UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-KSB

(Mark One)

þANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2007

OR

¨ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number: 000-50561

ENIGMA SOFTWARE GROUP, INC.

(Name of Small Business Issuer in Its Charter)

Delaware (State or other jurisdiction of incorporation or organization)	20-2675930 (I.R.S. Employer Identification No.)
150 Southfield Avenue, Suite 1432, Stamford, CT	06902
(Address of principal executive offices)	(Zip Code)

(888) 360-0646

(Issuer's Telephone Number)

Securities registered under Section 12(b) of the Exchange Act: None

Securities registered under Section 12(g) of the Exchange Act:

Title of Each Class

Common Stock, $.001 Par Value

Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. ¨

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

Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB.þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No þ

State issuer’s revenues for its most recent fiscal year. $3,413,967

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was sold, or the average bid and asked prices of such common equity, as of a specified date within the past 60 days. $95,811 as of March 26, 2008.

APPLICABLE ONLY TO CORPORATE REGISTRANTS

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date. 6,387,372 shares of Common Stock, $0.001 par value, outstanding as of March 26, 2008.

Transitional Small Business Disclosure Format (Check One): Yes ¨ No þ

ENIGMA SOFTWARE GROUP, INC.

TABLE OF CONTENTS TO ANNUAL REPORT

ON FORM 10-KSB

YEAR ENDED DECEMBER 31, 2007

	PART I
Item 1.	Description of Business	3
Item 2.	Description of Property	5
Item 3.	Legal Proceedings	5
Item 4.	Submission of Matters to a Vote of Security Holders	5

	PART II
Item 5.	Market for Common Equity, Related Stockholder Matters and Small Business Issuer Purchases of Equity Securities	6
Item 6.	Management’s Discussion and Analysis or Plan of Operation	7
Item 7.	Financial Statements	23
Item 8.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	23
Item 8A.	Controls and Procedures	23
Item 8B.	Other Information	24

	PART III
Item 9.	Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16 (a) of the Exchange Act	25
Item 10.	Executive Compensation	27
Item 11.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	30
Item 12.	Certain Relationships and Related Transactions, and Director Independence	31
Item 13.	Exhibits	31
Item 14.	Principal Accountant Fees and Services	31

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PART I

Item 1. Description of Business.

Enigma Software Group, Inc. (“Enigma” or the “Company”), is a Delaware corporation, headquartered in Connecticut, that was formed in 2005 and is the surviving corporation of a reverse takeover with Maxi Group, Inc. (“Maxi”); however, the business of the Company actually commenced in 1999. The Company is a developer of security software products designed to give customers information and control over the programs installed on their computers in an automated and easy-to-use way, thereby enhancing transparency and user-control. The Company sells and distributes its software products, which are downloadable, over the Internet.

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

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

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

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

The Company presently employs eight persons on a full-time basis.

Principal Product and its Market:

The Company's principal product SpyHunter® (“SpyHunter”) is an in-house developed software utility program that is used to scan and remove Spyware and Adware from customers’ computers and is marketed under the name SpyHunter. The Company estimates that during the years ended December 31, 2007 and 2006, its expenditures for research and development related to SpyHunter and other products amounted to $105,000 and $138,000, respectvely.

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Spyware and other parasitic programs are installed on computers without the computer owners' knowledge or consent. Spyware programs allow their makers to monitor Internet browsing patterns, inundate computers with "pop-up" ads, transmit sensitive user data (including personal and financial information), and more. Many people are familiar with freeware, shareware, cookies, media players, interactive content and file sharing, but what they may not realize is that some of the aforementioned may contain hidden code or components that allow the developers of these applications and tools to collect and disseminate information about those using them.

To protect our customers from Spyware and other threats, SpyHunter scans the files on a computer's hard drive, as well as Windows registry settings. SpyHunter then compares these files against our spyware database. SpyHunter's database consists of complete component profiles (files, registry settings, MD5 file signatures, and other diagnostic information) of various adware applications, spyware programs, backdoor trojans, browser hijackers, tracking cookies, worms, keyloggers, etc. that commonly afflict computers connected to the Internet. If SpyHunter's scanning process is unable to detect a suspicious threat, the customer has the option to rapidly generate a diagnostic report. SpyHunter will then transmit this information directly to our spyware helpdesk database, which is supervised by our support department. Using this updated information, the customer is now able to successfully detect and remove the parasitic program which is compromising their system.

Spyware makers consistently update and alter their programs to avoid detection by anti-Spyware utilities like SpyHunter. For this reason, SpyHunter's spyware database is updated regularly using the collective diagnostic reports generated through our user base, coupled with the spyware component profiles assembled through our technical team's active research.

The Company operates in an extremely competitive sector of the software development industry. The market for our products and services is dynamic and subject to frequent technological changes. The intensity of this competition and the pace of change have steadily increased as customers have become more educated as to the threats of spyware, adware and malware. A number of companies offer freeware products that provide some of the functionality of our products, and as a result, our products have been affected by the availability of such freeware products, making it difficult for us to maintain our competitive position. Many of our competitors have significantly greater financial, marketing, service, support, technical and other resources available to them. Competitors with greater resources are able to undertake more extensive marketing campaigns, adopt more aggressive pricing policies and make more attractive offers to potential employees, distributors, resellers or other strategic partners. We expect additional competition from other established and emerging companies as the market for our products continues to develop.

Distribution Methods of the Product:

SpyHunter is downloaded over the Internet upon authorization of the customer’s credit card issuer. It is not sold in retail stores, but copies may be ordered on CD format from the Company’s website. Most users have historically found Enigma’s websites through advertisements purchased by the Company from Internet advertising companies and other advertising networks and search engines. Trial versions of SpyHunter are also available on download sites such as download.com and tucows.com. The Company also operates an affiliate program where other website operators can become resellers of Enigma products on a pay-for-performance basis. Most of the Company’s marketing agreements are short term purchase orders that either party can terminate, while other marketing is based on automated auctions for search engine advertising. None of the Company’s marketing agreements generate significant revenue for the Company.

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Trademarks and Patents:

SpyHunter® (“SpyHunter”), is the Company’s owned trademark, which was registered in the United States of America on May 16, 2006. The Company has no other trademarks, expect for “Enigma Software Group” and “Applications for the Masses”, each of which is a Common Law Trademark. The Company has no patents.

Item 2. Description of Property.

At December 31, 2007 and 2006, the Company had no significant fixed assets, having sold some of its excess assets during the year ended December 31, 2005, as employees were terminated, and having written down in that year, any remaining assets to a negligible value due to an impairment loss resulting from the Company vacating its office space at 17 State Street, New York, New York.The lease for that office space, which was entered into during 2004, was an operating lease for 6,236 square feet of office space requiring monthly rent of $16,629 and which was due to expire on November 30, 2007. In early 2006, the Company moved its offices to Stamford CT, where until mid 2007 it occupied space within an office suite complex, for which there was no lease. Rather the Company entered into an office service agreement with the operator of the office suite, giving the Company a license to use designated offices as well as business center facilities and services.

The office services agreement covered services, such as telephone, heat, electricity, furniture, lighting, coffee, water, restroom facilities, reception, conference facilities, mailbox, parking and office cleaning. The office services agreement was in effect until August 31, 2007, before which date the Company vacated the premises. On February 27, 2007, the Company signed a 15 month lease at a nearby facility at a lower cost, effective March 1, 2007. The Company presently occupies this space under a lease that expires in May 2008 and which the Company believes will be renewed for an additional 12 month period at that time.

The Company believes that this office space will provide sufficient space for its operations in the near future.

The Company does not have a policy with respect to investments in (i) real estate or interests in real estate, (ii) investments in real estate mortgages, or (iii) securities of or interests in persons primarily engaged in real estate activities, as the Company does not invest in such assets in the ordinary course of its business.

Item 3. Legal Proceedings.

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

Item 4. Submission of Matters to a Vote of Security Holders.

No matter was submitted to a vote of the security holders during the fourth quarter of the fiscal year covered by this report.

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PART II

Item 5. Market for Common Equity, Related Stockholder Matters and Small Business Issuer Purchases of Equity Securities.

Market Information

As of March 26, 2008, the most recent trading day on which shares of the Company were traded, the Company’s shares of common stock, par value $0.001 per share (the “Common Stock”) were quoted on the Nasdaq Over the Counter Bulletin Board (the “OTCBB”), under the trading symbol ENGM, at the closing bid price of $0.015 per share.

.

The following table gives the range of high and low bid prices for the Company’s Common Stock, during the years ended December 31, 2006 and 2007:

Fiscal 2006*	Low		High
First Quarter	$	0.06	$	0.25
Second Quarter	$	0.05	$	0.09
Third Quarter	$	0.04	$	0.07
Fourth Quarter	$	0.02	$	0.15
Fiscal 2007*
First Quarter	$	0.05	$	0.59
Second Quarter	$	0.20	$	0.65
Third Quarter	$	0.13	$	0.40
Fourth Quarter	$	0.02	$	0.25

*The high and low prices listed have been rounded up to the next highest two decimal places.

The market price of our Common Stock is subject to significant fluctuations in response to variations in our quarterly operating results, general trends in the market for the products we distribute, and other factors, over many of which we have little or no control. Broad market fluctuations, as well as general economic, business and political conditions, may adversely affect the market for our Common Stock, regardless of our actual or projected performance.

Holders

Our common shares are not widely held. As of March 24, 2008, there were 27 holders of record of the Company’s Common Stock. Of the Company’s 6,387,372 shares outstanding, 4,728,676 or approximately 74% were held in street name. For those shares held in street name, there were 214 NOBO’s, Non-Objecting Beneficial Owners, as of March 5, 2008, accounting for in excess of 3.4 million shares.

Dividends

The Company has not declared any cash dividends within the past two years on its Common Stock. The Company does not anticipate or contemplate paying dividends in the foreseeable future. It is the present intention of management to utilize available funds, if any, for the development of the Company’s business.

Securities Authorized for Issuance Under Equity Compensation Plans

	Number of securities to be issued upon exercise of outstanding options, warrants and rights		Weighted-average exercise price of outstanding options, warrants and rights		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
	(a)		(b)		(c)
Equity compensation plans approved by security holders		8,570,001	$	0.20		429,999
Equity compensation plans not approved by security holders		none		none		none
Total		8,570,001	$	0.20		429,999

Sales of Equity Securities

On June 28, 2006, the Company sold Debentures to Dutchess Private Equities Fund, LP and Dutchess Private Equities Fund, II, LP (collectively “Dutchess”) in the principal amount of One Million dollars ($1,000,000), convertible into shares of Common Stock of the Company. The issuance and sale of the Debentures is intended to be exempt from registration by virtue of Section 4(2) of the 1933 Act and the provisions of Regulation D thereunder, based on the Company’s belief that the offer and sale of the Debentures did not involve a public offering, as all of the purchasers were “accredited” investors and no general solicitation was involved in the offering.

On June 28, 2006, the Company issued 7,433,988 shares of its Preferred Stock to Colorado Stark and Alvin Estevez in exchange for 12,052,001 shares of such holders shares of the Company’s Common Stock. The issuance of the Preferred Stock is intended to be exempt from registration by virtue of Section 4(2) of the 1933 Act and the provisions of Regulation D thereunder, based on the Company’s belief that the issuance of the Preferred Stock did not involve a public offering, as all of the purchasers were “accredited” investors and no general solicitation was involved in the offering.

On July 20, 2007, the Company entered into a new Debenture Agreement (the “New Debenture Agreement”) with its secured lender, Dutchess Private Equities Fund, Ltd. as successor in interest to Dutchess Private Equities Fund, LP & Dutchess Private Equities Fund, II, LP (“Dutchess”) and immediately closed the transaction pursuant to which the Company issued secured debentures, convertible into shares of common stock of the Company, in the principal amount of five hundred thousand dollars ($500,000) (the “New Debentures”). The New Debentures bear interest at 12% per annum and are due in July of 2012. Interest only payments are due on the New Debentures until their maturity. The New Debentures are convertible into shares of common stock of the Company at the lesser of seven cents ($.07), or seventy-five percent (75%) of the lowest closing bid price of the Company’s common stock during the twenty (20) trading days immediately preceding a notice of conversion.

At the same time, the Company entered into a Warrant Agreement (the “New Warrant Agreement” or the “New Warrant”) with Dutchess, whereby the Company issued to Dutchess warrants to purchase 25,000,000 shares of the common stock of the Company at the exercise price of $0.01 per share of common stock. The term of the New Warrant is five years and it contains registration rights.

In consideration for the issuance of the New Debentures and the New Warrant, Dutchess agreed that all liquidated damages due from the Company to Dutchess, which were estimated to be approximately $1,000,000 at that time, plus additional daily accruals, resulting principally from the Company’s failure to have its then recent registration statement on Form SB-2 declared effective by the Securities and Exchange Commission prior to the deadline stipulated in the loan documents between the Company and Dutchess, and the inability of the Company to make the required loan principal payments resulting from such delay in effectiveness, were declared settled.

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Item 6. Management's Discussion and Analysis or Plan of Operation.

This Management'sDiscussion and Analysis or Plan of Operation (MD&A) contains forward-looking statements that involve known and unknown risks, significant uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed, or implied, by those forward-looking statements. You can identify forward-looking statements by the use of the words “may,” “will,” “should,” “could,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “intends,” “potential,” “proposed,” or “continue” or the negative of those terms. These statements are only predictions. In evaluating these statements, you should specifically consider various factors, including the risk factors outlined below. These factors may cause our actual results to differ materially from any forward-looking statements. Although we believe that the exceptions reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. We undertake no obligation to revise or update publicly any forward-looking statements for any reason.

Risk Factors

Our financial condition, business, operation and prospects involve a high degree of risk. You should carefully read and consider the risks and uncertainties described below as well as the other information in this report before deciding to invest in our Company. We consider these risks to be significant to your decision whether to invest in our Common Stock at this time. If any of the following risks actually occur, our business, results of operations and financial condition could be seriously harmed, the trading price of our Common Stock could decline and you may lose all or part of your investment.

Risks Related to Our Business and Industry

As of December 31, 2007 and 2006, there was substantial doubt about our ability to continue as a going concern.The Company may not be able to continue its operations and the financial statements do not include any adjustments that might result from the outcome of this uncertainty.

As of December 31, 2007 and 2006, the Company’s independent public accounting firm issued a “going concern opinion” wherein they stated that the accompanying financial statements were prepared assuming the Company will continue as a going concern. The Company did not generate sufficient cash flows from revenues during the years ended December 31, 2007 and 2006 to fund its operations. Also, as of December 31, 2007, the Company had negative net working capital of approximately $3.7 million. In addition, as discussed in Note O of the Notes to Consolidated Financial Statements, the Company was in default of its debenture agreements. These matters raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

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The Company continues to have negative cash flow and could run out of cash in one months or less.

Due to the default and the recourse rights of the Company’s lender, the Company’s working capital resources could be depleted within one month or less. If this situation were to occur, the Company would require additional funds of approximately $1,700,000 to pay its lender and cure the default. Please refer to Liquidity and Capital Resources in Management’s Discussion and Analysis of Financial Condition and Results of Operations.

If we do not continue to innovate and provide products and services that are useful to users, we may not remain competitive, and our revenues and operating results could suffer.

Our success depends on providing products and services that people use for a high quality Internet experience. Our competitors are constantly developing innovations in web search, online advertising and providing information to people. As a result, we must continue to invest significant resources in new product development in order to introduce new high-quality products and services that people will use. If we are unable to predict user preferences or industry changes, or if we are unable to modify our products and services on a timely basis, we may lose users and advertisers. Our sales will decline also if our innovations are not responsive to the needs of our users and advertisers, are not appropriately timed with market opportunity, or are not effectively brought to market.

We have a material weakness in internal controls due to a limited segregation of duties, and if we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud. As a result, current and potential stockholders could lose confidence in our financial reporting which could harm the trading price of our stock.

Effective internal controls are necessary for us to provide reliable financial reports and prevent fraud. Inferior internal controls could cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our stock. With only eight employees at the Company, of which only one employee is involved in the financial function full time and one employee part-time, there is very limited segregation of duties, which the Company has identified as a material weakness in our internal controls. However, we have implemented procedures to both limit access to bank accounts and to segregate the approval of invoices from disbursements of cash, but total segregation of duties is not practicable. As of December 31, 2007, the Company’s foreign subsidiary, UAB Enigma Software LT, (”UAB Enigma”) had 16 employees, none of whom are involved in the financial function. UAB Enigma uses an outside accounting service for recording, processing, summarizing and reporting transactions.

Our corporate culture has contributed to our success, and if we cannot maintain this culture as we grow, our business may be harmed as we might become less responsive to the market conditions that affect our products.

We believe that a critical contributor to our success has been our corporate culture, which we believe fosters innovation, creativity and teamwork. As our organization grows, and we are required to implement more complex organizational management structures, we may find it increasingly difficult to maintain the beneficial aspects of our corporate culture. This could negatively impact our future success.

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Existing or new legislation could expose us to substantial liability, restrict our ability to deliver services to our users, limit our ability to grow and cause us to incur significant expenses in order to comply with such laws and regulations.

