UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



FORM 10-Q



(Mark One)



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



For the quarterly period ended June 30, 2009



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



For the transition period from ___________________  to  _____________



Commission file number 000-25075



ARTIFICIAL LIFE, INC.

(Exact name of registrant as specified in its charter)



Delaware
        04-3253298(State of incorporation)
        (I.R.S. Employer Identification No.)




520 Broadway, Suite 350
            Santa Monica, CA 90401
            U.S.A.(Address of principal executive offices)




(310) 496-4288

(Issuers telephone number, including area code)



Not Applicable

(Former name, former address and former fiscal year,

if changed since last report)



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



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 during the preceding
12 months (or for such shorter period that the registrant was required to
submit and post such files). YesoNoo



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.



Large accelerated filero
        Accelerated filer
        o


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




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



Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:  As of July 31, 2009 there were 50,244,132 shares of Common Stock, $.01 par value per share, outstanding.



1   ARTIFICIAL LIFE, INC.



INDEX OF INFORMATION CONTAINED IN FORM 10-Q FOR THE

QUARTER ENDED JUNE 30, 2009




PAGE



PART I-FINANCIAL INFORMATION



Item 1  Financial Statements


Condensed Consolidated Balance Sheets as of June 30, 2009 (unaudited) and December 31, 2008
        3

Condensed Consolidated Statements of Operations and Comprehensive Income for the


Three Months and Six Months Ended June 30, 2009 and 2008 (unaudited)
        4

Condensed Consolidated Statements of Cash Flows for the Six Months Ended


June 30, 2009 and 2008 (unaudited)
        6






Notes to Condensed Consolidated Financial Statements (unaudited)
        7




Item 2  Managements Discussion and Analysis of Financial Condition and Results of Operations
        12




Item 3  Quantitative and Qualitative Disclosure About Market Risk
        19




Item 4  Controls and Procedures
        19






PART II - OTHER INFORMATION



Item 1  Legal Proceedings
        20




Item 1A  Risk Factors
        20




Item 2  Unregistered Sales of Equity Securities and Use of Proceeds
        20




Item 3  Defaults Upon Senior Securities
        20




Item 4  Submission of Matters to a Vote of Security Holders
        20




Item 5  Other Information
        20




Item 6  Exhibits
        20




Signatures
        21




2



---

PART I   FINANCIAL INFORMATION



ITEM 1.  FINANCIAL STATEMENTS



ARTIFICIAL LIFE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS





ASSETS


|                                                                                                                                                                                               |  |  |  | June 30, 2009 |             | December 31, 2008
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  |  | ------------- | ----------- | -----------------
|
|Current
assets:                                                                                                                                                                                |  |  |  |               |             |                  
|Cash                                                                                                                                                                                           |  |  |  | $             | 1,439,093   |                  
|Accounts
receivable, net                                                                                                                                                                       |  |  |  |               | 18,773,831  |                  
|Prepaid
expenses and other                                                                                                                                                                     |  |  |  |               | 471,661     |                  
|Deferred tax
asset                                                                                                                                                                             |  |  |  |               |            |                  
|Total current
assets                                                                                                                                                                           |  |  |  |               | 20,684,585  |                  
|                                                                                                                                                                                              
|Fixed assets,
net                                                                                                                                                                              |  |  |  |               | 3,069,557   |                  
|                                                                                                                                                                                              
|License
rights, net                                                                                                                                                                            |  |  |  |               | 14,968,150  |                  
|Prepaid
expenses, deposits and other assets                                                                                                                                                    |  |  |  |               | 1,497,828   |                  
|                                                                                                                                                                                               |  |  |  |               | 16,465,978  |                  
|TOTAL
ASSETS                                                                                                                                                                                   |  |  |  | $             | 40,220,120  |                  
|                                                                                                                                                                                              
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                          
|                                                                                                                                                                                              
|Accounts
payable                                                                                                                                                                               |  |  |  | $             | 2,498,716   |                  
|Accrued
expenses and other                                                                                                                                                                     |  |  |  |               | 620,903     |                  
|Income tax
payable                                                                                                                                                                             |  |  |  |               | 218,000     |                  
|Note payable
 officer/stockholder                                                                                                                                                             |  |  |  |               | 938,704     |                  
|Notes
payable                                                                                                                                                                                  |  |  |  |               | 1,000,000   |                  
|                                                                                                                                                                                              
|Total
liabilities (all current)                                                                                                                                                                |  |  |  |               | 5,276,323   |                  
|                                                                                                                                                                                              
|Stockholders equity:                                                                                                                                                                          |  |  |  |               |             |                  
|Preferred
stock, $.01 par value; 5,000,000 shares authorized, no shares issued and outstanding                                                                                                 |  |  |  |               |             |                  
|Common stock,
$.01 par value; 130,000,000 shares authorized, 50,244,132 shares issued and outstanding as of June 30, 2009 and 47,724,132 shares issued and
outstanding as of December 31, 2008 |  |  |  |               | 502,441     |                  
|Additional
paid-in capital                                                                                                                                                                     |  |  |  |               | 53,654,712  |                  
|Notes
receivable from stockholders                                                                                                                                                             |  |  |  |               | (19,577     | )                
|Accumulated
deficit                                                                                                                                                                            |  |  |  |               | (19,202,709 | )                
|Accumulated
other comprehensive income (loss)                                                                                                                                                  |  |  |  |               | 8,930       |                  
|Total
stockholders equity                                                                                                                                                                     |  |  |  |               | 34,943,797  |                  
|                                                                                                                                                                                               |  |  |  | $             | 40,220,120  |                  



See accompanying notes to unaudited condensed
consolidated financial statements.




3   ARTIFICIAL LIFE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME

(UNAUDITED)



Three-month Period EndedJune 30,
     
     Six-month Period EndedJune 30,2009
     
     2008
     
     2009
     
     2008Revenues:Software
license revenue
     
     
     
     $
     7,577,225
     
     
     $
     5,475,924
     
     
     $
     14,629,598
     
     
     $
     9,594,301Application
services and other revenue
     
     
     
     
     744
     
     
     
     5,546
     
     
     
     11,571
     
     
     
     12,1737,577,969
     
     
     
     5,481,470
     
     
     
     14,641,169
     
     
     
     9,606,474Cost of
revenues:Cost of
software license revenue
     
     
     
     
     1,090,980
     
     
     
     634,047
     
     
     
     1,817,250
     
     
     
     812,126Cost of
application services and other revenue
     
     
     
     
     6,627
     
     
     
     34,999
     
     
     
     21,769
     
     
     
     57,7201,097,607
     
     
     
     669,046
     
     
     
     1,839,019
     
     
     
     869,846Gross
Profit
     
     
     
     
     6,480,362
     
     
     
     4,812,424
     
     
     
     12,802,150
     
     
     
     8,736,628Operating
expenses:General and
administrative
     
     
     
     
     1,391,040
     
     
     
     581,860
     
     
     
     2,976,213
     
     
     
     1,028,792Research and
development
     
     
     
     
     924,311
     
     
     
     826,756
     
     
     
     1,782,637
     
     
     
