**UNITED
      STATES SECURITIES AND EXCHANGECOMMISSION**


**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**  **March
      31, 2008**


**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 x
                No o**





Indicate
                by check mark whether the registrant is a large accelerated filer,
                an
                accelerated filer, a non-accelerated filer, or a smaller reporting
                company. See definition of “large accelerated filer”, “accelerated filer”
                and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check
                one):
              
              Large
                accelerated filer oAccelerated filer xNon-accelerated
                filer o
                Smaller reporting company o
              
              Indicate
                by check mark whether the registrant is a shell company (as defined
                in
                Rule 12b-2 of the Exchange Act)
              **Yes o
                No x**
              
              **Applicable
                only to corporate issuers**As
                of May 8, 2008 (the most recent practicable date), there were 14,167,698
                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 Interim Consolidated Financial Statements
              6Item
                  2
              Management's
                  Discussion and Analysis of Financial Condition and Results of
                  Operations
              13Item
                  3
              Quantitative
                  and Qualitative Disclosures about Market Risk
              19Item
                  4
              Controls
                  and Procedures
              19**PART
                  II**
              **OTHER
                  INFORMATION**Item
                  1
              Legal
                  Proceedings
              20Item
                  1a
              Risk
                  Factors
              21Item
                  2
              UnregisteredSales
                  of Equity Securities and Use of Proceeds
              26Item
                  3
              Defaults
                  upon Senior Securities
              26Item
                  4
              Submission
                  of Matters to a Vote of Security Holders
              26Item
                  5
              Other
                  Information
              27Item
                  6
              Exhibits
              27**SIGNATURES**
              28


2




**PART
      I**


**FINANCIAL
      INFORMATION**


ITEM
      1 -
      FINANCIAL STATEMENTS




**DOCUMENT
      SECURITY SYSTEMS, INC.  AND SUBSIDIARIES**


**Consolidated
      Balance Sheets**


**As
      of**





**March
                31,**
            
            **December
                31,****2008**
            
            **2007****(unaudited)**
            
            **(audited)****ASSETS****Current
                assets:**Cash
                and cash equivalents
            
            $
            153,705
            
            $
            742,468Restricted
                cash
            
            
            177,345
            
            
            -Accounts
                receivable, net of allowance of $82,000 ($82,000 -2007)
            
            
            696,051
            
            
            617,320Inventory
            
            
            253,763
            
            
            259,442Loans
                to employees
            
            
            122,023
            
            
            120,732Prepaid
                expenses and other current assets
            
            
            399,284
            
            
            487,715Total
                current assets
            
            
            1,802,171
            
            
            2,227,677**Restricted
                cash**
            
            
            -
            
            
            177,345**Fixed
                assets, net**
            
            
            1,461,945
            
            
            1,494,540**Other
                assets**
            
            
            146,530
            
            
            147,958**Goodwill**
            
            
            1,396,734
            
            
            1,396,734**Other
                intangible assets, net**
            
            
            5,873,122
            
            
            6,149,530**Total
                assets**
            
            $
            10,680,502
            
            $
            11,593,784**LIABILITIES
                AND STOCKHOLDERS' EQUITY****Current
                liabilities:**Accounts
                payable
            
            $
            1,790,449
            
            $
            1,795,085Accrued
                expenses & other current liabilities
            
            
            1,042,509
            
            
            818,606Deferred
                revenue
            
            
            678,597
            
            
            732,355Current
                portion of capital lease obligations
            
            
            82,187
            
            
            79,948Total
                current liabilities
            
            
            3,593,742
            
            
            3,425,994**Revolving
                notes from related parties**
            
            
            1,290,000
            
            
            300,000**Long-term
                capital lease obligations**
            
            
            261,350
            
            
            294,821**Long-term
                deferred revenue**
            
            
            7,448
            
            
            15,938**Deferred
                tax liability**
            
            
            193,921
            
            
            200,000**Commitments
                and contingencies (see Note 9)****Stockholders'
                equity**Common
                stock, $.02 par value; 200,000,000 shares authorized,13,654,364 shares
                issued and outstanding (13,654,364 in 2007)
            
            
            273,087
            
            
            273,087Additional
                paid-in capital
            
            
            31,576,055
            
            
            31,298,571Accumulated
                deficit
            
            
            (26,515,101
            )
            
            (24,214,627
            )Total
                stockholders' equity
            
            
            5,334,041
            
            
            7,357,031**Total
                liabilities and stockholders' equity**
            
            $
            10,680,502
            
            $
            11,593,784




See
      accompanying notes




3





**DOCUMENT
      SECURITY SYSTEMS, INC. AND SUBSIDIARIES**


**Consolidated
      Statements of Operations**


**For
      The Three Months Ended March 31,**


(unaudited)





**2008**
            
            **2007**RevenueSecurity
                printing and products
            
            $
            932,221
            
            $
            991,648Royalties
            
            
            328,541
            
            
            298,796Digital
                solutions
            
            
            8,220
            
            
            162,802Legal
                products
            
            
            173,133
            
            
            175,682Total
                Revenue
            
            
            1,442,115
            
            
            1,628,928Costs
                of revenueSecurity
                printing and products
            
            
            595,633
            
            
            507,964Digital
                solutions
            
            
            3,507
            
            
            33,507Legal
                products
            
            
            97,096
            
            
            103,174Total
                costs of revenue
            
            
            696,236
            
            
            644,645**Gross
                profit**
            
            
            745,879
            
            
            984,283**Operating
                expenses:**Selling,
                general and administrative
            
            
            2,076,116
            
            
            1,797,146Research
                and development
            
            
            114,779
            
            
            94,408Impairment
                of patent defense costs
            
            
            291,581
            
            
            -Amortization
                of intangibles
            
            
            526,741
            
            
            345,639Operating
                expenses
            
            
            3,009,217
            
            
            2,237,193**Operating
                loss**
            
            
            (2,263,338
            )
            
            (1,252,910
            )**Other
                income (expense):**Interest
                income
            
            
            80
            
            
            40,808Loss
                on foreign currency transactions
            
            
            (11,629
            )
            
            (3,346
            )Interest
                expense
            
            
            (20,849
            )
            
            (1,153
            )**Loss
                from continuing operations before income taxes**
            
            
            (2,295,736
            )
            
            (1,216,601
            )Income
                tax expense
            
            
            4,738
            
            
            4,738**Loss
                from continuing operations**
            
            
            (2,300,474
            )
            
            (1,221,339
            )Income
                from discontinued operations (Note 7)
            
            
            -
            
            
            11,396**Net
                loss**
            
            $
            (2,300,474
            )
            $
            (1,209,943
            )**Net
                loss per share -basic and diluted:**Continuing
                operations
            
            $
            (0.17
            )
            $
            (0.09
            )Discontinued
                operations
            
            
            (0.00
            )
            
            (0.00
            )Net
                Loss
            
            $
            (0.17
            )
            $
            (0.09
            )**Weighted
                average common shares outstanding, basic and
                diluted**
            
            
            13,654,364
            
            
            13,584,795




See
      accompanying notes




4




**DOCUMENT
      SECURITY SYSTEMS, INC. AND SUBSIDIARIES**


**Consolidated
      Statements of Cash Flows**


**For
      the Three Months Ended March 31,**


(unaudited)