There are a number of emerging initiatives in the computer software industry. One example is the Consumer Protection Against Computer Spyware Act that provides protection for consumers against certain types of software. The aim of most of the emerging initiatives is to define which practices in the software industry are acceptable, which practices are violations of existing law, and what will require new laws. This type of legislation could impact us negatively in several ways, primarily because it would reduce the proliferation of Spyware, thereby making it more difficult to market an anti-Spyware software removal product.

During 2005, legislation pertaining to Spyware was enacted in 12 states, and is being considered in 28 additional states. This type of legislation imposes severe penalties for companies who are in the business of distributing and installing Spyware. Typically companies will be charged fines ranging from $1,000 to $1,000,000 for each instance of installing Spyware. In some states such as New York, in addition to sharp penalties, there are also criminal charges that can be brought for installing Spyware.

This type of legislation could impact our business negatively because it would reduce the proliferation of Spyware, thereby making it more difficult to market an anti-Spyware software removal product.

Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products, services and brand.

The technology and software we have developed, which underlie our products and services, are very important to us. Our proprietary products are not protected by patents. However, SpyHunter is protected as a registered trademark. To further protect our intellectual property rights, we license our software products and require our customers to enter into license agreements that impose restrictions on their ability to use the software or transfer it to other users. Additionally, we seek to avoid disclosure of our trade secrets through a number of means, including, but not limited to, requiring those persons with access to our proprietary information to execute confidentiality agreements with us, and by restricting access to our source code. In addition, we protect our software, documentation, templates and other written materials under trademark, trade secret and copyright laws. Even with all of these safeguards, there can be no assurance that such precautions will provide meaningful protection from competition or that competitors will not independently be able to develop similar technology. The copyright, trademark and trade secret laws, which are a significant source of protection for our intellectual property, offer only limited protection. In addition, legal standards relating to the validity, enforceability and scope of protection of intellectual property rights in software are uncertain and still evolving, and the future viability or value of any of our intellectual property rights is uncertain. Effective trademark, copyright and trade secret protection may not be available in every country in which our products are distributed or made available.If, in the future, litigation is necessary to enforce our intellectual property rights, to protect our trade secrets, or to determine the validity and scope of the proprietary rights of others, such litigation could result in substantial costs and diversion of resources and could have a material adverse effect on our business, operating results and/or financial condition. As a result, ultimately, we may be unable, for financial or other reasons, to enforce our rights under the various intellectual property laws described above.

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We may be subject to intellectual property rights claims in the future, which are costly to defend, and could require us to pay damages and limit our ability to use certain technologies in the future.

The Company has not been a party to an intellectual property suit. However, as we face increasing competition, the possibility of intellectual property rights claims against us grows. Our revenues rely significantly on our intellectual property and to the extent we become subject to any intellectual property claims, they would have a material effect on the Company, and our technologies may not be able to withstand third-party claims or rights against their use. Any intellectual property claims, with or without merit, could be time-consuming, expensive to litigate, or settle, and could divert management resources and attention. An adverse determination could also prevent us from offering our products and services to others and may require that we procure substitute products or services. With respect to an intellectual property rights claim, we may have to pay damages or stop using technology found to be in violation of a third party’s rights. We may have to seek a license for the technology, which may not be available on reasonable terms and may significantly increase our operating expenses. The technology also may not be available for license to us at all. As a result, we may be required to develop alternative non-infringing technology, which could require significant effort and expense. If we cannot license or develop technology for the infringing aspects of our business, we may be forced to limit our product and service offerings and we may be unable to compete effectively. Any of these results could harm our brand and operating results.

Our ability to offer our products and services may be affected by a variety of U.S. and foreign laws.

The laws relating to the liability of providers of online services for activities of their users are currently unsettled both in the U.S. and abroad. Claims have been threatened and filed under both U.S. and foreign law for defamation, libel, invasion of privacy and other data protection claims, tort, unlawful activity, copyright or trademark infringement, or other theories based on the nature and content of the materials searched and the ads posted or the content generated by our users. From time to time, we have received notices from individuals who do not want their names or web sites to appear in our web search results when certain keywords are searched. It is also possible we could be held liable for misinformation provided over the web when that information appears in our web search results. If one of these complaints results in liability to us, it could be potentially costly, encourage similar lawsuits, distract management and harm our reputation and possibly our business. Whether or not existing laws regulating or requiring licenses for certain businesses of our advertisers (including, for example, distribution of pharmaceuticals, adult content, financial services, alcohol or firearms), are applicable to us may be unclear. Existing or new legislation could expose us to substantial liability, restrict our ability to deliver services to our users, limit our ability to grow and cause us to incur significant expenses in order to comply with such laws and regulations. Several other federal laws could have an impact on our business. Compliance with these laws and regulations is complex and may impose significant additional costs on us. For example, the Digital Millennium Copyright Act (the “DMCA”) has provisions that limit, but do not eliminate, our liability for listing or linking to third-party web sites that include materials that infringe copyrights or other rights, so long as we comply with the statutory requirements of the DMCA. The Children’s Online Protection Act and the Children’s Online Privacy Protection Act restrict the distribution of materials considered harmful to children and impose additional restrictions on the ability of online services to collect information from minors. In addition, the Protection of Children from Sexual Predators Act of 1998 requires online service providers to report evidence of violations of federal child pornography laws under certain circumstances. Any failure on our part to comply with these regulations may subject us to additional liabilities.

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If we were to lose the services of our founders or our senior management team, we may not be able to execute our business strategy.

Our future success depends in large part upon the continued service of key members of our senior management team. In particular, our founders, Colorado Stark and Alvin Estevez, are critical to our overall management, as well as to the development of our technology, our culture and our strategic direction. Richard Scarlata, our Chief Financial Officer is the only full-time trained financial professional in our organization; he performs most of the duties that in many other cases would be performed by several people within a larger and deeper organization. We do not maintain any key-person life insurance policies. The loss of any of our management or key personnel could seriously harm our business.

If we are unable to retain or motivate key personnel or hire qualified personnel, we may not be able to grow effectively.

Our performance is largely dependent on the talents and efforts of highly-skilled individuals. Our future success depends on our continuing ability to identify, hire, develop, motivate and retain highly-skilled personnel for all areas of our organization; as well as to identify, contract with, motivate and retain contract personnel on an outsourced basis, for special projects. Competition in our industry for qualified employees and contractors is intense. Our continued ability to compete effectively depends on our ability to attract new employees and to retain and motivate our existing employees and to retain contract personnel. As we become a more mature company, we may find our recruiting efforts more challenging. The incentives to attract, retain and motivate employees provided by our stock option grants or by future arrangements, such as through cash bonuses, may not be as effective as in the past. If we do not succeed in attracting excellent personnel or retaining or motivating existing personnel, we may be unable to grow effectively.

Our two founders run our business and affairs collectively, which may harm their ability to manage effectively.

Colorado Stark, our Executive Chairman, and Alvin Estevez, our President and Chief Executive Officer (“CEO”), currently provide leadership as a team. Our Executive Chairman and CEO provide general supervision, direction, and control, subject to the control of the board of directors. As a result, they tend to operate collectively and to consult extensively with each other before significant decisions relating to all aspects of our operations are made. This may slow the decision-making process, and a disagreement among these individuals could prevent key strategic decisions from being made in a timely manner. If our two founders are unable to continue working well together in providing cohesive leadership, our business could be harmed.

We have a short operating history and a relatively new business model in an emerging and rapidly evolving market. This makes it difficult to evaluate our future prospects and may increase the risk of your investment.

From 1999 to 2003, we were engaged in analyzing the consumer software and internet service markets, which ultimately led to the development of SpyHunter, which was launched in 2003. As a result, we first derived cash from sales of consumer software security and privacy products in 2003. In 2005 and 2006, we attempted to develop an internet advertising search engine and spent considerable hours and dollars developing this service, however, our lack of success in this regard, has led us to abandon our efforts. You must consider our business and prospects in light of the risks and difficulties that we have encountered, and will continue to encounter, as an early-stage company in a new and rapidly evolving market. We may not be able to successfully address these risks and difficulties, which could materially harm our business and operating results.

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We have to keep up with rapid technological change to remain competitive.

Our future success will depend on our ability to adapt to rapidly changing technologies, to adapt our services to evolving industry standards and to improve the performance and reliability of our services. In addition, the widespread adoption of new Internet, networking or telecommunications technologies or other technological changes could require substantial expenditures to modify or adapt our services or infrastructure.

Our main product SpyHunter from which we have derived almost all of our revenue is currently has recently been updated with a number of product enhancements. It took us longer than expected to introduce these enhancements and as result ours sales in 2007 suffered. We continue to enhance our product with new spyware definitions, but if the market does not accept these product enhancements, our sales will decline.

The markets for certain of our products and services are new and the markets for all of our products and services are likely to change rapidly. Our future success will depend on our ability to anticipate changing customer requirements effectively, and in a timely manner, and to offer products and services that meet these demands. The development of new or enhanced software products and services is a complex and uncertain process. We recently added additional features to our SpyHunter product, which are primarily two sets of changes that we implemented.  The first set contains features that actively monitor a user’s computer in order to prevent new spyware infections; a scheduler to automatically check for new infections on the machine; and Domain Name Server (“DNS”) protection to prevent companies from spoofing URL's to trick users.  These are features that most of our competitors have and we did not until recently.  Adding these features has made our product more competitive. The second set of changes that we added are transparent to the user as additional features but have made our product more effective. It now contains the ability to remove security threats at the WinLogon Notify level. 

Historically, almost all of our revenue has come from our SpyHunter product, and we anticipate the majority of our revenue during 2008 and perhaps future years will be derived from further enhanced versions of SpyHunter. We have experienced, and may continue to experience design, development, testing and other difficulties that could delay or prevent the introduction of new products or product enhancements. Further, we may experience delays in market acceptance of new products or product enhancements as customers evaluate the advantages and disadvantages of upgrading to our new products or services.

Recently, our software product, SpyHunter, has been designated as a security threat by certain competitors. The Company disputed these designations and all of them were withdrawn. However, other competitors may make similar allegations in the future, and if the Company is not able to successfully dispute such allegations, our customers may cease to purchase our product and result in a decrease in our revenues.

Several of the Company’s competitors recently identified the Company’s core software product, SpyHunter, as a security threat to computers. The Company vigorously disputed these determinations that our product is a security threat, and all of the competitors withdrew the designation. Other competitors of the Company have made similar claims before, and the Company has been successful in disputing them as well. However, if other competitors make similar allegations in the future and we are unsuccessful in our efforts to defend our product against any such security threat designation, the acceptance of our product, as well as the revenue stream we receive as a result of the sales of our product, may substantially decrease.

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There is significant competition in our market, which could make it difficult to attract customers, cause us to reduce prices and result in reduced gross margins or loss of market share.

The market for our products and services is highly competitive, dynamic and subject to frequent technological changes. We expect the intensity of competition and the pace of change either to be maintained or at least be increased in the future. A number of companies offer freeware products that provide some of the functionality of our products. The Company’s products have been affected by the availability of such freeware products, thus we may not be able to maintain our competitive position against current or potential competitors, especially those with significantly greater financial, marketing, service, support, technical and other resources. Competitors with greater resources may be able to undertake more extensive marketing campaigns, adopt more aggressive pricing policies and make more attractive offers to potential employees, distributors, resellers or other strategic partners. We expect additional competition from other established and emerging companies as the market for our products continues to develop. We may not be able to compete successfully against current and future competitors.

We may not be able to access third party technology, which we depend upon to conduct our business, and as a result, we could experience delays in the development and introduction of new products and services or enhancements of existing products and services.

If we lose the ability to access third party technology which we use, are unable to gain access to additional products or are unable to integrate new technology with our existing systems, we could experience delays in our development and introduction of new products and services and related improvements or enhancements until equivalent or replacement technology can be accessed, if available, or developed internally, if feasible. If we experience these delays, our sales could be substantially reduced. We license technology that is incorporated into our products and services from third parties. In light of the rapidly evolving nature of technology, we may increasingly need to rely on technology licensed to us by other vendors, including providers of development tools that will enable us to quickly adapt our technology to new products and services. Technology from our current or other vendors may not continue to be available to us on commercially reasonable terms, or at all.

Risks Related to Our Stock Being Publicly Traded

Our stock price may be volatile.

Our Common Stock has been trading in the public market for three years. Until recently, trading volume had been extremely light. During the first nine months of 2007, weekly trading volume averaged approximately 1.2% of the total outstanding shares. However, since September 30, 2007 and through December 31, 2007, weekly trading volume averaged approximately 5.4% of the total outstanding shares, which period coincides with the issuance to Dutchess of 1,396,106 shares of Common Stock upon conversion of debentures. Such shares represent approximately 22% of the current outstanding shares and are presumed to have been disposed of by Dutchess shortly after their issuance. As of March 24, 2008, 74% of our outstanding shares were held in street name. As of that date there were 27 holders of record and as of March 5, 2008, 214 non-objecting beneficial owners. We cannot predict the extent to which the trading market for our Common Stock will change, or how liquid that market might become. The trading price of our Common Stock has been and is expected to continue to be highly volatile as well as subject to wide fluctuations in price in response to various factors, some of which are beyond our control. These factors include:

· Quarterly variations in our results of operations or those of our competitors.

· Announcements by us or our competitors of acquisitions, new products, significant contracts, commercial relationships or capital commitments.

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· Disruption to our operations.

· The emergence of new sales channels in which we are unable to compete effectively.

· Our ability to develop and market new and enhanced products on a timely basis.

· Commencement of, or our involvement in, litigation.

· Any major change in our board of directors or management.

· Any debenture conversions and subsequent sales of registered shares.

· Changes in governmental regulations or in the status of our regulatory approvals.

· Changes in earnings estimates or recommendations by securities analysts.

· General economic conditions and slow or negative growth of related markets.

In addition, the stock market in general, and the market for technology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. These broad market and industry factors may seriously harm the market price of our Common Stock, regardless of our actual operating performance. In addition, in the past, following periods of volatility in the overall market and the market price of a company’s securities, securities class action litigation has often been instituted against these companies. Such litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.

We do not intend to pay dividends on our Common Stock.

We have never declared or paid any cash dividend on our Common Stock. We currently intend to retain any future earnings and do not expect to pay any dividends in the foreseeable future.

Our two founders own a majority of the Company’s preferred stock, which will significantly impact our stockholders ability to influence corporate matters.

Until June 28, 2006, the date of the Dutchess Financing, our founders, executive officers, directors (and their affiliates) and employees together owned approximately 77.0% of the voting power of our outstanding capital stock. In particular, our two founders, Colorado Stark and Alvin Estevez combined, controlled approximately 74.2% of the voting power of our outstanding capital stock. With the issuance of the Debentures to Dutchess, Colorado Stark and Alvin Estevez exchanged their shares of Common Stock for shares of newly issued Series A Convertible Preferred Stock (the “Preferred Stock”). While the Preferred Stock ranks senior to the Common Stock with respect to dividends, and on parity with the Common Stock with respect to liquidation, the holders of shares of the Preferred Stock shall generally vote together with the holders of shares of the Common Stock on an as-if-converted basis. Furthermore, the shares of Preferred Stock owned by Messrs. Stark and Estevez have anti-dilution protection, whereby they will maintain the majority voting power of the Company’s capital stock. Consequently, Colorado Stark and Alvin Estevez’ ownership of the Preferred Stock allows them to retain significant influence over management and affairs and over all matters requiring stockholder approval, including the election of directors and significant corporate transactions, such as a merger or other sale of the Company or its assets, for the foreseeable future. This concentrated control limits the ability of stockholders to influence corporate matters and, as a result, we may take actions that our stockholders do not view as beneficial. As a result, the market price of our Common Stock could be adversely affected. (See Notes B, I and O of Notes to Consolidated Financial Statements.)

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Provisions in our charter documents and under Delaware law could discourage a takeover that stockholders may consider favorable.

Provisions in our Certificate of Incorporation and By-laws may have the effect of delaying or preventing a change of control or changes in our management. These provisions include the following:

· Our board of directors has the right to elect directors to fill a vacancy created by the expansion of the board of directors or the resignation, death or removal of a director, which may prevent stockholders from being able to fill vacancies on our board of directors.

· Our stockholders may act by written consent, provided that such consent is signed by all the shareholders entitled to vote with respect to the subject matter thereof. As a result, a holder, or holders, controlling a majority of our capital stock would not be able to take certain actions without holding a stockholders’ meeting.

· Our Certificate of Incorporation prohibits cumulative voting in the election of directors. This limits the ability of minority stockholders to elect director candidates.

As a Delaware corporation, we are also subject to certain Delaware anti-takeover provisions. Under Delaware law, a corporation may not engage in a business combination with any holder of 15% or more of its capital stock unless the holder has held the stock for three years or, among other things, the board of directors has approved the transaction. Our board of directors could rely on Delaware law to prevent or delay an acquisition of us.

You may experience substantial dilution as a result of the Dutchess financing transaction, as well as if we raise funds through the issuance of additional equity and/or convertible securities or issue stock to vendors in lieu of making cash payments for services.

