**UNITED
      STATES SECURITIES AND EXCHANGE**


**COMMISSION**


**Washington,
      D.C. 20549**




**FORM
      10-Q**




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


**THE
      SECURITIES EXCHANGE ACT OF 1934**




**For
      the quarterly period ended**  **June
      30, 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 o
              Accelerated
                  filer x
              Non-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
        August 7, 2008 (the most recent practicable date), there were 14,225,198
        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
            
            15Item
                3
            
            Quantitative
                and Qualitative Disclosures about Market Risk
            
            19Item
                4
            
            Controls
                and Procedures
            
            20**PART
                II**
            
            **OTHER
                INFORMATION**Item
                1
            
            Legal
                Proceedings
            
            20Item
                1a
            
            Risk
                Factors
            
            21Item
                2
            
            UnregisteredSales
                of Equity Securities and Use of Proceeds
            
            27Item
                3
            
            Defaults
                upon Senior Securities
            
            27Item
                4
            
            Submission
                of Matters to a Vote of Security Holders
            
            27Item
                5
            
            Other
                Information
            
            27Item
                6
            
            Exhibits
            
            27**SIGNATURES**
            
            28





2


**DOCUMENT
        SECURITY SYSTEMS, INC.  AND SUBSIDIARIES**
 **Consolidated
        Balance Sheets**
 **As
        of**


**PART
      I**




**FINANCIAL
      INFORMATION**




ITEM
      1 -
      FINANCIAL STATEMENTS


**June
                  30,**
                **2008**
              
              **December
                  31,**
                **2007****(unaudited)**
              
              **(audited)****ASSETS****Current
                  assets:**Cash
                  and cash equivalents
              
              $
              960,898
              
              $
              742,468Restricted
                  cash
              
              
              173,784
              
              
              -Accounts
                  receivable, net of allowance of $82,000
              
              
              966,742
              
              
              617,320Inventory
              
              
              243,945
              
              
              259,442Loans
                  to employees
              
              
              117,022
              
              
              120,732Prepaid
                  expenses and other current assets
              
              
              250,794
              
              
              487,715Total
                  current assets
              
              
              2,713,185
              
              
              2,227,677**Restricted
                  cash**
              
              
              -
              
              
              177,345**Fixed
                  assets, net**
              
              
              1,391,273
              
              
              1,494,540**Other
                  assets**
              
              
              272,255
              
              
              147,958**Goodwill**
              
              
              1,396,734
              
              
              1,396,734**Other
                  intangible assets, net**
              
              
              5,548,007
              
              
              6,149,530**Total
                  assets**
              
              $
              11,321,454
              
              $
              11,593,784**LIABILITIES
                  AND STOCKHOLDERS' EQUITY****Current
                  liabilities:**Accounts
                  payable
              
              $
              1,821,875
              
              $
              1,795,085Accrued
                  expenses & other current liabilities
              
              
              1,190,390
              
              
              818,606Short
                  term credit facilities
              
              
              500,000
              
              
              -Deferred
                  revenue & customer deposits
              
              
              195,911
              
              
              732,355Current
                  portion of capital lease obligations
              
              
              84,315
              
              
              79,948Total
                  current liabilities
              
              
              3,792,491
              
              
              3,425,994**Revolving
                  notes from related parties**
              
              
              1,858,000
              
              
              300,000**Long-term
                  capital lease obligations**
              
              
              234,387
              
              
              294,821**Long-term
                  deferred revenue**
              
              
              7,448
              
              
              15,938**Deferred
                  tax liability**
              
              
              198,659
              
              
              200,000**Commitments
                  and contingencies (see Note 10)****Stockholders'
                  equity**Common
                  stock, $.02 par value; 200,000,000 shares authorized,
                  14,225,198 shares issued and outstanding (13,654,364 in 2007),
                  (325,000 subscribed in 2008)
              
              
              284,504
              
              
              273,087Additional paid-in capital
              
              
              33,979,169
              
              
              31,298,571Subscriptions
                  receivable
              
              
              (1,300,000
              )
              
              -Accumulated deficit
              
              
              (27,733,204
              )
              
              (24,214,627
              )Total
                  stockholders' equity
              
              
              5,230,469
              
              
              7,357,031**Total
                  liabilities and stockholders' equity**
              
              $
              11,321,454
              
              $
              11,593,784


See
      accompanying notes




3


**DOCUMENT
        SECURITY SYSTEMS, INC. AND SUBSIDIARIES**
 **Consolidated
        Statements of Operations**
 (unaudited)


**Three
                  Months Ended June 30,**
              
              **Six
                  Months Ended June 30,****2008**
              
              **2007**
              
              **2008**
              
              **2007**RevenueSecurity
                  printing and products
              
              $
              1,155,032
              
              $
              826,734
              
              $
              2,087,253
              
              $
              1,818,382Royalties
              
              
              891,934
              
              
              294,157
              
              
              1,220,475
              
              
              592,953Digital
                  solutions
              
              
              8,220
              
              
              11,969
              
              
              16,440
              
              
              174,771Legal
                  products
              
              
              159,299
              
              
              161,663
              
              
              332,432
              
              
              337,345Total
                  Revenue
              
              
              2,214,485
              
              
              1,294,523
              
              
              3,656,600
              
              
              2,923,451Costs
                  of revenueSecurity
                  printing and products
              
              
              796,069
              
              
              547,575
              
              
              1,391,702
              
              
              1,055,538Digital
                  solutions
              
              
              3,507
              
              
              3,507
              
              
              7,014
              
              
              37,014Legal
                  products
              
              
              74,320
              
              
              90,593
              
              
              171,416
              
              
              193,767Total
                  costs of revenue
              
              
              873,896
              
              
              641,675
              
              
              1,570,132
              
              
              1,286,319**Gross
                  profit**
              
              
              1,340,589
              
              
              652,848
              
              
              2,086,468
              
              
              1,637,132**Operating
                  expenses:**Selling,
                  general and administrative
              
              
              1,962,230
              
              
              1,811,586
              
              
              4,038,346
              
              
              3,608,732Research
                  and development
              
              
              134,451
              
              
              108,889
              
              
              249,230
              
              
              203,297Impairment
                  of patent defense costs
              
              
              -
              
              
              -
              
              
              291,581
              
              
              -Amortization
                  of intangibles
              
              
              537,429
              
              
              433,090
              
              
              1,064,170
              
              
              778,729Operating
                  expenses
              
              
              2,634,110
              
              
              2,353,565
              
              
              5,643,327
              
              
              4,590,758**Operating
                  loss**
              
              
              (1,293,521
              )
              
              (1,700,717
              )
              
              (3,556,859
              )
              
              (2,953,626
              )**Other
                  income (expense):**Interest
                  income
              
              
              5
              
              
              34,179
              
              
              85
              
              
              74,987Loss
                  on foreign currency transactions
              
              
              (12,557
              )
              
              (945
              )
              
              (24,186
              )
              
              (4,291
              )Interest
                  expense
              
              
              (33,041
              )
              
              (1,296
              )
              
              (53,890
              )
              
              (2,449
              )Other
                  Income
              
              
              125,795
              
              
              -
              
              
              125,795
              
              
              -**Loss
                  from continuing operations before income taxes**
              
              
              (1,213,319
              )
              
              (1,668,779
              )
              
              (3,509,055
              )
              
