UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2010

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from to

Commission File Number 000-51869

SouthPeak Interactive Corporation

(Exact Name of Registrant as Specified in Its Charter)

Delaware	20-3290391
(State or Other Jurisdiction of	(I.R.S. Employer
Incorporation or Organization)	Identification No.)

2900 Polo Parkway

Midlothian, Virginia 23113

(804) 378-5100

(Address including zip code, and telephone number,

including area code, of principal executive offices)

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

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

Yes þ No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes o No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ¨

Accelerated filer ¨

Non-accelerated filer ¨

Smaller reporting company þ

(Do not check if a smaller reporting company)

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

Yes ¨ No þ

As of November 12, 2010, 60,795,538 shares of common stock, par value $0.0001 per share, of the registrant were outstanding.

TABLE OF CONTENTS

		Page

	PART I — FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Financial Statements (unaudited)	3
	Condensed Consolidated Balance Sheets as of September 30, 2010 and June 30, 2010 (unaudited)	3
	Condensed Consolidated Statements of Operations for the three months ended September 30, 2010 and 2009 (unaudited)	4
	Condensed Consolidated Statements of Cash Flows for the three months ended September 30, 2010 and 2009 (unaudited)	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	25
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	35
Item 4T.	Controls and Procedures	35

	PART II — OTHER INFORMATION

Item 1.	Legal Proceedings	36
Item 1A.	Risk Factors	37
Item 5.	Other Information	37
Item 6.	Exhibits	37

	SIGNATURES	39

PART I

Item 1. Condensed Consolidated Financial Statements

SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

	September 30, 2010			June 30, 2010
	(Unaudited)
Assets

Current assets:
Cash and cash equivalents	$	449,926		$	92,893
Accounts receivable, net of allowances of $885,516 and $5,700,931 and at September 30, 2010 and June 30, 2010, respectively		759,693			3,703,825
Inventories		1,451,590			1,211,301
Current portion of advances on royalties		12,891,370			12,322,926
Current portion of intellectual property licenses		383,571			383,571
Related party receivables		61,509			34,509
Prepaid expenses and other current assets		693,210			695,955

Total current assets		16,690,869			18,444,980

Property and equipment, net		2,623,114			2,667,992
Advances on royalties, net of current portion		1,538,144			1,511,419
Intellectual property licenses, net of current portion		1,438,393			1,534,286
Goodwill		7,911,800			7,911,800
Deferred debt issuance costs, net		667,867			-
Intangible assets, net		13,692			17,025
Other assets		11,117			11,280

Total assets	$	30,894,996		$	32,098,782

Liabilities and Shareholders’ Equity

Current liabilities:
Line of credit	$	-		$	3,830,055
Due to factor		1,940,268			-
Current portion of secured convertible debt		2,000,000			950,000
Current portion of long-term debt		66,385			65,450
Production advance payable in default		3,755,104			3,755,104
Accounts payable		10,585,161			12,663,788
Accrued royalties		1,786,608			2,530,253
Accrued expenses and other current liabilities		4,258,571			3,781,711
Deferred revenues		30,000			325,301
Due to related parties		25			2,200
Accrued expenses - related parties		113,249			322,281
Total current liabilities		24,535,371			28,226,143

Secured convertible debt, net of discount		1,522,815			-
Long-term debt, net of current portion		1,524,354			1,541,081
Warrant liability		2,807,425			-
Total liabilities	$	30,389,965		$	29,767,224

Commitments and contingencies		-			-

Shareholders’ equity:
Preferred stock, $0.0001 par value; 5,000,000 shares authorized; no shares issued and outstanding at September 30, 2010 and June 30, 2010		-			-
Series A convertible preferred stock, $0.0001 par value; 15,000,000 shares authorized; 5,503,833 and 5,503,833 shares issued and outstanding at September 30, 2010 and June 30, 2010, respectively; aggregate liquidation preference of $5,503,833 at September 30, 2010		550			550
Common stock, $0.0001 par value; 90,000,000 shares authorized; 59,846,537 and 59,774,370 shares issued and outstanding at September 30, 2010 and June 30, 2010, respectively		5,984			5,976
Additional paid-in capital		30,804,612			31,154,835
Accumulated deficit		(30,174,259	)		(28,973,325	)
Accumulated other comprehensive (loss) income		(131,856	)		143,522

Total shareholders’ equity		505,031			2,331,558
Total liabilities and shareholders’ equity	$	30,894,996		$	32,098,782

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

SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	For the three months ended September 30,
	2010			2009

Net revenues	$	1,431,859		$	16,709,649

Cost of goods sold:
Product costs		761,282			3,546,686
Royalties, net		(67,108	)		5,000,671
Intellectual property licenses		95,893			119,660

Total cost of goods sold		790,067			8,667,017

Gross profit		641,792			8,042,632

Operating expenses (income):
Warehousing and distribution		66,089			286,511
Sales and marketing		896,671			3,655,056
General and administrative		1,932,315			3,114,768
Gain on settlement of trade payables		(585,122	)		-

Total operating expenses		2,309,953			7,056,335

(Loss) income from operations		(1,668,161	)		986,297

Other expenses (income):
Change in fair value of warrant liability		(1,531,323	)		-
Interest and financing costs, net		1,064,096			299,316
Net (loss) income	$	(1,200,934	)	$	686,981

Basic (loss) income per share:	$	(0.02	)	$	0.02
Diluted (loss) income per share:	$	(0.02	)	$	0.01

Weighted average number of common shares outstanding - Basic		57,032,339			44,821,051
Weighted average number of common shares outstanding - Diluted		57,032,339			50,649,103

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

SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	For the three months ended September 30,
	2010			2009
Cash flows from operating activities:
Net (loss) income	$	(1,200,934	)	$	686,981
Adjustments to reconcile net (loss) income to net cash used in operating activities:
Depreciation and amortization		65,111			64,877
Loss on disposal of fixed assets		-			4,839
Allowances for price protection, returns, and defective merchandise		(2,257,431	)		958,427
Bad debt expense, net of recoveries		22,190			(37,531	)
Stock-based compensation expense		153,602			156,196
Amortization of royalties and intellectual property licenses		183,416			4,215,050
Amortization of debt discount and issuance costs		427,655			-
Change in fair value of warrant liability		(1,531,323	)		-
Fair market value adjustment to common stock issued for advances on royalties		(1,801	)		-
Gain on settlement of trade payables		(585,122	)		-
Changes in operating assets and liabilities:
Due to/from factor		(639,906	)		-
Accounts receivable		7,759,547			(8,530,233	)
Inventories		(240,289	)		(3,536,814	)
Advances on royalties		(1,185,783	)		(1,449,716	)
Related party receivables		(27,000	)		(38,825	)
Prepaid expenses and other current assets		2,745			136,031
Production advance payable		-			3,755,104
Accounts payable		(1,493,505	)		(688,416	)
Accrued royalties		(743.645	)		906,432
Accrued expenses and other current liabilities		476,860			1,281,329
Deferred revenues		(295,301	)		-
Accrued expenses - related parties		(209,032	)		(105,275	)

Total adjustments		(119,012	)		(2,908,525	)

Net cash used in operating activities		(1,319,946	)		(2,221,544	)

Cash flows from investing activities:
Purchases of property and equipment		(16,737	)		(26,734	)
Change in restricted cash		-			417,917

Net cash (used in) provided by investing activities		(16,737	)		391,183

Cash flows from financing activities:
Proceeds from line of credit		-			8,117,146
Repayments of line of credit		(3,830,055	)		(6,343,234	)
Repayments of long-term debt		(15,792	)		(11,853	)
Net repayments of amounts due to shareholders		-			(232,440	)
Net repayments of amounts due to related parties		(2,175	)		(122,845	)
Proceeds from the issuance of senior secured convertible notes		7,000,000			-
Payment of debt issuance costs		(733,959	)		-
Repayment of junior secured subordinated convertible promissory note		(450,000	)		-
Proceeds from the exercise of common stock warrants		1,075			-

Net cash provided by financing activities		1,969,094			1,406,774

Effect of exchange rate changes on cash and cash equivalents		(275,378	)		48,757

Net increase (decrease) in cash and cash equivalents		357,033			(374,830	)
Cash and cash equivalents at beginning of period		92,893			648,311

Cash and cash equivalents at end of period	$	449,926		$	273,481

Supplemental cash flow information:
Cash paid during the period for interest	$	178,348		$	99,261

Supplemental disclosure of non-cash activities:
Fair value of common stock warrant liability	$	4,338,748		$	-
Fair market value adjustment to common stock issued for advances on royalties	$	504,892		$	-
Conversion of junior secured subordinated convertible promissory note to senior secured convertible note	$	500,000		$
Issuance of vested restricted stock	$	7		$	-
Contingent purchase price payment obligation related to acquisition	$	-		$	596,634

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

SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1. Summary of Significant Accounting Policies

Business

SouthPeak Interactive Corporation (the “Company”) is an independent developer and publisher of interactive entertainment software. The Company develops, markets and publishes videogames for all leading gaming and entertainment hardware platforms, including home videogame consoles such as Microsoft Corporation’s (“Microsoft”) Xbox 360 (“Xbox360”), Nintendo Co. Ltd.’s (“Nintendo”) Wii (“Wii”), Sony Computer Entertainment’s (“Sony”) PlayStation 3 (“PS3”) and PlayStation 2 (“PS2”); handheld platforms such as Nintendo Dual Screen (“DS”), Nintendo DSi, Sony PlayStation Portable (“PSP”), Sony PSPgo, Apple Inc. (“Apple”) iPhone; and personal computers. The Company’s titles span a wide range of categories and target a variety of consumer demographics, ranging from casual players to hardcore gaming enthusiasts.

The Company maintains its operations in the United States and the United Kingdom. The Company sells its games to retailers and distributors in North America and United Kingdom, and primarily to distributors in the rest of Europe, Australia and Asia.

The Company has one operating segment, a publisher and distributor of interactive entertainment software for home video consoles, handheld platforms and personal computers. To date, management has not considered discrete geographical or other information to be relevant for purposes of making decisions about allocations of resources.

Going Concern

The accompanying condensed consolidated financial statements have been prepared on a going-concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The ability of the Company to continue as a going concern is predicated upon, among other things, generating positive cash flows from operations, curing the default on the production advance payable, and the resolution of various contingencies. On August 17, 2009, the Company entered into a unit production financing agreement with a producer relating to the production of certain games, of which the balance outstanding under this agreement was $3,755,104 at September 30, 2010 (see Note 5). The Company has failed to make the required payments under this agreement. As a result, the production advance payable is currently in default and is accruing additional production fees at $0.009 per unit (based upon 382,000 units) for each day after November 15, 2009 (approximately $1,004,000 through September 30, 2010). Management plans to maintain the Company’s viability as a going concern by:

•

attempting to expeditiously resolve its contingencies for amounts significantly less than currently accrued for in order to reduce aggregate liabilities on the Company’s condensed consolidated balance sheet and on payment terms manageable by the Company;

•

reducing costs and expenses in order to reduce the Company’s ongoing working capital needs and monthly cash burn;

•

seeking to increase the amount of its factoring facility; and

•

seeking to raise additional capital.

The Company has also invested in key new titles from which the anticipated profits should help improve its financial prospects. While the Company is committed to pursuing these options and others to address its viability as a going concern, there can be no assurance that these plans will be successfully completed or available on acceptable terms; and therefore, there is uncertainty about the Company’s ability to realize its assets or satisfy its liabilities in the normal course of business. If the Company is unsuccessful in pursuing these plans, it may be required to defer, reduce, or eliminate certain planned expenditures. The Company’s condensed consolidated financial statements do not include any adjustments that might result from the resolution of this uncertainty.

On July 12, 2010, the Company repaid in full the entire outstanding balance under the credit agreement with SunTrust Banks, Inc. (“SunTrust”) as a result of entering into a factoring agreement with Rosenthal & Rosenthal, Inc. (see Note 4).

1. Summary of Significant Accounting Policies, Cont.

The Company expects to draw on the factoring agreement during fiscal 2011 as necessary to help alleviate liquidity problems, although, as discussed above, the Company will also need to control expenses, maintain the sales backlog at appropriate levels, and keep shipment levels in line with booked orders in order to meet these requirements. As the factoring agreement is a demand note and subject to termination with 60 days notice, management can give no assurances that funds will be available to settle current liabilities as they become due. Ultimately, failure to obtain additional financing could jeopardize the Company’s ability to continue as a going concern.

On September 20, 2010, the Company entered into a purchase order financing arrangement with Wells Fargo Bank, National Association (“Wells Fargo”), for up to a maximum of $2,000,000, to provide funding for the development and production of games (see Note 7).

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements as of September 30, 2010 and for the three month periods ended September 30, 2010 and 2009 have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial reporting. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP. In the opinion of management, all adjustments (all of which are of a normal, recurring nature) considered for a fair presentation have been included. Operating results for the three months ended September 30, 2010 are not necessarily indicative of the results that may be expected for the year ending June 30, 2011.

The accounting policies followed by the Company with respect to unaudited interim financial statements are consistent with those stated in the Company’s annual report on Form 10-K. The accompanying June 30, 2010 financial statements were derived from the Company’s audited financial statements. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s annual report on Form 10-K for the year ended June 30, 2010 filed with the SEC on October 13, 2010.

The accompanying unaudited condensed consolidated financial statements include the accounts of SouthPeak Interactive Corporation, and its wholly-owned subsidiaries SouthPeak Interactive, L.L.C., SouthPeak Interactive, Ltd., Vid Sub, LLC, Gone Off Deep, LLC, Gamecock Media Europe Ltd., and IRP GmbH. All intercompany accounts and transactions have been eliminated in consolidation.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of net revenues and expenses during the reporting periods. The most significant estimates and assumptions relate to the recoverability of advances on royalties, intellectual property licenses and intangibles, valuation of inventories, realization of deferred income taxes, the adequacy of allowances for sales returns, price protection and doubtful accounts, accrued and contingent liabilities, the valuation of stock-based transactions and assumptions used in the Company’s goodwill impairment test. These estimates generally involve complex issues and require the Company to make judgments, involve analysis of historical and the prediction of future trends, and are subject to change from period to period. Actual amounts could differ significantly from these estimates.