You may experience substantial dilution if Dutchess converts its remaining Debentures into Common Stock of the Company. Since the conversion price of the Debentures fluctuates at a substantial percentage discount (25%) to fluctuating market prices, the number of shares issuable to Dutchess, upon conversion of the Debentures, is potentially limitless. In other words, the lower the average trading price of the Company’s shares at the time of conversion, the greater the number of shares that can be issued to Dutchess. This perceived risk of dilution may cause Enigma shareholders to sell their shares, thus contributing to a downward movement in the Company’s stock price, thereby potentially encouraging other Enigma shareholders to sell, or sell short, which could in turn further contribute to a spiraling stock price decline in Enigma’s Common Stock. You may also experience substantial dilution if Messrs. Stark and Estevez convert their shares of Preferred Stock into shares of Common Stock (See Notes B and I of Notes to Consolidated Financial Statements). The overall ownership of Dutchess at any one moment is limited to 9.9% of the outstanding shares of Common Stock in accordance with the Financing documents. However, Dutchess is free to sell any registered shares, which have been issued to them, into the market, thereby enabling Dutchess to convert the remaining Debentures or exercise additional warrants into shares of Common Stock. Since July 30, 2007, Dutchess has converted $54,157 of debentures due 2011 into 1,396,106 registered shares of the Company’s Common Stock. In addition, the Company issued 800,000 unregistered shares of the Company’s Common Stock to three investor relations consulting firms. The total of 2,196,106 shares of the Company’s Common Stock so issued, represents approximately 52% of the Company’s outstanding Common Stock prior to such issuances.

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Future sales of our Common Stock or sales of registered shares or shares subject to SEC Rule 144 may negatively affect the market price of our Common Stock.

As of March 26, 2008, there were 6,387,372 shares of our Common Stock outstanding, at a closing market price of $0.015 for a total market valuation of $95,811. We cannot predict the effect, if any, that future sales of shares of our Common Stock into the market will have on the market price of our Common Stock. However, sales or issuances of substantial amounts of Common Stock, including future shares issued upon the exercise of 40,000,000 Warrants, future shares issued upon the additional conversion of Debentures, or upon Messrs. Stark and Estevez converting their Preferred Stock into Common Stock, or upon exercise of stock options (of which 6,806,758 were fully vested as of December 31, 2007 and an additional approximate 2.2 million shares were either unvested or reserved for issuance), or the perception that such transactions could occur, may materially and adversely affect prevailing market prices for our Common Stock.

We could terminate our Securities and Exchange Commission Registration, which could cause our Common Stock to be de-listed from the Over the Counter Bulletin Board (“OTCBB”).

As a public company with fewer than 300 shareholders, Enigma files its periodic reports with the Securities and Exchange Commission (the “SEC”) and registers its shares of Common Stock under the Securities Exchange Act of 1934 (the “Exchange Act”) on a voluntary basis. Since the Company has fewer than 300stockholders of record, we are eligible to de-register our Common Stock under the Exchange Act. Although the Company does not currently plan to de-register its Common Stock, there can be no assurance that we would not de-register the Common Stock at some point in the future. If the Company were to take such action, it could inhibit the ability of the Company’s common stock holders to trade the shares in the open market, thereby severely limiting the liquidity of such shares. Furthermore, if we were to de-register, we would no longer be required to file annual and quarterly reports with the SEC and would no longer be subject to various substantive requirements of SEC regulations. De-registration would reduce the amount of information available to investors about our Company and may cause our Common Stock to be de-listed from the OTCBB. In addition, investors would not have the protections of certain SEC regulations to which we would no longer be subject. The Company has no intention of terminating the registration of the Common Stock, and in fact is constrained from doing so under the terms of its agreements with Dutchess.

Because the market for and liquidity of our shares is volatile and limited, and because we are subject to the "Penny Stock" rules, the level of trading activity in our Common Stock may be reduced.

Our Common Stock is quoted on the OTCBB (ENGM). The OTCBB is generally considered to be a less efficient market than the established exchanges or the NASDAQ markets. While our Common Stock continues to be quoted on the OTCBB, an investor may find it more difficult to dispose of, or to obtain accurate quotations as to the price of our Common Stock, compared to if our securities were traded on NASDAQ or a national exchange. In addition, our Common Stock is subject to certain rules and regulations relating to "penny stocks" (generally defined as any equity security that is not quoted on the NASDAQ Stock Market and that has a price less than $5.00 per share, subject to certain exemptions). Broker-dealers who sell penny stocks are subject to certain "sales practice requirements" for sales in certain nonexempt transactions (i.e., sales to persons other than established customers and institutional "accredited investors"), including requiring delivery of a risk disclosure document relating to the penny stock market and monthly statements disclosing recent bid and offer quotations for the penny stock held in the account, and certain other restrictions. If the broker-dealer is the sole market maker, the broker-dealer must disclose this, as well as the broker-dealer's presumed control over the market. For as long as our securities are subject to the rules on penny stocks, the liquidity of our Common Stock could be significantly limited. This lack of liquidity may also make it more difficult for us to raise capital in the future.

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Additional Information

We are obligated to file reports with the SEC pursuant to the Exchange Act. The public may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. We file electronically with the SEC. The address of that site is http://www.sec.gov.

General Discussion on Results of Operations and Analysis of Financial Condition

For the years ended December 31, 2007 and 2006

We begin our General Discussion and Analysis with a discussion of the Critical Accounting Policies and the Use of Estimates, which we believe are important for an understanding of the assumptions and judgments underlying our financial statements. We continue with a discussion of the Results of Operations for the years ended December 31, 2007 and 2006, followed by a discussion of Liquidity and Capital Resources available to finance our operations.

We are a developer of Internet-based systems and downloadable security software products designed to give our customers instant access to information on the web and control over the programs installed on their computers in an automated and easy to use way, thereby enhancing transparency and user control. Our business strategy is to leverage our knowledge of internet marketing, as well as our existing base of more than 750,000 users, to continue to develop Internet software products that further the values on which the Internet is based. Our consumer software product line is focused on delivering Internet privacy and security to individual users, homes, offices, and small businesses. Sales of SpyHunter® (“SpyHunter”) commenced in June 2003. In late January 2005, we began to license a new and improved product, SpyHunter 2.0, and in May 2006, with the introduction of SpyHunter 2.7, added important new features as well as changed the pricing structure. In October 2006 we introduced SpyHunter 2.8, and in March 2007, SpyHunter 2.9, each of which further enhanced our detection and removal features. Our latest product SpyHunter 3.0 was introduced in the fall of 2007 and incorporates all of the foregoing features as well as significant upgrades to make our SpyHunter product more competitive. These new features include one that actively monitors a user’s computer in order to prevent new spyware infections, a scheduler to automatically check for new infections on the machine, and a Domain Name Server (“DNS”) protection to prevent companies from spoofing URL's to trick users. 

Critical Accounting Policies and the Use of Estimates

Revenue Recognition

We recognize revenue from the sales of license fees and subscriptions of SpyHunter in accordance with accounting principles generally accepted in the United States of America that have been prescribed for the software industry. Revenue recognition requirements in the software industry are very complex and require us to make some estimates.

Specifically, we recognize such revenues in accordance with Statement of Position (“SOP”) No. 97-2 “Software Revenue Recognition,” as amended by SOP No. 98-9 “Modification of SOP No. 97-2, Software Revenue Recognition, With Respect to Certain Transactions.” These statements of position provide guidance for recognizing revenues related to sales by software vendors. We sell our principal software product, SpyHunter, along with its 6 month subscription service over the Internet. Customers order SpyHunter and simultaneously provide their credit card information to us. Upon receipt by us of authorization from the credit card issuer, the customer is able to download the product over the Internet. For the sales price of $29.99, we provide a license to use our product and post-contract customer support (“PCS”), which consists primarily of free updates to our software products as and when such updates are available, as well as e-mail and telephonic support.

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For sales of SpyHunter 1 series that occurred during the years ended December 31, 2003 and 2004, as well as during the month of January 2005, this PCS was provided for an indefinite period into the future. However, with the introduction at the end of January 2005 of our new and improved product, SpyHunter 2.0, PCS was limited to one year from the date of purchase. For SpyHunter 2.7, which was introduced in May 2006, and which replaced SpyHunter 2.0, and for SpyHunter 2.8, which was introduced in October 2006, and represents an upgrade over SpyHunter 2.7, as well as for SpyHunter 2.9, which was introduced in March 2007 and which contains further upgrades, PCS is limited to six months. Licensees of the SpyHunter 1 series were provided with PCS up until March 10, 2005, from which point forward we no longer supported that product, and at which time we began to recognize all of the revenue from the sales of SpyHunter series 1.

SpyHunter 2.7, 2.8, 2.9 and 3.0 contain improvements that are in recognition of the more challenging security threats that the Company noted in early 2006 and were developed in response to the needs of our customers. As part of Enigma’s renewed commitment to quality and customer satisfaction, spyware definition updates are a major facet of our customer support.

Because of the continuing threat of new spyware and adware, SpyHunter is not functional without these definition updates, which comprise the bulk of our PCS. The remainder of PCS consists of e-mail and telephonic customer support, which makes the product user friendly. Accordingly we believe that all of the value is attributable to PCS, and hence, the revenue from sales is attributable entirely to PCS and was deferred and recognized over 12 months in the case of the SpyHunter 2.0 and over 6 months in the cases of SpyHunter 2.7, 2.8, 2.9 and 3.0, in each case being the respective periods of PCS. Also in each case we utilize the ½ month convention in the month of sale and the corresponding final month of PCS. For all products, the renewal rate for PCS was and is $29.99, the same as the original sales price.

In accordance with SOP No. 97-2 and SOP No. 98-9, the fee is required to be allocated to the various elements based on vendor specific objective evidence (“VSOE”) of fair value. With respect to sales of SpyHunter 2.0, which had PCS limited to one year after the sale, and SpyHunter 2.7, 2.8, 2.9 and 3.0, which have PCS limited to six months after the sale, VSOE does exist for the allocation of revenue to the various elements of the arrangement, as we consider all of the revenue from such sales to be attributable to the service element because the SpyHunter download is useless without it. Accordingly, we recognized the license fees for SpyHunter 2.0 during the 12-month period, and for SpyHunter 2.7, 2.8, 2.9 and 3.0, for the 6-month period immediately subsequent to the sale.

Reserves for Product Returns

Our policy with respect to product returns is spelled out in our End User License Agreement (“EULA”), which states “…products purchased that are downloadable are NOT refundable; however, Enigma Software Group, Inc. reserves the right to award refunds to a customer on a per case basis.”As of December 31, 2007, we had not accrued a reserve for potential refunds or chargebacks, as our experience has been such that returns and chargebacks are not material to our overall revenues. We may voluntarily accept greater or fewer products for return.

Income Taxes

We make estimates to determine our current provision for income taxes, as well as our income taxes payable. Our estimates with respect to the current provision for income taxes take into account current tax laws and our interpretation of current tax laws, as well as possible outcomes of any future tax audits. Changes in tax laws or our interpretation of tax laws and the resolution of any future tax audits could significantly impact the amounts provided for income taxes in our financial statements.

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Legal Contingencies

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

Results of Operations For the Years Ended December 31, 2007 and 2006

Overview

Our goals for the past several years were to launch SpyHunter, generate significant licensing fees and continue to build on that success by generating even greater licensing fees. We are making progress in accomplishing these goals. Our business plan going forward is to continue to develop both Internet software products and services for consumers in order to establish recurring subscription revenue.

Revenues

For the years ended December 31, 2007 and 2006, reported revenues from the sale of software products and subscriptions were $3,150,364 and $1,207,824, respectively. This increase of approximately 161% for the current year period reflects both an increase in the number of new subscriptions, as a result of our increased marketing efforts, as well as an increase in the number of renewals, resulting from the reduction in the subscription period from 12 months to 6 months. However, because of our accounting policy for revenue recognition, (See Note D2 of Notes to Financial Statements) this is not the actual cash derived from sales of software products and subscriptions during the respective periods (See “Liquidity and Capital Resource” below).

Actual unit sales, net of credits and chargebacks, for the year ended December 31, 2007 reflect an increase of over 200% compared to the prior year. This was the case for both new (i.e., first-time) sales and renewal sales. Net unit sales increased from approximately 38,000 in 2006 to approximately 124,000 in 2007. Since a change in the subscription period from 12 months to 6 months also results in a 50% reduction of the deferral period for revenues, this change has a skewing effect in the comparability of amounts of reported revenues from one year to the next. With respect to such skewing difference, while it cannot be quantified precisely, it should be noted that as of December 31, 2007, deferred revenue as reported on the balance sheet was $1,102,224 as compared to $527,205 as of December 31, 2006, an increase of $575,019. The change in deferred revenue for each fiscal year, as reported in the Consolidated Statements of Cash Flows, was an increase in deferred revenue for the current year, a “source of cash” of $575,019, while for the prior year, the decrease in deferred revenue had the effect of being a “use of cash” of $42,407.

For years ended December 31, 2007, commission income and other revenue were $263,603 and $119,657, respectively. The increases are primarily attributable to commissions earned on sales of third-party owned products.

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Expenses

Expenses for the years ended December 31, 2007 and 2006 were $4,466,788 and $2,079,563, respectively.

	Year Ended December 31, 2007		Year Ended December 31, 2006
Marketing and selling	$	1,081,002	$	214,725
General and administrative		3,239,394		1,850,261
Depreciation and amortization		146,382		14,577
Total expenses	$	4,466,788	$	2,079,563

For the year ended December 31, 2007, marketing and selling expenses increased by approximately $866,000, and were almost than 5 times greater than such expenses for the prior year. Marketing and selling expenses include both the cost of advertising and the cost of commissions paid to third-parties for sales of SpyHunter on their respective websites. Thus, these increases were both responsible for and reflective of the increased unit sales discussed above under revenues. Marketing costs, which are expensed as incurred, relate directly to the level of unit sales activity for new subscriptions, as opposed to the revenue reported for the period, which may have been entirely or partially deferred, in accordance with SOP 97-2, as discussed above.

For the year ended December 31, 2007, general and administrative expenses increased by approximately $1.4 million. The increase principally reflects increased compensation and outsourcing expense ($108,000), increased shareholder and financial reporting expenses ($49,000), increased professional fees ($23,000), expenses associated with UAB Enigma ($377,000), and an increase in the cost of stock-based compensation expense ($804,000).

Depreciation and amortization expense increased by approximately $132,000 for the year ended December 31, 2007, when compared to the prior year. The increase is associated with the depreciation of fixed assets acquired by UAB Enigma ($10,000), the amortization of deferred financing costs ($76,000), and the amortization of deferred investor relations expenses associated with the issuance of 800,000 unregistered shares of Common Stock to three investor relations consulting firms ($46,000).

Operating Loss and Net Loss

As a result of the foregoing the Company incurred an operating loss of $1,052,811 for the year ended December 31, 2007, as compared to an operating loss of $752,082 for the prior year.

These losses were further increased by the incurrence of costs associated with the Dutchess Financing: principally; the recognition of discount expense on convertible debentures, debenture interest expense, fair value adjustments for derivatives and warrants and accretion adjustments for the beneficial conversion feature of the Preferred Stock, as well as the incurrence of a provision for liquidated damages, and a provision for debenture redemption premiums.

Liquidity and Capital Resources For the Years Ended December 31, 2007 and 2006

At December 31, 2007 and 2006, we had cash and cash equivalents of $95,223 and $471,254, respectively.

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Net cash provided by operating activities for the year ended December 31, 2007 was $331,551, which compares favorably to net cash used in operating activities for the year ended December 31, 2006, of $893,298. The positive swing in net cash provided by operating activities of approximately $1,225,000 reflects the increase in SpyHunter unit sales for the year, which amounted to approximately $2,600,000, net of increases in operating expenses, namely marketing and selling expenses ($860,000) and increases in general & administrative expenses net of non-cash options expense ($585,000) and net changes in working capital items.

Net cash used in investing activities for the year ended December 31, 2007 was $36,748, and principally represents capital expenditures for furniture, fixtures and computer equipment for UAB Enigma.

Net cash used in financing activities for the year ended December 31, 2007 was $670,834 and represents a portion of the payments required to be made to Dutchess due to the fact that the Registration Statement had not become effective and as result of the debt restructuring in July 2007 (See Notes B and O of Notes to Consolidated Financial Statements).

Actual results may be better or worse than anticipated, depending upon the Company’s actual sales results in future months. The Company’s liquidity position is extremely severe, as without the funds derived from the sale of Debentures to Dutchess, the Company would have run out of cash in July 2006. This was anticipated in the Company’s earlier filings, as was evidenced by the going concern opinion included in its 2005 audited financial statements.

On March 26, 2008, pursuant to provisions in the Old Debenture and the New Debenture, Dutchess issued to the Company a notice of an event of default (the “Default Notice”), due to the Company’s failure to make regular monthly interest payments and payments of principal under the terms of the Old Debenture and failure to make required interest payments under the New Debenture (the “Default”). Pursuant to the Old Debenture, the Company is obligated to pay Dutchess interest at the rate of twelve percent (12%) per annum, on a monthly basis, and amortizing monthly cash payments in the amount of $104,166.67, and under the New Debenture the Company is obligated to pay Dutchess interest at the rate of twelve percent (12%) per annum, compounded daily, on a monthly basis. Accordingly, as of March 24, 2008, the Company owed Dutchess an aggregate amount of $1,637,568.18 under both Debentures, including principal, interest and liquidated damages arising out of the Default. As a secured creditor, Dutchess is entitled to exercise its default remedies pursuant to a Security Agreement entered into in connection with the Old Debenture, including taking possession of all of the assets of the Company.

