UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



FORM 10-Q

(Mark One)



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



For the quarterly period ended June 30, 2010

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 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.)




26/F., 88 Hing Fat Street
Causeway Bay, Hong
Kong(Address of principal executive offices)




(+852) 3102-2800

(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 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. 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 (§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).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 filero
        Non-accelerated filero
(Do not check if 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, 2010, the
Registrant had 61,670,489 shares of common stock, $.01 par value per share, outstanding.

1   ARTIFICIAL LIFE, INC.



INDEX OF INFORMATION CONTAINED IN FORM 10-Q FOR THE

QUARTERLY PERIOD ENDED JUNE 30, 2010




Page No.PART I - FINANCIAL INFORMATIONItem 1.
        
        Unaudited Condensed Consolidated Financial StatementsCondensed Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009 (unaudited)
        
        
        3Condensed Consolidated Statements of Income and Comprehensive Income for the Six-Month Periods Ended June 30, 2010 and 2009 (unaudited)
        
        
        4Condensed Consolidated Statement of Changes in Stockholders Equity for the Six-Month Period Ended June 30, 2010 (unaudited)
        
        
        5Condensed Consolidated Statements of Cash Flows for the Six-Month Periods Ended June 30, 2010 and 2009 (unaudited)
        
        
        6Notes to Condensed Consolidated Financial Statements (unaudited)
        
        
        7Item 2.
        
        Managements Discussion and Analysis of Financial Condition and Results of Operations
        
        
        13Item 3.
        
        Quantitative and Qualitative Disclosures About Market Risk
        
        
        17Item 4T.
        
        Controls and Procedures
        
        
        18PART II - OTHER INFORMATIONItem 1.
        
        Legal Proceedings
        
        
        19Item 1A.
        
        Risk Factors
        
        
        19Item 2.
        
        Unregistered Sales of Equity Securities and Use of Proceeds
        
        
        19Item 3.
        
        Defaults Upon Senior Securities
        
        
        19Item 4.
        
        [Removed and Reserved]
        
        
        19Item 5.
        
        Other Information
        
        
        19Item 6.
        
        Exhibits
        
        
        20Signatures
        
        
        
        
        21







2



PART I-FINANCIAL INFORMATION



ITEM 1.  UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



ARTIFICIAL LIFE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)




June 30,
2010
        
        
        December 31, 2009USD
        
        
        USDASSETSCurrent assets:Cash
        $
        1,791,015
        
        $
        2,356,336Pledged deposit
        
        25,641
        
        
        -Trade accounts receivables, net of discount interest of $207,960 and $208,218, respectively
        
        16,968,456
        
        
        9,498,896Trade installment receivables, net of discount interest of $26,319 and $139,743, respectively
        
        4,243,341
        
        
        8,473,270Prepaid expenses and other
        
        778,321
        
        
        473,166Deferred income taxes, net
        
        837,714
        
        
        1,000,000Total current assets
        
        24,644,488
        
        
        21,801,668Fixed assets, net of accumulated depreciation of $2,331,951 and $1,932,684, respectively
        
        1,178,591
        
        
        1,575,531License rights, net of accumulated amortization of $9,501,157 and $6,317,060, respectively
        
        36,428,869
        
        
        26,421,105Prepaid expenses, deposits and other assets
        
        1,380,163
        
        
        1,325,702Deferred income taxes
        
        1,170,331
        
        
        710,00038,979,363
        
        
        28,456,807TOTAL ASSETS
        $
        64,802,442
        
        $
        51,834,006LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
        $
        3,736,656
        
        $
        2,297,854Accrued expenses and other
        
        521,769
        
        
        737,128Income taxes payable
        
        1,420,078
        
        
        17,394Note payable  officer/stockholder
        
        1,745,701
        
        
        1,606,328Note payable  stockholder
        
        -
        
        
        666,667Total liabilities (all current)
        
        7,424,204
        
        
        5,325,371Stockholders EquityPreferred stock, $.01 par value; 5,000,000 shares authorized,
no shares issued and outstanding
        
        -
        
        
        -Common stock, $.01 par value; 130,000,000 shares authorized,
60,590,489shares issued and outstanding as of June 30, 2010
and 57,411,203 shares issued and outstanding as of December 31, 2009
        
        605,904
        
        
        574,111Additional paid-in capital
        
        66,759,568
        
        
        63,006,782Notes receivable from stockholders
        
        (19,577)
        
        
        (19,577)Accumulated deficit
        
        (9,879,415)
        
        
        (17,117,425)Accumulated other comprehensive (loss) income
        
        (88,242)
        
        
        64,744Total stockholders equity
        
        57,378,238
        
        
        46,508,635TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
        $
        64,802,442
        
        $
        51,834,006



See accompanying notes
to unaudited condensed consolidated financial statements.



3



ARTIFICIAL LIFE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

AND COMPREHENSIVE INCOME

(UNAUDITED)




Three-Month Periods Ended June 30,
        
        Six-Month Periods Ended June 30,2010
        
        
        2009
        
        
        2010
        
        
        2009USD
        
        
        USD
        
        
        USD
        
        
        USDRevenues:Software license agreements
        $
        9,032,238
        
        $
        7,577,225
        
        $
        17,211,784
        
        $
        14,629,598Application services and other
        
        11,225
        
        
        744
        
        
        15,854
        
        
        11,5719,043,463
        
        
        7,577,969
        
        
        17,227,638
        
        
        14,641,169Cost of revenues:Cost of software license agreements
        
        1,831,715
        
        
        1,090,980
        
        
        3,261,353
        
        
        1,812,750Others
        
        91,826
        
        
        6,627
        
        
        151,967
        
        
        26,2691,923,541
        
        
        1,097,607
        
        
        3,413,320
        
        
        1,839,019Gross profit
        
        7,119,922
        
        
        6,480,362
        
        
        13,814,318
        
        
        12,802,150Operating expenses:General and administrative
        
        623,132
        
        
        1,988,105
        
        
        1,325,267
        
        
        3,639,996Research and development
        
        656,222
        
        
        842,437
        
        
        1,242,261
        
        
        1,620,243Sales and marketing
        
        399,038
        
        
        472,515
        
        
        895,337
        
        
        920,025Depreciation *
        
        205,897
        
        
        53,202
        
        
        427,501
        
        
        111,114Total operating expenses
        
        1,884,289
        
        
        3,356,259
        
        
        3,890,366
        
        
        6,291,378Income from operations
        
        5,235,633
        
        
        3,124,103
        
        
        9,923,952
        
        
        6,510,772Other income (expenses):Interest income and other income
        
        5,388
        
        
        109,483
        
        
        5,420
        
        
        109,503Interest expense
        
        (21,389)
        
