FORWARD-LOOKING STATEMENTS

Certain statements contained herein constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 (the "1995 Reform Act"). Document Security Systems, Inc. desires to avail itself of certain "safe harbor" provisions of the 1995 Reform Act and is therefore including this special note to enable us to do so. Except for the historical information contained herein, this report contains forward-looking statements (identified by the words "estimate," "project," "anticipate," "plan," "expect," "intend," "believe," "hope," "strategy" and similar expressions), which are based on our current expectations and speak only as of the date made. These forward-looking statements are subject to various risks, uncertainties and factors that could cause actual results to differ materially from the results anticipated in the forward-looking statements, including, without limitation, those contained in our Form 10-K for the year ended December 31, 2008, and those described herein that could cause actual results to differ materially from the results anticipated in the forward-looking statements, and the following:

· Our limited operating history with our business model

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

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

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

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

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

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

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

· The inability to adequately protect our intellectual property

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

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

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

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

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

Overview

Document Security Systems, Inc. (referred to in this report as "Document Security," "we," "us," "our" or "Company") markets and sells products designed to protect valuable information from unauthorized scanning, copying, and digital imaging. We develop sophisticated security technologies that are applied during the normal printing process and by virtually all printing methods including traditional offset, gravure, flexo, digital or via the Internet on paper, plastic, or packaging. We believe we are a leader of customized document protection solutions for companies and governments worldwide. We hold eight patents that protect our technology and have over a dozen patents in process or pending. Our technologies and products are used by federal, state and local governments, law enforcement agencies and are also applied by a broad variety of industries, including financial institutions, high technology and consumer goods, entertainment and gaming, healthcare/pharmaceutical, defense and genuine parts industries. Our customers use our technologies where there is a need for enhanced security for protection and verification of critical financial instruments and vital records, or where there are concerns of counterfeiting, fraud, identity theft, brand protection and liability.

Our core business is counterfeit prevention, brand protection and validation of authentic print media, including government-issued documents, currency, private corporate records and, securities. We believe we are a world leader in the research and development of optical deterrent technologies and have commercialized these technologies with a broad suite of products that offer our customers a wide array of document security solutions to satisfy their specific anti-counterfeiting requirements. Our technology can be used in securing sensitive and critical documents such as currency, automobile titles, spare parts forms for the aerospace industry, gift certificates, permits, checks, licenses, receipts, prescription and medical forms, engineering schematics, ID cards, labels, original music, coupons, homeland security manuals, consumer product and pharmaceutical packaging, tickets, and school transcripts. In addition, we have developed a digital product to implement our technologies in Internet-based environments utilizing standard desktop printers. We believe that our digital technology greatly expands the reach and potential market for our technologies and solutions. In December 2008, we acquired substantially all of the assets of DPI of Rochester, LLC, a privately held commercial printer located in Rochester, NY with approximately $7.6 million in sales in 2007. We formed a new subsidiary called DPI Secuprint to house this new company. As a result of this acquisition, we have significantly improved our ability to meet our current and expected future demand of our security paper products as well as improving our competitiveness in the market for custom security printing, especially in the areas of vital records, coupons, transcripts, and prescription paper. In addition, as a result of the acquisition, we believe we can offer our customers a wider range of commercial printing offerings.

Technologies

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

Products and Services

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

Security 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 to end-users that require anti-counterfeiting and authentication features in a wide range of printed materials such as documents, vital records, prescription paper, driver's licenses, birth certificates, receipts, manuals, identification materials, entertainment tickets, coupons, parts tracking forms, as well as product packaging including pharmaceutical and a wide range of consumer goods. In addition, we provide a full range of digital and large offset commercial printing capabilities to our customers.

Since our inception, we have primarily outsourced the production of the majority of our custom security print orders to strategic printing vendors. In December 2008, we acquired a commercial printer with long-run offset and short run digital printing capabilities that will allow us to produce the majority of our security print orders in-house. As a result of this acquisition, we have significantly improved our ability to meet our current and expected future demand of our security paper products as well as improving our competitiveness in the market for custom security printing, especially in the areas of vital records, coupons, transcripts, and prescription paper. We produce our plastic printed documents such as ID cards, event badges, and driver licenses at our manufacturing facility in Brisbane, California under the name Plastic Printing Professionals. In late 2007, we moved our P3 manufacturing facility to a 25,000 square foot facility in order to increase our plastic manufacturing capacity, and during 2008, we upgraded their production capabilities by adding equipment that will improve its productivity, along with equipment for high speed data encoding and equipment for production of high-volume precision RFID cards.

