UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

_____________________

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2008

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 registrant as specified in its charter)



|                                                               |                                     
|-------------------------------------------------------------- | ------------------------------------
|Florida                                                        | 65-0913583                          
|(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.)



|                                                   |           
|-------------------------------------------------- | ----------
|250 Corporate Boulevard, Suite E, Newark, Delaware | 19702     
|(Address of principal executive offices)           | (Zip Code)



Issuer's telephone number: (302)  455-1334



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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer.  See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act (check one).

Large accelerated filer   ̈ Accelerated filer  ̈   Non-accelerated filer  ̈   Smaller Reporting Company ý

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

The number of shares of the registrants Common Stock outstanding as of November 17, 2008 was 28,884,179.







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TABLE OF CONTENTS



|           |                                                                                       |     
|---------- | ------------------------------------------------------------------------------------- | ----
|           |                                                                                       | Page
|           | PART I  FINANCIAL INFORMATION                                                        |     
|           |                                                                                       |     
|Item 1     | Financial Statements                                                                  | 3   
|           |                                                                                       |     
|Item 2     | Managements Discussion and Analysis of Financial Condition
and Results of Operations | 3   
|           |                                                                                       |     
|Item 3     | Quantitative and Qualitative Disclosures About Market Risk                            | 9   
|           |                                                                                       |     
|Item 4     | Controls and Procedures                                                               | 9   
|           |                                                                                       |     
|           | PART II  OTHER INFORMATION                                                           |     
|           |                                                                                       |     
|Item 1     | Legal Proceedings                                                                     | 10  
|           |                                                                                       |     
|Item 1A    | Risk Factors                                                                          | 10  
|           |                                                                                       |     
|Item 2     | Unregistered Sales of Equity Securities and Use of Proceeds                           | 10  
|           |                                                                                       |     
|Item 3     | Defaults Upon Senior Securities                                                       | 11  
|           |                                                                                       |     
|Item 4     | Submission of Matters to a Vote of Security Holders                                   | 11  
|           |                                                                                       |     
|Item 5     | Other Information                                                                     | 11  
|           |                                                                                       |     
|Item 6     | Exhibits                                                                              | 12  
|           |                                                                                       |     
|Signatures |                                                                                       | 12  







2



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Item 1.

Financial Statements.



Our Financial Statements are attached as Appendix A (following Exhibits) and included as part of this Form 10-Q Report.



Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations



The following discussion Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements. The words anticipate, believe, expect, plan, intend, estimate, project, will, could, may and similar expressions are intended to identify forward-looking statements. Such statements reflect our current views with respect to future events and financial performance and involve risks and uncertainties. Should one or more risks or uncertainties occur, or should underlying assumptions prove incorrect, actual results may vary materially and adversely from those anticipated, believed, expected, planned, intended, estimated, projected or otherwise indicated. We caution you not to place undue reliance on these forward-looking statements, which we have made as of the date of this Quarterly Report on Form 10-Q.



The following provides information that management believes is relevant to an assessment and understanding of our plans and financial condition. The following selected financial information is derived from our historical financial statements and should be read in conjunction with such financial statements and notes thereto set forth elsewhere herein and the "Forward-Looking Statements" explanation included herein.



Results of Operations for the three months ended September 30, 2008 compared to the three months ended September 30, 2007



Total Revenue

Total revenue includes delivered and installed merchandise, installation and service labor customer service revenues, earned franchise license fees and franchise royalties.  Total revenue for the three months ended September 30, 2008 was $817,263 compared to $1,203,013 for the three months ended September 30, 2007, reflecting a decrease of $385,750 or 32%. This decrease is a result of decreased retail sales due to the closing of three of the Companys corporate stores, the change to allow most franchise purchases to be made directly from vendors versus through the Company, the decline in collected franchise royalties, the unavailability of import private label products, and some softening of consumer demand in the later part of the quarter, offset by the recognition of revenue from deferred franchise sales.





3



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The following is illustrative for the three months ended September 30:

|          |  |       |         |        |   |         |  |       |   |        |   |           |  |   |         |  |     |  
|--------- |  | ----- | ------- | ------ | - | ------- |  | ----- | - | ------ | - | --------- |  | - | ------- |  | --- | -
|          |  | 2008  |         | 2007  
|          |  |       |         | Gross  |   |         |  |       |   | Gross  |   |          
|          |  | Sales |         | Profit |   | %       |  | Sales |   | Profit |   | %        
|          |  |       |         |        |   |         |  |       |   |        |   |          
|Retail    |  | $     | 568,670 |        | $ | 158,356 |  | 28    | % |        | $ | 767,260   |  | $ | 220,206 |  | 29  | %
|Wholesale |  |       | 6,350   |        |   | 2,119   |  | 33    | % |        |   | 311,625   |  |   | 38,394  |  | 12  | %
|Franchise |  |       | 242,243 |        |   | 242,243 |  | 100   | % |        |   | 124,128   |  |   | 124,128 |  | 100 | %
|          |  |       |         |        |   |         |  |       |   |        |   |           |  |   |         |  |     |  
|Total     |  | $     | 817,263 |        | $ | 402,718 |  | 49    | % |        | $ | 1,203,013 |  | $ | 382,728 |  | 32  | %



For the three months ended September 30, 2008, retail sales decreased by $198,590, or 25.9%, when compared to the three months ended September 30, 2007 due to the closing of three corporate stores during the year ended June 30, 2008. Same-store sales, reflecting sales for the Companys Delaware locations, were $459,868 and $608,991 for the three months ended September 30, 2008 and 2007, respectively and decreased by $149,123 or 24.5%. This decrease is attributable to reduced consumer spending in the consumer electronics category generally experienced by most consumer electronics retailers and unavailability of import private label products.

Wholesale sales decreased $305,275 to $6,350 for the three months ended September 30, 2008 compared to $311,625 for the three months ended September 30, 2007.  The decrease in wholesale sales is reflective of the franchise stores acting independently of corporate headquarters.

For the three months ended September 30, 2008, the Company had total new customer orders of $524,583 compared to $1,257,384 for the three months ended September 30, 2007.  The Companys backlog at September 30, 2008 was $506,839 compared to $1,149,390 at September 30, 2007.

The Company has continued to emphasize an integrated approach to home theater design which increasingly includes not only audio and video equipment, but also complementary décor items including chairs, seating and furniture, as well as other interior design elements which taken together provide customers with total home theater design solutions.  The decrease in customer orders is related to the closing of the four design center as well as decrease wholesale sales from the franchise design centers.



4



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For the three months ended September 30, 2008, the Company collected $-0- non-refundable, initial franchise license fees versus $80,000 collected for the three months ended September 30, 2007.  For the three months ended September 30, 2008, the Company recognized a total of $236,500 in franchise license fees, consisting of $40,000 as earned revenue relating to the opening of one franchise and $196,500 (most of these funds were not held in escrow and used in the previous fiscal year) for franchises whose rights were terminated pursuant to their signed agreements.  For the three months ending September 30, 2007, the Company recognized $62,500 as earned revenue relating to the opening of its franchises.  At September 30, 2008, the Company had $80,000 in deferred franchise fees that will be recognized as earned revenue in periods when the franchise design centers open, or area development rights expire.

The Companys franchise contract provides royalty payments of approximately 4% of franchisee gross revenues.  For the three months ended September 30, 2008, franchise revenue, reflecting earned franchised fees and franchise royalties, decreased by $55,886 or 90.7%, when compared to the three months ended September 30, 2007.  All but a couple of the franchises have ceased payment of their franchise royalties claiming that the Company is in default of the franchise agreements. The Company has retained an experienced franchise lawyer and is currently in negotiations with a group of its franchises on an amicable solution, which may include a catch up provision or a buy out of the agreement by the franchisee.

Cost of Sales and Gross Profit

Gross profit amounts and percentages on retail sales for the three months ended September 30, 2008 amounted to $158,356 and 27.9% compared to $220,206 and 28.7% for the three months ended September 30, 2007.  Management expects gross profit percentages to remain consistent or rise as operations expand and imports are available for sale and distribution once again.

Operating Expenses

Occupancy Expenses

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 September 30, 2008, occupancy expenses were $147,265 compared to $155,067 for the three months ended September 30, 2007.  The decrease of $7,802 is attributable to the operating costs of a population of five Company-owned stores at September 30, 2008 versus two Company-owned stores open at September 30, 2007 offset by occupancy costs for the leases that the Company has settled on the closed properties.  For the three months ended September 30, 2008, the Company paid the balance of $41,242 to settle the Bel-Air, Maryland property lease.



5



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The Company closed its Lutherville, Maryland store in November 2008 and has negotiated a verbal agreement from the landlord to be released from all future lease obligations for six months rent totaling $38,988 less the security deposit of $12,500.  The total future lease obligations are $202,027.  This verbal commitment is not binding and there can be no assurances the landlord will abide by his verbal commitment and begin to take action to demanding fulfillment of lease obligations.

Selling, General and Administrative Expenses

Selling, general and administrative expenses include the compensation of design center personnel, support operations, advertising, marketing, franchise operational support other merchandising expenses, finance information systems, human resources training operations, related support functions, and executive officers compensation.  Selling, general and administrative expenses for the three months ended September 30, 2008 were $1,005,896 compared to $1,198,841 for the three months ended September 30, 2007 for a decrease of $192,945.

Advertising and Promotional expenses for the three months ended September 30, 2008 were $29,942 compared to $147,834 for the three months ended September 30, 2007 reflecting a decrease of $117,892 due to reduced spending across the board in all advertising categories in order to control expenses, and reduction of advertising in closed store markets.