**2008**
            
            **2007****Cash
                flows from operating activities:**Net
                loss
            
            $
            (2,300,474
            )
            $
            (1,209,943
            )Adjustments
                to reconcile net loss to net cash used by operating
                activities:Depreciation
                and amortization expense
            
            
            605,698
            
            
            391,398Stock
                based compensation
            
            
            406,848
            
            
            335,948Impairment
                of patent defense costs
            
            
            291,581
            
            
            -(Increase)
                decrease in assets:Accounts
                receivable
            
            
            (78,731
            )
            
            (399,940
            )Inventory
            
            
            5,679
            
            
            (77,163
            )Prepaid
                expenses and other assets
            
            
            (51,613
            )
            
            (6,065
            )Increase
                (decrease) in liabilities:Accounts
                payable
            
            
            (9,708
            )
            
            99,043Accrued
                expenses and other liabilities
            
            
            228,641
            
            
            142,961Deferred
                revenue
            
            
            (62,248
            )
            
            (41,861
            )Net
                cash used by operating activities
            
            
            (964,327
            )
            
            (765,622
            )**Cash
                flows from investing activities:**Purchase
                of fixed assets
            
            
            (46,362
            )
            
            (27,162
            )Purchase
                of other intangible assets
            
            
            (536,842
            )
            
            (380,306
            )Net
                cash used by investing activities
            
            
            (583,204
            )
            
            (407,468
            )**Cash
                flows from financing activities:**Borrowing
                on revolving note- related parties
            
            
            990,000
            
            
            -Repayments
                of capital lease obligations
            
            
            (31,232
            )
            
            (9,721
            )Payment
                of stock issuance costs
            
            
            -
            
            
            (519,619
            )Issuance
                of common stock
            
            
            -
            
            
            339,600Net
                cash provided (used) by financing activities
            
            
            958,768
            
            
            (189,740
            )**Net
                decrease in cash and cash equivalents**
            
            
            (588,763
            )
            
            (1,362,830
            )**Cash
                and cash equivalents beginning of period**
            
            
            742,468
            
            
            5,802,615**Cash
                and cash equivalents end of period**
            
            $
            153,705
            
            $
            4,439,785




See
      accompanying notes.




5




**DOCUMENT
      SECURITY SYSTEMS, INC.**


**NOTES
      TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**


**March
      31, 2008**


**(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, 2007.





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.





***Other
      Intangible Assets*** – Other
      intangible assets consists of costs associated with the application, acquisition
      and defense of our patents, contractual rights to patents and trade secrets
      associated with our technologies, a non-exclusive licensing agreement, and
      customer lists obtained as a result of acquisitions. Our patents and trade
      secrets are for document anti-counterfeiting and anti-scanning technologies
      and
      processes that form the basis of our document security business. External legal
      costs incurred to defend the Company’s patents are capitalized to the extent of
      an evident increase in the value of the patents and a successful outcome. Legal
      costs which relate to an unsuccessful outcome are expensed. The Company
      capitalizes the cost of an appeal until it is determined that the appeal will
      be
      unsuccessful. The Company’s capitalized patent defense costs expenses are
      analyzed for impairment based on the expected eventual success of the legal
      action and recoverability of proceeds or added economic value of the patent
      in
      excess of the costs. Legal actions related to the same patent defense case
      are
      unified into one asset group for the purposes on the impairment analysis. The
      Company amortizes its other intangible assets over their estimated useful lives.
      Patents are amortized over the remaining legal life, up to 20 years. Intangible
      asset amortization expense is classified as an operating expense.




On
      March
      19, 2008, the Company received notification that its appeal of the invalidation
      of its European Patent 455750B1 in the UK was not successful. As a result of
      the
      adverse court decision, the Company recognized an impairment loss of
      approximately $292,000 associated with the U.K appeal as of March 31, 2008.The
      impairment loss includes a judgment for reimbursement of estimated counterpart
      legal fees. The Company may owe additional counter party legal fees
      associated with the decision, which the Company will expense as soon as the
      amount, if any, is estimatable.




***Recent
      Accounting Pronouncements*** In
      September 2006, the FASB issued SFAS No.157 *,
      Fair Value Measurements* .
      SFAS
      No. 157, as amended, defines fair value, establishes a framework for measuring
      fair value in accordance with accounting principles generally accepted in the
      United States of America, and expands disclosures about fair value measurements.
      With respect to financial assets and liabilities, SFAS No. 157 is effective
      for
      financial statements issued for fiscal years beginning after November 15,
      2007. However, in February 2008, the FASB determined that an entity need
      not apply this standard to nonfinancial assets and liabilities that are
      recognized or disclosed at fair value in the financial statements on a
      nonrecurring basis until 2009. Accordingly, the Company’s adoption of this
      standard on January 1, 2008, is limited to financial assets and
      liabilities and did not have a material effect on the Company’s financial
      condition or results of operations. The Company’s still in the process of
      evaluating the impact of this standard with respect to its effect on
      nonfinancial assets and liabilities and has not yet determined the impact that
      it will have on the consolidated financial statements upon full adoption.


6




In
      February 2007, the FASB issued SFAS No. 159, *The
      Fair Value Option for Financial Assets and Financial
      Liabilities* ,
      which
      permits entities to choose to measure certain financial assets and liabilities
      at fair value. SFAS No. 159 is effective for years beginning after
      November 15, 2007. The Company has not adopted the fair value option
      method permitted by SFAS No. 159.





In
      December 2007, the Financial Accounting Standards Board issued Statement of
      Financial Accounting Standards No. 141 (revised 2007), “ *Business
      Combinations* ”
(“SFAS
      141R”), which replaces SFAS 141. SFAS 141R establishes principles and
      requirements for how an acquirer in a business combination recognizes and
      measures in its financial statements the identifiable assets acquired, the
      liabilities assumed, and any controlling interest; recognizes and measures
      the
      goodwill acquired in the business combination or a gain from a bargain purchase;
      and determines what information to disclose to enable users of the financial
      statements to evaluate the nature and financial effects of the business
      combination. SFAS 141R is to be applied prospectively to business combinations
      for which the acquisition date is on or after an entity’s fiscal year that
      begins after December 15, 2008. We are currently evaluating the potential
      impact of the adoption of SFAS 141R on our consolidated financial position,
      results of operations and cash flows





In
      December 2007, the FASB issued SFAS No. 160, *Noncontrolling
      Interests in Consolidated Financial Statements-on Amendment of ARB No.
      51* .
      SFAS
      No. 160 establishes accounting and reporting standards for the noncontrolling
      interest in a subsidiary. SFAS No. 160 is effective for financial statements
      issued for fiscal years beginning after December 15, 2008, and interim
      statements within those fiscal years. Among other things, SFAS No. 160 requires
      noncontrolling interest to be included as a component of shareholders’ equity.
      The Company does not currently have any noncontrolling interests.





On
      December 21, 2007, the SEC issued Staff Accounting Bulletin No. 110,
“Share-Based Payment”. SAB No. 110 addresses the use of a “simplified”
method in developing an estimate of expected term of “plain vanilla” share
      options in accordance SFAS No. 123(R), “Share-Based Payment”. SAB
      No. 110 allows the use of the “simplified” method of estimating expected
      term where a company may not have sufficient historical exercise data. SAB
      No. 110 is effective January 1, 2008 and the Company plans to
      continue to use the simplified method to estimate the expected term of its
      plain
      vanilla employee options.