              (2,885,379
              )Income
                  tax expense
              
              
              4,784
              
              
              4,738
              
              
              9,522
              
              
              9,476**Loss
                  from continuing operations**
              
              
              (1,218,103
              )
              
              (1,673,517
              )
              
              (3,518,577
              )
              
              (2,894,855
              )Income
                  from discontinued operations (Note 8)
              
              
              -
              
              
              (26,821
              )
              
              -
              
              
              (15,426
              )**Net
                  loss**
              
              $
              (1,218,103
              )
              $
              (1,700,338
              )
              $
              (3,518,577
              )
              $
              (2,910,281
              )**Net
                  loss per share -basic and diluted:**Continuing
                  operations
              
              $
              (0.09
              )
              $
              (0.12
              )
              $
              (0.26
              )
              $
              (0.21
              )Discontinued
                  operations
              
              
              (0.00
              )
              
              0.00
              
              
              (0.00
              )
              
              0.00Net
                  Loss
              
              
              (0.09
              )
              
              (0.12
              )
              
              (0.26
              )
              
              (0.21
              )**Weighted
                  average common shares outstanding, basic and
                  diluted**
              
              
              13,690,545
              
              
              13,625,408
              
              
              13,672,555
              
              
              13,605,327




See
      accompanying notes




4




**DOCUMENT
        SECURITY SYSTEMS, INC. AND SUBSIDIARIES**
 **Consolidated
        Statements of Cash Flows**
 **For
        the Six Months Ended June 30,**
 (unaudited)


**2008**
              
              **2007****Cash
                  flows from operating activities:**Net
                  loss
              
              $
              (3,518,577
              )
              $
              (2,910,281
              )Adjustments
                  to reconcile net loss to net cash used by operating
                  activities:Depreciation
                  and amortization expense
              
              
              1,222,084
              
              
              870,247Stock
                  based compensation
              
              
              1,056,018
              
              
              633,040Impairment
                  of patent defense costs
              
              
              291,581
              
              
              -Decrease
                  in restricted cash
              
              
              3,561
              
              
              -(Increase)
                  decrease in assets:Accounts
                  receivable
              
              
              (349,422
              )
              
              (75,175
              )Inventory
              
              
              15,497
              
              
              (61,743
              )Prepaid
                  expenses and other assets
              
              
              (164,027
              )
              
              (238,656
              )Increase
                  (decrease) in liabilities:Accounts
                  payable
              
              
              164,342
              
              
              360,023Accrued
                  expenses and other liabilities
              
              
              186,802
              
              
              (49,754
              )Deferred
                  revenue
              
              
              (544,934
              )
              
              (164,299
              )Net
                  cash used by operating activities
              
              
              (1,637,075
              )
              
              (1,636,598
              )**Cash
                  flows from investing activities:**Purchase
                  of fixed assets
              
              
              (189,802
              )
              
              (70,705
              )Purchase
                  of other intangible assets
              
              
              (756,626
              )
              
              (661,709
              )Net
                  cash used by investing activities
              
              
              (946,428
              )
              
              (732,414
              )**Cash
                  flows from financing activities:**Borrowing
                  on revolving note- related parties
              
              
              1,558,000
              
              
              -Borrowing
                  on short-term credit facility
              
              
              500,000
              
              
              -Repayments
                  of capital lease obligations
              
              
              (56,067
              )
              
              (18,115
              )Payment
                  of stock issuance costs
              
              
              -
              
              
              (519,619
              )Issuance
                  of common stock
              
              
              800,000
              
              
              355,225Net
                  cash provided (used) by financing activities
              
              
              2,801,933
              
              
              (182,509
              )**Net
                  increase (decrease) in cash and cash equivalents**
              
              
              218,430
              
              
              (2,551,521
              )**Cash
                  and cash equivalents beginning of period**
              
              
              742,468
              
              
              5,802,615**Cash
                  and cash equivalents end of period**
              
              $
              960,898
              
              $
              3,251,094




See
      accompanying notes.




5




**DOCUMENT
      SECURITY SYSTEMS, INC.**


**NOTES
      TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS**


**June
      30, 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 an expected successful
      outcome. Legal costs are expensed at the point when it is determined that the
      outcome is expected to be unsuccessful. 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 are analyzed for impairment based on
      the expected eventual outcome 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 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.




In
      April 2008, the FASB issued FSP FAS 142-3, “Determination of Useful Life of
      Intangible Assets” (“FSP FAS 142-3”). FSP FAS 142-3 amends the factors that
      should be considered in developing the renewal or extension assumptions used
      to
      determine the useful life of a recognized intangible asset under FAS 142,
“Goodwill and Other Intangible Assets.” FSP FAS 142-3 also requires expanded
      disclosure related to the determination of intangible asset useful lives. FSP
      FAS 142-3 is effective for fiscal years beginning after December 15, 2008.
      The Company is currently evaluating the potential impact the adoption of FAS
      FSP
      142-3 will have on its financial statements.


In
        May 2008, the FASB issued FASB Staff Position (“FSP”) APB 14-1, “Accounting
        for Convertible Debt Instruments That May Be Settled in Cash upon Conversion
        (Including Partial Cash Settlement)” (“FSP APB 14-1”), which clarifies the
        accounting for convertible debt instruments that may be settled in cash upon
        conversion, including partial cash settlement. FSP APB 14-1 specifies that
        an
        issuer of such instruments should separately account for the liability and
        equity components of the instruments in a manner that reflect the issuer’s
        non-convertible debt borrowing rate when interest costs are recognized in
        subsequent periods. FSP APB 14-1 is effective for fiscal years beginning
        after
        December 15, 2008, and retrospective application is required for all
        periods presented. The Company is currently evaluating the potential impact
        of
        the adoption of FSP APB 14-1 on its financial statements.


7


In
      May
      2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
      Accounting Principles. The purpose of this statement is to improve financial
      reporting by providing a consistent framework for determining applicable
      accounting principles to be used in the preparation of financial statements
      presented in conformity with accounting principles generally accepted in the
      United States of America. SFAS No. 162 will become effective 60 days after
      the
      SEC’s approval. The Company believes that the adoption of this standard on its
      effective date will not have a material effect on the consolidated financial
      statements




In
      June
      2008, the FASB issued FSP EITF 03-6-1 to address whether instruments granted
      in
      share-based payment transactions are participating securities prior to their
      vesting and therefore need to be included in the earnings per share calculation
      under the two-class method described in SFAS No. 128, “Earnings per Share.” This
      FSP requires companies to treat unvested share-based payment awards that have
      non-forfeitable rights to dividends or dividend equivalents as participating
      securities and thus, include them in calculation of basic earnings per share.
      FSP EITF 03-6-1 is effective for fiscal years beginning after December 15,
      2008.
      The Company does not anticipate a material impact on its financial statements
      or
      its computation of basic earnings per share upon adoption.




During
      the quarter ended June 30 2008, the Company adopted FSP 00-19-2, Accounting
      for Registration Payment Arrangements. This FSP specifies that the contingent
      obligation to make future payments or otherwise transfer consideration under
      a
      registration payment arrangement, whether issued as a separate agreement or
      included as a provision of a financial instrument or other agreement, should
      be
      separately recognized and measured in accordance with FASB Statement No. 5,
      Accounting for Contingencies. The Company has
      determined it to be remote, that
      it
      will be required to remit payments to the investors for failing to obtain an
      effective registration statement  on
      or
      before the required time frame .




