As filed with the Securities and Exchange Commission on February 23, 2007



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549



FORM 20-F



[ ]  REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED

or

[x]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED

For the fiscal year ended December 31, 2006

or

[]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934, AS AMENDED

For the transition period from __________ to ___________



Commission file number:



DIVERSINET CORP.

Province of Ontario, Canada

2235 Sheppard Avenue East, Suite 1700, Toronto, Ontario M2J 5B5



Securities registered or to be registered pursuant to Section 12(b) of the Act:      None

Securities registered or to be registered pursuant to Section 12(g) of the Act:       Common Shares, no par value

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:      None

Indicate the number of outstanding shares of each of the issuers classes of capital or common stock as of the close of the period covered by the Annual Report:     33,413,005 Common Shares as of December 31, 2006



Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.



Yes

[X]

No

[ ]



Indicate by check mark which financial statement item the registrant has elected to follow:

Item 17

[X]

Item 18

[ ]

#



DIVERSINET CORP.

FORM 20-F ANNUAL REPORT

TABLE OF CONTENTS

PART I

Page





ITEM 1.

IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

4

ITEM 2.

OFFER STATISTICS AND EXPECTED TIMETABLE

4

ITEM 3.

KEY INFORMATION

4

ITEM 3. (A)

SELECTED FINANCIAL DATA

4

ITEM 3. (B)

CAPITALIZATION AND INDEBTEDNESS

5

ITEM 3. (C)

REASONS FOR THE OFFER AND USE OF PROCEEDS

5

ITEM 3. (D)

RISK FACTORS

5

ITEM 4.

INFORMATION ON DIVERSINET

10

ITEM 4. (A)

HISTORY AND DEVELOPMENT OF DIVERSINET

10

ITEM 4. (B)

BUSINESS OVERVIEW

11

ITEM 4. (C)

ORGANIZATIONAL STRUCTURE

18

ITEM 4. (D)

PROPERTY, PLANT AND EQUIPMENT

18

ITEM 5.

OPERATING AND FINANCIAL REVIEW AND PROSPECTS

18

ITEM 5. (A)

OPERATING RESULTS

19

ITEM 5. (B)

LIQUIDITY AND CAPITAL RESOURCES

25

ITEM 5. (C)

RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES, ET CETERA.

27

ITEM 5. (D)

TREND INFORMATION

27

ITEM 5. (E)

OFF-BALANCE SHEET ARRANGEMENTS

27

ITEM 5. (F)

TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS

27

ITEM 6.

DIRECTORS, SENIOR MANAGEMENT, AND EMPLOYEES

27

ITEM 6. (A)

DIRECTORS AND SENIOR MANAGEMENT OF THE REGISTRANT

27

ITEM 6. (B)

COMPENSATION

28

ITEM 6. (C)

BOARD PRACTICES

29

ITEM 6. (D)

EMPLOYEES

32

ITEM 6. (E)

SHARE OWNERSHIP

33

ITEM 7.

MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

33

ITEM 7. (A)

MAJOR SHAREHOLDERS

33

ITEM 7. (B)

RELATED PARTY TRANSACTIONS

34

ITEM 7. (C)

INTERESTS OF EXPERTS AND COUNSEL

35

ITEM 8.

FINANCIAL INFORMATION

35

ITEM 8. (A)

FINANCIAL INFORMATION

35

ITEM 8. (B)

SIGNIFICANT CHANGES

35

ITEM 9.

THE OFFER AND LISTING

36

ITEM 9. (A)

OFFER AND LISTING DETAILS

36

ITEM 9. (B)

PLAN OF DISTRIBUTION

37

ITEM 9. (C)

MARKETS

37

ITEM 9. (D)

SELLING SHAREHOLDERS

37

ITEM 9. (E)

DILUTION

37

ITEM 9. (F)

EXPENSES OF THE ISSUE

37

ITEM 10.

ADDITIONAL INFORMATION

37

ITEM 10. (A)

SHARE CAPITAL

37

ITEM 10. (B)

MEMORANDUM AND ARTICLES OF ASSOCIATION

37

ITEM 10. (C)

MATERIAL CONTRACTS

37

ITEM 10. (D)

EXCHANGE CONTROLS AND OTHER LIMITATIONS AFFECTING SECURITYHOLDERS

38

ITEM 10. (E)

TAXATION

38

ITEM 10. (F)

DIVIDENDS AND PAYING AGENTS

43

ITEM 10. (G)

STATEMENT BY EXPERTS

43

ITEM 10. (H)

DOCUMENTS ON DISPLAY

43

ITEM 10. (I)

SUBSIDIARY INFORMATION

43

ITEM 11.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

43

ITEM 12.

DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

43

PART II

ITEM 13.

DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

43

ITEM 14.

MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS

44

ITEM 15.

CONTROLS AND PROCEDURES

44

ITEM 16. (A)

AUDIT COMMITTEE FINANCIAL EXPERT

44

ITEM 16. (B)

CODE OF ETHICS

44

ITEM 16. (C)

PRINCIPAL ACCOUNTANT FEES AND SERVICES

44

ITEM 16. (D)

EXEMPTION FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

45

ITEM 16. (E)

PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS

45

PART III

ITEM 17.

FINANCIAL STATEMENTS

45

ITEM 18.

FINANCIAL STATEMENTS

45

ITEM 19.

EXHIBITS

45

SIGNATURE PAGE

46

#



PART I

ITEM 1.  IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

Not Applicable.

ITEM 2.  OFFER STATISTICS AND EXPECTED TIMETABLE

Not Applicable.

ITEM 3.  KEY INFORMATION

3-A.

Selected Financial Data

The selected financial data for the fiscal years ended December 31, 2006, 2005, 2004, 2003 and October 31, 2003 and 2002, and for the fourteen months ended December 31, 2003 are derived from our audited financial statements.  The selected financial data for the two months ended December 31, 2003 are derived from our unaudited financial statements.  During 2003 we changed our fiscal year from October 31st to December 31st.  The following selected financial data should be read in conjunction with the consolidated financialstatements and the notes thereto and Operating Results appearing in Item 5-A. of this annual report.  As a result of a number of circumstances, including financing activities, the acquisition of DSS and Caradas and the U.S. dollar becoming the primary currency in which most of our business is transacted, effective October 1, 2003, we adopted the U.S. dollar as our measurement and reporting currency for preparation of our consolidated financial statements.  In addition, except where otherwise indicated, all financial information in this report is presented in United States dollars.

Our financial statements have been prepared in accordance with Canadian GAAP.  These principles conform in all material respects with U.S. GAAP except as described in Note 13 to our 2006 consolidated financial statements.  Under U.S. GAAP share capital would be greater and deficit would be less by $30,089,000 for each of the years due to the elimination of reduction in stated capital offset against accumulated shareholders deficit in March of 1999 recorded under Canadian GAAP which would not have been recognized under U.S. GAAP.

Selected Financial Data

(in 000s, except per share data)

|                                       | Fiscal Year Ended December 31 | Fiscal Year Ended December 31 | Fiscal Year Ended December 31 | Fiscal Year Ended December 31 | Fourteen Months Ended December31 | Two Months Ended December 31 | Fiscal Year Ended October 31 | Fiscal Year Ended October 31
|-------------------------------------- | ----------------------------- | ----------------------------- | ----------------------------- | ----------------------------- | -------------------------------- | ---------------------------- | ---------------------------- | ----------------------------
|                                       | 2006                          | 2005                          | 2004                          | 2003                          | 2003                             | 2003                         | 2003                         | 2002                        
|(In accordance with Canadian GAAP)    
|Revenue                                | 1,667                         | $1,101                        | $2,603                        | $1,395                        | $1,436                           | $467                         | $967                         | $710                        
|Loss from Continuing Operations        | (3,451)                       | (7,039)                       | (6,976)                       | (4,713)                       | (5,373)                          | (731)                        | (4,641)                      | (4,065)                     
|Loss from Discontinued Operations      | 0                             | (71)                          | (541)                         | (246)                         | (246)                            | (52)                         | (193)                        | 0                           
|Net Loss                               | (3,451)                       | (7,110)                       | (7,517)                       | (4,959)                       | (5,618)                          | (784)                        | (4,834)                      | (4,065)                     
|Weighted Average no. of shares (000s) | 28,740                        | 20,578                        | 12,145                        | 7,022                         | 6,478                            | 11,043                       | 5,715                        | 2,972                       
|Loss Per Share  Continuing Operations | (0.12)                        | (0.34)                        | (0.57)                        | (0.67)                        | (0.83)                           | (0.07)                       | (0.81)                       | (1.37)                      
|Net Loss Per Share                     | (0.12)                        | (0.35)                        | (0.62)                        | (0.71)                        | (0.87)                           | (0.07)                       | (0.85)                       | (1.37)                      
|Dividends Per Share                    | 0.00                          | 0.00                          | 0.00                          | 0.00                          | 0.00                             | 0.00                         | 0.00                         | 0.00                        
|Working Capital                        | 3,697                         | 1,081                         | 2,278                         | 452                           | 452                              | 452                          | 1,114                        | 1,752                       
|Long-term Liabilities                  | 0                             | 0                             | 0                             | 300                           | 300                              | 300                          | 300                          | 0                           
|Shareholders Equity                   | 4,086                         | 1,554                         | 5,835                         | 7,647                         | 7,647                            | 7,647                        | 8,462                        | 2,950                       
|Total Assets                           | 5,830                         | 2,013                         | 7,308                         | 11,004                        | 11,004                           | 11,004                       | 12,099                       | 4,009                       
|Share Capital                          | 58,414                        | 54,348                        | 52,445                        | 49,191                        | 49,191                           | 49,191                       | 49,202                       | 40,678                      
|(In accordance with U.S. GAAP)        
|Revenue                                | 1,667                         | $1,101                        | $2,603                        | $1,395                        | $1,436                           | $467                         | $967                         | $710                        
|Loss from Continuing Operations        | (3,451)                       | (6,599)                       | (6,398)                       | (4,713)                       | (5,373)                          | (731)                        | (4,641)                      | (4,100)                     
|Loss from Discontinued Operations      | 0                             | (71)                          | (541)                         | (246)                         | (246)                            | (52)                         | (193)                        | 0                           
|Net Loss                               | (3,451)                       | (6,670)                       | (6,939)                       | (4,959)                       | (5,618)                          | (784)                        | (4,834)                      | (4,100)                     
|Continuing Operations                  | (0.12)                        | (0.32)                        | (0.53)                        | (0.67)                        | (0.83)                           | (0.07)                       | (0.81)                       | (1.38)                      
|Net Loss Per Share                     | (0.12)                        | (0.32)                        | (0.57)                        | (0.71)                        | (0.87)                           | (0.07)                       | (0.85)                       | (1.38)                      
|Long-term Liabilities                  | 0                             | 0                             | 0                             | 300                           | 300                              | 300                          | 300                          | 0                           
|Shareholders Equity                   | 4,086                         | 1,554                         | 5,835                         | 7,647                         | 7,647                            | 7,647                        | 8,462                        | 2,950                       
|Total Assets                           | 5,830                         | 2,013                         | 7,308                         | 11,004                        | 11,004                           | 11,004                       | 11,945                       | 4,009                       
|Share Capital                          | 89,835                        | 84,437                        | 82,534                        | 79,281                        | 79,281                           | 79,281                       | 79,281                       | 70,767                      



At our March 1999 Annual Meeting, our shareholders approved a resolution providing for the reduction of our stated capital by$30,089,000.  This resulted in a reduction in our accumulated shareholders deficit in the same amount.  At December 31, 2006, we had an accumulated deficit of$59,746,000.  If our shareholders had not approved the reduction in our stated capital, our accumulated deficit at December 31, 2006 would have been $89,835,000 and December 31, 2005 would have been $84,437,000.

The following table sets forth the rate of exchange for the Canadian Dollar at the end of the five fiscal years ended December 31, 2006 and the end of each of the last six months, the average rates for the period, and the range of high and low rates for the period.  For purposes of this table, the rate of exchange means the noon buying rate in New York City for cable transfers in foreign currencies as certified for customs purposes by the Federal Reserve Bank of New York.  The table sets forth the number of Canadian Dollars required under that formula to buy one U.S. Dollar. The average rate means the average of the exchange rates on the last day of each month during the period.

|                           | U.S. Dollar/Canadian Dollar
|-------------------------- | ---------------------------
|                           | Close                      
|Month Ended 01/31/07       | 1.1770                     
|Month Ended 12/31/06       | 1.1664                     
|Month Ended 11/30/06       | 1.1343                     
|Month Ended 10/31/06       | 1.1212                     
|Month Ended 09/30/06       | 1.1142                     
|Month Ended 08/30/06       | 1.1084                     
|Fiscal Year Ended 12/31/06 | 1.1664                     
|Fiscal Year Ended 12/31/05 | 1.1613                     
|Fiscal Year Ended 12/31/04 | 1.2020                     
|Fiscal Year Ended 12/31/03 | 1.2924                     
|Fiscal Year Ended 10/31/02 | 1.5661                     

The exchange rate was 1.17 as of February 13, 2007.

3-B.  Capitalization and Indebtedness

Not Applicable.

3-C.  Reasons for the Offer and Use of Proceeds

Not Applicable.

3-D.  Risk Factors

When used in this annual report, the words may, will, expect, anticipate, continue, estimate, project, intend plan and similar expressions are intended to identify forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, regarding events, conditions and financial trends that may affect Diversinets future plans of operations, business strategy, operating results and financial position.  All statements, other than statements of historical facts, included or incorporated by reference in this document which address activities, events or developments which the Company expects or anticipates will or may occur in the future, including such things as future capital expenditures (including the amount and nature thereof), business strategy, expansion and growth of the Companys business and operations, and other such matters are forward-looking statements.  These statements are based on certain assumptions and analyses made by the Company in light of its experience and its perception of historical trends, current conditions and expected future developments as well as other factors it believes are appropriate in the circumstances.  Such statements are not guarantees of future performance and are subject to risks and significant uncertainties and that actual results may differ materially from those included within the forward-looking statements as a result of various factors.  The occurrence of any unanticipated events may cause actual results to differ from those expressed or implied by the forward-looking statements contained herein. Prospective investors are cautioned that any forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties and that actual results may differ materially from those included within the forward-looking statements as a result of various factors, some of which are described in the Risk Factors below.

We have limited financial resources, and if we fail to either raise capital when needed or generate revenues, we may need to cease operations.  Our ability to continue operations beyond the next fiscal year may be dependent on our ability to obtain additional financing.  Although we have made progress in developing our products and have completed initial consumer deployments, our revenue from operations is not sufficient to cover our operating expenses at present and is unlikely to be sufficient within fiscal 2007.  We have obtained funding for operations from private equity placements in the past, but there is no assurance we will be able to do so again in the near future at commercially reasonable terms or at all despite the progress of the business.  In July 2006, we completed a private placement of 1,538,463 units, at $0.65 per unit, for gross proceeds of $1,000,000 and issued 96,154 units for consulting services related to the private placement.  Each unit is comprised of one common share and one common share purchase warrant.  The warrant will be exercisable to purchase one common share for each whole warrant at a price of $1.00 and expire on July 26, 2008. In June 2006, we completed a private placement of 6,680,001 units, at $0.60 per unit, for gross proceeds of $4,008,000.  Each unit is comprised of one common share and one common share purchase warrant.  One half of the warrant will be exercisable to purchase one common share for each whole warrant at a price of $0.75, the other half warrant at $0.90, and expire on June 30, 2008.   In September 2005 we completed a private placement with the issuance of 5,000,000 common shares at a price of $0.40 per common share and 71,250 common share purchase warrants for gross proceeds of $2,000,000 to us.  The warrants expire on September 26, 2008 and are exercisable at $0.40 per share.  In December 2004 we completed a private placement with the issuance of 6,625,000 common shares at a price of $0.40 per common share for gross proceeds of $2,650,000.  In January 2004 we completed a private placement through the issuance of 1,000,000 common shares and 1,100,000 common share purchase warrants.  We received gross proceeds of $2,000,000 in the transaction.  The warrants were comprised of 500,000 warrants exercisable at $2.00 and 250,000 at $2.05 and 350,000 at $0.60.  Each warrant entitles the holder thereof to acquire one common share for a period of three years.  As well, the terms of new capital, if any, may materially dilute existing shareholders.  Our failure to either raise capital when needed or to generate revenues would leave us with insufficient resources to continue our business.

We have lost money in the past, we have realized minimal revenues from continuing operations, we expect to continue to sustain losses in the future and may never achieve profitability.We have not generated sufficient revenue to date from the sales of our solutions and licensing of our products. For the year ended December 31, 2006, we posted a net loss of $3,451,000. For the year ended December 31, 2005, we posted a net loss of $7,109,000.  For the year ended December 31, 2004, we posted a net loss of $7,517,000.  For the year ended December 31, 2003, we posted a net loss of $4,959,000.  For the fourteen months ended December 31, 2003, we posted a net loss of $5,618,000.  For the year ended October 31, 2003, we posted a net loss of $4,834,000, and $4,065,000 for the year ended October 31, 2002.  We generated revenue of $1,667,000 for the year ended December 31, 2006, $1,101,000 for the year ended December 31, 2005, $2,603,000 for the year ended December 31, 2004, $1,395,000 in the year ended December 31, 2003, $1,436,000 for the fourteen months ended December 31, 2003, $967,000 in the twelve months ended October 31, 2003, $710,000 in the year ended October 31, 2002.  The consolidated financial statements do not include any adjustments that might result from the outcome of that uncertainty.  We may never achieve profitability or maintain profitability, if achieved, on a consistent basis.

Our business plan is dependent upon customer adoption and commercial deployment of our products; if our business plan is not accepted, we may need to cease operations.Our ability to continue operations is also dependent on the acceptance of our secure authentication and related solutions and the adoption of advanced authentication protected applications over web and mobile data networks as an accepted method of personal information protection in sufficient volume for us to generate enough revenues to fund our expenses and capital requirements.  The personal authentication data market is in a very early stage, and it may not develop to a sufficient level to support our business.

We market our solutions to large companies, application developers and solution providers with specific market area expertise.  The implementation of our solutions by these entities typically involves a lengthy education process and a significant technical evaluation and commitment of capital and other resources.  This process is also subject to the risk of delays associated with customers internal budgeting and other procedures for approving large capital expenditures, deploying new technologies within their networks and testing and accepting new technologies that affect key operations. As a result, the associated sales and implementation cycles can be lengthy.  Our quarterly and annual operating results could be materially harmed if orders forecasted for a specific customer for a particular quarter are not realized.

Many of our early licensing agreements permitted our customers to examine and test our products with no initial up-front payments to us.  These customers are not required to make payments to us until they begin to use our solutions for commercial purposes.  In certain cases, we also enter into evaluation agreements, whereby potential customers may examine our solutions for a specified period of time with no payment to us.  Our current licensing agreements typically require the customer to pay a license fee attributable to the software components and the solution and upon shipment of these items to the customer, although we have sometimes waived the up-front fee.

We have a limited number of customers.  The loss of, or a significant reduction in business from, any of these customers would materially harm our business and results of operations, and our future prospects depend substantially on expanding our customer base.During fiscal 2004, 46% of revenue was generated from one customer and 64% of revenue was generated from two customers.  During fiscal 2005, 38% of revenue was generated from one customer and 67% from two customers.  During fiscal 2006, 56% of revenue was generated from one customer. The loss of revenues from one or more significant customers, or the failure to collect receivables due from a major customer in a timely manner would have a material adverse effect on our results of operations.  If we are unable to expand our customer base, our results of operations will suffer.

Fluctuations in foreign exchange may adversely affect our business.  Our functional currency is the U.S. dollar.  Sales generated outside Canada are generally denominated in U.S. dollars.  During fiscal 2004, 2005 and 2006, we have incurred a large portion of our expenses in U.S. dollars, but we also incurred a smaller portion of our expenses in other currencies including Canadian dollars, Pound Sterling and Hong Kong dollars.  Changes in the value of these currencies relative to the U.S. dollar may result in currency losses that may have an adverse effect on our operating results.  With the completion of our financings in June and July 2006, we have a portion of our cash resources in U.S. dollar short-term investments and in Canadian dollars.  During fiscal 2004, 2005 and 2006 we maintained a portion of our cash resources in both U.S. and Canadian dollar term deposits.

We may not be successful if we fail to attract and retain our key technical personnel.  During 2004, in order to reduce our largest single expenditure, salaries and benefits, we reduced our headcount of employees in the Diversinet, DSS and Caradas operations.  Workforce reductions may have a detrimental effect on the morale of remaining employees, impeding their performance levels.  In addition, our ability to attract potential new employees in the future may suffer if our reputation was hurt by this staff reduction.

We currently have three senior officers and 26 employees and 4 contractors.  We may not be able to improve our solutions and products or create new products if we lose any of our key employees or contractors.  We do not maintain key person life insurance policies on any of our employees.  Skilled technical personnel can be difficult to attract depending on the strength of the economy and competitive opportunities.  We may not be able to retain our current employees if they receive better job offers from other employers.

We are involved in litigation which could result in judgments against us which, in the aggregate, could total more than our combined current assets, working capital and net assets.There is currently one material claim pending against us.  If we lose this suit or enter into settlement requiring us to pay cash or issue any of our common shares, our liquidity and financial position will be adversely affected, and our shareholders ownership may be diluted.  During fiscal 2000, the Company and its wholly owned Barbados subsidiary, The Instant Publisher Ltd., were sued by a company that alleged that the Company breached a dealer agreement entered into in 1995 by the Companys former printing business and is seeking damages of $1,533,950 and damages of $25,000,000 for loss of reputation and loss of opportunity, pre-judgment and post-judgment interest, and costs. Management believes that a loss arising from this matter is probable and that the amount can reasonably be estimated.  The Company has recorded an amount for the liability based on its current estimate of the settlement amount.  As additional information becomes available, any potential liability related to this matter is assessed and the estimates will be revised accordingly.  Based on the currently available information, management believes that the ultimate outcome of this matter will not have a material adverse effect on our financial position or overall trends in results of operations.

We have limited experience in the authentication security software and identity management solutions field, and we are therefore subject to risks inherent in establishing a new business.  We have been in the authentication security software field since fiscal 2004 building upon our data security experience beginning in 1997 and the identity management solutions field in 2001, and we have only generated minimal revenues from this business.  We are not sufficiently established to fully evaluate or forecast our prospects, and we are subject to the risks inherent in establishing a new business enterprise.

Our ability to keep pace with the rapid technological changes and frequent new product introductions common in the information and communications technology industry will determine our ability to remain competitive and affect the viability of our products.  To succeed in the authentication security and the identity management solutions business, we believe that we will have to continuously improve the performance, features and reliability of our products and be the first to the market with new products or enhancements to existing products.  We cannot provide assurance that we will be able to improve our products in a timely manner.  The emerging market for authentication security solutions for identity protection is characterized by rapid technological developments, frequent new product introductions and evolving industry standards.  We anticipate this evolution will also occur in the authentication security and the identity management solutions market in which we focus our technological developments.  The adoption of new standards, or the informal adoption of certain standards by a significant percentage of the computer security and related industries, could require us to reconfigure our products.  We may not be able to counter challenges to our current products or to introduce product offerings that keep pace with the technological changes introduced by competitors or persons seeking to breach information security.  We are not currently aware of any significant new technologies either under development or about to be introduced in the mobile data security or the identity management solutions security field.

Further, our authentication and identity management products depend in part on the application of certain mathematical principles forming the basis of the encryption technology which is embedded in our products.  Any significant advance in techniques for decoding or cracking encrypted computer information could render some or all of our products obsolete or unmarketable.

Our products use algorithms, or mathematical formulae, to encrypt and secure information.  The security afforded by our products is predicated on the assumption that these mathematical formulae are very difficult to solve.  This assumption is based on the fact that years of theoretical and empirical research by leading mathematicians have not resulted in any efficient solutions to these problems.  There can be no assurance, however, that future research will not uncover efficient solutions to these problems.

Also, even if no breakthrough in solving these problems is discovered, they may eventually be solved by computer systems having sufficient speed and power.  If improved techniques for decoding encrypted information are developed or made possible by the increased availability of powerful computing resources, our products could be rendered obsolete.

The highly competitive nature of the information and communications technology fields could prevent us from achieving success.Our solutions are targeted at the new and rapidly evolving market for authentication and authorization products for mobile data communications, commerce, telecommunications and identity management.  This market is not mature.  We anticipate that it will be intensely competitive, subject to rapid change and significantly affected by new solution, product and service introductions and other market activities of industry participants.  Many of our competitors and potential competitors have a longer operating history, greater name recognition, larger installed customer base and significantly greater financial, technical and marketing resources than we have.  As a result, they may be able to adapt more quickly to new or emerging technologies and changes in customer requirements, and they could therefore render our technologies and products obsolete.

Because of the broad potential application of our authentication and authorization software and identity management solutions, we compete with vendors offering a wide range of computer security products.  These competitors include Entrust Technologies, Certicom, Verisign, Vasco and EMC Corp. (RSA Division).  There also may be other potential entrants to the market of whom we are not yet aware.

Our licensing revenues are dependent on our customers acceptance and use of our software products, and we expect our sales cycle to be lengthy.  Many of our early licensing agreements permitted our customers to examine and test our products with no initial up-front payments to us.  These customers are not required to make payments to us until they begin to use our product for commercial purposes.  We also enter into evaluation agreements in certain cases, whereby potential customers may examine our solutions for a specified period of time with no payment to us.  Our current licensing agreements typically require the customer to pay a license fee attributable to the software components and the application solution and upon shipment of these items to the customer, although we have sometimes waived the up-front fee.

We lack experience in sales and marketing, and we depend on our relationships with more established corporations to assist in selling and marketing our products.  We have limited sales and marketing experience and limited money to fund marketing.  A significant part of our business strategy is to form strategic relationships with more established companies to expose our solutions to a larger customer base than we could reach through a direct sales and marketing force.  Our existing relationships have not resulted in any significant revenues to date and may not result in any revenues in the future.

As a result of our emphasis on these relationships, our success will partially depend on both the ultimate success of the third parties with whom we have these relationships and the ability of these third parties to market our products and services successfully.

We cannot provide assurance that we will be able to enter into additional, or maintain our existing, strategic relationships on commercially reasonable terms, if at all.  Our failure to do so would require us to devote substantially more resources to the distribution, sales and marketing of our products and services.  Also, these strategic relationships do not afford us any exclusive marketing or distribution rights.  The third parties may reduce their commitments to us in the future or pursue alternative technologies.