1. Summary of Significant Accounting Policies, Cont.

Subsequent events have been evaluated through the filing date of these unaudited condensed consolidated financial statements.

Concentrations of Credit Risk, Major Customers and Major Vendors

The financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of cash balances with financial institutions and accounts receivable. The Company maintains cash in bank accounts that, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant risks on its cash in bank accounts.

The Company does not generally require collateral or other security to support accounts receivable. Management must make estimates of the uncollectibility of the accounts receivable. The Company considers accounts receivable past due based on how recently payments have been received. The Company has established an allowance for doubtful accounts based upon the facts surrounding the credit risk of specific customers, past collections history and other factors.

The Company has four customers, GameStop, Target, 1C Company, and Wal-Mart, which accounted for 27%, 15%, 14%, and 10%, respectively, of consolidated gross revenues for the three months ended September 30, 2010. PDQ Distribution accounted for 21% of consolidated gross accounts receivable at September 30, 2010. For the three months ended September 30, 2009, Wal-Mart, GameStop and Topware Entertainment accounted for 20%, 15% and 10%, respectively, of consolidated gross revenues. GameStop, Wal-Mart, and Atari accounted for 29%, 15% and 10%, respectively, of consolidated gross accounts receivable at June 30, 2010.

The Company publishes videogames for the proprietary console and hand-held platforms created by Microsoft, Sony and Nintendo, pursuant to the licenses they have granted to the Company. Should the Company’s licenses with any of such three platform developers not be renewed by the developer, it would cause a disruption in the Company’s operations. The Company expects that such contracts will be renewed in the normal course of business.

Amounts incurred related to these three vendors as of September 30, 2010 and 2009 and for the three-month periods ended September 30, 2010 and 2009 are as follows:

	Cost of Goods Sold — Products
	For the three months		For the three months		Accounts Payable
	ended September 30, 2010		ended September 30, 2009		As of September 30, 2010		As of June 30, 2010

Microsoft	$	199,336	$	2,737,842	$	-	$	158,592
Nintendo	$	166,684	$	831,796	$	-	$	-
Sony	$	589,862	$	27,522	$	577,815	$	449,042

Allowances for Returns, Price Protection, and Doubtful Accounts

Management closely monitors and analyzes the historical performance of the Company’s various games, the performance of games released by other publishers, and the anticipated timing of other releases in order to assess future demands of current and upcoming games. Initial volumes shipped upon title launch and subsequent reorders are evaluated to ensure that quantities are sufficient to meet the demands from the retail markets, but at the same time are controlled to prevent excess inventory in the channel.

The Company may permit product returns from, or grant price protection to, its customers under certain conditions. Price protection refers to the circumstances when the Company elects to decrease the wholesale price of a product based on the number of products in the retail channel and, when granted and taken, allows customers a credit against amounts owed by such customers to the Company with respect to open and/or future invoices. The criteria the Company’s customers must meet to be granted the right to return products or price protection include, among other things, compliance with applicable payment terms, and consistent delivery to the Company of inventory and sell-through reports. In making the decision to grant price protection to customers, the Company also considers other factors, including the facilitation of slow-moving inventory and other market factors.

1. Summary of Significant Accounting Policies, Cont.

Management must estimate the amount of potential future product returns and price protection related to current period revenues utilizing industry and historical Company experience, information regarding inventory levels, and the demand and acceptance of the Company’s games by end consumers. The following factors are used to estimate the amount of future returns and price protection for a particular game: historical performance of games in similar genres; historical performance of the hardware platform; sales force and retail customer feedback; industry pricing; weeks of on-hand retail channel inventory; absolute quantity of on-hand retail channel inventory; the game’s recent sell-through history (if available); marketing trade programs; and competing games. Significant management judgments and estimates must be made and used in connection with establishing the allowance for returns and price protection in any accounting period. Based upon historical experience, management believes the estimates are reasonable. However, actual returns and price protection could vary materially from management’s allowance estimates due to a number of unpredictable reasons including, among others, a lack of consumer acceptance of a game, the release in the same period of a similarly themed game by a competitor, or technological obsolescence due to the emergence of new hardware platforms. Material differences may result in the amount and timing of the Company’s revenues for any period if factors or market conditions change or if management makes different judgments or utilizes different estimates in determining the allowances for returns and price protection.

Similarly, management must make estimates of the uncollectibility of the Company’s accounts receivable. In estimating the allowance for doubtful accounts, the Company analyzes the age of current outstanding account balances, historical bad debts, customer concentrations, customer creditworthiness, current economic trends, and changes in the Company’s customers’ payment terms and their economic condition. Any significant changes in any of these criteria would affect management’s estimates in establishing the allowance for doubtful accounts.

At September 30, 2010 and June 30, 2010, accounts receivable allowances consisted of the following:

		September 30, 2010	June 30, 2010
Sales returns	$	104, 863	$	2,634,097
Price protection		182, 224		2,257,171
Doubtful accounts		597,006		771,442
Defective items		1,423		38,221

Total allowances	$	885,516	$	5,700,931

Inventories

Inventories are stated at the lower of average cost or market. Management regularly reviews inventory quantities on hand and in the retail channel and records a provision for excess or obsolete inventory based on the future expected demand for the Company’s games. Significant changes in demand for the Company’s games would impact management’s estimates in establishing the inventory provision. Inventory costs include licensing fees paid to platform proprietors. These licensing fees include the cost to manufacture the game cartridges. These licensing fees included in “cost of goods sold - product costs” amounted to $955,882 and $3,597,160 for the three months ended September 30, 2010 and 2009, respectively. Licensing fees included in inventory at September 30, 2010 and June 30, 2010 totaled $152,623 and $273,166, respectively.

Advances on Royalties

The Company utilizes independent software developers to develop its games in exchange for payments to the developers based upon certain contract milestones. The Company enters into contracts with the developers once the game design has been approved by the platform proprietors and is technologically feasible. Accordingly, the Company capitalizes such payments to the developers during development of the games. These payments are considered non-refundable royalty advances and are applied against the royalty obligations owed to the developer from future sales of the game. Any pre-release milestone payments that are not prepayments against future royalties are expensed to “cost of goods sold - royalties” in the period when the game is released. Capitalized royalty costs for those games that are cancelled or abandoned are charged to “cost of goods sold - royalties” in the period of cancellation. Capitalized costs for games that are cancelled or abandoned prior to product release are charged to “cost of goods sold - royalties” in the period of cancellation. There were no costs for games cancelled or abandoned during the three months ended September 30, 2010 and 2009, respectively.

1. Summary of Significant Accounting Policies, Cont.

Beginning upon the related game’s release, capitalized royalty costs are amortized to “cost of goods sold – royalties” based on the ratio of current revenues to total projected revenues for the specific game, generally resulting in an amortization period of twelve months or less.

The Company evaluates the future recoverability of capitalized royalty costs on a quarterly basis. For games that have been released in prior periods, the primary evaluation criterion is actual title performance. For games that are scheduled to be released in future periods, recoverability is evaluated based on the expected performance of the specific game to which the royalties relate. Criteria used to evaluate expected game performance include: historical performance of comparable games developed with comparable technology; orders for the game prior to its release; and, for any game sequel, estimated performance based on the performance of the game on which the sequel is based.

Significant management judgments and estimates are utilized in the assessment of the recoverability of capitalized royalty costs. In evaluating the recoverability of capitalized royalty costs, the assessment of expected game performance utilizes forecasted sales amounts and estimates of additional costs to be incurred. If revised forecasted or actual game sales are less than, and/or revised forecasted or actual costs are greater than, the original forecasted amounts utilized in the initial recoverability analysis, the net realizable value may be lower than originally estimated in any given quarter, which could result in an impairment charge. Material differences may result in the amount and timing of charges for any period if management makes different judgments or utilizes different estimates in evaluating these qualitative factors.

Intellectual Property Licenses

Intellectual property license costs consist of fees paid by the Company to license the use of trademarks, copyrights, and software used in the development of games. Depending on the agreement, the Company may use acquired intellectual property in multiple games over multiple years or for a single game. When no significant performance remains with the licensor upon execution of the license agreement, the Company records an asset and a liability at the contractual amount. The Company believes that the contractual amount represents the fair value of the liability. When significant performance remains with the licensor, the Company records the payments as an asset when paid and as a liability when incurred, rather than upon execution of the agreement. The Company classifies these obligations as current liabilities to the extent they are contractually due within the next twelve months. Capitalized intellectual property license costs for those games that are cancelled or abandoned are charged to “cost of goods sold - intellectual property licenses” in the period of cancellation. There were no costs for games cancelled or abandoned during the three months ended September 30, 2010 and 2009, respectively.

Beginning upon the related game’s release, capitalized intellectual property license costs are amortized to “cost of sales - intellectual property licenses” based on the greater of (1) the ratio of current revenues for the specific game to total projected revenues for all games in which the licensed property will be utilized or (2) the straight-line amortization method over the estimated useful lives of the licenses. As intellectual property license contracts may extend for multiple years, the amortization of capitalized intellectual property license costs relating to such contracts may extend beyond one year.

The Company evaluates the future recoverability of capitalized intellectual property license costs on a quarterly basis. For games that have been released in prior periods, the primary evaluation criterion is actual title performance. For games that are scheduled to be released in future periods, recoverability is evaluated based on the expected performance of the specific games to which the costs relate or in which the licensed trademark or copyright is to be used. Criteria used to evaluate expected game performance include: historical performance of comparable games developed with comparable technology; orders for the game prior to its release; and, for any game sequel, estimated performance based on the performance of the game on which the sequel is based. Further, as intellectual property licenses may extend for multiple games over multiple years, the Company also assesses the recoverability of capitalized intellectual property license costs based on certain qualitative factors, such as the success of other products and/or entertainment vehicles utilizing the intellectual property and the continued promotion and exploitation of the intellectual property.

Significant management judgments and estimates are utilized in the assessment of the recoverability of capitalized intellectual property license costs. In evaluating the recoverability of capitalized intellectual property license costs, the assessment of expected game performance utilizes forecasted sales amounts and estimates of additional costs to be incurred. If revised forecasted or actual game sales are less than, and/or revised forecasted or actual costs are greater than, the original forecasted amounts utilized in the initial recoverability analysis, the net realizable value may be lower than originally estimated in any given quarter, which could result in an impairment charge. Material differences may result in the amount and timing of charges for any period if management makes different judgments or utilizes different estimates in evaluating these qualitative factors.

1. Summary of Significant Accounting Policies, Cont.

Assessment of Impairment of Assets

Current accounting standards require that the Company assess the recoverability of purchased intangible assets subject to amortization and other long-lived assets whenever events or changes in circumstances indicate the remaining value of the assets recorded on its consolidated balance sheets is potentially impaired. In order to determine if a potential impairment has occurred, management must make various assumptions about the estimated fair value of the asset by evaluating future business prospects and estimated cash flows. For some assets, the Company’s estimated fair value is dependent upon predicting which of its products will be successful. This success is dependent upon several factors, which are beyond the Company’s control, such as which operating platforms will be successful in the marketplace, market acceptance of the Company’s products and competing products. Also, the Company’s revenues and earnings are dependent on the Company’s ability to meet its product release schedules.

The Company accounts for goodwill using the provisions within ASC Topic 350. Under ASC Topic 350, goodwill is considered to have an indefinite life, and is carried at cost. Goodwill is not amortized, but is subject to an impairment test annually and in between annual tests when events or circumstances indicate that the carrying value may not be recoverable. The Company performs its annual impairment testing at June 30. Impairment of goodwill is tested at the reporting unit level. The Company has one reporting unit, because none of the components of the Company constitute a business for which discrete financial information is available and for which Company management regularly reviews the results of operations.

To determine the fair value of the reporting unit used in the first step, the Company uses a combination of the market approach, which utilizes comparable companies’ data and/or the income approach, or discounted cash flows. Each step requires management to make judgments and involves the use of significant estimates and assumptions. These estimates and assumptions include long-term growth rates and operating margins used to calculate projected future cash flows, risk-adjusted discount rates based on the Company’s weighted average cost of capital, future economic and market conditions and determination of appropriate market comparables. These estimates and assumptions have to be made for each reporting unit evaluated for impairment. The Company’s estimates for market growth, its market share, and costs are based on historical data, various internal estimates, and certain external sources, and are based on assumptions that are consistent with the plans and estimates the Company is using to manage the underlying business. The Company’s business consists of publishing and distribution of interactive entertainment software and content using both established and emerging intellectual properties, and its forecasts for emerging intellectual properties are based upon internal estimates and external sources rather than historical information and have an inherently higher risk of accuracy. If future forecasts are revised, they may indicate or require future impairment charges. The Company bases its fair value estimates on assumptions it believes to be reasonable but that are unpredictable and inherently uncertain. Actual future results may differ from those estimates.

The Company determined that current business conditions, and the resulting decrease in the Company’s projected cash flows, constituted a triggering event which required the Company to perform interim impairment tests related to its long-lived assets and goodwill during the quarter ended September 30, 2010. The Company’s interim test on its long-lived assets indicated that the carrying value of its long-lived assets was recoverable and that no impairment existed as of the testing date. As of September 30, 2010, there was no impairment to goodwill. The Company will continue to monitor its goodwill and indefinite-lived intangible and long-lived assets for possible future impairment.

Revenue Recognition

The Company recognizes revenue from the sale of video games upon the transfer of title and risk of loss to the customer. Accordingly, the Company recognizes revenue for software titles when (1) there is persuasive evidence that an arrangement with the customer exists, which is generally a purchase order, (2) the product is delivered, (3) the selling price is fixed or determinable and (4) collection of the customer receivable is deemed probable. The Company’s payment arrangements with customers typically provide for net 30 and 60 day terms. Advances received for licensing and exclusivity arrangements are reported on the consolidated balance sheets as deferred revenues until the Company meets its performance obligations, at which point the revenues are recognized. Revenue is recognized after deducting estimated reserves for returns, price protection and other allowances. In circumstances when the Company does not have a reliable basis to estimate returns and price protection or is unable to determine that collection of a receivable is probable, the Company defers the revenue until such time as it can reliably estimate any related returns and allowances and determine that collection of the receivable is probable.