On
      December 12, 2007, the Financial Accounting Standards Board (FASB) ratified
      the
      Emerging Issues Task Force (“EITF”) opinion related to EITF Issue 07-1,
“Accounting for Collaborative Arrangements.” The Task Force reached a consensus
      that a collaborative arrangement is a contractual arrangement that involves
      two
      or more parties, all of which are both (a) involved as active participants
      in a
      joint operating activity that is not conducted primarily through a separate
      legal entity and (b) exposed to significant risks and rewards that depend on
      the
      commercial success of the joint operating activity. This Issue also addresses
      (i) the income statement classification by participants in a collaborative
      arrangement for transactions with third parties and transactions between the
      participants and (ii) financial statement disclosures. The consensus on EITF
      Issue 07-1 is effective for fiscal years beginning after December 15, 2008,
      and
      for interim periods within those fiscal years. Entities should apply the
      consensus retrospectively to all periods presented for only those collaborative
      arrangements existing as of the effective date, unless it is impractical to
      do
      so. The Company will adopt this new accounting pronouncement effective January
      1, 2009, and does not anticipate any material impact on its financial condition
      or results of operations.




**2.**  **Restricted
      Cash**




In
      July
      2007, the Company established a restricted cash balance of 87,500 pounds, or
      approximately $177,000, as collateral for a deed of guarantee that was required
      by the English Court of Appeals in order for the Company to pursue an appeal
      in
      that court. On March 19, 2008, the Company was notified that its appeal was
      denied and that the Company owed the European Central Bank, the successful
      party
      in the appeal, the 87,500 pounds. Accordingly, the Company classified the
      restricted cash as current as of March 31, 2008. (See Note 9 *Commitments
      and Contingencies)*




**3.**  **Inventory**




Inventory
      consisted of the following:




7




**March
                31,**
            
            **December
                31,****2008**
            
            **2007****(unaudited)**
            
            **(audited)**Finished
                Goods
            
            $
            170,578
            
            $
            161,978Raw
                Materials
            
            
            83,185
            
            
            97,464$
            253,763
            
            $
            259,442




**4.**  **Other
      Intangible Assets**




Other
      intangible assets are comprised of the following:





**March 31, 2008**
            
            **December 31, 2007****Useful**
              **Life**
            
            **Gross Carrying**
              **Amount**
            
            **Accumulated**
              **Amortizaton**
            
            **Net Carrying**
              **Amount**
            
            **Gross Carrying**
              **Amount**
            
            **Accumulated**
              **Amortizaton**
            
            **Net Carrying**
              **Amount**Royalty
                rights
            
            
            5
                years
            
            $
            90,000
            
            $
            76,500
            
            $
            13,500
            
            $
            90,000
            
            $
            72,000
            
            $
            18,000Other
                intangibles
            
            
            5
                years
            
            
            1,187,595
            
            
            392,814
            
            
            794,781
            
            
            1,187,595
            
            
            335,304
            
            
            852,291Patent
                and contractual rights
            
            
            Varied
                (1)
            
            
            8,450,756
            
            
            3,385,915
            
            
            5,064,841
            
            
            8,205,340
            
            
            2,926,101
            
            
            5,279,239**$**
            **9,728,351**
            
            **$**
            **3,855,229**
            
            **$**
            **5,873,122**
            
            **$**
            **9,482,935**
            
            **$**
            **3,333,405**
            
            **$**
            **6,149,530**





(1)-
      patent rights are amortized over their expected useful life which is generally
      the legal life of the patent. As of March 31, 2008 the weighted average
      remaining useful life of these assets in service was 3.6 years.




**5.**  **Revolving
      Notes From Related Parties**




On
      January 4, 2008, the Company entered into a Credit Facility Agreement with
      Fagenson and Co., Inc., as agent, a related party to Robert B. Fagenson, the
      Chairman of the Company's Board of Directors. Under the Fagenson Credit
      Agreement, the Company can borrow up to a maximum of $3,000,000 from time to
      time up to and until January 4, 2010. The advances are generally limited to
      $400,000 unless otherwise mutually agreed upon by both parties per fiscal
      quarter, with the exception of $600,000 that can be advanced at any time for
      patent litigation related bills. Any amount borrowed by the Company pursuant
      to
      the Fagenson Credit Agreement will have an annual interest rate of 2% above
      LIBOR and will be secured by the Common Stock of Plastic Printing Professionals,
      Inc., (“P3”) the Company's wholly owned subsidiary. Interest is payable
      quarterly in arrears and the principal is payable in full at the end of the
      term
      under the Fagenson Credit Agreement. In addition, on January 4, 2008, the
      Company also entered into a Credit Facility Agreement with Patrick White, the
      Company's Chief Executive Officer and a member of the Board of Directors. Under
      the White Credit Agreement, the Company can borrow up to $600,000 from time
      to
      time up to and until January 4, 2010. Any amount borrowed by the Company
      pursuant to the White Credit Agreement will have an annual interest rate of
      2%
      above LIBOR and will be secured by the accounts receivable of the Company,
      excluding the accounts receivable of P3. Interest is payable quarterly in
      arrears and the principal is payable in full at the End of the Term under the
      White Credit Agreement. Mr. White can accept common stock as payment of the
      loan
      upon a default. Under
      the
      terms of the agreement the Company is required to comply with various covenants.During the year ended December 31, 2007, Patrick White advanced the
      Company $300,000 while the terms of the credit facility agreement were being
      finalized.




As
      of
      March 31, 2008, the Company had outstanding $450,000 under the White Credit
      Agreement and $840,000 under the Fagenson Credit Agreement. Interest expense
      of
      approximately $10,000 was accrued under the Agreements as of March 31,
      2008.




**6.**  **Shareholders’
      Equity**




***Stock
      Issued for Patent Defense Costs*** ***-*** On
      November 14, 2006, the Company entered into an stock payment 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 to eliminate the Company’s
      cash requirements for MWE’s legal fees related to the ECB litigation, not to
      exceed $1.2 million in stock. During the three months ended March 31, 2007,
      23,593 restricted shares were issued to MWE to pay for approximately $268,000
      of
      legal incurred through December 31, 2006.


8





***Stock
      Issued in Private Placement*** ****** - On
      January 22, 2007, the Company sold 6 units at a price of $50,000 per unit for
      gross
      proceeds of $300,000consisting of 35,280 unregistered shares of the
      Company’s common stock and five-year warrants to purchase up to an aggregate of
      17,640 shares of the Company’s 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.




***Restricted
      Stock -*** As
      of
      March 31, 2008, there are 68,333 restricted shares granted to employees that
      vest through June 2009. In addition, there are 445,000 restricted shares that
      will vest only upon the occurrence of certain events over the next 4 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 March 31, 2008, vesting is not considered probable and no
      compensation expense has been recognized related to the performance
      grants.




***Stock
      Options*** - During
      the three months ended March 31, 2008, the Company issued options to purchase
      37,000 of its common shares at an exercise price of $6.31 per share to
      non-employee directors pursuant to the 2004 Non-Employee Officer Director Stock
      Option Plan that vest at the end of one of year of service on the Company’s
      Board of Directors. The fair value of these options amounted to $90,903
      determined by 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*** -There
      was no stock warrant activity during the three months ended March 31, 2008.
      During the three months ended March 31, 2007, the Company received approximately
      $39,600 in proceeds from the exercise of 9,000 warrants.