     1,350,673Sales and
marketing
     
     
     
     
     1,040,908
     
     
     
     513,621
     
     
     
     1,532,528
     
     
     
     936,256Total
operating expenses
     
     
     
     
     3,356,259
     
     
     
     1,922,237
     
     
     
     6,291,378
     
     
     
     3,315,721Income from
operations
     
     
     
     
     3,124,103
     
     
     
     2,890,187
     
     
     
     6,510,772
     
     
     
     5,420,907Other income
(expenses):Interest
income and other
     
     
     
     
     109,483
     
     
     
     1,026
     
     
     
     109,503
     
     
     
     3,958Interest
expense
     
     
     
     
     (36,228
     )
     
     
     (15,556
     )
     
     
     (66,480
     )
     
     
     (98,061
     )Foreign
currency transaction (losses) gains
     
     
     
     
     (283,154
     )
     
     
     190,412
     
     
     
     (412,360
     )
     
     
     358,405(209,899
     )
     
     
     175,882
     
     
     
     (369,337
     )
     
     
     264,302Income before
income taxes
     
     
     
     
     2,914,204
     
     
     
     3,066,069
     
     
     
     6,141,435
     
     
     
     5,685,209Income tax
expense
     
     
     
     
     (143,000
     )
     
     
     (375,755
     )
     
     
     (658,000
     )
     
     
     (501,310
     )Net
income
     
     
     
     
     2,771,204
     
     
     
     2,690,314
     
     
     
     5,483,435
     
     
     
     5,183,899Foreign
currency translation adjustment
     
     
     
     
     231,696
     
     
     
     15,753
     
     
     
     139,018
     
     
     
     53,300Comprehensive
income
     
     
     
     $
     3,002,900
     
     
     $
     2,706,067
     
     
     $
     5,622,453
     
     
     $
     5,237,199

4



Net income
per shareBasic
     
     
     
     $
     0.06
     
     
     $
     0.06
     
     
     $
     0.11
     
     
     $
     0.11Diluted
     
     
     
     $
     0.06
     
     
     $
     0.05
     
     
     $
     0.11
     
     
     $
     0.11Weighted
average shares outstandingBasic
     
     
     
     
     48,397,539
     
     
     
     46,249,746
     
     
     
     48,062,696
     
     
     
     45,158,361Diluted
     
     
     
     
     48,421,914
     
     
     
     49,195,815
     
     
     
     48,220,370
     
     
     
     47,672,154
 See accompanying notes to unaudited condensed consolidated
financial statements.




5



ARTIFICIAL LIFE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)




Six-month Period Ended June 30,2009
     
     2008Cash flows
from operating activities:Net income
     
     
     
     
     $5,483,435
     
     
     
     $5,183,899Adjustments
to reconcile net income to net (cash used) provided by in operating activities:Depreciation
and amortization
     
     
     
     
     1,935,938
     
     
     
     986,686Deferred
income tax expense
     
     
     
     
     500,000
     
     
     
     60,355Amortization
of discount on notes payable
     
     
     
     
     
     
     
     
     33,000Provision for
losses on doubtful accounts receivable
     
     
     
     
     2,623,162
     
     
     
     2,469Foreign
currency transaction (gain) loss
     
     
     
     
     412,360
     
     
     
     (358,405
     )Interest
expense accrued on notes payable officer / stockholder
     
     
     
     
     14,285
     
     
     
     7,727Salary
accrued to officer / stockholder
     
     
     
     
     175,395
     
     
     
     20,361Changes in
operating assets and liabilities:Increase in
restricted cash
     
     
     
     
     
     
     
     
     (165,000
     )Increase in
accounts receivable
     
     
     
     
     (13,981,178
     )
     
     
     (1,015,072
     )Increase in
prepaid expenses, deposits, and other assets
     
     
     
     
     (226,174
     )
     
     
     (1,026,802
     )Increase (decrease) in
accounts payable, accrued expenses and other
     
     
     
     
     1,573,791
     
     
     
     (815,576
     )Increase in
income tax payable
     
     
     
     
     158,000
     
     
     
     441,675Net cash
(used in) provided by operating activities
     
     
     
     
     (1,330,986
     )
     
     
     3,355,317Cash flows
from investing activities:Purchase of
fixed assets
     
     
     
     
     (45,879
     )
     
     
     (1,810,404
     )Purchase of
license rights
     
     
     
     
     (254,180
     )
     
     
     (4,647,761
     )Deposits on
fixed assets
     
     
     
     
     
     
     
     
     (2,871,800
     )Net cash used
in investing activities
     
     
     
     
     (300,059
     )
     
     
     (9,329,965
     )Cash flows
from financing activities:Net proceeds
from issuance of common stock
     
     
     
     
     1,905,200
     
     
     
     5,241,002Advances under
note payable to officer / stockholder
     
     
     
     
     202,257
     
     
     
     Repayment of
note payable to officer / stockholder
     
     
     
     
     (191,004
     )
     
     
     (288,808
     )Net cash
provided by financing activities
     
     
     
     
     1,916,453
     
     
     
     4,952,194Net increase
(decrease) in cash
     
     
     
     
     285,408
     
     
     
     (1,022,454
     )Cash,
beginning of period
     
     
     
     
     1,430,578
     
     
     
     6,210,435Effect of
exchange rate changes on cash
     
     
     
     
     (276,893
     )
     
     
     (812
     )Cash, end of
period
     
     
     
     $
     1,439,093
     
     
     $
     5,187,169Supplemental
disclosure of non-cash investing activity:Purchase of
license rights and related increase in accounts payable
     
     
     
     $
     6,443,500
     
     
     $
     Issuance of
common stock and warrants in satisfaction of accounts payable
     
     
     
     $
     66,000
     
     
     $
     
 See accompanying notes to unaudited condensed consolidated
financial statements.




6



ARTIFICIAL LIFE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)





1.
        BASIS OF PRESENTATION



The accompanying unaudited condensed consolidated financial statements of Artificial Life, Inc. (the Company) have been prepared in accordance with generally accepted accounting principles in the United States of America for interim financial information and in accordance with the instructions to Form 10-Q and Regulation S-X.  Accordingly, they do not include all information and footnotes required by generally accepted accounting principles for a complete financial statement presentation.  The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, as follows:



Artificial Life Asia Limited,located in Hong Kong, supports Artificial Life in its customer service and game development.



Artificial Life Europe GmbH, located in Berlin, Germany; formed in January 2007 to concentrate on customer service and support activities of sales and marketing expansion in European, Middle Eastern and African (EMEA) markets.



Artificial Life Japan Ltd., located in Tokyo, Japan; acquired by the Company in July 2007 for support activities of sales and marketing expansion in Japanese markets.



Artificial Life America, Inc., located in Los Angeles, California; formed in August 2008 to support U.S. customers and focus on design and creative direction for game development.



Artificial Life Ventures, Inc., Artificial Life USA, Inc., and Artificial Life Mobile Computing, Inc.,all non-operating, inactive subsidiaries in 2009 and 2008.



All significant inter-company balances and transactions have been eliminated in consolidation.