        
        (36,228)
        
        
        (41,759)
        
        
        (66,480)Foreign currency transaction loss
        
        (806,931)
        
        
        (283,154)
        
        
        (1,522,358)
        
        
        (412,360)(822,932)
        
        
        (209,899)
        
        
        (1,558,697)
        
        
        (369,337)Income before income taxes
        
        4,412,701
        
        
        2,914,204
        
        
        8,365,255
        
        
        6,141,435Income tax expense
        
        (823,488)
        
        
        (143,000)
        
        
        (1,127,245)
        
        
        (658,000)Net income
        
        3,589,213
        
        
        2,771,204
        
        
        7,238,010
        
        
        5,483,435Foreign currency translation adjustment
        
        (39,743)
        
        
        231,696
        
        
        (152,986)
        
        
        139,018Comprehensive income
        $
        3,549,470
        
        $
        3,002,900
        
        $
        7,085,024
        
        $
        5,622,453Net income per share:Basic
        $
        0.06
        
        $
        0.06
        
        $
        0.12
        
        $
        0.11Diluted
        $
        0.06
        
        $
        0.06
        
        $
        0.12
        
        $
        0.11Weighted average shares outstanding:Basic
        
        60,235,405
        
        
        48,397,539
        
        
        59,000,796
        
        
        48,062,696Diluted
        
        61,630,883
        
        
        48,421,914
        
        
        60,844,454
        
        
        48,220,370





See accompanying notes to unaudited condensed consolidated financial statements.



*     Depreciation is separately shown for reading convenience. Total depreciation for the three-month period ended June 30, 2010 is comprised of $205,897 (2009: $53,202) relating to general and administrative expenses. Total depreciation for the six-month period ended June 30, 2010 is comprised of $427,501 (2009: $111,114) relating to general and administrative expenses.


4





ARTIFICIAL LIFE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS EQUITY

(UNAUDITED)



Common Stock

Shares
        
        
        Amount
        
        
        Additionalpaid-incapital
        
        
        Notes
receivable
from
stockholders
        
        
        Accumulated
deficit
        
        
        Accumulated
other
comprehensive
income (loss)
        
        
        TotalstockholdersequityUSD
        
        
        USD
        
        
        USD
        
        
        USD
        
        
        USD
        
        
        USD
        
        
        USDBalances at January 1, 2010
        
        
        57,411,203
        
        
        $   574,111
        
        
        $   63,006,782
        
        
        $      (19,577)
        
        $
        (17,117,425)
        
        $
        64,744
        
        
        $46,508,635Issuance of common
stock and warrants in
private placements, net
        
        
        3,139,286
        
        
        31,393
        
        
        3,753,186
        
        
        -
        
        
        -
        
        
        -
        
        
        3,784,579Issuance of common
stock and warrants in
connection with private placements commission
        
        
        40,000
        
        
        400
        
        
        (400)
        
        
        -
        
        
        -
        
        
        -
        
        
        -Net income
        
        
        -
        
        
        -
        
        
        -
        
        
        -
        
        
        7,238,010
        
        
        -
        
        
        7,238,010Other comprehensive loss
  foreign currency
translation adjustment
        
        
        -
        
        
        -
        
        
        -
        
        
        -
        
        
        -
        
        
        (152,986)
        
        
        (152,986)Balances at June 30, 2010
        
        
        60,590,489
        
        
        $   605,904
        
        
        $   66,759,568
        
        
        $      (19,577)
        
        $
        (9,879,415)
        
        $
        (88,242)
        
        
        $57,378,238







5



ARTIFICIAL LIFE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

Six-Month Periods Ended June 30,2010
        
        
        2009USD
        
        
        USDCash flows from operating activities:Net income
        
        $
        7,238,010
        
        $
        5,483,435Adjustments to reconcile net income to net cash provided by (used in) operating activities:Depreciation and amortization
        
        
        3,688,855
        
        
        1,935,938Loss on disposal of fixed assets
        
        
        571
        
        
        -Deferred income tax (benefit) expense
        
        
        (298,045)
        
        
        500,000Bad and doubtful debt expense
        
        
        3,713
        
        
        2,623,162Realized gain on settlement of short-term investment
        
        
        (12,847)
        
        
        -Foreign currency exchange loss
        
        
        1,522,358
        
        
        412,360Interest expense accrued on advances from officer / stockholder
        
        
        20,999
        
        
        14,285Salary / bonus accrued to officer / stockholder
        
        
        55,664
        
        
        175,395Changes in operating assets and liabilities:Increase in trade accounts and installment receivables
        
        
        (9,462,183)
        
        
        (13,981,178)Decrease (increase) in prepaid expenses, deposits and other assets
        
        
        313,163
        
        
        (226,174)Increase in accounts payable
        
        
        15,847
        
        
        1,457,222(Decrease) increase in accrued expenses and other
        
        
        (202,728)
        
        
        116,569Increase in income taxes payable
        
        
        1,402,684
        
        
        158,000Increase in pledged deposit
        
        
        (25,641)
        
        
        -Net cash provided by (used in) operating activities
        
        
        4,260,420
        
        
        (1,330,986)Cash flows from investing activities:Purchase of fixed assets
        
        
        (40,131)
        
        
        (45,879)Purchase of license rights
        
        
        (7,825,156)
        
        
        (254,180)Purchase of short-term investment
        
        
        (603,750)
        
        
        -Proceeds from sale of short-term investment
        
        
        616,597
        
        
        -Net cash used in investing activities
        
        
        (7,852,440)
        