***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 months ended March 31, 2008,
      the
      Company recognized approximately $407,000 ($336,000- 2007) in stock-based
      compensation which has been classified as selling, general and administrative
      expense.





As
      of
      March 31, 2008, there was approximately $1.7 million of total unrecognized
      compensation costs related to non-vested options and restricted stock granted
      under the Company’s stock option plans which the Company expects to vest over a
      period of not to exceed five years. The total fair value of options, warrants
      and restricted shares that vested during the three months ended March 31, 2008
      was $217,000 ($85,000 - 2007).





**7.**  **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 operating results relating to these assets
      are segregated and reported as discontinued operations in the accompanying
      2007
      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****March 31, 2007**Revenues
            
            $
            120,704Cost
                of sales
            
            
            47,576Operating
                expenses
            
            
            61,732Income
                from discontinued operations
            
            $
            11,396




9





**8.**  **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 three months ended March 31, 2008,
      547,211 (566,711- 2007) common equivalent shares would have been added to the
      weighted average shares outstanding to compute the diluted weighted average
      shares outstanding.





**9.**  **Commitments
      and Contingencies**




*Legal
      Matters*


On
        August
        1, 2005, we commenced a suit against the European Central Bank (“ECB”) alleging
        patent infringement by the ECB and 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 0 455 750B1 (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, and also ruled that
        we
        will be required to pay attorneys and court fees of the ECB. The ECB have
        claimed attorneys and court fees in the amount of Euro 93,752 ($140,000),
        which,
        will be subject to an assessment procedure that will not likely be concluded
        earlier than the middle of 2008, which the Company will accrue as soon as
        the
        assessed amount, if any, is estimatable.
 
 On
        March 24, 2006, we received notice that the ECB has filed a separate claim
        in
        the United Kingdom and Luxembourg courts 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 was deemed invalid in the
        United Kingdom, and on March 19, 2008 this decision was upheld on appeal.
        The
        English Courts’ decision does not affect the validity of the Patent in other
        European countries. As a result of the English Court’s ruling, the Company was
        also required to pay a portion of the ECB’s legal costs associated with the
        English case. On March 30, 2007, the English Court awarded the ECB 30%
        of their costs of the initial trial ,
        of which the Company paid 90,000 British pounds ($182,000) on April 19, 2007.
        In
        July 2007, the Company posted a bond of 87,500 British pounds ($177,000),
        as
        collateral for the appeal costs. The Company was ordered on March 19, 2008
        to
        pay £87,500 ($177,000), towards ECB’s costs of the English appeal, corresponding
        to the bond posted which
        has
        been accrued as of March 31, 2008.We expect that an additional
        approximately 90,000 pounds ($182,000) will become payable by the Company
        for
        the costs of the initial trial, which is included in accrued expenses at
        March
        31, 2008. The
        Company may also owe additional legal fees associated with the appeal decision,
        which, unless otherwise agreed by the parties, will be subject to an assessment
        procedure that will not likely be concluded earlier than the third quarter
        of
        2008 , which
        the Company will accrue as soon as the assessed amount, if any, is
        estimatable.
 
 On
        March
        27, 2007 the Bundespatentgericht of the Federal Republic of Germany ruled
        that
        the German part of the Patent was valid, having considered the English Court’s
        decision. . A s
        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 ($67,000) which
        the
        Company will record when the amount, if any, is received. The
        ECB
        has filed an appeal against that decision, which is not expected to be decided
        before the end of 2009. On January 9, 2008 the French Court held that the
        Patent
        was invalid in France for the same reasons given by the English Court. The
        Company is not required to pay attorneys fees of the ECB as a result of the
        French decision. The Company intends to file an appeal against that decision.
        On
        March 12, 2008 the Dutch Court, having considered the English, German and
        French
        decisions, ruled that the Patent is valid in the Netherlands. The ECB filed
        an
        appeal against the decision on March 27, 2008.
 
 The
        Patent has thus been confirmed to be valid and enforceable in two jurisdictions
        (Germany and the Netherlands) which use the Euro as its national currency.
        Additional trials on the validity of the Patent are expected in other European
        jurisdictions in 2008 and 2009.
 10





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 us, 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 (McTaggert’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.




*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 March 31, 2008, 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 $500,000 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 three months ended March 31, 2007, the Company issued 23,593 shares of
      Common Stock valued at approximately $268,000 in conjunction with the payment
      of
      legal expenses which were capitalized as other intangible assets.




**11.**  **Segment
      Information**




The
      Company's businesses are organized, managed and internally reported as three
      operating segments. Two of these operating segments, Document Security Systems
      and Plastic Printing Professionals, 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 two 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 Company’s two segments is as follows:




11




**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 substantially all of 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 the retail and
                copying division are reported as discontinued operations and are
                not a
                component of these segment results (See Note 7).**Legal
                Supplies**
            
            Sale
                of specialty legal supplies, primarily to lawyers and law firms located
                throughout the United States via the website
                Legalstore.com.




Approximate
      information concerning the operations by reportable segment for the three months
      ended March 31, 2008 and 2007 is as follows. The Company relies on intersegment
      cooperation and management does not represent that these segments, if operated
      independently, would report the results contained herein:




**Document****Legal**
            
            **Security &****Supplies**
            
            **Production**
            
            **Corporate**
            
            **Total****3
                months ended March 31, 2008:**Revenues
                from external customers
            
            $
            173,000
            
            $
            1,269,000
            
            $
            -
            
            $
            1,442,000Depreciation
                and amortization
            
            
            4,000
            
            
            601,000
            
            
            1,000
            
            
            606,000Operating
                (loss) profit from continuing operations
            
            
            8,000
            
            
            (1,709,000
            )
            
            (599,000
            )
            
            (2,300,000
            )**3
                months ended March 31, 2007:**Revenues
                from external customers
            
            $
            176,000
            
            $
            1,453,000
            
            $
            -
            
            $
            1,629,000Depreciation
                and amortization
            
            
            3,000
            
            
            376,000
            
            
            12,000
            
            
            391,000Operating
                (loss) from continuing operations
            
            
            (1,000
            )
            
            (474,000
            )
            
            (746,000
            )
            
            (1,221,000
            )




**12.**
            **Subsequent
                Event**




On
      May 7,
      2008 the Company entered into a $500,000 unsecured credit facility with Taiko
      III Corp to fund the Company’s ongoing patent infringement and related lawsuits
      against the European Central Bank . Interest shall accrue on the unpaid
      principal amount at a 6% annual rate. The outstanding principal amount may
      be
      prepaid by the Company, in whole but not in part and including the full interest
      through the maturity of the loan, at its option so long as the Company provides
      Taiko III with prior written notice of such prepayment. The term of the credit
      facility is 364 days. Under
      the
      terms of the agreement the Company is required to comply with various covenants.In addition, the loan can be repaid by the Company, at the discretion
      of
      Taiko III if the Company had defaulted under the credit facility, by using
      the
      Company’s common stock issued at a discount to the market value at the time of
      the repayment of 33% to market at the time of payment at no less than $2.00
      per
      share and no more than $5.00 per share.




