$696,000, $351,000 and $274,000 in 1996, 1995 and 1994, respectively,
representing 8%, 6% and 6% of initial license revenues in 1996, 1995 and 1994,
respectively. Cost of initial licenses of software includes documentation,
reproduction costs, product packaging, packaging design, product media,
employment costs for training, installation and distribution personnel, the cost
of third party software and amortization of previously capitalized software
development costs. The increase of cost of initial licenses as a percentage of
initial license revenues was primarily the result of increased payments for
third party software integrated into the Company's Document Library software
products.
 
     Cost of annual licenses renewals.  Cost of annual licenses renewals
consists principally of the employment-related costs for the Company's technical
support staff, which performs technical software support services. Cost of
annual licenses renewal revenues was $497,000, $370,000 and $267,000 in 1996,
1995 and 1994, respectively, representing 21%, 19% and 18% of annual licenses
renewal revenues. These costs increased as a result of the increases in
personnel to support the expansion of the installed base of users of the
Company's software products and the increased product offerings of the Company.
 
     Cost of services and other.  Cost of services and other revenues were $1.1
million, $424,000 and $192,000 in 1996, 1995 and 1994, respectively,
representing 25%, 19% and 16% of services and other revenue. Cost of services
and other consists principally of the employment-related costs for the Company's
staff of product consultants and trainers. There are little or no costs related
to commissions from the sale of Xerox printers under the strategic marketing
alliance. The increase in cost of services and other revenues resulted
principally from the additional staffing to perform the Company's professional
services.
 
     Research and development.  Research and development expenses were $2.3
million, $1.7 million and $1 million in 1996, 1995 and 1994, respectively,
representing increases of 34% from 1995 to 1996 and 67% from 1994 to 1995.
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. As a
percentage of total revenue, research and development expenses were 15%, 17% and
15% in 1996, 1995 and 1994 respectively. The Company anticipates that it will
continue to direct significant resources to development and enhancement of
products.
 
     The Company expenses all costs for research and development of new products
until technological feasibility has been assured. Thereafter, costs of
production are capitalized until general release of the product. The capitalized
costs of software production are amortized using the greater of the amount
computed using
 
                                       16
<PAGE>   17
 
the ratio of current product revenues to estimated total product revenues or the
straight-line method over the remaining estimated economic lives of the
products. The Company capitalized software development expenses of $104,000,
$291,000 and $164,000 in 1996, 1995 and 1994, respectively. The increase in
capitalized software development expenses in 1995 compared to 1994, and
subsequent reduction from 1995 compared to 1996 was the result of the Company's
development of the Document Viewing Services product during 1995.
 
     Selling, and marketing.  Selling and marketing expenses were $7.4 million,
$4.4 million and $2.8 million in 1996, 1995 and 1994, respectively, representing
increases of 67% from 1995 to 1996 and 60% from 1994 to 1995. Selling and
marketing expenses consist primarily of salaries, commissions, marketing
programs and related costs for pre- and post-sales activity. The increase for
both periods was the result of adding personnel to increase geographic coverage
of the selling organization and, to a lesser extent, the higher commissions
associated with increased revenues. The increase in 1995 compared to 1996 was
also the result of adding employees to develop and deliver the professional
services. Selling and marketing expenses were 48%, 42% and 39% of total revenues
in 1996, 1995 and 1994, respectively.
 
     General and administrative.  General and administrative expenses consist of
employment-related costs for finance, administration and human resources, and
general corporate management and services. General and administrative expenses
were $1.7 million in 1996, $1.5 million in 1995 and $1.3 million in 1994
representing 11%, 14% and 18% of total revenue in 1996, 1995 and 1994,
respectively. The increase in general and administrative expenses in absolute
dollars was the result of growth in the finance and administrative operations to
support the growth of the Company. The decrease of these expenses as a
percentage of total revenues reflects the benefits of economies of scale.
 
     Interest income (expense), net.  Interest income (expense) is primarily
composed of interest income from cash and cash equivalents and short term
investments offset by financing charges related to equipment leases and other
debt. Interest income (expense), net was $318,000, $5,000 and $(9,000) in 1996,
1995 and 1994, respectively. The increase in dollar amount is primarily due to
higher cash balances resulting from the infusion of cash from the Company's
initial public offering of common stock completed in September 1996.
 
     Provision for income taxes.  Effective tax rates were approximately 31%,
38% and 47% in 1996, 1995 and 1994, respectively. These rates differ from the
federal statutory rate primarily due to recognition of a net operating loss
carryforward from the Company's foreign subsidiary. From its inception to
September 19, 1996, the Company's taxes were included in the consolidated tax
returns of Xerox Corporation. For reporting purposes, the Company recognized
income tax expense on pretax income at the tax rates in effect as if the Company
were filing tax returns on a stand-alone basis.
 
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
 
     The Company's total revenues and operating results can vary, sometimes
substantially, from quarter to quarter and are expected to vary significantly in
the future. The Company's revenues and operating results are difficult to
forecast. Future results will depend upon many factors, including the demand for
the Company's products, the level of product and price competition, the length
of the Company's sales cycle, the size and timing of individual license
transactions, the delay or deferral of customer implementations, the budget
cycles of the Company's customers, the Company's success in expanding its direct
sales force and indirect distribution channels, the timing of new product
introductions and product enhancements by the Company and its 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, the ability of the Company to develop and market new
products and control costs, and general domestic and international economic
conditions. In addition, the Company's sales generally reflect a relatively high
amount of revenues per order, and, therefore, the loss or delay of individual
orders could have a significant impact on revenues and quarterly operating
results of the Company. In addition, a significant amount of the Company's
revenues occur predominantly in the third month of each fiscal quarter and tend
to be concentrated in the latter half of that third month.
 
     The Company's software products generally are shipped as orders are
received. As a result, initial license revenues in any quarter are substantially
dependent on orders booked and shipped in that quarter. The timing
 
                                       17
<PAGE>   18
 
of receipt of initial license revenue is difficult to predict because of the
length of the Company's sales cycle, which is typically three to twelve months
from the initial contact. Because the Company's operating expenses are based on
anticipated revenue trends and because a high percentage of the Company's
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, the Company's operating results would be materially
adversely affected.
 
     Due to the foregoing factors, revenues and operating results for any
quarter are subject to significant variation, and the Company believes that
period-to-period comparisons of its results of operations are not necessarily
meaningful and should not be relied upon as indications of future performance.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     In September 1996, the Company completed its IPO and received net proceeds
of approximately $23.33 million.
 
     At December 31, 1996, the Company had $25.6 million in cash, cash
equivalents and short-term investments. The Company has an agreement with a bank
that provides a working capital line of credit at the bank's prime rate. The
agreement, which expires in July 1997, allows maximum borrowings of the lesser
of $2.5 million or 75% of eligible accounts receivable. At December 31, 1996,
the Company had no outstanding borrowings under this agreement.
 
     Net cash provided by operating activities was $1.7 million, $1.2 million
and $1.3 million in 1996, 1995 and 1994, respectively. Net cash used in
investing activities was $23.8 million, $589,000 and $411,000 in 1996, 1995 and
1994, respectively. In 1996, net cash used in investing activities was primarily
used for purchase of short term investments and to a lesser extent, for the
purchase of fixed assets. In 1995 and 1994, net cash used in investing
activities was primarily used for the purchase of fixed assets. Net cash
provided by financing activities in 1996 was $23.3 million, primarily from net
proceeds from the initial public offering of the Company's common stock. In 1995
net cash provided by financing activities was $27,000, primarily from issuance
of the Company's common stock pursuant to exercise of options granted under the
Employee Stock Option Plan, offset by payments of capital lease obligations. Net
cash used for financing activities in 1994 was primarily for repayment of bank
notes.
 
