UNITED
STATES SECURITIES AND EXCHANGE


COMMISSION


Washington,
D.C. 20549




FORM
10-Q




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


THE
SECURITIES EXCHANGE ACT OF 1934




For the quarterly period ended
September 30,
2009




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) has
filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934during 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  ̈





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Date File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files)*


Yes  ̈  No  ̈





*   The
issuer has not yet been phased into the interactive data
requirements





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  ̈Accelerated filer
 ̈Non-accelerated
filer   ̈Smaller reporting
company x





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


Yes
 ̈  No
x




Applicable
only to corporate issuers


As of
November 13, 2009 (the most recent practicable date), there were 15,182,062
shares of the issuer's Common Stock, $0.02 par value per share,
issued.





DOCUMENT
SECURITY SYSTEMS, INC.


FORM
10-Q


TABLE
OF CONTENTS





PART
      I
                            
                            FINANCIAL
      INFORMATIONItem
      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
                            17Item
      4T
                            
                            Controls
      and Procedures
                            24PART
      II
                            
                            OTHER
      INFORMATIONItem
      1
                            
                            Legal
      Proceedings
                            24Item
      1A
                            
                            Risk
      Factors
                            26Item
      2
                            
                            Unregistered Sales
      of Equity Securities and Use of Proceeds
                            28Item
      3
                            
                            Defaults
      upon Senior Securities
                            29Item
      4
                            
                            Submission
      of Matters to a Vote of Security Holders
                            29Item
      5
                            
                            Other
      Information
                            29Item
      6
                            
                            Exhibits
                            30SIGNATURES
                            31


2




PART
I




FINANCIAL
INFORMATION


ITEM 1 - FINANCIAL
STATEMENTS




DOCUMENT
SECURITY SYSTEMS, INC.  AND SUBSIDIARIES


Consolidated
Balance Sheets


As
of





September 30,
                                    
                                    
                                    December 31,2009
                                    
                                    
                                    2008(unaudited)ASSETSCurrent
      assets:Cash
      and cash equivalents
                                    
                                    $
                                    423,076
                                    
                                    
                                    $
                                    87,820Restricted
      cash
                                    
                                    
                                    -
                                    
                                    
                                    
                                    131,004Accounts
      receivable, net of allowance of $36,000 ($50,000- 2008)
                                    
                                    
                                    1,341,464
                                    
                                    
                                    
                                    1,284,208Inventory
                                    
                                    
                                    237,623
                                    
                                    
                                    
                                    359,034Loans
      to employees
                                    
                                    
                                    -
                                    
                                    
                                    
                                    67,781Prepaid
      expenses and other current assets
                                    
                                    
                                    125,129
                                    
                                    
                                    
                                    75,066Total
      current assets
                                    
                                    
                                    2,127,292
                                    
                                    
                                    
                                    2,004,913Assets
      held for sale
                                    
                                    
                                    255,372
                                    
                                    
                                    
                                    -Fixed
      assets, net
                                    
                                    
                                    1,349,020
                                    
                                    
                                    
                                    1,517,357Other
      assets
                                    
                                    
                                    315,508
                                    
                                    
                                    
                                    264,529Goodwill
                                    
                                    
                                    1,315,721
                                    
                                    
                                    
                                    1,396,734Other
      intangible assets, net
                                    
                                    
                                    1,972,375
                                    
                                    
                                    
                                    2,873,789Total
      assets
                                    
                                    $
                                    7,335,288
                                    
                                    
                                    $
                                    8,057,322LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilities:Accounts
      payable
                                    
                                    $
                                    1,779,018
                                    
                                    
                                    $
                                    1,411,942Accrued
      expenses & other current liabilities
                                    
                                    
                                    933,951
                                    
                                    
                                    
                                    1,312,745Deferred
      revenue & customer deposits
                                    
                                    
                                    25,273
                                    
                                    
                                    
                                    30,193Revolving
      notes from related parties
                                    
                                    
                                    3,033,000
                                    
                                    
                                    
                                    -Short-term
      debt, net of discount of $58,000 ($247,000 -2008)
                                    
                                    
                                    841,722
                                    
                                    
                                    
                                    652,511Current
      portion of capital lease obligations
                                    
                                    
                                    75,721
                                    
                                    
                                    
                                    78,367Total
      current liabilities
                                    
                                    
                                    6,688,685
                                    
                                    
                                    
                                    3,485,758Liabilities
      held for sale
                                    
                                    
                                    24,036
                                    
                                    
                                    
                                    -Revolving
      notes from related parties
                                    
                                    
                                    -
                                    
                                    
                                    
                                    2,283,000Capital
      lease obligations
                                    
                                    
                                    206,956
                                    
                                    
                                    
                                    210,365Deferred
      tax liability
                                    
                                    
                                    66,092
                                    
                                    
                                    
                                    51,878Commitments
      and contingencies (see Note 9)Stockholders'
      equityCommon
      stock, $.02 par value; 200,000,000 shares authorized, 14,974,062 shares
      issued and outstanding (14,369,764 in 2008) (325,000 subscribed in
      2008)
                                    
                                    
                                    299,481
                                    
                                    
                                    
                                    287,395Additional
      paid-in capital
                                    
                                    
                                    35,422,864
                                    
                                    
                                    
                                    35,538,695Common
      stock subscriptions receivable
                                    
                                    
                                    -
                                    
                                    
                                    
                                    (1,300,000
                                    )Accumulated
      deficit
                                    
                                    
                                    (35,372,826
                                    )
                                    
                                    
                                    (32,499,769
                                    )Total
      stockholders' equity
                                    
                                    
                                    349,519
                                    
                                    
                                    
                                    2,026,321Total
      liabilities and stockholders' equity
                                    
                                    $
                                    7,335,288
                                    
                                    
                                    $
                                    8,057,322




See
accompanying notes


3





DOCUMENT
SECURITY SYSTEMS, INC. AND SUBSIDIARIES


Consolidated
Statements of Operations





(unaudited)





Three
      Months Ended September 30,
                                      
                                      
                                      Nine
      Months Ended September 30,2009
                                      
                                      
                                      2008
                                      
                                      
                                      2009
                                      
                                      
                                      2008RevenueSecurity
      and commercial printing
                                      
                                      $
                                      2,246,700
                                      
                                      
                                      $
                                      1,334,184
                                      
                                      
                                      $
                                      6,605,209
                                      
                                      
                                      $
                                      3,421,437Technology
      license royalties and digital solutions
                                      
                                      
                                      204,334
                                      
                                      
                                      
                                      189,267
                                      
                                      
                                      
                                      618,908
                                      
                                      
                                      
                                      1,426,182Legal
      products
                                      
                                      
                                      101,611
                                      
                                      
                                      
                                      150,129
                                      
                                      
                                      
                                      355,107
                                      
                                      
                                      
                                      482,561Total
      Revenue
                                      
                                      
                                      2,552,645
                                      
                                      
                                      
                                      1,673,580
                                      
                                      
                                      
                                      7,579,224
                                      
                                      
                                      
                                      5,330,180Costs
      of revenueSecurity
      and commercial printing
                                      
                                      
                                      1,516,188
                                      
                                      
                                      
                                      635,934
                                      
                                      
                                      
                                      4,546,512
                                      
                                      
                                      
                                      2,027,636Technology
      license royalties and digital solutions
                                      
                                      
                                      3,507
                                      
                                      
                                      
                                      3,507
                                      
                                      
                                      
                                      10,521
                                      
                                      
                                      
                                      10,521Legal
      products
                                      
                                      
                                      56,073
                                      
                                      
                                      
                                      86,120
                                      
                                      
                                      
                                      178,892
                                      
                                      
                                      
                                      257,536Total
      costs of revenue
                                      
                                      
                                      1,575,768
                                      
                                      
                                      
                                      725,561
                                      
                                      
                                      
                                      4,735,925
                                      
                                      
                                      
                                      2,295,693Gross
      profit
                                      
                                      
                                      976,877
                                      
                                      
                                      
                                      948,019
                                      
                                      
                                      
                                      2,843,299
                                      
                                      
                                      
                                      3,034,487Operating
      expenses:Selling,
      general and administrative
                                      
                                      
                                      1,436,533
                                      
                                      
                                      
                                      1,789,790
                                      
                                      
                                      
                                      4,139,751
                                      
                                      
                                      
                                      5,828,136Research
      and development
                                      
                                      
                                      61,317
                                      
                                      
                                      
                                      72,876
                                      
                                      
                                      
                                      223,409
                                      
                                      
                                      
                                      322,106Impairment
      of patent defense costs
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      291,581Amortization
      of intangibles
                                      
                                      
                                      323,936
                                      
                                      
                                      
                                      540,934
                                      
                                      
                                      
                                      971,068
                                      
                                      
                                      
                                      1,605,104Operating expenses
                                      
                                      
                                      1,821,786
                                      
                                      
                                      
                                      2,403,600
                                      
                                      
                                      
                                      5,334,228
                                      
                                      
                                      
                                      8,046,927Operating
      loss
                                      
                                      
                                      (844,909
                                      )
                                      
                                      
                                      (1,455,581
                                      )
                                      
                                      
                                      (2,490,929
                                      )
                                      
                                      
                                      (5,012,440
                                      )Other
      income (expense):Interest
      income
                                      
                                      
                                      18,140
                                      
                                      
                                      
                                      484
                                      
                                      
                                      
                                      18,140
                                      
                                      
                                      
                                      569Gain
      (loss) on foreign currency transactions
                                      
                                      
                                      (1,453
                                      )
                                      
                                      
                                      7,534
                                      
                                      
                                      
                                      10,329
                                      
                                      
                                      
                                      (16,652
                                      )Interest
      expense
                                      
                                      
                                      (57,998
                                      )
                                      
                                      
                                      (41,208
                                      )
                                      
                                      
                                      (207,172
                                      )
                                      
                                      
                                      (95,098
                                      )Amortizaton
      of note discount
                                      
                                      
                                      (63,756
                                      )
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (189,211
                                      )
                                      
                                      
                                      -Loss
      on sale of patent assets
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (1,169,947
                                      )
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (1,169,947
                                      )Other
      income
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      -
                                      
                                      
                                      
                                      125,795Loss
      before income taxes
                                      
                                      
                                      (949,976
                                      )
                                      
                                      
                                      (2,658,718
                                      )
                                      
                                      
                                      (2,858,843
                                      )
                                      
                                      
                                      (6,167,773
                                      )Income
      tax expense
                                      
                                      
                                      4,738
                                      
                                      
                                      
                                      4,738
                                      
                                      
                                      
                                      14,214
                                      
                                      
                                      
                                      14,260Net
      loss
                                      
                                      $
                                      (954,714
                                      )
                                      
                                      $
                                      (2,663,456
                                      )
                                      
                                      $
                                      (2,873,057
                                      )
                                      
                                      $
                                      (6,182,033
                                      )Net
      loss per share -basic and diluted:
                                      
                                      $
                                      (0.06
                                      )
                                      
                                      $
                                      (0.19
                                      )
                                      
                                      $
                                      (0.20
                                      )
                                      
                                      $
                                      (0.45
                                      )Weighted
      average common shares outstanding, basic and diluted
                                      
                                      
                                      14,711,105
                                      
                                      
                                      
                                      14,286,192
                                      
                                      
                                      
                                      14,510,056
                                      
                                      
                                      
                                      13,879,891




See
accompanying notes





4




Consolidated
Statements of Cash Flows


For
the Nine Months Ended September 30,
 
 (unaudited)
 
 2009
                                  
                                  
                                  2008Cash
      flows from operating activities:Net
      loss
                                  
                                  $
                                  (2,873,057
                                  )
                                  
                                  $
                                  (6,182,033
                                  )Adjustments
      to reconcile net loss to net cash used by operating
      activities:Depreciation
      and amortization
                                  
                                  
                                  1,221,103
                                  
                                  
                                  
                                  1,841,975Stock
      based compensation
                                  
                                  
                                  (78,725
                                  )
                                  
                                  
                                  1,536,403Impairment
      of patent defense costs
                                  
                                  
                                  -
                                  
                                  
                                  
                                  291,581Amortization
      of note discount
                                  
                                  
                                  189,211
                                  
                                  
                                  
                                  -Impairment
      of patent defense costs
                                  
                                  
                                  
                                  
                                  
                                  
                                  1,169,947Decrease
      in restricted cash
                                  
                                  
                                  -
                                  
                                  
                                  
                                  19,845(Increase)
      decrease in assets:Accounts
      receivable
                                  
                                  
                                  (88,690
                                  )
                                  
