**UNITED
      STATES SECURITIES AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**


**FORM
      10-Q**




**QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF**


**THE
      SECURITIES EXCHANGE ACT OF 1934**




**For
      the quarterly period ended**  **September
      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 oAccelerated
                filer oNon-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
                oNo
x**
              
              **Applicable
                only to corporate issuers**As
                of November 12, 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
            
            15Item
                3
            
            Quantitative
                and Qualitative Disclosures about Market Risk
            
            25Item
                4
            
            Controls
                and Procedures
            
            25**PART
                II**
            
            **OTHER
                INFORMATION**Item
                1
            
            Legal
                Proceedings
            
            26Item
                1a
            
            Risk
                Factors
            
            27Item
                2
            
            UnregisteredSales
                of Equity Securities and Use of Proceeds
            
            34Item
                3
            
            Defaults
                upon Senior Securities
            
            34Item
                4
            
            Submission
                of Matters to a Vote of Security Holders
            
            34Item
                5
            
            Other
                Information
            
            34Item
                6
            
            Exhibits
            
            3435**SIGNATURES**





2




**PART
      I**





**FINANCIAL
        INFORMATION**
 ITEM
        1 -
        FINANCIAL STATEMENTS
  **DOCUMENT
        SECURITY SYSTEMS, INC. AND SUBSIDIARIES**
 **Consolidated
        Balance Sheets**


**September
                  30,**
              
              **December
                  31,****2007**
              
              **2006****(unaudited)**
              
              **(audited)****ASSETS****Current
                  assets:**Cash
                  and cash equivalents
              
              $
              1,376,944
              
              $
              5,802,615Accounts
                  receivable, net of allowanceof
                  $39,000 ($74,000 -2006)
              
              
              731,492
              
              
              618,622Inventory
              
              
              234,654
              
              
              239,416Prepaid
                  expenses and other current assets
              
              
              857,469
              
              
              224,782Total
                  current assets
              
              
              3,200,559
              
              
              6,885,435**Restricted
                  cash**
              
              
              177,345
              
              
              -**Fixed
                  assets, net**
              
              
              887,278
              
              
              637,732**Other
                  assets**
              
              
              145,351
              
              
              156,734**Goodwill**
              
              
              1,396,734
              
              
              1,396,734**Other
                  intangible assets, net**
              
              
              6,573,643
              
              
              5,389,564**Total
                  Assets**
              
              $
              12,380,910
              
              $
              14,466,199**LIABILITIES
                  AND STOCKHOLDERS' EQUITY****Current
                  liabilities:**Accounts
                  payable
              
              $
              1,472,350
              
              $
              1,283,503Accrued
                  expenses & other current liabilities
              
              
              564,126
              
              
              877,261Deferred
                  revenue
              
              
              780,912
              
              
              564,439Current
                  portion of capital lease obligations
              
              
              31,336
              
              
              34,814Total
                  current liabilities
              
              
              2,848,724
              
              
              2,760,017**Long-term
                  capital lease obligations**
              
              
              26,755
              
              
              50,417**Long-term
                  deferred revenue**
              
              
              15,938
              
              
              466,875**Commitments
                  and contingencies (see Note 9)****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
              
              
              31,235,453
              
              
              28,145,793Accumulated
                  deficit
              
              
              (22,019,481
              )
              
              (17,227,797
              )Total
                  stockholders' equity
              
              
              9,489,493
              
              
              11,188,890**Total
                  Liabilities and Stockholders' Equity**
              
              $
              12,380,910
              
              $
              14,466,199


See
        accompanying notes
  3
 **DOCUMENT
          SECURITY SYSTEMS, INC. AND SUBSIDIARIES**
 **Consolidated
            Statements of Operations**
 **(unaudited)**
 **Three
                    Months Ended**
                
                **Nine
                    Months Ended****September
                    30,**
                
                **September
                    30,**
                
                **September
                    30,**
                
                **September
                    30,****2007**
                
                **2006**
                
                **2007**
                
                **2006**RevenueSecurity
                    printing
                
                $
                945,941
                
                $
                723,916
                
                $
                2,764,323
                
                $
                2,185,193Royalties
                
                
                278,290
                
                
                246,528
                
                
                871,243
                
                
                343,223Digital
                    solutions
                
                
                9,469
                
                
                -
                
                
                184,240
                
                
                -Legal
                    products
                
                
                175,725
                
                
                167,518
                
                
                513,070
                
                
                483,983Total
                    Revenue
                
                
                1,409,425
                
                
                1,137,962
                
                
                4,332,876
                
                
                3,012,399Costs
                    of revenueSecurity
                    printing
                
                
                635,935
                
                
                511,343
                
                
                1,691,473
                
                
                1,399,820Digital
                    solutions
                
                
                3,507
                
                
                -
                
                
                40,521
                
                
                -Legal
                    products
                
                
                82,575
                
                
                86,355
                
                
                276,342
                
                
                267,240Total
                    costs of revenue
                
                
                722,017
                
                
                597,698
                
                
                2,008,336
                
                
                1,667,060**Gross
                    profit**
                
                
                687,408
                
                
                540,264
                
                
                2,324,540
                
                
                1,345,339**Operating
                    expenses:**Selling,
                    general and administrative
                
                
                1,979,171
                
                
                1,363,654
                
                
                5,587,903
                
                
                3,674,767Research
                    and development
                
                
                110,833
                
                
                93,693
                
                
                314,130
                
                
                262,577Amortization
                    of intangibles
                
                
                480,256
                
                
                275,714
                
                
                1,258,985
                
                
                763,989Operating
                    expenses
                
                
                2,570,260
                
                
                1,733,061
                
                
                7,161,018
                
                
                4,701,333**Operating
                    loss**
                
                
                (1,882,852
                )
                
                (1,192,797
                )
                
                (4,836,478
                )
                
                (3,355,994
                )**Other
                    income (expense):**Interest
                    income
                
                
                14,829
                
                
                7,200
                
                
                89,816
                
                
                51,338Loss
                    on foreign currency transactions
                
                
                (6,378
                )
                
                -
                
                
                (10,669
                )
                
                -Interest
                    expense
                
                
                (1,362
                )
                
                (2,788
                )
                
                (3,811
                )
                
                (13,632
                )****Loss
                    from continuing operations before income
                    taxes****
                
                
                (1,875,763
                )
                
                (1,188,385
                )
                
                (4,761,142
                )
                
                (3,318,288
                )Income
                    taxes
                
                
                4,738
                
                
                -
                
                
                14,214
                
                
                -**Loss
                    from continuing operations**
                
                
                (1,880,501
                )
                
                (1,188,385
                )
                
                (4,775,356
                )
                
                (3,318,288
                )**Loss
                    from discontinued operations (Note 6):**Gain
                    on sale of discontinued assets
                
                
                42,905
                
                
                -
                
                
                42,905
                
                
                -Loss
                    from operations of discontinuedoperations
                
                
                (43,807
                )
                
                (16,041
                )
                
                (59,233
                )
                
                (87,237
                )**Loss
                    on discontinued operations**
                
                
                (902
                )
                
                (16,041
                )
                
                (16,328
                )
                
                (87,237
                )**Net
                    loss**
                
                $
                (1,881,403
                )
                $
                (1,204,426
                )
                $
                (4,791,684
                )
                $
                (3,405,525
                )**Net
                    loss per share -basic and diluted:**Continuing
                    operations
                
                $
                (0.14
                )
                $
                (0.09
                )
                $
                (0.35
                )
                $
                (0.26
                )Discontinued
                    operations
                
                
                0.00
                
                
                0.00
                
                
                0.00
                
                
                0.00Net
                    Loss
                
                $
                (0.14
                )
                $
                (0.09
                )
                $
                (0.35
                )
                $
                (0.26
                )Weighted
                    average common shares outstanding,
                  basic
                    and diluted
                
                
                13,676,030
                
                
                12,920,315
                
                
                13,629,241
                
                
                12,868,887
 See
          accompanying notes
  4


**DOCUMENT
        SECURITY SYSTEMS, INC. AND SUBSIDIARIES**
  **Consolidated
        Statements of Cash Flows**
 **For
        the Nine Months Ended September 30,**
  **2007**
              
