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, 2008


OR





 ̈
            TRANSITION REPORT PURSUANT 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.)


2121
Avenue of the Stars, Suite 2550


Los
Angeles,
California            90067


(Address
of principal executive office)





Registrant’s
telephone number, including area code (310)601-2500





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, 2008, the last business day of the registrant’s most
recently completed second fiscal quarter was $502,000.


As
of April 10, 2009, the registrant had 38,243,937 shares of common stock
outstanding.




DOCUMENTS INCORPORATED BY
REFERENCE













TABLE
OF CONTENTS





PagePART IItem 1. Business
                    1Item 1A. Risk Factors
                    9Item 1B. Unresolved Staff Comments
                    23Item 2. Properties
                    23Item 3. Legal Proceedings
                    23Item 4. Submission of Matters to a Vote of
      Security Holders
                    23PART IIItem 5. Market For Registrant’s Common Equity,
      Related Stockholder Matters and Issuer Purchases of Equity Securities
                    24Item 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
                    40Item 8. Financial Statements and Supplementary
      Data
                    40Item 9. Changes in and Disagreements with
      Accountants on Accounting and Financial Disclosure
                    40Item 9A(T). Controls and Procedures
                    41Item 9B. Other Information
                    41PART IIIItem 10. Directors, Executive Officers and
      Corporate Governance
                    42Item 11. Executive Compensation
                    42Item 12. Security Ownership of Certain Beneficial
      Owners and Management and Related Stockholder Matters
                    42Item 13. Certain Relationships and Related
      Transactions and Director Independence
                    42Item 14. Principal Accountant Fees and Services
                    42PART IVItem 15. Exhibits, Financial Statement Schedules
                    42









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.




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, the Company’s 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 the Company’s wholly-owned subsidiary.  As a
result thereof, the historical and current business operations of Zoo Games now
comprise the Company’s principal business operations.  Unless the
context otherwise indicates, the use of the terms “we,” ‘our” or “us” refer to
the business and operations of Zoo Entertainment, Inc. through its operating and
wholly-owned subsidiaries, Zoo Games and Zoo Publishing, Inc.





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.









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 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.




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, we sold Zoo Digital back to its original owners
on November 28, 2008.





Zoo
Games’ principal executive offices are located at 770 Broadway, New York, NY
10003 and our telephone number is (646) 495-6399. 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 and PlayStation
2.   In addition, we intend to publish packaged entertainment
software titles for use on a variety of other gaming platforms, including Sony’s
PlayStation 3 and Microsoft’s Xbox 360. 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, iPhone and for use on personal computers
(PCs).





Our
current video game titles are targeted at various demographics, primarily at a
lower-priced “value” title. 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.





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 set a new industry record totaling $21.33 billion in 2008, a
19% increase over 2007 according to the NPD Group, a retail market research
firm. Of that total, hardware sales reached $7.81 billion (up 11% from 2007),
software sales totaled $10.96 billion (up 26% from 2007), and peripheral
accessory sales increased to $2.57 billion (up 14% from 2007. 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 had a strong finish to 2008.  The NPD
Group reports industry sales in the U.S. were $5.29 billion for the month of
December 2008, up 9% from the month of December 2007.  This was driven
primarily by software sales totaling $2.75 billion for the month of December
2008, up 15% from the month of December 2007. At least half of all Americans
claim to play PC and video games, with an estimated 69% of parents and
caregivers playing video games. The average video game player is 33 years old
and has been playing for nearly ten 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 is 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) 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 2 and 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 1 to PlayStation 2), 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.  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.  We believe the new generation of these systems creates
additional market opportunity for us and other publishers that can access both
the existing and installed base of current-generation systems while also
focusing on the creation of new titles for next-generation systems. 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.





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.





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 100 million units worldwide as of March
2009.  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.  The portable gaming system sold 2 million units in
Japan during the first 5 months of availability.  The U.S. launch was
April 5, 2009.  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 Network).




3




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. 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.





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. The Yankee Group, a
market research firm, forecasts that advertisers will increase their amount
spent on in-gaming advertising from roughly $330 million in 2008 to over $970
million by 2011.





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.





In 2008,
we released the following games:





Game
      Title
                                                          PlatformBarnyard
      Blast: Swine of the Night
                                                          DSCommand
      & Destroy
                                                          DSDouble
      Sequence
                                                          DSChampionship
      Pony
                                                          DSSea
      Monsters
                                                          PS2Shining
      Stars "Super Starcade"
                                                          DS1
      vs. 100
                                                          DSPuzzler
      Collection
                                                          DS/WiiGarfield's
      Fun Fest
                                                          DSOrder
      Up!
                                                          WiiTwin
      Strike: Operation Thunder
                                                          WiiMargot’s
      Word Brain
                                                          DS/WiiWordmaster
                                                          DSArmy
      Men: Soldiers of Misfortune
                                                          DS/WiiCalvin
      Tucker’s Redneck Jamboree
                                                          WiiJeep
      Thrills
                                                          Wii/PS2M&M’S
      Adventure
                                                          DS/WiiChrysler
      Classic Racing
                                                          DS/WiiSkate
      City Heroes
                                                          Wii




4




In
addition, the most successful games released by our subsidiary Zoo Publishing
during 2007, prior to our acquisition of it, include the following:





Game
      Title
                                    PlatformM&M's
      "Break 'Em"
                                    DS/GBABattleship/Connect
      4/Sorry/Trouble
                                    DSClue/Mouse
      Trap/Perfection/Aggravation
                                    DSDeal
      or No Deal
                                    DS/GBAHot
      Wheels Ultimate Racing
                                    PSPChicken
      Shoot
                                    DS/WiiBalls
      of Fury
                                    DS/WiiM&Ms
      Kart Racing
                                    DS/WiiShowtime
      Championship Boxing
                                    DS/WiiSea
      Monsters
                                    DS/Wii/PS2




Titles
already released in the first three and a half months of 2009
include:





Game
      Title
                                PlatformStory
      Hour Adventures & Fairy Tales
                                WiiBigfoot:
      Collision Course
                                DS/WiiDeal
      or No Deal
                                WiiM&M’S
      Beach Party
                                WiiYamaha
      Supercross
                                DS/WiiBuild’n
      Race
                                DS




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 by providing for the payment of
royalties to them based on sales of the developed product, only after we recoup
development costs. We have worked, and continue to work, with independent third
party developers.





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 Sam’s
Club.  We also have strong relationships with Jack of All Games
(“JOAG”), a subsidiary of Take-Two Interactive Software, Inc., Cokem and SVG,
who act as resellers of our products to smaller retail outlets. 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.




6




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, Midway Games, Inc., 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;





·
            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.




The
number of new video game releases for PCs in a given year is much higher than
the number of new video game releases for home consoles and handheld platforms.
The barriers to entry in the PC market are lower because there are no publishing
agreements with, or royalties to, be paid to the hardware
manufacturers.




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 and PSP, and from Nintendo to develop products for the GBA, GameCube, DS, Wii
and Micro.  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.




7




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.





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, as well as the manuals and
packaging for these products, and ship the finished 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
April 1, 2009, we had twenty-four full-time employees, of which four are in
product development and twenty are in selling, general and administrative
functions, including two employees 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.




8




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.




Unless
the context otherwise indicates, the use of the terms “we,” “our” or “us” refers
to the business and operations of Zoo Entertainment, Inc. through its operating
subsidiaries, Zoo Games and Zoo Publishing.




Risks
Related to Our Business




We have a limited operating history
in an evolving market, which may make it difficult to evaluate our business.





Although
certain of our subsidiaries have operated for several years prior to their
acquisition by us, Zoo was recently organized and has a limited history of
generating revenues. The future revenue potential of our business in this
evolving market is uncertain. As a result of our short operating history, we
have limited financial data that can be used to evaluate our business. Any
evaluation of our business and our prospects must be considered in light of our
limited operating history and the risks and uncertainties encountered by
companies in our stage of development. We cannot assure our investors that we
will be able to introduce our proposed products, operate our business
successfully or implement our strategies as described in this Annual Report on
Form 10-K or otherwise be successful in generating any revenues from our
activities. We are subject to all of the business risks and uncertainties
associated with any new business, including the risk that we will not achieve
our business objectives.





We have experienced operating losses,
and expect to incur future losses.




We have
incurred start-up costs and continue to incur restructuring costs, which consist
primarily of management and corporate salaries, rent, and professional fees.
Until we generate sufficient income to cover these costs, we will continue to
report operating losses. Through December 31, 2008, we have cumulative losses of
approximately $31.9 million. If we do become profitable, we may not be able to
sustain or increase our profitability. Continued losses or an inability to
sustain profitability, may have an adverse effect on our future operating
prospects.




We are
unable to predict whether we will be successful in our efforts. If we are not
successful, we will not be able to continue as a going concern. The report of
our independent auditors on our financial statements for the fiscal year ended
December 31, 2008 included an explanatory paragraph raising doubt about Zoo’s
ability to continue as a going concern.




Our
business activities will 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 will need to raise additional capital or incur debt
to fund our operations and strategic plan. We intend to seek at least $5 million
to $10 million in additional financing through sales of additional equity or
debt securities and/or loans from financial institutions, but there can be no
assurance that funds will be available to us on acceptable terms, if at all, and
any sales of additional securities will be dilutive to investors.




9




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 future
operating prospects, or 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 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 our products is long. 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.




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.





Our market 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.




10




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 and our predecessors’
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:




·
            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.




11




If game platform manufacturers refuse
to license their platforms to us or do 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.




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.




12




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.




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




13




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.




Certain
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 the majority
of 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.




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. 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.




14




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.




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.




15




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





Our sales
to Jack of All Games and Cokem accounted for approximately 30% and 14%,
respectively, of our gross sales for 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;





•
            potentially
      adverse tax treatment;





•
            difficulties
      with distributors;





•
            difficulties
      collecting our accounts receivable;





•
            relying
      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 operations and 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.




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.




16




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 be unable 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.





Our business is subject to risks
generally associated with the entertainment industry, and we may fail to
properly assess consumer tastes and preferences, causing product sales 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.




17




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





Continuing
our international operations may subject us to many risks,
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 our 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;





·
            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.






18




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.




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.





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, and the 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 open market;
  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.




19




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.




“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 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, will require 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,
2009. 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 45.0% 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 will be subject to the reporting requirements of the Exchange
Act and the Sarbanes-Oxley Act. The requirements of these rules and regulations
will increase our legal, accounting and financial compliance costs, will make
some activities more difficult, time-consuming and costly and may also place
undue strain on our personnel, systems and resources.




As we
grow, the Sarbanes-Oxley Act may require, among other things, that we maintain
effective disclosure controls and procedures and internal control over financial
reporting. This can be difficult to do. These reports may not be timely, and in
the past they have contained, and in the future they may contain,
errors.





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.




The
Sarbanes-Oxley Act will make it more difficult and more expensive for us to
maintain directors’ and officers’ liability insurance, and we may be required to
accept reduced coverage or incur substantially higher costs to maintain
coverage. If we are unable to maintain adequate directors’ and officers’
insurance, our ability to recruit and retain qualified directors, and officers
will be significantly curtailed.




21




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, and
carrier relationships, 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, some payments from carriers that we recognize
as revenue on a cash basis may be delayed unpredictably.





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;




·
            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.




22




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 Staff
Comments.





None.




Item 2.  Properties.





The
principal offices of Zoo are the offices of Trinad Management, LLC, located
at 2121 Avenue of the Stars, Suite 2550, Los Angeles, California
90067.  Trinad Management, LLC is a significant shareholder and
noteholder of the Company.  Zoo does not allocate any rent for use of
this facility.




The
principal offices of Zoo Games are at 770 Broadway, Suite 215, New York, New
York, 10003, where it leases 530 square feet in an executive office complex for
a monthly rent of $5,005 under a lease that expires on April 30, 2009. Zoo Games
is currently looking for other office space in New York City and can extend the
current lease on a month-to-month basis until a new location is
identified.




We also
lease 4,120 square feet of office space in Sicklerville, New Jersey for $6,220
per month, expiring on January 31, 2011, for the offices of Zoo
Publishing.




Item 3.
Legal
Proceedings.





On  February
19, 2009, Susan Kain Jurgensen, Steven Newton, Mercy Gonzalez, Bruce Kain,
Wesley Kain, Raymond Piece and Christie Walsh filed a compliant 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 seeks compensatory damages, punitive damages and preliminary
and permanent injunctive relief, among other remedies.  An answer is due on
May 15, 2009.  We believe we have meritorious defenses and intend to
vigorously defend the matter.





Revolution
Partners, LLC and Zoo Games, Inc., JAMS Alternative Dispute Resolution Reference
Number 1400011786.  In this action, pending in the Boston, Massachusetts
office of JAMS Alternative Dispute Resolution, the Claimant Revolution Partners,
LLC is seeking money damages for a claimed investment banking or finder’s fee
purportedly earned in connection with a reverse merger transaction and related
financing that we entered into in the third quarter of 2008.  We have
denied all material allegations and are vigorously defending the matter. 
At this time, discovery is ongoing.  The matter is scheduled for trial
before an arbitrator in July 2009.





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.
Submission of Matters
to a Vote of Security Holders.





No
matters were submitted to a vote of security holders during the fourth quarter
of the year ended December 31, 2008.




23




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
                  
                  Low2007First
      Quarter
                  
                  
                  N/A
                  
                  
                  
                  N/ASecond
      Quarter
                  
                  
                  N/A
                  
                  
                  
                  N/AThird
      Quarter
                  
                  
                  N/A
                  
                  
                  
                  N/AFourth
      Quarter
                  
                  
                  N/A
                  
                  
                  
                  N/A2008First
      Quarter
                  
                  $
                  1.35
                  
                  
                  $
                  1.00Second
      Quarter
                  
                  $
                  1.45
                  
                  
                  $
                  1.10Third
      Quarter
                  
                  $
                  2.50
                  
                  
                  $
                  1.45Fourth
      Quarter
                  
                  $
                  1.70
                  
                  
                  $
                  0.25





Holders
of common stock.


On April
1, 2009, we had approximately 97 registered stockholders of record of the
38,243,937 outstanding shares. 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, 2008.




24




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
                    
                    0
                    *
                    $
                    0
                    
                    25,000Equity
      compensation plans approved by Zoo Games security holders
                    
                    2,336,552
                    
                    $
                    1.76
                    
                    0Equity
      compensation plans not approved by security holders
                    
                    0
                    
                    
                    
                    
                    0Total
                    
                    2,336,552
                    
                    $
                    1.76
                    
                    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
(the "2007 Plan").




On
January 14, 2009, the 2007 Plan was amended to increase the aggregate number of
shares of common stock that may be issued under the plan from 1,000,000 shares
to 4,000,000 shares, and to increase the maximum number of shares with respect
to which stock rights may be granted to any participant in any fiscal year from
250,000 shares to 750,000 shares.




Unregistered
sales of securities.


None.





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.





In this
section, 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.).





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.




25




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 and PlayStation
2.   In addition, we intend to publish packaged entertainment
software titles for use on a variety of other gaming platforms, including Sony’s
PlayStation 3 and Microsoft’s Xbox 360. 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, iPhone and for use on personal computers
(PCs).  Our current video game titles are targeted at various
demographics, primarily at a lower-priced “value” title. 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.





