UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended ~~June~~ September 30, ~~2004~~2006

¨	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 0000-20981

DOCUMENT SCIENCES CORPORATION

(Exact name of registrant as specified in its charter)


Delaware		33-0485994
(State or Other Jurisdiction of Incorporation or Organization)		(IRS Employer Identification No.)

~~6339~~5958 ~~Paseo~~Priestly ~~del~~Drive ~~Lago~~

Carlsbad, California ~~92009~~92008

(Address of Principal Executive Offices including Zip Code)

(760) 602-1400

(Registrant’s Telephone Number including Area Code)

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

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, ~~(as~~or ~~defined~~a innon- ~~Exchange~~accelerated ~~Act~~filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2) of the Exchange Act. ~~Yes ¨ No x~~ (Check one):

AsLarge ofaccelerated ~~August~~filer ~~10,~~¨ Accelerated ~~2004,~~filer ~~there~~¨ Non-accelerated ~~were~~filer ~~3,946,024~~þ ~~shares of common stock of the registrant outstanding.~~

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

As of November 10, 2006, there were 4,305,623 shares of common stock of the registrant outstanding.

DOCUMENT SCIENCES CORPORATION

		PageNo.
		Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated balance sheets		3
Consolidated statements of operations		4
Consolidated statements of cash flows		5
Notes to consolidated financial statements		6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		812
Item 3. Quantitative and Qualitative Disclosures About Market Risk		2327
Item 4. Controls and Procedures		2328
PART II. OTHER INFORMATION
Item 1. Legal Proceedings		2429
Item 4. Submission of Matters to a Vote of Security Holders		24
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		29
Item 6. Exhibits and Reports on Form 8-K		24
Item 6. Exhibits		29
Signatures		2631

PART I. FINANCIAL INFORMATION

ITEM 1–FINANCIAL STATEMENTS (Unaudited)

DOCUMENT SCIENCES CORPORATION

CONSOLIDATED BALANCE SHEETS

	June 30, 2004			December 31,2003
	September 30,2006			December 31,2005
	(Unaudited)			(See notebelow)
ASSETS
Current assets:
Cash and cash equivalents	$	25,~~107~~260,~~080~~433		$	16,~~916~~692,~~595~~642
Short-term investments		31,~~487~~641,~~182~~414			31,~~979~~179,~~864~~851
Accounts receivable, net		511,~~421~~810,~~884~~125			67,~~959~~564,~~940~~929
Other current assets		1,~~083~~445,~~462~~102			~~655~~1,~~392~~666,382
Total current assets		1220,~~099~~157,~~608~~074			1317,~~511~~103,~~791~~804
Property and equipment, net		~~564~~744,~~639~~189			~~689~~788,~~575~~567
Software development costs, net		3984,~~401,022~~310			21,~~494~~698,~~634~~394
Goodwill, net		~~724~~4,~~615~~495,192			~~724~~4,~~615~~495,192
Other assets		265,281			202,944
Total assets	$	26,380,765		$	24,085,957
Total assets	$	17,055,165		$	17,623,559
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	~~213~~471,~~595~~114		$	~~205~~160,~~036~~160
Accrued compensation		~~988~~1,~~495~~237,907			1,~~088~~719,~~772~~869
Other accrued liabilities		1693,~~098,060~~403			1445,~~159,686~~659
Deferred revenue		916,~~407~~697,~~274~~872			1014,~~356~~861,~~855~~856
Total current liabilities		1119,~~707~~100,~~424~~296			1217,~~810~~187,~~349~~544
Obligations under capital leases		5811,~~995~~905			6927,~~405~~521
STOCKHOLDERS’ EQUITY
Common stock, $.001 par value		34,~~435~~377			34,~~331~~315
Treasury stock		(~~472~~293,~~231~~123	)		(~~556~~344,~~352~~858	)
Additional paid-in capital		813,~~961~~803,~~638~~612			813,~~759~~258,~~120~~962
Accumulated comprehensive loss		(107,795	)		(88,611	)
Accumulated other comprehensive income		661			18
Retained deficit		(36,~~096~~246,~~301~~963	)		(36,~~373~~047,~~683~~545	)
Total stockholders’ equity		57,~~288~~268,~~746~~564			46,~~743~~870,~~805~~892
Total liabilities and stockholders’ equity	$	1726,~~055~~380,~~165~~765		$	1724,~~623~~085,~~559~~957

Note: The balance sheet at December 31, ~~2003~~2005 has been derived from the audited consolidated financial statements at that date but does not include all of the information and disclosures required by U.S. generally accepted accounting principles for complete financial statements. See notes to unaudited consolidated financial statements.

DOCUMENT SCIENCES CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

	Three Months Ended June 30,					Six Months Ended June 30,
	Three Months EndedSeptember 30,					Nine Months EndedSeptember 30,
	2004		2003			2004			2003
	2006		2005			2006				2005
Revenues:
Initial license fees	$	1,593,320	$	1,457,623		$	3,201,021		$	2,505,493
License fees	$	5,509,267	$	5,128,929		$	16,242,752			$	14,708,982
Annual renewal license and support fees		2,929,296		2,593,637			5,738,144			5,193,476
Services and other		2,889,103		2,286,510			8,399,835				6,847,464
Services and other		955,223		1,069,927			1,799,092			2,030,885
Total revenues		8,398,370		7,415,439			24,642,587				21,556,446
Total revenues		5,477,839		5,121,187			10,738,257			9,729,854
Cost of revenues:
Cost of revenues:
License fees		966,455		1,078,795			3,185,690				3,317,855
Initial license fees		272,205		234,930			534,099			500,481
Services and other		2,471,598		2,081,653			7,462,625				5,567,692
Annual renewal license and support fees		504,119		445,396			1,017,753			819,211
Total cost of revenues		3,438,053		3,160,448			10,648,315				8,885,547
Services and other		741,696		720,203			1,431,365			1,400,985
Gross margin		4,960,317		4,254,991			13,994,272				12,670,899
Total cost of revenues		1,518,020		1,400,529			2,983,217			2,720,677
Operating expenses:
Gross margin		3,959,819		3,720,658			7,755,040			7,009,177
Research and development		1,590,614		1,613,984			4,356,412				4,311,484
Operating expenses:
Selling and marketing		2,313,439		1,976,649			7,030,561				6,262,075
Research and development		903,706		1,272,434			1,831,707			2,675,986
General and administrative		975,875		773,927			2,944,973				2,572,890
Selling and marketing		2,084,817		2,576,154			3,983,184			4,774,957
Total operating expenses		4,879,928		4,364,560			14,331,946				13,146,449
General and administrative		818,025		692,892			1,685,104			1,382,726
Income (loss) from operations		80,389		(109,569	)		(337,674	)			(475,550	)
Total operating expenses		3,806,548		4,541,480			7,499,995			8,833,669
Interest and other income, net		60,452		47,314			169,311				168,859
Income (loss) from operations		153,271		(820,822	)		255,045			(1,824,492	)
Income (loss) before income taxes		140,841		(62,255	)		(168,363	)			(306,691	)
Interest and other income, net		18,881		44,697			41,460			108,767
Provision for income taxes		25,670		6,375			31,055				19,540
Income (loss) before income taxes		172,152		(776,125	)		296,505			(1,715,725	)
Net income (loss)	$	115,171	$	(68,630	)	$	(199,418	)		$	(326,231	)
Provision for income taxes		6,882		3,034			19,123			26,444
Net income (loss) per share - basic	$	0.03	$	(0.02	)	$	(0.05	)		$	(0.08	)
Net income (loss)	$	165,270	$	(779,159	)	$	277,382		$	(1,742,169	)
Weighted average shares used in basic calculation		4,281,906		4,158,371			4,250,690				4,128,384
Net income (loss) per share–basic	$	0.05	$	(0.20	)	$	0.09		$	(0.45	)
Net income (loss) per share - diluted	$	0.02	$	(0.02	)	$	(0.05	)		$	(0.08	)
Weighted average shares used in basic calculation		3,284,161		3,880,010			3,253,225			3,874,944
Weighted average shares used in diluted calculation		5,324,126		4,158,371			4,250,690				4,128,384
Net income (loss) per share–diluted	$	0.04	$	(0.20	)	$	0.06		$	(0.45	)
Weighted average shares used in diluted calculation		4,460,011		3,880,010			4,431,845			3,874,944

See notes to unaudited consolidated financial statements.

DOCUMENT SCIENCES CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

	Six Months Ended June 30,
	Nine Months EndedSeptember 30,
	2004			2003
	2006			2005
Operating activities
Net income (loss)	$	277,382		$	(1,742,169	)
Net loss	$	(199,418	)	$	(326,231	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		~~146~~170,~~513~~551			~~218~~206,~~123~~686
Loss on disposal of fixed assets		—			~~423~~3,475
Amortization of software development costs		~~376~~714,~~290~~084			~~311~~1,~~354~~293,822
Provision for doubtful accounts		~~(295~~16,~~119~~261	)		(3484,~~508~~741	)
Stock-based compensation expense		359,272			—
Changes in operating assets and liabilities:
Accounts receivable		1(4,~~813~~261,~~161~~457	)		3(2,~~736~~333,~~428~~667	)
Other assets		~~(491~~221,~~267~~280	)		(28242,~~542~~019	)
Accounts payable		8310,~~628~~954			6369,~~579~~863
Accrued compensation		(~~100~~481,~~263~~962	)		~~(748~~601,~~100~~400	)
Other accrued liabilities		~~(50~~247,~~915~~744	)		(~~151~~102,~~469~~382	)
Deferred revenue		~~(948~~1,~~824~~836,016	)		~~(818~~693,~~131~~836	)
Net cash provided by operating activities		735,586			806,988
Net cash used in operating activities		(1,066,675	)		(219,958	)
Investing activities
Purchases of short-term investments		(~~914~~2,~~102~~700,920	)		(34,~~123~~167,~~777~~818	)
Maturities of short-term investments		12,~~415~~240,000			24,~~300~~525,000
Purchases of property and equipment, net		(21126,~~710~~173	)		(~~241~~525,~~568~~634	)
Proceeds from disposal of assets		—			1,160
Net cash used in investing activities		(587,093	)		(168,452	)
Additions to software development costs		(1,282,678	)		(590,128	)
Net cash used in investing activities		(803,490	)		(1,654,313	)
Financing activities
Principal payments under capital lease obligations		(1015,~~410~~616	)		(615,~~940~~616	)
Purchase of treasury stock		—(17,124	)		~~(11,390~~—	)
Sale of treasury stock		7268,~~734~~859			—36,859
Issuance of common stock		~~214~~185,~~009~~440			56174,~~535~~083
Net cash provided by financing activities		~~276~~221,~~333~~559			38195,~~205~~326
Increase (decrease) in cash and cash equivalents		208,429			(809,120	)
Decrease in cash and cash equivalents		(1,432,209	)		(193,084	)
Effect of foreign currency on cash		~~(17,944~~—	)		33(64,~~307~~456	)
Cash and cash equivalents at beginning of period		16,~~916~~692,~~595~~642			25,~~284~~193,~~367~~440
Cash and cash equivalents at end of period	$	25,~~107~~260,~~080~~433		$	14,~~508~~935,~~554~~900
Supplemental disclosure of cash flow information:
Interest paid	$	12,~~547~~172		$	12,~~206~~172
Income taxes paid	$	1931,~~123~~055		$	2619,~~444~~540
Capital lease obligations entered into for property and equipment	$	—		$	109,313

See notes to unaudited consolidated financial statements.

DOCUMENT SCIENCES CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

~~June~~ September 30, ~~2004~~2006

Note A - Basis of Presentation

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

These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, ~~2003~~2005, included in Document Sciences Corporation’s Annual Report on Form 10-K filed with the Securities and Exchange Commission. Operating results for the three and ~~six~~nine months ended ~~June~~ September 30, ~~2004~~2006 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, ~~2004~~2006. The consolidated balance sheet at December 31, ~~2003~~2005 has been derived from the audited financial statements at that date but does not include all of the information and disclosures required by accounting principles generally accepted in the United States for complete financial statements. Certain amounts for 2003 have been reclassified to conform with the 2004 presentation, including reclassification of $1,648,851 from “due from affiliates” to “accounts receivable” in the consolidated balance sheet at December 31, 2003.