Professional fees, excluding investment advisor expense, amounted to $245,728 for the three months ended September 30, 2008 compared to $188,955 for the three months ended September 30, 2007.  The increase of $56,773 is due to additional legal and management consulting services.

Personnel costs amounted to $213,782 for the three months ended September 30, 2008 compared to $482,355 for the three months ended September 30, 2007 for a decrease of $268,573.  This decrease is reflective of three closed corporate stores and the downsizing of personnel at corporate headquarters.

During the three months ended September 30, 2008, the Company also granted employees, directors and consultants stock bonuses.  There were no stock bonuses for the three months ended September 30, 2007.  For the three months ended September 30, 2008, the Company recognized $229,527 in expense in connection with these bonuses.

Other selling, general and administrative expenses consist of investment advisor expense, insurance, software, office expenses, bank charges, office, telephone, shipping, auto, depreciation and other miscellaneous expenses.  These expenses amounted to $286,917 for the three months ended September 30, 2008 compared to $379,697 for the three months ended September 30, 2007.  The decrease of $92,780 was primarily due to a tight control on expenses, workforce reductions, as well as the three stores that were closed during the year ended June 30, 2008.



We realized a loss from operations of $750,443 and $971,180 for the three months ended September 30, 2008 and 2007.



6



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Other Expense

Other expense increased from $121,974 for the three months ended September 30, 2007 to $237,372 for the three months ended September 30, 2008.  The increase of $115,398 is due to the accretion of discount on convertible notes of $97,815, a loss on disposal of fixed assets of $6,682 and an increase of interest expense of $31,985 offset by the forgiveness of debt of $19,789 and interest income of $1,295.

Net Loss

Net loss was $987,815 and $1,093,154 for the three months ended September 30, 2008 and 2007, respectively, for a decrease of $105,339, primarily resulting from the decrease in selling, general and administrative expenses as described above.

Critical Accounting Policies

The Companys accounting policies are more fully described in the Notes to Financial Statements.  As discussed in Note 1 of Notes to Financial Statements, the preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements. The Company believes that, of its significant accounting policies, the following may involve a higher degree of judgment, estimation, or complexity than other accounting policies.



Stock Based Compensation



In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS 123 (revised 2004), Share-Based Payment ("SFAS 123R").  SFAS 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 123(R) is similar to the approach described in SFAS 123.  However, SFAS 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 July 1, 2006, the Company adopted SFAS 123(R) using the modified prospective method as permitted under SFAS 123(R).  Under this transition method, compensation cost recognized in the first quarter of 2006 includes compensation cost for all share-based payments granted prior to but not yet vested as of December 30, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123.  In accordance with the modified prospective method of adoption, the Company's results of operations and financial position for prior periods have not been restated.



The Company uses the Black-Scholes option pricing model to calculate the grant-date fair value of an award.



7



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Liquidity and Capital Resources



The Companys cash position decreased to $43,344 at September 30, 2008 from $188,899 at June 30, 2008.  This decrease of $145,555 is due to the funding of the Companys cash used in operations and investing activities, offset by additional funds provided by incurring of indebtedness.



Working capital at September 30, 2008 was a deficit of $2,514,108 compared to the deficit of $2,109,856 at June 30, 2008, representing an increase of $404,252.  This decrease is due to the net impact of the issuance of short-term debentures offset by the decrease in deferred sales and deferred franchise fees.



The primary source of financing for the three months ended September 30, 2008 was derived from the borrowing of short-term debentures.



The Companys cash flow from operations since inception has been and continues to be negative.  The Company hopes to expand its revenues by increasing the number of Company-owned design stores and expanding its private label furniture line, RowOne.



Cash Flows



During the three months ended September 30, 2008, net cash used in operating activities was $596,035 consisting of payments for management, legal, professional and consulting expenses, rent and other expenditures necessary to maintain our business infrastructure, $90,000 in deferred financing fees, $236,500 in deferred franchise license fees, $106,098 in deferred sales, $28,662 in other current liabilities and $1,078 in inventory offset by $314,323 for the issuance of common stock for services, $35,737 for the issuance of warrants for services, $23,594 for vesting of stock options, $127,875 in amortization of deferred charges, $54,540 in amortization of deferred financing fees, $14,089 in amortization of stock grants, $97,815 in accretion of discount on convertible debt, $19,171 in accounts receivable, $38,663 in prepaid expenses, $6,865 in other assets, $25,880 in accounts payable, $6,136 in payroll liabilities and $42,953 in deferred compensation.



Net cash used in investing activities was $19,992, which was due primarily to the Companys cost to continue implementation of its new software program offset by the sale of two vehicles.



Net cash provided by financing activities for the three months ended September 30, 2008 was $470,472, which consists of $500,000 of short-term debenture proceeds offset by $29,528 in notes payable.



At September 30, 2008, our cash and cash equivalents totaled $43,344, our assets totaled $1,919,569, our liabilities totaled $6,126,030, and we had stockholders' deficit of $4,206,461.





8



---

Management expects increased operating costs in future periods due to a commitment to develop retail and wholesale on a regional and national scale. To accomplish this, management expects an increase in gross profits from sales resulting from the expansion of Company owned design stores, proceeds from additional capital contributions from shareholders and accredited investors, proceeds from its own private label furniture line, RowOne and, to the extent necessary, improvements through further modifications to its business plan.

In October 2008, the Company entered into an agreement to acquire a furniture company as part of its strategy to expand its RowOne product line into the consumer electronic and home furniture channels.  As of this date of this report, the closing date for this transaction has not been determined.  The Company anticipates being able to close on this transaction in the next quarter.  In connection with this transaction the Company signed an acquisition agreement with its investment banking firm. This agreement provides for the investment banking firm to receive $250,000 upon the close of the acquisition, which will be paid in the Companys common stock.



Item 3

Quantitative and Qualitative Disclosures About Market Risk.



Not Applicable.





Item 4

Controls and Procedures



Effectiveness of Disclosure Controls and Procedures



As of the end of the period covered by this report, an evaluation was performed under the supervision and with the participation of the Company's principal executive officers and financial officers 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 the end of the period covered by this report. The evaluation revealed to the Company's principal executive officer and financial officer that the design and operation of the Companys disclosure controls and procedures were not effective as of the end of the period covered by this report.



The determination that the design and operation of the Company's disclosure controls and procedures are ineffective is primarily due to our Companys inability to comply with our Exchange Act reporting because our accounting work was not timely completed, our financial statements were not timely prepared, and therefore our audit was not timely obtained. Current management considers these delays to be a result of previous managements failure to implement adequate controls and procedures.  Current management is actively working to make effective the design and operation of the Company's disclosure controls and procedures.







9



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Changes in Internal Control Over Financial Reporting



Our management, with the participation of the Company's principal executive officer and financial officer, evaluated whether there were any changes in the effectiveness of our internal control over financial reporting as of the end of our fourth fiscal quarter. In making this assessment, our management considered the implementation of new senior executive management, including a new chief executive officer and chief financial officer and new accounting support staff. Based on this evaluation, our management, with the participation of the Company's principal executive officers and financial officers, concluded that, there have been significant changes in the Company's internal controls and in other factors that significantly improved internal controls subsequent to the date of the above-described evaluation period.





PART II  OTHER INFORMATION

Item 1

Legal Proceedings



Not Applicable



Item 1A

Risk Factors



Not Applicable



Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

On November 18, 2008, our Company closed its private offering of 12% senior unsecured convertible debentures. Pursuant to the private offering, our Company issued 15.9 units at a price of $50,000 per unit. Each unit consisted of a $50,000 face value 12% Senior Unsecured Convertible Debenture (the Debenture) due July 2009 and a warrant (the Warrant) to purchase 10,000 shares of the common stock of the Company, par value $0.001 per share (the Common Stock) at an exercise price of $0.10 per share. We issued an aggregate of $795,000 of Debentures and Warrants to purchase up to 159,000 shares of Common Stock.



Each Note is convertible by the holder thereof, in whole or in part, at any time after October 31, 2008 at the price per share equal to the greater of (i) the product obtained by multiplying (.80) by the average closing or last sale price of the Companys Common Stock as quoted on the OTC Bulletin Board, NASDAQ, or any securities exchange, for twenty(20) consecutive trading days immediately prior to the conversion date; or (ii) $0.08 per share. Each Warrant entitles the holder to purchase shares of common stock of the Company at an exercise price of Ten Cents ($0.10) per share. The Warrant may be exercised any time prior to July 31, 2010.



The net proceeds to our Company from the offering is approximately $662,600. Allen, Goddard, McGowan, Pak & Partners, LLC(the Financial Representative)Member FINRA/SIPC served as the financial representative for the offering, and in exchange for serving as such, received: (i) a non-refundable cash engagement fee of $25,000 to cover the Financial Representatives attorneys fees; (ii) a cash fee of $103,350 in selling commissions and expense allowances; (iii) a  Class A Warrant to purchase 993,750 shares of the Companys common stock at an exercise price of $0.10 per share; and (iv) a Class B Warrant to purchase 15,900 shares of the Companys common stock at an exercise price of $0.10.



10



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The securities were issued in reliance upon exemptions from registration available under Rule 506 of Regulation D and Sections 4(2) and 4(6) of the Securities Act of 1933, as amended, and are restricted securities. No underwriters were utilized in the offering.