1. Summary of Significant Accounting Policies, Cont.

Some of the Company’s video games provide limited online features at no additional cost to the consumer. Generally, the Company considers such features to be incidental to the overall product offering and an inconsequential deliverable. Accordingly, the Company recognizes revenue related to video games containing these limited online features upon the transfer of title and risk of loss to the customer. In instances where online features or additional functionality are considered a substantive deliverable in addition to the video game, the Company takes this into account when applying its revenue recognition policy. This evaluation is performed for each video game together with any online transactions, such as electronic downloads or video game add-ons when it is released. When the Company determines that a video game contains online functionality that constitutes a more-than-inconsequential separate service deliverable in addition to the video game, principally because of its importance to game play, the Company considers that its performance obligations for this game extend beyond the delivery of the game. Fair value does not exist for the online functionality, as the Company does not separately charge for this component of the video game. As a result, the Company recognizes all of the revenue from the sale of the game upon the delivery of the remaining online functionality. In addition, the Company defers the costs of sales for this game and recognizes the costs upon delivery of the remaining online functionality.

With respect to online transactions, such as electronic downloads of games or add-ons that do not include a more-than-inconsequential separate service deliverable, revenue is recognized when the fee is paid by the online customer to purchase online content and the Company is notified by the online retailer that the product has been downloaded. In addition, persuasive evidence of an arrangement must exist, collection of the related receivable must be probable and the fee must be fixed and determinable.

The Company has an arrangement pursuant to which it distributes videogames co-published with another company for a fee based on the gross sales of the videogames. Under the arrangement, the Company bears the inventory risk as the Company purchases and takes title to the inventory, warehouses the inventory in advance of orders, prices and ships the inventory and invoices its customers for videogame shipments. Also under the arrangement, the Company bears the credit risk as the supplier does not guarantee returns for unsold videogames and the Company is not reimbursed by the supplier in the event of non-collection.

The Company records the gross amount of revenue under the arrangement as it is not acting as an agent for the principal in the arrangement as defined by ASC Topic 605.

Third-party licensees in Europe distribute certain video games under license agreements with the Company. The licensees paid certain minimum, non-refundable, guaranteed royalties when entering into the licensing agreements. Upon receipt of the advances, the Company defers their recognition and recognizes the revenues in subsequent periods as these advances are earned by the Company. As the licensees pay additional royalties above and beyond those initially advanced, the Company recognizes these additional royalties as revenues when earned.

With respect to license agreements that provide customers the right to make multiple copies in exchange for guaranteed amounts, revenue is recognized upon delivery of a master copy. Per copy royalties on sales that exceed the guarantee are recognized as earned. In addition, persuasive evidence of an arrangement must exist, collection of the related receivable must be probable, and the fee must be fixed and determinable.

Stock-Based Compensation

The Company estimates the fair value of share-based payment awards on the measurement date using the Black-Scholes option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the condensed consolidated statements of operations.

Stock-based compensation expense recognized in the condensed consolidated statements of operations is based on awards ultimately expected to vest and has been reduced for estimated forfeitures. Stock compensation guidance requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

1. Summary of Significant Accounting Policies, Cont.

The Company estimates the value of employee stock options on the date of grant using the Black-Scholes option pricing model. The Company’s determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to; the expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors.

The Company accounts for equity instruments issued to non-employees based on the estimated fair value of the equity instrument that is recorded on the earlier of the performance commitment date or the date the services required are completed. Until shares under the award are fully vested, the Company marks-to-market the fair value of the options at the end of each accounting period.

Foreign Currency Translation

The functional currency for the Company’s foreign operations is the applicable local currency. Accounts of foreign operations are translated into U.S. dollars using exchange rates for assets and liabilities at the balance sheet date and average prevailing exchange rates for the period for revenue and expense accounts. Adjustments resulting from translation are included in other accumulated comprehensive income (loss). Realized transaction gains and losses are included in income in the period in which they occur, except on intercompany balances considered to be long-term. Transaction gains and losses on intercompany balances considered to be long-term are recorded in other accumulated comprehensive income (loss). Foreign exchange transaction gains (losses) included in general and administrative expenses in the accompanying condensed consolidated statements of operations for the three months ended September 30, 2010 and 2009 amounted to $(49,786) and $(18,032), respectively.

Comprehensive (Loss) Income

For the three months ended September 30, 2010 and 2009, the Company’s comprehensive (loss) income was as follows:

	For the three
	months ended September 30,
	2010			2009

Net (loss) income	$	(1,200,934	)	$	686,981
Change in foreign currency translation adjustment		(275,378	)		82,500

Comprehensive (loss) income	$	(1,476,312	)	$	769,481

Fair Value Measurements

Effective July 1, 2009, the Company adopted the provisions of the fair value measurement accounting and disclosure guidance which establishes a three-level hierarchy that prioritizes the inputs used to measure fair value. The hierarchy requires entities to maximize the use of “observable inputs” and minimize the use of “unobservable inputs.” The three levels of inputs used to measure fair value are as follows:

•

Level 1: Quoted market prices in active markets for identical assets or liabilities.

•

Level 2: Quoted prices in active markets for similar assets and liabilities, quoted prices for identically similar assets or liabilities in markets that are not active and models for which all significant inputs are observable either directly or indirectly.

•

Level 3: Unobservable inputs reflecting the reporting entity's own assumptions or external inputs for inactive markets.

1. Summary of Significant Accounting Policies, Cont.

The following table summarizes the Company’s financial assets and liabilities that are measured at fair value on a recurring basis.

			Fair Value Measurements at Reporting Date Using
			Quoted Prices in
			Active Markets		Significant
			for Identical		Other		Significant
	As of		Financial		Observable		Unobservable
	September		Instruments		Inputs		Inputs
	30, 2010		(Level 1)		(Level 2)		(Level 3)
Assets:
Advances on royalties	$	696,762	$	696,762	$	-	$	-

Total assets at fair value	$	696,762	$	696,762	$	-	$	-

Liabilities:
Warrant liability	$	2,807,425	$	-	$	-	$	2,807,425

Total liabilities at fair value	$	2,807,425	$	-	$	-	$	2,807,425

On February 23, 2010, the Company issued to the videogame publisher 3,000,000 shares of common stock, valued at $1,020,000 based on the fair market value of the Company’s common stock on the date the agreement was executed by the parties. The Company has capitalized such payment to the videogame publisher and the amount is marked-to-market on a quarterly basis. The fair value of the advances on royalties is based entirely upon quoted market prices, which is a level 1 input. The Company recorded a $504,892 decrease to the carrying amount of asset related to the periodic fair value remeasurement at September 30, 2010. During the three months ended September 30, 2010, 16,158 shares were earned and $5,773 was expensed to “cost of goods sold – royalties”, and ($1,801) was expensed to “general and administrative” relating to the periodic fair value remeasurement. As of September 30, 2010, 2,787,048 shares of common stock, valued at $696,762, based on the fair market value of the Company’s common stock were included advances on royalties.

On July 19, 2010, the Company issued Series A warrants in connection with the sale of $5,500,000 of senior secured convertible notes. The Series A warrants entitle the holders to purchase an aggregate of 12,761,021 shares of common stock. The Series A warrants have an exercise price of $0.375 per share and a term of five years, and became exercisable upon the issue date. The Company has accounted for the Series A warrants as a liability because the exercise price of the warrants will reset if the Company issues stock at a lower price. At inception, the fair value of the Series A warrants of $4,338,748 was separated from the debt liability and recorded as a derivative liability which resulted in a reduction of the initial notional carrying amount of the senior secured convertible notes. The fair value of the warrants was computed using the Black-Scholes option pricing model. The Company assumed a risk-free interest rate of 1.73%, no dividends, expected volatility of 148.24% and the contractual life of the warrants of 5 years.

In addition, the purchasers of the senior secured convertible notes received Series B warrants which will expire, if the warrants become exercisable, on the fifth year anniversary of the date the Company announces its 2011 operating results. The number of Series B warrants each purchaser received is equal to 75% of the Series A warrants they obtained. The Series B warrants can only be exercised if the EBITDA Test under the senior secured convertible notes is not achieved or if the Company fails to announce its 2011 operating results by September 28, 2011. The obligation to deliver the Series B warrants was determined to be an embedded derivative. The Company has approached the valuation of this embedded derivative based on the probability that the EBITDA Test under the senior secured convertible notes will be achieved. Because the probability at inception that the EBITDA Test will not be achieved is considered to be de minimis (less than 5%), the fair value of the derivative instrument is not considered to be material and no value has been assigned to it.

The Company measures the fair value of the warrants at each balance sheet date, and records the change in fair value as a non-cash charge or gain to earnings each period. The warrants were valued at $2,807,425 at September 30, 2010. The Company recorded a non-cash gain of $1,531,323 due to the change in fair value of warrants during the three months ended September 30, 2010. The fair value of the warrants was computed using the Black-Sholes option pricing model. The Company assumed a risk-free interest rate of 1.27%, no dividends, expected volatility of 146.18% and the remaining contractual life of the warrants of 4.8 years.

1. Summary of Significant Accounting Policies, Cont.

The following table is a rollforward of the fair value of the warrants, as to which fair value is determined by Level 3 inputs:

	Three Months
	Ended
	September 30,
Description	2010
Beginning balance	$	-
Purchases, issuances, and settlements		4,338,748
Total (gain) loss included in net loss		(1,531,323	)
Ending balance	$	2,807,425

Earnings (Loss) Per Common Share

Basic earnings (loss) per share is computed by dividing net income (loss) attributable to common shareholders by the weighted average number of common shares outstanding for all periods. Diluted earnings per share is computed by dividing net income (loss) attributable to common shareholders by the weighted average number of shares outstanding, increased by common stock equivalents. Common stock equivalents represent incremental shares issuable upon exercise of outstanding options and warrants, the conversion of preferred stock and the vesting of restricted stock. However, potential common shares are not included in the denominator of the diluted earnings (loss) per share calculation when inclusion of such shares would be anti-dilutive, such as in a period in which a net loss is recorded. Potentially dilutive securities including outstanding options, warrants, restricted stock, and the conversion of preferred stock amounted to 11,060,106 for the three months ended September 30, 2010.

Recent Accounting Pronouncements

In October 2009, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2009-14, “Software (Topic 985): Certain Revenue Arrangements That Include Software Elements - a consensus of the FASB Emerging Issues Task Force (“EITF”)” (formerly EITF 09-3). ASU 2009-14 revises FASB ASC 985-605 to drop from its scope all tangible products containing both software and non-software components that operate together to deliver the products’ functions. It also amends the determination of how arrangement consideration should be allocated to deliverables in a multi-deliverable revenue arrangement. ASU 2009-14 is effective for fiscal years beginning after June 15, 2010. The adoption of ASU 2009-14 did not have a material impact on the Company’s condensed consolidated results of operations and financial condition.

In October 2009, the FASB issued ASU No. 2009-13, “Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements - a consensus of the FASB Emerging Issues Task Force” (formerly EITF 08-1), which amends the revenue recognition guidance for arrangements with multiple deliverables. ASU 2009-13 addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting and how to allocate consideration to each unit of accounting in the arrangement. This ASU replaces all references to fair value as the measurement criteria with the term selling price and establishes a hierarchy for determining the selling price of a deliverable. It also eliminated the use of the residual value method for determining the allocation of arrangement consideration. ASU 2009-13 is effective for fiscal years beginning after June 15, 2010. The adoption of ASU 2009-13 did not have a material impact on the Company’s condensed consolidated results of operations and financial condition as the majority of its revenues are driven from single element deliverables.

2. Inventories

Inventories consist of the following:

	September 30, 2010		June 30, 2010
Finished goods	$	714,144	$	1,085,433
Purchased parts and components		737,446		125,868
Total	$	1,451,590	$	1,211,301

3. Line of Credit

The Company had a $8.0 million revolving line of credit facility with SunTrust Banks, Inc. (“SunTrust”) that was scheduled to mature on November 30, 2010. As of June 30, 2010, the Company’s borrowing base could not exceed 55% of eligible accounts receivable plus $500,000. The line of credit bore interest at prime plus 1½%, which was 4.75% at June 30, 2010. SunTrust processed payments received on such accounts receivable as payments on the revolving line of credit. The line was collateralized by gross accounts receivable of approximately $1,861,000 at June 30, 2010. The line of credit was further collateralized by personal guarantees, and pledge of personal securities and assets by two Company shareholders, one of whom is the Company’s chairman, and certain other affiliates. The agreement contained certain financial and non-financial covenants. At June 30, 2010, the Company was not in compliance with these covenants.

At June 30, 2010, the outstanding line of credit balance was $3,830,055. At June 30, 2010, the Company had $-0- available under the credit facility. For the three months ended September 30, 2010 and 2009, interest expense relating to the line of credit was $2,021 and $51,759, respectively. There was $33,284 of accrued interest at June 30, 2010.

On July 12, 2010, the Company repaid in full the entire outstanding balance under the credit agreement as a result of entering into a factoring agreement with Rosenthal & Rosenthal, Inc. (see Note 4, Due to Factor for further discussion). As a result of such repayment, (i) the loan agreement has automatically terminated, (ii) SunTrust’s lien or security interest in the Company’s assets has been terminated, and (iii) all obligations of the Company under the loan agreement have been satisfied in full.

4. Due to Factor

On July 7, 2010, the Company entered into a Factoring Agreement with Rosenthal & Rosenthal, Inc. Under the Factoring Agreement, the Company agreed to sell certain receivables to Rosenthal & Rosenthal arising from sales of inventory to customers. In connection with the execution of the Factoring Agreement, each of the Company, its subsidiaries, Gone Off Deep LLC, SouthPeak Interactive Ltd, and Vid Sub, LLC, and the chairman, Terry Phillips, have executed guarantees in favor of Rosenthal & Rosenthal. In addition, the Company, Gone Off Deep and Vid Sub each granted to Rosenthal & Rosenthal a security interest against all their respective assets.

