UNITED
STATES SECURITIES AND EXCHANGE COMMISSION


Washington, D.C.
20549




Form 10-Q




(Mark One)þ
            
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      the Quarterly Period Ended December 31, 2009o
            
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934For
      the Transition Period from          to





Commission
File Number 000-51869




SouthPeak
Interactive Corporation


(Exact
Name of Registrant as Specified in Its Charter)




Delaware
              (State
      or Other Jurisdiction of
              Incorporation
      or Organization)
            20-3290391
              (I.R.S.
      Employer
              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)




Not
applicable


(Former
name, former address and former fiscal year, if changed since last
report)




Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.




Yes þ   
 No  ̈




Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).




Yes  ̈   
 No  ̈




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




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


(Do not
check if a smaller reporting company)




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




Yes o   
 No þ




As of
February 11, 2010, 46,193,600 shares of common stock, par value $0.0001 per
share, of the registrant were outstanding.





TABLE
OF CONTENTS




PagePART I —
      FINANCIAL INFORMATION
                                              
                                              
                                              3Item
      1.
                                              Financial
      Statements
                                              
                                              
                                              3Condensed
      Consolidated Financial Statements (unaudited)
                                              
                                              
                                              3Condensed
      Consolidated Balance Sheets as of December 31, 2009 and June 30, 2009
      (unaudited)
                                              
                                              
                                              3Condensed
      Consolidated Statements of Operations for the three months and six months
      ended December 31, 2009 and 2008 (unaudited)
                                              
                                              
                                              4Condensed
      Consolidated Statements of Cash Flows for the six months ended December
      31, 2009 and 2008 (unaudited)
                                              
                                              
                                              5Notes
      to Condensed Consolidated Financial Statements
                                              
                                              
                                              6Report
      of Independent Registered Public Accounting Firm
                                              
                                              
                                              27Item
      2.
                                              Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                                              
                                              
                                              28Item
      3.
                                              Quantitative
      and Qualitative Disclosures about Market Risk
                                              
                                              
                                              37Item
      4T.
                                              Controls
      and Procedures
                                              
                                              
                                              37PART II —
      OTHER INFORMATION
                                              
                                              
                                              40Item
      1.
                                              Legal
      Proceedings
                                              
                                              
                                              40Item
      1A.
                                              Risk
      Factors
                                              
                                              
                                              40Item
      5.
                                              Other
      Information
                                              
                                              
                                              40Item
      6.
                                              Exhibits
                                              
                                              
                                              41SIGNATURES
                                              
                                              
                                              42


2


PART I




Item 1.Condensed Consolidated
Financial Statements




SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


CONDENSED
CONSOLIDATED BALANCE SHEETS




December 31, 2009
                
                
                June 30, 2009(Unaudited)AssetsCurrent
      assets:Cash
      and cash equivalents
                
                $
                658,609
                
                
                $
                648,311Restricted
      cash
                
                
                849,600
                
                
                
                1,245,582Accounts receivable, net of
      allowances of $6,648,613 and $7,214,984 at December 31, 2009
      and June 30, 2009, respectively
                
                
                7,327,750
                
                
                
                4,972,417Inventories
                
                
                3,710,148
                
                
                
                4,459,837Current
      portion of advances on royalties
                
                
                6,867,061
                
                
                
                8,435,415Current
      portion of intellectual property licenses
                
                
                383,571
                
                
                
                410,995Related
      party receivables
                
                
                60,842
                
                
                
                33,207Prepaid
      expenses and other current assets
                
                
                530,449
                
                
                
                573,145Total
      current assets
                
                
                20,388,030
                
                
                
                20,778,909Property
      and equipment, net
                
                
                2,778,721
                
                
                
                2,754,139Advances
      on royalties, net of current portion
                
                
                1,551,869
                
                
                
                1,556,820Intellectual
      property licenses, net of current portion
                
                
                1,726,071
                
                
                
                1,917,858Goodwill
                
                
                8,031,766
                
                
                
                7,490,065Intangible
      assets, net
                
                
                23,692
                
                
                
                43,810Other assets
                
                
                11,600
                
                
                
                11,872Total
      assets
                
                $
                34,511,749
                
                
                $
                34,553,473Liabilities
      and Shareholders’ EquityCurrent
      liabilities:Line
      of credit
                
                $
                5,310,732
                
                
                $
                5,349,953Current
      maturities of long-term debt
                
                
                63,649
                
                
                
                50,855Production
      advance payable in default
                
                
                3,755,104
                
                
                
                -Accounts
      payable
                
                
                12,056,142
                
                
                
                19,686,168Accrued
      royalties
                
                
                1,693,805
                
                
                
                414,696Accrued
      expenses and other current liabilities
                
                
                5,004,449
                
                
                
                2,419,100Accrued
      litigation costs
                
                
                4,308,035
                
                
                
                -Deferred
      revenues
                
                
                295,301
                
                
                
                2,842,640Due
      to shareholders
                
                
                -
                
                
                
                232,440Due
      to related parties
                
                
                4,400
                
                
                
                125,045Accrued
      expenses - related parties
                
                
                137,288
                
                
                
                184,766Total
      current liabilities
                
                
                32,628,905
                
                
                
                31,305,663Long-term
      debt, net of current maturities
                
                
                1,574,608
                
                
                
                1,538,956Total
      liabilities
                
                
                34,203,513
                
                
                
                32,844,619Commitments
      and contingencies
                
                
                -
                
                
                
                -Shareholders’
      equity:Preferred
      stock, $0.0001 par value; 5,000,000 shares authorized; no shares issued
      and outstanding at December 31, 2009 and June 30, 2009
                
                
                -
                
                
                
                -Series
      A convertible preferred stock, $0.0001 par value; 15,000,000 shares
      authorized; 5,653,833 and 5,953,833 shares issued and outstanding at
      December 31, 2009 and June 30, 2009, respectively; aggregate liquidation
      preference of $5,653,833 at December 31, 2009
                
                
                565
                
                
                
                595Common
      stock, $0.0001 par value; 90,000,000 shares authorized; 45,106,600 and
      44,530,100 shares issued and outstanding at December 31, 2009 and June 30,
      2009, respectively
                
                
                4,511
                
                
                
                4,453Additional
      paid-in capital
                
                
                25,675,318
                
                
                
                25,210,926Accumulated
      deficit
                
                
                (25,101,085
                )
                
                
                (23,145,800
                )Accumulated
      other comprehensive loss
                
                
                (271,073
                )
                
                
                (361,320
                )Total
      shareholders’ equity
                
                
                308,236
                
                
                
                1,708,854Total
      liabilities and shareholders’ equity
                
                $
                34,511,749
                
                
                $
                34,553,473




See notes
to condensed consolidated financial statements.


3


SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


(Unaudited)




For the three months ended
                      December 31,
                    
                    
                    For the six months ended
                      December 31,2009
                    
                    
                    2008
                    
                    
                    2009
                    
                    
                    2008Net
      revenues
                    
                    $
                    10,063,952
                    
                    
                    $
                    17,308,874
                    
                    
                    $
                    26,773,601
                    
                    
                    $
                    25,696,577Cost
      of goods sold:Product
      costs
                    
                    
                    5,149,597
                    
                    
                    
                    6,939,774
                    
                    
                    
                    8,696,283
                    
                    
                    
                    12,365,327Royalties
                    
                    
                    1,618,962
                    
                    
                    
                    1,492,259
                    
                    
                    
                    6,619,633
                    
                    
                    
                    2,301,180Intellectual
      property licenses
                    
                    
                    99,797
                    
                    
                    
                    67,517
                    
                    
                    
                    219,457
                    
                    
                    
                    111,497Total
      cost of goods sold
                    
                    
                    6,868,356
                    
                    
                    
                    8,499,550
                    
                    
                    
                    15,535,373
                    
                    
                    
                    14,778,004Gross
      profit
                    
                    
                    3,195,596
                    
                    
                    
                    8,809,324
                    
                    
                    
                    11,238,228
                    
                    
                    
                    10,918,573Operating
      expenses:Warehousing
      and distribution
                    
                    
                    320,723
                    
                    
                    
                    268,980
                    
                    
                    
                    607,234
                    
                    
                    
                    476,563Sales
      and marketing
                    
                    
                    2,215,620
                    
                    
                    
                    3,954,803
                    
                    
                    
                    5,870,676
                    
                    
                    
                    5,950,539General
      and administrative
                    
                    
                    2,973,944
                    
                    
                    
                    2,747,840
                    
                    
                    
                    6,088,712
                    
                    
                    
                    4,128,265Restructuring
      costs
                    
                    
                    -
                    
                    
                    
                    560,806
                    
                    
                    
                    -
                    
                    
                    
                    560,806Transaction
      costs
                    
                    
                    -
                    
                    
                    
                    10,295
                    
                    
                    
                    -
                    
                    
                    
                    28,675Litigation
      costs
                    
                    
                    3,075,206
                    
                    
                    
                    -
                    
                    
                    
                    3,075,206
                    
                    
                    
                    -Gain
      on settlement of trade payables
                    
                    
                    (3,256,489
                    )
                    
                    
                    -
                    
                    
                    
                    (3,256,489
                    )
                    
                    
                    -Total
      operating expenses
                    
                    
                    5,329,004
                    
                    
                    
                    7,542,724
                    
                    
                    
                    12,385,339
                    
                    
                    
                    11,144,848(Loss)
      income from operations
                    
                    
                    (2,133,408
                    )
                    
                    
                    1,266,600
                    
                    
                    
                    (1,147,111
                    )
                    
                    
                    (226,275
                    )Interest
      expense, net
                    
                    
                    508,858
                    
                    
                    
                    100,055
                    
                    
                    
                    808,174
                    
                    
                    
                    158,934Net
      (loss) income
                    
                    
                    (2,642,266
                    )
                    
                    
                    1,166,545
                    
                    
                    
                    (1,955,285
                    )
                    
                    
                    (385,209
                    )Deemed
      dividend related to beneficial conversion feature on Series A convertible
      preferred stock
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    1,142,439Net
      (loss) income attributable to common shareholders
                    
                    $
                    (2,642,266
                    )
                    
                    $
                    1,166,545
                    
                    
                    $
                    (1,955,285
                    )
                    
                    $
                    (1,527,648
                    )Basic
      income (loss) per share:
                    
                    $
                    (0.06
                    )
                    
                    $
                    0.03
                    
                    
                    $
                    (0.04
                    )
                    
                    $
                    (0.04
                    )Diluted
      income (loss) per share:
                    
                    $
                    (0.06
                    )
                    
                    $
                    0.02
                    
                    
                    $
                    (0.04
                    )
                    
                    $
                    (0.04
                    )Weighted
      average number of common shares outstanding - Basic
                    
                    
                    45,039,292
                    
                    
                    
                    35,920,100
                    
                    
                    
                    44,930,125
                    
                    
                    
                    35,920,100Weighted
      average number of common shares outstanding - Diluted
                    
                    
                    45,039,292
                    
                    
                    
                    53,188,686
                    
                    
                    
                    44,930,125
                    
                    
                    
                    35,920,100




No effect
is given for dilutive securities for loss periods.