              
              **2006****Cash
                  flows from operating activities:**
              
              
              **(unaudited)**
              
              
              **(unaudited)**Net
                  loss
              
              $
              (4,791,684
              )
              $
              (3,405,525
              )Adjustments
                  to reconcile net loss to net cash used byoperating
                  activities:Depreciation
                  and amortization expense
              
              
              1,396,262
              
              
              927,635Stock
                  based compensation
              
              
              970,829
              
              
              591,684Net
                  gain on disposal of discontinued operations
              
              
              (42,905
              )
              
              -(Increase)
                  decrease in assets:Accounts
                  receivable
              
              
              (112,870
              )
              
              (389,229
              )Inventory
              
              
              4,762
              
              
              (30,487
              )Prepaid
                  expenses and other assets
              
              
              (171,526
              )
              
              (20,541
              )Increase
                  (decrease) in liabilities:Accounts
                  payable
              
              
              445,334
              
              
              360,080Accrued
                  expenses
              
              
              (25,635
              )
              
              (125,361
              )Deferred
                  revenue
              
              
              (234,464
              )
              
              595,783Net
                  cash used by operating activities
              
              
              (2,561,897
              )
              
              (1,495,961
              )**Cash
                  flows from investing activities:**Purchase
                  of fixed assets
              
              
              (423,918
              )
              
              (78,204
              )Proceeds
                  from the sale of discontinued operations
              
              
              80,000
              
              
              -Acquisition
                  of business
              
              
              -
              
              
              (1,301,670
              )Increase
                  in other intangible assets
              
              
              (1,150,977
              )
              
              (453,542
              )Net
                  cash used by investing activities
              
              
              (1,494,895
              )
              
              (1,833,416
              )**Cash
                  flows from financing activities:**Repayment
                  of long-term debt
              
              
              -
              
              
              (218,200
              )(Increase)
                  decrease in restricted cash
              
              
              (177,345
              )
              
              240,000Repayment
                  of capital lease obligations
              
              
              (27,140
              )
              
              (24,704
              )Payment
                  of accrued stock issuance costs
              
              
              (519,619
              )
              
              -Issuance
                  of common stock
              
              
              355,225
              
              
              899,159Net
                  cash (used) provided by financing activities
              
              
              (368,879
              )
              
              896,255**Net
                  decrease in cash and cash equivalents**
              
              
              (4,425,671
              )
              
              (2,433,122
              )**Cash
                  and cash equivalents beginning of period**
              
              
              5,802,615
              
              
              3,953,482**Cash
                  and cash equivalents end of period**
              
              $
              1,376,944
              
              $
              1,520,360




See
      accompanying notes




5




**DOCUMENT
      SECURITY SYSTEMS, INC.**


**NOTES
      TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**


**September
      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.




The
      Company recognizes 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.




The
      Company also enters into arrangements under which hosted software applications
      are provided. Revenue is recognized 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. Revenues related to these
      arrangements consist of system implementation service fees and software
      subscription fees. 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, revenue is recognized on 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 is the contractual life of the
      customer’s subscription agreement. Software subscription fees, which typically
      commence upon completion of the related system implementation, are recognized
      ratably over the applicable subscription period. Amounts billed and/or collected
      prior to satisfying our revenue recognition policy are reflected as deferred
      revenue.




6





***Share-Based
      Payments -*** The
      Company’s accounting policy for equity instruments issued to consultants and
      vendors in exchange for goods and services follows the provisions of EITF 96-18,
      “Accounting for Equity Instruments That are Issued to Other Than Employees for
      Acquiring, or in Conjunction with Selling, Goods or Services” and EITF 00-18,
“Accounting Recognition for Certain Transactions Involving Equity Instruments
      Granted to Other Than Employees.” The measurement date for the fair value of the
      equity instruments issued is determined at the earlier of (i) the date at
      which a commitment for performance by the consultant or vendor is reached or
      (ii) the date at which the consultant or vendor’s performance is complete.
      In the case of equity instruments issued to consultants, the fair value of
      the
      equity instrument is recognized over the term of the consulting
      agreement.





***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
      8).




**2.    
      Restricted Cash**




In
      July
      2007, the Company was required to establish a restricted cash balance of 87,500
      pounds, or approximately $177,000, as collateral for a deed of guarantee
      required by the English Court of Appeals in order for the Company to pursue
      an
      appeal in that court. (See Note 9 *Legal
      Matters)*




**3.**  **Inventory**




Inventory
      consisted of the following:




**September
                  30,**
              
              
              **December
                  31,****2007**
              
              
              **2006****(unaudited)**
              
              
              **(audited)**Finished
                  Goods
              
              $
              139,434
              
              $
              145,206Raw
                  Materials
              
              
              95,220
              
              
              94,210$
              234,654
              
              $
              239,416




7




**4.    
      Other Intangible Assets**




Other
      intangible assets are comprised of the following:


**September
                  30, 2007**
              
              
              **December
                  31, 2006****Useful**
              
              
              **Gross
                  Carrying**
              
              
              **Accumulated**
              
              
              **Net
                  Carrying**
              
              
              **Gross
                  Carrying**
              
              
              **Accumulated**
              
              
              **Net
                  Carrying****Life**
              
              
              **Amount**
              
              
              **Amortizaton**
              
              
              **Amount**
              
              
              **Amount**
              
              
              **Amortizaton**
              
              
              **Amount**Royalty
                  rights
              
              
              5
                  years
              
              $
              90,000
              
              $
              67,500
              
              $
              22,500
              
              $
              90,000
              
              $
              54,000
              
              $
              36,000Other
                  intangibles
              
              
              5
                  years
              
              
              1,187,595
              
              
              277,258
              
              
              910,337
              
              
              666,300
              
              
              149,036
              
              
              517,264Patent
                  and contractual rights
              
              
              Varied
                  (1)
              
              
              8,134,170
              
              
              2,493,364
              
              
              5,640,806
              
              
              6,212,400
              
              
              1,376,100
              
              
              4,836,300****
              **$**
              **9,411,765**
              
              **$**
              **2,838,122**
              
              **$**
              **6,573,643**
              ****
              **$**
              **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  September
                  30, 2007 the weighted average remaining useful life of these assets
                  in
                  service was 4.0
                  years.




**5.    
      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 nine months ended
      September 30, 2007, 60,866 restricted common shares were issued to MWE to pay
      for approximately $746,000 of legal fees incurred through September 30, 2007.
      In
      total, 107,881 shares valued at $1,203,000 have been issued to MWE.





***Stock
      Issued in Private Placement -*** On
      January 22, 2007, the Company sold 6 units at a price of $50,000 per unit
      consisting of 35,280 unregistered shares of its common stock and five-year
      warrants to purchase up to an aggregate of 17,640 shares of its 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, in January 2007, the Company paid $492,000
      of private placement fees and legal fees related to an offering that occurred
      during 2006.




***Restricted
      Stock -*** On
      May 3,
      2007, the Company granted 25,000 restricted shares of its common stock pursuant
      to the Company’s 2004 Employee Stock Option Plan 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 445,000 shares vest only upon the occurrence of certain events
      over the next 5 years, which include, among other things a change of control
      of
      the Company 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
      445,000 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. As of September 30, 2007, vesting is not considered
      probable and no compensation expense has been recognized.




8




***Stock
      Options*** - On
      March 26, 2007, the Company issued options to purchase 150,000 shares of its
      common stock pursuant to the Company’s 2004 Employee Stock Option Plan with an
      exercise price of $10.89 per share to a third party consultant that vest over
      three years, subject to certain vesting acceleration provisions. During the
      nine
      months ended September 30, 2007, the Company recognized approximately $98,000
      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 at the then current fair
      value of at each reporting date as the services are performed in accordance
      with
      EITF 96-18. In the case of equity instruments issued to consultants, the fair
      value of the equity instrument is recognized over the term of the consulting
      agreement in accordance to EITF 00-18.