Under the terms of the Factoring Agreement, the Company is selling certain of its receivables to Rosenthal & Rosenthal. For the approved receivables, Rosenthal & Rosenthal will assume the risk of collection. The Company has agreed to pay Rosenthal & Rosenthal a commission of .60% of the amount payable under all of the Company’s invoices to most of the Company’s customers against a minimum commission of $30,000 multiplied by the number of months in a contract period, with the first period being 12 months and the second 7 months. All payments received by Rosenthal & Rosenthal are payable to the Company after amounts due to Rosenthal & Rosenthal are satisfied. Under the Factoring Agreement, the Company has the right to borrow against payments due us at the rate of 65% of credit approved receivables. The borrowing rate against non-credit approved receivables is subject to negotiation. The interest rate on borrowings is equal to the greater of prime plus 1.5% per annum or 6.5% per annum. A $10,000,000 loan cap applies against the Company’s borrowings, which is subject to an increase of up to $3,000,000 if shareholders’ equity increases. The initial term of the Factoring Agreement ends on February 28, 2012.

Due (to) from factor consists of the following:

	September 30, 2010
Outstanding accounts receivable sold to factor	$	3,589,369
Cash collateral		53,354
Less: allowances		(2,580,174	)
Less: advances from factor		(3,002,817	)
	$	(1,940,268	)

4. Due to Factor, Cont.

Accounts receivable totaling $3,589,369 were sold to the factor at September 30, 2010, of which the Company assumed credit risk of $1,828,153. The following table sets forth adjustments to the price protection and other customer allowances included as a reduction of amounts due (to) from factor:

	Three months ended September 30, 2010
Beginning balance	$	-
Add: provision		(4,544,537	)
Less: amounts charged against allowance		1,964,363
Ending balance	$	(2,580,174	)

For the three months ended September 30, 2010, interest and financing costs relating to the factoring agreement were $155,458.

5. Production Advance Payable

On August 17, 2009, the Company entered into a unit production financing agreement with a producer relating to the production of certain games, of which the balance outstanding under this agreement was $3,755,104 at September 30, 2010 and June 30, 2010, respectively. Production fees relating to this production advance for the three months ended September 30, 2010 and 2009 totaled $278,860 and $199,946, respectively. The production fees for the three months ending September 30, 2010 related to the default status of the production advance, as described in the subsequent paragraph. These amounts are included in interest and financing costs, net on the accompanying condensed consolidated statements of operations. As of September 30, 2010 and June 30, 2010, accrued and unpaid production fees totaled $1,409,647 and $1,000,392, respectively, and are included in accrued expenses and other current liabilities. The Company is obligated to pay approximately $99,000 of production fees for every month the full production advance is outstanding past its due date of November 15, 2009. Pursuant to the agreement, the Company has assigned to the producer a portion of the net revenues related to the sale of certain games in Europe.

The Company has failed to make the required payments under this agreement. Accordingly, the production advance payable is currently in default and is accruing production fees at $0.009 per unit (based upon 382,000 units) for each day after November 15, 2009 (approximately $1,004,000 through September 30, 2010). Pursuant to the terms of the production financing agreement, the producer is free to exercise any rights in connection with the security interests granted.

6. Secured Convertible Debt

On April 29 and 30, 2010, the Company entered into a note purchase agreement pursuant to which the Company could issue up to $5,000,000 of junior secured subordinated promissory notes (the “Junior Notes”) in one or more closings and each of the Company’s subsidiaries guaranteed the Company’s obligations under the Junior Notes. Pursuant to the note purchase agreement, the Company issued Junior Notes in the aggregate principal amount of $950,000 in private placements that closed on April 30, 2010 and May 6, 2010. Of the Junior Notes issued on April 29 and 30, 2010, the Company’s chairman, purchased $500,000.

The Junior Notes were due and payable in full on December 27, 2010 and bore interest at the rate of 10% per annum. The Junior Notes were secured by all of the assets of the Company and its subsidiaries and the indebtedness under the Junior Notes and the security interest granted by the Company and its subsidiaries in the note purchase agreement were junior to the Company’s indebtedness to SunTrust Banks, Inc., the Company’s senior lender, and the indebtedness held by any future senior lender of the Company or its subsidiaries. The principal and accrued interest outstanding under each Junior Note was convertible, in whole or in part, at the option of its holder into shares of the Company’s common stock at a price per share of $0.45 per share.

The Company evaluated the conversion feature of the Junior Notes and determined that there was no beneficial conversion feature as the conversion price of $0.45 per share was greater than the fair value of the stock at the time of issuance.

6. Secured Convertible Debt, Cont.

On July 16, 2010, the Company repaid the $450,000 Junior Note plus accrued interest thereon with proceeds from the senior secured convertible notes. On July 16, 2010, the Company exchanged the $500,000 Junior Note issued to the Company’s chairman for a $500,000 senior secured convertible note (see discussion below). Interest expense for the three months ended September 30, 2010 related to the Junior Notes was $5,411. There was $-0- and $15,548 of accrued interest outstanding at September 30, 2010 and June 30, 2010, respectively.

On July 16, 2010, the Company entered into a Securities Purchase Agreement with CNH Diversified Opportunities Master Account, L.P., CNH CA Master Account, L.P., AQR Diversified Arbitrage Fund and Terry Phillips, the Company’s chairman, for the sale of $5,500,000 of senior secured convertible notes (the “Notes”) and warrants. Mr. Phillips’ Note was issued in exchange for a Junior Note originally issued to him on April 30, 2010. The Company received $5,000,000 in cash for $5,000,000 of the senior secured convertible notes and exchanged a $500,000 prior Junior Note for $500,000 of the senior secured convertible notes. The Notes are due and payable in full on July 19, 2013 and bear interest at the rate of 10.0% per annum. Interest is payable semi-annually commencing on December 31, 2010. The Notes are senior to all obligations of the Company with the exception of the indebtedness under the Company’s Factoring Agreement with Rosenthal & Rosenthal, Inc. (see Note 4). Interest expense for the three months ended September 30, 2010 was $111,528 and there was $111,528 of accrued interest outstanding at September 30, 2010.

The principal and interest due under the Notes are convertible at a price of $0.431 per share. The Company evaluated the conversion feature of the Notes and determined that there was no beneficial conversion feature as the conversion price of $0.431 per share was greater than the fair value of the stock at the time of issuance.

On August 31, 2010, the Company entered into an Amended and Restated Securities Purchase Agreement (the “Amended Purchase Agreement”), pursuant to which it sold an aggregate of $2,000,000 of a new series of senior secured convertible notes (the “Additional Notes”) to AQR Opportunistic Premium Offshore Fund, L.P., Advanced Series Trust, solely on behalf of the AST Academic Strategies Asset Allocation Portfolio, and Terry Phillips, the Company’s chairman. The Company received $2,000,000 in cash for $2,000,000 of the Additional Notes, of which $200,000 was paid by Terry Phillips, the Company’s chairman. The Additional Notes are due and payable in full on March 15, 2011 and bear interest at the rate of 24.0% per annum. Interest is payable on December 31, 2010 and on March 15, 2011, the maturity date. The Additional Notes are subject to the Pledge and Security Agreement and the Guaranty made by the Company’s subsidiaries. Interest expense for the three months ended September 30, 2010 was $38,666 and there was $38,666 of accrued interest outstanding at September 30, 2010.

The principal and interest due under the Additional Notes are convertible at a price of $20.00 per share. The Company evaluated the conversion feature of the Notes and determined that there was no beneficial conversion feature as the conversion price of $20.00 per share was greater than the fair value of the stock at the time of issuance.

As a part of the issuance of the Notes, the Company issued Series A warrants to the purchasers of the Notes giving them the right to purchase up to an aggregate of 12,761,021 shares of common stock at an exercise price of $0.375 per share. The Series A warrants expire on July19, 2015, unless sooner exercised.

In addition, the purchasers of the Notes received Series B warrants which will expire, if the warrants become exercisable, on the fifth year anniversary of the date the Company announces its 2011 operating results. The number of Series B warrants each purchaser received is equal to 75% of the Series A warrants they obtained. The Series B warrants can only be exercised if the EBITDA Test, as defined under the Notes, is not achieved or if the Company fails to announce its 2011 operating results by September 28, 2011. The exercise price of the Series B warrants is tied to the weighted average price of the Company’s common stock for each of the 30 consecutive trading days following the earlier of the announcement of the Company’s 2011 operating results or September 28, 2011. The exercise price per share is also subject to full ratchet anti-dilution protection and limitations on exercise as are the Series A warrants.

The Company’s senior secured convertible notes and certain warrants have been accounted for in accordance with applicable authoritative guidance for derivative instruments which requires identification of certain embedded features to be bifurcated from debt instruments and accounted for as derivative assets or liabilities. The derivative assets and liabilities are initially recorded at fair value and then at each reporting date, the change in fair value is recorded in the condensed consolidated statement of operations.

The Company has accounted for the Series A warrants as a liability because the exercise price of the warrants will reset if the Company issues stock at a lower price. At inception, the fair value of the Series A warrants of $4,338,748 was separated from the Notes and recorded as a derivative liability which resulted in a reduction of the initial notional carrying amount of the Notes, and as unamortized discount, which is being accreted over the term of the Notes using the straight-line method. The fair value of the warrants was computed using the Black-Scholes option pricing model. The Company assumed a risk-free interest rate of 1.73%, no dividends, expected volatility of 148.24% and the contractual life of the warrants of 5 years.

6. Secured Convertible Debt, Cont.

The obligation to deliver the Series B warrants was determined to be an embedded derivative. The Company has approached the valuation of this embedded derivative based on the probability that the EBITDA Test, as defined under the Notes, will not be achieved. Because the probability at inception that the EBITDA Test will not be achieved is considered to be de minimis (less than 5%), the fair value of the derivative instrument is not considered to be material and no value has been assigned to it.

As of September 30, 2010, the unamortized debt discount amounted to $3,977,185. Total amortization of the debt discount recorded as interest expense was $361,563 for the three months ended September 30, 2010.

In connection with the sale of the senior secured convertible notes and warrants, the Company executed a Registration Rights Agreement under which it agreed to register the shares of common stock underlying the senior secured convertible notes and warrants. The Registration Rights Agreement has been amended and currently provides that the Company file a registration statement by November 19, 2010 and to have it declared effective by January 31, 2011, if it is not subject to full review by the SEC, and by March 15, 2011 if it is subject to full review. Failure to have the registration statement declared effective within 60 days from the prescribed effectiveness deadline constitutes a default under the Notes.

The purchasers of the senior secured convertible notes and warrants were introduced to the Company by an investment bank pursuant to an engagement letter agreement with the Company. Pursuant to the engagement letter, the investment bank received a cash fee that was approximately equal to 5.0% of the aggregate proceeds raised in the financing. The Company recorded the cash fee and other direct costs incurred for the issuance of the senior secured convertible notes in aggregate of $733,959 as deferred debt issuance costs. Debt issuance costs are amortized on the straight-line method over the terms of the senior secured convertible notes, with the amounts amortized being recognized as interest expense. Amortization of deferred debt issuance costs included in interest expense for the three months ended September 30, 2010 totaled $66,092.

7. Purchase Order Financing

On September 20, 2010, the Company entered into a Master Purchase Order Assignment Agreement with Wells Fargo Bank, National Association (“Wells Fargo”). In connection with the execution of this Agreement, each of the Company, its subsidiaries, Gone Off Deep, LLC and Vid Sub, LLC, and the chairman, Terry Phillips (the “Guarantors”), have executed a Guaranty in favor of, and, along with the Company, have entered into a Security Agreement and Financing Statement with, Wells Fargo.

Under the terms of the Agreement, the Company may request that Wells Fargo accept the assignment of customer purchase orders and request that Wells Fargo purchase the required materials to fulfill such purchase orders. If accepted, Wells Fargo, in turn, will retain the Company to manufacture, process, and ship the ordered goods. Wells Fargo’s aggregate outstanding funding under the agreement shall not exceed $2,000,000. No amounts were outstanding as of September 30, 2010.

Upon receipt of customer payments by Wells Fargo, the Company will be paid a fee for its services, with such fee calculated pursuant to the terms of the agreement. Also from such customer payments, Wells Fargo shall be entitled to receive the following: (1) a transaction initiation and set-up fee equal to 1.5% of the aggregate amount outstanding on all amounts (including letters of credit) advanced by Wells Fargo; (2) a daily maintenance fee equal to 0.05% of all amounts (including letters of credit) advanced by Wells Fargo which remain outstanding for more than 30 days; and (3) a product advance fee equal to (a) the prime rate plus 2%, divided by 360, multiplied by (b) (i) the aggregate amount outstanding on all amounts (including letters of credit) advanced by Wells Fargo on account of purchases of products or other advances made in connection with a customer purchase order, multiplied (ii) by the number of days from the earlier of (A) the date on which any such letter of credit or purchase order or financial accommodation is negotiated into cash, or (B) the date funds are advanced by other than issuing a letter of credit or purchase order.

In addition, Wells Fargo is entitled to a commitment fee of $120,000 to be paid on the earlier of (a) September 20, 2011 or (b) the date on which the Agreement is terminated. Wells Fargo is also entitled to additional commitment fees for each renewal of the Agreement, and such fees will be paid on the earlier of (a) the first anniversary of the beginning of each renewal term or (b) the date on which the Agreement is terminated.

7. Purchase Order Financing, Cont.

Subject to the rights of senior lenders, the Company and the Guarantors have granted security interests in their assets to Wells Fargo under the Security Agreement and Financing Statement to secure the LLC’s obligations under the Agreement and the Guarantors’ guarantees of such obligations.

8. Related Party Transactions

For all periods presented, the Company had the following related party transactions.

Related Party Receivables

Related party receivables consist primarily of short-term advances to employees. No allowance has been provided due to the short-term nature and recoverability of such advances.

Included in related party receivables at September 30, 2010 is a $35,000 receivable resulting from a loan made to a company partially owned by the Company’s chairman and chief executive officer. Interest on the loan is 8.0% and the entire outstanding amount became payable upon demand on September 1, 2010.

Also included in related party receivables at September 30 and June 30, 2010 is a receivable attributed to lease income. The Company leases certain office space to a company whose shareholders are also shareholders of the Company, one of whom is the Company's chairman. At September 30, 2010 and June 30, 2010, $-0- and $7,815, respectively, was owed to the Company and is included in related party receivables.

