**U.
      S. SECURITIES AND EXCHANGE COMMISSION**


WASHINGTON,
      D.C. 20549










**FORM
      10 - Q**




(Mark
      One)




**x
      QUARTERLY REPORT
      PURSUANT TO SECTION 13 OR 15(d) OF**


**THE
      SECURITIES EXCHANGE ACT OF 1934**





**For
      the Quarterly Period Ended September 30, 2007**





**OR**





**o
      TRANSITION REPORT
      PURSUANT TO SECTION 13 OR 15(d) OF**


**THE
      SECURITIES EXCHANGE ACT OF 1934**





**Commission
      File Number 0-21743**





**NEOMEDIA
      TECHNOLOGIES, INC.**


(Exact
      Name of Issuer as Specified In Its Charter)





**Delaware**
            **36-3680347**(State
                or Other Jurisdiction of
            (I.R.S.
                EmployerIncorporation
                or Organization)
            Identification
                No.)**2201
                Second Street, Suite 600, Fort Myers, Florida**
            **33901**(Address
                of Principal Executive Offices)
            (Zip
                Code)




**239-337-3434**


Issuer's
      Telephone Number (Including Area Code)





Check
      whether the issuer (1) filed all reports required to be filed by Section 13
      or
      15(d) of the Exchange Act during the past 12 months (or for such shorter period
      that the registrant was required to file such reports), and (2) has been subject
      to such filing requirements for the past 90 days. Yes x 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
oNo
x




As
      of
      November 2, 2007, there were 1,021,324,111 shares of common stock and 20,097
      shares of Series C Convertible Preferred Stock outstanding .











**TABLE
      OF CONTENTS**




PART
                I —
                FINANCIAL INFORMATION
            
            1ITEM
                1. FINANCIAL STATEMENTS
            
            1CONDENSED
                CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 2007 (UNAUDITED)
                AND
                DECEMBER 31, 2006
            
            1CONDENSED
                CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
                FOR
                THE THREE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
                (UNAUDITED)
            
            2CONDENSED
                CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
                FOR
                THE NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006
                (UNAUDITED)
            
            3CONDENSED
                CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER
                30, 2007 AND 2006 (UNAUDITED)
            
            4UNAUDITED
                NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
            
            5ITEM
                2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
                RESULTS
                OF OPERATIONS
            
            46ITEM
                3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MAKRET
                RISK
            
            75ITEM
                4. CONTROLS AND PROCEDURES
            
            75PART
                II — OTHER INFORMATION
            
            78ITEM
                1. LEGAL PROCEEDINGS
            
            79ITEM
                1A. RISK FACTORS
            
            78ITEM
                2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
                PROCEEDS
            
            79ITEM
                3. DEFAULT UPON SENIOR SECURITIES
            
            79ITEM
                4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
            
            79ITEM
                5. OTHER INFORMATION
            
            80ITEM6.
                EXHIBITS AND REPORTS ON FORM 8-K
            
            81SIGNATURES
            
            82









**PART
      I**—**FINANCIAL INFORMATION**




**ITEM
      1. FINANCIAL STATEMENTS**





**NeoMedia
      Technologies, Inc. and Subsidiaries**


**Condensed
      Consolidated Balance Sheet** **s**


**(In
      Thousands, Except Share and Per Share Data)**




**September
                30**
            
            **December
                31,****2007**
            
            **2006
                ***(unaudited)**ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            226
            
            $
            2,813Trade
                accounts receivable, net of allowance for doubtful accounts of $16
                and
                $68, respectively
            
            
            121
            
            
            187Other
                accounts receivable
            
            
            0
            
            
            550Inventories,
                net of allowance for obsolete & slow-moving inventory of $58 and $53
                respectively
            
            
            267
            
            
            80Investment
                in marketable securities
            
            
            11
            
            
            57Prepaid
                expenses and other current assets
            
            
            134
            
            
            102Assets
                held for sale
            
            
            6,438
            
            
            19,420Total
                current assets
            
            
            7,197
            
            
            23,209Leasehold
                improvements & property and equipment, net
            
            
            110
            
            
            191Goodwill
            
            
            3,418
            
            
            3,418Capitalized
                patents, net
            
            
            2,615
            
            
            2,839Proprietary
                software, net
            
            
            3,591
            
            
            4,138Other
                intangible assets, net
            
            
            41
            
            
            42Cash
                surrender value of life insurance policy
            
            
            949
            
            
            863Other
                long-term assets
            
            
            3,705
            
            
            3,425**Total
                assets**
            
            $
            21,626
            
            $
            38,125**LIABILITIES
                AND SHAREHOLDERS’ DEFICIT**Current
                liabilities:Accounts
                payable
            
            $
            2,515
            
            $
            2,442Liabilities
                held for sale
            
            
            3,440
            
            
            10,257Taxes
                payable
            
            
            12
            
            
            5Accrued
                expenses
            
            
            3,278
            
            
            4,016Deferred
                revenues and other current liabilities
            
            
            461
            
            
            575Notes
                payable
            
            
            15
            
            
            15Accrued
                purchase price guarantee
            
            
            4,592
            
            
            19,667Derivative
                financial instruments
            
            
            32,346
            
            
            25,417Deferred
                tax liability
            
            
            527
            
            
            706Debentures
                payable
            
            
            7,500
            
            
            7,500Debentures
                payable at fair value
            
            
            22,797
            
            
            0Convertible
                preferred stock, mandatorily redeemable, $0.01 par value, 25,000,000
                sharesauthorized,
                22,000 issued, 20,877 shares outstanding, liquidation value of
                $20,877
            
            
            20,877
            
            
            21,657**Total
                liabilities**
            
            
            98,360
            
            
            92,257Commitments
                and contingencies (Note
                12)Shareholders’
                deficit:Common
                stock, $0.01 par value, 5,000,000,000 shares authorized, 956,968,323
                and656,853,390
                shares issued and 955,326,897 and 655,211,964 outstanding,
                respectively
            
            
            9,553
            
            
            6,376Additional
                paid-in capital
            
            
            116,356
            
            
            101,911Accumulated
                deficit
            
            
            (201,160
            )
            
            (160,930
            )Accumulated
                other comprehensive loss
            
            
            (704
            )
            
            (710
            )Treasury
                stock, at cost, 201,230 shares of common stock
            
            
            (779
            )
            
            (779
            )Total
                shareholders’ deficit
            
            
            (76,734
            )
            
            (54,132
            )**Total
                liabilities and shareholders’ deficit**
            
            $
            21,626
            
            $
            38,125




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





*
      -
      Amounts have been reclassified from the audited December 31, 2006 consolidated
      balance sheet to reflect assets and liabilities held for sale in relation to
      the
      Company’s discontinued operations. See note 1.




1


**NeoMedia
      Technologies, Inc. and Subsidiaries**


**Condensed
      Consolidated Statements of Operations** ****


**and
      Comprehensive Income (Loss) (Unaudited)**


**(In
      Thousands, Except Share and per Share Data)**





**Three
                Months Ended**
              **September
                30,****2007**
            
            **2006**Net
                sales
            
            $
            287
            
            $
            430Cost
                of sales
            
            
            324
            
            
            463Gross
                profit
            
            
            (37
            )
            
            (33
            )Sales
                and marketing expenses
            
            
            604
            
            
            1,307General
                and administrative expenses
            
            
            1,110
            
            
            1,870Research
                and development costs
            
            
            435
            
            
            579Income
                (loss) from operations
            
            
            (2,186
            )
            
            (3,789
            )Gain
                (loss) on extinguishment of debt
            
            
            201
            
            
            0Interest
                income (expense), net
            
            
            (7,186
            )
            
            (160
            )Gain
                (loss) on derivative financial instruments
            
            
            (12,215
            )
            
            (9,721
            )**INCOME
                (LOSS) FROM CONTINUING OPERATIONS**
            
            
            **(21,386**
            **)**
            
            **(13,670**
            **)****DISCONTINUED
                OPERATIONS (Note 4)**Income
                (loss) from operations of discontinued operations
            
            
            (780
            )
            
            (4,432
            )Impairment
                of assets of NeoMedia Telecom and MicroPaint Repair
            
            
            (3,967
            )
            
            0**INCOME
                (LOSS) FROM DISCONTINUED OPERATIONS**
            
            
            (4,747
            )
            
            (4,432
            )**NET
                INCOME (LOSS)**
            
            
            (26,133
            )
            
            (18,102
            )Accretion
                of dividends on convertible preferred stock
            
            
            (428
            )
            
            (604
            )**NET
                INCOME (LOSS) ATTRIBUTABLE TO COMMON SHAREHOLDERS**
            
            
            **(26,561**
            **)**
            
            **(18,706**
            **)**Comprehensive
                loss:Net
                income (loss)
            
            
            (26,133
            )
            
            (18,102
            )Other
                comprehensive income (loss):Unrealized
                gain (loss) on marketable securities
            
            
            (3
            )
            
            114Foreign
                currency translation adjustment
            
            
            (53
            )
            
            (320
            )**COMPREHENSIVE
                INCOME (LOSS)**
            
            **$**
            **(26,189**
            **)**
            **$**
            **(18,308**
            **)****Income
                (loss) per share from continuing operations—basic and
                diluted**
            
            **$**
            **(0.02**
            **)**
            **$**
            **(0.02**
            **)****Income
                (loss) per share from discontinued operations—basic and
                diluted**
            
            **$**
            **(0.01**
            **)**
            **$**
            **(0.01**
            **)****Net
                income (loss) per share—basic and diluted**
            
            **$**
            **(0.03**
            **)**
            **$**
            **(0.03**
            **)****Weighted
                average number of common
                shares**—**basic**
            
            
            **927,306,694**
            
            
            **644,720,857****Weighted
                average number of common
                shares**—**diluted**
            
            
            **927,306,694**
            
            
            **644,720,857**





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




2


**NeoMedia
      Technologies, Inc. and Subsidiaries**


**Condensed
      Consolidated Statements of Operations**


**and
      Comprehensive Income (Loss) (Unaudited)**


**(In
      Thousands, Except Share and per Share Data)**




**Nine
                Months Ended**
              **September
                30,****2007**
            
            **2006**Net
                sales
            
            $
            1,310
            
            $
            1,117Cost
                of sales
            
            
            1,011
            
            
            1,000Gross
                profit
            
            
            299
            
            
            117Sales
                and marketing expenses
            
            
            2,006
            
            
            4,013General
                and administrative expenses
            
            
            4,874
            
            
            5,199Research
                and development costs
            
            
            1,360
            
            
            1,561Income
                (loss) from operations
            
            
            (7,941
            )
            
            (10,656
            )Gain
                (loss) on extinguishment of debt
            
            
            454
            
            
            (1,858
            )Interest
                income (expense), net
            
            
            (9,841
            )
            
            (191
            )Write-off
                of deferred equity financing costs
            
            
            0
            
            
            (13,256
            )Gain
                (loss) on derivative financial instruments
            
            
            (14,601
            )
            
            6,073**INCOME
                (LOSS) FROM CONTINUING OPERATIONS**
            
            
            **(31,929**
            **)**
            
            **(19,888**
            **)****DISCONTINUED
                OPERATIONS (Note 4)**Income
                (loss) from operations of discontinued operations
            
            
            (1,609
            )
            
            (7,656
            )Income
                (loss) from disposal of 12Snap
            
            
            (257
            )
            
            0Impairment
                of assets of 12Snap, NeoMedia Telecom, and Micro Paint
                Repair
            
            
            (6,434
            )
            
            0**INCOME
                (LOSS) FROM DISCONTINUED OPERATIONS**
            
            
            (8,300
            )
            
            (7,656
            )**NET
                INCOME (LOSS)**
            
            
            **(40,229**
            **)**
            
            **(27,544**
            **)**Accretion
                of dividends on convertible preferred stock
            
            
            (1,289
            )
            
            (1,220
            )**NET
                INCOME (****LOSS)****ATTRIBUTABLE
                TO COMMON SHAREHOLDERS**
            
            
            **(41,518**
            **)**
            
            **(28,764**
            **)**Comprehensive
                loss:Net
                income (loss)
            
            
            (40,229
            )
            
            (27,544
            )Other
                comprehensive income (loss):Unrealized
                gain (loss) on marketable securities
            
            
            (46
            )
            
            (49
            )Foreign
                currency translation adjustment
            
            
            52
            
            
            (434
            )**COMPREHENSIVE
                INCOME (LOSS)**
            
            
            **($40,223**
            **)**
            
            **($28,027**
            **)****Income
                (loss) per share from continuing operations—basic and
                diluted**
            
            **$**
            **(0.04**
            **)**
            **$**
            **(0.04**
            **)****Income
                (loss) per share from discontinued operations—basic and
                diluted**
            
            **$**
            **(0.01**
            **)**
            **$**
            **(0.01**
            **)****Net
                income (loss) per share—basic and diluted**
            
            **$**
            **(0.05**
            **)**
            **$**
            **(0.05**
            **)****Weighted
                average number of common
                shares**—**basic**
            
            
            **835,772,746**
            
            
            **602,132,555****Weighted
                average number of common
                shares**—**diluted**
            
            
            **835,772,746**
            
            
            **602,132,555**





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




3





**NeoMedia
      Technologies, Inc. and Subsidiaries**


**Condensed
      Consolidated Statements of Cash Flows (Unaudited)**


**(In
      Thousands)**





**Nine
                Months****Ended
                September 30,****2007**
            
            **2006**CASH
                FLOWS FROM OPERATING ACTIVITIES:Loss
                from continuing operations
            
            $
            (31,929
            )
            $
            (19,888
            )Adjustments
                to reconcile net loss to net cash used in operating
                activities:Depreciation
                and amortization
            
            
            870
            
            
            793Loss
                on early extinguishment of debt
            
            
            (454
            )
            
            1,858Change
                in fair value from revaluation of warrants and embedded conversion
                features
            
            
            14,601
            
            
            (6,073
            )Write-off
                of deferred equity financing costs
            
            
            0
            
            
            13,256Stock-based
                compensation expense
            
            
            2,221
            
            
            2,777Interest
                expense related to convertible debt
            
            
            8,203
            
            
            22Increase
                in value of life insurance policies
            
            
            (86
            )
            
            (28
            )Changes
                in operating assets and liabilitiesTrade
                and other accounts receivable
            
            
            545
            
            
            (671
            )Inventories
            
            
            (187
            )
            
            55Prepaid
                expenses and other current assets
            
            
            (32
            )
            
            (227
            )Accounts
                payable and accrued liabilities
            
            
            (112
            )
            
            927Deferred
                revenue and other current liabilities
            
            
            (293
            )
            
            1,206Net
                cash used in operating activities
            
            
            (6,653
            )
            
            (5,993
            )CASH
                FLOWS FROM INVESTING ACTIVITIES:Cash
                received from sale of (paid to acquire) CSI International, Inc.,
                Mobot,
                Inc., Sponge Ltd., Gavitec AG, and 12Snap AG, net of cash
                acquired
            
            
            1,100
            
            
            (13,867
            )Acquisition
                of property and equipment
            
            
            (15
            )
            
            (236
            )Acquisition
                of patents and other intangible assets
            
            
            0
            
            
            (160
            )Advances
                to discontinued subsidiaries Micro Paint Repair, 12Snap, Telecom
                Services,
                Mobot, and Sponge
            
            
            (2,282
            )
            
            (4,957
            )Acquisition
                related costs
            
            
            0
            
            
            (164
            )Payment
                of purchase price guarantee obligations
            
            
            (2,579
            )
            
            0Amounts
                received (issued) under notes receivable
            
            
            671
            
            
            (500
            )Net
                cash used in investing activities
            
            
            (3,105
            )
            
            (19,884
            )CASH
                FLOWS FROM FINANCING ACTIVITIES:Borrowing
                under convertible debt instruments, net of fees of $981 in 2007 and
                $0 in
                2006
            
            
            8,253
            
            
            5,000Repayments
                on notes payable and convertible debt instrument
            
            
            (1,015
            )
            
            (436
            )Net
                proceeds from issuance of common stock, net of issuance costs of
                $24 in
                2006
            
            
            0
            
            
            210Net
                proceeds from issuance of Series C convertible preferred stock, net
                of
                issuance costs of $2,725 in 2006
            
            
            0
            
            
            14,066Net
                proceeds from exercise of stock options and warrants
            
            
            17
            
            
            8,419Net
                cash provided by financing activities
            
            
            7,255
            
            
            27,259EFFECT
                OF EXCHANGE RATE CHANGES ON CASH FROM CONTINUING
                OPERATIONS
            
            
            (84
            )
            
            (1,120
            )**NET
                INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS FROM CONTINUING
                OPERATIONS**
            
            
            (2,587
            )
            
            262CASH
                AND CASH EQUIVALENTS, BEGINNING OF PERIOD
            
            
            2,813
            
            
            1,704**CASH
                AND CASH EQUIVALENTS, END OF PERIOD**
            
            **$**
            **226**
            
            **$**
            **1,966**SUPPLEMENTAL
                CASH FLOW INFORMATION:Interest
                paid during the period
            
            $
            636
            
            $
            48Supplemental
                disclosure of investing and financing activities:Unrealized
                gain (loss) on marketable securities
            
            
            (40
            )
            
            (361
            )Fair
                value of 258,620,948 shares issued to satisfy purchase price guarantee
                obligations
            
            
            12,721
            
            
            0Fair
                value of 28,854,685 shares issued to satisfy debt guarantee
                obligation
            
            
            698
            
            
            0Prepaid
                acquisition costs applied to purchase price
            
            
            0
            
            
            168Fair
                value of shares and notes receivable from Pickups Plus, Inc. acquired
                in
                exchange for Series C Convertible Preferred Stock
            
            
            0
            
            
            594Carrying
                value of promissory note and accrued interest paid in exchange for
                Series
                C Convertible Preferred Stock
            
            
            0
            
            
            (3,208
            )Fair
                value of shares issued to acquire CSI International, Inc., Mobot,
                Inc.,
                Sponge Ltd., Gavitec AG, 12Snap AG, and BSD Software, Inc.
            
            
            0
            
            
            46,964Change
                in net assets resulting from acquisitions of CSI International, Inc.,
                Mobot, Inc., Sponge Ltd., Gavitec AG, 12Snap AG, and BSD Software,
                Inc.
            
            
            0
            
            
            62,240Accretion
                of dividends on Series C Convertible Preferred Stock
            
            
            1,289
            
            
            1,220Fair
                value of outstanding warrants reclassified to liabilities
            
            
            0
            
            
            13,884Portion
                of change in fair value of outstanding warrants converted to liabilities
                recorded to paid-in capital
            
            
            0
            
            
            3,790Initial
                fair value of Series C Convertible Preferred Stock (host instrument
                only)
            
            
            0
            
            
            4,908Deferred
                stock-based financing costs associated with Series C Convertible
                Preferred
                Stock
            
            
            0
            
            
            3,198Difference
                between net proceeds and recorded fair value of Series C Convertible
                Preferred Stock
            
            
            0
            
            
            4,041Advance
                receivable from Mobot, Inc. forgiven upon acquisition
            
            
            0
            
            
            1,500





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




4


**NEOMEDIA
      TECHNOLOGIES, INC. AND SUBSIDIARIES**


**UNAUDITED
      NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**





**1.**  **BASIS
      OF PRESENTATION AND NATURE OF BUSINESS OPERATIONS**





**Basis
      of Presentation**





The
      condensed consolidated financial statements include the financial statements
      of
      NeoMedia Technologies, Inc. and its wholly-owned subsidiaries (“NeoMedia” or the
“Company”). The condensed balance sheet as of December 31, 2006, which has been
      derived from audited financial statements, and the 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-K for the fiscal year ended December 31,
      2006. 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 condensed consolidated financial
      position of NeoMedia as of September 30, 2007, the results of operations for
      the
      three and nine month periods ended September 30, 2007 and 2006, and cash flows
      for the nine month periods ended September 30, 2007 and 2006. The results of
      operations for the three and nine month periods ended September 30, 2007 are
      not
      necessarily indicative of the results which may be expected for the entire
      fiscal year. All significant intercompany accounts and transactions have been
      eliminated in preparation of the condensed consolidated financial
      statements.





**Going
      Concern**





The
      accompanying condensed consolidated financial statements have been prepared
      in
      conformity with accounting principles generally accepted in the United States
      of
      America, which contemplate continuation of the Company as a going concern.
      Net
      loss for the three and nine month periods ended September
      30 ,
      2007
      was $26,133,000, and $40,229,000, respectively. Net cash used in operations
      for
      the nine months ended September 30, 2007 was $6,653,000, and net cash used
      for
      discontinued operations (including operating, investing, and financing
      activities, as well as effect of exchange rates on cash for discontinued
      subsidiaries) was $741,000. NeoMedia also has an accumulated deficit of
      $201,160,000, and a working capital deficit of $91,163,000 as of
      September 30, 2007 ,
      of
      which $ 32,346,000 relates
      to the fair value of derivative financial instruments .





The
      items
      discussed above raise substantial doubts about the Company's ability to continue
      as a going concern. The Company's financial resources are insufficient to
      maintain operations beyond April, 2008, and the Company will require additional
      financing in order to execute its operating plan and continue as a going
      concern. The Company cannot predict whether this additional financing will
      be in
      the form of equity, debt, or another form. The Company may not be able to obtain
      the necessary additional capital on a timely basis, on acceptable terms, or
      at
      all. In any of these events, the Company may be unable to implement its current
      plans for expansion, repay its debt obligations as they become due or respond
      to
      competitive pressures, any of which circumstances would have a material adverse
      effect on its business, prospects, financial condition and results of
      operations. The financial statements do not include any adjustments relating
      to
      the recoverability and reclassification of recorded asset amounts or amounts
      and
      reclassification of liabilities that might be necessary, should the Company
      be
      unable to continue as a going concern.





Should
      financing sources fail to materialize, management would seek alternate funding
      sources such as the sale of common and/or preferred stock, the issuance of
      debt,
      or the sale of its marketable assets. Management's plan is to secure adequate
      funding to bridge the commercialization of its core code-reading
      business.




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




5





In
      the
      event that these financing sources do not materialize, or that NeoMedia is
      unsuccessful in increasing its revenues and profits, NeoMedia will be forced
      to
      further reduce its costs, may be unable to repay its debt obligations as they
      become due, or respond to competitive pressures, any of which circumstances
      would have a material adverse effect on its business, prospects, financial
      condition and results of operations. Additionally, if these funding sources
      or
      increased revenues and profits do not materialize, and NeoMedia is unable to
      secure additional financing, NeoMedia could be forced to reduce or curtail
      its
      business operations unless it is able to engage in a merger or other corporate
      finance transaction with a better capitalized entity.





**Nature
      of Business Operations**





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





Prior
      to
      2006, 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).




During
      the first quarter of 2006, NeoMedia acquired 12Snap AG (“12Snap”) of Munich,
      Sponge Ltd. (“Sponge”) of London, Gavitec AG of Aachen, Germany (“Gavitec”),
      Mobot, Inc. (“Mobot”) of Lexington, Massachusetts, and BSD Software, Inc. of
      Calgary, Canada (“BSD”), and wound down its NCIS business unit. As a result,
      during the year ended December 31, 2006, NeoMedia operated under the following
      three business units:




·
            NeoMedia
                Mobile (NMM) - encompassing NeoMedia's physical-world-to-internet
                and
                mobile marketing technologies and
                products;





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





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





During
      August 2006, NeoMedia announced that it intended to sell its Micro Paint Repair
      business. On November 1, 2007 the Company entered into a definitive purchase
      agreement to sell the assets of the Micro Paint Repair business unit, excluding
      the assets of the U.S. Auto Xperience operations. During the fourth quarter
      of
      2006, NeoMedia divested of its Mobot and Sponge subsidiaries. During January
      2007, NeoMedia made the strategic decision with respect to its corporate
      structure in 2007 and beyond to shed its remaining non-core 12Snap and Telecom
      Services business units to focus on the area that management believes will
      deliver the most value - the core code-reading business. During April 2007,
      NeoMedia sold the 12Snap business. On
      October 30, 2007, NeoMedia completed the sale of its Telecom
      Services business unit.





As
      a
      result of the divestitures of 12Snap, Mobot, Sponge, and Telecom Services,
      and
      the proposed divestiture of Micro Paint Repair, beginning in the first quarter
      of 2007 NeoMedia evaluated its business as one consolidated business, focusing
      on its core code-reading business and related intellectual
      property.




6





For
      purposes of these financial statements, NeoMedia Micro Paint Repair, NeoMedia
      Telecom Services, 12Snap, Sponge, and Mobot are considered discontinued
      operations as of September 30, 2007 and for the three and nine month periods
      ended September 30, 2007 and 2006. NeoMedia Micro Paint Repair, NeoMedia Telecom
      Services, 12Snap, Sponge, and Mobot qualified as separate operating business
      units because they (i) engaged in business activities that earned revenues
      and
      incurred expenses, (ii) had operating results that were regularly reviewed
      by
      decision makers for the purposes of allocating resources to the segment, and
      (iii) had separate discreet financial information.





On
      September 26, 2007, NeoMedia announced plans to relocate its corporate
      headquarters, as well as changes in current key personnel. NeoMedia is currently
      based out of Ft. Myers, Florida, and is relocating its operations to Atlanta,
      Georgia during the fourth quarter of 2007, in order to offer close contact
      to
      potential customers and easier access to international markets. NeoMedia will
      continue to operate its Aachen, Germany office, consisting of the operations
      of
      Gavitec. NeoMedia also announced that Christian Steinborn, 37, CEO of Gavitec,
      will assume the additional role of Chief Operating Officer of NeoMedia. Mr.
      Steinborn will oversee global sales opportunities and business operations of
      both NeoMedia and Gavitec. Christian is a seasoned executive with years of
      experience in the wireless industry and demonstrates consistent execution of
      sales and profitability initiatives. In addition, Charles W. Fritz, the founder
      and Chairman of the Board of NeoMedia, has resigned his role as Chairman of
      the
      Board. Mr. Fritz plans to pursue ventures in economic and environmental
      industries. NeoMedia has entered into a consulting arrangement with Mr. Fritz
      whereby he will provide sales, marketing, and other services to NeoMedia for
      a
      period of one year.




**Reclassifications
      and Other**





Certain
      amounts in the 2006 condensed consolidated financial statements have been
      reclassified to conform to the 2007 presentation, most notably, net sales were
      formerly reported as separate line items “ Technology
      license, service and products ,”
and
      “Micro Paint Repair Products and Services.” As a result of the winding down of
      the former NCIS business unit and the proposed sale of the Micro Paint Repair
      business unit, revenue from continuing operations now consists of license
      revenue and is being reported under the caption “Net sales.”





In
      addition, due to the Company’s decision to sell the Telecom Services and Micro
      Paint Repair business units, and the completed divestitures of 12Snap, Mobot
      and
      Sponge, results of operations from each of these units have been reclassified
      under the caption “Discontinued Operations” for all periods shown on the
      accompanying condensed consolidated statement of operations, and assets and
      liabilities relating to these units are combined into the captions “Assets held
      for sale” and “Liabilities held for sale,” respectively, on the accompanying
      condensed consolidated balance sheet. Additionally, the statements of cash
      flows
      for the nine months ended September 30, 2006 have been reclassified to exclude
      the cash flows of the discontinued business units.




7


While
      preparing the Company’s quarterly report on Form 10-Q for the second quarter of
      2007, the Company became aware of amounts that were incorrectly reported in
      its
      2006 Forms 10-Q and 10-K for the third quarter of 2006 and year end 2006,
      respectively. This issue has been reviewed by the Company pursuant to SEC Staff
      Accounting Bulletin No. 99 and FASB Statement of Financial Accounting Standards
      No. 154, and determined to be not material to the 2006 financial reports. The
      Company further determined that the correction of the prior year misstatement
      in
      the current year financial reports would be material to the current year
      financial statements. Pursuant to the SEC Staff Accounting Bulletin No. 108
      (“SAB 108”), the Company has corrected its December 31, 2006 consolidated
      audited balance sheet presented in this third quarter 2007 Form 10-Q to reflect
      the corrected amounts. Pursuant to SAB 108, correcting prior year financial
      statements for immaterial errors would not require previously filed reports
      to
      be amended. The following table reflects the adjustments to the statement of
      operations for the three and nine months ended September 30, 2006, and to the
      balance sheet as of December 31, 2006 (all amounts in thousands):




**Statement
                of operations**
            
            Three
                Months Ended September 30, 2006As
                Reported
            
            Adjustment
            
            CorrectedLoss
                on derivative financial instruments
            
            
            (9,271
            )
            
            (450
            )
            
            (9,721
            )Net
                loss from continuing operations
            
            
            (29,289
            )
            
            (450
            )
            
            (29,739
            )Net
                loss
            
            
            (30,909
            )
            
            (450
            )
            
            (31,359
            )Net
                loss attributable to common shareholders
            
            
            (31,513
            )
            
            (450
            )
            
            (31,963
            )Comprehensive
                loss
            
            
            (31,113
            )
            
            (450
            )
            
            (31,563
            )




**Statement
                of operations**
            
            Nine
                Months Ended September 30, 2006As
                Reported
            
            Adjustment
            
            CorrectedGain
                (loss) on derivative financial instruments
            
            
            6,523
            
            
            (450
            )
            
            6,073Net
                loss from continuing operations
            
            
            (24,268
            )
            
            (450
            )
            
            (24,718
            )Net
                loss
            
            
            (27,094
            )
            
            (450
            )
            
            (27,544
            )Net
                loss attributable to common shareholders
            
            
            (28,314
            )
            
            (450
            )
            
            (28,764
            )Comprehensive
                loss
            
            
            (27,577
            )
            
            (450
            )
            
            (28,027
            )




**Balance
                sheet**
            
            As
                of December 31, 2006As
                Reported
            
            Adjustment
            
            CorrectedDerivative
                financial instruments
            
            
            25,819
            
            
            (402
            )
            
            25,417Total
                liabilities
            
            
            92,659
            
            
            (402
            )
            
            92,257Additional
                paid-in capital
            
            
            100,541
            
            
            (1,370
            )
            
            101,911Accumulated
                deficit
            
            
            (159,962
            )
            
            968
            
            
            (160,930
            )Total
                shareholders equity / (deficit)
            
            
            (54,534
            )
            
            (402
            )
            
            (54,132
            )





8


**2.**  **SUMMARY
      OF SIGNIFICANT ACCOUNTING POLICIES**





The
      following significant accounting policies were not applicable as of the filing
      of the annual report for the year ended December 31, 2006. For a complete
      discussion of the Company’s significant accounting policies, please refer to the
      Company’s annual report on Form 10-K for the fiscal year ended December 31,
      2006.