See notes
to condensed consolidated financial statements.


4


SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(Unaudited)




For
      the six months ended
                      December
      31,2009
                    
                    
                    2008Cash flows from
      operating activities:Net
      loss
                    
                    $
                    (1,955,285
                    )
                    
                    $
                    (385,209
                    )Adjustments
      to reconcile net loss to net cash provided by (used in) operating
      activities:Depreciation
      and amortization
                    
                    
                    129,972
                    
                    
                    
                    164,909Allowances
      for price protection, returns, and defective merchandise
                    
                    
                    (531,050
                    )
                    
                    
                    3,542,272Bad
      debt expense, net of recoveries
                    
                    
                    (35,321
                    )
                    
                    
                    538,622Stock-based
      compensation expense
                    
                    
                    359,920
                    
                    
                    
                    342,505Common
      stock and warrants issued to vendor
                    
                    
                    104,500
                    
                    
                    
                    -Amortization
      of royalties and intellectual property licenses
                    
                    
                    5,443,825
                    
                    
                    
                    1,844,853Loss
      on disposal of fixed assets
                    
                    
                    4,839
                    
                    
                    
                    -Gain
      on settlement of trade payables
                    
                    
                    (3,256,489
                    )
                    
                    
                    -Changes
      in operating assets and liabilities:Accounts
      receivable
                    
                    
                    (1,788,962
                    )
                    
                    
                    (2,079,345
                    )Inventories
                    
                    
                    749,689
                    
                    
                    
                    1,559,586Advances
      on royalties
                    
                    
                    (3,651,309
                    )
                    
                    
                    (5,604,552)Intellectual
      property licenses
                    
                    
                    -
                    
                    
                    
                    (915,000
                    )Related
      party receivables
                    
                    
                    (27,635
                    )
                    
                    
                    24,673Prepaid
      expenses and other current assets
                    
                    
                    42,696
                    
                    
                    
                    (40,518
                    )Other
      assets
                    
                    
                    -
                    
                    
                    
                    (5,017
                    )Production
      advance payable
                    
                    
                    3,755,104
                    
                    
                    
                    -Accounts
      payable
                    
                    
                    (4,318,114
                    )
                    
                    
                    (5,188,640
                    )Accrued
      royalties
                    
                    
                    1,279,109
                    
                    
                    
                    (363,324
                    )Accrued
      expenses and other current liabilities
                    
                    
                    1,988,225
                    
                    
                    
                    618,998Accrued
      litigation costs
                    
                    
                    4,308,035
                    
                    
                    
                    -Deferred
      revenues
                    
                    
                    (2,547,339
                    )
                    
                    
                    (872,886
                    )Accrued
      expenses - related parties
                    
                    
                    (47,478)
                    
                    
                    
                    (4,182
                    )Total
      adjustments
                    
                    
                    1,962,217
                    
                    
                    
                    (6,437,046
                    )Net
      cash provided by (used in) operating activities
                    
                    
                    6,932
                    
                    
                    
                    (6,822,255
                    )Cash
      flows from investing activities:Purchases
      of property and equipment
                    
                    
                    (65,544
                    )
                    
                    
                    (219,666
                    )Cash
      payments to effect acquisition, net of cash acquired
                    
                    
                    -
                    
                    
                    
                    (247,542
                    )Change
      in restricted cash
                    
                    
                    395,982
                    
                    
                    
                    (1,904
                    )Net
      cash provided by (used in) investing activities
                    
                    
                    330,438
                    
                    
                    
                    (469,112
                    )Cash
      flows from financing activities:Proceeds
      from line of credit
                    
                    
                    16,557,571
                    
                    
                    
                    16,825,346Repayments
      of line of credit
                    
                    
                    (16,596,792
                    )
                    
                    
                    (14,254,607
                    )Repayments
      of long-term debt
                    
                    
                    (25,013
                    )
                    
                    
                    (12,211
                    )Net
      proceeds from (repayments of) amounts due to shareholders
                    
                    
                    (232,440
                    )
                    
                    
                    (228,998
                    )Net
      proceeds from (repayments of) amounts due to related
    parties
                    
                    
                    (120,645
                    )
                    
                    
                    10,111Proceeds
      from the issuance of Series A convertible preferred stock, net of cash
      offering costs
                    
                    
                    -
                    
                    
                    
                    1,250,281Net
      cash (used in) provided by financing activities
                    
                    
                    (417,319
                    )
                    
                    
                    3,589,922Effect
      of exchange rate changes on cash and cash equivalents
                    
                    
                    90,247
                    
                    
                    
                    (180,944
                    )Net
      increase (decrease) in cash and cash equivalents
                    
                    
                    10,298
                    
                    
                    
                    (3,882,389
                    )Cash
      and cash equivalents at beginning of the period
                    
                    
                    648,311
                    
                    
                    
                    4,095,036Cash
      and cash equivalents at end of the period
                    
                    $
                    658,609
                    
                    
                    $
                    212,647Supplemental
      cash flow information:Cash
      paid during the period for interest
                    
                    $
                    243,011
                    
                    
                    $
                    157,744Cash
      paid during the period for taxes
                    
                    $
                    -
                    
                    
                    $
                    -Supplemental
      disclosure of non-cash activities:Intellectual
      property licenses included in accrued expenses and other current
      liabilities
                    
                    $
                    -
                    
                    
                    $
                    135,000Contingent
      purchase price payment obligation related to Gamecock
      acquisition
                    
                    $
                    597,124
                    
                    
                    $
                    421,956Decrease
      in goodwill with respect to finalizing purchase price
      allocation
                    
                    $
                    55,423
                    
                    
                    $
                    -Purchase
      of vehicle through the assumption of a note payable
                    
                    $
                    73,459
                    
                    
                    $
                    -




See notes
to condensed consolidated financial statements.


5


SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




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 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, continuing to generate
positive cash flows from operations, curing the default on the production
advance payable, renewing its line of credit with SunTrust Banks, Inc.
(“SunTrust”) and/or obtaining alternative or additional financing, and the
resolution of various contingencies.  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 for in order to reduce aggregate liabilities on the
      Company’s balance sheet and on payment terms managable by the
      Company;




·
            seeking
      the renewal of its line of credit with SunTrust, and/or obtaining
      alternative or additional financing in order to address the month to month
      nature of the Company’s current line of credit;
  and




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




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.




In
November 2009, a court in the United Kingdom ruled against a subsidiary of
the Company in a dispute involving a videogame distributor (see Note 10). 
As part of the court proceedings between the Company and the videogame
distributor, the Company has escrowed $849,600 as of December 31, 2009, pending
resolution of the matter.  As a result of the court’s ruling the
Company recorded accrued litigation costs of $4,308,035 for this
matter.


6




SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




1. Summary of Significant
Accounting Policies, continued




On August
13, 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 December 31, 2009 (see Note
11).  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 14, 2009 (approximately $160,000
through December 31, 2009).




In order
to meet its working capital needs during the past fiscal year as well as
currently, the Company has been, and is, dependent on its line of credit with
SunTrust.  This line of credit matured on December 31, 2009 and has been
extended on a month to month basis.  The line of credit has been in place
since 2005 and has been extended every year thereafter. Management is currently
in discussions with SunTrust to renew the line of credit.  While management
believes the line of credit will be renewed, there are no assurances that the
line of credit will be renewed or renewed at terms that are acceptable to the
Company.  In the event the line of credit is not renewed, management plans
to pursue other financing sources which, based upon the quality of the Company’s
receivables, management believes will be available to the Company.  The
Company’s largest shareholder, who serves as the Company’s chairman, previously
committed to fund operating cash shortfalls in the absence of another source of
financing.  This commitment is no longer available. In addition,
independent of the risks associated with the month to month nature of the line
of credit, the Company has engaged an investment bank for the purpose of
potentially raising capital to fund its growth most likely through the sale of
equity securities during its fiscal year ended June 30, 2010.  However,
such capital, if needed and available, may not have terms favorable to the
Company or its current shareholders.




Additionally
and irrespective of having a credit facility or other funding in place,
management closely monitors the retail/consumer landscape and reevaluates its
sales and revenue forecasts in order to scale its expenses and game development
costs to the Company’s performance and its available capital.  This results
from the fact that the Company’s business model allows it to scale certain of
its costs in reference to its available capital and market conditions, including
funding new game development costs as well as certain operating expenses, such
as sales and marketing costs. The Company is evaluating alternatives for cost
reduction and as well as certain efficiency and cost containment measures to improve its profitability and cash flow.