     With the exception of plans to undertake capital spending to expand the
corporate facilities in the first quarter of 1997, the Company has no
significant capital spending or purchase commitments other than normal purchase
commitments and commitments under facilities and capital leases.
 
     The Company believes that its existing cash balances and anticipated cash
flows from operations will be sufficient to meet its anticipated cash needs for
working capital and capital expenditures at least through the next twelve
months. A portion of the Company's cash could be used to acquire or invest in
complementary businesses or products or obtain the right to use complementary
technologies. The Company is currently evaluating, in its ordinary course of
business, potential investments such as businesses, products or technologies.
The Company has no current understandings, commitments or agreements with
respect to any acquisition of other businesses, products or technologies.
 
ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
 
     The information required by this item is in Item 14 of Part IV of this
Report and is incorporated into this item by reference.
 
ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE.
 
     Not applicable
 
                                       18
<PAGE>   19
 
                                    PART III
 
ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.
 
     The information required by this item concerning the Company's directors is
incorporated by reference to the information set forth in the section entitled
"Election of Directors -- Nominees" in the Company's Proxy Statement for the
1997 Annual Meeting of Stockholders to be filed with the Commission within 120
days after the end of the Company's fiscal year ended December 31, 1996, except
that the information required by this item concerning the executive officers of
the Company is incorporated by reference to the information set forth in the
section entitled "Executive Officers of the Company" at the end of Part I of
this Form 10-K.
 
ITEM 11.  EXECUTIVE COMPENSATION.
 
     The information required by this item regarding executive compensation is
incorporated by reference to the information set forth in the section entitled
"Executive Officer Compensation" in the Company's Proxy Statement for the 1997
Annual Meeting of Stockholders to be filed with the Commission within 120 days
after the end of the Company's fiscal year ended December 31, 1996.
 
ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
          MANAGEMENT.
 
     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 the Company's Proxy Statement for the 1997
Annual Meeting of Stockholders to be filed with the Commission within 120 days
after the end of the Company's fiscal year ended December 31, 1996.
 
ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
 
     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 the Company's Proxy Statement
for the 1997 Annual Meeting of Stockholders to be filed with the Commission
within 120 days after the end of the Company's fiscal year ended December 31,
1996.
 
                                    PART IV
 
ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
 
     (a) The following documents are filed as part of this Form 10-K:
 
          1. Financial Statements.  The following consolidated financial
     statements, and related notes thereto, of the Company and the Report of
     Independent Auditors are included in Part IV of this Report on the pages
     indicated by the Index to Financial Statements as presented on page 22 of
     this Report.
 
          Report of Ernst & Young LLP, Independent Auditors
 
          Consolidated Balance Sheets -- December 31, 1996 and 1995
 
          Consolidated Statements of Income -- Fiscal Years Ended December 31,
     1996, 1995 and 1994
 
        Consolidated Statements of Redeemable Preferred Stock and Stockholders'
        Equity -- Three Year Period Ended December 31, 1996
 
          Consolidated Statements of Cash Flows -- Fiscal Years Ended December
     31, 1996, 1995 and 1994
 
          Notes to Consolidated Financial Statements
 
                                       19
<PAGE>   20
 
          2. Financial Statement Schedule.  The following financial statement
     schedule of the Company for the fiscal years ended December 31, 1996, 1995
     and 1994 is filed as part of this Form 10-K and should be read in
     conjunction with the Consolidated Financial Statements, and related notes
     thereto, of the Company.
 
             Schedule II Valuation and Qualifying
        Accounts---------------------------------------S-1
 
             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 14(c) below.
 
     (b) Reports on Form 8-K.  No reports on Form 8-K were filed by the Company
during the fiscal quarter ended December 31, 1996.
 
     (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 14(a) above.
 
                                       20
<PAGE>   21
 
                                   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 on this 21st day of
March 1997.
 
                                          DOCUMENT SCIENCES CORPORATION
 
                                          By:        /s/  TONY N. DOMIT
                                            ------------------------------------
                                                       TONY N. DOMIT
                                               President and Chief Executive
                                                           Officer
Dated: March 21, 1997
 
                               POWER OF ATTORNEY
 
     KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Tony N. Domit and Barbara E. Amantea and
each of them, jointly and severally, his or her attorneys-in-fact, each with
full power of substitution, for him or her 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 each said
attorneys-in-fact or his or her substitute or substitutes, 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 and in the capacities and on the dates indicated:
 
<TABLE>
<CAPTION>
            SIGNATURES                                 TITLE                         DATE
-----------------------------------    -------------------------------------    ---------------
<C>                                    <S>                                      <C>
 
         /s/ TONY N. DOMIT             President and Chief Executive Officer
-----------------------------------    (principal executive officer)
           Tony N. Domit                                                        March 21, 1997
      /s/ BARBARA E. AMANTEA           Vice President, Chief Financial
-----------------------------------    Officer and Secretary (principal
        Barbara E. Amantea             financial and accounting officer)        March 21, 1997
        /s/ ROBERT V. ADAMS            Chairman of the Board of Directors
-----------------------------------
          Robert V. Adams                                                       March 21, 1997
       /s/ COLIN J. O'BRIEN            Director
-----------------------------------
         Colin J. O'Brien                                                       March 21, 1997
       /s/ JAMES J. COSTELLO           Director
-----------------------------------
         James J. Costello                                                      March 21,1997
       /s/ THOMAS L. RINGER            Director
-----------------------------------
         Thomas L. Ringer                                                       March 21, 1997
                                       Director
-----------------------------------
          Barton L. Faber
</TABLE>
 
                                       21
<PAGE>   22
 
                         DOCUMENT SCIENCES CORPORATION
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
<TABLE>
<S>                                                                                      <C>
Report of Ernst & Young LLP, Independent Auditors....................................     F-1
Consolidated Balance Sheets..........................................................     F-2
Consolidated Statements of Income....................................................     F-3
Consolidated Statements of Redeemable Preferred Stock and Stockholders' Equity.......     F-4
Consolidated Statements of Cash Flows................................................     F-5
Notes to Consolidated Financial Statements...........................................     F-6
</TABLE>
 
                                       22
<PAGE>   23
 
               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
 
The Board of Directors and Stockholders
Document Sciences Corporation
 
     We have audited the accompanying consolidated balance sheets of Document
Sciences Corporation as of December 31, 1995 and 1996, and the related
consolidated statements of income, redeemable preferred stock and stockholders'
equity and cash flows for each of the three years in the period ended December
31, 1996. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. 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, 1995 and 1996, and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended December 31, 1996, in conformity with generally accepted accounting
principles.
 
