**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

**FORM        10-Q**

| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE                        SECURITIES EXCHANGE ACT OF 1934 |
|---|----------------------------------------------------------------------------------------------------------------|

 

For the        quarterly period ended March 31, 2008 OR

 

| o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE                        SECURITIES EXCHANGE ACT OF 1934 |
|---|-----------------------------------------------------------------------------------------------------------------|

 

|   | For the transition period from ______________to                        ______________ |
|--------|---------------------------------------------------------------------------------------|

 

Commission File Number 0-27494

SILVERSTAR HOLDINGS, LTD.

(Exact        name of Registrant as Specified in Its Charter)

| Bermuda                         | Not Applicable                    |
|---------------------------------|-----------------------------------|
| (State or Other Jurisdiction of | (IRS Employer Identification No.) |
| Incorporation or Organization)  |                              |

 

Clarendon House, Church Street, Hamilton HM CX, Bermuda

(Address        of Principal Executive Offices with Zip Code)

 

Registrant’s Telephone Number, Including Area Code:        809-295-1422

_____________________________________________________________________

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 [ X ] No [ ]

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

 

| Large accelerated filer                    o                                  |        | Accelerated filer                    o             |
|-------------------------------------------------------------------------------|--------|----------------------------------------------------|
| Non-accelerated filer                        o                                |   | Smaller reporting company                        x |
| (Do not check if a smaller 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        x

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE        PRECEDING FIVE YEARS:

Indicate by check mark whether the registrant has filed all documents and        reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of        1934 subsequent to the distribution of securities under a plan confirmed by a court.        Yes o          No o

APPLICABLE ONLY TO CORPORATE ISSUERS:

| **Title of Class**   | **Shares Outstanding****on May 7, 2008** |
|----------------------|------------------------------------------|
| Class A Common Stock | 19,914,417                               |
|                 |                                     |
|                 |                                     |

 

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**SILVERSTAR HOLDINGS, LTD.**

 

**INDEX        TO QUARTERLY REPORT ON FORM 10-Q**

**Quarter Ended March 31, 2008**

 

**PART I        – FINANCIAL INFORMATION**

| Item 1

                          | Financial Statements                                                                                                                                         |
|----------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------|
|  

                          | Condensed Consolidated Balance                        Sheets at March 31, 2008 (Unaudited) and June 30, 2007                                                 |
|  

                          | Condensed Consolidated Statements                        of Operations (Unaudited) for the three months ended March 31, 2008 and                        2007 |
|  

                          | Condensed Consolidated                        Statements of Operations (Unaudited) for the nine months ended March 31,                        2008 and 2007  |
|  

                          | Condensed Consolidated Statements                        of Cash Flows (Unaudited) for nine months ended March 31, 2008 and                        2007      |
|  

                          | Notes to the Condensed Consolidated                        Financial Statements (Unaudited)                                                                  |
| Item 2

                          | Management’s Discussion and                        Analysis of Financial Condition and Results of Operations                                           |
| Item 3

                          | Quantitative and Qualitative                        Disclosures About Market Risk                                                                            |
| Item 4

                          | Controls and Procedures                                                                                                                                      |

 

**PART II        – OTHER INFORMATION**

| Item 1

                           | Legal Proceedings                                                                  |
|-----------------------------------------|------------------------------------------------------------------------------------|
| Item 1A

                          | Risk Factors                                                                       |
| Item 2

                           | Unregistered Sales of Equity                        Securities and Use of Proceeds |
| Item 3

                           | Defaults upon Senior                        Securities                             |
| Item 4

                           | Submission of Matters to a Vote of                        Security Holders         |
| Item 5

                           | Other Information                                                                  |
| Item 6

                           | Exhibits                                                                           |
|  

                           | SIGNATURES                                                                         |

 

 

2

 

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**SILVERSTAR HOLDINGS, LTD. AND        SUBSIDIARIES**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

 

| **ASSETS**                                                                                                                                                                                                            | **March 31,**

**2008** | **June 30,****2007** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-------------------------|----------------------|
| Current Assets:                                                                                                                                                                                                       | **(Unaudited)**         |                 |
| Cash and cash equivalents, includes restricted cash                        of$756,370 and $590,990, respectively                                                                                                      | $7,408,235              | $3,693,149           |
| Cash restricted for foreign tax estimated                        liability                                                                                                                                            | 658,373                 | 1,064,040            |
| Accounts receivable, net                                                                                                                                                                                              | 2,240,510               | 6,908,846            |
| Inventories, net                                                                                                                                                                                                      | 808,022                 | 900,128              |
| Current portion of long-term notes receivable                                                                                                                                                                         | 294,147                 | 256,982              |
| Prepaid expenses and other current assets                                                                                                                                                                             | 430,376                 | 669,730              |
| Assets available for sale                                                                                                                                                                                             | -                       | 505,650              |
| Total current assets                                                                                                                                                                                                  | $11,839,663             | $13,998,525          |
| Property, plant and equipment, net                                                                                                                                                                                    | 526,085                 | 488,031              |
| Software development costs, net                                                                                                                                                                                       | 7,832,701               | 5,183,033            |
| Investments in non-marketable securities                                                                                                                                                                              | 1,131,066               | 1,143,566            |
| Long-term notes receivable                                                                                                                                                                                            | -                       | 214,222              |
| Goodwill, net                                                                                                                                                                                                         | 921,440                 | 890,038              |
| Intangible assets, net                                                                                                                                                                                                | 15,588,953              | 20,611,189           |
| Deferred tax asset                                                                                                                                                                                                    | 622,471                 | 625,217              |
| Deferred charges and other assets                                                                                                                                                                                     | 1,047,021               | 631,843              |
| Total assets                                                                                                                                                                                                          | $39,509,400             | $43,785,664          |
| **LIABILITIES AND STOCKHOLDERS’                        EQUITY**                                                                                                                                                 |                    |                 |
| Current Liabilities:                                                                                                                                                                                                  |                    |                 |
| Lines of credit                                                                                                                                                                                                       | $2,203,292              | $2,875,472           |
| Notes payable – acquisition                                                                                                                                                                                     | 2,665                   | 5,475,179            |
| Earn out notes payable - acquisition                                                                                                                                                                                  | 3,953,887               | 3,847,426            |
| Accounts payable                                                                                                                                                                                                      | 3,519,416               | 6,959,835            |
| Accrued royalty expense                                                                                                                                                                                               | 1,655,577               | 2,937,887            |
| Accrued expenses                                                                                                                                                                                                      | 2,281,038               | 3,355,852            |
| Deposit on July 2007 private placement                                                                                                                                                                                | -                       | 630,403              |
| Estimated liability for foreign tax                                                                                                                                                                                   | 271,685                 | 616,458              |
| Total current liabilities                                                                                                                                                                                             | 13,887,560              | 26,698,512           |
|                                                                                                                                                                                                                  |                    |                 |
| Convertible secured debentures                                                                                                                                                                                        | 7,246,238               | 4,790,779            |
| Other long-term liabilities                                                                                                                                                                                           | 419,024                 | 412,363              |
| Total Liabilities                                                                                                                                                                                                     | $21,552,822             | $31,901,654          |
| Commitments, contingencies and other matters                                                                                                                                                                          |                    |                 |
| Stockholders’ equity:                                                                                                                                                                                           |                    |                 |
| Preferred stock, $.01 par value; 5,000,000 shares                        authorized;no shares issued and outstanding                                                                                                  |  

-               |  

-            |
| Common stock, Class A, $.01 par value, 50,000,000 shares                        authorized; 19,806,177, 1,496,700 shares in treasury and 9,621,891 shares                        issued and outstanding, respectively | 198,061                 | 96,218               |
| Common stock, Class B, $.01 par value; 2,000,000 shares                        authorized; 0 shares and 835,260 shares issued and outstanding,                        respectively                                    | -                       | 8,353                |
| Common stock, FSAH Class B $.001 par value; 10,000,000                        shares authorized;0 and 2,671,087 shares issued and outstanding,                        respectively                                    | -                       | 600                  |
| Additional paid-in capital                                                                                                                                                                                            | 82,720,580              | 67,843,919           |
| Accumulated deficit                                                                                                                                                                                                   | (65,525,174)            | (56,796,978)         |
| Accumulated comprehensive income                                                                                                                                                                                      | 563,111                 | 731,898              |
| Total stockholders’ equity                                                                                                                                                                                      | 17,956,578              | 11,884,010           |
| Total liabilities and stockholders’ equity                                                                                                                                                                      | $39,509,400             | $43,785,664          |

         

See notes to condensed consolidated financial statements

 

3

 

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**SILVERSTAR HOLDINGS, LTD. AND        SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(UNAUDITED)**

 

                                                                                                                                                             

|                                                                                 | **Three Months Ended March 31,** |
|--------------------------------------------------------------------------------------|----------------------------------|
|                                                                                 | **2008**                         | **2007** |
| Net Revenues                                                                         | $5,861,240                       | $4,603,017 |
| Operating expenses:                                                                  |                             |   |
| Cost of sales                                                                        | 2,370,810                        | 1,782,905 |
| Development costs and royalties                                                      | 327,017                          | 399,609 |
| Selling, general and administrative                                                  | 3,147,412                        | 2,689,716 |
| Amortization of software development costs                                           | 1,246.772                        | 53,617 |
| Amortization of acquired intangibles                                                 | 1,054,426                        | 1,929,917 |
| Depreciation                                                                         | 50,238                           | 62,458 |
|                                                                       | 8,196,675                        | 6,918,222 |
| Operating loss                                                                       | (2,335,435)                      | (2.315,205) |
|                                                                       |                             |   |
| Other income (expense)                                                               | 2                                | (426) |
| Foreign currency loss                                                                | (280,448)                        | (88,212) |
| Amortization of convertible debt discounts and issuance                        costs | (63,073)                         | (172,990) |
| Interest expense                                                                     | (129,100)                        | (254,155) |
| Interest income                                                                      | 41,487                           | 89,697 |
| Loss before income taxes                                                             | (2,766,567)                      | (2,741,291) |
| Provision for income taxes                                                           | (821)                            | (9,737) |
| Net Loss                                                                             | ($2,767,388)                     | ($2,751,028) |
|                                                                                 |                             |   |
| Loss per share:                                                                      |                             |   |
| Basic and diluted                                                                    | ($.14)                           | ($.27) |
|                                                                       |                             |   |
| Weighted average common stock outstanding:                                           |                             |   |
| Basic and diluted                                                                    | 19,806,117                       | 10,119,834 |

 

See notes to condensed consolidated financial statements

 

4

 

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**SILVERSTAR HOLDINGS, LTD. AND        SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(UNAUDITED)**

 

|                                                                                 | **Nine Months Ended March 31,** |
|--------------------------------------------------------------------------------------|---------------------------------|
|                                                                                 | **2008**                        | **2007** |
| Net Revenues                                                                         | $20,536,813                     | $7,842,551 |
| Operating Expenses:                                                                  |                            |   |
| Cost of sales                                                                        | 8,187,392                       | 3,154,475 |
| Development costs and royalties                                                      | 1,342,124                       | 1,455,325 |
| Selling, general and administrative                                                  | 10,299,600                      | 4,754,887 |
| Amortization of software development costs                                           | 2,795,404                       | 53,617 |
| Amortization of acquired intangibles                                                 | 5,488,688                       | 2,603,105 |
| Depreciation                                                                         | 141,065                         | 95,136 |
|                                                                                 | 28,254,273                      | 12,116,545 |
|                                                                                 |                            |   |
| Operating loss                                                                       | (7,717,460)                     | (4,273,994) |
|                                                                                 |                            |   |
| Other income (expense)                                                               | (12,393)                        | (434) |
| Foreign currency (losses) gains                                                      | (227,420)                       | 7,143 |
| Gain on sale of fixed assets                                                         | 90,348                          | - |
| Amortization of convertible debt discounts and issuance                        costs | (617,989)                       | (503,522) |
| Interest expense                                                                     | (430,562)                       | (614,878) |
| Interest income                                                                      | 187,092                         | 404,645 |
| Loss before income taxes                                                             | (8,728,384)                     | (4,981,040 |
| Benefit (provision) for income taxes                                                 | 185                             | (13,907) |
| Net loss                                                                             | ($8,728,199)                    | ($4,994,137) |
|                                                                                 |                            |   |
| Loss per share:                                                                      |                            |   |
| Basic and diluted                                                                    | ($.49)                          | ($.52) |
| Weighted average common stock outstanding:                                           |                            |   |
| Basic and diluted                                                                    | 17,889,808                      | 9,566,842 |

