**UNITED
        STATES**
 **SECURITIES
        AND EXCHANGE COMMISSION**
 **WASHINGTON,
        DC 20549**
  
 
 **FORM
        10-KSB**
  (Mark
        One)
  **þ** **** ANNUAL
        REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
        1934
  for
        the
        fiscal year ended December 31, 2006
  OR
 
  ̈ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
        OF
        1934
 
 Commission
        File Number: 0-50561
  **ENIGMA
        SOFTWARE GROUP, INC.**
 (Name
        of
        Small Business Issuer in Its Charter)
  **Delaware**
              **20-2675930**(State
                  or Other Jurisdiction of
                Incorporation
                  or Organization)
              (I.R.S.
                  Employer
                Identification
                  No.)2
                  Stamford Landing, Suite 100, Stamford, CT
                (Address
                  of Principal Executive Offices)
              06902
                (Zip
                  Code)
  (888)
        360-0646
 (Issuer's
        Telephone Number, Including Area Code)
  Securities
        registered under Section 12(b) of the Exchange Act: None
  Securities
        registered under Section 12(g) of the Exchange Act:
  Title
                  of Each Class
              Name
                  of Each Exchange on Which RegisteredCommon
                  Stock, $.001 Par Value
              Over-the-Counter
                  Bulletin Board
  Check
        whether the issuer is not required to file reports pursuant to Section 13
        or
        15(d) of the Exchange Act.  ̈
 
 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 þ No o
 
 Check
        if
        there is no disclosure of delinquent filers in response to Item 405 of
        Regulation S-B contained in this form, and no disclosure will be contained,
        to
        the best of the registrant’s knowledge, in definitive proxy or information
        statements incorporated by reference in Part III of this Form 10-KSB or any
        amendment to this Form 10-KSB. þ
 
 Indicate
        by check mark whether the registrant is a shell company (as defined in Rule
        12b-2 of the Exchange Act).
 Yes  ̈ No þ
  State
        issuer’s revenues for its most recent fiscal year. $1,327,481
  State
        the
        aggregate market value of the voting and non-voting common equity held by
        non-affiliates computed by reference to the price at which the common equity
        was
        sold, or the average bid and asked prices of such common equity, as of a
        specified date within the past 60 days. $ 1,550,768 as of March 21, 2007.
  **APPLICABLE
        ONLY TO CORPORATE REGISTRANTS**
  State
        the
        number of shares outstanding of each of the issuer’s classes of common equity,
        as of the latest practicable date. 4,191,266 shares
        of
        Common Stock, $0.001 par value, outstanding as of March 20, 2007.
  Transitional
        Small Business Disclosure Format (Check One): Yes  ̈ No þ
 
 
  **ENIGMA
        SOFTWARE GROUP, INC.**
  **TABLE
        OF CONTENTS TO ANNUAL REPORT**
 **ON
        FORM 10-KSB**
 **YEAR
        ENDED DECEMBER 31, 2006**
  **PART
                  I****Item
                  1.****Description
                  of Business**
              
              
              **3****Item
                  2.****Description
                  of Property**
              
              
              **4****Item
                  3.****Legal
                  Proceedings**
              
              
              **5****Item
                  4.****Submission
                  of Matters to a Vote of Security Holders**
              
              
              **5****PART
                  II****Item
                  5.****Market
                  for Common Equity, Related Stockholder Matters and Small Business
                  Issuer
                  Purchases of Equity Securities**
              
              
              **6****Item
                  6.****Management’s
                  Discussion and Analysis or Plan of Operation**
              
              
              **7****Item
                  7.****Financial
                  Statements**
              
              
              **24****Item
                  8.****Changes
                  in and Disagreements With Accountants on Accounting and Financial
                  Disclosure**
              
              
              **24****Item
                  8A.****Controls
                  and Procedures**
              
              
              **24****Item
                  8B.****Other
                  Information**
              
              
              **25****PART
                  III****Item
                  9.****Directors,
                  Executive Officers, Promoters and Control Persons; Compliance with
                  Section
                  16 (a) of the Exchange Act**
              
              
              **25****Item
                  10.****Executive
                  Compensation**
              
              
              **27****Item
                  11.****Security
                  Ownership of Certain Beneficial Owners and Management and Related
                  Stockholder Matters**
              
              
              **30****Item
                  12.****Certain
                  Relationships and Related Transactions, and Director
                  Independence**
              
              
              **31****Item
                  13.****Exhibits**
              
              
              **33****Item
                  14.****Principal
                  Accountant Fees and Services**
              
              
              **33**
  2
  **PART
        I**
 
 **Item
        1. Description of Business.**
 
 Enigma
        Software Group, Inc. (“Enigma” or the “Company”), is a Delaware corporation,
        headquartered in Connecticut, that was formed in 2005 and is the surviving
        corporation of a reverse takeover with Maxi Group, Inc. (“Maxi”); however, the
        business of the Company actually commenced in 1999. The Company is a developer
        of security software products designed to give customers information and
        control
        over the programs installed on their computers in an automated and easy-to-use
        way, thereby enhancing transparency and user-control. The Company sells and
        distributes its software products, which are downloadable, over the Internet.
 
 Maxi,
        which was a non-operating public company, was incorporated on June 17, 1986
        in the State of Nevada. On December 29, 2004, Maxi entered into a Share
        Exchange Agreement (the "Acquisition Agreement") with Adorons.com, Inc.
        (formerly known as Enigma Software Group, Inc.) a closely-held, Delaware
        corporation which commenced operations in 1999 (“Adorons”). Adorons was a
        developer of an Internet-based search network and downloadable security software
        products designed to give customers instant access to information on the
        web and
        control over the programs installed on their computers in an automated and
        easy-to-use way, thereby enhancing transparency and user-control.
 
 Pursuant
        to the terms of the Acquisition Agreement, which closed on February 16,
        2005, Maxi acquired substantially all of the issued and outstanding capital
        stock of Adorons, in exchange for 14,158,953 newly issued shares of Maxi's
        common stock (the "Exchange"). In addition, Maxi acquired for $50,000,
        97,633,798 shares of its own common stock from certain of its stockholders
        prior
        to the Exchange, which shares were canceled on February 16, 2005. Three
        stockholders of Adorons, who held 151,858 shares of common stock, did not
        exchange their shares for Maxi common stock at the time of the Exchange.
        However, on April 8, 2005, these stockholders did exchange all of their
        shares for 429,305 shares of Maxi common stock. For reporting purposes, these
        shares are considered to have been exchanged as of February 16, 2005.
 
 The
        14,588,258 shares of common stock represented approximately 89.81% of the
        ownership interests in Maxi. The Exchange, which resulted in the stockholders
        of
        Adorons obtaining control of Maxi, represented a recapitalization of Maxi,
        or a
        "reverse takeover" rather than a business combination. As a non-operating
        company, the assets and liabilities of Maxi were not material to the reverse
        takeover. For accounting purposes, Adorons was considered to be an acquirer
        in
        the reverse acquisition transaction and, consequently, the financial statements
        are the historical financial statements of Adorons and the reverse takeover
        has
        been treated as a recapitalization of Adorons. Additionally, on
        February 16, 2005, Maxi issued 135,000 shares of common stock to a related
        party for the assumption of certain liabilities that amounted to approximately
        $46,000.
 
 On
        April 14, 2005, Maxi completed a reincorporation merger to the state of
        Delaware and changed its name to Enigma Software Group, Inc. On May 17,
        2005, Adorons merged into its parent company, Enigma Software Group, Inc.,
        and
        ceased to exist as a separate company. Henceforth, Enigma Software Group,
        Inc.
        (“Enigma”) is defined as the Company.
 
 The
        Company presently employs eight persons on a full-time basis. However, during
        the year ended December 31, 2005, it had employed as many as 18 persons on
        a full and part-time basis. Eleven employees were terminated by the Company
        during the year ended December 31, 2005, (one of whom has since been
        rehired in January 2007) in an effort to reduce fixed operating costs, and
        some of their functions were outsourced, as well as absorbed by the remaining
        then seven employees.
  3
 
 ***Principal
        Product and its Market:***
 
 The
        Company's principal product SpyHunter® (“SpyHunter”) is an in-house developed
        software utility program that is used to scan and remove Spyware and Adware
        from
        customers’ computers and is marketed under the name SpyHunter.
 
 Spyware
        and other parasitic programs are installed on computers without the computer
        owners' knowledge or consent. Spyware programs allow their makers to monitor
        Internet browsing patterns, inundate computers with "pop-up" ads, transmit
        sensitive user data (including personal and financial information), and more.
        Many people are familiar with freeware, shareware, cookies, media players,
        interactive content and file sharing, but what they may not realize is that
        some
        of the aforementioned may contain hidden code or components that allow the
        developers of these applications and tools to collect and disseminate
        information about those using them.
 
 To
        protect our customers from Spyware and other threats, SpyHunter scans the
        files
        on a computer's hard drive, as well as Windows registry settings. SpyHunter
        then
        compares these files against our spyware database. SpyHunter's database consists
        of complete component profiles (files, registry settings, MD5 file signatures,
        and other diagnostic information) of various adware applications, spyware
        programs, backdoor trojans, browser hijackers, tracking cookies, worms,
        keyloggers, etc. that commonly afflict computers connected to the Internet.
        If
        SpyHunter's scanning process is unable to detect a suspicious threat, the
        customer has the option to rapidly generate a diagnostic report. SpyHunter
        will
        then transmit this information directly to our spyware helpdesk database,
        which
        is supervised by our support department. Using this updated information,
        the
        customer is now able to successfully detect and remove the parasitic program
        which is compromising their system.
 
 Spyware
        makers consistently update and alter their programs to avoid detection by
        anti-Spyware utilities like SpyHunter. For this reason, SpyHunter's spyware
        database is updated regularly using the collective diagnostic reports generated
        through our user base, coupled with the spyware component profiles assembled
        through our technical team's active research.
 
 ***Distribution
        Methods of the Product:***
 
 SpyHunter
        is downloaded over the Internet upon authorization of the customer’s credit card
        issuer. It is not sold in retail stores, but copies may be ordered on CD
        format
        from the Company’s website. Most users have historically found Enigma’s websites
        through advertisements purchased by the Company from Internet advertising
        companies and other advertising networks and search engines. Trial versions
        of
        SpyHunter are also available on download sites such as download.com and
        tucows.com. The Company also operates an affiliate program where other website
        operators can become resellers of Enigma products on a pay-for-performance
        basis. Most of the Company’s marketing agreements are short term purchase orders
        that either party can terminate, while other marketing is based on automated
        auctions for search engine advertising. None of the Company’s marketing
        agreements generate significant revenue for the Company.
 
 **Item
        2. Description of Property.**
 
 At
        December 31, 2006, the Company had no significant fixed assets, having sold
        some of its excess assets during the year ended December 31, 2005, as
        employees were terminated, and having written down in that year, any remaining
        assets to a negligible value due to an impairment loss resulting from the
        Company vacating its office space at 17 State Street, New York, New
        York.  The
        lease
        for that office space, which was entered into during 2004, was an operating
        lease for 6,236 square feet of office space requiring monthly rent of $16,629
        and which was due to expire on November 30, 2007. There is no lease for the
        Company’s current office space, which is located within an office suite complex
        in Stamford, Connecticut. Rather the Company entered into an office service
        agreement with the operator of the office suite, giving the Company a license
        to
        use designated offices as well as business center facilities and services.
  4
 
 The
        office services agreement covers services, such as telephone, heat, electricity,
        furniture, lighting, coffee, water, restroom facilities, reception, conference
        facilities, mailbox, parking and office cleaning. Pursuant to the office
        services agreement, the Company has six employees in approximately 350 square
        feet of dedicated office space under a six month lease agreement that has
        provisions for automatic renewals and is currently in effect until
        August 31, 2007, subject to the next automatic six month renewal, unless
        cancelled by either party. In February 2007, the Company notified the operator
        of the office suite complex that it would not renew again and would vacate
        the
        premises prior to August 31, 2007. On February 27, 2007, the Company signed
        a 15 month lease at a nearby facility at a lower cost, effective March 1,
        2007.
 
 **Item
        3. Legal Proceedings.**
 
 From
        time
        to time the Company is involved in routine legal matters incidental to its
        business. In the opinion of management, the ultimate resolution of such matters
        will not have a material adverse effect on its financial position, results
        of
        operations or liquidity .
 
 **Item
        4. Submission of Matters to a Vote of Security Holders** **.**
 
 No
        matter
        was submitted to a vote of the security holders during the fourth quarter
        of the
        fiscal year covered by this report.
  5
  **PART
        II**
  **Item
        5.**  **Market
        for Common Equity, Related Stockholder Matters and Small Business Issuer
        Purchases of Equity Securities.**
  ***Market
        Information***
  As
        of
        March 21, 2007, the most recent trading day on which shares of the Company
        were
        traded, the Company’s shares of common stock, par value $0.001 per share (the
“Common Stock”) were quoted on the Nasdaq Over the Counter Bulletin Board (the
“OTCBB”), under the trading symbol ENGM, at the closing bid price of $0.37 per
        share.
  The
        following table gives the range of high and low bid prices for the Company’s
        Common Stock, during the years ended December 31, 2005 and
        2006:
 
 **Low**
              
              ******High****Fiscal
                  2005***First
                  Quarter (commencing February 22)
              
              $
              0.42
              
              $
              2.45Second
                  Quarter
              
              $
              0.90
              
              $
              1.54Third
                  Quarter
              
              $
              0.30
              
              $
              1.40Fourth
                  Quarter
              
              $
              0.20
              
              $
              0.55**Fiscal
                  2006***First
                  Quarter
              
              $
              0.06
              
              $
              0.25Second
                  Quarter
              
              $
              0.05
              
              $
              0.09Third
                  Quarter
              
              $
              0.04
              
              $
              0.07Fourth
                  Quarter
              
              $
              0.02
              
              $
              0.15
 
 * The
        high
        and low prices listed have been rounded up to the next highest two decimal
        places.
 
 The
        market price of our Common Stock is subject to significant fluctuations in
        response to variations in our quarterly operating results, general trends
        in the
        market for the products we distribute, and other factors, over many of which
        we
        have little or no control. Broad market fluctuations, as well as general
        economic, business and political conditions, may adversely affect the market
        for
        our Common Stock, regardless of our actual or projected performance.
  ***Holders***
 As
        of
        March 22, 2007, there were 31 holders of record of the Company’s Common Stock.
        Of the Company’s 4,191,266 shares outstanding, 1,725,351 or approximately 41%
        were held in street name.
  ***Dividends***
  The
        Company has not declared any cash dividends within the past two years on
        its
        Common Stock. The Company does not anticipate or contemplate paying dividends
        in
        the foreseeable future. It is the present intention of management to utilize
        available funds, if any, for the development of the Company’s business.
  6
 
 ***Securities
        Authorized for Issuance Under Equity Compensation
        Plans***
  Number
                  of securities to
                be
                  issued upon exercise of
                outstanding
                  options,
                warrants
                  and
                rights
              
              Weighted-average
                exercise
                  price of
                outstanding
                  options,
                warrants
                  and
                rights
              
              Number
                  of securities remaining
                available
                  for future issuance
                under
                  equity compensation
                plans
                  (excluding
                securities
                  reflected in column (a))(a)
              
              (b)
              
              (c)Equity
                  compensation plansapproved
                  by security holders
              
              
              2,984,001
              
              $
              0.23
              
              
              15,999Equity
                  compensation plans notapproved
                  by security holders
              
              
              none
              
              
              none
              
              
              noneTotal
              
              
              2,984,001
              
              $
              0.23
              
              
              15,999
  ***Sales
        of Equity Securities***
  On
        June
        28, 2006, the Company sold Debentures to Dutchess Private Equities Fund,
        LP and
        Dutchess Private Equities Fund, II, LP (collectively “Dutchess”) in the
        principal amount of One Million dollars ($1,000,000), convertible into shares
        of
        Common Stock of the Company. The issuance and sale of the Debentures is intended
        to be exempt from registration by virtue of Section 4(2) of the 1933 Act
        and the
        provisions of Regulation D thereunder, based on the Company’s belief that the
        offer and sale of the Debentures did not involve a public offering, as all
        of
        the purchasers were “accredited” investors and no general solicitation was
        involved in the offering.
 
 On
        June
        28, 2006, the Company issued 7,433,988 shares of its Preferred Stock to Colorado
        Stark and Alvin Estevez in exchange for 12,052,001 shares of such holders
        shares
        of the Company’s Common Stock. The issuance of the Preferred Stock is intended
        to be exempt from registration by virtue of Section 4(2) of the 1933 Act
        and the
        provisions of Regulation D thereunder, based on the Company’s belief that the
        issuance of the Preferred Stock did not involve a public offering, as all
        of the
        purchasers were “accredited” investors and no general solicitation was involved
        in the offering.
 
 **Item
        6. Management's** **Discussion** **and Analysis or Plan of Operation.**
 
 This Management's **** Discussion
        and Analysis or Plan of Operation (MD&A) contains forward-looking statements that involve known and unknown
        risks, significant uncertainties and other factors that may cause our actual
        results, levels of activity, performance or achievements to be materially
        different from any future results, levels of activity, performance or
        achievements expressed, or implied, by those forward-looking statements.
        You can
        identify forward-looking statements by the use of the words “may,” “will,”
“should,” “could,” “expects,” “plans,” “anticipates,” “believes,” “estimates,”
“predicts,” “intends,” “potential,” “proposed,” or “continue” or the negative of
        those terms. These statements are only predictions. In evaluating these
        statements, you should specifically consider various factors, including the
        risk
        factors outlined below. These factors may cause our actual results to differ
        materially from any forward-looking statements. Although we believe that
        the
        exceptions reflected in the forward-looking statements are reasonable, we
        cannot
        guarantee future results, levels of activity, performance or achievements.
        Therefore, actual results may differ materially and adversely from those
        expressed in any forward-looking statements. We undertake no obligation to
        revise or update publicly any forward-looking statements for any
        reason.
  7
  **Risk
        Factors**
  Our
        financial condition, business, operation and prospects involve a high degree
        of
        risk. You should carefully read and consider the risks and uncertainties
        described below as well as the other information in this report before deciding
        to invest in our Company. We consider these risks to be significant to your
        decision whether to invest in our Common Stock at this time. If any of the
        following risks actually occur, our business, results of operations and
        financial condition could be seriously harmed, the trading price of our Common
        Stock could decline and you may lose all or part of your
        investment.
  **Risks
        Related to Our Business and Industry**
  ***As
        of December 31, 2006, there was substantial doubt about our ability to
        continue as a going concern.***  ***The
        Company may not be able to continue its operations and the financial statements
        do not include any adjustments that might result*** ***from
        the outcome of this uncertainty.***
 
 As
        of
        December 31, 2006, the Company’s independent public accounting firm issued
        a “going concern opinion” wherein they stated that the accompanying financial
        statements were prepared assuming the Company will continue as a going concern.
        The Company did not generate sufficient cash flows from revenues during the
        year
        ended December 31, 2006 to fund its operations. Also, as of
        December 31, 2006, the Company had negative net working capital of
        approximately $2 million. In addition, as discussed in Notes A, B and Q of
        the *Notes
        to Consolidated Financial Statements* ,
        the
        Company was required, beginning January 1, 2007 to make substantial
        amortizing principal and debt redemption premium payments, which payments
        put
        further strain on the Company’s limited cash resources. These matters raise
        substantial doubt about the Company’s ability to continue as a going concern.
        The financial statements do not include any adjustments that might result
        from
        the outcome of this uncertainty. Unless the Company is successful in generating
        increased sales, additional sources of revenue, or obtaining additional capital,
        or restructuring its business, the Company is likely to deplete its net working
        capital reserves during 2007.
  ***The
        Company continues to have negative cash flow and could run out of cash in
        six
        months or fewer.***
  At
        the
        present level of business activity and assuming that current sales continue
        at
        the average rate experienced during the months of December 2006 and January
        and February 2007, and the Company is required to continue making amortizing
        principal and debt redemption premium payments to Dutchess because of the
        non-effectiveness of the Company’s Registration Statement on Form SB-2, the
        Company’s working capital resources could be depleted within six months or
        fewer, i.e., sometime in the third quarter of 2007. Actual results may be
        better
        or worse than anticipated, depending upon the Company’s actual sales results.
  If
        all
        sales were to cease, and without reducing expenditures accordingly, the
        Company’s working capital reserves would be depleted within weeks. Therefore, if
        this situation were to occur, the Company would require additional funds
        of at
        least $2,000,000 in order to continue operations for the next 12 months.
        Please
        refer to Liquidity and Capital Resources in Management’s Discussion and Analysis
        of Financial Condition and Results of Operations.
  ***If
        we do not continue to innovate and provide products and services that are
        useful
        to users, we may not remain competitive, and our revenues and operating results
        could suffer.***
  Our
        success depends on providing products and services that people use for a
        high
        quality Internet experience. Our competitors are constantly developing
        innovations in web search, online advertising and providing information to
        people. As a result, we must continue to invest significant resources in
        new
        product development in order to introduce new high-quality products and services
        that people will use. If we are unable to predict user preferences or industry
        changes, or if we are unable to modify our products and services on a timely
        basis, we may lose users and advertisers. Our sales will also decline if
        our
        innovations are not responsive to the needs of our users and advertisers,
        are
        not appropriately timed with market opportunity, or are not effectively brought
        to market.
  8
  ***We
        have a material weakness in internal controls due to a limited segregation
        of
        duties, and if we fail to maintain an effective system of internal controls,
        we
        may not be able to accurately report our financial results or prevent fraud.
        As
        a result, current and potential stockholders could lose confidence in our
        financial reporting which could harm the trading price of our
        stock.***
  Effective
        internal controls are necessary for us to provide reliable financial reports
        and
        prevent fraud. Inferior internal controls could cause investors to lose
        confidence in our reported financial information, which could have a negative
        effect on the trading price of our Common Stock. During the year ended
        December 31, 2005, we found it necessary to reduce our staffing in order to
        conserve cash, as our level of business activity declined. As a result, there
        is
        very limited segregation of duties, and the Company has identified this as
        a
        material weakness in our internal controls. However, we have implemented
        procedures to both limit access to bank accounts and to segregate the approval
        of invoices from disbursements of cash, but with only eight employees at
        the
        Company, of which only one full-time employee and one part-time employee
        are
        involved in the financial function, total segregation of duties is not
        practicable.
 
