Edgar Filing: NEOMEDIA TECHNOLOGIES INC

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

x ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2006

¨ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period ____________ to__________

Commission File Number 0-21743

NEOMEDIA TECHNOLOGIES, INC.

(Exact Name of Issuer 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)

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

Securities Registered Under Section 12(b) of the Exchange Act:

	Name of each exchange
Title of Each Class	on which registered
Common Stock, par value $.01	Over-the-Counter Bulletin Board

Securities Registered Under Section 12(g) of the Exchange Act: NONE

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

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.

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨

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

As of June 30, 2006, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $133,607,000, based on the last sale price as reported on the Over-the-Counter Bulletin Board of $0.231 per share.

As of March 19, 2007, there were 897,194,732 shares of common stock and 21,622 shares of Series C Convertible Preferred Stock outstanding.

PART I

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Form 10-K contains forward-looking statements and information relating to NeoMedia Technologies, Inc. (“NeoMedia” or “the Company”). NeoMedia intends to identify forward-looking statements in this prospectus by using words such as "believes," "intends," "expects," "may," "will," "should," "plan," "projected," "contemplates," "anticipates," "estimates," "predicts," "potential," "continue," or similar terminology. These statements are based on the Company’s beliefs as well as assumptions the Company made using information currently available to us. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. Because these statements reflect the Company’s current views concerning future events, these statements involve risks, uncertainties, and assumptions. Actual future results may differ significantly from the results discussed in the forward-looking statements.

ITEM 1. BUSINESS

General

NeoMedia (www.neom.com) is a pioneer in mobile enterprise and marketing technology, bridging the physical and electronic world with innovative direct-to-mobile-Web technology solutions. NeoMedia’s flagship qode® service links users to the wireless, electronic world. NeoMedia is headquartered in Fort Myers, Florida, with an office in Aachen, Germany. The qode® suite of easy-to-use, market-driven products and applications is based on a strong foundation of patented technology, comprising the qode® (www.qode.com) platform, qode® reader and qode® window, all of which provide One Click to Content™ connectivity for products, print, packaging and other physical objects to link directly to specific desired content on the mobile Internet.

During 2006, NeoMedia operated under three distinct operating entities:

·	NeoMedia Mobile (NMM) - encompassing NeoMedia’s physical-world-to-internet and mobile marketing technologies qode®, Gavitec, 12Snap, Sponge and Mobot

·	NeoMedia Telecom Services (NTS) - encompassing the billing, clearinghouse and information management services of recently-acquired BSD Software, Inc.

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

During August 2006, NeoMedia announced that it intended to sell its NMPR business. During the fourth quarter of 2006, NeoMedia divested of its Mobot and Sponge subsidiaries. During January 2007, NeoMedia made the strategic decision with respect to its corporate structure in 2007 and beyond, deciding to shed its remaining non-core 12Snap and NTS business units to focus on the area that management believes will deliver the most value - the core code-reading business. The NMPR, Mobot and Sponge businesses is classified as discontinued operations in NeoMedia’s consolidated financial statements as of December 31, 2006, and 12Snap and NTS will be classified as discontinued operations in NeoMedia’s consolidated financial statements during the first quarter of 2007.

As a result of the actual and planned sales of these business units, NeoMedia will be structured as one operating unit during 2007. The following business discussion will focus on NeoMedia’s structure in 2007 with its core business, consisting of qode®, Gavitec, and the related intellectual property. The Company will operate out of its Ft. Myers, Florida headquarters, and its European office located near Aachen, Germany.

Company History

NeoMedia was incorporated under the laws of the State of Delaware on July 29, 1996, to acquire by tax-free merger Dev-Tech Associates, Inc., NeoMedia's predecessor, which was organized in Illinois in December 1989. In March 1996, Dev-Tech's common stock was split, with an aggregate of 2,551,120 shares of common stock being issued in exchange for the 164 then-issued and outstanding shares of common stock. On August 5, 1996, NeoMedia acquired all of the shares of Dev-Tech in exchange for the issuance of shares of NeoMedia's common stock to Dev-Tech's stockholders.

As of December 31, 2006, NeoMedia also had the following wholly-owned subsidiaries: 12Snap AG, incorporated in Germany; Gavitec AG, incorporated in Germany; NeoMedia Micro Paint Repair, Inc., incorporated in Nevada; NeoMedia Telecom Services, Inc., incorporated in Nevada; NeoMedia Migration, Inc., incorporated in Delaware; Distribuidora Vallarta, S.A., incorporated in Guatemala (a dormant subsidiary); NeoMedia Technologies of Canada, Inc., incorporated in Canada (a dormant subsidiary); NeoMedia Tech, Inc., incorporated in Delaware (a dormant subsidiary); NeoMedia EDV GMBH, incorporated in Austria (a dormant subsidiary); NeoMedia Technologies Holding Company B.V., incorporated in the Netherlands (a dormant subsidiary); NeoMedia Technologies de Mexico S.A. de C.V., incorporated in Mexico (a dormant subsidiary); NeoMedia Migration de Mexico S.A. de C.V., incorporated in Mexico (a dormant subsidiary); NeoMedia Technologies do Brazil Ltd., incorporated in Brazil (a dormant subsidiary); and NeoMedia Technologies UK Limited, incorporated in the United Kingdom (a dormant subsidiary).

Recent Developments

Agreement to Sell 12Snap - March 2007

On March 20, 2007, NeoMedia reached an agreement with Bernd Michael (the “Buyer”), a private investor and former shareholder of 12Snap prior to NeoMedia’s acquisition of 12Snap, pursuant to which the Buyer will buy from NeoMedia 90% of the shares of 12Snap, subject to the following material terms and conditions:

·	$1,100,000 will be paid in cash at Closing, and $500,000 will be placed into escrow and released to NeoMedia 90 days after Closing, assuming no warranty claims;

·	Buyer will forgive purchase price obligation in the amount of $880,000, such obligation resulting from the sale and purchase agreement between NeoMedia and the former shareholders of 12Snap

·	12Snap management will waive their purchase price obligations in the amount of $880,000, and return to NeoMedia 2,525,818 shares of NeoMedia common stock issued previously;

·	Buyer will return to NeoMedia 2,525,818 NeoMedia shares issued previously;

·	NeoMedia will retain a 10% ownership of 12Snap, subject to an option agreement pursuant to which NeoMedia has the right to sell and Buyer has the right to acquire the remaining 10% stake held by NeoMedia for a purchase price of $750,000 after December 31;

·	12snap and NeoMedia will execute a cooperation agreement pursuant to which 12snap will remain NeoMedia preferred partner and enjoy most favored prices, and 12snap will perform certain research and development functions for NeoMedia; and

·	The transaction is subject to completion of a material definitive agreement

$7.5 Million Convertible Debenture - March 2007

NeoMedia entered into a Securities Purchase Agreement, dated March 27, 2007, with Cornell Capital Partners. Pursuant to the March Debenture Agreement, Cornell Capital Partners agreed to purchase 13% secured convertible debentures maturing two years from the date of issuance in the aggregate amount of $7,459,000. The March Debenture Agreement also provided for the issuance to the purchasers, at no additional cost to the purchasers, warrants to purchase 125,000,000 shares of NeoMedia common stock at an exercise price of $0.04 per share. In connection with the March Debenture Agreement, NeoMedia also entered into a registration rights agreement with the Purchasers that requires the Company to (i) file a registration statement with the SEC registering the resale of the shares of common stock issuable upon conversion of the convertible debenture and the exercise of the warrants within 30 days of receiving a written notice from the purchasers requesting filing, (ii) achieve effectiveness within 120 days of receiving a notice to file the registration statement and (iii) maintain effectiveness of the registration statement. Failure to meet these requirements will require the Company to incur liquidating damages amounting to 2% of the principal per month. The debentures are secured by substantially all of the Company’s assets.

At any time from the closing date until December 29, 2008, the Purchasers have the right to convert the convertible debenture into NeoMedia common stock at the then effective conversion price, which varies relative to our trading stock price, as follows: $0.05 per share, or 90% of the lowest closing bid price (as reported by Bloomberg) of the common stock for the 30 trading days immediately preceding the conversion date. The conversion is limited such that the holder cannot exceed 4.99% ownership, unless the holders waive their right to such limitation. The limitation will terminate under any event of default.

In connection with the March Debenture Agreement, NeoMedia applied $1,312,000 of the gross proceeds toward payment of liquidated damages accrued on previous convertible instruments payable to the purchaser, and $366,000 toward accrued interest on previous convertible debentures. Cornell also retained fees of $781,000, resulting in net proceeds to the Company of $5,000,000.

Agreement with Certain Former Shareholders of 12Snap - March 2007

On March 16, 2007, NeoMedia entered into an agreement with certain former shareholders of 12Snap, a wholly owned subsidiary of NeoMedia acquired during February 2006, pursuant to which NeoMedia satisfied its purchase price obligation to these shareholders through the issuance of restricted common stock. Pursuant to the terms of the original purchase agreement, in the event that NeoMedia’s stock price at the time the consideration shares are saleable (either upon effectiveness of a registration statement containing the shares, or under Rule 144) was less than $0.3956, NeoMedia was obligated to compensate 12Snap shareholders in cash for the difference between the price at the time the shares become saleable and $0.3956. On February 22, 2007, the shares became eligible for resale under Rule 144. The actual calculated purchase price obligation to NeoMedia based on the volume weighted average closing price of NeoMedia stock for the ten days up to and including February 22, 2007 was $16,233,000. Pursuant to the terms of the March 2007 agreement, NeoMedia issued 197,620,948 shares of restricted common stock to five separate parties, in satisfaction of purchase price obligation totaling $9,427,000. The remaining balance on the purchase price obligation after this payment was $6,806,000.

Agreement with Former Shareholders of Gavitec - January 2007

On January 23, 2007, NeoMedia entered into an agreement with the former shareholders of Gavitec, a wholly owned subsidiary of NeoMedia acquired during February 2006. Pursuant to the terms of the original sale and purchase agreement under which NeoMedia acquired Gavitec, the number of shares of NeoMedia common stock issued as consideration for the acquisition of Gavitec 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. The sale and purchase stipulated that, in the event that NeoMedia’s stock price at the time the original consideration shares became saleable (either upon effectiveness of a registration statement containing the shares, or under Rule 144) was less than $0.389, NeoMedia would be obligated to compensate the former Gavitec shareholders, in cash, for the difference between the price at the time the shares become saleable and $0.389.

Pursuant to the terms of the amended agreement, NeoMedia and the former Gavitec shareholders agreed that the entire purchase price obligation shall be satisfied through the payment by NeoMedia of (i) $1,800,000 in cash, payable no later than February 28, 2007, and (ii) 61,000,000 shares of NeoMedia common stock, to be issued no later than February 28, 2007. The Amendment Agreement stipulates that, in the event that the 61,000,000 shares are not registered for resale by August 31, 2007, interest shall accrue at a rate of 8% per annum on the agreed value of the shares of $1,900,000. NeoMedia also agreed to pay interest accrued on the purchase price in the amount of $213,000 and reimburse $100,000 of costs related to the acquisition to the primary former shareholder of Gavitec no later than February 28, 2007 (subsequently extended to March 31, 2007). NeoMedia issued the shares and made cash payments of $2,113,000 during March 2007 in satisfaction of the obligation.

$2.5 Million Convertible Debenture - December 2006

NeoMedia entered into a Securities Purchase Agreement, dated December 29, 2006, with Cornell Capital Partners. Pursuant to the December Debenture Agreement, Cornell Capital Partners agreed to purchase 10% secured convertible debentures maturing two years from the date of issuance in the aggregate amount of $2,500,000. The December Debenture Agreement also provided for the issuance to the purchasers, at no additional cost to the purchasers, warrants to purchase 42,000,000 shares of NeoMedia common stock at an exercise price of $0.06 per share. In connection with the December Debenture Agreement, NeoMedia also entered into a registration rights agreement with the Purchasers that requires the Company to (i) file a registration statement with the SEC registering the resale of the shares of common stock issuable upon conversion of the convertible debenture and the exercise of the warrants, (ii) achieve effectiveness by March 29, 2007 and (iii) maintain effectiveness of the registration statement. Failure to meet these requirements will require us to incur liquidating damages amounting to 2% of the principal per month, but in no event shall consideration paid as liquidating damages exceed $500,000. The debentures are secured by substantially all of NeoMedia’s assets.

At any time from the closing date until December 29, 2008, the Purchasers have the right to convert the convertible debenture into NeoMedia common stock at the then effective conversion price, which varies relative to NeoMedia’s trading stock price, as follows: $0.06 per share, or 90% of the lowest closing bid price (as reported by Bloomberg) of the common stock for the 30 trading days immediately preceding the conversion date. The conversion is limited such that the holder cannot exceed 4.99% ownership, unless the holders waive their right to such limitation. The limitation will terminate under any event of default.

As an inducement to enter into the December Debenture Agreement, on December 29, 2006 NeoMedia repriced 210,000,000 warrants held by Cornell to $0.04 per share, subject to all the original terms and conditions of the respective warrant agreements. The warrant amendments each contain a stipulation whereby, for a period of six months, NeoMedia shall have the right to redeem the warrants on a cashless basis at an effective price of $0.12 per share. As a result of the repricing, NeoMedia recognized warrant repricing expense of $703,000 during the twelve months ended December 31, 2006.

As of December 31, 2006, the Company was in default of this instrument due to the Company’s pending registration statement to register the underlying shares of previous convertible instruments not becoming effective by the specified date. As a result of the default, the holder of the securities could redeem the convertible debentures and preferred stock for cash at their discretion, and could convert warrants on a cashless basis at their discretion.

Sale of Investment in iPoint - December 2006

On December 29, 2006, NeoMedia sold 12,875,609 ordinary shares of iPoint-media PLC (“iPoint”) for net cash proceeds of $1,574,000. NeoMedia originally invested $1,000,000 cash in exchange for 17% of iPoint’s outstanding shares on September 10, 2004. During late September 2006, iPoint completed a reverse takeover of Elm Investments PLC and began trading on the London Stock Exchange.

On October 26, 2004, NeoMedia announced that all holders of its common stock as of November 17, 2004 would be entitled to receive a dividend of one share of iPoint common stock for approximately every 18,000 shares of NeoMedia stock held as of November 17, 2004, and that the date of the property dividend payment would be announced, and the distribution made, after the iPoint shares underlying the dividend were covered by an effective registration statement that was to be filed by iPoint with the SEC. iPoint was not granted effectiveness by the SEC with respect to the registration statement, therefore NeoMedia was prohibited from issuing the dividend.

Senior Management and Board Changes - December 2006

Effective December 8, 2006 NeoMedia accepted the resignation of Charles T. Jensen, 63, from his roles as President, Chief Executive Officer and a member NeoMedia’s board of directors. Effective December 20, 2006 NeoMedia accepted the resignation of Martin Copus, 52, from his role as Chief Operating Officer and head of the NeoMedia Mobile business unit. Charles W. Fritz, 50, assumed the role of interim Chief Executive Officer, and will retain his position as Chairman of NeoMedia’s board of directors. Mr. Fritz will act as Chief Executive Officer on an interim basis until such time as a permanent replacement is appointed by NeoMedia’s board of directors.

Roger M. Pavane, NeoMedia’s senior vice president of sales and marketing, now leads efforts for the mobile division in the Americas, and Dr. Christian Steinborn, managing director of NeoMedia’s Gavitec AG - mobile digit subsidiary in Germany, leads efforts in Europe and Asia.

Effective December 22, 2006, William E. Fritz resigned as a member of the Board of Directors and as Corporate Secretary of NeoMedia. Mr. Fritz, who has served as a Director since the Company’s inception in 1996, resigned for personal reasons.

On February 2, 2007, NeoMedia appointed George O’Leary to its board of directors. Mr. O’Leary is currently the President of SKS Consulting of South Florida Corp. (“SKS”) and is working with the Company under a two year consulting agreement, under which he will lead the execution of the Company’s strategic plan. Prior to assuming his duties with NeoMedia, he was and still is a consultant to NeoGenomics (OTCBB:NGNM) and was acting Chief Operating Officer from October 2004 to April 2005 where he helped the turn-around of that organization. He is currently a member of the board of directors of NeoGenomics. Prior to becoming an officer of NeoGenomics, Mr. O’Leary was the President and CFO of Jet Partners, LLC from 2002 to 2004. During that time annual revenues grew from $12 million to $17.5 million. From 1996 to 2000, Mr. O’Leary was CEO and President of Communication Resources Incorporated (CRI), where annual revenues grew from $5 million to $40 million during his tenure. Prior to CRI, Mr. O’Leary was Vice President of Operations of Cablevision Industries, where he ran $125 million of business for this major cable operator until it was sold to Time Warner.

Divestiture of Mobot, Inc. - December 2006

On February 17, 2006, NeoMedia acquired all of the outstanding shares of Mobot in exchange for $3,500,000 cash and $6,500,000 stock (which equated to 16,931,493 shares of NeoMedia common stock), plus forgiveness of notes payable totaling $1,500,000 due from Mobot. 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 with Mobot also contained a provision that, in the event that NeoMedia’s stock price at the time the consideration shares became saleable (either upon effectiveness of a registration statement containing the shares, or under Rule 144) was 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.

On December 6, 2006, NeoMedia and FMS Group, Inc. (“FMS”), a group consisting of former shareholders of Mobot, completed a transaction pursuant to which NeoMedia divested of its ownership interest in Mobot. The principal reasons for NeoMedia divesting of the Mobot business were: (i) a depressed NeoMedia stock price, which led to a large potential cash obligation stemming from the purchase price obligation clause in the original purchase agreement, (ii) the fact that the purchase price obligation would become due no later than February 17, 2007, and (iii) operating losses from the Mobot businesses putting strains on NeoMedia’s working capital.

The material terms of the transaction with FMS were as follows:

·	NeoMedia transferred 100% of its ownership interest in Mobot to FMS, and in return received 16,000 shares (18% ownership) of FMS, which will operate the Mobot business;

·	All obligations under the original merger agreement, including the purchase price guarantee obligation, were terminated;

·	NeoMedia contributed $67,000 cash to FMS at closing, and an additional $200,000 on December 27, 2006;

NeoMedia received 16,931 preference shares in FMS that can be redeemed to reacquire the 16,931,493 original consideration shares originally issued to acquire Mobot. Each preference share can be redeemed for 1,000 shares of the NeoMedia common stock at NeoMedia’s discretion within 15 months of the closing of this transaction, for cash in the amount of 40% of the then-current market value of the underlying NeoMedia shares. After 15 months, the preference shares can be redeemed upon a liquidation event of FMS or NeoMedia, for either 1,000 shares of NeoMedia common stock each, or for the current cash equivalent of the shares, at FMS’ discretion;

NeoMedia entered into a license agreement with Mobot, pursuant to which NeoMedia received a license to use the Mobot image recognition service for barcode-related applications. The license is exclusive in the Americas, Europe and Australia, restricted in Japan, Korea, and Singapore, and non-exclusive in other areas of the world. The exclusivity is subject to NeoMedia meeting certain minimum transaction volume requirements or making minimum cash payments;

·	NeoMedia entered into a mutual release with each of the former Mobot shareholders in which the parties released each other from the terms of the original Mobot merger agreement, and the former Mobot shareholders consented to the release of the pending legal action against NeoMedia; and

·	NeoMedia has no involvement in the ongoing operations of FMS, does not have board representation of FMS, and pursuant to the sale agreement must vote its shares at the direction of the FMS board

Divestiture of Sponge Ltd. - November 2006

On February 20, 2006, NeoMedia acquired all of the outstanding shares of Sponge in exchange for (i) approximately $6 million cash, (ii) 33,097,135 shares of NeoMedia common stock with a fair market value at the time of acquisition of approximately $13.1 million, and (iii) approximately $4.4 million contingent consideration in the form of NeoMedia common stock if, during the two-year period beginning at closing, the Sponge business earned in excess of approximately $2.3 million in net profits. Pursuant to the terms of the original 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. The merger agreement stipulated that, in the event that NeoMedia’s stock price at the time the consideration shares became saleable (either upon effectiveness of a registration statement containing the shares, or under Rule 144) was less than $0.384, NeoMedia would have been obligated to compensate Sponge shareholders in cash for the difference between the price at the time the shares became saleable and $0.384.

On November 14, 2006, NeoMedia and Sponge signed a definitive share purchase and settlement agreement, pursuant to which NeoMedia divested of a material portion of its ownership interest in Sponge. The material terms of the share purchase and settlement agreement are as follows: (i) NeoMedia returned 92.5% of its ownership interest in Sponge, retaining 7.5% ownership of Sponge, (ii) NeoMedia relinquished its Board of Directors positions at Sponge, (iii) the 33,097,135 shares of NeoMedia common stock that were issued as consideration to acquire Sponge were returned to NeoMedia and retired; (iv) all obligations under the original merger agreement, including the purchase price guarantee obligation, were terminated, and (v) Sponge returned $100,000 cash (net of attorney fees) to NeoMedia at closing and $150,000 by March 7, 2007 (fully collected as of this filing).