 

See notes to condensed consolidated financial statements

 

 

5

 

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**SILVERSTAR HOLDINGS, LTD. AND        SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOW**

**(UNAUDITED)**

 

|                                                                                                                      | **Nine Months Ended March 31,** |
|---------------------------------------------------------------------------------------------------------------------------|---------------------------------|
|                                                                                                                      | **2008**                        | **2007** |
| Cash flows from operating activities:                                                                                     |                            |   |
| Net loss                                                                                                                  | ($8,728,199)                    | ($4,994,137) |
| Adjustments to reconcile net loss to net cash used in                        operating activities:                        |                            |   |
| Depreciation and amortization                                                                                             | 9,043,146                       | 3,255,380 |
| Loss on disposal of marketable securities                                                                                 | 12,500                          | - |
| (Gain) loss on disposal of fixed assets                                                                                   | (90,348)                        | 10,195 |
| Stock-based compensation                                                                                                  | 346,492                         | 196,824 |
| Stock issued for services                                                                                                 | 45,067                          | 308,740 |
| Bad debt expense (recovery)                                                                                               | (40,237)                        | 80,801 |
| Unrealized foreign currency (gains) losses                                                                                | 11,863                          | (19,215) |
| Accrued interest income on notes receivable                                                                               | (19.042)                        | (20,782) |
| Changes in operating assets and liabilities, net (see note                        6)                                      | (6,966,640)                     | (119,006) |
| Decrease in estimated liability for foreign tax                                                                           | (291,829)                       | - |
| Increase (decrease) in other assets                                                                                       | 77,789                          | (14,675) |
| Increase in other liabilities                                                                                             | -                               | 173,025 |
| Net cash used in operating activities                                                                                     | ($6,599,438)                    | ($1,142,850) |
|                                                                                                            |                            |   |
| Cash flows from investing activities:                                                                                     |                            |   |
| Cash paid for acquisition of Empire                                                                                       | -                               | (8,072,070) |
| Proceeds from sale of fixed assets                                                                                        | 660,896                         | 11,008 |
| Purchase of intangible assets                                                                                             | (435,465)                       | - |
| Purchase of fixed assets                                                                                                  | (195,307)                       | (80,503) |
| Proceeds from repayment of long-term note                        receivable                                               | 137,619                         | 151,662 |
| Decrease in cash restricted for foreign tax estimated                        liability                                    | 281,762                         | - |
| Net cash provided by (used in) investing                        activities                                                | $449,505                        | ($7,989,903) |
|                                                                                                            |                            |   |
| Cash flows from financing activities:                                                                                     |                            |   |
| Short term borrowings (repayments), net                                                                                   | (6,009,228)                     | (66,302) |
| Net proceeds from convertible debenture less capitalized                        costs of

$936,024 and $270,286           |  

6,563,976               |  

1,129,714 |
| Proceeds from exercise of warrants                                                                                        | 1,397,937                       | - |
| Proceeds from private placement sales of common stock, net                        of

offering costs of $1,089,726 and $0 |  

7,910,269               |  

650,000 |
| Proceeds from the exercise of stock options                                                                               | 170,850                         | 56,472 |
| Purchase of treasury stock                                                                                                | -                               | (25,424) |
| Net cash provided by financing activities                                                                                 | 10,033,804                      | $1,744,460 |
|                                                                                                            |                            |   |
| Effect of exchange rates on cash                                                                                          | (168,785)                       | 345,276 |
| Net increase (decrease) in cash and cash                        equivalents                                               | 3,715,086                       | (7,043,017) |
| Cash and cash equivalents, beginning of period                                                                            | 3,693,149                       | 9,075,259 |
| Cash and cash equivalents, end of period                                                                                  | $7,408,235                      | $2,032,242 |
| Supplemental cash flow information:                                                                                       |                            |   |
| Cash paid for interest                                                                                                    | $521,650                        | $550,560 |
| Cash paid for income taxes                                                                                                | $800                            | $10,025 |

 

See notes to condensed consolidated financial statements

 

6

 

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**SILVERSTAR HOLDINGS, LTD. AND        SUBSIDIARIES**

**NOTES        TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

| **NOTE 1.** | **FINANCIAL INFORMATION** |
|-------------|---------------------------|

Silverstar Holdings, Ltd. (the “Company”) is the parent company        of Empire Interactive, PLC (“Empire”), a leading worldwide publisher of        interactive entertainment software for all game platforms, and Strategy First, Inc.        (“Strategy First”), a leading worldwide publisher of entertainment software for        the Personal Computer (PC). The Company is also a minority shareholder in Magnolia        Broadband Wireless, a development stage company which is developing mobile wireless        broadband products.

 

| **NOTE 2.** | **LIQUIDITY CONSIDERATIONS** |
|-------------|------------------------------|

 

Historically, we have met our cash flow requirements through the sale of        debt or equity securities, the sale of assets, or through operating cash flow. However,        there is no guarantee that we will be successful in meeting our cash flow requirements        going forward. We anticipate meeting our cash flow requirements through one or a        combination of the following:

|   | **•** | Generate significant short term operating earnings and cash                        flow primarily through our Empire subsidiary. Empire’s title release                        schedule for the next 12 months includes several multi-platform games most                        notably Hello Kitty and PipeMania. We anticipate that the launch of these                        games, along with Empire’s ongoing business will generate operating                        profits and cash flow in the short term. Empire continues to explore US                        distribution agreements with major entertainment publishers which would                        provide significant short term cash flow to us. |
|--------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | Raise additional capital through the exercise of existing                        warrants and the sale of equity or debt securities. The Company currently                        has approximately 7.78 million warrants outstanding with exercise prices                        ranging from $1.50 to $2.50. The company has a continuing relationship with                        an investment banking firm to assist it should it decide to raise                        additional capital in the future. |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Raise additional capital through the sale of certain                        intellectual property. The company has had preliminary discussions with a                        third party to sell certain of its intellectual property and would                        entertain the sale of such intellectual property should the sales price                        justify a transaction. |
|--------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | The Company has approximately $658,000 of restricted cash                        set aside to match our current South African tax assessment. We believe                        that we have strong arguments to set aside this assessment. If this                        assessment is set aside, this cash would be available for                        operations. |
|--------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

The        Company believes that these actions and others to be taken by us will improve liquidity and        achieve positive cash flow. However, there can be no assurance that any of these events        will occur.

 

| **NOTE 3.** | **BASIS OF PREPARATION** |
|-------------|--------------------------|

 

The        unaudited consolidated financial statements include the accounts of the Company and all of        its subsidiaries in which it has a majority voting interest. Investments in affiliates are        accounted for under the equity or cost method of accounting. All significant inter-company        accounts and transactions have been eliminated in the consolidated financial        statements.

 

Pursuant to the rules and regulations of the Securities and Exchange        Commission for Form 10-Q, the financial statements, footnote disclosures and other        information normally included in financial statements prepared in accordance with generally        accepted accounting principles have been condensed. The financial statements contained in        this report are unaudited but, in the opinion of the Company, reflect all

 

7

 

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adjustments, consisting of only normal recurring adjustments necessary to        fairly present the financial position of the Company as of March 31, 2008 and the results        of operations and cash flows for the interim periods of the fiscal year ending June 30,        2008 (“fiscal 2008”) and the fiscal year ended June 30, 2007 (“fiscal        2007”) presented herein. The results of operations for any interim period are not        necessarily indicative of results for the full year. These financial statements, footnote        disclosures and other information should be read in conjunction with the financial        statements and the notes thereto included in the Company’s annual report on Form 10-K        for the year ended June 30, 2007.

**Net        Income or Loss Per Share**

Basic        net income or loss per share is computed by dividing net income or loss by the weighted        average number of shares of common stock outstanding. Diluted net income or loss per share        is computed by dividing net income or loss by the weighted average number of shares of        common stock outstanding and dilutive potential shares of common stock reflecting the        dilutive effect of stock options, warrants, convertible debentures and shares to be issued        in connection with prior acquisitions. Dilutive potential common shares, stock options,        warrants and convertible debentures for all periods presented are computed utilizing the        treasury stock method. The dilutive effect of shares to be issued in connection with the        obligations related to prior acquisitions is computed using the average market price for        the quarter. The total number of shares that could potentially dilute earnings per share,        but which were not included in the calculations of diluted earnings per share because to do        so would have been anti-dilutive, was 20,194,451 and 18,706,909 for the three months ended        March 31, 2008 and 2007 respectively and 11,063,832 and 10,352,983 for the nine months        ended March 31, 2008 and 207, respectively.

**Cash        and Cash Equivalents**

Cash        and cash equivalents consist of cash and all highly liquid investments with original        maturities of three months or less. The vast majority of the Company’s cash balances        are held in liquid accounts at two highly rated financial institutions. While these        deposits are not insured, the quality of such financial institutions is such that the risks        of loss on these funds are minimal. Restricted cash balances at March 31, 2008 totaled        $756,370 which is used as collateral on the Company’s line of credit.

**Software Development Cost**

Historically, Empire has incurred significant software development expenses        in connection with the production of its products. Pursuant to Statement of Financial        Accounting Standards (“SFAS”) No. 86 an analysis must be conducted to determine        when commercial feasibility of a product is reached. Once commercial feasibility of a        product is reached, development expenses should start to be capitalized and then the        amortization process begins. There is no consensus in the interactive entertainment        software industry with respect to commercial feasibility of a product. Empire’s        management took the position that commercial feasibility was reached toward the end of the        development process and not, as some other companies do, at the beginning of the process.        As a result, Empire had not capitalized any development costs with respect to its products.        As previously disclosed, the Company undertook an evaluation and analysis of the        appropriateness of this position. This analysis was completed during the quarter ending        March 31, 2007. Based on this evaluation and analysis, the Company determined that there is        a clearly defined decision point early in the development process where a product evolves        from concept to commercial feasibility. This decision point is either reached with the        consent of third parities or through an internal process where management decides to move        forward with a product’s development once a game concept has been approved. The        Company also concluded those instances in which concept approval had been given and a game        did not become a commercial product did not have a material adverse effect on the Company.        As a result, the Company now capitalizes research and development expenses after concept        approval.

**Stock-Based Compensation**

In        December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS        No. 123R, “Share-Based Payment.” This standard replaced SFAS No. 123,        “Accounting for Stock-Based Compensation”

 

8

 

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and        supersedes Accounting Principles Board (“APB”) Opinion No. 25,        “Accounting for Stock Issued to Employees.” The standard requires companies to        recognize all share-based payments to employees, including grants of employee stock        options, in the financial statements based on their fair values on the grant date and is        effective for annual periods beginning after June 15, 2005. In accordance with the revised        statement, the Company recognizes the expenses attributable to stock options granted or        vested subsequent to July 1, 2005. During the nine month periods ended March 31, 2008 and        2007 the Company recognized expenses of $346,492 and $196,824 respectively, for employee        stock options and restricted shares that vested. Based on existing unvested option        agreements the Company anticipates an additional expense of approximately $62,908 in fiscal        2008 which could increase if additional options are granted during the fiscal year. As of        March 31, 2008, $582,929 of total unrecognized compensation costs related to non-vested        options is scheduled to be recognized over a weighted average period of 2.38 years. The        Company’s options and warrants outstanding and exercisable as of March 31, 2008 had        no intrinsic value.

