**U.
        S. SECURITIES AND EXCHANGE COMMISSION**
 WASHINGTON,
        D.C. 20549
 _________________________________
 
 **FORM
        10 - Q**
 (Mark
        One)
 **x QUARTERLY
        REPORT
        PURSUANT TO SECTION 13 OR 15(d) OF**
 **THE
        SECURITIES EXCHANGE ACT OF 1934**
 
 **For
        the Quarterly Period Ended March 31, 2006**
 
 **OR**
 
 **o TRANSITION
        REPORT
        PURSUANT TO SECTION 13 OR 15(d) OF**
 **THE
        SECURITIES EXCHANGE ACT OF 1934**
 
 **Commission
        File Number 0-21743**
 
 **NEOMEDIA
        TECHNOLOGIES, INC.**
 (Exact
        Name of Issuer as Specified In Its Charter)
 
 **Delaware**
              **36-3680347**(State
                  or Other Jurisdiction of Incorporation or
                  Organization)
              (I.R.S.
                  Employer Identification No.)**2201
                  Second Street, Suite 600, Fort
                  Myers, Florida**
              **33901**(Address
                  of Principal Executive
                  Offices)
              (Zip
                  Code)**239-337-3434**Issuer's
                Telephone Number (Including Area Code)
 
 Check
        whether the issuer (1) filed all reports required to be filed by Section
        13 or
        15(d) of the Exchange Act during the past 12 months (or for such shorter
        period
        that the registrant was required to file such reports), and (2) has been
        subject
        to such filing requirements for the past 90
        days.            
Yes x  No
o
 
 Indicate
        by check mark whether the registrant is a large accelerated filer, an
        accelerated filer, or a non-accelerated filer. See definition of “accelerated
        filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
        one): Large Accelerated Filer o  
 Accelerated
        Filer x Non-accelerated
        Filer o
  Indicate
        by check mark whether the registrant is a shell company (as defined in Rule
        12b-2 of the Exchange Act). Yes o No
x
 
 As
        of
        April 28, 2006, there were 630,759,953 outstanding shares of the issuer's
        Common
        Stock, and 22,000 outstanding shares of the issuer’s Series C Convertible
        Preferred Stock.
  
  **TABLE
        OF CONTENTS**
 PART
                    I --FINANCIAL INFORMATION
                1ITEM 1. FINANCIAL STATEMENTS
                1CONDENSED
                    CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 2006 (UNAUDITED)
                    AND DECEMBER
                    31, 2005
                1CONDENSED
                    CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
                    FORTHE
                    THREE MONTHS ENDED MARCH 31, 2006 AND 2005 (UNAUDITED)
                2CONDENSED
                    CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE THREEMONTHS ENDED  MARCH 31,
                    2006 AND 2005 (UNAUDITED)
                3NOTES
                    TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
                4ITEM
                    2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
                  CONDITION AND RESULTS OF OPERATIONS
                39ITEM
                    3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
                    RISK.
                50ITEM
                    4.  CONTROLS AND PROCEDURES
                50PART
                    II--OTHER INFORMATION
                51ITEM
                    1.  LEGAL PROCEEDINGS
                51ITEM
                    3.  DEFAULT UPON SENIOR SECURITIES
                61ITEM
                    4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY
                    HOLDERS
                61ITEM
                    5.  OTHER INFORMATION
                61ITEM
                    6.  EXHIBITS AND REPORTS ON FORM 8-K
                62SIGNATURES
                64
 
 
 **PART
        I -- FINANCIAL INFORMATION**
  **ITEM
        1. FINANCIAL STATEMENTS**
 **NeoMedia
        Technologies, Inc. and Subsidiaries**
 **Condensed
        Consolidated Balance Sheets**
 **(In
        Thousands, Except Share Data)**
 **March
                  31**
              
              **December
                  31****2006**
              
              **2005****ASSETS**
              
              (unaudited)
              
              *Current
                  assets:Cash
                  and cash equivalents
              
              $
              7,115
              
              $
              2,291Trade
                  accounts receivable, net of allowance for doubtful accounts of
                  $73 and
                  $203, respectively
              
              
              5,159
              
              
              341Inventories,
                  net of allowance for obsolete & slow-moving inventory of
                  $0
              
              
              852
              
              
              423Investment
                  in marketable securities
              
              
              453
              
              
              104Prepaid
                  expenses and other current assets
              
              
              1,478
              
              
              151Total
                  current assets
              
              
              15,057
              
              
              3,310Leasehold
                  improvements & property and equipment, net
              
              
              628
              
              
              236Capitalized
                  patents, net
              
              
              3,072
              
              
              3,134Micro
                  paint chemical formulations and proprietary process, net
              
              
              1,422
              
              
              1,450Goodwill
              
              
              48,881
              
              
              1,099Other
                  Intangible assets, net
              
              
              22,057
              
              
              246Cash
                  surrender value of life insurance policy
              
              
              799
              
              
              769Loan
                  to Mobot
              
              
              ---
              
              
              1,500Other
                  long-term assets
              
              
              893
              
              
              667**Total
                  assets**
              
              **$**
              **92,809**
              
              **$**
              **12,411****LIABILITIES
                  AND SHAREHOLDERS’ DEFICIT**Current
                  liabilities:Accounts
                  payable
              
              $
              5,408
              
              $
              1,574Amounts
                  payable under settlement agreements
              
              
              97
              
              
              1,844Liabilities
                  of discontinued business unit
              
              
              676
              
              
              97Taxes
                  payable
              
              
              1,112
              
              
              80Accrued
                  expenses
              
              
              4,460
              
              
              898Deferred
                  revenues
              
              
              2,576
              
              
              676Notes
                  payable
              
              
              3,774
              
              
              3,015Derivative
                  financial instruments
              
              
              23,432
              
              
              ---Total
                  current liabilities
              
              
              41,535
              
              
              8,184Preferred
                  stock, $0.01 par value, 25,000,000 shares authorized, 22,000
                  issuedand
                  outstanding, liquidation value of $22,000
              
              
              1,847
              
              
              ---Shareholders’
                  equity:Common
                  stock, $0.01 par value, 1,000,000,000 shares authorized,630,885,698
                  and 475,387,910 shares issued and 629,244,272 and
                  467,601,717 outstanding, respectively
              
              
              6,293
              
              
              4,676Additional
                  paid-in capital
              
              
              151,407
              
              
              106,456Deferred
                  stock-based compensation
              
              
              (146
              )
              
              (169
              )Deferred
                  equity financing costs
              
              
              (13,256
              )
              
              (13,256
              )Accumulated
                  deficit
              
              
              (93,842
              )
              
              (92,524
              )Accumulated
                  other comprehensive loss
              
              
              (250
              )
              
              (177
              )Treasury
                  stock, at cost, 201,230 shares of common stock
              
              
              (779
              )
              
              (779
              )Total
                  shareholders’ equity
              
              
              49,427
              
              
              4,227**Total
                  liabilities and shareholders’ equity**
              
              **$**
              **92,809**
              
              **$**
              **12,411**
 The
        accompanying notes are an integral part of these condensed consolidated
        financial statements.
 
 *
        -
        Derived from NeoMedia’s audited financial statements for the year ended December
        31, 2005.
  1
  **NeoMedia
        Technologies, Inc. and Subsidiaries**
 **Condensed
        Consolidated Statements of Operations** ****
 **and
        Comprehensive Loss (Unaudited)**
 **(In
        Thousands, Except per Share Data)**
 **Three
                  Months Ended March 31,****2006**
              
              **2005**NET
                  SALES:Technology
                  license, service and products
              
              $
              1,675
              
              $
              292Micro
                  paint repair products and services
              
              
              377
              
              
              455Total
                  net sales
              
              
              2,052
              
              
              747COST
                  OF SALES:Technology
                  license, service and products
              
              
              827
              
              
              176Micro
                  paint repair products and services
              
              
              419
              
              
              273Total
                  cost of sales
              
              
              1,246
              
              
              449GROSS
                  PROFIT
              
              
              806
              
              
              298Sales
                  and marketing expenses
              
              
              1,540
              
              
              795General
                  and administrative expenses
              
              
              1,326
              
              
              603Research
                  and development costs
              
              
              550
              
              
              184Stock
                  based compensation expense
              
              
              1,517
              
              
              96Loss
                  from operations
              
              
              (4,127
              )
              
              (1,380
              )Other
                  income
              
              
              4
              
              
              ---Gain
                  (loss) on extinguishment of debt
              
              
              (1,964
              )
              
              138Interest
                  income
              
              
              2
              
              
              23Gain
                  on derivative financial instruments
              
              
              4,768
              
              
              ---**NET
                  LOSS**
              
              
              **(1,317**
              **)**
              
              **(1,219**
              **)**Accretion
                  of dividends on convertible preferred stock
              
              
              (137
              )
              
              ---**NET
                  LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS**
              
              
              **(1,454**
              **)**
              
              **(1,219**
              **)****Comprehensive
                  Loss**Net
                  loss
              
              
              (1,317
              )
              
              (1,219
              )Other
                  comprehensive loss:Unrealized
                  gain (loss) on marketable securities
              
              
              149
              
              
              (42
              )Foreign
                  currency translation adjustment
              
              
              (222
              )
              
              11**COMPREHENSIVE
                  LOSS**
              
              **$**
              **(1,390**
              **)**
              **$**
              **(1,250**
              **)****LOSS
                  PER SHARE--BASIC AND DILUTED**
              
              **$**
              **(0.00**
              **)**
              **$**
              **(0.00**
              **)****LOSS
                  PER SHARE ATTRIBUTABLE TO COMMON SHAREHOLDERS**
              
              **$**
              **(0.00**
              **)**
              **$**
              **(0.00**
              **)****Weighted
                  average number of common shares--basic and
                  diluted**
              
              
              **527,991,819**
              
              
              **437,764,971**
 The
        accompanying notes are an integral part of these condensed consolidated
        financial statements.
  2
  **NeoMedia
        Technologies, Inc. and Subsidiaries**
 **Condensed
        Consolidated Statements of Cash Flows (Unaudited)**
 **(In
        Thousands)**
 **Three
                  Months Ended****March
                  31,****2006**
              
              **2005**CASH
                  FLOWS FROM OPERATING ACTIVITIES:Net
                  loss
              
              
              ($1,317
              )
              
              ($1,219
              )Adjustments
                  to reconcile net loss to net cash used in operating
                  activities:Depreciation
                  and amortization
              
              
              453
              
              
              160Loss
                  on early extinguishment of debt
              
              
              1,964
              
              
              —Gain
                  on derivative financial instruments
              
              
              (4,768
              )
              
              —Stock-based
                  compensation expense
              
              
              1,517
              
              
              96(Increase)
                  decrease in value of life insurance policies
              
              
              (30
              )
              
              10Changes
                  in operating assets and liabilitiesTrade
                  accounts receivable, net
              
              
              432
              
              
              (265
              )Inventory
              
              
              (323
              )
              
              3Other
                  current assets
              
              
              (156
              )
              
              54Accounts
                  payable, amounts due under financing agreements, liabilities in
                  excessof
                  assets of discontinued business unit, accrued expenses and stock
                  liability
              
              
              (249
              )
              
              (425
              )Deferred
                  revenue other current liabilities
              
              
              (109
              )
              
              (74
              )Net
                  cash used in operating activities
              
              
              (2,586
              )
              
              (1,660
              )CASH
                  FLOWS FROM INVESTING ACTIVITIES:Cash
                  paid to acquire Mobot, Inc., Sponge Ltd., Gavitec AG, and 12Snap
                  AG, net
                  of cash and marketable securities acquired
              
              
              (11,891
              )
              
              —Amounts
                  issued under notes receivable
              
              
              (500
              )
              
              —Investments
              
              
              —
              
              
              (500
              )Acquisition
                  related costs
              
              
              (59
              )
              
              —Capitalization
                  of software development and purchased intangible assets
              
              
              (8
              )
              
              (38
              )Acquisition
                  of property and equipment
              
              
              (66
              )
              
              (88
              )Net
                  cash used in investing activities
              
              
              (12,524
              )
              
              (626
              )CASH
                  FLOWS FROM FINANCING ACTIVITIES:Net
                  proceeds from issuance of Series C Convertible Preferred Stock,
                  net of
                  issuance costs of $2,725 in 2006
              
              
              14,066
              
              
              —Net
                  proceeds from issuance of common stock, net of issuance costs of
                  $24 in
                  2006 and $85 in 2005
              
              
              210
              
              
              1,505Net
                  proceeds from exercise of stock options and warrants
              
              
              8,131
              
              
              173Borrowings
                  under notes payable and long-term debt
              
              
              —
              
              
              10,500Repayments
                  on notes payable and long-term debt
              
              
              (2,251
              )
              
              (1,600
              )Cash
                  commitment fee for $100 million Standby Equity Distribution
                  Agreement
              
              
              —
              
              
              (1,000
              )Net
                  cash provided by financing activities
              
              
              20,156
              
              
              9,578**EFFECT
                  OF EXCHANGE RATE CHANGES ON CASH**
              
              
              (222
              )
              
              11**NET
                  INCREASE IN CASH AND CASH EQUIVALENTS**
              
              
              **4,824**
              
              
              **7,303**CASH
                  AND CASH EQUIVALENTS, BEGINNING OF PERIOD
              
              
              2,291
              
              
              2,634**CASH
                  AND CASH EQUIVALENTS, END OF PERIOD**
              
              **$**
              **7,115**
              
              **$**
              **9,937**SUPPLEMENTAL
                  CASH FLOW INFORMATION:Interest
                  paid/(received) during the period
              
              $
              13
              
              $
              47Income
                  taxes paid
              
              
              —
              
              
              —Non-cash
                  investing and financing activities:Unrealized
                  gain (loss) on marketable securities
              
              
              149
              
              
              (42
              )Prepaid
                  acquisition costs applied to purchase price
              
              
              168
              
              
              —Fair
                  value of shares and notes receivable fromPickups
                  Plus, Inc. acquired in exchange for Series C Convertible Preferred
                  Stock
              
              
              594
              
              
              —Carrying
                  value of promissory note and accrued interest paid in exchange
                  for Series
                  C Convertible Preferred Stock
              
              
              (3,208
              )
              
              —Fair
                  value of shares issued to acquire Mobot, Inc.,Sponge
                  Ltd., Gavitec AG, 12Snap AG, and BSD Software, Inc.
              
              
              46,964
              
              
              —Change
                  in net assets resulting from acquisitions of Mobot, Inc.,Sponge
                  Ltd., Gavitec AG, 12Snap AG, and BSD Software, Inc.
              
              
              60,594
              
              
              —Accretion
                  of dividends on Series C Convertible Preferred Stock
              
              
              137
              
              
              —Fair
                  value of outstanding warrants converted to liabilities
              
              
              13,884
              
              
              —Portion
                  of change in fair value of outstanding warrants converted to liabilities
                  recorded to paid-in capital
              
              
              3,790
              
              
              —Fair
                  value of Series C Convertible Preferred Stock (host instrument
                  only)
              
              
              4,908
              
              
              —Deferred
                  stock-based financing costs associated with Series C Convertible
                  Preferred
                  Stock
              
              
              3,198
              
              
              —Difference
                  between net proceeds and recorded fair value of Series C Convertible
                  Preferred Stock
              
              
              4,041
              
              
              —Advance
                  receivable from Mobot, Inc. forgiven upon acquisition
              
              
              1,500
              
              
              —Accretion
                  of dividend on Series C Convertible Preferred Stock
              
              
              137
              
              
              —Fair
                  value of stock issued for services and deferred to future
                  periods
              
              
              —
              
              
              239Gain
                  on extinguishment of debt paid in common stock
              
              
              —
              
              
              138Direct
                  costs associated with Standby Equity Distribution Agreement and
                  Equity
                  Line of Credit
              
              
              —
              
              
              1,204Fair
                  value of warrants as fees related to the $100 million Standby Equity
                  Distribution Agreement
              
              
              —
              
              
              12,256
 
 
 The
        accompanying notes are an integral part of these condensed consolidated
        financial statements.
  3
  **NEOMEDIA
        TECHNOLOGIES, INC. AND SUBSIDIARIES**
 **UNAUDITED
        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 
 
 **1.** **BASIS
        OF PRESENTATION AND NATURE OF BUSINESS OPERATIONS**
 
 **Basis
        of Presentation**
 
 The
        condensed consolidated financial statements include the financial statements
        of
        NeoMedia Technologies, Inc. and its wholly-owned subsidiaries (“NeoMedia” or the
“Company”). The accompanying unaudited condensed consolidated financial
        statements have been prepared in accordance with the instructions to Form
        10-Q
        and do not include all of the information and footnotes required by accounting
        principles generally accepted in the United States of America for complete
        consolidated financial statements. These condensed consolidated financial
        statements and related notes should be read in conjunction with the Company’s
        Form 10-KSB for the fiscal year ended December 31, 2005. In the opinion of
        management, these condensed consolidated financial statements reflect all
        adjustments which are of a normal recurring nature and which are necessary
        to
        present fairly the consolidated financial position of NeoMedia as of March
        31,
        2006, the results of operations for the three month periods ended March 31,
        2006
        and 2005, and cash flows for the three month period ended March 31, 2006
        and
        2005. The results of operations for the three month periods ended March 31,
        2006
        are not necessarily indicative of the results which may be expected for the
        entire fiscal year. All significant intercompany accounts and transactions
        have
        been eliminated in preparation of the condensed consolidated financial
        statements.
 
 **Going
        Concern**
 
 The
        accompanying condensed consolidated financial statements have been prepared
        in
        conformity with accounting principles generally accepted in the United States
        of
        America, which contemplate continuation of the Company as a going concern.
        However, the Company has reported net losses of $1,317,000 and $1,219,000
        for
        the three months ended March 31, 2006 and 2005 and $9,147,000 and $7,230,000
        for
        the years ended December 31, 2005 and 2004, respectively, and has an accumulated
        deficit of $93,842,000 as of March 31, 2006. In addition, the Company had
        working capital deficit of $26,478,000 as of March 31, 2006.
 
 If
        the
        Company’s financial resources are insufficient, the Company may require
        additional financing in order to execute its operating plan and continue
        as a
        going concern. The Company cannot predict whether this additional financing
        will
        be in the form of equity, debt, or another form. The Company may not be able
        to
        obtain the necessary additional capital on a timely basis, on acceptable
        terms,
        or at all. In any of these events, the Company may be unable to implement
        its
        current plans for expansion, repay its debt obligations as they become due
        or
        respond to competitive pressures, any of which circumstances would have a
        material adverse effect on its business, prospects, financial condition and
        results of operations. The financial statements do not include any adjustments
        relating to the recoverability and reclassification of recorded asset amounts
        or
        amounts and reclassification of liabilities that might be necessary, should
        the
        Company be unable to continue as a going concern.
 
 Should
        these financing sources fail to materialize, management would seek alternate
        funding sources through sale of common and/or preferred stock. Management’s plan
        is to secure adequate funding to bridge the profitability from the NeoMedia
        Mobile, NeoMedia Micro Paint Repair, and NeoMedia Telecom Services
        businesses.
  4
 
 **Nature
        of Business Operations**
 
 During
        2005, NeoMedia was structured and evaluated by its Board of Directors and
        management as three distinct business units: NeoMedia Internet Switching
        Software (NISS), NeoMedia Micro Paint Repair (NMPR), and NeoMedia Consulting
        and
        Integration Services (NCIS).
 
