SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549




FORM
10-QSB




(Mark
One)


[x]   QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE


SECURITIES
EXCHANGE ACT OF 1934




For the
quarterly period ended December 31, 2007.


OR




[
]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE


SECURITIES
EXCHANGE ACT OF 1934




For the
transition period from ________ to ________




Commission
File number 0-26845





Theater
Xtreme Entertainment Group, Inc.


-------------------------------------------------------------------------------------------------


(Exact
name of small business issuer as specified in its charter)





Florida


------------------------------------------------------------------------------------------------


(State or
other jurisdiction of incorporation or organization)





65-0913583


-------------------------------------------------------------------------------------------------


(IRS
Employer Identification No.)





250
Corporate Boulevard, Suites E & F, Newark,
Delaware  19702


---------------------------------------------------------------------------------------------------


(Address
of principal executive offices)





(302)
455-1334


---------------------------------------------------------------------------------------------------


(Issuer’s
telephone number)




N/A


------------------------------------------------------------------------------------------------------


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





Check
whether the issuer (1) filed all reports required to be filed by Section 13 or
15(d) of the Exchange Act during the past twelve 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.  X 
Yes   ___ No





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


__
Yes   X   No





APPLICABLE
ONLY TO CORPORATE ISSUERS





State the
number of shares outstanding of each of the issuer’s classes of common equity,
as of the latest practicable date: As of February 18, 2008, there were
20,812,425 shares of common stock, $0.001 par value, issued and
outstanding.





Transitional
Small Business Disclosure Format (check one):  Yes
___    No  X





THEATER
XTREME ENTERTAINMENT GROUP, INC.





Form
10-QSB Index


December
31, 2007





PagePart
      I: Financial InformationItem 1.
            Financial Statements
            3Balance Sheet as of December 31, 2007 and June 30, 2007
      (Unaudited)
            3Statements of Operations for the Three and Six Months
      Ended
              December 31, 2007 and 2006
    (Unaudited)
            4Statement of Changes in Stockholders’ Equity/Deficit for
      the
              Six Months Ended December 31, 2007
      (Unaudited)
            5Statement of Cash Flows for the Six Months
      EndedDecember 31, 2007 and 2006
    (Unaudited)
            6Notes To Financial Statements
      (Unaudited)
            7Item 2.
            Management’s Discussion and Analysis or Plan of
      Operation
            13Item 3.
            Controls and Procedures
            15Part
      II:   Other InformationItem 4.
            Submission of Matters to a Vote of Security
      Holders
            16Item 6.
            Exhibits
            17Signatures
            18










PARTI


FINANCIAL
INFORMATION





Item
1.  Financial Statements




THEATERXTREME ENERTAINMENT GROUP, INC.BALANCE
      SHEETSDECEMBER
      31, 2007 AND JUNE 30, 2007DECEMBER
      31
              
              
              JUNE
      302007
              
              
              2007Assets
              
              (Unaudited)
              
              
              (Audited)Current
      Assets:Cash
      and equivalents
              
              $
              90,353
              
              
              $
              232,583Accounts
      receivable, net of allowance of $ 56,568, and $ 65,782
              
              
              202,853
              
              
              
              292,060Inventory
              
              
              560,605
              
              
              
              810,504Prepaid
      expenses
              
              
              351,498
              
              
              
              164,390Other
      current Assets
              
              
              173,073
              
              
              
              219,045Total
      current assets
              
              
              1,378,382
              
              
              
              1,718,582Property
      and Equipment, net
              
              
              698,952
              
              
              
              933,394Other
      Assets:Deferred
      financing fees
              
              
              285,911
              
              
              
              342,990Deposits
              
              
              48,954
              
              
              
              48,954Total
      Assets
              
              $
              2,412,199
              
              
              $
              3,043,920Liabilities
      and Stockholders' DeficitCurrent
      Liabilities:Accounts
      payable and accrued expenses
              
              $
              1,280,782
              
              
              $
              801,978Payroll
      liabilities
              
              
              128,454
              
              
              
              149,221Current
      portion of notes payable
              
              
              38,052
              
              
              
              37,047Non-convertible
      debentures
              
              
              300,000
              
              
              
              300,000Promissory
      Notes
              
              
              225,000
              
              
              
              -Deferred
      franchise fees
              
              
              316,500
              
              
              
              299,000Deferred
      sales
              
              
              625,286
              
              
              
              495,751Total
      current liabilities
              
              
              2,914,074
              
              
              
              2,082,997Long-term
      Liabilities:Non-convertible
      debentures
              
              
              2,700,000
              
              
              
              2,700,000Notes
      payable, net of current portion
              
              
              87,246
              
              
              
              107,224Total
      long-term liabilities
              
              
              2,787,246
              
              
              
              2,807,224Total
      liabilities
              
              
              5,701,320
              
              
              
              4,890,221Stockholders'
      Equity (Deficit):Preferred
      stock, no par value, 5,000,000 shares authorized,no
      shares issued and outstanding
              
              
              -
              
              
              
              -Common
      stock, $.001 par, 50 million shares authorized;20,812,425
      and 20,087,425 shares issuedand
      outstanding
              
              
              20,812
              
              
              
              20,087Additional
      paid in capital
              
              
              6,126,796
              
              
              
              5,541,029Accumulated
      deficit
              
              
              (9,436,729
              )
              
              
              (7,407,417
              )Total
      stockholders' deficit
              
              
              (3,289,121
              )
              
              
              (1,846,301
              )Total
      Liabilities and Stockholders' Deficit
              
              $
              2,412,199
              
              
              $
              3,043,920




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





3


THEATERXTREME ENTERTAINMENT GROUP,
    INC.STATEMENTS
      OF OPERATIONSTHREE
      AND SIX MONTHS ENDED DECEMBER 31, 2007 AND 2006Three
      Months Ended
              
              
              Six
      Months EndedDecember
      31
              
              
              December
      312007
              
              
              2006
              
              
              2007
              
              
              2006Revenues
              
              $
              1,175,562
              
              
              $
              1,702,189
              
              
              $
              2,378,780
              
              
              $
              3,164,717Cost
      of revenues
              
              
              723,760
              
              
              
              1,014,866
              
              
              
              1,544,045
              
              
              
              1,947,460Occupancy
      expenses
              
              
              176,711
              
              
              
              104,858
              
              
              
              330,924
              
              
              
              226,771Selling,
      general and administrative expenses
              
              
              1,086,430
              
              
              
              1,206,042
              
              
              
              2,286,331
              
              
              
              2,262,5041,986,901
              
              
              
              2,325,766
              
              
              
              4,161,300
              
              
              
              4,436,735Loss
      from operations
              
              
              (811,339
              )
              
              
              (623,577
              )
              
              
              (1,782,520
              )
              
              
              (1,272,018
              )Interest
      income
              
              
              -
              
              
              
              358
              
              
              
              -
              
              
              
              600Interest
      expense
              
              
              (124,818
              )
              
              
              (81,654
              )
              
              
              (246,792
              )
              
              
              (85,218
              )Net
      loss
              
              $
              (936,157
              )
              
              $
              (704,873
              )
              
              $
              (2,029,312
              )
              
              $
              (1,356,636
              )Basic
      and diluted:Loss per common
      share
              
              $
              (0.04
              )
              
              $
              (0.04
              )
              
              $
              (0.10
              )
              
              $
              (0.07
              )Weighted
      average shares
              
              
              20,812,425
              
              
              
              19,810,900
              
              
              
              20,737,425
              
              
              
              19,615,997







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








4


THEATERXTREME ENTERTAINMENT GROUP, INC.STATEMENT
      OF STOCKHOLDERS' EQUITYSIX
      MONTHS ENDED DECEMBER 31, 2007Number
      of($
      US except shares)
              
              Shares
      -
              
              
              
              
              
              Additional
              
              
              
              
              
              TotalCommon
              
              
              Common
              
              
              Paid-in
              
              
              Accumulated
              
              
              Stockholders'Stock
              
              
              Stock
              
              
              Capital
              
              
              Deficit
              
              
              EquityBalance
      at June 30, 2007 (Audited)
              
              
              20,087,425
              
              
              $
              20,087
              
              
              $
              5,541,029
              
              
              $
              (7,407,417
              )
              
              $
              (1,846,301
              )Issuance
      of common stock, services rendered,net
      of transfer agent and legal fees
              
              
              725,000
              
              
              $
              725
              
              
              $
              436,312
              
              
              $
              -
              
              
              
              437,037Vested
      employee stock options
              
              
              
              -
              
              
              
              -
              
              
              
              48,686
              
              
              
              -
              
              
              
              48,686Vested
      non-employee stock options
              
              
              -
              
              
              
              -
              
              
              
              (2,831
              )
              
              
              -
              
              
              
              (2,831
              )Issuance
      of warrants, notes payable
              
              
              -
              
              
              
