U. S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 
FORM 10 - Q
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2006

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 0-21743

NEOMEDIA TECHNOLOGIES, INC.
(Exact Name of Issuer as Specified In Its Charter)
 
Delaware
36-3680347
(State or Other Jurisdiction of
(I.R.S. Employer
Incorporation or Organization)
Identification No.)

2201 Second Street, Suite 600, Fort Myers, Florida
33901
(Address of Principal Executive Offices)
(Zip Code)

239-337-3434 Issuer's Telephone Number (Including Area Code) 

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 Noo
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): Large Accelerated Filer o Accelerated Filer x  Non-accelerated Filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

As of October 23, 2006, there were 663,369,101 outstanding shares of the issuer's Common Stock, and 22,000 outstanding shares of the issuer’s Series C convertible preferred stock.
 
 
TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION
1
   
ITEM 1. FINANCIAL STATEMENTS
1
   
CONDENSED CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 2006 (UNAUDITED) AND DECEMBER 31, 2005
1
   
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005 (UNAUDITED)
2
   
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005 (UNAUDITED)
4
   
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005 (UNAUDITED)
6
   
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
8
   
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
54
   
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
73
   
ITEM 4. CONTROLS AND PROCEDURES
73
   
PART II — OTHER INFORMATION
74
   
ITEM 1. LEGAL PROCEEDINGS
74
   
ITEM 1A. RISK FACTORS
76
   
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
86
   
ITEM 3. DEFAULT UPON SENIOR SECURITIES
86
   
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
86
   
ITEM 5. OTHER INFORMATION
86
   
SIGNATURES
88

 
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NeoMedia Technologies, Inc. and Subsidiaries
Condensed Consolidated Balance Sheets
(In Thousands, Except Share Data)
 
       
(Restated)
  
   
September 30,
2006
  
December 31,
2005
  
   
(unaudited)
  
*
  
ASSETS              
Current assets:
              
Cash and cash equivalents
  
$
3,133
  
$
1,704
  
Trade accounts receivable, net of allowance for doubtful accounts of $96 and $203, respectively
    
6,097
   
130
 
Inventories, net of allowance for obsolete & slow-moving inventory of $0
    
53
   
2
 
Investment in marketable securities
    
255
   
104
 
Prepaid expenses and other current assets
    
753
   
121
 
Assets held for sale
    
3,451
   
4,058
 
Total current assets
    
13,742
   
6,119
 
 
          
Leasehold improvements & property and equipment, net
    
564
   
110
 
Goodwill
    
50,082
   
—
 
Other Intangible assets, net
    
21,405
   
3,274
 
Cash surrender value of life insurance policy
    
797
   
769
 
Loan to Mobot
    
—
    
1,500
 
Other long-term assets
    
1,232
   
639
 
Total assets
  
$
87,822
  
$
12,411
  
 
          
LIABILITIES AND SHAREHOLDERS’ EQUITY
      
Current liabilities:
    
Accounts payable
  
$
5,550
  
$
1,502
  
Amounts payable under settlement agreements
    
97
   
97
 
Liabilities of discontinued business unit
    
676
   
676
 
Liabilities held for sale
    
750
   
669
 
Taxes payable
    
1,178
   
85
 
Accrued expenses
    
4,771
   
1,833
 
Deferred revenues and other
    
1,925
   
307
 
Notes payable
    
2,340
   
3,015
 
Derivative financial instruments
    
26,677
   
—
 
Total current liabilities
    
43,964
   
8,184
 
               
Long term debentures payable
    
73
   
—
 
               
Preferred stock, $0.01 par value, 25,000,000 shares authorized, 22,000 issued
          
and outstanding, liquidation value of $22,000, and accreted dividends of $1,220.
    
2,931
   
—
 
 
          
Shareholders’ equity:
      
Common stock, $0.01 par value, 5,000,000,000 shares authorized, 656,853,390 and
          
475,387,910 shares issued and 655,211,964 and 467,601,717 outstanding, respectively
    
6,552
   
4,676
 
Additional paid-in capital
    
155,359
    
106,287
 
Deferred equity financing costs
    
—
   
(13,256
)
Accumulated deficit
    
(119,618
)
  
(92,524
)
Accumulated other comprehensive loss
    
(660
)
  
(177
)
Treasury stock, at cost, 201,230 shares of common stock
    
(779
)
  
(779
)
Total shareholders’ equity
    
40,854
   
4,227
 
Total liabilities and shareholders’ equity
  
$
87,822
  
$
12,411
  
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

* - Derived from NeoMedia's audited financial statements for the year ended December 31, 2005 and restated for reclassification of assets and liabilities held for sale related to the Micro Paint business unit.
 
1

NeoMedia Technologies, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations 
and Comprehensive Income (Loss) (Unaudited)
(In Thousands, Except Share and per Share Data)
       
 
  
   
Three Months Ended September 30
  
   
2006
  
2005
  
           
(Restated *)
  
Net sales
  
$
6,249
  
$
193
  
Cost of sales
    
4,112
   
116
 
Gross profit
    
2,137
   
77
 
               
Sales and marketing expenses
    
2,795
   
589
 
General and administrative expenses
    
2,659
   
765
 
Research and development costs
    
1,013
   
123
 
Stock based compensation expense
    
2,320
   
93
 
           
Loss from operations
    
(6,650
)
  
(1,493
)
           
Gain on extinguishment of debt
    
—
   
1
 
Interest income (expense), net
    
(112
)
  
(77
)
Write-off of deferred equity financing costs
    
(13,256
)
  
—
 
Change in fair value from revaluation of warrants and embedded conversion features
    
(9,271
 )  
—
 
           
NET LOSS FROM CONTINUING OPERATIONS
    
(29,289
)
  
(1,569
)
 
          
DISCONTINUED OPERATIONS (Note 4)
              
Net loss from Micro Paint business to be sold
    
(1,620
)
  
(381
)
             
NET LOSS
    
(30,909
)
  
(1,950
)
               
Accretion of dividends on convertible preferred stock
    
(604
)
  
—
 
               
NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS
    
(31,513
)
  
(1,950
)
               
Comprehensive Loss:
          
Net loss
    
(30,909
)
  
(1,950
)
Other comprehensive loss:
          
Unrealized loss on marketable securities
    
(312
)
  
(4
)
Foreign currency translation adjustment
    
108
   
15
 
               
COMPREHENSIVE LOSS
  
$
(31,113
)
$
(1,939
)
               
Loss per share from continuing operations--basic and diluted
  
$
(0.05
)
$
(0.00
)
Loss per share from discontinued operations--basic and diluted
  
$
(0.00
)
$
(0.00
)
Net loss per share--basic and diluted
  
$
(0.05
)
$
(0.00
)
Loss per share attributable to common shareholders -- basic and diluted
 
$
(0.05
)
$
(0.00
)
 
          
Weighted average number of common shares--basic and diluted
    
644,720,857
   
456,695,836
 
 
* - Restated for reclassification of operations related to the Micro Paint business unit (Note 4).
 
The accompanying notes are an integral part of these condensed consolidated financial statements.
 
2

NeoMedia Technologies, Inc. and Subsidiaries
Condensed Consolidated Statements of Operations 
and Comprehensive Income (Loss) (Unaudited)
(In Thousands, Except Share and per Share Data)
        
 
  
   
Nine Months Ended September 30
  
   
2006
  
2005
  
        
(Restated *)
  
Net sales
  
$
14,129
  
$
762
  
Cost of sales
    
8,887
   
440
 
Gross profit
    
5,242
   
322
  
               
Sales and marketing expenses
    
6,719
    
1,332
  
General and administrative expenses
    
6,752
   
2,143
 
Research and development costs
    
2,309
   
365
  
Stock based compensation expense
    
4,948
   
593
 
 
          
Loss from operations
    
(15,486
)
  
(4,111
)
 
          
Gain (loss) on extinguishment of debt
    
(1,858
)
  
172
 
Interest income (expense), net
    
(191
)
  
(223
)
Write-off of deferred equity financing costs
    
(13,256
)
  
—
 
Change in fair value from revaluation of warrants and embedded conversion features
    
6,523
    
—
 
 
          
NET LOSS FROM CONTINUING OPERATIONS
    
(24,268
)
  
(4,162
)
 
          
DISCONTINUED OPERATIONS (Note 4)
              
Net loss from Micro Paint business to be sold
    
(2,826
)
  
