UNITED STATESSECURITIES 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 March 31,
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. Yes [X]   No [  ]




Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.




Large accelerated filer [  ]            
      Accelerated filer [  ]Non-accelerated filer [  ] (Do not check if a smaller
reporting company) Smaller reporting company [X]




Indicate by check mark whether the registrant is a shell
company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ]   No [X]




State the number of shares of each of the Issuers
classes of common equity, as of the latest practicable date: As of April 30, 2009 there were 47,724,132 shares of Common Stock, $.01 par value per
share, outstanding.


---





ARTIFICIAL LIFE, INC.




INDEX OF INFORMATION CONTAINED IN FORM 10-Q FOR THE
QUARTER ENDED MARCH 31, 2009


|                                                                                                                                        |  |  |  | PAGE
|--------------------------------------------------------------------------------------------------------------------------------------- |  |  |  | ----
|PART I-FINANCIAL INFORMATION                                                                                                           
|Item 1 
Financial Statements                                                                                                           |  |  |  |     
|Condensed
Consolidated Balance Sheets as of March 31, 2009 (unaudited) and December 31, 2008                                            |  |  |  |     
|Condensed
Consolidated Statements of Operations and Comprehensive Income for the Three Months Ended March 31, 2009 and 2008 (unaudited) |  |  |  |     
|Condensed
Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2009 and 2008 (unaudited)                          |  |  |  |     
|Notes to
Condensed Consolidated Financial Statements (unaudited)                                                                        |  |  |  |     
|                                                                                                                                       
|Item 2 
Managements Discussion and Analysis of Financial Condition and Results of Operations                                          |  |  |  |     
|                                                                                                                                       
|Item 3 
Quantitative and Qualitative Disclosure About Market Risk                                                                      |  |  |  |     
|                                                                                                                                       
|Item 4 
Controls and Procedures                                                                                                        |  |  |  |     
|                                                                                                                                        |  |  |  |     
|                                                                                                                                       
|PART IIOTHER INFORMATION                                                                                                              
|                                                                                                                                       
|Item 1 
Legal Proceedings                                                                                                              |  |  |  |     
|                                                                                                                                       
|Item 1A
 Risk Factors                                                                                                                  |  |  |  |     
|                                                                                                                                       
|Item 2 
Unregistered Sales of Equity Securities and Use of Proceeds                                                                    |  |  |  |     
|                                                                                                                                       
|Item 3 
Defaults Upon Senior Securities                                                                                                |  |  |  |     
|                                                                                                                                       
|Item 4 
Submission of Matters to a Vote of Security Holders                                                                            |  |  |  |     
|                                                                                                                                       
|Item 5 
Other Information                                                                                                              |  |  |  |     
|                                                                                                                                       
|Item 6 
Exhibits                                                                                                                       |  |  |  |     
|                                                                                                                                       
|Signatures                                                                                                                              |  |  |  |     



2


---



PART I FINANCIAL INFORMATION




ITEM 1. FINANCIAL STATEMENTS




ARTIFICIAL LIFE, INC. CONDENSED CONSOLIDATED BALANCE
SHEETS







|                                                                                    |  |  |  | March 31, 2009 |             | December 31, 2008
|----------------------------------------------------------------------------------- |  |  |  | -------------- | ----------- | -----------------
|
|ASSETS                                                                              |  |  |  |                |             |                  
|                                                                                   
|Current
assets:                                                                     |  |  |  |                |             |                  
|Cash                                                                                |  |  |  | $              | 120,477     |                  
|Accounts
receivable, net                                                            |  |  |  |                | 16,509,716  |                  
|Prepaid
expenses and other                                                          |  |  |  |                | 646,363     |                  
|Deferred tax
asset                                                                  |  |  |  |                |            |                  
|Total current
assets                                                                |  |  |  |                | 17,276,556  |                  
|Fixed assets,
net                                                                   |  |  |  |                | 3,103,070   |                  
|License
rights, net                                                                 |  |  |  |                | 12,077,873  |                  
|Prepaid
expenses, deposits and other assets                                         |  |  |  |                | 1,036,738   |                  
|                                                                                    |  |  |  |                | 13,114,611  |                  
|TOTAL
ASSETS                                                                        |  |  |  | $              | 33,494,237  |                  
|                                                                                   
|LIABILITIES AND STOCKHOLDERS EQUITY                                                |  |  |  |                |             |                  
|Accounts
payable                                                                    |  |  |  | $              | 1,441,265   |                  
|Accrued
expenses and other                                                          |  |  |  |                | 395,090     |                  
|Income tax
payable                                                                  |  |  |  |                | 75,000      |                  
|Note payable
 officer/stockholder                                                  |  |  |  |                | 613,185     |                  
|Notes
payable                                                                       |  |  |  |                | 1,000,000   |                  
|Total
liabilities (all current)                                                     |  |  |  |                | 3,524,540   |                  
|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,                        |  |  |  |                |            |                  
|47,724,132
shares issued and outstanding as of March 31, 2009 and December 31, 2008 |  |  |  |                | 477,241     |                  
|Additional
paid-in capital                                                          |  |  |  |                | 51,708,712  |                  
|Notes
receivable from stockholders                                                  |  |  |  |                | (19,577     | )                
|Accumulated
deficit                                                                 |  |  |  |                | (21,973,913 | )                
|Accumulated
other comprehensive loss                                                |  |  |  |                | (222,766    | )                
|Total
stockholders equity                                                          |  |  |  |                | 29,969,697  |                  
|                                                                                    |  |  |  | $              | 33,494,237  |                  