The nature of our products subjects us to product liability risks, potential lost revenues and adverse publicity in the event of product failure.  Our customers may rely on our products to prevent unauthorized access to computer networks.  Malfunctions or design defects of our products could:

•

cause interruptions, delays or cessation of services to our customers,

•

result in product returns,

•

result in liability for damages,

•

adversely affect the markets perception of the security offered by our product, resulting in a lack of demand for our products, or

•

require us to make significant expenditures to alleviate the problem.



Our license agreements may not be adequate to limit our liability.A large number of claims by our customers could subject us to significant liability as well as limit the demand for our solutions and products.  In most cases our license and support agreements attempt to limit our liability to the total amount of the licensing and support fees paid during the twelve-month period preceding an alleged error in or failure of our software.  This contractual provision may not always be enforceable.  Courts have held that contractual limitations of liability of this type, or the shrink-wrap licenses in which they are sometimes embodied, are unenforceable because the licensee does not sign them.  If these contract provisions limiting our liability are not enforceable, we could be obligated to pay significant damages resulting from customer claims.

If computer hackers find ways to circumvent our products, our products would not perform their essential function.  Any compromise of the security offered by our products, in a single incident or a series of incidents, would make our products less attractive to our customers.  Software error or failure may result from a hacker seeking unauthorized access to a computer network.  The methods used by hackers are evolving rapidly and generally are not recognized until they are launched against one or more systems.  We are unable to anticipate hackers tactics.  The publicity surrounding any security breaches could adversely affect the public perception of the security offered by our authentication and authorization products and make it more difficult for us to sell our products.

We might not always be able to enforce our intellectual property rights.Our success depends significantly upon our proprietary technology, and our means of protecting our proprietary and intellectual property rights may not be adequate.  We rely on a combination of patent and trademark laws, trade secrets, confidentiality agreements and contractual provisions to protect our proprietary rights.  We have two U.S. patents, which will be in effect until at least August 22, 2017, and three patents granted in Israel in effect until 2017 and 2021, as well as 13 applications pending in Israel, the United States and Canada.  We cannot provide assurance that any of our applications will be approved, that any new patents will be issued, that we will develop proprietary products or technologies that are subject to patent, that any issued patent will provide us with any competitive advantages or will not be challenged by third parties.  Furthermore, we cannot provide assurance that the patents of others will not have a material adverse effect on our business and operating results.  There is also a risk that our competitors will independently develop similar technology, duplicate our products or design around our patents or other intellectual property rights.

If our technology or products were determined to infringe upon the rights of others, we would be required to obtain licenses to use that technology.  If we are not able to obtain a license in a timely manner on acceptable terms or at all, we may have to stop producing our product until we can develop an alternative that does not infringe the rights of others.

Patent disputes are common in technology-related industries.  We cannot provide assurance that we will have the financial resources to enforce or defend a patent infringement or proprietary rights action.  As the number of products and competitors in our target markets grows, the likelihood of infringement claims also increases.  Any claims or litigation may be time-consuming and costly, cause product shipment delays or require us to redesign our product or require us to enter into royalty or licensing agreements.  Any of these events could have a material adverse effect on our business and operating results.  Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to use our proprietary information and software.  In addition, the laws of some foreign countries do not protect proprietary and intellectual property rights to as great an extent as do the laws of Canada and the United States.

Changes in the export regulation of encryption-based technologies may restrict our ability to sell or license our products.Our products are subject to export controls under Canadian and U.S. laws and regulations.  These laws and regulations may be revised from time to time in ways that may materially and adversely affect our ability to sell our products abroad or to make products available for sale or license via international computer networks such as the Internet, although pursuant to an international treaty, a number of countries have relaxed, or are in the process of relaxing, their export rules as applicable to products licensed by us.  Canadian and U.S. government controls on the export of encryption technologies which we license from third parties and which are embedded in our products may, if subject to revision, be amended and subsequently restrict our ability to freely export our products.  As a result, foreign competitors subject to less stringent export controls on their products may be able to compete more effectively than we can in the global information and computer security market.

Our articles of incorporation authorize us to issue an unlimited number of common shares, which could result in dilution to our shareholders. Subject to regulatory and/or shareholder approval, shareholders may experience dilution or limitations in takeover attempts because our articles of incorporation allow us to issue an unlimited number of common shares.  Our shareholders have no right to purchase additional common shares when we issue new shares.  As of December 31, 2006, we had 33,413,005 common shares issued and outstanding.

If our common shares should become ineligible for continued quotation on the OTC BB or a public trading market does not continue for any reason, holders of our common shares may have difficulty selling their shares.Our common shares became ineligible for continued quotation on the NASDAQ SmallCap Market and are now trading on the Over the Counter Bulletin Board; therefore holders of our common shares will have difficulty selling their shares.  Our common shares were quoted on the NASDAQ SmallCap Market from June 1995 through late April 2003.



Our common shares may continue to be penny stock, which may adversely affect the liquidity of our common shares.The United States Securities and Exchange Commission has adopted regulations that define a penny stock to be any equity security that has a market price, as defined in those regulations, of less than $5.00 per share, subject to certain exceptions.  Our common shares are currently penny stock.

Generally, for any transaction involving a penny stock, a broker-dealer is required to deliver, prior to the transaction, a disclosure schedule relating to the penny stock market as well as disclosure concerning, among other things, the commissions payable, current quotations for the securities and information on the limited market in penny stocks.

The liquidity of our common shares may be materially and adversely affected if our common shares continue to be penny stock due to the administration requirements imposed by these rules.

It may be difficult for our shareholders to enforce civil liabilities under the U.S. federal securities laws because we are incorporated in Canada.  We are incorporated under Canadian law and the majority of our directors and executive officers are Canadian citizens or residents.  All, or a substantial portion, of these persons assets and substantially all of our assets are located outside the United States.  As a result, it may not be possible for investors to effect service of process within the United States upon those persons or us or to enforce against them judgments of U.S. courts predicated upon civil liabilities under U.S. federal or state securities laws.  Also, there is uncertainty as to the enforceability in Canada, in original actions or in actions for enforcement of judgments of the U.S. courts, of civil liabilities predicated upon U.S. federal or state securities laws.

We may be treated as a passive foreign investment company, which would have adverse tax consequences for our U.S. shareholders.  We may be treated as a passive foreign investment company, or a PFIC.  A non-U.S. corporation generally will be considered a PFIC for any taxable year if either (1) at least 75% of its gross income is passive income or (2) at least 50% of the value of its assets (based on an average of the quarterly values of the assets during a taxable year) is attributable to assets that produce or are held for the production of passive income. While we do not believe that we should be treated as a PFIC, whether we are treated as a PFIC depends on questions of fact concerning our assets and revenues.  Accordingly, we cannot assure you that we will not be treated as a PFIC.

If we were to be treated as a PFIC, there could be material adverse tax consequences to U.S. holders of our common shares for any taxable year during which they held our common shares, including:



having gains realized on the sale of common shares treated as ordinary income, rather than capital gain;



having interest charges apply to the proceeds of common share sold in prior periods;



realizing no increase in the tax basis for common shares held to fair market value upon shareholders death; and



losing preferential rate applicable to dividends received on common shares held.



The determination of whether we are classified as a PFIC is made on an annual basis and will depend on factors such as the composition of our income and assets from time to time as well as our common share price. Therefore, it is possible that we could be classified as a PFIC for any particular year.

ITEM 4.  INFORMATION ON DIVERSINET

4-A.

History and Development of Diversinet

Diversinet Corp. (formerly The Instant Publisher Inc.) was formed on December 8, 1993 through the amalgamation of The Instant Publisher Inc. with Lombard Consolidated Resources Inc., an Ontario corporation.  We are regulated in accordance with the Ontario Business Corporations Act.

Our registered and principal office is located at 2235 Sheppard Avenue East, Suite 1700, Toronto, Ontario, Canada, M2J 5B5 (telephone: 416-756-2324; fax: 416-756-7346).

The following table provides the amount spent on capital expenditures for the years ended December 31, 2006, 2005, and 2004:

|YEAR | AMOUNT
|---- | ------
|2006 | 75,000
|2005 | 73,000
|2004 | 24,000

With the exception of the sale of the DSS assets in February 2005 as detailed in this report herein, there have been no major capital divestitures during the fiscal years ended December 31, 2006, 2005, or 2004.  A large portion of the capital expenditures have been computer hardware, furniture and fixture and software required for our ongoing operations.  Most of these expenditures have occurred at our head office.  We currently have no significant capital expenditures or divestiture projects in process.  All capital expenditures have been financed through working capital.

4-B.

Business Overview

We are an authentication security software product and service company that develops, markets and distributes mobile and PC-based authentication solutions that provide for secure access to on-line services and corporate networks, as well as the secure transmission of data over mobile networks.  Our solution encompasses all aspects of communication and commercial transaction security requirements, covering the authentication and authorization of individuals involved, the integrity of the information being sent.

We provide authentication security products for the secure access to data over web and mobile networks and are striving to become the leading provider of personal device-based authentication services.  Our strategy to achieve this objective involves: targeting emerging mobile data and messaging markets, expanding strategic partnerships and sales channel relationships, maintaining a leadership position in terms of products and services, research and development, and building awareness of the Diversinet brand.

We develop, license, service and support the Diversinet MobiSecure suite of mobile authentication products, solutions and services.  Diversinet MobiSecure Client provides the ability to support multiple mobile authentication solutions and service applications across a wide range of mobile device platforms.  Based on our intellectual property, patents and Diversinet Passport Trust PlatformTM developed over the last seven years, we have consolidated our core technology capabilities to an application licensee/reseller business model and re-branded our offerings as the Diversinet MobiSecure suite of mobile authentication products, solutions and services.  As a packaged software and security appliance provider, Diversinet products, solutions and services allow companies to deploy the robust mobile-optimized strong authentication infrastructure needed for trusted exchange of sensitive information over data networks quickly and cost-effectively. This enables companies to reduce the time-to-market for delivery of new secure mobile data applications and business services.

The Diversinet MobiSecureTM product, solution and service suite is comprised of the following individual software products and service offerings:

•

Diversinet MobiSecureTM Clientmobile-optimized strong authentication software thatcan be embedded on a variety of mobile devices, manages the trusted credentials used to authenticate the mobile user for secure personal communications and commercial transactions and generates One-Time Passwords according to variety of industry-standard and proprietary algorithms.

•

Diversinet MobiSecureTM Authentication Server Center (MASC) is a specialized server product which provides Over-the-Air (OTA) Diversinet MobiSecureTM Client software, credential provisioning and registration lifecycle management for mobile and PC device users.  Additionally, the Authentication Server will offer mobile-optimized validation services.  Finally the server also offers Short Message Service (SMS)-based OTP functionality to support zero-client mobile devices for mobile authentication services for users that do not carry mobile devices that can support our client software directly.

•

Diversinet MobiSecureTM SDKprovides mobile application developers with a suite of security Application Program Interface (APIs) to integrate the Diversinet MobiSecure Client software and service bureau infrastructure across a range of mobile device platforms, Internet and mobile data networks for secure personal communication and commercial transactions.

•

Diversinet’s MobiSecureTM Wallet is a client-side secure container application, which can access or hold confidential personal information, such as user id and access information via fax, email and SMS.  It operates in concert with the MobiSecureTM Vault, a server-side secure container application, and allows a user to access a host of personal information files.  Personal health records, financial information, payment information, entertainment or loyalty information can be accessed in real time, directly from a users mobile phone or other hand-held access device.  The MobiSecure Vault provides large file storage and backup to the Wallet and is accessible through web service interfaces and adaptors.



Industry Background

In recent years, the personal data industry has been growing on many fronts.  We believe the worldwide growth of the mobile data industry is being propelled by the explosive growth of the Internet and the consequent demand for mobile data access to the Internet, high penetration rates for users of mobile telephones, intense price competition among mobile network operators and the emergence of worldwide standards for mobile data communications.



Security has and will continue to be a major concern for the mobile data community.  The increasing number of consumers and businesses that expect the ability to securely access confidential information and conduct transactions wirelessly has created the interest and demand for mobile device security.



The mobile data market is not readily adaptable to its networks, applications and devices used within existing wired solutions.  Mobile data networks are fundamentally different from wired networks.  In wired networks, the Intel chip in a PC is the common device platform, Microsoft Windows is the dominant operating system and the browser is the common graphical user interface.  Mobile data networks currently have no dominant standards for client platforms, with a large variety of operating systems and user interfaces.  The mobile device may be a PDA, PDA/Phone combination, intelligent mobile device or a smart phone.  Many operating systems and configuration options as well as network operator network policy arrangements are being employed.   Therefore the mobile device market is technically more complex than the existing PC Internet market in terms of technical diversity.



Mobile industry standards are emerging, and we are a member and contributor to many of the standard-setting bodies.  One of the main standards setting forums is the Open Mobile Alliance (formerly the WAP or Wireless Application Protocol Forum).  The objective of this association is to develop standards intended to bring highly-optimized Internet content to mobile devices by creating global mobile data protocol specifications and standards that work across all mobile network technologies. In addition to the Open Mobile Alliance, we are a Coordinating member of the initiative for Open AuTHentication (also known as OATH) an industry-wide collaboration to develop an open reference architecture by leveraging existing open standards for the universal adoption of strong authentication. We are also a member of the Liberty Alliance Project, an open body working to address the technical, business, and policy challenges surrounding identity and web services; and the NFC Forum, an industry group focusing on Near Field Communications standards for RFID/proximity communications used in mobile payments and related applications.



Need For Secure Transactions Supported By Strong Authentication

The openness and accessibility that have stimulated the adoption and growth of the Internet and mobile and wired public and private networks, also create threats to the authenticity, privacy and integrity of information that is transmitted across or stored on the networks.  Well-publicized Internet fraud experienced by on-line companies and attacks resulting in overloading of popular e-business web sites by hackers and phishing experts have highlighted the need for improved user authentication. Identity theft is the fastest growing types of consumer fraud.  The Federal Trade Commission in the United States has estimated,that each year ten million Americans are victims of identity theft with a total cost to business and consumers exceeding $50 billion. Additionally, FTC estimates that almost 2 million U.S. Internet users experience fraud each year, with 70% of the cases associated with online banking or bill payment. Enhanced user authentication  commonly known as strong authentication  is the next wave of security enablers to curb the rise in identity theft. The security risks associated with personal communications and commercial transactions over the Internet, and over mobile and wired public and private networks, have accentuated the need for strong authentication solutions that protect user identity, data and devices.



In order to further define and deliver to the market needs for strong authentication solutions, the initiative for Open AuTHentication (OATH) was founded in February 2004 by Verisign including a host leading global information and communication technology industry companies as charter members: IBM, Gemalto, Entrust, Diversinet, Vasco, SafeNet and others.  According to OATH, strong authentication connotes a stringent level of security that combines a user ID with a software or hardware token to form a unique device that validates a users identity when accessing a software application or network.   It represents a foundational element of trusted networks where multiple business partners can securely share confidential information. Online identities secured only by static passwords can be exploited, resulting in identity theft or compromised systems.  Existing two-factor authentication approaches, while more effective, are often expensive and complex, and their lack of interoperability poses significant barriers to adoption.  An industry-wide collaborative effort to promote Open Strong Authentication will remove these barriers and broaden enterprises use of the Internet to communicate, collaborate, and conduct commerce in new ways.



Market Acceptance of Strong Authentication

A wide range of products and services has been introduced to address strong authentication requirements for wired applications and services.  For example, products such as password tokens, smart cards and USB authenticators, which limit network access only to users having recognized addresses or entering recognized passwords, provide access control by providing One-Time-Passwords (OTPs).  These OTP products are generally limited in their flexibility, user convenience and are expensive to the general enterprise and consumer markets.   Globally, there are over 30 million hardware authentication tokens in the market, as stated by vendors RSA (The Security Division of EMC), Vasco Data Security and others, with the average end user cost per token of $35 per unit for enterprise remote access deployments.  This cost does not include system and server fees associated with validating the identity of the user as well as backend integration to the application and/or service provider.



Globally, there are an estimated 230 million online banking and brokerage users today, with the vast majority of these accounts authenticated by a simple password for online access.  We believe that globally, the enterprise and consumer mass markets have not yet adopted strong authentication because of the associated high-costs for the tokens and because of the inconvenience of carrying multiple authentication devices to remotely access Internet lifestyle communities such as banking, wagering, associations, corporate information and public sector services. For strong authentication to take hold for the mass market, each individual user would be required to carry, and pay for, one token for each access point.  We believe a soft token capable of addressing multiple access points created within, or delivered to, a mobile device, will increase the acceptance for strong authentication.



Need for Mobile Authentication Services

We believe that as mobile devices proliferate in the marketplace and become both smarter and connected to the Internet the requirements to authenticate the device and the users become critical. The identity of the individual is under greater threat than at anytime during the past and must be maintained and protected in order to facilitate transactions over the wireless network and the Internet. Whether an individual is downloading a ring-tone to their phone, requesting private health data from a hospital database or simply expecting their email to be secure, authentication services are essential in a mobile world.

The prevention of fraud, the ability to thwart phishing schemes, the need to protect identities and private information are all dependent upon authentication of individuals using mobile devices and their associated services.

Market Size

Mobile devices are becoming pervasive in many parts of the world.  Today there are 2 billion plus wireless phones worldwide with predictions of subscribers reaching three billion by 2010, as networks grow and prices for handsets continue to drop according to Goldman Sachs Research.  Over 700 mobile network operators worldwide contribute to subscriber growth and will be seeking to retain subscribers through the provision of innovative authentication services.

Our products and services target wireless subscribers worldwide by enhancing the mobile device function to provide both a trusted identity and the capability to generate and receive One-Time Passwords.

Our MobiSecure product also operates on Windows-based personal computers, of which there are approximately 500 million deployed around the world.

Financial Institutions worldwide are concerned with the weaknesses inherent in simple passwords as single factor authentication.  According to Soleil Equity Research, approximately 50,000 banks worldwide have recognized the need for strong authentication and have begun to offer limited wireless device One-Time Password delivery.

Demand Drivers

We believe that the four significant drivers of demand for mobile-optimized strong authentication products and services are as follows:

1.

Rise of phishing and identity theft over the Internet

Consumers are becoming less trustful of Internet online systems for banking and commerce as identity theft and phishing attacks (sending an e-mail to a user falsely claiming to be an established legitimate enterprise in an attempt to scam the user into surrendering private information that will be used for identity theft.) on consumers increase. We believe consumers are looking for more secure means of identifying themselves to financial institutions, online commerce suppliers and online service providers. The acceptance of One-Time Password token generators will enter the consumer market as the banking industry and e-commerce providers seek solutions to protect their customer transactions.

2.

Rise of Federated Identity Networks

Federated identity networks are increasing to help businesses establish a virtual network, or circle of trust, through authentication (of an identity) and single sign-on across domains.  The vision is that users and their identities are grouped and trusted across many boundaries such as those with partners, customers and third-party contractors.

The Liberty Alliance, the leading identity network, is setting standards for the implementation of federated networks, and we believe the Liberty Alliance framework is emerging as a de facto standard for mobile identity based data services. Within Liberty, member companies collectively represent close to 400 million mobile subscribers, more than half of the mobile devices in the market, some 80% of all Subscriber Identity Modules (SIM) and approximately 55% of the mobile network infrastructure providers.

Strong authentication is critical to the success of all federated networks however,  as mobile network operators become identity providers in federated networks, mobile optimized authentication must be integrated on the mobile device in order to prevent identity theft and fraud.

3.

Mandated Government Regulation

Enterprises are looking toward stronger authentication methods in order to track and control who has access to what information in order to comply with demanding regulations such as the Sarbanes-Oxley Act and the Health Insurance Portability and Accountability Act (HIPAA). Hackers cannot be tolerated when corporations are legally responsible to protect the privacy of the data under their control. Additionally, the recent U.S. FFIEC guidelines require financial institutions to implement enhanced authentication measures (beyond simple username/password) when authenticating bank customers when using online financial services.

4.

Lack of security as an impediment to m-commerce and e-commerce growth

Security is often regarded as the primary impediment to the mainstream adoption of the Internet as a business tool.  Given the importance attached to the Internet and mobile networks and the related potential for cost reduction and revenue generation, the issue of security becomes one of fundamental need and importance.

Much publicized security incidents including misappropriation of personal data on smart phones, high profile identity theft, and the continued rise in phishing attacks have provided a growing perception among many consumers that there is a risk involved in transmitting information via mobile networks and the Internet. We believe electronic commerce, both Internet and mobile based will benefit from improved mobile authentication services that correctly identify users and reliably encrypt data over mobile networks.

Strategy

We strive to be a leader in providing mobile-optimized strong authentication products, solutions and services to protect mobile user identity, data and devices over mobile data networks and other networks, including corporate networks, telecommunications systems and the Internet.  We continue to develop new innovative products and services such as MobiSecure Wallet, our client-side secure container application, which can access or hold confidential personal information, such as user id and access information via fax, email and SMS and MobiSecure Vault, a server-side secure container application, and allows a user to access a host of personal information files.  With these products personal health records, financial information, payment information, entertainment or loyalty information can be accessed in real time, directly from a users mobile phone or other hand-held access device.  The MobiSecure Vault provides large file storage and backup to the Wallet and is accessible through web service interfaces and adaptors.

The key elements of our strategy to achieve this objective include the following:

Target emerging strong authentication markets.  Our sales and marketing activities are primarily targeted at emerging Internet markets to protect consumer, enterprise, and commerce high-value applications with mobile assisted One-Time Password token solutions, in addition to more traditional forms of personal communications and commercial transactions over mobile data networks.  Within these markets, our customers and partners include device manufacturers, network infrastructure manufacturers, application developers, certificate authorities and mobile network operators.  Our business plan is dependent of the cooperation of numerous parties to a transaction.

Expand strategic relationships.  We have formed relationships in the areas of sales, marketing and technology with industry leaders, and expect to continue to form such relationships in the future, to encourage widespread acceptance of our mobile authentication products, solutions and services.  These include relationships with such companies as:

VeriSign

Microsoft

RSA, The Security Division of EMC

Research In Motion

Magna Entertainment Corp.

Visa

SanDisk

BlueCross





Maintain what we believe to be a leadership position in terms of research and development of technology.In In late 1996, we acquired technology that consists of concepts and methods that relate to automatic and safe public information communication systems and methods for secure distribution of information.  We have invested, and intend to continue to invest, significantly in the development of our technology.  We will base future development of our technology on mobile device security market requirements.  In January 1999, we were issued a patent for this technology by the U.S. Patent and Trademark Office that will be in effect until August 22, 2017.  In April 2001 we received an U.S. patent for our technology relating to the handling of permissions.  In June 2001 we received an Israeli patent that will be in effect until 2021 for our technology relating to safe communications handshake and data transfer.  In July 2003, we received a patent from the State of Israel Patent Office for our System and Method for Reliable Key Transfer.  This patent will be effective until 2021.  This system and method provides for an automated method to securely update root certificate authority (CA) keys and certificates (basis for root rollover) and combine domains. On August 5, 2003, we received a trademark from the U.S. Patent and Trademark Office for our Diversinet logo.  This trademark will be effective until 2013.  On November 2, 2003, we received a patent from the State of Israel Patent Office for our System and Method for Handling Permits.  This patent will be effective until 2017.  The patented technology provides for a unique permit separation model that enhances the security and privacy of wired and wireless e-commerce systems by improving the management of personal privileges in advanced PKI security environments.  On September 5, 2006, we received a patent from the U.S. Patent and Trademark Office for our Method of establishing secure communications in a digital network using pseudonymic digital identifiers. On November 21, 2006, we received a patent from the State of Israel Patent Office for our Communication system and method. On January 30, 2007, we received a patent from the Canadian Intellectual Property Office for our System and Method for Reliable Key Transfer. The patented technology describes a method to securely update root CA keys and certificates (Basis for Root Rollover) and combine domains.

Build awareness of the Diversinet brand.  One of our main goals is to establish our brand as a leader for mobile authentication products, solutions and services for all transactions over mobile data networks.  We plan to achieve this goal through a variety of programs that will generate brand awareness.  These include regular press and investor sessions, an ongoing pro-active speaking program by senior management and regular interaction with major market influencers.

Strengthening our Presence in the Canadian, US and other markets.  We believe the Canadian and U.S. markets will be active and growing markets for our mobile authentication products, solutions and services.  To strengthen our position in these important markets we are focusing our sales and marketing efforts to align our resources with strategic partners in each territory to deliver to local market needs.

Products and Services

We believe our technology and approach to mobile authentication services have several distinct advantages over existing security methods.  Most notably, our solutions were developed specifically for the mobile environment.  Our mobile-optimized technology minimizes demands placed on scarce device resources such as processor and memory, and as a result assists in conserving battery life.  Our technology also minimizes the amount of data sent over the network and the number of steps required to achieve a secure connection, which optimizes consumer network resources

We develop, market and distribute a complimentary product and service suite: Diversinet MobiSecureTM Client and Diversinet MobiSecureTM Authentication Server together provide, what we believe to be, a comprehensive security solution with a focus on mobile applications residing on Palm, RIM, Symbian, Microsoft and Java-based operating systems; mobile browser-based devices; and GSM/SIM (Subscriber Identity Module) based devices.

Our products and services are designed to address the unique needs of mobile devices, networks and applications.  When integrated with specific applications, our products enable mobile users to effectively manage secure communications and transactions across mobile data networks.

Diversinet MobiSecureTM Client

The MobiSecureTM Client is a mobile device resident software tool designed to support applications running on the mobile device with an accessible security service package.  The primary product objective is to enhance mobile device resident applications to utilize a series of mobile security functions supporting Authentication, Privacy, Integrity and Non-repudiation.

The MobiSecureTM Client package contains several initial applications.  These include a user One-Time Password (OTP) application as well as appropriate One-Time Password browser plug-ins to allow One-Time Passwords to be generated automatically during browser sessions.

Diversinet MobiSecureTM Authentication Server

The Diversinet MobiSecureTM Authentication server product will operate as a customer facilities hosted application server.

MobiSecureTM Authentication server provides the basis for both supporting the provisioning of the Mobile SecureTM Client and the delivery of an SMS two-factor authentication service as well as validating the generated token values to permit access to corporate or secure facilities.

Product and Service Development

Our engineering group is focused on developing core technologies and enhancements to existing product lines to maintain and extend what we believe to be our technology and product leadership position.  More specifically, the group is currently focused on the development of additional features for Diversinet MobiSecureTM software and the Mobile SecureTM Authentication Server the features of which will be assessed in terms of market demand and competition.