(1,307
)
           
NET LOSS
    
(27,094
)
  
(5,469
)
               
Accretion of dividends on convertible preferred stock
    
(1,220
)
  
—
  
               
NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS
    
(28,314
)
  
(5,469
)
               
Comprehensive Loss:
          
Net loss
    
(27,094
)
  
(5,469
)
Other comprehensive loss:
          
Unrealized loss on marketable securities
    
(49
)
  
(133
)
Foreign currency translation adjustment
    
(434
)
  
24
  
               
COMPREHENSIVE LOSS
  
$
(27,577
)
$
(5,578
)
               
Loss per share from continuing operations--basic and diluted
  
$
(0.04
)
$
(0.01
)
Loss per share from discontinued operations--basic and diluted
  
$
(0.00
)
$
(0.00
)
Net loss per share--basic and diluted
  
$
(0.04
)
$
(0.01
)
Loss per share attributable to common shareholders -- basic and diluted
 
$
(0.05
)
$
(0.01
)
 
          
Weighted average number of common shares--basic and diluted
    
602,132,555
   
451,487,240
 
 
* - Restated for reclassification of operations related to the Micro Paint business unit (Note 4).
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

3

NeoMedia Technologies, Inc. and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In Thousands)
 
   
Nine Months Ended
  
   
September 30,
  
   
2006
  
2005
  
CASH FLOWS FROM OPERATING ACTIVITIES:
  
 
  
(Restated*)
  
Net loss from continuing operations
    
($24,268
)
  
($4,162
)
Adjustments to reconcile net loss to net cash used in operating activities:
    
Depreciation and amortization
   
2,209
   
359
 
Loss on early extinguishment of debt
    
1,858
   
—
  
Change in fair value from revaluation of warrants and embedded conversion features
    
(6,523
) 
  
—
  
Write-off of deferred equity financing costs
    
13,256
   
—
  
Stock-based compensation expense
    
4,948
   
593
 
Interest expense allocated to debt
    
22
   
—
  
Increase in value of life insurance policies
    
(28
)
  
(13
)
 
    
   
 
Changes in operating assets and liabilities
              
Trade accounts receivable, net
    
(918
)
  
(28
)
Inventory
    
55
   
—
  
Other current assets
    
(252
)
  
(671
)
Accounts payable, amounts due under settlement agreements, liabilities
              
in excess of assets of discontinued business unit and accrued expenses
    
553
   
(283
)
Deferred revenue other current liabilities
    
707
   
(118
)
Net cash used in operating activities
    
(8,381
)
  
(4,323
)
               
CASH FLOWS FROM INVESTING ACTIVITIES:
    
   
 
Cash paid to acquire Mobot, Inc., Sponge Ltd., Gavitec AG, and 12Snap AG, net of cash acquired
    
(11,891
)
  
—
  
Acquisition of property and equipment
    
(339
)
  
(54
)
Capitalization of software development and purchased intangible assets
    
(160
)
  
(1,639
)
Investment in iPoint-media
    
—
    
(500
)
Advances to discontinued Micro Paint Repair subsidiary
    
(1,633
)
  
(1,924
) 
Acquisition related costs
    
(164
)
  
—
  
Amounts issued under notes receivable
    
(500
)
  
—
  
Net cash used in investing activities
    
(14,687
)
  
(4,117
)
 
    
   
 
CASH FLOWS FROM FINANCING ACTIVITIES:
              
Borrowing under notes payable and convertible debt instrument
    
5,000
   
9,932
 
Repayments on notes payable and convertible debt instrument
    
(2,530
)
  
(5,811
)
Net proceeds from issuance of common stock, net of issuance costs of $24 in 2006 and $105 in 2005
    
210
   
6,262
 
Net proceeds from issuance of Series C convertible preferred stock, net of issuance costs of $2,725 in 2006
    
14,066
   
—
  
Net proceeds from exercise of stock options and warrants
    
8,419
   
909
 
Cash commitment fee for $100 million Standby Equity Distribution Agreement
    
—
    
(1,000
)
Net cash provided by financing activities
    
25,165
   
10,292
  
 
    
   
 
EFFECT OF EXCHANGE RATE CHANGES ON CASH FOR CONTINUING OPERATIONS
    
(668
)
  
—
  
 
    
   
 
NET INCREASE IN CASH AND CASH EQUIVALENTS FROM CONTINUING OPERATIONS
    
1,429
   
1,852
 
 
    
   
 
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
    
1,704
   
2,606
 
 
    
   
 
CASH AND CASH EQUIVALENTS, END OF PERIOD
  
$
3,133
  
$
4,458
  
 
    
   
 
               
SUPPLEMENTAL CASH FLOW INFORMATION:
    
   
 
Interest paid during the period
    
48
    
47
 
Non-cash investing and financing activities:
    
   
 
Unrealized gain (loss) on marketable securities
    
(361
)
  
—
  
Prepaid acquisition costs applied to purchase price
    
168
   
—
  
Fair value of shares and notes receivable from Pickups Plus, Inc. acquired in exchange for Series C Convertible Preferred Stock
    
594
   
—
  
Carrying value of promissory note and accrued interest paid in exchange for Series C Convertible Preferred Stock
    
(3,208
)
  
—
  
Fair value of shares issued to acquire Mobot, Inc., Sponge Ltd., Gavitec AG, 12Snap AG, and BSD Software, Inc.
    
46,964
   
—
  
Change in net assets resulting from acquisitions of Mobot, Inc., Sponge Ltd., Gavitec AG, 12Snap AG, and BSD Software, Inc.
    
62,240
   
—
  
Accretion of dividends on Series C Convertible Preferred Stock
    
1,824
   
—
  
Fair value of outstanding warrants reclassified to liabilities
    
13,884
   
—
  
Portion of change in fair value of outstanding warrants converted to liabilities recorded to paid-in capital
    
3,790
   
—
  
Fair value of Series C Convertible Preferred Stock (host instrument only)
    
4,908
   
—
  
Deferred stock-based financing costs associated with Series C Convertible Preferred Stock
    
3,198
   
—
  
Difference between net proceeds and recorded fair value of Series C Convertible Preferred Stock
    
4,041
   
—
  
Advance receivable from Mobot, Inc. forgiven upon acquisition
    
1,500
   
—
  
Gain (loss) on extinguishment of debt paid in common stock
    
—
    
349
 
Fair value of stock issued for services and deferred to future periods
    
—
    
239
 
Direct costs associated with Standby Equity Distribution Agreement and Equity Line of Credit
    
—
    
1,204
 
Fair value of warrants issued as fees related to the $100 million Standby Equity Distribution Agreement
    
—
    
12,256
 

The accompanying notes are an integral part of these condensed consolidated financial statements.
 
*2005 cash flows have been restated to remove the cash flows from the NeoMedia Micro Paint Repair business unit, which has been reclassified to discontinued operations and assets and liabilities held for sale.

4

NEOMEDIA TECHNOLOGIES, INC. AND SUBSIDIARIES
UNAUDITED NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION AND NATURE OF BUSINESS OPERATIONS

Basis of Presentation

The condensed consolidated financial statements include the financial statements of NeoMedia Technologies, Inc. and its wholly-owned subsidiaries (“NeoMedia” or the “Company”). The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete consolidated financial statements. These condensed consolidated financial statements and related notes should be read in conjunction with the Company’s Form 10-KSB for the fiscal year ended December 31, 2005. In the opinion of management, these condensed consolidated financial statements reflect all adjustments which are of a normal recurring nature and which are necessary to present fairly the consolidated financial position of NeoMedia as of September 30, 2006, the results of operations for the three and nine month periods ended September 30, 2006 and 2005, and cash flows for the nine month periods ended September 30, 2006 and 2005. The results of operations for the three and nine month periods ended September 30, 2006 are not necessarily indicative of the results which may be expected for the entire fiscal year. All significant intercompany accounts and transactions have been eliminated in preparation of the condensed consolidated financial statements.

Going Concern

The accompanying condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company as a going concern. Net loss for the nine months ended September 30, 2006 was $27,094,000, which includes a gain from the change in fair value from revaluation of warrants and embedded conversion features of $6,523,000 and a charge for the write-off of the deferred equity financing costs of $13,256,000. NeoMedia also reported net losses of $9,147,000 and $7,230,000 for the years ended December 31, 2005 and 2004, respectively, and has an accumulated deficit of $119,618,000 and a working capital deficit of $30,222,000 as of September 30, 2006.