The principal reasons for NeoMedia divesting of the Sponge business were: (i) a depressed NeoMedia stock price, which led to a large potential cash obligation stemming from the purchase price obligation clause in the original purchase agreement, (ii) the fact that the purchase price obligation would become due no later than February 23, 2007, and (iii) the return of the original consideration shares for retirement.

$5 Million Convertible Debenture - August 2006

On August 24, 2006, NeoMedia sold to Cornell Capital Partners LP 10% secured convertible debentures maturing two years from the date of issuance with a face value of $5,000,000. At any time until August 24, 2008, the holders have the right to convert the secured convertible debenture, in whole or in part, into NeoMedia common stock of at the then effective conversion price, which varies relative to the trading stock price, as follows: $0.15 per share, or 90% of the lowest closing bid price of the common stock for the 30 trading days immediately preceding the conversion date. Except in the event of a default, the conversions are limited such that the holder cannot exceed 4.99% ownership, unless the holders waive their right to such limitation. The debentures are secured by substantially all of the Company’s assets. In connection with the Agreement, the Company also entered into a registration rights agreement with the Purchaser that required the Company to (i) file a registration statement with the SEC registering the resale of the shares of common stock issuable upon conversion of the convertible debenture and the exercise of the warrants, (ii) achieve effectiveness within a stated period and (iii) maintain effectiveness of the registration statement. Failure to meet these requirements will require the Company to incur liquidated damages amounting to 2% of the principal per month, but in no event shall consideration paid as liquidated damages exceed $1,000,000. The debentures are secured by substantially all of the Company’s assets.

In connection with the secured convertible debentures, NeoMedia issued to Cornell Capital Partners warrants to purchase shares of NeoMedia common stock as follows: 50,000,000 warrants with an exercise price of $0.05 per share, 25,000,000 warrants with an exercise price of $0.15 per share, 50,000,000 warrants with an exercise price of $0.20 per share, and 50,000,000 warrants with an exercise price of $0.25 per share. The exercise prices of these warrants were subsequently repriced to $0.04 in connection with a convertible debenture financing in December 2006. In addition, NeoMedia repriced warrants previously issued to Cornell in connection with its February 2006 and August 2006 financings, as follows: 10,000,000 warrants were repriced from $0.20 to $0.10, 20,000,000 warrants were repriced from $0.50 to $0.10, 25,000,000 warrants were repriced from $0.40 to $0.15, and 30,000,000 warrants were repriced from $0.35 to $0.10. NeoMedia recorded an warrant repricing expense in the amount of $2,835,000 during the third quarter in connection with the repricing.

NeoMedia is currently in default of the Investor Registration Rights Agreement entered into on August 24, 2006, in connection with the $5 million secured convertible debenture, because the registration statement to register the shares underlying the secured convertible debenture was not declared effective by the specified date. Due to the current default status, the Purchasers have certain material additional rights in this financing arrangement that did not previously exist. Specifically,

·	The full fair value of the secured convertible debenture is now callable in the amount of $5,000,000;

·	The warrants can be exercised on a cashless basis as described above;

·	NeoMedia is responsible for liquidated damages; NeoMedia has accrued $393,000 as the expected fair value of liquidated damages relating to the secured convertible debenture as of December 31, 2006;

·	The requirement for the Purchaser to maintain an ownership interest in NeoMedia of less than 5% is terminated;

HipCricket, Inc. - August 2006

On August 24, 2006, NeoMedia terminated a previously announced non-binding letter of intent to acquire HipCricket, Inc. (“HipCricket”) of Essex, CT, due to an inability of the parties to come to terms on a definitive purchase price. On February 16, 2006, NeoMedia and HipCricket signed the letter of intent, under which NeoMedia intended to acquire all of the outstanding shares of HipCricket in exchange for $500,000 cash and $4,000,000 of NeoMedia common stock. The letter of intent was 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 promissory note, dated February 16, 2006, in the amount of $250,000 and a 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. In the event the notes were not repaid within 90 days of the termination, NeoMedia has the right to convert the notes into shares of HipCricket common stock assuming a valuation of $4.5 million for HipCricket. The notes matured during November 2006. On February 28, 2007, NeoMedia and HipCricket reached an agreement pursuant to which HipCricket will repay the amounts owing under the note in cash over a period of one year. HipCricket made payments of $300,000 on March 2, 2007; an additional $100,000 is due on August 28, 2007, and the final $100,000 plus any interest accrued thereon is due no later than February 28, 2008. In the event the remaining cash payments are not made, NeoMedia will have the right to convert any unpaid balances (including principal and interest) into shares of HipCricket common stock under the same terms as the original notes.

Series C Convertible Preferred Stock

On February 17, 2006, NeoMedia sold to Cornell Capital Partners 8% cumulative Series C convertible perefrered stock with a face value of $22,000,000. At any time until February 17, 2009, the holders have the right to convert the preferred stock, in whole or in part, into NeoMedia common stock at the then effective conversion price, which varies relative to the trading stock price, as follows: $0.50 per share, or 97% of the lowest closing bid price of the common stock for the 30 trading days immediately preceding the conversion date. Except in the event of a default, the conversions are limited such that the holder cannot exceed 4.99% ownership, unless the holders waive their right to such limitation.

In connection with the Series C convertible perefrered stock, NeoMedia issued to Cornell Capital Partners warrants to purchase shares of NeoMedia common stock as follows: 20,000,000 warrants with an exercise price of $0.50 per share, 25,000,000 warrants with an exercise price of $0.40 per share, and 30,000,000 warrants with an exercise price of $0.35 per share. The exercise prices of these warrants were subsequently repriced to $0.04 in connection with a convertible debenture financing in December 2006.

NeoMedia filed a registration statement covering the shares related to the conversion option beyond the date stipulated in the investor registration rights agreement, and the registration statement had not been made effective by the date stipulated in the investor registration rights agreement. As such, NeoMedia has accrued $1,200,000 as the expected value of liquidated damages relating to the Series C convertible stock as of December 31, 2006.

Due to the current default status, the Purchasers have certain material additional rights in this financing arrangement that did not exist prior to default. Specifically,

·	The full fair value of the Series C convertible preferred stock is now callable in the amount of $21,657,000;

·	The warrants can be exercised on a cashless basis as described above;

·	The requirement for the Purchasers to maintain an ownership interest in NeoMedia of less than 5% is waived;

·	NeoMedia is responsible for liquidated damages as described above.

Industry Overview

NeoMedia’s qode® platform and mobile phone software connect the physical world to the electronic world, through consumer, enterprise, educational and governmental applications. An early pioneer in the wireless solutions industry, NeoMedia has been developing its qode® platform and applications since 1996. During that time, NeoMedia has also established an extensive portfolio of intellectual property.

The original commercial use of the qode® technology depended on utilizing a scanning device (e.g. pen with scanner) to de-code printed codes, which it would then link via PC to the Internet to enable the consumer to retrieve extensive information on the Internet. With the advent and proliferation of the cell phone, NeoMedia realized the immense potential to reach consumers anywhere and anytime with a device that they carried with them. This was further augmented by the escalation of camera phones in the marketplace over the past several years. With the qode® platform, cell phone users (and users of other mobile devices such as personal digital assistants) are able to directly access the mobile internet in one step, via “texting,” “keying,” or “clicking” on printed barcodes or smartcodes, or “keying” in keywords or product on their cell phones.

NeoMedia anticipates continued rapid growth in the mobile marketing industry over the coming years, due to:

(1) Increased growth of mobile subscribers, and those subscribers accessing the Internet. According to the Cellular Telecommunications & Internet Association (CTIA) and the Mobile Marketing Association (MMA), there are 2.6 billion phones in use worldwide - more than TVs and PCs combined.

(2) Improvements in infrastructure. The penetration of high speed GPRS networks is increasing bandwidths, which in turn allows more complex application development, faster speed and enhanced user experience, resulting in mobile customers embracing mobile content in ever greater numbers and complexity.

(3) Enhanced handset functionality. Color screens and camera phones are driving sales of mobile devices in the replacement market. According to Informa, Camera phones will represent 81% of total handset market sales by 2011. As camera and operating system functionality evolve and standardize, the opportunity for more robust and compete solutions is greatly enhanced.

Strategy

NeoMedia has spent the past decade as a pioneer in the process of linking the physical world to the electronic world, developing, patenting and implementing four generations of continuously refined switch technology that bridges these environments. During the past two and a half years, NeoMedia has introduced qode® for Camera Cell Phones and the qode® GoWindow and CodeWindow, to capitalize on the rapidly emerging mobile marketing sector. With this industry positioned for rapid worldwide growth, NeoMedia believes it is poised to gain global market share through its patented qode® direct-to-web platform, applications and services.

Building on customers and relationships already in place, NeoMedia is focused on targeting manufacturers within the media and enterprise space, including newspapers, publishers, real estate, physical world advertisers, and beverage producers to design their products to become more interactive. NeoMedia envisions a future in which consumers routinely “qode® it” when they want more information on a product or service.

NeoMedia’s goals in 2007 and beyond include hiring a new sales force, while penetrating three verticals with at least six major customers. Another major goal is to partner with at least three major carriers (North American, UK and mainland European) who will embed, adopt and commit to utilize every feature qode® has to offer.

NeoMedia is also making great strides to create a global standard for the wireless Web. During February 2007, NeoMedia co-hosted a meeting in London attended by representatives from leading carriers, phone manufacturers, advertising agencies, brands, publications, and others, aimed at standardizing the barcode-capturing process.

Beyond consumer goods, the qode® platform is also an effective platform for other industry markets and can be utilized through other devices, such as personal computers. As such, NeoMedia is pursuing opportunities in areas as diverse as homeland security, banking, search, food labeling, inventory tracking and multiple enterprise applications—from affinity programs to mobile service solutions to complete company management systems.

As a result of certain strategy decisions made in January 2007, NeoMedia is in the process of selling its non-core business units NMPR, 12Snap, and NTS in order to focus on the roll-out of its core code-reading business.

Products/Services

qode® is a mobile marketing service, based on the patented qode® technology platform, which enables brand managers and product manufacturers to market directly to their target customers via their portable devices such as mobile phones and PDAs. By entering a word or phrase (e.g.: brand name or tagline) into a mobile device using the qode® GoWindow; by entering a numeric product code into a mobile device using the qode® CodeWindow; or by clicking on a barcode or smart code on product packaging or marketing collateral using qode® for Camera Phones, a consumer can retrieve tailored Web content in a single step, even to pages deep-linked within a website. qode® bypasses long URLs, search engines or difficult-to-navigate phone menus by linking directly from a word or code to mobile commerce, rebates, contests, coupons, registration, instructional videos, ad tracking, polling, customer profiling and more.

The qode® solution consists of:

·	Word Registration and Activation

1.	Registration of brand names and taglines in the qode® WordRegistry^™. The WordRegistry is the official repository for qode® keywords;

2.	Bidding for non-trademarked generic keywords (e.g., cola, burger, car); and

3.	Activation of brand names, taglines and non-trademarked keywords by linking them to mobile web content using the Link Manager Software.

·	New Code Activation. NeoMedia can create custom smartcodes to print on product packaging or literature, a subway poster, a direct mailer or other marketing collateral. Consumers with a camera phone then click on the code to link directly to Web content designated by the product’s manufacturer.

·	Existing Code Activation. As with new smartcodes, qode® can link already-existing product codes, such as UPC, EAN, JAN, and ISBN codes, to tailored Web content.

Upon activation, the qode® platform also provides the following word management tools:

·	Link Manager Software. Software for a PC that allows a product owner to link keywords and codes to a specific URL;

·	Handset Software. Device software required for a mobile device customers to read activated codes and keywords; and

·	Enterprise Reporting. Allows product owner of keywords or codes to track the number of consumer “hits” by code, date and time.

Other value-added services include:

·	Click Management Services

·	Link Manager Service. Management of the linking of all words and codes on behalf of a product owner; and

·	Code Verification. Testing of each code to ensure that it is printed properly and that it links to the correct URL.

·	Web Content Creation Services. Assistance in creating Web content for mobile devices in XHTML, WAP and other mobile formats.

·	Mobile Marketing Campaign Services. Assistance in creating mobile advertising campaigns using products with qode^® technology.

·	Customized Reporting. Customized reporting and data mining that allows product owners to receive additional data about their marketing campaigns.

·	Server Software. For companies managing a large number of codes or keywords, server software is available that allows clients to store the links within their organization’s network.

In addition to the qode® platform, NeoMedia also offers mobile couponing and ticketing through its MD-20 and EXIO point of sale devices. MD-20 and EXIO are able to read and process two-dimensional smartcode symbologies such as Data Matrix from mobile phone displays as well as printed one-dimensional (1D) barcodes. Thanks to a high-speed digital signal processors and a high-resolution camera, the machines automatically recognize smartcodes sent as SMS (text) or MMS (picture message) to any compatible mobile phone.

MD-20 and EXIO are designed for various direct marketing applications such as mobile ticketing, mobile couponing, mobile payment and mobile loyalty programs, and are therefore the ideal off-the-shelf solution for innovative application areas such as m-Commerce, 1-to-1-communication, entertainment and retail trade. They have been used in various applications around the world, including a mobile couponing application surrounding the World Cup in Germany in June 2006, and a mobile ticketing application with Portugal’s largest cinema chain.

To date, the Company has not received material revenues from the sale of its qode® products.

Strategic Relationships

NeoMedia has developed strategic relationships to leverage its capabilities across new geographic and product markets.

During January 2007, NeoMedia signed a performance-based agency agreement with NexMobil LLC, pursuant to which NexMobil will sell qode® products and services in the Middle East, India, Korea, and Pakistan.

During December 2006, NeoMedia announced that it was partnering with News Group Newspapers, and its market-leading Sunday newspaper, the News of the World®, to introduce qode® in the U.K. News of the World– with a readership of 8.2 million (source: National Readership Survey of Great Britain, January-July 2006) – will use qode® initially to bring TV clips of English Premier League football (soccer) to its readers via their cell phones over the mobile internet, as News Group has won the rights to broadcast league games to mobile phones in a joint bid with BSkyB. qode® technology could also be used by News of the World advertisers to offer readers discount vouchers, or additional product information via their handsets.

During October 2006, NeoMedia signed a partnering agreement with Cyber Century of City Here, a leading Chinese Internet marketing firm to bring qode® to www.gbq.cn, a social networking website established in 2000, which currently has 2 million registered users, mainly 18 to 35 years of age.

During October 2006, NeoMedia’s Gavitec strengthened its exclusive license agreement with mobile marketing specialist Omniprime, pursuant to which Omniprime will sell mobile couponing and ticketing applications in the Philippines using Gavitec’s technology.

During July 2006, NeoMedia expanded its presence and broadened its business opportunities in China by signing an operating agreement with Shang Fang Wei Ye Technology Development Limited Company of Beijing, to introduce and market qode® technology in key markets in Asia.

During 2005, Gavitec and PostFinance, the largest Swiss bank for private customers, started a project with system integrator Unisys and numerous partners in the retail sector (Migros, COOP, SBB, McDonald’s, Interdiscount, Mobilezone and PostShops) enabling customers to pay easily and safely by mobile phone instead of EC-card - the first mobile macro-payment system worldwide.

Gavitec concluded three further business co-operations during 2005: first with RegiSoft Ltd., a leading developer of innovative VAS solutions for the mobile market place, then with REA Card GmbH, a market leader for cashless payment systems and lastly with Clicktivities AG, a supplier of digital premium solutions. The cooperation agreement with RegiSoft Ltd. focuses on the integration of Gavitec hardware solutions and RegiSoft’s World Trade Server™ (WTS™) to provide customers with complete and integrated products and services for mobile marketing, mobile ticketing and mobile couponing. Gavitec and the two subsidiaries of REA Systeme GmbH, REA Card GmbH and FunkTicket AG, intend to bundle their competencies and products in order to enable secure and easy payments by mobile phones. In addition, they plan to develop a hybrid-system which combines Gavitec scanners with REA terminals to one single payment system. In conjunction with Clicktivities AG, Gavitec plans to address the mobile marketing segment by offering customized digital solutions for eBusiness.

NeoMedia has on ongoing relationship with Baniak Pine and Gannon, a Chicago law firm specializing in intellectual property licensing and litigation. The firm assists NeoMedia in seeking out potential licensees of its intellectual property portfolio, including any resulting litigation. Baniak Pine and Gannon currently represents NeoMedia in its lawsuit against Scanbuy.

During 2004 and 2005, NeoMedia engaged key partners around the world to assist in the commercialization of the qode^® family of products. During such time NeoMedia has partnered with affiliates and resellers, such as Big Gig Strategies (United Kingdom), Relyco and IT-Global (United States), Mobedia (Italy), AURA Digital Communications (Australia), E&I Marketing (Taiwan), Deusto Sistemas (Spain), and Jorge Christen and Partners LLP (Mexico).

Sales and Marketing

NeoMedia has worked to establish a global network of direct salespeople, affiliates and business development personnel to market, upsell and cross-sell its suite of products and services. NeoMedia’s target markets across a number of geographic regions including: the U.S., the U.K., Western Europe, Italy, the Middle East, and Asia/Pacific.

Key target markets for the sales force include:

Brand Marketers and Marketing Services Agencies. NeoMedia markets its robust suite of end-to-end (and everything in between) mobile marketing products and services both to advertising agencies, who maintain the primary relationships with major brands while the NeoMedia business units creates and manages the wireless marketing campaign portion of the relationship, and directly to brand/product marketers where there is a higher level of wireless experience or expertise.

·	Media. NeoMedia works with publishers to “inter-activate” their content. By placing a barcode directly on print media or even on a television ad, media providers can add a new dimension of interactivity and marketing effectiveness to their media.

Network Operators/Carriers & Handset Manufacturers. There are a range of applications and platforms that are suited directly for network operators or carriers and the handset manufacturers who supply them; many applications are custom developed at the request of these operators and manufacturers. One of NeoMedia’s primary goals is to have its qode® handset software embedded on camera phones during the manufacturing process, bypassing the need for the consumer to download.

·	Retailers. In addition to mobile marketing campaigns carried out on behalf of major retailers in a variety of markets by the NeoMedia Wireless companies, Gavitec’s EXIO and MD20 products represent the next evolution in point-of-sale equipment offering m-coupons and m-commerce.

·	Enterprise Clients, Government & Education. The robust and innovative platforms on which many of the products offered by NeoMedia run, can be customized to work in numerous other environments and in many industries including finance, security, tracking and labeling.

Customers and Clients

Some of NeoMedia’s clients for its qode® and Gavitec products and services have included Prentice Hall, News Group Newspapers, McDonald’s Portugal, and others. NeoMedia is also in the process of scoping projects for five major insurance companies in China (PICC Property and Casualty Co. Ltd., China United Property Insurance Co, Alltrust Insurance Company of China Ltd., Hua An Sinosafe Insurance Co. Ltd., and Yong An Insurance Co. Ltd.).

NeoMedia also generates revenue from the licensing of its patent portfolio. To date, NeoMedia has licensed its patents to, or settled patent-related lawsuits with, Digital:Convergence, A.T. Cross Company, Symbol Technologies, Brandkey Systems Corporation, Virgin Entertainment Group, and AirClic, Inc. NeoMedia intends to pursue additional license agreements of its patent portfolio in the future, in addition to enabling consumer brand and enterprise organization campaigns and projects.

Competition

NeoMedia believes it has positioned itself to compete as a global leader in mobile marketing solutions. However, within the mobile marketing industry there are a number of competitors, many of which are just beginning to appear, who offer parts of the mobile marketing equation. In general, due to the relative immaturity of the mobile marketing industry, small players have sprung up offering very specialized products and services.

As the mobile marketing industry matures, NeoMedia expects consolidation as industry leaders emerge. Moreover, NeoMedia believes it is well positioned at the onset due to its intellectual property, including many patents, on which its products and services are based. NeoMedia expects that its intellectual property, coupled with its early aggregation of proven market leaders, will serve as a competitive advantage as this market matures.

Product Liability

The Company has never had any product liability claim asserted against it. Currently the Company maintains product liability insurance, but there can be no guarantee that such policy will be sufficient to cover any claims made against the Company.