              -
              
              
              
              12,200
              
              
              
              -
              
              
              
              12,200Issuance
      of warrants, services rendered
              
              
              -
              
              
              
              -
              
              
              
              91,400
              
              
              
              -
              
              
              
              91,400Net
      loss for the six months endedDecember
      31, 2007
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (2,029,312
              )
              
              
              (2,029,312
              )Balance
      at December 31, 2007 (Unaudited)
              
              
              20,812,425
              
              
              $
              20,812
              
              
              $
              6,126,796
              
              
              $
              (9,436,729
              )
              
              $
              (3,289,121
              )


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





5


THEATERXTREME ENTERTAINMENT GROUP,
INC.STATEMENTS
      OF CASH FLOWSSIX
      MONTHS ENDED DECEMBER 31(UNAUDITED)2007
              
              
              2006Cash
      flows from operating activities:Net
      Loss
              
              $
              (2,029,312
              )
              
              $
              (1,356,636
              )Adjustments
      to reconcile net loss tonet
      cash used in operating activities:Depreciation
              
              
              237,009
              
              
              
              74,643Amortization
      of prepaid consulting services
              
              
              259,983
              
              
              
              -Issuance
      of common stock for services
              
              
              41,250
              
              
              
              40,000Increase
      (decrease) in Allowance for Doubtful Accounts
              
              
              (9,214
              )
              
              
              25,000Employee
      stock option vesting for compensation
              
              
              48,686
              
              
              
              64,805Non-employee
      stock option vesting for services
              
              
              (2,831
              )
              
              
              4,780Amortization
      of deferred charges
              
              
              57,079
              
              
              
              223,465(Increase)
      decrease in assetsAccounts
      receivable
              
              
              98,421
              
              
              
              (189,382
              )Inventory
              
              
              249,899
              
              
              
              (1,830
              )Prepaid
      expenses
              
              
              53,301
              
              
              
              (52,377
              )Other
      Assets
              
              
              45,972
              
              
              
              (96,037
              )Increase
      (decrease) in liabilitiesAccounts
      payable and accrued expenses
              
              
              478,804
              
              
              
              (68,357
              )Payroll
      liabilities
              
              
              (20,767
              )
              
              
              51,225Deferred
      franchise fees
              
              
              17,500
              
              
              
              30,000Deferred
      sales
              
              
              129,535
              
              
              
              236,599Net
      cash provided by (or used in) operating activities
              
              
              (344,685
              )
              
              
              (1,014,102
              )Cash
      flows from investing activities:Deposits
      on stores and corporate facility
              
              
              -
              
              
              
              (28,234
              )Purchase
      of property and equipment
              
              
              (2,567
              )
              
              
              (30,362
              )Net
      cash used in investing activities
              
              
              (2,567
              )
              
              
              (58,596
              )Cash
      flows from financing activities:Repayment
      of notes payable
              
              
              (19,978
              )
              
              
              (150,775
              )Proceeds
      from non-convertible debentures
              
              
              -
              
              
              
              1,500,000Proceeds
      from short-term promissory notes
              
              
              225,000
              
              
              
              -Proceeds
      from issuance of common stock
              
              
              -
              
              
              
              60,614Net
      cash provided by financing activities
              
              
              205,022
              
              
              
              1,409,839Net
      increase (decrease) in cash
              
              
              (142,230
              )
              
              
              337,141Cash
      and equivalents, beginning of period
              
              
              232,583
              
              
              
              466,481Cash
      and equivalents, end of period
              
              $
              90,353
              
              
              $
              803,622Supplemental
      disclosure:Cash
      paid during the period for interest
              
              $
              41,402
              
              
              $
              25,128Supplemental
      disclosure of non-cashinvesting
      and financing activites:Liabilities
      assumed as part of acquisition of property
              
              $
              -
              
              
              $
              2,598Acquisition
      of property and equipmentby
      issuance of notes payable
              
              $
              -
              
              
              $
              210,608Prepaid
      consulting servicesby
      issuance of common stock
              
              $
              437,750
              
              
              $
              425,000Prepaid
      consulting servicesby
      issuance of warrants
              
              $
              90,800
              
              
              $
              -Deferred
      Financing chargesby
      issuance of warrants
              
              $
              577,400
              
              
              $
              577,400


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


6


THEATERXTREME ENTERTAINMENT GROUP, INC.


NOTES
TO FINANCIAL STATEMENTS


(UNAUDITED)





Note
1:  Nature of Operations and Significant Accounting
Policies





Basis of
Presentations.The accompanying unaudited financial statements
have been prepared in accordance with U.S. generally accepted accounting
principles for interim financial information and with the instructions for Form
10-QSB and Item 310(b) of Regulation S-B.  Additionally, these
financial statements have not been reviewed by the Company’s principal
accountants, Morison Cogen LLP, and, as such, they are subject to
adjustment.  Subsequent to a completed review by Morison Cogen, LLP,
the Company intends to file an amended 10-QSB.  Accordingly, these
financial statements do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements.  In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three and six months ending December
31, 2007 are not necessarily indicative of the results that may be expected for
the year ending June 30, 2008. The unaudited financial statements should be read
in conjunction with the financial statements and footnotes thereto included in
the Company’s Annual Report on Form 10-KSB for the fiscal year ended June 30,
2007.





Nature of
Operations.Theater Xtreme Entertainment Group, Inc. (the
“Company”), a Florida corporation, is a retail store and franchise marketing
company engaged in retail sales and distribution through the operation of
Company-owned home cinema design stores, the sale of franchise licenses and
wholesale product distribution to franchisees. The Company opened its first
Company retail store, or design store on September 1, 2003 in Newark,
Delaware.   In August 2004 the Company opened a second Company
owned design store in Wilmington, Delaware.  A third Company owned
design store opened in Bel Air, Maryland in September 2005.  In July,
2006, the Company purchased the assets and assumed the leasehold of its
franchisee located in Leesport, Pennsylvania. In March, 2007, the Company
relocated its Wilmington, Delaware design store to an improved location in
Wilmington, Delaware.  The Company sold twenty-two franchises through
June 30, 2007 and an additional two through September 30, 2007 bringing the
total number of franchises sold through December 31, 2007 to twenty-four. The
first franchise design center opened in May, 2005 in East Longmeadow,
Massachusetts.  Through June 30, 2007 the Company had nine franchise
stores opened and operating. During the six months ended December 31, 2007, an
additional two franchise stores opened bringing the total number of opened and
operating franchise locations to eleven. Effective November 6, 2007, the Company
closed two of its five Company-owned retail stores, one in Leesport,
Pennsylvania (formerly a franchise store) and one in Newark, Delaware (its first
location) and eliminated staff at these locations.  The Company has
taken these actions as part of a recently implemented store performance
evaluation and cost and expense reduction initiative developed earlier and
designed to reduce costs and expenses.





Industry Risks. The Company
participates in a highly volatile industry that is characterized by rapid
technological change, intense competitive pressure, and cyclical market
patterns. The Company’s results of operations will be affected by a wide variety
of factors, including general economic conditions, decreases in average selling
prices over the life of any particular product, the timing of new product
introductions (by the Company, its competitors, and others), the ability to
acquire sufficient quantities of a given product in a timely manner, the timely
implementation of new technologies, the ability to safeguard intellectual
property from competitors, and the effect of new technologies resulting in rapid
escalation of demand for some products in the face of equally steep decline in
demand for others. Based on the factors noted herein, the Company may experience
substantial period-to-period fluctuations in future operating
results.





7


THEATER
XTREME ENTERTAINMENT GROUP, INC.


NOTES
TO FINANCIAL STATEMENTS


(UNAUDITED)








Note
1:  Nature of Operations and Significant Accounting Policies
(Continued)





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





Revenue
Recognition.Retail sales include all sales from Company-owned
design centers.  The following is a summary of earned revenues for the
three and six months ended December 31:


Three
      Months Ended December 31
              
              Six
      Months Ended December 312007
              
              2006
              
              2007
              
              2006Retail
      sales
              $
              940,601
              $
              1,305,897
              
              1,708,065
              
              2,568,461Wholesale
      sales
              
              161,863
              
              331,233
              
              473,488
              
              493,253Franchise
      licenses and royalties
              
              73,098
              
              65,059
              
              197,227
              
              103,003Total
      revenues
              $
              1,175,562
              $
              1,702,189
              
              2,378,780
              
              3,164,717


Retail
sales represent the sale and installation of home-theater
equipment.  In accordance with the SEC’s Staff Accounting Bulletin No.
104 (SAB 104) “Revenue
Recognition,” the Company recognizes revenue when persuasive evidence of
a customer arrangement exists or acceptance occurs, receipt of goods by the
customer occurs, the price is fixed or determinable, and the sales revenues are
considered collectible.  Revenue is recognized on such sales when the
equipment is delivered and the installation is substantially
completed.  Generally these events occur on the same date. Revenues
are recognized on a completion of work or product delivered basis for larger,
more complex systems where installation occurs over a period of
time.  Larger systems are principally aggregations of a number of
smaller, same-customer service work orders or product orders that collectively
are characterized as complex installations whose service or product delivery
dates can extend over a number of weeks owing to both customer installation time
preferences or unavailability of product.





