**UNITED
      STATES SECURITIES AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**




**FORM
      10-Q**




**QUARTERLY
      REPORT UNDER SECTION 13 OR 15(d) OF**


**THE
      SECURITIES EXCHANGE ACT OF 1934**




**For
      the quarterly period ended**  **June
      30, 2007**




**1-32146**Commission
                file number







**DOCUMENT
                SECURITY SYSTEMS, INC.**(Exact
                name of registrant as specified in its
                charter)





**New
                York**
            
            **16-1229730**(State
                of incorporation)
            
            (IRS
                Employer Identification Number)





**28
                Main Street East, Suite 1525****Rochester,****NY****14614**(Address
                of principal executive office)





**(585)
                325-3610**(Registrant's
                telephone number)





**Indicate
      by check mark whether the registrant:**


(1)
      filed
      all reports required to be filed by Section 13 or 15(d) of the Exchange Act
      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
      xNo 
o**







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





Large
                accelerated filer o
            Accelerated
                filer o
            Non-accelerated
                filer x





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act)


**Yes
xNo  o**




**Applicable
      only to corporate issuers**





As
      of
      August 9, 2007 (the most recent practicable date), there were 13,676,030 shares
      of the issuer's Common Stock, $0.02 par value per share,
      outstanding.







**DOCUMENT
                SECURITY SYSTEMS, INC.**
              **FORM
                10-Q**
              **TABLE
                OF CONTENTS****PART
                I**
            
            **FINANCIAL
                INFORMATION**Item
                1
            
            Financial
                StatementsConsolidated
                Balance Sheets
            
            3Consolidated
                Statements of Operations
            
            4Consolidated
                Statements of Cash Flows
            
            5Notes
                to Financial Statements
            
            6Item
                2
            
            Management's
                Discussion and Analysis of Financial Condition and Results of
                Operations
            
            14Item
                3
            
            Quantitative
                and Qualitative Disclosures about Market Risk
            
            26Item
                4
            
            Controls
                and Procedures
            
            26**PART
                II**
            
            **OTHER
                INFORMATION**Item
                1
            
            Legal
                Proceedings
            
            27Item
              1a
            
            Risk
              Factors
            
            28Item
                2
            
            UnregisteredSales
                of Equity Securities and Use of Proceeds
            
            29Item
                3
            
            Defaults
                upon Senior Securities
            
            29Item
                4
            
            Submission
                of Matters to a Vote of Security Holders
            
            29Item
                5
            
            Other
                Information
            
            29Item
                6
            
            Exhibits
            
            29**SIGNATURES**




2




**PART
      I**






**FINANCIAL
      INFORMATION**


ITEM
      1 -
      FINANCIAL STATEMENTS




**DOCUMENT
                  SECURITY SYSTEMS, INC.  AND
                  SUBSIDIARIES****Consolidated
                  Balance Sheets**
 **June
                    30,**
                ****
                **December
                    31,**
                ********
                ****
                **2007**
                ****
                **2006**
                ********
                ****
                **(unaudited)**
                ****
                **(audited)****ASSETS****Current
                    assets:**Cash
                    and cash equivalents
                
                $
                3,251,094
                
                $
                5,802,615Accounts
                    receivable, net of allowance of $39,000 ($74,000 -2006)
                
                
                693,797
                
                
                618,622Inventory
                
                
                301,159
                
                
                239,416Prepaid
                    expenses and other current assets
                
                
                397,152
                
                
                224,782Assets
                    held for sale
                
                
                38,000
                
                
                -**Total
                    current assets**
                
                
                4,681,202
                
                
                6,885,435**Fixed
                    assets, net**
                
                
                578,919
                
                
                637,732**Other
                    assets**
                
                
                146,935
                
                
                156,734**Goodwill**
                
                
                1,396,734
                
                
                1,396,734**Other
                    intangible assets, net**
                
                
                6,773,529
                
                
                5,389,564**Total
                    Assets**
                
                $
                13,577,319
                
                $
                14,466,199**LIABILITIES
                    AND STOCKHOLDERS' EQUITY****Current
                    liabilities:**Accounts
                    payable
                
                $
                1,595,937
                
                $
                1,283,503Accrued
                    expenses & other current liabilities
                
                
                540,007
                
                
                877,261Deferred
                    revenue
                
                
                677,827
                
                
                564,439Current
                    portion of capital lease obligations
                
                
                31,336
                
                
                34,814Total
                    current liabilities
                
                
                2,845,107
                
                
                2,760,017**Long-term
                    capital lease obligations**
                
                
                35,780
                
                
                50,417**Long-term
                    deferred revenue**
                
                
                189,188
                
                
                466,875**Commitments
                    and contingencies (see Note 8)****Stockholders'
                    equity**Common
                    stock, $.02 par value;200,000,000
                    shares authorized, 13,676,030 shares issued and outstanding (13,544,724
                    in
                    2006)
                
                
                273,521
                
                
                270,894Additional
                    paid-in capital
                
                
                30,371,801
                
                
                28,145,793Accumulated
                    deficit
                
                
                (20,138,078
                )
                
                (17,227,797
                )Total
                    stockholders' equity
                
                
                10,507,244
                
                
                11,188,890Total
                    Liabilities and Stockholders' Equity
                
                $
                13,577,319
                
                $
                14,466,199See
                    accompanying notes


3


**DOCUMENT
                  SECURITY SYSTEMS, INC. AND
                  SUBSIDIARIES****Consolidated
                  Statements of
                  Operations****(unaudited)****Three
                  Months Ended**
              
              **Six
                  Months****Ended****June
                  30,**
              
              **June
                  30,**
              
              **June
                  30,**
              
              **June
                  30,****2007**
              
              **2006**
              
              **2007**
              
              **2006**RevenueSecurity
                  printing
              
              $
              826,734
              
              $
              970,572
              
              $
              1,818,382
              
              $
              1,462,655Royalties
              
              
              294,157
              
              
              60,081
              
              
              592,953
              
              
              96,695Digital
                  solutions
              
              
              11,969
              
              
              -
              
              
              174,771
              
              
              -Legal
                  products
              
              
              161,663
              
              
              145,028
              
              
              337,345
              
              
              315,086Total
                  Revenue
              
              
              1,294,523
              
              
              1,175,681
              
              
              2,923,451
              
              
              1,874,436Costs
                  of revenueSecurity
                  printing
              
              
              547,575
              
              
              562,548
              
              
              1,055,538
              
              
              889,854Digital
                  solutions
              
              
              3,507
              
              
              -
              
              
              37,014
              
              
              -Legal
                  products
              
              
              90,593
              
              
              76,791
              
              
              193,767
              
              
              179,508Total
                  costs of revenue
              
              
              641,675
              
              
              639,339
              
              
              1,286,319
              
              
              1,069,362**Gross
                  profit**
              
              
              652,848
              
              
              536,342
              
              
              1,637,132
              
              
              805,074**Operating
                  expenses:**Selling,
                  general and administrative
              
              
              1,811,586
              
              
              1,370,558
              
              
              3,608,732
              
              
              2,311,953Research
                  and development
              
              
              108,889
              
              
              96,282
              
              
              203,297
              
              
              168,884Amortization
                  of intangibles
              
              
              433,090
              
              
              268,275
              
              
              778,729
              
              
              488,275Operating expenses
              
              
              2,353,565
              
              
              1,735,115
              
              
              4,590,758
              
              
              2,969,112**Operating
                  loss**
              
              
              (1,700,717
              )
              
              (1,198,773
              )
              
              (2,953,626
              )
              
              (2,164,038
              )**Other
                  income (expense):**Interest
                  income
              
              
              34,179
              
              
              17,242
              
              
              74,987
              
              
              44,138Gain/(loss)
                  on foreign currency adjustments
              
              
              (945
              )
              
              -
              
              
              (4,291
              )
              
              -Interest
                  expense
              
              
              (1,296
              )
              
              (5,381
              )
              
              (2,449
              )
              
              (10,844
              )**Loss
                  before income taxes and discontinued operations**
              
              
              (1,668,779
              )
              
              (1,186,912
              )
              
              (2,885,379
              )
              
              (2,130,744
              )Income
                  taxes
              
              
              4,738
              
              
              -
              
              
              9,476
              
              
              -**Loss
                  from continuing operations**
              
              
              (1,673,517
              )
              
              (1,186,912
              )
              
              (2,894,855
              )
              
              (2,130,744
              )Loss
                  from discontinued operations (Note 5)
              
              
              (26,821
              )
              
              (19,625
              )
              
              (15,426
              )
              
              (70,355
              )**Net
                  loss**
              
              $
              (1,700,338
              )
              $
              (1,206,537
              )
              $
              (2,910,281
              )
              $
              (2,201,099
              )**Net
                  loss per share -basic and diluted:**Continuing
                  operations
              
              $
              (0.12
              )
              $
              (0.09
              )
              $
              (0.21
              )
              $
              (0.17
              )Discontinued
                  operations
              
              
              0.00
              
              
              0.00
              
              
              0.00
              
              
              0.00Net
                  Loss
              
              $
              (0.12
              )
              $
              (0.09
              )
              $
              (0.21
              )
              $
              (0.17
              )**Weighted
                  average common shares outstanding, basic and
                  diluted**
              
              
              13,625,408
              
              
              12,850,491
              
              
              13,605,327
              
              
              12,824,935






See
      accompanying notes




4


**DOCUMENT
          SECURITY SYSTEMS, INC. AND SUBSIDIARIES**
  **Consolidated
            Statements of Cash Flows**
 **For
              the Six Months Ended June 30,**
  **2007**
              
              
              **2006****(unaudited)**
              
              
              **(unaudited**
              **)****Cash
                  flows from operating activities:**Net
                  loss
              $
              (2,910,281
              )
              $
              (2,201,099
              )Adjustments
                  to reconcile net loss to net cash used by operating
                  activities:Depreciation and amortization expense
              
              870,247
              
              
              607,410Stock
                  based compensation
              
              633,040
              
              
              280,450(Increase) decrease in assets:Accounts receivable
              
              (75,175
              )
              
              (362,012
              )Inventory
              
              (61,743
              )
              
              (57,600
              )Prepaid expenses and other assets
              
              (238,656
              )
              
              (8,385
              )Increase (decrease) in liabilities:Accounts payable
              
              360,023
              
              
              293,126Accrued
                  expenses
              
              (49,754
              )
              
              (69,096
              )Deferred
                  revenue
              
              (164,299
              )
              
              -Net
                  cash used by operating activities
              
              (1,636,598
              )
              
              (1,517,206
              )**Cash
                  flows from investing activities:**Purchase
                  of fixed assets
              
              (70,705
              )
              
              (69,887
              )Acquisition
                  of business
              
              -
              
              
              (1,301,670
              )Increase
                  in other intangible assets
              
              (661,709
              )
              
              (77,841
              )Net
                  cash used by investing activities
              
              (732,414
              )
              
              (1,449,398
              )**Cash
                  flows from financing activities:**Repayment of long-term debt
              
              -
              
              
              (25,075
              )Repayment
                  of capital lease obligations
              
              (18,115
              )
              
              (16,333
              )Payment
                  of stock issuance costs
              
              (519,619
              )
              
              -Issuance
                  of common stock, net
              
              355,225
              
              
              757,770Net
                  cash (used) provided by financing activities
              
              (182,509
              )
              
              716,362**Net
                  increase (decrease) in cash and cash equivalents**
              
              (2,551,521
              )
              
              (2,250,242
              )**Cash
                  and cash equivalents beginning of period**
              
              5,802,615
              
              
              3,953,482**Cash
                  and cash equivalents end of period**
              $
              3,251,094
              
              $
              1,703,240




See
      accompanying notes.