        
        (300,059)Cash flows from financing activities:Net proceeds from issuance of common stock and warrants
        
        
        3,784,579
        
        
        1,905,200Advances under note payable to officer/stockholder
        
        
        1,093,667
        
        
        202,257Repayment of note payable to officer/stockholder
        
        
        (1,030,957)
        
        
        (191,004)Repayment of note payable to stockholder
        
        
        (666,667)
        
        
        -Net cash provided by financing activities
        
        
        3,180,622
        
        
        1,916,453Net (decrease) increase in cash
        
        
        (411,398)
        
        
        285,408Cash at beginning of period
        
        
        2,356,336
        
        
        1,430,578Effect of exchange rate changes on cash
        
        
        (153,923)
        
        
        (276,893)Cash at end of period
        
        $
        1,791,015
        
        $
        1,439,093Supplemental cash flow disclosure:Cash paid for interest
        
        $
        90,371
        
        $
        108,574Cash paid for income taxes
        
        $
        23,557
        
        $
        -Supplemental disclosure of non-cash investing and financing activities:Purchase of software hosting service in satisfaction for trade accounts receivable
        
        $
        690,000
        
        $
        -Purchase of license rights through offsetting arrangement
        
        $
        3,360,000
        
        $
        6,443,500Issuance of common stock and warrants in satisfaction of accounts payable
        
        $
        -
        
        $
        66,000Issuance of common stock and warrants in satisfaction of commissions
        
        $
        50,000
        
        $
        -




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) and its subsidiaries (the
Group) 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 unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned
subsidiaries, as follows:



Artificial Life Asia
Limited,located in Hong Kong; develops products and 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.,Artificial Life Ventures, Inc., Artificial Life USA, Inc., and Artificial
Life Mobile Computing, Inc.; all non-operating, inactive subsidiaries in 2010, 2009 and 2008.



Green Cortex,
Inc., located in Hong Kong; formed in May 2010 to develop mobile business applications and sustainability
products and to venture into the green IT business.



All significant intercompany
accounts and transactions have been eliminated in consolidation.



The preparation of financial
statements in conformity with accounting principles generally accepted in the United States of America requires management to make
certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting
periods. Actual results could differ from those estimates.



Operating results for the
three-month and six-month period ended June 30, 2010 are not necessarily indicative of results that may be expected for the year
ending December 31, 2010. Amounts at December 31, 2009 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, 2009.



The accompanying unaudited
condensed consolidated financial statements include all adjustments, comprised of normal recurring adjustments and accruals,
considered necessary by management to fairly state the Companys results of operations, financial position and cash flows.
These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial
statements and notes thereto included in the Companys Annual Report on Form 10-K for the year ended December 31, 2009, which
has been filed with the Securities and Exchange Commission.



Reclassifications:



Certain reclassifications of
prior period amounts have been made to conform to the current period presentation. Beginning from the second quarter of 2010, the
Company reports bad debt expense as a component of general and administrative expenses in the unaudited condensed consolidated
statements of income and comprehensive income. Prior to the second quarter of 2010, the bad debt expense was partially included as
a component of sales and marketing expenses.




7




Recently issued and adopted accounting standards




In April 2010, the Financial
Accounting Standards Board (FASB) issued Accounting Standards Updates (ASU) 2010-17, which amends ASC 605,
Revenue Recognition. ASU 2010-17 provides guidance on applying the milestone method to milestone payments for
achieving specified performance measure when those payments are related to uncertain future events limited to transactions
involving research and development. Entities can make an accounting policy election to recognize arrangement consideration
received for achieving specified performance measure during the period in which the milestones are achieved, provided certain
criteria are met. ASU 2010-17 is effective for interim and annual periods beginning on or after June 15, 2010, with early adoption
permitted. The Company does not expect the adoption of ASU 2010-17 to have a material impact on its consolidated financial
statements.



In October 2009, the FASB issued
ASU 2009-14, which amends ASC 985-605, Software-Revenue Recognition, to exclude from its requirements (a) non-software
components of tangible products and (b) software components of tangible products that are sold, licensed, or leased with tangible
products when the software components and non-software components of the tangible product function together to deliver the
tangible product's essential functionality. ASU 2009-14 will be effective prospectively for revenue arrangements entered into or
materially modified in fiscal years beginning on or after June 15, 2010, and early adoption will be permitted. The Company does
not expect the adoption of this statement to have a material impact on its consolidated financial statements.




2.
        PLEDGED DEPOSIT



At June 30, 2010, the Company
maintained an interest-bearing pledged deposit of $25,641 (2009: nil), required under an agreement with a bank to assure future
corporate card credit availability. The deposit is restricted for use and the agreement is renewed automatically on a
month-to-month basis.




3.
        EMPLOYEE STOCK BASED COMPENSATION



At January 1, 2010, 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, 2010 or 2009.



At June 30, 2010, the Company
had outstanding options to purchase 4,065,000 shares of common stock under its stock option plan, issued to employees as
follows:




Weighted average exercise price
        $0.91



Aggregate intrinsic value
        $74,700



Weighted average remaining contractual term
        2.40 years



At June 30, 2010, the Company had outstanding warrants to purchase 1,400,000 shares of common stock issued to employees as follows:




Weighted average exercise price
        $0.89



Aggregate intrinsic value
        $35,000



Weighted average remaining contractual term
        2.43 years



In July 2010, the Company
granted options to an employee to purchase 300,000 shares of common stock under the Companys Amended and Restated 1998
Equity Incentive Plan at an exercise price of $0.90 per share. These options have a three-year term and vest annually in equal
installments over the term.



In July 2010, the Company
granted warrants to an employee to purchase 300,000 shares of common stock. The warrants have a three-year term with exercise
price at $1 and are immediately exercisable.