Customer
deposits on orders that are not completed are shown as deferred revenue. Also
included in deferred revenue is an amount that represents the unexpired
(unearned) portions of paid customer extended service contracts. In addition,
the Company has deferred revenue from the sales of franchise licenses. Such
revenue will be recognized when the related franchise design center opens for
business, as that is the time when the Company has substantially completed its
obligations to these franchisees.





The
following is a summary of amounts included in deferred sales as at December
31:


2007
              
              2006Deferred
      retail sales
              $
              610,032
              $
              890,877Unearned
      service contract revenue
              
              15,254
              
              25,428Total
      deferred retail sales
              $
              625,286
              $
              916,305


8


THEATER
XTREME ENTERTAINMENT GROUP, INC.


NOTES
TO FINANCIAL STATEMENTS


(UNAUDITED)








Note
1:  Nature of Operations and Significant Accounting Policies
(Continued)





Loss Per
Share.The Company follows SFAS No. 128, "Earnings Per Share,"
resulting in the presentation of basic and diluted earnings (loss) per
share.  The basic loss per share calculations include the change in
capital structure which resulted from the merger for all periods
presented.  For the three and six months ended December 31, 2007 and
2006, the basic and diluted loss per share are the same, because the assumed
conversion of the common stock equivalents would be anti-dilutive as the Company
experienced net losses for these periods.





Income Taxes.  The
Company accounts for income taxes under SFAS No. 109, “Accounting for Income
Taxes,” which requires an asset and liability approach to financial accounting
and reporting for income taxes.  Deferred income tax assets and
liabilities are computed annually for temporary differences between the
financial statement and tax bases of assets and liabilities that will result in
taxable or deductible amounts in the future based on enacted tax laws and rates
applicable to the periods in which the differences are expected to affect
taxable income.  Valuation allowances are established when necessary
to reduce deferred tax assets to the amount expected to be
realized.  Income tax expense is the tax payable or refundable for the
period plus or minus the change during the period in deferred tax assets and
liabilities.





Inventory
Obsolescence.Inventory represents a significant portion of
the Company’s assets.  The Company’s profitability and viability are
highly dependent on the demand for its products.  An imbalance between
purchasing levels and sales could cause rapid and material obsolescence, and
loss of competitive price advantage and market share.  The Company
believes that its product mix has provided sufficient diversification to
mitigate this risk.  At the end of each reporting period, the Company
reduces the value of its inventory by an estimate of what the Company believes
to be obsolete, and the Company recognizes an expense in this amount, which is
included in cost of sales in its statement of operations.





In the
Company’s industry, merchandise models change periodically. When they do, the
Company reclassifies the old model into a discontinued category. The Company
also reclassifies merchandise into the discontinued category when the Company
decides it no longer wants to sell the item. At the end of each reporting
period, the Company reviews the value of discontinued merchandise and reduces
its value in cases where the net realizable value is estimated to be less than
the cost of the merchandise. Generally, the Company attempts to sell these
discontinued models at standard retail prices. The Company also similarly
evaluates the obsolescence of its display inventories and service parts
inventory.





Shipping and Handling Fees and
Costs.  The Company classifies shipping and handling fees when
charged to the customer as revenue. The Company classifies shipping and handling
costs as part of selling and administration expenses.  Shipping and
handling costs were $7,171 and $16,996 for the three months ended December 31,
2007 and 2006, respectively, and $18,588 and $41,017 for the six months ended
December 31, 2007 and 2006, respectively.  In view of the Company’s
treatment of shipping and handling costs as a component of selling, general and
administrative cost, its gross margin may not be comparable to those of other
companies where shipping and handling costs are included in cost of
revenue.





Advertising
Costs.Advertising and sales promotion costs are expensed as
incurred. Advertising and promotion expense, excluding investor relations
expenses, totaled $100,995 and $113,834 for the three months ended December 31,
2007 and 2006, respectively and $184,925 and $287,616 for the six months ended
December 31, 2007 and 2006, respectively.


9


THEATER
XTREME ENTERTAINMENT GROUP, INC.


NOTES
TO FINANCIAL STATEMENTS


(UNAUDITED)





Note
1:  Nature of Operations and Significant Accounting Policies
(Continued)





Investor Relations
Costs.Investor relations services are expensed as incurred.
Investor relations expenses, including investor relations promotional costs,
totaled $30,204 and $152,076 for the three months ended December 30, 2007 and
2006, respectively, and $137,783 and $240,025 for the six months ended December
30, 2007 and 2006, respectively,.





Stock-Based
Compensation.In December 2004, the Financial Accounting
Standards Board (“FASB”) issued Statement of Financial Accounting Standard SFAS
No. 123 (revised 2004), Share-Based Payment (“SFAS
No. 123(R)”). SFAS No. 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to
Employees, and amends SFAS No. 95, Statement of Cash
Flows.  Generally, the approach in SFAS No. 123(R) is similar
to the approach described in SFAS No. 123. However, SFAS No. 123(R) requires
share-based payments to employees, including grants of employee stock options,
to be recognized in the income statement based on their fair values at the date
of grant. Pro forma disclosure is no longer an alternative.





On
January 1, 2006, the Company adopted SFAS No. 123(R) using the modified
prospective method as permitted under SFAS No. 123(R). Under this transition
method, beginning with the first calendar quarter of 2006, recognized
compensation costs include compensation cost for all non-forfeited share-based
payments granted, based on the grant-date fair value estimated in accordance
with the provisions of SFAS No. 123(R), and without regard to vesting. In
accordance with the modified prospective method of adoption, the Company’s
results of operations and financial position for the year ended June 30, 2006
have not been restated.





As a
result of the adoption of SFAS No. 123(R), a) during the three months ended
December 31, 2007 and 2006, the Company’s net income was approximately $10,691
and $34,541 lower, respectively, as a result of stock-based compensation
expense, including $(6,552) and $2,390, respectively, recognized on behalf of
outside board members and b) during the six months ended December 31, 2007 and
2006, the Company’s net income was approximately $45,855 and $69,585 lower,
respectively, as a result of stock-based compensation expense, including
$(2,831) and $4,780 respectively, recognized on behalf of outside board members.
The negative amounts recognized on behalf of outside board members reflect a
reversal of stock option expense recognized in previous periods that were
reversed in the three months ended December 31, 2007 as a result of forfeited
stock options that were not exercised.




As of
December 31, 2007, there was $254,001 of unrecognized compensation expenses and
$45,400 of unrecognized expenses for services related to non-vested market-based
option share awards that are expected to be recognized through the fiscal year
ended June 30, 2011.


10


THEATERXTREME ENTERTAINMENT GROUP, INC.


NOTES
TO FINANCIAL STATEMENTS


(UNAUDITED)








Note
1:  Nature of Operations and Significant Accounting Policies
(Continued)





Recently Issued
Pronouncements:  In June 2006, the Financial Accounting
Standards Board ("FASB") issued Interpretation No. 48 ("FIN 48"), Accounting for Uncertainty in Income
Taxes. FIN 48 prescribes detailed guidance for the financial statement
recognition, measurement and disclosure of uncertain tax positions recognized in
an enterprise's financial statements in accordance with FASB Statement No. 109,
Accounting for Income
Taxes. Tax positions must meet a more-likely-than-not recognition
threshold at the effective date to be recognized upon the adoption of FIN 48 and
in subsequent periods. FIN 48 will be effective for fiscal years beginning after
December 15, 2006 (the Company’s fiscal year 2008) and the provisions of FIN 48
will be applied to all tax positions under Statement No. 109 upon initial
adoption. The cumulative effect of applying the provisions of this
interpretation will be reported as an adjustment to the opening balance of
retained earnings for that fiscal year. The Company is currently evaluating the
potential impact of FIN 48 on its financial statements.





In
September, 2006, the SEC issued Staff Accounting Bulletin No. 108 ("SAB No.
108"). SAB No. 108 addresses the process and diversity in practice of
quantifying financial statement misstatements resulting in the potential build
up of improper amounts on the balance sheet. The Company will be required to
adopt the provisions of SAB No.108 in fiscal 2008. The Company currently does
not believe that the adoption of SAB No. 108 will have a material impact on its
consolidated financial statements.