In addition, NeoMedia has material liquidity events that could adversely affect its ability to continue as a going concern, primarily:

·  In the event that NeoMedia’s stock price at the time the consideration shares issued in connection with the acquisitions of Mobot, Sponge, Gavitec, and 12Snap become saleable is less than the contractual price (between $0.3839 and $0.3956), NeoMedia is obligated to compensate the sellers in cash for the difference between the price at the time the shares become saleable and the relevant contractual price. Assuming a stock price at the time the shares become saleable of $0.10, which was the last sale price on October 23, 2006, NeoMedia would have a cash liability of $32.7 million relating to the guarantees.

·  During the nine months ended September 30, 2006, NeoMedia made cash payments totaling $2.1 million to silent partners of 12Snap, as partial payment under silent partner agreements entered into by 12Snap prior to the acquisition of 12Snap by NeoMedia. The agreements call for additional cash payments of approximately $2.5 million on or before December 31, 2006.

If the Company’s financial resources are insufficient, the Company may require additional financing in order to execute its operating plan and continue as a going concern. The Company cannot predict whether this additional financing will be in the form of equity, debt, or another form. The Company may not be able to obtain the necessary additional capital on a timely basis, on acceptable terms, or at all. In any of these events, the Company may be unable to implement its current plans for expansion, repay its debt obligations as they become due or respond to competitive pressures, any of which circumstances would have a material adverse effect on its business, prospects, financial condition and results of operations. The financial statements do not include any adjustments relating to the recoverability and reclassification of recorded asset amounts or amounts and reclassification of liabilities that might be necessary, should the Company be unable to continue as a going concern.

5
 
During August 2006, NeoMedia announced its intent to sell its Micro Paint Repair business unit. NeoMedia expects to receive cash proceeds from the sale of the division, which will be used to fund the operations and growth of the NeoMedia Mobile and NeoMedia Telecom Services businesses.

Should these financing sources fail to materialize, management would seek alternate funding sources such as the sale of common and/or preferred stock, the issuance of debt, or the sale of its marketable assets. Management’s plan is to secure adequate funding to bridge the profitability from the NeoMedia Mobile and NeoMedia Telecom Services businesses.

Nature of Business Operations

Historically, NeoMedia has been structured and evaluated by its Board of Directors and management as three distinct business units: NeoMedia Internet Switching Software (NISS), NeoMedia Micro Paint Repair (NMPR), and NeoMedia Consulting and Integration Services (NCIS).

NCIS is the original business line upon which the Company was founded. This unit resells client-server equipment and related software, and general and specialized consulting services. Because of decreased demand for systems integration products, and increased consolidation and competition in the industry in general, during 2005 resources allocated to the NCIS business unit were increasingly used in sales and business development efforts associated with the NISS business unit. During February 2006, NeoMedia’s Board of Directors elected to formally wind down the NCIS business unit. As a result, during February 2006, NeoMedia closed its Lisle, Illinois facility out of which the NCIS business unit was based. NeoMedia does, however, plan to continue servicing existing contracts and customers. 

During the first quarter of 2006, following the completion of the acquisitions of 12Snap AG (“12Snap”), Sponge Ltd. (“Sponge”), Gavitec AG (“Gavitec”), Mobot, Inc. (“Mobot”), and BSD Software, Inc. (“BSD”), as well as the winding down of the NCIS business unit, NeoMedia restructured into the following three business units:

- NeoMedia Mobile (NMM) - encompassing NeoMedia’s physical-world-to-internet and mobile marketing technologies branded under Qode®, 12Snap, Sponge, Gavitec and Mobot. During the second quarter of 2006, NeoMedia rebranded its PaperClick suite of products under the brand name Qode®.

- NeoMedia Telecom Services (NTS) - encompassing the billing, clearinghouse and information management services of Triton Global Business Services, the operating subsidiary of BSD Software, which was acquired in March 2006

- NeoMedia Micro Paint Repair (NMPR) - encompassing the micro paint and auto aftermarket accessories manufactured and distributed by NeoMedia

On August 30, 2006, NeoMedia signed a non-binding letter of intent to sell its Micro Paint Repair business unit to Jose Sada, a technology partner of NeoMedia Micro Paint Repair, backed by Global Emerging Markets Group of New York City. The letter of intent calls for completion of the transaction on or before November 24, 2006.

6

Reclassifications

Certain amounts in the 2005 condensed consolidated financial statements have been reclassified to conform to the 2006 presentation, most notably, “License revenue” and “Resales of software and technology equipment and service fees”, which were formerly reported as separate line items on NeoMedia’s consolidated statement of operations, are now condensed into the category entitled, “Technology license, service & products.” This is primarily due to the winding down of the former NCIS business unit and consolidation of revenues relating to the NCIS unit into the NMM unit, as well as the addition of new revenue streams from Mobot, Sponge, Gavitec, 12Snap, and BSD that fall into the same general category.

In addition, due to the pending sale of the Micro Paint Repair business unit, results of operations from this unit have been reclassified to restate into the caption “Net loss from Micro Paint business to be sold” for all periods shown, and assets and liabilities relating to this unit are combined into the captions “Assets held for sale” and “Liabilities held for sale,” respectively. Additionally, the statement of cash flows for the nine months ended September 30, 2005 has been restated to exclude the cash flows of the discontinued Micro Paint Repair business unit.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

As a result of the addition of the operations of Mobot, Sponge, Gavitec, 12Snap and BSD, and the issuance of the Series C convertible preferred stock and a convertible debenture during the nine months ended September 30, 2006, NeoMedia is presenting certain significant accounting policies that were not applicable as of the filing of its last annual report for the year ended December 31, 2005.

Stock-based Compensation

Beginning January 1, 2006, NeoMedia began to account for stock-based compensation in accordance with SFAS No. 123(R), Share-Based Payment. Under the fair value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the vesting period. Determining the fair value of share-based awards at the grant date requires judgment, including estimating expected dividends. In addition, judgment is also required in estimating the amount of share-based awards that are expected to be forfeited. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially impacted. Stock-based compensation expense is calculated using the Black-Scholes-Merton option pricing model on the date of grant. This option valuation model requires input of highly subjective assumptions. Because NeoMedia’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing model does not necessarily provide a reliable single measure of fair value of its employee stock options.

Fair Value of Derivatives

The Company generally does not use derivative financial instruments to hedge exposures to cash-flow risks or market-risks that may affect the fair values of its financial instruments. However, certain other financial instruments, such as warrants and embedded conversion features that are indexed to the Company’s common stock, are classified as liabilities when either (a) the holder possesses rights to net-cash settlement or (b) physical or net-share settlement is not within the control of the Company. In such instances, net-cash settlement is assumed for financial accounting and reporting, even when the terms of the underlying contracts do not provide for net-cash settlement. Such financial instruments are initially recorded at fair value and subsequently adjusted to fair value through a change to earnings at the close of each reporting period.

The caption “Derivative Financial Instruments” consists of (i) the fair values associated with derivative features embedded in the Series C convertible preferred stock, (ii) the fair values of the detachable warrants that were issued in connection with the preferred stock and the convertible debenture financing arrangements, and (iii) the fair value of detachable warrants that were outstanding prior to the issuance of the preferred stock and the convertible debenture financing arrangements.  

7

Sales Taxes Payable

Sales taxes payable represents amounts collected on behalf of specific regulatory agencies that require remittance on a specified date. These amounts are collected at the time of sales and are detailed on invoices provided to customers. At September 30, 2006 sales taxes payable were $1,178,000, of which $851,000 were delinquent sales taxes assumed by NeoMedia in connection with its acquisitions, certain of which are subject to payment plans. In compliance with the Emerging Issues Task Force consensus on issue number 06-03, NeoMedia accounts for sales taxes on a net basis.

Revenue Recognition 

NeoMedia derives  revenues from the following  sources:  (1) license revenues relating to patents and internally-developed software, (2) hardware, software, and service revenues related to mobile marketing campaign design and implementation, and (3) sale of its proprietary Micro Paint Repair solution.

