UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington, D.C.
20549




Form 10-K




(Mark
One)


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


For
the fiscal year ended June 30, 2010


OR





o
            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 000-51869




SOUTHPEAK
INTERACTIVE CORPORATION


(Exact Name of Registrant as
Specified in Its Charter)




Delaware
              
              20-3290391(State
      or Other Jurisdiction of
              
              (I.R.S.
      EmployerIncorporation
      or Organization)
              
              Identification
      No.)




2900
Polo Parkway


Midlothian,
Virginia 23113


(804)
378-5100


(Address including zip code, and
telephone number, including area code, of principal executive
offices)




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




None




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




Common
stock, par value $.0001 per share


Class W
warrants, each to purchase one share of common stock


Class Y
warrants, each to purchase one share of common stock


Class Z
warrants, each to purchase one share of common stock


(Title
of Class)




Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.  Yes  ̈     No þ




Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.  Yes o     No þ




Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 (the
“Exchange Act”) during the preceding 12 months (or for such shorter period
that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days.  Yes þ     No o




Indicate
by check mark whether the registrant (1) 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 (Section 232.405 of this chapter) during the
preceding 12 months (or for such shorter period that the registrant was
required to submit and post such files).  Yes o     No o




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




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check
one):




Large accelerated filer o
              
              Accelerated filer o
              
              Non-accelerated filer o
              
              Smaller reporting company þ




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




The
aggregate market value of the common stock held by nonaffiliates of the
registrant (15,348,914 shares), based on the $.32 closing price of the
registrant’s common stock as reported on the Over-the-Counter bulletin board on
December 31, 2009, was approximately $4,911,652. For purposes of this
computation, all officers, directors and 10% beneficial owners of the registrant
are deemed to be affiliates. Such determination should not be deemed to be an
admission that such officers, directors or 10% beneficial owners are, in fact,
affiliates of the registrant.




As of
October 13, 2010, there were 60,795,538 outstanding shares of the registrant’s
common stock.










TABLE
OF CONTENTS




PagePART
      IItem
      1.  Business
                
                4Item
      1A.  Risk Factors
                
                12Item 1B.  Unresolved
      Staff Comments
                
                25Item 2.  
      Properties
                
                25Item 3.  
      Legal Proceedings
                
                26Item 4.  
      Submission of Matters to a Vote of Security HoldersPART
      IIItem
      5.   Market for Registrant’s Common Equity, Related Stockholder
      Matters and Issuer Purchases of Equity Securities
                
                26Item
      7.  Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
                
                27Item
      7A.  Quantitative and Qualitative Disclosures about Market
      Risk
                
                39Item
      8.  Financial Statements and Supplementary Data
                
                39Item
      9.  Changes in and Disagreements with Accountants on Accounting
      and Financial Disclosure
                
                39Items
      9A(T).  Controls and ProceduresItem
      9B.  Other Information
                
                42PART
      IIIItem
      10.  Directors, Executive Officers and Corporate
      Governance
                
                43Item
      11.  Executive Compensation
                
                47Item
      12.  Security Ownership of Certain Beneficial Owners and
      Management and Related Stockholder Matters
                
                53Item
      13.  Certain Relationships and Related Transactions, and
      Director Independence
                
                55Item
      14.  Principal Accounting Fees and Services
                
                56PART
      IVItem
      15.  Exhibits and Financial Statement Schedules
                
                58





2





CAUTIONARY
NOTES REGARDING FORWARD-LOOKING STATEMENTS




We
believe that some of the information contained in this report constitutes
forward-looking statements within the definition of the Private Securities
Litigation Reform Act of 1995. You can identify these statements by
forward-looking words such as “may,” “expect,” “anticipate,” “contemplate,”
“believe,” “estimate,” “intend,” “plan,” and “continue” or similar words. You
should read statements that contain these words carefully because
they:




·
            discuss future
      expectations;





·
            contain projections of future
      results of operations or financial condition;
  or





·
            state other “forward-looking”
      information.




We
believe it is important to communicate our expectations to our stockholders.
However, there may be events in the future that we are not able to accurately
predict or over which we have no control. The risk factors and cautionary
language discussed in this report provide examples of risks, uncertainties and
events that may cause actual results to differ materially from the expectations
described by us in our forward-looking statements, including among other
things:




·
            our potential inability to
      compete with larger businesses in our
  industry;





·
            the limitations of our business
      model;





·
            our potential inability to
      anticipate and adapt to changing
  technology;





·
            the possibility that we may not
      be able to enter into publishing arrangements with some
      developers;





·
            our dependence on vendors to meet
      our commitments to
suppliers;





·
            our dependence on hardware
      manufacturers to publish new
videogames;





·
            our potential inability to recoup
      the up-front license fees paid to hardware
      manufacturers;





·
            our dependence on a limited
      number of customers;





·
            our potential dependence on the
      success of a few videogames;





·
            our dependence on developers to
      deliver their videogames on
time;





·
            the potential of
      litigation;





·
            interference with our business
      from the adoption of governmental regulations;
  and





·
            the inability to obtain
      additional financing to grow our
  business.




You are
cautioned not to place undue reliance on these forward-looking statements, which
speak only as of the date of this report. Forward-looking statements involve
known and unknown risks and uncertainties that may cause our actual future
results to differ materially from those projected or contemplated in the
forward-looking statements.




All
forward-looking statements included herein attributable to us or any person
acting on our behalf are expressly qualified in their entirety by the cautionary
statements contained or referred to in this section. Except to the extent
required by applicable laws and regulations, we undertake no obligation to
update these forward-looking statements to reflect events or circumstances after
the date of this report or to reflect the occurrence of unanticipated events.
You should be aware that the occurrence of the events described in the “Risk
Factors” section and elsewhere in this report could have a material adverse
effect on us.





3





PART
I




Item 1.  Business




Overview




We are an
independent developer and publisher of interactive entertainment software. We
utilize our network of independent studios and developers to create videogames
for all popular videogame systems, including:




·
            home videogame consoles such as
      Microsoft Xbox 360, Nintendo Wii, Sony PlayStation 3 and Sony PlayStation
      2;





·
            handheld platforms such as
      Nintendo DS, Nintendo DSi, Sony PSP, Sony PSPgo, and Apple iPhone;
      and





·
            personal
      computers.




Our
portfolio of games extends across a variety of consumer demographics, ranging
from adults to children and hard-core game enthusiasts to casual
gamers.




We are an
“indie” videogame developer and publisher working with independent software
developers and videogame studios to create our videogames. We have cultivated
relationships globally with independent developers and studios that provide us
with innovative and compelling videogame concepts.




We have
generated net revenues of approximately $12.5 million, $40.2 million, $47.3
million and $40.3 million for the fiscal years ended June 30, 2007, 2008, 2009,
and 2010, respectively. In fiscal years 2010 and 2009, however, we incurred net
losses primarily as a result of litigation costs, interest associated with the
production advance payable, write offs for sequels we acquired but have chosen
not to pursue, increased sales and marketing expenses and other expenses
associated with the October 2008 acquisition of Gone Off Deep, LLC, doing
business as Gamecock Media Group, or Gamecock, an independent videogame
publisher based in Austin, Texas.  We refer to the acquisition of
Gamecock herein as the Gamecock Acquisition. Despite the net losses incurred by
us in fiscal years 2010 and 2009, management expects its growth strategy will
drive performance above industry averages for 2011 and beyond. We plan to
leverage our business model and the expanding universe of independent developers
and studios to accelerate investment in new and creative videogames in order to
serve a rapidly expanding base of global consumers.




We
incorporated in Delaware on August 10, 2005, under the name Global Services
Partners Acquisition Corp., to serve as a vehicle to effect an acquisition,
through a merger, capital stock exchange, asset acquisition or other similar
business combination with a then-unidentified operating business. On May 12,
2008, we acquired all of the outstanding membership interests of SouthPeak
Interactive L.L.C., or SouthPeak, pursuant to a Membership Interest Purchase
Agreement. SouthPeak was originally formed in 1996 as an independent business
unit of SAS Institute, Inc. We refer to the reverse acquisition of SouthPeak
herein as the “SouthPeak Acquisition.” We are headquartered in Midlothian,
Virginia, and have offices in Grapevine, Texas and Leichester,
England.




Our
Industry




We
operate in a growing industry with highly favorable industry dynamics. 2007
marked a year of transition and growth in videogame sales based on the
introduction of the next generation of videogame systems in 2005 and
2006.  Particularly, the introduction of Microsoft’s Xbox 360, Sony
PlayStation 3 and Nintendo’s Wii systems are driving demand for new videogames
with increasing sophistication and graphics, given the enhanced functionality of
the systems, including high-definition capability and the ability to access the
Internet. New handheld devices, such as Nintendo DS and DSi, and Sony PSP, are
also expanding the market for new content.





4





Expanding
gamer demographics have also driven demand for interactive entertainment
software in recent years, with videogames becoming a mainstream entertainment
choice for a maturing, sophisticated audience. According to the Entertainment
Software Association, for the period 2005 to 2009, the U.S. computer and
videogame software sales grew 10.6% while the entire U.S. economy grew at a rate
of less than two percent. At least half of all Americans claim to play PC or
console videogames, with an estimated 65% of heads of households playing games.
The average game player is 34 years old and has been playing for nearly 12
years. The “Global
Entertainment and Media Outlook: 2008-2012” published by PricewaterhouseCoopers' Global
Entertainment and Media Practice estimates that the videogame industry is
expected to grow from $48.3 billion in global sales in 2008 to $68.3 billion in
2012, a compounded annual growth rate of approximately 10.3%. The largest
category is console games, which is expected to grow from $27.8 billion in 2008
to $34.7 billion in 2012, a compounded annual growth rate of approximately
6.9%.




Our
Strategy




Our
strategy is to establish a portfolio of successful proprietary content for the
major videogame systems, and to capitalize on the growth of the interactive
entertainment market. We currently work exclusively with independent software
developers and videogame studios to develop our videogames. This strategy
enables us to source and create highly innovative videogames while avoiding the
high fixed costs and risk of having a large internal development studio. Through
outsourcing, we are also able to access videogame concepts and content from
emerging studios globally, providing us with significant new product
opportunities with reduced initial financial outlay, compared to internally
developed videogames.




Our
approach is to identify and secure new videogames and intellectual property
rights that focus on delivering profitable, high-quality videogames developed by
talented and reputable professionals. We approach each videogame concept with a
disciplined focus on delivering high contribution margin based on the
anticipated market opportunity.




We
continue to strengthen our position as a leading “indie” videogame publisher and
attract additional independent developers and studios to develop videogames for
us. We are a unique channel for independent developers and studios to bring
their videogames to market and allow them the creative freedom to maximize the
gaming experience. We provide our developers substantial latitude in the
creative process, which has historically resulted in more innovative products.
We work collaboratively with these developers to evaluate emerging trends and
original videogame concepts in an effort to identify new and unique products
that meet continuously evolving consumer trends.




Our
growth strategy is designed to capitalize on our fundamental business strengths
and growth characteristics of the videogame industry. The Company experienced a
15% decrease in net revenue from fiscal year 2009 due to the shift of release
dates for significant titles but we believe our business model can renew a very
high growth rate in the future.  Elements of this growth strategy
include:




·
            focusing on the most current and
      popular videogame systems;





·
            developing innovative and
      compelling content;





·
            developing sequels to successful
      titles;





·
            pursuing digital content
      opportunities; and





·
            expanding our international
      business.




Our
Strengths




Strong
relationships with all of the major videogame retailers and expertise in
understanding consumer demand




Our
management team has significant experience in selling and marketing videogame
products to consumers through mass-market and specialty retailers. Our
management team understands customers’ needs, price points and shifting tastes,
allowing us to capitalize by developing videogames in specialized niches and
genres. Our management team has long-standing relationships with all of the
videogame retailers and distributors and has valuable insight into retail
distribution and a track record of successfully securing product placement and
shelf space. Specifically, Mr. Terry Phillips, our chairman, and Ms. Melanie
Mroz, our president and chief executive officer, worked for Phillips Sales as
sales agents for 17 and 11 years, respectively. In those positions they
represented numerous videogame publishers such as Sony, Take-Two, Konami, Capcom
and Eidos. They were involved in the sales launch of hundreds of videogames,
some of which included well-known franchises such as Grand Theft Auto, Metal
Gear Solid, Mortal Kombat, and Gran Turismo. Their experience also coincided
with the launches of Sony PlayStation, PlayStation 2 and PSP. Their comprised
customer base included GameStop, Wal-Mart, and Blockbuster.





5





Extensive
worldwide network of content developers




We are
positioned as an “indie” videogame developer and publisher and are recognized by
many independent developers and studios as a good alternative to the major
videogame publishers. We have relationships with many independent developers and
studios globally who present us with compelling videogame publishing
opportunities. We maintain contacts with these developers to review new
videogame concepts and proposals, and are constantly initiating new
relationships with emerging creative talent.




In
particular, our product development and production teams regularly participate
in videogaming conferences and conventions around the world and visit with
independent developers and studios to discuss videogame concepts and evaluate
their capabilities. Additionally, we actively share information with studios
regarding videogame market trends and the current buying preferences and
emerging tastes of our customers, positioning us as a valuable resource to
developers and studios in developing creative videogame concepts. We collaborate
with these developers and studios in identifying niche opportunities not yet
explored to develop and publish content.




Developer-friendly
mindset and vision providing the developer with creative freedom




Our
business model allows us flexibility in negotiating with and structuring
development agreements with independent developers and studios. Our
developer-friendly approach fosters an environment that allows developers and
studios to exercise their creative freedom in conceptualizing and designing a
videogame experience. The flexibility afforded to developers is a key component
in attracting developers to work with us and enables us to continue the growth
in our pipeline of products.




Our
Products




We have
published videogames on many videogame systems and in a variety of
genres, including action/adventure, role playing, racing, puzzle strategy,
fighting and combat. The following titles were released during the fiscal years
ended June 30, 2010 and 2009:




Fiscal
Year 2010





Title
              
              Platform
              
              Date ReleasedEU
      Rome Gold
              
              PC
              
              7/7/2009East
      India Company
              
              PC
              
              7/9/2009Brave:
      A Warrior’s Tale
              
              X360,
      Wii
              
              8/1/2009Hearts
      of Iron 3
              
              PC
              
              8/3/2009Raven
      Squad: Hidden Dagger
              
              X360,
      PC
              
              8/21/2009Section
      8
              
              X360,
      PC
              
              8/26/2009Trine
              
              PC
              
              9/4/2009Majesty
      2: The Fantasy Kingdom
              
              PC
              
              9/16/2009Supreme
      Ruler 2020
              
              PC
              
              9/17/2009Horrid
      Henry
              
              NDS,
      Wii, PC
              
              10/30/09My Baby First
      Steps
              
              NDS,
      Wii
              
              11/3/09Fallen
      Earth
              
              PC
              
              11/22/09Fast
      Food Panic
              
              NDS
              
              12/18/09Schrodinger’s
      Rat
              
              iPhone
              
              12/23/09Blood
      Bowl
              
              X360,
      PC
              
              1/26/10Hotel
      Giant 2
              
              PC
              
              1/26/10





6




Crime
      Scene
              
              NDS
              
              2/16/10Risen
              
              X360
              
              2/23/10Prison
      Break
              
              PS3,
      X360, PC
              
              3/20/10DJ
      Star (1)
              
              NDS
              
              3/26/10Sushi
      Go Round
              
              Wii,
      NDS
              
              3/30/10Elite
      Forces: Unit 77 (2)
              
              NDS
              
              4/19/10Dementium
      II
              
              NDS
              
              5/4/103D
      Dot Game Heroes
              
              PS3
              
              5/14/10Let’s
      Play: Ballerina
              
              Wii,
      NDS
              
              6/8/10Let’s
      Play: Garden
              
              Wii,
      NDS
              
              6/8/10Let’s
      Play: Flight Attendant
              
              Wii,
      NDS
              
              6/8/10Secret
      Files: Tunguska
              
              Wii,
      NDS
              
              6/29/10TNA
      Impact! Cross the Line
              
              NDS,
      PSP
              
              6/29/10




(1)
            DJ
      Star initially released by Deep Silver on November 10,
      2009.  Released by SouthPeak Interactive on March 26,
      2010.


(2)
            Elite
      Forces: Unit 77 initially released by Deep Silver on April 28,
      2009.  Released by SouthPeak Interactive on April 19,
      2010.




Fiscal
Year 2009




Title
              
              Platform
              
              Date ReleasedMr.
      Slime
              
              NDS
              
              7/14/2008B-Boy
              
              PS2,
      PSP
              
              7/28/2008Monster
      Madness – Grave Danger
              
              PS3
              
              8/4/2008Two
      Worlds Epic
              
              PC
              
              8/19/2008Igor
              
              NDA,
      Wii, PC
              
              9/15/2008Ninjatown
              
              NDS
              
              10/16/2008Bella
      Sara
              
              NDS,
      PC
              
              10/21/2008My
      Baby Boy
              
              NDS
              
              10/21/2008My
      Baby Girl
              
              NDS
              
              10/21/2008Legendary
              
              X360,
      PS3, PC
              
              11/10/2008Rise
      of the Argonauts
              
              X360,
      PS3, PC
              
              12/12/2008Big
      Bang Mini
              
              NDS
              
              1/21/2009X-Blades
              
              PC,
      PS3, X360
              
              2/10/2009Penumbra
      Collection
              
              PC
              
              2/17/2009Velvet
      Assassin
              
              X360,
      PC
              
              4/20/2009Pirates
      vs. Ninjas Dodgeball
              
              Wii
              
              5/4/2009Roogoo:
      Twisted Towers
              
              Wii
              
              6/24/2009Roogoo:
      Attack!
              
              NDS
              
              6/25/2009




Our
product pipeline is mostly focused on next generation videogame systems and
targets a broad consumer demographic. We currently have a pipeline of
approximately 18 titles in development, several of which are specifically
targeted to emerging videogamer demographics.




Developing
Our Products




We
develop our products exclusively by contracting with independent software
developers and videogame studios. We enter into comprehensive development
agreements with these parties that outline financial terms, development
milestones, completion dates and final product delivery dates. Our product
development and production teams carefully select developers and studios to
develop videogames based on their capabilities, suitability, availability and
cost. We usually have broad rights to commercially utilize products created by
the developers and studios with which we work. Development agreements are
structured to provide developers and studios with incentives to provide timely
and satisfactory performance by associating payments with the achievement of
substantive development milestones, and by providing for the payment of
royalties to them based on sales of the developed product after we recoup our
development costs. Our development agreements generally provide us with the
right to monitor development efforts and cease advance payments if specified
development milestones are not achieved.





7





The
development cycle for new videogames depends on the videogame system and the
complexity and scope of the videogame. The development cycle for console and PC
videogames ranges from 12 to 24 months and the development cycle for handheld
videogames ranges from six to 18 months.




Upon
completion of development, each videogame is extensively play-tested to ensure
compatibility with the appropriate videogame system and to minimize the number
of bugs and other defects found in the product. If required, we also send the
videogame to the manufacturer for its review and approval. Although historically
we developed our titles for a single videogame system release, many of our new
title releases will be released simultaneously on multiple videogame
systems.




Platform
License Agreements




We have
entered into license agreements with Sony, Microsoft and Nintendo to develop and
publish software titles in North America, Europe and Australia for the Xbox 360,
Wii, PlayStation 3 and PlayStation 2 console systems and the Nintendo DS,
Nintendo GBA and Sony PSP hand-held devices. Each license allows us to create
multiple products for the applicable platform, subject to certain approval
rights which are reserved by each licensor. We are not required to obtain any
licenses to develop titles for the PC.




Under the
terms of these respective license agreements, Microsoft, Sony and Nintendo
granted us the right and license to develop, market, publish and distribute
software titles for their videogame systems. The agreements require us to submit
products to Microsoft, Sony or Nintendo, as applicable, for approval and for us
to make royalty payments to Microsoft, Sony or Nintendo, as applicable, based on
the number of units manufactured. In addition, products for these platforms
are required to be manufactured by Microsoft, Sony or Nintendo, as applicable,
or other approved manufacturers.




Manufacturing
Our Products




Sony,
Nintendo and Microsoft either manufacture or control selection of approved
manufacturers of software products sold for use on their respective videogame
systems. We place a purchase order for the manufacture of our products with
Sony, Nintendo or Microsoft and then send software code and a prototype of the
product to the manufacturer, together with related artwork, user instructions,
warranty information, brochures and packaging designs for approval, defect
testing and manufacture. Games are generally shipped within two to three weeks
of receipt of our purchase order and all materials. We occasionally experience
difficulties or delays in the manufacture of our titles; however, such delays
have not significantly harmed our business to date.




Production
of PC products is performed by third party vendors in accordance with our
specifications and includes CD-ROM pressing, assembly of components, printing of
packaging and user manuals and shipping of finished goods. We send software code
and a prototype of a title, together with related artwork, user instructions,
warranty information, brochures and packaging designs, to the manufacturers.
Games are generally shipped within two weeks of receipt of our manufacturing
order.




We have
not experienced material delays due to manufacturing defects. Our videogame
titles typically carry a 90-day limited warranty. Our platform licenses require
us to provide a standard defective product warranty on all of the products sold.
Generally, we are responsible for resolving, at our own expense, any warranty or
repair claims. We have not experienced any material warranty claims, but there
is no guarantee that we will not experience such claims in the
future.




Sales
and Marketing




Our
marketing and promotional efforts are intended to maximize exposure and broaden
distribution of our videogames, promote brand name recognition, assist retailers
and properly position, package and merchandise our videogames. We implement a
range of promotional sales and marketing activities to help increase awareness
among retailers, including public relations campaigns; demo distributions,
promotions and cross-promotional activities with third parties (through
trailers, demo discs, standees, posters, pre-sell giveaways at retail stores,
and videogame kiosks at sporting and outdoor events); and print, online,
television, radio, and outdoor advertisements. Additionally, we customize public
relations programs to create awareness with all relevant audiences, including
core gamers and mass entertainment consumers.





8





We employ
various other marketing methods designed to promote consumer awareness,
including in-store promotions and point-of-purchase displays, direct mail,
co-operative advertising, as well as attendance at trade shows. We host media
events throughout the year at which print, broadcast and online journalists can
preview, review and evaluate our products prior to their release. In addition to
regular face-to-face meetings and communications with our sales force, we employ
extensive trade marketing efforts including: direct marketing to buyers and
store managers; trade shows; various store manager shows; and distribution and
sales incentive programs. We label and market our products in accordance with
the Entertainment Software Rating Board, or ESRB, principles and
guidelines.




We market
and sell our products in North America and internationally via sales offices in
Grapevine, Texas and Leichester, England, respectively.




Our
Customers




Our
products are available for sale or rental in thousands of retail outlets in
North America. In North America, our products are primarily sold directly to
mass merchandisers, consumer electronics stores, discount warehouses, national
retail chain stores and videogame specialty stores. Our products are also sold
to smaller, regional retailers, as well as distributors who, in turn, sell our
products to retailers that we do not service directly, such as grocery and drug
stores. Our North American customers include Best Buy, Blockbuster, GameStop,
Target, Toys R Us and Wal-Mart.




We
utilize electronic data interchange with most of our major customers in order to
(i) efficiently receive, process, and ship customer product orders, and (ii)
accurately track and forecast sell-through of products to consumers in order to
determine whether to order additional products from the manufacturers. We
believe that the direct relationship model we use allows us to better manage
inventory, merchandise and communications. We currently ship all of our products
to our North American customers from a distribution center located in
Indiana.




We
conduct our international activities via our office in Leichester, England. This
office manages sales, marketing and distribution operations for our European,
Asian and Australian customers. In the United Kingdom, we sell directly to
several key retail accounts, and work with a distributor partner to call on
other accounts. Throughout the rest of Europe and in Australia and Asia, our
products are sold through third-party distribution and licensing arrangements.
These parties are responsible for all marketing and consumer press within their
respective territories. We seek to maximize our worldwide revenues and profits
by continuing to expand the number of selling relationships we maintain in major
territories. We ship all of our products to our foreign customers from a
distribution center located in London.




For the
fiscal year ended June 30, 2010, we generated approximately 81% of our net
revenues in North America and 19% of our net revenues elsewhere. On a worldwide
basis, our largest customers, Wal-Mart and GameStop, accounted for approximately
19% and 18%, respectively, of consolidated gross revenues for the year ended
June 30, 2010.




Competition




The
videogame industry is intensely competitive and new videogame products and
platforms are regularly introduced. Our competitors vary in size from small
companies with limited resources to large corporations with greater financial,
marketing, and product development resources than we have. Due to their
different focuses and allocations of resources, certain of our competitors spend
more money and time on developing and testing products, undertake more extensive
marketing campaigns, adopt more aggressive pricing policies, pay higher fees to
licensors for desirable motion picture, television, sports and character
properties, and pay more to third-party software developers. In addition,
competitors with large product lines and popular titles typically have greater
leverage with retailers, distributors, and other customers who may be willing to
promote titles with less consumer appeal in return for access to such
competitor’s most popular titles. We believe that the main competitive factors
in the videogame industry include: product quality, features, innovation and
playability; brand name recognition; compatibility with popular platforms;
access to distribution channels; price; marketing; and customer
service.





9





We
compete primarily with other publishers of videogames for consoles and PCs.
Significant third-party videogame competitors currently include, among others:
Activision Blizzard; Atari; Capcom; Electronic Arts; Konami; LucasArts; Majesco
Entertainment; Namco-Bandai; Sega; Take-Two Interactive; THQ; Ubisoft;
Viacom/MTV; Warner Bros. Interactive; and Walt Disney. In addition, Sony,
Nintendo, and Microsoft compete directly with us in the development of software
titles for their respective platforms.




Seasonality




The
interactive entertainment software industry is highly seasonal, with sales
typically higher during the fourth calendar quarter, due primarily to increased
demand for videogames during the holiday buying season. The Christmas selling
season accounts for about half of the industry’s yearly sales of
videogames.




Traditionally,
the majority of our sales for this key selling period ship in our fiscal first
and second quarters, which end on September 30 and December 31,
respectively.  Significant working capital is required to finance the
manufacturing of inventory of products that ship during these
quarters.




Intellectual
Property




We have
obtained licenses for videogame software developed by third parties in
connection with our publishing business, and we regard these licenses, including
the trademarks, copyrights, patents and trade secrets related to such videogame
software, as proprietary intellectual property. The underlying trademarks,
copyrights, trade secrets and patents often are separately protected by the
third party developers of the software by enforcement of intellectual property
laws. To protect our proprietary licenses from unauthorized use and
infringement, we maintain employee or third-party nondisclosure and
confidentiality agreements, contractual restrictions on copying and
distribution, as well as “shrink-wrap” or “click-wrap” license agreements or
limitations-on-use of software included with our products.




We obtain
rights to publish and distribute videogames developed by third parties. We
endeavor to protect our developers’ software and production techniques under
copyright, trademark and trade secret laws as well as through contractual
restrictions on disclosure, copying and distribution. Although we do not hold
any patents, we sometimes obtain trademark and copyright registrations for our
products.




As the
number of videogames in the market increases, so too may the likelihood that
videogame publishers will become the subject of claims that their software
infringes the intellectual property rights of others. Although we believe that
the videogames and technologies of the developers and studios with whom we have
contractual relationships do not and will not infringe or violate proprietary
rights of others, it is possible that infringement of proprietary rights of
others may occur. Any claims of infringement, with or without merit, could be
time consuming, costly and difficult to defend.




Employees




As of
June 30, 2010, we employed approximately 53 people, of whom 4 were outside the
United States. We believe that our ability to attract and retain qualified
employees is a critical factor in the successful development of our products and
that our future success will depend, in large measure, on our ability to
continue to attract and retain qualified employees. None of our employees are
represented by a labor union or covered by a collective bargaining agreement and
we consider our relations with employees to be favorable.




Executive
Officers and Key Employees




Information
regarding our executive officers and key employees is set forth under the
heading “Directors, Executive Officers and Corporate Governance,” contained in
Part III, Item 10 of this report.





10





Subsequent
Events





As of
July 12, 2010, the Company repaid in full the entire outstanding balance
under the SunTrust line of credit. Pursuant to the loan agreement, the Company
had a $8.0 million revolving line of credit facility with SunTrust that was
scheduled to mature on November 30, 2010.  The revolving credit line
was collateralized by gross accounts receivable, personal guarantees, and a
pledge of personal securities and assets by two Company shareholders, one
of whom is the Company’s chairman, and certain other affiliates. As a
result of such repayment, (i) the loan agreement has automatically
terminated, (ii) SunTrust’s lien or security interest in the Company’s
assets has been terminated, and (iii) all obligations of the Company under
the loan agreement have been satisfied in full.





On July
12, 2010, the Company entered into a Factoring Agreement with Rosenthal &
Rosenthal, Inc.  Under the Factoring Agreement, the Company has agreed to
sell receivables arising from sales of inventory to Rosenthal &
Rosenthal.  In connection with the entry into the Factoring Agreement, the
Company, its subsidiaries, Gone Off Deep LLC, SouthPeak Interactive Ltd, and Vid
Sub, LLC, and the chairman, Terry Phillips, have each executed guarantees in
favor of Rosenthal & Rosenthal.  In addition, the Company, Gone
Off Deep and Vid Sub each granted to Rosenthal & Rosenthal a security
interest against all their respective assets.




Under the
terms of the Factoring Agreement, the Company is selling all of its receivables
to Rosenthal & Rosenthal.  For the approved receivables, Rosenthal
& Rosenthal will assume the risk of collection. The Company has agreed to
pay Rosenthal & Rosenthal a commission of .60% of the amount payable under
all of the Company’s invoices to most of the Company’s customers against a
minimum commission of $30,000 multiplied by the number of months in a contract
period, with the first period being 12 months and the second 7
months.  All payments received by Rosenthal & Rosenthal are
payable to the Company after amounts due to Rosenthal & Rosenthal are
satisfied.  Under the Factoring Agreement, the Company has the right
to borrow against payments due us at the rate of 65% of credit approved
receivables.  The borrowing rate against non-credit approved
receivables is subject to negotiation. The interest rate on borrowings is equal
to the greater of prime plus 1.5% per annum or 6.5% per annum.  A
$10,000,000 loan cap applies against the Company’s borrowings, which is subject
to an increase of up to $3,000,000 if shareholders’ equity increases.  The
initial term of the Factoring Agreement ends on February 28, 2012.





On July
16, 2010, the Company entered into a Securities Purchase Agreement with CNH
Diversified Opportunities Master Account, L.P., CNH CA Master Account, L.P., AQR
Diversified Arbitrage Fund and Terry Phillips, the Company’s chairman, for the
sale of $5,500,000 of senior secured convertible notes and
warrants.  Mr. Phillips’ Note was issued in exchange for a junior
secured convertible note originally issued to him on April 30, 2010 (see Note
9).  The Company received $5.0 million in cash for $5.0 million of the
senior secured convertible notes and exchanged a $500,000 prior junior secured
convertible note for $500,000 of the senior secured convertible
notes.





On August
31, 2010, the Company entered into an Amended and Restated Securities Purchase
Agreement pursuant to which it sold an aggregate of an additional $2.0 million
of a new series of senior secured convertible promissory notes to AQR
Opportunistic Premium Offshore Fund, L.P., Advanced Series Trust, solely on
behalf of the AST Academic Strategies Asset Allocation Portfolio, and Terry
Phillips, SouthPeak’s chairman.  The Company received $2.0 million in
cash for $2.0 million of the additional notes, of which $200,000 was paid by
Terry Phillips, the Company’s chairman.





On
September 20, 2010, the Company entered into a Master Purchase Order Assignment
Agreement with Wells Fargo Bank, National Association (“Wells
Fargo”).  Under the terms of the agreement, the Company may
request that Wells Fargo accept the assignment of customer purchase orders and
request that Wells Fargo purchase the required materials to fulfill such
purchase orders.  If accepted, Wells Fargo, in turn, will retain the
Company to manufacture, process, and ship the ordered goods. Wells Fargo’s
aggregate outstanding funding under the agreement shall not exceed
$2,000,000.  Upon receipt of customer payments by Wells Fargo, the
Company will be paid a fee for its services, with such fee calculated pursuant
to the terms of the agreement. Also from such customer payments, Wells Fargo
shall be entitled to receive the following: (1) a transaction initiation
and set-up fee equal to 1.5% of the aggregate amount outstanding on all amounts
(including letters of credit) advanced by Wells Fargo; (2) a daily maintenance
fee equal to 0.05% of all amounts (including letters of credit) advanced by
Wells Fargo which remain outstanding for more than 30 days; and (3) a product
advance fee equal to (a) the prime rate plus 2%, divided by 360, multiplied by
(b) (i) the aggregate amount outstanding on all amounts (including letters of
credit) advanced by Wells Fargo on account of purchases of products or other
advances made in connection with a customer purchase order, multiplied (ii) by
the number of days from the earlier of (A) the date on which any such letter of
credit or purchase order or financial accommodation is negotiated into cash, or
(B) the date funds are advanced by other than issuing a letter of credit or
purchase order.  Subject to the rights of senior lenders, the Company
and its subsidiaries have granted security interests in their assets to Wells
Fargo under the Security Agreement and Financing Statement to secure the LLC’s
obligations under the Agreement and the Guarantors’ guarantees of such
obligations.





11





Available
Information




We make
available free of charge on or through our Internet website our annual reports
on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and
all amendments to those reports as soon as reasonably practicable after such
material is electronically filed with or furnished to the SEC. Our website
address is www.southpeakgames.com.




Item
1A.Risk
Factors




We
operate in a rapidly changing environment that involves a number of risks, some
of which are beyond our control. This discussion highlights some of the risks
that may affect future operating results. These are the risks and uncertainties
we believe are most important for you to consider. Additional risks and
uncertainties not presently known to us, which we currently deem immaterial or
which are similar to those faced by other companies in our industry or
businesses in general, may also impair our businesses operations. If any of the
following risks or uncertainties actually occur, our business, financial
condition and operating results would likely suffer.




Risks
Related to our Business and Operations




We
have received an audit report from our independent registered public
accounting firm expressing doubt regarding our ability to continue as a going
concern.
  Our
independent registered public accounting firm noted in their audit report
accompanying our financial statements as of June 30, 2010 and 2009 and for
the years then ended that our default on a production advance payable,
our significant legal contingencies, and significant operating losses and
negative cash flows from operating activities raise substantial doubt about our
ability to continue as a going concern. Management has taken steps to maintain
our viability as a going concern by entering into a factoring agreement with
Rosenthal & Rosenthal, Inc., a purchase order financing agreement with Wells
Fargo Bank, National Association, the issuance of senior secured convertible
notes, and plans to take the following additional steps:
 
 ·
              attempt
      to expeditiously resolve our contingencies for amounts significantly less
      than currently accrued for in order to reduce aggregate liabilities on our
      balance sheet on payment terms manageable by us;
  and
 
 ·
              reduce
      costs and expenses in order reduce or eliminate
  losses.
  Although
management is confident that we will be able to implement this plan, we cannot
assure you that the plan will be successful. This doubt about our ability to
continue as a going concern could adversely affect our ability to obtain
additional financing at favorable terms, if at all, as such an opinion may cause
investors to have reservations about our long-term prospects, and may adversely
affect our relationships with customers. If we cannot successfully continue as a
going concern, our stockholders may lose their entire investment in
us.




Stiff
competition within the videogame publishing industry, in particular, can
significantly reduce our market share, curtail potential revenue, and negatively
impact our long-term viability.




We
compete for licenses to properties and the sale of our videogames with the large
platform manufacturers such as Sony, Microsoft and Nintendo, each of which also
develops and markets software for its own platforms. Each of these competitors
can bundle their software with their hardware and create less demand for
individual sales of our videogames. Additionally, these hardware systems
manufacturers have better bargaining positions with respect to retail pricing,
shelf space and retailer accommodations than do any of their licensees,
including us, as well as the financial resources to withstand significant price
competition and to implement extensive advertising campaigns. These platform
providers may also give priority to their own games or to those of other
publishers when manufacturing capacity is insufficient.




Next
generation consoles require larger development teams and budgets to bring
videogames to market. Although we have been able to produce successful
videogames for these next generation consoles with industry competitive budgets,
we may be unable to continue to do so in the future.




We
compete, as well, with domestic videogame publishers such as Activision, Inc.;
Atari, Inc.; Capcom Co. Ltd.; Electronic Arts Inc.; Konami
Company Ltd.; Majesco Entertainment; Namco Bandai Games Ltd.; Sega
Enterprises, Ltd.; Take-Two Interactive Software, Inc.; THQ Inc.;
Ubisoft Entertainment; Viacom/MTV; Warner Bros Interactive; and the Walt Disney
Company. Many of our competitors have blockbuster videogames (with greater name
recognition among consumers), a broader product line, or greater financial,
marketing and other resources than we do. Accordingly, these competitors may be
able to market their products more effectively or make larger offers or
guarantees to independent developers in connection with the acquisition of
commercially desirable properties.




We
compete, as well, with a variety of independent publishers of proprietary
videogame software. Because platform licenses are non-exclusive, and many our
competitors also have licenses to develop and distribute videogame software for
these systems, new entrants could enter the market, including those with
business models similar to ours.





12





Our
videogame distribution operations also exist in a highly competitive
environment. Competition is based primarily on breadth, availability and
marketability of videogames; price; terms and conditions of sale; credit terms
and availability; speed of delivery; and effectiveness of sales and marketing
programs. Our competitors include regional, national and international
distributors, as well as hardware manufacturers and software publishers. We may
lose market share or be forced to reduce our prices in the future in response to
our competitors.




Our
business model can limit our growth prospects and long-term
viability.




We have
historically focused on publishing innovative videogames for underserved niches
that are generally sold at prices typical for big budget videogames produced by
the leading large videogame publishers. In doing so, we have relied on our
management’s industry experience to identify videogame concepts that can be
profitably produced, their ability to allocate the Company’s limited financial
resources among videogames under development and their ability to leverage
low-cost offshore videogame developers. There can be no assurance, however, that
we will be able to accurately assess the likelihood and volume of sales for
future videogames or to engage low-cost developers.




The
traditional distribution model of distributing original videogames through third
parties, such as independent videogame publishers, could be challenged by the
emergence of direct-to-consumer electronic delivery. Microsoft, Sony and
Nintendo each plan to provide a mechanism for videogame developers to publish
videogames via electronic store fronts that enable direct downloading of
videogame content, though only a limited number of videogames will be selected
for these electronic store fronts at any given time. Similar distribution venues
already exist for the personal computer platform. Whereas some videogames are
likely to entail program file sizes not easily distributed digitally due to
bandwidth and storage constraints, it is possible that videogame concepts
pursued by us in the future may not always have these constraints, and therefore
originators of such videogame concepts could potentially bypass the traditional
distribution and publication path, and take a direct-to-consumer approach, or
even choose to sign multi-product deals, be acquired by other publishers, or go
direct to our clients. Additionally, although we have been able to gain access
to the limited videogame slots available in electronic store fronts, there can
be no assurance that the number of videogames at electronic store fronts will
remain limited or that we will continue to be able to access limited available
videogame slots. Such changes in industry distribution practices and the number
of videogame slots made available at electronic store fronts could limit our
prospects for growth and negatively affect our profitability.





If
we are unable to anticipate and adapt to rapidly changing technology, our
results of operations and competitive position could be adversely
affected.




We derive
most of our revenue from the sale of videogame software developed for use on
popular consoles. The success of our business is affected in large part by the
market appeal of our published videogames and by the availability of an adequate
supply of the hardware systems on which they run. Our ability to accurately
predict which new videogame platforms will be successful in the marketplace, as
well as our ability to develop commercially successful products for these new
systems, will determine whether or not we will be competitive in the
future.




We
typically make product development decisions and commit significant resources
and time (18 to 24 months) in advance to remain competitive. If we choose not to
publish videogames for a new hardware system that is ultimately popular, our
competitive position and profitability may be adversely affected. Yet, even if
we seek to adapt to any new videogame platforms, we face the risk of not being
able to generate any significant earnings or recoup our investment as quickly as
anticipated if the new system does not gain widespread market appeal, is not
available in adequate quantities to meet consumer demand, or has a shorter life
cycle than anticipated. Alternatively, a platform for which we have not devoted
significant resources could be more successful than we had initially
anticipated, causing us to miss a vital earnings opportunity.





13





If
we are unable to enter into attractive publishing arrangements with developers
of highly innovative and commercially appealing videogames, our competitiveness
and prospects for growth could be severely impacted.




Our
success depends on our ability to timely identify and publish highly marketable
videogames. We rely on third-party software developers or development studios
for the development of most of our videogames. Because interactive videogame
developers are highly in demand, our relatively limited resources vis-a-vis our
competitors puts us at a competitive disadvantage when bidding to offer
attractive compensation packages, advance royalties or ample pre-development
financing to desirable developers, and potentially reduces our chances of
winning the right to publish highly innovative videogames. Such a situation
could severely impact our competitiveness and prospects for growth.




If
we fail to satisfy our obligations under agreements with third-party developers
and licensors, our operating results could be materially adversely
affected.




Software
developers who have developed videogames for us in the past may not be available
to develop videogame software for us in the future. Due to the limited number of
third-party software developers and the limited control that we exercise over
them, these developers may not manage to complete videogames for us on time and
within product quality expectations, if at all. We have entered into agreements
with third parties to acquire the rights to publish and distribute proprietary
videogame software. These agreements typically require us to make advance
payments, pay royalties and satisfy other conditions. Our advance payments may
not be sufficient to permit developers to develop new software successfully,
which could result in material delays and significantly increase our costs to
bring particular products to market. Future sales of our videogames may not be
sufficient to recover advances to software developers and licensors, and we may
not have adequate financial and other resources to satisfy our contractual
commitments to such developers. If we fail to satisfy our obligations under
agreements with third-party developers, the agreements may be terminated or
modified in ways that are burdensome and materially adversely affect our
operating results and long-term viability.




If
we are unable to sell any of the works we have committed to fund, our operating
margins could be adversely affected.




We
typically enter into contracts with suppliers that are matched with commitments
to fund original work development under specific terms. As of June 30, 2010, we
have entered into contracts with 5 independent software developers pursuant
to which we are subject to minimum funding commitments and we may enter into
additional contracts with similar commitments in the future. To date, we have
sufficiently met our commitments with each of those suppliers, but we cannot
assure you that in the future our earnings and/or liquidity will meet or exceed
our commitments with each vendor. If we are unable to sell any of the works we
have committed to fund, our operating margins could be adversely
affected.





If
we are unable to secure approval from hardware manufacturers to publish new
videogames for their respective platforms, our business could suffer
significantly or, alternatively, if we fail to satisfy our obligations under
agreements with first-party platform manufacturers such as Microsoft, Sony, and
Nintendo, our operating results could be materially adversely
affected.




We are
dependent on non-exclusive licenses from platform manufacturers (Microsoft,
Nintendo and Sony) for the right to publish videogames for their platforms. Our
existing platform licenses require that we obtain approval for the publication
of new videogames on a videogame-by-videogame basis. As a result, the number of
videogames we are able to publish for these platforms, and our sales from
videogames for these platforms, may be limited. A manufacturer may elect not to
renew or extend our license agreement at the end of its term, or adversely
modify it, for whatever reason. Consequently, we may be unable to publish new
videogames for the applicable platforms or we may be required to do so on less
attractive terms. This will not only prevent us from publishing additional
videogames for a manufacturer but also negatively impact our operating results
and prospects for growth.





In
addition, our contracts with the console manufacturers often grant the
manufacturers approval rights over new software products, and control over the
development of our videogames. These rights and privileges of hardware
manufacturers could adversely affect our results of operations or financial
condition by:




·
            Causing
      the termination of a new project for which we have expended significant
      resources;





·
            Impeding
      the development and shipment of newly published videogames to customers;
      and





·
            Increasing
      development lead times and costs which could be avoided if we are able to
      manufacture new videogame software
  independently.





14





Microsoft
released its next-generation hardware platform, the Xbox 360, into the North
American marketplace in November 2005, and each of Sony and Nintendo introduced
their respective next-generation platforms PlayStation 3 and the Wii into the
marketplace during November 2006. While we have licenses for Microsoft Xbox 360,
Nintendo Wii, DS and Gameboy Advance, and for Sony PlayStation 3, Playstation 2,
and Playstation Portable, we may be unable to obtain licenses for future
hardware platforms.