 NCIS
        is
        the original business line upon which the Company was founded. This unit
        resells
        client-server equipment and related software, and general and specialized
        consulting services. Because of decreased demand for systems integration
        products, and increased consolidation and competition in the industry in
        general, during 2005 resources allocated to the NCIS business unit were
        increasingly used in sales and business development efforts associated with
        the
        NISS business unit. During
        February 2006, NeoMedia’s Board of Directors elected to formally wind down the
        NCIS business unit. As a result, during February 2006, NeoMedia closed its
        Lisle, Illinois facility out of which the NCIS business unit was based. NeoMedia
        does, however, plan to continue servicing existing contracts and
        customers .
 
 During
        the first quarter of 2006, following the completion of the acquisitions of
        12Snap AG (“12Snap”), Sponge Ltd. (“Sponge”), Gavitec AG (“Gavitec”), Mobot,
        Inc. (“Mobot”), and BSD Software, Inc. (“BSD”), as well as the winding down of
        the NCIS business unit, NeoMedia restructured into the following three business
        units:
 
 -
        NeoMedia Mobile (NMM) - encompassing NeoMedia’s physical-world-to-internet and
        mobile marketing technologies branded under PaperClick, 12Snap, Sponge, Gavitec
        and Mobot
  -
        NeoMedia Micro Paint Repair (NMPR) - encompassing the micro paint and auto
        aftermarket accessories manufactured and distributed by NeoMedia
 
 -
        NeoMedia Telecom Services (NTS) - encompassing the billing, clearinghouse
        and
        information management services of recently-acquired BSD
 
 
 **Reclassifications**
 
 Certain
        amounts in the 2005 condensed consolidated financial statements have been
        reclassified to conform to the 2006 presentation, most notably, “License
        revenue” and “Resales of software and technology equipment and service fees”,
        which were formerly shown as separate line items on NeoMedia’s consolidated
        statement of operations, are now condensed into the category entitled,
“Technology license, service & products.” This is primarily due to the
        winding down of the former NCIS business unit and consolidation of revenues
        relating to the NCIS unit into the NMM unit, as well as the addition of new
        revenue streams from Mobot, Sponge, Gavitec, 12Snap, and BSD that fall into
        the
        same general category.
  5
  **2.** **SUMMARY
        OF SIGNIFICANT ACCOUNTING POLICIES**
 
 A s
        a
        result of the addition of the operations of Mobot, Sponge, Gavitec, 12Snap
        and
        BSD, and the Series C Convertible Preferred Stock sale during the three months
        ended March 3,1 2006, NeoMedia is presenting herewith certain significant
        accounting policies that were not applicable as of the filing of its last
        annual
        report for the year ended December 31, 2005.
  **Stock-based
        Compensation**
 
 Beginning
        January 1, 2006, NeoMedia began to account for stock-based compensation in
        accordance with SFAS No. 123(R), *Share-Based
        Payment* .
        Under
        the fair value recognition provisions of this statement, share-based
        compensation cost is measured at the grant date based on the value of the
        award
        and is recognized as expense over the vesting period. Determining the fair
        value
        of share-based awards at the grant date requires judgment, including estimating
        expected dividends. In addition, judgment is also required in estimating
        the
        amount of share-based awards that are expected to be forfeited. If actual
        results differ significantly from these estimates, stock-based compensation
        expense and our results of operations could be materially impacted. Stock-based
        compensation expense is calculated using the Black-Scholes-Merton option
        pricing
        model on the date of grant. This option valuation model requires input of
        highly
        subjective assumptions. Because NeoMedia’s employee stock options have
        characteristics significantly different from those of traded options, and
        because changes in the subjective input assumptions can materially affect
        the
        fair value estimate, in management's opinion, the existing model does not
        necessarily provide a reliable single measure of fair value of its employee
        stock options.
 
 **Fair
        Value of Derivatives**
 
 The
        Company generally does not use derivative financial instruments to hedge
        exposures to cash-flow risks or market-risks that may affect the fair values
        of
        its financial instruments. However, certain other financial instruments,
        such as
        warrants and embedded conversion features that are indexed to the Company’s
        common stock, are classified as liabilities when either (a) the holder possesses
        rights to net-cash settlement or (b) physical or net-share settlement is
        not
        within the control of the Company. In such instances, net-cash settlement
        is
        assumed for financial accounting and reporting, even when the terms of the
        underlying contracts do not provide for net-cash settlement. Such financial
        instruments are initially recorded at fair value and subsequently adjusted
        to
        fair value 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. **
 
 **Sales
        Taxes Payable**
 
 Sales
        taxes payable represents amounts collected on behalf of specific regulatory
        agencies that require remittance on a specified date. These amounts are
        collected at the time of sales and are detailed on invoices provided to
        customers. At March 31, 2006 sales taxes payable were $1,112,000, of which
        $980,000 were delinquent sales taxes assumed by NeoMedia in connection with
        its
        acquisitions, certain of which are subject to payment plans.
 
 **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.
  6
 
 (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.
 
 (2)
            Technology
                service & product revenue, which includes sales of software and
                technology equipment, service fee and telecom revenue attributed
                primarily
                fees for processing Canadian and U.S. terminated call records for
                telecommunication companies.  These revenue generating items are
                recognized  based on guidance  provided in  SEC Staff 
                Accounting  Bulletin  (“SAB”) No. 104,  "Revenue 
                Recognition  in Financial Statements,"  as amended (SAB
                104).  Software and technology equipment resale
                revenue is recognized when persuasive evidence of an arrangement
                exists, the price to the customer is fixed and determinable, delivery
                of
                the service has occurred and collectibility is reasonably assured. 
                Service revenues including maintenance fees for
                providing system updates for software products, user documentation
                and
                technical support are recognized over the life of
                the contract.  Software  license revenue  from 
                long-term  contracts  has  been  recognized  on
                a  percentage  of completion  basis,  along with the
                 associated  services being  provided.  Telecom
                revenues are recognized at the time that calls are accepted by the
                clearing house for billing to customers.  The Company’s recently
                acquired subsidiaries BSD, Mobot and Gavitec follow this
                policy. 
 (3)
            Technology
                service also includes mobile marketing services to its customers
                which
                mobile marketing projects are recognized after the completion of
                the
                project and accepted by the customer.  All response and messaging
                based revenues are recognized at the time such responses are received
                and
                processed and the Company recognizes its premium messaging revenues
                on a
                gross basis based on guidance provided in Emerging Issues Task Force
                No.
                99-19 (EITF 99-19), “Reporting Revenue Gross as Principal or Net as an
                Agent.”  However, pursuant to EITF 01-09, the Company offsets any
                consideration given to its customers against revenue. Consulting
                and
                management revenues and revenues for periodic services are recognized
                as
                services are performed.  NeoMedia uses  stand-alone 
                pricing to determine an element's  vendor  specific 
                objective  evidence  (“VSOE”) in order to allocate an
                arrangement  fee amongst various pieces of a 
                multi-element  contract.  The Company’s recently acquired
                subsidiaries 12Snap and Sponge follow this
                policy. 
 (4)
            Revenue
                for training and certification 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 training costs and initial products sold with the system, and
                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. 
 7
 In
        December 2003, the SEC issued SAB 104, “Revenue Recognition.” SAB 104
        supersedes SAB 101, “Revenue Recognition in Financial Statements.”
SAB 104’s primary purpose is to rescind accounting guidance contained in
        SAB 101 related to multiple element revenue arrangements, superseded as a
        result of the issuance of EITF 00-21, “Accounting for Revenue Arrangements
        with Multiple Deliverables.” Additionally, SAB 104 rescinds the SEC’s
        Revenue Recognition in Financial Statements Frequently Asked Questions and
        Answers (the “FAQ”) issued with SAB 101 that had been codified in SEC Topic
        13, Revenue Recognition. Selected portions of the FAQ have been incorporated
        into SAB 104. While the wording of SAB 104 has changed to reflect the
        issuance of EITF 00-21, the revenue recognition principles of SAB 101
        remain largely unchanged by the issuance of SAB 104, which was effective
        upon issuance. The adoption of SAB 104 did not impact NeoMedia’s
        consolidated financial statements.
  8
  **3.  
        ACQUISITIONS**
 
 During
        the three months ended March 31, 2006, NeoMedia completed acquisitions of
        Mobot,
        Sponge, Gavitec, 12Snap, and BSD.
 
 **Acquisition
        of Mobot**
 
 On
        February 9, 2006, NeoMedia and Mobot. ( www.mobot.com )
        signed
        a definitive merger agreement, subject to closing conditions, under which
        NeoMedia acquired all of the outstanding shares of Mobot in exchange for
        $3,500,000 cash and 16,931,493 shares of NeoMedia common stock (2,604,845
        of
        which are being held in escrow for a period of one year from the closing
        date
        for the purpose of securing the indemnification obligations outlined in the
        purchase agreement). On February 17, 2006, NeoMedia and Mobot completed the
        closing requirements and the acquisition became effective. Pursuant to the
        terms
        of the merger agreement, the number of shares of NeoMedia common stock to
        be
        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. In the event that NeoMedia’s
        stock price (at the time the consideration shares are saleable) is less than
        $0.3839, NeoMedia is obligated to compensate Mobot shareholders in cash for
        the
        difference between the price at the time the shares become saleable and $0.3839.
        Assuming a stock price at the time the shares become saleable of $0.25, which
        was the last sale price on May 10, 2006, NeoMedia would have a cash liability
        of
        $2.3 million resulting from this clause. In addition to cash and stock, at
        closing NeoMedia forgave notes payable totaling $1,500,000 due from Mobot.
        This
        amount is considered other additional consideration in the purchase price
        allocation.
 
 Mobot
        is
        a pioneer in visual search and recognition technology designed to make marketing
        effective and innovative using mobile devices. Launched in 2004 to help
        companies cultivate rewarding relationships with the world’s 1.5 billion mobile
        phone users, Mobot gives marketers, content providers and carriers the tools
        to
        make it easy for any consumer with a camera phone to interact with their
        offerings. Mobot’s customers include, amongst others, ELLEgirl magazine, for
        which Mobot “turned on” advertisements throughout the magazine that linked to
        content and customer loyalty promotions on the mobile Internet; The Light
        Agency, who distributes Mobot’s visual search and recognition technology to the
        U.K. grocery sector through its award-winning mobile phone-based loyalty
        program
        with the Sainsburys-owned convenience store chain Jackson’s; and Warner Music
        Group’s U.S. sales and retail marketing company WEA Corp., running a
        snap-and-enter contest in music stores for music fans to win tailored offers,
        samples and discounts.
 
 NeoMedia
        completed the acquisitions of Mobot, Sponge, Gavitec, and 12Snap in an effort
        to
        gain entry into the rapidly evolving global mobile marketing
        industry.
  9
  The
        acquisition was accounted for under the purchase method. The actual purchase
        price was based on cash paid, the fair value of NeoMedia stock around the
        date
        of the acquisition, and direct costs associated with the combination. The
        purchase price has initially been allocated (subject to final determination)
        as
        follows:
 (Dollars
                  inThousands)Value of 16,931,493 shares issued at $0.395 per share (1)
              
              $
              6,688Cash paid
              
              
              3,500Direct costs of acquisition
              
              
              8Advances to Mobot forgiven at acquisition
              
              
              1,500Total Fair Value of Purchase Price
              
              
              11,696Assets
                  Acquired:Cash and cash equivalents
              
              $
              328Accounts receivable
              
              
              44Other current assets
              
              
              29Property, plant & equipment
              
              
              30Customer contracts and relationships
              
              
              400Capitalized software platform
              
              
              5,000Copyrighted materials
              
              
              200Goodwill
              
              
              6,084Total Assets Acquired
              
              
              12,115Less
                  Liabilities Assumed:Accounts payable
              
              
              51Accrued liabilities
              
              
              132Deferred revenue
              
              
              236Total Liabilities Assumed
              
              
              419Net
                  assets acquired
              
              $
              11,696
  (1)
        -
        Shares were valued using the average stock price for two days before and
        two
        days after the measurement date, as defined in SFAS 141 and EITF
        99-12
  The
        combination is being accounted for as a purchase business combination as
        defined
        by Statement of Financial Accounting Standards No. 141, Business Combinations.
        A
        final determination of the allocation of the purchase price to the assets
        acquired and liabilities assumed has not been made, and should be considered
        preliminary and is subject to the completion of a comprehensive independent
        valuation of the assets acquired and liabilities assumed. The Company expects
        to
        obtain an independent valuation, currently in process, by the filing of its
        second quarter 2006 Form 10-Q in August 2006.
 
 The
        values assigned to intangible assets, aside from goodwill, are subject to
        amortization. The intangible assets were assigned the following lives for
        amortization purposes:
  Estimated
                  UsefulIntangible
                  asset
              Life
                  (in years)Customer
                  contracts and relationships
              5Copyrighted
                  materials
              5Capitalized
                  software platform
              7
  10
  Goodwill
        was not assigned a life and will be tested for impairment as defined by
        Statement of Financial Accounting Standards No. 144, Accounting for the
        Impairment or Disposal of Long-Lived Assets.
  The
        accompanying consolidated statement of operations presented herein contains the
        results of operations for Mobot for the period from February 18, 2006, through
        March 31, 2006. Pro-forma results of operations for the three months ended
        March
        31, 2006 and 2005 are presented at the end of this Note 3.
 
 **Acquisition
        of Sponge**
 
 On
        February 20, 2006, NeoMedia and Sponge signed a definitive share purchase
        agreement, subject to closing conditions, under which NeoMedia acquired all
        of
        the outstanding shares of Sponge in exchange for $6,141,000 cash and 33,097,135
        shares of NeoMedia common stock (3,400,490 of which are being held in escrow
        for
        a period of one year from the closing date for the
        purpose of securing the indemnification obligations outlined in the purchase
        agreement ).
        The
        agreement also calls for Sponge to earn an additional £2,500,000 (approximately
        $4.4 million) in the form of NeoMedia common stock if, during the two-year
        period beginning at closing, the Sponge business earns in excess of £1,300,000
        (approximately $2.3 million) in net profits. On February 23, 2006, NeoMedia
        and
        Sponge completed the closing requirements and the acquisition became effective.
        Pursuant to the terms of the merger agreement, the number of shares of NeoMedia
        common stock to be issued as consideration was calculated using a share price
        of
        $0.384, which
        was
        the volume-weighted average closing price of NeoMedia common stock for the
        ten
        days up to and including February 8, 2006 .
        In the
        event that NeoMedia’s stock price (at the time the consideration shares are
        saleable) is less than $0.384, NeoMedia is obligated to compensate Sponge
        shareholders in cash for the difference between the price at the time the
        shares
        become saleable and $0.384. Assuming
        a stock price at the time the shares become saleable of $0.25, which was
        the
        last sale price on May 10, 2006, NeoMedia would have a cash liability of
        $4.4
        million resulting from this clause .
 
 Founded
        in 2001, Sponge has grown to become a U.K. market leader in providing mobile
        applications to agencies and media groups, and gain recognition as one of
        Europe’s top independent developers of mobile applications and content. Today,
        Sponge counts more than 40 agencies, including WPP, Aegis and BBH, as clients,
        and supplies services for over 100 world-class brands, including Coca
        Cola ® ,
        Heineken ® and
        Diageo. Sponge also supplies a range of mobile services to media groups,
        including News International, Trinity Mirror, Endemol and IPC. For
        Walker’s (Frito-Lay) potato chips, Sponge enabled a promotion that offered
        consumers of Walker’s -- the U.K.’s largest snack brand -- to win an iPod every
        5 minutes for 4 weeks, by texting a unique code found on-pack into the Sponge
        platform. More than 5% of the total U.K. population participated in the
        campaign, which has been expanded to Belgium and the Netherlands on the basis
        of
        its success in the U.K. A total of 23% of the U.K. population interacted
        with
        Sponge applications in 2005.
 
 NeoMedia
        completed the acquisitions of Mobot, Sponge, Gavitec, and 12Snap in an effort
        to
        gain entry into the rapidly evolving global mobile marketing
        industry.
  11
  The
        acquisition was accounted for under the purchase method. The actual purchase
        price was based on cash paid, the fair value of NeoMedia stock around the
        date
        of the acquisition, and direct costs associated with the combination. The
        purchase price has initially been allocated (subject to final determination)
        as
        follows:
 (Dollars
                  inThousands)Value
                  of 33,097,135 shares issued at $0.395 per share (1)
              
              $
              13,073Cash paid
              
              
              6,141Direct costs of acquisition
              
              
              73Total
                  Fair Value of Purchase Price
              
              
              19,287Assets
                  Acquired:Cash and cash equivalents
              
              $
              177Accounts receivable
              
              
              617Other current assets
              
              
              35Property, plant & equipment
              
              
              53Customer contracts and relationships
              
              
              400Capitalized software platform
              
              
              1,300Brand name
              
              
              500Copyrighted materials
              
              
              50Goodwill
              
              
              16,871Total Assets Acquired
              
              
              20,003Less
                  Liabilities Assumed:Accounts payable
              
              
              190Accrued liabilities
              
              
              322Other current liabilities
              
              
              204Total Liabilities Assumed
              
              
              716Net
                  assets acquired
              
              $
              19,287
  (1)
        -
        Shares were valued using the average stock price for two days before and
        two
        days after the measurement date, as defined in SFAS 141 and EITF
        99-12
 
 The
        combination is being accounted for as a purchase business combination as
        defined
        by Statement of Financial Accounting Standards No. 141, Business Combinations.
        A
        final determination of the allocation of the purchase price to the assets
        acquired and liabilities assumed has not been made, and should be considered
        preliminary and is subject to the completion of a comprehensive independent
        valuation of the assets acquired and liabilities assumed. The Company expects
        to
        obtain an independent valuation, currently in process, by the filing of its
        second quarter 2006 Form 10-Q in August 2006.
 
 The
        values assigned to intangible assets, aside from goodwill, are subject to
        amortization. The intangible assets were assigned the following lives for
        amortization purposes:
  
 Estimated
                  UsefulIntangible
                  asset
              Life
                  (in years)Customer
                  contracts and relationships
              5Copyrighted
                  materials
              5Capitalized
                  software platform
              7Brand
                  name
              10
  12
  Goodwill
        was not assigned a life and will be tested for impairment as defined by
        Statement of Financial Accounting Standards No. 144, Accounting for the
        Impairment or Disposal of Long-Lived Assets.
 
 The
        purchase agreement calls for Sponge to earn an additional £2,500,000
        (approximately $4.4 million) in the form of NeoMedia common stock if, during
        the
        two-year period beginning on February 23, 2006, the Sponge business earns
        in
        excess of £1,300,000 (approximately $2.3 million) in net profits, plus £1 of
        NeoMedia common stock for each £1 the earning exceed £1,300,000 during the
        two-year period. No shares are to be issued pro rata if the earnings target
        is
        not met.
 