Digital Security Solutions: Using software that we have developed, we can electronically render several of our technologies digitally to extend the use of optical security to the end-user of sensitive information. With our 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 DMC'S patented technology so that it cannot be read by the naked eye. Reading the hidden content, or authenticating the document is performed with a proprietary viewing device or software.

Technology Licensing: We license our anti-counterfeiting technology and trade secrets to security printers through licensing arrangements. We seek licensees that have a broad customer base that can benefit from our technologies or have unique and strategic capabilities that expand the capabilities that we can offer our potential customers. Licenses can be for a single technology or for a package of technologies. We offer licensees a variety of pricing models, including:

· Pay us one price per year;

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

· Joint venture or profit sharing arrangement.

Legal Products: We also own and operate Legalstore.com, an Internet company which sells legal supplies and documents, including security paper and products for the users of legal documents and supplies in the legal, medical and educational fields. On June 22, 2009, we signed a non-binding letter of intent to sell the assets of our wholly owned web property subsidiary commonly known as "Legalstore.com", to Internet Media Services, Inc. ("IMS"). Under the terms of the Letter of Intent, IMS will acquire the Web property and related assets commonly referred to as the LegalStore.com from us and as payment will issue to the Company common stock of IMS equal to 30% of the outstanding shares of IMS on the Closing Date. Within 180 days after the Closing Date, or as soon as practicable, IMS intends to file a Registration Statement on Form S-1 with the Securities and Exchange Commission ("SEC") registering certain shares of IMS common stock, including the agreed number of shares of IMS common stock to be issued to the Company under the Agreement. At which time, the Company intends to declare the Record Date for the issuance of a shareholder dividend of shares of IMS Common Stock, the number of which has yet to be determined, to the beneficial share owners of Document Security Systems, Inc. Common Stock on such Record Date. Completion of the transaction is subject to entering into a definitive purchase agreement for the sale of the assets and the satisfaction of any conditions and covenants contained therein. At this time the parties have not entered into a definitive agreement for the transaction and there can be no assurance that we will enter into such an agreement or complete the transaction on acceptable terms or at all.

Results of Operations for the Three and Six Months Ended June 30, 2009 Compared to the Three and Six Months ended June 30, 2008

The following discussion and analysis provides information that our management believes is relevant to an assessment and understanding of our results of operations and financial condition. During the second quarter of 2009, the Board of Directors approved a plan to sell and the Company entered into a non-binding letter of intent to sell its legal products business. In accordance with FASB 144 guidance for long-lived assets to be exchanged for nonmonetary assets, the Company accounts for the revenue and expenses of this operation as a being held and used until such time that the sale takes place.

The discussion should be read in conjunction with the financial statements and footnotes in this quarterly report and in our annual report on Form 10-K for the year ended December 31, 2008.

Revenue

                                Three Months         Three Months                          Six Months           Six Months
                               Ended June 30,       Ended June 30,                       Ended June 30,       Ended June 30,
                                    2009                 2008            % change             2009                 2008            % change
Revenue
Security and commercial
printing                      $      1,942,000     $      1,155,000              68 %   $      4,359,000     $      2,087,000             109 %
Technology license
royalties and digital
solutions                              191,000              900,000             -79 %            415,000            1,237,000             -66 %
Legal products                         115,000              159,000             -28 %            253,000              332,000             -24 %
Total Revenue                        2,248,000            2,214,000               2 %          5,027,000            3,656,000              38 %

For the three months ended June 30, 2009, revenue increased 2% from the same period in 2008. Security and commercial print sales increased 68% during the quarter which reflects the impact of the Company's acquisition of DPI Secuprint, a commercial printer, in December, 2008. This increase was primarily offset by a decrease in royalty revenue of 79% which reflects the impact of a non-recurring royalty of $542,000 recorded in the second quarter of 2008 that affected the comparison. Excluding this item, revenue for the second quarter of 2009 would have increased 34% from the second quarter of 2008.