 ***Our
        corporate culture has contributed to our success, and if we cannot maintain
        this
        culture as we grow, our business may be harmed as we might become less
        responsive to the market conditions that affect our
        products.***
  We
        believe that a critical contributor to our success has been our corporate
        culture, which we believe fosters innovation, creativity and teamwork. As
        our
        organization grows, and we are required to implement more complex organizational
        management structures, we may find it increasingly difficult to maintain
        the
        beneficial aspects of our corporate culture. This could negatively impact
        our
        future success.
  ***Existing
        or new legislation could expose us to substantial liability, restrict our
        ability to deliver services to our users, limit our ability to grow and cause
        us
        to incur significant expenses in order to comply with such laws and
        regulations.***
  There
        are
        a number of emerging initiatives in the computer software industry. One
        example is the Consumer Protection Against Computer Spyware Act that provides
        protection for consumers against certain types of software. The aim of most
        of
        the emerging initiatives is to define which practices in the software industry
        are acceptable, which practices are violations of existing law, and what
        will
        require new laws. This
        type of legislation could impact us negatively in several ways, primarily
        because it would reduce the proliferation of Spyware, thereby making it more
        difficult to market an anti-Spyware software removal product.
 
 For
        example, during 2005, legislation pertaining to Spyware was enacted in 12
        states. Such legislation is being considered in a number of additional states.
        This type of Legislation imposes severe penalties for companies who are in
        the
        business of distributing and installing Spyware. Typically companies will
        be
        charged fines ranging from $1,000 to $1,000,000 for each instance of installing
        Spyware. In some states such as New York, in addition to sharp penalties,
        there
        are also criminal charges that can be brought for installing Spyware.
  9
 
 This
        type
        of legislation could impact our business negatively because it would reduce
        the
        proliferation of Spyware, thereby making it more difficult to market an
        anti-Spyware software removal product .
 
 ***Our
        intellectual property rights are valuable, and any inability to protect them
        could reduce the value of our products, services and
        brand.***
  The
        technology and software we have developed, which underlie our products and
        services, are very important to us. Our proprietary products are not protected
        by patents. However, SpyHunter is protected as a registered trademark. To
        further protect our intellectual property rights, we license our software
        products and require our customers to enter into license agreements that
        impose
        restrictions on their ability to use the software or transfer it to other
        users.
        Additionally, we seek to avoid disclosure of our trade secrets through a
        number
        of means, including, but not limited to, requiring those persons with access
        to
        our proprietary information to execute confidentiality agreements with us,
        and
        by restricting access to our source code. In addition, we protect our software,
        documentation, templates and other written materials under trademark, trade
        secret and copyright laws. Even with all of these safeguards, there can be
        no
        assurance that such precautions will provide meaningful protection from
        competition or that competitors will not independently be able to develop
        similar technology. The copyright, trademark and trade secret laws, which
        are a
        significant source of protection for our intellectual property, offer only
        limited protection. In addition, legal standards relating to the validity,
        enforceability and scope of protection of intellectual property rights in
        software are uncertain and still evolving, and the future viability or value
        of
        any of our intellectual property rights is uncertain. Effective trademark,
        copyright and trade secret protection may not be available in every country
        in
        which our products are distributed or made available. ** If,
        in
        the future, litigation is necessary to enforce our intellectual property
        rights,
        to protect our trade secrets, or to determine the validity and scope of the
        proprietary rights of others, such litigation could result in substantial
        costs
        and diversion of resources and could have a material adverse effect on our
        business, operating results and/or financial condition. As a result, ultimately,
        we may be unable, for financial or other reasons, to enforce our rights under
        the various intellectual property laws described above.
  ***We
        may be subject to intellectual property rights claims in the future, which
        are
        costly to defend, and could require us to pay damages and limit our ability
        to
        use certain technologies in the future.***
  The
        Company has not been a party to an intellectual property suit. However, as
        we
        face increasing competition, the possibility of intellectual property rights
        claims against us grows. Our revenues rely significantly on our intellectual
        property and to the extent we become subject to any intellectual property
        claims, they would have a material effect on the Company, and our technologies
        may not be able to withstand third-party claims or rights against their use.
        Any
        intellectual property claims, with or without merit, could be time-consuming,
        expensive to litigate, or settle, and could divert management resources and
        attention. **** An
        adverse determination could also prevent us from offering our products and
        services to others and may require that we procure substitute products or
        services . With
        respect to an intellectual property rights claim, we may have to pay damages
        or
        stop using technology found to be in violation of a third party’s rights. We may
        have to seek a license for the technology, which may not be available on
        reasonable terms and may significantly increase our operating expenses. The
        technology also may not be available for license to us at all. As a result,
        we
        may be required to develop alternative non-infringing technology, which could
        require significant effort and expense. If we cannot license or develop
        technology for the infringing aspects of our business, we may be forced to
        limit
        our product and service offerings and we may be unable to compete effectively.
        Any of these results could harm our brand and operating results.
  10
  ***Our
        ability to offer our products and services may be affected by a variety of
        U.S.
        and foreign laws.***
  The
        laws
        relating to the liability of providers of online services for activities
        of
        their users are currently unsettled both in the U.S. and abroad. Claims have
        been threatened and filed under both U.S. and foreign law for defamation,
        libel,
        invasion of privacy and other data protection claims, tort, unlawful activity,
        copyright or trademark infringement, or other theories based on the nature
        and
        content of the materials searched and the ads posted or the content generated
        by
        our users. From time to time, we have received notices from individuals who
        do
        not want their names or web sites to appear in our web search results when
        certain keywords are searched. It is also possible we could be held liable
        for
        misinformation provided over the web when that information appears in our
        web
        search results. If one of these complaints results in liability to us, it
        could
        be potentially costly, encourage similar lawsuits, distract management and
        harm
        our reputation and possibly our business. Whether or not existing laws
        regulating or requiring licenses for certain businesses of our advertisers
        (including, for example, distribution of pharmaceuticals, adult content,
        financial services, alcohol or firearms), are applicable to us may be unclear.
        Existing or new legislation could expose us to substantial liability, restrict
        our ability to deliver services to our users, limit our ability to grow and
        cause us to incur significant expenses in order to comply with such laws
        and
        regulations. Several other federal laws could have an impact on our business.
        Compliance with these laws and regulations is complex and may impose significant
        additional costs on us. For example, the Digital Millennium Copyright Act
        (the
“DMCA”) has provisions that limit, but do not eliminate, our liability for
        listing or linking to third-party web sites that include materials that infringe
        copyrights or other rights, so long as we comply with the statutory requirements
        of the DMCA. The Children’s Online Protection Act and the Children’s Online
        Privacy Protection Act restrict the distribution of materials considered
        harmful
        to children and impose additional restrictions on the ability of online services
        to collect information from minors. In addition, the Protection of Children
        from
        Sexual Predators Act of 1998 requires online service providers to report
        evidence of violations of federal child pornography laws under certain
        circumstances. Any failure on our part to comply with these regulations may
        subject us to additional liabilities.
  ***If
        we were to lose the services of our founders or our senior management team,
        we
        may not be able to execute our business strategy.***
  Our
        future success depends in large part upon the continued service of key members
        of our senior management team. In particular, our founders, Colorado Stark
        and
        Alvin Estevez, are critical to our overall management, as well as to the
        development of our technology, our culture and our strategic direction. Richard
        M. Scarlata, our Chief Financial Officer is the only full-time trained financial
        professional in our organization; he performs most of the duties that in
        many
        other cases would be performed by several people within a larger and deeper
        organization. We do not maintain any key-person life insurance policies.
        The
        loss of any of our management or key personnel could seriously harm our
        business.
  ***If
        we are unable to retain or motivate key personnel or hire qualified personnel,
        we may not be able to grow effectively.***
  Our
        performance is largely dependent on the talents and efforts of highly-skilled
        individuals. Our future success depends on our continuing ability to identify,
        hire, develop, motivate and retain highly-skilled personnel for all areas
        of our
        organization; as well as to identify, contract with, motivate and retain
        contract personnel on an outsourced basis, for special projects. Competition
        in
        our industry for qualified employees and contractors is intense. Our continued
        ability to compete effectively depends on our ability to attract new employees
        and to retain and motivate our existing
        employees and to retain contract
        personnel . As
        we
        become a more mature company, we may find our recruiting efforts more
        challenging. The incentives to attract, retain and motivate employees provided
        by our stock option grants or by future arrangements, such as through cash
        bonuses, may not be as effective as in the past. If we do not succeed in
        attracting excellent personnel or retaining or motivating existing personnel,
        we
        may be unable to grow effectively.
  11
  ***Our
        two founders run our business and affairs collectively, which may harm their
        ability to manage effectively.***
  Colorado
        Stark, our Executive Chairman, and Alvin
        Estevez ,
        our
        President and Chief Executive Officer (“CEO”), currently provide leadership as a
        team. Our Executive Chairman and CEO provide general supervision, direction,
        and
        control, subject to the control of the board of directors. As a result, they
        tend to operate collectively and to consult extensively with each other before
        significant decisions relating to all aspects of our operations are made.
        This
        may slow the decision-making process, and a disagreement among these individuals
        could prevent key strategic decisions from being made in a timely manner.
        If our
        two founders are unable to continue working well together in providing cohesive
        leadership, our business could be harmed.
  ***We
        have a short operating history and a relatively new business model in an
        emerging and rapidly evolving market. This makes it difficult to evaluate
        our
        future prospects and may increase the risk of your
        investment.***
  From
        1999
        to 2003, we were engaged in analyzing the consumer software and internet
        service
        markets, which ultimately led to the development of SpyHunter, which was
        launched in 2003. As a result, we first derived cash from sales of consumer
        software security and privacy products in 2003, all of which revenue, as
        well as
        that of 2004 and the month of January 2005, had been deferred for financial
        reporting purposes and was recognized in the first and second fiscal quarters
        of
        2005, as is discussed in the *Notes
        to Consolidated Financial Statements* .
        We also
        attempted to develop an internet advertising search engine and spent
        considerable hours and dollars on developing this service, however, our lack
        of
        success in this regard, has led us to abandon our efforts. You must consider
        our
        business and prospects in light of the risks and difficulties that we have
        encountered, and will continue to encounter, as an early-stage company in
        a new
        and rapidly evolving market. We may not be able to successfully address these
        risks and difficulties, which could materially harm our business and operating
        results. As discussed in our *Notes
        to Consolidated Financial Statements* ,
        we have
        developed a new business model which is in the process of being implemented.
        If
        we are unsuccessful in this regard, the Company may run out of cash during
        the
        third quarter of 2007.
  ***We
        have to keep up with rapid technological change to remain
        competitive.***
  Our
        future success will depend on our ability to adapt to rapidly changing
        technologies, to adapt our services to evolving industry standards and to
        improve the performance and reliability of our services. In addition, the
        widespread adoption of new Internet, networking or telecommunications
        technologies or other technological changes could require substantial
        expenditures to modify or adapt our services or infrastructure.
  ***Our
        main product SpyHunter from which we have derived almost all of our revenue
        is
        currently in need of product enhancements. If we are unable to introduce
        these
        product enhancements on a timely basis, or if the market does not accept
        these
        products or product enhancements, our sales will
        decline.***
  The
        markets for certain of our products and services are new and the markets
        for all
        of our products and services are likely to change rapidly. Our future success
        will depend on our ability to anticipate changing customer requirements
        effectively, and in a timely manner, and to offer products and services that
        meet these demands. The development of new or enhanced software products
        and
        services is a complex and uncertain process. We are currently working on
        adding
        additional features to our SpyHunter product, which are primarily two sets
        of
        changes that we are in the process of implementing for our SpyHunter
        product.  The first set contains features that will actively monitor a
        user’s computer in order to prevent new spyware infections; a
        scheduler to automatically check for new infections on the machine; and
        Domain Name Server (“DNS”) protection to prevent companies from spoofing URL's
        to trick users.  These are features that most of our competitors have
        and we do not.  Adding these features will make our product more
        competitive. The second set of changes contains features that we are adding
        that
        will be transparent to the user as an additional feature but will make our
        product one of the most effective solutions available. It will contain the
        ability to remove security threats at the WinLogon Notify level. 
Historically, almost all of our revenue has come from our SpyHunter product,
        and
        we anticipate the majority of our revenue throughout 2007 will be derived
        from
        enhanced versions of SpyHunter. We may experience design, development, testing
        and other difficulties that could delay or prevent the introduction of new
        products or product enhancements. Further, we may experience delays in market
        acceptance of new products or product enhancements as customers evaluate
        the
        advantages and disadvantages of upgrading to our new products or
        services.
  12
  ***There
        is significant competition in our market, which could make it difficult to
        attract customers, cause us to reduce prices and result in reduced gross
        margins
        or loss of market share.***
  The
        market for our products and services is highly competitive, dynamic and subject
        to frequent technological changes. We expect the intensity of competition
        and
        the pace of change either to be maintained or at least be increased in the
        future. A number of companies offer freeware products that provide some of
        the
        functionality of our products. The Company’s products have been affected by the
        availability of such freeware products, thus we may not be able to maintain
        our
        competitive position against current or potential competitors, especially
        those
        with significantly greater financial, marketing, service, support, technical
        and
        other resources. Competitors with greater resources may be able to undertake
        more extensive marketing campaigns, adopt more aggressive pricing policies
        and
        make more attractive offers to potential employees, distributors, resellers
        or
        other strategic partners. We expect additional competition from other
        established and emerging companies as the market for our products continues
        to
        develop. We may not be able to compete successfully against current and future
        competitors.
  ***If
        our restructuring program is not successful, we may not achieve the operational
        and financial objectives we have set, and our business, financial condition
        and
        results of operations could be materially adversely affected. We are in the
        process of adapting a new business model that focuses on our core products,
        however, there can be no assurance our business model will be profitable.***
  In
        late
        2005 we were facing an upcoming liquidity crisis which could render the company
        insolvent. We began to implement our current restructuring program. The aim
        of
        the restructuring plan was to first stabilize and then grow the business
        by
        reducing costs and increasing revenues. The steps to reduce costs included
        terminating employees and our primary office lease, liquidating almost all
        of
        our Furniture and Equipment, terminating leases on our data center, and
        abandoning every product and service that the company had been developing
        with
        the exception of SpyHunter. The steps to increase revenue included increasing
        the quality of our SpyHunter products, increasing the quality of our SpyHunter
        product support, and increasing the marketing efforts for our SpyHunter product.
  The
        costs
        associated with the restructuring included $302,000 in equipment write downs,
        $123,000 to terminate the primary office lease, $21,000 to terminate the
        lease
        with the data center. Furthermore, we estimate that during 2004 and 2005,
        approximately 70% of our efforts were focusing on developing new products
        and
        services. All of these potential new products and services have been abandoned
        and we currently have no plans to pursue them again or reuse what we had
        developed.
  13
  We
        have
        reduced our monthly operating cost from an average of $202,000 per month
        during
        2005 to an average of $152,000 in 2006.
  In
        May of
        2006 we introduced SpyHunter 2.7 (and in October 2006 added new features
        for
        SpyHunter 2.8), which charges a recurring fee with the subscription period
        shortened from 12 months to 6 months, thereby doubling the price. Our average
        renewal rate for this brief time period is 80%. We have been able to dedicate
        our technical resources to improving our product. We still have additional
        improvements to make. (For information on these improvements please review
        the
        risk factor above, entitled, *"Our
        main product SpyHunter from which we have derived almost all of our revenue
        is
        currently in need of product enhancements.* ”)
        If we
        are unable to introduce these product enhancements on a timely basis, or
        if the
        market does not accept these products or product enhancements, our sales
        will
        decline. Month by month we continue to see increasing revenues and are beginning
        to breakeven on a cash flow basis, before debt service.
  There
        can
        be no assurance that we will be able to enhance our SpyHunter product or
        develop
        a new product or implement a business model that will be profitable. Previously,
        our product sales were non-recurring and substantially all of our reported
        and
        deferred revenue for 2003, 2004, 2005 and 2006 should be deemed as non-recurring
        revenue.
  ***We
        may not be able to access third party technology, which we depend upon to
        conduct our business, and as a result, we could experience delays in the
        development and introduction of new products and services or enhancements
        of
        existing products and services.***
  If
        we
        lose the ability to access third party technology which we use, are unable
        to
        gain access to additional products or are unable to integrate new technology
        with our existing systems, we could experience delays in our development
        and
        introduction of new products and services and related improvements or
        enhancements until equivalent or replacement technology can be accessed,
        if
        available, or developed internally, if feasible. If we experience these delays,
        our sales could be substantially reduced. We license technology that is
        incorporated into our products and services from third parties. In light
        of the
        rapidly evolving nature of technology, we may increasingly need to rely on
        technology licensed to us by other vendors, including providers of development
        tools that will enable us to quickly adapt our technology to new products
        and
        services. Technology from our current or other vendors may not continue to
        be
        available to us on commercially reasonable terms, or at all.
  **Risks
        Related to Our Stock Being Publicly Traded**
  ***Our
        stock price may be volatile.***
  Our
        Common Stock has been trading in the public market for just over two years.
        Until very recently, trading volume has been extremely light, as approximately
        59% of our outstanding shares are unregistered and cannot yet be traded.
        We
        cannot predict the extent to which a trading market will develop for our
        Common
        Stock or how liquid that market might become. The trading price of our Common
        Stock has been and is expected to continue to be highly volatile as well
        as
        subject to wide fluctuations in price in response to various factors, some
        of
        which are beyond our control. These factors include:
 ·
                Quarterly
                    variations in our results of operations or those of our competitors.
  ·
                Announcements
                    by us or our competitors of acquisitions, new products, significant
                    contracts, commercial relationships or capital commitments.
  14
  ·
                Disruption
                    to our operations.  ·
                  The
                      emergence of new sales channels in which we are unable to compete
                      effectively.  ·
                    Our
                        ability to develop and market new and enhanced products on
                        a timely basis.  ·
                      Commencement
                          of, or our involvement in, litigation.  ·
                        Any
                            major change in our board or management.  ·
                          Changes
                              in governmental regulations or in the status of our
                              regulatory approvals.  ·
                            Changes
                                in earnings estimates or recommendations by securities
                                analysts.  ·
                              General
                                  economic conditions and slow or negative growth
                                  of related
                                  markets.
 In
        addition, the stock market in general, and the market for technology companies
        in particular, have experienced extreme price and volume fluctuations that
        have
        often been unrelated or disproportionate to the operating performance of
        those
        companies. These broad market and industry factors may seriously harm the
        market
        price of our Common Stock, regardless of our actual operating performance.
        In
        addition, in the past, following periods of volatility in the overall market
        and
        the market price of a company’s securities, securities class action litigation
        has often been instituted against these companies. Such litigation, if
        instituted against us, could result in substantial costs and a diversion
        of our
        management’s attention and resources.
  ***We
        do not intend to pay dividends on our Common Stock.***
  We
        have
        never declared or paid any cash dividend on our Common Stock. We currently
        intend to retain any future earnings and do not expect to pay any dividends
        in
        the foreseeable future.
  ***Our
        two founders own a majority of the Company’s preferred stock, which will
        significantly impact our stockholders ability to influence corporate
        matters.***
  Until
        June 28, 2006, our founders, executive officers, directors (and their
        affiliates) and employees together owned approximately 77.0% of the voting
        power
        of our outstanding capital stock. In particular, our two founders, Colorado
        Stark and Alvin Estevez combined, controlled approximately 74.2% of the voting
        power of our outstanding capital stock. With the issuance of the convertible
        debentures (the “Debentures”) to Dutchess, Colorado Stark and Alvin Estevez
        exchanged their shares of Common Stock for shares of newly issued Series
        A
        Convertible Preferred Stock, par value $0.001 per share (the “Preferred Stock”).
        While the Preferred Stock ranks senior to the Common Stock with respect to
        dividends, and on parity with the Common Stock with respect to liquidation,
        the
        holders of shares of the Preferred Stock shall generally vote together with
        the
        holders of shares of the Common Stock on an as-if-converted basis. Furthermore,
        Messrs. Stark and Estevez’ shares of Preferred Stock have anti-dilution
        protection, whereby they will maintain the majority voting power of the
        Company’s capital stock. Consequently, Colorado Stark and Alvin Estevez’
ownership of the Preferred Stock allows them to retain significant influence
        over management and affairs and over all matters requiring stockholder approval,
        including the election of directors and significant corporate transactions,
        such
        as a merger or other sale of the Company or its assets, for the foreseeable
        future. This concentrated control limits the ability of stockholders to
        influence corporate matters and, as a result, we may take actions that our
        stockholders do not view as beneficial. As a result, the market price of
        our
        Common Stock could be adversely affected.
  15
  ***Provisions
        in our charter documents and under Delaware law could discourage a takeover
        that
        stockholders may consider favorable.***
  Provisions
        in our Certificate of Incorporation and By-laws may have the effect of delaying
        or preventing a change of control or changes in our management. These provisions
        include the following:
  ·
                  Our board of directors
                      has the right to
                      elect directors to fill a vacancy created by the expansion
                      of the board of
                      directors or the resignation, death or removal of a director,
                      which may
                      prevent stockholders from being able to fill vacancies on our
                      board of
                      directors.
  ·
                Our
                    stockholders may act by written consent, provided that such consent
                    is
                    signed by all the stockholders entitled to vote with respect
                    to the
                    subject matter thereof. As a result, a holder, or holders, controlling
                    a
                    majority of our capital stock would not be able to take certain
                    actions
                    without holding a stockholders’ meeting.
  ·
                Our
                      Certificate of Incorporation prohibits cumulative voting in
                      the
                      election of directors. This limits the ability of minority
                      stockholders to
                      elect director candidates.
 As
        a
        Delaware corporation, we are also subject to certain Delaware anti-takeover
        provisions. Under Delaware law, a corporation may not engage in a business
        combination with any holder of 15% or more of its capital stock unless the
        holder has held the stock for three years or, among other things, the board
        of
        directors has approved the transaction. Our board of directors could rely
        on
        Delaware law to prevent or delay an acquisition of the Company.
  ***You
        may experience substantial dilution as a result of the Dutchess financing
        transaction, as well as if we raise funds through the issuance of additional
        equity and/or convertible securities.***
  You
        may
        experience substantial dilution if Dutchess converts its Debentures into
        Common
        Stock of the Company. Since the conversion price of the Debentures fluctuates
        at
        a substantial percentage discount (25%) to fluctuating market prices, the
        number
        of shares issuable to Dutchess, upon conversion of the Debentures, is
        potentially limitless. In other words, the lower the average trading price
        of
        the Company’s shares at the time of conversion, the greater the number of shares
        that can be issued to Dutchess. This perceived risk of dilution may cause
        Enigma
        shareholders to sell their shares, thus contributing to a downward movement
        in
        the Company’s stock price, thereby potentially encouraging other Enigma
        shareholders to sell, or sell short, which could in turn further contribute
        to a
        spiraling stock price decline in Enigma’s Common Stock. You may also experience
        substantial dilution if Messrs. Stark and Estevez convert their shares of
        Preferred Stock into shares of Common Stock (See Note J in *Notes
        to Consolidated Financial Statements* ).
        Dutchess’ overall ownership at any one moment is limited to 9.9% of the
        outstanding shares of Common Stock in accordance with the financing documents.
        However, Dutchess is free to sell any shares into the market, which have
        been
        issued to them, thereby enabling Dutchess to convert the remaining Debentures
        or
        exercise additional warrants into shares of Common Stock.
  ***Our
        Common Stock has a small public float and future sales of our Common Stock,
        or
        sales of shares being registered under this document may negatively affect
        the
        market price of our Common Stock.***
  As
        of
        March 21, 2007, the most recent trading day in our Common Stock, there were
        4,191,266 shares of our Common Stock outstanding, at a closing market price
        of
        $0.37 for a total market valuation of approximately $1,550,768. Our Common
        Stock
        has a public float of approximately 1,700,000 shares, which shares are in
        the
        hands of public investors, and which, as the term "public float" is defined
        by
        NASDAQ, excludes shares that are held directly or indirectly by any of our
        officers or directors or any other person who is the beneficial owner of
        more
        than 10% of our total shares outstanding. These 1,700,000 shares are held
        by a
        relatively small number of stockholders of record. We cannot predict the
        effect,
        if any, that future sales of shares of our Common Stock into the market will
        have on the market price of our Common Stock. However, sales of substantial
        amounts of Common Stock, including future shares issued upon the exercise
        of
        15,000,000 Warrants, future shares issued upon the conversion of Debentures,
        or
        upon Colorado Stark and Alvin Estevez converting their Preferred Stock into
        Common Stock, or upon exercise of stock options (of which 2,984,001 were
        outstanding as of December 31, 2006 and an additional 15,999 shares were
        reserved for issuance), or the perception that such transactions could occur,
        may materially and adversely affect prevailing market prices for our Common
        Stock.
  16
  ***We
        could terminate our Securities and Exchange Commission Registration, which
        could
        cause our Common Stock to be de-listed from the
        OTCBB.***
  As
        a
        public company with fewer than 300 shareholders, Enigma files its periodic
        reports with the SEC and registers its shares of Common Stock under the
        Securities Exchange Act of 1934 (the “Exchange Act”) on a voluntary basis. Since
        the Company has fewer than 300 stockholdersof
        record, we are eligible to de-register our Common Stock under the Exchange
        Act.
        Although the Company does not currently plan to de-register its Common Stock,
        there can be no assurance that we would not de-register the Common Stock
        at some
        point in the future. If the Company was to take such action, it could inhibit
        the ability of the holders of the Company’s Common Stock to trade the shares in
        the open market, thereby severely limiting the liquidity of such shares.
        Furthermore, if we were to de-register, we would no longer be required to
        file
        annual and quarterly reports with the SEC and would no longer be subject
        to
        various substantive requirements of SEC regulations. De-registration would
        reduce the amount of information available to investors about our Company
        and
        may cause our Common Stock to be de-listed from the OTCBB. In addition,
        investors would not have the protections of certain SEC regulations to which
        we
        would no longer be subject. The Company has no intention of terminating the
        registration of the Common Stock, and in fact is constrained from doing so
        under
        the terms of its agreements with Dutchess.
  ***Because
        the market for and liquidity of our shares is volatile and limited, and because
        we are subject to the "Penny Stock" rules, the level of trading activity
        in our
        Common Stock may be reduced.***
  Our
        Common Stock is quoted on the OTCBB (ENGM). The OTCBB is generally considered
        to
        be a less efficient market than the established exchanges or the NASDAQ markets.
        While our Common Stock continues to be quoted on the OTCBB, an investor may
        find
        it more difficult to dispose of, or to obtain accurate quotations as to the
        price of our Common Stock, as compared to if our securities were traded on
        NASDAQ or a national exchange. In addition, our Common Stock is subject to
        certain rules and regulations relating to "penny stocks" (generally defined
        as
        any equity security that is not quoted on the NASDAQ Stock Market and that
        has a
        price less than $5.00 per share, subject to certain exemptions). Broker-dealers
        who sell penny stocks are subject to certain "sales practice requirements"
        for
        sales in certain nonexempt transactions (i.e., sales to persons other than
        established customers and institutional "accredited investors"), including
        requiring delivery of a risk disclosure document relating to the penny stock
        market and monthly statements disclosing recent bid and offer quotations
        for the
        penny stock held in the account, and certain other restrictions. If the
        broker-dealer is the sole market maker, the broker-dealer must disclose this,
        as
        well as the broker-dealer's presumed control over the market. For as long
        as our
        securities are subject to the rules on penny stocks, the liquidity of our
        Common
        Stock could be significantly limited. This lack of liquidity may also make
        it
        more difficult for us to raise capital in the future.
  17
  **Additional
        Information**
  We
        are
        obligated to file reports with the Securities and Exchange Commission (“SEC”)
        pursuant to the Securities Exchange Act of 1934, as amended, (the “Exchange
        Act”). The public may read and copy any materials that we file with the SEC at
        the SEC’s Public Reference Room at 100 F Street, N.E., Washington,
        D.C. 20549. The public may obtain information on the operation of the Public
        Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an
        Internet site that contains reports, proxy and information statements, and
        other
        information regarding issuers that file electronically with the SEC. We file
        electronically with the SEC. The address of that site is
        http://www.sec.gov.
  **General
        Discussion on Results of Operations and Analysis of Financial
        Condition**
  ***For
        the years ended December 31, 2006 and 2005***
  We
        begin
        our General Discussion and Analysis with a discussion of the Critical Accounting
        Policies and the Use of Estimates, which we believe are important for an
        understanding of the assumptions and judgments underlying our financial
        statements. We continue with a discussion of the Results of Operations for
        the
        years ended December 31, 2006 and 2005, followed by a discussion of
        Liquidity and Capital Resources available to finance our
        operations.
  We
        are a
        developer of Internet-based systems and downloadable security software products
        designed to give our customers instant access to information on the web and
        control over the programs installed on their computers in an automated and
        easy
        to use way, thereby enhancing transparency and user control. Our business
        strategy is to leverage our knowledge of internet marketing, as well as our
        existing base of more than 750,000 users, to continue to develop Internet
        software products that further the values on which the Internet is based.
        Our
        consumer software product line is focused on delivering Internet privacy
        and
        security to individual users, homes, offices, and small businesses. Sales
        of
        SpyHunter® (“SpyHunter”)  commenced
        in June 2003. In late January 2005, we began to license a new and
        improved product, SpyHunter 2.0, and in May 2006, with the introduction of
        SpyHunter 2.7, added important new features as well as changed the pricing
        structure. In October 2006, we introduced SpyHunter 2.8 to which we enhanced
        our
        detection and removal features and added a scheduler.
  **Critical
        Accounting Policies and the Use of Estimates**
  **Revenue
        Recognition**
  We
        recognize revenue from the sales of license fees and subscriptions of SpyHunter
        in accordance with accounting principles generally accepted in the United
        States
        of America that have been prescribed for the software industry. Revenue
        recognition requirements in the software industry are very complex and require
        us to make some estimates.
  Specifically,
        we recognize such revenues in accordance with Statement of Position (“SOP”)
        No. 97-2 “Software Revenue Recognition,” as amended by SOP No. 98-9
“Modification of SOP No. 97-2, Software Revenue Recognition, With Respect
        to Certain Transactions.” These statements of position provide guidance for
        recognizing revenues related to sales by software vendors. We sell our principal
        software product, SpyHunter, along with its 6 month subscription service
        over
        the Internet. Customers order SpyHunter and simultaneously provide their
        credit
        card information to us. Upon receipt by us of authorization from the credit
        card
        issuer, the customer is able to download the product over the Internet. For
        the
        sales price of $29.99, we provide a license to use our product and post-contract
        customer support (“PCS”), which consists primarily of free updates to our
        software products as and when such updates are available, as well as e-mail
        and
        telephonic support.
  18
  For
        sales
        of SpyHunter 1 series that occurred during the years ended December 31,
        2003 and 2004, as well as during the month of January 2005, this PCS was
        provided for an indefinite period into the future. However, with the
        introduction at the end of January 2005 of our new and improved product,
        SpyHunter 2.0, PCS was limited to one year from the date of purchase. For
        SpyHunter 2.7, which was introduced in May 2006, and which replaced SpyHunter
        2.0, and for SpyHunter 2.8, which was introduced in October 2006, and represents
        an upgrade over SpyHunter 2.7, PCS is limited to six months. Licensees of
        the
        SpyHunter 1 series were provided with PCS up until March 10, 2005, from
        which point forward we no longer supported that product, and at which time
        we
        began to recognize the revenue from the sales of SpyHunter series
        1.
  SpyHunter
        2.7 and 2.8 contain improvements that are in recognition of the more challenging
        security threats that the Company noted in early 2006 and were developed
        in
        response to our customers. As part of Enigma’s renewed commitment to quality and
        customer satisfaction, spyware definition updates are a major facet of our
        customer support.
  Because
        of the continuing threat of new spyware and adware, SpyHunter is not functional
        without these definition updates, which comprise the bulk of our PCS. The
        remainder of PCS consists of e-mail and telephonic customer support, which
        makes
        the product user friendly. Accordingly we believe that all of the value is
        attributable to PCS, and hence, the revenue from sales is attributable entirely
        to PCS and was deferred and recognized over 12 months in the case of the
        SpyHunter 2.0 and is deferred and recognized over 6 months in the case of
        the
        SpyHunter 2.7 and 2.8, the respective periods of PCS in each case. Also in
        each
        case we utilize the 1⁄2 month convention in the month of sale and the
        corresponding final month of PCS. For both products, the renewal rate for
        PCS
        was and is $29.99, the same as the original sales price.
  Customers
        are also able to order a CD version of, and an extended download service
        for,
        SpyHunter 2.7, in which case we earn commission income, all of which is
        recognized at the time of delivery of the product or service; as is any
        commission income that we earn on sales of other companies’ products or from
        on-line advertising of such products on our various websites.
  In
        accordance with SOP No. 97-2 and SOP No. 98-9, the fee is required to
        be allocated to the various elements based on vendor specific objective evidence
        (“VSOE”) of fair value. On all sales of SpyHunter 1 series which occurred from
        June 2003 through January 2005, VSOE did not exist for the allocation
        of revenue to the various elements of the arrangement. As a result, we deferred
        all revenue from these arrangements. This deferred revenue totaled $21,270,075
        and consisted of $6,320,000 deferred from the year ended December 31, 2003,
        approximately $14,850,000 deferred from the year ended December 31, 2004
        and approximately $105,000 deferred from the month of January 2005.
  We
        informed all of our customers that as of March 10, 2005, we would no longer
        support or provide updates to the SpyHunter 1 series software and we offered
        SpyHunter 2.0 to then existing customers free of charge for a period of 90
        days.
        Accordingly, we have recognized as revenue, all proceeds from the sales of
        SpyHunter 1 series that occurred from June 2003 through January 2005,
        ($21,270,075) during the 90 day period from March 11, 2005 through
        June 10, 2005, at the daily rate of 1/90 of the total deferred revenues.
  With
        respect to sales of SpyHunter 2.0 and SpyHunter 2.7 and 2.8, which have PCS
        limited to one year and six months, respectively, after the sale, VSOE does
        exist for the allocation of revenue to the various elements of the arrangement,
        as we consider all of the revenue from such sales to be attributable to the
        service element because the SpyHunter download is useless without it.
        Accordingly, we recognized the license fees for SpyHunter 2.0 during the
        12-month period, and for SpyHunter 2.7 and 2.8, for the 6-month period
        immediately subsequent to the sale.
  19
  **Reserves
        for Product Returns**
  Our
        policy with respect to product returns is spelled out in our End User License
        Agreement (“EULA”), which states “...products purchased that are downloadable are
        NOT refundable; however, Enigma Software Group, Inc. reserves the right to
        award
        refunds to a customer on a per case basis.”  As
        of
        December 31, 2006, we had not accrued a reserve for potential refunds or
        chargebacks, as our experience has been such that returns and chargebacks
        are
        not material to our overall revenues. We may voluntarily accept greater or
        fewer
        products for return.
  **Income
        Taxes**
  We
        make
        estimates to determine our current provision for income taxes, as well as
        our
        income taxes payable. Our estimates with respect to the current provision
        for
        income taxes take into account current tax laws and our interpretation of
        current tax laws, as well as possible outcomes of any future tax audits.
        Changes
        in tax laws or our interpretation of tax laws and the resolution of any future
        tax audits could significantly impact the amounts provided for income taxes
        in
        our financial statements.
  **Legal
        Contingencies**
  From
        time
        to time, we are involved in routine legal matters incidental to our business.
        In
        the opinion of management, the ultimate resolution of such matters will not
        have
        a material adverse effect on our financial position, results of operations
        or
        liquidity.
  **Results
        of Operations For the Years Ended December 31, 2006 and
        2005**
  **Overview**
  Our
        goals
        for the past several years were to launch SpyHunter, generate significant
        licensing fees and continue to build on that success by generating even greater
        licensing fees. We were successful in accomplishing these goals, but as
        discussed above, all of the revenue associated with the SpyHunter 1 series
        was
        deferred and not recognized as revenue until 2005, while the cash was received
        and used principally during 2003 and 2004 to support our operations. Therefore,
        a ll
        of our
        deferred revenue reported for 2003 and
        2004, approximately $21.1 million, was
        realized and recorded as non-recurring revenue during 2005, without any cash
        flow effect. Our
        business plan going forward is to continue to develop both Internet software
        products and services for consumers in order to establish recurring subscription
        revenue.
  During
        the third and fourth quarters of 2005, the Company attempted to restructure
        itself by transitioning from a license fee revenue model to an advertising
        based
        revenue model. This attempt ultimately failed and the Company completely
        abandoned this effort in January 2006. During the period of this attempted
        restructure, the Company terminated 11 of its 18 employees at a gross annual
        cost savings for salary and benefits, before outsourcing, of approximately
        $790,000, on a pre-tax basis. The terminated employees included 9 engineering
        and customer support personnel, and a portion of their workload was outsourced
        at an annual cost of approximately $150,000. In addition, several administrative
        employees were terminated to conserve capital resources and their workload
        was
        absorbed by the remaining employees.
  20
  **Revenues**
  For
        the
        year ended December 31, 2006, reported revenues from the sales of software
        products and subscriptions were $1,207,824, principally consisting of revenue
        recognized from sales of SpyHunter 2.0 and SpyHunter 2.7 and 2.8. Also, for
        the
        year ended December 31, 2006, commission income and advertising revenues
        were $119,657. For the year ended December 31, 2005, reported revenues from
        the sales of software products and subscriptions totaled $21,915,358, consisting
        of the non-cash recognition of deferred revenue from sales of the SpyHunter
        1
        series of approximately $21,275,000 (the cash generated by these license
        fees
        having all been received during the years ended December 31, 2003, 2004 and
        the month of January 2005 and used to support operations of those years and
        period, respectively); and approximately $640,000 of revenue recognized
        principally from sales of SpyHunter 2.0. Also for the year ended
        December 31, 2005, commission income and advertising revenues totaled
        $107,367.
 
