UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549


FORM
10-K


(Mark
One)


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


For
the fiscal year ended December 31, 2009


OR





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


For the Transition Period from                     to





Commission
File No.  333-124829





ZOO
ENTERTAINMENT, INC.


(Exact
name of registrant as specified in its charter)





DELAWARE
                  
                  71-1033391(State
      or other jurisdiction of
                    incorporation
      or organization)
                  
                  (I.R.S.
      Employer
                    Identification
      No.)


3805
Edwards Road, Suite 400


Cincinnati,
Ohio  45209


(Address
of principal executive office)





Registrant’s
telephone number, including area code (513)
824-8297





Securities
registered pursuant to Section 12(b) of the Act: NONE





Securities
registered pursuant to Section 12(g) of the Act:


Common
Stock, Par Value $0.001


(Title of
class)





Indicate
by check mark if the registrant is a well known seasoned issuer, as defined in
Rule 405 of the Securities Act.   Yes oNo þ


Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes oNo þ


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 þNo o


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 oNo o


Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§ 229.405 of this chapter) is not contained herein and, will not
be contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. o


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 o
            
            Accelerated
      filer o
            
            Non-accelerated
      filer   o
              (Do not check if a smaller reporting company)
            Smaller
      reporting company þ


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


The
aggregate market value of the registrant’s voting and non-voting common stock
held by non-affiliates of the registrant (without admitting that any person
whose shares are not included in such calculation is an affiliate) computed by
reference to the price at which the common stock was last sold on the OTC
Bulletin Board on June 30, 2009, the last business day of the registrant’s most
recently completed second fiscal quarter was $17.4 million.


As
of March 30, 2010, the registrant had 2,778,409,829 shares of common stock
outstanding.





TABLE
OF CONTENTS





PagePART
      IItem
      1. Business
                  1Item
      1A. Risk Factors
                  8Item
      1B. Unresolved Staff Comments
                  22Item
      2. Properties
                  22Item
      3. Legal Proceedings
                  23Item
      4. (Removed and Reserved)
                  23PART
      IIItem
      5. Market For Registrant’s Common Equity, Related Stockholder Matters and
      Issuer Purchases of Equity Securities
                  23Item
      6. Selected Financial Data
                  25Item
      7. Management’s Discussion and Analysis of Financial Condition and Results
      of Operations
                  25Item
      7A. Quantitative and Qualitative Disclosures About Market
    Risk
                  41Item
      8. Financial Statements and Supplementary Data
                  41Item
      9. Changes in and Disagreements with Accountants on Accounting and
      Financial Disclosure
                  41Item
      9A(T). Controls and Procedures
                  42Item
      9B. Other Information
                  43PART
      IIIItem
      10. Directors, Executive Officers and Corporate Governance
                  44Item
      11. Executive Compensation
                  48Item
      12. Security Ownership of Certain Beneficial Owners and Management and
      Related Stockholder Matters
                  51Item
      13. Certain Relationships and Related Transactions and Director
      Independence
                  54Item
      14. Principal Accountant Fees and Services
                  59PART
      IVItem
      15. Exhibits, Financial Statement Schedules
                  60





Safe
Harbor Statement under the Private Securities Litigation Reform Act of 1995





Information
included in this Annual Report on Form 10-K may contain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended (the “Securities Act”), and Section 21E of the Securities Exchange Act
of 1934, as amended (the “Exchange Act”). All statements, other than statements
of historical facts included in this Annual Report on Form 10-K regarding our
strategy, future operations, future financial position, projected expenses,
prospects and plans and objectives of management are forward-looking statements.
These statements may involve known and unknown risks, uncertainties and other
factors which may cause our actual results, performance or achievements to be
materially different from our future results, performance or achievements
expressed or implied by any forward-looking statements. Forward-looking
statements, which involve assumptions and describe our future plans, strategies
and expectations, are generally identifiable by use of the words “may,” “will,”
“should,” “expect,” “anticipate,” “estimate,” “believe,” “intend” or “project”
or the negative of these words or other variations on these words or comparable
terminology. Forward-looking statements are based on assumptions that may be
incorrect, and there can be no assurance that any projections or other
expectations included in any forward-looking statements will come to pass. Our
actual results could differ materially from those expressed or implied by the
forward-looking statements as a result of various factors, including the risk
factors described in greater detail in the section entitled “Risk Factors.”
Except as required by applicable laws, we undertake no obligation to update
publicly any forward-looking statements for any reason, even if new information
becomes available or other events occur in the future.





PART I





Item 1. 
Business.





In this
section, unless the context otherwise indicates, references to “we,” “us,”
“our,” “ours,” and “the Company” refer to Zoo Entertainment, Inc. (formerly
known as Driftwood Ventures, Inc.) and its operating and wholly-owned
subsidiary, Zoo Games, Inc. (formerly known as Green Screen Interactive
Software, Inc.) and its operating and wholly-owned subsidiary, Zoo Publishing,
Inc. (formerly known as Destination Software, Inc.).




Company
History





Zoo
Entertainment, Inc. (“Zoo” or the “Company”) was originally incorporated in the
State of Nevada on February 13, 2003 under the name Driftwood Ventures,
Inc.  On December 20, 2007, through a merger, the Company reincorporated in
the State of Delaware as a public shell company with no operations.




On
September 12, 2008, our wholly-owned subsidiary, DFTW Merger Sub, Inc., merged
with and into Zoo Games, Inc. (“Zoo Games”), with Zoo Games being the surviving
corporation, through an exchange of common stock of Zoo Games for common stock
of the Company.  Effective as of the closing of the merger, Zoo Games
became our wholly-owned subsidiary.  As a result thereof, the historical
and current business operations of Zoo Games now comprise the Company’s
principal business operations.


On
December 3, 2008, the Company changed its name to “Zoo Entertainment,
Inc.”




Zoo Games
commenced operations in March 2007 as Green Screen Interactive Software, LLC, a
Delaware limited liability company, and in May 2008, converted to a Delaware
corporation. On August 14, 2008, it changed its name to Zoo Games, Inc. Since
its initial organization and financing, Zoo Games embarked on a strategy of
partnering with and acquiring companies with compelling intellectual property,
distribution capabilities, and management with demonstrated records of
success.




In June
2007, Zoo Games acquired the assets of Supervillain Studios, Inc. which were
held by a wholly-owned subsidiary of Zoo Games, Supervillain Studios, LLC
(“Supervillain”).  The acquisition provided Zoo Games with access to
proprietary high end casual gaming content, established video game designers,
technical experts and producers capable of providing Zoo Games with high
quality, original casual games. On July 22, 2008, Zoo Games released Order Up!,
its first offering from Supervillain.   In our effort to refocus our
cash on our core business, we sold Supervillain back to its original owners on
September 16, 2008.


1




In
December 2007, Zoo Games acquired the capital stock of Destination Software,
Inc. (now known as Zoo Publishing, Inc., “Zoo Publishing”). The acquisition of
Zoo Publishing provided Zoo Games with a core business, North American
distribution, and further enhanced its experienced management team. Zoo
Publishing distributes software titles throughout North America and generated
over $30 million in annual revenue in 2007. Zoo Publishing expects to exploit
its development expertise, in combination with its sales, marketing and
licensing expertise, to target the rapidly expanding market for casual games,
particularly on Nintendo’s platforms, where Zoo Publishing has experienced
considerable success. By nurturing and growing this business unit, Zoo Games
believes it will be able to rapidly build a much larger distribution network,
enabling it to place a significant number of software titles with major
retailers.




In April
2008, Zoo Games acquired the capital stock of Zoo Digital Publishing Limited
(“Zoo Digital”), a business operated in the United Kingdom. This acquisition
provided Zoo Games with a profitable core business in the United Kingdom,
European distribution, and further enhanced its experienced management team. Zoo
Digital distributes software titles throughout Europe and generated over
$6.8 million in annual revenue in 2007.  In our effort to refocus our cash
on our core business operations, Zoo Publishing, we sold Zoo Digital back to its
original owners on November 28, 2008.





In June
2009, we formed a new company in the United Kingdom that is a wholly-owned
subsidiary of Zoo Games called Zoo Entertainment Europe Ltd. (“Zoo Europe”), to
focus on the sales and distribution of our products in Europe. In our effort to
refocus our cash on our core business operations, we decided to discontinue
operations of Zoo Europe effective December 2009.




Our
principal executive offices are located at 3805 Edwards Road, Suite 400
Cincinnati, OH 45209 and our telephone number is (513) 824-8297. Our web site
address is www.zoogamesinc.com.





Overview




We are a
developer, publisher and distributor of video game software for use on major
platforms including Nintendo’s Wii, DS, GBA, Sony’s PSP, PlayStation 2 and
iPhone.  We are also a distributor of video game software for use on
Microsoft’s Xbox 360.   In addition, we intend to publish packaged
entertainment software titles for use on a variety of other gaming platforms
including Sony’s PlayStation 3. We will also seek to create and sell
downloadable games for Microsoft’s Xbox Live Arcade, Sony’s PlayStation Network,
Nintendo’s Virtual Console, and for use on personal computers
(PCs).




Our
current video game titles are targeted at various demographics but primarily at
the lower-priced “value” market. In some instances, these titles are based on
licenses of well-known properties and, in other cases based on original
properties. We collaborate and enter into agreements with content providers and
video game development studios for the creation of our video games.





We also
operate a site called 2beegames.com which can be found at www.2beegames.com.  We hold contests for independent developers whereby they can
enter their games to win monetary prizes and potential publishing arrangements
with us.  This site allows us to attract fresh intellectual property, lower
production costs, decrease time to market, and improve margins.





Industry
Overview




The
interactive entertainment industry is mainly comprised of video game hardware
platforms, video game software and peripherals. Within this industry, combined
sales of video game hardware, video game software and video game peripherals in
the United States totaled $19.66 billion in 2009 according to the NPD Group, a
retail market research firm. Of that total, hardware sales reached $7.3 billion,
software sales totaled $10.5 billion, and peripheral accessory sales summed $1.8
billion. The industry, which started in the 1970’s and 80’s with titles such as
Pong and Pac-Man, continues to expand at a rapid pace.  Even in difficult
economic times, the video game industry finished strongly in 2009.  The NPD
Group reports industry sales in the U.S. were $5.53 billion for the month of
December 2009, up 5% from the month of December 2008.  This was driven
primarily by $2.19 billion in hardware sales and software sales totaling $2.58
billion for the month of December 2009.  65% of all Americans claim to play
PC and video games. The average video game player is 32 years old and has been
playing for nearly 12 years.


2





The
introductions of new gaming platforms such as the PS3, Xbox 360, Wii, and the
Internet have created additional opportunities for overall market growth.
Throughout the world, consumers are spending significant time and money playing
video games that range from the traditional console titles, to “massively
multiplayer” online role-playing games (MMOs), to hand-held cell phone games.
The online gaming experience has expanded both the audience and the revenue
opportunities for games - offering at one end of the spectrum new types of games
for more casual gamers - and, at the other end, large-scale subscription
multi-player experiences for more sophisticated gamers. The online games
business was projected by PricewaterhouseCoopers to almost double from worldwide
revenues of $5.2 billion in 2005 to $9.8 billion in 2009. Gaming on mobile
phones, still relatively new, is anticipated to hit $10 billion in 2009.
PricewaterhouseCoopers projects the total worldwide gaming market to approach
$49 billion by 2011.





The
interactive entertainment software market is composed of two primary markets.
The first is the console systems market, which is comprised of software created
for dedicated game consoles that use a television as a display. The most
recently released console systems include Sony’s PS3, Microsoft’s Xbox360, and
Nintendo’s Wii. The second primary market is software created for use on
personal computers (PCs). In addition to these primary markets, additional
viable markets exist for the Internet, mobile/handheld systems (mobile phones,
Sony PSP, Nintendo DS, Nintendo DSi) and for interactive play on home DVD
machines.





The
overall growth trends within the interactive entertainment software industry are
strong. The content is becoming more broadly appealing, allowing the industry to
continue to capture the younger consumer while retaining the older player with
content that is more relevant to them. In addition, we believe that the global
popularity of video games coupled with the growing base of available markets
will continue to permit publishers to substantially grow revenues and profits
for the foreseeable future.





Interactive
Entertainment Software Markets:





Console Systems: The console systems market is currently dominated by three major
platforms: Microsoft’s Xbox 360, Sony’s PlayStation 3 and Nintendo’s Wii. These
systems are now installed on an aggregate worldwide basis in well over 100
million households. The console market is characterized by generational
transitions in the hardware (i.e., Sony’s PlayStation 2 to PlayStation
3), which traditionally have been times of adaptation for existing
publishers and times of opportunity for emerging publishers.





With the
launch of the Xbox 360 platform in late 2005, and the 2007 launches of Sony’s
PS3 and Nintendo’s Wii, the next console transition is in full force. 
Cumulative worldwide sales for the Nintendo Wii reached 50 million units in
March 2009, making this the fastest-selling games console in history, surpassing
Sony’s Playstation 2.  Sales for all three major consoles have continued to
be very strong.  As of February 2010, Nintendo Wii, Xbox 360, and Sony’s
PlayStation 3 have reached worldwide cumulative sales of over 68 million, 38
million, and 32 million units respectively.  Improvements on
next-generation peripherals such as the Wii Balance Board or the Playstation 3
Eyetoy have also contributed to increased sales in the total industry.  In
2010, two highly anticipated peripherals will be hitting the market—Microsoft’s
Project Natal and Sony’s Playstation Move.  These additions to
the next-gen consoles will push both hardware and software sales through the
2010 holiday season, and allow for unprecedented creative and market
opportunities with software developers and publishers. We believe that video
game publishers will be able to generate increased margins as the installed base
of Xbox 360, PS3 and Wii achieves critical mass.


3


PC Systems: The Gartner Group, a market research firm, estimates that by the end of
2012 nearly 77% of US households will have at least one broadband connected
computer. The increase in PC ownership appears to be spurred by lower-cost
Pentium-based processing systems, which incorporate higher-speed CD-ROM or DVD
drives, modems and increasingly sophisticated graphics capabilities, and by the
continued growth and interest in the Internet.  PC games are also becoming
more accessible for players due to websites such as Steam.  Steam allows
developers and publishers to post downloadable games in which consumers can
purchase and download directly through the site in an efficient manner. Revenue
from PC games in 2009 reached $13.1 billion (up 3% from 2008) according to
the PC Gaming Alliance's 2009 Horizons Report.  This total not only
includes retail sales but also online ads and digital distribution. 
The survey also finds that over 70% of PC Gamers in North America
and Europe have purchased a full game online, and over 50% say they
have purchased a virtual item.





Mobile/Handheld
Systems: With more than five million units sold worldwide within months
of launch, the Sony PSP and Nintendo DS demonstrated the vitality of the
handheld games business, previously dominated by Nintendo’s Gameboy product
line.  The Nintendo DS has been the most successful handheld gaming console
in the marketplace, selling over 127 million units worldwide as of February
2010.  As of November 26, 2008, 396 titles have released for Sony PSP with
an average of 133,000 units sold per title, while 653 titles have released for
Nintendo DS with an average of 163,000 units sold per title, as reported in
NPD Data.  This success has fueled Nintendo to release a new handheld
platform, the DSi along with DS 3D.  The portable gaming system sold two
million units in Japan during the first five months of availability.  The
U.S. launch was April 5, 2009.  According to Nintendo, 6.16 million
Nintendo DSi units were sold in the US in 2009, bringing the worldwide sales to
16.43 million units through December 2009.  The Sony PSP has seen strong
sales numbers as well, reaching sales of over 56 million units worldwide as of
February 2010.  The market for “portable” games has been substantially
enhanced by the rise of more powerful mobile phones (i.e. Apple’s iPhone) and
the increased bandwidth of mobile networks (i.e. the 3G & 4G
Networks).  The Apple
iPhone has not only revolutionized portable gaming, but it has also dominated
the market. According to a July 2009 report from FADE LLC, the iPhone gaming
market controls $250 million in revenue since its launch in July of 2008, making
it larger than any console’s digital game service (XBLA, PSN,
WiiWare/VC).




Internet:
The next generation of hardware is resulting in a significantly higher
percentage of consoles connected to the Internet. Publishers will be able to
generate new revenue streams from the sale of downloadable games and from
subscription revenues for participation in MMOs and other micro-transaction
based games. Using systems such as Xbox Live Arcade and PS3 Network (Home),
publishers now have the ability to distribute downloadable products over the
Internet. In addition, the MMO genre continues on its high growth path, with
revenue expected to grow over 150% from 2006 through 2011 according to DFC
Intelligence, a market research firm.  Social
gaming has become a more recent phenomena. Social games are generally casual yet
structured online games through which users can engage with one another. In
February 2010, Information Services Group (ISG) released survey results on U.S.
and U.K. online social gaming. According to the survey, one hundred million
people are playing social games online. Facebook is the most popular destination
for online games, with 83% of respondents saying they have played games there.
ISG also finds that social games are quite the lucrative business. Twenty-eight
percent have purchased in-game currency with real-world money, and social games
are expected to generate $1 billion in revenue this year.




In-Game
Advertising Revenues: In-game advertising revenue is expected to be an
additional area of growth with the widespread adoption of the new console
systems. Advertisers have become aware of the increasing popularity of video
games as they look to expand into alternative platforms. According to analysts
at CitiGroup, the in-game advertising market should reach $1.0 billion in
revenue by 2014, marking a 40% growth from an expected $600 million in revenue
in 2009. PricewaterhouseCoopers estimates in-game advertising revenue to reach
$1.4 billion by 2013.




We
believe the outlook for the various gaming market segments is very strong,
growing rapidly, and accessible to us.




Products




We are a
developer, publisher and distributor of casual gaming software for use on major
platforms including Nintendo’s Wii, DS, GBA Sony’s PSP and PlayStation 2 and
PCs, X-Box 360, and iPhone.




In 2009,
we released the following games:




On the Nintendo Wii
Platform:





ARCADE
SHOOTING GALLERY


ATV QUAD
KINGS


BIGFOOT
COLLISION COURSE


BUILD N
RACE


CHICKEN
BLASTER


CHRYSLER
CLASSIC RACING


COLDSTONE
SCOOP IT UP


4





DEAL OR
NO DEAL


DEER
DRIVE


DODGE
RACING


DREAM
DANCE & CHEER


GLACIER
2


GROOVIN
BLOCKS


JELLY
BELLY BALLISTIC BEAN


M&M'S
BEACH PARTY


MONSTER
TRUCK MAYHEM


PACIFIC
LIBERATOR


PUZZLE
KINGDOMS


SMILEY
WORLD ISLAND CHALLENGE


ULTIMATE
DUCK HUNTING


YAMAHA
SUPERCROSS





On the Nintendo
Wii Platform
with Peripherals:





CHICKEN
BLASTER WITH GUN


CHICKEN
SHOOT WITH GUN


DEER
DRIVE W ITH GUN


ULTIMATE 
DUCK HUNTING WITH GUN





On the Nintendo DS
Platform:





ANIMAL
PARADISE WILD


BIGFOOT
COLLISION COURSE


CHICKEN
BLASTER


DINER
DASH: FLO ON THE GO


DODGE
RACING


DREAM
DANCER


DREAM
SALON


GARFIELD
GETS REAL


HELLO
KITTY BIG CITY DREAMS


HISTORY
CHANNEL GREAT EMPIRE


JELLY
BELLY BALLISTIC BEAN


MARGOTS
BEPUZZLED


PUZZLE
KINGDOMS


SMILEY
WORLD ISLAND CHALLENGE


WEDDING
DASH


YAMAHA
SUPER CROSS RACING





On the Sony PS2
Platform:





SUZUKI TT
SUPERBIKES 2





On the Microsoft Xbox
Platform:





RAIDEN
FIGHTER ACES


SKI DOO
SNOWMOBILE CHALLENGE


5


Product
Development





We use
third party development studios to create our video game products. We carefully
select third parties to develop video games based on their capabilities,
suitability, availability and cost. We usually have broad rights to commercially
utilize products created by the third party developers we work with. Development
contracts are structured to provide developers with incentives to provide timely
and satisfactory performance by associating payments with the achievement of
substantive development milestones, and sometimes by providing for the payment
of royalties to them based on sales of the developed product, only after we
recoup development costs.




Customers




Our
customers are comprised of national and regional retailers, specialty retailers
and video game rental outlets. We believe we have developed close relationships
with a number of retailers, including GameStop, Kmart and Target.  We also
have strong relationships with Atari, Jack of All Games (“JOAG”). Cokem and
Filpoint SVG, who act as resellers of our products to smaller retail outlets and
provide program buying for Wal-Mart, Best Buy and other larger customers. For
the year ended December 31, 2009, our most significant customers were Cokem,
JOAG (via Atari) and GamesSop, which accounted for approximately 29%, 21%
and 11% of our net revenue, respectively.  For the fiscal year ended 2008,
our most significant customers were JOAG and Cokem, which accounted for
approximately 30% and 14% of our net revenue, respectively.




Competition




The
interactive entertainment software industry is highly competitive. It is
characterized by the continuous introduction of new titles and the development
of new technologies. Our competitors vary in size from very small companies with
limited resources to very large corporations with greater financial, marketing
and product development resources than us.




The
principal factors of competition in our industry are:





•
            the
      ability to select and develop popular
titles;





•
            the
      ability to identify and obtain rights to commercially marketable
      intellectual properties; and





•
            the
      ability to adapt products for use with new
  technologies.





Successful
competition in our industry is also based on price, access to retail shelf
space, product quality, product enhancements, brand recognition, marketing
support and access to distribution channels.




We
compete with Microsoft, Nintendo and Sony, which publish software for their
respective systems. We also compete with numerous companies licensed by the
platform manufacturers to develop or publish software products for use with
their respective systems. These competitors include Activision Blizzard, Inc.,
Atari, Inc., Capcom Interactive, Inc., Electronic Arts, Inc., Konami,
Corp., Majesco Entertainment Company, Namco Networks America, Inc.,
SCi Entertainment Group PLC, Sega Corporation, Take-Two Interactive
Software, Inc., THQ, Inc., Ubisoft Entertainment and Vivendi Universal Games,
among others. We will face additional competition from the entry of new
companies into the video game market, including large diversified entertainment
companies as well as other independent publishing companies.




Many of
our competitors have significantly greater financial, marketing and product
development resources than we do. As a result, current and future competitors
may be able to:





•
            respond more quickly to new or
      emerging technologies or changes in customer
      preferences;


6





•
            undertake more extensive
      marketing campaigns;





•
            adopt more aggressive pricing
      policies;





•
            devote greater resources to
      secure rights to valuable licenses and relationships with leading software
      developers;





•
            gain access to wider distribution
      channels; and





•
            have better access to prime shelf
      space.





There is
also intense competition for shelf space among video game developers and
publishers, all of whom have greater brand name recognition, significantly more
titles and greater leverage with retailers and distributors than we do. In
addition, regardless of our competitors’ financial resources or size, our
success depends on our ability to successfully execute our competitive
strategies.





We
believe that large diversified entertainment, cable and telecommunications
companies, in addition to large software companies, are increasing their focus
on the interactive entertainment software market, which will likely result in
consolidation and greater competition.




We also
compete with providers of alternative forms of entertainment, such as providers
of non-interactive entertainment, including movies, television and music, and
sporting goods providers. If the relative popularity of video games were to
decline, our revenues, results of operations and financial condition likely
would be harmed.




These
competitive factors may result in price reductions, reduced gross margins and
loss of market share, and may have a material adverse effect on our
business.




Intellectual
Property




Platform
Licenses:




Hardware
platform manufacturers require that publishers and developers obtain licenses
from them to develop and publish titles for their platforms. We currently have
licenses from Sony to develop and publish products for PlayStation, PlayStation
2, Playstation 3, PSP Go and PSP, and from Nintendo to develop products for the
GBA, GameCube, DS, Wii, Dsi, Steam, PSN, Wii Ware, DSi Ware and Micro.
 We are also licensed by Apple to produce applications on iPhone. 
These licenses are non-exclusive and must be periodically renewed.  These
companies generally have approval over games for their platforms, on a
title-by-title basis, at their discretion.




Licenses from Third
Parties:




While we
develop and publish original titles, many of our titles are based on rights,
licenses, and properties, including copyrights and trademarks, owned by third
parties.  In addition, original titles many times include third party
licensed materials such as software and music.  License agreements with
third parties have variable terms and are terminable on a variety of
events.  Licensors often have fairly strict approval rights.  We are
often required to make minimum guaranteed royalty payments over the term of such
licenses, including advance payments against these guarantees.


7


Trademarks,
Trade Names and Copyrights:




Zoo Games
and its subsidiaries have used and applied to register certain trademarks to
distinguish our products from those of our competitors in the United States
and in foreign countries. Zoo Games and its subsidiaries are also licensed to
use certain trademarks, copyrights and technologies.  We believe that these
trademarks, copyrights and technologies are important to our business. The loss
of some of our intellectual property rights might have a negative impact on our
financial results and operations.




Seasonality




The
interactive entertainment business is highly seasonal, with sales typically
higher during the peak holiday selling season during the fourth quarter of the
calendar year. Traditionally, the majority of our sales for this key selling
period ship in our fiscal fourth quarter, which ends on December 31.
Significant working capital is required to finance the manufacturing of
inventory of products that ship during this quarter.




Manufacturing




Sony,
Nintendo and Microsoft control the manufacturing of our products that are
compatible with their respective video game consoles and ship
the products to us for distribution. Video games for Microsoft, Nintendo
and Sony game consoles consist of proprietary format CD-ROMs or DVD-ROMs and are
typically delivered to us within the relatively short lead time of
approximately two to three weeks. Sony PSP products adhere to a similar
production time frame, but use a proprietary media format called a Universal
Media Disc, or UMD.




With
respect to DS products, which use a cartridge format, Nintendo typically
delivers these products to us within 30 to 40 days after receipt of a
purchase order.




Initial
production quantities of individual titles are based upon estimated retail
orders and consumer demand. At the time a product is approved for manufacturing,
we must generally provide the platform manufacturer with a purchase order for
that product, and either cash in advance or an irrevocable letter of credit
for the entire purchase price. To date, we have not experienced any
material difficulties or delays in the manufacture and assembly of our products.
However, manufacturers’ difficulties, which are beyond our control, could impair
our ability to bring products to the marketplace in a timely
manner.




Employees




As of
March 15, 2010, we had twenty-nine (29) full-time employees and one (1)
part-time employee; of our employees, six (6) are in product
development, nineteen (19) are in selling, general and administrative
functions, and four (4) full-time employees and one (1) part-time employee
are located at a third-party warehouse. None of our employees are represented by
a labor union or are parties to a collective bargaining agreement, and we
believe our relationship with our employees is good.




Item 1A.
Risk Factors.




You
should carefully consider each of the risks described below and other
information contained in this Annual Report on Form 10-K, including our
consolidated financial statements and the related notes and those of our
predecessor companies. The following risks and the risks described elsewhere in
this Annual Report on Form 10-K, including in the section entitled “Management’s
Discussion and Analysis of Financial Condition and Results of Operation,” could
materially affect our business, prospects, financial condition, operating
results or cash flow. Additional risks and uncertainties not currently known to
us or that we currently deem immaterial may also adversely affect our business.
If any of these risks materialize, the trading price of our common stock could
decline.


8




Risks
Related to Our Business




We have experienced operating losses
since our inception, and may incur future losses.




We have
incurred start-up costs, restructuring costs, impairment of goodwill and other
intangible assets, and losses from discontinued operations during the past two
and a half years. Through December 31, 2009, we have cumulative losses of
approximately $45.1 million. If we do become profitable, we may not be able to
sustain our profitability. Continued losses or an inability to sustain
profitability may have an adverse effect on our future operating
prospects.





Our
business activities may require additional financing that might not be
obtainable on acceptable terms, if at all, which could have a material adverse
effect on our financial condition, liquidity and our ability to operate going
forward.




Although
there can be no assurance, our management believes that based on our current
plan there are sufficient capital resources from operations, including our
factoring and purchase order financing arrangements, to finance our immediate
operational requirements. We may need to raise additional capital or incur debt
to strengthen our cash position, facilitate expansion, pursue strategic
investments or to take advantage of business opportunities as they arise.




Failure
to obtain financing or obtaining financing on unfavorable terms could result in
a decrease in our stock price and could have a material adverse effect on our
financial condition, and could require us to significantly reduce
operations.




If our products fail to gain market
acceptance, we may not have sufficient revenues to pay our expenses and to
develop a continuous stream of new games.




Our
success depends on generating revenues from existing and new products. The
market for video game products is subject to continually changing consumer
preferences and the frequent introduction of new products. As a result, video
game products typically have short market lives spanning only three to
twelve months. Our products may not achieve and sustain market acceptance
sufficient to generate revenues to cover our costs and allow us to become
profitable. If our products fail to gain market acceptance, we may not have
sufficient revenues to develop a continuous stream of new games, which we
believe is essential to covering costs and achieving future
profitability.




Product development schedules are
long and frequently unpredictable, and we may experience delays in
introducing products, which may adversely affect our revenues.




The
development cycle for certain of our products can exceed one year. In addition,
the creative process inherent in video game development makes the length of the
development cycle difficult to predict, especially in connection with products
for a new hardware platform involving new technologies. As a result, we may
experience delays in product introductions. If an unanticipated delay affects
the release of a video game we may not achieve anticipated revenues for that
game, for example, if the game is delayed until after an important selling
season or after market interest in the subject matter of the game has begun to
decline. A delay in introducing a video game could also require us to spend more
development resources to complete the game, which would increase costs and lower
margins, and could affect the development schedule for future
products.


9


The
global economic downturn could result in a reduced demand for our products and
increased volatility in our stock price.





Current
uncertainty in global economic conditions pose a risk to the overall economy as
consumers and retailers may defer or choose not to make purchases in response to
tighter credit and negative financial news, which could negatively affect demand
for our products. Additionally, due to the weak economic conditions and
tightened credit environment, some of our retailers and distributors may not
have the same purchasing power, leading to lower purchases of our games for
placement into distribution channels. Consequently, demand for our products
could be materially different from expectations, which could negatively affect
our profitability and cause our stock price to decline.





Ourmarket is subject to rapid
technological change, and if we do not adapt to, and appropriately allocate our
resources among, emerging technologies, our revenues will be negatively
affected.




Technology
changes rapidly in the interactive entertainment industry. We must continually
anticipate and adapt our products to emerging technologies. When we choose to
incorporate a new technology into a product or to develop a product for a new
platform, operating system or media format, we will likely be required to
make a substantial investment one to two years prior to the introduction of the
product. If we invest in the development of video games incorporating a new
technology or for a new platform that does not achieve significant commercial
success, our revenues from those products likely will be lower than we
anticipated and may not cover our development costs. If, on the other hand, we
elect not to pursue the development of products incorporating a new technology
or for new platforms that achieve significant commercial success, our
potential revenues would also be adversely affected, and it may take significant
time and resources to shift product development resources to that technology or
platform. Any such failure to adapt to, and appropriately allocate resources
among, emerging technologies would harm our competitive position, reduce our
market share and significantly increase the time we take to bring popular
products to market.




Customer accommodations could
materially and adversely affect our business,results of operations, financial
condition, and liquidity.





When
demand for our product offerings falls below expectations, we may negotiate
accommodations to retailers or distributors in order to maintain our
relationships with our customers and access to our sales channels. These
accommodations include negotiation of price discounts and credits against future
orders commonly referred to as price protection. At the time of product
shipment, we establish reserves for price protection and other similar
allowances. These reserves are established according to our estimates of the
potential for markdown allowances based upon our historical rates, expected
sales, retailer inventories of products and other factors. We cannot predict
with certainty whether existing reserves will be sufficient to offset any
accommodations we will provide, nor can we predict the amount or nature of
accommodations that we will provide in the future. If actual accommodations
exceed our reserves, our earnings would be reduced, possibly materially. Any
such reduction may have an adverse effect on our business, financial condition
or results of operations. The granting of price protection and other allowances
reduces our ability to collect receivables and impacts our availability for
advances from our factoring arrangement. The continued granting of substantial
price protection and other allowances may require additional funding sources to
fund operations, but there can be no assurance that such funds will be available
to us on acceptable terms, if at all.




Significant
competition in our industry could adversely affect our business.




The
interactive entertainment software industry is highly competitive. It is
characterized by the continuous introduction of new titles and the development
of new technologies. Our competitors vary in size from very small companies with
limited resources to very large corporations with greater financial, marketing
and product development resources than us.




Many of
our competitors have significantly greater financial, marketing and product
development resources than we do. As a result, current and future competitors
may be able to:


10





·
            respond more quickly to new or
      emerging technologies or changes in customer
      preferences;





·
            undertake more
      extensive marketing
      campaigns;





·
            adopt more aggressive pricing
      policies;





·
            devote greater resources to
      secure rights to valuable licenses and relationships with leading software
      developers;





·
            gain access to wider distribution
      channels; and





·
            have better access to prime shelf
      space.





If we are
unable to compete successfully, we could lose sales, market share, opportunities
to license marketable intellectual property and access to next-generation
platform technology. We also could experience difficulty hiring and retaining
qualified software developers and other employees. Any of these consequences
would significantly harm our business, results of operations and financial
condition.





If game platform manufacturers refuse
to license their platforms to us ordo not manufacture our games on a
timely basis or at all, our revenues would be adversely affected.




We intend
to sell our products for use on proprietary game platforms manufactured by other
companies, including Microsoft, Nintendo and Sony. These companies can
significantly affect our business because:





·
            we may only publish their games
      for play on their game platforms if we receive a platform license from
      them, which is renewable at their
  discretion;





·
            we must obtain their prior review
      and approval to publish games on their
  platforms;





·
            if the popularity of a game platform declines
      or, if the manufacturer stops manufacturing a platform, does not meet the
      demand for a platform or delays the introduction of a platform in a region
      important to us, the games that we have published and that we are
      developing for that platform would
      likely produce lower sales than we
  anticipate;





·
            these manufacturers control the
      manufacture of, or approval to manufacture, and manufacturing costs of our
      game discs and cartridges;





·
            these manufacturers have the
      exclusive right to (1) protect the intellectual property rights to
      their respective hardware platforms and technology
      and (2) discourage others from producing unauthorized software for
      their platforms that compete with our games;
  and





·
            the manufacturing times,
      particularly in the fourth quarter, can be quite long. We may be unable to
      manufacture our
      products in a timely manner, if at all, to meet holiday or other
      demands.





We
currently have licenses from Sony to develop products for PlayStation,
PlayStation 2 and PSP, and from Nintendo to develop products for the GBA, the DS
and Wii. These licenses are non-exclusive, and as a result, many of our
competitors also have licenses to develop and distribute video game software for
these systems. These licenses must be periodically renewed, and if they are not,
or if any of our licenses are terminated or adversely modified, we may not be
able to publish games for such platforms or we may be required to do so on less
attractive terms. In addition, the interactive entertainment software products
that we intend to develop for platforms offered by Nintendo or Sony generally
are manufactured exclusively by that platform manufacturer or its approved
replicator. These manufacturers generally have approval and other rights that
will provide them with substantial influence over our costs and the release
schedule of such products. Each of these manufacturers is also a publisher of
games for its own hardware platform. A manufacturer may give priority to its own
products or those of our competitors, especially if their products compete with
our products. Any unanticipated delays in the release of our products or
increase in our development, manufacturing, marketing or distribution costs as a
result of actions by these manufacturers would significantly harm our business,
results of operations and financial condition.


11




Failure
to renew our existing brand and content licenses on favorable terms or at all
and to obtain additional licenses would impair our ability to introduce new
products and services or to continue to offer our products and services based on
third-party content.





Some of
our revenues are derived from our products and services based on or
incorporating brands or other intellectual property licensed from third parties.
Any of our licensors could decide not to renew our existing license or not to
license additional intellectual property and instead license to our competitors
or develop and publish its own products or other applications, competing with us
in the marketplace. Several of these licensors already provide intellectual
property for other platforms, and may have significant experience and
development resources available to them should they decide to compete with us
rather than license to us. In the past, competitors have successfully outbid us
for licenses that we previously held.




We have
both exclusive and non-exclusive license arrangements and both licenses that are
global and licenses that are limited to specific geographies. Our licenses
generally have terms that range from two to five years. We may be unable to
renew these licenses or to renew them on terms favorable to us, and we may be
unable to secure alternatives in a timely manner. Failure to maintain or renew
our existing licenses or to obtain additional licenses would impair our ability
to introduce new products and services or to continue to offer our current
products or services, which would materially harm our business, operating
results and financial condition. Some of our existing licenses impose, and
licenses that we obtain in the future might impose, development, distribution
and marketing obligations on us. If we breach our obligations, our licensors
might have the right to terminate the license which would harm our business,
operating results and financial condition.





Even if
we are successful in gaining new licenses or extending existing licenses, we may
fail to anticipate the entertainment preferences of our end users when making
choices about which brands or other content to license. If the entertainment
preferences of end users shift to content or brands owned or developed by
companies with which we do not have relationships, we may be unable to establish
and maintain successful relationships with these developers and owners, which
would materially harm our business, operating results and financial condition.
In addition, some rights are licensed from licensors that have or may develop
financial difficulties, and may enter into bankruptcy protection under U.S.
federal law or the laws of other countries. If any of our licensors files for
bankruptcy, our licenses might be impaired or voided, which could materially
harm our business, operating results and financial condition.




Rating systems for interactive
entertainment software, potential legislation and vendor or consumer opposition
could inhibit sales of our products.




Trade
organizations within the video game industry require digital entertainment
software publishers to provide consumers with information relating to graphic
violence, profanity or sexually explicit material contained in software titles,
and impose penalties for noncompliance. Certain countries have also established
similar rating systems as prerequisites for sales of digital entertainment
software in their countries. In some instances, we may be required to modify our
products to comply with the requirements of these rating systems, which
could delay the release of those products in these countries. We believe that we
comply with such rating systems and properly display the ratings and content
descriptions received for our titles. Several proposals have been made for
legislation to regulate the digital entertainment software, broadcasting and
recording industries, including a proposal to adopt a common rating system for
digital entertainment software, television and music containing violence or
sexually explicit material, and the Federal Trade Commission has issued reports
with respect to the marketing of such material to minors. Consumer advocacy
groups have also opposed sales of digital entertainment software containing
graphic violence or sexually explicit material by pressing for legislation in
these areas, including legislation prohibiting the sale of certain ‘‘M’’ rated
video games to minors, and by engaging in public demonstrations and media
campaigns. Retailers may decline to sell digital entertainment software
containing graphic violence or sexually explicit material, which may limit the
potential market for our ‘‘M’’ rated products, and adversely affect our
operating results. If any groups, whether governmental entities, hardware
manufacturers or advocacy groups, were to target our ‘‘M’’ rated titles, we
might be required to significantly change or discontinue a particular title,
which could adversely affect our business.


12




We could
also experience delays in obtaining ratings which would adversely impact our
ability to manufacture products.




We are dependent on third parties to
manufacture our products, and any delay or interruption in production would
negatively affect both our ability to make timely product introductions and our
results of operations.




All of
our products are manufactured by third parties who set the manufacturing prices
for those products. Therefore, we depend on these manufacturers, including
platform manufacturers, to fill our orders on a timely basis and to manufacture
our products at an acceptable cost. If we experience manufacturing delays or
interruptions, it would harm our business and results of
operations.





We
may be unable to develop and publish new products if we are unable to secure or
maintain relationships with third party video game software
developers.





We
utilize the services of independent software developers to develop our video
games. Consequently, our success in the video game market depends on our
continued ability to obtain or renew product development agreements with quality
independent video game software developers. However, we cannot assure you that
we will be able to obtain or renew these product development agreements on
favorable terms, or at all, nor can we assure you that we will be able to obtain
the rights to sequels of successful products which were originally developed for
us by independent video game software developers.





Many of
our competitors have greater financial resources and access to capital than we
do, which puts us at a competitive disadvantage when bidding to attract
independent video game software developers. We may be unable to secure or
maintain relationships with quality independent video game software developers
if our competitors can offer them better shelf access, better marketing support,
more development funding, higher royalty rates, more creative control or other
advantages. Usually, our agreements with independent software developers are
easily terminable if either party declares bankruptcy, becomes insolvent, ceases
operations or materially breaches its agreement.




We have
less control over a game developed by a third party because we cannot control
the developer’s personnel, schedule or resources. In addition, any of our
third-party developers could experience a business failure, be acquired by one
of our competitors or experience some other disruption. Any of these factors
could cause a game not to meet our quality standards or expectations, or not to
be completed on time or at all. If this happens with a game under
development, we could lose anticipated revenues from the game or our entire
investment in the game.




Our
failure to manage our growth and expansion effectively could adversely affect
our business.




Our
ability to successfully offer our products and implement our business plan in a
rapidly evolving market requires an effective planning and management process.
We expect to increase the scope of our operations domestically and
internationally. This growth will continue to place a significant strain on
management systems and resources. If we are unable to effectively manage our
growth or scale our development, our business could be adversely
affected.


13





The
acquisition of other companies, businesses or technologies could result in
operating difficulties, dilution or other harmful consequences.




We have
made acquisitions and, although we have no present intention to do so, we may
pursue further acquisitions, any of which could be material to our business,
operating results and financial condition. Certain of our acquired companies
were subsequently disposed during the past two and a half years.  These
acquisitions resulted in operating losses and losses from dispositions. 
Future acquisitions could divert management’s time and focus from operating our
business. In addition, integrating an acquired company, business or technology
is risky and may result in unforeseen operating difficulties and expenditures.
We may also raise additional capital for the acquisition of, or investment in,
companies, technologies, products or assets that complement our business. Future
acquisitions or dispositions could result in potentially dilutive issuances of
our equity securities, including our common stock, or the incurrence of debt,
contingent liabilities, amortization expenses or acquired in-process
research and development expenses, any of which could harm our financial
condition and operating results. Future acquisitions may also require us to
obtain additional financing, which may not be available on favorable terms or at
all.





Acquisitions
involve a number of risks and present financial, managerial and operational
challenges, including:





·
            diversion of management's
      attention from running existing
business;





·
            increased expenses, including
      travel,legal,
      administrative and compensation expenses resulting from newly hired
      employees;





·
            increased costs to integrate
      personnel, customer base and business practices of the acquired
      company;





·
            adverse effects on reported
      operating results due to possible write-down of goodwill
      associated with
acquisitions;





·
            potential disputes with sellers
      of acquired businesses, technologies, services or products;
      and





·
            dilution to stockholders if we
      issue securities in any
acquisition.





Any
acquired business, technology, product or service could significantly
under-perform relative to our expectations, and we may not achieve the benefits
we expect from acquisitions. In addition, a significant portion of the purchase
price of companies we acquire may be allocated to acquired goodwill and
other intangible assets, which must be assessed for impairment at least
annually. In the future, if our acquisitions do not yield expected returns, we
may be required to take charges to our earnings based on this impairment
assessment process, which could harm our operating results. For all these
reasons, our pursuit of an acquisition and investment strategy or any individual
acquisition or investment, could have a material adverse effect on our business,
financial condition and results of operations.




Our
success depends on our ability to attract and retain our key employees. We may
experience increased costs to continue to attract and retain senior management
and highly qualified software developers.




Our
success depends to a significant extent upon the performance of senior
management and on our ability to attract, motivate and retain highly qualified
software developers. We believe that as a result of consolidation in our
industry, there are now fewer highly skilled independent developers available to
us. Competition for these developers is intense, and we may not be successful in
attracting and retaining them on terms acceptable to us or at all. An increase
in the costs necessary to attract and retain skilled developers, and any
delays resulting from the inability to attract necessary developers or
departures, may adversely affect our revenues, margins and results of
operations.


14




The loss
of the services of any of our executive officers or other key employees could
harm our business. All of our executive officers and key employees are under
short term employment agreements which means, that their future employment with
the company is uncertain. All of our executive officers and key employees are
bound by a contractual non-competition agreement; however, it is uncertain
whether such agreements are enforceable and, if so, to what extent, which could
make us vulnerable to recruitment efforts by our competitors.




Our
future success also depends on our ability to identify, attract and retain
highly skilled technical, managerial, finance, marketing and creative personnel.
We face intense competition for qualified individuals from numerous technology,
marketing and mobile entertainment companies. We may be unable to attract and
retain suitably qualified individuals who are capable of meeting our growing
creative, operational and managerial requirements, or may be required to pay
increased compensation in order to do so.  Volatility or lack of
performance in our stock price may also affect our ability to attract and
retain our key employees. If we are unable to attract and retain the qualified
personnel we need to succeed, our business, operating results and financial
condition would be harmed.





The
loss of any of our key customers could adversely affect our sales.