Note B - Revenue Recognition

We ~~recognize~~derive ~~revenue~~our inrevenues ~~accordance~~principally ~~with~~from ~~Statement~~the licensing of ~~Position (SOP) 97-2~~software, ~~Software Revenue~~post ~~Recognition~~contract ~~and~~support ~~Staff~~fees ~~Accounting Bulletin~~ (~~SAB~~PCS) ~~No. 101, Revenue Recognition in Financial Statements. Initial license fees are recognized when a contract exists, the fee is fixed~~ and ~~determinable,~~professional ~~software delivery has occurred and collection of the receivable is deemed probable~~services. We ~~use the residual method to~~ recognize revenue ~~for~~in ~~all~~accordance ofwith ~~our~~Statement ~~license models. Our contracts specifically state the amount~~ of ~~initial~~Position ~~and~~(SOP) ~~annual~~97-2, ~~license~~Software Revenue ~~fees~~Recognition. ~~due~~Although ~~for~~some ~~each type of~~ software ~~licensed.~~ ~~If an undelivered element of the arrangement exists under the license arrangement, revenue~~ is ~~deferred~~licensed ~~based~~ on ~~vendor-specific~~a ~~objective~~perpetual ~~evidence~~basis, of the ~~fair~~majority ~~value~~ of ~~the~~our ~~undelivered~~licenses ~~element.~~are Ifcurrently ~~vendor~~time-~~specific~~based ~~objective~~licenses ~~evidence~~that ofare ~~fair value~~required ~~does~~to ~~not~~be ~~exist~~renewed ~~for~~annually. ~~all~~Revenues ~~undelivered~~are ~~elements,~~recognized ~~all~~when ~~revenue~~a iscontract ~~deferred until sufficient evidence~~ exists, orthe ~~all~~fee ~~elements have been delivered. We recognize revenue on transactions with payment terms greater than 30 days but less than twelve months~~is ~~from~~fixed ~~the~~and ~~contract date~~determinable, ifsoftware wedelivery ~~have~~has aoccurred ~~history~~and collection of ~~successfully collecting from~~ the ~~specific~~receivable ~~customer~~is ~~without~~deemed ~~providing concessions~~probable. Amounts billed or payments received in advance of revenue recognition are recorded as deferred revenue.

~~Note~~If Can arrangement includes multiple elements, we allocate the contract amount to the various elements based on vendor-specific ~~Transactions~~objective ~~with~~evidence ~~Affiliates~~(VSOE) of fair value, regardless of any separate prices stated within the contracts for each element. We base our VSOE on the price charged when the same element is sold separately. If an undelivered element of the arrangement exists, revenue is deferred based on VSOE of the fair value of the undelivered element. If VSOE of fair value does not exist for all undelivered elements, all revenue is deferred until sufficient evidence exists or all elements have been delivered. We use the residual method to recognize revenue when an arrangement includes one or more elements to be delivered at a future date and VSOE of the fair value of all undelivered elements exists.

~~From~~We ~~April~~recognize ~~2001~~fees ~~through~~for ~~November~~annual ~~2003,~~licensing ~~Xerox~~arrangements ~~Corporation~~ratably ~~was~~over anthe ~~affiliate~~contract term of ~~Document Sciences.~~twelve Onmonths ~~November~~because ~~18, 2003,~~ we ~~repurchased~~are ~~the~~unable ~~remaining~~to ~~740,024~~establish ~~shares~~VSOE offor ~~Document~~the ~~Sciences~~license ~~common~~and ~~stock~~support ~~owned~~elements byunder ~~Xerox.~~this ~~Since~~type ~~that~~of ~~transaction,~~bundled ~~Xerox is no longer an affiliate~~arrangement.

WeFor ~~have~~perpetual ~~distribution~~license ~~agreements~~arrangements, ~~with~~VSOE ~~affiliates~~ of ~~Xerox~~fair ~~providing~~value for ~~the~~ongoing ~~non-exclusive~~maintenance ~~right~~and tosupport ~~sub-license~~obligations ~~our~~(PCS) is ~~software~~determined inbased upon the ~~United States~~historical, ~~Europe,~~stand-alone ~~Australia~~renewal ~~and~~rates ~~Latin~~or ~~America~~pricing. ~~The~~We ~~terms~~recognize ofrevenue ~~the~~relating ~~distributor~~to ~~agreements provide that~~ the ~~affiliates~~perpetual ~~receive~~software alicense ~~discount~~arrangements ~~from~~at ~~the~~inception ~~list price~~ of ~~our~~the ~~licensed~~arrangement ~~products~~using ~~and annual license fees. During~~ the ~~six~~residual ~~months ended~~method ~~June~~as ~~30,~~discussed ~~2003 in which Xerox was our affiliate, revenues from affiliates of Xerox were $2~~above.3 ~~million. Included in accounts receivable is $1.0 million from these revenues at June 30, 2003.~~

~~Note~~Our Dcontracts -do ~~Computation~~not provide for specific upgrades. In addition, our standard contracts do not provide for rights of ~~Net~~return ~~Income~~or ~~(Loss)~~conditions ~~Per~~of ~~Share~~acceptance; however, in cases where acceptance criteria are provided, revenue is deferred and not recognized until all conditions are satisfied and written customer acceptance is obtained.

WeProfessional ~~present~~services revenue includes consulting services and training related to our ~~earnings~~software ~~(loss)~~products. ~~per~~Revenues ~~share~~generated ~~(EPS)~~from ~~information~~consulting inservices ~~accordance~~and ~~with~~training ~~Statement~~are ~~of Financial~~recognized ~~Accounting~~as ~~Standards~~the ~~(SFAS)~~related ~~No.~~services ~~128~~are performed and collectibility is deemed probable, ~~Earnings~~based ~~per~~on ~~Share~~VSOE of fair value of the services. ~~Basic~~VSOE ~~EPS~~of fair value for professional services is ~~computed~~determined bybased ~~dividing~~upon ~~income~~the orprice ~~loss~~charged ~~available~~when these services are sold separately. For professional services that are bundled with annual software licenses and are not deemed to ~~common~~be ~~stockholders~~essential (to the ~~numerator)~~functionality byof the ~~weighted-average~~delivered ~~number~~software product, we recognize the entire arrangement fee ratably over the longer of ~~common~~the ~~shares~~period ~~outstanding~~over (which the ~~denominator)~~professional services are ~~during~~expected to be rendered, or the PCS period., ~~Shares~~beginning ~~issued~~with ~~during~~delivery of the ~~period~~software and ~~shares~~commencement ~~reacquired~~of ~~during~~the professional services. In the ~~period~~vast ~~are~~majority ~~weighted~~of ~~for~~cases, the ~~portion~~arrangement offee is recognized ratably over the twelve month PCS period. In certain limited situations where we determine that ~~they~~professional ~~were~~services ~~outstanding.~~period ~~Basic~~is ~~EPS~~the ~~excludes~~longer ~~any~~period, ~~dilutive~~upon ~~effects~~the end of ~~options~~the PCS term, ~~warrants~~we recognize license and ~~convertible~~PCS revenues at that stage (on the residual basis), recognizing the remaining deferred revenue for ~~securities~~the unfinished services over the remaining period of such services.

~~The~~If ~~computation~~consulting ofservices ~~diluted~~are ~~EPS~~deemed isto ~~similar~~be essential to the ~~computation~~functionality of the ~~basic~~delivered ~~EPS~~software product, ~~except~~revenue ~~that~~from the ~~denominator~~entire arrangement is ~~increased~~recognized toon ~~include~~a ~~the~~percentage ~~number~~ of ~~additional~~completion ~~common~~method ~~shares~~or ~~that~~not ~~would~~until ~~have been outstanding if~~ the ~~common~~contract ~~shares~~is ~~underlying~~completed ~~outstanding~~in ~~options~~accordance ~~and~~with ~~warrants~~SOP ~~had~~81-1, ~~been~~Accounting ~~issued.~~for ~~The~~Performance ~~dilutive effect~~ of ~~outstanding~~ ~~options~~Construction-Type and ~~warrants~~Certain Production-Type ~~has~~Contracts, ~~been~~and ~~reflected~~Accounting inResearch ~~EPS~~Bulletin by(ARB) ~~application~~No. 45, ofLong-Term ~~the~~Construction-Type ~~treasury stock method~~Contracts. ~~The~~We ~~treasury~~measure ~~stock~~progress ~~method~~under ~~recognizes~~ the ~~use~~percentage of ~~proceeds~~completion ~~that~~method, ~~could~~depending beon ~~obtained~~how ~~upon~~the ~~exercise~~contract oflanguage ~~options~~is ~~and~~written, ~~warrants in computing diluted EPS.~~either Itby ~~assumes~~using ~~that any proceeds would be used to purchase common stock at~~ the ~~average~~percentage ~~market~~of ~~price~~total ~~during~~project ~~the~~hours ~~period.~~completed ~~Options~~or ~~and~~by ~~warrants will have a dilutive effect under~~ the ~~treasury~~completion ~~stock method only when the average market price~~ of ~~the~~phases ~~common stock~~in ~~during~~ the ~~period~~consulting ~~exceeds the exercise price of the options or warrants~~project. ~~Common~~Because ~~stock options to purchase 112,281 and 46,059 shares were excluded from~~ the ~~calculation~~phases of ~~weighted-average~~our ~~shares~~consulting ~~used~~projects inare ~~determining~~generally ~~diluted~~not ~~EPS~~of ~~for~~great ~~the~~duration ~~three months~~(2-6 ~~ended~~weeks ~~June~~on 30average), ~~2004~~we ~~and~~believe ~~2003,~~that ~~respectively,~~there ~~and~~are very ~~74,554~~limited ~~and~~circumstances ~~46,059~~where ~~shares~~materially ~~were~~different ~~excluded~~amounts ~~for~~would ~~the~~be ~~six~~reported ~~months~~under ~~ended~~different ~~June~~conditions ~~30,~~or ~~2004~~using ~~and~~different ~~2003, respectively, as their effect would have been antidilutive~~assumptions.

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

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

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

The computation of diluted EPS is similar to the computation of basic EPS, except that the denominator is increased to include the number of additional common shares that would have been outstanding if the common shares underlying outstanding options had been issued. The dilutive effect of outstanding options and warrants has been reflected in EPS by application of the treasury stock method. The treasury stock method recognizes the use of proceeds that could be obtained upon exercise of options and warrants in computing diluted EPS. It assumes that any proceeds would be used to purchase common stock at the average market price during the period. Options and warrants will have a dilutive effect under the treasury stock method only when the average market price of the common stock during the period exceeds the exercise price of the options or warrants. Common stock options to purchase 78,301 and 25,971 shares were excluded from the calculation of weighted-average shares used in determining diluted EPS for the three months ended September 30, 2006 and 2005, respectively, and 55,861 and 21,881 shares were excluded for the nine months ended September 30, 2006 and 2005, respectively, as their effect would have been antidilutive.

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

	Three Months Ended		Six Months Ended
	Three Months EndedSeptember 30,		Nine Months EndedSeptember 30,
	June 30,2004	June 30,2003	June 30,2004	June 30,2003
	2006	2005	2006	2005
Weighted average common shares outstanding used in basic EPS calculation	3,284,161	3,880,010	3,253,225	3,874,944
Weighted average common shares outstanding used in basic earnings per share calculation	4,281,906	4,158,371	4,250,690	4,128,384
Effect of dilutive stock options	1,~~175~~042,~~850~~220	—	~~1,178,620~~—	—
Shares used in diluted EPS calculation	45,~~460~~324,~~011~~126	34,~~880~~158,~~010~~371	4,~~431~~250,~~845~~690	34,~~874~~128,~~944~~384

Note D - Stockholders’ Equity

On August 1, 2006, the Company announced that the Board of Directors had authorized it to repurchase up to $1,000,000 of its common stock in open market or in private transactions, subject to the Company’s assessment of market conditions and buying opportunities from time to time. The Company expects to complete the repurchase program within one year, unless market conditions change significantly or the program is terminated sooner by the Board of Directors.

As of September 30, 2006, the Company had purchased 2,762 shares at an average price of $6.20 per share, including fees and commissions.

Note E - Stock-Based Compensation

~~As permitted by SFAS No. 123, Accounting for~~ Stock~~-based~~ ~~Compensation, we~~Plan ~~have~~Activity elected to follow Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for our employee stock options. Under APB Opinion No. 25, among other things, when the exercise price of our employee stock options is not less than the market price of the underlying stock on the date of grant, no compensation expense is recognized.