 At
        the
        end of the two-year measurement period (February 22, 2008), if the earnings
        target is met, the financial impact on NeoMedia of the issuance of additional
        shares would be a proportionate increase of approximately $4.4 million in
        the
        long-term assets acquired from Sponge, with a corresponding increase in
        depreciation expense from the point of issuance forward. If the earnings
        target
        is not met, no additional shares would be issued and there would be no financial
        impact to NeoMedia. Pursuant to SFAS 141, NeoMedia has not allocated a value
        to
        the contingent consideration in the initial purchase price.
  The
        accompanying consolidated statement of operations presented herein contains
        the
        results of operations for Sponge for the period from February 24, 2006, through
        March 31, 2006. Pro-forma results of operations for the three months ended
        March
        31, 2006 and 2005 are presented at the end of this Note 3.
 
 **Acquisition
        of Gavitec**
 
 On
        February 17, 2006, NeoMedia and Gavitec signed a definitive sale and purchase
        agreement, subject to closing conditions, under which NeoMedia acquired all
        of
        the outstanding shares of Gavitec in exchange for $1,800,000 cash and 13,660,511
        shares of NeoMedia common stock (1,366,051 of which are being held in escrow
        until December 31, 2006 for the
        purpose of securing the indemnification obligations outlined in the purchase
        agreement ).
        Pursuant to the terms of the merger agreement, the number of shares of NeoMedia
        common stock to be issued as consideration was calculated using a share price
        of
        $0.389, which
        was
        the volume-weighted average closing price of NeoMedia common stock for the
        ten
        days up to and including February 16, 2006. On
        February 23, 2006, NeoMedia and Gavitec completed the closing requirements
        and
        the acquisition became effective. In the event that NeoMedia’s stock price (at
        the time the consideration shares are saleable) is less than $0.389, NeoMedia
        is
        obligated to compensate Gavitec shareholders in cash for the difference between
        the price at the time the shares become saleable and $0.389. Assuming
        a stock price at the time the shares become saleable of $0.25, which was
        the
        last sale price on May 10, 2006, NeoMedia would have a cash liability of
        $2.0
        million resulting from this clause .
 
 Gavitec
        was founded in 1997 as a specialized provider and manufacturer of products
        and
        solutions for mobile marketing and mobile information technology. As a
        technology leader in code-reading systems and software for mobile applications,
        Gavitec offers its clients standardized or individual solutions in the areas
        of
        mobile marketing, mobile ticketing, mobile couponing, and mobile payment
        systems. Gavitec has
        run
        an in-market pilot program in Switzerland for its mobile macro-payment system
        with the leading Swiss retail bank PostFinance, Unisys, seven selected retailers
        including Migros, CoOp and McDonald’s and approximately a thousand consumers.
        Participants receive a personal Data Matrix code via text message to their
        mobile phone. Then to complete a purchase, participants hold their cell phone
        over Gavitec’s EXIO code reader and enter their PIN code to debit their
        PostFinance account. Gavitec has also run trials with “Coast Mobile” in
        conjunction with the British Broadcasting Corporation (BBC) and News
        International’s The Times newspaper, along with a number of other interactive
        mobile campaigns.
 
 NeoMedia
        completed the acquisitions of Mobot, Sponge, Gavitec, and 12Snap in an effort
        to
        gain entry into the rapidly evolving global mobile marketing
        industry.
  13
  The
        acquisition was accounted for under the purchase method. The actual purchase
        price was based on cash paid, the fair value of NeoMedia stock around the
        date
        of the acquisition, and direct costs associated with the combination. The
        purchase price has initially been allocated (subject to final determination)
        as
        follows:
 (Dollars
                  inThousands)Value
                  of 13,660,511 shares issued at $0.386 per share(1)
              
              $
              5,273Cash
                  paid
              
              
              1,800Direct
                  costs of acquisition
              
              
              26Total Fair Value of Purchase Price
              
              
              7,099Assets
                  Acquired:Cash and cash equivalents
              
              $
              74Accounts receivable
              
              
              173Inventory
              
              
              106Other current assets
              
              
              53Property, plant & equipment
              
              
              15Intangible assets
              
              
              3Capitalized software platform
              
              
              5,600Brand name
              
              
              500Copyrighted materials
              
              
              50Goodwill
              
              
              1,023Total Assets Acquired
              
              
              7,597Less
                  Liabilities Assumed:Accounts payable
              
              
              113Accrued liabilities
              
              
              24Deferred revenue
              
              
              117Other current liabilities
              
              
              244Total Liabilities Assumed
              
              
              498Net
                  assets acquired
              
              $
              7,099
  (1)
        -
        Shares were valued using the average stock price for two days before and
        two
        days after the measurement date, as defined in SFAS 141 and EITF
        99-12
  The
        combination is being accounted for as a purchase business combination as
        defined
        by Statement of Financial Accounting Standards No. 141, Business Combinations.
        A
        final determination of the allocation of the purchase price to the assets
        acquired and liabilities assumed has not been made, and should be considered
        preliminary and is subject to the completion of a comprehensive independent
        valuation of the assets acquired and liabilities assumed. The Company expects
        to
        obtain an independent valuation, currently in process, by the filing of its
        second quarter 2006 Form 10-Q in August 2006.
 
 The
        values assigned to intangible assets, aside from goodwill, are subject to
        amortization. The intangible assets were assigned the following lives for
        amortization purposes:
  Estimated
                  UsefulIntangible
                  asset
              Life
                  (in years)Copyrighted
                  materials
              5Capitalized
                  software platform
              7Brand
                  name
              10
  14
  Goodwill
        was not assigned a life and will be tested for impairment as defined by
        Statement of Financial Accounting Standards No. 144, Accounting for the
        Impairment or Disposal of Long-Lived Assets.
  The
        accompanying consolidated statement of operations presented herein contains
        the
        results of operations for Gavitec for the period from February 24, 2006,
        through
        March 31, 2006. Pro-forma results of operations for the three months ended
        March
        31, 2006 and 2005 are presented at the end of this Note 3.
  **Acquisition
        of 12Snap**
 
 On
        February 10, 2006, NeoMedia and 12Snap signed a definitive sale and purchase
        agreement, subject to closing conditions, under which NeoMedia acquired all
        of
        the outstanding shares of 12Snap in exchange for $2,500,000 cash and 49,294,581
        shares of NeoMedia common stock (6,319,818 of which are being held in escrow
        until June 30, 2006 for the
        purpose of securing the indemnification obligations outlined in the purchase
        agreement ).
        On
        February 28, 2006, NeoMedia and 12Snap completed the closing requirements
        and
        the acquisition became effective. Pursuant to the terms of the merger agreement,
        the number of shares of NeoMedia common stock to be issued as consideration
        was
        calculated using a share price of $0.3956, which
        was
        the volume-weighted average closing price of NeoMedia common stock for the
        ten
        days up to and including February 9, 2006 .
        In the
        event that NeoMedia’s stock price (at the time the consideration shares are
        saleable) is less than $0. 3956, NeoMedia is obligated to compensate 12Snap
        shareholders in cash for the difference between the price at the time the
        shares
        become saleable and $0.3956. Assuming
        a stock price at the time the shares become saleable of $0.25, which was
        the
        last sale price on May 10, 2006, NeoMedia would have a cash liability of
        $7.2
        million resulting from this clause .
 
 12snap
        AG
        is headquartered in Munich with branches in Düsseldorf, New York, London, Milan,
        Stockholm and Vienna. As an expert in innovative marketing and entertainment
        for
        mobile phones, 12snap combines know-how in mobile applications, mobile loyalty
        and mobile marketing. In the mobile marketing space, 12snap creates and
        implements national and pan-European mobile marketing campaigns for
        international brands; its mobile loyalty business unit offers customer loyalty
        programs for companies and brands, and its mobile applications business unit
        is
        the center for development and software. 12snap sells and licenses a wide
        spectrum of mobile solutions to satisfy the demands of the current growing
        market and the new uses of the third mobile phone generation from dynamic
        video
        services and multiplayer games to personalized messaging applications. 12snap
        has 75 employees, and services to companies including McDonald's,
        MTV ® ,
        Coca-Cola, Ferrero, Wella, adidas, Unilever and Gillette ® .
 
 NeoMedia
        completed the acquisitions of Mobot, Sponge, Gavitec, and 12Snap in an effort
        to
        gain entry into the rapidly evolving global mobile marketing
        industry.
  15
  The
        acquisition was accounted for under the purchase method. The actual purchase
        price was based on cash paid, the fair value of NeoMedia stock around the
        date
        of the acquisition, and direct costs associated with the combination. The
        purchase price has initially been allocated (subject to final determination)
        as
        follows:
 (Dollars
                  inThousands)Value
                  of 49,294,581 shares issued at $0.394 per share (1)
              
              $
              19,422Cash
                  paid
              
              
              2,500Direct
                  costs of acquisition
              
              
              113Total Fair Value of Purchase Price
              
              
              22,035Assets
                  Acquired:Cash and cash equivalents
              
              $
              465Investment in marketable securities
              
              
              951Accounts receivable
              
              
              2,683Other current assets
              
              
              554Property, plant & equipment
              
              
              224Intangible assets
              
              
              93Customer contracts and relationships
              
              
              400Capitalized software platform
              
              
              4,400Brand name
              
              
              1,400Copyrighted materials
              
              
              50Goodwill
              
              
              19,590Total
                  Assets
                  Acquired
              
              
              30,810Less
                  Liabilities Assumed:Accounts payable
              
              
              977Accrued liabilities
              
              
              1,990Deferred revenue
              
              
              1,434Other current liabilities
              
              
              225Notes payable
              
              
              4,149Total
                  Liabilities
                  Assumed
              
              
              8,775Net
                  assets acquired
              
              $
              22,035
  (1)
        -
        Shares were valued using the average stock price for two days before and
        two
        days after the measurement date, as defined in SFAS 141 and EITF
        99-12
  The
        combination is being accounted for as a purchase business combination as
        defined
        by Statement of Financial Accounting Standards No. 141, Business Combinations.
        A
        final determination of the allocation of the purchase price to the assets
        acquired and liabilities assumed has not been made, and should be considered
        preliminary and is subject to the completion of a comprehensive independent
        valuation of the assets acquired and liabilities assumed. The Company expects
        to
        obtain an independent valuation, currently in process, by the filing of its
        second quarter 2006 Form 10-Q in August 2006.
  16
  The
        values assigned to intangible assets, aside from goodwill, are subject to
        amortization. The intangible assets were assigned the following lives for
        amortization purposes:
  Estimated
                  UsefulIntangible
                  asset
              Life
                  (in years)Customer
                  contracts and relationships
              5Copyrighted
                  materials
              5Capitalized
                  software platform
              7Brand
                  name
              10
  Goodwill
        was not assigned a life and will be tested for impairment as defined by
        Statement of Financial Accounting Standards No. 144, Accounting for the
        Impairment or Disposal of Long-Lived Assets.
  The
        accompanying consolidated statement of operations presented herein contains
        the
        results of operations for 12Snap for the period from March 1, 2006, through
        March 31, 2006. Pro-forma results of operations for the three months ended
        March
        31, 2006 and 2005 are presented at the end of this Note 3.
  **Acquisition
        of BSD**
 
 On
        March
        21, 2006, NeoMedia completed its acquisition of BSD Software, Inc. of Calgary,
        Alberta, Canada for 7,123,698 shares of NeoMedia common stock. Pursuant to
        the
        terms of the merger agreement, the number of shares of NeoMedia common stock
        to
        be issued as consideration was calculated using a share price of $0.3467, which
        was
        the volume-weighted average closing price of NeoMedia common stock for the
        five
        days preceding March 21, 2006 .
        BSD
        owns 90% of the outstanding shares of Triton Global Business Services, Inc.,
        a
        provider of live and automated operator calling services and e-business support,
        including billing, clearinghouse and information management services, to
        companies in the telecommunications industry.
 
 NeoMedia
        completed the acquisitions of BSD for the purpose of increasing its revenue
        and
        profit through establishment of a Telecom Services business unit, as well
        as
        gaining access to the Canadian telecom industry in order to penetrate that
        market with the products of the NeoMedia Mobile division.
  17
  The
        acquisition was accounted for under the purchase method. The actual purchase
        price was based on cash paid, the fair value of NeoMedia stock around the
        date
        of the acquisition, and direct costs associated with the combination. The
        purchase price has initially been allocated (subject to final
        determination) as follows:
  (Dollars
                  inThousands)Value
                  of 7,123,698 shares issued at $0.352 per share (1)
              
              $
              2,508Direct
                  costs of acquisition
              
              
              8Total Fair Value of Purchase Price
              
              
              2,516Assets
                  Acquired:Cash and cash equivalents
              
              $
              55Accounts receivable
              
              
              1,733Other current assets
              
              
              13Property, plant & equipment
              
              
              61Customer contracts and relationships
              
              
              1,600Copyrighted materials
              
              
              150Goodwill
              
              
              4,202Total Assets Acquired
              
              
              7,814Less
                  Liabilities Assumed:Accounts payable
              
              
              2,423Accrued liabilities
              
              
              1,224Notes payable
              
              
              1,651Total Liabilities Assumed
              
              
              5,298Net
                  assets acquired
              
              $
              2,516
  (1)
        -
        Shares were valued using the average stock price for two days before and
        two
        days after the measurement date, as defined in SFAS 141 and EITF
        99-12
 
 The
        combination is being accounted for as a purchase business combination as
        defined
        by Statement of Financial Accounting Standards No. 141, Business Combinations.
        A
        final determination of the allocation of the purchase price to the assets
        acquired and liabilities assumed has not been made, and should be considered
        preliminary and is subject to the completion of a comprehensive independent
        valuation of the assets acquired and liabilities assumed. The Company expects
        to
        obtain an independent valuation, currently in process, by the filing of its
        second quarter 2006 Form 10-Q in August 2006.
 
 The
        values assigned to intangible assets, aside from goodwill, are subject to
        amortization. The intangible assets were assigned the following lives for
        amortization purposes:
  Estimated
                  UsefulIntangible
                  asset
              Life
                  (in years)Customer
                  contracts and relationships
              5Copyrighted
                  materials
              5
  Goodwill
        was not assigned a life and will be tested for impairment as defined by
        Statement of Financial Accounting Standards No. 144, Accounting for the
        Impairment or Disposal of Long-Lived Assets.
  18
  The
        accompanying consolidated statement of operations presented herein contains
        the
        results of operations for BSD for the period from March 22, 2006, through
        March
        31, 2006. Pro-forma results of operations for the three months ended March
        31,
        2006 and 2005 are presented at the end
        of
        this Note 3 .
  **Pro
        Forma Financial Information**
 
 Pro-forma
        operations as if NeoMedia combined with Mobot, Sponge, Gavitec, 12Snap and
        BSD
        as of January 1, 2006 are as follows:
  **Three
                  Months Ended March 31, 2006****Pro-forma****Adjust-**
              
              
              **Pro-forma****NeoMedia**
              **Mobot**
              **Sponge**
              **Gavitec**
              **12Snap**
              **BSD**
              **ments**
              
              
              **Combined**Total
                  net sales
              $2,052
              $85
              $811
              $778
              $3,044
              $2,366
              ($1,509)
              (A)
              
              $7,627Net
                  income (loss)
              ($1,318)
              ($383)
              $112
              ($1,201)
              $542
              ($137)
              ($381)
              (A)
              
              ($2,766)Net
                  income (loss) per share-basic and diluted
              ($0.00)
              
              
              
              
              
              $0.00
              (A)(B)
              
              ($0.00)Weighted
                  average common shares outstanding
              527,991,819
              
              
              
              
              
              155,445,734
              (B)
              
              683,437,553
 
 (A)
        -
        Adjustments are to reflect operations of each acquisition from the closing
        date
        through March 31, 2006 and amortization of intangible assets for the period
        January 1, 2006 through the respective closing dates. Results of operations
        for
        each acquisition from its respective closing date through March 31, 2006
        are
        included in NeoMedia's operations for the three months ended March 31, 2006.
        Closing dates for each acquisition were: Mobot (February 17, 2006); Sponge
        and
        Gavitec (February 23, 2006); 12Snap (February 28, 2006); and BSD (March 21,
        2006).
 
 (B)
        -
        Adjustment for shares that would have been issued in connection with
        acquisitions if they had occurred on January 1, 2006, calculated as
        follows:
  **Mobot**
              **Sponge**
              **Gavitec**
              **12Snap**
              **BSD**
              **Total**Total
                  stock consideration
              $6,500,000
              $11,400,000
              $5,400,000
              $19,500,000
              $2,279,263
              $45,079,263NeoMedia
                  stock price around January 1, 2006 (measurement date)
              $0.290
              $0.290
              $0.290
              $0.290
              $0.290Pro
                  forma number of shares of
                NeoMedia
                  to be issued as purchase price consideration
              22,413,793
              39,310,345
              18,620,690
              67,241,379
              7,859,527
              155,445,734
 
 Pro-forma
        operations as if NeoMedia combined with Mobot, Sponge, Gavitec, 12Snap and
        BSD
        as of January 1, 2005 are as follows:
  **Three
                  Months Ended March 31, 2005****Pro-forma****(B)**
              **Adjust-**
              
              
              **Pro-forma****NeoMedia**
              **Mobot**
              **Sponge**
              **Gavitec**
              **12Snap**
              **BSD**
              **ments**
              
              
              **Combined**Total
                  net sales
              $747
              $99
              $541
              $806
              $1,832
              $1,904
              ---
              
              
              $5,929Net
                  income (loss)
              ($1,219)
              ($193)
              $151
              ($1,180)
              ($743)
              $52
              ($830)
              (A)
              
              ($3,962)Net
                  income (loss) per share-basic and diluted
              ($0.00)
              
              
              
              
              
              $0.01
              (B)
              
              ($0.01)Weighted
                  average common shares outstanding
              437,764,971
              
              
              
              
              
              172,717,482
              (B)
              
              610,482,453
 
 (A)
        -
        Adjustment for amortization of intangible assets for the period January 1,
        2005
        through March 31, 2005.
 (B)
        -
        Adjustment for shares that would have been issued in connection with
        acquisitions if they had occurred on January 1, 2005, calculated as
        follows:
  **Mobot**
              **Sponge**
              **Gavitec**
              **12Snap**
              **BSD**
              **Total**Total
                  stock consideration
              $6,500,000
              $11,400,000
              $5,400,000
              $19,500,000
              $2,279,263
              $45,079,263NeoMedia
                  stock price around January 1, 2005 (measurement date)
              $0.261
              $0.261
              $0.261
              $0.261
              $0.261Pro
                  forma number of shares of
                NeoMedia
                  to be issued as purchase price consideration
              24,904,215
              43,678,161
              20,689,655
              74,712,644
              8,732,808
              172,717,482
 
 19
    **Tax
        Implications of Acquisitions**
 
 For
        income tax purposes, amounts assigned to particular assets acquired and
        liabilities assumed in the business combinations are different than amounts
        used
        for financial reporting. The differences in assigned values for financial
        reporting and tax purposes result in temporary differences. In applying SFAS
        109, “Accounting for Income Taxes”, the Company is required to recognize the tax
        effect of these temporary differences and, accordingly, a deferred tax liability
        has been recognized. The Company determined that its pre-existing and
        acquired deferred tax assets, and those acquired, including those subject
        to
        limitations, were more likely than not to be realized to the extent of the
        deferred tax liability. The reduction in the valuation allowance resulting
        in an
        asset was used to offset the deferred tax liability arising from the business
        combinations, pursuant to SFAS 109.
 
 In
        addition, the acquisitions of Sponge, Gavitec, 12Snap, and BSD involve a
        change
        of control of foreign entities, and as a result any net operating loss
        carryforward in existence prior to the acquisition may have limited or no
        use
        for NeoMedia.
 