**Financial
      Accounting Standards Board Interpretation No. 48**





The
      Company adopted the provisions of Financial Accounting Standards Board ("FASB")
      Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-an
      interpretation of FASB Statement No. 109” (“FIN 48”), on January 1, 2007. FIN 48
      clarifies the accounting for uncertainty in income taxes recognized in an
      enterprise's financial statements in accordance with FASB Statement 109,
“Accounting for Income Taxes,” and prescribes a recognition threshold and
      measurement process for financial statement recognition and measurement of
      a tax
      position taken or expected to be taken in a tax return. FIN 48 also provides
      guidance on derecognition, classification, interest and penalties, accounting
      in
      interim periods, disclosure and transition.





Based
      on
      its evaluation, the Company has concluded that there are no significant
      uncertain tax positions requiring recognition in its financial statements.
      The
      Company’s evaluation was performed for the tax years ended December 31, 2003,
      2004, 2005 and 2006, the tax years which remain subject to examination by major
      tax jurisdictions as of September 30, 2007.





The
      Company may from time to time be assessed interest or penalties by major tax
      jurisdictions, although any such assessments historically have been minimal
      and
      immaterial to the Company’s financial results. In the event the Company has
      received an assessment for interest and/or penalties, it has been classified
      in
      the financial statements as interest expense.





**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) sales from 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 the
                American  Institute  of  Certified  Public 
                Accountants  ("AICPA")  Statement of Position 97-2 "Software
                Revenue  Recognition" ("SOP 97-2"), as amended, and Statement of
                Position 98-9, Modification of SOP 97-2, “Software Revenue Recognition,
                With Respect to Certain Transactions.”.  License revenue is
                recognized if persuasive evidence of an agreement exists, delivery
                has
                occurred, pricing is fixed and determinable, and collectibility is
                probable.  The Company defers revenue related to license fees for
                which amounts have been collected but for which revenue has not been
                recognized in accordance with the above, and recognizes the revenue
                over
                the appropriate period.





(2)
            Technology
                service and product revenue, which includes sales of software and
                technology equipment and service fee is recognized  based on
                guidance  provided in  SEC Staff  Accounting 
                Bulletin  (“SAB”) No. 104,  "Revenue  Recognition  in
                Financial Statements,"  as amended (SAB 104).  Software
                and technology equipment resale revenue is
                recognized when persuasive evidence of an arrangement exists, the
                price to the customer is fixed and determinable, delivery of the
                service
                has occurred and collectibility is reasonably assured.
                Service revenues including maintenance fees for
                providing system updates for software products, user documentation
                and
                technical support are recognized over the life of
                the contract. The Company’s subsidiaries, Mobot (sold during 2006),
                and Gavitec follow this policy. The Company defers revenue related
                to
                technology service and product revenue for which amounts have been
                invoiced and or collected but for which the requisite service has
                not been
                provided. Revenue is then recognized over the matching service period.




9




(3)
            Technology
                service also includes mobile marketing services to its customers
                which
                mobile marketing projects are recognized after the completion of
                the
                project and acceptance by the customer.  All response and messaging
                based revenues are recognized at the time such responses are received
                and
                processed and the Company recognizes its premium messaging revenues
                on a
                net basis based on guidance provided in Emerging Issues Task Force
                Issues
                No. 99-19 (EITF 99-19), “Reporting Revenue Gross as Principal or Net as an
                Agent” and No. 01-09 (EITF 01-09), “Accounting for Consideration Given by
                a Vendor to a Customer.”  Consulting and management revenues and
                revenues for periodic services are recognized as services are
                performed.  NeoMedia uses  stand-alone  pricing to
                determine an element's  vendor  specific  objective 
                evidence  (“VSOE”) in order to allocate an arrangement  fee
                amongst various pieces of a  multi-element  contract.  The
                Company’s subsidiaries Sponge (sold during 2006) and 12Snap (sold during
                2007) followed this policy. Telecom revenues from NeoMedia’s subsidiary
                BSD are recognized at the time that calls are accepted by the
                clearinghouse for billing to customers on a net basis, based on guidance
                in EITF 99-19. The Company defers revenue related to mobile marketing
                service fees for which amounts have been invoiced and/or collected
                but for
                which revenue has not been recognized. Revenue is then recognized
                over the
                matching service period.





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





(5)
            Sales
                taxes represent 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. In compliance with the Emerging Issues Task Force consensus
                on
                issue number 06-03 (EITF 06-03), NeoMedia accounts for sales taxes
                on a
                net basis.




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


This
      Statement:





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




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




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




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




10




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





FAS
      155
      is effective for fiscal years beginning after September 15, 2006. The Company
      has adopted FAS 155 on an individual instrument basis and is currently applying
      FAS 155 to certain of its debt obligations. The Company will evaluate and
      determine on a case by case basis whether to apply FAS 155.




**Effect
      Of Recently Issued Accounting Pronouncements**




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





In
      September 2006, the Securities and Exchange Commission (“SEC”) issued Staff
      Accounting Bulletin No. 108 (“SAB 108”), *Financial
      Statements - Considering the Effects of Prior Year Misstatements when
      Quantifying Misstatements in Current Year Financial
      Statements.”* SAB 108
      provides guidance on how prior year misstatements should be taken into
      consideration when quantifying misstatements in current year financial
      statements for purposes of determining whether the current year’s financial
      statements are materially misstated. SAB 108 provides that once a current year
      misstatement has been quantified, the guidance in SAB No. 99, *Financial
      Statements - Materiality* ,
      should
      be applied to determine whether the misstatement is material and should result
      in an adjustment to the financial statements. Under certain circumstances,
      prior
      year financial statements will not have to be restated and the effects of
      initially applying SAB 108 on prior years will be recorded as a cumulative
      effect adjustment to beginning Retained Earnings on January 1, 2006, with
      disclosure of the items included in the cumulative effect. NeoMedia applied
      the
      provisions of SAB 108 with the preparation of NeoMedia’s annual financial
      statements for the year ended December 31, 2006. The application of the
      provisions of SAB 108 did not have a material impact on the Company’s financial
      statements for the three and nine month periods ended September 30,
      2007.





In
      September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined
      Benefit Pension and Other Postretirement Plans." This statement requires
      companies to recognize a net liability or asset and an offsetting adjustment
      to
      accumulated other comprehensive income to report the funded status of defined
      benefit pension and other postretirement benefit plans. The statement requires
      prospective application, and the recognition and disclosure requirements are
      effective for companies with fiscal years ending after December 15, 2006.
      Additionally, SFAS No. 158 requires companies to measure plan assets and
      obligations at their year-end balance sheet date. This requirement is effective
      for fiscal years ending after December 15, 2008. The impact of this adoption
      had
      no impact on our consolidated financial statements and we are in compliance
      with
      the measurement date provisions of this statement.





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




11





In
      December 2006, FASB Staff Position No. EITF 00-19-2 was issued. This FASB Staff
      Position (FSP) addresses an issuer’s accounting for registration payment
      arrangements. This FSP specifies that the contingent obligation to make future
      payments or otherwise transfer consideration under a registration payment
      arrangement, whether issued as a separate agreement or included as a provision
      of a financial instrument or other agreement, should be separately recognized
      and measured in accordance with FASB Statement No. 5, Accounting for
      Contingencies. The guidance in this FSP amends FASB Statements No. 133,
      Accounting for Derivative Instruments and Hedging Activities, and No. 150,
      Accounting for Certain Financial Instruments with Characteristics of both
      Liabilities and Equity, and FASB Interpretation No. 45, Guarantor’s Accounting
      and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
      Indebtedness of Others, to include scope exceptions for registration payment
      arrangements. This FSP further clarifies that a financial instrument subject
      to
      a registration payment arrangement should be accounted for in accordance with
      other applicable generally accepted accounting principles “GAAP” without regard
      to the contingent obligation to transfer consideration pursuant to the
      registration payment arrangement. The Company follows the guidance in FSP
      00-19-2 in assessing its liabilities related to the liquidated damages arising
      from the Company’s default position on the convertible financing
      arrangements.





In
      June
      2007, the FASB ratified the consensus on Emerging Issues Task Force “EITF” Issue
      No. 06−11, "Accounting for Income Tax Benefits of Dividends on Share−Based
      Payment Awards" ("EITF 06−11"). EITF 06−11 requires companies to recognize the
      income tax benefit realized from dividends or dividend equivalents that are
      charged to retained earnings and paid to employees for non−vested
      equity−classified employee share−based payment awards as an increase to
      additional paid−in capital. EITF 06−11 is effective for fiscal years beginning
      after September 15, 2007. While the Company is currently evaluating the
      provisions of EITF 06−11, the adoption is not expected to have any significant
      effect on the Company's consolidated financial position or results of
      operations.





In
      November 2006, the FASB ratified EITF Issue No. 06−7, “Issuer's Accounting for a
      Previously Bifurcated Conversion Option in a Convertible Debt Instrument When
      the Conversion Option No Longer Meets the Bifurcation Criteria in FASB Statement
      No. 133, Accounting for Derivative Instruments and Hedging Activities” (“EITF
      No. 06−7”). At the time of issuance, an embedded conversion option in a
      convertible debt instrument may be required to be bifurcated from the debt
      instrument and accounted for separately by the issuer as a derivative under
      SFAS
      No. 133, based on the application of EITF No. 00−19. Subsequent to the issuance
      of the convertible debt, facts may change and cause the embedded conversion
      option to no longer meet the conditions for separate accounting as a derivative
      instrument, such as when the bifurcated instrument meets the conditions of
      EITF
      No. 00−19 to be classified in stockholders' equity. Under EITF No. 06−7, when an
      embedded conversion option previously accounted for as a derivative under
      Statement of Financial Accounting Standards (“SFAS”) No. 133 no longer meets the
      bifurcation criteria under that standard, an issuer shall disclose a description
      of the principal changes causing the embedded conversion option to no longer
      require bifurcation under SFAS No. 133 and the amount of the liability for
      the
      conversion option reclassified to stockholders' equity. EITF No. 06−7 should be
      applied to all previously bifurcated conversion options in convertible debt
      instruments that no longer meet the bifurcation criteria in SFAS No. 133 in
      interim or annual periods beginning after December 15, 2006, regardless of
      whether the debt instrument was entered into prior or subsequent to the
      effective date of EITF No. 06−7. The adoption of EITF 06−7 did not have a
      material impact on our financial position, results of operations or cash
      flows.





In
      November 2006, the FASB ratified EITF Issue No. 06−6, Application of EITF Issue
      No. 05−7, ‘Accounting for Modifications to Conversion Options Embedded in Debt
      Instruments and Related Issues ** ’
(“EITF
      06−6”). EITF 06−6 addresses the modification of a convertible debt instrument
      that changes the fair value of an embedded conversion option and the subsequent
      recognition of interest expense for the associated debt instrument when the
      modification does not result in a debt extinguishment pursuant to EITF 96−19.
      The Company does not expect the adoption of EITF 06−6 to have a material impact
      on its consolidated financial position, results of operations or cash
      flows .




12





On
      January 1, 2007, the Company adopted the consensus reached in Emerging Issues
      Task Force (“EITF”) Issue No. 06−2, “Accounting for Sabbatical Leave and Other
      Similar Benefits Pursuant to FASB Statement No. 43.” EITF Issue No. 06−2
      provides recognition guidance on the accrual of employees’ rights to compensated
      absences under a sabbatical or other similar benefit arrangement. The adoption
      of EITF Issue No. 06−2 had no impact on our financial position, results of
      operations, or cash flows.





In
      September 2006, the Emerging Issues Task Force, or EITF, reached a consensus
      on
      Issue No. 06−1, Accounting for Consideration Given by a Service Provider to
      Manufacturers or Resellers of Equipment Necessary for an End-Customer to Receive
      Service from the Service Provider *.* EITF
      Issue No. 06−1 provides guidance regarding whether the consideration given by a
      service provider to a manufacturer or reseller of specialized equipment should
      be characterized as a reduction of revenue or an expense. This issue is
      effective for our annual reporting period ending December 31, 2007. Entities
      are
      required to recognize the effects of applying this issue as a change in
      accounting principle through retrospective application to all prior periods
      unless it is impracticable to do so. We are in the process of evaluating the
      impact of this issue on our consolidated financial statements . The
      Company does not expect the adoption of EITF 06−1 to have a material impact on
      its consolidated financial position, results of operations or cash
      flows .





In
      June
      2007, the FASB issued EITF Issue 07-3 “Accounting for Advance Payments for Goods
      or Services to Be Used in Future Research and Development Activities” (EITF
      07-3). The scope of EITF 07-3 is limited to nonrefundable advance payments
      for
      goods and services related to research and development activities. EITF 07-3
      requires that advanced payments be capitalized and subsequently expensed as
      the
      goods are delivered or services performed. NeoMedia is required to adopt EITF
      07-3 effective January 1, 2008. We do not expect the adoption of EITF 07-3
      to
      have a material impact on our consolidated results of operations and financial
      condition.





In
      June
      2007, the American Institute of Certified Public Accountants (“AICPA”) issued
      Statement of Position (“SOP”) 07-1, “Clarification of the Scope of the Audit and
      Accounting Guide Investment Companies and Accounting by Parent Companies and
      Equity Method Investors for Investments in Investment Companies” (“SOP 07-1”).
      SOP 07-1 provides guidance for determining whether an entity is within the
      scope
      of the AICPA “Audit and Accounting Guide Investment Companies” (the “Guide”).
      SOP 07-1 addresses whether the specialized industry accounting principles of
      the
      Guide should be retained by a parent company in consolidation. In addition,
      SOP
      07-1 includes certain disclosure requirements for parent companies and equity
      method investors in investment companies that retain investment company
      accounting in the parent company’s consolidated financial statements or the
      financial statements of an equity method investor. SOP 07-1 is effective for
      the
      Company as of December 1, 2008. In May 2007, the FASB issued FASB Staff Position
      (“FSP”) FIN 46R-7, “Application of FIN 46R to Investment Companies,” which
      amends FIN 46R to make permanent the temporary deferral of the application
      of
      FIN 46R to entities within the scope of the revised audit guide under SOP 07-1.
      FSP FIN No. 46R-7 is effective upon adoption of SOP 07-1. The Company is
      currently evaluating the potential impact of adopting SOP 07-1 and FSP FIN
      46R-7, and does not expect SOP 07-1 to have a material impact on our
      consolidated results of operations and financial condition.




13


**3.
      ACQUISITIONS**





On
      February 17, 2006, NeoMedia
      acquired all of the outstanding shares of Mobot in exchange for $3,500,000
      cash
      and $6,500,000 in stock, represented by 16,931,493 shares of NeoMedia common
      stock. On
      February 23, 2006, NeoMedia acquired all of the outstanding shares of Sponge
      in
      exchange for $6,141,000 cash and £6,550,000 in stock (approximately $13.1
      million at the time of the agreement), represented by 33,097,135 shares of
      NeoMedia common stock. On February 23, 2006, NeoMedia acquired all of the
      outstanding shares of Gavitec in exchange for $1,800,000 cash and $5,200,000
      in
      stock, represented by 13,660,511 shares of NeoMedia common stock. On February
      28, 2006, NeoMedia acquired all of the outstanding shares of 12Snap in exchange
      for $2,500,000 cash and $19,500,000 in stock, represented by 49,294,581 shares
      of NeoMedia common stock. On March 21, 2006, NeoMedia acquired BSD for 7,123,698
      shares of NeoMedia common stock.





On
      November 14, 2006, NeoMedia divested of 92.5% its ownership interest in Sponge.
      On December 6, 2006, NeoMedia sold 82% of its ownership interest in Mobot.
      On
      April 4, 2007, NeoMedia divested 90% of its ownership interest in 12Snap. On
      October 30, 2007, NeoMedia sold its 90% ownership stake in Triton Global
      Business Services, Inc., which had comprised the operations of NeoMedia’s
      Telecom Services business unit.





The
      consolidated statements of operations presented herein reflect the results
      of
      these acquired subsidiaries as follows: Mobot results are included from February
      18, 2006 through December 6, 2006 under the caption “Loss from discontinued
      operations”; Sponge results are included from February 24, 2006 through November
      14, 2006 under the caption “Loss from discontinued operations”; 12Snap results
      are included from February 24, 2006 through April 4, 2007 under the caption
      “Loss from discontinued operations”; BSD results are included from March 22,
      2006 through September 30, 2007 under the caption “Loss from discontinued
      operations”; and Gavitec results are included in NeoMedia’s consolidated results
      from continuing operations from February 24, 2006 through September 30, 2007.
      Pro-forma results of operations are presented at the end of this Note
      3.





The
      following disclosures reflect activity related to acquisitions since the filing
      of NeoMedia’s last annual report for the year ended December 31, 2006. For a
      complete discussion of the Company’s acquisition activity, please refer to the
      Company’s annual report on Form 10-K for the fiscal year ended December 31,
      2006.





**Gavitec**





The
      acquisition agreement between NeoMedia and Gavitec stipulated that, in the
      event
      that NeoMedia’s stock price at the time the consideration shares became saleable
      (either upon effectiveness of a registration statement containing the shares,
      or
      under Rule 144) was less than $0.389, NeoMedia was obligated to compensate
      Gavitec shareholders in cash for the difference between the price at the time
      the shares became saleable and $0.389. On January 23, 2007, NeoMedia entered
      into an agreement with the former shareholders of Gavitec, whereby this purchase
      price obligation was to be satisfied through the payment by NeoMedia of (i)
      $1,800,000 in cash, payable no later than February 28, 2007 (subsequently
      extended to March 31, 2007), and (ii) 61,000,000 shares of NeoMedia common
      stock
      to be issued no later than February 28, 2007. NeoMedia also agreed to pay
      interest accrued on the purchase price in the amount of $481,000 and reimburse
      $100,000 of costs related to the acquisition to the primary former shareholder
      of Gavitec no later than February 28, 2007. NeoMedia issued the shares and
      made
      cash payments of $2,113,000 during March 2007. In August 2007, payments totaling
      $157,000 were made. As of September 30, 2007, NeoMedia owes $111,000 in
      remaining interest payments relating to this obligation.




**12Snap**





During
      the first quarter of 2007, NeoMedia initiated an action plan to sell its 12Snap
      business. During the three months ended March 31, 2007, and the year ended
      December 31, 2006, NeoMedia recorded impairment charges of $2,467,000 and
      $18,327,000, respectively, to adjust the carrying value of the 12Snap asset
      group to the expected net proceeds from the sale of the assets. Prior to the
      impairment charge, the asset group consisted primarily of goodwill and other
      intangible assets recorded upon purchase of 12Snap by NeoMedia during the first
      quarter of 2006. In connection with its decision to sell the 12Snap business
      in
      the first quarter of 2007, NeoMedia revised its expected cashflow to reflect
      the
      estimated net cash proceeds that the Company anticipated receiving in a sale
      transaction. The operations of 12Snap are classified as discontinued operations
      during the three and nine months ended September 30, 2007 and 2006. The criteria
      for discontinued operations classification were met during the three and nine
      months ended September 30, 2007. (See Note 4)




14





Pursuant
      to the terms of the original purchase agreement, in the event that NeoMedia’s
      stock price at the time the consideration shares became saleable (either upon
      effectiveness of a registration statement containing the shares, or under Rule
      144) was less than $0.3956, NeoMedia was obligated to compensate 12Snap
      shareholders in cash for the difference between the price at the time the shares
      became saleable and $0.3956. On February 22, 2007, the shares became eligible
      for resale under Rule 144. The actual calculated purchase price obligation
      to
      NeoMedia based on the volume weighted average closing price of NeoMedia common
      stock for the ten days up to and including February 22, 2007 was $16,233,000.
      Because the amount of the purchase price guarantee was measurable and probable
      as of December 31, 2006, it was recorded at that date by reducing the fair
      value
      of the initial stock consideration by the amount of the contingency. On March
      19, 2007, NeoMedia issued 197,620,948 shares of its common stock in satisfaction
      of a portion of the purchase price obligation totaling $9,427,000. Additionally,
      NeoMedia has made cash payments against the liability totaling $467,000, and
      further reduced the balance through the forgiveness of $1,760,000 of the
      obligation in connection with the sale of 12Snap. The balance on the purchase
      price obligation as of September 30, 2007 was $4,592,000, which includes $13,000
      in interest accrued on a portion of the balance. The Company is currently
      negotiating payment terms for the balance of the obligation.




On
      April
      4, 2007, NeoMedia reached an agreement with Bernd Michael (the “Buyer”), a
      private investor and former shareholder of 12Snap prior to NeoMedia’s
      acquisition of 12Snap, pursuant to which the Buyer acquired from NeoMedia 90%
      of
      the shares of 12Snap, pursuant to the following material terms:




·
            $1,100,000
                was paid by the Buyer to the Company in cash at closing, of which
                $1,015,000 was paid directly to, and applied toward amounts owed
                to silent
                partners of 12Snap




·
            $500,000
                was placed into an escrow account for 90 days to secure warranty
                claims
                and release to NeoMedia during July
                2007;




·
            Buyer
                waived his portion of the purchase price guarantee obligation in
                the
                amount of $880,000;




·
            Buyer
                returned to NeoMedia 2,525,818 NeoMedia shares previously issued
                to the
                Buyer;




·
            12Snap
                management waived their portion of the purchase price guarantee obligation
                in the amount of $880,000;




·
            12Snap
                management returned to NeoMedia 5,225,039 shares of NeoMedia common
                stock
                previously issued to 12Snap
                management;




·
            NeoMedia
                retained a 10% ownership in 12Snap, subject to an option agreement
                pursuant to which NeoMedia has the right to sell and Buyer has the
                right
                to acquire the remaining 10% stake held by NeoMedia for a purchase
                price
                of $750,000 after December 31, 2007;
                and




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




NeoMedia
      recorded impairment charges of $0 and $2,467,000 during the three and nine
      months ended September 30, 2007, respectively, to adjust the carrying value
      of
      12Snap’s assets to the final fair market value. NeoMedia realized a loss on the
      disposal of 12Snap in the three and nine months ended September 30, 2007, in
      the
      amount of $0 and $257,000 respectively.





15




**BSD**





During
      January 2007, NeoMedia initiated an action plan to sell its Telecom Services
      business. On August 16, 2007, NeoMedia signed a binding letter of intent to
      sell
      its ownership of 90% of the outstanding shares of Triton, the operations of
      which comprise the Telecom Services business unit (acquired from BSD in March
      2006), to Greywolf
      for $1,500,000 cash (subsequently revised to $1,350,000) .
      On
      October 30, 2007, NeoMedia completed the sale of Triton to Greywolf, for
      $1,350,000 cash. Guy Fietz, who was the Vice President and General Manager
      of
      the NeoMedia Telecom Services business unit, is also the principal shareholder
      and CEO of Greywolf. Mr. Fietz received 6,190,476 shares of NeoMedia stock
      with
      a fair value of $130,000 a commission on the sale.





During
      the three months ended September 30, 2007, NeoMedia recorded an impairment
      charge of $3,378,000 to adjust the carrying value of the Telecom Services asset
      group to the actual net proceeds from the sale of the assets. Prior to the
      impairment charge, the asset group consisted primarily of goodwill and other
      intangible assets recorded upon purchase of BSD by NeoMedia during the first
      quarter of 2006. The operations of Telecom Services are classified as
      discontinued operations during the three and nine months ended September 30,
      2007 and 2006. The criteria for discontinued operations classification were
      met
      during the first three quarters of 2007. (See Note 4)





**Pro
      Forma Financial Information (Unaudited)**





Pro-forma
      results of operations as if NeoMedia was combined with Gavitec as of January
      1,
      2006 are as follows:


**Loss**
              
              **Weighted****Loss**
              
              **per
                  Share**
              
              **Average****Total**
              
              **from**
              
              **from**
              
              **Common****Net**
              
              **Continuing**
              
              **Continuing**
              
              **Shares****Sales**
              
              **Operations**
              
              **Operations**
              
              **Outstanding****Nine
                  Months Ended September 30, 2006**NeoMedia
              
              $
              1,117
              
              
              ($27,544
              )
              
              ($0.05
              )
              
              602,132,555Gavitec
              
              
              953
              
              
              (874
              )Pro
                  forma adjustments
              
              
              (864
              )(A)
              
              732
              (A)
              $
              0.00
              (A)(B)
              
              10,485,617
              (B)Pro
                  forma combined
              
              $
              1,206
              
              
              ($27,686
              )
              
              ($0.05
              )
              
              612,618,172






**Basis
      of Presentation** :
      NeoMedia acquired Mobot, Sponge, Gavitec, 12Snap, and BSD during the first
      quarter of 2006. During November and December 2006, NeoMedia divested of Mobot
      and Sponge. During April 2007, NeoMedia divested of 12Snap. On October 30,
      2007,
      NeoMedia sold its Telecom Services business, comprised of the Triton operations
      acquired from BSD. Because the results of BSD, 12Snap, Mobot, and Sponge have
      already been removed from NeoMedia's continuing operations and classified as
      discontinued operations for the nine months ended September 30, 2006, these
      entities have not been included in the pro forma results shown above. However,
      the pro forma shares issued as consideration for the acquisitions of Gavitec,
      12Snap, and BSD are reflected in the pro forma loss per share and weighted
      average common shares outstanding. The pro forma shares issued as consideration
      for the acquisitions of 12Snap, Mobot and Sponge, and NeoMedia shares returned
      in the sale of Sponge, are not reflected in the pro forma weighted average
      common shares outstanding, since for pro forma purposes the acquisition and
      disposal transactions are assumed to have occurred on January 1, 2006. Since
      the
      results of Gavitec were included in NeoMedia’s consolidated financial results
      for the entire three and nine month periods ended September 30, 2007, and the
      entire three month period ended September 30, 2006, separate pro forma results
      are not presented for these periods.





(A)
      Adjustment is to reflect operations of Gavitec from February 23, 2006 (closing
      date of acquisition) through September 30, 2006, and to reflect amortization
      of
      Gavitec intangible assets for the period January 1, 2006 through February 23,
      2006. Results of operations for Gavitec from February 23, 2006 through September
      30, 2006 are included in NeoMedia's results from continuing operations for
      the
      nine months ended September 30, 2006.





(B)
      Adjustment for shares that would have been issued in connection with the
      acquisitions of Gavitec and BSD if they had occurred on January 1, 2006. The
      adjustment between the reported and the pro forma number of weighted average
      shares outstanding is caused by (i) the weighting of the pro forma shares for
      the nine months ended September 30, 2006, whereas in the reported number the
      shares were only outstanding from the closing date of each acquisition through
      September 30, 2006, and (ii) the number of pro forma shares being higher than
      the actual shares issued due to a lower stock price on the pro forma date of
      issuance than the actual date of issuance. Using the stock price around January
      1, 2006, the pro forma number of shares that would have been issued
      was:





**Gavitec**
            
            **BSD**
            
            **Total**Total
                stock consideration
            
            $
            5,400,000
            
            $
            2,279,263
            
            $
            7,679,263Stock
                price on pro forma acquisition date
            
            $
            0.290
            
            $
            0.290Pro
                forma number of consideration shares
            
            
            18,620,690
            
            
            7,859,527
            
            
            26,480,217




16




**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 offset the deferred
      tax
      liability. In most cases the reduction in the valuation allowance resulted
      in an
      asset and was used to offset the deferred tax liability arising from the
      business combinations, pursuant to SFAS 109. A deferred tax liability was
      recognized where a net liability remained.