The        weighted average grant date fair value of options granted during the nine months ended        March 31, 2008 and March 31, 2007 and the significant assumptions used in determining the        underlying fair value of each option grant on the date of the grant utilizing the Black        Scholes option pricing model are noted in the following table. Expected volatility is based        on historical volatility data of the Company’s stock. As a result of the acquisition        of Empire which significantly changed the size and complexity of the Company, the        volatility of options granted after March 31, 2007 were computed using the average        volatility of competitor companies in the entertainment software industry. Historical stock        prices would not be indicative of their future prices, since the Company itself is so        different from what it was historically. SFAS 123(R) requires the use of expected        volatility in the calculation of the compensation expense of a stock option. While it        allows the use of historical volatility in calculating expected volatility, it does not        require the use of historical volatility and encourages the use of other factors. The        expected term of stock options granted is based on historical data and represents the        period of time that stock options are expected to be outstanding. The risk-free rate of the        stock options is based on the United States Treasury rate in effect at the time of        grant.

 

|                                                                             | 2008       | 2007       |
|----------------------------------------------------------------------------------|------------|------------|
| Weighted average grant-date fair value of options                        granted | $.63       | $.71       |
| Assumptions:                                                                     |       |       |
| Risk free interest rate                                                          | 1.71-5.08% | 4.65-4.82% |
| Expected life                                                                    | 3-4 years  | 2-5 years  |
| Expected volatility                                                              | 40-42%     | 48-111%    |
| Expected dividend yield                                                          | 0%         | 0%         |

 

|                           |   | Share OptionsOutstanding |   | Weighted AverageExercise |   |
|--------------------------------|--------|--------------------------|--------|--------------------------|--------|
| Outstanding, beginning of year |   | 1,510,000                |   | 1.72                     |   |
| Granted                        |   | 885,000                  |   | 1.87                     |   |
| Exercised                      |   | (122,500)                |   | 1.39                     |   |
| Terminated                     |   | (21,666)                 |   | 1.69                     |   |
| Forfeited                      |   | (20,000)                 |   | .16                      |   |
| Outstanding March 31, 2008     |   | 2,230,834                |   | 1.81                     |   |

 

 

| **NOTE 4.** | **SOFTWARE DEVELOPMENT COSTS** |
|-------------|--------------------------------|

 

As of        March 31, 2008 and June 30, 2007, net capitalized software development costs totaled        $7,832,701 and $5,183,033, respectively. Total costs capitalized during the nine and three        months ended March 31, 2008 were $5,477,619 and $2,397,696, respectively. Accumulated        amortization at March 31, 2008 and June 30, 2007 totaled $3,114,740 and $341,260,        respectively. Capitalized software development costs are amortized over a five-year period        based on weighted average expected sales from the date the title is launched.

 

9

 

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| **NOTE 5.** | **INTANGIBLE ASSETS** |
|-------------|-----------------------|

 

The components of amortizable intangible assets as of March 31, 2008 and        June 30, 2007 are as follows:

 

|                               | EstimatedUseful                        Life | Gross Carrying

Amount | AccumulatedAmortization | Total       |
|------------------------------------|---------------------------------------------|------------------------|-------------------------|-------------|
| Game titles – Strategy First | 10 years                                    | 1,693,256              | 472.829                 | 1,220,427   |
| Game titles – Empire         | 5 years                                     | 23,195,112             | 8,826,586               | 14,368,526  |
| Balance on March 31, 2008          |                                        | $24,888,368            | ($9,299,415)            | $15,588,953 |
|                     |                                        |                   |                    |        |
|                               | EstimatedUseful                        Life | Gross Carrying

Amount | AccumulatedAmortization | Total       |
| Game titles – Strategy First | 10 years                                    | 1,635,552              | (334,032)               | 1,301,520   |
| Game titles – Empire         | 5 years                                     | 23,437,099             | (4,127,430)             | 19,309,669  |
| Balance on June 30, 2007           |                                        | $25,072,651            | ($4,461,462)            | $20,611,189 |

 

Intangible assets that are subject to amortization are reviewed for        potential impairment whenever events or circumstances indicate that carrying amounts may        not be recoverable. Assets not subject to amortization are tested for impairment at least        annually.

Game        titles acquired as part of the acquisition of Strategy First are amortized using the        straight-line method over a ten-year period. The game titles of Empire are amortized over a        five-year period based on weighted average expected sales from the date the title is        launched. For titles that have not been launched as of March 31, 2008 a launch date was        estimated to project future amortization. No launch date was estimated for game titles with        a cost basis of $ 8,233,927 at March 31, 2008. The Company is evaluating whether the future        development costs for new versions of these titles warrant the expenditure. In the event        that these titles are not developed into new products these franchises may be sold or        discontinued. The Company has received an indication of interest for the sale of the        largest of these titles which approximates its carrying cost. However, in the event that        these titles are discontinued or their sales price is below their current cost basis the        Company may be forced to reduce the carrying costs of these assets. If the Company decides        to sell these assets the titles will be reclassified on the balance sheet as a current        asset in accordance with SFAS 144.

Amortization expense for intangible assets for the three and nine month        periods ended March 31, 2008 were $1,054,426 and $5,488,688, respectively. Amortization        expense for intangible assets for the three and nine month periods ended March 31, 2007        were $1,929,917 and $2,603,105 respectively. Estimated amortization expense for the rest of        fiscal 2008 and for the succeeding five fiscal years is as follows:

| 2008       | $1.077,023  |
|------------|-------------|
| 2009       | 2,946,287   |
| 2010       | 1,529,150   |
| 2011       | 838,694     |
| 2012       | 419,268     |
| 2013       | 208,801     |
| Thereafter | 335,733     |
| Other      | 8,233,997   |
|            | $15,558,953 |

 

 

| **NOTE 6.** | **CASH FLOWS** |
|-------------|----------------|

|                                                                                         |   | Nine Months Ended March 31, |       |
|----------------------------------------------------------------------------------------------|--------|-----------------------------|------------|
| Changes in operating assets and liabilities consist of the                        following: |   | 2008                        |       | 2007 |   |
| Decrease in accounts receivable                                                              |   |                        | $4,755,500 |   |   | $412,338 |   |
| Decrease in inventories                                                                      |   |                        | 93,050     |   |   | 217,043 |   |

 

 

10

 

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| (Increase) decrease in prepaid expenses and current                        assets                                                                                 |   |   | 239,537      |   |   | (202,085)   |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------------|--------|--------|-------------|--------|
| Software development costs capitalized                                                                                                                            |   |   | (5,477,619)  |   |   | (2,575,675) |   |
| Increase (decrease) in accounts payable                                                                                                                           |   |   | (3,474,507)  |   |   | 1,097,961   |   |
| Decrease in refundable deposits                                                                                                                                   |   |   | (630,403)    |   |   | -           |   |
| Increase (decrease) in accrued expenses                                                                                                                           |   |   | (2,472,202)  |   |   | 931,412     |   |
|                                                                                                                                                              |   |   | ($6,966,640) |   |   | ($119,006)  |   |
| Non-cash investing and financing activities were as                        follows:

Issuance of shares of common stock for debt                        repayment |   |   | $3,600,000   |   |   | -           |   |
| Beneficial conversion feature of convertible debt                                                                                                                 |   |   | $621,480     |   |   | -           |   |
| Fair value of warrants for convertible debt                                                                                                                       |   |   | $996,480     |   |   | -           |   |
| Issuance of shares of common stock for payment of                        acquisition expenses                                                                     |   |   | -            |   |   | $723,000    |   |
| Issuance of notes payable to former Empire                        shareholders                                                                                    |   |   | -            |   |   | $5,208,052  |   |
| Con Issuance of earn out notes payable –                        acquisition                                                                                 |   |   | -            |   |   | $12,051,061 |   |

 

 

| **NOTE 7** | **ACQUISITION** |
|------------|-----------------|

 

**Empire Interactive**

 

On        December 4, 2006, the Company announced that it had achieved more than 90% acceptance of        its offer to acquire the shares of Empire. Based on these acceptances, the Company        announced a formal closing of the offer to Empire shareholders and took control effective        December 1, 2006.

 

The        offer provided for either a cash payment of approximately $.13 per share (£.07 p), or        an earn-out alternative, where the initial payment was approximately $.09 per share        (£.049 p), with a further $.094 per share (£.05 p) in loan notes payable in        October 2007. Additionally, there is an earn-out payable in April 2008. The earn-out was        based on a formula of Empire’s EBITDA (as defined) for the fiscal year ended June 30,        2007. The earn out has been calculated and the Company’s March 31, 2008 balance sheet        includes a liability of approximately $3.95 million (£1.98 million) based on the        March 31, 2008 foreign exchange rate of $1.9951 US dollars to the British pound.

 

The        aggregate purchase price for Empire’s stock was approximately $17.98 million        (£9.22 million) (after adjusting for the actual earn out payable) based on the        December 1, 2006 foreign exchange rate of 1.9508 US dollar to the UK pound of which amount        approximately $5.2 million are loan notes which matured October 31, 2007 (of which all but        $3 thousand had been repaid as of March 31, 2008) and $3.8 million are loan notes payable        in April 2008 (of which $.00 had been repaid as of March 31, 2007). $.7 million of the        acquisition expenses were paid by the issuance of 406,180 shares of Silverstar’s        Class A common stock. Of this amount 350,000 shares were issued to a consultant to the        Company as a finder’s fee for the transaction pursuant to his consulting contract.        The consultant was subsequently appointed Chairman of the Board of Empire. Of the remaining        $8.3 million of the purchase price approximately $7.9 million has been paid by utilizing        the Company’s internal cash resources. The remaining $.4 million has been accrued as        a short-term liability.

The        purchase price was allocated on the basis of the estimated fair values of the assets        acquired and liabilities assumed.

 

11

 

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The fair value of the assets acquired and liabilities assumed        exceeded the purchase price and, therefore, the excess was allocated as a pro-rata        reduction of non-current assets, specifically intangible assets. The acquisition was        accounted for as a purchase. The intangible assets identified in connection with the        acquisition were recorded and are being amortized in accordance with the provisions of SFAS        No. 141 and 142. Details of the purchase price are as follows:

 

|  

Net assets acquired: |   |   |        |   |
|------------------------------|--------|--------|-------------|--------|
| Current assets               |   |   | $3,226,228  |   |
| Fixed assets                 |   |   | 898,804     |   |
| Intangible assets            |   |   | 23,238,073  |   |
| Other assets                 |   |   | 608,650     |   |
| Total assets                 |   |   | 27,971,755  |   |
| Total liabilities            |   |   | (9,987,976  | )      |
| Purchase price               |   |   | $17,983,779 |   |

 

The        following unaudited proforma summary presents consolidated financial information as if the        acquisition of Empire had occurred effective July 1, 2006. The proforma information does        not necessarily reflect the actual results that would have occurred, nor is it necessarily        indicative of future results of operations of the consolidated entities.

 

|              |   | Nine Months Ended

March 31, 2007 |
|-------------------|--------|-----------------------------------|
| Net revenues      |   | $18,276,963                       |   |
| Net loss          |   | ($6,746,019                       | ) |
| Loss per share:   |   |                              |   |
| Basic and diluted |   | ($.71                             | ) |

 

 

| **NOTE 8.** | **DEBT** |
|-------------|----------|

 

**Lines of Credit**

In June        2002, the Company obtained a secured line of credit facility for borrowings up to $1.0        million, which is fully secured by cash balances held in the Company’s account. This        liability is due on demand and has a floating interest rate that is based on the prime rate        minus 1.75%. On March 31, 2008, the prime rate was 5.25%. The balance outstanding under        this line of credit at March 31, 2008 and June 30, 2007 was $756,370 and $590,990        respectively.

Empire        has a line of credit secured by its receivables, inventory, and intangible assets. As of        March 31, 2008 and June 30, 2007 the amount outstanding under this facility was $1,446,922        (£725,238) and $2,284,482 (£1,140,018), respectively. The line of credit        accrues interest at an annual rate of 8.25%.