                                  
                                  (167,348
                                  )Inventory
                                  
                                  
                                  28,890
                                  
                                  
                                  
                                  29,170Prepaid
      expenses and other assets
                                  
                                  
                                  (33,261
                                  )
                                  
                                  
                                  (43,049
                                  )Increase
      (decrease) in liabilities:Accounts
      payable
                                  
                                  
                                  367,454
                                  
                                  
                                  
                                  (65,053
                                  )Accrued
      expenses and other liabilities
                                  
                                  
                                  (211,654
                                  )
                                  
                                  
                                  143,914Deferred
      revenue and customer deposits
                                  
                                  
                                  (4,920
                                  )
                                  
                                  
                                  (691,713
                                  )Net
      cash used by operating activities
                                  
                                  
                                  (1,483,649
                                  )
                                  
                                  
                                  (2,116,361
                                  )Cash
      flows from investing activities:Purchase
      of fixed assets
                                  
                                  
                                  (18,255
                                  )
                                  
                                  
                                  (226,716
                                  )Decrease
      in restricted cash
                                  
                                  
                                  131,004
                                  
                                  
                                  
                                  -Proceeds
      from the sale of patent assets
                                  
                                  
                                  -
                                  
                                  
                                  
                                  500,000Purchase
      of other intangible assets
                                  
                                  
                                  (183,630
                                  )
                                  
                                  
                                  (1,144,351
                                  )Net
      cash used by investing activities
                                  
                                  
                                  (70,881
                                  )
                                  
                                  
                                  (871,067
                                  )Cash
      flows from financing activities:Borrowing
      on revolving note- related parties
                                  
                                  
                                  1,030,000
                                  
                                  
                                  
                                  1,558,000Repayment
      on revolving note- related parties
                                  
                                  
                                  (280,000
                                  )Borrowings
      on short-term credit facility
                                  
                                  
                                  -
                                  
                                  
                                  
                                  500,000Repayment
      on short-term credit facility
                                  
                                  
                                  -
                                  
                                  
                                  
                                  (500,000
                                  )Payments
      of capital lease obligations
                                  
                                  
                                  (101,717
                                  )
                                  
                                  
                                  (75,411
                                  )Issuance
      of common stock, net
                                  
                                  
                                  1,241,503
                                  
                                  
                                  
                                  1,205,174Net
      cash provided by financing activities
                                  
                                  
                                  1,889,786
                                  
                                  
                                  
                                  2,687,763Net
      increase (decrease) in cash and cash equivalents
                                  
                                  
                                  335,256
                                  
                                  
                                  
                                  (299,665
                                  )Cash
      and cash equivalents beginning of period
                                  
                                  
                                  87,820
                                  
                                  
                                  
                                  742,468Cash
      and cash equivalents end of period
                                  
                                  $
                                  423,076
                                  
                                  
                                  $
                                  442,803
 See
accompanying notes.
  5




DOCUMENT
SECURITY SYSTEMS, INC.


NOTES
TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS


September
30, 2009


(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 Rule
8.03 of Regulation S-X for smaller reporting companies. 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, 2008.





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. In preparing these financial statements, the Company has
evaluated events and transactions for potential recognition or
disclosure.  These financial statements have not been updated for
subsequent events occurring after November 16, 2009.




Reclassifications
-Certain prior period amounts in the accompanying consolidated financial
statements and notes thereto have been reclassified to current period
presentation.  These classifications had no effect on the results of
operations for the period presented.  These reclassifications include
the combination of technology license royalties and digital solutions revenue
items into a single revenue item and cost of sale item.




Restricted Cash
-In July
2007, the Company established a restricted cash balance of 87,500 British
pounds, 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 British pounds.  On May 14, 2008, the Company made a payment of
87,500 British pounds to the European Central Bank as an interim payment of the
appeal costs pending final assessment by the Court which was made on July 31,
2009.   In August 2009, the funds were used to pay a portion of
the appeal costs owed by the Company.




Fair
Value of Financial Instruments – The Company discloses fair value
information about financial instruments. Fair value estimates discussed herein
are based upon certain market assumptions and pertinent information available to
management as of September 30, 2009. These financial instruments include cash
and cash equivalents, accounts receivable, accounts payable and accrued
expenses, revolving note payable, short-term debt and capital leases. Fair
values were assumed to approximate carrying values for these financial
instruments since they are short-term in nature and their carrying amounts
approximate fair values or they are receivable or payable on demand. The fair
value of the Company’s revolving note payable, short-term debt and capitalized
lease obligations is estimated based upon the quoted market prices for the same
or similar issues or on the current rates offered to the Company for debt of the
same remaining maturities. The carrying value approximates the fair value of
these debt instruments as of September 30, 2009 and December 31,
2008.


6


Continuing
Operations -The Company has incurred
significant net losses in previous years.  The Company’s ability to
fund its capital requirements out of its available cash and cash generated from
its operations depends on a number of factors. Some of these factors include the
Company’s ability to (i) increase commercial and security printing and plastic
card sales and (ii) increase sales of the Company’s digital
products.  While the Company has approximately $423,000 in cash and
approximately $567,000 of funds available to it under various credit facilities
as of September 30, 2009, the Company will likely need to raise additional funds
in the future in order to fund its working capital needs.   In December
2008, the Company borrowed $900,000 of short term debt in conjunction with its
acquisition of substantially all of the assets of DPI, a commercial printer,
which matures in December 2009.  Furthermore, the Company has two
credit facilities with related parties that will be due in January
2010.   As of September 30, 2009, there is $3,033,000 outstanding
under these credit facilities with related parties. The total amount due may be
up to $3,600,000.  In the event that the Company cannot pay these credit
facilities when due, the Company believes that it will be able to extend the
terms of these notes,  negotiate with the lenders other means of
satisfying these credit facilities, including the payment of amounts due in the
form of the Company’s equity, or refinance the amounts due with new debt
instruments.    There can be no assurance that such
additional financing, will be available on terms acceptable to the Company or at
all.  Failure to raise the funds necessary to finance future cash
requirements would adversely affect the Company’s ability to pursue its strategy
and could negatively affect operations in future periods.  The accompanying
financial statements do not reflect any adjustments that may be necessary in the
event the Company is unsuccessful in its fundraising efforts.




Recent Accounting
Pronouncements





In
December 2007, the Financial Accounting Standards Board (“FASB”) issued
SFAS 141(r), Business
Combinations, now Accounting Standards Codification (“ASC”) 805, which
addresses the accounting and disclosure for identifiable assets acquired,
liabilities assumed, and noncontrolling interests in a business combination. In
April 2009, the FASB issued FASB Staff Position No. FAS 141(r)-1,
Accounting for Assets Acquired
and Liabilities Assumed in a Business Combination That Arise from
Contingencies (FSP FAS 141(r)-1), which amended certain provisions of
SFAS 141(r) related to the recognition, measurement, and disclosure of assets
acquired and liabilities assumed in a business combination that arise from
contingencies. SFAS 141(r) and FSP FAS 141(r)-1 became effective in the first
quarter of 2009, and did not have a material impact on the consolidated
financial statements.





In
June 2008, the EITF reached a consensus in Issue No. 07-5,
“Determining Whether an Instrument (or Embedded Feature) Is Indexed to an
Entity’s Own Stock” (“EITF 07-5”), now ASC 815. This Issue addresses the
determination of whether an instrument (or an embedded feature) is indexed to an
entity’s own stock, which is the first part of the scope exception in paragraph
11(a) of SFAS 133. EITF 07-5 is effective for fiscal years beginning after
December 15, 2008, and interim periods within those fiscal years. Early
application is not permitted. The adoption of EITF 07-5 during the first quarter
of 2009 did not have a material impact on the consolidated financial
statements.





In
April 2009, the FASB issued FSP No. 157-4, Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly(FSP 157-4),
now ASC 820, which provides additional guidance for estimating fair value when
the volume and level of activity for the asset or liability have significantly
decreased. FSP 157-4 also provides additional guidance on circumstances that may
indicate that a transaction is not orderly. This guidance is effective for
interim reporting periods ending after June 15, 2009.  The
adoption of FSP 157-4 during the second quarter of 2009 did not have a material
impact on the consolidated financial statements.





In
April 2009, the FASB issued FSP No. 107-1 and APB 28-1, Interim Disclosures About Fair Value
of Financial Instruments(FSP 107-1 and APB 28-1), now ASC 825, which
require disclosures about fair value of financial instruments for interim
reporting periods. This guidance is effective for interim reporting periods
ending after June 15, 2009.  The adoption of FSP No. 107-1 and
APB 28-1 during the second quarter of 2009 did not have a material impact on the
consolidated financial statements.





In May
2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS No. 165”), now
ASC 855, to incorporate accounting guidance that originated as auditing
standards into the body of authoritative literature issued by the
FASB.  SFAS No. 165 requires the evaluation of subsequent events
through the date the financial statements are issued or are available for issue
and the disclosure of the date through which subsequent events were evaluated
and the basis for that date.  This statement is effective for interim
and annual financial periods ending after June 15, 2009.  The Company
adopted the requirements of SFAS No. 165 for the period ending June 30,
2009.  The adoption of SFAS No. 165 did not have a significant impact
on our consolidated financial position, results of operations or cash
flows.  See Note 1 – Basis of Presentation and Significant Accounting
Policies.


7


FASB
Codification.In July 2009, the FASB issued SFAS No. 168, “The
FASB Accounting Standards Codification and the Hierarchy of Generally Accepted
Accounting Principles (“GAAP”) (as amended)” (“SFAS No. 168”), now ASC 105,
making the FASB Accounting Standards Codification the single source of
authoritative nongovernmental U.S. GAAP.  The Codification is not
intended to change GAAP, however, it will represent a significant change in
researching issues and referencing U.S. GAAP in financial statements and
accounting policies.  This statement is effective for financial
statements issued for interim and annual periods ending after September 15,
2009.  The Company has adopted the new codification
standards.





2.    Inventory




Inventory
approximately consisted of the following:




September
      30,
                              
                              
                              December
      31,2009
                              
                              
                              2008(unaudited)Finished
      Goods
                              
                              $
                              53,000
                              
                              
                              $
                              138,000Work
      in process
                              
                              
                              75,000
                              
                              
                              
                              121,000Raw
      Materials
                              
                              
                              110,000
                              
                              
                              
                              100,000$
                              238,000
                              
                              
                              $
                              359,000




3.     Other
Intangible
Assets




Other
intangible assets are comprised of the following:





September 30, 2009 (unaudited)
                              
                              
                              December 31, 2008UsefulLife
                              
                              Gross Carrying
                                Amount
                              
                              
                              Accumulated
                                Amortizaton
                              
                              
                              Net Carrying
                                Amount
                              
                              
                              Gross
                                Carrying
                                Amount
                              
                              
                              Accumulated
                                Amortizaton
                              
                              
                              Net Carrying
                                AmountOther
      intangibles
                              
                              5
      years
                              
                              $
                              756,300
                              
                              
                              $
                              590,570
                              
                              
                              $
                              165,730
                              
                              
                              $
                              756,300
                              
                              
                              $
                              495,424
                              
                              
                              $
                              260,876Patent
      acquisition and defense costs
                              
                              Varied
      (1)
                              
                              
                              4,729,889
                              
                              
                              
                              3,583,803
                              
                              
                              
                              1,146,086
                              
                              
                              
                              4,729,889
                              
                              
                              
                              2,732,422
                              
                              
                              
                              1,997,467Patent
      application costs
                              
                              Varied
      (2)
                              
                              
                              788,526
                              
                              
                              
                              127,967
                              
                              
                              
                              660,559
                              
                              
                              
                              718,875
                              
                              
                              
                              103,429
                              
                              
                              
                              615,446$
                              6,274,715
                              
                              
                              $
                              4,302,340
                              
                              
                              $
                              1,972,375
                              
                              
                              $
                              6,205,064
                              
                              
                              $
                              3,331,275
                              
                              
                              $
                              2,873,789





(1)-
patent rights are amortized over their expected useful life which is generally
the legal life of the patent. As of September 30, 2009 the weighted average
remaining useful life of these assets in service was 1 year.




(2)-
patent rights are amortized over their expected useful life which is generally
the legal life of the patent. As of  September 30, 2009 the weighted
average remaining useful life of these assets in service was 15
years.





4.    
Short Term Debt




Revolving Notes-
Related Parties- On
January 4, 2008, the Company entered into a Credit Facility Agreement with
Fagenson & 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 is 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.


