DSS, INC. - Quarter Report: 2010 September (Form 10-Q)

Unassociated Document

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, 2010

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 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports)

And

(2) has been subject to such filing requirements for the past 90 days.

Yes x No ¨

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 12, 2010 (the most recent practicable date), there were 18,191,166 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 INFORMATION
Item 1	Financial Statements
	Consolidated Balance Sheets	3
	Consolidated Statements of Operations	4
	Consolidated Statements of Cash Flows	5
	Notes to Interim Consolidated Financial Statements	6
Item 2	Management's Discussion and Analysis of Financial Condition and Results of Operations	16
Item 4	Controls and Procedures	23

PART II	OTHER INFORMATION
Item 1	Legal Proceedings	23
Item 1A	Risk Factors	25
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	31
Item 3	Defaults upon Senior Securities	31
Item 4	(Removed and Reserved)	31
Item 5	Other Information	31
Item 6	Exhibits	31

SIGNATURES

PART I

FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS

DOCUMENT SECURITY SYSTEMS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

As of

	September 30, 2010			December 31, 2009
	(Unaudited)
ASSETS

Current assets:
Cash and cash equivalents	$	408,082		$	448,895
Accounts receivable, net of allowance of $66,000 ($66,000- 2009)		1,835,093			1,143,939
Inventory, net		813,717			184,174
Prepaid expenses and other current assets		80,675			91,310
Investment		228,607			-
Total current assets		3,366,174			1,868,318

Fixed assets, net		2,652,350			1,286,226
Other assets		325,953			305,507
Investment		-			350,000
Goodwill		1,943,081			1,315,721
Other intangible assets, net		2,396,599			1,588,969
Total assets	$	10,684,157		$	6,714,741

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Accounts payable	$	1,715,431		$	1,673,901
Accrued expenses & other current liabilities		1,079,293			934,595
Dividends payable		228,607			-
Revolving line of credit		285,705			-
Current portion of long-term debt		300,000			-
Current portion of capital lease obligations		85,994			78,167
Total current liabilities		3,695,030			2,686,663

Revolving notes from related party		583,000			583,000
Long-term debt, net of unamortized discount of $298,000 ($420,000 -2009)		2,101,812			954,616
Capital lease obligations		105,173			182,424
Deferred tax liability		85,042			70,830

Commitments and contingencies (see Note 8)

Stockholders' equity
Common stock, $.02 par value; 200,000,000 shares authorized, 18,106,166 shares issued and outstanding (16,397,887 in 2009)		362,122			327,957
Additional paid-in capital		43,273,348			38,399,033
Accumulated other comprehensive loss		(31,834	)		-
Accumulated deficit		(39,489,536	)		(36,489,782	)
Total stockholders' equity		4,114,100			2,237,208
Total liabilities and stockholders' equity	$	10,684,157		$	6,714,741

See accompanying notes

DOCUMENT SECURITY SYSTEMS, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

(Unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2010			2009			2010			2009
Revenue
Security and commercial printing	$	1,620,204		$	2,246,700		$	5,306,980		$	6,605,209
Packaging		1,381,526			-			3,452,106			-
Technology license royalties and digital solutions		149,206			204,334			492,052			618,908
Legal products		-			101,611			-			355,107
Total Revenue		3,150,936			2,552,645			9,251,138			7,579,224
Costs of revenue
Security and commercial printing		1,210,009			1,516,188			3,963,595			4,546,512
Packaging		1,056,274			-			2,673,455			-
Technology license royalties and digital solutions		-			3,507			5,476			10,521
Legal products		-			56,073			-			178,892
Total costs of revenue		2,266,283			1,575,768			6,642,526			4,735,925
Gross profit		884,653			976,877			2,608,612			2,843,299

Operating expenses:
Selling, general and administrative		1,332,229			1,436,533			4,441,793			4,139,751
Research and development		71,731			61,317			204,086			223,409
Amortization of intangibles		189,467			323,936			619,667			971,068
Operating expenses		1,593,427			1,821,786			5,265,546			5,334,228

Operating loss		(708,774	)		(844,909	)		(2,656,934	)		(2,490,929	)

Other income (expense):
Interest income		-			18,140			-			18,140
Loss in equity investment		(49,714	)		-			(121,393	)		-
Interest expense		(78,572	)		(57,998	)		(228,082	)		(207,172	)
Amortizaton of note discount		(40,732	)		(63,756	)		(122,196	)		(189,211	)
Gain on foreign currency transactions		-			(1,453	)		-			10,329
Other income		-			-			143,063			-

Loss before income taxes		(877,792	)		(949,976	)		(2,985,542	)		(2,858,843	)

Income tax expense		4,737			4,738			14,212			14,214
Net loss	$	(882,529	)	$	(954,714	)	$	(2,999,754	)	$	(2,873,057	)

Other comprehensive loss:
Interest rate swap loss		(6,000	)		-			(31,834	)		-

Comprehensive Loss	$	(888,529	)	$	(954,714	)	$	(3,031,588	)	$	(2,873,057	)

Net loss per share -basic and diluted:	$	(0.05	)	$	(0.06	)	$	(0.17	)	$	(0.20	)

Divedend per share	$	0.01		$	-		$	0.01		$	-

Weighted average common shares outstanding, basic and diluted		18,008,012			14,711,105			17,599,410			14,510,056

See accompanying notes

DOCUMENT SECURITY SYSTEMS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

For the Nine Months Ended September 30,

(Unaudited)

	2010			2009
Cash flows from operating activities:
Net loss	$	(2,999,754	)	$	(2,873,057	)
Adjustments to reconcile net loss to net cash used by operating activities:
Depreciation and amortization		949,683			1,221,103
Stock based compensation expense (reversal)		336,111			(78,725	)
Amortization of note discount		122,196			189,211
Loss in equity investment		121,393			-
Provision for inventory reserve		10,000			-
(Increase) decrease in assets:
Accounts receivable		593,122			(88,690	)
Inventory		(135,381	)		28,890
Prepaid expenses and other assets		(59,881	)		(33,261	)
Increase (decrease) in liabilities:
Accounts payable		(406,598	)		367,454
Accrued expenses and other current liabilities		207,614			(216,574	)
Net cash used by operating activities		(1,261,495	)		(1,483,649	)

Cash flows from investing activities:
Decrease in restricted cash		-			131,004
Purchase of fixed assets		(138,640	)		(18,255	)
Purchase of other intangible assets		(118,999	)		(183,630	)
Acquisition of business		(2,272,405	)		-
Net used by investing activities		(2,530,044	)		(70,881	)

Cash flows from financing activities:
Borrowing on revolving note- related parties		100,000			1,030,000
Repayment on revolving note- related parties		(100,000	)		(280,000	)
Borrowings on revolving line of credit		285,705			-
Borrowings on long-term debt		1,500,000			-
Payments of long-term debt		(175,000	)		-
Payments of capital lease obligations		(69,424	)		(101,717	)
Issuance of common stock, net		2,209,445			1,241,503
Net cash provided by financing activities		3,750,726			1,889,786

Net increase (decrease) in cash and cash equivalents		(40,813	)		335,256
Cash and cash equivalents beginning of period		448,895			87,820
Cash and cash equivalents end of period	$	408,082		$	423,076

See accompanying notes.

DOCUMENT SECURITY SYSTEMS, INC.

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2010

(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, 2009.

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.

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 deferred revenue and customer deposits into accrued expenses.

Fair Value of Financial Instruments - Fair value estimates discussed herein are based upon certain market assumptions and pertinent information available to management as of September 30, 2010. The carrying amounts reported in the balance sheet as of September 30, 2010 of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximate fair value because of the immediate or short-term maturity of these financial instruments. The fair value of revolving credit lines, notes payable and long-term debt approximates their carrying value as the stated or discounted rates of the debt reflect recent market conditions.