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**





As
      of
      September 30, 2007, NeoMedia had intangible assets used in its continuing
      operations with original historical cost, accumulated amortization, and carrying
      value as follows:





(US
                dollars in thousands)
            
            **Gavitec**
            
            **Other**
            
            **Total**PatentsHistorical
                cost
            
            $
            0
            
            $
            4,888
            
            $
            4,888Less:
                accumulated amortization
            
            
            0
            
            
            (2,273
            )
            
            (2,273
            )Carrying
                value as of September 30, 2007
            
            $
            0
            
            $
            2,615
            
            $
            2,615Proprietary
                SoftwareHistorical
                cost
            
            $
            4,600
            
            $
            763
            
            $
            5,363Less:
                accumulated amortization
            
            
            (1,050
            )
            
            (722
            )
            
            (1,772
            )Carrying
                value as of September 30, 2007
            
            $
            3,550
            
            $
            41
            
            $
            3,591Copyrighted
                MaterialsHistorical
                cost
            
            $
            64
            
            $
            0
            
            $
            64Less:
                accumulated amortization
            
            
            (23
            )
            
            0
            
            
            (23
            )Carrying
                value as of September 30, 2007
            
            $
            41
            
            $
            0
            
            $
            41**Total
                carrying value**
            
            **$**
            **3,591**
            
            **$**
            **2,656**
            
            **$**
            **6,247**





17




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





(US
                dollars in thousands)
            
            **Proprietary
                Software**
            
            **Copyrighted
                Materials**
            
            **Patents**
            
            **Total**2007
                (remaining 3 months)
            
            $
            171
            
            $
            2
            
            $
            75
            
            $
            2482008
            
            
            690
            
            
            11
            
            
            295
            
            
            9962009
            
            
            659
            
            
            11
            
            
            284
            
            
            9542010
            
            
            657
            
            
            11
            
            
            264
            
            
            9322011
            
            
            657
            
            
            3
            
            
            245
            
            
            905Thereafter
            
            
            757
            
            
            3
            
            
            1,452
            
            
            2,212**Total**
            
            **$**
            **3,591**
            
            **$**
            **41**
            
            **$**
            **2,615**
            
            **$**
            **6,247**





It
      is
      important to note that actual amortization expense could differ materially
      from
      the table due to subjective factors such as changes in assumptions of useful
      lives or impairment charges. The weighted average remaining life for the
      intangible assets was approximately 6.7 years as of September 30,
      2007.





As
      of
      September 30, 2007, the following intangible assets relating to discontinued
      operations were included in “Assets held for sale” on the accompanying
      consolidated balance sheet:





(US
                dollars in thousands)
            
            **Telecom
                Services**
            
            **Micro
                Paint Repair**
            
            **Total**Customer
                Contracts, net
            
            $
            1,084
            
            $
            54
            
            $
            1,138Proprietary
                Software, net
            
            
            0
            
            
            7
            
            
            7Copyrighted
                Materials, net
            
            
            108
            
            
            23
            
            
            131Patents,
                net
            
            
            0
            
            
            1,318
            
            
            1,318Goodwill,
                net
            
            
            1,024
            
            
            614
            
            
            1,638**Total**
            
            **$**
            **2,216**
            
            **$**
            **2,016**
            
            **$**
            **4,232**




**Goodwill**





As
      of
      September 30, 2007, goodwill consisted of $3,418,000 associated with NeoMedia’s
      acquisition of Gavitec. As of September 30, 2007, NeoMedia also had recorded
      goodwill in the amount of $614,000 and $1,024,000 relating to its Micro Paint
      Repair and Telecom Services businesses, respectively, that were held for sale
      as
      of September 30, 2007. These amounts are included in “Assets held for sale” on
      the accompanying consolidated balance sheet. During the three months ended
      September 30, 2007, NeoMedia recognized impairment charges of $3,378,000 and
      $589,000 to adjust the carrying value of the Telecom Services and Micro Paint
      Repair asset groups respectively, to the expected net proceeds from the sale
      of
      each asset group.





18


**4.
      DISCONTINUED OPERATIONS AND ASSETS AND LIABILITIES HELD FOR
      SALE**





**Micro
      Paint Repair Business Unit**





During
      August 2006, NeoMedia decided to sell its Micro Paint Repair business unit.
      On
      November 1, 2007 the Company entered into a definitive purchase
      agreement for the sale of the assets of the Micro Paint Repair
      business unit, excluding the assets of the U.S. Auto Xperience operations,
      with
      an expected closing date in mid November 2007.





NeoMedia
      has analyzed the pertinent facts of the proposed disposition with respect to
      the
      criteria outlined in SFAS 144, and has determined that all of the criteria
      have
      been met and continue to be met as of the date of this filing. Accordingly,
      NeoMedia is reporting the operating results of the Micro Paint Repair business
      unit as Discontinued Operations, and the assets and liabilities as Held for
      Sale
      for all periods presented in this filing. Assets Held for Sale are not
      depreciated or amortized.





During
      the three months ended September 30, 2007, NeoMedia recorded an impairment
      charge of $589,000 to adjust the carrying value of the Micro Paint Repair asset
      group to the expected net proceeds from the sale of the assets.





**Sponge
      and Mobot Businesses**





In
      the
      fourth quarter of 2006, NeoMedia disposed of two subsidiaries, Sponge and Mobot.
      All assets and liabilities associated with these two subsidiaries were disposed
      of in their respective sales and removed from NeoMedia’s consolidated balance
      sheet. In accordance with SFAS 144, NeoMedia is reporting the operating results
      of these two subsidiaries as Discontinued Operations for all periods presented
      in this filing. NeoMedia has analyzed the applicable accounting literature
      found
      in the SEC Staff Accounting Bulletin “SAB” Topic 5E, Accounting Principles Board
      (“APB”) Opinion 29, APB 18, Statement of Financial Accounting Standards “SFAS”
141, SFAS 144, and Emerging Issues Task Force (“EITF”) issue 01-2, and
      determined that the criteria for reporting the disposal of a business and
      reporting of discontinued operations have been met.





**12Snap
      Business**





In
      January 2007, NeoMedia management determined that it would focus on its core
      code-reading business in North America, the UK, mainland Europe, and China.
      In
      conjunction with this direction, the Company decided to sell its 12Snap business
      unit. On April 4, 2007, NeoMedia completed the sale of 12Snap. NeoMedia has
      analyzed the applicable accounting literature found in the SEC Staff Accounting
      Bulletin (SAB) Topic 5E, Accounting Principles Board (APB) Opinion 29, APB
      18,
      Statement of Financial Accounting Standards (SFAS) 141, SFAS 144, and Emerging
      Issues Task Force (EITF) issue 01-2, and determined that the criteria for
      reporting the disposal of a business and reporting of discontinued operations
      have been met.





**Telecom
      Services Business**





In
      connection with its January 2007 decision to focus on its core code-reading
      business, the Company also decided to sell the NeoMedia Telecom Services
      business unit. NeoMedia has analyzed the pertinent facts of the proposed
      transaction with respect to the criteria outlined in SFAS 144, and has
      determined that all of the criteria were met as of September 30, 2007 and
      continue to be met. Accordingly, NeoMedia is reporting the operating results
      of
      the NeoMedia Telecom Services business unit as discontinued operations, and
      the
      assets and liabilities as held for sale for all periods presented in this
      filing. Assets Held for Sale are not depreciated or amortized.




On
      August
      16, 2007, NeoMedia signed a binding letter of intent to sell its ownership
      of
      90% of the outstanding shares of Triton Global Business Services, Inc.
      (“Triton”), the operations of which comprise the Telecom Services business unit,
      to Greywolf
      Entertainment, Inc, a Canadian company, for $1,500,000 cash (subsequently
      revised to $1,350,000) .
      During
      the three months ended September 30, 2007, NeoMedia recorded an impairment
      charge of $3,378,000 to adjust the carrying value of the Telecom Services asset
      group to the expected net proceeds from the sale of the assets. On October
      30,
      2007, NeoMedia completed the sale of Triton, and as a result discontinued the
      operations of its Telecom Services business unit.




19




The
      operating results of the Micro Paint Repair, Sponge, Mobot, 12Snap, and Telecom
      Services businesses classified as discontinued operations for the three and
      nine
      month periods ended September 30, 2007 and 2006 are shown in the following
      table. These results include the following items: (i) a gain on extinguishment
      of debt realized by Telecom Services in the amount of $265,000 in the nine
      months ended September 30, 2007, (ii) an impairment charge to reduce 12Snap
      assets to their fair market value in the amount of $2,467,000 in the three
      and
      nine months ended September 30, 2007, (iii) an impairment charge to reduce
      the
      Telecom Services assets to their fair market value in the amount of $3,378,000
      in the three and nine months ended September 30, 2007, (iv) an impairment charge
      to reduce the Micro Paint Repair assets to their fair market value in the amount
      of $589,000 in the three and nine months ended September 30, 2007, (v)bad debt
      expense to write off accounts receivable from a material customer of the Telecom
      Services business unit in the amount of $405,000 in the three and nine months
      ended September 30, 2007, and (vi) a loss on the disposal of 12Snap in the
      amount of $257,000 in the nine months ended September 30, 2007. There is no
      tax
      expense or benefit to report due to NeoMedia’s net operating loss carry forward
      tax position.





(US
                dollars in thousands)
            
            **Three
                months ended September 30, 2007 (unaudited)****Micro****Paint**
            
            **Telecom****Repair**
            
            **Services**
            
            **12Snap**
            
            **Mobot**
            
            **Sponge**
            
            **Total**Net
                Sales
            
            $
            287
            
            $
            525
            
            $
            0
            
            $
            0
            
            $
            0
            
            $
            812Loss
                from discontinued operations
            
            
            ($913
            )
            
            ($3,716
            )
            
            ($92
            )
            
            ($11
            )
            
            ($15
            )
            
            ($4,747
            )




**Nine
                months ended September 30, 2007 (unaudited)****Micro****Paint**
            
            **Telecom****Repair**
            
            **Services**
            
            **12Snap**
            
            **Mobot**
            
            **Sponge**
            
            **Total**Net
                Sales
            
            $
            1,003
            
            $
            1,339
            
            $
            2,621
            
            $
            0
            
            $
            0
            
            $
            4,963Loss
                from discontinued operations
            
            
            ($2,122
            )
            
            ($3,706
            )
            
            ($2,394
            )
            
            ($34
            )
            
            ($44
            )
            
            ($8,300
            )




**Three
                months ended September 30, 2006 (unaudited)****Micro****Paint**
            
            **Telecom****Repair**
            
            **Services**
            
            **12Snap**
            
            **Mobot**
            
            **Sponge**
            
            **Total**Net
                Sales
            
            $
            367
            
            $
            547
            
            $
            2,226
            
            $
            125
            
            $
            264
            
            $
            3,529Income
                (loss) from discontinued operations
            
            
            ($1,619
            )
            $
            144
            
            
            ($1,846
            )
            
            ($581
            )
            
            ($530
            )
            
            ($4,432
            )




**Nine
                months ended September 30, 2006 (unaudited)****Micro****Paint**
            
            **Telecom****Repair**
            
            **Services**
            
            **12Snap**
            
            **Mobot**
            
            **Sponge**
            
            **Total**Net
                Sales
            
            $
            1,145
            
            $
            1,089
            
            $
            5,347
            
            $
            316
            
            $
            975
            
            $
            8,872Loss
                from discontinued operations
            
            
            ($2,826
            )
            
            ($135
            )
            
            ($2,672
            )
            
            ($1,275
            )
            
            ($748
            )
            
            ($7,656
            )





20


The
      assets and liabilities of the Micro Paint Repair and Telecom Services businesses
      classified as held for sale as of September 30, 2007 are shown in the following
      table. There are no assets or liabilities associated with the 12Snap, Sponge
      or
      Mobot subsidiaries as of September 30, 2007.





(US
                dollars in thousands)
            
            **September
                30, 2007****Micro****Paint**
            
            **Telecom****Repair**
            
            **Services**
            
            **Total****ASSETS**Current
                assets:Cash
                & cash equivalents
            
            $
            45
            
            $
            3
            
            $
            48Trade
                accounts receivable, net
            
            
            121
            
            
            1,427
            
            
            1,548Inventory
            
            
            324
            
            
            0
            
            
            324Prepaid
                expenses and other current assets
            
            
            77
            
            
            14
            
            
            91Total
                Current Assets
            
            $
            567
            
            $
            1,444
            
            $
            2,011Leasehold
                improvements and property and equipment, net
            
            
            139
            
            
            56
            
            
            195Goodwill
                and other intangible assets, net
            
            
            2,016
            
            
            2,216
            
            
            4,232Total
                Assets Held for Sale
            
            $
            2,722
            
            $
            3,716
            
            $
            6,438**LIABILITIES**Current
                liabilities:Accounts
                payable
            
            $
            25
            
            $
            1,753
            
            $
            1,778Accrued
                expenses
            
            
            40
            
            
            10
            
            
            50Taxes
                payable
            
            
            9
            
            
            1,268
            
            
            1,277Deferred
                revenue & other
            
            
            264
            
            
            71
            
            
            335Total
                Liabilities Held for Sale
            
            $
            338
            
            $
            3,102
            
            $
            3,440





21


The
      assets and liabilities of the Micro Paint Repair, 12Snap, and Telecom Services
      businesses classified as held for sale as of December 31, 2006 are shown in
      the
      following table. There are no assets or liabilities associated with the Sponge
      or Mobot subsidiaries as of December 31, 2006.




(US
                dollars in thousands)
            
            **December
                31, 2006****Micro****Paint**
            
            **Telecom****Repair**
            
            **Services**
            
            **12Snap**
            
            **Total****ASSETS**Current
                assets:Cash
                & cash equivalents
            
            $
            81
            
            $
            72
            
            $
            721
            
            $
            874Trade
                accounts receivable, net
            
            
            196
            
            
            1,577
            
            
            1,842
            
            
            3,615Inventory
            
            
            154
            
            
            0
            
            
            0
            
            
            154Prepaid
                expenses and other current assets
            
            
            36
            
            
            12
            
            
            407
            
            
            455Total
                Current Assets
            
            
            467
            
            
            1,661
            
            
            2,970
            
            
            5,098Leasehold
                improvements and property and equipment, net
            
            
            135
            
            
            48
            
            
            200
            
            
            383Goodwill
                and other intangible assets, net
            
            
            2,470
            
            
            5,593
            
            
            5,876
            
            
            13,939Total
                Assets Held for Sale
            
            $
            3,072
            
            $
            7,302
            
            $
            9,046
            
            $
            19,420**LIABILITIES**Current
                liabilities:Accounts
                payable
            
            $
            25
            
            $
            1,854
            
            $
            640
            
            $
            2,519Accrued
                expenses
            
            
            22
            
            
            6
            
            
            2,144
            
            
            2,172Taxes
                payable
            
            
            8
            
            
            1,037
            
            
            0
            
            
            1,045Deferred
                revenue & other
            
            
            352
            
            
            73
            
            
            4,096
            
            
            4,521Total
                Liabilities Held for Sale
            
            $
            407
            
            $
            2,970
            
            $
            6,880
            
            $
            10,257





Inventory
      included in assets held for sale is as follows:





(US
                dollars in thousands)
            
            **September
                30,**
            
            **December
                31,****2007**
            
            **2006**Raw
                materials
            
            $
            180
            
            $
            90Finished
                goods
            
            
            144
            
            
            64Total
            
            $
            324
            
            $
            154





Results
      of operations for all discontinued business units are included in the line
      item
      entitled “Loss from discontinued operations” on the accompanying consolidated
      statement of operations for all periods presented. Balance sheet items for
      all
      discontinued business units are included in the line items entitled “Assets held
      for sale” and “Liabilities held for sale” on the accompanying consolidated
      balance sheet for all periods presented. As a result, pro forma results of
      operations as if the sale of each entity had occurred at the beginning of the
      period reported, and pro forma balance sheets as if the sale of each entity
      had
      occurred at the balance sheet dates presented, are not shown separately in
      this
      footnote.





As
      of
      September 30, 2007, NeoMedia also had recorded goodwill in the amount of
      $614,000 and $1,024,000 relating to its Micro Paint Repair and Telecom Services
      businesses, respectively, that are held for sale. These amounts are included
      in
“Assets held for sale” on the accompanying consolidated balance sheet. During
      the three months ended September 30, 2007, NeoMedia recognized impairment
      charges of $3,378,000 and $589,000 to adjust the carrying value of the Telecom
      Services and Micro Paint Repair asset groups respectively, to the expected
      net
      proceeds from the sale of the assets.




22


**5.
      FINANCING**





The
      following disclosures reflect a summary of the Company’s outstanding convertible
      securities, as well as activity related to financing transactions since the
      filing of NeoMedia’s last annual report for the year ended December 31, 2006.
      For a complete discussion of the Company’s financing activity, please refer to
      the Company’s annual report on Form 10-K for the fiscal year ended December 31,
      2006. NeoMedia currently has four outstanding convertible securities, each
      held
      by YA Global Investments, L.P., (f/k/a Cornell Capital Partners) an accredited
      investor. For clarification purposes, this entity is referred to as “YA Global
      Investments” or the “Purchaser” throughout this document.





**Series
      C Convertible Preferred Stock**





NeoMedia previously
      issued 22,000 shares of $1,000 Series C 8% convertible preferred
      stock to YA Global Investments. The Series C convertible preferred stock is
      convertible into NeoMedia common stock at the then effective conversion price,
      which varies relative to NeoMedia’s trading stock price, at the lower of $0.02
      per share, or 97% of the lowest closing bid price (as reported by Bloomberg,
      L.P.) of the common stock for the 30 trading days immediately preceding the
      conversion date. The fixed conversion price was reset from $0.50 to $0.02 on
      August 24, 2007, as an inducement for YA Global Investments to enter into an
      additional financing arrangement with NeoMedia at that time. The conversions
      are
      limited such that YA Global Investments cannot exceed 4.99% ownership of
      NeoMedia. The 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.




YA
        Global
        Investments has converted the preferred stock, as follows:
 
 Date
              Series
                  C Shares
                Converted
              Series
                  C Shares
                Outstanding
              Common
                  Shares
                IssuedNovember
                  29, 2006
              378
              21,622
              6,631,579June
                  19, 2007
              245
              21,377
              8,781,362August
                  16, 2007
              500
              20,877
              25,773,196October
                  24, 2007
              600
              20,277
              45,801,527October
                  31, 2007
              180
              20,097
              13,740,458




The Series C
      convertible preferred stock, at the option of the holder, affords the Purchaser
      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. Each of the Company’s four convertible debenture instruments
      contain similar anti-dilution language.




In
      connection with the Series C convertible preferred stock, NeoMedia also entered
      into a Registration Rights Agreement with YA Global Investments that requires
      NeoMedia to, among other requirements, 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, and achieve
      and maintain effectiveness of the registration statement. NeoMedia failed to
      meet the registration requirements, and accordingly is subject to liquidated
      damages amounting to 1% of the outstanding amount of Series C preferred stock
      per month, not to exceed $1,200,000. On March 27, 2007, NeoMedia paid $821,000
      of liquidated damages from the proceeds of a secured convertible debenture
      entered into on that date. The remaining $379,000 has been accrued by the
      Company. On November 7, 2007, the SEC declared the Company’s S-3 Registration
      Statement effective.




23





Under
      the
      Series C Agreement, the Purchaser also received “A” warrants, “B” warrants and
“C” warrants to purchase 20,000,000, 25,000,000, and 30,000,000 shares of
      NeoMedia’s common stock, respectively, exercisable in three separate tranches at
      a price of $0.50, $0.40 and $0.35, respectively, per share, subject to
      adjustment, including anti-dilution protection similar to that described
      above .
      As an
      inducement to YA
      Global
      Investments to enter
      into subsequent financing arrangements with NeoMedia, the warrants were repriced
      on August 24, 2007 to $0.02 per share, subject to all the original terms and
      conditions of the respective warrant agreements. 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 $0.10 greater than the exercise price
      of
      any of the warrants for 15 consecutive trading days.





**$5
      Million Secured Convertible Debenture - August 2006**





NeoMedia
      has outstanding a 10% secured convertible debenture in the aggregate amount
      of
      $5,000,000, entered into on August 24, 2006 (the “August 2006 Debenture”). The
      August 2006 Debenture is convertible into NeoMedia common stock at the then
      effective conversion price, which varies relative to NeoMedia’s trading stock
      price, at the lower of $0.02 per share, or 90% of the lowest closing bid price
      (as reported by Bloomberg, L.P.) of the common stock for the 30 trading days
      immediately preceding the conversion date, and adjusts to 50% of the lowest
      closing bid price for the 30 preceding days in the event of a default. The
      fixed
      conversion price was reset from $0.15 to $0.02 on August 24, 2007, as an
      inducement for YA Global Investments to enter into an additional financing
      arrangement with NeoMedia at that time. The conversions are limited such that
      YA
      Global Investments cannot exceed 4.99% ownership of NeoMedia. The August 2006
      Debenture is secured by all of NeoMedia’s assets. The
      debenture agreements include anti-dilution language similar to the Series C
      convertible preferred stock.





Under
      the
      August 2006 Debenture Agreement, the Purchaser also received “A” warrants, “B”
warrants, “C” warrants and “D” warrants to purchase an aggregate of up to
      175,000,000 shares of common stock. The warrants were exercisable in four
      separate tranches at a price of $0.15, $0.25, $0.20 and $0.05 respectively
      per
      share, subject to adjustment, including anti-dilution protection similar to
      that
      described above for the Series C convertible preferred stock .
      The
      warrants have a five-year contractual life. As an inducement to YA Global
      Investments to enter into subsequent financing arrangements with NeoMedia ,
      the
      warrants were repriced on August 24, 2007 to $0.02 per share, subject to all
      the
      original terms and conditions of the respective warrant agreements. NeoMedia
      can
      force exercise of the warrants if the closing bid price of NeoMedia stock is
      more than $0.10 greater than the exercise price of any of the warrants for
      15
      consecutive trading days.





In
      connection with the August 2006 Debenture, NeoMedia also entered into a
      Registration Rights Agreement with YA Global Investments that required NeoMedia
      to, among other requirements, file a registration statement with the SEC
      registering the resale of the shares of common stock issuable upon conversion
      of
      the August 2006 debenture and the exercise of the warrants, and achieve and
      maintain effectiveness of the registration statement. NeoMedia failed to meet
      the registration requirements, and accordingly is subject to liquidated damages
      amounting to 2% of the outstanding amount of the August 2006 Debenture per
      month, not to exceed $1,000,000. On March 27, 2007, NeoMedia paid $491,000
      of
      liquidated damages from the proceeds of a secured convertible debenture entered
      into on that date. The remaining $510,000 has been accrued by the Company.
      On
      November 7, 2007, the SEC declared the Company’s S-3 Registration Statement
      effective.





**$2.5
      Million Secured Convertible Debenture - December 2006**





NeoMedia
      has outstanding a 10% secured convertible debenture in the aggregate amount
      of
      $2,500,000, entered into on December 29, 2006 (the “December 2006 Debenture”).
      The December 2006 Debenture is convertible into NeoMedia common stock at the
      then effective conversion price, which varies relative to NeoMedia’s trading
      stock price, at the lower of $0.02 per share, or 90% of the lowest closing
      bid
      price (as reported by Bloomberg, L.P.) of the common stock for the 30 trading
      days immediately preceding the conversion date, and adjusts to 50% of the lowest
      closing bid price for the 30 preceding days in the event of a default. The
      fixed
      conversion price was reset from $0.06 to $0.02 on August 24, 2007, as an
      inducement for YA Global Investments to enter into an additional financing
      arrangement with NeoMedia at that time. The conversions are limited such that
      YA
      Global Investments cannot exceed 4.99% ownership of NeoMedia. The December
      2006
      Debenture is secured by all of NeoMedia’s assets. The
      debenture agreements include anti-dilution language similar to the Series C
      convertible preferred stock.




24





Under
      the
      December 2006 Debenture Agreement, the Purchaser also received a warrant to
      purchase up to 42,000,000 shares of common stock at an exercise price of $0.06
      per share, subject to adjustment, including anti-dilution protection similar
      to
      that described above for the Series C convertible preferred stock .
      As an
      inducement to YA
      Global
      Investments to enter
      into subsequent financing arrangements with NeoMedia, the warrant was repriced
      on August 24, 2007 to $0.02 per share, subject to all the original terms and
      conditions of the warrant agreement. 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 $0.16 for ten consecutive trading days.





In
      connection with the December 2006 Debenture, NeoMedia also entered into a
      Registration Rights Agreement with YA Global Investments that required NeoMedia
      to, among other requirements, file a registration statement with the SEC
      registering the resale of the shares of common stock issuable upon conversion
      of
      the December 2006 debenture and the exercise of the warrants, and achieve and
      maintain effectiveness of the registration statement. NeoMedia failed to meet
      the registration requirements, and accordingly is subject to liquidated damages
      amounting to 2% of the outstanding amount of the December 2006 Debenture per
      month, not to exceed $500,000, which has been accrued by the Company. On
      November 7, 2007, the SEC declared the Company’s S-3 Registration Statement
      effective.





**$7.5
      Million Secured Convertible Debenture - March 2007**





NeoMedia
      has outstanding a 13% secured convertible debenture in the aggregate amount
      of
      $7,459,000, entered into on March 27, 2007 (the “March 2007 Debenture”). The
      March 2007 Debenture is convertible into NeoMedia common stock at the then
      effective conversion price, which varies relative to NeoMedia’s trading stock
      price, at the lower of $0.02 per share, or 90% of the lowest closing bid price
      (as reported by Bloomberg, L.P.) of the common stock for the 30 trading days
      immediately preceding the conversion date, and adjusts to 50% of the lowest
      closing bid price for the 30 preceding days in the event of a default. The
      fixed
      conversion price was reset from $0.05 to $0.02 on August 24, 2007, as an
      inducement for YA Global Investments to enter into an additional financing
      arrangement with NeoMedia at that time. The conversions are limited such that
      YA
      Global Investments cannot exceed 4.99% ownership of NeoMedia. The March 2007
      Debenture is secured by all of NeoMedia’s assets. The
      debenture agreements include anti-dilution language similar to the Series C
      convertible preferred stock.





Under
      the
      terms of the purchase agreement entered into in connection with the March 2007
      Debenture, the Purchaser also received warrants to purchase an aggregate of
      up
      to 125,000,000 shares of common stock. The warrants are exercisable at a price
      of $0.04 per share, subject to adjustment, including anti-dilution protection
      similar to that described above for the Series C convertible preferred
      stock .
      As an
      inducement to YA
      Global
      Investments to enter
      into subsequent financing arrangements with NeoMedia, the warrant was repriced
      on August 24, 2007 to $0.02 per share, subject to all the original terms and
      conditions of the warrant agreement. The warrants have a five-year contractual
      life. The warrants do not contain a forced exercise attribute similar to
      previously issued warrants.




In
      connection with the March 2007 Debenture, NeoMedia also entered into a
      Registration Rights Agreement with YA Global Investments that requires NeoMedia
      to, among other requirements, file a registration statement with the SEC
      registering the resale of the shares of common stock issuable upon conversion
      of
      the March 2007 Debenture and the exercise of the warrants, and achieve and
      maintain effectiveness of the registration statement. The registration statement
      must be filed within 120 days of receipt of notice from YA Global Investments.
      No such notice has been issued as of the date of this filing. The Company has
      not accrued any of the liquidated damages with a maximum potential of
      $1,800,000, because the Company does not believe that any penalties are probable
      at this time. On November 7, 2007, the SEC declared the Company’s S-3
      Registration Statement effective.




25




At
      the
      inception date of March 27, 2007, the net proceeds of the March 2007 Debenture
      were allocated as follows:




**Instrument:**Convertible
                debenture, at fair value
            
            $
            10,836,000Common
                stock warrants-derivative liability(1)
            
            
            5,638,000Derivative
                loss recognized
            
            
            (9,015,000
            )$
            7,459,000Payment
                of liquidating damages(2)
            
            
            (1,312,000
            )Payment
                of interest due(3)
            
            
            (366,000
            )Interest
                expense(4)
            
            
            (781,000
            )Total
                net proceeds received
            
            $
            5,000,000




(1)
            The
                Company issued warrants to purchase aggregate 125,000,000 shares
                of common
                stock in connection with the March 2007 Debenture, as described above.




(2)
            Liquidating
                damages arising from the February 2006 Series C convertible preferred
                stock financing arrangement and the August 2006 Debenture were paid
                from
                the proceeds in the amount of
                $1,312,000.




(3)
            Interest
                payments of $366,000 toward the August 2006 Debenture and the December
                2006 Debenture were made from the proceeds of the March 2007
                Debenture.




(4)
            Due
                to the default status, the financing costs of $781,000 were expensed
                to
                interest expense at inception.




**$1.8
      Million Secured Convertible Debenture - August 2007**





NeoMedia
      entered into a Securities Purchase Agreement, dated August 24, 2007 (the “August
      2007 Debenture”) with YA Global Investments. Pursuant to the August 2007
      Debenture Agreement, the Purchaser agreed to purchase 14% secured convertible
      debentures maturing two years from the date of issuance in the aggregate amount
      of $1,775,000. NeoMedia received cash proceeds from the transaction of
      $1,575,000, net of $200,000 fees paid to the Purchaser. The August 2007
      Debenture Agreement also provided for the issuance to the Purchaser, at no
      additional cost to the Purchaser, of 75,000,000 warrants to purchase shares
      of
      the Company's common stock. In connection with the August 2007 Debenture
      Agreement, the Company also entered into a registration rights agreement with
      the Purchaser that requires the Company to (i) file a registration statement
      with the SEC registering the resale of the shares of common stock issuable
      upon
      conversion of the convertible debenture and the exercise of the warrants within
      30 days of receipt of a request for filing from the Purchaser, (ii) achieve
      effectiveness within 90 days of receipt of a request for filing from the
      Purchaser, and (iii) maintain effectiveness of the registration statement.
      Failure to meet these requirements will require the Company to pay liquidated
      damages amounting to 2% of the principal per month, not to exceed $852,000.
      No
      accrual has been recorded for any damages that may become payable because the
      Company does not believe that any liability is probable at this
      time.