Our sales
to Cokem, Jack of All Games (via Atari) and Gamestop accounted for approximately
29%, 21% and 11%, respectively, of our gross revenues for the year ended
December 31, 2009. Our sales to Jack of All Games and Cokem accounted for
approximately 30% and 14%, respectively, of our gross revenues for the year
ended December 31, 2008.  Although we seek to broaden our customer base, we
anticipate that a small number of customers will continue to account for a large
concentration of our sales given the consolidation of the retail industry. We do
not have written agreements in place with several of our major customers.
Consequently, our relationship with these retailers could change at any time.
Our business, results of operations and financial condition could be adversely
affected if:





•
            we lose any of our significant
      customers;





•
            any of these customers purchase
      fewer of our offerings;





•
            any of these customers encounter
      financial difficulties, resulting in the inability to pay vendors, store
      closures or liquidation;





•
            less favorable foreign
      intellectual property laws making it more difficult to protect our
      properties from appropriation by
  competitors;





•
            we incur difficulties with
      distributors;





•
            we incur difficulties collecting our accounts
      receivable;





•
            we continue to rely on limited
      business relationships.





Our
failure to manage or address any of these could adversely affect our
business.





If our products contain errors, our
reputation, results of operationsand financial condition may be
adversely affected.




As video
games incorporate new technologies, adapt to new hardware platforms and become
more complex, the risk of undetected errors in products when first introduced
increases. If, despite our testing procedures, errors are found in new products
after shipments have been made, we could experience a loss of revenues, delay in
timely market acceptance of its products and damage to our reputation, any of
which may negatively affect our business, results of operations and
financial condition.


15




If we are unsuccessful in protecting
our intellectual property, our revenues may be adversely affected.




The
intellectual property embodied in our video games is susceptible to
infringement, particularly through unauthorized copying of the games, or piracy.
The increasing availability of high bandwidth Internet service has made, and
will likely continue to make, piracy of video games more common. Infringement of
our intellectual property may adversely affect our revenues through lost sales
or licensing fees, particularly where consumers obtain pirated video game copies
rather than copies sold by us, or damage to our reputation where consumers are
wrongly led by infringers to believe that low-quality infringing material
originated from us. Preventing and curbing infringement through enforcement of
the our intellectual property rights may be difficult, costly and time
consuming, and thereby ultimately not cost-effective, especially where the
infringement takes place in foreign countries where the laws are less favorable
to rights holders or not sufficiently developed to afford the level of
protection we desire.




If we infringe on the intellectual
property of others, our costs may rise and our results of operations may be adversely affected.




Although
we take precautions to avoid infringing the intellectual property of others, it
is possible that we or our third-party developers have done so or may do so in
the future. The number and complexity of elements in our products that result
from the advances in the capabilities of video game platforms increases the
probability that infringement may occur. Claims of infringement, regardless of
merit, could be time consuming, costly and difficult to defend. Moreover, as a
result of disputes over intellectual property, we may be required to discontinue
the distribution of one or more of its products, or obtain a license for the use
of or redesign those products, any of which could result in substantial costs
and material delays and materially adversely affect our results of
operations.




Indemnity provisions in various
agreements potentially expose us to substantial liability for intellectual
property infringement, damages caused by malicious software and other
losses.





In the
ordinary course of our business, most of our agreements with carriers and other
distributors include indemnification provisions. In these provisions, we agree
to indemnify them for losses suffered or incurred in connection with our
products and services, including as a result of intellectual property
infringement and damages caused by viruses, worms and other malicious software.
The term of these indemnity provisions is generally perpetual after execution of
the corresponding license agreement, and the maximum potential amount of future
payments we could be required to make under these indemnification provisions is
generally unlimited. Large future indemnity payments could harm our business,
operating results and financial condition.





We may beunable to develop and introduce in a
timely way new products or services, which could harm our brand.





The
planned timing and introduction of new products and services are subject to
risks and uncertainties. Unexpected technical, operational, deployment,
distribution or other problems could delay or prevent the introduction of new
products and services, which could result in a loss of, or delay in, revenues or
damage to our reputation and brand. Our attractiveness to branded content
licensors might also be reduced. In addition, new products and services may not
achieve sufficient market acceptance to offset the costs of development,
particularly when the introduction of a product or service is substantially
later than a planned “day-and-date” launch, which could materially harm our
business, operating results and financial condition.


16


Our business is subject to risks
generally associated with the entertainment industry, and we may fail to
properly assess consumer tastes and preferences, causing productsales to fall short of expectations.





Our
business is subject to all of the risks generally associated with the
entertainment industry and, accordingly, our future operating results will
depend on numerous factors beyond our control, including the popularity, price
and timing of new hardware platforms being released; economic, political and
military conditions that adversely affect discretionary consumer spending;
changes in consumer demographics; the availability and popularity of other forms
of entertainment; and critical reviews and public tastes and preferences, which
may change rapidly and cannot be predicted. A decline in the popularity of
certain game genres or particular platforms could cause sales of our titles to
decline dramatically. The period of time necessary to develop new game titles,
obtain approvals of platform licensors and produce finished products is
unpredictable. During this period, consumer appeal for a particular title may
decrease, causing product sales to fall short of expectations.




We have developed and may expand
international operations, which may subject us to economic, political,
regulatory and other risks.





We
continue to seek the most cost-effective method to distribute our products
internationally.  There are many risks involved with international
operations, including:




·
            difficulty in maintaining or
      finding a suitable distribution
partner;




·
            social, economic and political
      instability;




·
            compliance with multiple and
      conflicting foreign and domestic laws and
    regulations;




·
            changes in foreign and domestic
      legal and regulatory
      requirements or policies resulting in burdensome government controls,
      tariffs, restrictions, embargoes or export license
      requirements;




·
            currency
      fluctuations;




·
            difficulties in staffing and
      managing  international
operations;




·
            less favorable foreign intellectual property
      laws making it more difficult to protect our properties from appropriation
      by competitors;




·
            potentially adverse tax
      treatment;




·
            higher costs associated with
      doing business
internationally;




·
            challenges caused by
      distance, language
      and cultural differences;




·
            difficulties with
      distributors;




·
              protectionist laws and business
      practices that favor local businesses in some
      countries;
  ·
              foreign exchange controls that
      might prevent us from repatriating income earned in countries outside the United
      States;


·
            price
      controls;




·
            the servicing of regions by many
      different carriers;





17


·
            imposition of public sector
      controls;




·
            restrictions on the export or
      import of technology;




·
            greater fluctuations in sales to
      end users and
      through carriers in developing countries, including longer payment cycles
      and greater difficulties collecting our accounts receivable;
      and




·
            relying
      on limited business relationships.




Our failure
to manage or address any of these could adversely affect our business. In
addition, developing user interfaces that are compatible with other languages or
cultures can be expensive. As a result, our ongoing international expansion
efforts may be more costly than we expect. Further, expansion into developing
countries subjects us to the effects of regional instability, civil unrest and
hostilities, and could adversely affect us by disrupting communications and
making travel more difficult. These risks could harm our international expansion
efforts, which, in turn, could materially and adversely affect our business,
operating results and financial condition.





Our business is‘‘hit’’driven. If we do not deliver‘‘hit’’titles, or if consumers prefer
competing products, our sales could suffer.





While
many new products are regularly introduced, only a relatively small number of
‘‘hit’’ titles account for a significant portion of net revenue. Competitors may
develop titles that imitate or compete with our ‘‘hit’’ titles, and take sales
away from us or reduce our ability to command premium prices for those
titles. Hit products published by our competitors may take a larger share of
consumer spending than we anticipate which could cause our product sales to fall
below our expectations. If our competitors develop more successful products
or offer competitive products at lower price, or if we do not continue to
develop consistently high-quality and well received products, our revenue,
margins, and profitability will decline.





Our
business is subject to seasonal fluctuations.





We
experience fluctuations in quarterly and annual operating results as a result
of: the timing of the introduction of new titles; variations in sales of titles
developed for particular platforms; market acceptance of our titles; development
and promotional expenses relating to the introduction of new titles, sequels or
enhancements of existing titles; projected and actual changes in platforms; the
timing and success of title introductions by our competitors; product returns;
changes in pricing policies by us and our competitors; the size and timing of
acquisitions; the timing of orders from major customers; order cancellations;
and delays in product shipment. Sales of our products are also seasonal, with
peak shipments typically occurring in the fourth calendar quarter as a result of
increased demand for titles during the holiday season. Quarterly and annual
comparisons of operating results are not necessarily indicative of future
operating results.




Risks
Relating to Our Common Stock




The
liquidity of our common stock will be affected by its limited trading
market.




Bid and
ask prices for shares of our common stock are quoted on the OTC Bulletin Board
under the symbol “ZOOE.OB.” There is currently no broadly followed, established
trading market for our common stock. While we are hopeful that we will command
the interest of a greater number of investors, a broadly followed, established
trading market for our shares of common stock may never develop or be
maintained. Active trading markets generally result in lower price volatility
and more efficient execution of buy and sell orders. The absence of an active
trading market reduces the liquidity of our common stock. As a result of the
lack of trading activity, the quoted price for our common stock on the OTC
Bulletin Board is not necessarily a reliable indicator of its fair market value.
Further, if we cease to be quoted, holders of our common stock would find it
more difficult to dispose of, or to obtain accurate quotations as to the market
value of, our common stock, and the market value of our common stock would
likely decline.


18





The
market price of our common stock is highly volatile and subject to wide
fluctuations, and you may be unable to resell your shares at or above the
current price.





The
market price of our common stock is likely to be highly volatile and could be
subject to wide fluctuations in response to a number of factors that are beyond
our control, including announcements of new products or services by our
competitors. In addition, the market price of our common stock could be subject
to wide fluctuations in response to a variety of factors,
including:





·
            quarterly variations in our
      revenues and operating
expenses;





·
            developments in the financial
      markets, andthe
      worldwide or regional
economies;





·
            Announcements of innovations or
      new products or services by us or our
  competitors;





·
            fluctuations in merchant credit
      card interest rates;





·
            significant sales of our common
      stock or other securities in the openmarket;
  and





·
            changes in accounting
      principles.





In the
past, stockholders have often instituted securities class action litigation
after periods of volatility in the market price of a company’s securities. If a
stockholder were to file any such class action suit against us, we would incur
substantial legal fees and our management’s attention and resources would be
diverted from operating our business to respond to the litigation, which could
harm our business.




The
sale of securities by us in any equity or debt financing could result in
dilution to our existing stockholders and have a material adverse effect on our
earnings.




Any sale
of common stock by us in a future private placement offering could result in
dilution to the existing stockholders as a direct result of our issuance of
additional shares of our capital stock. In addition, our business strategy may
include expansion through internal growth by acquiring complementary businesses,
acquiring or licensing additional brands, or establishing strategic
relationships with targeted customers and suppliers. In order to do so, or to
finance the cost of our other activities, we may issue additional equity
securities that could dilute our stockholders’ stock ownership. We may also
assume additional debt and incur impairment losses related to goodwill and other
tangible assets, and this could negatively impact our earnings and results of
operations.




If
securities or industry analysts do not publish research or reports about our
business, or if they downgrade their recommendations regarding our common stock,
our stock price and trading volume could decline.





The
trading market for our common stock, if and when it develops, will be influenced
by the research and reports that industry or securities analysts publish about
us or our business. If any of the analysts who cover us downgrade our common
stock, our common stock price would likely decline. If analysts cease coverage
of our company or fail to regularly publish reports on us, we could lose
visibility in the financial markets, which in turn could cause our common stock
price or trading volume to decline.


19




“Penny stock”rules may restrict the market for
our common stock.





Our
common stock is subject to rules promulgated by the Securities and Exchange
Commission relating to “penny stocks,” which apply to companies whose
shares are not traded on a national stock exchange, trade at less than $5.00 per
share, or who do not meet certain other financial requirements specified by the
Securities and Exchange Commission. These rules require brokers who sell
“penny stocks” to persons other than established customers and “accredited
investors” to complete certain documentation, make suitability inquiries of
investors, and provide investors with certain information concerning the risks
of trading in such penny stocks. These rules may discourage or restrict the
ability of brokers to sell our common stock and may affect the secondary market
for our common stock. These rules could also hamper our ability to raise funds
in the primary market for our common stock.





If we continue to fail to maintain an
effective system of internal controls, we might not be able to report our
financial results accurately or prevent fraud; in that case, our stockholders
could lose confidence in
our financial reporting, which could negatively impact the price of our stock.





Effective
internal controls are necessary for us to provide reliable financial reports and
prevent fraud. In addition, Section 404 of the Sarbanes-Oxley Act of 2002,
or the Sarbanes-Oxley Act, requires us to evaluate and report on our internal
control over financial reporting for all our current operations and have our
independent registered public accounting firm attest to our evaluation beginning
with our Annual Report on Form 10-K for the year ending December 31, 2010. Our
management has determined that we have a material weakness in our internal
control over financial reporting related to not having a sufficient number of
personnel with the appropriate level of experience and technical expertise to
appropriately resolve non-routine and complex accounting matters or to evaluate
the impact of new and existing accounting pronouncements on our consolidated
financial statements while completing the financial statements close process.
Until this deficiency in our internal control over financial reporting is
remediated, there is a reasonable possibility that a material misstatement to
our annual or interim consolidated financial statements could occur and not be
prevented or detected by our internal controls in a timely manner. We are
committed to appropriately addressing this matter and we have engaged additional
qualified personnel to assist in these areas. We will continue to reassess our
accounting and finance staffing levels to ensure that we have the appropriate
accounting resources to handle the existing workload. We are in the process of
preparing and implementing an internal plan of action for compliance with
Section 404 and strengthening and testing our system of internal controls
to provide the basis for our report. The process of implementing our internal
controls and complying with Section 404 will be expensive and time -
consuming, and will require significant attention of management. We cannot be
certain that these measures will ensure that we implement and maintain adequate
controls over our financial processes and reporting in the future. Even if we
conclude, and our independent registered public accounting firm concurs, that
our internal control over financial reporting provides reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted
accounting principles, because of its inherent limitations, internal control
over financial reporting may not prevent or detect fraud or misstatements.
Failure to implement required new or improved controls, or difficulties
encountered in their implementation, could harm our operating results or cause
us to fail to meet our reporting obligations. If we or our independent
registered public accounting firm discover a material weakness or a significant
deficiency in our internal control, the disclosure of that fact, even if quickly
remedied, could reduce the market’s confidence in our financial statements and
harm our stock price. In addition, a delay in compliance with Section 404
could subject us to a variety of administrative sanctions, including
ineligibility for short form resale registration, action by the Securities and
Exchange Commission, and the inability of registered broker-dealers to make a
market in our common stock, which could further reduce our stock price and harm
our business.


20


We do not anticipate paying
dividends.





We have
never paid cash or other dividends on our common stock. Payment of dividends on
our common stock is within the discretion of our Board of Directors and will
depend upon our earnings, our capital requirements and financial condition, and
other factors deemed relevant by our Board of Directors.





Our
officers, directors and principal stockholders can exert significant influence
over us and may make decisions that may not be in the best interests of all
stockholders.




Our
officers, directors and principal stockholders (greater than 5% stockholders)
collectively beneficially own approximately 78% of our outstanding common stock.
As a result, this group will be able to affect the outcome of, or exert
significant influence over, all matters requiring stockholder approval,
including the election and removal of directors and any change in control. In
particular, this concentration of ownership of our common stock is likely to
have the effect of delaying or preventing a change of control of us or otherwise
discouraging or preventing a potential acquirer from attempting to obtain
control of us. This, in turn, could have a negative effect on the market price
of our common stock. It could also prevent our stockholders from realizing a
premium over the market prices for their shares of common stock. Moreover, the
interests of this concentration of ownership may not always coincide with our
interests or the interests of other stockholders, and, accordingly, this group
could cause us to enter into transactions or agreements that we would not
otherwise consider.




The requirements of being a public
company may strain our resources, divert management’s attention and affect our ability to
attract and retain qualified members for our Board of Directors.





As a
public company, we are subject to the reporting requirements of the Exchange Act
and the Sarbanes-Oxley Act. The requirements of these rules and regulations
increase our legal, accounting and financial compliance costs, may make some
activities more difficult, time-consuming and costly and may also place
undue strain on our personnel, systems and resources.




In order
to maintain and improve the effectiveness of our disclosure controls and
procedures and internal control over financial reporting, we will need to expend
significant resources and provide significant management oversight. We have a
substantial effort ahead of us to implement appropriate processes, document our
system of internal control over relevant processes, assess their design,
remediate any deficiencies identified and test their operation. As a result,
management’s attention may be diverted from other business concerns, which could
harm our business, operating results and financial condition. These efforts will
also involve substantial accounting-related costs.




Our financial results could vary
significantly from quarter to quarter and are difficult to predict.





Our
revenues and operating results could vary significantly from quarter to quarter
because of a variety of factors, many of which are outside of our control. As a
result, comparing our operating results on a period-to-period basis may not be
meaningful. In addition, we may not be able to predict our future revenues or
results of operations. We base our current and future expense levels on our
internal operating plans and sales forecasts, and our operating costs are to a
large extent fixed. As a result, we may not be able to reduce our costs
sufficiently to compensate for an unexpected shortfall in revenues, and
even a small shortfall in revenues could disproportionately and adversely affect
financial results for that quarter. Individual products and services represent
meaningful portions of our revenues and net loss in any quarter. We may incur
significant or unanticipated expenses when licenses are renewed.





In
addition to other risk factors discussed in this section, factors that may
contribute to the variability of our quarterly results include:





·
            the number of new products and
      services released by us and our
  competitors;





·
            the amount we reserve against
      returns and allowances;


21





·
            the timing of release of new
      products and services by us and our competitors, particularly those that
      may represent a
      significant portion of revenues in a
  period;





·
            the popularity of new products
      and services, and products and services released in prior
      periods;





·
            the expiration of existing
      content licenses;





·
            the timing of charges related to
      impairments of goodwill, intangible assets,
      royalties and minimum
guarantees;





·
            changes in pricing policies by us
      or our competitors;





·
            changes in the mix of original
      and licensed content, which have varying gross margins; the seasonality of
      our industry;





·
            fluctuations in the size and rate of growth
      of overall consumer demand for video game products, services and related
      content;





·
            strategic decisions by us or our
      competitors, such as acquisitions, divestitures, spin-offs, joint
      ventures, strategic investments or changes in business
      strategy;





·
            our success in entering new
      geographic markets;





·
            foreign exchange
      fluctuations;





·
            accounting rules governing
      recognition of revenue;





·
            the timing of compensation
      expense associated with equity compensation grants;
    and





·
            decisions by us to incur
      additional expenses, such as increases in marketing or research and
      development.





As a
result of these and other factors, our operating results may not meet the
expectations of investors or public market analysts who choose to follow our
company. Failure to meet market expectations would likely result in decreases in
the trading price of our common stock.




Item 1B.
Unresolved StaffComments.





Not
applicable as we are a smaller reporting company.




Item 2. 
Properties.





Our principal offices are located at
3805 Edwards Road, Suite 400 Cincinnati, OH 45209, where we lease approximately
7,705 square feet for a monthly rent of $9,567.04 from March 1, 2010 through
February 28, 2012, and a monthly rent of $10,273.33 from March 1, 2012 through February 28, 2014,
pursuant to a lease agreement that expires on February 28,
2014.


22





We
believe that our existing facilities are suitable and adequate for the business
conducted therein, appropriately used and have sufficient capacity for our
intended purpose.





Item 3.
Legal Proceedings.





On February
19, 2009, Susan J. Kain Jurgensen, Steven W. Newton, Mercy R. Gonzalez, Bruce C.
Kain, Wesley M. Kain, Raymond Pierce and Cristie E. Walsh filed a complaint
against Zoo Publishing, Zoo Games and Zoo in the Supreme Court of the State of
New York, New York County, index number 09 / 102381
alleging claims for breach of certain loan agreements and
employment agreements, intentional interference and fraudulent
transfer. The complaint sought compensatory damages, punitive damages and
preliminary and permanent injunctive relief, among other remedies. On June 18,
2009, we reached a settlement whereby we agreed to pay to the plaintiffs an
aggregate of $560,000 (the “Settlement Amount”) in full satisfaction of the
disputed claims, without any admission of any liability of wrongdoing as
follows: (a) $300,000 on June 26, 2009; (b) $60,000 on or before the earlier of
(i) the date that is 90 days from June 18, 2009 or (ii) the date the Company
obtains new and available financing, including any amounts currently held in
escrow that will be released from escrow after June 18, 2009, in any form and
from any source, in an amount totaling at least $2,000,000; (c) $100,000 on or
before December 18, 2009; and (d) $100,000 on or before June 18, 2010. To date,
$460,000 of the Settlement Amount has been paid to the plaintiffs. The Zoo
Publishing Notes and all other notes, employment, agreements, loan agreements,
options, warrants and other agreements relating to the plaintiffs (except
with respect to that certain Employment Agreement between Zoo Publishing and
Cristie E. Walsh) were terminated and all outstanding obligations of the Company
related to these agreements were cancelled. In addition, the plaintiffs returned
to us an aggregate of 5,563,950 shares of our common stock owned by them prior
to such date.





We are
also involved in various other legal proceedings and claims incident to the
normal conduct of our business. Although it is impossible to predict the outcome
of any legal proceeding and there can be no assurances, we believe that our
legal proceedings and claims, individually and in the aggregate, are not likely
to have a material adverse effect on our financial condition, results of
operations or cash flows.





Item 4.
(Removed and Reserved).




PART
II





Item 5.
Market For
Registrant’s Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity Securities.





Our
common stock is listed for trading on the OTC Bulletin Board under the
symbol “ZOOE.OB.”  Prior to January 30, 2009, our common stock was listed
for trading on the OTC Bulletin Board under the symbol “DFTW.OB.”  The
market for our common stock has often been sporadic, volatile and
limited.





The
following table sets forth, for the periods indicated, the high and low bid
quotations for our common stock as reported by the OTC Bulletin Board. The
prices reflect inter-dealer quotations, without retail markup, markdown or
commissions, and may not represent actual transactions.





High
                  
                  
                  LowFirst
      Quarter 2008
                  
                  $
                  1.35
                  
                  
                  $
                  1.00Second
      Quarter 2008
                  
                  $
                  1.45
                  
                  
                  $
                  1.10Third
      Quarter 2008
                  
                  $
                  2.50
                  
                  
                  $
                  1.45Fourth
      Quarter 2008
                  
                  $
                  1.70
                  
                  
                  $
                  0.25First
      Quarter 2009
                  
                  $
                  0.85
                  
                  
                  $
                  0.30Second
      Quarter 2009
                  
                  $
                  1.10
                  
                  
                  $
                  0.85Third Quarter
      2009
                  
                  $
                  1.10
                  
                  
                  $
                  0.75Fourth
      Quarter 2009
                  
                  $
                  0.75
                  
                  
                  $
                  0.75


23




Holders
of common stock.


On March
22, 2010, we had approximately 90 registered common stockholders of record of
the 2,778,409,829 outstanding shares of common stock. There were also an
undetermined number of holders who hold their stock in nominee or "street"
name.





Dividends
and dividend policy.


Since our
inception, we have not declared or paid any cash dividends to stockholders. The
declaration of any future cash dividend will be at the discretion of our Board
of Directors and will depend upon our earnings, if any, our capital requirements
and financial position, our general economic conditions, and other pertinent
conditions. It is our present intention not to pay any cash dividends in the
foreseeable future, but rather to reinvest earnings, if any, in our business
operations.





Securities
authorized for issuance under equity compensation plans.


The
following table sets forth information concerning our equity compensation plans
as of December 31, 2009.




Equity Compensation Plan Information





Plan Category
                
                Number of
                  securities
                  to be issued
                  upon
                  exercise of
                  outstanding
                  options,
                  warrants
                  and rights
                  (a)
                
                
                Weighted-
                  average
                  exercise
                  price of
                  outstanding
                  options,
                  warrants
                  and rights
                  (b)
                
                
                Number of
                  securities
                  remaining
                  available for
                  future
                  issuance
                  under equity
                  compensation
                  plans
                  (excluding
                  securities
                  reflected in
                  column (a))
                  (c)Equity
      compensation plans approved by Zoo security holders
                
                
                -
                *
                
                $
                -
                
                
                
                25,000Equity
      compensation plans approved by Zoo Games security holders
                
                
                2,589,810
                
                
                $
                1.29
                
                
                
                -Equity
      compensation plans not approved by security holders
                
                
                -
                
                
                
                
                
                
                
                -Total
                
                
                2,589,810
                
                
                $
                1.29
                
                
                
                25,000





*This
number does not include an aggregate of 900,000 restricted shares of our common
stock that we issued on June 23, 2008, and an aggregate of 75,000
restricted shares of our common stock that we issued on June 27, 2008, at a
purchase price of $0.001 per share to certain employees, directors and
consultants, pursuant to our 2007 Employee, Director and Consultant Stock Plan,
as amended (the "2007 Plan").





Unregistered
sales of securities.


None.


24





Issuer
purchases of equity securities.


None.





Item 6. Selected Financial
Data.





Not
applicable as we are a smaller reporting company.





Item 7. Management’s Discussion and Analysis of
Financial Condition and Results of Operations.





The
following discussion should be read in conjunction with, and is qualified in its
entirety by, the financial statements and the notes thereto included in this
report. This discussion contains certain forward-looking statements that involve
substantial risks and uncertainties. When used in this report, the words
"anticipate," "believe," "estimate," "expect” and similar expressions as they
relate to our management or us are intended to identify such forward-looking
statements. Our actual results, performance or achievements could differ
materially from those expressed in, or implied by, these forward-looking
statements. Historical operating results are not necessarily indicative of the
trends in operating results for any future period.





We are a
developer, publisher and distributor of video game software for use on major
platforms including Nintendo’s Wii, DS, GBA, Sony’s PSP, PlayStation 2 and
iPhone.  We are also a distributor of video game software for use on
Microsoft’s Xbox 360.   In addition, we intend to publish packaged
entertainment software titles for use on a variety of other gaming platforms
including Sony’s PlayStation 3. We will also seek to create and sell
downloadable games for Microsoft’s Xbox Live Arcade, Sony’s PlayStation 3
Network, Nintendo’s Virtual Console, and for use on personal computers
(PCs).




Our
current video game titles are targeted at various demographics but primarily at
the lower-priced “value” market. In some instances, these titles are based on
licenses of well-known properties and, in other cases based on original
properties. We collaborate and enter into agreements with content providers and
video game development studios for the creation of our video games.





We also
operate a site called 2beegames.com which can be found at
www.2beegames.com.  We hold contests for independent developers
whereby they can enter their games to win monetary prizes and potential
publishing arrangements with us.  This site allows us to attract fresh
intellectual property, lower production costs, decrease time to market, and
improve margins.





Zoo
Entertainment, Inc. was originally incorporated in the State of Nevada on
February 13, 2003 under the name Driftwood Ventures, Inc.  On December
20, 2007, through a merger, the Company reincorporated in the State of Delaware
as a public shell company with no operations.





On July
7, 2008, the Company entered into an Agreement and Plan of Merger, as
subsequently amended on September 12, 2008 (the “Merger Agreement”) with DFTW
Merger Sub, Inc., a Delaware corporation and a wholly-owned subsidiary of the
Company (“Merger Sub”), Zoo Games and a stockholder representative, pursuant to
which Merger Sub would merge with and into Zoo Games, with Zoo Games as the
surviving corporation through an exchange of common stock of Zoo Games for
common stock of the Company (the “Merger”).


25





On
September 12, 2008, the Company, Merger Sub, Zoo Games and the stockholder
representative completed the Merger and each outstanding share of Zoo Games
common stock, $0.001 par value per share (the “Zoo Games Common Stock”), on a
fully-converted basis, converted automatically into and became exchangeable for
shares of the Company’s common stock, $0.001 par value per share, based on an
exchange ratio equal to 7.023274. In addition, each of the 334,983 options to
purchase shares of Zoo Games Common Stock (the “Zoo Games Options”) outstanding
under Zoo Games’ 2008 Long-Term Incentive Plan were assumed by the Company,
subject to the same terms and conditions as were applicable under such plan
immediately prior to the Merger, and converted into 243,040 options to purchase
shares of the Company’s common stock at an exercise price of $2.58 per share,
421,396 options to purchase shares of the Company’s common stock at an exercise
price of $2.25 per share and 1,688,240 options to purchase shares of the
Company’s common stock at an exercise price of $1.52 per share. The 246,243
warrants to purchase shares of Zoo Games Common Stock outstanding at the time of
the Merger (the “Zoo Games Warrants”) were assumed by the Company and converted
into 1,411,186 warrants to acquire shares of the Company’s common stock at an
exercise price of $2.84 and 318,246 warrants to acquire shares of the Company’s
common stock at an exercise price of $2.13 per share. The merger consideration
consisted (i) 26,098,303 shares of the Company’s common stock, (ii) the
reservation of 2,352,677 shares of the Company’s common stock that are required
for the assumption of the Zoo Games Options and (iii) the reservation of
1,729,432 shares of the Company’s common stock that are required for the
assumption of the Zoo Games Warrants.





Upon the
closing of the Merger, as the sole remedy for the Zoo Games stockholders’
indemnity obligations, on behalf of the Zoo Games stockholders pursuant to the
Merger Agreement, the Company deposited 2,609,861 shares of the Company’s common
stock (the “Escrow Shares”), otherwise payable to such stockholders, into escrow
to be held by the escrow agent until December 31, 2009 in accordance with the
terms and conditions of an escrow agreement. No claims
were made against the stockholders pursuant to the Merger Agreement, and the
Escrow Shares were released from escrow.





Effective
as of the closing of the Merger, Zoo Games became our wholly-owned
subsidiary.  As a result thereof, the historical and current business
operations of Zoo Games now comprise our principal business
operations.





Zoo
Games





Zoo Games
was treated as the acquirer for accounting purposes in the reverse merger and
the financial statements of the Company represent the historical activity of Zoo
Games and consolidate the activity of Zoo beginning on September 12, 2008, the
date of the reverse merger.





Zoo Games
commenced operations in March 2007 as Green Screen Interactive Software, LLC, a
Delaware limited liability company, and in May 2008, converted to a Delaware
corporation. On August 14, 2008, it changed its name to Zoo Games, Inc. Since
its initial organization and financing, Zoo Games embarked on a strategy of
partnering with and/or acquiring companies with compelling intellectual
property, distribution capabilities, and/or management with demonstrated records
of success.





In June
2007, Zoo Games acquired the assets of Supervillain Studios, Inc. which were
held by the wholly-owned subsidiary of Zoo Games, Supervillain Studios,
LLC.  The acquisition provided Zoo Games with access to proprietary
high end casual gaming content, established video game designers, technical
experts and producers capable of providing Zoo Games with high quality, original
casual games. On July 22, 2008, Zoo Games released Order Up!, its first offering
from Supervillain.   In our effort to refocus our cash on our
core business, the Company sold the assets of Supervillain Studios LLC back to
its original owners on September 16, 2008.





In
December 2007, Zoo Games acquired the capital stock of Zoo
Publishing.  The acquisition of Zoo Publishing provided Zoo Games with
a profitable core business, North American distribution, and further enhanced
its experienced management team. Zoo Publishing distributes software titles
throughout North America and generated over $30 million in annual revenue in
2007. Zoo Publishing expects to exploit its development expertise, in
combination with its sales, marketing and licensing expertise, to target the
rapidly expanding market for casual games, particularly on Nintendo’s platforms,
where Zoo Publishing has experienced considerable success. By nurturing and
growing this business unit, Zoo Games believes it will be able to rapidly build
a much larger distribution network, enabling it to place a significant number of
software titles with major retailers.


26


In April
2008, Zoo Games acquired the capital stock of Zoo Digital, a business operated
in the United Kingdom. This acquisition provided Zoo Games with a profitable
core business in the United Kingdom, European distribution, and further enhanced
its experienced management team. Zoo Digital distributes software titles
throughout Europe and generated over $6.8 million in annual revenue in
2007.  In our effort to refocus our cash on our core business
operations, the Company sold Zoo Digital back to its original owners on November
28, 2008.
 
 In June
2009, we formed a new company in the United Kingdom that is a wholly-owned
subsidiary of Zoo Games called Zoo Entertainment Europe Ltd. (“Zoo Europe”), to
focus on the sales and distribution of our products in Europe. Zoo Europe
incurred initial start-up costs and minimal revenues beginning in the
quarter ended September 30, 2009.  The activity of Zoo Europe was
immaterial through the period ended December 31, 2009, and we record all
operating activities as one segment.  In our effort to refocus our
cash on our core business operations, we decided to discontinue operations of
Zoo Europe effective December 2009.
  The
financial statements of Zoo Entertainment and Zoo Games include operations of
each division from the date that they were acquired. Currently, the Company
has determined that it operates in one segment in the United
States.  The results for Supervillain, Repliqa and Zoo Digital are
included in discontinued operations for the periods presented.
 
 Results of
Operations
 
 For
the year ended December 31, 2009 as compared to the year ended December 31,
2008
 
 The
following table sets forth, for the period indicated the amount and percentage
of net revenue for significant line items in our statement of
operations:





(Amounts in Thousands Except Per Share Data)2009
                        
                        
                        2008Revenue
                        
                        $
                        48,709
                        
                        
                        
                        100
                        %
                        
                        $
                        36,313
                        
                        
                        
                        100
                        %Cost
      of goods sold
                        
                        
                        39,815
                        
                        
                        
                        82
                        %
                        
                        
                        30,883
                        
                        
                        
                        85
                        %Gross
      profit
                        
                        
                        8,894
                        
                        
                        
                        18
                        %
                        
                        
                        5,430
                        
                        
                        
                        15
                        %Operating
      expenses:General
      and administrative
                        
                        
                        6,788
                        
                        
                        
                        14
                        %
                        
                        
                        10,484
                        
                        
                        
                        29
                        %Selling
      and marketing
                        
                        
                        2,484
                        
                        
                        
                        5
                        %
                        
                        
                        4,548
                        
                        
                        
                        13
                        %Research
      and development
                        
                        
                        390
                        
                        
                        
                        1
                        %
                        
                        
                        5,857
                        
                        
                        
                        16
                        %Impairment
      of goodwill
                        
                        
                        14,704
                        
                        
                        
                        30
                        %
                        
                        
                        -
                        
                        
                        
                        -
                        %Depreciation
      and amortization
                        
                        
                        1,875
                        
                        
                        
                        4
                        %
                        
                        
                        1,760
                        
                        
                        
                        5
                        %Total
      operating expenses
                        
                        
                        26,241
                        
                        
                        
                        54
                        %
                        
                        
                        22,649
                        
                        
                        
                        62
                        %Loss
      from operations
                        
                        
                        (17,347
                        )
                        
                        
                        (
      36
                        )%
                        
                        
                        (17,219
                        )
                        
                        
                        (47
                        )%Interest
      expense, net
                        
                        
                        (2,975
                        )
                        
                        
                        (
      6
                        )%
                        
                        
                        (3,638
                        )
                        
                        
                        (10
                        )%Gain
      on extinguishment of debt
                        
                        
                        5,315
                        
                        
                        
                        11
                        %
                        
                        
                        -
                        
                        
                        
                        -
                        %Gain
      on legal settlement
                        
                        
                        4,328
                        
                        
                        
                        9
                        %
                        
                        
                        -
                        
                        
                        
                        -
                        %Other
      income – insurance recovery
                        
                        
                        860
                        
                        
                        
                        2
                        %
                        
                        
                        1,200
                        
                        
                        
                        3
                        %Loss
      from continuing operations before income tax benefit
                        
                        
                        (9,819
                        )
                        
                        
                        (
      20
                        )%
                        
                        
                        (19,657
                        )
                        
                        
                        (54
                        )%Income
      tax (expense) benefit
                        
                        
                        (3,143
                        )
                        
                        
                        (6
                        )
      %
                        
                        
                        4,696
                        
                        
                        
                        13
                        %Loss
      from continuing operations
                        
                        
                        (12,962
                        )
                        
                        
                        (
      27
                        )%
                        
                        
                        (14,961
                        )
                        
                        
                        (41
                        )%Loss
      from discontinued operations net of tax benefit
                        
                        
                        (235
                        )
                        
                        
                        -
                        %
                        
                        
                        (6,734
                        )
                        
                        
                        (19
                        )%Net
      loss
                        
                        $
                        (13,197
                        )
                        
                        
                        ( 27
                        )%
                        
                        $
                        (21,695
                        )
                        
                        
                        (60
                        )%Loss
      per common share from continuing operations
                        
                        $
                        (0.39
                        )
                        
                        
                        
                        
                        
                        $
                        (0.59
                        )




27




Net
Revenues





Net
revenues for the year ended December 31, 2009 were approximately $48.7 million,
an increase of approximately 34% over the revenues for the year ended December
31, 2008 of approximately $36.3 million, primarily all consisting of casual game
sales in North America.





Because
of a fire in our third party warehouse in October 2008, we entered into a
distribution agreement with Atari that has remained in effect for certain
customers through 2009.  With that agreement, we sell product to Atari
at a discount and they distribute product to certain of our
customers.  The sales in 2009 are recorded net of the $3.7 million fee
to Atari and the sales in 2008 are recorded net of the $1.4 million fee to
Atari; without the Atari fee, the sales increase from 2008 to 2009 would be
39%.





The
breakdown of gross sales by platform is:





2009
                    
                    
                    2008Nintendo
      Wii
                    
                    
                    64
                    %
                    
                    
                    45
                    %Nintendo
      DS
                    
                    
                    31
                    %
                    
                    
                    50
                    %SONY
      PS2
                    
                    
                    3
                    %
                    
                    
                    2
                    %Microsoft
      XBox
                    
                    
                    2
                    %
                    
                    
                    0
                    %Nintendo
      GBA
                    
                    
                    0
                    %
                    
                    
                    2
                    %SONY
      PSP
                    
                    
                    0
                    %
                    
                    
                    1
                    %





The best
sellers during the 2009 period were (i) Deal or No Deal, (ii) M&M Kart
Racing, and (iii) M&M Beach Party, all on the Nintendo Wii platform. The
various Wii games bundled with our gun blaster accounted for approximately 10%
of our sales during 2009.  The biggest sellers during the 2008 period
were (i) M&M Kart Racing on the Nintendo Wii platform, (ii) the compilation
of Battle Ship, Connect 4, Sorry & Trouble on the Nintendo DS platform, and
(iii) Deal or No Deal on the Nintendo DS platform.  The 2009 period
consisted of approximately 5.2 million units sold at an average price of $9.65
as compared to approximately 4.1 million units sold for an average price of
$10.00.





Gross
Profit





Gross
profit for 2009 was approximately $8.9 million, or 18% of net revenue, while the
gross profit for 2008 was approximately $5.4 million, or 15% of net revenue. The
costs included in the cost of goods sold consist of manufacturing and packaging
costs, royalties due to licensors relating to the current period’s revenues and
the amortization of product development costs relating to the current period’s
revenues. The Atari sales agreement was in place during the entire 2009 period
and for three months during 2008.  Atari’s fees that are recorded as a
reduction in revenue during 2009 were approximately $3.7 million as
compared to $1.4 million for the three months that the agreement was in
effect in 2008.  Without the fees to Atari, the gross profit would have
been 24% of net revenue in 2009 and 18% of net revenue in 2008.  As
part of our business plan to focus on higher margin games and more cost
effective product licenses, we opted to discontinue certain lower-margin
products in the 2009 period through the accelerated sale of such products at
lower than normal prices.   The 2008 period also included a
close-out initiative for a license that terminated during that period resulting
in similar overall margins for the 2008 period.  The 2008 period
included an unusually large amount of amortization of product development costs
for a game developed internally that did not earn out its development cost at
the expected rate, resulting in an additional 2% charge to the cost of goods
sold and therefore a 2% decrease in the gross margin for 2008.




28





General
and Administrative Expenses





General
and administrative expenses for 2009 were approximately $6.8 million as compared
to $10.5 million for 2008.  A reduction in the corporate headcount in the
New York office from 2008 to 2009 resulted in approximately $2.0 million of the
decrease from reduced salaries, rent and related expenses.  Additional
costs incurred in the 2008 period resulted from the Company’s reverse merger and
costs relating to going public, which were approximately $964,000 in accounting
and legal fees and approximately $582,000 in other consulting
costs.  These costs did not recur in 2009. Equity compensation
included in general and administrative expenses are approximately $592,000 in
2009 and approximately $1.6 million in 2008.  During 2009 the Company
incurred approximately $856,000 in cost for its European sales office that both
began and terminated during 2009.  These costs are included in the
2009 general and administrative expenses.





Selling
and Marketing Expenses





Selling
and marketing expenses for 2009 and 2008 were approximately $2.5 million and
$4.5 million, respectively. These expenses all relate to the sales of casual
games in North America and consist primarily of the salaries, commissions and
related costs for Zoo Publishing. The expenses in the 2009 period reflect a
reduction in salaries and related costs of $949,000 from the 2008 period
due to the transition of that operation from New Jersey to Ohio in 2009 and
resulting reduction in headcount and base salaries.  The balance of
the variance resulted primarily from approximately $1.0 million in advertising
and marketing expenses incurred in 2008 for various products that did not recur
in 2009.




Research
and Development Expenses





Research
and development expenses were $390,000 in 2009 as compared to approximately $5.9
million in 2008.  These expenses are a direct result of our decision
to discontinue the development of certain games during these periods. The 2008
costs of consisted of approximately $5.1million relating to various video game
products that were discontinued during the year and approximately $720,000 for a
video game that was still in development that we deemed unrecoverable in 2008.
The Company has modified its business model to focus on casual products which
carry significantly lower development risks and costs.




Impairment
of Goodwill





The
Company incurred a triggering event as of September 30, 2009 based on the equity
infusion of approximately $4.0 million for 50% ownership in the Company and the
conversion of the existing convertible debt during the fourth quarter of
2009.  As such, the Company performed an impairment analysis,
resulting in the full impairment of goodwill of $14.7 million.





Depreciation
and Amortization Expenses





Depreciation
and amortization costs for 2009 were approximately $1.9 million as compared to
approximately $1.8 million in 2008.  The amortization of intangibles
acquired from the Zoo Publishing acquisition that is included in these amounts
is approximately $1.6 million for both 2009 and 2008. The 2009 period includes
$130,000 resulting from the amortization of content intangibles obtained from
the New World IP license in May 2009.  The balance relates to
depreciation of fixed assets during the period.




29





Interest
Expense





Interest
expense for 2009 was approximately $3.0 million as compared to approximately
$3.6 million for 2008. The 2009 period includes approximately $1.6 million of
non-cash interest expense relating to the amortization on the Zoo Entertainment
notes, $496,000 of interest relating to the Zoo Entertainment notes and
approximately $358,000 of interest on the various promissory notes due to the
sellers of Zoo Publishing of which $293,000 is non-cash interest imputed at the
then market rate. In addition, the 2009 period includes $58,000 of interest on
the Solutions 2 Go loan and $133,000 of non-cash interest relating to the
warrants issued for the Solutions 2 Go exclusive distribution
rights.  Interest paid by Zoo Publishing in 2009 for the receivable
factoring facility and other financing arrangements were
$354,000.  The 2008 period includes $1.3 million of non-cash interest
expense relating to the amortization on the Zoo Entertainment notes, $610,000 of
non-cash interest expense relating to the accelerated amortization of the debt
discount resulting from the early extinguishment of debt and approximately $1.2
million of interest on the various promissory notes due to the sellers of Zoo
Publishing of which $1.0 million is non-cash interest imputed at the then market
rate. Also included in 2008 is $536,000 of interest expense on other notes
including the Zoo Entertainment notes.





Gain
on Extinguishment of Debt





The 2009
period includes approximately $5.3 million of gain on extinguishment of debt
resulting from the November 2009 conversion of approximately $11.9 million of
existing debt, including related accrued interest, into 1,189,439 shares of
Series B Preferred stock that subsequently converted into 1,188,439,000 shares
of common stock in March 2010. The total fair value of the Series B Preferred
stock was determined to be approximately $3.0 million, based on a $0.0025 value
per common share, the same value per share on the sale of Series A Preferred
stock with identical rights and features.  Of the $8.9 million gain on
extinguishment of debt, approximately $3.6 million is recorded as additional
paid-in-capital because that debt holder was also a shareholder with greater
than 10% of the outstanding common stock at the time of the debt conversion and
deemed to be a related party.  The remaining $5.3 million balance was
recorded as a gain on extinguishment of the debt.





Gain
on Legal Settlement





During
the 2009 period, we settled a lawsuit brought by the former sellers of Zoo
Publishing, resulting in a net gain on settlement of approximately $4.3 million.
The settlement eliminated the Company’s obligations for certain outstanding
notes, employee loans and other obligations for an aggregate amount of
approximately $3.9 million. The settlement returned approximately 5.6 million
shares to treasury valued at approximately $1.1 million. The Company’s remaining
cash obligations and litigation expense amounted to approximately $710,000,
resulting in a net gain on settlement of approximately $4.3
million.





Other
Income – Insurance Recovery





During
the 2009 period, our third party warehouse received $860,000 from their
insurance company relating to losses incurred by us from a fire in October
2008.  Those proceeds were applied against other amounts due from Zoo
to the third party warehouse and are reported as Other Income in 2009.  In
2008, we received $1.2 million from our insurance company relating to business
losses incurred from the same fire at a third party warehouse that housed our
inventory in October 2008.