Basis
of Presentation




The
accompanying unaudited condensed consolidated financial statements as of
December 31, 2009 and for the three and six month periods ended December 31,
2009 and 2008 have been prepared pursuant to the rules and regulations of the
Securities and Exchange Commission (“SEC”) and in accordance with accounting
principles generally accepted in the United States of America (“U.S. GAAP”) for
interim financial reporting. Accordingly, they do not include all of the
information and footnotes required by U.S. GAAP. In the opinion of management,
all adjustments (all of which are of a normal, recurring nature) considered for
a fair presentation have been included. Operating results for the three and six
months ended December 31, 2009 are not necessarily indicative of the results
that may be expected for the year ending June 30, 2010.




The
accounting policies followed by the Company with respect to unaudited interim
financial statements are consistent with those stated in the Company’s annual
report on Form 10-K. The accompanying June 30, 2009 financial statements were
derived from the Company’s audited financial statements. These unaudited
condensed consolidated financial statements should be read in conjunction with
the audited consolidated financial statements and the notes thereto included in
the Company’s annual report on Form 10-K for the year ended June 30, 2009 filed
with the SEC.




The
accompanying unaudited condensed 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, LLC, and Gamecock Media Europe Ltd. All intercompany accounts and
transactions have been eliminated in consolidation.


7


SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




1. Summary of Significant
Accounting Policies, continued




The
preparation of financial statements in conformity with U.S. GAAP 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 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.




Subsequent
events have been evaluated through the filing date (February 16, 2010) of these
unaudited condensed consolidated financial statements.




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. The Company maintains cash in bank accounts that, at times,
may exceed federally insured limits.  The Company has not experienced any
losses in such accounts and believes it is not exposed to any significant risks
on its cash in bank accounts.




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 four customers, Wal-Mart, GameStop, PDQ Distribution Limited, and
Solutions 2 Go, which accounted for 20%, 15%, 11%, and 10%, respectively, of
consolidated gross revenues for the six months ended December 31, 2009. 
GameStop, PDQ Distribution Limited, and Solutions 2 Go, accounted for 22%, 11%,
and 10%, respectively, of consolidated gross accounts receivable at December 31,
2009.  For the six months ended December 31, 2008, GameStop, Wal-Mart, and
Atari accounted for 18%, 17%, and 13%, 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 videogames 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 December 31, 2009 and June 30,
2009 and for the three–month and six-month periods ended December 31, 2009 and
2008 are as follows:




Cost of Goods Sold — Products
                
                
                Accounts PayableFor the
                  three
                  months
                  ended
                  December
                  31, 2009
                
                
                For the
                  three
                  months
                  ended
                  December
                  31, 2008
                
                
                For the
                  six
                  months
                  ended
                  December
                  31, 2009
                
                
                For the six
                  months
                  ended
                  December
                  31, 2008
                
                
                As of
                  December
                  31, 2009
                
                
                As of
                  June 30,
                  2009Microsoft
                
                $
                214,598
                
                
                $
                705,785
                
                
                $
                2,952,440
                
                
                $
                896,934
                
                
                $
                -
                
                
                $
                142,329Nintendo
                
                $
                3,194,743
                
                
                $
                2,912,174
                
                
                $
                4,026,539
                
                
                $
                3,737,477
                
                
                $
                -
                
                
                $
                -Sony
                
                $
                81,265
                
                
                $
                804,075
                
                
                $
                108,787
                
                
                $
                1,194,381
                
                
                $
                96,185
                
                
                $
                12,493




8


SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




1. Summary of Significant
Accounting Policies, continued




In
addition, the Company has purchased a significant amount of videogames for
resale for such platforms from a single supplier. Such purchases amounted to
$1,165,050 and $423,239 in “cost of goods sold - product costs” for the
three months ended December 31, 2009 and 2008, respectively. Such purchases
amounted to $1,165,050 and $1,959,738 in “cost of goods sold – product costs”
for the six months ended December 31, 2009 and 2008, respectively.  Amounts
included in accounts payable for this vendor at December 31, 2009 and June 30,
2009 totaled $1,600,000 and $8,652,019, respectively (see Note 12
regarding gain on settlement of trade payable related to Vendor 1).




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
December 31, 2009 and June 30, 2009, restricted cash consisted of the
following:




December
      31,
                      2009
                    
                    
                    June
      30,
                      2009Cash
      collateral for the line of credit (see Note 5)
                    
                    $
                    -
                    
                    
                    $
                    742,199Funds
      held in escrow pending resolution of litigation (see Note 10), of which
      $36,625 and $265,919 is included as a liability at December 31,
      2009 and June 30, 2009, respectively
                    
                    
                    849,600
                    
                    
                    
                    503,383Total
                    
                    $
                    849,600
                    
                    
                    $
                    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.


9


SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




1. Summary of Significant
Accounting Policies, continued




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
December 31, 2009 and June 30, 2009, accounts receivable allowances consisted of
the following:




December
      31,
                      2009
                    
                    
                    June
      30,
                      2009Sales
      returns
                    
                    $
                    1,821,643
                    
                    
                    $
                    1,294,082Price
      protection
                    
                    
                    3,932,078
                    
                    
                    
                    4,998,622Doubtful
      accounts
                    
                    
                    845,743
                    
                    
                    
                    874,645Defective
      items
                    
                    
                    49,149
                    
                    
                    
                    47,635Total
      allowances
                    
                    $
                    6,648,613
                    
                    
                    $
                    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
$3,490,606 and $7,087,766 for the three and six months ended December 31, 2009,
respectively, and $4,422,034 and $5,828,792 for the three and six months ended
December 31, 2008, respectively. Licensing fees included in inventory at
December 31, 2009 and June 30, 2009 totaled $2,108,028 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. There were no costs for games cancelled or abandoned
during the three-month and six-month periods ended December 31, 2009 and 2008,
respectively.




Beginning
upon the related game’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 game, generally resulting in an amortization
period of twelve months or less.




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.


10


SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




1. Summary of Significant
Accounting Policies, continued




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.
There were no costs for games cancelled or abandoned during the three-month and
six-month periods ended December 31, 2009 and 2008, respectively.




Beginning
upon the related 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 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.




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.


11


SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




1. Summary of Significant
Accounting Policies, continued




The
Company evaluates goodwill and intangibles with an indefinite life annually
(performed in the fourth quarter) and upon the occurrence of certain triggering
events or substantive changes in circumstances that indicate that the fair value
of goodwill or indefinite lived intangible assets may be impaired. 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 values of the reporting units 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.




The
Company determined that current business conditions, and the resulting decrease
in the Company’s projected cash flows, constituted a triggering event which
required the Company to perform interim impairment tests related to its
long-lived assets and goodwill during the quarter ended December 31, 2009. The
Company’s interim 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.  The Company will continue to monitor its goodwill and
indefinite-lived intangible and long-lived assets for possible future
impairment.




Assessment
of Impairment of Assets




Current
accounting standards require that the Company assess the recoverability of
purchased intangible assets 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.




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.


12


SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




1. Summary of Significant
Accounting Policies, continued




Revenue
Recognition




The
Company recognizes revenue from the sale of videogames 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 provides 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 videogames 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 videogames 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 videogame, the
Company takes this into account when applying its revenue recognition
policy.  This evaluation is performed for each videogame together with any
online transactions, such as electronic downloads or videogame add-ons when it
is released.  When the Company determines that a videogame contains online
functionality that constitutes a more-than-inconsequential separate service
deliverable in addition to the videogame, 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 videogame. 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.




Third-party
licensees in Europe distribute Gamecock’s videogames 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, and amortization
of intellectual property licenses.


13


SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




1. Summary of Significant
Accounting Policies, continued




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.




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.




·
            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 December 31, 2009, 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.




14


SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




1. Summary of Significant
Accounting Policies, continued




Comprehensive
Income (Loss)




For the
three-month and six-month periods ended December 31, 2009 and 2008, the
Company’s comprehensive income (loss) was as follows:




Three
      months ended
                
                
                Six
      months endedDecember
      31,
                  2009
                
                
                December
      31,
                  2008
                
                
                December
      31,
                  2009
                
                
                December
      31,
                  2008Net
      income (loss)
                
                $
                (2,642,266
                )
                
                $
                1,166,545
                
                
                $
                (1,955,285
                )
                
                $
                (385,209
                )Other
      comprehensive income (loss)Change
      in foreign currency translation adjustment
                
                
                7,747
                
                
                
                (85,581
                )
                
                
                90,247
                
                
                
                (180,944
                )Comprehensive
      income (loss)
                
                $
                (2,634,519
                )
                
                $
                1,080,964
                
                
                $
                (1,865,038
                )
                
                $
                (566,153
                )




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.




As the
Company reported a net loss for the three and six month periods ended December
31, 2009, basic and diluted earnings per share were the same for this
period.  Potentially dilutive securities totaling 6,293,273 shares for the
three months ended December 31, 2009 were excluded from the diluted earnings per
share calculation because of their anti-dilutive effect.  Potentially
dilutive securities totaling 6,058,925 and 17,616,289 shares for the six months
ended December 31, 2009 and 2008, respectively, were excluded from the diluted
earnings per share calculation because of their anti-dilutive
effect.




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 income (loss).




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.


15




SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




1. Summary of Significant
Accounting Policies, continued




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 is currently evaluating the impact that the adoption of this
guidance will have on its consolidated financial statements.




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”) will be added to the purchase price (i.e., goodwill) when the
contingency is resolved.




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




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.




16




SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES




Notes
to Condensed Consolidated Financial Statements


(Unaudited)




2. Gamecock Acquisition,
continued




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
                
                
                
                209,441Estimated 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 December 31, 2009:




AccumulatedGross
                        
                        
                        Amortization
                        
                        
                        NetRoyalty
      agreements (Advances on royalties)
                        
                        $
                        3,424,000
                        
                        
                        $
                        2,699,171
                        
                        
                        $
                        724,829Intangible
      assets, netGame
      sequel titles
                        
                        $
                        1,142,000
                        
                        
                        $
                        1,142,000
                        
                        
                        $
                        -Non-compete
      agreements
                        
                        
                        200,000
                        
                        
                        
                        200,000
                        
                        
                        
                        -Distribution
      agreements
                        
                        
                        40,000
                        
                        
                        
                        16,308
                        
                        
                        
                        23,692Total
      intangible assets, net
                        
                        $
                        1,382,000
                        
                        
                        $
                        1,358,308
                        
                        
                        $
                        23,692




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.