5




**DOCUMENT
      SECURITY SYSTEMS, INC.**


**NOTES
      TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**


**June
      30, 2007**


**(Unaudited)**




**1.    
      Basis of Presentation and Significant Accounting Policies**




The
      accompanying unaudited condensed consolidated financial statements have been
      prepared in accordance with U.S. generally accepted accounting principles for
      interim financial information and with the instructions to Form 10-Q and Article
      10 of Regulation S-X. Accordingly, these statements do not include all of the
      information and footnotes required by U.S. generally accepted accounting
      principles for complete financial statements. In the opinion of management,
      the
      accompanying balance sheets and related interim statements of operations and
      cash flows include all adjustments, consisting only of normal recurring items,
      necessary for their fair presentation in accordance with U.S. generally accepted
      accounting principles. All significant intercompany transactions have been
      eliminated.





Interim
      results are not necessarily indicative of results expected for a full year.
      For
      further information regarding Document Security Systems, Inc (the “Company”)
      accounting policies, refer to the audited consolidated financial statements
      and
      footnotes thereto included in the Company's Form 10-K for the fiscal year ended
      December 31, 2006.





The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States requires management to make estimates
      and assumptions that affect the reported amounts of assets and liabilities
      and
      disclosure of contingent assets and liabilities at the date of the financial
      statements and the reported amounts of revenues and expenses during the
      reporting period. Actual results could differ materially from those estimates
      and assumptions.





***Revenue
      Recognition*** - Sales
      of
      security and other printing products, and legal products are recognized when
      a
      product or service is delivered, shipped or provided to the customer and all
      material conditions relating to the sale have been substantially performed.




We
      recognize revenue from technology licenses over the term of license agreements
      once all the following criteria for revenue recognition have been met: (1)
      persuasive evidence of an agreement exists; (2) the right and ability to use
      the
      product or technology has been rendered; (3) the fee is fixed and determinable
      and not subject to refund or adjustment; and (4) collection of the amounts
      due
      is reasonably assured.




For
      digital solutions sales, revenue is recognized in accordance with the American
      Institute of Certified Public Accountant's Statement of Position (SOP) No.
      97-2,
      "Software Revenue Recognition," as modified by SOP No. 98-9, "Modification
      of
      SOP No. 97-2, Software Revenue Recognition with Respect to Certain Transactions"
      and Staff Accounting Bulletin (SAB) No. 104, "Revenue Recognition." Accordingly,
      revenue is recognized when all of the following conditions are satisfied: (1)
      there is persuasive evidence of an arrangement; (2) the service or product
      has
      been provided to the customer; (3) the amount of fees to be paid by the customer
      is fixed or determinable (4) the collection of our fees is reasonably
      assured.




6




We
      also
      enter into arrangements under which we provide hosted software applications.
      We
      recognize revenue for these arrangements based on the provisions of EITF No.
      00-3, Application of AICPA SOP 97-2 to Arrangements That Include the Right
      to
      Use Software Stored on Another Entity’s Hardware (“EITF 00-3”), and the
      provisions of Staff Accounting Bulletin No. 104, “Revenue Recognition in
      Financial Statements”, when there is persuasive evidence of an arrangement,
      collection of the resulting receivable is probable, the fee is fixed or
      determinable and acceptance has occurred. Our revenues related to these
      arrangements consist of system implementation service fees and software
      subscription fees. We have determined that the system implementation services
      represent set-up services that do not qualify as separate units of accounting
      from the software subscriptions as the customer would not purchase these
      services without the purchase of the software subscription. As a result, we
      recognize system implementation fees ratably over a period of time from when
      the
      core system implementation services are completed and accepted by the customer
      over the remaining customer relationship life, which we have determined is
      the
      contractual life of the customer’s subscription agreement. We recognize software
      subscription fees, which typically commence upon completion of the related
      system implementation, ratably over the applicable subscription period. Amounts
      billed and/or collected prior to satisfying our revenue recognition policy
      are
      reflected as deferred revenue.




***Share-Based
      Payments -*** The
      Company measures compensation expense for its non-employee stock-based
      compensation under the Financial Accounting Standards Board (FASB) Emerging
      Issues Task Force (EITF) Issue No. 96-18, "Accounting for Equity Instruments
      that are Issued to Other Than Employees for Acquiring, or in Conjunction with
      Selling, Goods or Services". The EITF applies when the fair value of the equity
      instrument issued is used to measure the transaction, as this is more reliable
      than the fair value of the services received. The fair value is determined
      based
      on the measurement date which is the date that the commitment for performance
      by
      the counterparty has been reached or the counterparty's performance is complete.
      Prior to the measurement date, the fair value is determined at each reporting
      date and used as an estimate of the expected fair value to record compensation
      as the services are being performed and the instruments are being earned.




***Recent
      Accounting Pronouncements*** -In July
      2006, the Financial Accounting Standards Board (“FASB”) issued Financial
      Interpretation 48, Accounting for Uncertainty in Income Taxes - an
      interpretation of FASB Statement 109 (“FIN 48”). FIN 48 clarifies the
      accounting for uncertainty in income taxes recognized in the financial
      statements in accordance with SFAS 109, Accounting for Income Taxes and requires
      a two-step approach to evaluate tax positions and determine if they should
      be
      recognized in the financial statements. The two-step approach involves
      recognizing any tax positions that are “more likely than not” to occur and then
      measuring those positions to determine if they are recognizable in the financial
      statements. The interpretation is effective for fiscal years beginning after
      December 15, 2006. We adopted FIN 48 on January 1, 2007. (See Note
      7)





7


**2.
      Inventory**




Inventory
      consisted of the following:




**June
                  30,**
              
              
              **December
                  31,****2007**
              
              
              **2006****(unaudited)**
              
              
              **(audited)**Finished
                  Goods
              
              
              $
              193,658
              
              $
              145,206Materials
              
              
              
              107,501
              
              
              94,210$
              301,159
              
              $
              239,416






**3.    
      Other Intangible Assets**




Other
      intangible assets are comprised of the following:





**June
                  30, 2007**
              
              **December
                  31, 2006****Useful
                  Life**
              
              **Gross
                  Carrying Amount**
              
              **Accumulated
                  Amortizaton**
              
              **Net
                  Carrying Amount**
              
              **Gross
                  Carrying Amount**
              
              **Accumulated
                  Amortizaton**
              
              **Net
                  Carrying Amount**Royalty
                  rights
              
              
              5
                  years
              
              $
              90,000
              
              $
              63,000
              
              $
              27,000
              
              $
              90,000
              
              $
              54,000
              
              $
              36,000Other
                  intangibles
              
              
              5
                  years
              
              
              1,187,595
              
              
              219,474
              
              
              968,121
              
              
              666,300
              
              
              149,036
              
              
              517,264Patent
                  and contractual rights
              
              
              Varied
                  (1
              )
              
              7,853,800
              
              
              2,075,392
              
              
              5,778,408
              
              
              6,212,400
              
              
              1,376,100
              
              
              4,836,300**$**
              **9,131,395**
              ****
              **$**
              **2,357,866**
              ****
              **$**
              **6,773,529**
              ****
              **$**
              **6,968,700**
              ****
              **$**
              **1,579,136**
              ****
              **$**
              **5,389,564**
  (1)-
          patent rights are amortized over their expected useful life which is generally
          the legal life of the patent. As of June 30, 2007 the weighted average
          remaining
          useful life of these assets in service was 4.2 years.


**4.    
      Shareholders’ Equity**




***Stock
      Issued for Patent Defense Costs -*** On
      November 14, 2006, the Company entered into an agreement with McDermott Will
      & Emery LLP (“MWE”), its lead counsel on its European Central Bank (“ECB
      Litigation”) patent infringement and related cases. The agreement with MWE
      allows the Company to use its common stock with a value not to exceed $1.2
      million to eliminate the Company’s cash requirements for MWE’s legal fees
      related to the ECB patent validity litigation. During the six months ended
      June
      30, 2007, 60,866 restricted common shares were issued to MWE to pay for
      approximately $746,000 of legal fees incurred through June 30, 2007.





***Stock
      Issued in Private Placement -*** On
      January 22, 2007, the Company sold 6 units at a price of $50,000 per unit for
      gross cash proceeds of $300,000, consisting of 35,280 unregistered shares of
      our
      common stock and five-year warrants to purchase up to an aggregate of 17,640
      shares of our common stock, at an exercise price of $11.75 per share. The fair
      market value of these warrants was determined using the Black Scholes option
      pricing model at $107,000. The Company incurred placement agent fees associated
      with the offering equal to 9% commissions, or $27,000. In addition, during
      the
      six months ended June 30, 2007, the Company paid $470,000 of private placement
      fees related to an offering that occurred during 2006.