                                                               ERNST & YOUNG LLP
 
San Diego, California
January 22, 1997
 
                                       F-1
<PAGE>   24
 
                         DOCUMENT SCIENCES CORPORATION
 
                          CONSOLIDATED BALANCE SHEETS
 
<TABLE>
<CAPTION>
                                                                            DECEMBER 31,
                                                                     --------------------------
                                                                        1995           1996
                                                                     ----------     -----------
<S>                                                                  <C>            <C>
ASSETS
Current assets:
  Cash and cash equivalents........................................  $1,271,120     $ 2,465,694
  Short-term investments...........................................          --      23,142,885
  Accounts receivable, less allowance for doubtful accounts of
     $22,957 and $227,112 in 1995 and 1996, respectively...........   2,152,732       2,257,025
  Due from affiliates..............................................   1,612,600       2,377,364
  Deferred income taxes............................................      79,200         170,700
  Other current assets.............................................     164,233         232,304
                                                                     ----------     -----------
Total current assets...............................................   5,279,885      30,645,972
Property and equipment, net........................................     632,225         998,203
Computer software costs, net of accumulated amortization of
  $280,719 and $384,785 in 1995 and 1996, respectively.............     377,172         377,342
                                                                     ----------     -----------
                                                                     $6,289,282     $32,021,517
                                                                     ==========     ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable.................................................  $  328,609     $   698,711
  Accrued compensation.............................................     444,409         831,541
  Other accrued liabilities........................................     130,487         457,492
  Deferred revenue.................................................   1,596,965       2,477,723
  Current income tax payable to affiliate..........................   1,382,100         311,000
  Current portion of obligations under capital leases..............      44,100          62,439
                                                                     ----------     -----------
Total current liabilities..........................................   3,926,670       4,838,906
Obligations under capital leases...................................      98,500         115,740
Deferred income taxes..............................................     157,000         156,500
Commitments
Series A Redeemable Preferred Stock, $.001 par value; 6,000,000
  shares authorized, issued and outstanding at December 31, 1995;
  2,000,000 shares authorized, no shares issued and outstanding at
  December 31, 1996; liquidation preference of $2,000,000 in
  1995.............................................................   1,250,750              --
Stockholders' equity
  Common stock, $.001 par value;
  Authorized shares -- 30,000,000
  Issued and outstanding shares -- 1,311,423 in 1995 and 10,722,168
     in 1996.......................................................       1,311          10,722
  Deferred compensation............................................          --        (351,473)
  Unrealized gain on short-term investments........................          --          13,222
  Additional paid-in capital.......................................     110,550      25,382,203
  Retained earnings................................................     744,501       1,855,697
                                                                     ----------     -----------
Total stockholders' equity.........................................     856,362      26,910,371
                                                                     ----------     -----------
                                                                     $6,289,282     $32,021,517
                                                                     ==========     ===========
</TABLE>
 
                            See accompanying notes.
 
                                       F-2
<PAGE>   25
 
                         DOCUMENT SCIENCES CORPORATION
 
                       CONSOLIDATED STATEMENTS OF INCOME
 
<TABLE>
<CAPTION>
                                                                 YEARS ENDED DECEMBER 31,
                                                         ----------------------------------------
                                                            1994           1995           1996
                                                         ----------     ----------     ----------
<S>                                                      <C>            <C>            <C>
Revenues:
  Initial license fees (including $1,098,400,
     $2,518,700 and $2,289,300 from affiliates in 1994,
     1995 and 1996, respectively)......................  $4,425,970     $6,299,230     $8,593,220
  Annual renewal license and support fees (including
     $312,800, $461,500 and $476,500 from affiliates in
     1994, 1995 and 1996, respectively)................   1,521,389      1,942,353      2,420,780
  Services and other (including $528,000, $934,700 and
     $1,456,000 from affiliates in 1994, 1995 and 1996,
     respectively).....................................   1,223,897      2,270,460      4,305,294
                                                         ----------     ----------     ----------
Total revenues.........................................   7,171,256     10,512,043     15,319,294
Cost of revenues:
  Initial license fees.................................     273,667        350,860        695,750
  Annual renewal license and support fees..............     266,902        369,732        496,871
  Services and other...................................     191,865        423,888      1,092,219
                                                         ----------     ----------     ----------
Total cost of revenues.................................     732,434      1,144,480      2,284,840
                                                         ----------     ----------     ----------
Gross profit...........................................   6,438,822      9,367,563     13,034,454
Operating expenses:
  Research and development.............................   1,044,761      1,747,194      2,336,252
  Selling and marketing (including $113,500, $167,200
     and $180,600 to affiliates in 1994, 1995 and 1996,
     respectively).....................................   2,765,414      4,415,158      7,359,336
  General and administrative...........................   1,274,847      1,519,865      1,673,928
                                                         ----------     ----------     ----------
Total operating expenses...............................   5,085,022      7,682,217     11,369,516
                                                         ----------     ----------     ----------
Income from operations.................................   1,353,800      1,685,346      1,664,938
Interest income (expense), net.........................      (9,125)         5,079        317,508
                                                         ----------     ----------     ----------
Income before provision for income taxes...............   1,344,675      1,690,425      1,982,446
Provision for income taxes.............................     632,900        638,400        621,500
                                                         ----------     ----------     ----------
Net income.............................................  $  711,775     $1,052,025     $1,360,946
                                                         ==========     ==========     ==========
Net income per share...................................  $     0.09     $     0.13     $     0.14
                                                         ==========     ==========     ==========
Shares used in per share calculation...................   8,256,165      8,291,732      9,490,747
                                                         ==========     ==========     ==========
</TABLE>
 
                            See accompanying notes.
 
                                       F-3
<PAGE>   26
 
                         DOCUMENT SCIENCES CORPORATION
 
 CONSOLIDATED STATEMENTS OF REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
                                                                                     STOCKHOLDERS' EQUITY
                                                                      --------------------------------------------------
                                             SERIES A REDEEMABLE
                                               PREFERRED STOCK            COMMON STOCK        ADDITIONAL
                                          -------------------------   ---------------------     PAID-IN       DEFERRED
                                            SHARES        AMOUNT        SHARES      AMOUNT      CAPITAL     COMPENSATION
                                          -----------   -----------   -----------   -------   -----------   ------------
<S>                                       <C>           <C>           <C>           <C>       <C>           <C>
Balance at December 31, 1993............    6,000,000   $   584,750         3,000   $     3   $    45,593    $       --
  Accretion on Series A Redeemable
    Preferred Stock.....................           --       333,000            --        --            --            --
  Net income............................           --            --            --        --            --            --
                                           ----------   -----------    ----------   -------   -----------     ---------
Balance at December 31, 1994............    6,000,000       917,750         3,000         3        45,593            --
  Issuance of common stock upon exercise
    of options..........................           --            --     1,308,423     1,308        64,957            --
  Accretion on Series A Redeemable
    Preferred Stock.....................           --       333,000            --        --            --            --
  Net income............................           --            --            --        --            --            --
                                           ----------   -----------    ----------   -------   -----------     ---------
Balance at December 31, 1995............    6,000,000     1,250,750     1,311,423     1,311       110,550            --
  Issuance of common stock upon initial
    public offering.....................           --            --     2,182,500     2,183    23,331,329            --
  Issuance of common stock upon exercise
    of options..........................           --            --        88,245        88         6,964            --
  Accretion on Series A Redeemable
    Preferred Stock.....................           --       249,750            --        --            --            --
  Deferred compensation.................           --            --            --        --       440,000      (440,000)
  Amortization of deferred
    compensation........................           --            --            --        --            --        88,527
  Redemption of Series A Redeemable
    Preferred Stock.....................   (6,000,000)   (1,500,500)    7,140,000     7,140     1,493,360            --
  Unrealized gain on short-term
    investments.........................           --            --            --        --            --            --
  Net income............................           --            --            --        --            --            --
                                           ----------   -----------    ----------   -------   -----------     ---------
Balance at December 31, 1996............           --   $        --    10,722,168   $10,722   $25,382,203    $ (351,473)
                                           ==========   ===========    ==========   =======   ===========     =========
 