Operating results for the six months ended June 30, 2009, are not necessarily indicative of results that may be expected for the year ending December 31, 2009.  Amounts at December 31, 2008, are derived from the Companys audited consolidated financial statements.  For further information, refer to the audited consolidated financial statements and notes thereto included in the Companys annual Report on Form 10-K for the year ended December 31, 2008.



The financial information included in this report has been prepared in conformity with the accounting policies reflected in the financial statements included in the Companys Annual Report on Form 10-K filed with the Securities and Exchange Commission.



Recently issued and adopted accounting standards



On January 1, 2008, the
Company adopted Statement of Financial Accounting Standards (SFAS)
No. 157,Fair Value Measurements.
SFAS No. 157 established a framework for measuring the fair value of assets and
liabilities. This framework is intended to provide increased consistency in how
fair value determinations are made under various existing accounting standards
which permit, or in some cases require, estimates of fair market value. SFAS No.
157 also expands financial statement disclosure requirements about a
companys use of fair value measurements, including the effect of such
measures on earnings. In February 2008, the FASB issued Staff Position FAS
157-2, which delayed the effective date of SFAS 157 for nonfinancial assets and
nonfinancial liabilities, except for items that are recognized or disclosed at
fair value in the financial statements on a recurring basis (at least annually).
The Company adopted Staff Position FAS 157-2 on January 1, 2009. At June 30,
2009, the Company had no financial assets or liabilities subject to recurring
fair value measurements.

SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities, allows entities to voluntarily choose to measure certain financial assets and liabilities at fair value (fair value option). The fair value option may be elected on an instrument-by-instrument basis and is irrevocable, unless a new election date occurs. If the fair value option is elected for an instrument, SFAS No. 159 specifies that unrealized gains and losses for that instrument be reported in earnings at each subsequent reporting date. The Company did not elect to apply the fair value option to any outstanding instruments.



7



In April 2009, the FASB issued FSP SFAS No. 107-1 and Accounting
Principles Board Opinion (APB) 28-1,Interim
Disclosures about Fair Value of Financial Instruments,
(FSP 107-1), which requires that the fair value disclosures required for all
financial instruments within the scope of SFAS No. 107,Disclosures about Fair Value of Financial Instruments, be included in interim financial statements. This FSP also requires
entities to disclose the method and significant assumptions used to estimate the
fair value of financial instruments on an interim and annual basis and to
highlight any changes from prior periods. FSP 107-1 is effective for
interim period ending after June 15, 2009. The adoption of FSP 107-1 did not
have a material impact on the Companys consolidated financial statements.

In June 2009, the FASB approved its Accounting Standards Codification (Codification) as the single source of authoritative United States accounting and reporting standards applicable for all non-governmental entities, with the exception of the SEC and its staff. The Codification, which changes the referencing of financial standards, is effective for interim or annual financial periods ending after September 15, 2009. Therefore, in the third quarter of fiscal year 2009, all references made to US GAAP will use the new Codification numbering system prescribed by the FASB. As the Codification is not intended to change or alter existing US GAAP, it is not expected to have any impact on the Companys consolidated financial position or results of operations.

On January 1, 2009, the Company adopted SFAS No. 141(Revised 2007),Business Combinations,(SFAS No. 141R). SFAS No. 141R provides revised guidance on how acquirers recognize and measure the consideration transferred, identifiable assets acquired, liabilities assumed, noncontrolling interests, and goodwill acquired in a business combination. SFAS No. 141R also expands required disclosures surrounding the nature and financial effects of business combinations. Management believes that the adoption of SFAS 141R will have an impact on the accounting for any future acquisition, if one were to occur. The Company is required to apply the guidance in SFAS 141R for any future business combinations.

On January 1, 2009, the Company adopted SFAS No. 160,Noncontrolling Interests in Consolidated Financial Statements. SFAS No. 160 establishes accounting and reporting standards for a noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It 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. Because all of the Companys subsidiaries are wholly-owned by the Company, there are no noncontrolling interests, and as a result, the adoption of this standard had no effect on the Companys consolidated financial statements.

On January 1, 2009, the Company adopted SFAS No. 161,Disclosures about Derivative Instruments and Hedging Activities an amendment of FASB Statement No.133. SFAS No. 161 requires enhanced disclosures about the Companys derivative and hedging activities. The adoption of SFAS 161 did not have an impact on the Companys financial statements.



On January 1, 2009, the Company adopted the provisions of Emerging Issues Task Force (EITF) 07-05,Determining whether an Instrument (or Embedded Feature) Is Indexed to an Entitys Own Stock, which provides guidance on determining what types of instruments or embedded features in an instrument held by a reporting entity can be considered indexed to its own stock for the purpose of evaluating the first criteria of the scope exception in paragraph 11(a) of SFAS 133.  The adoption of this EITF required the Company to perform additional analysis on its free standing equity instruments; however, it did not have an impact on the Companys consolidated financial statements.



Reclassifications:



Certain amounts reported in the 2008 interim financial statements have been reclassified to conform to the 2009 presentation.



8

2.
        STOCK BASED COMPENSATION





At January 1, 2009, all outstanding options and warrants issued to employees were fully vested and exercisable.  There were no stock options granted during the six-month periods ended June 30, 2009 and 2008.  At June 30, 2009, the Company had outstanding options to purchase 2,065,000 shares of common stock under its stock option plan, issued to employees as follows:




Weighted average exercise price
        $0.88



Aggregate intrinsic value
        $139,350



Weighted average remaining contractual term
        0.49 year



At June 30, 2009, the Company had outstanding warrants to purchase 700,000 shares of common stock issued to employees as follows:




Weighted average exercise price
        $0.83



Aggregate intrinsic value
        $42,000



Weighted average remaining contractual term
        0.43 year




3.
        CUSTOMER CONCENTRATION



Financial instruments that
potentially subject the Company to concentrations of credit risk consist
primarily of trade accounts receivable. The Company extends credit to its
customers in the normal course of business and generally does not require
collateral. Due to the global financial
crisis and general market conditions, in 2009 the Company has granted extended payment terms (up to 180 days) to
certain customers. The Company assesses the
probability of collection from each customer at the outset of the arrangement
based on a number of factors, including the customers payment history and
its current creditworthiness. If in managements judgment collection is not probable, the Company does not record revenue until the uncertainty
is removed.

Management performs ongoing
credit evaluations, and the Company maintains an allowance for potential credit
losses based upon its loss history and its aging analysis. The allowance for
doubtful accounts of $3,354,450 at June 30, 2009, and $731,500 at December 31,
2008, is the Companys best estimate of the amount of probable credit
losses in existing accounts receivable. Management reviews the allowance
for doubtful accounts each reporting period based on a detailed analysis of
accounts receivable. In the analysis, management primarily considers the age of
the customers receivable and also considers the creditworthiness of the
customer, the economic conditions of the customers industry, the general
economic conditions and trends and the business relationship and history with
its clients among other factors. If any of these factors change, the Company may
also change its original estimates, which could impact the level of the
Companys future allowance for doubtful accounts. If judgments regarding
the collectability of accounts receivable were incorrect, adjustments to the
allowance may be required, which would reduce profitability.Since the Companys accounts receivable are often
concentrated in a relatively few number of customers, a significant change in
the liquidity or financial position of any one of these customers could have a
material adverse effect on the Companys financial
statements. During the six months ended June 30, 2009, the Company entered into agreements with certain of its customers to offset accounts receivable of approximately $6.4 million from these customers with accounts payable for the same amount to these customers. The offset of these receivables and payables represents a legal right of setoff and has been accounted for in accordance with the provisions of FASB Interpretation No. ("FIN") 39.