Government Regulation

Existing or future legislation could limit the growth of use of the Internet, which would curtail the Company’s revenue growth. Statutes and regulations directly applicable to Internet communications, commerce and advertising are becoming more prevalent. Congress recently passed laws regarding children’s online privacy, copyrights and taxation. The law remains largely unsettled, even in areas where there has been legislative action. It may take years to determine whether and how existing laws governing intellectual property, privacy, libel and taxation apply to the Internet, e-commerce, m-commerce and online advertising. In addition, the growth and development of e-commerce may prompt calls for more stringent consumer protection laws, both in the United States and abroad.

Certain of the Company’s proprietary technology allows for the storage of demographic data from NeoMedia’s users. In 2000, the European Union adopted a directive addressing data privacy that may limit the collection and use of certain information regarding Internet users. This directive may limit the Company’s ability to collect and use information collected by the Company’s technology in certain European countries. In addition, the Federal Trade Commission and several state governments have investigated the use by certain Internet companies of personal information. The Company could incur significant additional expenses if new regulations regarding the use of personal information are introduced or if the Company’s privacy practices are investigated.

Employees

As of December 31, 2006, NeoMedia employed 134 persons, of which 102 were employed by the 12Snap, NTS, and NMPR businesses held for sale. Of the remaining 32 employees, 22 were located at the Company’s headquarters in Fort Myers, Florida, and 10 at the Company’s Aachen, Germany office. None of the Company’s employees are represented by a labor union or bound by a collective bargaining agreement. The Company believes that its employee relations are good.

The Company's success depends on a significant extent on the performance of its senior management and certain key employees. Competition for highly skilled employees, including sales, technical and management personnel, is intense in the computer industry in general, and the mobile marketing industry specifically. Failure to attract additional qualified employees or to retain the services of key personnel could materially adversely affect the Company's business.

ITEM 1A. RISK FACTORS

Risks Related to NeoMedia’s Business

NeoMedia Has Historically Lost Money And Losses May Continue

NeoMedia has incurred substantial operating losses since inception, and could continue to incur substantial losses for the foreseeable future. NeoMedia reported net losses of $67,438,000, $9,147,000 and $7,230,000 for the years ended December 31, 2006, 2005 and 2004, respectively. NeoMedia’s accumulated losses were $159,962,000 and $92,524,000 as of December 31, 2006 and 2005, respectively. As of December 31, 2006 and 2005, NeoMedia had a working capital deficit of $81,167,000 and $2,065,000, respectively. NeoMedia had stockholders’ equity/(deficit) of $(54,534,000) and $4,227,000 as of December 31, 2006 and 2005, respectively. NeoMedia generated revenues from continuing operations of $10,309,000, $877,000, and $973,000 for the years ended December 31, 2006, 2005, and 2004, respectively. In addition, during the years ended December 31, 2006, 2005, and 2004, NeoMedia recorded negative cash flows from continuing operations of $9,958,000, $4,883,000, and $3,937,000, respectively. To succeed, NeoMedia must develop new client and customer relationships and substantially increase its revenue derived from improved products and additional value-added services. NeoMedia has expended, and to the extent it has available financing, NeoMedia intends to continue to expend, substantial resources to develop and improve its products, increase its value-added services and to market its products and services. These development and marketing expenses must be incurred well in advance of the recognition of revenue. As a result, NeoMedia may not be able to achieve or sustain profitability.

NeoMedia’s Independent Registered Public Accounting Firm Have Added Going Concern Language To Their Report On NeoMedia’s Consolidated Financial Statements, Which Means That NeoMedia May Not Be Able To Continue Operations

The report of Stonefield Josephson, Inc., NeoMedia’s independent registered public accounting firm, with respect to NeoMedia’s consolidated financial statements and the related notes for the years ended December 31, 2006, 2005 and 2004, indicates that, at the date of their report, NeoMedia had suffered significant recurring losses from operations and its working capital deficit raised substantial doubt about its ability to continue as a going concern. NeoMedia’s consolidated financial statements do not include any adjustments that might result from this uncertainty.

NeoMedia Will Need to Raise Additional Funds to Continue Its Operations

NeoMedia had cash balances of $3,606,000 as of December 31, 2006. Additionally, during March 2007 NeoMedia sold convertible debentures resulting in net funding to the Company of $5,000,000. NeoMedia could receive additional cash at future dates as from the following sources: (i) sale of non-core business units NeoMedia Micro Paint Repair, 12Snap, and NeoMedia Telecom Services, (ii) from the exercise of stock options, to the extent that the exercise price of such stock options is less than the market price of NeoMedia’s common stock, and (iii) from the exercise of stock warrants, to the extent that the warrants become registered for resale and the exercise price of such stock warrants is less than the market price of NeoMedia’s common stock at the time of exercise, and to the extent that the holder of such warrants does not elect to perform a “cashless” exercise, in which case NeoMedia would not receive any cash proceeds from the exercise. However, none of these events is contractually obligated. In order to satisfy its obligations that are currently due and that will come due, and maintain its operations in the absence of a material increase in revenues, NeoMedia will need to either generate from the sale of its non-core businesses, or raise additional cash from outside sources. The most likely source of cash in the short term is from the sale of the 12Snap and/or Micro Paint Repair business unit.

In the event that (i) NeoMedia is unsuccessful in divesting of its non-core business units in a timely fashion, (ii) NeoMedia’s stock price does not increase to levels where it can force exercise of enough of its outstanding warrants to generate material operating capital, (iii) the market for NeoMedia’s stock will not support the sale of shares underlying such warrants or other funding sources, or (iv) NeoMedia does not realize a material increase in revenue during the next 12 months, NeoMedia will have to seek additional cash sources. There can be no assurances that such funding sources will be available. If necessary funds are not available, NeoMedia’s business and operations would be materially adversely affected and in such event, NeoMedia would be forced to attempt to reduce costs and adjust its business plan, and could be forced to sell certain of its assets, including its remaining subsidiaries.

NeoMedia Has Material Weaknesses in Its Internal Control over Financial Reporting that May Prevent The Company from Being Able to Accurately Report Its Financial Results or Prevent Fraud, which Could Harm Its Business and Operating Results.

Effective internal controls are necessary for us to provide reliable and accurate financial reports and prevent fraud. In addition, Section 404 under the Sarbanes-Oxley Act of 2002 requires that NeoMedia assess, and its independent registered public accounting firm attest to, the design and operating effectiveness of internal control over financial reporting. If NeoMedia cannot provide reliable and accurate financial reports and prevent fraud, its business and operating results could be harmed. NeoMedia has in the past discovered, and may in the future discover, areas of its internal controls that need improvement. NeoMedia has identified six material weaknesses in its internal control as of December 31, 2006. These matters and NeoMedia’s efforts regarding remediation of these matters, as well as efforts regarding internal controls generally are discussed in detail in Part II, Item 9A, Controls and Procedures, of this Annual Report on Form 10-K. However, as NeoMedia’s material weaknesses in its internal controls demonstrates, NeoMedia cannot be certain that the remedial measures its has taken to date will ensure that NeoMedia designs, implements, and maintains adequate controls over its financial processes and reporting in the future. Additionally, since the requirements of Section 404 are ongoing and apply for future years, NeoMedia cannot be certain that it or its independent registered public accounting firm will not identify additional deficiencies or material weaknesses in its internal controls in the future, in addition to those identified as of December 31, 2006. Remedying the material weaknesses that have been presently identified, and any additional deficiencies, significant deficiencies or material weaknesses that NeoMedia or its independent registered public accounting firm may identify in the future, could in the future require NeoMedia to incur significant costs, hire additional personnel, expend significant time and management resources or make other changes. Any delay or failure to design and implement new or improved controls, or difficulties encountered in their implementation or operation, could harm our operating results, cause NeoMedia to fail to meet its financial reporting obligations, or prevent NeoMedia from providing reliable and accurate financial reports or avoiding or detecting fraud. Disclosure of NeoMedia’s material weaknesses, any failure to remediate such material weaknesses in a timely fashion or having or maintaining ineffective internal controls could cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of NeoMedia stock and its access to capital.

NeoMedia Has Guaranteed The Value Of Stock Issued In Connection With Recent Mergers Through The Registration Of The Shares, Which Could Result In A Material Cash Liability

Pursuant to the terms of the merger agreements with Gavitec and 12Snap, in the event that NeoMedia’s stock price at the time the consideration shares issued in connection with each acquisition are saleable (either upon effectiveness of a registration statement containing the shares, or under Rule 144) is less than the price at which they were valued for purposes of the merger agreement ($0.389 per share with respect to Gavitec and $0.3956 per share with respect to 12Snap), NeoMedia is obligated to compensate the sellers in cash for the difference between the price at the time the shares become saleable and the price the shares were valued for purposes of the merger agreement.

On January 23, 2007, NeoMedia reached an agreement with the former shareholders of Gavitec, pursuant to which the parties agreed that the entire purchase price obligation would be satisfied through the payment by NeoMedia of (i) $1,800,000 in cash, payable no later than February 28, 2007 (subsequently extended to March 31, 2007), and (ii) 61,000,000 shares of NeoMedia common stock, to be issued no later than February 28, 2007. The Amendment Agreement stipulates that, in the event that the 61,000,000 shares are not registered for resale by August 31, 2007, interest shall accrue at a rate of 8% per annum on the agreed value of the shares of $1,900,000. NeoMedia also agreed to pay interest accrued on the purchase price in the amount of $213,000 and reimburse $100,000 of costs related to the acquisition to the primary former shareholder of Gavitec no later than February 28, 2007. NeoMedia issued the shares and made cash payments of $2,113,000 during March 2007 in satisfaction of the obligation.

During the first quarter of 2007, NeoMedia issued 197,620,948 shares of its common stock in satisfaction of $9,427,000 of the total $16,233,000 12Snap purchase price guarantee amount. The remaining balance on the purchase price obligation after this payment was $6,806,000. The Company is currently negotiating payment terms for the balance of the obligation.

All Of The Company’s Assets Are Pledged To Secure Certain Debt Obligations, Which The Company Could Fail To Repay

Pursuant to secured convertible debentures, dated as of March 27, 2007, August 24, 2006 and December 29, 2006, in the principal amount of $7,459,000, $5,000,000 and $2,500,000, respectively, issued to Cornell Capital Partners, LP, the Company was required to secure such secured convertible debentures’ repayment with substantially all of its assets. In the event the Company is unable to repay the secured convertible debentures, it could lose all of its assets and be forced to cease its operations. If the Company is found to be in default under the debentures, the full principal amount of the debentures, together with interest and other amounts owing, may become immediately due and payable. As of December 31, 2006, the Company was in default of a covenant contained in the financing agreements due to the Company’s pending registration statement to register the underlying shares of the convertible instruments not becoming effective by the specified date. NeoMedia is also in default of Series C convertible preferred stock with a face value of $22,000,000. As a result of the default, the holder of the securities could redeem the convertible debentures and preferred stock for cash at their discretion. Additionally, as a result of the default, Cornell Capital Partners currently has the right to exercise on a cashless basis 250,000,000 of the warrants they hold, and NeoMedia may not receive any cash proceeds from such exercises.

NeoMedia Has Contractual Commitments To Pay Silent Partners

Resulting from the acquisition of 12 Snap, NeoMedia has a commitment to pay approximately $1 million of remaining obligations to Silent Partners of 12Snap that come due by March 31, 2007, which have not been paid as of the date of this filing. If NeoMedia’s financial resources are insufficient, or if NeoMedia is unable to negotiate a payment plan, NeoMedia may require additional financing in order to meet this obligation. There is no guarantee that NeoMedia will be able to obtain the necessary additional capital to meet this obligation on a timely basis, on acceptable terms, or at all. In any of these events, NeoMedia may be unable to repay this obligation when it becomes due.

There Is Limited Information Upon Which Investors Can Evaluate NeoMedia’s Business Because The Physical-World-To-Internet Market Has Existed For Only A Short Period Of Time

The physical-world-to-Internet market in which NeoMedia operates is a recently developed market. Further, NeoMedia has conducted operations in this market only since March 1996. Consequently, NeoMedia has a relatively limited operating history upon which an investor may base an evaluation of NeoMedia’s primary business and determine NeoMedia’s prospects for achieving its intended business objectives. To date, NeoMedia has had limited sales of its physical-world-to-Internet products. NeoMedia is prone to all of the risks inherent to the establishment of any new business venture, including unforeseen changes in its business plan. An investor should consider the likelihood of NeoMedia’s future success to be highly speculative in light of its limited operating history in its primary market, as well as the limited resources, problems, expenses, risks, and complications frequently encountered by similarly situated companies in new and rapidly evolving markets, such as the physical-world-to-Internet space. To address these risks, NeoMedia must, among other things:

·	maintain and increase its client base;

·	implement and successfully execute its business and marketing strategy;

·	continue to develop and upgrade its products;

·	continually update and improve service offerings and features;

·	respond to industry and competitive developments; and

·	attract, retain, and motivate qualified personnel.

NeoMedia may not be successful in addressing these risks. If NeoMedia is unable to do so, its business, prospects, financial condition, and results of operations would be materially and adversely affected.

NeoMedia’s Future Success Depends On The Timely Introduction Of New Products And The Acceptance Of These New Products In The Marketplace.

Rapid technological change and frequent new product introductions are typical for the markets NeoMedia serves. NeoMedia’s future success will depend in large part on continuous, timely development and introduction of new products that address evolving market requirements. To the extent that NeoMedia fails to introduce new and innovative products, it may lose market share to its competitors, which may be difficult to regain. Any inability, for technological or other reasons, to successfully develop and introduce new products could materially and adversely affect NeoMedia’s business.

NeoMedia’s Common Stock Is Deemed To Be “Penny Stock,” Which May Make It More Difficult For Investors To Sell Their Shares Due To Suitability Requirements

NeoMedia’s common stock is deemed to be “penny stock” as that term is defined in Rule 3a51-1 promulgated under the Securities Exchange Act of 1934, as amended. These requirements may reduce the potential market for NeoMedia’s common stock by reducing the number of potential investors. This may make it more difficult for investors in NeoMedia’s common stock to sell shares to third parties or to otherwise dispose of them. This could cause NeoMedia’s stock price to decline. Penny stocks are stock:

·	with a price of less than $5.00 per share;

·	that are not traded on a “recognized” national exchange;

·	whose prices are not quoted on the NASDAQ automated quotation system (NASDAQ listed stock must still have a price of not less than $5.00 per share); or

·	in issuers with net tangible assets less than $2 million (if the issuer has been in continuous operation for at least three years) or $10 million (if in continuous operation for less than three years), or with average revenues of less than $6 million for the last three years.

Broker-dealers dealing in penny stocks are required to provide potential investors with a document disclosing the risks of penny stocks. Moreover, broker-dealers are required to determine whether an investment in a penny stock is a suitable investment for a prospective investor.

Existing Shareholders Will Experience Significant Dilution When Certain Investors Convert Their Preferred Stock to Common Stock, Convert Outstanding Convertible Debentures, Or When the Investors Exercise Their Warrants and Receive Common Stock Shares Under The Investment Agreement With The Investors

The issuance of shares of common stock pursuant to the conversion of Series C convertible preferred stock, the conversion of convertible debentures, or the exercise of warrants pursuant to NeoMedia’s transactions with Cornell Capital Partners will have a dilutive impact on NeoMedia’s stockholders. As a result, NeoMedia’s net income or loss per share could decrease in future periods, and the market price of its common stock could decline. In addition, the lower NeoMedia’s stock price is, the more shares of common stock NeoMedia will have to issue pursuant to the conversion of preferred stock or the convertible debentures. If NeoMedia’s stock price is lower, then existing stockholders would experience greater dilution.

Due To The Accounting Treatment Of Certain Convertible Preferred Stock And Convertible Debenture Instruments Issued By NeoMedia, A Fluctuation In NeoMedia’s Stock Price Could Have A Material Impact On NeoMedia’s Results Of Operations

During the year ended December 31, 2006, NeoMedia recognized income in the amount of $13,645,000 resulting from adjustments recorded to reflect the change in fair value from revaluation of warrants and embedded conversion features in connection with its Series C convertible preferred shares and its convertible debentures. NeoMedia will adjust the carrying value of its derivative instruments to market at each balance sheet date. As a result, NeoMedia could experience significant fluctuations in its net income (loss) in future periods from such charges based on corresponding movement in NeoMedia’s share price.

NeoMedia Is Uncertain Of The Success Of Its NeoMedia Mobile Business Unit And The Failure Of This Unit Would Negatively Affect The Price Of NeoMedia’s Stock

NeoMedia provides products and services that provide a link from physical objects, including printed material, to the mobile Internet. NeoMedia can provide no assurance that:

·	its NeoMedia Mobile business unit will ever achieve profitability;

·	its current product offerings will not be adversely affected by the focusing of its resources on the physical-world-to-Internet space; or

·	the products NeoMedia develops will obtain market acceptance.

In the event that the NeoMedia Mobile business unit should never achieve profitability, that NeoMedia’s current product offerings should so suffer, or that NeoMedia’s products fail to obtain market acceptance, NeoMedia’s business, prospects, financial condition, and results of operations would be materially adversely affected.

A Large Percentage Of NeoMedia’s Assets Are Intangible Assets, Which Will Have Little Or No Value If NeoMedia’s Operations Are Unsuccessful

At December 31, 2006 and 2005, approximately 57% and 39%, respectively, of NeoMedia’s total assets used in continuing operations were intangible assets and goodwill, consisting primarily of rights related to NeoMedia’s patents, other intellectual property, and excess of purchase price over fair market value paid for Gavitec, 12Snap, and BSD. If NeoMedia’s operations are unsuccessful, these assets will have little or no value, which would materially adversely affect the value of NeoMedia’s stock and the ability of NeoMedia’s stockholders to recoup their investments in NeoMedia’s capital stock.

NeoMedia reviews its amortizable intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is required to be tested for impairment at least annually. NeoMedia may be required to record a significant charge to earnings in its financial statements during the period in which any impairment of NeoMedia’s goodwill or amortizable intangible assets is determined, resulting in an impact on results of operations.

Certain Of NeoMedia’s Emerging Products And Services Have Limited History And May Not Result In Success

To date, NeoMedia has conducted limited marketing efforts directly relating to its emerging technology products, consisting primarily of the qode® suite of products, and certain products of recent acquisition of Gavitec. Many of NeoMedia’s marketing efforts with respect to these emerging technologies have been largely untested in the marketplace, and may not result in materially increased sales of these emerging products and services. To penetrate the emerging markets in which it competes, NeoMedia expects that it will have to exert significant efforts to create awareness of, and demand for, its emerging products and services. To the extent funding is available, NeoMedia intends to continue to expand its sales and marketing resources as the market continues to mature. NeoMedia’s failure to further develop its sales and marketing capabilities and successfully market its emerging products and services would have a material adverse effect on its business, prospects, financial condition, and results of operations.

NeoMedia’s Internally Developed Systems Are Inefficient And May Put NeoMedia At A Competitive Disadvantage

NeoMedia uses internally developed technologies for a portion of its systems integration services, as well as the technologies required to interconnect its clients’ and customers’ physical-world-to-Internet systems and hardware with its own. As NeoMedia develops these systems in order to integrate disparate systems and hardware on a case-by-case basis, these systems are inefficient and require a significant amount of customization. Such client and customer-specific customization is time consuming and costly and may place NeoMedia at a competitive disadvantage when compared to competitors with more efficient systems.

NeoMedia Could Fail To Attract Or Retain Key Personnel

NeoMedia’s future success will depend in large part on its ability to attract, train, and retain additional highly skilled executive level management, creative, technical, and sales personnel. Competition is intense for these types of personnel from other technology companies and more established organizations, many of which have significantly larger operations and greater financial, marketing, human, and other resources than NeoMedia has. NeoMedia may not be successful in attracting and retaining qualified personnel on a timely basis, on competitive terms, or at all. NeoMedia’s failure to attract and retain qualified personnel could have a material adverse effect on its business, prospects, financial condition, and results of operations.

NeoMedia Depends Upon Its Senior Management And Their Loss Or Unavailability Could Put NeoMedia At A Competitive Disadvantage

NeoMedia’s success depends largely on the skills of certain key management and technical personnel, including Charles W. Fritz, NeoMedia’s founder and Chairman of the Board of Directors and the interim Chief Executive Officer, David A. Dodge, NeoMedia’s Chief Financial Officer, Roger M. Pavane, NeoMedia's senior vice president of sales and marketing and head of NeoMedia’s mobile division in the Americas, and Dr. Christian Steinborn, managing director of NeoMedia's Gavitec AG - mobile digit subsidiary in Germany and head of NeoMedia’s mobile division in Europe and Asia. The loss of the services of these individuals could materially harm NeoMedia’s business because of the cost and time necessary to replace and train a replacement. Such a loss would also divert management attention away from operational issues. NeoMedia does not presently maintain a key-man life insurance policy on any of these key individuals. During December 2006, Charles T. Jensen, NeoMedia’s former President and Chief Executive Officer, Martin N. Copus, NeoMedia’s former Chief Operating Officer and the head of its NeoMedia Mobile business unit, and William E. Fritz, outside director, each resigned their positions.