See accompanying notes to unaudited condensed consolidated
financial statements.




3


---



ARTIFICIAL LIFE, INC. CONDENSED CONSOLIDATED
STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (UNAUDITED)







|                                              |  |  |  | Three-month Periods Ended March 31, |           
|--------------------------------------------- |  |  |  | ----------------------------------- | ----------
|
|Revenues:                                     |  |  |  |                                     |           
|Software
license revenue                      |  |  |  | $                                   | 7,052,373 
|Application
services and other revenue        |  |  |  |                                     | 10,827    
|                                              |  |  |  |                                     | 7,063,200 
|Cost of
revenues:                             |  |  |  |                                     |           
|Cost of
software license revenue              |  |  |  |                                     | 726,270   
|Cost of
application service and other revenue |  |  |  |                                     | 15,142    
|                                              |  |  |  |                                     | 741,412   
|Gross
Profit                                  |  |  |  |                                     | 6,321,788 
|Operating
expenses:                           |  |  |  |                                     |           
|General and
administrative                    |  |  |  |                                     | 1,585,173 
|Research and
development                      |  |  |  |                                     | 858,326   
|Sales and
marketing                           |  |  |  |                                     | 491,620   
|Total
operating expenses                      |  |  |  |                                     | 2,935,119 
|Income from
operations                        |  |  |  |                                     | 3,386,669 
|Other income
(expense):                       |  |  |  |                                     |           
|Interest
income and other                     |  |  |  |                                     | 20        
|Interest
expense                              |  |  |  |                                     | (30,252   
|Foreign
currency transaction (loss) gain      |  |  |  |                                     | (129,206  
|                                              |  |  |  |                                     | (159,438  
|Income before
income taxes                    |  |  |  |                                     | 3,227,231 
|Income tax
expense                            |  |  |  |                                     | (515,000  
|Net
income                                    |  |  |  |                                     | 2,712,231 
|Foreign
currency translation adjustment       |  |  |  |                                     | (92,678   
|Comprehensive
income                          |  |  |  | $                                   | 2,619,553 
|Net income
per share                          |  |  |  |                                     |           
|Basic                                         |  |  |  | $                                   | 0.06      
|Diluted                                       |  |  |  | $                                   | 0.06      
|Weighted
average shares outstanding           |  |  |  |                                     |           
|Basic                                         |  |  |  |                                     | 47,724,132
|Diluted                                       |  |  |  |                                     | 48,044,509



See accompanying notes to unaudited condensed consolidated
financial statements.




4


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ARTIFICIAL LIFE, INC. CONDENSED CONSOLIDATED
STATEMENTS OF CASH FLOWS (UNAUDITED)