If
we incur unanticipated levels of returns of our videogames from customers, or
price concessions granted to them, our operating results could significantly
suffer.




We are
exposed to the risk that customers will return our products, or seek to secure
price concessions for any bulk orders. Our distribution arrangements with our
customers generally do not give them the right to return videogames to us or to
cancel firm orders. However, when demand for our offerings falls below
expectations, we can sometimes accept product returns for stock balancing and
negotiate accommodations to customers in order to maintain healthy relationships
with them, as well as continued access to their sales channels. These
accommodations include negotiation of price discounts and credits against future
orders, referred to as price concessions. The estimated reserve for returns and
price concessions is based on our managements evaluation of expected sales,
potential markdown allowances based on historical experience, market acceptance
of products produced, retailer inventory levels, budgeted customer allowances
and the nature of the videogame and existing commitments to
customers.




While we
believe that we can reliably estimate future returns and price concessions, we
cannot predict with certainty whether existing reserves will be sufficient to
offset any accommodations we will actually provide, nor can we predict the
amount or nature of accommodations that we will provide in the future.
Furthermore, the continued granting of substantial price protection and other
allowances may require us to raise additional funds for our operating
requirements, but there is no assurance that such funds will be available to us
on acceptable terms, if at all. In addition, the license fees we pay Sony,
Microsoft and Nintendo are non-refundable and cannot be recovered when
videogames are returned. Ultimately, if our return rates and price concessions
for published videogames materially exceed our reserves, our operating results
may be adversely affected.




If our inventory
of next-generation videogames is not fully sold and we have paid upfront
significant license fees and manufacturing costs, our operating results and net
worth may be materially adversely affected.




When
publishing for videogame consoles, videogame publishers take on the burden of a
great deal of inventory risk. All significant console manufacturers since
Nintendo with its NES (1985) have monopolized the manufacture of every videogame
made for their console, and have required all publishers to pay a license fee
for every videogame so manufactured. This license fee is generally due at the
time of manufacturing the videogame and is based upon the number of videogames
being manufactured, unlike license fee payments in most other industries, in
which license fees are paid following actual sales of the product. So, if a
videogame publisher orders one million copies of its videogame, but half of them
do not sell, the publisher has already paid the full console manufacturer
license fee on one million copies of the videogame, and has to absorb that cost.
Furthermore, non-moving inventory of videogames tend to decline substantially in
value over time or to become obsolete. If this situation happens to us, and
price concessions are not available on unsold products, we could incur
significant losses, which could materially adversely affect our profitability
and net worth.





We
are dependent upon a limited number of customers and the loss of any of four key
customers could materially adversely affect our business.




We are
dependent on a small number of large customers for a significant portion of our
sales, and the loss of one or more of these clients, or a significant decrease
in total revenues from any of these clients, could seriously hurt our business.
For example, we have two customers, Wal-Mart and GameStop that accounted for
approximately 19% and 18%, respectively, of consolidated gross revenues for the
year ended June 30, 2010, and approximately 15% and 29%, respectively, of
consolidated gross accounts receivable at June 30, 2010.





15





Approximately
95% of our sales are made through purchase orders subject to agreements with our
customers, including GameStop and Wal-Mart, through which the customer may
reduce the videogames they purchase from us, renegotiate the terms on which they
purchase our videogames, or terminate their relationship with us at any time.
Certain of our customers may decline to carry products containing mature
content. A substantial reduction in orders, including as a result of a product
being rated “AO” (age 18 and over); difficulty in collecting receivables in
full, or within a reasonable time period, or within reserve levels; or
termination of our relationship with the customer as a result of a number of
factors (including their level of satisfaction with the support services they
receive from us, demand for or pricing of competing videogames, and their
ability to continue their operations) could adversely affect our operating
results and business viability.




We
are dependent on the success of a few videogames, and unless we are able to gain
and maintain market acceptance for newly published videogames in the future, our
growth and earnings prospects could be severely compromised.




A limited
number of videogames may produce a disproportionately large amount of our sales.
Due to this dependence on a limited number of videogames, the failure of one or
more of these products to achieve anticipated results may significantly harm our
business and financial results.




If
our contracted videogame developers fail to deliver their finished videogames on
time, or at all, we stand to incur significant losses that could severely
adversely affect our financial performance.




We rely
upon our third-party software developers to deliver videogames within
anticipated release schedules and cost projections.




While
timetables for the development and delivery of videogame software are set in
advance, videogame production schedules are difficult to predict and can be
subject to delays. Schedule slippage is very common due to the uncertain
schedules of software development. Most publishers have suffered a “false
launch,” in which the development staff assures the company that videogame
development will be completed by a certain date and a marketing launch is
planned around that date, including advertising commitments, and then, after all
the advertising is paid for, the development staff announces that the videogame
will “slip,” and will actually be ready several months later than originally
intended. When the videogame finally appears, the effects among consumers of the
marketing launch - excitement and “buzz” over the release of, and intent of
customers to purchase, the videogame - have dissipated, and lackluster interest
leads to weak sales. These problems are compounded if the videogame is supposed
to ship for the Christmas selling season, but actually slips into the subsequent
year.




The
development cycle for new videogames can range from twelve to twenty four months
and can be expected to increase in connection with the development of
next-generation software. After development of a videogame, it may take between
nine to twelve additional months to develop the product for other hardware
platforms. Since we have no direct control over the business, finances and
operating practices of external videogame developers, a delay or failure by
these developers to make shipments or to complete the work performed - whether
due to operational issues, financial difficulties, or faulty business decisions
- may result in delays in, or cancellations of, product releases that may
threaten our ability to obtain sufficient amounts of our product to sell to our
customers when they demand them. In addition, customers may, under certain
contracts, have the ability to terminate agreements to purchase videogame
publications in view of issues concerning work quality and originality, or
prolonged delay or significant revisions to published videogames. Terminations
by clients of their purchase commitments can significantly dampen our revenue
and cause our business to suffer tremendous losses.




Because
many leading independent videogame developers are small companies that are
dependent on a few key individuals for the completion of a project, this also
exposes us to the risk that these developers will lose a key employee, go out of
business before completing a project, or simply cease work on a project for
which we have hired them, and this occurrence could also be highly detrimental
to our ability to compete and to generate additional revenue.





16





Our
business is highly dependent on the success and availability of videogame
systems manufactured by third parties, as well as our ability to develop
commercially successful products for these systems.




We derive
most of our revenue from the sale of products for play on videogame systems
manufactured by third parties, such as Microsoft Xbox 360, Nintendo Wii,
Nintendo DS, Nintendo DSi, Apple iPhone, Sony PlayStation 3, Sony PlayStation 2,
SonyPSP and Sony PSPgo. The success of our business is driven in large part by
the commercial success and adequate supply of these videogame systems, our
ability to accurately predict which systems will be successful in the
marketplace, and our ability to develop commercially successful products for
these systems. We must make product development decisions and commit significant
resources well in advance of anticipated product ship dates. A videogame system
for which we are developing products may not succeed or may have a shorter life
cycle than anticipated. If consumer demand for the systems for which we are
developing products is lower than our expectations, our revenue will suffer, we
may be unable to fully recover the investments we have made in developing our
products, and our financial performance will be harmed. Alternatively, a system
for which we have not devoted significant resources could be more successful
than we had initially anticipated, causing us to miss out on meaningful revenue
opportunities.





Our
industry is cyclical, driven by the periodic introduction of new videogame
systems. As we continue to move through the current cycle, our industry growth
may slow down and as a result, our operating results may be difficult to
predict.




Videogame
systems have historically had a life cycle of four to six years, which causes
the videogame software market to be cyclical as well. The current cycle began
with Microsoft’s launch of the Xbox 360 in 2005, and continued in 2006 when Sony
and Nintendo launched their next-generation systems, the PlayStation 3 and the
Wii, respectively. Sales of software designed for these videogame systems
represent the majority of our revenue, so our growth and success are highly
correlated to sales of videogame systems. While there are indications that this
current cycle may be extended longer than prior cycles, in part, due to the
growth of online services and content and the greater graphic and processing
power of the current generation hardware, we expect growth in the installed base
of the current generation of videogame systems to slow as we enter the back half
of this cycle. This slow-down in sales of videogame systems, which may be
exacerbated by the current economic environment, may cause a corresponding
slow-down in the growth of sales of videogame software, which could
significantly affect our operating results. Consequently, the decline in
prior-generation product sales, particularly the PlayStation 2, may be greater
or faster than we anticipate, and sales of products for the new videogame
systems may be lower or increase more slowly than we anticipate. Moreover,
development costs for the current cycle of videogame systems continue to be
greater on a per-title basis than development costs for prior-generation
videogame systems. In addition, in light of the current economic environment and
where we stand in the current generation videogame system cycle, our industry
may experience slower growth than in recent years. As a result of these factors,
during the next several quarters and years, we expect our operating results to
be difficult to predict.





The
videogame hardware manufacturers set the royalty rates and other fees that we
must pay to publish games for their platforms, and therefore have significant
influence on our costs. If one or more of these manufacturers change their fee
structure, our profitability will be materially impacted.




In order
to publish products for a videogame system such as the Xbox 360, Sony
PlayStation 3 or Wii, we must take a license from Microsoft, Sony and Nintendo,
respectively, which gives these companies the opportunity to set the fee
structures that we must pay in order to publish games for that platform.
Similarly, these companies have retained the flexibility to change their fee
structures, or adopt different fee structures for new features for their
videogame systems. The control that hardware manufacturers have over the fee
structures for their videogame systems could adversely impact our costs,
profitability and margins.





The
availability of additional capital may be limited.




Recent
disruptions in financial markets have resulted in a severe tightening of credit
availability in the United States. Liquidity in credit markets has contracted
significantly, making terms for certain financings less attractive. Ongoing
turmoil in the credit markets may make it difficult for us to obtain financing,
on acceptable terms or at all, for working capital, capital expenditures,
acquisitions and other investments. These difficulties could adversely affect
our operations and financial performance.





17





Our
business may be affected by issues in the economy that affect consumer
spending.




Our
products involve discretionary spending on the part of consumers. We believe
that consumer spending is influenced by general economic conditions and the
availability of discretionary income. This makes our products particularly
sensitive to general economic conditions and economic cycles. Certain economic
conditions, such as United States or international general economic downturns,
including periods of increased inflation, unemployment levels, tax rates,
interest rates, gasoline and other energy prices, or declining consumer
confidence could reduce consumer spending. Reduced consumer spending may result
in reduced demand for our products and may also require increased selling and
promotional expenses. A reduction or shift in domestic or international consumer
spending could negatively impact our business, results of operations and
financial condition. Consumers are generally more willing to make discretionary
purchases, including purchases of products like ours, during periods in which
favorable economic conditions prevail. If economic conditions worsen, our
business, financial condition and results of operations could be adversely
affected.




Our
business is subject to risks generally associated with the entertainment
industry, any of which could significantly harm our operating
results.




Our
business is subject to risks that are generally associated with the
entertainment industry, many of which are beyond our control. These risks could
negatively impact our operating results and include: the popularity, price and
timing of our videogames and the videogame systems on which they are played;
economic conditions that adversely affect discretionary consumer spending;
changes in consumer demographics; the availability and popularity of other forms
of entertainment; and critical reviews and public tastes and preferences, which
may change rapidly and cannot necessarily be predicted.




We
rely on a primary distribution service provider for a significant portion of our
products and the failure of this service provider to perform as expected could
materially harm our results of operations.




We
outsource shipping, receiving, warehouse management and related functions for
our United States publishing and distribution businesses. Our future performance
will depend, in part, on our outsource provider’s ability to successfully
distribute our products. If our provider does not perform adequately, or if we
lose our provider as our distributor and are unable to obtain a satisfactory
replacement in a timely manner, our sales and results of operations could
suffer.




If
delays or disruptions occur in the delivery to our customers of newly published
videogames following their commercial release, our operating results could be
materially adversely affected.




Certain
of our licensing and marketing agreements contain provisions that would impose
penalties in the event that we fail to meet agreed upon videogame release dates.
The life cycle of a videogame generally involves a relatively high level of
sales during the first few months after introduction, followed by a rapid
decline in sales. New products may not achieve significant market acceptance or
generate sufficient sales to permit us to recover development, manufacturing and
marketing costs associated with these products. Because revenues associated with
an initial product launch generally constitute a high percentage of the total
revenue associated with the life of a product, delays in product releases or
disruptions following the commercial release of one or more new videogames could
adversely affect the sales of such products and cause our operating results to
materially suffer and differ from expectations.




If
we incur substantial costs for market testing and sales activities after our new
videogames are published, and fail to anticipate market demand or secure
customer contracts, our profitability and liquidity could be materially
adversely affected.




We
typically undertake market testing and sales activities before each of our
videogames is eventually approved for deployment by a given customer. In
addition, once a customer contract is signed, there is a period in which
revisions to videogame features are made, which can contribute to further delays
in the realization of revenue. If we incur significant expenses associated with
market testing, product revisions, and sales and marketing and are not
successful in anticipating market demand for our videogames or in securing
contracts from our targeted customers, we may generate insufficient revenue to
fully cover our costs, including our investment in videogame development, and
our profitability and liquidity could be severely affected.




18





If our published videogames suffer from grave defects,
market acceptance of our product may be adversely affected, our results of
operations adversely affected, and our reputation seriously harmed.




Our
published videogames can contain major defects, which could delay market
acceptance of our products; cause customers to either terminate relationships
with, or initiate product liability suits against us, or both; or divert our
engineering resources, and consequently adversely impact our results of
operations and our reputation.




If
our licensed intellectual property is not adequately protected from unauthorized
use or access by others, our competitiveness could be significantly undermined
and our viability adversely affected.




We have
obtained licenses for videogame software developed by third parties in
connection with our publishing business, and we regard these licenses, including
for the trademarks, copyrights, and trade secrets to such videogame software, as
proprietary intellectual property. The underlying trademarks, copyrights, and
trade secrets and often are separately protected by the third party developers
of the software by enforcement of intellectual property laws. To protect our
proprietary licenses from unauthorized use and infringement, we maintain
employee or third-party nondisclosure and confidentiality agreements,
contractual restrictions on copying and distribution, as well as “shrink-wrap”
or “click-wrap” license agreements or limitations-on-use of software included
with our products.




Our
licenses, however, are vulnerable to misappropriation and infringement, which
could undermine our competitiveness and materially adversely affect our
business. It is difficult to effectively police unauthorized use of our licenses
and we cannot be certain that existing intellectual property laws will provide
adequate protection for our products. Despite our efforts to protect our
proprietary rights, unauthorized parties may try to copy our videogames, or to
reverse engineer the licensed software. Well-organized piracy operations that
have proliferated in recent years also have the ability to download pirated
copies of our published software over the Internet. In addition, the laws of
some foreign countries where our products are or may be distributed may not
protect our proprietary rights to as great an extent as United States law, or
are poorly enforced. If we are unable to protect our software against piracy, or
prevent the misappropriation and infringement of our licenses in any form, our
competitiveness and viability could be severely adversely affected.




If
we infringe on the proprietary rights of others, unknowingly or not, we could
sustain major damages to our business.




Although
we believe our software and technologies and the software and technologies of
third-party developers and publishers with whom we have contractual relations do
not and will not infringe or violate proprietary rights of others, it is
possible that infringement of proprietary rights of others has occurred or may
occur.




Any
claims of infringement, with or without merit, could be time consuming, costly
and difficult to defend. Parties making claims of infringement may be able to
obtain injunctive or other equitable relief that could require us to discontinue
the distribution of our interactive entertainment software, prevent us from
obtaining a license or redesigning our videogames, block us from publishing new
materials, and compel us to pay substantial damages. In the event of a
successful claim of infringement, we may need to obtain one or more licenses
from third parties, which may not be available at a reasonable cost, if at all;
divert attention and resources away from our daily business; impede or prevent
delivery of our published videogames; and require us to pay significant
royalties, licensing fees and damages. The defense of any lawsuit could result
in time-consuming and expensive litigation, regardless of the merits of such
claims, and could also result in damages, license fees, royalty payments and
restrictions on our ability to provide our services, any of which could harm our
business.




We
are subject to the risks and uncertainties associated with international trade,
which could adversely affect our business.




As we
expand our international operations, we are exposed to other risks, including:
different market dynamics and consumer preferences; unexpected changes in
international political, regulatory and economic developments; increased credit
risks, tariffs and duties; difficulties in coordinating foreign transactions and
operations; shipping delays; and possible impediments to the collection of
foreign accounts receivable. Moreover, all of our international sales are made
in local currencies, which could fluctuate against the U.S. dollar. While we may
use forward exchange contracts to a limited extent to seek to mitigate foreign
currency risk, our results of operations could be adversely affected by
unfavorable foreign currency fluctuations. These or other factors could have an
adverse effect on our business.





19





If
we are unable to effectively manage and fund our expansion initiatives, we could
incur huge charges, which in turn could undermine our growth plans.




Over the
past several years, we have expanded our publishing operations, enlarged our
work force, and increased our investments in proprietary videogames created by
third-party developers. To manage this growth successfully, we have been
required to hire, train and manage an increasing number of management,
technical, marketing, and other personnel. Furthermore, we have required, and
may required, significant cash resources to fuel our expansion activities, and
have sought debt and equity financing to fund related costs. There is no
guarantee, however, that we could obtain any additional financing required on
acceptable terms or at all. The issuance of new equity securities of the
Company, moreover, would result in dilution to the interests of our
stockholders. Unless we are able to effectively manage our growth activities,
our business may be materially adversely affected.




We
may not be able to adequately adjust our cost structure in a timely fashion in
response to a sudden decrease in demand.




A
significant portion of our sales and marketing and general and administrative
expenses are comprised of personnel and facilities. In the event of a
significant decline in revenues, we may not be able to exit facilities, reduce
personnel, or make other changes to our cost structure without disruption to our
operations or without significant termination and exit costs. Management may not
be able to implement such actions in a timely manner, if at all, to offset an
immediate shortfall in revenues and profit. Moreover, reducing costs may impair
our ability to produce and develop videogames at sufficient levels in the
future. We are subject to the risk that our inventory values may decline and
protective terms under supplier arrangements may not adequately cover the
decline in values.




Failure
to collect our accounts receivable on a timely basis will negatively impact our
cash flow.




Our sales
are typically made on credit. We do not hold any collateral to secure payment
from our customers. As a result, we are subject to credit risks, particularly in
the event that a significant amount of our receivables represent sales to a
limited number of retailers or are concentrated in foreign markets. Although we
continually assess the creditworthiness of our customers, which are principally
large, national retailers, if we are unable to collect our accounts receivable
as they become due, our financial condition and cash flow could be adversely
affected. From time to time we may purchase from financial institutions
insurance on our receivables (with certain limits) to help protect us from loss
in the event of a customer’s bankruptcy or insolvency.




Our
quarterly operating results may fluctuate significantly due to various factors
related to our operations, which could cause our stock price to decline and
could result in substantial losses to investors.




Our
quarterly operating results have varied widely in the past and are likely to
vary in the future, due to numerous factors, several of which are not under our
control. These factors include the timing of our release of new videogames,
customer demand for our videogames, and fluctuations in receivables collections
and quarterly working capital needs. Other factors that cause fluctuations in
our sales and operating results include:




·
            The
      timing of release of our competitors’
products;





·
            The
      popularity of both new videogames and videogames released in prior
      periods;





·
            The
      profit margins for videogames we
sell;





·
            Competition
      in the industry for retail shelf
space;





·
            Changing
      consumer demand for videogames for different platforms;
  and




·
            The
      timing of the introduction of new platforms and the accuracy of retailers’
      forecasts of consumer demand.


20





The
uncertainties associated with videogame development, including varying
manufacturing lead times, production delays and the approval process for
products by hardware manufacturers and other licensors also make it difficult to
predict the quarter in which our products will ship and therefore may cause us
to fail to meet financial expectations. In future quarters, operating results
may fall below the expectations of securities analysts and investors and the
price of our stock could decline significantly.




The
videogame publishing industry is highly seasonal, with the Christmas selling
season accounting for a substantial portion of the industry’s yearly sales of
consol and computer videogames, leading to a concentrated glut of high-quality
competition every year in every videogame category during this seasonal period.
Although historically we have not been materially impacted by the industry
seasonality primarily because we have produced a limited volume of videogames
that have been absorbed by the market even in low volume periods of the year, we
may be impacted by the industry seasonality in the future as we increase the
volume of our videogame production. Our failure or inability to introduce
products on a timely basis to meet seasonal fluctuations in demand could
adversely affect our business and operating results in the future.




We
believe that quarter-to-quarter comparisons of our operating results will not be
a good indication of our future performance. We may not be able to maintain
consistent profitability on a quarterly or annual basis. It is likely that in
some future quarter, our operating results may be below the expectations of
public market analysts and investors and as a result of the above-mentioned
factors, and other factors described throughout this “Risk Factors” section, the
price of our common stock may fall or significantly fluctuate, and possibly
bring about significant reductions to stockholder value.




If
we fail to maintain effective internal control over financial reporting and
disclosure controls and procedures in the future, we may not be able to
accurately report our financial results, which could have an adverse effect on
our business.




If our
internal control over financial reporting and disclosure controls and procedures
are not effective, we may not be able to provide reliable financial information.
Subsequent to the filing of the Form 10-Q for the period ended March 31, 2009,
we determined that our condensed consolidated financial statements as of March
31, 2009 and for the three- and nine-month periods ended March 31, 2009, as
included in the Form 10-Q for the period ended March 31, 2009, should be
restated as they contained errors that resulted in misstatements of inventories,
accounts payable, accrued royalties, accrued expenses and other current
liabilities, due to shareholders, additional paid-in-capital, product costs,
royalties, sales and marketing and general and administrative expenses.
Accordingly, we restated our condensed consolidated financial statements as of
March 31, 2009 and for the three- and nine-month periods ended March 31, 2009.
In connection with this restatement, we determined that our internal control
over financial reporting during the period ended March 31, 2009 was not
effective due to the existence of material weaknesses in our internal control
over financial reporting relating to our quarter-end closing process, our
controls over related party transactions, our general and administrative expense
accruals and our reconciliation of inventory liability clearing accounts.
Although we have implemented additional procedures that we believe enable us to
properly prepare and review our condensed consolidated financial statements, we
cannot be certain that these measures will ensure that we maintain adequate
controls over our financial reporting process in the future. If we discover
additional deficiencies, we will make efforts to remediate these deficiencies;
however, there is no assurance that we will be successful either in identifying
deficiencies or in their remediation. Any failure to maintain effective controls
in the future could adversely affect our business or cause us to fail to meet
our reporting obligations. Such non-compliance could also result in an adverse
reaction in the financial marketplace due to a loss of investor confidence in
the reliability of our condensed consolidated financial statements. In addition,
perceptions of our business among customers, suppliers, rating agencies,
lenders, investors, securities analysts and others could be adversely
affected.





If
we fail to retain the services of senior management, our business and prospects
could be materially adversely affected.




Our
continued success will depend to a significant extent upon the performance and
contributions of our senior management and upon our ability to attract, motivate
and retain highly qualified employees. We are dependent upon key senior
management to effectively manage our business in a highly competitive
environment. If one or more of our key officers joins a competitor or forms a
competing company, we may experience material interruptions in product
development, delays in bringing products to market, difficulties in our
relationships with licensors, suppliers and customers, and the loss of
additional personnel, which could significantly harm our business, financial
condition and operating results. Additionally, failure to continue to attract
and retain qualified management personnel could adversely affect our business
and prospects.


21





We do not
have “key person” life insurance policies covering any of our employees, nor are
we certain if any such policies will be obtained or maintained in the future. In
particular, we will depend in large part on the abilities of Mr. Terry Phillips
and Ms. Melanie Mroz, who are the chairman, and president and chief executive
officer, respectively, of the Company, to effectively execute future
strategies.




If
we fail to hire and retain qualified personnel, in an industry where competition
for qualified personnel is intense, our business could be seriously
harmed.




Our
business, operating results and financial condition could be materially and
adversely affected if we lose the services of key technical, sales or marketing
employees, or if we fail to attract additional highly qualified employees. Our
employees are responsible for ensuring the timely publication, distribution and
continued improvement of proprietary videogames that our clients demand, for
promptly addressing client requirements through technical and operational
support services, and for identifying and developing opportunities to provide
additional products and/or services to existing clients. The loss of the
services of these employees, the inability to attract or retain qualified
personnel in the future, or delays in hiring qualified personnel could limit our
ability to generate revenues and to successfully operate our
business.




Competition
for employees can be intense and the process of locating key personnel with the
right combination of skills is often lengthy. We rely to a substantial extent on
the expertise, skills and knowledge of management, marketing, sales, technical
and technology personnel to formulate and implement our business plan, as well
as to identify, support, publish and market quality videogames. Although we have
granted incentives to some employees, we may not be able to continue to retain
these personnel at current compensation levels, or at all. The compensation
arrangements with such employees could result in increased expenses and have a
negative impact on our operating results. In addition, if one or more of these
individuals leaves us, we may experience material delays in bringing products to
market, which could have a material adverse effect on our business and
prospects.





Growth
of our business will result in increased demands on our management and limited
human capital resources, which we may not be able to meet.




Any
future growth in our business, whether organic or through acquisitions, will
result in increased responsibility for our management and increased demands on
our personnel. As our business grows, we will be required to retain qualified
personnel who can expand our customer base and ensure continued development and
delivery of highly innovative and technologically advanced videogames. We must
continue to enhance and expand our management, technical, selling and marketing
capabilities to accommodate this growth. To manage future growth, we will need
to:





·
            Retain
      and hire competent senior management and marketing personnel to manage
      publishing and marketing
activities;





·
            Maintain
      and expand our base of operating, financial and administrative personnel;
      and





·
            Continue
      to train, motivate, and retain existing employees and attract and
      integrate new employees.




If we are
unable to manage future expansion, our ability to provide and maintain superior
services to our vendors and customers could be compromised, which could in turn
damage our reputation and substantially harm the business.


22





Our
business and products are subject to potential legislation. The adoption of such
proposed legislation could limit the retail market for our
products.




Several
proposals have been made for federal legislation to regulate our industry. Such
proposals seek to prohibit the sale of “M” rated, “AO” rated and “Rating
Pending” products to under-17 audiences (while the ESRB rating recommends an
appropriate age group, there is currently no legal prohibition on any game
sales). If any such proposals are enacted into law, they may limit the potential
market for our “M” rated products in the United States, and adversely affect our
operating results. Other countries, such as Germany, have adopted laws
regulating content both in packaged games and those transmitted over the
Internet that are stricter than current United States laws. In the United
States, proposals have also been made by numerous state legislators to regulate
the sale of “M” or “AO” rated products and prohibit the sale of interactive
entertainment software products containing certain types of violence or sexual
materials to under 17 or 18 audiences. While such legislation to date has been
enjoined by industry and retail groups, the adoption into law of such
legislation in federal and/or in state jurisdictions in which we do significant
business could severely limit the retail market for our “M” rated
titles.




Failure
to obtain a target rating for certain of our products, as well as videogame
re-rating, could negatively impact our sales.




The ESRB
system uses a rating symbol that suggests the appropriate player age group, and
content descriptor information, such as graphic violence, profanity, or sexually
explicit material. The ESRB rating is printed on each videogame package and
retailers may use the rating to restrict sales to the recommended age groups.
Retail customers take the ESRB rating into consideration when deciding which
videogames they will purchase. If the ESRB or a manufacturer determines that any
of our videogames should have a rating directed to an older or more mature
consumer, we may be less successful in marketing and selling said
videogames.




We claim
compliance with rating system requirements and the proper display of the
designated rating symbols and content descriptors. In some instances, however,
we may have to modify certain videogames in order to market them under the
expected rating, which could delay or disrupt the release of these videogames.
In the United States, we expect our videogames to receive ESRB ratings of “E”
(age 6 and older), “E10+” (age 10 and older), “T” (age 13 and over) or “M” (age
17 and over). In addition to these ratings, the ESRB may also rate a videogame
as “AO” (age 18 and over). A few of our published videogames have been rated “M”
by the ESRB. If we are unable to obtain M ratings as a result of changes in the
ESRB’s ratings standards or for other reasons, including the adoption of
legislation in this area, our business and prospects could be negatively
affected. In the event any of our videogames are re-rated by the ESRB, we may be
required to record a reserve for anticipated product returns and inventory
obsolescence, which could expose us to additional litigation, administrative
fines and penalties and other potential liabilities, and could adversely affect
our operating results.





Content
policies adopted by retailers, consumer opposition and litigation could
negatively impact sales of our products.




Retailers
may decline to sell videogame software containing what they judge to be graphic
violence or sexually explicit material or other content that they deem
inappropriate for their businesses. If retailers decline to sell our products
based upon their opinion that they contain objectionable themes, graphic
violence or sexually explicit material or other generally objectionable content,
or if any of our previously “M” rated series products are rated “AO,” we might
be required to significantly change or discontinue particular titles or series,
which could seriously affect our business. Consumer advocacy groups have opposed
sales of videogame software containing objectionable themes,
violence, sexual material or other objectionable content by pressing for
legislation in these areas and by engaging in public demonstrations and media
campaigns.




Our
Chairman is subject to an SEC cease and desist order.




Our
Chairman, Mr. Terry Phillips, agreed, in May 2007, to a settlement with the
Securities and Exchange Commission, or SEC, in a proceeding arising from certain
actions in 2000 and 2001. Without admitting or denying the allegations, Mr.
Phillips agreed to consent to the entry of an order to cease and desist from
committing or causing any violations of Section 10(b) of the Securities Exchange
Act of 1934, or the Exchange Act, and Exchange Act Rules 10b-5 and 13b2-1 and
from causing any violations of Sections 13(a) and 13(b)(2)(A) of the Exchange
Act and Exchange Act Rules 12b-2, 13a-1 and 13a-13.


23





This
proceeding arose from the involvement in 2000 and 2001 of Mr. Phillips, Capitol
Distributing, L.L.C., and another private company of which Mr. Phillips was a
principal, in certain actions of Take-Two Interactive Software, Inc., where Mr.
Phillips was accused of taking receipt of merchandise from Take-Two Interactive
Software, Inc. and later returning the merchandise to Take-Two without making an
effort to sell the merchandise. In his agreement to cease and desist, Mr.
Phillips paid a civil penalty of $50,000.




Should
Mr. Phillips be found to have violated the terms of the SEC’s order in the
future, he may be subject to further enforcement action, including legal action
imposing injunctive relief and assessing fines or penalties, which could have a
material impact on our reputation and business.





The
Company, our chairman and CEO have received Wells Notices which may result in
sanctions against them.





We, our
chairman and our CEO, have received Wells Notices from the staff of the
Securities and Exchange Commission advising that the staff will recommend
to the Securities and Exchange Commission that cease and desist orders issue for
alleged violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the
Securities and Exchange Act and certain rules adopted under this
act.  In addition, civil penalties are being recommended for Mr.
Phillips.  These alleged violations result from the facts underlying
the need to file an amended Form 10Q/A for the fiscal quarter ended March 31,
2009.  Any adverse determinations resulting from these alleged
violations could harm our reputation and business and adversely impact the value
of our outstanding shares.





Risks
Relating to our Securities




Because
we do not currently intend to pay dividends on our common stock, stockholders
will benefit from an investment in our common stock only if it appreciates in
value.




We do not
currently anticipate paying any dividends on shares of our common stock. Any
determination to pay dividends in the future will be made by our board of
directors and will depend upon results of operations, financial condition,
contractual restrictions, restrictions imposed by applicable law and other
factors our board of directors deems relevant. Accordingly, realization of a
gain on stockholder investments will depend on the appreciation of the price of
our common stock. There is no guarantee that our common stock will appreciate in
value or even maintain the price at which stockholders purchased their
shares.





The
concentration of our capital stock ownership will likely limit a stockholders
ability to influence corporate matters, and could discourage a takeover that
stockholders may consider favorable and make it more difficult for a stockholder
to elect directors of its choosing.




As of
October 13, 2010, our executive officers, directors and affiliates together
beneficially owned approximately 35.9% of our outstanding common stock. As a
result, these stockholders have the ability to exert significant control over
matters that require approval by all our stockholders, including the election of
directors and approval of significant corporate transactions. The interests of
these stockholders might conflict with the interests of the other
holders of our securities, and it may cause us to pursue transactions that,
in their judgment, could enhance their equity investments, even though such
transactions may involve significant risks to our other security holders. The
large concentration of ownership in a small group of stockholders might also
have the effect of delaying or preventing a change of control of our company
that our other stockholders may view as beneficial.




It may be
difficult for you to resell shares of our common stock if an active
market for our common
stock does not develop.




Our
common stock is not actively traded on a securities exchange and we currently do
not meet the initial listing criteria for any registered securities exchange,
including the Nasdaq Stock Market. Our securities are quoted on the less
recognized Over-the-Counter Bulletin Board. This factor may further
impair our stockholders’ ability to sell their shares
when they want and/or could depress our stock price. As a
result, stockholders may find it difficult to dispose of, or to obtain
accurate quotations of the price of, our securities because smaller quantities
of shares may be bought and sold, transactions could be delayed and security
analyst and news coverage of our company may be limited. These factors could
result in lower prices and larger spreads in the bid and ask prices for our
shares.


24





We seek to manage
our business with a view to achieving long-term results, and this could have a
negative effect on short-term trading.




Our focus
is on creation of stockholder value over time, and we intend to make decisions
that will be consistent with this long-term view. As a result, some of our
decisions, such as whether to make or discontinue operating investments, manage
our balance sheet and capital structure, or pursue or discontinue strategic
initiatives, may be in conflict with the objectives of short-term traders.
Further, this could adversely affect our quarterly or other short-term results
of operations.




Our
warrants may have an adverse effect on the market price of our common
stock.




We have
outstanding warrants to purchase 15,418,748 shares of common stock. There is
also an option to purchase 200,000 Class Z warrants and 260,000 Class W warrants
issued to the representative of the underwriters in our initial public offering.
The sale, or even the possibility of sale, of the shares underlying the warrants
and options could have an adverse effect on the market price for our securities
or on our ability to obtain future public financing. If and to the extent these
warrants are exercised, the common stockholders may experience dilution to their
holdings




Item 1B. Unresolved Staff
Comments




None.




Item
2.       Properties




We lease
a 5,500 square-foot office suite for our corporate headquarters in Midlothian,
Virginia under an agreement that expires in December 2010 (See Item 13 “Certain
Relationships and Related Transactions”). We also lease a three-story office
suite in Leichester, England for our international operations under an agreement
that expires in November 2012. We own a 7,000 square-foot office building and a
3,746 square-foot office building in Grapevine, Texas, which house our North
American sales and marketing department and our product production and
development management departments. We believe our current facilities are
suitable and adequate to meet our current needs, and that suitable additional or
substitute space will be available as needed to accommodate expansion of our
operations. As we expand our business into new markets, we expect to lease
additional office facilities. See Note 11 to the notes to our consolidated
financial statements and “Management’s Discussion and Analysis of Financial
Condition and Results of Operations - Commitments” appearing elsewhere in this
report for information regarding our lease obligations.


25


Item
3.       Legal
Proceedings




In
February, 2010, the Company, SouthPeak Interactive, L.L.C., and Gamecock were
served with a complaint filed in the U.S. District Court for the Southern
District of Texas by TimeGate Studios, Inc., or TimeGate, alleging various
breach of contract and other claims related to a publishing agreement, or the
Publishing Agreement, entered into between Gamecock and TimeGate in June 2007.
TimeGate is seeking the return of all past and future revenue generated from the
videogame related to the Publishing Agreement, an injunction against the Company
and its subsidiaries, damages to be assessed, and discretionary interest and
costs.  The court has ordered that the arbitration clause of the publishing
agreement applies and has directed the parties to arbitrate. The Company has no
estimate at this time of its potential exposure and cannot, at this time,
predict the outcome of this matter. The Company and its subsidiaries intend to
vigorously defend all claims.





In
September, 2010, we instituted summary proceedings in the Lyon France Commercial
Court against Nobilis Group in which we have alleged the Licensing and
Distribution Agreements for the games we were to obtain and have obtained from
Nobilis, including the My Baby games, were wrongfully terminated.  In
addition, we have claimed that the grant of the rights to My Baby 3 to Majesco
were unlawful.  We are seeking the reinstatement of the agreements and
damages associated with the actions of Nobilis.





On
September 3, 2010,  we, Terry Phillips, our chairman, and Melanie
Mroz, our CEO,  received Wells Notices from the staff of the
Securities and Exchange Commission advising that the staff will recommend
to the Securities and Exchange Commission that cease and desist orders issue for
alleged violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the
Securities and Exchange Act and Rules 12b-20 and 13a-13 adopted under this
act.  In addition, the staff has alleged violations by Mr. Phillips
and Ms. Mroz of Rule 13b-2 and Rule 13a-14 by Ms. Mroz. These alleged violations
result from the facts underlying the need to file an amended Form 10Q/A for the
fiscal quarter ended March 31, 2009.





Other
than the foregoing, we are not currently subject to any material legal
proceedings. We have fully resolved to the satisfaction of the receiver of CDV
Software Entertainment Group, AG, the outstanding judgment principally obtained
against Gamecock in the United Kingdom, thereby reaffirming the elimination of
this judgment liability in the third quarter of this year from the set-off we
asserted. From time to time, however, we are named as a defendant in legal
actions arising from our normal business activities. Although we cannot
accurately predict the amount of our liability, if any, that could arise with
respect to legal actions currently pending against us, we do not expect that any
such liability will have a material adverse effect on our consolidated financial
position, operating results or cash flows. We believe that we have obtained
adequate insurance coverage, rights to indemnification, or where appropriate,
have established reserves in connection with these legal
proceedings.




PART
II




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




Market
Price for Equity Securities




Following
our initial public offering in April 2006, our Series A units,
Series B units, common stock, Class B common stock, Class W
warrants and Class Z warrants were listed on the Over-the-Counter Bulletin
Board under the symbols GSPAU, GSPBU, GSPA, GSPAB, GSPAW and GSPAZ,
respectively.




Our Class
B common stock ceased trading on the Over-the-Counter Bulletin Board and was
automatically cancelled and converted into a right to receive $5.36 per share
from our trust fund on April 25, 2008. As a result of the cancellation of the
Class B common stock, our Series B units were mandatorily separated from their
associated Class W warrants and then cancelled on April 25, 2008.




On July
31, 2009, our Series A units were mandatorily separated from their associated
shares of common stock and Class Z warrants and our Series A units ceased
trading. On August 7, 2009, our Series A units were cancelled.


26





On April
7, 2009, we registered for resale our Class Y warrants.  There is no
established current public market for our Class Y warrants.





Our
common stock, Class W warrants and Class Z warrants now trade on the
Over-the-Counter Bulletin Board under the symbols SOPK, SOPKW and SOPKZ,
respectively.   The following table sets forth, for the calendar
quarter indicated, the quarterly high and low closing bid prices of our
securities as reported on the Over-the-Counter Bulletin Board in U.S. dollars.
The quotations listed below reflect interdealer prices, without retail markup,
markdown or commission and may not necessarily represent actual
transactions.


Common Stock
                          
                          
                          Class W
                            Warrants
                          
                          
                          Class Z
                            Warrants
                          
                          
                          Series A
                            UnitsHigh
                          
                          
                          Low
                          
                          
                          High
                          
                          
                          Low
                          
                          
                          High
                          
                          
                          Low
                          
                          
                          High
                          
                          
                          LowFiscal
      Year ended June 30, 2009First
      Quarter
                          
                          
                          2.52
                          
                          
                          
                          1.50
                          
                          
                          
                          0.46
                          
                          
                          
                          0.15
                          
                          
                          
                          0.55
                          
                          
                          
                          0.20
                          
                          
                          
                          10.50
                          
                          
                          
                          6.00Second
      Quarter
                          
                          
                          1.75
                          
                          
                          
                          0.52
                          
                          
                          
                          0.15
                          
                          
                          
                          0.07
                          
                          
                          
                          0.25
                          
                          
                          
                          0.10
                          
                          
                          
                          6.00
                          
                          
                          
                          1.25Third
      Quarter
                          
                          
                          0.52
                          
                          
                          
                          0.51
                          
                          
                          
                          0.07
                          
                          
                          
                          0.05
                          
                          
                          
                          0.10
                          
                          
                          
                          0.031
                          
                          
                          
                          1.25
                          
                          
                          
                          1.00Fourth
      Quarter
                          
                          
                          0.80
                          
                          
                          
                          0.30
                          
                          
                          
                          0.05
                          
                          
                          
                          0.05
                          
                          
                          
                          0.031
                          
                          
                          
                          0.01
                          
                          
                          
                          1.00
                          
                          
                          
                          1.00Fiscal
      Year ended June 30, 2010First
      Quarter
                          
                          
                          0.52
                          
                          
                          
                          0.10
                          
                          
                          
                          0.05
                          
                          
                          
                          0.005
                          
                          
                          
                          0.01
                          
                          
                          
                          0.0015
                          
                          
                          
                          1.00
                          *
                          
                          
                          1.00
                          *Second
      Quarter
                          
                          
                          0.37
                          
                          
                          
                          0.10
                          
                          
                          
                          0.005
                          
                          
                          
                          0.001
                          
                          
                          
                          0.02
                          
                          
                          
                          0.005
                          
                          
                          
                          -
                          
                          
                          
                          -Third
      Quarter
                          
                          
                          0.40
                          
                          
                          
                          0.26
                          
                          
                          
                          0.001
                          
                          
                          
                          0.0005
                          
                          
                          
                          0.10
                          
                          
                          
                          0.031
                          
                          
                          
                          -
                          
                          
                          
                          -Fourth
      Quarter
                          
                          
                          0.40
                          
                          
                          
                          0.22
                          
                          
                          
                          0.0005
                          
                          
                          
                          0.0005
                          
                          
                          
                          0.031
                          
                          
                          
                          0.01
                          
                          
                          
                          -
                          
                          
                          
                          -




*
Our Series A units ceased trading and were cancelled on August 7,
2009.





As of
October 13, 2010, there were approximately 75 holders of record of our common
stock, 9 holders of record of our Class W warrants, 8 holders of record of our
Class Z warrants, and 69 holders of record of our Class Y warrants.





Dividend
Policy




We have
not paid any dividends on our common stock to date and do not anticipate paying
any dividends in the foreseeable future. We intend to retain future earnings, if
any, in the operation and expansion of our business. Any future determination to
pay cash dividends will be made at the discretion of our board of directors and
will depend on our financial condition, results of operations, capital
requirements and other factors that our board of directors deems relevant.
Investors should not purchase our common stock with the expectation of receiving
cash dividends.




Securities
Authorized for Issuance under Equity Compensation Plans




The table
setting forth this information is included in Part III-Item 12, “Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters.”




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




The
following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our consolidated financial
statements and related notes that appear elsewhere in this report. In addition
to historical consolidated financial information, the following discussion
contains forward-looking statements that reflect our plans, estimates and
beliefs. Our actual results could differ materially from those discussed in the
forward-looking statements. Factors that could cause or contribute to these
differences include those discussed below and elsewhere in this report,
particularly in “Risk Factors” in Item 1A.


27





Going
Concern





The
accompanying financial statements have been prepared on a going-concern basis,
which contemplates the realization of assets and satisfaction of liabilities in
the normal course of business.  The ability of the Company to continue as a
going concern is predicated upon, among other things, generating positive cash
flows from operations, curing the default on the production advance payable, and
the resolution of various contingencies.  In their
report on our audited financial statements for the year ended June 30, 2010, our
independent registered public accounting firm included an explanatory paragraph
regarding concerns about our ability to continue as a going
concern.  Our financial statements contain additional note disclosure
describing the circumstances that lead to this disclosure by our independent
registered public accounting firm.




Overview




We are an
independent developer and publisher of interactive entertainment software. We
utilize our network of independent studios and developers to create videogames
for all popular videogame systems, including:





·
            home videogame consoles such as
      Microsoft Xbox 360, Nintendo Wii, Sony PlayStation 3 and Sony PlayStation
      2;





·
            handheld platforms such as
      Nintendo DS, Nintendo DSi, Sony PSP, Sony PSPgo, and Apple iPhone;
      and





·
            personal
      computers.