7Our stock incentive plans provide for the issuance of restricted stock, incentive stock options and non-statutory options to purchase common shares and other awards to eligible employees, officers, directors and consultants. Our 2004 Stock Incentive Plan (the “2004 Plan”) was approved at our Annual Meeting of Stockholders on April 29, 2004. The 2004 Plan provides for the issuance of up to 900,000 shares. The Compensation Committee, subject to the provisions of the 2004 Plan, determines the terms of the restricted stock and stock option agreements, including vesting requirements. In general, stock grants vest over a four year period. The maximum term of the options granted under the 2004 Plan is ten years. The exercise price of stock options under the 2004 Plan must equal at least the fair market value on the date of grant.

AsOur ~~required~~previous ~~under~~plans, ~~SFAS~~the ~~No.~~1993 ~~123,~~and ~~the~~1995 ~~pro~~Stock ~~forma~~Option ~~effects~~Plans, ofhave ~~stock-based~~been ~~compensation~~replaced onby ~~net~~the ~~income~~2004 ~~(loss)~~Plan and ~~net~~no ~~earnings~~additional awards ~~(loss)~~may ~~per~~be ~~common~~granted ~~share~~thereunder. ~~have~~These ~~been~~plans ~~estimated~~had atprovided for the ~~date~~issuance of ~~grant~~up ~~using~~to ~~the~~2,279,250 ~~Black-Scholes~~shares ~~option~~and ~~pricing~~had ~~model~~been ~~based~~amended onto provide for the ~~following~~issuance ~~weighted-average~~of ~~assumptions:~~an ~~risk-free~~additional ~~interest~~2,100,000 ~~rates~~shares. ofThere ~~4%,~~are ~~dividend~~no ~~yields~~shares ofsubject ~~0%,~~to ~~expected~~outstanding ~~volatility~~options offrom ~~.59~~the to1993 Plan ~~.62~~as ~~and~~of aDecember 31, ~~weighted-average~~2004. ~~expected~~The ~~life~~1995 ofPlan ~~the~~has ~~option~~options ofexercisable ~~seven~~through ~~years~~January 26, 2014.

~~For purposes of adjusted pro forma disclosures, the estimated fair value of the options is amortized to expense over the option’s vesting period.~~ The ~~effect~~following ~~of applying SFAS No. 123 for purposes of providing pro forma disclosures is not likely to~~table besummarizes ~~representative~~stock ofoption ~~the~~activity ~~effects~~under onall our ~~operating~~equity ~~results~~incentive ~~for future years because changes in the subjective input assumptions can materially affect future value estimates. Our pro forma information is as follows~~plans:

	Three Months Ended						Six Months Ended
	Number of Shares		WeightedAverageExercisePrice			Weighted AverageRemainingContractualTerm(years)		AggregateIntrinsicValue
	June 30,2004		June 30,2003				June 30,2004			June 30, 2003
Outstanding at December 31, 2005	2,294,722		$	3.31
Net income (loss), as reported less stock-based compensation expense	$	11,604	$	(894,839	)		$	33,661		$	(1,977,600	)
Granted	50,000			6.64
Adjusted pro forma basic net income (loss) per share	$	0.00	$	(0.23	)		$	0.01		$	(0.51	)
Exercised	(61,688	)		3.69
Adjusted pro forma diluted net income (loss) per share	$	0.00	$	(0.23	)		$	0.01		$	(0.51	)
Forfeited or expired	(122,183	)		6.15
Outstanding at September 30, 2006	2,160,851		$	3.21		5.30		$	6,087,292
Exercisable at September 30, 2006	2,049,369		$	3.03		5.09		$	6,086,384

~~Note~~As Fof –September 30, ~~Subsequent~~2006, ~~Events~~134,031 shares were available for future issuance.

OnOur ~~July~~1997 ~~20,~~Employee ~~2004,~~Stock wePurchase ~~purchased~~Plan ~~the~~provides ~~remaining~~for ~~79% of~~ the ~~outstanding~~issuance ~~common stock~~of shares of ~~Objectiva~~our ~~Software~~common ~~Solutions~~stock, ~~Inc.,~~up ~~making~~to ~~Objectiva~~ a ~~wholly-owned~~total ~~subsidiary.~~of ~~The~~500,000 ~~consideration~~shares, ~~paid~~ to ~~the~~eligible ~~Objectiva~~employees. ~~shareholders~~The price ~~was~~of ~~$3.6~~the ~~million~~common ~~consisting~~shares ofpurchased ~~$392,800~~under inthe ~~cash~~Plan ~~and~~is ~~629,793~~equal ~~shares~~to 85% of ~~our~~the ~~common~~fair ~~stock~~market ~~(with a~~ value of ~~$3.2~~ ~~million~~the ~~calculated~~common ~~based~~shares on ~~our~~the ~~average~~first ~~price~~or ~~per~~last ~~share~~day as of the ~~close~~offering ~~of trading from July 16~~period, ~~2004~~whichever ~~through~~is ~~July 22, 2004)~~lower. ~~The~~Employees ~~stock~~who ~~portion~~choose ~~consisted~~to ofparticipate ~~newly~~in ~~issued shares where as over 95% of~~ the ~~shares~~plan ~~are~~can ~~restricted from resale, which~~withhold ~~restrictions~~between ~~lapse~~one ~~over~~and aten ~~period~~percent of ~~three~~their ~~years~~wages. ~~Due~~However, toan ~~insufficient~~employee ~~time~~can ~~between~~not ~~the~~purchase ~~acquisition~~more ~~date~~than ~~and the filing of this Form 10-Q~~5,000 weshares ~~have~~in ~~not~~any ~~completed~~one ~~our~~offering ~~estimate~~period. As of ~~the~~September 30, ~~purchase~~2006, ~~price~~90,322 orshares ~~our~~were ~~purchase~~available ~~price~~for ~~allocation~~issuance.

Adoption of SFAS No. 123

On January 1, 2006, we adopted SFAS 123(R) Share-Based Payment, which requires the measurement and recognition of compensation expense for all stock-based payment awards made to employees and directors, including employee stock options and employee stock purchases, based on estimated fair values. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) 107 relating to SFAS 123(R). We have applied the provisions of SAB 107 in our adoption of SFAS 123(R).

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

We adopted SFAS 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of our fiscal year 2006. In accordance with the modified prospective transition method, our consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). Stock-based compensation expense recognized under SFAS 123(R) for the nine months ended September 30, 2006 consisted of stock-based compensation expense related to employee stock options and employee stock purchases of approximately $128,000, or $0.03 per share (basic). There was no stock-based compensation expense related to employee stock options and employee stock purchases recognized during the nine months ended September 30, 2005.

The following table summarizes stock-based compensation expense related to employee stock options and stock purchases under SFAS 123(R) for the three and nine months ended September 30, 2006 which was allocated as follows:


	Three Months		Nine Months
Cost of sales	$	21,000	$	74,000
Research and development		5,000		18,000
Selling, general and administrative		10,000		36,000

Total	$	36,000	$	128,000

On December 22, 2005, of our Board of Directors approved the acceleration of the vesting of all unvested stock options awarded under our stock incentive plans for those employees and directors with more than one year of service with the Company, effective December 22, 2005. The decision to accelerate the vesting of these outstanding stock options was made primarily to reduce the non-cash compensation expense that we would have otherwise recorded in future periods as a result of adopting SFAS 123(R). We estimate that the acceleration eliminated approximately $1.5 million of cumulative pre-tax compensation charges that would have been recognized during 2006, 2007 and 2008 as the stock options would have continued to vest. Additionally, as a result of changes in accounting required by SFAS 123(R) and a desire to design our long-term incentive plans in a manner that creates a stronger link to operating and market performance, our Board of Directors approved a substantial change in the form of awards that we grant. Beginning in late 2005, stock option grants issued under our existing stock incentive plans were reduced and replaced with grants of restricted stock.

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


	Three Months Ended September 30,				Nine Months Ended September 30,
	2006		2005		2006		2005
Expected life of options	5.68 years		7 years		5.68 years		7 years
Expected volatility	85	%	52	%	85	%	52	%
Risk-free interest rates	4.4	%	6.0	%	4.4	%	6.0	%
Dividend yields	0	%	0	%	0	%	0	%

In determining fair value, we used the following criteria:

Expected Term. The expected term of options granted represents the period of time that the option is expected to be outstanding. We estimate the expected term of the option grants based on historical exercise patterns that are believed to be representative of future behavior as well as other various factors.

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

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

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

Forfeitures. SFAS 123R requires companies to estimate forfeitures at the time of grant and revise those estimates in subsequent reporting periods if actual forfeitures differ from those estimates. We use historical data to estimate pre-vesting option forfeitures and record share-based compensation expense only for those awards that are expected to vest. For purposes of calculating pro forma information under SFAS 123 for periods prior to the date of adoption of SFAS 123R, we accounted for forfeitures as they occurred.

For purposes of adjusted pro forma disclosures, the estimated fair value of the options is amortized to expense over the option’s vesting period. The effect of applying SFAS 123 for purposes of providing pro forma disclosures is not likely to be representative of the effects on our operating results for future years because changes in the subjective input assumptions can materially affect future value estimates. Our pro forma information is as follows for the three and nine months ended September 30, 2005:


	Three Months			Nine Months
Net loss as reported	$	(68,630	)	$	(326,231	)
Deduct stock-based compensation expense		(383,627	)		(1,063,370	)

Pro forma net loss	$	(452,257	)	$	(1,389,601	)

Adjusted pro forma basic and diluted net loss per share	$	(0.11	)	$	(0.34	)

Nonvested Shares

Stock Options. A summary of the status of our nonvested stock options issued under our 2004 Stock Incentive Plan for the nine months ended September 30, 2006 was as follows:


	Shares		Weighted Average Grant- Date Fair Value
Nonvested shares outstanding at December 31, 2005	98,350		$	6.35
Granted	50,000		$	6.64
Vested	(24,593	)	$	6.18
Forfeited	(12,275	)	$	6.54

Nonvested shares outstanding at September 30, 2006	111,482		$	6.49

As of September 30, 2006, there was approximately $271,000 of total compensation cost related to nonvested share-based compensation arrangements for stock options granted under the plans. That cost is expected to be recognized over a weighted average period of 1.72 years. During the nine months ended September 30, 2006, we recognized approximately $101,000 in compensation expense related to nonvested shares.

Restricted Stock. A summary of the status of our nonvested restricted stock issued under our 2004 Stock Incentive Plan for the nine months ended September 30, 2006 was as follows:


	Shares		Weighted Average Grant- Date Fair Value
Nonvested shares outstanding at December 31, 2005	87,300		$	7.36
Granted	116,100		$	6.50
Vested	—		$	0.00
Forfeited	(1,500	)	$	7.13

Nonvested shares outstanding at September 30, 2006	201,900		$	6.86

As of September 30, 2006, there was approximately $1.1 million of total compensation cost related to nonvested share-based compensation arrangements for restricted stock granted under the plans. That cost is expected to be recognized over a weighted average period of 1.89 years. During the nine months ended September 30, 2006, we recognized approximately $236,100 in compensation expense related to nonvested restricted shares.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Critical Accounting Policies

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

8Revenue Recognition. We derive our revenues principally from the licensing of software, post contract support fees (PCS) and professional services. We recognize revenue in accordance with Statement of Position (SOP) 97-2, Software Revenue Recognition. We offer both perpetual software licenses and time-based software licenses that are required to be renewed annually. Revenues are recognized when a contract exists, the fee is fixed and determinable, software delivery has occurred and collection of the receivable is deemed probable. Amounts billed or payments received in advance of revenue recognition are recorded as deferred revenue.