NeoMedia May Be Unsuccessful In Integrating Its Gavitec Acquisition With Its Current Business

The success of the acquisition of Gavitec could depend on the ability of NeoMedia’s executive management to integrate the business plan of Gavitec with NeoMedia’s overall business plan. Failure to properly integrate the business could have a material adverse effect on the expected revenue and operations of the acquisition, as well as the expected return on investment for NeoMedia. During the first quarter of 2006, NeoMedia acquired two businesses, Mobot and Sponge, each of which was divested during the fourth quarter of 2006, less than one year after acquisition. In addition, during February 2007 NeoMedia decided to attempt to sell its wholly owned subsidiaries 12Snap and NeoMedia Telecom Services, both of which were acquired during the first quarter of 2006. For the year ended December 31, 2006, 12Snap and NeoMedia Telecom Services accounted for approximately 91% of NeoMedia’s consolidated revenues, and approximately 5% of NeoMedia’s consolidated net loss for the year ended December 31, 2006. In addition, assets of 12Snap and NeoMedia Telecom Services represented approximately 44% of NeoMedia’s consolidated assets as of December 31, 2006. NeoMedia expects to experience a decrease in revenues and operating losses during 2007 relative to 2006 as a result of these actual and anticipated divestitures.

NeoMedia May Be Unable To Protect Its Intellectual Property Rights And May Be Liable For Infringing The Intellectual Property Rights Of Others

NeoMedia’s success in the physical-world-to-Internet market is dependent upon its proprietary technology, including patents and other intellectual property, and on the ability to protect proprietary technology and other intellectual property rights. In addition, NeoMedia must conduct its operations without infringing on the proprietary rights of third parties. NeoMedia also intends to rely upon unpatented trade secrets and the know-how and expertise of its employees, as well as its patents. To protect its proprietary technology and other intellectual property, NeoMedia relies primarily on a combination of the protections provided by applicable patent, copyright, trademark, and trade secret laws as well as on confidentiality procedures and licensing arrangements. Although NeoMedia believes that it has taken appropriate steps to protect its unpatented proprietary rights, including requiring that its employees and third parties who are granted access to NeoMedia’s proprietary technology enter into confidentiality agreements, NeoMedia can provide no assurance that these measures will be sufficient to protect its rights against third parties. Others may independently develop or otherwise acquire patented or unpatented technologies or products similar or superior to NeoMedia’s.

NeoMedia licenses from third parties certain software tools that are included in NeoMedia’s services and products. If any of these licenses were terminated, NeoMedia could be required to seek licenses for similar software from other third parties or develop these tools internally. NeoMedia may not be able to obtain such licenses or develop such tools in a timely fashion, on acceptable terms, or at all. Companies participating in the software and Internet technology industries are frequently involved in disputes relating to intellectual property. NeoMedia may in the future be required to defend its intellectual property rights against infringement, duplication, discovery, and misappropriation by third parties or to defend against third party claims of infringement. Likewise, disputes may arise in the future with respect to ownership of technology developed by employees who were previously employed by other companies. Any such litigation or disputes could result in substantial costs to, and a diversion of effort by, NeoMedia. An adverse determination could subject NeoMedia to significant liabilities to third parties, require NeoMedia to seek licenses from, or pay royalties to, third parties, or require NeoMedia to develop appropriate alternative technology. Some or all of these licenses may not be available to NeoMedia on acceptable terms or at all, and NeoMedia may be unable to develop alternate technology at an acceptable price or at all. Any of these events could have a material adverse effect on NeoMedia’s business, prospects, financial condition, and results of operations.

NeoMedia Is Exposed To Product Liability Claims And An Uninsured Claim Could Have A Material Adverse Effect On NeoMedia’s Business, Prospects, Financial Condition, And Results Of Operations, As Well As The Value Of NeoMedia’s Stock

Many of NeoMedia’s projects are critical to the operations of its clients’ businesses. Any failure in a client’s information system could result in a claim for substantial damages against NeoMedia, regardless of NeoMedia’s responsibility for such failure. NeoMedia could, therefore, be subject to claims in connection with the products and services that it sells. NeoMedia currently maintains product liability insurance. There can be no assurance that:

·	NeoMedia has contractually limited its liability for such claims adequately or at all; or

·	NeoMedia would have sufficient resources to satisfy any liability resulting from any such claim.

The successful assertion of one or more large claims against NeoMedia could have a material adverse effect on its business, prospects, financial condition, and results of operations.

NeoMedia Will Not Pay Cash Dividends And Investors May Have To Sell Their Shares In Order To Realize Their Investment

NeoMedia has not paid any cash dividends on its common stock and does not intend to pay cash dividends in the foreseeable future. NeoMedia intends to retain future earnings, if any, for reinvestment in the development and marketing of NeoMedia’s products and services. As a result, investors may have to sell their shares of common stock to realize their investment.

Some Provisions Of NeoMedia’s Certificate of Incorporation And bylaws May Deter Takeover Attempts, Which May Limit The Opportunity Of NeoMedia’s Stockholders To Sell Their Shares At A Premium To The Then-Current Market Price

Some of the provisions of NeoMedia’s Certificate of Incorporation and bylaws could make it more difficult for a third party to acquire NeoMedia, even if doing so might be beneficial to NeoMedia’s stockholders by providing them with the opportunity to sell their shares at a premium to the then-current market price. On December 10, 1999, NeoMedia’s Board of Directors adopted a stockholders rights plan and declared a non-taxable dividend of one right to acquire Series A Preferred Stock of NeoMedia, par value $0.01 per share, on each outstanding share of NeoMedia’s common stock to stockholders of record on December 10, 1999 and each share of common stock issued thereafter until a pre-defined hostile takeover date. The stockholder rights plan was adopted as an anti-takeover measure, commonly referred to as a “poison pill.” The stockholder rights plan was designed to enable all stockholders not engaged in a hostile takeover attempt to receive fair and equal treatment in any proposed takeover of NeoMedia and to guard against partial or two-tiered tender offers, open market accumulations, and other hostile tactics to gain control of NeoMedia. The stockholders rights plan was not adopted in response to any effort to acquire control of NeoMedia at the time of adoption. This stockholders rights plan may have the effect of rendering more difficult, delaying, discouraging, preventing, or rendering more costly an acquisition of NeoMedia or a change in control of NeoMedia. Certain of NeoMedia’s directors, officers and principal stockholders, Charles W. Fritz, William E. Fritz and The Fritz Family Limited Partnership and their holdings were exempted from the triggering provisions of NeoMedia’s “poison pill” plan, as a result of the fact that, as of the plan’s adoption, their holdings might have otherwise triggered the “poison pill”.

In addition, NeoMedia’s Certificate of Incorporation authorizes the Board of Directors to designate and issue preferred stock, in one or more series, the terms of which may be determined at the time of issuance by the Board of Directors, without further action by stockholders, and may include voting rights, including the right to vote as a series on particular matters, preferences as to dividends and liquidation, conversion, redemption rights, and sinking fund provisions.

NeoMedia is authorized to issue a total of 25,000,000 shares of Preferred Stock, par value $0.01 per share. The issuance of any preferred stock could have a material adverse effect on the rights of holders of NeoMedia’s common stock, and, therefore, could reduce the value of shares of NeoMedia’s common stock. In addition, specific rights granted to future holders of preferred stock could be used to restrict NeoMedia’s ability to merge with, or sell NeoMedia’s assets to, a third party. The ability of the Board of Directors to issue preferred stock could have the effect of rendering more difficult, delaying, discouraging, preventing, or rendering more costly an acquisition of NeoMedia or a change in NeoMedia’s control.

Risks Relating To NeoMedia’s Industry

The Security Of The Internet Poses Risks To The Success Of NeoMedia’s Entire Business

Concerns over the security of the Internet and other electronic transactions, and the privacy of consumers and merchants, may inhibit the growth of the Internet and other online services generally, especially as a means of conducting commercial transactions, which may have a material adverse effect on NeoMedia’s physical-world-to-Internet business.

NeoMedia Will Only Be Able To Execute Its Physical-World-To-Internet Business Plan If Internet Usage and Electronic Commerce Continue To Grow

NeoMedia’s future revenues and any future profits are substantially dependent upon the widespread acceptance and use of the Internet and camera devices on mobile telephones. If use of the Internet and camera devices on mobile telephones does not continue to grow or grows more slowly than expected, or if the infrastructure for the Internet and camera devices on mobile telephones does not effectively support the growth that may occur, or does not become a viable commercial marketplace, NeoMedia’s physical-world-to-Internet business, and therefore NeoMedia’s business, prospects, financial condition, and results of operations, could be materially adversely affected. Rapid growth in the use of, and interest in, the Internet and camera devices on mobile telephones is a recent phenomenon, and may not continue on a lasting basis. In addition, customers may not adopt, and continue to use mobile telephones as a medium of information retrieval or commerce. Demand and market acceptance for recently introduced services and products over the mobile Internet are subject to a high level of uncertainty, and few services and products have generated profits. For NeoMedia to be successful, consumers and businesses must be willing to accept and use novel and cost efficient ways of conducting business and exchanging information.

In addition, the public in general may not accept the use of the Internet and camera devices on mobile telephones as a viable commercial or information marketplace for a number of reasons, including potentially inadequate development of the necessary network infrastructure or delayed development of enabling technologies and performance improvements. To the extent that mobile phone Internet usage continues to experience significant growth in the number of users, their frequency of use, or in their bandwidth requirements, the infrastructure for the mobile Internet may be unable to support the demands placed upon them. In addition, the mobile Internet and mobile interactivity could lose its viability due to delays in the development or adoption of new standards and protocols required to handle increased levels of mobile Internet activity, or due to increased governmental regulation. Significant issues concerning the commercial and informational use of the mobile Internet, and online networks technologies, including security, reliability, cost, ease of use, and quality of service, remain unresolved and may inhibit the growth of Internet business solutions that utilize these technologies. Changes in, or insufficient availability of, telecommunications services to support the Internet, the Web or other online services also could result in slower response times and adversely affect usage of the Internet, the Web and other online networks generally and NeoMedia’s physical-world-to-Internet product and networks in particular.

NeoMedia May Not Be Able To Adapt As The Internet, Physical-World-To-Internet, And Customer Demands Continue To Evolve

NeoMedia may not be able to adapt as the mobile Internet and physical-world-to-Internet markets and consumer demands continue to evolve. NeoMedia’s failure to respond in a timely manner to changing market conditions or client requirements would have a material adverse effect on its business, prospects, financial condition, and results of operations. The mobile Internet and physical-world-to-Internet markets are characterized by:

·	rapid technological change;

·	changes in user and customer requirements and preferences;

·	frequent new product and service introductions embodying new technologies; and

·	the emergence of new industry standards and practices that could render proprietary technology and hardware and software infrastructure obsolete.

NeoMedia’s success will depend, in part, on its ability to:

·	enhance and improve the responsiveness and functionality of its products and services;

·	license or develop technologies useful in its business on a timely basis;

·	enhance its existing services, and develop new services and technologies that address the increasingly sophisticated and varied needs of NeoMedia’s prospective or current customers; and

·	respond to technological advances and emerging industry standards and practices on a cost-effective and timely basis.

NeoMedia May Not Be Able To Compete Effectively In Markets Where Its Competitors Have More Resources

While the market for physical-world-to-Internet technology is relatively new, it is already highly competitive and characterized by an increasing number of entrants that have introduced or developed products and services similar to those offered by NeoMedia. NeoMedia believes that competition will intensify and increase in the near future. NeoMedia’s target market is rapidly evolving and is subject to continuous technological change. As a result, NeoMedia’s competitors may be better positioned to address these developments or may react more favorably to these changes, which could have a material adverse effect on NeoMedia’s business, prospects, financial condition, and results of operations.

Some of NeoMedia’s competitors have longer operating histories, larger customer bases, longer relationships with clients, and significantly greater financial, technical, marketing, and public relations resources than NeoMedia. NeoMedia may not successfully compete in any market in which it conducts or may conduct operations. NeoMedia may not be able to penetrate markets or market its products as effectively as NeoMedia’s better-funded more-established competitors.

In The Future There Could Be Government Regulations And Legal Uncertainties Which Could Harm NeoMedia’s Business

Any new legislation or regulation, the application of laws and regulations from jurisdictions whose laws do not currently apply to NeoMedia’s business, or the application of existing laws and regulations to the Internet and other online services, could have a material adverse effect on NeoMedia’s business, prospects, financial condition, and results of operations. Due to the increasing popularity and use of the Internet, the Web and other online services, federal, state, and local governments may adopt laws and regulations, or amend existing laws and regulations, with respect to the Internet or other online services covering issues such as taxation, user privacy, pricing, content, copyrights, distribution, and characteristics and quality of products and services. The growth and development of the market for electronic commerce may prompt calls for more stringent consumer protection laws to impose additional burdens on companies conducting business online. The adoption of any additional laws or regulations may decrease the growth of the Internet, the Web or other online services, which could, in turn, decrease the demand for NeoMedia’s services and increase NeoMedia’s cost of doing business, or otherwise have a material adverse effect on NeoMedia’s business, prospects, financial condition, and results of operations. Moreover, the relevant governmental authorities have not resolved the applicability to the Internet, the Web and other online services of existing laws in various jurisdictions governing issues such as property ownership and personal privacy and it may take time to resolve these issues definitively.

Certain of NeoMedia’s proprietary technology allows for the storage of demographic data from NeoMedia’s users. In 2000, the European Union adopted a directive addressing data privacy that may limit the collection and use of certain information regarding Internet users. This directive may limit NeoMedia’s ability to collect and use information collected by NeoMedia’s technology in certain European countries. In addition, the Federal Trade Commission and several state governments have investigated the use by certain Internet companies of personal information. NeoMedia could incur significant additional expenses if new regulations regarding the use of personal information are introduced or if NeoMedia’s privacy practices are investigated.

ITEM 1B. UNRESOLVED STAFF COMMENTS.

None.

ITEM 2. PROPERTIES

NeoMedia’s principal executive, development and administrative office is located at 2201 Second Street, Suite 600, Fort Myers, Florida 33901. NeoMedia occupies approximately 12,000 square feet under terms of a written lease from an unaffiliated party which expires on July 31, 2008, with monthly rent totaling approximately $18,000.

The Company maintains a production and product development facility for its Micro Paint Repair Business unit in Calgary, Alberta, Canada, occupying approximately 4,000 square feet under the terms of a written month-to-month lease from an affiliated party with monthly rent totaling $2,400.

The Company maintains a training, demonstrations, production, distribution, and retail services facility for its Micro Paint Repair Business unit in Ft. Myers, Florida, occupying approximately 10,000 square feet under the terms of a written lease from an unaffiliated party expiring on February 28, 2008, with monthly rent totaling approximately $9,000.

The Company maintains an office housing its NeoMedia Telecom Services operations at Suite 300, 5824 Second Street S.W., Calgary, Alberta, Canada T2H 0H2 and occupies approximately 3,900 square feet under terms of a lease which expires February 28, 2009. NeoMedia Telecom Services’ operations are capable of being quickly and efficiently re-located with no interruption in service provisioning.

The Company maintains an office housing its Gavitec AG operations at Jens-Otto-Krag-Str. 11, 52146 Würselen, Germany and occupies approximately 4400 square feet under terms of a lease which expires September 30, 2008.

The Company maintains an office housing 12Snap’s UK operations at 19 Bulstrode Street, London, W1U 2JN and occupies approximately 400 square feet under terms of a lease which expires with a 1 month written notice. The Company maintains an office housing 12Snap’s Sweden operations at Kungsgatan 4A, Stockholm 111 43, and occupies approximately 2,700 square feet under terms of a lease which expires June 30, 2009. The Company maintains an office housing 12Snap’s main operations at Lazarettstrasse 4, Munich 80636 and occupies approximately 2,800 square feet under terms of a lease which expires with a 180 day written notice. The Company maintains an office housing 12Snap’s Romania operations at Coriolan Brediceanu 8, et.6, Timisoara 300011, and occupies approximately 1,400 square feet under terms of a lease which expires with 60 days written notice.

During 2005, NeoMedia occupied a sales facility at 2150 Western Court, Suite 230, Lisle, Illinois 60532, occupying approximately 6,000 square feet under the terms of a written month-to-month lease from an unaffiliated party with monthly rent totaling approximately $4,000. During February 2006, NeoMedia cancelled the lease and centralized the operations from this facility to its Ft. Myers, FL headquarters.

The Company believes that existing office space is adequate to meet current and short-term requirements for its operations.

ITEM 3. LEGAL PROCEEDINGS

The Company is involved in various legal actions arising in the normal course of business, both as claimant and defendant. While it is not possible to determine with certainty the outcome of these matters, it is the opinion of management that the eventual resolution of the following legal actions could have a material adverse effect on the Company’s financial position or operating results.

Scanbuy, Inc.

On January 23, 2004, NeoMedia filed suit against Scanbuy, Inc. (“Scanbuy”) in the Northern District of Illinois, claiming that Scanbuy has manufactured, or has manufactured for it, and has used, or actively induced others to use, technology which allows customers to use a built-in UPC bar code scanner to scan individual items and access information, thereby infringing NeoMedia’s patents. The complaint stated that on information and belief, Scanbuy had actual and constructive notice of the existence of the patents-in-suit, and, despite such notice, failed to cease and desist their acts of infringement and continue to engage in acts of infringement of the patents-in-suit. On April 15, 2004, the court dismissed the suits against Scanbuy for lack of personal jurisdiction.

On April 20, 2004, NeoMedia re-filed its suit against Scanbuy in the Southern District of New York alleging patent infringement. Scanbuy filed its answer on June 2, 2004. NeoMedia filed its answer and affirmative defenses on July 23, 2004. On February 13, 2006, Scanbuy filed an amended answer to the complaint. NeoMedia filed its reply to Scanbuy’s amended answer on March 6, 2006. On January 20, 2007, the court dismissed Scanbuy's request for a summary judgment. Discovery is ongoing.

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

None.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

The Company’s shares trade on the Over-the-counter Bulletin Board (“OTCBB”) under the symbol “NEOM.” As of December 31, 2006, the Company had 637,591,747 common shares outstanding.

The following table summarizes the high and low closing sales prices per share of the common stock for the periods indicated as reported on the Over-the-counter Bulletin Board:

	(U.S. dollars)

2005	HIGH		LOW
First Quarter	$	0.29	$	0.22
Second Quarter	$	0.72	$	0.19
Third Quarter	$	0.51	$	0.32
Fourth Quarter	$	0.45	$	0.28

2006		HIGH		LOW
First Quarter	$	0.42	$	0.29
Second Quarter	$	0.32	$	0.20
Third Quarter	$	0.23	$	0.11
Fourth Quarter	$	0.12	$	0.05

Holders

As of December 31, 2006, NeoMedia had an estimated 16,000 recordholders of its common stock.

Dividends

The Company has not declared or paid any cash dividends on its common stock during the years ended December 31, 2006, 2005, or 2004. The Company will base any issuance of dividends upon its earnings, financial condition, capital requirements and other factors considered important by its board of directors. Delaware law and the Company’s certificate of incorporation do not require the board of directors to declare dividends on the Company’s common stock. The Company expects to retain all earnings, if any, generated by its operations for the development and growth of its business and does not anticipate paying any dividends to its stockholders for the foreseeable future.

Securities authorized for issuance under equity compensation plans

The following table presents certain information with respect to the Company’s equity compensation plans as of December 31, 2006:

					Number of
					securities
	Number of				remaining available
	securities to be				for future issuance
	issued upon		Weighted-average		under equity
	exercise of		exercise price of		compensation plans
	outstanding		outstanding		(excluding
	options, warrants		options, warrants		securities reflected
	and rights		and rights		in column (a))
Plan Category	(a)		(b)		(c)
Equity compensation plans approved by security holders		105,822,455	$	0.20		79,567,544

Equity compensation plans not approved by security holders		—		—		—

Total		105,822,455	$	0.20		79,567,544

Performance Graph

In accordance with the rules of the SEC, this section entitled “Performance Graph” shall not be incorporated by reference into any of NeoMedia’s future filings under the Securities Act or the Exchange Act, and shall not be deemed to be soliciting material or to be filed under the Securities Act or the Exchange Act.

The following graph illustrates the cumulative total stockholder return that would have been realized (assuming reinvestment of dividends) by an investor who invested $100 on December 31, 2001 in each of i) NeoMedia common stock, ii) the Russell MicroCap Index, iii) Axcess International common stock, and iv) Critical Path Inc. common stock. Axcess International and Critical Path Inc. were chosen for comparison as they also trade on the OTCBB, have similar market capitalization, and similar standard industry codes. There are not currently any published peer group indexes or line of business indexes available for comparative use, nor were there any readily identifiable peer groups.