**Notes Payable**

On        March 31, 2008 the Company owed $2,665 in notes payable to former shareholders of Empire        pursuant to the offer made for the acquisition of Empire. The Company owed $5,475,179 on        these notes at June 30, 2007. This amount included accrued interest at 4% per annum and was        payable on October 31, 2007. All note holders who have tendered their notes have been paid        in full.

The        Company owed $3,953,887 as of March 31, 2008 as earn out consideration based on        Empire’s EBITDA for the fiscal year ended June 30, 2007 and is payable on April 30,        2008. The balance on these notes at June 30, 2007 was $3,847,426. Interest accrued at 4%        per annum beginning November 1, 2007.

The        Company paid off approximately $2,800,000 of this debt in April 2008.

 

 

12

 

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| **NOTE 9.** | **CONVERTIBLE SECURED DEBENTURES** |
|-------------|------------------------------------|

 

On        October 31, 2005, the Company issued to DKR SoundShore Oasis Holding Fund Ltd. (the        “Purchaser”) a $5,000,000 principal amount Variable Rate Secured Convertible        Debenture due October 31, 2008 (the “2005 Debenture”) and a five year warrant        to purchase 791,139 shares of the Company’s common stock at an exercise price of        $1.896 per share (the “Warrant”).

In May        2006, the Company repaid $1,400,000 of the outstanding principal balance along with an        early payment penalty of approximately $210,000. During the nine months ended March 31,        2007, the Purchaser converted the remaining $3,600,000 outstanding principal amount of the        2005 Debenture for 2,164,899 shares of Class A common stock. The Company paid monthly        interest on the outstanding principal amount of the 2006 Debenture at a rate per annum        equal to the prime rate for the applicable interest period plus 1.5%.

On        October 19, 2006, the Company issued to the Purchaser another Variable Rate Secured        Convertible Debenture in the principal amount of $1,400,000 due October 31, 2008 (the        “2006 Debenture”). The 2006 Debenture is convertible at the option of the        Purchaser, into shares of common stock at a conversion price of $1.738 per        share.

The        Company pays monthly interest on the outstanding principal amount of the 2006 Debenture at        a rate per annum equal to the prime rate for the applicable interest period plus 1.5%. The        interest rate for any interest period decreases by 2% to the extent that the volume        weighted average trading price of the common stock for the five consecutive trading days        immediately prior to such interest period (the “Trigger Price”) exceeds the        conversion price by 25% (and shall be decreased by an additional 2% for every successive        25% that the Trigger Price exceeds the then applicable conversion price but in no event        shall the interest rate be less than 0%). All overdue accrued and unpaid interest to be        paid under the 2006 Debenture shall entail a late fee at a rate of 18% per        annum.

The        Purchaser and the Company amended the terms of the 2006 Debenture in June 2007. Under the        terms of the amendment (i) the maturity date of the 2005 Debenture was extended to April        30, 2010; (ii) there will be no amortization of principal under the Debenture; and (iii)        the Debenture will be mandatorily convertible if the closing sale price of the        Company’s common stock equals or exceeds $3.48 per share. This mandatory conversion        is subject to volume requirements.

The        Company’s obligations under the 2006 Debenture are secured by a lien on certain        assets of the Company in favor of the Purchaser, and guaranteed by certain subsidiaries of        the Company. In addition, the obligations of the Company under the 2006 Debenture are        personally guaranteed by Mr. George Karfunkel. Mr. Karfunkel is compensated in        the amount of 5% of the current principal outstanding amount of the 2006 Debenture per        annum.

As        consideration for entering into the amendment, the Company reduced the exercise price of        the Warrant $.10 to $1.7986 per share. The fair value for the reduction in the exercise        price of the Warrant was estimated at the grant date using the Black-Scholes option pricing        model using the following weighted average assumptions: risk-free interest rate of 4.37%,        dividend yields of 0% and a volatility factor of the expected market price of the        Company’s common stock of 106.66%. Based upon the closing price per share of the        Company’s common stock on the date of issuance, the Company estimated the fair value        of the exercise price reduction and allocated $10,490 of the proceeds from the 2005        Debenture to the 2005 Warrant, which is presented as a discount on the 2005 Debenture, net        of amortization to be taken over term of the 2005 Debenture using the effective interest        method. As a result of the June 2007 debt modification the remaining fair values of the        Warrant is being amortized on a straight line method through April 30, 2010.

 

On March 19, 2008, the Company issued to accredited investors 9% Secured        Convertible Debentures in the aggregate principal amount of $7,500,000 due March 19, 2012        and warrants to purchase an aggregate of 3,124,999 shares of the Company's common stock,        par value $.01 per share at an exercise price of $1.50 per share. The term of the warrants        is five years.

 

 

13

 

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The Debentures are convertible at any time, at the option of        the purchasers, into shares of Common Stock at a conversion price of $1.2026 per share.        However, if after the date that a registration statement covering the resale of the shares        issuable upon conversion of the Debentures is effective, the average daily volume weighted        average price of the Common Stock for 30 consecutive trading days exceeds $2.40, the        Company may require the purchasers to convert all or part of their outstanding        Debentures.

 

The        value of the warrants and the conversion feature of the debentures using the using the        Black-Scholes option pricing model using the following weighted average assumptions:        risk-free interest rate of 2.36%, dividend yields of 0% and a volatility factor of the        expected market price of the Company’s common stock of 43.21% which resulted in the        warrants being valued at $996,480 and the conversion feature being valued at $621,480. The        warrants and the conversion feature are both being amortized using the straight line method        over the term of the Debenture.

 

The        Company’s obligations under the 2008 Debenture are secured by a lien on certain        assets of the Company in favor of the Purchaser, and guaranteed by all the subsidiaries of        the Company (except Empire Interactive PLC and Strategy First Inc.) and the Purchasers, and        guaranteed by certain subsidiaries of the Company. In addition, the obligations of the        Company under the 2008 Debenture are personally guaranteed by Mr. George Karfunkel.        Mr. Karfunkel is compensated in the amount of 6% of the current principal outstanding        amount of the 2008 Debenture per annum.

 

During        the nine months ending March 31, 2008 the Purchaser converted an aggregate amount of        $3,600,000 of their 2005 Debenture in exchange for 2,164,899 shares of Class A common        stock,

 

The        balance of the notes as of March 31, 2008 and June 30, 2007, net of unamortized discounts        was as follows:

 

|                                              |   |   | March 31   |   |   | June 30,   |   |
|---------------------------------------------------|--------|--------|------------|--------|--------|------------|--------|
|                                              |   |   | 2008       |   |   | 2007       |   |
| Principal amount of notes                         |   |   | $8,900,000 |   |   | $5,000,000 |   |
| Discounts for beneficial conversion features      |   |   | (629,737   | )      |   | (58,765    | )      |
| Discounts for fair value of warrants and

Options |   |   | (1,024,025 | )      |   | (150,456   | )      |
| Balance, net of unamortized discounts             |   |   | $7,246,238 |   |   | $4,790,779 |   |
| Less current portion                              |   |   | —    |   |   | —    |   |
| Long-term portion                                 |   |   | $7,246,238 |   |   | $4,790,779 |   |

 

Scheduled maturities of the convertible debentures as of March 31, 2008 are        as follows:

 

| 1 Year or less |   |   | -          |
|----------------|--------|--------|------------|
| April 30, 2010 |   |   | $1,400,000 |
| March 19, 2012 |   |   | 7,500,000  |
| Total          |   |   | $8,900,000 |

 

Interest        expense related to the notes amounted to $115,041 and $36,857 during the nine and three        months ended March 31, 2008, respectively.

 

Amortization of discounts for the beneficial conversion features and        warrants resulted in charges to Amortization of Convertible Debt Discounts and Issuance        Costs totaling $173,418 and $17,110 during the nine and three months ended March 31, 2008        respectively The Company also incurred loan costs of $2,205,144 directly related to        securing these notes, which includes $1,020,000 paid for personal guarantees on the        outstanding balances. The annual guarantees are equal to 5% of the outstanding loan balance        on the Convertible debt that was modified in June of 2007 and 6% of the March 19, 2008        debenture. The loan costs were originally amortized over the term of the notes. As a result        of the June 2007 debt modification the remaining loan issuance costs are being amortized on        a straight line method through April 30, 2010. Loan costs incurred in connection with the        March 19, 2008 debenture are being amortized on a straight line method through March 19,        2012.The annual guarantee fees are amortized over twelve months. Amortization expenses for        the guarantee and debt issuance costs totaled $444,571 and $45,963 for the nine and three        months ended March 31, 2008 respectively.

 

14

 

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| **NOTE 10.** | **COMMITMENTS, CONTINGENCIES AND LEGAL                        MATTERS** |
|--------------|-------------------------------------------------------------------------|

 

In        April 2006, the Company’s First South African subsidiary received a letter from the        South African Revenue Service (“SARS”) challenging certain tax treatment of        dividends and operating loss carry forwards for the years 2002 through 2004. Subsequently        SARS issued two tax assessments for approximately $2.9 million. The Company had contended        that its South African tax filings were in full compliance with all applicable laws and had        vigorously defended its position in this regard. The Company had retained an amount of cash        equal to the assessments in South Africa to satisfy any potential liability that may        arise.

In May        2007, the Company through an arbitration procedure with SARS reached an agreement whereby        SARS agreed in principle to drop the larger of its two assessments. The Company conceded        the principle of SARS second assessment. On August 31, 2007, the Company paid approximately        $300,000 to SARS in regard to this assessment. The Company is vigorously disputing a        further amount of R5,394,708 (approximately $658,373 based on the March 31 foreign exchange        of $.12355 US dollars to one South African Rand) and believes it has strong arguments in        this regard based on among other factors, computational errors made by SARS in its        assessment. Based on its payments to SARS, the Company has reduced its estimated liability        to R2,216,286 (approximately $271,685). The Company believes its remaining liability to        SARS is lower than this amount, however, in the event its arguments are unsuccessful, it        may be forced to increase this liability. In April 2008 the Company brought a request        seeking a court order to dismiss SARS’ claims in this regard. A ruling on this        request should be made within the next few months.

In        August 2007, Empire was served with a lawsuit brought by a former distributor in Portugal.        The lawsuit claims that Empire had no right to utilize other distributors in Portugal and        seeks 630,000 euros (approximately $995,400 based on the March 31, 2008 foreign exchange        rate of $1.5800 US dollars to one Euro) in damages. Empire believes this claim has no merit        as its distribution agreements are tailored for individual products only and do not give        blanket distribution rights to outside distributors. Empire intends to vigorously defend        itself.

**Commitments and Contingencies**

During        the first quarter of fiscal 2006, the Company entered into agreements with two of Strategy        First’s game developers to guarantee certain of their royalty payments. The guarantee        is limited to $100,000. Royalties owed to these developers as of March 31, 2008 are less        than $20,000.

The        Company anticipates that Strategy First will pay the royalties due to its developers when        earned and does not anticipate having to make any payments under these        guarantees.

On        March 29, 2006, Strategy First entered into an agreement to acquire certain intellectual        property rights for $200,000 in cash and the issuance of options to acquire 100,000 shares        of the Company’s common stock at an exercise price of $1.50. The options vest when        net sales, as defined in the purchase agreement, exceed $750,000 and expire on December 31,        2008. The agreement also provides for commissions of twenty-five percent of net sales in        the event they exceed $500,000 through December 31, 2008. As of March 31, 2008 revenues        earned since inception under this agreement totaled approximately $360,000.

 

 

15

 

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On        December 4, 2006, the Company announced that it had achieved more than 90% acceptance of        the Company’s offer to acquire the shares of Empire. Based on these acceptances, the        Company announced a formal closing of the offer to Empire shareholders effective December        1, 2006. The Company paid consideration to the shareholders as follows: approximately $6.8        million paid at closing; an additional $5.5 million in loan notes payable on October 31,        2007; and further contingent consideration of $3.9 million based on Empire’s EBIDTA        for the 12 months ended June 30, 2007 and due on April 30, 2008. As of March 31, 2008 all        amounts have been satisfied except for the April 30, 2008 payment of approximately $3.95        million and approximately $3 thousand on the loan notes payable that were due October 31,        2007.