 **Intangible
        Assets Acquired**
 
 As
        of
        March 31, 2006, intangible assets acquired (subject to adjustment) in connection
        with the acquisitions of Mobot, Sponge, Gavitec, 12Snap, and BSD were valued
        as
        follows:
 (in
                  thousands)**Mobot**
              
              **Sponge**
              
              **Gavitec**
              
              **12
                  Snap**
              
              **BSD**
              
              **Total**Customer
                  Contracts
              
              $
              400
              
              $
              400
              
              $
              -
              
              $
              400
              
              $
              1,600
              
              $
              2,800Proprietary
                  Software Platform
              
              
              5,000
              
              
              1,300
              
              
              5,600
              
              
              4,400
              
              
              -
              
              
              16,300Brand
                  Name
              
              
              -
              
              
              500
              
              
              500
              
              
              1,400
              
              
              -
              
              
              2,400Copyrighted
                  Materials
              
              
              200
              
              
              50
              
              
              50
              
              
              50
              
              
              150
              
              
              500Goodwill
              
              
              6,084
              
              
              16,871
              
              
              1,023
              
              
              19,590
              
              
              4,202
              
              
              47,770Total
              
              $
              11,684
              
              $
              19,121
              
              $
              7,173
              
              $
              25,840
              
              $
              5,952
              
              $
              69,770
 
 Accumulated
        amortization on the acquired intangibles as of March 31, 2006 was:
 (in
                  thousands)**Mobot**
              
              **Sponge**
              
              **Gavitec**
              
              **12
                  Snap**
              
              **BSD**
              
              **Total**Customer
                  Contracts
              
              $
              9
              
              $
              8
              
              $
              -
              
              $
              7
              
              $
              27
              
              $
              51Proprietary
                  Software Platform
              
              
              83
              
              
              19
              
              
              79
              
              
              52
              
              
              -
              
              
              233Brand
                  Name
              
              
              -
              
              
              5
              
              
              5
              
              
              12
              
              
              -
              
              
              22Copyrighted
                  Materials
              
              
              5
              
              
              1
              
              
              1
              
              
              1
              
              
              2
              
              
              10Total
              
              $
              97
              
              $
              33
              
              $
              85
              
              $
              72
              
              $
              29
              
              $
              316
 
 The
        carrying value of the acquired intangibles as of March 31, 2006
        was:
 (in
                  thousands)**Mobot**
              
              **Sponge**
              
              **Gavitec**
              
              **12
                  Snap**
              
              **BSD**
              
              **Total**Customer
                  Contracts
              
              $
              391
              
              $
              392
              
              $
              -
              
              $
              393
              
              $
              1,573
              
              $
              2,749Proprietary
                  Software Platform
              
              
              4,917
              
              
              1,281
              
              
              5,521
              
              
              4,348
              
              
              -
              
              
              16,067Brand
                  Name
              
              
              -
              
              
              495
              
              
              495
              
              
              1,388
              
              
              -
              
              
              2,378Copyrighted
                  Materials
              
              
              195
              
              
              49
              
              
              49
              
              
              49
              
              
              148
              
              
              490Goodwill
              
              
              6,084
              
              
              16,871
              
              
              1,023
              
              
              19,590
              
              
              4,202
              
              
              47,770Total
              
              $
              11,587
              
              $
              19,088
              
              $
              7,088
              
              $
              25,768
              
              $
              5,923
              
              $
              69,454
 
 20
 
 Estimated
        amortization expense on the acquired intangibles is expected to be:
 
 (in
                  thousands)**Customer****Contracts**
              
              **Proprietary****Software**
              
              **Brand****Name**
              
              **Copyrighted****Materials**
              
              **Total**2006
              
              $
              471
              
              $
              1,979
              
              $
              202
              
              $
              85
              
              $
              2,7372007
              
              
              560
              
              
              2,329
              
              
              240
              
              
              100
              
              
              3,2292008
              
              
              560
              
              
              2,329
              
              
              240
              
              
              100
              
              
              3,2292009
              
              
              560
              
              
              2,329
              
              
              240
              
              
              100
              
              
              3,2292010
              
              
              560
              
              
              2,329
              
              
              240
              
              
              100
              
              
              3,229Thereafter
              
              
              89
              
              
              4,005
              
              
              1,238
              
              
              1,365
              
              
              6,697Total
              
              $
              2,800
              
              $
              15,300
              
              $
              2,400
              
              $
              1,850
              
              $
              22,350
 
 It
        is
        important to note that actual amortization expense could differ materially
        from
        the table due to subjective factors such as changes in assumptions of useful
        lives, impairment charges, or changes in the purchase price allocation upon
        final determination. The Company expects to obtain an independent valuation,
        currently in process, by the filing of its second quarter 2006 Form 10-Q
        in
        August 2006.
 
 **Letter
        of Intent to Acquire Hip Cricket**
 
 On
        February 16, 2006, NeoMedia signed a non-binding letter of intent to acquire
        HipCricket, Inc. (“HipCricket”) of Essex, CT ( www.hipcricket.com )
        in
        exchange for $500,000 cash and $4,000,000 of NeoMedia common stock. The number
        of shares to be issued as stock consideration is to be determined using the
        volume-weighted average closing price of NeoMedia stock for the ten days
        prior
        to the signing of a definitive purchase agreement. The letter of intent is
        subject to due diligence and signing of a mutually agreeable definitive purchase
        agreement by both parties.
 
 In
        addition to signing the LOI, NeoMedia loaned HipCricket the principal amount
        of
        $500,000 in the form of two unsecured promissory notes. The notes accrue
        interest at a rate of 8% per annum. The notes will 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 LOI. In the event the acquisition is not consummated,
        the
        notes will become due 90 days after termination of the LOI. In the event
        the LOI
        is terminated and the notes are not repaid within 90 days of such cancellation,
        the notes will convert into shares of HipCricket common stock.
 
 HipCricket
        is a leading mobile marketing firm that provides innovative, custom solutions
        to
        broadcasters and brand marketers. Today, HipCricket works with five of the
        top
        10 radio groups in the U.S. as well as with some 40 major brand marketers.
        HipCricket combines senior marketing expertise with state-of-the-art mobile
        and
        event marketing technologies to offer clients unprecedented interactivity
        with
        their consumers, viewers, listeners or customers on a one-to-one personal
        level.
  21
   **4. 
        FINANCING**
 
 **Securities
        Purchase Agreement - Series C Convertible Preferred Stock**
 
 The
        Company entered into a Securities Purchase Agreement, dated February 17,
        2006
        (the “Agreement”) with Cornell Capital Partners LP, an accredited investor (the
“Purchasers”). Pursuant to the Agreement, the Purchasers agreed to purchase 8%
        cumulative Series C convertible preferred stock to be fully
        converted three (3) years from the date of issuance in the aggregate amount
        of $22,000,000. Net consideration from this arrangement amounted to $17,854,000,
        comprised of cash of $14,066,000, marketable securities with a calculated
        fair
        value of $579,000 and a purchase value of $2,000,000, and the extinguishment
        of
        $3,209,000 of preexisting indebtedness. In addition, the Purchaser withheld
        $2,725,000 commitment and structuring fees from the gross proceeds. The
        Agreement also provides for the issuance to the Purchasers, at no additional
        cost to the purchasers, warrants to purchase shares of the Company's common
        stock. The Agreement also calls for the purchasers to acquire an additional
        $5,000,000 of Series C convertible preferred stock on the date a registration
        statement filed by the Company is declared effective by the U.S. Securities
        and
        Exchange Commission. In connection with the Agreement, the Company 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 preferred stock
        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 liquidating
        damages
        amounting to 1.0% for each month, but in no event shall consideration paid
        as
        liquidating damages exceed $1,200,000.
  On
        February 17, 2006, the Company issued the Purchasers $22,000,000 in aggregate
        principal amount of such 8% cumulative Series C convertible preferred stock.
        At
        any time from the closing date until February 17, 2009, the Purchasers have
        the
        right to convert the preferred stock, in whole or in part, into common stock
        of
        the Company at the then effective conversion price, which varies relative
        to the
        Company’s trading stock price, as follows: $0.50 per share, or 97% of the lowest
        closing bid prices (as reported by Bloomberg) of the common stock for the
        30
        trading days immediately preceding the conversion date. The conversions are
        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.
 
 The
        series 8%
        cumulative Series C
        convertible preferred stock also afford the Purchasers anti-dilution protection
        should, at any time while the Series C preferred stock instruments are
        outstanding, the Company offer, sell or grant any option to purchase or offer,
        sell or grant any right to re-price its securities, or otherwise dispose
        of or
        issue any common stock or common stock equivalents, entitle any person to
        acquire shares of common stock at an effective price per share less than
        the
        then effective conversion price (excluding employee stock options), as
        calculated by the formula described above; then, in such instance, the
        conversion price for the convertible preferred stock shares shall be reduced
        to
        the lower price. In case of any such adjustment in the effective conversion
        price for the convertible preferred shares, this could significantly dilute
        existing investors.
  Under
        the
        Agreement, the Purchasers also received “A” warrants, “B” warrants and “C”
warrants to purchase an aggregate of up to 75,000,000 shares of common stock.
        The warrants are exercisable in three separate traunches at a price of $0.50,
        $0.40 and $0.35 respectively per share, subject to adjustment, included under
        anti-dilution protection similar to that described above .
        The
        warrants have a five-year contractual life. NeoMedia can force exercise of
        the
        warrants if the closing bid price of NeoMedia stock is more than $0.05 greater
        than the exercise price of any of the warrants for 15 consecutive days.
  The
        8%
        cumulative Series C convertible preferred stock contains consequences in
        case of
        default. Events of default which could subject the Company to penalties and
        liabilities as specified in the Agreement include:
  ·
            Any
                case or action of bankruptcy or insolvency commenced by the Company
                or any
                subsidiary, against the Company or adjudicated by a court against
                the
                Company for the benefit of creditors;  ·
            Any
                default in its obligations under a mortgage or debt in excess of
                $100,000;  22
  ·
            Any
                cessation in the eligibility of the Company’s stock to be quoted on a
                trading market;  ·
            Any
                lapse in the effectiveness of the registration statement covering
                the
                shares related to the conversion option, the warrants as described
                and
                transacted in the securities purchase agreement and accompanying
                documents;  ·
            Any
                failure to deliver certificates within the specified time;
                and  ·
            Any
                failure, by the Company, to pay in full the amount of cash due pursuant
                to
                a buy-in or failure to pay any amounts owed on account on account
                of an
                event of default within 10 days of the date
                due.  Other
        provisions included in the Agreement include the following:
  ·
            The
                8% cumulative Series C convertible preferred stock is convertible
                into
                common stock, at the option of the Purchaser, at any time after the
                effective date.  ·
            Conversions
                can be made in increments and from time to
                time.  ·
            The
                8% cumulative Series C convertible preferred stock has voting rights
                on an
                “as converted” basis, meaning the Purchaser is entitled to vote the number
                of shares of common stock into which the 8% cumulative Series C
                convertible preferred stock was convertible as of the record date
                for a
                meeting of shareholders  ·
            As
                promptly as practicable after any conversion date, the Company shall
                cause
                its transfer agent to deliver a certificate representing the converted
                shares, free of any legends and trading restrictions for the number
                of
                shares converted;  ·
            The
                Company will reserve and keep available authorized and unissued registered
                shares available to be issued upon
                conversion;  ·
            Purchaser
                will not be responsible for any transfer taxes relative to issuance
                of
                shares;  ·
            If
                the Company offers, sells or grants stock at an effective per share
                price
                less than the then Conversion Price, then the Conversion Price shall
                be
                reduced to equal the effective conversion, exchange or purchase price
                for
                such common stock or common stock equivalents (excluding employee
                stock
                options or shares issued as consideration in a business
                combination);  23
  At
        February 17, 2006, a summary is as follows:
 
 **Instrument:**Convertible
                  Preferred Stock(1)
              
              $
              1,711,000Common
                  stock warrants(2)
              
              
              16,172,000Embedded
                  conversion feature
              
              
              1,935,000Debt
                  extinguishment loss(3)
              
              
              (1,964,000
              )Total gross proceeds
              
              $
              17,854,000
 
 (1)
            The
                discount to the face value of the 8% cumulative Series C convertible
                preferred stock that resulted from the allocation along with deferred
                costs is being accreted through periodic charges to additional paid-in
                capital using the effective interest method. Accretion of the deferred
                costs amounted to $137,000 and $0 during the quarters ended March
                31, 2006
                and 2005, respectively. 
 (2)
            The
                Company issued additional warrants to purchase aggregate 75,000,000
                shares
                of common stock in connection with the 8% cumulative Series C convertible
                preferred stock. The Company also issued 2,000,000 warrants (valued
                at
                $447,000) as financing fees. 
 (3)
            The
                financing arrangement settled face value $3,209,000 of preexisting
                indebtedness. The debt extinguishment loss was calculated as the
                amount
                that the fair value of securities issued (using a relative fair value
                basis) exceeded the Company’s carrying
                value. 
 The
        carrying value of the 8% cumulative Series C convertible preferred stock
        amounted to $1,847,000, net of unaccreted deferred cost of $25,432,000, at
        March
        31, 2006. Face value of Series C convertible preferred stock at March 31,
        2006
        is $22,000,000. Derivative financial instruments arising from the issuance
        of
        Series C convertible preferred stock are initially recorded and continuously
        carried at fair values. Upon conversion of any derivative financial instrument,
        the change in fair value from the previous reporting date to the date of
        conversion is recorded to income (loss), and then the carrying value is recorded
        to paid-in capital, provided all other criteria for equity classification
        are
        met. The following tabular presentation reflects the components of derivative
        financial instruments on the Company’s balance sheet at March 31,
        2006:
 
 **(Assets)
                  Liabilities:**
              
              **March
                  31, 2006**Cornell
                  warrants
              
              $
              13,280,000Embedded
                  conversion feature
              
              
              1,575,000Other
                  warrants(1)
              
              
              8,195,000$
              23,432 ,000
 
 
 (1)
            The
                fair values of certain other derivative financial instruments (warrants)
                that existed at the time of the issuance of Series C convertible
                preferred
                stock were reclassified from stockholders’ equity to liabilities when, in
                connection with the issuance of Series C convertible preferred stock,
                the
                Company no longer controlled its ability to share-settle these
                instruments. These derivative financial instruments had fair values
                of
                $13,883,000 and $8,195,000 on February 17, 2006 and March 31, 2006,
                respectively. These warrants will be reclassified to stockholders’ equity
                when the Company reacquires the ability to share-settle the instruments. 
 The
        following tabular presentation reflects the number of common shares into
        which
        the aforementioned derivative financial instruments are indexed at March
        31,
        2006:
 
 **Shares
                  of**
                **common
                  stock**Cornell
                  warrants
              
              
              75,000,000Embedded
                  conversion feature (1)
              
              
              71,585,052Other
                  warrants
              
              
              31,325,000179,910,052
 
 (1)
            The
                terms of the embedded conversion features (ECF) in the Series C
                Convertible Preferred Stock provide for variable conversion rates
                that are
                indexed to the Company’s trading common stock price. As a result, the
                number of indexed shares is subject to continuous fluctuation. For
                presentation purposes, the number of shares of common stock into
                which the
                ECF was convertible as of March 31, 2006 was calculated as the face
                value
                of $22,000,000 plus assumed dividends of $220,000 if declared,
                divided by 97% of the lowest closing bid price for the 30 trading
                days
                preceding March 31, 2006. 
 24
  Derivative
        income for the three months ended March 31, 2006 and 2005 associated with
        adjustments recorded to reflect the aforementioned derivatives at fair value
        amounted to $2,870,000 and $0, respectively.
  Fair
        value considerations for derivative financial instruments :
 
 Freestanding
        derivative instruments, consisting of warrants that arose from the Cornell
        financing and those reclassified as described above are valued using the
        Black-Scholes-Merton valuation methodology because that model embodies all
        of
        the relevant assumptions that address the features underlying these instruments.
        Significant assumptions included in this model as of March 31, 2006 are as
        follows:
 
 Holder
              Cornell
              OtherInstrument
              Warrants
              WarrantsExercise
                  price
              $0.35
                  - $0.50
              $0.01
                  - $3.45Term
                  (years)
              5.0
              1.0
                  - 5.0Volatility
              70.80%
              52.56%
                  -70.80%Risk-free
                  rate
              3.65%
              3.65%
 
 Embedded
        derivative financial instruments, arising from the Series C Convertible
        Preferred Stock, consist of multiple individual features that were embedded
        in
        the instrument. The Company evaluated all significant features of the hybrid
        instruments and, where required under current accounting standards, bifurcated
        features for separate report classification. These features were aggregated
        into
        one compound derivative financial instrument for financial reporting purposes.
        The compound embedded derivative instruments are valued using the Flexible
        Monte
        Carlo methodology because that model embodies certain relevant assumptions
        (including, but not limited to, interest rate risk, credit risk, and
        conversion/redemption privileges) that are necessary to value these complex
        derivatives.
 
 Assumptions
        included exercise estimates/behaviors and the following other significant
        estimates:
 
 **Instrument**
              **Features**Conversion
                  prices
              $0.95
                  - $1.29Remaining
                  terms (years)
              1
                  -
                  5Equivalent
                  volatility
              52.56%
                  - 56.47%Equivalent
                  interest-risk adjusted rate
              8.17%
                  - 8.58%Equivalent
                  credit-risk adjusted yield rate
              14.50%
 
 Equivalent
        amounts reflect the net results of multiple modeling simulations that the
        Monte
        Carlo Simulation methodology applies to underlying assumptions. The assumptions
        included in the Monte Carlo Simulation calculation are highly subjective
        and
        subject to interpretation.
  25
  **Standby
        Equity Distribution Agreements with Cornell**
  On
        October 27, 2003, NeoMedia and Cornell entered into a $20 million Standby
        Equity
        Distribution Agreement (the “2003 SEDA”). The agreement provides for a maximum
“draw” of $280,000 per week, not to exceed $840,000 in any 30-day period, and
        Cornell will purchase up to $20 million of the Company’s common stock over a
        two-year period. The SEDA became effective during January 2004, and expired
        after a two-year term in January 2006. During the three months ended March
        31,
        2006 and 2005, NeoMedia sold 751,880 and 6,998,931 shares of its common stock
        to
        Cornell pursuant to the 2003 SEDA. The following table summarizes funding
        received from Cornell during the three months ended March 31, 2006 and
        2005:
 **Three**
              
              **Three****Months**
              
              **Months****Ended**
              
              **Ended****March
                  31,**
              
              **March
                  31,****2006**
              
              **2005**Number
                  of shares sold to Cornell
              
              
              751,880
              
              
              6,998,931Gross
                  Proceeds from sale of shares to Cornell
              
              $
              234,000
              
              $
              1,709,000Less:
                  discounts and fees*
              
              
              (24,000
              )
              
              (204,000
              )Net Proceeds from sale of shares to Cornell
              
              $
              210,000
              
              $
              1,505,000
 
 *
        Pursuant to the terms of the 2003 SEDA , stock is valued at 98% of the lowest
        closing bid price during the week it was sold.
  On
        March
        30, 2005, NeoMedia and Cornell entered into a Standby Equity Distribution
        Agreement (the “2005 SEDA”) under which Cornell agreed to purchase up to $100
        million of NeoMedia 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. The shares would be valued at 98% of the lowest closing bid price
        during the five-day period following the delivery of a notice of purchase
        by
        NeoMedia, and NeoMedia would pay 5% of the gross proceeds of each purchase
        to
        Cornell. Concurrent with the SEDA, NeoMedia entered into an escrow agreement
        with Cornell and an escrow agent, under which the escrow agent holds in an
        escrow account shares of NeoMedia common stock, and the cash paid by Cornell
        for
        such shares, issued pursuant to an advance under the SEDA. The shares and
        funds
        can only be released upon receipt by the escrow agent of a joint disbursement
        instruction signed by NeoMedia and Cornell. NeoMedia expects to file a
        registration statement with the SEC to register the shares underlying the
        2005
        SEDA. The 2005 SEDA would become available at the time the SEC declares
        effective a registration statement containing such shares.
 