In
September, 2006, the FASB issued SFAS No. 157, Fair Value Measurements,
("SFAS No. 157"). SFAS No. 157 establishes a framework for measuring fair value
and expands disclosures about fair value measurements.  The changes to
current practice resulting from the application of this statement relate to the
definition of fair value, the methods used to measure fair value, and the
expanded disclosures about fair value measurements.  The Statement is
effective for fiscal years beginning after November 15, 2007 and interim periods
within those fiscal years.  The Company does not believe that the
adoption of the provisions of SFAS No. 157 will materially impact its financial
position or results of operations.





In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities.  This Statement permits
entities to choose to measure many financial instruments and certain other items
at fair value that are not currently required to be measured at fair
value.  The objective is to improve financial reporting by providing
entities with the opportunity to mitigate volatility in reported earnings caused
by measuring related assets and liabilities differently without having to apply
complex hedge accounting provisions.  This statement also establishes
presentation and disclosure requirements designed to facilitate comparisons
between entities that choose different measurement attributes for similar types
of assets and liabilities.  This Statement is effective for financial
statements issued for fiscal years beginning after November 15, 2007 and will
become effective for the Company beginning with the first quarter of fiscal
2009.  The Company has not yet determined the impact of the adoption
of SFAS No. 159 on its financial statements and footnote
disclosures.


11


THEATER
XTREME ENTERTAINMENT GROUP, INC.


NOTES
TO FINANCIAL STATEMENTS


(UNAUDITED)








Note
2:  Management’s Plans





Future
capital requirements and the adequacy of available funds will depend on numerous
factors and risks, including, among other factors, the successful expansion and
increase in the number of Company-owned retail design centers and the sale of
Company franchises. Further, the Company’s results of operations and resulting
capital requirements will be affected by a variety of additional factors and
risks including, but not limited to, general economic conditions, decreases in
average selling prices over the life of any particular product, new product and
technology introductions and the ability to develop and maintain critical
strategic supply and co-marketing relationships.





The
Company has incurred significant losses from operations, has an accumulated
deficit and a highly leveraged capital position that raises substantial doubts
about the Company’s ability to continue as a going concern. The financial
statements do not include any adjustments related to recoverability and
classification of recorded asset amounts or the amount and classification of
liabilities that might be necessary should the Company be unable to continue as
a going concern. The Company expects to incur significant expenditures to
further the development and commercialization of its products. To achieve this,
the Company has requested and received deferral of interest payments due to its
principal debtor through December 31, 2007 and the deferral of principal
payments due to its non-convertible debenture holders through March 17, 2008.
The Company is also currently negotiating with its both its principal lender and
its short term debenture and promissory note creditors for modification of the
terms of all of its debt instruments and is diligently pursuing the raising of
additional funds. The Company has identified a number of potential sources of
new funding and is currently working toward a conclusion that would provide
interim funds as well as a longer term capital raise effort.  The Company
has identified a number of potential sources of new funding and is currently
working toward a conclusion that would provide interim funds as well as a longer
term capital raise effort.  However, at the time of preparation of these
statements no definitive arrangements have been made and there is no assurance
that any would be forthcoming.




Note
3:  Notes Payable





Between
July 20 and August 15, 2007, the Company executed and delivered promissory notes
to three accredited investors ( the “Promissory Note Investors”) in the
aggregate face amount of $225,000 (the “Promissory Notes”), and warrants (the
“Promissory Warrants”) to purchase up to 112,500shares, in the
aggregate, of the Company’s common stock (the “Promissory Note Financing”). The
proceeds of the Promissory Note Financing were used for general corporate
purposes. The Promissory Notes bear interest at 14% per annum, mature one year
from the date of issue and may be prepaid at any time without
penalty.  The Promissory Warrants have an exercise price of $1.00 per
share and are subject to full ratchet price protection for the five-year life of
the Promissory Warrants.  Repayment of the Promissory Notes is
guaranteed by Scott R. Oglum, Chief Executive Officer of the Company, through
separate Guaranty and Pledge agreements with all three accredited investors. The
guarantees are secured by a pledge by Mr. Oglum of up to 3,618,275 shares, in
the aggregate, of the Company’s common stock which he owns representing his
entire holdings. In September, 2007, the Company indemnified Mr. Oglum, in
connection with the Guaranty and Pledge Agreements, for any and all payments
made by Mr. Oglum to the holders of the Promissory Notes and for the dollar
amount of any unrecovered proceeds pursuant to the sale of any of the Pledged
Shares as may be sold pursuant to the Guaranty and Pledge
Agreements.  The Promissory Note Financing was made in reliance on an
exemption from securities registration afforded by the provisions of Section
4(2) of the Securities Act of 1933, as amended. See also Note 7, Subsequent
events.


12


THEATER
XTREME ENTERTAINMENT GROUP, INC.


NOTES
TO FINANCIAL STATEMENTS


(UNAUDITED)








Note
3:  Notes Payable (continued)





In
October, 2007, the Company and Kinzer Technology, LLC (“Kinzer”) amended the
March Debenture. Under the original terms of the March Debenture, the Company
was prohibited from incurring any additional unsecured indebtedness for borrowed
money after March 6, 2007 in excess of $1.0 million.  The amendment
increases the amount of such indebtedness which may be incurred after March 6,
2007 to $2.0 million.  The March Debenture also requires quarter
annual interest payments on each April 1, July 1, October 1, and January
1.  The amendment permits the Company to defer the interest payments
otherwise due on October 1, 2007 and January 1, 2008 until July 1,
2008.





In
December 2007, the Company and the holders of three debentures, whose aggregate
face value amounted to $300,000, agreed to amend the debentures.  The
amendment extended the due date of the payment of amounts due and payable on the
debentures to March 17, 2008.  In consideration for this amendment,
the Company issued warrants to the debenture holders entitling them to purchase
up to 150,000 shares of Registrant’s Common Stock, in the aggregate, at an
exercise price of $1.00 per share.





Note
4:  Common Stock





During
the six months ended December 31, 2007, the Company issued 650,000 of its common
shares at $0.61 per share, representing the fair value of the price per share at
the time of issuance, with an  aggregate value of $395,650, net of
legal expenses, and granted warrants to purchase 500,000 shares of the Company’s
common stock at an exercise price of $1.00 per share, to a consultant for
services rendered. The Company valued the common stock purchase warrants at
$90,800. The values of the common stock and purchase warrants shall both be
amortized over a twelve month period.





During
the six months ended December 31, 2007, the Company issued 75,000 of its common
shares at $0.55 per share, representing the fair value of the price per share at
the time of issuance, with an aggregate value of $41,387, net of legal expenses,
to another unrelated consultant for services rendered.





During
the six months December 31, 2007, the Company granted warrants to purchase 8,750
shares of the Company’s common stock at an exercise price of $1.00 per share to
a consultant in consideration for services rendered. The Company valued these
warrants at $600 and expensed this amount in the six months ended December 31,
2007 as a consulting expense.





During
the six months December 31, 2007, the Company granted warrants to purchase
112,500 shares of the Company’s common stock, in the aggregate, at exercise
prices of $1.00 per share separately to three accredited investors in connection
with the Promissory Note Financing. The Company has valued these warrants at
$12,000, in the aggregate and will expense this amount over the time of the
respective underlying Promissory Notes. See Note 3, Notes Payable.





In
December 2007, the Company and the holders of three debentures, whose aggregate
face value amounts to $300,000, agreed to amend the debentures.  The
amendment extended the due date of the payment of amounts due and payable on the
debentures to March 17, 2008.  In consideration for this amendment,
the Company issued warrants to the debenture holders entitling them to purchase
up to 150,000 shares of Company’s Common Stock, in the aggregate, at an exercise
price of $1.00 per share.  The Company has valued these warrants at
$200, in the aggregate, and has expensed this amount in the three months ended
December 31, 2007.  See Note 3, Notes Payable.


13


THEATER
XTREME ENTERTAINMENT GROUP, INC.


NOTES
TO FINANCIAL STATEMENTS


(UNAUDITED)








Note
4:  Common Stock (continued)





Additionally,
in December, 2007, in separate transactions, the Company and all holders of
common stock purchase warrants issued by the Company which had heretofore
included full ratchet protection (the “R Warrants”) entered into agreements to
amend the terms of the R Warrants to remove from the R Warrants those provisions
calling for full ratchet protection.  The eliminated provisions would
have given the holders the right to acquire shares at a lower exercise price at
any time that the Company issued equity securities at an effective price lower
than the then current exercise price of the outstanding warrants.





The
Company uses the Black-Scholes option pricing model to calculate the grant-date
fair value of an award, with the following assumptions: no dividend yield,
expected volatility of between 45% and 60%, risk-free interest rate of between
3.0% to 5.25% and expected option life of five years.