Income
Tax (Expense) Benefit





We
recorded an income tax expense of approximately $3.1 million for the year ended
December 31, 2009.  There were various book to tax differences that
resulted in the Company having taxable income for 2009; the
income tax expense, in part, is based on permanent differences that are
non-deductible for tax purposes, predominantly related to the impairment of
goodwill. The net deferred tax component of the tax expense is
approximately $2.9 million.  During the year ended December 31, 2008,
we recorded a tax benefit of approximately $6.1 million, approximately $4.7
million from continuing operations and approximately $1.4 million attributed to
discontinued operations.





Loss
from Discontinued Operations





During
2009, we wrote-off $235,000 relating to the balance due from the sale of Zoo
Digital in 2008 because it was determined to be uncollectible during this
period.   During 2008, we incurred an aggregate of approximately
$6.7 million in losses, net of an approximately $1.4 million tax benefit, from
four operating divisions which were subsequently discontinued, so the net losses
relating to those operations are recorded separately as a loss from discontinued
operations. The loss relating to Zoo Digital was approximately $4.6 million, the
loss relating to Supervillain was approximately $3.2 million, the loss relating
to Repliqa was $219,000 and the loss relating to the on-line initiative was
$146,000.




30




Loss
per Common Share from Continuing Operations





The loss
per common share from continuing operations for the year ended December 31, 2009
was $0.39, based on a weighted average shares outstanding for the period of 33.5
million, versus a loss per share from continuing operations of $0.59, based on a
weighted average shares outstanding of 25.4 million for the year ended December
31, 2008.




Liquidity and Capital Resources





We
incurred a loss from continuing operations of approximately $13.0 million,
including an impairment charge related to goodwill of $14.7 million, for
the year ended December 31, 2009 and a net loss of approximately $15.0 million
from continuing operations for the year ended December 31, 2008. Our principal
sources of cash during the 2009 period were proceeds from the $5 million equity
raise in the fourth quarter of 2009, cash generated from the use of our purchase
order and receivable financing arrangements, and cash generated from operations
throughout the year.




Net cash
used in continuing operations for 2009 was approximately $5.5 million, while net
cash used in continuing operations for 2008 was $12.1 million. The
specifics of the Atari sales agreement, which was in effect during the 2009
period for some of our customers, where Atari prepays the Company for the
cost of goods for most of our sales and pays the balance due within 15 days of
shipping the product, resulted in significant improvements for our cash provided
from operations in the 2009 period, as compared to the 2008 period.  The
nature of the customer advances from Atari also reduces our receivables, as
compared to standard trade sales where we wouldn’t collect the receivable until
up to 60 days after shipment of our goods.  As of the end of December
2008, Atari was distributing for all our customers, while at the end of December
2009, Atari was distributing for only certain customers.  The net
increase in receivables for the year ended December 31, 2009 was approximately
$2.2 million, while the net increase in receivables for the year ended December
31, 2008 was approximately $500,000.  The inventory decreased by
approximately $1.0 million from December 31, 2008 to December 31, 2009 as we
made an effort to minimize our cash outlay for product by building product to
order and increasing our inventory turns.  Also in the 2008 period,
the Company was spending more cash developing higher-cost video games that had a
longer development cycle which put a strain on our working capital for that
period; while in 2009 we focused mostly on developing lower-cost video games and
our cash constraints also limited our spending on development of new video games
in 2009.




Net cash
used in investing activities for the year ended December 31, 2009 was $338,000,
while net cash provided by investing activities for the year ended December 31,
2008 was approximately $2.1 million.  The cash used in the 2009 period
consisted of $312,000 invested for intellectual property and $26,000 for the
purchase of fixed assets.  During the 2008 period, the Company
benefited from the receipt of approximately $1.7 million of cash from the
reverse merger and used $67,000 cash for the purchase of fixed
assets.




Net cash
provided by financing activities for the year ended December 31, 2009 was
approximately $7.6 million, while net cash provided by financing activities for
the year ended December 31, 2008 was approximately $12.9 million.  The
2009 period includes approximately $90,000, net, repaid to the purchase order
financing facility and approximately $900,000, net, received from the
receivable factoring facility, as well as $7,000 from the exercise of
warrants.  In addition, we received a $2.0 million customer advance
from Solutions 2 Go, Inc. in the 2009 period for exclusive Canadian distribution
rights which is being treated as a loan due to the fixed maturity date
and interest bearing features of the advance.  During 2008 we received
approximately $6.1 million from the sale of equity securities, received
approximately $8.9 million from the issuance of convertible notes and repaid a
net amount of approximately $2.0 million for the purchase order financing and
factor arrangements.




31




The $5.0
million sale of our Series A Convertible Preferred Stock and common stock
purchase warrants that closed on November 20, 2009 and December 16, 2009, and
the conversion of approximately $11.9 million underlying our convertible notes
into equity, put us into a positive net working capital position of
approximately $5.6 million as of  December 31, 2009, leaving us better
positioned to meet our cash needs.




On May
16, 2008, Mandalay Media, Inc. (“Mandalay”) provided a bridge loan to us of $2.0
million (the “Mandalay Note”) in connection with the potential acquisition by
Mandalay of Zoo Games. The Mandalay Note bore interest at a rate of 10% per
annum. The letter of intent between Mandalay and Zoo Games was terminated, and
the Mandalay Note was paid in full on July 7, 2008.




On July
7, 2008, Zoo provided a bridge loan of up to $7.0 million to Zoo Games (the
“Company Loan”). The Company Loan bore interest at a rate of 10% per annum
(increasing upon default). Under the terms of the Company Loan, Zoo Games could
borrow on a weekly basis, repay without penalty or premium and continue to
borrow amounts until September 30, 2008, provided that any advance made by Zoo
to Zoo Games is contingent upon a mutually approved budget for the use of such
advance by Zoo Games, which approval will not be unreasonably withheld by Zoo.
The Company Loan and all accrued interest were automatically extinguished upon
the closing of the Merger. We used $2.03 million of the amounts borrowed to
repay all amounts outstanding under the Mandalay Note on July 7, 2008. The
additional advances were used for working capital purposes.





Zoo
Entertainment Notes





On July
7, 2008, as amended,, we entered into a note purchase agreement under which the
purchasers agreed to provide loans to us in the aggregate principal amount of
$9.0 million, in consideration for the issuance and delivery of senior secured
convertible promissory notes. As partial inducement to purchase the notes, we
issued to the purchasers warrants to purchase 8,181,818 shares of our common
stock. The notes had an interest rate of five percent (5%) for the one year term
of the note commencing from issuance, unless extended. All of the warrants have
a five year term and an exercise price of $0.01 per share.  In connection
with the note purchase agreement, the Company satisfied a management fee
obligation by issuing additional senior secured convertible promissory notes in
the principal amount of $750,000 and warrants to purchase 681,818 shares of
common stock of the Company. All of the warrants have a five year term and an
exercise price of $0.01 per share.





On
September 26, 2008,  we entered into a note purchase agreement, as
amended, with four investors, pursuant to which the purchasers agreed to provide
a loan to us in the aggregate principal amount of $1.4 million, in consideration
for the issuance and delivery of senior secured convertible promissory notes. As
partial inducement to purchase the notes, we issued to the purchasers warrants
to purchase 1,272,726 shares of our common stock. The notes had an interest
rate of five percent (5%) for the time period beginning on September 26, 2008
and ending on September 26, 2009, unless extended.    The
warrants have a five year term and an exercise price of $0.01 per
share.





On November 20, 2009, the requisite
holders (the “Holders”) of the Company’s senior secured convertible notes
issued in the aggregate principal amount of $11.15 million, described
aboveagreed that if the Company raises a
minimum of $4.0 million of new capital, they will convert their debt into shares
of Series B Convertible Preferred Stock (“Series B Preferred Stock”) that will ultimately convert into
sharesof common stock
representing approximately 36.5% of the equity of the Company. As a result of
the consummation of our sale of Series A Preferred Stock resulting in gross
proceeds to the Company of approximately $4.2 million, on November 20, 2009,
approximately $11.9 million of principal plus
accrued and unpaid interest underlying the notes converted into an aggregate of
1,188,439 shares of Series B Preferred Stock. On January 13, 2010, our Board of
Directors and stockholders holding approximately 66.7% ofour outstanding voting capital stock
approved an amendment to our Certificate of Incorporation to increase the number
of authorized shares of common stockfrom 250,000,000 shares to
3,500,000,000 shares(the
“Charter
Amendment”). The consents
we received constituted
the only stockholder approval required for the Charter Amendment under the
Delaware General Corporation Law (the “DGCL”) and our existing Certificate of
Incorporation and Bylaws. Pursuant to Rule 14c-2 of the Securities Exchange
Act of 1934, asamended, stockholder approval of this
amendment will become effective on or after such date that is approximately 20
calendar days following the date we first mailed the definitive Information
Statement Pursuant to Section 14(c) (the “Information Statement”) to our stockholders.  The
Information Statement was first sent to our stockholders on February 16, 2010. On March 10, 2010,
the Company filed the Charter Amendment with the Secretary of State of the State
of Delaware.  The Charter Amendment increased the Company’s authorized
shares of common stock, par value $0.001 per share, from 250,000,000 shares to
3,500,000,000 shares.Upon
the filing of the Charter Amendment on March 10, 2010, the Series B Preferred
Stock automatically converted to 1,188,439,000shares of common
stock.




32





Zoo
Publishing Notes





In
connection with Zoo Games’ acquisition of Zoo Publishing, there was an
outstanding 3.9% promissory note for the benefit of the former shareholders of
Zoo Publishing in the aggregate principal amount of $2,957,500. Of that amount,
$1,137,500 of the principal plus accrued and unpaid interest was scheduled to be
paid on or before September 18, 2009 and the remaining $1,820,000 plus accrued
and unpaid interest was scheduled to be paid on or before December 18, 2010.
Also in connection with the acquisition of Zoo Publishing, Zoo Games was
required to pay an individual an aggregate of $608,400. Of that amount, $292,500
was due on December 18, 2010 and $315,900 was scheduled to be paid on July 31,
2011, in cash or our common stock based on the fair market value of our common
stock as of July 31, 2011, at the election of Zoo Games. In connection with the
Settlement Agreement dated June 18, 2009, all the Zoo Publishing Notes and the
note to the individual were cancelled and no cash payments were required to be
made for either the principal amounts of the notes or the interest accrued. The
net amount of the obligations relieved for the Zoo Publishing Notes was
approximately $3.0 million and is included in the Gain on Settlement on the
Statement of Operations.





As part
of the acquisition of Zoo Publishing, Zoo Games was required to pay $1,200,000
to an employee of Zoo Publishing. Of that amount, as of September 30, 2009, Zoo
Games paid $487,000; $93,000 is past due and $620,000 will be paid on July 31,
2011, in cash or our common stock based on the fair market value of our common
stock as of July 31, 2011, at the election of Zoo Games.





Zoo
Publishing has additional debt outstanding which debt existed prior to Zoo
Games’ acquisition of that subsidiary. As of December 31, 2009, Zoo Publishing
owes approximately $300,000 as a result of the repurchase of certain
stock from a former stockholder. The terms of this note are repayment in monthly
increments of $10,000.





Zoo
Publishing also takes advances from our factor, Working Capital Solutions, Inc.,
which utilizes existing accounts receivable in order to provide working capital
to fund all aspects of our continuing business operations. Under the terms of
our factoring and security agreement, our receivables are sold to the factor,
with recourse. The factor, in its sole discretion, determines whether or not it
will accept each receivable based upon the credit risk factor of each individual
receivable or account. Once a receivable is accepted by the factor, the factor
provides funding, subject to the terms and conditions of the factoring and
security agreement. The amount remitted to us by the factor equals the invoice
amount of the receivable adjusted for any discounts or allowances provided to
the account, less 25% which is deposited into a reserve account established
pursuant to the agreement, less allowances and fees. In the event of default,
valid payment dispute, breach of warranty, insolvency or bankruptcy on the part
of the receivable account, the factor can require the receivable to be
repurchased by us in accordance with the agreement. The amounts to be paid by us
to the factor for any accepted receivable include a factoring fee of 0.6% for
each ten (10) day period the account is open. We began to use the
factor again in September 2009 and as of December 31, 2009, we had factored
approximately $1.4 million of invoices and received $900,000 advance against
these receivables.  This agreement expires in September 2010 and we
have agreed in principle to increase borrowing levels effective April 1,
2010.




33





In
addition to the receivable financing agreement with Working Capital Solutions,
Inc., Zoo Publishing also utilizes purchase order financing with Wells Fargo
Bank, National Association (“Wells Fargo”), to fund the manufacturing of video
game products. Under the terms of our agreement, we assign purchase orders
received to Wells Fargo, which may accept or decline the assignment of specific
purchase orders. The purchase order financing allows us to order manufactured
video game product from the manufacturer. Upon receipt of a purchase order,
Wells Fargo advances the funds to the video game product manufacturer. This
advance permits us to order the video game product to satisfy the purchase
orders and projected purchase orders submitted by our accounts. The interest
rate is prime plus 4.0% on outstanding advances.





On April
6, 2009, we entered into an amended and restated purchase order financing
arrangement with Wells Fargo pursuant to an amended and restated master purchase
order assignment agreement (the “Assignment Agreement”). The Assignment
Agreement amended and restated in its entirety the master purchase order
assignment agreement between Wells Fargo (formerly known as Transcap Trade
Finance, LLC) and Zoo Publishing, dated as of August 20, 2001, as
amended.





Pursuant
to the Assignment Agreement, the Company will assign purchase orders received
from customers to Wells Fargo, and request that Wells Fargo purchase the
required materials to fulfill such purchase orders. Wells Fargo, which may
accept or decline the assignment of specific purchase orders, will retain us to
manufacture, process and ship ordered goods, and will pay us for our services
upon Wells Fargo’s receipt of payment from the customers for such ordered
goods. Upon payment in full of the purchase order invoice by the applicable
customer to Wells Fargo, Wells Fargo will re-assign the applicable purchase
order to us. We will pay to Wells Fargo a fee upon their funding of each
purchase order and we commit to pay a total fee for twelve months in the
aggregate amount of $337,500. If the fees earned during the twelve month period
do not exceed $337,500, we are required to pay the difference between the
$337,500 and the amounts already paid on the earlier of the twelve month
anniversary of the date of the Assignment Agreement, or the date of termination
of the Assignment Agreement. Wells Fargo is not obligated to provide
purchase order financing under the Assignment Agreement if the aggregate
outstanding funding exceeds $5,000,000. The Assignment Agreement is for an
initial term of twelve months, and shall continue thereafter for successive
twelve month renewal terms unless either party terminates the Assignment
Agreement by written notice to the other no later than 30 days prior to the end
of the initial term or any renewal term. If the term of the Assignment
Agreement is renewed for one or more twelve month terms, for each such twelve
month term, we will pay to Wells Fargo a commitment fee in the sum of $337,500,
to be offset against actual fees paid by us upon their payment of each purchase
order, to be paid on the earlier of the twelve month anniversary of such renewal
date or the date of termination of the Assignment Agreement. The initial
and renewal commitment fees are subject to waiver if certain product volume
requirements are met.  We extended the purchase order financing
facility through April 2011 and have agreed in principle to increase the
borrowing capacity at lower fees and interest rates effective April 6,
2010.




In
connection with the Assignment Agreement, on April 6, 2009 we also entered into
an amended and restated security agreement and financing statement (the
“Security Agreement”) with Wells Fargo. The Security Agreement amends and
restates in its entirety that certain security agreement and financing
statement, by and between Transcap Trade Finance, LLC and Zoo Publishing,
dated as of August 20, 2001. Pursuant to the Security Agreement, we granted
to Wells Fargo a first priority security interest in certain of our assets as
set forth in the Security Agreement, as well as a subordinate security interest
in certain other of our assets (the “Common Collateral”), which security
interest is subordinate to the security interests in the Common Collateral held
by certain of our senior lenders, as set forth in the Security
Agreement.





Also in
connection with the Assignment Agreement, on April 6, 2009, Mark Seremet,
President and Chief Executive Officer of Zoo Games and a director of Zoo
Entertainment, and David Rosenbaum, the President of Zoo Publishing, entered
into a Guaranty with Wells Fargo, pursuant to which Messrs. Seremet and
Rosenbaum agreed to guaranty the full and prompt payment and performance of the
obligations under the Assignment Agreement and the Security
Agreement.




34





On May
12, 2009, the Company entered into a letter agreement with each of Mark Seremet
and David Rosenbaum (the “Fee Letters”), pursuant to which, in consideration for
Messrs. Seremet and Rosenbaum entering into the Guaranty with Wells Fargo for
the full and prompt payment and performance by the Company and its subsidiaries
of the obligations in connection with a purchase order financing (the “Loan”),
the Company agreed to compensate Mr. Seremet in the amount of $10,000 per month,
and Mr. Rosenbaum in the amount of $7,000 per month, for so long as the
executive remains employed while the Guaranty and Loan remain in full force and
effect. If the Guaranty is not released by the end of the month following
termination of employment of either Messrs. Seremet or Rosenbaum, the monthly
fee shall be doubled for each month thereafter until the Guaranty is
removed.





In
connection with the financing consummated on November 20, 2009, Messrs. Seremet
and Rosenbaum agreed to amend their respective Fee Letters, pursuant to which:
in the case of Mr. Seremet, the Company will pay to Mr. Seremet a fee of $10,000
per month for so long as the Guaranty remains in full force and effect, but only
for a period ending on November 20, 2010; and, in the case of Mr. Rosenbaum, the
Company will pay to Mr. Rosenbaum a fee of $7,000 per month for so long as the
Guaranty remains in full force and effect, but only for a period ending on
November 20, 2010.  In addition, the amended Fee Letters provide that,
in consideration of each of their continued personal guarantees, we will issue
to each of Messrs. Seremet and Rosenbaum, an option to purchase shares of common
stock or restricted shares of common stock, equal to approximately a 6.25%
ownership interest on a fully diluted basis, respectively.  Subject to the
effectiveness (the “Effective Date”) of an amendment to the Company’s
Certificate of Incorporation authorizing an increase in the number of authorized
shares of the Company’s common stock, par value $0.001 per share, from
250,000,000 shares to 3,500,000,000 shares (the “Charter Amendment”), on
February 11, 2010, the Company issued options to purchase 202,581,600 shares of
common stock to each of Mark Seremet and David Rosenbaum pursuant to the Fee
Letters. The options have an exercise price of $0.0025 per share and vest as
follows:  commencing as of the Effective Date, 72% vest immediately,
14% on May 12, 2010 and 14% vest on May 12, 2011. On January 13, 2010, our Board
of Directors and stockholders holding approximately 66.7% of our outstanding
voting capital stock approved the Charter Amendment. The consents we received
constituted the only stockholder approval required for the Charter Amendment
under the Delaware General Corporation Law (the “DGCL”) and our existing
Certificate of Incorporation and Bylaws. Pursuant to Rule 14c-2 of the
Securities Exchange Act of 1934, as amended, stockholder approval of this
amendment will become effective on or after such date that is approximately 20
calendar days following the date we first mailed the definitive Information
Statement Pursuant to Section 14(c) (the “Information Statement”) to our
stockholders.  The Information Statement was first sent to our stockholders
on February 16, 2010. On March 10, 2010, the
Company filed the Charter Amendment with the Secretary of State of the State of
Delaware.





As a
result of a fire in October 2008 that destroyed our inventory and impacted our
cash flow from operations, we entered into an agreement with Atari, Inc.
(“Atari”). This agreement became effective on October 24, 2008 and provided for
Zoo Publishing to sell its products to Atari without recourse and Atari will
resell the products to wholesalers and retailers that are acceptable to
Atari in North America. This agreement provides for Atari to prepay the Company
for the cost of goods and pay the balance due within 15 days of shipping the
product. Atari’s fees approximate 10% of our standard selling
price. Atari takes a reserve from the initial payment for potential
customer sales allowances, returns and price protection that is analyzed and
reviewed within a 60 day period to be liquidated no later than July 31,
2010. The agreement initially expired on March 31, 2009, but was
amended to extend the term for certain customers until March 31,
2010.





The $5.0
million sale of our Series A Convertible Preferred Stock and common stock
purchase warrants that closed on November 20, 2009 and December 16, 2009, and
the conversion of approximately $11.9 million underlying our convertible notes
into equity helped the Company to achieve an approximately $5.6 million positive
working capital position as of December 31, 2009.  We believe the
existing cash and cash generated from operations are sufficient to meet our
immediate operating requirements, along with our current financial arrangements.
We may need to raise additional capital to strengthen our cash position,
facilitate expansion, pursue strategic investments or to take advantage of
business opportunities as they arise.




35





Critical
Accounting Policies and Estimates




The
preparation of financial statements in conformity with generally accepted
accounting principles in the United States of America ("GAAP") requires
management to make estimates and assumptions about future events and apply
judgments 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. We base our estimates and judgments on historical experience
and current trends and other assumptions that management believes to be
reasonable at the time our consolidated financial statements are prepared. On a
regular basis, management reviews the accounting policies, assumptions,
estimates and judgments to ensure that our financial statements are fairly
presented in accordance with GAAP. However, because future events and their
effects cannot be determined with certainty, actual amounts could differ
significantly from these estimates.




We have
identified the policies below as critical to our business operations and the
understanding of our financial results and they require management's most
difficult, subjective or complex judgments, resulting from the need to make
estimates about the effect of matters that are inherently uncertain. The impact
and any associated risks related to these policies on our business operations is
discussed throughout Management's Discussion and Analysis of Financial Condition
and Results of Operations where such policies affect our reported and expected
financial results.




Revenue
Recognition




We
recognize revenue upon the transfer of title and risk of loss to our customers.
Accordingly, we recognize revenue for software when (1) there is persuasive
evidence that an arrangement with our customer exists, which is generally a
customer purchase order, (2) the product is delivered, (3) the selling
price is fixed or determinable, (4) collection of the customer receivable
is deemed probable and (5) we do not have any continuing obligations. Our
payment arrangements with customers typically provide net 30 and 60-day terms.
Advances received from customers are reported on the balance sheet as deferred
revenue until we meet our performance obligations, at which point we recognize
the revenue.




Revenue
is recognized after deducting estimated reserves for returns and price
concessions. In specific circumstances when we do not have a reliable basis to
estimate returns and price concessions or are unable to determine that
collection of receivables 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 receivables is probable.





Allowances for Returns and
Price Concessions




We accept
returns and grant price concessions in connection with our publishing
arrangements. Following reductions in the price of our products, we grant price
concessions to permit customers to take credits against amounts they owe us with
respect to merchandise unsold by them. Our customers must satisfy certain
conditions to entitle them to return products or receive price concessions,
including compliance with applicable payment terms and confirmation of
field inventory levels.




Our
distribution arrangements with customers do not give them the right to return
titles or to cancel firm orders. However, we sometimes accept returns from our
distribution customers for stock balancing and make accommodations for
customers, which include credits and returns, when demand for specific titles
falls below expectations.




36




We make
estimates of future product returns and price concessions related to current
period product 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 hardware platform, 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 products 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, these estimates are inherently subjective and 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.




Inventory




Inventory
is stated at the lower of actual cost or market. We estimate the net realizable
value of slow-moving inventory on a title-by-title basis and charge the excess
of cost over net realizable value to cost of sales.





Product Development
Costs




We
utilized both internal development teams and third party product developers to
develop the titles we publish.  With the sale of Supervillain in
September 2008, we no longer have any internal development studios or related
costs.




We
capitalized internal product development costs (including stock-based
compensation, specifically identifiable employee payroll expense and incentive
compensation costs related to the completion and release of titles), as well as
third party production and other content costs, subsequent to establishing
technological feasibility of a video game title. Technological feasibility of a
product includes the completion of both technical design documentation and game
design documentation. Amortization of such capitalized costs is recorded on a
title-by-title basis in cost of goods sold using the proportion of current year
revenues to the total revenues expected to be recorded over the life of the
title.




We
frequently enter into agreements with third party developers that normally
require us to make advance payments for game development and production
services. In exchange for our advance payments, we receive the exclusive
publishing and distribution rights to the finished game title. Such agreements
allow us to fully recover the advance payments to the developers at an agreed
royalty rate earned on the subsequent retail sales of such games, net of any
agreed costs. We capitalize all advance payments to developers as product
development. On a product-by-product basis, we reduce product development costs
and record a corresponding amount of research and development expense for any
costs incurred by third party developers prior to establishing technological
feasibility of a product. We typically enter into agreements with third party
developers after completing the technical design documentation for our products
and therefore record the design costs leading up to a signed developer contract
as research and development expense. We also generally contract with third party
developers that have proven technology and experience in the genre of the video
game being developed, which often allows for the establishment of technological
feasibility early in the development cycle. In instances where the documentation
of the design and technology are not in place prior to an executed contract, we
monitor the product development process and require our third party
developers to adhere to the same technological feasibility standards that apply
to our internally developed products.





We also
capitalize advance payments as product development costs subsequent to
establishing technological feasibility of a video game title and amortize them,
on a title-by-title basis, as product development costs in cost of goods sold.
Royalty amortization is recorded using the proportion of current year revenues
to the total revenues expected to be recorded over the life of the
title.




37




At each
balance sheet date, or earlier if an indicator of impairment exists, we evaluate
the recoverability of capitalized product development costs, advance development
payments and any other unrecognized minimum commitments that have not been paid,
using an undiscounted future cash flow analysis, and charge any amounts that are
deemed unrecoverable to cost of goods sold if the product has already been
released. If the product is discontinued prior to completion, any prepaid
unrecoverable advances are charged to research and development expense. We use
various measures to estimate future revenues for our video game titles,
including past performance of similar titles and orders for titles prior to
their release. For sequels, the performance of predecessor titles is also taken
into consideration.




Prior to
establishing technological feasibility, we expense research and development
costs as incurred.





In
December 2007, the FASB issued FASB ASC Topic 808-10-15, “Accounting for
Collaborative Arrangements” (ASC 808-10-15) which defines collaborative
arrangements and requires collaborators to present the result of activities for
which they act as the principal on a gross basis and report any payments
received from (made to) the other collaborators based on other applicable
authoritative accounting literature, and in the absence of other applicable
authoritative literature, on a reasonable, rational and consistent accounting
policy is to be elected.  Effective January 1, 2009, the Company adopted
the provisions of FASB ASC Topic 808-10-15.  The adoption of the statement
did not have an impact on the Company’s consolidated financial position, results
of operations or cash flows.




Licenses and
Royalties




Licenses
consist of payments and guarantees made to holders of intellectual property
rights for use of their trademarks, copyrights, technology or other intellectual
property rights in the development of our products. Agreements with rights
holders generally provide for guaranteed minimum royalty payments for use of
their intellectual property.  When significant performance remains to
be completed by the licensor, we record payments when actually
paid.  Certain licenses extend over multi-year periods and
encompass multiple game titles. In addition to guaranteed minimum payments,
these licenses frequently contain provisions that could require us to pay
royalties to the license holder, based on pre-agreed unit sales
thresholds.




Amounts
paid for licensing fees are capitalized on the balance sheet and are amortized
as royalties in cost of goods sold on a title-by-title basis at a ratio of
current period revenues to the total revenues expected to be recorded over the
remaining life of the title.  Similar to product development costs, we
review our sales projections quarterly to determine the likely recoverability of
our capitalized licenses as well as any unpaid minimum obligations. When
management determines that the value of a license is unlikely to
be recovered by product sales, capitalized licenses are charged to cost of
goods sold, based on current and expected revenues, in the period in which such
determination is made. Criteria used to evaluate expected product performance
and to estimate future sales for a title include: historical performance of
comparable titles; orders for titles prior to release; and the estimated
performance of a sequel title based on the performance of the title on which the
sequel is based.




Asset
Impairment




Business Combinations—Goodwill and Intangible Assets.    The purchase method of accounting requires that
assets acquired and liabilities assumed be recorded at their fair values on the
date of a business acquisition. Our consolidated financial statements and
results of operations reflect an acquired business from the completion date of
an acquisition. The costs to acquire a business, including transaction,
integration and restructuring costs, are allocated to the fair value of net
assets acquired upon acquisition. Any excess of the purchase price over the
estimated fair values of the net tangible and intangible assets acquired is
recorded as goodwill.





Goodwill
is the excess of purchase price paid over identified intangible and tangible net
assets of acquired companies. Intangible assets consist of trademarks, customer
relationships, content and product development. Certain intangible assets
acquired in a business combination are recognized as assets apart from goodwill.
Identified intangibles other than goodwill are generally amortized using the
straight-line method over the period of expected benefit ranging from one to ten
years, except for intellectual property, which are usage-based intangible assets
that are amortized using the shorter of the useful life or expected revenue
stream.




38





The
Company performs a goodwill impairment test at least on an annual basis and
whenever events or changes in circumstances indicate that the carrying value may
not be recoverable from estimated future cash flows. We will perform tests
of impairment in the fourth quarter of each fiscal year or earlier if indicators
of impairment exist. We determine the fair value of each reporting unit
using a discounted cash flow analysis and compare such values to the respective
reporting unit's carrying amount.





The
Company incurred a triggering event as of September 30, 2009 based on the equity
infusion of approximately $4.0 million for 50% ownership in the Company and the
conversion of the existing convertible debt during the fourth quarter of
2009.  As such, the Company performed an impairment analysis which
resulted in an impairment of goodwill of $14.7 million in 2009.  There
was no impairment of other intangible assets.




Long-lived assets including
identifiable intangibles.  We review long-lived assets for
impairment whenever events or changes in circumstances indicate that the related
carrying amounts may not be recoverable. Determining whether impairment has
occurred typically requires various estimates and assumptions, including
determining which cash flows are directly related to the potentially impaired
asset, the useful life over which cash flows will occur, their amount and the
asset's residual value, if any. In turn, measurement of an impairment loss
requires a determination of fair value, which is based on the best
information available. We use internal discounted cash flow estimates, quoted
market prices when available and independent appraisals, as appropriate, to
determine fair value. We derive the required cash flow estimates from our
historical experience and our internal business plans and apply an appropriate
discount rate.  See section above entitled “Asset
Impairment”.




Stock-based
Compensation




Stock-based
compensation expense is measured at the grant date based on the fair value of
the award and is recognized as expense over the vesting period. Determining the
fair value of share-based awards at the grant date requires judgment, including,
in the case of stock option awards, estimating expected stock volatility. In
addition, judgment is also required in estimating the amount of share-based
awards that are expected to be forfeited. If actual results differ significantly
from these estimates, stock-based compensation expense and our results of
operations could be materially impacted.




Income
Taxes




Zoo Games
was a limited liability company from inception until May 16, 2008 and followed
all applicable United States tax regulations for a limited liability company.
Effective May 16, 2008 when Zoo Games became incorporated, it became necessary
for us to make certain estimates and assumptions to compute the provision for
income taxes including allocations of certain transactions to different tax
jurisdictions, amounts of permanent and temporary differences, the
likelihood of deferred tax assets being recovered and the outcome of
contingent tax risks. These estimates and assumptions are revised as new events
occur, more experience is acquired and additional information is obtained. The
impact of these revisions is recorded in income tax expense or benefit in the
period in which they become known.





We
account for uncertain income tax positions by recognizing in the consolidated
financial statements only those tax positions we determine to be more likely
than not of being sustainable upon examination, based on the technical merits of
the positions, under the presumption that the taxing authorities have full
knowledge of all relevant facts. The determination of which tax positions are
more likely than not sustainable requires us to use significant judgments and
estimates, which may or may not be borne out by actual results.





39




Recently
Issued Accounting Pronouncements





Effective
January 1, 2009, the Company adopted ASC Topic 815 which clarifies the
determination of whether an instrument (or an embedded feature) is indexed to an
entity’s own stock. The adoption of ASC Topic 815 did not have a significant
impact on our results of operations or financial position.





In June
2009, the FASB issued ASC Topic 105 which establishes the FASB Accounting
Standards Codification as the single source of authoritative GAAP for all
non-governmental entities, with the exception of the SEC and its staff. ASC
Topic 105 changes the referencing and organization of accounting guidance and is
effective for interim and annual periods ending after September 15, 2009. Since
it is not intended to change or alter existing GAAP, the Codification did not
have any impact on the Company’s financial condition or results of
operations.  Going forward, the Board will not issue new standards in
the form of Statements, FASB Staff Positions, or Emerging Issues Task Force
Abstracts; instead, it will issue Accounting Standards Updates. The FASB will
not consider Accounting Standards Updates as authoritative in their own right;
these updates will serve only to update the Codification, provide background
information about the guidance, and provide the bases for conclusions on the
change(s) in the Codification. In the description of Accounting Standards
Updates that follows, references in “italics” relate to Codification Topics and
Subtopics, and their descriptive titles, as appropriate.





Accounting
Standards Updates Not Yet Effective





In June
2009, an update was made to “Consolidation – Consolidation of Variable Interest
Entities.” Among other things, the update replaces the calculation for
determining which entities, if any, have a controlling financial interest in a
variable interest entity (VIE) from a quantitative based risks and rewards
calculation, to a qualitative approach that focuses on identifying which
entities have the power to direct the activities that most significantly impact
the VIE’s economic performance and the obligation to absorb losses of the VIE or
the right to receive benefits from the VIE. The update also requires ongoing
assessments as to whether an entity is the primary beneficiary of a VIE
(previously, reconsideration was only required upon the occurrence of specific
events), modifies the presentation of consolidated VIE assets and liabilities,
and requires additional disclosures about a company’s involvement in VIEs. This
update will be effective for the company beginning January 1, 2010. Management
has concluded that adoption of this update will have no significant impact on
the company’s consolidated financial position and results of operations when it
becomes effective in 2010.





Other
Accounting Standards Updates not effective until after December 31, 2009, are
not expected to have a significant effect on the company’s consolidated
financial position or results of operations.





Off-Balance
Sheet Arrangements





We do not
have any relationships with unconsolidated entities or financial partners, such
as entities often referred to as structured finance or special purpose entities,
which would have been established for the purpose of facilitating off-balance
sheet arrangements or other contractually narrow or limited purposes. In
addition, we do not have any undisclosed borrowings or debt, and we have not
entered into any synthetic leases. We are, therefore, not materially exposed to
any financing, liquidity, market or credit risk that could arise if we had
engaged in such relationships.





Fluctuations
in Operating Results and Seasonality





We
experience fluctuations in quarterly and annual operating results as a result
of: the timing of the introduction of new titles; variations in sales of titles
developed for particular platforms; market acceptance of our titles; development
and promotional expenses relating to the introduction of new titles, sequels or
enhancements of existing titles; projected and actual changes in platforms; the
timing and success of title introductions by our competitors; product returns;
changes in pricing policies by us and our competitors; the size and timing of
acquisitions; the timing of orders from major customers; order
cancellations; and delays in product shipment. Sales of our products are also
seasonal, with peak shipments typically occurring in the fourth calendar quarter
as a result of increased demand for titles during the holiday season. Quarterly
and annual comparisons of operating results are not necessarily indicative of
future operating results.




40





Legal
Matters





On February 19, 2009, Susan J. Kain Jurgensen, Steven W.
Newton, Mercy R. Gonzalez, Bruce C. Kain, Wesley M. Kain, Raymond Pierce and
Cristie E. Walsh filed a complaint against Zoo Publishing, Zoo Games and Zoo in
the Supreme Court of the State of New York, New York County, index number
09 / 102381 alleging claims for breach
of certain loan agreements and employment
agreements, intentional interference and fraudulent transfer.
The complaint sought compensatory damages, punitive damages and preliminary
and permanent injunctive relief, among other remedies. On June 18, 2009, we
reached a settlement whereby we agreed to pay to the plaintiffs an aggregate of
$560,000 (the “Settlement Amount”) in full satisfaction of the disputed claims,
without any admission of any liability of wrongdoing as follows: (a) $300,000 on
June 26, 2009; (b) $60,000 on or before the earlier of (i) the date that is 90
days from June 18, 2009 or (ii) the date the Company obtains new and available
financing, including any amounts currently held in escrow that will be released
from escrow after June 18, 2009, in any form and from any source, in an amount
totaling at least $2,000,000; (c) $100,000 on or before December 18, 2009; and
(d) $100,000 on or before June 18, 2010. To date, $460,000 of the Settlement
Amount has been paid to the plaintiffs. The Zoo Publishing Notes and all other
notes, employment, agreements, loan agreements, options, warrants and other
agreements relating to the plaintiffs (except with respect to that certain
Employment Agreement between Zoo Publishing and Cristie E. Walsh) were
terminated and all outstanding obligations of the Company related to these
agreements were cancelled. In addition, the plaintiffs returned to us an
aggregate of 5,563,950 shares of our common stock owned by them prior to such
date.





We are
also involved in various other legal proceedings and claims incident to the
normal conduct of our business. Although it is impossible to predict the outcome
of any legal proceeding and there can be no assurances, we believe that our
legal proceedings and claims, individually and in the aggregate, are not likely
to have a material adverse effect on our financial condition, results of
operations or cash flows.




Item 7A. Quantitative and Qualitative
Disclosures About Market Risk.





Not
applicable as we are a smaller reporting company.





Item 8. Financial Statements and Supplementary Data.





The
financial statements required by Item 8 are submitted in a separate section
of this report, beginning on Page F-1, and are incorporated herein and made a
part hereof.





Item 9. Changes in and Disagreements
with Accountants on Accounting and
Financial Disclosure.





As
previously disclosed in that Current Report on Form 8-K filed with the
Securities and Exchange Commission on November 5, 2008, effective October 30,
2008, we dismissed Raich Ende Malter & Co. LLP (“Raich Ende”) as our
independent public accounting firm and appointed Amper, Politziner & Mattia,
LLP (“AP&M”) as our independent public accounting firm to provide audit
services for us. The decision to change accountants was approved by our board of
directors.





From
April 18, 2008 to October 30, 2008, the period of time that Raich Ende served as
our principal accountant, no audits were performed by Raich Ende and,
therefore, no reports were issued that (i) contained an adverse opinion or
disclaimers of opinion and (ii) were qualified or modified as to
uncertainty, audit scope or accounting principles.




41





From
April 18, 2008 to October 30, 2008, there were no disagreements between us and
Raich Ende on any matter of accounting principles or practices, financial
statement disclosure, or auditing scope or procedures, which disagreements, if
not resolved to the satisfaction of Raich Ende, would have caused Raich Ende to
make reference to the subject matter of the disagreements in connection with its
reports on our financial statements during such periods. None of the events
described in Item 304(a)(1)(v) of Regulation S-K occurred during the period that
Raich Ende served as our principal accountant.





During
our fiscal years ended December 31, 2007 and December 31, 2006, and through
October 30, 2008, we did not consult with AP&M regarding the application of
accounting principles to a specified transaction, or the type of audit opinion
that might be rendered on our financial statements and no written or oral report
was provided by AP&M that was a factor considered by us in reaching a
decision as to the accounting, auditing or financial reporting issues, and the
Company did not consult AP&M on or regarding any matters set forth in Item
304(a)(2)(i) or (ii) of Regulation S-K.




Item 9A(T). Controls andProcedures.





Disclosure
controls and procedures.


Our
management, with the participation of our Chief Executive Officer and Chief
Financial Officer, has evaluated the effectiveness of our disclosure controls
and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e), as of
the end of the period covered by this report.





In
designing and evaluating our disclosure controls and procedures, management
recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives.





No system
of controls can prevent errors and fraud. A control system, no matter how well
designed and operated, can provide only reasonable, not absolute, assurance that
the control system’s objectives will be met. Further, the design of a control
system must reflect the fact that there are resource constraints, and the
benefits of controls must be considered relative to their costs. Because of the
inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within our company have been detected. These inherent limitations include
the realities that judgments in decision-making can be faulty, and that
breakdowns can occur. Controls can also be circumvented by individual acts of
some people, by collusion of two or more people, or by management override of
the controls. The design of any system of controls is based in part upon
certain assumptions about the likelihood of future events, and there can be no
assurance that any design will succeed in achieving its stated goals under all
potential future conditions. Over time, controls may become inadequate because
of changes in conditions or deterioration in the degree of compliance with its
policies or procedures. Because of the inherent limitations in a cost-effective
control system, misstatements due to error or fraud may occur and not be
detected.





Based on
the evaluation of the effectiveness of our disclosure controls and procedures,
our Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e)
and 15d-15(e)) were not effective at a reasonable assurance level.





Our
management has determined that we have a material weakness in our internal
control over financial reporting related to not having a sufficient number of
personnel with the appropriate level of experience and technical expertise to
appropriately resolve non-routine and complex accounting matters or to evaluate
the impact of new and existing accounting pronouncements on our consolidated
financial statements while completing the financial statements close
process.





Changes
in controls and procedures.





There
were no changes in our internal control over financial reporting identified in
connection with the evaluation of such internal control that occurred during the
fourth quarter of our last fiscal that year materially affected, or that are
reasonably likely to materially affect, our internal control over financial
reporting.




42





Management’s
Annual Report on Internal Control Over Financial Reporting.





Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f)
under the Exchange Act. Our internal control over financial reporting is
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles, or GAAP. Our internal
control over financial reporting includes those policies and procedures
that:





• pertain
to the maintenance of records that in reasonable detail accurately and fairly
reflect transactions involving our assets;





• provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with GAAP, and that our
receipts and expenditures are being made only in accordance with the
authorization of our management; and





• provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of our assets that could have a material effect
on the financial statements.





Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.





Management
assessed the effectiveness of our internal control over financial reporting as
of December 31, 2009. In making this assessment, management used the framework
set forth in the report entitled Internal Control-Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission, or COSO.
The COSO framework summarizes each of the components of a company’s internal
control system, including (i) the control environment, (ii) risk assessment,
(iii) control activities, (iv) information and communication, and (v)
monitoring. Our management has determined that we have a material weakness in
our internal control over financial reporting related to not having a sufficient
number of personnel with the appropriate level of experience and technical
expertise to appropriately resolve non-routine and complex accounting
matters or to evaluate the impact of new and existing accounting
pronouncements on our consolidated financial statements while completing the
financial statements close process.  Based on this evaluation,
management determined that our system of internal control over financial
reporting was not effective as of December 31, 2009.





Until
this deficiency in our internal control over financial reporting is remediated,
there is a reasonable possibility that a material misstatement to our annual or
interim consolidated financial statements could occur and not be prevented or
detected by our internal controls in a timely manner.





Due to
resource constraints in 2009, both monetary and time, we were not able to
appropriately address this matter in 2009.  We are committed
to addressing this in 2010 and we will reassess our accounting and finance
staffing levels to determine and seek the appropriate accounting resources to be
added to our staffto handle the existing workload.





This
report does not include an attestation report of our registered public
accounting firm regarding internal control over financial reporting.
Management’s report was not subject to attestation by our registered public
accounting firm pursuant to temporary rules of the SEC that permit the Company
to provide only a management’s report in this report.




Item 9B. Other Information.





Not
applicable.




43




PART III




Item 10.Directors,
Executive Officers and Corporate Governance.





Set forth
below are the names of our directors and executive officers, their ages, their
offices in Zoo Entertainment, Inc., if any, their principal occupations or
employment for the past five years, the length of their tenure as directors and
the names of other public companies in which such persons hold directorships, if
any.




Name
              
              Age
              
              Position(s)Mark
      Seremet
              
              45
              
              Director,
      Chief Executive Officer and PresidentJay
      A. Wolf
              
              37
              
              Chairman
      of the Board and SecretaryBarry
      I. Regenstein
              
              52
              
              DirectorJohn
      Bendheim
              
              56
              
              DirectorDrew
      Larner
              
              45
              
              DirectorMoritz
      Seidel
              
              38
              
              DirectorDavid
      Smith
              
              63
              
              DirectorDavid
      J. Fremed
              
              49
              
              Chief
      Financial OfficerDavid
      Rosenbaum
              
              57
              
              President
      of Zoo PublishingSteven
      Buchanan
              
              50
              
              Chief
      Operating Officer of Zoo
Publishing




Our board
of directors has concluded that at the time of this filing, each of the members
of the board of directors should serve as a director based upon his particular
experience, qualifications, attributes and skills, in light of our business and
structure.  Biographical information for our directors and executive
officers are as follows:





Mark Seremet.Mr.
Seremet has been our Chief Executive Officer and President since May 2009, and
has served as a director since September 2008. He has been Chief Executive
Officer of Zoo Games since January 2009 and has served as President of Zoo Games
since April 2007. Prior to his start at Zoo, Mr. Seremet was an activist
internet investor with investments in private companies. From 2005-2006 Mr.
Seremet also served as CEO of Spreadshirt.com, which he quickly grew
to a lead provider of online, customized merchandise. Mr. Seremet is a
co-founder and the first CEO of Take-Two Interactive Software, Inc.,
which he helped take public in 1997, and where he was President and Chief
Operating Officer from 1993 to 1998. Additionally, he served as the Chief
Operating Officer of Picis from 1998-2000, SA in Barcelona, Spain and
orchestrated its registration for an initial public offering on the Nouveau
Marche. Mr. Seremet is also the founder and Chief Executive Officer of Paragon
Software, which was acquired in 1992 by MicroProse. Mr. Seremet serves on the
boards of Serklin, Inc. He was named Young Entrepreneur of the Year by the U.S.
Small Business Administration in 1989 for Pennsylvania and the Mid-Atlantic
region and received a B.S. in Business Computer Systems Analysis from Saint
Vincent College.  Mr. Seremet’s extensive experience in the video game
industry, his familiarity with our business and his management and
entrepreneurial skills, are an asset to his services as a director.