12




**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, 2007 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 virtually 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 eight
      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 by a broad variety
      of
      industries,, 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
      record and, securities. 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 to satisfy their specific
      anti-counterfeiting requirements. 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 a digital product to implement our technologies
      in Internet-based environments utilizing standard desktop printers. We believe
      that our On digital technology greatly expands the reach and potential market
      for our technologies and solutions.





*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**.


13





*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 market to 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 digital 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 - Licensees estimate their annual usage and pay
                us a
                single payment which is reviewed each year based on actual
                usage.


·
            Pay
                a percentage of sales of the technology - Licensees only pay as they
                sell
                product containing our technology. For example, if they sell $1 million
                of
                products containing in our technology, the licensee would pay us
                a
                percentage, 2.5% to 10%, of the sales price of their
                products.


·
            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 our
                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 Months Ended***  ***March
      31, 2008***




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, 2007. 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 was a component of its security printing
      segment, as a discontinued operation. All amounts have been adjusted to reflect
      the Company’s results after the effect of the discontinued
      operations.




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.




14




**Revenue**




**Three Months**
              **Ended March 31,**
              **2008**
            
            **Three Months**
              **Ended March 31,**
              **2007**
            
            **% change vs.**
              **2007***Revenue*Security
                printing & products
            
            $
            932,000
            
            $
            992,000
            
            
            -6
            %Royalties
            
            
            329,000
            
            
            299,000
            
            
            10
            %Digital
                solutions
            
            
            8,000
            
            
            163,000
            
            
            -95
            %Legal
                products
            
            
            173,000
            
            
            176,000
            
            
            -2
            %*Total
                Revenue*
            
            
            1,442,000
            
            
            1,630,000
            
            
            -12
            %




**Document
      Security and Production**




For
      the
      three months ended March 31, 2008, revenue decreased 12% from the same period
      in
      2007. The decrease in revenue is primarily due to the absence of a large digital
      solutions sale during 2008 as compared to the first quarter of 2007. In
      addition, the Company experienced a decrease in security printing & products
      revenue as the result of the timing of large orders as well as disruptions
      in
      production caused by the relocation of the Company’s plastic printing operations
      to a new facility that was finalized in February of 2008.




**Cost
      of Sales and Gross Profit**




**Three Months**
              **Ended March 31,**
              **2008**
            
            **Three Months**
              **Ended March 31,**
              **2007**
            
            **% change vs.**
              **2007***Costs
                of revenue*Security
                printing & products
            
            $
            596,000
            
            $
            508,000
            
            
            17
            %Digital
                solutions
            
            
            4,000
            
            
            34,000
            
            
            -88
            %Legal
                products
            
            
            97,000
            
            
            103,000
            
            
            -6
            %*Total
                cost of revenue*
            
            
            697,000
            
            
            645,000
            
            
            8
            %*Gross
                profit*Security
                printing & products
            
            
            336,000
            
            
            484,000
            
            
            -31
            %Royalties
            
            
            329,000
            
            
            299,000
            
            
            10
            %Digital
                solutions
            
            
            4,000
            
            
            129,000
            
            
            -97
            %Legal
                products
            
            
            76,000
            
            
            73,000
            
            
            4
            %*Total
                gross profit*
            
            
            745,000
            
            
            985,000
            
            
            -24
            %**Three Months**
              **Ended March 31,**
              **2008**
            
            
            **Three Months**
              **Ended March 31,**
              **2007**
            
            
            **% change vs.**
              **2007***Gross
                profit percentage:*
            
            
            52
            %
            
            60
            %
            
            -13
            %




Gross
      Profit




Gross
      profit deceased 24% in the first quarter of 2008 as compared to 2007, primarily
      as a result of the decrease in digital solution sales. In addition, the Company
      experienced a gross profit decrease from the sales of its security printing
      and
      products primarily due to the impact of higher depreciation and rental costs
      associated with the Company’s upgrade to certain of its production equipment and
      the move to a larger facility of its plastic printing operations. These costs
      were not offset by an increase in revenues, which were negatively affected
      by
      production downtimes caused by the relocation project which was finalized in
      February of 2008.




15




**Operating
      Expenses**




**Three Months**
              **Ended March 31,**
              **2008**
            
            **Three Months**
              **Ended March 31,**
              **2007**
            
            **% change vs.**
              **2007***Selling,
                general and administrative*General
                and administrative compensation
            
            $
            575,000
            
            $
            410,000
            
            
            40
            %Stock
                based payments
            
            
            407,000
            
            
            336,000
            
            
            21
            %Professional
                Fees
            
            
            367,000
            
            
            320,000
            
            
            15
            %Sales
                and marketing
            
            
            389,000
            
            
            519,000
            
            
            -25
            %Depreciation
                and amortization
            
            
            42,000
            
            
            20,000
            
            
            110
            %Other
            
            
            295,000
            
            
            192,000
            
            
            54
            %Research
                and development
            
            
            115,000
            
            
            94,000
            
            
            22
            %Impairment
                of patent defense costs
            
            
            292,000
            
            
            -Amortization
                of intangibles
            
            
            527,000
            
            
            346,000
            
            
            52
            %*Total
                Operating Expenses*
            
            
            3,009,000
            
            
            2,237,000
            
            
            35
            %




**Selling,
      General and Administrative**




General
      and administrative compensation costs
      were 40% greater in the first quarter of 2008 as compared to the first quarter
      of 2007 which reflects the addition of internal legal counsel whom had formerly
      worked for the Company in a retainer relationship. In addition, the increase
      reflects an increase in the estimated accrued paid time off benefits made during
      the first quarter of 2008 and an increase in compensation of the Company’s board
      of directors.




Professional
      fees




**Three Months**
              **Ended March 31,**
              **2008**
            
            **Three Months**
              **Ended March 31,**
              **2007**
            
            **% change vs.**
              **2007***Professional
                Fees Detail*Accounting
                and auditing
            
            $
            142,000
            
            $
            113,000
            
            
            26
            %Consulting
            
            
            149,000
            
            
            91,000
            
            
            64
            %Legal
                Fees
            
            
            33,000
            
            
            55,000
            
            
            -40
            %Stock
                Transfer, SEC and Investor Relations
            
            
            43,000
            
            
            61,000
            
            
            -30
            %$
            367,000
            
            $
            320,000
            
            
            15
            %




The
      increase in professional fees reflect an increase in accounting and auditing
      fees incurred during the first quarter of 2008 in which the majority of the
      Company’s year-end audit work was performed. In addition, the increase reflects
      audit fees associated with the Company’s first year Sarbanes Oxley compliance
      efforts. Consulting fees reflect the impact of a third-party consulting firms
      hired during the latter half of 2007 and early 2008. During March 2008, the
      Company initiated a cost-cutting program that is expected to significantly
      reduce the amount spent on outside consultants.




Sales
      and marketing expenses, including sales and marketing personnel costs, decreased in the first
      quarter of 2008 as the Company reduced the usage of a public relations firm
      and
      significantly reduced the amount spent on travel and entertainment. These costs
      savings were offset by increases to the Company’s direct sales staff during the
      latter half of 2007 and early 2008. The Company has initiated several cost
      saving measures in 2008 related to its sales and marketing costs and expects
      to
      realize additional sales and marketing cost-savings during the remainder of
      2008.