The
      August 2007 Debenture is secured by (a) certain Pledged Property, as such term
      is defined in that certain Security Agreement, dated August 24, 2007, by and
      between the parties and perfected pursuant to UCC-1 Financing Statements filed
      with the Delaware Department of State (the UCC Filing Section) on or about
      August 24, 2007 and with the Florida Secured Transaction Registry on or about
      August 24, 2007; and (b) certain Patent Collateral, as defined in a security
      agreement (patent), entered into on August 24, 2007.





At
      any
      time from the closing date until August 24, 2009, the Purchaser has the right
      to
      convert the convertible debenture into common stock of the Company at the then
      effective conversion price, which varies relative to the Company’s trading stock
      price, as follows: $0.02 per share, or 80% of the lowest closing bid price
      (as
      reported by Bloomberg) of the common stock for the 10 trading days immediately
      preceding the conversion date, and adjusts to 50% of the lowest closing bid
      price for the 30 preceding days in the event of a default. The conversion is
      limited such that the holder cannot exceed 4.99% ownership, unless the holders
      waive their right to such limitation.




26





The
      convertible debenture, at the option of the holder, affords the Purchaser
      anti-dilution protection should, at any time while the convertible debenture
      is
      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 debenture shall be reduced to the lower
      price.




Under
      the
      terms of the agreement, the Purchaser also received warrants to purchase an
      aggregate of up to 75,000,000 shares of common stock. The warrants are
      exercisable at a price of $0.02 per share, subject to adjustment, including
      anti-dilution protection similar to that described above .
      The
      warrants have a five-year contractual life. The warrants do not contain a forced
      exercise attribute similar to previously issued warrants.





At
      the
      inception date of August 24, 2007, the net proceeds of the August 2007 Debenture
      were allocated as follows:




**Instrument:**Convertible
                debenture at fair value
            
            $
            4,539,000Common
                stock warrants-derivative liability(1)
            
            
            1,762,000Derivative
                loss recognized
            
            
            (4,726,000
            )Total
                net proceeds received
            
            $
            1,575,000






(1)
            The
                Company issued warrants to purchase aggregate 75,000,000 shares of
                common
                stock at an exercise price of $0.02 per share in connection with
                the
                August 2007 Debenture, as described
                above




27




**Warrants**





As
      described herein, YA Global Investments hold warrants to purchase shares of
      NeoMedia stock that were issued in connection with the convertible securities.
      The exercise prices of warrants held by YA Global Investments have been adjusted
      from time to time as inducement for YA Global Investments to enter into
      subsequent financing arrangements. YA Global Investments’ warrant holdings are
      outlined in the following table:





**Restated**
            
            **Restated****Exercise**
            
            **Exercise****Shares**
            
            **Original**
            
            **Price**
            
            **Price****Underlying**
            
            **Exercise**
            
            **December
                29,**
            
            **August
                24,****Original
                Issue Date**
            
            **Warrant**
            
            **Price**
            
            **2006****(1)**
            
            **2007****(2)**March
                30, 2005
            
            
            10,000,000
            
            $
            0.20
            
            $
            0.04
            
            $
            0.02February
                17, 2006(3)
            
            
            20,000,000
            
            $
            0.50
            
            $
            0.04
            
            $
            0.02February
                17, 2006(3)
            
            
            25,000,000
            
            $
            0.40
            
            $
            0.04
            
            $
            0.02February
                17, 2006(3)
            
            
            30,000,000
            
            $
            0.35
            
            $
            0.04
            
            $
            0.02August
                24, 2006(3)
            
            
            25,000,000
            
            $
            0.15
            
            $
            0.04
            
            $
            0.02August
                24, 2006(3)
            
            
            50,000,000
            
            $
            0.25
            
            $
            0.04
            
            $
            0.02August
                24, 2006(3)
            
            
            50,000,000
            
            $
            0.20
            
            $
            0.04
            
            $
            0.02August
                24, 2006(3)
            
            
            50,000,000
            
            $
            0.05
            
            
            n/a
            
            $
            0.02December
                29, 2006(4)
            
            
            42,000,000
            
            $
            0.06
            
            
            n/a
            
            $
            0.02March
                27, 2007
            
            
            125,000,000
            
            $
            0.04
            
            
            n/a
            
            $
            0.02August
                24, 2007
            
            
            75,000,000
            
            $
            0.02
            
            
            n/a
            
            
            n/a**Total**
            
            
            **502,000,000**






(1)
            The
                exercise price of certain warrants outstanding as of December 29,
                2006 was
                repriced as an inducement for YA Global Investments to enter into
                a
                financing arrangement with NeoMedia on that
                date.





(2)
            The
                exercise price of all warrants outstanding as of August 24, 2007
                was
                repriced as an inducement for YA Global Investments to enter into
                a
                financing arrangement with NeoMedia on that
                date.





(3)
            NeoMedia
                can force exercise of the warrants if the closing bid price of NeoMedia
                stock is more than $0.10 greater than the exercise price of any of
                the
                warrants for 15 consecutive trading
                days.





(4)
            NeoMedia
                can force exercise of the warrants if the closing bid price of NeoMedia
                stock is more than $0.16 for 10 consecutive trading
                days.





**Default
      and Other Considerations**





Each
      of
      the convertible securities described above contains consequences in case of
      default. Events of default which could subject the Company to penalties,
      damages, and liabilities as specified in the financing agreements
      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;




·
            Any
                cessation in the eligibility of the Company’s stock to be quoted on a
                trading market;




28




·
            Failure
                to timely file the registration statement covering the shares related
                to
                the conversion option, or failure to make the registration statement
                effective timely (NeoMedia is in default of this provision with respect
                to
                the Series C convertible preferred stock , the August 2006 Debenture,
                and
                the December 2006 Debenture);




·
            Any
                lapse in the effectiveness of the registration statement covering
                the
                shares related to the conversion option and the
                warrants;




·
            Any
                failure to deliver certificates within the specified time;




·
            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 of an event
                of
                default within 10 days of the date due;
                and




·
            Failure
                by the Company to sell its Micro Paint Repair and Telecom Services
                business units before September 30, 2007 (with respect to the August
                2007
                Debenture only).




Other
      material provisions of the convertible securities include the
      following:




·
            The
                convertible securities are convertible into common stock, at the
                option of
                YA Global Investments, at any time after the effective
                date;




·
            Conversions
                can be made in increments and from time to
                time;




·
            As
                promptly as practicable after any conversion date and subject to
                an
                effective registration statement or an exemption from registration,
                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;




·
            YA
                Global Investments 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-effective 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;




·
            Without
                YA Global Investments’ consent NeoMedia
                cannot:




­·
            issue
                or sell any shares of common stock or preferred stock without
                consideration or for consideration per share less than the closing
                bid
                price immediately prior to its issuance,




­·
            issue
                or sell any preferred stock, warrant, option, right, contract, call,
                or
                other security or instrument granting the holder thereof the right
                to
                acquire common stock for consideration per share less than the closing
                bid
                price immediately prior to its issuance,




­·
            enter
                into any security instrument granting the holder a security interest
                in
                any of its assets,or




­·
            file
                any registration statements on Form S-8.




29




­·
            Pursuant
                  to security agreements between NeoMedia and YA Global Investments
                  signed
                  in connection with the convertible debentures, the Purchaser has
                  a
                  security interest in all of NeoMedia’s assets.




NeoMedia
      is currently in default of all of the outstanding convertible instruments,
      due
      primarily to its failure to register the shares underlying the instruments
      by
      the prescribed deadline, and for failure to sell its Micro Paint Repair and
      Telecom Services businesses by September 30, 2007, as required by the August
      2007 Debenture. Due to the current default status, YA
      Global
      Investments has
      certain material rights that did not exist prior to default. Specifically,
      the
      full face value of each convertible instrument is callable, and NeoMedia is
      responsible for liquidated damages until the default is cured, as
      follows:





**Series
                C****Convertible**
            
            **August**
            
            **December**
            
            **March**
            
            **August****Preferred**
            
            **2006**
            
            **2006**
            
            **2007**
            
            **2007****Stock**
            
            **Debenture**
            
            **Debenture**
            
            **Debenture**
            
            **Debenture**
            
            **Total**Amount
                callable (face value)
            
            $
            20,877,000
            
            $
            5,000,000
            
            $
            2,500,000
            
            $
            7,459,000
            
            $
            1,775,000
            
            $
            37,611,000Liquidated
                damages paid March 27, 2007
            
            $
            821,000
            
            $
            491,000
            
            
            0
            
            
            0
            
            
            0
            
            $
            1,312,000Liquidated
                damages accrued at September 30, 2007
            
            $
            379,000
            
            $
            510,000
            
            $
            500,000
            
            
            0
            
            
            0
            
            $
            1,389,000





In
      addition, the accounting for the convertible securities reflects certain
      specific accounting rules and regulations that are applicable under the default
      provision:





·
            Prior
                to the default, NeoMedia was accreting dividends on the Series C
                convertible preferred stock, using the effective interest method,
                through
                periodic charges to additional paid in capital. Due to the default
                status,
                NeoMedia accreted dividends to the full fair value of the Series
                C
                convertible preferred stock during the fourth quarter of
                2006.




·
            Prior
                to the default, NeoMedia was accreting the debt discount on the August
                2006 Debenture and theDecember
                2006 Debenture,
                using the effective interest method, through periodic charges to
                interest
                expense. Due to the default status, during the fourth quarter of
                2006,
                NeoMedia accreted debt discount to the full fair value of these secured
                convertible debentures.




·
            The
                Series C convertible preferred stock is now reported as demand debt
                in the
                current liabilities section of the balance sheet, pursuant to the
                guidance
                outlined in SFAS 150.




·
            The
                secured convertible debentures are reported as debt in the current
                liabilities section of the balance sheet rather than long term because
                the
                debenture is callable as demand debt due to the
                default.




**Fair
      Value Considerations**





In
      accordance with Statement of Financial Accounting Standards No. 133,
‘Accounting for Derivative Instruments and Hedging Activities’
(“FASB 133”), the Company determined that the conversion features of the
      Series C convertible preferred stock, the August 2006 Debenture, and the
      December 2006 Debenture met the criteria of embedded derivatives and that the
      conversion features of these instruments needed to be bifurcated and accounted
      for as derivative instrument liabilities. These instruments do not meet the
      definition of “conventional convertible debt” because the number of shares which
      may be issued upon their conversion is not fixed, and there is no cap on the
      number of shares that could be issued upon conversion. Therefore, the conversion
      feature fails to qualify for equity classification under EITF 00-19, and
      must be accounted for as a derivative liability.




30





Beginning
      in 2007, each new financing arrangement is evaluated, on an
      instrument-by-instrument basis, under Statement of Financial Accounting
      Standards 155, ‘Accounting for Certain Hybrid Financial Instruments an amendment
      of FASB Statements No. 133 and 140’ (“FASB 155”), which permits fair value
      re-measurement for any hybrid financial instrument that contains an embedded
      derivative that otherwise would require bifurcation. During the evaluation
      of
      the March 2007 Debenture and the August 2007 Debenture, the Company determined
      that (i) the hybrid debt instrument embodied certain derivative features whose
      risks and rewards were not clearly and closely related to the risks and rewards
      of the host debt instrument and (ii) warrants issued in connection with the
      March 2007 Debenture and the August 2007 Debenture did not meet all of the
      established criteria for equity classification. Additionally, the March 2007
      Debenture and the August 2007 Debenture extended a right to the holder to
      accelerate repayment of the debt (default put) and each contains cash penalties
      upon the occurrence of certain contingent events. The default put may be
      triggered by certain events that are not related to the debt characteristics
      of
      the debentures and those events are not within the Company’s control. The
      warrants do not meet all of the established criteria for equity classification
      provided in EITF 00-19 and were recorded as derivative liabilities. As permitted
      by FAS 155, the Company has elected not to bifurcate the embedded derivatives
      in
      the March 2007 Debenture and the August 2007 Debenture and accordingly these
      convertible instruments are being carried at their fair values, with the changes
      in the fair value of the secured convertible debenture, together with the
      changes in the fair values of the warrants, recorded in the statement of
      operations.





Freestanding
      derivative instruments, consisting of warrants that arose from the financings,
      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 used in this model as
      of
      September 30, 2007 are as follows:


**Series
                  C****Convertible**
              
              **August**
              
              **December**
              
              **March**
              
              **August****Preferred**
              
              **2006**
              
              **2006**
              
              **2007**
              
              **2007****Stock**
              
              **Debenture**
              
              **Debenture**
              
              **Debenture**
              
              **Debenture**
              
              **Other**Holder
              
              
              YA
                  Global Inv.
              
              
              YA
                  Global Inv.
              
              
              YA
                  Global Inv.
              
              
              YA
                  Global Inv.
              
              
              YA
                  Global Inv.
              
              
              OtherInstrument
              
              
              Warrants
              
              
              Warrants
              
              
              Warrants
              
              
              Warrants
              
              
              Warrants
              
              
              WarrantsExercise
                  price
              
              $
              0.02
              
              $
              0.02
              
              $
              0.02
              
              $
              0.02
              
              $
              0.02
              
              $
              0.01-$3.45Term
                  (years)
              
              
              3.38
              
              
              3.92
              
              
              4.25
              
              
              4.50
              
              
              4.92
              
              
              0.27-3.38Volatility
              
              
              108
              %
              
              105
              %
              
              152
              %
              
              152
              %
              
              152
              %
              
              108.%-181
              %Risk-free
                  rate
              
              
              4.03
              %
              
              4.23
              %
              
              4.23
              %
              
              4.23
              %
              
              4.23
              %
              
              3.82%-4.05
              %





Embedded
      derivative financial instruments arising from the convertible instruments
      consist of multiple individual features that were embedded in each instrument.
      For each convertible instrument, the Company evaluated all significant features
      and, as required under current accounting standards, aggregated the components
      into one compound derivative financial instrument for financial reporting
      purposes. For financings recorded in accordance with FAS 133, 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. For
      financings recorded in accordance with FAS 155, the entire hybrid instrument
      is
      initially recorded at fair value and subsequent changes in fair value are
      recognized in earnings.




31


Assumptions
      used as of September 30, 2007 included exercise estimates/behaviors and the
      following other significant estimates:





**Series
                C****Convertible**
            
            **August**
            
            **December**
            
            **March**
            
            **August****Preferred**
            
            **2006**
            
            **2006**
            
            **2007**
            
            **2007****Stock**
            
            **Debenture**
            
            **Debenture**
            
            **Debenture**
            
            **Debenture**Conversion
                prices
            
            $
            0.016
            
            $
            0.0083
            
            $
            0.0083
            
            
            *
            
            
            *Remaining
                terms (years)
            
            
            1.38
            
            
            0.92
            
            
            1.25
            
            
            *
            
            
            *Equivalent
                volatility
            
            
            175.70
            %
            
            181.77
            %
            
            173.70
            %
            
            *
            
            
            *Equivalent
                interest-risk adjusted rate
            
            
            11.80
            %
            
            9.21
            %
            
            14.05
            %
            
            *
            
            
            *Equivalent
                credit-risk adjusted yield rate
            
            
            67.65
            %
            
            37.20
            %
            
            36.03
            %
            
            *
            
            
            *




* -
        Financial instruments recorded at fair value under SFAS155 were valued using
        the
        common stock equivalent approach.  The common stock equivalent was
        calculated using the shares indexed to the financial instruments valued at
        the
        market rate of the Company stock and the present value of the
        coupon.





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.





**Current
      Period Accounting Considerations**





Due
      to
      the Company’s default position with respect to the convertible financial
      instruments, the carrying value of each instrument in effect as of December
      31,
      2006 was written up to the respective full face value during the fourth quarter
      of 2006. In addition, the March 2007 Debenture and the August 2007 Debenture
      were each recorded at their full fair value pursuant to FAS 155. The carrying
      value and fair value of each instrument as of September 30, 2007
      was:





**Series
                C****Convertible**
            
            **August**
            
            **December**
            
            **March**
            
            **August****Preferred**
            
            **2006**
            
            **2006**
            
            **2007**
            
            **2007****Stock**
            
            **Debenture**
            
            **Debenture**
            
            **Debenture**
            
            **Debenture**Carrying
                value
            
            $
            20,877,000
            
            $
            5,000,000
            
            $
            2,500,000Fair
                value
            
            
            
            
            
            
            
            
            
            
            $
            18,449,000
            
            $
            4,348,000





Derivative
      financial instruments arising from the issuance of convertible financial
      instruments are initially recorded, and continuously carried, at fair value.
      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.




32




The
      following tabular presentation reflects the components of derivative financial
      instruments related to convertible financial instruments on the Company’s
      balance sheet at September 30, 2007:





**Series
                C****Convertible**
            
            **August**
            
            **December**
            
            **March**
            
            **August****Preferred**
            
            **2006**
            
            **2006**
            
            **2007**
            
            **2007****Stock**
            
            **Debenture**
            
            **Debenture**
            
            **Debenture**
            
            **Debenture****(Assets)
                Liabilities:**Common
                stock warrants
            
            $
            990,000
            
            $
            2,765,000
            
            $
            672,000
            
            $
            2,225,000
            
            $
            1,305,000Embedded
                conversion feature
            
            
            11,403,000
            
            
            8,675,000
            
            
            3,976,000
            
            
            0
            
            
            0Other
                warrants(1)
            
            
            98,000
            
            
            0
            
            
            0
            
            
            0
            
            
            0$
            12,491,000
            
            $
            11,440,000
            
            $
            4,648,000
            
            $
            2,225,000
            
            $
            1,305,000






(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
                $14,331,000, $977,000 and $98,000 on February 17, 2006, December
                31, 2006,
                and September 30, 2007, respectively. The decrease in fair value
                of these
                other derivative financial instruments resulted primarily from a
                decrease
                in NeoMedia’s share price between February 17, 2006, December 31, 2006,
                and September 30, 2007. The change in fair value is reported as “Gain on
                derivative financial instruments” on the condensed consolidated statement
                of operations during each period. These warrants will be reclassified
                to
                stockholders’ equity when the Company reacquires the ability to
                share-settle the instruments.





The
      following table reflects the number of common shares into which the convertible
      instruments and warrants are convertible or exercisable at September 30,
      2007:





**Series
                C****Convertible**
            
            **August**
            
            **December**
            
            **March**
            
            **August****Preferred**
            
            **2006**
            
            **2006**
            
            **2007**
            
            **2007**
            
            **Other****Stock**
            
            **Debenture**
            
            **Debenture**
            
            **Debenture**
            
            **Debenture**
            
            **Warrants**Common
                stock warrants
            
            
            75,000,000
            
            
            175,000,000
            
            
            42,000,000
            
            
            125,000,000
            
            
            75,000,000
            
            
            22,825,000Embedded
                conversion feature(1)
            
            
            1,465,098,124
            
            
            602,409,639
            
            
            301,204,819
            
            
            898,632,651
            
            
            213,855,422
            
            
            0Total
            
            
            1,540,098,124
            
            
            777,409,639
            
            
            343,204,819
            
            
            1,023,632,651
            
            
            288,855,422
            
            
            22,825,000






(1)
            The
                terms of the embedded conversion features in the convertible instruments
                presented above 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 embedded
                conversion feature in the Series C convertible stock was convertible
                as of
                September 30, 2007 was calculated as the face value plus assumed
                dividends
                (if declared), divided by 97% of the lowest closing bid price for
                the 30
                trading days preceding September 30, 2007. The number of shares of
                common
                stock into which the embedded conversion feature in the convertible
                debentures was convertible as of September 30, 2007 was calculated
                as the
                face value of each instrument divided by the lower of $0.01 or 50%
                of the
                average closing market price of NeoMedia's common stock for the 10
                days
                prior to September 30, 2007.




33


Changes
      in the fair value of convertible instruments that are carried at fair value
      (the
      March 2007 Debenture and the August 2007 Debenture) and changes in the fair
      values of derivative instrument liabilities (including warrants and the
      bifurcated embedded derivative features of convertible instruments not carried
      at fair value) are reported as “Gain (loss) on derivative financial instruments”
in the accompanying condensed consolidated statement of operations, as
      follows:





**Series
                C****Convertible**
            
            **August**
            
            **December**
            
            **March**
            
            **August**
            
            **Other**
            
            **Total****Preferred**
            
            **2006**
            
            **2006**
            
            **2007**
            
            **2007**
            
            **Derivative**
            
            **Derivative****Period**
            
            **Stock**
            
            **Debenture**
            
            **Debenture**
            
            **Debenture**
            
            **Debenture**
            
            **Instruments**
            
            **Gain
                (loss)**Three
                months ended September 30, 2007
            
            
            ($3,545,000
            )
            
            ($5,295,000
            )
            
            ($892,000
            )
            $
            1,825,000
            
            
            ($4,269,000
            )
            
            ($39,000
            )
            
            ($12,215,000
            )Three
                months ended September 30, 2006
            
            $
            4,160,000
            
            
            ($13,431,000
            )
            
            0
            
            
            0
            
            
            0
            
            
            0
            
            
            ($9,271,000
            )Nine
                months ended September 30, 2007
            
            
            ($4,155,000
            )
            $
            501,000
            
            
            ($910,000
            )
            
            ($5,603,000
            )
            
            ($4,269,000
            )
            
            ($165,000
            )
            
            ($14,601,000
            )Nine
                months ended September 30, 2006
            
            $
            19,933,000
            
            
            ($13,431,000
            )
            
            0
            
            
            0
            
            
            0
            
            $
            21,000
            
            $
            6,523,000





The
      fair
      value of derivative financial instrument liabilities recorded as of September
      30, 2007 (unaudited) and December 31, 2006 was:





**September
                30,**
            
            **December
                31,**(US
                dollars in thousands)
            
            **2007**
            
            **2006**(Unaudited)Warrants
                and embedded conversion features in preferred stock
            
            $
            12,491
            
            $
            8,815Warrants
                and embedded conversion features in certain debentures
            
            
            19,618
            
            
            15,679Fair
                value of future payment obligation
            
            
            0
            
            
            564Special
                preference stock of Mobot
            
            
            237
            
            
            359Total
                derivative financial instruments
            
            $
            32,346
            
            $
            25,417





As
      described herein, NeoMedia repriced 427,000,000 warrants held by YA Global
      Investments on August 24, 2007, resulting in an expense on NeoMedia’s statements
      of operations of $563,000 for the three and nine month periods ended September
      30, 2007. No such charge was recognized during the three or nine month periods
      ended September 30, 2006.





As
      of
      September 30, 2007 cumulative dividends earned but not declared in excess of
      the
      carrying value for the Series C convertible preferred stock were $1,289,000,
      and
      are included in the net loss attributable to common shareholders.




34


**6.** **INVESTMENT
      IN MARKETABLE SECURITIES AND OTHER LONG-TERM ASSETS**





On
      February 25, 2005, NeoMedia invested $250,000 in exchange for 8,333,333 shares
      of Pickups Plus, Inc. (“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. PUPS, a
      franchiser of retail automotive parts and accessories stores catering to the
      light truck market, 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).
      Investment in marketable securities consist of the fair market value of the
      PUPS
      common stock of $11,000 as of September 30, 2007.





Other
      long term assets and investments consisted of the following as of September
      30,
      2007:





**Unrealized****Holding**
            
            **Impairment****Gains**
            
            **Amount**
            
            **Carrying****Cost**
            
            **(Losses)**
            
            **Recognized**
            
            **Value**Held
                to maturity, notes receivable PUPS
            
            $
            379,000
            
            $
            0
            
            
            ($379,000
            )
            $
            0Investment
                in Mobot
            
            
            1,926,000
            
            
            0
            
            
            0
            
            
            1,926,000Investment
                in Sponge
            
            
            1,399,000
            
            
            0
            
            
            0
            
            
            1,399,000Investment
                in 12Snap
            
            
            380,000
            
            
            0
            
            
            0
            
            
            380,000Total
            
            $
            4,084,000
            
            $
            0
            
            
            ($379,000
            )
            $
            3,705,000






(1)
            Held
                to maturity securities consist of four notes receivable from PUPS
                with a
                face value of $1,611,000 and a fair value of $0. NeoMedia incurred
                an
                impairment charge of $379,000 in the fourth quarter of 2006 to reduce
                the
                carrying value of the notes receivable to their expected realizable
                value
                of zero. 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.





(2)
            Investment
                in Mobot consists of shares of FMS Group, representing NeoMedia’s 18%
                ownership of FMS Group, which currently operates the Mobot
                business.





(3)
            Investment
                in Sponge consists of shares of Sponge, representing NeoMedia’s 7.5%
                ownership of Sponge.





(4)
            Investment
                in 12Snap consists of shares of 12Snap, representing NeoMedia’s 10%
                ownership of 12Snap.




35




**7.** **COMPUTATION
      OF NET INCOME (LOSS) PER SHARE**





Basic
      net
      income (loss) per share is computed by dividing net income (loss) by the
      weighted average number of shares of common stock outstanding during the period.
      Diluted earnings per share is computed on the basis of the weighted average
      number of shares of common stock plus the effect of dilutive potential common
      shares outstanding during the period using the treasury stock method. Dilutive
      potential common shares include in-the-money stock options and warrants, and
      convertible preferred stock and debenture instruments. During the three and
      nine
      months ended September 30, 2007 and 2006, the Company reported net loss per
      share, and as such basic and diluted loss per share were equivalent. For the
      three and nine months ended September 30, 2007 and 2006, the Company has
      excluded all outstanding stock options and warrants, as well as convertible
      securities on an “as-converted” basis, from the calculation of diluted net loss
      per share because these securities are anti-dilutive. The shares excluded from
      the calculation of diluted net loss per share are detailed in the table
      below:





**Three
                and Nine Months****Ended
                September 30,****2007**
            
            **2006**In-the-money
                stock options
            
            
            24,850,000
            
            
            42,303,600In-the-money
                stock warrants
            
            
            2,500,000
            
            
            120,150,000Series
                C Convertible Preferred Stock(1)
            
            
            1,465,098,124
            
            
            216,494,845Convertible
                debentures(1)
            
            
            2,016,102,530
            
            
            50,505,0513,508,550,654
            
            
            429,453,496






(1)
                The
                    terms of the embedded conversion features in the convertible
                    instruments
                    presented above 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
                    embedded
                    conversion feature in the Series C convertible stock was convertible
                    as of
                    September 30, 2007 was calculated as the face value plus assumed
                    dividends
                    (if declared), divided by 97% of the lowest closing bid price
                    for the 30
                    trading days preceding September 30, 2007. The number of shares
                    of common
                    stock into which the embedded conversion feature in the convertible
                    debentures was convertible as of September 30, 2007 was calculated
                    as the
                    face value of each instrument divided by the lower of $0.01 or
                    50% of the
                    average closing market price of NeoMedia's common stock for the
                    10 days
                    prior to September 30,
                    2007.




36




**8.
      STOCK BASED COMPENSATION**





**Equity-based
      Compensation Plans**





Effective
      March 27, 1998, NeoMedia adopted the 1998 Stock Option Plan making available
      for
      grant to employees of NeoMedia options to purchase up to 8,000,000 shares of
      NeoMedia's common stock. The stock option committee of the Board of Directors
      has the authority to determine to whom options will be granted, the number
      of
      options, the related term, and exercise price. The option exercise price may
      be
      less than the fair market value per share of NeoMedia's common stock on the
      date
      of grant. Options generally vest 20% upon grant and 20% per year thereafter.
      The
      options expire ten years from the date of grant. As of September 30, 2007,
      no
      options were outstanding under the 1998 Stock Option Plan.





Effective
      June 6, 2002, NeoMedia adopted its 2002 Stock Option Plan. The 2002 Stock Option
      Plan provides for authority for the stock option committee of the Board of
      Directors to grant non-qualified stock options with respect to a maximum of
      10,000,000 shares of common stock. The option exercise price may be less than
      the fair market value per share of NeoMedia's common stock on the date of grant,
      and may be granted with any vesting schedule as approved by the stock option
      committee. As of September 30, 2007, no options were outstanding under the
      2002
      Stock Option Plan.





Effective
      September 24, 2003, NeoMedia adopted its 2003 Stock Option Plan. The 2003 Stock
      Option Plan provides for authority for the stock option committee of the Board
      of Directors to grant non-qualified stock options with respect to a maximum
      of
      150,000,000 shares of common stock. The option exercise price may be less than
      the fair market value per share of NeoMedia's common stock on the date of grant,
      and may be granted with any vesting schedule as approved by the stock option
      committee. As of September 30, 2007, options to purchase 109,168,494 shares
      of
      common stock were outstanding under the 2003 Stock Option Plan.





Effective
      October 31, 2003, NeoMedia adopted the 2003 Stock Incentive Plan. Under the
      terms of the 2003 Stock Incentive Plan, NeoMedia has set aside up to 30 million
      shares of common stock to be issued to pay compensation and other expenses
      related to employees, former employees, consultants, and non-employee directors.
      As of September 30, 2007, 426,451 shares of common stock remained available
      for
      issuance under the 2003 Stock Incentive Plan.