During
      2007 the Company has issued options to purchase 177,5000 of its common shares pursuant
      to the Company’s 2004 Employee Stock Option Plan and the 2004 Non-Employee
      Officer Director Stock Option Plan at exercise
      prices ranging from $11.10 to $12.50 per share to employees and directors that
      vest between one to two years. During the nine months ended September 30, 2007,
      the Company recognized approximately $194,000 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.





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




In
      June,
      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 from June 16, 2007
      to
      December 31, 2007. In exchange, 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. During the nine
      months ended September 30, 2007, the Company recognized approximately $223,000
      of stock based compensation associated with these warrants, prior to the
      modification of the warrants.




In
      August
      2007, the Company issued 25,000 fully vested warrants to purchase the Company’s
      shares with an exercise price of $12.59 per share with a three-year term to
      a
      unrelated third party consultant. In September 2007, the Company issued 136,750
      warrants to purchase the Company’s shares with an exercise price of $12.63 per
      share with a five-year term to another unrelated third party consultant of
      which
      50% of the warrants vested upon issuance with the remaining warrants to vest
      six
      months from the date of grant, subject to certain vesting acceleration
      provisions. As a result of these warrant issuances, the Company recognized
      $46,000 of compensation expense during the three months ended September 30,
      2007. In addition, approximately $525,000 was recorded as prepaid services
      associated with the nonforfeitable, fully vested portion of these warrant
      grants. The Company values stock warrants utilizing the Black Scholes option
      pricing model. The Company records stock based payment expense related to these
      warrants at the then current fair value of at each reporting date as the
      services are performed in accordance with EITF 96-18. In the case of equity
      instruments issued to consultants, the fair value of the equity instrument
      is
      recognized over the term of the consulting agreement in accordance to EITF
      00-18. Accordingly, the Company records the fair value of nonforfeitable, fully
      vested warrants issued for future consulting services as prepaid services in
      its
      consolidated balance sheet.




9





***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 nine months ended September
      30, 2007, the Company recognized approximately $338,000 and $971,000,
      respectively ($311,000 and $592,000- respectively, in 2006) in stock-based
      compensation.





As
      of
      September 30, 2007, there were approximately $9.1 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 of not to exceed five years. The total fair value of
      options, warrants and restricted shares that vested during the nine-month period
      ended September 30, 2007 was approximately $1,657,000 ($542,000 -
      2006).





**6.    
      Discontinued Operations**





On
      September 25, 2007, the Company sold certain assets and the operations of its
      retail copying and quickprinting operations to an unrelated third party for
      $80,000 and the assumption of ongoing operating leases. The sale included fixed
      assets with a net book value of approximately $37,000. The Company recognized
      a
      gain on the sale of approximately $43,000. In accordance with SFAS 144, the
      disposal of assets constitutes a component of the entity and has been accounted
      for as discontinued operations. The Company recognized a gain on the sale of
      approximately $43,000. The operating results relating to these assets 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**
              
              
              **Nine
                  Months Ended****September
                  30,**
              
              
              **September
                  30,**
              
              
              **September
                  30,**
              
              
              **September
                  30,****2007**
              
              
              **2006**
              
              
              **2007**
              
              
              **2006**Revenues
              
              $
              72,791
              
              $
              125,347
              
              $
              292,282
              
              $
              423,426Cost
                  of sales
              
              
              48,720
              
              
              70,027
              
              
              150,525
              
              
              265,505Operating
                  expenses
              
              
              67,878
              
              
              71,361
              
              
              200,990
              
              
              245,158Loss
                  from discontinuedoperations
              
              $
              (43,807
              )
              $
              (16,041
              )
              $
              (59,233
              )
              $
              (87,237
              )


**7.    
      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 nine-month period ended September
      30,
      2007, 767,887 (875,436- 2006) common equivalent shares would have been added
      to
      the weighted average shares outstanding to compute the diluted weighted average
      shares outstanding.




10





**8.
       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
      tax deficiencies
      in the provision for income taxes in the consolidated statements of
      operations.  As of September 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.




**9.    
      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 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*




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. The Court of First Instance
      ruled on September 5, 2007 that it does not have jurisdiction to rule on the
      patent infringement claim, which has opened the door for country-by-country
      infringement litigation.





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. 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. 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.
      This appeal is scheduled for February 4, 2008. 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 rewarded the ECB 180,000 pounds ($365,000) for such reimbursement, of
      which the Company paid 90,000 pounds ($182,000) on April 4, 2007 and the
      remaining 90,000 pounnds ($182,000) is included in accrued expense at September
      30, 2007. On March 27, 2007, the German Federal Patent Court
      (Bundespatentgericht) in Munich ruled that the Patent was valid in Germany.
      This
      ruling validates the legal basis of the Company’s infringement suit against the
      ECB. The ECB is appealing the German ruling. In addition, as a result of this
      ruling, the Company expects to be awarded reimbursements for its costs
      associated with the German validity case, which is Euro
      44,692 .
      On June
      4, 2007, a trial was held in the Paris High Court in Paris, France regarding
      a
      validity of the Patent. A decision in the French trial is expected on January
      9,
      2008. The Netherlands trial has been set for December 14, 2007 in Amsterdam,
      and
      the Spanish trial in early 2008. Additional trials regarding validity are
      expected to commence in the four other countries during 2008 and
      2009.




11





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.




12




*Commitments*




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 September 30, 2007, there have been no settlement amounts
      related to these agreements.




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.


**10.
      Supplemental Cash Flow Information**




During
      the nine months ended September 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 issued fully vested, nonforfeitable warrants to consultants of
      approximately $525,000 that are recorded as a prepaid expense that will be
      recognized as stock based compensation expense over the term of the consulting
      agreement. 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 nine months ended September 30, 2006, the Company issued
      18,704 shares of Common Stock valued at $250,000 in conjunction with the
      acquisition of Plastic Printing Professionals.




**11.    
      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 September
                2007,
                the Company sold 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
                6).




13




**Legal
                Supplies**
            Sale
                of specialty legal supplies, primarily to lawyers and law firms located
                throughout the United States as
                Legalstore.com.




Approximate information concerning the operations by reportable segment for
      the
      three and nine months ended September 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:


**Legal**
              
              **Security
                  &****Supplies**
              
              **Production**
              
              **Corporate**
              
              **Total****3
                  months ended Septmber 30, 2007:**Revenues
                  from external customers from continuing operations
              
              $
              176,000
              
              $
              1,233,000
              
              $
              -
              
              $
              1,409,000Depreciation
                  and amortization from continuing operations
              
              
              3,000
              
              
              511,000
              
              
              1,000
              
              
              515,000Segment
                  profit or (loss) from continuingoperations
              
              
              (13,000
              )
              
              (799,000
              )
              
              (1,069,000
              )
              
              (1,881,000
              )**3
                  months ended September 30, 2006:**Revenues
                  from external customers from continuing operations
              
              $
              $168,000
              
              $
              970,000
              
              $
              -
              
              
              1,138,000Depreciation
                  and amortization from continuing operations
              
              
              3,000
              
              
              288,000
              
              
              16,000
              
              
              307,000Segment
                  profit or (loss) from continuingoperations
              
              
              13,000
              
              
              (773,000
              )
              
              (428,000
              )
              
              (1,188,000
              )
  **Document****Legal**
              
              
              **Security
                  &****Supplies**
              
              
              **Production**
              
              
              **Corporate**
              
              
              **Total****9
                  months ended September 30, 2007:**Revenues
                  from external customers from continuing operations
              
              $
              513,000
              
              $
              3,820,000
              
              $
              -
              
              $
              4,333,000Depreciation
                  and amortization from continuing operations
              
              
              9,000
              
              
              1,324,000
              
              
              30,000
              
              
              1,363,000Segment
                  profit or (loss) from continuingoperations
              
              
              (11,000
              )
              
              (2,217,000
              )
              
              (2,547,000
              )
              
              (4,775,000
              )
  **9
                  months ended September 30, 2006:**Revenues
                  from external customers from continuing operations
              
              $
              484,000
              
              $
              2,528,000
              
              $
              -
              
              $
              3,012,000Depreciation
                  and amortization from continuing operations
              
              
              9,000
              
              
              796,000
              
              
              72,000
              
              
              877,000Segment
                  profit or (loss) from continuingoperations
              
              
              (18,000
              )
              
              (1,845,000
              )
              
              (1,455,000
              )
              
              (3,318,000
              )
  14




**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.




15





*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**.