Derivative instruments are recorded as assets and liabilities at estimated fair value based on available market information. The Company's derivative instrument is an interest rate swap that changes a variable rate into a fixed rate on the term loan and qualifies as a cash flow hedge and is included in accrued expenses on the accompanying Consolidated Balance Sheet as of September 30, 2010. Gains and losses on these instruments are recorded in other comprehensive income (loss) until the underlying transaction is recorded in earnings. When the hedged item is realized, gains or losses are reclassified from accumulated other comprehensive income (loss) (AOCI) to the Consolidated Statement of Operations on the same line item as the underlying transaction. The cumulative net loss attributable to this cash flow hedge recorded in AOCl at September 30, 2010, was approximately $32,000.

Conventional Convertible Debt -When the convertible feature of the conventional convertible debt provides for a rate of conversion that is below market value, this feature is characterized as a beneficial conversion feature (“BCF"). Prior to the determination of the BCF, the proceeds from the debt instrument were first allocated between the convertible debt and any detachable free standing instruments that are included, such as common stock warrants. The Company recorded a BCF as a debt discount pursuant to ASC Topic 470-20, (formerly EITF Issue No. 98-5 “Accounting for Convertible Securities with Beneficial Conversion Features or Contingency Adjustable Conversion Ratio," and EITF Issue No. 00-27, “Application of EITF Issue No. 98-5 to Certain Convertible Instrument(s)"). In those circumstances, the convertible debt will be recorded net of the discount related to the BCF. The Company amortizes the discount to interest expense over the life of the debt using the effective interest method.

Investment - On October 8, 2009, the Company entered into an Asset Purchase Agreement with Internet Media Services, Inc. (“IMS”) whereby the Company sold the assets and liabilities of Legalstore.com, a division of the Company, in exchange for 7,500,000 shares of common stock of IMS. The Company recorded its investment IM as an equity method investment at the fair market value of the business sold. Management determined that the transaction qualified as a derecoginition of a subsidiary under ASC 810-10-40. Therefore, the Company accounted for the deconsolidation of a subsidiary (“the business”) by recording the consideration received at fair market value and recognizing a gain in net loss during the year ending December 31, 2009 measured as the difference between: the fair value of the consideration received (7,500,000 shares of common stock of IMS or a 37% interest) and the carrying value of the assets and liabilities sold. Given that the consideration received was not readily measurable because of the lack of activity in IMS prior to the transaction, the Company determined that the value of the “business transferred” was more readily measurable. The Company determined the fair market value of the business transferred based on a discounted cash flow model. Under the equity method investment the Company is required to account for the difference between the cost of an investment and the amount of the underlying equity in net assets of an investee as if the investee were a consolidated subsidiary. If the investor is unable to relate the difference to specific accounts of the investee (e.g., property and equipment), the difference should be considered to be the same as goodwill. Investors shall not amortize goodwill associated with equity method investments after the date ASC 350 (formally Statement No. 142, Goodwill and Other Intangible Assets), is initially applied by the entity in its entirety. The Company determined that given the lack of activity in IMS prior to the transaction, the difference between the cost of the investment (fair market value) and the underlying equity interest is attributable to goodwill which difference amounted to approximately $243,000 at December 31, 2009.

Up until September 23, 2010, the Company recognized a loss on its investment in IMS of approximately $121,000 using the equity method of accounting for the investment. On September 23, 2010, the Company’s Board of Directors declared a dividend whereas the Company would distribute to its stockholders of record on October 8, 2010 on a pro-rata basis its shares of stock in Internet Media Services. As a result, the Company has recorded a dividend payable of approximately $229,000 which was the book value of the investment as of September 23, 2010.

Earnings Per Common Share - The Company presents basic and diluted earnings per share. Basic earnings per share reflects the actual weighted average of shares issued and outstanding during the period. Diluted earnings per share are computed including the number of additional shares that would have been outstanding if dilutive potential shares had been issued. In a loss year, the calculation for basic and diluted earnings per share is considered to be the same, as the impact of potential common shares is anti-dilutive.

For the nine months ended September 30, 2010 and 2009, there were up to 2,580,699 and 1,815,270 respectively, of shares potentially issuable under convertible debt agreements, options, warrants and restricted stock agreements that could dilute basic earnings per share in the future were excluded from the calculation of diluted earnings per share because their inclusion would have been anti-dilutive to the Company’s losses in the respective periods.

Concentration of Credit Risk - The Company acquired Premier Packaging Corporation in February 2010. During the year ended December 31, 2009, 72% of Premier Packaging’s sales were to two customers and which comprised 81% of Premier Packaging’s accounts receivable balance as of December 31, 2009. During the nine month period ended September 30, 2010, these two customers accounted for 32% of the Company’s consolidated revenue. As of September 30, 2010 one of the customers, which accounted for 25% of the Company’s consolidated sales for the first nine months of 2010, has a contract with the Company that is currently set to expire in July 2011, and comprised 26% of the Company’s consolidated accounts receivable as of September 30, 2010

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; (ii) increase sales of the Company’s digital products; and (iii) integrate its new acquisition of Premier Packaging with its existing product lines. As of September 30, 2010, the Company has approximately $408,000 in cash but a negative working capital of $329,000. As of September 30, 201, the Company has $417,000 available to it under one credit facility, along with up to $714,000 available under a credit line at its Premier Packaging subsidiary, which the Company may need to use in order to ensure it has sufficient working capital to operate its business. Furthermore, the Company may need additional funds for its business. To address its working capital needs in the past, the Company has been able to obtain equity based financing, including most recently, on July 21, 2010 and July 22, 2010, the Company raised a aggregate of $1,080,000, net of fees, from the sale of common stock. The Company expects to be able to continue to obtain equity based financing to meet its obligations if the Company cannot generate sufficient cash from its operations, although there is no guarantee that the Company will be able to do so.

Recent Accounting Pronouncements

In January 2010, the FASB issued ASU 2010-6, “Improving Disclosures About Fair Value Measurements” (“ASU 2010-6”), which requires reporting entities to make new disclosures about recurring or nonrecurring fair-value measurements including significant transfers into and out of Level 1 and Level 2 fair-value measurements and information on purchases, sales, issuances, and settlements on a gross basis in the reconciliation of Level 3 fair- value measurements. ASU 2010-6 is effective for interim and annual reporting periods beginning after December 15, 2009, except for Level 3 reconciliation disclosures which are effective for interim and annual periods beginning after December 15, 2010. The Company adopted the requirements within ASU 2010-6 as of January 1, 2010. The adoption did not have an impact on our financial statements.

In July 2010, the FASB issued ASU 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” The new disclosure guidance will significantly expand the existing requirements and will lead to greater transparency into a company’s exposure to credit losses from lending arrangements. The extensive new disclosures of information as of the end of a reporting period will become effective for both interim and annual reporting periods ending on or after December 15, 2010. Specific disclosures regarding activity that occurred before the issuance of the ASU, such as the allowance roll-forward and modification disclosures, will be required for periods beginning on or after December 15, 2010. The Company is currently assessing the impact that ASU 2010-20 will have on its consolidated financial statements.

2. Inventory

Inventory approximately consisted of the following:

	September 30,		December 31,
	2010		2009

Finished Goods	$	381,274	$	38,093
Work in process		145,135		58,493
Raw Materials		297,308		87,588
		823,717		184,174
Less inventory reserve		(10,000)		-
	$	813,717	$	184,174

3. Other Intangible Assets

Other intangible assets are comprised of the following:

		September 30, 2010 (unaudited)						December 31, 2009
	Useful Life	Gross Carrying Amount		Accumulated Amortizaton		Net Carrying Amount		Gross Carrying Amount		Accumulated Amortizaton		Net Carrying Amount
Acquired intangibles	5 years	$	2,038,300	$	736,588	$	1,301,712	$	756,300	$	622,285	$	134,015
Patent acquisition and defense costs	Varied (1)		4,729,889		4,257,789		472,100		4,729,889		3,879,341		850,548
Patent application costs	Varied (2)		831,961		209,174		622,787		776,159		171,753		604,406
		$	7,600,150	$	5,203,551	$	2,396,599	$	6,262,348	$	4,673,379	$	1,588,969

(1)- patent rights are amortized over their expected useful life which is generally the legal life of the patent. As of September 30, 2010 the weighted average remaining useful life of these assets in service was 1.24 years.