~~Revenue~~If ~~Recognition.~~an Wearrangement ~~recognize~~includes ~~revenue~~multiple ~~in accordance with SOP 97-2~~elements, ~~Software~~we ~~Revenue Recognition,~~allocate ~~and~~the ~~SAB~~contract ~~No.~~amount ~~101,~~to ~~Revenue~~the ~~Recognition~~various inelements ~~Financial~~based ~~Statements.~~on vendor-specific ~~Initial~~objective ~~license~~evidence ~~fees~~(VSOE) ~~are~~of ~~recognized~~fair ~~when a contract exists~~value, ~~the~~regardless ~~fee~~of isany ~~fixed~~separate ~~and~~prices ~~determinable,~~stated ~~software~~within ~~delivery has occurred and collection of~~ the ~~receivable~~contracts ~~is deemed~~for ~~probable~~each element. We ~~use~~base ~~the residual method to recognize revenue for all of~~ our ~~license~~VSOE ~~models.~~on ~~Our~~the ~~contracts~~price ~~specifically~~charged ~~state~~when the ~~amount~~same ofelement ~~initial~~is ~~and~~sold ~~annual license fees due for each type of software licensed~~separately. If an undelivered element of the arrangement exists ~~under the license arrangement~~, revenue is deferred based on ~~vendor-specific~~VSOE ~~objective evidence~~ of the fair value of the undelivered element. If ~~vendor-specific~~VSOE ~~objective evidence~~ of fair value does not exist for all undelivered elements, all revenue is deferred until sufficient evidence exists or all elements have been delivered. We ~~recognize~~use ~~revenue~~the onresidual ~~transactions~~method ~~with~~to ~~payment~~recognize ~~terms~~revenue ~~greater~~when ~~than~~an 30arrangement ~~days~~includes ~~but~~one ~~less~~or ~~than~~more ~~twelve~~elements ~~months~~to ~~from~~be ~~the~~delivered ~~contract~~at ~~date,~~a iffuture wedate ~~have~~and ~~a history~~VSOE of ~~successfully collecting from~~ the ~~specific~~fair ~~customer~~value ~~without providing concessions. Amounts billed or payments received in advance~~ of ~~revenue~~all ~~recognition~~undelivered ~~are~~elements ~~recorded as deferred revenue~~exists.

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

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

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

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

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

Software Development 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 technological feasibility of the product has been established. After technological feasibility has been established, direct production costs, including programming and testing, are capitalized until general release of the product.

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

~~Allowance~~Impairment ~~for~~of ~~Doubtful~~Goodwill. ~~Accounts~~The value of our goodwill could be impacted by future adverse changes such as declines in our operating results or failure to meet the performance projections included in our forecasts of future operating results. We ~~maintain~~evaluate these assets on an ~~allowance~~annual ~~for~~basis ~~doubtful~~or ~~accounts for~~more ~~estimated~~frequently ~~losses~~if ~~resulting~~indicators ~~from~~of impairment exist. In the ~~inability~~process of our ~~customers~~annual toimpairment review, ~~make~~we ~~required~~primarily ~~payments.~~use Ifa discounted cash flow method to determine the ~~financial~~fair ~~condition~~value of our ~~customers~~assets. ~~were~~Significant tomanagement ~~deteriorate,~~judgment ~~resulting~~is required in anthe ~~impairment~~forecasts of ~~their~~future ~~ability~~operating results that are used in the discounted cash flow method of valuation. The estimates we have used are consistent with the plans and estimates that we use to ~~make~~manage ~~payments~~our business. It is possible, ~~additional~~however, ~~allowances~~that the plans and estimates used may be ~~required,~~ ~~which~~incorrect. ~~would~~If ~~result~~our inactual anresults, ~~additional~~or ~~general~~the plans and ~~administrative~~estimates ~~expense~~used in ~~the~~future impairment ~~period~~analyses, ~~such~~are ~~determination~~lower isthan ~~made.~~the Atoriginal estimates used to assess the ~~end~~recoverability of ~~each~~these ~~reporting period~~assets, we ~~perform~~could aincur ~~detailed~~impairment ~~review~~charges.

9Allowance for Doubtful Accounts. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required, which would result in an additional general and administrative expense in the period such determination is made. At the end of each reporting period, we perform a detailed review of outstanding balances by customer and invoice. We utilize statistical and account specific analysis to determine the adequacy of our reserve, as well as comparing balances to historical losses. If our assumptions or analysis are incorrect, our operating results for future periods may be adversely affected.

Deferred Income Taxes. Deferred income taxes reflect the net effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. At December 31, 2005, we had net deferred tax assets of $4.3 million. Due to the uncertainty of realizing a portion of these net deferred tax assets, we have maintained a valuation allowance of $4.0 million for net deferred tax assets. Such uncertainty primarily relates to the potential for future taxable income as well as loss carryforwards and tax credits expiring in 2018 and 2012, respectively. In addition, pursuant to Sections 382 and 383 of the Internal Revenue Code, annual use of our net operating loss carryforwards may be limited in the event of a cumulative change in ownership of more than 50% within a three-year period. No valuation allowance has been recorded to offset the remaining

$275,000 of ~~outstanding~~net ~~balances~~deferred bytax ~~customer~~assets ~~and~~as ~~invoice.~~we Wehave ~~utilize~~determined ~~statistical~~that ~~and~~it ~~account~~is ~~specific~~more ~~analysis~~likely than not that these assets will be realized. We will continue to ~~determine~~assess the ~~adequacy~~likelihood of ~~our~~realization ~~reserve~~of such assets; however, asif ~~well~~future asevents ~~comparing~~occur ~~balances~~which todo ~~historical~~not ~~losses.~~make Ifthe ~~our~~realization ~~assumptions~~of orsuch ~~analysis~~assets ~~are~~more ~~incorrect~~likely than not, ~~our~~we will record a valuation allowance against all or a portion of the remaining net deferred tax assets. Examples of future events that might occur which would make the realization of such assets not likely is a lack of taxable income resulting from poor operating results ~~for~~during ~~future~~2006. ~~periods~~As ~~may~~a beresult ~~adversely~~of ~~affected~~our assessment at September 30, 2006, our net deferred tax asset remained at $275,000.

~~Deferred~~Results ~~Income Taxes. Deferred income taxes reflect the net effect~~ of ~~temporary~~ ~~differences~~Operations ~~between the carrying amounts of assets and liabilities~~ for ~~financial reporting purposes and~~ the ~~amounts~~Three used for income tax purposes. At December 31, 2003, we had net deferred tax assets of $2.7 million. Due to the uncertainty of realizing a portion of these net deferred tax assets, we have maintained a valuation allowance of $2.4 million for net deferred tax assets. Such uncertainty primarily relates to the potential for future taxable income as well as loss carryforwards and ~~tax~~Nine ~~credits~~Months ~~expiring~~Ended ~~in 2018 and 2012~~September 30, ~~respectively.~~2006 ~~In addition, pursuant to Sections 382~~ and 383 of the Internal Revenue Code, annual use of our net operating loss carryforwards may be limited in the event of a cumulative change in ownership of more than 50% within a three-year period. No valuation allowance has been recorded to offset the remaining $275,000 of net deferred tax assets as we have determined that it is more likely than not that these assets will be realized within the next fiscal period. We will continue to assess the likelihood of realization of such assets; however, if future events occur which do not make the realization of such assets more likely than not, we will record a valuation allowance against all or a portion of the remaining net deferred tax assets. Examples of future events that might occur which would make the realization of such assets not likely are unanticipated costs associated with the integration of Objectiva and a lack of taxable income resulting from poor operating results during 2005. ~~At June 30, 2004, the net deferred tax assets of $275,000 remained unchanged.~~

Results of Operations for the Three and Six Months Ended June 30, 2004 and 2003

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

	Three Months Ended June 30,				Six Months Ended June 30,
	Three MonthsEndedSeptember 30,				Nine MonthsEndedSeptember 30,
	2004		2003		2004		2003
	2006		2005		2006		2005
Revenues:
Initial license fees	29	%	28	%	30	%	26	%
License fees	66	%	69	%	66	%	68	%
Annual renewal license and support fees	54		51		53		53
Services and other	34		31		34		32
Services and other	17		21		17		21
Total revenues	100		100		100		100
Cost of revenues:
Initial license fees	5		4		5		5
License fees	12		15		13		15
Annual renewal license and support fees	9		9		10		9
Services and other	29		28		30		26
Services and other	14		14		13		14
Total cost of revenues	41		43		43		41
Total cost of revenues	28		27		28		28
Gross profit	59		57		57		59
Gross profit	72		73		72		72
Operating expenses:
Research and development	1619		2522		17		2820
Selling and marketing	3827		5027		3729		4929
General and administrative	1512		1410		1612		1412
Total operating expenses	6958		8959		7058		9161
Income (loss) from operations	31		(162	)	2(1	)	(192	)
Interest and other income, net	—		1		1—		1
Income (loss) before income taxes	31		(151	)	3(1	)	(181	)
Provision for income taxes	—		—		—		—
Net income (loss)	31	%	(151	)%	3(1	)%	(181	)%

Revenues

Our revenues are divided into ~~three~~two categories based upon the sources from which they are derived: ~~initial~~(i) term-based ~~license~~licenses ~~fees,~~and perpetual licenses and related annual renewal license and support fees, and (ii) services and other revenues. ~~The~~License ~~following~~fees ~~discussion~~consist isprimarily ~~separated~~of ~~into~~perpetual ~~these~~fees, ~~categories~~fees for the first year of use of our products and annual renewal license and PCS fees. Services and other revenues consist of fees for consulting, software outsourcing, application development and training services performed by us as well as miscellaneous other operational revenues. We sell our products principally through our direct sales force domestically and through distributors and VARs internationally. The following table summarizes revenues (in thousands) and the percentage change over the previous year for the periods indicated:

The following table summarizes revenues (in thousands) and the percentage change over the same period of the prior year for the periods indicated:


	Three Months Ended September 30,								Nine Months Ended September 30,
	2006				2005				2006				2005
License fees	$	5,509	7	%	$	5,129	4	%	$	16,243	10	%	$	14,709	7	%
Services and other		2,889	26	%		2,286	78	%		8,400	23	%		6,847	139	%

Total revenues	$	8,398	13	%	$	7,415	19	%	$	24,643	14	%	$	21,556	30	%

	Three Months Ended June 30,								Six Months Ended June 30,
	2004				2003				2004				2003
Initial license fees	$	1,594	9	%	$	1,457	(35	)%	$	3,201	28	%	$	2,506	(30	)%
Annual renewal license and support fees		2,929	13			2,594	10			5,738	10			5,193	12
Services and other		955	(11	)		1,070	2			1,799	(11	)		2,031	(10	)
Total revenues	$	5,478	7	%	$	5,121	(9	)%	$	10,738	10	%	$	9,730	(7	)%

Initial license fees. Initial license fees consist primarily of upfront license fees for the first year of use of our products.

The components of initial license fees (in thousands) of our product families consist of the following:

	Three Months EndedJune 30,				Six Months Ended June 30,
	2004		2003		2004		2003
Products:
CompuSet	$	840	$	781	$	1,407	$	1,298
Document Library Services		60		369		637		759
xPression		694		307		1,157		449
Total initial license fees	$	1,594	$	1,457	$	3,201	$	2,506

The increases in initial license fees for the three and six months ended June 30, 2004 were due to higher sales in the United States and improved product sales of xPression. The lesser amounts for the three and six months ended June 30, 2003 compared to 2002 were due to lower sales in the United States attributable to elongated sales cycles caused by the weak economy, uncertainty generated by geopolitical factors and tighter budgets. Additionally, the impact of transitioning our marketing and sales effort from one based exclusively on our existing Autograph suite to one focused largely around our new xPression architecture had not progressed as rapidly as we had anticipated.

Annual renewal license and support fees. Annual renewal license and support fees consist of license fees for the initial and continued use and support of our licensed products. The increases for the three and six months ended June 30, 2004 and 2003 were due to increases in our base of licensed software and in our list prices.

Services and other. Services and other revenues consist of fees for consulting, application development and training services performed by us as well as miscellaneous other operational revenues. The decreases for the three and six months ended June 30, 2004 were due to unbillable services performed related to the implementation of xPression which had taken longer than projected for certain customers. The decrease for the six months ended June 30, 2003 was largely due to an increase in unbillable services due to difficulties arising in the initial implementation of xPression. Additionally, we had a decrease in billable revenue due to internal training of our services personnel in the use of xPression.

Cost of Revenues

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

	Three Months Ended June 30,								Six Months Ended June 30,
	Three Months Ended September 30,								Nine Months Ended September 30,
	2004				2003				2004				2003
	2006				2005				2006				2005
Initial license fees	$	272	16	%	$	235	(34	)%	$	534	7	%	$	501	(29	)%
License fees	$	966	(10	)%	$	1,079	14	%	$	3,186	(4	)%	$	3,318	33	%
Annual renewal license and support fees		504	13			446	18			1,018	24			819	9
Services and other		2,472	19	%		2,081	121	%		7,462	34	%		5,568	135	%
Services and other		742	3			720	8			1,431	2			1,401	4
Total cost of revenues	$	3,438	9	%	$	3,160	67	%	$	10,648	20	%	$	8,886	82	%
Total cost of revenues	$	1,518	8	%	$	1,401	(12	)%	$	2,983	10	%	$	2,721	(3	)%

Cost of initial license fees. Cost of initial license fees includes amortization of previously capitalized software development costs, costs of third party software, employment costs for distribution personnel and product packaging. The increases for the three and six months ended June 30, 2004 were due to an increase in amortization of software development costs. The decreases for the three and six months ended June 30, 2003 were due to a decrease in amortization of software development costs.