 

| **NOTE 11.** | **NEW ACCOUNTING PRONOUNCEMENTS** |
|--------------|-----------------------------------|

 

In        February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial        Instruments, an amendment of FASB Statements No. 133 and 140.” This statement permits        fair value remeasurement for any hybrid financial instrument that contains an embedded        derivative that otherwise would require bifurcation, and eliminates a restriction on the        passive derivative instruments that a qualifying special-purpose entity (SPE) may hold. The        statement is effective for fiscal years beginning after September 15, 2006. The Company        does not believe this standard will have a material effect on its financial position or        results of operations.

 

In        July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for        Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109.” This        Interpretation prescribes a recognition threshold and measurement attribute for the        financial statement recognition and measurement of a tax position taken or expected to be        taken in a tax return. This Interpretation also provides guidance on de-recognition,        classification, interest and penalties, accounting in interim periods, disclosure, and        transition. The Interpretation is effective for fiscal years beginning after December 15,        2006. The Company has evaluated the potential impact of FIN 48 on its consolidated        financial statements and has not identified any material uncertain tax positions requiring        disclosure under this interpretation.

 

In        September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” This        Statement defines fair value, establishes a framework for measuring fair value and expands        disclosure about fair value measurements, and is effective for financial statements issued        for fiscal years beginning after November 15, 2007, and interim periods within those fiscal        years. The Company is currently evaluating the effect that the adoption of this Statement        will have on its consolidated results of operations and financial condition.

 

On        February 15, 2007, the FASB issued Statement of Financial Accounting Standards No. 159,        “The Fair Value Option for Financial Assets and Financial Liabilities –        including an Amendment of FASB Statement No. 115” (“FASB 159”). This        standard permits an entity to measure financial instruments and certain other items at the        estimated fair value. Most of the provisions of SFAS No. 159 are elective; however, the        amendment to FASB No. 15, “Accounting for Certain Investments in Debt and Equity        Securities,” applies to all entities that own trading and available-for-sale        securities. The fair value option created by SFAS 159 permits an entity to measure eligible        items at fair value as of specified election dates. The fair value option (a) may generally        be applied instrument by instrument, (b) is irrevocable unless a new election date occurs,        and (c) must be applied to the entire instrument and not to only a portion of the        instrument. SFAS 159 is effective as of the beginning of the first fiscal year that begins        after November 15, 2007. Early adoption is permitted as of the beginning of the previous        fiscal year provided that the entity (i) makes that choice in the first 120 days of that        year, (ii) has not yet issued financial statements for any interim period of such year, and        (iii) elects to apply the provisions of FASB 157. The Company is currently evaluating the        impact of SFAS 159, if any, on its consolidated financial statements.

 

In        December 2007, the FASB issued SFAS No. 141(R), Business Combinations, or SFAS 141(R).        SFAS 141(R) establishes principles and requirements for how the acquirer of a business        recognizes and measures in its financial statements the identifiable assets acquired, the        liabilities assumed, and any non-controlling interest in the acquiree. SFAS 141(R) also        provides guidance for recognizing and measuring the goodwill acquired in the business        combination and determines what information to disclose to enable users of the financial        statements to evaluate the nature and financial effects of the business combination. The        provisions of SFAS 141(R) are effective for financial statements issued for fiscal years        beginning after December 15, 2008. We are currently assessing the financial impact of        SFAS 141(R) on our consolidated financial statements.

 

16

 

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In        December 2007, the FASB issued SFAS 160, Non-controlling Interests in Consolidated        Financial Statements — An Amendment of ARB No. 51, or SFAS 160. SFAS 160 amends        Accounting Research Bulletin No. 51, “Consolidated Financial Statements,”        or ARB 51, to establish accounting and reporting standards for the non-controlling interest        in a subsidiary and for the deconsolidation of a subsidiary. This statement also amends        certain of ARB 51’s consolidation procedures for consistency with the requirements of        SFAS 141(R). In addition, SFAS 160 also includes expanded disclosure requirements regarding        the interests of the parent and its non-controlling interest. The provisions of SFAS 160        are effective for fiscal years beginning March 1, 2009. Earlier adoption is        prohibited. We are currently assessing the financial impact of SFAS 160 on our consolidated        financial statements.

 

In March        2008, the FASB issued SFAS 161, Disclosures about Derivative Instruments and Hedging        Activities—an amendment of FASB Statement No. 133. SFAS 161 amends SFAS 133 and        changes the disclosure requirements for derivative instruments and hedging activities.        Entities are required to provide enhanced disclosures about (a) how and why an entity uses        derivative instruments, (b) how derivative instruments and related hedged items are        accounted for under Statement 133 and its related interpretations, and (c) how derivative        instruments and related hedged items affect an entity’s financial position, financial        performance, and cash flows. The Statement is effective for financial statements issued for        fiscal years and interim periods beginning after November 15, 2008, with early application        encouraged. We are currently assessing the financial impact of SFAS 161 on our consolidated        statements

 

| **NOTE 12.** | **PRIVATE PLACEMENT** |
|--------------|-----------------------|

 

Pursuant to a purchase agreement, dated July 2, 2007, by and among the        Company and certain accredited investors, the Company sold an aggregate of 6,206,891 shares        (the “Shares”) of its common stock and warrants (the “Warrants”) to        purchase up to 4,344,826 shares of its common stock at an exercise price of $2.10 per        share, at a price per unit of $1.45.

The sale        an issuance of the Shares and Warrants was structured to close in two closings. The first        closing was completed on July 5, 2007, pursuant to which the Company sold and issued an        aggregate of 2,057,495 Shares and Warrants to purchase up to an aggregate of 1,440,234        shares of its common stock. The second closing was completed on September 6, 2007, pursuant        to which the Company sold and issued an aggregate of 4,149,396 shares of its common stock        and Warrants to purchase up to 2,904,592 shares of its common stock at the second closing.        Net proceeds received from the sale of the Shares and Warrants under this agreement totaled        $7,915,264 which consisted of gross proceeds from the sale of stock and warrants of        $8,995,995 less issuance costs of $1,089,726.

 

| **NOTE 13.** | **SALE OF REAL PROPERTY** |
|--------------|---------------------------|

 

Empire        Interactive (Europe), Ltd. owned a freehold commercial business premises at Unit 2, Kings        Meadow, Olney Mead, Oxford OX2 0ES. The premises occupy 3,514 square feet and were vacant        since November 2006. The sale of this property was finalized on November 30, 2007. The        property was recorded on the balance sheet as a current asset at June 30, 2007 in        accordance with SFAS 144. Net proceeds from the sale of this property were $646,973 and the        gain recognized totaled $93,918.

 

| **NOTE 14.** | **SUBSEQUENT EVENTS** |
|--------------|-----------------------|

 

On April        14, 2008 stock options valued at $335,236 were granted to former Empire shareholders in        consideration for their reduction of the value of their earn out notes payable. These        options vest immediately and expire on December 31, 2010. The details of the options        granted are as follows:

 

17

 

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| Weighted average grant-date fair value of options                        granted | $.84       |
|----------------------------------------------------------------------------------|------------|
| Assumptions:                                                                     |       |
| Risk free interest rate                                                          | 1.88%      |
| Expected life                                                                    | 2.71 years |
| Expected volatility                                                              | 39.91%     |

         

Subsequent        to March 31, 2008, Empire signed a letter of intent to establish a lease for new office        space in London. The Company will be the guarantor on the lease. The term planned will be        five years (with a five-year option) with the rent expected to range from $261,000 to        $285,000 annually. Once the lease is executed, Empire plans to move within four months and        will then vacate their present space.

 

 

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| **ITEM 2** | **MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL                        CONDITION AND RESULTS OF OPERATIONS** |
|------------|------------------------------------------------------------------------------------------------------------------------|

The        following discussion should be read in conjunction with the Company’s condensed        consolidated financial statements and the related notes included therein and the        Company’s Annual Report on Form 10-K for the year ended June 30, 2007.

This        Management’s Discussion and Analysis of Financial Condition and Results of Operations        include forward-looking statements. We have based these forward-looking statements on our        current plans, expectations and beliefs about future events. Actual results could differ        materially because of factors discussed in “Risk Factors” in Part I,        Item 1A of our Annual Report on Form 10-K for the year ended June 30, 2007.

 

**Background and History**

         

We were        incorporated in September 1995. Our business plan is to actively manage and grow our        presence in the interactive software entertainment industry both organically and through        acquisitions.

 

We sold        our last remaining South African operations in November 2000 although we still have        significant assets that are denominated in South African Rand. The assets include cash and        notes receivables. Currently we do not have a financial hedging program to protect against        the depreciation of the South African Rand against the US dollar and, therefore, as long as        we hold assets denominated in South African Rand we will continue to record income        statement gains or losses to the extent that the South African Rand’s value        fluctuates relative to the US dollar.

 

On        April 21, 2005, we acquired Strategy First, a leading worldwide publisher of entertainment        software for the PC. We acquired Strategy First through the jurisdiction of the Montreal        bankruptcy court. Pursuant to the approved plan of arrangement, we paid (i) cash        consideration to the creditors of Strategy First of $609,000; (ii) issued 377,000 shares of        our common stock; (iii) issued warrants to purchase 200,000 shares of our common stock; and        (iv) assumed approximately $400,000 in existing bank debt, as well as contingent        consideration based on the future profitability of Strategy First.

On        December 4, 2006, we announced that we had achieved more than 90% acceptance of our offer        to acquire the shares of Empire. Based on these acceptances, we announced a formal closing        of the offer to Empire shareholders effective December 1, 2006. We paid consideration to        the shareholders as follows: approximately $6.8 million paid at closing and an additional        $5.5 million in loan notes which were paid in full during this quarter. Additionally,        further contingent consideration of approximately $3.8 million based on Empire’s        EBIDTA for the 12 months ended June 30, 2007 and this is due on April 30, 2008.

 

19

 

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**Quarter Ended March 31, 2008 As Compared to Quarter Ended March 31,        2007**

**Revenues**

Revenues increased $1.258 million to $5.861 million during the third quarter        of fiscal 2008 as compared to $4.603 million in the comparable quarter of the previous        year. This increase was primarily the result of higher unit sales due to increased title        releases during the quarter versus the same period last fiscal year. Empire’s revenue        in the comparable quarter was $3.630 million as compared to $5.565 for this quarter.        Strategy First’s revenue for this quarter was $.295 million versus $.973 million in        the comparable quarter last year. Strategy First generated significant additional online        revenue during the quarter ended March 31, 2007 primarily due to a contractual agreement        with Turner Gametap as well as online offerings. Empire’s revenue is derived        primarily from sales of console games and PC games while Strategy First solely sells PC        games.

**Cost        of Sales**

The        cost of sales was $2.371 million in the third quarter of fiscal 2008, or 40.4% of total        revenues. For the comparable quarter of the previous year, cost of sales was $1.783 million        or 38.7% of revenues. This increase was primarily the result of a higher proportion of        console game sales which have a lower margin than PC titles. Cost of goods sold consists        primarily of the actual tangible costs of the product along with any labor and overhead        costs.

**Development and Royalties**

Development and royalty costs decreased $.072 million for the third quarter        of fiscal 2008 over the comparable quarter in the previous year. The decrease primarily        relates to increased sales of Company owned intellectual property in the current quarter as        opposed titles supplied by outside parties. These products have lower royalty rates than        those supplied by third parties.

**Selling, General and Administrative Expenses**

Selling, general and administrative expenses for the third quarter of fiscal        2008 were $3.147 million, or 53.7% of sales, as compared to $2.690 million, or 58.4% of        sales, for the comparable quarter of the previous year. Of this $.458 million variance,        corporate overhead increased $.183 million due to non cash compensation and increased        payroll expenses as we have added management level employees to oversee our significantly        increased business. The balance of the increase of $.274 million was due primarily to        increased sales costs and additional personnel at the Empire subsidiary. Empire’s        SG&A consists mostly of administrative, marketing and sales staff primarily in the        United Kingdom.