|                                                                                     |  |  |  | Three-month Period Ended March 31, |           
|------------------------------------------------------------------------------------ |  |  |  | ---------------------------------- | ----------
|
|Cash flows
from operating activities:                                                |  |  |  |                                    |           
|Net
income                                                                           |  |  |  | $                                  | 2,712,231 
|Adjustments
to reconcile net income (loss) to net cash used in operating activities: |  |  |  |                                    |           
|Depreciation
and amortization                                                        |  |  |  |                                    | 779,683   
|Deferred
income tax expense                                                          |  |  |  |                                    | 500,000   
|Amortization
of discount on notes payable                                            |  |  |  |                                    |          
|Provision for
losses on doubtful accounts receivable                                 |  |  |  |                                    | 1,095,212 
|Foreign
currency transaction loss (gain)                                             |  |  |  |                                    | 129,206   
|Interest
expense accrued on notes payable officer / stockholder                      |  |  |  |                                    | 4,038     
|Bonus accrued
to officer / stockholder                                               |  |  |  |                                    | 23,052    
|Changes in
operating assets and liabilities:                                         |  |  |  |                                    |           
|Increase in
restricted cash                                                          |  |  |  |                                    |          
|Increase in
accounts receivable                                                      |  |  |  |                                    | (3,836,206
|Decrease (increase) in
prepaid expenses, deposits and other assets                   |  |  |  |                                    | 50,533    
|Decrease in
accounts payable, accrued expenses and other                             |  |  |  |                                    | (2,484,025
|Increase in
income tax payable                                                       |  |  |  |                                    | 15,000    
|Net cash used
in operating activities                                                |  |  |  |                                    | (1,011,276
|Cash flows
from investing activities:                                                |  |  |  |                                    |           
|Purchase of
fixed assets                                                             |  |  |  |                                    | (14,105   
|Purchase of
license rights                                                           |  |  |  |                                    |          
|Net cash used
in investing activities                                                |  |  |  |                                    | (14,105   
|Cash flows
from financing activities:                                                |  |  |  |                                    |           
|Net proceeds
from issuance of common stock                                           |  |  |  |                                    |          
|Repayment of
note payable to officer / stockholder                                   |  |  |  |                                    | (151,676  
|Net cash (used
in) provided by financing activities                                  |  |  |  |                                    | (151,676  
|Net decrease
in cash                                                                 |  |  |  |                                    | (1,177,057
|Cash, beginning of period                                                            |  |  |  |                                    | 1,430,578 
|Effect of
exchange rate changes on cash                                              |  |  |  |                                    | (133,044  
|Cash, end of period                                                                  |  |  |  | $                                  | 120,477   
|                                                                                    
|Supplemental
disclosure of non-cash investing activity:                              |  |  |  |                                    |           
|Purchase of
license rights in exchange for accounts payable                          |  |  |  | $                                  | 3,177,250 



See accompanying notes to unaudited condensed consolidated
financial statements.




5


---



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 three
months ended March 31, 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




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 March 31, 2009, the
Company has no financial assets or liabilities subject to recurring fair value measurements.




6


---



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 will require 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 will be 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.




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.




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 three-month
periods ended March 31, 2009 or 2008. At March 31, 2009, the Company had outstanding options to purchase 2,165,000 shares of common stock under its
stock option plan, issued to employees as follows:







|Weighted average
exercise price             |  |  |  | $0.87   
|------------------------------------------- |  |  |  | --------
|Aggregate
intrinsic value                   |  |  |  | $8,450  
|Weighted average
remaining contractual term |  |  |  | 0.7
year



7


---



At March 31, 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                   |  |  |  | $0      
|Weighted average
remaining contractual term |  |  |  | 0.7
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. As a result, 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
($1,826,500 at March 31, 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, and general economic conditions and trends, 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.




At March 31, 2009, the Company
had 80 telecom carriers, resellers, distributors and general corporate customers compared to 70 such customers at December 31, 2008, and compared to 48
customers at March 31, 2008.




For the three-month period ended
March 31, 2009, the Company had two customers that represented approximately 62% and 36% of the Companys revenues. For the three-month period
ended March 31, 2008, the Company had three customers that represented approximately 70%, 25% and 3% of the Companys revenues.




At March 31, 2009, accounts
receivable were due from 57 customers. Of these, three customers accounted for 86% of total accounts receivable; one accounted for approximately 62%
and two accounted for approximately 12% each. At March 31, 2009, the average age of accounts receivable from all customer was 91 days as compared to 83
days at December 31, 2008.




4. NET INCOME PER SHARE




Basic net income per share is
calculated based on the weighted average number of common shares outstanding for the three month periods ended March 31, 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 ended March 31, 2009 and 2008.







|                                              |  |  |  | 2009 |            | 2008
|--------------------------------------------- |  |  |  | ---- | ---------- | ----
|Shares used
in basic per share calculation    |  |  |  |      | 47,724,132 |     
|Effect of
dilutive securities:                |  |  |  |      |            |     
|Options                                       |  |  |  |      | 245,108    |     
|Warrants                                      |  |  |  |      | 75,269     |     
|Shares used
in dilutive per share calculation |  |  |  |      | 48,044,509 |     



8


---



5. INCOME TAXES




The difference between the
expected and effective income tax expense recorded for the three-month periods ended March 31, 2009 and 2008, is due primarily to changes in the
valuation allowance on net deferred tax assets.