<CAPTION>
 
                                          UNREALIZED
                                            GAIN ON      RETAINED
                                          SHORT-TERM     EARNINGS
                                          INVESTMENTS   (DEFICIT)       TOTAL
                                          -----------   ----------   -----------
<S>                                       <C>           <C>          <C>
Balance at December 31, 1993............    $    --     $ (353,299)  $  (307,703)
  Accretion on Series A Redeemable
    Preferred Stock.....................         --       (333,000)     (333,000)
  Net income............................         --        711,775       711,775
                                            -------     ----------   -----------
Balance at December 31, 1994............         --         25,476        71,072
  Issuance of common stock upon exercise
    of options..........................         --             --        66,265
  Accretion on Series A Redeemable
    Preferred Stock.....................         --       (333,000)     (333,000)
  Net income............................         --      1,052,025     1,052,025
                                            -------     ----------   -----------
Balance at December 31, 1995............         --        744,501       856,362
  Issuance of common stock upon initial
    public offering.....................         --             --    23,333,512
  Issuance of common stock upon exercise
    of options..........................         --             --         7,052
  Accretion on Series A Redeemable
    Preferred Stock.....................         --       (249,750)     (249,750)
  Deferred compensation.................         --             --            --
  Amortization of deferred
    compensation........................         --             --        88,527
  Redemption of Series A Redeemable
    Preferred Stock.....................         --             --     1,500,500
  Unrealized gain on short-term
    investments.........................     13,222             --        13,222
  Net income............................         --      1,360,946     1,360,946
                                            -------     ----------   -----------
Balance at December 31, 1996............    $13,222     $1,855,697   $26,910,371
                                            =======     ==========   ===========
</TABLE>
 
                            See accompanying notes.
 
                                       F-4
<PAGE>   27
 
                         DOCUMENT SCIENCES CORPORATION
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                               YEARS ENDED DECEMBER 31,
                                                      -------------------------------------------
                                                         1994            1995            1996
                                                      -----------     ----------     ------------
<S>                                                   <C>             <C>            <C>
OPERATING ACTIVITIES
Net income..........................................  $   711,775     $1,052,025     $  1,360,946
Adjustments to reconcile net income to net cash
  provided by operating activities:
  Depreciation and amortization.....................       63,102        141,685          254,373
  Loss on disposal of fixed assets..................           --             --              313
  Amortization of computer software costs...........      103,483        136,068          104,066
  Amortization of deferred compensation.............           --             --           88,527
  Current income tax expense payable to
     affiliates.....................................      653,700        591,400       (1,071,100)
  Deferred income taxes.............................      (20,800)        47,000          (92,000)
  Provision for doubtful accounts...................        3,613          9,344          204,155
  Changes in operating assets and liabilities:
     Accounts receivable............................   (1,461,372)      (920,885)      (1,073,212)
     Other current assets...........................     (114,934)       (23,258)         (68,071)
     Accounts payable...............................       82,693        209,087          370,102
     Accrued liabilities............................      892,877       (508,671)         714,137
     Deferred revenue...............................      343,777        515,250          880,758
                                                         --------       --------       ----------
Net cash provided by operating activities...........    1,257,914      1,249,045        1,672,994
INVESTING ACTIVITIES
Purchases of short term investments.................           --             --      (23,129,663)
Purchases of property and equipment, net............     (247,660)      (297,964)        (526,895)
Proceeds from disposal of assets....................           --             --            8,000
Additions to computer software costs................     (163,629)      (290,980)        (104,236)
                                                         --------       --------       ----------
Net cash used for investing activities..............     (411,289)      (588,944)     (23,752,794)
FINANCING ACTIVITIES
Proceeds from note payable to bank..................      100,000             --               --
Repayments of note payable to bank..................     (445,000)            --               --
Principal payments under capital lease
  obligations.......................................      (29,379)       (39,080)         (66,190)
Proceeds from issuance of common stock..............           --         66,265       23,340,564
                                                         --------       --------       ----------
Net cash provided by (used for) financing
  activities........................................     (374,379)        27,185       23,274,374
                                                         --------       --------       ----------
Increase in cash and cash equivalents...............      472,246        687,286        1,194,574
Cash and cash equivalents at beginning of year......      111,588        583,834        1,271,120
                                                         --------       --------       ----------
Cash and cash equivalents at end of year............  $   583,834     $1,271,120     $  2,465,694
                                                         ========       ========       ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid.......................................  $    15,800     $   12,283     $     29,430
                                                         ========       ========       ==========
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND
  FINANCING ACTIVITIES:
Capital lease obligations entered into for property
  and equipment.....................................  $    55,592     $  130,941     $    101,769
                                                         ========       ========       ==========
</TABLE>
 
                            See accompanying notes.
 
                                       F-5
<PAGE>   28
 
                         DOCUMENT SCIENCES CORPORATION
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1.  ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
ORGANIZATION
 
     Document Sciences Corporation (the "Company") was incorporated on October
18, 1991 in Delaware as a subsidiary of Xerox Corporation ("Xerox"). The Company
develops, markets and supports a family of document automation software products
and services used in high volume electronic publishing applications. Autograph,
the Company's document automation software architecture, enables personalized
publishing solutions for many industries including insurance, managed
healthcare, financial services, telecommunications, government agencies and
commercial print service bureaus.
 
     The Company currently derives substantially all of its license revenues
from licenses of CompuSet, Autograph's flagship product, and related products
and from fees for services related to the CompuSet software. The Company's
financial performance will continue to depend, in significant part, on the
successful development, introduction and customer acceptance of new and enhanced
versions of the CompuSet software and related products. There can be no
assurance that the Company will continue to be successful in developing and
marketing CompuSet products and related services.
 
     The Company currently has a variety of contractual and informal
relationships with Xerox and affiliates of Xerox, including a strategic
marketing alliance agreement, a transfer and license agreement and various
distribution agreements. There can be no assurance that Xerox or its affiliates
will continue these relationships. The failure by the Company to maintain these
relationships with Xerox and its affiliates could have a material adverse effect
on the Company's financial statements.
 
BASIS OF PRESENTATION
 
     In 1994, the Company established a wholly-owned subsidiary, Document
Sciences Europe, in Sophia Antipolis, France in order to market and support its
products to the European community. The accompanying consolidated financial
statements include the accounts of the Company and its subsidiary. Significant
intercompany accounts and transactions have been eliminated in consolidation.
 
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
 
     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
 
FOREIGN OPERATIONS
 
     The functional currency of the Company's France subsidiary is the French
Franc. The balance sheet accounts of the subsidiary are translated into United
States dollars at exchange rates prevailing at the balance sheet dates. Revenues
and expenses are translated into U.S. dollars at the average rates of exchange
during the period. Net realized translation adjustments were insignificant in
1994, 1995 and 1996. Foreign currency transaction gains and losses are included
in the consolidated statements of income and were not material during the years
ended December 31, 1994, 1995 and 1996.
 
CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
 
     Cash and cash equivalents consist of cash and highly liquid investments
which include debt securities with remaining maturities when acquired of three
months or less and are stated at market. The Company
 
                                       F-6
<PAGE>   29
 
                         DOCUMENT SCIENCES CORPORATION
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
evaluates the financial strength of institutions at which significant
investments are made and believes the related credit risk is limited to an
acceptable level.
 
     The Company has adopted Statement of Financial Accounting Standards
("SFAS") No. 115, Accounting for Certain Investments in Debt and Equity
Securities, and classifies its investments as available-for-sale in accordance
with that standard. Available-for-sale securities are carried at fair value.
Unrealized gains and losses, net of tax, are reported in stockholders' equity.
Realized gains and losses and declines in value judged to be
other-than-temporary, if any, on available-for-sale securities will be included
in investment income. The cost of securities sold is based on the specific
identification method.
 
CONCENTRATION OF CREDIT RISK
 
     The Company sells its products primarily to large, multinational customers
in the United States, Europe, Canada and Australia. The Company derived 26%, 42%
and 34% of its total revenues from customers outside the United States for the
years ended December 31, 1994, 1995 and 1996, respectively. A significant
concentration of the Company's customers are in the insurance and commercial
print service industries. No customer has accounted for 10% or more of the
Company's revenue in any one year.
 