**Amortization and Depreciation**

Amortization of software development costs and intangible assets in the        third quarter of fiscal 2008 increased by $.318 million versus the comparable quarter of        the previous year. Intangible amortization decreased by $.875 million primarily due to        accelerated amortization of intangible assets acquired in the Empire acquisition which        declines over time. $1.247 million of Empire’s software development costs were        amortized in this period as opposed to $.054 million of software development costs in the        comparable period last year. This was due primarily to the fact that the Company began        capitalizing software development costs during this period in 2007 and, therefore, had        minimal amortization expenses at that time. Depreciation expense was $50 thousand for the        third quarter of fiscal 2008 and $62 thousand in the comparable quarter of the previous        year, a decrease of $12 thousand. Empire’s assets comprise primarily of computers and        furniture and fixtures.

 

 

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**Foreign Currency Gains (Losses)**

Foreign        currency gains or losses are the result of subsidiaries of the Company using different        functional currencies and arise from fluctuations of the subsidiaries base currency against        the US dollar. The functional currency of Empire interactive and Strategy First are the        British pound and the Canadian dollar respectively. Gains (losses) from discontinued South        African operations are the result of fluctuations of the South African Rand against the US        dollar. Foreign currency losses during the third quarter of fiscal 2008 were $.280 million        and consisted of losses of $.370 million related to the remaining assets from the sale of        discontinued South African operations and gains of $.090 million recognized by our        operating subsidiaries. Foreign currency losses during the third quarter of fiscal 2007        were $.088 million and consisted of losses of $.093 million related to the remaining assets        from the sale of discontinued South African operations and gains of $.005 million        recognized by our operating subsidiaries.

**Amortization of Convertible Debt Discounts and Issuance        Costs**

Amortization of convertible debt discounts and issuance costs were $.063        million in the third quarter of fiscal 2008 as compared with $.173 million during the        comparable quarter in the previous year. These expenses relate to the issuances of our $5        million convertible debenture in October 2005 and the issuance of our $7.5 million        convertible debenture in March 2008. The decrease of $.11 million is due primarily to the        conversion of $3.6 million of debentures into approximately 2,150,000 shares of common        stock during fiscal 2008. Amortization of convertible debt discounts and issuance costs        related to our 2008 $7.5 million convertible debenture began March 19, 2008.

**Interest Income**

Interest income of $41,000 was recorded for the third quarter of fiscal 2008        as compared to interest income of $90,000 for the comparable quarter of the previous year.        The decrease of $49,000 is primarily the result of the Company’s lower average cash        balances.

**Interest Expense**

Interest expense of $129,000 was recorded for the third quarter of fiscal        2008 as compared to $254,000 in the comparable quarter of the previous year. Interest        expense decreased primarily as the result of lower interest charges on the convertible        debenture security due to lower principal amounts outstanding.

**Provision for Income Taxes**

We are        registered in Bermuda, where no income tax laws are applicable. Three of our subsidiaries        are subject to US income taxes, three subsidiaries are subject to United Kingdom income        taxes, one subsidiary is subject to Canadian income taxes and one is subject to South        African income taxes. None of them has had significant taxable income and overall the        Company has incurred losses for tax purposes. The deferred tax asset generated by the tax        losses and temporary differences has been fully reserved with the exception of        approximately $622,000 carried as a long-term asset that will be offset against future        taxable earnings of Empire in the UK.

In        April 2006, our First South African subsidiary received a letter from the South African        Revenue Service (“SARS”) challenging certain tax treatment of dividends and        operating loss carry forwards for the years 2002 through 2004. Subsequently SARS issued two        tax assessments for approximately $2.9 million. The Company had contended that its South        African tax filings were in full compliance with all applicable laws and had vigorously        defended its position in this regard. The Company had retained an amount of cash equal to        the assessments in South Africa to satisfy any potential liability that may        arise.

In May,        2007, the Company through an arbitration procedure with SARS reached an agreement whereby        SARS agreed in principle to drop the larger of its two assessments. The Company conceded        the principle of SARS second assessment. On August 31, 2007, the Company paid approximately        $300,000 to SARS in regard to this assessment. The Company is vigorously disputing a        further amount of approximately $770,000 and believes it has strong arguments in this        regard based on among other factors, computational errors made by SARS in its assessment.        Based on its payments to SARS, the Company has reduced its estimated liability to        approximately $271,000. The Company believes its remaining liability to SARS is lower than        this amount, however, in the event its arguments are unsuccessful, it may be forced to        increase this liability. In April 2008 the Company brought a request seeking a court order        to dismiss SARS’ claims in this regard. A ruling on this request should be made        within the next few months.

 

21

 

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**Net        Loss**

 

We have        recognized a net loss of $2.767 million during third quarter of fiscal 2008 compared to a        net loss of $2.751 million during the comparable quarter in the previous year. During the        quarter ended March 31, 2007 the Company capitalized $.690 million of software development        costs previously expensed. This had the effect of reducing the loss for the March 2007        quarter by $.690 million. The major component of this operating loss was amortization of        acquired intangibles and software development costs of $4.394 million. For the quarter        ended March 31, 2008, there was non-cash stock compensation of $.112 million as well as        common shares issued for services of $.021 million. Operating EBITDA Income was $.148        million and $.090 million for the quarters ended March 31, 2008 and March 31, 2007,        respectively.

 

|                                          | Quarters Ended March 31, |   |
|-----------------------------------------------|--------------------------|--------|
|                                          | 2008                     |   | 2007 |   |
| Operating EBITDA reconciliation:              |                     |   |   |   |
| Operating loss                                | ($2,335,435)             |   | ($2,315,205 | ) |
| Depreciation                                  | 50,238                   |   | 62,458 |   |
| Amortization of intangibles                   | 1,054,426                |   | 1,919,917 |   |
| Amortization of software development costs    | 1,246,772                |   | 53,617 |   |
| Stock -based compensation                     | 111,861                  |   | 119,239 |   |
| Shares issued for services                    | 20,676                   |   | 250.000 |   |
| Operating EBITDA                              | $148,538                 |   | $90,026 |   |
| Operating EBITDA per share                    | $.01                     |   | $.01 |   |
| Weighted average number of shares outstanding | 19.806,117               |   | 10,119,824 |   |

 

See        Note 4 to the financial statements for the amount of software development costs capitalized        during the period.

 

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**Nine        Months Ended March 31, 2008 As Compared to Nine Months Ended March 31, 2007**

**Revenues**

Revenues increased $12.694 million to $20.537 million during the first nine        months of fiscal 2008 as compared to $7.843 million in the comparable nine months of the        previous year. This increase was primarily the result of the increased revenue of Empire        Interactive PLC. Fiscal 2008 year to date revenues include the operations of Empire for        nine months versus four month of operations in the comparable period of the prior fiscal        year. Empire’s revenue’s increased $13.481 million from $5.670 million during        the four month period in fiscal year 2007 to $19.151 million for the nine months ended        March 31, 2008. Empire’s revenue is derived primarily from sales of console games and        PC games while Strategy First solely sells PC games.

**Cost        of Sales**

Cost of        sales was $8.187 million for the first nine months of fiscal 2008, or 39.8% of total        revenues. For the comparable nine months of the previous year, cost of sales was $3.154        million or 40.2% of revenues. Of this increase Empire accounted for $5,127 million for the        nine months and Strategy First had decreased cost of sales during the same period of $.094        million due to decreased sales. Cost of goods sold consists primarily of the actual        tangible costs of the product along with any labor and overhead costs.

**Development and Royalties**

         

Development and royalty costs decreased $113,000 for the first nine months        of fiscal 2008 over the comparable period in the previous year. Development and royalty        costs for Strategy First decreased approximately $221,000 from $447,000 during the nine        months ended March 31, 2007 to $226,000 during the same period in the current fiscal year.        Empire’s development and royalty costs increased approximately $107,000 during the        nine months ended March 31, 2008 as compared to the four months of activity that was        included in the same period of the prior fiscal year. Development costs and royalties when        measured as percentage of sales decreased to 5.8% from 17.8% in the comparable period of        the prior fiscal year. The decrease in the percentage of development and royalty costs for        both Strategy First and Empire was primarily caused by variances in the royalty percentages        due to outside parties and changes in the product mix. The development and royalty expense        consists primarily of royalty expenses due to third party holders of intellectual property        rights. Additionally it includes certain development costs which are not capitalized. These        costs are primarily related to the oversight and quality control of development projects.        These costs are primarily reflected in the Company’s payroll expenses.

**Selling, General and Administrative Expenses**

Selling, general and administrative expenses for the first nine months of        fiscal 2008 were $10.300 million, or 50.2% of sales, as compared to $4.755 million, or        60.6% of sales, for the comparable period of the previous year. Of this variance $5.063        million was due to the inclusion of Empire for nine months versus four months in the        comparable period last year. Empire’s SG&A consists mostly of administrative,        marketing and sales staff primarily in the United Kingdom. Corporate overhead expenses        increased $.697 million primarily as the result of increased non-cash compensation, and        increased payroll expenses as we have added management level employees to oversee our        significantly increased business.

**Amortization and Depreciation**

Amortization of software development costs and intangible assets in the        first nine months quarter of fiscal 2008 increased $5.627 million over the comparable        period of the previous year due to the inclusion of $5.489 million of amortization of        intangible assets acquired in the Empire acquisition and $2.795 million of Empire’s        software development costs amortized in this period as opposed to $2.603 million of        amortization of intangibles and $.054 million amortization of software development costs in        the comparable period last year. The acquisition of Empire was completed in December of        2006 therefore in

 

23

 

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the        comparable period there was only 4 months of intangible amortization as opposed to nine        months of amortization in this period. Additionally, due to a change in accounting for        software development costs in the third quarter of last year there was comparatively little        amortization in the comparable prior period versus a full nine months of amortization in        this period. Depreciation expense was $141,000 for the first nine months of fiscal 2008 and        $95,000 in the comparable period of the previous year, an increase of $46,000. This was due        to including depreciation of Empire’s assets for a full nine months versus four        months in the comparable period. Empire’s assets comprise primarily of computers and        furniture and fixtures.

**Foreign Currency Gains (Losses)**

Foreign        currency gains or losses are the result of subsidiaries of the Company using different        functional currencies and arise from fluctuations of the subsidiaries base currency against        the US dollar. The functional currency of Empire interactive and Strategy First are the        British pound and the Canadian dollar respectively. Gains (losses) from discontinued South        African operations are the result of fluctuations of the South African Rand against the US        dollar. Foreign currency losses during the nine months ended March 31, 2008 were $.0227        million and consisted of losses of $.303 million related to the remaining assets from the        sale of discontinued South African operations and gains of $.06 million recognized by our        operating subsidiaries. Foreign currency gains during the nine months ended March 31, 2007        were $.007, million and consisted of losses of $83,000 related to the remaining assets from        the sale of discontinued South African operations and gains of $90,000 recognized by our        operating subsidiaries.

**Amortization of Convertible Debt Discounts and Issuance        Costs**

Amortization of convertible debt discounts and issuance costs were $.618        million in the first nine months of fiscal 2008 as compared with $.504 million during the        comparable period in the previous year. These expenses relate to the issuance of our $5        million convertible debenture to DKR SoundShore Oasis in October 2005 and our $7.5 million        convertible debenture with certain accredited investors in March 2008 The increase of $.114        million is due primarily to the accelerated amortization upon the conversion of $3.6        million of debentures into approximately 2,150,000 shares of common stock during the nine        months ending March 31, 2008.

**Interest Income**

Interest income of $187 thousand was recorded for the first nine months of        fiscal 2008 as compared to interest income of $405 thousand for the comparable nine months        of the previous year. The decrease of $218 thousand is primarily the result of the        Company’s average lower cash balances.

**Interest Expense**

Interest expense of $.431 million was recorded for the first nine        months of fiscal 2008 as compared to $.615 million in the comparable nine months of the        previous year. Interest expense decreased primarily as the result of lower interest charges        on the 2005 convertible debenture security due to lower average principal amounts        outstanding and lower effective interest rates during the nine months ending March 31,        2008.