Item 3

Defaults Upon Senior Securities

In November 2008, holders of an aggregate of $200,000 in face value promissory notes (two $100,000 promissory notes) demanded the payment of principal on each such notes that were due on July 17, 2008 and August 15, 2008, respectively. The promissory notes were guaranteed by an affiliated third party and secured with such third partys personal assets. Prior to November 2008, the note holders agreed to extend the principal due date on the promissory notes to an undetermined future date so long as our Company continued to pay interest on the principal of the promissory notes.   In November 2008, the third party guarantor of the promissory notes agreed to transfer all of the assets securing the promissory notes to the note holders in full payment and satisfaction of the entire principal and interest amount due under the Promissory Note. Upon the closing of that agreement, which we expect to occur on or before November 20, 2008, our Company will have no further obligations pursuant to such promissory notes.



Item 4

Submission of Matters to a Vote of Security Holders



Not Applicable



Item 5

Other Information



Not Applicable



11



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Item 6

Exhibits

(31)

31.1

Certification of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.



31.2

Certification of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

(32)

32.1

Certification of the Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.



32.2

Certification of the Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.





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.



Registrant



By:  /s/ Robert Oberosler

Robert Oberosler,

Chief Executive Officer



Dated: November 19, 2008



By:  /s/ Robert Oberosler

Robert Oberosler,

Chief Executive Officer



Dated: November 19, 2008



By: /s/Theresa Q. Hoffmann

Theresa Q. Hoffmann,

Interim Chief financial Officer



Dated: November 19, 2008



12



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THEATER XTREME ENTERTAINMENT GROUP, INC.



FINANCIAL STATEMENTS



SEPTEMBER 30, 2008



(UNAUDITED)















































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THEATER XTREME ENTERTAINMENT GROUP, INC.







CONTENTS



|                                   |           
|---------------------------------- | ----------
|                                   | PAGE      
|                                   |           
|BALANCE SHEETS                     | F-1       
|                                   |           
|STATEMENTS OF OPERATIONS           | F-2       
|                                   |           
|STATEMENTS OF STOCKHOLDERS EQUITY | F-3       
|                                   |           
|STATEMENTS OF CASH FLOWS           | F-4       
|                                   |           
|NOTES TO FINANCIAL STATEMENTS      | F-5  F-21











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THEATER XTREME ENTERTAINMENT GROUP, INC.

BALANCE SHEETS





|                                            |                                                                      |                    |              |               |             |             
|------------------------------------------- | -------------------------------------------------------------------- | ------------------ | ------------ | ------------- | ----------- | ------------
|                                            |                                                                      | September 30, 2008 |              | June 30, 2008
|                                            | (Unaudited)                                                          |                    | (Audited)   
|Assets                                      |                                                                      |                    |             
|                                            |                                                                      |                    |             
|Current Assets                              |                                                                      |                    |             
|                                            | Cash and equivalents                                                 | $                  | 43,344       |               | $           | 188,899     
|                                            | Accounts receivable, net of allowance of $4,000                      |                    | 40,256       |               |             | 59,427      
|                                            | Inventory                                                            |                    | 379,133      |               |             | 378,055     
|                                            | Deferred charges                                                     |                    | 244,124      |               |             | 163,750     
|                                            | Prepaid expenses                                                     |                    | 41,344       |               |             | 80,007      
|                                            | Other Current Assets                                                 |                    | 116,859      |               |             | 123,724     
|Total Current Assets                        |                                                                      | 865,060            |              |               | 993,862    
|                                            |                                                                      |                    |              |               |             |             
|Property and Equipment, net                 |                                                                      | 581,501            |              |               | 607,986    
|                                            |                                                                      |                    |              |               |             |             
|Other Assets                                |                                                                      |                    |              |               |            
|                                            | Deferred Financing Fees                                              |                    | 313,637      |               |             | 215,885     
|                                            | Deferred charges                                                     |                    | 127,915      |               |             | -           
|                                            | Deposits                                                             |                    | 31,456       |               |             | 31,456      
|                                            |                                                                      |                    |              |               |             |             
|Total Assets                                | $                                                                    | 1,919,569          |              | $             | 1,849,189  
|                                            |                                                                      |                    |              |               |             |             
|Liabilities and Stockholders' Deficit       |                                                                      |                    |              |               |            
|                                            |                                                                      |                    |              |               |            
|Current Liabilities                         |                                                                      |                    |              |               |            
|                                            | Accounts payable and accrued expenses                                | $                  | 1,171,042    |               | $           | 1,145,162   
|                                            | Payroll liabilities                                                  |                    | 117,171      |               |             | 111,035     
|                                            | Deferred compensation                                                |                    | 98,446       |               |             | 55,493      
|                                            | Current portion of notes payable                                     |                    | 21,057       |               |             | 38,052      
|                                            | Non-convertible debentures                                           |                    | 300,000      |               |             | 300,000     
|                                            | Non-convertible promissory notes                                     |                    | 225,000      |               |             | 225,000     
|                                            | Convertible promissory notes, net of discount of $-0- and $13,317    |                    | 299,960      |               |             | 286,643     
|                                            | 12% Senior unsecured convertible debentures, net of discount $80,831 |                    | 419,169      |               |             | -           
|                                            | Embedded derivative, convertible debt                                |                    | 379,966      |               |             | 223,716     
|                                            | Deferred franchise fees                                              |                    | 80,000       |               |             | 316,500     
|                                            | Deferred sales                                                       |                    | 267,357      |               |             | 373,455     
|                                            | Other current liabilities                                            |                    | -            |               |             | 28,662      
|Total Current Liabilities                   |                                                                      | 3,379,168          |              |               | 3,103,718  
|                                            |                                                                      |                    |              |               |             |             
|Long-term Liabilities                       |                                                                      |                    |              |               |            
|                                            | Non-convertible debentures                                           |                    | 2,700,000    |               |             | 2,700,000   
|                                            | Notes payable, net of current portion                                |                    | 46,862       |               |             | 59,395      
|                                            | Total long-term liabilities                                          |                    | 2,746,862    |               |             | 2,759,395   
|Total Liabilities                           |                                                                      | 6,126,030          |              |               | 5,863,113  
|                                            |                                                                      |                    |              |               |             |             
|Stockholders' Deficit:                      |                                                                      |                    |              |               |            
|                                            | Preferred stock, $0.001 par value, 5 million shares authorized,      |                    |              |               |             |             
|                                            | 1,300,000 and 1,300,000 shares issued and outstanding at             |                    |              |               |             |             
|                                            | September 30, 2008 and June 30, 2008                                 |                    | 1,300        |               |             | 1,300       
|                                            | Common stock, $0.001 par value, 100 million shares authorized;       |                    |              |               |             |             
|                                            | 28,884,179 and 21,887,425 shares issued and outstanding at           |                    | 28,884       |               |             | 21,887      
|                                            | September 30, 2008 and June 30, 2008                                 |                    |              |               |             |             
|                                            | Additional paid in capital                                           |                    | 8,649,498    |               |             | 7,715,384   
|                                            | Deferred charges                                                     |                    | (145,833)    |               |             | -           
|                                            | Accumulated deficit                                                  |                    | (12,740,310) |               |             | (11,752,495)
|Total Stockholder's Deficit                 |                                                                      | (4,206,461)        |              |               | (4,013,924)
|                                            |                                                                      |                    |              |               |             |             
|Total Liabilities and Stockholders' Deficit | $                                                                    | 1,919,569          |              | $             | 1,849,189  







See accompanying notes to these financial statements.

F-1



---

THEATER EXTREME ENTERTAINMENT GROUP, INC.

STATEMENTS OF OPERATIONS FOR THE THREE MONTHS ENDED

SEPTEMBER 30, 2008 AND 2007

(UNAUDITED)





|                                             |                         |   |                    |            |                    |             |           
|-------------------------------------------- | ----------------------- | - | ------------------ | ---------- | ------------------ | ----------- | ----------
|                                             |                         |   | September 30, 2008 |            | September 30, 2007
|                                             |                         |   |                    |            |                   
|Revenues                                     |                         | $ | 817,263            |            | $                  | 1,203,013  
|                                             |                         |   |                    |            |                    |             |           
|Cost of revenues                             |                         |   | 414,545            |            |                    | 820,285    
|Occupancy expenses                           |                         |   | 147,265            |            |                    | 155,067    
|Selling, general and administrative expenses |                         |   | 1,005,896          |            |                    | 1,198,841  
|                                             |                         |   |                    | 1,567,706  |                    |             | 2,174,193 
|                                             |                         |   |                    |            |                    |             |           
|                                             |                         |   |                    |            |                    |             |           
|Loss from operations                         |                         |   | (750,443)          |            |                    | (971,180)  
|                                             |                         |   |                    |            |                    |             |           
|Other Income and (Expense):                  |                         |   |                    |            |                    |            
|Loss on disposal of assets                   |                         |   | (6,682)            |            |                    | -          
|Forgiveness of debt                          |                         |   | 19,789             |            |                    | -          
|Interest income                              |                         |   | 1,295              |            |                    | -          
|Interest expense                             |                         |   | (153,959)          |            |                    | (121,974)  
|Accretion of discount on convertible debt    |                         |   | (97,815)           |            |                    | -          
|                                             |                         |   |                    |            |                    |             |           
|Net loss                                     |                         | $ | (987,815)          |            | $                  | (1,093,154)
|                                             |                         |   |                    |            |                    |             |           
|                                             | Basic and diluted:      |   |                    |            |                    |             |           
|                                             | Loss per common share   |   | $                  | (0.04)     |                    |             | (0.05)    
|                                             |                         |   |                    |            |                    |             |           
|                                             | Weighted average shares |   |                    | 27,211,042 |                    | $           | 20,661,601





See accompanying notes to these financial statements.