17


SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




2. Gamecock Acquisition,
continued




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
      30,2010
      (six months ended June 30, 2010)
                      
                      $
                      6,6672011
                      
                      $
                      13,3332012
                      
                      $
                      3,692




The
weighted average estimated amortization period as of December 31, 2009 is 21
months.




As of
December 31, 2009, a total of $1,473,177, 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.




For the three
                    months ended
                    December 31, 2008
                  
                  For the six
                    months ended
                    December 31, 2008Pro
      forma net revenues
                  
                  $
                  17,472,058
                  
                  
                  $
                  26,505,788Pro
      forma net loss
                  
                  $
                  940,575
                  
                  
                  $
                  (34,722,961
                  )Pro
      forma net loss per share—basic
                  
                  $
                  0.03
                  
                  
                  $
                  (0.97
                  )Pro
      forma net loss per share—diluted
                  
                  $
                  0.02
                  
                  
                  $
                  (0.97
                  )




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%.




3. Inventories




Inventories
consist of the following:




December
      31,
                        2009
                      
                      
                      June
      30,
                        2009Finished
      goods
                      
                      $
                      3,353,439
                      
                      
                      $
                      3,858,518Purchased
      parts and components
                      
                      
                      356,709
                      
                      
                      
                      601,319Total
                      
                      $
                      3,710,148
                      
                      
                      $
                      4,459,837




18




SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




4. Property and Equipment,
net




Property
and equipment, net was comprised of the following:




December
      31,
                          2009
                        
                        
                        June
      30,
                          2009Land
                        
                        $
                        544,044
                        
                        
                        $
                        544,044Building
      and leasehold improvements
                        
                        
                        1,496,099
                        
                        
                        
                        1,496,147Computer
      equipment and software
                        
                        
                        765,659
                        
                        
                        
                        719,621Office
      furniture and other equipment
                        
                        
                        439,990
                        
                        
                        
                        353,4063,245,792
                        
                        
                        
                        3,113,218Less:
      accumulated depreciation and amortization
                        
                        
                        467,071
                        
                        
                        
                        359,079Property
      and equipment, net
                        
                        $
                        2,778,721
                        
                        
                        $
                        2,754,139




Depreciation
and amortization expense for the three months and six months ended December 31,
2009 was $61,269 and $109,251, respectively.  For the three months and six
months ended December 31, 2008, depreciation and amortization expense was
$46,504 and $82,713, respectively.




5. Line of
Credit




The
Company has a $7.5 million revolving line of credit facility with SunTrust that
matured on December 31, 2009 and has been extended on a month to month basis.
From time to time SunTrust in its sole and absolute discretion may increase the
Company’s line of credit in the form of an overadvance agreement. As of December
31, 2009 and June 30, 2009, the Company’s borrowing base may not exceed 65% of
eligible accounts receivable plus $500,000. The line of credit bears interest at
prime plus 1⁄2%, which was 3.75% at December 31, 2009 and June 30, 2009. SunTrust
processes payments received on such accounts receivable as payments on the
revolving line of credit. The line is collateralized by gross accounts
receivable of approximately $8,247,000 and $8,673,000 at December 31, 2009 and
June 30, 2009, respectively. The line of credit is 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 contains certain financial and non-financial
covenants. At December 31, 2009, the Company was in compliance with these
covenants.




At
December 31, 2009 and June 30, 2009, the outstanding line of credit balance was
$5,310,732 and $5,349,953, respectively. At December 31, 2009 and June 30, 2009,
the Company had $49,796 and $-0-, respectively, available under its credit
facility. For the three months and six months ended December 31, 2009, interest
expense relating to the line of credit was $65,211 and $116,970,
respectively.  For the three months and six months ended December 31, 2008,
interest expense relating to the line of credit was $55,571 and $86,703,
respectively.


19




SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




6. Long-term
Debt




Long-term
debt was comprised of the following:




December
      31,
                        2009
                      
                      
                      June
      30,
                        2009Mortgages
      payableFirst National Bank
                      
                      $
                      1,027,099
                      
                      
                      $
                      1,039,078Southwest Securities, FSB
                      
                      
                      486,356
                      
                      
                      
                      493,437Vehicle
      notes payable
                      
                      
                      124,802
                      
                      
                      
                      57,296Total
      debt
                      
                      
                      1,638,257
                      
                      
                      
                      1,589,811Less
      current portion
                      
                      
                      63,649
                      
                      
                      
                      50,855Total
      long-term debt
                      
                      $
                      1,574,608
                      
                      
                      $
                      1,538,956




In
connection with the purchase of an office building in Grapevine, Texas, 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 December 31, 2009).  Principal and interest are
payable in monthly installments of $3,439 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.




In
connection with the purchase of an office building and land in Grapevine, Texas,
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 adjusts every five years
to prime minus 1⁄4% (7.5% at December 31, 2009). 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
scheduled maturities of the long-term debt are as follows:




Year
      ending June 30,2010
      (six months ended June 30, 2010)
                  
                  $
                  31,7342011
                  
                  
                  65,4512012
                  
                  
                  68,9932013
                  
                  
                  73,3472014
                  
                  
                  489,276Thereafter
                  
                  
                  909,456Total
                  
                  
                  1,638,257Less:
      current maturities
                  
                  
                  63,649Long-term
      debt, net of current portion
                  
                  $
                  1,574,608


20


SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




7. Related
Party Transactions




Related
Party Receivables




Related
party receivables consist of short-term advances to employees and an overpayment
of amounts owed to an affiliate of two shareholders of the Company, one of whom
is the Company’s chairman. No allowance has been provided due to the short-term
nature and recoverability of such advances.




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.  Subsequent to June 30, 2009, the amount was repaid.  At
December 31, 2009 and June 30, 2009, the amount due was $-0- and $232,440,
respectively.




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
was payable to the affiliate and is included in due to related parties in the
accompanying consolidated balance sheets.  At September 30, 2009, the
Company was owed $38,390 from this affiliate, resulting from an overpayment of
amounts owed.  The amount was repaid to the Company as of December 31,
2009.




The
Company incurred fees for broadband usage to an entity partially owned by two
shareholders of the Company, one of whom is the Company’s chairman. Broadband
usage fees for the three and six months ended December 31, 2009 were $6,600 and
$13,200, respectively. Broadband usage fees for the three and six months ended
December 31, 2008 were $20,850 and $41,700, respectively. These amounts are
included in general and administrative expenses in the accompanying consolidated
statements of operations. At December 31, 2009 and June 30, 2009, $4,400
and $11,546, respectively, remained as a payable to the affiliate and is
included in due to related parties in the accompanying consolidated balance
sheets.




Accrued
Expenses - Related Parties




Accrued
expenses - related parties as of and for the six months ended December 31, 2009
and the year ended June 30, 2009 are as follows:




Six months ended
                          December
      31,
                          2009
                        
                        
                        Year ended
                          June 30,
                          2009Balance
      at beginning of period
                        
                        $
                        184,766
                        
                        
                        $
                        5,770Expenses
      incurred:Rent
                        
                        
                        55,000
                        
                        
                        
                        100,250Commissions
                        
                        
                        265,297
                        
                        
                        
                        705,032Less:
      amounts paid
                        
                        
                        (367,775
                        )
                        
                        
                        (626,286
                        )Balance
      at end of period
                        
                        $
                        137,288
                        
                        
                        $
                        184,766




The
Company incurred sales commissions for the marketing and sale of videogames with
two affiliates of the Company’s chairman.  Sales commissions for the three
and six months ended December 31, 2009 were $172,231 and $265,297,
respectively.  Sales commissions for the three and six months ended
December 31, 2008 were $171,331 and $273,227, respectively.  These amounts
are included in sales and marketing in the accompanying consolidated statements
of operations.




21




SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




7. Related
Party Transactions,
continued




Lease
- 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 $27,500 and $55,000 for the three and six months
ended December 31, 2009, respectively.  Related party lease expense was
$22,625 and $45,250 for the three and six months ended December 31, 2008,
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 $3,907 and $7,815 for the three and six months ended
December 31, 2009, respectively.  Related lease income was $3,907 and
$7,815 for the three and six months ended December 31, 2008, respectively. 
These amounts are included in general and administrative expense in the
accompanying consolidated statements of operations.  The lease expires on
December 31, 2010.




8. Commitments




Total
future minimum commitments are as follows:




Software
                  
                  
                  OfficeDevelopers
                  
                  
                  Lease
                  
                  
                  TotalFor
      the year ending June 30,2010
      (six months ended June 30, 2010)
                  
                  $
                  4,536,364
                  
                  
                  $
                  74,712
                  
                  
                  $
                  4,611,0762011
                  
                  
                  637,818
                  
                  
                  
                  94,424
                  
                  
                  
                  732,2422012
                  
                  
                  -
                  
                  
                  
                  39,424
                  
                  
                  
                  39,4242013
                  
                  
                  -
                  
                  
                  
                  16,427
                  
                  
                  
                  16,427Total
                  
                  $
                  5,174,182
                  
                  
                  $
                  224,987
                  
                  
                  $
                  5,399,169




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. On
October 26, 2007, the Company executed an agreement with a third party game
developer in connection with certain development agreements. Pursuant to the
agreement, the Company has committed to spend specified amounts for marketing
support of the related game which is to be developed. “Cost of goods sold -
royalties” related to this development agreement amounted to $1,618,962 and
$6,619,633 for the three and six months ended December 31, 2009, respectively,
and $1,492,259 and $2,301,180 for the three and six months ended December 31,
2008, 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 three and six months ended December 31,
2009 was $8,906 and $14,767, respectively. Office rent expense for the three and
six months ended December 31, 2008 was $16,437 and $33,537,
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 three
and six months ended December 31, 2009 was $27,500 and $55,000, respectively.
Office rent expense for the three and six months ended December 31, 2008 was
$22,625 and $45,250, respectively


22


SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




8. Commitments, continued




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.