In contemplation of Dutchess issuing the Default Notice, the Company and Dutchess entered into negotiations to resolve the Default. As a consequence of these discussions, the Company and Dutchess have developed the following plan (the “Plan”) to restructure the Company and to cure the Default. If effected, under the Plan Dutchess would waive the liquidated damages arising out of the Default and rescind acceleration of the Debentures. The Plan is currently structured as described below.

First, the Plan contemplates that Title America Corp., a Nevada corporation (“Title America”), an affiliate of Dutchess and sole shareholder of Tool City, Inc., a California corporation (“Tool City”), would enter into a Securities Purchase Agreement, with the holders of all of the Company’s shares of Series A Convertible Preferred Stock, par value $0.001 per share (the “Series A Preferred Stock”), pursuant to which such individuals, who are the Company’s Executive Chairman and Chief Executive Officer, would sell all of the Series A Preferred Stock to Dutchess and as a result would no longer be stockholders of the Company (the “Preferred Stock Purchase”). The amount paid by Title America for the Series A Preferred Stock would equal $1,000, an amount which will be paid from Title America’s working capital. Based on the closing bid price of the Company’s shares of common stock, par value $0.001 per share (the “Common Stock”), on March 20, 2008, if the Preferred Stock Purchase is effected, Dutchess would own 100% of the Company’s Preferred Stock, and would beneficially own 98.81% of the Company’s Common Stock, based on the conversion rights of the shares of Preferred Stock, the conversion of the Debentures into shares of Common Stock, and the exercise of 40,000,000 common stock purchase warrants (the “Warrants”) held by Dutchess, without giving effect to certain blockers on conversion or exercise provided for in the Debentures or the Warrants, which will be removed in conjunction with the Preferred Stock Purchase.

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In addition, upon the closing of the proposed Preferred Stock Purchase, Dutchess is expected to appoint Theodore Smith, Michael Novielli and Douglas Leighton (the “New Directors”) to the Company’s Board of Directors (the “Board”). The Plan contemplates that all of the current members of the Company’s Board, Alvin Estevez, Colorado Stark and Edwin J. McGuinn, Jr., the sole member of the Company’s Audit Committee and Compensation Committee, would resign from the Board ten (10) calendar days following the mailing to the Company’s stockholders of a Schedule 14F-1 Information Statement pertaining to the appointment of the New Directors to the Company’s Board. As a result of the Preferred Stock Purchase and the election of the New Directors, Dutchess is expected to acquire control of the Company.

The Plan contemplates that following the closing of the Preferred Stock Purchase, the Company and Title America intend to enter into a Share Exchange Agreement (the “SEA”). Pursuant to the SEA, the Company would acquire all of the stock of Tool City and Tool City would become a wholly-owned subsidiary of the Company. In exchange for all of the common stock of Tool City, the Company would issue to Title America shares of a new series of Preferred Stock of the Company (the “Series B Preferred Stock”) which would be convertible into shares of Common Stock and would have an aggregate liquidation preference of $8,314,000. The Plan contemplates that the shares of Series A Preferred Stock acquired by Dutchess in the Preferred Stock Purchase would then be cancelled, whereupon Dutchess and its affiliates would beneficially own approximately 95.67% of the Company’s Common Stock, based on the conversion rights of the Series B Preferred Stock and the Debentures and their ownership of the Warrants.

The Plan contemplates that following the closing of the Preferred Stock Purchase, the Company and Title America intend to enter into a Share Exchange Agreement (the “SEA”). Pursuant to the SEA, the Company would acquire all of the stock of Tool City and Tool City would become a wholly-owned subsidiary of the Company. In exchange for all of the stock of Tool City, the Company would issue to Title America shares of a new series of Preferred Stock of the Company (the “Series B Preferred Stock”) which will be convertible into shares of Common Stock and will have an aggregate liquidation preference of $8,314,000. The Plan contemplates that the shares of Series A Preferred Stock acquired by Dutchess in the Preferred Stock Purchase would then be cancelled, whereupon Dutchess and its affiliates would beneficially own approximately 95.67% of the Company’s Common Stock, based on the conversion rights of the Series B Preferred Stock and the Debentures and their ownership of the Warrants.

Management believes that the Company would have an increased ability to satisfy its obligations under the Debentures after its acquisition of Tool City. Tool City provides title and auto pawn loans against the equity in vehicle owner’s cars. Tool City has historically had minimal credit losses due to its low loan-to-value ratios, technological advancements permitting the tracking of vehicles serving as collateral for outstanding loans, and the liquidity of collateral against which Tool City makes loans. Revenues are generated from interest on outstanding loans, sales from repossessed cars, and the resale of pawned items. Tool City currently has nine employees, and was founded in 1996 to serve consumers located in Southern California. All of the outstanding common stock of Tool City was recently purchased by Title America. Accordingly, the Company would enter into a new line of business upon the acquisition of Tool City.

The Plan further contemplates that after the acquisition of Tool City, the Company would exit its existing software business and sell substantially all of the assets of such business to Enigma Software Group USA, LLC, a Connecticut limited liability company (“Enigma Software Group”), formed by Messrs. Estevez and Stark for the purposes of effecting the Asset Purchase (as defined below). The parties are expected to enter into an Asset Purchase Agreement (the “APA”), whereby Enigma Software Group would assume substantially all of the assets and liabilities, excluding the Debentures, including interest due thereon and liquidation damages, of the Company (the “Asset Purchase”). It is expected that the Enigma Software Group would indemnify the Company in connection with such liabilities that it assumes and would assure that at the closing of the Asset Purchase the Company retains $172,500 in cash. In addition, Messrs. Estevez and Stark, and certain other employees, would cancel an aggregate amount of options representing the right to purchase 8,203,676 of the Company’s Common Stock.

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On March 27, 2008, the Company filed a Current Report on Form 8-K reporting the foregoing. The Company expects to file additional Current Reports on Form 8-K reporting aspects of the transactions contemplated by the Plan.

There will be no opportunity for any stockholder to vote on the above transactions. Management believes the Plan is the only viable alternative to realize significant value for the Company’s stockholders. The Company cannot currently satisfy the obligations owed under the Debentures and is incurring liquidated damages on a daily basis. The Plan offers the Company’s stockholders the potential benefits of a new line of business. Management believes that the Plan is in the best interests of the stockholders since it avoids the high costs of litigation and bankruptcy and the unknown results of such proceedings. Moreover, the Plan is intended to allow the Company’s common stockholders to maintain the same percentage ownership interest in the Company that they presently own on a fully-diluted basis.

The Company notes that neither it nor Dutchess nor any of their affiliates has yet entered into any binding agreement with respect to the Plan, and the transactions contemplated by the Plan and described above represent solely intentions and expectations with respect to the Plan. There can be no assurance that the Plan will be implemented as summarized above, or at all.

In the event the Plan and the transactions contemplated thereunder are not consummated, the Company would be in financial distress and would have to pursue other opportunities to satisfy the Default. There can be no assurance that any viable alternatives would be available. As a result, the Company could be faced with the immediate foreclosure on its assets by Dutchess.

Item 7.Financial Statements.

Information in response to this Item is set forth in the Financial Statements, beginning on Page F-1 of this filing.

Item 8.Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.

As previously reported in Forms 8-K and 8-K/A filed with the SEC on January 24, 2006 and January 30, 2006, respectively, the Company’s Board of Directors (the “Board”) dismissed its independent registered public accounting firm, Eisner LLP (“Eisner”), and engaged the services of Bagell, Josephs, Levine & Company, L.L.C. (“BGL”). The Board approved the dismissal of Eisner, who had served as the Company’s independent public accountants for the two fiscal years ended December 31, 2004, and the subsequent interim periods through September 30, 2005 and the appointment of BJL.

The Company is not aware, and has not been advised by its independent registered public accountants, of any disagreement on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure for the years ended December 31, 2007 and 2006.

Item 8A. Controls and Procedures

Disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports filed or submitted under the Exchange Act of 1934 are recorded, processed, summarized and reported, within the time periods specified in the rules and forms of the Securities and Exchange Commission. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports filed under the Securities Exchange Act of 1934 is accumulated and communicated to management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding required disclosure.

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A material weakness in the Company’s disclosure controls and procedures existed as of December 31, 2007, due to the Company’s limited number of employees. With regard to such personnel, there was a weakness as a result of the limited segregation of duties amongst our employees. As a result, our CEO and CFO determined that the Company’s disclosure controls and procedures were not effective as of the period ended December 31, 2007. We have taken no steps to remediate this weakness.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during the fourth quarter that materially affected, or were reasonably likely to materially affect, our internal control over financial reporting.

Item 8B. Other Information.

None.

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PART III

Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act.

Set forth below is certain information concerning each of the directors and executive officers of the Company as of March 27, 2007:

Name	Age	Position	With Company Since
Colorado Stark	36	Executive Chairman, Director	1999
Alvin Estevez	36	President and CEO, Director	1999
Edwin J. McGuinn, Jr.	56	Director	2005
Richard M. Scarlata	65	CFO and Treasurer	2004

Colorado Stark. Mr. Stark co-founded the Company in 1999 and currently serves as its Executive Chairman. Having worked in the investment banking industry for over 12 years, Mr. Stark offers Enigma his expertise in sales, business development, raising capital, and structuring transactions to enhance shareholder value. From 2001 to 2003, in addition to serving as Enigma Software Group's Executive Chairman, Mr. Stark also served as president of Brill Capital. Brill Capital was a Venture Capital Placement agent that helped US companies, in the fields of biotechnology and communications, raise capital from Taiwan.

Alvin Estevez. Mr. Estevezis also a co-founder of the Company and currently serves as its President and CEO, having held such positions since 1999. He comes from a network security background and prior to co-founding Enigma, he worked at defense contractor Northrop Grumman, as well as with related subsidiaries and entities. Mr. Estevez brings to the Company the experience of managing large groups of technical personnel along with the expertise of building enterprise level technology systems.

Edwin J. McGuinn, Jr. Mr. McGuinn currently serves as a Director of the Company, having been so elected in March 2005. Mr. McGuinn also serves on the Audit Committee and the Compensation Committee and has been designated the Audit Committee Financial Expert. Mr. McGuinn is independent, as that term is used in Item 7(d) (3) (iv) of Schedule 14A under the Exchange Act. Mr. McGuinn is currently the Chairman and CEO of MRU Holdings, Inc., having held such position since April 2004. MRU Holdings, Inc. is a specialty finance company that provides undergraduate and graduate students with funds for higher education. Prior to joining MRU Holdings, Inc., Mr. McGuinn was the President and CEO of eLOT, Inc., having held such positions from May 2000 until November 2004. eLOT, Inc. is a company whose focus was the development of consumer e-commerce products and integrated network management systems for the sale of state and governmental lottery tickets on the Internet. Prior to joining eLOT, Inc., Mr. McGuinn was President and CEO of Limitrader.com from January 1999 until May 2000. Limitrader.com is the first Internet based trading platform for the new issue and secondary trading of corporate bonds. Mr. McGuinn also sits on the Board of Directors of eLOT, Inc. and the board of a venture capital company and several development stage companies specializing in financial technology and Internet services.

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Richard M. Scarlata. Mr. Scarlata became CFO of the Company as of December 30, 2004. From 1999 until that date, Mr. Scarlata was self-employed as a consultant, providing financial, accounting and business advisory services to clients. From 1993, Mr. Scarlata held at different intervals the CFO and CEO positions at Rockefeller Center Properties, Inc., a publicly traded REIT. Mr. Scarlata possesses an MBA degree in Finance, and has been a CPA since 1970. Previously, Mr. Scarlata had also served as an Adjunct Professor of Finance at Monroe College in The Bronx, NY.

Audit Committee

In March 2005, the Company adopted an Audit Committee Charter and designated Edwin J. McGuinn Jr., the sole member of the Audit Committee, as the independent audit committee financial expert. The appointment of Mr. McGuinn satisfies the definition of independence in accordance with SEC rules and NASDAQ listing standards.

The Audit Committee makes such examinations as are necessary to monitor the corporate financial reporting and the external audits of the Company, to provide to the Board of Directors (the “Board”) the results of its examinations and recommendations derived there from, to outline to the Board improvements made, or to be made, in internal control, to nominate independent auditors, and to provide to the Board such additional information and materials as it may deem necessary to make the Board aware of significant financial matters that require Board attention.

Compensation Committee

In March 2005, the Company adopted a Compensation Committee Charter. The compensation committee is authorized to review and make recommendations to the Board regarding all forms of compensation to be provided to the executive officers and directors of the Company, including stock compensation, and bonus compensation to all employees. Mr. McGuinn is the sole member of the Compensation Committee.

Nominating Committee

The Company does not have a Nominating Committee and the full Board acts in such capacity for the immediate future due to the limited size of the Board, which consists of three members.

Compliance with Section 16(a) of the Exchange Act

Section 16(a) of the Securities Exchange Act of 1934 requires that the Company’s directors and executive officers and persons who beneficially own more than ten percent (10%) of a registered class of its equity securities, file with the SEC reports of ownership and changes in ownership of its common stock and other equity securities. Executive officers, directors, and greater than ten percent (10%) beneficial owners are required by SEC regulation to furnish the Company with copies of all Section 16(a) reports that they file. Based solely upon a review of the copies of such reports furnished to us or written representations that no other reports were required, the Company believes that, during 2006 all filing requirements applicable to its executive officers, directors, and greater than ten percent (10%) beneficial owners were met.

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Code of Ethics

In March 2005, the Company adopted a Code of Ethics. The Code of Ethics applies to the Company’s CEO, CFO, principal accounting officer and all persons performing similar functions.

Item 10. Executive Compensation.

The following table sets forth information concerning all cash and non-cash compensation awarded to, earned by or paid to all of the executive officers of the Company, who served during the fiscal year ended December 31, 2007, for services in all capacities to the Company:

SUMMARY COMPENSATION TABLE
Name & Principal Position	Year		Salary ($)		Bonus ($)		Stock Awards ($)		Option Awards(1) ($)		Non-Equity Incentive Plan Compensation ($)		Nonqualified Deferred Compensation Earnings ($)		All Other Compensation ($)			Total ($)
Alvin Estevez President & CEO		2007	$	150,000		0		0	$	3,015		0		0	$	35,500	(2)(3)	$	188,515
		2006	$	150,000		0		0	$	11,056		0		0	$	32,750	(2)(3)	$	193,806
Colorado Stark Executive Chairman		2007	$	150,000		0		0	$	3,015		0		0	$	35,500	(2)(3)	$	188,515
		2006	$	150,000		0		0	$	11,056		0		0	$	29,596	(2)(3)	$	190,652
Richard M. Scarlata CFO & Treasurer		2007	$	110,000		0		0	$	132,847		0		0	$	20,500	(3)	$	263,347
		2006	$	110,000		0		0	$	11,070		0		0	$	12,500	(3)	$	133,570

(1) See Notes D [8] and J of the Notes to Consolidated Financial Statements.

(2) The amounts for both Alvin Estevez and Colorado Stark include a perquisite payment for automobile allowance in the amount of $20,000. Messrs. Estevez and Stark also serve as directors of the Company, but without compensation for the director services.

(3) The balance of the amounts for both Alvin Estevez and Colorado Stark include Enigma’s matching of employee contributions to the Company’s 401(k) defined contribution plan (“401(k) Plan”). The amount for Richard M. Scarlata represents Enigma’s matching of employee contributions to the 401(k) Plan. Under the 401(k) Plan, which became effective on May 1, 2004, eligible employees are able to make contributions to the 401(k) Plan, which are matched by the Company at the rate of 100% of an individual employee’s contribution up to the maximum allowable by law, which for 2007 was generally $15,500. See Note K of the Notes to Consolidated Financial Statements.

Employment Agreements

Messrs. Estevez, Stark, and Scarlata each have an employment agreement with the Company that currently extends until December 31, 2010. The employment agreements each provide for an initial term of employment of three years, which term is automatically extended for an additional one year term unless either party notifies the other of its intention not to renew for an additional year. The employment agreements provide for annual discretionary performance bonuses and additional incentive awards, including stock options and stock grants. In addition, the employment agreements each contain non-compete, non-disclosure and non-solicitation restrictive covenants, which last for a period of 12 months following the date of the employee’s termination from the Company. A copy of each of these employment agreements was filed as an exhibit to the Company’s Form 8-K filed on February 16, 2005.

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Messrs. Estevez, Stark and Scarlata participate in the Company’s defined contribution plan, the Enigma Software Group, Inc. 401(k) Plan, (the "401(k) Plan"). The 401(k) Plan became effective on May 1, 2004. Eligible employees are able to make contributions to the 401(k) Plan, which are matched by the Company at the rate of 100% of an individual employee’s contribution up to the maximum allowable by law, which for 2007 was generally $15,500.

The Company recognizes compensation costs associated with stock options over each employee’s service period, which in all cases is the vesting period for such stock option grants. The 2007 stock option awards vest ratably over a period of 12 months from the date of grant, which is the requisite service period for such awards. No other conditions, such as market or performance conditions, must be satisfied in order for the option awards to fully vest.