The product will continue to develop with a focus on the unique characteristics of the mobile market and enhancements to Over-the-Air provisioning.  Our engineering group reviews relevant proposed industry standards or conventions as they are developed and seeks to make our products compatible with each of them.  We participate in industry standard bodies, such as the initiative for OATH, ensuring OATH compliance of our products. Through the Liberty Alliance Project we assist in the development of business guidelines for mobile deployments. Through our membership with the Open Mobile Alliance (OMA) we monitor the activities of others, such as the Internet Engineering Task Force (IETF) and the American National Standards Institute (ANSI).

Consulting Services and Support

We believe that a high level of service and support will be critical to our success and that a close and active customer relationship is important to facilitate rapid implementation of our solutions, assure customer satisfaction and provide us with important information regarding evolving customer requirements.  We are continuing the process of building a Diversinet MobiSecureTM services group that will provide product integration services, customized engineering support and training to our customers through our channel partners.

Research and Development

We expect that our future success will depend in large part on our ability to continue to maintain what we believe is a leadership position in terms of research and development of technology.  Our research and development efforts are focused on developing core technologies and enhancements to existing products and services in order to maintain and extend our technology and product leadership position.  We leverage open industry standards and open source initiatives to maintain our pulse on the mobile, security and IT industries.

As of December 31, 2006, our research and development staff consisted of 21 employees (of which 8 hold advanced degrees in science or business).  Research and development expenditures were $0.8 million in the fiscal year ended December 31, 2006, $1.2 million in the fiscal year ended December 31, 2005, $1.2 million in the fiscal year ended December 31, 2004, and $1.3 million in the fiscal year ended December 31, 2003.  We expect to spend approximately $2.3 million in fiscal 2007.  We believe that timely development of new and enhanced security products is necessary to remain competitive in the marketplace.

Customers

To date, we have executed limited pre-commercial collaboration programs with a wide range of market development partners and customers for mobile authentication services.  In addition, we received service revenue for support and maintenance from other service contracts for professional services and solutions.

Competition

Our mobile authentication technology is targeted at the new and rapidly evolving demand for mobile-optimized strong authentication solutions.  Although the competitive environment has yet to develop fully, we anticipate that it will be highly competitive, subject to rapid change and significantly affected by new product and service introductions and other market activities by industry participants.  We believe we are one of a few companies that currently have mobile authentication services based on the OATH reference architecture available in the mobile device security market that provides an end-to-end solution.  There are a number of successful security vendors who have announced their intention to compete in the mobile space.  These include RSA, SafeNet, and Entrust.  While these competitors have better name recognition in general, we are striving to become a leading brand in mobile authentication services today.  We also anticipate competition from a number of other larger and smaller companies that provide other security solutions.  Many of our competitors and potential competitors have significantly greater resources than we have.

The principal competitive factors affecting the market for mobile authentication services include technical features, ease of use, reliability, level of security, scalability, customer service and support and price.  There are also significant technical challenges that are unique to the mobile environment, including constraints in device processing and storage capabilities, and network throughput limitations.  We believe our products have been optimized for this unique and technically challenging environment.  Our future success will largely depend on our ability to make our products available to serve the rapidly growing mobile authentication services market, rather than taking market share away from competitors.

Regulatory Matters

Some of our products are subject to special export restrictions administered by the Canadian government and are also subject to import restrictions and/or use restrictions imposed by countries such as the United States, although pursuant to a recent international treaty, a number of countries have relaxed, or are in the process of relaxing, their export rules as applicable to products of the type licensed by us.  Consequently, our ability to export our products to destinations outside of Canada is subject to a variety of government approvals or licensing requirements.  These export controls may also restrict our ability to make some products available for sale via international computer networks such as the Internet.  Re-export of the products between countries other than the United States and Canada may be subject to the export control laws of those countries in addition to those provisions of Canadian export control laws that apply to re-exported goods.  In light of these restrictions, depending on the country of destination, industry sector and/or end-user, some of our products made available abroad may contain significantly weaker encryption capabilities than those available to customers in Canada, and there can be no assurance that we will continue to be able to export our products to any destinations outside of Canada.  Such restrictions could potentially have an adverse effect on our business, financial condition and results of operations.

Intellectual Property

We rely on a combination of patent, trade secret and trademark laws, non-disclosure agreements and contractual provisions to establish and protect our proprietary rights.  We also seek to protect our trade secrets and other proprietary information through license agreements with customers and suppliers, as well as non-disclosure and non-competition agreements with employees and consultants.

On January 26, 1999, we received a patent from the U.S. Patent and Trademark Office for our Method for Safe Communication which will be in effect until August 22, 2017.  This method consists of the safe distribution of encryption keys, including a known public and secret private key, and establishes a secure link between computer users who reside at separate locations and who have had no previous secure communications.

On April 10, 2001, we received a patent from the U.S. Patent and Trademark Office for our System and Method for Handling Permits.  The patented technology provides for a unique permit separation model that enhances the security and privacy of wired and wireless e-commerce systems by improving the management of personal privileges in advanced PKI security environments.

On June 20, 2001, we received a patent from the State of Israel Patent Office for our Apparatus and Method for Safe Communication Handshake and Data Transfer.  This patent will be effective until 2021.  This apparatus and method provides for the safe distribution of encryption keys, including a known public and secret private key, and establishes a secure link between computer users who reside at separate locations and who have had no previous secure communications.

On July 11, 2003, we received a patent from the State of Israel Patent Office for our System and Method for Reliable Key Transfer.  This patent will be effective until 2021.  This system and method provides for an automated method to securely update root certificate authority keys and certificates (basis for root rollover) and combine domains.

On August 5, 2003, we received a trademark from the U.S. Patent and Trademark Office and the Canadian Trademark Office for our Diversinet logo.  This trademark will be effective until 2013.

On November 2, 2003, we received a patent from the State of Israel Patent Office for our System and Method for Handling Permits.  This patent will be effective until 2017.  The patented technology provides for a unique permit separation model that enhances the security and privacy of wired and wireless e-commerce systems by improving the management of personal privileges in advanced PKI security environments.

On September 5, 2006, we received a patent from the U.S. Patent and Trademark Office for our Method of establishing secure communications in a digital network using pseudonymic digital identifiers.  The patented technology describes a technique for anonymous electronic identity.

On January 30, 2007, we received a patent from the Canadian Intellectual Property Office for our System and Method for Reliable Key Transfer. The patented technology describes a method to securely update root CA keys and certificates (Basis for Root Rollover) and combine domains.

On November 21, 2006, we received a patent from the State of Israel Patent Office for our Communication system and method. The patented technology describes a method to access databases from multiple access devices according to customer choice.

Applications for sixteen other patents have also been submitted in USA and Canada based on the same concept for which the United States patent was granted, as well as other concepts.

We have also applied to register as trademarks with the United States Patent and Trademark Office and/or the Canadian Trademark Office the name MobiSecure, but there can be no assurance that these trademarks will be successfully registered.

We continue to seek patent and trademark protection where appropriate.

Marketing and Sales

Marketing

Our marketing efforts will support our two primary marketing objectives:

(i)

increasing awareness through building the Diversinet brand; and

(ii)

generating sales leads in our target markets.  Our efforts to increase awareness and build our brand will entail gaining positive coverage in targeted trade and business publications and establishing and developing relationships with analysts from market influencers.  We will pursue the generation of sales leads through the implementation of programs and active participation in targeted events with cooperative marketing activities in support of channel partners.

Sales

We offer our mobile authentication products, solutions and services globally to security providers, mobile network operators and application providers employing several sales models to target our intended markets.

We believe that our coverage of these markets by our sales team through our partners is necessary to pursue our targeted customer base, which is still in the early stage of high-value secure mobile application deployment and testing.  Our customer focus is in providing mobile authentication solutions to security providers, mobile network operators and application providers, both directly and through licensed distribution channels.  We are also exploring OEM relationships for the private branding of our products, solutions and services.

The current sales and implementation cycle for our mobile authentication products, solutions and services is approximately six months and consists of four phases:

•

Initial contact and customer education/qualification

•

Pilot proof of concept

•

Early deployment testing

•

Phased production rollout

Seasonality

Seasonality does not affect our main business; our business generally does not fluctuate based solely on the time of year.

Raw Materials and Suppliers

We do not use a significant amount of raw materials in our business.  Substantially all of the raw materials that we use in our business are either freely available, such as office supplies, or are easily available to us at reasonable prices, such as computer hardware and software.

4-C.

Organizational Structure

In January 2003, we acquired 100% ownership of DSS, a professional services company, in Fremont California.  In February 2005 DSS completed an asset sale agreement whereby it sold the majority of its current assets, capital assets, current liabilities, consultant and customer accounts for $250,000.  As part of the agreement, Diversinet is entitled to a five year annual fee of up to $120,000 per year based on the purchaser meeting certain gross profit and net profit criteria.  In September 2003, we acquired 100% ownership of Caradas, a smart card-based application security company headquartered just outside Boston, Massachusetts.

During 2001, we entered into an agreement with an Asian company to establish a joint venture to conduct certain of our Asian activities.  Each party holds a 50% interest in the joint venture, Atria Limited (formerly Diversinet Hong Kong Limited).  During the second quarter of 2004, we received notification from the other joint venture partner of their intent to terminate the joint venture agreement and wind up the joint venture.  During the fourth quarter of 2004 we increased our depreciation charge by $145,000 (and reducing our capital assets cost base by $330,000 and our accumulated depreciation and amortization for our capital assets by $185,000) for our joint venture assets in recognition that we are in the process of winding up the joint venture.  The joint venture is currently inactive.

We have five inactive wholly-owned subsidiaries, Diversinet Corporation of America, incorporated in Delaware, Diversinet Inc., an Ontario corporation which was formed on November 20, 1996; Instant Publisher Ltd., a Barbados corporation formed on December 2, 1993; Diversinet (Israel) Ltd., an Israeli corporation; and DSS Software Technologies, incorporated in California.

4-D.

Property, Plant and Equipment

Our head office is located in leased premises of approximately 8,500 square feet at 2235 Sheppard Avenue East, Suite 1700, Toronto, Canada M2J 5B5.  The lease for our head office expires in April 2012.

ITEM 5.   OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Our financial statements have been prepared in accordance with Canadian GAAP.  These principles conform in all material respects with U.S. GAAP except as described in Note 13 to our 2006 consolidated financial statements.



The following discussion should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this annual report.  Except for historical information, the following discussion contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended.  Such forward-looking statements involve risks and uncertainties.  Such forward-looking statements include, among others, those statements including the words, expects, anticipates, intends, believes, and similar language.  Our actual results may differ significantly from those projected in the forward-looking statements.  Factors that might cause future results to differ materially from those discussed in the forward-looking statements include, but are not limited to, those discussed in Risk Factors in Item 3-D. of this annual report.



We have incurred operating losses in each of the last five fiscal years due to losses from our continuing operations of developing security products and our discontinued operations of developing and marketing the IPS 950 instant color digital printing system.  We have sustained our business during this period through the sale of common shares in a series of private placements.  We cannot provide assurance that we will be able to raise sufficient funds in the future to sustain our operations.



5-A.

Operating Results

Overview

Founded in 1997 and based in Toronto, Canada, we are a provider of personal authentication and security solutions for the wireless world.  Our software and services protect user identity and provide secure access for consumer and business applications using a variety of mobile phones, Personal Digital Assistants and personal computers.  Our scaleable, open mobile security platform enables enterprises and service providers to rapidly develop, deploy and manage next-generation wireless security services.  Our technology simplifies what had previously been a complex set of technical problems in both information security and wireless data communications.  In January 2005 we began to focus on the evolving protection and trust needs of mobile users.  These financial results reflect this shift in focus and the time required to build up a customer base under this new strategy and a rebuilding of the sales and marketing strategy of the company.



Our MobiSecure soft tokens and MobiSecure Authentication Service Center (MASC) enable financial service providers, mobile network operators and security service providers to rapidly develop, deploy and manage secure on-line services for mobile device and PC users worldwide.  Our MobiSecure soft tokens are securely provisioned and managed by MASC and are available on the leading intelligent mobile device platforms, including Symbian, Microsoft, RIM, Palm and Java-based phones as well as on personal computers running Microsoft Windows.



Our MobiSecure Wallet is a client-side secure container application, which can access or hold confidential personal information, such as user id and access information via fax, email and SMS.  It operates in concert with the MobiSecure Vault, a server-side secure container application, and allows a user to access a host of personal information files.  Personal health records, financial information, payment information, entertainment or loyalty information can be accessed in real time, directly from a users mobile phone or other hand-held access device.  The MobiSecure Vault provides large file storage and backup to the Wallet and is accessible through web service interfaces and adaptors.



Our combination of client software and wireless provisioning services enables the issuance and management of mobile device authentication tokens and also creates a technology platform from which we can provide an entirely new and powerful set of capabilities in the mobile e-commerce environment in the form of digital identities, digital permissions and wireless wallets.  In addition to providing mobile device security and provisioning solutions, we deploys an experienced professional services team for application development, consulting, training and technical support.



During 2004, the average US  Canadian dollar rate was 1.30.  During 2005, the average U.S.  Canadian dollar rate was 1.16, causing our Canadian dollar expenditures to increase relative to the U.S. dollar.  During 2006, the average U.S.  Canadian dollar rate was 1.13, causing our Canadian dollar expenditures to increase relative to the U.S. dollar.



Operating Results



Unaudited quarter ended December 31, 2006 compared to the unaudited quarter ended December 31, 2005

Revenue

For the quarter ending December 31, 2006, we reported revenue of $286,000 compared to $159,000 for the quarter ended December 31, 2005.  During the quarter, we generated 70% (100% in 2005) from consulting services and 30% (nil in 2005) from licensing.  The higher revenue for the 2006 quarter was due to a large amount for a license and professional services agreement entered into with a leading global identity authentication and protection company serving several million consumers.  During Q4 2006 we signed an agreement with BCNEPA under which we have invoiced $900,000 (and received $900,000) which invoiced amount is included in deferred revenue on the balance sheet.



Cost of sales

Cost of sales were $50,000 for the quarter ended December 31, 2006 compared to $13,000 for the same quarter in 2005.  The increase is due to a contract for professional services in which one employees wages are charged to cost of sales.  This contract started in November of 2005.



Expenses

Research and development expenses were $316,000 for the quarter ended December 31, 2006 compared to $310,000 for the same period of 2005.  Sales and marketing expenses were $189,000 for the quarter ended December 31, 2006 compared to $354,000 for the same period of 2005.  The Q4 2005 results include severance costs as we realigned the sales and marketing team.  Throughout the quarter the average number of employees in this department was four less than the prior year.  This resulted in remuneration, travel and human resource cost being reduced by $138,000.  Public and media relations expenses were decreased by $23,000 over Q4 2005.  General and administrative expenses were $797,000 for the quarter ended December 31, 2006 compared to $503,000 for the same period of 2005.  The 2006 quarter includes Canadian $250,000 in litigation costs (2005 - $nil) and $90,000 in stock-based compensation expense, compared to $177,000 for the same period in 2005.



Depreciation and amortization

Depreciation and amortization expense was $38,000 for the quarter ended December 31, 2006 compared to $48,000 for the same period of 2005.  The variance is the result of applying our rates to a declining net asset balance.



Other Income

We reported net income from discontinued operations of $nil for the quarter ended December 31, 2006 compared to net income of $28,000 in the prior years comparative period.



Net Loss

We reported a net loss of $1,050,000 for the quarter ended December 31, 2006 and $1,030,000 for the quarter ended December 31, 2005.  The loss per share was $(0.03) for the quarter ended December 31, 2006 compared to $(0.04) for the December quarter of 2005.



Year ended December 31, 2006 compared to year ended December 31, 2005

Revenue

For the year ending December 31, 2006 and 2005, we reported revenue of $1,667,000 and $1,101,000 respectively.  We generated 84% (73% in 2005) of our revenues from the United States, 12% (18% in 2005) from the Asia Pacific region, 2% (9% in 2005) from Canada and 2% (nil in 2005) from other areas during the year ended December 31, 2006.  During this year, we generated 94% (100% in 2005) from consulting services and 6% (nil in 2005) from licensing.  During 2006 we began and completed work on the RSA Security development product.  We applied a zero gross margin percentage of completion method for this development agreement, providing us with $845,000 in revenues and $845,000 in cost of sales in fiscal 2006.  During Q4 2006 we signed an agreement with BCNEPA under which we have invoiced $900,000 included in deferred revenue on the balance sheet.  We expect to commence recognition of revenue related to this arrangement over the coming quarters as we deliver the MASC license and the associated 100,000 tokens to BCNEPA.  In January 2005 Diversinet began to focus on the evolving protection and trust needs of mobile users.  These financial results reflect this shift in focus and the time required to build up a customer base under this new strategy and a rebuilding of the sales and marketing strategy of the company.  During the third quarter of 2005 we received notice from one of our customers that they would not be renewing our contract to provide test lab services.  This contract represented $479,000 in 2005 revenues.



During 2006, 78% of our revenue came from three customers (67% in 2005 from two different customers).  While we are endeavoring to increase our customer base, the market that we operate in is still in an evolving stage and our revenue is still quite small.  Therefore, it is reasonable to expect that our revenue may continue to be concentrated among relatively few customers for the near future.



Cost of sales

Cost of sales were $1,041,000 (gross margin of 38%) for the year ended December 31, 2006 compared to $563,000 (gross margin of 49%) for 2005.  This represents the direct costs associated for completing the software solutions and consulting services revenue.  The lower margins for 2006 are the result of lower margins on a significant strategic customer (RSA Security) in 2006.



Expenses

Research and development expenses were $832,000 for the year ended December 31, 2006 compared to $1,242,000 for 2005.  Starting in Q1 2006, the development department focused a portion of their work effort towards completing modification to our products for RSA Security.  In the past, this departments time has been spent conducting research and developing our products for general availability.  As a result, during 2006, product development costs of $730,000 were reallocated from research and development to cost of sales.  Costs were further reduced in 2006 by $288,000 from the receipt of funds for our scientific research and experimental development (SRED) claim for the 2003, 2004 and 2005 fiscal years.  The increase in development costs of $608,000 (before the SRED credit and cost of sales allocation) over 2005 was largely due to an increase of 31% in the head count (from 16 to 21 people) in this department.



Sales and marketing expenses were $701,000 for the year ended December 31, 2006 compared to $1,290,000 for 2005.  The decrease in costs in this department was due to a 38% reduction in the average head count (from 8 to 5).  Further cost reductions included a decrease in travel costs of $46,000, conferences by $40,000 and memberships by $28,000.  Included in the December 31, 2006 sales and marketing expenses is $33,000 ($nil for 2005) relating to stock-based compensation expenses.



General and administrative expenses were $2,485,000 for the year ended December 31, 2006 compared to $2,301,000 for 2005.  Included in the December 31, 2006 general and administrative expenses is $874,000 ($986,000 for 2005) relating to stock-based compensation expenses.  The Company is required to estimate the fair value of stock-based compensation granted to employees and to expense the fair value over the estimated vesting period of the stock options and warrant grants.  Professional fees increased by $76,000 over 2005 due to greater spending in investor and public relations areas.  We have also accrued Canadian $250,000 in regards to litigation costs that we are currently involved in.



Depreciation and amortization

Depreciation and amortization expense was $159,000 for the year ended December 31, 2006 compared to $540,000 for 2005.  The reduction in 2006 is primarily due to the sale of the DSS assets in February 2005, which led to reduced depreciation and amortization.  This is consistent with the reduction in net capital assets.



Other Income

Foreign exchange losses were $18,000 for the year ended December 31, 2006 compared to $11,000 for 2005.  We earned interest and other income of $118,000 during 2006 compared to $32,000 for 2005 through investing our excess cash.



We reported a loss from discontinued operations of $nil for the year ended December 31, 2006 compared to $71,000 for 2005.  In February 2005 DSS completed an agreement whereby it sold the majority of its current assets, capital assets, current liabilities, consultant and customer accounts for $250,000.  With the sale of the DSS assets, we have included the results of DSS as a single line item (discontinued operations) in the financial statements.  During the first quarter of 2005, with the sale of DSS assets, goodwill from the acquisition of DSS of $392,000 has been included in determining the loss on disposition.



Net Loss

We reported a net loss for the year ended December 31, 2006 of $3,451,000 compared to $7,109,000 for 2005.  These net losses include stock-based compensation expense relating to the issuance of options and warrants of $906,000 and $986,000 during 2006 and 2005 respectively and a goodwill and customer asset impairment charge of $nil and $2,225,000 for 2006 and 2005 respectively.



Year ended December 31, 2005 compared to year ended December 31, 2004

Revenue

For the year ending December 31, 2005 and 2004, we reported revenue of $1,101,000 and $2,603,000 respectively.  We generated 73% (90% in 2004) of our revenues from the United States, 18% (2% in 2004) from the Asia Pacific region, 9% (4% in 2004) from Canada and nil (4% in 2004) from other areas during the year ended December 31, 2005.  During 2005, we generated 100% (87% in 2004) from consulting services and nil (13% in 2004) from licensing.  The lower revenue for 2005 was due to a reduction in the Caradas revenues of approximately $1.5 million.  During the third quarter of 2005 we received notice from one of our customers that they would not be renewing our contract to provide test lab services.  This contract represented $479,000 in 2005 revenues ($355,000 in 2004).  In 2004, we received $195,000 from a license sale of our Connexus Client software.  In January 2005 Diversinet began to focus on the evolving protection and trust needs of mobile users.  This shift resulted in a decrease in our US professional services in the amount of $833,000.  These financial results reflect this shift in focus and the time required to build up a customer base under this new strategy and a rebuilding of the sales and marketing strategy of the company.



During 2005, 67% (64% in 2004) of our revenue came from two customers.  While we are endeavoring to increase our customer base, the market that we operate in is still in an evolving stage and our revenue is still quite small.  Therefore, it is reasonable to expect that our revenue may continue to be concentrated among relatively few customers for the near future.



Cost of sales

Cost of sales were $563,000 (gross margin of 49%) for the year ended December 31, 2005 compared to $1,427,000 (gross margin of 45%) for 2004.  This represents the direct costs associated for completing the software solutions and consulting services revenue.  The increase in the gross margins for 2005 are due in part to a $200,000 higher margin test lab project.



Expenses

Research and development expenses were $1,242,000 for the year ended December 31, 2005 compared to $1,154,000 for 2004.  During 2004 we received $141,000 relating to investment tax credits for R&D work done in 2003 and the two month stub period in 2002.



Sales and marketing expenses were $1,290,000 for the year ended December 31, 2005 compared to $1,195,000 for 2004.  The increase in sales and marketing is largely due to the implementation of the new strategy of the evolving protection and trust needs of mobile users started in January 2005.



General and administrative expenses were $2,301,000 for the year ended December 31, 2005 compared to $2,369,000 for 2004.  Included in the December 31, 2005 general and administrative expenses is $986,000 ($761,000 for 2004) relating to stock-based compensation expenses.  Remuneration and travel increased $146,000 over 2004 as a result of the addition to our executive team of a President offset by the reduction of an employee at head office.  Professional fees decreased by $353,000 over 2004 due to non-recurring legal settlements and consulting services which were not incurred in 2005.  Two large accounts were written off in 2004 resulting in bad debt charges of $85,000 (2005 for $nil).  Rent expense increased to $158,000 ($119,000 for 2004) relating to our head office in Toronto, Canada.



Depreciation and amortization

Depreciation and amortization expense was $540,000 for the year ended December 31, 2005 compared to $920,000 for 2004.  During the fourth quarter of 2004 we increased our depreciation charge by $145,000 for our joint venture assets in recognition that we were in the process of winding up the joint venture.  With the sale of the DSS assets in February 2005, we expected to see reduced depreciation and amortization.  These figures also include amortization of purchased technology and customer assets acquired on September 1, 2003 in the amount of $126,000 ($189,000 for 2004) and $221,000 ($331,000 for 2004), respectively.



During the third quarter of 2005, we received notice from one of our customers that they would not be renewing our contract to provide test lab services.  Therefore, with there being no continuing customers from the September 2003 Caradas purchase and with our new strategy focused on the evolving protection and trust needs of mobile users, we determined that net customer assets were impaired under the fair value based methodology as prescribed under GAAP.  We have recorded a customer asset impairment charge of $331,000 (nil- 2004).  In consideration of the adverse change noted above, we completed our goodwill impairment testing during the third quarter of 2005.  As part of the purchase price calculation, and ultimately affecting the goodwill, the original value attributed to common shares provided in the Caradas acquisition was $3.45 per common share.  As the result of the above the fair value of our goodwill exceeded its carrying value which results in a $1,895,000 impairment charge in 2005.  As Caradas has been unable to attract significant new customers in order to generate positive cash flows, we determined that the fair value of our goodwill exceeded its carrying value by $1,895,000 as at September 30, 2005 ($2,500,000 for 2004).



Other Income

Foreign exchange losses were $11,000 for the year ended December 31, 2005 compared to $28,000 for 2004.  We earned interest and other income of $32,000 during 2005 compared to $16,000 for 2004 through investing our excess cash.



We reported a loss from discontinued operations of $71,000 for the year ended December 31, 2005 compared to $541,000 for 2004.  In February 2005 DSS completed an agreement whereby it sold the majority of its current assets, capital assets, current liabilities, consultant and customer accounts for $250,000.  With the sale of the DSS assets, we have included the results of DSS as a single line item (discontinued operations) in the financial statements.  During the first quarter of 2005, with the sale of DSS assets, goodwill from the acquisition of DSS of $392,000 has been included in determining the loss on disposition.



Net Loss

We reported a net loss for the year ended December 31, 2005 of $7,109,000 compared to $7,517,000 for 2004.  These net losses include stock-based compensation expense relating to the issuance of options and warrants of $986,000 and $761,000 during 2005 and 2004 respectively and a goodwill and customer asset impairment charge of $2,225,000 and $2,500,000 for 2005 and 2004 respectively.



Critical Accounting Policies and Estimates

The nature of our business is not highly complex, as we operate in one primary business.  We develop, market and distribute wireless security infrastructure solutions and identity management solutions and professional services to the enterprise, financial services, government and gaming and wagering marketplace. As part of providing these solutions we perform professional services to install, support and integrate our solutions with other applications.  We operate globally in a functional organization.  We do not have any off-balance sheet financing, other than operating leases entered into in the normal course of business and we do not actively engage in derivative or hedging transactions.  With the acquisitions of DSS and Caradas in 2003, the majority of our revenues and expenses are now in U.S. dollars.  Therefore during 2003 we switched our functional currency from Canadian to U.S. dollars.  A significant portion of our cash balance is denoted in U.S. dollars.



The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period.  Significant estimates are used in determining the allowance for doubtful accounts, the useful lives of intangible assets, including customer assets and purchased technology, and goodwill impairment.  In making such estimates and assumptions, management consults with employees knowledgeable in the area; gathers relevant information; where appropriate, seeks advice from qualified third parties; and, makes judgments, which in the opinion at that time, represent fair, balanced and appropriate conservative estimates and assumptions.