**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. On May 14, 2008, the Company was ordered
      to
      pay the 87,500 pounds to the European Central Bank as an interim payment of
      the
      appeal costs pending final assessment by the Court which is expected in the
      fourth quarter of 2008. The Company was not able to apply the funds in its
      restricted account to this payment. The Company will use the restricted funds
      to
      pay additional fees due upon final assessment of the costs by the Court, if
      any.
      Accordingly, the Company classified the restricted cash as current as of June
      30, 2008. (See Note 10 *Commitments
      and Contingencies)*




**3.**
            **Inventory**




Inventory
      consisted of the following:


**June
                  30,**
                **2008**
              
              **December
                  31,**
                **2007****(unaudited)**
              
              **(audited)**Finished
                  Goods
              
              $
              132,359
              
              $
              161,978Raw
                  Materials
              
              
              111,586
              
              
              97,464$
              243,945
              
              $
              259,442




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




Other
      intangible assets are comprised of the following:


**June
                  30, 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
              
              $
              81,000
              
              $
              9,000
              
              $
              90,000
              
              $
              72,000
              
              $
              18,000Other
                  intangibles
              
              
              5
                  years
              
              
              1,187,595
              
              
              450,598
              
              
              736,997
              
              
              1,187,595
              
              
              335,304
              
              
              852,291Patent
                  and contractual Rights
              
              
              Varied
                  (1
              )
              
              8,663,070
              
              
              3,861,060
              
              
              4,802,010
              
              
              8,205,340
              
              
              2,926,101
              
              
              5,279,239**$**
              **9,940,665**
              ****
              **$**
              **4,392,658**
              ****
              **$**
              **5,548,007**
              ****
              **$**
              **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 June 30, 2008 the weighted average
          remaining
          useful life of these assets in service was 3.3 years.
  8




**5.**
            **Revolving
                Notes and Credit
                Facility**




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 repayment 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
      were
      being finalized.




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 line of credit
      is 364 days. 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 at a discount to the market value at the
      time of the repayment at 33% to market at the time of payment at no less than
      $2.00 per share and no more than $5.00 per share. (See Note 10 for
      registration rights)




As
      of
      June 30, 2008, the Company had outstanding $450,000 under the White Credit
      Agreement, $1,408,000 under the Fagenson Credit Agreement, and $500,000 under
      the Taiko III Agreement. Interest expense of approximately $30,000 was accrued
      under the related party agreements during the six-month period ending June
      30, 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 validity litigation,
      not to exceed $1.2 million in stock. During the six months ended June 30, 2007,
      60,866 restricted common shares were issued to MWE to pay for approximately
      $746,000 of legal fees incurred through June 30, 2007.





9


***Stock
      Issued in Private Placement*** - On
      June
      25, 2008 the Company entered into two Share Purchase Agreements pursuant to
      which the Company agreed to sell a total of 500,000 shares of the Company’s
      common stock for an aggregate purchase price of $2,000,000. Pursuant to the
      terms of the first Agreement, the Company sold 150,000 shares of Common Stock
      to
      the Purchaser for $600,000 payable on June 25, 2008. Pursuant to the terms
      of
      the second Agreement, the Company sold 350,000 shares of Common Stock for
      $1,400,000, with $100,000 payable on June 25, 2008 and the remaining $1,300,000
      payable in six-month installments over a two-year period. Pursuant to the terms
      of the first Agreement, the Purchaser may not sell the 150,000 shares of Common
      Stock purchased thereunder earlier than June 25, 2009. Pursuant to the terms
      of
      the second Agreement, the Purchaser may not sell the 350,000 shares of Common
      Stock purchased thereunder until the earlier of (i) one year after the Purchase
      Price being paid in full to the Company, or (ii) the one-year anniversary of
      a
      Payment Failure Termination Event (as defined in the second Agreement). 
(See Note 10 Commitments)





On
      January 22, 2007, the Company sold 6 units at a price of $50,000 per unit for
      gross proceeds of $300,000 consisting 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
      June 30, 2008, there are 78,925 restricted shares granted to employees and
      consultants that vest through June 2009. In addition, there are 195,000
      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
      195,000 shares, if vested, would result in the recording of stock based
      compensation expense of approximately $2,438,000 over the period beginning
      when
      any of the contingent vesting events is deemed to be probable over the expected
      requisite service period. As of June 30, 2008, vesting is not considered
      probable and no compensation expense has been recognized related to the
      performance grants. On May 10, 2008, the Company accelerated the vesting of
      33,333 restricted shares and retired 250,000 of unvested restricted stock as
      the
      result of a separation agreement with the Company’s former President. The 33,333
      shares of restricted stock, formerly set to vest pro-ratably through June 2009,
      were accelerated to vest pro-ratably on a monthly basis over a ten-month vesting
      period ending in March 2009. As a result of the acceleration of the 33,333
      shares of restricted stock, the Company recognized approximately $194,000 of
      stock based compensation during the second quarter of 2008. (See Note 10
      Commitments)




***Stock
      Options*** - During
      the six months ended June 30, 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 Company also issued options to purchase 50,000 of its
      common shares at an exercise price of $5.68 per share to employees pursuant
      to
      the 2004 Employee Stock Option Plan that will vest over three years. The
      aggregate fair value of these options amounted to approximately $220,000
      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*** - During
      the six months ended June 30, 2008, the Company received $100,000 in proceeds
      from the exercise of warrants to purchase 50,000 shares of our common stock.
      During the six months ended June 30, 2007, the Company received approximately
      $55,000 in proceeds from the exercise of warrants to purchase 12,125 shares
      of
      our common stock.





***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 six months ended June 30, 2008, the
      Company recognized approximately $1,056,000 ($633,000- 2007) in stock-based
      compensation, of which $1,026,000 was classified as selling, general and
      administrative expense, and $30,000 was classified as research and development
      costs. Approximately $194,000 of the expense was the result of the acceleration
      of vesting of restricted shares to the Company’s former President as the result
      of his separation from the Company in May 2008.





As
      of
      June 30, 2008, there was approximately $1.1 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.





**7.**
                **Other
                    Income**




On
      May
      31, 2008, the Company was awarded a judgment of approximately $126,000 pursuant
      to a positive judgement for the Company in its counterclaim the matter “Frank
      LaLoggia v. Document Security Systems, Inc”, which the Company won in June 2006.
      The Company expects to collect the full amount of the judgment.




10




**8.**
            **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**
                **June
                  30, 2007**
              
              **Six
                  Months Ended**
                **June
                  30, 2007**Revenues
              
              $
              98,786
              
              
              219,491Cost
                  of sales
              
              
              54,229
              
              
              101,804Operating
                  expenses
              
              
              71,378
              
              
              133,113Income
                  from discontinued operations
              
              $
              (26,821
              )
              
              (15,426
              )





**9.**
            **Earnings
                Per Share**





Basic earnings per share is computed by dividing net income by the
      weighted-average number of common shares outstanding for the period. Diluted
      earnings per share is computed by including the number of additional shares
      that
      would have been outstanding if dilutive potential shares had been issued. In
      periods of losses, diluted loss per share is computed on the same basis as
      basic
      loss per share as the inclusion of any other potential shares outstanding would
      be anti-dilutive. If
      the
      Company had generated earnings during the six month period ended June 31, 2008,
      478,829 (693,671- 2007) common equivalent shares would have been added to the
      weighted average shares outstanding to compute the diluted weighted average
      shares outstanding.