Effective
      December 16, 2005, NeoMedia adopted its 2005 Stock Option Plan. The 2005 Stock
      Option Plan provides for authority for the stock option committee of the Board
      of Directors to grant non-qualified stock options with respect to a maximum
      of
      60,000,000 shares of common stock. The option exercise price may be less than
      the fair market value per share of NeoMedia's common stock on the date of grant,
      and may be granted with any vesting schedule as approved by the stock option
      committee. As of September 30, 2007, options to purchase all 60,000,000 shares
      of common stock remained available for issuance under the 2005 Stock Option
      Plan.





**Stock
      Option Repricing - February 2007**





On
      February 1, 2007, NeoMedia instituted a stock option repricing plan as a
      retention tool to align its employees with the new vision of NeoMedia. Under
      the
      plan, NeoMedia repriced 50,148,750 stock options held by current employees,
      contractors, and directors.





Options
      for employees of NeoMedia’s ongoing operations were repriced as follows: (i)
      options that were vested as of February 1, 2007, were repriced to $0.045 per
      share, which was the last sale price on February 1, 2007, (ii) options that
      are
      scheduled to vest during the remainder of 2007 were repriced to $0.075, (iii)
      options that vest during 2008 were repriced to $0.125, and (iv) options that
      vest during 2009 were repriced to $0.175. Options will continue to vest on
      their
      regular schedule, which generally is 25% upon grant and 25% on each subsequent
      anniversary date.




37





The
      Company also repriced options for outside directors as follows: options with
      an
      exercise price below $0.24 were repriced to $0.045, and options with an exercise
      price $0.24 or higher were repriced to $0.075.





In
      addition, the Company repriced options held by employees of its held for sale
      Micro Paint Repair and Telecom Services businesses, such that all vested options
      were repriced to $0.045 per share, and all unvested options vest upon sale
      of
      the respective business unit at an exercise price of $0.075 per share, with
      a
      12-month period to exercise after the sale of each respective business unit
      is
      completed.





NeoMedia
      accounted for the repricing of stock options in accordance with FASB Statement
      No. 123, Accounting for Stock-Based Compensation (“Statement 123(R)”). NeoMedia
      calculated the fair value of the modified and the repriced options using the
      original terms and the modified terms as of the repricing date, and recorded
      the
      incremental cost of the modified option over the original option as additional
      compensation cost. Costs related to fully vested options including accelerated
      vesting were expensed immediately and the costs related to unvested stock
      options will be recognized over the remaining vesting period of the option. Unrecognized
      compensation expense relating to the original option grant will continue to
      be
      recognized as if the repricing had not occurred.





In
      connection with the option repricing, NeoMedia recognized additional stock
      based
      compensation expense as outlined in the following table. No expense was
      recognized during the three and nine months ended September 30, 2006 in
      connection with the repricing.





**Three**
            
            **Nine****Months**
            
            **Months****Ended**
            
            **Ended****September
                30,**
            
            **September
                30,****2007**
            
            **2007**(in
                thousands)Stock
                option repricing expense allocated to:Sales
                and marketing expense
            
            $
            5
            
            $
            120General
                and administrative expense
            
            
            3
            
            
            121Research
                and development expense
            
            
            2
            
            
            68Total
                stock option repricing expense included in continuing
                operations
            
            
            10
            
            
            309Plus:
                stock option repricing expense included in discontinued
                operations
            
            
            42
            
            
            791Total
                stock option repricing expense reflected in net loss
            
            **$**
            **52**
            
            **$**
            **1,100**





The
      weighted-average grant-date fair value of options repriced on February 1, 2007,
      using the options’ modified terms, was $0.03. As of September 30, 2007, there
      was $18,000 of total unrecognized compensation cost related to nonvested options
      repriced on February 1, 2007. That cost is expected to be recognized over a
      weighted-average period of 0.7 years.




38


**Stock
      Incentive Plan**





Under
      the
      shareholder-approved 2003 Stock Incentive Plan, NeoMedia has set aside up to
      30,000,000 shares of common stock to be issued to pay compensation and other
      expenses related to employees, former employees, consultants, and non-employee
      directors. During the three and nine months ended September 30, 2007 and 2006,
      NeoMedia issued shares from the 2003 Stock Incentive Plan as
      follows:





**Three
                Months Ended**
            
            **Nine
                Months Ended****September
                30,**
            
            **September
                30,**(US
                dollars in thousands, except share amounts)
            
            **2007**
            
            **2006**
            
            **2007**
            
            **2006**Shares
                issued under 2003 Stock Incentive Plan
            
            
            0
            
            
            11,767,186
            
            
            1,298,957
            
            
            11,949,033Aggregate
                grant date fair value of shares issued
            
            
            0
            
            $
            1,589
            
            $
            73
            
            $
            1,653Expense
                recognized
            
            
            0
            
            $
            1,589
            
            $
            73
            
            $
            1,653





**Adoption
      of FASB Statement No. 123**





Prior
      to
      January 1, 2006, NeoMedia accounted for its stock option plans under the
      recognition and measurement provisions of APB Opinion No. 25, Accounting for
      Stock Issued to Employees, and related Interpretations, as permitted by
      Statement 123(R). 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 Statement 123(R), using the modified-prospective-transition
      method. Under that transition method, compensation cost recognized in 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 were not
      restated.





**Three
                months ended**
            
            **Nine
                months ended****September
                30,**
            
            **September
                30,****2007**
            
            **2006**
            
            **2007**
            
            **2006**(in
                thousands)
            
            (in
                thousands)Stock
                based compensation allocated to:Sales
                and marketing expense
            
            $
            207
            
            $
            359
            
            $
            757
            
            $
            1,169General
                and administrative expense
            
            
            268
            
            
            1,914
            
            
            1,110
            
            
            2,616Research
                and development expense
            
            
            85
            
            
            130
            
            
            327
            
            
            390Total
                stock based compensationincluded
                in continuing operations
            
            
            560
            
            
            2,403
            
            
            2,194
            
            
            4,175Plus:
                stock based compensationincluded
                in discontinued operations
            
            
            191
            
            
            335
            
            
            1,273
            
            
            1,287Total
                stock based compensationexpense
                reflected in net loss
            
            **$**
            **751**
            
            **$**
            **2,738**
            
            **$**
            **3,467**
            
            **$**
            **5,462**





39


During
      the three and nine months ended September 30, 2007, NeoMedia issued stock
      options as follows:





**Three**
            
            **Nine****Months**
            
            **Months****Ended**
            
            **Ended****September
                30,**
            
            **September
                30,****2007**
            
            **2007**Employees
            
            
            30,000
            
            
            7,803,500Officers
            
            
            0
            
            
            20,000,000Directors
            
            
            538,219
            
            
            538,219Contractors
            
            
            2,079,407
            
            
            3,079,407Total
            
            
            2,647,626
            
            
            31,421,126





Estimated
      income tax benefits recognized during the three and nine months ended September
      30, 2007 and 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.





The
      weighted-average grant-date fair value of options granted during the nine months
      ended September 30, 2007 and 2006 was $0.02 and $0.11, respectively. The total
      intrinsic value of options exercised during the nine months ended September
      30,
      2007 and 2006 was $77,000 and $425,000, respectively. Total cash received from
      options exercised was $16,000 and $350,000, respectively, for the nine months
      ended September 30, 2007 and 2006. As of September 30, 2007, there was
      $3,347,000 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 1.3 years.




NeoMedia
      used the following assumptions for grants during the nine months ended September
      30, 2007 and 2006:





**Nine
                months ended****September
                30,****2007**
            
            **2006**Volatility
            
            
            108
            %
            
            56%
                - 117
            %Expected
                dividends
            
            
            0
            
            
            0Expected
                term (in years)
            
            
            3
            
            
            3Risk-free
                rate
            
            
            4.35
            %
            
            4.35
            %




40




**Warrant
      Repricing**




On
      April
      12, 2007, NeoMedia entered into an agreement with Thornhill Capital LLC
      (“Thornhill”), an independent consultant, pursuant to which NeoMedia agreed to
      reprice up to 10,000,000 warrants held by Thornhill upon achievement of certain
      performance conditions. Upon signing of the agreement, which calls for the
      termination of any obligations due from NeoMedia to Thornhill under the terms
      of
      a previous consulting agreement between the parties and Thornhill’s commitment
      to assist with the development
      of the China market for NeoMedia’s technology products , 2,000,000
      warrants were repriced from $0.227 to $0.048, 1,000,000 warrants were repriced
      from $0.11 to $0.048, and 500,000 warrants were repriced from $0.11 to $0.048.
      In addition, the following warrants could be subject to future repricing if
      certain milestones are met: (i) 2,000,000 warrants would be repriced from $0.227
      to $0.048 upon
      execution of a contract outlining mutually agreed payment terms for amounts
      owed
      to NeoMedia by Automart Inc., a customer of NeoMedia’s Micro Paint Repair
      business unit, (ii) 2 ,000,000
      warrants would be repriced from $0.328 to $0.048 and 1,500,000 warrants would
      be
      repriced from $0.11 to $0.048 upon receipt of payment by NeoMedia from Automart,
      Inc. (iii) 500,000
      warrants would
      have been
      repriced from
      $0.11 to $0.048 o n
      October
      12, 2007 had Thornhill still been assisting with the development of the China
      market. However, they were not repriced as Thornhill is no longer assisting
      with
      the development of the China market as of the date of this financial statement,
      and (iv) 500,000 warrants could have been, but will not be, repriced from
      $0.11 to $0.048 on
      April
      12, 2008, as Thornhill is no longer assisting with the development of the China
      market as the date of this financial statement.




The
      change in fair value resulting from the modified terms of the warrants are
      reflected under the caption “General and administrative expenses” on the
      accompanying consolidated statement of operations. During the nine months ended
      September 30, 2007, NeoMedia recognized stock based compensation expense of
      $5,000 relating to this repricing. As a part of the repricing, NeoMedia
      reclassified $248,000 from “Derivative liabilities” to “Additional paid in
      capital” on the accompanying balance sheet.




41




**9.** **SEGMENT
      REPORTING**




As
      of
      September 30, 2007, NeoMedia was structured and evaluated by its Board of
      Directors and management as one operating unit, comprised of the Company’s core
      code-reading technology and related intellectual property. NeoMedia is
      headquartered in Ft. Myers, Florida, and operates principally in the United
      States, and in Europe through its office in Aachen, Germany. Segment reporting
      excludes Micro Paint Repair, Mobot, Sponge, 12Snap and Telecom Services business
      units which are classified as discontinued operations during the three and
      nine
      months ended September 30, 2007 and 2006, and the related assets and liabilities
      held for sale.





Consolidated
      net sales and net loss from continuing operations for the three and nine month
      periods ended September 30, 2007 and 2006, and identifiable assets as of
      September 30, 2007 by geographic area were as follows:





**Three
                Months Ended**
            
            **Nine
                Months Ended****September
                30,**
            
            **September
                30,**(US
              dollars in thousands)
            
            **2007**
            
            **2006**
            
            **2007**
            
            **2006****Net
                Sales:**United
                States
            
            $
            152
            
            $
            184
            
            $
            455
            
            $
            491Germany
            
            
            135
            
            
            246
            
            
            855
            
            
            626Total
            
            $
            287
            
            $
            430
            
            $
            1,310
            
            $
            1,117**Net
                Loss from Continuing Operations:**United
                States
            
            
            ($20,832
            )
            
            ($13,532
            )
            
            ($31,086
            )
            
            ($19,501
            )Germany
            
            
            (554
            )
            
            (138
            )
            
            (843
            )
            
            (387
            )Total
            
            
            ($21,386
            )
            
            ($13,670
            )
            
            ($31,929
            )
            
            ($19,888
            )**Identifiable
                Assets**United
                States
            
            $
            7,664Germany
            
            
            7,524Total
            
            $
            15,188





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.





As
      a
      result of the divestitures of 12Snap, Mobot, Sponge, and Telecom Services,
      and
      the proposed divestiture of Micro Paint Repair, beginning in the first quarter
      of 2007 NeoMedia evaluated its business as one consolidated business, focusing
      on its core code-reading business and related intellectual property. Results
      of
      these operations are included in discontinued operations in the financial
      statements presented herein. Since all results from continuing operations are
      included in one business segment, NeoMedia is not presenting continuing
      operations by segment for the periods presented herein.




42


**10.** **INVENTORY**





Inventories
      for continuing operations, 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 September 30, 2007 (unaudited) and
      December 31, 2006:





(US
                  dollars in thousands)
            
            **September
                30, 2007**
            
            **December
                31, 2006**(Unaudited)Raw
                materials
            
            $
            35
            
            $
            0Finished
                goods
            
            
            231
            
            
            80Total
            
            $
            267
            
            $
            80




**11.** **ACCRUED
      LIABILITIES**





Accrued
      liabilities for continuing operations consist of the following as of September
      30, 2007 (unaudited) and December 31, 2006:





(US
                dollars in thousands)
            
            **September
                30, 2007**
            
            **December
                31, 2006**Accruals
                related to silent partner agreements
            
            $
            33
            
            $
            213Accrued
                legal and accounting costs
            
            
            56
            
            
            179Accruals
                for disputed services
            
            
            794
            
            
            794Accrued
                operating expenses
            
            
            977
            
            
            728Payroll
                related accruals
            
            
            30
            
            
            9Accrued
                liquidated damages
            
            
            1,388
            
            
            2,093Total
            
            $
            3,278
            
            $
            4,016





Additionally,
      NeoMedia has accrued the amount of $4,592,000 relating to a purchase price
      guarantee obligation in connection with its acquisition of 12Snap noted in
      the
      next section.





**12.** **COMMITMENTS
      AND CONTINGENCIES**





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





·
            NeoMedia
                leases its office facilities and certain office and computer equipment
                under various operating leases which provide for minimum rents and
                generally include options to renew for additional
                periods;


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


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


·
            NeoMedia
                has outstanding Series C convertible preferred shares with face value
                of
                $20,877,000 and convertible debentures with a face value of $16,734,000
                that are subject to conversion at future dates, plus the accrued
                expected
                value of liquidated damages of $1,388,000 relating to these convertible
                instruments; and


·
            NeoMedia
                has accrued the amount of $4,592,000 relating to a purchase price
                guarantee obligation in connection with its acquisition of
                12Snap.




43




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





**Series
                C****Subsidiary**
            
            
            
            **Convertible****Operating**
            
            **Acquisition**
            
            **Convertible**
            
            **Preferred****Leases**
            
            **Commitments**
            
            **Debentures**
            
            **Stock**
            
            **Total**(US
                dollars in thousands)2007
                (remaining three months)
            
            $
            71
            
            $
            4,592
            
            $
            31,685
            
            $
            20,877
            
            $
            57,2252008
            
            
            148
            
            
            0
            
            
            0
            
            
            0
            
            
            1482009
            
            
            12
            
            
            0
            
            
            0
            
            
            0
            
            
            122010
            
            
            3
            
            
            0
            
            
            0
            
            
            0
            
            
            32011
            
            
            0
            
            
            0
            
            
            0
            
            
            0
            
            
            0Thereafter
            
            
            0
            
            
            0
            
            
            0
            
            
            0
            
            
            0**Total**
            
            **$**
            **234**
            
            **$**
            **4,592**
            
            **$**
            **31,685**
            
            **$**
            **20,877**
            
            **$**
            **57,388**





In
      addition, as of September 30, 2007, NeoMedia had future obligations relating
      to
      its discontinued Micro Paint Repair and Telecom Services businesses totaling
      $1,397,000, most of which is expected to be assumed by the buyers upon the
      anticipated sale of each business unit.





**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 possible that the eventual
      resolution of the following legal actions could have a material adverse effect
      on the Company’s financial position or operating results.




**Scanbuy,
      Inc.**




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





On
      April
      20, 2004, NeoMedia re-filed its suit against Scanbuy in the Southern District
      of
      New York alleging patent infringement. Scanbuy filed its answer on June 2,
      2004.
      NeoMedia filed its answer and affirmative defenses on July 23, 2004. On January
      20, 2007, the court dismissed Scanbuy's request for a summary judgment.
      Discovery is ongoing. NeoMedia
      expects to agree in November, 2007, to stay the pending patent litigation
      against Scanbuy for a period of six months.





**Electronic
      Frontier Foundation**





In
      October 2007, NeoMedia received a communication from the United States Patent
      and Trademark Office (USPTO) stating that a request by the Electronic Frontier
      Foundation for Ex-Parte Reexamination of U.S. Patent No. 6,199,048 (“the ‘048
      patent”) has been granted. Although the ‘048 patent is an important NeoMedia
      patent, it is not alone. NeoMedia has a portfolio consisting of U.S. and foreign
      patents and pending applications relating to various inventions surrounding
      the
      processing of machine readable codes over wireless networks. NeoMedia believes
      some or all of the claims of the ‘048 patent will be confirmed by the USPTO in
      the course of the re-examination.




44





**13.** **OTHER
      EVENTS**





**HipCricket
      Note Receivable**





On
      July
      27, 2007, NeoMedia entered into a settlement agreement with HipCricket, Inc.
      (“HipCricket”) for the early payment of a note receivable due to NeoMedia from
      HipCricket. The parties agreed that HipCricket would pay NeoMedia $221,000
      in
      settlement of notes and interest payable from HipCricket to NeoMedia totaling
      $246,000, of which $100,000 was due on August 31, 2007 and $146,000 was due
      on
      February 28, 2008. The payment was made on July 27, 2007.





**14.** **SUBSEQUENT
      EVENTS**





**Organizational
      Changes - October 2007**





Effective
      on October 15, 2007, Charles W. Fritz, the founder and Chairman of the Board
      of
      NeoMedia, resigned his role as Chairman of the Board.





On
      October 19, 2007, NeoMedia approved the Executive Services Agreement with Tatum,
      LLC, pursuant to which Mr. Frank Pazera, 46, was hired as NeoMedia’s Chief
      Financial Officer. Mr. Pazera replaces Scott Womble, who has been Interim Chief
      Financial Officer since June 22, 2007. Mr. Womble will retain the title of
      Chief
      Accounting Officer until his departure in December 2007. Mr. Pazera, a partner
      in the Atlanta office of Tatum LLC, has held CFO positions in both publicly
      traded and privately held technology companies. Mr. Pazera began his career
      at
      Arthur Andersen & Co. More recently, Mr. Pazera was Interim Chief Executive
      Officer of Covista Communications, Inc. where he also previously served as
      Chief
      Financial Officer and Treasurer. Mr. Pazera has also held Senior Financial
      Executive positions at Airgate PCS, Inc., Network One, MCI Telecommunications
      and Turner Broadcasting, among others. Mr. Pazera holds a BBA in Accounting
      from
      the University of Wisconsin, Milwaukee and an MBA from the Goizueta Business
      School at Emory University, Atlanta.





**Sale
      of Triton - October 2007**





On
      October 30, 2007, NeoMedia completed the sale of its ownership interest in
      Triton, which comprised the operations of the Company’s Telecom Services
      business unit, to Greywolf for $1,350,000 cash. With the sale of Triton,
      NeoMedia ceased operations of its Telecom Services business unit. Guy Fietz,
      who
      was the Vice President and General Manager of the NeoMedia Telecom Services
      business unit, is also the principal shareholder and CEO of Greywolf. Mr. Fietz
      received 6,190,476 shares of NeoMedia stock with a fair value of $130,000 as
      a
      commission on the sale.




**Sale
        of Micro Paint Repair assets - November
        2007**


On
        November 1, 2007, the Company entered into a definitive purchase agreement
        with
        Micro Paint Holdings Limited, a New Zealand corporation, for the sale of
        the
        assets of the Micro Paint Repair business unit, excluding the assets of the
        U.S.
        Auto Xperience operations, with an expected closing date in mid November
        2007,
        for $2,000,000 cash and $200,000 in the stock of Micro Paint Holdings
        Limited.


45


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





**Leadership
      Changes**





Effective
      June 18, 2007, NeoMedia named William J. Hoffman as its Chief Executive Officer,
      replacing Charles W. Fritz, NeoMedia’s Chairman and founder, who has served as
      the Company’s interim CEO since December 2006. Prior to joining NeoMedia, Mr.
      Hoffman served as CEO of Uniqua Technologies, Inc. in Atlanta, a company he
      co-founded in 2003 with the acquisition of the assets of TIC Enterprises, LLC,
      and the merger of Vectorlink Communications Corporation. TIC was a $100 million
      subsidiary of NUI Corporation (NYSE: NUI), and TIC (now Technology Solutions
      Corp) is a national leader in sales and marketing of wireless telecom products
      and services. There, he was responsible for driving revenue growth of 1,140%
      in
      18 months.





Previously,
      as the CEO and a director of mBlox, Inc, the world’s largest mobile transaction
      network, Mr. Hoffman served in London, Atlanta and Sunnyvale, CA. There he
      focused on reorganizing, restructuring, and rapidly growing the business to
      over
      180 countries. His responsibilities included capital structure, Board,
      organization, strategy, and execution of the firm’s business plan. He was
      instrumental in developing partnerships with more than 500 wireless operators
      around the globe including Vodafone®, T-Mobile®, Verizon® and Cingular®, and
      achieving a $75 million annual run-rate in 18 months time for the world’s
      largest provider of messaging infrastructure.





Mr.
      Hoffman, who has served as president, CEO and COO for several other
      telecommunications companies, also spent 8 years with Sprint managing Sprint’s
      business services throughout the State of Florida. He earned a B.S. in
      Electrical Engineering at Auburn University, which he attended on a special
      U.S.
      Army scholarship. Mr. Hoffman served in the U.S. Army from 1983-87, attaining
      the rank of Captain. During July 2007, Mr. Hoffman replaced A. Hayes Barclay
      as
      a member of the Company’s Board of Directors.





Effective
      June 30, 2007, David A. Dodge resigned his position as Vice President and CFO,
      and was replaced by J. Scott Womble, the Company's Corporate Controller, on
      an
      interim basis.





Effective
      July 17, 2007, A. Hayes Barclay resigned his position as a member of NeoMedia’s
      Board of Directors.





On
      September 26, 2007, NeoMedia announced plans to relocate its corporate
      headquarters. NeoMedia is currently based out of Ft. Myers, Florida, and is
      relocating its operations to Atlanta, Georgia effective in the fourth quarter
      of
      2007, in order to offer close contact to potential customers and easier access
      to international markets. NeoMedia will continue to operate its Aachen, Germany
      office, consisting of the operations of Gavitec.





On
      September 26, 2007, NeoMedia announced that Christian Steinborn, 37, CEO of
      Gavitec, will assume the additional role of Chief Operating Officer of NeoMedia.
      Mr. Steinborn will oversee global sales opportunities and business operations
      of
      both NeoMedia and Gavitec. Christian is a seasoned executive with years of
      experience in the wireless industry and demonstrates consistent execution of
      sales and profitability initiatives.





Effective
      October 15, 2007, Charles W. Fritz, the founder and Chairman of the Board of
      NeoMedia, resigned his role as Chairman of the Board.





On
      October 19, 2007, NeoMedia approved the Executive Services Agreement with Tatum,
      LLC, pursuant to which Mr. Frank Pazera, 46, was hired as NeoMedia’s Chief
      Financial Officer. Mr. Pazera replaces Scott Womble, who has been Interim Chief
      Financial Officer since June 22, 2007. Mr. Womble will retain the title of
      Chief
      Accounting Officer until his departure in December 2007. Mr. Pazera, a partner
      in the Atlanta office of Tatum LLC, has held CFO positions in both publicly
      traded and privately held technology companies. Mr. Pazera began his career
      at
      Arthur Andersen & Co. More recently, Mr. Pazera was Interim Chief Executive
      Officer of Covista Communications, Inc. where he also previously served as
      Chief
      Financial Officer and Treasurer. Mr. Pazera has also held Senior Financial
      Executive positions at Airgate PCS, Inc., Network One, MCI Telecommunications
      and Turner Broadcasting, among others. Mr. Pazera holds a BBA in Accounting
      from
      the University of Wisconsin, Milwaukee and an MBA from the Goizueta Business
      School at Emory University, Atlanta.




46





**Corporate
      Structure**





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





The
      majority of the consideration issued to acquire Gavitec, Mobot, 12Snap, and
      Sponge consisted of shares of NeoMedia common stock, the value of which was
      guaranteed, in cash, to the recipients by NeoMedia from the time of issuance
      through the time the shares were registered for resale (either upon
      effectiveness of a registration statement containing the shares, or under Rule
      144). As a result of NeoMedia’s declining share price from the first quarter of
      2006 through the end of 2006, the purchase price guarantee obligations relating
      to these acquisitions became far greater than NeoMedia could reasonably satisfy
      with cash. Primarily as a result of the pending purchase price guarantee
      obligations, during the fourth quarter of 2006 NeoMedia divested of the majority
      of Sponge and Mobot back to their original owners, with the respective purchase
      price guarantee obligations being terminated as part of each transaction.
      Additionally, during the first nine months of 2007, NeoMedia satisfied its
      purchase price guarantee obligation to the former shareholders of Gavitec,
      and
      satisfied approximately 72% of the 12Snap purchase price guarantee obligation.





During
      August 2006, NeoMedia announced that it intended to sell its Micro Paint Repair
      business. On November 1, 2007 the Company entered into a definitive purchase
      agreement to sell the assets of the Micro Paint Repair business unit, excluding
      the assets of the U.S. Auto Xperience operations. During January 2007, the
      Company made the strategic decision to attempt to sell its remaining non-core
      business units in the most profitable, timely and viable manner possible. 12Snap
      was sold during April 2007. Telecom Services was sold during October 2007.
      NeoMedia plans to use the strategic equity earned through the sale of these
      assets in 2007 to reduce its current burn rate, help the Company move closer
      to
      profitability, and provide financial stability by the end of 2007 and become
      profitable by the third quarter of 2008. Most importantly, the shedding of
      NeoMedia’s non-core assets affords the Company the ability to focus all its
      resources on its core business initiatives. Management realizes the challenges
      that the Company faces in the global application of its technology, and can
      now
      present qode® to the wireless industry and the public using a more systematic
      and focused approach.





The
      Company continues to focus on becoming the worldwide leader in camera initiated
      transactions for mobile devices. Management believes that the decision to sell
      the non-core assets has led to a more focused vision for moving the Company
      forward and creating shareholder value, focusing on the core code-reading
      business and related intellectual property in North America, the UK, mainland
      Europe and China.





On
      September 26, 2007, NeoMedia announced plans to relocate its corporate
      headquarters, as well as changes in current key personnel. NeoMedia is currently
      based out of Ft. Myers, Florida, and is relocating its operations to Atlanta,
      Georgia in order to offer close contact to potential customers and easier access
      to international markets. NeoMedia will continue to operate its Aachen, Germany
      office, consisting of the operations of Gavitec.





**The
      Core Business**





NeoMedia
      has made significant inroads into the burgeoning mobile marketing industry
      and
      run many successful physical-world-to-mobile-web campaigns over the past several
      months.




47





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





·
            In
                October 2007, NeoMedia unveiled its NeoReader Universal client which
                allows a myriad of handsets to read and translate the most common
                forms of
                2D barcodes, and 1D UPC codes. This capability radically expands
                the
                addressable market for the Company’s network
                services.





·
            During
                July 2007, NeoMedia expanded its relationship with Mexico-based marketing
                agency Mobalis to include the promotion of qode® at REVENTOUR, a traveling
                music festival which visits 20 cities throughout Mexico from June
                through
                November. Attendance at REVENTOUR is estimated to be in excess of
                200,000
                participants.





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




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





·
            During
                July and August 2007, Case Western Reserve University in Cleveland,
                Ohio
                employed the use of qode technology with Sprint handsets to run the
                annual
                scavenger hunt used in new student orientation. Orientation leaders
                were
                equipped with Sprint handsets with qode preinstalled and used to
                lead
                small orientation groups on a campus tour. Strategically placed codes
                were
                “clicked” on in order to retrieve clues to their next location in the
                University campus.





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





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





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





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





·
            In
                June 2007, Gavitec secured a field trial with McDonalds’s of Germany for
                use of its EXIO platform for monetization of mobile coupons at 22
                stores
                across the country. This trial, if successful, will lead to the
                installation of EXIO’s at over 2,000
                stores.





NeoMedia
      also made significant inroads into Asia during the past year, as
      follows:





·
            Gavitec
                signed an exclusive license agreement with mobile marketing specialist
                Omniprime, pursuant to which Omniprime will sell mobile couponing
                and
                ticketing applications in the Philippines using Gavitec’s technology. In
                conjunction with this agreement Gavitec secured an order in July,
                2007,
                for approximately €1,020,000 (approximately $1,367,000 US Dollars) for
                mobile code reader technology for use in the public transportation
                system
                in the Philippines, to be filled over 30
                months.




48




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





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





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





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





NeoMedia
      has numerous issued patents with others in process and is continuing to seek
      to
      optimize the value of its intellectual property portfolio around the world.
      On
      January 20, 2007, Judge John E. Sprizzo dismissed Scanbuy's request for a
      summary judgment in the Company’s patent infringement case against Scanbuy.
      While the case is not over yet, NeoMedia continues to remain confident in the
      final outcome. Refer to Part II, Item I for additional information. Also on
      the
      patent front, during July 2007 the US Patent and Trademark Office rejected
      an
      application by the Electronic Frontier Foundation (EFF) to invalidate the
      Company’s patents and intellectual property on how camera phones read,
      translate, and process images and codes. The Electronic Frontier Foundation
      refiled their application in August 2007. In October 2007, NeoMedia was notified
      by the US Patent and Trademark Office that the EFF’s request for re-examination
      had been granted.