              (1)   Technology license fees, including Intellectual Property licenses, represent revenue from the licensing of NeoMedia’s proprietary  software  tools and  applications products.  NeoMedia licenses its  development  tools and  application  products pursuant to non-exclusive and  non-transferable  license agreements.  The basis for license fee revenue recognition is substantially governed by American  Institute  of  Certified  Public  Accountants  ("AICPA")  Statement of Position 97-2 "Software Revenue  Recognition" ("SOP 97-2"), as amended, and Statement of Position 98-9, Modification of SOP 97-2, “Software Revenue Recognition, With Respect to Certain Transactions”.  License revenue is recognized if persuasive evidence of an agreement  exists,  delivery has occurred, pricing is fixed and determinable, and collectibility is probable.  The Company defers revenue related to license fees for which amounts have been collected but for which revenue has not been recognized in accordance with the above, and recognizes the revenue over the appropriate period.


(2)  Technology service & product revenue, which includes sales of software and technology equipment, service fee and telecom revenue attributed primarily fees for processing Canadian and U.S. terminated call records for telecommunication companies.  These revenue generating items are recognized  based on guidance  provided in  SEC Staff  Accounting  Bulletin  (“SAB”) No. 104,  "Revenue  Recognition  in Financial Statements,"  as amended (SAB 104).  Software and technology equipment resale revenue is recognized when persuasive evidence of an arrangement exists, the price to the customer is fixed and determinable, delivery of the service has occurred and collectibility is reasonably assured.  Service revenues including maintenance fees for providing system updates for software products, user documentation and technical support are recognized over the life of the contract.  Software  license revenue  from  long-term  contracts  has  been  recognized  on a  percentage  of completion  basis,  along with the  associated  services being  provided.  Telecom revenues are recognized at the time that calls are accepted by the clearing house for billing to customers.  The Company’s recently acquired subsidiaries BSD, Mobot and Gavitec follow this policy. The Company defers revenue related to technology service & product revenue for which amounts have been invoiced and or collected but for which the requisite service has not been provided. Revenue is then recognized over the matching service period.

(3)   Technology service also includes mobile marketing services to its customers which mobile marketing projects are recognized after the completion of the project and accepted by the customer.  All response and messaging based revenues are recognized at the time such responses are received and processed and the Company recognizes its premium messaging revenues on a gross basis based on guidance provided in Emerging Issues Task Force Issues No. 99-19 (EITF 99-19), “Reporting Revenue Gross as Principal or Net as an Agent,” and No. 01-09 (EITF 01-09) “Accounting for Consideration Given by a Vendor to a Customer.”  However, pursuant to EITF 01-09, the Company offsets any consideration given to its customers against revenue. Consulting and management revenues and revenues for periodic services are recognized as services are performed.  NeoMedia uses  stand-alone  pricing to determine an element's  vendor  specific  objective  evidence  (“VSOE”) in order to allocate an arrangement  fee amongst various pieces of a  multi-element  contract.  The Company’s recently acquired subsidiaries 12Snap and Sponge follow this policy. The Company defers revenue related to mobile marketing service fees for which amounts have been invoiced and/or collected but for which revenue has not been recognized. Revenue is then recognized over the matching service period.

8
 
(4)   Revenue for licensing and exclusivity on NeoMedia’s Micro Paint Repair systems is recognized equally over the term of the contract, which is currently one year.  A portion of the initial fee paid by the customer is allocated to licensing, training costs and initial products sold with the system. Revenue is recognized upon completion of training and shipment of the products, provided there is VSOE in a multiple element arrangement.  Ongoing product and service revenue is recognized as products are shipped and services performed.  The Company defers revenue related to micro paint repair licensing for which amounts have been invoiced and/or collected and revenue is then recognized over the estimated contract period, which is currently one year.

In December 2003, the SEC issued SAB 104, “Revenue Recognition.” SAB 104 supersedes SAB 101, “Revenue Recognition in Financial Statements.” SAB 104’s primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superseded as a result of the issuance of EITF 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.” Additionally, SAB 104 rescinds the SEC’s Revenue Recognition in Financial Statements Frequently Asked Questions and Answers (the “FAQ”) issued with SAB 101 that had been codified in SEC Topic 13, Revenue Recognition. Selected portions of the FAQ have been incorporated into SAB 104. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104, which was effective upon issuance. The adoption of SAB 104 did not impact NeoMedia’s consolidated financial statements.
 
3. ACQUISITIONS

During the nine months ended September 30, 2006, NeoMedia completed acquisitions of Mobot, Sponge, Gavitec, 12Snap, and BSD.

Acquisition of Mobot

On February 9, 2006, NeoMedia and Mobot signed a definitive merger agreement, subject to closing conditions, under which NeoMedia acquired all of the outstanding shares of Mobot in exchange for $3,500,000 cash and 16,931,493 shares of NeoMedia common stock (2,604,845 of which are being held in escrow for a period of one year from the closing date for the purpose of securing the indemnification obligations outlined in the purchase agreement). On February 17, 2006, NeoMedia and Mobot completed the closing requirements and the acquisition became effective. In addition to cash and stock, at closing NeoMedia forgave notes payable totaling $1,500,000 due from Mobot. This amount is considered other additional consideration in the purchase price allocation. Pursuant to the terms of the merger agreement, the number of shares of NeoMedia common stock that were issued as stock consideration was calculated using a share price of $0.3839, which was the volume-weighted average closing price of NeoMedia common stock for the ten days up to and including February 8, 2006. The merger agreement between NeoMedia and Mobot also contained a provision that, in the event that NeoMedia’s stock price at the time the consideration shares become saleable is less than $0.3839, NeoMedia would be obligated to compensate Mobot shareholders in cash for the difference between the price at the time the shares become saleable and $0.3839. Assuming a stock price at the time the shares become saleable of $0.10, which was the last sale price on October 23, 2006, NeoMedia would have had a cash liability of $4.8 million resulting from this clause.

9
 
Mobot is a pioneer in visual search and recognition technology designed to make marketing effective and innovative using mobile devices. Launched in 2004 to help companies cultivate rewarding relationships with mobile phone users, Mobot gives marketers, content providers and carriers the tools to make it easy for any consumer with a camera phone to interact with their offerings. Mobot’s customers include, amongst others, ELLEgirl magazine, for which Mobot “turned on” advertisements throughout the magazine that linked to content and customer loyalty promotions on the mobile Internet; The Light Agency, who distributes Mobot’s visual search and recognition technology to the U.K. grocery sector through its award-winning mobile phone-based loyalty program with the Sainsburys-owned convenience store chain Jackson’s; and Warner Music Group’s U.S. sales and retail marketing company WEA Corp., running a snap-and-enter contest in music stores for music fans to win tailored offers, samples and discounts.

NeoMedia completed the acquisitions of Mobot, Sponge, Gavitec, and 12Snap in an effort to gain entry into the rapidly evolving global mobile marketing industry.

The actual purchase price was based on cash paid, the fair value of NeoMedia stock around the date of the Mobot acquisition, and direct costs associated with the combination. The purchase price was allocated as follows:
   
(Dollars in
  
   
Thousands)
  
Value of 16,931,493 shares issued at $0.395 per share (1)
  
$
6,688
  
Cash paid
    
3,500
 
Direct costs of acquisition
    
8
 
Advances to Mobot forgiven at acquisition
    
1,500
 
Total Fair Value of Purchase Price
    
11,696
 
         
Assets Purchased:
        
Cash and cash equivalents
  
$
328
  
Accounts receivable
    
68
 
Other current assets
    
49
 
Property, plant & equipment
    
30
 
Intangible assets
    
13
 
Customer contracts and relationships
    
440
 
Capitalized software platform
    
4,200
 
Copyrighted materials
    
90
 
Goodwill
    
6,778
 
Total Assets Purchased
    
11,996
 
         
Less Liabilities Assumed:
        
Accounts payable
  
$
51
  
Accrued liabilities
    
132
 
Deferred revenue
    
117
 
Total Liabilities Assumed
    
300
 
 
(1) - Shares were valued using the average stock price for two days before and two days after the measurement date, as defined in SFAS 141 and EITF 99-12
 
10

The combination was accounted for as a purchase business combination as defined by Statement of Financial Accounting Standards No. 141, Business Combinations. The allocation of the purchase price to the assets acquired and liabilities assumed was based on an independent valuation report obtained by the Company. The allocation is subject to change resulting from the purchase price guarantee contingency described above.

The values assigned to intangible assets, aside from goodwill, are subject to amortization. The intangible assets were assigned the following lives for amortization purposes:
 
   
Estimated useful
life (in years)
  
Intangible asset
    
 
 
Customer contracts and relationships
    
5
  
Copyrighted materials
    
5
  
Capitalized software platform
    
7
  
 
Goodwill was not assigned a life and will be tested for impairment as defined by Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.
 