***Restricted
      Stock -*** On
      May 3,
      2007, the Company granted 25,000 restricted shares that will vest over two
      years
      to a member of its senior management team. These shares were valued at the
      fair
      value on the grant date at approximately $312,000. Also on May 3, 2007, the
      Company granted 445,000 restricted shares of common stock pursuant to the
      Company’s 2004 Employee Stock Option Plan to certain members of senior
      management. These shares only vest upon the occurrence of certain events over
      the next 5 years, which include a change of control or other merger or
      acquisition of the Company, the achievement of certain financial goals,
      including among other things a successful result of the Company’s patent
      infringement lawsuit against the European Central Bank. These shares, if vested,
      would result in the recording of stock based compensation expense of
      approximately $5,563,000 over the period beginning when any of the contingent
      vesting events is deemed to be probable over the expected requisite service
      period.




8




***Stock
      Options*** - On
      March 26, 2007, the Company issued 150,000 options to purchase the Company’s
      shares at $10.89 per share to a third party consultant that vest over a 3 years,
      subject to certain vesting acceleration provisions. During the six months ended
      June 30, 2007, the Company recognized approximately $93,000 of compensation
      expense associated with these options. The Company records stock based payment
      expense related to these options at the then current fair value of at each
      reporting date as the services are performed in accordance with EITF 96-18.




During
      2007, the Company has issued 157,500 options to purchase the Company’s shares at
      exercise prices ranging from $11.10 to $12.50 per share to employees and
      directors that vest between 1 to 2 years. During the six months ended June
      30,
      2007, the Company recognized approximately $107,000 of compensation expense
      associated with these options. The Company values stock options utilizing the
      Black Scholes option pricing model. The Company records stock based payment
      expense related to these options based on the grant date fair value in
      accordance with FASB 123R.




In
      June 2007, the Company's Board of Directors approved
      the addition of 500,000 shares of Company Stock authorized to be issued under
      the Company's 2004 Employee's Stock Option Plan.  The approval and any
      grants covered under these shares are subject to shareholder
      approval.





***Stock
      Warrants*** - During
      the six months ended June 30, 2007, the Company received approximately $55,000
      in proceeds from the exercise of warrants to purchase 12,125 shares of our
      common stock.




On
      June
      13, 2007, the Company entered into an agreement with International Barcode
      Technologies, also known as BTI, to extend the expiration date of warrants
      to
      purchase 500,000 shares of common stock of the Company at a purchase price
      of
      $10.00 per share that the Company previously issued to BTI with an original
      expiration date of  June 16, 2007 to December 31, 2007 in exchange for
      which BTI has agreed to provide the Company with a license to market and produce
      BTI’s advanced barcode technologies in the United States for five years. The
      value of the extension of the warrant was determined to be approximately
      $521,000 using the Black-Scholes option pricing model. This amount was recorded
      as an other intangible asset and will be amortized over the expected useful
      life
      of the license agreement of five years.




***Stock-Based
      Compensation*** **-** Stock-based
      compensation includes expense charges for all stock-based awards to employees,
      directors and consultants. Such awards include option grants, warrant grants,
      and restricted stock awards. During the three and six months ended June 30,
      2007, the Company recognized approximately $297,000 and $633,000, respectively
      ($253,000 and $280,000- 2006, respectively) in stock-based
      compensation.





As
      of
      June 30, 2007, there was approximately $8.9 million of total unrecognized
      compensation costs related to non-vested options and restricted stock granted
      under the Company’s stock option plans, the cost of which will be recognized if
      earned over a period not to exceed 5 years. The total fair value of options
      and
      restricted shares that vested during the six-month period ended June 30, 2007
      was $318,000 ($59,000 - 2006).




9




**5.    
      Discontinued Operations**





In
      June
      2007, the Company’s Board of Directors approved a plan to sell various assets
      relating to its retail copying and quickprinting operations, a component of
      its
      Document Security and Production segment. On July 19, 2007, the Company entered
      into an agreement to sell certain assets and the operations of the
      division.  The sale includes fixed assets with a net book value of
      approximately $38,000. The Company expects to finalize the sale during the
      third
      quarter of 2007 and expects that the gain from the sale to not be significant.
      In accordance with SFAS 144, the disposal of assets constitute a component
      of
      the entity and have been accounted for as discontinued operation and
      accordingly, the assets have been segregated from continuing operations in
      the
      accompanying balance sheet and classified as assets held for sale. The operating
      results relating to these assets held for sale are segregated and reported
      as
      discontinued operations in the accompanying 2007 and 2006 consolidated statement
      of operations. The results of operations directly attributed to the division’s
      operations that have been reclassified from continuing operations are as
      follows:





**Three
                  Months Ended**
              
              **Six
                  Months Ended****June
                  30,**
              
              
              **June
                  30,**
              
              
              **June
                  30,**
              
              
              **June
                  30,****2007**
              
              
              **2006**
              
              
              **2007**
              
              
              **2006**Revenues
              
              $
              98,786
              
              $
              134,124
              
              $
              219,491
              
              $
              298,079Cost
                  of sales
              
              
              54,229
              
              
              79,304
              
              
              101,804
              
              
              195,478Operating
                  expenses
              
              
              71,378
              
              
              74,445
              
              
              133,113
              
              
              172,956Loss
                  from discontinued operations
              
              $
              (26,821
              )
              $
              (19,625
              )
              $
              (15,426
              )
              $
              (70,355
              )





**6.    
      Earnings Per Share**





Basic earnings per share is computed by dividing net income by the
      weighted-average number of common shares outstanding for the period. Diluted
      earnings per share is computed by including the number of additional shares
      that
      would have been outstanding if dilutive potential shares had been issued. In
      periods of losses, diluted loss per share is computed on the same basis as
      basic
      loss per share as the inclusion of any other potential shares outstanding would
      be anti-dilutive. If
      the
      Company had generated earnings during the six-month period ended June 30, 2007,
      693,671 (904,496- 2006) common equivalent shares would have been added to the
      weighted average shares outstanding to compute the diluted weighted average
      shares outstanding.





**7.    
      Income Taxes**




We
      adopted the Financial Accounting Standard Board’s Interpretation No. 48,
      Accounting for Income Tax Uncertainties (“FIN 48”), on January 1, 2007. 
FIN 48 clarifies the accounting for uncertain income tax positions recognized
      in
      financial statements and requires the impact of a tax position to be recognized
      in the financial statements if that position is more likely than not of being
      sustained by the taxing authority.  As of January 1, 2007, there were no
      unrecognized tax positions. Our policy is to recognize interest and penalties
      on
      unrecognized tax positions in provision for income taxes in the consolidated
      statements of operations.  As of June 30, 2007, the Company has no accrued
      interest or penalties related to uncertain tax positions. Tax years beginning
      in
      2003 are subject to examination by taxing authorities, although net operating
      loss and credit carryforwards from all years are subject to examinations and
      adjustments for at least three years following the year in which the attributes
      are used.




10




**8.    
      Commitments and Contingencies**




*Operating
      Lease*




On
      May
      19, 2007, the Company entered in to a seven-year operating lease for an
      approximately 25,000 square foot production facility in Brisbane, California.
      Pursuant to the terms of the lease, the Company will be responsible for future
      minimum lease commitments as follows:




**2007**
              $
                  109,058**2008**
              $
                  241,217**2009**
              $
                  248,454**2010**
              $
                  255,907**2011**
              $
                  263,585**2012**
              $
                  271,492**Thereafter**
              $
                  433,535$
                  1,823,248






*Legal
      Matters*




Pursuant
      to an agreement made in December 2004, the Company is required to share the
      economic benefit derived from settlements, licenses or subsequent business
      arrangements that the Company obtains from any infringer of patents formerly
      owned by the Wicker Family. For infringement matters involving certain U.S.
      patents, the Company will be required to disburse 30% of the settlement
      proceeds. For infringement matters involving certain foreign patents, including
      the lawsuit against the European Central Bank described in Part II Item 1 -
      Legal Proceedings, the Company will be required to disburse 14% of the
      settlement proceeds. These payments do not apply to licenses or royalties to
      patents that the Company has developed or obtained from persons other than
      the
      Wicker Family. As of June 30, 2007, there have been no settlement amounts
      related to these agreements.




The
      Company is engaged in a patent dispute with the European Central Bank (see
      Part
      II Item 1- Legal Proceedings). The patent dispute includes patent validity
      suits
      that the Company is engaged in nine European national courts. To date, the
      Company has been able to significantly mitigate the cash outlays required for
      legal costs associated with the dispute by negotiating legal fee caps and using
      shares of its common stock for payments. However, the Company will be required
      to pay additional legal costs and related fees, each of which may be
      significant, in each of the nine validity suits. In addition, each party to
      the
      lawsuit will typically be responsible for reimbursements to the other party
      for
      a portion of the winning party’s legal fees related to individual rulings each
      of the various cases. To date, the Company has received a favorable ruling
      regarding validity in the German Court and an unfavorable ruling regarding
      validity in the English Court. In the English Court, the Company was ordered
      to
      pay 180,000 pounds (USD $365,000) to the ECB for legal cost reimbursement,
      of
      which 90,000 pounds (USD $182,000) was paid on April 4, 2007 and the remaining
      90,000 pounds (USD 182,000) is included in accrued expenses at June 30, 2007.
      The Company is awaiting a determination by the German Court on the amount that
      it will receive from the ECB for reimbursement of the Company’s legal costs. As
      the validity cases and the infringement case ensue, the Company will be required
      to utilize outside counsel in each foreign court and could continue to receive
      adverse rulings which will require the Company to reimburse the ECB legal costs
      which would likely be significant, with current estimates of the potential
      remaining litigation costs relating to patent validity, not including costs
      covered by fees caps negotiated with its lead counsel, of between $1,000,000
      to
      $2,000,000. The payment of these amounts and the payment of additional legal
      fees could adversely affect the Company’s financial position and would likely
      require the Company to raise additional funds, which may not be on terms
      favorable to the Company.




11




In
      May
      2005, the Company made an agreement with its legal counsel in charge of the
      Company’s patent infringement litigation in the Court of First Instance with the
      European Central Bank which capped its fees for all matters associated with
      that
      infringement litigation at $540,000 plus expenses, and a $150,000 contingent
      payment upon a successful ruling or settlement on the Company’s behalf in that
      litigation. The Company will record the $150,000 in the period in which the
      Company has determined that a successful ruling or settlement is probable.