**10.**
            **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 formally
      requested DSS to pay attorneys and court fees in the amount of Euro 93,752
      ($144,000), which, unless the amount is agreed will be subject to an assessment
      procedure that will not likely be concluded until approximately the end 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. Proceedings were commenced before the national courts seeking revocation
      and declarations of ****** invalidity  of
      the
      Patent in each of the Netherlands, Belgium, Italy, France, Spain, Germany and
      Austria. On March 26, 2007, the High Court of Justice, Chancery Division, and
      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 Court rejected the ECB’s allegations of invalidity
      based on lack of novelty, lack of inventive step and insufficiency, but held
      that the patent was invalid for added subject matter. The English Court’s
      decision does not affect the validity of the Patent in other European countries.
      On March 30, 2007, the English Court awarded the ECB 30%
      of
      their costs (including legal fees) of the initial trial ,
      of
      which the Company paid 90,000 British pounds ($182,000) on April 19, 2007.
      We
      expect that an additional 90,000 pounds ($182,000) will become payable by the
      Company for the costs of the initial trial, which is included in accrued
      expenses as of June 30, 2008. In July 2007, the Company posted a bond of 87,500
      British pounds ($177,000), as collateral for the appeal costs, which is recorded
      as restricted cash at June 30, 2008. On June 19, 2008, the Company paid 87,500
      British pounds ($177,000 based on the applicable exchange rate on that date)
      towards the **** ECB’s
      costs of the English appeal in
      addition to the bond posted. The
      Company may also owe additional legal fees associated with the Court of Appeal
      decisions, which, unless otherwise agreed by the parties, will be subject to
      an
      assessment procedure that will not likely be concluded earlier than the first
      quarter of 2009. The Company
      will record the assessed amount, if any, as soon as it is
      estimatable.





11


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 2010. 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 required to pay de minimus attorneys’ fees of the ECB as a result of the
      French decision. The Company filed an appeal against the French decision on
      May
      7, 2008. 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 Dutch decision on March 27, 2008. A trial
      was also held in Madrid, Spain on June 3 and 5, 2008 and oral and written
      closing submissions were made on July 19, 2008. A judgment is expected in the
      second half of 2008.




The
      Patent has thus been confirmed to be valid and enforceable in two jurisdictions
      (Germany and the Netherlands) that 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.





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
      or
      Maxon 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 these legal proceedings to which we are a party will have a material
      adverse effect on our results of operations, cash flows or our financial
      condition.




12


*Commitments*




In
      May
      2008, the Company entered into a Separation Agreement with its former President
      that, among other things, accelerated the vesting of 33,333 shares of restricted
      common stock of the Company that were previously awarded to the former President
      pursuant to the Company’s 2004 Employee Stock Option Plan so that such shares
      vested in equal monthly installments during the immediately following ten
      months. The Separation Agreement further provided that if the former
      President does not realize at least $212,000 in gross proceeds from the
      sale of such 33,333 shares of restricted stock upon their vesting, then the
      Company would pay the former President any shortfall of the $212,000
      in cash or additional shares of common stock of the Company at the election
      of
      the Company. As of June 30, 2008, 3,334 of such 33,333 shares had vested
      generating gross proceeds of approximately $17,000.




In
      May
      2008, the Company entered into a Credit Facility Note with Taiko III Corp.
      in
      which it was entitled to borrow up to $500,000 (see note 5 above). Pursuant
      to
      the terms of the Credit Facility Note, if the Company defaults on repayment
      of
      the $500,000 then Taiko III Corp. may require the Company to repay any
      outstanding indebtedness under such Credit Facility Note by issuing to Taiko
      III
      Corp. common stock of the Company. If the Company makes such repayment with
      its
      common stock, Taiko III Corp. may demand registration of such 500,000 shares
      with the Securities and Exchange Commission on Form S-3 with such registration
      statement to take effect no later than 150 days after notice of such
      registration is provided by Taiko III Corp. If
      the
      Company fails to register the shares, liquidated damages of 1% per month of
      the
      amount converted, up to 10%, would be payable by the Company until such shares
      were registered.




In
      June
      2008, the Company entered into two Stock Purchase Agreements in which it sold
      500,000 shares of its common stock to Walton Invesco Inc. for an aggregate
      purchase price of $2.0 million (see Note 6). Pursuant to the terms of such
      Stock
      Purchase Agreements, Walton Invesco Inc. may demand registration of such 500,000
      shares with the Securities and Exchange Commission on Form S-3 with such
      registration statement to take effect no later than (i) 120 days after payment
      in full for such shares under the applicable agreement or, (ii) with respect
      to
      350,000 shares, 270 days after a Payment Failure Termination Event (as defined
      in the applicable Stock Purchase Agreement).




Pursuant
      to an agreement made in December 2004, the Company is required to share the
      economic benefit derived from settlements, licenses or subsequent business
      arrangements that the Company obtains from any infringer of patents formerly
      owned by the Wicker Family. For infringement matters involving certain U.S.
      patents, the Company will be required to disburse 30% of the settlement
      proceeds. For infringement matters involving certain foreign patents, including
      the lawsuit against the European Central Bank described in Part II Item 1 -
      Legal Proceedings, the Company will be required to disburse 14% of the
      settlement proceeds. These payments do not apply to licenses or royalties to
      patents that the Company has developed or obtained from persons other than
      the
      Wicker Family. As of June 30, 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.




**11.**
            **Supplemental
                Cash Flow Information**




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




13




**12.**
            **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:




**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 8).**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 and six months ended June 30, 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:


**Legal**
                **Supplies**
              
              **Document**
                **Security
                  &**
                **Production**
              
              **Corporate**
              
              **Total****3
                  months ended June 30, 2008:**Revenues
                  from external customers
              
              $
              159,000
              
              $
              2,055,000
              
              $
              -
              
              $
              2,214,000Depreciation
                  and amortization
              
              
              4,000
              
              
              611,000
              
              
              1,000
              
              
              616,000Segment
                  profit (loss) from continuing operations
              
              
              27,000
              
              
              (536,000
              )
              
              (709,000
              )
              
              (1,218,000
              )**3
                  months ended June 30, 2007:**Revenues
                  from external customers
              
              $
              162,000
              
              $
              1,133,000
              
              $
              -
              
              $
              1,295,000Depreciation
                  and amortization
              
              
              3,000
              
              
              459,000
              
              
              17,000
              
              
              479,000Segment
                  profit (loss) from continuing operations
              
              
              3,000
              
              
              (945,000
              )
              
              (732,000
              )
              
              (1,674,000
              )
  **Legal**
                **Supplies**
              
              **Document**
                **Security
                  &**
                **Production**
              
              **Corporate**
              
              **Total****6
                  months ended June 30, 2008:**Revenues
                  from external customers
              
              $
              332,000
              
              $
              3,325,000
              
              $
              -
              
              $
              3,657,000Depreciation
                  and amortization
              
              
              8,000
              
              
              1,212,000
              
              
              2,000
              
              
              1,222,000Segment
                  profit (loss) from continuing operations
              
              
              35,000
              
              
              (2,246,000
              )
              
              (1,308,000
              )
              
              (3,519,000
              )**6
                  months ended June 30, 2007:**Revenues
                  from external customers
              
              $
              337,000
              
              $
              2,586,000
              
              $
              -
              
              $
              2,923,000Depreciation
                  and amortization
              
              
              6,000
              
              
              835,000
              
              
              29,000
              
              
              870,000Segment
                  profit (loss) from continuing operations
              
              
              2,000
              
              
              (1,419,000
              )
              
              (1,478,000
              )
              
              (2,895,000
              )
  14




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




***FORWARD-LOOKING
      STATEMENTS***




Certain
      statements contained herein constitute “forward-looking statements” within the
      meaning of the Private Securities Litigation Reform Act of 1995 (the “1995
      Reform Act”). Document Security Systems, Inc. desires to avail itself of certain
“safe harbor” provisions of the 1995 Reform Act and is therefore including this
      special note to enable us to do so. Except for the historical information
      contained herein, this report contains forward-looking statements (identified
      by
      the words "estimate," "project," "anticipate," "plan," "expect," "intend,"
      "believe," "hope," "strategy" and similar expressions), which are based on
      our
      current expectations and speak only as of the date made. These forward-looking
      statements are subject to various risks, uncertainties and factors, including,
      without limitation, those contained in our Form 10-K for the year ended December
      31, 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 a digital product to implement our technologies
      in
      Internet-based environments utilizing standard desktop printers. We believe
      that
      our 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 AuthentiGuard trade names.