4.
        CUSTOMER CONCENTRATION



Financial instruments that
potentially subject the Company to concentrations of credit risk consist primarily of trade accounts and installment receivables.
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 and 2010, the Company granted or 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



8





number of factors, including the
customers payment history and its current creditworthiness. If in managements judgment collection is not reasonably
assured, 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. Management reviews the allowance for doubtful accounts each reporting period based on a detailed analysis of trade
receivables and makes the best estimate of the amount of credit losses in existing trade receivables. 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, general economic conditions and trends, and the Companys business
relationship and history with its customers, 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 receivables were incorrect, adjustments to the allowance may be required, which would reduce
profitability.The Companys trade receivable are often concentrated in a relatively
few number of customers, and 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. At June 30, 2010 and December 31, 2009, there was no
allowance for doubtful accounts.



Due to the extended payment
terms granted to certain customers, payments from customers may be collected over an extended period of time. The related
receivables have been discounted using a 3.25% discount rate to reflect the present value of the future collection of payments,
which is to be amortized using the effective interest method over the period in which payments are made and the balance is
outstanding. The unamortized discount on these receivables is approximately $208,000 at June 30, 2010 and $208,000 at December 31,
2009.



In addition to the extended
payment terms granted to certain customers mentioned above, the Company has one customer with whom it has a long-standing business
relationship, and to whom it has been selling software since 2007. At December 31, 2009, the Company entered into an installment
receivable agreement with this customer, which is due in various installments through December 31, 2010. This receivable has been
discounted using a 3.25% discount rate to reflect the interest component of the transaction, which is to be amortized using the
effective interest method over the period in which payments are made and the balance is outstanding. The discount rate is reset
periodically, if necessary, considering prevailing interest rates. The unamortized discount on this receivable is approximately
$26,000 at June 30, 2010 and $140,000 at December 31, 2009.



At June 30, 2010, the Company
had 91 telecom carriers, resellers, distributors and general corporate customers, compared to 95 at June 30, 2009. For the
three-month period ended June 30, 2010, the Company had three customers that represented approximately 44%, 31% and 22% of the
Companys revenues, respectively. For the six-month period ended June 30, 2010, the Company had five customers that
represented approximately 31%, 23%, 16%, 16%, 12% of the Companys revenues, respectively. 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 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.



At June 30, 2010, trade
receivables were due from 42 customers. Of these, six customers accounted for approximately 33%, 19%, 13%, 10%, 9% and 9% of total
trade receivables, respectively. At June 30, 2010, the average age of trade receivables from all customers was 122 days as
compared to 128 days at December 31, 2009.



During December 2009, the
Company commenced discussions with one of the Companys key licensors with a view to acquiring certain license rights. This
purchase was eventually concluded on March 26, 2010, at a resulting cost to the Company of Euro 2,500,000 (USD 3,360,000).
Consequently, the Company recorded the purchase of these license rights during the six-month period ended June 30,
2010.



The Company also entered into
discussions to sell certain license rights of a newly developed technology of the Company to that same party. The sale of such
rights was concluded on March 29, 2010. The Company recognized revenue of Euro 4,000,000 (USD 5,376,000) in relation to this sale
during the six-month period ended June 30, 2010.



Management has concluded that
both of the above transactions were conducted on an arms length basis in the normal course of business and that the
considerations for the purchase and sale of the respective license rights reflected their respective fair market value.



In view of the fact that the
above transactions involved the same third party, the Company entered into an offsetting agreement with such party whereby the
total consideration for the sale of certain license rights for Euro 4,000,000 (USD 5,376,000) was partially offset against the
amount payable by the Company related to the acquisition



9





of license rights of Euro
2,500,000 (USD 3,360,000). Management of the Company considered it appropriate and advantageous for the Company to minimize cash
expenditures and credit risk exposure and thereby entered into such offsetting arrangement.




5.
        UNCOLLECTED DEFERRED REVENUE



Because of the Companys
revenue recognition policies, there are circumstances for which the Company is unable to recognize revenue relating to certain
sales transactions that have been billed, but the related receivable has not been collected. While the receivable represents a
legally enforceable obligation of the customer, for balance sheet presentation purposes, deferred revenue has been offset with the
related receivable, and no amounts appear in the consolidated balance sheets for such transactions. The aggregate amount of
unrecognized accounts receivable and deferred revenue was approximately $4.8 million at June 30, 2010 and December 31,
2009.




6.
        FIXED ASSETS



Fixed assets are stated at cost
less depreciation and if applicable, impairment.




7.
        LICENSE RIGHTS



License rights consist of the
following at June 30, 2010 and December 31, 2009:




June 30,    2010
        
        December 31,2009USD
        
        USDLicense rights
        $               45,930,026
        
        $               32,738,165Less: accumulated amortization
        (9,501,157)
        
        (6,317,060)$               36,428,869
        
        $               26,421,105



Amortization expenses for the six-month periods ended June 30, 2010 and 2009 were approximately $3,261,000 and $1,813,000, respectively. Amortization expense for the three-month periods ended June 30, 2010 and 2009 were approximately $1,832,000 and $1,091,000, respectively.



Beginning in 2007 and continuing through 2010, the Company acquired from several vendors certain license rights for the reselling, sublicensing and localization and marketing of certain technologies in specified geographic regions throughout the world. In January 2010, the Company entered into a new license rights agreement with a vendor to combine all previous licenses into one unified worldwide license. This new license expires on December 31, 2014.



During the quarter ended June 30, 2010, the Company acquired from a vendor two license rights for reselling, sublicensing and localization and marketing of certain technology in specified geographic regions throughout Europe. These new licenses expire in April and May, 2015, respectively.




8.
        NET INCOME PER SHARE



Basic netincome per share is calculated based on the weighted average number of common shares outstanding for the three-month and six-month periods ended June 30, 2010 and 2009.  Diluted net income per share is computed using the weighted average number of common shares outstanding during the period and the weighted average dilutive common equivalent shares outstanding during the period. Common equivalent shares consist of the incremental common shares issuable upon the exercise of stock options and warrants; common equivalent shares are excluded from the calculation if their effect is anti-dilutive.






10



The following table sets forth
the computation of fully diluted shares for the three-month and six-month periods ended June 30, 2010 and 2009.