F-2



---

THEATER XTREME ENTERTAINMENT GROUP, INC.

STATEMENT OF STOCKHOLDERS DEFICIT

FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2008

(UNAUDITED)





|                                                                  |   |                 |  |              |       |            |            |        |   |         |  |          |           |             |           |               |  |   |              |  |           |            
|----------------------------------------------------------------- | - | --------------- |  | ------------ | ----- | ---------- | ---------- | ------ | - | ------- |  | -------- | --------- | ----------- | --------- | ------------- |  | - | ------------ |  | --------- | -----------
|                                                                  |   | Preferred Stock |  | Common Stock |       | Additional |            |        |   |         |  | Total   
|                                                                  |   | Number of       |  | Preferred    |       | Number of  |            | Common |   | Paid-in |  | Deferred |           | Accumulated |           | Stockholders'
|                                                                  |   | Shares          |  | Stock        |       | Shares     |            | Stock  |   | Capital |  | Charges  |           | Deficit     |           | Equity       
|BALANCE AT JUNE 30, 2008                                          |   | 1,300,000       |  | $            | 1,300 |            | 21,887,425 |        | $ | 21,887  |  | $        | 7,715,384 |             | $         | -             |  | $ | (11,752,495) |  | $         | (4,013,924)
|                                                                  |   |                 |  |              |       |            |            |        |   |         |  |          |           |             |           |               |  |   |              |  |           |            
|Issuance of common stock to employees                             |   | -               |  |              | -     |            | 150,000    |        |   | 150     |  |          | 10,350    |             |           | -             |  |   | -            |  |           | 10,500     
|                                                                  |   |                 |  |              |       |            |            |        |   |         |  |          |           |             |           |               |  |   |              |  |           |            
|Issuance of common stock to board of directors                    |   | -               |  |              | -     |            | 1,500,000  |        |   | 1,500   |  |          | 103,500   |             |           | -             |  |   | -            |  |           | 105,000    
|                                                                  |   |                 |  |              |       |            |            |        |   |         |  |          |           |             |           |               |  |   |              |  |           |            
|Issuance of common stock to officers                              |   | -               |  |              | -     |            | 1,427,678  |        |   | 1,428   |  |          | 98,510    |             |           | -             |  |   | -            |  |           | 99,938     
|                                                                  |   |                 |  |              |       |            |            |        |   |         |  |          |           |             |           |               |  |   |              |  |           |            
|Issuance of common stock for services                             |   | -               |  |              | -     |            | 3,919,076  |        |   | 3,919   |  |          | 269,965   |             |           | -             |  |   | -            |  |           | 273,884    
|                                                                  |   |                 |  |              |       |            |            |        |   |         |  |          |           |             |           |               |  |   |              |  |           |            
|Issuance of warrants for services                                 |   | -               |  |              | -     |            | -          |        |   | -       |  |          | 405,027   |             |           | -             |  |   | -            |  |           | 405,027    
|                                                                  |   |                 |  |              |       |            |            |        |   |         |  |          |           |             |           |               |  |   |              |  |           |            
|Issuance of warrants for convertible notes                        |   | -               |  |              | -     |            | -          |        |   | -       |  |          | 9,079     |             |           | -             |  |   | -            |  |           | 9,079      
|                                                                  |   |                 |  |              |       |            |            |        |   |         |  |          |           |             |           |               |  |   |              |  |           |            
|Deferred charges for common stock issued
     for future services | - |                 |  | -            |       | -          |            |        | - |         |  | -        |           |             | (175,000) |               |  | - |              |  | (175,000)
|                                                                  |   |                 |  |              |       |            |            |        |   |         |  |          |           |             |           |               |  |   |              |  |           |            
|Amortization of deferred charges                                  |   | -               |  |              | -     |            | -          |        |   | -       |  |          | -         |             |           | 29,167        |  |   | -            |  |           | 29,167     
|                                                                  |   |                 |  |              |       |            |            |        |   |         |  |          |           |             |           |               |  |   |              |  |           |            
|Vesting of employee stock grants                                  |   | -               |  |              | -     |            | -          |        |   | -       |  |          | 933       |             |           | -             |  |   | -            |  |           | 933        
|                                                                  |   |                 |  |              |       |            |            |        |   |         |  |          |           |             |           |               |  |   |              |  |           |            
|Vesting of officer stock grants                                   |   | -               |  |              | -     |            | -          |        |   | -       |  |          | 13,156    |             |           | -             |  |   | -            |  |           | 13,156     
|                                                                  |   |                 |  |              |       |            |            |        |   |         |  |          |           |             |           |               |  |   |              |  |           |            
|Vesting of employee options                                       |   | -               |  |              | -     |            | -          |        |   | -       |  |          | 19,429    |             |           | -             |  |   | -            |  |           | 19,429     
|                                                                  |   |                 |  |              |       |            |            |        |   |         |  |          |           |             |           |               |  |   |              |  |           |            
|Vesting of non-employee options                                   |   | -               |  |              | -     |            | -          |        |   | -       |  |          | 4,165     |             |           | -             |  |   | -            |  |           | 4,165      
|                                                                  |   |                 |  |              |       |            |            |        |   |         |  |          |           |             |           |               |  |   |              |  |           |            
|Net loss for the three months ended 
     September 30, 2008      |   | -               |  |              | -     |            | -          |        |   | -       |  |          | -         |             |           | -             |  |   | (987,815)    |  |           | (987,815)  
|                                                                  |   |                 |  |              |       |            |            |        |   |         |  |          |           |             |           |               |  |   |              |  |           |            
|BALANCE AT SEPTEMBER 30, 2008                                     |   | 1,300,000       |  | $            | 1,300 |            | 28,884,179 |        | $ | 28,884  |  | $        | 8,649,498 |             | $         | (145,833)     |  | $ | (12,740,310) |  | $         | (4,206,461)





See accompanying notes to these financial statements.

F-3



---

THEATER XTREME ENTERTAINMENT GROUP, INC.

STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007

(UNAUDITED)