 The
        price
        charged for each SpyHunter product, Series 1, SpyHunter 2.0 and SpyHunter
        2.7
        and 2.8 was or is $29.99. SpyHunter Series 1 was introduced in June 2003
        and discontinued in January 2005 with the introduction of SpyHunter 2.0.
        SpyHunter 2.0 was discontinued in May 2006 with the introduction of SpyHunter
        2.7. SpyHunter 2.8, which was introduced in October 2006, contains a number
        of
        upgrades that were not available in SpyHunter 2.7.
  During
        the approximate 16 months that SpyHunter 2.0 was sold, the Company produced
        31
        spyware definition updates, for an average of slightly less than two per
        month.
        In recognition of the more challenging security threats that the Company
        noted
        in the months immediately prior to May 2006 and in response to our customers,
        Enigma introduced SpyHunter 2.7 in May 2006 with upgrades in October 2006
        to
        SpyHunter 2.8, with the commitment that spyware definition updates would
        become
        a major facet of our customer support.
  Accordingly,
        we have provided 58 such updates in that approximate 8 month period
        May-December 2006, for an average of over 7 updates per month, or more than
        triple the rate of spyware definition updates produced for SpyHunter 2.0.
        The
        production of such updates is labor intensive. Therefore, in recognition
        of the
        increased costs of defending against new threats with more timely and
        comprehensive definition updates, the Company determined it was necessary
        to
        increase the price of its product, but being sensitive to the historic price
        point of $29.99, decided to reduce the term of its customer support contract
        from 12 months to 6, without increasing the price point.
  **Expenses**
  Expenses
        for the years ended December 31, 2006 and
        2005 were $2,097,743 and $3,281,380, respectively.
  **Year
                  Ended**
                **December 31,****2006**
              
              **Year
                  Ended**
                **December 31,****2005**Marketing
                  and selling
              
              $
              214,725
              
              $
              308,015General
                  and administrative
              
              
              1,868,441
              
              
              2,425,265Write-down
                  of impaired assets
              
              
              
              
              
              387,055Depreciation
                  and amortization
              
              
              14,577
              
              
              161,045Total
                  expenses
              
              $
              2,097,743
              
              $
              3,281,830
  Marketing
        and selling expenses are expensed as incurred and relate directly to the
        level
        of “current sales” activity as opposed to the revenue reported, under SOP 97-2,
        for the period, which may have been entirely or partially deferred, as discussed
        above. For the year ended December 31, 2006, marketing and selling expenses
        declined by approximately $93,000, or 30%, from that of the prior year
        comparable period. This decline reflects reduced advertising dollar expenditures
        during the first half of 2006, in order to conserve cash. Normally there
        is a
        direct correlation between advertising dollar expenditures and “current sales.”
That normal relationship was skewed in 2006 by the Company’s need to conserve
        cash.
  21
  The
        Company determines “current sales” based on sales that occur during the period
        upon which we are reporting. “Current sales” are the amount of cash sales that
        were generated during that period. The amount of sales reported on the Statement
        of Operations, under the caption “Sales of software products and subscription
        services” is a number derived from the Company’s application of SOP 97-2 and
        includes a portion cash or current sales that occurred in prior periods.
        “Current sales” of software products and subscription services declined for the
        year 2006 from 2005 by approximately $59,000, from $1,207,000 to $1,148,000.
  For
        the
        years ended December 31, 2006 and 2005, General and Administrative expenses
        were approximately $1,868,000 and $2,425,000, respectively. The decline of
        $557,000, or approximately 23%, is principally due to decreases in compensation
        and benefits expense reflecting the lay-off of 11 employees in 2005.
  **Write-down
        of Impaired Assets**
 
 At
        December 31, 2005, the Company incurred an impairment charge of $387,055,
        representing: the difference between what the Company had received,
        approximately $4,000, from the disposal of its excess furniture and fixtures;
        and the abandonment of its leasehold improvements (see *Notes
        to Consolidated Financial Statements* ),
        and
        their respective carrying values at that date; and the security deposit of
        $83,147, on its office lease. As of December 31, 2006, the Company had not
        incurred an impairment charge.
 
 **Net
        Income (Loss)**
  As
        a
        result of the foregoing and after accounting for interest income, debenture
        interest expense, debenture redemption premium, discount expense on convertible
        debentures, fair value adjustments for derivatives and warrants, provision
        for
        liquidated damages, accretion adjustment for the beneficial conversion feature
        of the Preferred Stock, (all of which are associated with the Convertible
        Debentures and the issuance of Preferred Stock) and any related income tax
        expense/(benefits), there was a net loss of approximately $1,967,000 for
        the
        year ended December 31, 2006, as compared to a net income of approximately
        $10,173,000 for the prior year.
  **Liquidity
        and Capital Resources For the Years Ended December 31, 2006 and
        2005**
  At
        December 31, 2006 and 2005, we had cash and cash equivalents of $471,254
        and $472,008, respectively. As discussed above, without the net $905,000
        received in connection with the Dutchess financing transaction, the Company
        would have had to have cease operations prior to December 31,
        2006.
  Net
        cash
        used in operating activities for the year ended December 31, 2006, was
        approximately $893,000, compared to net cash used in operating activities
        of
        approximately $137,000 for the year ended December 31, 2005, representing
        an increase in net cash used in operating activities of $756.000. However,
        the
        $137,000 for the prior year reflects the release of approximately $1,005,000
        from restricted cash as well as a refund of prepaid income taxes of
        approximately $257,000. Without both of these cash sources, the Company would
        have reported approximately $1,400,000 of net cash used in operating activities
        for the year ended December 31, 2005, or approximately $500,000 more than
        for the year ended December 31, 2006. The balance of the change in net cash
        used in operating activities is principally attributable to the lower general
        and administrative expenses discussed above.
  22
  At
        the
        present level of business activity, the Company’s ongoing monthly gross
        operating cash disbursements are expected to average $190,000, excluding
        debt
        service. At December 31, 2006, the Company had a net working capital
        deficit of approximately $2.0 million. After adding back a derivative
        liability, a warrant liability, a dividend payable in connection with a
        preferred stock beneficial conversion feature, and deferred revenue, all
        of
        which totaled approximately $2.4 million, the Company had net working
        capital of approximately $370,000 available to fund ongoing operations and
        required debt service payments. As discussed in Note H of the accompanying *Notes
        to Consolidated Financial Statements* ,
        the
        Debenture Agreement contains provisions for amortizing cash payments, allocated
        to principal and debenture redemption premium, to be made if the Registration
        Statement has not been declared effective by January 1, 2007, which is the
        case.
        As a result thereof, the Company was required to make amortizing principal
        payments and redemption premium payments to Dutchess on January 2,
        February 1 and March 1, 2007, which totaled approximately $246,000.
        Until the Registration Statements is declared effective, which the Company
        presently estimates will occur on or about May 15, 2007, the Company will
        be
        required to make further such payments on April 2, 2007 and probably on
        May 1, 2007 The payment made on March 1, 2007 created an event of
        default under the financing documents. (See Notes B and Q of the accompanying *Notes
        to Consolidated Financial Statements* .)
 