NeoMedia Indexed Performance:

	As of December 31,
	2001		2002		2003		2004		2005		2006
NeoMedia	$	100.00	$	7.86	$	97.86	$	189.29	$	217.14	$	37.86
Russell Microcap Index	$	100.00	$	83.90	$	139.57	$	159.31	$	163.40	$	190.43
Axcess International	$	100.00	$	11.87	$	51.37	$	39.50	$	18.72	$	26.71
Critical Path Inc.	$	100.00	$	18.61	$	12.14	$	13.41	$	2.46	$	1.00

Recent Issuances of Unregistered Securities

On March 19, 2007, the Company issued 197,620,948 shares of common stock to the former 12Snap shareholders as partial payment against the purchase price protection clause of the original sale and purchase agreement between the former 12Snap shareholders and NeoMedia. The shares were valued at $0.045 per share, which was the contractual price based on fair value at the time of issuance.

On March 1, 2007, the Company issued 61,000,000 shares of common stock to the former Gavitec shareholders as partial payment against the purchase price protection clause of the original sale and purchase agreement between the former Gavitec shareholders and NeoMedia. The shares were valued at $0.053 per share, which was the contractual price based on fair value at the time of issuance.

On November 28, 2006, the Company issued 6,631,579 shares of common stock to Cornell Capital Partners upon conversion by Cornell of Series C convertible preferred stock. The shares were valued at $0.057 per share, which was the contractual price based on fair value at the time of issuance.

On June 15, 2006, the Company issued 3,721,698 shares of its common stock a an initial payment against debt and accrued interest owed to Wayside Solutions, Inc. (“Wayside”), a corporation that had provided financing to BSD prior to the acquisition of to BSD by the Company. Prior to the acquisition, the Company reached an agreement with Wayside to pay the outstanding debt due to Wayside subsequent to completion of the acquisition. The shares contain a make whole provision that calls for additional shares to be issued in the event the value of the original shares at the time of registration is less than the value at the time they were issued. The last sale price on the date of issuance was $0.227 per share.

On April 26, 2006, the Company issued 1,512,093 shares of its common stock in satisfaction of the debt and accrued interest due to Guy Fietz, CEO, President and a shareholder of BSD, and now Vice President and General Manager of NeoMedia Telecom Services. NeoMedia valued the stock at $0.24 per share, which was the last sale price on the date of issuance.

On March 21, 2006, the Company issued an aggregate of 7,123,698 shares as consideration paid to acquire all of the shares of BSD Software, Inc. (“BSD”) The shares were issued to the former shareholders of BSD, which was a publicly traded company prior to the transaction. The shares were valued at $0.352 per share, which was the average stock price for two days before and two days after the announcement of the acquisition.

On February 23, 2006, the Company issued an aggregate of 33,097,135 shares to 12 separate parties as part of the consideration paid to acquire all of the shares of Sponge Ltd. The shares were valued at $0.395 per share, which was the average stock price for two days before and two days after the announcement of the acquisition.

On February 23, 2006, the Company issued an aggregate of 13,660,511 shares to 8 separate parties as part of the consideration paid to acquire all of the shares of Gavitec AG. The shares were valued at $0.386 per share, which was the average stock price for two days before and two days after the announcement of the acquisition.

On February 22, 2006, the Company issued an aggregate of 49,294,581 shares to 23 separate parties as part of the consideration paid to acquire all of the shares of 12Snap AG. The shares were valued at $0.394 per share, which was the average stock price for two days before and two days after the announcement of the acquisition.

On February 17, 2006, the Company issued an aggregate of 16,931,493 shares to 11 separate parties as part of the consideration paid to acquire all of the shares of Mobot, Inc. The shares were valued at $0.395 per share, which was the average stock price for two days before and two days after the announcement of the acquisition.

On July 26, 2005, the Company issued to Newbridge Securities, an unrelated party, 44,723 shares of common stock in exchange for placement agent services to be provided in connection with NeoMedia’s Standby Equity Distribution Agreement with Cornell Capital Partners. The shares were valued at $0.41, which was the market price at the time of issuance.

On June 25, 2004, the Company issued to Marvin Tkachuk, an unrelated distribution agent, 322,228 shares of common stock in exchange for exclusivity rights under a distribution contract. The shares were valued at $0.074, which was the market price at the time of the agreement.

On June 9, 2004, the Company issued to Stanton Hill, a current outside consultant and former president of CSI International, Inc., 518,185 shares of common stock as payment for debt acquired with the purchase by NeoMedia of CSI in February 2004. The shares were valued at $0.061, which was the market price at the time of the agreement.

On March 8, 2004, the Company issued to Stone Street Asset Management, LLC, 40,000,000 warrants to purchase shares of common stock at an exercise price of $0.05 per share. The market price at the time of issuance was $0.11.

On February 25, 2004, the Company issued 103,199 shares of stock to David Kaminer, as payment of past due professional services. The shares were valued at $0.097. The market price at the time of the agreement was $0.102.

On February 6, 2004, the Company issued 7,000,000 shares of common stock to CSI International, Inc. shareholders in connection with NeoMedia’s purchase of CSI. The closing market price on the date of issuance was $0.10.

The Company relied upon the exemption provided in Section 4(2) of the Securities Act and/or Rule 506, which cover “transactions by an issuer not involving any public offering,” to issue securities discussed above without registration under the Securities Act of 1933. The certificates representing the securities issued displayed a restrictive legend to prevent transfer except in compliance with applicable laws, and the Company’s transfer agent was instructed not to permit transfers unless directed to do so by us, after approval by the Company’s legal counsel. The Company believes that the investors to whom securities were issued had such knowledge and experience in financial and business matters as to be capable of evaluating the merits and risks of the prospective investment. The Company also believes that the investors had access to the same type of information as would be contained in a registration statement.

ITEM 6. SELECTED FINANCIAL DATA

	Years Ended December 31,
	2006(a)			2005(b)			2004(b)			2003			2002
	(in thousands, except share data)
				(Reclassified)*			(Reclassified)*
Total net sales	$	10,309		$	877		$	973		$	2,400		$	9,399
Net loss from continuing operations		($52,252	)		($7,146	)		($6,272	)		($5,382	)		($7,421	)
Net loss per share from continuing operations		($0.09	)		($0.02	)		($0.02	)		($0.04	)		($0.26	)

Total assets	$	38,125		$	12,411		$	10,406		$	3,876		$	4,323
Total liabilities	$	92,659		$	8,184		$	6,014		$	7,079		$	10,349

* - Reclassification of operations of the discontinued Micro Paint, Mobot, and Sponge business units

(a) - during the year ended December 31, 2006, NeoMedia acquired five subsidiaries: Mobot, Inc., Gavitec AG, Sponge Ltd., 12Snap AG, and BSD Software, Inc. Net sales for the year ended December 31, 2006 are materially higher than prior years as a result of net sales from these acquired subsidiaries. In addition, net loss from continuing operations for the year ended December 31, 2006 includes the following items that were not incurred in previous years: (i) $18,327,000 impairment charge to write down carrying value of 12Snap asset group, (ii) $13,256,000 charge to write off deferred equity financing costs associated with the 2005 Standby Equity Distribution Agreement with Cornell Capital Partners, (iii) interest charges of $7,770,000 incurred to adjust convertible debentures to their redemption value, (iv) $7,250,000 stock based compensation resulting primarily from the adoption of SFAS 123(R) on January 1, 2006, and (v) a gain of $13,645,000 resulting from the change in fair value from repricing and revaluation of warrants and embedded conversion features associated with the preferred stock and convertible debenture financing.

(b) - Results of operations for the years ended December 31, 2005 and 2004 include reclassification of operations of the discontinued Micro Paint, Mobot, and Sponge business units. Financial position as of December 31, 2005 is reclassified for Micro Paint business unit assets and liabilities held for sale.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Corporate Structure

During 2006, with its acquisitions of Gavitec, Mobot, 12Snap, and Sponge, NeoMedia implemented an aggressive growth strategy aimed at penetrating the rapidly evolving mobile marketing industry, and capturing a significant portion of early adopting marketers to drive high volumes of physical-world-to-mobile-internet traffic through the NeoMedia engine.

The majority of the consideration issued to acquire Gavitec, Mobot, 12Snap, and Sponge consisted of shares of NeoMedia common stock, the value of which was guaranteed, in cash, to the recipients by NeoMedia from the time of issuance through the time the shares were registered for resale (either upon effectiveness of a registration statement containing the shares, or under Rule 144). As a result of NeoMedia’s declining share price from the first quarter through the end of 2006, the make whole provisions relating to these acquisitions became far greater than NeoMedia could reasonably satisfy with cash. Primarily as a result of the pending make whole provisions, during the fourth quarter of 2006 NeoMedia divested of the majority of Sponge and Mobot back to the original owners, with the respective make whole liability provisions being forgiven as part of each transaction. Additionally, during the first quarter of 2007, NeoMedia reached an agreement with the former shareholders of Gavitec that will allow for the majority of that make whole to be paid in shares. NeoMedia also reached an agreement with former shareholders of 12Snap representing approximately 61% of that make whole for payment in common stock.

During August 2006, NeoMedia announced that it intended to sell its Micro Paint Repair business. During the fourth quarter of 2006, NeoMedia divested of its Mobot and Sponge subsidiaries. During January 2007, the Company decided to attempt to sell its remaining non-core business units (12Snap and Telecom Services) in the most profitable, timely and viable manner possible. NeoMedia plans to use the strategic equity earned through the sale of these assets to reduce its current burn rate, help the Company move closer to profitability, and provide financial stability by the end of 2007, and to become profitable by the first quarter of 2008. Most importantly, the shedding of NeoMedia’s non-core assets affords the Company the ability to focus all its resources on its core business initiatives. Management realizes the challenges that the Company faces in the global application of its technology, and can now present qode® to the industry and the public in a more systematic and focused approach, marketing it as “the next phase of the Internet” and the wireless Web.

Despite the divestures of Sponge and Mobot, and the planned sales of 12Snap and NeoMedia Telecom, NeoMedia continues to focus on becoming the worldwide leader in linking the physical world to the mobile internet. Management believes that the decision to sell the non-core assets has led to a more focused vision for moving the Company forward and creating shareholder value, focusing on the core code-reading business and related intellectual property in North America, the UK, mainland Europe and China.

The Core Business

During 2006, NeoMedia made significant inroads into the burgeoning mobile marketing industry and ran many successful physical-world-to-mobile-web campaigns.

In North America, qode® technology has been trialed and implemented across a wide variety of products and industries, including:

·	qode® was featured in an interactive textbook published by Prentice Hall, in which students can link to mobile online content through the qode® reader on their mobile phones.

ONE water, the ethical water brand, featured codes on 5 million of its water bottles that link to the mobile internet via qode® starting in December, when the first shipments of more than 5 million bottles bearing qode®. The bottles were sold at more than 4,000 retail outlets throughout the United Kingdom.

·	NeoMedia is partnered with News Group Newspapers, and its market-leading Sunday newspaper, the News of the World®, to use qode® in the United Kingdom to bring television clips of English Premier League soccer to its readers via their mobile phones

In Europe, Gavitec also designed, implemented, and ran multiple mobile marketing solutions:

·	Gavitec was contracted by AWK Aussenwerbung GmbH, Germany’s second-largest outdoor advertising company, to develop a mobile order-management and control system using Gavitec technology;

Gavitec partnered with solution provider TopSolutions to equip Lusomundo, Portugal's leading cinema chain, with admission terminals for mobile tickets that allow movie-goers to obtain tickets through a cash-free Web-based transaction, and receive an electronic ticket as an SMS on their mobile phones;

·	Gavitec ran or participated in other campaigns during 2006 with customers such as McDonald’s Portugal, Amnesty International, Malaysian Railways, World Soccer Games 2006, EMT (Empresa Malagueña de Transportes, a Spanish public transport provider), Ströer, and Bitburger beer;

NeoMedia also made significant inroads into Asia during 2006, as follows:

·	Gavitec signed an exclusive license agreement with mobile marketing specialist Omniprime, pursuant to which Omniprime will sell mobile couponing and ticketing applications in the Philippines using Gavitec’s technology.

·	NeoMedia contracted with five large Chinese insurance companies to adapt qode® to enable millions of policy holders in China to use their cell phones to link directly to their insurance company's Mobile Internet site

·	During January 2007, NeoMedia signed a performance-based agency agreement with NexMobil LLC, pursuant to which NexMobil will sell qode® products and services in the Middle East, India, Korea, and Pakistan.

Building on the deals already completed, NeoMedia will focus on targeting manufacturers within the media and enterprise space, including newspapers, publishers, real estate, physical world advertisers, and beverage producers to design their products to become more interactive. NeoMedia envisions a future in which consumers routinely “qode® it” when they want more information on a product or service. NeoMedia’s goals include hiring a new sales force, while penetrating three verticals with at least six major customers. Another major goal is to partner with at least three major carriers or manufacturers (North American, UK and mainland European) who will embed, adopt and commit to utilize every feature qode® has to offer.

NeoMedia is also making great strides to create a global standard for the wireless Web. NeoMedia co-hosted a high-level meeting in London during February 2007 with some of the world’s leading technology firms to begin to define and document this important standards-based initiative. NeoMedia believes the outcome of the meeting was extremely positive and expects, along with its numerous innovative partners, to continue to play an active role in the standardization of the physical-world-to-web initiative. One of NeoMedia’s key initiatives is to evaluate and optimize the value of its and its partners’ collective intellectual property relating to this space.

NeoMedia has numerous issued patents with others in process and is continuing to seek to optimize the value of its intellectual property portfolio around in the world. On January 20, 2007, Judge John E. Sprizzo dismissed Scanbuy's request for a summary judgment in the Company’s patent infringement case against Scanbuy. While the case is not over yet, NeoMedia continues to remain confident in the final outcome.

In terms of new leadership, NeoMedia saw the departure of its CEO and COO during the fourth quarter of 2006. The Company expects to name a permanent CEO during 2007. In addition, Roger Pavane was brought in as SVP of Sales and Marketing and is heading up the mobile division efforts in the Americas and the UK. Mr. Pavane is a wireless industry veteran with 20+ years experience in this space. Also, Dr. Christian Steinborn, current president of Gavitec, was promoted to head up the mobile division efforts in the rest of the world, with a focus on mainland Europe and China. Finally, during January 2007 NeoMedia appointed George O’Leary as a member of its Board of Directors. Mr. O’Leary is currently the President of SKS Consulting of South Florida Corp. and is working with NeoMedia under a two year consulting agreement to lead the execution of the strategic plan.

Accounting Treatment of Series C Convertible Preferred Stock and Convertible Debenture

Due to a default on Series C convertible preferred stock (February 17, 2006) and Convertible Debentures (August 24, 2006 and December 29, 2006) resulting from failure to register the underlying common shares by the prescribed deadline, NeoMedia recorded an accretion of dividends on convertible preferred stock in the amount of $20,324,000 to adjust the carrying value of the Series C convertible preferred stock to its redemption value, and also recorded interest expense in the amount of $7,770,000 to adjust the carrying value of the convertible debentures to their face value. The accretion of dividends is a component of net loss attributable to common shareholders, and as is not included in NeoMedia’s net loss.

Additionally, NeoMedia recognized a gain on derivative financial instruments of $13,645,000 during the year ended December 31, 2006. The gain is due to the change in fair value of derivative financial instruments resulting from a decrease in NeoMedia's stock price from the date of inception of each instrument through December 31, 2006. The fair value of the derivative financial instruments at each measurement date correlates to NeoMedia's stock price at the same date. As a result, NeoMedia's net loss varies significantly from its cash flow from operations during the year ended December 31, 2006. In future periods, NeoMedia's loss could fluctuate dramatically from quarter to quarter if its stock price is significantly different from the stock price at the end of the previous measurement period. Because NeoMedia cannot guarantee that it has enough authorized shares to net share settle the Series C convertible preferred stock, the change in fair value of derivative instruments will be recorded to NeoMedia's statement of operations each reporting period until the Series C convertible preferred stock is fully converted.

NeoMedia also recorded a charge of $3,537,000 related to the repricing of certain warrants that were issued in conjunction with the Series C convertible preferred stock.

Write-off of Deferred Financing Costs

In the third quarter of 2006, NeoMedia incurred a non-cash charge to income in the amount of $13,256,000 to write off deferred equity financing costs related to its $100 million Standby Equity Distribution Agreement. The costs were originally recorded in March 2005 and represent the fair value of warrants issued as financing costs associated with the 2005 SEDA. The Company believes that it can no longer consider the 2005 SEDA a viable financing source due to the utilization of the preferred stock financing and the debenture financing.

Impairment of 12Snap Assets

During the first quarter of 2007, NeoMedia initiated an action plan to sell its subsidiary 12Snap. During the year ended December 31, 2006, NeoMedia recorded an impairment charge of $18,327,000 to adjust the carrying value of the 12Snap asset group to the expected net proceeds from the sale of the assets. Prior to the impairment charge, the asset group consisted primarily of goodwill and other intangible assets recorded upon purchase of 12Snap by NeoMedia during the first quarter of 2006. In connection with its decision to sell the 12Snap business in the first quarter of 2007, NeoMedia altered its expected cashflow to reflect the estimated net cash proceeds that the Company anticipates receiving in a sale transaction. Since the sale is not subject to a binding and completed agreement, actual cash received from the sale could vary materially from the assumptions used in the impairment analysis, which would result in a gain or loss at the time the sale is completed. The impairment charge did not result in the violation of any debt covenants. NeoMedia also carries on its balance sheet intangible assets associated with its Gavitec, Telecom services, and Micro Paint Repair business (included in assets held for sale) that were tested for impairment and were deemed not to be impaired.

Related Party Transaction

During the fourth quarter of 2005 and first quarter of 2006, NeoMedia shipped and invoiced $759,000 of Micro Paint Repair products to Automart, Inc. In the third quarter of 2006, NeoMedia established a reserve for bad debt against the open accounts receivable, and wrote off the deferred revenue and deferred costs, incurring a net charge to its statement of operations of $653,000. NeoMedia will recognize revenue on these shipments if and when collectibility is reasonably assured. David A. Dodge, NeoMedia’s Chief Financial Officer, and Kevin Hunter, NeoMedia’s Chief Scientist, are each members of the board of directors of Automart, a publicly traded company trading in the Over-the-counter Bulletin Board.

Critical Accounting Policies

The United States Securities and Exchange Commission (the “SEC”) issued Financial Reporting Release No. 60, “Cautionary Advice Regarding Disclosure About Critical Accounting Policies” (“FRR 60”), suggesting companies provide additional disclosure and commentary on their most critical accounting policies. In FRR 60, the SEC defined the most critical accounting policies as the ones that are most important to the portrayal of a company’s financial condition and operating results, and require management to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, NeoMedia’s most critical accounting policies include: intangible asset valuation, which affects amortization and impairment of goodwill and other intangibles; financial instruments and concentrations of credit risk, which affects gains and losses from derivative financial instruments; allowance for doubtful accounts; inventory valuation, which affects cost of sales and gross margin; stock based compensation; estimate of litigation-based liability; and revenue recognition. NeoMedia also has other key accounting policies, such as policies for revenue recognition, including the deferral of a portion of revenues on sales to distributors, allowance for doubtful accounts, and stock-based compensation. The methods, estimates and judgments NeoMedia uses in applying these most critical accounting policies have a significant impact on the results it reports in its consolidated financial statements.

Intangible Asset Valuation. The determination of the fair value of certain acquired assets and liabilities is subjective in nature and often involves the use of significant estimates and assumptions. Determining the fair values and useful lives of intangible assets especially requires the exercise of judgment. While there are a number of different generally accepted valuation methods to estimate the value of intangible assets acquired, NeoMedia primarily uses the weighted-average probability method outlined in SFAS 144. This method requires significant management judgment to forecast the future operating results used in the analysis. In addition, other significant estimates are required such as residual growth rates and discount factors. The estimates NeoMedia has used are consistent with the plans and estimates that NeoMedia uses to manage its business, based on available historical information and industry averages. The judgments made in determining the estimated useful lives assigned to each class of assets acquired can also significantly affect NeoMedia’s net operating results.

According to SFAS 144, a long-lived asset should be tested for recoverability whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. The following are examples of such events or changes in circumstances:

·	A significant decrease in the market price of the asset

·	A significant adverse change in the extent or manner in which the asset is being used, or in its physical condition

·	A significant adverse change in legal factors or in the business climate that could affect the value of the asset, including an adverse action or assessment by a regulator

·	An accumulation of costs significantly in excess of the amount originally expected

·	A current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of the asset

·	A current expectation that, more likely than not, the asset will be sold or otherwise disposed of significantly before the end of its previously estimated useful life.