|                                        |                                                         |  |  |   |                    |           |                    |         |            
|--------------------------------------- | ------------------------------------------------------- |  |  | - | ------------------ | --------- | ------------------ | ------- | -----------
|                                        |                                                         |  |  |   | September 30, 2008 |           | September 30, 2007
|Cash flows from operating activities:   |                                                         |  |  |   |                    |          
|                                        | Net Loss                                                |  |  |   | $                  | (987,815) |                    | $       | (1,093,154)
|                                        | Adjustments to reconcile net loss to                    |  |  |   |                    |           |                    |         |            
|                                        | net cash used in operating activities:                  |  |  |   |                    |           |                    |         |            
|                                        | Loss On Disposal of Fixed Assets                        |  |  |   |                    | 6,682     |                    |         | -          
|                                        | Depreciation                                            |  |  |   |                    | 39,795    |                    |         | 68,590     
|                                        | Amortization of prepaid consulting services             |  |  |   |                    | -         |                    |         | 136,483    
|                                        | Issuance of warrants for services                       |  |  |   |                    | 35,737    |                    |         | 600        
|                                        | Issuance of common stock for services                   |  |  |   |                    | 314,323   |                    |         | 41,387     
|                                        | Increase (decrease) in Allowance for Doubtful Accounts  |  |  |   |                    | -         |                    |         | (416)      
|                                        | Employee stock option vesting for compensation          |  |  |   |                    | 19,429    |                    |         | 31,443     
|                                        | Non-employee stock option vesting for services          |  |  |   |                    | 4,165     |                    |         | 3,721      
|                                        | Amortization of deferred charges                        |  |  |   |                    | 127,875   |                    |         | 34,063     
|                                        | Amortization of deferred financing fees                 |  |  |   |                    | 54,540    |                    |         | -          
|                                        | Amortization of employee stock grants                   |  |  |   |                    | 933       |                    |         | -          
|                                        | Amortization of officer stock grants                    |  |  |   |                    | 13,156    |                    |         | -          
|                                        | Accretion of discount on convertible debt               |  |  |   |                    | 97,815    |                    |         | -          
|                                        | (Increase) decrease in assets                           |  |  |   |                    |           |                    |         |            
|                                        | Accounts receivable                                     |  |  |   |                    | 19,171    |                    |         | 60,741     
|                                        | Inventory                                               |  |  |   |                    | (1,078)   |                    |         | 59,700     
|                                        | Prepaid expenses                                        |  |  |   |                    | 38,663    |                    |         | 41,155     
|                                        | Deferred financing fees                                 |  |  |   |                    | (90,000)  |                    |         | -          
|                                        | Other assets                                            |  |  |   |                    | 6,865     |                    |         | 11,286     
|                                        | Increase (decrease) in liabilities                      |  |  |   |                    |           |                    |         |            
|                                        | Accounts payable and accrued expenses                   |  |  |   |                    | 25,880    |                    |         | 191,400    
|                                        | Payroll liabilities                                     |  |  |   |                    | 6,136     |                    |         | (2,591)    
|                                        | Deferred compensation                                   |  |  |   |                    | 42,953    |                    |         | -          
|                                        | Deferred franchise fees                                 |  |  |   |                    | (236,500) |                    |         | 17,500     
|                                        | Deferred sales                                          |  |  |   |                    | (106,098) |                    |         | 187,269    
|                                        | Other current liabilities                               |  |  |   |                    | (28,662)  |                    |         | -          
|                                        | Net cash used in operating activities                   |  |  |   |                    | (596,035) |                    |         | (210,823)  
|                                        |                                                         |  |  |   |                    |           |                    |         |            
|Cash flows from investing activities:   |                                                         |  |  |   |                    |           |                    |        
|                                        | Sale of property and equipment                          |  |  |   |                    | 20,899    |                    |         | -          
|                                        | Purchase of property and equipment                      |  |  |   |                    | (40,891)  |                    |         | (2,567)    
|                                        | Net cash used in investing activities                   |  |  |   |                    | (19,992)  |                    |         | (2,567)    
|                                        |                                                         |  |  |   |                    |           |                    |         |            
|Cash flows from financing activities:   |                                                         |  |  |   |                    |           |                    |        
|                                        | Repayment of notes payable                              |  |  |   |                    | (29,528)  |                    |         | (8,893)    
|                                        | Proceeds from short-term promissory notes               |  |  |   |                    | -         |                    |         | 225,000    
|                                        | Proceeds from short-term convertible debt               |  |  |   |                    | 500,000   |                    |         | -          
|                                        | Net cash provided by financing activities               |  |  |   |                    | 470,472   |                    |         | 216,107    
|                                        |                                                         |  |  |   |                    |           |                    |         |            
|Net increase (decrease) in cash         |                                                         |  |  |   | (145,555)          |           |                    | 2,717  
|                                        |                                                         |  |  |   |                    |           |                    |         |            
|Cash and equivalents, beginning of year |                                                         |  |  |   | 188,899            |           |                    | 232,583
|                                        |                                                         |  |  |   |                    |           |                    |         |            
|Cash and equivalents, end of year       |                                                         |  |  | $ | 43,344             |           | $                  | 235,300
|                                        |                                                         |  |  |   |                    |           |                    |         |            
|Supplemental disclosure:                |                                                         |  |  |   |                    |           |                    |        
|                                        | Cash paid during the period for interest                |  |  |   | $                  | 25,161    |                    | $       | 15,048     
|                                        |                                                         |  |  |   |                    |           |                    |         |            
|Supplemental disclosure of non-cash     |                                                         |  |  |   |                    |           |                    |        
|investing and financing activities:     |                                                         |  |  |   |                    |           |                    |        
|                                        |                                                         |  |  |   |                    |           |                    |         |            
|                                        | Prepaid consulting services by issuance of common stock |  |  |   | $                  | -         |                    | $       | 395,650    
|                                        |                                                         |  |  |   |                    |           |                    |         |            
|                                        | Deferred charges by issuance of warrants                |  |  |   | $                  | 306,997   |                    | $       | 90,800     
|                                        |                                                         |  |  |   |                    |           |                    |         |            
|                                        | Deferred Financing charges by issuance of warrant       |  |  |   | $                  | 62,292    |                    | $       | 12,000     
|                                        |                                                         |  |  |   |                    |           |                    |         |            
|                                        | Discount on debt due to beneficial conversion           |  |  |   | $                  | 156,250   |                    | $       | -          
|                                        |                                                         |  |  |   |                    |           |                    |         |            
|                                        | Deferred charges by issuance of common stock            |  |  |   | $                  | 175,000   |                    | $       | -          
|                                        |                                                         |  |  |   |                    |           |                    |         |            
|                                        | Discount on debt due to issuance of warrants            |  |  |   | $                  | 9,079     |                    | $       | -          



See accompanying notes to these financial statements.

F-4



---

THEATER XTREME ENTERTAINMENT GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

SEPTEMBER 30, 2008 AND 2007







NOTE 1 - NATURE OF OPERATIONS AND SUMMARY SIGNIFICANT ACCOUNTING POLICIES



Basis of Presentation

The accompanying unaudited financial statements have been prepared by Theater Xtreme Entertainment Group, Inc. (the Company).  These statements include all adjustments (consisting only of its normal recurring adjustments) which management believes necessary for a fair presentation of the statements and have been prepared on a consistent basis using the accounting polices described in the Summary of Accounting Policies included in the 2008 Annual Report.  Certain financial information and footnote disclosures normally indicated in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to those rules and regulations, although the Company firmly believes that the accompanying disclosures are adequate to make the information presented not misleading.  The financial statements should be read in conjunction with the financial statements and notes thereto included in the Companys Annual Report on Form 10-KSB for the year ended June 30, 2008, as filed with the Securities and Exchange Commission.   The interim operating results for the three months ending September 30, 2008 may not be indicative of operating results expected for the full year.



History and Nature of Operations

Theater Xtreme Entertainment Group, Inc. (the Company), a Florida corporation, operates retail stores selling and installing complete home theater systems, along with being a retailer and wholesaler of home theater furnishings and accessories and a  franchise marketing company.The Company opened its first Company retail store, or design center on September 1, 2003 in Newark, Delaware.



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.



Comprehensive Income

The Company follows the Statement of Financial Accounting Standard (SFAS) No. 130, Reporting Comprehensive Income.  Comprehensive income is a more inclusive financial reporting methodology that includes disclosure of certain financial information that historically has not been recognized in the calculation of net income.  Since the Company has no items of other comprehensive income, comprehensive income (loss) is equal to net income (loss).



Fair Value of Financial Instruments

The Companys financial statements consist of cash and cash equivalents, accounts receivable, payables, accrued expenses and deposits.  The carrying values of these items approximate fair value because of their short maturities.  The carrying value of notes payable also approximate fair value because the interest rates of these notes approximates current market interest rates.



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.



F-5



---

THEATER XTREME ENTERTAINMENT GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

SEPTEMBER 30, 2008 AND 2007







NOTE 1 - NATURE OF OPERATIONS AND SUMMARY SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)



Cash Equivalents

The Company considers all short-term securities purchased with a maturity of three months or less to be cash equivalents.



Concentration of Credit Risk

Certain financial instruments potentially subject the Company to a concentration of credit risk. These financial instruments consist primarily of cash and trade accounts receivable. The Company maintains its cash in bank deposit accounts which, at times, may exceed federally insured limits. As of October 10, 2008, accounts were guaranteed by the Federal Deposit Insurance Corporation (FDIC) up to $250,000.  The Company has not experienced any losses in such accounts. Concentration of credit risk with respect to accounts receivable are limited due to the Companys short payment terms and restrictive customer credit limits.



Accounts Receivable

The Company generally seeks full payment for its retail products and services prior to delivery and installation and does not normally sell its products and services to retail customers on an open credit basis.  From time to time, however, certain exceptions or accommodations are made for creditworthy retail customers. For wholesale sales to franchisees, the Company does, from time to time, extend limited credit terms to creditworthy franchisees.  Management closely monitors outstanding accounts receivable and charges off to expense any balances that are determined to be uncollectible or establishes an allowance for doubtful accounts. As of September 30, 2008 and June 30, 2008, the allowances for doubtful accounts were $4,000. Bad debt expense was $12,000 and $-0- for the three months ended September 30, 2008 and 2007, respectively.



Inventory

The Companys inventory is stated at the lower of cost (first-in, first-out) or market (net realizable value), and consists of the following at:



|                                 |  |                    |         |               |  |        
|-------------------------------- |  | ------------------ | ------- | ------------- |  | -------
|                                 |  | September 30, 2008 |         | June 30, 2008
|                                 |  |                    |         |              
|Equipment and furniture products |  | $                  | 185,881 |               |  | 199,172
|Cables and supplies              |  |                    | 19,230  |               |  | 19,812 
|Retail displays                  |  |                    | 174,022 |               |  | 159,071
|                                 |  |                    |         |               |  |        
|                                 |  | $                  | 379,133 |               |  | 378,055





Property and Equipment

The cost of property and equipment is depreciated over the estimated useful lives of the assets.Leasehold improvements are amortized over the lesser of the length of the related leases or the estimated useful lives of the assets.  Depreciation is computed using the straight-line method.  The estimated useful lives are as follows:





|                       |             
|---------------------- | ------------
|Computer equipment     | 3 years     
|Office equipment       | 5 years     
|Office furniture       | 7 years     
|Vehicles               | 5 years     
|Leasehold improvements | 3 to 7 years





F-6



---

THEATER XTREME ENTERTAINMENT GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

SEPTEMBER 30, 2008 AND 2007





NOTE 1 - NATURE OF OPERATIONS AND SUMMARY SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)



Recoverability of Long-lived Assets

The Company follows SFAS No. 144 Accounting for the Impairment or Disposal of Long-Lived Assets.  Long-lived assets to be held and used are reviewed for impairment whenever events or changes in circumstances indicate that the related carrying amount may not be recoverable. When required, impairment losses on assets to be held and used are recognized based on the excess of the assets carrying amount.  Fair value of the asset and long-lived assets to be disposed of are reported at the lower of carrying amount or fair value less cost to sell. The Company is not aware of any events or circumstances that indicate the existence of an impairment that would be material to the Companys annual financial statements.