Our
portfolio of games extends across a variety of consumer demographics, ranging
from adults to children and hard-core game enthusiasts to casual
gamers.




We are an
“indie” videogame developer and publisher working with independent software
developers and videogame studios to create our videogames. We have cultivated
relationships globally with independent developers and studios that provide us
with innovative and compelling videogame concepts.




Our
strategy is to establish a portfolio of successful proprietary content for the
major videogame systems, and to capitalize on the growth of the interactive
entertainment market. We currently work exclusively with independent software
developers and videogame studios to develop our videogames. This strategy
enables us to source and create highly innovative videogames while avoiding the
high fixed costs and risk of having a large internal development studio. Through
outsourcing, we are also able to access videogame concepts and content from
emerging studios globally, providing us with significant new product
opportunities with limited initial financial outlay.




Sources
of Revenue




Revenue
is primarily derived from the sale software titles developed on our behalf by
third parties and other content partnerships. Our unique business model of
sourcing and developing creative product allows us to better manage our fixed
costs relative to industry peers.




Our
operating margins are dependent in part upon our ability to continually release
new products that perform according to our budgets and forecasts, and manage our
product development costs. Our product development costs include license
acquisition, videogame development, and third party royalties. Agreements with
third party developers generally give us exclusive publishing and marketing
rights and require us to make advance royalty payments, pay royalties based on
product sales and satisfy other conditions.




Fiscal
Year 2010 Releases




We
released the following videogames in fiscal year 2010:


28





Title
                      
                      Platform
                      
                      Date
      ReleasedEU
      Rome Gold
                      
                      PC
                      
                      7/7/2009East
      India Company
                      
                      PC
                      
                      7/9/2009Brave:
      A Warrior’s Tale
                      
                      X360,
      Wii
                      
                      8/1/2009Hearts
      of Iron 3
                      
                      PC
                      
                      8/3/2009Raven
      Squad: Hidden Dagger
                      
                      X360,
      PC
                      
                      8/21/2009Section
      8
                      
                      X360,
      PC
                      
                      8/26/2009Trine
                      
                      PC
                      
                      9/4/2009Majesty
      2: The Fantasy Kingdom
                      
                      PC
                      
                      9/16/2009Supreme
      Ruler 2020
                      
                      PC
                      
                      9/17/2009Horrid
      Henry
                      
                      NDS,
      Wii, PC
                      
                      10/30/09My
      Baby First Steps
                      
                      NDS,
      Wii
                      
                      11/3/09Fallen
      Earth
                      
                      PC
                      
                      11/22/09Fast
      Food Panic
                      
                      NDS
                      
                      12/18/09Schrodinger’s
      Rat
                      
                      iPhone
                      
                      12/23/09Blood
      Bowl
                      
                      X360,
      PC
                      
                      1/26/10Hotel
      Giant 2
                      
                      PC
                      
                      1/26/10Crime
      Scene
                      
                      NDS
                      
                      2/16/10Risen
                      
                      X360
                      
                      2/23/10Prison
      Break
                      
                      PS3,
      X360, PC
                      
                      3/20/10DJ
      Star (1)
                      
                      NDS
                      
                      3/26/10Sushi
      Go Round
                      
                      Wii,
      NDS
                      
                      3/30/10Elite
      Forces: Unit 77 (2)
                      
                      NDS
                      
                      4/19/10Dementium
      II
                      
                      NDS
                      
                      5/4/103D
      Dot Game Heroes
                      
                      PS3
                      
                      5/14/10Let’s
      Play: Ballerina
                      
                      Wii,
      NDS
                      
                      6/8/10Let’s
      Play: Garden
                      
                      Wii,
      NDS
                      
                      6/8/10Let’s
      Play: Flight Attendant
                      
                      Wii,
      NDS
                      
                      6/8/10Secret
      Files: Tunguska
                      
                      Wii,
      NDS
                      
                      6/29/10TNA
      Impact! Cross the Line
                      
                      NDS,
      PSP
                      
                      6/29/10





(1)
            DJ
      Star initially released by Deep Silver on November 10,
      2009.  Released by SouthPeak Interactive on March 26,
      2010.


(2)
            Elite
      Forces: Unit 77 initially released by Deep Silver on April 28, 2009.
      Released by SouthPeak Interactive on April 19,
  2010.





Critical
Accounting Policies and Estimates





Our
consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States. The preparation
of these consolidated financial statements requires estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and expenses, and
related disclosure of contingent assets and liabilities. Estimates were based on
historical experience and on various other assumptions that we believe to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results could differ materially
from these estimates under different assumptions or conditions.




We have
identified the policies below as critical to our business operations and the
understanding of our financial results. The impact and any associated risks
related to these policies on our business operations are discussed throughout
management’s discussion and analysis of financial condition and results of
operations where such policies affect our reported and expected financial
results.




Allowances for Returns, Price
Protection and Other Allowances.We accept returns from,
and grant price concessions to, our customers under certain conditions.
Following reductions in the price of our videogames, we grant price concessions
to permit customers to take credits against amounts they owe us with respect to
videogames unsold by them. Our customers must satisfy certain conditions to
entitle them to return videogames or receive price concessions, including
compliance with applicable payment terms and confirmation of field inventory
levels and sell-through rates.


29





We make
estimates of future videogame returns and price concessions related to current
period revenue. We estimate the amount of future returns and price concessions
for published titles based upon, among other factors, historical experience and
performance of the titles in similar genres, historical performance of the
videogame system, customer inventory levels, analysis of sell-through rates,
sales force and retail customer feedback, industry pricing, market conditions
and changes in demand and acceptance of our videogame by consumers.




Significant
management judgments and estimates must be made and used in connection with
establishing the allowance for returns and price concessions in any accounting
period. We believe we can make reliable estimates of returns and price
concessions. However, actual results may differ from initial estimates as a
result of changes in circumstances, market conditions and assumptions.
Adjustments to estimates are recorded in the period in which they become
known.




Inventories.Inventories are
stated at the lower of average cost or market. Management regularly reviews
inventory quantities on hand and in the retail channel and records a provision
for excess or obsolete inventory based on the future expected demand for our
games. Significant changes in demand for our games would impact management’s
estimates in establishing the inventory provision.




Advances on Royalties.We
utilize independent software developers to develop our videogames and make
payments to the developers based upon certain contract milestones. We enter into
contracts with the developers once the videogame design has been approved by the
videogame system manufacturers and is technologically feasible. Accordingly, we
capitalize such payments to the developers during development of the videogames.
These payments are considered non-refundable royalty advances and are applied
against the royalty obligations owed to the developer from future sales of the
videogame. Any pre-release milestone payments that are not prepayments against
future royalties are expensed to “cost of goods sold - royalties” in the period
when the game is released. Capitalized royalty costs for those videogames that
are cancelled or abandoned are charged to “cost of goods sold - royalties” in
the period of cancellation.




Beginning
upon the related videogame’s release, capitalized royalty costs are amortized to
“cost of goods sold – royalties,” based on the ratio of current revenues to
total projected revenues for the specific videogame, generally resulting in an
amortization period of twelve months or less.




We
evaluate the future recoverability of capitalized royalty costs on a quarterly
basis. For videogames that have been released in prior periods, the primary
evaluation criterion is actual title performance. For videogames that are
scheduled to be released in future periods, recoverability is evaluated based on
the expected performance of the specific videogame to which the royalties
relate. Criteria used to evaluate expected game performance include: historical
performance of comparable videogames developed with comparable technology;
orders for the videogame prior to its release; and, for any videogame sequel,
estimated performance based on the performance of the videogame on which the
sequel is based.




Significant
management judgments and estimates are utilized in the assessment of the
recoverability of capitalized royalty costs. In evaluating the recoverability of
capitalized royalty costs, the assessment of expected videogame performance
utilizes forecasted sales amounts and estimates of additional costs to be
incurred. If revised forecasted or actual videogame sales are less than, and/or
revised forecasted or actual costs are greater than, the original forecasted
amounts utilized in the initial recoverability analysis, the net realizable
value may be lower than originally estimated in any given quarter, which could
result in an impairment charge. Material differences may result in the amount
and timing of charges for any period if management makes different judgments or
utilizes different estimates in evaluating these qualitative
factors.




Intellectual Property Licenses.Intellectual property license costs consist of fees paid by us to license
the use of trademarks, copyrights, and software used in the development of
videogames. Depending on the agreement, we may use acquired intellectual
property in multiple videogames over multiple years or for a single videogame.
When no significant performance remains with the licensor upon execution of the
license agreement, we record an asset and a liability at the contractual amount.
We believe that the contractual amount represents the fair value of the
liability. When significant performance remains with the licensor, we record the
payments as an asset when paid to the licensee and as a liability upon
achievement of certain contractual milestones rather than upon execution of the
agreement. We classify these obligations as current liabilities to the extent
they are contractually due within the next 12 months. Capitalized intellectual
property license costs for those videogames that are cancelled or abandoned are
charged to “cost of goods sold - intellectual property licenses” in the period
of cancellation.


30





Beginning
upon the related video game's release, capitalized intellectual
property license costs are amortized to “cost of sales - intellectual property
licenses” based on the greater of: (1) the ratio of current revenues for the
specific videogame to total projected revenues for all videogames in which the
licensed property will be utilized or (2) the straight-line amortization based
on the useful lives of the asset. As intellectual property license contracts may
extend for multiple years, the amortization of capitalized intellectual property
license costs relating to such contracts may extend beyond one
year.




We
evaluate the future recoverability of capitalized intellectual property license
costs on a quarterly basis. For videogames that have been released in prior
periods, the primary evaluation criterion is actual title performance. For
videogames that are scheduled to be released in future periods, recoverability
is evaluated based on the expected performance of the specific videogames to
which the costs relate or in which the licensed trademark or copyright is to be
used. Criteria used to evaluate expected game performance include: historical
performance of comparable videogames developed with comparable technology;
orders for the game prior to its release; and, for any videogame sequel,
estimated performance based on the performance of the videogame on which the
sequel is based. Further, as intellectual property licenses may extend for
multiple videogames over multiple years, we also assess the recoverability of
capitalized intellectual property license costs based on certain qualitative
factors, such as the success of other products and/or entertainment vehicles
utilizing the intellectual property and the holder’s right to continued
promotion and exploitation of the intellectual property.




Significant
management judgments and estimates are utilized in the assessment of the
recoverability of capitalized intellectual property license costs. In evaluating
the recoverability of capitalized intellectual property license costs, the
assessment of expected game performance utilizes forecasted sales amounts and
estimates of additional costs to be incurred. If revised forecasted or actual
videogame sales are less than, and/or revised forecasted or actual costs are
greater than, the original forecasted amounts utilized in the initial
recoverability analysis, the net realizable value may be lower than originally
estimated in any given quarter, which could result in an impairment charge.
Material differences may result in the amount and timing of charges for any
period if management makes different judgments or utilizes different estimates
in evaluating these qualitative factors.




Revenue Recognition.We
recognize revenues from the sale of our video games upon the transfer of title
and risk of loss to the customer.  We apply the provisions of
Statement of Position 97-2, “Software Revenue Recognition,” in conjunction with
the applicable provisions of Staff Accounting Bulletin No. 104, “Revenue
Recognition.” Accordingly, we recognize revenues for software titles when (1)
there is persuasive evidence that an arrangement with the customer exists, which
is generally a purchase order, (2) the product is delivered, (3) the selling
price is fixed or determinable and (4) collection of the customer receivable is
deemed probable. Our payment arrangements with customers typically provide for
net 30 and 60 day terms. Advances received for licensing and exclusivity
arrangements are reported on the consolidated balance sheets as deferred
revenues until we meet our performance obligations, at which point the revenues
are recognized. Revenue is recognized after deducting estimated reserves for
returns, price protection and other allowances. In circumstances when we do not
have a reliable basis to estimate returns and price protection or is unable to
determine that collection of a receivable is probable, we defer the revenue
until such time as we can reliably estimate any related returns and allowances
and determine that collection of the receivable is probable.





Some of
our video games provide limited online features at no additional cost to the
consumer. Generally, we consider such features to be incidental to the overall
product offering and an inconsequential deliverable. Accordingly, we recognize
revenue related to video games containing these limited online features upon the
transfer of title and risk of loss to our customer. In instances where online
features or additional functionality arc considered a substantive deliverable in
addition to the video game, we take this into account when applying our revenue
recognition policy. This evaluation is performed for each video game together
with any online transactions, such as electronic downloads or video game add-ons
when it is released. When we determine that a video game contains online
functionality that constitutes a more-than-inconsequential separate service
deliverable in addition to the video game, principally because of its importance
to game play, we consider that our performance obligations for this game extend
beyond the delivery of the game. Fair value does not exist for the online
functionality, as we do not separately charge for this component of the video
game. As a result, we recognize all of the revenue from the sale of the game
upon the delivery of the remaining online functionality. In addition, we defer
the costs of sales for this game and recognize the costs upon delivery of the
remaining online functionality.


31





With
respect to online transactions, such as electronic downloads of games or add-ons
that do not include a more-than-inconsequential separate service deliverable,
revenue is recognized when the fee is paid by the online customer to purchase
online content and we are notified by the online retailer that the product has
been downloaded. In addition, persuasive evidence of an arrangement must exist,
collection of the related receivable must be probable and the fee must be fixed
and determinable.





The
Company has an arrangement pursuant to which it distributes videogames
co-published with another company for a fee based on the gross sales of the
videogames.  Under the arrangement, the Company bears the inventory
risk as the Company purchases and takes title to the inventory, warehouses the
inventory in advance of orders, prices and ships the inventory and invoices its
customers for videogame shipments.  Also under the arrangement, the
Company bears the credit risk as the supplier does not guarantee returns for
unsold videogames and the Company is not reimbursed by the supplier in the event
of non-collection. The Company records the gross amount of revenue under the
arrangement as it is not acting as an agent for the principal in the arrangement
as defined by ASC Topic 605.





Third-party
licensees in Europe distribute Gamecock’s video games under license agreements
with Gamecock. The licensees paid certain minimum, non-refundable, guaranteed
royalties when entering into the licensing agreements. Upon receipt of the
advances, we defer their recognition and recognize the revenues in subsequent
periods as these advances are earned by us. As the licensees pay additional
royalties above and beyond those initially advanced, we recognize these
additional royalties as revenues when earned.





With
respect to license agreements that provide customers the right to make multiple
copies in exchange for guaranteed amounts, revenue is recognized upon delivery
of a master copy. Per copy royalties on sales that exceed the guarantee are
recognized as earned. In addition, persuasive evidence of an arrangement must
exist, collection of the related receivable must be probable, and the fee must
be fixed and determinable.




Stock-Based Compensation.We
account for stock-based compensation in accordance with ASC Topic 718, Compensation – Stock
Compensation. ASC 718 requires companies to estimate the fair value of
share-based payment awards on the measurement date using an option-pricing
model. The value of the portion of the award that is ultimately expected to vest
is recognized as expense over the requisite service periods in the consolidated
statements of operations.




Stock-based
compensation expense recognized in the consolidated statements of operations is
based on awards ultimately expected to vest and has been reduced for estimated
forfeitures. ASC 718 requires forfeitures to be estimated at the time of grant
and revised, if necessary, in subsequent periods if actual forfeitures differ
from those estimates.




We account
for equity instruments issued to non-employees in accordance with ASC Topic 505,
Equity, Subtopic 50,
Equity-Based Payments to
Non-Employees.




We
estimate the value of employee, non-employee director and non-employee stock
options on the date of grant using the Black-Scholes option pricing model. Our
determination of fair value of share-based payment awards on the date of grant
using an option-pricing model is affected by our stock price as well as
assumptions regarding a number of highly complex and subjective variables. These
variables include, but are not limited to; the expected stock price volatility
over the term of the awards, and actual and projected employee stock option
exercise behaviors.




Amortizable Intangible Assets.Intangible assets subject to amortization are carried at cost less
accumulated amortization. Amortizable intangible assets consist of game sequels,
non-compete agreements and distribution agreements. Intangible assets subject to
amortization are amortized over the estimated useful life in proportion to the
pattern in which the economic benefits are consumed, which for some intangibles
assets are approximated by using the straight-line method. Long-lived assets
including amortizable intangible assets are reviewed for impairment in
accordance with Accounting Standards Codification Topic 360, Property, Plant, and
Equipment, (“ASC 360”) whenever events or changes in circumstances
indicate that the carrying amount of such assets may not be recoverable.
Determination of recoverability is based on an estimate of undiscounted future
cash flows resulting from the use of the asset and its eventual disposition.
Measurement of any impairment loss for long-lived assets and amortizable
intangible assets is based on the amount by which the carrying value exceeds the
fair value of the asset.


32





Business Combinations. We
estimate the fair value of assets acquired, and liabilities assumed in a
business combination. Our assessment of the estimated fair value of each of
these can have a material effect on our reported results as intangible assets
are amortized over various lives. Furthermore, a change in the estimated fair
value of an asset or liability often has a direct impact on the amount to
recognize as goodwill, an asset that is not amortized. Often determining the
fair value of these assets and liabilities assumed requires an assessment of
expected use of the asset, the expected future cash flows related to the asset,
and the expected cost to extinguish the liability. Such estimates are inherently
difficult and subjective and can have a material impact on our consolidated
financial statements.




Assessment of Impairment of
Goodwill.ASC Topic 350, Intangibles – Goodwill and
Other, Subtopic 20, Goodwill, (“ASC 350-20”)
requires a two-step approach to testing goodwill for impairment. ASC 350-20
requires that the impairment test be performed at least annually by applying a
fair-value-based test. The first step measures for impairment by applying
fair-value-based tests. The second step (if necessary) measures the amount of
impairment by applying fair-value-based tests to the individual assets and
liabilities.




To
determine the fair values of the reporting units used in the first step, we use
a combination of the market approach, which utilizes comparable companies’ data
and/or the income approach, or discounted cash flows. Each step requires us to
make judgments and involves the use of significant estimates and assumptions.
These estimates and assumptions include long-term growth rates and operating
margins used to calculate projected future cash flows, risk-adjusted discount
rates based on our weighted average cost of capital, future economic and market
conditions and determination of appropriate market comparables. These estimates
and assumptions have to be made for each reporting unit evaluated for
impairment. Our estimates for market growth, our market share and costs are
based on historical data, various internal estimates and certain external
sources, and are based on assumptions that are consistent with the plans and
estimates we are using to manage the underlying business. Our business consists
of publishing and distributing interactive entertainment software and content
using both established and emerging intellectual properties and our forecasts
for emerging intellectual properties are based upon internal estimates and
external sources rather than historical information and have an inherently
higher risk of accuracy. If future forecasts are revised, they may indicate or
require future impairment charges. We base our fair value estimates on
assumptions we believe to be reasonable but that are unpredictable and
inherently uncertain. Actual future results may differ from those
estimates.




Costs
of Goods Sold and Operating Expenses




Cost of Goods Sold. Cost of
goods sold consists of royalty payments to third party developers, license fees
to videogame manufacturers, intellectual property costs for items such as
trademarked characters and game engines, manufacturing costs of the videogame
discs, cartridges or similar media and the write-off of acquired game sequel
titles. Videogame system manufacturers approve and manufacture each videogame
for their videogame system. They charge their license fee for each videogame
based on the expected retail sales price of the videogame. Such license fee is
paid by us based on the number of videogames manufactured. Should some of the
videogames ultimately not be sold, or the sales price to the retailer be reduced
by us through price protection, no adjustment is made by the videogame system
manufacturer in the license fee originally charged. Therefore, because of the
terms of these license fees, we may have an increase in the cost of goods as a
percent of net revenue should we fail to sell a number of copies of a videogame
for which a license has been paid, or if the price to the retailer is
reduced.




We
utilize third parties to develop our videogames on a royalty payment basis. We
enter into contracts with third party developers once the videogame design has
been approved by the videogame system manufacturer and is technologically
feasible. Specifically, payments to third party developers are made when certain
contract milestones are reached, and these payments are capitalized. These
payments are considered non-refundable royalty advances and are applied against
the royalty obligations owing to the third party developer from the sales of the
videogame. To the extent these prepaid royalties are sales performance related,
the royalties are expensed against projected sales revenue at the time a
videogame is released and charged to costs of goods sold. Any pre-release
milestone payments that are not prepayments against future royalties are
expensed when a videogame is released and then charged to costs of goods sold.
Capitalized costs for videogames that are cancelled or abandoned prior to
product release are charged to “cost of goods sold - royalties” in the period of
cancellation.


33





Warehousing and Distribution
Expenses. Our warehousing and distribution expenses primarily consist of
costs associated with warehousing, order fulfillment, and shipping. Because we
use third-party warehousing and order fulfillment companies in the United States
and in Europe, the expansion of our product offerings and escalating sales will
increase our expenditures for warehousing and distribution in proportion to our
increased sales.




Sales and Marketing Expenses.
Sales and marketing expenses consist of advertising, marketing and promotion
expenses, and commissions to external sales representatives. As the number of
newly published videogames increases, advertising, marketing and promotion
expenses are expected to rise accordingly. We recognize advertising, marketing
and promotion expenses as incurred, except for production costs associated with
media advertising, which are deferred and charged to expense when the related ad
is run for the first time. We also engage in cooperative marketing with some of
our retail channel partners. We accrue marketing and sales incentive costs when
revenue is recognized and such amounts are included in sales and marketing
expense when an identifiable benefit to us can be reasonably estimated;
otherwise, the incentives are recognized as a reduction to net revenues. Such
marketing is offered to our retail channel partners based on a single sales
transaction, as a credit on their accounts receivable balance, and would include
items such as contributing to newspaper circular ads and in store banners and
displays.




General and Administrative
Expenses. General and administrative expenses primarily represent
personnel-related costs, including corporate executive and support staff,
general office expenses, consulting and professional fees, and various other
expenses. Personnel-related costs represent the largest component of general and
administrative expenses. We expect that our personnel costs will increase as the
business continues to grow. We expect to incur additional increased costs for
personnel and consultants as a result of becoming a publicly traded company
which requires compliance and adherence to new regulations for corporate
governance and accounting. Depreciation expense also is included in general and
administrative expenses.




Interest and Financing Costs.
Interest and financing costs are attributable to our line of credit and
financing arrangements that are used to fund development of videogames with
third parties, which often takes 12-24 months. Additionally, such costs are used
to finance the accounts receivables prior to payment by customers.




Consolidated
Results of Operations




The
following table sets forth our results of operations expressed as a percentage
of net revenues for fiscal years 2010 and 2009:




For the years ended June 30,2010
                                            
                                            
                                            2009Net
      revenues
                                            
                                            
                                            100.0
                                            %
                                            
                                            
                                            100.0
                                            %Cost
      of goods sold:Product
      costs
                                            
                                            
                                            38.9
                                            %
                                            
                                            
                                            51.5
                                            %Royalties
                                            
                                            
                                            30.7
                                            %
                                            
                                            
                                            20.4
                                            %Write-off
      of acquired game sequel titles
                                            
                                            
                                            -
                                            
                                            
                                            
                                            2.4
                                            %Intellectual
      property licenses
                                            
                                            
                                            1.0
                                            %
                                            
                                            
                                            1.0
                                            %Total
      cost of goods sold
                                            
                                            
                                            70.6
                                            %
                                            
                                            
                                            75.3
                                            %Gross
      profit
                                            
                                            
                                            29.4
                                            %
                                            
                                            
                                            24.7
                                            %Operating
      expenses:Warehousing
      and distribution
                                            
                                            
                                            2.9
                                            %
                                            
                                            
                                            2.7
                                            %Sales
      and marketing
                                            
                                            
                                            19.6
                                            %
                                            
                                            
                                            24.9
                                            %General
      and administrative
                                            
                                            
                                            27.9
                                            %
                                            
                                            
                                            20.6
                                            %Restructuring
      costs
                                            
                                            
                                            -
                                            
                                            
                                            
                                            1.4
                                            %Transaction
      costs
                                            
                                            
                                            -
                                            
                                            
                                            
                                            0.1
                                            %Litigation
      costs
                                            
                                            
                                            7.6
                                            %
                                            
                                            
                                            -Loss
      on settlement of registration rights penalty
                                            
                                            
                                            0.3
                                            %
                                            
                                            
                                            -Gain
      on settlement of contingent purchase price obligation
                                            
                                            
                                            (2.3
                                            )%
                                            
                                            
                                            -Gain
      on extinguishment of accrued litigation costs
                                            
                                            
                                            (8.1
                                            )%
                                            
                                            
                                            -Gain
      on settlement of trade payables
                                            
                                            
                                            (8.1
                                            )%
                                            
                                            
                                            -Total
      operating expenses
                                            
                                            
                                            39.8
                                            %
                                            
                                            
                                            49.6
                                            %Loss
      from operations
                                            
                                            
                                            (10.4
                                            )%
                                            
                                            
                                            (25.0
                                            )%Interest
      expense, net
                                            
                                            
                                            4.0
                                            %
                                            
                                            
                                            0.8
                                            %Loss
      before taxes
                                            
                                            
                                            (14.4
                                            )%
                                            
                                            
                                            (25.8
                                            )%Income
      tax expense
                                            
                                            
                                            -
                                            
                                            
                                            
                                            -Net
      loss
                                            
                                            
                                            (14.4
                                            )%
                                            
                                            
                                            (25.8
                                            )%Deemed
      dividend related to beneficial conversion feature on Series A convertible
      preferred stock
                                            
                                            
                                            -
                                            
                                            
                                            
                                            2.4
                                            %Net
      loss attributable to common shareholders
                                            
                                            
                                            (14.4
                                            )%
                                            
                                            
                                            (28.2
                                            )%


34





Years
ended June 30, 2010 and June 30, 2009




Net Revenues. Net revenues
for fiscal year 2010 were $40,299,139, a decrease of $6,980,555, or 15%, from
net revenues of $47,279,694 for fiscal year 2009. The decrease in net revenues
was primarily driven by selling fewer units for next generation platforms, which
have a higher MSRP, in the year ending June 30, 2010 versus the prior
period.  This decrease in revenues was slightly offset by releasing an
increased number of titles. For fiscal year 2010, the number of videogame units
sold increased to approximately 2,551,000, an increase of 133,000 units from the
units sold in fiscal year 2009. Average net revenue per videogame unit sold
decreased 19%, from $19.55 to $15.80 for fiscal years 2009 and 2010,
respectively. This average decrease in price is mainly due to selling more
handheld units, which have a lower MSRP, in fiscal year 2010 versus
2009.




Cost of Goods Sold. Cost of
goods sold for fiscal year 2010 decreased to $28,449,866, down $7,179,002, or
20%, from $35,628,868 for fiscal year 2009. This decrease is primarily
attributed to a $8,722,360, or 36%, decrease in product costs, which was
primarily driven by the concentration on the My Baby brand.  The My
Baby brand is produced only for the Nintendo DS and Wii platforms and costs less
to build. The decrease in product costs was offset by a $2,728,552, or 28%,
increase in royalty expense.  This increase was driven by the release of
Section 8, Horrid Henry, and My Baby First Steps as well as the release of two
of our co-publishing games, Risen and Prison Break.




Gross Profit. For fiscal
years 2010 and 2009, gross profit increased to $11,849,273 from $11,650,826, or
2%, and gross profit margin increased to approximately 29% from 25%. The
increase in gross profit isattributed to prior
period write offs of acquired game sequels from the Gamecock
Acquisition.




Warehousing and Distribution
Expenses. For fiscal years 2010 and 2009, warehousing and distribution
expenses were $1,149,338 and $1,254,947, respectively, resulting in a decrease
of 8%. This decrease is due primarily to the Company’s direct shipments of video
game units to stores and distribution centers rather than storing in inventory
warehouses.




Sales and Marketing Expenses.
For fiscal year 2010, sales and marketing expenses decreased 33% to $7,882,584
from $11,778,958 for fiscal year 2009. This decrease is primarily due to our
cost reduction strategy. Sales and marketing costs vary on a videogame by
videogame basis depending on market conditions and consumer demand, and do not
necessarily increase or decrease proportionate to sales volumes. For fiscal year
2010, we incurred $565,279 in marketing costs that will benefit us in
future periods. Included in sales and marketing expenses for fiscal year
2010 is a non-cash charge of $95,709 for stock options granted to
vendor.


35





General and Administrative Expenses.For fiscal year 2010, general and administrative expenses increased 16%
to $11,251,764 from $9,720,488 for fiscal year 2009. Accounting fees included in
general and administrative expenses increased 104% from $448,562 for the year
ended June 30, 2009 to $914,532 for the year ended June 30, 2010 as a result of
increased audit fees and Sarbanes-Oxley compliance consulting fees. Legal costs
included in general and administrative expenses increased 127% from $881,215 for
the year ended June 30, 2009 to $2,000,649 for the year ended June 30, 2010 as a
result of increased litigation and costs associated with being a public company.
Wages increased from $3,073,581 for the year ended June 30, 2009 to $3,771,354
for the year ended June 30, 2010, an increase of 23%. Travel and
entertainment expenses were $428,817 for the year ended June 30, 2009,
decreasing 25% to $321,607 for the year ended June 30, 2010. General and
administrative expenses as a percentage of net revenues increased, to
approximately 28% for the year ended June 30, 2010 from 21% for the same period
in fiscal year 2009.  In addition, for the year ended June 30, 2010,
general and administrative expenses includes $594,997 for noncash compensation
related to employee stock options and restricted stock granted, a decrease of
$54,322, or 8%, from the comparable period in 2009.




Restructuring and Transaction
Costs: For fiscal year 2009, we incurred $639,210 in restructuring costs
related to the Gamecock Acquisition. These primarily consist of salaries and
severance for Gamecock employees who separated from service after the Gamecock
Acquisition as part of restructuring Gamecock's operations and rent expense for
the Gamecock office space that is no longer in use. For fiscal year 2009, we
incurred $64,628 in costs related to the Gamecock Acquisition. These costs
included professional fees to accounting firms, law firms and advisors and
travel expenses related to the Gamecock Acquisition.





Litigation Costs. For the
year ending June 30, 2010, litigation costs associated with the matter involving
CDV Software Entertainment A.G., or CDV, were $3,075,206.





Loss on Settlement of Registration
Rights Penalty.  For the year ending June 30, 2010, the loss on
settlement of penalty was $111,497. This penalty arose from the registration
rights agreement we maintained with the purchasers of our Series A Preferred
Stock. We settled this penalty by extending the term of the warrants issued to
these purchasers.





Gain on Settlement of Contingent
Purchase Price Obligation. For the year ended June 30, 2010, the gain on
settlement of contingent purchase price obligation was $908,210. Pursuant to the
terms of the Gamecock Agreement, the Company was obligated to pay the Seller 7%
of the future revenues from sales of certain Gamecock games, net of certain
distribution fees and advances.  On March 3, 2010, the Company settled
this contingent purchase price payment obligation in exchange for the issuance
to the Seller of 700,000 shares of common stock (which were valued at $245,000
based on the fair market value of the Company’s common stock on the settlement
date) and the payment of $200,000 in cash.





Gain on Extinguishment of Accrued
Litigation Costs. For the year ended June 30, 2010, the gain on
litigation was $3,249,610, which was the result of the Company’s settlement of
litigation.





Gain on Settlement of Trade
Payables. For the year ending June 30, 2010, the gain on settlement of
trade payables was $3,257,996, which was the result of negotiations with various
unsecured creditors for the settlement and payment of trade payables at amounts
less than the recorded liability.




Operating Loss. For fiscal
year 2010, our operating loss was $4,205,300 as compared to operating loss of
$11,807,405 for fiscal year 2009.




Interest and Financing Costs.
For fiscal year 2010, interest and financing costs increased to $1,622,225 from
$399,247 for fiscal year 2009 due to a to an increase in average borrowings
levels and as a result of expense related to the production advance
payable.  The production advance payable is currently in default and is
accruing production fees at $0.009 per unit (based upon 382,000 units) for each
day after November 14, 2009 (approximately $725,000 through June 30,
2010.


36





Net Loss. For fiscal year
2010, our net loss was $5,827,525, as compared to net loss of $12,206,652
for fiscal year 2009.




Quarterly
Operating Results Not Meaningful




Our
quarterly net revenues and operating results have varied widely in the past and
can be expected to vary in the future, due to numerous factors, several of which
are not under our control. These factors include the timing of our release of
new titles, the popularity of both new titles and titles released in prior
periods, changes in the mix of titles with varying gross margins, the timing of
customer orders and fluctuations in consumer demand for gaming platforms.
Accordingly, our management believes that quarter-to-quarter comparisons of our
operating results are not meaningful.




Liquidity
and Capital Resources




Our
primary cash requirements have been to fund (i) the development, manufacturing
and marketing of our videogames, (ii) working capital, (iii) capital
expenditures and (iv) litigation costs and settlements. Historically, we have
met our capital needs through our operating activities, our line of credit and,
prior to the acquisition of SouthPeak by us, loans from related parties and our
stockholders. Our cash and cash equivalents were $92,893 and $648,311 at June
30, 2010 and 2009, respectively.




Line of
Credit. Throughout the
past fiscal year, we maintained a line of credit with SunTrust that was
scheduled to mature on November 30, 2010. At June 30, 2010 and June 30, 2009, the
outstanding line of credit balance was $3,830,055 and $5,349,953, respectively,
and the remaining available under the line of credit amounted to $-0- and $-0-,
respectively.  As of July 12, 2010, the Company repaid in full the
entire outstanding balance owed to SunTrust through a new factoring line of
credit.




Factoring Agreement.  On
July 12, 2010, the Company entered into a Factoring Agreement with Rosenthal
& Rosenthal, Inc.  Under the Factoring Agreement, the Company has
agreed to sell receivables arising from sales of inventory to Rosenthal &
Rosenthal.  Under the terms of the Factoring Agreement, the Company is
selling all of its receivables to Rosenthal & Rosenthal.  For the
approved receivables, Rosenthal & Rosenthal will assume the risk of
collection. The Company has agreed to pay Rosenthal & Rosenthal a commission
of .60% of the amount payable under all of the Company’s invoices to most of the
Company’s customers against a minimum commission of $30,000 multiplied by the
number of months in a contract period, with the first period being 12 months and
the second 7 months.  All payments received by Rosenthal &
Rosenthal are payable to the Company after amounts due to Rosenthal &
Rosenthal are satisfied.  Under the Factoring Agreement, the Company
has the right to borrow against payments due us at the rate of 65% of credit
approved receivables.  The borrowing rate against non-credit approved
receivables is subject to negotiation. The interest rate on borrowings is equal
to the greater of prime plus 1.5% per annum or 6.5% per annum.  A
$10,000,000 loan cap applies against the Company’s borrowings, which is subject
to an increase of up to $3,000,000 if shareholders’ equity increases.  The
initial term of the Factoring Agreement ends on February 28, 2012.




Account Receivable.
Generally, we have been able to collect our accounts receivable in the ordinary
course of business. We do not hold any collateral to secure payment from
customers. We are subject to credit risks, particularly if any of our accounts
receivable represent a limited number of customers. If we are unable to collect
our accounts receivable as they become due, it could adversely affect our
liquidity and working capital position.




At June
30, 2010 and 2009, amounts due from our three largest customers comprised
approximately 54% and 52% of our gross accounts receivable balance,
respectively. We believe that the receivable balances from these largest
customers do not represent a significant credit risk based on past collection
experience, although we actively monitor each customer’s credit worthiness and
economic conditions that may impact our customers’ business and access to
capital. We are monitoring the current turmoil in the economy, the global
contraction of current credit and other factors as it relates to our customers
in order to manage the risk of uncollectible accounts
receivable.


37





Our
accounts payable for the fiscal years ended June 30, 2010 and 2009 decreased
$6,985,653, or 36%, to $12,663,788.  This decrease was mainly attributable
to the settlement of multiple trade payables during the fiscal year ended June
30, 2010.  Our accrued expenses for the fiscal years ended June 30,
2010 and 2009 increased $1,362,611, or 56%, to $3,781,711.  This increase
was primarily attributed to the March 31, 2010 purchase of a development
contract for the videogame Stronghold 3.  Several of our fiscal year-end
accounts payable associated with pre-acquisition obligations of Gamecock have
been settled at substantial discounts.  Other Gamecock payables along with
SouthPeak related obligations are subject to adjustments, which we anticipate
will materially reduce our accounts payable balance.  The revenue generated
from new videogame releases in the first quarter of our 2011 fiscal year along
with the anticipated revenue generated in the second quarter should enable us to
further reduce our accounts payable and accrued expense balances.




Senior Secured Convertible Notes.On July 16, 2010, the Company entered into a Securities Purchase
Agreement with CNH Diversified Opportunities Master Account, L.P., CNH CA Master
Account, L.P., AQR Diversified Arbitrage Fund and Terry Phillips, the Company’s
chairman, for the sale of $5,500,000 of senior secured convertible notes
and warrants.  Mr. Phillips’ Note was issued in exchange for a
junior secured convertible note originally issued to him on April 30, 2010 (see
Note 9).  The Company received $5.0 million in cash for $5.0 million
of the senior secured convertible notes and exchanged a $500,000 prior junior
secured convertible note for $500,000 of the senior secured convertible
notes (see Note 26, Subsequent Events for further discussion).





On August
31, 2010, the Company entered into an Amended and Restated Securities Purchase
Agreement (the “Amended Purchase Agreement”), pursuant to which it sold an
aggregate of $2.0 million of a new series of senior secured convertible
promissory notes (the “Additional Notes”) to AQR Opportunistic Premium Offshore
Fund, L.P., Advanced Series Trust, solely on behalf of the AST Academic
Strategies Asset Allocation Portfolio, and Terry Phillips, SouthPeak’s chairman
(collectively, the “Additional Note Buyers”).  The Company received
$2.0 million in cash for $2.0 million of the Additional Notes, of which $200,000
was paid by Terry Phillips, the Company’s chairman.





Purchase Order Assignment
Agreement.On September 20, 2010, we entered into a Master
Purchase Order Assignment Agreement with Wells Fargo Bank, National Association.
Under the terms of the Agreement, the Company may request that Wells Fargo
accept the assignment of customer purchase orders and request that Wells Fargo
purchase the required materials to fulfill such purchase orders.  If
accepted, Wells Fargo, in turn, will retain the Company to manufacture, process,
and ship the ordered goods. Wells Fargo’s aggregate outstanding funding under
the agreement shall not exceed $2,000,000. Upon receipt of customer
payments by Wells Fargo, the Company will be paid a fee for its services, with
such fee calculated pursuant to the terms of the agreement. Also from such
customer payments, Wells Fargo shall be entitled to receive the
following: (1) a transaction initiation and set-up fee equal to 1.5% of the
aggregate amount outstanding on all amounts (including letters of credit)
advanced by Wells Fargo; (2) a daily maintenance fee equal to 0.05% of all
amounts (including letters of credit) advanced by Wells Fargo which remain
outstanding for more than 30 days; and (3) a product advance fee equal to (a)
the prime rate plus 2%, divided by 360, multiplied by (b) (i) the aggregate
amount outstanding on all amounts (including letters of credit) advanced by
Wells Fargo on account of purchases of products or other advances made in
connection with a customer purchase order, multiplied (ii) by the number of days
from the earlier of (A) the date on which any such letter of credit or purchase
order or financial accommodation is negotiated into cash, or (B) the date funds
are advanced by other than issuing a letter of credit or purchase order. A
security agreement secures the advances made to us under this
agreement.




Although
there can be no assurance, we believe our current cash and cash equivalents and
projected cash flow from operations, along with availability under our factoring
line and Wells Fargo agreement, will provide us with sufficient liquidity to
satisfy our cash requirements for working capital, capital expenditures and
commitments through at least the next 12 months. In addition, if we were unable
to fully fund our cash requirements through current cash and cash equivalents
and projected cash flow from operations, we would need to obtain additional
financing through a combination of equity and debt financings. If any such
activities become necessary, there can be no assurance that we would be
successful in obtaining additional financing, particularly in light of the
general economic downturn.




Cash Flows. We expect that we
will make significant expenditures relating to advances on royalties to
third-party developers to fund our continued growth. Cash flows from operations
are affected by our ability to release successful titles. Though many of these
titles have substantial royalty advances and marketing expenditures, once a
title recovers these costs, incremental net revenues typically will directly and
positively impact cash flows.


38





For
fiscal years 2010 and 2009, we had net cash used in operating activities of
$961,475 and $3,251,878, respectively.




Cash
provided by investing activities for the fiscal year 2010 was $655,108 and used
in investing activities for fiscal year 2009 was $1,853,431. The cash provided
by investing activities during fiscal year 2010 was from the release of
restricted cash. The cash used in investing activities for fiscal year 2009 was
related to the purchase of office and computer equipment and the Gamecock
Acquisition.




During
fiscal year 2010, financing activities resulted in net cash used of $753,893 and
during fiscal year 2009, financing activities resulted in net cash provided of
$1,869,864.




International
Operations.Net revenue earned
outside of North America is principally generated by our operations in Europe,
Australia and Asia. For fiscal years 2010 and 2009, approximately 19% and 11%,
respectively, of our net revenue was earned outside of the US. We are subject to
risks inherent in foreign trade, including increased credit risks, tariffs and
duties, fluctuations in foreign currency exchange rates, shipping delays and
international political, regulatory and economic developments, all of which can
have a significant impact on our operating results.




Item
7A. Quantitative and
Qualitative Disclosures about Market Risk




We are
subject to market risks in the ordinary course of our business, primarily risks
associated with interest rate and foreign currency fluctuations.




Interest Rate Risk. Our line
of credit bears interest at prime plus 1⁄2%, which was 4.75% at June 30, 2010. We
have two mortgages for facilities in Grapevine, Texas, which bear interest at
prime plus 1.0% (5.5% at June 30, 2010) and prime minus 1⁄4% (interest rate is
fixed at 7.5% until March 2013), respectively. Historically, fluctuations in
interest rates have not had a significant impact on our operating results,
however, changes in market rates may impact our future interest
expense.




Foreign Currency Risk. We
transact business in various foreign currencies and are exposed to financial
market risk resulting from fluctuations in foreign currency exchange rates,
particularly the British Pound and the Euro, which results in the recognition of
foreign currency transaction gains or losses. We monitor the volatility of the
British Pound, the Euro and all other applicable currencies frequently
throughout the year. While we have not engaged in foreign currency hedging, we
may in the future use hedging programs, currency forward contracts, currency
options and/or other derivative financial instruments commonly used to reduce
financial market risks if we determine that such hedging activities are
appropriate to reduce risk.




Item
8. Financial Statements and
Supplementary Data




Our
consolidated financial statements and related notes required by this item are
set forth as a separate section of this report. See Part IV, Item 15 of this
report.




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




None.


39





Item
9A(T). Controls and
Procedures




Restatement
of Previously Issued Financial Statements




In
connection with the filing of our Form 10-Q/A with the SEC on September 11,
2009, during the first fiscal quarter of 2010, management reevaluated the
effectiveness of our disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended
(the “Exchange Act”)). Based on that reevaluation, the Chief Executive Officer,
who was also serving as our interim Chief Financial Officer, and in consultation
with our Chairman, concluded that the our disclosure controls and procedures
were not effective as of March 31, 2009 as a result of the following material
weaknesses in our internal control over financial reporting.




·
            There were material operational
      deficiencies related to the preparation and review of financial
      information during our quarter end closing process.  These items
      resulted in more than a remote likelihood that a material misstatement or
      lack of disclosure within our interim financial statements would not be
      prevented or detected.  Our senior financial management lacked
      the necessary experience and we did not maintain a sufficient number of
      qualified personnel to support our financial reporting and close process.
      This reduced the likelihood that such individuals could detect a material
      adjustment to our books and records or anticipate, identify, and resolve
      accounting issues in the normal course of performing their assigned
      functions.  This material weakness resulted in adjustments to
      inventories, accounts payable, accrued royalties, accrued expenses and
      other current liabilities, due to shareholders, additional paid-in
      capital, product costs, royalties, sales and marketing and general and
      administrative expenses in our condensed consolidated financial statements
      for the three and nine month periods ended March 31,
      2009.