9. 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 December 31, 2009 and June 30, 2009 were
1,379,867 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 approximate 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  to employees and non-employees were as
follow:




For the six
                      months ended
                      December 31, 2009
                    
                    
                    For the six
                      months ended
                      December 31, 2008Risk-free
      interest rate
                    
                    
                    2.20
      – 3.85
                    %
                    
                    
                    2.87
      – 4.01
                    %Weighted-average
      volatility
                    
                    
                    160.78
      – 166.29
                    %
                    
                    
                    57.56
                    %Expected
      term
                    
                    5.5
      – 9.44 years
                    
                    
                    5.5
      - 6 yearsExpected
      dividends
                    
                    
                    0.0
                    %
                    
                    
                    0.0
                    %




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 three
                          months ended
                          December 31,
                          2009
                        
                        
                        For the three
                          months ended
                          December 31,
                          2008
                        
                        
                        For the six
                          months ended
                          December
                          31, 2009
                        
                        
                        For the six
                          months ended
                          December
                          31, 2008Sales
      and marketing
                        
                        $
                        12,196
                        
                        
                        $
                        37,734
                        
                        
                        $
                        39,818
                        
                        
                        $
                        75,468General
      and administrative
                        
                        
                        191,528
                        
                        
                        
                        132,790
                        
                        
                        
                        320,102
                        
                        
                        
                        267,037Total
      stock-based compensation expense
                        
                        $
                        203,724
                        
                        
                        $
                        170,524
                        
                        
                        $
                        359,920
                        
                        
                        $
                        342,505




As of
December 31, 2009, the Company’s unrecognized stock-based compensation for stock
options issued to employees and non-employee directors was approximately
$742,719 and will be recognized over a weighted average of 1.8 years.  The
Company estimated a 5% forfeiture rate related to the stock-based compensation
expense calculated for employees and non-employee directors.


23





SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




9. Stock-based
Compensation, continued




The
following table summarizes the Company’s stock option activity for employees,
non-employee directors, and non-employees for the six months ended December
31, 2009:




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 six months ended December 31, 2009Granted
                                    
                                    
                                    567,000
                                    
                                    
                                    
                                    0.64
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -Exercised
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -Forfeited,
      cancelled or expired
                                    
                                    
                                    87,667
                                    
                                    
                                    
                                    1.75
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -Outstanding
      as of December 31, 2009
                                    
                                    
                                    2,439,633
                                    
                                    
                                    $
                                    1.44
                                    
                                    
                                    
                                    9.03
                                    
                                    
                                    $
                                    -Exercisable
      as of December 31, 2009
                                    
                                    
                                    360,999
                                    
                                    
                                    $
                                    2.27
                                    
                                    
                                    
                                    8.52
                                    
                                    
                                    $
                                    -Exercisable
      and expected to be exercisable
                                    
                                    
                                    2,049,071
                                    
                                    
                                    $
                                    1.46
                                    
                                    
                                    
                                    9.02
                                    
                                    
                                    $
                                    -




The
aggregate intrinsic value represents the total pre-tax intrinsic value based on
the Company’s closing stock price ($0.32 per share) as of December 31, 2009,
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 three months ended December 31, 2009 was $0.50
per share.




The
following table summarizes the Company’s restricted stock activity for the six
months ended December 31, 2009:




Shares
                        
                        
                        Weighted-
                          Average
                          Grant Date
                          Fair ValueOutstanding
      as of June 30, 2009
                        
                        
                        115,500
                        
                        
                        $
                        2.14Activity
      for the six months ended December 31, 2009Granted
                        
                        
                        1,065,000
                        
                        
                        
                        0.37Vested
                        
                        
                        101,500
                        
                        
                        
                        2.27Forfeited,
      cancelled or expired
                        
                        
                        -
                        
                        
                        
                        -Outstanding
      as of December 31, 2009
                        
                        
                        1,079,000
                        
                        
                        $
                        0.39Vested
      as of December 31, 2009
                        
                        
                        101,500
                        
                        
                        $
                        2.27




As of
December 31, 2009, the Company’s unrecognized stock-based compensation for
restricted stock issued to employees and non-employee directors was
approximately $360,420 and will be recognized over a weighted average of 2.7
years.




10. Contingencies




The
Company was obligated to file a registration statement with the SEC covering the
resale of the shares of its common stock issued upon conversion of the Series A
convertible preferred stock and the exercise of Class Y warrants within 30 days
following the Company’s filing of its Form 10-K for the fiscal year in 2008 but
no later than January 15, 2009. The Company filed a registration statement on
Form S-1 with the SEC, however, the registration statement was not declared
effective by the SEC within the prescribed time period.


24




SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




10. Contingencies,
continued




Since the
registration statement was not declared effective by the SEC within the
prescribed time period, the Company is obligated to 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 effective. Accordingly, the Company has recognized a liability for
liquidating damages and interest totaling $196,511 for the year ended June 30,
2009.  The amount of the liability at December 31, 2009 and June 30, 2009
was $196,511.




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.




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.  As
of December 31, 2009, the amount held in escrow was approximately $849,600 and
is included in restricted cash.  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. This
amount represents the full amount of the judgment against Gamecock and its
subsidiary. Of this judgment, $555,332 represents the judgment liability of
SouthPeak Interactive Corporation.




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 postponed and
a new date has not been set.  As of December 31, 2009, 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.




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.  Excluding the $4,308,035 accrued for
the ruling against Gamecock Media Europe, Ltd., the Company has accrued an
aggregate amount of $2,314,650 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
intends to cooperate in all respects with the SEC’s investigation.




25





SOUTHPEAK
INTERACTIVE CORPORATION AND SUBSIDIARIES


Notes
to Condensed Consolidated Financial Statements


(Unaudited)




11. Production Advance
Payable




On August
13, 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 December 31, 2009. 
Production fees relating to this production advance for the three and six months
ended December 31, 2009 totaled $375,658 and $575,604, respectively, and include
the production fees of $160,000 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 statements of operations . As
of December 31, 2009, accrued and unpaid production fees totaled approximately
$565,000 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
14, 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 14, 2009 (approximately $160,000 through December 31,
2009).  Pursuant to the terms of the production financing agreement, the
producer is free to exercise any rights in connection with the security
interests granted.




12. Gain on Settlement of Trades
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
three months and six months ended December 31, 2009, the Company’s gain on
settlement of trade payables was as follows:




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
                  )
                  
                  
                  -
                  
                  
                  
                  164,989Total
                  
                  $
                  6,900,681
                  
                  
                  $
                  (1,422,334
                  )
                  
                  $
                  (2,117,358
                  )
                  
                  $
                  (104,500
                  )
                  
                  $
                  3,256,489




(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.




13.
Subsequent
Events




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 generate 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
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.




26




REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




To the
Board of Directors and Shareholders of


SouthPeak
Interactive Corporation




We have
reviewed the accompanying consolidated balance sheet of SouthPeak Interactive
Corporation and subsidiaries as of December 31, 2009 and the related
consolidated statements of operations and cash flows for the three-month and
six-month periods ended December 31, 2009 and 2008. These interim financial
statements are the responsibility of the Company’s management.




We
conducted our review in accordance with the standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with the
standards of the Public Company Accounting Oversight Board (United States), the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an
opinion.




Based on
our review, we are not aware of any material modifications that should be made
to the accompanying interim financial statements for them to be in conformity
with accounting principles generally accepted in the United States of
America.




We have
previously audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheet of
SouthPeak Interactive Corporation and subsidiaries as of June 30, 2009 and the
related consolidated statements of operations, shareholders’ equity, and cash
flows for the year then ended (not presented herein), and in our report dated
October 13, 2009, we expressed an unqualified opinion on those consolidated
financial statements. In our opinion, the information set forth in the
accompanying consolidated balance sheet as of June 30, 2009 is fairly stated, in
all material respects, in relation to the consolidated balance sheet from which
it has been derived.




The
accompanying consolidated financial statements have been prepared assuming that
the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company’s default on its production
advance payable, a material uncertainty in connection with the renewal of its
line of credit and significant contingencies raise substantial doubt about
its ability to continue as a going concern. Management’s plans concerning 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


February
16, 2010


27


Item 2.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 and in our
annual report on Form 10-K for the year ended June 30,
2009.




This
report includes forward-looking statements that are made pursuant to the safe
harbor provisions of the Private Securities Litigation Reform Act of 1995. These
forward-looking statements can be identified by the use of words such as
“anticipate,” “believe,” “estimate,” “may,” “intend,” “expect,” “will,”
“should,” “seeks” or other similar expressions. Forward-looking statements
reflect our plans, expectations and beliefs, and involve inherent risks and
uncertainties, many of which are beyond our control. You should not place undue
reliance on any forward-looking statement, which speaks only as of the date
made. 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 of Part II.




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 of software titles developed on our behalf by
independent software developers and videogame studios.  Our unique business
model of globally sourcing and developing creative product allows us to better
manage our fixed costs relative to our competition.  In North America, we
sell our videogames both to retailers and distributors, and in Europe, Australia
and Asia, we primarily sell our videogames to distributors.




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.