Due to Related Parties

During the three months ended September 30, 2010 and 2009, the Company expensed $6,600 related to broadband usage from an internet service provider partially owned by two shareholders of the Company, one of whom is the Company's chairman, of which $25 and $2,200 remained as a payable to the affiliate and is included in due to related parties in the accompanying condensed consolidated balance sheets at September 30, 2010 and June 30, 2010, respectively. These amounts are included in general and administrative expenses in the accompanying condensed consolidated statements of operations.

Accrued Expenses - Related Parties

Accrued expenses - related parties as of and for the three months ended September 30, 2010 and the year ended June 30, 2009 are as follows:

	Three months ended September 30, 2010			Year ended June 30, 2009
Balance at beginning of period	$	322,281		$	221,493
Expenses incurred:
Rent		27,500			110,000
Commissions		40,371			551,932
Less: amounts paid		(276,903	)		(561,144	)
Balance at end of period	$	113,249		$	322,281

The Company incurred sales commissions for the marketing and sale of videogames with four affiliates of the Company’s chairman. Sales commissions for the three months ended September 30, 2010 and 2009 were $40,371 and $108,046, respectively. These amounts are included in sales and marketing in the accompanying condensed consolidated statements of operations.

Lease - Related Parties

The Company leases certain office space from a company whose shareholders are also shareholders of the Company, one of whom is the Company’s chairman. Related party lease expense was $27,500 for the three months ended September 30, 2010 and 2009. These amounts are included in the general and administrative expense in the accompanying condensed consolidated statements of operations. The lease expires on December 31, 2010.

8. Related Party Transactions, Cont.

The Company leases certain office space to a company whose shareholders are also shareholders of the Company, one of whom is the Company’s chairman. Related lease income was $3,908 for the three months ended September 30, 2010 and 2009. These amounts are included in general and administrative expense in the accompanying condensed consolidated statements of operations. The lease expires on December 31, 2010.

9. Commitments

Total future minimum commitments are as follows:

	Software		Office
	Developers		Lease		Total
For the year ending June 30,

2011 (nine months ended June 30, 2011)	$	5,722,739	$	49,272	$	5,772,011
2012		-		29,029		29,029
2013		-		33,867		33,867
2014		-		-		-
2015		-		-		-
Total	$	5,722,739	$	112,168	$	5,834,907

10. Stock-based Compensation

In May 2008, the Company’s board of directors and its shareholders approved the 2008 Equity Incentive Compensation Plan (the “2008 Plan”) for the grant of stock awards, including restricted stock and stock options, to officers, directors, employees and consultants. The 2008 Plan expires in May 2018. Shares available for future grant as of September 30, 2010 and June 30, 2010 were 85,888 and 919,372, respectively, under the 2008 Plan.

Stock awards and shares are generally granted at prices which the Company’s board of directors believes approximate the fair market value of the awards or shares at the date of grant. Individual grants generally become exercisable ratably over a period of three years from the date of grant. The contractual terms of the options range from three to ten years from the date of grant.

The Company uses the Black-Scholes option pricing model to determine the fair value of stock-based compensation to employees and non-employees. The determination of fair value is affected by the Company’s stock price and volatility, employee exercise behavior, and the time for the shares to vest.

The assumptions used in the Black-Scholes option pricing model to value the Company’s option grants to employees and non-employees were as follow:

	For the three months ended September 30, 2010	For the three months ended September 30, 2009
Risk-free interest rate	1.6 – 2.5%	2.5 - 3.5%
Weighted-average volatility	155 - 157%	161 – 165%
Expected term	5.5 – 8.7 years	5.5 - 9.7 years
Expected dividends	0.0%	0.0%

The following table summarizes the stock-based compensation expense resulting from stock options and restricted stock in the Company’s consolidated statements of operations:

	For the three months ended September 30, 2010		For the three months ended September 30, 2009
Sales and marketing	$	10,705	$	27,622
General and administrative		142,897		128,574
Total stock-based compensation expense	$	153,602	$	156,196

10. Stock-based Compensation, Cont.

As of September 30, 2010, the Company’s unrecognized stock-based compensation for stock options issued to employees and non-employee directors was approximately $623,390 and will be recognized over a weighted average of 1.8 years. The Company estimated a 5.0% forfeiture rate related to the stock-based compensation expense calculated for employees and non-employee directors.

The following table summarizes the Company’s stock option activity for employees, non-employee directors, and non-employees for the three months ended September 30, 2010:

	Options		Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value
Outstanding as of June 30, 2010		2,882,128	$	1.16		-	$	-
Activity for the nine months ended September 30, 2010
Granted		696,500		0.30		9.88		9,000
Exercised		-				-		-
Forfeited, cancelled or expired		58,667		0.67		8.81		-
Outstanding as of September 30, 2010		3,519,961	$	0.90		8.81	$	9,000
Exercisable as of September 30, 2010		1,226,212	$	1.38		8.19	$	-
Exercisable and expected to be exercisable		2,293,749	$	0.93		8.77	$	7,715

The aggregate intrinsic value represents the total pre-tax intrinsic value based on the Company’s closing stock price ($0.25 per share) as of September 30, 2010, which would have been received by the option holders had all option holders exercised their options as of that date.

The weighted average fair value of stock options granted to employees and non-employee directors during the three months ended September 30, 2010 was $0.30 per share.

The following table summarizes the Company’s restricted stock activity for the nine months ended March 31, 2010:

	Shares		Weighted- Average Grant Date Fair Value
Outstanding as of June 30, 2010		1,085,000	$	0.37
Activity for the nine months ended September 30, 2010
Granted		195,651		0.23
Vested		65,000		0.75
Forfeited, cancelled or expired		-		-
Outstanding as of September 30, 2010		1,215,651	$	0.33
Vested as of September 30, 2010		178,500	$	1.64

10. Stock-based Compensation, Cont.

As of September 30, 2010, the Company’s unrecognized stock-based compensation for restricted stock issued to employees and non-employee directors was approximately $293,211 and will be recognized over a weighted average of 1.94 years.

11. Contingencies

On October 27, 2008, Gamecock was served with a demand for arbitration by a developer alleging various breaches of contract related to a publishing agreement entered into between Gamecock and the developer on December 12, 2007. The developer is seeking an award of $4,910,000, termination of the agreement, exclusive control of the subject videogame, and discretionary interest and costs. Gamecock has responded stating that the developer’s attempts to terminate the publishing agreement constitute wrongful termination of the agreement and breach of the agreement. Gamecock has also filed a counterclaim against the developer seeking the return of approximately $5.9 million in advances on royalties in the event the publishing agreement is terminated. The developer has filed a supplemental demand for arbitration concerning royalty payments due under a separate publishing agreement and is seeking an award of $41,084. An arbitration scheduled for January 2010 has been put on hold pending possibility of settlement. As of September 30, 2010, the Company believes it has accrued sufficient amounts to cover potential losses related to this matter. The Company’s management currently believes that resolution of this matter will not have a material adverse effect on the Company’s consolidated financial position or results of operations. However, legal issues are subject to inherent uncertainties and there exists the possibility that the ultimate resolution of this matter could have a material adverse effect on the Company’s consolidated financial position and the results of operations in the period in which any such effect is recorded.

In February 2010, the Company, SouthPeak Interactive, L.L.C., and Gamecock were served with a complaint by TimeGate Studios, Inc., or TimeGate, alleging various breach of contract and other claims related to a publishing agreement, or the Publishing Agreement, entered into between Gamecock and TimeGate in June 2007. TimeGate is seeking the return of all past and future revenue generated from the videogame related to the Publishing Agreement, an injunction against the Company and its subsidiaries, damages to be assessed, and discretionary interest and costs. Based upon the current status of this claim, the Company is of the opinion that it has limited or no exposure in connection with this claim.

On May 10, 2010, SouthPeak Interactive, L.L.C. and Melanie Mroz were served with a complaint by Spidermonk Entertainment, LLC or Spidermonk, alleging various breach of contract and other claims related to a publishing agreement, or the Publishing Agreement, entered into between Southpeak and Spidermonk in November, 2007. Spidermonk is seeking the unpaid milestone payments related to the development of the game “Roogoo” videogame as well as other highly speculative damages related to the poor sales performance of this game. The Company has no estimate at this time of its potential exposure and cannot, at this time, predict the outcome of this matter. The Company and its subsidiaries intend to vigorously defend all claims.

In September 2010, the Company instituted summary proceedings in the Lyon France Commercial Court against Nobilis Group in which the Company has alleged the Licensing and Distribution Agreements for the games the Company was to obtain and has obtained from Nobilis, including the My Baby games, were wrongfully terminated. In addition, the Company has claimed that the grant of the rights to My Baby 3 to Majesco were unlawful. The Company is seeking the reinstatement of the agreements and damages associated with the actions of Nobilis. Following a hearing on October 26, 2010, the court has rendered a temporary summary judgment reinstating the agreement for My Baby First Steps and ordered Nobilis to advise Nintendo to build all products pursuant to the My Baby First Steps contract, which includes the My Baby First Steps game and an additional fourteen games. A further hearing was held on November 9, 2010, in which the Company sought to affirm the court’s prior judgment reinstating the My Baby First Steps contract as well as to reinstate the My Baby 1 contract. The court has not yet rendered any decision regarding these matters. The parties are in settlement negotiations.

Other than the foregoing, the Company is engaged in litigation incidental to the Company’s business to which the Company is a party. While the Company cannot predict the ultimate outcome of these various legal proceedings, it is management’s opinion that, individually, the resolution of these matters should not have a material effect on the consolidated financial position or results of operations of the Company. As of September 30, 2010, the Company has accrued an aggregate amount of $839,903 related to such matters. The Company expenses legal costs as incurred in connection with a loss contingency.

On August 26, 2009, the Company was notified that the SEC was conducting a non-public, fact-finding investigation regarding certain matters underlying the amendment of its Form 10-Q, and the restatement of its financial statements, for the period ended March 31, 2009, and the termination of its former chief financial officer. The Company has provided the SEC with the documents requested and has cooperated in all respects with the SEC’s investigation.

11. Contingencies, Cont.

On September 3, 2010, the Company, Terry Phillips, the Company’s chairman, and Melanie Mroz, the Company’s CEO, received Wells Notices from the staff of the Securities and Exchange Commission advising that the staff will recommend to the Securities and Exchange Commission that cease and desist orders issue for alleged violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934 and Rules 12b-20 and 13a-13 adopted under this act. In addition, the staff has alleged violations by Mr. Phillips and Ms. Mroz of Rule 13b-2 and Rule 13a-14 by Ms. Mroz. These alleged violations result from the facts underlying the need to file an amended Form 10Q/A for the fiscal quarter ended March 31, 2009.

Legal proceedings have been threatened by the Company’s former CFO against the Company in connection with allegations of discrimination and retaliation against a whistle blower and wrongful termination. The claim seeks an undisclosed amount in lost wages in addition to certain employee benefits and punitive damages. The Company believes this claim is without merit and intends to defend this action vigorously.

From time to time, the Company is subject to various claims and legal proceedings. If management believes that a loss arising from these matters is probable and can reasonably be estimated, the Company would record the amount of the loss, or the minimum estimated liability when the loss is estimated using a range, and no point within the range is more probable than another. As additional information becomes available, any potential liability related to these matters is assessed and the estimates are revised, if necessary.

12. Gain on Settlement of Trades Payables

The gain on the settlement of trade payables at less than recorded values results from negotiations with various unsecured creditors for the settlement and payment of the trade payable at amounts less than that the recorded liability. For the three months ended September 30, 2010, the Company’s gain on settlement of trade payables was as follows:

	Net Trade Payables Settled		Other Assets Acquired/ Liabilities Assumed		Payments in Cash			Payments in Equity		Forgiveness of Debt

Vendor 1	$	12,000	$	-	$	(10,000	)	$	-	$	2,000
Vendor 2		1,064,848		-		(481,726	)		-		583,122
	$	1,076,848	$	-	$	(491,726	)	$	-	$	585,122

13. Additional Financial Statement Information

Accrued expenses and other current liabilities consist of the following:

	September 30,		June 30,
	2010		2010

Accrued expenses	$	1,693,186	$	1,700,208
Reserve for marketing development funds (MDF)		388,433		344,210
Commissions		100,344		161,678
Guaranteed royalty payments		135,000		135,000
Accrued payroll and payroll taxes		193,304		266,740
Customer cash in advance deposits		50,920		31,793
Accrued interest		1,586,386		1,062,200
Other		110,998		79,882

	$	4,258,571	$	3,781,711

No other items accounted for greater than five percent of total current liabilities as of September 30, 2010 or June 30, 2010.

14. Subsequent Event

Effective November 1, 2010, the number of authorized shares of common stock of the Company was increased from 90,000,000 to 190,000,000. The increase was effective upon the filing of an amendment to the Company's certificate of incorporation with the State of Delaware. The Company's Board of Directors and stockholders approved the amendment in July 2010, and the amendment was filed following the delivery of an Information Statement to the Company's stockholders on October 8, 2010.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes that appear elsewhere in this report and in our annual report on Form 10-K for the year ended June 30, 2010.

This report includes forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements can be identified by the use of words such as “anticipate,” “believe,” “estimate,” “may,” “intend,” “expect,” “will,” “should,” “seeks” or other similar expressions. Forward-looking statements reflect our plans, expectations and beliefs, and involve inherent risks and uncertainties, many of which are beyond our control. You should not place undue reliance on any forward-looking statement, which speaks only as of the date made. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this report, and in “Risk Factors” in Item 1A, Part I, of our annual report on Form 10-K for the year ended June 30, 2010.

Going Concern

Overview

We are an independent developer and publisher of interactive entertainment software. We utilize our network of independent studios and developers to create videogames for all popular videogame systems, including:

home videogame consoles such as Microsoft Xbox 360, Nintendo Wii, Sony PlayStation 3 and Sony PlayStation 2;

	·	handheld platforms such as Nintendo DS, Nintendo DSi, Sony PSP, Sony PSPgo and Apple iPhone; and

	·	personal computers.

Our portfolio of games extends across a variety of consumer demographics, ranging from adults to children and hard-core game enthusiasts to casual gamers.

We are an “indie” videogame developer and publisher working with independent software developers and videogame studios to create our videogames. We have cultivated relationships globally with independent developers and studios that provide us with innovative and compelling videogame concepts.