 At
        the
        present level of business activity, and assuming that current sales continue
        at
        the average rate experienced during the months of December 2006 and January
        and February 2007, and assuming that the Company is required to continue
        making
        amortizing principal and debt redemption premium payments to Dutchess because
        of
        the non-effectiveness of the Registration Statement, the Company’s working
        capital resources could be depleted within six months or fewer, i.e., sometime
        in the third quarter of 2007. As discussed in Note Q to the accompanying *Notes
        to Consolidated Financial Statements* ,
        as of
        December 31, 2006, the Company was required to make principal payments and
        debenture redemption premium payments totaling $104,167 on each of
        January 1 and February 1, 2007. These payments to Dutchess were
        required because the Registration Statement had not been declared effective
        prior to January 1, 2007 and continues to not be effective. These payments,
        plus the required monthly interest payments, amounting to 1% of the outstanding
        principal, severely depleted the Company’s working capital reserves in the first
        two months of 2007. Unless the Company receives forbearance from Dutchess
        on a
        portion of future required payments under the Debenture, the Company could
        deplete its working capital reserves within the next four to six
        months.
  Actual
        results may be better or worse than anticipated, depending upon the Company’s
        actual sales results in future months. The Company’s liquidity position is
        extremely severe, as without the funds derived from the sale of Debentures
        to
        Dutchess, the Company would have run out of cash in July 2006. This was
        anticipated in the Company’s earlier filings, as is evidenced by the going
        concern opinion included in its 2005 audited financial statements.
  Because
        our business is evolving and changing, our operating cash flow may continue
        to
        suffer, and past operations are not a good gauge for anticipating future
        operations. In addition, we have taken on substantial debt. On the positive
        side, we have effectively reduced our operating overhead by reducing staff
        and
        utilizing outsourcing channels and by moving our corporate headquarters from
        lower Manhattan to Stamford, Connecticut. We are hopeful that these overhead
        reductions will help to improve our operating results.
 
 Net
        cash
        used in investing activities for the years ended December 31, 2006 and 2005
        were approximately $12,500 and $6,500. Acquisitions of furniture and fixtures
        and computer equipment accounted for the major portion of investing activities
        in each year.
  23
  Net
        cash
        provided by financing activities for the years ended December 31, 2006 and
        2005, were $905,000 and $0, respectively. Net proceeds from the issuance
        of the
        Debentures to Dutchess accounts for all of the net cash provided by financing
        activities during the year ended December 31, 2006.
  **Item
        7.**  **Financial
        Statements.**
  Information
        in response to this Item is set forth in the Financial Statements, beginning
        on
        Page F-1 of this filing.
 
 **Item
        8.**  **Changes
        in and Disagreements With Accountants on Accounting and Financial
        Disclosure.**
  As
        previously reported in Forms 8-K and 8-K/A filed with the SEC on
        January 24, 2006 and January 30, 2006, respectively, the Company’s Board of
        Directors (the “Board”) dismissed its independent registered public accounting
        firm, Eisner LLP (“Eisner”), and engaged the services of Bagell, Josephs, Levine
& Company, L.L.C. (“BGL”). The Board approved the dismissal of Eisner, who
        had served as the Company’s independent public accountants for the two fiscal
        years ended December 31, 2004, and the subsequent interim periods through
        September 30, 2005 and the appointment of BJL.
  The
        Company is not aware, and has not been advised by its independent registered
        public accountants, of any disagreement on any matter of accounting principles
        or practices, financial statement disclosure, or auditing scope or procedure
        for
        the years ended December 31, 2006 and 2005.
  **Item
        8A. Controls and Procedures**
  Our
        disclosure controls and procedures are designed to ensure that material
        information relating to the Company are made known by others within the Company
        to our Chief Executive Officer (“CEO”), Chief Financial Officer (“CFO”) and
        others in the Company involved in the preparation of our annual report and
        our
        quarterly reports. The Company has evaluated, with the participation of the
        Company’s CEO and CFO, the effectiveness of the design and operation of the
        Company’s disclosure controls and procedures as of December 31, 2006,
        pursuant to Exchange Act Rule 15d-15. Based upon that evaluation, the CEO
        and
        CFO concluded that the Company’s disclosure controls and procedures are
        effective in timely alerting them to material information relating to the
        Company required to be included in the Company’s periodic filings with the SEC.
 
 As
        noted
        in the Company’s interim filings, a
        material weakness in the Company’s internal controls over financial reporting
        existed as of June 30, 2006, and September 30, 2006 with regard to our
        design and maintenance of adequate controls over the preparation, review,
        presentation and disclosure of amounts included in our Balance Sheet and
        Statements of Operations and Cash Flows, which resulted in misstatements
        therein.  The impact of the issuance of secured convertible debentures and
        the related warrants, and the proceeds therefrom, were not appropriately
        classified as liabilities on the Balance Sheet and the related fair value
        adjustments on the Statement of Operations and financing cash inflows and
        outflows on the Statement of Cash Flows. In addition, the beneficial conversion
        feature of the convertible preferred stock was not appropriately classified
        on
        the Balance Sheet and the related accretion adjustment on the Statement of
        Operations and financing cash inflows and outflows on the Statement of Cash
        Flows. Finally, Temporary and Permanent equity as they relate to the convertible
        preferred stock were misstated.
  24
 
 During
        the fourth quarter, the Company requested and received counsel from its
        independent public accountants concerning the appropriate financial disclosure
        and treatment of derivative securities. In addition, the Company, including
        the
        Company’s CFO, reviewed literature detailing the proper disclosure and treatment
        pertaining to the accounting of these derivative securities. During the fourth
        quarter, and as a result of the aforementioned, the Company’s CEO and CFO
        concluded that the preparation of financial statements with respect to such
        misstatements have been corrected in the restated financial statements included
        herein.
 
 A
        material weakness in the Company’s disclosure controls and procedures existed as
        of December 31, 2006, due to the Company’s limited number of employees. With
        regard to such personnel, there was a weakness as a result of the limited
        segregation of duties amongst our employees.
  **Item
        8B. Other Information.**
  None.
  **PART
        III**
  **Item
        9.**  **Directors,
        Executive Officers, Promoters and Control Persons; Compliance** **with
        Section 16(a) of the Exchange Act.**
  Set
        forth
        below is certain information concerning each of the directors and executive
        officers of the Company as of March 20, 2007:
 Name
                
                Age
                
                Position
                
                With
                    Company SinceColorado
                    Stark
                
                35
                
                Executive
                    Chairman, Director
                
                1999Alvin
                    Estevez
                
                35
                
                President
                    and CEO, Director
                
                1999Edwin
                    J. McGuinn, Jr.
                
                55
                
                Director
                
                2005Richard
                    M. Scarlata
                
                64
                
                CFO
                    and Treasurer
                
                2004
 
  *Colorado
        Stark.* Mr.
        Stark co-founded the Company in 1999 and currently serves as its Executive
        Chairman. Having
        worked in the investment banking industry for over 12 years, Mr. Stark offers
        Enigma his expertise in sales, business development, raising capital, and
        structuring transactions to enhance shareholder value. From 2001 to
        2003, in addition to serving as Enigma Software Group's Executive Chairman,
        Mr.
        Stark also served as president of Brill Capital. Brill Capital was a Venture
        Capital Placement agent that helped US companies, in the fields of
        biotechnology and communications, raise capital from Taiwan.
 
 **  *Alvin
        Estevez.* Mr.
        Estevez  is
        also a
        co-founder of the Company and currently serves as its President and CEO, having
        held such positions since 1999. He comes from a network security background
        and
        prior to co-founding Enigma, he worked at defense contractor Northrop Grumman,
        as well as with related subsidiaries and entities. Mr. Estevez brings to
        the
        Company the experience of managing large groups of technical personnel along
        with the expertise of building enterprise level technology systems.
  25
 
 *Edwin
        J. McGuinn, Jr.* Mr.
        McGuinn currently serves as a Director of the Company, having been so elected
        in
        March 2005. Mr. McGuinn also serves on the Audit Committee and the Compensation
        Committee and has been designated the Audit Committee Financial Expert. Mr.
        McGuinn is *independent* ,
        as that
        term is used in Item 7(d) (3) (iv) of Schedule 14A under the Exchange
        Act. ** Mr.
        McGuinn is currently the Chairman and CEO of MRU Holdings, Inc., having held
        such position since April 2004. MRU Holdings, Inc. is a specialty finance
        company that provides undergraduate and graduate students with funds for
        higher
        education. Prior to joining MRU Holdings, Inc., Mr. McGuinn was the President
        and CEO of eLOT, Inc., having held such positions from May 2000 until November
        2004. eLOT, Inc. is a company whose focus was the development of consumer
        e-commerce products and integrated network management systems for the sale
        of
        state and governmental lottery tickets on the Internet. Prior to joining
        eLOT,
        Inc., Mr. McGuinn was President and CEO of Limitrader.com from January 1999
        until May 2000. Limitrader.com is the first Internet based trading platform
        for
        the new issue and secondary trading of corporate bonds. Mr. McGuinn also
        sits on
        the Board of Directors of eLOT, Inc. and the board of a venture capital company
        and several development stage companies specializing in financial technology
        and
        Internet services.
 
 *Richard
        M. Scarlata.* Mr.
        Scarlata became CFO of the Company as of December 30, 2004. From 1999 until
        that date, Mr. Scarlata was self-employed as a consultant, providing financial,
        accounting and business advisory services to clients. From 1993,
        Mr. Scarlata held at different intervals the CFO and CEO positions at
        Rockefeller Center Properties, Inc., a publicly traded REIT. Mr. Scarlata
        possesses an MBA degree in Finance, and has been a CPA since 1970. Previously,
        Mr. Scarlata had also served as an Adjunct Professor of Finance at Monroe
        College in The Bronx, NY.
  **Audit
        Committee**
  In
        March
        2005, the Company adopted an Audit Committee Charter and designated Edwin
        J.
        McGuinn Jr., the sole member of the Audit Committee, as the independent audit
        committee financial expert. The appointment of Mr. McGuinn satisfies the
        definition of independence in accordance with SEC rules and NASDAQ listing
        standards.
 
 The
        Audit
        Committee makes such examinations as are necessary to monitor the corporate
        financial reporting and the external audits of the Company, to provide to
        the
        Board of Directors (the “Board”) the results of its examinations and
        recommendations derived there from, to outline to the Board improvements
        made,
        or to be made, in internal control, to nominate independent auditors, and
        to
        provide to the Board such additional information and materials as it may
        deem
        necessary to make the Board aware of significant financial matters that require
        Board attention.
  **Compensation
        Committee**
  In
        March
        2005, the Company adopted a Compensation Committee Charter. The compensation
        committee is authorized to review and make recommendations to the Board
        regarding all forms of compensation to be provided to the executive officers
        and
        directors of the Company, including stock compensation, and bonus compensation
        to all employees. Mr. McGuinn is the sole member of the Compensation
        Committee.
  26
  **Nominating
        Committee**
  The
        Company does not have a Nominating Committee and the full Board acts in such
        capacity for the immediate future due to the limited size of the Board, which
        consists of three members.
  **Compliance
        with Section 16(a) of the Exchange Act**
  Section
        16(a) of the Securities Exchange Act of 1934 requires that the Company’s
        directors and executive officers and persons who beneficially own more than
        ten
        percent (10%) of a registered class of its equity securities, file with the SEC
        reports of ownership and changes in ownership of its common stock and other
        equity securities. Executive officers, directors, and greater than ten percent
        (10%) beneficial owners are required by SEC regulation to furnish the Company
        with copies of all Section 16(a) reports that they file. Based solely upon
        a
        review of the copies of such reports furnished to us or written representations
        that no other reports were required, the Company believes that, during 2006
        all
        filing requirements applicable to its executive officers, directors, and
        greater
        than ten percent (10%) beneficial owners were met.
  **Code
        of Ethics**
  In
        March
        2005, the Company adopted a Code of Ethics. The Code of Ethics applies to
        the
        Company’s CEO, CFO, principal accounting officer and all persons performing
        similar functions.
  **Item
        10. Executive Compensation** .
  The
        following table sets forth information concerning all cash and non-cash
        compensation awarded to, earned by or paid to all of the executive officers
        of
        the Company, who served during the fiscal year ended December 31, 2006, for
        services in all capacities to the Company:
  SUMMARY
          COMPENSATION TABLE
 Name
                  & Principal Position
              
              Year
              
              Salary
                ($)
              
              Bonus
                ($)
              
              Stock
                  Awards
                ($)
              
              Option
                  Awards(1)
                ($)
              
              Non-Equity
                  Incentive Plan Compensation
                ($)
              
              Nonqualified
                  Deferred Compensation Earnings
                ($)
              
              All
                  Other Compensation
                ($)
              
              Total
                ($)Alvin
                  Estevez President & CEO
              
              
              2006
              
              $
              150,000
              
              
              0
              
              
              0
              
              $
              11,056
              
              
              0
              
              
              0
              
              $
              32,750
              (2)(3)
              $
              193,806Colorado
                  Stark Executive Chairman
              
              
              2006
              
              $
              150,000
              
              
              0
              
              
              0
              
              $
              11,056
              
              
              0
              
              
              0
              
              $
              29,596
              (2)(3)
              $
              190,652Richard
                  M. Scarlata CFO & Treasurer
              
              
              2006
              
              $
              110,000
              
              
              0
              
              
              0
              
              $
              11,070
              
              
              0
              
              
              0
              
              $
              12,500
              (3)
              $
              133,570
 
 (1)
        See
        Notes D [8] and K of the Notes to Consolidated Financial
        Statements.
  (2)
        The
        amounts for both Alvin Estevez and Colorado Stark include a perquisite payment
        for automobile allowance in the amount of $20,000. Messrs. Estevez and Stark
        also serve as directors of the Company, but without compensation for the
        director services.
  (3)
        The
        balance of the amounts for both Alvin Estevez and Colorado Stark include
        Enigma’s matching of employee contributions to the Company’s 401(k) defined
        contribution plan (“401(k) Plan”). The amount for Richard M. Scarlata represents
        Enigma’s matching of employee contributions to the 401(k) Plan. Under the 401(k)
        Plan, which became effective on May 1, 2004, eligible employees are able to
        make contributions to the 401(k) Plan, which are matched, effective
        September 1, 2006, by the Company at the rate of 100% of an individual
        employee’s contribution up to the maximum allowable by law, which for 2006 was
        generally $15,000. Prior to September 1, 2006, the Company matched 50% of
        the first $10,000 of an individual employee's contribution to the 401(k)
        Plan.
  27
  **Employment
        Agreements**
  Messrs.
        Estevez, Stark, and Scarlata each have an employment agreement with the Company
        that currently extends until December 31, 2009. The employment agreements
        each provide for an initial term of employment of three years, which term
        is
        automatically extended for an additional one year term unless either party
        notifies the other of its intention not to renew for an additional year.
        The
        employment agreements provide for annual discretionary performance bonuses
        and
        additional incentive awards, including stock options and stock grants. In
        addition, the employment agreements each contain non-compete, non-disclosure
        and
        non-solicitation restrictive covenants, which last for a period of 12 months
        following the date of the employee’s termination from the Company. A copy of
        each of these employment agreements was filed as an exhibit to the Company’s
        Form 8-K filed on February 16, 2005.
 
 Messrs.
        Estevez, Stark and Scarlata participate in the Company’s defined contribution
        plan, the Enigma Software Group, Inc. 401(k) Plan, (the "401(k) Plan"). The
        401(k) Plan became effective on May 1, 2004. Eligible employees are able to
        make contributions to the 401(k) Plan, which are matched, effective September
        1,
        2006, by the Company at the rate of 100% of an individual employee’s
        contribution up to the maximum allowable by law, which for 2006 was generally
        $15,000. Prior to September 1, 2006, the Company matched 50% of the first
        $10,000 of an individual employee's contribution.
 
 The
        Company recognizes compensation costs associated with stock options over
        each
        employee’s service period, which in all cases is the vesting period for such
        stock option grants. The 2006 stock option awards vest ratably over a period
        of
        12 months from the date of grant, which is the requisite service period for
        such
        awards. No other conditions, such as market or performance conditions, must
        be
        satisfied in order for the option awards to fully vest.
 
 The
        following table sets forth information with respect to outstanding equity
        awards
        at December 31, 2006 held by the persons named in the Summary Compensation
        Table:
  OUTSTANDING
          EQUITY AWARDS AT FISCAL YEAR-END (1)
 Option
                  Awards (1)
              
              Stock
                  AwardsName
              
              Number
                  of Securities Underlying Unexercised Options
                (#)
                  Exercisable
              
              Number
                  of Securities Underlying Unexercised Options (#)
                  Unexercisable
              
              Equity
                  Incentive Plan Awards: Number of Securities Underlying Unexercised
                  Unearned Options (#)
              
              Option
                  Exercise Price
                ($)
              
              Option
                  Expiration Date
              
              Number
                  of Shares or Units of Stock That Have Not Vested (#)
              
              Market
                  Value of Shares or Units of Stock That Have Not Vested ($)
              
              Equity
                  Incentive Plan Awards: Number of Unearned Shares, Units or Other
                  Rights
                  That Have Not Vested (#)
              
              Equity
                  Incentive Plan Awards: Market or Payout Value of Unearned Shares,
                  Units or
                  Other Rights That Have Not Vested ($)Alvin
                  Estevez
                President
                  & CEO
              
              
              225,000(2
                26,293(3
              )
                )
              
              0
                0
              
              
              50,246(2
                0(4
              )
                )
              $
                $
              0.0715
                1.2100
              
              
              4/12/2011
                5/17/2010
              
              
              0
              
              
              0
              
              
              0
              
              
              0Colorado
                  Stark
                Executive
                  Chairman
              
              
              225,000(2
                20,238(3
              )
                )
              
              0
                0
              
              
              50,246(2
                0(4
              )
                )
              $
                $
              0.0715
                1.2100
              
              
              4/12/2011
                5/17/2010
              
              
              0
              
              
              0
              
              
              0
              
              
              0Richard
                  M. Scarlata
                CFO
                  & Treasurer
              
              
              225,000(2
                161,718(3
              )
                )
              
              0
                0
              
              
              50,246(2
                118,271(3
              )
                )
              $
                $
              0.0650
                1.1000
              
              
              4/12/2016
                5/17/2015
              
              
              0
              
              
              0
              
              
              0
              
              
              0
  (1)
        See
        Notes D [8] and K of Notes to Consolidated Financial Statements.
  28
  (2)
        Represents stock option grants for the year ended December 31, 2006; such
        grants
        vest ratably on the first day of each month of January to April,
        2007.
  (3)
        Represents stock option grants for the year ended December 31, 2005; Mr.
        Scarlata’s grant vests 101,377 shares on January 1, 2007 and 16,894 shares on
        January 1, 2008.
  (4)
        The
        2005 stock option awards for Messrs. Estevez and Stark were fully vested
        at
        December 31, 2006.
  **Compensation
        of Directors**
  The
        following table sets forth information with respect to director’s compensation
        for the fiscal year ended December 31, 2006:
  DIRECTOR
          COMPENSATION
 Name
              
              Fees
                  Earned or Paid in Cash
                ($)
              
              Stock
                  Awards ($)
              
              Option
                  Awards ($)
              
              Non-Equity
                  Incentive Plan Compensation
                ($)
              
              Nonqualified
                  Deferred Compensation Earnings
              
              All
                  Other Compensation
                ($)
              
              Total
                ($)Edwin
                  J. McGuinn, Jr.
              