Second
Quarter 2010 Releases




We
released the following videogames in the three months ended December 31,
2009:




Title
                  
                  Platform
                  
                  Date
      ReleasedHorrid
      Henry
                  
                  NDS,
      Wii, PC
                  
                  10/30/09My
      Baby First Steps
                  
                  NDS,
      Wii
                  
                  11/3/09Fast
      Food Panic
                  
                  NDS
                  
                  12/18/09Schrodinger’s
      Rat
                  
                  iPhone
                  
                  12/23/09




28


Cost
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, and manufacturing costs of videogame
discs, cartridges or similar media. Videogame system manufacturers approve and
manufacture each videogame for their videogame system.  The videogame
system manufacturers charge us a license fee for each videogame 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 to the license fee originally charged.  Because of the
terms of these license fees, we may have an increase in the cost of goods sold
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 independent software developers and videogame studios
once the videogame design has been approved by the videogame system manufacturer
and is technologically feasible.  Payments to independent software
developers and videogame studios 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
that are owed to the independent software developer or videogame studio 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.




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 North America 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 salaries and related costs, advertising,
marketing and promotion expenses, and commissions to external sales
representatives. As we release more newly published videogames, 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.  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
independent software developers and videogame studios. Additionally, such costs
are used to finance accounts receivables prior to payment by
customers.




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.




Our
significant accounting policies are described in Note 1 to the accompanying
consolidated financial statements and in our annual report
on Form 10-K for the year ended June 30, 2009. The following
accounting policies involve a greater degree of judgment and complexity.
Accordingly, these are the policies we believe are the most critical to aid in
fully understanding and evaluating our consolidated financial condition and
results of operations.


29


Allowances for Returns, Price
Protection and Other Allowances.We accept returns from,
and grant price concessions to, our customers under certain conditions. 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 periodic confirmation
reports of field inventory levels and sell-through rates.




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,
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 videogame’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,
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 videogames upon the transfer of title
and risk of loss to the customer.  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 we are unable to determine that collection of a
receivable is probable, we defer the revenue until such time as we can reliably
estimate any related returns and allowances and determine that collection of the
receivable is probable.




Some of
our videogames 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 videogames 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 are considered a substantive deliverable in
addition to the videogame, we take this into account when applying our revenue
recognition policy. This evaluation is performed for each videogame together
with any online transactions, such as electronic downloads or videogame add-ons
when it is released. When we determine that a videogame contains online
functionality that constitutes a more-than-inconsequential separate service
deliverable in addition to the videogame, 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
videogame. 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.




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.




Third-party
licensees in Europe distribute Gamecock’s videogames under license agreements
with Gamecock. The licensees pay 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.


31


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 estimate the fair value of stock-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.




We account
for equity instruments issued to non-employees in accordance with accounting
guidance surrounding stock compensation and equity-based payment for
non-employees.




We
estimate the value of employee, non-employee directors and
non-employee stock options on the date of grant using the Black-Scholes
option pricing model. Our determination of fair value of stock-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 (expected term).




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 financial
statements.




Assessment of Impairment of
Goodwill.Current accounting standards provide for a two-step
approach to testing goodwill for impairment, which must 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.




Potential
Loss Contingencies. 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.




Consolidated
Results of Operations




The
following table sets forth our results of operations expressed as a percentage
of net revenues for the three and six months ended December 31, 2009 and
2008:


32




For the
                                                    three months ended
                                                    December 31,
                                                  
                                                  
                                                  For the
                                                    six months ended
                                                    December 31,2009
                                                  
                                                  
                                                  2008
                                                  
                                                  
                                                  2009
                                                  
                                                  
                                                  2008Net
      revenues
                                                  
                                                  
                                                  100.0
                                                  %
                                                  
                                                  
                                                  100.0
                                                  %
                                                  
                                                  
                                                  100.0
                                                  %
                                                  
                                                  
                                                  100.0
                                                  %Cost
      of goods sold:Product
      costs
                                                  
                                                  
                                                  51.2
                                                  %
                                                  
                                                  
                                                  40.1
                                                  %
                                                  
                                                  
                                                  32.5
                                                  %
                                                  
                                                  
                                                  48.1
                                                  %Royalties
                                                  
                                                  
                                                  16.1
                                                  %
                                                  
                                                  
                                                  8.6
                                                  %
                                                  
                                                  
                                                  24.7
                                                  %
                                                  
                                                  
                                                  9.0
                                                  %Intellectual
      property licenses
                                                  
                                                  
                                                  0.9
                                                  %
                                                  
                                                  
                                                  0.4
                                                  %
                                                  
                                                  
                                                  0.8
                                                  %
                                                  
                                                  
                                                  0.4
                                                  %Total
      cost of goods sold
                                                  
                                                  
                                                  68.2
                                                  %
                                                  
                                                  
                                                  49.1
                                                  %
                                                  
                                                  
                                                  58.0
                                                  %
                                                  
                                                  
                                                  57.5
                                                  %Gross
      profit
                                                  
                                                  
                                                  31.8
                                                  %
                                                  
                                                  
                                                  50.9
                                                  %
                                                  
                                                  
                                                  42.0
                                                  %
                                                  
                                                  
                                                  42.5
                                                  %Operating
      expenses:Warehousing
      and distribution
                                                  
                                                  
                                                  3.2
                                                  %
                                                  
                                                  
                                                  1.6
                                                  %
                                                  
                                                  
                                                  2.3
                                                  %
                                                  
                                                  
                                                  1.9
                                                  %Sales
      and marketing
                                                  
                                                  
                                                  22.0
                                                  %
                                                  
                                                  
                                                  22.8
                                                  %
                                                  
                                                  
                                                  21.9
                                                  %
                                                  
                                                  
                                                  23.2
                                                  %General
      and administrative
                                                  
                                                  
                                                  29.6
                                                  %
                                                  
                                                  
                                                  15.9
                                                  %
                                                  
                                                  
                                                  22.8
                                                  %
                                                  
                                                  
                                                  16.1
                                                  %Restructuring
      costs
                                                  
                                                  
                                                  -
                                                  %
                                                  
                                                  
                                                  3.2
                                                  %
                                                  
                                                  
                                                  -
                                                  %
                                                  
                                                  
                                                  2.2
                                                  %Transaction
      costs
                                                  
                                                  
                                                  -
                                                  %
                                                  
                                                  
                                                  0.1
                                                  %
                                                  
                                                  
                                                  -
                                                  %
                                                  
                                                  
                                                  0.1
                                                  %Litigation
      costs
                                                  
                                                  
                                                  30.6
                                                  %
                                                  
                                                  
                                                  -
                                                  %
                                                  
                                                  
                                                  11.5
                                                  %
                                                  
                                                  
                                                  -
                                                  %Gain
      on settlement of trade payables
                                                  
                                                  
                                                  (32.4
                                                  )%
                                                  
                                                  
                                                  -
                                                  %
                                                  
                                                  
                                                  (12.2
                                                  )%
                                                  
                                                  
                                                  -
                                                  %Total
      operating expenses
                                                  
                                                  
                                                  53.0
                                                  %
                                                  
                                                  
                                                  43.6
                                                  %
                                                  
                                                  
                                                  46.3
                                                  %
                                                  
                                                  
                                                  43.4
                                                  %(Loss)
      income from operations
                                                  
                                                  
                                                  (21.2
                                                  )%
                                                  
                                                  
                                                  7.3
                                                  %
                                                  
                                                  
                                                  (4.3
                                                  )%
                                                  
                                                  
                                                  (0.9
                                                  )%Interest
      expense, net
                                                  
                                                  
                                                  5.1
                                                  %
                                                  
                                                  
                                                  0.6
                                                  %
                                                  
                                                  
                                                  3.0
                                                  %
                                                  
                                                  
                                                  0.6
                                                  %Net
      (loss) income
                                                  
                                                  
                                                  (26.3
                                                  )%
                                                  
                                                  
                                                  6.7
                                                  %
                                                  
                                                  
                                                  (7.3
                                                  )%
                                                  
                                                  
                                                  (1.5
                                                  )%Deemed
      dividend related to beneficial conversion feature on Series A convertible
      preferred stock
                                                  
                                                  
                                                  -
                                                  %
                                                  
                                                  
                                                  0.0
                                                  %
                                                  
                                                  
                                                  -
                                                  %
                                                  
                                                  
                                                  4.4
                                                  %Net
      (loss) income attributable to common shareholders
                                                  
                                                  
                                                  (26.3
                                                  )%
                                                  
                                                  
                                                  6.7
                                                  %
                                                  
                                                  
                                                  (7.3
                                                  )%
                                                  
                                                  
                                                  (5.9
                                                  )%




Three
Months Ended December 31, 2009 and 2008




Net Revenues. Net revenues
for the three months ended December 31, 2009 were $10,063,952, a decrease of
$7,244,922, or 42%, from net revenues of $17,308,874 for the three months ended
December 31, 2008. The decrease in net revenues was primarily driven by a
decrease in the number of titles released, the product mix sold and a weaker
than expected retail environment in the three months ended December 31, 2009
versus the three months ended December 31, 2008.  For the three months
ended December 31, 2009, the number of videogame units sold decreased to
approximately 645,000, a decrease of approximately 125,000 units from the units
sold in the prior period. Average net revenue per videogame unit sold decreased
31%, from $22.48 to $15.60 for the three months ended December 31, 2008 and
2009, respectively. This average decrease in price per unit is due to the
Company’s concentration on the My Baby brand and the selling of fewer units for
next generation platforms (Xbox 360, PlayStation 3), which have a higher
Manufacturer’s Suggested Retail Price (“MSRP”), in the three months ended
December 31, 2009 versus the prior period.




Cost of Goods Sold. Cost
of goods sold for the three months ended December 31, 2009 decreased to
$6,868,356, down $1,631,194, or 19%, from $8,499,550 for the prior period.
Product costs for the three months ended December 31, 2009 decreased $1,790,177,
or 26%, from the comparable period in 2008.  This decrease was primarily
driven by the concentration on the My Baby brand, which is produced only for the
Nintendo DS and Wii platforms and, accordingly, costs less to build.  The
decrease in product costs was offset by an increase in royalty expense. 
The cost of royalty expense for the three months ended December 31, 2009 was
$1,618,962, an increase of 8%, from royalty expense of $1,492,259 for the three
months ended December 31, 2008.  This increase is primarily attributable to
an increase in developer royalty agreements associated with the European
release of Section 8 and Horrid Henry.