Three-month period ended June 30,

        
        Six-month period ended
June 30,2010
        
        2009

        

        2010
        
        2009Weighted average shares outstanding - basic
        60,235,405
        
        48,397,539
        
        59,000,796
        
        48,062,696Dilutive securities:Stock options
        853,517
        
        24,375
        
        1,129,983
        
        93,488Warrants
        541,961
        
        -
        
        713,675
        
        64,186Shares used in dilutive net income per share calculation
        61,630,883
        
        48,421,914
        
        60,844,454
        
        48,220,370




9.
        INCOME TAXES



For the three-month period ended
June 30, 2010, the Company recorded an income tax expense of $823,488 (2009: $143,000). The income tax expense for the three-month
period ended June 30, 2010 was determined based on the estimated annual effective income tax rate for the year ended December 31,
2010.



For the six-month period ended
June 30, 2010, the income tax expense includes a current income tax expense of $1,425,290 (2009: $658,000) and deferred tax credit
of $298,045 (2009: nil). The deferred tax credit includes a discrete deferred tax benefit of $415,207 (2009: nil), which was
recognized as a result of a change in judgment during the six-month period ended June 30, 2010 about the realizability of the
deferred tax assets of certain subsidiaries of the Company in future years. The change in judgment was mainly due to the
successful development and launching of new products during the period.




10.
        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 was held in September 2009 before the State Court in Berlin. In February 2010, the Court
ordered the Company to pay the plaintiff a settlement of approximately $350,000 and all court and attorney fees incurred by the
plaintiff. The settlement amount and the estimated court and attorney fees have been accrued as of June 30, 2010 and December 31,
2009. The Company filed an appeal with the State Court in Berlin in March 2010, and no payment will be made until a final judgment
is issued by the Court. Management believes the Company has adequately reserved for litigation and that the ultimate outcome of
the pending appeal will not have a material adverse impact on the Companys consolidated financial position or results of
operations taken as a whole.




11.
        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 accrued salary and bonus. The note
bears interest at 5%, secured by the assets of the Company and repayable on demand.





11



Activity on the note payable during the six-month
periods ended June 30, 2010 and 2009 is as follows:




2010
        
        2009USD
        
        USDBeginning balance, January 1
        
        $     1,606,328
        
        $        737,771Advances
        
        1,093,667
        
        202,257Repayments
        
        (1,030,957)
        
        (191,004)Accrued salary/bonus
        
        55,664
        
        175,395Accrued interest
        
        20,999
        
        14,285Ending balance, June 30
        
        $     1,745,701
        
        $        938,704



On July 8, 2010, the Company
repaid $760,000 of the outstanding loan balance of $1,694,329 owed to its chief executive officer through the issuance of
1,000,000 shares of common stock at a purchase price of $0.76 per share (the closing price at July 7, 2010). On the same date, a
substitute loan agreement was entered into between the Company and its chief executive officer on the remaining balance of
$934,329, which bears interest at 5%, secured by the assets of the Company and repayable on demand.



Notes payable:



Prior to January 1, 2008, the
Company issued promissory notes 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. These 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. In the fourth quarter of 2009, the Company paid one of the
notes in full ($333,333). The remaining note with a balance of $666,667 was fully paid in January 2010.




12.
        STOCKHOLDERS EQUITY



During the six-month period
ended June 30, 2010, the Company closed private placement offerings with three institutional investors and two accredited
investors for 3,139,286 shares of common stock and warrants to purchase an additional 1,063,668 shares of common stock. The
warrants have a two-year term with exercise prices ranging from $0.80 to $2, which are immediately exercisable. The shares of
common stock and warrants were sold for an aggregate purchase price of $3,784,579, net of placement commissions of $125,000, of
which $50,000 was paid through issuance of 40,000 shares of commons stock and warrants to purchase 20,000 shares of common stock.
The warrants have a two-year term with exercise price at $2, which are immediately exercisable. The issuance of the common stock
and warrants are exempt from the registration requirements of the Securities Act of 1933, as amended, or the Securities Act, in
accordance with Section 4(2) of the Securities Act and Regulations D and S under the Securities Act.




13.
        FAIR VALUE MEASUREMENTS



Accounting standards define 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 nonperformance.



The fair value of trade accounts
receivables, trade installment receivables, accounts payable and accrued expenses approximate the respective carrying amounts
because of the short-term maturity of these instruments. The non-financial instruments, which include fixed assets and license
rights, are not required to be carried at fair value on a recurring basis. However, if certain triggering events occur such that a
non-financial instrument is required to be evaluated for impairment, a resulting asset impairment would require that non-financial
instrument be recorded at the lower of its historical cost or its fair value.





12





14.
        FINANCIAL INSTRUMENTS




Concerns that certain highly
leveraged European governments could default on their debt obligations have resulted in significant price declines and price
volatility in sovereign debt securities, currency exchange rates and securities issued by the financial institutions that lend to
these governments in Europe. The Company transacts business globally and is exposed to currency exchange rate risk for monetary
assets and liabilities held or denominated in foreign currencies, primarily the Euro. The Company may enter into derivative
instruments to reduce the volatility of earnings associated with changes in foreign currency. During the six-month period ended
June 30, 2009, no such derivative instrument was used. Derivative instruments may expose the Company to credit risk to the extent
the counterparty may be unable to meet the terms of the derivative instrument.  The Company seeks to mitigate such risk
by limiting its counterparty to major financial institution.



In June 2010, the Company
invested in a EUR500,000 (USD603,750) short-term investment issued by a bank. The investment bears an interest rate of 5.5% per
annum and has a term of 2 weeks. The bank has the discretion to settle the investment in USD of $616,597 or Euro of EUR501,299
(inclusive of interest). Such contract was intended to offset foreign exchange exposures of the Companys trade accounts
receivable balances denominated in Euro. The contract matured during the quarter ended June 30, 2010 and the bank settled the
investment in United States dollars of $616,597. The resulting interest income and foreign currency exchange gain of $1,597 (2009:
nil) and $11,250 (2009: nil), respectively were included in other income.




15.
        SUBSEQUENT EVENTS



In July 2010, the Company issued
80,000 shares of common stock to a consultant at $0.97 per share (the closing price at the date of transaction) for prepaid
consulting services. These services are to be provided through the respective term which expires in July 2011. The Company will
amortize the amount on a straight-line basis, as services are provided, over the respective term of the agreement.