**Effect
      of Discontinued Operations on Net Loss and Financial
      Position**





Assets
      and liabilities of the Micro Paint Repair, Telecom Services, and 12Snap
      businesses classified as held for sale are shown in the following table. There
      were no assets or liabilities associated with the Sponge or Mobot subsidiaries
      as of the balance sheet dates of September 30, 2007 or December 31,
      2006.





**Micro****Paint**
            
            **Telecom**(US
                dollars in thousands)
            
            **Repair**
            
            **Services**
            
            **12Snap**
            
            **Total**As
                of September 30, 2007 (unaudited)Total
                Assets Held for Sale
            
            $
            2,723
            
            $
            3,716
            
            $
            0
            
            $
            6,438Total
                Liabilities Held for Sale
            
            
            338
            
            
            3,102
            
            
            0
            
            
            3,440As
                of December 31, 2006Total
                Assets Held for Sale
            
            $
            3,072
            
            $
            7,302
            
            $
            9,046
            
            $
            19,420Total
                Liabilities Held for Sale
            
            
            407
            
            
            2,970
            
            
            6,880
            
            
            10,257




49





The
      operating results of the Micro Paint Repair, Telecom Services, 12Snap, Mobot,
      and Sponge businesses classified as discontinued operations are shown in the
      following table. There is no tax expense or benefit to report due to NeoMedia’s
      net operating loss carry forward tax position.





**Three
                months ended September 30, 2007 (unaudited)****Micro****Paint**
            
            **Telecom**(US
                dollars in thousands)
            
            **Repair**
            
            **Services**
            
            **12Snap**
            
            **Mobot**
            
            **Sponge**
            
            **Total**Net
                Sales
            
            $
            287
            
            $
            525
            
            $
            0
            
            $
            0
            
            $
            0
            
            $
            812Loss
                from discontinued operations
            
            
            ($913
            )
            
            ($3,716
            )
            
            ($92
            )
            
            ($11
            )
            
            ($15
            )
            
            ($4,747
            )




**Nine
                months ended September 30, 2007 (unaudited)****Micro****Paint**
            
            **Telecom****Repair**
            
            **Services**
            
            **12Snap**
            
            **Mobot**
            
            **Sponge**
            
            **Total**Net
                Sales
            
            $
            1,003
            
            $
            1,339
            
            $
            2,621
            
            $
            0
            
            $
            0
            
            $
            4,963Loss
                from discontinued operations
            
            
            ($2,122
            )
            
            ($3,706
            )
            
            ($2,394
            )
            
            ($34
            )
            
            ($44
            )
            
            ($8,300
            )




**Three
                months ended September 30, 2006 (unaudited)****Micro****Paint**
            
            **Telecom****Repair**
            
            **Services**
            
            **12Snap**
            
            **Mobot**
            
            **Sponge**
            
            **Total**Net
                Sales
            
            $
            367
            
            $
            547
            
            $
            2,226
            
            $
            125
            
            $
            264
            
            $
            3,529Income
                (Loss) from discontinued operations
            
            
            ($1,619
            )
            $
            144
            
            
            ($1,846
            )
            
            ($581
            )
            
            ($530
            )
            
            ($4,432
            )




**Nine
                months ended September 30, 2006 (unaudited)****Micro****Paint**
            
            **Telecom****Repair**
            
            **Services**
            
            **12Snap**
            
            **Mobot**
            
            **Sponge**
            
            **Total**Net
                Sales
            
            $
            1,145
            
            $
            1,089
            
            $
            5,347
            
            $
            316
            
            $
            975
            
            $
            8,872Loss
                from discontinued operations
            
            
            ($2,826
            )
            
            ($135
            )
            
            ($2,672
            )
            
            ($1,275
            )
            
            ($748
            )
            
            ($7,656
            )




Depreciation
      and amortization costs suspended on assets held for sale for the three and
      nine
      months ended September 30, 2007 are:





(US
                dollars in thousands)
            
            **Micro
                Paint Repair**
            
            **Telecom
                Services**
            
            **12snap**
            
            **Total**Three
                months ended September 30, 2007
            
            $
            71
            
            $
            77
            
            $
            0
            
            $
            148Nine
                months ended September 30, 2007
            
            $
            213
            
            $
            236
            
            $
            220
            
            $
            669





50




**Stock
      Option Repricing**





On
      February 1, 2007, NeoMedia instituted a stock option repricing plan as a
      retention tool to align its employees with the new vision of NeoMedia. Under
      the
      plan, NeoMedia repriced 50,148,750 stock options held by current employees,
      contractors, and directors.





Options
      for employees of NeoMedia’s ongoing operations were repriced as follows: (i)
      options that were vested as of February 1, 2007, were repriced to $0.045 per
      share, which was the last sale price on February 1, 2007, (ii) options that
      are
      scheduled to vest during the remainder of 2007 were repriced to $0.075, (iii)
      options that vest during 2008 were repriced to $0.125, and (iv) options that
      vest during 2009 were repriced to $0.175. Options will continue to vest on
      their
      regular schedule, which generally is 25% upon grant and 25% on each subsequent
      anniversary date. The Company also repriced options for outside directors as
      follows: options with an exercise price below $0.24 were repriced to $0.045,
      and
      options with an exercise price $0.24 or higher were repriced to $0.075.





In
      addition, the Company repriced options held by employees of its held for sale
      Micro Paint Repair and Telecom Services businesses, such that all vested options
      were repriced to $0.045 per share, and all unvested options will vest upon
      sale
      of the respective business unit at an exercise price of $0.075 per share, with
      a
      12-month period to exercise.





The
      weighted-average grant-date fair value of options repriced on February 1, 2007,
      using the options’ modified terms, was $0.03. As of September 30, 2007, there
      was $18,000 of total unrecognized compensation cost related to nonvested options
      repriced on February 1, 2007. That cost is expected to be recognized over a
      weighted-average period of 0.3 years.





**Stock-Based
      Compensation**




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




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




51


Total
      stock based compensation recognized during the three and nine month periods
      ended September 30, 2007 and 2006 was:





**Three
                months ended**
            
            **Nine
                months ended****September
                30,**
            
            **September
                30,****2007**
            
            **2006**
            
            **2007**
            
            **2006**(in
                thousands)
            
            (in
                thousands)Stock
                based compensation allocated to:Sales
                and marketing expense
            
            $
            207
            
            $
            359
            
            $
            757
            
            $
            1,169General
                and administrative expense
            
            
            268
            
            
            1,914
            
            
            1,110
            
            
            2,616Research
                and development expense
            
            
            85
            
            
            130
            
            
            327
            
            
            390Total
                stock based compensationincluded
                in continuing operations
            
            
            560
            
            
            2,403
            
            
            2,194
            
            
            4,175Plus:
                stock based compensationincluded
                in discontinued operations
            
            
            191
            
            
            335
            
            
            1,273
            
            
            1,287Total
                stock based compensationexpense
                reflected in net loss
            
            **$**
            **751**
            
            **$**
            **2,738**
            
            **$**
            **3,467**
            
            **$**
            **5,462**




Approximately
      46% and 37% of the stock-based compensation expense recorded during the nine
      months ended September 30, 2007 and 2006, respectively, relates to the continued
      vesting of stock options that were granted prior to January 1, 2006. As of
      September 30, 2007, there was $3,347,000 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
      1.3 years.





**Accounting
      Treatment of Series C Convertible Preferred Stock and Convertible
      Debentures**





NeoMedia
      recognized a gain (loss) on derivative financial instruments of ($12,215,000)
      and ($9,721,000) during the three months ended September 30, 2007 and 2006,
      respectively. During the nine months ended September 30, 2007 and 2006, NeoMedia
      recognized a gain (loss) of ($14,601,000) and $6,073,000, respectively. The
      gains and losses are due to the change in fair value of derivative financial
      instruments resulting primarily from the changes in NeoMedia's stock price
      during the reporting period. The fair value of the derivative financial
      instruments at each measurement date correlates to NeoMedia's stock price at
      the
      same date. As a result, NeoMedia's net loss varies significantly from its cash
      flow from operations during the three and nine months ended September 30, 2007
      and 2006. In future periods, NeoMedia's loss could fluctuate dramatically from
      quarter to quarter if its stock price is significantly different from the stock
      price at the end of the previous measurement period. Because NeoMedia cannot
      guarantee that it has enough authorized shares to net share settle the
      convertible instruments, the change in fair value of derivative instruments
      will
      be recorded to NeoMedia's statement of operations each reporting period until
      the convertible instruments are fully converted.





**Change
      in Certified Registered Public Accounting Firm**





On
      August
      29, 2007, NeoMedia notified Stonefield Josephson, Inc. that the Company was
      dismissing Stonefield as its independent registered public accounting firm,
      effective immediately. The Board of Directors of the Company approved the
      dismissal of Stonefield as the Company’s independent registered public
      accounting firm on August 29, 2007, after recommendation and approval from
      the
      Audit Committee of the Board of Directors of the Company.




The
      reports of Stonefield on the Company’s financial statements for the fiscal years
      ended as of December 31, 2006 and 2005 did not contain an adverse opinion or
      disclaimer of opinion and were not qualified or modified as to uncertainty,
      audit scope or accounting principles, except that the opinion contained an
      explanatory paragraph stating that the Company's significant operating losses,
      negative cash flows from operations and working capital deficit raise
      substantial doubt about its ability to continue as a going concern. Stonefield’s
      report on the Company’s internal controls over financial reporting expressed an
      unqualified opinion on management’s assessment of, and an adverse opinion on,
      the effectiveness of internal control over financial reporting, due to the
      existence of several material weakness as of December 31, 2006.




52




During
      the Company’s fiscal years ended December 31, 2006 and 2005, and through the
      date hereof, there were no disagreements between the Company and Stonefield
      on
      any matter of accounting principles or practices, financial statement disclosure
      or auditing scope or procedure, which disagreements, if not resolved to
      Stonefield’s satisfaction, would have caused Stonefield to make a reference to
      the matter in its reports on the Company’s financial statements for such
      years.





On
      August
      31, 2007, the Company engaged Kingery & Crouse, P.A., to serve as its
      independent registered public accounting firm for the fiscal year ending
      December 31, 2007, and to perform procedures related to the financial statements
      included in the Company’s quarterly reports on Form 10-Q, which are expected to
      commence with, and include, the quarter ending September 30, 2007. The
      engagement of Kingery & Crouse was approved by the Board of Directors of the
      Company, after approval and recommendation by the Audit Committee of the Board
      of Directors of the Company.




During
      the Company’s two most recent fiscal years ended December 31, 2006 and 2005, and
      during any subsequent interim period prior to the date of the engagement of
      Kingery & Crouse as the Company’s independent registered public accounting
      firm, neither the Company nor anyone acting on its behalf consulted with Kingery
      & Crouse regarding (i) the application of accounting principles to a
      specific transaction, either completed or proposed, or the type of audit opinion
      that might be rendered on the Company’s financial statements, and neither a
      written report was provided to the Company or oral advice was provided that
      Kingery & Crouse concluded was an important factor considered by the Company
      in reaching a decision as to the accounting, auditing or financial reporting
      issue; or (ii) any matter that was either the subject of a disagreement (as
      defined in Item 304(a)(1)(iv) of Regulation S-K and the related instructions)
      or
      a reportable event (as described in Item 304(a)(1)(v) of Regulation
      S-K).





**Related
      Party Transaction**





During
      the fourth quarter of 2005 and first quarter of 2006, NeoMedia shipped and
      invoiced $759,000 of Micro Paint Repair products to Automart, Inc. In the third
      quarter of 2006, NeoMedia established a reserve for bad debt against the open
      accounts receivable, and wrote off the deferred revenue and deferred costs,
      incurring a net charge to its statement of operations of $653,000. NeoMedia
      will
      recognize revenue on these shipments if and when collectibility is reasonably
      assured. David A. Dodge, NeoMedia’s former Chief Financial Officer, is a member
      of the board of directors of Automart Inc. Kevin Hunter, NeoMedia’s Chief
      Scientist, serves as an advisor to the board of directors of Automart Inc.





On
      October 30, 2007, NeoMedia completed the sale of its ownership interest in
      Triton, which comprised the operations of the Company’s Telecom Services
      business unit, to Greywolf for $1,350,000 cash. With the sale of Triton,
      NeoMedia ceased operations of its Telecom Services business unit. Guy Fietz,
      who
      was the Vice President and General Manager of the NeoMedia Telecom Services
      business unit, is also the principal shareholder and CEO of Greywolf. Mr. Fietz
      received 6,190,476 shares of NeoMedia stock with a fair value of $130,000 as
      a
      commission on the sale.





**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.




53





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





*Financial
      Instruments and Concentrations of Credit Risk.* The
      Company’s financial instruments consist of cash and cash equivalents, accounts
      receivable, accounts payable, accrued expenses, notes payable, derivative
      financial instruments, other current liabilities, convertible preferred stock,
      and convertible debenture financing. Management believes the carrying values
      of
      cash and cash equivalents, accounts receivable, accounts payable, accrued
      expenses, notes payable, and other current liabilities approximate their fair
      values due to their short-term nature.




54





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 and certain convertible debentures, (ii) the fair values of
      the
      detachable warrants that were issued in connection with the Series C convertible
      preferred stock and convertible debentures financing arrangements, (iii) the
      fair value of detachable warrants that were outstanding prior to the issuance
      of
      the Series C Preferred Shares, and (iv) special preference shares held in Mobot,
      Inc., a private company.





The
      Company utilizes various types of financing to fund its business needs,
      including convertible preferred stock, convertible debentures, and other
      instruments indexed to the Company’s own stock. The embedded conversion features
      utilized in these instruments require periodic measurement of the fair value
      of
      the derivative components. Pursuant to FAS 133, FAS 155, and EITF 00-19 NeoMedia
      updates the fair value of these derivative components at each reporting
      period.





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





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





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





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




55





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





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





(2)
            Technology
                service and product revenue, which includes sales of software and
                technology equipment and service fee is recognized  based on
                guidance  provided in  SEC Staff  Accounting 
                Bulletin  (“SAB”) No. 104,  "Revenue  Recognition  in
                Financial Statements,"  as amended (SAB 104).  Software
                and technology equipment resale revenue is
                recognized when persuasive evidence of an arrangement exists, the
                price to the customer is fixed and determinable, delivery of the
                service
                has occurred and collectibility is reasonably assured.
                Service revenues including maintenance fees for
                providing system updates for software products, user documentation
                and
                technical support are recognized over the life of
                the contract. The Company’s subsidiaries, Mobot (sold during 2006),
                and Gavitec follow this policy. The Company defers revenue related
                to
                technology service and product revenue for which amounts have been
                invoiced and or collected but for which the requisite service has
                not been
                provided. Revenue is then recognized over the matching service period.





(3)
            Technology
                service also includes mobile marketing services to its customers
                which
                mobile marketing projects are recognized after the completion of
                the
                project and acceptance by the customer.  All response and messaging
                based revenues are recognized at the time such responses are received
                and
                processed and the Company recognizes its premium messaging revenues
                on a
                net basis based on guidance provided in Emerging Issues Task Force
                Issues
                No. 99-19 (EITF 99-19), “Reporting Revenue Gross as Principal or Net as an
                Agent” and No. 01-09 (EITF 01-09), “Accounting for Consideration Given by
                a Vendor to a Customer.”  Consulting and management revenues and
                revenues for periodic services are recognized as services are
                performed.  NeoMedia uses  stand-alone  pricing to
                determine an element's  vendor  specific  objective 
                evidence  (“VSOE”) in order to allocate an arrangement  fee
                amongst various pieces of a  multi-element  contract.  The
                Company’s subsidiaries Sponge (sold during 2006) and 12Snap (sold in 2007)
                followed this policy. Telecom revenues from NeoMedia’s subsidiary BSD are
                recognized at the time that calls are accepted by the clearinghouse
                for
                billing to customers on a net basis, based on guidance in EITF 99-19.
                The
                Company defers revenue related to mobile marketing service fees for
                which
                amounts have been invoiced and/or collected but for which revenue
                has not
                been recognized. Revenue is then recognized over the matching service
                period.





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




56







(5)
            Sales
                taxes represent 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. In compliance with the Emerging Issues Task Force consensus
                on
                issue number 06-03 (EITF 06-03), NeoMedia accounts for sales taxes
                on a
                net basis.





*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 September 30, 2007 and December 31, 2006.





*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.





*Financial
      Accounting Standards Board Interpretation No. 48.* The
      Company adopted the provisions of Financial Accounting Standards Board ("FASB")
      Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-an
      interpretation of FASB Statement No. 109” (“FIN 48”), on January 1, 2007. FIN 48
      clarifies the accounting for uncertainty in income taxes recognized in an
      enterprise's financial statements in accordance with FASB Statement 109,
“Accounting for Income Taxes,” and prescribes a recognition threshold and
      measurement process for financial statement recognition and measurement of
      a tax
      position taken or expected to be taken in a tax return. FIN 48 also provides
      guidance on derecognition, classification, interest and penalties, accounting
      in
      interim periods, disclosure and transition.





Based
      on
      its evaluation, the Company has concluded that there are no significant
      uncertain tax positions requiring recognition in its financial statements.
      The
      Company’s evaluation was performed for the tax years ended December 31, 2003,
      2004, 2005 and 2006, the tax years which remain subject to examination by major
      tax jurisdictions as of September 30, 2007.





The
      Company may from time to time be assessed interest or penalties by major tax
      jurisdictions, although any such assessments historically have been minimal
      and
      immaterial to the Company’s financial results. In the event the Company has
      received an assessment for interest and/or penalties, it has been classified
      in
      the financial statements as interest expense.





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




This
      Statement:





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




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




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




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




57




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





FAS
      155
      is effective for fiscal years beginning after September 15, 2006. The Company
      has adopted FAS 155 on an individual instrument basis and is currently applying
      FAS 155 to certain of its debt obligations. The Company will evaluate and
      determine on a case by case basis whether to apply FAS 155.




**Effect
      Of Recently Issued Accounting Pronouncements**




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





In
      September 2006, the Securities and Exchange Commission (“SEC”) issued Staff
      Accounting Bulletin No. 108 (“SAB 108”), *Financial
      Statements - Considering the Effects of Prior Year Misstatements when
      Quantifying Misstatements in Current Year Financial
      Statements.”* SAB 108
      provides guidance on how prior year misstatements should be taken into
      consideration when quantifying misstatements in current year financial
      statements for purposes of determining whether the current year’s financial
      statements are materially misstated. SAB 108 provides that once a current year
      misstatement has been quantified, the guidance in SAB No. 99, *Financial
      Statements - Materiality* ,
      should
      be applied to determine whether the misstatement is material and should result
      in an adjustment to the financial statements. Under certain circumstances,
      prior
      year financial statements will not have to be restated and the effects of
      initially applying SAB 108 on prior years will be recorded as a cumulative
      effect adjustment to beginning Retained Earnings on January 1, 2006, with
      disclosure of the items included in the cumulative effect. NeoMedia applied
      the
      provisions of SAB 108 with the preparation of NeoMedia’s annual financial
      statements for the year ended December 31, 2006. The application of the
      provisions of SAB 108 did not have a material impact on the Company’s financial
      statements for the three and nine month periods ended September 30,
      2007.





In
      September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined
      Benefit Pension and Other Postretirement Plans." This statement requires
      companies to recognize a net liability or asset and an offsetting adjustment
      to
      accumulated other comprehensive income to report the funded status of defined
      benefit pension and other postretirement benefit plans. The statement requires
      prospective application, and the recognition and disclosure requirements are
      effective for companies with fiscal years ending after December 15, 2006.
      Additionally, SFAS No. 158 requires companies to measure plan assets and
      obligations at their year-end balance sheet date. This requirement is effective
      for fiscal years ending after December 15, 2008. The impact of this adoption
      had
      no impact on our consolidated financial statements and we are in compliance
      with
      the measurement date provisions of this statement.





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




58





In
      December 2006, FASB Staff Position No. EITF 00-19-2 was issued. This FASB Staff
      Position (FSP) addresses an issuer’s accounting for registration payment
      arrangements. This FSP specifies that the contingent obligation to make future
      payments or otherwise transfer consideration under a registration payment
      arrangement, whether issued as a separate agreement or included as a provision
      of a financial instrument or other agreement, should be separately recognized
      and measured in accordance with FASB Statement No. 5, Accounting for
      Contingencies. The guidance in this FSP amends FASB Statements No. 133,
      Accounting for Derivative Instruments and Hedging Activities, and No. 150,
      Accounting for Certain Financial Instruments with Characteristics of both
      Liabilities and Equity, and FASB Interpretation No. 45, Guarantor’s Accounting
      and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
      Indebtedness of Others, to include scope exceptions for registration payment
      arrangements. This FSP further clarifies that a financial instrument subject
      to
      a registration payment arrangement should be accounted for in accordance with
      other applicable generally accepted accounting principles “GAAP” without regard
      to the contingent obligation to transfer consideration pursuant to the
      registration payment arrangement. The Company follows the guidance in FSP
      00-19-2 in assessing its liabilities related to the liquidated damages arising
      from the Company’s default position on the convertible financing
      arrangements.





In
      June
      2007, the FASB ratified the consensus on Emerging Issues Task Force “EITF” Issue
      No. 06−11, "Accounting for Income Tax Benefits of Dividends on Share−Based
      Payment Awards" ("EITF 06−11"). EITF 06−11 requires companies to recognize the
      income tax benefit realized from dividends or dividend equivalents that are
      charged to retained earnings and paid to employees for non−vested
      equity−classified employee share−based payment awards as an increase to
      additional paid−in capital. EITF 06−11 is effective for fiscal years beginning
      after September 15, 2007. While the Company is currently evaluating the
      provisions of EITF 06−11, the adoption is not expected to have any significant
      effect on the Company's consolidated financial position or results of
      operations.





In
      November 2006, the FASB ratified EITF Issue No. 06−7, “Issuer's Accounting for a
      Previously Bifurcated Conversion Option in a Convertible Debt Instrument When
      the Conversion Option No Longer Meets the Bifurcation Criteria in FASB Statement
      No. 133, Accounting for Derivative Instruments and Hedging Activities” (“EITF
      No. 06−7”). At the time of issuance, an embedded conversion option in a
      convertible debt instrument may be required to be bifurcated from the debt
      instrument and accounted for separately by the issuer as a derivative under
      SFAS
      No. 133, based on the application of EITF No. 00−19. Subsequent to the issuance
      of the convertible debt, facts may change and cause the embedded conversion
      option to no longer meet the conditions for separate accounting as a derivative
      instrument, such as when the bifurcated instrument meets the conditions of
      EITF
      No. 00−19 to be classified in stockholders' equity. Under EITF No. 06−7, when an
      embedded conversion option previously accounted for as a derivative under
      Statement of Financial Accounting Standards (“SFAS”) No. 133 no longer meets the
      bifurcation criteria under that standard, an issuer shall disclose a description
      of the principal changes causing the embedded conversion option to no longer
      require bifurcation under SFAS No. 133 and the amount of the liability for
      the
      conversion option reclassified to stockholders' equity. EITF No. 06−7 should be
      applied to all previously bifurcated conversion options in convertible debt
      instruments that no longer meet the bifurcation criteria in SFAS No. 133 in
      interim or annual periods beginning after December 15, 2006, regardless of
      whether the debt instrument was entered into prior or subsequent to the
      effective date of EITF No. 06−7. The adoption of EITF 06−7 did not have a
      material impact on our financial position, results of operations or cash
      flows.





In
      November 2006, the FASB ratified EITF Issue No. 06−6, Application of EITF Issue
      No. 05−7, ‘Accounting for Modifications to Conversion Options Embedded in Debt
      Instruments and Related Issues ** ’
(“EITF
      06−6”). EITF 06−6 addresses the modification of a convertible debt instrument
      that changes the fair value of an embedded conversion option and the subsequent
      recognition of interest expense for the associated debt instrument when the
      modification does not result in a debt extinguishment pursuant to EITF 96−19.
      The Company does not expect the adoption of EITF 06−6 to have a material impact
      on its consolidated financial position, results of operations or cash
      flows .




59





On
      January 1, 2007, the Company adopted the consensus reached in Emerging Issues
      Task Force (“EITF”) Issue No. 06−2, “Accounting for Sabbatical Leave and Other
      Similar Benefits Pursuant to FASB Statement No. 43.” EITF Issue No. 06−2
      provides recognition guidance on the accrual of employees’ rights to compensated
      absences under a sabbatical or other similar benefit arrangement. The adoption
      of EITF Issue No. 06−2 did not have a material impact on our financial position,
      results of operations, or cash flows.





In
      September 2006, the Emerging Issues Task Force, or EITF, reached a consensus
      on
      Issue No. 06−1, Accounting for Consideration Given by a Service Provider to
      Manufacturers or Resellers of Equipment Necessary for an End−Customer to Receive
      Service from the Service Provider *.* EITF
      Issue No. 06−1 provides guidance regarding whether the consideration given by a
      service provider to a manufacturer or reseller of specialized equipment should
      be characterized as a reduction of revenue or an expense. This issue is
      effective for our annual reporting period ending December 31, 2007. Entities
      are
      required to recognize the effects of applying this issue as a change in
      accounting principle through retrospective application to all prior periods
      unless it is impracticable to do so. We are in the process of evaluating the
      impact of this issue on our consolidated financial statements . The
      Company does not expect the adoption of EITF 06−1 to have a material impact on
      its consolidated financial position, results of operations or cash
      flows .





In
      June
      2007, the FASB issued EITF Issue 07-3 “Accounting for Advance Payments for Goods
      or Services to Be Used in Future Research and Development Activities” (EITF
      07-3). The scope of EITF 07-3 is limited to nonrefundable advance payments
      for
      goods and services related to research and development activities. EITF 07-3
      requires that advanced payments be capitalized and subsequently expensed as
      the
      goods are delivered or services performed. NeoMedia is required to adopt EITF
      07-3 effective January 1, 2008. We do not expect the adoption of EITF 07-3
      to
      have a material impact on our consolidated results of operations and financial
      condition.





In
      June
      2007, the American Institute of Certified Public Accountants (“AICPA”) issued
      Statement of Position (“SOP”) 07-1, “Clarification of the Scope of the Audit and
      Accounting Guide Investment Companies and Accounting by Parent Companies and
      Equity Method Investors for Investments in Investment Companies” (“SOP 07-1”).
      SOP 07-1 provides guidance for determining whether an entity is within the
      scope
      of the AICPA “Audit and Accounting Guide Investment Companies” (the “Guide”).
      SOP 07-1 addresses whether the specialized industry accounting principles of
      the
      Guide should be retained by a parent company in consolidation. In addition,
      SOP
      07-1 includes certain disclosure requirements for parent companies and equity
      method investors in investment companies that retain investment company
      accounting in the parent company’s consolidated financial statements or the
      financial statements of an equity method investor. SOP 07-1 is effective for
      the
      Company as of December 1, 2008. In May 2007, the FASB issued FASB Staff Position
      (“FSP”) FIN 46R-7, “Application of FIN 46R to Investment Companies,” which
      amends FIN 46R to make permanent the temporary deferral of the application
      of
      FIN 46R to entities within the scope of the revised audit guide under SOP 07-1.
      FSP FIN No. 46R-7 is effective upon adoption of SOP 07-1. The Company is
      currently evaluating the potential impact of adopting SOP 07-1 and FSP FIN
      46R-7, and does not expect SOP 07-1 to have a material impact on our
      consolidated results of operations and financial condition.





60


**Results
      of Operations for the Three Months Ended September 30, 2007 As Compared to
      the
      Three Months Ended September 30, 2006**





*Net
      sales.* Total
      net
      sales for the three months ended September 30, 2007 were $287,000, which
      represented a $143,000, or 33%, decrease from $430,000 for the three months
      ended September 30, 2006.  This decrease resulted from (i) $112,000
      decreased net sales in 2007 from Gavitec, and (ii) a decrease of $31,000 in
      net
      sales from the Company’s underlying business represented by qode® and NeoMedia’s
      legacy software products.





*Cost
      of sales.* Cost
      of
      sales was $324,000 for the three months ended September 30, 2007 compared to
      $463,000 for the three months ended September 30, 2006, a decrease of $139,000,
      or 30%.  This decrease resulted from (i) $122,000 decreased product and
      service related cost of sales from Gavitec due to a favorable product mix,
      and
      (ii) lower cost of sales of $17,000 from the Company’s underlying business
      represented by qode® and NeoMedia’s legacy software products.





*Gross
      profit.* Gross profit was $(37,000) for the three months ended September 30, 2007, a
      decrease of $4,000, or 12%, compared with gross profit of $(33,000) for the
      three months ended September 30, 2006.  This decrease resulted from (i)
      lower gross profit of $14,000 from the Company’s underlying business represented
      by qode® and NeoMedia’s legacy software products, offset by (ii) $10,000
      increased operational gross profit from Gavitec through favorable product mix.
      Gross profit is negative as a result of amortization of product-related
      intangible assets charged to cost of goods sold in the amount of $164,000 during
      each of the three month periods ended September 30, 2007 and 2006.





*Sales
      and marketing.* Sales
      and
      marketing expenses were $604,000 for the three months ended September 30, 2007,
      compared to $1,307,000 for the three months ended September 30, 2006, a decrease
      of $703,000 or 54%.  This decrease resulted from (i) lower sales and
      marketing expense in the Company’s underlying business represented by qode® and
      NeoMedia’s legacy software products of $523,000 in 2007 relative to 2006, (ii)
      lower stock based compensation expense allocated to sales and marketing in
      2007
      of $104,000, and (iii) lower sales and marketing expenses of $76,000 from
      Gavitec.