In the year ended December 31, 2006, we did not make any significant changes in, nor take any corrective actions regarding, our internal controls or other factors that could significantly affect these controls.  We periodically review our internal controls for effectiveness and we plan to conduct an evaluation of our disclosure controls and procedures each quarter.  Other important accounting policies are described in note 1 to our consolidated financial statements.



Revenue Recognition

We derive our revenue primarily from two sources: sales of products, including hardware and software licenses, and services and professional services.  Significant management judgments and estimates must be made and used in connection with the revenue recognized in any reporting period.  Material differences may affect the amount and timing of our revenue for any period if our management made different judgments.  We have relied upon Statement of Position 97-2, Software Revenue Recognition, EITF 00-21, Accounting of Revenue Arrangements with Multiple Deliverables in developing our revenue recognition policies and CICA 3400 Revenue.



For all sales, we use a binding contract, purchase order or another form of documented agreement as evidence of an arrangement with the customer.  Revenues from software license agreements are recognized upon receipt of an executed license agreement and shipment of the software, if there are no significant remaining vendor obligations, collection of the receivable is probable and payment is due in accordance with our normal payment terms.



We consider delivery to occur when we ship the product, so long as title and risk of loss have passed to the customer, as the customer has the right to use the product from that date.



At the time of a transaction, we assess whether the sale amount is fixed or determinable and whether collection is probable.  If we determine the fee is not fixed or determinable, we recognize revenue when payment becomes due.  We assess collectibility based on a number of factors, including the creditworthiness of the customer.  If we determine that collectibility is not probable, we do not record revenue until such time when collectibility becomes probable, which is generally upon the receipt of cash.



Revenue earned on software arrangements involving multiple elements (i.e., software products, upgrades/enhancements, post contract customer support, installation, training, et cetera) is allocated to each element based on vendor specific objective evidence of relative fair value of the elements. When arrangements contain multiple elements and vendor specific objective evidence (VSOE) of fair value exists only for all undelivered elements, we recognize revenue for the delivered elements using the residual method.  VSOE of fair value for each element is either the price charged when the same element is sold separately or the price established by management, having the relevant authority to do so, for an element not yet sold separately.  For arrangements containing multiple elements wherein VSOE of fair value does not exist for all undelivered elements, revenue for the delivered and undelivered elements is deferred until VSOE of fair value exists or all elements have been delivered.  The revenue allocated to post contract customer support is recognized ratably over the term of the support and revenue allocated to service elements (such as training and installation) is recognized as the services are performed.



Consulting revenues are recognized on a time and materials basis, or on a percentage of completion basis, depending on the contract, as employees and subcontractors provide services. Revenue from time and materials service contracts are recognized as the services are provided.  Revenue from long term contacts is recognized based on actual hours incurred as specific deliverables are achieved consistent with the Companys proportional performance under the contractual arrangement.  Losses on contracts are recognized during the period in which the loss first becomes probable and reasonably estimable.  Contract losses are determined to be the amount by which the estimated direct and indirect costs of the contract exceed the estimated total revenues that will be generated by the contract. Revenue recognized in excess of billings is recorded as unbilled services.  Billings in excess of revenue recognized are recorded as deferred revenue until the above revenue recognition criteria are met.  Reimbursements, including those relating to travel and other out-of-pocket expenses, and other similar third-party costs, are included in revenues.



Maintenance service revenue, whether sold separately or as part of a multiple element arrangement, is deferred and recognized ratably over the term of the maintenance contract, generally twelve months.  Revenue allocated to professional service elements is recognized as the services are performed.



Due to the complexity of some software license agreements, we routinely apply judgment to the application of software revenue recognition accounting principles to specific agreements and transactions.  Different judgments and/or different contract structures could have led to different accounting conclusions, which could have had a material effect on our reported quarterly earnings.



Capital Assets

We record our capital assets at their cost less accumulated depreciation.  On a periodic basis, management reviews the carrying values of these assets and compares it to their estimated net recoverable amount.  The determination of net recoverable amount necessitates various assumptions, many of which are forward looking and which are based on managements best estimate of future revenues, expenses and cash flows.  To the extent that actual financial performance adversely differs from the results projected by these assumptions, an impairment charge in the value of these assets would be necessary.



Goodwill and Other Intangible Assets

Goodwill is the residual amount that results when the purchase price of an acquired business exceeds the sum of the amounts allocated to the tangible and intangible assets acquired, less liabilities assumed, based on their fair values.  When we enter into a business combination, the purchase method of accounting is used.  Goodwill is assigned as of date of the business combination to reporting units that are expected to benefit from the business combination.  Goodwill is not amortized but instead is tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired.  The impairment test is carried out in two steps. In the first step, the carrying amount of the reporting unit, including goodwill is compared with its fair value.  When the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered to be impaired and the second step of the impairment test is unnecessary.  The second step is carried out when the carrying amount of reporting unit exceeds its fair value, in which case, the implied fair value of the reporting units goodwill, determined in the same manner as the value of goodwill is determined in a business combination, is compares with its carrying amount to measure the amount of the impairment loss, if any.



During the third quarter of 2005, a Caradas customer contract expired and accordingly a goodwill and customer asset impairment analysis was performed for the Caradas reporting unit.  The impairment analysis indicated that the fair values of goodwill and customer assets were nil, and the Company recorded a goodwill write down of $1,894,690 and a customer assets write down of $330,768.  The impairment analysis for DSS indicated that the fair value of goodwill was nil and accordingly we recorded an impairment charge of $392,242 (included in loss from discontinued operations).  Application of the goodwill impairment test requires judgment, including assignment of assets and liabilities and determination of the fair value of each reporting unit.  The fair value of each reporting unit is estimated using a discounted cash flow methodology.  This requires significant judgments including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, the useful life over which cash flows will occur, and determination of discount rate and terminal asset value.  The Company believes goodwill is recorded at its fair value as at December 31, 2006.



During fiscal 2004, Caradas was unable to attract significant new customers in order to generate expected cash flows, and DSS lost key management which resulted in the loss of several customers over the course of the year.  The Company completed a goodwill impairment test as at December 31, 2004 and determined that goodwill of $2,500,000 relating to Caradas and $525,000 relating to DSS was impaired under the fair value methodology as prescribed under GAAP.  Goodwill impairment charges for DSS have been included in the results from discontinued operations for all periods presented.



Recent Accounting Developments

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (SFAS 154), which replaces Accounting Principles Board Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS 154 provides guidance on the accounting for and reporting of changes in accounting principles and error corrections. SFAS 154 requires retrospective application to prior periods financial statements of voluntary changes in accounting principle and changes required by new accounting standards when the standard does not include specific transition provisions, unless it is impracticable to do so. Certain disclosures are also required for restatements due to correction of an error. SFAS 154 is effective for accounting changes and corrections of errors, made in fiscal years beginning after December 15, 2005. The impact that the adoption of SFAS 154 will have on the Companys results of operations and financial condition will depend on the nature of future accounting changes and the nature of transitional guidance provided in future accounting pronouncements.



In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109(FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in the financial statements by standardizing the level of confidence needed to recognize uncertain tax benefits and the process for measuring the amount of benefit to recognize. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Corporation is currently evaluating the interpretation and will adopt FIN 48 in the first quarter of 2007. The cumulative effect of adopting FIN 48 will be recorded in retained earnings. The Corporation does not expect adoption of FIN 48 to have a material effect on its financial statements.



In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108 (Topic 1N):  Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108).  The SEC believes that a registrant should quantify a current year misstatement using both the iron curtain approach and the rollover approach.  If the over/understatement of current year expense is material to the current year, after all of the relevant quantitative and qualitative factors are considered, the prior year financial statements should be corrected.  Correcting prior year financial statements for immaterial errors would not require previously filed reports to be amended.  We have evaluated our accounts and determined that SAB 108 does not impact our reported results.

5-B.

Liquidity and Capital Resources

Quarter ended December 31, 2006 compared to quarter ended December 31, 2005

The net change in cash and cash equivalents and short term investments for the fourth quarter of 2006 was $356,000 compared to $(1,214,000) for the fourth quarter of 2005.  The Q4 2006 increase is largely due cash receipts of $900,000 received under the BCNEPA agreement.  This amount is recorded in deferred revenue and will be recognized as revenue in future periods.  The Q4 2005 decrease is mainly due to the continuing operating activities which used cash in an amount of $1,191,000.



Year ended December 31, 2006 compared to year ended December 31, 2005

Cash and cash equivalents at December 31, 2006 were $5,146,000 compared with $1,356,000 at December 31, 2005.  The net change in cash and cash equivalents and short term investments for 2006 was $3,791,000 compared to $(1,368,000) for 2005.  The fiscal 2006 increase was largely due to the June and July private placements in which gross proceeds of $5,008,000 were raised.  This was offset by operating activities which used cash in an amount of $1,210,000 which includes the receipt from BCNEPA of $900,000 included as part of the deferred revenues.  The fiscal 2005 decrease is mainly due to continuing operations which used cash in an amount of $3,291,000 which was offset by a financing completed during 2005 for gross proceeds of $2,000,000.



On July 26, 2006, we completed a private placement of 1,538,463 units, at $0.65 per unit, for gross proceeds of $1,000,000 and issued 96,154 units for consulting services related to the private placement.  Each unit is comprised of one common share and one common share purchase warrant.  The warrant will be exercisable to purchase one common share for each whole warrant at a price of $1.00 and expire on July 26, 2008.



On June 30, 2006, we completed a private placement of 6,680,001 units, at $0.60 per unit, for gross proceeds of $4,008,000.  Each unit is comprised of one common share and one common share purchase warrant.  One half of the warrant will be exercisable to purchase one common share for each whole warrant at a price of $0.75, the other half warrant at $0.90, and expire on June 30, 2008.



On September 26, 2005, we completed a private placement of 5,000,000 common shares for gross proceeds of $2,000,000 and issued 71,250 common share purchase warrants to our placement agent.  Each warrant entitles the holder to acquire one common share at a price of $0.40 per common share for a period of three years from September 26, 2005.  During 2005 the Board approved an incentive plan, based on achievement of certain milestones, for the entire management team and employees consisting of up to $2,000,000 in cash and 2,000,000 nominal value warrants.



As of December 31, 2006, we had commitments under non-cancelable operating leases for our facilities and equipment through 2012 in amounts of $1,098,000.



We are not subject to material market risk exposures, except for risks related to interest rate fluctuations and foreign currency exchange rates.  Our exposure to market rate risk for changes in interest rates relates primarily to our cash equivalents and short term investments, created by our past financings.  We have not used derivative financial instruments in our short term investments.  We invest in high quality money market instruments and bonds with terms of less than 90 days.  We are averse to principal loss and ensure the safety and preservation of our invested funds by limiting default, market and reinvestment risk.  We do not make use of a bank line of credit and do not have any long-term debt.  The impact of inflation has not been material to our business over the past five years.



We believe that our cash and cash equivalents as at December 31, 2006 of $5,146,000 is sufficient to meet our short-term working capital requirements for the next twelve months.  We may need to raise additional amounts to meet our working capital requirements through private or public financings, strategic relationships or other arrangements.  However, additional funding may not be available on terms attractive to us, or at all.  If we enter into strategic relationships to raise additional funds, we may be required to relinquish rights to certain of our technologies.  Our failure to either raise capital when needed or to generate revenues would leave us with insufficient resources to continue our business.



The following table presents unaudited selected financial data for each of the last eight quarters ending December 31, 2006:



|                   | Revenue for the period | Loss from continuing operations | Loss (income) from discontinued operations | Loss for the period | Loss per share from continuing operations | Loss per share
|------------------ | ---------------------- | ------------------------------- | ------------------------------------------ | ------------------- | ----------------------------------------- | --------------
|                   | ($000s)               | ($000s)                        | ($000s)                                   | ($000s)            | ($)                                       | ($)           
|December 31, 2006  | 285                    | 1,050                           | -                                          | 1,050               | 0.03                                      | 0.03          
|September 30, 2006 | 432                    | 932                             | -                                          | 932                 | 0.03                                      | 0.03          
|June 30, 2006      | 477                    | 747                             | -                                          | 747                 | 0.03                                      | 0.03          
|March 31, 2006     | 473                    | 722                             | -                                          | 722                 | 0.03                                      | 0.03          
|December 31, 2005  | 159                    | 1,057                           | (28)                                       | 1,030               | 0.04                                      | 0.04          
|September 30, 2005 | 258                    | 3,371                           | (48)                                       | 3,323               | 0.17                                      | 0.17          
|June 30, 2005      | 330                    | 1,453                           | 5                                          | 1,458               | 0.08                                      | 0.08          
|March 31, 2005     | 354                    | 1,158                           | 142                                        | 1,299               | 0.06                                      | 0.07          

The September 30, 2005 quarterly loss is higher than previous quarters largely due to the inclusion of a goodwill impairment change of $1,895,000 and a customer asset impairment charge of $331,000.



5-C.

Research and Development, Patents and Licenses, et cetera

We plan to continue to invest in research and development for our mobile device security products based on the technology we purchased in 1996, and we anticipate spending approximately $2,307,000 in the year ending December 31, 2007 in connection with these efforts.  We expect to allocate funds almost entirely to salary payments to staff for the continued research and development of our security product suite.  We cannot reasonably estimate when the benefits, if any, of the continued development costs will be realized.  We also cannot reasonably estimate whether any of the continuing development costs will result in revenue for us, or whether additional sources of funding will be available if continued development of the technology is unsuccessful.



5-D.

Trend Information

At this time, we cannot identify any known trends that are reasonably likely to have a material effect on our business due to a number of factors.  We currently have several customers that are using our products for pilot projects.  The sales cycle can take a significant amount of time.  In addition to customer constraints, such as budgetary restrictions, the integration process required to make our products function properly within a customers specific application may be complex.  Mobile data commerce applications are also in their infancy, and the need for security applications is dependent on the adoption of these applications by consumers.



Our revenue model consists of (i) license fees from the licensing of our product suite which are one-time fees typically recorded upon execution of the license agreement, (ii) consulting revenues, as employees and subcontractors provide services to our customers, which are recognized on a time and materials basis, or on a percentage of completion basis, depending on the contract, as employees and subcontractors provide services (iii) recurring royalties from the provision of certificates and permits, and (iv) annual support fees.  As our business evolves, we expect that most of our revenue will be generated through recurring royalties.  This revenue stream is dependent on the adoption of transaction-based applications over wireless networks and therefore cannot be accurately projected at this time.



We are not aware of any other trends, uncertainties, demands, commitments or events which are reasonably likely to have a material effect upon our net sales or revenues, income from continuing operations, profitability, liquidity or capital resources.



5-E.

Off-balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have had, or are reasonably likely to have, a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.



5-F.

Tabular Disclosure of Contractual Obligations

We are committed under operating leases for a total amount of approximately $1,098,000. The minimum payments due in each of the following years are as follows:



|Contractual obligations     | Total      | Less than 1 year | 2-3 years | 4-5 years | More than 5 years
|--------------------------- | ---------- | ---------------- | --------- | --------- | -----------------
|Operating lease obligations | 1,097,764  | 214,570          | 410,734   | 404,966   | 67,494           
|Total                       | $1,097,764 | $214,570         | $410,734  | $404,966  | $67,494          



ITEM 6.   DIRECTORS, SENIOR MANAGEMENT, AND EMPLOYEES

6-A.

Directors and Senior Management

Set forth below is information concerning our executive officers and directors as of February 20, 2007:

|Name               | Position          | Age
|------------------ | ----------------- | ---
|Albert Wahbe       | Chairman          | 61 
|Nagy Moustafa      | CEO and Director  | 44 
|Ravi Chiruvolu     | Director          | 38 
|Mark Steinman      | Director          | 60 
|James Wigdale, Jr. | Director          | 47 
|David Hackett      | CFO and Secretary | 42 



The following sets forth certain information about each of our directors and executive officers:



Albert E. Wahbe, 61, (Chairman) has served as a Director since July 2006. Mr. Wahbe was previously Executive Vice President and Group Head, Global Transaction Banking at Scotiabank, where he led the evolution of e-commerce and e-banking to provide Global Business solutions. Mr. Wahbe was also CEO of e-Scotia, where he developed Scotiabanks Internet banking, e-commerce, wireless, telephone banking and smart card technologies for consumers. Prior to Scotiabank, Mr. Wahbe held several senior management positions in marketing and technology operations at I.B.M. Canada. Mr. Wahbe graduated from Harvard University Graduate School of Business in 1998, completing the Advanced Management Program and International Senior Management Program.



Nagy Moustafa, 44, has served as Diversinets Chief Executive Officer since November 1997 and President from November 1997 to December 2003.  Mr. Moustafa has more than 16 years of professional experience working in technology and engineering.



Ravi Chiruvolu, 38, has served as a director since July 2006.  Mr. Chiruvolu runs Top Shelf Capital, which is a technology fund that focuses on increasing shareholder value for primarily microcap public companies. He holds an MBA from Harvard Business School and a Bachelor of Science in Mechanical Engineering and a MS in Engineering (specialization in robotics and control systems) from MIT.



Mark C. Steinman, 59, (Past Chairman) has served as a Director since June 1998.  Mr. Steinman has over thirty years of corporate finance experience.  He has been the Executive Vice President and Chief Financial Officer of Stelco Inc. (1999-2003), the Chief Financial Officer of Spar Aerospace (1996-1999) and Chief Financial Officer of Rogers Cablesystems (1991-1995).  He is also on the Brock University Board of Trustees, the Audit Committee of the Niagara YMCA and presently serves as the Audit Committee Chair of Diversinet.  Mr. Steinman is presently a business consultant.



James (Jay) B. Wigdale Jr., 47, has served as a Director since January 2005. Mr. Wigdale founded Lakefront Partners, LLC, a money-management firm, in 1998 and is the firms Chief Investment Officer.  Prior to founding Lakefront, he was senior VP of Institutional Sales and Regional Manager for Robert W. Baird & Co.  Mr. Wigdale was also the VP of Corporate Banking from 1984 to 1990 at Barnett Bank, Inc. (now Bank of America).  He holds a Bachelor of Science (Marketing) degree from Miami University of Ohio.



David Hackett, 42, has served as Chief Financial Officer and Corporate Secretary since March 2002.  Previously, Mr. Hackett was CFO of a technology and service provider to electronic marketplaces, where he oversaw start-up operations, public financing and acquisitions.  Mr. Hackett has also held senior financial management positions at EveryWare Development, Alliance Atlantis Communications and Entertainment Information Services Ltd.  Mr. Hackett is a CA and holds an MBA from the University of Western Ontario.



6-B.

Compensation

The following table and notes show the executive compensation paid or accrued by us during the year ended December 31, 2006 to our officers earning in excess of$100,000 per year:

|                                                                 | Annual Compensation | Long Term
Compensation
|---------------------------------------------------------------- | ------------------- | ----------------------
|Name and Principal Position                                      | Salary
(Cdn$)       | Bonus(4)
(Cdn$)       
|Nagy Moustafa
Chief Executive Officer                            | 220,000(1)          | 112,738               
|David Hackett
Chief Financial Officer                            | 180,000(2)          | -                     
|David Annan
Chief Technology Officer                             | 188,333(3)          | 25,353                
|Stuart Vaeth
Chief Security Officer                              | 163,151(4)          | 66,038                
|John Couse
Senior Vice President, Sales and Business Development | 150,000(5)          | 5,766                 



(1)

Mr. Moustafa is currently being compensated at the rate of Cdn $220,000 per annum.  See Employment Agreements.

(2)

Mr. Hackett is currently being compensated at the rate of Cdn $180,000 per annum.  See Employment Agreements.

(3)

Mr. Annan is currently being compensated at the rate of Cdn $200,000 per annum.  See Employment Agreements.

(4)

Mr. Vaeth is currently being compensated at the rate of U.S.$140,000 per annum. See Employment Agreement

(5)

Mr. Couse is currently being compensated at the rate of Cdn $150,000 per annum. See Employment Agreements.

(6)

Bonus allocations, if any, are determined annually at the discretion of the board of directors on the recommendation of the Compensation Committee, bonuses are paid and recorded as compensation in the fiscal year following the year in which they are earned as the determination is made by the Board in the following year.

There were no long-term incentive awards other than stock options made to the executive officers listed above during the fiscal year ended December 31, 2006.  There are no pension plan benefits in place for our executive officers and none of our senior officers or directors is indebted to us.

Employment Agreements

We entered into an employment agreement with Nagy Moustafa, effective September 15, 2004, replacing an employment contract effective September 29, 1997 as amended on October 1, 2002.  The contract provides an annual base salary of Cdn$220,000 and an annual performance bonus of up to Cdn$250,000.  The contract provides for payment of 24 months salary and bonus upon termination of employment, and payment of 36 months salary and bonus upon termination as a result of a change-in-control or a change in responsibilities following a change-in-control.  The agreement also contains certain non-competition and non-disclosure provisions.



We entered into an employment agreement and consulting agreement with David Hackett, effective January 1, 2005, replacing an employment agreement effective March 26, 2002, as amended, which provides for an annual base salary of Cdn$180,000 and a performance bonus of Cdn$100,000, payable upon the achievement of corporate objectives.  The contract provides for payment of six months salary and bonus upon termination of employment, and payment of 18 months salary and bonus upon termination as a result of a change-in-control or a change in responsibilities following a change-in-control.  The employment agreement also contains certain change of control bonuses, non-disclosure provisions and is renewable annually, subject to certain termination provisions.



We entered into an employment agreement with David Annan, effective January 3, 2005, amended on April 17, 2006 which provides for an annual base salary of Cdn$200,000 and a performance bonus of Cdn$80,000, payable upon the achievement of corporate objectives.  The contract provides for payment of three months salary and bonus upon termination of employment.  The employment agreement also contains certain change of control bonuses, non-disclosure provisions and is renewable annually, subject to certain termination provisions.



We entered into an employment agreement with Stuart Vaeth, effective April 5, 2004, amended on January 1, 2006 which provides for an annual base salary of Usd$140,000 and a performance bonus of Usd$70,000, payable upon the achievement of corporate objectives.  The contract provides for payment of three months salary and bonus upon termination of employment.  The employment agreement also contains certain change of control bonuses, non-disclosure provisions and is renewable annually, subject to certain termination provisions.



We entered into an employment agreement with John Couse, effective January 3, 2005, amended on September 8, 2005 which provides for an annual base salary of Cdn$150,000 and a performance bonus consistent with standard terms and conditions in the Diversinet Sales Commission Program and payable upon the achievement of corporate objectives.  The contract provides for payment of two weeks salary upon termination of employment.  The employment agreement also contains certain change of control bonuses, non-disclosure provisions and is renewable annually, subject to certain termination provisions.



Compensation of Directors

On July 31, 2006, the Company issued 300,000 common shares to non-management board members in lieu of cash compensation.  Our directors received no compensation during fiscal 2006 for attending meetings of the board of directors or a committee of the board of directors.



Options to Purchase Our Securities

Our Amended and Restated Stock Option Plan was established on October 15, 1993 and was amended on February 4, 1997, April 16, 1999, May 15, 2000, January 22, 2003, August 15, 2003, February 22, 2005 and February 22, 2006.  Under our share option plan, options for up to a specified maximum limit of 4,148,538 common shares may be granted from time to time by the board of directors to our directors, officers, employees and consultants of us and any of our subsidiaries.  Options granted under our share option plan generally have an exercise price equal to the greater of (i) the closing price of the common shares on the day immediately proceeding the day of the grant, and (ii) the weighted average price over the preceding five trading days of the grant and generally will be exercisable quarterly over a two-year period and will expire after five years.

The share option plan provides that:

(i)

The maximum number of common shares which may be reserved for issuance to any participant pursuant to share options may not exceed 5% of the common shares outstanding at the time of grant (on a non-diluted basis) less the aggregate number of common shares reserved for issuance to such person under any other option to purchase common shares from treasury granted as a compensation or incentive mechanism;

(ii)

The maximum number of common shares that may be issued to any one insider and his associates within a one-year period may not exceed 5% of the outstanding issue;

(iii)

The maximum number of common shares that may be reserved for issuance to Diversinet insiders is limited to 10% of the common shares of the outstanding issue at the time of the grant (on a non-diluted basis) less the aggregate number of common shares reserved for issuance to insiders under any other share compensation arrangement; and

(iv)

The maximum number of common shares that may be issued to our insiders within a one-year period may not exceed 10% of the outstanding issue.

As at February 20, 2007, there were a total of 2,124,349 options to purchase common shares outstanding under our share option plan at exercise prices ranging from $0.37 to $6.10 with expiration dates ranging from March 25, 2007 to January 16, 2012.  The directors and officers as a group hold options to purchase 921,000 of our common shares.  The following table provides details on the share options granted to our directors, officers, employees and consultants under the terms of our share option plan as at February 20, 2007.

|Share Options Outstanding
|-------------------------
|Optionee                 
|Directors and Officers   
|Employees and Consultants



6-C.

Board Practices

Our Board presently consists of five directors who are elected annually.  Each director elected will hold office until the close of business of our first annual meeting of shareholders following his election unless his office is earlier vacated in accordance with our by-laws.  In July 2006 Albert Wahbe was appointed as Director and Chairman of the Board and Ravi Chiruvolu was appointed Director.  During 2006, Brian Barry and Keith Powell resigned as directors.  During 2005 we had three director resignations, Stanley Beck, Charles Shiu and Charles Walton.  James B. Wigdale was appointed on January 3, 2005 to replace one of the directors.  Brian Barry was appointed on March 11, 2005 to replace one of the directors.  The Board has established three standing committees: the Audit Committee, the Compensation Committee and the Governance Committee.  Committee members are appointed annually following our annual meeting of shareholders.

Audit Committee

The Audit Committee is comprised of four non-management directors.  The Audit Committee has adopted a formal charter that details its mandate.



The Audit Committee has also established procedures for the receipt, retention and treatment of complaints regarding accounting, internal accounting controls or auditing matters and the confidential, anonymous submission by employees of complaints or concerns regarding questionable accounting or auditing matters.  Any employee of ours or our affiliates may submit a good faith complaint regarding accounting or auditing matters to our management without fear of dismissal or retaliation of any kind.