NeoMedia follows the two-step process outlined in SFAS 144 for determining if an impairment charge should be taken: (1) the expected undiscounted cashflows from a particular asset or asset group are compared to the carrying value; if the expected undiscounted cashflows are greater than the carrying value, no impairment is taken, but if the expected undiscounted cashflows are less than the carrying value, then (2) an impairment charge is taken for the difference between the carrying value and the expected discounted cashflows. The assumptions used in developing expected cashflow estimates are similar to those used in developing other information used by NeoMedia for budgeting and other forecasting purposes. In instances where a range of potential future cashflows is possible, NeoMedia uses a probability-weighted approach to weigh the likelihood of those possible outcomes. In such instances, NeoMedia uses a discount rate equal to the yield on 0-coupon treasury instrument with a life equal to expected life of the assets being tested.

Financial Instruments and Concentrations of Credit Risk. The Company’s financial instruments consist of cash and cash equivalents, accounts receivable, accounts payable, accrued expenses, notes payable, derivative financial instruments, other current liabilities, convertible preferred stock, and convertible debenture financing. Management believes the carrying values of cash and cash equivalents, accounts receivable, accounts payable, accrued expenses, notes payable, and other current liabilities approximate their fair values due to their short-term nature. The fair value of convertible preferred stock and convertible debentures is estimated on December 31, 2006 to be approximately $21,657,000 and $7,500,000, respectively.

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 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 financing arrangement, and (iii) the fair value of detachable warrants that were outstanding prior to the issuance of the Series C Preferred Shares.

The Company utilizes various types of financing to fund its business needs, including convertible preferred stock, convertible debentures, and other instruments indexed to the Company’s own stock. The embedded conversion features utilized in these instruments require periodic measurement of the fair value of the derivative components. Pursuant to FAS 133 and EITF 00-19 NeoMedia updates the fair value of these derivative components at each reporting period.

Allowance for Doubtful Accounts. NeoMedia maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. Allowance for doubtful accounts is based on NeoMedia’s assessment of the collectibility of specific customer accounts, the aging of accounts receivable, NeoMedia’s history of bad debts, and the general condition of the industry. If a major customer’s credit worthiness deteriorates, or NeoMedia’s customers’ actual defaults exceed historical experience, NeoMedia’s estimates could change and impact its reported results.

Inventory. Inventories are stated at lower of cost (using the first-in, first-out method) or market. NeoMedia continually evaluates the composition of its inventories assessing slow-moving and ongoing products and maintains a reserve for slow-moving and obsolete inventory as well as related disposal costs.

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 NeoMedia’s results of operations could be materially impacted. Stock-based compensation expense is calculated using the Black Scholes 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.

Estimate of Litigation-based Liability. From time to time, NeoMedia is defendant in certain litigation in the ordinary course of business (see the section entitled “Legal Proceedings”). NeoMedia accrues liabilities relating to these lawsuits on a case-by-case basis. NeoMedia generally accrues attorney fees and interest in addition to the liability being sought. Liabilities are adjusted on a regular basis as new information becomes available. NeoMedia consults with its attorneys to determine the viability of an expected outcome. The actual amount paid to settle a case could differ materially from the amount accrued.

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 and product revenue, which includes sales of software and technology equipment and service fee is 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. The Company’s subsidiaries Mobot (sold during 2006), and Gavitec follow this policy. The Company defers revenue related to technology service and 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 net 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.” 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 subsidiaries 12Snap and Sponge (sold during 2006) follow this policy. Telecom revenues from NeoMedia's subsidiary BSD are recognized at the clearing house for billing to customers on a net basis, based on guidance in EITF 99-19. 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.

(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.

Income Tax Valuation Allowance. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be recognized. The Company has recorded a 100% valuation allowance as December 31, 2006 and 2005.

Foreign Currency Translation. The local currency has been primarily used as the functional currency throughout the world. Translation gains and losses of those operations that use local currency as the functional currency are included in the consolidated balance sheets as “Accumulated other comprehensive income (loss).” Where the U.S. dollar is used as the functional currency, foreign currency gains and losses are reflected in income.

Other Financial Information

NeoMedia maintains the following valuation allowance accounts in its consolidated balance sheet. These reserves are presented net in their respective categories.

Valuation Allowance Accounts:
(thousands)	2006		2005
Reserve for bad debts		146		14
Reserve for inventory shrinkage and obsolescence		53		0
Total valuation reserves		199		14

Proposed Dispositions of 12Snap and NeoMedia Telecom Services (“NTS”)

In January 2007, NeoMedia management determined that it would focus on its core code-reading business in North America, the UK, mainland Europe, and China. In conjunction with this direction, subsidiaries 12Snap and NTS will be sold in the most profitable, timely, and viable manner possible. NeoMedia has analyzed the pertinent facts of the proposed disposition of these two subsidiaries and has determined the criteria included in paragraph 30 of SFAS 144, outlined above, were met after the date of the balance sheet included in this filing. Specificallly, the decision to sell these two businesses was committed to by the Company in January 2007. Accordingly, the results of operations and the assets and liabilities of these two subsidiaries are included in the accompanying consolidated statements of operations and balance sheets.

The results of operations of the 12Snap and NTS subsidiaries included in NeoMedia’s operating loss from continuing operations is as follows.

	Year Ended December 31, 2006
	NTS			12 Snap			Total
Net sales	$	1,371		$	7,333		$	8,704
Cost of sales		---			2,054			2,054
Gross profit		1,371			5,279			6,650

Sales and marketing expenses		400			4,053			4,453
General and administrative expenses		1,166			1,692			2,858
Research and development costs		---			1,258			1,258
Amortization of intangibles		806			732			1,538
Impairment charge		---			18,327			18,327
Income/(Loss) from operations of business available for sale		($1,001	)		($20,783	)		($21,784	)

The assets and liabilities of the 12 Snap and Telecom subsidiaries included with NeoMedia’s balance sheet are as follows.

	December 31, 2006
	NTS		12 Snap		Total
ASSETS
Current assets:
Cash and cash equivalents	$	72	$	721	$	793
Trade accounts receivable, net		1,577		1,842		3,419
Inventories, net		---		---		---
Prepaid expenses and other current assets		12		407		419
Total current assets		1,661		2,970		4,631

Leasehold improvements & property and equipment, net		48		200		248
Goodwill		4,402		---		4,402
Other intangible assets, net		1,192		5,815		7,007
Other long-term assets		---		---		---
Total assets	$	7,303	$	8,985	$	16,288

LIABILITIES
Current liabilities:
Accounts payable	$	1,854	$	640	$	2,494
Taxes payable		1,037		---		1,037
Accrued expenses		6		384		390
Deferred revenues and other		73		4,097		4,170
Total liabilities	$	2,970	$	5,121	$	8,091

The following proforma statement of operations shows what NeoMedia’s operating results from continuing operations would have been if the proposed sales of NTS and 12 Snap had occurred as of January 1, 2006.

										Pro-forma
										NeoMedia
	NeoMedia									without NTS
	as reported			NTS			12 Snap			and 12 Snap
Net sales	$	10,309			($1,371	)		($7,333	)	$	1,605
Cost of sales		3,863			---			(2,054	)		1,809
Gross profit		6,446			(1,371	)		(5,279	)		(204	)

Sales and marketing expenses		10,239			(400	)		(4,053	)		5,786
General and administrative expenses		12,125			(1,972	)		(2,424	)		7,729
Research and development costs		3,522			---			(1,258	)		2,264
Impairment Charge		18,706			---			(18,327	)		379
Loss from operations		(38,146	)		1,001			20,783			(16,362	)

Gain (loss) on extinguishment of debt		(1,879	)		---			---			(1,879	)
Amortization of debt discount		---			---			---			---
Interest income (expense), net		(10,182	)		---			---			(10,182	)
Write-off of deferred equity financing costs		(13,256	)		---			---			(13,256	)
Gain on sale of marketable securities		1,103			---			---			1,103
Gain on embedded conversion features of derivative financial instruments		13,645			---			---			13,645
Change in fair value from revaluation of warrants in derivative financial instruments		(3,537	)		---			---			(3,537	)

LOSS FROM CONTINUING OPERATIONS		(52,252	)		1,001			20,783			(30,468	)

DISCONTINUED OPERATIONS (Note 4)
Net loss from discontinued operations		(5,768	)		---			---			(5,768	)
Loss on disposal of Sponge and Mobot subsidiaries		(9,418	)		---			---			(9,418	)
LOSS FROM DISCONTINUED OPERATIONS		(15,186	)		---			---			(15,186	)

NET LOSS		($67,438	)	$	1,001		$	20,783			($45,654	)

Note: since 2005 and 2004 pro forma statements of operations are omitted, since NTS and 12Snap were both acquired during 2006,

Stock-Based Compensation

NeoMedia adopted Statement of Financial Accounting Standards No. 123 (“SFAS 123R”) on January 1, 2006, using the modified-prospective transition method for stock option grants and restricted stock issued after January 1, 2006. As a result, the unamortized compensation expense from stock options granted prior to January 1, 2006 is not included in the statement of operations. SFAS 123R requires all share-based payments to employees to be recognized in the income statement based on their fair values. Under the modified-prospective transition method, compensation cost recognized for the year ended December 31, 2006 includes: (a) vesting of compensation cost for all share-based payments granted, but not yet vested as of January 1, 2006 based on the grant-date fair value estimated in accordance with the original provisions of SFAS 123R, and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. Such amounts are reduced by NeoMedia’s estimate of forfeitures of all unvested awards.

Prior to January 1, 2006, NeoMedia accounted for its stock-based compensation plans under the intrinsic-value method prescribed in Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees,” (“APB 25”) and related interpretations as permitted by Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation.” (“SFAS 123”). Under APB 25, when the exercise price of options granted to employees equals the market price of the common stock on the date of grant, no compensation expense is recorded. When the exercise price of options granted to employees is less than the market price of the common stock on the date of grant, compensation expense is recognized over the vesting period. Had NeoMedia accounted for stock based compensation under the fair value method during the years ended December 31, 2005 and 2004, net loss would have been higher by $4,124,000 and $1,445,000, respectively, during these periods, causing an increase to the reported net loss per share of $0.01 and $0.01, respectively.

SFAS 123R requires share-based payments to employees to be measured at fair value. However, the valuation of employee stock options is an inherently subjective process, since market values are generally not available for long-term, non-transferable employee stock options. Accordingly, an option pricing model is utilized to derive an estimated fair value. NeoMedia uses the Black-Scholes-Merton pricing model in order to calculate the estimated fair value for its stock options.

Approximately 61% of the stock-based compensation expense recorded during the year ended December 31, 2006 relates to the continued vesting of stock options that were granted prior to January 1, 2006. In accordance with the transition provisions of SFAS 123R, the grant date estimates for these options have not been changed.

As of December 31, 2006, there was $5,122,000 of total stock-based compensation expense not yet recognized relating to non-vested awards granted under NeoMedia’s option plans and restricted stock agreements as calculated under SFAS 123R. This expense is net of estimated forfeitures and is expected to be recognized over a weighted-average period of approximately 1.1 years. The amount of stock-based compensation expense to be recorded in any future period cannot be exactly predicted due to the uncertainty of future grant levels and actual forfeitures to be recorded. Additionally, changes to the assumptions used in the Black Scholes model could cause a material change in the amount of compensation expense to be recorded in future reporting periods.

One of the key components used in calculating the fair value of stock options is the volatility of the underlying stock. As of January 1, 2006, NeoMedia reevaluated its volatility calculation to take into consideration the guidance outlined in Statement 123(R). Prior to January 1, 2006, NeoMedia calculated volatility using only historical share price data. Under the provisions of Statement 123(R), from January 1, 2006 onward NeoMedia has considered historical volatility, as well expected future volatility. As a result, NeoMedia’s volatility decreased significantly for stock based compensation granted during the year ended December 31, 2006 as compared with stock based compensation granted prior to January 1, 2006. NeoMedia will evaluate its volatility on an ongoing basis using the most current information available. NeoMedia expects that, under the guidelines of Statement 123(R), future volatility will more closely resemble 2006 levels than previous years. As of December 31, 2006, NeoMedia was using calculated volatility of 117%.

Effect Of Recently Issued Accounting Pronouncements

Emerging Issues Task Force issue number 06-03 “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation)” has been adopted early by NeoMedia in the first quarter of 2006. The implementation of EITF 06-03 had no impact on current or historical financial statements.

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments”. This Statement amends FASB Statements No. 133, Accounting for Derivative Instruments and Hedging Activities, and No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This Statement resolves issues addressed in Statement 133 Implementation Issue No. D1, "Application of Statement 133 to Beneficial Interests in Securitized Financial Assets."

This Statement:

Permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation

Clarifies which interest-only strips and principal-only strips are not subject to the requirements of Statement 133

Establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation

Clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives

Amends Statement 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument.

This statement is effective for fiscal years beginning after September 15, 2006. The Company is currently evaluating the impact of adopting this statement; however, the Company does not expect the adoption of this provision to have a material effect on its financial position, results of operations or cash flows.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets”. This Statement applies to companies that service financial assets and liabilities. This statement is effective for fiscal years beginning after September 15, 2006. The Company does not service financial assets or liabilities. The Company does not expect this Statement to have any effect on its financial position, results of operations or cash flows.

In June 2006, the FASB issued FASB Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes,” that provides guidance on the accounting for uncertainty in income taxes recognized in financial statements. The interpretation will be adopted by the Company on January 1, 2007. The Company is currently evaluating the impact of adopting FIN 48; however, does not expect the adoption of this provision to have a material effect on the financial position, results of operations or cash flows.

In July 2006, the FASB issued FASB Staff Position (FSP) No. FAS 13-2, “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction,” that provides guidance on how a change or a potential change in the timing of cash flows relating to income taxes generated by a leveraged lease transaction affects the accounting by a lessor for the lease. This staff position was adopted by the Company on January 1, 2007. The Company is currently evaluating the impact of adopting this FSP; however, the Company does not expect the adoption of this provision to have a material effect on its financial position, results of operations or cash flows.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements”. This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. This Statement applies under other accounting pronouncements that require or permit fair value measurements, the Board having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, this Statement does not require any new fair value measurements. However, for some entities, the application of this Statement will change current practice. This statement is effective for fiscal years beginning after November 15, 2007. The Company may adopt this statement for its 2007 fiscal year. The Company is currently evaluating the impact of adopting this statement; however, the Company does not expect the adoption of this provision to have a material effect on its financial position, results of operations or cash flows.

In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R)" ("SFAS 158"). SFAS 158 requires an entity to recognize in its statement of financial position an asset for a defined benefit pension or postretirement plan's overfunded status or a liability for a plan's underfunded status, and to recognize changes in that funded status through other comprehensive income in the year in which the changes occur. SFAS 158 will not change the amount of net periodic benefit expense recognized in an entity's results of operations. SFAS 158 is effective for fiscal years ending after December 15, 2006. The Company does not have a defined benefit pension plan. SFAS 158 did not have an impact on the Company’s financial statements or disclosures.

In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 108 (“SAB 108”), Financial Statements - Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB 108 provides guidance on how prior year misstatements should be taken into consideration when quantifying misstatements in current year financial statements for purposes of determining whether the current year’s financial statements are materially misstated. SAB 108 provides that once a current year misstatement has been quantified, the guidance in SAB No. 99, Financial Statements - Materiality, should be applied to determine whether the misstatement is material and should result in an adjustment to the financial statements. Under certain circumstances, prior year financial statements will not have to be restated and the effects of initially applying SAB 108 on prior years will be recorded as a cumulative effect adjustment to beginning Retained Earnings on January 1, 2006, with disclosure of the items included in the cumulative effect. NeoMedia will apply the provisions of SAB 108 with the preparation of NeoMedia’s annual financial statements for the calendar year ending December 31, 2006. The application of the provisions of SAB 108 did not have a material impact on the Company’s financial statements for the calendar year ending December 31, 2006.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”. The objective of this statement is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This Statement is expected by the board to expand the use of fair value measurement, which is consistent with the Board’s long-term measurement objectives for accounting for financial instruments. This statement is effective for fiscal years beginning after November 15, 2007. The Company may adopt this statement for its 2007 fiscal year. The Company is currently evaluating the impact of adopting this statement; however, the Company does not expect the adoption of this provision to have a material effect on its financial position, results of operations or cash flows.

Results Of Operations For The Year Ended December 31, 2006 As Compared To The Year Ended December 31, 2005

Net sales. Total net sales for the year ended December 31, 2006 were $10,309,000, which represented a $9,432,000, or 1,075%, increase from $877,000 for the year ended December 31, 2005. This increase resulted from $9,658,000 net sales from subsidiaries Gavitec, 12Snap and BSD, all of which were acquired during the first quarter of 2006 and an increase of $128,000 in net sales from the Company’s underlying business represented by qode® and intellectual property licensing, offset by a decrease in net sales of $354,000 from the Company’s Consulting and Integration Services business unit that was wound down in 2005.

Cost of sales. Cost of sales were $3,863,000 for the year ended December 31, 2006 compared to $583,000 for the year ended December 31, 2005, an increase of $3,280,000, or 563%. This increase resulted from (i) $2,444,000 product and service related cost of sales from subsidiaries Gavitec, 12Snap and BSD, all of which were acquired during the first quarter of 2006, and (ii) amortization of $1,081,000 of intangible assets relating to the acquisitions of Gavitec, 12Snap and BSD, offset by (iii) a reduction in cost of sales of $245,000 from the Company’s underlying business represented by qode® and NeoMedia’s legacy software products and the Company’s wound down Consulting and Integration Services business.

Gross profit. Gross profit was $6,446,000 for the year ended December 31, 2006, an increase of $6,152,000, or 2,093%, compared with gross profit of $294,000 for the year ended December 31, 2005. This increase resulted from (i) $7,214,000 operational gross profit from subsidiaries Gavitec, 12Snap and BSD, all of which were acquired during the first quarter of 2006, and (ii) increased gross profit of $175,000 from the Company’s underlying business represented by qode®, NeoMedia’s legacy software products, offset by (iii) a decrease in gross profit of $156,000 from the Company’s Consulting and Integration Services business unit that was wound down in 2005, and (iv) amortization of $1,081,000 of intangible assets relating to the acquisitions of Gavitec, 12Snap and BSD.

Sales and marketing. Sales and marketing expenses were $10,329,000 for the year ended December 31, 2006, compared to $2,592,000 for the year ended December 31, 2005, an increase of $7,647,000 or 295%. This increase resulted from (i) sales and marketing expenses of $4,688,000 from subsidiaries Gavitec, 12Snap and BSD, all of which were acquired during the first quarter of 2006, (ii) stock based compensation expense allocated to sale and marketing of $2,253,000, and (iii) higher sales and marketing expense in the Company’s underlying business represented by qode® and NeoMedia’s legacy software products of $786,000 in 2006.

General and administrative. General and administrative expenses increased by $9,105,000, or 301%, to $12,125,000 for the year ended December 31, 2006, compared to $3,020,000 for the year ended December 31, 2005. The increase resulted from (i) stock based compensation expense allocated to general and administrative expense of $4,405,000, (ii) of higher accounting, professional, and legal services of $1,949,000 due to Company’s implementation of Sarbanes Oxley, higher audit fees resulting from a more complex reporting structure and transactions, actual and threatened lawsuits, and registration statements, (iii) general and administrative expenses of $2,315,000 from subsidiaries Gavitec, 12Snap and BSD, all of which were acquired during the first quarter of 2006, and (iv) amortization of $455,000 of intangible assets relating to the acquisitions of Gavitec, 12Snap and BSD.

Research and development. During the year ended December 31, 2006, NeoMedia charged to expense $3,522,000 of research and development costs, an increase of $2,930,000 or 495% compared to $592,000 for the year ended December 31, 2005. The increase resulted from (i) research and development expenses of $1,584,000 from subsidiaries Gavitec, 12Snap and BSD, all of which were acquired during the first quarter of 2006, (ii) increased research and development expense related to qode® products of $795,000, and (iii) stock based compensation expense allocated to research and development of $592,000.

Impairment Charge. During the year ended December 31, 2006, NeoMedia incurred an impairment charge in the amount of $18,706,000 primarily to write down intangible assets associated with its 12Snap business. During the year ended December 31, 2005, NeoMedia incurred charges of $1,115,000 relating to the write-down of assets acquired from Secure Source Technologies in 2003, and to impair investments in iPoint-media and Intactis Software, Inc.