 As
        a
        commitment fee for Cornell to enter into the 2005 SEDA, NeoMedia issued 50
        million warrants to Cornell with an exercise price of $0.20 per share, and
        a
        term of three years, and also paid a cash commitment fee of $1 million. During
        the three months ended March 31, 2006, Cornell exercised 40 million of the
        warrants, generating cash proceeds of $8 million to NeoMedia. NeoMedia also
        issued 4 million warrants with an exercise price of $0.227 to a consultant
        as a
        fee in connection with the 2005 SEDA, which have not been exercised. As of
        March
        31, 2005, NeoMedia recorded the $12.3 million fair value of the warrants
        to
“Deferred equity financing costs” and, upon effectiveness of the 2005 SEDA, will
        amortize this amount to additional paid-in capital straight-line over the
        two-year life of the 2005 SEDA.
  26
 **Promissory
        Note Payable to Cornell**
 
 On
        March
        30, 2005, NeoMedia borrowed from Cornell the principal amount of $10,000,000
        before discounts and fees in the form of a secured promissory note. Cornell
        withheld structuring and escrow fees of $68,000 related to the note. The
        note
        was originally scheduled to be repaid at a rate of $1,120,000 per month
        commencing May 1, 2005, which was subsequently changed to $840,000 per month,
        continuing until principal and interest were paid in full. The note accrued
        interest at a rate of 8% per annum on any unpaid principal. In connection
        with
        the note, NeoMedia and Cornell entered into a Security Agreement under which
        the
        note was secured by all of NeoMedia's assets other than its patents and patent
        applications. NeoMedia also escrowed 25,000,000 shares of its restricted
        common
        stock as security for the note. During the period from March 30, 2005 through
        January 9, 2006, NeoMedia made payments against the principal totaling
        $7,210,000. On February 17, 2006, NeoMedia retired the balance of the principal
        in the amount of $2,790,000, plus accrued interest of $419,000, from the
        proceeds of the Series C convertible preferred financing arrangement with
        Cornell. In connection with the payment and issuance of the Series C Convertible
        Preferred Stock, NeoMedia recognized a loss on extinguishment of debt of
        $1,964,000 during the three months ended March 31, 2006.
  **5.** **INVESTMENT
        IN MARKETABLE SECURITIES**
 
 On
        February 25, 2005, NeoMedia invested $250,000 in exchange for 8,333,333 shares
        of PUPS restricted common stock. On February 17, 2006, as a component of
        net
        proceeds from the issuance of 8% Series C Convertible Preferred Stock, NeoMedia
        received marketable securities with a fair value of $579,000, of which, $200,000
        represented 20,000,000 shares of PUPS common stock and $379,000 in notes
        designated as held to maturity. NeoMedia acquired an additional 20,000,000
        shares of PUPS common stock for a purchase price equal to $389,000. PUPS is
        a
        retail operator and franchiser of retail automotive parts and accessories
        stores
        catering to the light truck market, and also provides new vehicle preparation,
        environmental protection packages, detailing and reconditioning products
        and
        services. In accordance with Statements
        of Financial Accounting Standards No. 115, “Accounting for Certain Investments
        in Debt and Equity Securities,” the investment in PUPS is being recorded as
        available-for-sale securities and reported at fair value. Accordingly,
        unrealized gains and losses on the equity securities are reflected in the
        condensed consolidated statement of operations and comprehensive income
        (loss).
 
 The
        investments in marketable securities are summarized as follows:
 **As
                  of March 31, 2006**Unrealized
              
              Unrealized
              
              FairCost
              
              Holding
                  Gain
              
              Holding
                  Losses
              
              ValueAvailable-for-sale
              
              $
              639,000
              
              $
              -
              
              
              ($
                  186,000
              )
              $
              453,000Held
                  to maturity
              
              $
              379,000
              
              $
              -
              
              $
              -
              
              $
              379,000
 
 Held
        to
        maturity securities consist of four notes receivable from PUPS with a face
        value
        of $1,365,000 and a fair value of $379,000. The fair value of $379,000 is
        recorded in other long-term assets on the consolidated balance sheet as of
        March
        31, 2006. The notes are delinquent and accrue interest at rates between 12-24%.
        NeoMedia has not recorded any interest since the Company is using the cost
        recovery method.
  27
 **6.** **FINANCIAL
        INSTRUMENTS**
  The
        carrying amount of the Company's cash equivalents, accounts receivable, prepaid
        expenses, other current assets, cash surrender value of life insurance policy,
        accounts payable and accrued expenses, accrued salaries and benefits, and
        payable to merchants approximates their estimated fair values due to the
        short-term maturities of those financial instruments.
 
 Rates
        currently available to the Company for debt with similar terms and remaining
        maturities are used to estimate fair value of existing debt.
  It
        is not
        practicable to estimate the fair value of the Company’s 17% investment in the
        common stock of i-Point Media Ltd. and its investments of 250,000 shares
        of
        preferred stock of Intactis Software, Inc ., because
        of the lack of quoted market prices and the inability to estimate fair value
        without incurring excessive costs. During the year ended December 31, 2005
        NeoMedia took an impairment of the carrying values of its investments in
        iPoint-media and Intactis of $530,000 and $250,000, respectively. No impairment
        charge was taken during the three months ended March 31, 2006. The net carrying
        value of these investments were $470,000 amd $0 as of March 31,
        2006.
  For
        all
        available-for-sale investment securities, the carrying values represents
        fair
        value of the securities and unrealized gain (losses) that are other than
        temporary are recognized as other comprehensive income (loss). NeoMedia does
        not
        hold these securities for speculative or trading purposes. Also see Note
        5.
  **7.** **COMPUTATION
        OF NET LOSS PER SHARE**
 
 Basic
        net
        loss per share is computed by dividing net loss by the weighted average number
        of shares of common stock outstanding during the period. NeoMedia has excluded
        all outstanding stock options and warrants from the calculation of diluted
        net
        loss per share because these securities are anti-dilutive for all years
        presented. The shares excluded from the calculation of diluted net loss per
        share are detailed in the table below:
 
 **March
                  31, 2006**
              **March
                  31, 2005**Outstanding
                  Stock Options
              124,005,799
              83,206,621Outstanding
                  Warrants
              108,325,000
              72,825,000Convertible
                  Preferred Stock (on an as converted basis) - March 31,
                  2006
              71,585,052
              ---
  28
  **8. 
        STOCK BASED COMPENSATION**
 
 At
        March
        31, 2006, NeoMedia has four employee stock option plans (the 1996 Stock Option
        Plan, the 1998 Stock Option Plan, the 2003 Stock Option Plan, and the 2005
        Stock
        Option Plan) and one employee stock compensation plan (the 2003 Stock Incentive
        Plan) (collectively, the “Plans”). Prior to January 1, 2006, NeoMedia accounted
        for those plans under the recognition and measurement provisions of APB Opinion
        No. 25, Accounting for Stock Issued to Employees, and related Interpretations,
        as permitted by FASB Statement No. 123, Accounting for Stock-Based Compensation.
        No stock-based employee compensation cost was recognized in the statement
        of
        operations for the fiscal years or interim periods ended prior to December
        31,
        2005, as all options granted under those plans had an exercise price equal
        to
        the market value of the underlying common stock on the date of grant. Effective
        January 1, 2006, NeoMedia adopted the fair value recognition provisions of
        FASB
        Statement No. 123(R), Share-Based Payment, using the
        modified-prospective-transition method. Under that transition method,
        compensation cost recognized in the first quarter of 2006 includes: (a)
        compensation cost for all share-based payments granted prior to, but not
        yet
        vested as of January 1, 2006, based on the grant date fair value estimated
        in
        accordance with the original provisions of Statement 123, 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
        Statement 123(R). Results for prior periods have not been restated.
  As
        a
        result of adopting Statement 123(R) on January 1, 2006, NeoMedia’s net loss for
        the three months ended March 31, 2006 is $1,477,000 higher than if it had
        continued to account for share-based compensation under Opinion 25. Basic
        and
        diluted income per share for the three months ended March 31, 2006 would
        have
        been $0.00 if NeoMedia had not adopted Statement 123(R), compared to reported
        basic and diluted loss per share of $0.00. Estimated income tax benefits
        recognized during the three months ended March 31, 2006 were offset by a
        valuation allowance since realization was not reasonably
        assured.
  Prior
        to
        the adoption of Statement 123(R), it was NeoMedia’s policy to present all tax
        benefits of deductions resulting from the exercise of stock options as operating
        cash flows in its statement of cash flows, however, due to NeoMedia’s tax loss
        carryforward, any such benefits were always fully offset by a valuation
        allowance. Statement 123(R) requires the cash flows resulting from the tax
        benefits resulting from tax deductions in excess of the compensation cost
        recognized for those options (excess tax benefits) to be classified as financing
        cash flows. NeoMedia will use this presentation if and when it has exhausted
        its
        tax loss carryforward.
  29
  The
        following table illustrates the effect on net loss and loss per share if
        NeoMedia had applied the fair value recognition provisions of Statement 123
        to
        options granted under NeoMedia’s stock option plans in 2005. For purposes of
        this pro forma disclosure, the value of the options is estimated using a
        Black-Scholes option-pricing formula and amortized to expense over the options’
vesting periods.
 
 **Three
                  Months****Ended
                  March 31,****2005**Net
                  Loss, as reported
              ($1,219)Add:
                  stock-based employee compensationexpense
                  included in reported net income,net
                  of related tax effects
              ---Deduct:
                  Total stock-based employeecompensation
                  expense determined underfair
                  value method for all awards, net ofrelated
                  tax effects
              (725)Pro-forma
                  net loss
              ($1,944)Net
                  Loss per share:Basic
                  and diluted - as reported
              ($0.00)Basic
                  and diluted - pro-forma
              ($0.00)
 
 Note
        that
        the above pro forma disclosures are provided for the three months ended March
        31, 2005 because employee stock options were not accounted for using the
        fair-value method during those periods.
 
 The
        Plans
        permit the grant of share options and shares to NeoMedia’s employees, board of
        directors, and outside consultants. NeoMedia believes that such awards better
        align the interests of its employees with those of its shareholders. Option
        awards are generally granted with an exercise price equal to the market price
        of
        NeoMedia’s stock at the date of grant; those option awards generally vest over a
        period of 3 years and have 10-year contractual terms. Shares granted upon
        the
        exercise of stock options are granted from treasury. The fair value of each
        option award is estimated on the date of grant using the Black-Scholes valuation
        model that uses the assumptions noted in the following table. Because Black-Scholes valuation
        model incorporates ranges of assumptions for inputs, those ranges are disclosed.
        Expected volatilities are based on the expected impact on future stock price
        of
        expected future revenue and earnings, historical volatility of NeoMedia’s stock,
        and other factors. NeoMedia uses historical data to estimate option exercise
        and
        employee termination within the valuation model. The expected term of options
        granted represents the period of time that options granted are expected to
        be
        outstanding.
  **Three
                  months ended March 31,****2006**
              **2005**Volatility
              56%
              431%
                  - 440%Expected
                  dividends
              ---
              ---Expected
                  term (in years)
              3
              3Risk-free
                  rate
              4.35%
              4.50%
 
 As
        of
        January 1, 2006, NeoMedia reevaluated its volatility calculation to take
        into
        consideration the guidance outlined in SFAS 123R. Prior to January calculated
        volatility using only historical share price data. Under the provisions of
        SFAS
        123, 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 three months
        ended
        March 31, 2006. NeoMedia will evaluate its volatility on an ongoing basis
        using
        the most current information available. NeoMedia expects that, under the
        guidelines of SFAS 123R, future volatility will more closely resemble 2006
        levels than previous years.
  30
 
 A
        summary
        of option activity under the Plans as of March 31, 2006, and changes during
        the
        three months then ended is presented below:
  **Weighted****Weighted**
              
              **Average****Average**
              
              **Remaining**
              
              **Aggregate****Exercise**
              
              **Contractual**
              
              **Intrinsic****Shares**
              
              **Price**
              
              **Term**
              
              **Value**(In
                  thousands)
              
              
              
              (in
                  years)
              
              (In
                  thousands)Outstanding
                  at January 1, 2006
              100,041
              
              $0.18Granted
              24,695
              
              $0.37Exercised
              (731)
              
              $0.18Forfeited
              ---
              
              ---Outstanding
                  at March 31, 2006
              124,005
              
              $0.22
              
              8.8
              
              $16,989Vested
                  or expected to vest at March 31, 2006
              76,126
              
              $0.16
              
              5.2
              
              $14,439
 
 The
        weighted-average grant-date fair value of options granted during the three
        months ended March 31, 2006 was $0.11. The total intrinsic value of options
        exercised during the three months ended March 31, 2006 was $156,000. Total
        cash
        received from options exercised was $131,000 and $174,000 for the three months
        ended March 31, 2006 and 2005, respectively.
 
 A
        summary
        of the status of NeoMedia’s nonvested shares as of March 31, 2006, and changes
        during the three months ended March 31, 2006, is presented below:
 
 **Weighted****Average****Grant
                  Date****Nonvested
                  Shares**
              
              **Shares**
              
              **Fair
                  Value**(in
                  thousands)Nonvested
                  at January 1, 2006
              
              44,215
              
              $0.18Granted
              
              15,146
              
              $0.12Vested
              
              (11,481)
              
              $0.19Forfeited
              
              ---
              
              ---Nonvested at March 31, 2006
              
              47,880
              
              $0.16
 
 As
        of
        March 31, 2006, there was $10,127,000 of total unrecognized compensation
        cost
        related to nonvested share-based compensation arrangements granted under
        the
        Plans. That cost is expected to be recognized over a weighted-average period
        of
        2.4 years.
  31
  **9.** **SEGMENT
        REPORTING**
  As
        of
        March 31, 2006, NeoMedia was structured and evaluated by its Board of Directors
        and Management as three distinct business units:
 
 -
        NeoMedia Mobile (NMM) - encompassing NeoMedia’s physical-world-to-internet and
        mobile marketing technologies branded under PaperClick, 12Snap, Sponge, Gavitec
        and Mobot
  -
        NeoMedia Micro Paint Repair (NMPR) - encompassing the micro paint and auto
        aftermarket accessories manufactured and distributed by NeoMedia
 
 -
        NeoMedia Telecom Services (NTS) - encompassing the billing, clearinghouse
        and
        information management services of recently-acquired BSD
  NeoMedia’s
        reportable segments are strategic business units that offer different technology
        and marketing strategies. NMM is headquartered in Ft. Myers, Florida, and
        operates principally in the United States and in Europe through the recent
        acquisitions of Sponge (United Kingdom), 12Snap (Germany) and Gavitec (Germany).
        NMPR is headquartered in Ft. Myers, Florida, and currently sells into Canada,
        the United States, Australia, New Zealand, Scandinavia, Mexico and China.
        NTS is
        headquartered in Calgary, Alberta, Canada and presently primarily operates
        within Canada.
  32
  Consolidated
        net sales by geographic area for the three-month periods ended March 31,
        2006
        and 2005 were as follows:
 (in
                  thousands)**Three
                  Months Ended****March
                  31,****2006**
              
              **2005****Net
                  Sales:**United
                  States
              
              $
              442
              
              $
              610Germany
              
              
              217
              
              
              ---United
                  Kingdom
              
              
              300
              
              
              ---Canada
              
              
              393
              
              
              137Italy
              
              
              687
              
              
              ---Other
              
              
              13
              
              
              ---$
              2,052
              
              $
              747
 33
  Consolidated
        net sales, net operating losses for the three-month periods ended March 31,
        2006
        and 2005, and identifiable assets as of March 31, 2006, by business unit
        were as
        follows:
 
 (in
                  thousands)**Three
                  Months Ended****March
                  31,****2006**
              
              **2005****Net
                  Sales:**NeoMedia
                  Mobile (1)
              
              $
              1,443
              
              $
              20NeoMedia
                  Telecom Services (2)
              
              
              232
              
              
              ---NeoMedia
                  Micro Paint Repair (3)
              
              
              377
              
              
              455NeoMedia
                  Consulting & Integration Services (4)
              
              
              ---
              
              
              272$
              2,052
              
              $
              747**Net
                  Loss:**NeoMedia
                  Mobile (1)
              
              
              ($1,868
              )
              
              ($254
              )NeoMedia
                  Telecom Services (2)
              
              
              (400
              )
              
              ---NeoMedia
                  Micro Paint Repair (3)
              
              
              (452
              )
              
              (165
              )NeoMedia
                  Consulting & Integration Services (4)
              
              
              ---
              
              
              (323
              )Corporate
                  overhead (5)
              
              
              (1,401
              )
              
              (477
              )Charges
                  related to convertible preferred stock sale
              
              
              2,804
              
              
              ---($1,317
              )
              
              ($1,219
              )**Identifiable
                  Assets**NeoMedia
                  Mobile (1)
              
              $
              72,058NeoMedia
                  Telecom Services (2)
              
              
              7,893NeoMedia
                  Micro Paint Repair
              
              
              4,217NeoMedia
                  Consulting & Integration Services (3)
              
              
              ---Corporate
              
              
              8,641$
              92,809
 
 (1)
        -
        NeoMedia Mobile consists of NeoMedia's PaperClick and patent business, Mobot,
        Sponge, Gavitec, and 12Snap. Mobot operations are included in NeoMedia's
        consolidated financial results for the period February 18, 2006 through March
        31, 2006. Gavitec and Sponge operations are included in NeoMedia's consolidated
        financial results for the period February 24, 2006 through March 31, 2006.
        12Snap operations are included in NeoMedia's consolidated financial results
        for
        the period March 1, 2006 through March 31, 2006. Net loss includes $563,000
        of
        stock based compensation recognized pursuant to SFAS 123
 
 (2)
        -
        NeoMedia Telecom Services consists of the operations of BSD Software, Inc.,
        acquired March 21, 2006, and included in NeoMedia's consolidated financial
        results for the period March 22, 2006 through March 31, 2006. Net loss includes
        $405,000 of stock based compensation recognized pursuant to SFAS
        123
 
 (3)
        - Net
        loss includes $161,000 of stock based compensation recognized pursuant to
        SFAS
        123
 
 (4)
        -
        NeoMedia Consulting & Integration Services business unit was wound down
        during the first quarter of 2006 and combined with the NeoMedia Mobile business
        unit. Results from operations previously included in this business unit are
        now
        included in the NeoMedia Mobile business unit
 
 (5)
        - Net
        loss includes $348,000 of stock based compensation recognized pursuant to
        SFAS
        123
 