The Audit Committee assists the Board in its oversight functions as they relate to the accounting, financial reporting, auditing, risk management and internal controls.  The Audit Committee has the following duties and responsibilities: (a) reviewing our audited financial statements and our unaudited interim financial statements and recommending whether such statements should be approved by the Board; (b) reviewing managements discussion and analysis of financial condition and results of operations and related press releases and recommending whether such documents should be approved by the Board; (c) recommending to the Board the firm of independent auditors to be nominated for appointment by shareholders at each annual general meeting and, where necessary, the removal of the independent auditors; (d) reviewing the scope and adequacy of audits to be conducted by the independent auditors; (e) adopting and annually reassessing formal terms of reference for the independent auditors; (f) monitoring and evaluating the independence and performance of the independent auditors; (g) pre-approving all non-audit services to be provided to us by our independent auditors prior to the commencement of such services; (h) reviewing all post-audit management letters containing the recommendations of the independent auditors and response or follow-up thereto from management; (i) reviewing and monitoring the integrity, adequacy and timeliness of the financial reporting and disclosure practices; (j) monitoring our compliance with legal and regulatory requirements related to financial reporting and disclosure; (k) monitoring and evaluating the adequacy of the internal accounting and audit procedures; (l) reviewing and ensuring the acceptability of our accounting principles; (m) identifying the principal financial risks; (n) overseeing reporting on internal controls of management and ensuring that management has designed and implemented an effective system of internal controls; (o) reviewing, and if deemed advisable, approving all related party transactions as defined in the governing legislation; (p) annually reviewing and reassessing the adequacy of the duties and responsibilities of the Audit Committee; and (q) any other matters that the Audit Committee feels are important to its mandate or that the Board chooses to delegate to it.



It is the responsibility of the Audit Committee to maintain an open avenue of communication between itself, our independent outside auditor and our management.  In performing its role, the Audit Committee is empowered to investigate any matter brought to its intention, with full access to all our books, records, accounts, facilities and personnel.  The Audit Committee is also empowered to instruct and retain outside counsel or other experts as necessary.



The members of the Audit Committee are Mark Steinman (Chair), Albert Wahbe, Ravi Chiruvolu and James Wigdale, all of whom are non-management directors.  To carry out its responsibilities, the Audit Committee held four meetings during the year ended December 31, 2006, four meetings during the year ended December 31, 2005 and four meetings during the year ended December 31, 2004.



Compensation Committee

Overview and Philosophy

The Compensation Committee is comprised of two directors.  It is the responsibility of the Compensation Committee to determine the level of compensation and to develop recommendations for stock option grants for approval by the Board of Directors in respect of our senior executives with a view to providing such executives with a competitive compensation package having regard to performance.  Performance is defined to include achievement of our strategic objective of growth, development of the business, enhancement of shareholder value and attainment of annual goals as set by the Board of Directors.  The members of the Compensation Committee are Albert Wahbe (Chair) and Ravi Chiruvolu.



Published industry salary data is reviewed and relied upon in the Compensation Committees assessment of appropriate compensation levels, specifically the analysis of proxies of certain public software companies and appropriate and relevant compensation surveys.



The Compensation Committee recognizes that the industry sector in which we operate is both highly competitive and undergoing significant globalization with the result that there is substantial demand for qualified, experienced executive personnel.  The Compensation Committee considers it crucial that we are assured of retaining and rewarding its top caliber executives who are essential to the attainment of our ambitious long-term, strategic goals.



For these reasons, the Compensation Committee believes our executive compensation arrangements must remain competitive with those offered by other companies of similar size, scope, performance levels and complexity of operations, including some, but not all, of the companies comprising the Nasdaq Stock Market, the Over the Counter Bulletin Board and the Toronto Venture Exchange.



Annual Cash Compensation (Base Salary Plus Performance Incentives)

The Compensation Committee believes that annual cash compensation should be paid commensurate with attained performance.  The executive cash compensation consists of base compensation and performance incentives.  Base salaries for executive officers are established by considering a number of factors, including our operating results; the executives individual performance and measurable contribution to our success; and pay levels of similar positions with comparable companies in the industry.  The Compensation Committee believes that our executive compensation must remain competitive for us to retain talented executives.  Base salaries are typically reviewed annually.



The purpose of annual performance incentive compensation is to provide cash compensation that is at-risk on an annual basis and is contingent on the achievement of annual business and operating objectives.  Annual incentives measure business performance and individual performance, and are designed to provide a pay-out scale with high upside opportunity for high performance and zero pay out for low performance. The Compensation Committee sets targets for executive bonuses each year and the pay out of those bonuses, if any, is determined based on our operating results, the executives measurable contribution to our success, and bonus levels of similar positions with comparable companies in the industry.



For the year ending December 31, 2006, the Compensation Committee recommended and approved a total of $116,000 for the executive team out of a potential total bonus pool of $430,000 or 27% of the potential total bonus pool.  The low percentage pay out of executive bonuses reflects the view of both management and the Compensation Committee that executive bonuses should be based on the factors described above.  There are currently no guaranteed executive bonuses for 2007 or beyond.



Stock Options

The Committee recommends executive stock options under the Diversinet Corp. Amended and Restated Stock Option Plan to foster executive officer ownership of our common stock, to stimulate a long-term orientation in decisions and to provide direct linkage with stockholder interests.  The Compensation Committee considers the total compensation package, industry practices and trends, the executives accountability level, and assumed potential stock value in the future when granting stock options.  The Compensation Committee recommends option amounts to provide retention considering projected earnings to be derived from option gains based upon relatively conservative assumptions relating to planned growth and earnings.  Therefore, the stock option program is intended to serve as an effective and competitive long-term incentive and retention tool for our executives, as well as other key employees.  The exercise prices of stock options granted to executive officers are equal to the fair market value of our common stock on the date of grant.  Therefore, stock options provide an incentive to maximize our profitable growth that ordinarily, over time, should be reflected in the price of our common stock.



Benefits

We provide benefits to the named executive officers that are generally available to all our employees.



Chief Executive Officer Compensation

The Chief Executive Officers compensation is paid in accordance with the terms of his employment contract which provides for payment of an annual base salary of Cdn$220,000 and an annual performance bonus of up to Cdn$250,000.  In addition, Mr. Moustafa participates in the Amended and Restated Stock Option Plan.



The Compensation Committee did not directly base Mr. Moustafas bonus and option grants on rates for comparable employers, although the Compensation Committee did consider the compensation of CEOs of other issuers in the same industry in determining Mr. Moustafas overall compensation.  In addition, Mr. Moustafa is entitled to participate in our bonus plan and stock option awards as part of his compensation.  In the financial year ended December 31, 2006, Mr. Moustafa was granted 100,000 options to purchase Common Shares.  The historical stock option awards to Mr. Moustafa are consistent with our compensation philosophy, which is to tie a portion of the Chief Executive Officers compensation to corporate performance and the achievement of growth in shareholder value.



Governance Committee

The Governance Committee is comprised of two non-management directors.  The Governance Committee assists the Board of Directors in fulfilling its oversight responsibilities related to seeking candidates for membership on the Board of Directors, assessing the corporate governance policies and processes of the Board of Directors and reviewing from time to time the policies of the Board of Directors related to director qualifications, compensation, tenure and retirement.  The members of the Governance Committee are James Wigdale (chair) and Mark Steinman.



6-D.

Employees

As of the February 20, 2007, we have three senior officers, 26 employees and 4 contractors.  All of our senior officers are located in Toronto.  Of our 29 employees, 21 are in research and development (of which eight hold advanced degrees in science or business), 3 are in sales and marketing and 5 are in finance and administration.



We currently have one employee in the United States and 28 in Canada.  Our employees are not unionized.  We believe that our relations with our employees are good.  We enter into employment contracts with most of our officers, managers and employees, which contain a non-compete clause both for the period of their employment with us and for one year thereafter.



6-E.

Share Ownership

Information as to the share ownership of our directors and executive officers is found under Item 6 - Directors, Senior Management and Employees under Compensation - Diversinet Corp. Amended and Restated Stock Option Plan and under Item 7 - Major Shareholders.



ITEM 7

MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

7-A.

Major Shareholders

Diversinet is a publicly owned Canadian corporation.  Another corporation or any government does not control us directly or indirectly.

As of February 20, 2007, we had 33,859,255 common shares outstanding.

The following table shows the ownership of our common shares as of February 20, 2007 of:

•

each person known to us to be the beneficial owner of more than 5% of our outstanding common shares;

•

each of our directors and officers; and

•

all of our directors and officers as a group.

The second column indicates the number of common shares actually owned, and the third column indicates the number of common shares that each person has the right to acquire within sixty days from the date hereof upon the exercise of outstanding options, warrants or convertible securities.  The fourth column reflects a description of the shares underlying those options, warrants and convertible securities and the vesting and exercise prices thereof.  The fifth column reflects the sum of the second and third columns, expressed as a percentage of the issued and outstanding common shares of Diversinet.

Unless otherwise indicated, the business address for each of these individuals is c/o Diversinet Corp., 2235 Sheppard Avenue East, Suite 1700, Toronto, Ontario Canada  M2J 5B5.

|Name                                                  | Number of Shares Owned | Number of Options or Warrants Owned | Options Represent                                                                                                                                                                                                                                                         | Percentage of Outstanding Shares
|----------------------------------------------------- | ---------------------- | ----------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------
|Nagy Moustafa                                         | 587,724                | 502,250
options                     | The vested and immediately exercisable portion of options to purchase 521,000 common shares at purchase prices ranging from $0.37 to Cdn $3.38 per share.  The balance of these options vest at the rate of 12.5% per quarter beginning January 13, 2006.                 | 3.2%                            
|David Hackett                                         | 190,092                | 298,125
options                     | The vested and immediately exercisable portion of options to purchase an aggregate of 300,000 common shares at purchase prices ranging between $0.40 and $5.50 per share.  The balance of these options vest at the rate of 12.5% per quarter beginning January 13, 2006. | 1.4%                            
|Albert Wahbe                                          | 4,700,000              | 4,600,000
warrants                  | The vested and immediately exercisable portion of warrants to purchase an aggregate of 2,300,000 common shares at a purchase price of $0.75 and 2,300,000 common shares at a purchase price of $0.90.                                                                     | 24.2%                           
|Mark Steinman                                         | 192,500                | 92,500                              | The vested and immediately exercisable portion of an option to purchase 100,000 common shares at a purchase prices ranging between of $0.40 and Cdn $3.38 per share. The balance of these options vest at the rate of 8.3% per quarter, beginning November 18, 2004.      | 1.0%                            
|Lakefront Partners, LLC and James B. Wigdale, Jr. (1) | 4,639,462              | 966,667
warrants                    | The vested and immediately exercisable portion of warrants to purchase an aggregate of 300,000 common shares at $0.40, 333,334 at $0.75 and 333,333 at $0.90.                                                                                                             | 16.1%                           
|All Officers and Directors as a group (5 persons)     | 10,309,778             | 6,459,542                           |                                                                                                                                                                                                                                                                           | 41.6%                           
|*  Less than 1%                                       |                        |                                     |                                                                                                                                                                                                                                                                           |                                 

(1)

Mr. Wigdale is the control person of Lakefront Capital Management, LLC, the manager of Lakefront Partners, LLC.  Both Lakefront Partners, LLC and Mr. Wigdale have offices located at 205 E. Wisconsin Avenue, Suite 210, Milwaukee, WI 53202.  Lakefront Partners, LLC and Mr. Wigdale may be deemed to be acting jointly or in concert in respect to their security holdings of Diversinet.



7-B.

Related Party Transactions

As part of the June 2006 private placement, Albert Wahbe acquired 4,600,000 units.  Albert Wahbe, one of our directors as of July 2006, owns 4,700,000 common shares and 4,600,000 common share purchase warrants representing approximately 24.2% of the issued and outstanding common shares of the Company, assuming the exercise of such warrants.  Mr. Wahbe also entered into a performance based consulting agreement to provide sales and business development services for the Company.

As part of the June 2006 private placement, Lakefront Partners, LLC acquired 666,667 units.  As well, during the September 2005 private placement, Lakefront Partners, LLC acquired 725,000 common shares.  In 2004 we completed two financings in which Lakefront Partners, LLC and James B. Wigdale, Jr. participated.  James Wigdale, Jr., one of our directors, controls Lakefront Partners, LLC.  Mr. Wigdale received consideration relating to services performed during the 2004 year of 1,100,000 share purchase warrants (750,000 exercisable at $2.05 and 350,000 exercisable at $0.60 per common share) valued at $1,593,710 as well as 300,000 common shares and 300,000 share purchase warrants (exercisable at $0.40 per common share) valued at $97,140 relating to private placements.  Currently, Lakefront beneficially owns 3,909,462 common shares and 666,667 common share purchase warrants and Mr. Wigdale owns 730,000 common shares and 300,000 common share purchase warrants, together representing approximately 16.1% of the issued and outstanding common shares of the Company, assuming the exercise of such warrants.

A former member of our Board of Directors, Brian Barry, received consideration (while a Director) relating to services performed during the 2006 year of 100,000 share purchase warrants (exercisable at $0.63 per common share) valued at $4,717 relating to consulting services performed for the company.

In February 2004, we amended the DSS Software Technologies share purchase agreement.  The promissory note in the amount of $600,000 payable in installments of $300,000 on January 2, 2004 and $300,000 on January 2, 2005 has been replaced by the issuance of 200,000 Diversinet common shares and cash payments of $50,000 in February 2004, $50,000 on April 2004 and $100,000 on January 2005.  The existing 120,000 warrants exercisable at $3.75 have been replaced by issuance of 120,000 warrants exercisable at $2.05, exercisable after January 1, 2005 expiring on December 31, 2006.  During August 2004, we settled a dispute with a former shareholder of DSS and received 50,000 Diversinet common shares (with a fair value of $21,000) and the elimination of the promissory note payable of $150,000 ($50,000 on April 2004 and $100,000 on January 2005) which was recorded as a reduction of expenses from discontinued operations.  Additional future cash considerations of $800,000 based on achievement of certain financial targets were also eliminated.

7-C.

Interests of Experts and Counsel

Not Applicable.

ITEM 8

FINANCIAL INFORMATION

8-A.

Consolidated Statements and Other Financial Information

The financial statements are included in this Registration Statement, Form 20-F under Item 17.

Legal proceedings

There is currently one material claim pending against us, the Instant Publisher (Israel) litigation.  If we lose this suit or enter into settlement requiring us to pay cash or to issue any of our common shares, our liquidity and financial position will be adversely affected and our shareholders ownership may be diluted.

Instant Publisher (Israel) Litigation Matter

In May 2000, the Company and its wholly owned Barbados subsidiary, The Instant Publisher Ltd., were sued by a company that alleged that the Company breached a dealer agreement entered into in 1995 by the Companys former printing business and is seeking damages of $1,533,950 and damages of $25,000,000 for loss of reputation and loss of opportunity, pre-judgment and post-judgment interest, and costs. Management believes that a loss arising from this matter is probable and that the amount can reasonably be estimated.  The Company has recorded an amount for the liability based on its current estimate of the settlement amount.  As additional information becomes available, any potential liability related to this matter is assessed and the estimates will be revised accordingly.  Based on the currently available information, management believes that the ultimate outcome of this matter will not have a material adverse effect on our financial position or overall trends in results of operations.

In addition to the above, in the ordinary course of business, we and our subsidiaries have legal proceedings brought against us.

8-B.  Significant Changes

During February 2005, one of our subsidiaries (DSS) entered into an Asset Purchase Agreement to sell the majority of its assets and liabilities to a third party.  The effect of this will be that we will discontinue providing services to DSS customers.  During 2005, the revenues associated with DSS were $453,000.



During February 2006, Kashif Hassan resigned as President.  Mr. Hassans role has been filled by the current senior management team.  Mr. Hassans departure did not result from any disagreement with the Company.  When Mr. Hassan joined the team in early 2005 as President, his focus was to restructure the organization around our mobile mass market authentication solutions.  With the achievement of these turnaround milestones accomplished, Kash has completed his objectives.



During February 2006, RSA Security Inc. entered into a license agreement under which Diversinet will provide mobile device and PC-based software tokens and integrated provisioning services.  The agreement includes licensing, development and revenue-sharing components that will result when launched by RSA Security in revenues of a minimum of $2.2 million to Diversinet over three years.  Under this commercial agreement, the Diversinet MobiSecure soft token suite and Diversinets MobiSecure Authentication Service Center (MASC) will be integrated into RSA Securitys products and services, enabling the downloading, provisioning, and management of RSA Securitys mobile and PC-based soft tokens.



In December 2006 we entered into a consulting and licensing agreement with Blue Cross of Northeast Pennsylvania (BCNEPA).  The agreement will generate revenue of $1,000,000 for consulting work and the delivery of the solution to the customers first 100,000 users.  BCNEPA will utilize our MobiSecure products, based on our MobiSecure soft token technology, to enable secure access and management of personal medical records by individuals and health care providers through mobile phones, handheld wireless devises and personal computers.



Except as noted above, no significant change has occurred since the date of the audited financial statements included in this Annual Report on Form 20-F.



ITEM 9

THE OFFER AND LISTING

9-A.  Offer and Listing Details

The following table lists the high, low and closing prices on the OTC Bulletin Board (from April 30, 2003) and NASDAQ (prior to April 30, 2003) of our common shares for the last five fiscal years ended December 31:

|OTC Bulletin Board and NASDAQ Trading Activity
|----------------------------------------------
|Year ended December 31,                       
|2006                                          
|2005                                          
|2004                                          
|2003                                          
|2002                                          

The following table lists the high, low and closing prices on the OTC Bulletin Board of our common shares for the last eight fiscal quarters:

|OTC Bulletin Board Trading Activity
|-----------------------------------
|Quarter Ended                      
|December 31, 2006                  
|September 30, 2006                 
|June 30, 2006                      
|March 31, 2006                     
|December 31, 2005                  
|September 30, 2005                 
|June 30, 2005                      
|March 31, 2005                     

The following table lists the high, low and closing prices on the OTC Bulletin Board of our common shares for the last six months:

|OTC Bulletin Board Trading Activity
|-----------------------------------
|Month Ended                        
|January 2007                       
|December 2006                      
|November 2006                      
|October 2006                       
|September 2006                     
|August 2006                        

Our common shares are issued in registered form and the following information is taken from the records of Computershare Investor Services Inc. located in Toronto, Ontario, Canada, the registrar and transfer agent for our common shares.

On February 13, 2007, the shareholders list for our common shares showed 171 registered shareholders and 33,844,255 shares outstanding.  Of the 171 registered shareholders, 132 list U.S. addresses, showing ownership of an aggregate of 19,759,204 shares, representing 58% of our outstanding common shares.

We have not declared any dividends for the last eight years and do not anticipate that we will do so in the foreseeable future.  Our present policy is to retain future earnings, if any, for use in our operations and the expansion of our business.

9-B.   Plan of Distribution

Not Applicable.

9-C.   Markets

Our common shares began trading on the NASDAQ SmallCap MarketSM on June 20, 1995.  Prior to December 3, 2002, our common shares traded on the NASDAQ SmallCap MarketSM under the symbol DVNT.  Effective December 3, 2002 our common shares trade under the symbol DVNTC with the exception of a 20 period from January 28, 2003 to February 25, 2003 when our common shares traded under the symbol DVNTD.  From February 25, 2003 until April 30, 2003 ours common shares traded under the symbol DVNTC.  On April 30, 2003 NASDAQ delisted our common shares.  From April 30, 2003 to present our common shares have been trading on the OTC Bulletin Board under the symbol DVNTF.

Prior to August 2000 our shares were also traded on the now defunct Canadian Dealers Network.

9-D.   Selling Shareholders

Not Applicable.

9-E.   Dilution

Not Applicable.

9-F.   Expenses of the Issue

Not Applicable.

ITEM 10.  ADDITIONAL INFORMATION

10-A.

Share Capital

General

Our authorized share capital consists of an unlimited number of common shares, no par value.  As of December 31, 2006, we had 33,413,005 common shares issued and outstanding.  We have no authorized preferred shares.

Common Shares

Each common share is entitled to one vote on all matters submitted to a vote by shareholders, including the election of directors.  There are no cumulative voting rights in the election of directors.  All common shares are equal to each other with respect to liquidation and dividend rights and are entitled to receive dividends if and when our board declares them out of funds legally available for distribution.  Upon our liquidation, all assets available for distribution are distributable among shareholders according to their respective holdings.  There are no preemptive rights to purchase any additional, unissued common shares.

Warrants

We have outstanding warrants as at December 31, 2006 exercisable for up to an aggregate of 10,044,047 of our common shares at exercise prices ranging from $0.40 per share to $2.50 per share.

10-B.

Memorandum and Articles of Association

1.

Our Certificate of Incorporation No. is 1054873 (Ontario).  Our objectives are not indicated on the registration form.  However, our objective is to enable mobile e-commerce (m-commerce) services with our wireless security infrastructure solutions.

2.

(a)

A Director shall disclose in writing to us or request to have entered into the minutes of the meeting the nature and extent of his interest regarding any material contracts.

(a)

Not Applicable.

(b)

Not Applicable.

(c)

Not Applicable.  Directors are appointed at the annual shareholders meeting or appointed by special resolution.

(d)

Not Applicable.

(e)

Not Applicable.

(f)

Not Applicable.

(g)

Not Applicable.

1.

Each of our common shares is entitled to one vote on all matters submitted to a vote by shareholders, including the election of directors.  There are no cumulative voting rights in the election of directors.  All common shares are equal to each other with respect to liquidation and dividend rights and are entitled to receive dividends if and when our board declares them out of funds legally available for distribution.  Upon our liquidation, all assets available for distribution are distributable among shareholders according to their respective holdings.  There are no preemptive rights to purchase any additional, unissued common shares.



10-C.

Material Contracts

During February 2005, one of our subsidiaries (DSS) entered into an Asset Purchase Agreement to sell the majority of its assets and liabilities to a third party.  The effect of this will be that we will discontinue providing services to DSS customers.  During 2005, the revenues associated with DSS were $453,000.

In February 2006, RSA Security Inc. entered into a license agreement under which Diversinet will provide mobile device and PC-based software tokens and integrated provisioning services.   The agreement includes licensing, development and revenue-sharing components that will result in revenues of a minimum of $2.2 million to Diversinet over three years.  Under this commercial agreement, the Diversinet MobiSecure soft token suite and Diversinets MobiSecure Authentication Service Center (MASC) will be integrated into RSA Securitys products and services, enabling the downloading, provisioning, and management of RSA Securitys mobile and PC-based soft tokens.

In December 2006 we entered into a consulting and licensing agreement with Blue Cross of Northeast Pennsylvania (BCNEPA).  The agreement will generate revenue of $1,000,000 for consulting work and the delivery of the solution to the customers first 100,000 users.  BCNEPA will utilize our MobiSecure products, based on our MobiSecure soft token technology, to enable secure access and management of personal medical records by individuals and health care providers through mobile phones, handheld wireless devises and personal computers.

Other than listed above, we have not entered into any other material contracts, other than contracts entered into in the ordinary course of business and those listed herein to which we are a party, for the two years immediately preceding publication of this Form 20-F.

10-D.

Exchange Controls

The federal Investment Canada Act (the ICA), which became effective on June 30, 1985, regulates the acquisition by non-Canadians of control of a Canadian Business (as defined in the Investment Canada Act).  Such an acquisition is either notifiable or reviewable depending on its structure and the value of the assets of the Canadian business being acquired.  In effect, the ICA requires review by Investment Canada, the agency which administers the ICA, and approval by the Canadian government in the case of an acquisition of control of a Canadian business by a non-Canadian that is a WTO Investor (as defined in the ICA) where: (i) in the case of a direct acquisition of control of a Canadian entity (i.e., through a share purchase), the assets of the entity carrying on the Canadian Business and of all other entities in Canada, the control of which is acquired exceeds$184 million (this threshold is adjusted annually for inflation and growth in Canadas domestic product); or (ii) in the case of a direct acquisition of assets of a Canadian Business (i.e., through an asset acquisition) the value of the assets used in carrying on the Canadian business exceeds$184 million.  Indirect acquisitions (for example, the acquisition of the foreign parent of the Canadian business) of assets or indirect acquisitions of control by a WTO investor are not reviewable, but are still notifiable.  Where an investor is not a WTO Investor, review is required where: (i) in the case of a direct acquisition of control of a Canadian Business, the value of the assets of the business and all other entities being acquired is$5 million or more; or (ii) in the case of an indirect acquisition of control of a Canadian Business, where the Canadian Business has assets of$50 million or more in value; or (iii) in the case of an acquisition of assets of a Canadian Business, the assets represents more than 50% of the assets of the original group and the value of the acquired assets exceeds$5 million.  These lower thresholds also apply, even where the investor is a WTO investor, where the Canadian Business is engaged in certain activities relating to Canadas cultural heritage or national identity such as book publishing, film production and distribution, television and radio, production and distribution of music, uranium production, certain financial services or transportation services.

In the context of Diversinet, in essence, three methods of acquiring control of a Canadian business are regulated by the ICA: (i) the acquisition of all or substantially all of the assets used in carrying on the Canadian business; (ii) the acquisition, directly or indirectly, of voting shares of a Canadian corporation carrying on the Canadian business; (iii) the acquisition of voting shares of an entity which controls, directly or indirectly, another entity carrying on a Canadian business. An acquisition of a majority of the voting interests of an entity, including a corporation, is deemed to be an acquisition of control in accordance with the ICA.  An acquisition of less than one-third of the voting shares of a corporation is deemed not to be an acquisition of control.  An acquisition of less than a majority, but one-third or more, of the voting shares of a corporation is presumed to be an acquisition of control unless it can be established that on the acquisition the corporation is not, in fact, controlled by the acquirer through the ownership of voting shares.  For partnerships, trusts joint ventures or other unincorporated entities, an acquisition of less than a majority of the voting interests is deemed not to be an acquisition of control.

If an acquisition of control of a Canadian business by a non-Canadian is not reviewable, the ICA requires a formal notification to the Canadian government.  These provisions require a foreign investor to give notice in the required form, which notices are for information, as opposed to review, purposes.

10-E.  Taxation

Certain Canadian Federal Income Tax Consequences

The following summary of the material Canadian federal income tax considerations generally applicable in respect of the holding and disposition of common shares reflects our opinion as of the date hereof.  The tax consequences to any particular holder of common shares will vary according to the status of that holder as an individual, trust, corporation or member of a partnership, the jurisdiction in which that holder is subject to taxation, the place where that holder is resident and, generally, according to that holders particular circumstances.

This summary is applicable only to holders who are resident solely in the United States, have never been resident in Canada, deal at arms length with us, hold their common shares as capital property and who will not use or hold the common shares in carrying on business in Canada.

This summary is based upon the provisions of the Income Tax Act (Canada) and the regulations thereunder (collectively, the Tax Act or ITA) and the Canada-United States Tax Convention (the Tax Convention) as at the date hereof and the current administrative practices of the Canada Customs and Revenue Agency.  This summary does not take into account provincial income tax consequences.