     Credit is extended based on an evaluation of the customer's financial
condition and a cash deposit is generally not required. The Company estimates
its potential losses on trade receivables on an ongoing basis and provides for
anticipated losses in the period in which the revenues are recognized. Credit
losses have historically been minimal and have been within management's
expectations.
 
ACCOUNTING STANDARD ON IMPAIRMENT OF LONG-LIVED ASSETS
 
     In March 1995, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of, which requires impairment losses to be
recorded on long-lived assets used in operations when indicators of impairment
are present and the undiscounted cash flows estimated to be generated by those
assets are less than the assets' carrying amount. SFAS 121 also addresses the
accounting for long-lived assets that are expected to be disposed of. The
Company adopted SFAS 121 in 1996 and the adoption had no impact on the Company's
financial statements.
 
COMPUTER SOFTWARE COSTS
 
     In accordance with 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 the 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 software costs 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 (generally five years). 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 result in
charges to the results of operations in future periods.
 
DEPRECIATION AND AMORTIZATION
 
     Depreciation is provided on a straight-line method over the estimated
useful lives of the assets (generally five years). Amortization of leasehold
improvements is provided over the lesser of the remaining lease term or the
estimated useful life of the improvements.
 
                                       F-7
<PAGE>   30
 
                         DOCUMENT SCIENCES CORPORATION
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
REVENUE RECOGNITION
 
     The Company recognizes revenue in accordance with AICPA Statement of
Position on Software Revenue Recognition No. 91-1. Initial license fee revenue
is recognized upon shipment of the product to customers if no significant
Company obligations remain and collection of the receivable is deemed probable.
The portion of the initial license fee revenue which represents the software
support for the first year is deferred and recognized ratably over the contract
period. In subsequent years, customers pay annual license fees for continued use
and support of licensed software. Annual renewal license and support fees
revenue is deferred and recognized ratably over the contract period. Revenues
from commissions paid by Xerox in connection with the sale of Xerox printer
products are recognized upon installation of the printer products. Revenues
generated from consulting and training services are recognized as the related
services are performed.
 
COMPUTATION OF NET INCOME PER SHARE
 
     Net income per share is computed using the weighted average number of
common shares and common stock equivalents outstanding. Common equivalent shares
from stock options and warrants are excluded from the computation when their
effect is antidilutive except that, pursuant to the Securities and Exchange
Commission Staff Accounting Bulletins, common shares and common equivalent
shares issued during the twelve months prior to the initial filing of the
Registration Statement with the Securities and Exchange Commission have been
included in the calculation as outstanding for all periods prior to the
Company's initial public offering (using the treasury stock method). The
calculation also gives effect to the conversion of all convertible preferred
shares (using the if-converted method), which automatically converted into
common shares upon completion of the Company's initial public offering.
 
STOCK OPTIONS
 
     In 1996, the Company adopted SFAS No. 123, Accounting for Stock-Based
Compensation. As permitted by the Statement, the Company has elected to continue
accounting for its stock-based compensation in accordance with the provisions of
APB 25. As such, the new provisions of SFAS 123 had no impact on the financial
position or results of operations of the Company.
 
INCOME TAXES
 
     The Company follows the liability method of accounting for income taxes, as
set forth in SFAS No. 109. The Company and Xerox had a Tax Sharing Agreement
that provided for the allocation between the Company and Xerox of all
responsibilities, liabilities and benefits relating to taxes paid or payable by
either the Company or Xerox for all taxable periods. Through September 19, 1996,
the Company was included in the consolidated tax returns of Xerox and the
Company's share of Xerox's consolidated income tax liability was determined on a
separate company basis computed under Internal Revenue Code guidelines. The
Company's income tax liability due to Xerox totaled $1,382,100 at December 31,
1995, which was paid in 1996, and $311,000 at September 19, 1996. Subsequent to
the Company's initial public offering on September 19, 1996, the Company was no
longer included in the consolidated tax returns of Xerox and will file separate
tax returns.
 
                                       F-8
<PAGE>   31
 
                         DOCUMENT SCIENCES CORPORATION
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
2.  FINANCIAL STATEMENT INFORMATION
 
PROPERTY AND EQUIPMENT
 
     Property and equipment are stated at cost and consist of the following at
December 31:
 
<TABLE>
<CAPTION>
                                                                1995           1996
                                                              ---------     ----------
        <S>                                                   <C>           <C>
        Computer equipment..................................  $ 625,591     $  929,241
        Office furniture and fixtures.......................    171,399        236,573
        Office equipment....................................     46,367        168,432
        Leasehold improvements..............................     46,590        168,246
                                                               --------     ----------
                                                                889,947      1,502,492
        Less accumulated depreciation and amortization......   (257,722)      (504,289)
                                                               --------     ----------
                                                              $ 632,225     $  998,203
                                                               ========     ==========
</TABLE>
 
     Equipment acquired under capital leases totaled $66,255, $145,112 and
$192,611 (net of accumulated amortization of $16,259, $35,085 and $75,161) at
December 31, 1994, 1995 and 1996, respectively.
 
INVESTMENTS
 
     The Company has classified all of its marketable securities as
available-for-sale securities. The following table summarizes available-for-sale
securities at December 31, 1996:
 
<TABLE>
<CAPTION>
                                                               GROSS          GROSS
                                                             UNREALIZED     UNREALIZED      ESTIMATED
                                                COST           GAINS          LOSSES       FAIR VALUE
                                             -----------     ----------     ----------     -----------
<S>                                          <C>             <C>            <C>            <C>
U.S. treasury securities...................  $ 3,513,585      $     --       $  8,305      $ 3,505,280
U.S. government agency obligations.........    2,969,622         1,271            772        2,970,121
Obligations of states, territories and
  political subdivisions...................   14,600,365        37,440         15,491       14,622,314
U.S. corporate securities..................    1,544,517           311          1,232        1,543,596
U.S. corporate commercial paper............      501,574            --             --          501,574
                                             -----------       -------        -------      -----------
                                             $23,129,663      $ 39,022       $ 25,800      $23,142,885
                                             ===========       =======        =======      ===========
</TABLE>
 
     Included in cash and cash equivalents at December 31, 1995 were $398,889 in
U.S. treasury securities and $298,470 in U.S. government agency obligations. At
December 31, 1995, the difference between amortized cost and the estimated fair
value of the available-for-sale securities was not material.
 
     The amortized cost and estimated fair value of available-for-sale
securities at December 31, 1996, by contractual maturity, are shown below:
 
<TABLE>
<CAPTION>
                                                                                     ESTIMATED
                                                                       COST         FAIR VALUE
                                                                    -----------     -----------
<S>                                                                 <C>             <C>
Due in one year or less...........................................  $ 5,071,310     $ 5,068,204
Due after one year through five years.............................   18,058,353      18,074,681
                                                                    -----------     -----------
                                                                    $23,129,663     $23,142,885
                                                                    ===========     ===========
</TABLE>
 
                                       F-9
<PAGE>   32
 
                         DOCUMENT SCIENCES CORPORATION
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
3.  DOMESTIC AND FOREIGN OPERATIONS
 
     The table below summarizes the Company's domestic operations and those of
its subsidiary, Document Sciences Europe.
 