The accompanying consolidated statement of operations presented herein for the nine months ended September 30, 2006, contains the results of operations for Mobot for the period from February 18, 2006, through September 30, 2006. The accompanying consolidated statement of operations presented herein for the three months ended September 30, 2006, contains the results of operations for Mobot for the entire nine month period. Pro-forma results of operations for the three and nine months ended September 30, 2006 and 2005 are presented at the end of this Note 3.
 
Acquisition of Sponge

On February 20, 2006, NeoMedia and Sponge signed a definitive share purchase agreement, subject to closing conditions, under which NeoMedia acquired all of the outstanding shares of Sponge in exchange for $6,141,000 cash and 33,097,135 shares of NeoMedia common stock (3,400,490 of which are being held in escrow for a period of one year from the closing date for the purpose of securing the indemnification obligations outlined in the purchase agreement). The agreement also calls for Sponge to earn an additional £2,500,000 (approximately $4.4 million) in the form of NeoMedia common stock if, during the two-year period beginning at closing, the Sponge business earns in excess of £1,300,000 (approximately $2.3 million) in net profits. On February 23, 2006, NeoMedia and Sponge completed the closing requirements and the acquisition became effective. Pursuant to the terms of the merger agreement, the number of shares of NeoMedia common stock to be issued as consideration was calculated using a share price of $0.384, which was the volume-weighted average closing price of NeoMedia common stock for the ten days up to and including February 8, 2006. In the event that NeoMedia’s stock price (at the time the consideration shares are saleable) is less than $0.384, NeoMedia is obligated to compensate Sponge shareholders in cash for the difference between the price at the time the shares become saleable and $0.384. Assuming a stock price at the time the shares become saleable of $0.10, which was the last sale price on October 23, 2006, NeoMedia would have a cash liability of $9.4 million resulting from this clause.

Founded in 2001, Sponge has grown to become a U.K. market leader in providing mobile applications to agencies and media groups, and gain recognition as one of Europe’s top independent developers of mobile applications and content. Today, Sponge counts more than 40 agencies, including WPP, Aegis and BBH, as clients, and supplies services for over 100 world-class brands, including Coca Cola®, Heineken® and Diageo. Sponge also supplies a range of mobile services to media groups, including News International, Trinity Mirror, Endemol and IPC. For Walker’s (Frito-Lay) potato chips, Sponge enabled a promotion that offered consumers of Walker’s -- the U.K.’s largest snack brand -- to win an iPod every 5 minutes for 4 weeks, by texting a unique code found on-pack into the Sponge platform. More than 5% of the total U.K. population participated in the campaign, which has been expanded to Belgium and the Netherlands on the basis of its success in the U.K. A total of 23% of the U.K. population interacted with Sponge applications in 2005.

11
 
NeoMedia completed the acquisitions of Mobot, Sponge, Gavitec, and 12Snap in an effort to gain entry into the rapidly evolving global mobile marketing industry.

The actual purchase price was based on cash paid, the fair value of NeoMedia stock around the date of the Sponge acquisition, and direct costs associated with the combination. The purchase price has been allocated as follows:
 
   
(Dollars in
  
   
Thousands)
  
Value of 33,097,135 shares issued at $0.395 per share (1)
  
$
13,073
  
Cash paid
    
6,141
 
Direct costs of acquisition
    
194
 
Total Fair Value of Purchase Price
    
19,408
 
         
Assets Purchased:
        
Cash and cash equivalents
  
$
177
  
Accounts receivable
    
617
 
Other current assets
    
35
 
Property, plant & equipment
    
53
 
Customer contracts and relationships
    
400
 
Capitalized software platform
    
1,300
 
Brand name
    
800
 
Copyrighted materials
    
50
 
Goodwill
    
16,692
 
Total Assets Purchased
    
20,124
 
         
Less Liabilities Assumed:
        
Accounts payable
  
$
190
  
Accrued liabilities
    
322
 
Other current liabilities
    
204
 
Total Liabilities Assumed
    
716
 
 
(1) - Shares were valued using the average stock price for two days before and two days after the measurement date, as defined in SFAS 141 and EITF 99-12

The combination is being accounted for as a purchase business combination as defined by Statement of Financial Accounting Standards No. 141, Business Combinations. The allocation of the purchase price to the assets acquired and liabilities assumed is based on an independent valuation report obtained by the Company. The allocation is subject to change resulting from the purchase price guarantee contingency described above.
 
12

The values assigned to intangible assets, aside from goodwill, are subject to amortization. The intangible assets were assigned the following lives for amortization purposes:
 
   
Estimated useful
  
Intangible asset
  
life (in years)
  
Customer contracts and relationships
    
5
  
Copyrighted materials
    
5
  
Capitalized software platform
    
7
  
Brand name
    
10
  
 
Goodwill was not assigned a life and will be tested for impairment as defined by Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.

The purchase agreement calls for the management of Sponge to earn an additional £2,500,000 (approximately $4.4 million) in the form of NeoMedia common stock if, during the two-year period beginning on February 23, 2006, the Sponge business earns in excess of £1,300,000 (approximately $2.3 million) in net profits, plus £1 of NeoMedia common stock for each £1 that earnings exceed £1,300,000 during the two-year period. No shares are to be issued pro rata if the earnings target is not met.

At the end of the two-year measurement period (February 22, 2008), if the earnings target is met, the financial impact on NeoMedia of the issuance of additional shares would be a proportionate increase of approximately $4.4 million in the long-term assets acquired from Sponge, with a corresponding increase in depreciation expense from the point of issuance forward. If the earnings target is not met, no additional shares would be issued and there would be no financial impact to NeoMedia. Pursuant to SFAS 141, NeoMedia has not allocated a value to the contingent consideration in the initial purchase price. Accordingly the final purchase price will not be determined until the conclusion of this contingency.

The accompanying consolidated statement of operations presented herein for the nine months ended September 30, 2006, contains the results of operations for Sponge for the period from February 24, 2006, through September 30, 2006. The accompanying consolidated statement of operations presented herein for the three months ended September 30, 2006, contains the results of operations for Sponge for the entire three month period. Pro-forma results of operations for the three and nine months ended September 30, 2006 and 2005 are presented at the end of this Note 3.
 
Acquisition of Gavitec

On February 17, 2006, NeoMedia and Gavitec signed a definitive sale and purchase agreement, subject to closing conditions, under which NeoMedia acquired all of the outstanding shares of Gavitec in exchange for $1,800,000 cash and 13,660,511 shares of NeoMedia common stock (1,366,051 of which are being held in escrow until December 31, 2006 for the purpose of securing the indemnification obligations outlined in the purchase agreement). Pursuant to the terms of the merger agreement, the number of shares of NeoMedia common stock to be issued as consideration was calculated using a share price of $0.389, which was the volume-weighted average closing price of NeoMedia common stock for the ten days up to and including February 16, 2006. On February 23, 2006, NeoMedia and Gavitec completed the closing requirements and the acquisition became effective. In the event that NeoMedia’s stock price (at the time the consideration shares are saleable) is less than $0.389, NeoMedia is obligated to compensate Gavitec shareholders in cash for the difference between the price at the time the shares become saleable and $0.389. Assuming a stock price at the time the shares become saleable of $0.10, which was the last sale price on October 23, 2006, NeoMedia would have a cash liability of $3.9 million resulting from this clause.

13
 
Gavitec was founded in 1997 as a specialized provider and manufacturer of products and solutions for mobile marketing and mobile information technology. As a technology leader in code-reading systems and software for mobile applications, Gavitec offers its clients standardized or individual solutions in the areas of mobile marketing, mobile ticketing, mobile couponing, and mobile payment systems. Gavitec has run an in-market pilot program in Switzerland for its mobile macro-payment system with the leading Swiss retail bank PostFinance, Unisys, seven selected retailers including Migros, CoOp and McDonald’s and approximately a thousand consumers. Participants receive a personal Data Matrix code via text message to their mobile phone. Then to complete a purchase, participants hold their cell phone over Gavitec’s EXIO code reader and enter their PIN code to debit their PostFinance account. Gavitec has also run trials with “Coast Mobile” in conjunction with the British Broadcasting Corporation (BBC) and News International’s The Times newspaper, along with a number of other interactive mobile campaigns.