*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:





·
            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.




16




·
            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 Nine Months Ended***  ***September
      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 effect of the
      discontinued operations. On September 25, 2007, the Company sold 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.


**Revenue**
 **Three
                  Months Ended September 30, 2007**
              
              
              **Nine
                  Months Ended September 30, 2007****%
                  change vs. 3 months**
              
              
              
              
              
              **%
                  change vs. 9 months****$**
              
              
              **ended
                    September 30,**
                  **2006**
              
              
              **$**
              
              
              **ended
                    September 30,**
                  **2006**RevenueSecurity
                  printing
              
              $
              946,000
              
              
              31
              %
              $
              2,765,000
              
              
              27
              %Royalties
              
              
              278,000
              
              
              13
              %
              
              871,000
              
              
              154
              %Digital
                  solutions
              
              
              9,000
              
              
              
              
              
              184,000Legal
                  products
              
              
              176,000
              
              
              5
              %
              
              513,000
              
              
              6
              %Total
                  Revenue
              
              
              1,409,000
              
              
              24
              %
              
              4,333,000
              
              
              44
              %




Document
        Security and Production




For
      the
      three-month period ended September 30, 2007, revenue from continuing operations
      increased 24% from the same period ended September 30, 2006. The increase in
      revenue resulted primarily from increases sales of security printing and
      increases in royalty revenue from the licensing of the Company’s patented
      technology. Sales of security printing, after removing in discontinued
      operations, increased 31% from the prior year’s quarter which reflected
      increased demand for the Company’s plastic printing unit driven by shipments on
      a foreign driver license project along with increases in sales of its security
      paper products, which were positively impacted by orders of security paper
      for
      Medicaid Prescription Pads. The Company, through its agreement with Boise
      Cascade provides paper that meets the standard Medicaid legislation regarding
      paper-based anti-copy/anti-scan security features required in Medicaid papers.
      The Company saw a significant increase in orders for secure prescription paper
      based on recent U.S. Federal legislation from that requires secure paper to
      be
      used in order to receive Medicaid reimbursements for prescriptions. While the
      initial deadline for compliance was moved from October 1, 2007 to April 1,
      2008,
      the Company experienced a increase in demand for security paper as healthcare
      providers rushed to meet the new requirements.




17




For
      the
      nine-month period ended September 30, 2007, revenue from continuing operations
      increased 44% from the same period ended September 30, 2006. The Company has
      increased revenue in all of its major product categories, including increases
      in
      royalty revenue from the licensing of the Company’s patented technology, an
      increase in sales of security products and documents, including initial
      shipments on a foreign driver license project and increased demand of the
      Company’s security paper, and for initial sales of the Company’s On-Demand
      product which was introduced in early 2007. In addition, the security printing
      revenue increase reflects the effect of the Company’s acquisition in February
      2006 of Plastic Printing Professionals.




Legal
      Products




Revenue from our legal products business, Legalstore.com, increased 5% during
      the third quarter of 2007 compared with the third quarter of 2006, and has
      increased 6% through the first nine 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 September 30, 2007**
              
              
              **Nine
                  Months Ended September 30, 2007****%
                  change vs. 3 months**
              
              
              
              
              
              **%
                  change vs. 9 months****$**
              
              
              **ended
                    September 30,****2006**
              
              
              **$**
              
              
              **ended
                    September 30,****2006**Costs
                  of revenueSecurity
                  printing & products
              
              $
              636,000
              
              
              24
              %
              $
              1,691,000
              
              
              21
              %Digital
                  solutions
              
              
              3,000
              
              
              
              
              
              41,000Legal
                  products
              
              
              83,000
              
              
              -3
              %
              
              276,000
              
              
              3
              %Total
                  cost of sales
              
              
              722,000
              
              
              21
              %
              
              2,008,000
              
              
              20
              %Gross
                  profitSecurity
                  printing & products
              
              
              310,000
              
              
              46
              %
              
              1,073,000
              
              
              37
              %Royalties
              
              
              278,000
              
              
              13
              %
              
              871,000
              
              
              154
              %Digital
                  solutions
              
              
              6,000
              
              
              
              
              
              143,000Legal
                  products
              
              
              93,000
              
              
              13
              %
              
              237,000
              
              
              9
              %Total
                  gross profit
              
              
              687,000
              
              
              27
              %
              
              2,324,000
              
              
              73
              %




**Three
                  Months Ended September 30, 2007**
              
              
              **Nine
                  Months Ended September 30, 2007****%
                  change vs. 3 months**
              
              
              
              
              
              **%
                  change vs. 9 months****ended
                  September 30,**
              
              
              
              
              
              **ended
                  September 30,****%**
              
              
              **2006**
              
              
              
              
              
              **2006**Gross
                  profit percentage:Security
                  printing & products
              
              
              33
              %
              
              11
              %
              
              39
              %
              
              8
              %Royalties
              
              
              100
              %
              
              0
              %
              
              100
              %
              
              0
              %Digital
                  solutions
              
              
              67
              %
              
              
              
              
              78
              %Legal
                  supplies
              
              
              53
              %
              
              8
              %
              
              46
              %
              
              3
              %Gross
                  profit percentage:
              
              
              49
              %
              
              2
              %
              
              54
              %
              
              20
              %


18




Gross
      Profit




During
      the third quarter of 2007, gross profit from continuing operations increased
      27%
      to $687,000 as compared to the third quarter of 2006 driven by the increase
      in
      sales volume. During the first nine months of 2007, gross profit from continuing
      operations increased 73% to $2,324,000. Along with increases as the result
      of
      license agreements with 100% gross profit percentages and a digital solution
      implementation with a 78% gross profit percentage, 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. These items resulted
      in
      the Company’s gross profit margin increasing 20% during the first nine months of
      2007 as compared to the first nine months of 2006.


**Operating
        Expenses**


**Three
                  Months Ended September 30, 2007**
              
              **Nine
                  Months Ended September 30, 2007****%
                  change vs. 3 months**
              
              
              
              **%
                  change vs. 9 months****ended
                  September 30,**
              
              
              
              **ended
                  September 30,****$**
              
              **2006**
              
              **$**
              
              **2006**Selling,
                  general and administrativeGeneral
                  and administrativecompensation
              
              $
              514,000
              
              
              25
              %
              $
              1,310,000
              
              
              23
              %Stock
                  based payments
              
              
              338,000
              
              
              9
              %
              
              971,000
              
              
              64
              %Professional
                  fees
              
              
              352,000
              
              
              66
              %
              
              1,036,000
              
              
              10
              %Sales
                  and marketing
              
              
              466,000
              
              
              108
              %
              
              1,525,000
              
              
              149
              %Depreciation
                  and amortization
              
              
              20,000
              
              
              11
              %
              
              61,000
              
              
              -18
              %Other
              
              
              289,000
              
              
              55
              %
              
              685,000
              
              
              74
              %Research
                  and development
              
              
              111,000
              
              
              18
              %
              
              314,000
              
              
              19
              %Amortization
                  of intangibles
              
              
              480,000
              
              
              74
              %
              
              1,259,000
              
              
              65
              %Total
                  Operating Expenses
              
              
              2,570,000
              
              
              48
              %
              
              7,161,000
              
              
              52
              %
  **Selling,
        General and Administrative**




The
      Company’s selling, general and administrative costs increases generally reflect
      increases in stock based payments and 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
      increases from continuing operations for the three and nine months ended
      September 30 , 2007 reflect the impact of additions at the Company in senior
      management and administrative personnel and the impact of increases in medical
      benefit costs of 11% as compared to the prior year. In addition, the Company
      incurred annual payrate increases on average of approximately 6% for existing
      employees as compared to 2006 rates. The Company does not anticipate significant
      growth in its general and administrative compensation costs as it believes
      that
      it is sufficiently staffed for its current and near-term
      requirements.