              $
              10,000
              
              
              0
              
              $
              190
              
              
              0
              
              
              0
              
              
              0
              
              $
              10,190
  Non-employee
        Directors of the Company are paid $10,000 per year in director fees, payable
        quarterly. No fees are paid for meeting attendance or for committee service.
        Non-employee Directors also receive non-qualified stock options as
        follows:
 
 Initial
        Grant .
        Upon
        initial election to the Board, a Non-employee Director shall receive a grant
        of
        Stock Option grant to purchase 39,000 shares of Stock with an exercise price
        equal to the fair market value as of the date of grant. The Option shall
        vest as
        to 13,000 shares on the one year anniversary of the date of grant, 13,000
        shares
        on the second anniversary of the date of grant, and 13,000 shares on the
        third
        anniversary of the date of grant, as long as the Board member is still a
        member
        of the Board as of such date. The Option shall have a term of ten
        years.
  Annual
        Grant .
        Every
        Non-employee Director shall be entitled to an annual grant of a Stock Option
        to
        purchase 3,000 Shares on the last trading day in March following the each
        anniversary of the member joining the Board. The Options shall be fully vested
        on the date of grant, with a term of ten years. The exercise price shall
        be the
        fair market value as of the date of the grant.
  During
        the year ended December 31, 2006, Mr. McGuinn was awarded an option to
        purchase 3,000 shares exercisable at $0.065 per share. The Option was fully
        vested upon the date of grant. During the year ended December 31, 2005, Mr.
        McGuinn was awarded an Option to purchase 39,000 shares exercisable at $1.26
        per
        share. The Option vested as to 13,000 shares on each of March 8, 2006 and
        March
        8, 2007, and shall vest with respect to the remaining 13,000 shares on March
        8,
        2008, as long as Mr. McGuinn remains a Board member at such time.
  29
  **Item
        11. Security Ownership of Certain Beneficial Owners and
        Management** **.**
  The
        following table sets forth certain information with respect to the beneficial
        ownership of the Common Stock of the Company as of March 20, 2007, for: (i)
        each
        person who is known by the Company to beneficially own more than 5 percent
        of
        the Company’s Common Stock, (ii) each of the Company’s directors, (iii) each of
        the Company’s Named Executive Officers, and (iv) all directors and executive
        officers as a group. As of March 20, 2007, the Company had 4,191,266 shares
        of
        Common Stock outstanding.
 **Name
                    and Address**
                  **of
                    Beneficial Owner (1)**
                
                **Shares
                    Beneficially Owned**
                
                **Percentage
                    of Shares Beneficially Owned**
                
                **Percentage
                    of Total Voting Power**
                
                **Position**Colorado
                    Stark
                
                
                6,056,872
                (2)
                
                34.3
                %
                
                34.3
                %
                
                Executive
                    Chairman
                  &
                    DirectorAlvin
                    Estevez
                
                
                5,995,129
                (2)
                
                33.9
                %
                
                33.9
                %
                
                President
                    & CEO and DirectorDutchess
                    Private Equities Fund, LP, Dutchess Private Equities Fund, II,
                    LP
                
                
                1,397,088
                
                
                7.9
                %
                
                7.9
                %Edwin
                    J. McGuinn, Jr.
                
                
                0
                
                
                0
                
                
                0
                
                
                DirectorRichard
                    M. Scarlata
                
                
                0
                
                
                0
                
                
                0
                
                
                CFO
                    & TreasurerGuy
                    Bitetto
                
                
                398,609
                
                
                2.26
                %
                
                2.26
                %
                
                SecretaryMichael
                    Zelvin
                  7
                    Lee Lane
                  Rye
                    Brook, NY 10573
                
                
                403,858
                
                
                2.3
                %
                
                2.3
                %Directors
                    and Executive Officers as a Group
                  (4
                    persons)
                
                
                **12,052,001**
                
                
                **68.2**
                **%**
                
                **68.2**
                **%**
  
 (1)
              Except
                  where otherwise indicated, the address of the beneficial owner
                  is deemed
                  to be the same address as the
                  Company.
  (2)
              Includes
                  all shares of Common Stock underlying Messrs. Stark and Estevez’ Preferred
                  Stock that they may obtain within 60 days, assuming the conversion
                  of the
                  1,397,088 shares underlying the Dutchess
                  Debentures.
 
 The
        following table sets forth certain information with respect to the beneficial
        ownership of the Preferred Stock of the Company as of March 20, 2007, for:
        (i) each person who is known by the Company to beneficially own more than
        5
        percent of the Company’s Preferred Stock, (ii) each of the Company’s directors,
        (iii) each of the Company’s Named Executive Officers, and (iv) all directors and
        executive officers as a group. As of March 20, 2007, the Company had
        7,433,988 shares of Preferred Stock outstanding.
  30
 **Name
                    and Address**
                  **of
                    Beneficial Owner**
                
                **Shares**
                  **Beneficially**
                  **Owned**
                
                **Percentage**
                  **of
                    Shares**
                  **Beneficially**
                  **Owned**
                
                **Percentage**
                  **of**
                  **Total
                    Voting Power**
                
                **Position**Colorado
                    Stark
                
                
                3,736,036
                
                
                50.3
                %
                
                50.3
                %
                
                Executive
                    Chairman & DirectorAlvin
                    Estevez
                
                
                3,697,952
                
                
                49.7
                %
                
                49.7
                %
                
                President
                    & CEO and DirectorEdwin
                    J. McGuinn, Jr.
                
                
                0
                
                
                0
                
                
                0
                
                
                DirectorRichard
                    M. Scarlata
                
                
                0
                
                
                0
                
                
                0
                
                
                CFO
                    & TreasurerDirectors
                    and Executive Officers as a Group (4 persons)
                
                
                **7,433,988**
                
                
                **100**
                **%**
                
                **100**
                **%**
 **Securities
        Authorized for Issuance Under Equity Compensation Plans**
  On
        March
        8, 2005, the Company adopted a Stock Option and Grant Plan (the “Plan”), a copy
        of which was filed as an exhibit to the Company’s Form 10-KSB for the fiscal
        year ended December 31, 2004. The Plan has been approved by the Company’s
        stockholders.
 
 The
        following table sets forth certain information with respect to the
        Plan:
 Number
                      of securities to
                    be
                      issued upon exercise of
                    outstanding
                      options,
                    warrants
                      and
                    rights
                  
                  Weighted-average
                    exercise
                      price of
                    outstanding
                      options,
                    warrants
                      and
                    rights
                  
                  Number
                      of securities remaining
                    available
                      for future issuance
                    under
                      equity compensation
                    plans
                      (excluding
                    securities
                      reflected in column (a))(a)
                  
                  (b)
                  
                  (c)Equity
                      compensation plansapproved
                      by security holders
                  
                  
                  2,984,001
                  
                  $
                  0.23
                  
                  
                  15,999Equity
                      compensation plans notapproved
                      by security holders
                  
                  
                  none
                  
                  
                  none
                  
                  
                  noneTotal
                  
                  
                  2,984,001
                  
                  $
                  0.23
                  
                  
                  15,999
 **Item
        12. Certain Relationships and Related Transactions** **,
        and Director Independence**
  Colorado
        Stark and Alvin Estevez had combined control of approximately 74.2% of our
        outstanding Common Stock, representing approximately 74.2% of the voting
        power
        of our outstanding capital stock. However, as a result of the Dutchess financing
        they exchanged their shares of Common Stock for shares of newly issued Preferred
        Stock. The board of directors of the Company concluded that it was in the
        best
        interests of the Company to provide the Messrs. Stark and Estevez shares
        of the
        Company’s Preferred Stock in exchange for their shares of Common Stock. Messrs.
        Stark and Estevez founded the Company and have been instrumental in the
        operations and performance of the Company since inception. Messrs. Stark
        and
        Estevez would not have remained with the Company unless they were afforded
        the
        anti-dilution protection as a result of the Dutchess financing. Dutchess
        was the
        only source of financing for the Company, and the Company could not have
        survived without the Dutchess financing as well as the management services
        of
        Messrs. Stark and Estevez. The board of directors gave the Preferred Holders
        the
        anti-dilution protection they sought with respect to the new class of Preferred
        Stock. No other shareholder was in the same position as Messrs. Stark and
        Estevez, and the board of directors believed that no other shareholder would
        want to relinquish the liquidity associated with the Company’s Common Stock in
        order to receive the anti-dilution protection of the Preferred Stock. There
        was
        no change in the ownership nor the rights of the non-affiliated shareholders
        of
        the Company based on the decision to issue shares of the Company’s Preferred
        Stock to Messrs. Stark and Estevez.
  31
  Since
        the
        holders of shares of the Preferred Stock shall generally vote together with
        the
        holders of shares of the Common Stock on an as-if-converted basis, Colorado
        Stark and Alvin Estevez retain significant influence over management and
        affairs
        and over all matters requiring stockholder approval, including the election
        of
        directors and significant corporate transactions, such as a merger or other
        sale
        of the Company or its assets, for the foreseeable future. This concentrated
        control limits the ability of stockholders to influence corporate matters
        and,
        as a result, we may take actions that our stockholders do not view as
        beneficial. As a result, the market price of our Common Stock could be adversely
        affected.
  Messrs.
        Stark and Estevez co-founded the Company in 1999. In addition to investing
        their
        own capital in Enigma, additional equity capital was raised from family members,
        friends and associates. At the time that Enigma became a public company,
        upon
        its reverse takeover of Maxi in February 2005, and until June 2006, Messrs.
        Stark and Estevez owned 6,056,872 and 5,995,129 shares of the Company’s Common
        Stock, respectively. Such amounts represented 37.3% and 36.9%, respectively,
        of
        the total common shares outstanding. In connection with the Dutchess financing
        in June 2006, Messrs Stark and Estevez each exchanged their shares of the
        Company’s Common Stock for 3,736,036 and 3,697,952 shares, respectively, of the
        Company’s newly issued Preferred Stock at an exchange rate was .61683 shares of
        Preferred Stock for each share of Common Stock. The purpose of this exchange
        was
        to provide anti-dilution protection to Messrs. Stark and Estevez in light
        of the
        potential dilutive effect upon conversion of the Debentures and exercise
        of the
        Warrants. The Preferred Stock has the potential to be extremely dilutive
        to
        holders of the Common Stock. The number of shares issuable upon conversion
        of
        the Preferred Stock works in conjunction with the number of shares issuable
        upon
        conversion of the Debentures. The maximum amount of dilution to be experienced
        by Messrs. Stark and Estevez from their original holdings of Common Stock,
        as a
        result of conversion of the Debentures and issuance of stock from the exercise
        of Warrants, is 15%.
  Consequently
        the conversion rate of Dutchess’ Debenture is a fluctuating 25% discount from
        the market price around the time of conversion, with a maximum conversion
        rate
        of $.07 per share. Furthermore, the conversion rate of the Preferred Stock
        fluctuates with the conversion rate of the Dutchess Debentures and Warrants,
        as
        set forth in Article 3.2(d) (vi) of the Certificate of Designation of the
        Series
        A Convertible Preferred Stock, and is thus a discount of 25% from current
        market
        price. Dutchess’ overall ownership at any one moment is limited to 9.9% of the
        outstanding shares of Common Stock in accordance with the financing documents.
        However, Dutchess is free to sell any shares into the market, which have
        been
        issued to them, thereby enabling Dutchess to convert the remaining Debentures
        or
        exercise additional warrants into shares of Common Stock.
  In
        connection with the reverse takeover of Maxi, in February 2005, shareholders
        acquired 2.827 common shares of Maxi in exchange for each share of “Old” Enigma
        (as defined below) securities, which in turn became an equal number of common
        shares of “New” Enigma, the Registrant, upon the renaming of the Company from
        Maxi to Enigma and its statutory re-incorporation in Delaware.
  Colorado
        Stark exchanged 2,142,500 shares of “Old” Enigma for 6,056,872 shares of Maxi.
        Alvin Estevez exchanged 2,120,668 shares of “Old” Enigma for 5,995,129 shares of
        Maxi. Esther Stark, sister of Colorado Stark, exchanged 2,858 shares of “Old”
Enigma for 8,080 shares of Maxi. Gary Stark, father of Colorado Stark, exchanged
        14,286 shares of “Old” Enigma for 40,387 shares of Maxi. Jordan Stark, brother
        of Colorado Stark, exchanged 2,143 shares of “Old” Enigma for 6,058 shares of
        Maxi. Marjorie Stark, mother of Colorado Stark, exchanged 1,429shares of
“Old”
Enigma for 4,040 shares of Maxi. Daniel Radovanovic, brother-in-law of Alvin
        Estevez, exchanged 20,000 shares of “Old” Enigma for 56,540 shares of
        Maxi.
  32
  In
        anticipation of the reverse takeover, in December 2004, Mathew Evans, one
        of the
        shareholders of Maxi, who was also at that time a Director, President, CEO,
        CFO
        and Secretary of Maxi, returned to Maxi (and Maxi cancelled) 750,000 shares
        of
        its Common Stock owned by him for no consideration. Such cancellation was
        reflected in a Schedule 13D filed by Mr. Evans with the SEC on December 9,
        2004.
  During
        2004, Adorons (“Old” Enigma) loaned $120,000 to its Alvin Estevez, who is
        President and CEO and also one of the Company’s founders as well as a
        stockholder. This loan, including interest at market rates, was repaid in
        February 2005 prior to the completion of the reverse takeover, by the redemption
        and cancellation of 21,840 shares of Adorons’ Common Stock owned by this
        individual.
  In
        November 2004 the Company entered into a financial advisory agreement with
        Jesup
& Lamont Securities Corporation, whose chairman, Stephen DeGroat, owned
        approximately 0.05% of the Company’s Common Stock. The agreement provided for a
        $500,000 advisory fee payable in cash upon the Company’s execution of a Share
        Exchange Agreement with a public company, which amount was paid in December
        2004
        to that entity.
  During
        2004, in connection with the preparation of financial statements for the
        2002
        and 2003 fiscal years, Nobska Associates, LLC, a company of which
        Richard M. Scarlata, the Company’s CFO and Treasurer is a principal, was
        paid a fee of $23,850 and was reimbursed for out-of-pocket expenses totaling
        $293 for services rendered.
  Edwin
        J.
        McGuinn, Jr. is an independent director of the Company, and as such, he
        satisfies the definition of independence in accordance with SEC rules and
        NASDAQ
        listing standards. Colorado Stark and Alvin Estevez are not independent
        directors of the Company.
 
 **Item
        13. Exhibits** **.**
  Listed
        in
        the Exhibit Index on page 36 hereof.
  **Item
        14. Principal Accountant Fees and Services**
  **Audit
        Fees**
  The
        aggregate fees billed or to be billed for professional services rendered
        by our
        independent registered public accounting firm for the audit of our annual
        financial statements, review of financial statements included in our quarterly
        reports and other fees that are normally provided by the accounting firm
        in
        connection with statutory and regulatory filings or engagements for the fiscal
        year ended December 31, 2006 was $66,817.
 
 **Audit
        Related Fees**
  The
        aggregate fees billed or to be billed for audit related services by our
        independent registered public accounting firm that are reasonably related
        to the
        performance of the audit or review of our financial statements, other than
        those
        previously reported in this Item 14, for the fiscal year ended December 31,
        2006 was $-0-.
  33
  **Tax
        Fees**
  The
        aggregate fees billed for professional services rendered by our independent
        registered public accounting firm for tax compliance, tax advice and tax
        planning for the fiscal year ended December 31, 2006 was
        $2,500.
  **All
        Other Fees**
  The
        aggregate fees billed for products and services provided the Company’s
        predecessor accounting firm for the fiscal year ended December 31, 2006 was
        $17,000.
  **Audit
        Committee**
  **A** fter
        his
        joining the Board of Directors in March 2005, Mr. McGuinn was designated
        as the
        sole member of the audit committee and the independent audit committee financial
        expert. It is the policy of the Company for all work performed by its
        independent registered public accounting firm to be approved in advance by
        the
        Board of Directors. All of the services described above in this Item 14 were
        approved in advance by the Board of Directors during 2006.
 
 34
  **SIGNATURES**
  In
        accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
        this report to be signed on its behalf by the undersigned, thereunto duly
        authorized.
 **E****NIGMA****S****OFTWARE****G****ROUP****,
                  I****NC****.**Date: March
                23, 2007
              By
              /s/
                Alvin EstevezAlvin Estevez
                President
                    and Chief Executive Officer
  In
        accordance with the Exchange Act, this report has been signed below by the
        following persons on behalf of the registrant and in the capacities and on
        the
        dates indicated.
 
 Signature
              
              Title
              
              Date/s/
                  Alvin Estevez
              
              President
                  and Chief Executive Officer
              
              March
                  23, 2007Alvin
                  Estevez
              
              (Principal
                  Executive Officer)/s/
                  Colorado Stark
              
              Executive
                  Chairman
              
              March
                  23, 2007Colorado
                  Stark/s/
                  Richard M. Scarlata
              
              Chief
                  Financial Officer and Treasurer
              
              March
                  23, 2007Richard
                  M. Scarlata
              
              (Principal
                  Financial Officer)/s/
                  Edwin J. McGuinn, Jr.
              
              Director
              
              March
                  23, 2007Edwin
                  J. McGuinn, Jr.
 
 35
 **INDEX
          TO EXHIBITS**
 EXHIBIT
                      NO.
                  
                  DESCRIPTION
                      OF EXHIBIT2
                  
                  Share
                      Exchange Agreement, effective as of February 16, 2005, by and among
                      the Company, Enigma and the Stockholders (incorporated by reference
                      to
                      Exhibit 2 in the Company’s Form 8-K filed February 18, 2005 (the
                      “February 18 Form 8-K”)).2.1
                  
                  Agreement
                      and Plan of Merger, dated March 9, 2005 (incorporated by reference
                      to
                      Exhibit 2.1 in the Company’s Form 8-K filed March 8,
                      2005).3(i)
                  
                  Articles
                      of Incorporation of the Company (incorporated by reference
                      to Exhibit 3(i)
                      in the Company’s Form 10-KSB, filed April 10, 2006).3(ii)
                  
                  Bylaws
                      of the Company (incorporated by reference to Exhibit 3(ii)
                      in the
                      Company’s Form 10-KSB, filed April 10, 2006).10.1
                  
                  Lease
                      Agreement, dated as of April 2004, by and between Enigma and RFR/SF
                      17 State Street LP (incorporated by reference to Exhibit 10.1
                      of the
                      February 18 Form 8-K).10.2
                  
                  Employment
                      Agreement, dated as of November 15, 2004, by and between Enigma
                      and
                      Colorado Stark (incorporated by reference to Exhibit 10.2 of
                      the
                      February 18 Form 8-K).10.3
                  
                  Employment
                      Agreement, dated as of November 15, 2004, by and between Enigma
                      and Alvin
                      Estevez (incorporated by reference to Exhibit 10.3 of the February 18
                      Form 8-K).10.4
                  
                  Employment
                      Agreement, dated as of December 30, 2004, by and between Enigma and
                      Richard M. Scarlata (incorporated by reference to Exhibit 10.4
                      of the
                      February 18 Form 8-K).10.5
                  
                  Audit
                      Committee Charter, dated March 8, 2005 (incorporated by reference
                      to
                      Exhibit 10.5 in the Company’s Form 10-KSB filed March 29, 2005 (the “2004
                      Form 10-KSB”)).10.6
                  
                  Compensation
                      Committee Charter, dated March 8, 2005 (incorporated by reference
                      to
                      Exhibit 10.6 of the 2004 Form 10-KSB).10.7
                  
                  Stock
                      Option and Grant Plan, dated March 8, 2005 (incorporated by
                      reference to
                      Exhibit 10.7 of the 2004 Form 10-KSB).14
                  
                  Code
                      of Ethics, dated March 8, 2005 (incorporated by reference to
                      Exhibit 14 of
                      the 2004 Form 10-KSB).16
                  
                  Letter
                      on change in certifying accountant (incorporated by reference
                      to Exhibit
                      16.1 of the Company’s Form 8-K/A filed January 30,
                      2006).21
                  
                  Subsidiaries
                      (incorporated by reference to Exhibit 21 of the 2004 Form
                      10-KSB).31.1*
                  
                  Certifications
                      pursuant to Section 302 of the Sarbanes-Oxley Act of
                      2002.31.2*
                  
                  Certifications
                      pursuant to Section 302 of the Sarbanes-Oxley Act of
                      2002.32.1*
                  
                  Certification
                      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
                      Section 906 of
                      the Sarbanes-Oxley Act of 2002.32.2*
                  
                  Certification
                      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
                      Section 906 of
                      the Sarbanes-Oxley Act of
                      2002.
 *
            Filed
            herewith.
  36




Enigma
      Software Group, Inc.




Annual
      Report to Shareholders




**Index
      to Financial Statements**





**Page**Report
                of Independent Registered Public Accounting Firm
            
            F-2Consolidated
                Balance Sheet
            
            F-3Consolidated
                Statements of Operations
            
            F-4Consolidated
                Statements of Changes in Capital Deficit
            
            F-5Consolidated
                Statement of Temporary Equity
            
            F-6Consolidated
                Statements of Cash Flows
            
            F-7Notes
                to Consolidated Financial Statements
            
            F-8
                - F-24





F-1




**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**




Board
      of
      Directors and Stockholders


Enigma
      Software Group, Inc.


2
      Stamford Landing, Suite 100


Stamford,
      CT 06902





We
      have
      audited the accompanying consolidated balance sheet of Enigma Software Group,
      Inc., (the “Company”) as of December 31, 2006, and the related consolidated
      statements of operations, changes in capital deficit, temporary equity and
      cash
      flows for each of the years in the two-year period ended December 31, 2006.
      These consolidated financial statements are the responsibility of the Company's
      management. Our responsibility is to express an opinion on these consolidated
      financial statements based on our audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audit to obtain reasonable assurance about whether the
      consolidated financial statements are free of material misstatement. The Company
      is not required to have, nor were we engaged to perform, an audit of its
      internal control over financial reporting. Our audit included consideration
      of
      internal control over financial reporting as a basis for designing audit
      procedures that are appropriate in the circumstances, but not for the purpose
      of
      expressing an opinion on the effectiveness of the Company’s internal control
      over financial reporting. Accordingly, we express no such opinion. An audit
      also
      includes examining, on a test basis, evidence supporting the amounts and
      disclosures in the financial statements, assessing the accounting principles
      used and significant estimates made by management, as well as evaluating the
      overall financial statement presentation. We believe that our audits provide
      a
      reasonable basis for our opinion.





In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the financial position of Enigma Software Group,
      Inc.,
      as of December 31, 2006, and the results of its operations and its cash flows
      for each of the years in the two-year period ended December 31, 2006 in
      conformity with accounting principles generally accepted in the United States
      of
      America.





The
      accompanying consolidated financial statements have been prepared assuming
      the
      Company will continue as a going concern. As discussed in Note A to the
      consolidated financial statements, the Company did not generate sufficient
      cash
      flows from revenues during the year ended December 31, 2006, to fund its
      operations. Also at December 31, 2006, the Company had negative net working
      capital of $1,983,367. The Company’s net working capital position has continued
      to deteriorate into the first quarter of 2007. Unless the Company is successful
      in generating new sources of revenue, or obtaining debt or equity financing,
      or
      restructuring its business, the Company is likely to deplete its working capital
      during 2007. These matters raise substantial doubt about the Company’s ability
      to continue as a going concern. Management’s plan in regard to these matters is
      also described in Note A. The consolidated financial statements do not include
      any adjustments that might result from the outcome of this
      uncertainty.