The following table sets forth information with respect to outstanding equity awards at December 31, 2007 held by the persons named in the Summary Compensation Table:

OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END (1)
	Option Awards (1)												Stock Awards
Name	Number of Securities Underlying Unexercised Options (#) Exercisable			Number of Securities Underlying Unexercised Options (#) Unexercisable		Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options (#)			Option Exercise Price ($)		Option Expiration Date		Number of Shares or Units of Stock That Have Not Vested (#)		Market Value of Shares or Units of Stock That Have Not Vested ($)		Equity Incentive Plan Awards: Number of Unearned Shares, Units or Other Rights That Have Not Vested (#)		Equity Incentive Plan Awards: Market or Payout Value of Unearned Shares, Units or Other Rights That Have Not Vested ($)
Alvin Estevez President & CEO		0 225,000 26,293	(2)  (3)  (4)		0 0		0 0	(3)   (5)	$ $	0.0715 1.2100		4/12/2011 5/17/2010		0		0		0	0
Colorado Stark Executive Chairman		0 225,000 20,238	(2)  (3)  (4)		0 0		0 0	(3)   (5)	$ $	0.0715 1.2100		4/12/2011 5/17/2010		0		0		0	0
Richard M. Scarlata CFO & Treasurer		1,100,000 225,000 161,718	(2)  (3)  (4)		0 0 0		274,998 0 16,894	(3)   (4)	$ $ $	0.1500 0.0650 1.1000		8/16/2017 4/12/2016 5/17/2015		0		0		0	0

(1) See Notes D [8] and J of Notes to Consolidated Financial Statements.

(2) Represents stock option grants for the year ended December 31, 2007; such grants vest ratably on the last day of each month of April 2007 to March, 2008. Messrs. Estevez and Stark received no option grants in 2007.

(3) Represents stock option grants for the year ended December 31, 2006; such grants vested ratably on the first day of each month of May 2006 to April, 2007.

(4) Represents stock option grants for the year ended December 31, 2005; Mr. Scarlata’s grant vests 16,894 shares on January 1, 2008.

(5) The 2006 and 2005 stock option awards for Messrs. Estevez and Stark and were fully vested at December 31, 2007.

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Compensation of Directors

The following table sets forth information with respect to director’s compensation for the fiscal year ended December 31, 2007:

DIRECTOR COMPENSATION

Name	Fees Earned or Paid in Cash ($)		Stock Awards ($)		Option Awards ($)		Non-Equity Incentive Plan Compensation ($)		Nonqualified Deferred Compensation Earnings		All Other Compensation ($)		Total ($)
Edwin J. McGuinn, Jr.	$	10,000		0	$	41,250		0		0		0	$	51,250

Non-employee Directors of the Company are paid $10,000 per year in director fees, payable quarterly. No fees are paid for meeting attendance or for committee service.

Non-employee Directors also receive non-qualified stock options as follows:

Initial Grant. Upon a Board member who is not an employee joining the Board, such member shall receive a grant of Stock Options to purchase 75,000 shares of Stock with an exercise price equal to the Fair Market Value. The Option shall vest 25,000 Shares on the one year anniversary of the date of grant, 25,000 Shares on the second anniversary of the date of grant, and 25,000 Shares on the three year anniversary of the date of grant as long as the Board member is still a member of the Board as of such date. The Option shall have a term of ten years.

Annual Grant. Every Board member who is not an employee shall be entitled to an annual grant of Stock Options to purchase 25,000 Shares on the last trading day in March following the first anniversary of the member joining the Board. The Options shall fully vest on the date of grant with a term of ten years. The exercise price shall be the Fair Market Value.

Special Grant. Every Board member who is not an employee and has been a Board Member prior to the date of the Amendment of this Plan shall be entitled to a one time special grant of Stock Options to purchase 100,000 Shares on the last trading day of the month in which this Amendment of the Plan is adopted. The Options shall fully vest on the date of grant with a term of ten years. The exercise price shall be the Fair Market Value.

During the year ended December 31, 2007, Mr. McGuinn was awarded options to purchase 25,000 shares exercisable at $0.25 per share and options to purchase 100,000 shares exercisable at $0.35 per share. The Options were fully vested upon the date of grant. During the year ended December 31, 2006, Mr. McGuinn was awarded an Option to purchase 3,000 shares exercisable at $0.065 per share. The Option was fully vested upon the date of grant. During the year ended December 31, 2005, Mr. McGuinn was awarded an Option to purchase 39,000 shares exercisable at $1.26 per share. The Option vested as to 13,000 shares on each of March 8, 2006 and March 8, 2007, and shall vest with respect to the remaining 13,000 shares on March 8, 2008, as long as Mr. McGuinn remains a Board member at such time.

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Item 11. Security Ownership of Certain Beneficial Owners and Management.

The following table sets forth certain information with respect to the beneficial ownership of the Common Stock of the Company as of March 25, 2008, for: (i) each person who is known by the Company to beneficially own more than 5 percent of the Company’s Common Stock, (ii) each of the Company’s directors, (iii) each of the Company’s Named Executive Officers, and (iv) all directors and executive officers as a group. As of March 25, 2008, the Company had 6,387,372 shares of Common Stock outstanding.

Title of Class	Name and Address of Beneficial Owner (1)	Shares Beneficially Owned		Percentage of Shares Beneficially Owned			Percentage of Total Voting Power			Position
Common Stock	Colorado Stark		199,979,477		37.23	%		37.23	%		Executive Chairman & Director
Common Stock	Alvin Estevez		197,940,948		36.86	%		36.86	%		President & CEO and Director
Common Stock	Dutchess Private Equities Fund, Ltd. 50 Commonwealth Avenue Boston, MA 02116		132,773,099		24.72	%		24.72	%
Common Stock	Edwin J. McGuinn, Jr.		0		0			0			Director
Common Stock	Richard M. Scarlata		0		0			0			CFO & Treasurer
	Directors and Executive Officers as a Group (4 persons)		397,920,425		74.09	%		74.09	%

(1)Except where otherwise indicated, the address of the beneficial owner is deemed to be the same address as the Company.

The following table sets forth certain information with respect to the beneficial ownership of the Preferred Stock of the Company as of March 25, 2008, for: (i) each person who is known by the Company to beneficially own more than 5 percent of the Company’s Preferred Stock, (ii) each of the Company’s directors, (iii) each of the Company’s Named Executive Officers, and (iv) all directors and executive officers as a group. As of March 25, 2008, the Company had 7,433,988 shares of Preferred Stock outstanding.

Title of Class	Name and Address of Beneficial Owner		Shares Beneficially Owned		Percentage of Shares Beneficially Owned			Percentage of Total Voting Power			Position
Preferred Stock		Colorado Stark		3,736,036		50.3	%		50.3	%		Executive Chairman & Director
Preferred Stock		Alvin Estevez		3,697,952		49.7	%		49.7	%		President & CEO and Director
Preferred Stock		Edwin J. McGuinn, Jr.		0		0			0			Director
Preferred Stock		Richard M. Scarlata		0		0			0			CFO & Treasurer
		Directors and Executive Officers as a Group (4 persons)		7,433,988		100	%		100	%

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Securities Authorized for Issuance Under Equity Compensation Plans

On March 8, 2005, the Company adopted a Stock Option and Grant Plan (the “Plan”), a copy of which was filed as an exhibit to the Company’s Form 10-KSB for the fiscal year ended December 31, 2004. On March 13, 2007, the Plan was amended to, among other things, allow for an increase to 9,000,000 shares, the maximum aggregate number of shares of Common Stock reserved and available for issuance under the Plan. The Plan has been approved by the Company’s stockholders.

The following table sets forth certain information with respect to the Plan:

	Number of securities to be issued upon exercise of outstanding options, warrants and rights		Weighted-average exercise price of outstanding options, warrants and rights	Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column
	(a)		(b)	(c)
Equity compensation plans approved by security holders	8,570,001	$	0.20	429,999
Equity compensation plans not approved by security holders	none		none	none
Total	8,570,001	$	0.20	429,999

Item 12. Certain Relationships and Related Transactions, and Director Independence

There were no related party transactions during fiscal year 2007.

Edwin J. McGuinn, Jr. is an independent director of the Company, and as such, he satisfies the definition of independence in accordance with SEC rules and NASDAQ listing standards. Colorado Stark and Alvin Estevez are not independent directors of the Company.

Item 13. Exhibits.

Listed in the Exhibit Index on page 34 hereof.

Item 14. Principal Accountant Fees and Services

Audit Fees

The aggregate fees billed or to be billed for professional services rendered by our independent registered public accounting firm for the audit of our annual financial statements, review of financial statements included in our quarterly reports and other fees that are normally provided by the accounting firm in connection with statutory and regulatory filings or engagements for the fiscal years ended December 31, 2007 and 2006, were $81,632 and $66,817, respectively.

Audit Related Fees

The aggregate fees billed or to be billed for audit related services by our independent registered public accounting firm that are reasonably related to the performance of the audit or review of our financial statements, other than those previously reported in this Item 14, for the fiscal years ended December 31, 2007 and 2006 were $-0- and $-0-, respectively.

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Tax Fees

The aggregate fees billed for professional services rendered by our independent registered public accounting firm for tax compliance, tax advice and tax planning for the fiscal years ended December 31, 2007 and 2006 were $2,500 and $2,500, respectively.

All Other Fees

The aggregate fees billed for products and services provided the Company’s predecessor accounting firm for the fiscal years ended December 31, 2007 and 2006 were $5,000 and $17,000, respectively.

Audit Committee

After his joining the Board of Directors in March 2005, Mr. McGuinn was designated as the sole member of the audit committee and the independent audit committee financial expert. It is the policy of the Company for all work performed by its independent registered public accounting firm to be approved in advance by the Board of Directors. All of the services described above in this Item 14 were approved in advance by the Board of Directors during 2007 and 2006.

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SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	ENIGMA SOFTWARE GROUP, INC.
Date: March 28, 2008	By:	/s/ Alvin Estevez
		Alvin Estevez President and Chief Executive Officer

In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Signature	Title	Date
/s/ Alvin Estevez Alvin Estevez	President and Chief Executive Officer (Principal Executive Officer)	March 28, 2008
/s/ Colorado Stark Colorado Stark	Executive Chairman	March 28, 2008
/s/ Richard M. Scarlata Richard M. Scarlata	Chief Financial Officer and Treasurer (Principal Financial Officer)	March 28, 2008
/s/ Edwin J. McGuinn, Jr. Edwin J. McGuinn, Jr.	Director	March 28, 2008

33

INDEX TO EXHIBITS

EXHIBIT NO.	DESCRIPTION OF EXHIBIT
2	Share Exchange Agreement, effective as of February 16, 2005, by and among the Company, Enigma and the Stockholders (incorporated by reference to Exhibit 2 in the Company’s Form 8-K filed February 18, 2005 (the “February 18 Form 8-K”)).
2.1	Agreement and Plan of Merger, dated March 9, 2005 (incorporated by reference to Exhibit 2.1 in the Company’s Form 8-K filed March 8, 2005).
3(i)	Articles of Incorporation of the Company (incorporated by reference to Exhibit 3(i) in the Company’s Form 10-KSB, filed April 10, 2006).
3(ii)	Bylaws of the Company (incorporated by reference to Exhibit 3(ii) in the Company’s Form 10-KSB, filed April 10, 2006).
4.1	Certificate of Designation of Series A Convertible Preferred Stock, filed June 29, 2006 (incorporated by reference to Exhibit 4.1 in the Company’s Form 8- K filed on June 30, 2006).
10.1	Lease Agreement, dated as of April 2004, by and between Enigma and RFR/SF 17 State Street LP (incorporated by reference to Exhibit 10.1 of the February 18 Form 8-K).
10.2	Employment Agreement, dated as of November 15, 2004, by and between Enigma and Colorado Stark (incorporated by reference to Exhibit 10.2 of the February 18 Form 8-K).
10.3	Employment Agreement, dated as of November 15, 2004, by and between Enigma and Alvin Estevez (incorporated by reference to Exhibit 10.3 of the February 18 Form 8-K).
10.4	Employment Agreement, dated as of December 30, 2004, by and between Enigma and Richard M. Scarlata (incorporated by reference to Exhibit 10.4 of the February 18 Form 8-K).
10.5	Audit Committee Charter, dated March 8, 2005 (incorporated by reference to Exhibit 10.5 in the Company’s Form 10-KSB filed March 29, 2005 (the “2004 Form 10-KSB”)).
10.6	Compensation Committee Charter, dated March 8, 2005 (incorporated by reference to Exhibit 10.6 of the 2004 Form 10-KSB).
10.7	Stock Option and Grant Plan, dated March 8, 2005 (incorporated by reference to Exhibit 10.7 of the 2004 Form 10-KSB).
10.8	Subscription Agreement, dated June 28, 2006, by and among Enigma Software Group, Inc., Dutchess Private Equities Fund, LP and Dutchess Private Equities Fund, II, LP. (incorporated by reference to Exhibit 10.1 in the Company’s Form 8-K filed on June 30, 2006).
10.9	Debenture Registration Rights Agreement, dated June 28, 2006, by and among Enigma Software Group, Inc., Dutchess Private Equities Fund, LP and Dutchess Private Equities Fund, II, LP. (incorporated by reference to Exhibit 10.2 in the Company’s Form 8-K filed on June 30, 2006).
10.10	Debenture Agreement, dated June 28, 2006, by and among Enigma Software Group, Inc., Dutchess Private Equities Fund, LP and Dutchess Private Equities Fund, II, LP. (incorporated by reference to Exhibit 10.3 in the Company’s Form 8-K filed on June 30, 2006).
10.11	Share Exchange Agreement, dated June 28, 2006, among Enigma Software Group, Inc., Colorado Stark and Alvin Estevez (incorporated by reference to Exhibit 10.4 in the Company’s Form 8-K filed on June 30, 2006).
10.12	Debenture Agreement between the Company and Dutchess entered into July 20, 2007 (incorporated by reference to Exhibit 99.1 in the Company’s Form 8- K filed on July 25, 2007).
10.13	Warrant Agreement between the Company and Dutchess entered into July 20, 2007 (incorporated by reference to Exhibit 99.2 in the Company’s Form 8-K filed on July 25, 2007).

34

10.14	Warrant Agreement between the Company and Dutchess entered into July 20, 2007 (incorporated by reference to Exhibit 99.2 in the Company’s Form 8-K filed on July 25, 2007).
10.13	Amendment No. 1 to the Stock Option Plan (incorporated by reference to Exhibit A of the Company’s Definitive Schedule 14C Information Statement, filed on April 12, 2007).
14	Code of Ethics, dated March 8, 2005 (incorporated by reference to Exhibit 14 of the 2004 Form 10-KSB).
16	Letter on change in certifying accountant (incorporated by reference to Exhibit 16.1 of the Company’s Form 8-K/A filed January 30, 2006).
21	Subsidiaries (incorporated by reference to Exhibit 21 of the 2004 Form 10-KSB).
31.1*	Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*	Certifications pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

* Filed herewith.

35

Enigma Software Group, Inc.

Annual Report to Shareholders

Index to Financial Statements

	Page
Report of Independent Registered Public Accounting Firm		F-2
Consolidated Balance Sheet		F-3
Consolidated Statements of Operations		F-4
Consolidated Statements of Changes in Capital Deficit		F-5
Consolidated Statement of Temporary Equity		F-6
Consolidated Statements of Cash Flows		F-7
Notes to Consolidated Financial Statements		F-8 - F-32

F-1

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

Certified Public Accountants

406 Lippincott Drive, Ste. J

Marlton, NJ 08053-4168

(856) 346-2828 Fax (856) 396-0022

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

Enigma Software Group, Inc.

150 Southfield Avenue, Suite 1432

Stamford, Connecticut 06902-7756

We have audited the accompanying consolidated balance sheet of Enigma Software Group, Inc., as of December 31, 2007, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the years in the two-year period ended December 31, 2007. Enigma Software Group, Inc.’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits.

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

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Enigma Software Group, Inc. as of December 31, 2007, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America.

The accompanying financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 1 to the financial statements, unless the Company is successful in generating new sources of revenue, or obtaining debt or equity financing, or restructuring its business, the Company is likely to deplete its working capital during 2008. These matters raise substantial doubt about the Company’s ability to continue as a going concern. Management’s plan in regard to these matters is also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

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

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

Marlton, NJ 08053

March 27, 2008

AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS (AICPA)

CENTER FOR AUDIT QUALITY (CAQ)

NEW JERSEY SOCIETY OF CERTIFIED PUBLIC ACCOUNTANTS

PENNSYLVANIA INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS

F-2

Enigma Software Group, Inc.