16




Other
      expenses are
      primarily rent and utilities, office supplies, IT support, bad debt expense
      and
      insurance costs. Increases in the first quarter of 2008 as compared to the
      first
      quarter of 2007 reflect costs increases associated with a larger organization
      and increases in administrative rent associated with the move of the Company’s
      plastic printing division.




**Impairment
      of Patent Defense Costs**




On
      March
      19, 2008, the Company received notification that its appeal of the invalidation
      of its European Patent 455750B1 in the UK was not successful. As result of
      the
      adverse court decision, the Company recognized an impairment loss of $292,000
      associated with the U.K appeal as of March 31, 2008. The impairment loss
      includes a judgment for reimbursement of estimated counterpart legal fees.
      The
      Company may be obligated to pay additional counter party legal fees associated
      with the decision, which the Company will expense as soon as the amount, if
      any,
      is estimatable.




**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, and
      costs for the use of third-party printers’ facilities to test our technologies
      on equipment that we do not have access to internally. During the first quarter
      of 2008, the Company incurred an increase in research and development costs
      due
      to an increase in third-party printer costs related to certain research
      projects. We expect that our research and development costs will continue at
      current levels for the foreseeable future.




**Amortization
      of Intangibles**




Amortization
      of intangibles expense increased 52% in the first quarter of 2008 as compared
      to
      the first quarter of 2007 which was primarily the result of an increase of
      $1.3
      million in the Company’s patent defense costs. We amortize the costs associated
      with patent rights that we acquired in 2005 and legal costs associated with
      the
      registration and defense of our patents, including the costs associated with
      our
      lawsuit against the ECB for patent infringement and the related ECB countersuits
      for patent validity. A significant portion of these assets were acquired by
      the
      issuance of equity-based instruments. Our net amortizable patent asset base
      at
      March 31, 2008 was approximately $5.0 million and will generate approximately
      $1.9 million in annual amortization expense during the next 3 years. In
      addition, the Company has approximately $808,000 of net other intangible assets
      as of March 31, 2008 that consist of a royalty right, a non-exclusive marketing
      right, as well as acquired intangibles including customer lists and a trade
      name. 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. The Company
      reviews these assets for impairment annually or if a triggering event occurs.
      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.




**Net
      Loss and Loss Per Share**




**Three Months Ended March 31,****2008**
            
            **2007**
            
            **% change vs. 2007**Net
                loss
            
            
            (2,300,000
            )
            
            (1,210,000
            )
            
            90
            %Net
                loss per share, basic and diluted
            
            
            (0.17
            )
            
            (0.09
            )
            
            87
            %Weighted
                average common shares outstanding, basic and diluted
            
            
            13,654,364
            
            
            13,584,795
            
            
            1
            %




17




During
      the first quarter of 2008, the Company experienced a net loss of $2.3 million,
      a
      90% increase from the net loss of the first quarter of 2007. The Company’s
      losses primarily reflect the increase in the Company’s expense base without
      offsetting increases in revenue and gross profits. At the Company’s current
      stage of development, revenue growth and resulting net profits or losses can
      be
      significantly impacted by large individual sales orders. During the first
      quarter of 2008, the Company did not have any large individual sales to offset
      its growth in its expenses. During March of 2008, the Company began a
      cost-cutting program to reduce its expense base to a level more in line with
      its
      current revenue levels. In addition, the Company’s results are significantly
      negatively impacted by its patent defense efforts, which the Company believes
      will result in a successful result for the Company, and stock-based
      compensation.




**Non-GAAP
      Financial Performance Measure**




The
      Company uses Adjusted EBITDA as a non-GAAP financial performance measurement.
      Adjusted EBITDA is calculated by adding back to net income (loss) interest,
      income taxes, depreciation, amortization, and stock-based compensation expense.
      Adjusted EBITDA is provided to investors to supplement the results of operations
      reported in accordance with GAAP. Management believes Adjusted EBITDA is useful
      to help investors analyze the operating trends of the business before and after
      the adoption of SFAS 123(R) and to assess the relative underlying performance
      of
      businesses with different capital and tax structures. Management believes that
      Adjusted EBITDA provides an additional tool for investors to use in comparing
      its financial results with other companies in the industry, many of which also
      use Adjusted EBITDA in their communications to investors. By excluding non-cash
      charges such as amortization, depreciation and stock-based compensation, as
      well
      as non-operating charges for interest and income taxes, investors can evaluate
      the Company's operations and its ability to generate cash flows from operations
      and can compare its results on a more consistent basis to the results of other
      companies in the industry. Management also uses Adjusted EBITDA to evaluate
      potential acquisitions, establish internal budgets and goals, and evaluate
      performance of its business units and management.




The
      Company considers Adjusted EBITDA to be an important indicator of the Company's
      operational strength and performance of its business and a useful measure of
      the
      Company's historical and prospective operating trends. However, there are
      significant limitations to the use of Adjusted EBITDA since it excludes interest
      income and expense and income taxes, all of which impact the Company's
      profitability and operating cash flows, as well as depreciation, amortization
      and stock-based compensation. Document Security Systems believes that these
      limitations are compensated by clearly identifying the difference between the
      two measures. Consequently, Adjusted EBITDA should not be considered in
      isolation or as a substitute for net income (loss) presented in accordance
      with
      GAAP. Adjusted EBITDA as defined by the Company may not be comparable with
      similarly named measures provided by other entities.




**Three Months Ended March 31,****2008**
            
            **2007**
            
            **% change vs. 2007**Net
                Loss
            
            $
            (2,300,000
            )
            $
            (1,210,000
            )
            
            90
            %Add
                back:Depreciation
            
            
            79,000
            
            
            45,000
            
            
            76
            %Amortization
                of Intangibles
            
            
            527,000
            
            
            346,000
            
            
            52
            %Stock
                based payments
            
            
            407,000
            
            
            336,000
            
            
            21
            %Interest
                Income
            
            
            -
            
            
            (41,000
            )
            
            -100
            %Interest
                Expense
            
            
            21,000
            
            
            1,000
            
            
            2000
            %Income
                Taxes
            
            
            5,000
            
            
            5,000Adjusted
                EBITDA
            
            
            (1,261,000
            )
            
            (518,000
            )
            
            143
            %




**LIQUIDITY
      AND CAPITAL RESOURCES**




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




18




**As Of And For The Period Ended:****March 31, 2008**
            
            **March 31, 2007**
            
            **% change vs. 2007**Cash
                flows from:Operating
                activities
            
            $
            (964,000
            )
            $
            (766,000
            )
            
            -26
            %Investing
                activities
            
            
            (583,000
            )
            
            (407,000
            )
            
            -43
            %Financing
                activities
            
            
            959,000
            
            
            (190,000
            )
            
            605
            %Working
                capital
            
            
            (1,792,000
            )
            
            3,008,000
            
            
            -160
            %Current
                ratio
            
            
            0.50
            
            
            2.00
            
            
            -25
            %Cash
                and cash equivalents
            
            $
            154,000
            
            $
            4,440,000
            
            
            -97
            %Funds
                Available from Open Credit Facilities
            
            $
            2,310,000
            
            $
            -




As
      of
      March 31, 2008, our cash and cash equivalents were $154,000, down from $742,000
      at December 31, 2007. The decrease was primarily due to the use of cash for
      operations and the use of cash to defend the Company’s patent rights offset by
      the receipt of $990,000 from the Company’s revolving note facility with related
      parties. The Company expects to continue to use cash for its operations and
      for
      the defense of its patents through the remainder of 2008. In March 2008, the
      Company initiated a cost reduction program in order to bring its cash
      expenditures to a level closer to its current revenue base. The Company expects
      to reach operating cash flow breakeven at approximately $9.0 million in annual
      revenue.