/s/
      BAGELL, JOSEPHS, LEVINE & COMPANY, L.L.C.


Bagell,
      Josephs, Levine & Company, L.L.C.


Gibbsboro,
      NJ 08026





March
      15,
      2007




F-2





**Enigma
                Software Group, Inc.**
              **Consolidated
                Balance Sheet**
              **December 31,
                2006**




**ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            471,254Accounts
                receivable
            
            
            252,387Other
                current assets
            
            
            1,271Total
                current assets
            
            
            724,912Property
                and equipment, net
            
            
            14,379Deferred
                financing costs, net
            
            
            85,500Other
                assets
            
            
            11,088**Total
                Assets**
            
            $
            835,879**LIABILITIES,
                TEMPORARY EQUITY AND CAPITAL DEFICIT**Current
                Liabilities:Accounts
                payable and accrued expenses
            
            $
            101,306Current
                portion of secured convertible debenture, due 2011, net
            
            
            41,667Debenture
                redemption premium payable
            
            
            104,166Accrued
                debenture interest
            
            
            10,000Accrued
                liability for liquidated damages
            
            
            96,295Derivative
                liability
            
            
            1,017,834Warrant
                liability
            
            
            742,260Dividend
                payable in connection with Preferred Stock beneficial
                conversion
            
            
            67,546Deferred
                revenue
            
            
            527,205Total
                current liabilities
            
            
            2,708,279Secured
                convertible debentures, due 2011, net, less current
                portion
            
            
            58,333Commitments
                and contingencies**Total
                Liabilities**
            
            
            2,766,612**TEMPORARY
                EQUITY**Series
                A convertible preferred stock, par value $0.001, 10,000,000 shares
                authorized; 7,433,988 issued and outstanding
            
            
            5,404**CAPITAL
                DEFICIT**Series
                A convertible preferred stock, par value $0.001, 10,000,000 shares
                authorized; 7,433,988 issued and outstanding
            
            
            2,030Common
                stock, par value $0.001, 100,000,000 shares authorized;4,191,266
                issued and outstanding
            
            
            4,191Additional
                paid-in capital
            
            
            153,479Accumulated
                Deficit
            
            
            (2,095,837
            )Total
                capital deficit
            
            
            (1,936,137
            )**Total
                Liabilities, Temporary Equity and Capital Deficit**
            
            $
            835,879*See
                notes to consolidated financial statements.*




F-3




**Enigma
                Software Group, Inc.**
              **Consolidated
                Statements of Operations**




Year
                ended December 31,2006
            
            2005**Revenues:**Sales
                of software products and subscriptions
            
            $
            1,207,824
            
            $
            21,915,358Commission
                income and advertising revenues
            
            
            119,657
            
            
            107,367Total
                revenues
            
            
            1,327,481
            
            
            22,022,725**Expenses:**Marketing
                and selling
            
            
            214,725
            
            
            308,015General
                and administrative
            
            
            1,868,441
            
            
            2,425,265Write-down
                of impaired assets
            
            
            -
            
            
            387,055Depreciation
                and amortization
            
            
            14,577
            
            
            161,045Total
                costs and expenses
            
            
            2,097,743
            
            
            3,281,380Operating
                (loss) income
            
            
            (770,262
            )
            
            18,741,345Interest
                income
            
            
            18,180
            
            
            13,448Debenture
                interest expense
            
            
            (61,000
            )Debenture
                redemption premium
            
            
            (104,166
            )Discount
                expense on convertible debentures
            
            
            (100,000
            )Fair
                value adjustments for derivatives and warrants
            
            
            (760,095
            )Provision
                for liquidated damages
            
            
            (96,295
            )Accretion
                adjustment for beneficial conversion featureof
                Preferred Stock
            
            
            (92,925
            )(Loss)
                income before income tax provision
            
            
            (1,966,563
            )
            
            18,754,793Income
                tax provision
            
            
            -
            
            
            8,581,697**Net
                (loss) income**
            
            $
            (
                1,966,563
            )
            $
            10,173,096Basic
                net (loss)/income per common share
            
            $
            (0.20
            )
            $
            0.63Diluted
                net (loss)/income per common share
            
            $
            (0.20
            )
            $
            0.63Weighted
                average shares outstanding:Basic
            
            
            10,068,680
            
            
            16,129,178Diluted
            
            
            10,068,680
            
            
            16,129,178*See
                notes to consolidated financial statements.*





F-4




**Enigma
                Software Group, Inc.**
              **Consolidated
                Statement of Changes in Capital Deficit**
              **For
                the two years ended December 31,
                2006**




**Preferred
                Stock**
            
            **Common
                Stock**
            
            
            
            
            
            **Treasury
                Stock****Shares**
            
            **Par
                value**
            
            **Shares**
            
            **Par
                value**
            
            **Additional
                Paid-in**
              **Capital**
            
            **Accumulated**
              **Deficit**
            
            **Shares**
            
            **Amount**
            
            **Total
                Capital Deficit****Balance
                - December 31, 2004**
            
            
            
            
            
            
            
            
            **14,838,198**
            
            **$**
            **14,838**
            
            **$**
            **74,048**
            
            **$**
            **(10,302,370**
            **)**
            
            **(188,197**
            **)**
            **$**
            **(4,660**
            **)**
            **$**
            **(10,218,144**
            **)**Shares
                redeemed in connection withrepayment
                of loan by shareholder
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (61,743
            )
            
            (123,485
            )
            
            (123,485
            )Shares
                deemed issued in connection with Maxi Group, Inc. merger
            
            
            
            
            
            
            
            
            1,655,009
            
            
            1,655
            
            
            (1,655
            )Shares
                of Treasury Stock cancelled
            
            
            
            
            
            
            
            
            (249,940
            )
            
            (250
            )
            
            (127,895
            )
            
            
            
            
            249,940
            
            
            128,145Net
                income for the year
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            10,173,096
            
            
            
            
            
            
            
            
            10,173,096**Balance
                - December 31, 2005**
            
            
            
            
            
            
            
            
            **16,243,267**
            
            **$**
            **16,243**
            
            **$**
            **(55,502**
            **)**
            **$**
            **(129,274**
            **)**
            
            **-**
            
            **$**
            **-**
            
            **$**
            **(168,533**
            **)**Exchange
                and cancellation of common shares for newly issued preferred
                shares
            
            
            7,433,988
            
            $
            7,434
            
            
            (12,052,001
            )
            
            (12,052
            )
            
            4,618Stock
                based compensation expense
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            178,985
            
            
            
            
            
            
            
            
            
            
            
            178,985To
                provide for temporary equity
            
            
            
            
            
            (5,404
            )
            
            
            
            
            
            
            
            25,378
            
            
            
            
            
            
            
            
            
            
            
            19,974Net
                loss for the year
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (1,966,563
            )
            
            
            
            
            
            
            
            (1,966,563
            )**Balance
                - December 31, 2006**
            
            
            7,433,988
            
            **$**
            **2,030**
            
            
            **4,191,266**
            
            **$**
            **4,191**
            
            **$**
            **153,479**
            
            **$**
            **(2,095,837**
            **)**
            
            
            
            
            
            
            **$**
            **(1,936,137**
            **)**




*See
                notes to consolidated financial
                statements.*




F-5




**Enigma
                Software Group, Inc.**
              **Consolidated
                Statement of Temporary Equity**
              **For
                the two years ended December 31,
                2006**




**Balance
                - December 31, 2004**
            
            $
            -**Balance
                - December 31, 2005**
            
            $
            -Issuance
                of Preferred Stock
            
            $
            5,404**Balance
                - December 31, 2006**
            
            $
            5,404*See
                notes to consolidated financial statements.*





F-6




**Enigma
                Software Group, Inc.**
              **Consolidated
                Statements of Cash Flows**
              **For
                the years ended
                December 31,**




2006
            
            2005**Cash
                flows from operating activities:**Net
                (loss) income
            
            $
            (1,966,563
            )
            $
            10,173,096Adjustments
                to reconcile net (loss) income to net cash used in operating
                activities:Fair
                value adjustments for derivatives and warrants
            
            
            760,095Discount
                expense on convertible debentures
            
            
            100,000Provision
                for liquidated damages
            
            
            96,295Accretion
                adjustment for beneficial conversion feature of Preferred
                Stock
            
            
            92,925Debenture
                redemption premium payable
            
            
            104,166Stock-based
                compensation expense
            
            
            178,985Depreciation
                and amortization
            
            
            14,577
            
            
            161,045Deferred
                tax asset
            
            
            
            
            
            8,495,000Write-down
                of impaired assets, net of cash proceeds
            
            
            
            
            
            387,055Interest
                income on loan repaid by officer
            
            
            
            
            
            (819
            )Changes
                in:Restricted
                cash
            
            
            
            
            
            1,004,640Accounts
                receivable
            
            
            (201,092
            )
            
            (38,355
            )Prepaid
                expenses and other current assets
            
            
            6,501
            
            
            146,941Other
                assets
            
            
            (11,088
            )Prepaid
                income taxes
            
            
            
            
            
            256,711Accounts
                payable and accrued expenses
            
            
            (35,692
            )
            
            (213,749
            )Accrued
                debenture interest
            
            
            10,000Income
                taxes payable
            
            
            
            
            
            86,166Deferred
                revenue
            
            
            (42,407
            )
            
            (20,594,957
            )Net
                cash used in operating activities
            
            
            (893,298
            )
            
            (137,226
            )**Cash
                flows from investing activities:**Purchase
                of property and equipment
            
            
            (12,456
            )
            
            (9,285
            )Proceeds
                from disposition of excess property and equipment
            
            
            
            
            
            2,785Net
                cash used in investing activities
            
            
            (12,456
            )
            
            (6,500
            )**Cash
                flows from financing activities:**Issuance
                of convertible debentures
            
            
            1,000,000Less:
                Deferred financing costs in connection with issuance of convertible
                debentures
            
            
            (95,000
            )Net
                cash provided by financing activities
            
            
            905,000**Net
                decrease in cash and cash equivalents**
            
            
            (754
            )
            
            (143,726
            )Cash
                and cash equivalents - beginning of year
            
            
            472,008
            
            
            615,734**Cash
                and cash equivalents - end of year**
            
            $
            471,254
            
            $
            472,008**Non-cash
                transaction:**Common
                shares redeemed in connection with repayment of loan and interest
                by
                shareholder
            
            $
            -
            
            $
            123,485**Supplemental
                disclosure of cash flow information:**Cash
                paid for:Interest
            
            $
            51,000
            
            $
            -Taxes
            
            $
            -
            
            $
            2,191*See
                notes to consolidated financial statements.*





F-7




**Enigma
      Software Group, Inc.**


**Notes
      to Consolidated Financial Statements**


**For
      the years ended December 31, 2006 and 2005**




**NOTE
      A -**  ORGANIZATIONANDNATUREOFOPERATIONS




Enigma
      Software Group, Inc. (“Enigma” or the “Company”), is a Delaware corporation,
      headquartered in Connecticut, that was formed in 2005 and is the surviving
      corporation of a reverse takeover with Maxi Group, Inc. (“Maxi”). Enigma
      commenced operations in 1999 and is a developer of security software products
      designed to give customers control over the programs installed on their
      computers in an automated and easy-to-use way, thereby enhancing transparency
      and user-control. In February of 2005, Enigma, upon completion of a reverse
      takeover transaction with Maxi, began trading on the Over the Counter Bulletin
      Board (the “OTCBB”). Enigma currently trades on the OTCBB under the symbol
“ENGM.” The consolidated financial statements include the accounts of the
      Company and its two wholly-owned subsidiaries, which are not material to the
      consolidated results. The only intercompany transactions are investments in
      and
      advances to, subsidiaries, which have been eliminated in consolidation. One
      wholly-owned subsidiary is a foreign corporation formed under the laws of the
      Republic of Lithuania. This subsidiary, which is basically a cost center and
      has
      no revenues, commenced operations in the fourth quarter of 2006 and its
      financial statements, which are prepared in the local currency, have been
      converted to U.S. dollars using the appropriate exchange rates. A foreign
      currency translation loss, which is not material to the consolidated results,
      is
      included in General and Administrative expenses for the year ended
      December 31, 2006.




Enigma’s
      products utilize proprietary technology and target the consumer market. The
      Enigma consumer software product line is currently distributed exclusively
      over
      the Internet by download, and is focused on delivering Internet privacy and
      security to individual users, home offices, and small businesses. Enigma’s
      integrated products work to protect customers’ computers from Spyware, unwanted
      advertising, tracking, and malicious hacker attacks. The Company’s SpyHunter®
product (“SpyHunter”) is a utility that is used to scan and remove Spyware and
      Adware from customers’ computers. Enigma has derived most of its revenue to date
      from SpyHunter license fees, including subscriptions for updates and customer
      service. Users are able to download trial versions of Enigma’s products from its
      various websites and then can decide whether to purchase fully licensed versions
      over the Internet via credit card. Users who purchase the fully licensed version
      pay a fee of $29.99, download the product to their computers and are then
      entitled to receive support and regular updates for 6 months from the date
      of
      purchase.




The
      Company did not generate sufficient cash flows from revenues to fund its
      operations during the years ended December 31, 2006 and 2005. In
      June 2006, Enigma entered into a One million Dollar ($1,000,000)
      convertible debenture agreement with Dutchess Private Equities Fund, LP and
      Dutchess Private Equities Fund, II, LP (collectively “Dutchess”) (see Notes B
      and H). Prior to the funding from Dutchess, in 2005, in order to slow the
      outflow of cash until new sources of revenue could be generated or financing
      obtained, the Company reduced its work force by more than 60%; and in early
      2006, the Company downsized and relocated its offices from New York City to
      Stamford Connecticut, at a significantly reduced rental rate. In addition,
      in
      2006, all of Enigma’s remaining employees deferred their salaries until the
      Dutchess transaction was funded.




**Going
      Concern - The Company continues to lose money and may not stay in
      operations:**




At
      December 31, 2006, the Company had a net working capital deficit of
      approximately $2.0 million. After adding back a derivative liability, a warrant
      liability, a dividend payable in connection with a preferred stock beneficial
      conversion feature, and deferred revenue, all of which totaled approximately
      $2.4 million, the Company had net working capital of approximately $370,000
      available to fund ongoing operations and required debt service payments. The
      Company was required to make amortizing principal payments and redemption
      premium payments to Dutchess on January 2, February 1 and March 1, 2007, which
      totaled approximately $246,000 and will be required to make further such
      payments on April 2, 2007 and probably on May 1, 2007. The payment made on
      March
      1, 2007 created an Event of Default under the Financing, documents. (See Notes
      B
      and Q). The financial statements do not include any adjustments that might
      result from the outcome of this uncertainty.




F-8





At
      December 31, 2005, the Company had negative net working capital of $175,533,
      including deferred revenue of $569,612, which after being added back, provided
      the Company with net working capital of $394,079.




**NOTE
      B -**  FINANCINGTRANSACTION




On
      June 28, 2006, the Company, entered into a Subscription Agreement (the
“Subscription Agreement”) with Dutchess and immediately closed the transaction
      pursuant to which the Company issued secured debentures, convertible into shares
      of common stock of the Company (the “Common Stock”), in the principal amount of
      One million Dollars ($1,000,000) (the “Debentures”) (See Note H). Dutchess
      funded Five Hundred Thousand Dollars ($500,000) to the Company upon the initial
      closing and funded an additional Five Hundred Thousand Dollars ($500,000) to
      the
      Company on July 25, 2006 (the “Financing”), simultaneous with the Company’s
      filing of a registration statement (the “Registration Statement”) with the SEC,
      covering the shares of Common Stock underlying the Debentures.




The
      filing of the Registration Statement was in accordance with a Debenture
      Registration Rights Agreement, which was also entered into by the Company and
      Dutchess on June 28, 2006 and under which the Company is obligated to
      register 58,000,000 shares of Common Stock underlying the exercise of the
      warrants (the “Warrants”) and the shares underlying the conversion of the
      Debentures. Also, in connection with the Financing, on June 28, 2006, the
      Company and Dutchess entered into a Debenture Agreement, a Security Agreement
      and a Warrant Agreement.




Pursuant
      to the Security Agreement, the Company granted Dutchess a first priority
      security interest in certain property of the Company in order to secure the
      prompt payment, performance and discharge in full of all of the Company’s
      obligations under the Debentures and exercise and discharge in full of all
      of
      the Company’s obligations under the Warrants.




The
      Registration Rights Agreement between the Company and Dutchess provides for
      liquidated damages to the extent that the Company does not attain certain
      milestones within specified time frames. Specifically, if the Company had failed
      to file the Registration Statement within 35 calendar days after the Closing
      (a
      milestone which was met by the Company) liquidated damages amounting to
      approximately $20,000 per month would have been payable to Dutchess and the
      Conversion Price of the Debentures would have decreased by 10%. In addition,
      liquidated damages amounting to approximately $20,000 per month are payable
      by
      the Company, in the event that the Registration Statement is not declared
      effective within 90 calendar days after the Closing. Such liquidated damages
      are
      payable for each 30 calendar day period after the 90 day milestone on a
      pro-rata, compounded daily basis until the Registration Statement becomes
      effective. Furthermore, liquidated damages amounting to approximately $20,000
      per month are payable by the Company, in the event that it fails to respond
      to
      any Securities and Exchange Commission (“SEC”) comments or correspondence within
      seven business days of receipt of such by the Company and within nine business
      days in the case of SEC staff accounting comments. As of December 31, 2006,
      liquidated damages totaling approximately $96,000 have been accrued by the
      Company in connection with these two provisions, as the Registration Statement
      was not then and still has not yet been declared effective and the Company
      has
      required more than nine business days to respond, in each case, to the SEC
      staff’s first, second and third round of comments on the Registration Statement.
      Once the Registration Statement has become effective, if Dutchess’ right to sell
      is suspended for any reason for a period of 5 business days, then the Company
      must pay liquidated damages in the amount of 2% of the face amount of the then
      outstanding Debentures for each 10 day calendar period that the suspension
      is in
      effect.




F-9




The
      Debenture Agreement provides that if the Registration Statement is not declared
      effective on or before January 1, 2007, then the Company shall make
      amortizing cash payments to Dutchess on the first business day of each month,
      while there is an outstanding balance on the Debentures, until the Registration
      Statement is declared effective, or the Debentures have been repaid in full.
      Such payments are in the amount of $104,166.67 and are allocated to principal
      at
      the rate of 1/12 of the face amount of the Debentures, ($83,333.33) and to
      a
      debenture redemption premium ($20,833.34), (see Note Q). Accordingly, in
      accordance with Financial Accounting Standards Board (“FASB”) Staff Position
      regarding Emerging Issues Task Force (“EITF”) No. 00-19-2 “Accounting for
      Registration Payment Arrangement” (“EITF 00-19-2”),the Company has estimated
      that the Registration should become effective sometime in May of 2007 and has
      reported as a current liability five months worth of amortizing principal
      payments of $416,667, net of debt discount of $375,000 for a net current
      liability of $41,667 and five debenture redemption premium payments totaling
      $104,166 due with those amortizing principal payments.




In
      connection with the Financing, the Company’s two founders and principal
      stockholders, Colorado Stark and Alvin Estevez, each exchanged their shares
      of
      Common Stock (collectively 12,052,001 shares of Common Stock) for an aggregate
      7,433,988 shares of newly issued Series A Convertible Preferred Stock (the
      “Preferred Stock”) convertible initially at the rate of $0.07, (the “Initial
      Conversion Price”.) While the Preferred Stock ranks senior to the Common Stock
      with respect to dividends, and on parity with the Common Stock with respect
      to
      liquidation, the holders of shares of the Preferred Stock shall generally vote
      together with the holders of shares of the Common Stock on an as-if-converted
      basis. The number of shares issuable upon conversion of the Preferred Stock,
      issued as an anti-dilutive device to Colorado Stark and Alvin Estevez, work
      in
      tandem with the number of shares issuable upon conversion of the Debentures.
      Prior to the financing between the Company and Dutchess, Messrs. Stark and
      Estevez, owned 74.2% of the Company’s Common Stock. Assuming the full conversion
      of the 58,000,000 shares underlying the exercise of the warrants (the
“Warrants”) and the shares underlying the conversion of the Debentures that the
      Company is obligated to register, the maximum amount of dilution to be
      experienced by Messrs. Stark and Estevez is 15%. Such number was derived
      assuming Dutchess’ full conversion of the 58,000,000 shares, as well as Messrs.
      Stark and Estevez’ conversion of their shares of Preferred Stock into shares of
      the Company’s Common Stock at the Initial Conversion Price. Assuming such
      conversion, Dutchess would own 58,000,000 shares of the Company’s Common Stock,
      Messrs. Stark and Estevez would own 106,199,827 shares of the Company’s Common
      Stock, and the number of shares outstanding immediately prior to the time of
      such conversion would remain at 4,191,266. In this instance, Messrs. Stark
      and
      Estevez would own 63.1% of the Company’s Common Stock, a 15% decrease from the
      74.2% of Common Stock they owned prior to entering into the financing with
      Dutchess.




The
      conversion rate of Dutchess’ Debentures is a fluctuating 25% discount from the
      market price around the time of conversion, with a maximum conversion rate
      of
      $0.07 per share. Furthermore, the conversion rate of the Preferred Stock
      fluctuates with the conversion rate of the Dutchess Debentures and the Warrants’
exercise price, as set forth in Article 3.2(d) (vi) of the Certificate of
      Designation of the Series A Convertible Preferred Stock, and is thus a discount
      of 25% from current market price. Dutchess’ overall ownership at any one moment
      is limited to 9.9% of the outstanding shares of Common Stock in accordance
      with
      the Financing documents. However, Dutchess is free to sell any shares into
      the
      market, which have been issued to them, thereby enabling Dutchess to convert
      the
      remaining Debentures or exercise additional Warrants into shares of Common
      Stock. The shares of Common Stock that will be issued, if the shares of
      Preferred Stock are converted, will be very dilutive to the Company’s common
      stockholders (see Note J).