Gain (loss) on extinguishment of debt. Loss on extinguishment of debt was $1,879,000 during the year ended December 31, 2006, compared with a gain of $172,000 for the year ended December 31, 2005, an increase of $2,051,000, or 1,192%. The 2006 loss on extinguishment of debt resulted from debt retired in connection with the Series C preferred stock issued and sold to Cornell on February 17, 2006. A loss was incurred on the surrender of a certain promissory note to Cornell dated March 30, 2005 in connection with the preferred stock sale. During the year ended December 31, 2005, NeoMedia recognized a gain on extinguishment of debt of $172,000, resulting from the payment of debt at a discount to its book value.

Interest income (expense). Interest income (expense) consists primarily of interest charges related to convertible debentures, interest accrued for creditors as part of financed purchases, past due balances, and notes payable, net of interest earned on cash equivalent investments. Interest expense increased by $9,889,000, or 3,375%, to $10,182,000 for the year ended December 31, 2006 from $293,000 for the year ended December 31, 2005. The increase resulted from (i) a charge to write up convertible debentures to their redemption value in the amount of $7,500,000, (ii) the accrual of $1,958,000 of liquidated damages related to the Series C convertible preferred stock and a convertible debenture issued in August 2006, and increased other interest charges of $431,000.

Write-off of deferred equity financing costs. During the year ended December 31, 2006, NeoMedia incurred a charge of $13,256,000 to write off deferred equity financing costs related to the 2005 SEDA. No comparable charges were taken during the year ended December 31, 2005.

Gain on sale of marketable securities. During the year ended December 31, 2006, NeoMedia recognized a gain of $1,103,000 relating to the sale of shares of iPoint-media. No such gains were recognized during the year ended December 31, 2005.

Gain on embedded conversion features of derivative financial instruments. Gain from embedded conversion features of derivative financial instruments was $13,645,000 for the year ended December 31, 2006. The gain is associated with the preferred stock sale on February 17, 2006 and the convertible debenture financing dated August 24, 2006. Certain derivatives and embedded conversion features were created at the time of each offering and are recorded at fair value on the accompanying balance sheet. The gain for the year ended December 31, 2006 is the reduction in value of the derivatives and embedded conversion features from the inception of each financing to December 31, 2006 and is due almost entirely to a reduction in NeoMedia’s stock price from the inception of each financing to December 31, 2006. There was no such gain or loss on derivative financial instruments for the year ended December 31, 2005.

Warrant repricing expense. NeoMedia recorded a charge resulting from repricing of warrants in the amount of $3,537,000 for the year ended December 31, 2006. The charge relates to certain warrants that were repriced in connection with convertible debenture financings in August and December 2006.

Loss from discontinued business units. During the year ended December 31, 2006, NeoMedia entered into a letter of intent to sell its NMPR business unit. Also during the year ended December 31, 2006, NeoMedia divested of the majority of its interests in Mobot and Sponge. Accordingly, NeoMedia has classified the operations of NMPR, Mobot, and Sponge as discontinued operations. Loss from the discontinued business units represents direct operations of the NMPR business during the year ended December 31, 2006, and direct operations of Mobot and Sponge from their respective acquisition dates (February 17, 2006 for Mobot and February 23, 2006 for Sponge) through their respective disposal dates (December 6, 2006 for Mobot and November 14, 2006 for Sponge).

The net loss from the NMPR business unit for the year ended December 31, 2006 was $2,996,000, an increase of $995,000 or 50% from the loss of $2,001,000 for the year ended December 31, 2005. The increased loss is due to the fixed overhead costs related to the expansion into the US and China markets of $494,000 and the establishment of a bad debt reserve in the amount of $653,000 relating to products shipped to a customer in China. The net loss from the Mobot business from February 16, 2006 (date of acquisition) through December 31, 2006 was $1,642,000. The net loss from the Sponge business from February 16, 2006 (date of acquisition) through December 31, 2006 was $1,129,000. NeoMedia did not record any operations related to these businesses in 2005 since they were acquired in 2006.

Loss on disposal of Sponge and Mobot subsidiaries. During the year ended December 31, 2006, NeoMedia recognized a loss on the disposal of its Sponge and Mobot subsidiaries in the amount of $9,418,000, representing the difference between the fair value of consideration received (as it was a better indicator of fair value) and the carrying value immediately prior to sale.

Net loss. The net loss for the year ended December 31, 2006 was $67,438,000, which represented a $58,290,000, or 637% increase from a $9,148,000 loss for the year ended December 31, 2005. This increased net loss resulted from (i) an increase in impairment charges of $17,591,000 during 2006 resulting primarily from the impairment of assets related to 12Snap, (ii) a charge of $13,256,000 recognized to write off deferred equity financing costs associated with the 2005 SEDA, (iii) a loss on the sale of Sponge and Mobot during 2006 totaling $9,418,000, (iv) charge of $7,500,000 incurred to write the carrying value of convertible debentures to their face value as a result of a default by the Company on the debenture, (v) an increase of $7,110,000 to stock based compensation expense as a result of the adoption of SFAS 123(R) on January 1, 2006, (vi) increased losses of $6,093,000 from the Company’s underlying business represented by qode®, NeoMedia’s legacy software products, and corporate administration including audit and legal fees, (vii) increased losses of $3,766,000 from the Micro Paint business held for sale, and the Sponge and Mobot businesses divested in 2006, all of which are included in discontinued operations, (viii) warrant repricing expense of $3,537,000, (ix) losses from subsidiaries Gavitec, 12Snap and BSD, all of which were acquired during the first quarter of 2006, of $2,909,000 and (x) a loss on the extinguishment of debt in the amount of $1,858,000, offset by (xi) a gain on the sale of shares of iPoint-media stock of $1,103,000, and (xii) a gain from the change in fair value of embedded conversion features associated with the Series C preferred stock, warrants, and convertible debenture in the amount of $13,645,000.

Known trends, demands, commitments, or uncertainties. During the fourth quarter of 2006, NeoMedia divested of Mobot and Sponge, wholly owned subsidiaries acquired during the first quarter of 2006. Also, during the first quarter of 2007, NeoMedia announced its intent to sell additional subsidiaries NeoMedia Telecom and 12Snap. As a result, NeoMedia expects its sales, cost of sales, gross profit, operating expenses, and net loss over the next 12 months to decrease materially compared with its 2006 results, which reflect operations of these subsidiaries. Had NeoMedia divested of NeoMedia Telecom and 12Snap as of January 1, 2006, then for the year ended December 31, 2006 NeoMedia’s consolidated revenue would have been $1,605,000, and its net loss would have been $45,654,000.

Results of Operations for the Year Ended December 31, 2005 as Compared to the Year Ended December 31, 2004

Net sales. Total net sales for the year ended December 31, 2005 were $877,000, which represented a $96,000, or 10%, decrease from $973,000 for the year ended December 31, 2004. This decrease resulted from a decrease of $276,000 from the Company’s Consulting and Integration Services business unit that was wound down in 2004, offset by an increase in net sales from the Company’s underlying business represented by qode® and intellectual property licensing of $180,000.

Cost of sales. Cost of sales were $583,000 for the year ended December 31, 2005 compared to $926,000 for the year ended December 31, 2004, a decrease of $343,000, or 37%. This decrease resulted from a reduction in cost of sales of $398,000 relating to the Company’s Consulting and Integration Services business that was wound down during 2004, as well as a reduction in product-related amortization of $55,000.

Gross profit. Gross profit was $294,000 for the year ended December 31, 2005, an increase of $247,000, or 526%, compared with gross profit of $47,000 for the year ended December 31, 2004. This increase resulted from increased gross profit of $125,000 from the Company’s underlying business represented by qode®, NeoMedia’s legacy software products, as well as higher gross profit of $122,000 from the Company’s Consulting and Integration Services business unit that was wound down in 2004.

Sales and marketing. Sales and marketing expenses were $2,592,000 for the year ended December 31, 2005, compared to $1,170,000 for the year ended December 31, 2004, an increase of $1,422,000 or 126%. This increase resulted from the addition of sales force and cost associated with marketing and promotion of the Company’s qode^® products in 2005.

General and administrative. General and administrative expenses increased by $883,000, or 41%, to $3,020,000 for the year ended December 31, 2005, compared to $2,137,000 for the year ended December 31, 2004. The increase resulted primarily from additional personnel and higher legal and professional fees in 2005 resulting from registration and regulatory filings.

Research and development. During the year ended December 31, 2005, NeoMedia charged to expense $592,000 of research and development costs, an increase of $129,000 or 28% compared to $463,000 for the year ended December 31, 2004. The increase was due to the addition of development staff hired in connection with the commercialization of the qode® product line.

Stock based compensation expense Stock based compensation was $140,000 for the year ended December 31, 2005, as compared with $440,000 for the year ended December 31, 2004, a decrease of $300,000, or 68%. The decrease was due to higher stock based compensation during 2004 in lieu of cash payments to outside consultants.

Gain (loss) on extinguishment of debt. Gain on extinguishment of debt was $172,000 during the year ended December 31, 2005, compared with $140,000 for the year ended December 31, 2004, an increase of $32,000, or 23%. The gains resulted from the payment of debt at a discount to its book value.

Amortization of debt discount. During the year ended December 31, 2004, NeoMedia recognized an amortization of debt issuance cost of $2,500,000 relating to the fair value of warrants granted to Cornell Capital Partners in connection with promissory notes issued to Cornell by NeoMedia during January 2004. During the year ended December 31, 2005, NeoMedia did not recognize any such expense.

Interest expense. Interest expense consists primarily of interest accrued for creditors as part of financed purchases, past due balances, notes payable and interest earned on cash equivalent investments. Interest expense increased by $104,000, or 55%, to $293,000 for the year ended December 31, 2005 from $189,000 for the year ended December 31, 2004, due to increased expense associated with interest on notes payable in 2005 compared with 2004.

Impairment Charge. During the year ended December 31, 2005, NeoMedia incurred charges of $1,115,000 relating to the write-down of assets acquired from Secure Source Technologies in 2003, and to impair investments in iPoint-media and Intactis Software, Inc. No such impairments were recognized during the year ended December 31, 2004.

Loss from discontinued business units. During the year ended December 31, 2005, NeoMedia entered into a letter of intent to sell its NMPR business unit. Accordingly, NeoMedia has classified the operations of NMPR as discontinued operations. Loss from the discontinued operations represents direct operations of the NMPR business during the year ended December 31, 2005, and during the period from February 6, 2004 (acquisition date) through December 31, 2004. The net loss from the NMPR business unit for the year ended December 31, 2005 was $2,001,000, an increase of $1,043,000 or 109% from the loss of $958,000 for the year ended December 31, 2004. The increased loss is due to fixed overhead costs related to the expansion into the US and international markets of $1,149,000, offset by higher gross margin of $106,000.

Net loss. The net loss for the year ended December 31, 2005 was $9,147,000, which represented a $1,917,000, or 27% increase from a $7,230,000 loss for the year ended December 31, 2004. This increased net loss resulted from (i) $2,259,000 increased loss from the Company’s underlying business represented by qode®, NeoMedia’s legacy software products, and corporate administration, (ii) impairment charges of $1,115,000 recognized during 2005 relating to investments in Secure Source Technologies, iPoint-media, and Intactis Software, and (iii) $1,043,000 increased losses from the Micro Paint business held for sale, offset by (iv) the amortization of debt discount of $2,500,000 in 2004 relating to the fair value of warrants granted in connection with promissory notes issued in 2004.

Liquidity and Capital Resources

Current Period Activity

Net cash from operations. Net cash used in continuing operating activities (net of cash used from operations of discontinued business unit) was $9,958,000, $4,883,000, and $3,937,000 for the years ended December 31, 2006, 2005, and 2004, respectively. The year-over-year increase was driven by the following factors: (i) additional sales, marketing, research and development resources employed to complete the technical requirements for a 2006 qode® launch in the U.S. and Europe; (ii) increased general and administrative costs in 2006 associated with supporting the new acquisitions and other administrative initiatives such as Sarbanes Oxley; (iii) negative operational cashflow in 2006 from acquired subsidiaries Gavitec and 12Snap, and (iv) negative operational cashflow in 2006 from discontinued Micro Paint Repair, Mobot, and Sponge operations.

Net cash used in investing. NeoMedia’s net cash flow used in investing activities (net of cash used in investing of discontinued business unit) for the years ended December 31, 2006, 2005, and 2004, was $15,097,000, $6,343,000, and $4,543,000, respectively. The increase resulted from the investment of $11,891,000 in the acquisitions of Mobot, Sponge, Gavitec and 12Snap. NeoMedia also advanced $500,000 to Hip Cricket in the form of promissory notes, and increased capital expenditures on equipment and software required for the qode® launch.

Net cash provided by financing activities. Net cash provided by financing activities for the years ended December 31, 2006, 2005, and 2004, was $27,276,000, $10,306,000, and $11,025,000, respectively. NeoMedia received $21,296,000 from the sale of Series C convertible stock and convertible debentures during 2006, $5,000,000 from the sale of convertible debentures in August 2006, and $2,230,000 from the sale of convertible debentures in December 2006. NeoMedia received $210,000, $8,572,000, and $7,906,000 from the sale of its common stock, primarily under the 2003 SEDA, during the years ended December 31, 2006, 2005, and 2004, respectively. NeoMedia also received $8,444,000, $923,000, and $2,687,000 from the exercise of stock options and warrants during the years ended December 31, 2006, 2005, and 2004, respectively. Additionally, NeoMedia repaid debt and notes payable of $2,674,000, $8,121,000, and $8,653,000 during the years ended December 31, 2006, 2005, and 2004, respectively.

Net cash used in discontinued operations. Net cash used in the Company’s discontinued Micro Paint Repair operations for the year ended December 31, 2006 was $2,078,000, of which $2,026,000 was used in operations, $56,000 was used in investing activities, and $4,000 was generated as a result of the effect of exchange rates on cash. Net cash used in the Company’s discontinued Micro Paint Repair operations for the year ended December 31, 2005 was $1,782,000, of which $1,626,000 was used in operations, $167,000 was used in investing activities, and $11,000 was used as a result of the effect of exchange rates on cash. Net cash used in the Company’s discontinued Micro Paint Repair operations for the year ended December 31, 2004 was $775,000, of which $713,000 was used in operations, $2,000 was used in investing activities, and $60,000 was used as a result of the effect of exchange rates on cash. The negative cashflow from operations of the discontinued Micro Paint Repair business will cease upon the anticipated sale of the business unit, which is expected to reduce NeoMedia’s consolidated cash used in operations.

Net cash used in the Company’s discontinued Mobot operations for the year ended December 31, 2006 was $1,351,000, of which $1,323,000 was used in operations, and $28,000 was used in investing activities. Net cash used in the Company’s discontinued Sponge operations for the year ended December 31, 2006 was $239,000, of which $235,000 was used in operations, and $4,000 was used in investing activities. The negative cashflow from operations of the discontinued Mobot and Sponge businesses ceased upon the sale of these business units in the fourth quarter of 2006.

As of December 31, 2006, NeoMedia has a working capital deficiency of $81,167,000, of which $25,819,000 relates to the fair value of derivative financial instruments. NeoMedia intends to fund its working capital deficiency as described in “Sources of Cash and Projected Cash Requirements”.

Significant Liquidity Events

Agreement to Sell 12Snap - March 2007

·	$1,100,000 will be paid in cash at Closing, and $500,000 will be placed into escrow and released to NeoMedia 90 days after Closing, assuming no warranty claims;

·	Buyer will forgive purchase price obligation in the amount of $880,000, such obligation resulting from the sale and purchase agreement between NeoMedia and the former shareholders of 12Snap

·	12Snap management will waive their purchase price obligations in the amount of $880,000, and return to NeoMedia 2,525,818 shares of NeoMedia common stock issued previously;

·	Buyer will return to NeoMedia 2,525,818 NeoMedia shares issued previously;

·	NeoMedia will retain a 10% ownership of 12Snap, subject to an option agreement pursuant to which NeoMedia has the right to sell and Buyer has the right to acquire the remaining 10% stake held by NeoMedia for a purchase price of $750,000 after December 31;

·	12snap and NeoMedia will execute a cooperation agreement pursuant to which 12snap will remain NeoMedia preferred partner and enjoy most favored prices, and 12snap will perform certain research and development functions for NeoMedia; and

·	The transaction is subject to completion of a material definitive agreement

$7.5 Million Convertible Debenture - March 2007

At any time from the closing date until December 29, 2008, the Purchasers have the right to convert the convertible debenture into NeoMedia common stock at the then effective conversion price, which varies relative to NeoMedia’s trading stock price, as follows: $0.05 per share, or 90% of the lowest closing bid price (as reported by Bloomberg) of the common stock for the 30 trading days immediately preceding the conversion date. The conversion is limited such that the holder cannot exceed 4.99% ownership, unless the holders waive their right to such limitation. The limitation will terminate under any event of default.

12Snap and Gavitec Purchase Price Obligation

As of December 31, 2006, NeoMedia had recorded liabilities of $16,233,000 and $5,194,000 relating to purchase price guarantee obligations associated with its acquisitions of 12Snap and Gavitec, respectively. Pursuant to the terms of each acquisition, 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 became saleable (either upon effectiveness of a registration statement containing the shares, or under Rule 144) was 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. The shares became saleable during the first quarter of 2007. AS of December 31, 2006, these liabilities were imminent and incurred beyond a reasonable doubt. As a result, NeoMedia accrued the amount payable under these obligations of $16,233,000 to 12Snap shareholders and $5,194,000 to Gavitec shareholders.

NeoMedia and the former Gavitec shareholders agreed that the entire purchase price obligation shall be satisfied through the payment by NeoMedia of (i) $1,800,000 in cash, payable no later than February 28, 2007, and (ii) 61,000,000 shares of NeoMedia common stock, to be issued no later than February 28, 2007. The Amendment Agreement stipulates that, in the event that the 61,000,000 shares are not registered for resale by August 31, 2007, interest shall accrue at a rate of 8% per annum on the agreed value of the shares of $1,900,000. NeoMedia also agreed to pay interest accrued on the purchase price in the amount of $213,000 and reimburse $100,000 of costs related to the acquisition to the primary former shareholder of Gavitec no later than February 28, 2007 (subsequently extended to March 31, 2007). NeoMedia made payments of $2,113,000 during March 2007 in satisfaction of the obligation.

During the first quarter of 2007, NeoMedia issued 197,620,948 shares of its common stock in satisfaction of $9,427,000 of the 12Snap purchase price guarantee amount. The remaining balance on the purchase price obligation after this payment was $6,806,000. The Company is currently negotiating payment terms for the balance of the obligation.

Silent Partners

Prior to the acquisition of 12Snap by NeoMedia, 12Snap entered into silent partnership debt arrangements with principal and interest totaling $4.8 million. The partnership agreements were scheduled to terminate on December 31, 2008 and 2009. However, due to the acquisition of all shares of 12Snap by NeoMedia, an early termination was agreed on for the silent partnership agreements. Those silent partnerships terminated as of February 28, 2006 with the acquisition of 12Snap by NeoMedia. NeoMedia made payments toward the outstanding principal of $2.1 million and $0.6 million during March 2006 and December 2006, respectively. The balance as of December 31, 2006 relating to silent partners was $2.1 million. NeoMedia made additional payments of $1.0 million during February 2007. The remaining balance of approximately $1.1 million is due on or before March 31, 2007, which has not been paid as of the date of this filing.

China Order

During the fourth quarter of 2005 and first quarter of 2006, NeoMedia shipped and invoiced $757,000 of Micro Paint Repair products to Automart for which payment has not been received. The accounts receivable related to this transaction have been fully reserved. Recognition of revenue on this transaction has been deferred since this is a new customer in a new territory. If and when payment is made, NeoMedia expects to recognize revenue for these shipments, and would also receive a material cash infusion. In the absence of payment, NeoMedia would not recognize revenue related to these products and would not recoup its cost of goods sold which have already been paid. If not collected, these assets could be sold in connection with the proposed sale of the NMPR business unit.

Sources of Cash and Projected Cash Requirements

NeoMedia intends to fund its growth and working capital deficiencies from the following sources during 2007 and beyond:

$7.5 million convertible debenture - March 2007. On March 27, 2007, the Company sold convertible debentures with a face value of $7.5 million to Cornell Capital Partners. Net proceeds to the Company were $5 million. The Company expects to use the funds to bridge to the sale of its non-core business units, and to the extent applicable, to pay outstanding liabilities associated with its acquisitions.

Sale of non-core business units. During August 2006, NeoMedia announced its intent to sell its Micro Paint Repair business unit. Additionally, during January 2007, the Company decided to sell wholly-owned subsidiaries 12Snap and NeoMedia Telecom Services. Any cash proceeds realized from the sale of these non-core business units will be used to fund the operations of NeoMedia’s core code reading business, consisting of qode®, Gavitec, and the related intellectual property. Pursuant to the terms of the latest convertible debenture financing completed in March 2007, NeoMedia is obligated to contribute a minimum of 50% of the proceeds from the sale of any of its non-core assets toward repayment of the March 2007 convertible debenture.