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”).




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, otherwise payable to such stockholders, into escrow to be held by the
escrow agent in accordance with the terms and conditions of an escrow
agreement.





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





Zoo Games
is treated as the acquirer for accounting purposes in this 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.




26




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.




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.





The
financial statements of Zoo Games include operations of each division from the
date that they were acquired.




The 2007
financial statements include operations of each division as
follows:





·
            Corporate and Publishing -
      includes nine months of activity beginning on March 23, 2007. This
      division oversees the corporate and video game publishing operations of
      the Company.


·
            Supervillain - a video game
      development studio acquired in June 2007 that was discontinued in
      September 2008 (included in discontinued operations for both periods
      presented).


·
            Cyoob (Repliqa) - a group
      developing a recommendation engine to be used on the internet that was
      acquired in June 2007 and discontinued during January 2008 (included in
      discontinued operations for both periods
  presented).


·
            Zoo Publishing - a publisher,
      developer and distributor of video games for the casual market that was
      acquired on December 18, 2007.  2007 results include thirteen
      days of activity beginning December 19,
  2007.




The 2008
financial statements include operations of each division as
follows:





Continuing
operations:


·
            Corporate and Publishing – 12
      months


·
            Zoo Publishing – 12
      months


·
            Zoo beginning on September 12,
      2008, the date of the reverse
merger.





Discontinued
operations:


·
            Zoo Digital which was acquired on
      April 4, 2008 and disposed of on November 28,
  2008


·
            Supervillain
      and


·
            Repliqa




27




Results
of Operations





For
the year ended December 31, 2008 as compared to the period from March 23, 2007
to December 31, 2007





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 $000’s except per share data)For
      The PeriodsYear
      Ended
                                        December
      31,
                                        2008
                                      
                                      
                                      March
      23, 2007
                                        (Inception)
      to
                                        December
      31,
                                        2007Revenue
                                      
                                      $
                                      36,313
                                      
                                      
                                      
                                      100
                                      %
                                      
                                      $
                                      565Cost
      of goods sold
                                      
                                      
                                      30,883
                                      
                                      
                                      
                                      85
                                      %
                                      
                                      
                                      485Gross
      profit
                                      
                                      
                                      5,430
                                      
                                      
                                      
                                      15
                                      %
                                      
                                      
                                      80Operating
      expenses:General
      and administrative expenses
                                      
                                      
                                      10,484
                                      
                                      
                                      
                                      29
                                      %
                                      
                                      
                                      2,666Selling
      and marketing expenses
                                      
                                      
                                      4,548
                                      
                                      
                                      
                                      12
                                      %
                                      
                                      
                                      146Research
      and development expenses
                                      
                                      
                                      5,857
                                      
                                      
                                      
                                      16
                                      %
                                      
                                      
                                      3,360Depreciation
      and amortization
                                      
                                      
                                      1,760
                                      
                                      
                                      
                                      5
                                      %
                                      
                                      
                                      126Total
      Operating expenses
                                      
                                      
                                      22,649
                                      
                                      
                                      
                                      62
                                      %
                                      
                                      
                                      6,298Loss
      from operations
                                      
                                      
                                      (17,219
                                      )
                                      
                                      
                                      (47
                                      )%
                                      
                                      
                                      (6,218
                                      )Interest
      (expense) income, net
                                      
                                      
                                      (3,638
                                      )
                                      
                                      
                                      (10
                                      )%
                                      
                                      
                                      (896
                                      )Other
      income – insurance recovery
                                      
                                      
                                      1,200
                                      
                                      
                                      
                                      3
                                      %
                                      
                                      
                                      -Loss
      from continuing operations before benefit for income taxes
                                      
                                      
                                      (19,657
                                      )
                                      
                                      
                                      (54
                                      )%
                                      
                                      
                                      (7,114
                                      )Income
      tax benefit
                                      
                                      
                                      4,696
                                      
                                      
                                      
                                      13
                                      %
                                      
                                      
                                      58Loss
      from continuing operations
                                      
                                      
                                      (14,961
                                      )
                                      
                                      
                                      (41
                                      )%
                                      
                                      
                                      (7,056
                                      )Loss
      from discontinued operations, net of tax benefit
                                      
                                      
                                      (6,734
                                      )
                                      
                                      
                                      (19
                                      )%
                                      
                                      
                                      (3,189
                                      )Net
      loss
                                      
                                      $
                                      (21,695
                                      )
                                      
                                      
                                      (60
                                      )%
                                      
                                      $
                                      (10,245
                                      )Loss
      per share from continuing operations
                                      
                                      $
                                      (0.59
                                      )
                                      
                                      
                                      
                                      
                                      
                                      $
                                      (1.07
                                      )




28




Net Revenues. Net revenues
for the year ended December 31, 2008 were approximately $36.3 million, all
consisting of casual game sales in North America.  The breakdown of
gross sales by platform is:





Nintendo
      DS
                      
                      
                      50
                      %Nintendo
      Wii
                      
                      
                      45
                      %Nintendo
      GBA
                      
                      
                      2
                      %SONY
      PS2
                      
                      
                      2
                      %SONY
      PSP
                      
                      
                      1
                      %




The
biggest sellers during this period on the Nintendo DS platform were (i) the
compilation of Battle Ship, Connect 4, Sorry & Trouble, (ii) Deal or No
Deal, and (iii) the compilation of Clue, Perfection & Aggravation. The
biggest sellers during this period on the Nintendo Wii platform were the M&M
Kart Racing, Chicken Shoot and Showtime Championship Boxing.





The
revenues during the period from March 23, 2007 to December 31, 2007 consist of
casual game sales in North America for the thirteen day period beginning in
December 19, 2007 when we acquired Zoo Publishing.





Gross Profit.Gross profit
for the year ended December 31, 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 gross profit in 2008 was
negatively impacted by the October 2008 fire and the subsequent agreement to
sell our products through Atari for the remainder of the 2008
period.  Atari’s fees amounted to approximately $1.2 million and were
recorded as a reduction in revenue.  The gross margin of the sales for
the period from December 19, 2007 to December 31, 2007 was 14%.





General and Administrative Expenses.General and administrative expenses for the year ended December 31, 2008
were approximately $10.5 million as compared to $2.7 million for the period from
March 23, 2007 to December 31, 2007. The 2008 period includes $7.2 million for
the operations of the corporate and publishing group, including salary and
related costs, professional fees and rent expenses and $876,000 for Zoo
Publishing expenses. The 2008 period also included approximately $2.0 million in
consulting, audit and legal fees for services performed in connection with our
reverse merger and included approximately $2.8 million in share based
compensation. The 2007 period includes nine months of corporate and publishing
expenses for Zoo Games, consisting primarily of salaries and related costs and
professional fees.





Selling and Marketing Expenses.Selling and marketing expenses for the year ended December 31, 2008 were
approximately $4.5 million as compared to $146,000 for the period ended December
31, 2007.  These expenses all relate to the sales of casual games in
North America and are primarily the salaries, commissions and related costs for
Zoo Publishing.





Research and Development Expenses.Research and development expenses for the year ended December 31, 2008
were approximately $5.9 million as compared to $3.4 million for the period ended
December 31, 2007. The 2008 expenses consist of approximately $5.1million
relating to various video game products that were discontinued during the period
and approximately $720,000 for a video game still in development that we deemed
unrecoverable.  The 2007 period includes approximately $1.8 million
relating to a game that was discontinued and approximately $1.5 million relating
to video game publishing rights that were terminated.




29




Depreciation and Amortization
Expenses.Depreciation and amortization costs for the year ended December
31, 2008 were approximately $1.8 million as compared to $126,000 in the prior
period. The 2008 period includes approximately $1.7 million resulting from the
amortization of intangibles acquired from the Zoo Publishing acquisitions. The
balance relates to depreciation of fixed assets during the
period.   The 2007 period includes $69,000 resulting from the
amortization of the Zoo Publishing intangibles.





Interest
Expense.Interest expense for the 2008 period was
approximately $3.6 million as compared to $896,000 for the 2007 period. 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.  The 2007 period includes $843,000 charged to
interest expense resulting from the beneficial conversion feature in our bridge
notes issued during 2007 that were converted to equity in December
2007.





Other Income – Insurance
Recovery.In 2008, we
received $1.2 million from our insurance company relating to business losses
incurred from a fire at a third party warehouse that housed our inventory in
October 2008.





Income Tax Benefit. In 2008, we recorded
an income tax benefit of approximately $4.7 million, while the income tax
benefit recorded for the 2007 period was $58,000.  The 2008 tax
benefit is based on losses incurred from continuing operations since we
converted from a limited liability corporation (“LLC”) to a general corporation
on May 16, 2008.  Any losses incurred prior to May 16, 2008 were
passed along to the members of the LLC.





Loss from Discontinued
Operations.  In November 2008, we sold Zoo Digital back to the
original owners, incurring a pre-tax loss for the eight-month period that we
owned Zoo Digital of approximately $4.5 million, consisting of an operating loss
of approximately $1.2 million and a loss on the disposition of net assets of
approximately $3.3 million.  The tax benefit recognized in 2008
related to the loss on Zoo Digital was $1.4 million.  In September
2008, the Company sold Supervillain back to the original owners, incurring a
loss for the 2008 period of approximately $3.2 million, consisting of an
operating loss for the period of approximately $2.6 million and a loss on the
disposition of net assets of $528,000. In January 2008, management determined to
discontinue Zoo Games’s involvement in the operations of Repliqa and recorded a
loss from discontinued operations of $219,000. Also during 2008, we discontinued
the operations of an on-line concept and incurred a loss from discontinued
operations of $146,000. In the 2007 period, approximately $2.1 million of the
loss relates to the Repliqa and on-line operations that were discontinued in
2008 and approximately $1.1 million of the loss relates to the Supervillain
operations. The revenues from the discontinued operations were approximately
$2.5 million in 2008 and $785,000 during the period from March 23, 2007 to
December 31, 2007.  The 2008 period includes a tax benefit of
approximately $1.1 million.





Loss per share from continuing
operations.The loss per share from continuing operations was
$0.59 for 2008, based on a weighted average shares outstanding for the year of
25.4 million, vs. a loss per share from continuing operations of $1.07, based on
a weighted average shares outstanding of 6.6 million for the period from March
23, 2007 to December 31, 2007.




30




Liquidity
and Capital Resources





We
incurred a loss from continuing operations of approximately $15.0 million for
the year ended December 31, 2008 and a net loss of approximately $7.1 million
from continuing operations for the period from March 23, 2007 to December 31,
2007. Our principal source of cash is from sales of our debt and equity
securities and the use of our purchase order financing and factor arrangements.
Net cash used in operating activities for 2008 was $14.3 million and for the
period from March 23, 2007 to December 31, 2007 was $7.3 million.




We raised
an aggregate of $21.4 million, net, from various debt and equity financings from
our inception to December 2008, as follows:





·
            $5.0 million, net in the initial
      sale of our common equity in May and June
  2007;





·
            $2.8 million, net from October
      2007 through December 2007 in the sale of a 12% debt security that was
      converted into the common equity we sold in December
      2007;





·
            $7.5 million, net in December
      2007 from the sale of our common equity;
  and





·
            $6.1 million, net during the
      first nine months of 2008 from the sale of our common
      equity.





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 were 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 $2.029 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 and as amended on July 15, 2008 and July 31, 2008, 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 First Financing Notes, we issued to the purchasers
warrants to purchase 8,181,818 shares of our common stock. The notes bear an
interest rate of five percent (5%) for the one year term of the note commencing
from issuance, unless extended. Upon the occurrence of an investor sale, as
defined in the notes, the entire outstanding principal amount of the notes and
any accrued interest thereon will be automatically converted into shares of our
common stock determined by dividing the note balance by the lesser of (i) an
amount equal to the price per share of investor stock paid by the purchasers of
such shares in connection with the investor sale, or (ii) $2.00; provided, that
in the event that the investor sale is for less than $1.00 per share, then the
notes will only be automatically convertible with our consent.  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, we granted a security interest in all of
our assets to each of the purchasers to secure our obligations under the
notes.




31




On
September 26, 2008, we entered into a note purchase agreement 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 bear an
interest rate of five percent (5%) for the time period beginning on September
26, 2008 and ending on September 26, 2009, unless extended. Upon the occurrence
of an investor sale, as defined in the notes, the entire outstanding principal
amount of the notes and any accrued interest thereon will be automatically
converted into shares of our common stock determined by dividing the note
balance by the lesser of (i) an amount equal to the price per share of investor
stock paid by the purchasers of such shares in connection with the investor
sale, or (ii) $2.00; provided, that in the event that the investor sale is for
less than $1.00 per share, then the notes will only be automatically convertible
with our consent. 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 September 26, 2008, we granted a security interest
in all of our assets to each of the purchasers to secure our obligations
under the notes.




A
significant portion of our cash was used during 2007 and 2008 in connection with
our acquisitions.  We used $7.4 million of our cash during 2007 in the
acquisitions of the assets of Supervillain, and the stock of Zoo
Publishing.  We used approximately $626,000 of our cash during
2008 with respect to the outstanding obligations in connection with our
prior acquisition of Zoo Publishing.  We used approximately $191,000 of our
cash in 2007 and $450,000 cash in 2008 towards the investments in Cyoob and
Repliqa LLC. We used $202,000 cash in 2007 and $67,000 cash in 2008 for capital
expenditures for continuing operations.




Zoo
Publishing





In
connection with Zoo Games’ acquisition of Zoo Publishing, there is 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 must be paid on or
before September 18, 2009 and the remaining $1,820,000 plus accrued and unpaid
interest must be paid on or before December 18, 2010. As part of that
acquisition transaction, Zoo Games also has a remaining obligation to two
employees of Zoo Publishing in connection with that acquisition transaction. Zoo
Games is required to pay one of those individuals $1,200,000. Of that amount,
Zoo Games paid $327,000 in 2008, $253,000 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 Games is
required to pay the other individual an aggregate of $608,400. Of that amount,
$292,500 is due on December 18, 2010 and $315,900 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 was outstanding prior to
Zoo Games’ acquisition of that subsidiary.  As of December 31, 2008, Zoo
Publishing owes an aggregate of approximately $1.0 million to various
individuals.  Of this amount, $370,000 is owed as a result of the
repurchase of certain stock from a former stockholder.  This amount is
being repaid by its terms in monthly increments of $10,000.  In addition,
this amount includes a loan to Zoo Publishing from its President of which
approximately $150,000 remains outstanding. The note bears interest at an annual
rate of 4% and is past due.





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, 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 20% 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 have not used
the factor since we entered into the Atari agreement in October 2008 (see
below).




32




In
addition to the receivable financing, Zoo Publishing also utilizes purchase
order financing with Transcap Trade Finance, LLC, to fund the manufacturing of
video game products. Under the terms of our agreement, we assign purchase orders
received to Transcap Trade Finance, LLC, 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, Transcap Trade Finance, LLC opens a letter of credit to the
video game product manufacturer. The letter of credit 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 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 Trade Finance, LLC and Zoo Publishing, dated as of August 20, 2001, as
amended.