At March 31, 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 concluded that as of March 31, 2009, the net deferred tax asset is not more likely than not of being 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 March 31, 2009, the Company
has recorded a current income tax payable of $75,000, which consists of estimated state income taxes and 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 the Company 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, and
the Company intends to file a counterclaim for damages of at least $1 million. The Company cannot predict the outcome; however, 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.




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 unsecured and repayable until sufficient new funding for payback is available. Activity on the note payable during the quarters ended March 31,
2009 and 2008, is as follows:







|                             |  |  |  | 2009 |          | 2008
|---------------------------- |  |  |  | ---- | -------- | ----
|Beginning
balance, January 1 |  |  |  | $    | 737,771  |     
|Repayments                   |  |  |  |      | (151,676 | )   
|Accrued
salary and bonus     |  |  |  |      | 23,052   |     
|Accrued
interest             |  |  |  |      | 4,038    |     
|Ending
balance, March 31     |  |  |  | $    | 613,185  |     



Other Notes:




At December 31, 2008, 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. 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. These notes were
determined not to have any beneficial conversion feature, as the conversion price exceeded the market price of the Company’s common stock.




9


---



8. 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 nonperformance.




Fair Value Hierarchy




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  Unobservable inputs to the valuation
methodology that are significant to the measurement of fair value of assets or liabilities.




Assets and Liabilities Measured at Fair Value on a
Recurring Basis




The Company measures its
financial assets at fair value. The Company does not have any financial liabilities that are measured at fair value on a
recurring basis. The fair value of these financial assets was determined using the following inputs as of March 31, 2009 and December 31,
2008:







|     |  |  |  | March 31, 2009 |         | December 31, 2008
|---- |  |  |  | -------------- | ------- | -----------------
|
|Cash |  |  |  | $              | 120,477 |                  



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.




10


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OVERVIEW




In the first quarter of 2009, we
sold over 3,443,000 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 and especially in 2009 is on the development, sales and launch of iPhone and iPOD Touch games. Since December 2008 through May
2009, the Company has successfully developed and released the following seven 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 and
iDroidsTM.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The number of downloads achieved
with these games has already far exceeded the 1 million mark and 4 of the released games have already reached the top 10 ranks for most downloads in
the USA and/or in many other countries around the globe (on the Apple app store resales platform).




In January 2009, we signed a license
agreement with the German car maker BMW to launch a promotional iPhone game for the new BMW Z4 car model. In March 2009, we signed an additional
license agreement with BMW for the BMW F1 Sauber Formula One racing team.




In February 2009, we launched the
SHOOTER iPhone game with Paramount. The game reached the second highest level of downloads in the app store of Apple.




In March 2009, we launched the
BMW Expression of Joy Z4 LITE iPhone game. Also in March 2009, we signed a license agreement with the German soccer club BVB Borussia Dortmund to
develop a Java soccer game for the club.




During the three months ended
March 31, 2009, we continued to market and expand the distribution of our products in Europe and Asia by entering into various strategic relationships.
We are now selling in over 100 countries globally through resellers and telecom partners and globally to all countries that have an agreement with
Apple and their app store/iTunes distribution platform.




In addition to marketing our
current products, we continue to focus on developing many 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 on-going talks with global media, major global brands and game companies to license more appealing
content and intellectual properties.




Even though several of the 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 March 31, 2009, we had
total assets of $33,494,237 and total liabilities of $3,524,540. As of March 31, 2009, current assets were $17,276,556 as compared to $16,704,265 at
December 31, 2008, and current liabilities were $3,524,540 as compared to $2,940,329 at December 31, 2008.




We had 68 full time employees as
of March 31, 2009. We also hire temporary staff, external consultants and interns to support our operations.




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As we are still in the early
phase of the global roll out of our key mobile products in several countries around the world, and as we resume research and development and new
engineering efforts, 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. Factors that may affect our operating results include 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, 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 and European markets. Gross profit margins will vary from
product to product and between products and services and the countries in which we launch our products. 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 is often 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.




RESULTS OF OPERATIONS




THREE MONTHS ENDED MARCH 31, 2009 COMPARED TO THREE
MONTHS ENDED MARCH 31, 2008




REVENUES: Revenues for the
quarter ended March 31, 2009 were $7,063,200 as compared to $4,125,004 for the quarter ended March 31, 2008. The increase of revenues of $2,938,196 or
71% was mainly due to increased product license revenue 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 Mobile BoosterTM.




COST OF REVENUES: Cost of
revenues mainly consist of amortization of intangible assets. Cost of revenues for the quarter ended March 31, 2009 was $741,412 as compared to
$200,800 for the quarter ended March 31, 2008. The increase of $540,612 or 269% was primarily due to amortization expense of license
rights.