As
      of
      March 31, 2008, we have an aggregate of $2,310,000 remaining available under
      two
      revolving notes that the Company secured with related parties that terminate
      on
      January 4, 2010. In
      addition, on May 7, 2008 the Company entered into a $500,000 unsecured credit
      facility to fund the ongoing patent infringement and related lawsuits against
      the ECB. On May 9, 2008, the Company borrowed $300,000 under this agreement.




The
      Company expects that these available funds are sufficient to meet is cash needs
      for the next twelve months.




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




The
      market risk disclosures as set forth in Item 7A of our Annual Report on Form
      10-K for the year ended December 31, 2007 have not changed
      materially.




**ITEM
      4 - CONTROLS AND PROCEDURES**




**Evaluation
      of Disclosure Controls and Procedures**




Management
      is responsible for establishing and maintaining effective disclosure controls
      and procedures. Our Chief Executive Officer and Chief Financial Officer
      participated with our management in evaluating the effectiveness of our
      disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
      under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)).
      Based on this evaluation, and in light of the material weaknesses in our
      internal control over financial reporting that are discussed in our Annual
      Report on Form 10-K for the fiscal year ended December 31, 2007 these officers
      have concluded that our disclosure controls and procedures were not effective.
      To address the material weaknesses described in Annual Report on Form 10-K
      for
      the fiscal year ended December 31, 2007, we performed additional analyses and
      other post-closing procedures to ensure our consolidated financial statements
      were prepared in accordance with accounting principles generally accepted in
      the
      United States of America (U.S. GAAP). Accordingly, management believes that
      the
      financial statements included in this Quarterly Report on Form 10-Q fairly
      present, in all material respects, our financial condition, result of operations
      and cash flows for the periods presented.




19


**Changes
      in Internal Control Over Financial Reporting**





There
      have been no changes in our internal control over financial reporting during
      the
      first quarter of fiscal 2008 that have materially affected, or are reasonably
      likely to materially affect, our internal control over financial
      reporting.




**PART
      II**


**OTHER
      INFORMATION**




**ITEM
      1 - LEGAL PROCEEDINGS**


On
        August
        1, 2005, we commenced a suit against the European Central Bank (“ECB”) alleging
        patent infringement by the ECB and 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 0 455 750B1 (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, and also ruled that
        we
        will be required to pay attorneys and court fees of the ECB. The ECB have
        claimed attorneys and court fees in the amount of Euro 93,752 ($140,000),
        which,
        will be subject to an assessment procedure that will not likely be concluded
        earlier than the middle of 2008, which the Company will accrue as soon as
        the
        assessed amount, if any, is estimatable.
 
 On
        March 24, 2006, we received notice that the ECB has filed a separate claim
        in
        the United Kingdom and Luxembourg courts 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 was deemed invalid in the
        United Kingdom, and on March 19, 2008 this decision was upheld on appeal.
        The
        English Courts’ decision does not affect the validity of the Patent in other
        European countries. As a result of the English Court’s ruling, the Company was
        also required to pay a portion of the ECB’s legal costs associated with the
        English case. On March 30, 2007, the English Court awarded the ECB 30%
        of their costs of the initial trial ,
        of which the Company paid 90,000 British pounds ($182,000) on April 19, 2007.
        In
        July 2007, the Company posted a bond of 87,500 British pounds ($177,000),
        as
        collateral for the appeal costs. The Company was ordered on March 19, 2008
        to
        pay £87,500 ($177,000), towards ECB’s costs of the English appeal, corresponding
        to the bond posted which
        has
        been accrued as of March 31, 2008.We expect that an additional
        approximately 90,000 pounds ($182,000) will become payable by the Company
        for
        the costs of the initial trial, which is included in accrued expenses at
        March
        31, 2008. The
        Company may also owe additional legal fees associated with the appeal decision,
        which, unless otherwise agreed by the parties, will be subject to an assessment
        procedure that will not likely be concluded earlier than the third quarter
        of
        2008 , which
        the Company will accrue as soon as the assessed amount, if any, is
        estimatable.
 
 On
        March
        27, 2007 the Bundespatentgericht of the Federal Republic of Germany ruled
        that
        the German part of the Patent was valid, having considered the English Court’s
        decision. . A s
        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 ($67,000) which
        the
        Company will record when the amount, if any, is received.  The
        ECB
        has filed an appeal against that decision, which is not expected to be decided
        before the end of 2009. On January 9, 2008 the French Court held that the
        Patent
        was invalid in France for the same reasons given by the English Court. The
        Company is not required to pay attorneys fees of the ECB as a result of the
        French decision. The Company intends to file an appeal against that decision.
        On
        March 12, 2008 the Dutch Court, having considered the English, German and
        French
        decisions, ruled that the Patent is valid in the Netherlands. The ECB filed
        an
        appeal against the decision on March 27, 2008.
 
 The
        Patent has thus been confirmed to be valid and enforceable in two jurisdictions
        (Germany and the Netherlands) which use the Euro as its national currency.
        Additional trials on the validity of the Patent are expected in other European
        jurisdictions in 2008 and 2009.
 20





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 us, 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 (McTaggert’s wife) and Arcis Digital Security, Inc. (a company in
      which Ms. Wu is involved) as additional defendants. Maxon has asserted a
      counterclaim against us contending that our purported acquisition of a certain
      patent from Thomas Wicker in 2002 gave rise to an alleged right on the part
      of
      Maxon to receive a portion of Thomas Wicker’s proceeds from such acquisition. We
      have denied the material allegations of all of the counterclaims. If Adler
      is
      successful, it may materially affect us, our financial condition, and our
      ability to market and sell certain of our technology and related products.
      This
      case is in discovery phase, and it is too soon to determine how the various
      issues raised by the lawsuit will be determined.





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





**ITEM
      1A - RISK FACTORS**




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, 2007.





***We
      have a limited operating history with our 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 $26,515,000 at March 31, 2008. 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 this new business 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 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 secured credit facilities that have large principal payments due and if
      we
      are unable to repay them with cash we may be forced to repay, in whole on in
      part, with each credit facility’s applicable collateral, which would have a
      material adverse effect on our financial position.***





On
      January 4, 2008, we entered into two credit facilities with and aggregate
      borrowing capacity of $3.6 million that is repayable in full on January 4,
      2010.
      One of these credit facilities has a borrowing limit of $3.0 million and is
      secured by our stock in our Plastic Printing Professionals, Inc. subsidiary,
      and
      the other credit facility has a borrowing limit of $600,000 and is secured
      by
      our accounts receivable. On May 7, 2008, we entered into a $500,000 unsecured
      credit facility with Taiko III Corp. to fund our ongoing patent infringement
      and
      related lawsuits against the European Central Bank (“ECB”) that is repayable in
      full on May 7, 2009. In addition, the loan with Taiko III can be repaid by
      the
      Company, at the discretion of Taiko III if the Company defaults under the credit
      facility, by using the Company’s common stock issued at a discount to the
      market value at the time of the repayment of
      33% to
      market at the time of payment at no less than $2.00 per share and no more than
      $5.00 per share. If we cannot generate sufficient cash from operations or
      raise cash from other sources, including without limitation, fund-raising
      through sales of equity, and if we cannot refinance the credit facilities,
      we
      may have to repay, in whole or in part, one or both of the credit facilities
      with each credit facility’s applicable collateral, which would have a material
      adverse effect on our financial position.