Consolidated Balance Sheet

December 31, 2007

ASSETS
Current assets:
Cash and cash equivalents	$	95,223
Accounts receivable		415,780
Prepaid expenses		5,375
Deferred expense, net		65,302
Other current assets		16,620
Total current assets		598,300
Property and equipment, net		36,889
Other assets		14,325
Total Assets	$	649,514
LIABILITIES, TEMPORARY EQUITY AND CAPITAL DEFICIT
Current Liabilities:
Accounts payable and accrued expenses	$	70,115
Current portion of secured convertible debenture, due 2011, net		409,176
Current portion of secured convertible debenture, due 2012, net		500,000
Debenture redemption premium payable		227,294
Accrued debenture interest		18,674
Accrued liability for liquidated damages		114,214
Derivative liability		832,412
Warrant liability		1,116,281
Dividend payable in connection with Preferred Stock beneficial conversion		1,550
Deferred revenue		1,102,224
Total current liabilities		4,391,940
Secured convertible debentures, due 2011, net, less current portion		-
Secured convertible debentures, due 2012, net, less current portion		-
Commitments and contingencies
Total Liabilities		4,391,940
TEMPORARY EQUITY
Series A convertible preferred stock, par value $0.001, 10,000,000 shares authorized; 7,433,988 issued and outstanding		3,162
CAPITAL DEFICIT
Series A convertible preferred stock, par value $0.001, 10,000,000 shares authorized; 7,433,988 issued and outstanding		4,272
Common stock, par value $0.001, 250,000,000 shares authorized;
6,387,372 issued and outstanding		6,387
Additional paid-in capital		1,277,233
Accumulated deficit		(5,033,480	)
Total capital deficit		(3,745,588	)
Total Liabilities, Temporary Equity and Capital Deficit	$	649,514

See notes to consolidated financial statements.

F-3

Enigma Software Group, Inc.

Consolidated Statements of Operations

Years ended December 31,

	2007			2006
Revenues:
Sales of software products and subscriptions	$	3,150,364		$	1,207,824
Commission income and other revenue		263,603			119,657
Total revenues		3,413,967			1,327,481
Expenses:
Marketing and selling		1,081,002			214,725
General and administrative		3,239,394			1,850,261
Depreciation and amortization		146,382			14,577
Total expenses		4,466,788			2,079,563
Operating loss		(1,052,811	)		(752,082	)
Debenture interest expense		(110,302	)		(61,000	)
Provision for debenture redemption premium		(257,294	)		(104,166	)
Provision for liquidated damages		(517,919	)		(96,295	)
Discount expense on convertible debentures		(900,000	)		(100,000	)
Fair value adjustments for derivatives and warrants		(188,599	)		(760,095	)
Accretion adjustment for beneficial conversion feature
of Preferred Stock		89,282			(92,925	)
Loss before income tax provision		(2,937,643	)		(1,966,563	)
Income tax provision		-			-
Net loss	$	( 2,937,643	)	$	( 1,966,563	)
Basic net loss per common share	$	(0.63	)	$	(0.20	)
Diluted net loss per common share	$	(0.63	)	$	(0.20	)
Weighted average shares outstanding:
Basic		4,671,632			10,068,680
Diluted		4,671,632			10,068,680

See notes to consolidated financial statements.

F-4

Enigma Software Group, Inc.

Consolidated Statement of Changes in Capital Deficit

For the two years ended December 31, 2007

	Preferred Stock					Common Stock						Additional Paid-in			Accumulated			Total Capital
	Shares		Par value			Shares			Par value			Capital			Deficit			Deficit
Balance - December 31, 2005							16,243,267		$	16,243		$	(55,502	)	$	(129,274	)	$	(168,533	)
Exchange and cancellation of common shares for newly issued preferred shares		7,433,988	$	7,434			(12,052,001	)		(12,052	)		4,618
Stock based compensation expense													178,985						178,985
To provide for temporary equity				(5,404	)								25,378						19,974
Net loss for the year																(1,966,563	)		(1,966,563	)
Balance - December 31, 2006		7,433,988	$	2,030			4,191,266		$	4,191		$	153,479		$	(2,095,837	)	$	(1,936,137	)
Issuance of registered common
shares upon conversion of
debentures							1,396,106			1,396			52,761						54,157
Issuance of restricted common
shares							800,000			800			111,145						111,945
Stock based compensation
expense													983,134						983,134
To relieve temporary equity				2,242									(23,286	)					(21,044	)
Net loss for the year																(2,937,643	)		(2,937,643	)
Balance - December 31, 2007		7,433,988	$	4,272			6,387,372		$	6,387		$	1,277,233		$	(5,033,480	)	$	(3,745,588	)

See notes to consolidated financial statements.

 

F-5

Enigma Software Group, Inc.

Consolidated Statement of Temporary Equity

For the two years ended December 31, 2007

Balance - December 31, 2005	$	-
To provide for temporary equity		5,404
Balance - December 31, 2006	$	5,404
To relieve temporary equity		( 2,242	)
Balance - December 31, 2007	$	3,162

See notes to consolidated financial statements.

F-6

Enigma Software Group, Inc.

Consolidated Statements of Cash Flows

For the years ended December 31,

	2007			2006
Cash flows from operating activities:
Net loss	$	(2,937,643	)	$	(1,966,563	)
Adjustments to reconcile net loss to net cash provided by (used) in operating activities:
Stock based compensation expense		983,134			178,985
Discount expense on convertible debentures		900,000			100,000
Provision for liquidated damages		517,919			96,295
Provision for debenture redemption premium		257,294			104,166
Fair value adjustments for derivatives and warrants		188,599			760,095
Depreciation and amortization		146,382			14,577
Accretion adjustment for beneficial conversion feature of Preferred Stock		(89,282	)		92,925
Changes in:
Accounts receivable		(163,393	)		(201,092	)
Prepaid expenses		(5,375	)		6,501
Other current assets		(15,349	)
Other assets		(3,237	)		(11,088	)
Accounts payable and accrued expenses		(31,191	)		(35,692	)
Accrued debenture interest		8,674			10,000
Deferred revenue		575,019			(42,407	)
Net cash provided by (used in) operating activities		331,551			(893,298	)
Cash flows from investing activities:
Purchase of property and equipment		(36,748	)		(12,456	)
Net cash used in investing activities		(36,748	)		(12,456	)
Cash flows from financing activities:
Repayment of current portion of secured convertible debentures, due 2011		(536,667	)
Payment of accrued debenture redemption premium		(134,167	)
Issuance of convertible debentures					1,000,000
Less: Deferred financing costs incurred in connection with issuance of convertible debentures, due 2011					(95,000	)
Net cash (used in) provided by financing activities		(670,834	)		905,000
Net decrease in cash and cash equivalents		(376,031	)		(754	)
Cash and cash equivalents - beginning of year		471,254			472,008
Cash and cash equivalents - end of year	$	95,223		$	471,254
Supplemental disclosure of cash flow information:
Cash paid for Interest	$	101,628		$	51,000

See notes to consolidated financial statements.

F-7

Enigma Software Group, Inc.

Notes to Consolidated Financial Statements

For the years ended December 31, 2007 and 2006

NOTE A - CORPORATE ORGANIZATION, GOING CONCERN AND DESCRIPTION OF BUSINESS

Corporate organization

Enigma Software Group, Inc. (“Enigma” or the “Company”), is a Delaware corporation, headquartered in Connecticut, that was formed in 2005 and is the surviving corporation of a reverse takeover with Maxi Group, Inc. (“Maxi”). Enigma commenced operations in 1999 and is a developer of security software products designed to give customers control over the programs installed on their computers in an automated and easy-to-use way, thereby enhancing transparency and user-control. In February of 2005, Enigma, upon completion of a reverse takeover transaction with Maxi, began trading on the Over the Counter Bulletin Board (the “OTCBB”). Enigma currently trades on the OTCBB under the symbol “ENGM.” The consolidated financial statements include the accounts of the Company and its three wholly-owned subsidiaries. The only intercompany transactions are investments in and advances to, subsidiaries, which have been eliminated in consolidation. UAB Enigma Software Group LT (“UAB Enigma”), one of the Company’s wholly-owned subsidiaries, is a foreign corporation formed under the laws of the Republic of Lithuania. UAB Enigma, which is a cost center, has no revenues other than intercompany revenues. UAB Enigma commenced operations in the fourth quarter of 2006 and its financial statements, which are prepared in the local currency, have been converted to U.S. dollars using the appropriate exchange rates. A foreign currency translation loss, which is not material to the consolidated results, is included in General and Administrative expenses for the years ended December 31, 2007 and 2006.

Going Concern - The Company is in default under certain debentures, does not have the ability to satisfy its obligations and may not be able to continue its operations

The Company did not generate sufficient cash flows from revenues to fund its operations and debt service during the years ended December 31, 2007 and 2006. In June 2006, Enigma entered into a One Million Dollar ($1,000,000) convertible debenture agreement (the “Old Debenture Agreement”) with Dutchess Private Equities Fund, LP and Dutchess Private Equities Fund, II, LP (see Notes B and G).

In July 2007, the Company entered into a new Five Hundred Thousand Dollar ($500,000) convertible debenture agreement (the “New Debenture Agreement”) with Dutchess Private Equities Fund, Ltd. as successor in interest to Dutchess Private Equities Fund, LP & Dutchess Private Equities Fund, II, LP (“Dutchess”) (see Notes B and G).

F-8

At December 31, 2007, the Company had a net working capital deficit of approximately $3.8 million. After adding back a derivative liability, a warrant liability and a dividend payable in connection with a preferred stock beneficial conversion feature, all of which totaled approximately $2.0 million, the Company still had net a working capital deficit of approximately $1.8 million (of which approximately $1.3 was due to Dutchess).

At December 31, 2006, the Company had a net working capital deficit of approximately $1.9 million. After adding back a derivative liability, a warrant liability, and a dividend payable in connection with a preferred stock beneficial conversion feature, all of which totaled approximately $1.8 million, the Company still had net working capital deficit of approximately $100,000.

Beginning on January 2, 2007, the Company had been required to make monthly amortizing principal payments and redemption premium payments to Dutchess each in the amount of approximately $104,167. Due to its deteriorating cash position the Company was unable to make the full required payment on March 1, 2007 and in subsequent months, thereby creating multiple Events of Default under the Financing documents. Such Events of Default were cured in July 2007. (See Notes B and G).

Subsequent to July 2007, in accordance with an agreement with Dutchess (see Notes B and G), the Company was required to make monthly amortizing principal payments and redemption premium payments on the Old Debenture Agreement, as well as interest payments on both the Old Debenture Agreement and the New Debenture Agreement. Due to its deteriorating cash condition, the Company was unable to make the payments due to Dutchess on neither December 1, 2007, January 2, 2008, February 1, 2008, nor March 2, 2008, thereby creating new multiple Events of Default. The financial statements do not include any adjustments that might result from the outcome of these uncertainties.

Dutchess and the Company have developed a plan for the curing of these new multiple Events of Default in a manner that is fair and equitable to the shareholders of the Company as well as to the parties to the agreement (See Note O).

Description of Business

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

F-9

NOTE B - FINANCING TRANSACTION

On June 28, 2006, the Company entered into a Subscription Agreement (the “Subscription Agreement”) with Dutchess pursuant to which the Company issued secured debentures, convertible into shares of the Company’s common stock, par value $0.001 per share (the “Common Stock”), in the principal amount of One Million Dollars ($1,000,000) (the “Old Debentures”) (See Note G). Dutchess funded Five Hundred Thousand Dollars ($500,000) to the Company upon the initial closing and funded an additional Five Hundred Thousand Dollars ($500,000) to the Company on July 25, 2006 (the “Financing”); simultaneous with the Company’s filing of the Registration Statement with the SEC, covering the shares of Common Stock underlying the Old Debentures.

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

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

Liquidated Damages

The Registration Rights Agreement between the Company and Dutchess provides for liquidated damages to the extent that the Company does not attain certain milestones within specified time frames. Pursuant to the Registration Rights Agreement, liquidated damages amounting to approximately $20,000 per month, were payable by the Company, in the event that the Registration Statement was not declared effective within 90 calendar days after the closing of the Financing. Such liquidated damages were payable for each 30 calendar day period after the 90 day milestone on a pro-rata, compounded daily basis, until the Registration Statement was declared effective. Furthermore, liquidated damages amounting to approximately $20,000 per month were payable by the Company, in the event that it failed to respond to any SEC comments or correspondence within seven business days of receipt of such by the Company and within nine business days in the case of SEC staff accounting comments. In addition, liquidated damages accrued as a result of the Company’s inability to make the full required monthly payments of $104,167 (see Note A). As a result, as of June 30, 2007, liquidated damages totaling $953,510 had been accrued by the Company in connection with these provisions, as (1) the Registration Statement was not declared effective until June 7, 2007; (2) the Company had required more than nine business days to respond, in each case, to the SEC staff’s numerous rounds of comments on the Registration Statement; and (3) the inability of the Company to make the required principal payments in full. However, as discussed below, in connection with the New Debenture Agreement, the Company was relieved of a portion of the liability for such liquidated damages, plus such damages that had continued to accrue from June 30, 2007 to the issuance of the New Debenture. With the Registration Statement having been declared effective, if Dutchess’ right to sell is suspended for any reason for a period of 5 business days, then the Company must pay liquidated damages in the amount of 2% of the face amount of the then outstanding Old Debentures for each 10 day calendar period that the suspension is in effect.

F-10

As a result of the Company’s default in December 2007, liquidated damages of approximately $114,000 were accrued by the Company at December 31, 2007. Additional liquidated damages continue to accrue at the approximate monthly rate of $114,000, absent a curing of the default (See Note O).

Exchange of Common Stock for Preferred Stock

In connection with the Financing, the Company’s two founders and principal stockholders, Colorado Stark and Alvin Estevez, each exchanged their shares of Common Stock (collectively 12,052,001 shares of Common Stock) for an aggregate 7,433,988 shares of newly issued Series A Convertible Preferred Stock, par value $0.001 per share (the “Preferred Stock”), convertible initially at the rate of $0.07 (the “Initial Conversion Price”). While the Preferred Stock ranks senior to the Common Stock with respect to dividends, and on parity with the Common Stock with respect to liquidation, the holders of shares of the Preferred Stock shall generally vote together with the holders of shares of the Common Stock on an as-if-converted basis. The number of shares issuable upon conversion of the Preferred Stock, issued as an anti-dilutive device to Colorado Stark and Alvin Estevez, work in tandem with the number of shares issuable upon conversion of the Debentures. Prior to the Financing between the Company and Dutchess, Messrs. Stark and Estevez, owned 74.2% of the Company’s Common Stock. Assuming the full conversion of the 58,000,000 shares underlying the exercise of the Old Warrants and the shares underlying the conversion of the Old Debentures that the Company was obligated to register, the maximum amount of dilution to be experienced by Messrs. Stark and Estevez is 15%. Such number was derived assuming Dutchess’ full conversion of the 58,000,000 shares, as well as Messrs. Stark and Estevez’ conversion of their shares of Preferred Stock into shares of the Company’s Common Stock at the Initial Conversion Price. Assuming such conversion, Dutchess would own 58,000,000 shares of the Company’s Common Stock, Messrs. Stark and Estevez would own 106,199,827 shares of the Company’s Common Stock, and the number of shares outstanding immediately prior to the time of such conversion would remain at 4,191,266. In this instance, Messrs. Stark and Estevez would own 63.1% of the Company’s Common Stock, a 15% decrease from the 74.2% of Common Stock they owned prior to entering into the Financing.

F-11

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

Debt restructure

On July 15, 2007, the Company and Dutchess reached an agreement whereby, among other things, the Company agreed to pay down the remaining principal of the Old Debentures, plus a required 25% redemption premium, plus accrued interest, on the first business day of every month commencing August 1, 2007. Accordingly, these liabilities are classified entirely as current liabilities on the accompanying balance sheet. During the six-month period ended December 31, 2007, the Company paid Dutchess $278,000 in principal reductions and $69,500 in redemption premiums. However, due to its deteriorating cash condition, the Company was unable to make the required payments to Dutchess on neither December 1, 2007, January 2, 2008, February 1, 2008, nor on March 3, 2008, thereby creating new multiple Events of Default. Dutchess and the Company have reached an agreement on curing these new multiple Events of Default (See Note O).

On July 20, 2007, in connection with the New Debenture Agreement the Company issued a new secured convertible debenture to Dutchess in the amount of $500,000 (the “New Debenture”) on similar terms to those of the Old Debenture and Dutchess agreed to forego the payment of liquidated damages, which as of June 30, 2007 had accrued in the amount of $953,510. No cash was received by the Company upon the issuance of the New Debenture; however the Company was relieved of the current liability for liquidated damages, plus such damages that continued to accrue from June 30, 2007 to the issuance of the New Debenture, the total of which the Company estimates to have been in excess of $1,000,000. As a result of the Company’s failure to make the payments required on December 1, 2007, the principal under the New Debenture was accelerated and this liability and its required debenture redemption premiums payable are classified entirely as current liabilities on the accompanying balance sheet.

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NOTE C - REVERSE TAKEOVER

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

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

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

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

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NOTE D - SIGNIFICANT ACCOUNTING POLICIES

[1] Fair value of financial instruments

At December 31, 2007 and 2006, the Company’s financial instruments included cash, accounts receivable and accounts payable. The carrying values of these instruments approximate their fair value because of their short-term nature.