GROSS MARGIN: Gross margin for
the quarter ended March 31, 2009 was $6,321,788 as compared to $3,924,204 for the quarter ended March 31, 2008. The increase of $2,397,584 or 61% 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 consist 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 March 31,
2009 were $1,585,173 as compared to $446,932 for the quarter ended March 31, 2008. The increase of $1,138,241 was mainly due to a charge to increase
the allowance for doubtful accounts receivable by approximately $1,095,000, and due to slight increases in legal, staff and office
expenses.




SALES AND MARKETING: Sales and
marketing expenses consist of salary expenses of sales and marketing personnel, costs relating to marketing materials, advertising, trade show related
expense, traveling and public relations activities. Sales and marketing expenses for the quarter ended March 31, 2009 were $491,620 as compared to
$422,635 for the quarter ended March 31, 2008. The increase of $68,985 was primarily due to slight increases in staff and consulting, office and
traveling expenses.




RESEARCH & DEVELOPMENT:
Research and development expenses consist 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
March 31, 2009 were $858,326 as compared to $523,917 for the quarter ended March 31, 2008.




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The increase of $334,409 was
mainly due to increases of approximately $269,000 in staff and consulting expenses and $75,000 in data hosting and web service.




OTHER EXPENSE/INCOME: Other
(expense)/income for the quarter ended March 31, 2009 was ($159,438) as compared to $88,420 for the quarter ended March 31, 2008. Net expense of $159,438
was mainly due to interest expense of ($30,252) and foreign currency transaction losses of approximately ($129,000) in this quarter comparing to a
gain of approximately $168,000 in the first quarter of 2008.




INCOME FROM OPERATIONS AND NET
INCOME: Income from operations for the quarter ended March 31, 2009 was $3,386,669 as compared to income from operations of $2,530,720 for the quarter
ended March 31, 2008. The income from operations is mainly due to revenue of $7,063,200 from the sale of product licenses for our mobile games, one
time downloads and monthly subscription revenues for 3G games and business application licenses offset by cost of revenue of $741,412 and operational
cost of $2,935,119. Net income for the quarter ended March 31, 2009 was $2,712,231 as compared to net income of 2,493,585 for the quarter ended March
31, 2008. The basic and diluted net income per share for the first quarter of 2009 was $0.06, as compared to $0.06 and $0.05, respectively,
for the quarter ended March 31, 2008.




The difference between the
expected and effective income tax expense recorded for the three-month periods ended March 31, 2009 and 2008, is due primarily to changes in the
valuation allowance on net deferred tax assets.




At March 31, 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 concluded that as of March 31, 2009, the net deferred tax asset is not more likely than not of being 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 March 31, 2009, the Company
has recorded a current income tax payable of $75,000, which consists of estimated state income taxes and federal alternative minimum
tax.




LIQUIDITY AND CAPITAL RESOURCES




As of March 31, 2009, we had a
working capital surplus of $13,752,016 and stockholders equity of $29,969,697.




We have borrowed funds from time
to time in the past from our chief executive officer, Eberhard Schoneburg. As of March 31, 2009, we owed our CEO an aggregate amount of $613,185, as
compared to $737,771 at December 31, 2008. In April and May 2009, our CEO advanced an additional $246,788, including deferred salary of $44,531, to the
Company. The advanced funds bear interest at a rate of 5% per year and are unsecured.




The Company continued to generate
income in the first quarter of 2009, and we expect that cash flows 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 twelve months.




We expect that we will need to
raise additional capital to support our operations and accommodate planned future growth. 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.




In addition, 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 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 accounts receivable 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. Nonetheless, continuation or further worsening of these difficult




13


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financial and macroeconomic
conditions could have a significant adverse effect on our sales, collectability of our accounts receivables, profitability and results of
operations.




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 March 31, 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 will require 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 will be 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.




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




14


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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 March 31, 2009, we did not
have any 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 our Principal 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 Principal Financial Officer have concluded that our disclosure controls and procedures were effective as of March 31,
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.




15


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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 the Company 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 and
intends to file a counterclaim for damages of at least $1 million. The Company cannot predict the outcome; however, 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.




ITEM 1A  RISK FACTORS




Not applicable.




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







|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.



16


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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: May 12,
2009 |  |  |  |                                                                                                                    
|                   |  |  |  | By: /s/ Eberhard SchoneburgName: Eberhard Schoneburg Title: Chief Executive Officer and
Principal Financial Officer



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