At June 30, 2009, the
Company had 95 telecom carriers, resellers, distributors and general corporate
customers compared to 70 such customers at December 31, 2008 and 52 such
customers at June 30, 2008. For the three-month and six-month periods ended June
30, 2009, resellers and distributors represented approximately 62% of the
Companys revenues.

For the three-month period
ended June 30, 2009, the Company had two customers that represented
approximately 60% and 37% of the Companys revenues, respectively. For the
three-month period ended June 30, 2008, the Company had two customers that
represented approximately 55% and 42% of the Companys revenues,
respectively. For the six-month period ended June 30, 2009, the Company had
three customers that represented
approximately 61%, 19% and 17% of the Companys revenues, respectively. For
the six-month period ended June 30, 2008, the Company had three customers that
represented approximately 61%, 24% and 11% of the Companys revenues,
respectively.

At June 30, 2009, accounts
receivable were due from 56 customers. Of these, three customers accounted for
approximately 72%, 13% and 9% of the accounts receivable, respectively. At June
30, 2009, 34% and 55% of accounts receivable were aged within 30 days and 60
days, respectively. At June 30, 2009, the average age of accounts receivable
from all customers was 104 days as compared to 83 days at December 31, 2008. The
average age of receivables from the Companys three largest customers at
June 30, 2009 was 135 days.



9



4.
        NET INCOME PER SHARE




Basic netincome per share is
calculated based on the weighted average number of common shares outstanding for
the three and six month periods ended June 30, 2009 and 2008. Diluted earnings
per share reflects additional common shares that would have been outstanding if
dilutive potential common shares had been issued, as well as any adjustment to
income that would result from the assumed issuance. Potential common shares that
may be issued by the Company relate to outstanding stock options and warrants,
and are determined using the treasury stock method. The following table sets
forth the computation of fully diluted shares for the three months and six
months ended June 30, 2009 and 2008.



Threemonth Period EndedJune 30
     Sixmonth Period EndedJune 302009
     
     
     
     2008
     
     
     
     2009
     
     
     
     2008Shares used
in basic per share calculation
     
     
     
     
     48,397,539
     
     
     
     46,249,746
     
     
     
     48,062,696
     
     
     
     45,158,361Effect of
dilutive securities:Options
     
     
     
     
     24,375
     
     
     
     1,381,581
     
     
     
     93,488
     
     
     
     1,251,495Warrants
     
     
     
     
     
     
     
     
     1,564,488
     
     
     
     64,186
     
     
     
     1,262,298Shares used
in dilutive per share calculation
     
     
     
     
     48,421,914
     
     
     
     49,195,815
     
     
     
     48,220,370
     
     
     
     47,672,154
 


5.
        INCOME TAXES



The difference between the expected and effective income tax expense
recorded for the six-month periods ended June 30, 2009 and 2008, is due
primarily to changes in the valuation allowance on net deferred tax assets.



At June 30, 2009, the Companys deferred tax asset which has been
fully allowed for, primarily consists of net operating loss carryforwards. The
recognition of this net deferred tax asset is based on the Companys
analysis of past, current and projected financial results of the Companys
operations. Based on this analysis, management does not believe that as of June
30, 2009, it is more likely than not that the asset can be realized. If
future taxable income exceeds the level that has been assumed in calculating the
deferred tax asset, the valuation allowance could be reduced with a
corresponding credit to income.



At June 30, 2009, the Company has recorded a current income tax payable
of $218,000, which consists of estimated state income taxes and U.S. federal
alternative minimum tax.




6.
        CONTINGENCIES



From time to time, legal proceedings or disputes arise in the normal course of business. The Company monitors and reviews these matters and maintains accruals where appropriate.



In September 2008, an action was brought against Artificial Life Europe GmbH in Germany in a contractual dispute, in which a claim of approximately $375,000 was made against the Company.  A court hearing is scheduled for September 2009 before the State Court in Berlin. The Company intends to contest this claim and defend itself vigorously, including the filing of available counterclaims.  While the Company cannot predict the outcome of the matter, the Company believes that the final outcome of this matter will not have a material adverse impact on its financial position or results of operation.



10



7.
        NOTES PAYABLE



Related party note payable:



The Company has a revolving
note payable to its chief executive officer for advances made by him to the
Company, as well as deferred salary and bonus. The note bears interest at 5%,
and is repayable upon demand. On August 10 2009, the Board of Directors of the
Company approved a loan agreement that was executed by the Company and the chief
executive officer under which the note payable is secured by the assets of the
Company. Activity on the note payable to the chief executive officer during the
six months ended June 30, 2009 and 2008, was as follows:



2009
     
     2008Beginning
balance, January 1
     
     
     
     $
     737,771
     
     
     $
     751,860Advances
     
     
     
     
     202,257
     
     
     
     Repayments
     
     
     
     
     (191,004
     )
     
     
     (288,808
     )Accrued
salary and bonus
     
     
     
     
     175,395
     
     
     
     20,361Accrued
interest
     
     
     
     
     14,285
     
     
     
     7,727Ending
balance, June 30
     
     
     
     $
     938,704
     
     
     $
     491,140
 

Other notes:



The Company has promissory
notes payable to two non-related party stockholders for an aggregate principal
amount of $1,000,000. These notes are unsecured, bear an annual interest rate of
10%, and matured on December 31, 2008. The notes are due on demand, and the
holders may convert the notes and any unpaid interest accumulated thereon into
shares of common stock at a conversion price of $2.50 per share. The Company
determined that the notes did not have any beneficial conversion feature, as the
conversion exercise price exceeded the market price of the Companys common
stock.




8.
        STOCKHOLDERS EQUITY



During the quarter ended
June 30, 2009, the Company issued 2,520,000 shares of common stock along with
warrants to purchase an additional 1,545,000 shares of common stock for cash of $1,905,200. As part of this placement, one party received 100,000 shares and warrants to purchase 100,000 shares in satisfaction of $66,000 of accounts payable. The private placement offering was made to seven
institutional and two individual accredited investors. In connection with the
private placement offering, the Company retained a selling agent to whom it paid
a commission of $33,000.  The issuance of the common stock and warrants are
exempt from the registration requirements of the Securities Act of 1933, as
amended.  The warrants have a two-year term with exercise prices ranging
from $0.80 to $1.25 per share and are immediately exercisable.




9.
        FAIR VALUE MEASUREMENTS



SFAS No. 157 defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which the Company would transact, and considers assumptions that market participants would use when pricing the asset or liability, such as inherent risk, transfer restrictions, and risk of non performance.