·
            There were material operational
      deficiencies in our controls over related party transactions which
      resulted in a more than remote likelihood that a material misstatement or
      lack of disclosure in our interim financial statements would not be
      prevented or detected.  Management determined that established
      controls over related party transactions were not consistently applied to
      all related party transactions. This inconsistent application led to
      breakdowns in communication between management and our accounting
      department and resulted in an increased likelihood that the accounting
      department would not detect a significant transaction affecting us which
      would lead to a material adjustment to our books and records or a material
      change to the disclosure in the footnotes to our interim financial
      statements. This material weakness resulted in adjustments to inventories,
      due to shareholders, and product costs in our condensed consolidated
      financial statements for the three and nine month periods ended March 31,
      2009.




·
            There were material internal
      control and operational deficiencies related to the maintenance of our
      accruals and related expense accounts.  These items resulted in
      more than a remote likelihood that a material misstatement or lack of
      disclosure within our interim financial statements would not be prevented
      or detected.  Specifically, effective controls were not designed
      and in place to ensure the completeness, accuracy and timeliness of the
      recording of accruals for services provided and not billed at period end.
      This increased the likelihood that our accruals would be materially
      understated.  This material weakness resulted in adjustments to
      accounts payable, accrued royalties, accrued expenses and other current
      liabilities, product costs, royalties, sales and marketing and general and
      administrative expenses in our condensed consolidated financial statements
      for the three and nine month periods ended March 31,
      2009.




·
            There were material internal
      control and operational deficiencies related to our reconciliation of
      inventory liability clearing accounts.  This item resulted in
      more than a remote likelihood that a material misstatement or lack of
      disclosure within our interim financial statements would not be prevented
      or detected.  Specifically, our account reconciliations,
      analyses and review procedures were ineffective as they lacked independent
      and timely review and separate review and approval of journal entries
      related to these accounts.  This material weakness resulted in
      adjustments to inventories in our condensed consolidated financial
      statements for the three and nine month periods ended March 31,
      2009.




40




Evaluation
of Disclosure Controls and Procedures




An
evaluation was carried out under the supervision and with the participation of
our management, including our Chief Executive Officer and our Chief Financial
Officer, and in consultation with our Chairman, of the effectiveness of the
design and operation of our disclosure controls and procedures, to ensure that
the information required to be disclosed by us in this quarterly report was
recorded, processed, summarized and reported within the time periods specified
in the SEC’s rules and Form 10-K and that such information required to be
disclosed was accumulated and communicated to management, including our Chief
Executive Officer and our Chief Financial Officer, to allow timely decisions
regarding required disclosure.  Based upon this reevaluation, our Chief
Executive Officer and our Chief Financial Officer, concluded that our disclosure
controls and procedures were not effective as of June 30, 2010 as a result of
the previously identified material weaknesses in our internal control over
financial reporting.





In
connection with the preparation of our annual report on Form 10-K for the year
ended June 30, 2009, under the supervision and with the participation of
management, including our Chief Executive Officer, who was also serving as our
interim Chief Financial Officer, and in consultation with our Chairman and our
interim Chief Accounting Officer, we conducted an evaluation of the
effectiveness of our internal control over financial reporting based on the
framework in “Internal
Control — Integrated Framework”issued by the Committee of
Sponsoring Organizations of the Treadway Commission. Based on our evaluation
under the framework in “Internal Control — Integrated
Framework”, our management concluded that our internal control over
financial reporting was not effective as of June 30, 2009 as a result of the
previously identified material weaknesses.




Management’s
Report on Internal Control over Financial Reporting




Management
is responsible for establishing and maintaining adequate internal control over
financial reporting, as such term is defined in Exchange
Act Rule 13a-15(f). Under the supervision and with the
participation of management, including our Chief Executive Officer, who is also
serving as our interim Chief Financial Officer, and in consultation with our
Chairman and our interim Chief Accounting Officer, we conducted an evaluation of
the effectiveness of our internal control over financial reporting based on the
framework in “Internal
Control — Integrated Framework”issued by the Committee of
Sponsoring Organizations of the Treadway Commission. Based on our evaluation
under the framework in “Internal Control — Integrated
Framework”, our management concluded that our internal control over
financial reporting was not effective as of June 30, 2009 as a result of the
previously identified material weaknesses.




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




Changes
in Internal Control over Financial Reporting




As
discussed above, as of June 30, 2009, we had material weaknesses in our internal
control over financial reporting.




In
addition to the remediation measures described below under the heading
“Remediation Steps to Address Material Weakness”,  we previously
reported that we have undertaken the following remediation measures through the
quarter ended March 31, 2010 to address the previously reported material
weaknesses in internal control over financial reporting and disclosure controls
and procedures:




·
            we implemented a closing calendar
      and consolidation process that includes accrual based financial statements
      being reviewed by qualified personnel in a timely
      manner;





·
            we review consolidating financial
      statements with senior management and the audit committee of the board of
      directors; and





·
            we complete disclosure checklists
      for both GAAP and SEC required disclosures to ensure disclosures are
      complete.





·
            we have appointed a Chief
      Financial Officer with the requisite experience in internal
      accounting in the videogame industry and made other related personnel
      changes;




41




·
            we have enhanced our computer
      software and internal procedures related to information technology in
      order to migrate from spreadsheet applications into automated functions
      within the accounting
system;





·
            we have implemented access
      controls into our financial accounting software;
  and





·
            we have had
      communications with our employees regarding ethics and the availability of
      our internal fraud hotline.





·
            we have provided training to our
      management and accounting personnel regarding established controls and
      procedures for related party
  transactions;





Remediation
Steps to Address Material Weakness




In
quarter ended June 30, 2010 we have adopted the following measures to continue
the remediation of the material weaknesses as reported in our June 30, 2009
annual report:




·
            we have made staff changes so
      that the accounting persons responsible for the preparation of external
      reporting, including public filings, are qualified accountants who stay
      abreast of new requirements through subscriptions and
      training.  New pronouncements are summarized and reported to
      accounting staff, Management and the Audit Committee as
      appropriate;





·
            we have instituted a quarterly
      review of all vendors and customers to ensure proper related party
      disclosure;





·
            we continue to communicate and
      enforce all policies and procedures relating to purchasing for the
      company;





·
            we have instituted a monthly
      reconciliation of our inventory and additionally we use our bill of
      materials (BOM) and purchase order  modules in our accounting
      system to ensure accurate tracking of
  inventory.





We have
remediated all but the first material weakness listed under the heading
“Restatement of Previously Issued Financial Statements” above, since we
determined that we required further additional controls to restrict access to
our automated accounting system.  These controls were put into effect
in the first quarter for fiscal year 2011 but did not exist in fiscal year
2010.  As for the initial material weakness we have determined that
for quarter ended June 30, 2010 we still possessed a material weakness resulting
from the ability of certain personnel to access our automated accounting
system.  In the first quarter of fiscal year 2011 we have corrected
this weakness by restricting access to all employees other than those employees
under the direct supervision of the Chief Financial Officer.





Management
anticipates that the actions described above and the resulting improvements in
controls will strengthen its internal control over financial reporting relating
to the preparation of the condensed consolidated financial
statements.  As we improve our internal control over financial
reporting and implement remediation measures, we may supplement or modify the
remediation measures described above.  Management is committed to
implementing effective control policies and procedures and will continually
update our Audit Committee as to the progress and status of our remediation
efforts to ensure that they are adequately implemented.




Item 9B.Other
Information




None.




42




PART III




Item 10.  Directors,
Executive Officers and Corporate Governance




Our
executive officers, key employees and directors and their respective ages and
positions as of October 13, 2010 are as follows:




Name
                      
                      Age
                      
                      PositionTerry
      Phillips*
                      
                      52
                      
                      ChairmanMelanie
      Mroz *
                      
                      47
                      
                      President,
      Chief Executive Officer andDirectorReba
      L. McDermott*
                      
                      44
                      
                      Chief
      Financial OfficerDavid
      Buckel
                      
                      48
                      
                      DirectorLouis
      M. Jannetty
                      
                      58
                      
                      DirectorPaul
      Eibeler
                      
                      55
                      
                      Director





*
            Denotes
      an executive officer




Terry Phillips has served as
our chairman since May 2008. Prior to that, Mr. Phillips served as the managing
member of SouthPeak since 2000, when he purchased certain SouthPeak assets from
SAS Institute. Mr. Phillips is also the managing member of Phillips Sales, Inc.
(PSI), a company that he founded in 1991 that has become one of the largest
manufacturer representative agencies specializing in the videogame industry. PSI
represented many of the industry leading companies including, Sony Computer
Entertainment America, THQ, Take-Two, Midway, Capcom Namco and Konami. PSI was
awarded “manufacturer representative of the year” by Sony Computer Entertainment
America in 1998 and has generated over $2 billion in sales since inception. In
2003, substantially all of Phillips Sales was sold to an ESOP. From March
1999 to present, Mr. Phillips was the manager of Capitol Distributing,
L.L.C., a videogame distribution company. From 1987 to 1991, Mr. Phillips was
vice president of sales for Acclaim Entertainment, a videogame publisher. In an
administrative proceeding before the SEC, in May 2007, Mr. Phillips agreed to
cease and desist from committing or causing any violations of Section 10(b) of
the Exchange Act and Exchange Act Rules 10b-5 and 13b2-1 and from causing any
violations of Sections 13(a) and 13(b)(2)(A) of the Exchange Act and Exchange
Act Rules 12b-2, 13a-1 and 13a-13. This proceeding arose from the involvement in
2000 and 2001 of Mr. Phillips, Capital Distributing and another private
company in which he was a principal in certain actions of Take-Two Interactive
Software, Inc. Mr. Phillips holds a Bachelor of Science in Business
Administration from Elmira College in New York.




Melanie Mroz has served as
our president, chief executive officer and director since May 2008. From August,
2009 until March 2010, Ms. Mroz assumed the duties of our interim chief
financial officer.  Ms. Mroz was a member of SouthPeak from 2000 until
May 2008. In 2005, she assumed responsibility for SouthPeak’s day-to-day
operations.  In 1996, Ms. Mroz joined Phillips Sales, Inc., one of the
largest manufacturer representative agencies in the videogame industry, to head
its representation of Sony Computer Entertainment America and thereafter assumed
other management duties. While at Phillips Sales, Inc., Ms. Mroz represented
some of the most successful videogame titles in the industry to major retailers,
including titles such as “Metal Gear Solid” from Konami America and “Grand Theft
Auto” from Take-Two Interactive Software, Inc. From January 1995 to December
1996, Ms. Mroz was the vice president of sales for Digital Pictures, Inc., a
private digital imaging, animation, and video products producer. From March 1992
to January 1995, Ms. Mroz was the national sales manager for Sony Imagesoft. Ms.
Mroz entered the interactive software industry in 1986 with entertainment and
educational software distributor SoftKat, then a division of W.R.Grace &
Co. Ms. Mroz began with SoftKat as a buyer in the purchasing
department and later became the director of purchasing. Ms. Mroz holds a
Bachelor of Science from Winona State University in Minnesota.




43




Reba McDermott has served as
our chief financial officer since April 2010.  From August 2009 until
she was named chief financial officer, Ms. McDermott served as our interim chief
accounting officer.  Prior to joining the Company, she served as the chief
financial officer of OuterNet Management, LP, an Austin, Texas-based data center
services company providing network security, software as a service,
virtualization, hosted business applications and private cloud architectures,
from December 2008 until August 2009.  From June 2007 until November
2008, Ms. McDermott served as the assistant plant controller and the plant
controller at the Canton, New York facility of Corning, Inc., a Fortune 500
specialty glass and ceramics manufacturer.  Prior to joining Corning,
Inc., from February 2005 until February 2007, Ms. McDermott served as assistant
controller and corporate controller for Aspyr Media, Inc., an Austin,
Texas-based developer and distributor of video games. From 2000 until 2005, Ms.
McDermott served in various capacities, including cost accounting manager and
revenue analyst, for Silicon Laboratories, Inc., a semiconductor manufacturer in
Austin, Texas.  Ms. McDermott received a Bachelor’s degree in
Accounting from Virginia Commonwealth University, a Bachelor’s degree in
Marketing Management from the University of Arkansas and a Master
of Business Administration from the University of Texas.




David Buckel has served as
one of our directors since August 2008. Since January of 2010, Mr. Buckel has
served as corporate secretary and chief financial officer of Ants Software, a
publicly traded Company. Mr. Buckel has served as chief financial officer of
Ryla, Inc., a call center solutions provider with expertise in customer contact
solutions and business process outsourcing and left to join Ants right before
the sale of the Company. Between January 2008 and February 2009, Mr. Buckel
served as a senior executive in operations and finance for Smarterville, Inc., a
portfolio company of Sterling Partners, which creates, manufactures, and sells
educational products. Prior to that, Mr. Buckel served as vice president and
chief financial officer of Internap Network Services Corporation (Nasdaq: INAP),
managing the company’s accounting, finance, purchasing, financial planning
analysis, investor relations, corporate development and other operating
functions. Mr. Buckel was with Internap from July 2003 until December 2007, and
led the company through its March 2004 public offering and subsequent leveraged
financings. Mr. Buckel was also senior vice president and chief
financial officer of Interland Corporation and Applied Theory Corporation, both
NASDAQ listed companies, where he managed numerous financial and operational
groups. Mr. Buckel also managed and led an IPO for Applied Theory in 1999. Mr.
Buckel, a Certified Management Accountant, holds a B.S. degree in Accounting
from Canisius College and a M.B.A. degree in Finance and Operations Management
from Syracuse University.




Louis M. Jannetty has served
as one of our directors since August 2008. From 1986 to 2008, Mr. Jannetty
served as the chief executive officer of Jansco Marketing Inc., a manufacturer
representative firm that specializes in the videogame industry and represented
major publishers such as Sony, Capcom, Eidos, Midway, Konami, Take Two, THQ, and
Namco Bandai. Prior to Jansco Marketing, Mr. Jannetty held executive positions
with Activision and Johnson and Johnson. Since 2005, Mr. Jannetty has also been
a principal in Janco Development LLC, a real estate holding and development
company. Mr. Jannetty received his Bachelor of Arts degree from Fairfield
University in 1974.




Paul Eibeler has served as
one of our directors since July 2009.  Mr. Eibeler is currently the
chairman of the board of directors of both Cokem International, an interactive
games distribution company, for which he has served as a director since
September 2007, and Viking Productions, a licensed products company in the
Caribbean market, for which he has served as a director since January
2007.  Mr. Eibeler served as chief executive officer of Take-Two
Interactive Software, Inc., a global publisher, developer and distributor of
interactive entertainment software, hardware and accessories, from January 2005
until March 29, 2007 and as president and a director of Take-Two from April 2004
until March 29, 2007.  In addition, Mr. Eibeler served as president of
Take-Two from July 2000 until June 2003 and as a director from December 2000
until February 2003.  Prior to that time, Mr. Eibeler was a
consultant for Microsoft’s Xbox launch team. From July 2003 to
October 2003, Mr. Eibeler was president and chief operating officer of
Acclaim Entertainment’s North America Division, a company engaged in publishing
video games and, from 1998 to 1999, Mr. Eibeler served as Acclaim North
America’s executive vice president and general manager.  Acclaim filed
a petition under Chapter 7 of the federal Bankruptcy Code in
September 2004. Mr. Eibeler received a B.A. from Loyola
College.




Information
Relating to Corporate Governance and the Board of Directors




Our
bylaws authorize our board of directors to appoint among its members one or more
committees, each consisting of one or more directors. Our board of directors has
established two standing committees: an Audit Committee and a Compensation
Committee.




44




Our Board
of Directors has adopted charters for the Audit and Compensation Committees
describing the authority and responsibilities delegated to each committee by the
board of directors. Our board of directors has also adopted Corporate Governance
Guidelines, a Code of Business Conduct and Ethics and a Whistleblower Policy. We
post on our website, at www.southpeakgames.com, the
charters of our Audit and Compensation Committees and our Code of Business
Conduct and Ethics. These documents are also available in print to any
stockholder requesting a copy in writing from our corporate secretary at the
address of our executive offices set forth in this report. We intend to disclose
any amendments to or waivers of a provision of our Code of Business Conduct and
Ethics made with respect to our directors or executive officers on our
website.




Interested
parties may communicate with our board of directors or specific members of our
board of directors, including our independent directors and the members of our
various board committees, by submitting a letter addressed to the board of
directors of SouthPeak Interactive Corporation c/o any specified individual
director or directors at the address listed herein. Any such letters will be
sent to the indicated directors.




The
Audit Committee




The
purpose of the Audit Committee is (i) to oversee our accounting and
financial and reporting processes and the audits of our financial statements,
(ii) to provide assistance to our board of directors with respect to its
oversight of the integrity of our financial statements, our compliance with
legal and regulatory requirements, the independent registered public accounting
firm’s qualifications and independence, and the performance of our internal
audit function, if any, and independent registered public accounting firm, and
(iii) to prepare the report required by the rules promulgated by the SEC.
The primary responsibilities of the Audit Committee are set forth in its charter
and include various matters with respect to the oversight of our accounting and
financial reporting process and audits of our financial statements on behalf of
our board of directors. The Audit Committee also selects the independent auditor
to conduct the annual audit of our financial statements; reviews the proposed
scope of such audit; reviews our accounting and financial controls with the
independent auditor and our financial accounting staff; and, unless otherwise
delegated by our board of directors to another committee, reviews and approves
transactions between us and our directors, officers, and their
affiliates.




The Audit
Committee currently consists of Messrs. Buckel, Jannetty and Eibeler each
of whom is an independent director under the Nasdaq Marketplace Rules and under
rules adopted by the SEC pursuant to the Sarbanes-Oxley Act of 2002. The board
of directors previously determined that all members of the Audit Committee meet
the requirements for financial literacy and that Mr. Buckel qualifies as an
“audit committee financial expert” in accordance with applicable rules and
regulations of the SEC. Mr. Buckel serves as the Chairman of the Audit
Committee.




The Compensation
Committee




The
purpose of the Compensation Committee includes determining, or recommending to
our board of directors for determination, the compensation of our chairman,
chief executive officer and president and any other executive officer of ours
who reports directly to the board of directors, and the members of the board of
directors; determining, or recommending to the board of directors for
determination, the compensation of all of our other executive officers; and
discharging the responsibilities of our board of directors relating to our
compensation programs and compensation of our executives. In fulfilling its
responsibilities, the Compensation Committee shall also be entitled to delegate
any or all of its responsibilities to a subcommittee of the Compensation
Committee. Information regarding our processes and procedures for the
consideration and determination of executive and director compensation is
addressed in the Compensation Discussion and Analysis below. The Compensation
Committee currently consists of Messrs. Buckel, Jannetty and Eibeler.
Mr. Jannetty serves as the Chairman of the Compensation
Committee.




Process
for Selecting Nominees to the Board of Directors




The board
of directors has no standing nominating committee. It is the board of directors’
view, given its relatively small size and independent directors, that it is
sufficient to select or recommend director nominees itself. Each director has
the opportunity to suggest any nominee and such suggestions are comprehensively
reviewed by the independent directors. The board of directors does not have a
charter for our nominating process. However, the qualities and skills sought in
prospective members of the board of directors generally require that director
candidates be qualified individuals who, if added to the board of directors,
would provide the mix of director characteristics, experience, perspectives and
skills appropriate for us. In accordance with the Corporate Governance
Guidelines adopted by the board of directors, criteria for selection of
candidates include, but are not limited to:




45




·
            diversity, age, background,
      skills and experience deemed appropriate by the independent directors in
      their discretion;





·
            possession of personal qualities,
      characteristics and accomplishments deemed appropriate by the independent
      directors in their
discretion;





·
            knowledge and contacts in the
      communities and industries in which we conduct
      business;





·
            ability and willingness to devote
      sufficient time to serve on the board of directors and its
      committees;





·
            knowledge and expertise in
      various activities deemed appropriate by the independent directors in
      their discretion; and





·
            fit of the individual’s skills,
      experience and personality with those of other directors in maintaining an
      effective, collegial and responsive board of
    directors.




Such
persons should not have commitments that would conflict with the time
commitments of a director of the Company.




The board
of directors does not have a specific policy for consideration of nominees
recommended by security holders due in part to the relatively small size of the
board of directors and the lack of turnover in board of directors’ membership to
date. However, security holders can recommend a prospective nominee for the
board of directors by writing to our corporate secretary at our corporate
headquarters and providing the information required by our bylaws, along with
any additional supporting materials the security holder considers appropriate.
There have been no recommended nominees from security holders for election at
the Annual Meeting. We do not pay fees to third parties for evaluating or
identifying potential nominees.




Board
and Committee Meetings




Our board
of directors held a total of seven meetings during the fiscal year ended June
30, 2010. The Audit and Compensation Committees of our board of directors held
nine meetings during the fiscal year ended June 30, 2010. During the fiscal year
ended June 30, 2010, no director attended fewer than 75% of the aggregate of the
total number of meetings of our board of directors.




Section
16(a) Beneficial; Ownership Reporting Compliance




Section 16(a)
of the Exchange Act requires our directors, officers, and persons that own more
than 10% of a registered class of our equity securities to file reports of
ownership and changes in ownership with the SEC. Our officers, directors and 10%
stockholders are required by SEC regulations to furnish us with copies of all
Section 16(a) forms they file. We prepare Section 16(a) forms on
behalf of our directors and officers based on the information provided by
them.




Based
solely on review of this information, we believe that, during the 2010 fiscal
year, no reporting person failed to file the forms required by
Section 16(a) of the Exchange Act on a timely basis, except for (i) Form 4
for Mr. Louis Jannetty to report the acquisition of options that occurred on
July 1, 2008 that was reported on July 22, 2009, (ii) a Form 4 for Ms. Melanie
Mroz to report the gift of stock that occurred on October 15, 2009 that was
reported on October 22, 2009, and (iii) a Form 4 for Ms. Reba McDermott to
report the grant of stock that occurred on October 1, 2009 that was reported on
November 24, 2009.




46




Item 11.  Executive
Compensation




Compensation
Discussion and Analysis




The
following Compensation Discussion and Analysis contains a discussion of the
material elements of compensation awarded to, earned by or paid to (i) each
person who served as our chief executive officer, (ii) each person who
served as our chief financial officer, and (iii) our chairman for the
fiscal years ended June 30, 2010 and 2009.  We have prepared the
Compensation Discussion and Analysis to provide you with information that we
believe is necessary to understand our executive compensation policies and
decisions as they relate to the compensation of Terry Phillips, our chairman,
Melanie Mroz, our president and chief executive officer, and Reba McDermott, our
chief financial officer starting on April 1, 2010 (Ms. McDermott had previously
served as the interim chief accounting officer).  These three
individuals are referred to as our “named executive officers.”




Executive
Compensation Program Objectives and Overview




Objectives.  We
operate in a highly competitive and challenging environment. To attract, retain,
and motivate qualified executive officers, we aim to establish wages and
salaries that are competitive with those of executives employed by similar
firms.  Another objective of our compensation policies is to motivate
employees by aligning their interests with those of our stockholders through
equity incentives, thereby giving them a stake in our growth and prosperity and
encouraging the continuance of their services with us or our subsidiaries. Given
our relative size, we have determined to take a simple approach to compensating
our named executive officers and to avoid other forms of compensation, such as
awards under non-equity incentive plans, non-qualified defined benefit plans and
pension plans.




Our
compensation program is designed to reward performance, both individual
performance and the performance of the company as a whole.  While base
salaries for our executives should reflect the marketplace for similar
positions, a significant portion of their compensation is earned based on our
financial performance and the financial performance of each executive’s area of
responsibility.  We strongly believe in measurement of quantifiable
results and this emanates from our belief that sustained strong financial
performance is an effective means of enhancing long-term stockholder
value.




Compensation Program Administration
and Policies.  The Compensation Committee, which is comprised
exclusively of independent directors, has general responsibility for executive
compensation and benefits, including incentive compensation and equity-based
plans. Specific salary and bonus levels, as well as the amount and timing of
equity grants, are determined on a case-by-case basis and reflect our
overall compensation objectives. The Compensation Committee also serves as the
administrator of our 2008 Equity Incentive Compensation Plan, and is the entity
authorized to grant equity awards under that plan. Finally, the Compensation
Committee is responsible for the determination of the extent to which each
executive may be entitled to any bonus payments based upon
individual and/or Company performance, as contemplated by the terms of
such executive’s employment agreement.




Pay Elements.  We
provide the following pay elements to our executive officers in varying
combinations to accomplish our compensation objectives:




·
            Base
    salary;





·
            Annual incentives in the form of
      cash bonuses;





·
            Equity-based compensation (stock
      options and restricted stock grants) pursuant to our 2008 Equity Incentive
      Compensation Plan; and





·
            Certain modest executive
      perquisites and benefits.




We fix
each executive’s base salary at a level we believe enables us to hire and retain
individuals in a competitive environment and to reward satisfactory individual
performance and a satisfactory level of contribution to our overall business
goals. We utilize cash bonuses to reward performance achievements within the
past fiscal year, and similarly, we utilize equity-based compensation under our
2008 Equity Incentive Compensation Plan to provide additional long-term rewards
for short-term performance achievements, which we believe encourages similar
performance over a longer term.




Each
compensation element and its purpose are further described below.




47




Base Salary.  Base
salary is intended to compensate the executive for the basic market value of the
position and the responsibilities of that position relative to other positions
in the Company. The base salary for each of our executives is initially
established through negotiation at the time of hire, based on such factors as
the duties and responsibilities of the position, the individual executive’s
experience and qualifications, the executive’s prior salary and competitive
salary information. Generally, the Chairman will recommend annual base salary
(and changes thereto) with respect to the other executives to the Compensation
Committee. The Compensation Committee will determine the Chairman’s base salary
by reference to the same criteria.




We
annually review our base salaries, and may adjust them from time to time based
on market trends. We also review the applicable executive’s responsibilities,
performance and experience. We do not provide formulaic base salary increases to
our executives. If necessary, we will realign base salaries with market levels
for the same positions in companies of similar size to us represented in
compensation data we review, if we identify significant market changes in our
data analysis. Additionally, we intend to adjust base salaries as warranted
throughout the year for promotions or other changes in the scope or breadth of
an executive’s role or responsibilities.




In
September 2009, the Compensation Committee recommended for approval by the full
board of directors base salaries for our executive officers. It was noted that
Mr. Phillips and Ms. Mroz have agreed to accept below-market base salaries until
the performance of the Company can support an increase.  The board of
directors established the 2010 base salaries for Mr. Phillips and Ms. Mroz at
$100,000 and $150,000, respectively.  Ms. McDermott’s annual base
salary for 2010 is $125,000.




Annual Incentives (Cash
Bonuses).  We provide a cash bonus opportunity to all of our
executive officers. We pay bonuses for the previous fiscal year generally during
the month following the filing of our audited financial statements with the SEC.
Generally, bonuses are payable to the extent provided in the employment
agreements negotiated with individual executives as approved by the Compensation
Committee. Those employment agreements that provide for the payment of cash
bonuses contemplate that they are based upon an evaluation of both our
performance and the performance of the individual executive and/or at
the sole discretion of the board of directors. Individual performance is
measured based on the achievement of quantifiable performance objectives
established by the Compensation Committee at the beginning of our fiscal year.
We believe linking cash bonuses to both Company and individual performance will
motivate executives to focus on our annual revenue growth, profitability, cash
flow and liquidity, which we believe should improve long-term stockholder value
over time.




Equity-Based
Compensation.  Our Compensation Committee believes that
granting shares of restricted stock and/or stock options on an annual
basis to existing executives provides an important incentive to retain
executives and rewards them for our short-term performance while also creating
long-term incentives to sustain that performance. Generally, grants of
restricted stock vest in one year and grants of stock options vest over three
years and no shares or options vest before the first day of the succeeding
fiscal year (the fiscal year following the fiscal year in which the options were
actually granted).




Executive Perquisites and
Benefits.  Our philosophy is to provide executives with limited
perquisites. The value of the perquisites (if any) and benefits provided to our
named executive officers is set forth in the Summary Compensation Table below,
and their aggregate cost for all of our executives in the fiscal year ended June
30, 2010 was $166,753.




Severance
and Other Benefits upon Termination of Employment




The
employment agreements with Terry Phillips, our chairman, and Melanie Mroz, our
president and chief executive officer, contain certain terms and conditions
relating to payments and continuation of health benefits in the event of the
severance of their employment with us. The specific terms and conditions
relating to severance payments for Mr. Phillips and Ms. Mroz are summarized
below and graphically displayed in the section entitled “Potential Payments Upon
Termination.” There are no provisions with respect to severance payments in any
other employment agreement for our named executive officers. We are not and were
not a party to any other change in control agreements or other severance
arrangements.




48




In order
to support our compensation objective of attracting, retaining and motivating
qualified executives, we believe that, in certain cases, we may decide to
provide executives with severance protections upon certain types of termination.
These severance protections would be negotiated on an individual by individual
basis.




Option
Grant Practices and Policies




It is
intended to be the practice of the Compensation Committee to grant stock options
under the 2008 Equity Incentive Compensation Plan with an exercise price equal
to or greater than the closing price of our common stock on the date of
grant.




Compensation
Committee Report on Executive Compensation




The
Compensation Committee has certain duties and powers as described in its
charter. The Compensation Committee is currently composed of Louis M. Jannetty,
David Buckel and Paul Eibeler, three of the non-employee directors named at the
end of this report, each of whom is independent as defined by Nasdaq Marketplace
Rules.




The
Compensation Committee of the Company has reviewed and discussed with management
the Compensation Discussion and Analysis required by Item 402(b) of
Regulation S-K of the Exchange Act and, based on such review and discussions,
the Compensation Committee has recommended to our board of directors that the
Compensation Discussion and Analysis section be included in this annual report
on Form 10-K, as filed with the SEC.




By
      the Compensation Committee,Louis
      M. Jannetty, ChairmanDavid
      BuckelPaul
      Eibeler





Compensation
Committee Interlocks and Insider Participation




No member
of our Compensation Committee has served as one of our officers or employees at
any time. None of our executive officers serve as a member of the Compensation
Committee of any other company that has an executive officer serving as a member
of our board of directors. None of our executive officers serve as a member of
the board of directors of any other company that has an executive officer
serving as a member of our Compensation Committee.




Summary
Compensation Table




The
following table sets forth, for the fiscal years ended June 30, 2010 and
2009, compensation information for: (i) each person who served as our chief
executive officer at any time during the periods covered, (ii) each person
who served as our chief financial officer at any time during the periods
covered; and (iii) our chairman.




Name
                                    
                                    Year
                                    
                                    Salary
                                    
                                    
                                    Stock
                                      Awards (1)
                                    
                                    
                                    Option
                                      Awards (1)
                                    
                                    
                                    All Other
                                      Compensation
                                    
                                    
                                    TotalTerry
      Phillips,
                                    
                                    2010
                                    
                                    $
                                    95,833
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    $
                                    13,787
                                    (2)
                                    
                                    $
                                    109,620Chairman
                                    
                                    2009
                                    
                                    $
                                    100,000
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    $
                                    8,909
                                    (3)
                                    
                                    $
                                    108,909Melanie
      Mroz,
                                    
                                    2010
                                    
                                    $
                                    148,750
                                    
                                    
                                    
                                    -
                                    
                                    
                                    $
                                    98,000
                                    
                                    
                                    $
                                    93,787
                                    (4)
                                    
                                    $
                                    340,537President,
      Chief Executive Officer and Director
                                    
                                    2009
                                    
                                    $
                                    150,000
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    $
                                    8,249
                                    (5)
                                    
                                    $
                                    158,249Reba
      McDermott
                                    
                                    2010
                                    
                                    $
                                    92,500
                                    
                                    
                                    
                                    -
                                    
                                    
                                    $
                                    114,100
                                    
                                    
                                    $
                                    56,864
                                    (7)
                                    
                                    $
                                    263,464Chief
      Financial Officer (6)
                                    
                                    2009
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -Andrea
      Gail Jones,
                                    
                                    2010
                                    
                                    $
                                    24,018
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    $
                                    2,315
                                    
                                    
                                    $
                                    26,333Chief
      Financial Officer and Treasurer (8)
                                    
                                    2009
                                    
                                    $
                                    105,000
                                    
                                    
                                    $
                                    12,650
                                    
                                    
                                    $
                                    60,000
                                    
                                    
                                    $
                                    3,749
                                    (9)
                                    
                                    $
                                    181,399




49




(1)
            Amounts
      reported represent the aggregate grant date fair value computed in
      accordance with FASB ASC Topic 718 utilizing the assumptions discussed in
      Note 7 to our consolidated financial
  statements.





(2)
            Amount
      includes $13,419 for the employee portion of health, dental and long-term
      care insurance premiums paid by us on the individual’s behalf and $368 for
      life and accidental death insurance premium paid by us on the individual’s
      behalf.





(3)
            Amount
      includes $3,381 for the employee portion of health, dental and long-term
      care insurance premiums paid by us on the individual’s behalf, $4,000 for
      a car allowance through May 2009, $1,160 for the use of one of our cars
      beginning in June 2009, and $368 for life and accidental death insurance
      premium paid by us on the individual’s
behalf.





(4)
            Amount
      includes $75,000 for incentive bonus, $13,419 for the employee portion of
      health, dental and long-term care insurance premiums paid by us on the
      individual’s behalf, $5,000 for a car allowance, and $368 for life and
      accidental death insurance premium paid by us on the individual’s
      behalf.





(5)
            Amount
      includes $3,381 for the employee portion of health, dental and long-term
      care insurance premiums paid by us on the individual’s behalf, $4,500 for
      a car allowance, and $368 for life and accidental death insurance premium
      paid by us on the individual’s
behalf.





(6)
            Effective
      August 16, 2009, Ms. McDermott was appointed by the Board to serve as our
      interim Chief Accounting Officer.  Effective April 1, 2010, Ms.
      McDermott was appointed by the Board to serve as our Chief Financial
      Officer.





(7)
            Amount
      includes $48,644 for incentive bonus, $7,883 for the employee portion of
      health, dental and long-term care insurance premiums paid by us on the
      individual’s behalf, and $337 for life and accidental death insurance
      premium paid by us on the individual’s
behalf.





(8)
            On
      August 14, 2009, Ms. Jones was terminated as our Chief Financial Officer
      and Treasurer.





(9)
            Amount
      includes $3,381 for the employee portion of health, dental and long-term
      care insurance premiums paid by us on the individual’s behalf and $368 for
      life and accidental death insurance premium paid by us on the individual’s
      behalf.





Outstanding
Equity Awards at Fiscal Year End




The
following table sets forth certain information concerning outstanding equity
awards held by our named executive officers at June 30, 2010:




Option AwardsNumber of Securities
                        
                        
                        Number of Securities
                        
                        
                        Option
                        
                        OptionUnderlying Unexercised
                        
                        
                        Underlying Unexercised
                        
                        
                        Exercise
                        
                        ExpirationName
                        
                        Options — Exercisable
                        
                        
                        Options — Unexercisable
                        
                        
                        Price
                        
                        DateReba
      McDermott
                        
                        
                        
                        
                        
                        
                        300,000
                        (1)
                        
                        $
                        0.30
                        
                        3/31/202010,000
                        (2)
                        
                        $
                        0.32
                        
                        12/31/201950,000
                        (3)
                        
                        $
                        0.51
                        
                        9/30/2019Melanie
      Mroz
                        
                        
                        
                        
                        
                        
                        100,000
                        (4)
                        
                        $
                        0.30
                        
                        3/31/202033,333
                        (5)
                        
                        
                        66,667
                        
                        
                        $
                        0.72
                        
                        6/30/2019





(1) The stock option award vests in three
equal annual installments commencing on April 1, 2011.




50




(2) The
stock option award vests in three equal annual installments commencing on
January 1, 2011.


(3) The
stock option award vests in three equal annual installments commencing on
October 1, 2010


(4) The stock option award vests in three
equal annual installments commencing on April 1, 2011.


(5) The
stock option award vests in three equal annual installments commencing on July
1, 2010.




Director
Compensation and Other Information




For
fiscal year 2010 we compensated non-employee members of our board of directors
through a mixture of cash and equity-based compensation. We paid each
non-employee director an annual retainer consisting of $5,000 cash, 20,000
shares of restricted stock, vesting in one year, and 50,000 options to purchase
our common stock, vesting in one year.  The chairperson of our Audit
Committee received an additional 5,000 shares of restricted stock, vesting in
one year.  Paul Eibeler, who joined our board of directors July 28,
2009, received an additional 50,000 options to purchase our common stock,
vesting in one year, as an initial bonus for joining our board of
directors.  To the extent that a non-employee director serves for less
than the full fiscal year, he or she would receive a pro-rated portion of the
annual retainer equal to the proportionate amount of the fiscal year for which
he or she served as a director. We reimburse our directors for reasonable
travel and other expenses incurred in connection with attending meetings of our
board of directors. Employees who also serve as directors receive no additional
compensation for their services as a director.




The
following table sets forth the compensation earned by our non-employee directors
in the fiscal year ended June 30, 2010.




Name
                    
                    Fees
                      Earned or
                      Paid in
                      Cash
                    
                    
                    Stock
                      Awards (1)(2)
                    
                    
                    Option
                      Awards (1)(3)(4)
                    
                    
                    TotalDavid
      Buckel
                    
                    $
                    5,000
                    
                    
                    $
                    18,750
                    
                    
                    $
                    35,500
                    
                    
                    $
                    59,250Louis
      M. Jannetty
                    
                    $
                    5,000
                    
                    
                    $
                    15,000
                    
                    
                    $
                    35,500
                    
                    
                    $
                    55,500Paul
      Eibeler
                    
                    $
                    5,000
                    
                    
                    $
                    15,000
                    
                    
                    $
                    71,000
                    
                    
                    $
                    91,000





(1)
            Amounts
      reported represent the aggregate grant date fair value computed in
      accordance with FASB ASC Topic 718 utilizing the assumptions discussed in
      Note 7 to our consolidated financial
  statements.





(2)
            The
      grant date fair values of the restricted stock awards granted to our
      non-employee directors during the fiscal year ended June 30, 2010 are as
      follows:





Name
                  
                  Total
                    Grant Date
                    Fair ValueDavid
      Buckel
                  
                  $
                  18,750Louis
      M. Jannetty
                  
                  $
                  15,000Paul
      Eibeler
                  
                  $
                  15,000








(3)
              As
      of June 30, 2010, the number of aggregate shares underlying outstanding
      option awards held by our non-employee directors is as
      follows:





Name
                  
                  Option Awards
                    OutstandingDavid
      Buckel
                  
                  
                  115,000Louis
      M. Jannetty
                  
                  
                  145,000Paul
      Eibeler
                  
                  
                  100,000




51




(4)
            The
      grant date fair values of option awards granted to our non-employee
      directors during the fiscal year ended June 30, 2010 are as
      follows:





Name
                  
                  Total
                    Grant Date
                    Fair ValueDavid
      Buckel
                  
                  $
                  35,500Louis
      M. Jannetty
                  
                  $
                  35,500Paul
      Eibeler
                  
                  $
                  71,000




Employment
Arrangements with Executive Officers




In May
2008, we entered into employment agreements with Terry Phillips, pursuant to
which Mr. Phillips serves as our chairman.  Also in May 2008, we
entered into an employment agreement with Melanie Mroz, pursuant to which
Ms. Mroz serves as our president and chief executive
officer.  The employment agreements have an initial term of three
years, and will automatically renew for successive additional one-year periods
thereafter unless either we or the executive notifies the other that the term
will not be extended. Mr. Phillips and Ms. Mroz receive salaries of
$100,000 and $150,000, respectively, per year, and are also eligible
to receive bonuses and equity awards that may be granted by our board of
directors or its compensation committee.  The employment agreements
provide for continuation of salary and benefits for a period of three months
upon termination other than for “cause” (as defined in the agreement) and
continuation of salary for a period of three months upon termination due to
disability.





Potential Payments upon
Termination




We are
not a party to any employment agreement providing for payments with respect to
an event that may constitute a “change of control.”




Mr.
Phillips and Ms. Mroz are entitled to receive their applicable base salary and
health benefits for three months following termination of employment other than
for “cause.” Mr. Phillips and Ms. Mroz are entitled to receive their applicable
base salary for three months following termination of employment due to
disability.




Termination
of Employment by the Company other than for “Cause” (1)
  Name
                    
                    Continuation ofSalary
                    
                    
                    Continuation ofHealth Benefits
                    
                    
                    TotalTerry
      Phillips
                    
                    $
                    25,000
                    
                    
                    $
                    4,332
                    
                    
                    $
                    29,332Melanie
      Mroz
                    
                    $
                    37,500
                    
                    
                    $
                    3,021
                    
                    
                    $
                    40,521
  Termination
of Employment due to Disability (2)
  Name
                    
                    Continuation ofSalary
                    
                    
                    Continuation ofHealth Benefits
                    
                    
                    TotalTerry
      Phillips
                    
                    $
                    25,000
                    
                    
                    $
                    -
                    
                    
                    $
                    25,000Melanie
      Mroz
                    
                    $
                    37,500
                    
                    
                    $
                    -
                    
                    
                    $
                    37,500




52




(1)
            Under the employment agreements,
      each executive may be terminated for “cause” if such executive: (i)
      commits a material breach of (a) his or her obligations or agreements
      under his or her employment agreement or (b) any of the covenants
      regarding non-disclosure of confidential information, assignment of
      intellectual property rights, non-competition and/or non-solicitation
      applicable to such executive under any stock option agreement or other
      agreement entered into between the executive and the Company; (ii)
      willfully neglects or fails to perform his or her material duties or
      responsibilities to the Company, such that the business or reputation of
      the Company is (or is threatened to be) materially and adversely affected;
      (iii) commits an act of embezzlement, theft, fraud or any other act of
      dishonesty involving the Company or any of its customers; or (iv) is
      convicted of or pleads guilty or no contest to a felony or other crime
      that involves moral
turpitude.





(2)
            Under the employment agreements,
      each executive may be terminated due to disability if such executive: (i)
      is unable, despite whatever reasonable accommodations the law requires, to
      render services to the Company for more than 90 consecutive days because
      of physical or mental disability, incapacity, or illness, or (ii) is found
      to be disabled within the meaning of the Company’s long-term disability
      insurance coverage as then in effect (or would be so found if he or she
      applied for the coverage or
benefits).





We
anticipate that we will generally enter into negotiated severance and release
agreements with an executive upon the event of termination of an executive
without cause.




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




The
following table provides information concerning beneficial ownership of our
common stock as of October 1, 2010, by:




·
            each stockholder, or group of
      affiliated stockholders, that we know owns more than 5% of our outstanding
      common stock;





·
            each of our executive
      officers;





·
            each of our directors;
      and





·
            all of our executive officers and
      directors as a group.




The
following table lists the number of shares and percentage of shares beneficially
owned based on 60,795,538 shares of common stock outstanding as of October 1,
2010.




Beneficial
ownership is determined in accordance with the rules of the SEC, and generally
includes voting power and/or investment power with respect to the securities
held. Shares of common stock subject to options and warrants currently
exercisable or exercisable within 60 days of October 1, 2010, are deemed
outstanding and beneficially owned by the person holding such options or
warrants for purposes of computing the number of shares and percentage
beneficially owned by such person, but are not deemed outstanding for purposes
of computing the percentage beneficially owned by any other person. Except as
indicated in the footnotes to this table, the persons or entities named have
sole voting and investment power with respect to all shares of our common stock
shown as beneficially owned by them.




Unless
otherwise indicated, the principal address of each of the persons below is c/o
SouthPeak Interactive Corporation, 2900 Polo Parkway, Midlothian, Virginia
23113.