In
      addition to the foregoing, we are subject to other legal proceedings that have
      arisen in the ordinary course of business and have not been finally adjudicated.
      Although there can be no assurance in this regard, in the opinion of management,
      none of the legal proceedings to which we are a party, whether discussed herein
      or otherwise, will have a material adverse effect on our results of operations,
      cash flows or our financial condition.




**9.      
      Supplemental Cash Flow Information**




During
      the six months ended June 30, 2007, the Company issued 60,866 shares of Common
      Stock valued at approximately $746,000 in conjunction with the payment of legal
      expenses which were capitalized as other intangible assets. In addition, the
      Company extended the term of previously issued warrants to a warrant holder
      in
      exchange for a license valued at approximately $521,000. During the six months
      ended June 30, 2006, the Company issued 18,704 shares of Common Stock valued
      at
      $250,000 in conjunction with the acquisition of Plastic Printing
      Professionals.




**10.    
      Segment Information**




The Company's businesses are organized, managed and internally reported as
      four
      operating segments. Three of these operating segments, Document Security
      Systems, Plastic Printing Professionals and Patrick Printing, respectively,
      are
      engaged in various aspects of developing and applying printing technologies
      and
      procedures to produce, or allow others to produce, documents with a wide range
      of features, including the Company’s patented technologies and trade secrets.
      For the purposes of providing segment information, these three operating
      segments have been aggregated into one reportable segment in accordance with
      Financial Accounting Standards Board (“FASB”) Statement No. 131- *“Disclosures
      about Segments of an Enterprise and Related Information”* .
      A
      summary of the two segments is as follows:




**Document**
              **Security
                and**
              **Production**
            License,
                manufacture and sale of document security technologies, including
                digital
                security print solutions and secure printed products at Document
                Security
                Systems and Plastic Printing Professionals divisions. In July 2007,
                the
                Company entered into an agreement to sell the assets of its retail
                printing and copying division, a former component of the Document
                Security
                and Production segment, to an unrelated third party as this operation
                was
                not critical to the Company’s core operations. The results of this
                division are reported as discontinued operations and are not a component
                of these segment results (See Note 5).**Legal
                  Supplies**
            Sale
                of specialty legal supplies, primarily to lawyers and law firms located
                throughout the United States as
                Legalstore.com.





12




Approximate information concerning the operations by reportable segment for
      the
      three and six months ended June 30, 2007 and 2006 is as follows. The Company
      relies on intersegment cooperation and management does not represent that these
      segments, if operated independently, would report the results contained herein:




****
              
              ****
              **Document**
              ****
              
              ****
              ****
              ********
              ****
              ****
              ****
              **Security
                  &**
              ****
              ****
              ****
              ****
              ******3
                  months ended June 30, 2007:**
              ****
              **Legal
                  Supplies**
              ****
              **Production**
              ****
              **Corporate**
              ****
              **Total**Revenues
                  from external customers
              
              $
              162,000
              
              $
              1,133,000
              
              $
              -
              
              $
              1,295,000Depreciation
                  and amortization
              
              
              3,000
              
              
              459,000
              
              
              17,000
              
              
              479,000Segment
                  profit or (loss) from continuing operations
              
              
              3,000
              
              
              (945,000
              )
              
              (732,000
              )
              
              (1,674,000
              )**3
                  months ended June 30, 2006:**Revenues
                  from external customers
              
              $
              145,000
              
              $
              1,031,000
              
              $
              -
              
              $
              1,176,000Depreciation
                  and amortization
              
              
              1,000
              
              
              302,000
              
              
              28,000
              
              
              331,000Segment
                  profit or (loss) from continuing operations
              
              
              (18,000
              )
              
              (625,000
              )
              
              (544,000
              )
              
              (1,187,000
              )
  ****
              
              ****
              **Document**
              ****
              
              ****
              ****
              ********
              ****
              ****
              ****
              **Security
                  &**
              ****
              ****
              ****
              ****
              ******6
                  months ended June 30, 2007:**
              ****
              **Legal
                  Supplies**
              ****
              **Production**
              ****
              **Corporate**
              ****
              **Total**Revenues
                  from external customers
              
              $
              337,000
              
              $
              2,586,000
              
              $
              -
              
              $
              2,923,000Depreciation
                  and amortization
              
              
              6,000
              
              
              835,000
              
              
              29,000
              
              
              870,000Segment
                  profit or (loss) from continuing operations
              
              
              2,000
              
              
              (1,419,000
              )
              
              (1,478,000
              )
              
              (2,895,000
              )**6
                  months ended June 30, 2006:**Revenues
                  from external customers
              
              $
              315,000
              
              $
              1,559,000
              
              $
              -
              
              $
              1,874,000Depreciation
                  and amortization
              
              
              2,000
              
              
              549,000
              
              
              56,000
              
              
              607,000Segment
                  profit or (loss) from continuing operations
              
              
              (30,000
              )
              
              (1,074,000
              )
              
              (1,027,000
              )
              
              (2,131,000
              )







13







**ITEM
      2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
      OF
      OPERATIONS**




***FORWARD-LOOKING
      STATEMENTS***




Certain
      statements contained herein constitute “forward-looking statements” within the
      meaning of the Private Securities Litigation Reform Act of 1995 (the “1995
      Reform Act”). Document Security Systems, Inc. desires to avail itself of certain
“safe harbor” provisions of the 1995 Reform Act and is therefore including this
      special note to enable us to do so. Except for the historical information
      contained herein, this report contains forward-looking statements (identified
      by
      the words "estimate," "project," "anticipate," "plan," "expect," "intend,"
      "believe," "hope," "strategy" and similar expressions), which are based on
      our
      current expectations and speak only as of the date made. These forward-looking
      statements are subject to various risks, uncertainties and factors, including,
      without limitation, those contained in our Form 10-K for the year ended December
      31, 2006 and those described herein that could cause actual results to differ
      materially from the results anticipated in the forward-looking
      statements.




**Overview**




Document
      Security Systems, Inc. (referred to in this report as “Document Security,” “we,”
“us,” “our” or “Company”) markets and sells products designed to protect
      valuable information from unauthorized scanning, copying, and digital imaging.
      We develop sophisticated security technologies that are applied during the
      normal printing process and by all printing methods including traditional
      offset, gravure, flexo, digital or via the internet on paper, plastic, or
      packaging. We believe we are a leader of customized document protection
      solutions for companies and governments worldwide. We hold seven patents that
      protect our technology and have over a dozen patents in process or pending.
      Our
      technologies and products are used by federal, state and local governments,
      law
      enforcement agencies and are also applied to a broad variety of industries
      as
      well, including financial institutions, high technology and consumer goods,
      entertainment and gaming, healthcare/pharmaceutical, defense and genuine parts
      industries. **** Our
      customers use our technologies where there is a need for enhanced security
      for
      protecting and verification of critical financial instruments and vital records,
      or where there are concerns of counterfeiting, fraud, identity theft, brand
      protection and liability.





Our
      core
      business is counterfeit prevention, brand protection and validation of authentic
      print media, including government-issued documents, currency, private corporate
      records, securities and more. We believe we are a world leader in the research
      and development of optical deterrent technologies and have commercialized these
      technologies with a broad suite of products that offer our customers a wide
      array of document security solutions that satisfy their specific
      anti-counterfeiting requirements. We provide document security technology to
      security printers, corporations and governments worldwide. Our technology can
      be
      used in securing sensitive and critical documents such as currency, automobile
      titles, spare parts forms for the aerospace industry, gift certificates,
      permits, checks, licenses, receipts, prescription and medical forms, engineering
      schematics, ID cards, labels, original music, coupons, homeland security
      manuals, consumer product and pharmaceutical packaging, tickets, and school
      transcripts. In addition, we have developed an On-Demand TM product
      to implement our technologies in Internet-based environments utilizing standard
      desktop printers. We believe that our On-Demand technology greatly expands
      the
      reach and potential market for our technologies and solutions.




14




*Technologies*





We
      have
      developed or acquired over 30 technologies that provide to our customers a
      wide
      spectrum of solutions. Our primary anti-counterfeiting products and technologies
      are marketed under the following trade names:





·
            **AuthentiGuardTM
                On-Demand**


·
            **AuthentiGuardTMLaser
                Moiré**


·
            **AuthentiGuardTM
                Prism**


·
            **AuthentiGuardTM
                Pantograph 4000**


·
            **AuthentiGuardTM
                Survivor 21**


·
            **AuthentiGuardTM
                Obscurascan**


·
            **AuthentiGuardTM
                Block-Out**


·
            **AuthentiGuardTM
                MicroPerf**


·
            **AuthentiGuardTM
                Phantom**


·
            **AuthentiGuardTMVeriGlow**.




The
        Company also seeks to expand its capabilities and product offerings, from
        time
        to time, that are complementary to the Company's document security
        technologies.  The Company promotes the concept that layers of security
        provide the strongest level of security for any given document, including
        documents containing RFID and biometric technologies.
  In
        June 2007, the Company entered into an agreement with
        International Barcode Corporation, (BTI) to license the right to market and
        produce BTI's advanced RSS bar-code technologies in the United States.  In
        late 2006, GSI adopted RSS bar codes as the standard for all scanning systems
        by
        2010.  DSS believes that the adoption of RSS technology will be a part
        of a major upgrade cycle in document technologies by companies around the
        world, and that the incorporation of RSS technologies into its product suite
        will enable the Company to be a benefactor of this market
        trend.




Our
      ability to compete effectively depends in part to
      our ability to maintain the proprietary nature of our technology, products
      and
      manufacturing processes.  We principally rely upon patent, trademark, trade
      secrets and contract law to establish and protect our proprietary rights. 
By aggressively defending our intellectual property rights, we believe that
      we
      may be able to secure a potentially significant amount of additional and ongoing
      revenue by securing licensing agreements with those persons, companies or
      governments that we believe are infringing our Patents.


*Products
      and Services*





**Document
      Security Solutions and Production** :
      Our
      technology portfolio allows us to create unique custom secure paper, plastic,
      packaging and Internet-based solutions. We target end-users that require
      anti-counterfeiting and authentication features in a wide range of printed
      materials like documents, vital records, driver’s licenses, birth certificates,
      receipts, manuals, identification materials, entertainment tickets, coupons,
      parts tracking forms, as well as product packaging including pharmaceutical
      and
      a wide range of consumer goods.