The
following summarizes warrants to purchase the Company’s Common Stock outstanding
through December 31, 2007:


Number
      of
              
              ExerciseWarrants
              
              PriceWarrants
      outstanding at June 30, 2007
              
              1,625,160
              
              $   1.00Warrants
      issued during the six monthsended
      December 31, 2007
              
              
              771,250
              
              $   1.00Warrants
      outstanding at June 30, 2007
              
              2,396,410
              
              $   1.00


See also,
Note 7, Subsequent Events.





Note
5:  Stock Option Plan





In April, 2005, stockholders holding a
majority of the shares of the Company’s common stock approved the adoption of
the Company’s 2005 Stock Option Plan (the “Plan”). The Plan is designed to help
the Company attract, motivate and retain high quality employees necessary to
execute the Company’s business plans successfully. On December 21, 2005
stockholders holding a majority of the shares of the Company’s common stock
approved an increase in the number of common shares allocated to the Plan to
2,000,000, from 1,400,000 shares.  Participation in the Plan is
limited to employees and outside Directors. The exercise price of both incentive
and nonqualified stock options is at least the fair market value of the
Company’s common stock at the time of the grant. The options generally vest over
a three to four year period and expire no later than ten years from the date of
grant.





As of
June 30, 2005, the Company had 890,000 option shares remaining to be exercised.
Pursuant to the terms of the Plan as amended, employees and outside Directors
were granted options to purchase shares of the Company’s common stock as
follows: 170,900 option shares for the year ended June 30, 2007 and 850,000
option shares for the year ended June 30, 2006. For the year ended June 30, 2007
and 2006 forfeited option shares totaled 150,000 and 75,100 option shares,
respectively, During the year ended June 30, 2007, 200,083 options were
exercised leaving a remaining exercisable balance of 1,515,717 option shares as
of June 30, 2007.  No option shares were exercised during the year
ended June 30, 2006. The exercise prices per share of these options range from
$0.35 to $1.12 and vesting is either 25% or 33% each year on the anniversary of
grant date contingent upon continuing employment or services as a member of the
Board of Directors.


14


THEATER
XTREME ENTERTAINMENT GROUP, INC.


NOTES
TO FINANCIAL STATEMENTS


(UNAUDITED)








Note
5:  Stock Option Plan (continued)





The
Company uses the Black-Scholes option pricing model to calculate the grant-date
fair value of an award, with the following assumptions: no dividend yield,
expected volatility of between 45% and 60%, risk-free interest rate of between
3.0% to 5.25% and expected option life of ten years.





At June
30, 2007, there were 1,515,717 stock options outstanding under the 2005 Stock
Option Plan.  At December 31, 2007, there were 1,292,092 stock options
outstanding under the 2005 Stock Option Plan. In the six months ended December
31, 2007, the Company granted no options to employees, made no grants of
non-qualified options, In the six months ended December 31, 2007 there were no
exercises of options and an aggregate of 223,625 stock options were
forfeited.





A summary
of stock option transactions for the six months ended December 31, 2007 is as
follows:


Incentive
      Stock Options
              
              Nonqualified
      Stock OptionsWeighted
              
              
              
              WeightedStock
              
              Average
              
              Stock
              
              AverageOptions
              
              Exercise
              
              Options
              
              ExerciseOutstanding
              
              Price
              
              Outstanding
              
              PriceBalance,
      June 30, 2007
              
              1,335,717
              
              $0.54
              
              180,000
              
              $0.48Granted
      during the period
              
              -
              
              xx
              
              -
              
              xxExercised
      during the period
              
              -
              
              xx
              
              -
              
              xxCancelled
      / forfeited during the period
              
              (163,625)
              
              $0.44
              
              (60,000)
              
              $0.48Balance,
      September 30, 2007
              
              1,172,092
              
              $0.55
              
              120,000
              
              $0.48
  The
following table summarizes information about stock options outstanding at
December 31, 2007:





Summary
      of ISO Options
              
              Summary
      of Nonqualified OptionsOutstanding
              
              Exercisable
              
              Outstanding
              
              ExercisableNumber
              
              Weighted
              
              Number
              
              Number
              
              Weighted
              
              NumberOutstanding
              
              Average
              
              Outstanding
              
              Outstanding
              
              Average
              
              Outstandingat
              
              Remaining
              
              at
              
              at
              
              Remaining
              
              atExercise
              
              December
      31
              
              Contractual
              
              December
      31
              
              December
      31
              
              Contractual
              
              December
      31Price
              
              2007
              
              Life
              
              2007
              
              2007
              
              Life
              
              2007$0.35
              
              751,667
              
              7.6
      Years
              
              470,000
              
              100,000
              
              7.3
      Years
              
              50,000$0.61
              
              50,000
              
              9.4
      Years
              
              -
              
              -
              
              xx
              
              -$0.80
              
              50,000
              
              9.3
      Years
              
              -
              
              -
              
              xx
              
              -$0.89
              
              50,000
              
              9.3
      Years
              
              -
              
              -
              
              xx
              
              -$1.00
              
              265,000
              
              8.5
      Years
              
              66,250
              
              -
              
              xx
              
              -$1.04
              
              5,425
              
              8.9
      Years
              
              1,356
              
              -
              
              xx
              
              -$1.12
              
              -
              
              xx
              
              -
              
              20,000
              
              9.0
      Years
              
              5,0001,172,092
              
              
              
              537,606
              
              120,000
              
              
              
              55,000





15


THEATER
XTREME ENTERTAINMENT GROUP, INC.


NOTES
TO FINANCIAL STATEMENTS


(UNAUDITED)





Note
6:  Income Taxes





Deferred
income taxes reflect the net effect of an operating loss carryforward. There are
no significant temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the corresponding amounts used
for income tax purposes.  The components of the deferred assets are as
follows at December 31, 2007 and June 30, 2007:





December 31, 2007
            
            June 30 2007Net
      operating loss tax benefit
            
            $
            3,727,000
            
            
            $
            2,884,000Non-deductible
      options
            
            
            100,000
            
            
            
            85,000Allowance
      for bad debt
            
            
            26,000
            
            
            
            26,000Less
      valuation allowance
            
            
            (3,863,000
            )
            
            
            (2,995,000
            )$
            0
            
            
            $
            0





A
valuation allowance was required because the ultimate realization of deferred
tax assets is dependent upon future taxable income and management believes that
it is more likely than not that the deferred tax asset will not be realized
through future taxable income.  There is no income tax benefit for the
losses for the six months ended December 31, 2007, because management has
determined that the realization of the net deferred tax asset is not assured and
has created a valuation allowance for the entire amount of such
benefits.





At June
30, 2007, the Company had a net operating loss carryforward for Federal and
State income tax purposes of approximately $7,150,000 which, if not used, will
expire in various years through June 30, 2028.





Note
7:  Subsequent Events





On
January 4, 2008, the Company elected Harold R. Bennett to its Board of Directors
and granted Mr. Bennett stock options to purchase 50,000 shares of the Company’s
Common Stock at an exercise price of $0.10 per share , representing the fair
value of the Company’s Common Stock at the time of grant.  The Company
has valued these options at $1,800 and will expense this amount over the
four-year vesting period of the grant of options.





On
January 15, 2008, the Company executed and delivered, to two accredited
investors (the “Investors”), (i) convertible promissory notes in the aggregate
face amount of $263,116.44 (the “Convertible Promissory Notes”), and (ii)
warrants (the “Warrants”) to purchase up to an aggregate of 263,116 shares of
the Registrant’s common stock (the “Promissory Financing”).  The
Convertible Promissory Notes mature 120 days from date of issue and may be
prepaid at any time in whole or in part without penalty. The Convertible
Promissory Notes bear interest at 21% per annum, due and payable at maturity.
The Investors may convert the principal balance of the Convertible Promissory
Notes plus accrued interest (if any), in whole or in part, into Common Shares,
at their election at any time prior to payment at a conversion price equal to
Ten Cents ($0.10) per share.  The Warrants have an exercise price of
$0.50per share for the five-year life of the Warrants. The Company has
valued these warrants at $1,600 and will expense this amount in the three months
ended March 31, 2008.





The
Company uses the Black-Scholes option pricing model to calculate the grant-date
fair value of an award, with the following assumptions: no dividend yield,
expected volatility of between 45% and 60%, risk-free interest rate of between
3.0% to 5.25% and expected option life of ten years.





16


Item2.  Management’s Discussion and Analysis or Plan
of Operation





Forward-Looking
Information





The
following discussion of the Company’s financial condition and results of
operations should be read in conjunction with the Company’s financial statements
and notes for the three and six month periods ended December 31, 2007 included
herein and its audited financial statements and notes included in the Company’s
Annual Report on Form 10-KSB for the year ended June 30, 2007 as filed with the
Securities and Exchange Commission. This discussion and other sections of this
Quarterly Report contain, in addition to historical information, forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. Forward-looking statements involve known and unknown risks, uncertainties
and other factors, which may cause the Company’s actual results, performance or
achievements expressed or implied by these forward-looking statements to differ
materially from such forward-looking statements. The forward-looking statements
included in this report may prove to be inaccurate.