19




Stock-based
      payments during
      the three months ended September 30, 2007 were relatively consistent with the
      three months ended September 30, 2006. The 2007 period reflects expenses due
      to
      options and restricted stock grants to new employees and consultants, including
      an addition to the Company’s senior management team. The Company believes that
      the grant of equity instruments is an important component of its overall
      compensation program because it improves the Company’s ability to attract and
      retain its human resources as well as obtain the services of various third
      parties without consuming its cash resources significantly. During the third
      quarter of 2007, the Company issued warrants to two unrelated third party
      consultants which resulted in approximately $46,000 of stock based expense
      recorded during the quarter as a result of these warrants. Stock-based
      compensation during the three months ended September 30, 2006 included
      approximately $223,000 of expense recognized for the issuance of warrants to
      International Barcode Corporation (d/b/a Barcode Technology) (“BTI”) in
      consideration for a cross-marketing relationship. There was no expense
      associated with these warrants during the third quarter of 2007. The
      Company values stock warrants utilizing the Black Scholes option pricing model.
      The Company records stock based payment expense related to these warrants at
      the
      then current fair value of at each reporting date as the services are performed
      in accordance with EITF 96-18. In the case of equity instruments issued to
      consultants, the fair value of the equity instrument is recognized over the
      term
      of the consulting agreement in accordance to EITF 00-18. 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.




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 in the period in which any of the contingent
      vesting events is deemed to be probable.




Professional
      fees


**Three
                  Months Ended September 30, 2007**
              
              
              **Nine
                  Months Ended September 30, 2007****%
                  change vs. 3 months**
              
              
              
              
              
              **%
                  change vs. 9 months****ended
                  September 30,**
              
              
              
              
              
              **ended
                  September 30,****$**
              
              
              **2006**
              
              
              **$**
              
              
              **2006***Professional
                  Fees Detail*Accounting
                  and auditing
              
              $
              71,000
              
              
              209
              %
              $
              236,000
              
              
              70
              %Consulting
              
              
              95,000
              
              
              28
              %
              
              292,000
              
              
              36
              %Legal
                  Fees
              
              
              120,000
              
              
              126
              %
              
              255,000
              
              
              -4
              %Stock
                  Transfer, SEC and InvestorRelations
              
              
              66,000
              
              
              74
              %
              
              253,000
              
              
              7
              %$
              352,000
              
              
              87
              %
              $
              1,036,000
              
              
              21
              %




Professional
      fees include legal, accounting, shareholder services, investor relations, and
      consulting costs. During the first nine 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 significant
      costs associated with the Company’s Sarbanes Oxley compliance requirements.
      Consulting fees increased during the first nine 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 during the first nine months of 2007 have remained relatively flat
      as
      compared to 2006 as the Company expends costs on certain of its legal matters.
      Legal cost increases associated with increased activity in the Company’s Adler
      Technologies matter have been partially offset by cost savings associated with
      the hiring of an in-house counsel that had formerly worked for the Company
      in a
      retainer arrangement. These legal costs do not include approximately $1,923,000
      of legal and related costs incurred during the first nine months of 2007
      ($922,000 -2006) 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 9 - Legal Matters* )




20




Sales
      and marketing expenses, including sales and marketing personnel costs, increased in the third
      quarter and through the first nine 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 third quarter of 2007, the
      Company’s costs included costs associated with the September 17, 2007 launch of
      its AuthentiGuard® On-Demand(TM) product, attendance at several trade shows and
      international business development efforts, including meetings with prospective
      customers in Saudi Arabia, Germany, and Mexico. In addition, the Company
      initiated a direct mailing campaign to targeted vertical markets as a method
      of
      increasing the awareness of the Company’s products.




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
      increases associated with a larger organization and increase in rent associated
      with the move of the Company’s plastic printing division to a 25,000 square foot
      facility, a five-fold increase in space for that division. In addition, rent
      increased due to the addition of a Washington, DC sales office in
      2007.




**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.




**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 net amortizable patent asset base
      at
      September 30, 2007 was approximately $5.6 million and will generate
      approximately $1.7 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.




21




In
      addition, the Company has approximately $932,000 of net other intangible assets
      as of September 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 $250,000 of annual
      amortization expense during the next 4 years.




In
      addition, the Company has approximately $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**




On
      September 25, 2007, the Company sold certain assets and the operations of its
      retail copying and quick-printing operations to an unrelated third party for
      $80,000 and the assumption of ongoing operating leases. The sale included fixed
      assets with a net book value of approximately $37,000. The Company recognized
      a
      gain on the sale of approximately $43,000. In accordance with SFAS 144, the
      disposal of assets constitutes a component of the entity and has been accounted
      for as discontinued operations. Prior to the sale, revenue from those operations
      decreased 42% for the three months and 31% for nine months ended September
      30,
      2007, respectively, as compared to the 2006 periods. The decline in sales of
      these operations was primarily contributed to the Company’s shift of resources
      from these operations to its security research and operations in the middle
      of
      2006.




**Net
      loss and loss per share**


**Three
                  Months Ended September 30, 2007**
              
              
              **Nine
                  Months Ended September 30, 2007****%
                  change vs. 3 months**
              
              
              
              
              
              **%
                  change vs. 9 months****ended
                  September 30,**
              
              
              
              
              
              **ended
                  September 30,****$**
              
              
              **2006**
              
              
              **$**
              
              
              **2006**Net
                  loss
              
              
              (1,881,000
              )
              
              56
              %
              
              (4,792,000
              )
              
              41
              %Net
                  loss per share, basic and diluted
              
              
              (0.14
              )
              
              57
              %
              
              (0.35
              )
              
              35
              %Weighted
                  average commonshares
                  outstanding, basic and diluted
              
              
              13,676,030
              
              
              6
              %
              
              13,629,241
              
              
              6
              %




During
      the third quarter and first nine months of 2007, the Company experienced a
      net
      loss of $1.9 million and $4.8 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. As discussed below, our net income is
      significantly impacted by amortization of intangibles and stock-based
      compensation expense, which accounted for 43% and 47%, of the Company’s net
      losses for the third quarter and first nine months of 2007,
      respectively.




During
      the third quarter and first nine months 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
      primarily due common shares issued by the Company in a private placement in
      December 2006 and January 2007, and for the payment of patent defense costs.




22




**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.




Adjusted
      EBITDA


**Three
                  Months Ended September 30, 2007**
              
              
              **Nine
                  Months Ended September 30, 2007****%
                  change vs. 3 months**
              
              
              
              
              
              **%
                  change vs. 9 months****ended
                  September 30,**
              
              
              
              
              
              **ended
                  September 30,****$**
              
              
              **2006**
              
              
              **$**
              
              
              **2006**Net
                  Loss
              
              $
              (1,881,000
              )
              
              56
              %
              $
              (4,792,000
              )
              
              41
              %Add
                  back:Depreciation
              
              
              45,000
              
              
              0
              %
              
              137,000
              
              
              -16
              %Amortization
                  of Intangibles
              
              
              480,000
              
              
              74
              %
              
              1,259,000
              
              
              65
              %Stock
                  based payments
              
              
              338,000
              
              
              9
              %
              
              971,000
              
              
              64
              %Interest
                  Income
              
              
              (15,000
              )
              
              114
              %
              
              (90,000
              )
              
              76
              %Interest
                  Expense
              
              
              1,000
              
              
              -67
              %
              
              4,000
              
              
              -71
              %Income
                  Taxes
              
              
              5,000
              
              
              
              
              
              14,000854,000
              
              
              36
              %
              
              2,295,000
              
              
              55
              %Adjusted
                  EBITDA loss
              
              
              (1,027,000
              )
              
              78
              %
              
              (2,497,000
              )
              
              30
              %




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 September 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 57% and 51% during the third quarter and first nine months
      of 2007, respectively, as compared to the 2006 periods. Along with expense
      increases associated with a increase in the size of the Company and an increase
      in its production facilities and capabilities, the Company has significantly
      increased spending for marketing and sales efforts. It is the Company’s belief
      that the amounts it is incurring during the current periods for sales and
      marketing are investments that will drive future revenue to Adjusted EBITDA
      break-even levels. However, 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.