Revenue Recognition

Retail sales include all sales from Company-owned design centers.  The following is a summary of earned revenues at September 30:



|                                 |  |      |         |      |   |          
|-------------------------------- |  | ---- | ------- | ---- | - | ---------
|                                 |  | 2008 |         | 2007
|                                 |  |      |         |     
|Retail sales                     |  | $    | 568,670 |      | $ | 767,260  
|Wholesale sales                  |  |      | 6,350   |      |   | 311,625  
|Franchise licenses and royalties |  |      | 242,243 |      |   | 124,128  
|Total revenues                   |  | $    | 817,263 |      | $ | 1,203,013





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:



|                                  |  |                    |         |               |   |        
|--------------------------------- |  | ------------------ | ------- | ------------- | - | -------
|                                  |  | September 30, 2008 |         | June 30, 2008
|                                  |  |                    |         |              
|Deferred retail sales             |  | $                  | 262,349 |               | $ | 365,162
|Unearned service contract revenue |  |                    | 5,008   |               |   | 8,293  
|Total deferred retail sales       |  | $                  | 267,357 |               | $ | 373,455





F-7



---

THEATER XTREME ENTERTAINMENT GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

SEPTEMBER 30, 2008 AND 2007





NOTE 1 - NATURE OF OPERATIONS AND SUMMARY SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)



Loss per Share

The company follows SFAS 128, Earnings per Share, resulting in the presentation of basic and diluted loss per share.  The basic loss per share calculations includes the change in capital structure for all periods presented.  Because the Company reported a net loss for each of the three months ending September 30, 2008 and 2007, common stock equivalents consisting of options and warrants were anti-dilutive; therefore, the basic and diluted net loss per share for each of these periods was the same.



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 $10,447 and $14,128 for the three months ending September 30, 2008 and 2007, 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 $29,942 and $147,834 for the three months ending September  30, 2008 and 2007, respectively.



Investor Relations Costs

Investor relations services are expensed as incurred. Investor relations expenses, including investor relations promotional costs, totaled $104,726 and $107,579 for the three months ending September 30, 2008 and 2007, respectively.





F-8



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THEATER XTREME ENTERTAINMENT GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

SEPTEMBER 30, 2008 AND 2007





NOTE 1 - NATURE OF OPERATIONS AND SUMMARY SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)



Store Opening Costs

Store opening costs and other start-up costs are expensed as incurred.



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.



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 200%, risk-free interest rate of from between 3.0% to 5.25% and expected option life of up to ten years.



As of September 30, 2008, there was $355,962 of unrecognized compensation expenses and $43,352 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, 2012.



Recently Adopted Accounting Pronouncements

During September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 157, Fair Value Measurements (SFAS 157), which is effective for fiscal years beginning after November 15, 2007 with earlier adoption encouraged. SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. In February 2008, the FASB issued FASB Staff Position FAS 157-2, Effective Date of FASB Statement No. 157, which delayed the effective date of SFAS 157 for all non-financial assets and liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis, until January 1, 2009.   The Company adopted SFAS 157 on July 1, 2008 for all financial assets and liabilities, but the implementation did not require additional disclosures or have a significant impact on the Company's financial statements.  The Company has not yet determined the impact the implementation of SFAS 157 will have on the Companys non-financial assets and liabilities which are not recognized or disclosed on a recurring basis.  However, the Company does not anticipate that the full adoption of SFAS 157 will significantly impact their consolidated financial statements.



During February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilitiesincluding an amendment of FASB Statement No. 115 (SFAS 159), which permits entities to choose to measure many financial instruments and certain other items at fair value.



The objective of SFAS 159 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. The Company has adopted SFAS 159 on July 1, 2008 and has elected not to measure any additional financial assets, liabilities or other items at fair value.



F-9



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THEATER XTREME ENTERTAINMENT GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

SEPTEMBER 30, 2008 AND 2007





NOTE 1 - NATURE OF OPERATIONS AND SUMMARY SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)



Recently Issued Accounting Pronouncements

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, which is effective January 1, 2009. SFAS 161 requires enhanced disclosures about derivative instruments and hedging activities to allow for a better understanding of their effects on an entitys financial position, financial performance, and cash flows. Among other things, SFAS 161 requires disclosures of the fair values of derivative instruments and associated gains and losses in a tabular formant. The Company has not yet determined the impact of the adoption of SFAS 161 on its financial statements and footnotes disclosures.



On December 4, 2007, the FASB issued SFAS No. 141R, Business Combinations (SFAS No. 141R).  SFAS No. 141R requires the acquiring entity in a business combination to recognize all the assets acquired and liabilities assumed, establishes the acquisition date fair value as the measurement objective for all assets acquired and liabilities assumed, and requires the acquirer to expand disclosures about the nature and financial effect of the business combination.  SFAS No. 141R is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.  This statement is effective for the Company beginning May 1, 2009 and will change the accounting for business combinations on a prospective basis.



In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statementsan amendment of Accounting Research Bulletin No. 51 (SFAS 160). SFAS 160 establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parents ownership interest, and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. SFAS 160 also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. This statement is effective for the Company beginning January 1, 2009.   This statement is not currently applicable since it has no majority-owned subsidiaries.



In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162, The Hierarchyof Generally Accepted Accounting Principles(FAS 162"). This Standard identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles. FAS 162 directs thehierarchy to the entity, rather than the independent auditors, as the entity is responsible for selecting accounting principles for financial statements that are presented in conformity with generally accepted accounting principles. The Standard is effective 60 days following SEC approval of the Public Company Accounting Oversight Board amendments to remove the hierarchy of generally accepted accounting principles from the auditing standards. FAS 162 is not expected to have an impact on the financial statements.



In April 2008, the FASB issued FASB Staff Position (FSP) FAS 142-3, Determination of the Useful Life of Intangible Assets, which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible Assets.This Staff Position is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. Application of this FSP is not expected to have a significant impact on the financial statements.



F-10



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THEATER XTREME ENTERTAINMENT GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

SEPTEMBER 30, 2008 AND 2007







NOTE 1 - NATURE OF OPERATIONS AND SUMMARY SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)



Recently Issued Accounting Pronouncements (Continued)

In June 2008, the FASB issued FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities. This FSP provides that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. The Company does not currently have any share-based awards that would qualify as participating securities. Therefore, application of this FSP is not expected to have an effect on the Company's financial reporting.



In May 2008, the FASB issued FASB Staff Position (FSP) APB 14-1, Accounting for Convertible Debt That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)("FSP 14-1"). FSP 14-1 will be effective for financial statements issued for fiscal years beginning after December 15, 2008. The FSP includes guidance that convertible debt instruments that may be settled in cash upon conversion should be separated between the liability and equity components, with each component being accounted for in a manner that will reflect the entity's nonconvertible debt borrowing rate when interest costs are recognized in subsequent periods. The Company has not yet determined the impact of the adoption of FSP 14-1 on its financial statements and footnotes.



Reclassifications

Certain reclassifications have been made to the June 30, 2008 financial statements to conform to the September 30, 2008 presentation.





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, overall macro-economic issues, strength of the consumer in the targeted average household income range, the successful expansion of the re-designed Company-owned retail design centers, and lastly the successful launch and the sales of the RowOne Jasper line of products.  The Company plans to acquire a furniture company as part of its strategy to expand it RowOne product line into the consumer electronic and home furniture channels.  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, decreases in average selling prices over the life of any particular product, new product and technology introductions, the ability to adequately fund the complete build out of the corporate stores on a timely schedule, the ability to maintain the cost savings measures enacted as part of the turnaround, and the ability to develop and maintain critical supply chain, outsource and distribution relationships.



F-11



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THEATER XTREME ENTERTAINMENT GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

SEPTEMBER 30, 2008 AND 2007







NOTE 2 - MANAGEMENTS PLANS (CONTINUED)



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 February 1, 2009, and is currently negotiating with its short term debenture creditors for an extension of the term of the short-term debentures for an additional year, 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. At the time of preparation of these statements the company has entered into an advisory and investment banking relationship with Allen Partner LLC and closed on a senior debenture raise of $800,000 less fees and expenses. The Company now intends to begin raising longer term capital. There is no assurance that any additional capital would be forthcoming.



The Company is working closely with its debt holders, using a number of options including (i) the Company reached an agreement with debt holders of certain loans in default that were guaranteed by a third party. The guarantor will transfer secured assets which will satisfy the loans in full including principal and interest. (ii) the Company has received verbal agreements from certain debt holders to extend loans beyond the original maturity dates until which time the loans will exchange into a new debt offering the company anticipates will take place in the near future, (iii) the company has received verbal agreements to extend certain loans beyond the maturity date until a solution can be reached to satisfy the loans in full.  Thus far the Company has been able to reach amicable solutions with the current debt holders and anticipates continued cooperation.



The Company has experience significant losses in previous years and continues to lose money. Over the past quarter the Company has taken significant steps to reduce losses and implement its new growth initiatives.  The Company has made significant strides in reducing cash burn and anticipates (based on the success of its growth initiatives) to be cash flow positive at sometime during the next fiscal year



The Company is highly leveraged and is dependent on infusion of new funds to implement its growth initiatives and work through its highly leveraged position. The Company anticipates it will remain highly leveraged for the foreseeable future.