Jay A. Wolf.  Mr.
Wolf has served as a director and our Secretary since October 1, 2007, and as
Executive Chairman of our board of directors since February 11,
2010.  He is the founder and principal of Wolf Capital LP an
investment advisory firm he formed in October 2009 to focus on small cap public
companies. From November 2003 until September 2009, Mr. Wolf was a partner at
Trinad Capital LLC, an activist hedge fund focused on micro-cap public
companies. During his work at Trinad, Mr. Wolf assisted distressed and early
stage public companies through active board participation, the assembly of
management teams and business and financial strategies. Prior to his work at
Trinad, Mr. Wolf served as executive vice president of Corporate Development for
Wolf Group Integrated Communications Ltd. Prior to that, Mr. Wolf worked at
Canadian Corporate Funding, Ltd., a Toronto-based merchant bank as an analyst in
the firm’s senior debt department and subsequently for Trillium Growth Capital,
the firm’s venture capital fund. Mr. Wolf currently also sits on the boards of
Xcorporeal, Inc. (XCR), Hythiam Inc. (HYTM) and NorthStar Systems, Inc. Mr. Wolf
is also a member of the board of governors at Cedars-Sinai Hospital. He is a
former director of Asianada, Inc., ProLink Holdings Corp., Mandalay Media, Inc.,
Atrinsic, Inc., Shells Seafood Restaurants, Inc., Optio Software, Inc.,
Xcorporeal Operations, Inc., Zane Acquisition I, Inc., Zane Acquisition II,
Inc., Starvox Communications, Inc. and Noble Medical Technologies,
Inc.  Mr. Wolf received his B.A from Dalhousie
University.
 
 Mr. Wolf
was Chief Operating Officer and Chief Financial Officer of Starvox
Communications, Inc. from March 2005 to March 2007.  On March 26,
2008, StarVox Communications, Inc. filed a voluntary petition for liquidation
under Chapter 7 of the United States Bankruptcy Code in the United States
Bankruptcy Court for the Northern District of California, San
Jose.  Shells Seafood Restaurants, Inc., a company for which Mr. Wolf
formerly served as a director, filed a voluntary petition for reorganization
under Chapter 11 of the United States Bankruptcy Code in the United States
Bankruptcy Court for the Middle District of Florida, Tampa Division, on
September 2, 2008.
 
 Mr.
Wolf’s broad range of investment and operations experience, which includes
senior and subordinated debt lending, private equity and venture capital
investments, mergers and acquisitions advisory work and public equity
investments, equip him with the qualifications and skills to serve on our board
of directors.




44





Barry I.
Regenstein.  Mr.
Regenstein has served as a director since October 1, 2007. Mr. Regenstein is
also President and Chief Financial Officer of Command Security Corporation. Mr.
Regenstein has served as Command Security Corporation’s President since January
2006, as its Executive Vice President and Chief Operating Officer from August
2004 until December 2005, and also as its Chief Financial Officer since October
2004. Trinad Capital Master Fund, Ltd. is a significant shareholder of Command
Security Corporation and Mr. Regenstein has formerly served as a consultant for
Trinad Capital Master Fund, Ltd. from February 2004 until August 2004. Prior to
that period, Mr. Regenstein served as a Senior Vice President and Chief
Financial Officer of GlobeGround North America LLC (formerly Hudson General
Corporation), an airport services company from 2001 until 2003. Mr. Regenstein
also served as Vice President and Chief Financial Officer of GlobeGround North
America LLC from 1997 to 2001 and was employed in various executive capacities
with GlobeGround North America LLC since 1982. Prior to joining Hudson General
Corporation, he was with Coopers & Lybrand in Washington, D.C. Mr.
Regenstein is a Certified Public Accountant and received a B.S. in Accounting
from the University of Maryland and an M.S. in Taxation from Long Island
University. Mr. Regenstein is also a member of the board of directors of Command
Security Corporation (MOC).   He is a former director of Mandalay
Media, Lateral Media, ProLink Holdings, Mediavest, New Motion and US
Wireless.  Mr. Regenstein’s over 30 years of business experience, including
over 25 years in operations and finance of contract services companies, are
valuable to his contributions as a director.





John Bendheim.   Mr.
Bendheim has served as a director since June 2008. Mr. Bendheim is President of
Bendheim Enterprises, Inc., a real estate investment holding company with
operations located exclusively in California and Nevada. Mr. Bendheim has
specialized in providing equity funding for real estate transactions.
Previously, he was President of Benditel Incorporated (1988-1994), an apparel
manufacturer based in Los Angeles, California. Mr. Bendheim has invested in real
estate for his personal account since 1976 and has owned apartments, surgery
centers, office buildings, condominiums, model homes, industrial buildings,
recreational vehicle parks, and convenience centers.  Mr. Bendheim was
the past Chairman of the Cedars-Sinai Board of Governors (2000-2002) and is
the current chairman of the Los Angeles Sports & Entertainment
Commission.  He is a member of the Board of Directors of the Brentwood
School, California Republic Bank, Cedars-Sinai Medical Center, Lowenstein
Foundation, Beverly Hills Chamber of Commerce, University Of Southern California
Alumni Association Board of Governors, Cedars Sinai Medical Genetics Institute-
Community Advisory Board, USC Marshall School Board of Leaders, Wallace
Annenberg Center For the Performing Arts, Los Angeles Committee on Foreign
Relations, and the Evergreen Community School.  Mr. Bendheim received
a B.S. degree in 1975 and an MBA in 1976 from the University of Southern
California.   Mr. Bendheim’s extensive management skills and his
experience in providing equity funding for companies, are useful in his services
as a director.





Drew Larner.Mr. Larner has
served as a director since September 2008.  He is CEO of Rdio, Inc., a
digital music subscription service.  From 2003 to 2009, he was a Managing
Director of Europlay Capital Advisors, a Los Angeles-based merchant bank and
advisory firm specializing in media and technology companies.  Prior to
Europlay, Mr. Larner spent over twelve years as an executive in the motion
picture industry, most recently as Executive Vice-President at Spyglass
Entertainment Group. In that role, he was involved in all operations of Spyglass
with specific oversight of business development, international distribution and
business and legal affairs.  Mr. Larner was responsible for managing the
company’s output arrangements with the Walt Disney Company, Kirch Media, Canal
Plus and Toho Towa (among others) as well as the equity investments of Disney,
Svensk Filmindustri (a subsidiary of the Bonnier Group) and Lusomundo
Audiovisuais (a subsidiary of Portuguese Telecom) in Spyglass. During Mr.
Larner’s tenure at Spyglass, the company released over fifteen feature films
including the blockbuster hit The Sixth Sense, as well as
successes Seabiscuit, Bruce Almightyand The Recruit. Prior to
Spyglass, Mr. Larner spent a total of five years at Morgan Creek Productions
during which time he headed up the business and legal affairs department and
then moved on to run Morgan Creek International, the company’s international
distribution subsidiary.  In this period, Morgan Creek released over twenty
feature films including hits Ace Ventura: Pet Detective,
its sequel Ace Ventura: When
Nature Calls, Robin
Hood: Prince of Thievesand Last of the Mohicans.  Additionally,
Mr. Larner spent two years as Vice President/Business Affairs at Twentieth
Century Fox.  Mr. Larner began his career as an attorney in the Century
City office of O’Melveny & Myers. Mr. Larner currently serves on the Board
of Directors of Broadspring, an online search and advertising company. Mr.
Larner received a B.A. from Wesleyan University, after which he earned a J.D.
from Columbia Law School.   Mr. Larner’s background and
experience with technology and entertainment are assets to his services as
a director.




45




Moritz Seidel.  Mr.
Seidel has served as a director since January 2009.  Since April 2007, Mr.
Seidel has been the managing director of T7M7 Unternehmensaufbau GmbH, a
privately held Venture Capital firm focused on early-stage investments in
Ecommerce and gaming companies. He has also served as a Managing Director of
MyBestBrands GmbH, an B2C Ecommerce service, since November 2008. In 1998 he
founded Webfair AG, a company that provides software solutions to automotive
manufacturers (OEMs) and became its Chief Executive Officer. Webfair ́s software
is used today by more than 50% of all automotive OEMs to monitor the status,
bonus schemes and improvement processes of their dealer networks in
Europe.  In March 2006, Webfair AG was acquired by Urban Science Inc.,
headquartered in Detroit, Michigan.  Mr. Seidel was responsible for the
integration of Webfair AG within the international Urban Science organization
and left the company in April 2007. From 1994 to 1997, Mr. Seidel was a
consultant with Roland Berger & Partner, the largest management consulting
firm of European origin. His focus was consumer goods, retail and internet. He
is a member of the Entrepreneurs Organization (YEO and EO). Mr. Seidel graduated
at the age of 23 from the University of Regensburg, Germany with a Diploma in
Business Studies (Diplom Kaufmann) and went to school in Germany and United
States. Mr. Seidel’s experience with internet and gaming companies, coupled with
his management skills, are valuable contributions to his services as a
director.




David E.
Smith. Mr. Smith
has served as a director since December 2009.  Mr. Smith is the President,
CEO, Chairman and primary beneficial owner of Coast Asset Management, LLC, a
private investment management firm. Since 1971, following his graduation from
the MBA program at the University of California at Berkeley, Mr. Smith has
worked in various capacities in the securities industry. His past experience
includes a stint at Security Pacific Bank (1973-1983), where Mr. Smith was a
Vice President responsible for the sales and fixed income arbitrage trading
activities of the Investment Department. In March 1983, Mr. Smith joined
Oppenheimer and Company as a bond arbitrageur trading that firm's proprietary
capital account. In 1986, Mr. Smith was appointed a Senior Vice President at
Oppenheimer, a position he held until he left in November 1990. Following his
departure from Oppenheimer, Mr. Smith founded the predecessor for what would
ultimately become Coast Asset Management, LLC.  Coast Asset Management, LLC
is not affiliated with the Issuer.  Mr. Smith’s experience in the
securities industry and his entrepreneurial skills are assets to our board of
directors.





David J.
Fremed.  Mr. Fremed has been our Chief Financial Officer since
May 2009, and Chief Financial Officer of Zoo Games since August 2007. He is a
broad-based financial executive with extensive experience in financial
operations, budgeting and forecasting, and strategic planning. Prior to working
at Zoo Games, he was Executive VP and Chief Financial Officer at Grand Toys
International Limited (Nasdaq: GRIN ) where he helped grow the company from $10
million to $150 million in just two years. Mr. Fremed also spent four years at
Atari, Inc. as Senior VP of Finance and Chief Financial Officer. During
that time he was responsible for all financial functions including treasury, SEC
reporting, and compliance. Prior to Atari, Mr. Fremed spent ten years at Marvel
Enterprises, Inc. (MVL) and its predecessor in various financial capacities,
including Chief Financial Officer. Mr. Fremed earned his MBA in Finance from New
York University in 1987 and is a Certified Public Accountant.





David Rosenbaum.  Mr.
Rosenbaum has been the President of Zoo Publishing since April 2009.  He
has served in various capacities at Zoo Publishing since July 2006 including as
Senior Vice President of Sales.  Mr. Rosenbaum served as the Sales Manager
of Elmex Corporation, a western model company, from 1975 to 1980, and again from
1982 to 1983.  He served as the Sales Manager of General Toy
Distribution, a toy distribution company, from 1979 to 1981.  Mr.
Rosenbaum was also the Sales Manager of Kramer Brothers Distribution
Company, a hobby distributor, from 1981 to 1982, and of Associated Independent
Distributors from 1983 to 1989.  In 1989, Mr. Rosenbaum founded Jack of All
Games, which he sold in 1998, but remained on as President through March
2006.  Mr. Rosenbaum received a B.A. from the University of Cincinnati in
1974.




46





Steven Buchanan.  Mr.
Buchanan has been the Chief Operating Officer of Zoo Publishing since February
2010.  Mr. Buchanan has served as a consultant in a range of
capacities at Zoo Publishing since March 2009. Mr. Buchanan has held a
variety of executive titles at Jack of All Games, a video game distribution
company, including Executive Vice President of Sales and Marketing and President
from 1999 to 2009.  At various times between 1992 and 1999, he served
as District Sales Manager, Eastern Zone Sales Manager and National Sales
Director of Sega of America, a video game publisher. Mr. Buchanan also served as
a Buyer Merchandiser from 1981 to 1992, specializing in video games, at Meijer,
a Michigan based hypermarket.




There are
no family relationships among our directors or executive officers.




Section
16(a) Beneficial Ownership Reporting Compliance.
 
 Section
16(a) of the Securities Exchange Act of 1934 requires our officers and
directors, and persons who own more than ten percent of a registered class of
our equity securities, to file reports of ownership and changes in ownership
with the Securities and Exchange Commission (“SEC”). These persons are required
by regulation to furnish us with copies of all Section 16(a) reports that they
file. Based on our review of the copies of these reports received by us, or
written representations from the reporting persons that no other reports were
required, we believe that, during 2009, all filing requirements applicable to
our current officers, directors and greater than ten percent beneficial owners
were complied with.
  Code
of Ethics.
 
 Now that
we are no longer a shell company, we intend to establish a code of
ethics.
 
 Committees
of the Board of Directors.
  The Board
has determined that each member of the audit committee is “independent,” as that
term is defined under Rule 10A-3(b)(1) of the Securities and Exchange Act of
1934, as amended.
 
 Audit Committee.The Audit
Committee of our Board of Directors consists of Messrs. Barry Regenstein
(Chairman), John Bendheim and Drew Larner. Our Audit Committee held one meeting
in 2008, since we became an operating company as a result of the merger with Zoo
Games in September 2008.  Our Audit Committee has the authority to retain
and terminate the services of our independent accountants, review annual
financial statements, consider matters relating to accounting policy and
internal controls and review the scope of annual audits.  The Audit
Committee acts under a written charter, which more specifically sets forth its
responsibilities and duties, as well as requirements for the Committee’s
composition and meetings.  The Board has determined that
Messrs. Barry Regenstein, John Bendheim and Drew Larner are “financial
experts” serving on its Audit Committee, and are independent, as the SEC has
defined that term under Item 407 of Regulation S-K.  Please see the
biographical information for these individuals contained in the section
above.  During 2008, the Audit Committee held one
meeting.   During 2009, the Audit Committee held five
meetings.
 
 Nominating Committee.We are
not a listed company and there is no legal requirement that we have a nominating
committee. We do not have a formal policy in regard to nominations, but the
board of directors would consider any person as a nominee whose name is
submitted in writing at its corporate address at least 120 days before a meeting
at which directors are to be elected.
 
 Compensation Committee.We
have a Compensation Committee consisting of Messrs. Barry Regenstein, Drew
Larner and John Bendheim.The Compensation
Committee determines matters pertaining to the compensation and expense
reporting of certain of our executive officers, and administers our stock
option, incentive compensation, and employee stock purchase plans.  The
Compensation Committee acts under a written charter, which more specifically
sets forth its responsibilities and duties, as well as requirements for the
Committee’s composition and meetings.  During 2008, the Compensation
Committee held one meeting.  During 2009, the Compensation Committee held
three meetings.




47




Independence of
Directors.  Our Board currently consists of seven members. They
are Jay Wolf, Barry Regenstein, John Bendheim, Drew Larner, Moritz Seidel, Mark
Seremet and David Smith. Messrs. Regenstein, Bendheim, Larner, Seidel and Smith
are independent directors. We have determined their independence using the
definition of independence set forth under the applicable NASDAQ
Marketplace rules.
 
 Item 11. Executive
Compensation.
 
 SUMMARY
COMPENSATION TABLE
  The
following table shows the compensation paid or accrued during the fiscal years
ended December 31, 2009 and 2008 to (1) our Chief Executive Officer and (2) our
two most highly compensated executive officers, other than our Chief Executive
Officer, who earned more than $100,000 during the fiscal year ended December 31,
2009. The table includes additional executives who would have been among the two
most highly compensated executive officers, other than our Chief Executive
Officer, except for the fact that they were not serving as executive officers of
the Company as of December 31, 2009.




Name and
                                                          Principal Position
                                                        
                                                        Year
                                                        
                                                        Salary
                                                        
                                                        Bonus
                                                        
                                                        Stock
                                                          Awards
                                                        
                                                        Option
                                                          Awards
                                                        
                                                        All Other
                                                          Compensation
                                                        
                                                        TotalRobert
      S. Ellin, former
                                                        
                                                        2009
                                                        
                                                        
                                                        0
                                                        
                                                        
                                                        0
                                                        
                                                        
                                                        0
                                                        
                                                        
                                                        0
                                                        
                                                        
                                                        0
                                                        
                                                        
                                                        0Chief
      Executive Officer
                                                        
                                                        2008
                                                        
                                                        
                                                        0
                                                        
                                                        
                                                        0
                                                        
                                                        
                                                        275,000
                                                        (2)
                                                        
                                                        0
                                                        
                                                        
                                                        0
                                                        
                                                        
                                                        275,000of Zoo Entertainment(1)Mark
      E. Seremet,
                                                        
                                                        2009
                                                        
                                                        
                                                        325,000
                                                        
                                                        
                                                        0
                                                        
                                                        
                                                        0
                                                        
                                                        
                                                        225,000
                                                        (4)
                                                        
                                                        105,300
                                                        (5)
                                                        
                                                        655,300ChiefExecutive
      Officer of Zoo
                                                        
                                                        2008
                                                        
                                                        
                                                        260,222
                                                        
                                                        
                                                        0
                                                        
                                                        
                                                        25,000
                                                        (6)
                                                        
                                                        510,164
                                                        (7)
                                                        
                                                        7,200
                                                        (8)
                                                        
                                                        802,586Entertainment(3)David
      J. Fremed,
                                                        
                                                        2009
                                                        
                                                        
                                                        328,500
                                                        
                                                        
                                                        0
                                                        
                                                        
                                                        0
                                                        
                                                        
                                                        0
                                                        
                                                        
                                                        15,300
                                                        (9)
                                                        
                                                        343,800ChiefFinancial
      Officer of Zoo
                                                        
                                                        2008
                                                        
                                                        
                                                        314,000
                                                        
                                                        
                                                        0
                                                        
                                                        
                                                        0
                                                        
                                                        
                                                        51,017
                                                        (12)
                                                        
                                                        15,600
                                                        (11)
                                                        
                                                        380,617Entertainment(10)David
      Rosenbaum,
                                                        
                                                        2009
                                                        
                                                        
                                                        375,000
                                                        
                                                        
                                                        0
                                                        
                                                        
                                                        0
                                                        
                                                        
                                                        0
                                                        
                                                        
                                                        85,700
                                                        (13)
                                                        
                                                        460,700President
      of Zoo
                                                        
                                                        2008
                                                        
                                                        
                                                        375,000
                                                        
                                                        
                                                        187,500
                                                        
                                                        
                                                        0
                                                        
                                                        
                                                        552,112
                                                        (14)
                                                        
                                                        25,000
                                                        (15)
                                                        
                                                        1,139,612Publishing





(1)
            Mr. Ellin resigned as Chief
      Executive Officer on
      May 1, 2009 and resigned as a director on November 18,
      2009.


(2)
            Mr. Ellin received 250,000
      restricted shares of our common stock in June 2008 valued at $1.10 per
      share in accordance with ASC Topic 718.


(3)
            Mr. Seremet became Chief
      Executive Officer of
      Zoo Entertainment on May 1, 2009.  Prior to that he was Chief
      Executive Officer of Zoo Games.


(4)
              Mr. Seremet received options to
      acquire 750,000 shares of our stock at a fair market value of $225,000 in
      accordance with ASC Topic 718.
 (5)
              Mr. Seremet received $90,000 in
      2009 as cash compensation for his personal guaranty of various loan
      facilities and we
      paid a net amount for family medical benefits of
      $15,300.
 (6)
              Mr. Seremet received 16,484
      shares of our common stock in lieu of a cash bonus in 2008 valued at
      $25,000 in accordance with ASC Topic 718.
 (7)
              Mr. Seremet received options to
      acquire 702,327
      shares of our stock valued at $510,164 in accordance with ASC Topic
      718.
 (8)
              Includes a $600 monthly car
      allowance.
  (9)
              Includes a $600 monthly car
      allowance, a $25,000 relocation payment and family medical benefits
      totaling$11,284.
 (10)
              Mr. Fremed became Chief Financial
      Officer of Zoo Entertainment on May 1, 2009.  Prior to that he
      was Chief Financial Officer of Zoo Games.
 (11)
              Consists of family medical
      benefits.
 (12)
              Mr. Fremed received options to
      acquire 70,233 shares ofour stock valued at $51,017 in
      accordance with ASC Topic 718.
 (13)
              Mr. Rosenbaum received $63,000 in
      2009 as cash compensation for his personal guaranty of various loan
      facilities and the Company paid a net amount for family medical benefits
      of $22,700.
 (14)
              Mr. Rosenbaum received options to
      acquire 760,031 shares of our stock valued at $552,112 in accordance with
      ASC Topic 718.
 (15)
              Consists of family medical
      benefits.


48


On
January 14, 2009, Zoo Games entered into an employment agreement (the “Seremet
Employment Agreement”) with Mark Seremet, a director of the Company and
President of Zoo Games, pursuant to which Mr. Seremet also became Chief
Executive Officer of Zoo Games. The Seremet Employment Agreement is for a term
of three years, at an initial base salary of $325,000 per year and provides for
a bonus at the discretion of the Company’s board of directors. The Seremet
Employment Agreement is renewable automatically for successive one year periods
unless either party gives written notice not to renew at least 60 days prior to
the expiration of the initial term or any renewal terms. The Company also
granted Mr. Seremet an option to purchase 750,000 shares of the Company’s common
stock, at an exercise price of $0.30 per share, pursuant to the Company’s 2007
Employee, Director and Consultant Stock Plan, as amended. Mr. Seremet became
Chief Executive Officer and President of Zoo Entertainment on May 1,
2009.
 
 On
January 14, 2009, Mr. Seremet’s previous employment agreement was terminated in
connection with Zoo Games and Mr. Seremet entering into the Seremet Employment
Agreement. Under the previous employment agreement, Mr. Seremet agreed to serve
as President of Zoo Games. Mr. Seremet’s previous employment agreement provided
for a term ending on April 30, 2011 with an annual base salary of $250,000 and a
bonus based on a performance milestones as determined by the compensation
committee of Zoo Games. The previous employment agreement was renewable
automatically for successive one year periods unless either party gives written
notice not to renew at least 60days prior to the expiration of the initial term
or any renewal terms. Mr. Seremet was entitled to receive a monthly car
allowance of up to $600 per month and was entitled to participate in Zoo Games’s
benefit plans in the same manner and at the same levels as Zoo Games makes such
opportunities available to all of Zoo Games’s employees. If the previous
employment agreement was terminated by Mr. Seremet for Good Reason (as defined
in the Original Employment Agreement) or by Zoo Games without Cause (as defined
in the previous employment agreement) then Mr. Seremet was entitled to receive
(a) 1.5 times the sum of his then current base salary and bonus earned with
respect to the employment year preceding the year in which he was terminated
(the “Prior Bonus”), payable over eighteen months from the termination date, (b)
payment of premiums for Mr. Seremet under Zoo Games’s health plans or materially
similar benefits, (c) any earned but unpaid base salary or bonus, (d) any earned
but unpaid performance bonus from the prior fiscal year and (e) acceleration of
vesting of all outstanding stock options and restricted stock which have not
vested as of the date of such termination, if any. If Mr. Seremet’s employment
was terminated as the result of his death, his heirs will be entitled to receive
(i) any earned but unpaid base salary or bonus, (ii) any earned but unpaid
performance bonus from the prior fiscal year and (iii) acceleration of vesting
of all outstanding stock options and restricted stock which have not vested as
of the date of death, if any. Mr. Seremet was subject to traditional
non-competition and employee non-solicitation restrictions while he was employed
by Zoo Games and for a period of one year after termination, except that if the
agreement was not renewed at the end of a term, the one-year restricted period
shall not apply unless Mr. Seremet is paid the sum of his then current base
salary and Prior Bonus. The
options to purchase 702,327 shares of common stock issued to Mr. Seremet in 2008
are fully-vested and have an exercise price of $1.52 per
share.
 
 On
January 1, 2008, Zoo Publishing entered into an employment agreement with David
Rosenbaum, which was subsequently amended on July 1, 2008 and July 23, 2009,
pursuant to which he became Senior Vice President of Sales. The term of the
agreement is four years with an annual base salary of $375,000 for the first two
years and $400,000 for the remaining years. Mr. Rosenbaum is eligible to receive
a bonus as pay be approved by the board of directors. If Mr. Rosenbaum’s
employment is terminated by the Company without cause, severance must be paid
according to the following: if the termination is within the first twelve months
of the employment agreement, Mr. Rosenbaum shall receive twenty-four months of
compensation less the amount already paid; if the termination is after twelve
months but before thirty-six months, Mr. Rosenbaum shall receive twelve months
of severance pay; if the termination is after thirty-six months, Mr. Rosenbaum
shall receive the remainder of pay due to him under the employment agreement.
The
options to purchase 760,031 shares of common stock issued to Mr. Rosenbaum in
2008 are fully-vested and have an exercise price of $1.52 per
share. In April 2009, Mr. Rosenbaum was appointed as President of
Zoo Publishing.




On May 12, 2009, we entered into a letter agreement with each of
Mark Seremet and David Rosenbaum (the “Fee Letters”), pursuant to which, in
consideration for Messrs. Seremet and Rosenbaum each entering into a Guaranty
with Wells Fargo for the full and prompt payment and performance by the Company
and its subsidiaries of the obligations in connection with a purchase order
financing (the “Loan”), we agreed to compensate Mr. Seremet in the amount of
$10,000 per month, and Mr. Rosenbaum in the amount of $7,000 per month, for so
long as such executive remains employed while the Guaranty and Loan remain in
full force and effect. If the Guaranty is not released by the end of the month
following termination of employment of either Messrs. Seremet or Rosenbaum, as
applicable, the monthly fee shall be doubled for each month thereafter until the
Guaranty is removed.
 
 In
connection with the financing consummated on November 20, 2009, Messrs. Seremet
and Rosenbaum agreed to amend their respective Fee Letters, pursuant to which:
in the case of Mr. Seremet, the Company will pay to Mr. Seremet a fee of $10,000
per month for so long as the Guaranty remains in full force and effect, but only
for a period ending on November 20, 2010; and, in the case of Mr. Rosenbaum, the
Company will pay to Mr. Rosenbaum a fee of $7,000 per month for so long as the
Guaranty remains in full force and effect, but only for a period ending on
November 20, 2010. In addition, the amended Fee Letters provide that, in
consideration of each of their continued personal guarantees, we will issue to
each of Messrs. Seremet and Rosenbaum, an option to purchase shares of common
stock or restricted shares of common stock, equal to approximately a 6.25%
ownership interest on a fully diluted basis, respectively. Subject to the
effectiveness (the “Effective Date”) of an amendment to the Company’s
Certificate of Incorporation authorizing an increase in the number of authorized
shares of the Company’s common stock, par value $0.001 per share, from
250,000,000 shares to 3,500,000,000 shares (the “Charter Amendment”), on
February 11, 2010, the Company issued options to purchase 202,581,600 shares of
common stock to each of Mark Seremet and David Rosenbaum pursuant to the Fee
Letters. The options have an exercise price of $0.0025 per share and vest as
follows: commencing as of the Effective Date, 72% vest immediately, 14% on May
12, 2010 and 14% vest on May 12, 2011. On January 13, 2010, our Board of
Directors and stockholders holding approximately 66.7% of our outstanding voting
capital stock approved the Charter Amendment. On March 10, 2010, the Company
filed the Charter Amendment with the Secretary of State of the State of
Delaware, and the Company’s authorized shares of common stock increased from
250,000,000 to 3,500,000,000.




On June
4, 2007, as amended on August 8, 2008, David J. Fremed and Zoo Games entered
into an employment agreement pursuant to which Mr. Fremed became Chief Financial
Officer of Zoo Games. Mr. Fremed’s employment agreement provides for a term that
commenced on August 16, 2007 and ends on June 15, 2010, with a starting annual
base salary of $250,000. Mr. Fremed’s annual base salary will increase to no
less than $265,000 after twelve months and to no less than $285,000 after
twenty-four months. Mr. Fremed is entitled to a bonus of at least $50,000 per
twelve month period, based on certain milestones and paid quarterly. Mr. Fremed
also received equity grants of incentive units when Zoo Games was a limited
liability company. Mr. Fremed is entitled to receive reimbursement of up to $500
per month for expenses associated with his automobile. Mr. Fremed is entitled to
participate in Zoo Games’s benefit plans in the same manner and the same levels
as Zoo Games makes such opportunities available to the senior executives of Zoo
Games. Mr. Fremed’s employment is at will and Zoo Games may terminate Mr.
Fremed’s employment at any time. If Zoo Games terminates the employment
agreement without Cause (as defined in the employment agreement), then Mr.
Fremed will continue to receive six months of salary, bonus and benefits. If Zoo
Games terminates the employment agreement as a result of Change in Control of
Zoo Games (as defined in the employment agreement), or if, in connection with a
Change in Control of Zoo Games, Mr. Fremed's duties are diminished below those
of the Chief Financial Officer, or are materially diminished below those
that he had in the month prior to the Change in Control and Mr. Fremed
resigns due to such diminution of duties, then Mr. Fremed will be entitled
to receive twelve months of salary, bonus and benefits. Under the employment
agreement, Mr. Fremed is subject to traditional non-competition and employee
non-solicitation restrictions while he is employed by Zoo Games and for a period
of one year thereafter except that the one-year restricted period shall not
apply unless Mr. Fremed is paid his then current base salary. The options to
purchase 70,233 shares
of common stock issued to Mr. Fremed in 2008 are fully-vested and have an
exercise price of $1.52 per share.
 
 Effective
February 15, 2010, Zoo Games entered into Amendment Number Two to the June 4,
2007 David Fremed Employment Agreement (the “Amended Employment Agreement”) with
Mr. Fremed, which amended his original employment agreement. The term of the
Amended Employment Agreement is for two years, at an annual base salary of
$335,000.  He is also eligible to receive a bonus at the discretion of
the board of directors.




49




2009 OUTSTANDING EQUITY AWARDS AT FISCAL
YEAR-END
 
 Stock AwardsEquityOption Awards
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  Incentive
                                                                  
                                                                  EquityEquity
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  Plan
                                                                  
                                                                  Incentive PlanIncentive
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  Awards:
                                                                  
                                                                  Awards:Plan
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  Number of
                                                                  
                                                                  Market orAwards:
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  Number
                                                                  
                                                                  Market
                                                                  
                                                                  Unearned
                                                                  
                                                                  Payout ValueNumber of
                                                                  
                                                                  
                                                                  Number of
                                                                  
                                                                  Number of
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  of Shares
                                                                  
                                                                  Value of
                                                                  
                                                                  Shares,
                                                                  
                                                                  of UnearnedSecurities
                                                                  
                                                                  
                                                                  Securities
                                                                  
                                                                  Securities
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  or Units
                                                                  
                                                                  Shares or
                                                                  
                                                                  Units or
                                                                  
                                                                  Shares, UnitsUnderlying
                                                                  
                                                                  
                                                                  Underlying
                                                                  
                                                                  Underlying
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  
                                                                  of Stock
                                                                  
                                                                  Units of
                                                                  
                                                                  Other
                                                                  
                                                                  or OtherUnexercised
                                                                  
                                                                  
                                                                  Unexercised
                                                                  
                                                                  Unexercised
                                                                  
                                                                  Option
                                                                  
                                                                  
                                                                  
                                                                  That
                                                                  
                                                                  Stock That
                                                                  
                                                                  Rights That
                                                                  
                                                                  Rights ThatOptions (#)
                                                                  
                                                                  
                                                                  Options (#)
                                                                  
                                                                  Unearned
                                                                  
                                                                  Exercise
                                                                  
                                                                  Option
                                                                  
                                                                  Have Not
                                                                  
                                                                  Have Not
                                                                  
                                                                  Have Not
                                                                  
                                                                  Have NotName
                                                                  
                                                                  Exercisable
                                                                  
                                                                  
                                                                  Unexercisable
                                                                  
                                                                  Options
                                                                  
                                                                  Price($)
                                                                  
                                                                  Expiration Date
                                                                  
                                                                  Vested (#)
                                                                  
                                                                  Vested ($)
                                                                  
                                                                  Vested (#)
                                                                  
                                                                  Vested ($)(1)Robert
      S. Ellin
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0Mark
      Seremet
                                                                  
                                                                  
                                                                  702,328
                                                                  
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  1.52
                                                                  
                                                                  July 2018
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  08,062
                                                                  
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  2.58
                                                                  
                                                                  May 2018
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  00
                                                                  
                                                                  
                                                                  
                                                                  750,000
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0.30
                                                                  
                                                                  January 2019
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0David
      Rosenbaum
                                                                  
                                                                  
                                                                  760,031
                                                                  
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  1.52
                                                                  
                                                                  July 2018
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0David
      Fremed
                                                                  
                                                                  
                                                                  42,575
                                                                  
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  2.58
                                                                  
                                                                  May 2018
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  023,411
                                                                  
                                                                  
                                                                  
                                                                  46,822
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  2.13
                                                                  
                                                                  September 2018
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0
                                                                  
                                                                  
                                                                  0


DIRECTOR COMPENSATION





The
following table reflects the compensation paid to our current directors during
the fiscal year ended December 31, 2009.




Fees
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            NonqualifiedEarned or
                            
                            
                            
                            
                            
                            
                            
                            
                            Non-Equity
                            
                            
                            DeferredPaid in
                            
                            
                            Stock
                            
                            
                            Option
                            
                            
                            Incentive Plan
                            
                            
                            Compensation
                            
                            
                            All OtherCash
                            
                            
                            Awards
                            
                            
                            Awards
                            
                            
                            Compensation
                            
                            
                            Earnings
                            
                            
                            Compensation
                            
                            
                            TotalName
                            
                            
                            ($)
                            
                            
                            ($)
                            
                            
                            ($)
                            
                            
                            ($)
                            
                            
                            ($)
                            
                            
                            ($)
                            
                            
                            ($)BarryRegenstein
                            
                            
                            
                            12,500
                            (1)
                            
                            
                            -
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            12,500Drew
      Larner
                            
                            
                            
                            7,500
                            (2)
                            
                            
                            -
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            7,500John
      Bendheim
                            
                            
                            
                            5,000
                            (3)
                            
                            
                            -
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            —
                            
                            
                            
                            5,000





(1)
            $10,000
      for chairman of the Audit Committee and $2,500 as a member of the
      Compensation Committee.


(2)
            $5,000
      for chairman of the Compensation Committee and $2,500 as a member of the
      Compensation Committee


(3)
            $2,500
      as a member of the Compensation Committee and $2,500 as a member of the
      Compensation Committee




In
October 2008, the Board considered, and subsequently approved on February 11,
2010, the following compensation scheme for the members of the Audit Committee
and the Compensation Committee for the fiscal year 2009.





·
            Audit Committee:





-
            Chairman - $20,000 per year, plus
      non-qualified options to purchase 100,000 shares of the
      Company’s common stock, vesting over
      three years and in accordance with the terms set forth in the
      Company’s standard form of non-qualified
      stock optionagreement.





-
            Members - $5,000 per year, plus
      non-qualified options to purchase 25,000 shares of the Company’s common stock, vesting over
      three years and in accordance with the terms set forth in the
      Company’s standard form of non-qualified
      stock optionagreement.





·
            Compensation
      Committee:





-
            Chairman- $10,000 per year, plus
      non-qualified options to purchase 50,000 shares of the Company’s common stock, vesting over
      three years and in accordance with the terms set forth in the
      Company’s standard form ofnon-qualified stock option
      agreement.





-
            Members - $5,000 per year, plus
      non-qualified options to purchase 25,000 shares of the Company’s common stock, vesting over
      three years and in accordance with the terms set forth in the
      Company’s standard form ofnon-qualified stock option
      agreement.




50




Members
of the Audit Committee and Compensation Committee received six months of cash
compensation during 2009 for their Board service during 2009. On February 11,
2010, the Company issued 2,743,800 shares, 1,829,400 shares and 4,573,200
shares, respectively, of restricted common stock to each of Drew Larner, John
Bendheim and Barry Regenstein in consideration for each of them serving as a
member of the Company’s Compensation Committee and Audit Committee in lieu of
the balance of the cash compensation that was due to them for their 2009 Board
Committee service. No stock options were issued to any directors during 2009 in
connection with the compensation packages described above.





Termination
of Employment and Change-in-Control Arrangements





Mr.
Seremet’s employment agreement may be terminated for Cause (as defined in his
employment agreement) by Zoo Games upon written notice, without Cause by Zoo
Games, for Good Reason by Mr. Seremet, death or disability, or at Mr. Seremet’s
election upon 30 days prior written notice. In the event the employment
agreement is terminated for Cause, death or disability, or at the election of
Mr. Seremet, Zoo Games will have no further obligations other than the payment
of earned but unpaid salary and accrued vacation days.  In the event
that the employment agreement is terminated without Cause by Zoo Games or for
Good Reason by Mr. Seremet,  Zoo Games shall pay to Mr. Seremet any
earned but unpaid salary, acrrued vacation days,  and severance in a
lump sum aount equivalent to one year of annual base salary in effect on the
date of termination. The payment of severance is conditioned upon Mr. Seremet’s
release of all claims against Zoo Games.
  If Mr.
Rosenbaum’s employment is terminated by Zoo Publishing without cause, severance
must be paid according to the following: if the termination is within the first
twelve months of the employment agreement, Mr. Rosenbaum shall receive
twenty-four months of compensation less the amount already paid; if the
termination is after twelve months but before thirty-six months, Mr. Rosenbaum
shall receive twelve months of severance pay; if the termination is after
thirty-six months, Mr. Rosenbaum shall receive the remainder of pay due to him
under the employment agreement.




Mr.
Fremed’s employment is at will and Zoo Games may terminate Mr. Fremed’s
employment at any time. If Zoo Games terminates the employment agreement without
Cause (as defined in the employment agreement), then Mr. Fremed will continue to
receive six months of salary, bonus and benefits. If Zoo Games terminates the
employment agreement as a result of Change in Control of Zoo Games (as defined
in the employment agreement), or if, in connection with a Change in Control of
Zoo Games, Mr. Fremed's duties are diminished below those of the Chief Financial
Officer, or are materially diminished below those that he had in the month
prior to the Change in Control and Mr. Fremed resigns due to such diminution of
duties, then Mr. Fremed will be entitled to receive twelve months of
salary, bonus and benefits.




Other
than as described above, we have no plans or arrangements with respect to
remuneration received or that may be received by the
above-referenced named executive officers to compensate such officers in
the event of termination of employment (as a result of resignation, retirement,
change of control) or a change of responsibilities following a change of
control.




Item 12. Security Ownership of
Certain Beneficial Owners and Management and Related Stockholder
Matters.





The
following table sets forth certain information with respect to the beneficial
ownership of our common stock as of March 30, 2010 for (i) each of our Chief
Executive Officer and our two most highly compensated executive officers, who
are referred to as named executive officers, (ii) each of our directors, (iii)
all persons, including groups, known to us to own beneficially more than five
percent (5%) of any class of our voting stock and (iv) all current executive
officers and directors as a group. As of March 30, 2010, the Company
had 2,778,409,829 shares of common stock outstanding.




51




Common
                                        
                                        
                                        Percentage ofName
      and Address of Owner (1)
                                        
                                        
                                        Stock
                                        
                                        
                                        VotingPower5%
      Stockholders;Robert
      Ellin (2)
                                        
                                        
                                        
                                        268,565,826
                                        
                                        
                                        9.7Patricia
      Peizer (3)
                                        
                                        
                                        
                                        321,684,000
                                        
                                        
                                        11.6Harris
      Toibb (4)
                                        
                                        
                                        
                                        268,680,309
                                        
                                        
                                        9.7Peter
      Brant (5)
                                        
                                        
                                        
                                        227,723,631
                                        
                                        
                                        8.2Directors
      and named executive officers:Jay
      Wolf (6) (11)
                                        
                                        
                                        
                                        206,097,604
                                        
                                        
                                        7.4Barry
      Regenstein (7) (11)
                                        
                                        
                                        
                                        8,446,550
                                        
                                        
                                        *John
      Bendheim (8) (11)
                                        
                                        
                                        
                                        5,265,550
                                        
                                        
                                        *Drew
      Larner (9) (11)
                                        
                                        
                                        
                                        5,929,950
                                        
                                        
                                        *Moritz
      Seidel (10) (11)
                                        
                                        
                                        
                                        121,848,632
                                        
                                        
                                        4.4Mark
      Seremet (12) (11)
                                        
                                        
                                        
                                        167,479,639
                                        
                                        
                                        5.7David
      Fremed (13) (11)
                                        
                                        
                                        
                                        25,697,785
                                        
                                        
                                        *David
      Rosenbaum (14) (11)
                                        
                                        
                                        
                                        186,765,633
                                        
                                        
                                        6.4David
      Smith (15) (11)
                                        
                                        
                                        
                                        631,844,322
                                        
                                        
                                        22.7All
      current directors and executive officers as a group (nine persons)
      (16)
                                        
                                        
                                        
                                        1,359,375,665
                                        
                                        
                                        43.6





* Less
than one percent




(1)
Except as specifically indicated in the footnotes to this table, the persons
named in this table have sole voting and investment power with respect to all
shares of common stock shown as beneficially owned by them, subject to community
property laws where applicable. Beneficial ownership is determined in accordance
with the rules of the Securities and Exchange Commission. In computing the
number of shares beneficially owned by a person and the percentage ownership of
that person, shares of common stock subject to options, warrants or rights held
by that person that are currently exercisable or exercisable, convertible or
issuable within 60 days of March 15, 2010, are deemed outstanding. Such shares,
however, are not deemed outstanding for the purpose of computing the percentage
ownership of any other person.




(2)
Consists of 250,000 shares of restricted common stock held by Mr. Ellin,
211,735,553 shares of common stock held by Trinad Capital Master Fund, Ltd.
(“TCMF”) and 56,580,273 shares of common stock held by Trinad Management, LLC
(“Trinad Management”), which is an affiliate of and provides investment
management services to, TCMF. The address of TCMF is 2121 Avenue of the Stars,
Suite 2550, Los Angeles, CA 90067. Robert S. Ellin has sole voting and
investment power with respect to the shares held of record by TCMF.





(3)
Consists of an aggregate of 321,684,000 shares of common stock, of which
196,206,000 shares are held by Socius Capital Group, LLC and 125,478,000 shares
are held by Focus Capital Partners, LLC, each of which are entities owned and
controlled by Patricia Peizer. Ms. Peizer has sole voting and investment power
with respect to the shares. This amount does not include warrants to purchase an
aggregate of 610,316,000 shares of common stock held by Socius Capital Group,
LLC and Focus Capital Partners that are not exercisable within 60 days as a
result of a 9.9% ownership limitation contained in the warrants. The address for
Ms. Peizer is 11150 Santa Monica Boulevard, Los Angeles, CA 90025.




(4)
Consists of 268,403,768 shares of common stock and immediately exercisable
warrants to purchase 276,541 shares of common stock, but does not include
warrants to purchase 2,272,727 shares of common stock that are not exercisable
within sixty (60) days as a result of a 4.99% ownership limitation contained in
the warrants. The address of Harris Toibb is 6355 Topenga Boulevard, Suite 335,
Woodland Hills, CA 91367.





(5)
Consists of 225,606,000 shares of common stock owned by Ariza, LLC, a Company
controlled by Mr. Brant, and 2,048,127 shares of common stock, immediately
exercisable warrants to purchase 37,246 shares of common stock and options to
purchase 32,258 shares of common stock, held by Mr. Brant. The amount does not
include 189,692 shares of common stock and warrants to purchase 47,421 shares of
common stock held by The Bear Island Paper Company LLC Thrift Plan-Aggressive
Growth Fund, of which Mr. Brant is the economic beneficiary and shares
investment and dispositive power with the trustees of the Plan of which Mr.
Brant is one trustee. Mr. Brant has the sole power to vote or dispose of the
shares held by Ariza, LLC The address for Mr. Brant is c/o Brant Industries,
Inc., 80 Fieldpoint Road, Greenwich, CT 06830.