Cost of annual renewal license and support fees. Costs of annual renewal license fees consist principally of the employment-related costs for our technical support staff. The increases for the three and six months ended June 30, 2004 and 2003 were due to an increase in staff to support xPression.

Cost of services and other. Costs of services and other consist principally of the employment-related costs of our consulting and training staff. Our consulting and training headcount has remained approximately the same the last couple of years.

Operating Expenses

~~The~~Research ~~following~~and ~~table~~development. ~~summarizes~~Research ~~operating~~and development expenses ~~(in~~consist ~~thousands)~~primarily ~~and~~of the ~~percentage~~employee ~~change~~related ~~over~~costs ~~the~~of ~~same~~personnel ~~period~~associated ofwith ~~the~~developing ~~prior~~new ~~year~~products, ~~for~~enhancing ~~the~~existing ~~periods~~products, ~~indicated:~~testing software products and developing product documentation.

	Three Months Ended June 30,								Six Months Ended June 30,
	2004				2003				2004				2003
Research and development	$	904	(29	)%	$	1,272	9	%	$	1,832	(32	)%	$	2,676	(4	)%
Selling and marketing		2,085	(19	)		2,576	45			3,983	(17	)		4,775	38
General and administrative		818	18			693	(21	)		1,685	22			1,383	(14	)
Total operating expenses	$	3,807	(16	)%	$	4,541	19	%	$	7,500	(15	)%	$	8,834	12	%

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

12General and administrative. General and administrative expenses consist of employee related costs for finance, administration, information technology and human resources, allowance for doubtful accounts and general corporate management expenses, including public company expenses, director expenses, legal fees, and accounting fees.

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


	Three Months Ended September 30,								Nine Months Ended September 30,
	2006				2005				2006				2005
Research and development	$	1,591	(1	)%	$	1,614	69	%	$	4,356	1	%	$	4,311	55	%
Selling and marketing		2,313	17	%		1,977	(8	)%		7,031	12	%		6,262	1	%
General and administrative		976	26	%		774	1	%		2,945	14	%		2,573	5	%

Total operating expenses	$	4,880	12	%	$	4,365	13	%	$	14,332	9	%	$	13,146	15	%

Research and development. Research and development expenses consist primarily of the employment-related costs of personnel associated with developing new products, enhancing existing products, testing software products and developing product documentation. We anticipate that we will continue to direct significant resources to the development and enhancement of our products.

	Three Months Ended June 30,								Six Months Ended June 30,
	2004				2003				2004				2003
Research and development (net)	$	904	(29	)%	$	1,272	9	%	$	1,832	(32	)%	$	2,676	(4	)%
Capitalized software development costs		659	77			372	(40	)		1,283	117			590	(24	)
Research and development (gross)	$	1,563	(5	)%	$	1,644	(8	)%	$	3,115	(5	)%	$	3,266	(9	)%

Capitalized software development costs mainly include payroll related costs of our engineering resources, allocated facilities costs and consulting fees paid to Objectiva in relation to the development of xPression. The amount of software development costs to be capitalized in the future may change if the time between the establishment of technological feasibility of a product and its general release changes. The increases in capitalized software development costs for the three and six months ended June 30, 2004 were due to the timing of technological feasibility and additional testing being performed on xPression 2.0. The decreases in gross research and development expenses for the three and six months ended June 30, 2004 were primarily due to decreases in personnel costs of $123,500 and $171,300, respectively.

The lower capitalized software development costs for the three and six months ended June 30, 2003 were due to the timing of technological feasibility of then current projects. The decreases in gross research and development expenses for the three and six months ended June 30, 2003 were primarily due to decreases in outside consultants of $70,700 and $156,300, respectively, and decreases in allocated facility and communication costs of $60,100 and $134,800, respectively.

Selling and marketing. Selling and marketing expenses consist primarily of salaries, commissions, marketing programs and related costs for pre- and post-sales activity. The decreases for the three and six months ended June 30, 2004 were primarily due to decreases in personnel costs of $277,300 and $340,400, respectively, travel and meeting expenses of $94,000 and $216,200, respectively, and trade shows and advertising of $50,200 and $138,000, respectively.

The higher costs for the three and six months ended June 30, 2003 were primarily due to increases in personnel costs of $473,100 and $724,400, respectively, outside consultants of $118,900 and $255,700, respectively, and trade shows and advertising in support of the release of xPression of $84,800 and $204,500, respectively.

General and administrative. General and administrative expenses consist of employment-related costs for finance, administration and human resources, allowance for doubtful accounts and general corporate management expenses, including legal and audit fees. The increases for the three and six months ended June 30, 2004 were primarily due to increases in personnel costs of $112,000 and $222,800, respectively, and bad debt expense of $107,200 for the six months ended June 30, 2004. The increases in personnel costs were due to a reclassification in 2004 of certain personnel from other departments.

The lower costs for the three and six months ended June 30, 2003 were primarily due to decreases in personnel costs of $89,900 and $137,200, respectively, allocated facility and communication costs of $82,800 and $130,100, respectively, offset by an increase in professional fees of $24,300 and $82,500, respectively.

Other items

Interest and other income, net. Interest and other income, net is composed of interest income from cash and cash equivalents and proceeds from short-term ~~investments~~investment disposals, offset by interest expense related to capital leases and proceeds ~~losses~~from on disposals of fixed assets. Interest and other income, net was $18,900 and $44,700 for the three months ended June 30, 2004 and 2003, respectively, and $41,500 and $108,800 for the six months ended June 30, 2004 and 2003, respectively. The decreases for the three and six months ended June 30, 2004 were the result of less interest income due to lower cash balances and lower interest rates.

Provision for income taxes. Provision for income taxes ~~was~~reflects ~~$6,900 and $3,000 for~~ the ~~three~~ months ended June 30, 2004 and 2003, respectively, and $19,100 and $26,400 for the six months ended June 30, 2004 and 2003, respectively. These amounts were due to foreign taxes. For the six months ended June 30, 2004, there has been no change to the net ~~deferred~~effect ~~tax assets~~ of ~~$275,000,~~temporary sodifferences between ~~there is no provision. We will continue to assess~~ the ~~likelihood~~carrying ofamounts ~~realization~~ of ~~our net deferred tax~~ assets. Ifand ~~future~~liabilities ~~events~~for ~~occur~~financial ~~that~~reporting dopurposes ~~not~~and ~~make~~ the ~~realization~~amounts ofused ~~such~~for ~~assets~~income ~~more likely than not, a valuation allowance will be established against all or a portion of the net deferred~~ tax ~~assets~~purposes.

~~Liquidity~~Three and ~~Capital~~nine months ~~Resources~~ended September 30, 2006 compared to the three and nine months ended September 30, 2005

~~Our sources~~License offee ~~cash~~revenue ~~come~~for ~~mainly~~the ~~from~~third ~~operations~~quarter and first ~~sales~~nine ~~and~~months ~~maturities~~ of ~~short-term~~2006 ~~investments.~~increased ~~Our~~by ~~main~~7% ~~uses of cash are for payroll~~ and ~~outside~~10%, ~~consultants.~~respectively, ~~Our~~over ~~main~~the ~~project~~comparable ~~underway~~2005 isperiods ~~xPression~~and ~~2.0.~~was Weprimarily ~~currently~~due ~~anticipate~~to ~~releasing~~higher ~~this~~initial ~~major upgrade~~sales of our xPression ~~software~~Enterprise inSuite ~~the~~and ~~4th~~increased ~~quarter~~PCS ofrevenues ~~2004.~~from Weour doincreasing ~~not~~base ~~use~~of ~~any equity-linked derivatives or stock~~licensed assoftware ausers, ~~form~~partially ofoffset ~~liquidity~~by toreduced ~~fund~~sales in our ~~operations.~~older WeAutograph ~~currently~~suite doof ~~not have any debt from borrowed money~~products.

WeServices ~~believe~~and ~~that~~other ~~our~~revenues ~~existing~~for ~~cash~~the ~~balances~~third quarter and ~~anticipated~~first nine ~~cash~~months ~~flows~~of ~~from~~2006 ~~operations~~increased ~~will~~by be26% ~~sufficient~~and to23%, ~~meet~~respectively, ~~our~~over ~~anticipated~~the ~~cash~~comparable ~~needs~~2005 ~~for~~periods. ~~working~~The ~~capital~~majority ~~and~~of ~~capital~~the ~~expenditures~~increase atwas ~~least~~from ~~through~~ the ~~next~~delivery ~~twelve months. A portion~~ of ~~our~~implementation ~~cash~~and ~~could~~other beservices ~~used~~ to ~~acquire~~customers orwho ~~invest~~have inlicensed ~~complementary~~our ~~businesses~~xPression software. Consulting orservices ~~products~~provided orby toour ~~obtain~~Objectiva ~~the~~subsidiary ~~right~~also contributed to ~~use~~the ~~complementary~~quarterly ~~technologies~~increase.

AtLicense ~~June~~fees ~~30,~~cost ~~2004,~~of werevenue ~~had~~for ~~$5.6~~the third ~~million~~quarter inand ~~cash,~~first ~~cash~~nine ~~equivalents~~months ~~and~~of ~~short-term~~2006 ~~investments.~~decreased ~~This~~by is10% aand ~~decrease~~4%, ~~of $302~~respectively,~~200~~ from ~~December~~the ~~31, 2003.~~comparable ~~The~~2005 ~~primary~~periods ~~causes~~and ~~for this decrease~~ were aprimarily ~~$948,800~~due ~~decrease~~to indecreases ~~deferred~~of ~~revenue~~approximately $120,000 aand ~~net increase of~~ $~~906~~580,~~400~~000 in software ~~development~~amortization ~~costs~~related ~~and~~to aolder ~~$491,900~~products ~~increase~~that are innow ~~other~~fully ~~assets~~amortized, partially offset by aincreases in salary-related expenses of approximately $~~1.8~~0 ~~million~~and ~~decrease~~$300,000 inand ~~receivables.~~royalties ~~Our short-term~~of ~~investments~~approximately ~~are~~$70,000 ~~invested~~and in$190,000 ~~U.S.~~from ~~government~~the ~~agency~~respective ~~obligations~~2005 periods.

As Services and other cost of ~~June~~revenues ~~30,~~for ~~2004,~~the wethird ~~did~~quarter ~~not~~and ~~have~~first ~~any~~nine ~~other~~months ~~relationships~~of ~~with~~2006 ~~unconsolidated~~increased ~~entities~~by or19% ~~financial~~and ~~partners,~~34% ~~such~~respectively asover ~~entities~~the ~~often~~third ~~referred~~quarter and first nine months of 2005 due to asan ~~structured~~increase ~~finance~~in orpersonnel ~~special~~related ~~purpose~~costs ~~entities,~~required ~~which~~to ~~would~~sustain ~~have~~existing ~~been~~projects ~~established~~and ~~for~~to ~~the~~staff ~~purpose~~anticipated ~~of facilitating~~new ~~off-balance~~projects. ~~sheet~~Salary ~~arrangements~~and orsalary ~~other~~related ~~contractually~~costs ~~narrow~~accounted orfor ~~limited~~over ~~purposes.~~85% Asof ~~such,~~the wetotal ~~are~~period ~~not~~over ~~materially~~period ~~exposed~~cost increases. Increased facility costs related to ~~any~~our ~~financing~~new headquarters facility, ~~liquidity~~outside consultant costs, ~~market~~travel orand ~~credit~~communication ~~risk~~costs ~~that~~also ~~could~~contributed ~~arise~~to ifthe wepercentage ~~had~~growth ~~engaged~~in services costs in ~~such~~excess ~~relationships~~of the percentage growth in services revenues.