Pursuant
to the Assignment Agreement, we 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 commitment fee in
the aggregate amount of $337,500, 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, 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 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 Senior Vice 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.




33




As a
result of the 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 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.  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,
2009.  The agreement expired on March 31, 2009, but was amended to extend
the term until April 30, 2009.





Net cash
used in continuing operations was $12.1 million for the year ended December 31,
2008 and was $7.3 million for the period from March 23, 2007 to December 31,
2007.  The operations of Zoo Publishing generated cash flow of $2.7
million in 2008 and used approximately $1.0 million in cash for operations for
the thirteen day period in 2007.   The 2008 year included a full
twelve months of activities for the corporate operations of Zoo
Games.  In addition, we incurred costs related to the reverse merger
in 2008 resulting primarily from the requirement to audit prior year’s financial
statements.




We
believe the existing cash and cash generated from operations will be sufficient
to meet our immediate operating requirements along with our current financial
arrangements. However, given our strategic plan, working capital requirements,
debt obligations, planned capital expenditures and potential future
acquisitions, we will need to raise additional capital within the short-term. We
also need to either raise enough capital to force conversion of the $11.2
million of Zoo Entertainment Notes, at face value, that mature between July and
September 2009 into equity or restructure the maturing note
obligations.  We believe that we require at least an additional $5
million to $10 million in financing in order to fund our operating requirements
and strategic plan for the following 12 months. However, there can be no
assurances that we will be able to secure any such financing on favorable terms,
if at all. If we do not secure such financing on a timely basis, it will have a
material adverse effect on our financial condition.





In
addition, we may raise additional capital to strengthen our cash position,
facilitate expansion, pursue strategic investments or to take advantage of
business opportunities as they arise.





The
report of our independent auditors on our financial statements for the fiscal
year ended December 31, 2008 includes an explanatory paragraph raising doubt
about the Company’s ability to continue as a going concern.





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.




34




Revenue
Recognition




We
recognize revenue upon the transfer of title and risk of loss to our customers.
We apply the provisions of Statement of Position 97-2, "Software Revenue
Recognition" in conjunction with the applicable provisions of Staff Accounting
Bulletin No. 104, "Revenue Recognition." 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.




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,
which consists principally of finished goods, 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.




35




Product Development
Costs




We
utilize both internal development teams and third party product developers to
develop the titles we publish.




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), 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
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 royalties 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.




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.




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.  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.




36




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
(1) current period revenues to the total revenues expected to be recorded
over the remaining life of the title or (2) the contractual royalty rate
based on actual net product sales as defined in the licensing agreement,
whichever is greater. Similar to software 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.




We
evaluate our goodwill annually for impairment or more frequently if indicators
of potential impairment exist. The determination of whether or not goodwill has
become impaired involves a significant level of judgment in the assumptions
underlying the approach used to determine the value of our reporting units. We
generally use either the income, cost or market approach to aid in our
conclusions of such fair values and asset lives. The income approach presumes
that the value of an asset can be estimated by the net economic benefit to be
received over the life of the asset, discounted to present value. The cost
approach presumes that an investor would pay no more for an asset than its
replacement or reproduction cost. The market approach estimates value based on
what other participants in the market have paid for reasonably similar assets.
Although each valuation approach is considered in valuing the assets acquired,
the approach ultimately selected is based on the characteristics of the asset
and the availability of information. Changes in our strategy or market
conditions could significantly impact these judgments and require reductions to
recorded intangible asset balances.




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.




Stock-based
Compensation




We
account for stock-based compensation in accordance with SFAS No. 123(R),
Share-Based Payment. Under the fair value recognition provisions of this
statement, share-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.




37




Income
Taxes




Zoo Games
was a limited liability company (“LLC”) from inception until May 16, 2008 and
followed all applicable US tax regulations for an LLC. 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.





In 2007,
we adopted the provisions of FIN 48, which clarifies accounting for uncertain
income tax positions. This interpretation requires us to recognize 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.





Recently Issued Accounting
Pronouncements





In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements” (SFAS No. 160), which is an amendment of
Accounting Research Bulletin (“ARB”) No. 51. This statement clarifies that a
noncontrolling interest in a subsidiary is an ownership interest in the
consolidated entity that should be reported as equity in the consolidated
financial statements. This statement changes the way the consolidated income
statement is presented, thus requiring consolidated net income to be reported at
amounts that include the amounts attributable to both parent and the
noncontrolling interest. This statement is effective for the fiscal years, and
interim periods within those fiscal years, beginning on or after December 15,
2008. The adoption of SFAS No. 160 did not have a significant impact on our
results of operations or financial position.




In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations” (SFAS No. 141R). This statement replaces FASB Statement No. 141,
“Business Combinations.” This statement retains the fundamental requirements in
SFAS 141 that the acquisition method of accounting (which SFAS No. 141 called
the purchase method) be used for all business combinations and for an acquirer
to be identified for each business combination. This statement defines the
acquirer as the entity that obtains control of one or more businesses in the
business combination and establishes the acquisition date as the date that the
acquirer achieves control. This statement requires an acquirer to recognize the
assets acquired, the liabilities assumed, and any noncontrolling interest in the
acquiree at the acquisition date, measured at their fair values as of that date,
with limited exceptions specified in the statement. This statement applies
prospectively to business combinations for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after
December 15, 2008.




In
February 2008, the FASB issued FSP FAS 157-2, “Effective Date of FASB Statement
No. 157”. FSP FAS 157-2 delays the effective date of SFAS
No. 157, “ Fair Value
Measurements”, for certain nonfinancial assets and nonfinancial
liabilities, except those that are recognized or disclosed at fair value in the
financial statements on a recurring basis (at least annually). SFAS No. 157
establishes a framework for measuring fair value and expands disclosures about
fair value measurements. FSP FAS 157-2 defers the effective date of certain
provisions of SFAS No. 157 to fiscal years beginning after
November 15, 2008, and interim periods within those fiscal years, for items
within the scope of this FSP. The adoption of FSP FAS 157-2 did not have a
significant impact on our results of operations or financial
position.




38




In
April 2008, the FASB issued FSP FAS 142-3, “Determination of the Useful Life of
Intangible Assets”. FSP FAS 142-3 amends the factors an entity should
consider in developing renewal or extension assumptions used in determining the
useful life of recognized intangible assets under SFAS No. 142, “Goodwill and Other Intangible
Assets”. This guidance for determining the useful life of a recognized
intangible asset applies prospectively to intangible assets acquired
individually or with a group of other assets in either an asset acquisition or
business combination. FSP FAS 142-3 is effective for fiscal years, and interim
periods within those fiscal years, beginning after December 15, 2008, and
early adoption is prohibited. The adoption of FSP FAS 142-3 did not have a
significant impact on our results of operations and financial
position.





In
May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted
Accounting Principles” (“FAS 162”). FAS 162 is intended to improve
financial reporting by identifying a consistent framework, or hierarchy, for
selecting accounting principles to be used in preparing financial statements
that are presented in conformity with GAAP for nongovernmental entities. FAS 162
is effective 60 days following the SEC’s approval of the Public Company
Accounting Oversight Board amendments to AU Section 411, “The Meaning of
Present Fairly in Conformity with Generally Accepted Accounting Principles.” We
do not expect the adoption of this statement to have a significant impact on our
results of operations or financial position.




On May 9,
2008, the FASB issued Staff Position ("FSP") APB 14-1, Accounting for
Convertible Debt Instruments That May Be Settled in Cash upon Conversion
(Including Partial Cash Settlements), which clarifies that convertible debt
instruments that may be settled in cash upon conversion (including partial cash
settlement) are not addressed by paragraph 12 of APB Opinion No. 14, Accounting
for Convertible Debt and Debt Issued with Stock Purchase Warrants. The FSP
specifies that issuers of such instruments should separately account for the
liability and equity components in a manner that will reflect the entity's
nonconvertible debt borrowing rate when interest cost is recognized in
subsequent periods. FSP APB 14-1 is effective for financial statements issued
for fiscal years beginning after December 15, 2008 and interim periods within
those fiscal years. The adoption of FSP APB 14-1 will not have a significant
impact on our results of operations or financial position.




Legal
Matters





On  February
19, 2009, Susan Kain Jurgensen, Steven Newton, Mercy Gonzalez, Bruce Kain,
Wesley Kain, Raymond Piece and Christie Walsh filed a compliant 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 seeks compensatory damages, punitive damages and preliminary
and permanent injunctive relief, among other remedies.  An answer is due on
May 15, 2009.  We believe we have meritorious defenses and intend to
vigorously defend the matter.





Revolution
Partners, LLC and Zoo Games, Inc., JAMS Alternative Dispute Resolution Reference
Number 1400011786.  In this action, pending in the Boston, Massachusetts
office of JAMS Alternative Dispute Resolution, the Claimant Revolution Partners,
LLC is seeking money damages for a claimed investment banking or finder’s fee
purportedly earned in connection with a reverse merger transaction and related
financing that we entered into in the third quarter of 2008.  We have
denied all material allegations and are vigorously defending the matter. 
At this time, discovery is ongoing.  The matter is scheduled for trial
before an arbitrator in July 2009.





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.





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.




39




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.




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.





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.




40




Item 9A(T).Controls
and Procedures.





Evaluation
of disclosure controls and procedures.


Our
management is responsible for establishing and maintaining adequate internal
controls over financial reporting, as defined in Exchange Act
Rules 13a-15(e) and 15d-15(e), as of the end of the period covered by this
report.   Since the acquisition of Zoo Games and its subsidiaries
occurred in September 2008 at the end of our fiscal year, we concluded that the
management does not need to evaluate the effectiveness of the internal controls
and procedures of Zoo Games for our 2008 report.  Therefore, the
evaluation for 2008 is limited solely to the operations of Zoo Entertainment,
Inc.  We will evaluate the effectiveness of the internal controls and
procedures of Zoo Games for the 2009 Annual Report.  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.
 
 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 in 2009 and we will reassess
our accounting and finance staffing levels to determine and seek the appropriate
accounting resources to be added to the team to handle the existing
workload.




Changes
in controls and procedures.


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





Management’s
annual report on internal control over financial reporting.


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.




Subject
to the limitations above, management believes that the consolidated financial
statements and other financial information contained in this report, fairly
present in all material respects our financial condition, results of operations,
and cash flows for the periods presented.





This
annual 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
public accounting firm pursuant to temporary rules of the Securities and
Exchange Commission that permit us to provide only management’s report in this
annual report.




Item 9B.
Other
Information.





Not
applicable.




41




PART
III




Item 10. Directors,
Executive Officers and Corporate Governance.





The
response to this item will either be set forth in our Proxy Statement,
or will be filed under Item 10 of a future amendment to this Annual Report
on Form 10-K, in either case to be filed with the Securities and Exchange
Commission not later than 120 days after the end of the fiscal year covered by
this Annual Report on Form 10-K.





Item
11. Executive
Compensation.





The
response to this item will either be set forth in our Proxy Statement, or will
be filed under Item 11 of a future amendment to this Annual Report on Form 10-K,
in either case to be filed with the Securities and Exchange Commission not later
than 120 days after the end of the fiscal year covered by this Annual Report on
Form 10-K.





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





The
response to this item will either be set forth in our Proxy Statement, or will
be filed under Item 12 of a future amendment to this Annual Report on Form 10-K,
in either case to be filed with the Securities and Exchange Commission not later
than 120 days after the end of the fiscal year covered by this Annual Report on
Form 10-K.





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





The
response to this item will either be set forth in our Proxy Statement, or will
be filed under Item 13 of a future amendment to this Annual Report on Form 10-K,
in either case to be filed with the Securities and Exchange Commission not later
than 120 days after the end of the fiscal year covered by this Annual Report on
Form 10-K.





Item
14. Principal
Accounting Fees and Services.





The
response to this item will either be set forth in our Proxy Statement, or will
be filed under Item 14 of a future amendment to this Annual Report on Form 10-K,
in either case to be filed with the Securities and Exchange Commission not later
than 120 days after the end of the fiscal year covered by this Annual Report on
Form 10-K.




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:




42




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).3.3
                  
                  Bylaws
      (incorporated by reference to that Current Report on Form 8-K filed with
      the Securities and Exchange Commission on December 21,
      2007).4.1
                  
                  Form
      of Note (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  (incorporated by reference to that Current Report on
      Form 8-K filed with the Securities and Exchange Commission on October 2,
      2008).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).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).
  43
  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).
  44
  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).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
                  
                  1st
      Amended 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 1st
      Amended 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 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
      Kain-Jurgensen Employment Agreement between Zoo Publishing, Inc. and Susan
      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).
  45
  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).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).
  46
  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).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).
  47
  10.52
                  
                  Guaranty
      of Zoo Publishing obligations to Transcap Trade Finance made by Susan
      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 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
      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).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.  †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. 
      †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 dated 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 dated
      November 5, 2008).21.1
                  
                  Subsidiaries
      of Zoo Entertainment, Inc. †31.1
                  
                  Certification
      of Robert S. Ellin, Chief Executive Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002. †31.2
                  
                  Certification
      of Charles Bentz, Chief Financial Officer pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002. †
  48
  32.1
                  
                  Certification
      of Robert S. Ellin, Principal Executive Officer, and Charles Bentz,
      Principal Financial Officer, pursuant to U.S.C. Section 1350.†





*
Management compensation agreements


**Confidential
treatment as to certain portions requested


†
Filed herewith




49




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:
      April 15, 2009
                By:
                /s/ Charles BentzCharles
      Bentz, 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/ Robert S. Ellin
                
                Chief
      Executive OfficerRobert
      S. Ellin
                
                (principal
      executive
                
                April
      15, 2009officer)
      and DirectorBy:
                /s/ Charles Bentz
                
                Chief
      Financial Officer
                
                April
      15, 2009Charles
      Bentz
                
                (principal
      financialofficer,
      principal accounting officer)By:
                /s/ Jay A. Wolf
                
                Secretary,
      Director
                
                April
      15, 2009Jay
      A. WolfBy:
                /s/ Mark Seremet
                
                Director
                
                April
      15, 2009Mark
      SeremetBy:
                /s/ Barry Regenstein
                
                Director
                
                April
      15, 2009Barry
      RegensteinBy:
                /s/ John Bendheim
                
                Director
                
                April
      15, 2009John
      BendheimBy:
                /s/ Drew Larner
                
                Director
                
                April
      15, 2009Drew
      LarnerBy:
                
                
                Director
                
                April
      15, 2009Moritz
      Seidel




50




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, 2008 and 2007
                  
                  
                  F-3Consolidated
      Statements of Operations for the Year Ended December 31, 2008 and the
      Period from March 23, 2007 (Inception) to December 31,
2007
                  
                  
                  F-4Consolidated
      Statements of Cash Flow for the Year Ended December 31, 2008 and the
      Period from March 23, 2007 (Inception) to December 31,
2007
                  
                  
                  F-5Consolidated
      Statements of Stockholders’ Equity for the Period from March 23, 2007
      (Inception) to December 31, 2007 and for the Year Ended December 31,
      2008
                  
                  
                  F-6Notes
      to Consolidated Financial Statements
                  
                  
                  F-7
      - F-31




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.
(formerly Zoo Games, Inc.) and Subsidiaries as of December 31, 2008 and 2007,
and the related consolidated statements of operations, stockholders’ equity and
cash flows for the year ended December 31, 2008 and for the period March 23,
2007 (inception) to December 31, 2007.  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. (formerly Zoo Games, Inc.) and Subsidiaries as of December
31, 2008 and 2007, and the results of their operations and their cash flows for
year ended December 31, 2008 and for the period March 23, 2007 (inception) to
December 31, 2007, in conformity with accounting principles generally accepted
in the United States of America.