 Operating
        costs included in one segment may benefit other segments, and therefore these
        segments are not designed to measure operating income or loss directly related
        to the products included in each segment.
  34
  **11.** **ACCRUED
        LIABILITIES**
 
 Accrued
        liabilities consist of the following as of March 31, 2006:
 (dollars
                  inthousands)Accruals
                  related to silent partner agreements
              
              $
              1,382Accrued
                  legal and accounting costs
              
              
              1,156Accruals
                  for disputed services
              
              
              984Accrued
                  operating expenses
              
              
              572Payroll
                  related accruals
              
              
              366Total
              
              $
              4,460
   **12.** **INVENTORY**
 
 Inventories,
        consisting of material, material overhead, labor and processing costs, are
        stated at the lower of cost (first-in, first-out) or market and consist of
        the
        following at March 31, 2006:
 (dollars
                  inthousands)Raw
                  materials
              
              $
              61Work-in-process
              
              
              17Finished
                  goods
              
              
              774$
              852
 
 **13.** **COMMITMENTS
        AND CONTINGENCIES**
 
 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 also party to various consulting agreements that
        carry
        payment obligations into future years. Additionally, NeoMedia issued Series
        C
        Convertible Preferred shares with face value of $22,000,000 (and a commitment
        for an additional $5,000,000 purchase by the purchasers under the same terms)
        that are subject to conversion no later than February 17, 2009. NeoMedia
        holds
        notes payable to certain vendors and silent partners 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:
 
 (dollars
                  in thousands)**Series
                  C****Vendor
                  &**
              
              
              
              **Convertible****Operating**
              
              **Consulting**
              
              **Notes**
              
              **Preferred****Leases**
              
              **Agreements**
              
              **Payable**
              
              **Stock**
              
              **Total**2006
                  (remaining nine months)
              
              $
              755
              
              $
              470
              
              $
              3,137
              
              $
              ---
              
              $
              4,3622007
              
              
              772
              
              
              473
              
              
              634
              
              
              ---
              
              
              1,8792008
              
              
              515
              
              
              269
              
              
              3
              
              
              ---
              
              
              7872009
              
              
              186
              
              
              153
              
              
              ---
              
              
              27,000
              
              
              27,3392010
              
              
              85
              
              
              117
              
              
              ---
              
              
              ---
              
              
              202Thereafter
              
              
              363
              
              
              117
              
              
              ---
              
              
              ---
              
              
              480Total
              
              $
              2,676
              
              $
              1,599
              
              $
              3,774
              
              $
              27,000
              
              $
              35,049
 
 35
  It
        is not
        possible to predict the maximum potential amount of future payments under
        these
        or similar agreements due to the conditional nature of the Company’s obligations
        and the facts and circumstances involved in each particular agreement. The
        Company does not record a liability for claims related to indemnification
        unless
        the Company concludes that the likelihood of a material claim is probable
        and
        estimable. Historically, payments pursuant to these indemnifications have
        been
        immaterial. See Item 1 of Part II of this Form 10-Q for discussion of legal
        proceedings.
  **14.** **OTHER**
 
 **Liabilities
        related to silent partnership arrangements**
  12Snap,
        a
        wholly-owned subsidiary of NeoMedia, entered into three silent partnership
        arrangements in 2000 with principal borrowing amounts, totaling
        EUR 3,500,000 (approximately $4.2 million). Silent partnerships are a
        common form of investment in Germany. The purpose of a silent partnership
        is to
        financially support the Company in its efforts to research, design and develop
        its product and services, while allowing the lenders not to become a legal
        owner
        of the company and thus not become liable for the obligation of the company.
        The
        lenders are not involved in the management of 12Snap, but significant business
        decisions such as changes in the articles of incorporation, mergers and
        acquisitions or significant contractual matters are subject to their
        approval.
  The
        partnership agreements regularly terminate on December 31, 2008 and 2009.
        However, due to the acquisition of all shares of 12Snap by NeoMedia, an early
        termination has been agreed on for all silent partnership agreements. Those
        silent partnerships have thus terminated as of February 28, 2006. According
        to
        the termination agreements EUR 1,750,000 (approximately $2.1 million) were
        repaid to the silent partners in March 2006. Another installment amounting
        to
        EUR 1,750,000 (approximately $2.1 million) plus interest will be due as of
        December 31, 2006.
  **Debt
        of NeoMedia Telecom Services**
 
 The
        NeoMedia Telecom Services business unit was formed in March 2006 with the
        acquisition of BSD Software, Inc. BSD was party to certain debt agreements
        prior
        to the acquisition which became obligations of NeoMedia upon completion of
        the
        acquisition, as follows:
 
 Wayside
        Solutions, Inc., a corporation affiliated with BSD, provided financing services
        to BSD prior to the acquisition. Prior to the acquisition, NeoMedia reached
        an
        agreement with Wayside to pay the outstanding debt due to Wayside subsequent
        to
        completion of the acquisition. The agreement calls for NeoMedia to pay up
        to
        $789,000 of Wayside debt through a cash payment plan, or, in the event NeoMedia
        files a registration statement, NeoMedia can elect to pay the remaining balance
        in shares of its common stock immediately prior to filing of the registration
        statement and include the shares for registration. As of March 31, 2006,
        NeoMedia had recorded a liability of $789,000 relating to this liability.
        NeoMedia had not made any payments against the liability as of the date of
        this
        filing.
  Amounts
        due to Guy Fietz, CEO, President and a shareholder of BSD, and now Vice
        President and General Manager of NeoMedia Telecom Services, totaled $512,000
        at
        March 31, 2006. These amounts were paid in full during April 2006 through
        the
        issuance of 1,512,093 shares of NeoMedia common stock.
  NeoMedia
        also assumed a mounts
        due to former BSD shareholders which bear interest at rates varying from
        0%-10%
        per annum, are unsecured and due on demand and are subject to cash payment
        plans. Amounts due under such arrangements were $230,000 as of March 31,
        2006.
  **Micro
        Paint Developments in China**
  36
 
 On
        February 28, 2006, NeoMedia signed a 10-year exclusive supplier agreement
        with
        Automart, a Beijing-based joint venture operating under the laws of the People's
        Republic of China specializing in automobile sales, financing, insurance
        and
        repair. Automart is the brand name of Jinche Yingang Auto Technological Services
        Limited, with which NeoMedia signed a distribution agreement in August 2005.
        The
        new agreement expands on the previous agreement, giving Automart the exclusive
        rights to distribute NeoMedia’s micro paint repair products to their own stores
        and others throughout China, Hong Kong, Macao, and Taiwan, and also guaranteeing
        that Automart will purchase at least 70% of its non-micro paint products
        through
        NeoMedia as its distributor. NeoMedia has signed distribution agreements
        with
        DuPont and PPG, and intends to become a distributor of other automotive
        aftermarket products to Automart.
 
 During
        the fourth quarter of 2005 and first quarter of 2006, NeoMedia shipped and
        invoiced $825,000 of Micro Paint Repair products to Automart that has not
        yet
        been recognized in revenue as of March 31, 2006. If and when collectibility
        is
        reasonably assured, NeoMedia expects to recognize revenue for these shipments.
        The amount of $560,000 is included in inventory as of March 31, 2006.
  **Pick
        Ups Plus and Automotive Preservation**
 
 On
        February 25, 2005, NeoMedia invested $250,000 in exchange for 8,333,333 shares
        of Pickups Plus, Inc. (“PUPS”)(OTCBB:PUPS) restricted common stock. PUPS is
        a
        retail operator and franchiser of retail automotive parts and accessories
        stores
        catering to the light truck market, and also provides new vehicle preparation,
        environmental protection packages, detailing and reconditioning products
        and
        services. In addition, on February 17, 2006, NeoMedia acquired an additional
        20,000,000 shares of PUPS common stock from Cornell Capital Partners acquired
        from the proceeds of the Series C Convertible Preferred Stock sale. The total
        of
        28,333,333 shares owned represent approximately 19.75% of PUPS outstanding
        shares (based on 143,482,281 PUPS shares outstanding as of March 15, 2006).
        Because the investment represents less than 20% of PUPS outstanding shares,
        and
        because NeoMedia does not exercise significant influence over PUPS operations
        or
        decision making, NeoMedia has recorded the investment as available for sale
        securities and reported at fair value. As of March 31, 2006, NeoMedia has
        recorded an unrealized holding loss of $186,000 due to the decrease in the
        quoted market price of PUPS common stock.
 
 Also
        on
        February 25, 2005, NeoMedia signed two non-binding Letters of Intent to acquire
        up to 100% of Automotive Preservation, Inc. (“AP”), a distributor of automotive
        paint and accessory products, from AP’s parent company, PUPS. The first Letter
        of Intent calls for NeoMedia to initially acquire 30% of AP for $1,600,000,
        to
        be paid $600,000 in cash, $554,000 in shares of NeoMedia restricted common
        stock, and $446,000 through the assumption of AP debt by NeoMedia. Under
        the
        second Letter of Intent, upon completion of the acquisition of the initial
        30%
        of AP by NeoMedia, NeoMedia would have the option to acquire an additional
        30%
        of AP for $1,650,000, payable in shares of NeoMedia restricted common stock.
        The
        second Letter of Intent also gives NeoMedia the option to purchase the final
        40%
        of AP for either: (i) $2,200,000, payable in shares of NeoMedia restricted
        common stock, if NeoMedia exercises this right within 12 months of acquiring
        the
        second 30% of AP, or (ii) a price equivalent to AP’s previous quarter EBITDA
        multiplied by 8, payable in shares of NeoMedia restricted common stock. Both
        Letters of Intent are non-binding and subject to due diligence by NeoMedia
        and
        AP. On September 21, 2005, the BOD approved to change the deal structure
        for the
        acquisition of AP, so that the Company would acquire only 30% of AP for a
        total
        purchase price of $1.6 million of which $600,000 would be paid in cash and
        $446,000 would be paid through the assumption of debt, and $554,000 through
        the
        issuance of restricted NeoMedia stock. NeoMedia will not acquire the remaining
        70% of AP under the new structure.
  **15.** **SUBSEQUENT
        EVENTS**
 
 During
        April 2006 ,
        NeoMedia announced its intention to issue a stock dividend with the distribution
        of common shares of Pickups Plus, Inc. as a property dividend. NeoMedia will
        distribute 8,333,333 shares of Pickups Plus common stock, which it acquired
        in
        February 2005, to NeoMedia shareholders of record as of April 28, 2006. The
        shares will be distributed at such time as Pickups Plus files and makes
        effective a registration statement registering the shares.
  37
 
 During
        April 2006 ,
        the
        Instituto Mexicano de la Propiedad Industrial, the patent office in Mexico,
        awarded patent No. 233529 to NeoMedia, which corresponds to patents issued
        to
        the company by the U.S. Patent Office and the Canadian Intellectual Property
        Office, for a "Method and System for Accessing Electronic Resources via
        Machine-Readable Data on Intelligent Documents." Dr. Kevin Hunter, NeoMedia’s
        chief scientist, is the inventor of record. NeoMedia has also filed for patents
        for the process in Europe, Japan and Brazil. The patent deals with improved
        methods of storing information placed directly on physical objects as
        PC-readable data utilizing 2-dimensional bar codes and various data compression
        techniques.
 
 During
        April 2006, 12snap introduced its
        mobile marketing applications - 12cam, 12yella and 12pixmix - into 17 countries
        in the Middle East, North Africa and Turkey through a distribution agreement
        with Egyptian-based telecommunications firm Telecom Arabia, a specialist
        in
        marketing and distribution of mobile phone applications and software in the
        Arab
        countries. Under the terms of the agreement, Telecom Arabia will pursue
        marketing and sales opportunities and coordinate pricing and distribution
        strategies to various channels, including mobile phone retailers and network
        providers. Additionally, Telecom Arabia will help to develop local product
        interfaces and ensure compliance with copyright regulations in each of the
        17
        countries.
 
 During
        April 2006, 12snap **** signed
        an
        agreement with Lufthansa to leverage 12snap’s expertise to "mobilize" the
        cross-media communication of Lufthansa’s involvement in soccer in Germany.
        12snap prevailed in a multi-company pitch. Soccer fans will be able to receive
        a
        comprehensive mobile entertainment package from Lufthansa, ranging from
        soccer-themed content and games, to competitions, video clips and an interactive
        quiz. The mobile application will run on 12snap’s technology platform, which has
        been the basis for executing its award-winning mobile marketing campaigns
        for
        several years. Lufthansa is the official partner of the German Soccer
        Association and of record-holding champion club FC Bayern Munich.
  38
  **ITEM
        2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS**
 
 During
        2006, NeoMedia has continued its efforts to commercialize its NeoMedia Mobile
        and NeoMedia Micro Paint Repair business units, both in North America and
        overseas. As part of the commercialization efforts, NeoMedia began to implement
        an aggressive growth campaign focusing on expansion through three major avenues:
        acquisition and globalization.
  
 To
        this
        end, during the second half of 2005 and the first quarter of 2006, NeoMedia
        made
        the following strategic maneuvers:
 
 August 2005:
              
              signed
                  agreement to distribute Micro Paint products to China via Jinche
                  Automotive GroupSeptember 2005:
              
              signed
                  agreement to distribute Micro Paint products to Mexico and
                  Latin America via Micropaint de MexicoOctober 2005:
              
              signed
                  agreement to distribute Micro Paint products to Scandinavia
                  via WITHO-ASDecember 2005:
              
              signed
                  agreements to distribute DuPont and PPG automotive aftermarket
                  products to
                  Jinche in ChinaFebruary 2006:
              
              completed
                  acquisitions of Mobot (US), 12Snap (Europe), Gavitec
                  (Europe), and Sponge (Europe); signed letter of intent to acquire
                  Hip
                  Cricket; completed $22 million funding to
                  finance acquisitions and future growthMarch 2006:
              
              completed
                  acquisition of BSD Software, creating the NeoMedia
                  Telecom Services (NTS) business
                  unit
  **Acquisitions**
 
 During
        2005 and the first quarter of 2006, NeoMedia has aggressively pursued
        acquisitions that will confirm its presence in the global mobile marketing
        space. To this end, during the three months ended March 31, 2006, NeoMedia
        completed, or agreed to complete, acquisitions of Mobot, Sponge, Gavitec,
        12Snap, BSD, and Hip Cricket. It is the intention of NeoMedia’s board of
        directors and management to continue to pursue strategic acquisitions in
        both
        its mobile marketing and the micro paint repair business units.
  **First
        Quarter 2006 Developments for New Acquisitions**
 
 *Mobot* continued its ground-breaking work with ELLEgirl and The Light Agency over
        Q1.
        With ELLEgirl, Hachette’s magazine, Mobot provides its visual search and
        recognition technology to deliver exciting promotions within each monthly
        issue.
        In a recent issue a “Daily Instant Win” campaign encouraged readers to use
        camera phones to snap a picture of a different advertisement each day, and
        through Mobot’s visual-matching technology, enter to win numerous prizes. Mobot
        is also continuing its partnership with The Light Agency to exclusively
        distribute its visual search and recognition technology to the U.K. grocery
        sector. Mobot’s technology enhances The Light Agency’s award-winning mobile
        phone-based loyalty program with the Sainsburys-owned convenience store chain
        Jackson’s by allowing consumers to receive offers on products by snapping a
        photo in-store and sending it to Mobot’s server via mobile.
 
 *Sponge* has
        managed a range of mobile activity in first quarter 2006 for IPC Magazines,
        Audi, Frito Lay and Thomson Holidays. Through a range of sales promotion
        and
        interactive agencies, Sponge has also worked on a number of brand promotions,
        including: a major specialist motorcycle magazine; on-pack text-to-win mechanics
        for two drink brands; and a campaign for a men’s cosmetics brand. Based in the
        UK, Sponge’s campaigns in first quarter 2006 expanded geographically with
        activity in Ireland, France, The Netherlands and the U.S. Sponge has also
        made a
        number of developments to its platform to launch its Draw Engine which enables
        the easy deployment of ratio, timed and winning moments draws - very frequently
        requested by major brands and agencies after Sponge’s successful Walker’s (Frito
        Lay) campaign in 2005 (whereby over 5 % of the U.K. population participated).
        Additional developments include the addition of highest bid auction application
        alongside lowest bid auction mechanics, which resulted in Thomson Holidays
        and
        its digital interactive agency Remote Media running their second successful
        campaign with Sponge.
 
 39
 
 *Gavitec* continues to successfully market its Exio and MD20 scanners through mobile
        solutions partners to clients including McDonald’s Portugal, EMT (Empresa
        Malagueña de Transportes), a Spanish public transport company and BNP Paribas, a
        leading European and global banking and financial institution. TopSolutions,
        a
        leading software development and systems integration house, is Gavitec’s mobile
        solutions partner for McDonald’s Portugal, which is running a large scale
        mobile-couponing program. EMT continued to run a pilot during first quarter
        2006
        that gave EMT the distinction of being the first Spanish public transport
        company effectively and successfully using mobile ticketing. Through the
        use of
        Gavitec technology, EMT passengers are now able to pay for and receive bus
        tickets using their own mobile phones. BNP Paribas, in conjunction with
        RedShift, an interactive marketing agency and mobile solution partner, expects
        to launch the first interactive mobile campaign in France using Gavitec’s
        scanning and browsing applications based on 2D codes. On the technological
        front, Gavitec furthered the development of its code-reading capabilities
        adding
        QR-Engine on JAVA to augment its existing DataMatrix technology on JAVA.
        Now,
        the engine can be downloaded via Internet or telephone connection to a
        considerable number of mobile phones, providing the opportunity to distribute
        the innovative software to a broader audience—business-to-consumer "mass market"
        applications.
 
 In
        the
        first quarter of 2006, *12snap* reached
        consumers far beyond its headquarters in Germany and offices in the UK,
        Italy, Sweden and Austria. Through campaigns for such high profile brand
        names
        as adidas and Nokia, 12snap reached many countries throughout the EMEA (Europe,
        Middle East & Africa) region. This geographic reach also allowed 12snap to
        strengthen its technology to be compatible with the different carriers and
        handsets available in the EMEA. Additionally, 12snap continued to roll out
        new
        and exciting mobile marketing campaigns for Coca-Cola, most recently
        implementing the “Coke Fridge” campaign - a year-long campaign which updates
        itself dynamically over the mobile internet generating great excitement and
        response - more
        than
        1.3 million codes were collected from Coke bottles by consumers in just the
        first six weeks of this campaign.
 