SFAS No. 157 establishes a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. A financial instruments categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. SFAS No. 157 establishes three levels of inputs that may be used to measure fair value:



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



Level 2 Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities, quoted prices in markets with insufficient volume or infrequent transactions (less active markets), or model-derived valuations in which all significant inputs are observable or can be derived principally from or corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (supported by little or no market activity).

At June 30, 2009, the Company has no financial assets or liabilities subject to recurring fair value measurements.



The Company's financial instruments include cash, accounts receivable, accounts payable, and notes payable. Management estimates that the carrying amounts of the non-related party financial instruments approximate their fair values due to their short-term nature. The fair value of the related party notes payable is not practical to estimate due to the related party nature of the underlying transactions.



11


10.
        SUBSEQUENT EVENTS




The Company evaluated events
through August 11, 2009 for consideration as a subsequent event to be
included in its June 30, 2009 Financial Statements issued August 12,
2009.



ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



General



The following Management's
Discussion and Analysis is intended to help the reader understand our results of
operations and financial condition and is provided as a supplement to, and
should be read in conjunction with our financial statements and the related
notes included elsewhere in this Quarterly Report on Form 10-Q. This discussion
contains, in addition to historical statements, forward-looking statements that
involve risks and uncertainties. Our actual future results could differ
significantly from the results discussed in the forward-looking statements.
Factors that could cause or contribute to such differences include, but are not
limited to, the factors discussed in the section titled "Risk Factors" in our
Annual Report on Form 10-K for the year ended December 31, 2008. Any
forward-looking statement speaks only as of the date on which such statement is
made and we do not intend to update any such forward-looking statements.



Overview



In the second quarter of 2009, we sold over 4,593,000 of our mobile 3G and Java games globally, primarily to resellers, aggregators and hand set manufacturers.  The sales include one time downloads, end user subscriptions via operator decks, off-deck sales, bulk reseller packages and pre-installation licenses for cell phones.



However, the focus of the Company since the end of 2008 has been on the development, sales and launch of iPhone and iPOD Touch games (referred to collectively as iPhone games).  From December 2008 through July 2009, the Company has successfully developed and released the following nine iPhone games:



Amateur Surgeon (with Cartoon Networks),

SHOOTER (with Paramount),

BMW Expression of Joy Z4 LITE,

BMW Experience Z4,

RED BULL Air Race LITE,

RED BULL Air Race World Championship,

iDroids,

iSoccer Backstreet and

VERMINATOR



These iPhone games have been downloaded an aggregate of more than 1.7 million times, and four games have been at one time within the top 10 most downloaded games in the United States and/or in many other countries around the globe on the Apple App Store platform.



In April 2009, we signed a license agreement with the renowned German soccer club, VfB Stuttgart to launch a soccer title VfB  The Official Mobile Game for mobile devices.  The game is tentatively scheduled for release in the third quarter of 2009, around the start of the new 2009/2010 soccer season.



In April 2009, we signed an agreement with Starz Media to launch an iPhone game inspired by the upcoming horror movie Pandorum, from Overture Films.  The game is tentatively scheduled for release in the third quarter of 2009 just prior to the films debut in theaters globally.



In April and May 2009, we launched the RED BULL Air Race World Championship Lite and Full Versions, the first official air race motor sport games for the iPhone and iPod touch platform.



In April 2009, we signed a three-year license agreement with multi-platinum two-time, Grammy-winning rock band Linkin Park and Warner Brothers Records to launch a social community based music game featuring Linkin Parks music on the iPhone and iPod touch platform.  The first launch is tentatively scheduled for the fourth quarter of 2009.



In May 2009, we launched the iDroidsMania, our first branded game offered in the Apple App Store.  The game has been launched as a full version and a free lite version containing the first two levels as a trial.



12


In May 2009, we started
working as a subcontractor for China Telecom, one of the three Chinese telecom
operators that have recently been awarded a 3G license from the Chinese
government.  We are working with China Telecom in Hunan to set up the 3G
WAP content and sales platform. After the successful launch in Hunan, we intend
to expand our service coverage and product sales with a wide variety of premium
3G mobile entertainment products and services to more provinces and cities in
China and other telecommunication companies.



In May 2009, we launched the BMW Z4 Experience iPhone game for the new BMW Z4 Roadster.



In June 2009, we launched iSoccer Backstreet, our first 3D soccer game.



In June 2009, we launched the VERMINATOR, our own branded iPhone game.



During the six months ended June 30, 2009, we continued to market and expand the distribution of our products in Europe, Asia and the United States by entering into various strategic relationships. Our products are now sold in over 100 countries through resellers and telecom partners and in over 65 countries through Apples App Store/iTunes distribution platform.



In addition to marketing our current products, we continue to focus on developing more new iPhone/iPod Touch and Smart Phone products, such as real time 3D/3G games and massive multi-player mobile games. We are also in ongoing talks with global media and major global brands to license additional appealing content and intellectual property.



Even though several of our new products and services have successfully been launched in several countries, there can be no guarantee that these new products and services will contribute substantially to our future revenues or will continue to be successful.



As of June 30, 2009, we had
total assets of $40,220,120 and total liabilities of $5,276,323. As of June 30,
2009, current assets were $20,684,585 as compared to $16,704,265 at December 31,
2008, and current liabilities were $5,276,323 as compared to $2,940,329 at
December 31, 2008.



We had 59 full time employees as of June 30, 2009. We also hire temporary staff, external consultants and interns to support our operations.



As we are still in the early
phase of the global roll out of our key mobile products in several countries
around the world, results of operations to date may not be indicative of our
future results of operations. Moreover, we expect to experience significant
fluctuations in our future operating results due to a variety of factors
including the speed of the expansion of the 3G mobile markets, the general
market acceptance of our products, our ability to sell and license our third
party intellectual property, the increasing diversity and number of mobile phone
handset types, the amount of software consulting we undertake in the future, our
success in creating and entering into strategic alliances, our mix of product
and service sales, our response to competitive pressure, our ability to attract
and retain qualified personnel, and our ability to execute our business strategy
in the Asian, European and American markets. Gross profit margins will vary from
product to product between products and services and among the countries in
which our products are sold. In addition, our sales mix may vary from period to
period and our gross margins will fluctuate accordingly.



In addition, the stability of our earnings is also heavily influenced by macroeconomic factors. As the economy improves or worsens, our business may be similarly impacted. Macroeconomic factors, such as the current conditions in the debt markets, have impacted and will continue to impact our business. At this time, we view the direction of the economy to be uncertain, which does not allow us a high degree of certainty in predicting our earnings.





13


Results of Operations



Three months ended June 30, 2009 Compared to three months ended June 30, 2008



REVENUES:  Revenues for the quarter ended June 30, 2009 were $7,577,969 as compared to $5,481,470 for the quarter ended June 30, 2008.  The increase in revenues of $2,096,499 or 38% was mainly due to increased (a) product license revenue from mobile games, one-time downloads, (b) monthly subscription revenues for 3G games derived from mobile operators, bulk resellers and hand set distributors and (c) license revenues from the sale of our technology platform Mobile Booster.