The
accompanying consolidated financial statements have been prepared assuming the
Company will continue as a going concern.  As more fully described in Note
2 to the consolidated financial statements, the Company has incurred losses
since inception; net cash outflows from operations and has a working capital
deficiency of approximately $9.2 million at December 31, 2008. In addition, the
Company has note obligations maturing between July and September 2009 with a
total face value of approximately $12.3 million. These conditions raise
substantial doubt about the Company’s ability to continue as a going
concern.  Management’s plans in regard to these matters are also described
in Note 2 to the consolidated financial statements.  The consolidated
financial statements do not include any adjustments that may result from the
outcome of this uncertainty.





/s/
Amper, Politziner & Mattia, LLP




April 15,
2009


New York,
New York


F-2





Zoo
Entertainment, Inc. and Subsidiaries


Consolidated
Balance Sheets


As
of December 31, 2008 and 2007


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





2008
                    
                    
                    2007ASSETSCurrent
      AssetsCash
                    
                    $
                    849
                    
                    
                    $
                    169Accounts
      receivable, net of allowances for returns and discounts of $1,160 and
      $1,167
                    
                    
                    1,832
                    
                    
                    
                    1,316Inventory
                    
                    
                    3,120
                    
                    
                    
                    1,555Prepaid
      expenses and other current assets
                    
                    
                    2,124
                    
                    
                    
                    4,098Product
      development costs, net - current
                    
                    
                    5,338
                    
                    
                    
                    3,139Deferred
      tax asset
                    
                    
                    688
                    
                    
                    
                    1,438Total
      Current Assets
                    
                    
                    13,951
                    
                    
                    
                    11,715Fixed
      assets, net
                    
                    
                    214
                    
                    
                    
                    384-Goodwill
                    
                    
                    14,704
                    
                    
                    
                    16,204Intangible
      assets, net
                    
                    
                    14,747
                    
                    
                    
                    17,535Product
      development costs, net
                    
                    
                    -
                    
                    
                    
                    1,120Total
      Assets
                    
                    $
                    43,616
                    
                    
                    $
                    46,958LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      LiabilitiesAccounts
      payable
                    
                    $
                    5,709
                    
                    
                    $
                    3,274Financing
      arrangements
                    
                    
                    849
                    
                    
                    
                    2,893Accrued
      expenses and other current liabilities
                    
                    
                    5,167
                    
                    
                    
                    5,932Notes
      payable, net of discount of $145 and $662
                      -
      current portion
                    
                    
                    1,803
                    
                    
                    
                    2,877Convertible
      notes payable, net of discount of $1,576
                    
                    
                    9,574
                    
                    
                    
                    -Total
      current liabilities
                    
                    
                    23,102
                    
                    
                    
                    14,976Notes
      payable, net of discount of $885 and $2,438
                      -
      non current portion
                    
                    
                    1,772
                    
                    
                    
                    4,032Deferred
      tax liability
                    
                    
                    688
                    
                    
                    
                    6,220Other
      long-term liabilities
                    
                    
                    620
                    
                    
                    
                    167Total
      Liabilities
                    
                    
                    26,182
                    
                    
                    
                    25,395Commitments
      and ContingenciesStockholders'
      EquityPreferred
      Stock, par value $0.001, 5,000,000 shares authorized, none issued and
      outstanding
                    
                    
                    -
                    
                    
                    
                    -Common
      Stock, par value $0.001, 75,000,000 shares authorized, 38,243,937 issued
      and outstanding December 31, 2008 and 15,684,845 issued and outstanding
      December 31, 2007
                    
                    
                    38
                    
                    
                    
                    16Additional
      Paid-in-capital
                    
                    
                    52,692
                    
                    
                    
                    31,792Accumulated
      deficit
                    
                    
                    (31,940
                    )
                    
                    
                    (10,245
                    )Treasury
      Stock, at cost 2,237,376 shares in 2008
                    
                    
                    (3,356
                    )
                    
                    
                    -Total
      Stockholders' Equity
                    
                    
                    17,434
                    
                    
                    
                    21,563Total
      Liabilities and Stockholders' Equity
                    
                    $
                    43,616
                    
                    
                    $
                    46,958





See
accompanying notes to consolidated financial statements


F-3





Zoo
Entertainment, Inc. and Subsidiaries


Consolidated
Statements of Operations


For
the Year Ended December 31, 2008 and the Period from March 23, 2007 (Inception)
to December 31, 2007


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





Year Ended
                  
                  
                  March 23 -December
                    31,
                  
                  
                  December
                    31,2008
                  
                  
                  2007Revenue
                  
                  $
                  36,313
                  
                  
                  $
                  565Cost
      of goods sold
                  
                  
                  30,883
                  
                  
                  
                  485Gross
      profit
                  
                  
                  5,430
                  
                  
                  
                  80Operating
      expenses:General
      and administrative expenses
                  
                  
                  10,484
                  
                  
                  
                  2,666Selling
      and marketing expenses
                  
                  
                  4,548
                  
                  
                  
                  146Research
      and development expenses
                  
                  
                  5,857
                  
                  
                  
                  3,360Depreciation
      and amortization
                  
                  
                  1,760
                  
                  
                  
                  126Total
      Operating expenses
                  
                  
                  22,649
                  
                  
                  
                  6,298Loss
      from operations
                  
                  
                  (17,219
                  )
                  
                  
                  (6,218
                  )Interest
      (expense) income, net
                  
                  
                  (3,638
                  )
                  
                  
                  (896
                  )Other
      income - Insurance recovery
                  
                  
                  1,200
                  
                  
                  
                  -Loss
      from continuing operations before income tax benefit
                  
                  
                  (19,657
                  )
                  
                  
                  (7,114
                  )Income
      tax benefit
                  
                  
                  4,696
                  
                  
                  
                  58Loss
      from continuing operations
                  
                  
                  (14,961
                  )
                  
                  
                  (7,056
                  )Loss
      from discontinued operations, net of tax benefit:loss
      from discontinued operations, net of $200 tax benefit in
    2008
                  
                  
                  (4,052
                  )
                  
                  
                  (3,189
                  )loss
      from disposal of net assets, net of $1,190 tax benefit in
    2008
                  
                  
                  (2,682
                  )
                  
                  
                  -Loss
      from discontinued operations
                  
                  
                  (6,734
                  )
                  
                  
                  (3,189
                  )Net
      loss
                  
                  $
                  (21,695
                  )
                  
                  $
                  (10,245
                  )Loss per share - basic and
      diluted:Continuing
      operations
                  
                  $
                  (0.59
                  )
                  
                  $
                  (1.07
                  )Discontinued
      operations:loss
      from operations
                  
                  
                  (0.16
                  )
                  
                  
                  (0.48
                  )loss
      from disposal of net assets
                  
                  
                  (0.11
                  )
                  
                  
                  0.00Discontinued
      operations total
                  
                  
                  (0.27
                  )
                  
                  
                  (0.48
                  )Net
      loss
                  
                  $
                  (0.85
                  )
                  
                  $
                  (1.56
                  )Weighted
      average shares outstanding
                    -
      basic and diluted
                  
                  
                  25,394,264
                  
                  
                  
                  6,579,350





See
accompanying notes to consolidated financial statements


F-4




Zoo
Entertainment, Inc. and Subsidiaries


Consolidated
Statements of Cash Flow


For
the Year Ended December 31, 2008 and the Period from March 23, 2007(Inception)
to December 31, 2007


(in
$000's)





Year Ended
                                                  
                                                  
                                                  March 23, 2007 -December 31,
                                                  
                                                  
                                                  December 31,2008
                                                  
                                                  
                                                  2007Operating
      Activities:Net
      loss
                                                  
                                                  $
                                                  (21,695
                                                  )
                                                  
                                                  $
                                                  (10,245
                                                  )Loss
      from discontinued operations
                                                  
                                                  
                                                  (6,734
                                                  )
                                                  
                                                  
                                                  (3,189
                                                  )Net
      loss from continuing operations
                                                  
                                                  
                                                  (14,961
                                                  )
                                                  
                                                  
                                                  (7,056
                                                  )Adjustments
      to reconcile net loss from continuing operations to net cash used in
      operating activities:Depreciation
      and amortization
                                                  
                                                  
                                                  1,760
                                                  
                                                  
                                                  
                                                  126Interest
      arising from amortization of debt discount
                                                  
                                                  
                                                  3,443
                                                  
                                                  
                                                  
                                                  886Deferred
      income taxes
                                                  
                                                  
                                                  (4,782
                                                  )
                                                  
                                                  
                                                  (58
                                                  )Share
      based compensation
                                                  
                                                  
                                                  2,759
                                                  
                                                  
                                                  
                                                  138Other
      changes in assets and liabilities, net
                                                  
                                                  
                                                  (291
                                                  )
                                                  
                                                  
                                                  (1,373
                                                  )Net
      cash used in continuing operations
                                                  
                                                  
                                                  (12,072
                                                  )
                                                  
                                                  
                                                  (7,337
                                                  )Net
      cash (used in) provided by discontinued operations
                                                  
                                                  
                                                  (2,184
                                                  )
                                                  
                                                  
                                                  60Net
      cash used in operating activities
                                                  
                                                  
                                                  (14,256
                                                  )
                                                  
                                                  
                                                  (7,277
                                                  )Investing
      activities:Capital
      expenditures
                                                  
                                                  
                                                  (67
                                                  )
                                                  
                                                  
                                                  (202
                                                  )Cash
      received from reverse merger with Zoo
                                                  
                                                  
                                                  1,669
                                                  
                                                  
                                                  
                                                  -Disposition
      (acquisition) of assets of discontinued operations, net of cash
      acquired
                                                  
                                                  
                                                  477
                                                  
                                                  
                                                  
                                                  (1,599
                                                  )Acquisition
      of stock of Zoo Publishing, net of cash acquired
                                                  
                                                  
                                                  (2
                                                  )
                                                  
                                                  
                                                  (6,000
                                                  )Net
      cash provided by (used in) investing activities
                                                  
                                                  
                                                  2,077
                                                  
                                                  
                                                  
                                                  (7,801
                                                  )Financing
      activities:Proceeds
      from sale of equity securities
                                                  
                                                  
                                                  6,118
                                                  
                                                  
                                                  
                                                  15,247Proceeds
      from Zoo issuance of convertible notes - pre-merger
                                                  
                                                  
                                                  7,785
                                                  
                                                  
                                                  
                                                  -Proceeds
      from issuance of convertible notes - post-merger
                                                  
                                                  
                                                  1,000
                                                  
                                                  
                                                  
                                                  -Net
      repayments in connection with financing facilities
                                                  
                                                  
                                                  (2,044
                                                  )
                                                  
                                                  
                                                  -Net
      cash provided by financing activities
                                                  
                                                  
                                                  12,859
                                                  
                                                  
                                                  
                                                  15,247Increase
      in cash
                                                  
                                                  
                                                  680
                                                  
                                                  
                                                  
                                                  169Cash
      at beginning of period
                                                  
                                                  
                                                  169
                                                  
                                                  
                                                  
                                                  -Cash
      at end of period
                                                  
                                                  $
                                                  849
                                                  
                                                  
                                                  $
                                                  169





See
accompanying notes to consolidated financial statements


F-5





Zoo
Entertainment, Inc. and Subsidiaries


Consolidated
Statements of Stockholders' Equity For the Period from March 23, 2007
(Inception) to December 31, 2007 and


For
the Year ended December 31, 2008


(in
000's)





Preferred Stock
                      
                      
                      Common Stock
                      
                      
                      Additional
                      
                      
                      Accumulated
                      
                      
                      Treasury StockShares
                      
                      
                      Par value
                      
                      
                      Shares
                      
                      
                      Par
                        Value
                      
                      
                      Paid-in-
                        Capital
                      
                      
                      Deficit
                      
                      
                      Shares
                      
                      
                      Par
                        Value
                      
                      
                      TotalFounder's
      shares
                      
                      
                      
                      
                      $
                      -
                      
                      
                      
                      2,374
                      
                      
                      $
                      3
                      
                      
                      $
                      64
                      
                      
                      $
                      -
                      
                      
                      
                      
                      
                      $
                      -
                      
                      
                      $
                      67Issuance
      of members' units, net of costs
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      7,676
                      
                      
                      
                      8
                      
                      
                      
                      15,239
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      15,247Equity-based
      compensation expense
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      1,068
                      
                      
                      
                      1
                      
                      
                      
                      70
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      71Issuance
      of common units for SVS acquisition
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      351
                      
                      
                      
                      -
                      
                      
                      
                      490
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      490Issuance
      of common units for Zoo Publishing acquisition
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      3,162
                      
                      
                      
                      3
                      
                      
                      
                      8,170
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      8,173Commitment
      to Issue common units for Zoo Publishing acquisition
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      5,447
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      5,447Issuance
      of common units for Radar publishing rights
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      1,054
                      
                      
                      
                      1
                      
                      
                      
                      1,469
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      1,470Bridge
      Note beneficial conversion factor
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      -
                      
                      
                      
                      
                      
                      
                      
                      843
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      843Net
      loss
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (10,245
                      )
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      (10,245
                      )Balance
      December 31, 2007
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      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
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      1,605Zoo
      shares acquired upon the completion of the reverse merger
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      11,327
                      
                      
                      
                      11
                      
                      
                      
                      1,186
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      1,724Value
      of warrants issued in connection with debt financing
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      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
                      )
                      
                      $
                      17,434





See
accompanying notes to consolidated financial statements


F-6


ZOO
ENTERTAINMENT, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




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. No
terms have been established for the preferred stock. 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 (the “Merger Agreement”) 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 (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 (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
is 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 for the period from March 23, 2007 to September
12, 2008 have been adjusted to reflect this recapitalization.




Zoo
Games, a Delaware corporation, is a New York City-based 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 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. We 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.





Currently,
the Company has determined that it operates in one business segment in North
America, as described above, which includes the operations of Zoo
Publishing.





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.




F-7




2.
GOING CONCERN





These
consolidated financial statements have been prepared assuming the Company
will continue as a going concern. The Company has incurred losses since
inception, resulting in an accumulated deficit of approximately $31.9
million and a working capital deficiency of approximately $9.2 million at
December 31, 2008. For the year ended December 31, 2008, the Company generated
negative cash flows from operations of approximately $12.1 million. Further
losses are anticipated in the development of its business raising substantial
doubt about the Company's ability to continue as a going concern. In addition,
the Company has various notes maturing between July and September 2009 with a
total face value of approximately $12.3 million.  The Company has been
in discussions with the debt holders to either convert a portion or the entirety
of the debt to equity or extend or amend the terms of the
debt.   Its ability to continue as a going concern is dependent
upon the ability of the Company to generate cash flow from operations sufficient
to maintain its daily business activities as well as acquiring financing from
outside sources through the sale of equity or debt instruments as well as
restructuring its maturing note obligations. While management has plans to seek
financing through additional sales of such instruments, there is no assurance
that such financing can be obtained. These consolidated financial statements do
not include any adjustments relating to the recoverability and classification of
recorded assets, or the amounts of and classification of liabilities that might
be necessary as a result of this uncertainty.