21





***Due
      to our low cash balance and negative cash flow, we may have to further reduce
      our costs by curtailing future operation.***





We
      have
      incurred significant net losses in previous years. Our ability to fund our
      capital requirements out of our available cash and cash generated from our
      operations depends on a number of factors. Some of these factors include our
      ability to (i) increase paper and plastic card sales and (ii) increase sales
      of
      our digital products. If we cannot generate positive cash flow from operations,
      we will have to continue to reduce our costs and raise working capital from
      other sources. These measures could include selling or consolidating certain
      operations or assets, and delaying, canceling or scaling back product
      development and marketing programs. These measures could materially and
      adversely affect our ability to operate profitably.





***Our
      ability to effect a financing transaction to fund our operations could adversely
      affect the value of your stock.***





If
      we
      seek additional financing through raising additional capital through public
      or
      private equity offerings or debt financing, such additional capital financing
      may not be available to us on favorable terms and our stockholders will likely
      experience substantial dilution. Material shortage of capital will require
      us to
      take steps such as reducing our level of operations, disposing of selected
      assets, effecting financings on less than favorable terms or seeking protection
      under federal bankruptcy laws.





***Our
      limited cash resources may not be sufficient to fund continuing losses from
      operations and the expenses of the current patent validity and patent
      infringement litigations.***





The
      cost
      to defend current and future litigation may be significant. We cannot assure
      you
      that the ultimate cost of current known or future unknown litigation and claims
      will not exceed our current expectations and/or our ability to pay such costs
      and it is possible that such litigation costs could have a material adverse
      effect on our business, financial condition and operating results. In addition,
      litigation is time consuming and could divert management attention and resources
      away from our business, which could adversely affect our business, financial
      condition and operating results.





***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 1- 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 of our products
      based on any patent that is invalidated.





***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 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 adverse rulings 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, with our current estimates of between $1,000,000 to $2,000,000.
      The
      payment of these amounts could have a
      material adverse impact on our operations, cash available and
      liquidity .




***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.




22





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 or applied for U.S., European and International Patents 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.





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 companies will purchase 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.





***Certain
      of our recently developed products are not yet commercially accepted and there
      can be no assurance that those products will be accepted, which would adversely
      affect our financial results.***





Over
      the
      past one to two years, we have spent significant funds and time to create new
      products by applying our technologies onto media other than paper, including
      plastic and cardboard packaging, and delivered our technologies digitally.
      We
      have had limited success in selling our products that are on cardboard packaging
      and those that are delivered digitally. If we are not able to successfully
      sell
      these new products, our financial results will be adversely affected.


23





***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.





***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 Plastic Printing Professionals, Inc.
      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.


24





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.





***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; Peter Ettinger, our President; 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
      agreement with David Wicker expires in June 2008. 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.





***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 more aggressive expansion
      of 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. 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.





**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
      March 31, 2008, there are approximately 185 million shares 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.
      We
      currently have no specific plans to issue shares of our common stock for any
      purpose. However, 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.


25





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





As
      of
      March 31, 2008, there were outstanding stock options and warrants to purchase
      an
      aggregate of 1,324,343 shares of our Common Stock at exercise prices ranging
      from $2.00 to $12.65 per share, most of which are currently exercisable. To
      the
      extent that these securities are exercised, dilution to our stockholders will
      occur. In addition, as of March 31, 2008, there were 513,333 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.





***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**




The
      shareholders of the Company voted on four items at the Annual Meeting of
      Shareholders held on May 1, 2008:




1.  Election
      of seven Directors to serve for a term of one year until the 2009 Annual Meeting
      of Stockholders, or until their successors are duly elected and qualified.




2.  Approval
      of an amendment to the 2004 Employee Stock Option Plan to, among other things,
      increase the shares available for award under 2004 Employee Stock Option Plan
      by
      500,000.




3.  Approval
      of an amendment to the 2004 Non-Executive Director Stock Option Plan that will,
      among other things, increase the number of authorized shares by 100,000 and
      increase the number of stock options awarded to non-employee directors in the
      annual grant of stock options




4.  Ratification
      of the appointment of Freed Maxick & Battaglia, CPAs, PC, as the Company’s
      independent registered public accounting firm for the fiscal year ending
      December 31, 2008.


26




The
      nominees for director were elected based on the following vote:




**Nominee**
            
            **Votes For**
            
            **Votes Withheld**Patrick
                White
            
            
            11,747,530
            
            
            364,302Peter
                Ettinger
            
            
            9,553,237
            
            
            2,558,595David
                Wicker
            
            
            11,785,495
            
            
            326,337Timothy
                Ashman
            
            
            11,901,854
            
            
            209,978Alan
                E. Harrison
            
            
            11,820,861
            
            
            290,971Robert
                B. Fagenson
            
            
            11,901,134
            
            
            210,698Ira
                A. Greenstein
            
            
            11,900,261
            
            
            211,571




The
      amendment to the Company’s 2004 Employee Stock Option Plan was adopted based on
      the following vote:


6,701,332
      Votes for approval


509,591
      Votes against


186,102
      Abstentions


4,714,807
      Broker non-votes




The
      amendment to the Company’s 2004 Employee Stock Option Plan was adopted based on
      the following vote:


6,517,632
      Votes for approval


409,833
      Votes against


469,560
      Abstentions


4,714,807
      Broker non-votes




The
      proposal to ratify the appointment of Freed Maxick & Battaglia, CPAs, PC, as
      the Company’s independent registered public accounting firm for the fiscal year
      ending December 31, 2008 was adopted and received the following votes:


11,617,389
      Votes for approval


368,260
      Votes against


126,181
      Abstentions


0
      Broker
      non-votes




**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
                3.1Articles
                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
                3.2By-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
                31.1Certifications
                of Chief Executive Officer Pursuant to Section 302 of the Sarbanes
                Oxley
                Act
              
              Item
                31.2Certifications
                of Acting Chief Financial Officer Pursuant to Section 302 of the
                Sarbanes
                Oxley Act
              
              Item
                32.1Certification
                of Chief Executive Officer Pursuant to Section 906 of the Sarbanes
                Oxley
                Act
              
              Item
                32.2Certification
                of Acting Chief Financial Officer Pursuant to Section 906 of the
                Sarbanes
                Oxley Act




27




**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.**May
                12,
                2008
            
            By:
            /s/
                Patrick WhitePatrick
                White
              Chief
                Executive OfficerMay
                12,
                2008
            
            By:
            /s/
                Philip JonesPhilip
                Jones
              Acting
                Chief Financial Officer
              (Vice
                President of Finance)




28