*General
      and administrative.* General
      and administrative expenses decreased by $760,000, or 41%, to $1,110,000 for
      the
      three months ended September 30, 2007, compared to $1,870,000 for the three
      months ended September 30, 2006. The decrease resulted from (i) lower
      accounting, professional, and legal services of $597,000 due to Company’s
      implementation of Sarbanes Oxley and integration of subsidiaries during the
      three months ended September 20, 2007, (ii) lower stock based compensation
      expense of $151,000, and (iii) decreased general and administrative expenses
      of
      $12,000 from Gavitec, resulting from higher costs in 2006 associated with the
      integration of the business into NeoMedia’s consolidated
      operations.





*Research
      and development.* During
      the three months ended September 30, 2007, research and development expense
      was
      $435,000, a decrease of $144,000 or 25% compared to $579,000 for the three
      months ended September 30, 2006.  The decrease resulted from (i) lower
      research and development expenses of $76,000 related to Gavitec, (ii) lower
      stock based compensation expense allocated to research and development of
      $45,000, and (iii) lower research and development expense related to qode®
products of $23,000.





*Gain
      (loss) on extinguishment of debt.* During
      the three months ended September 30, 2007, NeoMedia recorded a gain on
      extinguishment of debt in the amount of $201,000, resulting from the settlement
      of debt at other than book value. No gain or loss on debt extinguishment was
      recognized during the three months ended September 30, 2006.





*Interest
      income (expense).* Interest
      income (expense) consists primarily of interest and liquidated damage charges
      related to convertible debentures, interest accrued for creditors as part of
      financed purchases, past due balances, and notes payable, net of interest earned
      on cash equivalent investments. Interest expense increased by $7,026,000, or
      4,391%, to $7,186,000 for the three months ended September 30, 2007, from
      $160,000 for the three months ended September 30, 2006. The increase resulted
      from (i) $7,115,000 of interest expense on the Company’s convertible debenture
      financing arrangements, of which $7,149,000 related to a charge to write the
      March 2007 Debenture up to its face value, offset by (iii) lower other interest
      expense of $89,000.




61





*Loss
      on derivative financial instruments.* Loss
      on
      derivative financial instruments was $12,215,000 for the three months ended
      September 30, 2007, compared with $9,721,000 for the three months ended
      September 30, 2006, an increase of $2,494,000 or 26%.  The gains and losses
      are associated with the preferred stock sale on February 17, 2006, and the
      convertible debenture financings dated August 24, 2006, December 29, 2006,
      March
      27, 2007, and August 24, 2007.  Certain derivatives and embedded conversion
      features were created at the time of each offering and are recorded at fair
      value on the accompanying balance sheet *.* The
      gains
      (losses) represent the reduction (appreciation) in value of the derivatives
      and
      embedded conversion features from the beginning of each reporting period
      presented to the end of the period.





*Loss
      from discontinued business units* . 
      During 2006, NeoMedia sold its Mobot and Sponge businesses, and entered into
      a
      letter of intent to sell its Micro Paint Repair business. During the first
      quarter of 2007, NeoMedia made the strategic business decision to sell its
      12Snap and Telecom Services businesses. NeoMedia completed the sale of its
      Telecom Services business on October 30, 2007. Accordingly, NeoMedia has
      classified the operations of Micro Paint Repair, Mobot, Sponge, 12Snap and
      Telecom Services as discontinued operations. Loss from the discontinued business
      units in 2007 reflects direct operations of the Micro Paint Repair and Telecom
      Services units for the full three months ended September 30, 2007. 12Snap,
      Mobot, and Sponge were discontinued prior to July 1, 2007, and accordingly
      net
      loss from these entities during the three months ended September 30, 2007
      consists solely of recognition of previously issued stock based compensation
      expense. Loss from the discontinued business units during the three months
      ended
      September 30, 2006 reflects direct operations of Micro Paint Repair, Mobot,
      Sponge, 12Snap and Telecom Services for the entire three month
      period.





The
      net
      loss from the Micro Paint Repair business unit for the three months ended
      September 30, 2007 was $912,000, a decrease of $707,000 or 44% from the loss
      of
      $1,619,000 for the three months ended September 30, 2006. The decreased loss
      is
      due to a $653,000 charge to write off accounts receivable of the business unit’s
      distributor in China, lower stock based compensation expense in 2007 of
      $320,000, and lower operational losses of $323,000 resulting form cost
      reductions, offset by an impairment charge of $589,000 taken during 2007 to
      adjust the carrying value of the asset group to the expected net proceeds from
      the potential sale of this business. The net loss from the 12Snap business
      for
      the three months ended September 30, 2007 was $93,000, a decrease of $1,753,000
      or 95% from the loss of $1,846,000 for the three months ended September 30,
      2006. The 2007 loss consists entirely of recognition of previously issued stock
      based compensation expense. The 2006 loss consists of $1,492,000 of stock based
      compensation expense, and $127,000 of other operational losses. The net loss
      from the Telecom Services business for the three months ended September 30,
      2007
      was $3,716,000, an increase of $3,860,000 or 2,681% from income of $144,000
      for
      the three months ended September 30, 2006. The decrease primarily results from
      an impairment charge of $3,378,000 taken in 2007 to adjust the carrying value
      to
      estimated fair value, and higher operational losses of $482,000 from this
      business in 2007. NeoMedia’s operating results are $570,000 favorable in the
      three months ended September 30, 2007 to the same period in 2006 due to the
      disposal of Mobot. NeoMedia’s operating results are $515,000 favorable in the
      three months ended September 30, 2007 to the same period in 2006 due to the
      disposal of Sponge.





*Net
      Loss* . 
      The net loss for the three months ended September 30, 2007 was $26,133,000,
      which represented an increased loss of $8,031,000, or 44% from a net loss of
      $18,102,000 for the three months ended September 30, 2006.  The net loss
      resulted from (i) $7,115,000 increased interest expense recorded during 2007,
      primarily resulting from a charge to write the March 2007 Debenture up to its
      face value, (ii) impairment charges of $3,378,000 and $589,000 recorded to
      adjust the carrying values of the Telecom Services and Micro Paint Repair asset
      groups, respectively, to their estimated fair values, (iii) an increased loss
      on
      derivative financial instruments of $2,494,000, offset by (iv) increased
      profitability of $173,000 from the Gavitec operations, (v) $201,000 gain on
      debt
      retired at other than book value in 2007, (vi) lower stock based compensation
      expense of $300,000 in 2007, (vii) lower costs in 2007 in the underlying qode®
business of $621,000, (viii) lower corporate, legal, and accounting costs in
      2007 of $598,000, (ix) lower losses from normal operations of discontinued
      subsidiaries of $3,652,000 in 2007.




62





*Known
      trends, demands, commitments, or uncertainties.* During
      August 2006, NeoMedia announced that it intended to sell its Micro Paint Repair
      business unit. During the fourth quarter of 2006, NeoMedia divested of Mobot
      and
      Sponge, wholly owned subsidiaries acquired during the first quarter of 2006.
      Also, during the first quarter of 2007, NeoMedia announced its intent to sell
      additional subsidiaries NeoMedia Telecom and 12Snap. NeoMedia sold 12Snap on
      April 4, 2007, and completed the sale of Telecom Services on October 30, 2007.
      As a result, NeoMedia expects its sales, cost of sales, gross profit, operating
      expenses, and net loss over the next 12 months to more closely resemble the
      result presented herein, than results presented in the Company’s Forms 10-Q
      filed during 2006.




63


**Results
      of Operations for the Nine Months Ended September 30, 2007 As Compared to the
      Nine Months Ended September 30, 2006**





*Net
      sales.* Total
      net
      sales for the nine months ended September 30, 2007 were $1,310,000, which
      represented a $193,000, or 17%, increase from $1,117,000 for the nine months
      ended September 30, 2006.  This increase resulted from $229,000 increased
      net sales in 2007 from Gavitec which was acquired during the first quarter
      of
      2006 and only reflected in NeoMedia’s results for a portion of that operating
      period, offset by a decrease of $36,000 in net sales from the Company’s
      underlying business represented by qode® and intellectual property licensing.





*Cost
      of sales.* Cost
      of
      sales were $1,011,000 for the nine months ended September 30, 2007 compared
      to
      $1,000,000 for the nine months ended September 30, 2006, an increase of $11,000,
      or 1%.  This increase resulted from (i) $111,000 decreased product and
      service related cost of sales from Gavitec which was acquired during the first
      quarter of 2006 and only reflected in NeoMedia’s results for a portion of that
      operating period, offset by (ii) increased amortization of $99,000 of intangible
      assets relating to the acquisition of Gavitec, and (iii) higher cost of sales
      of
      $23,000 from the Company’s underlying business represented by qode® and
      NeoMedia’s legacy software products and the Company’s wound down Consulting and
      Integration Services business.





*Gross
      profit.* Gross profit was $299,000 for the nine months ended September 30, 2007, an
      increase of $182,000, or 156%, compared with gross profit of $117,000 for the
      nine months ended September 30, 2006.  This increase resulted from (i)
      $340,000 increased operational gross profit from Gavitec do to increased sales
      and favorable product mix, offset by (ii) decreased gross profit of $59,000
      from
      the Company’s underlying business represented by qode®, NeoMedia’s legacy
      software products, and (iii) amortization of $99,000 of intangible assets
      relating to the acquisition of Gavitec.





*Sales
      and marketing.* Sales
      and
      marketing expenses were $2,006,000 for the nine months ended September 30,
      2007,
      compared to $4,013,000 for the nine months ended September 30, 2006, a decrease
      of $2,007,000 or 50%.  This decrease resulted from (i) lower sales and
      marketing expense in the Company’s underlying business represented by qode® and
      NeoMedia’s legacy software products of $1,571,000 in 2007 relative to 2006, (ii)
      lower stock based compensation expense allocated to sales and marketing in
      2007
      of $298,000, and (iii) lower sales and marketing expenses of $138,000 from
      Gavitec, which was acquired during the first quarter of 2006.





*General
      and administrative.* General
      and administrative expenses decreased by $325,000, or 6%, to $4,874,000 for
      the
      nine months ended September 30, 2007, compared to $5,199,000 for the nine months
      ended September 30, 2006. The decrease resulted from (i) lower accounting,
      professional, and legal services of $185,000 due to Company’s implementation of
      Sarbanes Oxley and integration of subsidiaries during the nine months ended
      September 30, 2006, and (ii) lower stock based compensation expense of $194,000,
      partially offset by (iii) higher general and administrative expenses of $54,000
      related to Gavitec, which was acquired during the first quarter of 2006.





*Research
      and development.* During
      the nine months ended September 30, 2007, research and development expense
      was
      $1,360,000, a decrease of $201,000 or 13% compared to $1,561,000 for the nine
      months ended September 30, 2006.  The decrease resulted from (i) lower
      research and development expense related to qode® products of $385,000, and (ii)
      lower stock based compensation expense allocated to research and development
      of
      $63,000, partially offset by (iii) higher research and development expenses
      of
      $247,000 from Gavitec, which was acquired during the first quarter of
      2006.





*Gain
      (loss) on extinguishment of debt.* Gain
      on
      the extinguishment of debt in the nine months ended September 30, 2007 was
      $454,000, which was $2,312,000 or 124% favorable to the loss on the
      extinguishment of debt of $1,858,000 in the same period of 2006. The 2006 loss
      results primarily from debt retired in connection with the Series C preferred
      stock issued and sold to YA Global Investments on February 17, 2007. ** A
      loss
      was incurred on the surrender of a certain promissory note to YA Global
      Investments dated March 30, 2005 in connection with the preferred stock sale.
      During the nine months ended September 30, 2007, NeoMedia recorded gains of
      $198,000 on the extinguishment of a liability at Gavitec and $256,000 related
      to
      the conversion of a derivative instrument.




64





*Interest
      income (expense).* Interest
      income (expense) consists primarily of interest charges related to convertible
      debentures, interest accrued for creditors as part of financed purchases, past
      due balances, and notes payable, net of interest earned on cash equivalent
      investments.  Interest expense increased by $9,650,000, or 5,052%, to
      $9,841,000 for the nine months ended September 30, 2007, from $191,000 for
      the
      nine months ended September 30, 2006. The increase resulted from (i) higher
      interest charges of $8,973,000 recorded to adjust the convertible debentures
      to
      face value, (ii) accrual of $607,000 of liquidated damages related to the
      Company’s default on its convertible financing arrangements during 2007, and
      (iii) higher other interest expense of $70,000.





*Gain
      (loss) on derivative financial instruments.* Gain
      (loss) on derivative financial instruments was $(14,601,000) for the nine months
      ended September 30, 2007, compared with $6,073,000 for the nine months ended
      September 30, 2006, a decrease of $20,674,000 or 340%.  The gains and
      losses are associated with the preferred stock sale on February 17, 2006, and
      the convertible debenture financings dated August 24, 2006, December 29, 2006,
      March 27, 2007, and August 24, 2007.  Certain derivatives and embedded
      conversion features were created at the time of each offering and are recorded
      at fair value on the accompanying balance sheet *.* The
      gains
      (losses) represent the reduction (appreciation) in value of the derivatives
      and
      embedded conversion features from the beginning of each reporting period
      presented to the end of the period.





*Loss
      from discontinued business units* . 
      During 2006, NeoMedia entered into a letter of intent to sell its Micro Paint
      Repair business, and sold its Mobot and Sponge businesses. During the first
      quarter of 2007, NeoMedia made the strategic decision to sell its 12Snap and
      Telecom Services businesses. On October 30, 2007, NeoMedia sold its Telecom
      Services business unit. Accordingly, NeoMedia has classified the operations
      of
      Micro Paint Repair, Mobot, Sponge, 12Snap and Telecom Services as discontinued
      operations during the nine months ended September 30, 2007. Loss from the
      discontinued business units in 2007 reflects direct operations of the Micro
      Paint Repair and Telecom Services units for the full nine months ended September
      30, 2007, and for 12Snap for the period January 1, 2007 through April 4, 2007
      (disposal date). Loss from the discontinued business units in 2006 represents
      direct operations of Micro Paint Repair for the full nine months ended September
      30, 2006, and direct operations of Mobot, Sponge, 12Snap and Telecom Services
      from their respective acquisition dates (February 17, 2006 for Mobot, February
      23, 2006 for Sponge, February 28, 2006 for 12Snap, and March 21, 2006 for
      Telecom Services) through September 30, 2006.





The
      net
      loss from the Micro Paint Repair business unit for the nine months ended
      September 30, 2007 was $2,121,000, a decrease of $705,000 or 25% from the loss
      of $2,826,000 for the nine months ended September 30, 2006. The decreased loss
      is due to a bad debt charge of $653,000 recorded in the nine months ended
      September 30, 2006 related to sales to the business unit’s Chinese distributor,
      lower depreciation expense of $235,000 due to the suspension of amortization
      during the period that the business was held for sale, and $406,000 improved
      operational results, offset by an impairment charge of $589,000 taken during
      2007 to adjust the carrying value of the asset group to the expected net
      proceeds from the potential sale of this business. Net loss from the 12Snap
      business for the nine months ended September 30, 2007 was $2,394,000, a change
      of $278,000 or 10% from a net loss of $2,672,000 for the period from February
      28, 2006 through September 30, 2006. The increase loss results primarily from
      an
      impairment charge in the amount of $2,467,000 during the nine months ended
      September 30, 2007 to adjust the carrying value of 12Snap assets to the fair
      value of assets received in the sale on April 4, 2007, coupled with a loss
      on
      the disposal of the 12Snap business of $257,000 from the recognition of its
      previously unrealized cumulative currency translation adjustment, offset by
      an
      increase to the operational income of 12Snap of $3,002,000 in 2007 as compared
      with 2006. Net loss from the Telecom Services business for the nine months
      ended
      September 30, 2007 was $3,706,000, a change of $3,571,000 or 2,645% from the
      loss of $135,000 for the period from March 21, 2006 through September 30, 2006.
      The decrease results primarily from an impairment charge of $3,378,000 and
      a bad
      debt charge of $405,000 to write off accounts receivable from a primary
      customer, offset by improved operating margins of $211,000. NeoMedia’s operating
      results are $1,241,000 favorable in the nine months ended September 30, 2007
      to
      the same period in 2006 due to the disposal of Mobot. NeoMedia’s operating
      results are $704,000 favorable in the nine months ended September 30, 2007
      to
      the same period in 2006 due to the disposal of Sponge.




65





*Net
      loss* . 
      The net loss for the nine months ended September 30, 2007 was $40,229,000,
      which
      represented a $12,685,000, or 46% increase from the $27,544,000 net loss for
      the
      nine months ended September 30, 2006.  This increased net loss resulted
      from (i) a loss resulting from the change in fair value of embedded conversion
      features associated with the Series C preferred stock, warrants, and convertible
      debenture in the amount of $14,601,000 in the nine months ended September 30,
      2007 compared with a gain of $6,073,000 in the same period in 2006, (ii) an
      increase of $9,580,000 in interest expense during the nine months ended
      September 30, 2007 to adjust the carrying value of the March 2007 convertible
      debenture financing to its face value due to the Company’s default position,
      liquidating damages on convertible financing arrangements in default, and
      interest expense on convertible debentures (iii) impairment charges of
      $3,378,000, $2,467,000, and $589,000 to adjust the carrying value of Telecom
      Services, 12Snap, and Micro Paint Repair asset groups, respectively, to their
      fair values, (iv) a loss on the disposal of the 12Snap business of $257,000,
      offset by (v) improved operations of Gavitec of $78,000, (vi) increased gains
      on
      debt retired at other than book value of $94,000, (vii) lower stock based
      compensation expense of $555,000 in 2007, (viii) lower losses of $2,012,000
      in
      the nine months ended September 30,2007 compared with the same period in 2006
      from the underlying business represented by qode®, NeoMedia’s legacy software
      products, and corporate administration including audit and legal fees, (ix)
      lower debt retirement charges associated with convertible instruments of
      $2,218,000, (x) lower losses from the of operations of discontinued subsidiaries
      Telecom Services 12Snap, Mobot, and Sponge of $6,047,000, and (xi) a write-off
      of deferred financing costs of $13,256,000 in 2006 with no corresponding charge
      in 2007.





*Known
      trends, demands, commitments, or uncertainties.* During
      August 2006, NeoMedia announced that it intended to sell its Micro Paint Repair
      business unit. On November 1, 2007 the Company entered into a definitive
      purchase agreement to sell the assets of the Micro Paint Repair business unit,
      excluding the assets of the U.S. Auto Xperience operations. During the fourth
      quarter of 2006, NeoMedia divested of Mobot and Sponge, wholly owned
      subsidiaries acquired during the first quarter of 2006. Also, during the first
      quarter of 2007, NeoMedia announced its intent to sell additional subsidiaries
      NeoMedia Telecom and 12Snap. NeoMedia sold 12Snap on April 4, 2007, and
      completed the sale of Telecom Services on October 30, 2007. As a result,
      NeoMedia expects its sales, cost of sales, gross profit, operating expenses,
      and
      net loss over the next 12 months to more closely resemble the result presented
      herein, than results presented in the Company’s Forms 10-Q filed during 2006.




**Liquidity
      and Capital Resources**





**Current
      Period Activity**





*Net
      cash from operations.* Net cash
      used in continuing operating activities (net of cash used from operations of
      discontinued business unit) was $ 6,653 ,000
      and
      $ 5,993 ,000
      for
      the nine months ended September 30, 2007 and 2006, respectively, an increase
      of
      $ 660 ,000,
      or 11 %.
      The
      increase resulted from payment of accrued liquidated damages and interest of
      $ 1,678, 000
      from
      the proceeds of the March 2007 convertible debenture, offset by lower cash
      used
      in ongoing operations of $ 1,018 ,000.





*Net
      cash used in investing.* NeoMedia’s net cash flow used in investing activities (net of cash used in
      investing in discontinued business units) for the nine months ended September
      30, 2007 and 2006, was $3,105,000 and $19,884,000, respectively, a decrease
      of
      $16,779,000 or 84%. The decrease resulted from (i) the investment of $13,867,000
      in the acquisitions of Mobot, Sponge, Gavitec and 12Snap during the nine months
      ended September 30, 2006, (ii) proceeds from the sale of 12Snap of $1,100,000
      received in the nine months ended September 30, 2007, (iii) reduced advances
      to
      discontinued subsidiaries of $2,675,000 in the nine months ended September
      30,
      2007 as compared with the same period in 2006, (iv) collection of notes
      receivable of $671,000 in the nine months ended September 30, 2007, as compared
      to amounts advanced in the same period in 2006 of $500,000, and (v) reduced
      acquisition related costs and lower acquisitions of fixed assets and software
      of
      $545,000, offset by (vi) payments of purchase price obligations relating to
      Gavitec and 12Snap of $2,579,000.




66





*Net
      cash provided by financing activities* .
      Net
      cash provided by financing activities was $7,255,000 and $27,259,000 for the
      nine months ended September 30, 2007 and 2006, respectively, a decrease of
      $20,004,000 or 73%. NeoMedia received $8,253,000 proceeds from the sale of
      convertible debentures in the nine months ended September 30, 2007, compared
      with $5,000,000 in 2006. NeoMedia also received $14,066,000 from the sale of
      Series C convertible stock during the nine months ended September 30, 2006.
      NeoMedia received $17,000 and $8,419,000 from the exercise of stock options
      and
      warrants during the nine months ended September 30, 2007 and 2006, respectively.
      NeoMedia satisfied repayments on notes payable and convertible debt in the
      nine
      months ended September 30, 2007 and 2006, of $1,015,000 and $436,000,
      respectively. NeoMedia also received $210,000 from the sale of common stock
      during the nine months ended September 30, 2006.





*Net
      cash used in discontinued operations* .
      Net
      cash used in the Company’s discontinued Micro Paint Repair operations for the
      nine months ended September 30, 2007 was $1,001,000, of which $1,012,000 was
      used in operations, $4,000 was used in investing activities, and $15,000 was
      generated as a result of the effect of exchange rates on cash. Net cash used
      in
      the Company’s discontinued Micro Paint Repair operations for the nine months
      ended September 30, 2006 was $1,837,000, of which $1,830,000 was used in
      operations, $22,000 was used in investing activities, and $15,000 was generated
      as a result of the effect of exchange rates on cash.





Net
      cash
      used in the Company’s discontinued 12Snap operations for the nine months ended
      September 30, 2007 was $974,000, of which $159,000 was generated from
      operations, $1,125,000 was used in financing activities to repay silent partner
      debt, and $8,000 was used as a result of the effect of exchange rates on cash.
      Net cash used in the Company’s discontinued 12Snap operations for the nine
      months ended September 30, 2006 was $2,504,000, of which $993,000 was used
      in
      operations, $83,000 was used in investing activities, $2,036,000 was used in
      financing activities to repay silent partner debt, and $608,000 was generated
      as
      a result of the effect of exchange rates on cash.





Net
      cash
      used in the Company’s discontinued Telecom Services operations for the nine
      months ended September 30, 2007 was $309,000, of which $112,000 was provided
      by
      operations, $8,000 was used in investing activities, $2,000 net was used for
      financing activities, and $411,000 was used as a result of the effect of
      exchange rates on cash. Net cash used in the Company’s discontinued Telecom
      Services operations for the nine months ended September 30, 2006 was $428,000,
      of which $221,000 was used in operations, $58,000 was used in financing
      activities to repay notes payable, and $149,000 was used as a result of the
      effect of exchange rates on cash.





Net
      cash
      used in the Company’s discontinued Mobot operations for the nine months ended
      September 30, 2006 was $816,000, of which $796,000 was used in operations,
      and
      $20,000 was used in investing activities. Since this business was sold during
      2006, there was no effect on cash during the nine months ended September 30,
      2007.





Net
      cash
      used in the Company’s discontinued Sponge operations for the nine months ended
      September 30, 2006 was $385,000, of which $378,000 was used in operating
      activities, and $7,000 was used as a result of the effect of exchange rates
      on
      cash. Since this business was sold during 2006, there was no effect on cash
      during the nine months ended September 30, 2007.




As
      of
      September 30, 2007, NeoMedia has a working capital deficiency of $91,163,000,
      of
      which $32,346,000 relates to the fair value of derivative financial instruments,
      and $51,174,000 relates to the carrying value of debentures and convertible
      preferred stock that are convertible into shares of NeoMedia common stock.
      NeoMedia intends to fund its working capital deficiency as described in “Sources
      of Cash and Projected Cash Requirements”.





67




**Significant
      Liquidity Events**




**Going
      Concern**




The
      accompanying consolidated financial statements have been prepared in conformity
      with accounting principles generally accepted in the United States of America,
      which contemplate continuation of the Company as a going concern. Net loss
      for
      the nine months ended September 30, 2007 was $40,229,000 compared to net loss
      of
      $27,544,000, for the nine months ended September 30, 2006. Net cash used for
      operations was $6,653,000 and $5,993,000, for the nine months ended September
      30, 2007 and 2006, respectively. NeoMedia also has an accumulated deficit of
      $201,160,000 and a working capital deficit of $91,163,000 as of September 30,
      2007.





The
      items
      discussed above raise substantial doubts about the Company’s ability to continue
      as a going concern. The Company’s financial resources are insufficient to
      maintain operations beyond April, 2008, and the Company will require additional
      financing in order to execute its operating plan and continue as a going
      concern. The Company cannot predict whether this additional financing will
      be in
      the form of equity, debt, or another form. The Company may not be able to obtain
      the necessary additional capital on a timely basis, on acceptable terms, or
      at
      all. In any of these events, the Company may be unable to implement its current
      plans for expansion, repay its debt obligations as they become due or respond
      to
      competitive pressures, any of which circumstances would have a material adverse
      effect on its business, prospects, financial condition and results of
      operations. The financial statements do not include any adjustments relating
      to
      the recoverability and reclassification of recorded asset amounts or amounts
      and
      reclassification of liabilities that might be necessary, should the Company
      be
      unable to continue as a going concern.





Should
      financing sources fail to materialize, management would seek alternate funding
      sources such as the sale of common and/or preferred stock, the issuance of
      debt,
      or the sale of its marketable assets. Management’s plan is to secure adequate
      funding to bridge the commercialization of its core code-reading business.





NeoMedia
      plans to attempt to address its working capital deficiency through the use
      of
      proceeds from the sale of its Telecom Services business unit (sold on October
      30, 2007), from proceeds of the proposed sale of its Micro Paint Repair business
      unit, through additional strategic investments, and by continuing to reduce
      its
      workforce and overhead expenses in non-critical areas. In addition, NeoMedia
      will attempt to generate additional revenue and profit from the launch of its
      core code-reading products and the value optimization of its patent portfolio.





In
      the
      event that these financing sources do not materialize, or that NeoMedia is
      unsuccessful in increasing its revenues and profits, NeoMedia will be forced
      to
      further reduce its costs, may be unable to repay its debt obligations as they
      become due, or respond to competitive pressures, any of which circumstances
      would have a material adverse effect on its business, prospects, financial
      condition and results of operations. Additionally, if these funding sources
      or
      increased revenues and profits do not materialize, and NeoMedia is unable to
      secure additional financing, NeoMedia could be forced to reduce or curtail
      its
      business operations unless it is able to engage in a merger or other corporate
      finance transaction with a better capitalized entity.





**Sale
      of Telecom Services Business**





On
      October 30, 2007, NeoMedia completed the sale of its ownership interest in
      Triton, which comprised the operations of the Company’s Telecom Services
      business unit, to Greywolf for $1,350,000 cash. With the sale of Triton,
      NeoMedia ceased operations of its Telecom Services business unit. Guy Fietz,
      who
      was the Vice President and General Manager of the NeoMedia Telecom Services
      business unit, is also the principal shareholder and CEO of Greywolf. Mr. Fietz
      received 6,190,476 shares of NeoMedia stock with a fair value of $130,000 as
      a
      commission on the sale.




68





**$1.8
      Million Secured Convertible Debenture - August 2007**





On
      August
      24, 2007, NeoMedia entered into the August 2007 Debenture agreement with YA
      Global Investments. Pursuant to the August 2007 Debenture Agreement, YA Global
      Investments agreed to purchase 14% secured convertible debentures maturing
      two
      years from the date of issuance in the aggregate amount of $1,775,000. NeoMedia
      received cash proceeds from the transaction of $1,575,000, net of $200,000
      fees
      paid to the Purchaser. The August 2007 Debenture Agreement also provided for
      the
      issuance to the Purchaser, at no additional cost to the Purchaser, of 75,000,000
      warrants to purchase shares of the Company's common stock. In connection with
      the August 2007 Debenture Agreement, the Company also entered into a
      registration rights agreement with the Purchaser that requires the Company
      to
      (i) file a registration statement with the SEC registering the resale of the
      shares of common stock issuable upon conversion of the convertible debenture
      and
      the exercise of the warrants within 30 days of receipt of a request for filing
      from the Purchaser, (ii) achieve effectiveness within 90 days of receipt of
      a
      request for filing from the Purchaser, and (iii) maintain effectiveness of
      the
      registration statement.





