SecProbe.io

CORRESP
1
filename1.htm

      Unassociated Document

    May
      9,
      2008

    VIA
      EDGAR

    Securities
      and Exchange Commission

    100
      F
      Street, NE

    Washington,
      D.C. 20549

              Attention:

              Kari
                Jin

              Kathleen
                Collins

              Re:

              Document
                Security Systems, Inc. (the “Company”)

              Form
                10-K for Fiscal Year Ended December 31, 2007 Filed March 17,
                2008

    Dear
      Staff:

    On
      behalf
      of Document Security Systems, Inc., this letter responds to the comments of
      the
      staff (the “Staff”) of the Securities and Exchange Commission (the “Commission”)
      to the filing of the above-referenced annual report (the “Filing”), which were
      included in the Staff’s letter dated April 11, 2008 (the “Staff Letter”).

    In
      this
      letter, we have reproduced your comments and have followed each comment with
      our
      response. The numbered paragraphs of this letter set forth below correspond
      to
      the numbered paragraphs of the Staff Letter. References in the responses to
      “we,” “our,” “Company” or “us” mean Document Security Systems, Inc.

    Non-GAAP
      Financial Performance Measure, page 27

    1. We
      note your use of the non-GAPP measure Adjusted EBITDA, which excludes a number
      of recurring items. We also note in your disclosure that management believes
      this measure to be a relevant measure of performance of the Company. Considering
      your present Adjusted EBITDA as a performance measure, tell us how considered
      the disclosures requirements of Question 8 of Frequently Asked Questions
      Regarding the Use of Non-GAAP Financial Measures (FAQ) to present the
      following:

              ·

              The
                manner in which management uses the non-GAAP measure to conduct or
                evaluate its business;

              ·

              The
                economic substance behind management’s decision to use such a
                measure;

              ·

              The
                material limitations associated with the use of non-GAAP financial
                measure
                as compared to the use of the most directly comparable GAAP financial
                measure;

              ·

              The
                manner in which management compensates for these limitations when
                using
                the non-GAAP financial measure;
                and

              ·

              The
                substantive
                reasons why management believes the non-GAAP financial measure provides
                useful information to investors.

    Further,
      we note that management uses Adjusted EBITDA to measure the Company’s “core
      operating performance without certain non-cash expenditures.” Explain what you
      mean by “core operating performance” and explain why excluding non-cash
      compensation is indicative of the Company’s “core” operating performance. If you
      intend to use this terminology, it should be adequately defined and you should
      explain how the Company determined that the excluded items were representative
      of your “core” performance.

    Response:

    Similar
      to other companies in our industry, we use Adjusted EBITDA to assess our
      business performance. We believe EBTIDA is a standard measurement of financial
      performance used by securities analysts and others evaluating a company’s
      performance as an indicator of the company’s operating results and the ability
      of a company to generate cash flow from operations. Furthermore, we include
      stock-based payments as an additional adjustment item because it is similar
      to
      other items generally excluded from EBITDA in order to provide an indication
      of
      a company’s ability to generate cash flow from operations. We provided this
      information so that investors who believe that Adjusted EBITDA is a relevant
      financial measure can obtain that information in one place and reduce the
      computational requirements on such investor.

    Our
      discussion of core operating expenses in our filing was intended to provide
      additional quantitative and qualitative data to help the reader understand
      the
      trends in our Adjusted EBITDA. We acknowledge that stock-based compensation
      and
      depreciation and amortization are important expenses of the Company.
      However, based on the Company’s current stage of development, the Company feels
      the costs that have the most direct cash flow impact are important for an
      investor. By providing the elements of what we considered core cash based
      operating expenses in parenthesis, which is included in the second paragraph
      of
      the Non-GAAP Financial Performance Measures section, we felt that we were
      adequately cross referencing the reader to cost elements previously detailed
      in
      the discussion section labeled “Operating Expenses”. Furthermore, we provided a
      computation regarding core operating trends in order to reduce the computational
      requirements of the reader.

    We
      agree
      that the discussion of our use of a non-GAAP Financial Performance measure
      should be expanded to provide the reader a more detailed explanation on why
      management feels Adjusted EBITDA is a relevant measure of the Company’s
      performance. In addition, we will more clearly define core operating expenses
      when, or if, we present it as a relevant measurement in understanding our
      Adjusted EBITDA trends. We will include the following disclosure in future
      filings:

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

        2

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

    Consolidated
      Statements of Operations, Page F-4

    2. We
      note that amortization of intangibles has been classified as other operating
      expenses in your statements of operations as opposed to cost of revenue. Tell
      us
      how you considered including the amortization of intangibles as a cost of
      revenue and specifically tell us how you considered Question 17 to SFAS 86
      Staff
      Implementation Guide.