Exercise of options and warrants. On of the Company’s shareholders, Cornell Capital Partners, currently holds warrants to purchase up to 427,000,000 shares of Company common stock at exercise prices between $0.04 and $0.06 per share. NeoMedia can force exercise of the warrants if the closing bid price of NeoMedia stock is more than $0.10 greater than the exercise price of any of the warrants for 15 consecutive trading days. It is important to note that the warrants held by Cornell Capital Partners contain a provision that, if NeoMedia is in default of the warrant agreement, the holder can perform a “cashless” exercise of the warrants and in lieu of making payment of the exercise price in cash, elect instead to withhold shares as consideration for the exercise price. In the event of such a “cashless” exercise, NeoMedia would not receive any cash proceeds upon the exercise of such warrants. NeoMedia is currently in default of: the Investor Registration Rights Agreement entered into on February 17, 2006, in connection with the Series C convertible preferred stock, which called for a registration statement containing the shares underlying the secured convertible debentures to be filed by June 1, 2006; and the Investor Registration Rights Agreement entered into on August 24, 2006 in connection with the secured convertible debentures, which called for the shares underlying the secured convertible debentures to be registered by November 22, 2006. Such a default of the Investor Registration Rights Agreements constitutes an event of default under the warrant agreements. As a result, Cornell Capital Partners currently has the right to exercise on a cashless basis 250,000,000 of the warrants they hold, and NeoMedia may not receive any cash proceeds from such exercises.

In addition, certain outstanding employee stock options are in-the-money and could be exercised at the holders’ discretion from time to time. As of December 31, 2006, NeoMedia had 105,822,455 outstanding employee stock options, of which 26,169,444 were in-the-money based on the closing price on December 31, 2006 of $0.053 per share. Total potential proceeds from exercise of all in-the-money options are $1,125,000. On February 1, 2007, NeoMedia instituted a stock option repricing plan as a retention tool to align its employees with the new vision of NeoMedia. Under the Plan, NeoMedia repriced 50,178,750 stock options held by current employees, contractors, and directors as follows: (i) options that were vested as of February 1, 2007, were repriced to $0.045 per share, which was the last sale price on February 1, 2007, (ii) options that are scheduled to vest during the remainder of 2007 were repriced to $0.075, (iii) options that vest during 2008 were repriced to $0.125, and (iv) options that vest during 2009 were repriced to $0.175. Options will continue to vest on their regular schedule, which generally is 25% upon grant and 25% on each subsequent anniversary date. NeoMedia expects that additional funds could be realized upon exercise of such repriced options.

$100 Million SEDA. On March 30, 2005, NeoMedia and Cornell Capital Partners entered into a Standby Equity Distribution Agreement under which Cornell Capital Partners agreed to purchase up to $100 million of NeoMedia’s common stock over a two-year period, with the timing and amount of the purchase at NeoMedia’s discretion. The maximum amount of each purchase would be $2,000,000 with a minimum of five business days between advances. Based on NeoMedia’s current market capitalization and other outstanding securities, NeoMedia does not believe that the 2005 SEDA is currently a viable source of financing.

NeoMedia’s reliance on Cornell Capital Partners as its primary financing source has certain ramifications that could affect future liquidity and business operations. For example, pursuant to the terms of the convertible debenture agreements between NeoMedia and Cornell signed in connection with the convertible debenture sales, without Cornell’s consent NeoMedia cannot (i) issue or sell any shares of Common Stock or preferred stock without consideration or for consideration per share less than the closing bid price immediately prior to its issuance, (ii) issue or sell any preferred stock, warrant, option, right, contract, call, or other security or instrument granting the holder thereof the right to acquire common stock for consideration per share less than the closing bid price immediately prior to its issuance, (iii) enter into any security instrument granting the holder a security interest in any of its assets of, or (iv) file any registration statements on Form S-8. In addition, pursuant to security agreements between NeoMedia and Cornell signed in connection with the convertible debentures, Cornell has a security interest in all of NeoMedia’s assets. Such covenants could severely harm NeoMedia’s ability to raise additional funds from sources other than Cornell, and would likely result in a higher cost of capital in the event funding were secured.

Additionally, pursuant to the terms of the investment agreement between NeoMedia and Cornell signed in connection with the Series C convertible preferred stock sale, NeoMedia cannot (i) enter into any debt arrangements in which it is the borrower, (ii) grant any security interest in any of its assets, or (iii) grant any security below market price.

NeoMedia has incurred both cash and non-cash costs associated with the financing arrangements with Cornell Capital Partners, as follows:

·	In connection with the $7.5 million convertible debenture in March 2007, NeoMedia issued 125,000,000 warrants to Cornell with an exercise price of $0.04 per share. NeoMedia also paid cash fees of $781,000 from the proceeds.

In connection with the $2.5 million convertible debenture in December 2006, NeoMedia issued 42,000,000 warrants to Cornell with an exercise price of $0.04 per share, and repriced an additional 210,000,000 warrants held by Cornell Capital Partners that had been issued in connection with previous financings. NeoMedia also paid cash fees of $270,000 from the proceeds.

In connection with the $5 million convertible debenture in August 2006, NeoMedia issued 175,000,000 warrants to Cornell with exercise prices between $0.05 and $0.25 (which were subsequently repriced in December 2006), and repriced 85,000,000 warrants that had been issued in connection with a previous financing (which were subsequently further repriced in December 2006).

In connection with the $27 million Series C convertible preferred stock sale in February 2006, NeoMedia incurred the following costs: (i) Cornell held back a $2,700,000 cash fee from the proceeds of the sale, (ii) NeoMedia issued 75 million warrants to Cornell with exercise prices between $0.35 and $0.50, which were subsequently repriced, and (iii) NeoMedia issued 2,000,000 warrants with an exercise price of $0.328 to another party for structuring and consulting fees associated with the sale.

In connection with the 2005 SEDA in March 2005, NeoMedia incurred the following costs: (i) NeoMedia issued 75,000,000 warrants to Cornell with an exercise price of $0.20, 10,000,000 of which were subsequently repriced to $0.04 in connection with the convertible debenture financings in August 2006 and December 2006, and (ii) NeoMedia issued 4,000,000 warrants with an exercise price of $0.227 to another party for structuring and consulting fees associated with the 2005 SEDA. The fair value of these warrants in the amount of $13,256,000 was written off during the year ended December 31, 2006.

NeoMedia’s cash flow used in operations was $10 million (net of cash used in operations of discontinued Mobot, Sponge, and Micro Paint Repair business units of $3.6 million) for the year ended December 31, 2006. In the event that (i) NeoMedia is unsuccessful in divesting of its non-core business units in a timely fashion, (ii) NeoMedia’s stock price does not increase to levels where it can force exercise of enough of its outstanding warrants to generate material operating capital, (iii) the market for NeoMedia’s stock will not support the sale of shares underlying such warrants or other funding sources, or (iv) NeoMedia does not realize a material increase in revenue during the next 12 months, NeoMedia will have to seek additional cash sources. There can be no assurances that such funding sources will be available. If necessary funds are not available, NeoMedia’s business and operations would be materially adversely affected and in such event, NeoMedia would attempt to reduce costs and adjust its business plan, and could be forced to sell certain of its assets, including its subsidiaries.

Contractual Obligations

NeoMedia is party to various commitments and contingencies, such as:

·	NeoMedia and its subsidiaries lease office facilities and certain office and computer equipment under various operating leases

·	NeoMedia is party to various payment arrangements with its vendors that call for fixed payments on past due liabilities

·	NeoMedia is party to various consulting agreements that carry payment obligations into future years.

·	NeoMedia issued Series C convertible preferred shares with face value of $22,000,000 and convertible debentures with a face value of $14.5 million that are subject to conversion at future dates

·	NeoMedia holds notes payable to certain vendors and silent partners of an acquired subsidiary that mature at various dates in the future.

The following table sets forth NeoMedia’s future minimum payments due under operating leases, vendor and consulting agreements, convertible stock agreements, and debt agreements:

	(US dollars in thousands)
											Series C
			Vendor &				Subsidiary				Convertible
	Operating		Consulting		Notes		Acquisition		Convertible		Preferred
	Leases		Agreements		Payable		Commitments		Debentures		Stock		Total

2007	$	693	$	1,069	$	2,155	$	22,367	$	7,500		25,514	$	59,299
2008		399		124		—		—		—		—		522
2009		85		—		—		—		—		—		85
2010		15		—		—		—		—		—		15
2011		—		—		—		—		—		—		—
Thereafter		—		—		—		—		—		—		—
Total	$	1,192	$	1,193	$	2,155	$	22,367	$	7,500	$	25,514	$	59,921

Going Concern

The accompanying 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 years ended December 31, 2006, 2005, and 2004 was $67,438,000, $9,147,000, and $7,230,000, respectively. Net cash used for operations was $9,958,000, $4,883,000, and $3,937,000. NeoMedia also has an accumulated deficit of $159,962,000 and a working capital deficit of $81,167,000 as of December 31, 2006.

During January 2007, the Company made a strategic decision to sell its 12Snap and Telecom Services businesses. During the year ended December 31, 2006, revenues from these businesses accounted for 91% of NeoMedia’s consolidated revenues. In the event that the Company is successful in selling these businesses, revenue, gross margin, and operating expenses would decline materially relative to 2006.

NeoMedia has the following material liquidity events:

·	As of December 31, 2006, NeoMedia had recorded liabilities of $16,233,000 and $5,194,000 relating to purchase price guarantee obligations associated with its acquisitions of 12Snap and Gavitec, respectively.

Prior to the acquisition of 12Snap by NeoMedia, 12Snap entered into silent partnership debt arrangements with principal borrowing amounts totaling $4.2 million (EUR 3.5 million). The partnership agreements were scheduled to terminate on December 31, 2008 and 2009. However, due to the acquisition of all shares of 12Snap by NeoMedia, an early termination was agreed on for the silent partnership agreements. Those silent partnerships terminated as of February 28, 2006 with the acquisition of 12Snap by NeoMedia. NeoMedia made payments toward the outstanding principal of $2.1 million and $0.6 million during March 2006 and December 2006, respectively. The balance as of December 31, 2006 relating to silent partners was $2.1 million. NeoMedia made additional payments of $1.0 million during February 2007. The remaining balance of $1.1 million is due on or before March 31, 2007, which has not been paid as of the date of this filing.

During January 2007, NeoMedia and the former Gavitec shareholders agreed that the entire purchase price obligation would be satisfied through the payment by NeoMedia of (i) $1,800,000 in cash, payable no later than February 28, 2007(subsequently extended to March 31, 2007), and (ii) 61,000,000 shares of NeoMedia common stock, to be issued no later than February 28, 2007. NeoMedia also agreed to pay interest accrued on the purchase price in the amount of $213,000 and reimburse $100,000 of costs related to the acquisition to the primary former shareholder of Gavitec no later than February 28, 2007 (subsequently extended to March 31, 2007). NeoMedia made payments of $2,113,000 during March 2007 in satisfaction of the obligation.

The items discussed above raise substantial doubts about the Company’s ability to continue as a going concern.

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.

Should 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 commercialization of its core code-reading business.

NeoMedia plans to attempt to address its working capital deficiency by completing the proposed sales of the 12Snap, Micro Paint Repair, and NeoMedia Telecom business units, and continuing to reduce its workforce and overhead expenses in non-critical areas. In addition, NeoMedia will attempt to generate additional revenue and profit from the launch of its core code-reading products and the value optimization of its patent portfolio.

In the event that these financing sources do not materialize, or that NeoMedia is unsuccessful in increasing its revenues and profits, NeoMedia will be forced to further reduce its costs, may be unable to 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. Additionally, if these funding sources or increased revenues and profits do not materialize, and NeoMedia is unable to secure additional financing, NeoMedia could be forced to reduce or curtail its business operations unless it is able to engage in a merger or other corporate finance transaction with a better capitalized entity.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The following discussion about NeoMedia’s market risk involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements.

Interest Rate Risk. NeoMedia’s exposure to interest rate risk from changes in market interest rates relates primarily to its cash balances. As of December 31, 2006, NeoMedia had cash balances of $3,606,000, which were held in a money market account with returns based on market interest rates. NeoMedia does not hold derivative financial instruments or equity investments in its investment portfolio. Due in part to these factors, NeoMedia’s future interest income may be adversely impacted due to changes in interest rates. The level of exposure correlated directly to NeoMedia’s cash balances. In the event NeoMedia is successful in raising additional capital, selling its non-core business units, and generating profits from its core code-reading business, the Company expects to have additional cash balances to invest in a wider array of short-and long-term securities and other investments. There have been no material changes in NeoMedia’s investment methodology regarding its cash equivalents and short-term investments during the year ended December 31, 2006. Based on NeoMedia’s cash and cash equivalent at December 31, 2006, a hypothetical 10% increase/decrease in interest rates would increase/decrease NeoMedia’s annual interest income and cash flows by approximately $36,000.

Investment Risk. As of December 31, 2006, NeoMedia had investments in the following privately held companies for business and strategic purposes: Sponge Ltd., Mobot, Inc., and Intactis Software, Inc. NeoMedia also owns common shares and notes receivable of Pickups Plus, Inc., a publicly held company. NeoMedia’s investments in common stock of publicly traded companies are accounted for as available-for-sale, carried at current market value and are classified as long-term as they are strategic in nature. NeoMedia periodically evaluates whether any declines in fair value of NeoMedia’s investments are other-than-temporary based on a review of qualitative and quantitative factors. For investments with publicly quoted market prices, these factors include the time period and extent by which its accounting basis exceeds its quoted market price. NeoMedia considers additional factors to determine whether declines in fair value are other-than-temporary, such as the investee’s financial condition, results of operations, and operating trends. The evaluation also considers publicly available information regarding the investee companies. For investments in private companies with no quoted market price, NeoMedia considers similar qualitative and quantitative factors as well as the implied value from any recent rounds of financing completed by the investee. Based upon an evaluation of the facts and circumstances during 2006, NeoMedia determined that an other-than-temporary decline in fair value had occurred in its notes receivable from Pickups Plus, resulting in an impairment charge of $379,000 to reflect changes in the fair value. Based upon an evaluation of the facts and circumstances during 2005, NeoMedia determined that an other-than-temporary decline in fair value had occurred with respect to its investments in Secure Source Technologies and Intactis Software, resulting in impairment charges of $1,115,000 to reflect changes in the fair values. Based upon an evaluation of the facts and circumstances during 2004, NeoMedia determined that no other-than-temporary declines in fair value had occurred.

Foreign Currency Risk. NeoMedia conducts business internationally in several currencies, and as such, is exposed to adverse movements in foreign currency exchange rates.

NeoMedia’s exposure to foreign exchange rate fluctuations arise in part from: (1) translation of the financial results of foreign subsidiaries into U.S. dollars in consolidation; (2) the re-measurement of non-functional currency assets, liabilities and intercompany balances into U.S. dollars for financial reporting purposes; and (3) non-U.S. dollar denominated sales to foreign customers. NeoMedia does not hedge or use of foreign currency forward contracts to manage its foreign currency risks. Historically, neither fluctuations in foreign exchange rates nor changes in foreign economic conditions have had a significant impact on the Company’s financial condition or results of operations. Foreign exchange rate fluctuations did not have a material impact on NeoMedia’s financial results for the years ended December 31, 2006, 2005, and 2004.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Financial Statements to this Form 10-K are attached commencing on page F-1.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders

NeoMedia Technologies, Inc.

We have audited the accompanying consolidated balance sheets of NeoMedia Technologies, Inc. as of December 31, 2006 and 2005, and the related consolidated statements of operations, shareholders’ equity (deficit) and other comprehensive loss, and cash flows for the years ended December 31, 2006, 2005 and 2004. Our audits also included the consolidated financial statement schedule listed in the index at Item 15(a)(ii). These consolidated financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of NeoMedia Technologies, Inc. as of December 31, 2006 and 2005, and the results of their operations and their cash flows for the years ended December 31, 2006, 2005 and 2004 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related consolidated financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

As discussed in Note 15 to the consolidated financial statements, effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (Revised 2004), “Share-Based Payment.”

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company's significant operating losses, negative cash flows from operations and working capital deficit raise substantial doubt about its ability to continue as a going concern. Management's plans regarding these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of NeoMedia Technologies, Inc.’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated April 2, 2007 expressed an unqualified opinion on management’s assessment of internal control over financial reporting, and an adverse opinion on the effectiveness of internal control over financial reporting.

/s/ Stonefield Josephson, Inc.

Los Angeles, California

April 2, 2007

F-1

NeoMedia Technologies, Inc. and Subsidiaries

Consolidated Balance Sheets

(In Thousands, Except Share Data)

	December 31,			December 31,
	2006			2005
ASSETS
Current assets:
Cash and cash equivalents	$	3,606		$	1,704
Trade accounts receivable, net of allowance for doubtful accounts of $146 and $14, respectively		3,606			130
Other Receivables		550			---
Inventories, net of allowance for obsolete and slow-moving inventory of $53 and $0 respectively.		80			2
Investment in marketable securities		57			104
Prepaid expenses and other current assets		521			121
Assets held for sale		3,072			4,058
Total current assets		11,492			6,119

Leasehold improvements and property and equipment, net		439			110
Goodwill		7,882			---
Customer contracts, net		1,416			---
Proprietary software, net		8,110			---
Brand name,net		1,467			---
Copyrighted materials,net		192			---
Patents and other Intangible assets, net		2,839			3,274
Cash surrender value of life insurance policy		863			769
Loan to Mobot		---			1,500
Other long-term assets		3,425			639
Total assets	$	38,125		$	12,411

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	4,936		$	2,275
Liabilities held for sale		407			669
Taxes payable		1,042			85
Accrued expenses		4,406			1,833
Deferred revenues and customer prepayments		2,563			307
Notes payable		2,196			3,015
Accrued purchase price guarantee		21,427			---
Derivative financial instruments		25,819			---
Deferred tax liability		706			---
Debentures payable		7,500			---
Series C convertible preferred stock, $0.01 par value, 25,000,000 shares authorized,
22,000 shares issued, 21,622 shares outstanding, liquidation value of $21,657.		21,657			---
Total liabilities		92,659			8,184
Commitments and contingencies (Note 13)

Shareholders’ equity (deficit):
Common stock, $0.01 par value, 5,000,000,000 shares authorized, 639,233,173 and
475,387,910 shares issued and 637,591,747 and 467,601,717 outstanding, respectively		6,376			4,676
Additional paid-in capital		100,541			106,287
Deferred equity financing costs		---			(13,256	)
Accumulated deficit		(159,962	)		(92,524	)
Accumulated other comprehensive loss		(710	)		(177	)
Treasury stock, at cost, 201,230 shares of common stock		(779	)		(779	)
Total shareholders’ equity (deficit)		(54,534	)		4,227
Total liabilities and shareholders’ equity (deficit)	$	38,125		$	12,411

The accompanying notes form an integral part of these consolidated financial statements.

F-2

NeoMedia Technologies, Inc. and Subsidiaries

Consolidated Statements of Operations

and Comprehensive Loss

(In Thousands, Except Share and per Share Data)

	Years Ended December 31,
	2006			2005			2004

Net sales	$	10,309		$	877		$	973
Cost of sales		3,863			583			926
Gross profit		6,446			294			47

Sales and marketing expenses		10,239			2,592			1,170
General and administrative expenses		12,125			3,020			2,137
Research and development costs		3,522			592			463
Impairment charge		18,706			1,115			—
Loss from operations		(38,146	)		(7,025	)		(3,723	)

Gain (loss) on extinguishment of debt		(1,879	)		172			140
Amortization of debt discount		—			—			(2,500	)
Interest income (expense), net		(10,182	)		(293	)		(189	)
Write-off of deferred equity financing costs		(13,256	)		—			—
Gain on sale of marketable securities		1,103			—			—
Gain from change in fair value of derivative financial instruments		13,645			—			—
Repricing of warrants related to financing transactions		(3,537	)		—			—

LOSS FROM CONTINUING OPERATIONS		(52,252	)		(7,146	)		(6,272	)

DISCONTINUED OPERATIONS (Note 4)
Loss from discontinued operations		(5,768	)		(2,001	)		(958	)
Loss on disposal of Sponge and Mobot subsidiaries		(9,418	)		—			—
LOSS FROM DISCONTINUED OPERATIONS		(15,186	)		(2,001	)		(958	)

NET LOSS		(67,438	)		(9,147	)		(7,230	)

Accretion of dividends on convertible preferred stock		(20,324