8




As of
September 30, 2009, the Company had outstanding $450,000 under the White Credit
Agreement, $2,583,000 under the Fagenson Credit Agreement.  Interest
expense for the first nine months of 2009 amounted to approximately $84,000 for
these agreements. As of September 30, 2009, approximately $146,000 of interest
expense is included in accrued expenses.  As of September 30, 2009,
the Company was in default of both agreements due to a failure to pay interest
when due.  Both Fagenson & Co., Inc. and Patrick White have waived
the defaults through January 1, 2010.




Short-Term Debt- On December
18, 2008, the Company’s wholly owned subsidiary, Secuprint, Inc. (dba DPI
Secuprint, Inc.) entered a Secured Promissory Note with Baum Capital
Investments Inc. (“Baum Capital Note”) in the principal amount of up to $900,000
to pay for most of the cash portion of the purchase price of the Company’s
acquisition of substantially all of the assets of DPI of Rochester,
LLC.  The Baum Capital Note has a one-year term, is secured by all of
the assets of DPI Secuprint and has an annual interest rate of 15%, with a
reduction to 12%, depending on whether certain conditions are met after three
months.   The note is subject to pre-payment provisions if, among
other provisions, DPI Secuprint’s cash receipts do not exceed its cash
expenditures for any two consecutive months during the term.  As of
September 30, 2009, the Company believes that it is in compliance with all of
the covenants of the Note.   Interest expense for the first nine
months of 2009 amounted to approximately $100,000 for this agreement, of which
approximately $9,000 is included in accrued expenses as of September 30,
2009.





In
conjunction with the Baum Capital Note, the Company issued warrants to purchase
up to a total of 250,000 shares of the Company’s common stock at an average
price of $2.00 per share.  The warrants are exercisable as of February
16, 2009 and expire on December 17, 2013.  The fair value of the
warrants of approximately $256,000 was determined using the Black Scholes option
pricing model, and was recorded as discount on debt and will be amortized over
the term of the Note.   Amortization of approximately $189,000
was recorded in the first nine months of 2009.




5.    
Shareholders’ Equity




Restricted Stock
–As of September 30, 2009, there are 50,000 unvested restricted shares
granted to an employee that vests proratably through December
2013.  In addition, there are 45,000 restricted shares that will vest
only upon the occurrence of certain events prior to May 3, 2012, 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
45,000 shares, if vested, would result in the recording of stock based
compensation expense of approximately $563,000, the grant date fair value, over
the period beginning when any of the contingent vesting events is deemed to be
probable over the expected requisite service period.  As of September
30, 2009, vesting is not considered probable and no compensation expense has
been recognized related to the performance grants.    During
the first nine months of 2009, the Company retired 212,500 of unvested
restricted stock as the result of the resignations of two
employees.





Stock
Subscription Agreement - On June 3, 2009, the Company and Walton Invesco,
Inc. executed a letter agreement terminating the parties' Share Purchase
Agreement dated June 25, 2008 and any obligations outstanding thereunder. Under
the Share Purchase Agreement, Walton had agreed to purchase 350,000 shares of
the Company's Common Stock for $1,400,000, or $4.00 per share, payable in five
installments over a two-year period.  The first installment of
$100,000 was paid.  A second payment installment in the amount of
$300,000 was due on December 25, 2008, but was not paid.  As a result,
the parties agreed to terminate the Share Purchase Agreement which resulted in
the cancellation of 325,000 of the Company’s shares as of June 3,
2009.





Stock Issued in
Private Placements- In June, 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 first Agreement, the Purchaser could 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 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 which was cancelled on June 3,2009 as per
above.


9


On August
20, 2008, the Company entered into an agreement with Trebuchet Capital Partners,
LLC who agreed to pay substantially all of the litigation costs associated with
pending validity proceedings initiated by the ECB in eight European countries
relating to the Company’s European Patent 0 455 750B1 that the Company has
claimed the ECB infringed in printing of the Euro
currency.   Trebuchet has also purchased 100,000 shares of the
Company’s common stock, subject to the American Stock Exchange approving the
listing of such shares, for an aggregate purchase price of $400,000, the
proceeds of which were used by the Company to pay existing litigation
cost.





Between
May 29, 2009 and June 22, 2009, the Company sold 56 investment units in a
private placement at a price of $10,000 per unit for aggregate proceeds of
$560,000 less $44,000 in expenses, consisting of 400,000 shares of common
stock and warrants to purchase an aggregate of 80,000 shares of common
stock.  The estimated fair market value of these warrants was
determined using the Black Scholes option pricing model at approximately
$80,000.  On July 15, 2009, the Company sold 24.5 investment units for
$10,000 per unit for gross cash proceeds of $245,000, consisting of 175,000
shares of Common Stock and Warrants to purchase an aggregate of 35,000 shares of
Common Stock. The estimated fair market value of these warrants was determined
using the Black Scholes option pricing model at approximately
$34,000.  On August 24, 2009, the Company completed the sale of 7
investment units in a private placement pursuant to subscription agreements with
one accredited investor dated the same date.  In the transaction, the
Company sold 7 investment units for $10,000 per unit for gross cash proceeds of
$70,000, consisting of 50,000 shares of common stock and warrants to purchase an
aggregate of 10,000 shares of common stock.  The estimated fair market
value of these warrants was determined using the Black Scholes option pricing
model at approximately $10,000.  Each investment unit consisted of
7,142 shares of its common stock and five-year warrants to purchase up to an
aggregate of 1,427 shares of its common stock at an exercise price of $2.00 per
share.





On
September 4, 2009, the Company completed the sale of 44 investment units in a
private placement pursuant to subscription agreements with three accredited
investors dated the same date. Each investment unit is comprised of 6,250 shares
of the Company’s common stock and five year warrants to purchase 1,250 shares of
common stock at an exercise price of $2.00 per share. In the transaction, the
Company sold 44 investment units for $10,000 per unit for gross cash proceeds of
$440,000, less expenses of $52,000, consisting of 275,000 shares of common stock
and warrants to purchase an aggregate of 55,000 shares of common stock. The
estimated fair market value of these warrants was determined using the Black
Scholes option pricing model at approximately $54,000.




Stock
Options – During the nine months ended September 30, 2009, the Company
issued options to purchase 40,000 of its common shares at an exercise price of
$1.86 per share to non-employee directors pursuant to the 2004 Non-Employee
Officer Director Stock Option Plan that vest at the end of one year of service
on the Company’s Board of Directors.  The fair value of these options
amounted to approximately $28,000 determined by utilizing the Black Scholes
option pricing model.  In addition, the Company issued options to
purchase 288,000 of its common shares at an exercise price of $4.00 per share
under the Company’s 2004 Employees’ Stock Option Plan to certain employees,
including 50,000 options to its chief financial officer and 50,000 options to
its vice president of operations who is also a board member.  The fair
value of these options amounted to approximately $145,000 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.  During the nine months ended
September 30, 2009, the Company cancelled 168,000 unvested options due to
employee terminations.




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 nine months ended
September 30, 2009, the Company had a negative stock compensation expense of
approximately $79,000 or $0.01 per share (positive stock compensation
expense of $1,536,000- 2008 or ($0.11) per share) as current-period stock based
compensation expense was more than offset by reversals of previously recorded
stock-based compensation expense for stock options and restricted shares issued
to the Company’s employees which terminated unvested due to employee
terminations that occurred during the first nine months of 2009.





As of
September 30, 2009, there was approximately $313,000 of total unrecognized
compensation costs (excluding the $563,000 that vest upon the occurrence of
certain events) 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.


10


6.   Impairment
of Patent Defense Costs and Loss on Sale of Patent Assets Other
Income





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.  On July 31, 2009, the UK court made the final assessment
of costs for the UK patent validity case due from the Company to the ECB of
356,490 pounds, of which the Company has paid $332,000 pounds through September
30, 2009 and owes approximately 25,000 pounds (approximately $40,000 as of
September 30, 2009), which amount was included in accrued expenses as of
September 30, 2009





On August
20, 2008, the Company entered into an agreement with Trebuchet Capital Partners,
LLC (“Trebuchet”)  under which Trebuchet has agreed to pay
substantially all of the litigation costs associated with pending validity
proceedings initiated by the European Central Bank (“ECB”) in eight European
countries relating to the Company’s European Patent 0 455 750B1 that the
Company  has claimed the ECB infringed in printing of the Euro
currency (the “Patent”). Trebuchet also agreed to pay substantially all of the
litigation costs associated with future validity challenges filed by the ECB or
other parties, provided that Trebuchet elects to assume the defense of any such
challenges, in its sole discretion, and patent infringement suits filed against
the ECB and certain other alleged infringers of the Patent, all of which suits
may be brought at the sole discretion of Trebuchet and may be in the name of the
Company, Trebuchet or both. The Company provided Trebuchet with the sole and
exclusive right to manage infringement litigation relating to the Patent in
Europe, including the right to initiate litigation in the name of the Company,
Trebuchet or both and to choose whom and where to sue, subject to certain
limitations set forth in the agreement. Under the terms of the Agreement, the
Company and Trebuchet have agreed to equally share all proceeds generated from
litigation relating to the Patent, including judgments and licenses or other
arrangements entered into in settlement of any such litigation. Trebuchet is
also entitled to recoup any litigation expenses specifically awarded to the
Company in such actions. Under the terms of the Agreement, and in consideration
for Trebuchet’s funding obligations, the Company assigned and transferred a 49%
interest of the Company’s rights, title and interest in the Patent to Trebuchet
which allows Trebuchet to have a separate and distinct interest in and share of
the Patent, along with the right to sue and recover in litigation, settlement or
otherwise to collect royalties or other payments under or on account of the
Patent.  Pursuant to this transaction, the Company recognized a loss
on the sale of patent assets for its assignment and transfer of 49% of its
ownership rights in the patent, which had a net book value of approximately
$1,670,000, for proceeds of $500,000,   As a result, the Company
recognized a loss on sale of patent assets of $1,170,000.





7.     Other
Income




On May
31, 2008, the Company was awarded a judgment of approximately $126,000 pursuant
to a positive judgment for the Company in its counterclaim 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.




8.    
Earnings Per Share





Basic
earnings per share is computed by dividing net income by the weighted-average
number of common shares outstanding for the period.  Diluted earnings
per share is computed by including the number of additional shares that would
have been outstanding if dilutive potential shares had been issued. In periods
of losses, diluted loss per share is computed on the same basis as basic loss
per share as the inclusion of any other potential shares outstanding would be
anti-dilutive.   If the Company had generated earnings during the
nine month period ended September 30, 2009, 235,665 (426,980 - 2008) common
equivalent shares would have been added to the weighted average shares
outstanding to compute the diluted weighted average shares
outstanding.




9.    
Commitments and Contingencies




Legal
Matters-On
August 1, 2005, the Company commenced a suit against the European Central Bank
(“ECB”) alleging patent infringement by the ECB and claimed unspecified damages.
We brought the suit in the European Court of First Instance in
Luxembourg.  We alleged that all Euro banknotes in circulation
infringe the Company 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 the Company to pay attorneys and
court fees in the amount of Euro 93,752 ($137,000 as of September 30, 2009),
which, unless the amount is settled will be subject to an assessment procedure
that will not likely be concluded until of the end of 2009 or first half of
2010, which the Company will accrue as soon as the assessed amount, if any, is
reasonably estimatable.


11




On
March 24, 2006, the Company received notice that the ECB had 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.  As a result of these decisions, the Company was notified
of the final assessment of the reimbursable ECB costs for both court cases was
356,490 pounds, of which the Company has paid $332,000 pounds through September
30, 2009 and owes approximately 25,000 pounds (approximately $40,000 as of
September 30, 2009), which amount was included in accrued expenses as of
September 30, 2009





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.  As a result of this ruling, the Company expects to be
awarded reimbursements for its costs associated with the German validity case,
which is Euro 44,692 ($65,000 at September 30, 2009), 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.  On November 3,
2009, the Belgium Court held that the Patent was invalid in Belgium for the same
reasons given by the English and French courts.   Costs
reimbursements, if any, associated with the Belgium validity case are covered
under the Trebuchet Agreement as described below.   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 last
quarter of 2009.





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
allowing the Company or Trebuchet Capital Partners, on the Company’s behalf, to
proceed with infringement cases in these countries if we choose to do
so.  Additional trials on the validity of the Patent are expected in
other European jurisdictions during 2009.