*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.





15


**Security
      Paper** : Our
      primary product for the retail end-user market is AuthentiGuard Security Paper.
      AuthentiGuard Security Paper uses our Pantograph 4000 technology, and 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. The hidden warning 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.





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




***Results
      of Operations for the Three and Six Months Ended***  ***June
      30, 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 an
      unrelated third party. 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 discontinued
      operations.




**Revenue**


**Three
                  Months**
                **EndedJune
                  30,****2008**
              
              **Three
                  Months**
                **EndedJune
                  30,****2007**
              
              **%
                  change**
                **vs.
                  2007**
              
              **Six
                  MonthsEnded**
                **June
                  30, 2008**
              
              **Six
                  MonthsEnded**
                **June
                  30, 2007**
              
              **%
                      change vs.****2007***Revenue*Security
                  printing & products
              
              $
              1,155,000
              
              $
              827,000
              
              
              40
              %
              $
              2,087,000
              
              $
              1,818,000
              
              
              15
              %Royalties
              
              
              892,000
              
              
              294,000
              
              
              203
              %
              
              1,221,000
              
              
              593,000
              
              
              106
              %Digital
                  solutions
              
              
              8,000
              
              
              12,000
              
              
              -33
              %
              
              16,000
              
              
              175,000
              
              
              -91
              %Legal
                  products
              
              
              159,000
              
              
              162,000
              
              
              -2
              %
              
              332,000
              
              
              337,000
              
              
              -1
              %*Total
                  Revenue*
              
              
              2,214,000
              
              
              1,295,000
              
              
              71
              %
              
              3,656,000
              
              
              2,923,000
              
              
              25
              %




**Document
      Security and Production**




For
      the
      three months ended June 30, 2008, revenue increased 71% from the same period
      in
      2007. The increase in revenue was primarily the result of two factors. First,
      the Company experienced a 40% increase in sales of its security printing and
      products with sales increases experienced for both its plastic and paper based
      products. The demand for the Company’s security technology and the strength in
      our core secure printing business is reflected in the wide range of products
      we
      delivered during the quarter, including shipments of Medicaid-ready prescription
      paper under its continued relationship with Boise Cascade, two separate foreign
      country orders for drivers licenses, and a large secure coupon paper order.
      Second, the Company recognized approximately $542,000 of previously deferred
      royalty revenue as the result of a new agreement with the Ergonomic Group in
      April 2008. Under a previous agreement with the Ergonomic Group, the Company
      received $1,000,000 in non-refundable license and royalty fees, of which
      $500,000 was recognized as royalty revenue pro-ratably over a two year license
      period and the remaining $500,000 was considered a prepaid royalty, to be
      recognized as revenue when sales of products using the licensed technology
      were
      made. This agreement was cancelled and a new agreement with the Ergonomic Group
      that covers the Company’s newest digital technologies was established. As a
      result, the non refundable license and royalty payment no longer met the
      criteria for deferral. Absent the impact of recognizing the $542,000 in deferred
      royalties, revenue during the second quarter of 2008 grew 29% from the second
      quarter of 2007.




For
      the
      first six months of 2008, revenue increased 25% compared to the first six months
      of 2007 primarily as a the result of the significant impact of royalty revenue
      recognized in the second quarter of 2008 as discussed above, along with a 15%
      growth in the company’s sales of its security printing and products. These
      growth areas were partially offset by a significant decline in digital solutions
      sales during the first half of 2008 as compared to the first half of 2007 due
      to
      the absence of any digital solutions implementations during 2008.




**Cost
      of Sales and Gross Profit**


**Three
                  Months**
                **EndedJune
                  30,****2008**
              
              **Three
                  Months**
                **EndedJune
                  30,****2007**
              
              **%
                  change vs.**
                **2007**
              
              **Six
                  MonthsEnded**
                **June
                  30, 2008**
              
              **Six
                  Months**
                **EndedJune
                  30,****2007**
              
              **%
                  change vs.**
                **2007***Costs
                  of revenue*Security
                  printing & products
              
              $
              796,000
              
              $
              548,000
              
              
              45
              %
              $
              1,392,000
              
              $
              1,055,000
              
              
              32
              %Digital
                  solutions
              
              
              4,000
              
              
              3,000
              
              
              33
              %
              
              7,000
              
              
              37,000
              
              
              -81
              %Legal
                  products
              
              
              74,000
              
              
              91,000
              
              
              -19
              %
              
              171,000
              
              
              194,000
              
              
              -12
              %*Total
                  cost of revenue*
              
              
              874,000
              
              
              642,000
              
              
              36
              %
              
              1,570,000
              
              
              1,286,000
              
              
              22
              %*Gross
                  profit*Security
                  printing & products
              
              
              359,000
              
              
              279,000
              
              
              29
              %
              
              695,000
              
              
              763,000
              
              
              -9
              %Royalties
              
              
              892,000
              
              
              294,000
              
              
              203
              %
              
              1,221,000
              
              
              593,000
              
              
              106
              %Digital
                  solutions
              
              
              4,000
              
              
              9,000
              
              
              -56
              %
              
              9,000
              
              
              138,000
              
              
              -93
              %Legal
                  products
              
              
              85,000
              
              
              71,000
              
              
              20
              %
              
              161,000
              
              
              143,000
              
              
              13
              %*Total
                  gross profit*
              
              
              1,340,000
              
              
              653,000
              
              
              105
              %
              
              2,086,000
              
              
              1,637,000
              
              
              27
              %




**Three
                  Months**
                **EndedJune
                  30,****2008**
              
              **Three
                  Months**
                **EndedJune
                  30,****2007**
              
              **%
                  change vs.**
                **2007**
              
              **Six
                  MonthsEnded**
                **June
                  30, 2008**
              
              **Six
                  MonthsEnded**
                **June
                  30, 2007**
              
              **%
                  change vs.**
                **2007**Gross
                  profit percentage:
              
              
              61
              %
              
              50
              %
              
              22
              %
              
              57
              %
              
              56
              %
              
              2
              %




Gross
      Profit




Gross
      profit increased 106% to $1,340,000 in the second quarter of 2008 as compared
      to
      the $653,000 of gross profit realized in the second quarter of 2007, primarily
      as a result of significant increase in royalty related income, primarily the
      result of the aforementioned recognition of $542,000 of deferred revenue. This
      increase was slightly offset by higher costs of sales for security printing
      and
      products due to higher depreciation and rent costs associated with the Company’s
      upgrade to certain of its production equipment and the move of its plastic
      printing division to a larger facility. For the six months ended June 30, 2008,
      the Company’s gross profit increased in line with revenue as the Company’s gross
      profit percentage was generally consistent with the first half of 2007. 
In
      the six-month 2007 period, the Company had a large digital solution sale with
      a
      gross margin of 78%. In the six-month 2008 period, the
      Company did not have a comparable digital sale, however, the Company did have
      the large deferred revenue item. The impact of these large items resulted in
      the
      comparability of gross profit percentage between the two periods. Otherwise,
      gross margins of the Company’s security printing and products group declined,
      which reflected the impact of higher costs of sales due to the Company’s move of
      its plastic printing division to a larger facility.