23




**LIQUIDITY
      AND CAPITAL RESOURCES**




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


**Nine
                  Months Ended****September
                  30,**
              
              
              **September
                  30,**
              
              
              **%****2007**
              
              
              **2006**
              
              
              **Change****(unaudited)**
              
              
              **(unaudited)**Cash
                  flows (used) provided by:Operating
                  activities
              
              $
              (2,562,000
              )
              $
              (1,496,000
              )
              
              -71
              %Investing
                  activities
              
              
              (1,495,000
              )
              
              (1,833,000
              )
              
              18
              %Financing
                  activities
              
              
              (369,000
              )
              
              896,000
              
              
              -141
              %Working
                  capital
              
              
              352,000
              
              
              456,000
              
              
              -23
              %Current
                  ratio
              
              
              1.12
              x
              
              1.21
              x
              
              -7
              %




As
      of
      September 30, 2007, we had cash and cash equivalents of $1.4 million, a 76%
      decrease from December 31, 2006. As discussed below, the decrease in the
      Company’s cash position is primarily due to the payment of legal fees associated
      with its patent applications and defense costs, as well as cash used for
      operations.




Operating
      Cash Flow -During the first nine months of 2007, the Company used approximately
      $2.6 million of cash for operations, which is consistent with the Adjusted
      EBITDA loss of $2.5 million during the same period. As discussed above, the
      44%
      increase in revenue during 2007, has been offset by increases in the Company’s
      expenditures, primarily on sales and marketing, production facility expansion
      and Sarbanes Oxley compliance costs. As of September 30, 2007, the Company
      believes that it will need to reach an annual revenue level of approximately
      $9.0 million based on its projected mix of revenue in order to maintain positive
      operating cash flow.




Investing
      Cash Flow -During the first nine months of 2007, the Company used approximately
      $1.5 million of cash for fixed asset additions and to invest in its patent
      portfolio. During the third quarter of 2007, the Company initiated a move into
      new production facility for its San Francisco area plastic printing division.
      Along with increasing the space of the division five-fold, the Company purchased
      new equipment, including a state of the art laminator and a digital plate system
      that significantly will increase the output capacity and efficiency of its
      operations. The Company began to move into the new facility in November, 2007.
      In addition, the Company made payments for legal costs associated with patent
      applications and the defense of its patents, which includes payments to cover
      third party experts fees associated with the Company’s litigation against the
      ECB. During this period, the Company used 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 November 9, 2007, the Company has approximately 239,000 warrants
      outstanding and exercisable at exercise prices below the closing market price
      of
      our Common stock as of November 9, 2007 of $7.30 that, if exercised, would
      produce approximately $1.3 million in cash proceeds to the Company.




24




Cash
      Flows From Discontinued Operations -During the nine months ended September
      30,
      2007, the company’s  retail
      printing and copying division used approximately $31,000 of cash
      for operations. 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 statement s of cash flows for the nine months
      ended
      September 30, 2007 and 2006.




Future
      Capital Needs - As a result of the foregoing, there can be no assurance that
      cash on hand and cash flow generated internally by the Company will be adequate
      to fund the operation of its businesses over the next twelve months. We have
      recently engaged certain financial advisors to assist the Company in entering
      into business relationships or partnerships with certain strategic investors.
      There can be no assurance that we will be able to raise any capital, or that
      any
      such capital would be raised on terms favorable to the Company, or that any
      financing could be obtained without significantly diluting the ownership
      interest of existing shareholders. Accordingly, we may be required to make
      significant changes to our current business plans, including the implementation
      of company-wide cost reductions.




**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.





25




Commencing
      in the second 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.




**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. The Court of First Instance
      ruled on September 5, 2007 that it does not have jurisdiction to rule on the
      patent infringement claim, which has opened the door for country-by-country
      infringement litigation.





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. 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. 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.
      This appeal is scheduled for February 4, 2008. 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 rewarded the ECB 180,000 pounds ($365,000) for such reimbursement, of
      which the Company paid 90,000 pounds ($182,000) on April 4, 2007. On March
      27,
      2007, the German Federal Patent Court (Bundespatentgericht) in Munich ruled
      that
      the Patent was valid in Germany. This ruling validates the legal basis of the
      Company’s infringement suit against the ECB. The EBC is appealing the German
      ruling. In addition, as a result of this ruling, the Company expects to be
      awarded reimbursements for its costs associated with the German validity case,
      which is Euro
      44,692 .
      On June
      4, 2007, a trial was held in the Paris High Court in Paris, France regarding
      a
      validity of the Patent. A decision in the French trial is expected on January
      9,
      2008. The Netherlands trial has been set for December 14, 2007 in Amsterdam,
      and
      the Spanish trial in early 2008. Additional trials regarding validity are
      expected to commence in the four other countries during 2008 and
      2009.





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.




26





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**




An investment in our securities is subject to numerous risks, including the
      Risk
      Factors described below. Our business, operating results or financial condition
      could be materially adversely affected by any of the following risks. The risks
      described below are not the only ones we face. Additional risks we are not
      presently aware of or that we currently believe are immaterial may also
      materially affect our business. The trading price of our Common Stock could
      decline due to any of these risks. In assessing these risks, you should also
      refer to the other information contained or incorporated by reference in this
      Form 10-Q, including our financial statements and related notes and
      information contained in our Form 10-K for the year ended December 31,
      2006




27





***We
      have a limited operating history with our new business model, which limits
      the
      information available to you to evaluate our
      business.***





Since
      our
      inception in 1984, we have accumulated deficits from historical operations
      of
      approximately $22,019,000 at September 30, 2007. In 2002, we changed our
      business model and chose to strategically focus on becoming a developer and
      marketer of secure technologies for all forms of print media. We have continued
      to incur losses since we began our new business model. Also, we have limited
      operating and financial information relating to our new business model regarding
      our On-DemandTM suite of products to evaluate our performance and
      future prospects. Due to the change in our business model, we do not view our
      historical financials as being a good indication of our future. We face the
      risks and difficulties of a company going into a new business model including
      the uncertainties of market acceptance, competition, cost increases and delays
      in achieving business objectives. There can be no assurance that we will succeed
      in addressing any or all of these risks, and the failure to do so could have
      a
      material adverse effect on our business, financial condition and operating
      results.





***We
      have a history of operating losses and we expect to continue to incur
      losses.***





Since
      we
      changed our business model in 2002, we have not yet achieved profitability
      and
      we expect to continue incurring net losses until we recognize sufficient
      revenues . We
      had
      net losses of approximately $4,832,000 and $2,843,000 for the years ended
      December 31, 2006 and 2005, respectively, and approximately $4,792,000 for
      the
      first nine months of 2007. The principal causes of our losses are likely to
      continue to be costs resulting from the operation of our businesses, including
      costs associated with being a public company, costs relating to defending our
      patent rights, and failure to generate sufficient revenue.





***If
      we lose our current litigation, we may lose certain of our technology rights
      which may affect our business plan.***





We
      are
      subject to litigation and alleged litigation, including our litigation with
      the
      European Central Bank, in which parties allege, among other things, that certain
      of our patents are invalid. For more information regarding this litigation,
      see
      Part II -Item I- Legal Proceedings. If the ECB or other parties are successful
      in invalidating any or all of our patents, it may materially affect us, our
      financial condition, and our ability to market and sell certain technology.





***If
      we lose our current infringement litigation we may be liable for significant
      legal costs of our counterparts.***




We
      have
      been able to mitigate the cash outlays that we have been required to make for
      legal costs of our current infringement litigation and related invalidity cases
      against the European Central Bank by, among other things, negotiating legal
      fee
      caps and using shares of our common stock for payments. However, if we receive
      an adverse ruling in any of our infringement or related invalidity cases against
      the European Central Bank, we will likely be responsible for a large portion
      of
      the legal costs that were expended by the European Central Bank in such case,
      which would likely be significant. The payment of these amounts could adversely
      affect the Company’s financial position.