On August
20, 2008, the Company entered into an agreement with Trebuchet Capital Partners,
LLC (“Trebuchet”) under which Trebuchet has agreed to pay substantially all
of the litigation costs associated with pending validity proceedings initiated
by the European Central Bank (“ECB”) in eight European countries relating to the
Company’s European Patent 0 455 750B1 that the Company  has claimed
the ECB infringed in printing of the Euro currency (the “Patent”). Trebuchet
also agreed to pay substantially all of the litigation costs associated with
future validity challenges filed by the ECB or other parties, provided that
Trebuchet elects to assume the defense of any such challenges, in its sole
discretion, and patent infringement suits filed against the ECB and certain
other alleged infringers of the Patent, all of which suits may be brought at the
sole discretion of Trebuchet and may be in the name of the Company, Trebuchet or
both. The Company provided Trebuchet with the sole and exclusive right to manage
infringement litigation relating to the Patent in Europe, including the right to
initiate litigation in the name of the Company, Trebuchet or both and to choose
whom and where to sue, subject to certain limitations set forth in the agreement
under the terms of the Agreement, and in consideration for Trebuchet's funding
obligations, the Company assigned and transferred a 49% interest of the
Company's rights, title and interest in the Patent to Trebuchet which allows
Trebuchet to have a separate and distinct interest in and share of the Patent,
along with the right to sue and recover in litigation, settlement or otherwise
to collect royalties or other payments under or on account of the Patent. In
addition, the Company and Trebuchet have agreed to equally share all proceeds
generated from litigation relating to the Patent, including judgments and
licenses or other arrangements entered into in settlement of any such
litigation. Trebuchet is also entitled to recoup any litigation expenses
specifically awarded to the Company in such actions.


12





On
January 31, 2003, the Company 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 the
Company has an interest. The Company 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
the Company acquired in 2002. These alleged agreements, generally, would have
authorized Adler to manufacture in Canada the Company’s “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 the
Company.  Among other things, the Company contends that certain of the
purported agreements are not binding and/or enforceable.  To the
extent any of them are binding and enforceable, the Company claims 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 the Company, claiming Adler owns or co-owns or has a
license to use certain of the Company’s technologies.  In May 2005,
the Company filed a first amended and supplemental complaint adding Blanks/USA
and Raymond Maxon as additional defendants.  In February 2007, the
Company filed a 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 the Company contending that the Company’s 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.  The Company has denied the material
allegations of all of the counterclaims.  If Adler or Maxon is
successful,or if a settlement is made, it may materially affect the Company, the
Company’s financial condition, and the Company’s ability to market and sell
certain of the Company technology and related products.  This case is
in discovery phase, and it is too soon to determine how the various issues
raised by the lawsuit will be determined.





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





Contingent
Litigation Payment – In May 2005, the Company made an agreement with its
legal counsel in charge of the Company’s litigation with the European Central
Bank which capped the fees for all matters associated with that 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.




In
addition, 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, the Company will be required to disburse 14% of the settlement
proceeds.  These payments do not apply to licenses or royalties to
patents that the Company has developed or obtained from persons other than the
Wicker Family.  As of September 30, 2009, there have been no
settlement amounts related to these agreements.





Contingent
Purchase Price -In December, 2008, the Company acquired substantially all
of the assets of DPI of Rochester, LLC (“DPI”) in which the Company guaranteed
up to $50,000 to certain parties depending on whether certain conditions
occurred within five years of the acquisition.   As of September 30,
2009, the Company considers the likelihood that the payment will be required as
remote.





Employment
agreements - 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 did 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 the amount that such
proceeds is less than $212,000 in cash or additional shares of common stock of
the Company.  As of June 30, 2009, all 33,333 shares had vested
generating gross proceeds of approximately $99,000.  The Company has
agreed to issue up to 30,000 shares of stock to pay the remaining amount due of
$113,000, of which 9,000 were issued during the quarter ended September 30,
2009.  As of September 30, 2009, $96,000 remains due under the
agreement and is recorded in accrued expenses as of September 30,
2009.  Any remaining amounts due under the agreement after the shares
are issued, if any, can be paid in cash or additional shares.


13





Operating Leases
-In March 2009, the Company, through its wholly-owned subsidiary DPI
Secuprint, entered into two operating lease agreements for production equipment
with Baum Capital Investments.  The leases contain end of lease
residual values that aggregate a total of $800,000.   Pursuant to
these lease agreements, the Company is subject to certain conditions that place
restrictions on the ability of DPI Secuprint to transfer cash or other assets to
its parent, Document Security Systems, or other subsidiaries, during the lives
of the leases.  Total lease commitments associated with these leases
as of September 30, 2009 are as follows:





2009
                    
                    
                    82,6292010
                    
                    
                    422,1312011
                    
                    
                    440,3482012
                    
                    
                    394,4192013
                    
                    
                    274,175Thereafter
                    
                    
                    545,921Total
                    
                    $
                    2,159,623




10.      Supplemental
Cash Flow Information




During the nine months ended September
30, 2009, the Company entered into capitalized leases of approximately $96,000
for production equipment at its commercial print facility.   Cash
paid for interest during the nine months ended September 30, 2009, was
approximately $153,000 ($31,000 -2008).  During the nine months ended
September 30, 2008, the Company issued 19,260 shares for the payment of
approximately $94,000 of marketing expenses.




11.    
Segment Information




The
Company's businesses are organized, managed and internally reported as four
operating segments.  Three of these operating segments, Document
Security Systems, Plastic Printing Professionals, and DPI Secuprint, 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,
along with traditional commercial printing on paper and
plastic.    For the purposes of providing segment
information, these three operating segments have been aggregated into one
reportable segment in accordance with ASC 280.  A summary of the two
segments follows:




Security
      and
                Commercial
                Printing
              License,
      manufacture and sale of patented document security technologies, including
      digital security print solutions, and general commercial printing,
      primarily on paper and plastic.  Comprises the operations of
      Document Security Systems, Plastic Printing Professionals, and DPI
      Secuprint, which the Company acquired on December 18,
      2008.Legal
      Supplies
              Sale
      of specialty legal supplies, primarily to lawyers and law firms located
      throughout the United States as Legalstore.com. During the fourth
      quarter of 2009, the Company sold its legal products
      business.  In accordance with FASB ASC 360-10-45-9 guidance for
      long-lived assets, the Company accounts for the assets and certain
      liabilities as held for sale as of September 30, 2009.  In
      accordance with ASC 205-20-45, the Company continues to report the results
      of operations for Legalstore.com as continued operations given the
      Company’s continued involvement after the
sale.





Approximate
information concerning the Company’s operations by reportable segment for the
three and nine months ended September 30, 2009 and 2008 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:


14




3 months ended September 30, 2009:
                                
                                Legal
                                  Supplies
                                
                                
                                Security and
                                  Commercial
                                  Printing
                                
                                
                                Corporate
                                
                                
                                TotalRevenues
      from external customers
                                
                                $
                                102,000
                                
                                
                                $
                                2,451,000
                                
                                
                                $
                                -
                                
                                
                                $
                                2,553,000Depreciation
      and amortization
                                
                                
                                5,000
                                
                                
                                
                                395,000
                                
                                
                                
                                1,000
                                
                                
                                
                                401,000Segment
      profit (loss)
                                
                                
                                10,000
                                
                                
                                
                                (505,000
                                )
                                
                                
                                (460,000
                                )
                                
                                
                                (955,000
                                )3
      months ended September 30, 2008:Revenues
      from external customers
                                
                                $
                                151,000
                                
                                
                                $
                                1,523,000
                                
                                
                                $
                                -
                                
                                
                                $
                                1,674,000Depreciation
      and amortization
                                
                                
                                4,000
                                
                                
                                
                                615,000
                                
                                
                                
                                1,000
                                
                                
                                
                                620,000Segment
      profit (loss)
                                
                                
                                (6,000
                                )
                                
                                
                                (2,046,000
                                )
                                
                                
                                (611,000
                                )
                                
                                
                                (2,663,000
                                )





9
      months ended September 30, 2009:
                                        
                                        Legal
                                          Supplies
                                        
                                        
                                        Security and
      Commercial
                                          Printing
                                        
                                        
                                        Corporate
                                        
                                        
                                        TotalRevenues
      from external customers
                                        
                                        $
                                        355,000
                                        
                                        
                                        $
                                        7,224,000
                                        
                                        
                                        $
                                        -
                                        
                                        
                                        $
                                        7,579,000Depreciation
      and amortization
                                        
                                        
                                        15,000
                                        
                                        
                                        
                                        1,203,000
                                        
                                        
                                        
                                        3,000
                                        
                                        
                                        
                                        1,221,000Segment
      profit (loss)
                                        
                                        
                                        37,000
                                        
                                        
                                        
                                        (1,610,000
                                        )
                                        
                                        
                                        (1,300,000
                                        )
                                        
                                        
                                        (2,873,000
                                        )9
      months ended September 30, 2008:Revenues
      from external customers
                                        
                                        $
                                        483,000
                                        
                                        
                                        $
                                        4,847,000
                                        
                                        
                                        $
                                        -
                                        
                                        
                                        $
                                        5,330,000Depreciation
      and amortization
                                        
                                        
                                        12,000
                                        
                                        
                                        
                                        1,827,000
                                        
                                        
                                        
                                        3,000
                                        
                                        
                                        
                                        1,842,000Segment
      profit (loss)
                                        
                                        
                                        29,000
                                        
                                        
                                        
                                        (4,293,000
                                        )
                                        
                                        
                                        (1,918,000
                                        )
                                        
                                        
                                        (6,182,000
                                        )




12.    
Assets and Liabilities Held For Sale




As of September 30, 2009, the Company
has classified the assets and liabilities of Legalstore.com, reported in the
“Legal Supplies” segement, as held for sale.  The Company signed an
asset purchase agreement on October 8, 2009 to sell various assets and
liabilities of Legalstore.com in exchange for common stock of Internet Media
Services, Inc (See Note 13).   The Company expects to record the
asset sale at fair market value on the date of sale based on the estimated fair
market value the Company calculated utilizing a discounted cash flow projection
model. The Company has not yet determined the amount of any gain or the timing
for recognition from the sale. The assets and liabilities of Legalstore.com have
been reported as long-term in the accompanying balance sheet as of September 30,
2009 because they are not expected to be realized in the normal operating cycle
as a result of the receipt of an equity method investment as proceeds for the
sale. The assets and liabilities of Legalstore.com included in the sale are as
follows:




Cash
                      
                      
                      18,186Accounts
      receivable
                      
                      
                      31,434Inventory
                      
                      
                      92,521Fixed
      Assets
                      
                      
                      32,218Goodwill
                      
                      
                      81,013Assets
                      
                      
                      255,372AP
                      
                      
                      18,563Accrued
      liabilities
                      
                      
                      5,473Liabilities
                      
                      
                      24,036Net
                      
                      
                      231,336




15




13.    
Subsequent Events




On
October 8, 2009, Lester Levin Inc., (“LLI”) a wholly owned subsidiary of the
Company entered into an Asset Purchase Agreement with Internet Media Services,
Inc., (“IMS”), whereby LLI agreed to sell the assets associated with its
LegalStore.Com business (“LegalStore”) to IMS (the “Asset Purchase
Agreement”).





In consideration of the sale and
transfer of the LegalStore assets, IMS agreed to issue 7,500,000 shares of
common stock, par value $.001 per share, of IMS to the Company. Pursuant to the
Asset Purchase Agreement and related agreements, IMS agreed to file a
registration statement on Form S-1, within 180 days of closing, with respect to
the IMS Common Stock.





On October 8, 2009, the transactions
contemplated by the Asset Purchase Agreement were closed and in accordance
therewith LLI sold the Acquired Assets to IMS in exchange for the IMS Common
Stock issued to the Company (the “Transaction”).




On
October 19, 2009, the Company completed the sale of 17.6 investment units in a
private placement pursuant to subscription agreements with three accredited
investors dated the same date. Each investment unit is comprised of 6,250 shares
of the Company’s common stock and five year warrants to purchase 1,250 shares of
common stock at an exercise price of $2.00 per share.   In the
transaction, the Company sold 17.6 investment units for $10,000 per unit for
gross cash proceeds of $176,000, consisting of 110,000 shares of common stock
and warrants to purchase an aggregate of 22,000 shares of common
stock.