Gross Profit. For the
three months ended December 31, 2009 and 2008, gross profit decreased to
$3,195,596 from $8,809,324, or 64%. Gross profit margin decreased to
approximately 32% for the three months ended December 31, 2009 from 51% in the
same period in 2008. The decrease in gross profit isattributed to selling
fewer units for next generation platforms, which have a higher MSRP, in the
three months ended December 31, 2009 versus the prior period.


33




Warehousing and Distribution
Expenses. For the three months ended December 31, 2009 and 2008,
warehousing and distribution expenses were $320,723 and $268,980, respectively,
resulting in an increase of 19%. This increase is primarily attributed to rising
storage fees and costs associated with the production of My Baby brand
units.




Sales and Marketing Expenses.
For the three months ended December 31, 2009, sales and marketing expenses
decreased 44% to $2,215,620 from $3,954,803 for the three months ended December
31, 2008. This decrease is primarily due to lower direct spending as a result of
releasing fewer titles during the three months ended December 31, 2009 versus
the prior period. The majority of marketing associated with the My Baby brand
was expensed during the three months ended September 30, 2009.  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. Included in sales and marketing expenses for the
three months ended December 31, 2009 and 2008 is a non-cash charge of $12,196
and $37,734, respectively, for stock options granted to vendors and other
non-employees.




Gain on Settlement of Trade
Payables. For the three months ended December 31, 2009, the gain on
settlement of trade payables was $3,256,489, 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.




Litigation Costs. For
the three months ended December 31, 2009, litigation costs associated with the
matter involving CDV Software Entertainment A.G., or CDV, were $3,075,206 (see
Item 1, “Legal Proceedings,” of Part II of this report).




General and Administrative
Expenses.For the three months ended December 31, 2009, general and
administrative expenses increased $226,104 to $2,973,944 from $2,747,840 for the
prior period. Wages included in general and administrative expenses
increased from $687,724 for the three months ended December 31, 2008 to
$1,019,144 for the three months ended December 31, 2009, an increase of
48%.  Professional fees increased 40% from $452,830 for the three months
ended December 31, 2008 to $632,714 for the three months ended December 31,
2009, as a result of legal and accounting fees related to current litigation and
costs associated with being a public company. Travel and entertainment expenses
were $124,896 for the three months ended December 31, 2008, as
compared to $61,828 for the three months ended December 31, 2009. Bad debt
expense decreased 100% from $534,312 for the three months ended December 31,
2008 to $2,210 for the three months ended December 31, 2009, as a result of bad
debt incurred during the prior period. General and administrative expenses as a
percentage of net revenues increased, to approximately 30% for the three months
ended December 31, 2009 from 16% for the prior period.  In addition, for
the three months ended December 31, 2009, general and administrative expenses
includes $191,528 for noncash compensation related to employee stock options and
restricted stock granted, an increase of $58,738, or 44%, from the comparable
period in 2008.




Restructuring and Transaction
Costs. For the three months ended December 31, 2008, we incurred
$560,806 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.  For the three months ended December 31, 2008, we incurred
$10,295 in costs related to the reverse acquisition. These costs included
professional fees to accounting firms, law firms and advisors.




Operating (Loss) Income. For
the three months ended December 31, 2009, our operating loss was $2,133,408, a
decrease of $3,400,008, or 268%, over operating income of $1,266,600 for the
prior period.




Interest and Financing
Costs. For the three months ended December 31, 2009, interest and
financing costs increased to $508,858 from $100,055 for the prior period due to
an increase in average borrowings as a result of the increase in our accounts
receivable as well as interest 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 $160,000 through December 31,
2009).




Net (Loss) Income. For the
three months ended December 31, 2009, our net loss was $2,642,266, a
decrease of $3,808,811, or 327%, over net income of $1,166,545 for the prior
period.




Six
Months Ended December 31, 2009 and 2008




Net Revenues.  Net
revenues for the six months ended December 31, 2009 were $26,773,601, an
increase of $1,077,024, or 4%, from net revenues of $25,696,577 for the
comparable period in 2008.  The increase in net revenues was primarily
driven by the increased volume of units sold, which was partially offset by
selling fewer units for next generation platforms, which have a higher
MSRP, in the six months ended December 31, 2009 versus the prior period.
For the six months ended December 31, 2009, the number of videogame units sold
increased to approximately 1,382,000 units, an 82,000 increase from 1,300,000
units sold for the comparable period in 2008.  Average net revenue per
videogame unit sold decreased 2%, from $19.77 to $19.37 for the six month
periods ended December 31, 2008 and 2009, respectively. This decrease is
due to selling fewer units for next generation platforms in the current period
as we focus on the My Baby brand, a Nintendo DS and Wii game.  The decrease
is also a result of sales discounts being higher than expected which is
attributed to the difficult retail environment.


34


Cost of Goods Sold. 
Cost of goods sold for the six months ended December 31, 2009 increased to
$15,535,373, up $757,369, or 5%, from $14,778,004 for the comparable period in
2008. This increase is primarily attributed to an increase in royalty
expense.  The cost of royalty expense for the six months ended December 31,
2009 increased $4,318,453, or 188%, to $6,619,633, which was driven by the
release of Section 8, Horrid Henry, and My Baby First Steps.  The increase
in royalty expense was offset by a $3,669,044, or 30%, decrease in product costs
for the six months ended December 31, 2009 when compared to the same period in
2008. The decrease in product costs was primarily driven by the concentration on
the My Baby brand, which is produced only for the Nintendo DS and Wii platforms
and costs less to build.




Gross Profit.  For the
six month periods ended December 31, 2009 and 2008, gross profit increased to
$11,238,228 from $10,918,573, or 3%, and gross profit margin remained flat
period over period at 42%.




Warehousing and Distribution
Expenses. For the six months ended December 31, 2009 and 2008,
warehousing and distribution expenses were $607,234 and $476,563, respectively,
resulting in an increase of 27%. This increase is due primarily to increase in
units shipped and units currently being held at our third party warehouse when
compared to 2008.




Sales and Marketing
Expenses.  For the six months ended December 31, 2009, sales and
marketing expenses decreased 1% to $5,870,676 from $5,950,539 for the comparable
period in 2008. 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. Included in sales and
marketing expenses for the six months ended December 31, 2009 and 2008 is a
non-cash charge of $39,818 and $75,468, respectively, for stock options granted
to vendors and other non-employees.




Gain on Settlement of Trade
Payables. For the six months ended December 31, 2009, the gain on
settlement of trade payables was $3,256,489, 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.




Litigation Costs. For
the six months ended December 31, 2009, litigation costs associated with the
matter involving CDV were $3,075,206 (see Item 1, “Legal Proceedings,” of
Part II of this report).




General and Administrative
Expenses.  For the six months ended December 31, 2009, general and
administrative expenses increased 48% to $6,088,712 from $4,128,265 for the
comparable period in 2008. Wages included in general and administrative expenses
increased from $1,276,583 for the six months ended December 31, 2008 to
$1,981,694 for the six months ended December 31, 2009, an increase of 55%. 
Professional fees increased 178% from $688,320 for the six months ended December
31, 2008 to $1,910,561 for the six months ended December 31, 2009 as a result of
legal and accounting fees related to current litigation and costs associated
with being a public company. Travel and entertainment expenses were $209,499 for
the six months ended December 31, 2008, decreasing 45% to $115,151 for the six
months ended December 31, 2009. General and administrative expenses as a
percentage of net revenues increased, to approximately 23% for the six months
ended December 31, 2009 from 16% for the same period in fiscal year 2009. 
In addition, for the six months ended December 31, 2009, general and
administrative expenses includes $320,102 for noncash compensation related to
employee stock options and restricted stock granted, an increase of $53,065, or
20%, from the comparable period in 2008.




Restructuring and Transaction
Costs: For the six months ended December 31, 2008, we incurred
$560,806 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.  For the six months ended December 31, 2008, we incurred
$28,675 in costs related to the Acquisition. These costs included professional
fees to accounting firms, law firms and advisors.




Operating (Loss)
Income.  For the six months ended December 31, 2009, our operating
loss increased 407% to $1,147,111 from an operating loss of $226,275 for the
prior period.




Interest and Financing
Costs.  For the six months ended December 31, 2009, interest and
financing costs increased to $808,174 from $158,934 for the prior year period
due to an increase in average borrowings as a result of the increase in our
accounts receivable as well as interest 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 $160,000 through December
31, 2009).




Net Loss.  For the six
months ended December 31, 2009, our net loss increased 408% to $1,955,285 from a
net loss of $385,209 in the prior period.