This summary is not exhaustive of all possible income tax consequences.  It is not intended as legal or tax advice to any particular holder of common shares and should not be so construed.  Each holder should consult his own tax advisor with respect to the income tax consequences applicable to him in his own particular circumstances.

Dividends

In the case of any dividends paid to non-resident shareholders, we withhold the Canadian tax, which remits only the net amount to the shareholder.  The rate of withholding tax is generally 25% but by virtue of Article X of the Tax Convention, the rate of tax on dividends paid to persons who are residents only of the United States for purposes of the Tax Convention is generally limited to 15% of the gross amount of the dividend (or 5% in the case of certain corporate shareholders owning at least 10% of our voting shares).

Dispositions

A non-resident of Canada is not subject to tax under the ITA in respect of a capital gain realized upon the disposition of a common share unless the share is taxable Canadian property to the holder thereof and the non-resident is not entitled to relief under a tax treaty.  In the case of a non-resident holder to whom our common shares are taxable Canadian property and who is resident only in the United States for purposes of the Tax Convention, no tax under the ITA will be payable on a capital gain realized on such shares by reason of the Tax Convention unless the value of such shares is derived principally from real property situated in Canada.  We believe that the value of our common shares is not derived from real property situated in Canada.

Our common shares will be taxable Canadian property to a non-resident holder if, at any time during the period of sixty months immediately preceding the disposition, the non-resident holder, persons with whom the non-resident holder did not deal at arms length, or the non-resident holder together with persons with whom the holder did not deal at arms length owned 25% or more of our issued shares of any class or series.  Holders to whom our common shares are taxable Canadian property and who are not entitled to relief under the Tax Convention should consult their own tax advisors in advance of any disposition of common shares.

United States Federal Income Tax Consequences

The following is a discussion of material United States Federal income tax consequences generally applicable to a U.S. Holder (as defined below) of our common shares.  This discussion does not address all potentially relevant Federal income tax matters, and it does not address consequences peculiar to persons subject to special provisions of Federal income tax law, such as, for example, tax-exempt organizations, qualified retirement plans, persons subject to alternative minimum tax, financial institutions, insurance companies, real estate investment trusts, regulated investment companies, broker-dealers, non-resident alien individuals or foreign corporations whose ownership of our common shares is not effectively connected with the conduct of a trade or business in the United States and shareholders who acquired their shares through the exercise of employee share options or otherwise as compensation.  In addition, this discussion only applies to common shares held by U.S. Holders as capital assets within the meaning of Section 1221 of the Internal Revenue Code of 1986, as amended, and does not cover any state, local or foreign tax consequences.

The following discussion is based upon the sections of the Internal Revenue Code, Treasury Regulations, published Internal Revenue Service rulings, published administrative positions of the Internal Revenue Service and court decisions that are currently applicable, any or all of which could be materially and adversely changed, possibly on a retroactive basis, at any time.  The following discussion is for general information only and is not intended to be, nor should it be construed to be, legal or tax advice to any holder or prospective holder of our common shares and no opinion or representation with respect to the United States Federal income tax consequences to any such holder or prospective holder is made. Accordingly, holders and prospective holders of our common shares should consult their own tax advisors about the federal, state, local, and foreign tax consequences of purchasing, owning and disposing of our common shares.

U.S. Holders

As used herein, a U.S. Holder includes any person, with the exception of those subject to special provisions of Federal income tax law, who holds our common shares who is a citizen or resident of the United States, a partnership or corporation organized under the laws of the United States, an estate, the income of which is subject to United States federal income tax without regard to its source and a trust if a United States court is able to exercise primary supervision over administration of the trust and one or more United States persons have authority to control all substantial decisions of the trust or if the trust was in existence on August 20, 1996 and has elected to continue to be treated as a United States person, and any other person or entity whose ownership of our common shares is effectively connected with the conduct of a trade or business in the United States.

Distributions on Our Common Shares

U.S. Holders receiving dividend distributions (including constructive dividends) with respect to our common shares are required to include in gross income for United States Federal income tax purposes the gross amount of such distributions to the extent that we have current or accumulated earnings and profits, without reduction for any Canadian income tax withheld from such distributions.  Such Canadian tax withheld may be credited, subject to certain limitations, against the U.S. Holders United States Federal Income tax liability or, alternatively, may be deducted in computing the U.S. Holders United States Federal taxable income by those who itemize deductions (see more detailed discussion at Foreign Tax Credit below).  To the extent that distributions exceed our current or accumulated earnings and profits, they will be treated first as a return of capital up to the U.S. Holders adjusted basis in the common shares and thereafter as gain from the sale or exchange of the common shares.  Preferential tax rates for long-term capital gains are applicable to an U.S. Holder, which is an individual, estate or trust.  There are currently no preferential tax rates for long-term capital gains for an U.S. Holder, which is a corporation.  Dividends paid in Canadian dollars will be included in income in an U.S. dollar amount based on the exchange rate at the time of their receipt.  U.S. Holders should consult their own tax advisors regarding the treatment of any foreign currency gain or loss on any Canadian dollars received as a dividend which are converted into U.S. dollars on a date subsequent to receipt.

Dividends paid on our common shares will not generally be eligible for the dividends received deduction provided to corporations receiving dividends from certain United States corporations. A U.S. Holder which is a corporation may, under certain circumstances, be entitled to a 70% deduction of the United States source portion of dividends received from us (unless we qualify as a foreign personal holding company or a passive foreign investment company, as defined below) if such U.S. Holder owns shares representing at least 10% of the voting power and value of Diversinet. The availability of this deduction is subject to several complex limitations, which are beyond the scope of this discussion.

Foreign Tax Credit

A U.S. Holder who pays (or has withheld from distributions) Canadian income tax with respect to the ownership of our common shares may be entitled, at the option of the U.S. Holder, to either a deduction or a tax credit for such foreign tax paid or withheld.  Generally, it will be more advantageous to claim a credit because a credit reduces United States Federal income taxes on a dollar-for-dollar basis, while a deduction merely reduces the taxpayers income subject to tax.  This election is made on an annual basis and applies to all foreign income taxes (or taxes in lieu of income tax) paid by (or withheld from) the U.S. Holder during the year.  There are significant and complex limitations which apply to the credit, among which is the general limitation that the credit cannot exceed the proportionate share of the U.S. Holder United States income tax liability that the U.S. Holders foreign source income bears to his/her or its worldwide taxable income.

In the determination of the application of this limitation, the various items of income and deduction must be classified into foreign and domestic sources. Complex rules govern this classification process. There are further limitations on the foreign tax credit for certain types of income such as passive income, high withholding tax interest, financial services income, shipping income, and certain other classifications of income.  In certain circumstances, recently enacted legislation and other guidance issued by the United States Treasury may deny a United States holder foreign tax credits (and instead may allow deductions) for foreign taxes imposed on a dividend if the United States holder (i) has not held the common shares for at least 16 days in the 30-day period beginning 15 days before the ex-dividend date, during which it is not protected from risk of loss; (ii) is obligated to make payments related to the dividends; or (iii) holds the common shares in arrangements in which the United States holders expected economic profit, after non-U.S. taxes, is insubstantial.

The availability of the foreign tax credit and the application of the limitations on the credit are fact specific and holders and prospective holders of our common shares should consult their own tax advisors regarding their individual circumstances.

Disposition of Our Common Shares

A U.S. Holder will recognize gain or loss upon the sale of our common shares equal to the difference, if any, between (i) the amount of cash plus the fair market value of any property received, and (ii) the shareholders tax basis in the our common shares.  Any gain recognized on the sale or other disposition of common shares will generally be U.S. source income.  Any loss recognized on the sale or other disposition of common shares will generally be U.S. source.  However, such loss will be foreign source to the extent certain dividends were received by the U.S. Holder within the 24-month period proceeding the date on which the loss was recognized.  This gain or loss will be capital gain or loss if the common shares are capital asset in the hands of the U.S. Holder, which will be a short-term or long-term capital gain or loss depending upon the holding period of the U.S. Holder.  Gains and losses are netted and combined according to special rules in arriving at the overall capital gain or loss for a particular tax year.  Deductions for net capital losses are subject to significant limitations.  For U.S. Holders who are individuals, a capital loss is deductible only to the extent of capital gains, plus ordinary income of up to U.S. $3,000; any unused portion of such net capital loss may be carried over to be used in later tax years until such net capital loss is thereby exhausted.  For U.S. Holders which are corporations (other than corporations subject to Subchapter S of the Internal Revenue Code), any unused net capital loss may be carried back three years from the loss year and carried forward five years from the loss year to be offset against capital gains until such net capital loss is thereby exhausted.  If the amount realized on a sale or exchange is not denominated in U.S. dollars, the amount realized will be equal to the U.S. dollar value thereof, determined at the spot rate on the date of the sale or exchange.

Until such time as our common shares are listed on a stock exchange prescribed for the purposes of the Income Tax Act (Canada) (which includes NASDAQ, but not the OTC BB) our common shares will be taxable Canadian property for the purposes of the Income Tax Act (Canada).



Under section 116 of the Income Tax Act (Canada), non-resident vendors who dispose of certain types of taxable Canadian property (including our common shares for as long as they are not listed on a prescribed stock exchange), have to notify Canada Customs and Revenue Agency (CCRA) about the disposition either before they dispose of the property or after they dispose of it.  This notification (the Notice of Disposition) is due not later than ten (10) days after the date the property was disposed of.  The vendor may be able to claim an exemption under an applicable tax treaty at the time the Notice of Disposition is filed.  If no exemption is available under an applicable treaty, before CCRA can issue a certificate of compliance to the vendor, CCRA must receive either an amount to cover the tax owing, or appropriate security for the tax on any gain the vendor may realize at the time the property is disposed of. Such payments or security the vendor provides will be credited to the vendors account.  If the vendor does not comply with the section 116 requirements, which the vendor must do so before receiving the certificate of compliance, the purchaser of the property may deduct or withhold a specified amount from the proceeds of the disposition to cover any tax which the vendor owes.



When filing a Notice of Disposition and claiming an exemption under a specific tax treaty, necessary documentation to support the claim should be submitted along with the request.  The documentation which is acceptable must be based on the particular tax treaty under which the exemption is claimed, such as proof of residency, or that the gain has or will be reported in the vendors country.  Tax officials, in some countries, will supply the necessary certification required to claim the exemption. The United States Department of the Treasury, Internal Revenue Service will provide certification for corporations, exempt organizations and individuals. Requests for certification should be sent to the appropriate service centre. The Department of the Treasury, Publication 686, Certification for Reduced Tax Rates in Tax Treaty Countries, outlines the certification process.



If the vendor does not obtain a certificate pursuant to section 116, the purchaser becomes liable to pay as tax, on behalf of the vendor, an amount equal to 25% of the proceeds of disposition.  The purchaser of the property is then entitled to withhold that amount from the proceeds of the disposition to cover any tax which the vendor owes or may owe.



The required amount must be remitted to the Receiver General for Canada 30 days after the end of the month is which the property was acquired.



Other Considerations

In the following three circumstances, the above sections of the discussion may not describe the United States Federal income tax consequences resulting from the holding and disposition of our common shares.  Based on (a) the number of shareholders of our common shares, and (b) the majority ownership of our shares by Canadian residents, we do not believe that we are either a Foreign Personal Holding Company or a Controlled Foreign Corporation.  However, we do believe that we are likely to be treated as a Passive Foreign Investment Company for the taxable years 2006, 2005 and 2004.

Foreign Personal Holding Company

If, at any time during a taxable year, more than 50% of the total combined voting power or the total value of our outstanding shares are owned, actually or constructively, by five or fewer individuals who are citizens or residents of the United States and 60% or more of our gross income for such year was derived from certain passive sources (e.g. from dividends received from unrelated persons), we would be treated as a foreign personal holding company.  In that event, U.S. Holders that hold our common shares would be required to include in gross income for such year their allowable portions of such foreign personal holding company income to the extent that we do not actually distribute such income.

Controlled Foreign Corporation

If more than 50% of the voting power of all classes of shares or the total value of our shares is owned, directly or indirectly, by U.S. shareholders, each of whom own 10% or more of our voting shares (U.S. Shareholders), we could be treated as a controlled foreign corporation (a CFC) under SubPart F of the Internal Revenue Code.  If we were classified as a CFC and as a PFIC, CFC treatment would prevail with respect to U.S. Shareholders.  CFC classification would effect many complex results including the required inclusion by such U. S. shareholders in income of their pro rata share: of SubPart F Income (as specially defined by the Internal Revenue Code) of Diversinet; and of our earnings invested in U.S. property.  In addition, under Section 1248 of the Internal Revenue Code, gain from the sale or exchange of our common shares by a U.S. person who is or was a U.S. shareholder (as defined in the Internal Revenue Code) at any time during the five years period ending with the sale or exchange is generally treated as ordinary dividend income to the extent of our earnings and profits attributable to the shares sold or exchanged.  Because of the complexity of SubPart F, and because it is not clear that we are a controlled foreign corporation, a more detailed review of these rules is outside of the scope of this discussion.

Passive Foreign Investment Company

As stated above, we believe that we will not be treated as a passive foreign investment company (PFIC), as defined in Section 1297 of the Internal Revenue Code, for our fiscal years 2006 or 2005.

United States income tax legislation contains rules governing PFICs, that can have significant tax effects on U.S. Holders of foreign corporations. These rules do not apply to non-U.S. Holders.  Section 1297 of the Internal Revenue Code defines a PFIC as a corporation that is not formed in the United States and, for any taxable year, either (i) 75% or more of its gross income is passive income, which includes interest, dividends and some types of rents and royalties or (ii) the average percentage, by fair market value (or, if the company is a controlled foreign corporation or makes an election, by adjusted tax basis), of its assets that produce or are held for the production of passive income is 50% or more.  Based on these tests we do not meet the definition of a PFIC in 2000, 2001, 2002, 2003, 2004, 2005 or 2006.

An U.S. Holder who holds shares in a foreign corporation during any year in which such corporation qualifies as a PFIC is subject to U.S. Federal income taxation under alternative tax regimes, depending upon whether such U.S. Holder makes elections.  The following is a discussion of these alternative tax regimes as applicable to our U.S. Holders.

A U.S. Holder of a PFIC who does not make either of the elections described below (a Non-electing U.S. Holder) is subject to special taxation rules under Section 1291 of the Internal Revenue Code with respect to (i) gains realized on the disposition (or deemed to be realized by reason of a pledge) of his/her common shares and (ii) excess distributions by us, defined as any distribution received by a U.S. Holder from a PFIC in a taxable year that is greater than 125% of the average distributions received by the U.S. Holder in the three preceding taxable years, or, if shorter, the U.S. Holders holding period for the shares.

A Non-electing U.S. Holder generally would be required to include in income pro rata all gains realized on the disposition of his/her common shares and all excess distributions over the entire holding period for the PFIC common shares.  All gains or excess distributions allocated to prior years of the U.S. Holder (other than years prior to the first taxable year of the company during such U.S. Holders holding period and beginning after January 1, 1987 for which it was a PFIC) would be taxed at the highest tax rate for each such prior year applicable to ordinary income.  The Non-electing U.S. Holder also would be liable for interest on the foregoing tax liability for each such prior year calculated as if such liability had been due with respect to each such prior year.  A Non-electing U.S. Holder that is not a corporation must treat this interest charge as personal interest which, as discussed above, is partially or wholly non-deductible.  The balance of the gain or the excess distribution will be treated as ordinary income in the year of the disposition or distribution, and no interest charge will be incurred with respect to such balance.

If we are a PFIC for any taxable year during which a Non-electing U.S. Holder holds common shares, then we will continue to be treated as a PFIC with respect to such common shares, even if we are no longer a PFIC as defined above.  A Non-electing U.S. Holder may terminate this deemed PFIC status by electing to recognize a gain (which will be taxed under the rules discussed above for Non-electing U.S. Holders) as if such common shares had been sold on the last day of the last taxable year for which it was a PFIC.

Under Section 1291(f) of the Internal Revenue Code, the Department of the Treasury has issued proposed regulations that would treat as taxable transfers of PFICshares by Non-electing U.S. Holders that are generally not otherwise taxed, such as gifts, exchanges pursuant to corporate reorganizations, and transfers at death.  Special, generally adverse, rules will apply with respect to the common shares while the company is a PFIC. For example under Section 1298(b)(6) of the Internal Revenue Code, a U.S. Holder who uses PFICshares as security for a loan (including a margin loan) will, except as may be provided in regulations, be treated as having made a taxable disposition of such shares.

Alternatively, if we are a PFIC, an U.S. Holder (an Electing U.S. Holder) who owns common shares is permitted generally to elect out of the tax treatment discussed above, if an U.S. Holder makes a mark-to-market election with respect to common shares.  Under such election, an Electing U.S. Holder would generally recognize as ordinary income for each taxable year an amount equal to the excess, if any, of the fair market value of common shares as of the close of the taxable year over the Electing U.S. Holders adjusted tax basis in such shares.  An Electing U.S. Holder would generally be allowed an ordinary deduction (to the extent of any net mark-to-market gains recognized for prior taxable years) for the excess, if any, of the adjusted tax basis of the common shares over their fair market value as of the close of the taxable year.  An Electing U.S. Holders adjusted tax basis of the common shares would generally be adjusted to reflect the amounts included or deducted under the mark-to-market election.  Additionally, any gain on the actual sale or other disposition of the common shares generally will be treated as ordinary income.  Ordinary loss treatment also would generally apply to any loss realized on the actual sale or other disposition of the common shares to the extent that the amount of such loss did not exceed the net mark-to-market gains previously included with respect to such shares.  An election to mark to market would generally apply to the taxable year made and all subsequent taxable years.  A mark-to-market election is subject to complex and specific rules and requirements, and U.S. Holders are strongly urged to consult their tax advisors concerning such election if the company is classified as a PFIC.

Finally, an U.S. Holder who elects in a timely manner to treat us as a qualified electing fund (a QEF) as defined in the Internal Revenue Code would be subject to another set of special rules different from those described above.  Although a QEF election may be beneficial to some U.S. Holders depending upon their particular tax situations, it requires us to make information available to such holders, and we do not intend to make such information available even if it is classified as a PFIC.  Accordingly, the QEF election will not be available to U.S. Holders.

The foregoing discussion is based on existing provisions of the Internal Revenue Code, existing and proposed regulations thereunder, and current administrative ruling and court decisions, all of which are subject to change. Any such change could affect the validity of this discussion. In addition, the implementation of aspects of the PFIC rules requires the issuance of regulations which in many instances have not been promulgated and which may have retroactive effect. There can be no certainty that any of these proposed regulations will be enacted or promulgated and if so, the form they will take or the effect that they may have on this discussion. Accordingly, and due to the complexity of the PFIC rules, U.S. Holders who are shareholders of Diversinet are strongly urged to consult their own tax advisors concerning the impact of these rules on their investment in us.

10-F.

Dividends and Paying Agents

Not Applicable.

10-G.

Statements by Experts

Not Applicable.

10-H.

Documents on Display

We are subject to certain of the information requirements of the Securities Exchange Act of 1934, as amended (the Exchange Act), and in accordance therewith, files reports and other information with the SEC.  As a foreign private issuer, we are exempt from the rules under the Exchange Act prescribing the furnishing and content of proxy statements, and its officers, directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions contained in Section 16 of the Exchange Act.  As a foreign private issuer, we are not required to publish financial statements as frequently or as promptly as United States companies.

We file annual reports and other information with the SEC.  You may read and copy any of these documents at the SECs Public Reference Room at Judiciary Plaza, 450 Fifth Street NW, Washington, D.C. 20549.  You may obtain information on the operation of the Public Reference Room by calling the SEC at (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. The address of that site is http://www.sec.gov.  We also file annual reports and other information in Canada on The System for Electronic Document Analysis and Retrieval (SEDAR).  The address of that site is www.sedar.com.

10-I.

Subsidiary Information

Our consolidated financial statements include the accounts of Atria Limited, a 50% owned inactive joint venture that operated in Hong Kong and its wholly-owned inactive subsidiaries, Diversinet Corporation of America, a Delaware corporation, Diversinet Inc., an Ontario corporation, Diversinet (Israel) Ltd., an Israeli corporation and The Instant Publisher Ltd., a Barbados corporation.  For the fiscal year ended December 31, 2006, 2005 and 2004 our consolidated financial statements will also include the accounts of DSS Software Technologies, the wholly owned subsidiary we acquired in January 2003, as discontinued operations.  For the fiscal year ended December 31, 2006, 2005 and 2004 our consolidated financial statements will also include Caradas, Inc., the wholly owned subsidiary we acquired in September 2003.

ITEM 11.  Quantitative and Qualitative Disclosure about Market Risk

We believe that inflation has not had a material impact on our results of operations for each of our fiscal years in the three-year period ended December 31, 2006.  However, there can be no assurance that future inflation would not have an adverse impact on our operating results and financial condition.  We have limited market risk exposure since we do not have any outstanding variable rate debt or derivative financial and commodity instruments as of December 31, 2006.

Since we currently earn revenues and incur expenses in United States dollars and Canadian dollars, exchange rates for these and other local currencies in countries where we may operate in the future may fluctuate in relation to the United States dollar and such fluctuations may have an adverse effect on our earnings or assets when Canadian or local currencies are exchanged for United States dollars.  We have not entered into forward foreign exchange contracts.  Losses and gains resulting from the translation of revenue and expenses denominated in foreign currencies into United States dollars have been included in our results of operations.  For the year ended December 31, 2006, we had a foreign exchange loss of $18,000 compared to $11,000 for the year ended December 31, 2005, and $28,000 for the year ended December 31, 2004.

ITEM 12.  Description of Securities Other than Equity Securities

Not Applicable.

PART II

ITEM 13.  Defaults, Dividend Arrearages and Delinquencies

None

ITEM 14.  Material Modifications to the Rights to Security Holders and Use of Proceeds

None

ITEM 15.  Controls and Procedures

Disclosure controls and procedures: are controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports we file with the Securities and Exchange Commission is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms and that the information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.  The Company has developed and implemented a disclosure controls and procedures policy with a view to promoting consistent disclosure controls and procedures practices.

We carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the fiscal year covered by this Annual Report on Form 20-F.  This evaluation was carried out under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer.  Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are effective.  There was no changes in our internal control over financial reporting during the year ended December 31, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There have been no changes in our internal control over financial reporting identified in connection with the evaluation described above that occurred during the period covered by this annual report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

We recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and our management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.  Projections of any evaluation of effectiveness to future periods are also subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.  In addition, internal controls over financial reporting remains an evolving concept and, as acknowledged by the SEC in both its rule-making and concept releases as well as its Final Report of the Committee on Smaller Public Companies released in April 2006, no definitive industry definition or guidance for management currently exists as to what constitutes adequate internal controls for smaller public companies like us.  Accordingly, in light of the continuing SEC dialog as to what constitutes effective control procedures for smaller public companies, our controls and procedures are subject to on-going review and revision by our management.

ITEM 16A.  Audit Committee Financial Expert

Messrs. Wahbe, Chiruvolu, Steinman and Wigdale, all of whom are non-management directors currently comprise the Audit Committee.  Mr. Steinman is Chairman of the Audit Committee.

Mr. Steinman has thirty years of corporate finance experience and is currently an independent consultant.  Until 2003, Mr. Steinman was Executive Vice President and Chief Financial Officer of Stelco Inc. and prior to 1999 as Chief Financial Officer of Spar Aerospace and Chief Financial Officer of Rogers Cablesystems.  The Board has determined that Mr. Steinman of the Audit Committee meets the requirements of an audit committee financial expert, as defined in Item 16A of Form 20-F.

ITEM 16B.  Code of Ethics

As part of its stewardship responsibilities, the Board of Directors has approved a formal Code of Business Conduct and Ethics that govern the behavior of our directors, officers and employees.  The Board monitors compliance with these standards and is responsible for the granting of any waivers from these standards to directors or officers.  Disclosure will be made by us of any waiver from these standards granted to our directors or officers in our quarterly report that immediately follows the grant of such waiver.  No waiver has been granted to date.

ITEM 16 C.  Principal Accountant Fees and Services

KPMG LLP served as our auditors for the fiscal years ended December 31, 2006, December 31, 2005, December 31, 2004, December 31, 2003 and October 31, 2002.  The only fees paid to KPMG LLP were Audit Fees.

Audit Fees

KPMG LLP billed us $169,000 in fiscal 2006 ($145,000 in fiscal 2005) for professional services rendered for the audit of the Annual Consolidated Financial Statements and services that are normally provided in connection with statutory and regulatory filings.

Audit Fees are the aggregate fees billed by KPMG for the audit of our annual financial statements, attestation services that are provided in connection with statutory and regulatory filings or engagements and assistance in responding to comment letters from securities regulatory bodies and consultations with our management as to accounting or disclosure treatment of transactions or events and/or the actual or potential impact of final or proposed rules, standards or interpretation by the securities regulatory authorities, accounting standard vetting bodies or other regulatory or standard setting bodies.

Audit Committee Pre-Approval Policies

The Audit Committee nominate and engages the independent auditors to audit the financial statements, and approves all audit, audit-related services, tax services and other services provided by KPMG LLP.  Any services provided by KPMG LLP that are not specifically included within the scope of the audit must be pre-approved by the Audit Committee prior to any engagement.  The Audit Committee is permitted to approve certain fees for audit-related services, tax services and other services pursuant to a de minimus exception before the completion of the engagement.

ITEM 16 D.  Exemptions from the Listing Standards for Audit Committees

None

ITEM 16 E.  Purchases of Equity Securities by the Issuer and Affiliated Purchasers

Not Applicable.

PART III

ITEM 17.  Financial Statements

Our financial statements have been prepared in accordance with Canadian GAAP.  These principles conform in all material respects with U.S. GAAP except as described in Note 13 to our 2006 consolidated financial statements.

Reference is made to our consolidated financial statements and related footnotes attached as an exhibit to this Report.

ITEM 18.  Financial Statements

We have elected to provide financial statements pursuant to Item 17.

ITEM 19.  Exhibits

Financial Statements:

•

KPMG LLP Auditors Report dated February 22, 2007

•

Consolidated Balance Sheets as at December 31, 2006 and December 31, 2005.

•

Consolidated Statements of Earnings and Deficit for the years ended December 31, 2006, 2005, and 2004.

•

Consolidated Statements of Cash Flows for the years ended December 31, 2006, 2005 and 2004.

•

Notes to Consolidated Financial Statements.