F-10




**NOTE
      C -**  **REVERSETAKEOVER**




Maxi,
      a
      non-operating public company, was incorporated on June 17, 1986 in the
      State of Nevada. On December 29, 2004, Maxi entered into a Share Exchange
      Agreement (the "Acquisition Agreement") with Adorons.com, Inc. (formerly known
      as Enigma Software Group, Inc.) a closely-held, Delaware corporation which
      commenced operations in 1999 (“Adorons”). Adorons was a developer of an
      Internet-based search network and downloadable security software products
      designed to give customers instant access to information on the web and control
      over the programs installed on their computers in an automated and easy-to-use
      way, thereby enhancing transparency and user-control.




Pursuant
      to the terms of the Acquisition Agreement, which closed on February 16,
      2005, Maxi acquired substantially all of the issued and outstanding capital
      stock of Adorons, in exchange for 14,158,953 newly issued shares of Maxi's
      common stock (the "Exchange"). In addition, Maxi acquired for $50,000,
      97,633,798 shares of its own common stock from certain of its stockholders
      prior
      to the Exchange, which shares were canceled on February 16, 2005. Three
      stockholders of Adorons, who held 151,858 shares of common stock, did not
      exchange their shares for Maxi common stock at the time of the Exchange.
      However, on April 8, 2005, these stockholders did exchange all of their
      shares for 429,305 shares of Maxi common stock. For reporting purposes, these
      shares are considered to have been exchanged as of February 16, 2005.




The
      14,588,258 shares of common stock represented approximately 89.81% of the
      ownership interests in Maxi. The Exchange, which resulted in the stockholders
      of
      Adorons obtaining control of Maxi, represented a recapitalization of Maxi,
      or a
      reverse takeover rather than a business combination. As a non-operating company,
      the assets and liabilities of Maxi were not material to the reverse takeover.
      For accounting purposes, Adorons was considered to be an acquirer in the reverse
      acquisition transaction and, consequently, the financial statements are the
      historical financial statements of Adorons and the reverse takeover has been
      treated as a recapitalization of Adorons. Additionally, on February 16,
      2005, Maxi issued 135,000 shares of common stock to a related party for the
      assumption of certain liabilities that amounted to approximately
      $46,000.




On
      April 14, 2005, Maxi completed a reincorporation merger to the state of
      Delaware and changed its name to Enigma Software Group, Inc. On May 17,
      2005, Adorons merged into its parent company, Enigma Software Group, Inc.,
      and
      ceased to exist as a separate company.




**NOTE
      D -**  **SIGNIFICANTACCOUNTINGPOLICIES**




**[1]**
              **Fair
                  value of financial
                  instruments:**




At
      December 31, 2006 and 2005, the Company’s financial instruments included
      cash, accounts receivable and accounts payable. The carrying values of these
      instruments approximate their fair value because of their short-term nature.




At
      December 31, 2006, financial instruments also included the Debentures.
      Because the Debentures contain a conversion feature that is deemed to be an
      embedded derivative requiring bifurcation from the debt host instrument, they
      are precluded from being accounted for as conventional convertible debt.
      Specifically, the Company has concluded that since, among other things, the
      Debenture contract does not contain economic characteristics and risks that
      are
      contained in its embedded derivative (i.e., the Company’s Common Stock) and the
      host instrument does not meet the definition of conventional convertible debt
      required by Emerging Issues Task Force Issue No. 00-19 “Accounting for
      Derivative Financial Instruments Indexed to, and Potentially Settled in a
      Company’s Own Stock” (“EITF 00-19”), as it contains provisions that could result
      in the conversion ratio not being fixed, the Debentures should be accounted
      for
      pursuant to the provisions of Statement of Financial Accounting Standards
      No. 133, “Accounting for Derivative Instruments and Hedging Activities,”
(“FAS 133”). Accordingly, the fair value of the derivative liability as of the
      December 31, 2006, has been estimated using a Black-Scholes-Merton model
      with the following assumptions: Debenture conversion price of $0.035 equal
      to
      75% of the closing market price of the Company’s Common Stock as of the last
      trading day on which the Company’s Common Stock traded prior to
      December 31, 2006; a five year life in the case of the non-current portion
      of the Debentures and an average 2 month life in the case of the current portion
      of the Debentures (see Note B); estimated the amount of dividends the Company
      would pay to be zero; an expected volatility of 221.13%, based on the average
      of
      the historical volatility for the Company’s Common Stock during its 22 months of
      trading activity; and a risk-free interest rate of 4.65%, based on the U.S.
      Treasury constant maturity rate for the period equal to the expected life of
      the
      derivative instrument.




F-11




**[2]**
              **Revenue
                  recognition:**




With
      respect to license fees generated from the sales of software products and
      subscriptions services for downloadable security software products, the Company
      recognizes revenues in accordance with Statement of Position (“SOP”)
      No. 97-2, "Software Revenue Recognition," as amended by SOP No. 98-9,
      "Modification of SOP No. 97-2, Software Revenue Recognition, With Respect
      to Certain Transactions." These statements provide guidance for recognizing
      revenues related to sales by software vendors. The Company sells its SpyHunter
      software with the subscription service for spyware definition updates and
      product support over the Internet. Customers place their orders and
      simultaneously provide their credit card information to the Company. Upon
      receipt of authorization from the credit card issuer, the Company licenses
      the
      customer to download SpyHunter over the Internet. For the sales price, the
      Company provides a subscription for post-contract customer support ("PCS")
      for a
      period of six months, which consists primarily of e-mail support and free
      updates of its SpyHunter software, as and when such updates are available.
      In
      accordance with SOP No. 97-2 and SOP No. 98-9, the fee is required to
      be allocated to the various elements, based on vendor-specific objective
      evidence ("VSOE") of fair value.




In
      connection with the issuance of SpyHunter 2.0, which was released in late
      January 2005, the Company announced to all of its then existing customers
      that as of March 10, 2005, the Company would no longer support and/or
      provide updates to its SpyHunter software issued prior to the introduction
      of
      SpyHunter 2.0 (“SpyHunter 1 series”), and the Company ceased to offer the
      SpyHunter 1 series, for which PCS had been provided for an indefinite period.
      As
      an incentive to purchase the then recently released SpyHunter 2.0, the Company
      offered this software to its existing customers free of charge for a period
      of
      90 days. Since VSOE did not exist for the allocation of revenue to the various
      elements of the SpyHunter 1 series arrangement, as the Company had not limited
      the amount of time it would support the product, the Company had deferred all
      revenue from such arrangements. However, with the discontinuance of the
      SpyHunter 1 series, the Company began to recognize its deferred revenue related
      to the SpyHunter 1 series, beginning in March 2005, ratably over a period of
      90
      days. Accordingly, during the year ended December 31, 2005, the Company
      recognized as revenue, all sales from its SpyHunter 1 series software, while
      no
      additional cash was received during that year in connection with these
      subscription and product sales. Substantially all (97%) of the revenue from
      sales of software subscriptions and products reported during the year ended
      December 31, 2005 is from SpyHunter 1 series sales, which occurred during
      2003, 2004 and January 2005.




F-12




SpyHunter
      2.0 provided for twelve months of post-contract customer support and updates,
      if
      any. Accordingly, the Company recognized revenue from sales of subscriptions
      of
      SpyHunter 2.0 ratably over the 12-month period subsequent to each sale of
      SpyHunter 2.0. During May 2006, the Company introduced SpyHunter 2.7, and in
      the
      fourth quarter of 2006, introduced SpyHunter 2.8. In the case of both, the
      Company provides post-contract customer support and updates, if any, for a
      period of six months. The Company considers all revenue from the sales of
      SpyHunter 2.0, 2.7 and 2.8 to be attributable to the service elements.




With
      respect to commission income, the Company recognizes such revenue at the time
      of
      delivery of the product or the service for which the commission is earned;
      and
      with respect to on-line advertising, at the time the advertising revenue is
      generated as determined by the consumer’s click-through to the advertiser’s
      website.




The
      Company’s license agreement for its SpyHunter software does not provide the
      Company’s customers with any right of return. However, the Company may decide to
      accept customer returns on a case-by-case basis. For the years ended
      December 31, 2006 and 2005, customer returns and chargebacks were
      minimal.




**[3]**
              **Property,
                  plant and equipment:**




Furniture,
      equipment and computer hardware are depreciated using the straight-line method
      over their estimated useful lives of up to five years. Purchased computer
      software products are amortized using the straight-line method over their
      estimated useful lives of three years. Leasehold improvements are amortized
      by
      the straight-line method over the shorter of the remaining term of the lease
      or
      the economic useful life of the asset. The Company evaluates its long-lived
      assets in accordance with SFAS No. 144, “Accounting for the Impairment or
      Disposal of Long-Lived Assets”. In the evaluation, the Company compares the
      values of such assets to the estimated undiscounted future cash flows expected
      from the use of the assets and their eventual disposition. When the estimated
      undiscounted future cash flows are less than the carrying amount, an impairment
      loss is recognized equal to the difference between the assets’ fair value and
      their carrying value. At December 31, 2005, the Company incurred an
      impairment charge of $387,055, representing the difference between what the
      Company had received and expected to receive, $3,785, from the disposal of
      its
      excess furniture and fixtures, as well as the abandonment of its leasehold
      improvements (see Note N), and their respective carrying values at that date;
      and the security deposit of $83,147, on its office lease.




**[4]**
              **Software
                  development costs:**




The
      Company accounts for software development costs in accordance with Statement
      of
      Financial Accounting Standards (“SFAS”) No. 86, “Computer Software to Be
      Sold, Leased, or Otherwise Marketed”. Such costs are expensed prior to
      achievement of technological feasibility and thereafter are capitalized. There
      have been very limited software development costs incurred between the time
      the
      SpyHunter software and its related enhancements have reached technological
      feasibility and its general release to customers. As a result, all software
      development costs have been charged to general and administrative
      expense.




F-13




**[5]**
              **Advertising
                  expenses:**




Advertising
      expenses, consisting primarily of space purchased from various Internet-based
      marketers as well as search engines, are expensed as incurred. For the years
      ended December 31, 2006 and 2005, advertising expense amounted to $87,193
      and $88,611, respectively, and is included in marketing and selling expenses
      in
      the Company’s Consolidated Statement of Operations for those respective
      years.




**[6]**
              **Income
                  taxes:**




The
      Company uses the asset and liability method to account for income taxes. Under
      this method, deferred tax assets and liabilities are recognized for the future
      tax consequences attributable to differences between the financial statement
      carrying amounts of existing assets and liabilities and their respective tax
      bases. Deferred tax assets and liabilities are measured using the enacted tax
      rates expected to apply to taxable income in the years during which those
      temporary differences are expected to be recovered or settled.




**[7]**
              **Accounting
                  estimates:**




The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States of America requires management to make
      estimates and assumptions that affect the reported amounts of assets and
      liabilities and disclosure of contingent assets and liabilities at the date
      of
      the financial statements and the reported amounts of revenue, costs and expenses
      during the period. Estimates are used in accounting for cost of post-contract
      customer support, sales returns and allowances, lives of depreciable and
      amortizable assets, employee benefits, valuation of derivatives, provision
      for
      income taxes, realization of deferred tax assets and stock-based compensation
      expenses. Actual results could differ from those estimates.




**[8]**
              **Stock-based
                  compensation
                  expense:**




The
      Company recognizes compensation costs associated with stock options over each
      employee’s service period, which in all cases is the vesting period for such
      stock option grants. In December 2004, the Financial Accounting Standards Board
      (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123
      (revised 2004), “Share-Based Payment” (“SFAS 123R”). SFAS 123R establishes
      standards that require companies to record the cost resulting from all
      share-based payment transactions using the fair value method. Transition under
      SFAS 123R permits using a modified version of prospective application under
      which compensation costs are recorded for unvested shares outstanding or a
      modified retrospective method under which all prior periods impacted by SFAS
      123R are restated. SFAS 123R became effective, for the Company, as of January
      1,
      2006, with early adoption permitted. Enigma adopted prospective application
      in
      2006, and accordingly compensation costs associated with stock options that
      were
      unvested at December 31, 2005 and which vested in the first quarter of 2006
      were
      expensed in the first quarter of 2006. This resulted in a charge to earnings
      of
      $108,263 in that quarter. Accordingly, the financial statements for the
      Company’s prior interim periods and fiscal years will not reflect any restated
      amounts. In addition, for compensation costs incurred in the second, third
      and
      fourth quarters of 2006 in connection with stock options granted and vested
      during 2006, the Company recorded charges to earnings of $40,308 in the second
      quarter and $15,207 in each of the third and fourth quarters, resulting in
      a
      total charge of $178,985 for the year ended December 31, 2006. All stock-based
      compensation expense is included in General and Administrative expense on the
      Company’s Consolidated Statement of Operations. Since the portion of this
      expense related to Incentive Stock Options (“ISOs”) is not deductible for tax
      purposes, its recording gave rise to a deferred tax asset of approximately
      $61,000. However, since the Company has reported a loss before income tax
      provision for the year ended December 31, 2006, and has utilized all if its
      Net
      Operating Loss carryforwards, such benefit would not be realizable, and as
      a
      result, has been entirely offset by a valuation reserve.




F-14





**[9]**
              **Earnings
                  per share:**




Basic
      earnings (loss) per share are computed by dividing the income/loss available
      to
      common stockholders by the weighted average number of common shares outstanding.
      For the year ended December 31, 2006 diluted earnings per share would
      include the dilutive effect, if any, from the potential exercise of stock
      options using the treasury stock method, as well as the potential conversion
      of
      shares of Preferred Stock into Common Stock, the potential conversion of
      Convertible Debentures into shares of Common Stock and the potential issuance
      of
      shares of Common Stock upon potential exercise of Warrants. Since such treatment
      for the year ended December 31, 2006 would be anti-dilutive, diluted
      earnings per share are equivalent to basic earnings per share. For the year
      ended December 31, 2005, diluted earnings per share would include the
      dilutive effect, if any, from the potential exercise of stock options using
      the
      treasury stock method. Options to purchase common stock were outstanding during
      the year ended December 31, 2005, but were not included in the computation
      of diluted earnings per share because the options’ exercise prices were greater
      than the average market price of the common shares and, therefore, the effect
      would have been anti-dilutive.




**[10]**
              **Future
                  impact of recently issued accounting
                  standards:**




In
      June 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error
      Corrections, a replacement of APB Opinion No. 20 and FASB Statement
      No. 3.” SFAS No. 154 will become effective for accounting changes and
      corrections of errors made in fiscal year 2006 and beyond. The effect of this
      statement on the Company’s Financial Statements will depend on the nature and
      significance of future accounting changes subject to this statement.




**[11]**
              **Cash
                  and cash
                  equivalents:**




The
      Company considers all highly liquid investments with an original maturity of
      three months or less to be cash equivalents.




**NOTE
      E -**  **RESTRICTEDCASH**




Under
      a
      credit card processing agreement with a financial institution, which was
      terminated as of December 31, 2004, the Company had been required to
      maintain a security reserve deposit as collateral. The amount of the deposit
      was
      at the discretion of the financial institution and as of January 1, 2005 it
      was $1,004,640. During the year ended December 31, 2005, these funds were
      released to the Company and were reflected in net cash provided by operating
      activities for the year ended December 31, 2005, with the result that net
      cash used in operating activities for the year ended December 31, 2005 was
      $137,226. Without the benefit of these funds, the Company, in all likelihood,
      would have exhausted its cash resources prior to December 31,
      2005.




F-15




**NOTE
      F -**  **CONCENTRATIONSOFCREDITRISK**




C ASH  AND
        CASH
        EQUIVALENTS




The
      Company has placed its cash and cash equivalents with highly capitalized
      financial institutions insured by the Federal Deposit Insurance Corporation
      (“FDIC”). At December 31, 2006 and 2005, such cash balances were in excess
      of FDIC limits.




A CCOUNTS
        RECEIVABLE


The
      Company utilizes a third-party servicer (the “servicer”) that acts as a retail
      merchant to process its sales of software products and to collect its sales
      receipts from the customers’ credit card companies. The servicer holds the
      receipts until the end of the month subsequent to the month of the sale, at
      which time it remits the funds, net of the servicer’s commission, to the
      Company. This process represents a significant concentration of the Company’s
      accounts receivable. Accordingly, if the servicer were not able to pay the
      amounts owed to the Company, the impact would have a material adverse effect
      upon the Company’s liquidity, financial position and results of
      operation.




**NOTE
      G -**  **PROPERTY
      ANDEQUIPMENT**




Property
      and equipment is comprised of the following at December 31:




**2006**
            
            **2005**
            
            **Estimated**
              **Useful
                Lives**Computer
                hardware
            
            **$**
            **23,163**
            
            **$**
            **14,000**
            
            
            **3
                - 5 years**Furniture
                and fixtures
            
            
            **3,293**
            
            
            **0**
            
            
            **5
                years**Gross
                property and equipment
            
            
            **26,456**
            
            
            **14,000**Less
                accumulated depreciation
            
            
            **12,077**
            
            
            **7,000**Net
                property and equipment
            
            **$**
            **14,379**
            
            **$**
            **7,000**





During
      the year ended December 31, 2006 the Company recorded depreciation expense
      of $5,077 and during the year ended December 31, 2005, the Company recorded
      depreciation and amortization expense of $161,045. As discussed in Note D-3,
      the
      Company recognized an impairment charge of $387,055 during the year ended
      December 31, 2005. As the Company terminated 61% of its employees during
      the year ended December 31, 2005 and outsourced their functions to
      independent contractors, as well as the remaining employees, the computer and
      communications equipment, software and furniture and fixtures used by those
      former employees became excess. At December 31, 2005, the Company had sold
      some of that property and equipment to its employees and former employees,
      and
      had entered into an agreement with a third party to sell a portion of the
      remainder. Since this property and equipment was principally computer and
      telecommunications equipment, its fair value was deemed to be de minimis and
      the
      undepreciated balance was written off, net of a token amount of actual and
      anticipated proceeds.




Until
      March 1, 2006, the Company had leased space at 17 State Street, New
      York, New York (the "Building"). On March 10, 2006, the Company advised the
      owner of the Building that in view of the owner's breach of certain of its
      obligations under the Company's lease of space at the Building, the Company
      had
      no choice but to vacate the premises (see Note N.) Accordingly, the Company
      relocated to offices in Stamford, Connecticut in order to conserve cash while
      it
      attempted to develop a viable business plan, rebuild its business and explore
      strategic alternatives. The furniture and fixtures at this location as well
      as
      the leasehold improvements of the demised premises were abandoned and the
      Company deemed them to be worthless as of December 31, 2005.




F-16




**NOTE
      H -** ****S****ECURED****C****ONVERTIBLE****D****EBENTURES****D****UE****2011****




The
      Debentures bear interest at 12% per annum, payable monthly, and are due in
      June
      of 2011. The Debentures are convertible into shares of Common Stock of the
      Company at the lesser of $0.07 per share or seventy-five percent (75%) of the
      lowest closing bid price of the Common Stock during the 20 trading days
      immediately preceding a notice of conversion (the “Conversion Price”). The
      Warrants are also exercisable at the Conversion Price and may be exercised
      any
      time after issuance through and including June 28, 2011. The shares of
      Common Stock that will be issued, if the underlying Debentures are converted
      and
      the Warrants are exercised, will be very dilutive to the Company’s common
      stockholders (see Note J). The potential conversion of Convertible Debentures
      into shares of Common Stock and the potential issuance of shares of Common
      Stock
      upon the potential exercise of Warrants give rise to a Derivative Liability
      and
      a Warrant Liability, respectively. The Company has calculated the potential
      value of each respective liability using the Black-Scholes-Merton option-pricing
      model: with the Company’s latest stock trading price of $0.05 at, or prior to,
      December 31, 2006; the annualized historical volatility of the Company’s
      stock price over a period of 22 months of 221.13%; an estimated exercise price
      of $0.0375, equal to the estimated Conversion Price at December 31, 2006;
      an estimated life of 5 years for the non-current portion of the Convertible
      Debentures and an average estimated life of 2 months for the current portion
      of
      the Convertible Debentures; and a discount rate of 4.65% equal to the yield
      on 5
      year Treasury Notes issued December 29, 2006. These calculations resulted
      in an estimated value of $1,017,834 for the convertibility feature of the
      Convertible Debentures and an estimated value of $742,260 for the Warrants.
      Such
      amounts were recorded as liabilities in the Company’s consolidated financial
      statements as of December 31, 2006, giving rise to a charge to earnings for
      the year ended December 31, 2006 of $760,095 for the fair value adjustment
      of derivatives and warrants. At June 30, 2006, a Convertible Debenture
      Discount of $1 million was netted against the liability for Convertible
      Debentures, thereby reducing that liability to a net of zero. The Convertible
      Debentures are due in 60 months from the Closing; therefore the $1,000,000
      discount is being amortized as an expense at the rate of $16,666.67 per month.
      Accordingly, as of December 31, 2006, Discount Expense on Convertible
      Debentures has been so expensed for six months with the result that $100,000
      ($41,667 and $58,333 current and non-current portions, respectively) of
      Debentures outstanding are reported on the balance sheet, net of unamortized
      discount. The Debenture Agreement contains provisions for amortizing cash
      payments, allocated to principal and debenture redemption premium, to be made
      if
      the Registration Statement has not been declared effective by January 1,
      2007, which is the case. Failure to make such payments when due and in the
      amount due is considered an Event of Default under the Debenture Agreement.
      See
      Notes B and Q).