(2)- patent rights are amortized over their expected useful life which is generally the legal life of the patent. As of September 30, 2010 the weighted average remaining useful life of these assets in service was 14.4 years.

4. Debt

Revolving Note - Related Party- 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 could borrow up to a maximum of $3,000,000 from time to time up to and until January 4, 2010. Any amount borrowed by the Company pursuant to the Fagenson Credit Agreement has annual interest rate of 2% above LIBOR and is 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. On December 11, 2009, the Company entered into a Letter Agreement with the lender for the conversion of $2,000,000 of debt owed under the Credit Facility into 1,250,000 shares of Document Security Systems Common Stock. In addition, the parties amended the Credit Facility to allow for a maximum borrowing of up to $1,000,000 and extended the due date to January 4, 2012. As of September 30, 2010, the Company had outstanding $583,000 ($583,000 – December 31, 2009) under the Fagenson Credit Agreement. Under the terms of the agreement the Company is required to comply with various covenants. As of September 30, 2010, the Company was in default of the Fagenson Credit Agreement due to a failure to pay interest when due. Fagenson and Co. has waived the defaults through January 1, 2012.

Interest expense for revolving notes from related parties for the nine months ended September 30, 2010 was approximately $14,000 ($84,000 – 2009) of which approximately $167,000 is included in accrued expenses as of September 30, 2010 ($152,000 –December 31, 2009).

Notes Payable - On December 9, 2009, the Company used the proceeds from a $350,000 Convertible Note and a $575,000 Promissory Note, respectively, to pay in full a $900,000 Term Note. The $350,000 Convertible Note matures November 24, 2012, accrues interest at 10%, payable quarterly, and is convertible into up to 218,750 shares of Document Security Systems Common Stock. The $575,000 Promissory Note matures November 24, 2012 and accrues interest at 10%, payable quarterly. Both Notes are secured with equal rights by the assets of the Company’s wholly owned subsidiary, DPI Secuprint. In conjunction with the convertible note, the Company determined a beneficial conversion feature existed amounting to approximately $94,000 which was recorded as discount on debt and is being amortized over the term of the Note. Under the terms of the agreements the Company is required to comply with various covenants, which the Company was in compliance with as of September 30, 2010.

On December 30, 2009, the Company used the proceeds from a $450,000 Convertible Note to pay in full $450,000 due under a Credit Facility. The $450,000 Convertible Note matures June 23, 2012, accrues interest at 8%, payable quarterly, is convertible into up to 260,116 shares of Document Security Systems Common Stock, and is secured by the accounts receivable of the Company, excluding the accounts receivable of the Company’s wholly owned subsidiaries, Plastic Printing Professionals and DPI Secuprint. In conjunction with the Note, the Company issued to the holders of the Note warrants to purchase up to 65,000 shares of the Company’s common stock within five years at $2.00 per share. The estimated fair market value of these warrants was determined using the Black Scholes option pricing model at approximately $72,000, which was recorded as discount on debt and is being amortized over the term of the Note. Furthermore, in conjunction with this convertible note, the Company determined a beneficial conversion feature existed amounting to approximately $257,000, which was recorded as discount on debt and is being amortized over the term of the Note. In addition, the Company recorded expense of approximately $110,000 for the fair value of 40,000 warrants to purchase the shares of the Company’s common stock at $2.00 issuable under the terms of the Convertible Note as a result of the Company’s failure to timely file a registration statement for the shares issuable upon conversion of the note and underlying the warrants, respectively, Under the terms of the agreements the Company is required to comply with various covenants, which the Company was in compliance as of September 30, 2010.

On February 12, 2010, the Company acquired all of the outstanding common stock of Premier Packaging Corporation (“Premier”) from Robert B. and Joan T. Bzdick for $2,000,000 in cash and 735,437 shares of the Company's common stock. In connection with the transaction, the Company incurred secured bank debt in the principal amount of $1,500,000 which was used to partially satisfy the purchase price of the Premier common stock. In conjunction with the transaction, the Company entered into a Credit Facility Agreement with RBS Citizens, N.A. (“Citizens Bank”) pursuant to which Citizens Bank provided Premier Packaging Corporation with a term loan of $1,500,000, and a revolving credit line of up to $1,000,000. The Credit Facility Agreement contains customary representations and warranties, affirmative and negative covenants, including financial covenants (minimum coverage ratio, debt to EBITDA ratio, and current ratio requirements) and events of default and is secured by all of the assets of Premier Packaging Corporation. The credit facilities are also secured by cross guarantees by Document Security Systems, Inc., and its other wholly owned subsidiaries, Plastic Printing Professionals, Inc. and Secuprint, Inc (“DPI Secuprint”). The $1,500,000 term loan matures March 1, 2013 and is payable in 35 monthly payments of $25,000 plus interest commencing March 1, 2010 and a payment of $625,000 on the 36 month. Interest accrues at LIBOR plus 3.75%. The proceeds of the term loan were used as partial payment of the purchase of all of the outstanding common stock of Premier Packaging Corporation. The revolving line of credit up to $1,000,000 is accessible by the Premier Packaging division subject to certain terms matures on February 12, 2011 and is payable in monthly installments of interest only beginning on March 1, 2010. Interest accrues at 1 Month LIBOR plus 3.75%. The Company subsequently entered into an interest rate swap agreement to lock into a 5.6% effective interest over the life of the term loan. As of September 30, 2010, the remaining principal balance due on the Note was $1,325,000 and there was approximately $286,000 outstanding on the revolving credit line.

5. Stockholders’ Equity

Restricted Stock – As of September 30, 2010, there are 40,000 unvested restricted shares granted to an employee that vests proratably through December 2013. The unvested shares are valued at $84,000. 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, 2010, vesting is not considered probable and no compensation expense has been recognized related to the performance grants.

On February 12, 2010, the Company acquired all of the outstanding common stock of Premier Packaging Corporation from Robert B. and Joan T. Bzdick for $2,000,000 in cash and 735,437 shares of the Company's common stock which was valued at $2,547,675.

On February 17, 2010, the Company completed the sale of 20 investment units in a private placement pursuant to subscription agreements with six accredited investors. Each investment unit was comprised of 5,000 shares of the Company’s common stock and five year warrants to purchase 1,000 shares of common stock at an exercise price of $3.50 per share. In the transaction, the Company sold 20 investment units for $15,000 per unit for gross cash proceeds of $300,000, consisting of 100,000 shares of common stock and warrants to purchase an aggregate of 20,000 shares of common stock. In connection with these sales EKN Financial Services Inc., a registered broker-dealer, acted as non-exclusive placement agent. EKN Financial Services, Inc. received a cash fee in the aggregate of $30,000 as commission for these sales. On February 17, 2010, the Company also sold 20 investment units for gross cash proceeds of $270,000, consisting of 100,000 shares of common stock and warrants to purchase an aggregate of 20,000 shares of common stock. No placement agent fees were paid on these sales. On February 23, 2010, the Company issued 304,000 shares of common stock pursuant to the exercise of warrants in which the Company received proceeds of $608,000.

On July 21, 2010 and July 22, 2010, Document Security Systems entered into subscription agreements with each of twenty two (22) accredited investors. Under these subscription agreements the Company issued an aggregate of 413,787 shares of common stock and five-year warrants to purchase 82,753 shares of common stock, in consideration of an aggregate of $1,200,000. The warrants are exercisable at $3.75 per share. The Company paid Aegis Capital Corp., for its services as placement agent, a 7% commission, and a 3% non-accountable expense allowance, in the aggregate amount of $120,000. In addition, we issued the placement agent five year warrants to purchase 41,379 shares of common stock, exercisable at $3.75 per share.

Stock Options – During the nine months ended September 30, 2010, the Company issued options to purchase 40,000 of its common shares at an exercise price of $2.45 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 $38,000 determined by utilizing the Black Scholes option pricing model. In addition, the Company issued options to purchase 170,000 of its common shares at an exercise prices between $3.23 and $4.00 per share under the Company’s 2004 Employees’ Stock Option Plan to certain employees. The fair value of these options amounted to approximately $235,000 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 ASC 718.