53




Number ofShares
                      
                      Percentage ofBeneficially
                      
                      OutstandingOwned
                      
                      SharesExecutive Officers and
      DirectorsTerry
      Phillips (1)
                      
                      
                      18,945,906
                      
                      30.0
                      %Melanie
      Mroz (2)
                      
                      
                      3,214,459
                      
                      5.3
                      %Reba
      McDermott (3)
                      
                      
                      16,667
                      
                      *David
      Buckel (4)
                      
                      
                      210,217
                      
                      *Paul
      Eibeler (5)
                      
                      
                      185,217
                      
                      *Louis
      M. Jannetty (6)
                      
                      
                      225,217
                      
                      *All
      executive officers and directors as a group
    (6 persons)
                      
                      
                      22,797,683
                      
                      35.9
                      %Other 5%
      StockholdersGreg
      Phillips
                      
                      
                      10,394,900
                      
                      17.1
                      %Intermezzo
      Establishment (7)
                      
                      
                      5,000,000
                      
                      8.2
                      %Hummingbird
      Management, L.L.C. (8)
                      
                      
                      4,078,499
                      
                      6.6
                      %Atlas
      II, LP (9)
                      
                      
                      3,866,000
                      
                      6.2
                      %Paragon
      Investment Fund (10)
                      
                      
                      5,000,000
                      
                      8.2
                      %FI
      Investment Group, LLC (11)
                      
                      
                      3,808,523
                      
                      5.9
                      %





*
            Less than
    1%


(1)
            Includes
      1,160,093 shares of common stock issuable upon exercise of Series A
      warrants and 1,160,093 shares of common stock issuable upon conversion of
      senior secured convertible note.


(2)
            Includes
      33,333 shares of common stock issuable upon exercise of
      options.


(3)
            Consists
      of 16,667 shares of common stock issuable upon exercise of
      options.


(4)
            Includes
      115,000 shares of common stock issuable upon exercise of
      options.  The address of Mr. Buckel is 1065 Admiral Crossing,
      Alpharetta, Georgia 30005.


(5)
            Includes
      100,000 shares of common stock issuable upon exercise of
      options.  The address of Mr. Eibeler is 41 Frost Creek
      Drive, Lattingtown, New York 11560.


(6)
            Includes
      135,000 shares of common stock issuable upon exercise of
      options.  The address of Mr. Jannetty is 10 Cordage Park
      Circle, Suite 235, Plymouth, Massachusetts
  02360.


(7)
            The
      address of Intermezzo Establishment is Landstrasse 114, 9495 Triefen,
      Liechtenstein.  The foregoing information is derived from a
      Schedule 13D filed April 9, 2010.


(8)
            Includes
      1,350,030 shares of common stock issuable upon exercise of Class Y
      warrants, held by Hummingbird Value Fund, L.P. (“HVF”), Hummingbird
      Microcap Value Fund, L.P. (“Microcap Fund”), Hummingbird SPAC Partners,
      L.P. (“SPAC”), Hummingbird Concentrated Fund, L.P. (“Concentrated”) and
      Tarsier Nanocap Value Fund, L.P. (“Tarsier”, together with HVF, Microcap
      Fund, SPAC and Concentrated, the “Hummingbird Funds”). As investment
      manager of the Hummingbird Funds, Hummingbird Management, L.L.C.
      (“Hummingbird”) may be deemed to have the sole voting and investment
      authority over the shares of common stock and warrants owned by the
      Hummingbird Funds. The managing member of Hummingbird is Paul Sonkin. Mr.
      Sonkin, as the managing member and control person of Hummingbird, may be
      deemed to have the sole voting and investment authority over the shares of
      common stock and the warrants beneficially owned by Hummingbird.
      Hummingbird Capital, LLC (“HC”), as the general partner of each of the
      Hummingbird Funds, may be deemed to have the sole voting and investment
      authority over such shares and warrants owned by the Hummingbird Funds.
      Each of Hummingbird, Mr. Sonkin and HC disclaim any beneficial ownership
      of the shares of common stock and the warrants owned by the Hummingbird
      Funds. The business address of Hummingbird Management, L.L.C. is 145 East
      57th Street,
      8th Floor,
      New York, New York 10022.


(9)
            Includes
      1,496,500 shares of common stock issuable upon exercise of Class Y
      warrants and Class Z warrants. Patty Shanley is the General Partner of
      Atlas II, L.P. and consequently may be deemed to be the beneficial owner
      of its holdings by virtue of controlling the voting and dispositive powers
      of Atlas II, L.P. The business address of Atlas II, L.P. is 11470 Stone
      Corral Place, Gold River, CA 95670.  The foregoing information
      is derived from a Schedule 13G filed June 19,
  2009.


(10)
            The
      business address of Paragon Investment Fund is Bahnhofstrasse 76, 8001
      Zurich, Switzerland.  The foregoing information is derived from
      a Schedule 13D filed April 9, 2010.


(11)
            Includes
      3,093,333 shares of common stock issuable upon conversion of Series A
      convertible preferred stock and 500,000 shares of common stock issuable
      upon exercise of Class Y warrants. On June 5, 2008, FI Investment Group,
      LLC acquired 2,093,333 shares of Series A convertible preferred stock upon
      the conversion of outstanding principal and interest owed by SouthPeak
      Interactive, L.L.C., a subsidiary of the Company, at a purchase price of
      $1.00 per share. Frank Islam is the principal of FI Investment Group and,
      as such, has indirect voting and dispositive power over the shares of
      Series A convertible preferred stock and the warrants held by FI
      Investment Group, LLC. The business address of FI Investment Group, LLC is
      1600 Tysons Boulevard, Suite 1150, McLean, Virginia
  22102.




54




Equity
Compensation Plan Information




The
following table sets forth certain information as of the end of the most
recently completed fiscal year with respect to compensation plans (including
individual compensation arrangements) under which our equity securities are
authorized for issuance.




Number of Securities
                        
                        
                        Weighted Averageto be Issued Upon
                        
                        
                        Exercise Price of
                        
                        
                        Number ofExercise of Outstanding
                        
                        
                        Outstanding
                        
                        
                        SecuritiesOptions, Warrants
                        
                        
                        Options, Warrants
                        
                        
                        Remaining AvailablePlan Category
                        
                        and Rights
                        
                        
                        and Rights
                        
                        
                        for Future IssuanceEquity
      compensation plans approved by security holders
                        
                        
                        2,882,128
                        
                        
                        
                        1.16
                        
                        
                        
                        1,032,872Equity
      compensation plans not approved by security holders




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




Certain
Relationships and Related Transactions




Other
than the transactions described under the heading “Executive Compensation” (or
with respect to which such information is omitted in accordance with SEC
regulations) and the transactions described below, since July 1, 2009 there
have not been, and there is not currently proposed, any transaction or series of
similar transactions to which we were or will be a participant in which the
amount involved exceeded or will exceed $120,000, and in which any director,
executive officer, holder of 5% or more of any class of our capital stock or any
member of the immediate family of any of the foregoing persons had or will have
a direct or indirect material interest.




On
January 1, 2008, we entered into a three-year lease for office space for our
headquarters in Midlothian, Virginia. The lease is with Phillips Land, L.C., an
organization in which Terry Phillips, our chairman, and Greg Phillips
each beneficially own 50%. The rent is $9,167 per month. The terms of the lease
are comparable to those terms available from non-affiliate sources in that
the price per square foot is equal to prevailing rates.




On
January 1, 2008, we leased office space in our Grapevine, Texas office to
Phillips Sales, Inc., an organization in which Terry Phillips and Greg
Phillips collectively own 5%. Terry Phillips is the managing member of Phillips
Sales. The lease agreement provides for a term of three years and a rent of
$1,303 per month. The terms of the lease are comparable to those terms available
to non-affiliate sources in that the price per square foot is equal to
prevailing rates.




We have
paid sales commissions, upon the sale of products, to Phillips Sales and West
Coast Sales, Inc., an organization of which Terry Phillips indirectly
owns 37.5%. Terry Phillips is the managing member of West Coast
Sales. Such commissions approximated market rates and equaled $543,788 for
the fiscal year ended June 30, 2010. The sales commission arrangements are
materially and substantially the same as our sales commission arrangements with
unrelated parties.




In
February 2009, we received a short-term advance of $307,440 from Terry
Phillips.  This advance was unsecured and non-interest
bearing.  The amount of principal repaid to Mr. Phillips during the
years ended June 30, 2009 and June 30, 2010 was $75,000 and $232,440,
respectively.  At June 30, 2010, the amount due to Mr. Phillips was
$-0-.  The advance was made on a short-term basis to fund the
production of additional cartridges for a particular videogame. The terms of the
advance were superior to those terms available from non-affiliate sources in
that the advance was non-interest bearing and the outstanding principal amount
was not secured by any of our assets.





On April
29 and 30, 2010, we entered into a note purchase agreement pursuant to which the
Company issued junior secured subordinated promissory notes in the aggregate
principal amount of $950,000.  Of the notes issued on April 30, 2010,
Terry Phillips, our chairman, purchased $500,000.  The notes, which
were cancelled and repaid on July 19, 2010 in connection with the entry into the
Securities Purchase Agreement described below, were due and payable in full on
December 27, 2010, bore interest at the rate of 10% per annum and were
secured by all of the assets of the Company and our subsidiaries.  The
principal and accrued interest outstanding under each note was convertible, in
whole or in part, at the option of its holder into shares of our common stock at
a price per share of $0.45 per share.  On July 19, 2010, Mr.
Phillips’s note was exchanged for a senior secured convertible note in the
aggregate principal amount of $500,000 and accrued interest outstanding under
the note as of that date, in the amount of $11,233 was paid to Mr. Phillips in
cash.




55




On July
16, 2010, we entered into a Securities Purchase Agreement with certain
investors, including Terry Phillips for the sale of $5,500,000 of senior
secured convertible notes and associated warrants.  The closing on the
transaction occurred on July 19, 2010.  Mr. Phillips’s note, in the
aggregate principal amount of $500,000, was issued in exchange for the
junior secured convertible note originally issued to him on April 30,
2010.  The notes are senior to all obligations of the Company with the
exception of the indebtedness under our financing arrangement with Rosenthal
& Rosenthal, Inc. and are secured by all of our assets and those of our
subsidiaries.  The notes bear interest at 10.0% per annum and
principal and interest due under the notes are initially convertible at a price
of $.431 per share.  Mr. Phillips and the other holders of the notes
received Series A warrants equal in number to the shares initially issuable upon
conversion of the principal amount due under the notes, at an exercise price of
$.375 per share.  In addition, Mr. Phillips and the other holders of
the notes received Series B warrants equal in number to 75% of the Series A
warrants they obtained.  In connection with the sale of the notes and
warrants, we executed a Registration Rights Agreement pursuant to which this
Registration Statement is being filed.





On
August 31, 2010, we entered into an Amended and Restated Securities Purchase
Agreement (the “Amended Purchase Agreement”), pursuant to which it sold an
aggregate of $2.0 million of a new series of senior secured convertible
promissory notes (the “Additional Notes”) to AQR Opportunistic Premium Offshore
Fund, L.P., Advanced Series Trust, solely on behalf of the AST Academic
Strategies Asset Allocation Portfolio, and Terry Phillips, SouthPeak’s chairman
(collectively, the “Additional Note Buyers”).  The Company received
$2.0 million in cash for $2.0 million of the Additional Notes, of which $200,000
was paid by Terry Phillips, the Company’s chairman.





Procedures
for Approval of Related Transactions




Our
policy for the review and approval of transactions between us and related
persons is set forth in the charter of our Audit Committee. Pursuant to the
charter of our Audit Committee, it is the responsibility of our Audit Committee,
unless specifically delegated by our board of directors to another committee of
the board of directors, to review and approve all transactions or arrangements
in which we were or will be a participant in which the amount involved,
exceeded, or will exceed $120,000 and in which any director, executive officer,
holder of 5% or more of any class of our capital stock or any member of the
immediate family of any of the foregoing persons had or will have a direct or
indirect material interest. Additionally, it is the responsibility of our Audit
Committee, unless specifically delegated by our board of directors to another
committee of the board of directors, to review and make recommendations to the
board of directors, or approve, any contracts or other transactions with
our current or former executive officers, including consulting
arrangements, employment agreements, change-in-control agreements,
termination arrangements, and loans to employees made or guaranteed by
us.




Director
Independence




Our board
of directors has determined, after considering all the relevant facts and
circumstances, that each of Messrs. Buckel, Eibeler and Jannetty are independent
directors, as “independence” is defined in the Nasdaq Marketplace Rules, because
they have no relationship with us that would interfere with their exercise of
independent judgment.




Item 14.Principal Accountant
Fees and Services




Reznick
Group, P.C., an
independent registered public accounting firm, has audited our consolidated
financial statements for the fiscal years ended June 30, 2010 and
2009.




56




The
aggregate fees billed to us by Reznick Group, P.C. for the fiscal years ended
June 30, 2010 and June 30, 2009 are as follows:




2010
                    
                    
                    2009Audit
      Fees
                    
                    $
                    522,153
                    
                    
                    $
                    349,546Audit-Related
      Fees
                    
                    
                    –
                    
                    
                    
                    –Total
                    
                    $
                    522,153
                    
                    
                    $
                    349,546





(1)
            Audit Fees consist of fees
      incurred for the audits of our annual financial statements and the review
      of our interim financial
statements.





(2)
            Audit-Related Fees consist of
      fees incurred for assurance and related services that are reasonably
      related to the performance of the audit or review of our financial
      statements and are not reported under the category “Audit
      Fees.”




The
charter of our Audit Committee provides that the duties and responsibilities of
our Audit Committee include the pre-approval of all audit, audit-related, tax,
and other services permitted by law or applicable SEC regulations (including fee
and cost ranges) to be performed by our independent registered public accounting
firm. Any pre-approved services that will involve fees or costs exceeding
pre-approved levels will also require specific pre-approval by the Audit
Committee. Unless otherwise specified by the Audit Committee in pre-approving a
service, the pre-approval will be effective for the 12-month period following
pre-approval. The Audit Committee will not approve any non-audit services
prohibited by applicable SEC regulations or any services in connection with a
transaction initially recommended by the independent registered public
accounting firm, the purpose of which may be tax avoidance and the tax treatment
of which may not be supported by the Internal Revenue Code and related
regulations.




To the
extent deemed appropriate, the Audit Committee may delegate pre-approval
authority to the Chairman of the Audit Committee or any one or more other
members of the Audit Committee provided that any member of the Audit Committee
who has exercised any such delegation must report any such pre-approval decision
to the Audit Committee at its next scheduled meeting. The Audit Committee will
not delegate to management the pre-approval of services to be performed by the
independent registered public accounting firm.




Our Audit
Committee requires that our independent registered public accounting firm, in
conjunction with our chief financial officer, be responsible for seeking
pre-approval for providing services to us and that any request for pre-approval
must inform the Audit Committee about each service to be provided and must
provide detail as to the particular service to be provided.




All of
the services provided by Reznick Group, P.C. described above under the captions
“Audit Fees” and “Audit-Related Fees” were pre-approved by our Audit
Committee.




57




PART IV




Item 15. Exhibits and
Financial Statement Schedules




(a)   Documents filed as part of this
report:




Consolidated
      Financial Statements:
                
                61Report
      of Independent Registered Public Accounting Firm for the years ended June
      30, 2010 and 2009;
                
                62Consolidated
      balance sheets as of June 30, 2010 and 2009;
                
                63Consolidated
      statements of operations for the years ended June 30, 2010 and
      2009;
                
                64Consolidated
      statements of cash flows for the years ended June 30, 2010 and
      2009;
                
                65Consolidated
      statements of shareholders’ equity for the years ended June 30, 2010 and
      2009; and
                
                66Notes
      to consolidated financial statements.
                
                67




All other
financial schedules are not required under the related instructions or are
inappropriate and, therefore, have been omitted.




(b)   Exhibits




The
exhibits listed in the accompanying Index to Exhibits are filed or incorporated
by reference as part of this report.




58




SIGNATURES




Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act
of 1934, the registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.




SOUTHPEAK
      INTERACTIVE CORPORATIONBy:
                /s/
      Melanie MrozMelanie
      MrozPresident,
      Chief Executive OfficerDate:





59




POWER
OF ATTORNEY




KNOW ALL
MEN BY THESE PRESENTS that each person whose signature to this Annual
Report on Form 10-K appears below hereby constitutes and appoints each of Terry
Phillips and Melanie Mroz as such person’s true and lawful attorney-in-fact and
agent, with full power of substitution and resubstitution, for such person and
in such person’s name, place and stead, in any and all capacities, to sign any
and all amendments to this Annual Report on Form 10-K, and to file the
same, with all exhibits thereto, and other documents in connection therewith,
with the SEC, and does hereby grant unto each said attorney-in-fact and agent
full power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the premises, as fully to all
intents and purposes as such person might or could do in person, hereby
ratifying and confirming all that each said attorney-in-fact and agents or any
of them, or their substitutes, may lawfully do or cause to be done by virtue
hereof.




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




Signature
                
                Title
                
                Date/s/ TERRY PHILLIPS
                
                Chairman
      of the BoardTerry
      Phillips/s/ MELANIE MROZ
                
                President,
      Chief Executive Officer
                  and
      DirectorMelanie
      Mroz
                
                (Principal
      Executive Officer)/s/ REBA L. McDERMOTT
                
                Chief
      Accounting Officer and Chief Financial OfficerReba
      L. McDermott
                
                (Principal
      Financial and Accounting Officer)/s/ DAVID BUCKEL
                
                DirectorDavid
      Buckel/s/ PAUL EIBELER
                
                DirectorPaul
      Eibeler/s/ LOUIS M. JANNETTY
                
                DirectorLouis
      M. Jannetty




60





INDEX
TO CONSOLIDATED FINANCIAL STATEMENTS




PagesReport
      of Independent Registered Public Accounting Firm
                        
                        62Consolidated
      balance sheets as of June 30, 2010 and 2009
                        
                        63Consolidated
      statements of operations for the years ended June 30, 2010 and
      2009
                        
                        64Consolidated
      statements of cash flows for the years ended June 30, 2010 and
      2009
                        
                        65Consolidated
      statements of shareholders’ equity for the years ended June 30, 2010 and
      2009
                        
                        66Notes
      to Consolidated Financial Statements
                        
                        67




61





REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To the
Board of Directors and Shareholders of


SouthPeak
Interactive Corporation:





We have
audited the accompanying consolidated balance sheets of SouthPeak Interactive
Corporation and subsidiaries as of June 30, 2010 and 2009, and the related
consolidated statements of operations, cash flows and shareholders’ equity for
the years then ended. These consolidated financial statements are the
responsibility of the Company’s management. Our responsibility is to express an
opinion on these consolidated financial statements based on our
audits.





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




In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of SouthPeak Interactive
Corporation and subsidiaries as of June 30, 2010 and 2009, and the results of
their operations and their cash flows for the years then ended, in conformity
with U.S. generally accepted accounting principles.





The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern. As discussed in Note 1, the Company has incurred significant operating
losses and negative cash flows from operating activities, has substantial
contingencies, and is in default of its production advance payable. These
factors, among others, as discussed in Notes 1 and 20 to
the consolidated financial statements, raise substantial doubt about the
Company’s ability to continue as a going concern. Management’s plans in regard
to these matters are also described in Note 1. The consolidated financial statements do not
include any adjustments that might result from the outcome of this
uncertainty.




/s/
Reznick Group, P.C.




Vienna,
Virginia


October
13, 2010


62





SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS





June 30, 2010
                                          
                                          
                                          June 30, 2009AssetsCurrent
      assets:Cash
      and cash equivalents
                                          
                                          $
                                          92,893
                                          
                                          
                                          $
                                          648,311Restricted
      cash
                                          
                                          
                                          -
                                          
                                          
                                          
                                          1,245,582Accounts
      receivable, net of allowances of $5,700,931 and $7,214,984 and at June 30,
      2010 and 2009, respectively
                                          
                                          
                                          3,703,825
                                          
                                          
                                          
                                          4,972,417Inventories
                                          
                                          
                                          1,211,301
                                          
                                          
                                          
                                          4,459,837Current
      portion of advances on royalties
                                          
                                          
                                          12,322,926
                                          
                                          
                                          
                                          8,435,415Current
      portion of intellectual property licenses
                                          
                                          
                                          383,571
                                          
                                          
                                          
                                          410,995Related
      party receivables
                                          
                                          
                                          34,509
                                          
                                          
                                          
                                          33,207Prepaid
      expenses and other current assets
                                          
                                          
                                          695,955
                                          
                                          
                                          
                                          573,145Total
      current assets
                                          
                                          
                                          18,444,980
                                          
                                          
                                          
                                          20,778,909Property
      and equipment, net
                                          
                                          
                                          2,667,992
                                          
                                          
                                          
                                          2,754,139Advances
      on royalties, net of current portion
                                          
                                          
                                          1,511,419
                                          
                                          
                                          
                                          1,556,820Intellectual
      property licenses, net of current portion
                                          
                                          
                                          1,534,286
                                          
                                          
                                          
                                          1,917,858Goodwill
                                          
                                          
                                          7,911,800
                                          
                                          
                                          
                                          7,490,065Intangible
      assets, net
                                          
                                          
                                          17,025
                                          
                                          
                                          
                                          43,810Other assets
                                          
                                          
                                          11,280
                                          
                                          
                                          
                                          11,872Total
      assets
                                          
                                          $
                                          32,098,782
                                          
                                          
                                          $
                                          34,553,473Liabilities
      and Shareholders’ EquityCurrent
      liabilities:Line
      of credit
                                          
                                          $
                                          3,830,055
                                          
                                          
                                          $
                                          5,349,953Current
      maturities of long-term debt
                                          
                                          
                                          65,450
                                          
                                          
                                          
                                          50,855Production
      advance payable in default
                                          
                                          
                                          3,755,104
                                          
                                          
                                          
                                          -Accounts
      payable
                                          
                                          
                                          12,663,788
                                          
                                          
                                          
                                          19,649,441Accrued
      royalties
                                          
                                          
                                          2,530,253
                                          
                                          
                                          
                                          414,696Accrued
      expenses and other current liabilities
                                          
                                          
                                          3,781,711
                                          
                                          
                                          
                                          2,419,100Secured
      subordinated convertible promissory notes
                                          
                                          
                                          950,000
                                          
                                          
                                          
                                          -Deferred
      revenues
                                          
                                          
                                          325,301
                                          
                                          
                                          
                                          2,842,640Due
      to shareholders
                                          
                                          
                                          -
                                          
                                          
                                          
                                          232,440Due
      to related parties
                                          
                                          
                                          2,200
                                          
                                          
                                          
                                          125,045Accrued
      expenses - related parties
                                          
                                          
                                          322,281
                                          
                                          
                                          
                                          221,493Total
      current liabilities
                                          
                                          
                                          28,226,143
                                          
                                          
                                          
                                          31,305,663Long-term
      debt, net of current maturities
                                          
                                          
                                          1,541,081
                                          
                                          
                                          
                                          1,538,956Total
      liabilities
                                          
                                          
                                          29,767,224
                                          
                                          
                                          
                                          32,844,619Commitments
      and contingencies
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -Shareholders’
      equity:Preferred
      stock, $0.0001 par value; 5,000,000 shares authorized; no shares issued
      and outstanding at June 30, 2010 and 2009
                                          
                                          
                                          -
                                          
                                          
                                          
                                          -Series
      A convertible preferred stock, $0.0001 par value; 15,000,000 shares
      authorized; 5,503,833 and 5,953,833 shares issued and outstanding at June
      30, 2010 and 2009, respectively; aggregate liquidation preference of
      $5,503,833
                                          
                                          
                                          550
                                          
                                          
                                          
                                          595Common
      stock, $0.0001 par value; 90,000,000 shares authorized; 59,774,370 and
      44,530,100 shares issued and outstanding at June 30, 2010 and 2009,
      respectively
                                          
                                          
                                          5,976
                                          
                                          
                                          
                                          4,453Additional
      paid-in capital
                                          
                                          
                                          31,154,835
                                          
                                          
                                          
                                          25,210,926Accumulated
      deficit
                                          
                                          
                                          (28,973,325
                                          )
                                          
                                          
                                          (23,145,800
                                          )Accumulated
      other comprehensive income (loss)
                                          
                                          
                                          143,522
                                          
                                          
                                          
                                          (361,320
                                          )Total
      shareholders’ equity
                                          
                                          
                                          2,331,558
                                          
                                          
                                          
                                          1,708,854Total
      liabilities and shareholders’ equity
                                          
                                          $
                                          32,098,782
                                          
                                          
                                          $
                                          34,553,473





The
accompanying notes are an integral part of these consolidated financial
statements.


63




SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF OPERATIONS





For the years ended June 30,2010
                                                              
                                                              
                                                              2009Net
      revenues
                                                              
                                                              $
                                                              40,299,139
                                                              
                                                              
                                                              $
                                                              47,279,694Cost
      of goods sold:Product
      costs
                                                              
                                                              
                                                              15,655,261
                                                              
                                                              
                                                              
                                                              24,377,621Royalties
                                                              
                                                              
                                                              12,383,362
                                                              
                                                              
                                                              
                                                              9,654,810Write-off
      of acquired game sequel titles
                                                              
                                                              
                                                              -
                                                              
                                                              
                                                              
                                                              1,142,000Intellectual
      property licenses
                                                              
                                                              
                                                              411,243
                                                              
                                                              
                                                              
                                                              454,437Total
      cost of goods sold
                                                              
                                                              
                                                              28,449,866
                                                              
                                                              
                                                              
                                                              35,628,868Gross
      profit
                                                              
                                                              
                                                              11,849,273
                                                              
                                                              
                                                              
                                                              11,650,826Operating
      expenses (income):Warehousing
      and distribution
                                                              
                                                              
                                                              1,149,338
                                                              
                                                              
                                                              
                                                              1,254,947Sales
      and marketing
                                                              
                                                              
                                                              7,882,584
                                                              
                                                              
                                                              
                                                              11,778,958General
      and administrative
                                                              
                                                              
                                                              11,251,764
                                                              
                                                              
                                                              
                                                              9,720,488Restructuring
      costs
                                                              
                                                              
                                                              -
                                                              
                                                              
                                                              
                                                              639,210Transaction
      costs
                                                              
                                                              
                                                              -
                                                              
                                                              
                                                              
                                                              64,628Litigation
      costs
                                                              
                                                              
                                                              3,075,206
                                                              
                                                              
                                                              
                                                              -Loss
      on settlement of registration rights penalty
                                                              
                                                              
                                                              111,497
                                                              
                                                              
                                                              
                                                              -Gain
      on settlement of contingent purchase price obligation
                                                              
                                                              
                                                              (908,210
                                                              )
                                                              
                                                              
                                                              -Gain
      on extinguishment of accrued litigation costs
                                                              
                                                              
                                                              (3,249,610
                                                              )
                                                              
                                                              
                                                              -Gain
      on settlement of trade payables
                                                              
                                                              
                                                              (3,257,996
                                                              )
                                                              
                                                              
                                                              -Total
      operating expenses
                                                              
                                                              
                                                              16,054,573
                                                              
                                                              
                                                              
                                                              23,458,231Loss
      from operations
                                                              
                                                              
                                                              (4,205,300
                                                              )
                                                              
                                                              
                                                              (11,807,405
                                                              )Interest
      expense, net
                                                              
                                                              
                                                              1,622,225
                                                              
                                                              
                                                              
                                                              399,247Loss
      before income tax expense
                                                              
                                                              
                                                              (5,827,525
                                                              )
                                                              
                                                              
                                                              (12,206,652
                                                              )Income
      tax expense
                                                              
                                                              
                                                              -
                                                              
                                                              
                                                              
                                                              -Net
      loss
                                                              
                                                              
                                                              (5,827,525
                                                              )
                                                              
                                                              
                                                              (12,206,652
                                                              )Deemed
      dividend related to beneficial conversion feature on Series A convertible
      preferred stock
                                                              
                                                              
                                                              -
                                                              
                                                              
                                                              
                                                              1,142,439Net
      loss attributable to common shareholders
                                                              
                                                              $
                                                              (5,827,525
                                                              )
                                                              
                                                              $
                                                              (13,349,091
                                                              )Basic
      loss per share:
                                                              
                                                              $
                                                              (0.12
                                                              )
                                                              
                                                              $
                                                              (0.36
                                                              )Diluted
      loss per share:
                                                              
                                                              $
                                                              (0.12
                                                              )
                                                              
                                                              $
                                                              (0.36
                                                              )Weighted
      average number of common shares outstanding - Basic
                                                              
                                                              
                                                              47,906,342
                                                              
                                                              
                                                              
                                                              36,978,758Weighted
      average number of common shares outstanding - Diluted
                                                              
                                                              
                                                              47,906,342
                                                              
                                                              
                                                              
                                                              36,978,758





The
accompanying notes are an integral part of these consolidated financial
statements.


64




SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS





For
      the years ended June 30,2010
                                                                      
                                                                      
                                                                      2009Cash flows from
      operating activities:Net
      loss
                                                                      
                                                                      $
                                                                      (5,827,525
                                                                      )
                                                                      
                                                                      $
                                                                      (12,206,652
                                                                      )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization
                                                                      
                                                                      
                                                                      269,235
                                                                      
                                                                      
                                                                      
                                                                      378,153Allowances
      for price protection, returns, and defective merchandise
                                                                      
                                                                      
                                                                      (1,541,256
                                                                      )
                                                                      
                                                                      
                                                                      5,510,293Bad
      debt expense, net of recoveries
                                                                      
                                                                      
                                                                      27,203
                                                                      
                                                                      
                                                                      
                                                                      596,226Stock-based
      compensation expense
                                                                      
                                                                      
                                                                      690,706
                                                                      
                                                                      
                                                                      
                                                                      741,618Common
      stock and warrants issued to vendor
                                                                      
                                                                      
                                                                      95,000
                                                                      
                                                                      
                                                                      
                                                                      -Loss
      on disposal of fixed assets
                                                                      
                                                                      
                                                                      4,839
                                                                      
                                                                      
                                                                      
                                                                      -Amortization
      of royalties and intellectual property licenses
                                                                      
                                                                      
                                                                      7,894,105
                                                                      
                                                                      
                                                                      
                                                                      10,109,247Write-off
      of acquired game sequel titles
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      1,142,000Fair
      market value adjustment to common stock issued for advances on royalties
      earned and included in royalties expense
                                                                      
                                                                      
                                                                      1,805
                                                                      
                                                                      
                                                                      
                                                                      -Gain
      on settlement of trade payables
                                                                      
                                                                      
                                                                      (3,257,996
                                                                      )
                                                                      
                                                                      
                                                                      -Gain
      on settlement of contingent purchase price obligation
                                                                      
                                                                      
                                                                      (908,210
                                                                      )
                                                                      
                                                                      
                                                                      -Gain
      on settlement of accrued litigation costs
                                                                      
                                                                      
                                                                      (3,249,610
                                                                      )
                                                                      
                                                                      
                                                                      -Loss
      on settlement of registration rights penalty and warrant
      modification
                                                                      
                                                                      
                                                                      111,497Changes
      in operating assets and liabilities:Accounts
      receivable
                                                                      
                                                                      
                                                                      2,782,645
                                                                      
                                                                      
                                                                      
                                                                      3,176,920Inventories
                                                                      
                                                                      
                                                                      3,248,536
                                                                      
                                                                      
                                                                      
                                                                      2,235,552Advances
      on royalties
                                                                      
                                                                      
                                                                      (7,052,879
                                                                      )
                                                                      
                                                                      
                                                                      (11,845,881
                                                                      )Intellectual
      property licenses
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      (1,290,000
                                                                      )Related
      party receivables
                                                                      
                                                                      
                                                                      (1,302
                                                                      )
                                                                      
                                                                      
                                                                      15,036Prepaid
      expenses and other current assets
                                                                      
                                                                      
                                                                      (122,810
                                                                      )
                                                                      
                                                                      
                                                                      644,945Other
      assets
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      11,102Production
      advance payable
                                                                      
                                                                      
                                                                      3,755,104
                                                                      
                                                                      
                                                                      
                                                                      -Accounts
      payable
                                                                      
                                                                      
                                                                      (3,604,461
                                                                      )
                                                                      
                                                                      
                                                                      (107,110
                                                                      )Accrued
      royalties
                                                                      
                                                                      
                                                                      2,115,557
                                                                      
                                                                      
                                                                      
                                                                      (387,345
                                                                      )Accrued
      expenses - related parties
                                                                      
                                                                      
                                                                      137,515
                                                                      
                                                                      
                                                                      
                                                                      215,723Deferred
      revenues
                                                                      
                                                                      
                                                                      (2,517,339
                                                                      )
                                                                      
                                                                      
                                                                      (886,460
                                                                      )Accrued
      expenses and other current liabilities
                                                                      
                                                                      
                                                                      5,988,166
                                                                      
                                                                      
                                                                      
                                                                      (1,305,245
                                                                      )Total
      adjustments
                                                                      
                                                                      
                                                                      4,866,050
                                                                      
                                                                      
                                                                      
                                                                      8,954,774Net
      cash used in operating activities
                                                                      
                                                                      
                                                                      (961,475
                                                                      )
                                                                      
                                                                      
                                                                      (3,251,878
                                                                      )Cash
      flows from investing activities:Purchases
      of property and equipment
                                                                      
                                                                      
                                                                      (87,091
                                                                      )
                                                                      
                                                                      
                                                                      (499,410
                                                                      )Cash
      payments to effect acquisition, net of cash acquired
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      (247,543
                                                                      )Change
      in restricted cash
                                                                      
                                                                      
                                                                      742,199
                                                                      
                                                                      
                                                                      
                                                                      (1,106,478
                                                                      )Net
      cash provided by (used in) investing activities
                                                                      
                                                                      
                                                                      655,108
                                                                      
                                                                      
                                                                      
                                                                      (1,853,431
                                                                      )Cash
      flows from financing activities:Proceeds
      from line of credit
                                                                      
                                                                      
                                                                      26,272,571
                                                                      
                                                                      
                                                                      
                                                                      35,739,346Repayments
      of line of credit
                                                                      
                                                                      
                                                                      (27,792,469
                                                                      )
                                                                      
                                                                      
                                                                      (35,241,212
                                                                      )Repayments
      of long-term debt
                                                                      
                                                                      
                                                                      (56,739
                                                                      )
                                                                      
                                                                      
                                                                      (30,681
                                                                      )Net
      (repayments of) proceeds from amounts due to shareholders
                                                                      
                                                                      
                                                                      (232,440
                                                                      )
                                                                      
                                                                      
                                                                      3,442Net
      (repayments of) proceeds from amounts due to related
    parties
                                                                      
                                                                      
                                                                      (122,845
                                                                      )
                                                                      
                                                                      
                                                                      115,145Proceeds
      from the issuance of Series A convertible preferred stock, net of cash
      offering costs
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      1,283,824Proceeds
      from the issuance of secured subordinated convertible promissory
      notes
                                                                      
                                                                      
                                                                      950,000
                                                                      
                                                                      
                                                                      
                                                                      -Proceeds
      from the exercise of common stock warrants
                                                                      
                                                                      
                                                                      28,029
                                                                      
                                                                      
                                                                      
                                                                      -Proceeds
      from issuance of common stock
                                                                      
                                                                      
                                                                      200,000
                                                                      
                                                                      
                                                                      
                                                                      -Net
      cash (used in) provided by financing activities
                                                                      
                                                                      
                                                                      (753,893
                                                                      )
                                                                      
                                                                      
                                                                      1,869,864Effect
      of exchange rate changes on cash and cash equivalents
                                                                      
                                                                      
                                                                      504,842
                                                                      
                                                                      
                                                                      
                                                                      (211,280
                                                                      )Net
      decrease in cash and cash equivalents
                                                                      
                                                                      
                                                                      (555,418
                                                                      )
                                                                      
                                                                      
                                                                      (3,446,725
                                                                      )Cash
      and cash equivalents at beginning of year
                                                                      
                                                                      
                                                                      648,311
                                                                      
                                                                      
                                                                      
                                                                      4,095,036Cash
      and cash equivalents at end of year
                                                                      
                                                                      $
                                                                      92,893
                                                                      
                                                                      
                                                                      $
                                                                      648,311Supplemental
      cash flow information:Cash
      paid during the year for interest
                                                                      
                                                                      $
                                                                      559,916
                                                                      
                                                                      
                                                                      $
                                                                      372,032Cash
      paid during the year for taxes
                                                                      
                                                                      $
                                                                      -
                                                                      
                                                                      
                                                                      $
                                                                      62,888Supplemental
      disclosure of non-cash activities:Intellectual
      property licenses included in accrued expenses and other current
      liabilities
                                                                      
                                                                      $
                                                                      -
                                                                      
                                                                      
                                                                      $
                                                                      50,000Purchase
      of land and building through the assumption of a mortgage note
      payable
                                                                      
                                                                      $
                                                                      -
                                                                      
                                                                      
                                                                      $
                                                                      500,000Purchase
      of vehicle through the assumption of a note payable
                                                                      
                                                                      $
                                                                      73,459
                                                                      
                                                                      
                                                                      $
                                                                      58,100Decrease
      in goodwill with respect to finalizing purchase price
      allocation
                                                                      
                                                                      $
                                                                      55,423
                                                                      
                                                                      
                                                                      $
                                                                      -Advances
      on royalties paid with common stock
                                                                      
                                                                      $
                                                                      1,020,000
                                                                      
                                                                      
                                                                      $
                                                                      -Fair
      market value adjustment to common stock issued for advances on
      royalties
                                                                      
                                                                      $
                                                                      254,145
                                                                      
                                                                      
                                                                      $
                                                                      -Issuance
      of common stock in asset acquistion
                                                                      
                                                                      $
                                                                      3,000,000
                                                                      
                                                                      
                                                                      $Warrants
      issued in connection with Gamecock acquisition
                                                                      
                                                                      $
                                                                      -
                                                                      
                                                                      
                                                                      $
                                                                      1,218,098Contingent
      purchase price payment obligations related to Gamecock
      acquisition
                                                                      
                                                                      $
                                                                      477,158
                                                                      
                                                                      
                                                                      $
                                                                      876,053Common
      stock and warrants issued for settlement of trade payables
                                                                      
                                                                      $
                                                                      104,500
                                                                      
                                                                      
                                                                      $
                                                                      -Issuance
      of restricted stock
                                                                      
                                                                      $
                                                                      11
                                                                      
                                                                      
                                                                      $
                                                                      -Conversion
      of preferred stock to common stock
                                                                      
                                                                      $
                                                                      45
                                                                      
                                                                      
                                                                      $
                                                                      -Barter
      transaction in exchange for inventory
                                                                      
                                                                      $
                                                                      -
                                                                      
                                                                      
                                                                      $
                                                                      73,208Common
      stock issued for settlement of contingent purchase price payment
      obligation
                                                                      
                                                                      $
                                                                      245,000
                                                                      
                                                                      
                                                                      $
                                                                      -Release
      of restricted cash to videogame distributor
                                                                      
                                                                      $
                                                                      798,000
                                                                      
                                                                      
                                                                      $
                                                                      -





The
accompanying notes are an integral part of these consolidated financial
statements.


65


SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


CONSOLIDATED STATEMENTS
OF SHAREHOLDERS’ EQUITY




Series A Convertible
                                                                        Preferred Stock
                                                                      
                                                                      
                                                                      Common Stock
                                                                      
                                                                      
                                                                      Additional
                                                                        Paid-in
                                                                      
                                                                      
                                                                      Accumulated
                                                                      
                                                                      
                                                                      Accumulated
                                                                        Other
                                                                        Comprehensive
                                                                      
                                                                      
                                                                      Total
                                                                        Shareholders’
                                                                        EquityShares
                                                                      
                                                                      
                                                                      Amount
                                                                      
                                                                      
                                                                      Shares
                                                                      
                                                                      
                                                                      Amount
                                                                      
                                                                      
                                                                      Capital
                                                                      
                                                                      
                                                                      Deficit
                                                                      
                                                                      
                                                                      Income (loss)
                                                                      
                                                                      
                                                                      (Deficit)Balance,
      June 30, 2008
                                                                      
                                                                      
                                                                      12,984,833
                                                                      
                                                                      
                                                                      $
                                                                      1,298
                                                                      
                                                                      
                                                                      
                                                                      35,920,100
                                                                      
                                                                      
                                                                      $
                                                                      3,592
                                                                      
                                                                      
                                                                      $
                                                                      20,825,105
                                                                      
                                                                      
                                                                      $
                                                                      (9,796,709
                                                                      )
                                                                      
                                                                      $
                                                                      (150,040
                                                                      )
                                                                      
                                                                      $
                                                                      10,883,246Net
      loss
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      (12,206,652
                                                                      )
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      (12,206,652
                                                                      )Foreign
      currency translation adjustment
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      (211,280
                                                                      )
                                                                      
                                                                      
                                                                      (211,280
                                                                      )Comprehensive
      loss
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      (12,417,932
                                                                      )Issuance
      of Series A convertible preferred stock, net of offering
    costs
                                                                      
                                                                      
                                                                      1,579,000
                                                                      
                                                                      
                                                                      
                                                                      158
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      1,283,666
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      1,283,824Conversion
      of preferred stock to common stock
                                                                      
                                                                      
                                                                      (8,610,000
                                                                      )
                                                                      
                                                                      
                                                                      (861
                                                                      )
                                                                      
                                                                      
                                                                      8,610,000
                                                                      
                                                                      
                                                                      
                                                                      861
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -Deemed
      dividend related to beneficial conversion feature on Series A convertible
      preferred stock
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      1,142,439
                                                                      
                                                                      
                                                                      
                                                                      (1,142,439
                                                                      )
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -Compensatory
      restricted stock and stock options
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      741,618
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      741,618Warrants
      issued in connection with acquisition
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      1,218,098
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      1,218,098Balance,
      June 30, 2009
                                                                      
                                                                      
                                                                      5,953,833
                                                                      
                                                                      
                                                                      $
                                                                      595
                                                                      
                                                                      
                                                                      
                                                                      44,530,100
                                                                      
                                                                      
                                                                      $
                                                                      4,453
                                                                      
                                                                      
                                                                      $
                                                                      25,210,926
                                                                      
                                                                      
                                                                      $
                                                                      (23,145,800
                                                                      )
                                                                      
                                                                      $
                                                                      (361,320
                                                                      )
                                                                      
                                                                      $
                                                                      1,708,854Net
      loss
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      (5,827,525
                                                                      )
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      (5,827,525
                                                                      )Foreign
      currency translation adjustment
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      504,842
                                                                      
                                                                      
                                                                      
                                                                      504,842Comprehensive
      loss
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      (5,322,683
                                                                      )Compensatory
      restricted stock and stock options
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      690,706
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      690,706Issuance
      of restricted stock
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      113,500
                                                                      
                                                                      
                                                                      
                                                                      11
                                                                      
                                                                      
                                                                      
                                                                      (11
                                                                      )
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -Conversion
      of preferred stock to common stock
                                                                      
                                                                      
                                                                      (450,000
                                                                      )
                                                                      
                                                                      
                                                                      (45
                                                                      )
                                                                      
                                                                      
                                                                      457,912
                                                                      
                                                                      
                                                                      
                                                                      45
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -Advances
      on royalties paid with common stock
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      3,000,000
                                                                      
                                                                      
                                                                      
                                                                      300
                                                                      
                                                                      
                                                                      
                                                                      1,019,700
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      1,020,000Valuation
      adjustment to common stock issued for advances on
royalties
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      254,145
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      254,145Issuance
      of common stock in asset acquisition
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      10,000,000
                                                                      
                                                                      
                                                                      
                                                                      1,000
                                                                      
                                                                      
                                                                      
                                                                      2,999,000
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      3,000,000Issuance
      of common stock and warrants for settlement of trade
    payables
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      175,000
                                                                      
                                                                      
                                                                      
                                                                      18
                                                                      
                                                                      
                                                                      
                                                                      104,482
                                                                      
                                                                      
                                                                      
                                                                      
                                                                      
                                                                      
                                                                      
                                                                      
                                                                      
                                                                      
                                                                      
                                                                      104,500Issuance
      of common stock for services
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      100,000
                                                                      
                                                                      
                                                                      
                                                                      10
                                                                      
                                                                      
                                                                      
                                                                      94,990
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      95,000Excercise
      of common stock purchase warrants
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      197,858
                                                                      
                                                                      
                                                                      
                                                                      19
                                                                      
                                                                      
                                                                      
                                                                      28,010
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      28,029Issuance
      of common stock for settlement of contingent purchase price payment
      obligation
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      700,000
                                                                      
                                                                      
                                                                      
                                                                      70
                                                                      
                                                                      
                                                                      
                                                                      244,930
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      245,000Issuance
      of common stock for cash
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      500,000
                                                                      
                                                                      
                                                                      
                                                                      50
                                                                      
                                                                      
                                                                      
                                                                      199,950
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      200,000Modification
      of warrants for settlement of registration rights penalty
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      308,007
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      -
                                                                      
                                                                      
                                                                      
                                                                      308,007Balance,
      June 30, 2010
                                                                      
                                                                      
                                                                      5,503,833
                                                                      
                                                                      
                                                                      $
                                                                      550
                                                                      
                                                                      
                                                                      
                                                                      59,774,370
                                                                      
                                                                      
                                                                      $
                                                                      5,976
                                                                      
                                                                      
                                                                      $
                                                                      31,154,835
                                                                      
                                                                      
                                                                      $
                                                                      (28,973,325
                                                                      )
                                                                      
                                                                      $
                                                                      143,522
                                                                      
                                                                      
                                                                      $
                                                                      2,331,558





The
accompanying notes are an integral part of these consolidated financial
statements.