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 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.




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, lives of intangibles, realization of goodwill and
intangibles, allocation of purchase price, valuation of inventories and the
adequacy of allowances for returns, price concessions and doubtful accounts.
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.  As of December 31,
2008, Atari had prepaid us approximately $1.8 million and the receivable due
from Atari was approximately $1.8 million, before allowances.  Our
five largest ultimate customers accounted for approximately 60% and 83% of net
revenue for the years ended December 31, 2008 and 2007, respectively. These five
largest customers accounted for 3% and 10% of our gross accounts receivable as
of December 31, 2008 and 2007, respectively. We believe that the receivable
balances from these customers do not represent a significant credit risk based
on past collection experience. The receivables from our factor included in our
gross accounts receivable were $0 and $175,000 as of December 31, 2008 and 2007,
respectively. 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,
primarily consisting of finished goods, 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.


F-8





Product Development
Costs





We
utilize both internal development teams and third party product developers to
develop the titles we publish.





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), 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.





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 apply 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 2008, we wrote-off approximately $5.1 million of
expense relating to costs incurred for the development of nine games that were
abandoned and we expensed $720,000 for a game still in development that we
deemed unrecoverable.  In the 2007 period, we wrote off approximately
$1.9 million of expense relating to costs incurred for the development of a game
that was abandoned, we wrote off $1.5 million relating to video game publishing
rights that were terminated and we expensed approximately $1.0 million for other
costs incurred by our internal development studio prior to technological
feasibility that could not be capitalized.  Those costs are included
in the 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 Statement of
Operations.




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.


F-9


Licensing
fees are capitalized on the 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
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.




The
Company accounts for its goodwill in accordance with Statement of Financial
Accounting Standards 142, “Goodwill and Other Intangibles”. Under this standard,
the Company is required to perform 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. On
December 31, 2008, we performed our annual test for impairment of goodwill and
determined no impairment existed.  We will continue to 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.





Impairment of Long-Lived
Assets, Including Definitive 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.




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. We apply the provisions of Statement of Position 97-2, "Software
Revenue Recognition", in conjunction with the applicable provisions of Staff
Accounting Bulletin No. 104, "Revenue Recognition." 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, included in current liabilities until we
meet our performance obligations, at which point we recognize the
revenue.





Revenue
is recognized after deducting 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.


F-10


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.





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 to purchase shares of common stock of the Company to certain management
and employees during 2008 and 2007. In accordance with SFAS 123(R), Share-Based
Payment, we record compensation expense over the requisite service period based
on their relative fair values.




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. The
assumptions and variables used for the current period grants were developed
based on SFAS 123(R) and SEC guidance contained in Staff Accounting
Bulletin (SAB) No. 107, "Share-Based Payment." The following table
summarizes the assumptions and variables used by us to compute the weighted
average fair value of stock option grants:





For the Year
                  
                  
                  For the Period FromEnded
                  
                  
                  March 23, 2007 toDecember31,2008
                  
                  
                  December 31, 2007Risk-free
      interest rate
                  
                  
                  3.07
                  %
                  
                  
                  3.45
                  %Expected
      stock price volatility
                  
                  
                  70.0
                  %
                  
                  
                  45.0
                  %Expected
      term until exercise (years)
                  
                  
                  5
                  
                  
                  
                  5Dividends
                  
                  None
                  
                  
                  None





For the
years ended December 31, 2008 and 2007, 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.


F-11





Earnings (Loss) per
Share




Basic
earnings (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 warrants and options outstanding is
anti-dilutive because of losses, the dilutive loss per share is the same as the
basic loss per share. As a result, 6,502,159 and 1,007,405 warrants as of
December 31, 2008 and 2007, respectively and 2,336,552 and 243,040 options to
acquire shares of common stock as of December 31, 2008 and 2007, respectively
were excluded from the EPS calculations for all periods presented.





Foreign Currency
Translation




The
functional currency for our former foreign operation 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,
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’s and the unit holders are 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 bases 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.





During
2007, the Company adopted the provisions of FASB Interpretation No. 48,
“Accounting for Uncertainty in Income Taxes — an interpretation of FASB
Statement No. 109” (“FIN 48”), which clarifies the accounting for uncertain
income tax positions. This interpretation requires us to recognize in the
consolidated financial statements only those tax positions which we have
determined to be more likely than not 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.




Fair Market Value of
Financial Instruments





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 convertible notes that were issued with
warrants are recorded net of the unamortized discount applied to the
warrants.





Recently Issued Accounting
Pronouncements





In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements” (SFAS No. 160), which is an amendment of
Accounting Research Bulletin (“ARB”) No. 51. This statement clarifies that a
noncontrolling interest in a subsidiary is an ownership interest in the
consolidated entity that should be reported as equity in the consolidated
financial statements. This statement changes the way the consolidated income
statement is presented, thus requiring consolidated net income to be reported at
amounts that include the amounts attributable to both parent and the
noncontrolling interest. This statement is effective for the fiscal years, and
interim periods within those fiscal years, beginning on or after December 15,
2008. The adoption of SFAS No. 160 did not have a significant impact on our
results of operations or financial position.




In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations” (SFAS No. 141R). This statement replaces FASB Statement No. 141,
“Business Combinations.” This statement retains the fundamental requirements in
SFAS 141 that the acquisition method of accounting (which SFAS No. 141 called
the purchase method) be used for all business combinations and for an acquirer
to be identified for each business combination. This statement defines the
acquirer as the entity that obtains control of one or more businesses in the
business combination and establishes the acquisition date as the date that the
acquirer achieves control. This statement requires an acquirer to recognize the
assets acquired, the liabilities assumed, and any noncontrolling interest in the
acquiree at the acquisition date, measured at their fair values as of that date,
with limited exceptions specified in the statement. This statement applies
prospectively to business combinations for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after
December 15, 2008.


F-12





In
February 2008, the FASB issued FSP FAS 157-2, “Effective Date of FASB Statement
No. 157”. FSP FAS 157-2 delays the effective date of SFAS
No. 157, “ Fair Value
Measurements”, for certain nonfinancial assets and nonfinancial
liabilities, except those that are recognized or disclosed at fair value in the
financial statements on a recurring basis (at least annually). SFAS No. 157
establishes a framework for measuring fair value and expands disclosures about
fair value measurements. FSP FAS 157-2 defers the effective date of certain
provisions of SFAS No. 157 to fiscal years beginning after
November 15, 2008, and interim periods within those fiscal years, for items
within the scope of this FSP. The adoption of FSP FAS 157-2 will not have a
significant impact on our results of operations or financial
position.




In
April 2008, the FASB issued FSP FAS 142-3, “Determination of the Useful Life of
Intangible Assets”. FSP FAS 142-3 amends the factors an entity should
consider in developing renewal or extension assumptions used in determining the
useful life of recognized intangible assets under SFAS No. 142, “Goodwill and Other Intangible
Assets”. This guidance for determining the useful life of a recognized
intangible asset applies prospectively to intangible assets acquired
individually or with a group of other assets in either an asset acquisition or
business combination. FSP FAS 142-3 is effective for fiscal years, and interim
periods within those fiscal years, beginning after December 15, 2008, and
early adoption is prohibited. The adoption of FSP FAS 142-3 did not have a
significant impact on our results of operations and financial
position.





In
May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted
Accounting Principles” (“FAS 162”). FAS 162 is intended to improve
financial reporting by identifying a consistent framework, or hierarchy, for
selecting accounting principles to be used in preparing financial statements
that are presented in conformity with GAAP for nongovernmental entities. FAS 162
is effective 60 days following the SEC’s approval of the Public Company
Accounting Oversight Board amendments to AU Section 411, “The Meaning of
Present Fairly in Conformity with Generally Accepted Accounting
Principles.”  We do not expect the adoption of this statement to have
a significant impact on our results of operations or financial
position.





On May 9,
2008, the FASB issued Staff Position ("FSP") APB 14-1, “Accounting for Convertible Debt
Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash
Settlements)”, which clarifies that convertible debt instruments that may
be settled in cash upon conversion (including partial cash settlement) are not
addressed by paragraph 12 of APB Opinion No. 14, Accounting for Convertible Debt
and Debt Issued with Stock Purchase Warrants. The FSP specifies that issuers of
such instruments should separately account for the liability and equity
components in a manner that will reflect the entity's nonconvertible debt
borrowing rate when interest cost is recognized in subsequent periods. FSP APB
14-1 is effective for financial statements issued for fiscal years beginning
after December 15, 2008 and interim periods within those fiscal years. The
adoption of FSP APB 14-will not have a significant impact on our results of
operations or financial position.





4.
BUSINESS ACQUISITIONS AND DISPOSITIONS





During
the years ended December 31, 2007 and 2008, we consummated the acquisitions and
dispositions described below, which largely reflect our efforts to expand our
business by adding development studios, established distribution systems, a
seasoned sales team and talented personnel resources to our existing
infrastructure. The acquisitions were accounted for under the purchase method of
accounting in accordance with FASB 141 and the results of operations and
financial position of these acquisitions are included in our consolidated
financial statements from their respective acquisition dates.




Supervillain Studios
(Discontinued Operation)





In June
2007, the Company acquired the assets of Supervillain Studios, Inc.
(“Supervillain” or “SVS”), a video game developer based in Santa Ana,
California. The total purchase price consisted of the following:


(amounts
      in $000’s)Cash
      at closing
                  
                  $
                  1,400Promissory
      Notes, net of $989 debt discount
                  
                  
                  1,111Fair
      value of 351,171 common shares issued
                  
                  
                  490Acquisition-related
      costs
                  
                  
                  53Total
      purchase price
                  
                  $
                  3,054




In
addition, there was $333,000 to be paid to each of Supervillain’s three
shareholders (an aggregate of up to $1.0 million) that remain employed by the
Company or its affiliates on the third anniversary of the Supervillain closing.
The $333,000 was accrued for as compensation on a straight-line basis over a
three-year period. The Supervillain Promissory Note was payable in three
installments; $500,000 of principal together with accrued interest at the rate
of 5% per annum is payable on each of (A) the earlier of December 14, 2008 or
the date that the Company consummates a round of equity financing of $20.0
million or more and (B) the earlier of December 14, 2008 or the date that the
Company consummates a round of equity financing of $31.0 million or more. The
balance of the Supervillain Promissory Note, together with any accrued interest,
was due on June 14, 2010.


F-13


Effective
September 16, 2008, the Company sold SVS back to its original owners. In
connection with the sale, certain assets that were developed by SVS after its
original acquisition remain with the Company. All unpaid obligations related to
the acquisition were assumed and a net payment of $500,000 was due to the SVS
owners. When the $500,000 is paid in full, the SVS owners will return 351,171
shares of common stock of the Company that are currently held in escrow. These
shares have been accounted for as Treasury Stock at December 31,
2008.  As of December 31, 2008, $225,000 remains due to the SVS
owners.  The Company reported a loss of approximately $528,000
relating to the disposition of SVS and a loss of approximately $2.6 million and
$1.1 million for its discontinued operations for 2008 and the 2007 period,
respectively. The assets disposed and liabilities relieved are (in
$000’s):




Fixed
      assets
                  
                  $
                  112Goodwill
                  
                  
                  1,500Intangibles
                  
                  
                  1,057Accrued
      expenses relieved
                  
                  
                  (558
                  )Notes
      payable relieved ($2,100, net of $544 discount)
                  
                  
                  (1,556
                  )Common
      shares to be returned to Treasury at fair value
                  
                  
                  (527
                  )Additional liability
                  
                  
                  500Net
      assets disposed
                  
                  $
                  528





Zoo Publishing,
Inc.





In
December 2007, the Company acquired the shares of Zoo Publishing.  The
purchase price was paid as follows (in $000’s):




Cash
      at closing
                  
                  $
                  7,040Promissory
      Notes, net of $2,346 debt discount
                  
                  
                  4,414Fair
      value of 3,160,874 common shares issued
                  
                  
                  8,173Fair
      value of 2,106,582 common shares to be issued (issued July
      2008)
                  
                  
                  5,447Acquisition-related
      costs
                  
                  
                  69Total
      purchase price
                  
                  $
                  25,143





The cash
purchase price was approximately $7.0 million at closing, with approximately
$1.8 million to be paid 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 a promissory note (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 was 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) is payable December 18, 2010.





In July
2008, the Company restructured the Zoo Publishing Note and certain other amounts
due so that approximately $3.2 million of debt due was converted to equity of
the Company at the then current market price of $10.65 per share (equivalent to
$1.52 per share after the reverse merger) and the remaining debt was
restructured so that approximately $1.1 million is due on September 18, 2009,
approximately $100,000 is due on September 18, 2010, $2.0 million is due
December 18, 2010 and approximately $300,000 is due on July 31,
2011.




Cyoob, Inc. and Repliqa, LLC
(Discontinued Operation)





In June
2007, we acquired a 24.75% interest in the outstanding stock of Cyoob, Inc.
(“Cyoob”). Cyoob’s assets were transferred to Repliqa, LLC (“Repliqa”) and the
Company acquired a 35% membership interest in Repliqa, ultimately allowing the
Company to own 51.09% of the operating business of Repliqa. Repliqa was
developing a recommendation engine to be used on the internet. We paid
approximately $1.2 million for the interest in Cyoob and we committed to pay
approximately $1.2 million for the membership interest in Repliqa. Prior to
December 31, 2007, the assets of Repliqa were impaired and we recorded $2.0
million as a loss on impairment on this investment in the 2007 financial
statements. This operation had no revenue. In January 2008, the Board and
management decided to discontinue its involvement with the operations and this
was recorded as a discontinued operation on the 2008 financial statements.
During 2008, the Company sustained an additional $219,000 in losses that are
included in the loss from discontinued operations.


F-14




Zoo Digital Publishing
Limited (Discontinued Operation)





In April
2008, the Company acquired the shares of Zoo Digital Publishing Limited (“Zoo
Digital”). The purchase price was paid as follows:




(amounts
      in $000’s)Cash
      due at closing
                  
                  $
                  630Cash
      due by December 31, 2008
                  
                  
                  370Promissory
      Notes, net of $547 debt discount
                  
                  
                  1,953Fair
      value of 1,580,237 common shares issued
                  
                  
                  4,086Acquisition-related
      costs
                  
                  
                  188Total
      purchase price
                  
                  $
                  7,227





In
addition, there is $500,000 to be paid to each of Zoo Digitals two shareholders
(an aggregate of up to $1.0 million) that remain employed by the Company or its
affiliates on the third anniversary of the Zoo Digital closing. The full amount
is being accrued for as compensation on a straight-line basis over a three-year
period. The cash purchase price was $630,000 paid at closing, with $370,000 to
be paid within the next nine months. The $2.5 million promissory note was
payable $1.5 million with the Company’s next round of financing and $1.0 million
was due April 2009. In addition, the Company was obligated under the purchase
agreement to remit to the sellers an amount equal to 80% of any resultant tax
savings from the utilization of the UK loss carryforward existing at the time of
the acquisition.