These
statements are based on a number of assumptions concerning future events, and
are subject to a number of uncertainties and other factors, many of which are
outside its control. Actual results may differ materially from such statements
for a number of reasons, including the effects of regulation and changes in
capital requirements and funding. In light of the significant uncertainties
inherent in these forward-looking statements, you should not consider this
information to be a guarantee by us or any other person that the Company’s
objectives and plans will be achieved. The Company does not undertake to update
or revise its forward-looking statements even if experience or future changes
make it clear that any projected results (expressed or implied) will not be
realized.




Some of
the information that follows does not constitute historical fact but merely
reflects management’s intent, belief or expectations regarding the anticipated
effect of events, circumstances and trends.  Such statements should
also be considered as forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995.  Management believes
that their expectations are based on reasonable assumptions within the bounds of
their knowledge of the Company’s business and operations. Factors that might
cause or contribute to differences between management’s expectations and actual
results include:




·
            the
      ability to obtain the franchise growth and profitability as anticipated by
      management;


·
            the
      ability to maintain margin and sales growth
  rates;


·
            the
      ability to attract and retain quality
employees;


·
            the
      effect of changing economic
conditions;


·
            the
      ability to obtain adequate equity and/or debt financing, the proceeds of
      which would be used principally to fund the opening of additional stores
      and for working capital


·
            the
      continued demand for the Company’s products and services;
    and


·
            the
      ability successfully to compete with competitors in the Company’s
      industry.




The
listing of factors is not intended to include all potential risk
factors.  The Company makes no commitment to update these factors or
to revise any forward-looking statements for events or circumstances, occurring
after the statement is issued, except as required by law.




Overview




The
Company is a retail store and franchise marketing company engaged in retail
sales and distribution through the operation of its home cinema design centers,
the sale of franchise stores and wholesale product distribution to
franchisees.




The
Company’s design centers focus on the sale and installation of affordable large
screen front projection in-home cinema rooms comprised of video and audio home
theater components. A majority of




17


its home
theater systems are installed on-site at customer homes, with screen sizes
ranging from 80 inches to over 12 feet. The Company also sells theater seating,
interior décor items, accessories and its proprietary digital theater management
system called OneViewTM. The Company targets its home theater system marketing
toward a larger consumer base than traditional custom home theater companies and
focuses on lower retail price points in a store setting where customers can
easily and readily encounter the complete home theater experience in a number of
home settings.




The
Company’s first retail store or “design center” opened on September 1, 2003 in
Newark, Delaware and was built to resemble an actual movie theater.  A
separate distribution center, warehouse and administrative office facility
opened in February 2004, also in Newark, Delaware.  This multi-purpose
facility provides installation and service, warehousing and product
distribution, and other retail support services to a cluster of company-owned
design centers in contiguous and surrounding areas.  The Company
anticipates that it will open additional Company-owned design centers in the
Mid-Atlantic region in the future.




The
following table sets forth the number of design centers:




Theater
Xtreme Entertainment Group,
Inc.




Number
      of design stores at June 30, 2005
              2
              
              1
              
              3
              
              3
              
              6Net
      additions (deletions) in the fiscal year ended June 30,
    2006
              1
              
              5
              
              6
              
              9
              
              15Number
      of design stores at June 30, 2006
              3
              
              6
              
              9
              
              12
              
              21Net
      additions (deletions) in the fiscal year ended June 30,
    2007
              2
              
              3
              
              5
              
              0
              
              5Number
      of design stores at June 30, 2007
              5
              
              9
              
              14
              
              12
              
              26Net
      additions (deletions) in the three months ended September 30,
      2007
              0
              
              2
              
              2
              
              0
              
              2Number
      of design stores at September 30, 2007
              5
              
              11
              
              16
              
              12
              
              28Net
      additions (deletions) in the three months ended December 31,
      2007
              (2)
              
              0
              
              (2)
              
              0
              
              (2)Number
      of design stores at December 31, 2007
              3
              
              11
              
              14
              
              12
              
              26


In
November, 2007, the Company closed two of its underperforming Company-owned
retail outlets. In the three months ended December 31, 2007, no new franchise
stores opened.




The
Company has a limited operating history for evaluating trends and
seasonality.




18







Results
of Operations for the three months ended December 31, 2007 compared to the three
months ended December 31, 2006




Recognized
sales revenue for the three months ended December 31, 2007 was $1,175,562
compared to $1,702,189 for the three months ended December 31, 2006, reflecting
a decrease of (31)%. This decrease is primarily the result of decreased retail
sales in underperforming and closed retail outlets.  Aggregate gross
profit amounts and percentages were $451,802 and 38% for the three months ended
December 31, 2007 as compared to $687,323 and 40% for the three months ended
December 31, 2006.




The
following is illustrative for the three months ended December 31:


Three
      months ended December 312007
              
              
              2006Gross
              
              
              
              
              
              
              
              
              GrossSales
              
              
              Profit
              
              
              %
              
              
              Sales
              
              
              Profit
              
              
              %Retail
              
              $
              940,601
              
              
              $
              377,562
              
              
              
              40
              %
              
              $
              1,305,897
              
              
              $
              584,425
              
              
              
              45
              %Wholesale
              
              $
              161,863
              
              
              $
              1,142
              
              
              
              1
              %
              
              $
              331,233
              
              
              $
              37,839
              
              
              
              11
              %Franchise
              
              $
              73,098
              
              
              $
              73,098
              
              
              
              100
              %
              
              $
              65,059
              
              
              $
              65,059
              
              
              
              100
              %Total
              
              $
              1,175,562
              
              
              $
              451,802
              
              
              
              38
              %
              
              $
              1,702,189
              
              
              $
              687,323
              
              
              
              40
              %





For the
three months ended December 31, 2007, retail sales decreased by $(365,296), or
(28)%, when compared to the three months ended December 31, 2006. Same-store
sales, reflecting sales for the Company’s Delaware locations, were $743,134 and
$753,153 for the three months ended December 31, 2007 and 2006, respectively and
decreased by $(10,019), or (1)%. This decrease is attributable mainly to reduced
consumer spending in the consumer electronics category generally experienced by
most consumer electronics retailers. New stores sales were $197,467 for the
three months ended December, 2007 compared to $552,744 for the three months
ended December 31, 2006 and accounted for the majority of the overall retail
sales decrease and amounted to a $(355,277) or a (64)% decline. This decrease is
attributable mainly to reduced consumer spending in the consumer electronics
category generally experienced by most consumer electronics retailers coupled
with their less than favorable site locations. New stores reflect the inclusion
of the Company’s Leesport, Pennsylvania and Bel Air and Lutherville design
stores, of which Leesport, Pennsylvania is now closed.




Gross
profit amounts and percentages on retail sales for the three months ended
December 31, 2007 amounted to $377,562 and 40% compared to $584,425 and 45% for
the three months ended December 31, 2006.  The decline in gross margin
is attributable to the sale of retail displays and other obsolete component
models at less than standard retail pricing. Additionally, the Company wrote
down more defective cables used in installations.




For the
three months ended December 31, 2007, the Company recognized wholesale sales,
principally sales to franchisees, of $161,863 compared to $331,233 for the three
months ended December 31, 2006, reflecting a (51)% decrease.  This
decrease results from almost all of the Company’s franchisees purchasing audio
and video product components directly from manufacturers as opposed to
purchasing these components through the Company.  Wholesale gross
profit amounts and percentages were $1,142 and 1% for the three months ended
December 31, 2007 compared to $37,839 and 11% for the three months ended
December 31, 2006.  This decline is attributable to the change in the
franchise purchasing channel.




For the
three months ended December 31, 2007, the Company recognized no earned revenue
relating to the opening of its franchises compared to $25,000 recognized in the
three months ended December 31, 2006. No new franchises were opened during the
period.  The Company’s franchise contract provides royalty payments of
approximately 4% of franchisee gross revenues.  For the three months
ended December 31, 2007, the Company recognized franchise royalties of $73,098
compared to $40,059 in royalties recognized for the three months ended December
31, 2006.




19


Occupancy
expenses include leasing expenses for retail design centers and office and
warehouse facilities, property taxes, utilities, maintenance and other related
occupancy expenses.  For the three months ended December 31, 2007,
occupancy expenses were $176,711 compared to $104,858 for the three months ended
December 31, 2006.  The increase is attributable to the operating
costs of a population of five Company-owned stores at December 31, 2007 versus
four Company-owned stores open at December 31, 2006. During the three months
ended December 31, 2007, the Company closed two of its
stores.  Despite these closures, occupancy costs will continue until
such time as the Company can reach an understanding as to sub-leasing these
closed properties.