On
October 21, 2009, the Company entered to a Consulting Agreement with Vertical
Innovation, Inc. ("Vertical Innovation"), a related party to Internet Media
Services, Inc., for internet related consulting services (the
"Consulting Agreement").  The Consulting Agreement provides that
Vertical Innovation will provide consulting services upon request during the
term of the agreement related to Internet development and
strategy.  The Consulting Agreement is for a two year term unless
earlier terminated by the Company for cause, as defined in the Consulting
Agreement.  The compensation to be paid to Vertical Innovation under
the Consulting Agreement is in the form of warrants to purchase 50,000 shares of
the Company's common stock at $3.00, 100,000 shares of common stock at $3.50 and
50,000 shares of common stock at $4.00.  Issuance of the Warrants is
subject to NYSE Amex approval under an additional listing
application.  The Company initially valued these warrants at
approximately $260,000 using the Black-Scholes option pricing model which the
Company expects to record as expense over a two year period.  The
actual expense associated with these warrants will be based on the measurement
date, the vesting is contingent on certain performance
conditions.


16






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 that could cause actual results to differ
materially from the results anticipated in the forward-looking statements,
including, without limitation, those contained in our Form 10-K for the year
ended December 31, 2008, and those described herein that could cause actual
results to differ materially from the results anticipated in the forward-looking
statements, and the following:




·
            Our
      limited operating history with our business
  model


·
            Our
      ability to pay or renegotiate three secured credit facilities that have
      large principal payments due in December 2009 and January
    2010


·
            Our
      low cash balance and limited financing currently available to us, we may
      in the near future have a number of obligations that we will be unable to
      meet without generating additional income or raising additional
      capital.


·
            The
      risk of insolvency or bankruptcy if we cannot generate additional income
      or raise additional capital in the near
future


·
            Further
      cost reductions or curtailment in future operations due to our low cash
      balance and negative cash flow


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


·
            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
      loss in current litigation in which we may lose certain of our technology
      rights, which may affect our business
plan.


·
            The
      inability to adequately protect our intellectual
  property


·
            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.


·
            The
      failure of our products and services to achieve market
      acceptance


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


·
            The
      inability to compete in our market, especially against established
      industry competitors with greater market presence and financial
      resources.


·
            The
      inability to meet our growth strategy of acquiring complementary
      businesses and assets and expanding our existing operations to include
      manufacturing capabilities.




Overview




Document
Security Systems, Inc. (referred to in this report as “Document Security,” “we,”
“us,” “our” or “Company”) markets, produces 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 protection and
verification of critical financial instruments and vital records, or where there
are concerns of counterfeiting, fraud, identity theft, brand protection and
liability.


17





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. In
December 2008, we acquired substantially all of the assets of DPI of Rochester,
LLC, a privately held commercial printer located in Rochester, NY with
approximately $7.6 million in sales in 2007.   We formed a new
subsidiary called DPI Secuprint to house this new company.  As a
result of this acquisition, we have significantly improved our ability to meet
our current and expected future demand of our security paper products as well as
improving our competitiveness in the market for custom security printing,
especially in the areas of vital records, coupons, transcripts, and prescription
paper.   In addition, as a result of the acquisition, we believe
we can offer our customers a wider range of commercial printing
offerings.





Technologies





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





Products
and Services





Generic Security
Paper:  Our primary product for the retail end-user market is
AuthentiGuard® Security Paper.  AuthentiGuard® Security Paper is blank
paper that contains our Pantograph 4000TM technology.  The paper
reveals hidden warning words, logos or images using The Authenticator- our
proprietary viewing lens –when the paper is faxed, copied or
scanned.  The hidden words appear on the duplicate or the computer
digital file and essentially prevent documents, including forms, coupons and
tickets, from being counterfeited.  We market and sell our
AuthentiGuard® Security Paper primarily through one major paper distributor:
Boise.  Since 2005, Boise has marketed our AuthentiGuard® Security
Paper under its Boise Beware brand name in North America, primarily through its
commercial paper sales group. We retain the rights to sell the AuthentiGuard®
Security Paper directly to end-users anywhere in the world.





Security andCommercialPrinting:  Our
technology portfolio allows us to create unique custom secure paper, plastic,
packaging and Internet-based and software enterprise solutions.  We
market and sell to end-users that require anti-counterfeiting and authentication
features in a wide range of printed materials such as documents, vital records,
prescription paper, 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.  In addition, we provide a full range of digital and
large offset commercial printing capabilities to our customers.





Since our
inception, we have primarily outsourced the production of the majority of our
custom security print orders to strategic printing vendors.  In
December 2008, we acquired a commercial printer with long-run offset and short
run digital printing capabilities that will allow us to produce the majority of
our security print orders in-house.  As a result of this acquisition,
we have significantly improved our ability to meet our current and expected
future demand of our security paper products as well as improving our
competitiveness in the market for custom security printing, especially in the
areas of vital records, coupons, transcripts, and prescription
paper.   We produce our plastic printed documents such as ID
cards, event badges, and driver licenses at our manufacturing facility in
Brisbane, California under the name Plastic Printing
Professionals.  Our P3 manufacturing facility is 25,000 square
foot and during 2008, we upgraded their production capabilities by adding
equipment that will improve its productivity, along with equipment for high
speed data encoding and equipment for production of high-volume precision RFID
cards.





Digital Security
Solutions: Using software that we have developed, we can
electronically render several of our technologies digitally to extend the use of
optical security to the end-user of sensitive information.  With
our  AuthentiGuardTM DX  we market a networked appliance that
allows the author of any Microsoft Office document (Outlook, Word, Excel, or
PowerPoint) to secure nearly any of its alphanumeric content when it is printed
or digitally stored. AuthentiGuard® DX prints selected content using DMC’S
patented technology so that it cannot be read by the naked
eye.  Reading the hidden content, or authenticating the document is
performed with a proprietary viewing device or software.




18





Technology
Licensing:  We license our anti-counterfeiting technology and
trade secrets to security printers through licensing arrangements.  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.  Licenses can
be for a single technology or for a package of technologies.  We offer
licensees a variety of pricing models, including:





·
            Pay
      us one price per year;


·
            Pay
      us a percentage of gross sales price of the product containing the
      technology during the term; or


·
            Joint
      venture or profit sharing
arrangement.





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.  On October 8, 2009 we sold the assets and certain liabilities
associated with our LegalStore.Com business to Internet Media
Services.




Results of
Operations for the Three and Nine Months Ended September 30,
2009 Compared to the Three and Nine Months ended September 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.   During the fourth quarter
of 2009, the Company finalized an agreement to sell its legal products
business.   In accordance with ASC 205-20-45, as a result of the
significant continued involvement of the Company after the sale, the Company
continues to account for the revenue and expenses of this operation as continued
oprations.




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, 2008.




Revenue




Three Months
                  Ended
                  September 30,
                  2009
                
                
                Three Months
                  Ended September
                  30, 2008
                
                
                % change
                
                
                Nine Months
                  Ended September
                  30, 2009
                
                
                Nine Months
                  Ended
                  September 30,
                  2008
                
                
                % changeRevenueSecurity
      and commercial printing
                
                $
                2,247,000
                
                
                $
                1,334,000
                
                
                
                68
                %
                
                $
                6,605,000
                
                
                $
                3,421,000
                
                
                
                93
                %Technology
      license royalties and digital solutions
                
                
                204,000
                
                
                
                189,000
                
                
                
                8
                %
                
                
                619,000
                
                
                
                1,427,000
                
                
                
                -57
                %Legal
      products
                
                
                102,000
                
                
                
                150,000
                
                
                
                -32
                %
                
                
                355,000
                
                
                
                483,000
                
                
                
                -27
                %Total
      Revenue
                
                
                2,553,000
                
                
                
                1,673,000
                
                
                
                53
                %
                
                
                7,579,000
                
                
                
                5,331,000
                
                
                
                42
                %




For the
three months ended September 30, 2009, revenue increased 53% from the same
period in 2008.     Security and commercial print sales
increased 68% during the quarter which reflects the impact of the Company’s
acquisition of DPI Secuprint, a commercial printer, in December,
2008.  This increase was slightly offset by a decrease in revenue from
the Company’s legal products division, Legalstore.com, which the Company sold in
October of 2009.




For the
nine months ended September 30, 2009, revenue increased 42% from the first nine
months of 2008, due to the Company’s acquisition of its commercial printing
business in December 2008, which more than offset the 57% decline in technology
license royalties and digital solutions revenue as a result of a non-recurring
royalty of $542,000 recorded in the second quarter of 2008 that affected the
comparison.  During 2009, all of the Company’s divisions were
adversely affected by significant delays or reductions in orders by core
customers that reflected the rapid decline in the U.S. and global economies
during the latter half of 2008 and the first half of
2009.    The Company began to see demand in each of
divisions to return to more traditional levels in the third quarter of 2009 and
expects this trend to continue as the U.S. and global economies
stabilize.


19




Cost
of Sales and Gross Profit




Three Months
                  Ended
                  September 30,
                  2009
                
                
                Three Months
                  Ended September
                  30, 2008
                
                
                % change
                
                
                Nine Months
                  Ended September
                  30, 2009
                
                
                Nine Months
                  Ended
                  September 30,
                  2008
                
                
                % changeCosts
      of revenueSecurity
      and commercial printing
                
                $
                1,516,000
                
                
                $
                636,000
                
                
                
                138
                %
                
                $
                4,547,000
                
                
                $
                2,028,000
                
                
                
                124
                %Technology
      license royalties and digital solutions
                
                
                4,000
                
                
                
                4,000
                
                
                
                0
                %
                
                
                11,000
                
                
                
                11,000
                
                
                
                0
                %Legal
      products
                
                
                56,000
                
                
                
                86,000
                
                
                
                -35
                %
                
                
                179,000
                
                
                
                258,000
                
                
                
                -31
                %Total
      cost of revenue
                
                
                1,576,000
                
                
                
                726,000
                
                
                
                117
                %
                
                
                4,737,000
                
                
                
                2,297,000
                
                
                
                106
                %Gross
      profitSecurity
      and commercial printing
                
                
                731,000
                
                
                
                698,000
                
                
                
                5
                %
                
                
                2,058,000
                
                
                
                1,393,000
                
                
                
                48
                %Technology
      license royalties and digital solutions
                
                
                200,000
                
                
                
                185,000
                
                
                
                8
                %
                
                
                608,000
                
                
                
                1,416,000
                
                
                
                -57
                %Legal
      products
                
                
                46,000
                
                
                
                64,000
                
                
                
                -28
                %
                
                
                176,000
                
                
                
                225,000
                
                
                
                -22
                %Total
      gross profit
                
                
                977,000
                
                
                
                947,000
                
                
                
                3
                %
                
                
                2,842,000
                
                
                
                3,034,000
                
                
                
                -6
                %




ThreeMonths
                  Ended
                  September30,
                  2009
                
                
                Three Months
                  Ended September
                  30, 2008
                
                
                % change
                
                
                Nine Months
                  Ended September
                  30, 2009
                
                
                Nine Months
                  Ended
                  September 30,
                  2008
                
                
                % changeGross
      profit percentage:
                
                
                38
                %
                
                
                57
                %
                
                
                -33
                %
                
                
                37
                %
                
                
                57
                %
                
                
                -35
                %




Gross
profit increased 3% to $977,000 in the third quarter of 2009 as compared to the
third quarter of 2008.  The increase was due to the increase in sales,
but was minimized by the increase in the amount of commercial printing revenue
as a percentage of total due to the Company’s acquisition of DPI Secuprint, a
commercial printer, in December, 2008. Commercial printing typically
carries lower margins than the Company’s security printing
projects.  In addition, the Company has increased the fixed cost
component of its cost of sales as a result of investments in equipment at the
Company’s plastic printing facility which has significantly increased production
capacity.  While these investments lower the Company’s gross profits
at its traditional revenue levels, they will allow the Company to significantly
increase its revenue potential at the facility at traditional
margins.