    Response:

    The
      Company has three classes of intangibles assets that are subject to
      amortization: patent rights acquisition, patent defense and patent application
      costs; other acquired intangibles (customer lists, trade-names, a non-compete
      agreement and a barcode technology license agreement); and a royalty agreement.
      The Company considers Rule 5-03(b) of Regulation S-X when classifying expenses,
      along with specific guidance for certain expense items. In regard to the
      amortization of intangibles, the Company considered the guidance in SAB Topic
      11-B, along with SFAS 86 “Accounting for the Costs of Computer Software to Be
      Sold, Leased, or Otherwise Marketed” as discussed below.

    Patent
      defense costs are associated with the defense of a patented technology that
      was
      specifically designed for intaglio printing processes most commonly used for
      the
      production of currency. The patent relates to older technology that is not
      currently being sold or marketed by the Company. The Company has expended
      approximately $7.6 million to acquire the rights to this patent and in legal
      costs associated with an infringement and related actions associated with this
      patent. The Company records amortization associated with these costs as
      operating expenses to the extent that the costs are an asset. The Company
      records these expenses as an asset as long as the Company believes the
      associated actions will be successful. As discussed in the response to Question
      4 below, the Company currently believes that its action against the European
      Central Bank for patent infringement will be successful, and that the Company
      will in turn be awarded significant cash proceeds. .

    In
      addition, the Company has incurred approximately $583,000 of patent application
      costs associated with the expansion of its patent portfolio and increased its
      worldwide patent coverage of technologies that are newer than the
      above-referenced patents that are subject of the patent infringement and related
      litigations. The Company recorded amortization expense of $41,000 associated
      with these capitalized patent application costs as an operating expense in
      2007
      ($22,000 - 2006; $0 - 2005). The Company considered Rule 5-03(b) of Regulation
      S-X and Topic 11-B when classifying its patent application related intangible
      amortization expense. The Company considered the function of its patent
      application efforts is to provide the legal protection over potential
      competitors and to ensure that the Company is not infringing on other persons’
patents when selling its products. The Company considered whether the legal
      costs associated with its patent applications should be a direct cost of a
      product or service that uses the technology associated with the patent. The
      Company believes that the value of a patent is similar to the value of a
      trademark or copyright. These legal devices create long-term value for several
      reasons, including legal protection over competitive factors, and sales and
      marketing benefits by providing customers a level of comfort that what they
      are
      purchasing is unique. In addition, the Company believes that the decision to
      incur these costs is discretionary since the associated products or services
      can
      be sold before or after the life of a patent (or trademark or
      copyright).

        3

    Finally,
      the Company also markets digital solutions. Our digital solutions involve the
      delivery of a system that allows our customers to create our security print
      features and to print them on digital and desktop printers. To date, we have
      provided this service to customers on a customized basis and have recognized
      revenue of these implementations in accordance with the guidance in AICPA SOP
      97-2, SAB 104, EITF 00-3 based on the individual circumstances of the project.
      Direct costs associated with these implementations, which to date have primarily
      consisted of third party services, have been expensed as incurred as a cost
      of
      sales. We do not have a standardized, “out-of-the-box” product or software that
      we sell that enables this product. The Company does not currently have
      capitalized software costs that are related to a software product marketed
      or
      sold to its customers. The Company does not believe that SFAS 86 “Accounting for
      the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed”
including the guidance provided by Question 17 and its response, are applicable
      to its revenue. Additionally, the Company does not have any other intangible
      assets related to this product. The Company will add an accounting policy
      disclosure regarding its classification of amortization expense in accordance
      with APB 22 in future filings.

    3. We
      note that the Company does not separately disclose cost of royalty revenues
      on
      the face of your income statement. Please tell us how you considered Rule
      5-03(b) of Regulation S-X to disclose costs and expenses in the same manner
      as
      related revenues.

    Response:

    The
      Company has considered Rule 5-03(b) of Regulation S-X in determining the
      appropriate classification of its costs and expenses related to revenue. The
      Company records in costs of sales the cost associated with the direct production
      and delivery of its products and services.

    Specifically,
      the Company’s royalty revenue is derived from customers who utilize the
      Company’s printing techniques, printing know-how and printing trade secrets,
      some of which are covered under patents or patents pending. Our licensing
      program involves the transfer of knowledge of these printing and graphical
      techniques. Furthermore, our customers often rely on our personnel to assist
      them in calibrating their printing devices in order to achieve a level of
      quality needed in order to achieve the desired printing effect.

    The
      Company’s believes that its royalty revenue does not have direct costs
      associated with it. Generally, our license customers report and pay for usage
      of
      our technology based on usage subject to certain minimum amounts. These
      customers require little to no interaction or support from us once they are
      certified licensees. To date, the costs incurred by the Company associated
      with
      the Company’s licensing revenue are as follows: sales commissions to internal
      sales personnel, back office administrative costs, customer support and, in
      a
      less direct manner, research and development costs associated with developing
      new technologies, and patent application fees. It is important to note that
      the
      research and development costs and pat