NeoMedia completed the acquisitions of Mobot, Sponge, Gavitec, and 12Snap in an effort to gain entry into the rapidly evolving global mobile marketing industry.
 
The actual purchase price was based on cash paid, the fair value of NeoMedia stock around the date of the Gavitec acquisition, and direct costs associated with the combination. The purchase price has been allocated as follows:

   
(Dollars in
  
   
Thousands)
  
Value of 13,660,511 shares issued at $0.386 per share (1)
  
$
5,273
  
Cash paid
    
1,800
 
Direct costs of acquisition
    
114
 
Total Fair Value of Purchase Price
    
7,187
 
         
Assets Purchased:
        
Cash and cash equivalents
  
$
74
  
Accounts receivable
    
173
 
Inventory
    
106
 
Other current assets
    
53
 
Property, plant & equipment
    
15
 
Intangible assets
    
3
 
Capitalized software platform
    
4,600
 
Copyrighted materials
    
50
 
Goodwill
    
2,611
 
Total Assets Purchased
    
7,685
 
         
Less Liabilities Assumed:
        
Accounts payable
  
$
113
  
Accrued liabilities
    
24
 
Deferred revenue
    
117
 
Other current liabilities
    
244
 
Total Liabilities Assumed
    
498
 
 
(1) - Shares were valued using the average stock price for two days before and two days after the measurement date, as defined in SFAS 141 and EITF 99-12
 
The combination is being accounted for as a purchase business combination as defined by Statement of Financial Accounting Standards No. 141, Business Combinations. The allocation of the purchase price to the assets acquired and liabilities assumed is based on an independent report obtained by the Company. The allocation is subject to change resulting from the purchase price guarantee contingency described above.

14
 
The values assigned to intangible assets, aside from goodwill, are subject to amortization. The intangible assets were assigned the following lives for amortization purposes:
 
   
Estimated useful
  
Intangible asset
  
life (in years)
  
Copyrighted materials
    
5
  
Capitalized software platform
    
7
  
Brand name
    
10
  
 
Goodwill was not assigned a life and will be tested for impairment as defined by Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.
 
The accompanying consolidated statement of operations presented herein for the nine months ended September 30, 2006, contains the results of operations for Gavitec for the period from February 24, 2006, through September 30, 2006. The accompanying consolidated statement of operations presented herein for the three months ended September 30, 2006, contains the results of operations for Gavitec for the entire three month period. Pro-forma results of operations for the three and nine months ended September 30, 2006 and 2005 are presented at the end of this Note 3.
 
Acquisition of 12Snap

On February 10, 2006, NeoMedia and 12Snap signed a definitive sale and purchase agreement, subject to closing conditions, under which NeoMedia acquired all of the outstanding shares of 12Snap in exchange for $2,500,000 cash and 49,294,581 shares of NeoMedia common stock. On February 28, 2006, NeoMedia and 12Snap completed the closing requirements and the acquisition became effective. Pursuant to the terms of the merger agreement, the number of shares of NeoMedia common stock to be issued as consideration was calculated using a share price of $0.3956, which was the volume-weighted average closing price of NeoMedia common stock for the ten days up to and including February 9, 2006. In the event that NeoMedia’s stock price (at the time the consideration shares are saleable) is less than $0.3956, NeoMedia is obligated to compensate 12Snap shareholders in cash for the difference between the price at the time the shares become saleable and $0.3956. Assuming a stock price at the time the shares become saleable of $0.10, which was the last sale price on October 23, 2006, NeoMedia would have a cash liability of $14.6 million resulting from this clause.

12snap AG is headquartered in Munich with branches in Düsseldorf, New York, London, Milan, Stockholm and Vienna. As an expert in innovative marketing and entertainment for mobile phones, 12snap combines know-how in mobile applications, mobile loyalty and mobile marketing. In the mobile marketing space, 12snap creates and implements national and pan-European mobile marketing campaigns for international brands; its mobile loyalty business unit offers customer loyalty programs for companies and brands, and its mobile applications business unit is the center for development and software. 12snap sells and licenses a wide spectrum of mobile solutions to satisfy the demands of the current growing market and the new uses of the third mobile phone generation from dynamic video services and multiplayer games to personalized messaging applications. 12snap has 75 employees, and services to companies including McDonald's, MTV®, Coca-Cola, Ferrero, Wella, adidas, Unilever and Gillette®.

NeoMedia completed the acquisitions of Mobot, Sponge, Gavitec, and 12Snap in an effort to gain entry into the rapidly evolving global mobile marketing industry.

15

The actual purchase price was based on cash paid, the fair value of NeoMedia stock around the date of the 12 Snap acquisition, and direct costs associated with the combination. The purchase price has initially allocated as follows:

   
(Dollars in
  
   
Thousands)
  
Value of 49,294,581 shares issued at $0.394 per share (1)
  
$
19,422
  
Cash paid
    
2,500
 
Direct costs of acquisition
    
114
 
Total Fair Value of Purchase Price
    
22,036
 
         
Assets Purchased:
        
Cash and cash equivalents
  
$
465
  
Investment in marketable securities
    
951
 
Accounts receivable
    
2,683
 
Other current assets
    
554
 
Property, plant & equipment
    
224
 
Intangible assets
    
93
 
Customer contracts and relationships
    
400
 
Capitalized software platform
    
4,400
 
Brand name
    
1,600
 
Copyrighted materials
    
50
 
Goodwill
    
19,391
 
Total Assets Purchased
    
30,811
 
         
Less Liabilities Assumed:
        
Accounts payable
  
$
977
  
Accrued liabilities
    
1,990
 
Deferred revenue
    
1,434
 
Other current liabilities
    
225
 
Notes payable
    
4,149
 
Total Liabilities Assumed
    
8,775
 
 
(1) - Shares were valued using the average stock price for two days before and two days after the measurement date, as defined in SFAS 141 and EITF 99-12

The combination is being accounted for as a purchase business combination as defined by Statement of Financial Accounting Standards No. 141, Business Combinations. The allocation of the purchase price to the assets acquired and liabilities assumed is based on an independent valuation report obtained by the Company. The allocation is subject to change resulting from the purchase price guarantee contingency described above.

The values assigned to intangible assets, aside from goodwill, are subject to amortization. The intangible assets were assigned the following lives for amortization purposes:
 
   
Estimated useful
  
Intangible asset
  
life (in years)
  
Customer contracts and relationships
    
5
  
Copyrighted materials
    
5
  
Capitalized software platform
    
7
  
Brand name
    
10
  
 
16
 
Goodwill was not assigned a life and will be tested for impairment as defined by Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.

The accompanying consolidated statement of operations presented herein for the nine months ended September 30, 2006, contains the results of operations for 12Snap for the period from March 1, 2006, through September 30, 2006. The accompanying consolidated statement of operations presented herein for the three months ended September 30, 2006, contains the results of operations for 12Snap for the entire three month period. Pro-forma results of operations for the three and nine months ended September 30, 2006 and 2005 are presented at the end of this Note 3.
 
Acquisition of BSD

On March 21, 2006, NeoMedia completed its acquisition of BSD Software, Inc. of Calgary, Alberta, Canada for 7,123,698 shares of NeoMedia common stock. Pursuant to the terms of the merger agreement, the number of shares of NeoMedia common stock to be issued as consideration was calculated using a share price of $0.3467, which was the volume-weighted average closing price of NeoMedia common stock for the five days preceding March 21, 2006. BSD owns 90% of the outstanding shares of Triton Global Business Services, Inc., a provider of live and automated operator calling services and e-business support, including billing, clearinghouse and information management services, to companies in the telecommunications industry.

NeoMedia completed the acquisitions of BSD for the purpose of increasing its revenue and profit through establishment of a Telecom Services business unit, as well as gaining access to the Canadian telecom industry in order to penetrate that market with the products of the NeoMedia Mobile division.