Our strategy is to establish a portfolio of successful proprietary content for the major videogame systems, and to capitalize on the growth of the interactive entertainment market. We currently work exclusively with independent software developers and videogame studios to develop our videogames. This strategy enables us to source and create highly innovative videogames while avoiding the high fixed costs and risk of having a large internal development studio. Through outsourcing, we are also able to access videogame concepts and content from emerging studios globally, providing us with significant new product opportunities with limited initial financial outlay, compared to internally developed videogames.

Sources of Revenue

Revenue is primarily derived from the sale of videogame titles developed on our behalf by third parties and other content partnerships. Our unique business model of sourcing and developing creative product allows us to better manage our fixed costs relative to industry peers.

Our operating margins are dependent in part upon our ability to continually release new products that perform according to our budgets and forecasts, and manage our product development costs. Our product development costs include license acquisition, videogame development, and third-party royalties. Agreements with third-party developers generally give us exclusive publishing and marketing rights and require us to make advance royalty payments, pay royalties based on product sales and satisfy other conditions.

Cost of Goods Sold and Operating Expenses

Cost of Goods Sold. Cost of goods sold consists of royalty payments to third party developers, license fees to videogame manufacturers, intellectual property costs for items such as trademarked characters and game engines, manufacturing costs of the videogame discs, cartridges or similar media and the write-off of acquired game sequel titles. Videogame system manufacturers approve and manufacture each videogame for their videogame system. They charge their license fee for each videogame based on the expected retail sales price of the videogame. Such license fee is paid by us based on the number of videogames manufactured. Should some of the videogames ultimately not be sold, or the sales price to the retailer be reduced by us through price protection, no adjustment is made by the videogame system manufacturer in the license fee originally charged. Therefore, because of the terms of these license fees, we may have an increase in the cost of goods as a percent of net revenue should we fail to sell a number of copies of a videogame for which a license has been paid, or if the price to the retailer is reduced.

We utilize third parties to develop our videogames on a royalty payment basis. We enter into contracts with third party developers once the videogame design has been approved by the videogame system manufacturer and is technologically feasible. Specifically, payments to third party developers are made when certain contract milestones are reached, and these payments are capitalized. These payments are considered non-refundable royalty advances and are applied against the royalty obligations owing to the third party developer from the sales of the videogame. To the extent these prepaid royalties are sales performance related, the royalties are expensed against projected sales revenue at the time a videogame is released and charged to costs of goods sold. Any pre-release milestone payments that are not prepayments against future royalties are expensed when a videogame is released and then charged to costs of goods sold. Capitalized costs for videogames that are cancelled or abandoned prior to product release are charged to “cost of goods sold - royalties” in the period of cancellation.

Warehousing and Distribution Expenses. Our warehousing and distribution expenses primarily consist of costs associated with warehousing, order fulfillment, and shipping. Because we use third-party warehousing and order fulfillment companies in the United States and in Europe, the expansion of our product offerings and escalating sales will increase our expenditures for warehousing and distribution in proportion to our increased sales.

Sales and Marketing Expenses. Sales and marketing expenses consist of advertising, marketing and promotion expenses, and commissions to external sales representatives. As the number of newly published videogames increases, advertising, marketing and promotion expenses are expected to rise accordingly. We recognize advertising, marketing and promotion expenses as incurred, except for production costs associated with media advertising, which are deferred and charged to expense when the related ad is run for the first time. We also engage in cooperative marketing with some of our retail channel partners. We accrue marketing and sales incentive costs when revenue is recognized and such amounts are included in sales and marketing expense when an identifiable benefit to us can be reasonably estimated; otherwise, the incentives are recognized as a reduction to net revenues. Such marketing is offered to our retail channel partners based on a single sales transaction, as a credit on their accounts receivable balance, and would include items such as contributing to newspaper circular ads and in store banners and displays.

General and Administrative Expenses. General and administrative expenses primarily represent personnel-related costs, including corporate executive and support staff, general office expenses, consulting and professional fees, and various other expenses. Personnel-related costs represent the largest component of general and administrative expenses. We expect that our personnel costs will increase as the business continues to grow. Depreciation expense also is included in general and administrative expenses.

Gain on Settlement of Trade Payables. Gain on settlement of trade payables is the result of negotiations with various unsecured creditors for the settlement and payment of trade payables at amounts less than the recorded liability.

Change in Fair Value of Warrant Liability. The Company’s senior secured convertible notes and certain warrants have been accounted for in accordance with applicable authoritative guidance for derivative instruments which requires identification of certain embedded features to be bifurcated from debt instruments and accounted for as derivative assets or liabilities. The derivative assets and liabilities are initially recorded at fair value and then at each reporting date, the change in fair value is recorded in the condensed consolidated statement of operations.

Interest and Financing Costs. Interest and financing costs are attributable to our financing arrangements that are used to fund development of videogames with third parties, which often takes 12-24 months. Additionally, such costs are used to finance the accounts receivables prior to payment by customers.

Critical Accounting Policies and Estimates

Our condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these condensed consolidated financial statements requires estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. Estimates were based on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ materially from these estimates under different assumptions or conditions.

Our significant accounting policies are described in Note 1 to the accompanying condensed consolidated financial statements and in our annual report on Form 10-K for the year ended June 30, 2010. The following accounting policies involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our consolidated financial condition and results of operations.

Allowances for Returns, Price Protection and Other Allowances. We accept returns from, and grant price concessions to, our customers under certain conditions. Following reductions in the price of our videogames, we grant price concessions to permit customers to take credits against amounts they owe us with respect to videogames unsold by them. Our customers must satisfy certain conditions to entitle them to return videogames or receive price concessions, including compliance with applicable payment terms and confirmation of field inventory levels and sell-through rates.

We make estimates of future videogame returns and price concessions related to current period revenue. We estimate the amount of future returns and price concessions for published titles based upon, among other factors, historical experience and performance of the titles in similar genres, historical performance of the videogame system, customer inventory levels, analysis of sell-through rates, sales force and retail customer feedback, industry pricing, market conditions and changes in demand and acceptance of our videogame by consumers.

Significant management judgments and estimates must be made and used in connection with establishing the allowance for returns and price concessions in any accounting period. We believe we can make reliable estimates of returns and price concessions. However, actual results may differ from initial estimates as a result of changes in circumstances, market conditions and assumptions. Adjustments to estimates are recorded in the period in which they become known.

Inventories. Inventories are stated at the lower of average cost or market. Management regularly reviews inventory quantities on hand and in the retail channel and records a provision for excess or obsolete inventory based on the future expected demand for our games. Significant changes in demand for our games would impact management’s estimates in establishing the inventory provision.

Advances on Royalties. We utilize independent software developers to develop our videogames and make payments to the developers based upon certain contract milestones. We enter into contracts with the developers once the videogame design has been approved by the videogame system manufacturers and is technologically feasible. Accordingly, we capitalize such payments to the developers during development of the videogames. These payments are considered non-refundable royalty advances and are applied against the royalty obligations owed to the developer from future sales of the videogame. Any pre-release milestone payments that are not prepayments against future royalties are expensed to “cost of goods sold - royalties” in the period when the game is released. Capitalized royalty costs for those videogames that are cancelled or abandoned are charged to “cost of goods sold - royalties” in the period of cancellation.

Beginning upon the related videogame’s release, capitalized royalty costs are amortized to “cost of goods sold – royalties,” based on the ratio of current revenues to total projected revenues for the specific videogame, generally resulting in an amortization period of twelve months or less.

We evaluate the future recoverability of capitalized royalty costs on a quarterly basis. For videogames that have been released in prior periods, the primary evaluation criterion is actual title performance. For videogames that are scheduled to be released in future periods, recoverability is evaluated based on the expected performance of the specific videogame to which the royalties relate. Criteria used to evaluate expected game performance include: historical performance of comparable videogames developed with comparable technology; orders for the videogame prior to its release; and, for any videogame sequel, estimated performance based on the performance of the videogame on which the sequel is based.

Significant management judgments and estimates are utilized in the assessment of the recoverability of capitalized royalty costs. In evaluating the recoverability of capitalized royalty costs, the assessment of expected videogame performance utilizes forecasted sales amounts and estimates of additional costs to be incurred. If revised forecasted or actual videogame sales are less than, and/or revised forecasted or actual costs are greater than, the original forecasted amounts utilized in the initial recoverability analysis, the net realizable value may be lower than originally estimated in any given quarter, which could result in an impairment charge. Material differences may result in the amount and timing of charges for any period if management makes different judgments or utilizes different estimates in evaluating these qualitative factors.

Intellectual Property Licenses. Intellectual property license costs consist of fees paid by us to license the use of trademarks, copyrights, and software used in the development of videogames. Depending on the agreement, we may use acquired intellectual property in multiple videogames over multiple years or for a single videogame. When no significant performance remains with the licensor upon execution of the license agreement, we record an asset and a liability at the contractual amount. We believe that the contractual amount represents the fair value of the liability. When significant performance remains with the licensor, we record the payments as an asset when paid to the licensee and as a liability upon achievement of certain contractual milestones rather than upon execution of the agreement. We classify these obligations as current liabilities to the extent they are contractually due within the next 12 months. Capitalized intellectual property license costs for those videogames that are cancelled or abandoned are charged to “cost of goods sold - intellectual property licenses” in the period of cancellation.

Beginning upon the related videogame’s release, capitalized intellectual property license costs are amortized to “cost of sales - intellectual property licenses” based on the greater of: (1) the ratio of current revenues for the specific videogame to total projected revenues for all videogames in which the licensed property will be utilized or (2) the straight-line amortization based on the useful lives of the asset. As intellectual property license contracts may extend for multiple years, the amortization of capitalized intellectual property license costs relating to such contracts may extend beyond one year.

We evaluate the future recoverability of capitalized intellectual property license costs on a quarterly basis. For videogames that have been released in prior periods, the primary evaluation criterion is actual title performance. For videogames that are scheduled to be released in future periods, recoverability is evaluated based on the expected performance of the specific videogames to which the costs relate or in which the licensed trademark or copyright is to be used. Criteria used to evaluate expected game performance include: historical performance of comparable videogames developed with comparable technology; orders for the game prior to its release; and, for any videogame sequel, estimated performance based on the performance of the videogame on which the sequel is based. Further, as intellectual property licenses may extend for multiple videogames over multiple years, we also assess the recoverability of capitalized intellectual property license costs based on certain qualitative factors, such as the success of other products and/or entertainment vehicles utilizing the intellectual property and the holder’s right to continued promotion and exploitation of the intellectual property.

Significant management judgments and estimates are utilized in the assessment of the recoverability of capitalized intellectual property license costs. In evaluating the recoverability of capitalized intellectual property license costs, the assessment of expected game performance utilizes forecasted sales amounts and estimates of additional costs to be incurred. If revised forecasted or actual videogame sales are less than, and/or revised forecasted or actual costs are greater than, the original forecasted amounts utilized in the initial recoverability analysis, the net realizable value may be lower than originally estimated in any given quarter, which could result in an impairment charge. Material differences may result in the amount and timing of charges for any period if management makes different judgments or utilizes different estimates in evaluating these qualitative factors.

Revenue Recognition. We recognize revenues from the sale of our videogames upon the transfer of title and risk of loss to the customer. We recognize revenues for software titles when (1) there is persuasive evidence that an arrangement with the customer exists, which is generally a purchase order, (2) the product is delivered, (3) the selling price is fixed or determinable, and (4) collection of the customer receivable is deemed probable. Our payment arrangements with customers typically provide for net 30 and 60 day terms. Advances received for licensing and exclusivity arrangements are reported on the consolidated balance sheets as deferred revenues until we meet our performance obligations, at which point the revenues are recognized. Revenue is recognized after deducting estimated reserves for returns, price protection and other allowances. In circumstances when we do not have a reliable basis to estimate returns and price protection or we are unable to determine that collection of a receivable is probable, we defer the revenue until such time as we can reliably estimate any related returns and allowances and determine that collection of the receivable is probable.

Some of our videogames provide limited online features at no additional cost to the consumer. Generally, we consider such features to be incidental to the overall product offering and an inconsequential deliverable. Accordingly, we recognize revenue related to videogames containing these limited online features upon the transfer of title and risk of loss to our customer. In instances where online features or additional functionality are considered a substantive deliverable in addition to the videogame, we take this into account when applying our revenue recognition policy. This evaluation is performed for each videogame together with any online transactions, such as electronic downloads or videogame add-ons when it is released. When we determine that a videogame contains online functionality that constitutes a more-than-inconsequential separate service deliverable in addition to the videogame, principally because of its importance to game play, we consider that our performance obligations for this game extend beyond the delivery of the game. Fair value does not exist for the online functionality, as we do not separately charge for this component of the videogame. As a result, we recognize all of the revenue from the sale of the game upon the delivery of the remaining online functionality. In addition, we defer the costs of sales for this game and recognize the costs upon delivery of the remaining online functionality.

With respect to online transactions, such as electronic downloads of games or add-ons that do not include a more-than-inconsequential separate service deliverable, revenue is recognized when the fee is paid by the online customer to purchase online content and we are notified by the online retailer that the product has been downloaded. In addition, persuasive evidence of an arrangement must exist, collection of the related receivable must be probable and the fee must be fixed and determinable.

We have an arrangement pursuant to which we distribute videogames co-published with another company for a fee based on the gross sales of the videogames. Under the arrangement, we bear the inventory risk as we purchase and take title to the inventory, warehouses the inventory in advance of orders, prices and ships the inventory and invoices its customers for videogame shipments. Also under the arrangement, we bear the credit risk as the supplier does not guarantee returns for unsold videogames and we are not reimbursed by the supplier in the event of non-collection. We record the gross amount of revenue under the arrangement as we are not acting as an agent for the principal in the arrangement as defined by Accounting Standard Codification (“ASC”) Topic 605.

Third-party licensees in Europe distribute videogames under license agreements with us. The licensees pay certain minimum, non-refundable, guaranteed royalties when entering into the licensing agreements. Upon receipt of the advances, we defer their recognition and recognize the revenues in subsequent periods as these advances are earned by us. As the licensees pay additional royalties above and beyond those initially advanced, we recognize these additional royalties as revenues when earned.