<TABLE>
<CAPTION>
                                           UNITED
                                           STATES          FRANCE       ELIMINATIONS        TOTAL
                                         -----------     ----------     ------------     -----------
<S>                                      <C>             <C>            <C>              <C>
YEAR ENDED DECEMBER 31, 1994
Sales to unaffiliated customers........  $ 4,861,398     $  370,658     $         --     $ 5,232,056
Sales to affiliates....................    1,405,800        533,400               --       1,939,200
Transfers between geographic areas.....      507,388             --         (507,388)             --
                                         -----------     ----------     ------------     -----------
Revenues...............................  $ 6,774,586     $  904,058     $   (507,388)    $ 7,171,256
                                         ===========     ==========     ============     ===========
Operating income (loss)................  $ 1,736,832     $ (383,032)    $         --     $ 1,353,800
                                         ===========     ==========     ============     ===========
Identifiable assets....................  $ 3,475,168     $  750,063     $    (16,666)    $ 4,208,565
                                         ===========     ==========     ============     ===========
</TABLE>
 
<TABLE>
<CAPTION>
                                           UNITED
                                           STATES          FRANCE       ELIMINATIONS        TOTAL
                                         -----------     ----------     ------------     -----------
<S>                                      <C>             <C>            <C>              <C>
YEAR ENDED DECEMBER 31, 1995
Sales to unaffiliated customers........  $ 5,350,838     $1,246,305     $         --     $ 6,597,143
Sales to affiliates....................    1,929,300      1,985,600               --       3,914,900
Transfers between geographic areas.....    1,528,352             --       (1,528,352)             --
                                         -----------     ----------     ------------     -----------
Revenues...............................  $ 8,808,490     $3,231,905     $ (1,528,352)    $10,512,043
                                         ===========     ==========     ============     ===========
Operating income (loss)................  $ 1,691,074     $   (5,728)    $         --     $ 1,685,346
                                         ===========     ==========     ============     ===========
Identifiable assets....................  $ 4,748,787     $1,557,161     $    (16,666)    $ 6,289,282
                                         ===========     ==========     ============     ===========
</TABLE>
 
<TABLE>
<CAPTION>
                                           UNITED
                                           STATES          FRANCE       ELIMINATIONS        TOTAL
                                         -----------     ----------     ------------     -----------
<S>                                      <C>             <C>            <C>              <C>
YEAR ENDED DECEMBER 31, 1996
Sales to unaffiliated customers........  $10,165,741     $  931,753     $         --     $11,097,494
Sales to affiliates....................    3,919,970        301,830               --       4,221,800
Transfers between geographic areas.....      254,611        999,738       (1,254,349)             --
                                         -----------     ----------     ------------     -----------
Revenues...............................  $14,340,322     $2,233,321     $ (1,254,349)    $15,319,294
                                         ===========     ==========     ============     ===========
Operating income (loss)................  $ 1,167,424     $  497,514     $         --     $ 1,664,938
                                         ===========     ==========     ============     ===========
Identifiable assets....................  $31,335,821     $  702,362     $    (16,666)    $32,021,517
                                         ===========     ==========     ============     ===========
</TABLE>
 
     The Company uses affiliated distributors to sell its products in Canada,
Australia and New Zealand (See Note 9).
 
4.  CREDIT FACILITY
 
     The Company has an agreement with a bank that provides a working capital
line of credit which allows maximum borrowings at the lesser of $2,500,000 or
75% of eligible accounts receivable (as defined). The agreement also provides
for letters of credit up to an aggregate of $100,000. Borrowings under the line
of credit bear interest at the bank's prime rate. The line of credit is
renewable annually at the sole discretion of the bank and expires in July 1997.
The Company had no outstanding borrowings or letters of credit as of December
31, 1995 and 1996.
 
                                      F-10
<PAGE>   33
 
                         DOCUMENT SCIENCES CORPORATION
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
5.  LEASES
 
     The Company leases its corporate office in San Diego, California under an
operating lease which expires in 2000. Under the terms of the lease, effective
February 1, 1997, monthly rental payments will be increased annually by 4%. The
lease provides the Company with an option to extend the lease term for an
additional three years at the base rent in effect for the last year of the
initial lease term. In addition, the Company may exercise a one-time
cancellation option effective any time after January 31, 1998 with the payment
of certain penalties. The Company also leases certain equipment under capital
leases. Annual future minimum lease payments, which include $121,400 for the
effect of the potential exercise of the cancellation option, are as follows:
 
<TABLE>
<CAPTION>
                                                                     OPERATING     CAPITAL
                       YEARS ENDING DECEMBER 31,                      LEASES        LEASES
    ---------------------------------------------------------------  ---------     --------
    <S>                                                              <C>           <C>
    1997...........................................................  $ 272,817     $ 80,499
    1998...........................................................    238,405       75,667
    1999...........................................................      5,084       41,558
    2000...........................................................         --       12,346
    2001...........................................................         --        1,260
                                                                      --------     --------
                                                                     $ 516,306      211,330
                                                                      --------
    Less amount representing interest.........................................      (33,151)
                                                                                   --------
    Present value of net minimum lease payments...............................      178,179
    Less current portion......................................................      (62,439)
                                                                                   --------
    Long-term portion of capital lease obligations............................     $115,740
                                                                                   ========
</TABLE>
 
     Rent expense for the years ended December 31, 1994, 1995 and 1996 was
$137,160, $255,599 and $292,098, respectively.
 
6.  SERIES A REDEEMABLE PREFERRED STOCK
 
     Each share of Series A Redeemable Preferred Stock was converted into 1.19
shares of Common Stock upon the Company's initial public offering.
 
7.  STOCKHOLDERS' EQUITY
 
STOCK SPLIT
 
     On June 19, 1996, the Company's Board of Directors authorized a 3 for 1
stock split for all outstanding Common Stock and Series A Redeemable Preferred
Stock, which received stockholder approval and became effective on September 19,
1996. All share and per share amounts in the accompanying consolidated financial
statements have been retroactively restated to reflect the stock split. Upon
completion of the public offering on September 19, 1996, the authorized capital
stock of the Company consisted of 30,000,000 shares of Common Stock and
2,000,000 shares of Preferred Stock.
 
STOCK INCENTIVE PLANS
 
     The Company's Stock Incentive Plans (the "Plans") provide for the issuance
of incentive and nonstatutory options to purchase Common Shares to eligible
employees, officers, directors of, and consultants to the Company. The Company's
1993 Stock Incentive Plan (the "1993 Plan") provided for the issuance of up to
1,500,000 shares. In October 1995, the Board of Directors approved the 1995
Stock Incentive Plan (the "1995 Plan"), which provided for the issuance of an
additional 779,250 shares which include 29,250 shares previously reserved for
issuance under the 1993 Plan. The 1995 Plan replaces the 1993 Plan. All
outstanding
 
                                      F-11
<PAGE>   34
 
                         DOCUMENT SCIENCES CORPORATION
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
options under the 1993 Plan remain exercisable in accordance with their original
terms. Terms of the stock purchase or stock option agreements, including vesting
requirements, are determined by the Board of Directors, subject to the
provisions of the 1995 Plan. The maximum term of options granted under the 1995
Plan is ten years. The exercise price of incentive stock options must equal at
least the fair market value on the date of grant. The exercise price of
nonstatutory stock options and stock issued under purchase rights must equal at
least 85% of the fair market value on the date of grant or time of issuance.
 