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, 2010, the Company had stock compensation expense of approximately $336,000 and impacted net loss by ($0.02 per share) (negative stock compensation expense of $79,000- 2009; $0.01 per share).

As of September 30, 2010, there was approximately $454,000 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 proratably through December 2013.

Dividend Declared -On September 23, 2010, the Company’s Board of Directors declared a dividend whereas the Company would distribute to its stockholders of record on October 8, 2010 on a pro-rata basis its 7,500,000 shares of stock in Internet Media Services. As a result, the Company has recorded a dividend payable of approximately $229,000 which was the book value of the investment as of September 23, 2010.

6. Business Combination

On February 12, 2010, the Company acquired all of the outstanding common stock of Premier Packaging Corporation (“Premier”) from Robert B. and Joan T. Bzdick for $2,000,000 in cash and 735,437 shares of the Company's common stock with a value of $2,566,675 at February 12, 2010. The cash payment was subject to a working capital adjustment which was not required as the working capital was within the target range. In addition, the purchase price is subject to increase if the capital gains tax rate that was in effect as of February 12, 2010 is retroactively increased by legislation or otherwise whereas the seller’s tax on its gain increases. Any increase in taxes will be payable by the Company in either cash or stock. The Company believes this contingent payment is remote. In addition, the seller has registration rights for its shares to which the Company is subject to registration penalties of up to $5,000 per month after 120 days.

The acquisition has been accounted for as a business combination, whereby the Company measured the identifiable assets acquired and liabilities assumed based on the acquisition date fair value. The Company incurred approximately $30,000 of acquisition related legal and professional fees that were expensed in the period in which they were incurred. The Company is required to recognize and measure any related goodwill acquired in the business combination or a gain from a bargain purchase. Based on management’s preliminary assumptions, the fair value of the assets acquired and liabilities assumed was less than the purchase price resulting in the recording of goodwill. Goodwill totaling approximately $627,000 represents the excess of the purchase price over the fair value of tangible and identifiable intangible assets acquired and is due primarily to expected increased market penetration from future products in the secure packaging market and synergies expected from combining packaging capabilities of Premier with the printing capabilities of the Company’s Secuprint division. The goodwill recorded with the transaction is not deductible for income taxes. Since the acquisition through September 30, 2010, Premier has $1,382,000 in sales and a net loss of $27,000

The Company engaged a valuation expert, The Financial Valuation Group, to assist management in determining the fair value of the assets acquired. The allocation of the purchase price and the estimated useful lives associated with the acquired assets and liabilities is as follows:

Fair value of the consideration transferred	$	4,566,675	Estimated Useful Lives

Fair value of assets acquired and liabilities assumed:

Cash	$	5,290
Accounts receivable		1,284,227
Inventories		504,162
Machinery and equipment		1,557,500	3 to 7 years
Other intangible assets		1,372,000	5 to 10 years
Goodwill		627,360
Total Assets	$	5,350,539

Liabilities assumed:
Accounts payable	$	448,128
Revolving credit lines		277,645
Accrued Liabilities		58,091
Total Liabilities	$	783,864

Total prelimary purchase price	$	4,566,675

Set forth below is the unaudited proforma revenue, operating loss, net loss and loss per share of the Company as if Premier Packaging Corporation had been acquired by the Company as of January 1, 2009.

	Three Months Ended September 30,						Nine Months Ended September 30,
(unaudited)	2010			2009			2010			2009

Revenue		3,150,936			4,214,950			10,135,506			12,179,226
Operating Loss		(708,774	)		(749,606	)		(2,722,790	)		(2,278,642	)
Net Loss		(882,529	)		(859,411	)		(3,067,421	)		(2,660,770	)
Basic and diluted loss per share		(0.05	)		(0.06	)		(0.17	)		(0.18	)

7. Other Income

In March, 2010, the Company received notification that it was due approximately $143,000 for New York State Qualified Emerging Technology Company (“QETC”) refundable tax credits for the tax year ended 2008 which the Company received in April, 2010.

8. 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 which, unless the amount is settled will be subject to an assessment procedure that has not been initiated, the Company will accrue as soon as the assessed amount, if any, is reasonably estimatable.

In 2006, the Company received notices that the ECB had filed separate claims in each of the United Kingdom, The Netherlands, Belgium, Italy, France, Spain, Germany, Austria 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. On March 26, 2007, the High Court of Justice, Chancery Division, Patents Court in London, England ruled that the Patent was deemed invalid in the United Kingdom, and on March 19, 2008 this decision was upheld on appeal. 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. At September 30, 2010, the Company had paid all except approximately $16,000 of the final assessment. The remaining $16,000 was in accrued expenses as of September 30, 2010 which the Company paid in full as of October 31, 2010.

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. On July 6, 2010, the Company was notified that the German Court has ruled that the Patent, that was awarded to the Company by the European Patent Office and upheld as valid in a previous hearing in the German Court of First Instance, has now been deemed invalid in Germany due to added matter. 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 filed an appeal against the French decision on May 7, 2008. On March 20, 2010, the Company was informed that the decision was upheld in the French appeal. On March 12, 2008 the Dutch Court ruled that the Patent is valid in the Netherlands. The ECB filed an appeal against the Dutch decision on March 27, 2008. The Dutch appeal was heard in June 2010, with a decision expected in late 2010 or early 2011. 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 as were similarly informed by the Austrian court on November 17, 2009. Cost reimbursement, if any, associated with the Belgium, Austrian, and French validity cases as well as the appeals in Germany and France are covered under the Trebuchet agreement described below. On March 24, 2010 the Spanish Court ruled that the Patent was valid. In Italy the validity case is expected to be heard again by a newly appointed judge in late 2010 and a hearing in Luxembourg thereafter.

On August 20, 2008, the Company entered into an agreement with Trebuchet Capital Partners, LLC (“Trebuchet”) under which Trebuchet agreed to pay substantially all of the litigation costs associated validity proceedings in eight European countries relating to the Patent. Trebuchet also agreed to pay substantially all of the litigation costs associated with any 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.

The Patent has thus been confirmed to be valid and enforceable in two jurisdictions (the Netherlands and Spain) 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. On February 18, 2010, Trebuchet, on behalf of the Company, filed an infringement suit in the Netherlands. The suit is being lodged against the ECB and two security printing entities with manufacturing operations in the Netherlands, Joh. Enschede Banknotes B.V.; and Koninklijke Joh. Enschede B.V. The ECB and the security printers have been notified and the court hearing date is tentatively scheduled for January 21, 2011.

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 net settlement proceeds. For infringement matters involving certain foreign patents, the Company will be required to disburse 14% of the net 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, 2010, there has 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, 2010, 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 September 30, 2010, there is no remaining amount due under the agreement.

Operating leases with a related party - In conjunction with it acquisition of Premier Packaging in February 2010, the Company entered into a ten-year lease for a production facility in Victor, NY with Robert Bzdick, the former owner of Premier Packaging, and the Company’s Chief Operating Officer and President of Premier Packaging. The minimum future lease payments subsequent to September 30, 2010 under this lease are as follows:

2010	$	40,000
2011	$	160,000
2012	$	160,000
2013	$	160,000
2014	$	160,000
2015	$	160,000
Thereafter	$	735,000

9. Supplemental Cash Flow Information

During the nine months ended September 30, 2010, the Company issued 735,437 shares valued at $2,566,675 as a partial payment of an acquisition. In addition, the Company satisfied approximately $74,000 of accrued expenses by issuing common stock of the Company and had a non-cash other comprehensive loss item for an interest rate swap loss of approximately $32,000. Cash paid for interest during the nine months ended September 30, 2010, was approximately $185,000 ($153,000 - 2009). On September 23, 2010, the Company declared a "non-cash" dividend of 7,500,000 shares of the Company's investment in Internet Media Services to be distributed to stockholders of the Company on record on October 8, 2010. During the nine months ended September 30, 2009, the Company entered into capital leases of approximately $96,000 for production equipment at its commercial print facility and satisfied approximately $33,000 of accrued expenses by issuing common stock.