Stock-Based Compensation. We account for stock-based compensation in accordance with ASC Topic 718, Compensation – Stock Compensation. ASC 718 requires companies to estimate the fair value of share-based payment awards on the measurement date using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the consolidated statements of operations.

Stock-based compensation expense recognized in the consolidated statements of operations is based on awards ultimately expected to vest and has been reduced for estimated forfeitures. ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

We account for equity instruments issued to non-employees in accordance with ASC Topic 505, Equity, Subtopic 50, Equity-Based Payments to Non-Employees.

We estimate the value of employee, non-employee director and non-employee stock options on the date of grant using the Black-Scholes option pricing model. Our determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors.

Amortizable Intangible Assets. Intangible assets subject to amortization are carried at cost less accumulated amortization. Amortizable intangible assets consist of game sequels, non-compete agreements and distribution agreements. Intangible assets subject to amortization are amortized over the estimated useful life in proportion to the pattern in which the economic benefits are consumed, which for some intangibles assets are approximated by using the straight-line method. Long-lived assets including amortizable intangible assets are reviewed for impairment in accordance with ASC Topic 360, Property, Plant, and Equipment, whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. Measurement of any impairment loss for long-lived assets and amortizable intangible assets is based on the amount by which the carrying value exceeds the fair value of the asset.

Assessment of Impairment of Goodwill. ASC Topic 350, Intangibles – Goodwill and Other, Subtopic 20, Goodwill , (“ASC 350-20”) requires a two-step approach to testing goodwill for impairment. ASC 350-20 requires that the impairment test be performed at least annually by applying a fair-value-based test. The first step measures for impairment by applying fair-value-based tests. The second step (if necessary) measures the amount of impairment by applying fair-value-based tests to the individual assets and liabilities.

To determine the fair values of the reporting units used in the first step, we use a combination of the market approach, which utilizes comparable companies’ data and/or the income approach, or discounted cash flows. Each step requires us to make judgments and involves the use of significant estimates and assumptions. These estimates and assumptions include long-term growth rates and operating margins used to calculate projected future cash flows, risk-adjusted discount rates based on our weighted average cost of capital, future economic and market conditions and determination of appropriate market comparables. These estimates and assumptions have to be made for each reporting unit evaluated for impairment. Our estimates for market growth, our market share and costs are based on historical data, various internal estimates and certain external sources, and are based on assumptions that are consistent with the plans and estimates we are using to manage the underlying business. Our business consists of publishing and distributing interactive entertainment software and content using both established and emerging intellectual properties and our forecasts for emerging intellectual properties are based upon internal estimates and external sources rather than historical information and have an inherently higher risk of accuracy. If future forecasts are revised, they may indicate or require future impairment charges. We base our fair value estimates on assumptions we believe to be reasonable but that are unpredictable and inherently uncertain. Actual future results may differ from those estimates.

Change in Fair Value of Warrant Liability. We are required to classify the fair value of certain warrants issued as a liability, with subsequent changes in fair value to be recorded as income (loss) on change in fair value of warrant liability. The fair value of the warrants is determined using the Black-Scholes option pricing model and is affected by changes in inputs to that model including our stock price, expected stock price volatility, the contractual term, and the risk-free interest rate. Our estimate of the expected volatility is based on historical volatility. The expected term of the warrants is based on the time to expiration of the warrants from the date of measurement. Risk-free interest rates are derived from the yield on U.S. Treasury debt securities. We will continue to classify the fair value of the warrants as a liability until the warrants are exercised, expire or are amended in a way that would no longer require these warrants to be classified as a liability.

Consolidated Results of Operations

The following table sets forth our results of operations expressed as a percentage of net revenues for the three months ended September 30, 2010 and 2009:

	For the three months ended September 30,
	2010			2009

Net revenues		100.0	%		100.0	%

Cost of goods sold:
Product costs		53.2	%		21.3	%
Royalties, net		(4.7)	%		29.9	%
Intellectual property licenses		6.7	%		0.7	%
Total cost of goods sold		55.2	%		51.9	%

Gross profit		44.8	%		48.1	%

Operating expenses:
Warehousing and distribution		4.6	%		1.7	%
Sales and marketing		62.6	%		21.9	%
General and administrative		135.0	%		18.6	%
Gain on settlement of trade payables		(40.9)	%		-	%
Total operating expenses		161.3	%		42.2	%

(Loss) income from operations		(116.5)	%		5.9	%

Other expenses (income):
Change in fair value of warrant liability		(106.9)	%		-	%
Interest and financing costs, net		74.3	%		1.8	%

Net (loss) income		(83.9)	%		4.1	%

Comparison of the Three Months Ended September 30, 2010 and 2009

Net Revenues. Net revenues for the three months ended September 30, 2010 were $1,431,859, a decrease of $15,277,790, or 91%, from net revenues of $16,709,649 for the three months ended September 30, 2009. The decrease in net revenues was primarily driven by releasing a decreased number of titles. For the three months ended September 30, 2010, the number of videogame units sold decreased to approximately 135,000, a decrease of 602,000 units from the units sold in the comparable period in 2009. During the three months ended September 30, 2009, we released ten new titles versus no new titles during the current period due to the delay of certain launch dates of upcoming releases. Additionally, due to the litigation with Nobilis, we were unable to manufacture or ship any of the My Baby brand products during the three months ended September 30, 2010. This decrease in new titles in addition to being unable to ship My Baby brand products directly impacted the amount of units shipped. Average net revenue per videogame unit sold decreased 53%, from $22.67 to $10.61 for the three months ended September 30, 2009 and 2010, respectively. This average decrease in price is mainly due to selling older units during the three months ended September 30, 2010, which are discounted and have a lower price point, versus the sales of new release titles in the comparable period in 2009.

Cost of Goods Sold. Cost of goods sold for the three months ended September 30, 2010 decreased to $790,067, down $7,876,950, or 91%, from $8,667,017 for the comparable period in 2009. Product costs for the three months ended September 30, 2010 decreased $2,785,404, or 79%, from the comparable period in 2009. This decrease was primarily driven by the decrease in units shipped from the prior period. For the three months ended September 30, 2010, the number of videogame units sold decreased to approximately 135,000, a decrease of approximately 602,000 units from the units sold in the prior period. For the three months ended September 30, 2010, we incurred negative royalty expense of $67,108 compared to royalty expense of $5,000,671 for the three months ended September 30, 2009. This $5,067,779, or 101%, decrease from the comparable period in 2009 was primarily attributed to sales discounts passed on to a distribution partner that reduced our accrued royalty liability. Due to the significant decrease in new titles released and net revenues, there was not enough royalty expense to offset the reduction in liability.

Gross Profit. For the three months ended September 30, 2010 and 2009, gross profit decreased by $7,400,840, or 92%, to $641,792 from $8,042,632. Gross profit margin decreased to approximately 45% for the three months ended September 30, 2010 from 48% in the same period in 2009. The decrease in gross profit is attributable to the lack of new release titles, which sell at a higher price point, in the three months ended September 30, 2010, as compared to the comparable period in 2009.

Warehousing and Distribution Expenses. For the three months ended September 30, 2010 and 2009, warehousing and distribution expenses were $66,089 and $286,511, respectively, resulting in a decrease of 77%. This decrease is due primarily to a decrease in units shipped and units currently being held at our third party warehouse when compared to the same period in 2009.

Sales and Marketing Expenses. For the three months ended September 30, 2010, sales and marketing expenses decreased 75% to $896,671 from $3,655,056 for the three months ended September 30, 2009. This decrease is primarily due to our cost reduction strategy as well as the decrease in the number of new titles released during the three months ended September 30, 2010 versus the comparable prior year period. Sales and marketing costs vary on a videogame by videogame basis depending on market conditions and consumer demand, and do not necessarily increase or decrease proportionate to sales volumes. Included in sales and marketing expenses for the three months ended September 30, 2010 and 2009 is a non-cash charge of $10,705 and $27,622, respectively, for stock options granted to vendors and other non-employees.

General and Administrative Expenses. For the three months ended September 30, 2010, general and administrative expenses decreased $1,182,453 to $1,932,315 from $3,114,768 for the comparable prior year period. Wages included in general and administrative expenses decreased from $962,547 for the three months ended September 30, 2009 to $716,569 for the three months ended September 30, 2010, a decrease of 26%. Professional fees decreased 88% from $1,277,847 for the three months ended September 30, 2009 to $153,055 for the three months ended September 30, 2010, as a result of legal and accounting fees related to litigation in the comparable period in 2009. Travel and entertainment expenses were $53,323 for the three months ended September 30, 2009, as compared to $101,077 for the three months ended September 30, 2010. General and administrative expenses as a percentage of net revenues increased, to approximately 135% for the three months ended September 30, 2010 from 19% for the same period in 2009. In addition, for the three months ended September 30, 2010, general and administrative expenses includes $142,897 for noncash compensation related to employee stock options and restricted stock granted, an increase of $14,323, or 11%, from the comparable period in 2009.

Gain on Settlement of Trade Payables. For the three months ended September 31, 2010, the gain on settlement of trade payables was $585,122, which was the result of negotiations with various unsecured creditors for the settlement and payment of trade payables at amounts less than the recorded liability.

Operating (Loss) Income. For the three months ended September 30, 2010, our operating loss was $1,668,161, an increase of $2,654,458, or 269%, over operating income of $986,297 for the same period in 2009.

Interest and Financing Costs, Net. For the three months ended September 30, 2010, interest and financing costs increased to $1,064,096 from $299,316 for the comparable prior year period due to an increase in average borrowings levels, amortization of debt issuance costs, and as a result of expense related to the production advance payable. Amortization of debt issuance costs related to the senior secured convertible notes for the three months ended September 30, 2010 totaled $66,092. The production advance payable is currently in default and is accruing production fees at $0.009 per unit (based upon 382,000 units) for each day after November 14, 2009, which amounted to approximately $279,000 for the three months ending September 30, 2010. The increase in interest and financing costs is also attributed to amortization of the debt discount associated with the Series A warrants that were issued with the senior secured convertible notes. Amortization of the debt discount totaled $361,562 for the three months ended September 30, 2010.

Net (Loss) Income. For the three months ended September 30, 2010, our net loss was $1,200,934 over net income of $686,981 for the same period in 2009.

Quarterly Operating Results Not Meaningful

Our quarterly net revenues and operating results have varied widely in the past and can be expected to vary in the future due to numerous factors, several of which are not under our control. These factors include the timing of our release of new titles, the popularity of both new titles and titles released in prior periods, changes in the mix of titles with varying gross margins, the timing of customer orders, and fluctuations in consumer demand for gaming platforms. Accordingly, our management believes that quarter-to-quarter comparisons of our operating results are not meaningful.

Liquidity and Capital Resources

Our primary cash requirements have been to fund (i) the development, manufacturing and marketing of our videogames, (ii) working capital, and (iii) capital expenditures. Historically, we have met our capital needs, including working capital, capital expenditures and commitments, through our operating activities, our line of credit, through the sale of our equity securities, and, prior to the reverse acquisition, loans from related parties and our shareholders. Our cash and cash equivalents were $449,926 at September 30, 2010 and $92,893 at June 30, 2010.

Line of Credit. During fiscal year 2010, we maintained a line of credit with SunTrust that was scheduled to mature on November 30, 2010. At June 30, 2010, the outstanding line of credit balance was $3,830,055 and the remaining available under the line of credit amounted to $-0-. As of July 12, 2010, we repaid in full the entire outstanding balance owed to SunTrust through a new factoring line of credit.

Factoring Agreement. On July 12, 2010, we entered into a factoring agreement with Rosenthal & Rosenthal, Inc. (the “Factoring Agreement”). Under the Factoring Agreement, we agreed to sell receivables arising from sales of inventory to Rosenthal & Rosenthal. Under the terms of the Factoring Agreement, we are selling all of our receivables to Rosenthal & Rosenthal. For the approved receivables, Rosenthal & Rosenthal will assume the risk of collection. We have agreed to pay Rosenthal & Rosenthal a commission of .60% of the amount payable under all of our invoices to most of our customers against a minimum commission of $30,000 multiplied by the number of months in a contract period, with the first period being 12 months and the second 7 months. All payments received by Rosenthal & Rosenthal are payable to us after amounts due to Rosenthal & Rosenthal are satisfied. Under the Factoring Agreement, we have the right to borrow against payments due us at the rate of 65% of credit approved receivables. The borrowing rate against non-credit approved receivables is subject to negotiation. The interest rate on borrowings is equal to the greater of prime plus 1.5% per annum or 6.5% per annum. A $10,000,000 loan cap applies against our borrowings, which is subject to an increase of up to $3,000,000 if shareholders’ equity increases. The initial term of the Factoring Agreement ends on February 28, 2012. At September 30, 2010, $1,940,268 was due to Rosenthal & Rosenthal under the Factoring Agreement.

Accounts Receivable. Generally, we have been able to collect our accounts receivable in the ordinary course of business. We do not hold any collateral to secure payment from customers. We are subject to credit risks, particularly if any of our accounts receivable represent a limited number of customers. If we are unable to collect our accounts receivable as they become due, it could adversely affect our liquidity and working capital position.

At September 30, 2010 and June 30, 2010, amounts due from our three largest customers comprised approximately 30% and 54% of our gross accounts receivable balance, respectively. We believe that the receivable balances from these largest customers do not represent a significant credit risk based on past collection experience, although we actively monitor each customer’s credit worthiness and economic conditions that may impact our customers’ business and access to capital. We continue to monitor the lagging economy, the global contraction of credit markets and other factors as they relate to our customers in order to manage the risk of uncollectible accounts receivable.

Senior Secured Convertible Notes. On July 16, 2010, we entered into a Securities Purchase Agreement with CNH Diversified Opportunities Master Account, L.P., CNH CA Master Account, L.P., AQR Diversified Arbitrage Fund and Terry Phillips, our chairman, for the sale of $5,500,000 of senior secured convertible notes (the “Initial Notes”) and related warrants. Mr. Phillips’ Initial Note was issued in exchange for a junior secured convertible note originally issued to him on April 30, 2010. We received $5,000,000 in cash for $5,000,000 of the senior secured convertible notes and exchanged a $500,000 prior junior secured convertible note for $500,000 of the senior secured convertible notes.