 *NeoMedia
        Telecom* successfully
        tested a new technological solution throughout first quarter 2006 that is
        now
        market ready; its new IP billing solution combines telecommunications costs
        from
        multiple providers, including content and special services, and consolidates
        them onto one single bill. Based on Internet Protocol (IP), the new service
        lets
        customers of NeoMedia Telecom bill their customers through local exchange
        carriers. Prior to the acquisition, BSD was recognized in
        the
        Branham TOP 300 largest tech companies in Canada (at #158) - a prestigious
        IT
        award highlighting the top Canadian IT companies.
  **Consulting
        & Integration Services Business Unit**
 
 As
        part
        of the acceleration of global expansion in PaperClick and Paint, as well
        as the
        creation of the NeoMedia Telecom Services (NTS) business unit through the
        BSD
        acquisition, NeoMedia also decided in February 2006 to wind down its legacy
        NeoMedia Consulting & Integration Services (NCIS) business unit. The NCIS
        unit consisted of client-server equipment and related software resales. The
        resale market has been commoditized over the past several years, and NeoMedia
        believes its resources are better spent on the development and commercialization
        of its NMM, NMPR and NTS business units. Certain of the proprietary products
        associated with the NCIS business, such as PDF-417 and Maxicode print encoder
        software and WISP migration tools, will be retained by NeoMedia and consolidated
        with the NMM unit. NeoMedia does not intend to pursue additional resales
        of
        hardware and software or integration services not directly related to its
        other
        business units.
  40
 
 **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. NeoMedia used a rate of 10% for purposes
        of discounting cashflows in 2006 and 2005.
  41
 
 *Financial
        Instruments and Concentrations of Credit Risk.* The
        Company’s financial instruments consist of cash and cash equivalents, accounts
        receivable, accounts payable, and accrued expenses, notes payable, derivative
        financial instruments, other current liabilities and convertible preferred
        stock. Management believes the carrying values of cash and cash equivalents,
        accounts payable, accounts payable and 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 is estimated on March
        31,
        2006 to be approximately $18,173,000.
 
 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..
 
 *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 our 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.
  42
 
 *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 .
 
 (2)
            Technology
                service & 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.  Software  license revenue  from 
                long-term  contracts  has  been  recognized  on
                a  percentage  of completion  basis,  along with the
                 associated  services being  provided.  Telecom
                revenues are recognized at the time that calls are accepted by the
                clearing house for billing to customers. The Company’s recently acquired
                subsidiaries BSD, Mobot, and Gavitec follow this policy. The Company
                defers revenue related to technology service & product revenue for
                which amounts have been invoiced and or collected but for which the
                requisite service has not been provided. Revenue is then recognized
                over
                the matching service period. 
 (3)
            Technology
                service also includes mobile marketing services to its customers
                which
                mobile marketing projects are recognized after the completion of
                the
                project and accepted by the customer.  All response and messaging
                based revenues are recognized at the time such responses are received
                and
                processed and the Company recognizes its premium messaging revenues
                on a
                net basis based on guidance provided in Emerging Issues Task Force
                No.
                99-19 (EITF 99-19), “Reporting Revenue Gross as Principal or Net as an
                Agent.”  Consulting and management revenues and revenues for periodic
                services are recognized as services are performed.  NeoMedia
                uses  stand-alone  pricing to determine an element's 
                vendor  specific  objective  evidence  (“VSOE”) in
                order to allocate an arrangement  fee amongst various pieces of
                a  multi-element  contract.  The Company’s recently
                acquired subsidiaries 12Snap and Sponge follow this policy. The Company
                defers revenue related to mobile marketing service fees for which
                amounts
                have been invoiced and/or collected but for which revenue has not
                been
                recognized. Revenue is then recognized over the matching service
                period. 
 (4)
            Revenue
                for training and certification 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 training costs and initial products sold with the system, and
                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 training and certification for which amounts have been
                invoiced and/or collected but for which revenue has not been recognized.
                Revenue is then recognized over the estimated contract period, which
                is
                currently one year. 
 43
  In
        December 2003, the SEC issued SAB 104, “Revenue Recognition.” SAB 104
        supersedes SAB 101, “Revenue Recognition in Financial Statements.”
SAB 104’s primary purpose is to rescind accounting guidance contained in
        SAB 101 related to multiple element revenue arrangements, superseded as a
        result of the issuance of EITF 00-21, “Accounting for Revenue Arrangements
        with Multiple Deliverables.” Additionally, SAB 104 rescinds the SEC’s
        Revenue Recognition in Financial Statements Frequently Asked Questions and
        Answers (the “FAQ”) issued with SAB 101 that had been codified in SEC Topic
        13, Revenue Recognition. Selected portions of the FAQ have been incorporated
        into SAB 104. While the wording of SAB 104 has changed to reflect the
        issuance of EITF 00-21, the revenue recognition principles of SAB 101
        remain largely unchanged by the issuance of SAB 104, which was effective
        upon issuance. The adoption of SAB 104 did not impact NeoMedia’s
        consolidated financial statements.
 
 *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 of March 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.
 
 **Stock-Based
        Compensation**
  NeoMedia
        adopted Statement of Financial Accounting Standards No. 123 (“SFAS 123R”)
        on January 1, 2006, using the prospective method for stock option grants
        prior to January 1, 2006 and 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 three months ended March 31,
        2006 includes: (a) 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 123, 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.
  44
  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 use the
        Black-Scholes-Merton pricing model in order to calculate the estimated fair
        value for its stock options.
 
 Approximately
        68% of the stock-based compensation expense recorded in the three months
        ended
        March 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
        March 31, 2006, there was $10.1 million 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 2.4 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.
  **Effect
        Of Recently Issued Accounting Pronouncements**
  A
        discussion of recent accounting pronouncements is included in Note 2 to the
        consolidated financial statements included in our Annual Report on Form 10-KSB
        for the year ended December 31, 2005.
  45
  **Results
        Of Operations For The Three Months Ended March 31, 2006 As Compared To The
        Three
        Months Ended March 31, 2005**
 
 *Net
        sales.* Total
        net
        sales for the three months ended March 31, 2006 were $2,052,000, which
        represented a $1,305,000, or 175%, increase from $747,000 for the three months
        ended March 31, 2005.  This increase primarily resulted from sales of
        subsidiaries 12Snap, Sponge, Mobot, Gavitec, and BSD, all of which were acquired
        during the first quarter of 2006.  NeoMedia could realize a material
        increase in revenue over the next 12 months relative to 2005 due to the
        acquisitions of Mobot, 12Snap, Sponge, Gavitec, and BSD for the entire
        quarter.  NeoMedia could also realize a material increase in revenue over
        the next 12 months if the Company is successful in implementing its
        PaperClick ® go-to-market strategy, if pending court cases involving its intellectual
        property are resolved in NeoMedia’s favor, or if it is successful in
        implementing the expansion of the Micro Paint Repair business unit into China
        and other geographies.
 
 *Technology
        license, service, product and licenses.* Technology
        service, product and license sales increased $1,383,000, or 474% to $1,675,000
        for the three months ended March 31, 2006 compared to $292,000 for the three
        months ended March 31, 2005.  The increase was primarily the result of
        sales of subsidiaries 12Snap, Sponge, Mobot, Gavitec, and BSD, all of which
        were
        acquired during the first quarter of 2006.   NeoMedia could realize an
        increase in license fees over the next 12 months due to the recent acquisitions
        of Mobot, 12Snap, Sponge, Gavitec, and BSD, if the Company is successful
        in
        implementing its PaperClick ® go-to-market strategy, or if pending court cases involving its intellectual
        property are resolved in NeoMedia’s favor.
 
 *Micro Paint Repair products and services.* Sales
        of Micro Paint Repair products and services were $377,000 for the three months
        ended March 31, 2006, compared with $455,000 for the three months ended March
        31, 2005, a decrease of $78,000, or 17%.  The decrease was primarily due to
        a shipment of products totaling $290,000 to the Company’s distributor in New
        Zealand during the first quarter of 2005. In addition, during the fourth
        quarter
        of 2005 and first quarter of 2006, NeoMedia shipped and invoiced $825,000
        of
        product to Beijing Sino-US Jinche Yingang Auto Technological Services Limited
        that has not yet been recognized as revenue as of March 31, 2006 Once
        collectibility is reasonably assured, NeoMedia expects to recognize revenue
        for
        these shipments.  NeoMedia could realize a material increase in Micro Paint
        Repair revenue if the Company is successful in continuing the expansion of
        the
        business unit into China and other geographies.
 
 *Cost of technology license, service, product and licenses.* Cost
        of
        technology services, products and licenses fees were $827,000 for the three
        months ended March 31, 2006 compared to $176,000 for the three months ended
        March 31, 2006, an increase of $651,000, or 370%.  The increase was due
        almost entirely from the cost of sales of subsidiaries 12Snap, Sponge, Mobot,
        Gavitec, and BSD, all of which were acquired during the first quarter of
        2006.
 
 *Cost
        of Micro Paint Repair products and services.* Cost of Micro Paint Repair products and services was $419,000 for the three
        months ended March 31, 2006, compared with $273,000 for the three months
        ended
        March 31, 2005, an increase of $146,000, or 54%.  This increase is the
        result of fixed cost of goods sold associated with NeoMedia’s corporate Micro
        Paint facility in Ft. Myers, Florida. The facility operated at a gross margin
        loss during the first quarter of 2006 as it gained market traction.  Cost
        of micro paint repair products and services as a percentage of related sales
        was
        111% in 2006, compared to 60% in 2005.  NeoMedia expects cost of micro
        paint repair products and services to more closely resemble 2005 as compared
        to
        2006 as the corporate facility increases its customer base and profitability
        and
        product sales expand globally.
 
 *Gross Profit.* Gross profit was $806,000 for the three months ended March 31, 2006, an increase
        of $508,000, or 170%, compared with gross profit of $298,000 for the three
        months ended March 31, 2005.  This increase was primarily the result of the
        gross profit of the subsidiaries 12Snap, Sponge, Mobot, Gavitec, and BSD,
        all of
        which were acquired during the first quarter of 2006.
 
 *Sales
        and marketing.* Sales
        and
        marketing expenses were $1,540,000 for the three months ended March 31, 2006,
        compared to $795,000 for the three months ended March 31, 2005, an increase
        of
        $745,000 or 94%.  This increase resulted primarily from the addition of
        sales force and cost associated with added sales and marketing resources
        associated with Mobot, 12Snap, Sponge, Gavitec, and BSD.  NeoMedia expects
        sales and marketing expense to increase over the next 12 months with the
        continued development and expansion of the NeoMedia Mobile , NeoMedia Micro
        Paint Repair, and NeoMedia Telecom product groups.
  46
 
 *General
        and administrative.* General
        and administrative expenses increased by $721,000, or 120%, to $1,326,000
        for
        the three months ended March 31, 2006, compared to $603,000 for the three
        months
        ended March 31, 2005. The increase resulted primarily from increased
        infrastructure expense coupled with the expenses of the subsidiaries 12Snap,
        Sponge, Mobot, Gavitec, and BSD, all of which were acquired during the first
        quarter of 2006.  NeoMedia expects general and administrative expense to
        increase over the next 12 months with the continued expansion of the NeoMedia
        Mobile business.
 
 *Stock
        based compensation expense.* Stock
        based compensation was $1,517,000 for the three months ended March 31, 2006,
        as
        compared with $96,000 for the three months ended March 31, 2005, and increase
        of
        $1,421,000, or 1,480%.  The increase was due to the adoption of SFAS 123R
        (Share Based Payment) on January 1, 2006.
 
 *Research
        and development.* During
        the three months ended March 31, 2006, NeoMedia charged to expense $550,000
        of
        research and development costs, an increase of $366,000 or 199% compared
        to
        $184,000 for the three months ended March 31, 2005.  The increase is
        primarily due to the addition of development staff hired and acquired in
        connection with the commercialization of the NeoMedia Mobile business
        unit.  NeoMedia expects research and development costs to increase over the
        next 12 months with the continued development efforts of NeoMedia Mobile
        business unit products and services worldwide.
 
 *Gain
        and loss on extinguishment of debt.* NeoMedia
        incurred a loss on extinguishment of debt of $1,964,000 for the three months
        ended March 31, 2006 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
        three months ended March 31, 2005, NeoMedia recognized a gain on extinguishment
        of debt of $138,000, resulting from the payment of debt at a discount to
        the
        book value of the debt.  These gains resulted from a difference between the
        cash or market value of stock issued to settle the debt and the carrying
        value
        of the debt at the time of settlement.
 
 *Interest
        income.* Interest
        income consists primarily of interest accrued for creditors as part of financed
        purchases, past due balances, and notes payable, net of interest earned on
        cash
        equivalent investments.  Interest income decreased by $21,000, or 91%, to
        $2,000 for the three months ended March 31, 2006 from $23,000 for the three
        months ended March 31, 2005, due to a reduction in interest bearing
        notes.
 
 *Gain
        on derivative financial instruments.* Gain
        on
        derivative financial instruments was $4,768,000 for the three months ended
        March
        31, 2006.  The gain is on the derivatives associated with the preferred
        stock sale on February 17, 2006.  Certain derivatives were created at the
        time of the offering and those derivatives are recorded at fair value on
        the
        accompanying balance sheet. ** The
        gain
        for the three months ended March 31, 2006 is the reduction in value of the
        derivative from February 17, 2006 to March 31, 2006 and is due almost entirely
        to a reduction in NeoMedia’s stock price from February 17, 2006 to March 31,
        2006.   There was no such gain or loss on derivative financial
        instruments for the three months ended March 31, 2005.
 
 *Net
        Loss* . 
        The net loss for the three months ended March 31, 2006 was $1,317,000, which
        represented a $98,000, or 8% increase from a $1,219,000 loss for the three
        months ended March 31, 2005.  The increase in net loss is due to the
        increase in loss from operations coupled with the loss on extinguishment
        of debt
        and was offset to a large degree by the gain on derivative financial
        instruments.
  47
 
 **Liquidity
        and Capital Resources**
 
 Net
        cash
        used in operating activities was $2,586,000 for the three months ended March
        31 ,
        2006,
        compared with $1,660,000 for the three months ended March
        31,
        2006 .
        NeoMedia’s net cash flow used in investing activities for the three months ended March
        31,
        2006 and 2005 was
        $12,524,000 and $626,000, respectively. Net cash provided by financing
        activities for the three months ended March
        31 ,
        2006
        and 2005 was $20,156,000 and $9,578,000, respectively.
 
 During
        the three months ended March
        31,
        2006, NeoMedia made payments totaling $2.1 million to silent partners of
        12Snap,
        a NeoMedia wholly-owned subsidiary, as partial payment under silent partner
        agreements entered into by 12Snap prior to the acquisition.
 
 In
        the
        event that NeoMedia’s stock price at the time the consideration shares issued in
        connection with the recent acquisitions of Mobot, Sponge, Gavitec, and 12Snap
        become saleable is less than the contractual price (between $0.3839 and
        $0.3956), NeoMedia is obligated to compensate the sellers in cash for the
        difference between the price at the time the shares become saleable and the
        relevant contractual price. Assuming a stock price at the time the shares
        become
        saleable of $0.25, which was the last sale price on May 10, 2006, NeoMedia
        would
        have a cash liability of $15.9 million resulting from these clauses.
 
 **Contractual
        Obligations**
 
 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 also party to various consulting agreements that
        carry
        payment obligations into future years. Additionally, NeoMedia issued Series
        C
        Convertible Preferred shares with face value of $22,000,000 (and a commitment
        for an additional $5,000,000 purchase by the purchasers under the same terms)
        that are subject to conversion no later than February 17, 2009.
 
 In
        addition, NeoMedia is obligated to make debt payments by December 31, 2006
        in
        connection with silent partner agreements totaling approximately $2.1 million
        plus accrued interest and penalties.
 
 The
        NeoMedia Telecom Services business unit was formed in March 2006 with the
        acquisition of BSD Software, Inc. BSD was party to certain debt agreements
        prior
        to the acquisition which became obligations of NeoMedia upon completion of
        the
        acquisition, as follows:
 
 Wayside
        Solutions, Inc., a corporation affiliated with BSD, provided financing services
        to BSD prior to the acquisition. Prior to the acquisition, NeoMedia reached
        an
        agreement with Wayside to pay the outstanding debt due to Wayside subsequent
        to
        completion of the acquisition. The agreement calls for NeoMedia to pay up
        to
        $789,000 of Wayside debt through a cash payment plan, or, in the event NeoMedia
        files a registration statement, NeoMedia can elect to pay the remaining balance
        in shares of its common stock immediately prior to filing of the registration
        statement and include the shares for registration. As of March 31, 2006,
        NeoMedia had recorded a liability of $789,000 relating to this liability.
        NeoMedia had not made any payments against the liability as of the date of
        this
        filing.
  Amounts
        due to Guy Fietz, CEO, President and a shareholder of BSD, and now Vice
        President and General Manager of NeoMedia Telecom Services, totaled $512,000
        at
        March 31, 2006. These amounts were paid in full during April 2006 through
        the
        issuance of 1,512,093 shares of NeoMedia common stock.
  NeoMedia
        also assumed a mounts
        due to former BSD shareholders which bear interest at rates varying from
        0%-10%
        per annum, are unsecured and due on demand and are subject to cash payment
        plans. Amounts due under such arrangements were $230,000 as of March 31,
        2006.
  48
  The
        following table sets forth NeoMedia’s future minimum payments due under
        operating leases, vendor and consulting agreements, convertible stock
        agreements, and debt agreements:
 
 (dollars
                  in thousands)**Series
                  C****Vendor
                  &**
              
              
              
              **Convertible****Operating**
              
              **Consulting**
              
              **Notes**
              
              **Preferred****Leases**
              
              **Agreements**
              
              **Payable**
              
              **Stock**
              
              **Total**2006
                  (remaining nine months)
              
              $
              755
              
              $
              470
              
              $
              3,137
              
              $
              ---
              
              $
              4,3622007
              
              
              772
              
              
              473
              
              
              634
              
              
              ---
              
              
              1,8792008
              
              
              515
              
              
              269
              
              
              3
              
              
              ---
              
              
              7872009
              
              
              186
              
              
              153
              
              
              ---
              
              
              27,000
              
              
              27,3392010
              
              
              85
              
              
              117
              
              
              ---
              
              
              ---
              
              
              202Thereafter
              
              
              363
              
              
              117
              
              
              ---
              
              
              ---
              
              
              480Total
              
              $
              2,676
              
              $
              1,599
              
              $
              3,774
              
              $
              27,000
              
              $
              35,049
  **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 NeoMedia as a going concern. However, NeoMedia
        has reported net losses of $1,317,000 and $1,219,000 for the three months
        ended
        March 31, 2006 and 2005, respectively and has an accumulated deficit of
        $93,843,000 as of March 31, 2006. In addition, NeoMedia had working capital
        deficit of $26,478,000 as of March 31, 2006. All of the factors discussed
        above,
        amongst others, raise substantial doubt about the Company’s ability to continue
        as a going concern.
 
 If
        NeoMedia’s financial resources are insufficient NeoMedia may
        require additional financing in order to execute its operating plan and continue
        as a going concern. NeoMedia cannot
        predict whether this additional financing will be in the form of equity,
        debt,
        or another form. NeoMedia 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, NeoMedia may be
        unable to implement its current plans for expansion, repay its debt obligations
        as they become due, pay any additional costs required under its recently
        completed acquisition agreements, 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 NeoMedia be
        unable
        to continue as a going concern.
 
 NeoMedia
        intends to fund its growth and working capital deficiencies from the following
        sources during 2006 and beyond:
 
 During
        the first quarter of 2006, NeoMedia received approximately $14.1 million
        net
        proceeds from the convertible preferred stock sale to Cornell, and an additional
        $8 million proceeds received upon exercise of warrants held by Cornell. NeoMedia
        used $13.8 million of the proceeds to pay the cash portion of the purchase
        price
        of Mobot, Gavitec, Sponge, and 12Snap. NeoMedia can force conversion of certain
        warrants held by Cornell if the closing bid price of NeoMedia stock is greater
        than $0.30 for five consecutive days, at which point NeoMedia would receive
        an
        additional $2 million proceeds. NeoMedia also is also entitled to receive
        an
        additional $5 million upon registration of the shares underlying the convertible
        preferred stock held by Cornell.
 