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 accompanying notes included
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, 2009. 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



During the first half of 2010,
the Company further strengthened its position as a leading full service global mobile software provider by offering a wide variety
of mobile products such as mobile games and entertainment, mobile TV, mobile advertisement, mobile distribution and aggregation,
mobile business applications, and its leading edge mobile commerce platform.



We are a registered developer
for Apples iPhone, iPod Touch and iPad platforms and develop games and applications for these platforms and we are a leading
publisher of iPhone/iPod games. Our iPhone games have been downloaded an aggregate of more than 15.2 million times since the
launch of our first iPhone game at the end of 2008. As of June 30, 2010, we have produced and released 30 games for the iPhone,
iPod touch and iPad. The top title was downloaded close to 3.9 million times, the second most close to 2.7 million times and the
third most over 1.8 million times. The average number of downloads per game was about 0.51 million. During the second quarter of
2010, our iPhone games were downloaded approximately 3.4 million times.



During the six-month period
ended June 30, 2010, 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 70 countries through Apples App Store/iTunes distribution platform.



In the second quarter of 2010,
we continued focusing our sales efforts on the sales of our new m-commerce platform, OPUS-MTM, and were very successful
with our efforts as the majority of our new revenues were related to or derived from this product since its commercial launch.
OPUS-MTM, with its broad appeal, flexible module selection concept,



13






competitive pricing, hosting
support and comprehensive feature set is our current key product and the basis for our future expansion.



In May 2010, we established a
new subsidiary, named Green Cortex, Inc., a company based in Hong Kong, to develop sustainability products and to venture into the
booming green IT business. It will combine mobile broadband technology, augmented reality and artificial intelligence technology
to target a range of green IT markets globally with a mission to minimize global carbon footprints and energy consumption. The
unique approach of the Company is to combine leading edge mobile technology with artificial intelligence to develop unique and
innovative products in this field.



In June 2010, we announced our
soon to be launched mobile telemedicine health solution GluCoMo (short for: GluCose Monitor), the first in a series of planned
mobile healthcare products. GluCoMo is a diabetes management solution leveraging OPUS-M platform for end-consumers,
healthcare providers and healthcare businesses. GluCoMo is scheduled for commercial availability in August, 2010.



In July, 2010, we relocated our
global headquarters from Los Angeles back to Hong Kong to minimize overhead and reduce production cost.



As of June 30, 2010, we had
total assets of $64,802,442 and total liabilities of $7,424,204. As of June 30, 2010, current assets were $24,644,488 as compared
to $21,801,668 at December 31, 2009, and current liabilities were $7,424,204 as compared to $5,325,371 at December 31, 2009.



As of June 30, 2010, we had 59
full-time employed staff. We also hire temporary staff, external consultants and interns to support our operations.



RESULTS OF OPERATIONS



THREE-MONTH PERIOD ENDED JUNE 30, 2010 COMPARED
TO THREE-MONTH PERIOD ENDED JUNE 30, 2009



REVENUES: Revenues for the
quarter ended June 30, 2010 were $9,043,463 as compared to $7,577,969 for the quarter ended June 30, 2009. The increase of
revenues of $1,465,494 or 19% was mainly due to global licensing deals for the sale of our m-commerce platform,
OPUS-M.



COST OF REVENUES: Cost of
revenues mainly consist of amortization of intangible assets. Cost of revenues for the quarter ended June 30, 2010 was $1,923,541
as compared to $1,097,607 for the quarter ended June 30, 2009. The increase of $825,934 or 75% was primarily due to the increased
amortization of additional license rights acquired.



GROSS MARGIN: Gross margin for
the quarter ended June 30, 2010 was $7,119,922 as compared to $6,480,362 for the quarter ended June 30, 2009. The increase of
$639,560 or 10% was mainly due to global license deals for the sale of our m-commerce platform, OPUS-M, offset by the
decreased product license revenue generated from mobile games and amortization of license rights acquired.



GENERAL AND ADMINISTRATIVE:
General and administrative expenses consisted of salary for administrative personnel, rent, professional fees, and costs
associated with employee benefits, supplies, communications, travel, and provision for doubtful accounts. General and
administrative expenses for the quarter ended June 30, 2010 were $623,132 as compared to $1,988,105 for the quarter ended June 30,
2009. The decrease of $1,364,973 or 69% was mainly due to significant decrease in bad debt expense of approximately $1.5 million,
offset by the increase in professional fees. The significant decrease in bad debt expense was due to a one-time write-off of trade
receivables in 2009 which were determined to be irrecoverable after managements detailed analysis.



SALES AND MARKETING: Sales and
marketing expenses consisted of salary expenses of sales and marketing personnel, costs relating to marketing materials,
advertising, trade show related expenses, traveling and public relations activities. Sales and marketing expenses for the quarter
ended June 30, 2010 were $399,038 as compared to $472,515for the quarter ended June 30,
2009. The decrease of $73,477 or 16% was mostly due to decrease in consulting expenses.




14



RESEARCH & DEVELOPMENT:
Research and development expenses consisted of salary, training, consulting, subcontracting and other expenses incurred to develop
and fulfill the design specifications and productions of the products and services from which we derive our revenues. Research and
development expenses for the quarter ended June 30, 2010 were $656,222 as compared to $842,437 for the quarter ended June 30,
2009. The decrease of $186,215 or 22% was primarily due to decrease in staff and consulting expenses, offset by increase in data
hosting and web service costs.



OTHER EXPENSE/INCOME: Other
(expense)/income for the quarter ended June 30, 2010 was ($822,932) as compared to ($209,899) for the quarter ended June 30, 2009.
Net expense of $822,932 was primarily due to foreign currency transaction losses of approximately $807,000 in this quarter
compared to approximately $283,000 in the second quarter of 2009. The increase in foreign currency transaction losses was mostly
due to the adverse effect of the weakening of the Euro relative to the United States Dollar on the trade receivables denominated
in Euro.