The actual purchase price was based on cash paid, the fair value of NeoMedia stock around the date of the BSD acquisition, and direct costs associated with the combination. The purchase price has been allocated as follows:
 
   
(Dollars in
  
   
Thousands)
  
Value of 7,123,698 shares issued at $0.352 per share (1)
  
$
2,508
  
Direct costs of acquisition
    
7
 
Total Fair Value of Purchase Price
    
2,515
 
         
Assets Purchased:
        
Cash and cash equivalents
  
$
55
  
Accounts receivable
    
1,733
 
Other current assets
    
13
 
Property, plant & equipment
    
61
 
Customer contracts and relationships
    
1,300
 
Copyrighted materials
    
130
 
Goodwill
    
4,402
  
Total Assets Purchased
    
7,694
 
         
Less Liabilities Assumed:
        
Accounts payable
  
$
2,424
  
Accrued liabilities
    
1,224
 
Notes payable
    
1,531
 
Total Liabilities Assumed
    
5,179
 
 
(1) - Shares were valued using the average stock price for two days before and two days after the measurement date, as defined in SFAS 141 and EITF 99-12

17
 
The combination is being accounted for as a purchase business combination as defined by Statement of Financial Accounting Standards No. 141, Business Combinations. The allocation of the purchase price to the assets acquired and liabilities assumed is based on an independent valuation report obtained by the Company.

The values assigned to intangible assets, aside from goodwill, are subject to amortization. The intangible assets were assigned the following lives for amortization purposes:
 
   
Estimated useful
  
Intangible asset
  
life (in years)
  
Customer contracts and relationships
    
5
  
Copyrighted materials
    
5
  
 
Goodwill was not assigned a life and will be tested for impairment as defined by Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets.

The accompanying consolidated statement of operations presented herein for the nine months ended September 30, 2006, contains the results of operations for BSD for the period from March 22, 2006, through September 30, 2006. The accompanying consolidated statement of operations presented herein for the three months ended September 30, 2006, contains the results of operations for BSD for the entire three month period. Pro-forma results of operations for the three and nine months ended September 30, 2006 and 2005 are presented at the end of this Note 3.
 
18

Pro Forma Financial Information

Pro-forma results of operations as if NeoMedia was combined with Mobot, Sponge, Gavitec, 12Snap and BSD as of January 1, 2006 are as follows:
 
   
Three Months Ended September 30, 2006
  
                           
Pro
       
                           
Forma
       
                           
Adjust-
  
Pro-forma
  
   
NeoMedia
  
Mobot
  
Sponge
  
Gavitec
  
12Snap
  
BSD
  
ments
  
Combined
  
Total net sales
  
$
6,249
  
$
125
  
$
265
  
$
246
  
$
2,226
  
$
3,205
    
($6,067
)(A)
$
6,249
  
Net income (loss)
    
($30,909
)
  
($388
)
  
($420
)
  
($359
)
  
($166
)
$
228
  
$
1,105
(A)
  
($30,909
)
Net income (loss) per share-
                                                  
basic and diluted
    
($0.05
)
                                
—
    
($0.05
)
Weighted average common
                                                  
shares outstanding
    
644,720,857
                                  
—
    
644,720,857
 
 
   
Nine Months Ended September 30, 2006
  
                           
Pro
      
                           
Forma
      
                           
Adjust-
  
Pro-forma
  
   
NeoMedia
  
Mobot
  
Sponge
  
Gavitec
  
12Snap
  
BSD
  
ments
  
Combined
  
Total net sales
  
$
14,129
  
$
344
  
$
1,488
  
$
953
  
$
8,457
  
$
8,479
    
($13,876
)(B)
$
19,974
  
Net income (loss)
    
($27,094
)
  
($1,007
)
  
($458
)
  
($428
)
  
($51
)
$
474
  
$
1,305
(B)
  
($27,259
)
Net income (loss) per share-
                                                  
basic and diluted
    
($0.04
)
                              
$
—
 (B)(C)   
($0.04
)
Weighted average common
                                                  
shares outstanding
    
602,132,555
                                 
58,652,190
(C)  
660,784,745
 

(A) - Adjustment to back out the operations of each subsidiary, which were included in NeoMedia’s consolidated operations for the entire three month period ended September 30, 2006

(B) - Adjustments are to reflect operations of each acquisition from the closing date through September 30, 2006 and amortization of intangible assets for the period January 1, 2006 through the respective closing dates. Results of operations for each acquisition from its respective closing date through September 30, 2006 are included in NeoMedia's operations for the nine months ended September 30, 2006. Closing dates for each acquisition were: Mobot (February 17, 2006); Sponge and Gavitec (February 23, 2006); 12Snap (February 28, 2006); and BSD (March 21, 2006).

(C) - Adjustment for shares that would have been issued in connection with acquisitions if they had occurred on January 1, 2006. Using the stock price around January 1, 2006, the pro forma number of shares that would have been issued was:
 
   
Mobot
  
Sponge
  
Gavitec
  
12Snap
  
BSD
  
Total
  
Total stock consideration
  
$
6,500,000
  
$
11,400,000
  
$
5,400,000
  
$
19,500,000
  
$
2,279,263
  
$
45,079,263
  
NeoMedia stock price around January 1, 2006 (measurement date)
  
$
0.290
  
$
0.290
  
$
0.290
  
$
0.290
  
$
0.290
        
Pro forma number of shares of NeoMedia to be issued as purchase price consideration
    
22,413,793
   
39,310,345
   
18,620,690
   
67,241,379
   
7,859,527
   
155,445,734
 
 
19
 
The adjustment between the reported and the pro forma number of weighted average shares outstanding is caused by (i) the weighting of the pro forma shares for the entire nine month period ended September 30, 2006, whereas in the reported number the shares were only outstanding from the closing date through September 30, 2006, and (ii) the number of pro forma shares being higher than the actual shares issued due to a lower stock price on the pro forma date of issuance.

Pro-forma results of operations as if NeoMedia was combined with Mobot, Sponge, Gavitec, 12Snap and BSD as of January 1, 2005 are as follows:
 
   
Three Months Ended September 30, 2005
  
                           
Pro
      
                           
Forma
      
                       
(B)
  
Adjust-
  
Pro-forma
  
   
NeoMedia
  
Mobot
  
Sponge
  
Gavitec
  
12Snap
  
BSD
  
ments
  
Combined
  
Total net sales
  
$
193
  
$
56
  
$
609
  
$
198
  
$
2,114
  
$
2,273
    
—
  
$
5,443
  
Net income (loss)
    
($1,950
)
  
($818
)
$
53
    
($492
)
  
($140
)
  
($134
)
  
($723
)(A)
  
($4,204
)
Net income (loss) per share-
                                                  
basic and diluted
    
($0.00
)
                                
($0.01
)(A)(B)
  
($0.01
)
Weighted average common
                                                  
shares outstanding
    
456,695,836
                                 
172,717,482
(B)
  
629,413,318
 
 
   
Nine Months Ended September 30, 2005
  
                           
Pro
      
                           
Forma
      
                       
(B)
  
Adjust-
  
Pro-forma
  
   
NeoMedia
  
Mobot
  
Sponge
  
Gavitec
  
12Snap
  
BSD
  
ments
  
Combined
  
Total net sales
  
$
762
  
$
144
  
$
1,544
  
$
590
  
$
5,600
  
$
6,387
    
—
 
$
15,027
  
Net income (loss)
    
($5,469
)
  
($918
)
$
172
    
($747
)
  
($816
)
$
127
    
($2,170
)(A)
  
($9,821
)
Net income (loss) per share-
                                                  
basic and diluted
    
($0.01
)
                                
($0.01
)(A)(B)
  
($0.02
)
Weighted average common
                                                  
shares outstanding
    
451,487,240
                                 
172,717,482
(B)  
624,204,722
 

(A) - Adjustment for amortization of intangible assets for the periods presented.

(B) - Adjustment for shares that would have been issued in connection with acquisitions if they had occurred on January 1, 2006. Using the stock price around January 1, 2006, the pro forma number of shares that would have been issued was:

   
Mobot
  
Sponge
  
Gavitec
  
12Snap
  
BSD
  
Total
  
Total stock consideration
  
$
6,500,000
  
$
11,400,000
  
$
5,400,000
  
$
19,500,000
  
$
2,279,263
  
$
45,079,263
  
NeoMedia stock price around January 1, 2005 (measurement date)
  
$
0.261
  
$
0.261
  
$
0.261
  
$
0.261
  
$
0.261
        
Pro forma number of shares of NeoMedia to be issued as purchase price consideration
    
24,904,215
   
43,678,161
   
20,689,655
   
74,712,644
   
8,732,808
   
172,717,483
 
 
20

Tax Implications of Acquisitions

For income tax purposes, amounts assigned to particular assets acquired and liabilities assumed in the business combinations are different than amounts used for financial reporting. The differences in assigned values for financial reporting and tax purposes result in temporary differences. In applying SFAS 109, “Accounting for Income Taxes”, the Company is required to recognize the tax effect of these temporary differences and, accordingly, a deferred tax liability has been recognized. The Company determined that its pre-existing and acquired deferred tax assets, and those acquired, including those subject to limitations, were more likely than not to be realized to the extent of the deferred tax liability. The reduction in the valuation allowance resulting in an asset was used to offset the deferred tax liability arising from the business combinations, pursuant to SFAS 109.