On August 31, 2010, we entered into an Amended and Restated Securities Purchase Agreement, pursuant to which we sold an aggregate of $2,000,000 of a new series of senior secured convertible promissory notes (the “Additional Notes”) to AQR Opportunistic Premium Offshore Fund, L.P., Advanced Series Trust, solely on behalf of the AST Academic Strategies Asset Allocation Portfolio, and Terry Phillips, our chairman. We received $2,000,000 in cash for $2,000,000 of the Additional Notes, of which $200,000 was paid by Mr. Phillips.

Purchase Order Assignment Agreement. On September 20, 2010, we entered into a master purchase order assignment agreement (the “Purchase Order Assignment Agreement”) with Wells Fargo Bank, National Association (“Wells Fargo”). Under the terms of the Purchase Order Assignment Agreement, we may request that Wells Fargo accept the assignment of customer purchase orders and request that Wells Fargo purchase the required materials to fulfill such purchase orders. If accepted, Wells Fargo, in turn, will retain us to manufacture, process, and ship the ordered goods. Wells Fargo’s aggregate outstanding funding under the agreement shall not exceed $2,000,000. Upon receipt of customer payments by Wells Fargo, we will be paid a fee for its services, with such fee calculated pursuant to the terms of the agreement. Also from such customer payments, Wells Fargo shall be entitled to receive the following: (1) a transaction initiation and set-up fee equal to 1.5% of the aggregate amount outstanding on all amounts (including letters of credit) advanced by Wells Fargo; (2) a daily maintenance fee equal to 0.05% of all amounts (including letters of credit) advanced by Wells Fargo which remain outstanding for more than 30 days; and (3) a product advance fee equal to (a) the prime rate plus 2%, divided by 360, multiplied by (b) (i) the aggregate amount outstanding on all amounts (including letters of credit) advanced by Wells Fargo on account of purchases of products or other advances made in connection with a customer purchase order, multiplied (ii) by the number of days from the earlier of (A) the date on which any such letter of credit or purchase order or financial accommodation is negotiated into cash, or (B) the date funds are advanced by other than issuing a letter of credit or purchase order. A security agreement secures the advances made to us under the Purchase Order Assignment Agreement.

Although there can be no assurance, we believe our current cash and cash equivalents and projected cash flow from operations, along with availability under our factoring line and Wells Fargo agreement, will provide us with sufficient liquidity to satisfy our cash requirements for working capital, capital expenditures and commitments through at least the next 12 months. In addition, if we were unable to fully fund our cash requirements through current cash and cash equivalents and projected cash flow from operations, we would need to obtain additional financing through a combination of equity and debt financings. If any such activities become necessary, there can be no assurance that we would be successful in obtaining additional financing, particularly in light of the general economic downturn. In their report on our audited financial statements for the year ended June 30, 2010, our independent registered public accounting firm included an explanatory paragraph regarding concerns about our ability to continue as a going concern. See "Note 1. Summary of Significant Accounting Policies- Going Concern" to our condensed consolidated financial statements included elsewhere in this report for additional information.

Cash Flows. We expect that we will make expenditures relating to advances on royalties to third-party developers to which we have made commitments to fund. Cash flows from operations are affected by our ability to release successful titles. Though many of these titles have substantial royalty advances and marketing expenditures, once a title recovers these costs, incremental net revenues typically will directly and positively impact cash flows.

During the three months ended September 30, 2010, we had net cash used in operating activities of $1,319,946, and during the three months ended September 30, 2009, we had net cash used in operating activities $2,221,544.

During the three months ended September 30, 2010, investing activities resulted in net cash used of $16,737 and during the three months ended September 30, 2009, investing activities resulted in net cash provided of $391,183. The cash provided was a result of the release of restricted cash during the three months ended September 30, 2010.

During the three months ended September 30, 2010, financing activities resulted in net cash provided of $1,969,094 and during the three months ended September 30, 2009, financing activities resulted in net cash provided of $1,406,774.

International Operations. Net revenue earned outside of North America is principally generated by our operations in Europe, Australia and Asia. For the three months ended September 30, 2010 and 2009, approximately 12% and 28%, respectively, of our net revenue was earned outside of the U.S. We are subject to risks inherent in foreign trade, including increased credit risks, tariffs and duties, fluctuations in foreign currency exchange rates, shipping delays and international political, regulatory and economic developments, all of which can have a significant impact on our operating results.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

For quantitative and qualitative disclosures about market risk, see Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” of our annual report on Form 10-K for the year ended June 30, 2010. Our exposures to market risk have not changed materially since June 30, 2010.

Item 4. Controls and Procedures

Restatement of Previously Issued Financial Statements

On September 11, 2009, we filed an amendment to our quarterly report on Form 10-Q for the quarter ended March 31, 2009 with the Securities Exchange Commission (the “SEC”) to restate our previously issued financial statements included in the report. In connection with that filing, during the first fiscal quarter of 2010, management reevaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”)). Based on that reevaluation, our chief executive officer, who was then also serving as our interim chief financial officer, and in consultation with our chairman, concluded that our disclosure controls and procedures were not effective as of March 31, 2009 as a result of a number of material weakness in our internal control over financial reporting, all of which, other than as set forth in the following paragraph, were remediated during the fiscal year ended June 30, 2010 and disclosed in our Form 10-K for such period.

There were material operational deficiencies related to the preparation and review of financial information during our quarter end closing process. These items resulted in more than a remote likelihood that a material misstatement or lack of disclosure within our interim financial statements would not be prevented or detected. Our senior financial management lacked the necessary experience and we did not maintain a sufficient number of qualified personnel to support our financial reporting and close process. This reduced the likelihood that such individuals could detect a material adjustment to our books and records or anticipate, identify, and resolve accounting issues in the normal course of performing their assigned functions. This material weakness resulted in adjustments to inventories, accounts payable, accrued royalties, accrued expenses and other current liabilities, due to shareholders, additional paid-in capital, product costs, royalties, sales and marketing and general and administrative expenses in our condensed consolidated financial statements for the three and nine month periods ended March 31, 2009.

Evaluation of Disclosure Controls and Procedures

An evaluation was carried out under the supervision and with the participation of our management, including our chief executive officer and our chief financial officer, and in consultation with our chairman, of the effectiveness of the design and operation of our disclosure controls and procedures, to ensure that the information required to be disclosed by us in this quarterly report was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and Form 10-Q and that such information required to be disclosed was accumulated and communicated to management, including our chief executive officer and our chief financial officer, to allow timely decisions regarding required disclosure. Based upon this reevaluation, our chief executive officer and our chief financial officer, concluded that our disclosure controls and procedures were not effective as of September 30, 2010 as a result of the material weakness in our internal control over financial reporting identified in the paragraph above.

Changes in Internal Control over Financial Reporting

As discussed above, as of September 30, 2010, we had a material weakness in our internal control over financial reporting.

In addition to the remediation measures described below under the heading “Remediation Steps to Address Material Weakness,” we have made the following changes to address the previously reported material weaknesses in internal control over financial reporting and disclosure controls and procedures:

we implemented a closing calendar and consolidation process that includes accrual based financial statements being reviewed by qualified personnel in a timely manner;

we review consolidating financial statements with senior management and the audit committee of the board of directors;

we complete disclosure checklists for both GAAP and SEC required disclosures to ensure disclosures are complete;

we have appointed a chief financial officer with the requisite experience in internal accounting in the videogame industry and made other related personnel changes;

we have enhanced our computer software and internal procedures related to information technology in order to migrate from spreadsheet applications into automated functions within the accounting system;

we have implemented access controls into our financial accounting software;

we have made staff changes so that the accounting persons responsible for the preparation of external reporting, including public filings, are qualified accountants who stay abreast of new requirements through subscriptions and training. New pronouncements are summarized and reported to accounting staff, management and the audit committee as appropriate; and

we continue to communicate and enforce all policies and procedures relating to purchasing for our company.

In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law. This legislation includes an exemption for companies with less than $75 million in market capitalization (non-accelerated filers) to Section 404(b) of the Sarbanes-Oxley Act of 2002, which requires an external auditor’s report on the effectiveness of a registrant’s internal control over financial reporting. The SEC has not published a final rule on this new law. We are in the process of determining the effects, if any, of this new law.

Remediation Steps to Address Material Weakness

During the quarter ended September 30, 2010, we continued to remediate the remaining material weakness in our internal controls over financial reporting by putting in effect further additional controls to restrict access to our automated accounting system and restricting access to our automated accounting system to only those employees under the direct supervision of our Chief Financial Officer.

Management anticipates that the actions described above and the resulting improvements in controls will strengthen its internal control over financial reporting relating to the preparation of the condensed consolidated financial statements. As we improve our internal control over financial reporting and implement remediation measures, we may supplement or modify the remediation measures described above. Management is committed to implementing effective control policies and procedures and will continually update our Audit Committee as to the progress and status of our remediation efforts to ensure that they are adequately implemented.

PART II

Item 1. Legal Proceedings

In September 2010, we instituted summary proceedings in the Lyon France Commercial Court against Nobilis Group in which we have alleged the Licensing and Distribution Agreements for the games we were to obtain and have obtained from Nobilis, including the My Baby games, were wrongfully terminated. In addition, we have claimed that the grant of the rights to My Baby 3 to Majesco were unlawful. We are seeking the reinstatement of the agreements and damages associated with the actions of Nobilis. Following a hearing on October 26, 2010, the court has rendered a temporary summary judgment reinstating the agreement for My Baby First Steps and ordered Nobilis to advise Nintendo to build all products pursuant to the My Baby First Steps contract, which includes the My Baby First Steps game and an additional fourteen games. A further hearing was held on November 9, 2010, in which we sought to affirm the court’s prior judgment reinstating the My Baby First Steps contract as well as to reinstate the My Baby 1 contract. The court has not yet rendered any decision regarding these matters. The parties are in settlement negotiations.

On September 3, 2010, we, Mr. Phillips, our chairman, and Melanie J. Mroz, our CEO, have received Wells Notices from the staff of the SEC (the “Staff”) advising that the staff will recommend that the SEC institute a cease and desist proceeding against us and Ms. Mroz with respect to our alleged violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and certain rules adopted thereunder, and bring a civil injunctive action against Mr. Phillips for abiding and abetting the foregoing violations of our company. In addition, the Staff intends to recommend that, in the civil action, the SEC seek a civil penalty against Mr. Phillips. These alleged violations result from the facts underlying then need to file an amended quarterly report on Form 10-Q for the fiscal quarter ended March 31, 2009.

Other than the foregoing, there have been no material development in any material legal proceedings. From time to time, however, we are named as a defendant in legal actions arising from our normal business activities. Although we cannot accurately predict the amount of our liability, if any, that could arise with respect to legal actions currently pending against us, we do not expect that any such liability will have a material adverse effect on our consolidated financial position, operating results or cash flows. We believe that we have obtained adequate insurance coverage, rights to indemnification, or where appropriate, have established reserves in connection with these legal proceedings.

Item 1A. Risk Factors

“Item 1A. Risk Factors” of our annual report on Form 10-K for the year ended June 30, 2010 includes a discussion of our risk factors. There have been no material changes to risk factors as previously disclosed in our annual report on Form 10-K filed with the Securities and Exchange Commission on October 13, 2010.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. (Removed and Reserved)

Item 5. Other Information

None.

Item 6. Exhibits

Exhibit
Number		Exhibit

3.1(1)		Amended and Restated Certificate of Incorporation.
3.2*		First Certificate of Amendment of Amended and Restated Certificate of Incorporation.
3.3(1)		Amended and Restated Bylaws.
4.1(2)		Form of senior secured convertible note.
4.2(2)		Form of Series A Warrant issued to senior secured convertible note holders.
4.3(2)		Form of Series B Warrant issued to senior secured convertible note holders.
4.4(3)		Form of Additional Notes.
10.1(4)		Factoring Agreement, dated as of July 7, 2010, between SouthPeak Interactive, L.L.C. and Rosenthal & Rosenthal.
10.2(2)		Securities Purchase Agreement, dated July 16, 2010, among the Company and the purchasers named therein.
10.3(2)		Pledge and Security Agreement dated July 16, 2010 securing senior secured convertible notes.
10.4(2)		Registration Rights Agreement, dated July 19, 2010, executed in conjunction with issuance of senior secured convertible notes.
10.5(5)		First Amendment to May 12, 2008 Registration Rights Agreement dated August 17, 2010.
10.6(3)		Amended and Restated Securities Purchase Agreement, dated August 31, 2010, among the Company and the purchasers named therein.
10.7(6)		Master Purchase Order Assignment Agreement, dated September 21, 2010, with Wells Fargo Bank, N.A.
10.8(6)		Security Agreement, dated September 21, 2010, for the benefit of Wells Fargo Bank, N.A.
31.1*		Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.

31.2*		Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Act of 1934, as amended.
32.1*		Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

*	Filed herewith

(1)	Incorporated by reference to an exhibit to the Current Report on Form 8-K of the Registrant filed with the Securities and Exchange Commission on May 15, 2008.

(2)	Incorporated by reference to an exhibit to the Current Report on Form 8-K of the Registrant filed with the Commission on July 22, 2010.

(3)	Incorporated by reference to an exhibit to the Current Report on Form 8-K of the Registrant filed with the Commission on September 3, 2010.

(4)	Incorporated by reference to an exhibit to the Current Report on Form 8-K of the Registrant filed with the Commission on July 14, 2010.

(5)	Incorporated by reference to an exhibit to the Current Report on Form 8-K of the Registrant filed with the Commission on August 20, 2010.

(6)	Incorporated by reference to an exhibit to the Current Report on Form 8-K of the Registrant filed with the Commission on September 27, 2010.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	SOUTHPEAK INTERACTIVE CORPORATION

	By:	/s/ Melanie Mroz
		Melanie Mroz
		President and Chief Executive Officer

		/s/ Reba McDermott
		Reba McDermott
		Chief Financial Officer
		(Principal Accounting Officer)
Date: November 15, 2010

INDEX TO EXHIBITS

Exhibit
Number		Exhibit

3.2		First Certificate of Amendment of Amended and Restated Certificate of Incorporation.
31.1		Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.
31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Act of 1934, as amended.
32.1		Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

SouthPeak Interactive CORP 10-Q