In July
2008, the Company restructured the promissory note so that $2.0 million of debt
due was converted to equity of the Company at the then current market price of
$10.65 per share (equivalent to $1.52 per share after the reverse merger) and
the remaining $500,000 is due on December 31, 2008.




The
following table summarizes the allocation of the purchase price based on the
estimated value of the assets acquired and liabilities assumed as of the
acquisition date:





(amounts
      in $000’s)Cash
                  
                  $
                  342Other
      current assets
                  
                  
                  3,989Fixed
      Assets
                  
                  
                  82Other
      assets
                  
                  
                  78Goodwill
                  
                  
                  1,960Content
                  
                  
                  1,789Trademarks
                  
                  
                  840Customer
      Relationships
                  
                  
                  2,337Current
      liabilities assumed
                  
                  
                  (2,800
                  )Deferred
      tax liability
                  
                  
                  (1,390
                  )Net
      assets acquired
                  
                  $
                  7,227





Effective
November 28, 2008, the Company sold Zoo Digital back to its original
owners.  All unpaid obligations related to the acquisition were
relieved and a net payment of approximately $403,000 was due from the Zoo
Digital owners to the Company, to be paid in nine equal monthly installments
beginning in January 2009.  In addition, the Zoo Digital owners
returned 1,886,205 shares of common stock of the Company.  These
shares have been accounted for as treasury stock.  The Company
reported a loss of approximately $3.3 million relating to the disposition of Zoo
Digital and a loss of approximately $1.2 million for its discontinued operations
for the year ended December 31, 2008. The assets disposed and liabilities
relieved are (in $000’s):




Current
      assets
                  
                  $
                  3,961Fixed
      assets
                  
                  
                  57Goodwill
                  
                  
                  1,960Intangibles
                  
                  
                  4.698Accrued
      expenses relieved
                  
                  
                  (3,022
                  )Notes
      payable relieved ($500, net of $9 discount)
                  
                  
                  (491
                  )Deferred
      taxes
                  
                  
                  (1,190
                  )Shares
      to be returned to Treasury at fair value
                  
                  
                  (2,829
                  )Net
      assets disposed
                  
                  $
                  3,144




F-15


Loss from Discontinued
Operations




The loss
from discontinued operations is summarized as follows for the year ended
December 31, 2008 (in $000’s):





Repliqa
                      
                      $
                      (219
                      )On-line
      concept
                      
                      
                      (146
                      )Supervillain
      – operations
                      
                      
                      (2,646
                      )Supervillain
      - loss on disposition of assets
                      
                      
                      (528
                      )Zoo
      Digital – operations
                      
                      
                      (1,241
                      )Zoo
      Digital - loss on disposition of assets
                      
                      
                      (3,344
                      )Total
      pretax loss from discontinued operations
                      
                      
                      (8,124
                      )Credit
      for income taxes
                      
                      
                      1,390Loss
      from discontinued operations, net of tax benefit
                      
                      $
                      (6,734
                      )





The loss
from discontinued operations for the period from March 23, 2007 to December 31,
2007 consists of approximately $2.1 million from Repliqa and the on-line concept
and approximately $1.1 million from Supervillain operations.





The
revenues from the discontinued operations were approximately $2.5 million for
the year ended December 31, 2008 and $785,000 during the period from March 23,
2007 to December 31, 2007.  For the year ended December 31, 2008,
approximately $2.3 million of revenue was generated from foreign operations with
none being recorded in the 2007 period.





Pro forma
results





The
following unaudited summary pro forma information assumes the Zoo Publishing
acquisition had occurred on January 1, 2007. The pro forma results related to
Supervillain and Repliqa have been eliminated as we discontinued our interest in
Repliqa in January 2008 and Supervillain in September 2008. The pro forma
information, as presented below, is not necessarily indicative of the results
that would have been obtained had the acquisition occurred on January 1, 2007
(in $000’s):





March
      23, 2007 -December 31, 2007(unaudited)Revenue
                        
                        $
                        31,173Loss
      from continuing operations
                        
                        
                        (8,059
                        )Basic
      and diluted loss per unit from continuing operations
                        
                        $
                        (0.86
                        )Weighted
      average shares
                        
                        
                        9,351,875




No
proforma results are required for 2008 as Zoo Digital was bought and sold within
the same year.


F-16





5.
INVENTORY




Inventory
consisted of:





(amounts
      in $000’s)December
      31,2008
                  
                  2007Finished
      products
                  
                  $
                  2,939
                  
                  
                  $
                  1,502Parts
      and supplies
                  
                  
                  181
                  
                  
                  
                  53Inventory
                  
                  $
                  3,120
                  
                  
                  $
                  1,555





Estimated
product returns included in Inventory at December 31, 2008 and 2007 were
$337,000 and $542,000, respectively.




6.
PREPAID EXPENSES AND OTHER CURRENT ASSETS





Prepaid
expense and other current assets consisted of:




(amounts
      in $000’s)December 31, 2008
                  
                  
                  December 31, 2007Vendor
      advances for inventory
                  
                  $
                  555
                  
                  
                  $
                  2,424Prepaid
      royalties
                  
                  
                  1,072
                  
                  
                  
                  1,321Income
      taxes receivable
                  
                  
                  55
                  
                  
                  
                  188Other
      prepaid expenses
                  
                  
                  442
                  
                  
                  
                  165Prepaid
      expenses and other current assets
                  
                  $
                  2,124
                  
                  
                  $
                  4,098




7.
PRODUCT DEVELOPMENT COSTS




Details
of our capitalized product development costs were as follows:





(amounts
      in $000’s)December 31, 2008
                      
                      
                      December 31, 2007Current
                      
                      
                      Non-Current
                      
                      
                      Current
                      
                      
                      Non-CurrentProduct
      development costs, internallydeveloped,
      net of amortization
                      
                      $
                      170
                      
                      
                      $
                      -
                      
                      
                      $
                      88
                      
                      
                      $
                      -Product
      development costs, externallydeveloped,
      net of amortization
                      
                      
                      5,168
                      
                      
                      
                      -
                      
                      
                      
                      3,051
                      
                      
                      
                      1,120Product
      development costs
                      
                      $
                      5,338
                      
                      
                      $
                      -
                      
                      
                      $
                      3,139
                      
                      
                      $
                      1,120





The
December 31, 2007 balance includes $88 of net product development costs relating
to operations that were discontinued in 2008.


F-17





8.
FIXED ASSETS, NET


Fixed
assets, net consisted of:





(amounts
      in $000’s)December 31, 2008
                  
                  
                  December 31, 2007Computer
      equipment
                  
                  $
                  254
                  
                  
                  $
                  214Furniture
      and fixtures
                  
                  
                  90
                  
                  
                  
                  156Office
      equipment
                  
                  
                  52
                  
                  
                  
                  30Leasehold
      improvements
                  
                  
                  -
                  
                  
                  
                  50Other
                  
                  
                  3
                  
                  
                  
                  17Less:
      Accumulated depreciation and amortization
                  
                  
                  (185
                  )
                  
                  
                  (83
                  )Fixed
      Assets, net
                  
                  $
                  214
                  
                  
                  $
                  384





The
December 31, 2007 balance includes $112 of net fixed assets relating to
operations that were discontinued in 2008.




9. GOODWILL





Goodwill
was generated from the acquisitions of the assets of Supervillain and the stock
of Zoo Publishing during the period ended December 31, 2007, and the acquisition
of the stock of Zoo Digital in 2008 as described in Note 4 as follows (in
$000’s):




Supervillain
      (discontinued in 2008)
                    
                    $
                    1,500Zoo
      Publishing
                    
                    
                    14,704Total
      Goodwill Dec. 31. 2007
                    
                    
                    16,204Zoo
      Digital
                    
                    
                    1,960Less
      Supervillain disposition
                    
                    
                    (1,500
                    )Less
      Zoo Digital disposition
                    
                    
                    (1,960
                    )Total
      Goodwill December 31, 2008
                    
                    $
                    14,704




10.
INTANGIBLE ASSETS, NET





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





(amounts in $000’s)December 31, 2008
                                                          
                                                          
                                                          December
                                                            31, 2007EstimatedUseful
                                                          
                                                          
                                                          GrossLives
                                                          
                                                          
                                                          Carrying
                                                          
                                                          
                                                          Accumulated
                                                          
                                                          
                                                          Net Book
                                                          
                                                          
                                                          Net Book(Years)
                                                          
                                                          
                                                          Amount
                                                          
                                                          
                                                          Amortization
                                                          
                                                          
                                                          Value
                                                          
                                                          
                                                          ValueContent
                                                          
                                                          10
                                                          
                                                          
                                                          $
                                                          12,202
                                                          
                                                          
                                                          $
                                                          1,271
                                                          
                                                          
                                                          $
                                                          10,931
                                                          
                                                          
                                                          $
                                                          12,151Trademarks
                                                          
                                                          10
                                                          
                                                          
                                                          
                                                          1,510
                                                          
                                                          
                                                          
                                                          157
                                                          
                                                          
                                                          
                                                          1,353
                                                          
                                                          
                                                          
                                                          2,171Customer
      relationships
                                                          
                                                          10
                                                          
                                                          
                                                          
                                                          2,749
                                                          
                                                          
                                                          
                                                          286
                                                          
                                                          
                                                          
                                                          2,463
                                                          
                                                          
                                                          
                                                          3,213Total
      Intangible Assets
                                                          
                                                          
                                                          
                                                          
                                                          $
                                                          16,461
                                                          
                                                          
                                                          $
                                                          1,714
                                                          
                                                          
                                                          $
                                                          14,747
                                                          
                                                          
                                                          $
                                                          17,535




Amortization
expense related to intangible assets for the year ended December 31, 2008 and
the period from March 23, 2007 to December 31, 2007 was $2.0 million, and
$235,000, respectively.




The
December 31, 2007 amount includes approximately $1.1 million of net intangible
assets relating to Supervillain which was discontinued during the year ended
December 31, 2008.


In
connection with the disposition of Supervillain in September 2008, approximately
$1.1 million of net intangibles were eliminated.


In
connection with the acquisition of Zoo Digital in April 2008, approximately $5.0
million of intangibles were added and in connection with the sale of Zoo Digital
in November 2008, approximately $4.7 million of net intangibles were
eliminated.





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


F-18





(amounts
      in $000’s)Year ended Dec. 31,2009
                        
                        $
                        1,6462010
                        
                        
                        1,6462011
                        
                        
                        1,6462012
                        
                        
                        1,6462013
                        
                        
                        1,646Thereafter
                        
                        
                        6,517Total
                        
                        $
                        14,747





11.
CREDIT AND FINANCING ARRANGEMENTS AND ATARI AGREEMENT




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, 2008 and 2007 were approximately $855,000 and $2.9 million,
respectively. The interest rate is prime plus 4.0% on outstanding advances. As
of December 31, 2008 and 2007, the effective interest rates were 7.25% and
8.75%, respectively.  The charges and interest expense on the advances
total approximately $1.1 million for 2008 and are minimal for the 2007 period
and are included in the cost of goods sold in the accompanying consolidated
statement of operations.  As of December 31, 2008, the Company’s
obligations under such agreement were personally guaranteed by the Zoo Games and
Zoo Publishing Presidents.  See Subsequent Events Note 22 for a
description of our amended and restated facility.





Zoo
Publishing uses a factor to approve credit and to collect the proceeds from a
substantial portion of its sales. During 2008, the Company used two different
factoring facilities:





·
            Under
      the terms of the first agreement, Zoo Publishing assigned to the factor
      and the factor purchases from Zoo Publishing eligible accounts receivable.
      In connection with these arrangements, the factor had a security interest
      in substantially all of the Zoo Publishing assets. The factor, in its sole
      discretion, determined whether or not it would accept a receivable based
      on its assessment of credit risk. Once a receivable was accepted by the
      factor, the factor assumed substantially all of the credit risk associated
      with the receivable. The factor was required to remit payments to Zoo
      Publishing for the assigned accounts receivable in accordance with the
      terms of the assigned invoice, regardless of whether the factor received
      payment on the receivable, so long as the customer does not have a valid
      dispute related to the invoice. The amount remitted to Zoo Publishing by
      the factor equaled the invoiced amount adjusted for allowances and
      discounts Zoo Publishing had provided to the customer. The factor charged
      0.25% of invoiced amounts plus a fee for every 10 days the amount is
      uncollected from the customer, subject to certain minimum charges per
      invoice and a monthly maintenance charge, for these credit and collection
      services. For the year ended December 31, 2008, the factor purchased
      $918,000 of eligible gross receivables. This agreement was terminated in
      March 2008. The factor’s charges and interest expense on the advances are
      included in interest in the accompanying consolidated statement of
      operations and amounted to approximately $44,000 for the 2008 period and
      $12,000 for the thirteen-day period in 2007. At December 31, 2007,
      accounts receivable included $175,000 due from the
  factor.




·
            In
      August 2008, Zoo Publishing entered into a new 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. 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 20% 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. From August to December 2008, the
      factor purchased approximately $3.9 million of eligible gross receivables.
      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. 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. This facility is guaranteed by the
      Company’s President.


F-19




As a
result of the fire in October 2008 that destroyed our inventory and impacted our
cash flow from operations, (See Note 21) 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 expired on March 31, 2009, but was
amended to extend the term until April 30, 2009.  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 2008, we recorded approximately $10.9
million 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, 2009.  As of December 31, 2008, Atari had prepaid
the Company approximately $1.8 million for goods not yet shipped which is
recorded as customer advances in accrued expenses and other current
liabilities.  Also, as of December 31, 2008, Atari owed the Company
approximately $1.8 million, before allowances, for goods already shipped which
is recorded in accounts receivable.





12.
ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES





Accrued
expenses and other current liabilities consisted of:





(amounts
      in $000’s)December 31, 2008
                  
                  
                  December 31, 2007Customer
      advances (the 2008 amount is all from Atari)
                  
                  $
                  1,828
                  
                  
                  $
                  1,671Due
      to customers
                  
                  
                  710
                  
                  
                  
                  -Obligation
      arising from Zoo Publishing acquisition
                  
                  
                  254
                  
                  
                  
                  1,200Obligations
      relating to Cyoob acquisition
                  
                  
                  100
                  
                  
                  
                  977Obligations
      to compensate current and former employees
                  
                  
                  720
                  
                  
                  
                  208Zoo
      Publishing pension plan (1)
                  
                  
                  17
                  
                  
                  
                  425Commission
      for equity raise
                  
                  
                  -
                  
                  
                  
                  345Royalty
                  
                  
                  252
                  
                  
                  
                  793Operating
      expenses
                  
                  
                  965
                  
                  
                  
                  229Interest
                  
                  
                  321
                  
                  
                  
                  84Total
                  
                  $
                  5,167
                  
                  
                  $
                  5,932




(1)   The
Zoo Publishing pension plan liability was assumed with the acquisition of Zoo
Publishing. The plan was subsequently cancelled and there is no additional Zoo
Publishing pension plan liability.