Exhibits:

|1.1  | Certificate of Incorporation(1)                                                                        
|---- | -------------------------------------------------------------------------------------------------------
|4.1  | Form of Stock Purchase Agreement for the June 30, 2006 private placement (2)                           
|4.2  | Form of Stock Purchase Agreement for the July 26, 2006 private placement(2)                            
|4.3  | Form of Stock Purchase Agreement dated September 15, 2005. (3)                                         
|4.4  | Share Purchase Agreement with Caradas, Inc. (3)                                                        
|4.5  | Asset Purchase Agreement with DSS Software Technologies (1)                                            
|8    | List of Subsidiaries                                                                                   
|11.1 | Code of Business Conduct and Ethics. (1)                                                               
|12.1 | Certification of the Chief Executive Officer Pursuant to Sarbanes-Oxley Act of 2002.                   
|12.2 | Certification of the Chief Financial Officer Pursuant to Sarbanes-Oxley Act of 2002.                   
|13.1 | Certification of Periodic Financial Report Pursuant to Sarbanes-Oxley Act of 2002, U.S.C. Section 1350.
|13.2 | Certification of Periodic Financial Report Pursuant to Sarbanes-Oxley Act of 2002, U.S.C. Section 1350.
|23.1 | Consent of KPMG LLP.                                                                                   

(1)

Previously filed with prior years Form 20-F.

(2)

Previously filed with our F-1 on July 31, 2006

(3)

Previously filed with our F-1/A on November 3, 2005

#



SIGNATURE PAGE

Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, as amended, the Registrant certifies that it meets all of the requirements for filing on Form 20-F and has duly caused this annual report to be signed on its behalf by the undersigned, there unto duly authorized.

DIVERSINET CORP.



By:

/s/ NAGY MOUSTAFA

Nagy Moustafa

Chief Executive Officer



Dated: Dated: February 23, 2007

#



MANAGEMENTS REPORT

The accompanying consolidated financial statements and all information in the Annual Report have been prepared by management and have been reviewed and approved by the Board of Directors of the Company.  The consolidated financial statements were prepared in accordance with accounting principles generally accepted in Canada and, where appropriate, reflect managements best estimates and judgments.  Management is responsible for the accuracy, integrity and objectivity of the consolidated financial statements within reasonable limits of materiality and for the consistency of financial data included in the text of the Annual Report with that contained in the consolidated financial statements.



To assist management in the discharge of these responsibilities, the Company maintains a system of internal controls and systems designed to provide reasonable assurance that its assets are safeguarded, that only valid and authorized transactions are executed and that accurate, timely and comprehensive financial information is prepared and disclosed.  The internal control systems and financial records are subject to reviews by external auditors during the examination of the financial statements.  Management recognizes its responsibility for conducting the Companys affairs to comply with the requirements of applicable laws and established financial standards and principles, and for maintaining proper standards of conduct in its activities.



The Companys Audit Committee is appointed by the Board of Directors annually and is comprised of three non-management directors.  The Audit Committee meets with management as well as with the independent auditors to satisfy itself that management is properly discharging its financial reporting responsibilities and to review the consolidated financial statements and the independent auditors report.  The Audit Committee reports its findings to the Board of Directors for consideration in approving the consolidated financial statements for presentation to the shareholders.  The Audit Committee has responsibility for engaging or re-appointing the Companys independent auditors.  The independent auditors have direct and unrestricted access to the Audit Committee to discuss their audit and related findings as to the integrity of the Companys financial reporting.



The consolidated financial statements have been audited by KPMG LLP, Chartered Accountants, on behalf of the shareholders, in accordance with generally accepted auditing standards.  Their report outlines the scope of their audit and expresses their opinion on the consolidated financial statements of the Company.

|/s/ NAGY MOUSTAFA                                        | /s/ DAVID HACKETT                     
|-------------------------------------------------------- | --------------------------------------
|Nagy Moustafa, Chief Executive Officer
February 22, 2007 | David Hackett, Chief Financial Officer





















AUDITORS REPORT TO THE SHAREHOLDERS

We have audited the consolidated balance sheets of Diversinet Corp. as at December 31, 2006 and 2005 and the consolidated statements of earnings and deficit and cash flows for each of the years in the three year period ended December 31, 2006.  These financial statements are the responsibility of the Companys management.  Our responsibility is to express an opinion on these financial statements based on our audits.



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



In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of the Company as at December 31, 2006 and 2005 and the results of its operations and its cash flows for each of the years in the three year period ended December 31, 2006 in accordance with Canadian generally accepted accounting principles.



Canadian generally accepted accounting principles vary in certain significant respects from US generally accepted accounting principles. Information relating to the nature and effect of such differences is presented in Note 13 to the consolidated financial statements.





/s/KPMG LLP

Chartered Accountants, Toronto, Canada, February 22, 2007



#







DIVERSINET CORP.

Consolidated Balance Sheets

(In United States dollars)





|As at December 31                          | 2006           | 2005          
|------------------------------------------ | -------------- | --------------
|Assets                                     |                |               
|Current assets:                            |                |               
|Cash and cash equivalents                  | $    5,146,315 | $    1,355,562
|Accounts receivable                        | 154,109        | 67,305        
|Prepaid expenses                           | 141,081        | 117,245       
|Total current assets                       | 5,441,505      | 1,540,112     
|                                           |                |               
|Capital assets, net (note 3)               | 388,723        | 473,010       
|Total assets                               | $    5,830,228 | $    2,013,122
|                                           |                |               
|                                           |               
|                                           |               
|Liabilities and Shareholders Equity       |               
|Current liabilities:                       |                |               
|Accounts payable                           | $      172,291 | $      153,100
|Accrued liabilities (note 4)               | 633,661        | 226,679       
|Deferred revenue                           | 938,550        | 79,000        
|Total current liabilities                  | 1,744,502      | 458,779       
|                                           |                |               
|Shareholders equity:                      |                |               
|Share capital (note 5):                    |                |               
|Authorized:                                |                |               
|Unlimited common shares                    |                |               
|Issued and outstanding:                    |                |               
|33,413,005 (24,316,691  2005)             |                |               
|common shares                              | 58,414,036     | 54,347,652    
|Contributed surplus                        | 3,646,283      | 2,521,422     
|Cumulative translation adjustment          | (1,520,721)    | (1,520,721)   
|Share purchase warrants (note 5)           | 3,291,832      | 2,500,977     
|Deficit                                    | (59,745,704)   | (56,294,987)  
|Total shareholders equity                 | 4,085,726      | 1,554,343     
|                                           |                |               
|Commitments and contingencies (note 9)     |                |               
|                                           |                |               
|Total liabilities and shareholders equity | $    5,830,228 | $    2,013,122

See accompanying notes to consolidated financial statements.



On behalf of the Board:

/s/ ALBERT WAHBE

/s/ NAGY MOUSTAFA

Albert Wahbe, Chairman

Nagy Moustafa, Director

#







DIVERSINET CORP.

Consolidated Statements of Earnings and Deficit

(In United States dollars)



|Year ended December 31                     | 2006           | 2005           | 2004          
|------------------------------------------ | -------------- | -------------- | --------------
|Revenue                                    | $    1,666,965 | $    1,101,104 | $    2,602,894
|Cost of sales                              | 1,041,096      | 562,987        | 1,426,922     
|Gross margin                               | 625,869        | 538,117        | 1,175,972     
|                                           |                |                |               
|Expenses:                                  |                |                |               
|Research and development                   | 831,925        | 1,241,599      | 1,153,758     
|Sales and marketing                        | 700,870        | 1,289,940      | 1,195,434     
|General and administrative                 | 2,484,556      | 2,301,032      | 2,369,025     
|Depreciation and amortization              | 159,048        | 539,770        | 920,323       
|Goodwill impairment charge (note 1b)       | -              | 1,894,690      | 2,500,000     
|Customer asset impairment charge           | -              | 330,768        |              
|                                           | 4,176,399      | 7,597,799      | 8,138,540     
|                                           |                |                |               
|Loss before the following                  | (3,550,530)    | (7,059,682)    | (6,962,568)   
|                                           |                |                |               
|Foreign exchange loss                      | 18,291         | 10,586         | 28,386        
|Interest income and other income           | (118,104)      | (31,632)       | (15,598)      
|                                           |                |                |               
|Loss from continuing operations            | (3,450,717)    | (7,038,636)    | (6,975,356)   
|Loss from discontinued operations (note 2) | -              | (70,860)       | (541,486)     
|                                           |                |                |               
|Loss for the year                          | (3,450,717)    | (7,109,496)    | (7,516,842)   
|                                           |                |                |               
|Deficit, beginning of year                 | (56,294,987)   | (49,185,491)   | (41,668,649)  
|Deficit, end of year                       | $(59,745,704)  | $(56,294,987)  | $(49,185,491) 
|                                           |                |                |               
|Basic and diluted loss per share from      |                |                |               
|continuing operations                      | $    (0.12)    | $    (0.34)    | $    (0.57)   
|Basic and diluted loss per share           | $    (0.12)    | $    (0.35)    | $    (0.62)   
|                                           |                |                |               
|                                           |                |                |               
|Weighted average number of common shares   | 28,740,174     | 20,578,427     | 12,144,565    
|                                           |                |                |               



See accompanying notes to consolidated financial statements.

#







DIVERSINET CORP.

Consolidated Statements of Cash Flows

(In United States dollars)



|For the year ended December 31                    | 2006            | 2005            | 2004           
|------------------------------------------------- | --------------- | --------------- | ---------------
|                                                  |                 |                 |                
|Cash provided by (used in):                       |                 |                 |                
|                                                  |                 |                 |                
|Operating activities:                             |                 |                 |                
|Loss for the year from continuing operations      | $   (3,450,717) | $   (7,038,636) | $   (6,975,356)
|Items not involving cash:                         |                 |                 |                
|Depreciation and amortization                     | 159,048         | 539,770         | 920,323        
|Goodwill impairment charge (note 1b)              |                | 1,894,690       | 2,500,000      
|Customer asset impairment charge                  |                | 330,768         |               
|Stock-based compensation expense                  | 906,444         | 986,257         | 760,916        
|Change in non-cash operating working capital:     |                 |                 |                
|Accounts receivable                               | (86,804)        | 258,634         | 39,392         
|Prepaid expenses                                  | (23,836)        | 70,408          | 184,554        
|Accounts payable                                  | 19,191          | 6,016           | (182,896)      
|Accrued liabilities                               | 406,982         | (252,102)       | (571,658)      
|Deferred revenue                                  | 859,550         | (86,343)        | (312,106)      
|Cash used in continuing operations                | (1,210,142)     | (3,290,538)     | (3,636,831)    
|Cash provided by discontinued operations          |                | (92,042)        | 94,858         
|Cash used in operations                           | (1,210,142)     | (3,382,580)     | (3,541,973)    
|                                                  |                 |                 |                
|Financing activities:                             |                 |                 |                
|Issue of common shares, common share              |                 |                 |                
|purchase options and warrants for cash            | 5,075,656       | 1,842,183       | 4,565,503      
|Notes payable                                     |                | (4,611)         | (17,456)       
|Proceeds from sale of discontinued operations     |                | 250,000         |               
|Repayment of promissory notes payable             |                |                | (50,000)       
|Cash provided by financing activities             | 5,075,656       | 2,087,572       | 4,498,047      
|                                                  |                 |                 |                
|Investing activities:                             |                 |                 |                
|Proceeds of disposition of short-term investments |                | 2,000,000       | (756,040)      
|Capital assets additions                          | (74,761)        | (72,928)        | (24,070)       
|Cash provided by (used in) investing activities   | (74,761)        | 1,927,072       | (780,110)      
|                                                  |                 |                 |                
|Increase in cash and cash equivalents             | 3,790,753       | 632,064         | 175,964        
|                                                  |                 |                 |                
|Cash and cash equivalents, beginning of year      | 1,355,562       | 723,498         | 547,534        
|                                                  |                 |                 |                
|Cash and cash equivalents, end of year            | $    5,146,315  | $    1,355,562  | $     723,498  
|                                                  |                 |                 |                
|Supplementary non-cash financing and              |                 |                 |                
|investing activities:                             |                 |                 |                
|Issuance of shares in settlement of debt          |                |                | 400,000        



See accompanying notes to consolidated financial statements.

#







DIVERSINET CORP.

Notes to Consolidated Financial Statements

(In United States dollars)

Years ended December 31, 2006, 2005, and 2004

Diversinet Corp. (the Company), an Ontario corporation, develops, markets and distributes wireless security infrastructure solutions and identity management solutions and professional services to the health services, financial services, software security, storage and memory manufacturers, entertainment and gaming and telecommunications marketplaces.

1.

Significant accounting policies:

These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in Canada, which, except as described in note 13, conform in all material respects with accounting principles generally accepted in the United States.  Significant accounting policies adopted by the Company are as follows:

(a)

Basis of consolidation:

The consolidated financial statements include the accounts of the Company and its subsidiaries.  All significant intercompany transactions and balances have been eliminated.

(b)

Goodwill and customer assets:

Goodwill is the residual amount that results when the purchase price of an acquired business exceeds the sum of the amounts allocated to the identifiable tangible and intangible assets acquired, less liabilities assumed, based on their fair values.  When the Company enters into a business combination, the purchase method of accounting is used.  Goodwill is assigned as of the date of the business combination to reporting units that are expected to benefit from the business combination.  Goodwill is not amortized but instead is tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired.  The impairment test is carried out in two steps. In the first step, the carrying amount of the reporting unit, including goodwill, is compared with its fair value.  When the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered to be impaired and the second step of the impairment test is unnecessary.  The second step is carried out when the carrying amount of reporting unit exceeds its fair value, in which case, the implied fair value of the reporting units goodwill, determined in the same manner as the value of goodwill is determined in a business combination, is compared with its carrying amount to measure the amount of the impairment loss, if any.

During the third quarter of 2005, a customer contract related to the Companys Caradas reporting unit expired and accordingly a goodwill and customer asset impairment analysis was performed for the Caradas reporting unit.  The impairment analysis indicated that the fair values of goodwill and customer assets were nil, and the Company recorded a goodwill write down of $1,894,690 and a customer assets write down of $330,768.  The impairment analysis for DSS Technologies (DSS) indicated that the fair value of goodwill was nil and accordingly recorded an impairment charge of $392,242, which is included in discontinued operations (note 2).  Application of the goodwill impairment test requires judgment, including assignment of assets and liabilities and determination of the fair value of each reporting unit.  The fair value of each reporting unit is estimated using a discounted cash flow methodology.  This requires significant judgments including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for our business, the useful life over which cash flows will occur, and determination of discount rate and terminal asset value.

During fiscal 2004, Caradas was unable to attract significant new customers in order to generate expected cash flows, and DSS lost key management which resulted in the loss of several customers over the course of the year.  The Company completed a goodwill impairment test as at December 31, 2004 and determined that goodwill of $2,500,000 relating to Caradas and $525,000 relating to DSS was impaired under the fair value methodology as prescribed under GAAP.  Goodwill impairment charges for DSS have been included in the results from discontinued operations for all periods presented.

The changes in the carrying amount of goodwill for the years ended December 31, 2005 and 2004 are as follows:

|Balance December 31, 2003          | $    5,311,932      
|---------------------------------- | --------------------
|Goodwill impairment charge         | (3,025,000)         
|Balance December 31, 2004          | 2,286,932           
|Goodwill impairment charges        | (2,286,932)         
|Balance December 31, 2005 and 2006 | $                  

(c)

Impairment or disposal of long-lived assets:

The Company reviews capital and intangible assets (long-lived assets) for impairment on an annual basis or whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.  Absent any triggering factors during the year, the Company conducts its long-lived asset assessment in the fourth quarter to correspond with its planning cycle.  An impairment loss is recognized when the carrying amount of an asset that is held and used exceeds the projected undiscounted future cash flows expected from its use and disposal, and is measured as the amount by which the carrying amount of the asset exceeds its fair value which is measured by discounted cash flows when quoted market prices are not available.  For assets available-for-sale, an impairment loss is recognized when the carrying amount exceeds the fair value less costs to sell.

(d)

Revenue recognition:

The Company recognizes revenue in accordance with Statement of Position (SOP) 97-2, Software Revenue Recognition, issued by the American Institute of Certified Public Accountants (AICPA) in October 1997 as amended by SOP 98-9 issued in December 1998.  The Company derives revenue from licensing its products and providing related services, including installation, integration, and maintenance.

(i) License revenue:

The Company recognizes product revenue when it has an executed license agreement with the customer, the software product has been delivered, the amount of the fees to be paid by the customer is fixed and determinable, and collection of these fees is deemed probable.  The Company considers fees related to arrangements with significant payments due beyond its normal trading terms not to be fixed or determinable.  If the fee is not fixed or determinable, revenue is recognized as the payments become due from the customer.  If collectibility is not considered probable, revenue is recognized when the fee is collected.

The Company enters into software license agreements that provide for future license payments to be made based on the number of users.  Customers who exceed their licensed fixed level of users are required to pay additional license fees.  Revenue associated with additional users is recognized when the amount becomes determinable, and when the requirements of revenue recognition as set out above has been met.

(ii) Service revenue:

Typically, software license agreements are multiple element arrangements as they also include consulting, related maintenance and/or implementation services fees.  Arrangements that include consulting services are evaluated to determine whether those services are essential to the functionality of other elements of the arrangements.  The Companys software products are generally fully functional upon delivery and implementation and do not require any significant modification or alteration for customer use, however, for larger customers, customization services may be significant.  Customers generally purchase consulting services to facilitate the adoption of the Companys technology and may contract with the Company to have dedicated personnel to participate in the services being performed, but the customer may also decide to use their own resources or appoint other professional service organizations to provide these services.

In determining whether the services are essential to the functionality of its software, the Company applies the criteria in SOP 97-2.  When the services are considered essential to the functionality of the software, the Company recognizes both the software product revenue and services revenue under the percentage of completion method using the input method based on the ratio of direct labour hours incurred to date to total projected labour hours.  When services are not considered essential, the entire arrangement fee is allocated to each element in the arrangement based on the respective vendor specific objective evidence (VSOE) of the fair value of each element. VSOE used in determining the fair value of license revenue is based on the price charged by the Company when the same element is sold in similar quantities to a customer of similar size and nature.  VSOE used in determining fair value for installation, integration and training is based on the standard daily rates for the type of service being provided multiplied by the estimated time to complete the task.  VSOE used in determining the fair value of maintenance and technical support is based on the annual renewal rates.  The revenue allocable to the software license is recognized when the product revenue criteria are met.  The revenue allocable to the consulting services is recognized as the services are performed.  In instances where VSOE exists for undelivered elements but does not exist for delivered elements of a software arrangement, the Company uses the residual method of allocation of the arrangement fees for revenue recognition purposes.  For arrangements containing multiple elements wherein VSOE of fair value does not exist for all undelivered elements, revenue for the delivered and undelivered elements is deferred until VSOE of fair value exists or all elements have been delivered.

Consulting, implementation and training revenues are recognized as the services are performed, generally on a time and materials basis.  Consulting revenues attributed to fixed price arrangements are recognized using the proportional performance method based on direct labour costs incurred to date as a percentage of total estimated direct labour costs to complete the project as this better reflects the pattern in which the Companys obligations to its customers are fulfilled and revenue is earned.  When total cost estimates exceed revenues in a fixed price arrangement, the estimated losses are recognized immediately based upon an average fully burdened daily cost rate applicable to the consulting individuals delivering the services.

(iii) Maintenance revenue:

Maintenance and support revenues paid in advance are non-refundable and are recognized ratably over the term of the agreement, which typically is twelve months.

The Company provides upgrade rights only as part of Post-contract Customer Support (PCS or maintenance) arrangements.  Maintenance generally includes the right to receive unspecified updates and upgrades, determined solely by the Company, after the software license period begins.  These unspecified update and upgrade rights generally provide for the customer to receive bug fixes and future enhancements, respectively, to the existing software.  The Company does not enter into arrangements that provide for specified upgrade rights.  Unspecified updates and upgrades are included in maintenance revenue.  Maintenance revenue is recognized ratably over the term of the maintenance contract.

(iv) Deferred revenue:

Product and services revenues that have been prepaid but do not yet qualify for recognition as revenue under the Companys revenue recognition policy are reflected as deferred revenue on the consolidated balance sheets.

(e)

Cash and cash equivalents:

Cash and cash equivalents include cash on account and short-term investments in money market instruments with original maturities of 90 days or less when acquired.

(f)

Investment tax credits:

Investment tax credits are accrued when qualifying expenditures are made and there is reasonable assurance that the credits will be realized.  Investment tax credits earned with respect to current expenditures for qualified research and development activities are included in the consolidated statements of earnings and deficit as a reduction of related expenses in the year the refund is received.  In 2006, the Company reduced research and development expenses by $288,000 (2005 - $nil, 2004 - $135,000) for refunds received during the year in relation to the 2003, 2004 and 2005 fiscal years scientific research and development claims.  Assistance related to the acquisition of capital assets used for research and development is credited against the related capital assets.

(g)

Research and development costs:

Research costs are expensed as incurred.  Software development costs are deferred once costs meet the criteria under Canadian generally accepted accounting principles for deferral and amortization.  Such deferred costs are amortized, commencing when the product is commercially released, on a straight-line basis over two years.  The recoverability of any unamortized deferred development costs is reviewed on an ongoing basis.

(h)

Purchased and acquired technology:

The Company capitalizes purchased technology and amortizes such costs over its estimated useful life.  The carrying value is assessed on a periodic basis to determine if a write-down is required.

(i)

Customer assets:

Customer relationships acquired through business combinations are amortized over their estimated useful life. Acquired customer contract assets are amortized over the related contract terms as services are performed.  The carrying value is accessed on a periodic basis to determine if a write-down is required.

(j)

Foreign currency translation:

The Company uses the U.S. dollar as its measurement and reporting currency in the preparation of its consolidated financial statements.

Monetary assets and liabilities denominated in foreign currencies are translated into United States dollars at the exchange rates prevailing at the consolidated balance sheet dates.  Non-monetary assets and liabilities are translated at historical rates.  Transactions in foreign currencies are translated into United States dollars at the approximate rates prevailing at the dates of the transactions.  Foreign exchange gains and losses are included in the loss for the period.

(k)

Capital assets:

Capital assets are stated at cost less accumulated depreciation and amortization.  Depreciation and amortization is provided over the estimated useful lives of the assets at the following annual rates and bases:

|Asset                  | Basis             | Rate              
|---------------------- | ----------------- | ------------------
|Computer hardware      | Declining balance | 30%               
|Computer software      | Declining balance | 30%               
|Furniture and fixtures | Declining balance | 20%               
|Leasehold improvements | Straight-line     | Over term of lease

(l)

Income taxes:

The Company accounts for income taxes using the asset and liability method.  Under this method, future income taxes are recognized at the enacted or substantively enacted tax rate expected to be applicable at the date of reversal for all significant temporary differences between the tax and accounting bases of assets and liabilities and for certain tax carry forward items.  Future income tax assets are recognized only to the extent that, in the opinion of management, it is more likely than not that the future income tax assets will be realized.  Future income tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of the substantive enactment of the change.

(m)

Earnings per share:

Basic earnings per share is computed using the weighted average number of common shares that are outstanding during the year.  Diluted earnings per share is computed using the weighted average number of common and potential common shares outstanding during the year.  Potential common shares consist of the incremental number of common shares issuable upon the exercise of stock options and warrants and are calculated using the treasury stock method.

(n)

Stock-based compensation:

The Company estimates the fair value of stock-based compensation granted to employees since November 1, 2002 and expenses the fair value over the estimated vesting period of the stock options.

(o)

Use of estimates:

The preparation of these consolidated financial statements in conformity with generally accepted accounting principles 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 these consolidated financial statements and the reported amounts of revenue and expenses during the year.  Actual results could differ from those estimates.

1.

Acquisitions and discontinued operations:

In February 2005, the Companys subsidiary DSS Software Technologies (DSS) completed an agreement whereby it sold the majority of its current assets, capital assets, current liabilities, consultant and customer accounts for $250,000.  Diversinet is entitled to a five-year annual fee of up to $120,000 per year based on the purchaser meeting certain gross profit and net profit criteria.  These amounts will be recorded as income from discontinued operations, if and when received.

The results of DSS have been excluded from continuing operations in the statements of operations and deficit for all periods presented.  The following summarises the impact of discontinued operations on the balance sheet and statement of operations and deficit for all periods presented.



|For the year ended December 31:                | 2006 | 2005      | 2004     
|---------------------------------------------- | ---- | --------- | ---------
|Income Statement                               | $    | $         | $        
|Revenue                                        |     | 453,361   | 4,441,994
|Expenses                                       |     | 820,772   | 4,983,480
|Income (loss) from discontinued operations     |     | (367,411) | (541,486)
|Gain on disposition of discontinued operations |     | 296,551   |         
|Loss from discontinued operations              |     | (70,860)  | (541,486)
|Loss per share from discontinued operations    |     | 0.00      | (0.04)   

Expenses in the loss on disposition of discontinued operations includes the elimination of the related goodwill of $nil (2005 - $392,242, 2004  $525,000).

During the third quarter of 2004, the Company settled a dispute with a former shareholder of DSS and received 50,000 Diversinet common shares (with a fair value of $21,000) and the cancellation of a promissory note payable by the Company of $150,000, which was recorded as a reduction of discontinued expenses in the table above.  Additional future cash consideration of $800,000 receivable based on achievement of certain financial targets was also eliminated.

2.

Capital assets:

|December 31, 2006      | Cost           | Accumulated depreciation and amortization | Net book value
|---------------------- | -------------- | ----------------------------------------- | --------------
|Computer hardware      | $    1,236,368 | $      1,017,847                          | $      218,521
|Computer software      | 513,518        | 447,595                                   | 65,923        
|Furniture and fixtures | 280,867        | 200,971                                   | 79,896        
|Leasehold improvements | 26,821         | 2,438                                     | 24,383        
|                       | $    2,057,574 | $    1,668,851                            | $      388,723



|December 31, 2005      | Cost tst t     | Accumulated depreciation and amortization | Net book value
|---------------------- | -------------- | ----------------------------------------- | --------------
|Computer hardware      | $    1,214,614 | $      928,857                            | $      285,757
|Computer software      | 506,783        | 420,786                                   | 85,997        
|Furniture and fixtures | 269,717        | 182,390                                   | 87,327        
|Leasehold improvements | 158,713        | 144,784                                   | 13,929        
|                       | $    2,149,827 | $    1,676,817                            | $      473,010



3.

Accrued liabilities:

|                  | 2006           | 2005         
|----------------- | -------------- | -------------
|Compensation      | $      252,928 | $      42,256
|Professional fees | 335,731        | 101,973      
|Miscellaneous     | 45,002         | 82,450       
|                  | $      633,661 | $     226,679

4.

Share capital, warrants and common share purchase options:

There are an unlimited number of authorized common shares with no par value.