In addition, the acquisitions of Sponge, Gavitec, 12Snap, and BSD involve a change of control of foreign entities, and as a result any net operating loss carryforward in existence prior to the acquisition may have limited or no use for NeoMedia.
 
21

Intangible Assets

As of September 30, 2006, NeoMedia had intangible assets with a cost as follows:

 
  
12 Snap
 
Sponge
 
Gavitec
 
Mobot
 
BSD
 
Other
 
Total
  
Customer Contracts
  
$
400
  
$
400
  
$
—
  
$
440
  
$
1,300
  
$
—
  
$
2,540
  
Proprietary Software
    
4,516
   
1,300
   
4,603
   
4,210
   
—
   
937
   
15,566
  
Brand Name
    
1,600
   
800
   
—
   
5
   
—
   
—
    
2,405
  
Copyrighted Materials
    
50
   
50
   
50
   
90
   
130
   
—
    
370
  
Patents
   
—
   
—
   
—
   
10
   
—
   
4,888
   
4,898
  
Goodwill
    
19,391
   
16,799
   
2,712
   
6,778
   
4,402
   
—
   
50,082
  
Total
  
$
25,957
  
$
19,349
  
$
7,365
  
$
11,533
  
$
5,832
  
$
5,825
  
$
75,861
  

Accumulated amortization on NeoMedia's intangible assets as of September 30, 2006, was:

 
 
12 Snap
 
Sponge
 
Gavitec
 
Mobot
 
BSD
 
Other
 
Total
 
Customer Contracts
  
$
47
  
$
48
  
$
—
  
$
54
  
$
152
  
$
—
  
$
301
  
Proprietary Software
    
367
   
112
   
393
   
370
   
—
   
667
   
1,909
 
Brand Name
    
93
   
48
   
—
   
2
   
—
   
—
    
143
 
Copyrighted Materials
    
6
   
6
   
6
   
11
   
15
   
—
    
44
 
Patents
   
—
    
—
   
—
   
2
   
—
    
1,974
   
1,976
 
Goodwill
    
—
   
—
   
—
   
—
   
—
   
—
    
—
 
Total
  
$
513
  
$
214
  
$
399
  
$
439
  
$
167
  
$
2,641
  
$
4,373
  

The carrying value of NeoMedia's intangible assets as of September 30, 2006 was:

 
  
12 Snap
 
Sponge
 
Gavitec
 
Mobot
 
BSD
 
Other
 
Total
  
Customer Contracts
  
$
353
  
$
352
  
$
—
  
$
386
  
$
1,148
  
$
—
  
$
2,239
  
Proprietary Software
    
4,149
   
1,188
   
4,210
   
3,839
   
—
    
269
   
13,655
  
Brand Name
    
1,507
   
752
   
—
   
3
   
—
    
—
   
2,262
  
Copyrighted Materials
    
44
   
44
   
44
   
79
   
115
   
—
   
326
  
Patents
   
—
    
—
    
—
    
8
   
—
   
2,914
   
2,922
  
Goodwill
    
19,391
   
16,799
   
2,712
   
6,778
   
4,402
   
—
   
50,082
  
Total
  
$
25,444
  
$
19,135
  
$
6,966
  
$
11,093
  
$
5,665
  
$
3,183
  
$
71,486
  

Estimated future amortization expense on NeoMedia's intangible assets is expected to be:

 
 
Customer Contracts
 
Proprietary Software
 
Brand Name
 
Copyrighted Materials
 
Patents
 
Goodwill
 
Total
  
2006
  
$
127
  
$
556
  
$
60
  
$
19
  
$
76
  
$
—
  
$
838
  
2007
    
508
    
2,224
    
241
    
74
    
304
    
—
    
3,351
  
2008
    
508
    
2,224
    
182
    
74
    
304
    
—
    
3,292
  
2009
    
508
    
2,224
    
182
    
74
    
304
    
—
    
3,292
  
2010
    
356
    
2,224
    
182
    
74
    
304
    
—
    
3,140
  
Thereafter
    
232
    
4,204
    
1,414
    
11
    
1,630
    
—
    
7,491
  
Total
  
$
2,239
  
$
13,656
  
$
2,261
  
$
326
  
$
2,922
  
$
—
  
$
21,404
  

It is important to note that actual amortization expense could differ materially from the table due to subjective factors such as changes in assumptions of useful lives or impairment charges.
 
22

The weighted average remaining life for the intangible assets was approximately 6.8 years as of September 30, 2006.
 
Letter of Intent to Acquire Hip Cricket

On August 24, 2006, NeoMedia terminated a non-binding letter of intent to acquire HipCricket, Inc. (“HipCricket”), due to an inability of the parties to come to terms on a definitive purchase price. On February 16, 2006, NeoMedia and Hip Cricket signed the letter of intent, under which NeoMedia intended to acquire all of the outstanding shares of Hip Cricket in exchange for $500,000 cash and $4,000,000 of NeoMedia common stock, subject to due diligence and signing of a mutually agreeable definitive purchase agreement by both parties.
 
In addition to signing the letter of intent, NeoMedia loaned HipCricket the principal amount of $500,000 in the form of a) a promissory note, dated February 16, 2006, in the amount of $250,000 and (b) that certain promissory note, dated March 20, 2006, in the amount of $250,000. The notes accrue interest at a rate of 8% per annum. The notes were to be applied toward the cash portion of the purchase price upon signing of a definitive purchase agreement for the acquisition of all of the outstanding shares of HipCricket by NeoMedia, as contemplated in the letter of intent. Due to the termination of the letter of intent, and pursuant to the terms of the notes, the face amount of the notes, plus any and all interest accrued thereon, will become payable and due on November 22, 2006. In the event the Notes are not repaid by November 22, 2006, the notes will convert into shares of HipCricket common stock using a valuation of $4.5 million for HipCricket.

4. DISCONTINUED OPERATIONS AND ASSETS AND LIABILITIES HELD FOR SALE - MICRO PAINT REPAIR BUSINESS UNIT

On August 30, 2006, NeoMedia signed a non-binding letter of intent to sell its Micro Paint Repair business unit to Jose Sada, a technology partner of NeoMedia Micro Paint Repair, backed by Global Emerging Markets Group of New York City. The letter of intent calls for completion of the transaction on or before November 24, 2006.

The letter of intent contained the following material terms:
 
 
-
the letter of intent is subject to completion of due diligence review by the buyers,
     
 
-
the letter of intent is subject to negotiation of material terms of the transaction,
     
 
-
the letter of intent is subject to negotiation of a sales price of the business unit,
     
 
-
the letter of intent is subject to ability of the buyers to obtain funding,
     
 
-
the letter of intent can be terminated by either party without cause with written notice,
     
 
-
NeoMedia cannot shop the business unit to other buyers while the letter of intent is in effect, with the exception of specifically named alternate potential buyers.

SFAS 144 governs the accounting over this transaction. NeoMedia has analyzed the pertinent facts of the proposed transaction with respect to the criteria outlined in SFAS 144, and has determined that all of the criteria have been met. Accordingly NeoMedia is reporting the operating results of the MPR business unit as Discontinued Operations, and the assets and liabilities as Held for Sale. The amounts reported as discontinued operations and assets and liabilities held for sale have been appropriately reclassified and reported in the financial statements presented in this filing.

The operating results of the MPR business unit classified as discontinued operations are indicated in the following table.
 
23

   
Three Months Ended
  
Nine Months Ended
  
   
September 30,
  
September 30,
  
   
2006
  
2005
  
2006
 
2005
 
Net sales
  
$
368
  
$
244
  
$
1,145
  
$
960
  
Cost of sales
    
605
   
220
   
1,592
   
795
 
Gross profit
    
(237
)
  
24
   
(447
)
  
165
 
                           
Sales and marketing expenses
    
207
   
216
   
801
   
1,019
 
General and administrative expenses
    
777
   
68