Operating
Expenses




Three Months
                  Ended
                  September 30,
                  2009
                
                
                Three Months
                  EndedSeptember
                  30, 2008
                
                
                % change
                
                
                Nine Months
                  Ended September
                  30, 2009
                
                
                Nine Months
                  Ended
                  September 30,
                  2008
                
                
                % changeOperating
      ExpensesSales,
      general and administrative compensation
                
                $
                855,000
                
                
                $
                539,000
                
                
                
                59
                %
                
                $
                2,713,000
                
                
                $
                1,622,000
                
                
                
                67
                %Professional
      Fees
                
                
                147,000
                
                
                
                206,000
                
                
                
                -29
                %
                
                
                434,000
                
                
                
                780,000
                
                
                
                -44
                %Sales
      and marketing
                
                
                34,000
                
                
                
                204,000
                
                
                
                -83
                %
                
                
                105,000
                
                
                
                892,000
                
                
                
                -88
                %Research
      and development
                
                
                61,000
                
                
                
                73,000
                
                
                
                -16
                %
                
                
                223,000
                
                
                
                322,000
                
                
                
                -31
                %Rent
      and utilities
                
                
                129,000
                
                
                
                122,000
                
                
                
                6
                %
                
                
                399,000
                
                
                
                322,000
                
                
                
                24
                %Other
                
                
                197,000
                
                
                
                197,000
                
                
                
                0
                %
                
                
                452,000
                
                
                
                580,000
                
                
                
                -22
                %$
                1,423,000
                
                
                $
                1,341,000
                
                
                
                6
                %
                
                $
                4,326,000
                
                
                $
                4,518,000
                
                
                
                -4
                %Other
      Operating ExpensesDepreciation
      and amortization
                
                
                36,000
                
                
                
                42,000
                
                
                
                -14
                %
                
                
                116,000
                
                
                
                126,000
                
                
                
                -8
                %Stock
      based payments
                
                
                38,000
                
                
                
                480,000
                
                
                
                -92
                %
                
                
                (79,000
                )
                
                
                1,506,000
                
                
                
                -105
                %Impairment
      of patent defense costs
                
                
                -
                
                
                
                -
                
                
                
                
                
                
                
                -
                
                
                
                292,000
                
                
                
                -100
                %Amortization
      of intangibles
                
                
                324,000
                
                
                
                541,000
                
                
                
                -40
                %
                
                
                971,000
                
                
                
                1,605,000
                
                
                
                -40
                %398,000
                
                
                
                1,063,000
                
                
                
                -63
                %
                
                
                1,008,000
                
                
                
                3,529,000
                
                
                
                -71
                %Total
      Operating Expenses
                
                
                1,821,000
                
                
                
                2,404,000
                
                
                
                -24
                %
                
                
                5,334,000
                
                
                
                8,047,000
                
                
                
                -34
                %


20




Selling, General and
Administrative




Sales, general and
administrative compensation costs were 59% and 67% higher in the three
and nine months ending September, 30, 2009, respectively, as compared to the
comparable 2008 periods, due to the inclusion of sales and administrative staff
additions as the result of the Company’s acquisition of its commercial printing
business in December 2008.   Otherwise, SG&A compensation
costs would have decreased 32% and 27% during the three and nine months ended
September 30, 2009, respectively, as compared to the comparable 2008 periods, as
the result of staff reductions that the Company initiated in the middle of 2008
and during the first quarter of 2009.




Professional feesdecreased in 29% third quarter of  2009 from the third quarter
of 2008 primarily as a result of a significant decrease in consulting fees of
approximately $80,000 due to cost cuts initiated by the Company in
2008.  This decrease was offset by an increase of approximately
$40,000 in legal fees incurred by the Company during the three months ended
September 30, 2009 as compared to the three months ended September 30,
2008.




Sales and marketing
expenses decreased significantly in the third quarter and first nine months of
2009 as compared to 2008 as the Company has changed its primary sales and
marketing strategy resulting in a reduction in its non-direct marketing costs,
its international sales cost, and an overall reduction in sales related
travel.  The Company has recently focused its efforts on direct sales
techniques that utilize telephone and web-conferencing communication with
current and prospective customers, along with increasing its internet presence
focused on the Company’s primary e-commerce website
www.protectedpaper.com.   The Company expects to see increases in
its sales and marketing expenses in the remainder of 2009 and in 2010 as general
economic conditions improve.




Research and development
costsconsist primarily of compensation costs for research personnel and
direct costs for the use of third-party printers’ facilities to test our
technologies on equipment that we do not have access to
internally.   Research and development costs decreased during the
2009 periods as compared to the comparable 2008 periods as the result of lower
external research costs and reduction in compensation cost as the Company
reduced the department by 2 persons.




Rent and utilities
costs have increased in 2009 over 2008 as a result of the Company’s acquisition
of its commercial printing business in December 2008, which operates a 20,000
square foot facility in Rochester, NY.




Other operating
expenses are primarily equipment maintenance and repairs, office supplies, IT
support, bad debt expense and insurance costs.  On a consolidated
basis, these costs were flat in the third quarter of 2009 as compared to the
third quarter of 2008, despite the addition of other expenses associated with
the Company’s acquisition of DPI Secuprint in in December 2008.




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 decreased during the three and
nine month periods ended September 30, 2009 as compared to the comparable 2008
periods, as current-period stock based compensation expense was more than offset
by reversals of previously recorded stock-based compensation expense for stock
options and restricted shares issued to the Company’s employees which terminated
unvested due to employee terminations that occurred during 2009.




Impairment of Patent Defense
CostsOn 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.   No such
expense was incurred in 2009.




Amortization of
intangibles expense decreased 40% in the three and nine months ended
September 30, 2009, as compared to the 2008 periods as a result of the reduction
in the Company’s net capitalized patent acquisition and defense costs asset from
$2.3 million as of September 30, 2008 to $1.1 million as of September 30,
2009.   The reduction in the Company’s patent acquisition and
defense costs was primarily due to the Company’s transfer and assignment of 49%
of its interest in the patent to a third-party in August 2008, which resulted in
a reduction in the asset of approximately $1.7 million.


21




Other
Income and expenses




Three Months
                    Ended
                    September 30,
                    2009
                  
                  
                  Three Months
                    EndedSeptember
                    30, 2008
                  
                  
                  %change
                  
                  
                  Nine Months
                    Ended September
                    30, 2009
                  
                  
                  Nine Months
                    Ended
                    September 30,
                    2008
                  
                  
                  %changeOther
      income (expense):Gain/(Loss)
      on foreign currency adjustments
                  
                  
                  (1,000
                  )
                  
                  
                  8,000
                  
                  
                  
                  -113
                  %
                  
                  
                  10,000
                  
                  
                  
                  (17,000
                  )
                  
                  
                  -159
                  %Interest
      Income
                  
                  
                  18,000
                  
                  
                  
                  -
                  
                  
                  
                  
                  
                  
                  
                  18,000
                  
                  
                  
                  -Interest
      expense
                  
                  
                  (58,000
                  )
                  
                  
                  (41,000
                  )
                  
                  
                  41
                  %
                  
                  
                  (207,000
                  )
                  
                  
                  (95,000
                  )
                  
                  
                  118
                  %Loss
      on sale of patent assets
                  
                  
                  -
                  
                  
                  
                  (1,170,000
                  )
                  
                  
                  
                  
                  
                  
                  -
                  
                  
                  
                  (1,170,000
                  )Amortizaton
      of note discount
                  
                  
                  (64,000
                  )
                  
                  
                  -
                  
                  
                  
                  
                  
                  
                  
                  (189,000
                  )
                  
                  
                  -Other
      income
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  
                  
                  
                  
                  -
                  
                  
                  
                  126,000Other
      income (expense), net
                  
                  
                  (105,000
                  )
                  
                  
                  (1,203,000
                  )
                  
                  
                  -91
                  %
                  
                  
                  (368,000
                  )
                  
                  
                  (1,156,000
                  )
                  
                  
                  -68
                  %




During the first nine months of 2009,
the Company had significant increases in interest expense over the comparable
period in 2008 as a result of the Company’s borrowings it made during 2008
against its various credit facilities and for interest associated with a
$900,000 Secured Promissory Note which the Company used to acquire its
commercial printing business in December of 2008.  As of September 30,
2009, the Company had $3.0 million outstanding under it revolving notes at an
interest rate of LIBOR plus 2%, which was approximately 3.27% as of September
30, 2009, and $900,000 was outstanding under the Secured Promissory Note which
had an annual interest rate of 12%.




During
the first nine months of 2009, the Company also recognized amortization of note
discount expense of approximately $189,000 for warrants that were issued in
conjunction with the secured promissory note which had a fair value of
approximately $256,000 and will be amortized over the term of the
note.  In 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.  Also in 2008,  the Company entered into an agreement
with Trebuchet Capital Partners, LLC Pursuant to the Agreement, Trebuchet has
agreed to pay substantially all of the litigation costs associated with pending
validity proceedings initiated by the European Central Bank in eight European
countries relating to the Company’s European Patent 0 455 750B1 that the Company
has claimed the ECB infringed in printing of the Euros
currency.  Under the terms of the Agreement, and in consideration for
Trebuchet’s funding obligations, the Company assigned and transferred a 49%
interest of the Company’s rights, title and interest in the Patent to Trebuchet
which allows Trebuchet to have as a separate and exclusive interest including a
separate and distinct right to exploit the Patent. Pursuant to this transaction,
the Company recognized a loss on the sale of patent assets for its assignment
and transfer of 49% of its ownership rights in the patent, which had a net book
value of approximately $1,670,000, for $500,000,   As a result,
the Company recognized a loss on sale of patent assets of
$1,170,000.




Net
Loss and Loss Per Share




Three Months
                  Ended June 30,
                  2009
                
                
                Three Months
                  Ended September
                  30, 2008
                
                
                % change
                
                
                Nine Months
                  Ended September
                  30, 2009
                
                
                Nine Months
                  Ended
                  September 30,
                  2008
                
                
                % changeNet
      loss
                
                $
                (955,000
                )
                
                $
                (2,663,000
                )
                
                
                -64
                %
                
                $
                (2,873,000
                )
                
                $
                (6,182,000
                )
                
                
                -54
                %Net
      loss per share, basic and diluted
                
                $
                (0.06
                )
                
                $
                (0.19
                )
                
                
                -68
                %
                
                $
                (0.20
                )
                
                $
                (0.45
                )
                
                
                -56
                %Weighted
      average common shares outstanding, basic and diluted
                
                
                14,711,105
                
                
                
                14,286,192
                
                
                
                3
                %
                
                
                14,510,056
                
                
                
                13,879,891
                
                
                
                5
                %




During the third quarter of 2009, the
Company experienced a net loss of $954,000, a 64% decrease from the net loss of
the third quarter of 2008.  The decrease in net loss during the
quarter was primarily the result of the significant decrease in other operating
costs, along with the absence of a non-recurring loss on sale of patent which
the Company incurred in the third quarter of 2008.   For the
first nine months of 2009, the Company’s net loss decreased 54% from the
comparable period in 2008 primarily due to the significant decrease in the
Company’s other operating expenses in 2009, which more than offset increases in
interest expense and amortization of note discount associated with the increase
in debt incurred by the Company in the latter half of 2008 and during the first
nine months of 2009.


22




LIQUIDITY
AND CAPITAL RESOURCES




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




As Of And For The Period Ended:September 30,
                      2009
                    
                    
                    September 30,
                      2008
                    
                    
                    % change vs.
                      2008Cash
      flows from:Operating
      activities
                    
                    $
                    (1,484,000
                    )
                    
                    $
                    (2,116,000
                    )
                    
                    
                    30
                    %Investing
      activities
                    
                    
                    (71,000
                    )
                    
                    
                    (871,000
                    )
                    
                    
                    92
                    %Financing
      activities
                    
                    
                    1,890,000
                    
                    
                    
                    2,688,000
                    
                    
                    
                    30
                    %Working
      capital
                    
                    
                    (4,561,000
                    )
                    
                    
                    (836,000
                    )
                    
                    
                    446
                    %Current
      ratio
                    
                    
                    0.32
                    x
                    
                    
                    0.68
                    x
                    
                    
                    -53
                    %Cash
      and cash equivalents
                    
                    $
                    423,000
                    
                    
                    $
                    443,000
                    
                    
                    
                    -5
                    %Short
      Term Debt
                    
                    $
                    3,933,000
                    
                    
                    $
                    1,858,000
                    
                    
                    
                    112
                    %Funds
      Available from Open Credit Facilities
                    
                    $
                    567,000
                    
                    
                    $
                    1,742,000
                    
                    
                    
                    -67
                    %




As of
September 30, 2009, our cash balance was approximately $423,000, up from $88,000
at December 31, 2008.  The increase in cash was due to the receipt of
funds from borrowings from Company’s credit facilities along with cash proceeds
from the sale of the Company’s equity.  During the first nine months
of 2009, the Company used $1.5 million of cash for operations and $71,000 for
investments in long-lived assets.  These amounts were significantly
lower than comparable 2008 levels which reflects the improvement of the
Company’s operating results, including the positive impact on operating cash
flows from the Company’s acquisition of its commercial printing business in
December 2008.  In addition, in 2009, the Company essentially
eliminated cash outflows associated with the Company’s patent litigation efforts
as a result of its litigation agreement in August 2008 with Trebuchet Capital
Partners.