66


SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements





1. Summary of Significant
Accounting Policies




Business




SouthPeak
Interactive Corporation (the “Company”) is an independent developer and
publisher of interactive entertainment software.  The Company develops,
markets and publishes videogames for all leading gaming and entertainment
hardware platforms, including home videogame consoles such as Microsoft
Corporation’s (“Microsoft”) Xbox 360 (“Xbox360”), Nintendo Co. Ltd.’s
(“Nintendo”) Wii (“Wii”), Sony Computer Entertainment’s (“Sony”) PlayStation 3
(“PS3”) and PlayStation 2 (“PS2”); handheld platforms such as Nintendo Dual
Screen (“DS”), Nintendo DSi, Sony PlayStation Portable (“PSP”), Sony PSPgo,
Apple Inc. (“Apple”) iPhone; and personal computers.  The Company’s titles
span a wide range of categories and target a variety of consumer demographics,
ranging from casual players to hardcore gaming enthusiasts.




The
Company maintains its operations in the United States and the United Kingdom.
The Company sells its games to retailers and distributors in North America and
United Kingdom, and primarily to distributors in the rest of Europe, Australia
and Asia.




The
Company has one operating segment, a publisher and distributor of interactive
entertainment software for home video consoles, handheld platforms and personal
computers.  To date, management has not considered discrete geographical or
other information to be relevant for purposes of making decisions about
allocations of resources.




Gamecock
Acquisition




On
October 10, 2008, the Company acquired Gone Off Deep, LLC, doing business
as Gamecock Media Group (“Gamecock”), pursuant to a definitive purchase
agreement.  Gamecock’s operations were included in the Company’s financial
statements for all periods subsequent to the consummation of the business
combination only.




Going
Concern




The
accompanying consolidated financial statements have been prepared on a
going-concern basis, which contemplates the realization of assets and
satisfaction of liabilities in the normal course of business.  The ability
of the Company to continue as a going concern is predicated upon, among other
things, generating positive cash flows from operations, curing the default on
the production advance payable, and the resolution of various
contingencies.  On August 17, 2009, the Company entered into a unit
production financing agreement with a producer relating to the production of
certain games, of which the balance outstanding under this agreement was
$3,755,104 at June, 30, 2010 (see Note 7).  The Company has failed to make
the required payments under this agreement.  As a result, the production
advance payable is currently in default and is accruing additional production
fees at $0.009 per unit (based upon 382,000 units) for each day after November
15, 2009 (approximately $725,000 through June 30, 2010).  Management plans
to maintain the Company’s viability as a going concern by:




·
            attempting to expeditiously
      resolve its contingencies for amounts significantly less than currently
      accrued in order to reduce aggregate liabilities on the Company’s
      consolidated balance sheet and on payment terms manageable by the Company;
      and





·
            reducing costs and expenses in
      order to reduce or eliminate
losses.




The
Company is seeking to raise additional capital through public and/or private
placement offerings.  The ability of the Company to continue as a going
concern is dependent upon the success of capital offerings or alternative
financing arrangements and expansion of its operations.  If the Company is
unsuccessful in raising additional capital from any of these sources, it will
defer, reduce, or eliminate certain planned expenditures.  The Company will
continue to consider other financing alternatives. There can be no assurance
that the Company will be able to obtain any sources of financing on acceptable
terms, or at all.





While the
Company is committed to pursuing these options and others to address its
viability as a going concern, there can be no assurance that these plans will be
successfully completed; and therefore, there is uncertainty about the Company’s
ability to realize its assets or satisfy its liabilities in the normal course of
business. The Company’s consolidated financial statements do not include any
adjustments that might result from the resolution of this
uncertainty.


67




On July
12, 2010, the Company repaid in full the entire outstanding balance under the
credit agreement as a result of entering into a factoring agreement with
Rosenthal & Rosenthal, Inc. (the “Factor”) (see Note 26, Subsequent Events
for further discussion).





The
Company expects to draw on the factoring agreement during fiscal 2011 as
necessary to help alleviate liquidity problems, although, as discussed above,
the Company will also need to control expenses, maintain the sales backlog at
appropriate levels, and keep shipment levels in line with booked orders in order
to meet these requirements.  As the factoring agreement is a demand note
and subject to termination with 60 days notice, management can give no
assurances that funds will be available to settle current liabilities as they
become due. Ultimately, failure to obtain additional financing could jeopardize
the Company’s ability to continue as a going concern.





On July
16, 2010, the Company entered into a Securities Purchase Agreement with CNH
Diversified Opportunities Master Account, L.P., CNH CA Master Account, L.P., AQR
Diversified Arbitrage Fund and Terry Phillips, the Company’s chairman, for the
sale of $5,500,000 of senior secured convertible notes and
warrants.  Mr. Phillips’ Note was issued in exchange for a junior
secured convertible note originally issued to him on April 30, 2010 (see Note
9).  The Company received $5.0 million in cash for $5.0 million of the
senior secured convertible notes and exchanged a $500,000 prior junior secured
convertible note for $500,000 of the senior secured convertible notes (see
Note 26, Subsequent Events for further discussion).





On August
31, 2010, the Company entered into an Amended and Restated Securities Purchase
Agreement (the “Amended Purchase Agreement”), pursuant to which it sold an
aggregate of $2.0 million of a new series of senior secured convertible
promissory notes (the “Additional Notes”) to AQR Opportunistic Premium Offshore
Fund, L.P., Advanced Series Trust, solely on behalf of the AST Academic
Strategies Asset Allocation Portfolio, and Terry Phillips, SouthPeak’s chairman
(collectively, the “Additional Note Buyers”).  The Company received
$2.0 million in cash for $2.0 million of the Additional Notes, of which $200,000
was paid by Terry Phillips, the Company’s chairman (see Note 26, Subsequent
Events for further discussion).





On
September 20, 2010, the Company entered into a purchase order financing
arrangement with Wells Fargo Bank, National Association (“Wells Fargo”), for up
to a maximum of $2.0 million, to provide funding for the development and
production of games (Note 26, Subsequent Events for further
discussion).





Principles
of Consolidation




The
consolidated financial statements include the accounts of SouthPeak Interactive
Corporation, and its wholly-owned subsidiaries SouthPeak Interactive, L.L.C.,
SouthPeak Interactive, Ltd., Vid Sub, LLC, Gone Off Deep, L.L.C. and Gamecock
Media Europe Ltd. All intercompany accounts and transactions have been
eliminated in consolidation.


68





Use
of Estimates




The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the dates
of the financial statements and the reported amounts of net revenues and
expenses during the reporting periods. The most significant estimates and
assumptions relate to the recoverability of advances on royalties, intellectual
property licenses and intangibles, valuation of inventories, realization of
deferred income taxes, the adequacy of allowances for sales returns,
price protection and doubtful accounts, accrued and contingent liabilities,
the valuation of stock-based transactions and assumptions used in the
Company’s goodwill impairment test.  These estimates generally
involve complex issues and require the Company to make judgments, involve
analysis of historical and the prediction of future trends, and are subject to
change from period to period. Actual amounts could differ significantly from
these estimates.





Concentrations
of Credit Risk, Major Customers and Major Vendors




The
financial instruments which potentially subject the Company to concentrations of
credit risk consist primarily of cash balances with financial institutions and
accounts receivable. At various times during the years ended June 30, 2010 and
2009, the Company had deposits in excess of the Federal Deposit Insurance
Corporation (“FDIC”) limit at a financial institution in the United States; and
in excess of the Financial Services Compensation Scheme (“FSCS”) limit at a
financial institution in the UK.




The
Company does not generally require collateral or other security to support
accounts receivable. Management must make estimates of the uncollectibility of
the accounts receivable. The Company considers accounts receivable past due
based on how recently payments have been received. The Company has established
an allowance for doubtful accounts based upon the facts surrounding the credit
risk of specific customers, past collections history and other
factors.




The
Company has two customers, Wal-Mart and GameStop, that accounted for 19% and
18%, respectively, of consolidated gross revenues for the year ended June 30,
2010.   GameStop, Wal-Mart, and Atari accounted for 29%, 15% and 10%,
respectively, of consolidated gross accounts receivable at June 30,
2010.  For year ended June 30, 2009, Wal-Mart and GameStop accounted
for 18% and 16%, respectively, of consolidated gross
revenues.  Navarre Corporation, GameStop, and Wal-Mart accounted for
20%, 17% and 15%, respectively, of consolidated gross accounts receivable at
June 30, 2009.




The
Company publishes video games for the proprietary console and hand-held
platforms created by Microsoft, Sony and Nintendo, pursuant to the licenses they
have granted to the Company. Should the Company’s licenses with any of such
three platform developers not be renewed by the developer, it would cause a
disruption in the Company’s operations. The Company expects that such contracts
will be renewed in the normal course of business.




Amounts
incurred related to these three vendors as of and for the years ended June 30,
2010 and 2009 are as follows:





Cost of Goods Sold — Products
                  For the years ended June 30,
                
                
                Accounts Payable
                  As of June 30,2010
                
                
                2009
                
                
                2010
                
                
                2009Microsoft
                
                $
                4,036,722
                
                
                $
                2,645,797
                
                
                $
                158,592
                
                
                $
                142,329Nintendo
                
                $
                7,737,416
                
                
                $
                8,202,395
                
                
                $
                -
                
                
                $
                -Sony
                
                $
                881,832
                
                
                $
                1,693,880
                
                
                $
                449,042
                
                
                $
                12,493




In
addition, the Company has purchased a significant amount of video games for
resale for such platforms from a single supplier. Such purchases amounted to
$1,392,524 and $4,191,109 in “cost of goods sold - product costs” for the years
ended June 30, 2010 and 2009, respectively. Amounts included in accounts payable
for this vendor at June 30, 2010 and 2009 totaled $1,376,209 and $8,652,019,
respectively.


69




Fair
Values of Financial Instruments




The
recorded amounts of the Company’s cash and cash equivalents, receivables,
accounts payable, and accrued liabilities approximate fair values principally
because of the short-term nature of these items.  The fair value of
the Company’s long-term obligations, the majority of which are carried at a
variable rate of interest, are estimated based on the current rates offered to
the Company for obligations of similar terms and maturities. Under this method,
the Company’s fair value of long-term obligations was not significantly
different than the carrying values at June 30, 2010 and 2009.




Cash
and Cash Equivalents




Cash and
cash equivalents include all highly liquid investments with maturities of three
months or less when purchased.




Restricted
Cash




Restricted
cash relates to deposits held as cash collateral for the line of credit and
funds held in escrow pending resolution of an outstanding litigation
matter.




At June
30, 2010 and 2009, restricted cash consisted of the following:




2010
                                    
                                    
                                    2009Cash
      collateral for the line of credit (See Note 6)
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    742,199Funds
      held in escrow pending resolution of litigation (See Note 24), of which
      $265,919 is included as a liability at June 30,
    2009
                                    
                                    
                                    -
                                    
                                    
                                    
                                    503,383Total
                                    
                                    $
                                    -
                                    
                                    
                                    $
                                    1,245,582




Allowances
for Returns, Price Protection, and Doubtful Accounts




Management
closely monitors and analyzes the historical performance of the Company’s
various games, the performance of games released by other publishers, and the
anticipated timing of other releases in order to assess future demands of
current and upcoming games. Initial volumes shipped upon title launch and
subsequent reorders are evaluated to ensure that quantities are sufficient
to meet the demands from the retail markets, but at the same time are
controlled to prevent excess inventory in the channel.




The
Company may permit product returns from, or grant price protection to, its
customers under certain conditions. Price protection refers to the circumstances
when the Company elects to decrease the wholesale price of a product based
on the number of products in the retail channel and, when granted
and taken, allows customers a credit against amounts owed by such customers to
the Company with respect to open and/or future invoices. The criteria the
Company’s customers must meet to be granted the right to return products or
price protection include, among other things, compliance with applicable payment
terms, and consistent delivery to the Company of inventory and sell-through
reports. In making the decision to grant price protection to customers, the
Company also considers other factors, including the facilitation of slow-moving
inventory and other market factors.




Management
must estimate the amount of potential future product returns and price
protection related to current period revenues utilizing industry and historical
Company experience, information regarding inventory levels, and the demand and
acceptance of the Company’s games by end consumers. The following factors are
used to estimate the amount of future returns and price protection for a
particular game: historical performance of games in similar genres; historical
performance of the hardware platform; sales force and retail customer feedback;
industry pricing; weeks of on-hand retail channel inventory; absolute quantity
of on-hand retail channel inventory; the game’s recent sell-through history (if
available); marketing trade programs; and competing games. Significant
management judgments and estimates must be made and used in connection with
establishing the allowance for returns and price protection in any accounting
period. Based upon historical experience, management believes the estimates are
reasonable. However, actual returns and price protection could vary materially
from management’s allowance estimates due to a number of unpredictable reasons
including, among others, a lack of consumer acceptance of a game, the release in
the same period of a similarly themed game by a competitor, or technological
obsolescence due to the emergence of new hardware platforms. Material
differences may result in the amount and timing of the Company’s revenues for
any period if factors or market conditions change or if management makes
different judgments or utilizes different estimates in determining the
allowances for returns and price protection.


70





Similarly,
management must make estimates of the uncollectibility of the Company’s accounts
receivable. In estimating the allowance for doubtful accounts, the Company
analyzes the age of current outstanding account balances, historical bad debts,
customer concentrations, customer creditworthiness, current economic trends, and
changes in the Company’s customers’ payment terms and their economic condition.
Any significant changes in any of these criteria would affect management’s
estimates in establishing the allowance for doubtful accounts.




At June
30, 2010 and 2009, accounts receivable allowances consisted of the
following:




2010
                            
                            
                            2009Sales
      returns
                            
                            $
                            2,634,097
                            
                            
                            $
                            1,294,082Price
      protection
                            
                            
                            2,257,171
                            
                            
                            
                            4,998,622Doubtful
      accounts
                            
                            
                            771,442
                            
                            
                            
                            874,645Defective
      items
                            
                            
                            38,221
                            
                            
                            
                            47,635Total
      allowances
                            
                            $
                            5,700,931
                            
                            
                            $
                            7,214,984





Inventories




Inventories
are stated at the lower of average cost or market. Management regularly reviews
inventory quantities on hand and in the retail channel and records a provision
for excess or obsolete inventory based on the future expected demand for the
Company’s games. Significant changes in demand for the Company’s games would
impact management’s estimates in establishing the inventory
provision.  Inventory costs include licensing fees paid toplatform proprietors.
These licensing fees include the cost to manufacture the game cartridges. These
licensing fees included in “cost of goods sold - product costs” amounted to
$12,655,970 and $12,542,072, for the years ended June 30, 2010 and 2009,
respectively. Licensing fees included in inventory at June 30, 2010 and 2009
totaled $273,166 and $920,747, respectively.




Advances on
Royalties




The
Company utilizes independent software developers to develop its
games in exchange for payments to the developers based upon
certain contract milestones. The Company enters into contracts with the
developers once the game design has been approved by the platform proprietors
and is technologically feasible.  Accordingly, the Company capitalizes
such payments to the developers during development of the games. These payments
are considered non-refundable royalty advances and are applied against the
royalty obligations owed to the developer from future sales of the game. Any
pre-release milestone payments that are not prepayments against future royalties
are expensed to “cost of goods sold - royalties” in the period when the game is
released. Capitalized royalty costs for those games that are cancelled or
abandoned are charged to “cost of goods sold - royalties” in the period of
cancellation.  Capitalized costs for games that are cancelled or
abandoned prior to product release are charged to “cost of goods sold -
royalties” in the period of cancellation. The costs were $-0- and $202,562 and
for the years ended June 30, 2010 and 2009, respectively.




Beginning
upon the related games release, capitalized royalty costs are amortized to “cost
of goods sold – royalties” based on the ratio of current revenues to total
projected revenues for the specific game, generally resulting in an amortization
period of twelve months or less.


71


The
Company evaluates the future recoverability of capitalized royalty costs on a
quarterly basis. For games that have been released in prior periods, the primary
evaluation criterion is actual title performance. For games that are scheduled
to be released in future periods, recoverability is evaluated based on the
expected performance of the specific game to which the royalties relate.
Criteria used to evaluate expected game performance include: historical
performance of comparable games developed with comparable technology; orders for
the game prior to its release; and, for any game sequel, estimated performance
based on the performance of the game on which the sequel is based.




Significant
management judgments and estimates are utilized in the assessment of the
recoverability of capitalized royalty costs. In evaluating the recoverability of
capitalized royalty costs, the assessment of expected game performance utilizes
forecasted sales amounts and estimates of additional costs to be incurred. If
revised forecasted or actual game sales are less than, and/or revised forecasted
or actual costs are greater than, the original forecasted amounts utilized in
the initial recoverability analysis, the net realizable value may be lower than
originally estimated in any given quarter, which could result in an impairment
charge. Material differences may result in the amount and timing of charges for
any period if management makes different judgments or utilizes different
estimates in evaluating these qualitative factors.





Intellectual
Property Licenses




Intellectual
property license costs consist of fees paid by the Company to license the use of
trademarks, copyrights, and software used in the development of games. Depending
on the agreement, the Company may use acquired intellectual property in multiple
games over multiple years or for a single game.  When no significant
performance remains with the licensor upon execution of the license agreement,
the Company records an asset and a liability at the contractual amount. The
Company believes that the contractual amount represents the fair value of the
liability. When significant performance remains with the licensor, the Company
records the payments as an asset when paid and as a liability when incurred,
rather than upon execution of the agreement. The Company classifies these
obligations as current liabilities to the extent they are contractually due
within the next twelve months.  Capitalized intellectual property
license costs for those games that are cancelled or abandoned are charged to
“cost of goods sold - intellectual property licenses” in the period of
cancellation.




Beginning
upon the related games release, capitalized intellectual property license costs
are amortized to “cost of sales - intellectual property licenses” based on the
greater of (1) the ratio of current revenues for the specific game to total
projected revenues for all games in which the licensed property will be utilized
or (2) the straight-line amortization method over the estimated useful lives of
the licenses. As intellectual property license contracts may extend for multiple
years, the amortization of capitalized intellectual property license costs
relating to such contracts may extend beyond one year.




The
Company evaluates the future recoverability of capitalized intellectual property
license costs on a quarterly basis. For games that have been released in prior
periods, the primary evaluation criterion is actual title performance. For games
that are scheduled to be released in future periods, recoverability is evaluated
based on the expected performance of the specific games to which the costs
relate or in which the licensed trademark or copyright is to be used. Criteria
used to evaluate expected game performance include: historical performance of
comparable games developed with comparable technology; orders for the game prior
to its release; and, for any game sequel, estimated performance based on the
performance of the game on which the sequel is based.  Further, as
intellectual property licenses may extend for multiple games over multiple
years, the Company also assesses the recoverability of capitalized intellectual
property license costs based on certain qualitative factors, such as the
success of other products and/or entertainment vehicles utilizing the
intellectual property and the continued promotion and exploitation of the
intellectual property.




Significant
management judgments and estimates are utilized in the assessment of the
recoverability of capitalized intellectual property license costs. In evaluating
the recoverability of capitalized intellectual property license costs, the
assessment of expected game performance utilizes forecasted sales amounts and
estimates of additional costs to be incurred. If revised forecasted or actual
game sales are less than, and/or revised forecasted or actual costs are greater
than, the original forecasted amounts utilized in the initial recoverability
analysis, the net realizable value may be lower than originally estimated in any
given quarter, which could result in an impairment charge. Material differences
may result in the amount and timing of charges for any period if management
makes different judgments or utilizes different estimates in evaluating these
qualitative factors.


72




Property
and Equipment




Property
and equipment are recorded at cost. Depreciation and amortization is provided
using the straight-line method over the estimated useful lives: buildings, 40
years; computer equipment and software, 3 to 5 years; office furniture and other
equipment, 5 to 10 years; and leasehold improvements, 5 years. When assets are
retired or disposed of, the cost and accumulated depreciation and amortization
thereon are removed and any resulting gains or losses are recognized in current
operations. Expenditures for maintenance and repairs are charged to operations
as incurred. Renewals and betterments are capitalized.




Internal-use
Software





The
Company capitalizes direct costs of materials and services used in the
development of internal-use software.  Amounts capitalized are
amortized on a straight-line basis over a period of three to five years and are
reported as a component of computer equipment and software within property and
equipment, net.  Unamortized computer software costs as of June 30, 2010
and 2009 are $54,834 and $74,617, respectively.  Amortization expense
of computer software costs are $41,724 and $34,330 for the years ended June
30, 2010 and 2009, respectively.




Goodwill
and Intangible Assets




Goodwill
is the excess of purchase price paid over identified intangible and tangible net
assets of Gamecock. Intangible assets consist of acquired game sequel titles,
distribution and non-compete agreements. Certain intangible assets acquired in a
business combination are recognized as assets apart from goodwill. Identified
intangibles other than goodwill are generally amortized using the straight-line
method over the period of expected benefit ranging from one to three years,
except for acquired game sequel titles, which is a usage-based intangible asset
that is amortized using the shorter of the useful life or expected revenue
stream. During the year ended June 30, 2009, the Company incurred an impairment
charge of $1,142,000 related to the write-off of acquired game sequel titles due
to the underperformance of the acquired titles.





Assessment
of Impairment of Assets




Current
accounting standards require that the Company assess the recoverability of
purchased intangible assets subject to amortization and other long-lived assets
whenever events or changes in circumstances indicate the remaining value of the
assets recorded on its consolidated balance sheets is potentially impaired. In
order to determine if a potential impairment has occurred, management must make
various assumptions about the estimated fair value of the asset by evaluating
future business prospects and estimated cash flows. For some assets, the
Company’s estimated fair value is dependent upon predicting which of its
products will be successful. This success is dependent upon several factors,
which are beyond the Company’s control, such as which operating platforms
will be successful in the marketplace, market acceptance of the Company’s
products and competing products. Also, the Company’s revenues and earnings are
dependent on the Company’s ability to meet its product release
schedules.




The
Company accounts for goodwill using the provisions within ASC Topic 350. Under
ASC Topic 350, goodwill is considered to have an indefinite life, and is carried
at cost. Goodwill is not amortized, but is subject to an impairment test
annually and in between annual tests when events or circumstances indicate that
the carrying value may not be recoverable. The Company performs its annual
impairment testing at June 30.  Impairment of goodwill is tested
at the reporting unit level.  The Company has one reporting unit, because
none of the components of the Company constitute a business for which discrete
financial information is available and for which Company management regularly
reviews the results of operations.




To
determine the fair value of the reporting unit used in the first step, the
Company uses a combination of the market approach, which utilizes comparable
companies’ data and/or the income approach, or discounted cash flows. Each step
requires management to make judgments and involves the use of significant
estimates and assumptions. These estimates and assumptions include long-term
growth rates and operating margins used to calculate projected future cash
flows, risk-adjusted discount rates based on the Company’s weighted average cost
of capital, future economic and market conditions and determination of
appropriate market comparables. These estimates and assumptions have to be made
for each reporting unit evaluated for impairment. The Company’s estimates for
market growth, its market share, and costs are based on historical data, various
internal estimates, and certain external sources, and are based on assumptions
that are consistent with the plans and estimates the Company is using to manage
the underlying business. The Company’s business consists of publishing and
distribution of interactive entertainment software and content using both
established and emerging intellectual properties, and its forecasts for emerging
intellectual properties are based upon internal estimates and external sources
rather than historical information and have an inherently higher risk of
accuracy. If future forecasts are revised, they may indicate or require future
impairment charges. The Company bases its fair value estimates on assumptions it
believes to be reasonable but that are unpredictable and inherently uncertain.
Actual future results may differ from those estimates.


73





The
Company’s annual test on its long-lived assets indicated that the carrying value
of its long-lived assets was recoverable and that no impairment existed as of
the testing date.  As of June 30, 2010, there was no impairment to
goodwill.  The Company will continue to monitor its long-lived assets
and goodwill for possible future impairment.




Derivative
Financial Instruments




The
Company does not use derivative instruments to hedge exposures to cash flow,
market, or foreign currency risks.




The
Company reviews the terms of convertible debt and equity instruments issued to
determine whether there are embedded derivative instruments, including the
embedded conversion option, that are required to be bifurcated and accounted for
separately as a derivative financial instrument. When the risks and rewards of
any embedded derivative instrument are not “clearly and closely” related to the
risks and rewards of the host instrument, the embedded derivative instrument is
generally required to be bifurcated and accounted for separately. If the
convertible instrument is debt, or has debt-like characteristics, the risks and
rewards associated with the embedded conversion option are not “clearly and
closely” related to that debt host instrument. The conversion option has the
risks and rewards associated with an equity instrument, not a debt instrument,
because its value is related to the value of our common stock. Nonetheless, if
the host instrument is considered to be “conventional convertible debt” (or
“conventional convertible preferred stock”), bifurcation of the embedded
conversion option is generally not required. However, if the instrument is not
considered to be conventional convertible debt (or conventional convertible
preferred stock), bifurcation of the embedded conversion option may be required
in certain circumstances. Generally, where the ability to physical or net-share
settle the conversion option is deemed to be not within the control of the
Company, the embedded conversion option is required to be bifurcated and
accounted for as a derivative financial instrument liability.




In
connection with the sale of convertible debt and equity instruments, the Company
may also issue freestanding options or warrants. Additionally, the Company may
issue options or warrants to non-employees in connection with consulting or
other services they provide. Although the terms of the options and warrants may
not provide for net-cash settlement, in certain circumstances, physical or
net-share settlement may be deemed to not be within the control of the Company
and, accordingly, the Company may be required to account for these freestanding
options and warrants as derivative financial instrument liabilities, rather than
as equity.




Derivative
financial instruments are required to be initially measured at their fair value.
For derivative financial instruments that shall be accounted for as liabilities,
the derivative instrument is initially recorded at its fair value and is then
re-valued at each reporting date, with changes in the fair value reported as
charges or credits to income.




In
circumstances where the embedded conversion option in a convertible instrument
may be required to be bifurcated and there are also other embedded derivative
instruments in the convertible instrument that are required to be bifurcated,
the bifurcated derivative instruments are accounted for as a single, compound
derivative instrument.




If the
embedded derivative instrument is to be bifurcated and accounted for as a
liability, the total proceeds received will be first allocated to the fair value
of the bifurcated derivative instrument. If freestanding options or warrants
were also issued and are to be accounted for as derivative instrument
liabilities (rather than as equity), the proceeds are next allocated to the fair
value of those instruments. The remaining proceeds, if any, are then allocated
to the convertible instrument itself, usually resulting in that instrument being
recorded at a discount from its face amount. In circumstances where a
freestanding derivative instrument is to be accounted for as an equity
instrument, the proceeds are allocated between the convertible instrument and
the derivative equity instrument, based on their relative fair
values.


74





To the
extent that the fair values of the bifurcated and/or freestanding derivative
instrument liabilities exceed the total proceeds received, an immediate charge
to income is required to be recognized, in order to initially record the
derivative instrument liabilities at their fair value. The discount from the
face value of the convertible debt instrument is required to be amortized over
the life of the instrument through periodic charges to income, using the
effective interest method. When the instrument is convertible preferred stock,
the periodic amortization of the discount is charged directly to retained
earnings.




In
December 2008, the Financial Accounting Standards Board ("FASB") issued ASC
Topic 815 (formerly EITF 07-5, Determining Whether an instrument
(or Embedded Feature) Is Indexed to an Entity 's Own Stock). ASC Topic
815 affects companies that have provisions in their securities purchase
agreements (e.g. convertible instruments) that provide for the reset of the
current conversion price based upon new issuances by companies at prices below
the current conversion price of said instrument. Securities purchase agreements
with such provisions will require the embedded derivative instrument to be
bifurcated and separately accounted for as a derivative. Subject to certain
exceptions, the Company's Series A convertible preferred stock provides for
resetting the conversion price if the Company issues new common stock below $
1.00 per share. ASC Topic 815 is effective for financial statements issued for
fiscal years and interim periods beginning after December 15, 2008. The Company
adopted ASC Topic 815 on July 1, 2009. The adoption of this statement did not
have a material impact on the Company's consolidated financial position, results
of operations or cash flows as the reset conversion provision did not meet the
definition of a derivative since it was not readily net-cash
settled.





The
Company reviews the classification of derivative instruments, including whether
such instruments should be recorded as liabilities or as equity, at the end of
each reporting period. Derivative instrument liabilities are required to be
classified in the balance sheet as current or non-current based on whether or
not net-cash settlement of the derivative instrument could be required within 12
months of the balance sheet date. The Company currently does not have any
derivative instruments that are required to be bifurcated and recorded as
liabilities.




Convertible
Preferred Stock with Detachable Warrants and Beneficial Conversion
Feature




The
Company accounts for the issuance of detachable stock purchase warrants in
accordance with ASC Topic 470, whereby the Company separately measures the fair
value of the detachable warrants and records such amounts as a deemed dividend
over the period the warrants are outstanding.




In
accordance with the provisions of ASC Topic 470, the Company allocates a
portion of the proceeds received to the embedded beneficial conversion feature,
based on the difference between the effective conversion price of the proceeds
allocated to the convertible preferred stock and the fair value of the
underlying common stock on the date the convertible preferred stock was issued.
Since the convertible preferred stock also had detachable stock purchase
warrants, the Company first allocated the proceeds to the stock purchase
warrants and the convertible preferred stock and then allocated the resulting
convertible preferred stock proceeds between the beneficial conversion feature,
which was accounted for as paid-in capital, and the initial carrying amount of
the convertible preferred stock. The discount resulting from the beneficial
conversion feature is recorded as a deemed dividend.





Registration
Rights




Pursuant
to the sale of Series A convertible preferred stock, the Company was obligated
to file a registration statement with the Securities and Exchange Commission
(“SEC”) covering the resale of the shares of its common stock within 30 days
following the Company’s filing of its Form 10-K for the year ended June 30, 2008
but not later than October 15, 2008 (the “Filing Deadline”).




If the
registration statement is not filed with the SEC by the Filing Deadline, the
Company will make pro rata payments to each holder of Series A convertible
preferred stock in an amount equal to .5% of the aggregate amount invested by
such holder of Series A convertible preferred stock for each 30 day period (or
portion thereof) for which no registration statement is filed.  In
accordance with ASC Topic 825, the Company recognized a $196,510 liability at
June 30, 2009 associated with the registration rights
agreement.


75





On June
30, 2010, the Company entered into an Amendment to the Registration Rights
Agreement (the “Amendment”) to the Registration Rights Agreement dated May 12,
2008 among the Company, and various investors holding a majority of the
registrable securities, as defined in the Registration Rights Agreement. 
In connection with the Amendment, the liquidated damages provisions were
deleted, the previously accrued liability was eliminated, and the Company agreed
to extend the expiration date of the Y warrants held by various investors
holding a majority of the registrable securities one year to May 31, 2014. 
The resulting modification was considered to be a cancellation of the original
warrant agreements and the issuance of new warrant agreements. The impact to the
consolidated financial statements was to record $308,007 of expense for the
difference in the fair value of the new warrant agreements and the fair value of
the original warrant agreements immediately prior to the modification based on
the Black-Scholes option pricing model. In addition, the Company recorded a loss
on settlement of registration rights penalty of $111,497 in the consolidated
statements of operations for the year ended June 30, 2010.




Income
Taxes




Income
taxes are accounted for under the asset and liability method. Deferred tax
assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and operating
loss and tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date. A
valuation allowance is established to reduce deferred tax assets to the amounts
expected to be realized.





Revenue
Recognition




The
Company recognizes revenue from the sale of video games upon the transfer of
title and risk of loss to the customer. Accordingly, the Company recognizes
revenue for software titles when (1) there is persuasive evidence that an
arrangement with the customer exists, which is generally a purchase order, (2)
the product is delivered, (3) the selling price is fixed or determinable and (4)
collection of the customer receivable is deemed probable.  The
Company’s payment arrangements with customers typically provide for net 30 and
60 day terms. Advances received for licensing and exclusivity arrangements are
reported on the consolidated balance sheets as deferred revenues until the
Company meets its performance obligations, at which point the
revenues are recognized. Revenue is recognized after deducting
estimated reserves for returns, price protection and other allowances. In
circumstances when the Company does not have a reliable basis to estimate
returns and price protection or is unable to determine that collection of a
receivable is probable, the Company defers the revenue until such time as it can
reliably estimate any related returns and allowances and determine that
collection of the receivable is probable.





Some of
the Company’s video games provide limited online features at no additional cost
to the consumer. Generally, the Company considers such features to be incidental
to the overall product offering and an inconsequential deliverable. Accordingly,
the Company recognizes revenue related to video games containing these limited
online features upon the transfer of title and risk of loss to the
customer.  In instances where online features or additional
functionality are considered a substantive deliverable in addition to the video
game, the Company takes this into account when applying its revenue recognition
policy.  This evaluation is performed for each video game together
with any online transactions, such as electronic downloads or video game add-ons
when it is released.  When the Company determines that a video game
contains online functionality that constitutes a more-than-inconsequential
separate service deliverable in addition to the video game, principally because
of its importance to game play, the Company considers that its performance
obligations for this game extend beyond the delivery of the game. Fair
value does not exist for the online functionality, as the Company does not
separately charge for this component of the video game. As a result, the Company
recognizes all of the revenue from the sale of the game upon the delivery of the
remaining online functionality.  In addition, the Company defers the
costs of sales for this game and recognizes the costs upon delivery of the
remaining online functionality.




With
respect to online transactions, such as electronic downloads of games or add-ons
that do not include a more-than-inconsequential separate service deliverable,
revenue is recognized when the fee is paid by the online customer to purchase
online content and the Company is notified by the online retailer that the
product has been downloaded. In addition, persuasive evidence of an arrangement
must exist, collection of the related receivable must be probable and the fee
must be fixed and determinable.




76





The
Company has an arrangement pursuant to which it distributes videogames
co-published with another company for a fee based on the gross sales of the
videogames.  Under the arrangement, the Company bears the inventory
risk as the Company purchases and takes title to the inventory, warehouses the
inventory in advance of orders, prices and ships the inventory and invoices its
customers for videogame shipments.  Also under the arrangement, the
Company bears the credit risk as the supplier does not guarantee returns for
unsold videogames and the Company is not reimbursed by the supplier in the event
of non-collection.




The
Company records the gross amount of revenue under the arrangement as it is not
acting as an agent for the principal in the arrangement as defined by ASC Topic
605.




Third-party
licensees in Europe distribute Gamecock’s video games under license agreements
with Gamecock. The licensees paid certain minimum, non-refundable, guaranteed
royalties when entering into the licensing agreements. Upon receipt of the
advances, the Company defers their recognition and recognizes the revenues in
subsequent periods as these advances are earned by the Company. As the
licensees pay additional royalties above and beyond those initially advanced,
the Company recognizes these additional royalties as revenues when
earned.




With
respect to license agreements that provide customers the right to make multiple
copies in exchange for guaranteed amounts, revenue is recognized upon delivery
of a master copy. Per copy royalties on sales that exceed the guarantee are
recognized as earned.  In addition, persuasive evidence of an
arrangement must exist, collection of the related receivable must be probable,
and the fee must be fixed and determinable.




Consideration
Given to Customers and Received from Vendors




The
Company offers sales incentives and other consideration to its customers. Sales
incentives and other consideration that are considered adjustments of the
selling price of the Company’s games, such as rebates and product placement
fees, are reflected as reductions to revenue.  Sales incentives and
other consideration that represent costs incurred by the Company for assets or
services received, such as the appearance of games in a customer’s national
circular ad, are reflected as sales and marketing expenses.




Cost
of Goods Sold




Cost of
goods sold includes: manufacturing costs, royalties, write-off of
acquired game sequel titles, and amortization of intellectual property
licenses.




Shipping
and Handling




The
Company incurs shipping and handling costs in its operations. These costs
consist of freight expenses incurred for third-party shippers to transport the
product to the customers. These costs are included in the warehousing and
distribution expenses in the accompanying consolidated statements of operations.
Amounts billed to customers are included in net revenues.


77


SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements




1. Summary of Significant
Accounting Policies, continued




Advertising




The
Company expenses advertising sales promotion expenses as incurred, except for
production costs associated with media advertising which are deferred and
charged to expense the first time the related advertisement is run. The Company
engages in cooperative marketing with certain retail channel partners. The
Company accrues marketing and sales incentive costs when the revenue is
recognized and such amounts are included in sales and marketing expense when
there is an identifiable benefit for which the Company can reasonably estimate
the fair value of the benefit; otherwise, they are recognized as a reduction of
net revenues. In addition, during the year ended June 30, 2009, the Company
engaged in an advertising barter transaction in which the Company sold
inventory in exchange for marketing services and recorded the transaction based
on the value of the asset transferred. Revenues and marketing expenses in the
amount of $73,208 were recorded in accordance with ASC Topic
605.  Advertising expenses for the years ended June 30, 2010 and 2009
were $6,327,304 and $10,178,741, respectively, and are included in sales and
marketing in the accompanying consolidated statements of
operations.




Stock-Based
Compensation




The
Company estimates the fair value of share-based payment awards on the
measurement date using the Black-Scholes option-pricing model. The value of the
portion of the award that is ultimately expected to vest is recognized as
expense over the requisite service periods in the consolidated statements of
operations.





Stock-based
compensation expense recognized in the consolidated statements of operations is
based on awards ultimately expected to vest and has been reduced for estimated
forfeitures. Stock compensation guidance requires forfeitures to be estimated at
the time of grant and revised, if necessary, in subsequent periods if actual
forfeitures differ from those estimates.




The
Company estimates the value of employee stock options on the date of grant using
the Black-Scholes option pricing model. The Company’s determination of fair
value of share-based payment awards on the date of grant using an option-pricing
model is affected by the Company’s stock price as well as assumptions regarding
a number of highly complex and subjective variables. These variables include,
but are not limited to; the expected stock price volatility over the term of the
awards, and actual and projected employee stock option exercise
behaviors.




The
Company accounts for equity instruments issued to non-employees based on the
estimated fair value of the equity instrument that is recorded on the earlier of
the performance commitment date or the date the services required are
completed.  Until shares under the award are fully vested, the Company
marks-to-market the fair value of the options at the end of each accounting
period.




Transaction
Costs




Prior to
the acquisition of SouthPeak Interactive, L.L.C., the Company was a
non-operating public shell. Pursuant to Securities and Exchange Commission
("SEC") rules, the merger or acquisition of a private operating company into a
non-operating public shell with nominal net assets is considered a capital
transaction, rather than a business combination. Accordingly, for accounting
purposes, the transaction was treated as a reverse acquisition and
recapitalization, and pro-forma information is not presented. Transaction costs
incurred in the reverse acquisition were expensed.


78


SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements




1. Summary of Significant
Accounting Policies, continued




Foreign
Currency Translation




The
functional currency for the Company’s foreign operations is the applicable local
currency. Accounts of foreign operations are translated into U.S. dollars using
exchange rates for assets and liabilities at the balance sheet date and average
prevailing exchange rates for the period for revenue and expense accounts.
Adjustments resulting from translation are included in other accumulated
comprehensive income (loss). Realized transaction gains and losses are included
in income in the period in which they occur, except on intercompany balances
considered to be long-term. Transaction gains and losses on intercompany
balances considered to be long-term are recorded in other accumulated
comprehensive income (loss). Foreign exchange transaction gains (losses)
included in general and administrative expenses in the accompanying consolidated
statements of operations for the years ended June 30, 2010 and 2009 amounted to
$241,341 and $(45,676), respectively.




Comprehensive
Income (Loss)




Comprehensive
income (loss) is disclosed in the consolidated statements of shareholders’
equity. Foreign currency translation adjustments have been the only component of
comprehensive loss to date. Accordingly, accumulated other comprehensive income
(loss) is equal to the accumulated translation adjustment of $143,522 and
($361,320) at June 30, 2010 and 2009, respectively. The Company’s item of other
comprehensive income (loss) is its foreign currency translation adjustment,
which relates to investments that are considered permanent in nature and
therefore do not require tax adjustments.





For the
years ended June 30, 2010 and 2009, the Company’s comprehensive income (loss)
was as follows:




For theyears ended June 30,2010
                                                
                                                2009Net
      loss
                                                $
                                                (5,827,525
                                                )
                                                $
                                                (12,206,652
                                                )Change
      in foreign currency translation adjustment
                                                
                                                504,842
                                                
                                                
                                                (211,280
                                                )Comprehensive
      income (loss)
                                                $
                                                (5,322,683
                                                )
                                                $
                                                (12,417,932
                                                )




Fair
Value Measurements




Effective
July 1, 2009, the Company adopted the provisions of the fair value measurement
accounting and disclosure guidance related to non-financial assets and
liabilities recognized or disclosed at fair value on a nonrecurring basis. This
standard establishes a framework for measuring fair value and requires enhanced
disclosures about fair value measurements, and clarifies that fair value is an
exit price, representing the amount that would be received to sell an asset or
paid to transfer a liability in an orderly transaction between market
participants. The provisions also establish a fair value hierarchy that
prioritizes the inputs to valuation techniques used to measure fair value. The
guidance requires that assets and liabilities carried at fair value be
classified and disclosed in one of the following three
categories:




§
            Level 1: Quoted market prices in
      active markets for identical assets or
  liabilities.





§
            Level 2: Quoted prices in active
      markets for similar assets and liabilities, quoted prices for identically
      similar assets or liabilities in markets that are not active and models
      for which all significant inputs are observable either directly or
      indirectly.




79





§
            Level 3: Unobservable inputs
      reflecting the reporting entity's own assumptions or external inputs for
      inactive markets.




The
determination of where assets and liabilities fall within this hierarchy is
based upon the lowest level of input that is significant to the fair value
measurement. While the Company has previously invested in certain assets that
would be classified as "level 1", as of June 30, 2010, the Company does not hold
any "level 1" cash equivalents that are measured at fair value on a recurring
basis, nor does the Company have any assets or liabilities that are based on
"level 2" or "level 3" inputs.





On
February 23, 2010, the Company issued to the videogame publisher 3,000,000
shares of common stock, valued at $1,020,000, based on the fair market
value of the Company’s common stock on the date the agreement was executed by
the parties. The Company has capitalized such payment to the videogame publisher
and the amount is marked-to-market on a quarterly basis.  The fair
value of the advances on royalties is based entirely upon quoted market prices,
which is a Level 1 input.  The Company recorded a $254,145 increase to
the carrying amount of asset related to the periodic fair value remeasurement at
June 30, 2010.  During the year ended June 30, 2009, 196,219 shares
were earned and $68,519 was expensed to “cost of goods sold – royalties”, of
which $1,805 related to the periodic fair value remeasurement.  As of
June 30, 2010, 2,803,781 shares of common stock, valued at $1,205,626, based on
the fair market value of the Company’s common stock were included advances on
royalties.




80




SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements




1. Summary of Significant
Accounting Policies, continued




Earnings
(Loss) Per Common Share




Basic
earnings (loss) per share is computed by dividing net income (loss) attributable
to common shareholders by the weighted average number of common shares
outstanding for all periods.  Diluted earnings per share is computed
by dividing net income (loss) attributable to common shareholders by the
weighted average number of shares outstanding, increased by common stock
equivalents.  Common stock equivalents represent incremental shares
issuable upon exercise of outstanding options and warrants, the conversion of
preferred stock and the vesting of restricted stock. However, potential common
shares are not included in the denominator of the diluted earnings (loss) per
share calculation when inclusion of such shares would be anti-dilutive, such as
in a period in which a net loss is recorded.  Potentially dilutive
securities including outstanding options, warrants, restricted stock, and the
conversion of preferred stock amounted to 7,581,089 and 14,145,866 during the
years ended June 30, 2010 and 2009, respectively.