**Provision for Income Taxes**

We are        registered in Bermuda, where no income tax laws are applicable. Two of our subsidiaries are        subject to US income taxes, one subsidiary is subject to Canadian income taxes and one is        subject to South African income taxes. Up to this date, none of them has had taxable income        as they have incurred losses for tax purposes. The deferred tax asset generated by the tax        losses and temporary differences has been fully reserved.

 

24

 

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In        April 2006, the Company’s First South African subsidiary received a letter from the        South African Revenue Service (“SARS”) challenging certain tax treatment of        dividends and operating loss carry forwards for the years 2002 through 2004. Subsequently        SARS issued two tax assessments for approximately $2.9 million. The Company had contended        that its South African tax filings were in full compliance with all applicable laws and had        vigorously defended its position in this regard. The Company had retained an amount of cash        equal to the assessments in South Africa to satisfy any potential liability that may        arise.

In May        2007, the Company through an arbitration procedure with SARS reached an agreement whereby        SARS agreed in principle to drop the larger of its two assessments. The Company conceded        the principle of SARS second assessment. On August 31, 2007, the Company paid approximately        $300,000 to SARS in regard to this assessment. The Company is vigorously disputing a        further amount of R5,394,708 (approximately $658,373 based on the March 31 foreign exchange        of $.12355 US dollars to one South African Rand) and believes it has strong arguments in        this regard based on among other factors, computational errors made by SARS in its        assessment. Based on its payments to SARS, the Company has reduced its estimated liability        to R2,216,286 (approximately $271,685). The Company believes its remaining liability to        SARS is lower than this amount, however, in the event its arguments are unsuccessful, it        may be forced to increase this liability. In April 2008 the Company brought a request        seeking a court order to dismiss SARS’ claims in this regard. A ruling on this        request should be made within the next few months.

 

**Net        Loss**

         

We have        recognized a net loss of $8.728 million for the nine months ended March 31, 2008 as        compared to a net loss of $4.994 million during the comparable period in the previous year.        The comparable period in the prior year only included Empire’s results of operations        for four months. The major component of this operating loss was amortization of acquired        intangibles and software development costs of $8.284 million. There was non-cash stock        compensation $.346 million as well as common shares issued for services of $.045 million.        Operating EBITDA income (loss) was $1.099 million for the nine months ended March 31, 2008        and ($1.017) million for the nine months ended March 31, 2007.

 

|                                           |   | Nine Months Ended March 31, |   |
|------------------------------------------------|--------|-----------------------------|--------|
|                                           |   | 2008                        |   | 2007 |   |
| Operating EBITDA reconciliation:               |   |                        |   |   |   |
| Operating loss                                 |   | ($7,717,460)                |   | ($4,273,994) |   |
| Depreciation                                   |   | 141,065                     |   | 95,136 |   |
| Amortization of intangibles                    |   | 5,488,688                   |   | 2,603,105 |   |
| Amortization of software development costs     |   | 2,795,404                   |   | 53,617 |   |
| Stock-based compensation                       |   | 346,492                     |   | 196,824 |   |
| Shares issued for services                     |   | 45,067                      |   | 308,740 |   |
| Operating EBITDA                               |   | $1.099,256                  |   | ($1,016,572) |   |
| Operating EBITDA per share                     |   | $.06                        |   | ($.11) |   |
| Weighted average number of shares

Outstanding |   | 17,889,808                  |   | 9,566,842 |   |

         

See Note        4 to the financial statements for the amount of software development costs capitalized        during the period.

 

**Financial Condition, Liquidity and Capital Resources**

Cash        increased by approximately $3.715 million from $3.693 million at June 30, 2007 to $7.408        million at March 31, 2008 as a result of securing additional long term financing in March        2008.

 

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The        cash balances are being held for repayment of earn out notes, and working capital purposes.        Included in this amount is $.756 million which is classified as restricted cash. This        amount relates to cash used to guarantee a line of credit for our subsidiary, Strategy        First.

Working        capital deficit was $2.048 million at March 31, 2008 compared to a deficit of $12.700        million at June 30, 2007. This improvement of $10.652 million is primarily due to the        result of net proceeds from a private placement sale of common stock of approximately $7.91        million as well as repayment of a portion of notes payable to former Empire shareholders of        approximately 5.4 million. The company also received net proceeds of approximately 6.56        million from the issuance of a $7.50 million debenture in March 2008.

At        March 31, 2008 we had net borrowings of $2.200 million which consisted of advances against        the two lines of credit one secured by the Company’s cash the other secured by        Empire’s receivables, inventory, and intangible assets. Additionally, we have $1.400        million face amount outstanding in our convertible debenture issued to DKR SoundShore        Oasis. The carrying value of this debenture at March 31, 2008 net of unamortized warrants        and stock conversion features is approximately $1.353 million. We currently pay monthly        interest on this amount at a rate of prime plus 1.5%. However, there is an offset of this        interest based on share price. This debenture matures April 30, 2010. During March 2008 the        nominal interest rate was approximately 7%.

During        March, 2008 we issued $7.500 million of debentures with a carrying value of $5.894 million        as of March 31, 2008. We currently pay monthly interest on this amount at a rate of 9%.        These debentures mature on March 19, 2012. We also had seller note obligations of        approximately $3.9 million at March 31, 2008. We paid off approximately $2,800,000 of this        debt in April 2008 and expect to satisfy this obligation in full by June 30,        2008.

Historically, we have met our cash flow requirements through the sale of        debt or equity securities, the sale of assets, or through operating cash flow. However,        there is no guarantee that we will be successful in meeting our cash flow requirements        going forward. We anticipate meeting our cash flow requirements through one or a        combination of the following:

|   | **•** | Generate significant short term operating earnings and cash                        flow primarily through our Empire subsidiary. Empire’s title release                        schedule for the next 12 months includes several multi-platform games most                        notably Hello Kitty and PipeMania. We anticipate that the launch of these                        games, along with Empire’s ongoing business will generate operating                        profits and cash flow in the short term. Empire continues to explore US                        distribution agreements with major entertainment publishers which would                        provide significant short term cash flow to us. |
|--------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | Raise additional capital through the exercise of existing                        warrants and the sale of equity or debt securities. The Company currently                        has approximately 7.78 million warrants outstanding with exercise prices                        ranging from $1.50 to $2.50. The company has a continuing relationship with                        an investment banking firm to assist it should it decide to raise                        additional capital in the future. |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | Raise additional capital through the sale of certain                        intellectual property. The company has had preliminary discussions with a                        third party to sell certain of its intellectual property and would                        entertain the sale of such intellectual property should the sales price                        justify a transaction. |
|--------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

|   | **•** | The Company has approximately $658,000 of restricted cash                        set aside to match our current South African tax assessment. We believe                        that we have strong arguments to set aside this assessment. If this                        assessment is set aside, this cash would be available for                        operations. |
|--------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

The        Company believes that these actions and others to be taken by us will improve liquidity and        achieve positive cash flow. However, there can be no assurance that any of these events        will occur.

 

 

 

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**Critical Accounting Policies**

The        following is a discussion of the accounting policies that we believe are critical to our        operations:

**Revenue Recognition**

We        distribute the majority of its products through third-party software distributors to        mass-merchant and major retailers and directly to certain PC software retailers, all of        which have traditionally sold consumer entertainment software products. Additionally, we        may license its products to distributors in exchange for royalty payments. The distribution        of products is governed by purchase orders, distribution agreements or direct sale        agreements, most of which allow for product returns and price markdowns. On a product by        product basis, based on historical data we record a provision from 4% to 30% for product        returns and price markdowns as a reduction of gross sales at the time the product passes to        these distributors or retailers.

The        provision for anticipated product returns and price markdowns is primarily based upon our        analysis of historical product return and price markdown results. Should product        sell-through results at retail store locations fall significantly below anticipated levels        the adequacy of this allowance may be insufficient. We will review the adequacy of our        allowance for product returns and price markdowns and if necessary will make adjustments to        this allowance on a quarterly basis. In the case of royalty income, we will record this        income when earned based on sales reports from our distributors. In many cases, the company        receives guaranteed royalty income and these revenues are recorded upon signing of the        royalty agreements. These amounts are carried as accounts receivable until paid.

**Development Costs**

Under        SFAS No. 86 software development cost should be capitalized once technical feasibility is        achieved. In the case of Empire this would be when the product is commercially viable        (“commercial feasibility). We have determined to our satisfaction that there is a        clearly defined decision point quite early in development where a product passes from        concept to commercial feasibility. This decision point is either reached with the consent        of outside parties such as Sony or Microsoft or through an internal process where        management decides to move forward with a product’s development once a game concept        has been approved. To date, there has been no material instance where concept approval has        been given and a game has not become a commercial product. We have, therefore, decided to        capitalize software development costs after concept approval.

At        December 31, 2006 we were performing an analysis to determine when technical feasibility is        achieved. December 2006 software development costs of $693,268 were expensed during the        quarter ended December 31, 2006. Upon completion of the analysis, we capitalized these        December 2006 software development costs which resulted in our capitalizing $2,575,675 in        research and development costs during the quarter ended March 31, 2007.

The        table sets forth below the effect on the quarterly earnings for the nine and three months        ending March 31, 2007 had we capitalized our software development costs starting on        December 1, 2006.

 

|                                                                               |   | **Nine Months** | **Quarter**   | **Quarter**    | **Quarter**   |
|------------------------------------------------------------------------------------|--------|-----------------|---------------|----------------|---------------|
|                                                                               |   | **Ended**       | **Ended**     | **Ended**      | **Ended**     |
|                                                                               |   | **3/31/2007**   | **3/31/2007** | **12/31/2006** | **9/30/2006** |
|                                                                               |   |            |          |           |          |
| Net loss as reported                                                               |   | ($4,994,137)    | ($2,751,028)  | ($1,301,671)   | ($941,438)    |
| Effect of change in estimate                                                       |   | 3,026           | (690,242)     | 693,268        | -             |
| Net loss assuming                        capitalization

starting December 1, 2006 |   | ($4,991,111)    | ($3,441,270)  | ($608,403)     | ($941,438)    |
| Loss per share as reported:                                                        |   |            |          |           |          |
| Basic and diluted                                                                  |   | ($.52)          | ($.27)        | ($.14)         | ($.10)        |

| Loss per share assuming capitalization

starting December 1, 2006: |   |   |   |   |
|--------------------------------------------------------------------|--------|--------|--------|--------|
| Basic and diluted                                                  |   | ($.52) | ($.34) | ($.06) | ($.10) |
|                                                                    |        |        |        |        |  |

 

 

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**Goodwill Valuation**

         

Goodwill        represents the excess of the purchase price over the fair market value of net assets        acquired. The process of determining goodwill requires judgment. Evaluating goodwill for        impairment involves the determination of the fair value of our reporting units. Inherent in        such fair value determinations are certain judgments and estimates, including the        interpretation of current economic indicators and market valuations, and our strategic        plans with regard to our operations. To the extent additional information arises or our        strategies change, it is possible that our conclusion regarding goodwill impairment could        change, which could have a material effect on our financial position and results of        operations. For those reasons, we believe that the accounting estimate related to goodwill        impairment is a critical accounting estimate.

 

We        review goodwill annually (or more frequently under certain conditions) for impairment in        accordance with SFAS No. 142, goodwill and other intangible assets. We perform our annual        impairment test of goodwill in the fourth quarter of our fiscal year. While we believe that        no impairment existed as of December 31, 2007, there can be no assurances that future        economic or financial developments might not lead to an impairment of goodwill.

I**ntangible Assets**

Intangible assets include software game titles. Intangible assets, excluding        goodwill and Empire game titles are stated on the basis of cost and are amortized on a        straight-line basis over estimated lives of three to ten years. Empire game titles are        amortized over a five-year period based on weighted average expected sales from the date        the title is launched. For titles that have not yet been launched as of March 31, 2008 a        launch date was estimated to project future amortization Intangible assets with indefinite        lives are not amortized but are evaluated for impairment annually unless circumstances        dictate otherwise. Management periodically reviews intangible assets for impairment based        on an assessment of undiscounted future cash flows, which are compared to the carrying        value of the intangible assets. Should these cash flows not equal or exceed the carrying        value of the intangible, a discounted cash flow model is used to determine the extent of        any impairment charge required.