10. Segment Information

The Company's businesses are organized, managed and internally reported as four operating segments. Three of these operating segments, Document Security Systems, Plastic Printing Professionals, and 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. The fourth business is engaged in the production of packaging products and is classified as a separate segment. A summary of the three 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.

Packaging

The Company acquired Premier Packaging in February 12, 2010 which produces packaging products such as boxes, mailers, and point of sale displays for various end-users.

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.

Approximate information concerning the Company’s operations by reportable segment for the three and nine months ended September 30, 2010 and 2009 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:

3 months ended September 30, 2010:	Legal Supplies		Security and Commercial Printing			Packaging			Corporate			Total
Revenues from external customers	$	-	$	1,769,000		$	1,382,000		$	-		$	3,151,000
Depreciation and amortization		-		221,000			86,000			1,000			308,000
Segment profit (loss)		-		(657,000	)		(27,000	)		(199,000	)		(883,000	)
Indentifiable assets		-		5,099,000			5,177,000			408,000			10,684,000

3 months ended September 30, 2009:
Revenues from external customers	$	102,000	$	2,451,000		$	-		$	-		$	2,553,000
Depreciation and amortization		5,000		395,000			-			1,000			401,000
Segment profit (loss)		10,000		(505,000	)		-			(460,000	)		(955,000	)
Indentifiable assets		255,000		6,649,000			-			431,000			7,335,000

9 months ended September 30, 2010:	Legal Supplies		Security and Commercial Printing			Packaging			Corporate			Total
Revenues from external customers	$	-	$	5,799,000		$	3,452,000		$	-		$	9,251,000
Depreciation and amortization		-		736,000			212,000			2,000			950,000
Segment profit (loss)		-		(1,941,000	)		(102,000	)		(957,000	)		(3,000,000	)
Indentifiable assets		-		5,099,000			5,177,000			408,000			10,684,000

9 months ended September 30, 2009:
Revenues from external customers	$	355,000	$	7,224,000		$	-		$	-		$	7,579,000
Depreciation and amortization		15,000		1,203,000			-			3,000			1,221,000
Segment profit (loss)		37,000		(1,610,000	)		-			(1,300,000	)		(2,873,000	)
Indentifiable assets		255,000		6,649,000			-			431,000			7,335,000

11. Subsequent Events

On October 8, 2010, the Company wholly owned subsidiary, Premier Packaging Corporation amended its Credit Facility Agreement with RBS Citizens, N.A. (“Citizens Bank”) to add a Standby Term Loan Note pursuant to which Citizens Bank will provide Premier Packaging with up to $450,000 towards the funding of eligible equipment purchases. The Company has 12 months to draw a line of credit, after which the balance of funds advanced from the line is converted into a 5 year term loan. Interest accrues at LIBOR plus 3.00%. The Credit Facility Agreement was amended to include the Standby Term Note and contains customary representations and warranties, affirmative and negative covenants, and events of default and is secured by all of the assets of Premier Packaging Corporation. The Credit Facility is secured by cross guarantees by Document Security Systems, Inc., and its other wholly owned subsidiaries, Plastic Printing Professionals, Inc. and Secuprint, Inc. On October 12, 2010, the Company drew approximately $53,000 from the Standby line for the purchase of certain equipment.

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, 2009, 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 low cash balance and negative working capital 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.

Overview

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

Our core business is counterfeit prevention, brand protection and validation of authentic print media, including government-issued documents, currency, private corporate 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 February 2010, we acquired Premier Packaging, a privately held commercial packaging company located in Victor, NY with approximately $7.3 million in sales in 2009. As a result of this acquisition, we have entered the packaging market with the intent to introduce our security technologies to a new audience geared toward the protection of brand counterfeiting. We believe that the use of our technologies on product packaging presents a significant opportunity. In addition, this acquisition will allow us to strengthen our competitive position in the traditional commercial printing and packaging markets as we will be able to offer a very price effective combination of services.

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

Security and Commercial Printing: Our technology portfolio allows us to create unique custom secure paper, plastic, packaging and Internet-based and software enterprise solutions. We market and sell under the name Document Security Systems 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.

Our primary product for the retail end-user market is AuthentiGuard® Security Paper. AuthentiGuard® Security Paper is blank paper that contains our Pantograph 4000™ 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.

We produce secure and non-secure printing at our 20,000 square foot printing facility in Rochester, NY. Our printing division has a high speed 6 color press along with two digital presses along with a full range of die cutting, packing, and folding capabilities.

We produce our secure and non-secure plastic printed documents such as ID cards, event badges, and driver licenses at our 25,000 square foot facility in Brisbane, California under the name Plastic Printing Professionals. Our plastic division has the capabilities for high speed data encoding and production of high-volume precision RFID cards.

Packaging: We produce our secure and non-secure packaging products such as boxes, mailers, point of sale displays, utilizing a CAD/CAM design system that allows for early stage prototyping at our manufacturing facility in Victor, New York. Our packaging division offers automated die cutting, high speed folding, gluing, window and paper patching, automated in-line inserting, pick and place and tip-on systems.

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 AuthentiGuard® 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 our 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.

The Company has developed an internet delivered technology called AuthentiGuard® – On Demand™ where information is hidden and then verified utilizing an inexpensive viewing glass. This technology is currently being utilized by a Central American country for travel visas.

The Company has also developed digital versions of its AuthentiGuard® – Prism™ and AuthentiGuard® – Pantograph 4000™ technologies which are produced on HP Indigo Presses, Canon Color Copiers, Ricoh Color Copiers and Konica Desktop Printers. The Company sells the digital products directly through its internal sales force and it has also entered a contract to sell its digital solutions through a third party who specializes in hardware software engineering solutions.

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

Pay Per Finished Piece

Legal Products: We also owned and operated 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 liabilities associated with our Legalstore.com business in exchange for 7,500,000 shares of common stock of Internet Media Services, Inc., representing approximately 37% of the outstanding shares of the newly formed company. Commencing on October 18, 2010, the Company distributed its 7,500,000 shares of Internet Media Services to the Company’s shareholders of record on October 8, 2010 on a pro-rata basis. The shares of Internet Media Services were recorded as an equity method investment by the Company and had a book value of approximately $229,000 on the date the dividend was declared.

Results of Operations for the Three and Nine Months Ended September 30, 2010 Compared to the Three and Nine Months ended September 30, 2009

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 third quarter of 2009, the Company’s Board of Directors finalized an agreement to sell its legal products business. In accordance with ASC 205-20-45, the Company reported the results of Legalstore.com as continued operations because the operations and cash flow of the component were not eliminated and given the Company’s continued involvement after the sale.

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, 2009.

Revenue

	Three Months Ended September 30, 2010		Three Months Ended September 30, 2009		% change			Nine Months Ended September 30, 2010		Nine Months Ended September 30, 2009		% change
Revenue
Security and commercial printing	$	1,620,000	$	2,247,000		-28	%	$	5,307,000	$	6,605,000		-20	%
Packaging		1,382,000		-					3,452,000		-
Technology license royalties and digital solutions		149,000		204,000		-28	%		492,000		619,000		-21	%
Legal products		-		102,000		-100	%		-		355,000		-100	%
Total Revenue	$	3,151,000	$	2,553,000		23	%	$	9,251,000	$	7,579,000		22	%

For the three months ended September 30, 2010, revenue was $3.2 million compared to $2.6 million for the three months ended September 30, 2009, an increase of 23%. In February 2010, the Company acquired Premier Packaging Corp, which had sales of $1,382,000. The addition of Premier Packaging sales offset a 28% decline in security and commercial print revenue and a decrease of 28% of technology license royalties and digital solutions, and the absence of legal products revenue in 2010 as the division was sold in the fourth quarter of 2009. The primary factor in the reduction of commercial and security printing sales was a 32% reduction in sales of commercial printing due to the continued weakness in sales in the Company’s regional market and the absence of larger orders from the Company’s largest commercial printing customer, which the Company had received in the during 2009.