The following details the changes in issued and outstanding shares, compensation options and warrants:

|                                         | Compensation options and warrants | Common shares
|---------------------------------------- | --------------------------------- | -------------
|                                         | Number                            | Amount       
|Balance, December 31, 2003               | 1,020,404                         | $   1,331,652
|Stock options exercised (a)              |                                  |             
|Private Placement (b)                    | 1,100,000                         | 1,593,710    
|Private Placement (c)                    | 300,000                           | 97,140       
|Acquisition of Caradas (d)               | (100,000)                         | (335,300)    
|Professional services (e)                | 288,000                           | 183,366      
|Warrants cancelled and expired (h)       | (40,000)                          | (39,639)     
|Balance December 31, 2004                | 2,568,404                         | 2,830,929    
|Private Placement (f)                    | 71,250                            | 25,066       
|Acquisition of Caradas (d)               | (100,000)                         | (335,300)    
|Professional services (g)                | 375,000                           | 72,353       
|Warrants cancelled and expired (h)       | (701,404)                         | (92,071)     
|Board compensation (l)                   |                                   |              
|Stock options exercised (a)              |                                  |             
|Balance December 31, 2005                | 2,213,250                         | 2,500,977    
|Private Placement (i)                    | 6,680,001                         | 1,139,741    
|Private Placement (j)                    | 1,634,617                         | 266,616      
|Professional services (k)                | 113,179                           | 25,254       
|Board compensation (l)                   |                                   |              
|Warrants cancelled and expired (h)       | (597,000)                         | (640,756)    
|Employee bonus (m)                       |                                   |              
|Stock options and warrants exercised (a) |                                  |             
|Balance December 31, 2006                | 10,044,047                        | $   3,291,832

Shares issued for other than cash consideration are valued at their market price at the date of agreement for issuance.

(a)

During 2004, 2005, and 2006 the Company granted options to certain employees, officers and directors under a share option plan (note 10), enabling them to purchase common shares of the Company.

(b)

On January 20, 2004, the Company completed a private placement of 1,000,000 common shares and 1,100,000 common share purchase warrants for gross proceeds of $2,000,000.  All the warrants expire on January 15, 2007 with 500,000 vesting immediately and exercisable at $2.00 per share, 350,000 vesting on January 15, 2005 and exercisable at a price of $2.05 and the remaining 250,000 warrants vesting on July 15, 2004 and exercisable at a price of $2.05 per share.  During December 2004, the Company repriced the 350,000 warrants vesting on January 15, 2005 to $0.60 in connection with the financing in (c) below.

(c)

On December 20, 2004, the Company completed a private placement of 6,925,000 common shares and 300,000 common share purchase warrants for gross proceeds of $2,650,000.  Each warrant entitles the holder thereof to acquire one common share at a price of $0.40 per common share for a period of up to three years from December 20, 2004.

(d)

On September 1, 2003, Diversinet acquired 100% of the outstanding shares of Caradas, Inc. The aggregate consideration was 1,417,500 Diversinet common shares and 200,000 share purchase warrants.  The share purchase warrants are exercisable at $2.45 per share for five years.  During 2004, 100,000 share purchase warrants were cancelled and the remaining warrants were repriced to $0.40.  During 2005, the remaining 100,000 share purchase warrants were cancelled and the value transferred to contributed surplus.

(e)

Professional services:

The following chart summarizes the activity during the year ended December 31, 2004:

|                                       | Compensation options and warrants
|-------------------------------------- | ---------------------------------
|                                       | Number                           
|Advisory board consulting services (i) | 25,000                           
|Consulting services (ii)               | 72,000                           
|Consulting services (iii)              | 15,000                           
|Consulting services (iv)               | 18,000                           
|Consulting services (v)                | 38,000                           
|Consulting services (vi)               | 100,000                          
|Consulting services (vii)              | 20,000                           
|                                       | 288,000                          

(i)

On January 16, 2004, the Company entered into an agreement for advisory board consulting services.  In consideration for the services to be rendered in accordance with the agreement, Diversinet issued a three-year warrant terminating on January 30, 2006 to purchase up to 25,000 of our common shares at $2.50 per share in regards to the compensation payable by us for these services.  These warrants expired unexercised.

(ii)

On January 31, 2004, the Company entered into an agreement for public relations services.  In consideration for the services to be rendered in accordance with the agreement, Diversinet issued a two-year warrant terminating on January 30, 2006 to purchase up to 72,000 of our common shares at $2.50 per share in regards to partial compensation payable by us for these services.  These warrants expired unexercised.

(iii)

On April 11, 2004 the Company amended an agreement for consulting services dated August 20, 2003.  As additional consideration for the services to be rendered in accordance with the agreement, Diversinet issued a five-year warrant terminating on April 11, 2009 to purchase up to 15,000 of our common shares at $1.90 per share in regards to the compensation payable by us for these services.

(iv)

On May 1, 2004 the Company entered into an agreement for consulting services.  In consideration for the services to be rendered in accordance with the agreement, Diversinet issued a two-year warrant terminating on May 17, 2006 to purchase up to 18,000 of our common shares at $1.65 per share in regards to the compensation payable by us for these services.  These warrants expired unexercised.

(v)

On September 20, 2004, the Company entered into an agreement for corporate marketing. In consideration for the services to be rendered in accordance with the agreement, Diversinet issued a share purchase warrant terminating on December 31, 2005 to purchase up to 38,000 of our common shares at $0.50 per share in regards to the compensation payable by us for these services.  These warrants expired unexercised.

(vi)

On September 20, 2004, the Company entered into an agreement for sales strategy consulting.  In consideration for the services to be rendered in accordance with the agreement, Diversinet issued a share purchase warrant terminating on December 31, 2005 to purchase up to 100,000 of our common shares at $0.50 per share in regards to the compensation payable by us for these services.  These warrants expired unexercised.

(vii)

On September 22, 2004, the Company entered into an agreement for internal legal services.  In part consideration for the services to be rendered in accordance with the agreement, Diversinet issued a share purchase warrant terminating on January 31, 2006 to purchase up to 20,000 of our common shares at $0.50 per share in regards to the compensation payable by us for these services. These warrants expired unexercised.

(a)

On September 26, 2005, the Company completed a private placement of 5,000,000 common shares and 71,250 common share purchase warrants for gross proceeds of $2,000,000.  Each warrant entitles the holder thereof to acquire one common share at a price of $0.40 per common share for a period of up to three years from September 26, 2005.

(b)

Professional services:

The following chart summarizes the activity during the year ended December 31, 2005:

|                                       | Compensation options and warrants
|-------------------------------------- | ---------------------------------
|                                       | Number                           
|Advisory board consulting services (i) | 125,000                          
|Consulting services (ii)               | 30,000                           
|Consulting services (iii)              | 15,000                           
|Consulting services (iv)               | 30,000                           
|Consulting services (v)                | 50,000                           
|Consulting services (vi)               | 25,000                           
|Consulting services (vii)              | 100,000                          
|                                       | 375,000                          

(i)

On April 1, 2005, the Company issued common share purchase warrants to each of the members of our advisory board.  These warrants vest at a rate of 8.3% per month over a one-year period and expire on December 31, 2006.  Each holder of these warrants is entitled to purchase common shares at $0.66 per share.  During 2006, 25,000 warrants were exercised and the remainder expired unexercised.

(ii)

On March 15, 2005, the Company entered into an agreement for consulting services.  In consideration for the services to be rendered in accordance with the agreement, a warrant was issued that is exercisable from November 20, 2005 to March 20, 2006 to purchase up to 30,000 of our common shares at $0.80 per share. These warrants expired unexercised.

(iii)

On July 21, 2005, the Company entered into an agreement for consulting services.  In consideration for the services to be rendered in accordance with the agreement, a warrant was issued that is exercisable from April 20, 2006 to July 20, 2006 to purchase up to 15,000 of our common shares at $0.62 per share. These warrants expired unexercised.

(iv)

On July 21, 2005, the Company entered into a consulting agreement for consulting services.  In consideration for the services to be rendered in accordance with the agreement, a warrant was issued that is exercisable from February 28, 2008 to May 31, 2008 to purchase up to 30,000 of our common shares at $0.71 per share.

(v)

On September 8, 2005, the Company entered into an agreement for consulting services.  In consideration for the services to be rendered in accordance with the agreement, a warrant was issued that is exercisable from September 7, 2006 to September 7, 2008 to purchase up to 50,000 of our common shares at $0.40 per share.

(vi)

On September 15, 2005, the Company entered into an agreement for professional services of a technical consultant.  In consideration for the services to be rendered in accordance with the agreement, a warrant was issued that is exercisable from May 15, 2006 to September 15, 2006 to purchase up to 25,000 of our common shares at $0.40 per share.  These warrants expired unexercised.

(vii)

On July 30, 2005 the Company entered into an agreement for professional services.  In consideration for the services to be rendered in accordance with the agreement, a warrant was issued that is exercisable from July 30, 2005 to July 30, 2006 to purchase up to 100,000 of our common shares at $0.63 per share.  These warrants expired unexercised.

(a)

Amount related to warrants expiring during the period unexercised.  The value of warrantsthat have vested prior to the cancellation or expiration date has been reclassified to contributed surplus.

(b)

On June 30, 2006, the Company completed a private placement of 6,680,001 units, at $0.60 per unit, for gross proceeds of $4,008,000.  Each unit is comprised of one common share, one-half common share purchase warrant at $0.75 and one-half common share purchase warrant at $0.90.  Each whole warrant will be exercisable to purchase one common share and expire on June 30, 2008.  The Company allocated $1,139,741 of the net proceeds to the warrants and $2,868,000 less costs of 19,741 to share capital based on their estimated relative fair value.

(c)

On July 26, 2006, the Company completed a private placement of 1,538,463 units, at $0.65 per unit, for gross proceeds of $1,000,000 and issued 96,154 units for consulting services related to the private placement.  Each unit is comprised of one common share and one common share purchase warrant.  The warrant will be exercisable to purchase one common share for each whole warrant at a price of $1.00 and expire on July 26, 2008.  The Company allocated $266,616 of the net proceeds to the warrants and $754,000, less costs of $31,330, to share capital based on their estimated relative fair value.

(d)

Professional services:

The following chart summarizes the activity during the year ended December 31, 2006:

|                         | Compensation options and warrants | Common shares
|------------------------ | --------------------------------- | -------------
|                         | Number                            | Amount       
|Consulting services (i)  | 95,179                            | $  20,873    
|Consulting services (ii) | 18,000                            | 4,381        
|                         | 113,179                           | $  25,254    

(i)

On January 1, 2006, the Company entered into an agreement for public relations services.  In consideration for the services to be rendered in accordance with the agreement, a combination of common shares and common share purchase warrants were issued each quarter.  Of the common share purchase warrants issued, 30,000 are exercisable at $1.00 and vested on March 30, 2006, 25,000 are exercisable at $1.20 and vested on June 30, 2006, 21,429 are exercisable at $1.40 and vested on September 30, 2006 and the remaining 18,750 are exercisable at $1.60 and vested on December 31, 2006.  These common share purchase warrants expire on December 31, 2007.

(ii)

On September 6, 2006, the Company entered into an agreement for marketing consulting services.  In consideration for the services to be rendered in accordance with the agreement, a warrant to purchase 25,000 common shares at $0.56 was issued with equal vesting on each of October 6, November 6 and December 6, 2006.  During 2006, 7,000 warrants were exercised.  This warrants expire on September 6, 2007.

(a)

On May 12, 2005 and on July 31, 2006, the Company issued common shares to each non-management board member in lieu of cash compensation.

(b)

During 2006 common shares were issued to some employees in lieu of cash bonuses.

1.

Basic and diluted loss per share:

Common shares issuable upon the exercise of options and warrants that could dilute basic loss per share in the future were not included in the computation of diluted loss per share because to do so would have been anti-dilutive for all periods presented.  Anti-dilutive options amounted to 2,174,349 at December 31, 2006, 2,409,873 at December 31, 2005 and 1,178,486 at December 31, 2004.  Anti-dilutive warrants amounted to 10,044,047 at December 31, 2006, 2,213,250 at December 31, 2005 and 2,568,404 at December 31, 2004 respectively.

2.

Income taxes:

The tax effects of significant temporary differences representing future tax assets is as follows:

|                                                     | 2006         | 2005        
|---------------------------------------------------- | ------------ | ------------
|Future tax assets:                                   |              |             
|Operating loss carryforwards                         | $10,429,483  | $11,577,330 
|Capital loss carryforwards                           | 747,058      | 818,264     
|Share issue costs                                    | 118,643      | 155,117     
|Research and development costs                       | 3,382,463    | 3,612,437   
|Capital assets, accounting basis less than tax basis | 5,886,872    | 6,384,259   
|                                                     | 20,564,518   | 22,547,407  
|Valuation allowance                                  | (20,564,518) | (22,547,407)
|Net future tax assets                                | $           | $          

In assessing the realizability of future tax assets, management considers whether it is more likely than not that some portion or all of the future tax assets will not be realized.  The ultimate realization of future tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible.  Management considers projected future taxable income, uncertainties related to the industry in which the Company operates and tax planning strategies in making this assessment.

At December 31, 2006, the Company has non-capital losses available for carryforward for Canadian income tax purposes amounting to $28,292,000.  These losses expire in the following fiscal years:

|2007 | 12,084,000   
|---- | -------------
|2008 | 3,620,000    
|2009 | 411,000      
|2010 | 4,401,000    
|2014 | 2,708,000    
|2015 | 3,460,000    
|2026 | 1,608,000    
|     | $  28,292,000

The Company also has non-capital losses available for carryforward for United States income tax purposes amounting to  $2,803,000, expiring between 2018 and 2026.

3.

Segmented information:

The Company operates in a single reportable operating segment.  This segment derives its revenue from the sale of secured wireless and identity management solutions and related products and services.  As at December 31, 2006, 100% (2005 - 100%, 2004 - 75%) of the capital assets were located in Canada and nil% (2005 - nil%, 2004 - 25%) were located in the United States.

A summary of sales to major customers that exceeded 10% of total sales and the approximate amount due from these customers during each of the years in the three-year period ended December 31, 2006 are as follows:

|           |      | Sales |      | Accounts Receivable
|---------- | ---- | ----- | ---- | -------------------
|           | 2006 | 2005  | 2004 | 2006               
|Customer 1 | 56%  | 0%    | 0%   |                   
|Customer 2 | 11%  | 0%    | 0%   | $50,000            
|Customer 3 | 11%  | 18%   | 0%   |                   
|Customer 4 | 0%   | 29%   | 18%  |                   
|Customer 5 | 0%   | 38%   | 46%  |                   

Revenue is attributable to geographic location based on the location of the customer during each of the years in the three-year period ended December 31, 2006 are as follows:

|              | 2006            | 2005            | 2004          
|------------- | --------------- | --------------- | --------------
|Sales:        |                 |                 |               
|United States | $     1,396,543 | $      801,700  | $    2,334,510
|Canada        | 33,872          | 99,680          | 116,526       
|Asia          | 203,550         | 199,724         | 41,858        
|Other         | 33,000          |                | 110,000       
|              |                 | $     1,666,965 | $    1,101,104

During each of the years in the three-year period ended December 31, 2006 revenue is attributable to products as follows:

|                    | 2006            | 2005           | 2004          
|------------------- | --------------- | -------------- | --------------
|Sales:              |                 |                |               
|Consulting services | $     1,576,965 | $    1,101,104 | $    2,274,007
|Licensing           | 90,000          |               | 328,887       
|                    | $     1,666,965 | $    1,101,104 | $    2,602,894

4.

Commitments and contingencies:

(a)

Litigation:

Management is of the opinion that the claims listed below are without merit and will not materially impact the Company.  As a result, no provision for loss has been made in these consolidated financial statements.

(i)

During fiscal 2000, the Company and its wholly owned Barbados subsidiary, The Instant Publisher Ltd., were sued by a company that alleged that the Company breached a dealer agreement entered into in 1995 by the Companys former printing business and is seeking damages of $1,533,950 and damages of $25,000,000 for loss of reputation and loss of opportunity, pre-judgment and post-judgment interest, and costs.  Management believes that a loss arising from this matter is probable and that the amount can reasonably be estimated.  The Company has recorded an amount for the liability based on its current estimate of the settlement amount.  As additional information becomes available, any potential liability related to this matter is assessed and the estimates will be revised accordingly.  Based on the currently available information, management believes that the ultimate outcome of this matter, will not have a material adverse effect on our financial position or overall trends in results of operations.

(ii)

In addition to the above, in the ordinary course of business, the Company and its subsidiaries have legal proceedings brought against them.

(b)

Lease commitments:

Total future minimum lease payments including operating costs are as follows:

|2007 | 214,570       
|---- | --------------
|2008 | 208,251       
|2009 | 202,483       
|2010 | 202,483       
|2011 | 202,483       
|2012 | 67,494        
|     | $    1,097,764

Rental expense was $155,000 for the year ended December 31, 2006 (2005 - $158,000, 2004 - $153,000).

5.

Share option plan:

The Company grants options to certain employees, officers, directors and consultants under a share option plan (the Plan), enabling them to purchase common shares of the Company.  The exercise price of an option under the Plan may not be less than the current market price of common shares on the day immediately proceeding the day the share option was granted.  The Plan provides that the number of common shares reserved for issuance under the Plan shall not exceed 3,705,127 common shares (being 4,148,538 options reserved for issuance less 443,411 exercised to date).  During 2005, the Company reduced the stock option vesting period from three years to two years (which has correspondingly shortened the expense amortization period) and also started to compensate Directors with stock grants or cash and option grants.  This has increased compensation expense.  As at December 31, 2006, the number of common shares reserved for future issues of stock options amounts to 1,530,778.

Assumptions used when valuing the options and warrants at their date of grant using the Black-Scholes option pricing model include: risk-free interest rate of 4% (2005  3%, 2004  3%), estimated life of five years, expected divided yield of 0% and average volatility of 120% (2005  150%, 2004  150%).

The following table summarizes information about stock options outstanding at December 31, 2006:

|Options outstanding     |                    | Options vested                                     
|----------------------- | ------------------ | ---------------------------------------------------
|Range of exercise price | Number outstanding | Weighted average remaining contractual life  years
|$0.37  $0.60           | 1,582,414          | 3.27                                               
|$0.62  $1.50           | 180,297            | 0.87                                               
|$1.51  $6.10           | 411,638            | 1.66                                               
|                        | 2,174,349          | 2.86                                               



Changes for the employee stock option plan during the year ended December 31, 2006 were as follows:

|                                                               | Year ended 2006  |                                 | Year ended 2005
|-------------------------------------------------------------- | ---------------- | ------------------------------- | ---------------
|                                                               | Number of shares | Weighted average exercise price |                
|Options outstanding, beginning of year                         | 2,409,873        | $    0.98                       |                
|Options granted                                                | 740,661          | 0.43                            |                
|Options exercised                                              | (194,875)        | 0.40                            |                
|Options cancelled                                              | (781,310)        | 1.03                            |                
|Options outstanding, end of year                               | 2,174,349        | 0.83                            |                
|Options exercisable, end of year                               | 1,784,036        | 0.91                            |                
|Weighted average fair value of options granted during the year |                  | $  0.39                         |                

6.

Financial instruments and risk management:

The Company is exposed to the following risks related to financial assets and liabilities:

(a)

Currency risk:

The Company is subject to currency risk through its activities in Canada, United Kingdom, Europe and Asia.  Unfavourable changes in the exchange rate may affect the operating results of the Company.

The Company does not actively use derivative instruments to reduce its exposure to foreign currency risk.  However, dependent on the nature, amount and timing of foreign currency receipts and payments, the Company may enter into forward exchange contracts to mitigate the associated risks.  The Company has not entered into such contracts at December 31, 2006 and 2005.

(b)

Fair values:

The fair values of the Companys financial instruments approximate their carrying amounts due to their short-term nature.

(c)

Credit risk:

Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of cash equivalents, short-term investments and accounts receivable.  Cash equivalents and short-term investments are maintained at high-quality financial institutions.

The Company generally does not require collateral for sales on credit.  The Company closely monitors extensions of credit.  Management assesses the need for allowances for potential credit losses by considering the credit risk of specific customers, historical trends and other information.

Valuation Accounts and Reserves:

|                                | 2006                 | 2005                 | 2004           
|------------------------------- | -------------------- | -------------------- | ---------------
|Allowance for Doubtful Accounts |                      |                      |                
|Opening balance                 | $                  - | $      218,500       | $       132,500
|Write offs                      | -                    | (218,500)            | -              
|Additions                       | 20,000               | -                    | 86,000         
|Closing balance                 | $        20,000      | $                  - | $       218,500

Additions to the allowance to doubtful accounts are charged to the income statement through the bad debt expense as part of the general and administrative expenses.

7.

Related party transactions:

Related party transactions are in the normal course of operations and are measured at the exchange amount, which is the amount established and agreed to by the related parties.

As part of the June 2006 private placement, Albert Wahbe acquired 4,600,000 units.  Albert Wahbe, one of our directors as of July 2006, owns 4,700,000 common shares and 4,600,000 common share purchase warrants representing approximately 24% of the issued and outstanding common shares of the Company, assuming the exercise of such warrants.  Mr. Wahbe also entered into a performance based consulting agreement to provide sales and business development services for the Company, during 2006 he received $10,000 relating to this agreement.

As part of the June 2006 private placement, Lakefront Partners, LLC acquired 666,667 units.  As well, during the September 2005 private placement, Lakefront Partners, LLC acquired 725,000 common shares.  In 2004 we completed two financings in which Lakefront Partners, LLC and James B. Wigdale, Jr. participated.  These units were acquired at the same price and terms as unrelated investors.  James Wigdale, Jr., one of our directors, controls Lakefront Partners, LLC.  As at December 31, 2006, Lakefront beneficially owns 3,909,462 common shares and 666,667 common share purchase warrants and Mr. Wigdale owns 380,000 common shares and 1,400,000 common share purchase warrants, together representing approximately 18% of the issued and outstanding common shares of the Company, assuming the exercise of such warrants.

A former member of our Board of Directors, received consideration (while a Director) relating to services performed during the 2006 year of 100,000 share purchase warrants (exercisable at $0.63 per common share) valued at $4,717 relating to consulting services performed for the company.

Diversinets CEO is a member of the board of directors of the purchaser of the DSS asset agreement.

8.

Reconciliation of Canadian and United States generally accepted accounting principles (GAAP):

The consolidated financial statements are prepared in accordance with Canadian generally accepted accounting principles.  Material differences between Canadian and United States generally accepted accounting principles are described below.

|                                                 | 2006          | 2005          | 2004         
|------------------------------------------------ | ------------- | ------------- | -------------
|Share capital:                                   |               |               |              
|Canadian GAAP                                    | $58,414,036   | $54,347,652   | $52,445,135  
|Elimination of reduction of share capital (a)    | 30,089,054    | 30,089,054    | 30,089,054   
|U.S. GAAP                                        | $88,503,090   | $84,436,706   | $82,534,189  
|Deficit and comprehensive loss:                  |               |               |              
|Canadian GAAP                                    | $(59,745,704) | $(56,294,987) | $(49,185,491)
|Elimination of reduction of share capital (a)    | (30,089,054)  | (30,089,054)  | (30,089,054) 
|Compensation expense (b)(i)                      | (991,696)     | (991,696)     | (991,696)    
|Compensation expense (b)(ii)                     | 1,016,799     | 1,016,799     | 577,549      
|U.S. GAAP                                        | $(89,809,655) | $(86,358,938) | $(79,688,692)
|Consolidated statements of loss:                 |               |               |              
|Loss under Canadian GAAP                         | $(3,450,717)  | $(7,109,496)  | $ (7,516,842)
|Compensation expense (b)(ii)                     | -             | 439,250       | 577,549      
|Loss under U.S. GAAP                             | $(3,450,717)  | $(6,670,246)  | $ (6,939,293)
|Basic and diluted loss per share under U.S. GAAP | $(0.12)       | $(0.32)       | $(0.57)      
|Comprehensive loss under U.S. GAAP               | $(3,450,717)  | $(6,670,246)  | $ (6,939,293)

(a)

Share capital and deficit:

On March 1, 1999, the shareholders approved a resolution to reduce the stated capital of the Company by $30,089,054 to eliminate the deficit as at October 31, 1999.  Under Canadian GAAP, a reduction of the carrying amount of share capital of outstanding common shares is allowed with a corresponding offset to deficit.  This reclassification, which the Company made in 2000 to eliminate the deficit that existed at October 31, 1999, did not meet the criteria specified by U.S. GAAP and results in an increase to share capital with a corresponding increase in deficit of $30,089,054.

(b)

Compensation expense:

Effective January 1, 2006, the Company is required to apply the provisions of FASB Statement No. 123R (SFAS 123R), which requires all share based payments to be recognized in the financial statements based on their fair values using either a modified  prospective or modified  retrospective transition method.  The company has adopted this standard using the modified - prospective method and, therefore recognizes share-based compensation for any new share-based awards and awards modified, repurchased or cancelled after the required effective date, January 1, 2006.  Under SFAS 123 R, the company is required to determine the grant date fair value of the stock-based awards grated to employees. The company is continuing to use the Black-Scholes option pricing model to value these options.  The related grant date fair value is subsequently recognized as stock-based compensation expense over the requisite service period.  As a result, stock-based compensation expense recognized under U.S. GAAP after December 31, 2005 equals the amount recognized under Canadian GAAP when the fair value method has been applied since 2003.  Previously, the Company adjusted compensation cost for actual forfeitures at the time forfeitures occurred. SFAS 123R requires the company to estimate forfeitures as part of the initial measure of the grant date fair value of the award.  The cumulative effect of the change in accounting policy for the adjustment related to the forfeitures for the prior periods is not material at January 1, 2006.

(c)

Notes to consolidated financial statements:

In order to comply with U.S. GAAP, the following note to the consolidated financial statements would need to be added:

Recent accounting pronouncements:

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (SFAS 154), which replaces Accounting Principles Board Opinion No. 20, Accounting Changes, and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS 154 provides guidance on the accounting for and reporting of changes in accounting principles and error corrections. SFAS 154 requires retrospective application to prior periods financial statements of voluntary changes in accounting principle and changes required by new accounting standards when the standard does not include specific transition provisions, unless it is impracticable to do so. Certain disclosures are also required for restatements due to correction of an error. SFAS 154 is effective for accounting changes and corrections of errors, made in fiscal years beginning after December 15, 2005. The impact that the adoption of SFAS 154 will have on the Companys results of operations and financial condition will depend on the nature of future accounting changes and the nature of transitional guidance provided in future accounting pronouncements.

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