52





(6)
Consists of 159,641,000 shares of restricted common stock, 40,994,654 shares of
common stock andnon-qualified stock options to purchase up to 5,461,950 shares
of common stock for a purchase price of $0.0041 per share that will vest and
become exercisable within the next 60 days. This does not include non-qualified
stock options to purchase up to 16,385,850 shares of common stock for a purchase
price of $0.0041per share that are not vested and not exercisable within the
next 60days.





(7)
Consists of 4,623,200 shares of restricted common stock andnon-qualified stock
options to purchase up to 3,823,350 shares of common stock for a purchase price
of $0.0041 per share that will vest and be exercisable within the next 60 days.
Thisdoes not include non-qualified stock options to purchase up to 11,470,050
shares of common stock for a purchase price of $0.0041per share that are not
vested and not exercisable within the next 60 days.





(8)
Consists of 2,079,400 shares of restricted common stock and non-qualified stock
options to purchase up to 3,186,150 shares of common stock for a purchase price
of $0.0041 per share that will vest and be exercisable within the next 60days.
This does not include non-qualified stock options to purchase up to 9,558,450
shares of common stock for a purchase price of $0.0041per share that are not
vested and not exercisable within the next 60 days.





(9)
Consists of 2,743,800 shares of restricted common stock andnon-qualified stock
options to purchase up to 3,186,150 shares of common stock for a purchase price
of $0.0041 per share that will vest and be exercisable within the next 60 days.
Thisdoes not include non-qualified stock options to purchase up to 9,558,450
shares of common stock for a purchase price of $0.0041per share that are not
vested and not exercisable within the next 60 days.





(10)
Consists of 120,027,932 shares of common stock held by T7M7 Unternehmensaufbau
GmbH. Mr. Seidel is the Managing Director of T7M7 Unternehmensaufbau GmbH, and
as a result, may be deemed to indirectly beneficially own an aggregate of
120,027,932 shares of common stock. Mr. Seidel disclaims beneficial ownership of
these securities. Mr. Seidel has the sole voting and investment power with
respect to the shares held by T7M7 Unternehmensaufbau GmbH. Also consist of
non-qualified stock options held by Mr. Seidel to purchase up to 1.820.700
shares of common stock for a purchase price of $0.0041 per share that will vest
and be exercisable within the next 60 days, but does not include non-qualified
stock options to purchase up to 5,462,100 shares of common stock for a purchase
price of $0.0041 per share that are not vested and not exercisable within the
next 60 days. The address of T7M7 Unternehmensaufbau GmbH is Occam-Strasse 4,
Rueckgebauede, 80802, Muenchen, Germany.





(11) The
address of each of these persons is c/o Zoo Entertainment, Inc., 3805 Edwards
Road, Suite 400, Cincinnati, OH 45209.





(12)
Consists: of 20,645,825 shares of common stock, immediately exercisable warrants
to purchase 5,893 shares of common stock for a purchase price of $2.13 per
share; immediately exercisable warrants to purchase 8,779 shares of common stock
for a purchase price of $2.84 per share; non-qualified stock options to purchase
up to 702,328 shares of common stock for a purchase price of $1.52 per share and
non-qualified stock options to purchase up to 8,062 shares of common stock for a
purchase price of $2.58 per share, in each case which is fully vested and
immediately exercisable;non-qualified stock options to purchase up to 250,000
shares of common stock for a purchase price of $0.30 per share that will vest
and be exercisable within the next 60 days, but does not include non-qualified
stock options to purchase up to 500,000 shares of common stock for a purchase
price of $0.30 per share that are not vested and not exercisable within the next
60 days; and non-qualified stock options to purchase up to 145,858,752 shares of
common stock for a purchase price of $0.0025 per share that will vest and become
exercisable within the next 60days, but does not include non-qualified stock
options to purchase up to 56,722,848 shares of common stock for a purchase price
of $0.0025 per share that are not vested and not exercisable within the next 60
days.




53





(13)
Consists of: 142,839 shares of common stock; non-qualified stock options to
purchase up to 42,575 shares of common stock for a purchase price of $2.58 per
share which are fully vested and immediately exercisable; non-qualified stock
options to purchase up to 23,411 shares of common stock for a purchase price of
$2.13 per share that are vested and exercisable, but does not include
non-qualified stock options to purchase up to 46,822 shares of common stock for
a purchase price of $2.13 per share that are not vested and not exercisable
within the next 60days; and non-qualified stock options to purchase up to
25,488,960 shares of common stock for a purchase price of $0.0041 per share that
will vest and become exercisable within the next 60 days, but does not include
non-qualified stock options to purchase up to 10,923,840 shares of common stock
for a purchase price of $0.0041per share that are not vested and not exercisable
within the next 60 days.





(14)
Consists of: 40,117,478 shares of common stock; immediately exercisable warrants
to purchase 29,371 shares of common stock for a purchase price of $2.13 per
share;non-qualified stock options to purchase up to 760,031 shares for a
purchase price of $1.52 per share which are fully vested and immediately
exercisable; and non-qualified stock options to purchase up to 145,858,752
shares of common stock for a purchase price of $0.0025 per share that will vest
and be exercisable within the next 60 days, but does not include non-qualified
stock options to purchase up to 56,722,848 shares of common stock for a purchase
price of $0.0025 per share that are not vested and not exercisable within the
next 60 days.





(15)
Consists of: 621,083,000 shares of common stock owned directly by Mr. Smith;
6,481,965 shares of common stock owned by Coast Sigma Fund, LLC and 2,458,657
shares of common stock owned by Coast medina, LLC, both companies of which are
controlled by Mr. Smith; non-qualified stock options to purchase up to 1,820,700
shares of common stock for a purchase price of $0.0041 per share that will vest
and become exercisable within the next 60 days, but does not include
non-qualified stock options to purchase up to 5,462,100 shares of common stock
for a purchase price of $0.0041per share that are not vested and not exercisable
within the next 60 days. Mr. Smith became a director of the Company on December
14, 2009. The address for Mr. Smith is 2450 Colorado Ave., Suite 100 East Tower,
Santa Monica, CA 90404.





(16)
Includes warrants to purchase 44,043 shares of common stock and options to
purchase 338,291,871 shares of common stock.





Item 13. Certain Relationships and
Related Transactions, and Director Independence.





The
following is a description of transactions that were entered into with our
executive officers, directors or 5% stockholders during the past two fiscal
years. We believe that all of the transactions described below were made on
terms no less favorable to us than could have been obtained from an unaffiliated
third party. All future related transactions will be approved by our audit
committee or the full board of directors.




On July
7, 2008, we entered into a Note Purchase Agreement with TCMF and the investors
set forth on the schedule thereto, as subsequently amended on July 15, 2008,
July 31, 2008 and August 15, 2008 (the “Note Purchase Agreement”), pursuant to
which the investors agreed to provide a loan to the Company in the aggregate
principal amount of $9,000,000, in consideration for the issuance and delivery
of senior secured convertible promissory notes (the “Notes”). As partial
inducement to purchase the Notes, we issued to the investors warrants to
purchase common stock of the Company (the “Warrants,” and together with the
issuance of the Notes, the “Financing”). The offering period of the Financing
closed on August 15, 2008. Pursuant to the Note Purchase Agreement on July 7,
2008, we issued to TCMF, a principal stockholder of the Company of which Robert
Ellin, our former Chief Executive Officer and a former director is the managing
director, and of which Jay Wolf, our Secretary and a director was a managing
director until December 2009, a Note in the aggregate principal amount of
$2,500,000. The Note bore an interest rate of five percent (5%) for the time
period beginning on July 7, 2008 and ending on July 7, 2009, unless extended.
Upon the occurrence of an investor sale, as defined in the Note, the entire
outstanding principal amount of the Note and any accrued interest thereon will
be automatically converted into shares of common stock of the Company. In
connection with the Note Purchase Agreement, we issued to TCMF a Warrant to
purchase 2,272,727 shares of common stock of the Company. The Warrant has a five
year term and an exercise price of $0.01 per share. On July 30, 2008, TCMF
exercised its Warrant to purchase 2,272,727 shares of common stock of the
Company. On November 20, 2009, the Notes issued to TCMF converted into shares of
Series B Convertible Preferred Stock. On January 13, 2010, our Board of
Directors and stockholders holding approximately 66.7% of our outstanding voting
capital stock approved the Charter Amendment. The consents we received
constituted the only stockholder approval required for the Charter Amendment
under the Delaware General Corporation Law (the “DGCL”) and our existing
Certificate of Incorporation and Bylaws. Pursuant to Rule 14c-2 of the
Securities Exchange Act of 1934, as amended, stockholder approval of this
amendment will become effective on or after such date that is approximately 20
calendar days following the date we first mailed the definitive Information
Statement Pursuant to Section 14(c) (the “Information Statement”) to our
stockholders. The Information Statement was first sent to our stockholders on
February 16, 2010. On March 10, 2010, the Company filed the Charter Amendment
with the Secretary of State of the State of Delaware.


Upon the
filing of the Charter Amendment on March 10, 2010, the Series B Preferred Stock
automatically converted to shares of common stock.




54




In
connection with an amendment to the Management Agreement, as described below, we
issued to Trinad Management, LLC, an affiliate of TCMF, of which ( “Trinad”) a
Note in the principal amount of $750,000 and a Warrant to purchase 681,818
shares of the Company’s common stock, on the same terms and conditions as the
Notes and Warrants issued in the financing. On November 20, 2009, the Note
issued to Trinad converted into shares of Series B Convertible Preferred Stock.
Upon the filing of the Charter Amendment on March 10, 2010, the Series B
Preferred Stock automatically converted to shares of common stock.





Pursuant
to a Security Agreement, dated as of July 7, 2008, as amended, we granted a
security interest in all of its assets to each of the investors, including TCMF,
to secure our obligations under the Notes. Additionally, on July 7, 2008, Trinad
executed a joinder to the Security Agreement. The security interests were
terminated upon the conversion of the Notes into shares of Series B Convertible
Preferred Stock.





On July
31, 2008, TCMF executed a counterpart signature page to the Note Purchase
Agreement, pursuant to which we issued to TCMF a Note in the principal amount of
$1,500,000. As partial inducement to purchase the Note, TCMF received a Warrant
to purchase 1,363,636 shares of common stock of the Company. The Note and
Warrant issued to TCMF were issued on the same terms and conditions as the Notes
and Warrants that were issued in the initial closing of the Financing. On August
1, 2008, TCMF exercised its Warrant to purchase 1,363,636 shares of common stock
of the Company. On November 20, 2009, the Note issued to TCMF converted into
shares of Series B Convertible Preferred Stock. Upon the filing of the Charter
Amendment on March 10, 2010, the Series B Preferred Stock automatically
converted to shares of common stock.





On
September 26, 2008, we entered into a note purchase agreement with TCMF and the
investors set forth on the schedule thereto, pursuant to which the investors
agreed to provide a loan to the Company in the aggregate principal amount of up
to $5,000,000 (the “Second Financing). Pursuant to the note purchase agreement,
we issued to TCMF a Note in the principal amount of $500,000. As partial
inducement to purchase the Note, TCMF received a Warrant to purchase 454,545
shares of common stock of the Company. The Note and Warrant issued to TCMF in
the Second Financing were issued on the same terms and conditions as the Notes
and Warrants that were issued in the initial closing of the Financing. On
September 26, 2008, TCMF exercised its Warrant to purchase 454,545 shares of
common stock of the Company. As of April 30, 2009, $515,000 of principal plus
accrued interest was outstanding on the Note issued to TCMF, and no payments of
principal or interest have been made. Pursuant to a Security Agreement, dated as
of September 26, 2008, we granted a security interest in all of its assets to
the investors, including TCMF, to secure our obligations under the Notes issued
in the Second Financing. On November 20, 2009, the Note issued to TCMF converted
into shares of Series B Convertible Preferred Stock. The security interests were
terminated upon the conversion of the Note into shares of Series B Convertible
Preferred Stock. Upon the filing of the Charter Amendment on March 10, 2010, the
Series B Preferred Stock automatically converted to shares of common
stock.




55





On
October 24, 2007, we executed a loan agreement, as subsequently amended on
November 21, 2007 and April 18, 2008 (the "Loan Agreement") with TCMF, whereby
TCMF agreed to loan to the Company a principal amount of up to $500,000 (the
“Loan”) and to increase the entire outstanding principal amount of the Loan and
any accrued interest thereon, which was to be due and payable by the Company
upon, and not prior to, a Next Financing (as defined in the Loan Agreement), to
an amount of not less than $750,000. On July 7, 2008, pursuant to a further
amendment to the Loan Agreement and in consideration of TCFM’s participation in
the Financing and receipt of the Notes and Warrants issued thereunder, the Loan
Agreement automatically terminated upon the initial closing of the Financing,
and the loan thereunder, in the principal amount of $360,000, plus any accrued
interest, was cancelled and extinguished with no obligation or liability of the
Company.




On
October 24, 2007, we entered into a Management Agreement (the “Management
Agreement”) with Trinad, an affiliate of TCMF. Pursuant to the terms of the
Management Agreement, Trinad agreed to provide certain management services,
including, without limitation, the sourcing, structuring and negotiation of a
potential business combination transaction involving the Company. We agreed to
pay Trinad a management fee of $90,000 per quarter, plus reimbursement of all
expenses reasonably incurred by Trinad in connection with the provision of
management services. The fees incurred for the year ended December 31, 2007 were
waived by Trinad. The Management Agreement was terminable by either party upon
written notice, subject to a termination fee of $1,000,000 upon termination by
the Company. On July 7, 2008, the Company and Trinad amended the Management
Agreement to provide that it automatically terminated upon the initial closing
of the Financing, in which such case the termination fee was reduced to
$750,000. The Management Agreement, as amended, also provided that the Company
may satisfy the payment of such termination fee by delivery to Trinad of Notes
in the aggregate amount of $750,000 and a Warrant to purchase 618,818 shares of
common stock of the Company, such Notes and Warrants to be on the same terms of
the Notes and Warrants sold and issued by the Company to the purchasers in the
Financing. The Management Agreement automatically terminated upon the initial
closing of the Financing on July 7, 2008. In accordance with the terms of
Amendment No. 1 to the Management Agreement, the termination fee was reduced
from $1,000,000 to $750,000, which we satisfied by delivery to Trinad of a Note
in the principal amount of $750,000 and 681,818 Warrants to purchase common
stock of the Company. On November 20, 2009, the Note issued to Trinad converted
into shares of Series B Convertible Preferred Stock. Upon the filing of the
Charter Amendment on March 10, 2010, the Series B Preferred Stock automatically
converted to shares of common stock.




On May
12, 2009, we entered into a letter agreement with each of Mark Seremet and David
Rosenbaum (the “Fee Letters”), pursuant to which, in consideration for Messrs.
Seremet and Rosenbaum each entering into a Guaranty with Wells Fargo for the
full and prompt payment and performance by the Company and its subsidiaries of
the obligations in connection with a purchase order financing (the “Loan”), we
agreed to compensate Mr. Seremet in the amount of $10,000 per month, and Mr.
Rosenbaum in the amount of $7,000 per month, for so long as the executive
remains employed while the Guaranty and Loan remain in full force and effect. If
the Guaranty is not released by the end of the month following termination of
employment of either Messrs. Seremet or Rosenbaum, the monthly fee shall be
doubled for each month thereafter until the Guaranty is removed.




56





In
connection with the financing consummated on November 20, 2009, Messrs. Seremet
and Rosenbaum agreed to amend their respective Fee Letters, pursuant to which:
in the case of Mr. Seremet, the Company will pay to Mr. Seremet a fee of $10,000
per month for so long as the Guaranty remains in full force and effect, but only
for a period ending on November 20, 2010; and, in the case of Mr. Rosenbaum, the
Company will pay to Mr. Rosenbaum a fee of $7,000 per month for so long as the
Guaranty remains in full force and effect, but only for a period ending on
November 20, 2010. In addition, the amended Fee Letters provide that, in
consideration of each of their continued personal guarantees, we will issue to
each of Messrs. Seremet and Rosenbaum, an option to purchase shares of common
stock or restricted shares of common stock, equal to approximately a 6.25%
ownership interest on a fully diluted basis, respectively. Subject to the
effectiveness (the “Effective Date”) of an amendment to the Company’s
Certificate of Incorporation authorizing an increase in the number of authorized
shares of the Company’s common stock, par value $0.001 per share, from
250,000,000 shares to 3,500,000,000 shares (the “Charter Amendment”), on
February 11, 2010, the Company issued options to purchase 202,581,600 shares of
common stock to each of Mark Seremet and David Rosenbaum pursuant to the Fee
Letters. The options have an exercise price of $0.0025 per share and vest as
follows: commencing as of the Effective Date, 72% vest immediately, 14% on May
12, 2010 and 14% vest on May 12, 2011. On January 13, 2010, our Board of
Directors and stockholders holding approximately 66.7% of our outstanding voting
capital stock approved the Charter Amendment. The consents we received
constituted the only stockholder approval required for the Charter Amendment
under the Delaware General Corporation Law (the “DGCL”) and our existing
Certificate of Incorporation and Bylaws. Pursuant to Rule 14c-2 of the
Securities Exchange Act of 1934, as amended, stockholder approval of this
amendment will become effective on or after such date that is approximately 20
calendar days following the date we first mailed the definitive Information
Statement Pursuant to Section 14(c) (the “Information Statement”) to our
stockholders. The Information Statement was first sent to our stockholders on
February 16, 2010. On March 10, 2010, the Company filed the Charter Amendment
with the Secretary of State of the State of Delaware.





On
November 20, 2009, we entered into a Securities Purchase Agreement with certain
investors identified therein, including Mark Seremet, our Chief Executive
Officer and President, David Rosenbaum, President of Zoo Publishing, Moritz
Seidel, one of our directors, and David E. Smith, who became a director on
December 14, 2009, pursuant to which we agreed to sell to certain investors in a
private offering an aggregate of up to 2,000,000 shares of our Series A
Convertible Preferred Stock, par value $0.001 per share (“Series A Preferred
Shares”) at a price per share equal to $2.50, for gross proceeds to us of up to
$5,000,000 (the “November Financing”). On November 20, 2009, we sold 20,000
Series A Preferred Shares to Mr. Seremet for gross proceeds of $50,000, 40,000
Series A Preferred Shares to Mr. Rosenbaum for gross proceeds of $100,000,
120,000 Series A Preferred Shares to Mr. Seidel for gross proceeds of $300,000
and 400,000 Series A Preferred Shares to Mr. Smith for gross proceeds of
$1,000,000. The Series A Preferred Shares sold to Messrs. Seremet, Rosenbaum,
Seidel and Smith were issued on the same terms and conditions as the Series A
Preferred Shares sold to the other investors in the November
Financing.




On December 16, 2009, we entered into a Securities Purchase
Agreement, with certain investors identified therein, including David E. Smith,
one of our directors, pursuant to which we agreed to sell to certain investors
in a private offering the balance of the Series A Preferred Shares that were not
sold in the November Financing described above, at a price per share equal to
$2.50 and on the same terms and conditions as the Series A Preferred Shares sold
in the November Financing. On December 16, 2009, we sold 100,000 Series A
Preferred Shares to Mr. Smith for gross proceeds of $250,000. The Series A
Preferred Shares sold to Mr. Smith were issued on the same terms and conditions
as the Series A Preferred Shares sold to the other investors in the
financing.





Zoo
Games





Zoo Games
engages in various business relationships with its shareholders and officers and
their related entities. The significant relationships are as
follows:





Lease
of Premises




Zoo Games
leased its office space in New York, New York from 575 Broadway Associates, LLC
a company owned principally by Peter M. Brant, a former member of the board of
directors of Zoo Games and one of the Company’s principal stockholders. Zoo
Games leased 5,000 square feet at this location for a monthly rent of $23,750
from April 2007 to October 2008. Zoo Games has paid rent in the amount of
$183,000 for 2007 and $234,000 during 2008. Zoo Games believes that the rent and
lease terms are at market and are no more favorable to the landlord than
comparable leases that could be obtained under an independent third party
arrangement.




57




Transactions





Mark
Seremet, President of Zoo Games, received $549,000 in connection with the sale
of a portion of his shares in Cyoob, Inc to Zoo Games. The agreement entitled
Mr. Seremet to receive an additional $549,000 from Zoo Games for such shares.
However, this amount was converted to an aggregate of 257,052 shares of common
stock of the Company in April, 2008.





In
connection with Zoo Publishing’s factoring facility with Working Capital
Solutions, Inc., in August 2008, Mr. Seremet provided Working Capital Solutions
with a personal validity guarantee pursuant to which Mr. Seremet made certain
representations and warranties on behalf of Zoo Publishing and agreed to be
personally liable for a breach of those representations and warranties. The
Company granted Mr. Seremet a fully vested non-qualified stock option to
purchase up to 702,327 shares of common stock of the Company for an exercise
price of $1.52 per share in consideration for Mr. Seremet’s provision of such
guaranty.




From
October 2007 to December 2007, Zoo Games issued an aggregate of $2,800,000 in
12% convertible notes in its bridge financing (the “Bridge Financing”). The
principal outstanding amounts under the notes issued in the Bridge Financing,
and the accrued interest, were to be automatically converted into equity at the
first closing of an equity financing (the “Equity Financing”) in which Zoo Games
raised at least $15,000,000 inclusive of the amounts converted from the Bridge
Financing, at a value of 75% of the average price at which the equity securities
were sold in the Equity Financing. In connection with the conversion of the
convertible notes into equity, participants in the Bridge Financing were given
the right to receive warrants in the Equity Financing to purchase Zoo Games’
common units for a purchase price equal to 75% of the exercise price of the
warrants issued in the Equity Financing. Mr. Seremet, Zoo Games’ Chief Executive
Officer invested $50,000 in the Bridge Financing. Mr. Peter Brant, a former
director of Zoo Games and a principal stockholder of the Company and an entity
related to Mr. Brant invested an aggregate of $714,583 in the Bridge Financing.
Of that amount, convertible notes in the amount of $114,583 were issued to Mr.
Brant in exchange for rent payments due to 575 Broadway Associates.




From
December 2007 through May 2008, prior to its conversion from a limited liability
company to a corporation, Zoo Games issued common shares and warrants to
purchase common shares in an equity financing pursuant to which Zoo Games raised
an aggregate of $16,400,000, inclusive of the convertible notes which were
automatically converted into the securities issued in the equity financing, as
described above. Mr. Seremet’s convertible note was converted into 23,570 common
shares and warrants to purchase up to 5,893 common shares for an exercise price
of $2.13 per share. In addition, Mr. Seremet invested $100,000 in the equity
financing in exchange for 35,116 common shares and warrants to purchase up to
8,779 common shares for an exercise price of $2.84 per unit. The convertible
notes of Mr. Brant and his related entities were converted into an aggregate of
338,676 common shares and warrants to purchase up to 84,666 shares for an
exercise price of $2.13 per share. S.A.C. Venture Investments, LLC a principal
stockholder of the Company, invested an aggregate of $1,250,000 in exchange for
an aggregate of 438,955 common shares and warrants to purchase an aggregate of
109,739 common shares for an exercise price of $2.84 per share. Mr. Harris
Toibb, a principal stockholder of the Company, and entities related to Mr. Toibb
invested an aggregate of $3,150,000 in exchange for an aggregate of 1,106,166
common shares and warrants to purchase an aggregate of 276,541 common shares for
an exercise price of $2.84 per share. Mr. Toibb also provided various consulting
services to the Company in connection with the restructuring of Zoo Games’
indebtedness and certain other strategic matters. In connection with the
provision of those services, in July 2008 we issued 702,440 shares of its common
stock to Mr. Toibb.




58




Item 14. Principal Accounting Fees
and Services.





The
following table presents fees for professional services related to the audits
and reviews of our interim and annual financial statements and other audit
related services for the years ended December 31, 2009 and 2008:





The
following table presents fees for professional services related to the audits
and reviews of our interim and annual financial statements and other audit
related services for the years ended December 31, 2009 and 2008:




2009
                
                
                2008Audit
      fees:(1)
                
                $
                168,000
                
                
                $
                199,000Audit
      related fees:(2)
                
                
                0
                
                
                
                0Tax
      fees:(3)
                
                
                0
                
                
                
                0All
      other fees:(4)
                
                
                0
                
                
                
                0Total
                
                $
                168,000
                
                
                $
                199,000




Policy on
Pre-Approval of Audit and Permissible Non-audit Services of Independent
Auditors




Consistent
with SEC policies regarding auditor independence, the Board has responsibility
for appointing, setting compensation and overseeing the work of the independent
auditor. In recognition of this responsibility, the Board has established a
policy to pre-approve all audit and permissible non-audit services provided by
the independent auditor.




Prior to
engagement of the independent auditor for the next year’s audit, management will
submit an aggregate of services expected to be rendered during that year for
each of the following four categories of services to the Board for
approval.




1. Auditservices include audit
work performed in the preparation of financial statements, as well as work that
generally only the independent auditor can reasonably be expected to provide,
including comfort letters, statutory audits, and attest services and
consultation regarding financial accounting and/or reporting standards. For
2009, all services were performed by Amper, Politziner & Mattia, LLP. For
2008, $175,000 was for services performed by Amper, Politziner & Mattia,
LLP, and $24,000 was for services perfomed by Raich Ende Malter & Co.
LLP.




2. Audit-Relatedservices are for
assurance and related services that are traditionally performed by the
independent auditor, including due diligence related to mergers and
acquisitions, employee benefit plan audits, and special procedures required to
meet certain regulatory requirements.




3. Taxservices include all
services performed by the independent auditor’s tax personnel except those
services specifically related to the audit of the financial statements, and
includes fees in the areas of tax compliance, tax planning, and tax
advice.




4. Other Feesare those
associated with services not captured in the other categories.




Prior to
engagement, the Audit Committee of the Board pre-approves these services by
category of service. The fees are budgeted and the Audit Committee of the Board
requires the independent auditor and management to report actual fees versus the
budget periodically throughout the year by category of service. During the year,
circumstances may arise when it may become necessary to engage the independent
auditor for additional services not contemplated in the original pre-approval.
In those instances, the Audit Committee of the Board requires specific
pre-approval before engaging the independent auditor.




59




Effective
as of October 30, 2008, we dismissed Raich Ende Malter & Co. LLP as our
independent public accounting firm and retained Amper, Politziner & Mattia,
LLP for all audit and audit-related services during 2008.





PART IV





Item 15. Exhibits, Financial
Statement Schedules.





(1) Financial Statements.





The
financial statements required by Item 15 are submitted in a separate section of
this report, beginning on Page F-1, and are incorporated herein and made a part
hereof.





(2) Financial Statement
Schedules.





Those
financial statement schedules required by Item 15 have been omitted because of
the absence of conditions under which they are required or because the required
information is included in the financial statements or notes
thereto.





(3) Exhibits.





The
following exhibits are filed with this report, or incorporated by reference as
noted:




EXHIBIT INDEX
 
 ExhibitNo.
                
                Description2.1
                
                Plan
      and Agreement of Merger, between Zoo Entertainment, Inc. f/k/a
      Driftwood Ventures, Inc., a Delaware corporation (“Zoo”), and Driftwood
      Ventures, Inc., a Nevada corporation, dated as of November 19, 2007
      (incorporated by reference to that DEF 14C Information Statement filed
      with the Securities and Exchange Commission on November 30,
      2007).2.2
                
                Agreement
      and Plan of Merger, by and among Zoo, DFTW Merger Sub, Inc., Zoo Games
      Interactive Software, Inc. (“Zoo Games”) and the stockholder
      representative, dated as of July 7, 2008 (incorporated by reference to
      that Current Report on Form 8-K filed with the Securities and Exchange
      Commission on July 11, 2008.)2.3
                
                Amendment
      to Agreement and Plan of Merger, by and among Zoo, DFTW Merger Sub, Inc.,
      Zoo Games and the stockholder representative, dated as of September 12,
      2008 (incorporated by reference to that Current Report on Form 8-K filed
      with the Securities and Exchange Commission on September 18,
      2008).3.1
                
                Certificate
      of Incorporation (incorporated by reference to that Current Report on Form
      8-K filed with the Securities and Exchange Commission on December 21,
      2007).3.2
                
                Certificate
      of Ownership and Merger, filed with the Secretary of State of the State of
      Delaware on December 3, 2008 (incorporated by reference to that Current
      Report on Form 8-K filed with the Securities and Exchange Commission on
      December 8, 2008).
  60
 
 3.3
                      
                      Certificate
      of Amendment to Certificate of Incorporation, filed on August 26, 2009
      (incorporated by reference to that Current Report on Form 8-K filed with
      the Securities and Exchange Commission on August 31,
  2009).3.4
                      
                      Certificate
      of Designation, Preferences and Rights of Series A Convertible Preferred
      Stock (incorporated by reference to that Current Report on Form 8-K filed
      with the Securities and Exchange Commission on November 27, 2009)
      .3.5
                      
                      Certificate
      of Designation, Preferences and Rights of Series B Convertible Preferred
      Stock (incorporated by reference to that Current Report on Form 8-K filed
      with the Securities and Exchange Commission on November 27,
      2009).3.6
                      
                      Bylaws
      (incorporated by reference to that Current Report on Form 8-K filed with
      the Securities and Exchange Commission on December 21,
    2007).3.7
                      
                      Certificate
      of Amendment to Certificate of Incorporation (incorporated by reference to
      that Current Report on Form 8-K filed with the Securities and Exchange
      Commission on March 16, 2010).4.1
                      
                      Form
      of Note issued to investors (incorporated by reference to that Current
      Report on Form 8-K filed with the Securities and Exchange Commission on
      July 11, 2008).4.2
                      
                      Form
      of Note issued to investors (incorporated by reference to that
      Current Report on Form 8-K filed with the Securities and Exchange
      Commission on October 2, 2008).4.3
                      
                      Form
      of Warrant issued to investors  (incorporated by reference to
      that Current Report on Form 8-K filed with the Securities and Exchange
      Commission on July 11, 2008).4.4
                      
                      Form
      of Warrant issued to investors (incorporated by reference to that Current
      Report on Form 8-K filed with the Securities and Exchange Commission on
      October 2, 2008).4.5
                      
                      Form
      of Warrant issued to Focus Capital Partners, LLC and Socius Capital Group,
      LLC (incorporated by reference to that Current Report on Form 8-K filed
      with the Securities and Exchange Commission on December 21,
      2009).4.6
                      
                      Warrant
      issued to Solutions 2 Go, Inc. (incorporated by reference to that
      Quarterly Report on Form 10-Q filed with the Securities and Exchange
      Commission on November 23, 2009).10.1
                      
                      Loan
      Agreement with Trinad Capital Master Fund, Ltd. (“Trinad”), dated as of
      October 24, 2007, as amended on November 21, 2007 (incorporated by
      reference to that Current Report on Form 8-K filed with the Securities and
      Exchange Commission on October 25, 2007 and November 21, 2007,
      respectively).10.2
                      
                      Amendment
      No. 2 to Loan Agreement, by and between Zoo and Trinad, dated as of April
      18, 2008 (incorporated by reference to that Current Report on Form 8-K
      filed with the Securities and Exchange Commission on April 22,
      2008).10.3
                      
                      Amendment
      No. 3 to the Loan Agreement, by and between Zoo and Trinad, dated as of
      July 7, 2008 (incorporated by reference to that Current Report on Form 8-K
      filed with the Securities and Exchange Commission on July 11,
      2008).10.4*
                      
                      Management
      Agreement, between Zoo and Trinad Management, LLC, dated as of
      October 24, 2007 (incorporated by reference to that  DEF 14C
      Information Statement and filed with the Securities and Exchange
      Commission on November 30, 2007).10.5
      *
                      
                      Amendment
      No. 1 to the Management Agreement, by and between Zoo and Trinad
      Management, LLC, dated as of July 7, 2008 (incorporated by reference to
      that Current Report on Form 8-K filed with the Securities and Exchange
      Commission on July 11,
2008).
  61
 
 10.6*
                
                2007
      Employee, Director and Consultant Stock Plan (incorporated by reference to
      that Annual Report on Form 10-KSB filed with the Securities and Exchange
      Commission on April 8, 2008).10.7*
                
                Amendment
      to 2007 Employee, Director and Consultant Stock Plan (incorporated by
      reference to that Current Report on Form 8-K filed with the Securities and
      Exchange Commission on January 16, 2009).10.8
                
                Commercial
      Lease Agreement, by and between Trinad Management, LLC and Zoo, dated as
      of May 1, 2008 (incorporated by reference to that Current Report on Form
      8-K filed with the Securities and Exchange Commission on May 7,
      2008).10.9
                
                Letter
      Agreement, dated as of June 1, 2008, by and between Zoo and DDK Consulting
      (incorporated by reference to that Current Report on Form 8-K filed with
      the Securities and Exchange Commission on June 2,
2008).10.10
                
                Note
      Purchase Agreement, by and among Zoo, Trinad, Back Bay LLC (“Back Bay”),
      Cipher 06 LLC (“Cipher”), Soundpost Capital, LP (“Soundpost LP”),
      Soundpost Capital Offshore Ltd. (“Soundpost Offshore”) and S.A.C. Venture
      Investments, LLC (“S.A.C.”), dated as of July 7, 2008 (incorporated by
      reference to those Current Reports on Form 8-K filed with the Securities
      and Exchange Commission on July 11, 2008, July 30, 2008, August 1, 2008
      and August 15, 2008).10.11
                
                Amendment
      No. 1 to the Note Purchase Agreement, dated as of July 15, 2008
      (incorporated by reference to that Current Report on Form 8-K filed with
      the Securities and Exchange Commission on July 15,
  2008).10.12
                
                Amendment
      No. 2 to the Note Purchase Agreement, dated as of July 31, 2008
      (incorporated by reference to that Current Report on Form 8-K filed with
      the Securities and Exchange Commission on July 31,
  2008).10.11
                
                Security
      Agreement, by and among Zoo, Trinad, Back Bay, Cipher, Soundpost LP,
      Soundpost Offshore and S.A.C., dated as of July 7, 2008. (incorporated by
      reference to those Current Reports on Form 8-K filed with the Securities
      and Exchange Commission on July 11, 2008, July 30, 2008, August 1, 2008
      and August 15, 2008).10.12
                
                Securities
      Purchase Agreement, by and between Zoo Games and Zoo, dated as of July 7,
      2008 (incorporated by reference to that Current Report on Form 8-K filed
      with the Securities and Exchange Commission on July 11,
    2008).10.13
                
                Amendment
      No. 1 to the Securities Purchase Agreement, dated as of July 15, 2008
      (incorporated by reference to that Current Report on Form 8-K filed with
      the Securities and Exchange Commission on July 15,
  2008).10.14
                
                Senior
      Secured Note, issued by Zoo Games on July 7, 2008 (incorporated by
      reference to that Current Report on Form 8-K filed with the Securities and
      Exchange Commission on July 11, 2008).10.15
                
                Pledge
      Agreement, by and between Zoo and Zoo Games, dated as of July 7, 2008
      (incorporated by reference to that Current Report on Form 8-K filed with
      the Securities and Exchange Commission on July 11,
  2008).10.16
                
                Security
      Agreement, by and among Zoo, Zoo Games, Zoo Games Online LLC, Zoo Digital
      Publishing Limited, Supervillain Studios, LLC and Zoo Games, Inc. (the
      “Subsidiaries”), dated as of July 7, 2008 (incorporated by reference to
      that Current Report on Form 8-K filed with the Securities and Exchange
      Commission on July 11, 2008).10.17
                
                Guaranty,
      by and among the Subsidiaries, dated as of July 7, 2008 (incorporated by
      reference to that Current Report on Form 8-K filed with the Securities and
      Exchange Commission on July 11,
2008).
  62
 
 10.18
                
                Note
      Purchase Agreement, by and among Zoo, Trinad, Back Bay, Sandor Capital
      Master Fund LP (“Sandor”) and John S. Lemak (“Lemak”), dated as of
      September 26, 2008  (incorporated by reference to that Current
      Report on Form 8-K filed with the Securities and Exchange Commission on
      October 2, 2008).10.19
                
                Security
      Agreement, by and among Zoo, Trinad, Back Bay, Sandor and Lemak, dated as
      of September 26, 2008  (incorporated by reference to that
      Current Report on Form 8-K filed with the Securities and Exchange
      Commission on October 2, 2008).10.20
                
                1
      stAmended and Restated Employment Agreement between Zoo Games and
      Mark Seremet, dated as of April 16, 2006. (incorporated by reference to
      that Current Report on Form 8-K filed with the Securities and Exchange
      Commission on September 18, 2008).10.21*
                
                Amendment
      Number One to the 1 stAmended and Restated Employment Agreement between Zoo Games and
      Mark Seremet, dated as of July 15, 2008. (incorporated by reference to
      that Current Report on Form 8-K filed with the Securities and Exchange
      Commission on September 18, 2008).10.22*
                
                Employment
      Agreement, by and between Zoo Games and Mark Seremet, dated as of January
      14, 2009 (incorporated by reference to that Current Report on Form 8-K
      filed with the Securities and Exchange Commission on January 16,
      2009).10.23*
                
                Employment
      Agreement between Zoo Games and David J. Fremed, dated as of June 4, 2007
      (incorporated by reference to that Current Report on Form 8-K filed with
      the Securities and Exchange Commission on September 18,
    2008).10.24*
                
                Amendment
      Number One to the June 4, 2007 David Fremed Employment Agreement between
      Zoo Games and David J. Fremed, effective as of August 8, 2008.
      (incorporated by reference to that Current Report on Form 8-K filed with
      the Securities and Exchange Commission on September 18,
    2008).10.25*
                
                Employment
      Agreement between Zoo Games and Evan Gsell, dated as of May 22, 2007
      (incorporated by reference to that Current Report on Form 8-K filed with
      the Securities and Exchange Commission on September 18,
    2008).10.26*
                
                Employment
      Agreement between Zoo Publishing, Inc. and Susan J. Kain-Jurgensen, dated
      as of December 18, 2007 (incorporated by reference to that Current Report
      on Form 8-K filed with the Securities and Exchange Commission on September
      18, 2008).10.27*
                
                Amendment
      Number One to the Susan J. Kain-Jurgensen Employment Agreement between Zoo
      Publishing, Inc. and Susan J. Kain-Jurgensen effective as of July 16, 2008
      (incorporated by reference to that Current Report on Form 8-K filed with
      the Securities and Exchange Commission on September 18,
    2008).10.18*
                
                2008
      Long-Term Incentive Plan of Zoo Games (incorporated by reference to that
      Current Report on Form 8-K filed with the Securities and Exchange
      Commission on September 18, 2008).10.19
                
                Agreement
      between Barry Hatch and Ian Stewart, and Zoo Games, dated as of April 4,
      2008 (incorporated by reference to that Current Report on Form 8-K filed
      with the Securities and Exchange Commission on September 18,
      2008).10.30
                
                Amendment
      to Loan Note Instrument of Zoo Games, dated as of July 31, 2008
      (incorporated by reference to that Current Report on Form 8-K filed with
      the Securities and Exchange Commission on September 18,
    2008).
  63
 
 10.31
                
                Loan
      facility of £325,000 (approximately U.S. $650,000) from I.C. Stewart 2001
      Trust to Zoo Digital Publishing Limited, dated as of April 1, 2008
      (incorporated by reference to that Current Report on Form 8-K filed with
      the Securities and Exchange Commission on September 18,
    2008).10.32
                
                Cash
      Flow Financing Facility of Zoo Digital Publishing with Bank of Scotland,
      dated as of November 21, 2006 (incorporated by reference to that Current
      Report on Form 8-K filed with the Securities and Exchange Commission on
      September 18, 2008).10.33
                
                Amendment
      to Cash Flow Financing Facility of Zoo Digital Publishing with Bank of
      Scotland, dated as of January 7, 2008 (incorporated by reference to that
      Current Report on Form 8-K filed with the Securities and Exchange
      Commission on September 18, 2008).10.34
                
                Overdraft
      Financing Facility of Zoo Digital Publishing with Bank of Scotland, dated
      as of July 11, 2008 (incorporated by reference to that Current Report on
      Form 8-K filed with the Securities and Exchange Commission on September
      18, 2008).10.35
                
                Lease
      Agreement between Paul Andrew Williams and Clare Marie Williams t/a Towers
      Investments of Valley House and Zoo Digital Publishing, Limited, dated as
      of February 1, 2007 (incorporated by reference to that Current Report on
      Form 8-K filed with the Securities and Exchange Commission on September
      18, 2008).10.36**
                
                First
      Renewal License Agreement for the Nintendo DS System between Nintendo Co.,
      Ltd. And Zoo Digital Publishing Limited, dated as of May 25, 2008
      (incorporated by reference to that Current Report on Form 8-K filed with
      the Securities and Exchange Commission on September 18,
    2008).10.37**
                
                Confidential
      License Agreement for the Wii Console between Nintendo Co., Ltd. and Zoo
      Digital Publishing Limited, dated as of May 15, 2007 (incorporated by
      reference to that Current Report on Form 8-K filed with the Securities and
      Exchange Commission on September 18, 2008).10.38
                
                Guaranty
      of Mark Seremet, dated as of August 11, 2008 (incorporated by reference to
      that Current Report on Form 8-K filed with the Securities and Exchange
      Commission on September 18, 2008).10.39
                
                Playstation2
      Licensed Publisher Agreement between Sony Computer Entertainment Europe
      Limited and Zoo Digital Publishing Limited, dated as of August 22, 2002
      (incorporated by reference to that Current Report on Form 8-K filed with
      the Securities and Exchange Commission on September 18,
    2008).10.40
                
                Playstation
      Portable Licensed Publisher Agreement between Sony Computer Entertainment
      Europe Limited and Zoo Digital Publishing Limited, dated as of August 7,
      2008 (incorporated by reference to that Current Report on Form 8-K filed
      with the Securities and Exchange Commission on September 18,
      2008).10.41
                
                Amended
      and Restated Promissory Note of Supervillain Studios, LLC and TSC Games,
      Inc., dated as of June 14, 2007, in the aggregate principal amount of
      $2,100,000 (incorporated by reference to that Current Report on Form 8-K
      filed with the Securities and Exchange Commission on September 18,
      2008).10.42
                
                Sublease
      between Supervillain Studios, LLC and Supervillain Studios, Inc. (now
      known as TSC Games, Inc.), dated as of June 14, 2007 (incorporated by
      reference to that Current Report on Form 8-K filed with the Securities and
      Exchange Commission on September 18, 2008).10.43
                
                Confidential
      License Agreement for the Wii Console between Nintendo of America Inc. and
      Zoo Publishing, Inc., dated as of July 14, 2008 (incorporated by reference
      to that Current Report on Form 8-K filed with the Securities and Exchange
      Commission on September 18,
2008).
  64
 
 10.44
                
                Confidential
      License Agreement for Nintendo DS between Nintendo of America Inc. and Zoo
      Publishing, dated as of October 1, 2005 (incorporated by reference to that
      Current Report on Form 8-K filed with the Securities and Exchange
      Commission on September 18, 2008).10.45
                
                Confidential
      License Agreement for the Nintendo DS System between Nintendo Co., Ltd.
      and Zoo Publishing, dated as of April 4, 2005 (incorporated by reference
      to that Current Report on Form 8-K filed with the Securities and Exchange
      Commission on September 18, 2008).10.46**
                
                PSP
      Licensed Publisher Agreement between SONY Computer Entertainment America
      Inc. and Zoo Publishing, dated as of January 20, 2006 (incorporated by
      reference to that Current Report on Form 8-K filed with the Securities and
      Exchange Commission on September 18, 2008).10.47**
                
                PS2
      Licensed Publisher Agreement between SONY Computer Entertainment America
      Inc. and Zoo Publishing, dated as of November 20, 2002 (incorporated by
      reference to that Current Report on Form 8-K filed with the Securities and
      Exchange Commission on September 18, 2008).10.48
                
                Zoo
      Games, Inc. Form of Non-Qualified Stock Option Award Agreement
      (incorporated by reference to that Current Report on Form 8-K filed with
      the Securities and Exchange Commission on September 18,
    2008).10.49
                
                Business
      Lease between Lakeside Business Park, LLC and DSI, dated as of September
      20, 2007 (incorporated by reference to that Current Report on Form 8-K
      filed with the Securities and Exchange Commission on September 18,
      2008).10.50
                
                Factoring
      and Security Agreement between Zoo Publishing, Inc. and Working Capital
      Solutions, Inc., dated as of August 5, 2008 (incorporated by reference to
      that Current Report on Form 8-K filed with the Securities and Exchange
      Commission on September 18, 2008).10.51
                
                Promissory
      Note of Zoo Publishing to the estate of Stuart Kaye in the principal
      amount of $647,830, dated, as of January 1, 2007 (incorporated by
      reference to that Current Report on Form 8-K filed with the Securities and
      Exchange Commission on September 18, 2008).10.52
                
                Guaranty
      of Zoo Publishing obligations to Transcap Trade Finance made by Susan J.
      Kain-Jurgensen, dated as of December 19, 2007 (incorporated by reference
      to that Current Report on Form 8-K filed with the Securities and Exchange
      Commission on September 18, 2008).10.53
                