**Operating
      Expenses**


**Three
                  Months**
                **EndedJune
                  30,****2008**
              
              **Three
                  Months**
                **EndedJune
                  30,****2007**
              
              **%
                  change vs.**
                **2007**
              
              **Six
                  MonthsEnded**
                **June
                  30, 2008**
              
              **Six
                  Months**
                **EndedJune
                  30,****2007**
              
              **%
                  change vs.**
                **2007***Selling,
                  general and administrative*General
                  and administrative compensation
              
              $
              508,000
              
              $
              534,000
              
              
              -5
              %
              $
              1,084,000
              
              $
              947,000
              
              
              14
              %Stock
                  based payments
              
              
              619,000
              
              
              297,000
              
              
              108
              %
              
              1,026,000
              
              
              633,000
              
              
              62
              %Professional
                  Fees
              
              
              207,000
              
              
              364,000
              
              
              -43
              %
              
              574,000
              
              
              684,000
              
              
              -16
              %Sales
                  and marketing
              
              
              299,000
              
              
              391,000
              
              
              -24
              %
              
              687,000
              
              
              910,000
              
              
              -25
              %Depreciation
                  and amortization
              
              
              42,000
              
              
              20,000
              
              
              110
              %
              
              84,000
              
              
              40,000
              
              
              110
              %Other
              
              
              288,000
              
              
              205,000
              
              
              40
              %
              
              583,000
              
              
              395,000
              
              
              48
              %Research
                  and development
              
              
              134,000
              
              
              109,000
              
              
              23
              %
              
              249,000
              
              
              203,000
              
              
              23
              %Impairment
                  of patent defense costs
              
              
              -
              
              
              -
              
              
              
              
              
              292,000
              
              
              -Amortization
                  of intangibles
              
              
              537,000
              
              
              433,000
              
              
              24
              %
              
              1,064,000
              
              
              779,000
              
              
              37
              %*Total
                  Operating Expenses*
              
              
              2,634,000
              
              
              2,353,000
              
              
              12
              %
              
              5,643,000
              
              
              4,591,000
              
              
              23
              %




16




**Selling,
      General and Administrative**




General
      and administrative compensation costs
      decreased 5% in the second quarter of 2008 as compared to the second quarter
      of
      2007 which was the primarily the result of the Company’s separation with its
      former President in May 2008. This reduction was partially offset by an increase
      in the cash compensation of the non-employee members of the Company’s board of
      directors.




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. Stock-based compensation increases in
      the
      three and six month periods ended June 2008 reflect equity-based payments made
      to third-party consultants and approximately $194,000 of expense as the result
      of the acceleration of vesting of restricted shares and $18,000 due to the
      modification of options to the Company’s former President as the result of his
      separation from the Company in May 2008.




Professional
      fees -
      The
      decrease in professional fees during the second quarter and first six months
      of
      2008 primarily reflect a decrease in non-patent related legal fees, including
      the impact of the Company hiring its former legal counsel in May 2007, a
      reduction in accounting fees, and reductions in stock transfer and investor
      relations fees. These cost savings were partially offset by increases in the
      use
      of consultants for sales and business development efforts during the first
      three
      months of 2008. In March 2008, the Company initiated a cost-cutting program
      that
      is expected to significantly reduce the amount spent on outside consultants,
      which is partially reflected in the second quarter of 2008.


**Three
                  Months**
                **EndedJune
                  30,****2008**
              
              **Three
                  Months**
                **EndedJune
                  30,****2007**
              
              **%
                  change vs.**
                **2007**
              
              **Six
                  MonthsEnded**
                **June
                  30, 2008**
              
              **Six
                  MonthsEnded**
                **June
                  30, 2007**
              
              **%
                  change vs.**
                **2007***Professional
                  Fees Detail*Accounting
                  and auditing
              
              $
              30,000
              
              $
              52,000
              
              
              -42
              %
              $
              172,000
              
              $
              165,000
              
              
              4
              %Consulting
              
              
              113,000
              
              
              106,000
              
              
              7
              %
              
              262,000
              
              
              197,000
              
              
              33
              %Legal
                  Fees
              
              
              18,000
              
              
              80,000
              
              
              -78
              %
              
              51,000
              
              
              135,000
              
              
              -62
              %Relations
              
              
              46,000
              
              
              126,000
              
              
              -63
              %
              
              89,000
              
              
              187,000
              
              
              -52
              %$
              207,000
              
              $
              364,000
              
              
              -43
              %
              $
              574,000
              
              $
              684,000
              
              
              -16
              %




Sales
      and marketing expenses, including sales and marketing personnel costs, decreased in the second
      quarter and first half of 2008 as the Company reduced sales and marketing
      headcount by four, reduced public relations and marketing costs and
      significantly reduced the amount spent on travel and entertainment. The Company
      reduced these costs as it realigned its sales process in order to maximize
      the
      results of its sales and marketing efforts with the goal of focusing of near
      term revenue opportunities.




Other
      expenses are
      primarily rent and utilities, office supplies, IT support, bad debt expense
      and
      insurance costs. Increases in the second quarter an first half of 2008 reflect
      costs increases associated with an increase in rent costs and one time costs
      associated with the move of the Company’s plastic printing division to a larger
      facility, higher utility costs, and an increase in insurance costs.




**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.




**Other
      Income**




On
      May
      31, 2008, the Company was awarded a judgment of approximately $126,000 pursuant
      to a counterclaim by the Company in the matter “Frank LaLoggia v. Document
      Security Systems, Inc”, which the Company won in June 2006. The Company expects
      to collect the full amount of the judgment.




**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 second quarter
      of 2008, the Company incurred an increase in research and development costs
      for
      the development costs for software associated with its digital delivery of
      its
      security print technologies.