WeResearch ~~have~~and noDevelopment ~~significant~~expenses ~~capital~~for ~~spending~~the orthird ~~purchase~~quarter ~~commitments~~of ~~other~~2006 ~~than normal~~decreased ~~purchase~~by ~~commitments~~1% ~~and~~from ~~commitments~~the ~~under~~third ~~facilities~~quarter ~~and~~of ~~equipment~~2005 ~~leases.~~and ~~Lease~~increased ~~commitments~~by 1% for the ~~next~~nine ~~five~~month periods ~~years~~ended ~~are $301~~September 30,~~968,~~ ~~$54,271,~~2006 ~~$55,275,~~over ~~$52,838~~the ~~and~~comparable ~~$11,945,~~2005 ~~respectively~~period.

~~Acquisition~~Selling ofand ~~Objectiva.~~marketing Onexpenses ~~July~~for ~~20,~~the ~~2004,~~third wequarter ~~paid~~and ~~consideration~~first ofnine ~~$3.6~~months ~~million~~of ~~for~~2006 ~~the~~increased ~~remaining~~by 7917% ofand 12%, respectively over the ~~outstanding~~comparable ~~common~~2005 ~~stock~~periods and were primarily due to increases of ~~Objectiva~~approximately ~~Software~~$220,000 ~~Solutions~~and $530,000 ~~Inc.~~in ~~Objectiva~~salary ~~employs~~and ~~nearly~~salary 90related ~~people~~costs, and ~~specializes~~increases in ~~enterprise~~travel ~~software~~and ~~development~~entertainment, ~~including~~commissions ~~rapid~~and ~~prototyping~~trade show expenses, ~~product~~offset ~~co-development,~~by reduced expenses related to outside consultants and facilities costs for our European operations.

For the third quarter and first nine months of 2006, general and administrative expenses increased by 26% and 14%, respectively over the third quarter and first nine months of 2005. Included in the three and nine month periods of 2005 was a one time credit for a French VAT refund of approximately $391,000. Adjusting the 2005 totals for this amount results in general and administrative expenses for the third quarter and first nine months of 2006 decreasing by 16% and 1%, respectively, from the comparable 2005 periods. This decrease is due primarily to decreases in salary related costs and outside consulting, partially offset by increases in recruiting costs and public company expenses.

~~product~~With ~~migration~~respect ~~and~~to ~~porting~~the ~~and~~increase ~~product~~in ~~reengineering.~~interest Weand ~~have~~other ~~had~~income a– ~~business~~net ~~relationship~~for ~~with~~the ~~Objectiva~~three ~~since~~month ~~2001. On~~period ~~January~~ended 16September 30, ~~2002~~ 2006, weas ~~entered~~compared ~~into~~to athe ~~two-year~~three month period ended September 30, ~~$3.1~~2005, ~~million~~improved ~~development~~interest ~~services~~rates ~~agreement~~in ~~with~~2006 ~~Objectiva~~on toinvested ~~help~~cash ~~with~~balances ~~our~~yielded ~~programming~~higher ofinterest ~~xPression~~income. OnInterest ~~January~~and ~~16,~~other ~~2004~~income—net for the nine month period ended September 30, we2006 ~~signed~~was ~~another~~approximately ~~two-year~~equal ~~development~~to ~~services~~the ~~agreement~~balance ~~for~~at ~~$3.3~~September 30, ~~million. The~~2005 ~~three~~as ~~founders~~a gain on sale of ~~Objectiva~~securities ~~are~~of ~~now~~approximately ~~officers~~$69,000 in the second quarter of ~~Document~~2005 ~~Sciences.~~offset ~~Please~~the ~~see~~improved ~~Note~~interest Fincome –amounts ~~Subsequent~~recorded ~~Events~~in ~~for~~2006 ~~additional~~over ~~information~~those recorded in 2005.

The quarterly provisions for income taxes in 2006 and 2005 relate to foreign taxes. We will continue to assess the likelihood of realization of our federal and state net deferred tax assets. If future events occur that do not make the realization of such assets more likely than not, a valuation allowance will be established against all or a portion of the net deferred tax assets.

Trends and Factors That May Affect Future Operating Results

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

Our ~~software~~license ~~products~~fee ~~generally~~revenues ~~are~~depend ~~shipped~~on aswhen orders are received. Asfrom aand shipped to customers; however, because of our ~~result~~revenue recognition policies, ~~initial~~our ~~license~~customers’ ~~fees~~implementation inschedules ~~any~~and ~~quarter~~the ~~are~~complexity ~~substantially~~of ~~dependent~~the onimplementation ~~orders~~process, ~~booked~~revenue ~~and~~from ~~shipped~~some software shipments may not be recognized in ~~that~~the same quarter as the shipment occurs. The timing of receipt of ~~initial~~these license fees is also difficult to predict because of the length of our sales cycle. For Autograph products, our sales cycle is typically three to nine months from initial contact. For xPression products, our sales cycle is typically ~~six~~nine months to over one year from initial contact. Because our operating expenses are based on anticipated revenue trends and because a high percentage of our expenses are relatively fixed, a delay in the recognition of revenue from a limited number of initial license transactions could cause significant variations in operating results from quarter to quarter and could result in losses. To the extent such expenses precede, or are not subsequently followed by, increased revenues, our operating results could be materially adversely affected.

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

Liquidity and Capital Resources

Our sources of cash are derived primarily from operations and sales and maturities of short-term investments. We currently do not have any debt from borrowed money. Our short-term investments are invested in U.S. government agency obligations and high quality commercial paper.

We believe that our existing cash balances and anticipated cash flows from operations will be sufficient to meet our anticipated cash needs for working capital and capital expenditures at least through the next twelve months. In this regard, a portion of our cash could be used to acquire or invest in complementary businesses or products or to obtain the right to use complementary technologies. We have no material current understandings, commitments or agreements with respect to any acquisition in whole of other businesses, products or technologies.

At September 30, 2006, we had $6,902,000 in cash, cash equivalents and short-term investments. This is a decrease of $971,000 from December 31, 2005. Cash decreased during the nine month period primarily due to an increase in accounts receivable of $4,261,000 and a decrease in accrued compensation of $482,000, partially offset by an increase in deferred revenue of $1,836,000, increases in accounts payable and other accrued liabilities of $559,000, and common stock sales totaling $254,000. Accounts receivable and the related deferred revenue typically increase significantly in the third quarter resulting from our normal invoicing for the renewal of annual license and maintenance fees for customers whose contracts expire at calendar year-end. In addition, two license agreements totaling approximately $2.5 million were recorded during the third quarter of 2006 for which we will recognize revenue over the respective terms of the arrangements.

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


	Totals		Payment Due by Period
	Totals		3 Months Ended December 31		1-3 Years		3-5 Years
Capital Lease Obligations	$	32,726	$	5,205	$	27,521	$	0
Operating Lease Obligations		2,944,413		182,947		1,446,244		1,315,222

Totals	$	2,977,139	$	188,152	$	1,473,765	$	1,315,222

Forward-looking Statements

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

•

national, international, regional and local economic, competitive, geopolitical and regulatory conditions and developments;

1519

• the market for ~~document~~dynamic ~~automation software (including the emerging~~ content ~~processing~~publishing ~~market)~~software;

•

market acceptance of enhancements to our existing products and introduction of new products;

• continued profitability of our professional services; and

• maintaining our relationships with ~~Xerox and~~ our other distribution partners~~; and~~.

•Our actual results could differ materially from those discussed herein due to a number of factors, including those set forth in this discussion, under “Certain Factors Affecting Document Sciences Corporation” and other ~~uncertainties~~risks detailed from time to time in our SEC reports. In addition, ~~all~~the discussion of ~~which~~our ~~are~~results ~~difficult~~of tooperations ~~predict~~should be read in conjunction with the sections entitled “Risk Factors” and ~~many~~“Management’s Discussion and Analysis of ~~which~~Financial ~~are~~Condition ~~beyond~~and Results of Operations” in our ~~control~~2005 Annual Report on Form 10-K for the fiscal year ended December 31, 2005 and in reports we file with the Securities and Exchange Commission. You are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date of that statement. We undertake no obligation to publicly release the results of any revision of the forward-looking statements.

Our actual results could differ materially from those discussed herein due to a number of factors, including those set forth in this discussion, under “Certain Factors Affecting Document Sciences Corporation” and other risks detailed from time to time in our SEC reports. In addition, the discussion of our results of operations should be read in conjunction with the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2003 Annual Report on Form 10-K for the fiscal year ended December 31, 2003 and in reports we file with the Securities and Exchange Commission. You are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date of that statement. We undertake no obligation to publicly release the results of any revision of the forward-looking statements.

Certain Factors Affecting Document Sciences Corporation

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

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

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

• the demand for our products and services;

•

the level of product and price competition;

•

the length of our sales cycle;

• the size, elements and timing of individual ~~license~~software ~~transactions~~arrangements;

16• the renewal rates for our annual software licenses;

•

the delay or deferral of customer implementations;

•

the budget cycles of our customers;

•

our success in expanding our direct sales force or indirect distribution channels;

•

the acceptance and timing of our new product introductions and enhancements, as well as those of our competitors;

•

our mix of products and services;

•

our level of international sales;

•

our ability to successfully implement our operational, growth and other strategies;

•

the timing and amount of software capitalization and amortization;

•

the activities of and acquisitions by our competitors;

•

our timing of new hires;

•

changes in foreign currency exchange rates; and

•

our ability to develop and market new products and to control costs.

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

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

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

Our future business, operating results and financial condition ~~depends~~depend upon market acceptance of our existing products, as well as our ability to respond to emerging industry standards and practices and to develop new products that address the future needs of our target markets. Our Autograph family of products has been applied mainly to document automation applications producing paper-based documents. We have started to extend our core technology to the Internet, intranets and commercial on-line services. However, we cannot assure you that we will be successful in developing, introducing and marketing new products or product enhancements, including new products or the extension of existing products for the Internet, intranets and commercial on-line services, on a timely and cost effective basis, if at all. In addition, we cannot assure you that our newer products, such as xPresso and xPression, or enhancements to existing products will adequately meet the requirements of the marketplace or achieve market acceptance. Moreover, delays in our commercial shipments of new products or enhancements may result in ~~client~~ client dissatisfaction and a delay or loss of product revenues. In addition, in order to provide our customers with integrated product solutions, our future success will also depend in part upon our ability to maintain and enhance relationships with our technology partners.

If21 ~~for technological or other reasons we are unable to develop and introduce new products or enhancements of existing products in a timely manner in response to changing market conditions or client~~

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

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

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

We currently derive a significant portion of our revenues ~~with~~from Xerox.

We currently have a variety of contractual and informal relationships with Xerox and affiliates of Xerox, including a cooperative marketing agreement, a transfer and license agreement and various distribution agreements. We rely on these relationships and agreements for a significant portion of our total revenues. Revenues derived from relationships with Xerox and affiliates of Xerox accounted for ~~approximately~~ approximately $12.85 million and $2.3.0 million for the ~~six~~nine months ended ~~June~~ September 30, ~~2004~~2006 and ~~2003~~2005, respectively, representing 1610% and 2313% of our total revenues, respectively.

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

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

1822

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

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

The success of our recent acquisition depends on successful integration.

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

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

~~As of~~We ~~June 30, 2004, we had~~ derived ~~44%,~~a ~~20%~~substantial ~~and~~percentage ~~36%~~ of our ~~initial~~ license revenue ~~revenues~~ from ~~our~~two ~~CompuSet,~~product ~~DLS~~lines ~~and~~in ~~xPression~~2006 ~~product~~and ~~lines, respectively~~2005. As a result, factors that may adversely impact the pricing of or demand for these products, such as competition from other products, negative publicity or obsolescence of the hardware or software environments in which our products run, could have a material adverse effect on our business, operating results and financial condition. Our financial performance will depend significantly on the successful development, introduction and customer acceptance of new and enhanced versions of our xPression software and xPresso software, as well as continued customer acceptance of ~~CompuSet~~Compose, DLS and related products.

~~Licenses~~Revenues tofrom end users in the insurance ~~and~~industry ~~finance industries in the United States~~ accounted for 6344% ~~and 32%~~ of ~~initial~~total ~~license~~ revenues in ~~2004~~the nine months ended September 30, ~~respectively~~2006. Our future success will depend on our ability to continue to successfully market our products in ~~these~~the insurance industry, as well as the finance and ~~other~~print services industries, and introduce their use in new industries. Our failure to do so ~~would~~could have a material adverse effect on our business, operating results and financial condition.