Additionally,
      our custom security solutions include our On-Demand technology that provides
      custom hosted or server-based digital solutions for our customers. Depending
      on
      our customer’s specific requirements, we host a secure server that accepts user
      inputs and delivers custom, variable secure documents for output at the user
      location, or offer a bundled server solution that allows for the production
      of
      custom, variable secure documents within the user’s network
      environment.





**Security
      Paper** : Our
      primary product for the retail end-user market is AuthentiGuard Security Paper.
      AuthentiGuard Security Paper uses our Pantograph 4000 technology. It is a paper
      that reveals hidden warning words, logos or images using The Authenticator-
      our
      proprietary viewing lens - or when the paper is faxed, copied, scanned or
      re-imaged in any form. The hidden words appear on the duplicate or the computer
      digital file and essentially prevents important documents from being
      counterfeited. We market and sell our Security Paper primarily through two
      major
      paper distributors: Boise Cascade and PaperlinX Limited.





**Technology
      Licensing:** We
      license our anti-counterfeiting technology and trade secrets through licensing
      arrangements with security printers. We seek licensees that have a broad
      customer base that can benefit from our technologies or have unique and
      strategic capabilities that expand the capabilities that we can offer our
      potential customers. Revenue from Licensing can take several forms. Licenses
      can
      be for a single technology or for a package of technologies.  
Licensee's can choose from a variety of payment models, such as:




15




·
            Pay
                one price per year - Licensee will estimate their annual usage and
                a
                single payment is paid and reviewed each year based on actual
                results.


·
            Pay
                a percentage of sales of the technology - Licensees only pay as they
                sell
                product containing the technology. If, for example, they sell $1
                million
                in our security technology printing, they would pay us from 2.5%
                to 10% of
                the sales price of their jobs.


·
            Pay
                on a per piece method - Licensees pay royalties based on a price
                per
                piece.   A pre-determined price schedule is implemented based on
                job volumes and a per-piece price is utilized. Typically, the higher
                the
                volume, the lower the price per
                piece.


·
            Joint
                venture licensing- profit sharing arrangement with clients where
                DSS
                shares the net profit of all products sold containing DSS
                Technologies.





**Legal
      Products** :
      We also
      own and operate Legalstore.com, an Internet company which sells legal supplies
      and documents, including security paper and products for the users of legal
      documents and supplies in the legal, medical and educational fields. While
      not a
      component of our core business strategy, we continuously seek to maximize the
      revenue and profitability of this operation.




***Results
      of Operations for the Three and Six Months Ended***  ***June
      30, 2007***




The following discussion and analysis provides information that our management
      believes is relevant to an assessment and understanding of our results of
      operations and financial condition. The discussion should be read in conjunction
      with the financial statements and footnotes in this quarterly report and in
      our
      annual report on Form 10-K for the year ended December 31, 2006. All amounts
      have been adjusted to reflect the Company’s results after affect of discontinued
      operations. During the second quarter of 2007, the Board of Directors approved
      a
      plan to sell and the Company entered into a preliminary agreement to sell its
      copying and quick-printing business to a private investor. In accordance with
      FASB 144, the Company accounts for the revenue and expenses of this operation,
      which is a component of its security printing segment, as a discontinued
      operation.




The
      following discussion also includes a non-GAAP financial measure which has been
      reconciled to the most comparable GAAP financial measure of net loss. Our
      management believes that this performance measure is a relevant indicator of
      the
      Company’s financial performance.




**Summary**




16




****
              ****
              **Three
                  Months Ended June 30, 2007**
              ****
              **Six
                  Months Ended June 30, 2007**
              ********
              **$**
              ****
              **%
                  change vs. 3 months ended June 30, 2006**
              ****
              **$**
              ****
              **%
                  change vs. 6 months ended June 30, 2006**Revenue,
                  net
              
              
              1,295,000
              
              
              10
              %
              
              2,923,000
              
              
              56
              %Costs
                  of revenue
              
              
              642,000
              
              
              0
              %
              
              1,286,000
              
              
              20
              %Gross
                  profit
              
              
              653,000
              
              
              22
              %
              
              1,637,000
              
              
              103
              %Total
                  Operating Expenses
              
              
              2,353,000
              
              
              35
              %
              
              4,591,000
              
              
              55
              %Operating
                  loss
              
              
              (1,700,000
              )
              
              42
              %
              
              (2,954,000
              )
              
              37
              %Other
                  income (expense):Interest
                  income
              
              
              34,000
              
              
              100
              %
              
              75,000
              
              
              70
              %Gain
                  (loss) from Foreign Currency Transactions
              
              
              (1,000
              )
              
              
              
              
              (4,000
              )Interest
                  expense
              
              
              (1,000
              )
              
              (80
              %)
              
              (2,000
              )
              
              (82
              %)Loss
                  before income taxes
              
              
              (1,668,000
              )
              
              40
              %
              
              (2,885,000
              )
              
              35
              %Income
                  taxes
              
              
              5,000
              
              
              -
              
              
              10,000
              
              
              -Loss
                  from discontinued operations
              
              
              27,000
              
              
              37
              %
              
              15,000
              
              
              (79
              %)Net
                  loss
              
              
              (1,700,000
              )
              
              41
              %
              
              (2,910,000
              )
              
              32
              %




**Revenue**




**Three
                  Months Ended June 30, 2007**
              ****
              **Six
                  Months Ended June 30, 2007**
              ********
              ****
              **$**
              ****
              **%
                  change vs. 3 months ended June 30, 2006**
              ****
              **$**
              ****
              **%
                  change vs. 6 months ended June 30, 2006**RevenueSecurity
                  printing
              
              $
              827,000
              
              
              (15
              %)
              $
              1,818,000
              
              
              24
              %Royalties
              
              
              294,000
              
              
              390
              %
              
              593,000
              
              
              511
              %Digital
                  solutions
              
              
              12,000
              
              
              
              
              
              175,000Legal
                  products
              
              
              162,000
              
              
              12
              %
              
              337,000
              
              
              7
              %Total
                  Revenue
              
              
              1,295,000
              
              
              10
              %
              
              2,923,000
              
              
              56
              %






For
      the
      three-month period ended June 30, 2007, revenue from continuing operations
      increased 10% from the same period ended June 30, 2006. The increase in revenue
      resulted primarily from increases in royalty revenue from the licensing of
      the
      Company’s patented technology. Sales of security printing, after factoring in
      discontinued operations, declined 15% from the prior year’s quarter due to the
      timing of large orders. In the three months ended June 30, 2006, the Company
      completed its initial shipments to Paperlinx of its SecureLinx line of safety
      paper. During the 2007 quarter, the Company did not have any corresponding
      large
      orders that were shipped, including any shipments of driver’s license order
      which the Company anticipates making shipments during the third and fourth
      quarter of 2007. In addition, the Company did not have any implementations
      of
      its new line of digital security solutions during the June 30, 2007 quarter.
      The
      Company continues to anticipate that digital solution sales will be a
      significant component of it revenue during the remainder of 2007.




17


For
      the
      six-month period ended June 30, 2007, revenue from continuing operations
      increased 56% from the same period ended June 30, 2006. The increase in revenue
      was primarily due to increases in royalty revenue from the licensing of the
      Company’s patented technology, a digital solution sale for a custom On-Demand
      solution in the first quarter of 2007 and an increase in sales of security
      products and documents, including initial shipments on a foreign driver license
      project. In addition, the security printing revenue increase reflects the effect
      of the Company’s acquisition in February 2006 of Plastic Printing Professionals.
      The Company expects that revenues will continue to increase at a similar pace,
      especially during the fourth quarter of 2007 as the Company begins the national
      roll-out of its "On-Demand" Product Suite, with its partner, The Ergonomic
      Group. The product roll-out is supported by the newly developed website,
www.authenticate-360.com which provides interactive information on the
      impact of couterfeiting and how "On-Demand" products help mitigate these
      risks.




Legal
      Products




Revenue from our legal supplies business, Legalstore.com, grew 12% during the
      second quarter of 2007 compared with the second quarter of 2006, and 7% through
      the first six months of 2007 compared to 2006. While we view our legal supplies
      business segment as a non-core part of our company, we continue to seek growth
      opportunities for the business. The Company is currently redesigning the
      Legalstore.com’s website and e-commerce platform along with expanding its
      product offerings.




**Cost
      of Sales and Gross Profit**




**Three
                  Months Ended June 30, 2007**
              ****
              **Six
                  Months Ended June 30, 2007**
              ********
              ****
              **$**
              ****
              **%
                  change vs. 3 months ended June 30, 2006**
              ****
              **$**
              ****
              **%
                  change vs. 6 months ended June 30, 2006**Costs
                  of revenueSecurity
                  printing & products
              
              $
              548,000
              
              
              (3
              %)
              $
              1,055,000
              
              
              19
              %Digital
                  solutions
              
              
              3,000
              
              
              
              
              
              37,000Legal
                  products
              
              
              91,000
              
              
              18
              %
              
              194,000
              
              
              8
              %Total
                  cost of sales
              
              
              642,000
              
              
              0
              %
              
              1,286,000
              
              
              20
              %Gross
                  profitSecurity
                  printing & products
              
              
              279,000
              
              
              (32
              %)
              
              763,000
              
              
              33
              %Royalties
              
              
              294,000
              
              
              390
              %
              
              593,000
              
              
              511
              %Digital
                  solutions
              
              
              9,000
              
              
              
              
              
              138,000Legal
                  products
              
              
              71,000
              
              
              4
              %
              
              143,000
              
              
              6
              %Total
                  gross profit
              
              
              653,000
              
              
              22
              %
              
              1,637,000
              
              
              103
              %




18


**Three
                  Months Ended June 30, 2007**
              
              **Six
                  Months Ended June 30, 2007****%**
              
              **%
                  change vs. 3 months ended June 30, 2006**
              
              **%**
              
              **%
                  change vs. 6 months ended June 30, 2006**Gross
                  profit percentage:Security
                  printing & products
              
              
              34
              %
              
              (20
              %)
              
              42
              %
              
              7
              %Royalties
              
              
              100
              %
              
              0
              %
              
              100
              %
              
              0
              %Digital
                  solutions
              
              
              75
              %
              
              
              
              
              79
              %Legal
                  supplies
              
              
              44
              %
              
              (7
              %)
              
              42
              %
              
              (1
              %)Gross
                  profit percentage:
              
              
              50
              %
              
              11
              %
              
              56
              %
              
              30
              %




Gross
      Profit




During
      the second quarter of 2007, gross profit from continuing operations increased
      22% to $653,000 as compared to the second quarter of 2006. Increases in profits
      from license royalty agreements were partially offset by a 20% decline in gross
      profit from the security print operations, which were negatively impacted by
      the
      lack of delivery of any large orders during the quarter as discussed above.