At December 31, 2007 and 2006, financial instruments also included the Debentures. Because the Debentures contain a conversion features that are deemed to be an embedded derivatives requiring bifurcation from the debt host instrument, they are precluded from being accounted for as conventional convertible debt. Specifically, the Company has concluded that since, among other things, the Debenture contracts do not contain economic characteristics and risks that are contained in their embedded derivative (i.e., the Company’s Common Stock) and the host instruments do not meet the definition of conventional convertible debt required by Emerging Issues Task Force Issue No. 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in a Company’s Own Stock” (“EITF 00-19”), as they contain provisions that could result in the conversion ratio not being fixed, the Debentures should be accounted for pursuant to the provisions of Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” (“FAS 133”). Accordingly, the fair value of the derivative liabilities as of the December 31, 2007 and 2006, have been estimated using a Black-Scholes-Merton model with the following assumptions:

	December 31, 2007			December 31, 2006
Debenture conversion price (1)	$	.0188		$	0.35
Expected live of the debt (2)		3 months current			2 months current 5 year non-current
Estimated dividends (3)	$	0.00		$	0.00
Expected volatility (4)		282.19	%		221.13	%
Risk-free interest rate (5)		3.63	%		4.65	%

(1) Debenture conversion price equal to 75% of the closing market price of the Company’s Common Stock as of the last trading day on which the Company’s Common Stock traded prior to December 31, 200 7 and 2006.

(2) A three month live in the case of December 31, 2007 non-current Debentures is assumed; while in the case of December 31, 2006, a five year life in the case of the non-current portion of the Debentures and an average 2 month life in the case of the current portion of the Debentures is assumed.

(3) Estimated the amount of dividends the Company would pay to be zero.

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(4) The expected volatility at December 31, 2007 and 2006 of 282.19% and 221.13% respectively, are based on the average of the historical volatility for the Company’s Common Stock during its respective 34 and 22 months of trading activity.

(5) The risk-free interest rate of 3.63% and 4.65% at December 31, 2007 and 2006, respectively, is based on the U.S. Treasury constant maturity rate for the period equal to the expected life of the derivative instrument.

[2] Revenue recognition:

With respect to license fees generated from the sales of software products and subscriptions services for downloadable security software products, the Company recognizes revenues in accordance with Statement of Position (“SOP”) No. 97-2, "Software Revenue Recognition," as amended by SOP No. 98-9, "Modification of SOP No. 97-2, Software Revenue Recognition, With Respect to Certain Transactions." These statements provide guidance for recognizing revenues related to sales by software vendors. The Company sells its SpyHunter software with the subscription service for spyware definition updates and product support over the Internet. Customers place their orders and simultaneously provide their credit card information to the Company. Upon receipt of authorization from the credit card issuer, the Company licenses the customer to download SpyHunter over the Internet. For a fee of $29.99, the Company provides a subscription for post-contract customer support ("PCS") for a period of six months from purchase, which consists primarily of e-mail support and free updates of its SpyHunter software, as and when such updates are available. In accordance with SOP No. 97-2 and SOP No. 98-9, the fee is required to be allocated to the various elements, based on vendor-specific objective evidence ("VSOE") of fair value.

During May 2006, the Company introduced SpyHunter 2.7, and in the fourth quarter of 2006 and the first quarter of 2007, introduced SpyHunter 2.8 and SpyHunter 2.9, respectively. The Company introduced SpyHunter 3 Security Suite® during the fourth quarter of 2007. In all cases, the Company provides PCS for a period of six months. The Company considers all revenue from the sales of SpyHunter to be attributable to the service elements.

With respect to commission income, the Company recognizes such revenue at the time of delivery of the product or the service for which the commission is earned.

The Company’s license agreement for its SpyHunter software does not provide the Company’s customers with any right of return. However, the Company may decide to accept customer returns on a case-by-case basis. For the years ended December 31, 2007 and 2006, customer returns and chargebacks were minimal.

[3] Property, plant and equipment:

Furniture, equipment and computer hardware are depreciated using the straight-line method over their estimated useful lives of up to five years. Purchased computer software products are amortized using the straight-line method over their estimated useful lives of three years. Leasehold improvements are amortized by the straight-line method over the shorter of the remaining term of the lease or the economic useful life of the asset. The Company evaluates its long-lived assets in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. In the evaluation, the Company compares the values of such assets to the estimated undiscounted future cash flows expected from the use of the assets and their eventual disposition. When the estimated undiscounted future cash flows are less than the carrying amount, an impairment loss is recognized equal to the difference between the assets’ fair value and their carrying value.

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[4] Software development costs:

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

[5] Advertising expenses:

Advertising expenses, consisting primarily of space purchased from various Internet-based marketers as well as search engines, are expensed as incurred. For the years ended December 31, 2007 and 2006, advertising expense amounted to $612,248 and $87,193, respectively, and is included in marketing and selling expenses in the Company’s Consolidated Statement of Operations for those respective years.

[6] Income taxes:

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

[7] Accounting estimates:

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

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[8] Stock-based compensation expense:

The Company recognizes compensation costs associated with stock options over each employee’s service period, which in all cases is the vesting period for such stock option grants. In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”). SFAS 123R established standards that require companies to record the cost resulting from all share-based payment transactions using the fair value method. Transition under SFAS 123R permits using a modified version of prospective application under which compensation costs are recorded for unvested shares outstanding or a modified retrospective method under which all prior periods impacted by SFAS 123R are restated. SFAS 123R became effective, for the Company, as of January 1, 2006, with early adoption permitted. Enigma adopted prospective application in 2006, and accordingly compensation costs associated with stock options that were unvested at December 31, 2005 and which vested in the first quarter of 2006 were expensed in the first quarter of 2006. This resulted in a charge to earnings of $108,263 in that quarter. Accordingly, the financial statements for the Company’s prior interim periods and fiscal years did not reflect any restated amounts. In addition, for compensation costs incurred in the subsequent quarters of 2006 in connection with stock options granted and vested during 2006, the Company recorded charges to earnings of $70,722 in those quarters, resulting in a total charge of $178,985 for the year ended December 31, 2006. For the year ended December 31, 2007,compensation costs incurred in connection with granted and vested during the year as well as older options which vested, the Company recorded a charge to earnings of $983,134. All stock-based compensation expense is included in General and Administrative expense on the Company’s Consolidated Statement of Operations. Since the portion of this expense related to Incentive Stock Options (“ISOs”) is not deductible for tax purposes, its recording gave rise to a deferred tax asset of approximately $344,000 and $61,000 at December 31, 2007 and 2006. However, since the Company has reported net losses before income tax provision for the years ended December 31, 2007 and 2006, and has utilized all if its Net Operating Loss carryforwards, such benefits will not be realizable, and as a result, have been entirely offset by a valuation reserve.

[9] Earnings per share:

Basic earnings (loss) per share are computed by dividing the income/(loss) available to common stockholders by the weighted average number of common shares outstanding. For the years ended December 31, 2007 and 2006 diluted earnings per share would include the dilutive effect, if any, from the potential exercise of stock options using the treasury stock method, as well as the potential conversion of shares of Preferred Stock into Common Stock, the potential conversion of Convertible Debentures into shares of Common Stock and the potential issuance of shares of Common Stock upon potential exercise of Warrants. Since such treatment for the years ended December 31, 2007 and 2006 would be anti-dilutive, diluted earnings per share are equivalent to basic earnings per share.

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[10] Future impact of recently issued accounting standards:

In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements, but it does not require any new fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company adopted these disclosures with respect to its outstanding debentures and warrants.

[11] Cash and cash equivalents:

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

NOTE E - CONCENTRATIONS OF CREDIT RISK

CASH AND CASH EQUIVALENTS

The Company has placed its cash and cash equivalents with highly capitalized financial institutions insured by the Federal Deposit Insurance Corporation (“FDIC”). At December 31, 2007 and 2006, such cash balances were in excess of FDIC limits.

ACCOUNTS RECEIVABLE

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

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NOTE F - PROPERTY AND EQUIPMENT

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

	2006		2005		Estimated Useful Lives
Computer hardware	$	40,642	$	23,163	3 years
Furniture and fixtures		6,060		3,293	5 - 6 years
Telecommunications equipment		2,502			3 years
Gross property and equipment		49,204		26,456
Less accumulated depreciation		12,315		12,077
Net property and equipment	$	36,889	$	14,379

During the years ended December 31, 2007 and 2006, the Company recorded depreciation expense of $14,238 and $5,077, respectively. Also during the years ended December 31, 2007 and 2006 the Company acquired property and equipment totaling $36,748 and $12,746, respectively, and during the year ended December 31, 2007, wrote off fully depreciated assets and associated accumulated depreciation of $14,000.

NOTE G - SECURED CONVERTIBLE DEBENTURES

[1]  SECURED CONVERTIBLE DEBENTURES DUE 2011

The Old Debentures bear interest at 12% per annum, payable monthly, and are due in June of 2011. However, in connection with the Company’s default as of December 4, 2007, (see Note B), the maturity of the Old Debentures has been accelerated and accordingly, the Old Debentures are reported as a current liability in the balance sheet. The Old Debentures are convertible into shares of Common Stock of the Company at the lesser of $0.07 per share or seventy-five percent (75%) of the lowest closing bid price of the Common Stock during the 20 trading days immediately preceding a notice of conversion (the “Conversion Price”). The Old Warrants are also exercisable at the Conversion Price and may be exercised any time after issuance through and including June 28, 2011. The shares of Common Stock that will be issued, if the underlying Old Debentures are converted and the Old Warrants are exercised, will be very dilutive to the Company’s common stockholders (see Note I).

During the third and fourth quarters of the year ended December 31, 2007, Dutchess converted a total of $54,157 face amount of the Old Debentures, at varying conversion prices ranging from $0.0188 to $0.07, into 1,396,106 registered shares of the Company’s Common Stock.

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The potential conversion of the Old Debentures into shares of Common Stock and the potential issuance of shares of Common Stock upon the potential exercise of the Old Warrants give rise to a derivative liability (the “Derivative Liability”) and a warrant liability (the “Warrant Liability”), respectively. The Company has calculated the potential fair value of each respective liability using the Black-Scholes-Merton option-pricing model: the annualized historical volatility of the Company’s stock price over a period of 34 months of 282.19%; an estimated exercise price of $0.0188, equal to the Conversion Price at December 31, 2007; a discount rate of 3.63% equal to the yield on 5 year US Treasury Notes issued December 28, 2007; an estimated life of 3 months for the Old Debentures; and an estimated life of 3.5 years for the Old Warrants.

[2] SECURED CONVERTIBLE DEBENTURES DUE 2012

On July 20, 2007, the Company entered into the New Debenture Agreement with Dutchess and immediately closed the transaction pursuant to which the Company issued the New Debentures. Interest only payments were due on the New Debentures until their maturity. However, in connection with the Company’s default as of December 4, 2007, (see Note B), the maturity of the New Debentures has been accelerated and accordingly, the New Debentures are reported as a current liability in the balance sheet. The New Debentures are convertible into shares of Common Stock of the Company at the lesser of seven cents ($.07), or seventy-five percent (75%) of the lowest closing bid price of the Company’s Common Stock during the twenty (20) trading days immediately preceding a notice of conversion. At the same time, the Company entered into a warrant agreement (the “New Warrant”) with Dutchess, whereby the Company issued to Dutchess warrants to purchase 25,000,000 shares of the Common Stock of the Company at the exercise price of $0.01 per share of Common Stock. The term of the New Warrant is five years and it contains registration rights. The shares of Common Stock that will be issued, if the underlying New Debentures are converted and the New Warrants are exercised, will be very dilutive to the Company’s common stockholders (see Note I).

In consideration for the issuance of the New Debentures and the New Warrant, Dutchess agreed that all liquidated damages due from the Company to Dutchess, which the Company and Dutchess estimate to have been approximately $1,000,000 as of July 20, 2007, plus additional daily accruals, resulting principally from the Company’s failure to have its recent registration statement on Form SB-2 declared effective by the SEC prior to the deadline stipulated in the Registration Rights Agreement between the Company and Dutchess, and the inability of the Company to make the required loan principal payments resulting from such delay in effectiveness, were declared settled.

The potential conversion of the New Debentures into shares of Common Stock and the potential issuance of shares of Common Stock upon the potential exercise of the New Warrants give rise to a Derivative Liability and a Warrant Liability respectively, as well. The Company has calculated the potential fair value of each respective liability using the Black-Scholes-Merton option-pricing model: the annualized historical volatility of the Company’s stock price over a period of 34 months of 282.19%; an estimated exercise price of $0.0188, equal to the Conversion Price at December 31, 2007; a discount rate of 3.63% equal to the yield on 5 year US Treasury Notes issued December 28, 2007; an estimated life of 3 months for the New Debentures; and an estimated life of 4.5 years for the New Warrants.

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[3] ESTIMATED FAIR VALUE

These calculations resulted in an estimated fair value of $832,412 for the convertibility feature of the Old and New Debentures and an estimated fair value of $1,116,281 for the Old and New Warrants at December 31, 2007. Such amounts were recorded as liabilities in the Company’s consolidated financial statements as of December 31, 2007, giving rise to a charge to earnings for year ended December, 2007 of $188,599. For the year ended December 31, 2006, the charge to earnings for the fair value adjustment of derivatives and warrants was $760,095.

[4] DEBT DISCOUNT EXPENSE

In connection with the issuance of the Old Debentures and the calculation of the fair value of the Warrant Liability and Derivative Liability at the time of issuance, a discount of $1 million was netted against the liability for the Old Debentures, thereby reducing that liability to a net of zero. As the Old Debentures were due 60 months from the closing of the Financing, the $1,000,000 discount was to be amortized as an expense at the rate of $16,667 per month. This was done through December 31, 2006, giving rise to a discount expense on the Old Debentures for the year ended December 31, 2006 of $100,000.However, as a result of the principal payments required to be made to Dutchess, due to the Registration Statement not having become effective, as well as the Company’s default as of December 4, 2007, unamortized debt discount expense of $900,000 associated with the then current portion of Old Debentures, was expensed during the year ended December 31, 2007.

In connection with the issuance of the New Debentures and the calculation of the fair value of the Warrant Liability and Derivative Liability at the time of issuance, a discount of $500,000 was netted against the liability for the New Debentures, thereby reducing that liability to a net of zero. As the New Debentures were due 60 months from the closing of the Financing, the $500,000 discount was to be amortized as an expense at the rate of $8,333 per month. However, as a result of the Company’s default as of December 4, 2007, no discount expense was taken and the New Debentures are reported in the consolidated balance sheet as a current liability.

NOTE H - TEMPORARY EQUITY

As of December 31, 2007, the Company did not have a sufficient quantity of authorized Common Stock to meet it potential obligations for conversion of the Old and New Debentures, the exercise of the Old and New Warrants and the conversion of the Preferred Stock. At the December 31, 2007 exercise price of $0.0188 per share, the remaining outstanding Old Debentures could have been converted into 21,764,700 shares of the Company’s Common Stock; the Old Warrants could have been exercised for 15,000,000 shares of the Company’s Common Stock; the outstanding New Debentures could have been converted into 26,595,745 shares of the Company’s Common Stock; the New Warrants could have been exercised for 25,000,000 shares of the Company’s Common Stock; and the Preferred Stock could have been converted into 270,191,009 shares of the Company’s Common Stock. The aggregate of the common shares outstanding and those shares due upon the conversions and the Warrant exercise, as of December 31, 2007, was approximately 365 million shares of Common Stock, which exceeded the 250 million shares of Common Stock authorized in the Company’s Certificate of Incorporation.

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During the year ended December 31, 2007, the Company was successful in increasing the number shares of its authorized Common Stock from 100 million to 250 million shares. However, because the number of shares issuable upon conversion of the Old and New Debentures as well the number of shares issuable upon conversion of the Preferred Stock varies inversely with the price of the Company’s Common Stock, the 150 million share increase in authorized shares of Common Stock proved to be insufficient.

Accordingly, the excess of such shares, 114,938,826, represented by 3,162,407 shares of the Company’s Preferred Stock, has been reclassified to Temporary Equity on the Consolidated Balance Sheet until this situation can be resolved. Management intends to study its alternatives to remedy this situation, including further increasing the number of authorized shares of Common Stock, with the consent of the Company’s shareholders. In addition, at December 31, 2007, based on the Company’s stock trading price and the conversion price of the preferred shares, a beneficial conversion feature estimated to be $3,643 exists, with respect to the Preferred Stock. At December 31, 2006, this beneficial conversion feature was estimated to be $92,925. Accordingly, a credit to income of $89,282 was required in connection with the Preferred Stock beneficial conversion feature. The portion of the estimated beneficial conversion feature of $3,643 that relates to the preferred shares deemed to be temporary equity ($1,550) was recorded as a dividend payable to preferred shareholders; and the portion that relates to the preferred shares in permanent equity ($2,093) was credited to Additional Paid-in Capital.

NOTE I - CAPITAL DEFICIT

The Company’s authorized capital stock consists of 250,000,000 shares of Common Stock and 10,000,000 shares of Preferred Stock. On August 9, 2007, the majority stockholders of the Company voted to increase the number of authorized Common Stock shares from 100,000,000 to 250,000,000 and the Company filed a Schedule 14C to that effect and in September 2007, the increase in authorized Common Stock became effective.