Future
Capital Needs As of
September 30, 2009, our cash balance was approximately $423,000, and our current
liabilities totaled approximately $6,688,000, which includes $3,033,000 of short
term debt under two credit facilities that are due on January 2, 2010, and a
$900,000 Secured Promissory Note due on December 19, 2009.  During
2009, we raised approximately $1.2 million, net of expenses, through the private
placement of our common stock and warrants.  The Company has and will
use these funds to fund its operating cash flow requirements.  In
order to meet our operating needs and these current obligations, we will need to
generate additional income from operations or obtain additional financing,
including without limitation, fund-raising through additional sales of
equity.  We also need to negotiate with our lenders to extend or
refinance our existing credit facilities.  Additionally, our ability
to utilize cash generated by our DPI Secuprint subsidiary for corporate
obligations is restricted by the terms of certain of its third party equipment
operating leases, which could negatively affect our ability to raise cash from
other sources, or to satisfy our obligations.The Company
expects to be able to sell its common stock in order to meet its future capital
needs, but there is no guarantee that the Company will be able to do
so.




Off-Balance
Sheet Arrangements




We do not
have any off-balance sheet arrangements that have, or are reasonably likely to
have, an effect on our financial condition, financial statements, revenues or
expenses.


23




Critical
Accounting Policies and Estimates




As of
September 30, 2009, our critical accounting policies and estimates have not
changed materially from those set forth in our Annual Report on Form 10-K for
the year ended December 31, 2008.




ITEM
4T - 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”)) as
of the end of the period covered by this report to provide reasonable assurance
that information we are required to disclose in reports that we file or submit
under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in SEC rules and forms and that such information is
accumulated and communicated to management, including the CEO and the CFO, as
appropriate, to allow timely decisions regarding required
disclosure.





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, 2008 these officers have concluded that our disclosure controls and
procedures were not effective.  The material weaknesses consist of an
insufficient complement of qualified accounting personnel and controls
associated with segregation of duties and ineffective controls associated with
identifying and accounting for complex and non-routine transactions in
accordance with U.S. generally accepted accounting principles.  To
address the material weaknesses 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). Notwithstanding these material weaknesses,
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.





There
can be no assurance, however, that our disclosure controls and procedures will
detect or uncover all failures of persons within the Company and its
consolidated subsidiaries to disclose material information otherwise required to
be set forth in our periodic reports. There are inherent limitations to the
effectiveness of any system of disclosure controls and procedures, including the
possibility of human error and the circumvention or overriding of the controls
and procedures. Accordingly, even effective disclosure controls and procedures
can only provide reasonable, not absolute, assurance of achieving their control
objectives.





Changes
in Internal Control Over Financial Reporting





During
the first nine months of 2009, the Company  incorporated the
accounting staff from its acquisition of a commercial printer in December 2008
into its financial reporting process and will seek to use these new resources to
improve its areas of deficiency in the financial reporting process.The Company will evaluate
the effect of its changes in internal controls during its annual assessment of
its internal controls as of December 31, 2009.   Additionally, as
described above under "Controls And Procedures - Evaluation of Disclosure
Controls and Procedures," we also began implementing additional procedures to
address the material weaknesses identified in our internal controls over
financial reporting.





An
evaluation was performed under the supervision of the Company’s management,
including the CEO and CFO, as required under Exchange Act Rule 13a-15(d) and
15d-15(d), of whether any change in the Company’s internal control over
financial reporting occurred during the fiscal quarter ended September 30,
2009.  Based on that evaluation, the Company’s management, including
the CEO and CFO, concluded that, other than the changes discussed above, no
other changes in our internal control over financial reporting occurred during
the first nine months of 2009 that have materially affected, or are reasonably
likely to materially affect, our internal control over financial
reporting.




PART II


OTHER
INFORMATION




ITEM
1 - LEGAL PROCEEDINGS




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


24




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 the European Court of First Instance in Luxembourg.  We
alleged that all Euro banknotes in circulation infringe the Company 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 the Company to pay attorneys and
court fees in the amount of Euro 93,752 ($137,000 as of September 30, 2009),
which, unless the amount is settled will be subject to an assessment procedure
that will not likely be concluded until of the end of 2009 or first half of
2010, which the Company will accrue as soon as the assessed amount, if any, is
reasonably estimatable.




On
March 24, 2006, the Company received notice that the ECB had 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.  As a result of these decisions, the Company was notified
of the final assessment of the reimbursable ECB costs for both court cases was
356,490 pounds, of which the Company has paid $332,000 pounds through September
30, 2009 and owes approximately 25,000 pounds (approximately $40,000 as of
September 30, 2009), which amount was included in accrued expenses as of
September 30, 2009





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.  As a result of this ruling, the Company expects to be
awarded reimbursements for its costs associated with the German validity case,
which is Euro 44,692 ($65,000 at September 30, 2009), 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.  On November 3,
2009, the Belgium Court held that the Patent was invalid in Belgium for the same
reasons given by the English and French courts.   Costs
reimbursements, if any, associated with the Belgium validity case are covered
under the Trebuchet Agreement as described below.   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 last
quarter of 2009.





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
allowing the Company or Trebuchet Capital Partners, on the Company’s behalf, to
proceed with infringement cases in these countries if we choose to do
so.  Additional trials on the validity of the Patent are expected in
other European jurisdictions during 2009.





On August
20, 2008, the Company entered into an agreement with Trebuchet Capital Partners,
LLC (“Trebuchet”) under which Trebuchet has agreed to pay substantially all
of the litigation costs associated with pending validity proceedings initiated
by the European Central Bank (“ECB”) in eight European countries relating to the
Company’s European Patent 0 455 750B1 that the Company  has claimed
the ECB infringed in printing of the Euro currency (the “Patent”). Trebuchet
also agreed to pay substantially all of the litigation costs associated with
future validity challenges filed by the ECB or other parties, provided that
Trebuchet elects to assume the defense of any such challenges, in its sole
discretion, and patent infringement suits filed against the ECB and certain
other alleged infringers of the Patent, all of which suits may be brought at the
sole discretion of Trebuchet and may be in the name of the Company, Trebuchet or
both. The Company provided Trebuchet with the sole and exclusive right to manage
infringement litigation relating to the Patent in Europe, including the right to
initiate litigation in the name of the Company, Trebuchet or both and to choose
whom and where to sue, subject to certain limitations set forth in the agreement
under the terms of the Agreement, and in consideration for the Trebuchet's
funding obligations, the Company assigned and transferred a 49% interest of the
Company's rights, title and interest in the Patent to Trebuchet which allows
Trebuchet to have a separate and distinct interest in and share of the Patent,
along with the right to sue and recover in litigation, settlement or otherwise
to collect royalties or other payments under or on account of the Patent. In
addition, the Company and Trebuchet have agreed to equally share all proceeds
generated from litigation relating to the Patent, including judgments and
licenses or other arrangements entered into in settlement of any such
litigation. Trebuchet is also entitled to recoup any litigation expenses
specifically awarded to the Company in such actions.


25





On
January 31, 2003, the Company 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 the
Company has an interest. The Company 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
the Company acquired in 2002. These alleged agreements, generally, would have
authorized Adler to manufacture in Canada the Company’s “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 the
Company.  Among other things, the Company contends that certain of the
purported agreements are not binding and/or enforceable.  To the
extent any of them are binding and enforceable, the Company claims 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 the Company, claiming Adler owns or co-owns or has a
license to use certain of the Company’s technologies.  In May 2005,
the Company filed a first amended and supplemental complaint adding Blanks/USA
and Raymond Maxon as additional defendants.  In February 2007, the
Company filed a 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 the Company contending that the Company’s 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.  The Company has denied the material
allegations of all of the counterclaims.  If Adler or Maxon is
successful,or if a settlement is made, it may materially affect the Company, the
Company’s financial condition, and the Company’s ability to market and sell
certain of the Company 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




We face many significant risks in
our business, some of which are unknown to us and not presently foreseen. These
risks could have a material adverse impact on our business, financial condition
and results of operations in the future. We have disclosed a number of material
risks under Item 1A of our annual report on Form 10-K for the year ended
December 31, 2008, which we filed with the Securities and Exchange
Commission on March 31, 2009. The following discussion is of material
changes to risk factors disclosed in that report.





We
have two secured credit facilities that have large principal payments due in
January 2010 and a $900,000 secured loan due in December 2009, and if we are
unable to repay them with cash we may be forced to repay, in whole or 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 an aggregate
borrowing capacity of $3.6 million that is repayable in full on January 4, 2010.
One of these credit facilities has a borrowing limit of $3.0 million and is
secured by our stock in our Plastic Printing Professionals, Inc. subsidiary, and
the other credit facility has a borrowing limit of $600,000 and is secured by
our accounts receivable, excluding the accounts receivable of our subsidiary
Plastic Printing Professionals, Inc. As of September 30, 2009, we have borrowed
$3,033,000 under these credit facilities and are in default of both agreements
due to a failure to pay interest when due.  Both Fagenson & Co.,
Inc. and Patrick White have waived the defaults through January 1,
2010.  In the event that the Company cannot pay these credit
facilities, including the unpaid interest, when due, the Company believes that
it will be able to extend the terms of these notes, or negotiate with the
lenders other means of satisfying these credit facilities, including the payment
of amounts due in the form of the Company’s equity.    There
can be no assurance that such additional financing, will be available on terms
acceptable to the Company or at all.  Failure to raise the funds necessary
to finance future cash requirements would adversely affect the Company’s ability
to pursue its strategy and could negatively affect operations in future periods.
 The accompanying financial statements do not reflect any adjustments that
may be necessary in the event the Company is unsuccessful in its fundraising
efforts.


26





On
December 18, 2008, our wholly owned subsidiary, Secuprint, Inc. (dba DPI
Secuprint, Inc.), entered into a secured loan of $900,000 to pay for most of the
cash portion of the purchase price of our acquisition of the assets of DPI of
Rochester, LLC.  The loan is due in December 2009 and is secured by
all of the assets of DPI Secuprint. The
Company expects to be able to refinance this obligation prior to its maturity
date, however, there is no guarantee that the Company will be able to do
so.





If we
cannot generate sufficient cash from operations or raise cash from other sources
including without limitation, fund-raising through additional sales of equity,
and if we cannot refinance the credit facilities or our secured loan, we may
have to repay, in whole or in part, one or all of the credit facilities or
secured loan with each credit facility's or note’s applicable collateral, which
would have a material adverse effect on our financial position.




Due
to our low cash balance and limited financing currently available to us, we may
in the near future have a number of obligations that we will be unable to meet
without generating additional income or raising additional
capital.  If we cannot generate additional income or raise additional
capital in the near future, we may become insolvent, fail to obtain appropriate
relief from bankruptcy, be made bankrupt and/or our stock may become illiquid or
worthless.





As of
September 30, 2009, our cash balance was approximately $423,000, and our current
liabilities totaled approximately $6,688,000, which includes $3,033,000 of short
term debt under two credit facilities that are due on January 2, 2010, and a
$900,000 Secured Promissory Note due on December 19, 2009.  In order
to meet our operating needs and these current obligations, we will need to
generate additional income from operations or obtain additional financing,
including without limitation, fund-raising through additional sales of
equity.  We may also need to negotiate with our lenders to extend or
refinance our existing credit facilities.  Additionally, our ability
to utilize cash generated by our DPI Secuprint subsidiary for corporate
obligations is restricted by the terms of certain of its third party equipment
operating leases, which could negatively affect our ability to raise cash from
other sources, or to satisfy our obligations.





If we do
not receive sufficient financing or sufficient funds from our operations we
may  (i) liquidate assets,  (ii) seek or be forced into
bankruptcy and/or obtain appropriate relief from bankruptcy and/or, (iii)
continue operations, but incur material harm to our
business,  operations or financial condition. These measures could
have a material adverse effect on our ability to continue as a going
concern.  Additionally, because of our financial condition, our Board
of Directors has a duty to our creditors that may conflict with the interests of
our stockholders.  Our Board of Directors may be required to make
decisions that favor the interests of creditors at the expense of our
stockholders to fulfill its fiduciary duty.  For instance, we may be
required to preserve our assets to maximize the repayment of debts versus
employing the assets to further grow our business and increase shareholder
value.  If we cannot generate enough income from our operations or are
unable to locate additional funds through financing, we may not have sufficient
resources to continue operations.





Due
to our low cash balance and negative cash flow, we may have to further reduce
our costs by curtailing future operations to continue as a
business.





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 security and commercial printing and plastic card sales
and (ii) increase sales of our digital products. While we have approximately
$567,000 of funds available to us under our various credit facilities as of
September 30, 2009, that expire in January of 2010, we will need additional
funds in the future in order to fund our working capital needs including equity
capital.  If we are not successful in generating needed funds from
operations or in capital raising transactions, we may need to reduce our costs
which 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.