The
      August 2007 Debenture is secured by (a) certain Pledged Property, as such term
      is defined in that certain Security Agreement, dated August 24, 2007, by and
      between the parties and perfected pursuant to UCC-1 Financing Statements filed
      with the Delaware Department of State (the UCC Filing Section) on or about
      August 24, 2007 and with the Florida Secured Transaction Registry on or about
      August 24, 2007; and (b) certain Patent Collateral, as defined in a security
      agreement (patent), entered into on August 24, 2007.





At
      any
      time from the closing date until August 24, 2009, the Purchaser has the right
      to
      convert the convertible debenture into common stock of the Company at the then
      effective conversion price, which varies relative to the Company’s trading stock
      price, as follows: $0.02 per share, or 80% of the lowest closing bid price
      (as
      reported by Bloomberg) of the common stock for the 10 trading days immediately
      preceding the conversion date, and adjusts to 50% of the lowest closing bid
      price in the event of a default. The conversion is limited such that the holder
      cannot exceed 4.99% ownership, unless the holders waive their right to such
      limitation.





Under
      the
      terms of the agreement, the Purchaser also received warrants to purchase an
      aggregate of up to 75,000,000 shares of common stock. The warrants are
      exercisable at a price of $0.02 per share, subject to adjustment, including
      anti-dilution protection. The
      warrants have a five-year contractual life. The warrants do not contain a forced
      exercise attribute similar to previously issued warrants. It
      is
      important to note that the warrants contain a provision that, if at the
      time of exercise, NeoMedia is in default of the warrant agreement, the holder
      can perform a “cashless” exercise of the warrants and in lieu of making payment
      of the exercise price in cash, elect instead to withhold shares as consideration
      for the exercise price. In the event of such a “cashless” exercise, NeoMedia
      would not receive any cash proceeds upon the exercise of such warrants. NeoMedia
      is currently in default of the Investor Registration Rights Agreement entered
      into on March 27, 2007, due to a pre-existing default on its previous financing
      arrangements with the Buyer. Such a default of the Investor Registration Rights
      Agreement constitutes an event of default under the warrant agreements issued
      in
      connection with the secured convertible debenture. As a result, YA
      Global
      Investments currently has the right to exercise on a cashless basis the 75,000,000 of
      warrants they hold that were issued in connection with the August 2007
      Debenture.




In
      connection with the August 2007 Debenture, NeoMedia and the Purchaser also
      entered into a Repricing Agreement whereby (i) the exercise price of 427,000,000
      warrants previously acquired by the purchaser under prior financing arrangements
      with NeoMedia was reset to $0.02, and (ii) the fixed conversion price on all
      convertible debentures and preferred stock held by the Purchaser was reset
      to
      $0.02.




69




**Sale
      of 12Snap - March 2007**




On
      April
      4, 2007, NeoMedia entered into a material definitive agreement with Bernd M.
      Michael (the “Buyer”), a private investor and former shareholder of 12Snap prior
      to NeoMedia’s acquisition of 12Snap, pursuant to which the Buyer purchased from
      NeoMedia 90% of the shares of 12Snap, pursuant to the following material
      terms:





·
            $1,100,000
                was paid by the Buyer to NeoMedia in cash at closing, of which $1,015,000
                was applied toward amounts owed to silent partners of
                12Snap;




·
            $500,000
                was placed into an escrow account for 90 days to secure warranty
                claims,
                and was paid during July 2007;




·
            Buyer
                waived his portion of the purchase price guarantee obligation in
                the
                amount of $880,000;




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




·
            12Snap
                management waived their portion of the purchase price guarantee obligation
                in the amount of $880,000;




·
            12Snap
                management returned to NeoMedia 5,225,039 shares of NeoMedia common
                stock
                previously issued to 12Snap
                management;




·
            NeoMedia
                will retain a 10% ownership in 12Snap, subject to an option agreement
                pursuant to which NeoMedia has the right to sell and Buyer has the
                right
                to acquire the remaining 10% stake held by NeoMedia for a purchase
                price
                of $750,000 after December 31, 2007;
                and




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




**$7.5
      Million Convertible Debenture - March 2007**




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





At
      any
      time from the closing date until December 29, 2008, the purchaser has the right
      to convert the convertible debenture into NeoMedia common stock at the then
      effective conversion price, which varies relative to NeoMedia’s trading stock
      price, at the lower of $0.02 per share, or 90% of the lowest closing bid price
      (as reported by Bloomberg, L.P.) of the common stock for the 30 trading days
      immediately preceding the conversion date and adjusts to 50% of the lowest
      closing bid price in the event of a default.





In
      connection with the March 2007 Debenture Agreement, NeoMedia applied $1,312,000
      of the gross proceeds toward payment of liquidated damages accrued on previous
      convertible instruments payable to the purchaser, and $366,000 toward accrued
      interest on previous convertible debentures. YA Global Investments also retained
      fees of $781,000, resulting in net proceeds to the Company of $5,000,000.





70





**Obligations
      Relating to Gavitec and 12Snap**





As
      of
      December 31, 2006, NeoMedia had recorded liabilities of $16,233,000 and
      $5,194,000 relating to purchase price guarantee obligations associated with
      its
      acquisitions of 12Snap and Gavitec, respectively. Pursuant to the terms of
      each
      acquisition, in the event that NeoMedia’s stock price at the time the
      consideration shares issued in connection with the acquisitions of Mobot,
      Sponge, Gavitec, and 12Snap became saleable (either upon effectiveness of a
      registration statement containing the shares, or under Rule 144) was less than
      the contractual price (between $0.3839 and $0.3956), NeoMedia is obligated
      to
      compensate the sellers in cash for the difference between the price at the
      time
      the shares became saleable and the relevant contractual price. The shares became
      saleable during the first quarter of 2007.





On
      January 23, 2007, NeoMedia entered into an agreement with the former
      shareholders of Gavitec, whereby this purchase price obligation is to be
      satisfied through the payment by NeoMedia of (i) $1,800,000 in cash, payable
      no
      later than February 28, 2007 (subsequently extended to March 31, 2007), and
      (ii)
      61,000,000 shares of NeoMedia common stock to be issued no later than February
      28, 2007. NeoMedia also agreed to pay interest accrued on the purchase price
      in
      the amount of $481,000 and reimburse $100,000 of costs related to the
      acquisition to the primary former shareholder of Gavitec no later than February
      28, 2007. NeoMedia issued the shares and made cash payments of $2,113,000 during
      March 2007. In August 2007, payments totaling $157,000 were made. As of
      September 30, 2007, NeoMedia owes $111,000 in remaining interest payments
      relating to this obligation.





During
      the nine months ended September, 2007, NeoMedia issued 197,620,948 shares of
      its
      common stock in satisfaction of a portion of the 12Snap purchase price
      obligation totaling $9,427,000 Additionally, NeoMedia has made cash payments
      against the liability totaling $467,000, and further reduced the balance through
      the forgiveness of $1,760,000 of the obligation in connection with the sale
      of
      12Snap. The balance on the purchase price obligation as of September 30, 2007
      was $4,592,000, which includes $13,000 in accrued interest. The Company is
      currently negotiating payment terms for the balance of the obligation.





Prior
      to
      the acquisition of 12Snap by NeoMedia, 12Snap entered into silent partnership
      debt arrangements with principal and interest totaling $4.8 million. The
      partnership agreements were scheduled to terminate on December 31, 2008 and
      2009. However, due to the acquisition of all shares of 12Snap by NeoMedia,
      an
      early termination was agreed on for the silent partnership agreements. Those
      silent partnerships terminated as of February 28, 2006 with the acquisition
      of
      12Snap by NeoMedia. NeoMedia made payments toward the outstanding principal
      of
      $2.1 million and $0.6 million during March 2006 and December 2006, respectively.
      The balance as of December 31, 2006 relating to silent partners was $2.1
      million. NeoMedia made additional payments of $1.0 million during February
      2007,
      and the remaining balance of $1.1 million was paid from the proceeds of the
      sale
      of 12Snap in April 2007.





**HipCricket
      Note Receivable**





On
      July
      27, 2007, NeoMedia entered into a settlement agreement with HipCricket for
      the
      early payment of a note receivable due to NeoMedia from HipCricket. The parties
      agreed that HipCricket would pay NeoMedia $221,000 in settlement of notes and
      interest payable from HipCricket to NeoMedia totaling $246,000, of which
      $100,000 was due on August 31, 2007 and $146,000 was due on February 28, 2008.
      The payment was made on July 27, 2007.





**China
      Order**





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





71





**Sources
      of Cash and Projected Cash Requirements**





As
      of
      September 30, 2007, NeoMedia’s cash balances were $226,000. NeoMedia intends to
      attempt to fund its growth and working capital deficiencies from the following
      sources during the remainder of 2007 and beyond:





*Sale
      of non-core business units.* During
      August 2006, NeoMedia announced its intent to sell its Micro Paint Repair
      business unit. On
      November 1, 2007 the Company entered into a definitive purchase
      agreement for the sale of the assets of the Micro Paint Repair
      business unit, excluding the assets of the U.S. Auto Xperience operations,
      with
      an expected closing date in mid November 2007. NeoMedia
      sold its Telecom Services business unit for $1,350,000 cash.





*Exercise
      of options and warrants.* One of
      the Company’s shareholders, YA
      Global
      Investments ,
      currently holds warrants to purchase up to 502,000,000 shares of Company common
      stock at an exercise price of $0.02 per share. NeoMedia
      can force exercise of certain of the warrants if the closing bid price of
      NeoMedia stock is more than $0.10 greater than the exercise price of any of
      the
      warrants for 15 consecutive trading days. It
      is
      important to note that the warrants held by YA
      Global
      Investments contain
      a provision that, if NeoMedia is in default of the warrant agreement, the
      holder can perform a “cashless” exercise of the warrants and in lieu of making
      payment of the exercise price in cash, elect instead to withhold shares as
      consideration for the exercise price. In the event of such a “cashless”
exercise, NeoMedia would not receive any cash proceeds upon the exercise of
      such
      warrants. NeoMedia is currently in default under the warrant agreements due
      to
      its default position under the Investor Registration Rights Agreements
      associated with certain of the convertible financings. As a result, YA
      Global
      Investments currently has the right to exercise on a cashless basis 502,000,000 of the
      warrants they hold, and NeoMedia may not receive any cash proceeds from such
      exercises.





In
      addition, certain outstanding employee stock options are in-the-money and could
      be exercised at the holders’ discretion from time to time. As of September 30,
      2007, NeoMedia had 109,168,494 outstanding employee stock options, of which
      24,850,000 were in-the-money based on the closing price on September 30, 2007
      of
      $0.0195 per share. Total potential proceeds to the Company from exercise of
      all
      in-the-money options are $236,000. On February 1, 2007, NeoMedia instituted
      a
      stock option repricing plan as a retention tool to align its employees with
      the
      new vision of NeoMedia. Under the Plan, NeoMedia repriced 50,148,750 stock
      options held by current employees, contractors, and directors. Options for
      employees of NeoMedia’s ongoing operations were repriced as follows: (i) options
      that were vested as of February 1, 2007, were repriced to $0.045 per share,
      which was the last sale price on February 1, 2007, (ii) options that are
      scheduled to vest during the remainder of 2007 were repriced to $0.075, (iii)
      options that vest during 2008 were repriced to $0.125, and (iv) options that
      vest during 2009 were repriced to $0.175. Options will continue to vest on
      their
      regular schedule, which generally is 25% upon grant and 25% on each subsequent
      anniversary date. The Company also repriced options for outside directors as
      follows: options with an exercise price below $0.24 were repriced to $0.045,
      and
      options with an exercise price $0.24 or higher were repriced to $0.075. In
      addition, the Company repriced options held by employees of its held for sale
      Micro Paint Repair and Telecom Services businesses, such that all vested options
      were repriced to $0.045 per share, and all unvested options will vest upon
      sale
      of the respective business unit at an exercise price of $0.075 per share, with
      a
      12-month period to exercise. NeoMedia expects that additional funds could be
      realized upon exercise of such repriced options.





*Strategic
      Investment* .
      NeoMedia is currently in the process seeking a significant strategic investment
      from a long term capital investor to secure sources of cash to fund the
      Company’s growth.





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




72





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





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





NeoMedia
      has incurred both cash and non-cash costs associated with the financing
      arrangements with YA
      Global
      Investments ,
      as
      follows:





·
            In
                connection with the $1.8 million convertible debenture in August
                2007,
                NeoMedia issued 75,000,000 warrants toYA
                Global Investmentswith
                an exercise price of $0.02 per share. NeoMedia paid cash fees of
                $200,000
                from the proceeds of the debenture. NeoMedia also repriced 427,000,000
                warrants previously issued toYA
                Global Investmentswith exercise prices of $0.04 -$0.06 to $0.02, and reset the fixed
                conversion price on all previously issued convertible debentures
                and
                convertible preferred stock to $0.02.





·
            In
                connection with the $7.5 million convertible debenture in March 2007,
                NeoMedia issued 125,000,000 warrants toYA
                Global Investmentswith an exercise price of $0.04 per share, which were subsequently
                repriced to $0.02 in August 2007. NeoMedia also paid cash fees of
                $781,000
                from the proceeds.





·
            In
                connection with the $2.5 million convertible debenture in December
                2006,
                NeoMedia issued 42,000,000 warrants toYA
                Global Investmentswith an exercise price of $0.04 per share, which were subsequently
                repriced to $0.02 in August 2007. NeoMedia also paid cash fees of
                $270,000
                from the proceeds.





·
            In
                connection with the $5 million convertible debenture in August 2006,
                NeoMedia issued 175,000,000 warrants toYA
                Global Investmentswith exercise prices between $0.05 and $0.25, which were subsequently
                repriced to $0.02 in August 2007.





·
            In
                connection with the $27 million Series C convertible preferred stock
                sale
                in February 2006, NeoMedia incurred the following costs: (i)YA
                Global Investmentsheld back a $2,700,000 cash fee from the proceeds of the sale, (ii)
                NeoMedia issued 75 million warrants toYA
                Global Investmentswith exercise prices between $0.35 and $0.50, which were subsequently
                repriced to $0.02 in August 2007, and (iii) NeoMedia issued 2,000,000
                warrants with an exercise price of $0.328 to another party for structuring
                and consulting fees associated with the sale.




73




·
            In
                connection with the 2005 SEDA entered into during March 2005, NeoMedia
                incurred the following costs: (i) NeoMedia issued 75,000,000 warrants
                toYA
                Global Investmentswith an exercise price of $0.20, 10,000,000 of which were subsequently
                repriced to $0.02 in August 2007, and (ii) NeoMedia issued 4,000,000
                warrants with an exercise price of $0.227 to another party for structuring
                and consulting fees associated with the 2005 SEDA. The fair value
                of these
                warrants at the time they were issued were recognized as deferred
                financing fees. The unamortized balance of these fees in the amount
                of
                $13,256,000 was written off during the year ended December 31, 2006.




NeoMedia’s
      cash flow used in operations was $6,653,000 (excluding cash used in operations
      of discontinued 12Snap, Telecom Services and Micro Paint Repair business units
      of $741,000) for the nine months ended September 30, 2007. In the event that
      (i)
      NeoMedia is unsuccessful in divesting of its Micro Paint Repair business unit
      in
      a timely fashion, (ii) NeoMedia’s stock price does not increase to levels where
      it can force exercise of enough of its outstanding warrants to generate material
      operating capital, (iii) the market for NeoMedia’s stock will not support the
      sale of shares underlying such warrants or other funding sources, or (iv)
      NeoMedia does not realize a material increase in revenue during the next 12
      months, NeoMedia will have to seek additional cash sources. There can be no
      assurances that such funding sources will be available. If necessary funds
      are
      not available, NeoMedia’s business and operations would be materially adversely
      affected and in such event, NeoMedia would attempt to reduce costs and adjust
      its business plan, and could be forced to sell certain of its assets, including
      its subsidiaries.





74


**Contractual
      Obligations**





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





·
            NeoMedia
                leases its office facilities and certain office and computer equipment
                under various operating leases which provide for minimum rents and
                generally include options to renew for additional
                periods;




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




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




·
            NeoMedia
                issued Series C convertible preferred shares with face value of
                $20,877,000 and convertible debentures with a face value of $16,734,000
                that are subject to conversion at future dates, plus the expected
                value of
                liquidated damages accrued in the amount of $1,388,000 relating to
                these
                convertible instruments; and




·
            NeoMedia
                has accrued the amount of $4,592,000 relating to a purchase price
                guarantee obligation in connection with its acquisition of
                12Snap.





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





**Series
                C****Subsidiary**
            
            
            
            **Convertible****Operating**
            
            **Acquisition**
            
            **Convertible**
            
            **Preferred****Leases**
            
            **Commitments**
            
            **Debentures**
            
            **Stock**
            
            **Total**(US
                dollars in thousands)2007
                (remaining three months)
            
            $
            71
            
            $
            4,592
            
            $
            31,685
            
            $
            20,877
            
            $
            57,2252008
            
            
            148
            
            
            0
            
            
            0
            
            
            0
            
            
            1482009
            
            
            12
            
            
            0
            
            
            0
            
            
            0
            
            
            122010
            
            
            3
            
            
            0
            
            
            0
            
            
            0
            
            
            32011
            
            
            0
            
            
            0
            
            
            0
            
            
            0
            
            
            0Thereafter
            
            
            0
            
            
            0
            
            
            0
            
            
            0
            
            
            0**Total**
            
            **$**
            **234**
            
            **$**
            **4,592**
            
            **$**
            **31,685**
            
            **$**
            **20,877**
            
            **$**
            **57,388**





In
      addition, as of September 30, 2007, NeoMedia had future obligations relating
      to
      its discontinued Micro Paint Repair and Telecom Services businesses totaling
      $1,397,000, most of which is expected to be assumed by the buyers upon the
      anticipated sale of each business unit.




75


**ITEM
      3.** **QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK** **.**





The
      Company is exposed to market risks associated with interest rates, investments,
      and currency movements on non-U.S. dollar denominated assets and liabilities.
      The Company assesses these risks on a regular basis. There have been no
      significant changes in the Company’s market risk since it filed its Annual
      Report on Form 10-K on April 3, 2007.





**ITEM
      4. CONTROLS AND PROCEDURES**





**Evaluation
      of Disclosure Controls and Procedures**





NeoMedia
      maintains disclosure controls and procedures, as defined in rules 13a-15(e)
      and
      15d-15(e) under the Securities and Exchange Act of 1934, as amended. These
      controls are designed to ensure that information required to be disclosed in
      the
      reports NeoMedia files or submits pursuant to the Securities and Exchange Act
      of
      1934 is recorded, processed, summarized and reported within the time periods
      specified in the rules and forms of the Securities and Exchange Commission,
      and
      that such information is accumulated and communicated to our management,
      including our Chief Executive Officer (“CEO”) and Chief Financial Officer
      (“CFO”), as appropriate, to allow timely decisions regarding required
      disclosure. In designing and evaluating NeoMedia’s disclosure controls and
      procedures, management recognizes disclosure controls and procedures, no matter
      how well designed and operated, can only provide reasonable assurance of
      achieving the desired control objectives, and in reaching a reasonable level
      of
      assurance, management necessarily is required to apply judgment in evaluating
      the cost-benefit relationship of possible controls and procedures.





NeoMedia
      carried out an evaluation, under the supervision and with the participation
      of
      its management, including the CEO and CFO, of the effectiveness of the design
      and operation of our disclosure controls and procedures as of the end of the
      period covered by this Quarterly Report on Form 10−Q. Based on this evaluation,
      the CEO and CFO concluded that NeoMedia’s disclosure controls and procedures
      were not effective as of September 30, 2007, at the reasonable assurance level,
      because of the material weaknesses described in Item 9A of NeoMedia’s Annual
      Report on Form 10−K for the fiscal year ended December 31, 2006, which NeoMedia
      is still in the process of remediating. Please see “Management’s Report on
      Internal Control over Financial Reporting” in Item 9A of the 2006 Form 10−K for
      a full description of these weaknesses.





Notwithstanding
      the material weaknesses described in Item 9A of the Form 10−K for the fiscal
      year ended December 31, 2006, NeoMedia believes that its condensed consolidated
      financial statements presented in this Quarterly Report on Form 10−Q fairly
      present, in all material respects, NeoMedia’s financial position, results of
      operations, and cash flows for all periods presented herein.





**Changes
      in Internal Control Over Financial Reporting**





There
      have been no changes to NeoMedia’s internal control over financial reporting
      during the quarter ended September 30, 2007 that have materially affected,
      or
      are reasonably likely to materially affect, NeoMedia’s internal control over
      financial reporting.





**Management’s
      Remediation Efforts**





As
      of the
      date of this filing, NeoMedia has taken or is currently taking the following
      steps to strengthen its internal control over financial reporting.
      Notwithstanding such efforts, the material weaknesses described in Item 9A
      of
      NeoMedia’s Form 10−K for the fiscal year ended December 31, 2006, will not be
      considered remediated until the new controls operate for a sufficient period
      of
      time and are tested (in accordance with the requirements of Section 404 of
      the
      Sarbanes-Oxley Act) to enable management to conclude that the controls are
      operating effectively.





1.
            Control
                environment over bank accounts. As disclosed in NeoMedia’s December 31,
                2006 Form 10-K, on January 9, 2007, management strengthened these
                controls
                by updating all appropriate bank signature cards, and by requiring
                two
                authorized signatures to add/change/delete employees who are authorized
                to
                input and verify wire transfers.




76




2.
            Review
                and approval of general ledger journal entries. As disclosed in our
                December 31, 2006 Form 10-K, on January 31, 2007, all journal entries
                are
                being reviewed and approved by the appropriate level of management
                prior
                to being input into the general
                ledger.





Management
      is currently addressing each of the material weaknesses in internal control
      over
      financial reporting cited in NeoMedia’s 2006 Form 10−K and is committed to
      remediating them as expeditiously as possible. Management will devote
      significant time and resources to the remediation effort.





77


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





On
      April
      20, 2004, NeoMedia re-filed its suit against Scanbuy in the Southern District
      of
      New York alleging patent infringement. Scanbuy filed its answer on June 2,
      2004.
      NeoMedia filed its answer and affirmative defenses on July 23, 2004. On January
      20, 2007, the court dismissed Scanbuy's request for a summary judgment.
      Discovery is ongoing. NeoMedia
      expects to agree in November, 2007, to stay the pending patent litigation
      against Scanbuy for a period of six months.





**Electronic
      Frontier Foundation**





In
      October 2007, NeoMedia received a communication from the United States Patent
      and Trademark Office (USPTO) stating that a request by the Electronic Frontier
      Foundation for Ex-Parte Reexamination of U.S. Patent No. 6,199,048 (“the ‘048
      patent”) has been granted. Although the ’048 patent is an important
      NeoMedia patent, it is not alone. NeoMedia has a portfolio consisting of U.S.
      and foreign patents and pending applications relating to various inventions
      surrounding the processing of machine readable codes over wireless networks.
      NeoMedia believes some or all of the claims of the ’048 patent will be
      confirmed by the USPTO in the course of the re-examination.




78


**ITEM
      1A. RISK FACTORS**





In
      addition to the other information set forth in this report, you should carefully
      consider the factors discussed in Part I, “Item 1A. Risk Factors” in
      our Annual Report on Form 10-K for the year ended December 31, 2006, which
      could
      materially affect NeoMedia’s business, financial condition or future results.
      The risks described in NeoMedia’s Annual Report on Form 10-K are not the only
      risks facing the Company. Additional risks and uncertainties not currently known
      to NeoMedia or that are currently deemed to be immaterial also may materially
      adversely affect NeoMedia’s business, financial condition and/or operating
      results.  There were no material changes in the Company's risk factors from
      the risks disclosed in the Company's Form 10-K for the year ended
      December 31, 2006.




**ITEM
      2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
      PROCEEDS**




On
      July
      20, 2007, NeoMedia issued 517,415 shares of unregistered common stock to two
      related parties as payment toward a consulting contract. The related parties
      were George O’Leary, who is a member of the Company’s Board of Directors and a
      consultant to the Company, and Jay Bonk, the Company’s Interim Executive Vice
      President of Sales and Marketing.





On
      August
      16, 2007, NeoMedia issued 28,854,685 shares of unregistered common stock to
      Tesscourt Capital, Ltd. as settlement of debt.





On
      October 2, 2007, NeoMedia issued 264,753 shares of unregistered common stock
      to
      two related parties as payment toward a consulting contract. The related parties
      were George O’Leary, who is a member of the Company’s Board of Directors and a
      consultant to the Company, and Jay Bonk, the Company’s Interim Executive Vice
      President of Sales and Marketing.





On
      October 31, 2007, NeoMedia issued 6,190,476 shares of unregistered common stock
      to Guy Fietz in conjunction with the disposition of the NeoMedia Telecom
      Services business unit.





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




**ITEM
      3. DEFAULT UPON SENIOR SECURITIES**




NeoMedia
      is currently in default of (i) the
      Investor Registration Rights Agreement entered into on February 17, 2006, in
      connection with the $22 million Series C Convertible preferred Stock Sale,
      (ii)
      the Investor Registration Rights Agreement entered into on August 24, 2006,
      in
      connection with the $5 million secured convertible debenture, (iii) the
      Investor Registration Rights Agreement entered into on December 29, 2006, in
      connection with the $2.5 million secured convertible debenture, and (iv) the
      Securities Purchase Agreement entered into on August 24, 2007, in connection
      with the $1.8 million secured convertible debenture. As a result, the Purchaser
      has certain rights with respect to the financing arrangements, specifically,
      (i)
      the full face value of each instrument is callable in the aggregate amount
      of
      $38,111,000, (ii) up to 492,000,000 warrants held by the Purchaser with an
      exercise price of $0.02 can be exercised on a cashless basis, and (iii) NeoMedia
      is responsible for liquidated damages as required by each financing arrangement.




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




None.




79




**ITEM
      5. OTHER INFORMATION**




Based
      upon the required market capitalization test as of the last day of the second
      quarter for the year ending December 31, 2007, the Company has determined that
      it will not have an accelerated filer status as of the end of the current fiscal
      year. The company will be required to perform this test on an annual basis
      as of
      the last day of the second quarter to determine its filing status.




80




**Item6.
      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****:**




On
        November 7, 2007, NeoMedia filed a report on Form 8-K with respect to Items
        1.01, disclosing that it had entered into a definitive purchase agreement
        for
        the sale of the assets of the Micro Paint Repair business unit, excluding
        the
        assets of the U.S. Auto Xperience operations to Micro Paint Holdings Limited,
        a
        New Zealand corporation, for $2,000,000 cash plus $200,000 in the stock of
        Micro
        Paint Holdings Limited, with an expected closing date in mid November.




On
      November 5, 2007, NeoMedia filed a report on Form 8-K with respect to Items
      1.01., 2.01, and 2.06, disclosing that it had completed the sale of its
      ownership in Triton Global Business Services, and that it expected to record
      a
      material impairment charge in connection with the sale.





On
      October 22, 2007, NeoMedia filed a report on Form 8-K with respect to Item
      5.02,
      disclosing that it had named Frank Pazera as Chief Financial
      Officer.





On
      October 1, 2007, NeoMedia filed a report on Form 8-K with respect to Items
      5.02
      and 8.01, disclosing that (i) the Company had announced plans to relocate its
      corporate headquarters, (ii) Christian Steinborn, 37, CEO of Gavitec, will
      assume the additional role of Chief Operating Officer of NeoMedia, and (iii)
      Charles W. Fritz, the founder and Chairman of the Board of NeoMedia, has
      resigned his role as Chairman of the Board. Mr. Fritz plans to pursue ventures
      in economic and environmental industries.





On
      September 4, 2007, NeoMedia filed a report on Form 8-K with respect to Item
      4.01, reporting that it had dismissed Stonefield Josephson, Inc. as its
      independent registered public accounting firm. On September 7, 2007, NeoMedia
      amended the 8-K to report that it had engaged Kingery & Crouse, P.A. as its
      independent registered public accounting firm, effective immediately.





On
      August
      30, 2007, NeoMedia filed a report on Form 8-K with respect to Items 1.01 and
      3.02, reporting that it had entered into a secured convertible debenture
      financing arrangement with YA Global Investments, L.P. (formerly known as
      Cornell Capital Partners) in the principal amount of $1,775,000.





On
      August
      21, 2007, NeoMedia filed a report on Form 8-K with respect to Item 8.01,
      reporting that it had entered into a letter of intent to sell its ownership
      of
      90% of the outstanding shares of Triton Global Business Services, Inc.
      (“Triton”), the operations of which comprise NeoMedia’s Telecom Services
      business unit, to Greywolf
      Entertainment, Inc, a Canadian company (the “Buyer”), for $1,500,000 cash (which
      was subsequently amended to $1,350,000) .





On
      August
      17, 2007, NeoMedia filed a report on Form 8-K with respect to Items 1.01 and
      3.02, reporting that it had entered into an agreement to issue 28,854,685 shares
      of unregistered common stock to Tesscourt Capital Ltd. in satisfaction of debt
      owed in connection with the Company’s acquisition of BSD Software in 2006.




81


**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:November
                8, 2007
            By:
            */s/
              William J. Hoffman*William
                J. Hoffman
                Chief
                  Executive Officer




Date:November
                8, 2007
            By:
            */s/
              Frank J. Pazera*Frank
                J. Pazera
                Chief
                  Financial Officer




Date:November
                8, 2007
            By:
            */s/
              J. Scott Womble*J.
                Scott Womble
                Principal
                  Accounting Officer




82