For the nine months ended September 30, 2010, revenue was $9.3 million compared to $7.6 million for the nine months ended September 30, 2009, an increase of 22%. The addition of Premier Packaging sales offset a 20% decline in security and commercial print revenue and a decrease of 21% of technology license royalties and digital solutions, and the absence of legal products revenue in 2010 as the division was sold in the fourth quarter of 2009.

Cost of Revenue and Gross Profit

	Three Months Ended September 30, 2010		Three Months Ended September 30, 2009		% change			Nine Months Ended September 30, 2010		Nine Months Ended September 30, 2009		% change

Costs of revenue
Security and commercial printing	$	1,210,000	$	1,516,000		-20	%	$	3,964,000	$	4,547,000		-13	%
Packaging		1,056,000		-					2,673,000		-
Technology license royalties and digital solutions		-		4,000		-100	%		5,000		11,000		-55	%
Legal products		-		56,000		-100	%		-		179,000		-100	%
Total cost of revenue		2,266,000		1,576,000		44	%		6,642,000		4,737,000		40	%

Gross profit
Security and commercial printing		410,000		731,000		-44	%		1,343,000		2,058,000		-35	%
Packaging		326,000		-					779,000		-
Technology license royalties and digital solutions		149,000		200,000		-26	%		487,000		608,000		-20	%
Legal products		-		46,000		-100	%		-		176,000		-100	%
Total gross profit		885,000		977,000		-9	%		2,609,000		2,842,000		-8	%

		Three Months Ended September 30, 2010				Three Months Ended September 30, 2009				% change				Nine Months Ended September 30, 2010				Nine Months Ended September 30, 2009				% change
Gross profit percentage:			28	%			38	%			-26	%			28	%			37	%			-24	%

Gross profit decreased 9% to $885,000 in the third quarter of 2010 as compared to the third quarter of 2009. The decrease was primarily due to the a significant decrease in the gross profits generated from the Company’s security and commercial printing as a result of decreases in sales at the Company’s commercial printing division, which nearly offset the increase in gross profits as a result of the Company’s packaging division which the Company acquired in February 2010. In addition, the Company did not have any gross profits from legal product sales as the division was sold in the fourth quarter of 2009. Gross profit for the nine months ended September 30, 2010 decreased 8%, which reflect a significant decrease in security and commercial print profits that the Company has experienced in 2010 due to the lack of large commercial print orders in 2010 that the Company had experienced in 2009. The Company’s gross profit percentage decrease for both periods reflects the larger weight that packaging sale, which typically carry a lower gross profit margin, has on the Company’s overall revenue areas, along with the weakness in commercial printing sales. The Company expects that the impact of the Company’s acquisition of it packaging division will be to decrease overall gross profit margins for at least the near future, especially as the number of non-security packaging projects out-number the security packaging projects, which the Company expect will be at higher profit margins.

Operating Expenses

	Three Months Ended September 30, 2010			Three Months Ended September 30, 2009		% change			Nine Months Ended September 30, 2010		Nine Months Ended September 30, 2009			% change

Operating Expenses
Sales, general and administrative compensation	$	870,000		$	855,000		2	%	$	2,561,000	$	2,713,000			-6	%
Professional Fees		92,000			147,000		-37	%		437,000		434,000			1	%
Sales and marketing		46,000			34,000		35	%		172,000		105,000			64	%
Research and development		72,000			61,000		18	%		205,000		223,000			-8	%
Rent and utilities		170,000			129,000		32	%		478,000		399,000			20	%
Other		(10,000	)		197,000		-105	%		361,000		452,000			-20	%
		1,240,000			1,423,000		-13	%		4,214,000		4,326,000			-3	%

Other Operating Expenses
Depreciation and software amortization		34,000			36,000		-6	%		96,000		116,000			-17	%
Stock based compensation		130,000			38,000		242	%		336,000		(79,000	)		-525	%
Amortization of intangibles		189,000			324,000		-42	%		620,000		971,000			-36	%
		353,000			398,000		-11	%		1,052,000		1,008,000			4	%

Total Operating Expenses	$	1,593,000		$	1,821,000		-13	%	$	5,266,000	$	5,334,000			-1	%

Selling, General and Administrative

Sales, general and administrative compensation costs were 2% higher in the three months ending September, 30, 2010 as compared to the three months ended September 30, 2009, which reflects the impact of the addition of approximately $168,000 of SG&A compensation expense from the packaging division the Company acquired in February 2010. Otherwise, SG&A compensation costs would have decreased 18% during the three months ended September 30, 2010, as compared to the three months ended September 30, 2009 as the result of staff reductions made by the Company throughout 2009 and in early 2010 primarily in its commercial printing division.

For the nine months ended September 30, 2010, SG&A compensation costs decreased 6% despite the addition of the packaging division, which added $387,000 of SG&A compensation expense. Otherwise, SG&A compensation expense has decreased 20% during the first nine months of 2010 as compared to the first nine months of 2009, which also reflects the staff reductions made by the Company throughout 2009 and in early 2010 primarily in its commercial printing division.

Professional fees in the three months ended September 30, 2010 were $92,000 a decrease of 37% from the third quarter of 2009, as the Company incurred lower legal costs. For the nine months ended 2010, professional fees were consistent with the first nine months of 2009.

Sales and marketing costs during the third quarter and first nine months of 2010 increased 35% and 64%, respectively, from the 2009 period as the Company re-initiated certain marketing efforts and trade show participation in 2010 based on expectations that the sales downturn the Company had experienced during the global recession was reversing.

Research and development costs consist 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 due to a reduction in compensation cost.

Rent and utilities increased as a result of the acquisition of Premier Packaging in February 2010.

Other expenses are primarily equipment maintenance and repairs, office supplies, IT support, bad debt expense and insurance costs. For the three months ended September 30, 2010, these costs decreased 105% as the result of a one time write off of previously accrued estimated expenses of approximately $139,000 that were never incurred and a write off of previous payroll related accruals that never transpired. Without these items, other expenses increased 12% in the three months ended September 30, 2010 compared to the three months ended September 30, 2009, primarily as the result of costs associated with the Company’s packaging division, which the Company acquired in February 2010. Otherwise, other operating expenses for the three and nine month periods ended September 30, 2010 were generally consistent with the 2009 periods.

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 in the third quarter of 2010 was $130,000 as compared to $38,000 in the third quarter of 2009 which reflected the impact of options granted to employees at Premier Packaging when the Company acquired it in February 2010, and to certain senior management, along with stock based compensation expense related to warrants issued to third parties for consulting.

Stock based compensation in the first nine months of 2010 was $336,000 as compared to a negative $79,000 stock based compensation expense for the first nine months of 2009 which reflected the effect of 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 quarter of 2009.

Amortization of intangibles expense decreases in the three and nine month periods ended September 30, 2010, as compared to the 2009 periods were a result of the reduction in the Company’s net capitalized patent acquisition and defense costs asset, offset by increases in amortization of other intangible expense of new other intangibles acquired.

Other Income and expenses

	Three Months Ended September 30, 2010			Three Months Ended September 30, 2009			% change			Nine Months Ended September 30, 2010			Nine Months Ended September 30, 2009			% change

Other income (expense):
Interest Income	$	-		$	18,000			-100	%	$	-		$	18,000			-100	%
Interest expense		(79,000	)		(58,000	)		36	%		(228,000	)		(207,000	)		10	%
Amortizaton of note discount		(41,000	)		(64,000	)		-36	%		(122,000	)		(189,000	)		-35	%
Loss in equity investment		(50,000	)		-						(121,000	)		-
Gain on foreign currency transactions		-			(1,000	)		-100	%		-			10,000			-100	%
Other income		-			-						143,000			-

Other income (expense), net	$	(170,000	)	$	(105,000	)		62	%	$	(328,000	)	$	(368,000	)		-11	%

Loss in equity investment: The Company recognizes gains or losses on its investment in Internet Media Services, the entity that purchased Legalstore.com business from the Company in October 2009 under the equity method of accounting for investments. On September 23, 2010, the Company’s Board of Directors declared a dividend whereas the Company would distribute to its stockholders of record on October 8, 2010 on a pro-rata basis its shares of stock in Internet Media Services. As a result, the Company has recorded a dividend payable of $229,000 which was the book value of the investment as of September 23, 2010.