As of December 31, 2007, 6,387,372 shares of Common Stock were issued and outstanding, 9,000,000 shares of Common Stock were reserved for issuance upon the exercise of outstanding and future stock options (see Note J), and 57,790,000 shares of Common Stock were reserved for conversion of the Old Debentures and exercise of the Old Warrants. The number of issued and outstanding common shares increased during the year ended December 31, 2007 in connection with the conversion of debentures in the principal amount of $54,157 due 2011 into 1,396,106 shares of Common Stock and the issuance of an aggregate of 800,000 shares of Common Stock pursuant to Section 4(2) of Securities Act of 1933, as amended, which shares were issued as consideration for the retention of three firms to provide investor relations services to the Company. These firms were engaged by the Company to create and execute a public awareness campaign, to assist in responding to inquiries from potential investors, to solicit research firm coverage of the Company and to prepare and post on various websites, both proprietary and non-proprietary, research reports on the Company.

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In addition, 7,433,988 shares of Preferred Stock were issued and outstanding. The Company has not and will not receive any proceeds from the conversion of the Old Debentures into Common Stock but will receive proceeds from the exercise of the Old Warrants, if so exercised. Similarly, the Company will not receive any proceeds from the conversion of the New Debentures into Common Stock but will receive proceeds from the exercise of the New Warrants, if so exercised.

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

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

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

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Conversion Rights. The holders of the Preferred Stock entered into a Lock-Up Agreement with the Company, whereby the holders of Preferred Stock agreed not to convert their shares of Preferred Stock into shares of the Company’s Common Stock from February 6, 2007, until in either case ending on the earlier to occur of (i) three hundred and sixty (360) days after the effective date of the Registration Statement (which would be approximately June 1, 2008) or (ii) the date on which the full face amount, accrued interest and penalties, if any, on the Debentures have been paid or (iii) the conversion in full of the Old Debentures, any accrued interest thereon and the full exercise of the Old Warrants (either being the “Lock-Up Period”). However, the holders of the Preferred Stock may convert their shares of Preferred Stock during the Lock-Up Period upon and after the occurrence of Dutchess acquiring a percentage threshold of the shares of the Company’s Common Stock, whether through partial conversion of the shares underlying the Old Debentures or exercise of the shares underlying the Old Warrants, on a pro rata basis with subsequent conversions of Common Stock that have been issued to Dutchess as a result of conversions of the Old Debentures and exercise of the Old Warrants.

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

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

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

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

Common Stock

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

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

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

NOTE J - STOCK OPTION PLAN

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

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During April of 2006, the Company granted options under the Stock Option Plan to seven employees, a non-employee director and several consultants to purchase an additional aggregate of 1,438,000 shares of the Company’s Common Stock at exercise prices ranging from $0.065-$0.0715. These options generally vested ratably over a period of 12 months from the date of grant, which is the requisite service period for such awards. No other conditions, such as market or performance conditions, must have been satisfied in order for the option awards to fully vest. Thus, all such options are now fully vested. Accordingly, the Company recognizes compensation costs associated with stock options over each employee’s respective service period, which in all cases is the vesting period for such stock option grants.

In November of 2006, three employees of the Company, namely, Alvin Estevez, Colorado Stark and Richard Scarlata,returned a portion of their 2005 options, which totaled 391,610 shares, to the Company and the Company cancelled them, adding them back to the pool for new option grants. Also in November of 2006, the Company granted an employee of UAB Enigma options to purchase 1,000,000 shares of the Company’s Common Stock at an exercise price of $0.03. These options were to vest over a period of three years from the date of grant, which was the requisite service period for such award. No other conditions, such as market or performance conditions, were to be satisfied in order for the option award to fully vest. However, this individual’s employment was terminated in the second quarter of 2007, and as part of the termination agreement, 125,000 options were deemed vested at the date of termination of employment (at the $0.03 option exercise price) and the other 875,000 shares were returned to the pool.

On March 13, 2007, the majority shareholders of the Company voted to adopt amendments to the Company’s Stock Option Plan to (a) increase the number of shares of Common Stock reserved and available for issuance under the Stock Option Plan from 3,000,000 shares of Common Stock to 9,000,000 shares of Common Stock, (b) automatically grant stock options to new members of the Board, who are not employees of the Company, to purchase 75,000 shares of Common Stock, (c) automatically grant annual stock options to every Board member, who is not an employee of the Company, to purchase 25,000 shares of Common Stock, and (d) grant one time stock options to every Board member, who is not an employee of the Company, if such individual was a member of the Board prior to the date of the amendment of the Stock Option Plan, to purchase 100,000 shares of the Common Stock. The amended Stock Option Plan became effective on May 8, 2007 in accordance with a Schedule 14C Information Statement, which was filed with the SEC on April 12, 2007 and mailed to all registered shareholders shortly thereafter.As a result of that amendment, an annual option for 25,000 shares was granted to the Company’s sole independent director, Mr. McGuinn, at an exercise price of $0.25 per share. Such option vested immediately. Also, as a result of that amendment, a one time option for 100,000 shares was granted to Mr. McGuinn as of May 31, 2007, at an exercise price of $0.35. Such option vested immediately as well.

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On August 16, 2007, as approved by the Board of Directors of the Company, the Company granted options under the Stock Option Plan to six employees of the Company, several consultants, and 19 employees of the Company’s wholly-owned foreign subsidiary, UAB Enigma, to purchase an additional aggregate of 6,370,000 shares of the Company’s Common Stock at an exercise price of $0.15. Subsequently, with the termination of several employees, 34,000 options were cancelled and returned to the pool. A portion of the options issued vested immediately upon issuance and the remainder vest ratably over the months through March 31, 2008, which is the requisite service period for such awards. No other conditions, such as market or performance conditions, must be satisfied in order for the option awards to fully vest. The following table presents the status of options outstanding under the Stock Option Plan as of December 31, 2007:

Year of Grant	# granted		# cancelled			# exercised		# outstanding		# vested			# unvested
2005		1,257,595		(711,594	)		0		546,001		(366,731	)		179,270
2006		2,438,000		(875,000	)		0		1,563,000		(1,563,000	)		0
2007		6,495,000		( 34,000	)		0		6,461,000		(4,876,997	)		1,584,003
Total		10,190,595		(1,620,594	)		0		8,570,001		(6,806,728	)		1,763,273

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

	Dividend Yield			Expected Volatility			Risk-Free Interest Rate			Expected Life
Pro-forma Fiscal Year ended Dec. 31, 2005		0	%		18.76	%		3.91	%		5 years
Options granted during the Fiscal Year ended Dec. 31, 2005		0	%		172.78	%		3.91-4.00	%		5 years
Options granted during the Quarter ended June 30, 2006		0	%		195.41	%		4.84	%		5 years
Options granted during the Quarter ended Dec. 31, 2006		0	%		210.14	%		4.60	%		5 years
Options granted during the Quarter ended Mar. 31, 2007		0	%		249.23	%		4.51	%		5 years
Options granted during the Quarter ended June 30, 2007		0	%		251.08	%		4.83	%		5 years
Options granted during the Quarter ended September 30, 2007		0	%		254.13	%		4.60	%		5 years

The Company does not currently pay cash dividends on its Common Stock and does not anticipate doing so in the foreseeable future. Accordingly, the expected dividend yield is zero. Expected volatility is based on the average of the historical volatility for the Company’s Common Stock for the period from commencement of trading in February 2005 to the date of the calculation. The risk free interest rate is equal to the U.S. Treasury constant maturity rate for securities issued nearest the option grant date and for the period equal to the expected life of the option. Since the Company has no experience on which to base the expected lives of a stock option, five years, or ½ of the option exercise period for all grantees, other than Messrs. Stark and Estevez, was used. The option exercise period for Messrs. Stark and Estevez is five years, which was used to determine the value of their options as well.

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NOTE K - PROFIT SHARING PLAN

The Company has a defined contribution plan, the Enigma Software Group, Inc. 401(k) Plan, (the "401(k) Plan"), under which eligible employees are able to make contributions that are matched, effective September 1, 2006, by the Company at the rate of 100% of an individual employee’s contribution, up to the maximum allowable by law. For 2007, that amount is generally $15,500 (for employees 50 years of age and older it is $20,500). Such amounts for 2006 were $15,000 and $20,000, respectively. Prior to September 1, 2006, the Company matched 50% of the first $10,000 of an individual employee's contribution. The Company's contributions to the 401(k) Plan for the years ended December 31, 2007 and 2006 were $105,434 and $76,481.

NOTE L - PROVISION FOR INCOME TAXES

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

	2007			2006
Computed benefit	$	(334,300	)	$	(668,600	)
State tax benefit, net of federal effect		( 25,000	)		( 50,000	)
Income tax benefit	$	(309,300	)	$	(718,600	)

As the income tax benefits of $309,300 and $718,600 may not be realized, they have been entirely offset by valuation allowances.

The tax effects of the temporary differences that give rise to deferred tax assets and liabilities at December 31, 2007 and 2006 are presented below:

	2007			2006
Deferred revenue	$	(1,102,224	)	$	(527,205	)
Net operating loss carryforwards		1,102,224			527,205
Net deferred tax asset	$	0		$	0

F-28

As of December 31, 2006, the Company had a federal net operating loss carryforward of approximately $987,000 available to offset future taxable income through 2021.

NOTE M - LEGAL PROCEEDINGS

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

NOTE N - COMMITMENTS AND CONTINGENCIES

Office Lease:

At December 31, 2006, there was no lease for the Company’s then current office space, which was located within an office suite complex in Stamford, Connecticut. Rather, the Company had entered into an office service agreement with the operator of the office suite giving the Company a license to use designated offices as well as business center facilities and services. The office services agreement, which had covered services such as: telephone, heat, electricity, furniture, lighting, restroom facilities, reception, conference facilities, mailbox, parking and office cleaning, was in effect until August 31, 2007. In February 2007, the Company notified the operator of the office suite complex that would not renew again and would vacate the premises prior to August 31, 2007. On February 27, 2007, the Company signed a 15 month lease at a nearby facility at a lower cost and moved into that space, which is its current space shortly thereafter. The lease expires May 31, 2008. The Company intends to renew the lease for another 15 month term.

Rent expense and office services expenses amounted to $75,025 and $79,587 for the years ended December 31, 2007 and 2006, respectively.

NOTE O - SUBSEQUENT EVENTS

On March 26, 2008, pursuant to provisions in the Old Debenture and the New Debenture, Dutchess issued to the Company a notice of an event of default (the “Default Notice”), due to the Company’s failure to make regular monthly interest payments and payments of principal under the terms of the Old Debenture and failure to make required interest payments under the New Debenture (the “Default”). Pursuant to the Old Debenture, the Company is obligated to pay Dutchess interest at the rate of twelve percent (12%) per annum, on a monthly basis, and amortizing monthly cash payments in the amount of $104,166.67, and under the New Debenture the Company is obligated to pay Dutchess interest at the rate of twelve percent (12%) per annum, compounded daily, on a monthly basis. Accordingly, as of March 24, 2008, the Company owed Dutchess an aggregate amount of $1,637,568.18 under both Debentures, including principal, interest and liquidated damages arising out of the Default. As a secured creditor, Dutchess is entitled to exercise its default remedies pursuant to a Security Agreement entered into in connection with the Old Debenture, including taking possession of all of the assets of the Company.

F-29

In contemplation of Dutchess issuing the Default Notice, the Company and Dutchess entered into negotiations to resolve the Default. As a consequence of these discussions, the Company and Dutchess have developed the following plan (the “Plan”) to restructure the Company and to cure the Default. If effected, under the Plan, Dutchess would waive the liquidated damages arising out of the Default and rescind acceleration of the Debentures. The Plan is currently structured as described below.

First, the Plan contemplates that Title America Corp., a Nevada corporation (“Title America”), an affiliate of Dutchess and sole shareholder of Tool City, Inc., a California corporation (“Tool City”), would enter into a Securities Purchase Agreement, with the holders of all of the Company’s shares of Series A Convertible Preferred Stock, par value $0.001 per share (the “Series A Preferred Stock”), pursuant to which such individuals, who are the Company’s Executive Chairman and Chief Executive Officer, would sell all of the Series A Preferred Stock to Dutchess and as a result would no longer be stockholders of the Company (the “Preferred Stock Purchase”). The amount paid by Title America for the Series A Preferred Stock would equal $1,000, an amount which will be paid from Title America’s working capital. Based on the closing bid price of the Company’s shares of common stock, par value $0.001 per share (the “Common Stock”), on March 20, 2008, if the Preferred Stock Purchase is effected, Dutchess would own 100% of the Company’s Preferred Stock, and would beneficially own 98.81% of the Company’s Common Stock, based on the conversion rights of the shares of Preferred Stock, the conversion of the Debentures into shares of Common Stock, and the exercise of 40,000,000 common stock purchase warrants (the “Warrants”) held by Dutchess, without giving effect to certain blockers on conversion or exercise provided for in the Debentures or the Warrants, which will be removed in conjunction with the Preferred Stock Purchase.

In addition, upon the closing of the proposed Preferred Stock Purchase, Dutchess is expected to appoint Theodore Smith, Michael Novielli and Douglas Leighton (the “New Directors”) to the Company’s Board of Directors (the “Board”). The Plan contemplates that all of the current members of the Company’s Board, Alvin Estevez, Colorado Stark and Edwin J. McGuinn, Jr., the sole member of the Company’s Audit Committee and Compensation Committee, would resign from the Board ten (10) calendar days following the mailing to the Company’s stockholders of a Schedule 14F-1 Information Statement pertaining to the appointment of the New Directors to the Company’s Board. As a result of the Preferred Stock Purchase and the election of the New Directors, Dutchess is expected to acquire control of the Company.

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The Plan contemplates that following the closing of the Preferred Stock Purchase, the Company and Title America intend to enter into a Share Exchange Agreement (the “SEA”). Pursuant to the SEA, the Company would acquire all of the stock of Tool City and Tool City would become a wholly-owned subsidiary of the Company. In exchange for all of the common stock of Tool City, the Company would issue to Title America shares of a new series of Preferred Stock of the Company (the “Series B Preferred Stock”) which would be convertible into shares of Common Stock and would have an aggregate liquidation preference of $8,314,000. The Plan contemplates that the shares of Series A Preferred Stock acquired by Dutchess in the Preferred Stock Purchase would then be cancelled, whereupon Dutchess and its affiliates would beneficially own approximately 95.67% of the Company’s Common Stock, based on the conversion rights of the Series B Preferred Stock and the Debentures and their ownership of the Warrants.

Management believes that the Company would have an increased ability to satisfy its obligations under the Debentures after its acquisition of Tool City. Tool City provides title and auto pawn loans against the equity in vehicle owner’s cars. Tool City has historically had minimal credit losses due to its low loan-to-value ratios, technological advancements permitting the tracking of vehicles serving as collateral for outstanding loans, and the liquidity of collateral against which Tool City makes loans. Revenues are generated from interest on outstanding loans, sales from repossessed cars, and the resale of pawned items. Tool City currently has nine employees, and was founded in 1996 to serve consumers located in Southern California. All of the outstanding common stock of Tool City was recently purchased by Title America. Accordingly, the Company would enter into a new line of business upon the acquisition of Tool City.

The Plan further contemplates that after the acquisition of Tool City, the Company would exit its existing software business and sell substantially all of the assets of such business to Enigma Software Group USA, LLC, a Connecticut limited liability company (“Enigma Software Group”), formed by Messrs. Estevez and Stark for the purposes of effecting the Asset Purchase (as defined below). The parties are expected to enter into an Asset Purchase Agreement (the “APA”), whereby Enigma Software Group would assume substantially all of the assets and liabilities, excluding the Debentures, including interest due thereon and liquidation damages, of the Company (the “Asset Purchase”). It is expected that the Enigma Software Group would indemnify the Company in connection with such liabilities that it assumes and would assure that at the closing of the Asset Purchase the Company retains $172,500 in cash. In addition, Messrs. Estevez and Stark, and certain other employees, would cancel an aggregate amount of options representing the right to purchase 8,203,676 of the Company’s Common Stock.

F-31

On March 27, 2008, the Company filed a Current Report on Form 8-K reporting the foregoing. The Company expects to file additional Current Reports on Form 8-K reporting aspects of the transactions contemplated by the Plan.

There will be no opportunity for any stockholder to vote on the above transactions. Management believes the Plan is the only viable alternative to realize significant value for the Company’s stockholders. The Company cannot currently satisfy the obligations owed under the Debentures and is incurring liquidated damages on a daily basis.The Plan offers the Company’s stockholders the potential benefits of a new line of business. Management believes that the Plan is in the best interests of the stockholders since it avoids the high costs of litigation and bankruptcy and the unknown results of such proceedings. Moreover, the Plan is intended to allow the Company’s common stockholders to maintain the same percentage ownership interest in the Company that they presently own on a fully-diluted basis.

The Company notes that neither it nor Dutchess nor any of their affiliates has yet entered into any binding agreement with respect to the Plan, and the transactions contemplated by the Plan and described above represent solely intentions and expectations with respect to the Plan. There can be no assurance that the Plan will be implemented as summarized above or at all.

In the event the Plan and the transactions contemplated thereunder are not consummated, the Company would be in financial distress and would have to pursue other opportunities to satisfy the Default. There can be no assurance that any viable alternatives would be available. As a result, the Company could be faced with the immediate foreclosure on its assets by Dutchess.

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