                Promissory
      Note of Zoo Publishing for the benefit of Susan J. Kain-Jurgensen in the
      principal amount of $506,670.99, dated as of April 15, 2008 (incorporated
      by reference to that Current Report on Form 8-K filed with the Securities
      and Exchange Commission on September 18, 2008).10.54
                
                Form
      of Non-Competition Agreement entered into by Mark Seremet and Susan J.
      Kain-Jurgensen, dated as of September 12, 2008 (incorporated by reference
      to that Current Report on Form 8-K filed with the Securities and Exchange
      Commission on September 18, 2008).10.55
                
                Sales
      Agreement, by and between Zoo Publishing, Inc. and Atari, Inc., dated as
      of October 24, 2008 (incorporated by reference to that Quarterly Report on
      Form 10-Q filed with the Securities and Exchange Commission on November
      19, 2009).10.56
                
                Agreement
      for the Sale and Purchase of the entire Issued Share Capital of Zoo
      Digital Publishing Limited, by and among Zoo Games, Zoo Digital Publishing
      Limited, Barry Hatch and Ian Clifford Stewart, dated as of December 2,
      2008 (incorporated by reference to that Current Report on Form 8-K filed
      with the Securities and Exchange Commission on December 8,
      2008).
  65
 
 10.57
                
                Amended
      and Restated Master Purchase Order Assignment Agreement, by and among Zoo
      Entertainment, Inc., Zoo Games, Zoo Publishing, Inc. and Wells Fargo Bank
      National Association, dated as of April 6, 2009 (incorporated by reference
      to that Current Report on Form 8-K filed with the Securities and Exchange
      Commission on April 9, 2009).10.58
                
                Amended
      and Restated Security Agreement and Financing Statement, by and among Zoo
      Entertainment, Inc., Zoo Games, Zoo Publishing, Inc. and Wells Fargo Bank
      National Association, dated as of April 6, 2009 (incorporated by reference
      to that Current Report on Form 8-K filed with the Securities and Exchange
      Commission on April 9, 2009).10.59
                
                Guaranty,
      by and among Wells Fargo Bank, National Association and Mark Seremet and
      David Rosenbaum as guarantors, dated as of April 6, 2009 (incorporated by
      reference to that Current Report on Form 8-K filed with the Securities and
      Exchange Commission on April 9, 2009).10.60
                
                Exchange
      Agreement, by and among Zoo Games, Supervillian Studios, LLC, TSC Games,
      Inc. and Stephen Ganem, Timothy Campbell and Chris Rausch, dated as of
      September 16, 2008 (incorporated by reference to that Annual Report on
      Form 10-K filed with the Securities and Exchange Commission on April 15,
      2009).10.61
                
                Amendment
      Number One to the October 24, 2008 Sales Agreement, by and between Zoo
      Publishing, Inc. and Atari, Inc., effective as of April 1, 2009
      (incorporated by reference to that Annual Report on Form 10-K filed with
      the Securities and Exchange Commission on April 15,
  2009).10.62
                
                Amendment
      Number Two to the October 24, 2008 Sales Agreement, by and between Zoo
      Publishing, Inc. and Atari, Inc., dated as of May 1, 2009 (incorporated by
      reference to that Current Report on Form 8-K filed with the Securities and
      Exchange Commission on May 7, 2009).10.63
                
                Letter
      Agreement, by and between Zoo Entertainment, Inc. and Mark Seremet, dated
      as of May 12, 2009 (incorporated by reference to that Current Report on
      Form 8-K filed with the Securities and Exchange Commission on May 18,
      2009).10.64
                
                Letter
      Agreement, by and between Zoo Entertainment, Inc. and David Rosenbaum,
      dated as of May 12, 2009 (incorporated by reference to that Current Report
      on Form 8-K filed with the Securities and Exchange Commission on May 18,
      2009).10.65
                
                License
      Agreement, by and among Zoo Entertainment, Inc., Zoo Publishing, Inc. and
      New World IP, LLC, dated as of May 1, 2009 (incorporated by reference to
      that Current Report on Form 8-K filed with the Securities and Exchange
      Commission on May 20, 2009).10.66
                
                Amendment
      No. 2 to Senior Secured Convertible Note, dated as of June 26, 2009, by
      and among Zoo Entertainment, Inc. and the holders of Notes set forth
      therein (incorporated by reference to that Quarterly Report on Form 10-Q
      filed with the Securities and Exchange Commission on August 14,
      2009).10.67
                
                Letter
      Agreement, dated as of June 26, 2009, by and among Zoo Entertainment, Inc.
      and the holders of Notes set forth therein (incorporated by reference to
      that Quarterly Report on Form 10-Q filed with the Securities and Exchange
      Commission on August 14, 2009).10.68**
                
                Amendment
      Number 3 to the October 24, 2008 Sales Agreement, dated as of June 15,
      2009, by and between Zoo Publishing, Inc. and Atari, Inc (incorporated by
      reference to that Quarterly Report on Form 10-Q filed with the Securities
      and Exchange Commission on August 14,
2009).
  66
 
 10.69
                
                Amendment
      No. 2 to License Agreement, dated as of May 20, 2009, by and among Zoo
      Publishing, Inc., Zoo Entertainment, Inc. and New World IP, LLC
      (incorporated by reference to that Quarterly Report on Form 10-Q filed
      with the Securities and Exchange Commission on August 14,
      2009).10.70*
                
                Employment
      Agreement, dated as of January 1, 2008, by and between Zoo Publishing,
      Inc. and David Rosenbaum (incorporated by reference to that Quarterly
      Report on Form 10-Q filed with the Securities and Exchange Commission on
      August 14, 2009).10.71*
                
                Amendment
      No. 1 to Employment Agreement, dated as of July 1, 2008, by and between
      Zoo Publishing, Inc. and David Rosenbaum (incorporated by reference to
      that Quarterly Report on Form 10-Q filed with the Securities and Exchange
      Commission on August 14, 2009).10.72*
                
                Amendment
      No. 2 to Employment Agreement, dated as of July 23, 2009, by and between
      Zoo Publishing, Inc. and David Rosenbaum (incorporated by reference to
      that Quarterly Report on Form 10-Q filed with the Securities and Exchange
      Commission on August 14, 2009).10.73
                
                Factoring
      and Security Agreement, dated as of September 9, 2009 and effective as of
      September 29, 2009,  by and between Zoo Publishing, Inc. and
      Working Capital Solutions, Inc. (incorporated by reference to that Current
      Report on Form 8-K filed with the Securities and Exchange Commission on
      October 2, 2009).10.74
                
                Continuing
      Unconditional Guaranty, dated as of September 9, 2009 and effective as of
      September 29, 2009, by and between Working Capital Solutions, Inc. and Zoo
      Entertainment, Inc. as guarantor (incorporated by reference to that
      Current Report on Form 8-K filed with the Securities and Exchange
      Commission on October 2, 2009).10.75
                
                Continuing
      Unconditional Guaranty, dated as of September 9, 2009 and effective as of
      September 29, 2009, by and between Working Capital Solutions, Inc. and Zoo
      Games, Inc. as guarantor (incorporated by reference to that Current Report
      on Form 8-K filed with the Securities and Exchange Commission on October
      2, 2009).10.76
                
                Individual
      Guaranty, by and between Working Capital Solutions, Inc. and Mark Seremet
      as guarantor, dated as of September 9, 2009 and effective as of September
      29, 2009 (incorporated by reference to that Current Report on Form 8-K
      filed with the Securities and Exchange Commission on October 2,
      2009).10.77
                
                Individual
      Guaranty, by and between Working Capital Solutions, Inc. and David
      Rosenbaum as guarantor, dated as of September 9, 2009 and effective as of
      September 29, 2009 (incorporated by reference to that Current Report on
      Form 8-K filed with the Securities and Exchange Commission on October 2,
      2009).10.78
                
                Amendment
      No. 3 to Senior Secured Convertible Note, dated as of August 31, 2009, by
      and among Zoo Entertainment, Inc. and the holders of Notes set forth
      therein (incorporated by reference to that Quarterly Report on Form 10-Q
      filed with the Securities and Exchange Commission on November 23,
      2009).10.79
                
                Advance
      Agreement, by and among Zoo Entertainment, Inc., Solutions 2 Go Inc. and
      Solutions 2 Go LLC, dated as of August 31, 2009 (incorporated by reference
      to that Quarterly Report on Form 10-Q filed with the Securities and
      Exchange Commission on November 23, 2009).10.80
                
                Exclusive
      Distribution Agreement, by and between Zoo Publishing, Inc. and Solutions
      2 Go Inc. and Solutions 2 Go LLC, dated as of August 31, 2009
      (incorporated by reference to that Quarterly Report on Form 10-Q filed
      with the Securities and Exchange Commission on November 23,
      2009).10.81
                
                Exclusive
      Distribution Agreement, by and between Zoo Publishing, Inc. and Solutions
      2 Go LLC, dated as of August 31, 2009 (incorporated by reference to that
      Quarterly Report on Form 10-Q filed with the Securities and Exchange
      Commission on November 23,
2009).
  67
 
 10.82
                  
                  Amendment
      1 to Fee Letter Agreement, by and between Zoo Entertainment, Inc. and Mark
      Seremet, dated as of August 31, 2009 (incorporated by reference to that
      Quarterly Report on Form 10-Q filed with the Securities and Exchange
      Commission on November 23, 2009).10.83
                  
                  Amendment
      1 to Fee Letter Agreement, by and between Zoo Entertainment, Inc. and
      David Rosenbaum, dated as of August 31, 2009 (incorporated by reference to
      that Quarterly Report on Form 10-Q filed with the Securities and Exchange
      Commission on November 23, 2009).10.84
                  
                  Continuing
      Personal Guaranty of Mark Seremet for the benefit of Solutions 2 Go Inc.
      and Solutions 2 Go LLC, dated as of August 31, 2009 (incorporated by
      reference to that Quarterly Report on Form 10-Q filed with the Securities
      and Exchange Commission on November 23, 2009).10.85
                  
                  Continuing
      Personal Guaranty of David Rosenbaum for the benefit of Solutions 2 Go
      Inc. and Solutions 2 Go LLC, dated as of August 31, 2009 (incorporated by
      reference to that Quarterly Report on Form 10-Q filed with the Securities
      and Exchange Commission on November 23, 2009).10.86
                  
                  Amendment
      No. 4 to Senior Secured Convertible Note, dated as of October 6, 2009, by
      and among Zoo Entertainment, Inc. and the holders of Notes set forth
      therein (incorporated by reference to that Quarterly Report on Form 10-Q
      filed with the Securities and Exchange Commission on November 23,
      2009).10.87
                  
                  Amendment
      No. 2 to Letter Agreement, by and between Zoo Entertainment, Inc. and Mark
      Seremet, dated as of November 20, 2009 (incorporated by reference to that
      Current Report on Form 8-K filed with the Securities and Exchange
      Commission on November 27, 2009).10.88
                  
                  Amendment
      No. 2 to Letter Agreement, by and between Zoo Entertainment, Inc. and
      David Rosenbaum, dated as of November 20, 2009 (incorporated by reference
      to that Current Report on Form 8-K filed with the Securities and Exchange
      Commission on November 27, 2009).10.89
                  
                  Amendment
      No. 6 to Senior Secured Convertible Promissory Note, by and among Zoo
      Entertainment, Inc. and the note holders set forth therein, dated as of
      November 20, 2009 (incorporated by reference to that Current Report on
      Form 8-K filed with the Securities and Exchange Commission on November 27,
      2009).10.90
                  
                  Amendment
      No. 5 to Senior Secured Convertible Note, dated as of November 2, 2009, by
      and among Zoo Entertainment, Inc. and the holders of Notes set forth
      therein (incorporated by reference to the Registration Statement on Form
      S-1 filed with the Securities and Exchange Commission on December 22,
      2009) .10.91
                  
                  Securities
      Purchase Agreement, by and among Zoo Entertainment, Inc. and the investors
      set forth therein, dated as of November 20, 2009 (incorporated by
      reference to the Registration Statement on Form S-1 filed with the
      Securities and Exchange Commission on December 22, 2009)
  .10.92
                  
                  Registration
      Rights Agreement, by and among Zoo Entertainment, Inc., Focus Capital
      Partners, LLC and Socius Capital Group, LLC, dated as of November 20, 2009
      (incorporated by reference to the Registration Statement on Form S-1 filed
      with the Securities and Exchange Commission on December 22,
      2009).10.93
                  
                  Securities
      Purchase Agreement, by and among Zoo Entertainment, Inc. and the investors
      set forth therein, dated as of December 16, 2009 (incorporated by
      reference to the Registration Statement on Form S-1 filed with the
      Securities and Exchange Commission on December 22,
  2009).
  68
 
 10.94
                          
                          Amendment
      No. 1 to Registration Rights Agreement, by and among Zoo Entertainment,
      Inc., Focus Capital Partners, LLC and Socius Capital Group, LLC, dated as
      of December 16, 2009 (incorporated by reference to the Registration
      Statement on Form S-1 filed with the Securities and Exchange Commission on
      December 22, 2009).10.95
                          
                          Employment
      Agreement, by and between Zoo Publishing, Inc. and Steve Buchanan, dated
      as of February 15, 2010 (incorporated by reference to that Current Report
      on Form 8-K filed with the Securities and Exchange Commission on February
      18, 2010).10.96
                          
                          Amendment
      Number Two to the June 4, 2007 David Fremed Employment Agreement, by
      and between Zoo Games, Inc. and David Fremed, dated as of February 15,
      2010 (incorporated by reference to that Current Report on Form 8-K filed
      with the Securities and Exchange Commission on February 18,
    2010).10.97
                          
                          Form
      of non-qualified stock option agreement. †10.98
                          
                          Form
      of restricted stock agreement. †16.1
                          
                          Letter
      from Rothstein, Kass & Company, P.C., dated as of April 21, 2008
      (incorporated by reference to that Current Report on Form 8-K filed with
      the Securities and Exchange Commission April 22, 2008).16.2
                          
                          Letter
      from Raich Ende Malter & Co. LLP, dated as of November 4, 2008
      (incorporated by reference to that Current Report on Form 8-K filed with
      the Securities and Exchange Commission November 5,
  2008).21.1
                          
                          Subsidiaries
      of Zoo Entertainment, Inc. (incorporated by reference to the Registration
      Statement on Form S-1 filed with the Securities and Exchange Commission on
      December 22, 2009).31.1
                          
                          Certification
      of Mark Seremet, Chief Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002. †31.2
                          
                          Certification
      of David Fremed, Chief Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002. †32.1
                          
                          Certification
      of Mark Seremet, Principal Executive Officer, and David Fremed, Principal
      Financial Officer, pursuant to U.S.C. Section 1350.
  †





*
Management compensation agreements


**Confidential
treatment as to certain portions requested


† Filed
herewith


69





SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) 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.




ZOO
      ENTERTAINMENT, INC.Date:
      March 31, 2010
              By:
              /s/ David FremedDavid
      Fremed, Chief Financial
Officer




Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities indicated below and on the dates indicated.




Signatures
                      
                      Title
                      
                      DateBy:
                      /s/ Mark Seremet
                      
                      Chief
      Executive OfficerMark
      Seremet
                      
                      (principal
      executive
                      
                      March 31, 2010officer)
      and DirectorBy:
                      /s/ David Fremed
                      
                      Chief
      Financial Officer
                      
                      March 31, 2010David
      Fremed
                      
                      (principal
      financialofficer,
      principal accounting officer)By:
                      /s/ Jay A. Wolf
                      
                      Director
                      
                      March 31, 2010Jay
      A. WolfBy:
                      /s/ David Smith
                      
                      Director
                      
                      March 31, 2010David
      SmithBy:
                      /s/ Barry Regenstein
                      
                      Director
                      
                      March 31, 2010Barry
      RegensteinBy:
                      /s/ John Bendheim
                      
                      Director
                      
                      March 31, 2010John
      BendheimBy:
                      /s/ Drew Larner
                      
                      Director
                      
                      March 31, 2010Drew
      LarnerBy:
                      /s/ Moritz Seidel
                      
                      Director
                      
                      March 31, 2010Moritz
      Seidel


70




ZOO
ENTERTAINMENT, INC.  AND SUBSIDIARIES
  INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS
 
 CONTENTS
              
              PAGE NO.Report
      of Independent Registered Public Accounting Firm
              
              
              F-2Consolidated
      Balance Sheets as of December 31, 2009 and 2008
              
              
              F-3Consolidated
      Statements of Operations for the Years Ended December 31, 2009 and
      2008
              
              
              F-4Consolidated
      Statements of Cash Flow for the Years Ended December 31, 2009 and
      2008
              
              
              F-5Consolidated
      Statements of Stockholders’ Equity for the Years Ended December 31, 2009
      and 2008
              
              
              F-6Notes
      to Consolidated Financial Statements
              
              
              F-7
      - F-35
  F-1


Report
of Independent Registered Public Accounting Firm





To the
Board of Directors


Zoo
Entertainment, Inc. and Subsidiaries





We have
audited the accompanying consolidated balance sheets of Zoo Entertainment, Inc.
and Subsidiaries as of December 31, 2009 and 2008, and the related consolidated
statements of operations, stockholders’ equity and cash flows for the years then
ended. These financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these financial
statements based on our audits.





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





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Zoo
Entertainment, Inc. and Subsidiaries as of December 31, 2009 and 2008, and the
results of their operations and their cash flows for the years then ended, in
conformity with accounting principles generally accepted in the United States of
America.





/s/
Amper, Politziner & Mattia, LLP





March 31,
2010


New York,
New York


F-2




Zoo
Entertainment, Inc. and Subsidiaries


Consolidated
Balance Sheets


(in
$000's except share and per share amounts)





December 31, 2009
                    
                    
                    December 31, 2008ASSETSCurrent
      AssetsCash
                    
                    $
                    2,664
                    
                    
                    $
                    849Accounts
      receivable and due from factor, net of allowances for returns and
      discounts of $835 and $1,160
                    
                    
                    4,022
                    
                    
                    
                    1,832Inventory
                    
                    
                    2,103
                    
                    
                    
                    3,120Prepaid
      expenses and other current assets
                    
                    
                    2,409
                    
                    
                    
                    2,124Product
      development costs, net
                    
                    
                    4,399
                    
                    
                    
                    5,338Deferred
      tax assets
                    
                    
                    578
                    
                    
                    
                    688Total
      Current Assets
                    
                    
                    16,175
                    
                    
                    
                    13,951Fixed
      assets, net
                    
                    
                    141
                    
                    
                    
                    214Goodwill
                    
                    
                    -
                    
                    
                    
                    14,704Intangible
      assets, net
                    
                    
                    15,733
                    
                    
                    
                    14,747Total
      Assets
                    
                    $
                    32,049
                    
                    
                    $
                    43,616LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      LiabilitiesAccounts
      payable
                    
                    $
                    3,330
                    
                    
                    $
                    5,709Financing
      arrangements
                    
                    
                    1,659
                    
                    
                    
                    849Customer
      advances
                    
                    
                    3,086
                    
                    
                    
                    1,828Accrued
      expenses and other current liabilities
                    
                    
                    2,333
                    
                    
                    
                    3,099Notes
      payable, net of discount of $0 and $145 - current portion
                    
                    
                    120
                    
                    
                    
                    1,803Convertible
      notes payable, net of discount of $0 and $1,576, including accrued
      interest of $0 and $240
                    
                    
                    -
                    
                    
                    
                    9,814Total
      Current Liabilities
                    
                    
                    10,528
                    
                    
                    
                    23,102Notes
      payable, net of discount of $0 and $885 - non current
    portion
                    
                    
                    180
                    
                    
                    
                    1,772Deferred
      tax liabilities
                    
                    
                    3,461
                    
                    
                    
                    688Other
      long-term liabilities
                    
                    
                    2,770
                    
                    
                    
                    620Total
      Liabilities
                    
                    
                    16,939
                    
                    
                    
                    26,182Commitments
      and ContingenciesStockholders'
      EquityPreferred
      Stock, par value $0.001, 5,000,000 authorizedSeries
      A, 1,389,684 issued and outstanding
                    
                    
                    1
                    
                    
                    
                    -Series
      B, 1,188,439 issued and outstanding
                    
                    
                    1
                    
                    
                    
                    -Common
      Stock, par value $0.001, 250,000,000 shares authorized, 39,425,755 issued
      and 31,624,429 outstanding December 31, 2009 and 38,243,937 issued and
      36,006,561 outstanding December 31, 2008
                    
                    
                    39
                    
                    
                    
                    38Additional
      Paid-in-capital
                    
                    
                    64,675
                    
                    
                    
                    52,692Accumulated
      deficit
                    
                    
                    (45,137
                    )
                    
                    
                    (31,940
                    )Treasury
      Stock, at cost, 7,801,326 shares December 31,2009 and 2,237,376 shares
      December 31, 2008
                    
                    
                    (4,469
                    )
                    
                    
                    (3,356
                    )Total
      Stockholders' Equity
                    
                    
                    15,110
                    
                    
                    
                    17,434Total
      Liabilities and Stockholders' Equity
                    
                    $
                    32,049
                    
                    
                    $
                    43,616





See
accompanying notes to consolidated financial statements


F-3





Zoo
Entertainment, Inc. and Subsidiaries


Consolidated
Statements of Operations


For
the Years Ended December 31, 2009 and 2008


(in
$000's except per share amounts)





Year Ended December 31,2009
                  
                  
                  2008Revenue
                  
                  $
                  48,709
                  
                  
                  $
                  36,313Cost
      of goods sold
                  
                  
                  39,815
                  
                  
                  
                  30,883Gross
      profit
                  
                  
                  8,894
                  
                  
                  
                  5,430Operating
      expenses:General
      and administrative
                  
                  
                  6,788
                  
                  
                  
                  10,484Selling
      and marketing
                  
                  
                  2,484
                  
                  
                  
                  4,548Research
      and development
                  
                  
                  390
                  
                  
                  
                  5,857Impairment
      of goodwill
                  
                  
                  14,704
                  
                  
                  
                  -Depreciation
      and amortization
                  
                  
                  1,875
                  
                  
                  
                  1,760Total
      operating expenses
                  
                  
                  26,241
                  
                  
                  
                  22,649Loss
      from operations
                  
                  
                  (17,347
                  )
                  
                  
                  (17,219
                  )Interest
      expense, net
                  
                  
                  (2,975
                  )
                  
                  
                  (3,638
                  )Gain
      on extinguishment of debt
                  
                  
                  5,315
                  
                  
                  
                  -Gain
      on legal settlement
                  
                  
                  4,328
                  
                  
                  
                  -Other
      income - insurance recovery
                  
                  
                  860
                  
                  
                  
                  1,200Loss
      from continuing operations before income tax (expense)
    benefit
                  
                  
                  (9,819
                  )
                  
                  
                  (19,657
                  )Income
      tax (expense) benefit
                  
                  
                  (3,143
                  )
                  
                  
                  4,696Loss
      from continuing operations
                  
                  
                  (12,962
                  )
                  
                  
                  (14,961
                  )Loss
      from discontinued operations, net of tax benefit of $1,390 for the year
      ended December 31, 2008
                  
                  
                  (235
                  )
                  
                  
                  (6,734
                  )Net
      loss
                  
                  $
                  (13,197
                  )
                  
                  $
                  (21,695
                  )Loss per common share - basic and
      diluted:Continuing
      operations
                  
                  $
                  (0.39
                  )
                  
                  $
                  (0.59
                  )Discontinued
      operations
                  
                  
                  -
                  
                  
                  
                  (0.27
                  )Net
      loss
                  
                  $
                  (0.39
                  )
                  
                  $
                  (0.85
                  )Weighted
      average common shares outstanding - basic and diluted
                  
                  
                  33,495,707
                  
                  
                  
                  25,394,264





See
accompanying notes to consolidated financial statements


F-4





Zoo
Entertainment, Inc. and Subsidiaries


Consolidated
Statements of Cash Flow


For
the Years Ended December 31, 2009 and 2008


(in
$000's)





Year Ended December 31,2009
                
                
                2008Operating
      Activities:Net
      loss
                
                $
                (13,197
                )
                
                $
                (21,695
                )Loss
      from discontinued operations
                
                
                (235
                )
                
                
                (6,734
                )Loss
      from continuing operations
                
                
                (12,962
                )
                
                
                (14,961
                )Adjustments
      to reconcile net loss from continuing operations to net cash used in
      operating activities:Gain
      on legal settlement
                
                
                (4,328
                )
                
                
                -Gain
      on extinguishment of debt
                
                
                (5,315
                )
                
                
                -Impairment
      of goodwill
                
                
                14,704
                
                
                
                -Depreciation
      and amortization
                
                
                1,875
                
                
                
                1,760Amortization
      of deferred debt discount
                
                
                1,870
                
                
                
                3,443Deferred
      income taxes
                
                
                2,883
                
                
                
                (4,782
                )Stock
      based compensation
                
                
                588
                
                
                
                2,759Other
      changes in assets and liabilities, net
                
                
                (4,801
                )
                
                
                (291
                )Net
      cash used in continuing operations
                
                
                (5,486
                )
                
                
                (12,072
                )Net
      cash used in discontinued operations
                
                
                -
                
                
                
                (2,184
                )Net
      cash used in operating activities
                
                
                (5,486
                )
                
                
                (14,256
                )Investing
      activities:Purchases
      of fixed assets
                
                
                (26
                )
                
                
                (67
                )Purchase
      of intellectual property
                
                
                (312
                )
                
                
                -Disposition
      of assets of discontinued operations, net of cash acquired
                
                
                -
                
                
                
                477Acquisition
      of stock of Zoo Publishing, net of cash acquired
                
                
                -
                
                
                
                (2
                )Cash
      received from acquisition of Driftwood
                
                
                -
                
                
                
                1,669Net
      cash (used in) provided by investing activities
                
                
                (338
                )
                
                
                2,077Financing
      activities:Proceeds
      from sale of equity securities
                
                
                7
                
                
                
                6,118Proceeds
      from sale of Preferred Series A stock, net of $178 costs
                
                
                4,822
                
                
                
                -Proceeds
      from Solutions 2 Go note for customer advance
                
                
                2,000
                
                
                
                -Proceeds
      from Driftwood issuance of convertible notes - pre-merger
                
                
                -
                
                
                
                7,785Proceeds
      from issuance of convertible notes - post-merger
                
                
                -
                
                
                
                1,000Net
      borrowings (repayments) in connection with financing
      facilities
                
                
                810
                
                
                
                (2,044
                )Net
      cash provided by financing activities
                
                
                7,639
                
                
                
                12,859Net
      increase in cash
                
                
                1,815
                
                
                
                680Cash
      at beginning of year
                
                
                849
                
                
                
                169Cash
      at end of year
                
                $
                2,664
                
                
                $
                849





See
accompanying notes to consolidated financial statements


F-5





Zoo
Entertainment, Inc. and Subsidiaries


Consolidated
Statement of Stockholders' Equity


For
the Years Ended December 31, 2009 and 2008


(in
000's)





Preferred StockSeries A
                                                                                                    
                                                                                                    Series B
                                                                                                    
                                                                                                    Common Stock
                                                                                                    
                                                                                                    Additional
                                                                                                    
                                                                                                    Accumulated
                                                                                                    
                                                                                                    Treasury StockShares
                                                                                                    
                                                                                                    Par value
                                                                                                    
                                                                                                    Shares
                                                                                                    
                                                                                                    Par value
                                                                                                    
                                                                                                    Shares
                                                                                                    
                                                                                                    Par Value
                                                                                                    
                                                                                                    Paid-in-Capital
                                                                                                    
                                                                                                    Deficit
                                                                                                    
                                                                                                    Shares
                                                                                                    
                                                                                                    Cost
                                                                                                    
                                                                                                    TotalBalance
      January 1, 2008
                                                                                                    
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    $
                                                                                                    -
                                                                                                    
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    $
                                                                                                    -
                                                                                                    
                                                                                                    
                                                                                                    15,685
                                                                                                    
                                                                                                    $
                                                                                                    16
                                                                                                    
                                                                                                    $
                                                                                                    31,792
                                                                                                    
                                                                                                    $
                                                                                                    (10,245
                                                                                                    )
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    $
                                                                                                    -
                                                                                                    
                                                                                                    $
                                                                                                    21,563Stock
      issued in connection with private placement offering
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    2,143
                                                                                                    
                                                                                                    
                                                                                                    2
                                                                                                    
                                                                                                    
                                                                                                    6,433
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    6,435Costs
      incurred in connection with private placement offering
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    (317
                                                                                                    )
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    (317
                                                                                                    )Stock
      issued in connection with the acquisition of Zoo Digital
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    1,581
                                                                                                    
                                                                                                    
                                                                                                    2
                                                                                                    
                                                                                                    
                                                                                                    4,084
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    4,086Exchange
      of promissory notes for common stock at fair value
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    5,973
                                                                                                    
                                                                                                    
                                                                                                    6
                                                                                                    
                                                                                                    
                                                                                                    6,022
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    6,028Beneficial
      conversion feature of debt issued
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    
                                                                                                    200
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    200Shares
      issued for consulting services
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    701
                                                                                                    
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    
                                                                                                    1,065
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    1,065Value
      of warrants issued for consulting services
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    63
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    63Compensation
      expense related to shares issued to employees
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    16
                                                                                                    
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    
                                                                                                    25
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    25Compensation
      expense related to options issued to employees
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    
                                                                                                    1,605
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    1,605Driftwood
      shares acquired upon the completion of the reverse merger
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    11,327
                                                                                                    
                                                                                                    
                                                                                                    11
                                                                                                    
                                                                                                    
                                                                                                    1,186
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    1,197Value
      of warrants issued in connection with debt financing
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    527
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    527Value
      of Shares to be returned to Treasury for SVS and Zoo Digital
      sale
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    2,237
                                                                                                    
                                                                                                    
                                                                                                    (3,356
                                                                                                    )
                                                                                                    
                                                                                                    (3,356
                                                                                                    )Shares
      issued for warrants exercised
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    818
                                                                                                    
                                                                                                    
                                                                                                    1
                                                                                                    
                                                                                                    
                                                                                                    7
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    8Net
      loss
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    (21,695
                                                                                                    )
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    (21,695
                                                                                                    )Balance
      December 31, 2008
                                                                                                    
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    
                                                                                                    38,244
                                                                                                    
                                                                                                    
                                                                                                    38
                                                                                                    
                                                                                                    
                                                                                                    52,692
                                                                                                    
                                                                                                    
                                                                                                    (31,940
                                                                                                    )
                                                                                                    
                                                                                                    2,237
                                                                                                    
                                                                                                    
                                                                                                    (3,356
                                                                                                    )
                                                                                                    
                                                                                                    17,434Issuance
      of Preferred Series A Stock, net of $178 in costs
                                                                                                    
                                                                                                    
                                                                                                    1,390
                                                                                                    
                                                                                                    
                                                                                                    1
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    4,821
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    4,822Conversion
      of Convertible Notes to Preferred Series B Stock
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    1,188
                                                                                                    
                                                                                                    
                                                                                                    1
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    6,568
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    6,569Stock-based
      compensation
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    
                                                                                                    88
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    88Value
      of shares returned to Treasury from settlement of
    litigation
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    5,564
                                                                                                    
                                                                                                    
                                                                                                    (1,113
                                                                                                    )
                                                                                                    
                                                                                                    (1,113
                                                                                                    )Warrants
      exercised
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    682
                                                                                                    
                                                                                                    
                                                                                                    1
                                                                                                    
                                                                                                    
                                                                                                    6
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    7Shares
      issued to employee in exchange for personal guaranty
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    500
                                                                                                    
                                                                                                    
                                                                                                    -
                                                                                                    
                                                                                                    
                                                                                                    100
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    100Value
      of warrants issued for Solutions 2 Go distribution advance
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    400
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    400Net
      loss
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    (13,197
                                                                                                    )
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    
                                                                                                    (13,197
                                                                                                    )Balance
      December 31, 2009
                                                                                                    
                                                                                                    
                                                                                                    1,390
                                                                                                    
                                                                                                    $
                                                                                                    1
                                                                                                    
                                                                                                    
                                                                                                    1,188
                                                                                                    
                                                                                                    $
                                                                                                    1
                                                                                                    
                                                                                                    
                                                                                                    39,426
                                                                                                    
                                                                                                    $
                                                                                                    39
                                                                                                    
                                                                                                    $
                                                                                                    64,675
                                                                                                    
                                                                                                    $
                                                                                                    (45,137
                                                                                                    )
                                                                                                    
                                                                                                    7,801
                                                                                                    
                                                                                                    $
                                                                                                    (4,469
                                                                                                    )
                                                                                                    $
                                                                                                    15,110





See
accompanying notes to consolidated financial statements




F-6





Zoo
Entertainment, Inc. And Subsidiaries


Notes to
Condensed Consolidated Financial Statements





NOTE
1.   DESCRIPTION OF ORGANIZATION AND REVERSE MERGER





Zoo
Entertainment, Inc., (“Zoo” or the “Company”) was incorporated under the laws of
the State of Nevada on February 13, 2003 under the name Driftwood Ventures,
Inc. On December 20, 2007, the Company reincorporated in Delaware and
increased its authorized capital stock from 75,000,000 shares to 80,000,000
shares, consisting of 75,000,000 shares of common stock, par value $0.001, per
share, and 5,000,000 shares of preferred stock, par value $0.001, per
share.  In August 2009, the Company increased its authorized shares of
common stock to 250,000,000, par value $0.001 per share. On November 20, 2009,
as a result of the Company consummating an approximately $4.2 million equity
raise, the Company issued Series A Convertible Preferred Stock (“Series A
Preferred Stock”) and warrants.  Concurrently, as a result of the
aforementioned preferred equity raise, the Company’s noteholders converted
approximately $11.8 million of existing debt and related accrued interest into
Series B Convertible Preferred Stock (“Series B Preferred Stock”).  On
December 16, 2009, as a result of the Company consummating an additional
preferred equity raise of $776,000, the Company issued to investors Series A
Preferred Stock.  The Series A Preferred Stock and the Series B Preferred
Stock will convert into common shares of the Company upon a sufficient increase
in authorized common shares of the Company. (See Notes 14 and 21 for further
details in connection with the conversion features and details of the actual
conversion on March 10, 2010).   The Company was engaged in acquiring and
exploring mineral properties until September 30, 2007 when this activity was
abandoned. The Company had been inactive until July 7, 2008 when the
Company entered into an Agreement and Plan of Merger, as subsequently amended on
September 12, 2008 with DFTW Merger Sub, Inc., a Delaware corporation and a
wholly-owned subsidiary of the Company (“Merger Sub”), Zoo Games, Inc. (“Zoo
Games”) (formerly known as Green Screen Interactive Software, Inc.) and a
stockholder representative, pursuant to which Merger Sub would merge with and
into Zoo Games, with Zoo Games as the surviving corporation through an exchange
of common stock of Zoo Games for common stock of the Company (the “Merger”). On
December 3, 2008, Driftwood Ventures, Inc. changed its name to Zoo
Entertainment, Inc.





On
September 12, 2008, upon the completion of the Merger, each outstanding share of
Zoo Games common stock, $0.001 par value per share (the “Zoo Games Common
Stock”) on a fully-converted basis, converted automatically into and became
exchangeable for shares of the Company’s common stock, $0.001 par value per
share based on an exchange ratio equal to 7.023274. In addition, by virtue of
the Merger, each of the 334,983 options to purchase shares of Zoo Games Common
Stock (the “Zoo Games Options”) outstanding under Zoo Games’ 2008 Long-Term
Incentive Plan were assumed by the Company, subject to the same terms and
conditions as were applicable under such plan immediately prior to the Merger,
and converted into 243,040 options to purchase shares of the Company’s common
stock at an exercise price of $2.58 per share, 421,396 options to purchase
shares of the Company’s common stock at an exercise price of $2.25 per share and
1,688,240 options to purchase shares of the Company’s common stock at an
exercise price of $1.52 per share. The 246,243 warrants to purchase shares of
Zoo Games Common Stock outstanding at the time of the Merger (the “Zoo Games
Warrants”) were assumed by the Company and converted into 1,411,186 warrants to
acquire shares of the Company’s common stock at an exercise price of $2.84 and
318,246 warrants to acquire shares of the Company’s common stock at an exercise
price of $2.13 per share. The merger consideration consisted of (i) 26,098,303
shares of the Company’s common stock, (ii) the reservation of 2,352,677 shares
of the Company’s common stock that are required for the assumption of the Zoo
Games Options and (iii) the reservation of 1,729,432 shares of the Company’s
common stock that are required for the assumption of the Zoo Games
Warrants.





Zoo Games
was treated as the acquirer for accounting purposes in this reverse merger and
the financial statements of the Company for all periods presented represent the
historical activity of Zoo Games and include the activity of Zoo beginning on
September 12, 2008, the date of the reverse merger. As a result of the reverse
merger, the equity transactions through September 12, 2008 have been adjusted to
reflect this recapitalization.


F-7


Zoo
Games, a Delaware corporation, is a developer, publisher and distributor of
interactive entertainment software for use on all major platforms including
Nintendo’s Wii and DS, Sony’s PSP and PlayStation 3, Microsoft’s Xbox 360, and
personal computers (PCs). Zoo Games sells primarily to major retail chains and
video game distributors. Zoo Games began business in March 2007, acquired the
assets of Supervillain Studios, Inc. (“SVS”) on June 13, 2007, acquired the
stock of Zoo Publishing, Inc. (“Zoo Publishing”) on December 18, 2007 and
acquired the stock of Zoo Digital Publishing Limited (“Zoo Digital”) on April 4,
2008. The consolidated financial statements include the results of their
operations from their respective acquisition dates. The Company also acquired an
interest in Cyoob, Inc., also known as Repliqa (“Repliqa”), on June 28, 2007.
During January 2008, Zoo Games’ board of directors made a determination to
discontinue its involvement with the operations of Repliqa. During September
2008, Zoo Games sold SVS back to its original owners. In November 2008, Zoo
Games sold Zoo Digital back to its original owners. Repliqa, SVS and Zoo
Digital have been reflected as discontinued operations for all periods
presented. In May 2009, we entered into a license agreement with New World IP
(Licensor”) pursuant to which the Licensor granted to Zoo Publishing all of the
Licensor’s rights to substantially all the intellectual property of Empire
Interactive Europe, Ltd. for a minimum royalty of $2.6 million. In June 2009, we
formed a new company called Zoo Entertainment Europe Ltd. (“Zoo Europe”), a 100%
subsidiary of Zoo Games, Inc. based in the United Kingdom for the purpose of
sales and distribution of our product in Europe.  We terminated the
operations of Zoo Europe in December 2009.





Currently,
the Company has determined that it operates in one segment in the United States
and will focus on developing, publishing and distributing interactive
entertainment software under the Zoo brand both in North American and
international markets.





On May
16, 2008, Zoo Games converted from a limited liability company to a
C-corporation and changed its name to Green Screen Interactive Software, Inc.
from Green Screen Interactive Software, LLC. In August 2008, it changed its name
to Zoo Games, Inc.





NOTE
2.   LIQUIDITY





The
Company has incurred losses since inception, resulting in an accumulated deficit
of approximately $45.1 million as of December 31, 2009.  For the year
ended December 31, 2009 the Company generated negative cash flows from
continuing operations of approximately $5.5 million, and for the year ended
December 31, 2008 the Company generated negative cash flows from continuing
operations of approximately $12.1 million.





As a
result of the Company consummating an aggregate of $5.0 million
of equity raises in the fourth quarter of 2009 and the conversion of
approximately $11.9 million in existing debt including related accrued interest
into equity during that period (See Note 7), the Company’s net working capital
position became positive.  As of December 31, 2009, the working capital was
approximately $5.6 million.





In March
2010, the Company extended its purchase order financing facility (See Note 9)
and we have agreed in principle to increase the borrowing capacity at lower fees
and interest rates through April 2011.  In addition, we have agreed in
principal to increase our receivable factoring facility (See Note 9) effective
April 1, 2010 to $5.25 million, which allows us to factor up to $7.0 million of
receivables at any point in time.





The
Company believes the existing cash and cash generated from operations are
sufficient to meet our immediate operating requirements, along with our current
financial arrangements through March 31, 2011.  We may need to raise
additional capital to strengthen our cash position, facilitate expansion, pursue
strategic investments or to take advantage of business opportunities as they
arise.





NOTE
3.   BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING
POLICIES





Principles
of Consolidation





The
consolidated financial statements of the Company include the accounts of Zoo
Games and its wholly and majority owned subsidiaries, Supervillain Studios LLC,
Zoo Publishing, Zoo Entertainment Europe Ltd., Zoo Digital Publishing Limited
and Repliqa during the periods that each subsidiary was directly or indirectly
owned by Zoo Games. All intercompany accounts and transactions are eliminated in
consolidation.


F-8





Use
of Estimates





The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States 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 revenue and expenses during the
reporting periods. The estimates affecting the consolidated financial statements
that are particularly significant include the recoverability of product
development costs, adequacy of allowances for returns, price concessions and
doubtful accounts, lives of intangibles, realization of goodwill and
intangibles, valuation of equity instruments and the valuation of inventories.
Actual amounts could differ from these estimates.





Concentration
of Credit Risk





We
maintain cash balances at what we believe are several high quality financial
institutions. While we attempt to limit credit exposure with any single
institution, balances often exceed FDIC insurable amounts.





If the
financial condition and operations of our customers deteriorate, our risk of
collection could increase substantially. A majority of our trade receivables are
derived from sales to major retailers and distributors. In October 2008, we
entered into an agreement with Atari, Inc. where sales from October 24, 2008
through March 31, 2009 for all customers that Atari deemed acceptable would be
through Atari and Atari would prepay us for the cost of goods and they would
bear the credit risk from the ultimate customer. This agreement was
subsequently amended to include sales to certain customers through March 31,
2010. As of December 31, 2009, Atari had prepaid us approximately $1.5 million
which is included in customer advances in current liabilities in the
consolidated balance sheet and the receivable due from Atari was approximately
$1.8 million, before allowances, which is included in accounts receivable in the
consolidated balance sheet. Our five largest ultimate customers accounted
for approximately 76% (customer A-29%, customer B-21%, customer C-11%) and 60%
(customer A-14%, customer B-30%) of net revenue for the years ended December 31,
2009 and 2008, respectively. These five largest customers accounted for 57% and
3% of our gross accounts receivable as of December 31, 2009 and 2008,
respectively. We believe that the receivable balances from Atari and our
ultimate customers do not represent a significant credit risk based on past
collection experience. During the year ended December 31, 2009, we sold
approximately $4.6 million of receivables to our factor with recourse. 
There were approximately $1.4 million of receivables due from our factor
included in our gross accounts receivable and due from factor as
of December 31, 2009 and $0 as of December 31, 2008. We regularly
review our outstanding receivables for potential bad debts and have had no
history of significant write-offs due to bad debts.





Inventory





Inventory
is stated at the lower of actual cost or market. We periodically evaluate the
carrying value of our inventory and make adjustments as necessary. Estimated
product returns are included in the inventory balances and also recorded at the
lower of actual cost or market.





Product
Development Costs





We
utilized both internal development teams and third party product developers to
develop the titles we publish.  With the sale of SVS in September 2008, we
no longer have any internal development studios or related costs.





We
capitalize internal product development costs (including stock-based
compensation, specifically identifiable employee payroll expense and incentive
compensation costs related to the completion and release of titles) as well as
third party production and other content costs, subsequent to establishing
technological feasibility of a title. Technological feasibility of a product
includes the completion of both technical design documentation and game design
documentation. Amortization of such capitalized costs is recorded on a
title-by-title basis in cost of goods sold using the proportion of current year
revenues to the total revenues expected to be recorded over the life of the
title.


F-9





We
frequently enter into agreements with third party developers that require us to
make advance payments for game development and production services. In exchange
for our advance payments, we receive the exclusive publishing and distribution
rights to the finished game title as well as, in some cases, the underlying
intellectual property rights. Such agreements allow us to fully recover the
advance payments to the developers at an agreed royalty rate earned on the
subsequent retail sales of such product, net of any agreed costs. We capitalize
all advance payments to developers as product development costs. On a
product-by-product basis, we reduce product development costs and record a
corresponding amount of research and development expense for any costs incurred
by third party developers prior to establishing technological feasibility of a
product as these advances are expended. We typically enter into agreements with
third party developers after completing the technical design documentation for
our products and, therefore, record the design costs leading up to a signed
development contract as research and development expense. We also generally
contract with third party developers that have proven technology and experience
in the genre of the video game being developed, which often allows for the
establishment of technological feasibility early in the development cycle. In
instances where the documentation of the design and technology are not in place
prior to an executed contract, we monitor the product development process and
require our third party developers to adhere to the same technological
feasibility standards that applied to our internally developed
products.





We also
capitalize advance payments as product development costs when advances are made
subsequent to establishing technological feasibility of a video game title and
amortize them, on a title-by-title basis, as product development costs in cost
of goods sold. Royalty amortization is recorded using the proportion of current
year unit sales and revenues to the total unit sales and revenues expected to be
recorded over the life of the title.