17


**Amortization
      of Intangibles**




Amortization
      of intangibles expense increased 24% in the second quarter of 2008 as compared
      to the second quarter of 2007 which was primarily the result of an increase
      of
      $0.8 million in the Company’s capitalized patent defense costs from June 2007 to
      June 2008. 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 June 30,
      2008
      was approximately $4.8 million and will generate approximately $1.9 million
      in
      annual amortization expense during the next 3 years. In addition, the Company
      has approximately $746,000 of net other intangible assets as of June 30, 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 3 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 validity or
      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**
                **EndedJune
                  30,****2008**
              
              **Three
                  Months**
                **EndedJune
                  30,****2007**
              
              **%
                  change vs.**
                **2007**
              
              **Six
                  MonthsEnded**
                **June
                  30, 2008**
              
              **Six
                  Months**
                **EndedJune
                  30,****2007**
              
              **%
                  change vs.**
                **2007**Net
                  loss
              
              $
              (1,218,000
              )
              $
              (1,700,000
              )
              
              -28
              %
              $
              (3,519,000
              )
              $
              (2,910,000
              )
              
              21
              %Net
                  loss per share, basic and diluted
              
              $
              (0.09
              )
              $
              (0.12
              )
              
              -29
              %
              $
              (0.26)
                  $
              
              
              (0.21
              )
              
              20
              %Weighted
                  average common shares outstanding, basic and diluted
              
              
              13,690,545
              
              
              13,625,408
              
              
              0
              %
              
              13,672,555
              
              
              13,605,327
              
              
              0
              %




During
      the second quarter of 2008, the Company experienced a net loss of $1.2 million,
      a 28% decrease from the net loss of the second quarter of 2007. The reduction
      in
      net loss during the quarter was primarily the result of the Company’s
      recognition of deferred revenue of approximately $542,000 during the quarter.
      The increase in revenue was partially offset by increases in stock based
      compensation costs, amortization of intangibles, and other expenses. As
      described above, these cost increases were partially offset by decreases in
      the
      Company’s other major expense classifications of selling, general and
      administrative compensation, professional fees and sales and marketing costs.
      Of
      the net loss of $1.2 million in second quarter of 2008, approximately $1.2
      million was due to the expense items of stock based compensation and
      amortization of intangibles.




18




**LIQUIDITY
      AND CAPITAL RESOURCES**




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


**As
                  Of And For The Six Months Ended:****June
                  30, 2008**
              
              **June
                  30, 2007**
              
              **%
                  change vs. 2007**Cash
                  flows from:Operating
                  activities
              
              $
              (1,637,000
              )
              $
              (1,637,000
              )
              
              0
              %Investing
                  activities
              
              
              (946,000
              )
              
              (732,000
              )
              
              -29
              %Financing
                  activities
              
              
              2,802,000
              
              
              (183,000
              )
              
              1631
              %Working
                  capital
              
              
              (1,079,000
              )
              
              1,836,000
              
              
              -159
              %Current
                  ratio
              
              
              0.72
              x
              
              1.65
                  x
              
              
              -25
              %Cash
                  and cash equivalents
              
              $
              961,000
              
              $
              3,251,000
              
              
              -70
              %Revolving
                  credit notes
              
              $
              2,358,000
              
              $
              -Funds
                  Available from Open Credit Facilities
              
              $
              1,742,000
              
              $
              -




As
      of
      June 30, 2008, our cash and cash equivalents were $961,000, up from $742,000
      at
      December 31, 2007. The increase was primarily due to the receipt of cash from
      issuance of shares in a private placement and exercise of warrants, along with
      the receipt of funds from various credit facilities which offset the use of
      cash
      for operations and the use of cash to defend the Company’s patent rights offset
      by the receipt of $2,058,000 from the Company’s three credit facilities. As of
      June 30, 2008, the Company had $2.4 million outstanding under three credit
      agreements, which are due and payable over the next two years.


**Payment
                  Due by Period****Total**
              
              **Less
                  than 1 year**
              
              **1-3
                  years**
              
              **3-5
                  years**
              
              **More
                  than 5 years**Credit
                  Facilities
              
              $
              2,358,000
              
              $
              500,000
              
              $
              1,858,000
              
              $
              -
              
              $
              -




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. As a result of these cost cuts, the
      Company has reduced its annual operating expense base by approximately $1.5
      million. The Company expects to reach operating cash flow breakeven at
      approximately $9.0 million in annual revenue, and believes that it can obtain
      this revenue level with its current level of resources.




As
      of
      June 30, 2008, we have an aggregate of $1,742,000 remaining available under
      two
      revolving notes that terminate on January 4, 2010. In
      addition, the Company has $1,300,000 in subscriptions receivable which it
      expects to receive in six-month installments over the next two years. Based
      on
      these funding sources, the Company believes that it has sufficient available
      funds to meet
      its cash needs for at least 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.





19


**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.
 
 **Changes
        in Internal Control Over Financial Reporting**
 
 During
        the second quarter of 2008, the Company eliminated the use of an outside
        consultant formerly used to enhance the segregation of duties for financial
        reporting. Concurrently, the Company modified and expanded one of its existing
        internal positions to accommodate some of the control objectives affected
        by the
        elimination of the outside consultant. However, during the second quarter,
        some
        of the control objectives of the new position were not met, as the new employee
        did not have sufficient time to train for the role prior to the end of the
        second quarter of 2008.
  **PART
        II**
 **OTHER
        INFORMATION**
  **ITEM
        1 - LEGAL PROCEEDINGS**
  Information
        concerning pending legal proceedings is incorporated herein by reference
        to Note
        10 to the Condensed Consolidated Financial Statements (Unaudited) in Part
        I of
        this Form 10-Q.
 
 On
        August
        1, 2005, we commenced a suit against the European Central Bank (“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 formally
        requested DSS to pay attorneys and court fees in the amount of Euro 93,752
        ($144,000), which, unless the amount is agreed will be subject to an assessment
        procedure that will not likely be concluded until approximately the end 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. Proceedings were commenced before the national courts seeking revocation
        and declarations of ****** invalidity  of
        the
        Patent in each of the Netherlands, Belgium, Italy, France, Spain, Germany
        and
        Austria. 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 Court rejected the ECB’s allegations of invalidity
        based on lack of novelty, lack of inventive step and insufficiency, but held
        that the patent was invalid for added subject matter. The English Court’s
        decision does not affect the validity of the Patent in other European countries.
        On March 30, 2007, the English Court awarded the ECB 30%
        of
        their costs (including legal fees) of the initial trial ,
        of
        which the Company paid 90,000 British pounds ($182,000) on April 19, 2007.
        We
        expect that an additional 90,000 pounds ($182,000) will become payable by
        the
        Company for the costs of the initial trial, which is included in accrued
        expenses as of June 30, 2008. In July 2007, the Company posted a bond of
        87,500
        British pounds ($177,000), as collateral for the appeal costs which is recorded
        as restricted cash at June 30, 2008. On June 19, 2008, the Company paid 87,500
        British pounds ($177,000 based on the applicable exchange rate on that date)
        towards the **** ECB’s
        costs of the English appeal in addition to the bond posted. The
        Company may also owe additional legal fees associated with the Court of Appeal
        decisions, which, unless otherwise agreed by the parties, will be subject
        to an
        assessment procedure that will not likely be concluded earlier than the first
        quarter of 2009. The Company
        will record the assessed amount, if any, as soon as it is
        estimatable.
 
 20
  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
        44,692 692 ($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 2010. 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 required to pay de minimus attorneys’ fees of the ECB as a result of the
        French decision. The Company filed an appeal against the French decision
        on May
        7, 2008. 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 Dutch decision on March 27, 2008. A trial
        was also held in Madrid, Spain on June 3 and 5, 2008 and oral and written
        closing submissions were made on July 19, 2008. A judgment is expected in
        the
        second half of 2008.
  The
        Patent has thus been confirmed to be valid and enforceable in two jurisdictions
        (Germany and the Netherlands) that 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.
 
 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
        or
        Maxon 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 these legal proceedings to which we are a party 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.
 
 21
  ***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 $27,733,000 at June 30, 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
        (“P3”), and the other credit facility has a borrowing limit of $600,000 and is
        secured by our accounts receivable, excluding the accounts receivable of
        P3. 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 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.
 