13.
NOTES PAYABLE




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





(amounts
      in $000’s)December 31,
                      2008
                    
                    
                    December 31,
                      2007Note DescriptionZoo
      Entertainment convertible notes, net of discounts attributable to the
      warrant value of $1,576
                    
                    $
                    9,574
                    
                    
                    $
                    -5.0% SVS
      sellers note
                    
                    
                    -
                    
                    
                    
                    1,3043.9% Zoo
      Publishing notes, net of discount of $1,030 and $2,304
                    
                    
                    2,536
                    
                    
                    
                    4,4572.95%
      note due June 2012 assumed from Zoo Publishing acquisition
                    
                    
                    370
                    
                    
                    
                    4908.25%
      Wachovia demand note assumed from Zoo Publishing
      acquisition
                    
                    
                    45
                    
                    
                    
                    50Note
      assumed from Zoo Publishing acquisition, 12% interest
                    
                    
                    25
                    
                    
                    
                    200Employee
      loans, payable on demand
                    
                    
                    331
                    
                    
                    
                    408Zoo
      Publishing employee loans at 4% interest
                    
                    
                    268
                    
                    
                    
                    -Total
                    
                    
                    13,149
                    
                    
                    
                    6,909Current
      portion
                    
                    
                    11,377
                    
                    
                    
                    2,877Non-current
      portion
                    
                    $
                    1,772
                    
                    
                    $
                    4,032




F-20


The face
amounts of the notes payable are due as follows:


(amounts
      in $000’s)Year Ending December
                  
                  Amount Due2009
                  
                  $
                  13,0772010
                  
                  
                  2,2322011
                  
                  
                  4362012
                  
                  
                  10Total
                  
                  $
                  15,755





Zoo Entertainment
Notes





On July
7, 2008 and 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 noteholders warrants to purchase 8,181,818 shares of
common stock of the Company. The notes bear an interest rate of five percent
(5%) for the one year term of the note commencing from issuance, unless
extended. Upon the occurrence of an investor sale, as defined in the notes, the
entire outstanding principal amount of the notes and any accrued interest
thereon will be automatically converted into shares of common stock of the
Company determined by dividing the note balance by the lesser of (i) an amount
equal to the price per share of investor stock paid by the purchasers of such
shares in connection with the investor sale, or (ii) $2.00; provided, that in
the event that the investor sale is for less than $1.00 per share, then the
notes will only be automatically convertible with the consent of the Company.
  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, 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
on 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
bear an interest rate of five percent (5%) for the time period beginning on
September 26, 2008 and ending on September 26, 2009, unless extended. Upon the
occurrence of an investor sale, as defined in the notes, the entire outstanding
principal amount of the notes and any accrued interest thereon will be
automatically converted into shares of common stock of the Company determined by
dividing the note balance by the lesser of (i) an amount equal to the price per
share of investor stock paid by the purchasers of such shares in connection with
the investor sale, or (ii) $2.00; provided, that in the event that the investor
sale is for less than $1.00 per share, then the notes will only be automatically
convertible with the consent of the Company. 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 is approximately $11.2
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 and an independent valuation firm. 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 December 31, 2008, the net deferred debt discount
of all the notes is $1.6 million and the net value of the notes recorded as of
December 31, 2008 is approximately $9.6 million.




Supervillain
Notes




In
connection with the purchase of the Supervillain assets, the Company’s
subsidiary Supervillain Studios LLC issued a promissory note (“Supervillain
Note”) in the amount of $2.1 million. The Supervillain Note was payable in three
installments; $500,000 of principal together with accrued interest at the rate
of 5% per annum is payable on each of (A) the earlier of December 14, 2008 or
the date that the Company consummates a round of equity financing of $20.0
million or more and (B) the earlier of December 14, 2008 or the date that the
Company consummates a round of equity financing of $31.0 million or more. The
balance of the Supervillain Note, together with any accrued interest, was due on
June 14, 2010. In connection with the aforementioned note, the Company recorded
a debt discount of $989,000. For the year ended December 31, 2008, amortization
of deferred debt discount and interest expense were $265,000 and $80,000,
respectively. All obligations under the Supervillain Note were terminated
effective September 16, 2008 with the sale of SVS back to the original
owners.


F-21




Zoo Publishing
Notes





In
connection with the acquisition of Zoo Publishing, the Company issued various
promissory notes (“Zoo Publishing Note”) in aggregate of approximately $6.8
million. Approximately $1.8 million of principal is 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 year ended December 31, 2008, amortization
of deferred debt discount and interest expense were $988,000 and $213,000,
respectively. In July 2008, 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 is due September 18, 2009,
$113,000 is due September 18, 2010, $2.0 million is due December 18, 2010 and
approximately $316,000 is due July 31, 2011.




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 6 months,
      minimum guaranteed interest per renewal is $ 12,000. The note is
      guaranteed by the Zoo Publishing President.  The balance due on
      the note as of December 31, 2008 is
$25,000.





·
            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, 2008 was $370,000; $120,000 is classified as current and $250,000 is
      classified as long-term. The payments are due monthly and the amount of
      the payment is $10,000 per month.





Zoo Digital
Notes




In
connection with the acquisition of Zoo Digital, the Company issued a promissory
note (“Zoo Note”) in the amount of $2.5 million. The Zoo Note stated that $1.5
million was to be paid upon the completion of the next round of financing and
$1.0 million to be paid April 4, 2009.   In connection with the
aforementioned note, the Company recorded a debt discount of $548,000. For the
year ended December 31, 2008, amortization of deferred debt discount was
$213,000.   In July 2008, $2 million of this debt was converted to common
stock of the Company based on fair value and the remaining $500,000 note is due
December 31, 2008.  This note was relieved as of November 28, 2008
when the Company sold Zoo Digital back to the original owners.





Zoo
Digital had an outstanding loan in the amount of £325,000 (approximately
U.S. $591,000) from I.C. Stewart 2001 Trust.   The loan bears interest
at an annual rate of 1.75% over the base lending rate of the Bank of
England.   Zoo Digital is required to pay interest quarterly in
arrears, and the entire amount outstanding must be repaid on April 4,
2009.  The responsibility to repay this loan was transferred back to
the original owners of Zoo Digital effective November 28, 2008.




Other
Notes




On May
16, 2008, Zoo Games entered into a Letter of Intent with Mandalay Media, Inc. to
merge. In conjunction with this merger, the Company received $2.0 million from
Mandalay Media and issued a 10% convertible note to Mandalay that was due
October 15, 2008. The beneficial conversion feature in this note was $200,000
and this is amortized over the five-month term of the note. The letter of intent
was terminated on June 16, 2008 and the Company repaid the note in full,
including approximately $29,000 of interest on July 7, 2008. The remaining
unamortized portion of the beneficial conversion feature in the amount of
$140,000 was expensed upon the repayment of the note.


F-22





14.
COMMITMENTS AND CONTINGENCIES





A summary
of annual minimum contractual obligations and commitments as of December 31,
2008 is as follows:





(amounts in $000’s)OperatingLicensing
                        
                        Leases
                        
                        Total2009
                        
                        $
                        418
                        
                        
                        $
                        75
                        
                        
                        $
                        4932010
                        
                        
                        -
                        
                        
                        
                        77
                        
                        
                        
                        772011
                        
                        
                        -
                        
                        
                        
                        6
                        
                        
                        
                        6Total
                        
                        $
                        418
                        
                        
                        $
                        158
                        
                        
                        $
                        576





Licensing and Marketing
Agreements





Our
licensing commitments primarily consist of obligations to holders of
intellectual property rights for use of their trademarks, copyrights, technology
or other intellectual property rights in the development of our products.
Licensing and marketing commitments expire at various times through October
2014. Certain of our licensing and marketing agreements also contain provisions
that would impose penalties if we fail to meet agreed upon software release
dates.





Lease
Commitments





Our
office facilities are occupied under non-cancelable operating leases expiring at
various times through January 2011. Rent expense amounted to $310,000 and
$235,000 for the year ending December 31, 2008 and the period from March 23,
2007 to December 31, 2007, respectively.





15.
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 will be 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, will 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, income (loss) before income taxes include the
following components (in $000's):


Period
      fromYear
      Ended
                  
                  
                  March
      23, 2007December
      31,
                  
                  
                  -
      December 31,2008
                  
                  
                  2007Pretax
      (loss):United
      States
                  
                  $
                  (23,196
                  )
                  
                  $
                  (10,303
                  )Foreign
                  
                  
                  (4,585
                  )
                  
                  
                  -$
                  (27,781
                  )
                  
                  $
                  (10,303
                  )





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.




F-23




The
components of income tax expense (benefit) are as follows (in
$000's):





Period
      fromYear
      Ended
                  
                  
                  March
      23, 2007December
      31,
                  
                  
                  -
      December 31,2008
                  
                  
                  2007Current:Federal
                  
                  $
                  -
                  
                  
                  $
                  -State
                  
                  
                  86
                  
                  
                  
                  -Foreign
                  
                  
                  -
                  
                  
                  
                  -Total
      Current
                  
                  
                  86
                  
                  
                  
                  -Deferred:Federal
                  
                  
                  (3,765
                  )
                  
                  
                  (46
                  )State
                  
                  
                  (1,017
                  )
                  
                  
                  (12
                  )Foreign
                  
                  
                  (1,390
                  )
                  
                  
                  -Total
      Deferred
                  
                  
                  (6,172
                  )
                  
                  
                  (58
                  )Total
                  
                  $
                  (6,086
                  )
                  
                  $
                  (58
                  )Income
      tax (benefit) allocated to:Continuing
      operations
                  
                  $
                  (4,696
                  )
                  
                  $
                  (58
                  )Discontinued
      operations
                  
                  
                  (1,390
                  )
                  
                  
                  -Total
                  
                  $
                  (6,086
                  )
                  
                  $
                  (58
                  )





No income
taxes were paid during the year ended December 31, 2008.





The
reconciliation of income tax expense (benefit) computed at the U.S. statutory
tax rates to income tax expense (benefit) is:





Period fromYear Ended
                  
                  
                  March 23, 2007December 31,
                  
                  
                  to December 31,2008
                  
                  
                  2007Tax
      at U.S. federal income tax rates
                  
                  
                  (34.0
                  )%
                  
                  
                  (34.0
                  )%State
      taxes, net of federal income tax benefit
                  
                  
                  (5.8
                  )
                  
                  
                  -Valuation
      allowance
                  
                  
                  7.0
                  
                  
                  
                  -Amount
      not subject to corporate income taxes
                  
                  
                  6.8
                  
                  
                  
                  33.7Impact
      of foreign tax rates and credits
                  
                  
                  1.1
                  
                  
                  
                  -Deferred
      taxes related to change in tax status
                  
                  
                  0.6
                  
                  
                  
                  -Nondeductible
      expenses and other
                  
                  
                  2.4
                  
                  
                  
                  (0.3
                  )(21.9
                  )%
                  
                  
                  (0.6
                  )%





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 are as follows (in
$000's):


F-24





December 31, 2008
                                    
                                    
                                    December 31, 2007Deferred tax assets:
                                    
                                    Current
                                    
                                    
                                    Long-term
                                    
                                    
                                    Current
                                    
                                    
                                    Long-termNet
      operating loss carryforwards
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    5,887
                                    
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    269Capital
      loss carryforwards
                                    
                                    
                                    -
                                    
                                    
                                    
                                    515
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -Allowance
      for doubtful accounts
                                    
                                    
                                    548
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    461
                                    
                                    
                                    
                                    -Inventory
      reserve
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    19
                                    
                                    
                                    
                                    -Bonuses
      payable
                                    
                                    
                                    461
                                    
                                    
                                    
                                    111
                                    
                                    
                                    
                                    714
                                    
                                    
                                    
                                    -Bonus
      and other accruals
                                    
                                    
                                    263
                                    
                                    
                                    
                                    74
                                    
                                    
                                    
                                    244
                                    
                                    
                                    
                                    -Non-qualified
      options
                                    
                                    
                                    -
                                    
                                    
                                    
                                    558
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -Gross
      deferred tax assets
                                    
                                    
                                    1,272
                                    
                                    
                                    
                                    7,145
                                    
                                    
                                    
                                    1,438
                                    
                                    
                                    
                                    269Valuation
      allowance
                                    
                                    
                                    (299
                                    )
                                    
                                    
                                    (1,800
                                    )
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -Net
      deferred tax assets
                                    
                                    
                                    973
                                    
                                    
                                    
                                    5,345
                                    
                                    
                                    
                                    1,438
                                    
                                    
                                    
                                    269Deferred
      tax liabilities:Property
      and equipment
                                    
                                    
                                    -
                                    
                                    
                                    
                                    (19
                                    )
                                    
                                    
                                    -
                                    
                                    
                                    
                                    (14
                                    )Intangibles
                                    
                                    
                                    -
                                    
                                    
                                    
                                    (5,831
                                    )
                                    
                                    
                                    -
                                    
                                    
                                    
                                    (6,475
                                    )Discount
      on notes
                                    
                                    
                                    (285
                                    )
                                    
                                    
                                    (183
                                    )
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -Total
      deferred tax liabilities
                                    
                                    
                                    (285
                                    )
                                    
                                    
                                    (6,033
                                    )
                                    
                                    
                                    -
                                    
                                    
                                    
                                    (6,489
                                    )Net
      deferred tax asset (liability)
                                    
                                    $
                                    688
                                    
                                    
                                    $
                                    (688
                                    )
                                    
                                    $
                                    1,438
                                    
                                    
                                    $
                                    (6,220
                                    )





The
Company has approximately $1.2 million of available capital loss carryforwards
which expire in 2013.  A valuation allowance of approximately $515,000
has been 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.  Additionally, a valuation allowance of approximately $1.6
million has been recognized to offset the net remaining deferred tax assets in
excess of deferred tax liabilities because we cannot reasonably project if and
when we will generate enough taxable income to utilize any of the deferred tax
asset.





As of
December 31, 2008, the Company has U.S. federal net operating loss (NOL)
carryforwards of approximately $13.1 million which will be available to offset
taxable U.S. income during the carryforward period and are expected to be fully
realized. The federal NOL will begin to expire in 2023. The Company has various
state net operating loss carryforwards of approximately $14.1 million which will
be available to offset taxable state income during the carryforward period. The
state NOL will also begin to expire in 2023.  The tax benefit of these
items is reflected in the above table of deferred tax assets and
liabilities.





16.
STOCKHOLDERS EQUITY AND STOCK-BASED COMPENSATION ARRANGEMENTS




Common
Stock





The
Company has authorized 75,000,000 shares of Common Stock, par value $0.001 and
5,000,000 preferred shares, par value $0.001. As of December 31, 2008, there are
38,243,937 common shares issued.