F-12



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THEATER XTREME ENTERTAINMENT GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

SEPTEMBER 30, 2008 AND 2007









NOTE 3  DEFERRED CHARGES



Deferred charges represent the unamortized fair value of the issuance of common stock and warrants for future services to non-employees which was accounted for in accordance with Emerging Issue Task Force No. 96-18, Accounting for Equity Instruments That Are Issued To Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, as follows:



|                                     |  |                    |           |               |   |        
|------------------------------------ |  | ------------------ | --------- | ------------- | - | -------
|                                     |  | September 30, 2008 |           | June 30, 2008
|                                     |  |                    |           |              
|Common Stock                         |  | $                  | 824,000   |               | $ | 649,000
|Warrants                             |  |                    | 397,797   |               |   | 90,800 
|                                     |  |                    | 1,221,797 |               |   | 739,800
|Less:  Accumulated Amortization      |  |                    | 703,925   |               |   | 576,050
|                                     |  |                    | 517,872   |               |   | 163,750
|                                     |  |                    |           |               |   |        
|Less:  Amount reflected as a contra- |  |                    |           |               |  
|equity for management consulting     |  |                    |           |               |  
|services provided by related party   |  | 145,833            |           |               | -
|                                     |  |                    |           |               |   |        
|Deferred Charges                     |  |                    | 372,039   |               |   | 163,750
|                                     |  |                    |           |               |   |        
|Less:  Current Portion               |  |                    | 244,124   |               |   | 163,750
|                                     |  |                    |           |               |   |        
|Deferred Charges                     |  | $                  | 127,915   |               | $ | -      





NOTE 4  SHORT-TERM DEBENTURES AND PROMISSORY NOTES



Short-Term Non-Convertible Debentures

In November 2006, the Company executed and delivered convertible debentures to three accredited investors (the Debenture Holders) in the aggregate face amount of $300,000 (the Debentures).  The Debentures bear interest at 15% per annum, payable on a monthly basis, mature in November 2007 and may be prepaid at any time with a penalty fee of 5% of the principal paid.  In December, 2007, the Company and the Debenture Holders, 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.  See Note 7.  In March, 2008, the Company and the Debenture Holders further extended the due date of the payment of amounts due and payable on the debentures to April 30, 2008 and later amended same to June 30, 2008. The Company and the Debenture Holders further extended the due date to July 31, 2008.  On August 20, 2008, the Debenture Holders agreed to further extend the due date of the loans.  The Debenture Holders agreed verbally to an additional extension until there can be a debt exchange into the Companys next debt offering.  These verbal commitments are not binding and there can be no assurances the debt holders will abide by their verbal commitment and begin to take action demanding repayment of the debt.



F-13



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THEATER XTREME ENTERTAINMENT GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

SEPTEMBER 30, 2008 AND 2007







NOTE 4  SHORT-TERM DEBENTURES AND PROMISSORY NOTES (CONTINUED)



Short-Term Non-Convertible Debentures (Continued)

Between July 20, 2007 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), valued at $12,000, fair value, using the Black-Scholes option pricing model and will be expensed over the term of the note.  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, former 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 out of pocket and legal expenses, not to include replacement of any shares lost or forfeited due to default by the company, 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 Company is currently in default on these notes.  The Company, due to cash restraints, is likely to default on $200,000 of the Promissory Notes that were personally guaranteed by Mr. Oglum and secured by his pledged shares.  The holders of the promissory notes could demand the shares from Mr. Oglum and upon receipt of these shares by the holders, the company believes the notes will be satisfied in full and there will be no further liability.  The Company and the holder of the $25,000 Promissory Note has agreed to an extension until February 2009.



Convertible Promissory Notes

In January, February and March, 2008, the Company executed and delivered, separately to six accredited investors (the Convertible Investors), (i) convertible promissory notes in the aggregate face amount of $563,076 (the Convertible Notes), and (ii) warrants (the C Warrants) to purchase up to an aggregate of 438,096 shares of the Companys common stock (the Convertible Financing). The Convertible Notes mature from 120 to 180 days from date of issue and may be prepaid at any time in whole or in part without penalty. The Convertible Notes bear interest at 19%, per annum, for the 180 day notes, and 21% per annum on the 120 day notes, and are due and payable at their respective maturity dates. The Convertible Investors may convert the principal balance of the Convertible 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 $0.10 per share.  The Company and the Convertible Investors of $249,960 of Convertible Notes have agreed verbally to extend the due date to February 2009.  The Company and the Convertible Investor of $25,000 of Convertible Notes have agreed verbally to an extension until there can be a debt exchange into the Companys next debt offering.  The Company and the Convertible Investor of $25,000 have agreed verbally to trade the payoff of the note for services.  These verbal commitments are not binding and there can be no assurances the debt holders will abide by their verbal commitment and begin to take action to demanding repayment of the debt and interest.  The balance at September 30, 2008 was $299,960.



F-14



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THEATER XTREME ENTERTAINMENT GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

SEPTEMBER 30, 2008 AND 2007







NOTE 4  SHORT-TERM DEBENTURES AND PROMISSORY NOTES (CONTINUED)



Convertible Promissory Notes (Continued)

The C Warrants have an exercise price of $0.50 per share for the five-year life of the Warrants. In accordance with EITF-00-19 (Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock), the C Warrants are classified as equity and the Company has valued the C Warrants at $60,556, representing the fair value using the Black-Sholes model at the time of the loans were made and reflected as a discount on the Convertible Notes to be accreted over their term. Additionally, in accordance with SFAS 133, the Convertible Notes are deemed derivative instruments requiring bifurcation of the conversion feature. Under EITF-00-27 (Application of Issue No. 98-5 to Certain Convertible Instruments), the Company has calculated an intrinsic conversion value of the Convertible Notes at $250,028 as of the issuance date and will treat this amount as an embedded derivative liability since the counterparty has a choice of settlement in cash or in shares. Changes in the fair value of the embedded derivative liability will be reflected in the statement of operations.  The aggregate embedded derivative liability will be reclassified to equity upon expiry or conversion of the conversion feature. Additionally, and in accordance with EITF-98-5 (Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios), the value of the C warrants and the beneficial conversion feature, totaling $310,584 as of the issuance date, is reflected as a discount assigned to the Convertible Notes.  The discount associated with the beneficial conversion feature is to be accreted over the period of the earliest conversion date. Since the Convertible Notes are convertible immediately, the Company accreted the entire $250,028 in the prior year.   The embedded derivative balance associated with these notes at September 30, 2008 was $223,716.  The discount associated with the issuance of the C Warrants is accreted over the term of the Convertible Notes.  The accretion of discount on the convertible debt was $13,317 for the three months ended September 30, 2008, consisting of the accretion of the embedded derivative liability of $-0- and the accretion of the warrants of $13,317.



12% Senior Unsecured Convertible Debentures

During the three months ended September 30, 2008, the Company issued 12%, senior unsecured convertible debentures (the Sr. Debentures) due July 2009 in the amount of $500,000, with warrants to purchase 100,000 shares of the Companys common stock at an exercise price of $0.10 per share. The Sr. Debentures mature on July 31, 2009 and bear interest at 12%, per annum, payable at maturity.  The Sr. Debentures and any accrued interest may be converted any time after October 31, 2008 at a conversion price of either (i) the product obtained by multiplying (.80) by the average closing or last sales price of the Companys Common Stock as quoted on the OTC Bulletin Board for twenty consecutive days immediately prior to the Conversion Date; or (ii) $0.08 per share.  The Sr. Debentures are subject to an automatic conversion if the Company consummates an equity financing which it receives aggregate gross proceeds of at least $5,000,000, inclusive of the Sr. Debentures.  This conversion would be equal to the product obtained by multiplying (.80) by the purchase price of the securities issued in the equity financing.



F-15



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THEATER XTREME ENTERTAINMENT GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

SEPTEMBER 30, 2008 AND 2007







NOTE 4  SHORT-TERM DEBENTURES AND PROMISSORY NOTES (CONTINUED)



12% Senior Unsecured Convertible Debentures (Continued)

The warrants have an exercise price of $0.10 per share for the two-year life of the Warrants. In accordance with EITF-00-19 (Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock), the warrants are classified as equity and the Company has valued the warrants at $9,079, representing the fair value using the Black-Sholes model at the time of the loans were made and reflected as a discount on the Convertible Notes to be accreted over their term. Additionally, in accordance with SFAS 133, the Convertible Notes are deemed derivative instruments requiring bifurcation of the conversion feature. Under EITF-00-27 (Application of Issue No. 98-5 to Certain Convertible Instruments), the Company has calculated an intrinsic conversion value of the Convertible Notes at $156,250 as of the issuance date and will treat this amount as an embedded derivative liability since there is a reset provision.  The carrying amount will not be adjusted until the reset has occurred.  Changes in the fair value of the embedded derivative liability will be reflected in the statement of operations.  The aggregate embedded derivative liability will be reclassified to equity upon expiry or conversion of the conversion feature. Additionally, and in accordance with EITF-98-5 (Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios), the value of the warrants and the beneficial conversion feature, totaling $165,329 as of the issuance date, is reflected as a discount assigned to the Convertible Notes.  The discount associated with the beneficial conversion feature is to be accreted over the period of the earliest conversion date.   The accretion for the three months ended September 30, 2008 is $84,498.  The embedded derivative balance at September 30, 2008 was $156,250.  The discount associated with the issuance of the warrants is accreted over the term of the Convertible Notes.  The accretion of discount on the convertible debt was $84,498 for the three months ended September 30, 2008, consisting of the accretion of the embedded derivative liability of $83,333 and the accretion of the warrants of $1,164.