Reclassifications




Certain
prior period amounts have been reclassified to conform to current period
presentations. The reclassifications did not impact previously reported total
assets, liabilities, shareholders’ equity or net loss.





Subsequent
Events





Material
subsequent events have been considered for disclosure and recognition through
the filing date of these consolidated financial statements.




Recent
Accounting Pronouncements




The
Financial Accounting Standards Board (“FASB”) has codified a single source of
U.S. GAAP, the “Accounting Standards Codification.” Unless needed to clarify a
point to readers, the Company will refrain from citing specific section
references when discussing application of accounting principles or addressing
new or pending accounting rule changes.




In
October 2009, the FASB issued Accounting Standards Update (“ASU”) No. 2009-14,
“Software (Topic 985): Certain Revenue Arrangements That Include Software
Elements - a consensus of the FASB Emerging Issues Task Force (“EITF”)”
(formerly EITF 09-3). ASU 2009-14 revises FASB ASC 985-605 to drop from its
scope all tangible products containing both software and non-software components
that operate together to deliver the products’ functions. It also amends the
determination of how arrangement consideration should be allocated to
deliverables in a multi-deliverable revenue arrangement. ASU 2009-14 is
effective for fiscal years beginning after June 15, 2010. Early adoption is
permitted with required transition disclosures based on the period of adoption.
The Company is currently evaluating the impact that the adoption of this
guidance will have on its consolidated financial statements.




In
October 2009, the FASB issued ASU No. 2009-13, “Revenue Recognition (Topic 605):
Multiple-Deliverable Revenue Arrangements - a consensus of the FASB Emerging
Issues Task Force” (formerly EITF 08-1), which amends the revenue recognition
guidance for arrangements with multiple deliverables.  ASU 2009-13
addresses how to determine whether an arrangement involving multiple
deliverables contains more than one unit of accounting and how to allocate
consideration to each unit of accounting in the arrangement. This ASU replaces
all references to fair value as the measurement criteria with the term selling
price and establishes a hierarchy for determining the selling price of a
deliverable. It also eliminated the use of the residual value method for
determining the allocation of arrangement consideration. ASU 2009-13 is
effective for fiscal years beginning after June 15, 2010. Early adoption is
permitted with required transition disclosures based on the period of adoption.
The Company does not expect the adoption of the new guidance to have a
significant impact on its consolidated financial statements as the majority of
its revenues are driven from single element deliverables.


81





2. Gamecock
Acquisition




On
October 10, 2008, the Company acquired Gamecock pursuant to a definitive
purchase agreement (the “Gamecock Agreement”) with Vid Agon, LLC (the “Seller”)
and Vid Sub, LLC (the “Member”). The Member is a wholly-owned subsidiary of the
Seller and Gamecock is a wholly-owned subsidiary of the
Member.  Pursuant to the terms of the Gamecock Agreement, the Company
acquired all of the outstanding membership interests of the Member in exchange
for aggregate consideration of 7% of the future revenues from sales of certain
Gamecock games, net of certain distribution fees and advances, and a warrant to
purchase 700,000 shares of the Company’s common stock.





The
amount of the contingent purchase price payment obligations (the “Gamecock
Earn-Out”) has been added to the purchase price (i.e. goodwill).




The
purchase price of Gamecock, adjusted from its initial purchase price and
finalized on October 10, 2009, consists of the following items:




Fair
      value of 700,000 warrants to purchase common stock with an exercise price
      of $1.50 per share based on the closing date of the transaction, October
      10, 2008
                            
                            $
                            1,033,164Transaction
      costs
                            
                            
                            750,000Total
      initial purchase consideration
                            
                            $
                            1,783,164





For
services rendered in connection with the acquisition of Gamecock, the Company
issued warrants with an exercise price of $1.50 to purchase 112,500 shares of
the Company’s common stock, exercisable on or before October 10,
2013.  The warrants were valued at $166,044, the fair market value on
the date of issuance, and were accounted for as a cost of the Gamecock
acquisition.





The fair
value of the stock warrants was determined using the Black-Scholes option
pricing model and the following assumptions: (a) the fair value of the Company’s
common stock of $2.35 per share, which is the closing price as of October 10,
2008, (b) volatility of 57.68%, (c) a risk free interest rate of 2.77%, (d)
an expected term, also the contractual term, of 5.0 years, and (e) an
expected dividend yield of 0.0%.




The
acquisition was accounted for under the purchase method of accounting with the
Company as the acquiring entity.  Accordingly, the consideration paid by
the Company to complete the acquisition was allocated to the assets acquired and
liabilities assumed based upon their estimated fair values as of the date of the
acquisition.  The allocation of the purchase price was based upon certain
external valuations and other analyses.  Between the acquisition date and
October 10, 2009, the Company adjusted its initial acquisition cost and
preliminary purchase price allocation to reflect adjustments to certain assets,
reserves, and obligations. The purchase price allocation was finalized on
October 10, 2009.




The final
purchase price allocations, adjusted from the preliminary purchase price
allocation disclosed as of June, 30 2009, were as follows:




Preliminary
                    Purchase Price
                    Allocation as of
                    June 30, 2009
                  
                  
                  Final Purchase
                    Price Allocation
                    as of October 10,
                    2009Working
      capital, excluding inventories
                  
                  $
                  827,287
                  
                  
                  $
                  827,287Inventories
                  
                  
                  156,745
                  
                  
                  
                  156,745Other
      current assets
                  
                  
                  36,369
                  
                  
                  
                  36,369Property
      and equipment
                  
                  
                  209,441
                  
                  
                  
                  209,441





82





Estimated useful lifeIntangible
      assets:Royalty
      agreements (Advances on royalties)
                              
                              1 –
      2 years
                              
                              
                              3,424,000
                              
                              
                              
                              3,424,000Game
      sequel titles
                              
                              5 –
      12 years
                              
                              
                              1,142,000
                              
                              
                              
                              1,142,000Non-compete
      agreements
                              
                              Less
      than 1 year
                              
                              
                              200,000
                              
                              
                              
                              200,000Distribution
      agreements
                              
                              3
      years
                              
                              
                              40,000
                              
                              
                              
                              40,000Goodwill
                              
                              Indefinite
                              
                              
                              6,595,123
                              
                              
                              
                              6,539,700Liabilities
                              
                              
                              
                              
                              (10,847,801
                              )
                              
                              
                              (10,792,378
                              )Total
      initial purchase consideration
                              
                              
                              
                              $
                              1,783,164
                              
                              
                              $
                              1,783,164




The
adjustments to the preliminary purchase price allocation disclosed as of June
30, 2009, compared to the final purchase price allocation completed as of
October 10, 2009, related to information obtained subsequent to June 30, 2009,
upon completion of the purchase price allocation procedures the Company
identified at the acquisition date.  Adjustments to the preliminary
purchase price allocation are primarily related to updated valuations in the
preliminary appraisals of identifiable intangible assets as well as the acquired
liabilities.




The
following table presents the gross and net balances, and accumulated
amortization of the components of the Company’s purchased amortizable intangible
assets included in the acquisition as of June 30, 2010:




AccumulatedGross
                      
                      
                      Amortization
                      
                      
                      NetRoyalty
      agreements (Advances on royalties)
                      
                      $
                      3,424,000
                      
                      
                      $
                      2,754,000
                      
                      
                      $
                      670,000Intangible
      assets, netGame
      sequel titles
                      
                      $
                      1,142,000
                      
                      
                      $
                      1,142,000
                      
                      
                      $
                      -Non-compete
      agreements
                      
                      
                      200,000
                      
                      
                      
                      200,000
                      
                      
                      
                      -Distribution
      agreements
                      
                      
                      40,000
                      
                      
                      
                      22,975
                      
                      
                      
                      17,025Total
      intangible assets, net
                      
                      $
                      1,382,000
                      
                      
                      $
                      1,364,975
                      
                      
                      $
                      17,025




Intangible
assets and goodwill are expected to be tax deductible.  During the year
ended June 30, 2009, the Company incurred an impairment charge of $1,142,000
related to write-off of acquired game sequel titles due to the underperformance
of the acquired titles.




Amortization
expense for the years ended June 30, 2010 and 2009 was $26,785 and $196,190,
respectively.





The
estimated future decreases (increases) to net income (loss) from the
amortization of the finite-lived intangible assets are the following
amounts:





Year ending June 30,2011
                
                $
                13,3332012
                
                $
                3,692




The
weighted average estimated amortization period as of June 30, 2010 is 15
months.




As of
June 30, 2010, a total of $1,353,211, which may be netted contractually against
adjustments for excess payables, as defined pursuant to the Gamecock Agreement,
of the Gamecock Earn-Out has been achieved and was recorded as goodwill in the
consolidated balance sheets.




The
following table summarizes the unaudited pro forma information assuming the
business combination had occurred at the beginning of the periods
presented.  This pro forma financial information is for informational
purposes only and does not reflect any operating efficiencies or inefficiencies
which may result from the business combination and therefore is not necessarily
indicative of results that would have been achieved had the businesses been
combined during the periods presented.


83




For the year ended
                            June 30, 2009Pro
      forma net revenues
                          
                          $
                          48,109,355Pro
      forma net loss
                          
                          
                          (45,563,382
                          )Pro
      forma net loss per share—basic
                          
                          
                          (1.23
                          )Pro
      forma net loss per share—diluted
                          
                          
                          (1.23
                          )




On
December 4, 2008, the Company acquired the remaining 4% minority interest in
Gamecock in exchange for aggregate consideration of 50,000 warrants to purchase
shares of the Company’s common stock, with an exercise price of $1.50 per
share, exercisable subject to the achievement of certain revenue targets.
The transaction has been accounted for as a purchase and resulted in an increase
to goodwill of $18,889.  The fair value of the stock warrants was
determined using the Black-Scholes option pricing model and the following
assumptions: (a) the fair value of the Company’s common stock of $1.10 per
share, which is the closing price as of December 4, 2008, (b) volatility of
63.76%, (c) a risk free interest rate of 1.51%, (d) an expected term, also the
contractual term, of 3.0 years, and (e) an expected dividend yield of
0.0%.





Gain
on Settlement of Earn-Out




Pursuant
to the terms of the Gamecock Agreement, the Company was obligated to pay the
Seller 7% of the future revenues from sales of certain Gamecock games, net of
certain distribution fees and advances.  On March 3, 2010, the Company
settled this contingent purchase price payment obligation in exchange for the
issuance to the Seller of 700,000 shares of common stock (which were valued at
$245,000 based on the fair market value of the Company’s common stock on the
settlement date) and the payment of $200,000 in cash.  In connection
with the settlement, the warrant to purchase 700,000 shares of the Company’s
common stock was cancelled. Under the settlement agreement, the Company and
Seller agreed to settle all current and future claims against one another. The
Company had previously accrued $1,353,211 for the contingent purchase price
payment to the Seller within accrued expenses and other current liabilities. As
a result of the settlement, for the year ended June 30, 2010, the Company has
recognized a gain on settlement of contingent purchase price obligation of
$908,210 in the accompanying consolidated statements of operations.




3. Inventories




At June
30, 2010 and 2009, inventories consist of the following:




2010
                                    
                                    
                                    2009Finished
      goods
                                    
                                    $
                                    1,085,433
                                    
                                    
                                    $
                                    3,858,518Purchased
      parts and components
                                    
                                    
                                    125,868
                                    
                                    
                                    
                                    601,319Total
                                    
                                    $
                                    1,211,301
                                    
                                    
                                    $
                                    4,459,837




During
the years ended June 30, 2010 and 2009, inventory was written down in the amount
of $138,237 and $-0-, respectively.





4. Property and Equipment,
net




At June
30, 2010 and 2009, property and equipment, net was comprised of the
following:




2010
                              
                              
                              2009Land
                              
                              $
                              544,044
                              
                              
                              $
                              544,044Building
      and leasehold improvements
                              
                              
                              1,496,099
                              
                              
                              
                              1,496,147Computer
      equipment and software
                              
                              
                              774,361
                              
                              
                              
                              719,621Office
      furniture
      and other equipment
                              
                              
                              440,424
                              
                              
                              
                              353,4063,254,928
                              
                              
                              
                              3,113,218Less:
      accumulated depreciation and amortization
                              
                              
                              586,936
                              
                              
                              
                              359,079Property
      and equipment, net
                              
                              $
                              2,667,992
                              
                              
                              $
                              2,754,139




84





Depreciation
and amortization expense for the years ended June 30, 2010 and 2009 was
$242,450 and $181,963, respectively.





5. Intellectual Property
Licenses




On August
28, 2007, the Company contracted to use copyrighted images in a game that a
third party developer developed for the Company for a total cost of
$100,000. In addition, on October 29, 2007, the Company contracted to
license software that would be used in the development of games by third parties
for a total cost of $2,685,000 to be paid within 18 months. At June 30,
2010 and 2009, the Company has accrued $135,000 related to these contracts,
which is included in accrued expenses and other current liabilities in the
accompanying consolidated balance sheets.





Amortization
expense was $411,243 and $454,437 for the years ended June 30, 2010 and 2009,
respectively, which was recorded as “cost of goods sold – intellectual property
licenses”.  As of June 30, 2010 and 2009, accumulated amortization was
$867,143 and $456,147, respectively.





Amortization
expense for these assets is anticipated to be $384,000 per year through fiscal
2015.





In July
2009, the Company adopted a new standard which provides guidance for determining
the useful life of a recognized intangible asset and requires enhanced
disclosures so that users of financial statements are able to assess the extent
to which the expected future cash flows associated with the asset are affected
by the Company’s intent and/or ability to renew or extend the arrangement. The
adoption of this standard did not impact the Company’s consolidated financial
statements.





6. Line of
Credit




The
Company had a $8.0 million revolving line of credit facility with SunTrust
Banks, Inc. (“SunTrust”) that was scheduled to mature on November 30,
2010.   As of June 30, 2010 and June 30, 2009, the Company’s borrowing
base could not exceed 55% and 65%, respectively, of eligible accounts receivable
plus $500,000. The line of credit bore interest at prime plus 11⁄2%, which was
4.75% and 3.75% at June 30, 2010 and June 30, 2009,
respectively.  SunTrust processed payments received on such accounts
receivable as payments on the revolving line of credit. The line was
collateralized by gross accounts receivable of approximately $1,861,000 and
$8,673,000 at June 30, 2010 and June 30, 2009, respectively. The line of credit
was further collateralized by personal guarantees, and pledge of personal
securities and assets by two Company shareholders, one of whom is the
Company’s chairman, and certain other affiliates. The agreement contained
certain financial and non-financial covenants. At June 30, 2010, the Company was
not in compliance with these covenants.




At June
30, 2010 and June 30, 2009, the outstanding line of credit balance was
$3,830,055 and $5,349,953, respectively. At June 30, 2010 and June 30, 2009, the
Company had $-0- and $-0-, respectively, available under its credit facility.
For the years ended June 30, 2010 and 2009, interest expense relating to the
line of credit was $220,910 and $211,063, respectively. There was $33,284
and $-0- of accrued interest at June 30, 2010 and 2009,
respectively.


85





On July
12, 2010, the Company repaid in full the entire outstanding balance under the
credit agreement as a result of entering into a factoring agreement with
Rosenthal & Rosenthal, Inc. (the “factor”) (see Note 26, Subsequent Events
for further discussion).




7. Production Advance
Payable





On August
17, 2009, the Company entered into a unit production financing agreement with a
producer relating to the production of certain games, of which the balance
outstanding under this agreement was $3,755,104 at June 30, 2010. 
Production fees relating to this production advance for the year ended June 30,
2010 totaled $1,141,382, and includes the production fees of $725,000 related to
the default status of the production advance, as described in the subsequent
paragraph.  These amounts are included in interest expense on the
accompanying consolidated statements of operations. As of June 30, 2010, accrued
and unpaid production fees totaled $1,000,392 and are included in accrued
expenses and other current liabilities. The Company is obligated to pay
approximately $103,000 of production fees for every month the full production
advance is outstanding past its due date of November 15, 2009.  Pursuant to
the agreement, the Company has assigned to the producer a portion of the net
revenues related to the sale of certain games in Europe.




The
Company has failed to make the required payments under this agreement. 
 Accordingly, the production advance payable is currently in default and is
accruing production fees at $0.009 per unit (based upon 382,000 units) for each
day after November 15, 2009 (approximately $725,000 through June 30,
2010).  Pursuant to the terms of the production financing agreement, the
producer is free to exercise any rights in connection with the security
interests granted.





8. Accrued Expenses and Other
Current Liabilities




Accrued
expenses and other current liabilities consist of the following:





June 30,2010
                              
                              
                              2009Accrued
      expenses
                              
                              $
                              1,700,208
                              
                              
                              $
                              1,543,319Reserve
      for marketing development funds (MDF)
                              
                              
                              344,210
                              
                              
                              
                              217,485Commissions
                              
                              
                              161,678
                              
                              
                              
                              139,527Guaranteed
      royalty payments
                              
                              
                              135,000
                              
                              
                              
                              135,000Accrued
      payroll and payroll taxes
                              
                              
                              266,740
                              
                              
                              
                              83,484Customer
      cash in advance deposits
                              
                              
                              31,793
                              
                              
                              
                              44,548Accrued
      interest
                              
                              
                              1,062,200
                              
                              
                              
                              -Other
                              
                              
                              79,882
                              
                              
                              
                              255,737$
                              3,781,711
                              
                              
                              $
                              2,419,100





9. Secured Subordinated
Convertible Promissory Notes




On April
29 and 30, 2010, the Company entered into a note purchase agreement pursuant to
which the Company could issue up to $5.0 million of junior secured subordinated
promissory notes (the “Junior Notes”) in one or more closings and each of the
Company’s subsidiaries guaranteed the Company’s obligations under the Junior
Notes.  Pursuant to the Note Purchase Agreement, the Company issued Junior
Notes in the aggregate principal amount of $950,000 in private placements that
closed on April 30, 2010 and May 6, 2010.  Of the Junior Notes issued
on April 29 and 30, 2010, the Company’s Chairman, purchased
$500,000.




The
Junior Notes are due and payable in full on December 27, 2010 and bear
interest at the rate of 10% per annum. The Junior Notes are secured by all of
the assets of the Company and its subsidiaries and the indebtedness under the
Junior Notes and the security interest granted by the Company and its
subsidiaries in the Note Purchase Agreement are junior to the Company’s
indebtedness to SunTrust Banks, Inc., the Company’s senior lender, and the
indebtedness held by any future senior lender of the Company or its
subsidiaries.  The principal and accrued interest outstanding under
each Junior Note is convertible, in whole or in part, at the option of its
holder into shares of the Company’s common stock at a price per share of $0.45
per share.


86




The
Company has evaluated the conversion feature of the Junior Notes and determined
that there is no beneficial conversion feature as the conversion price of $0.45
per share was greater than the fair value of the stock at the time of
issuance.





The
interest expense incurred for the year ended June 30, 2010 related to the
Junior Notes was $15,548. There was $15,548 of accrued interest at June 30,
2010.





10. Long-term
Debt




At June
30, 2010 and 2009, long-term debt was comprised of the following:




2010
                                    
                                    
                                    2009Mortgages
      payableFirst
      National Bank
                                    
                                    $
                                    1,013,964
                                    
                                    
                                    $
                                    1,039,078Southwest
      Securities, FSB
                                    
                                    
                                    479,000
                                    
                                    
                                    
                                    493,437Vehicle
      notes payable
                                    
                                    
                                    113,567
                                    
                                    
                                    
                                    57,296Total
      debt
                                    
                                    
                                    1,606,531
                                    
                                    
                                    
                                    1,589,811Less
      current portion
                                    
                                    
                                    65,450
                                    
                                    
                                    
                                    50,855Total
      long-term debt
                                    
                                    $
                                    1,541,081
                                    
                                    
                                    $
                                    1,538,956





On
January 30, 2009, the Company purchased a building in Grapevine, Texas for
$625,000.  In connection with the purchase, the Company entered into a
five year mortgage with a financial institution in the amount of
$500,000.  The interest rate on the mortgage adjusts daily to prime
plus 1.0% (5.5% at June 30, 2010).  Principal and interest are payable
in monthly installments of $3,439 beginning February 28, 2009 and continuing
until January 28, 2014 when the entire balance of principal and accrued interest
is due and payable.  The mortgage is secured by the land and
building. The Company’s chairman has personally guaranteed the
mortgage note.




On
October 4, 2007, the Company purchased a building and land in Grapevine, Texas
for $1,175,000. This building is being used by the Company as office space. In
connection with the purchase, the Company entered into a 20 year mortgage with a
financial institution in the amount of $1,068,450. The interest rate on the
mortgage is fixed at 7.5% until March 2013 and will adjust every five years to
prime minus 1⁄4%. The monthly principal and interest payment is $8,611 with
interest only payments for the first six months. The mortgage is secured by the
purchased land and building. Two shareholders of the Company, one of whom
is the Company’s chairman, have personally guaranteed the mortgage
note.





The
Company has entered into various note agreements for the purchase of vehicles
used in its business. The notes bear interest at rates between 0.0% and 7.34%,
require monthly payments of principal and interest and are generally secured by
the specific vehicle being financed. The notes have original terms of five
years.





The
interest expense incurred for the years ended June 30, 2010 and 2009
related to long-term debt was $108,876 and $91,004, respectively.




The
scheduled maturities of the long-term debt as of June 30, 2010 are as
follows:




Year
      ending June 30,2011
                        
                        $
                        65,4502012
                        
                        
                        68,9922013
                        
                        
                        73,3462014
                        
                        
                        489,2772015
                        
                        
                        48,981Thereafter
                        
                        
                        860,485Total
                        
                        
                        1,606,531Less:
      current maturities
                        
                        
                        65,450Long-term
      debt, net of current portion
                        
                        $
                        1,541,081




87





11. Related
Party Transactions




For all
periods presented, the Company had the following related party
transactions.





Related
party receivables




Related
party receivables consist primarily of short-term advances to employees. No
allowance has been provided due to the short-term nature and recoverability of
such advances.





Also
included in related party receivables at June 30, 2010 is a receivable
attributed to lease income. The Company leases certain office space to a company
whose shareholders are also shareholders of the Company, one of whom is the
Company's chairman.  At June 30, 2010 and 2009, $7,815 and $-0-,
respectively, was owed to the Company and is included in related party
receivables.  See Leases – Related Parties
within Note 11 for further details.





Due
to Shareholders




During
the year ended June 30 2009, the Company’s chairman advanced the Company
$307,440. The advance was unsecured, payable on demand and non-interest
bearing.  At June 30, 2009, the amount due was
$232,440.  The amount was repaid in full during the year end June 30,
2010.





Due
to Related Parties




During
the year ended June 30, 2009, the Company collected sales commissions totaling
$226,216 on behalf of an affiliate of two shareholders of the Company, one
of whom is the Company's chairman.  At June 30, 2009, $113,499
remained payable to the affiliate and is included in due to related parties in
the accompanying consolidated balance sheets. The amount was repaid in full
during the year end June 30, 2010.




During
the years ended June 30, 2010 and 2009, the Company expensed $26,400 and
$78,562, respectively, related to broadband usage from an internet
service provider partially owned by two shareholders of the Company, one of whom
is the Company's chairman, of which $2,200 and $11,546 remained as a
payable to the affiliate and is included in due to related parties in the
accompanying consolidated balance sheets at June 30, 2010 and 2009,
respectively.  These amounts are included in general and
administrative expenses in the accompanying consolidated statements of
operations.




During
the year ended June 30, 2009, the Company expensed $12,927 related to
purchases from an import company partially owned by the Company's
chairman, of which no amounts were outstanding at June 30, 2009.  This
amount is included in general and administrative expenses in the accompanying
consolidated statements of operations.




Accrued
Expenses - Related Parties




Accrued
expenses - related parties as of and for the years ended June 30, 2010 and 2009
are as follows:




2010
                            
                            
                            2009Balance
      at July 1
                            
                            $
                            221,493
                            
                            
                            $
                            14,061Expenses
      incurred:Rent
                            
                            
                            110,000
                            
                            
                            
                            100,250Commissions
                            
                            
                            551,932
                            
                            
                            
                            916,039Less:
      amounts paid
                            
                            
                            (561,144
                            )
                            
                            
                            (808,857
                            )Balance
      at June 30
                            
                            $
                            322,281
                            
                            
                            $
                            221,493




88





The
Company incurred sales commissions for the marketing and sale of video games
with four affiliates of the Company's chairman.  Sales commissions for
the years ended June 30, 2010 and 2009 were $551,932 and $916,039,
respectively.  These amounts are included in sales and marketing in
the accompanying consolidated statements of operations.





Leases
- Related Parties




The
Company leases certain office space from a company whose shareholders are also
shareholders of the Company, one of whom is the Company’s
chairman.  Related party lease expense was $110,000 and $100,250 for
the years ended June 30, 2010 and 2009, respectively.  These amounts
are included in the general and administrative expense in the accompanying
consolidated statements of operations. The lease expires on December 31, 2010.





The
Company leases certain office space to a company whose shareholders are also
shareholders of the Company, one of whom is the Company's chairman. 
Related lease income was $15,630 and $15,636 for years ended June 30, 2010 and
2009, respectively.  These amounts are included in general and
administrative expense in the accompanying consolidated statements of
operations.  The lease expires on December 31, 2010.





Revenue
– Related Parties





The
Company sold units of older, slow-moving video games to a company partially
owned by the Company’s chairman and chief executive officer.  Related
party revenue was $3,481 for the year ended June 30, 2010.  This
amount was included in net revenue in the accompanying consolidated statements
of operations.




12. Product Sales and Geographic
Information




The
Company operates in one reportable segment in which it is a publisher and
distributor of interactive entertainment software for home video consoles,
handheld platforms and personal computers. The Company’s published games have
accounted for a significant portion of the net revenues of the Company. Net
revenues by product groups are as follows:




Console
                
                
                Hand-held
                
                
                PC
                
                
                Other
                
                
                TotalFor
      the year endedJune
      30, 2010
                
                $
                17,400,334
                
                
                $
                17,158,740
                
                
                $
                5,740,065
                
                
                $
                -
                
                
                $
                40,299,139June
      30, 2009
                
                $
                25,263,570
                
                
                $
                19,378,357
                
                
                $
                2,707,505
                
                
                $
                (69,738
                )
                
                $
                47,279,694




Geographic
information is based on the location of the selling entity. Geographic
information regarding net revenues for the year ended June 30, 2010 and 2009 is
as follows:




North America
                
                
                Europe
                
                
                Other
                
                
                ConsolidatedAs
      of and for the year ended June 30, 2010Net
      revenues
                
                $
                32,560,862
                
                
                $
                6,989,875
                
                
                $
                748,402
                
                
                $
                40,299,139Long-lived
      assets
                
                
                13,402,417
                
                
                
                251,385
                
                
                
                -
                
                
                
                13,653,802As
      of and for the year ended June 30, 2009Net
      revenues
                
                $
                41,980,819
                
                
                $
                4,273,463
                
                
                $
                1,025,412
                
                
                $
                47,279,694Long-lived
      assets
                
                
                13,470,407
                
                
                
                304,157
                
                
                
                -
                
                
                
                13,774,564




13. Commitments




The total
future minimum commitments as of June 30, 2010 are as follows:


89





Software
                        
                        
                        OfficeDevelopers
                        
                        
                        Lease
                        
                        
                        TotalFor
      the year ending June 30,2011
                        
                        $
                        6,802,970
                        
                        
                        $
                        85,867
                        
                        
                        $
                        6,888,8372012
                        
                        
                        –
                        
                        
                        
                        30,867
                        
                        
                        
                        30,8672013
                        
                        
                        –
                        
                        
                        
                        28,294
                        
                        
                        
                        28,294Total
                        
                        $
                        6,802,970
                        
                        
                        $
                        145,028
                        
                        
                        $
                        6,947,998




Developer
of Intellectual Property Contracts




The
Company regularly enters into contractual arrangements with third parties for
the development of games as well as the rights to license intellectual property.
Under these agreements, the Company commits to provide specified payments to a
developer or intellectual property holders, based upon contractual arrangements,
and conditioned upon the achievement of specified development milestones. These
payments to third-party developers and intellectual property
holders typically are deemed to be advances and are recouped against future
royalties earned by the developers based on the sale of the related game. “Cost
of goods sold - royalties” amounted to $12,383,362 and $9,654,810 for the years
ended June 30, 2010 and 2009, respectively.




Lease
Commitments




In
January 2008, the Company entered into a new four year lease for its United
Kingdom office, with a yearly rent of approximately $30,000 plus value added tax
(VAT). Office rent expense for the years ended June 30, 2010 and 2009 was
$32,163 and $50,902, respectively.




The
Company entered into a non-cancelable operating lease with an affiliate, on
January 1, 2008, for offices located in Midlothian, Virginia. The lease provided
for monthly payments of $7,542 for the first 12 months and increased to $9,167
in January 2009 for the remaining 24 months. Office rent expense for the years
ended June 30, 2010 and 2009 was $110,000 and $100,250,
respectively.




Solicitation
Services




Prior to
the acquisition of SouthPeak Interactive, L.L.C., the Company engaged
HCFP/Brenner Securities, LLC (“HCFP”), on a non-exclusive basis, to act as its
agent for the solicitation of the exercise of the Class W and Class Z
warrants. In consideration for solicitation services, the Company agreed to
pay HCFP a commission equal to 5% of the exercise price for each Class W warrant
and Class Z warrant exercised after April 18, 2007 if the exercise is solicited
by HCFP. No services have been provided as of June 30, 2010.





For
services rendered in connection with the acquisition of SouthPeak Interactive,
L.L.C., the Company issued warrants with an exercise price of $1.00 to purchase
500,000 shares of the Company’s common stock, exercisable on or before April 25,
2013, to HCFP.




In
exchange for investment banking services related to the sale of the Series A
convertible preferred stock, the Company agreed to pay HCFP a fee
consisting of, (a) cash in an amount equal to 6.5% of the gross proceeds
received by the Company, including the conversion of indebtedness, (b) warrants
with an exercise price of $1.00 per share to purchase a number of shares of
common stock equal to 10% of the total number of shares of Series A convertible
preferred stock issued by the Company (for which HCFP received 1,456,383
warrants to purchase shares of common stock during the year ended June 30,
2009), and (c) one Class Y warrant for every ten Class Y warrants issued in
connection with the sale of Series A convertible preferred stock (for which HCFP
received Y warrants to purchase 616,015 shares of common stock during the year
ended June 30, 2009).  The fair value of the warrants was accounted
for as a cost of the Series A convertible preferred stock offering (see Notes 4
and 5).


90





Employment
Agreements





The
Company has employment agreements with several members of senior management. The
agreements, with terms ranging from approximately two to three years, provide
for minimum salary levels, performance bonuses, and severance
payments.




14. Capital
Stock




Preferred
Stock




On May
12, 2008 the Company amended the articles of incorporation by increasing the
number of preferred stock authorized, par value $0.0001 per share, from
5,000,000 to 20,000,000 shares of preferred stock. Of the 20,000,000 authorized,
15,000,000 of the preferred stock were designated Series A convertible preferred
stock. The Series A convertible preferred stock votes together as a single class
and on an as converted basis with the common stock. The Series A convertible
preferred stock has no dividend right. The Company can require the conversion of
the Series A convertible preferred stock if the 10 day weighted closing price
per share of the Company’s common stock is at least $2.00 per share. The
remaining preferred stock may be issued in one or more series and to fix the
number of shares constituting any such series and the preferences, limitations
and relative rights, including but not limited to, dividend rights, dividend
rate, voting rights, terms of redemption, redemption price or prices, conversion
rights and liquidation preferences of the shares constituting any
series.





Series
A Convertible Preferred Stock




During
the fiscal year ended June 30, 2009, the Company raised $1,579,000 in gross cash
proceeds through the private placement of 1,579,000 shares of a newly designated
class of Series A convertible preferred stock at a purchase price of $1.00 per
share to a group of accredited investors.




The
shares of Series A convertible preferred stock were initially convertible into
common stock at a conversion price of $1.00 per share. In conjunction with the
private placement, for every two shares of preferred stock purchased, each
purchaser was entitled to exchange one Class W or Class Z warrant in exchange
for one Class Y warrant. Each Class Y warrant entitles the holder to purchase a
share of common stock for $1.50 per share. The expiration date for the Y
warrants is May 31, 2013. During the fiscal year ended June 30, 2009, the
Company issued 6,160,149 Class Y warrants in exchange for the cancellation of
4,689,950 Class W and 1,470,199 Class Z warrants (see Note 5).




The
Company has accounted for the warrant exchange right similar to the issuance of
detachable stock purchase warrants in accordance with ASC Topic 470, whereby the
Company separately measured the fair value of the convertible preferred stock
and the warrant exchange right and allocated the total proceeds in accordance
with their relative fair value at the time of issuance.




In
accordance with the provisions of ASC Topic 470, the Company allocated a portion
of the proceeds received to the embedded beneficial conversion feature, based on
the difference between the effective conversion price of the proceeds allocated
to the convertible preferred stock and the fair value of the underlying common
stock on the date the convertible preferred stock was issued. Since the
convertible preferred stock also had detachable stock purchase warrants, the
Company first allocated the proceeds to the stock purchase warrants and the
convertible preferred stock and then allocated the resulting convertible
preferred stock proceeds between the beneficial conversion feature, which was
accounted for as paid-in capital, and the initial carrying amount of the
convertible preferred stock. During the year ended June 30, 2009, the discount
resulting from the beneficial conversion feature was recorded as a deemed
dividend in the amount of $1,142,439, representing the beneficial conversion
feature of the Series A convertible preferred stock.




The
Company incurred a fee for the financing equal to: (a) 6.5% of the gross
proceeds received for the sale of Series A convertible preferred stock,
including the conversion of indebtedness, payable in cash, (b) warrants with an
exercise price of $1.00 per share to purchase a number of shares of common stock
equal to 10% of the total number of shares of Series A convertible preferred
stock issued, and (c) one Class Y warrant for every ten Class Y warrants issued
pursuant to the sale of Series A convertible preferred stock. The fee was
accounted for as a cost of capital.


91





The
Company has registered for resale shares of its common stock issuable to the
investors and finders upon conversion of the preferred stock and exercise of the
warrants issued in the private placement. If the Company is unable to maintain
the effectiveness of the registration statement related to the Series A
convertible preferred stock for more than 30 days in any given year, the Company
is obligated to pay investors liquidated damages in cash equal to .5% of the
stated value of the Series A convertible preferred stock per month. Liquidated
damages will not accrue nor be payable for times during which the shares covered
by the related prospectus are transferable by the holder pursuant to Rule 144(k)
under the Securities Act of 1933, as amended.





The
Series A convertible preferred stock is convertible at the option of the holder
into shares of common stock at a rate of $1.00 per share divided by the
then-applicable conversion price. As of June 30, 2010 and 2009, the
conversion price was $0.96 and $1.00, respectively, per share and the
outstanding shares of Series A convertible preferred stock were convertible into
5,733,159 and 5,953,833, respectively, shares of common stock.





Subject
to certain exceptions, the conversion price will be adjusted if the Company
issues or sells shares of common stock or non-voting common stock (including
options to acquire shares and securities convertible into or exchangeable for
shares of common stock or non-voting common stock) without consideration or for
a consideration per share less than the conversion price for of the Series A
preferred stock in effect immediately prior to the issuance or
sale.  In that event, the conversion price will be reduced to a
conversion price (calculated to the nearest cent) determined by dividing
(1) an amount equal to the sum of (a) the number of shares of common
stock and non-voting common stock outstanding immediately prior to the issuance
or sale (including as outstanding all shares of common stock and non-voting
common stock issuable upon conversion of outstanding Series A convertible
preferred stock) multiplied by the conversion price then in effect; plus
(b) the consideration, if any, received by the Company upon the issuance or
sale, by (2) the total number of shares of common stock and non-voting
common stock outstanding immediately after such issuance or sale (including as
outstanding all shares of common stock and non-voting common stock issuable upon
conversion of outstanding Series A convertible preferred stock, without giving
effect to any adjustment in the number of shares issuable by reason of such
issue and sale).





If the
Company issues or sells shares of common stock or non-voting common stock for
cash, the cash consideration received will be deemed to be the amount received
by the Company, without deduction for any expenses incurred or any underwriting
commissions or concessions paid or allowed by the Company. If the Company issues
or sells shares of common stock or non-voting common stock for a consideration
other than cash, the amount of the consideration other than cash received shall
be deemed to be the fair value of such consideration as determined in good faith
by the board, without deduction for any expenses incurred or any underwriting
commissions or concessions paid or allowed by the Company.





No
adjustments to the conversion price are required for issuances of shares of
common stock or non-voting common stock upon any conversion of Convertible
Preferred Stock, or under the Company’s equity incentive plans.




Common
Stock




On May
12, 2008 the Company amended the articles of incorporation by increasing the
number of common stock authorized, par value $0.0001 per share, from 24,000,000
to 90,000,000 shares of common stock. Holders of the Company’s common stock are
entitled to one vote for each share held on all matters submitted to a vote of
stockholders and do not have cumulative voting rights. Holders of common stock
are entitled to receive proportionately any dividends that may be declared by
the Company’s board of directors, subject to the preferences and rights of any
shares of preferred stock. In the event of the Company’s liquidation,
dissolution or winding-up, holders of common stock will be entitled to receive
proportionately any of the Company’s assets remaining after the payment of debts
and liabilities and subject to the preferences and rights of any shares of
preferred stock. Holders of common stock have no preemptive, subscription,
redemption or conversion rights. The rights and privileges of holders of the
Company’s common stock are subject to any series of preferred stock that the
Company has issued or may issue in the future, including the Series A
convertible preferred stock.





Registration
Rights




Pursuant
to the sale of Series A convertible preferred stock, the Company was obligated
to file a registration statement with the Securities Exchange Commission (“SEC”)
covering the resale of the shares of its common stock within 30 days following
the Company’s filing of its Form 10-K for the year ended June 30, 2008 but no
later than October 15, 2008 (the “Filing Deadline”).


92




If the
registration statement is not filed with the SEC by the Filing Deadline, the
Company will make pro rata payments to each holder of Series A convertible
preferred stock in an amount equal to .5% of the aggregate amount invested by
such holder of Series A convertible preferred stock for each 30 day period (or
portion thereof) for which no registration statement is filed.  In
accordance with ASC Topic 825, the Company recognized a $196,510 liability at
June 30, 2009 associated with the registration rights agreement.






15. Warrants to Purchase Common
Stock




Prior to
the acquisition of SouthPeak Interactive, L.L.C., the Company had issued Class W
warrants to purchase 7,517,500 shares of its common stock, and Class Z warrants
to purchase 6,137,500 shares of its common stock.  The Class W and
Class Z warrants are subject to a registration rights agreement.  In
connection with the sale of Series A convertible preferred stock, during the
year ended June 30, 2009, the Company issued 6,160,149 Class Y warrants in
exchange for 4,689,950 Class W warrants and 1,470,199 Class Z
warrants.  The Company also issued 616,015 Class Y warrants to HCFP in
exchange for investment banking services.




The
holders of Class W and Class Z warrants may request the filing of a registration
statement; the Company is only required to use its best efforts to cause the
registration statement to be declared effective and, once effective, only to use
its best efforts to maintain its effectiveness. Accordingly, because the
Company’s obligation is merely to use its best efforts in connection with the
registration rights agreement and upon exercise of the warrants, the Company can
satisfy its obligation by delivering unregistered shares of common
stock.




Each
Class Y warrant issued is exercisable for one share of common stock. Except as
set forth below, the Class Y warrants entitle the holder to purchase shares, on
or before May 31, 2013, at $1.50 per share, subject to adjustment in the event
of stock dividends and splits, reclassifications, combinations and similar
events. As of June 30, 2010 and 2009, there were 6,776,164 Class Y warrants
outstanding, including the 616,015 warrants to HCFP.




Each
Class W warrant issued is exercisable for one share of common stock. Except
as set forth below, the Class W warrants entitle the holder to purchase shares,
on or before April 17, 2011, at $5.00 per share, subject to adjustment in the
event of stock dividends and splits, reclassifications, combinations and similar
events. As of June 30, 2010 and 2009, there were 2,827,550 Class W warrants
outstanding.




Each
Class Z warrant issued is exercisable for one share of common stock. Except as
set forth below, the Class Z warrants entitle the holder to purchase shares, on
or before April 17, 2013, at $5.00 per share, subject to adjustment in the event
of stock dividends and splits, reclassifications, combinations and similar
events. As of June 30, 2010 and 2009, there were 3,271,151 and 4,667,301,
respectively, Class Z warrants outstanding.




The
Company may redeem the Class Y warrants, Class W warrants and/or Class Z
warrants with the prior consent of HCFP, in whole or in part, at a price of
$0.05 per warrant at any time after the warrants become exercisable, upon a
minimum of 30 days’ prior written notice of redemption, and if, and only if, the
last sale price of the Company’s common stock equals or exceeds $2.50 per share,
$7.50 per share and $8.75 per share, for a Class Y warrant, Class W warrant and
Class Z warrant, respectively, for any 20 trading days within a 30 trading day
period ending three business days before the Company sent the notice of
redemption (the “Measurement Period”). In addition, the Company may not redeem
the Class Y warrants, Class W warrants and/or the Class Z warrants unless the
shares of common stock underlying such warrants are covered by an effective
registration statement.


93




The
Company has no obligation to net cash settle the exercise of the warrants. The
holders of Class Y warrants, Class W warrants and Class Z warrants do not have
the rights or privileges of holders of the Company’s common stock or any voting
rights until such holders exercise their respective warrants and receive shares
of the Company’s common stock.




In
connection with the Gamecock acquisition, the Company issued warrants to
purchase an aggregate of 862,500 shares of common stock at an exercise price of
$1.50 per share, and exercisable until October 10, 2013 as follows:




Warrants
      issued in connection with the purchase of the Gamecock acquisition (See
      Note 2), cancelled during 2010
                        
                        
                        700,000Warrants
      issued in connection with the purchase of the remaining 4% minority
      interest in Gamecock (See Note 2)
                        
                        
                        50,000Warrants
      issued to attorneys in connection with Gamecock acquisition (See Note
      2)
                        
                        
                        100,000Warrants
      issued to outside-consultant in connection with Gamecock acquisition (See
      Note 2)
                        
                        
                        12,500862,500




The fair
value of the stock warrants issued to the attorneys and the outside-consultant
was determined using the Black-Scholes option pricing model and the following
assumptions: (a) the fair value of the Company’s common stock of $2.35 per
share, which is the closing price as of October 10, 2008, (b) volatility of
57.68%, (c) a risk-free interest rate of 2.77%, (d) an expected term, also the
contractual term, of 5.0 years, and (e) an expected dividend yield of 0.0%. The
fair value of these warrants was accounted for as a cost of the Gamecock
Acquisition.




The
warrants contain a net exercise provision under which the holder may, in
lieu of payment of the exercise price in cash, surrender the warrant and receive
a net amount of shares based on the fair market value of the Company’s common
stock after deduction of the aggregate exercise price. The warrants also contain
provisions for the adjustment of the exercise price and the aggregate number of
shares issuable upon exercise of the warrants in the event of stock dividends,
stock splits, reorganizations, reclassifications and consolidations. The
warrants also contain piggy-back registration rights and other customary
provisions.




In April
2008, in connection with the SouthPeak Acquisition, the Company issued five-year
fully vested warrants to purchase 500,000 shares of common stock at $1.00 per
share valued at $63,905 for services related to the reverse
acquisition.  The fair value of the warrants issued in connection with
the SouthPeak Acquisition was determined using the Black-Scholes option pricing
model and the following assumptions: (a) the fair value of the Company’s common
stock of $0.40 per share, which is the closing price as of April 25, 2008, (b)
volatility of 60.94%, (c) a risk free interest rate of 3.20%, (d) an expected
term, also the contractual term, of 5.0 years, and (e) an expected dividend
yield of 0.0%.