During
2008, the following activity transpired relating to the Company’s common
stock:





(Share
amounts in 000’s)


·
            Issued
      2,143 shares of common stock in connection with raising $6.4 million from
      a private placement offering from January 2008 to April 2008. We incurred
      costs of $317,000 in connection with the offering.·
            Issued
      1,581 shares of common stock as partial payment for the acquisition of Zoo
      Digital in April 2008.·
            Exchanged
      various promissory notes totaling $6.0 million into 5,973 shares of the
      Company’s common stock based on fair value.·
            Issued
      702 shares of the Company’s common stock to a consultant as compensation
      for consulting services provided to the Company valued at approximately
      $1.1 million.·
            Issued
      16 shares of the Company’s stock to an employee in lieu of a $25,000 cash
      bonus.·
            Combined
      the 26,098 shares of stock from Zoo Games shareholders with the 11,327
      existing shares of the Company’s common stock on September 12, 2008. The
      paid-in-capital amount relating to the 11.3 million existing shares was
      approximately $1.2 million.·
            Exercised
      818 warrants and issued 818 shares of the Company’s common
      stock


F-25


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.





There
were 2,352,676 options outstanding under the Zoo Games, Inc. 2008 Long-Term
Incentive Plan dated September 12, 2008 at the date of the reverse merger. No
additional awards may be granted from this plan and this plan was adopted by the
Company as part of the reverse merger.


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:





2008
                            
                            
                            2007Weighted
                            
                            
                            
                            
                            
                            WeightedAverage
                            
                            
                            
                            
                            
                            AverageNumber
      Of
                            
                            
                            Exercise
                            
                            
                            Number
      Of
                            
                            
                            ExerciseShares
                            
                            
                            Price
                            
                            
                            Shares
                            
                            
                            PriceOutstanding
      at beginning of period
                            
                            
                            243,040
                            
                            
                            $
                            2.58
                            
                            
                            
                            -
                            
                            
                            $
                            -Granted
                            
                            
                            2,109,636
                            
                            
                            $
                            1.67
                            
                            
                            
                            243,040
                            
                            
                            $
                            2.58Canceled
                            
                            
                            (16,125
                            )
                            
                            $
                            2.58
                            
                            
                            
                            -
                            
                            
                            
                            -Exercised
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -Outstanding
      at end of year
                            
                            
                            2,336,552
                            
                            
                            $
                            1.76
                            
                            
                            
                            243,040
                            
                            
                            $
                            2.58Options
      exercisable at year-end
                            
                            
                            1,915,155
                            
                            
                            $
                            1.65
                            
                            
                            
                            243,040
                            
                            
                            $
                            2.58Weighted-average
      fair value of options granted during the year
                            
                            
                            
                            
                            
                            $
                            0.59
                            
                            
                            
                            
                            
                            
                            $
                            1..46





The fair
value of options granted during the year was approximately $1.3
million.





The
following table summarizes information about outstanding stock options at
December 31, 2008:





OptionsOutstanding
                          
                          
                          OptionsExercisableWeighted-Average
                          
                          
                          Weighted-
                          
                          
                          
                          
                          
                          Weighted-Remaining
                          
                          
                          Average
                          
                          
                          
                          
                          
                          AverageRange of
                          
                          Number
                          
                          
                          Contractual
                          
                          
                          Exercise
                          
                          
                          Number
                          
                          
                          ExerciseExercisePrices
                          
                          Outstanding
                          
                          
                          Life(Years)
                          
                          
                          Price
                          
                          
                          Exercisable
                          
                          
                          Price$2.58
                          
                          
                          226,915
                          
                          
                          
                          4.5
                          
                          
                          $
                          2.58
                          
                          
                          
                          226,915
                          
                          
                          $
                          2.58$2.25
                          
                          
                          421,398
                          
                          
                          
                          4.7
                          
                          
                          $
                          2.25
                          
                          
                          
                          -
                          
                          
                          
                          -$1.52
                          
                          
                          1,688,240
                          
                          
                          
                          4.6
                          
                          
                          $
                          1.52
                          
                          
                          
                          1,688,240
                          
                          
                          $
                          1.52$1.52
      to $2.58
                          
                          
                          2,336,552
                          
                          
                          
                          4.6
                          
                          
                          $
                          1.76
                          
                          
                          
                          1,915,155
                          
                          
                          $
                          1.65





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





Weighted-AverageWeighted-Average
                      
                      
                      RemainingNumber
                      
                      
                      Fair
      Value at
                      
                      
                      Contractual
      LifeOutstanding
                      
                      
                      Grant Date
                      
                      
                      (Years)Non-Vested
      shares at December 31, 2007-
                      
                      
                      -Options
      Granted
                      
                      
                      421,398
                      
                      
                      $
                      2.25
                      
                      
                      
                      4.7Options
      Vested
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Options
      forfeited or expired
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Non-Vested
      shares at December 31, 2008
                      
                      
                      421,398
                      
                      
                      $
                      2.25
                      
                      
                      
                      4.7


F-26





As of
December 31, 2008, there was approximately $237,000 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 2.7
years.





The
intrinsic value of options outstanding at December 31, 2008 is $0.





Warrants





There are
6,502,159 warrants outstanding. All are currently exercisable and have a
five-year life:




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:





2008
                
                
                2007Weighted
                
                
                
                
                
                WeightedAverage
                
                
                
                
                
                AverageNumber
      Of
                
                Exercise
                
                
                Number
      Of
                
                
                ExerciseWarrants
                
                Price
                
                
                Warrants
                
                
                PriceOutstanding
      at beginning of period
                
                
                1,007,405
                
                
                $
                2.62
                
                
                
                -
                
                
                $
                -Granted
                
                
                1,994,753
                
                
                $
                1.03
                
                
                
                1,007,405
                
                
                $
                2.62Assumed
      with  reverse merger
                
                
                4,318,182
                
                
                $
                0.01
                
                
                
                -
                
                
                
                -Canceled
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -Exercised
                
                
                (818,181
                )
                
                $
                0.01
                
                
                
                -
                
                
                
                -Outstanding
      at end of year
                
                
                6,502,159
                
                
                $
                0.73
                
                
                
                1,007,405
                
                
                $
                2.62Warrants
      exercisable at year-end
                
                
                6,502,159
                
                
                $
                0.73
                
                
                
                1,007,405
                
                
                $
                2.62





The
following table summarizes information about outstanding warrants at
December 31, 2008:





Warrants
      OutstandingWeighted
      AverageRange
      of
                                                    
                                                    Number
                                                    
                                                    
                                                    Remaining
                                                    
                                                    
                                                    Weighted
      AverageExercise
      Prices
                                                    
                                                    Outstanding
                                                    
                                                    
                                                    Contractual Life (Years)
                                                    
                                                    
                                                    Exercise Price2007 Warrants issued$2.13
                                                    
                                                    
                                                    318,246
                                                    
                                                    
                                                    
                                                    3.9
                                                    
                                                    
                                                    $
                                                    2.13$2.84
                                                    
                                                    
                                                    689,159
                                                    
                                                    
                                                    
                                                    4.0
                                                    
                                                    
                                                    $
                                                    2.84$2.13
      to $2.84
                                                    
                                                    
                                                    1,007,405
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    $
                                                    2.622008 Warrants issued$2.84
                                                    
                                                    
                                                    722,027
                                                    
                                                    
                                                    
                                                    4.2
                                                    
                                                    
                                                    $
                                                    2.84$0.01
                                                    
                                                    
                                                    1,272,726
                                                    
                                                    
                                                    
                                                    4.7
                                                    
                                                    
                                                    $
                                                    0.01$0.01
      to $2.84
                                                    
                                                    
                                                    1,994,753
                                                    
                                                    
                                                    
                                                    4.5
                                                    
                                                    
                                                    $
                                                    1.03Assumed
      with reverse merger
                                                    
                                                    
                                                    4,318,182
                                                    
                                                    
                                                    
                                                    4.6
                                                    
                                                    
                                                    $
                                                    0.01Exercised
      in 2008
                                                    
                                                    
                                                    (818,181
                                                    )
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    $
                                                    0.01Outstanding
      December 31, 2008
                                                    
                                                    
                                                    6,502,159
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    
                                                    $
                                                    0.73




F-27




In
addition, during 2008, the following various other transactions occurred which
impacted the Company’s additional paid-in-capital:





·
            Prior to the conversion to a
      C-corporation in May 2008, the Company had issued membership common
      shares, incentive shares and incentive profit shares. Upon the conversion
      to a C-corporation, each common share and incentive share was converted to
      one share of common stock; each incentive profit share was converted to a
      combination of common stock and rights to receive options. We expensed the
      unamortized portion of the value of the incentive profit shares in May
      2008. The total amount of expense recorded for the year ended December 31,
      2008 relating to these incentive profit shares was
      $354,000.


·
            In May 2008, Zoo Games received a
      $2.0 million loan and issued a 10% convertible note. The beneficial
      conversion feature in this note was $200,000 and is recorded as additional
      paid-in-capital.





17.
INTEREST, NET




(amounts
      in $000’s)Year
      Ended
                  
                  
                  Mar
      23, 2007 -December 31, 2008
                  
                  
                  December 31, 2007Interest
      arising from amortization of debt discount
                  
                  $
                  3,562
                  
                  
                  $
                  236Interest
      on various notes
                  
                  
                  492
                  
                  
                  
                  94Interest
      on bridge notes
                  
                  
                  132
                  
                  
                  
                  843Other
                  
                  
                  -
                  
                  
                  
                  12Less:
      Interest income
                  
                  
                  (9
                  )
                  
                  
                  (39
                  )Net
      interest - all operations
                  
                  
                  4,177
                  
                  
                  
                  1,146Interest
      relating to discontinued operations
                  
                  
                  (539
                  )
                  
                  
                  (250
                  )Interest
      expense, net
                  
                  $
                  3,638
                  
                  
                  $
                  896




F-28





18.
SUPPLEMENTAL CASH FLOW INFORMATION




Supplemental
cash flow information for the year ended December 31, 2008 and the period from
March 23, 2007 to December 31, 2007 is as follows:




(amounts
      in $000’s)Year
      Ended
                          
                          
                          Mar
      23, 2007 -December 31, 2008
                          
                          
                          December 31, 2007Changes in other assets and liabilitiesAccounts
      receivable
                          
                          $
                          (516
                          )
                          
                          
                          136Inventory
                          
                          
                          (1,565
                          )
                          
                          
                          366Prepaid
      expenses and other current assets
                          
                          
                          645
                          
                          
                          
                          (1,017
                          )Product
      development costs
                          
                          
                          155
                          
                          
                          
                          (2,115
                          )Accounts
      payable
                          
                          
                          1,726
                          
                          
                          
                          (24
                          )Accrued
      expenses and other current liabilities
                          
                          
                          (736
                          )
                          
                          
                          1,281Net
      changes in other assets and liabilities
                          
                          $
                          (291
                          )
                          
                          
                          (1,373
                          )Cash
      paid during the period for interest
                          
                          $
                          56
                          
                          
                          $
                          12Cash
      paid during the period for taxes
                          
                          $
                          3
                          
                          
                          
                          -Non
      Cash Investing and Financing Activities:Issuance
      of 1,580,237 shares in connection with the acquisition of Zoo
      Digital
                          
                          $
                          4,086
                          
                          
                          
                          -Receipt
      of 351,171 shares in Treasury in connection with the sale of
      Supervillain
                          
                          $
                          527
                          
                          
                          
                          -Receipt
      of 1,886,205 shares in Treasury in connection with the sale of Zoo
      Digital
                          
                          $
                          2,829
                          
                          
                          
                          -Exchange
      of debt for equity at original face value
                          
                          $
                          5,950
                          
                          
                          
                          -Issuance
      of 1,053,513 shares for publishing rights
                          
                          $
                          -
                          
                          
                          $
                          1,470Issuance
      of 3,160,874 shares for partial payment for acquisition of Zoo
      Publishing
                          
                          $
                          -
                          
                          
                          $
                          8,173Issuance
      of 351,171 shares in connection with the acquisition of net
      assets of Supervillain
                          
                          $
                          -
                          
                          
                          $
                          490Issuance
      of 54,142 shares to a related party in satisfaction of rent
      obligation
                          
                          $
                          -
                          
                          
                          $
                          114





19.
LITIGATION





On  February
19, 2009, Susan Kain Jurgensen, Steven Newton, Mercy Gonzalez, Bruce Kain,
Wesley Kain, Raymond Piece and Christie Walsh filed a compliant 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 seeks compensatory damages, punitive damages and preliminary
and permanent injunctive relief, among other remedies.  An answer is due on
May 15, 2009.  We believe we have meritorious defenses and intend to
vigorously defend the matter.





Revolution
Partners, LLC and Zoo Games, Inc., JAMS Alternative Dispute Resolution Reference
Number 1400011786.  In this action, pending in the Boston, Massachusetts
office of JAMS Alternative Dispute Resolution, the Claimant Revolution Partners,
LLC is seeking money damages for a claimed investment banking or finder’s fee
purportedly earned in connection with a reverse merger transaction and related
financing that we entered into in the third quarter of 2008. We have denied
all material allegations and are vigorously defending the matter.  At this
time, discovery is ongoing.  The matter is scheduled for trial before an
arbitrator in July 2009.





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.





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 $234,000 during 2008 and $183,000 for the period from
April 2007 to December 2007 for this office.


F-29





Mark
Seremet, Chief Executive Officer of Zoo Games and a director of the Company,
received $549,000 in connection with the sale of a portion of his shares in
Cyoob, Inc to Zoo Games during 2007. This amount is included in general and
administrative expenses. The agreement entitled Mr. Seremet to receive an
additional $549,000 from Zoo Games for such shares; however this debt was
converted to Zoo Games equity. Of such amount, $647,000 was recorded as
compensation and included in general and administrative expenses in the 2007
Statement of Operations.





In July
2008, Mark Seremet, Chief Executive Officer of Zoo Games and a director of the
Company, received 750,000 options to purchase shares of the Company’s common
stock at an exercise price of $1.52, the fair value at the date of issuance
based on other third-party transactions at that time, to compensate him for a
providing a personal guaranty for the Company’s receivable factoring facility.
These options are immediately exercisable.





A few Zoo
Publishing employees loaned the Company an aggregate of up to $765,000 in 2008
on a short-tem basis. The employees were paid interest at a 4% rate and all
amounts are expected to be repaid in full. (See note 13.)





21.  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.  The insurance company for the warehouse is
expected to pay approximately $860,000 to the warehouse for the value of our
goods destroyed in the fire that exceeded the Company’s property
insurance.  If this is received, it will be used to offset $860,000 of
liabilities that the Company has to the warehouse and recorded as other income
at that time.




22. SUBSEQUENT
EVENTS





On
January 14, 2009, the Company’s Board of Directors approved and adopted an
amendment to the 2007 Employee, Director and Consultant Stock Plan (the “2007
Plan”). The Amendment increased the number of shares of common stock that
may be issued under the 2007 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 2007 Plan remain in full force
and effect.





On
January 14, 2009, Zoo Games entered into an employment agreement with Mark
Seremet, currently a director of the Company and President of Zoo Games,
pursuant to which Mr. Seremet also became Chief Executive Officer of Zoo
Games.  Mr. Seremet’s employment agreement is for a term of three
years, at an initial base salary of $325,000 per year. 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.





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.





Pursuant
to the Assignment Agreement, we 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 commitment fee in
the aggregate amount of $337,500, 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, 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.


F-30


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 and Chief Executive Officer of Zoo Games and a director of Zoo
Entertainment, and David Rosenbaum, the Senior Vice 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.


F-31