COST OF REVENUES: Cost of
revenues mainly consisted of amortization of intangible assets. Cost of revenues
for the quarter ended June 30, 2009 was $1,097,607 as compared to $669,046 for
the quarter ended June 30, 2008. The increase of $428,561, or 64%, was primarily
due to the amortization of license rights.



GROSS MARGIN: Gross margin
for the quarter ended June 30, 2009 was $6,480,362 as compared to $4,812,424 for
the quarter ended June 30, 2008. The increase of $1,667,938, or 35%, was mainly
due to increased product license income from mobile games, one-time downloads
and monthly subscription revenues for 3G games derived from mobile operators,
bulk resellers and hand set distributors and a global license deal for the sale
of our technology platform offset by amortization of license rights acquired in
earlier periods.



GENERAL AND ADMINISTRATIVE:
General and administrative expenses consisted of salaries of administrative
personnel, rent, professional fees and costs associated with employee benefits,
supplies, communications, travel and the provision for doubtful accounts
receivable. General and administrative expenses for the quarter ended June 30,
2009 were $1,391,040 as compared to $581,860 for the quarter ended June 30,
2008. The increase of $809,180 was mainly due to a 2009 provision for doubtful
accounts receivable, off-set by a decrease in expenses related to public
relations and professional services.



SALES AND MARKETING: Sales
and marketing expenses consisted of salaries of sales and marketing personnel
and costs relating to marketing materials, advertising, trade shows, traveling
and public relations activities. Sales and marketing expenses for the quarter
ended June 30, 2009 were $1,040,908 as compared to $513,621 for the quarter
ended June 30, 2008. The increase of $527,287 was primarily due to an increased
allowance for doubtful accounts, partially offset by a decrease in expenses
related to marketing and sub-contracting expenses.



RESEARCH & DEVELOPMENT:
Research and development expenses consisted of salary, training, consulting,
subcontracting and other expenses incurred to develop and fulfill the design
specifications and production of the products and services from which we derive
our revenues. Research and development expenses for the quarter ended June 30,
2009 were $924,311 as compared to $826,756 for the quarter ended June 30, 2008.
The increase of $97,555 was mainly due to the increase in consulting
expenses.



OTHER EXPENSE/INCOME: Other
expenses for the quarter ended June 30, 2009 totaled $209,899, as compared to
other income of $175,882 for the quarter ended June 30, 2008. The other expenses
of $209,899 were mainly due to income of $109,483, interest expense of $36,228
and foreign currency transaction losses of approximately $283,154 in this
quarter compared to a gain of approximately $190,000 (primarily resulting from
foreign currency transaction gains) in the second quarter of 2008.



INCOME FROM OPERATIONS AND
NET INCOME: Income from operations for the quarter ended June 30, 2009 was
$3,124,103 as compared to income from operations of $2,890,187 for the quarter
ended June 30, 2008. Income from operations was mainly due to revenue of
$7,577,969 from the sale of product licenses for our mobile games and technology
licenses, which was offset by costs of revenue of $1,097,607 and operational
costs of $3,356,259. Net income for the quarter ended June 30, 2009 was
$2,771,204, compared to net income of $2,690,314 for the quarter ended June 30,
2008. Basic and diluted net income per share for the second quarter of 2009 was
$0.06, as compared to $0.06 and $0.05, respectively, for the quarter ended June
30, 2008.



14


Six Months Ended June 30, 2009 Compared with Six Months Ended June 30,2008



REVENUES:  Revenues for the six months ended June 30, 2009 were $14,641,169 as compared to $9,606,474 for the six months ended June 30, 2008.  The increase of revenues of $5,034,695 or 52% was mainly due to increased (a) product license revenue from mobile game one-time downloads, (b) monthly subscription revenues for 3G games derived from mobile operators, bulk resellers and hand set distributors and (c) license revenues from the sale of our technology platform Mobile Booster.



COST OF REVENUES:  Cost of revenues mainly consist of amortization of intangible assets.  Cost of revenues for the six month ended June 30, 2009 was $1,839,019 as compared to $869,846 for the six months ended June 30, 2008. The increase of $969,173, or 111%, was primarily due to the amortization of license rights.



GROSS MARGIN:  Gross margin for the six month ended June 30, 2009 was $12,802,150 as compared to $8,736,628 for the six months ended June 30, 2008.  The increase of $4,065,522, or 47%, was mainly due to increased product license income from mobile games, one-time downloads and monthly subscription revenues for 3G games derived from mobile operators, bulk resellers and hand set distributors and a global license deal for the sale of our technology platform, offset by amortization of license rights acquired in earlier periods.



GENERAL AND ADMINISTRATIVE:  General and administrative expenses consisted of salaries of administrative personnel, rent, professional fees and costs associated with employee benefits, supplies, communications, travel and the provision for doubtful accounts receivable. General and administrative expenses for the six months ended June 30, 2009 were $2,976,213 as compared to $1,028,792 for the six months ended June 30, 2008. The increase of $1,947,421 was mainly due to a 2009 provision for doubtful accounts receivable of approximately $2.1 million, offset by a decrease in expenses related to public relations and professional services.



SALES AND MARKETING:  Sales and marketing expenses consisted of salary expenses for sales and marketing personnel and costs relating to marketing materials, advertising, trade shows, traveling and public relations activities. Sales and marketing expenses for the six months ended June 30, 2009 were $1,532,528 as compared to $936,256 for the six months ended June 30, 2008. The increase of $596,272 was primarily due to increased allowances for doubtful accounts.



RESEARCH & DEVELOPMENT:  Research and development expenses consisted of salary, training, consulting, subcontracting and other expenses incurred to develop and fulfill the design specifications and production of the products and services from which we derive our revenues.  Research and development expenses for the six months ended June 30, 2009 were $1,782,637 as compared to $1,350,673 for the six months ended June 30, 2008. The increase of $431,964 was mainly due to increased consulting and telecommunication expenses.



OTHER EXPENSE/INCOME:  Other expenses for the six months ended June 30, 2009 totaled $369,337, as compared to other income of $264,302 for the six months ended June 30, 2008.  The other expenses of $369,337 were mainly due to interest income of $109,503, interest expense of $66,480 and foreign currency transaction losses of approximately $412,360 for the six months ended June 30, 2009 comparing to a gain of approximately $358,000 (primarily resulting from foreign currency transaction gains) for the six months ended June 30, 2008.



INCOME FROM OPERATIONS AND
NET INCOME: Income from operations for the six months ended June 30, 2009 was
$6,510,772 as compared to income from operations of $5,420,907 for the six
months ended June 30, 2008. Income from operations is mainly due to revenue of
$14,641,169 from the sale of product licenses for our mobile games, one-time
downloads and monthly subscription revenues for 3G games and technology
licenses, offset by costs of revenue of $1,839,019 and operational costs of
$6,291,378. Net income for the six months ended June 30, 2009 was $5,483,435 as
compared to net income of $5,183,899 for the six months ended June 30, 2008.
Basic and diluted net income per share for the six months ended June 30, 2009
was $0.11, as compared to $0.11 for the six months ended June 30,
2008.