     The following table summarizes stock option activity under the stock
incentive plans:
 
<TABLE>
<CAPTION>
                                                                                        WEIGHTED
                                                         NUMBER       OPTION PRICE    AVERAGE PRICE
                                                       OF SHARES       PER SHARE        PER SHARE
                                                       ----------     ------------    -------------
<S>                                                    <C>            <C>             <C>
Balance as of December 31, 1993......................   1,207,500           $  .03        $ .03
  Granted............................................     251,250      $.03-$  .17        $ .15
  Canceled...........................................     (18,000)          $  .17        $ .17
                                                       ----------
Balance as of December 31, 1994......................   1,440,750      $.03-$  .17        $ .05
  Granted............................................     232,575           $  .17        $ .17
  Exercised..........................................  (1,308,423)     $.03-$  .17        $ .05
  Canceled...........................................      (3,000)          $  .17        $ .17
                                                       ----------
Balance at December 31, 1995.........................     361,902      $.03-$  .17        $ .09
  Granted............................................     233,538      $.67-$15.00        $6.51
  Exercised..........................................     (88,245)     $.03-$  .17        $ .08
  Canceled...........................................      (9,750)     $.17-$ 8.50        $ .50
                                                       ----------
Balance at December 31, 1996.........................     497,445      $.03-$15.00        $3.13
                                                       ==========
</TABLE>
 
     As of December 31, 1996, 176,603 of the options were vested and exercisable
and 496,887 shares were available for future grant.
 
     Through December 31, 1996, the Company has recorded $440,000 of deferred
compensation on options granted to employees, representing the difference
between the option grant price and the deemed fair market value of the related
shares. The Company is amortizing such amount ratably over the vesting period of
the options, generally 48 months.
 
     Adjusted pro forma information regarding net income is required by SFAS
123, and has been determined as if the Company had accounted for its employee
stock options under the fair value method of that Statement. For options granted
in the year ended December 31, 1995 and the period ended September 19, 1996, the
fair value for options was estimated at the date of grant using the "minimum
value" method for option pricing with the following weighted-average
assumptions: risk-free interest rates of 6%; dividend yields of 0%; and a
weighted-average expected life of the option of seven years. For options granted
from September 19, 1996 to December 31, 1996, the fair value of options was
estimated at the date of grant using the "Black-Scholes" method for option
pricing with the following weighted-average assumptions: risk-free interest
rates of 6%; dividend yields of 0%; expected volatility of .7; and
weighted-average expected life of the option of seven years.
 
     For purposes of adjusted pro forma disclosures, the estimated fair value of
the options is amortized to expense over the options' vesting period. The effect
of applying SFAS 123 for purposes of providing pro forma
 
                                      F-12
<PAGE>   35
 
                         DOCUMENT SCIENCES CORPORATION
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
disclosures is not likely to be representative of the effects on reported net
income for future years. The Company's pro forma information is as follows:
 
<TABLE>
<CAPTION>
                                                              YEARS ENDED DECEMBER 31,
                                                              -------------------------
                                                                 1995           1996
                                                              ----------     ----------
        <S>                                                   <C>            <C>
        Adjusted pro forma net income.......................  $1,050,566     $1,379,289
        Adjusted pro forma net income per share.............  $     0.13     $     0.15
</TABLE>
 
8.  INCOME TAXES
 
     The provision for income taxes is as follows:
 
<TABLE>
<CAPTION>
                                                                  YEARS ENDED DECEMBER 31,
                                                             ----------------------------------
                                                               1994         1995         1996
                                                             --------     --------     --------
<S>                                                          <C>          <C>          <C>
Current:
  Federal..................................................  $542,000     $469,700     $482,000
  State....................................................   111,700      121,700      119,300
  Foreign..................................................        --           --      112,200
                                                             --------     --------     --------
                                                              653,700      591,400      713,500
Deferred (credit):
  Federal..................................................   (16,200)      39,500      (85,300)
  State....................................................    (4,600)       7,500       (6,700)
  Foreign..................................................        --           --           --
                                                             --------     --------     --------
                                                              (20,800)      47,000      (92,000)
                                                             --------     --------     --------
                                                             $632,900     $638,400     $621,500
                                                             ========     ========     ========
</TABLE>
 
     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. Significant components of
the deferred tax assets and liabilities are as follows:
 
<TABLE>
<CAPTION>
                                                                      DECEMBER 31,
                                                          -------------------------------------
                                                            1994          1995          1996
                                                          ---------     ---------     ---------
<S>                                                       <C>           <C>           <C>
Deferred tax liability -- computer software costs.......  $ (93,500)    $(157,000)    $(156,500)
Deferred tax assets:
  Foreign operating loss carryforwards..................    134,060       136,065            --
  Accrued vacation......................................     55,500        75,000       100,000
  Provision for doubtful accounts.......................      7,200         4,200        29,000
  State taxes...........................................         --            --        41,700
                                                          ---------     ---------     ---------
Total deferred tax assets...............................    196,760       215,265       170,700
Valuation allowance.....................................   (134,060)     (136,065)           --
                                                          ---------     ---------     ---------
Net deferred tax assets.................................     62,700        79,200       170,700
                                                          ---------     ---------     ---------
Net deferred tax liability..............................  $ (30,800)    $ (77,800)    $  14,200
                                                          =========     =========     =========
</TABLE>
 
     In 1995 and 1994, a valuation allowance was recognized to offset deferred
tax assets attributed to foreign operating loss carryforwards. In 1996, the
Company realized the benefit of the foreign operating loss carryforwards and
reduced the valuation allowance.
 
                                      F-13
<PAGE>   36
 
                         DOCUMENT SCIENCES CORPORATION
 
           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
 
     The differences between the Company's income tax provision and the amounts
computed by applying the statutory federal income tax rate of 35% in 1994, 1995
and 1996 to income before income taxes are as follows:
 
<TABLE>
<CAPTION>
                                                             YEARS ENDED DECEMBER 31,
                                                        -----------------------------------
                                                          1994         1995         1996
                                                        --------     --------     ---------
    <S>                                                 <C>          <C>          <C>
    Provision at statutory rate.......................  $470,636     $591,649     $ 693,856
    Benefit for graduated rates.......................   (13,447)     (16,904)      (19,824)
    State income taxes, net of federal benefit........    69,550       83,980        73,190
    Increase (decrease) in valuation reserves.........   134,060        2,005      (136,095)
    Benefit of research credits.......................   (57,733)     (57,547)      (71,665)
    Permanent differences and other...................    29,834       35,217        82,038
                                                        --------     --------      --------
    Provision for income taxes........................  $632,900     $638,400     $ 621,500
                                                        ========     ========      ========
</TABLE>
 
9.  TRANSACTIONS WITH AFFILIATES
 
     The Company has a strategic marketing alliance with Xerox under which the
parties have agreed to pay each other fees on referrals that lead to the
successful sale or licensing of each other's products. Included in services and
other revenues in the accompanying statements of income are commissions earned
from Xerox totaling $490,400, $752,000 and $1,352,400 in 1994, 1995 and 1996,
respectively. Commissions related to referrals from Xerox are included in
selling and marketing expense in the accompanying statements of income and
totaled $113,500, $167,200 and $180,600 in 1994, 1995 and 1996, respectively.
 
     The Company has distribution agreements with affiliates which provide the
affiliates with the non-exclusive right to sub-license the Company's software in
Australia, New Zealand and Canada. The terms of the distributor agreements
provide that the affiliates receive a discount from the list price of the
Company's products licensed, including maintenance and support. Revenues from
the affiliates under these agreements, net of discounts, were $796,600,
$1,088,200 and $818,600 in 1994, 1995 and 1996, respectively. Included in
accounts receivable are $193,500 and $385,300 from these revenues at December
31, 1995 and 1996, respectively.
 
     The Company has distribution agreements with affiliates which provide the
affiliates the non-exclusive right to sub-license the Company's software in
Europe. Revenues under these agreements totaled $533,400, $1,985,600 and
$2,050,800 in 1994, 1995 and 1996, respectively. Related accounts receivable are
$482,900 and $646,500 at December 31, 1995 and 1996, respectively.
 