On
November 5, 2009, in connection with a settlement of trade payables (See Note
21), the Company issued 150,000 warrants to purchase common stock, which were
valued on the settlement date, at $0.30 per share using the Black-Scholes option
pricing model with assumptions of 3.57 years expected term (equivalent to
contractual term), volatility of 170.76%, 0% dividend yield, 2.35% risk-free
interest rate, and stock price of $0.34 per share.





On March
3, 2010, in connection with the settlement of the contingent purchase price
payment obligation (See Note 2), the warrant to purchase 700,000 shares of the
Company’s common stock was cancelled.





On May 5,
2010, the Company entered into a stock purchase agreement pursuant to which the
Company could issue shares of its common stock in one or more closings to
persons who are accredited investors and holders of the Company’s Class W
warrants and Class Z warrants.  Pursuant to the stock purchase
agreement, purchasers can utilize Class W warrants and Class Z warrants
tendered to the Company for cancellation as payment of the purchase price for
the shares of common stock.  There is no minimum number of Class W
warrants or Class Z warrants that must be offered to the Company as payment for
shares of common stock and there is no limit to the number of Class W warrants
or Class Z warrants that the Company may accept.  The Company shall
issue one share of its common stock in exchange for the
following:


94




§
            six
      Class Z warrants and $0.15;


§
            25
      Class Z warrants; or


§
            100
      Class W warrants and $0.25.





On May 5,
2010, the Company completed the first closing of a private placement of its
common stock pursuant to the stock purchase agreement.  At the
closing, the Company issued 197,858 shares of its common stock to four
purchasers in exchange for the cancellation of 1,396,150 Class Z warrants and
$28,029 in cash.





On June
30, 2010, the Company entered into an Amendment to the Registration Rights
Agreement (the “Amendment”) to the Registration Rights Agreement dated May 12,
2008 among the Company, and various investors holding a majority of the
registrable securities, as defined in the Registration Rights Agreement. 
In connection with the Amendment, the liquidated damages provisions were deleted
and the Company agreed to extend the expiration date of the Y warrants held by
various investors holding a majority of the registrable securities one year to
May 31, 2014.  The resulting modification was considered to be a
cancellation of the original warrant agreements and the issuance of new warrant
agreements. The accounting impact was to record $308,007 of expense for the
difference in the fair value of the new warrant agreements and the fair value of
the original warrant agreements immediately prior to the modification based on
the Black-Scholes option pricing model. The Company recorded a non-cash loss on
settlement of registration rights penalty of $111,497 in the consolidated
statement of operations for the year ended June 30, 2010.





16. Income
Taxes




The
provision for income taxes consists of the following for the years ended June
30, 2010 and 2009:




2010
                                              
                                              
                                              2009Current:Federal
                                              
                                              $
                                              -
                                              
                                              
                                              $
                                              -State
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -Foreign
                                              
                                              
                                              -
                                              
                                              
                                              
                                              --
                                              
                                              
                                              
                                              -Deferred:Federal
                                              
                                              
                                              (2,711,826
                                              )
                                              
                                              
                                              (3,846,931
                                              )State
                                              
                                              
                                              (628,919
                                              )
                                              
                                              
                                              (893,751
                                              )Foreign
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -(3,340,745
                                              )
                                              
                                              
                                              (4,740,682
                                              )Other:Change
      in valuation allowance
                                              
                                              
                                              3,340,745
                                              
                                              
                                              
                                              4,740,682Income
      tax expense
                                              
                                              $
                                              -
                                              
                                              
                                              $
                                              -


95


SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Consolidated Financial Statements




16. Income Taxes,
continued




A
reconciliation of the statutory rate and the effective tax rate for the years
ended June 30, 2010 and 2009 is as follows:




2010
                                
                                
                                2009Statutory
      rate
                                
                                
                                35.00
                                %
                                
                                
                                35.00
                                %Permanent
      differences
                                
                                
                                (0.46
                                )%
                                
                                
                                (0.64
                                )%State
      income taxes—net of federal benefit
                                
                                
                                4.80
                                %
                                
                                
                                4.80
                                %Change
      in valuation allowance
                                
                                
                                (39.34
                                )%
                                
                                
                                (39.16
                                )%0.00
                                %
                                
                                
                                0.00
                                %




Income
taxes payable consists of the following at June 30, 2010 and 2009:




2010
                        
                        
                        2009Current:Federal
                        
                        $
                        -
                        
                        
                        $
                        -State
                        
                        
                        -
                        
                        
                        
                        -Income
      taxes payable
                        
                        $
                        -
                        
                        
                        $
                        -




Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes. Components of the Company's deferred
tax assets and liabilities at June 30, 2010 and 2009 were as
follows:






2010
                                          
                                          
                                          2009Deferred
      tax assets:Bad
      debt reserves
                                          
                                          $
                                          181,407
                                          
                                          
                                          $
                                          348,878Allowance
      for sales returns and price protection
                                          
                                          
                                          489,705
                                          
                                          
                                          
                                          1,937,634Net
      operating loss carryforwards
                                          
                                          
                                          8,474,067
                                          
                                          
                                          
                                          2,019,608Share
      based compensation
                                          
                                          
                                          345,667
                                          
                                          
                                          
                                          295,817Accrued
      expenses and other
                                          
                                          
                                          -
                                          
                                          
                                          
                                          22,587Other
      intangibles
                                          
                                          
                                          99,032
                                          
                                          
                                          
                                          71,874Other
                                          
                                          
                                          230
                                          
                                          
                                          
                                          -Foreign
      currency fluctuations
                                          
                                          
                                          201,905
                                          
                                          
                                          
                                          -A
      Acquired game sequel titles not currently deductible
                                          
                                          
                                          455,430
                                          
                                          
                                          
                                          1,286,532$
                                          10,247,443
                                          
                                          
                                          $
                                          5,982,930Less—valuation
      allowance
                                          
                                          
                                          (8,956,048
                                          )
                                          
                                          
                                          (5,615,303
                                          )Net
      deferred tax assets
                                          
                                          $
                                          1,291,395
                                          
                                          
                                          $
                                          367,627Deferred
      tax liabilities:Royalty
      advances
                                          
                                          $
                                          683,401
                                          
                                          
                                          $
                                          -Depreciation
      and amortization
                                          
                                          
                                          86,069
                                          
                                          
                                          
                                          61,703Prepaid
      and accrued expenses
                                          
                                          
                                          83,411
                                          
                                          
                                          
                                          42,956Amortization
      of goodwill
                                          
                                          
                                          438,514
                                          
                                          
                                          
                                          199,176Foreign
      currency fluctuations
                                          
                                          
                                          -
                                          
                                          
                                          
                                          63,792Net
      deferred tax liabilities
                                          
                                          $
                                          1,291,395
                                          
                                          
                                          $
                                          367,627Net
      deferred tax assets
                                          
                                          $
                                          -
                                          
                                          
                                          $
                                          -




96


As of
June 30, 2010 and 2009, the Company has recorded valuation allowances for
certain tax attributes and other deferred tax assets. At this time, sufficient
uncertainty exists regarding the future realization of these deferred tax assets
though future taxable income. If in the future the Company believes that it is
more likely than not that these deferred tax benefits will be realized, the
valuation allowances will be reversed.




At June
30, 2010, the Company had federal and state net operating loss carryforwards of
approximately $17,311,907 which will expire at various dates beginning in 2026,
if not utilized.




The
operations of the Company in the United Kingdom (“UK”) are subject to income tax
by the UK. However, because of the history of losses in the UK operations, the
Company has not paid any tax to the UK, and at June 30, 2010 and 2009, the
Company had foreign net operating loss carryforwards of approximately $3,973,000
and $765,000, respectively.




The
Company does not have any significant unrecognized tax benefits. The
Company's policy is to recognize interest and penalties accrued on any
unrecognized tax benefits as a component of income tax expense.  The
Company did not have any material accrued interest or a penalty associated with
any unrecognized tax benefits, nor was any material interest expense recognized
during the year ended June 30, 2010.





The
Company files income tax returns in the U.S. federal jurisdiction, various state
jurisdictions and the UK.  The tax years 2006 through 2009 remain open
to examination by the major taxing jurisdictions to which the Company is
subject, including U.S. and non-U.S. locations. The Company does not believe
there will be any material changes in its unrecognized tax positions over the
next twelve months.





17. Stock-based
Compensation




In May
2008, the Company’s board of directors and its shareholders approved the 2008
Equity Incentive Compensation Plan (the “2008 Plan”) for the grant of stock
awards, including restricted stock and stock options, to officers, directors,
employees and consultants.  The 2008 Plan expires in May 2018. Shares
available for future grant as of June 30, 2010 and 2009 were 919,372 and
2,924,200, respectively, under the 2008 Plan.




Stock
awards and shares are generally granted at prices which the Company’s board of
directors believes approximates the fair market value of the awards or shares at
the date of grant. Individual grants generally become exercisable ratably over a
period of three years from the date of grant. The contractual terms of the
options range from three to ten years from the date of grant.




The
Company uses the Black-Scholes option pricing model to determine the fair value
of stock-based compensation to employees and non-employees. The determination of
fair value is affected by the Company’s stock price and volatility, employee
exercise behavior, and the time for the shares to vest.




The
assumptions used in the Black-Scholes option pricing model to value the
Company’s option grants were as follow:




For the year ended
                        June 30, 2010
                      
                      For the year ended
                        June 30, 2009Risk-free
      interest rate
                      
                      2.20
      – 2.97%
                      
                      1.65
      – 4.01%Weighted-average
      volatility
                      
                      156
      – 166%
                      
                      58
      – 112%Expected
      term
                      
                      5.5
      – 9.0 years
                      
                      5-10
      yearsExpected
      dividends
                      
                      0.0%
                      
                      0.0%Estimated
      forfeiture rate
                      
                      5.0%
                      
                      5.0%


97


The
following table summarizes the stock-based compensation expense resulting from
stock options and restricted stock in the Company’s consolidated statements of
operations:




For the year ended
                          June 30, 2010
                        
                        
                        For the year ended
                          June 30, 2009Sales
      and marketing
                        
                        $
                        95,709
                        
                        
                        $
                        92,299General
      and administrative
                        
                        
                        594,997
                        
                        
                        
                        649,319Total
      stock-based compensation expense
                        
                        $
                        690,706
                        
                        
                        $
                        741,618




As of
June 30, 2010, the Company’s unrecognized stock-based compensation for stock
options issued to employees and non-employee directors was approximately
$585,573 and will be recognized over a weighted average of 1.7 years. The
Company estimated a 5.0% forfeiture rate related to stock-based compensation
expense calculated for employees and non-employee directors.




The
following table summarizes the Company’s stock option activity for employees,
non-employee directors, and non-employees for the year ended June 30,
2010:




Options
                      
                      
                      Weighted-
                        Average
                        Exercise
                        Price
                      
                      
                      Weighted-
                        Average
                        Remaining
                        Contractual
                        Term
                        (in years)
                      
                      
                      Aggregate
                        Intrinsic
                        ValueOutstanding
      as of June 30, 2009
                      
                      
                      1,960,300
                      
                      
                      $
                      1.69
                      
                      
                      
                      -
                      
                      
                      $
                      -Activity
      for the year ended June 30, 2010Granted
                      
                      
                      1,207,000
                      
                      
                      
                      0.46
                      
                      
                      
                      -
                      
                      
                      
                      -Exercised
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Forfeited,
      cancelled or expired
                      
                      
                      (285,172
                      )
                      
                      
                      1.78
                      
                      
                      
                      -
                      
                      
                      
                      -Outstanding
      as of June 30, 2010
                      
                      
                      2,882,128
                      
                      
                      $
                      1.16
                      
                      
                      
                      8.81
                      
                      
                      $
                      81,000Exercisable
      as of June 30, 2010
                      
                      
                      998,058
                      
                      
                      $
                      1.76
                      
                      
                      
                      8.31
                      
                      
                      $
                      -Exercisable
      and expected to be exercisable
                      
                      
                      2,711,942
                      
                      
                      $
                      1.20
                      
                      
                      
                      8.78
                      
                      
                      $
                      70,465




Included
in the above table are options to purchase 710,000 shares of common stock
granted to non-employees.  The options were granted at prices ranging
from $0.81 to $2.30 per share and vest over a 36 month period.




The
aggregate intrinsic value represents the total pre-tax intrinsic value based on
the Company’s closing stock price ($0.43 per share) as of June 30, 2010, which
would have been received by the option holders had all option holders exercised
their options as of that date.




The
weighted average fair value of stock options granted to employees and
non-employee directors during the year ended June 30, 2010 was $0.46 per
share.




The
following table summarizes the Company’s restricted stock activity for the year
ended June 30, 2010:




Shares
                      
                      
                      Weighted-
                        Average
                        Grant Date
                        Fair ValueOutstanding
      as of June 30, 2009
                      
                      
                      115,500
                      
                      
                      $
                      2.14Activity
      for the year ended June 30, 2010Granted
                      
                      
                      1,085,000
                      
                      
                      
                      0.37Vested
                      
                      
                      113,500
                      
                      
                      
                      2.16Forfeited,
      cancelled or expired
                      
                      
                      2,000
                      
                      
                      
                      1.20Outstanding
      as of June 30, 2010
                      
                      
                      1,085,000
                      
                      
                      $
                      0.37Vested
      as of June 30, 2010
                      
                      
                      113,500
                      
                      
                      $
                      2.16


98


As of
June 30, 2010, the Company’s unrecognized stock-based compensation for
restricted stock issued to employees and non-employee directors was
approximately $283,734 and will be recognized over a weighted average of 2.34
years.





18. Employee Savings
Plan




The
Company maintains an Employee Savings Plan (the “ Plan”) which
qualifies as a deferred salary arrangement under Section 401(k) of the Internal
Revenue Code. The Plan is available to all United States employees who meet the
eligibility requirements. Under the Plan, participating employees may elect
to defer a portion of their pre tax earnings, up to the maximum amount
allowed by the Internal Revenue Service. The Company currently does not match
employee contributions.




19. Restructuring




The
Company implemented an organizational restructuring as a result of the Gamecock
acquisition described in Note 2. This organizational restructuring is to
integrate different operations to create a streamlined organization within the
Company.




The
primary goals of the organizational restructuring were to rationalize the title
portfolio and consolidate certain corporate functions so as to realize the
synergies of the Gamecock acquisition.




Upon the
consummation of the Gamecock acquisition, the Company has commenced the
organizational restructuring activities, focusing first on North American and
European staff as well as redundant premises.  The Company
communicated to the North America and United Kingdom redundant employees and
ceased use of certain offices under operating lease agreements. The following
table details the amount of restructuring reserves included in accrued expenses
and other current liabilities in the consolidated balance sheets at June 30,
2010 and 2009:




FacilitiesSeverance(1)
                        
                        
                        Costs(1)
                        
                        
                        TotalRestructuring
      charges (charged to expense)
                        
                        $
                        562,761
                        
                        
                        $
                        76,449
                        
                        
                        $
                        639,210Utilization
      (cash paid or otherwise settled) (2)
                        
                        
                        529,120
                        
                        
                        
                        76,449
                        
                        
                        
                        605,569Balance
      at June 30, 2009
                        
                        $
                        33,641
                        
                        
                        $
                        -
                        
                        
                        $
                        33,641Restructuring
      charges (charged to expense)
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -Utilization
      (cash paid or otherwise settled) (2)
                        
                        
                        33,641
                        
                        
                        
                        -
                        
                        
                        
                        33,641Balance
      at June 30, 2010
                        
                        $
                        -
                        
                        
                        $
                        -
                        
                        
                        $
                        -




(1)
            Accounted for in accordance with
      ASC Topic 420.


(2)
            Utilization represents the amount
      of cash paid to settle restructuring liabilities
      incurred.


99


20. Contingencies





On
October 27, 2008, Gamecock was served with a demand for arbitration by a
developer alleging various breaches of contract related to a publishing
agreement entered into between Gamecock and the developer on December 12, 2007.
The developer is seeking an award of $4,910,000, termination of the agreement,
exclusive control of the subject videogame, and discretionary interest and
costs. Gamecock has responded stating that the developer’s attempts to terminate
the publishing agreement constitute wrongful termination of the agreement and
breach of the agreement. Gamecock has also filed a counterclaim against the
developer seeking the return of approximately $5.9 million in advances on
royalties in the event the publishing agreement is terminated.  The
developer has filed a supplemental demand for arbitration concerning royalty
payments due under a separate publishing agreement and is seeking an award of
$41,084.  An arbitration scheduled for January 2010 has been put on hold
pending possibility of settlement.  As of June 30, 2010, the Company
believes it has accrued sufficient amounts to cover potential losses
related to this matter.  The Company’s management currently believes that
resolution of this matter will not have a material adverse effect on the
Company’s consolidated financial position or results of operations. However,
legal issues are subject to inherent uncertainties and there exists the
possibility that the ultimate resolution of this matter could have a material
adverse effect on the Company’s consolidated financial position and the results
of operations in the period in which any such effect is recorded.





On March
12, 2009, the Company, Gamecock, SouthPeak Interactive, Ltd. and Gamecock Media
Europe, Ltd. were served with a complaint by a videogame distributor alleging a
breach of contract and other claims related to a publishing and distribution
agreement, or the Distribution Agreement, entered into between
Gamecock Media Europe, Ltd. and the videogame distributor in January 2008.
Judgment in the amount of $4,590,000 was obtained , most of which was
assessed against Gamecock.   The Company thereafter acquired a claim
against CDV giving the Company a claimed right of set-off against CDV which
allowed the Company to eliminate the judgment as a liability in the year ended
June 30, 2010.  CDV subsequently went into receivership and an agreement
among the Company, the receiver and other parties confirmed the elimination of
the judgment as a liability (see Note 24).





In February
2010, the Company, SouthPeak Interactive, L.L.C., and Gamecock were served with
a complaint by TimeGate Studios, Inc., or TimeGate, alleging various breach of
contract and other claims related to a publishing agreement, or the Publishing
Agreement, entered into between Gamecock and TimeGate in June 2007. 
TimeGate is seeking the return of all past and future revenue generated from the
videogame related to the Publishing Agreement, an injunction against the Company
and its subsidiaries, damages to be assessed, and discretionary interest and
costs. Based upon the current status of this claim, the Company is of the
opinion that it has limited or no exposure in connection with this
claim.




On May
10, 2010, SouthPeak Interactive, L.L.C. and Melanie Mroz were served with a
complaint by Spidermonk Entertainment, LLC or Spidermonk, alleging various
breach of contract and other claims related to a publishing agreement, or the
Publishing Agreement, entered into between Southpeak and Spidermonk in November,
2007.  Spidermonk is seeking the unpaid milestone payments related to the
development of the game “Roogoo” videogame as well as other highly speculative
damages related to the poor sales performance of this game. The Company has no
estimate at this time of its potential exposure and cannot, at this time,
predict the outcome of this matter. The Company and its subsidiaries intend to
vigorously defend all claims.





Other
than the foregoing, the Company is engaged in litigation incidental to the
Company’s business to which the Company is a party.  While the Company
cannot predict the ultimate outcome of these various legal proceedings, it is
management’s opinion that, individually, the resolution of these matters should
not have a material effect on the consolidated financial position or results of
operations of the Company. As of June 30, 2010, the Company has accrued an
aggregate amount of $1,781,518 related to such matters. The Company expenses
legal costs as incurred in connection with a loss
contingency.





On August
26, 2009, the Company was notified that the SEC was conducting a non-public,
fact-finding investigation regarding certain matters underlying the amendment of
its Form 10-Q, and the restatement of its financial statements, for the period
ended March 31, 2009, and the termination of its former chief financial
officer.  The Company has provided the SEC with the documents requested and
has cooperated in all respects with the SEC’s investigation.





On
September 3, 2010,  the Company, Terry Phillips, our chairman, and
Melanie Mroz, our CEO,  received Wells Notices from the staff of the
Securities and Exchange Commission advising that the staff will recommend
to the Securities and Exchange Commission that cease and desist orders issue for
alleged violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the
Securities and Exchange Act and Rules 12b-20 and 13a-13 adopted under this
act.  In addition, the staff has alleged violations by Mr. Phillips
and Ms. Mroz of Rule 13b-2 and Rule 13a-14 by Ms. Mroz. These alleged violations
result from the facts underlying the need to file an amended Form 10Q/A for the
fiscal quarter ended March 31, 2009.


100


Legal
proceedings have been threatened by the Company’s former CFO against the Company
in connection with allegations of discrimination and retaliation against a
whistle blower and wrongful termination. The claim seeks an undisclosed amount
in lost wages in addition to certain employee benefits and punitive
damages.  The Company believes this claim is without merit and intends
to defend this action vigorously.





From time
to time, the Company is subject to various claims and legal proceedings. If
management believes that a loss arising from these matters is probable and can
reasonably be estimated, the Company would record the amount of the loss, or the
minimum estimated liability when the loss is estimated using a range, and no
point within the range is more probable than another. As additional information
becomes available, any potential liability related to these matters is assessed
and the estimates are revised, if necessary.





21. Gain on Settlement of Trade
Payables





The gain
on the settlement of trade payables at less than recorded values results from
negotiations with various unsecured creditors for the settlement and payment of
the trade payable at amounts less than that the recorded liability. For the year
ended June 30, 2010, the Company’s gain on settlement of trade payables was as
follows:





Net Trade
                            Payables
                            Settled
                          
                          
                          Other Assets
                            Acquired/
                            Liabilities
                            Assumed
                          
                          
                          Payments
                            in Cash
                          
                          
                          Payments
                            in Equity
                          
                          
                          Forgiveness
                            of DebtVendor
      1(1)
                          
                          $
                          6,418,334
                          
                          
                          $
                          (1,422,334
                          )
                          
                          $
                          (2,000,000
                          )
                          
                          $
                          -
                          
                          
                          $
                          2,996,000Vendor
      2(2)
                          
                          
                          250,000
                          
                          
                          
                          -
                          
                          
                          
                          (50,000
                          )
                          
                          
                          (104,500
                          )
                          
                          
                          95,500Vendor
      3
                          
                          
                          232,347
                          
                          
                          
                          -
                          
                          
                          
                          (67,358
                          )
                          
                          
                          -
                          
                          
                          
                          164,989Vendor
      4
                          
                          
                          49,384
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          49,384Vendor
      5
                          
                          
                          785,549
                          
                          
                          
                          (239,051
                          )
                          
                          
                          (600,000
                          )
                          
                          
                          -
                          
                          
                          
                          (53,502
                          )Vendor
      6
                          
                          
                          11,250
                          
                          
                          
                          -
                          
                          
                          
                          (5,625
                          )
                          
                          
                          -
                          
                          
                          
                          5,625Total
                          
                          $
                          7,746,864
                          
                          
                          $
                          (1,661,385
                          )
                          
                          $
                          (2,722,983
                          )
                          
                          $
                          (104,500
                          )
                          
                          $
                          3,257,996




(1)
            In
      connection with this settlement agreement, the Company received inventory
      valued at $135,276, assumed the vendor’s future liability for price
      protection, returns, and defective merchandise, for games previously sold
      by or held by the Company, estimated to be $306,248, and recorded an
      inventory write-down, for inventory currently held by the Company, in the
      amount of $1,251,362 as a result of a reduction to a lower of cost or
      market value.  The reduction in inventory is required as the Company
      is prohibited from any future inventory returns and is completely
      responsible for the final disposition of
  inventory.




(2)
            Consists
      of 175,000 shares of common stock, which were valued based on the fair
      market value of the Company’s common stock on the settlement date and
      150,000 warrants to purchase common stock, which were valued on the
      settlement date, at $0.30 per share using the Black-Scholes option pricing
      model with assumptions of 3.57 years expected term (equivalent to
      contractual term), volatility of 170.76%, 0% dividend yield, 2.35%
      risk-free interest rate, and stock price of $0.34 per
    share.




22. Distribution
Revenues




The
Company has an arrangement pursuant to which it distributes videogames
co-published with another company for a fee based on the gross sales of the
videogames.  Under the arrangement, the Company bears the inventory
risk as the Company purchases and takes title to the inventory, warehouses the
inventory in advance of orders, prices and ships the inventory and invoices its
customers for videogame shipments.  Also under the arrangement, the
Company bears the credit risk as the supplier does not guarantee returns for
unsold videogames and the Company is not reimbursed by the supplier in the event
of non-collection.


101


The
Company records the gross amount of revenue under the arrangement as it is not
acting as an agent for the principal in the arrangement as defined by ASC Topic
605, Revenue
Recognition, Subtopic 45, Principal Agent
Considerations.




On
February 23, 2010, the Company issued to the videogame publisher 3,000,000
shares of common stock, valued at $1,020,000, based on the fair market
value of the Company’s common stock on the date the agreement was executed by
the parties. The Company has capitalized such payment to the videogame publisher
and the amount will be marked to market on a quarterly basis.





23. Purchase of Videogame
Development Contract




On March
31, 2010, the Company purchased all of the outstanding shares of stock of IRP
GmbH (“IRP”).  IRP’s sole asset is a videogame development
contract.  In connection with its purchase of IRP, the Company also
obtained a commitment from the former shareholders of IRP to assign to the
Company, at its request, any videogame distribution or development contracts and
intellectual property rights related to videogames obtained from CDV Software
Entertainment AG and its affiliates that revert to the former shareholders of
IRP or any of their affiliates.




As a
condition of any assignment of videogame distribution or development contracts
or intellectual property rights, the Company agreed to reimburse any development
funds which the former shareholders of IRP advanced and to assume responsibility
for meeting future obligations associated with any related
videogames.





The
Company purchased the shares of IRP and the commitment for future assignments
from the former shareholders of IRP in exchange for 10,000,000 shares of the
Company’s common stock (which were valued at $3,000,000 based on the fair market
value of the Company’s common stock on the acquisition date), $1,200,000 in cash
paid over the next eight months and payment of 10% of the net receipts from
sales of the IRP videogame. In addition, the Company granted the former IRP
shareholders certain customary piggyback registration rights with respect to the
shares of common stock issued to them.




The
purchase of the videogame development contract was accounted for as an asset
acquisition.  The total purchase price of $4.2 million was allocated
to the videogame development contract.  No other significant assets or
liabilities were acquired in this transaction.





24. Legal Settlement with a
Videogame Distributor





On March
12, 2009, the Company, Gamecock, SouthPeak Interactive, Ltd. and Gamecock Media
Europe, Ltd. were served with a complaint by a videogame distributor alleging a
breach of contract and other claims related to a publishing and distribution
agreement, or the Distribution Agreement, entered into between
Gamecock Media Europe, Ltd. and the videogame distributor in January 2008. The
videogame distributor is seeking the return of $4,590,000 in advances, an
injunction against the Company and its subsidiaries, approximately $650,000 in
specified damages, further damages to be assessed, and discretionary interest
and costs.  Gamecock Media Europe, Ltd. has filed a counterclaim against
the videogame distributor for $950,000 and discretionary interest and costs,
resulting from videogame sales and the achievement of a milestone under the
Distribution Agreement.  The case was heard in the United Kingdom in July
2009 and closing submissions were made to the court on or about July 22,
2009.  On November 20, 2009, the court issued its ruling in which some of
the videogame distributer’s claims were upheld and some were denied. 
Additionally, Gamecock Media Europe, Ltd.’s counterclaim was
dismissed.




As part
of the court proceedings between the Company and the videogame distributor, the
Company agreed (to avoid further costly hearings) to pay 35% of certain European
sales into an escrow account pending the final resolution of the case. 
Legal expenses associated with this complaint have been expensed as
incurred.  As a result of the court’s ruling, the Company recorded
accrued litigation costs of $4,308,035 for this matter. Additionally, the
Company recorded a loss of $2,898,820 which is included as litigation costs
within the accompanying consolidated statements of operations. This amount
represents the full amount of the judgment against Gamecock and its subsidiary.
Of this judgment, $555,332 represents the judgment liability of the
Company.  The amounts held in escrow were approximately $798,000 and
were released to the videogame distributor in January 2010 (see Note
25).


102


25.
Purchase and
Assignment of Repayment Claim




On March
31, 2010, pursuant to a Sale and Assignment Agreement between the Company and
one of the former shareholders of IRP, the Company acquired a repayment claim
against CDV Finance Schweiz, AG, of €3,700,000 (approximately USD $5.0
million), plus interest accrued thereon after March 31, 2010 (the
“Repayment Claim”), for approximately $500,000 in cash paid over the next eight
months.  The Repayment Claim is a part of a larger claim held by one
of the former shareholders of IRP against CDV Finance Schweiz, AG,
represented by a promissory note in the principal amount of approximately
€4,385,000 (approximately USD $6.0 million), (the “Note”). CDV Software
Entertainment AG, has assumed joint and several liability to pay the Note,
including the Repayment Claim.




In the
opinion of management, after consultation with legal counsel, the Company has
the legal right to set-off its outstanding accrued litigation costs with
CDV Software Entertainment AG under enforceable arrangements.  Because
a legal right to set-off exists, the Company is accounting for the Repayment
Claim as a settlement of its outstanding accrued litigation costs with CDV
Software Entertainment AG.  Accordingly, for the year ended June 30,
2010, the Company has recognized a gain on extinguishment of accrued litigation
costs of $3,249,610 in the accompanying consolidated statements of
operations.




26. Subsequent
Events




The
Company has evaluated subsequent events through October 13, 2010, which is the
date the Company filed its Annual Report on Form 10-K for the year ended June
30, 2010 with the Securities and Exchange Commission. With the exception of the
items listed below, there are no further subsequent events for
disclosure.





Subsequent
to June 30, 2010, the Company entered into agreements with two vendors to settle
outstanding payable balances.  Trade payables of approximately
$1,005,015 were extinguished in exchange for payments in cash of $502,004,
resulting in a gain of $503,011.





On July
7, 2010, the Company entered into a Factoring Agreement with Rosenthal &
Rosenthal, Inc..  Under the Factoring Agreement, the Company has agreed to
sell receivables arising from sales of inventory to Rosenthal &
Rosenthal.  In connection with the execution of the Factoring Agreement,
each of the Company, its subsidiaries, Gone Off Deep LLC, SouthPeak Interactive
Ltd, and Vid Sub, LLC, and the chairman, Terry Phillips, have executed
guarantees in favor of Rosenthal & Rosenthal.  In addition, the
Company, Gone Off Deep and Vid Sub each granted to Rosenthal & Rosenthal a
security interest against all their respective assets.




Under the
terms of the Factoring Agreement, the Company is selling all of its receivables
to Rosenthal & Rosenthal.  For the approved receivables, Rosenthal
& Rosenthal will assume the risk of collection. The Company has agreed to
pay Rosenthal & Rosenthal a commission of .60% of the amount payable under
all of the Company’s invoices to most of the Company’s customers against a
minimum commission of $30,000 multiplied by the number of months in a contract
period, with the first period being 12 months and the second 7
months.  All payments received by Rosenthal & Rosenthal are
payable to the Company after amounts due to Rosenthal & Rosenthal are
satisfied.  Under the Factoring Agreement, the Company has the right
to borrow against payments due us at the rate of 65% of credit approved
receivables.  The borrowing rate against non-credit approved
receivables is subject to negotiation. The interest rate on borrowings is equal
to the greater of prime plus 1.5% per annum or 6.5% per annum.  A
$10,000,000 loan cap applies against the Company’s borrowings, which is subject
to an increase of up to $3,000,000 if shareholders’ equity increases.  The
initial term of the Factoring Agreement ends on February 28, 2012.





As of
July 12, 2010, the Company repaid in full the entire outstanding balance
under the SunTrust line of credit. Pursuant to the loan agreement, the Company
had a $8.0 million revolving line of credit facility with SunTrust that matured
on November 30, 2010.  The revolving credit line was collateralized by
gross accounts receivable, personal guarantees, and a pledge of personal
securities and assets by two Company shareholders, one of whom is the
Company’s chairman, and certain other affiliates. As a result of such repayment,
(i) the loan agreement has automatically terminated, (ii) SunTrust’s
lien or security interest in the Company’s assets has been terminated, and
(iii) all obligations of the Company under the loan agreement have been
satisfied in full.


103


On July
16, 2010, the Company entered into a Securities Purchase Agreement with CNH
Diversified Opportunities Master Account, L.P., CNH CA Master Account, L.P., AQR
Diversified Arbitrage Fund and Terry Phillips, the Company’s chairman, for the
sale of $5,500,000 of senior secured convertible notes and
warrants.  Mr. Phillips’ Note was issued in exchange for a junior
secured convertible note originally issued to him on April 30, 2010 (see Note
9).  The Company received $5.0 million in cash for $5.0 million of the
senior secured convertible notes and exchanged a $500,000 prior junior secured
convertible note for $500,000 of the senior secured convertible
notes.





On August
31, 2010, the Company entered into an Amended and Restated Securities Purchase
Agreement (the “Amended Purchase Agreement”), pursuant to which it sold an
aggregate of $2.0 million of a new series of senior secured convertible
promissory notes (the “Additional Notes”) to AQR Opportunistic Premium Offshore
Fund, L.P., Advanced Series Trust, solely on behalf of the AST Academic
Strategies Asset Allocation Portfolio, and Terry Phillips, SouthPeak’s chairman
(collectively, the “Additional Note Buyers”).  The Company received
$2.0 million in cash for $2.0 million of the Additional Notes, of which $200,000
was paid by Terry Phillips, the Company’s chairman.





On
September 20, 2010, the Company entered into a Master Purchase Order Assignment
Agreement with Wells Fargo Bank, National Association (“Wells
Fargo”).   In connection with the execution of this Agreement,
each of the Company, its subsidiaries, Gone Off Deep, LLC and Vid Sub, LLC, and
the chairman, Terry Phillips (the “Guarantors”), have executed a Guaranty in
favor of, and, along with the Company, have entered into a Security Agreement
and Financing Statement with, Wells Fargo.





Under the
terms of the Agreement, the Company may request that Wells Fargo accept the
assignment of customer purchase orders and request that Wells Fargo purchase the
required materials to fulfill such purchase orders.  If accepted,
Wells Fargo, in turn, will retain the Company to manufacture, process, and ship
the ordered goods. Wells Fargo’s aggregate outstanding funding under the
agreement shall not exceed $2,000,000.




Upon
receipt of customer payments by Wells Fargo, the Company will be paid a fee for
its services, with such fee calculated pursuant to the terms of the agreement.
Also from such customer payments, Wells Fargo shall be entitled to receive the
following: (1) a transaction initiation and set-up fee equal to 1.5% of the
aggregate amount outstanding on all amounts (including letters of credit)
advanced by Wells Fargo; (2) a daily maintenance fee equal to 0.05% of all
amounts (including letters of credit) advanced by Wells Fargo which remain
outstanding for more than 30 days; and (3) a product advance fee equal to (a)
the prime rate plus 2%, divided by 360, multiplied by (b) (i) the aggregate
amount outstanding on all amounts (including letters of credit) advanced by
Wells Fargo on account of purchases of products or other advances made in
connection with a customer purchase order, multiplied (ii) by the number of days
from the earlier of (A) the date on which any such letter of credit or purchase
order or financial accommodation is negotiated into cash, or (B) the date funds
are advanced by other than issuing a letter of credit or purchase
order.




In
addition, Wells Fargo shall be entitled to a commitment fee of
$120,000 to be paid on the earlier of (a) September 20, 2011 or (b) the date on
which the Agreement is terminated. Wells Fargo shall also be entitled to
additional commitment fees for each renewal of the Agreement, and such fees
shall be paid on the earlier of (a) the first anniversary of the beginning of
each renewal term or (b) the date on which the Agreement is
terminated.




Subject
to the rights of senior lenders, the Company and the Guarantors have granted
security interests in their assets to Wells Fargo under the Security Agreement
and Financing Statement to secure the LLC’s obligations under the Agreement and
the Guarantors’ guarantees of such obligations.




On
September 2, 2010, the Company entered into a $500,000 settlement agreement with
a vendor whereby the Company agreed to immediately pay $227,783
as a partial payment of the total amount due.  The amount payable was
already recorded on the Company’s consolidated balance sheet at June 30,
2010.  Pursuant to the settlement agreement, the remaining balance of
$272,217 plus interest is payable in six monthly installments.  The
October 2010 payment has been made by the Company and $250,000 plus interest
remains payable.




To secure
the Company’s obligation to make the settlement payments, the Company’s chairman
was required to deposit $750,000 in shares of the Company’s stock in an escrow
to be administered by the vendor’s attorneys.




On
September 23, 2010, the Company entered into a $138,404 settlement agreement
with a vendor whereby the Company agreed to immediately pay
$5,000 as a partial payment of the total amount due.  The amount
payable was already recorded on the Company’s consolidated balance sheet at June
30, 2010.  Pursuant to the settlement agreement, the remaining balance
of $133,404 plus interest is payable in installments pursuant to the terms of
the settlement agreement.  The October 2010 payment has been made by
the Company and $113,404 plus interest remains payable.




In the
normal course of business the Company executes contracts with third parties for
the development of games.  During the period from July 1, 2010 through
October 13, 2010, the Company executed agreements with such developers for a
commitment to pay royalties of approximately $151,000
(£100,000).


104


Index
to Exhibits





Exhibit
                Number
              
              Description2.1(1)
              
              Membership
      Interest Purchase Agreement, dated as of May 12, 2008, among the
      Registrant, SouthPeak Interactive, LLC, and the members of SouthPeak
      Interactive, L.L.C.3.1(1)
              
              Amended
      and Restated Certificate of Incorporation of the Registrant, filed with
      the Secretary of State of the State of Delaware on May 12,
      2008.3.2(1)
              
              Amended
      and Restated Bylaws, dated as of May 12, 2008.3.3(1)
              
              Certificate
      of the Designations, Powers, Preferences and Rights of the Series A
      Convertible Preferred Stock (par value $.0001 per share), filed with the
      Secretary of State of the State of Delaware on May 12,
    2008.4.1(2)
              
              Specimen
      Common Stock Certificate.4.2(3)
              
              Specimen
      Class Y Warrant Certificate.4.3(2)
              
              Specimen
      Class W Warrant Certificate.4.4(2)
              
              Specimen
      Class Z Warrant Certificate.4.5(4)
              
              Form
      of Unit Purchase Option to be granted to
Representative.4.6(4)
              
              Form
      of Warrant Agreement between American Stock Transfer & Trust Company
      and the Registrant.4.7(4)
              
              Form
      of Warrant Agreement between American Stock Transfer & Trust Company
      and the Registrant.4.8(7)
              
              Warrant
      issued to Vid Agon, LLC, dated October 10, 2008.4.9(3)
              
              Form
      of Warrant issued in connection with the acquisition of Gamecock Media
      Group.4.10(8)
              
              Form
      of Warrant issued to Gamecock Media Group
Founders.4.11(9)
              
              Form
      of Warrant issued to HCFP/Brenner Securities, LLC.4.12(10)
              
              Form
      of senior secured convertible note4.13(11)
              
              Form
      of Series A Warrant issued to senior secured convertible note
      holders4.14(11)
              
              Form
      of Series B Warrant issued to senior secured convertible note
      holders10.1(1)
              
              Registrant’s
      2008 Equity Incentive Compensation Plan.10.2(1)
              
              Employment
      Agreement, dated as of May 12, 2008 between the Registrant and Terry M.
      Phillips.10.3(1)
              
              Employment
      Agreement, dated as of May 12, 2008 between the Registrant and Melanie
      Mroz.10.4(1)
              
              Purchase
      Agreement, dated as of May 12, 2008 among the Registrant, SouthPeak
      Interactive, L.L.C., and the investors set forth
  therein.10.5(1)
              
              Registration
      Rights Agreement, dated as of May 12, 2008 among the Registrant and the
      investors set forth therein.10.6(1)
              
              Form
      of Lock-Up Agreement, dated as of May 12, 2008.10.7(1)
              
              Sales
      Representative Agreement between SouthPeak Interactive, L.L.C. and
      Phillips Sales, Inc. dated July 21, 2006.10.8(1)
              
              Sales
      Representative Agreement between SouthPeak Interactive, L.L.C. and West
      Coast Sales, Inc. dated July 21, 2006.10.9(1)
              
              Lease
      Agreement, dated January 1, 2008, between Phillips Land, L.C. and
      SouthPeak Interactive, L.L.C.10.10(1)
              
              Lease
      Agreement, dated January 1, 2008, between SouthPeak Interactive, L.L.C.
      and Phillips Sales, Inc.10.11(7)
              
              Membership
      Interest Purchase Agreement, dated as of October 10, 2008, among the
      Registrant, Vid Agon, LLC and Vid Sub, LLC.10.12(12)
              
              Factoring
      Agreement between  SouthPeak Interactive, LLC and Rosenthal
      & Rosenthal dated10.13(10)
              
              Amended
      and Restated Securities Purchase Agreement between the Company and the
      purchasers of senior secured convertible notes10.14(11)
              
              Pledge
      and Security Agreement securing senior secured convertible
      notes10.15(11)
              
              Registration
      Rights Agreement dated July 19, 2010 executed in conjunction issuance of
      senior secured convertible notes10.16(13)
              
              First
      Amendment to May 12, 2008 Registration Rights Agreement dated August 17,
      201010.17(14)
              
              Master
      Purchase Order Assignment Agreement dated September 21, 2010 with Wells
      Fargo Bank, N.A.10.18(14)
              
              Security
      Agreement dated September 21,2010 for the benefit of Wells Fargo Bank,
      N.A.21.1*
              
              List
      of subsidiaries.23.1*
              
              Consent
      of Reznick Group, P.C.24.1*
              
              Power
      of Attorney (included on the signature page to this
    report).31.1*
              
              Certification
      of Chief Executive Officer pursuant to Rules 13a-14 and 15d-14 promulgated
      under the Securities Exchange Act of
1934.


105





31.2*
                
                Certification
      of Chief Financial Officer pursuant to Rules 13a-14 and 15d-14 promulgated
      under the Securities Exchange Act of 1934.32.1*
                
                Certification
      of Chief Executive Officer and Chief Financial Officer pursuant to 18
      U.S.C. Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.*
                
                Filed
      herewith(1)
                
                Incorporated
      by reference to an exhibit to the Current Report on Form 8-K of the
      Registrant filed with the Commission on May 15, 2008.(2)
                
                Incorporated
      by reference to an exhibit to the Quarterly Report on Form 10-Q of the
      Registrant filed with the Commission on June 16, 2008.(3)
                
                Incorporated
      by reference to an exhibit to the Registration Statement on Form S-1 of
      the Registrant originally filed with the Commission on October 15,
      2008.(4)
                
                Incorporated
      by reference to an exhibit to the Registration Statement on Form S-1 of
      the Registrant originally filed with the Commission on September 15,
      2005.(5)
                
                Incorporated
      by reference to an exhibit to the Current Report on Form 8-K of the
      Registrant filed with the Commission on August 14,
2008.(6)
                
                Incorporated
      by reference to an exhibit to the Annual Report on Form 10-K of the
      Registrant filed with the Commission on October 6,
2008.(7)
                
                Incorporated
      by reference to an exhibit to the Current Report on Form 8-K of the
      Registrant filed with the Commission on October 15,
  2008.(8)
                
                Incorporated
      by reference to an exhibit to the Quarterly Report on Form 10-Q of the
      Registrant filed with the Commission on February 17,
      2009.(9)
                
                Incorporated
      by reference to an exhibit to the Current Report on Form 8-K of the
      Registrant filed with the Commission on March 19, 2009.(10)
                
                Incorporated
      by reference to an exhibit to the Current Report on Form 8-K of the
      Registrant filed with the Commission on  September 3,
      2010.(11)
                
                Incorporated
      by reference to an exhibit to the Current Report on Form 8-K of the
      Registrant filed with the Commission on July 22, 2010.(12)
                
                Incorporated
      by reference to an exhibit to the Current Report on Form 8-K of the
      Registrant filed with the Commission on July 14, 2010.(13)
                
                Incorporated
      by reference to an exhibit to the Current Report on Form 8-K of the
      Registrant filed with the Commission on August 20, 2010
  .(14)
                
                Incorporated
      by reference to an exhibit to the Current Report on Form 8-K of the
      Registrant filed with the Commission on September 27,
  2010.


106