For the six months ended June 30, 2009, revenue increased 38% from the first six months of 2008, due to the Company's acquisition of its commercial printing business in December 2008, which more than offset the 66% decline in technology license royalties and digital solutions revenue as a result of the aforementioned non-recurring royalty revenue recorded in 2008. During 2009, all of the Company's divisions were adversely affected by significant delays or reductions in orders by core customers that reflected the rapid decline in the U.S. and global economies during the latter half of 2008 and the first half of 2009. The Company expects that demand in each of its divisions, including its newly acquired commercial printing division will return to historical levels during the latter half of 2009 as the U.S. and global economies stabilize.

Cost of Sales and Gross Profit

                               Three Months        Three Months                          Six Months           Six Months
                              Ended June 30,      Ended June 30,                       Ended June 30,       Ended June 30,
                                   2009                2008            % Change             2009                 2008            % change

Costs of revenue
Security and commercial
printing                      $     1,496,000     $       796,000              88 %   $      3,031,000     $      1,392,000             118 %
Technology license
royalties and digital
solutions                               4,000               4,000               0 %              7,000                7,000               0 %
Legal products                         60,000              74,000             -19 %            123,000              171,000             -28 %
Total cost of revenue               1,560,000             874,000              78 %          3,161,000            1,570,000             101 %

Gross profit
Security and commercial
printing                              446,000             359,000              24 %          1,328,000              695,000              91 %
Technology license
royalties and digital
solutions                             187,000             896,000             -79 %            408,000            1,230,000             -67 %
Legal products                         55,000              85,000             -35 %            130,000              161,000             -19 %
Total gross profit                    688,000           1,340,000             -49 %          1,866,000            2,086,000             -11 %



                                Three Months         Three Months                          Six Months           Six Months
                               Ended June 30,       Ended June 30,                       Ended June 30,       Ended June 30,
                                    2009                 2008            % change             2009                 2008            % change
Gross profit percentage:                    31 %                 61 %           -49 %                 37 %                 57 %           -35 %

Gross profit decreased 49% to $688,000 in the second quarter of 2009 as compared to the second quarter of 2008. The decrease was primarily impacted by the lack of $542,000 of gross profit which the Company gained in 2008 as the result of a non-recurring royalty revenue the Company recorded in the second quarter of 2008. Without the impact of this item, gross profit in the second quarter of 2008 would have been $798,000, which would have been only 14% higher than 2009. Gross profits were also negatively impacted by increases in production equipment lease and depreciation costs associated with new equipment put into production at the Company's plastic printing facility. As a result of these issues, and due to a significant change in the Company's business model as a result of the Company's acquisition of its commercial printing business in December of 2008, the Company's gross profit percentage decreased significantly to 31% during the second quarter of 2009. For the six months ended June 30, 2009, gross profit percentage was 37% which is slightly below the Company's expectations. The Company believes that its gross margin percentage should improve slightly over the last half of the year based on its current structure and the expected sales mix.

Operating Expenses

                                Three Months        Three Months                           Six Months          Six Months
                               Ended June 30,      Ended June 30,                        Ended June 30,       Ended June 30,
                                    2009                2008             % change             2009                 2008             % change

Operating Expenses

Sales, general and
administrative compensation    $       835,000     $       676,000               24 %   $      1,858,000     $      1,457,000               28 %
Professional Fees                       40,000             207,000              -81 %            287,000              574,000              -50 %
Sales and marketing                     11,000             131,000              -92 %             71,000              314,000              -77 %
Research and development                75,000             134,000              -44 %            162,000              249,000              -35 %
Rent and utilities                     115,000             122,000               -6 %            270,000              263,000                3 %
Other                                   70,000             166,000              -58 %            255,000              320,000              -20 %
                               $     1,146,000     $     1,436,000              -20 %   $      2,903,000     $      3,177,000               -9 %

Other Operating Expenses
Depreciation and
amortization                            40,000              42,000               -5 %             80,000               84,000               -5 %
Stock based payments                    28,000             619,000              -95 %           (117,000 )          1,026,000             -111 %
Impairment of patent defense
costs                                        -                   -                                     -              292,000
Amortization of intangibles            324,000             537,000              -40 %            647,000            1,064,000              -39 %
                                       392,000           1,198,000              -67 %            610,000            2,466,000              -75 %