**NOTE
      I -**  **TEMPORARYEQUITY**




As
      of
      December 31, 2006, the Company did not have a sufficient quantity of
      authorized Common Stock to meet it potential obligations for conversion of
      the
      Debentures, the exercise of the Warrants and the conversion of the Preferred
      Stock. At the December 29, 2006 closing stock price of $0.05, the
      Debentures could have been converted into 26,666,666 shares of the Company’s
      Common Stock, the Warrants could have been exercised for 15,000,000 shares
      of
      the Company’s Common Stock, and the Preferred Stock could have been converted
      into 198,239,680 shares of the Company’s Common Stock. The aggregate of the
      common shares outstanding and those shares due upon the conversions and the
      Warrant exercise, as of December 31, 2006, was in excess of
      244 million shares of Common Stock, which exceeded the 100 million
      shares of Common Stock authorized in the Company’s Certificate of Incorporation.
      Accordingly, the excess of such shares, 144,097,612, represented by 5,403,661
      shares of the Company’s Preferred Stock, has been reclassified to Temporary
      Equity on the Consolidated Balance Sheet until this situation can be resolved.
      Management intends to study its alternatives to remedy this situation, including
      increasing the number of authorized shares of Common Stock, with the consent
      of
      the Company’s shareholders. In addition, at December 31, 2006, based on the
      Company’s stock trading price and the conversion price of the preferred shares,
      a beneficial conversion feature exists with respect to the Preferred Stock.
      Accordingly, a charge to income of $92,925 was required in connection with
      the
      Preferred Stock beneficial conversion feature. The portion that relates to
      the
      preferred shares deemed to be temporary equity ($67,546) was recorded as a
      dividend payable to preferred shareholders; and the portion that relates to
      the
      preferred shares in permanent equity ($25,379) was credited to Additional
      Paid-in Capital.




F-17




**NOTE
      J -**  **CAPITALDEFICIT**




The
      Company’s authorized capital stock consists of 100,000,000 shares of Common
      Stock, par value $.001 per share and 10,000,000 shares of Preferred Stock,
      par
      value $.001 per share. As of December 31, 2006, 4,191,266 shares of Common
      Stock were issued and outstanding, 3,000,000 shares of Common Stock were
      reserved for issuance upon the exercise of outstanding stock options, and
      58,000,000 shares of Common Stock were reserved for conversion of the Debentures
      and exercise of the Warrants. In addition, 7,433,988 shares of Preferred Stock
      were issued and outstanding. As of December 31, 2005, 16,243,267 shares of
      Common Stock were issued and outstanding and 3,000,000 shares of Common Stock
      were reserved for issuance upon the exercise of outstanding stock options (see
      Note K.) No shares of Preferred Stock were issued or outstanding as
      December 31, 2005. The Company will not receive any proceeds from the
      conversion of the Debentures into Common Stock but will receive proceeds from
      the exercise of the Warrants, if so exercised.




**Preferred
      Stock** - As
      discussed in Note B, with the issuance of the Debentures to Dutchess, Messrs.
      Stark and Estevez exchanged their combined 12,052,001 shares of Common Stock
      for
      7,433,988 shares of Preferred Stock. The terms of the Preferred Stock
      follow:




***Voting,
      Dividend and Other Rights.*** The
      holders of shares of Preferred Stock shall vote together with the holders of
      shares of Common Stock and any other series of preferred stock or common stock
      that, by its terms, votes on an as-if-converted basis with the Common Stock
      on
      all matters to be voted on or consented to by the stockholders of the Company,
      except as may otherwise be required under the Delaware General Corporation
      Law
      (the “DGCL”). With respect to any such vote or consent, each holder of Preferred
      Stock shall only be entitled to vote the number of shares of Common Stock
      underlying the Preferred Stock that such holder has the right to convert as
      of
      the record date for determination of holders of Common Stock entitled to
      participate in such vote or action by consent. With respect to the payment
      of
      dividends and other distributions on the capital stock of the Company, other
      than the distribution of the assets upon a liquidation, dissolution or
      winding-up of the affairs of the Company, the Preferred Stock shall rank: (i)
      senior to the Common Stock of the Company, (ii) senior to any new class or
      series of stock of the Company that by its terms ranks junior to the Preferred
      Stock, or that does not provide any terms for seniority, as to payment of
      dividends, or (iii) on a parity with any new class or series of stock of the
      Company that by its terms ranks on a parity with the Preferred
      Stock.




***Rights
      upon Liquidation.*** With
      respect to the distribution of assets upon a liquidation, dissolution or
      winding-up of the affairs of the Company, whether voluntary or involuntary,
      the
      Preferred Stock shall rank (i) on a parity with the Common Stock, (ii) senior
      to
      any new class or series of stock of the Company that by its terms ranks junior
      to the Preferred Stock, or that does not provide any terms for seniority, as
      to
      distribution of assets upon liquidation, dissolution or winding-up, (iii) on
      a
      parity with any new class or series of stock of the Company that by its terms
      ranks on a parity with the Preferred Stock as to distribution of assets upon
      liquidation, dissolution or winding-up of the Company and (iv) with the consent
      of the holders of all of the then outstanding shares of the Preferred Stock,
      junior to any new class of stock of the Company that by its terms ranks senior
      to the Preferred Stock as to distribution of assets upon liquidation,
      dissolution or winding-up of the Company.




F-18




***Conversion
      Rights.*** The
      holders of the Preferred Stock entered into a Lock-Up Agreement with the
      Company, whereby the holders of Preferred Stock agreed not to convert their
      shares of Preferred Stock into shares of the Company’s Common Stock from
      February 6, 2007, until in either case ending on the earlier to occur of (i)
      three hundred and sixty (360) days after the effective date of the Registration
      Statement or (ii) the date on which the full face amount, accrued interest
      and
      penalties, if any, on the Debentures have been paid or (iii) the conversion
      in
      full of the Debentures, any accrued interest thereon and the full exercise
      of
      the Warrants (either being the “Lock-Up Period”). However, the holders of the
      Preferred Stock may convert their shares of Preferred Stock during the Lock-Up
      Period upon and after the occurrence of Dutchess acquiring a percentage
      threshold of the shares of the Company’s Common Stock, whether through partial
      conversion of the shares underlying the Debentures or exercise of the shares
      underlying the Warrants, on a pro rata basis with subsequent conversions of
      Common Stock that have been issued to Dutchess as a result of conversions of
      the
      Debentures and exercise of the Warrants.




In
      the
      event that the outstanding shares of Common Stock shall be subdivided into
      a
      greater number of shares, and no equivalent subdivision or increase is made
      with
      respect to the Preferred Stock, the conversion price, concurrently with the
      effectiveness of such subdivision or other increase, shall be proportionately
      decreased. In the event that the outstanding shares of Common Stock shall be
      combined or consolidated into a lesser number of shares of Common Stock, and
      no
      equivalent combination or consolidation is made with respect to the Preferred
      Stock, the conversion price then in effect shall, concurrently with the
      effectiveness of such combination or consolidation, be proportionately
      increased.




Each
      share of Preferred Stock shall automatically convert into shares of Common
      Stock
      at the then-effective conversion price, immediately upon the earlier of (i)
      the
      repayment in full by the Company of its obligations under the Debenture, or
      (ii)
      the conversion in full of the Debenture and any accrued interest thereon.




The
      number of shares issuable upon conversion of the Preferred Stock, issued as
      an
      anti-dilutive device to Messrs. Stark and Estevez, work in tandem with the
      number of shares issuable upon conversion of the Debentures. As discussed in
      the
      Company’s Certificate of Designation of the Preferred Stock, in the event of a
      conversion of the Preferred Stock, and provided that the weighted average of
      the
      price per share of the shares of Common Stock underlying the Debentures upon
      the
      conversion of such Debentures is less than the then-effective Conversion Price
      for the Preferred Stock, such conversion price shall be adjusted equitably
      such
      that it is equal to the weighted average of the price per share of the shares
      of
      Common Stock underlying the Debentures upon the conversion of such Debentures.




Since
      the
      Preferred Stock is intended to provide anti-dilution protection to the owners
      of
      the Preferred Stock, it is not considered to be a derivative as defined in
      FASB
      Opinion 133, and accordingly has not been considered in calculating diluted
      weighted average shares outstanding.




**Common
      Stock**




***Voting,
      Dividend and Other Rights.*** Each
      outstanding share of Common Stock will entitle the holder to one vote on all
      matters presented to the stockholders for a vote. Holders of shares of Common
      Stock will have no preemptive, subscription or conversion rights. The Company’s
      Board of Directors will determine if and when distributions may be paid out
      of
      legally available funds to the holders. Enigma has not declared any cash
      dividends during the past two fiscal years with respect to the Common Stock.
      A
      declaration of any cash dividends in the future will depend on a determination
      by the Board of Directors as to whether, in light of earnings, financial
      position, cash requirements and other relevant factors existing at the time,
      it
      appears advisable to do so. In addition, the Company has not declared or paid
      any dividends and has no plans to pay any dividends to the
      stockholders.




F-19




***Rights
      Upon Liquidation.*** Upon
      liquidation, subject to the right of any holders of the Preferred Stock to
      receive preferential distributions, each outstanding share of Common Stock
      may
      participate pro rata in the assets remaining after payment of, or adequate
      provision for, all known debts and liabilities.




***Majority
      Voting.*** The
      holders of a majority of the outstanding shares of Common Stock (in concert
      with
      the holders of the Preferred Stock) constitute a quorum at any meeting of the
      stockholders. A plurality of the votes cast at a meeting of stockholders elects
      the directors of the Company. The Common Stock does not have cumulative voting
      rights.




**NOTE
      K -**  **STOCKOPTIONPLAN**




During
      the year ended December 31, 2005, the Company granted options, under the 2005
      Stock Option and Grant Plan (the “Stock Option Plan”), to 18 employees, a
      non-employee director and consultants to purchase an aggregate of 1,257,595
      shares of the Company’s Common Stock at exercise prices ranging from
      $1.10-$1.26. The options vest over periods of up to three years, which is the
      requisite service period for such awards. No other conditions, such as market
      or
      performance conditions, must be satisfied in order for the option awards to
      fully vest. Subsequent to the granting of the options, 11 employees were
      terminated by the Company and their options were terminated. As a result, option
      grants for 319,984 shares were cancelled and returned to the Stock Option Plan,
      and the total number of options outstanding at December 31, 2005 was 937,611.





During
      April of 2006, the Company granted options under the Stock Option Plan to seven
      employees, a non-employee director and consultants to purchase an additional
      aggregate of 1,438,000 shares of the Company’s Common Stock at exercise prices
      ranging from $0.065-$0.0715. These options generally vest ratably over a period
      of 12 months from the date of grant, which is the requisite service period
      for
      such awards. No other conditions, such as market or performance conditions,
      must
      be satisfied in order for the option awards to fully vest. In November of 2006,
      three employees of the Company returned a portion (391,610) of their 2005
      options to the Company and the Company cancelled them adding them back to the
      pool for new option grants. Also in November of 2006, the Company granted an
      employee of its foreign subsidiary options to purchase 1,000,000 shares of
      the
      Company’s Common Stock at an exercise price of $0.03. The option vests over a
      period of three years from the date of grant, which is the requisite service
      period for such award. No other conditions, such as market or performance
      conditions, must be satisfied in order for the option award to fully vest.
      Accordingly, the Company recognizes compensation costs associated with stock
      options over each employee’s service period, which in all cases is the vesting
      period for such stock option grants.





The
      following table presents the status of options outstanding under the Stock
      Option Plan as of December 31, 2006:




Year
                of Grant
            
            #
                granted
            
            #
                cancelled
            
            #
                exercised
            
            #
                outstanding
            
            #
                vested
            
            #
                unvested2005
            
            
            1,257,595
            
            
            (711,594
            )
            
            0
            
            
            546,001
            
            
            (147,790
            )
            
            398,2112006
            
            
            2,438,000
            
            
            0
            
            
            0
            
            
            2,438,000
            
            
            (1,117,518
            )
            
            1,320,482Total
            
            
            3,695,595
            
            
            (711,594
            )
            
            0
            
            
            2,984,001
            
            
            (1,265,308
            )
            
            1,718,693




F-20




The
      fair
      value of each stock option granted is charged to earnings as such option vests.
      The fair value of each stock option granted was estimated as of the date of
      issuance using the Black-Scholes-Merton option-pricing model. The following
      table shows the range of assumptions for each group of options issued:




Options
                granted
              during
                the
              Quarter
              ended
                Dec. 31, 2006
            
            Options
                granted
              during
                the Quarter
              ended
                June 30, 2006
            
            Options
                granted
              during
                the Fiscal Year ended
              Dec. 31,
                2005
            
            Pro-forma
                Fiscal Year ended Dec. 31, 2005Dividend
                yield
            
            0%
            
            0%
            
            0%
            
            0%Expected
                Volatility
            
            210.14%
            
            195.41%
            
            172.78%
            
            18.76%Risk-Free
                Interest Rate
            
            4.60%
            
            4.84%
            
            3.91-4.00%
            
            3.91Expected
                Life
            
            5
                years
            
            5
                years
            
            5
                years
            
            5
                years





The
      Company does not currently pay cash dividends on its common stock and does
      not
      anticipate doing so in the foreseeable future. Accordingly, the expected
      dividend yield is zero. Expected volatility is based on the average of the
      historical volatility for the Company’s Common Stock for the period. The risk
      free interest rate is equal to the U.S. Treasury constant maturity rate for
      the
      period equal to the expected life of the option. Since the Company has no
      experience on which to base the expected live of a stock option, five years,
1⁄2
of the option exercise period for all grantees other than Messrs. Stark and
      Estevez, was used. The option exercise period for Messrs. Stark and Estevez
      is
      five years.




Prior
      to
      the adoption of SFAS 123R, the Company recorded compensation expense for its
      stock-based employee compensation plan in accordance with the intrinsic value
      method prescribed by Accounting Principles Board Opinion No. 25,
“Accounting for Stock Issued to Employees.” Intrinsic value is the amount by
      which the market price of the underlying stock exceeds the exercise price of
      the
      stock option on the measurement date, generally the date of grant. The Company’s
      options are issued at a strike price equal to or greater than the market price
      of the underlying stock at the date of grant, and accordingly, no compensation
      cost was recognized in 2005 for its stock option plan.




The
      following table illustrates the effect on net income and earnings per share
      for
      the year ended December 31, 2005, as if the Company had applied the fair
      value recognition provisions of SFAS 123R to stock-based employees
      compensation:




Year
                ended December 31, 2005Net
                income as reported
            
            $
            10,173,096Deduct:
                Stock-based employee compensation determined under fair-value based
                method
            
            
            (11,830
            )Pro-forma
                net income
            
            $
            10,161,266**Pro-forma
                net income per share, basic & diluted**As
                reported
            
            $
            0.63Pro-forma
            
            $
            0.63




F-21




**NOTE
      L -**  **PROFITSHARINGPLAN**




During
      2004, the Company adopted a defined contribution plan, the Enigma Software
      Group, Inc. 401(k) Plan, (the "401(k) Plan"). The 401(k) Plan became effective
      on May 1, 2004. Eligible employees are able to make contributions to the
      401(k) Plan, which are matched, effective September 1, 2006, by the Company
      at the rate of 100% of an individual employee’s contribution up to the maximum
      allowable by law, which for 2006 was generally $15,000. Prior to
      September 1, 2006, the Company matched 50% of the first $10,000 of an
      individual employee's contribution. The Company's contribution to the 401(k)
      Plan for the years ended December 31, 2006 and 2005 was $76,481 and
      $70,307, respectively. The 2006 contributions reflect the decline in the number
      of employees from 18 in 2005 to 7 in 2006, as well as the increase in the rate
      of the Company matching, effective September 1, 2006, and the suspension of
      Company matching contributions during the 2nd quarter of 2006 in order to
      conserve cash.




**NOTE
      M -**  **PROVISION
      FORINCOMETAXES**




The
      reconciliation of the income tax provision (benefit) computed at the U.S.
      federal statutory tax rate to the income tax (benefit) provision is as follows:




**2006**
            
            **2005**Computed
                (benefit) provision
            
            **$**
            **(668,600**
            **)**
            **$**
            **6,234,900**State
                tax (benefit) provision, net of federal effect
            
            
            **(
                50,000**
            **)**
            
            **3,080,003**Other
            
            
            
            
            
            **(733,206**
            **)**Income
                tax (benefit) provision
            
            **$**
            **(718,600**
            **)**
            **$**
            **8,581,697**





As
      the
      income tax benefit of $718,600 may not be realized, it has been entirely offset
      by a valuation allowance.





The
      tax
      effects of the temporary differences that give rise to deferred tax assets
      and
      liabilities at December 31, 2006 and 2005 are presented below:




**2006**
            
            **2005**Deferred
                revenue
            
            **$**
            **(527,205**
            **)**
            **$**
            **4,270,060**Net
                operating loss (carrybacks) carryforwards
            
            
            **527,205**
            
            
            **(4,270,060**
            **)**Net
                deferred tax asset
            
            **$**
            **0**
            
            **$**
            **0**





As
      of
      December 31, 2004, the Company had a federal net operating loss
      carryforward of approximately $12,559,000 available to offset future taxable
      income through 2024. This net operating loss carryforward was fully utilized
      during the year ended December 31, 2005.




**NOTE
      N -**  **LEGALPROCEEDINGS**




From
      time
      to time the Company is involved in routine legal matters incidental to its
      business. In the opinion of management, the ultimate resolution of such matters
      will not have a material adverse effect on its financial position, results
      of
      operations or liquidity.




F-22




**NOTE
      O -**  **COMMITMENTS
      ANDCONTINGENCIES**




**[1]**
              **Lease:**




As
      discussed in Note N, the Company no longer has a long-term lease obligation.
      There is no lease for the Company’s current office space, which is located
      within an office suite complex in Stamford, Connecticut. Rather, the Company
      entered into an office service agreement with the operator of the office suite
      giving the Company a license to use designated offices as well as business
      center facilities and services. The office services agreement covers services,
      such as telephone, heat, electricity, furniture, lighting, coffee, water,
      restroom facilities, reception, conference facilities, mailbox, parking and
      office cleaning. Pursuant to the office services agreement, the Company has
      six
      employees in approximately 350 square feet of dedicated office space under
      a six
      month lease agreement that has provisions for automatic renewals and is
      currently in effect until August 31, 2007 subject to the next automatic six
      month renewal, unless cancelled by either party. In February 2007, the Company
      notified the operator of the office suite complex that would not renew again
      and
      would vacate the premises prior to August 31, 2007. On February 27, 2007,
      the Company signed a 15 month lease at a nearby facility at a lower cost,
      effective March 1, 2007.




Rent
      expense and office services expense amounted to $79,587 for the year ended
      December 31, 2006 and rent expense amounted to $199,583 for the year ended
      December 31, 2005.




**[2]**
              **Consulting
                  agreement:**




In
      April
      of 2000, the Company entered into an eighteen-month consulting agreement with
      an
      individual. Under the terms of the agreement the consultant would receive
      125,000 shares of the Company’s common stock that would vest over the term of
      the agreement. The agreement was terminated in 2001 and the consultant received
      59,000 shares of the Company’s common stock in connection with the services that
      were provided through the termination date. The Company and the consultant
      reached an agreement and the consultant exchanged the shares for Maxi shares
      of
      common stock on April 8, 2005, as discussed in Note C.




**[3]**
              **Contingencies:**




From
      time
      to time the Company is involved in routine legal matters incidental to its
      business. In the opinion of management, the ultimate resolution of such matters
      will not have a material adverse effect on the Company’s financial position,
      results of operations or liquidity.




**NOTE
      P -**  **TRANSACTIONS
      WITHRELATEDPARTIES**




During
      2004, Adorons loaned $120,000 to its Chief Executive Officer, who is also one
      of
      the Company’s founders as well as a preferred stockholder. This loan, including
      interest at market rates, was repaid prior to the completion of the reverse
      takeover, by the redemption and cancellation of 21,840 shares of Adorons’ common
      stock owned by this individual. This redemption and cancellation of shares
      is
      presented in the Consolidated Statement of Changes in Capital Deficit as 61,743
      shares, which is the number of newly issued common shares of Maxi that this
      individual would have received in connection with the Exchange.




F-23




**NOTE
      Q -**  **SUBSEQUENTEVENTS**




As
      required under the Debenture Agreement (see Notes B and H), if the Registration
      Statement has not been declared effective on or before January 1, 2007,
      which is the case, the Company must make amortizing cash payments to Dutchess
      on
      the first business day of each month, while there is an outstanding balance
      on
      the Debentures, until the Registration Statement is declared effective, or
      the
      Debentures have been repaid in full. Such payments are in the amount of
      $104,166.67 and are allocated to principal at the rate of 1/12 of the face
      amount of the Debentures, ($83,333.33) and to a debenture redemption premium
      ($20,833.34). Failure to make such payments is an event of default as defined
      in
      the Debenture Agreement (“Event of Default”).




Accordingly,
      on January 2, 2007 and on February 1, 2007, the Company made such
      payments, and such a payment was due to have been made on March 1, 2007.
      However, the making of the required March 1 payment would have placed a
      severe strain on the Company’s limited cash resources. The Company has sought
      and Dutchess has granted limited, temporary relief from this obligation, with
      the result that on March 1, 2007 the Company made an amortizing cash
      payment to Dutchess in the amount of $37,500, of which $30,000 was allocated
      to
      principal and $7,500 was allocated to debenture redemption premium. The balance
      of the debenture redemption premium of $13,333.34 has been accrued as current
      liability to Dutchess, along with the payments due on April 2 and
      May 1, 2007. The Company expects that it will make similar payments on
      April 2, 2007 and on May 1, 2007, unless the Registration Statement
      has been declared effective prior to any of those dates. Such reduced payments
      are considered to be Events of Default.




Dutchess
      has agreed that through June 1, 2007, it will not hold Enigma in default
      specifically for reduced payments due on the Debentures, and that it reserves
      the right to charge any penalty specified in the Debenture Agreement for the
      Company’s failure to make full payment on the Debenture. The Company expects
      that the unpaid portion of the amortizing cash payments will be funded from
      future operating cash flow.




On
      February 27, 2007, the Company signed a 15 month lease at a nearby facility
      at a
      lower cost, effective March 1, 2007.




F-24