~~Our~~Inaccurate ~~growth~~sales isforecasts ~~dependent~~and/or ~~upon~~revenue ~~successfully~~projections ~~focusing~~could ~~our~~cause ~~distribution~~improper ~~channels~~planning and budgeting of our resources.

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

1923

~~Xerox,~~Our ~~IBM~~growth ~~Corporation~~is ~~and~~dependent ~~their~~upon distribution channels and affiliates by launching targeted joint marketing and value added reseller programs and by introducing new product offerings that are optimized for selected target markets and marketing channels. Additionally, we must form additional partnerships with system integrators and consultants in order to broaden our capacity to deliver complete document automation solutions that incorporate significant services content, while also maintaining our core domain expertise. We cannot assure you that we will be able to successfully ~~streamline~~focusing ~~and focus~~ our ~~worldwide~~ ~~channels,~~distribution ~~leverage our existing relationships or form new alliances~~channels. ~~If we fail to do so, it will have a material adverse effect on our business, operating results and financial condition.~~

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

Our products may suffer from defects or errors.

Software products, as complex as those we offer, may contain undetected defects or errors when first introduced or as new versions are released. As a result, depending on the severity of the defect or error, we could in the future ~~lose~~forego or delay recognition of revenues as a result of ~~software~~these errors or defects. In addition, our products are typically intended for use in applications that may be critical to a customer’s business. As a result, we expect that our customers and potential customers have a greater aversion and sensitivity to product defects than the general market for software products. We ~~have~~ experienced defects in connection with the introduction of our xPression product line in 2004, and believe that we have ~~worked~~addressed ~~to address~~ this problem, but we cannot assure you that, despite our testing, as well as testing by current and potential customers, additional errors will not be found in our existing products or new products or releases. Defects discovered after the commencement of commercial shipments, can result in ~~any~~loss of revenue, ~~the~~delay ~~following:~~in market acceptance, diversion of our development resources, damage to our reputation and/or increased service and warranty costs.

• loss of revenue

• delay in market acceptance;

• diversion of our development resources;

• damage to our reputation; or

• increased service and warranty costs.

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

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

We may be exposed to risks associated with international operations.

Our revenues from export sales, ~~including sales through our European subsidiary,~~ accounted for ~~$1.2~~12% ~~million~~ and ~~$1.5~~17% ~~million~~ for the three months ended ~~June~~ September 30, ~~2004~~2006 and ~~2003~~2005, respectively, and ~~$2.4~~14% ~~million~~ and ~~$2.8 million~~17% for the ~~six~~nine months ended ~~June~~ September 30, ~~2004~~2006 and ~~2003~~2005, respectively.

~~Our wholly~~24 owned subsidiary, Document Sciences Europe, markets and supports our products in Europe, Africa and the Middle East, for which they receive an agent fee. We license our products in Europe through VARs and to a much lesser extent, direct sales. Revenues generated by the activities of this subsidiary were $764,100 and $1.0 million for the three months ended June 30, 2004 and 2003, respectively, and $1.6 million and $1.7 million for the six months ended June 30, 2004 and 2003, respectively.

InWe ~~Australia,~~license ~~Canada and Latin America,~~ our products ~~are~~in ~~distributed~~Europe ~~and/or~~through ~~supported by Xerox affiliates and also by direct sale in Canada~~VARs. Revenues generated inby these ~~regions~~activities were $~~329~~680,~~400~~000 and $~~375~~812,~~900~~000 for the three months ended ~~June~~ September 30, ~~2004~~2006 and ~~2003~~2005, respectively, and $~~754,400~~2.2 million and $~~827,400~~2.4 million for the ~~six~~nine months ended ~~June~~ September 30, ~~2004~~2006 and ~~2003, respectively~~2005.

In ~~order~~Australia, toCanada ~~successfully~~and ~~expand~~Latin ~~export sales~~America, weour ~~must~~products ~~establish~~are ~~additional foreign~~distributed ~~operations,~~and/or ~~hire~~supported ~~additional~~by ~~personnel~~Xerox affiliates and ~~develop~~also ~~relationships~~by ~~with~~direct ~~additional~~sale ~~international~~in ~~resellers~~Canada. IfIn weChina, ~~are~~our ~~unable~~products toare dodistributed soand/or insupported aby ~~timely~~our ~~manner~~subsidiary, ~~our~~Objectiva. ~~growth~~Revenues generated in ~~international~~these ~~export~~regions ~~sales~~were ~~could be limited~~$351,000 and ~~our business~~$473,000 ~~operating results~~for ~~and~~the ~~financial~~three ~~condition~~months ~~could~~ended beSeptember 30, ~~materially~~2006 ~~adversely~~and ~~affected.~~2005, ~~In addition~~respectively, weand ~~cannot~~$1.2 ~~assure~~million ~~you~~and ~~that~~$1.3 wemillion ~~will~~for bethe ~~able~~nine tomonths ~~maintain~~ended orSeptember 30, ~~increase~~2006 ~~international~~and ~~market~~2005, ~~demand for our products~~respectively.

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

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

•Our ~~difficulties~~Objectiva software engineering team and supporting staff is located in a 12,000 square foot facility in Beijing, China. We are subject to a variety of risks associated with conducting operations in China, including those related to general economic conditions, regulatory changes, political unrest and potential reduced protection for our intellectual property rights. In addition to facing the difficulty of managing a large offshore organization, we must comply with a variety of laws and regulations, including trade restrictions, local labor ordinances, changes in tariff rates and import and export licensing requirements. Our success depends, in part, on our ~~international~~ability ~~operations;~~to anticipate these risks and manage these difficulties.

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

•Our ~~our~~business ~~limited~~is ~~experience~~dependent inon ~~localizing~~the ~~products~~market for ~~foreign~~dynamic ~~countries;~~content publishing software.

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

•25 ~~currency fluctuations;~~

• unexpected changes in regulatory requirements;

• tariffs and other trade barriers;

• potentially adverse tax consequences including restrictions on the repatriation of earnings; and

• the burdens of complying with a wide variety of foreign laws.

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

Our business is dependent on the market for document automation and content processing software.

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

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

Our ability to manage future change ~~will~~could affect our business.

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

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

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

Our business is dependent upon successfully protecting our proprietary rights.

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

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

2226

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

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

IfIntegration ~~any~~ of ~~these~~potential ~~factors occur, it could have a material adverse effect upon our~~ business, ~~operating~~or ~~results~~technology ~~and~~acquisitions ~~financial~~may ~~condition~~be difficult.

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

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

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

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

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Currency Exchange Risk

Our earnings and cash flows are subject to fluctuations due to changes in foreign currency exchange rates. To a certain extent, foreign currency exchange rate movements also affect our competitive position, as exchange rate changes may affect business practices and/or pricing strategies on non-U.S. based competitors. Our primary foreign currency risk exposures ~~exposure~~are is related to U.S. Dollar to Euro ~~conversions. Considering the anticipated cash flows from firm sales commitments~~ and ~~anticipated sales for the next quarter, a hypothetical 10% weakening or strengthening of the~~ U.S. Dollar ~~relative~~ to ~~all~~Chinese ~~other~~Yuan ~~currencies would not materially adversely affect expected third quarter 2004 earnings or cash flows~~conversions. ~~This~~Our ~~analysis~~subsidiary isin ~~dependent~~China onconducts ~~actual~~business ~~export sales~~primarily ~~during the next quarter occurring within 90% of budgeted forecasts. The effect of the hypothetical change~~ in ~~exchange rates ignores~~ the ~~affect~~Chinese ~~this movement may have on other variables including competitive risk~~Yuan. ~~If it were possible to~~ quantify this competitive impact, the results could well be different than the sensitivity effects described above. In addition, it is unlikely that all currencies would uniformly strengthen or weaken relative to the U.S. Dollar. In reality, some currencies may weaken while others may strengthen. Each month, we review our position for expected currency exchange rate movements.

Considering the anticipated cash flows from firm sales commitments and anticipated sales for the next quarter, a hypothetical 10% weakening of the U.S. Dollar relative to the Euro would not materially adversely affect expected fourth quarter 2006 earnings or cash flows. This analysis is dependent on actual export sales during the next quarter occurring within 90% of budgeted forecasts. The effect of the hypothetical change in exchange rates ignores the effect this movement may have on other variables including competitive risk. If it were possible to quantify this competitive impact, the results could well be different than the sensitivity effects described above. Each month, we review our position for expected currency exchange rate movements.

Interest Rate Risk

We are exposed to changes in interest rates primarily from our short-term available-for-sale investments. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of our interest sensitive financial instruments at ~~June~~ September 30, ~~2004~~2006. Declines in interest rates over time will, however, reduce our interest income.

ITEM 4.

CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

AsWe ofhave established and currently maintain disclosure controls and other procedures designed to ensure that information required to be disclosed in our reports filed under the ~~end~~Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the ~~period~~time ~~covered~~periods specified by the Securities and Exchange Commission’s rules and forms, and that such information ~~this~~is ~~quarterly~~accumulated ~~report~~and oncommunicated ~~Form~~to ~~10-Q~~our management, weincluding ~~evaluated~~our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. In designing and evaluating our disclosure controls and procedures, management recognized that any control or procedure, no matter how well designed and functioning, can provide only reasonable, but not absolute assurance of achieving the ~~effectiveness~~desired control objectives. In reaching a reasonable level of assurance, management applied its judgment in evaluating the ~~design~~cost-benefit relationship of possible controls and ~~operation~~procedures. Additionally, the design of ~~our~~any ~~disclosure~~system of controls is partially based upon certain assumptions of the likelihood of future events, and there can be no assurance that any design will achieve its stated goals under all potential future conditions. Over time, controls may become inadequate because of changing conditions, or the degree of compliance with policies and procedures may deteriorate. ~~That~~Consequently, ~~evaluation~~because ~~was~~of ~~performed~~the inherent limitations of a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

23As of the end of the period covered by this quarterly report on Form 10-Q, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures. That evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting him to material information relating to Document Sciences required to be included in our periodic SEC filings.

under the supervision and with the participation of our management, including our Chief Executive Officer, who also serves as our Chief Financial Officer. Based on that evaluation, our Chief Executive Officer concluded that our disclosure controls and procedures are effective in timely alerting him to material information relating to Document Sciences required to be included in our periodic SEC filings.

Changes in Internal Control over Financial Reporting

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

PART II. OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

We are not involved in any material legal proceedings.

ITEM 42. ~~SUBMISSION~~UNREGISTERED SALES OF ~~MATTERS~~EQUITY TOSECURITIES AAND ~~VOTE~~USE OF ~~SECURITY HOLDERS~~ PROCEEDS

AtThe following table provides information about purchases by the ~~Annual~~Company ~~Meeting~~during the fiscal quarter ended September 30, 2006 of ~~Stockholders~~equity ~~held~~securities onthat ~~April~~are ~~29,~~registered ~~2004,~~by the ~~following~~Company ~~individuals~~pursuant ~~were~~to ~~elected~~Section 12 toof the ~~Board~~Securities Exchange Act of ~~Directors:~~1934, as amended.

	Votes For	Votes Withheld
Period	Shares Purchased	Average Price		TotalNumber of SharesPurchased	Approximate Value of Shares that May Yet be Purchased (1)
John L. McGannon	2,669,059	121,715
July 1-30, 2006	—		—	—	$	1,000,000
Thomas L. Ringer	2,644,937	145,837
August 1-31, 2006	310	$	6.38	310	$	998,000
Barton L. Faber	2,612,617	178,157
September 1-30, 2006	2,452	$	6.18	2,452	$	982,900
Colin J. O’Brien	2,641,178	149,596
Total (as of September 30, 2006)	2,762	$	6.20	2,762	$	982,900

In(1) ~~addition~~On August 1, 2006, the ~~following~~Company ~~proposals were~~announced ~~voted~~that onthe atBoard ~~our~~of ~~Annual~~Directors ~~Meeting:~~had authorized it to repurchase up to $1,000,000 of its common stock in open market or in private transactions, subject to the Company’s assessment of market conditions and buying opportunities from time to time, and may, either in whole or in part, repurchase such stock through a trading plan pursuant to Rule 10b5-1 under the Securities Exchange Act of 1934. The Company expects to complete the repurchase program within one year, unless market conditions change significantly or the program is terminated sooner by the Board of Directors.