 ***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 and prosecute current and future patent 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.
 
 22
  ***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 without limitation
        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 validity or 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 .
 
 ***Our
        patent litigation strategy against the European Central Bank and elsewhere
        in
        Europe may include us entering into a joint venture or other contractual
        relationship with a third party that could result in us exchanging a significant
        percentage of the potential revenues derived from such litigation for the
        future
        funding of such litigation.***
 
 We
        have
        expended significant time and monetary resources in its patent litigation
        against the European Central Bank (See Part II Item I - Legal Proceedings).
        We
        have entered into negotiations with third parties to provide some or all
        of the
        future funding of such litigation, and related litigations, in exchange for
        sharing with such third parties a material portion of any revenue generated
        from
        such litigations. If such an arrangement is entered into by the Company,
        we
        cannot be assured that the amount of litigation proceeds shared with such
        third
        party will not far exceed the amount of funding provided by such third party.
        In
        addition, in order to induce such third party to enter into the above-described
        arrangement, we may cede decision making with respect to such litigations
        to
        such third party. We cannot be assured that the interests of our shareholders
        will be aligned fully with the interests of such third party, which may result
        in a material adverse effect on the amount of proceeds that we could or would
        realize, which would have a material adverse effect on the value of our common
        stock.
  ***If
        we are unable to adequately protect our intellectual property, our competitive
        advantage may disappear.***
  Our
        success will be determined in part by our ability to obtain United States
        and
        foreign patent protection for our technology and to preserve our trade secrets.
        Because of the substantial length of time and expense associated with developing
        new document security technology, we place considerable importance on patent
        and
        trade secret protection. We intend to continue to rely primarily on a
        combination of patent protection, trade secrets, technical measures, copyright
        protection and nondisclosure agreements with our employees and customers
        to
        establish and protect the ideas, concepts and documentation of software and
        trade secrets developed by us. Our ability to compete and the ability of
        our
        business to grow could suffer if these intellectual property rights are not
        adequately protected. There can be no assurance that our patent applications
        will result in patents being issued or that current or additional patents
        will
        afford protection against competitors. We rely on a combination of patents,
        copyrights, trademarks and trade secret protection and contractual rights
        to
        establish and protect our intellectual property. Failure of our patents,
        copyrights, trademarks and trade secret protection, non-disclosure agreements
        and other measures to provide protection of our technology and our intellectual
        property rights could enable our competitors to more effectively compete
        with us
        and have an adverse effect on our business, financial condition and results
        of
        operations. In addition, our trade secrets and proprietary know-how may
        otherwise become known or be independently discovered by others. No guarantee
        can be given that others will not independently develop substantially equivalent
        proprietary information or techniques, or otherwise gain access to our
        proprietary technology.
  In
        addition, we may be required to litigate in the future to enforce our
        intellectual property rights, to protect our trade secrets, to determine
        the
        validity and scope of the proprietary rights of others, or to defend against
        claims of infringement or invalidity. Any such litigation could result in
        substantial costs and diversion of resources and could have a material adverse
        effect on our business, financial condition or results of operations, and
        there
        can be no assurances of the success of any such litigation.
 
 23
  ***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.
 
 ***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.
 
 24
  ***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.
 
 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 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 2009. There can be no assurance that these persons will continue
        to agree to be employed by us after such dates.
 
 25
  ***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. In June 2008, we sold 350,000
        shares for an aggregate purchase price of $1.4 million, with $100,000 payable
        at
        closing and the remaining $1.3 million payable in six-month installments
        over
        two years. If the Purchaser of such 350,000 does not pay some or all of such
        remaining $1.3 million purchase price, we will have limited, if any, recourse
        against the purchaser other than recouping a pro-rata amount of the 350,000
        shares. If we do not receive the remaining $1.3 million of the purchase price
        on
        schedule, our financial position and financing resources may be materially
        adversely affected.
 
 **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
        June 30, 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.
 
 ***The
        exercise of our outstanding options and warrants and vesting of restricted
        stock
        awards may depress our stock price.***
 
 As
        of
        June 30, 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 and a weighted average exercise price of $10.26.
        In addition, as of June 30, 2008, there were 270,591 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.
 
 26
  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**
  On
        June
        25, 2008 the Company entered into two Share Purchase Agreements in which
        the
        Company agreed to sell a total of 500,000 shares of the Company’s common stock
        for an aggregate purchase price of $2,000,000. Pursuant to the terms of the
        first Agreement, the Company sold 150,000 shares of Common Stock to the
        Purchaser for $600,000 payable on June25, 2008. Pursuant to the terms of
        the
        second Agreement, the Company sold 350,000 shares of Common Stock for
        $1,400,000, with $100,000 payable on June25, 2008and the remaining $1,300,000
        payable in six-month installments over a two-year period. Pursuant to the
        terms
        of the first Agreement, the Purchaser may not sell the 150,000 shares of
        Common
        Stock purchased thereunder earlier than June 25, 2009. Pursuant to the terms
        of
        the second Agreement, the Purchaser may not sell the 350,000 shares of Common
        Stock purchased thereunder until the earlier of (i) one year after the Purchase
        Price being paid in full to the Company, or (ii) the one-year anniversary
        of a
        Payment Failure Termination Event (as defined in the second Agreement).
  **ITEM
        3 - DEFAULTS UPON SENIOR SECURITIES**
  None
  **ITEM
        4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**
  None
  **ITEM
        5 - OTHER INFORMATION**
  None
  **ITEM
        6 - EXHIBITS**
  The
        Exhibits listed below designated by an * are incorporated by reference to
        the
        filings by Document Security Systems, Inc. under the Securities Act of 1933
        or
        the Securities and Exchange Act of 1934, as indicated. All other exhibits
        are
        filed herewith.
 
 (a)
              
              Exhibits
                
                Item
                  3.1Articles
                  of Organization of the Registrant, 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
                  of the Registrant, as amended (incorporation by reference to exhibit
                  3.2
                  to the Company's Registration Statement No. 2-98684-NY on Form
                  S-18).*
                
                Item
                  10.1Share
                  Purchase Agreement, dated as of June 25, 2008, between the Registrant
                  and
                  Walton Invesco Inc.
                
                Item
                  10.2Share
                  Purchase Agreement, dated as of June 25, 2008, between the Registrant
                  and
                  Walton Invesco Inc.
  27
 Item
                    10.3Credit
                    Facility Note, dated May 7, 2008, between the Registrant and
                    Taiko III
                    Corp. (incorporation by reference to exhibit 10.1 to the Form
                    8-K, filed
                    May 12, 2008).*
                  
                  Item
                    10.4Confidential
                    Separation Agreement and General Release, dated May 10, 2008,
                    between
                    Peter Ettinger and the Registrant (incorporation by reference
                    to exhibit
                    10.1 to the Form 8-K, filed May 12, 2008).*
                  
                  Item
                    10.5Consulting
                    Agreement, dated May 12, 2008, between Peter Ettinger and the
                    Registrant
                    (incorporation by reference to exhibit 10.2 to the Form 8-K,
                    filed May 12,
                    2008).*
                  
                  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
  **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.**August
                11, 2008
              By:
              /s/ Patrick
                WhitePatrick
                WhiteChief
                Executive Officer
  August
                11, 2008
              By:
              /s/ Philip
                JonesPhilip
                JonesActing
                Chief Financial Officer
                (Vice
                  President of Finance)
 28