During
      the first six months of 2007, gross profit from continuing operations increased
      103% to $1,637,000. Along with increases as the result of license agreements
      and
      a digital solution implementation, the Company realized significant growth
      in
      security printing gross profits during the first quarter of 2007 primarily
      due
      to the impact of a large secure driver’s license project which was delivered
      during the first quarter of 2007. As a result, the Company’s gross profit margin
      has increased 30% during the first six months of 2007 as compared to the first
      six months of 2006.






**Operating
      Expenses**




**Three
                  Months Ended June 30, 2007**
              
              **Six
                  Months Ended June 30, 2007****$**
              ****
              **%
                  change vs. 3 months ended June 30, 2006**
              ****
              **$**
              ****
              **%
                  change vs. 6 months ended June 30, 2006**Selling,
                  general and administrativeGeneral
                  and administrative compensation
              
              $
              534,000
              
              
              37
              %
              $
              947,000
              
              
              45
              %Stock
                  based payments
              
              
              297,000
              
              
              17
              %
              
              633,000
              
              
              126
              %Professional
                  Fees
              
              
              364,000
              
              
              (4
              %)
              
              684,000
              
              
              (7
              %)Sales
                  and marketing
              
              
              391,000
              
              
              74
              %
              
              910,000
              
              
              135
              %Depreciation
                  and amortization
              
              
              20,000
              
              
              (29
              %)
              
              40,000
              
              
              (30
              %)Other
              
              
              205,000
              
              
              109
              %
              
              395,000
              
              
              98
              %Research
                  and development
              
              
              109,000
              
              
              14
              %
              
              203,000
              
              
              20
              %Amortization
                  of intangibles
              
              
              433,000
              
              
              62
              %
              
              779,000
              
              
              60
              %Total
                  Operating Expenses
              
              
              2,353,000
              
              
              36
              %
              
              4,591,000
              
              
              55
              %




19


**Selling,
      General and Administrative**




The
      Company’s selling, general and administrative costs increases generally reflect
      increases to the size of our organization as the result of the Company’s
      acquisition of P3 and increases in executive management, sales and operations
      personnel integral to the company’s sales growth strategy.




General
      and administrative compensation costs
      from continuing operations increased during the second quarter of 2007 reflect
      the impact of personnel additions at the Company during the second half of
      2006,
      and the hiring of an in-house counsel that had formerly worked for the Company
      in a retainer arrangement. In addition, the Company incurred annual payrate
      increases on average of approximately 6% for existing employees as compared
      to
      2006 rates. General and administrative compensation cost from continuing
      operations increased during the first six months of 2007 for these same reasons
      as well as due to the impact of the acquisition of P3 in February 2006.




Stock-based
      payments during
      the three months ended June 30, 2007 were flat as compared to the three months
      ended June 30, 2006, however, the makeup of the expense between the two periods
      was different. The 2007 period reflects expenses due to options and restricted
      stock grants to several recently added employees, including an addition to
      the
      Company’s senior management team. In addition, the Company issued options to a
      third-party financial advisor in March of 2007. The Company believes that the
      grant of equity instruments is an important component of its overall
      compensation program that is needed to attract and retain its human resources
      as
      well as obtain the services of various third parties without consuming its
      cash
      resources. Stock-based compensation during the three months ended June 30,
      2006,
      include approximately $223,000 of expense recognized for the issuance of
      warrants to International Barcode Corporation (d/b/a Barcode Technology) (“BTI”)
      in June 2006 in consideration for a cross-marketing relationship that enables
      the Company to expedite its entry into the Chinese market for secure documents.
      These warrants were fully vested as of March 31, 2007 and were set to expire
      in
      June of 2007. On June 13, 2007, the Company entered into an agreement with
      BTI
      to extend the expiration date of the warrants to December 31, 2007 in exchange
      for which BTI has agreed to provide the Company with a license agreement to
      market and produce BTI’s advanced barcode technologies in the United States for
      five years The value of the extension of the warrant was determined to be
      approximately $521,000. This amount was recorded as an other intangible asset
      and will be amortized over the expected useful life of the license agreement
      of
      five years.




In
      addition, on May 3, 2007, the Company granted a total of 445,000 restricted
      shares to certain members of senior management. These shares only vest upon
      the
      occurrence of certain events over the next 5 years, which include a change
      of
      control or other merger or acquisition of the Company, the achievement of
      certain financial goals, including among other things a successful result of
      the
      Company’s patent infringement suit against the European Central Bank. These
      shares, if vested, would result in the recording of stock based compensation
      expense of approximately $5,563,000 over the period beginning when any of the
      contingent vesting events is deemed to be probable over the expected requisite
      service period.




20




**Three
                  Months Ended June 30, 2007**
              
              **Six
                  Months Ended June 30, 2007****$**
              ****
              **%
                  change vs. 3 months ended June 30, 2006**
              ****
              **$**
              ****
              **%
                  change vs. 6 months ended June 30, 2006***Professional
                  Fees Detail*Accounting
                  and auditing
              
              $
              52,000
              
              
              0
              %
              $
              165,000
              
              
              42
              %Consulting
              
              
              106,000
              
              
              (5
              %)
              
              197,000
              
              
              40
              %Legal
                  Fees
              
              
              80,000
              
              
              (24
              %)
              
              135,000
              
              
              (37
              %)Stock
                  Transfer, SEC and Investor Relations
              
              
              126,000
              
              
              85
              %
              
              187,000
              
              
              (6
              %)$
              364,000
              
              
              9
              %
              $
              684,000
              
              
              2
              %




Professional
      fees include
      legal, accounting, shareholder services, investor relations, and consulting
      costs. During the first six months of 2007, accounting and auditing fee
      increases generally reflect an increase in costs as a result of the growth
      in
      the Company as compared to the same period of 2006, along with additional costs
      associated with the Company’s Sarbanes Oxley compliance requirements which is
      effective in 2007. Consulting fees increased during the first six months of
      2007
      as compared to 2006 due to addition of an intellectual property consultant,
      a
      new agreement with a German consulting firm, and the use of various financial
      consultants. Legal fees decreased due to the hiring of an in-house counsel
      that
      had formerly worked for the Company in a retainer arrangement and due to a
      general decrease in activity in the Company’s non-ECB related litigation. These
      legal costs do not include approximately $1,485,000,of legal and related costs
      incurred during the first half of 2007 associated with the application and
      defense of our patents which the company capitalizes and amortizes over the
      expected life of the patent. (See *Part
      I -Financial Information -Note 8* )
      As
      compared to 2006, second quarter SEC and investor relations costs increased
      due
      to the timing of certain printing and mailing costs associated with the
      Company’s annual shareholders meeting. However, year-to-date stock transfer, SEC
      and Investor Relations costs have decreased slightly during 2007 as compared
      to
      2006 primarily as a result of a reduction in certain investor relations
      consulting costs.




Sales
      and marketing expenses, including sales and marketing personnel costs, increased in the second
      quarter and through the first six months of 2007 as a result of significant
      expansion in the resources that the Company is investing to grow the size of
      its
      sales and marketing team and increase the reach of its products through
      expansion of its marketing efforts. During the second quarter of 2007, the
      Company’s costs included several international business development efforts,
      including meetings in Germany, the United Kingdom, Mexico, Indonesia and the
      Dominican Republic. In addition, the Company invested its marketing efforts
      towards the roll-out of the Company’s On-Demand product offerings in conjunction
      with its partner, The Ergonomic Group.




Other
      expenses from
      continuing operations are primarily rent and utilities, office supplies, IT
      support, bad debt expense and insurance costs. Increases in 2007 reflect costs
      associated with a larger organization.




**Research
      and Development**




We
      invest
      in research and development to improve our existing technologies and develop
      new
      technologies that will enhance our position in the document security market.
      Research and development costs consist primarily of compensation costs for
      our
      four persons who spend all or at least half of their time on developing new
      technologies or developing new uses for our existing technology. In addition,
      we
      incur costs for the use of third party printers’ facilities to test our
      technologies on equipment that we do not have access to internally. We seek
      patent protection for many of our inventions, and we currently have over a
      dozen
      formal patents applications pending, including provisional and PCT patent
      applications and applications that have entered the National Phase in various
      countries, including the United States, Canada, Europe, Japan, Brazil, Mexico,
      Indonesia and South Africa. We expect that our research and development costs
      will continue at current levels for the foreseeable future.




21


**Amortization
      of intangibles**




We
      amortize the costs associated with the patents that we acquired in 2005 and
      the
      legal costs associated with the development and defense of our patents,
      including the costs associated with our suit against the European Central Bank
      for patent infringement. In addition, we amortize our acquired intangibles
      from
      business combinations. A significant portion of these assets were acquired
      by
      the issuance of equity in the company. Our amortizable patent asset base at
      June
      30, 2007 was approximately $5.8 million and will generate approximately $1.5
      million in annual amortization expense during the next 4 years. The Company
      reviews these assets for impairment annually. If an impairment, such as
      unfavorable ruling in the Company’s patent infringement lawsuits or an
      assessment of non-commerciability of certain of its patents, then the Company
      would write-off a portion of these assets, which could be a significant expense
      in the period incurred.




In
      addition, the Company has approximately $1.0 million of other intangible assets
      as of June 30, 2007 that consist of various royalty rights and marketing and
      distribution rights as well as acquired intangibles including customer lists
      and
      trade names. These assets will generate approximately $200,000 of annual
      amortization expense during the next 5 years.




In
      addition, the Company has $1,397,000 in goodwill derived from acquisitions.
      Goodwill is not amortized, but could become a component of expense if an
      impairment is determined.