The difference between the expected and effective income tax expense
recorded for the six-month periods ended June 30, 2009 and 2008, is due
primarily to changes in the valuation allowance on net deferred tax assets.



At June 30, 2009, the Companys deferred tax asset, which has been
fully allowed for, primarily consisted of net operating loss carryforwards. The
recognition of this net deferred tax asset is based on the Companys
analysis of past, current and projected financial results of the Companys
operations. Based on this analysis, management does not believe that as of June
30, 2009, the net deferred tax asset will more likely than not be realized. If
future taxable income exceeds the level that has been assumed in calculating the
deferred tax asset, the valuation allowance could be reduced with a
corresponding credit to income.



At June 30, 2009, the Company has recorded a current income tax payable
of $218,000, which consists of estimated state income taxes and U.S. federal
alternative minimum tax.



15


CASH FLOW SUMMARY



Our cash flows from operating, investing and financing activities, as
reflected in the consolidated statements of cash flows for the six month periods ended
June 30, 2009 and 2008, are summarized as follows:




2009
     
     2008Cash provided
by (used in):Operating
activities
     
     
     
     $
     (1,330,986
     )
     
     $
     3,355,317Investing
activities
     
     
     
     
     (300,059
     )
     
     
     (9,329,965
     )Financing
activities
     
     
     
     
     1,916,453
     
     
     
     4,952,194Effect of
exchange rate changes on cash
     
     
     
     
     (276,893
     )
     
     
     (812
     )Net increase
(decrease) in cash, considering effect of exchange rate changes on cash
     
     
     
     $
     8,515
     
     
     $
     (1,023,266
     )
 

Cash used in operating activities was $1,330,986 for the six months ended
June 30, 2009, which was an increase of $4,686,303 compared to the six months
ended June 30, 2008.  This increase in cash used is due to growth in
the accounts receivable balance compared to the prior period and granting
certain customers extended payment terms (up to 180 days), offset by an increase
of net income, non-cash depreciation and amortization charges, deferred income
tax expense and foreign currency transaction loss.



Cash used in investing activities was $300,059 for the six months ended
June 30, 2009, which was a decrease of $9,029,906 compared to the six months
ended June 30, 2008.  This decrease was primarily due to decreased
expenditures relating to license rights and fixed assets, which were comprised
primarily of software.



Cash provided by financing activities was $1,916,453 for the six months
ended June 30, 2009, which was a decrease of $3,035,741 compared to the six
months ended June 30, 2008.   This decrease was due to the issuance of
common stock and warrants at a comparably lower price during the six months
ended June 30, 2009 compared to the prior period.



Liquidity and Capital Resources



As of June 30, 2009, we had
a working capital surplus of $15,408,262 and stockholders' equity of
$34,943,797.



On July 7, 2009, we
completed a private placement raising (through June 30, 2009) total cash proceeds of $1,905,200 through
the issuance of 2,420,000 shares of common stock to several investors. As part of this placement, one party received 100,000 shares and warrants to purchase 100,000 shares in satisfaction of $66,000 of accounts payable. We expect
that we will raise additional capital to support our operations, to finance
receivables and to accommodate planned future growth. We are currently also in
discussions with additional investors about further investments for the third or
fourth quarters of 2009. However, there can be no guarantees that such funds
will be available on commercially reasonable terms, if at all. If such financing
is not available on satisfactory terms, we may be unable to expand or continue
our business as desired and operating results may be adversely affected. Debt
financing will increase expenses and must be repaid regardless of operating
results. Equity financing could result in a substantial dilution to existing
stockholders.



We have borrowed funds from time to time in the past from our chief executive officer, Eberhard Schoneburg.  As of June 30, 2009, we owed Mr. Schoneburg an aggregate amount of $938,704, as compared to $737,771 at December 31, 2008.  During the three months ended June 30, 2009, Mr. Schoneburg advanced an additional $354,600 including deferred salary of $152,343 to the Company.  The advanced funds bear interest at a rate of 5% per year and are secured by the assets of the Company.



The Company continued to generate income in the second quarter of 2009, and we expect that cash flow generated from 2009 operations and additional financing through various sources will be sufficient to fund the Companys operations, working capital and commitment needs for the next 12 months.



Economic conditions in the
United States and in foreign markets in which we operate could substantially
affect our sales and profitability and our cash position and collection of
accounts receivable. Economic activity in the United States and throughout much
of the world has undergone a sudden, sharp economic downturn in 2008 and 2009
following the housing downturn and subprime lending collapse in the United
States and globally. Global credit and capital markets have experienced
unprecedented volatility and disruption. Business credit and liquidity have
tightened in much of the world. Some of our suppliers and customers may face
credit issues and could experience cash flow problems and other financial
hardships. These factors have had a substantial impact on the timeliness of
receivable collections from our customers. The Company cannot predict at this
point in time how this situation will develop and whether accounts receivable
may need to be written off in the coming quarters.



16



Changes in governmental banking, monetary and fiscal policies to restore liquidity and increase credit availability may not be effective in alleviating the global economic declines. It is difficult to determine the breadth and duration of the economic and financial market problems and the many ways in which they may affect our suppliers, customers and our business in general. Nonetheless, continuation or further worsening of these difficult financial and macroeconomic conditions could have a significant adverse effect on our sales, collectability of our accounts receivables, profitability and results of operations.



Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of trade accounts receivable. The Company extends credit to its customers in the normal course of business and generally does not require collateral.



The Companys standard
payment terms are normally within 90 days. In 2009, the Company has provided extended payment terms (up to 180 days) to certain customers. The
Company assesses the probability of collection from each customer at the outset
of the arrangement based on a number of factors, including the customers
payment history and its current creditworthiness. If in managements
judgment collection of a fee is not probable, the Company does not record
revenue until the uncertainty is removed.



Management performs ongoing
credit evaluations, and the Company maintains an allowance for potential credit
losses based upon its loss history and its aging analysis. The allowance for
doubtful accounts of $3,354,450 at June 30, 2009, and $731,500 at December 31,
2008, is the Companys best estimate of the amount of probable credit
losses in existing accounts receivable. Management reviews the allowance
for doubtful accounts each reporting period based on a detailed analysis of
accounts receivable. In the analysis, management primarily considers the age of
the customers receivable and also considers the creditworthiness of the
customer, the economic conditions of the customers industry, the general
economic conditions and trends and the business relationship and history with
its clients among other factors. If any of these factors change, the Company may
also change its original estimates, which could impact the level of the
Companys future allowance for doubtful accounts. If judgments regarding
the collectability of accounts receivable were incorrect, adjustments to the
allowance may be required, which would reduce profitability.Since the Companys accounts receivable are often
concentrated in a relatively few number of customers, a significant change in
the liquidity or financial position of any one of these customers could have a
material adverse effect on the Companys financial
statements. During the six months ended June 30, 2009, the Company entered into
agreements with certain of its customers to offset accounts receivable of approximately $6.4 million from these customers with
accounts payable for the same amount to these customers. The offset of these receivables and payables represents a legal right of
setoff and has been accounted for in accordance with the provisions of FASB Interpretation No. (“FIN”) 39.