At each
balance sheet date, or earlier if an indicator of impairment exists, we evaluate
the recoverability of capitalized development costs, advance development
payments and any other unrecognized minimum commitments that have not been paid,
using an undiscounted future cash flow analysis, and charge any amounts that are
deemed unrecoverable to cost of goods sold if the product has already been
released. If the product is discontinued prior to completion, any prepaid
unrecoverable advances are charged to research and development expense. We use
various measures to estimate future revenues for our product titles, including
past performance of similar titles and orders for titles prior to their release.
For sequels, the performance of predecessor titles is also taken into
consideration.





Prior to
establishing technological feasibility, we expense research and development
costs as incurred. During the years ended December 31, 2009 and 2008, we
wrote-off $390,000 and approximately $5.1 million, respectively, of expense
relating to costs incurred for the development of games that were abandoned
during those periods. In the 2008 period, we expensed $720,000 for a game
still in development that we deemed unrecoverable.  Those costs are
included in our statement of operations under research and development
expenses.  In addition in 2008, approximately $1.4 million of other costs
were incurred by our discontinued internal development studio prior to
technological feasibility that could not be capitalized, and these costs are
included in the loss from discontinued operations in the consolidated statement
of operations.





In
December 2007, the FASB issued FASB ASC Topic 808-10-15, “Accounting for
Collaborative Arrangements” (ASC 808-10-15) which defines collaborative
arrangements and requires collaborators to present the result of activities for
which they act as the principal on a gross basis and report any payments
received from (made to) the other collaborators based on other applicable
authoritative accounting literature, and in the absence of other applicable
authoritative literature, on a reasonable, rational and consistent accounting
policy is to be elected.  Effective January 1, 2009, the Company adopted
the provisions of ASC 808-10-15.  The adoption of the statement did not
have an impact on the Company’s consolidated financial position, results of
operations or cash flows.





Licenses
and Royalties





Licenses
consist of payments and guarantees made to holders of intellectual property
rights for use of their trademarks, copyrights, technology or other intellectual
property rights in the development of our products. Agreements with rights
holders generally provide for guaranteed minimum royalty payments for use of
their intellectual property.


F-10





Certain
licenses extend over multi-year periods and encompass multiple game titles. In
addition to guaranteed minimum payments, these licenses frequently contain
provisions that could require us to pay royalties to the license holder, based
on pre-agreed unit sales thresholds.





Licensing
fees are capitalized on the consolidated balance sheet in prepaid expenses and
are amortized as royalties in cost of goods sold, on a title-by-title basis, at
a ratio of current period revenues to the total revenues expected to be recorded
over the remaining life of the title. Similar to product development costs, we
review our sales projections quarterly to determine the likely recoverability of
our capitalized licenses as well as any unpaid minimum obligations. When
management determines that the value of a license is unlikely to be recovered by
product sales, capitalized licenses are charged to cost of goods sold, based on
current and expected revenues, in the period in which such determination is
made. Criteria used to evaluate expected product performance and to estimate
future sales for a title include: historical performance of comparable titles;
orders for titles prior to release; and the estimated performance of a sequel
title based on the performance of the title on which the sequel is
based.





Fixed
Assets





Office
equipment and furniture and fixtures are depreciated using the straight-line
method over their estimated useful life of five years. Computer equipment and
software are generally depreciated and amortized using the straight-line method
over three years. Leasehold improvements are amortized over the lesser of the
term of the related lease or seven years. The cost of additions and betterments
are capitalized, and repairs and maintenance costs are charged to operations, in
the periods incurred. When depreciable assets are retired or sold, the cost and
related allowances for depreciation are removed from the accounts and the gain
or loss is recognized. The carrying amounts of these assets are recorded at
historical cost.





Goodwill
and Intangible Assets





Goodwill
represents the premium paid over the fair value of the net tangible and
intangible assets acquired in a business combination.  Intangible assets
consist of trademarks, customer relationships, content and product development.
Certain intangible assets acquired in a business combination are recognized as
assets apart from goodwill. Identified intangibles other than goodwill are
generally amortized using the straight-line method over the period of expected
benefit ranging from one to ten years, except for intellectual property, which
are usage-based intangible assets that are amortized using the shorter of the
useful life or expected revenue stream.





The
Company is required to perform a goodwill impairment test on at least an annual
basis.  The goodwill impairment test is a two-step process, which requires
management to make judgments in determining what assumptions to use in the
calculation.  Application of the goodwill impairment test requires
significant judgments including estimation of future cash flows, which is
dependent on internal forecasts, estimation of the long-term rate of growth for
the business, the useful life over which cash flows will occur and determination
of weighted average cost of capital.  Changes in these estimates and
assumptions could materially affect the determination of fair value and/or
conclusions on goodwill impairment.  The Company conducts its annual
goodwill impairment test during the fourth quarter of each fiscal year, or more
frequently if indicators of impairment exist.  The Company periodically
analyzes whether any such indicators of impairment exist.  A significant
amount of judgment is involved in determining if an indicator of impairment has
occurred.  Such indicators may include a sustained, significant decline in
share price and market capitalization, a decline in expected future cash flows,
a significant adverse change in legal factors or in the business climate,
unanticipated competition and/or slower expected growth rates, among
others.  The Company compares the fair value of each reporting unit to the
carrying value and if the carrying amount of the goodwill exceeds the implied
fair value of the goodwill, an impairment loss is recognized.  As of
September 30, 2009, the Company determined that goodwill was impaired and as
such recorded an impairment charge of $14.7 million against the goodwill (see
Note 8).


F-11


Impairment
of Long-Lived Assets, Including Definite Life Intangible Assets





We review
all long-lived assets whenever events or changes in circumstances indicate that
the carrying amount of an asset may not be recoverable, including assets to be
disposed of by sale, whether previously held and used or newly acquired. We
compare the carrying amount of the asset to the estimated undiscounted future
cash flows expected to result from the use of the asset. If the carrying amount
of the asset exceeds estimated expected undiscounted future cash flows, we
record an impairment charge for the difference between the carrying amount of
the asset and its fair value. The estimated fair value is generally measured by
discounting expected future cash flows at our incremental borrowing rate or fair
value, if available.  The Company determined that no impairment for
definite lived intangible assets was identified in 2009 or 2008.




Revenue
Recognition





We earn
our revenue from the sale of internally developed interactive software titles
and from the sale of titles developed by and/or licensed from third party
developers ("Publishing Revenue").





We
recognize Publishing Revenue upon the transfer of title and risk of loss to our
customers.  Accordingly, we recognize revenue for software titles when
there is (1) persuasive evidence that an arrangement with the customer exists,
which is generally a customer 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 net 30 and 60-day terms. Advances received from customers are
reported on the consolidated balance sheet as customer advances and are included
in current liabilities until we meet our performance obligations, at which point
we recognize the revenue.





Revenue
is presented net of estimated reserves for returns, price concessions and other
allowances. In circumstances when we do not have a reliable basis to estimate
returns and price concessions or 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.





Allowances
for Returns, Price Concessions and Other Allowances





We may
accept returns and grant price concessions in connection with our publishing
arrangements. Following reductions in the price of our products, we grant price
concessions that permit customers to take credits for unsold merchandise against
amounts they owe us. Our customers must satisfy certain conditions to allow them
to return products or receive price concessions, including compliance with
applicable payment terms and confirmation of field inventory
levels.





Although
our distribution arrangements with customers do not give them the right to
return titles or to cancel firm orders, we sometimes accept returns from our
distribution customers for stock balancing and make accommodations to customers,
which include credits and returns, when demand for specific titles fall below
expectations.





We make
estimates of future product returns and price concessions related to current
period product revenue based upon, among other factors, historical experience
and performance of the titles in similar genres, historical performance of a
hardware platform, 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 products 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.


F-12


Consideration
Given to Customers and Received from Vendors





We have
various marketing arrangements with retailers and distributors of our products
that provide for cooperative advertising and market development funds, among
others, which are generally based on single exchange transactions. Such amounts
are accrued as a reduction to revenue when revenue is recognized, except for
cooperative advertising which is included in selling and marketing expense if
there is a separate identifiable benefit and the benefit's fair value can be
established.





We
receive various incentives from our manufacturers, including up-front cash
payments as well as rebates based on a cumulative level of purchases. Such
amounts are generally accounted for as a reduction in the price of the
manufacturer's product and included as a reduction of inventory or cost of goods
sold, based on (1) a ratio of current period revenue to the total revenue
expected to be recorded over the remaining life of the product or (2) an agreed
upon per unit rebate, based on actual units manufactured during the
period.





Equity-Based
Compensation





We issued
options and warrants to purchase shares of common stock of the Company to
certain management and employees during 2009 and 2008.  Grants vest over
periods ranging from immediate to three years and expire within ten years of
issuance.  Stock options that vest in accordance with service conditions
amortize over the applicable vesting period using the straight-line
method.





The fair
value of our equity-based compensation is estimated using the Black-Scholes
option-pricing model. This model requires the input of assumptions regarding a
number of complex and subjective variables that will usually have a significant
impact on the fair value estimate. These variables include, but are not limited
to, the volatility of our stock price and estimated exercise behavior.  As
a privately-held company until September 12, 2008, we used the stock prices of
equity raises to assist us in our calculations for 2008 grants.  There was
no activity subsequent to such date for the balance of 2008.  We had
limited trading volume in 2009, therefore we used the current market price,
bid-ask spreads and a marketability discount to determine the fair value of the
stock price.  The following table summarizes the assumptions and variables
used by us to compute the weighted average fair value of stock option
grants:





For the YearEnded December 31,2009
                  
                  
                  2008Risk-free
      interest rate
                  
                  
                  3.45
                  %
                  
                  
                  3.07
                  %Expected
      stock price volatility
                  
                  
                  60.0
                  %
                  
                  
                  70.0
                  %Expected
      term until exercise (years)
                  
                  
                  5
                  
                  
                  
                  5Expected
      dividend yield
                  
                  None
                  
                  
                  None





For the
years ended December 31, 2009 and 2008, we estimated the implied volatility for
publicly traded options on our common shares as the expected volatility
assumption required in the Black-Scholes option-pricing model. The
selection of the implied volatility approach was based upon the historical
volatility of companies with similar businesses and capitalization and our
assessment that implied volatility is more representative of future stock price
trends than historical volatility.





Loss
Per Share





Basic
loss per share ("EPS") is computed by dividing the net loss applicable to common
stockholders for the period by the weighted average number of shares of common
stock outstanding during the same period. Diluted EPS is computed by dividing
the net income applicable to common stockholders for the period by the weighted
average number of shares of common stock outstanding and common stock
equivalents, which includes warrants and options outstanding during the same
period. Since the inclusion of the 13,486,072 warrants and 2,589,810 options
outstanding as of December 31, 2009 and the 6,502,159 warrants and 2,336,552
options outstanding as of December 31, 2008 are anti-dilutive because of losses,
the dilutive loss per share is the same as the basic loss per
share.


F-13


Foreign
Currency Translation





The
functional currency for our former foreign operations was primarily the
applicable local currency, British pounds sterling and Euro. Accounts of foreign
operations were 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.  Realized and unrealized
transaction gains and losses are included in income in the period in which they
occur.  There was no translation adjustment required at December 31, 2009
and 2008.





Income
Taxes





Zoo Games
was a limited liability company from inception until May 16, 2008, when we
converted to a corporation. As a limited liability company, we were not required
to provide for any corporate tax. The loss from the Company’s operations was
passed to the unit holders via Form K-1 and the unit holders were responsible
for any resulting taxes. One of our subsidiaries, Zoo Publishing, was not a
limited liability company and we therefore were required to record a corporate
tax provision upon the acquisition of Zoo Publishing.





As a
corporation, we recognize deferred taxes under the asset and liability method of
accounting for income taxes. Under the asset and liability method, deferred
income taxes are recognized for differences between the financial statement and
tax basis of assets and liabilities at currently enacted statutory tax rates for
the years in which the differences are expected to reverse. The effect on
deferred taxes of a change in tax rates is recognized in income in the period
that includes the enactment date. Valuation allowances are established when we
determine that it is more likely than not that such deferred tax assets will not
be realized.





Fair
Value Measurement





In
accordance with “Fair Value Measurements and Disclosures”, Topic 820 of the FASB
ASC, which defines fair value as the price that would be received to sell an
asset or paid to transfer a liability in an orderly transaction between market
participants at the measurement date (exit price).  Topic 820 of the FASB
ASC establishes a fair value hierarchy, which prioritizes the inputs used in
measuring fair value into three broad levels as follows:





·
            Level
      1 – Unadjusted quoted market prices in active markets for identical assets
      or liabilities that the Company has the ability to access at the
      measurement date.


·
            Level
      2 – Quoted prices for similar assets or liabilities in active markets,
      quoted prices for identical or similar assts or liabilities in markets
      that are not active, inputs other than quoted prices that are observable
      for the asst or liability (i.e. interest rates, yield curves, etc.) an
      inputs that are derived principally from or corroborated by observable
      market data by correlation or other
means


·
            Level
      3 – Unobservable inputs that reflect assumptions about what market
      participants would use in pricing assets or liabilities based on the best
      information available.





As of
December 31, 2009, the carrying value of cash, accounts receivable, inventory,
prepaid expenses, accounts payable, accrued expenses, due to factor, and
advances from customers are reasonable estimates of the fair values because of
their short-term maturity. Notes payable are recorded net of the discount
which is computed as the difference between the market interest rate that the
Company would pay for financing at the time the note is issued and the stated
interest rate on the note.





The fair
value of the warrants under the Zoo entertainment Notes (See Note 11) was
detemined based upon Level 3 inputs.





Recently
Issued Accounting Pronouncements





Effective
January 1, 2009, the Company adopted ASC Topic 815 which clarifies the
determination of whether an instrument (or an embedded feature) is indexed to an
entity’s own stock. The adoption of ASC Topic 815 did not have a significant
impact on our results of operations or financial position.


F-14


In June
2009, the FASB issued ASC Topic 105 which establishes the FASB Accounting
Standards Codification as the single source of authoritative GAAP for all
non-governmental entities, with the exception of the SEC and its staff. ASC
Topic 105 changes the referencing and organization of accounting guidance and is
effective for interim and annual periods ending after September 15, 2009. Since
it is not intended to change or alter existing GAAP, the Codification did not
have any impact on the Company’s financial condition or results of
operations.  Going forward, the Board will not issue new standards in the
form of Statements, FASB Staff Positions, or Emerging Issues Task Force
Abstracts; instead, it will issue Accounting Standards Updates. The FASB will
not consider Accounting Standards Updates as authoritative in their own right;
these updates will serve only to update the Codification, provide background
information about the guidance, and provide the bases for conclusions on the
change(s) in the Codification. In the description of Accounting Standards
Updates that follows, references in “italics” relate to Codification Topics and
Subtopics, and their descriptive titles, as appropriate.





Accounting
Standards Updates Not Yet Effective





In June
2009, an update was made to “Consolidation – Consolidation of
Variable Interest Entities.”Among other things, the update replaces the
calculation for determining which entities, if any, have a controlling financial
interest in a variable interest entity (VIE) from a quantitative based risks and
rewards calculation, to a qualitative approach that focuses on identifying which
entities have the power to direct the activities that most significantly impact
the VIE’s economic performance and the obligation to absorb losses of the VIE or
the right to receive benefits from the VIE. The update also requires ongoing
assessments as to whether an entity is the primary beneficiary of a VIE
(previously, reconsideration was only required upon the occurrence of specific
events), modifies the presentation of consolidated VIE assets and liabilities,
and requires additional disclosures about a company’s involvement in VIEs. This
update will be effective for the company beginning January 1, 2010. Management
concluded that the adoption of this update will have no material impact on the
company’s consolidated financial position and results of operations when it
becomes effective in 2010.





Other
Accounting Standards Updates not effective until after December 31, 2009, are
not expected to have a significant effect on the Company’s consolidated
financial position or results of operations.





NOTE
4.   DISCONTINUED OPERATIONS





The loss
from discontinued operations for the years ended December 31, 2009 and 2008 is
summarized as follows:





(Amounts in Thousands)December31,2009
                      
                      
                      December31,2008Supervillain
                      
                      $
                      -
                      
                      
                      $
                      3,174Zoo
      Digital
                      
                      
                      235
                      
                      
                      
                      4,585Repliqa
                      
                      
                      -
                      
                      
                      
                      219Online
      concept
                      
                      
                      -
                      
                      
                      
                      146Tax
      benefit
                      
                      
                      -
                      
                      
                      
                      (1,390
                      )Loss
      from discontinued operations
                      
                      $
                      235
                      
                      
                      $
                      6,734





The
revenues from the discontinued operations for the years ended December 31, 2009
and 2008 were $0 and approximately $2.5 million, respectively.





NOTE
5.   INVENTORY





Inventory
consisted of:


(Amounts in Thousands)December 31, 2009
                  
                  
                  December 31, 2008Finished
      products
                  
                  $
                  1,247
                  
                  
                  $
                  2,939Parts
      and supplies
                  
                  
                  856
                  
                  
                  
                  181Totals
                  
                  $
                  2,103
                  
                  
                  $
                  3,120


F-15





Estimated
product returns included in inventory at December 31, 2009 and 2008 were
$261,000 and $337,000, respectively.





NOTE
6.   PREPAID EXPENSES AND OTHER CURRENT ASSETS





Prepaid
expenses and other current assets consisted of:





(Amounts in Thousands)December31,2009
                    
                    
                    December31,2008Vendor
      advances for inventory
                    
                    $
                    1,545
                    
                    
                    $
                    555Prepaid
      royalties
                    
                    
                    474
                    
                    
                    
                    1,072Income
      taxes receivable
                    
                    
                    -
                    
                    
                    
                    55Other
      prepaid expenses
                    
                    
                    390
                    
                    
                    
                    442Totals
                    
                    $
                    2,409
                    
                    
                    $
                    2,124





NOTE
7.   PRODUCT DEVELOPMENT COSTS





Details
of our capitalized product development costs were as follows:





(Amounts in thousands)December 31,
                    
                    
                    December 31,2009
                    
                    
                    2008Product
      development costs, externally developed, net of
    amortization
                    
                    $
                    4,399
                    
                    
                    $
                    5,168Product
      development costs, internally developed, net of
    amortization
                    
                    
                    -
                    
                    
                    
                    170Totals
                    
                    $
                    4,399
                    
                    
                    $
                    5,338





NOTE
8.   GOODWILL and INTANGIBLE ASSETS, NET





The
Company incurred a triggering event as of September 30, 2009 based on the equity
infusion of approximately $4.0 million for a 50% ownership in the Company
and the conversion of the existing convertible debt during the fourth quarter of
2009.  As such, the Company performed an impairment analysis utilizing an
approach employing multiple valuation methodologies, including a market approach
(market price multiples of comparable companies) and an income approach
(discounted cash flow analysis).  This approach is consistent with the
requirement to utilize all appropriate valuation techniques as described in ASC
820-10-35-24 “Fair Value Measurements and Disclosures”.  The values
ascertained using these methods were weighted to obtain a total fair value,
which was less the carrying value, therefore the Company recorded an impairment
charge of $14.7 million to fully impair the goodwill during the third
quarter of 2009.




The
following table sets forth the components of the intangible assets subject to
amortization:





Estimated
                    
                    
                    
                    
                    
                    (Amounts
      in Thousands)Useful
                    
                    
                    Gross
                    
                    
                    December
      31, 2009
                    
                    
                    December
      31, 2008Lives
                    
                    
                    Carrying
                    
                    
                    Accumulated
                    
                    
                    Net
      Book
                    
                    
                    Net
      Book(Years)
                    
                    
                    Amount
                    
                    
                    Amortization
                    
                    
                    Value
                    
                    
                    ValueContent
                    
                    10
                    
                    
                    $
                    14,965
                    
                    
                    $
                    2,620
                    
                    
                    $
                    12,345
                    
                    
                    $
                    10,931Trademarks
                    
                    10
                    
                    
                    
                    1,510
                    
                    
                    
                    309
                    
                    
                    
                    1,201
                    
                    
                    
                    1,353Customer
      relationships
                    
                    10
                    
                    
                    
                    2,749
                    
                    
                    
                    562
                    
                    
                    
                    2,187
                    
                    
                    
                    2,463Totals
                    
                    
                    
                    
                    $
                    19,224
                    
                    
                    $
                    3,491
                    
                    
                    $
                    15,733
                    
                    
                    $
                    14,747


F-16





Amortization
expense related to intangible assets was approximately $1.8 million and
approximately $2.0 million for the years ended December 31, 2009 and 2008,
respectively.





In May
2009, we entered into a license agreement with New World IP, LLC (“Licensor”)
pursuant to which the Licensor granted to Zoo Publishing all of the Licensor’s
rights to substantially all the intellectual property of Empire Interactive
Europe, LLC for a minimum royalty of $2.6 million to be paid within two
years.  At any time prior to April 1, 2011, Zoo Publishing has the option
to purchase all rights in and to suchgames.  At any time after April 1,
2011, Licensor has the right to sell all rights in and to the games to Zoo
Publishing. The $2.6 million of costs related to this agreement have been
capitalized and are included as Content in Intangible Assets and will be
amortized over ten years.  During 2009, we paid $150,000 of these costs and
as of December 31, 2009, approximately $2.2 million of the liability is recorded
in other long-term liabilities and $300,000 is recorded in accrued expenses in
the balance sheet.





The
following table presents the estimated amortization of intangible assets, based
on our present intangible assets, for the next five years as
follows:




YearEndingDecember31,
                    
                    (Amounts in Thousands)2010
                    
                    $
                    1,9222011
                    
                    
                    1,9222012
                    
                    
                    1,9222013
                    
                    
                    1,9222014
                    
                    
                    1,922Thereafter
                    
                    
                    6,123Total
                    
                    $
                    15,733





NOTE
9.   CREDIT AND FINANCING ARRANGEMENTS, ATARI AGREEMENT AND OTHER
CUSTOMER ADVANCES





In
connection with the Zoo Publishing acquisition, the Company entered into the
following credit and finance arrangements:





The
Company and Zoo Publishing entered into a purchase order financing agreement
with Transcap Trade Finance, LLC (“Transcap”) on December 19, 2007. This
agreement made the Company a party to a Master Purchase Order Assignment
Agreement dated August 20, 2001 pursuant to which Transcap agreed to provide
purchase order financing to or for the benefit of Zoo Publishing. Total advances
under the factoring arrangement include letters of credit for purchase order
financing and is limited to $10.0 million. The amounts outstanding as of
December 31, 2009 and 2008 were $759,000 and $849,000, respectively. The
interest rate is prime plus 4.0% on outstanding advances. As of December 31,
2009 and 2008, the effective interest rates were 7.25%.  The charges and
interest expense on the advances are included in the cost of goods sold in the
accompanying condensed consolidated statement of operations and were $326,000
and approximately $1.1 million for 2009 and 2008,
respectively.





On April
6, 2009, we entered into an amended and restated purchase order financing
arrangement with Wells Fargo Bank, National Association (“Wells Fargo”) pursuant
to an amended and restated master purchase order assignment agreement (the
“Assignment Agreement”). The Assignment Agreement amended and restated in
its entirety the master purchase order assignment agreement between Transcap and
Zoo Publishing, dated as of August 20, 2001, as amended.


F-17





Pursuant
to the Assignment Agreement, the Company will assign purchase orders received
from customers to Wells Fargo, and request that Wells Fargo purchase the
required materials to fulfill such purchase orders. Wells Fargo, which may
accept or decline the assignment of specific purchase orders, will retain us to
manufacture, process and ship ordered goods, and will pay us for our services
upon Wells Fargo’s receipt of payment from the customers for such ordered
goods. Upon payment in full of the purchase order invoice by the applicable
customer to Wells Fargo, Wells Fargo will re-assign the applicable purchase
order to us. We will pay to Wells Fargo a fee upon their funding of each
purchase order and we commit to pay a total fee for twelve months in the
aggregate amount of $337,500. If the fees earned during the twelve month period
do not exceed $337,500, we are required to pay the difference between the
$337,500 and the amounts already paid on the earlier of the twelve month
anniversary of the date of the Assignment Agreement, or the date of termination
of the Assignment Agreement. Wells Fargo is not obligated to provide
purchase order financing under the Assignment Agreement if the aggregate
outstanding funding exceeds $5,000,000. The Assignment Agreement is for an
initial term of twelve months, and shall continue thereafter for successive
twelve month renewal terms unless either party terminates the Assignment
Agreement by written notice to the other no later than 30 days prior to the end
of the initial term or any renewal term. If the term of the Assignment
Agreement is renewed for one or more twelve month terms, for each such twelve
month term, we will pay to Wells Fargo a commitment fee in the sum of $337,500,
to be offset against actual fees paid by us upon their payment of each purchase
order, to be paid on the earlier of the twelve month anniversary of such renewal
date or the date of termination of the Assignment Agreement. The initial
and renewal commitment fees are subject to waiver if certain product volume
requirements are met.





In
connection with the Assignment Agreement, on April 6, 2009 we also entered into
an amended and restated security agreement and financing statement (the
“Security Agreement”) with Wells Fargo. The Security Agreement amends and
restates in its entirety that certain security agreement and financing
statement, by and between Transcap and Zoo Publishing, dated as of August 20,
2001. Pursuant to the Security Agreement, we granted to Wells Fargo a first
priority security interest in certain of our assets as set forth in the Security
Agreement, as well as a subordinate security interest in certain other of our
assets (the “Common Collateral”), which security interest is subordinate to the
security interests in the Common Collateral held by certain of our senior
lenders, as set forth in the Security Agreement.





Also in
connection with the Assignment Agreement, on April 6, 2009, Mark Seremet,
President, Chief Executive Officer and a director of Zoo Entertainment and Zoo
Games, and David Rosenbaum, the President of Operations of Zoo Publishing,
entered into a Guaranty with Wells Fargo, pursuant to which Messrs. Seremet and
Rosenbaum agreed to guaranty the full and prompt payment and performance of the
obligations under the Assignment Agreement and the Security
Agreement.





On May
12, 2009, the Company entered into a letter agreement with each of Mark Seremet
and David Rosenbaum (the “Fee Letters”), pursuant to which, in consideration for
Messrs. Seremet and Rosenbaum entering into the Guaranty with Wells Fargo for
the full and prompt payment and performance by the Company and its subsidiaries
of the obligations in connection with a purchase order financing (the “Loan”),
the Company agreed to compensate Mr. Seremet in the amount of $10,000 per month,
and Mr. Rosenbaum in the amount of $7,000 per month, for so long as the
executive remains employed while the Guaranty and Loan remain in full force and
effect. If the Guaranty is not released by the end of the month following
termination of employment of either Messrs. Seremet or Rosenbaum, the monthly
fee shall be doubled for each month thereafter until the Guaranty is
removed.


F-18


Additionally,
pursuant to the Fee Letters, the Company agreed to grant under the Company’s
2007 Employee, Director and Consultant Stock Plan, as amended to each of Messrs.
Seremet and Rosenbaum, on such date that is the earlier of the conversion of at
least 25% of all currently existing convertible debt of the Company into equity,
or November 8, 2009 (the earlier of such date, the “Grant Date”), an option to
purchase that number of shares of the Company’s common stock equal to 6% and 3%
respectively, of the then issued and outstanding shares of common stock, based
on a fully diluted current basis assuming those options and warrants that have
an exercise price below $0.40 per share are exercised on that date but not
counting the potential conversion to equity of any outstanding convertible notes
that have not yet been converted and, inclusive of any options or other equity
securities or securities convertible into equity securities of the Company that
each may own on the Grant Date. The options shall be issued at an exercise
price equal to the fair market value of the Company’s common stock on the Grant
Date and pursuant to the Company’s standard form of nonqualified stock option
agreement; provided however that in the event the Guaranty has not been released
by Wells Fargo Bank as of the date of the termination of the option due to
termination of service, the option termination date shall be extended until the
earlier of the date of the release of the Guaranty or the expiration of the ten
year term of the option. In addition any options owned by Messrs. Seremet
and Rosenbaum as of the Grant Date with an exercise price that is higher than
the exercise price of the new options shall be cancelled as of the Grant Date.
 As part of the November 2009 financing, Messrs. Seremet and Rosenbaum
agreed to amend their respective Fee Letters, pursuant to which: in the case of
Mr. Seremet, the Company will pay to Mr. Seremet a fee of $10,000 per month for
so long as the Guaranty remains in full force and effect, but only for a period
ending on November 20, 2010; and, in the case of Mr. Rosenbaum, the Company will
pay to Mr. Rosenbaum a fee of $7,000 per month for so long as the Guaranty
remains in full force and effect, but only for a period ending on November 20,
2010.  In addition, the amended Fee Letters provide that, in consideration
of each of their continued personal guarantees, the Company’s Board of Directors
has approved an increase in the issuance of an option to purchase (restricted
stock or other incentives intended to comply with Section 409A of the Internal
Revenue Code, equal to) a 6.25% ownership interest, to each of Mr. Seremet and
Mr. Rosenbaum respectively.   On February 11, 2010, the Company issued
options to purchase shares of common stock of the Company to each of Mr. Seremet
and Mr. Rosenbaum in consideration for their continued personal guarantees (see
Note 21).  The Company issued the options on February 11, 2010 and
performed a Black-Scholes valuation to determine the value of the arrangements
on that date to be $542,000.  Of the $542,000, $403,000 is included as
stock compensation expense in the year ended December 31, 2009 based on the
value ascribed for the period from November 20, 2009 to December 31, 2009, in as
much as guarantees were in place and presumed vesting had taken place, and has
been included in accrued expenses in the December 31, 2009 consolidated balance
sheet.





Zoo
Publishing uses a factor to approve credit and to collect the proceeds from a
portion of its sales. In August 2008, Zoo Publishing entered into a
factoring agreement with Working Capital Solutions, Inc., which utilizes
existing accounts receivable in order to provide working capital to fund all
aspects of our continuing business operations. A new factoring agreement was
entered into on September 29, 2009 with Working Capital Solutions, Inc. 
Under the terms of our factoring and security agreement, we sell our receivables
to the factor, with recourse. The factor, in its sole discretion, determines
whether or not it will accept each receivable based upon the credit risk factor
of each individual receivable or account. Once a receivable is accepted by the
factor, the factor provides funding subject to the terms and conditions of the
factoring and security agreement. The amount remitted to us by the factor equals
the invoice amount of the receivable adjusted for any discounts or allowances
provided to the account, less 25% which is deposited into a reserve account
established pursuant to the agreement, less allowances and fees. In the event of
default, valid payment dispute, breach of warranty, insolvency or bankruptcy on
the part of the receivable account, the factor can require the receivable to be
repurchased by us in accordance with the agreement. The amounts to be paid by us
to the factor for any accepted receivable include a factoring fee of 0.6% for
each ten (10) day period the account is open. Since the factor acquires the
receivables with recourse, we record the gross receivables including amounts due
from our customers to the factor and we record a liability to the factor for
funds advanced to us from the factor. During the year ended December 31, 2009,
we sold approximately $4.6 million of receivables to the factor with
recourse.  At December 31, 2009, accounts receivable and due from factor
included approximately $1.4 million of amounts due from our customers to the
factor and the factor had an advance outstanding to the Company of $900,000. At
December 31, 2008, accounts receivable did not include any amounts due from our
customers to the factor and the factor did not have any advance outstanding to
the Company. In connection with the factoring facility, on September 29, 2009,
Mark Seremet, President, Chief Executive Officer and a director of the Company
and Zoo Games, and David Rosenbaum, the President of Operations of Zoo
Publishing, entered into a Guaranty with Working Capital Solutions, Inc.,
pursuant to which Messrs. Seremet and Rosenbaum agreed to guaranty the full and
prompt payment and performance of the obligations under factoring and security
agreement.


F-19


Atari
Agreement





As a
result of a fire in October 2008 that destroyed our inventory and impacted our
cash flow from operations, we entered into an agreement with Atari, Inc.
(“Atari”). This agreement became effective on October 24, 2008 and provided for
Zoo Publishing to sell its products to Atari without recourse and Atari will
resell the products to wholesalers and retailers that are acceptable to Atari in
North America. The agreement initially expired on March 31, 2009, but was
amended to extend the term for certain customers until March 31, 2010. This
agreement provided for Atari to prepay to the Company for the cost of goods and
pay the balance due within 15 days of shipping the product. Atari’s fees
approximate 10% of our standard selling price and they have been recorded as a
reduction in revenue. During the years ended December 31, 2009 and 2008, we
recorded approximately $33.6 million and $10.9 million, respectively, of net
sales to Atari.  Atari takes a reserve from the initial payment for
potential customer sales allowances, returns and price protection that is
analyzed and reviewed within a sixty day period to be liquidated no later than
July 31, 2010.  As of December 31, 2009 and 2008, Atari had prepaid the
Company approximately $1.5 million and approximately $1.8 million, respectively,
for goods not yet shipped which is recorded as customer advances in current
liabilities. Also, as of December 31, 2009 and 2008, Atari owed the Company
approximately $1.8 million and approximately $1.8 million, respectively, before
allowances, for goods already shipped which are recorded in accounts
receivable.





Other Customer Advance –
Solutions 2 Go, Inc.





On August
31, 2009, Zoo Publishing entered into an Exclusive Distribution Agreement with
Solutions 2 Go Inc., a Canadian corporation (“S2G Inc.”) and an Exclusive
Distribution Agreement with Solutions 2 Go, LLC, a California limited liability
company (“S2G LLC,” and together with S2G Inc., “S2G”), pursuant to which Zoo
Publishing granted to S2G the exclusive rights to market, sell and distribute
certain video games, related software and products, with respect to which Zoo
Publishing owns rights, in the territories specified therein.  In
connection with these distribution agreements, on August 31, 2009, the
Company entered into an Advance Agreement (the “Advance Agreement”) with S2G,
pursuant to which S2G made a payment to the Company in the amount of $1,999,999,
in advance of S2G’s purchases of certain products pursuant to
these distribution agreements. From August 31, 2009 until recoupment of the
advance in full, interest on the outstanding amount shall accrue at the rate of
ten percent (10%) per annum. Interest expense of $58,000 is recorded for the
year ended December 31, 2009.  The amount of any unrecouped advance
outstanding shall be repaid in its entirety to S2G no later than September 15,
2010. The advance shall be recouped, in whole or in part, from sales generated
by S2G of products purchased by S2G under the distribution agreements. A
percentage of the gross margin on the S2G Sales shall be applied to a recoupment
of the advance until the earlier of (i) the date on which the amount of the
unrecouped advance has been reduced to zero or (ii) September 15, 2010, on which
any unrecouped advance shall be repaid. As of December 31, 2009, the balance
remaining on the advance is approximately $1.4 million and this is included in
customer advances in the current liabilities section of the balance
sheet.





Notwithstanding
the foregoing, if, at any time prior to the recoupment of the advance in full,
the Company receives proceeds in connection with any sale of securities, or
otherwise raises additional capital, exceeding an aggregate of five million
dollars ($5,000,000), other than under a defined anticipated qualified
financing, the entire unrecouped advance under the advance agreement shall at
once become due and payable in full as of the funding date of the additional
capital transaction without written notice of acceleration to the Company. 
Additional capital transaction shall include, but not be limited to the sale or
issuance of any security by the Company, or any subsidiary of the Company, of
any kind or character whatsoever, where “security” is given its broadest meaning
including stock, warrants, options, convertible notes, and similar instruments
of all types.





In consideration
of S2G entering into the advance agreement, the Company agreed to issue to S2G
Inc. a warrant to purchase 7,665,731 shares of the Company’s common
stock (or such other number of shares of Common Stock that on the warrant
grant date (as defined below), represents 6% of the Company’s modified
fully-diluted shares, computed as if all outstanding convertible stock, warrants
and stock options that are, directly or indirectly, convertible into Common
Stock at a price of $0.75 or less, have been so converted), upon the occurrence
of an anticipated qualified financing, which means (i) the consummation of the
sale of shares of Common Stock by the Company which results in aggregate gross
proceeds to the Company of at least $4,000,000 and (ii) the conversion of the
Company’s senior secured convertible notes, in the aggregate original principal
amount of $11,150,000, into shares of Common Stock.  The warrant will have
a term of five years and an exercise price equal to $0.30.  The warrant to
acquire 7,665,731 shares was issued on August 31, 2009.  The warrant was
valued at $400,000 using the Black-Scholes model and this cost will be amortized
over twelve months through interest expense.  For the period ended December
31, 2009, $132,000 of additional interest expense was recorded in the
consolidated statement of operations for this advance.




The
advance is guaranteed by Messrs. Seremet, Rosenbaum and another employee. 
Messrs. Seremet and Rosenbaum did not receive any additional compensation for
this guarantee.  The employee who guaranteed the advance was granted
500,000 shares of common stock.  The value of the shares issued was
computed at $100,000 using the bid-ask spread of the Company’s stock price and
is recorded in the general and administrative expenses in the year ended
December 31, 2009.


F-20





NOTE
10.   ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES





Accrued
expenses and other current liabilities consisted of:





(Amounts in Thousands)December 31,
                    
                    
                    December 31,2009
                    
                    
                    2008Operating
      expenses
                    
                    $
                    773
                    
                    
                    
                    982Obligations
      to compensate current and former employees
                    
                    
                    561
                    
                    
                    
                    720Royalties
                    
                    
                    430
                    
                    
                    
                    252Obligations
      arising from acquisitions
                    
                    
                    233
                    
                    
                    
                    354Taxes
      payable
                    
                    
                    260
                    
                    
                    
                    -Due
      to customers
                    
                    
                    18
                    
                    
                    
                    710Interest
                    
                    
                    58
                    
                    
                    
                    81Totals
                    
                    $
                    2,333
                    
                    
                    $
                    3,099





NOTE
11.   NOTES PAYABLE





Outstanding
notes payable, net of unamortized discounts, are as follows:





(Amounts in Thousands)December 31,
                        
                        
                        December 31,2009
                        
                        
                        2008Zoo
      Entertainment convertible notes, net of discounts attributable to the
      warrant value of $0 and $1,576
                        
                        $
                        -
                        
                        
                        $
                        9,574Interest
      on convertible notes
                        
                        
                        -
                        
                        
                        
                        2403.9% Zoo
      Publishing notes, net of discount of $0 and $1,030
                        
                        
                        -
                        
                        
                        
                        2,5362.95%
      note due June 2012 assumed from Zoo Publishing acquisition
                        
                        
                        300
                        
                        
                        
                        3708.25%
      Wachovia demand note assumed from Zoo Publishing
    acquisition
                        
                        
                        -
                        
                        
                        
                        45Note
      assumed from Zoo Publishing acquisition, 12% interest
                        
                        
                        -
                        
                        
                        
                        25Employee
      loans, payable on demand
                        
                        
                        -
                        
                        
                        
                        331Zoo
      Publishing employee loans at 4% interest
                        
                        
                        -
                        
                        
                        
                        268Totals
                        
                        
                        300
                        
                        
                        
                        13,389Current
      portion
                        
                        
                        120
                        
                        
                        
                        11,617Non-current
      portion
                        
                        $
                        180
                        
                        
                        $
                        1,772





The
principal and interest amounts for the Zoo Entertainment convertible notes were
converted into equity as part of the November 2009 financing.





The face
amounts of the notes payable as of December 31, 2009 are due as
follows:





(Amounts in Thousands)YearEndingDecember
                            
                            AmountDue2010
                            
                            $
                            1202011
                            
                            
                            1202012
                            
                            
                            60Total
                            
                            $
                            300


F-21




Zoo
Entertainment Notes





On July
7, 2008, as amended on July 15, 2008 and July 31, 2008, the Company entered into
a note purchase agreement under which the purchasers agreed to provide loans to
the Company in the aggregate principal amount of $9.0 million, in consideration
for the issuance and delivery of senior secured convertible promissory
notes. In connection with the issuance of such notes, the Company issued to
the note holders warrants to purchase 8,181,818 shares of common stock of the
Company. The notes had an interest rate of five percent (5%) for the one year
term of the note commencing from issuance, unless extended. In connection with
the note purchase agreement, the Company satisfied a management fee obligation
by issuing additional senior secured convertible promissory notes in the
principal amount of $750,000 and warrants to purchase 681,818 shares of common
stock of the Company. All of the warrants have a five year term and an exercise
price of $0.01 per share. Pursuant to a security agreement, by and among the
Company and the purchasers, dated as of July 7, 2008, as amended on August 12,
2008, the Company granted a security interest in all of its assets to each of
the purchasers to secure the Company’s obligations under the notes.





On
September 26, 2008, the Company entered into a note purchase agreement pursuant
to which the purchasers agreed to provide a loan to the Company in the aggregate
principal amount of $1.4 million, in consideration for the issuance and delivery
of senior secured convertible promissory notes. In connection with the issuance
of such notes, the Company also issued warrants to purchase 1,272,726
shares of common stock of the Company to the note holders. The notes had an
interest rate of five percent (5%) for the time period beginning on September
26, 2008 and ending on September 26, 2009, unless extended. On October 6, 2009,
the maturity date was extended to November 2, 2009 and on November 2, 2009, the
maturity date was subsequently extended to February 2, 2010.  . The
warrants have a five year term and an exercise price of $0.01 per share.
Pursuant to a security agreement, by and among the Company and the purchasers,
dated September 26, 2008, the Company granted a security interest in all of its
assets to each of the purchasers to secure the Company’s obligations under the
notes.





The total
principal amount of all of the notes described above was approximately $11.15
million, $9.8 million of which was incurred prior to the date of the reverse
merger. The warrants issued with all the notes were valued at approximately $5.9
million by the Company. We used the income and market valuation approaches to
derive the Company’s business enterprise value and then used the Black-Scholes
option-pricing model, applying discounts for illiquidity and dilution, to
calculate the value of the warrants. The total deferred debt discount of
$5.9 million is amortized over the one year life of the notes. Prior to
September 12, 2008, 4,545,455 warrants were exercised and the interest expense
related to the discount of these warrants was accelerated. As of September 12,
2008, the deferred debt discount of the existing notes was approximately $2.4
million and the net value of the notes recorded as of September 12, 2008 was
approximately $7.8 million. On September 26, 2008, we issued $1.0 million of the
notes and 909,090 of the warrants which were valued at $527,000 using consistent
valuation methodologies as those used for all the previously issued notes. As of
November 20, 2009, the net value of the notes was approximately $11.9 million
including $734,000 of accrued interest.





On June
26, 2009, the Company entered into Amendment No. 2 to Senior Secured Convertible
Note (“Amendment No. 2”), with the requisite holders (the “Holders”) of the
Company’s senior secured convertible notes issued in the aggregate principal
amount of $11.15 million.  Pursuant to Amendment No. 2, the parties agreed
to extend the maturity date of the notes that were originally scheduled to
mature during July 2009 to August 31, 2009, or, if the Company receives comments
from the SEC with respect to the Information Statement Pursuant to Section 14(c)
(the “Information Statement”) that the Company filed on July 7, 2009 in
connection with an amendment to the Company’s Certificate of Incorporation
authorizing a sufficient number of shares of the Company’s common stock to
permit the conversion of the notes (“Certificate of Amendment”), on September
15, 2009. The Company did not receive comments from the SEC with respect to the
Information Statement and, as such, the maturity dates of such notes became
August 31, 2009. The Company entered into subsequent amendments with the Holders
extending the maturity date to November 2, 2009 and then subsequently to
February 2, 2010.


F-22


On
November 20, 2009, the requisite Senior Secured Convertible Note Holders agreed
that if the Company raises a minimum of $4.0 million of new capital, they will
convert their debt into convertible preferred shares of the Company that will
ultimately convert into common shares that represent 36.5% of the equity of the
Company. As a result of the Company consummating an approximately $4.2 million
preferred equity raise on November 20, 2009, upon which approximately $11.9
million of existing debt including related accrued interest converted into
convertible preferred equity, the Company issued 1,188,439 shares of Series B
Preferred stock that automatically convert into 1,188,439,000 shares of common
stock to the Senior Convertible Note Holders in exchange for their Notes when
there are sufficient common shares authorized. (See Note 21 for further details
in connection with the actual conversion on March 10, 2010).  The total
fair value of the Series B Preferred stock was determined to be approximately
$3.0 million, based on a $0.0025 value per common share, the same value per
share on the sale of Series A Preferred stock with identical rights and features
(See Note 14).  Of the $8.9 million gain on extinguishment of debt,
approximately $3.6 million is recorded as additional paid-in-capital because
that debt holder was also a shareholder with greater than 10% of the outstanding
common stock at the time of the debt conversion and deemed to be a related
party.  The remaining $5.3 million balance was recorded as a gain on
extinguishment of the debt.