Selling,
general and administrative expenses include the compensation of design center
personnel, the franchise sales and support operations, advertising, marketing
and other merchandising expenses, finance and information systems, human
resources and training operations, related support functions, and executive
officers compensation.  Selling, general and administrative expenses
for the three months ended December 31, 2007 were $1,086,430 compared to
$1,208,042 for the three months ended December 31, 2006. Expenses for the three
months ended December 31, 2007 include Advertising and Promotional expenses of
$100,995 compared to $113,834 spent during the three months ended December 31,
2006 reflecting reduced spending for media advertising. Professional fees,
excluding investment advisor expense, amounted to $197,853 for the three months
ended December 31, 2007 compared to $239,994 for the three months ended December
31, 2006 reflective of increased spending for management consulting services
offset by decreased legal fees. Investment advisor expense amounted to $30,204
for the three months ended December 31, 2007 compared to $152,076 for the three
months ended December 31, 2006. Depreciation expense for the three months ended
December 31, 2007 was $170,419 compared to $39,673 for the three months ended
December 31, 2006, the increase primarily due to the write-down of leasehold
assets of the two closed Company stores. The majority of the remaining change in
selling, general and administrative expenses is spread evenly throughout all
remaining expense categories.




20







Results
of Operations for the six months ended December 31, 2007 compared to the six
months ended December 31, 2006




Recognized
sales revenue for the six months ended December 31, 2007 was $2,378,780 compared
to $3,164,717 for the six months ended December 31, 2006, reflecting a decrease
of (33)%.  This decrease is primarily the result of decreased retail
sales in underperforming and closed retail outlets. Aggregate gross profit
amounts and percentages were $834,735 and 35% for the six months ended December
31, 2007 as compared to $1,217,257 and 39% for the six months ended December 31,
2006. The following is illustrative for the six months ended December
31:


Six
      months ended December 312007
              
              
              2006Gross
              
              
              
              
              
              
              
              
              GrossSales
              
              
              Profit
              
              
              %
              
              
              Sales
              
              
              Profit
              
              
              %Retail
              
              $
              1,708,065
              
              
              $
              597,972
              
              
              
              35
              %
              
              $
              2,568,461
              
              
              $
              1,054,238
              
              
              
              41
              %Wholesale
              
              $
              473,488
              
              
              $
              39,536
              
              
              
              8
              %
              
              $
              493,253
              
              
              $
              60,016
              
              
              
              12
              %Franchise
              
              $
              197,227
              
              
              $
              197,227
              
              
              
              100
              %
              
              $
              103,003
              
              
              $
              103,003
              
              
              
              100
              %Total
              
              $
              2,378,780
              
              
              $
              834,735
              
              
              
              35
              %
              
              $
              3,164,717
              
              
              $
              1,217,257
              
              
              
              39
              %


For the
six months ended December 31, 2007, retail sales decreased by $(860,396), or
(34)%, when compared to the six months ended December 31, 2006. Same-store
sales, reflecting sales for the Company’s Delaware locations, were $1,352,329
and $1,705,440 for the six months ended December 31, 2007 and 2006, respectively
and decreased significantly by $(353,111), or (21)%. This decrease is
attributable mainly to reduced consumer spending in the consumer electronics
category generally experienced by most consumer electronics retailers
experienced in the three months ended September 30, 2007. For the same
continuing reasons, new store sales were $355,736 and $863,021 for the six
months ended December 31, 2007 and 2006, respectively and accounted for a sales
decrease of $(507,285) or (59)%. New stores reflect the inclusion of the
Company’s Leesport, Pennsylvania and Bel Air and Lutherville design stores, of
which Leesport, Pennsylvania is now closed.




Gross
profit amounts and percentages on retail sales for the six months ended December
31, 2007 amounted to $597,972 and 35% compared to $1,054,238 and 41% for the six
months ended December 31, 2006.  The decline in gross margin is
attributable to the underabsorption of warehouse and installation personnel
costs owing to the decline of sales installations experienced in the first
fiscal quarter coupled with coupled with decreased margins on supplies, the
write down of defective cable inventory and the sale of retail displays and
other obsolete component models at less than standard retail
pricing.




For the
six months ended December 31, 2007, the Company recognized wholesale sales,
principally sales to franchisees, of $473,488 compared to $493,253 for the six
months ended December 31, 2006, reflecting a (4)% decrease.  This
decrease results from almost all of the Company’s franchisees purchasing audio
and video product components directly from manufacturers as opposed to
purchasing these components through the Company.  Wholesale gross
profit amounts and percentages were $39,536 and 8% compared to $60,016 and 12%
for the six months ended December 31, 2006.  This decline is
attributable to the change in the franchise purchasing channel.




For the
six months ended December 31, 2007, the Company recognized $62,500 in earned
revenue relating to the opening of its franchises compared to $50,000 recognized
in the six months ended December 31, 2006. Two new franchises were opened during
the period ended December 31, 2007.  The Company’s franchise contract
provides royalty payments of approximately 4% of franchisee gross
revenues.  For the six months ended December 31, 2007, the Company
recognized franchise royalties of $134,727 compared to $53,003 in royalties
recognized for the six months ended December 31, 2006.




21


Occupancy
expenses include leasing expenses for retail design centers and office and
warehouse facilities, property taxes, utilities, maintenance and other related
occupancy expenses.  For the six months ended December 31, 2007,
occupancy expenses were $330,924 compared to $226,771 for the six months ended
December 31, 2006.  The increase is attributable to the operating
costs of a population of five Company-owned stores at December 31, 2007 versus
four Company-owned stores open at December 31, 2006. During the six months ended
December 31, 2007, the Company closed two of its stores.  Despite
these closures, occupancy costs will continue until such time as the Company can
reach an understanding as to sub-leasing these closed properties.




Selling,
general and administrative expenses include the compensation of design center
personnel, the franchise sales and support operations, advertising, marketing
and other merchandising expenses, finance and information systems, human
resources and training operations, related support functions, and executive
officers compensation.  Selling, general and administrative expenses
for the six months ended December 31, 2007 were $2,286,331 compared to
$2,262,504 for the six months ended December 31, 2006. Expenses for the six
months ended December 31, 2007 include Advertising and Promotional expenses of
$184,925 compared to $287,616 spent during the six months ended December 31,
2006 reflecting reduced spending for media advertising. Professional fees,
excluding investment advisor expense, amounted to $386,807 for the six months
ended December 31, 2007 compared to $339,716 for the six months ended December
31, 2006 reflective of increased spending for management consulting services
partially offset by reduced legal fees. Investment advisor expense amounted to
$137,783 for the six months ended December 31, 2007 compared to $240,025 for the
six months ended December 31, 2006.  Depreciation expense for the six
months ended December 31, 2007 was $237,009 compared to $74,643 for the six
months ended December 31, 2006, the increase primarily due to the write-down of
leasehold assets of the two closed Company stores. The majority of the remaining
increase in selling, general and administrative expenses is spread evenly
throughout all remaining expense categories.




The
Company had net losses of $(2,029,312) and $(3,446,254) for the six months ended
December 31, 2007 and year ended June 30, 2007.  The Company had a
working capital deficit at December 31, 2007 that resulted in a current ratio of
0.47 at such date. The Company was able to maintain operations in the six months
ended December 31, 2007 only by borrowing $225,000 on a short-term basis at a
very high interest rate and allowing accounts payable and accrued expenses to
increase to $1,280,782 at December 31, 2007 from $801,978 at June 30,
2007.




As noted
in the Company’s auditor’s report for the twelve months ended June 30, 2007,
there is substantial doubt about the Company’s ability to continue as a going
concern. Nonetheless, the Company is seeking to remedy this extremely difficult
financial situation with cost-cutting measures and attempts to raise capital.
There is no assurance that cost-cutting measures will succeed nor is there any
assurance that additional capital will be available to the Company on any terms,
let alone terms acceptable to the Company.




Liquidity




The
Company’s cash needs are primarily for working capital to support inventory and
fund anticipated future net losses, and for the capital costs of expanding the
number of Company-owned design centers.  Additional working capital
will be used to further develop the Company’s ability to significantly expand
and support franchise operations.




The
Company’s cash position decreased to $90,353 at December 31, 2007 from $232,583
at June 30, 2007.  The loss for the six months ended December 31, 2007
of $(2,029,312) included non-cash depreciation and amortization charges
amounting to $496,992 and was further offset by a decreases in accounts
receivable and inventory of $98,421 and 249,899, respectively, an increase in
accounts payable of $478,804, an increase in deferred sales of $147,035, the
issuance of common share and warrants amounting to $41,250 for services
rendered, employee stock option vesting of 48,686 and a net increase


22


in
prepaid expenses and other assets of $123,540, resulting in a net cash used in
operating activities of $(344,685).During the six months ended December 31,
2007, the Company spent $2,567 for the acquisition of equipment.