		Affirmative Votes	Negative Votes	Abstain	Broker Non-votes
1.	Proposal to approve our 2004 Stock Incentive Plan.	966,039	810,083	56,120	0
2.	Proposal to ratify the appointment of Ernst & Young LLP as independent auditors for the fiscal year ending December 31, 2004.	2,744,835	44,574	1,365	0

ITEM 6.

EXHIBITS AND REPORTS ON FORM 8-K

(a)

Exhibits.

Set forth below is a list of the exhibits included as part of this Quarterly Report.

ExhibitNumber		Exhibit Description
3.1 (1)		Amended and Restated Certificate of Incorporation.
3.1(1)		Amended and Restated Certificate of Incorporation.
3.2 (1)		Amended and Restated Bylaws.
3.2(1)		Amended and Restated Bylaws.
4.1 (2)		Specimen Stock Certificate.
4.1(2)		Specimen Stock Certificate.
4.2(3)		Rights Agreement between the Registrant and U.S. Stock Transfer Corporation, as Rights Agent, dated May 11, 2001, which includes as Exhibit A thereto the form of Rights Certificate to be Distributed to Holders of Rights after the Distribution Date (as that term is defined in the Rights Agreement).
10.1(2, #)		Form of Indemnity Agreement Between the Registrant and each of its Officers and Directors.
10.2(3)		Form of Software License and Software Support Agreement.

2429

4.2 (3)		Rights Agreement between the Registrant and U.S. Stock Transfer Corporation, as Rights Agent, dated May 11, 2001, which includes as Exhibit A thereto the form of Rights Certificate to be Distributed to Holders of Rights after the Distribution Date (as that term is defined in the Rights Agreement).
10.3(3)		Form of Professional Services Agreement.
10.1 (2, #)		Form of Indemnity Agreement Between the Registrant and each of its Officers and Directors.
10.4(3)		Form of Value Added Reseller Agreement.
10.2 (3)		Form of Software License and Software Support Agreement.
10.5(4, #)		1997 Employee Stock Purchase Plan, as Amended.
10.3 (3)		Form of Professional Services Agreement.
10.6(4)		Lease for Principal Facilities, as Amended, and Assignment of Lease.
10.4 (3)		Form of Value Added Reseller Agreement.
10.7(5)		Stock Repurchase Agreement Between Xerox and the Registrant.
10.5 (4, #)		1997 Employee Stock Purchase Plan, as Amended.
10.8(6)		Development Services and Referral Agreement Between Objectiva Software Solutions, Inc. and the Registrant dated January 16, 2004.
10.6 (4)		Lease for Principal Facilities, as Amended, and Assignment of Lease.
10.9(7)		2004 Stock Incentive Plan.
10.7 (5, #)		John L. McGannon Employment Agreement.
10.10(8)		Stock Purchase Agreement Between Objectiva Software Solutions, Inc. and the Registrant.
10.8 (6)		Stock Repurchase Agreement Between Xerox and the Registrant.
10.11(9)		Lease for New Principal Facilities.
10.9 (7)		Development Services and Referral Agreement Between Objectiva Software Solutions, Inc. and the Registrant dated January 16, 2004.
10.12(10, #)		Form of Stock Option Agreement Used in Connection with the Registrant’s 2004 Stock Incentive Plan.
10.10 (8)		2004 Stock Incentive Plan.
10.13(11, #)		John L. McGannon Employment Agreement.
10.11 (9)		Stock Purchase Agreement Between Objectiva Software Solutions, Inc. and the Registrant.
10.14(11, #)		Daniel Fregeau Employment Agreement.
10.12 (#, *)		Tao Ye Employment Agreement.
10.15(11, #)		Nasser Barghouti Employment Agreement.
10.13 (#, *)		Nasser Barghouti Employment Agreement.
10.16(11, #)		J. Douglas Winter Employment Agreement.
10.14 (#, *)		J. Douglas Winter Employment Agreement.
10.17(11, #)		Tao Ye Employment Agreement.
14.1 (7)		Code of Conduct.
10.18(12, #)		Edward Calnan Employment Agreement.
31 (*)		Certification of CEO/CFO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
14.1(7)		Code of Conduct.
32 (*)		Certification of CEO/CFO Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
31.1(*)		Certification of CEO Pursuant to Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2(*)		Certification of CFO Pursuant to Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1(*)		Certification of CEO Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2(*)		Certification of CFO Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(1)	Previously filed as an exhibit to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on May 20, 2004.

(2) Previously filed as exhibits to Registration Statement on Form S-1 Registration Number 333-06344 filed with the Securities and Exchange Commission on June 20, 1996.

(3)	Previously filed as exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.

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

(5) Previously filed as ~~exhibits~~an exhibit to the Registrant’s ~~Annual~~Current Report on Form 108-K ~~for~~filed with the ~~fiscal~~Securities ~~year~~and ~~ended~~Exchange ~~December~~Commission 31on November 20, ~~2000~~2003.

(6) Previously filed as anexhibits ~~exhibit~~ to the Registrant’s ~~Current~~Annual Report on Form 810-K ~~filed~~for ~~with~~ the ~~Securities~~fiscal ~~and~~year ~~Exchange~~ended ~~Commission~~December ~~on November 20~~31, 2003.

(7) Previously filed as ~~exhibits~~Appendix A to the Registrant’s ~~Annual~~Proxy ~~Report~~Statement on ~~Form~~Schedule ~~10-K~~14A ~~for~~filed with the ~~fiscal~~Securities ~~year~~and ~~ended~~Exchange ~~December~~Commission 31on March 29, ~~2003~~2004.

(8) Previously filed as ~~Appendix~~an Aexhibit to the Registrant’s ~~Proxy~~Current ~~Statement~~Report on ~~Schedule~~Form ~~14A~~8-K filed with the Securities and Exchange Commission on ~~March~~August 294, 2004.

(9) Previously filed as an exhibit to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on ~~August~~March 42, ~~2004~~2005.

(10)	Previously filed as exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004.

(11)	Previously filed as exhibits to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 14, 2005.

(12)	Previously filed as an exhibit to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 20, 2006.

(#)	Indicates management compensatory plan, contract or arrangement.

(*)	Filed herewith.

~~(b)~~30 ~~Reports on Form 8-K.~~

We filed or furnished the following Current Reports on Form 8-K during the second quarter of 2004:

On April 30, 2004, we furnished a Current Report on Form 8-K that included a press release issued on April 29, 2004, announcing our first quarter 2004 financial results.

On May 20, 2004, we filed a Current Report on Form 8-K to file our Amended and Restated Certificate of Incorporation, as filed with the Secretary of State of the State of Delaware on September 19, 1996, and our Amended and Restated Bylaws, as adopted by the Board of Directors of Document Sciences Corporation on March 29, 2004.

SIGNATURES

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

	~~DOCUMENT SCIENCES CORPORATION~~	DOCUMENT SCIENCES CORPORATION
Date: August 10, 2004	/s/ John L. McGannon
Date: November 10, 2006		/s/ John L. McGannon
	John L. McGannon
		John L. McGannon President and Chief Executive Officer (Principal Executive Officer)
	President, Chief Executive Officer and
		/s/ Todd W. Schmidt
	Chief Financial Officer
		Todd W. Schmidt Chief Financial Officer (Principal Financial Officer)
	(Principal Executive Officer and
	Principal Financial Officer)

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EXHIBIT INDEX

Exhibit Number	Exhibit Description	Page
ExhibitNumber	Exhibit Description	Page
3.1 (1)	Amended and Restated Certificate of Incorporation.
3.1(1)	Amended and Restated Certificate of Incorporation.
3.2 (1)	Amended and Restated Bylaws.
3.2(1)	Amended and Restated Bylaws.
4.1 (2)	Specimen Stock Certificate.
4.1(2)	Specimen Stock Certificate.
4.2 (3)	Rights Agreement between the Registrant and U.S. Stock Transfer Corporation, as Rights Agent, dated May 11, 2001, which includes as Exhibit A thereto the form of Rights Certificate to be Distributed to Holders of Rights after the Distribution Date (as that term is defined in the Rights Agreement).
4.2(3)	Rights Agreement between the Registrant and U.S. Stock Transfer Corporation, as Rights Agent, dated May 11, 2001, which includes as Exhibit A thereto the form of Rights Certificate to be Distributed to Holders of Rights after the Distribution Date (as that term is defined in the Rights Agreement).
10.1 (2, #)	Form of Indemnity Agreement Between the Registrant and each of its Officers and Directors.
10.1(2, #)	Form of Indemnity Agreement Between the Registrant and each of its Officers and Directors.
10.2 (3)	Form of Software License and Software Support Agreement.
10.2(3)	Form of Software License and Software Support Agreement.
10.3 (3)	Form of Professional Services Agreement.
10.3(3)	Form of Professional Services Agreement.
10.4 (3)	Form of Value Added Reseller Agreement.
10.4(3)	Form of Value Added Reseller Agreement.
10.5 (4, #)	1997 Employee Stock Purchase Plan, as Amended.
10.5(4, #)	1997 Employee Stock Purchase Plan, as Amended.
10.6 (4)	Lease for Principal Facilities, as Amended, and Assignment of Lease.
10.6(4)	Lease for Principal Facilities, as Amended, and Assignment of Lease.
10.7 (5, #)	John L. McGannon Employment Agreement.
10.7(5)	Stock Repurchase Agreement Between Xerox and the Registrant.
10.8 (6)	Stock Repurchase Agreement Between Xerox and the Registrant.
10.8(6)	Development Services and Referral Agreement Between Objectiva Software Solutions, Inc. and the Registrant dated January 16, 2004.
10.9 (7)	Development Services and Referral Agreement Between Objectiva Software Solutions, Inc. and the Registrant dated January 16, 2004.
10.9(7)	2004 Stock Incentive Plan.
10.10 (8)	2004 Stock Incentive Plan.
10.10(8)	Stock Purchase Agreement Between Objectiva Software Solutions, Inc. and the Registrant.
10.11 (9)	Stock Purchase Agreement Between Objectiva Software Solutions, Inc. and the Registrant.
10.11(9)	Lease for New Principal Facilities.
10.12 (#, *)	Tao Ye Employment Agreement.
10.12(10, #)	Form of Stock Option Agreement Used in Connection with the Registrant’s 2004 Stock Incentive Plan.
10.13 (#, *)	Nasser Barghouti Employment Agreement.
10.13(11, #)	John L. McGannon Employment Agreement.
10.14 (#, *)	J. Douglas Winter Employment Agreement.
10.14(11, #)	Daniel Fregeau Employment Agreement.
14.1 (7)	Code of Conduct.
10.15(11, #)	Nasser Barghouti Employment Agreement.
31 (*)	Certification of CEO/CFO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
10.16(11, #)	J. Douglas Winter Employment Agreement.
32 (*)	Certification of CEO/CFO Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
10.17(11, #)	Tao Ye Employment Agreement.
10.18(12, #)	Edward Calnan Employment Agreement.
14.1(7)	Code of Conduct.
31.1(*)	Certification of CEO Pursuant to Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2(*)	Certification of CFO Pursuant to Rules 13a-14 and 15d-14, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1(*)	Certification of CEO Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2(*)	Certification of CFO Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(1)	Previously filed as an exhibit to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on May 20, 2004.

(2) Previously filed as exhibits to Registration Statement on Form S-1 Registration Number 333-06344 filed with the Securities and Exchange Commission on June 20, 1996.

(3)	Previously filed as exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.

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

~~(7)~~32 ~~Previously filed as exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003.~~

(8)Table Previouslyof filed as Appendix A to the Registrant’s Proxy Statement on Schedule 14A filed with the Securities and Exchange Commission on March 29, 2004.Contents

(97) Previously filed as anAppendix ~~exhibit~~A to the Registrant’s ~~Current~~Proxy ~~Report~~Statement on ~~Form~~Schedule ~~8-K~~14A filed with the Securities and Exchange Commission on ~~August~~March 429, 2004.

(8)	Previously filed as an exhibit to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 4, 2004.

(9)	Previously filed as an exhibit to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on March 2, 2005.

(10)	Previously filed as exhibits to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004.

(11)	Previously filed as exhibits to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 14, 2005.

(12)	Previously filed as an exhibit to the Registrant’s Current Report on Form 8-K filed with the Securities and Exchange Commission on September 20, 2006.

(#)	Indicates management compensatory plan, contract or arrangement.

(*)	Filed herewith.

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(8)Table Previouslyof filed as Appendix A to the Registrant’s Proxy Statement on Schedule 14A filed with the Securities and Exchange Commission on March 29, 2004.Contents

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