28





***If
      we are unable to adequately protect our intellectual property, our competitive
      advantage may disappear.***




Our
      success will be determined in part by our ability to obtain United States and
      foreign patent protection for our technology and to preserve our trade secrets.
      Because of the substantial length of time and expense associated with developing
      new document security technology, we place considerable importance on patent
      and
      trade secret protection. We intend to continue to rely primarily on a
      combination of patent protection, trade secrets, technical measures, copyright
      protection and nondisclosure agreements with our employees and customers to
      establish and protect the ideas, concepts and documentation of software and
      trade secrets developed by us. Our ability to compete and the ability of our
      business to grow could suffer if these intellectual property rights are not
      adequately protected. There can be no assurance that our patent applications
      will result in patents being issued or that current or additional patents will
      afford protection against competitors. We rely on a combination of patents,
      copyrights, trademarks and trade secret protection and contractual rights to
      establish and protect our intellectual property. Failure of our patents,
      copyrights, trademarks and trade secret protection, non-disclosure agreements
      and other measures to provide protection of our technology and our intellectual
      property rights could enable our competitors to more effectively compete with
      us
      and have an adverse effect on our business, financial condition and results
      of
      operations. In addition, our trade secrets and proprietary know-how may
      otherwise become known or be independently discovered by others. No guarantee
      can be given that others will not independently develop substantially equivalent
      proprietary information or techniques, or otherwise gain access to our
      proprietary technology.





In
      addition, we may be required to litigate in the future to enforce our
      intellectual property rights, to protect our trade secrets, to determine the
      validity and scope of the proprietary rights of others, or to defend against
      claims of infringement or invalidity. Any such litigation could result in
      substantial costs and diversion of resources and could have a material adverse
      effect on our business, financial condition or results of operations, and there
      can be no assurances of the success of any such litigation.





***We
      may face intellectual property infringement or other claims against us, our
      customers or our intellectual property that could be costly to defend and result
      in our loss of significant rights.***





Although
      we have received U.S. Patents and a European Patent with respect to certain
      technologies of ours, there can be no assurance that these patents will afford
      us any meaningful protection. Although we believe that our use of the technology
      and products we developed and other trade secrets used in our operations do
      not
      infringe upon the rights of others, our use of the technology and trade secrets
      we developed may infringe upon the patents or intellectual property rights
      of
      others. In the event of infringement, we could, under certain circumstances,
      be
      required to obtain a license or modify aspects of the technology and trade
      secrets we developed or refrain from using same. We may not have the necessary
      financial resources to defend an infringement claim made against us or be able
      to successfully terminate any infringement in a timely manner, upon acceptable
      terms and conditions or at all. Failure to do any of the foregoing could have
      a
      material adverse effect on us and our financial condition. Moreover, if the
      patents, technology or trade secrets we developed or use in our business are
      deemed to infringe upon the rights of others, we could, under certain
      circumstances, become liable for damages, which could have a material adverse
      effect on us and our financial condition. As we continue to market our products,
      we could encounter patent barriers that are not known today. A patent search
      will not disclose applications that are currently pending in the United States
      Patent Office, and there may be one or more such pending applications that
      would
      take precedence over any or all of our applications.




29





Furthermore,
      third parties may assert that our intellectual property rights are invalid,
      which could result in significant expenditures by us to refute such assertions.
      If we become involved in litigation, we could lose our proprietary rights,
      be
      subject to damages and incur substantial unexpected operating expenses.
      Intellectual property litigation is expensive and time-consuming, even if the
      claims are subsequently proven unfounded, and could divert management’s
      attention from our business. If there is a successful claim of infringement,
      we
      may not be able to develop non-infringing technology or enter into royalty
      or
      license agreements on acceptable terms, if at all. If we are unsuccessful in
      defending claims that our intellectual property rights are invalid, we may
      not
      be able to enter into royalty or license agreements on acceptable terms, if
      at
      all. This could prohibit us from providing our products and services to
      customers, which could have a material adverse effect on us and our financial
      condition.





***If
      our products and services do not achieve market acceptance, we may not achieve
      our revenue and net income goals in the time prescribed or at
      all.***





We
      are at
      the early stage of introducing our document security technology and products
      to
      the market. If we are unable to operate our business as contemplated by our
      business model or if the assumptions underlying our business model prove to
      be
      unfounded, we could fail to achieve our revenue and net income goals within
      the
      time we have projected, or at all, which could have a material adverse effect
      on
      our business. As a result, the value of your investment could be significantly
      reduced or completely lost.





We
      cannot
      assure you that a sufficient number of such companies will demand our products
      or services or other document security products. In addition, we cannot predict
      the rate of market’s acceptance of our document security solutions. Failure to
      maintain a significant customer base may have a material adverse effect on
      our
      business.





***The
      results of our research and development efforts are uncertain and there can
      be
      no assurance of the commercial success of our
      products.***





We
      believe that we will need to continue to incur research and development
      expenditures to remain competitive. The products we currently are developing
      or
      may develop in the future may not be technologically successful. In addition,
      the length of our product development cycle may be greater than we originally
      expect and we may experience delays in future product development. If our
      resulting products are not technologically successful, they may not achieve
      market acceptance or compete effectively with our competitors’
products.





***Changes
      in document security technology and standards could render our applications
      and
      services obsolete.***





The
      market for document security products, applications, and services is fast moving
      and evolving. Identification and authentication technology is constantly
      changing as we and our competitors introduce new products, applications, and
      services, and retire old ones as customer requirements quickly develop and
      change. In addition, the standards for document security are continuing to
      evolve. If any segments of our market adopt technologies or standards that
      are
      inconsistent with our applications and technology, sales to those market
      segments could decline, which could have a material adverse effect on us and
      our
      financial condition.




30





***The
      market in which we operate is highly competitive, and we may not be able to
      compete effectively, especially against established industry competitors with
      greater market presence and financial resources.***





Our
      market is highly competitive and characterized by rapid technological change
      and
      product innovations. Our competitors may have advantages over us because of
      their longer operating histories, more established products, greater name
      recognition, larger customer bases, and greater financial, technical and
      marketing resources. As a result, they may be able to adapt more quickly to
      new
      or emerging technologies and changes in customer requirements, and devote
      greater resources to the promotion and sale of their products. Competition
      may
      also force us to decrease the price of our products and services. We cannot
      assure you that we will be successful in developing and introducing new
      technology on a timely basis, new products with enhanced features, or that
      these
      products, if introduced, will enable us to establish selling prices and gross
      margins at profitable levels.





***Our
      growth strategy depends, in part, on our acquiring complementary businesses
      and
      assets and expanding our existing operations to include manufacturing
      capabilities, which we may be unable to do.***





Our
      growth strategy is based, in part, on our ability to acquire businesses and
      assets that are complimentary to our existing operations and expanding our
      operations to include manufacturing capabilities. We may also seek to acquire
      other businesses. The success of this acquisition strategy will depend, in
      part,
      on our ability to accomplish the following:





·
            identify
                suitable businesses or assets to buy;





·
            complete
                the purchase of those businesses on terms acceptable to us;





·
            complete
                the acquisition in the time frame we expect;
                and





·
            improve
                the results of operations of the businesses that we buy and successfully
                integrate their operations into our
                own.





Although
      we were able to successfully acquire our P3 subsidiary in February 2006, there
      can be no assurance that we will be successful in pursuing any or all of these
      steps on future transactions. Our failure to implement our acquisition strategy
      could have an adverse effect on other aspects of our business strategy and
      our
      business in general. We may not be able to find appropriate acquisition
      candidates, acquire those candidates that we find or integrate acquired
      businesses effectively or profitably.