**Forward-Looking Information**

We make        numerous forward-looking statements throughout this report including statements with        respect to our expected income, acquisitions and other growth opportunities, performance of        investments that we have made, and operating expenses. Frequently these statements are        introduced with words such as “expect,” “likely,”        “will,” “believe,” “estimate,” “project,”        “anticipate,” or “predict.” Actual results may differ materially        from those suggested by the forward-looking statements that we make for a number of reasons        including those described in Part II, Item 1A, “Risk Factors” of our report on        Form 10-K for the year ended June 30, 2007.

We        expressly disclaim any obligation to update or revise any forward-looking statements,        whether as a result of new information, future events or otherwise, except as required by        law.

 

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**ITEM        3**  **QUANTITATIVE AND        QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

The        Company does not ordinarily hold market risk sensitive instruments for trading purposes.        The Company does however recognize market risk from interest rate and foreign currency        exchange exposure.

**Interest Rate Risk**

At        March 31, 2008, our cash resources earned interest at variable rates. Accordingly, our        return on these funds is affected by fluctuations in interest rates. We also have        significant debt that is tied to interest rates and, therefore, any increase in interest        rates will have a negative effect on our interest payments. At March 31, 2008, we had two        convertible notes outstanding amounting to $8,900,000. The interest on $1.4 million of        these convertible notes is based on a floating rate equal to prime plus 1.5%. A        hypothetical 100 basis point change in interest rates would result in an approximately        $14,000 change in annual interest expense.

Approximately $2.2 million of our debt accrues interest at rates that vary        with changes in the US and UK prime rates. We estimate that, at our current level of debt,        for each 1% increase in the average annual prime interest rate, our annual interest expense        would increase by approximately $22,000.

**Foreign Currency Risk**

Empire        is incorporated in the United Kingdom and sells products throughout Europe, the United        States and Canada. Its functional currency is the British pound. This has exposed the        Company to market risk with respect to fluctuations in the relative value of the Euro,        the Canadian dollar, and the US dollar.

Strategy First is incorporated in Canada and sells products throughout the        United States and Europe. Its functional currency is the Canadian dollar. This has exposed        the company to market risk with respect to fluctuations in the relative value of        the Euro, British Pound, the Canadian dollar, and the US dollar.

Certain        of our cash balances and the remaining proceeds from the sale of its South African        subsidiaries are denominated in South African Rand. This has exposed us to market risk with        respect to fluctuations in the relative value of the South African Rand against the US        dollar.

We        currently do not hedge our South African Rand exposure. At March 31, 2008, we had assets        denominated in South African Rand of R 12. Million ($1.4 million).

 

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| **ITEM 4.** | **CONTROLS AND PROCEDURES** |
|-------------|-----------------------------|

At the        end of the period covered by this report, the Company carried out an evaluation, with the        participation of management of the Company, including the Company’s Chief Executive        Officer and Chief Financial Officer, of the effectiveness of the design and operation of        the Company’s disclosure controls and procedures. Based on the Company’s        evaluation, the Company’s Chief Executive Officer and Chief Financial Officer        concluded that the Company’s disclosure controls and procedures were effective. There        was no change in the Company’s internal control over financial reporting during the        quarter ended March 31, 2008 that has materially affected, or is reasonably likely to        materially affect, the Company’s internal control over financial        reporting.

 

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**PART        II. OTHER INFORMATION**

| **ITEM 1.** | **LEGAL PROCEEDINGS** |
|-------------|-----------------------|

Other        than as set forth below we are not currently a party to any material legal proceedings. We        may become from time to time involved in legal proceedings in the ordinary course of        business. We may not be successful in defending these or other claims. Regardless of the        outcome, litigation can result in substantial expense and could divert the efforts of our        management.

In        April 2006, the Company’s First South African subsidiary received a letter from the        South African Revenue Service (“SARS”) challenging certain tax treatment of        dividends and operating loss carry forwards for the years 2002 through 2004. Subsequently        SARS issued two tax assessments for approximately $2.9 million. The Company had contended        that its South African tax filings were in full compliance with all applicable laws and had        vigorously defended its position in this regard. The Company had retained an amount of cash        equal to the assessments in South Africa to satisfy any potential liability that may        arise.

In May        2007, the Company through an arbitration procedure with SARS reached an agreement whereby        SARS agreed in principle to drop the larger of its two assessments. The Company conceded        the principle of SARS second assessment. On August 31, 2007, the Company paid approximately        $300,000 to SARS in regard to this assessment. The Company is vigorously disputing a        further amount of R5,394,708 (approximately $658,373 based on the March 31 foreign exchange        of $.1235 US dollars to one South African Rand) and believes it has strong arguments in        this regard based on among other factors, computational errors made by SARS in its        assessment. Based on its payments to SARS, the Company has reduced its estimated liability        to R 2,216,286 (approximately $271,685). The Company believes its remaining liability to        SARS is lower than this amount, however, in the event its arguments are unsuccessful, it        may be forced to increase this liability. In April 2007 the Company brought a request        seeking a court order to dismiss SARS’ claims in this regard. A ruling on this        request should be made within the next few months.

 

In        January 2006, we brought an action against JoWood Software Productions AG seeking damages        in the amount of approximately $850,000 for expenses incurred in connection with our        unsuccessful acquisition of shares of JoWood. On October 4, 2007 the Vienna Municipal Court        dismissed the Company’s claims against JoWood. The Company has decided not to file an        appeal in this matter.

 

In        August 2007, Empire was served with a lawsuit brought by a former distributor in Portugal.        The lawsuit claims that Empire had no right to utilize other distributors in Portugal and        seeks 630,000 euros (approximately $995,400 based on the March 31, 2008 foreign exchange        rate of $1.58 US dollars to one Euro) in damages. Empire believes this claim has no merit        as its distribution agreements are tailored for individual products only and do not give        blanket distribution rights to outside distributors. Empire intends to vigorously defend        itself.

 

| **ITEM 1A.** | **RISK FACTORS** |
|--------------|------------------|

 

There        have been no material changes in the risks facing the Company as described in the        Company’s Form 10-K for the year ended June 30, 200 7 apart from the        following:

**We        are subject to significant working capital requirements for the acquisition or development        of new products and there is no assurance that we will have sufficient free working capital        to acquire or develop sufficient products to sustain overall corporate        profitability.**

 

 

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Among        the issues that effect our working capital requirements is the fact that we both acquire        third party products for publishing as well as develop our own products for future sale.        The acquisition of third party products usually requires an upfront royalty guarantee as        well as subsequent royalty payments. There is no assurance that we will have sufficient        financial resources to successfully compete with other publishers to acquire third party        titles. Furthermore our developed products are subject to development risks which could        result in delays and additional costs, and we must adapt to changes in software        technologies.

We        depend on third party software developers and our internal development department to        develop new interactive entertainment software within anticipated release schedules and        cost projections. The development cycle for new titles ranges from 12 to 24 months.        Development times and costs of next-generation software have increased substantially as a        result of the additional and enhanced features available in the newest games. After        development of a product, it may take between nine to 12 additional months to develop the        product for other hardware platforms. If developers experience financial difficulties,        additional costs or unanticipated development delays, we will not be able to release titles        according to our schedule and at budgeted costs. There can be no assurance that the        products so developed will be sufficiently successful so that we can recoup these costs or        make a profit on these products.

Additionally, in order to stay competitive, our internal development        department must anticipate and adapt to rapid technological changes affecting software        development. The introduction of the new generation platforms has required the development        of new software to play on such consoles and new technologies to create such software.        Because the new generation consoles have greater complexity and capabilities than the        predecessor platforms, costs are higher to develop games for new generation consoles.        Greater costs can lead to lower operating margins, negatively affecting our        profitability.

**We        currently are disputing a tax liability with the South African revenue service and we may        be forced to expense additional amounts in this matter**

In April        2006, our subsidiary, First South African Holdings, received a letter from the South        African Revenue Service (“SARS”) challenging certain tax treatment of dividends        and operating loss carry forwards for the years 2002 through 2004. On May 4, 2007, SARS        agreed in principle to drop the larger of its two assessments and on May 25 2007, SARS        formally approved this decision. We conceded the principle of SARS second assessment but        will continue to negotiate the ultimate liability due under this assessment. On August 31,        2007, we paid approximately $300,000 to SARS in regard to this assessment. We are        vigorously disputing a further amount of approximately $770,000 and believe we have strong        arguments in this regard based on among other factors, computational errors made by SARS in        its assessment. Based on its payments to SARS, the Company has reduced its estimated        liability to approximately $270,000. The Company believes its remaining liability to SARS        is lower than this amount, however, in the event its arguments are unsuccessful, it may be        forced to increase this liability

 

| **ITEM 2.** | **UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF                        PROCEEDS** |
|-------------|----------------------------------------------------------------------------------------|

None.

 

| **ITEM 3.** | **DEFAULTS UPON SENIOR SECURITIES** |
|-------------|-------------------------------------|

None.

 

| **ITEM 4.** | **SUBMISSION OF MATTERS TO A VOTE OF SECURITY                        HOLDERS** |
|-------------|--------------------------------------------------------------------------------|

 

|   | (a)    | The 2007 Annual Meeting of Stockholders of the Company (the                        “Annual Meeting”) was held on March 27,                        2008. |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                |
|        | (b)    | See item 4 (c)(i) below.                                                                                                                                            |
|   |   |                                                                                                                                                                |
|        | (c)    | The following matters were voted on at the Annual                        Meeting:                                                                                   |

 

         

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|   | (i) | The election of five directors to serve until the next                        annual meeting of stockholders and the election and                        qualification of their respective successors: |
|--------|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|        | Name of Director | Votes For Election | Authority to Vote Withheld |
|--------|------------------|--------------------|----------------------------|
|        | Michael Levy     | 11,593,249         | 1,193,854                  |
|        | Clive Kabatznik  | 11,998,218         |    788,885  |
|        | Cornelius Roodt  | 12,044,446         |    742,657  |
|        | Edward Roffman   | 12,044,446         |    742,657  |
|   | Edward Bernstein | 12,044,196         |    742,907  |

         

|   | (ii) | The ratification of the appointment of Rachlin LLC as                        independent accountants of the Company. |
|--------|------|----------------------------------------------------------------------------------------------------------------------|

 

|   | Votes for: 12,445,136                        | Votes Against: 272,392 | Abstentions: 69,574 |
|--------|----------------------------------------------|------------------------|---------------------|
|        |                               |                        |                     |
|        | Broker Non-Votes:                    196,034 |                        |                     |

         

         

         

| **ITEM 5.** | **OTHER INFORMATION** |
|-------------|-----------------------|

None.

 

| **ITEM 6.** | **EXHIBITS** |
|-------------|--------------|

 

| Exhibit Number | Description                                                                    |
|----------------|--------------------------------------------------------------------------------|
| 31.1           | Rule 13a-14(a)                        Certification of Chief Executive Officer |
| 31.2           | Rule 13a-14(a)                        Certification of Chief Financial Officer |
| 32.1           | Section 1350 Certification                        of Chief Executive Officer   |
| 32.2           | Section 1350 Certification                        of Chief Financial Officer   |
|           |                                                                           |
|           |                                                                           |

 

 

33

 

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**SIGNATURES**

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

Date: May        15, 2008

 

 

| SILVERSTAR HOLDINGS, LTD.                                                                  |
|--------------------------------------------------------------------------------------------|
|   

                         

  

                          |
| /s/ Clive Kabatznik                                                                        |
| Clive Kabatznik                                                                            |
| Chief Executive Officer                                                                    |
|   

                         

                                   |
| /s/ Lawrence Litowitz                                                                      |
| Lawrence Litowitz                                                                          |
| Chief Financial Officer                                                                    |

         

 

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