     Under the terms of a separate agreement with Xerox, the Company provided
software support services for Xerox Publishing Systems' products. Included in
annual revenue license and support fees are revenues from Xerox under this
agreement of $118,800 in 1994 and $89,100 in 1995. There were no revenues under
this agreement during 1996.
 
10.  EMPLOYEE RETIREMENT PLAN
 
401(K) PLAN
 
     The Company has an employee savings and retirement plan (the "401(k) Plan")
that is intended to be tax-qualified covering substantially all of the Company's
employees. Under the terms of the 401(k) Plan, employees may elect to contribute
up to 15% of their compensation, or the statutory prescribed limit, if less, to
the 401(k) Plan as a savings contribution. The Company may, in its discretion,
match employee contributions, at such rate as it determines, up to a maximum of
$3,000 or 10% of the employee's compensation. The 401(k) Plan has a profit
sharing element whereby the Company can contribute annually an amount determined
by the Board of Directors. An employee's interest in matching contributions and
profit sharing contributions generally vest over four years from the date of
employment.
 
                                      F-14
<PAGE>   37
 
                                  SCHEDULE II
 
                         DOCUMENT SCIENCES CORPORATION
                       VALUATION AND QUALIFYING ACCOUNTS
 
<TABLE>
<CAPTION>
                                      BALANCE AT     CHARGED TO     CHARGED TO                    BALANCE AT
                                      BEGINNING      COSTS AND        OTHER                          END
                                       OF YEAR        EXPENSES       ACCOUNTS      DEDUCTIONS      OF YEAR
                                      ----------     ----------     ----------     ----------     ----------
<S>                                   <C>            <C>            <C>            <C>            <C>
Year Ended December 31, 1994
  Allowance for doubtful accounts
     and returns....................   $ 10,000       $  3,613       $     --       $     --       $  13,613
Year Ended December 31, 1995
  Allowance for doubtful accounts
     and returns....................     13,613          9,344             --             --          22,957
Year Ended December 31, 1996
  Allowance for doubtful accounts
     and returns....................     22,957        204,155             --             --         227,112
</TABLE>
 
                                       S-1
<PAGE>   38
 
                         DOCUMENT SCIENCES CORPORATION
 
                           ANNUAL REPORT ON FORM 10-K
                        FOR YEAR ENDED DECEMBER 31, 1996
 
                               INDEX TO EXHIBITS
 
<TABLE>
<CAPTION>
EXHIBIT                                                                             SEQUENTIAL
NUMBER                             EXHIBIT DESCRIPTION                              PAGE NUMBER
------   -----------------------------------------------------------------------    -----------
<C>      <S>                                                                        <C>
  3.1    Restated Certificate of Incorporation of the Company filed May 1, 1992
         (which is incorporated herein by reference to Exhibit 3.1 to
         Registrant's Registration Statement on Form S-1, Registration No.
         333-06349 ("Registrant's 1996 S-1")).
  3.2    Form of Amended and Restated Certificate of Incorporation of the
         Company (which is incorporated herein by reference to Registrant's 1996
         S-1).
  3.3    Amended and Restated Bylaws of the Company (which is incorporated
         herein by reference to Registrant's 1996 S-1).
  3.4    Form of Certificate of Amendment of Certificate of Incorporation of the
         Company (which is incorporated herein by reference to Registrant's 1996
         S-1).
  4.1    Reference is made to Exhibits 3.1 and 3.2.
  4.2    Specimen Stock Certificate (which is incorporated herein by reference
         to Registrant's 1996 S-1).
*10.1    Form of Indemnity Agreement Between the Company and each of its
         Officers and Directors (which is incorporated herein by reference to
         Registrant's 1996 S-1).
*10.2    1993 Stock Option Plan and Form of Agreement (which is incorporated
         herein by reference to Registrant's 1996 S-1).
*10.3    1995 Stock Incentive Plan and Form of Agreement, as amended (which is
         incorporated herein by reference to Registrant's 1996 S-1).
*10.4    Stockholder Rights Agreement dated September 1996 Between the Company
         and Xerox Corporation (which is incorporated herein by reference to
         Registrant's 1996 S-1).
 10.5    Tax Sharing Agreement dated August 1996 Between the Company and Xerox
         Corporation (which is incorporated herein by reference to Registrant's
         1996 S-1).
 10.6    Transfer and License Agreement dated July 1, 1992, as amended in
         September 1994, Between the Company and Xerox Corporation (which is
         incorporated herein by reference to Registrant's 1996 S-1).
 10.7    Strategic Marketing Alliance Agreement dated September 1, 1993, Between
         the Company and Xerox Corporation (which is incorporated herein by
         reference to Registrant's 1996 S-1).
 10.8    Value Added Remarketer Agreement Between Xerox Canada Limited and the
         Company (which is incorporated herein by reference to Registrant's 1996
         S-1).
 10.9    Value Added Reseller Agreement Between N.V. Rank Xerox S.A. and the
         Company (which is incorporated herein by reference to Registrant's 1996
         S-1).
 10.10   Form of Professional Services Agreement (which is incorporated herein
         by reference to Registrant's 1996 S-1).
 10.11   Form of Domestic Value Added Remarketer Agreement (which is
         incorporated herein by reference to Registrant's 1996 S-1).
 10.12   Form of International Value Added Reseller Agreement (which is
         incorporated herein by reference to Registrant's 1996 S-1).
 10.13   Form of Software License and Software Support Agreement (which is
         incorporated herein by reference to Registrant's 1996 S-1).
 10.14   Lease for Company's Principal Facilities, as amended and Assignment of
         Lease.
*10.15   Letter Agreement Between Tony Domit and the Company (which is
         incorporated herein by reference to Registrant's 1996 S-1).
*10.16   Letter Agreement Between Thomas Anthony and the Company (which is
         incorporated herein by reference to Registrant's 1996 S-1).
</TABLE>
<PAGE>   39
 
<TABLE>
<CAPTION>
EXHIBIT                                                                             SEQUENTIAL
NUMBER                             EXHIBIT DESCRIPTION                              PAGE NUMBER
------   -----------------------------------------------------------------------    -----------
<C>      <S>                                                                        <C>
*10.17   Letter Agreement Between Judith A. O'Reilly and the Company (which is
         incorporated herein by reference to Registrant's 1996 S-1).
*10.18   Letter Agreement Between Daniel Fregeau and the Company (which is
         incorporated herein by reference to Registrant's 1996 S-1).
*10.19   Letter Agreement Between Alfred G. Altomare and the Company (which is
         incorporated herein by reference to Registrant's 1996 S-1).
 10.20   Value Added Reseller Agreement Between Geneva Digital Ltd. and the
         Company (which is incorporated herein by reference to Registrant's 1996
         S-1).
 10.21   Value Added Remarketer Agreement Between Business and Business and the
         Company (which is incorporated herein by reference to Registrant's 1996
         S-1).
*10.22   1997 Employee Stock Purchase Plan.
 11.1    Statement regarding calculation of net income (loss) per share.
 13.1    Annual Report to Stockholders for the year ended December 31, 1996 (to
         be deemed filed only to the extent required by the instructions to
         exhibits for reports on Form 10-K).
 21.1    List of Subsidiaries (which is incorporated herein by reference to
         Registrant's 1996 S-1).
 23.1    Consent of Ernst & Young LLP, Independent Auditors.
 24.1    Power of Attorney (See page 36).
 27      Financial Data Schedule.
</TABLE>
 
---------------
* Indicates management compensatory plan, contract or arrangement.