Other income: In March, 2010, the Company received notification that it was due approximately $143,000 for New York State Qualified Emerging Technology Company (“QETC”) refundable tax credits for the tax year ended 2008 which the Company received in April, 2010.

Net Loss and Loss Per Share

	Three Months Ended September 30, 2010			Three Months Ended September 30, 2009			% change			Nine Months Ended September 30, 2010			Nine Months Ended September 30, 2009			% change
Net loss	$	(883,000	)	$	(955,000	)		-8	%	$	(3,000,000	)	$	(2,873,000	)		4	%
Net loss per share, basic and diluted	$	(0.05	)	$	(0.06	)		-17	%	$	(0.17	)	$	(0.20	)		-15	%
Weighted average common shares outstanding, basic and diluted		18,008,012			14,711,105			22	%		17,599,410			14,510,056			21	%

During the three months ended September 30, 2010, the Company experienced a net loss of $883,000, an 8% decrease from the net loss during the three months ended September 30, 2009. The decrease in net loss during the quarter was primarily due to a decrease in gross profit during the quarter, offset by a significant decrease in other operating expenses due to the write-off of certain estimated accrued expenses.

For the first nine months of 2010, the Company has experienced a net loss of $3,000,000, a 4% increase from the net loss during the first nine months of 2009, which also primarily reflected a decrease in gross profits of 8% which was partially offset by a 1% decrease in operating expenses.

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, 2010			September 30, 2009			% change vs. 2009

Cash flows from:

Operating activities	$	(1,261,000	)	$	(1,484,000	)		15	%
Investing activities		(2,530,000	)		(71,000	)		-3463	%
Financing activities		3,751,000			1,890,000			98	%
Working capital		(329,000	)		(4,561,000	)		93	%
Current ratio		0.91	x		0.32	x		184	%

Cash and cash equivalents	$	408,000		$	423,000			-4	%
Funds Available from Open Credit Facilities	$	1,131,000		$	567,000			99	%
Debt (excluding unamortized debt discount and Capitalized Leases)	$	3,569,000		$	3,933,000			-9	%

As of September 30, 2010, our cash balance was approximately $408,000, down from $449,000 at December 31, 2009. During the first nine months of 2010, the Company used $1,261,000 of cash for operations, a 15% improvement over the use of cash for the first nine months of 2009, which reflects the positive effect of cost cuts at every division that allows the Company to use less cash to support its operations, offset by an increase in working capital of the Company’s packaging division due to that divisions typical increase in orders during the third and fourth quarters of the year. On February 12, 2010, the Company acquired Premier Packaging Corp for $2,000,000 in cash, which was funded by proceeds from a $1,500,000 Term Note and the proceeds from the exercise of warrants by certain warrant holders that the Company received during the quarter.

Future Capital Needs As of September 30, 2010, the Company has approximately $408,000 in cash and $417,000 available to it under one credit facility, along with up to $714,000 available under a credit line at its Premier Packaging subsidiary. While the Company’s working capital position has significantly improved since December 31, 2009, the Company continued to incur operating losses during the first nine months of 2010, and has negative working capital as of September 30, 2010. If the Company cannot generate sufficient cash from its operations in the future, the Company may need to raise additional funds in order to fund its working capital needs and pursue its growth strategy, which although there can be no assurances, management feels that sources for these additional funds will continue to be available through either current or future investors.

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.

Critical Accounting Policies and Estimates

As of September 30, 2010, 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, 2009.

ITEM 4 - CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Management is responsible for establishing and maintaining effective disclosure controls and procedures. Our Chief Executive Officer and Chief Financial Officer participated with our management in evaluating the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) 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, 2009 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

There has been no change to our internal control over financial reporting during the quarter covered by this Quarterly Report on Form 10-Q that has materially affected, or that is 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 Consolidated Financial Statements (Unaudited) in Part I of this Form 10-Q.

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 which, unless the amount is settled will be subject to an assessment procedure that has not been initiated, the Company will accrue as soon as the assessed amount, if any, is reasonably estimatable.

On March 27, 2007 the Bundespatentgericht of the Federal Republic of Germany ruled that the German part of the Patent was valid, having considered the English Court’s decision. On July 6, 2010, the Company was notified that the German Court has ruled that the Patent, that was awarded to the Company by the European Patent Office and upheld as valid in a previous hearing in the German Court of First Instance, has now been deemed invalid in Germany due to added matter. 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 filed an appeal against the French decision on May 7, 2008. On March 20, 2010, the Company was informed that the decision was upheld in the French appeal. On March 12, 2008 the Dutch Court ruled that the Patent is valid in the Netherlands. The ECB filed an appeal against the Dutch decision on March 27, 2008. The Dutch appeal was heard in June 2010, with a decision expected in late 2010 or early 2011. 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 as were similarly informed by the Austrian court on November 17, 2009. Cost reimbursement, if any, associated with the Belgium, Austrian, and French validity cases as well as the appeals in Germany and France are covered under the Trebuchet agreement described below. On March 24, 2010 the Spanish Court ruled that the Patent was valid. In Italy the validity case is to be heard again by a newly appointed judge during 2010 and a hearing in Luxembourg thereafter.

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, 2009, which we filed with the Securities and Exchange Commission on March 25, 2010. The following discussion is of material changes to risk factors disclosed in that report.

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.

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; (ii) increase sales of the Company’s digital products; and (iii) integrate its new acquisition of Premier Packaging with its existing product lines. As of September 30, 2010, the Company has approximately $408,000 in cash and $517,000 available to it under one credit facility, along with up to $714,000 available under a credit line at its Premier Packaging subsidiary. To address its working capital needs in the past, the Company has been able to obtain equity based financing, including most recently, on July 21, 2010 and July 22, 2010, the Company raised a aggregate of $1,080,000, net of fees, from the sale of common stock. The Company expects to be able to continue to obtain equity based financing to meet its obligations if the Company cannot generate sufficient cash from its operations, although there is no guarantee that the Company will be able to do so. 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.

We have a significant amount of indebtedness and may be unable to satisfy our obligations to pay interest and principal thereon when due.

As of September 30, 2010, we have the following approximate amounts of outstanding indebtedness:

(i)

$450,000 Convertible Note bearing interest at 8% per annum due June 23, 2012, convertible into up to 260,116 shares of Document Security Systems Common Stock, and is secured by the accounts receivable of the Company, excluding the accounts receivable of the Company’s wholly owned subsidiaries, Plastic Printing Professionals and DPI Secuprint, respectively.

(ii)

$350,000 Convertible Note bearing interest at 10% per annum due November 24, 2012, convertible into up to 218,750 shares of Document Security Systems Common Stock and is secured by the assets of the Company’s wholly owned subsidiary DPI Secuprint.

(iii)

$575,000 Promissory Note bearing interest at 10% per annum due November 24, 2012 and is secured by the assets of the Company’s wholly owned subsidiary DPI Secuprint.

(iv)

$583,000 due under a Credit Facility to a related party under which the Company can borrow up to $1,000,000 bearing interest at LIBOR plus 2% per annum due January 4, 2012.

Furthermore, in February 2010, the Company entered into new debt agreements in conjunction with its acquisition of Premier Packaging Corp as follows:

(v)

$1,325,000 due under Term Loan which matures March 1, 2013 and is payable in 35 monthly payments of $25,000 plus interest commencing March 1, 2010 and a payment of $625,000 on the 36 month. Interest accrues at 1 Month LIBOR plus 3.75% and is secured by all of the assets of the Company’s subsidiary, Premier Packaging Corporation, which the Company acquired on February 12, 2010. The Company subsequently entered into a interest rate swap agreement to lock into a 5.6% effective interest over the life of the term loan. The Loan has also been guaranteed by Document Security Systems, and its subsidiaries Plastic Printing Professionals and DPI Secuprint.

(vi)

Up to $1,000,000 in a revolving line of credit available for use by Premier Packaging, subject to certain limitations which matures on February 12, 2011 and is payable in monthly installments of interest only beginning on March 1, 2010. Interest accrues at 1 Month LIBOR plus 3.75%. As of September 30, 2010, there was approximately $286,000 outstanding on the line.