During
the six months ended December 31, 2007, to finance its loss, capital
expenditures, and changes in other working capital items, the Company increased
its notes payable by $225,000.




Between
July 20 and August 15, 2007, the Company executed and delivered promissory notes
to three accredited investors ( the “Promissory Note Investors”) in the
aggregate face amount of $225,000 (the “Promissory Notes”), and warrants (the
“Promissory Warrants”) to purchase up to 112,500shares, in the
aggregate, of the Company’s common stock (the “Promissory Note Financing”). The
proceeds of the Promissory Note Financing were used for general corporate
purposes. The Promissory Notes bear interest at 14% per annum, mature one year
from the date of issue and may be prepaid at any time without penalty. See Item
1, Note 3, Notes Payable.





At
December 31, 2007, the Company did not have a credit facility or line-of-credit
arrangement.  The Company has no compensating balance
requirements.  The Company has a borrowing covenant in connection with
the long term debenture (the “March Debenture”), as amended, whereby the
Company’s borrowing ability is proscribed to an aggregate of $2,000,000 in
additional unsecured indebtedness that may be incurred subsequent to March 6,
2007.  Should the Company exceed this limitation, the March Debenture
would become due and payable in its entirety.  Pursuant to this
covenant, the Company has $1,746,822 of remaining borrowing capacity as of
December 31, 2007.  Additionally and also pursuant to the March
Debenture, should the Company raise in excess of $6,000,000 in equity financing,
the March Debenture would become due and payable in its entirety.




In
October, 2007, the Company and Kinzer Technology, LLC (“Kinzer”) amended the
March Debenture.  Under the original terms of the March Debenture, the
Company was prohibited from incurring any additional unsecured indebtedness for
borrowed money after March 6, 2007 in excess of $1.0 million.  The
amendment increases the amount of such indebtedness which may be incurred after
March 6, 2007 to $2.0 million.  The March Debenture also requires
quarter annual interest payments on each April 1, July 1, October 1, and January
1.  The amendment permits the Company to defer the interest payments
otherwise due on October 1, 2007 and January 1, 2008 until July 1,
2008.





In
December 2007, the Company and the holders of three debentures in the aggregate
face amount of $300,000 agreed to amend the terms of the
debentures.  The amendment extended the due date of the payment of
amounts due and payable on the debentures to March 17,
2008.





The
Company does not have any committed sources of additional financing, and there
can be no assurance that additional funding, as necessary, will be available on
acceptable terms, if at all.  If adequate funds are not available, the
Company may be required to further delay, scale back, or eliminate certain
aspects of its business plan or current operations or attempt to obtain funds
through arrangements with collaborative partners or others that may require the
Company to surrender rights to Company methods, technologies, product
development projects, certain products or existing
markets.  Continuing losses together with the inability to secure
adequate additional funds could cause the Company to cease
operations.


23





The
Company’s cash flow from operations since inception has been and continues to be
negative.  If the Company does not raise a sufficient amount of
capital, it may not have the ability to remain in business until such time, if
ever, when it becomes profitable.




Although
management expects increased operating costs in future periods due to a
commitment to develop retail, franchising, and distribution operations on a
regional and national scale, it also recognizes the need to monitor its costs
and assess the progress of each of its Company-owned design stores. Accordingly,
it has begun and will continue a program of selective cost reduction and profit
improvement initiatives to keep costs within prescribed parameters. This program
had led to the closing of two of its five Company-owned design stores that were
underperforming at the store profit contribution level. Despite these closures,
management expects an increase in gross profits from sales resulting from the
opening of additional design stores whose locations will be in major
metropolitan retail centers. Additionally, management anticipates an increase in
contributions from its franchise operations, proceeds from additional capital
contributions from shareholders, and, to the extent necessary, improvements
through further modifications to its business plan.




The
Company either needs to reduce overhead expenses or increase the number of
profitable operating stores to the point where the aggregate contribution from
such stores offsets its future capital requirements. The adequacy of available
funds will depend on numerous factors and risks, including the number of and
planned implementation of the establishment of new Company-owned retail design
centers, the sale of Company franchises on a national level, the successful
development of internally branded products for distribution to franchisees, and
the results of risks associated with the ability to establish meaningful
consumer market identification, branding and penetration, the ability to adapt
to rapid technological changes, and the ability to successfully compete against
intense competitive pressures from potentially larger, better capitalized future
competitors when such enter the Company’s market segment.  Further,
the Company’s results of operations and resulting capital requirements will be
affected by a wide variety of additional factors and risks including, but
perhaps not limited to, general economic conditions, decreases in average
selling prices over the life of any particular product, new product and
technology introductions, the ability to acquire sufficient quantities of a
given product in a timely manner, the ability to develop and maintain critical
strategic supply and co-marketing relationships and the ability to safeguard
intellectual property.




In the
event the Company’s plans change or its assumptions change or prove to be
inaccurate or the funds available prove to be insufficient to fund operations at
the planned level (due to further unanticipated expenses, delays, problems or
otherwise), the Company could be required to obtain additional funds through
equity or debt financing, through strategic alliances with corporate partners
and others, or through other sources in order to successfully continue to
implement its business strategies.  There is no assurance any such
additional funds could be obtained by the Company.




The
Company’s current policy is to invest its cash reserves in bank deposits,
certificates of deposit, commercial paper, corporate notes, U.S. government
instruments or other investment-grade instruments.




There can
be no assurance that the Company will be able to successfully implement its
business strategies or that profitability will ever be achieved.  The
Company expects that its future operating results will fluctuate significantly
from year to year and will be impacted by factors beyond its
control.




Off-Balance
Sheet Arrangements







There are
no off-balance sheet arrangements to which the Company is a party.




24







Item
3. Controlsand Procedures.





An
evaluation was performed under the supervision and with the participation of the
Company’s principal executive officer and principal financial officer of the
effectiveness of the design and operation of the Company’s disclosure controls
and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under
the Exchange Act) as of December 31, 2007. The evaluation revealed to the
Company’s principal executive officer and principal financial officer that the
design and operation of the Company’s disclosure controls and procedures were
effective as of December 31, 2007.




There
have been no significant changes in the Company’s internal controls over
financial reporting that have materially affected, or are reasonably likely to
materially affect, the Company’s internal control for the period covered by this
Quarterly Report on Form 10-QSB.




25


PART
II


OTHER
INFORMATION








Item
2.  UnregisteredSales of Equity Securities and
Use of Proceeds





During
the three months ended December 31, 2007 the Company issued warrants to purchase
150,000 shares of its Common Stock, at an exercise price of $1.00 per share, in
connection with the extension of the due date for payment of principal and
interest of certain of its short-term debentures.





During
the three months ended December 31, 2007, the Company amended the terms of all
warrants that contained full-ratchet protection eliminating such full-ratchet
protection from the terms of the warrants. Subsequent to the amendments, the
Company had no warrants issued and outstanding that contained full ratchet
protection as at December 31, 2007.








Item
4. Submissionof Matters to a Vote of Security
Holders





On
November 20, 2007, the Company held its annual meeting during which the
shareholders elected the following individuals as Directors of the Company for a
one-year term, all of whom were incumbent Directors:





Name
            
            Votes
              For
            Votes
              Against
            AbstainedScott
      R. Oglum
            
            12,263,804
            0
            340,776Justin
      L. Schakelman
            
            12,264,493
            0
            340,087David
      R. Hludzinski
            
            12,263,805
            0
            340,775H.
      Gregory Silber
            
            12,264,493
            0
            340,087





Additionally,
at its November 20, 2007 annual meeting, shareholders voted on the following
proposal:





Proposal
            
            Votes
              For
            Votes
              Against
            AbstainedTo
      appoint Morison Cogen LLP as the Company’s independent
              auditors
            
            12,324,854
            249,252
            30,474





26








Item
6.  Exhibits





Exhibit
            Description of
      Exhibit31.1
            Certification pursuant to Rule 13a-14(a) of the
      Securities Exchange Act of 1934, as amended executed by the Chief
      Executive Officer of the Company.31.2
            Certification pursuant to Rule 13a-14(a) of the
      Securities Exchange Act of 1934, as amended executed by the Chief
      Financial Officer of the Company.32.1
            Certification pursuant to 18 U.S.C. Section 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 executed
      by the Chief Executive Officer of the Company.32.2
            Certification pursuant to 18 U.S.C. Section 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 executed
      by the Chief Financial Officer of the
  Company.


27


SIGNATURES





In accordance with the requirements of
the Exchange Act, the registrant caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.








THEATER
      XTREME ENTERTAINMENT GROUP, INC.February
      19, 2008
            By: /s/
      Scott R. OglumScott
      R. OglumChairman
      of the Board and Chief Executive OfficerBy: /s/
      James J. VincenzoJames
      J. VincenzoChief
      Financial Officer






28