**Discontinued
      operations**




Revenue
      from the company’s retail printing and copying division decreased 26% for the
      three months and six months ended June 30, 2007 as compared to the 2006 periods.
      Revenue for the division represented approximately 7% of the Company’s
      consolidated revenue for the three months and six months ended June 30, 2007
      as
      compared to 16% and 13% of consolidated revenue for the three months and six
      months ended June 30, 2006, respectively. The decline is sales was contributed
      to the Company’s shift of resources from its retail printing operations to its
      security research and operations since the middle of 2006. Operating losses
      from
      the division were less than 3% of consolidated operating losses for the Company
      during the three and six months ended 2007 and 2006, respectively.




**Net
      loss and loss per share**




22


**Three
                  Months Ended June 30, 2007**
              
              **Six
                  Months Ended June 30, 2007****$**
              ****
              **%
                  change vs. 3 months ended June 30, 2006**
              ****
              **$**
              ****
              **%
                  change vs. 6 months ended June 30, 2006**Net
                  loss
              
              
              (1,700,000
              )
              
              41
              %
              
              (2,910,000
              )
              
              32
              %Net
                  loss per share, basic and diluted
              
              
              (0.12
              )
              
              33
              %
              
              (0.21
              )
              
              24
              %Weighted
                  average common shares outstanding, basic and diluted
              
              
              13,625,408
              
              
              6
              %
              
              13,605,327
              
              
              6
              %




During
      the second quarter and first half of 2007, the Company experienced a net loss
      of
      $1.7 million and $2.9 million, respectively. While we experienced growth in
      our
      sales and gross profits during these periods, these increases did not offset
      significant increases in our operating expenses, especially significant
      increases in amortization expense, stock based compensation, compensation and
      sales and marketing expenses.




During
      the second quarter and first half of 2007, our basic and diluted loss per share
      increased due to the increased dollar value of our loss partially offset by
      an
      increase in the weighted average common shares outstanding during each of these
      periods as compared to 2006. Our outstanding shares have increased as we have
      issued our common shares for warrants exercised and for the purchase of patent
      assets.




**Non-GAAP
      Financial Performance Measure**




The
      following adjusted Earnings before interest, taxes, depreciation, amortization
      and non-cash stock compensation expense (“Adjusted EBITDA”) is presented because
      the Company’s management believes it to be a relevant measure of the performance
      of the Company. The Adjusted EBITDA is used by the Company’s management to
      measure its core operating performance without certain non-cash expenditures.
      The reconciliation of Adjusted EBITDA to net loss, the most comparable GAAP
      measure is presented below.




23


Adjusted
      EBITDA




**Three
                  Months Ended June 30, 2007**
              
              **Six
                  Months Ended June 30, 2007****$**
              
              **%
                  change vs. 3 months ended June 30, 2006**
              
              **$**
              
              **%
                  change vs. 6 months ended June 30, 2006**Net
                  Loss
              
              $
              (1,700,000
              )
              
              41
              %
              $
              (2,910,000
              )
              
              32
              %Add
                  back:Depreciation
              
              
              47,000
              
              
              (25
              %)
              
              91,000
              
              
              (24
              %)Amortization
                  of Intangibles
              
              
              433,000
              
              
              62
              %
              
              779,000
              
              
              60
              %Stock
                  based payments
              
              
              297,000
              
              
              17
              %
              
              633,000
              
              
              126
              %Interest
                  Income
              
              
              (34,000
              )
              
              100
              %
              
              (75,000
              )
              
              70
              %Interest
                  Expense
              
              
              1,000
              
              
              (80
              %)
              
              2,000
              
              
              (82
              %)Income
                  Taxes
              
              
              5,000
              
              
              
              
              
              9,000Adjusted
                  EBITDA
              
              
              (951,000
              )
              
              50
              %
              
              (1,471,000
              )
              
              9
              %




As
      described above, Adjusted EBITDA is a non-GAAP measurement of financial
      performance that the Company believes is relevant to the understanding of the
      Company’s financial results. During the three months ended June 30, 2007, the
      Company experienced an increase in its Adjusted EBITDA loss as increases in
      its
      revenue and gross profit did not offset greater increases in its core operating
      expenses (core operating expenses are general and administrative compensation,
      professional fees, sales and marketing, other and research and development
      costs). The Company’s core operating expenses from continuing operations
      increased 33% and 58% during the second quarter and first six months of 2007,
      respectively, as compared to the 2006 periods, primarily due to increases in
      sales and marketing expenses. The Company expects that it will continue to
      incur
      Adjusted EBITDA losses unless is can increase its revenue levels. It is the
      Company’s belief that the amounts it is incurring during the current periods for
      sales and marketing are critical investments required to increase the required
      break-even revenue levels. However, there the Company cannot be certain that
      it
      will be able to successfully obtain these break-even levels which would require
      the Company to significantly reduce its costs structure.




**LIQUIDITY
      AND CAPITAL RESOURCES**




The
      Company’s cash flows and other key indicators of liquidity are summarized as
      follows:




24




**Six
                  Months Ended****June
                  30**
              
              **June
                  30****2007**
              
              **2006**
              
              **%****(unaudited)**
              
              **(unaudited)**
              
              **Change**Cash
                  flows (used) provided by:Operating
                  activities
              
              $
              (1,637,000
              )
              $
              (1,517,000
              )
              
              (8
              %)Investing
                  activities
              
              
              (732,000
              )
              
              (1,449,000
              )
              
              49
              %Financing
                  activities
              
              
              (183,000
              )
              
              716,000
              
              
              (126
              %)Working
                  capital
              
              
              1,836,000
              
              
              1,069,000
              
              
              72
              %Current
                  ratio
              
              
              1.65
              x
              
              1.57
              x
              
              5
              %




As
      of
      June 30, 2007, we had cash and cash equivalents of $3.3 million, a 43% decrease
      from December 31, 2006. As discussed below, the decrease in the Company’s cash
      position is primarily due to the payment of fees related to a private placement
      of equity which the Company closed on December 26, 2006 and January 22, 2007,
      the payment of legal fees associated with its patent applications and defense
      costs, as well as cash used for operations. As discussed below, the Company
      believes that its cash balance as of June 30, 2007 will satisfy its projected
      working capital and capital expenditure requirements, including the costs
      related to its patent defense litigations, for at least the next 12 months.




Operating
      Cash Flow - Over time, operating cash flows are expected to mirror Adjusted
      EBITDA results. During the first six months of 2007, the Company used
      approximately $1.6 million of cash for operations, which is slightly greater
      than the Adjusted EBITDA loss of $1.4 million during the same period. This
      variance is primarily due to the payment of prepaid rent of approximately
      $200,000 for the Company’s new facility it has leased for its plastic printing
      division. For the foreseeable future, the Company will continue to use cash
      for
      operations at a similar pace, only to be offset by increases in revenue. As
      of
      June 30, 2007, the Company believes that it will need to reach an annual revenue
      level of approximately $7.5 million in order to maintain positive operating
      cash
      flow.




Investing
      Cash Flow -During the first half of 2007, the Company used approximately
      $732,000 of cash for fixed asset additions and to invest in its patent
      portfolio, including the payment of legal costs associated with patent
      applications and the defense of our patents, which includes payments to cover
      third party experts fees and other fees associated with the Company’s litigation
      against the ECB. The Company was able to use its equity to pay for approximately
      $746,000 of patent related costs as a result of its agreement with its lead
      counsel in its ECB litigation.




Financing
      Cash Flows -During the first quarter of 2007, the Company received approximately
      $340,000 from the private placement of stock and the exercise of warrants which
      was offset by the payment of approximately $520,000 in fees associated with
      the
      private placements concluded in the fourth quarter of 2006 and the first quarter
      of 2007. As of June 30, 2007, the Company has approximately 929,000 warrants
      outstanding and exercisable at exercise prices below the closing market price
      of
      our Common stock as of June 30, 2007 of $13.79 that, if exercised, would produce
      approximately $9.4 million in cash proceeds to the Company.




25


Cash
      flows from discontinued operations -During the six months ended June 30, 2007,
      operating cash flows from the company’s
      retail printing and copying division were essentially $0. In addition, during
      this period, the division did not have any investing or financing cash flow
      activities. Cash flows from discontinued operations are included in the
      consolidated statements of cash flows for the six months ended June 30, 2007
      and
      2006.




**ITEM
      3:   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK**




Our
      market risk exposures are related to our cash, cash equivalents and investments.
      We invest our excess cash in certificates of deposits with maturities of 90
      days
      or less. Changes in interest rates affect the investment income we earn and
      therefore impact our cash flows and results of operations.




We
      mitigate our foreign currency risks principally by contracting primarily in
      U.S.
      dollars. To date, all of our billings were denominated in the U.S. dollar.
      However, certain of our legal fees are payable in foreign currencies, for which
      a gain or loss is recognized on foreign currency transactions is recognized
      when
      payments are made. To date and for the foreseeable future, gains and losses
      on
      such transactions have been minimal.




**ITEM
      4 - CONTROLS AND PROCEDURES**




The
      Company maintains disclosure controls and procedures (as defined in Exchange
      Act
      Rule 13a-15(e)) that are designed to assure that information required to be
      disclosed in its Exchange Act reports is recorded, processed, summarized and
      reported within the time periods specified in the Securities and Exchange
      Commission's rules and forms, and that such information is accumulated and
      communicated to management, including the Chief Executive Officer and Acting
      Chief Financial Officer, as appropriate, to allow timely decisions regarding
      required disclosures.




In
      designing and evaluating the disclosure controls and procedures, management
      recognizes that any controls and procedures, no matter how well designed and
      operated, can provide reasonable assurance only of achieving the desired control
      objectives, and management necessarily is required to apply its judgment in
      weighting the costs and benefits of possible new or different controls and
      procedures. Limitations are inherent in all control systems, so no evaluation
      of
      controls can provide absolute assurance that all control issues and any fraud
      within the company have been detected.




As
      required by Exchange Act Rule 13a-15(b), as of the end of the period covered
      by
      this report, management, under the supervision and with the participation of
      its
      Chief Executive Officer and the Acting Chief Financial Officer, evaluated the
      effectiveness of the Company's disclosure controls and procedures. Based on
      this
      evaluation, management concluded that the Company's disclosure controls and
      procedures were effective as of that date.