35


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
independent registered public accounting firm noted in their report accompanying
our consolidated balance sheet of December 31, 2009 and the relatedconsolidated statements
of operations and cash flows for the three-month and six-month periods ended
December 31, 2009 and 2008 that our default on a production advance payable, the
material uncertainty in connection with the renewal of our line of credit and
our significant contingencies raisesubstantial doubt about
our ability to continue as a going concern. Management plans to maintain our
viability as a going concern by:
  ·
              attempting
      to expeditiously resolve our contingencies for amounts significantly less
      than currently accrued for in order to reduce aggregate liabilities on our
      balance sheet on payments terms manageable by
  us;
  ·
              seeking
      the renewal of our line of credit with SunTrust Bank, Inc., or SunTrust,
      and/or obtaining alternative or additional financing in order to address
      the month to month nature of our current line of credit;
    and
  ·
              reducing
      costs and expenses in order reduce or eliminate quarterly
      losses.
  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 (See Item 1A, “Risk Factors” of Part II of this report).
  Our
primary cash requirements have been to fund (i) the development, manufacturing
and marketing of our videogames, (ii) working capital, and (iii) capital
expenditures. Historically, we have met our capital needs, including working
capital, capital expenditures and commitments, through our operating activities,
our line of credit, through the sale of our equity securities, and, prior to the
reverse acquisition, loans from related parties and our
shareholders.  At this time, however, execution of management’s plan
to maintain our viability as a going concern is necessary for us to continue to
fully fund our cash requirements from operations.  If we are unable to
negotiate a significant reduction to our contingencies or we cannot renew our
line of credit or obtain other financing on acceptable terms, cash from our
operations will not be sufficient to fund our obligations as they come
due.  Our cash and cash equivalents were $658,609 at December 31, 2009
and $648,311 at June 30, 2009.
  Line of Credit. We have a
line of credit with SunTrust that matured on December 31, 2009 and has been
extended on a month to month basis. The line of credit bears interest at prime
plus 1⁄2%, which was 3.75% at December 31, 2009. Availability under the line of
credit is restricted to 65% of our eligible accounts receivable plus $500,000.
The line of credit is primarily secured by our accounts receivable. The line of
credit is further secured by the personal guarantees and pledge of personal
securities and assets, of two of our shareholders and certain of their
affiliates. At December 31, 2009, we were in compliance with all of the line of
credit’s covenants and requirements.  We are currently negotiating a
renewal of our line of credit, however, there are no assurances that the line of
credit will be renewed or renewed at terms that are acceptable to
us.
  At
December 31, 2009 and June 30, 2009, the outstanding line of credit balance was
$5,310,732 and $5,349,953, respectively, and the remaining available under the
line of credit amounted to $49,796 and $-0-, respectively.
  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
December 31, 2009 and June 30, 2009, amounts due from our three largest
customers comprised approximately 43% 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 continue to monitor the lagging economy, the global
contraction of credit markets and other factors as they relate to our customers
in order to manage the risk of uncollectible accounts receivable.
  Preferred Stock. During the
fourth quarter of fiscal year 2008 and the first half of fiscal year 2009, we
sold 14,563,833 shares of preferred stock valued at $14,563,833, which provided
additional liquidity to fund our continued growth through investment in
videogame development.
 36
  Cash Flows.We expect that we
will make expenditures relating to advances on royalties to third-party
developers to which we have made commitments to fund. 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.
  For the
six months ended December 31, 2009 we had net cash provided by operating
activities of $6,932, and in 2008 we had net cash used in operating activities
$6,822,255.
  During
the six months ended December 31, 2009, investing activities resulted in net
cash provided of $330,438 and during the six months ended December 31, 2008,
investing activities resulted in net cash used of $469,122. The cash provided
was a result of the increase in restricted cash during the six months ended
December 31, 2009.
  During
the six months ended December 31, 2009, financing activities resulted in net
cash used of $417,319 and during the six months ended December 31, 2008,
financing activities resulted in net cash provided of $3,589,922.
  The
Gamecock acquisition along with our various contingencies have caused a strain
on our cash flows, as we have needed to fund the payment of certain liabilities
Gamecock incurred prior to the Gamecock acquisition and pay certain amounts in
settlement of our contingencies. This strain on cash flows has limited our
ability to fund additional production of videogames. In particular, our
Chairman, Terry Phillips, advanced $307,440 to us in order to fund the
production of additional cartridges for a particular videogame. The advance was
unsecured, payable on demand and non-interest bearing. At June 30, 2009, the
amount due was $232,440. Subsequent to June 30, 2009, the amount was
repaid.
  International Operations.Net
revenue earned outside of North America is principally generated by our
operations in Europe, Australia and Asia. For the three months ended December
31, 2009 and 2008, approximately 27% and 4%, respectively, of our net revenue
was earned outside of the U.S. 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 3.Quantitative and Qualitative
Disclosures about Market Risk




For
quantitative and qualitative disclosures about market risk, see Item 7A,
“Quantitative and Qualitative Disclosures About Market Risk,” of our annual
report on Form 10-K for the year ended June 30, 2009. Our exposures to
market risk have not changed materially since June 30, 2009.




Item
4T. 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,
or the Exchange Act. Based on that reevaluation, the Chief Executive Officer,
who is 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.




37


·
            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.




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, who is also serving as
our interim Chief Financial Officer, and in consultation with our Chairman and
our interim Chief Accounting Officer, 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-Q 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, who is also serving as our interim Chief Financial Officer,
concluded that our disclosure controls and procedures were not effective as of
December 31, 2009 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 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.




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 have made the following
changes 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;




38


·
            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.




Remediation
Steps to Address Material Weakness




Beginning
in the first fiscal quarter of 2010, we began the process of remediating the
material weaknesses described above and enhancing our internal control over
financial reporting.  In connection with our remediation process, we have
taken the following remediation measures:




·
            we
      have hired an interim Chief Accounting Officer with the
      requisite experience in internal accounting in the videogame industry and
      made other related personnel
changes;




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




·
            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.




Additionally,
in connection with our remediation process we are implementing the following
remediation measures:




·
            we
      are developing additional training for our accounting personnel and
      reallocating duties of certain accounting
  personnel;




·
            we
      are enhancing procedures and documentation supporting our accruals;
      and




·
            we
      are incorporating more robust management review of our general and
      administrative expense accruals.




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 and will
remediate the material weakness identified by the end of our fiscal year
2010.  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.




39


PART II




Item 1.Legal
Proceedings




On March
12, 2009, we, along with Gamecock, SouthPeak Interactive, Ltd. and
Gamecock Media Europe, Ltd., were served with a complaint by CDV alleging
various 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 CDV in January 2008. CDV is seeking the return
of $4,590,000 in videogame development advances, an injunction against us
and our subsidiaries, approximately $650,000 in specified damages, further
damages to be assessed, and discretionary interest and costs. Gamecock Media
Europe, Ltd. filed a counterclaim against CDV for $950,000 and discretionary
interest and costs, resulting from videogame sales and the achievement of a
milestone under the Distribution Agreement. The hearing for both CDV’s claims
and Gamecock Media Europe’s counterclaim concluded on July 22, 2009. 
On November 20, 2009, the court issued its ruling in which some of CDV’s claims
were upheld and some were denied.  Additionally, Gamecock Media Europe,
Ltd.’s counterclaim was dismissed. The court awarded CDV approximately $3.8
million plus interest and legal expenses. This
amount, plus interest and legal expenses, represents the full amount of the
judgment against Gamecock and its subsidiary. Of this judgment, SouthPeak
Interactive Corporation is also liable for legal expenses.




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 postponed and
a new date has not been set.  As of December 31, 2009, the Company has
accrued sufficient amounts to cover anticipated liabilities related to this
matter.




Other
than the foregoing, we are not currently subject to any material legal
proceedings. From time to time, however, we are named as a defendant in legal
actions arising from our normal business activities. We believe that we have
obtained adequate insurance coverage, rights to indemnification, or where
appropriate, have established reserves in connection with these legal
proceedings.




Item 1A.Risk
Factors




“Item 1A.
Risk Factors” of our annual report on Form 10-K for the year ended June 30,
2009 includes a discussion of our risk factors.  There have been no
material changes to risk factors as previously disclosed in our annual report on
Form 10-K filed with the Securities and Exchange Commission on October 13,
2009.




We
have received a review report from our independent registered public
accountingfirm expressing doubt regarding our ability to continue
as a going concern.




Our
independent registered public accounting firm noted in their review report
accompanying our consolidated balance sheet of December 31, 2009 and the related
consolidated statements of operations and cash flows for the three-month and
six-month periods ended December 31, 2009 and 2008 that our default on a
production advance payable, the material uncertainty in connection with the
renewal of our line of credit and our significant contingencies raise
substantial doubt about our ability to continue as a going concern. Management
plans to maintain our viability as a going concern by:


·
              attempting
      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;
  ·
              seeking
      the renewal of our line of credit with SunTrust and/or obtaining
      alternative or additional financing in order to address the month to month
      nature of our current line of credit;
and
  ·
              reducing
      costs and expenses in order reduce or eliminate quarterly
      losses.
  Although
management is confident that we will be able to renew our line of credit and
implement the other aspects of 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.




Item
5.  Other
Information




Subsequent
Events




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 generate 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 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.


40


Item 6.Exhibits




ExhibitNumber
                
                Exhibit3.1(1)
                
                Amended
      and Restated Certificate of Incorporation.3.2(1)
                
                Amended
      and Restated Bylaws.15*
                
                Independent
      Registered Public Accounting Firm’s Awareness Letter.31.1*
                
                Certification
      of Chief Executive Officer pursuant to Rule 13a-14(a) and
      Rule 15d-14(a), promulgated under the Securities Exchange Act of
      1934, as amended.31.2*
                
                Certification
      of Chief Financial Officer pursuant to Rule 13a-14(a) and
      Rule 15d-14(a), promulgated under the Securities Act of 1934, as
      amended.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 Securities and Exchange Commission on May 15,
      2008.


41


SIGNATURES




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




SOUTHPEAK
      INTERACTIVE CORPORATIONBy:
                /s/ Melanie
      MrozMelanie
      Mroz
                  President,
      Chief Executive Officer and Interim Chief Financial
  OfficerDate: February
      16, 2010




42


INDEX
TO EXHIBITS




ExhibitNumber
                
                Exhibit3.1(1)
                
                Amended
      and Restated Certificate of Incorporation.3.2(1)
                
                Amended
      and Restated Bylaws.15*
                
                Independent
      Registered Public Accounting Firm’s Awareness Letter.31.1*
                
                Certification
      of Chief Executive Officer pursuant to Rule 13a-14(a) and
      Rule 15d-14(a), promulgated under the Securities Exchange Act of
      1934, as amended.31.2*
                
                Certification
      of Chief Financial Officer pursuant to Rule 13a-14(a) and
      Rule 15d-14(a), promulgated under the Securities Act of 1934, as
      amended.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 Securities and Exchange Commission on May 15,
      2008.