 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. NeoMedia expects to file a registration statement with
        the SEC
        during 2006 to register the shares underlying the $100 million 2005 SEDA.
        The
        2005 SEDA would become available at the time the SEC declares effective a
        registration statement containing such shares. As of the date of this filing,
        the Company had not yet filed such registration statement.
  49
 
 There
        can
        be no assurances that the market for NeoMedia’s stock will support the sale of
        sufficient shares of NeoMedia’s common stock to raise sufficient capital to
        sustain operations for such a period, or that actual revenue will meet
        management’s expectations. 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.
 
 **ITEM
        3.** **QUANTITATIVE
        AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK** **.**
  NeoMedia
        previously filed its periodic reports as a small business issuer through
        the
        period ended December 31, 2005. The information required by Item 305 of
        Regulation S-K was not required under the disclosure requirements for small
        business issuers. Pursuant to Item 305 of Regulation S-K, disclosure of
        quantitative and qualitative information about market risk is required in
        the
        first annual report. Information relating to interim financial statements
        is not
        required until after the first fiscal year end in which Item 305 is applicable.
        Accordingly, NeoMedia anticipates providing a quantitative and qualitative
        analysis regarding market risk in our Form 10-K for the year ending December
        31,
        2006.
 
 **ITEM
        4.  CONTROLS AND PROCEDURES**
 
 There
        were no policy reviews, improvements of documentation or general improvement
        in
        the state of internal controls that led to any change during the fiscal quarter,
        or subsequent to the end of the fiscal quarter through the date of this Form
        10-Q, that materially affected or were reasonably likely to materially affect,
        internal controls over financial reporting
  ***Evaluation
        of Disclosure Controls and Procedures*** .
        As of
        the end of the period covered by this report, the Company carried out an
        evaluation, under the supervision and with the participation of the Company’s
        Principal Executive Officer and Principal Financial Officer, of the
        effectiveness of the design and operation of the Company’s disclosure controls
        and procedures. The Company’s disclosure controls and procedures are designed to
        provide a reasonable level of assurance of achieving the Company’s disclosure
        control objectives. The Company’s Principal Executive Officer and Principal
        Financial Officer have concluded that the Company’s disclosure controls and
        procedures are, in fact, effective at this reasonable assurance level as
        of the
        end of period covered. In addition, the Company reviewed its internal controls,
        and there have been no significant changes in its internal controls or in
        other
        factors that could significantly affect those controls subsequent to the
        date of
        their last evaluation or from the end of the reporting period to the date
        of
        this Form 10-Q.
 
 ***Changes
        in Internal Controls*** .
        In
        connection with the evaluation of the Company’s internal controls during the
        Company’s fiscal quarter ended March 31, 2006, the Company’s Principal Executive
        Officer and Principal Financial Officer have determined that there were no
        changes to the Company’s internal controls over financial reporting that have
        materially affected, or are reasonably likely to materially effect, the
        Company’s internal controls over financial reporting during the quarter ended
        March 31, 2006, or subsequent to the date of their last evaluation, or from
        the
        end of the reporting period to the date of this Form 10-Q.
  50
  **PART
        II -- OTHER INFORMATION**
 
 **ITEM
        1.  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. The following outlined legal proceedings for which the potential
        outcome could be in excess of $50,000.
  **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. Discovery
        is ongoing.
 
 **Other
        Litigation**
 
 On
        October 19, 2005, Wachovia Bank, N.A. filed a complaint against NeoMedia
        in the
        twentieth judicial circuit court of Lee County, Florida, seeking payment
        of
        $97,000 of rent from previous years. NeoMedia has placed the requested funds
        into escrow with the court, pending resolution of the matter.
 
 In
        December 2002, Triton Global Communications, a subsidiary of BSD Software,
        Inc.,
        sued CanTalk for breach of contract. The action was brought before the Court
        of
        Queen's Bench, Winnipeg, Canada. The action alleges that CanTalk failed to
        perform under an outsource agreement pursuant to which CanTalk was to provide
        support for Triton's entry into the international operator service market.
        In
        response to the suit, CanTalk filed a counterclaim against Triton for $10,000
        alleging breach of contract.  Triton believes that CanTalk's counterclaim
        is without merit and it intends to defend the counterclaim.  There is no
        certainty that Triton will be successful in their defense of said
        counterclaim.
 
 In
        July
        2005 Broad Reach Network Inc. (BRN) filed a Statement of Claim against Triton
        Global Business Services Inc. ,
        a
        subsidiary of the former BSD Software, Inc. ,
        and now
        a subsidiary of NeoMedia effective with completion of the acquisition of
        BSD by
        NeoMedia on March 21, 2006. The action was brought before the court of Queen’s
        Bench, Calgary, Alberta. BRN is suing for damages and judgment in the amount
        of
        CDN $81,000 (approximately $69,000).  TGBSI has filed a statement of
        defense denying the amount of the indebtedness to BRN and filed a countersuit
        in
        the amount of CDN $50,000 for breach of contract.  The Company has accrued
        an amount in its liabilities to cover this contingency.  The final amount
        paid could differ materially from the amount accrued.
 
 On
        April
        18, 2006, 12Snap AG, a wholly-owned subsidiary of NeoMedia acquired on February
        28, 2006, received a letter of Technologie Beteiligungsfonds Bayern GmbH
&
Co. KG, Munich, to initiate arbitration proceedings. Technologie
        Beteiligungsfonds claims for a final payment in the amount of EUR 353,400
        plus
        interest of 5% per annum since March 1, 2006 arising out of a silent partnership
        agreement with 12Snap. The Company expects the matter will be subject to
        a
        German arbitration proceeding during the second or third quarter of
        2006.
  51
  **ITEM
        1A.  RISK FACTORS**
 
 **Risks
        Related to NeoMedia’s Business**
  **NeoMedia
        has Historically Lost Money and Losses May Continue**
  NeoMedia
        has incurred substantial losses since inception, and anticipates continuing
        to
        incur substantial losses for the foreseeable future. NeoMedia incurred a
        loss of
        $1,317,000, $1,219,00, $9,147,000 and $7,230,000 for the three months ended
        March 31, 2006 and 2005, and the years ended December 31, 2005 and 2004,
        respectively. NeoMedia’s accumulated losses were approximately $93,843,000 and
        $92,524,000 as of March 31, 2006 and December 31, 2005, respectively. As
        of
        March 31, 2006 and December 31, 2005 and 2004, NeoMedia had a working capital
        deficit of approximately $26,478,000, $4,874,000 and $2,597,000, respectively.
        NeoMedia had stockholders’ equity of $49,427,000, $4,227,000 and $4,392,000 as
        of March 31, 2006 and December 31, 2005 and 2004, respectively. NeoMedia
        generated revenues of $2,052,000, $747,000, $2,156,000 and $1,700,000 for
        the
        three months ended March 31, 2006 and 2005 and the years ended December 31,
        2005
        and 2004, respectively. In addition, during the three months ended March
        31,
        2006 and 2005 and the years ended December 31, 2005 and 2004, NeoMedia recorded
        negative cash flows from operations of $2,586,000, $1,660,000, $6,509,000
        and
        $4,650,000, 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, 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
        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 Mobot, Sponge, 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 is less than the
        price
        at which they were valued for purposes of the merger agreement (between $0.3839
        and $0.3956 per share), 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.
        Subsequent to the closing of the acquisitions, NeoMedia’s stock has traded as
        low as $0.202 per share. Assuming a stock price at the time the shares become
        saleable of $0.25, which was the last sale price on May 10, 2006, NeoMedia
        would
        have a cash liability of $15.9 million resulting from these
        clauses.
  **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 sold its physical-world-to-Internet products
        to only 12 companies. 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:
  52
  ·
            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.
  53
 
 **Existing
        Shareholders Will Experience Significant Dilution When Certain Investors
        Convert Their Preferred Stock to Common Stock 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 pursuant to our transaction with Cornell Capital
        Partners will have a dilutive impact on our stockholders. As a result, our
        net
        income or loss per share could decrease in future periods, and the market
        price
        of our common stock could decline.  In addition, the lower our stock price
        is, the more shares of common stock we will have to issue pursuant to the
        conversion of our preferred stock.  If our stock price is lower, then
        our existing stockholders would experience greater dilution.
  **Due
        To The Accounting Treatment Of Certain Convertible Preferred Stock Instruments
        Issued By NeoMedia, A Fluctuation In NeoMedia’s Stock Price Could Have A
        Material Impact On NeoMedia’s Results Of Operations**
  During
        the first quarter of 2006, NeoMedia recognized income in the amount of
        $4,768,000 from adjustments recorded to reflect the change in fair value
        of
        derivatives issued in connection with its Series C Convertible Preferred
        Shares.
        The income results from a decrease in NeoMedia’s share price from $0.389 per
        share at the time of issuance of the Series C Convertible Preferred Shares
        (February 17, 2006) to $0.345 at March 31, 2006. NeoMedia will adjust the
        carrying value of the 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 as a result of such charges.
  **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
        March
        31, 2006 and December 31, 2005 and 2004, approximately 81%, 48% and 49%,
        respectively, of NeoMedia’s total assets were intangible assets, consisting
        primarily of rights related to NeoMedia’s patents, other intellectual property,
        and excess of purchase price over fair market value paid for Mobot, Sponge,
        Gavitec, 12Snap, BSD, and CSI International, Inc. 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 our goodwill or amortizable intangible
        assets is determined, resulting in an impact on results of
        operations.
  54
 
  **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 PaperClick
            suite of
            products, and certain products of recent acquisitions Mobot and 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. 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 T. Jensen, NeoMedia’s President and Chief Executive
        Officer, Charles W. Fritz, NeoMedia’s founder and Chairman of the Board of
        Directors, Martin N. Copus, NeoMedia’s Chief Operating Officer and head of the
        NMM business unit, and David A. Dodge, NeoMedia’s Chief Financial Officer. The
        loss of the services of Messrs. Jensen, Fritz, Copus, or Dodge 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 Messrs. Jensen, Fritz, Copus, or Dodge.
  **NeoMedia
        May Be Unsuccessful In Integrating Its Recently Completed and Pending
        Acquisitions With Its Current Business**
  The
        success of the acquisitions of Mobot, 12Snap, Sponge, Gavitec, and BSD could
        depend on the ability of NeoMedia’s executive management to integrate the
        business plan of each company 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 acquisitions, as well as the expected
        return on investment for NeoMedia.
  55
  **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.
  56
  **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 thereby preserving control by the current
        stockholders.
  57
  **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:
  58
 
 ·
            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’s
        Competitors In The Micro Paint Repair Industry Could Duplicate NeoMedia’s
        Proprietary Processes**
  NeoMedia’s
        success in the micro paint repair industry depends upon proprietary chemical
        products and processes. There is no guarantee that NeoMedia’s competitors will
        not duplicate NeoMedia’s proprietary processes.
  **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. Many of NeoMedia’s competitors in the Micro Paint Repair business
        have a longer operating history in the industry, as well as access to greater
        financial resources. 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.
  59
 
 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.
 
 Certain
        of NeoMedia’s micro paint solutions could be subject to environmental
        regulations.
  60
  **Item
        2.  Unregistered Sales of Equity Securities and Use of Proceeds
        (** **a),
        (b), (c** **)
        and (** **d** **)**
  During
        the three months ended March 31, 2006, NeoMedia issued 112,983,720 unregistered
        shares of common stock as consideration for the acquisitions of Mobot, Sponge,
        Gavitec, and 12Snap. NeoMedia did not receive any cash proceeds from the
        issuance of the shares.
  **Item
        3.  Default upon Senior Securities**
  None.
  **Item
        4.  Submission of Matters to a Vote of Security
        Holders**
  On
        May 2,
        2006, NeoMedia filed a definitive proxy statement, submitting to a vote of
        securities holders the following items: (i) re-election of its current five
        directors, (ii) ratification of Stonefield Josephson, Inc. as NeoMedia’s
        auditors for the fiscal year ended December 31, 2006, and (iii) an increase
        to
        the Company’s authorized common shares to 5 billion.  The shareholder
        meeting is scheduled for June 28, 2006.
  **Item
        5.  Other Information**
  None.
  61
  **Item
        6. Exhibits and reports on form 8-K**
  **(a)**  **Exhibits** **:**
  **Exhibit
                  No.**
              **Description**
              **Location**31.1
              Certification
                  by Chief Executive Officer pursuant to 15 U.S.C. Section 7241,
                  as adopted
                  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
              Provided
                  herewith31.2
              Certification
                  by Chief Financial Officer pursuant to 15 U.S.C. Section 7241,
                  as adopted
                  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
              Provided
                  herewith32.1
              Certification
                  by Chief Executive Officer pursuant to 18 U.S.C. Section 1350,
                  as adopted
                  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
              Provided
                  herewith32.2
              Certification
                  by Chief Financial Officer pursuant to 18 U.S.C. Section 1350,
                  as adopted
                  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
              Provided
                  herewith
 
 (b)
              Reports
                  on Form 8-K:
  NeoMedia
        filed a report on Form 8-K on February 10, 2006, with respect to Item 8.01,
        reporting that Cornell Capital Partners had exercised warrants to purchase
        20,000,000 shares of NeoMedia common stock, par value $0.01 per share. The
        warrants were issued to Cornell Capital on March 30, 2005 as a commitment
        fee
        for Cornell Capital entering into that certain Standby Equity Distribution
        Agreement, dated March 30, 2006 by and between NeoMedia and Cornell Capital.
        The
        warrants had an exercise price equal to $0.20 per share. In connection with
        the
        exercise of the 20,000,000 Warrants, NeoMedia received proceeds of
        $4,000,000.
 
 NeoMedia
        filed a report on Form 8-K on February 10, 2006, with respect to Item 1.01,
        reporting that it had signed a definitive merger agreement under which NeoMedia
        acquired all of the outstanding shares of Mobot in exchange for $3,500,000
        cash
        and $6,500,000 in shares of NeoMedia common stock.
 
 NeoMedia
        filed a report on Form 8-K on February 14, 2006, with respect to Item 1.01,
        reporting that it had signed a definitive sale and purchase agreement under
        which NeoMedia acquired all of the outstanding shares of 12Snap AG of Munich,
        Germany, in exchange for $2,500,000 cash and $19,500,000 in shares of NeoMedia
        common stock.
 
 NeoMedia
        filed a report on Form 8-K on February 20, 2006, with respect to Items 1.01
        and
        8.01, reporting that it had signed a non-binding letter of intent to acquire
        HipCricket, Inc. of Essex, CT in exchange for $500,000 cash and $4,000,000
        of
        NeoMedia common stock. The 8-K also reported that NeoMedia had loaned Hip
        Cricket $250,000 in the form of an unsecured promissory note, the principal
        and
        interest of which would be applied toward the purchase price in the event
        the
        acquisition is completed.
 
 NeoMedia
        filed a report on Form 8-K on February 21, 2006, with respect to Items 1.01
        and
        3.02, reporting that it had entered into a $27 million convertible preferred
        stock sale agreement with Cornell Capital Partners.
 
 NeoMedia
        filed a report on Form 8-K on February 21, 2006, with respect to Item 1.01,
        reporting that it had signed a definitive sale and purchase agreement under
        which NeoMedia acquired all of the outstanding shares of Gavitec AG of Wurselen,
        Germany in exchange for $1,800,000 cash and $5,400,000 in shares of NeoMedia
        common stock.
  62
 
 NeoMedia
        filed a report on Form 8-K on February 21, 2006, with respect to Item 2.01,
        reporting that it had completed all of the closing requirements for the
        acquisition of Mobot, Inc.
  NeoMedia
        filed a report on Form 8-K on February 22, 2006, with respect to Item 1.01,
        reporting that it had signed a definitive share purchase agreement under
        which
        it acquired all of the outstanding shares of Sponge Ltd. Of London, in exchange
        for £3,450,000 (approximately $6 million) cash and £6,550,000 (approximately
        $11.4 million) in shares of NeoMedia common stock. The agreement also calls
        for
        Sponge to earn an additional £2,500,000 (approximately $4.4 million) in the form
        of NeoMedia common stock if, during the two-year period beginning at closing,
        the Sponge business earns in excess of £1,300,000 (approximately $2.3 million)
        in net profits.
 
 NeoMedia
        filed a report on Form 8-K on February 24, 2006, with respect to Item 2.01,
        reporting that it had completed all of the closing requirements for the
        acquisitions of 12 Snap AG, Gavitec AG, and Sponge Ltd.
 NeoMedia
        filed a report on Form 8-K on March 2, 2006, with respect to Item 1.01,
        reporting that it had signed a 10-year exclusive agreement with Beijing Sino-US
        Jinche Yingang Auto Technological Services Limited.
 
 NeoMedia
        filed a report on Form 8-K on March 22, 2006, with respect to Item 1.01,
        reporting that it had loaned an additional $250,000 to Hip Cricket, Inc.,
        pursuant to the terms of a previously signed letter of intent.
 
 NeoMedia
        filed a report on Form 8-K on March 23, 2006, with respect to Item 2.01,
        reporting that it had closed its acquisition of BSD Software, Inc.
  NeoMedia
        filed a report on Form 8-K on April 3, 2006, with respect to Item 8.01,
        reporting that Cornell Capital Partners had exercised warrants to purchase
        20,000,000 shares of NeoMedia common stock, par value $0.01 per share. The
        warrants were issued to Cornell Capital on March 30, 2005 as a commitment
        fee
        for Cornell Capital entering into that certain Standby Equity Distribution
        Agreement, dated March 30, 2006 by and between NeoMedia and Cornell Capital.
        The
        warrants had an exercise price equal to $0.20 per share. In connection with
        the
        exercise of the 20,000,000 Warrants, NeoMedia received proceeds of
        $4,000,000.
 
 NeoMedia
        filed amendment No. 1 to Form 8-K on May 3, 2006, with respect to Items 2.01
        and
        9.01, for the purposes of providing the required financial statements of
        Mobot,
        Inc.
 
 NeoMedia
        filed amendment No. 1 to Form 8-K on May 8, 2006, with respect to Items 2.01
        and
        9.01, for the purposes of providing the required financial statements of
        12Snap
        AG.
 
 NeoMedia
        filed amendment No. 1 to Form 8-K on May 8, 2006, with respect to Items 2.01
        and
        9.01, for the purposes of providing the required financial statements of
        Gavitec
        AG.
 
 NeoMedia
        filed amendment No. 1 to Form 8-K on May 9, 2006, with respect to Items 2.01
        and
        9.01, for the purposes of providing the required financial statements of
        Sponge
        Ltd.
  63
  **SIGNATURES**
 
 In
        accordance with the requirements of the Securities Exchange Act of 1934,
        the
        Registrant has caused this report to be signed on its behalf by the undersigned,
        thereunto duly authorized.
 
 
 **NEOMEDIA
                  TECHNOLOGIES, INC.**RegistrantDate:May
                  15, 2006
              By:*/s/
                  Charles T. Jensen*Charles
                  T. Jensen, President, Chief Executive Officer, and
                  DirectorDate:May
                  15, 2006
              By:*/s/
                  David A. Dodge*David
                  A. Dodge, Vice President,Chief
                  Financial Officer and principal accounting officer
  64