26


During
      the Company’s most recent fiscal quarter, the Company initiated reviews and
      analysis of internal control procedures and designs in the context of Section
      404 of the Sarbanes Oxley Act of 2002. The Company has begun and expects to
      continue to modify and change its internal control procedures to meet the
      compliance standards of the Sarbanes Oxley Act for its fiscal year ended
      December 31, 2007. The Company expects to make internal control changes to
      address control issues typically associated with a small company including
      a
      lack of segregation of duties. These changes may involve the addition of
      accounting staff, the use of consultants and external resources, or a
      combination thereof in order to achieve the desired internal control
      effectiveness.




**PART
      II**


**OTHER
      INFORMATION**




**ITEM
      1 - LEGAL PROCEEDINGS**




Information
      concerning pending legal proceedings is incorporated herein by reference to
      Note
      8 to the Condensed Consolidated Financial Statements (Unaudited) in Part I
      of
      this Form 10-Q.


On
        August
        1, 2005, we commenced a suit against the European Central Bank (the “ECB”)
        alleging patent infringement by the ECB and have claimed unspecified damages.
        We
        brought the suit in European Court of First Instance in Luxembourg. We alleged
        that all Euro banknotes in circulation infringe our European Patent 455750B1
        (the “Patent”), which covers a method of incorporating an anti-counterfeiting
        feature into banknotes or similar security documents to protect against
        forgeries by digital scanning and copying devices. We will seek all remedies
        available to us under the law. In November 2005, the European Central Bank
        filed
        its answer to our complaint asserting procedural and jurisdictional arguments.
        The ECB contended that the proper venue was not in the Court of First Instance,
        but rather in each individual country that is a member of the ECB. We responded
        to the European Central Bank’s answer in late December 2005, arguing that the
        Court of First instance was the proper venue. The parties are awaiting the
        ruling from the Court of First Instance on jurisdiction.
 
 On
        March
        24, 2006, we received notice that the ECB has filed a separate claim in the
        United Kingdom and Luxembourg patent courts (Luxembourg being the seat of
        the
        European Court of First Instance) seeking the invalidation of the Patent.
        Claims to invalidity in each of the Netherlands, Belgium, Italy, France,
        Spain,
        Germany and Austria were subsequently served on the Company. The proceedings
        in
        Luxembourg have been withdrawn by the ECB due to procedural irregularities;
        the
        ECB have the option to recommence those proceedings, but have not yet done
        so.
 
 On
        March
        26, 2007, the High Court of Justice, Chancery Division, Patents Court in
        London,
        England (the “English Court”) ruled that the Patent that was awarded to us by
        the European Patent Office Technical Board of Appeal has been deemed invalid
        in
        the United Kingdom on the grounds of added subject matter. The ECB’s attacks
        that the Patent was not new and was not inventive were dismissed. The English
        Court’s decision does not affect the validity of the Patent in other European
        countries. On March 30, 2007, the Company was given permission by the English
        Court to appeal to the Court of Appeal the ruling and an appeal was filed
        on 30
        April 2007. As a result of the ruling and according to English Court rules,
        the
        Company was also required to pay a portion of the ECB’s legal costs associated
        with the case. On April 2, 2007, the English Court ordered that the Company
        should pay 30% of the ECB’s reasonable legal costs, of which the Company paid
        90,000 pounds (USD $182,000) on April 4, 2007. The remaining amounts (estimated
        to be a further 90,000 pounds) will be calculated in a separate procedure
        likely
        to take place after the appeal. However, the outcome of the appeal will also
        either uphold (if the ECB are successful) or reverse (if the Company is
        successful) the award of costs at first instance.
 
 On
        March
        27, 2007, the German Federal Patent Court (Bundespatentgericht) in Munich
        (the
“German Court”) ruled, having seen the judgment of the English Court, that the
        Patent was valid in Germany. This ruling validates the Patent in Germany
        and
        confirms the legal basis of the Company’s infringement suit against the ECB. In
        addition, as a result of this ruling, the Company expects to be awarded
        reimbursements for a proportion of its costs associated with the German validity
        case, estimated at €35,000.
 
 On
        June
        4, 2007, a trial was held in the French High Court in  Paris,
        regarding validity of the Patent. A decision in the French trial is expected
        in
        approximately the middle of September of 2007. Additional trials regarding
        validity are expected to take place in the six other countries from late
        2007
        into 2008.


27


On
      January 31, 2003, we commenced an action, unrelated to the above ECB litigation,
      entitled New Sky Communications, Inc., As Successor-In-Interest To Thomas M.
      Wicker, Thomas M.Wicker Enterprises, Inc. and Document Security Consultants
      V.
      Adler Technologies, Inc. N/K/A Adlertech International, Inc. and Andrew
      McTaggert (United States District Court, Western District Of New York Case
      No.03-Cv-6044t(F)) regarding certain intellectual property in which we have
      an
      interest. We commenced this action alleging various causes of action against
      Adler Technologies, Inc. and Andrew McTaggert for breach of contract, breach
      of
      the duty of good faith and fair dealing, various business torts, including
      unfair competition and declaratory relief. Adler distributes and supplies
      anti-counterfeit document products and Mr. McTaggert is a principal of Adler.
      Adler had entered into several purported agreements with Thomas M. Wicker
      Enterprises and Document Security Consultants, both of which we acquired in
      2002. These alleged agreements, generally, would have authorized Adler to
      manufacture in Canada our “Checkmate®” patented system for verifying the
      authenticity of currency and documents. Other purported agreements were signed
      between these parties and Thomas Wicker regarding other technology claimed
      to
      have been owned by Wicker and assigned to us. Among other things, we contend
      that certain of the purported agreements are not binding and/or enforceable.
      To
      the extent any of them are binding and enforceable, we claim that Adler has
      breached these purported agreements, failed to make an appropriate accounting
      and payments under them , and may have exceeded the scope of its license. Adler
      has denied the material allegations of the complaint and has counterclaimed
      against our company, claiming Adler owns or co-owns or has a license to use
      certain technologies of ours. In May 2005, we filed our first amended and
      supplemental complaint adding Blanks/USA and Raymond Maxon as additional
      defendants. In February 2007, we filed our second amended and supplemental
      complaint adding Judith Wu (McTaggart’s wife) and Arcis Digital Security, Inc.
      (a company in which Ms. Wu is involved) as additional defendants. Maxon has
      asserted a counterclaim against us contending that our purported acquisition
      of
      a certain patent from Thomas Wicker in 2002 gave rise to an alleged right on
      the
      part of Maxon to receive a portion of Thomas Wicker’s proceeds from such
      acquisition. We have denied the material allegations of all of the
      counterclaims. If Adler is successful, it may materially affect us, our
      financial condition, and our ability to market and sell certain of our
      technology and related products. This case is in discovery phase, and it is
      too
      soon to determine how the various issues raised by the lawsuit will be
      determined.




In
      addition to the foregoing, we are subject to other legal proceedings that have
      arisen in the ordinary course of business and have not been finally adjudicated.
      Although there can be no assurance in this regard, in the opinion of management,
      none of the legal proceedings to which we are a party, whether discussed herein
      or otherwise, will have a material adverse effect on our results of operations,
      cash flows or our financial condition.




**ITEM
      1a - RISK FACTORS**




There
      have been no material changes from the risk factors disclosed in Part I,
      Item 1A, of the Company’s Annual Report on Form 10-K for the year ended
      December 31, 2006 and Part II, Item 1A of the Company’s Quarterly Report in
      Form 10-Q for the quarter ended March 31, 2007.




28


**ITEM
      2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
      PROCEEDS**




None




**ITEM
      3 - DEFAULTS UPON SENIOR SECURITIES**




None




**ITEM
      4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**




None




**ITEM
      5 - OTHER INFORMATION**




None




**ITEM
      6 - EXHIBITS**




The
      Exhibits listed below designated by an * are incorporated by reference to the
      filings by Document Security Systems, Inc. under the Securities Act of 1933
      or
      the Securities and Exchange Act of 1934, as indicated. All other exhibits are
      filed herewith.





(a)
              ExhibitsItem
                  3.1 Articles of Organization, as amended (incorporated by reference
                  to
                  exhibit 3.1 to the Company's Registration Statements No. 2-98684-NY
                  on
                  Form S-18).*
                
                Item
                  3.2 By-laws, as amended (incorporation by reference to exhibit
                  3.2 to the
                  Company's Registration Statement No. 2-98684-NY on Form
                  S-18).*
                
                Item
                  10.30License
                  and Distribution Agreement, dated November 8, 2006, between Document
                  Security Systems, Inc and PT Sekur Grafika
                
                Item
                  10.31Limited
                  Exclusive Patent License Agreement, dated December 29, 2006, between
                  Document Security Systems, Inc and Ergonomic Group, Inc.
                
                Item
                  10.32License
                  and Distribution Agreement, dated June 27, 2007, between Document
                  Security
                  Systems, Inc. and Cultura Interactiva S.A. de C.V.
                
                Item
                  10.33Warrant
                  No B-1, dated June 16, 2006, issued to International Barcode
                  Corporation
                
                Item
                  10.34Amendment
                  to Warrant B-1, dated June 13, 2007, between Document Security
                  Systems,
                  Inc. and International Barcode Corporation
                
                Item
                  10.35Letter
                  Agreement, dated June 11, 2007, between Document Security Systems,
                  Inc.
                  and International Barcode Corporation
                
                Item
                  31.1Certifications
                  of Chief Executive Officer Pursuant to Section 302 of the Sarbanes
                  Oxley
                  Act
                
                Item
                  31.2Certifications
                  of Acting Chief Financial Officer Pursuant to Section 302 of the
                  Sarbanes
                  Oxley Act
                
                Item
                  32.1Certification
                  of Chief Executive Officer Pursuant to Section 906 of the Sarbanes
                  Oxley
                  Act
                
                Item
                  32.2Certification
                  of Acting Chief Financial Officer Pursuant to Section 906 of the
                  Sarbanes
                  Oxley Act




29


**SIGNATURES**






In accordance with the requirements of the Exchange Act, the registrant caused
      this report on Form 10-Q to be signed on its behalf by the undersigned,
      thereunto duly authorized.




**DOCUMENT
                SECURITY SYSTEMS, INC.**Date: August
              14, 2007
            By:
            /s/ Patrick
              WhitePatrick
                White
              Chief
                Executive Officer










Date: August
              14, 2007
            By:
            /s/ Philip
              JonesPhilip
                  Jones
                Acting
                  Chief Financial Officer
                (Vice
                  President of Finance)









30