INCOME FROM OPERATIONS AND NET
INCOME: Income from operations for the quarter ended June 30, 2010 was $5,235,633 as compared to income from operations of
$3,124,103 for the quarter ended June 30, 2009. The income from operations is primarily due to revenue of $9,043,463 generated
from global licensing deals for the sale of our m-commerce platform, OPUS-M, offset by the cost of revenue of $1,923,541 and
the operational cost of $1,884,289. Net income for the quarter ended June 30, 2010 was $3,589,213 as compared to net income of
$2,771,204 for the quarter ended June 30, 2009. The basic and diluted net income per share for the second quarter of 2010 was
$0.06, as compared to $0.06 for the quarter ended June 30, 2009.



For the three-month period ended
June 30, 2010, we recorded an income tax expense of $823,488 (2009: $143,000). The income tax expense is calculated based on the
estimated annual effective income tax rate for the year ending December 31, 2010.



SIX-MONTH PERIOD ENDED JUNE 30, 2010 COMPARED TO
SIX-MONTH PERIOD ENDED JUNE 30, 2009



REVENUES: Revenues for the
six-month period ended June 30, 2010 were $17,227,638 as compared to $14,641,169 for the six-month period ended June 30, 2009. The
increase of revenues of $2,586,469 or 18% was mainly due to global licensing deals for the sale of our m-commerce platform,
OPUS-M.



COST OF REVENUES: Cost of
revenues mainly consist of amortization of intangible assets. Cost of revenues for the six-month period ended June 30, 2010 was
$3,413,320 as compared to $1,839,019 for the six-month period ended June 30, 2009. The increase of $1,574,301 or 86% was primarily
due to the increased amortization of additional license rights acquired.



GROSS MARGIN: Gross margin for
the six-month period ended June 30, 2010 was $13,814,318 as compared to $12,802,150 for the six-month period ended June 30, 2009.
The increase of $1,012,168 or 8% was mainly due to global license deals for the sale of our m-commerce platform, OPUS-M,
offset by the decreased product license revenue generated from mobile games and amortization of license rights acquired.



GENERAL AND ADMINISTRATIVE:
General and administrative expenses consisted of salary for administrative personnel, rent, professional fees, and costs
associated with employee benefits, supplies, communications, travel, and provision for doubtful accounts. General and
administrative expenses for the six-month period ended June 30, 2010 were $1,325,267 as compared to $3,639,996 for the six-month
period ended June 30, 2009. The decrease of $2,314,729 or 64% was mainly due to significant decrease in bad debt expense of
approximately $2.5 million, offset by the increase in professional fees. The significant decrease in bad debt expense was due to a
one-time write-off of trade receivables in 2009 which were determined to be irrecoverable after managements detailed
analysis.



SALES AND MARKETING: Sales and
marketing expenses consisted of salary expenses of sales and marketing personnel, costs relating to marketing materials,
advertising, trade show related expenses, traveling and public relations activities. Sales and marketing expenses for the
six-month period ended June 30, 2010 were $895,337 as compared to $920,025 for the six-month period ended June 30, 2009. The
decrease of $24,688 or 3% was primarily due to decrease in consulting expenses.




15




RESEARCH & DEVELOPMENT:
Research and development expenses consisted of salary, training, consulting, subcontracting and other expenses incurred to develop
and fulfill the design specifications and productions of the products and services from which we derive our revenues. Research and
development expenses for the six-month period ended June 30, 2010 were $1,242,261 as compared to $1,620,243 for the six-month
period ended June 30, 2009. The decrease of $377,982 or 23% was primarily due to decrease in staff and consulting expenses, offset
by increase in data hosting and web service and travel expenses .



OTHER EXPENSE/INCOME: Other
(expense)/income for the six-month period ended June 30, 2010 was ($1,558,697) as compared to ($369,337) for the six-month period
ended June 30, 2009. Net expense of $1,558,697 was primarily due to foreign currency transaction losses of approximately
$1,522,000 for the six-month period ended June 30, 2010 compared to approximately $412,000 for the six-month period ended June 30,
2009. The increase in foreign currency transaction losses was mostly due to the adverse effect of the weakening of the Euro relative
to the United States Dollar on the trade receivables denominated in Euro.



INCOME FROM OPERATIONS AND NET
INCOME: Income from operations for the six-month period ended June 30, 2010 was $9,923,952 as compared to income from operations
of $6,510,772 for the six-month period ended June 30, 2009. The income from operations is primarily due to revenue of $17,227,638
generated from global licensing deals for the sale of our m-commerce platform, OPUS-M, offset by the cost of revenue of $3,413,320
and the operational cost of $3,890,366. Net income for the six-month period ended June 30, 2010 was $7,238,010 as compared to net
income of $5,483,435 for the six-month period ended June 30, 2009. The basic and diluted net income per share for the six-month
period ended June 30, 2010 was $0.12, as compared to $0.11 for the six-month period ended June 30, 2009.



For the six-month period ended
June 30, 2010, the income tax expense includes a current income tax expense of $1,425,290 (2009: $658,000) and deferred tax credit
of $298,045 (2009: nil). The deferred tax credit includes a discrete deferred tax benefit of $415,207 (2009: nil) which was
recognized as a result of a change in judgment during the six-month period ended June 30, 2010 about the realizability of the
deferred tax assets of certain subsidiaries of the Company in future years. The change in judgment was mainly due to the
successful development and launching of new products during the period.



LIQUIDITY AND CAPITAL RESOURCES



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, 2010 and 2009, are summarized as follows:




2010
        
        2009USD
        
        USDCash (used in) provided by:Operating activities
        $                    4,260,420
        
        $                     (1,330,986)Investing activities
        (7,852,440)
        
        (300,059)Financing activities
        3,180,622
        
        1,916,453Effect of exchange rate changes on cash
        (153,923)
        
        (276,893)Net (decrease) increase in cash, considering effect of exchange rate changes on cash
        $                    (565,321)
        
        $                               8,515



Net cash provided by operating
activities was $4,260,420 for the six-month period ended June 30, 2010, which was an increase of $5,591,406 compared to the
six-month period ended June 30, 2009. This increase in cash provided was due primarily to the increase in net income and
collections from customers.