Our
      acquisition program and strategy may lead us to contemplate acquisitions of
      companies in bankruptcy, which entail additional risks and uncertainties. Such
      risks and uncertainties include, without limitation, that, before assets may
      be
      acquired, customers may leave in search of more stable providers and vendors
      may
      terminate key relationships. Also, assets are generally acquired on an “as is”
basis, with no recourse to the seller if the assets are not as valuable as
      may
      be represented. Finally, while bankrupt companies may be acquired for
      comparatively little money, the cost of continuing the operations may
      significantly exceed expectations.





We
      have
      in the past used, and may continue to use, our Common Stock as payment for
      all
      or a portion of the purchase price for acquisitions. If we issue significant
      amounts of our Common Stock for such acquisitions, this could result in
      substantial dilution of the equity interests of our stockholders.




31





***If
      we fail to retain our key personnel and attract and retain additional qualified
      personnel, we might not be able to pursue our growth
      strategy.***





Our
      future success depends upon the continued service of our executive officers
      and
      other key sales and research personnel who possess longstanding industry
      relationships and technical knowledge of our products and operations. The loss
      of any of our key employees, in particular, Patrick White, our Chief Executive
      Officer and Chief Financial Officer; Peter Ettinger, our President; Thomas
      Wicker, our Vice-President of Research and Development; and David Wicker, our
      Vice-President of Operations, could negatively impact our ability to pursue
      our
      growth strategy and conduct operations. Although we believe that our
      relationship with these individuals is positive, there can be no assurance
      that
      the services of these individuals will continue to be available to us in the
      future. We have extended our employment agreements with Patrick White to June
      2009. Our employment agreements with Thomas Wicker and David Wicker expired
      in
      June 2007. Our employment agreement with Peter Ettinger expires in June
      2009.There can be no assurance that these persons will continue to agree to
      be
      employed by us after such dates.





***If
      we do not successfully expand our sales force, we may be unable to increase
      our
      revenues.***





We
      must
      expand the size of our marketing activities and sales force to increase
      revenues. We continue to evaluate various methods of expanding our marketing
      activities, including the use of outside marketing consultants and
      representatives and expanding our in-house marketing capabilities. Going
      forward, we anticipate an increasing percentage of our revenues to come from
      the
      licensing of our newer technologies, where profit margins are significantly
      higher than those provided by Security Paper. If we are unable to hire or retain
      qualified sales personnel, if newly hired personnel fail to develop the
      necessary skills to be productive, or if they reach productivity more slowly
      than anticipated, our ability to increase our revenues and grow could be
      compromised. The challenge of attracting, training and retaining qualified
      candidates may make it difficult to meet our sales growth targets. Further,
      we
      may not generate sufficient sales to offset the increased expense resulting
      from
      expanding our sales force or we may be unable to manage a larger sales
      force.





***Future
      growth in our business could make it difficult to manage our
      resources.***





Our
      anticipated business expansion could place a significant strain on our
      management, administrative and financial resources. Significant growth in our
      business may require us to implement additional operating, product development
      and financial controls, improve coordination among marketing, product
      development and finance functions, increase capital expenditures and hire
      additional personnel. There can be no assurance that we will be able to
      successfully manage any substantial expansion of our business, including
      attracting and retaining qualified personnel. Any failure to properly manage
      our
      future growth could negatively impact our business and operating
      results.





***We
        cannot predict our future capital needs and we may not be able to secure
        additional financing.***
 
 We
        may
        need to raise additional funds in the future to fund our business, complete
        the
        development, testing and marketing of our products, or make strategic
        acquisitions or investments. We may require additional equity or debt
        financings, collaborative arrangements with corporate partners or funds from
        other sources for these purposes. We have recently engaged certain financial
        advisors to assist the Company in entering into business relationships and
        partnerships with certain strategic investors. No assurance can be given
        that
        these funds will be available for us to finance our development on acceptable
        terms, if at all. Such additional financings may involve substantial dilution
        of
        our stockholders or may require that we relinquish rights to certain of our
        technologies or products. In addition, we may experience operational
        difficulties and delays due to working capital restrictions. If adequate
        funds
        are not available from operations or additional sources of financing, we
        may
        have to delay or scale back our growth plans.




32





**Risks
      Related to Our Stock**





***Provisions
      of our certificate of incorporation and agreements could delay or prevent a
      change in control of our company.***





Certain
      provisions of our certificate of incorporation may discourage, delay, or prevent
      a merger or acquisition that a stockholder may consider favorable. These
      provisions include:





·
            the
                authority of the Board of Directors to issue preferred stock;
                and





·
            a
                prohibition on cumulative voting in the election of directors.





***We
      have a large number of authorized but unissued shares of common stock, which
      our
      management may issue without further stockholder approval, thereby causing
      dilution of your holdings of our common stock.***





As
      of
      September 30, 2007, there were approximately 185,000,000 of authorized but
      unissued shares of our common stock. Our management will continue to have broad
      discretion to issue shares of our common stock in a range of transactions,
      including capital-raising transactions, mergers, acquisitions, for anti-takeover
      purposes, and in other transactions, without obtaining stockholder approval,
      unless stockholder approval is required for a particular transaction under
      the
      rules of the American Stock Exchange, New York law, or other applicable laws.
      If
      our management determines to issue shares of our common stock from the large
      pool of such authorized but unissued shares for any purpose in the future
      without obtaining stockholder approval, your ownership position would be diluted
      without your further ability to vote on that transaction.





***The
      exercise of our outstanding options and warrants and vesting of restricted
      stock
      awards may depress our stock price.***





As
      of
      September 30, 2007, there were outstanding stock options and warrants to
      purchase an aggregate of 1,768,343 shares of our Common Stock at exercise prices
      ranging from $2.00 to $12.65 per share, of which 1,410,862 are currently
      exercisable. To the extent that these securities are exercised, dilution to
      our
      stockholders will occur. In addition, as of September 30, 2007, there were
      595,000 restricted shares of our common stock that are subject to various
      vesting terms. To the extent that these securities vest, dilution to our
      stockholders will occur. Moreover, the terms upon which we will be able to
      obtain additional equity capital may be adversely affected, since the holders
      of
      these securities can be expected to exercise or convert them at a time when
      we
      would, in all likelihood, be able to obtain any needed capital on terms more
      favorable to us than the exercise and conversion terms provided by those
      securities.





Sales
      of
      these shares in the public market, or the perception that future sales of these
      shares could occur, could have the effect of lowering the market price of our
      common stock below current levels and make it more difficult for us and our
      stockholders to sell our equity securities in the future.





Sale
      or
      the availability for sale of shares of common stock by stockholders could cause
      the market price of our common stock to decline and could impair our ability
      to
      raise capital through an offering of additional equity securities.




33





***We
      do not intend to pay cash dividends.***





We
      do not
      intend to declare or pay cash dividends on our common stock in the foreseeable
      future. We anticipate that we will retain any earnings and other cash resources
      for investment in our business. The payment of dividends on our common stock
      is
      subject to the discretion of our Board of Directors and will depend on our
      operations, financial position, financial requirements, general business
      conditions, restrictions imposed by financing arrangements, if any, legal
      restrictions on the payment of dividends and other factors that our Board of
      Directors deems relevant.




**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)
        Exhibits
  Item
          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
              31.1  Certifications
              of Chief Executive Officer Pursuant to Section 302 of the Sarbanes
              Oxley
              Act
  Item
                31.2  Certifications
                of Acting Chief Financial Officer Pursuant to Section 302 of the
                Sarbanes Oxley
                Act
  Item
                32.1  Certification
                of Chief Executive Officer Pursuant to Section 906 of the Sarbanes
                Oxley
                Act
  Item
                32.2  Certification
                of Acting Chief Financial Officer Pursuant to Section 906 of the
                Sarbanes Oxley
                Act
  34




**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.**November
                14, 2007
            By:
            /s/
                Patrick WhitePatrick
                White
              Chief
                Executive Officer




November
                    14, 2007
              By:
              /s/
                    Philip JonesPhilip
                    Jones
                  Acting
                    Chief Financial Officer
                  (Vice
                    President of Finance)
  35