Total Operating Expenses             1,538,000           2,634,000              -42 %          3,513,000            5,643,000              -38 %

Selling, General and Administrative

Sales, general and administrative compensation costs were 24% and 28% higher in the three and six months ending June, 30, 2009, respectively, as compared to the comparable 2008 periods, due to the inclusion of sales and administrative staff additions as the result of the Company's acquisition of its commercial printing business in December 2008. Otherwise, SG&A compensation costs would have decreased 25% and 11% during the three and six months ended June 30, 2009, respectively, as compared to the comparable 2008 periods, as the result of staff reductions that the Company initiated in the middle of 2008 and during the first quarter of 2009.

Professional fees have decreased in 2009 from the second quarter of 2008 as a result of significant decreases in non-patent related legal fees and accounting fees as the Company had reduced Sarbanes -Oxley related compliance costs as the result of the Company's change in classification to a smaller reporting company for its 2008 end of year audit. In addition, the Company had lower consulting and investor relations costs as it significantly limited certain activities associated with these costs in response to the lower sales volumes the Company experienced during the first six months of 2009. In addition, during the second quarter of 2009, the Company reversed approximately $60,000 of a previously accrued consulting expense that did not materialize.

Sales and marketing expenses have decreased significantly in 2009 as compared to 2008 as the Company has changed its primary sales strategies in response to the Company's significant reduction in its non-direct marketing costs, its international sales cost, and an overall reduction in sales related travel. The Company has recently focused its efforts on direct sales techniques that utilize telephone and web-conferencing communication with current and prospective customers. In addition, the Company experienced a reduction in internet based advertising during 2009. In addition, during the second quarter of 2009, the Company reversed approximately $15,000 of previously accrued expenses for certain potential sales related expense that did not materialize. The Company expects to increase its sales and marketing expenses in the second half of 2009 as economic conditions improve.

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 during the 2009 periods as compared to the comparable 2008 periods as the result of lower external research costs and reduction in compensation cost as the Company reduced the department by 2 persons.

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

Other operating expenses are primarily equipment maintenance and repairs, office supplies, IT support, bad debt expense and insurance costs. Decreases in the second quarter of 2009 as compared to the second quarter of 2008 reflect significant reductions in office expenses, and a reversal of $29,000 of bad debt expense due to collections of previously written off accounts receivables associated with the Company's commercial print operation.

Stock-based compensation includes expense charges for all stock-based awards to employees, directors and consultants. Such awards include option grants, warrant grants, and restricted stock awards. Stock-based compensation decreased during the three and six month periods ended June 30, 2009 as compared to the comparable 2008 periods, as current-period stock based compensation expense was more than offset by reversals of previously recorded stock-based compensation expense for stock options and restricted shares issued to the Company's employees which terminated unvested due to employee terminations that occurred during the three and six months ended June 30, 2009.

Impairment of Patent Defense Costs On March 19, 2008, the Company received notification that its appeal of the invalidation of its European Patent 455750B1 in the UK was not successful. As result of the adverse court decision, the Company recognized an impairment loss of $292,000 associated with the U.K appeal as of March 31, 2008. The impairment loss includes a judgment for reimbursement of estimated counterpart legal fees. No such expense was incurred in 2009.

Amortization of intangibles expense decreased 40% and 39% in the second quarter and first six months of 2009 as compared to the 2008 periods as a result of the reduction in the Company's net capitalized patent acquisition and defense costs asset from $4.3 million as of June 30, 2008 to $1.4 million as of June 30, 2009. The reduction in the Company's patent acquisition and defense costs was primarily due to the Company's transfer and assignment of 49% of its interest in the patent to a third-party in August 2008, which resulted in a reduction in the asset of approximately $1.7 million.

Other Income and expenses

                               Three Months        Three Months                          Six Months           Six Months
                              Ended June 30,      Ended June 30,                       Ended June 30,       Ended June 30,
                                   2009                2008            % change             2009                 2008            % change

Other income (expense):
Gain/(Loss) on foreign
currency adjustments                   12,000             (13,000 )          -192 %             12,000              (24,000 )          -150 %
Interest expense                      (68,000 )           (33,000 )           106 %           (149,000 )            (54,000 )           176 %
. . .