Net cash used in investing
activities was $7,852,440 for the six-month period ended June 30, 2010, which was an increase of $7,552,381 compared to the
six-month period ended June 30, 2009. This increase was primarily due to increased cash expenditures for purchase of license
rights.



Net cash provided by financing
activities was $3,180,622 for the six-month period ended June 30, 2010, which was an increase of $1,264,169 compared to the
six-month period ended June 30, 2009. This increase was primarily due to private placements that raised net cash proceeds of
$3,784,579, as compared to $1,905,200 raised in the six-month period ended June 30, 2009, offset by the repayment of note payable
of $666,667 during the six-month period ended June 30, 2010.




16



As of June 30, 2010, we had a
working capital surplus of $17,220,284 and stockholders' equity of $57,378,238.




We have borrowed funds from time
to time in the past from our chief executive officer, Eberhard Schoneburg. As of June 30, 2010, we owed our chief executive
officer an aggregate amount of $1,745,701, as compared to $1,606,328 at December 31, 2009. During the six-month period ended June
30, 2010, our chief executive officer advanced an additional $1,149,331, including deferred salary of $55,664, 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 2010, and we expect that cash flows generated from 2010 operations and additional
financing through various sources will be sufficient to fund the Companys operations, working capital, and commitment needs
for the next twelve 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 since 2008, following the housing downturn and subprime lending collapse in the United
States in 2009 and the sovereign debt crisis in Europe in 2010. 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 an 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 trade receivables may need to be allowed or for written off in the coming quarters.



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. Continuation or further worsening of
these difficult financial and macroeconomic conditions could have a significant adverse effect on our sales, collectability of our
trade receivables, profitability and results of operations.



Because the Companys trade
receivables 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. Since
2009, the Company has entered into offsetting agreements with customers whereby consideration for the sale of license rights
offset against amount payable by the Company related to the acquisition of license rights from the same party. Management of the
Company considered it appropriate and advantageous for the Company to minimize cash expenditures and credit risk exposure and
thereby entered into such offsetting arrangements. During the quarter ended June 30, 2010, no such offsetting agreement has been
entered into. The average age of receivables from the Companys six largest customers (which accounted for approximately 92%
of total trade receivables) was 180 days at June 30, 2010 as compared to 108 days at December 31, 2009. As of August 5, 2010, cash
receipt of approximately $8.3 million of the total trade accounts and installment receivables as at June 30, 2010 has been
collected, which has significantly increased as compared to the cash payment of approximately $4.6 million collected during the
full year of 2009.



Recently Issued and Adopted Accounting Pronouncements



We describe recent accounting
pronouncements in Item 1 - Condensed Consolidated Financial Statements - Notes to Condensed Consolidated Financial
Statements Note 1. Basis of Presentation.



OFF-BALANCE SHEET ARRANGEMENTS



At June 30, 2010, we did not
have any off-balance sheet arrangements.



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



Not applicable





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ITEM 4T. 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 their evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures
were effective as of June 30, 2010.



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 have materially affected, or are 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 2010 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.



ITEM 1A - RISK FACTORS



Not applicable.



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



See Part I, Note 12. Stockholders Equity.



ITEM 3 - DEFAULTS UPON SENIOR SECURITIES



Not applicable.



ITEM 4 - [REMOVED AND RESERVED]



ITEM 5 - OTHER INFORMATION



On July 1, 2010, we amended and
restated our Code of Ethics, which is disclosed on our Companys website atwww.artificial-life.com.



As reported on the current
report on Form 8-K filed on July 1, 2010, on July 1, 2010, we amended Eberhard Schoneburgs employment contract
(Amendment). The Amendment will extend the current employment agreement through December 31, 2014. In accordance with
the terms of the Amendment, Mr. Schoneburg will continue to serve as the current and acting chairman of the board of directors,
chief executive officer and president. All other terms of Mr. Schoneburgs employment agreement remain the same.



As reported on the current
report on Form 8-K filed on July 21, 2010 and the report on Form 4, on July 8, 2010, we repaid $760,000 of the outstanding loan
balance of $1,694,329 owed to Mr. Schoneburg through the issuance of 1,000,000 shares of common stock at a purchase price of $0.76
per share (being the closing price at July 7, 2010). On the same date, we issued to Mr. Schoneburg warrants to purchase an additional 300,000 shares of common stock. The
warrants have a three-year term with exercise price at $1, which are immediately exercisable. On the same date, a substitute loan
agreement was entered into between the Company and Mr. Schoneburg on the remaining balance of $934,329, which bears interest at
5%, secured by the assets of the Company and repayable on demand. The issuance of the common stock and warrants are exempt from
the registration requirements of the Securities Act of 1933, as amended, or the Securities Act, in accordance with Section 4(2) of
the Securities Act and Regulations D and S under the Securities Act.



As reported on the current
report on Form 8-K filed on July 19, 2010, on July 16, 2010, Mr. Schoneburg resigned as chief financial officer of the Company and
retained his positions as president, chief executive officer and chairman of the Company. The Companys former global
controller, Frank Namyslik, was appointed as the new chief financial officer.













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ITEM 6 - EXHIBITS




10.5
        Amendment to Employment Agreement, dated July 1, 2010 between the Registrant and Eberhard Schoneburg (Incorporated by reference to Exhibit 10.5 to the Registrants Current Report on Form 8-K/A filed on July 7, 2010)14.1*
        Amended and Restated Code of Ethics31.1*
        Certification of Principal Executive Officer pursuant to Exchange Act Rule 13a-1(a) or Rule 15d-14(a) (authorized by Section 302 of the Sarbanes-Oxley Act of 2002)31.2*
        Certification of Principal Financial Officer pursuant to Exchange Act Rule 13a-1(a) or Rule 15d-14(a) (authorized by Section 302 of the Sarbanes-Oxley Act of 2002)32.1*
        Certification of Principal Executive Officer Pursuant to 18 U.S.C. §1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2*
        Certification of Principal 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 5, 2010


By:/s/ Eberhard Schoneburg

Name: Eberhard Schoneburg

Title:   Chief Executive Officer











By:/s/ Frank Namyslik

Name: Frank Namyslik

Title:   Chief Financial Officer






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