Zoo
Publishing Notes





In
connection with the acquisition of Zoo Publishing, the Company issued various
promissory notes (“Zoo Publishing Note”) in an aggregate of approximately $6.8
million. Approximately $1.8 million of principal was payable at the earlier of
the Company’s completion of another round of financing or by December 2008 with
the $5.0 million balance to be paid in two installments pursuant to the “Zoo
Publishing Note.” The first installment of $2.5 million of principal together
with accrued interest at the rate of 3.9% per annum would be due on the earlier
of June 18, 2009 and the date on which the Company consummates a round of equity
financing of $40.0 million or more. The balance of the Zoo Publishing Note
(including accrued interest) would be payable December 18, 2010. In connection
with the aforementioned note, the Company recorded a debt discount of
approximately $2.3 million. For the years ended December 31, 2009 and 2008,
amortization of deferred debt discount was $294,000 and $988,000 and interest
expense was $64,000 and $213,000, respectively.  In July 2008, the $6.8
million of notes were restructured and approximately $3.2 million of this debt
was converted to common stock of the Company based on fair value and of the
remaining $3.6 million, approximately $1.1 million became due September 18,
2009, $113,000 became due September 18, 2010, $2.0 million became due December
18, 2010 and approximately $316,000 became due July 31, 2011.





In
connection with the Settlement Agreement dated June 18, 2009 (See Notes15 and
19), all the Zoo Publishing Notes were cancelled and no cash payments were
required to be made for either the principal amounts of the notes or the
interest accrued. The net amount of the obligation relieved for the Zoo
Publishing Notes was approximately $3.0 million and is included in the gain on
legal settlement on the statement of operations.





In
connection with the acquisition of Zoo Publishing, the Company also assumed a
liability of $1.2 million as part of the Zoo Publishing purchase price. Other
notes payable assumed from the Zoo Publishing acquisition included:





·
              $200,000 demand note with 12.0%
      percent interest per annum, callable in six months, minimum guaranteed
      interest per renewal is $12,000. The note is guaranteed by the Zoo
      Publishing President. The note was totally paid off by March 31,
      2009.


·
            Zoo Publishing purchased treasury
      stock from a former employee in December 2006 for the amount of $650,000.
      The balance on the note as of December 31, 2009 was $300,000;
      $120,000 is classified as current and $180,000 is classified as long-term.
      The payments are due monthly and the amount of the payment is $10,000 per
      month.


F-23


NOTE
12.  COMMITMENTS





Leases





A summary
of annual minimum lease commitments as of December 31, 2009 is as
follows:





OperatingLeases2010
                    
                    $
                    492011
                    
                    
                    10Total
                    
                    $
                    59





Our
office facilities are occupied under non-cancelable operating leases that expire
in February 2010 and January 2011. Rent expense amounted to $174,000 and
$310,000 for the years ending December 31, 2009 and 2008, respectively. 
 In January 2010, we signed a lease for new office facilities in Cincinnati
through February 2014 that provide for commitments of $67,000 in 2010, $115,000
in 2011, $102,000 in 2012, $113,000 in 2013 and $21,000 in 2014.





NOTE
13.   INCOME TAXES





Through May 15, 2008, the Company and
certain of its consolidated subsidiaries were taxed as a partnership under the
provisions of the Internal Revenue Code. Accordingly, the losses incurred
by the Company and those subsidiaries through May 15, 2008 were allocated to the
respective members and reported on their individual tax returns. Effective
May 16, 2008, the Company changed its tax status from a partnership to a
corporation and, as a result, began filing consolidated corporate tax returns
with its domestic subsidiaries. The provision for income taxes is based on
income recognized for financial statement purposes and includes the effects of
temporary differences between such income and that recognized for tax return
purposes as well as the deferred tax assets and liabilities recognized for
existing timing items relating to the Company's change in tax
status.





For
financial reporting purposes, loss before income taxes include the following
components (in thousands):





2009
                  
                  
                  2008Pretax
      (loss):United
      States
                  
                  $
                  (10,054
                  )
                  
                  $
                  (23,196
                  )Foreign
      (discontinued operations)
                  
                  
                  -
                  
                  
                  
                  (4,585
                  )$
                  (10,054
                  )
                  
                  $
                  (27,781
                  )





For 2008,
the United States pretax loss includes approximately $5.6 million for the period
through May 15, 2008 attributable to entities that are taxed as
partnerships.





The
components of income tax expense (benefit) for the years ended December 31,
2009 and 2008 are as follows (in thousands):





2009
                      
                      
                      2008Current:Federal
                      
                      $
                      135
                      
                      
                      $
                      —State
                      
                      
                      125
                      
                      
                      
                      86Total
      Current
                      
                      
                      260
                      
                      
                      
                      86Deferred:Federal
                      
                      
                      1,897
                      
                      
                      
                      (3,765
                      )State
                      
                      
                      986
                      
                      
                      
                      (1,017
                      )Foreign
                      
                      
                      —
                      
                      
                      
                      (1,390
                      )Total
      Deferred
                      
                      
                      2,883
                      
                      
                      
                      (6,172
                      )Total
                      
                      $
                      3,143
                      
                      
                      $
                      (6,086
                      )


F-24





During
2008, $4,696 of the tax benefit was allocated to continuing operations and
$1,390 was allocated to discontinued operations.





We paid
$23,000 to various state jurisdictions for income taxes during the year ended
December 31, 2009.  No income taxes were paid during the year ended
December 31, 2008.





The
reconciliations of income tax benefit computed at the U.S. statutory tax rates
to income tax expense (benefit) for the years ended December 31, 2009 and
2008 are:





2009
                    
                    
                    2008Tax
      at U.S. federal income tax rates
                    
                    
                    (34.0
                    )%
                    
                    
                    (34.0
                    )%State
      taxes, net of federal income tax benefit
                    
                    
                    6.9
                    
                    
                    
                    (5.8
                    )
 Permanent
      differences:Goodwill
                    
                    
                    49.7
                    
                    
                    
                    -Cancellation
      of indebtedness income
                    
                    
                    12.2
                    
                    
                    
                    -Litigation
      settlement - Purchase money debt reduction
                    
                    
                    (7.9
                    )
                    
                    
                    -
 Adjustment to
      NOL carryover balancenet
      of adjustment to valuation allowance
                    
                    
                    5.6
                    
                    
                    
                    -Impact
      of foreign tax rates and credits
                    
                    
                    2.5
                    
                    
                    
                    1.1Change
      in valuation allowance
                    
                    
                    -
                    
                    
                    
                    7.0Amount
      not subject to corporate income taxes
                    
                    
                    -
                    
                    
                    
                    6.8Deferred
      taxes related to change in tax status
                    
                    
                    -
                    
                    
                    
                    0.6Nondeductible
      expenses and other
                    
                    
                    (3.7
                    )
                    
                    
                    2.431.3
                    %
                    
                    
                    (21.9
                    )%





Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes. Significant components of the
Company's deferred tax assets and liabilities as of December 31, 2009 and
2008 are as follows (in thousands):





2009
                
                
                2008Current
                
                
                Long
      Term
                
                
                Current
                
                
                Long
      TermDeferred tax assets:Net
      operating loss carried forward
                
                $
                -
                
                
                $
                719
                
                
                $
                -
                
                
                $
                5,887Capital
      loss carryforwards
                
                
                
                
                
                
                431
                
                
                
                
                
                
                
                515Allowance
      for doubtful accounts
                
                
                315
                
                
                
                -
                
                
                
                548
                
                
                
                -Bonuses
      payable
                
                
                -
                
                
                
                -
                
                
                
                461
                
                
                
                111Bonus
      and other accruals
                
                
                363
                
                
                
                -
                
                
                
                263
                
                
                
                74Non-qualified
      options
                
                
                -
                
                
                
                569
                
                
                
                -
                
                
                
                558Alternative
      minimum  tax credit carryforward
                
                
                135
                
                
                
                -
                
                
                
                -
                
                
                
                -Gross
      deferred tax assets
                
                
                813
                
                
                
                1,719
                
                
                
                1,272
                
                
                
                7,145Valuation
      allowance
                
                
                (138
                )
                
                
                (293
                )
                
                
                (299
                )
                
                
                (1,800
                )Net
      deferred tax assets
                
                
                675
                
                
                
                1,426
                
                
                
                973
                
                
                
                5,345Deferred
      tax liabilities:Property
      and equipment
                
                
                -
                
                
                
                (17
                )
                
                
                -
                
                
                
                (19
                )Inventory
                
                
                (97
                )
                
                
                -
                
                
                
                -
                
                
                
                -Discounts
      on notes
                
                
                -
                
                
                
                -
                
                
                
                (285
                )
                
                
                (183
                )Intangibles
                
                
                -
                
                
                
                (4,870
                )
                
                
                -
                
                
                
                (5,831
                )Total
      deferred tax liabilities
                
                
                (97
                )
                
                
                (4,887
                )
                
                
                (285
                )
                
                
                (6,033
                )Net
      deferred tax asset (liability)
                
                $
                578
                
                
                $
                (3,461
                )
                
                $
                688
                
                
                $
                (688
                )


F-25





As of
December 31, 2008, the Company had approximately $1.2 million of available
capital loss carryforwards which expire in 2013.  A valuation allowance of
approximately $431,000 was recognized to offset the deferred tax assets related
to these carryforwards.  The Company currently does not have any capital
gains to utilize against this capital loss.  If realized, the tax benefit
of this item will be applied to reduce future capital gains of the
Company.





As of
December 31, 2009, the Company has US federal net operating loss (“NOL”)
carryforwards of approximately $1.6 million.  As a result of statutory
limitations, the company will only be able to utilize approximately $160,000 of
NOL and capital loss carryforwards per year.  The federal NOL will begin to
expire in 2028.  The Company has state NOL carryforwards of approximately
$3.0 million which will be available to offset taxable state income during the
carryforward period. The state NOL will also begin to expire in 2028.  The
tax benefit of this item is reflected in the above table of deferred tax assets
and liabilities.





NOTE
14.  STOCKHOLDERS’ EQUITY AND STOCK-BASED COMPENSATION
ARRANGEMENTS





The
Company has authorized 250,000,000 shares of common stock, par value $0.001, and
5,000,000 shares of preferred stock, par value $0.001 as of December 31, 2009.
(See Notes 14 and 21 for further details in connection with the conversion
features of the preferred shares and details of the March 2010 increase in
authorized shares of common stock).





Common
Stock





As of
December 31, 2009, there were 39,425,755 shares of common stock issued and
31,624,429 shares of common stock outstanding.




On June
26, 2009, our Board of Directors and stockholders holding approximately 63.6% of
our outstanding common stock approved an amendment to our Certificate of
Incorporation to increase the number of authorized shares of common stock from
75,000,000 shares to 250,000,000 shares (the “Share Increase”). The consents we
have received constitute the only stockholder approval required for the Share
Increase under the Delaware General Corporation Law (the “DGCL”) and our
existing Certificate of Incorporation and Bylaws. Pursuant to Rule 14c-2 of
the Securities Exchange Act of 1934, as amended, stockholder approval of these
amendments will become effective on or after such date that is approximately 20
calendar days following the date we first mailed the Information Statement to
our stockholders. After such date, the board of directors may implement the
Share Increase at any time, at its discretion, by filing a Certificate of
Amendment to our Certificate of Incorporation with the Secretary of State of the
State of Delaware. The Information Statement was first sent to our
stockholders on July 31, 2009. The board of directors effectuated the Share
Increase on August 26, 2009.





In
conjunction with the settlement of the litigation with the sellers of Zoo
Publishing on June 18, 2009 (see Notes 15 and 19), the sellers returned
5,563,950 shares of common stock to the Company.  These shares were valued
at $0.20 based on the bid-ask spread of the Company’s stock price and recorded
as treasury shares.





Preferred
Stock





As of
December 31, 2009, there were 1,389,684 shares of Series A Preferred Stock
and 1,188,439 shares of Series B Preferred Stock issued and outstanding. 
Both Series A Preferred Stock and Series B Stock will automatically convert to
common shares of the Company at a rate of 1:1,000 when there are a sufficient
number of common shares authorized.


F-26





Preferred
stock was issued in lieu of common stock in connection with the November 2009
and December 2009 equity raises because the Company did not have a sufficient
number of shares of common stock authorized.  On November 20, 2009, the
Company determined that it had the requisite number of votes of its holders of
common stock and preferred stock in order to effect an increase in its
authorized shares of common stock as soon as practicable to allow for all the
then outstanding preferred stock to automatically convert to common stock
immediately upon the effectiveness of an amendment to the Company's certificate
of incorporation authorizing an increase in its authorized shares of common
stock. On January 13, 2010, our Board of Directors and stockholders holding
approximately 66.7% of our outstanding voting capital stock approved an
amendment to our Certificate of Incorporation to increase the number of
authorized shares of common stock from 250,000,000 shares to 3,500,000,000
shares (the “Charter Amendment”). The consents we received constituted the only
stockholder approval required for the Charter Amendment under the Delaware
General Corporation Law (the “DGCL”) and our existing Certificate of
Incorporation and Bylaws. Pursuant to Rule 14c-2 of the Securities Exchange
Act of 1934, as amended, stockholder approval of this amendment will become
effective on or after such date that is approximately 20 calendar days following
the date we first mailed the definitive Information Statement Pursuant to
Section 14(c) (the “Information Statement”) to our stockholders.  The
Information Statement was first sent to our stockholders on February 16, 2010.
On March 10, 2010, the Companyfiled the CharterAmendment with the Secretary of
State of the State of Delaware.  The Charter Amendment increased the
Company’s authorized shares of common stock, par value $0.001 per share, from
250,000,000 shares to 3,500,000,000 shares(See Note 21).





On
November 20, 2009, the Company entered into a securities purchase agreement (the
“SPA”) with certain investors, consummating an approximately $4.2 million
convertible preferred equity raise, pursuant to which the Company  issued
Series A Preferred Stock that will convert into common shares of the Company
upon an increase in sufficient authorized common shares, representing 50% of the
equity of the Company. The Series A Preferred Stock have a rate of one (1) share
of Series A Preferred Stock for each $2.50 of value of the investment
amount.  The Company issued 1,180,282 shares of Series A Preferred Stock on
November 20, 2009.  On December 16, 2009, the Company received an
additional $776,000 from certain investors and issued an additional 209,402
shares of Series A Preferred Stock.





On
November 20, 2009, the Company entered into Amendment No. 6 to Senior Secured
Convertible Note with the requisite holders of the Company’s outstanding senior
secured convertible notes issued in the aggregate principal amount of
$11,150,000.  The amendment provides that, among other things, the
outstanding principal balance and all accrued and unpaid interest of $734,000
under the notes shall convert into shares of the Company’s Series B Preferred
Stock upon the consummation of an investor sale that results in aggregate gross
proceeds to the Company of at least $4,000,000, at a rate of one (1) share of
Series B Preferred Stock for each $10.00 of value of the note. 
 Moreover, the amendment provides that the notes shall no longer be deemed
to be outstanding and all rights with respect to the notes shall immediately
cease and terminate upon the conversion, except for the right of each holder to
receive the shares to which it is entitled as a result of such conversion. 
The Company issued 1,188,439 shares of Series B Preferred Stock on November 20,
2009 as a result of the conversion of the notes.





Options


As of
December 31, 2008, the Company’s 2007 Employee, Director and Consultant Stock
Plan allowed for an aggregate of 1,000,000 shares of common stock with respect
to which stock rights may be granted and a 250,000 maximum number of shares of
common stock with respect to which stock rights may be granted to any
participant in any fiscal year. As of December 31, 2008, an aggregate of
975,000 shares of restricted common stock of the Company are outstanding under
the Company’s 2007 Employee, Director and Consultant Stock Plan, and 25,000
shares of common stock were reserved for future issuance under this
plan.





On
January 14, 2009, the Company’s Board of Directors approved and adopted an
amendment to the 2007 Employee, Director and Consultant Stock Plan, which
increased the number of shares of common stock that may be issued under the
plan from 1,000,000 shares to 4,000,000 shares, and increased the maximum number
of shares of common stock with respect to which stock rights may be granted to
any participant in any fiscal year from 250,000 shares to 750,000 shares. All
other terms of the plan remain in full force and effect.


F-27





On
January 14, 2009, the Company granted Mr. Seremet an option to purchase 750,000
shares of the Company’s common stock at an exercise price of $0.30 per share,
pursuant to the Company’s 2007 Plan, as amended. There were no other options
issued during the year ended December 31, 2009.





On May
12, 2009, the Company entered into a letter agreement with each of Mark Seremet
and David Rosenbaum, pursuant to which, in consideration for Messrs. Seremet and
Rosenbaum entering into a Guaranty with Wells Fargo for the full and prompt
payment and performance by the Company and its subsidiaries of the obligations
in connection with a purchase order financing (the “Loan”) (see Note 9), the
Company agreed to compensate Mr. Seremet in the amount of $10,000 per month, and
Mr. Rosenbaum in the amount of $7,000 per month, for so long as the executive
remains employed while the Guaranty and Loan remain in full force and
effect. If the Guaranty is not released by the end of the month following
termination of employment of either Messrs. Seremet or Rosenbaum, the monthly
fee shall be doubled for each month thereafter until the Guaranty is removed.
 As part of the November 2009 financing, Messrs. Seremet and Rosenbaum
agreed to amend their respective letter agreements, pursuant to which, in
consideration of each of their continued personal guarantees, the Company’s
Board of Directors has approved  the issuance of an option to purchase
(restricted stock or other incentives intended to comply with Section 409A of
the Internal Revenue Code, equal to) a 6.25% ownership interest, to each of
Mr. Seremet and Mr. Rosenbaum respectively. Subject to the effectiveness of an
amendment to the Company’s Certificate of Incorporation authorizing an increase
in the number of authorized shares of the Company’s common stock, on February
11, 2010, the Company issued options to purchase shares of common stock to each
of Mr. Seremet and Mr. Rosenbaum in consideration for their continued personal
guarantees (see Note 21).





Subject
to the effectiveness of an amendment to the Company’s Certificate of
Incorporation authorizing an increase in the number of authorized shares of the
Company’s common stock, par value $0.001 per share, from 250,000,000 shares to
3,500,000,000, on February 11, 2010, the Company issued shares of common stock
and options to acquire common stock to various employees, directors and
consultants, outside of the Company’s 2007 Employee, Director and Consultant
Stock Plan (see Note 21).


A summary
of the status of the Company’s outstanding stock options as of December 31
and changes during the years then ended is presented below:





2009
                    
                    
                    2008Weighted
                    
                    
                    
                    
                    
                    WeightedAverage
                    
                    
                    
                    
                    
                    AverageNumber Of
                    
                    
                    Exercise
                    
                    
                    Number Of
                    
                    
                    ExerciseShares
                    
                    
                    Price
                    
                    
                    Shares
                    
                    
                    PriceOutstanding
      at beginning of year
                    
                    
                    2,336,552
                    
                    
                    $
                    1.76
                    
                    
                    
                    243,040
                    
                    
                    $
                    2.58Granted
                    
                    
                    750,000
                    
                    
                    $
                    0.30
                    
                    
                    
                    2,109,637
                    
                    
                    $
                    1.67Canceled
                    
                    
                    (496,742
                    )
                    
                    $
                    1.96
                    
                    
                    
                    (16,125
                    )
                    
                    $
                    2.58Outstanding
      at end of year
                    
                    
                    2,589,810
                    
                    
                    $
                    1.29
                    
                    
                    
                    2,336,552
                    
                    
                    $
                    1.76Options
      exercisable at year-end
                    
                    
                    1,699,345
                    
                    
                    $
                    1.84
                    
                    
                    
                    1,915,155
                    
                    
                    $
                    1.65





The fair
value of options granted during the year was $107,000.


F-28


The
following table summarizes information about outstanding stock options at
December 31, 2009:





OptionsOutstanding
                                              
                                              
                                              OptionsExercisableWeighted-Average
                                              
                                              
                                              Weighted-
                                              
                                              
                                              
                                              
                                              
                                              Weighted-Remaining
                                              
                                              
                                              Average
                                              
                                              
                                              
                                              
                                              
                                              AverageRange of
                                              
                                              Number
                                              
                                              
                                              Contractual
                                              
                                              
                                              Exercise
                                              
                                              
                                              Number
                                              
                                              
                                              ExerciseExercisePrices
                                              
                                              Outstanding
                                              
                                              
                                              Life(Years)
                                              
                                              
                                              Price
                                              
                                              
                                              Exercisable
                                              
                                              
                                              Price$2.58
                                              
                                              
                                              166,754
                                              
                                              
                                              
                                              3.5
                                              
                                              
                                              $
                                              2.58
                                              
                                              
                                              
                                              166,754
                                              
                                              
                                              $
                                              2.58$2.25
                                              
                                              
                                              210,698
                                              
                                              
                                              
                                              3.7
                                              
                                              
                                              $
                                              2.25
                                              
                                              
                                              
                                              70,233
                                              
                                              
                                              $
                                              2.25$1.52
                                              
                                              
                                              1,462,358
                                              
                                              
                                              
                                              3.6
                                              
                                              
                                              $
                                              1.52
                                              
                                              
                                              
                                              1,462,358
                                              
                                              
                                              $
                                              1.52$0.30
                                              
                                              
                                              750,000
                                              
                                              
                                              
                                              4.1
                                              
                                              
                                              $
                                              0.30
                                              
                                              
                                              
                                              -
                                              
                                              
                                              $
                                              0.30$0.30
      to $2.58
                                              
                                              
                                              2,589,810
                                              
                                              
                                              
                                              3.8
                                              
                                              
                                              $
                                              1.29
                                              
                                              
                                              
                                              1,699,345
                                              
                                              
                                              $
                                              1.84





The
following table summarizes the activity of non-vested outstanding stock
options:





Weighted-AverageWeighted-Average
                                    
                                    
                                    RemainingNumber
                                    
                                    
                                    Fair Value at
                                    
                                    
                                    Contractual LifeOutstanding
                                    
                                    
                                    GrantDate
                                    
                                    
                                    (Years)Non-Vested
      shares at December 31, 2008
                                    
                                    
                                    421,398
                                    
                                    
                                    $
                                    2.25
                                    
                                    
                                    
                                    4.7Options
      Granted
                                    
                                    
                                    750,000
                                    
                                    
                                    
                                    0.30
                                    
                                    
                                    
                                    4.1Options
      Vested
                                    
                                    
                                    (70,233
                                    )
                                    
                                    
                                    2.25
                                    
                                    
                                    
                                    3.7Options
      forfeited or expired
                                    
                                    
                                    (210,699
                                    )
                                    
                                    
                                    2.25
                                    
                                    
                                    
                                    3.7Non-Vested
      shares at December 31, 2009
                                    
                                    
                                    890,466
                                    
                                    
                                    $
                                    0.79
                                    
                                    
                                    
                                    4.0





As of
December 31, 2009, there was approximately $162,000 of unrecognized
compensation cost related to non-vested stock option awards, which is expected
to be recognized over a remaining weighted-average vesting period of 1.7 - 2.0
years.





The
intrinsic value of options outstanding at December 31, 2009 is
$0.





Warrants





On August
31, 2009, in consideration of Solutions 2 GO Inc. entering into an
advance agreement with the Company, we issued to Solutions 2 GO Inc. a warrant
to purchase 7,665,731 shares of the Company’s common stock, par value $0.001 per
share. The warrants have a term of five years and an exercise price equal
to $0.30.





As part
of the equity raise on November 20, 2009 and on December 16, 2009, we issued
warrants to purchase 610,316,000 shares of the Company’s common stock. 
 The warrants have a five year term and an exercise price of $0.01 per
share. The warrants contain customary limitations on the amount that can be
exercised. Additionally, the warrants provide that they cannot be exercised
until the effectiveness of the filing of an amendment to the Company’s
Certificate of Incorporation authorizing a sufficient number of shares of Common
Stock to permit the exercise of the warrants (see Preferred Stock discussion
above). In the event of any subdivision, combination, consolidation,
reclassification or other change of Common Stock into a lesser number, a greater
number or a different class of stock, the number of shares of Common Stock
deliverable upon exercise of the warrants will be proportionally decreased or
increased, as applicable, but the exercise price of the warrants will remain at
$0.01 per share.


As of
December 31, 2009, there were 623,802,072 warrants outstanding with
five-year lives expiring in 2012 through 2014, of which 13,486,072 are currently
exercisable.


F-29


A summary
of the status of the Company’s outstanding warrants as of December 31 and
changes during the years then ended is presented below:





2009
                
                
                2008Weighted
                
                
                
                
                
                WeightedAverage
                
                
                
                
                
                AverageNumber Of
                
                
                Exercise
                
                
                Number Of
                
                
                ExerciseWarrants
                
                
                Price
                
                
                Warrants
                
                
                PriceOutstanding
      at beginning of period
                
                
                6,502,159
                
                
                $
                0.73
                
                
                
                1,007,405
                
                
                $
                2.62Granted
                
                
                617,981,731
                
                
                $
                0.01
                
                
                
                1,994,753
                
                
                $
                1.03Assumed
      with  reverse merger
                
                
                -
                
                
                
                -
                
                
                
                4,318,182
                
                
                
                0.01Exercised
                
                
                (681,818
                )
                
                $
                0.01
                
                
                
                (818,181
                )
                
                
                0.01Outstanding
      at end of year
                
                
                623,802,072
                
                
                $
                0.02
                
                
                
                6,502,159
                
                
                $
                0.73Warrants
      exercisable at year-end
                
                
                13,486,072
                
                
                $
                0.02
                
                
                
                6,502,159
                
                
                $
                0.73





The
following table summarizes information about outstanding warrants at
December 31, 2009:





Warrants OutstandingWeighted-Average
                            
                            
                            Weighted-Remaining
                            
                            
                            AverageRange
      of
                            
                            Number
                            
                            
                            Contractual
                            
                            
                            ExerciseExercise Prices
                            
                            Outstanding
                            
                            
                            Life (Years)
                            
                            
                            Price$2.84
                            
                            
                            1,411,186
                            
                            
                            
                            3.3
                            
                            
                            $
                            2.84$2.13
                            
                            
                            318,246
                            
                            
                            
                            3.4
                            
                            
                            $
                            2.13$0.30
                            
                            
                            7,665,731
                            
                            
                            
                            4.9
                            
                            
                            $
                            0.30$0.01
                            
                            
                            614,406,909
                            
                            
                            
                            4.9
                            
                            
                            $
                            0.01$0.01
      to $2.84
                            
                            
                            623,802,072
                            
                            
                            
                            4.9
                            
                            
                            $
                            0.02





NOTE
15.  GAIN ON LEGAL SETTLEMENT





On June
18, 2009, we settled a lawsuit brought by the former sellers of Zoo Publishing,
resulting in a net gain on legal settlement of approximately $4.3 million. (See
Note 19)





The
settlement eliminated the following Company’s obligations totaling
$3,925,000:


·
            outstanding notes with a face
      value of $3,565,900, discounted as of June 18, 2009 for $736,000 and
      interest accrued of $219,000


·
            employee loans totaling
      $574,000


·
            other obligations for an
      aggregate amount of $302,000





In
conjunction with the settlement of the litigation with the sellers of Zoo
Publishing, the sellers returned 5,563,950 shares of common stock to the
Company. These treasury shares were valued at $0.20 and included as part of the
gain on legal settlement for approximately $1.1 million.


F-30





The
Company’s remaining cash obligations and litigation expense amounted to
approximately $710,000, resulting in a total net gain on settlement of
approximately $4.3 million.





NOTE
16.   FIRE LOSS AND INSURANCE RECOVERY





On
October 13, 2008, a third party warehouse in San Bernardino, California that we
use for packing our product from Zoo Publishing and shipping finished goods to
our customers was consumed by fire, destroying our entire inventory stored at
that location, with an approximate cost of $3.0 million. We collected on our
property insurance policy in the amount of approximately $2.1 million, which was
paid directly to our inventory financing company and was recorded as a reduction
of cost of goods sold.  We collected $1.2 million from our business income
insurance policy and this was recorded as other income on the statement of
operations in 2008.  During the 2009 period, our third party
warehouse received $860,000 from their insurance company relating to losses
incurred by us from the fire in October 2008.  Those proceeds were applied
against other amounts due to the third party warehouse by reducing our payables
and are reported as other income in the consolidated statement of operations in
2009.





NOTE
17.   INTEREST, NET


(Amounts in Thousands)Year Ended December 31,2009
                      
                      
                      2008Interest
      arising from amortization of debt discount
                      
                      $
                      2,003
                      
                      
                      $
                      3,562Interest
      on various notes
                      
                      
                      618
                      
                      
                      
                      624Interest
      on financing arrangements
                      
                      
                      354
                      
                      
                      
                      -Less
      interest income
                      
                      
                      -
                      
                      
                      
                      (9
                      )Net
      interest – all operations
                      
                      
                      2,975
                      
                      
                      
                      4,177Interest
      relating to discontinued operations
                      
                      
                      -
                      
                      
                      
                      (539
                      )Interest
      expense, net
                      
                      $
                      2,975
                      
                      
                      $
                      3,638





NOTE
18.   SUPPLEMENTAL CASH FLOW INFORMATION





Supplemental
cash flow information for the years ended December 31, 2009 and 2008 is as
follows:





(Amounts in Thousands)2009
                  
                  
                  2008Changes
      in other assets and liabilities:Accounts
      receivable and due from factor
                  
                  $
                  (2,190
                  )
                  
                  $
                  (516
                  )Inventory
                  
                  
                  1,017
                  
                  
                  
                  (1,565
                  )Prepaid
      expenses and other current assets
                  
                  
                  (153
                  )
                  
                  
                  645Product
      development costs
                  
                  
                  939
                  
                  
                  
                  155Accounts
      payable
                  
                  
                  (2,379
                  )
                  
                  
                  1,726Customer
      advances
                  
                  
                  (742
                  )
                  
                  
                  -Accrued
      expenses and other current liabilities
                  
                  
                  (1,293
                  )
                  
                  
                  (736
                  )Net
      changes in other assets and liabilities
                  
                  $
                  (4,801
                  )
                  
                  $
                  (291
                  )Cash
      paid during the year for interest
                  
                  $
                  -
                  
                  
                  $
                  56Cash
      paid during the year for taxes
                  
                  $
                  23
                  
                  
                  $
                  3Non-cash
      investing and financing activities:Conversion
      of convertible notes to Series B Preferred Stock
                  
                  $
                  11,884
                  
                  
                  $
                  -Receipt
      of 5,563,950 shares for partial settlement of litigation
                  
                  $
                  1,113
                  
                  
                  $
                  -Notes
      and obligations relieved for partial settlement of
    litigation
                  
                  $
                  3,925
                  
                  
                  $
                  -Acquisition
      of Intangible for long-term obligation
                  
                  $
                  2,600
                  
                  
                  $
                  -Issuance
      of 1,580,237 shares for partial payment of Zoo Digital
                  
                  $
                  -
                  
                  
                  $
                  4,086Receipt
      of 351,171 shares in Treasury in connection with the sale of
      Supervillain
                  
                  $
                  -
                  
                  
                  $
                  527Receipt
      of 1,866,205 shares in Treasury in connection with the sale of Zoo
      Digital
                  
                  $
                  -
                  
                  
                  $
                  2,829Exchange
      of debt for equity at original face value
                  
                  $
                  -
                  
                  
                  $
                  5,950


F-31





NOTE
19.   LITIGATION





On February
19, 2009, Susan Kain Jurgensen, Steven Newton, Mercy Gonzalez, Bruce Kain,
Wesley Kain, Raymond Pierce and Cristie Walsh filed a complaint against Zoo
Publishing, Zoo Games and Zoo in the Supreme Court of the State of New York, New
York County, index number 09 / 102381 alleging claims
for breach of certain loan agreements and employment
agreements, intentional interference and fraudulent transfer.
The complaint sought compensatory damages, punitive damages and preliminary
and permanent injunctive relief, among other remedies. On June 18, 2009, we
reached a settlement whereby we agreed to pay to the plaintiffs an aggregate of
$560,000 (the “Settlement Amount”) in full satisfaction of the disputed claims,
without any admission of any liability of wrongdoing as follows: (a) $300,000 on
June 26, 2009; (b) $60,000 on or before the earlier of (i) the date that is 90
days from June 18, 2009 or (ii) the date the Company obtains new and available
financing, including any amounts currently held in escrow that will be released
from escrow after June 18, 2009, in any form and from any source, in an amount
totaling at least $2,000,000; (c) $100,000 on or before December 18, 2009; and
(d) $100,000 on or before June 18, 2010. To date, $460,000 of the Settlement
Amount has been paid to the plaintiffs. The Zoo Publishing Notes and all other
notes, employment,  agreements, loan agreements, options, warrants and
other agreements  relating to the plaintiffs (except with respect to that
certain Employment Agreement between Zoo Publishing and Cristie Walsh) were
terminated and all outstanding obligations of the Company related to these
agreements were cancelled. In addition, the plaintiffs returned to us an
aggregate of 5,563,950 shares of our common stock owned by them prior to such
date.





We are
also involved in various other legal proceedings and claims incident to the
normal conduct of our business. Although it is impossible to predict the outcome
of any legal proceeding and there can be no assurances, we believe that our
legal proceedings and claims, individually and in the aggregate, are not likely
to have a material adverse effect on our financial condition, results of
operations or cash flows.





NOTE
20.   RELATED PARTY TRANSACTIONS





We leased
office space in New York from 575 Broadway Associates, LLC, a company owned
principally by one of our principal investors, from April 2007 to October 2008.
We paid rent expense of $0 and $234,000 during the years ended December 31, 2009
and 2008, respectively, to this related party.





Certain
Zoo Publishing employees loaned us an aggregate of up to $765,000 in 2008 on a
short-term basis. The Company accrued interest at 4% per annum and all amounts
were cancelled as part of the Settlement Agreement (see Note
15).


F-32


On April
6, 2009, we entered into an amended and restated purchase order financing
arrangement with Wells Fargo Bank, National Association (“Wells Fargo”) pursuant
to an amended and restated master purchase order assignment agreement (the
“Assignment Agreement”). In connection with the Assignment Agreement, on April
6, 2009 we also entered into an amended and restated security agreement and
financing statement (the “Security Agreement”) with Wells Fargo, pursuant to
which we granted to Wells Fargo a first priority security interest in certain of
our assets as set forth in the Security Agreement, as well as a subordinate
security interest in certain other of our assets (the “Common Collateral”),
which security interest is subordinate to the security interests in the Common
Collateral held by certain of our senior lenders, as set forth in the Security
Agreement. Also in connection with the Assignment Agreement, on April 6, 2009,
Mark Seremet, President and Chief Executive Officer of Zoo Games and a director
of Zoo Entertainment, and David Rosenbaum, the President of Zoo Publishing,
entered into a Guaranty with Wells Fargo, pursuant to which Messrs. Seremet and
Rosenbaum agreed to guaranty the full and prompt payment and performance of the
obligations under the Assignment Agreement and the Security Agreement. On May
12, 2009, we entered into a letter agreement with each of Mark Seremet and David
Rosenbaum (the “Fee Letters”), pursuant to which, in consideration for Messrs.
Seremet and Rosenbaum entering into the Guaranty with Wells Fargo for the full
and prompt payment and performance by the Company and its subsidiaries of the
obligations in connection with a purchase order financing (the “Loan”), we
agreed to compensate Mr. Seremet in the amount of $10,000 per month, and Mr.
Rosenbaum in the amount of $7,000 per month, for so long as the executive
remains employed while the Guaranty and Loan remain in full force and
effect. If the Guaranty is not released by the end of the month following
termination of employment of either Messrs. Seremet or Rosenbaum, the monthly
fee shall be doubled for each month thereafter until the Guaranty is
removed.





Additionally,
pursuant to the Fee Letters, the Company agreed to grant under the Company’s
2007 Employee, Director and Consultant Stock Plan, as amended to each of Messrs.
Seremet and Rosenbaum, on such date that is the earlier of the conversion of at
least 25% of all currently existing convertible debt of the Company into equity,
or November 8, 2009 (the earlier of such date, the “Grant Date”), an option to
purchase that number of shares of the Company’s common stock equal to 6% and 3%
respectively, of the then issued and outstanding shares of common stock, based
on a fully diluted current basis assuming those options and warrants that have
an exercise price below $0.40 per share are exercised on that date but not
counting the potential conversion to equity of any outstanding convertible notes
that have not yet been converted and, inclusive of any options or other equity
securities or securities convertible into equity securities of the Company that
each may own on the Grant Date. The options shall be issued at an exercise
price equal to the fair market value of the Company’s common stock on the Grant
Date and pursuant to the Company’s standard form of nonqualified stock option
agreement; provided however that in the event the Guaranty has not been released
by Wells Fargo Bank as of the date of the termination of the option due to
termination of service, the option termination date shall be extended until the
earlier of the date of the release of the Guaranty or the expiration of the ten
year term of the option. In addition any options owned by Messrs. Seremet
and Rosenbaum as of the Grant Date with an exercise price that is higher than
the exercise price of the new options shall be cancelled as of the Grant Date.
 As part of the November 2009 financing, Messrs. Seremet and Rosenbaum
agreed to amend their respective Fee Letters, pursuant to which: in the case of
Mr. Seremet, the Company will pay to Mr. Seremet a fee of $10,000 per month for
so long as the Guaranty remains in full force and effect, but only for a period
ending on November 20, 2010; and, in the case of Mr. Rosenbaum, the Company will
pay to Mr. Rosenbaum a fee of $7,000 per month for so long as the Guaranty
remains in full force and effect, but only for a period ending on November 20,
2010.  In addition, the amended Fee Letters provides that, in consideration
of each of their continued personal guarantees, the Company’s Board of Directors
has approved an increase in the issuance of an option to purchase (restricted
stock or other incentives intended to comply with Section 409A of the Internal
Revenue Code, equal to) a 6.25% ownership interest, to each of Mr. Seremet
and Mr. Rosenbaum respectively.    Subject to the effectiveness of an
amendment to the Company’s Certificate of Incorporation authorizing an increase
in the number of authorized shares of the Company’s common stock, on February
11, 2010, the Company issued options to purchase shares of common stock to each
of Mr. Seremet and Mr. Rosenbaum in consideration for their continued personal
guarantees (see Note 21).





NOTE
21.   SUBSEQUENT EVENTS





Subject
to the effectiveness (the “Effective Date”) of an amendment to the Company’s
Certificate of Incorporation authorizing an increase in the number of authorized
shares of the Company’s common stock, par value $0.001 per share, from
250,000,000 shares to 3,500,000,000 shares, on February 11, 2010, the Company
issued an aggregate of 168,662,400 shares of restricted common stock and options
to purchase 351,387,000 shares of common stock at an exercise price of $0.0041
per share to various employees, directors and consultants, outside of the
Company’s 2007 Employee, Director and Consultant Stock Plan.  The Company
also issued options to purchase 202,581,600 shares of common stock to each of
Mark Seremet, a director, Chief Executive Officer and President of the Company,
and David Rosenbaum, President of Zoo Publishing, Inc., in consideration for
their continued personal guarantees of the payment and performance by the
Company of certain obligations in connection with previously entered into
financing arrangements, pursuant to Fee Letters entered into between the Company
and each of Messrs. Seremet and Rosenbaum, dated as of May 12,2009,  as
amended on August 31, 2009 and November 20, 2009. The options have an exercise
price of $0.0025 per share and vest as follows:  commencing as of the
Effective Date, 72% vest immediately, 14% on May 12, 2010 and 14% vest on May
12, 2011.


F-33





On
January 13, 2010, our Board of Directors and stockholders holding approximately
66.7% of our outstanding voting capital stock approved an amendment to our
Certificate of Incorporation to increase the number of authorized shares of
common stock from 250,000,000 shares to 3,500,000,000 shares (the “Charter
Amendment”). The consents we received constituted the only stockholder approval
required for the Charter Amendment under the Delaware General Corporation Law
(the “DGCL”) and our existing Certificate of Incorporation and Bylaws. Pursuant
to Rule 14c-2 of the Securities Exchange Act of 1934, as amended,
stockholder approval of this amendment will become effective on or after such
date that is approximately 20 calendar days following the date we first mailed
the definitive Information Statement Pursuant to Section 14(c) (the “Information
Statement”) to our stockholders.  The Information Statement was first sent
to our stockholders on February 16, 2010. On March 10, 2010, the Company filed
the Charter Amendment with the Secretary of State of the State of
Delaware.  The Charter Amendment increased the Company’s authorized shares
of common stock, par value $0.001 per share, from 250,000,000 shares to
3,500,000,000 shares.





Upon the
filing of the Charter Amendment on March 10, 2010, both Series A Preferred Stock
and Series B Preferred Stock automatically converted to common shares of the
Company at a rate of 1:1,000.





NOTE
22.   RESTATEMENT OF SEPTEMBER 30, 2009 FINANCIAL
STATEMENTS





The
Company incurred a triggering event as of September 30, 2009 based on the equity
infusion of approximately $4.0 million for 50% ownership in the Company and the
conversion of the existing convertible debt during the fourth quarter of
2009.  For the September 30, 2009 financial statements, the Company
estimated impairment of goodwill at $14.7 million and impairment of other
intangible assets at $7.3 million for a total impairment charge of $22.0
million.  After the Company performed a formal impairment analysis, we
concluded that the resulting impairment of goodwill is $14.7 million and
there should be no impairment of other intangible assets. 
Therefore, the Company has restated its September 30, 2009 financial statements
to reflect this reduction in impairment of other intangible assets of
approximately $7.3 million.





In
addition, the Company erroneously reported the $2.0 million proceeds from a loan
for a customer advance in other changes in assets and liabilities, net in the
operating activities section of the statement of cash flows for the nine months
ended September 30, 2009.  Accordingly, it should be included in the
financing activities section of the statement of cash flows and has been
restated accordingly.





The
effects of our restatement on previously reported unaudited consolidated
financial statements as of September 30, 2009 are summarized as
follows:





The
effects on the Consolidated Balance Sheet as of September 30, 2009 (in
thousands):










(as
      previously reported)
                  
                  
                  (restated)Selected
      Balance Sheet Data:Intangible
      assets, net
                  
                  $
                  8,914
                  
                  
                  $
                  16,210Total
      assets
                  
                  
                  25,713
                  
                  
                  
                  33,009Accumulated
      deficit
                  
                  
                  (55,967
                  )
                  
                  
                  (48,671
                  )Total
      stockholders’ equity (deficiency)
                  
                  
                  (7,125
                  )
                  
                  
                  171





The
following table reflects the impact of the restatements on the Consolidated
Statements of Operations (in thousands except per share
amounts):


F-34





Three Months Ended September
30, 2009




(as
      previously reported)
                  
                  
                  (restated)Selected
      Statement of Operations Data:Impairment
      of goodwill and other intangible assets (as restated, goodwill
      only)
                  
                  $
                  22,000
                  
                  
                  $
                  14,704Total
      operating expenses
                  
                  
                  24,802
                  
                  
                  
                  17,506Loss
      from operations
                  
                  
                  (22,881
                  )
                  
                  
                  (15,585
                  )Loss
      from continuing operations
                  
                  
                  (22,391
                  )
                  
                  
                  (15,095
                  )Net
      loss
                  
                  
                  (22,626
                  )
                  
                  
                  (15,330
                  )Net
      loss per share – basic and diluted
                  
                  
                  (0.72
                  )
                  
                  
                  (0.49
                  )





NineMonths Ended September 30,
2009




(as
      previously reported)
                  
                  
                  (restated)Selected
      Statement of Operations Data:Impairment
      of goodwill and other intangible assets (as restated, goodwill
      only)
                  
                  $
                  22,000
                  
                  
                  $
                  14,704Total
      operating expenses
                  
                  
                  30,826
                  
                  
                  
                  23,530Loss
      from operations
                  
                  
                  (26,577
                  )
                  
                  
                  (19,281
                  )Loss
      from continuing operations
                  
                  
                  (23,792
                  )
                  
                  
                  (16,496
                  )Net
      loss
                  
                  
                  (24,027
                  )
                  
                  
                  (16,731
                  )Net
      loss per share – basic and diluted
                  
                  
                  (0.70
                  )
                  
                  
                  (0.49
                  )





The
following table reflects the impact of the restatements on the Consolidated
Statements of Cash Flows for the nine months ended September 30, 2009 (in
thousands):




(as
      previously reported)
                  
                  
                  (restated)Selected
      Cash Flow Data:Net
      loss
                  
                  $
                  (24,027
                  )
                  
                  $
                  (16,731
                  )Loss
      from continuing operations
                  
                  
                  (23,792
                  )
                  
                  
                  (16,496
                  )
 Impairment
      of goodwill and other intangible assets (as restated, goodwill
      only)
                  
                  
                  22,000
                  
                  
                  
                  14,704
 Other
      changes in assets and liabilities, net
                  
                  
                  (412
                  )
                  
                  
                  (2,412
                  )Net
      cash used in continuing operations
                  
                  
                  (2,723
                  )
                  
                  
                  (4,723
                  )Proceeds
      from Solutions 2 Go note for customer advance
                  
                  
                  -
                  
                  
                  
                  2,000Net
      cash provided by financing activities
                  
                  
                  2,661
                  
                  
                  
                  4,661


F-35