17



Recently Issued and Adopted Accounting Pronouncements



In September 2006, the
Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) No. 157,Fair Value Measurements. SFAS No. 157 establishes
a framework for measuring the fair value of assets and liabilities. This
framework is intended to provide increased consistency in how fair value
determinations are made under various existing accounting standards which
permit, or in some cases require, estimates of fair market value. SFAS No. 157
also expands financial statement disclosure requirements about a companys
use of fair value measurements, including the effect of such measures on
earnings. In February 2008, the FASB issued Staff Position FAS 157-2, which
delayed the effective date of SFAS 157 for nonfinancial assets and nonfinancial
liabilities, except for items that are recognized or disclosed at fair value in
the financial statements on a recurring basis (at least annually). The Company
adopted Staff Position FAS 157-2 on January 1, 2009. At June 30, 2009, the
Company has no financial assets or liabilities subject to recurring fair value
measurements.

SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities, allows entities to voluntarily choose to measure certain financial assets and liabilities at fair value (fair value option). The fair value option may be elected on an instrument-by-instrument basis and is irrevocable, unless a new election date occurs. If the fair value option is elected for an instrument, SFAS No. 159 specifies that unrealized gains and losses for that instrument be reported in earnings at each subsequent reporting date. The Company did not elect to apply the fair value option to any outstanding instruments.

In April 2009, the FASB
issued FSP SFAS No. 107-1 and Accounting Principles Board Opinion
(APB) 28-1,Interim Disclosures about Fair
Value of Financial Instruments, (FSP 107-1), which
requires that the fair value disclosures required for all financial instruments
within the scope of SFAS No. 107,Disclosures about Fair
Value of Financial Instruments, be included in interim
financial statements. This FSP also requires entities to disclose the method and
significant assumptions used to estimate the fair value of financial instruments
on an interim and annual basis and to highlight any changes from prior periods.
FSP 107-1 is effective for interim periods ending after June 15, 2009. The
adoption of FSP 107-1 is not expected to have a material impact on the
Companys consolidated financial statements.

In June 2009, the FASB approved its Accounting Standards Codification (Codification) as the single source of authoritative United States accounting and reporting standards applicable for all non-governmental entities, with the exception of the SEC and its staff. The Codification, which changes the referencing of financial standards, is effective for interim or annual financial periods ending after September 15, 2009. Therefore, in the third quarter of fiscal year 2009, all references made to US GAAP will use the new Codification numbering system prescribed by the FASB. As the Codification is not intended to change or alter existing US GAAP, it is not expected to have any impact on the Companys consolidated financial position or results of operations.

On January 1, 2009, the Company adopted SFAS No. 141(Revised 2007),Business Combinations,(SFAS No. 141R). SFAS No. 141R provides revised guidance on how acquirers recognize and measure the consideration transferred, identifiable assets acquired, liabilities assumed, noncontrolling interests, and goodwill acquired in a business combination. SFAS No. 141R also expands required disclosures surrounding the nature and financial effects of business combinations. Management believes that the adoption of SFAS 141R will have an impact on the accounting for any future acquisition, if one were to occur. The Company is required to apply the guidance in SFAS 141R for any future business combinations.

On January 1, 2009, the Company adopted SFAS No. 160,Noncontrolling Interests in Consolidated Financial Statements. SFAS No. 160 establishes accounting and reporting standards for a noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It 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. Because all of the Companys subsidiaries are wholly-owned by the Company, there are no noncontrolling interests, and as a result, the adoption of this standard had no effect on the Companys consolidated financial statements.

On January 1, 2009, the Company adopted SFAS No. 161,Disclosures about Derivative Instruments and Hedging Activities an amendment of FASB Statement No.133. SFAS No. 161 requires enhanced disclosures about the Companys derivative and hedging activities. The adoption of SFAS 161 did not have an impact on the Companys financial statements.





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On January 1, 2009, the Company adopted the provisions of Emerging Issues Task Force (EITF) 07-05,Determining whether an Instrument (or Embedded Feature) Is Indexed to an Entitys Own Stock, which provides guidance on determining what types of instruments or embedded features in an instrument held by a reporting entity can be considered indexed to its own stock for the purpose of evaluating the first criteria of the scope exception in paragraph 11(a) of SFAS 133.  The adoption of this EITF did not have an impact on the Companys consolidated financial statements.



Off-Balance Sheet Arrangements



At June 30, 2009, we did not have any material off-balance sheet arrangements.



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK



Not applicable.



ITEM 4. CONTROLS AND PROCEDURES



Evaluation of Disclosure Controls and Procedures



(a)Evaluation of Disclosure
Controls.Our Chief Executive Officer and Chief
Financial Officer evaluated the effectiveness of our disclosure controls and
procedures as of the end of the period covered by this report. Disclosure
controls and procedures are controls and other procedures that are designed to
ensure that information required to be disclosed by us in the reports that we
file or submit under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the SECs rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed by us in
the reports that we file under the Exchange Act is accumulated and communicated
to our management, as appropriate to allow timely decisions regarding required
disclosure. Based on his evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures
were effective as of June 30, 2009.



It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met.  In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events.  Because of these and other inherent limitations of control systems, there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.



(b)Changes in internal control over financial reporting.There have been no changes in our internal control over financial reporting that occurred during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.  Our management team will continue to evaluate our internal control over financial reporting throughout 2009 as we implement our Sarbanes Oxley testing methodologies.



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PART II - OTHER INFORMATION



ITEM 1 - LEGAL PROCEEDINGS



From time to time, legal proceedings or disputes arise in the normal course of business. The Company monitors and reviews these matters and maintains accruals where appropriate.



In September 2008, an action was brought against Artificial Life Europe GmbH in Germany in a contractual dispute, in which a claim of approximately $375,000 was made against the Company.  A court hearing is scheduled for September 2009 before the State Court in Berlin. The Company intends to contest this claim and defend itself vigorously, including the filing of available counterclaims. While the Company cannot predict the outcome of the matter, the Company does not believe that the final outcome will have a material adverse impact on its financial position or results of operations.



ITEM 1A  RISK FACTORS



There have been no material changes to the Companys risk factors as previously disclosed in Item 1A Risk Factors in the Companys Form 10-K for the fiscal year ended December 31, 2008.



ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS



Not applicable.



ITEM 3 - DEFAULTS UPON SENIOR SECURITIES



Not applicable.



ITEM 4  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS



Not applicable.



ITEM 5  OTHER INFORMATION



Not applicable.



ITEM 6 - EXHIBITS




10*
        Loan Agreement, dated August 10, 2009 between the Registrant and Eberhard Schoneburg.




31.1*
        Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2*
        Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32*
        Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.




*
        Filed herewith



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SIGNATURES



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



ARTIFICIAL LIFE, INC.



Date: August 12, 2009


By:/s/ Eberhard Schoneburg

Name: Eberhard Schoneburg

Title: Chief Executive Officer and


Chief Financial Officer





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