We have not made interest payments on the Credit Facility to a related party and have had to obtain a default waiver from the holder in the past, including one as of September 30, 2010. Absent a new financing or series of financings, our current operations may not generate sufficient cash to pay the interest and principal on these obligations when they become due. Accordingly, we may default in these obligations in the future and there is no guarantee that we will be able to obtain default waivers from the holders in the future.

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

We are subject to litigation and threatened litigation, including without limitation our litigation with the European Central Bank, in which parties allege, among other things, that certain of our patents are invalid. If the ECB or other parties are successful in invalidating any or all of our patents, it may materially affect us, our financial condition, and our ability to market and sell certain of our products based on any patent that is invalidated. Furthermore, we have granted nearly all control over our ECB Litigation to a third party, Trebuchet Capital Partners, LLC., who may or may not have the resources or capabilities to successfully defend our patent rights or meet its financial obligations. If Trebuchet is unable to meet its financial obligations, then we may be obligated to pay for certain court mandated legal costs to the ECB or other parties, which may materially affect our financial condition.

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

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

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

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

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

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

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

Over the past several years, we have spent significant funds and time to create new products by applying our technologies onto media other than paper, including plastic and cardboard packaging, and delivered our technologies digitally. We have had limited success in selling our products that are on cardboard packaging and those that are delivered digitally. Our business plan for 2010 and beyond includes plans to incur significant marketing and sales costs for these newer products, particularly the digitally delivered products. If we are not able to sell these new products, our financial results will be adversely affected.

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

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

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

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

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

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

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

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

identify suitable businesses or assets to buy;

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

complete the acquisition in the time frame we expect; and

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

Although we were able to acquire our Plastic Printing Professionals, Inc. subsidiary in February 2006 and our DPI Secuprint subsidiary in December 2008, and Premier Packaging in February 2010, there can be no assurance that we will be successful in pursuing any or all of these steps on future transactions. Our failure to implement our acquisition strategy could have an adverse effect on other aspects of our business strategy and our business in general. We may not be able to find appropriate acquisition candidates, acquire those candidates that we find or integrate acquired businesses effectively or profitably.

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

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

We may not realize the anticipated benefits of our recent acquisitions.

Our expectations regarding the earnings, operating cash flow, capital expenditures and liabilities resulting from our recent acquisition Premier Packaging Corp in February 2010 are based on information currently available to us and may prove to be incorrect. We may not realize any anticipated benefits of either of this acquisition and may not be successful in integrating the acquired assets into our existing business. In particular, 72% of Premier Packaging’s sales for the year ended December 31, 2009 were with two customers and which comprised 81% of Premier Packaging’s accounts receivable balance as of December 31, 2009. During the nine month period ended September 30, 2010, these two customers accounted for 32% of the Company’s consolidated revenue. As of September 30, 2010 one of the customers, which accounted for 25% of the Company’s consolidated sales for the first nine months of 2010, has a contract with the Company that is currently set to expire in July 2011, and comprised 26% of the Company’s consolidated accounts receivable as of September 30, 2010.

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

Our future success depends upon the continued service of our executive officers and other key sales and research personnel who possess longstanding industry relationships and technical knowledge of our products and operations. The loss of any of our key employees could negatively impact our ability to pursue our growth strategy and conduct operations. Although we believe that our relationship with these individuals is positive, there can be no assurance that the services of these individuals will continue to be available to us in the future. There can be no assurance that these persons will continue to agree to be employed by us after such dates.

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

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

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

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

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

We may need to raise additional funds in the future to fund our 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.

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

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

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

a prohibition on cumulative voting in the election of directors.

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

As of September 30, 2010, there were approximately 182 million authorized 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. If our Board of Directors 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.

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

As of September 30, 2010, we had (i) outstanding stock options and warrants to purchase an aggregate of 2,016,833 shares of our Common Stock at exercise prices ranging from $1.86 to $12.65 per share; (ii) 85,000 unvested restricted shares of our common stock that are subject to various vesting terms, and (iii) convertible notes that convert to up to 478,866 shares of our common stock. To the extent that these securities are converted into common stock, dilution to our stockholders will occur. Moreover, the terms upon which we will be able to obtain additional equity capital may be adversely affected, since the holders of these securities can be expected to exercise or convert them at a time when we would, in all likelihood, be able to obtain any needed capital on terms more favorable to us than the exercise and conversion terms provided by those securities.

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

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

We do not intend to pay cash dividends.

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

We have material weaknesses in our internal control over financial reporting structure, which, until remedied, may cause errors in our financial statements that could require restatements of our financial statements and investors may lose confidence in our reported financial information, which could lead to a decline in our stock price.

Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate the effectiveness of our internal control over financial reporting as of the end of each year, and to include a management report assessing the effectiveness of our internal control over financial reporting in each Annual Report on Form 10-K.

We have identified two material weaknesses in our internal control over financial reporting in our annual assessment of internal controls over financial reporting that management performed for the year ended December 31, 2009, in which management has concluded that (i) we did not maintain a sufficient complement of qualified accounting personnel and controls associated with segregation of duties; and (ii) we lack sufficient resources within the accounting department to have effective controls associated with identifying and accounting for complex and non-routine transactions in accordance with U.S. generally accepted accounting principles, and that the foregoing represented material weaknesses in our internal control over financial reporting. If our internal control over financial reporting or disclosure controls and procedures are not effective, there may be errors in our financial statements and in our disclosure that could require restatements. Investors may lose confidence in our reported financial information and in our disclosure, which could lead to a decline in our stock price.

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system's objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. Over time, controls may become inadequate because changes in conditions or deterioration in the degree of compliance with policies or procedures may occur. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

We are uncertain at this time of the costs to remediate all of the above listed material weaknesses, however, we anticipate the cost to be in the range of $200,000 to $400,000 (including the cost of hiring additional qualified accounting personnel to eliminate segregation of duties issues and using the services of accounting consultants for complex and non-routine transaction if and when they arise). We cannot guarantee that the actual costs to remediate these deficiencies will not exceed this amount.

As a result, we cannot assure you that significant deficiencies or material weaknesses in our internal control over financial reporting will not be identified in the future. Any failure to maintain or implement required new or improved controls, or any difficulties we encounter in their implementation, could result in significant deficiencies or material weaknesses, cause us to fail to timely meet our periodic reporting obligations, or result in material misstatements in our financial statements. Any such failure could also materially adversely affect the results of periodic management evaluations regarding disclosure controls and procedures and the effectiveness of our internal control over financial reporting required under Section 404 of the Sarbanes-Oxley Act of 2002 and the rules promulgated thereunder. In addition, the existence of a material weakness could result in errors in our financial statements that could result in a restatement of financial statements, that may cause investors to lose confidence in our reported financial information, leading to a decline in our stock price

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

In December 2008, we received a letter from the NYSE Amex stating that, based on the NYSE Amex’s review of publicly available information, we were considered to be below the NYSE Amex’s continued listing standards. After submitting a plan of compliance to the NYSE Amex and additional evaluation by the Exchange, we were informed in March 2010 that we had resolved the continued listing deficiencies. We cannot assure you that we will not receive additional deficiency letters in the future, or that we will continue to satisfy the continued listing standards in order to remain listed on the Exchange.

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

None

ITEM 3 - DEFAULTS UPON SENIOR SECURITIES

The Company has 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 Credit Agreement,as amended, the Company can borrow up to a maximum of $1,000,000 from time to time up to and until January 4, 2012. As of September 30, 2010, the Company was in default of the agreement due to a failure to pay interest when due. The holder has waived the default through January 1, 2012.

ITEM 4 - (REMOVED AND RESERVED)

ITEM 5 - OTHER INFORMATION

None

ITEM 6 - EXHIBITS

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

Exhibits

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 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.

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 15, 2010	By:	/s/ Patrick White
		Patrick White Chief Executive Officer

November 15, 2010	By:	/s/ Philip Jones
		Philip Jones Chief Financial Officer

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 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.