27





We
cannot predict our future capital needs and we may not be able to secure
additional financing.





We may need to raise additional funds
in the future to fund our working capital needs, to fund more aggressive
expansion of our business, to complete development, testing and marketing of our
products, or to 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 necessary funds will be available for us to finance our development
on acceptable terms, if at all.  Furthermore, 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.





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





As of September 30, 2009, there were
approximately 185 millionauthorized but unissued
shares of our common stock. Our management continues 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 NYSE Amex, New York law, or other applicable laws.  For instance,
during 2009 through November 13, 2009, we have issued 1,010,000 shares of common
stock and warrants to purchase an additional 202,000 shares of common
stock.  If our management determines to issue additional shares of our
common stock from the large pool of 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 such
transaction.





We
may not meet the continued listing standards of the NYSE AMEX





The
Company received notice from the NYSE Amex (formerly NYSE Alternext US) on
December 2, 2008 that based on a review of our Form 10-Q for the period ended
September 30, 2008, the Company did not meet certain of the Exchange’s continued
listing standards related to stockholders’ equity as set forth in Part 10 of the
NYSE Amex Company Guide.  The Company was afforded the
opportunity to submit a plan of compliance to the Exchange and on January 9,
2009 presented its plan to the Exchange. On January 29, 2009, the Exchange
notified the Company that it accepted the Company’s plan of compliance and
granted the Company an extension until June 2, 2010 to regain compliance with
the continued listing standards and that its listing is being continued pursuant
to this extension. The Company will be subject to periodic review by Exchange
Staff during the extension period. Failure to make progress consistent with the
plan or to regain compliance with the continued listing standards by the end of
the extension period could result in the Company being delisted from the
Exchange.  There is no guarantee that the Company will be able to
regain compliance to the listing standards and therefore, the Company’s common
shares may no longer be able to be traded, which 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.




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




Reference
is made to Item 1.01. “Entry into a Material Definitive Agreement” and Item
3.02. “Unregistered Sales of Equity Securities” of our Current Report on Form
8-K filed with the Securities and Exchange Commission on October 27, 2009 for a
description of our previously reported sales of unregistered securities on
October 21, 2009.









On August
24, 2009, the Company completed the sale of 7 investment units in a private
placement pursuant to subscription agreements with three accredited investors
dated the same date. Each investment unit is comprised of 7,142 shares of the
Company’s common stock and five year warrants to purchase 1,427 shares of common
stock at an exercise price of $2.00 per share. In the transaction, the Company
sold 7 investment units for $10,000 per unit for gross cash proceeds of $70,000,
consisting of 50,000 shares of common stock and warrants to purchase an
aggregate of 10,000 shares of common stock.





On
September 4, 2009, the Company completed the sale of 44 investment units in a
private placement pursuant to subscription agreements with three accredited
investors dated the same date. Each investment unit is comprised of 6,250 shares
of the Company’s common stock and five year warrants to purchase 1,250 shares of
common stock at an exercise price of $2.00 per share. In the transaction, the
Company sold 44 investment units for $10,000 per unit for gross cash proceeds of
$440,000, less expenses of $52,000, consisting of 275,000 shares of common stock
and warrants to purchase an aggregate of 55,000 shares of common
stock.


28





On
October 19, 2009, the Company completed the sale of 17.6 investment units in a
private placement pursuant to subscription agreements with three accredited
investors dated the same date. Each investment unit is comprised of 6,250 shares
of the Company’s common stock and five year warrants to purchase 1,250 shares of
common stock at an exercise price of $2.00 per share. In the transaction, the
Company sold 17.6 investment units for $10,000 per unit for gross cash proceeds
of $176,000, consisting of 110,000 shares of common stock and warrants to
purchase an aggregate of 22,000 shares of common stock.





In
connection with the Transactions, the Company has entered into a Registration
Rights Agreement, with each purchaser (the “Registration Rights
Agreement”). Pursuant to the Registration Rights Agreement, the Company granted
certain registration rights to the purchasers, including using its best efforts
to file a registration statement with the Securities and Exchange Commission
covering the resale of the shares of Common Stock sold in the Transaction and
shares underlying the Warrants, within 90 business days after the final closing
of the Transaction.  The Company must use its best efforts to maintain
the effectiveness of the registration statement until the earlier of (i) one
year from the final closing date of the Transaction, or (ii) the date that the
holders of the shares receive an opinion of counsel to the Company that all such
shares may be freely traded (without limitation or restriction as to quantity or
timing and without registration) pursuant to Rule 144 or
otherwise.  The Registration Rights Agreement, form of Subscription
Agreement and Warrants are collectively referred to herein as, the "Definitive
Agreements."





Copies of
the Definitive Agreements relating to the Transaction are filed herewith as
Exhibits 4.1, 10.1 and 10.2, and are incorporated herein by reference. The
foregoing summary descriptions of the Definitive Agreements are qualified in
their entirety by reference to the full texts of each of such
exhibits.





The
investment units, Common Stock, Warrants and Common Stock issuable upon exercise
of the Warrants (the "Securities") have not been registered under the Securities
Act of 1933, as amended (the “Securities Act”), and were issued and sold in
reliance upon the exemption from registration contained in Section 4(2) of the
Securities Act and Rule 506 of Regulation D promulgated
thereunder.  These securities may not be offered or sold in the United
States in the absence of an effective registration statement or an applicable
exemption from registration requirements.




ITEM
3 - DEFAULTS UPON SENIOR SECURITIES




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.  As of September 30, 2009, the Company has borrowed
$3,033,000 under the Fagenson & Co., Inc. and White credit facility
agreements and was in default of both agreements due to a failure to pay
interest when due.  Both Fagenson & Co., Inc. and Patrick White
have waived the default through January 1, 2010.




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




None




ITEM
5 - OTHER INFORMATION




None


29




ITEM
6 - EXHIBITS




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





(a)
                    ExhibitsItem
      3.1   Certificate of Incorporation of the Registrant, as
      amended (incorporated by reference to Exhibit 3.1 to the Company’s
      Registration Statement No. 2-98684-NY on Form S-18).Item
      3.2   By-Laws of the Registrant, as amended (incorporated
      by reference to Exhibit 3.2 to the Company’s Registration Statement No.
      2-98684-NY on Form S-18).Item
      4.1   Form of Warrant to Purchase Common Stock of Document
      Security Systems, Inc. dated May 29, 2009 (incorporated by reference to
      Exhibit 4.1 of Form 8-K filed June 3, 2009).Item
      10.1   Form of Subscription Agreement dated as of May 29,
      2009 between Document Security Systems, Inc. and the Subscribers
      (incorporated by reference to Exhibit 10.1 of Form 8-K filed June 3,
      2009).Item
      10.2   Form of Registration Rights Agreement dated as of
      May 29, 2009 executed and delivered by Document Security Systems, Inc. and
      the holders listed therein (incorporated by reference to Exhibit 10.2 of
      Form 8-K filed June 3, 2009).Item
      10.3   Asset Purchase Agreement between Lester Levin Inc.
      and Internet Media Services, Inc. dated October 8, 2009 (Exhibits and
      Schedules have been omitted pursuant to Regulation S-K Item 601(b)(2), but
      will be provided to the SEC upon request) (incorporated by reference to
      Exhibit 10.2 of Form 8-K filed October 14, 2009).Item
      10.4   Registration Rights Agreement between Document
      Security Systems, Inc. and Internet Media Services, Inc. dated October 8,
      2009 (incorporated by reference to Exhibit 10.2 of Form 8-K filed October
      14, 2009).Item
      10.5    Stock Pledge and Escrow Agreement between
      Lester Levin Inc., Document Security Systems, Inc., Internet Media
      Services, Inc., Raymond Meyers and Manufacturers and Traders Trust Company
      dated October 8, 2009.  (incorporated by reference to Exhibit
      10.2 of Form 8-K filed October 14, 2009).Item
      10.6   Stock Pledge and Escrow Agreement between Lester
      Levin Inc., Document Security Systems, Inc., Internet Media Services,
      Inc., Michael Buechler and Manufacturers and Traders Trust Company dated
      October 8, 2009. (incorporated by reference to Exhibit 10.2 of Form 8-K
      filed October 14, 2009).Item
      10.7   Voting Agreement between Document Security Systems,
      Inc., Internet Media Services, Inc., Raymond Meyers and Michael Buechler
      dated October 8, 2009.  (incorporated by reference to Exhibit
      10.2 of Form 8-K filed October 14, 2009).Item
      31.1   Certification of Chief Executive Officer as required
      by Rule 13a-14 or 15d-14 of the Securities Exchange Act of 1934, as
      adopted pursuant to Section 302 of the Sarbanes Oxley Act of
      2002.Item
      31.2   Certification of Chief Financial Officer as required
      by Rule 13a-14 or 15d-14 of the Securities Exchange Act of 1934, as
      adopted pursuant to Section 302 of the Sarbanes Oxley Act of
      2002.Item
      32.1   Certification of Chief Executive Officer as required
      by 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes Oxley Act of 2002.Item
      32.2   Certification of Chief Financial Officer as required
      by 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes Oxley Act of
2002.


30




SIGNATURES




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




DOCUMENT
      SECURITY SYSTEMS, INC.November
      16, 2009
                      
                      By:
                      /s/
      Patrick WhitePatrick
      WhiteChief
      Executive OfficerNovember
      16, 2009
                      
                      By:
                      /s/
      Philip JonesPhilip
      JonesChief
      Financial Officer


31


Exhibit
Index





Item
3.1   Certificate of Incorporation of the Registrant, as amended
(incorporated by reference to Exhibit 3.1 to the Company’s Registration
Statement No. 2-98684-NY on Form S-18).





Item
3.2   By-Laws of the Registrant, as amended (incorporated by
reference to Exhibit 3.2 to the Company’s Registration Statement No. 2-98684-NY
on Form S-18).





Item
4.1   Form of Warrant to Purchase Common Stock of Document
Security Systems, Inc. dated May 29, 2009 (incorporated by reference to Exhibit
4.1 of Form 8-K filed June 3, 2009).





Item
10.1   Form of Subscription Agreement dated as of May 29, 2009
between Document Security Systems, Inc. and the Subscribers (incorporated by
reference to Exhibit 10.1 of Form 8-K filed June 3, 2009).





Item
10.2   Form of Registration Rights Agreement dated as of May 29,
2009 executed and delivered by Document Security Systems, Inc. and the holders
listed therein (incorporated by reference to Exhibit 10.2 of Form 8-K filed June
3, 2009).





Item
10.3   Asset Purchase Agreement between Lester Levin Inc. and
Internet Media Services, Inc. dated October 8, 2009 (Exhibits and Schedules have
been omitted pursuant to Regulation S-K Item 601(b)(2), but will be provided to
the SEC upon request) (incorporated by reference to Exhibit 10.2 of Form 8-K
filed October 14, 2009).





Item
10.4   Registration Rights Agreement between Document Security
Systems, Inc. and Internet Media Services, Inc. dated October 8, 2009
(incorporated by reference to Exhibit 10.2 of Form 8-K filed October 14,
2009).





Item
10.5    Stock Pledge and Escrow Agreement between Lester
Levin Inc., Document Security Systems, Inc., Internet Media Services, Inc.,
Raymond Meyers and Manufacturers and Traders Trust Company dated October 8,
2009.  (incorporated by reference to Exhibit 10.2 of Form 8-K filed
October 14, 2009).





Item
10.6   Stock Pledge and Escrow Agreement between Lester Levin
Inc., Document Security Systems, Inc., Internet Media Services, Inc., Michael
Buechler and Manufacturers and Traders Trust Company dated October 8, 2009.
(incorporated by reference to Exhibit 10.2 of Form 8-K filed October 14,
2009).





Item
10.7   Voting Agreement between Document Security Systems, Inc.,
Internet Media Services, Inc., Raymond Meyers and Michael Buechler dated October
8, 2009.  (incorporated by reference to Exhibit 10.2 of Form 8-K filed
October 14, 2009).





Item
31.1   Certification of Chief Executive Officer as required by
Rule 13a-14 or 15d-14 of the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes Oxley Act of 2002.





Item
31.2   Certification of Chief Financial Officer as required by
Rule 13a-14 or 15d-14 of the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes Oxley Act of 2002.





Item
32.1   Certification of Chief Executive Officer as required by 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley
Act of 2002.





Item
32.2   Certification of Chief Financial Officer as required by 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley
Act of 2002.




32