NOTE 5  LONG-TERM DEBT, NOTES PAYABLE AND NON-CONVERTIBLE DEBENTURES



Long-term debt consists of the following at:



|                                                             |                                                        |   |                    |           |               |        |          
|------------------------------------------------------------ | ------------------------------------------------------ | - | ------------------ | --------- | ------------- | ------ | ---------
|                                                             |                                                        |   | September 30, 2008 |           | June 30, 2008
|                                                             |                                                        |   |                    |           |              
|Notes payable to various banks, in monthly installments      |                                                        |   |                    |           |               |       
|                                                             | ranging from $252 to $631, including interest ranging  |   |                    |           |               |        |          
|                                                             | from 7.25% to 8.99%, secured by various vehicles,      |   |                    |           |               |        |          
|                                                             | maturing from December 2008 to November 2012           |   | $                  | 67,919    |               | $      | 97,413   
|                                                             |                                                        |   |                    |           |               |        |          
|Capitalized lease with monthly payments of $34               |                                                        |   |                    |           |               |       
|                                                             | and imputed interest at 8% and 10%                     |   |                    |           |               |        |          
|                                                             | through July 2008                                      |   |                    | -         |               |        | 34       
|                                                             |                                                        |   |                    | 67,919    |               |        | 97,447   
|                                                             |                                                        |   |                    |           |               |        |          
|                                                             | Less current portion                                   |   |                    | (21,057)  |               |        | (38,052) 
|                                                             |                                                        |   |                    |           |               |        |          
|Notes Payable, net of current portion                        |                                                        | $ | 46,862             |           | $             | 59,395
|                                                             |                                                        |   |                    |           |               |        |          
|Non-convertible debenture payable to an accredited investor, |                                                        |   |                    |           |              
|                                                             | with payments of interest only due at the beginning of |   |                    |           |               |        |          
|                                                             | each calendar quarter, at a rate of 10% per annum,     |   |                    |           |               |        |          
|                                                             | principal due in September 2011                        |   | $                  | 2,700,000 |               | $      | 2,700,000



F-16



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THEATER XTREME ENTERTAINMENT GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

SEPTEMBER 30, 2008 AND 2007







NOTE 5  LONG-TERM DEBT, NOTES PAYABLE AND NON-CONVERTIBLE DEBENTURES (CONTINUED)



Non-Convertible Debenture

In October, 2007, the Company and Kinzer Technology, LLC (Kinzer) amended that certain debenture dated March 6, 2007 in the principal amount of $2.7 million payable to Kinzer (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 quarterly 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.



On March 31, 2008, the Company and Kinzer agreed to further amend the Debenture to defer the interest payment otherwise due on April 1, 2008 until July 1, 2008.



On June 27, 2008, the Company and Kinzer agreed to further amend the Debenture to defer the interest payment otherwise due on July 1, 2008 until September 30, 2008.  The amendment also changes the maturity date to September 30, 2011 and has waived the requirement of repayment upon equity financing in excess of $6,000,000.



On September 30, 2008, the Company and Kinzer agreed to further amend the Debenture to defer the interest payment otherwise due on October 1, 2008 until January 5, 2009.



The Company incurred interest costs of $100,065 for the three months ended September 30, 2008 and 2007.  For the three months ended September 30, 2008 and 2007, $32,010 of the amount incurred for interest expense reflects non-cash charges related to amortization of the costs of warrants attached to certain indebtedness.



NOTE 6  STOCKHOLDERS EQUITY



Common Stock

In July 2008, the Company entered into a one-year management contract in exchange for 2,500,000 shares of its common stock valued at $175,000, fair value and amortized over the life of the contract, with the shares vesting immediately.  For the three months ended September 30, 2008, the Company has recognized $29,167 in management expense.



In July 2008, the Company issued 1,000,000 shares of its common stock for legal services rendered during July 2008 valued at $70,000, fair value and recognized for the three months ended September 30, 2008.  The $70,000 was expensed during the three months ended September 30, 2008.



In July 2008, the Company issued 369,076 shares of its common stock for legal services that were included in accounts payable at June 30, 2008, valued at $25,835, fair value.



In July 2008, pursuant to the 2008 Plan, the Company issued 1,500,000 shares of its common stock to members of the board of directors, valued at $105,000 under the 2008 stock option plan and was expensed during the three months ended September 30, 2008.



In addition, the Company recognized $13,156 in compensation expense for the pro rata share of the stock grants that will vest in July, 2009,





F-17



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THEATER XTREME ENTERTAINMENT GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

SEPTEMBER 30, 2008 AND 2007





NOTE 6  STOCKHOLDERS EQUITY (CONTINUED)



Common Stock (Continued)

In July 2008, pursuant to the 2008 Plan, the Company granted 3,683,033 shares of its common stock to executive officers and 450,000 to non-executive officers and employees.  The Company issued 1,427,678 shares of its common stock to executive officers in July 2008, valued at $99,937, fair value.   In addition, the Company recognized $13,156 in compensation expense for the pro rata share of the stock grants that will vest in July 2009.



The Company recognized $113,093 of compensation expense for its executive officers for the three months ended September 30, 2008.



The Company issued 150,000 shares of its common stock to non-executive officers and employees in July 2008, valued at $10,500, fair value.  In addition, the Company recognized $933 in compensation expense for the pro rata share of the stock grants that will vest in July 2009.  The Company recognized $11,433 of compensation expense for its non-executive officers and employees for the three months ended September 30, 2008.



In July 2008, pursuant to the 2008 Plan, the Company granted 50,000 shares of its common stock to a consultant for services rendered, valued at $3,500, fair value.



Warrants

In July 2008, a former employee threatened legal action against the Company.  The Company entered into a separation agreement in August 2008, whereas the employees 450,000 options were cancelled in favor of a warrant to purchase 450,000 shares of the Companys common stock with an exercise price of $0.20 per share expiring on July 1, 2010.  The warrant was valued at $35,737, fair value and was expensed during the three months ended September 30, 2008.



In July 2008, the Company issued 4,500,000 warrants to purchase the Companys common stock to their investment banker pursuant to a two year contract beginning July 2008.  These warrants were valued at $306,997, fair value and are recognized over the life of the contract.  The Company recognized $25,583 of expense for the three months ended September 30, 2008.



In August 2008, the Company issued 375,000 Class A warrants to purchase the Companys common stock and 6,000 Class B warrants to purchase the Companys common stock to their investment banker in connection with the 12% Senior Unsecured Short-Term Debentures (the Sr. Debentures).  These warrants were valued at $37,317, fair value and recorded as deferred financing fees and amortized over the life of the Sr. Debentures.  Also issued in connection with the Sr. Debentures, were warrants to purchase 60,000 shares of the Companys common stock to the debenture holders.  The Company recognized $6,220 of investment expense for the three months ended September 30, 2008.



In September 2008, the Company issued 250,000 Class A warrants to purchase the Companys common stock and 4,000 Class B warrants to purchase the Companys common stock to their investment banker in connection with the Sr. Debentures.  These warrants were valued at $24,976, fair value and recorded as deferred financing fees and amortized over the life of the Sr. Debentures.  Also issued in connection with the Sr. Debentures, were warrants to purchase 40,000 shares of the Companys common stock to the debenture holders.  The Company recognized $2,271 in investment expense for the three months ended September 30, 2008.

|                                           |            |            |   |       |             
|------------------------------------------ | ---------- | ---------- | - | ----- | ------------
|                                           |            | Warrants   |   | Price
|Warrants outstanding at June 30, 2008      |            | 11,024,056 |   | $     | 0.61        
|                                           |            |            |   |       |             
|Issued                                     |            | 5,685,000  |   | $     | 0.10 - $0.20
|                                           |            |            |   |       |             
|Warrants outstanding at September 30, 2008 | 16,709,056 |            | $ | 0.44 
|                                           |            |            |   |       |             
|Exercisable, September 30, 2008            |            | 16,709,056 |   | $     | 0.44        





F-18



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THEATER XTREME ENTERTAINMENT GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

SEPTEMBER 30, 2008 AND 2007





NOTE 6  STOCKHOLDERS EQUITY (CONTINUED)



Warrants (Continued)



Information with respect to the Companys warrants that are outstanding as of September 30, 2008 is as follows:



|              |  |                       |  |                  |  |                                |     
|------------- |  | --------------------- |  | ---------------- |  | ------------------------------ | ----
|Range of      |  | Number of Warrants    |  | Weighted Average |  | Weighted Average              
|Exercise      |  | Currently Exercisable |  | Remaining        |  | Exercise Price of Options and 
|Prices        |  | at September 30, 2008 |  | Contractual Life |  | Warrants Currently Exercisable
|              |  |                       |  |                  |  |                               
|$0.10 - $1.00 |  | 16,709,506            |  | 3.7 years        |  | $                              | 0.44





NOTE 7  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.



In March 2008, the Companys board of directors adopted a new 2008 Equity Incentive Plan (2008 Plan). There were 7,000,000 shares of the Companys common stock allocated to the 2008 Plan and it is designed to provide incentives to attract, retain and motivate eligible persons whose present and potential contributions are key to the success of the Company by offering them an opportunity to participate in the Companys future performance through awards of options, the right to purchase common stock and stock bonuses. The exercise price of incentive stock options is at least the fair market value of the Companys common stock at the time of the grant. Participation in the plan is not limited to employees. The exercise price of non-incentive stock options cannot be lower than 85% of the fair market value of the Companys common stock at the time of 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 September 30, 2008, there was $355,962 of unrecognized compensation expenses and $43,352 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, 2018.



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 254%, risk-free interest rate of between 3.0% to 5.25% and expected option life of two to ten years.



At June 30, 2008, there were 3,321,967 stock options outstanding under the 2005 Stock Option Plan and the 2008 Plan.





F-19



---

THEATER XTREME ENTERTAINMENT GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

SEPTEMBER 30, 2008 AND 2007







NOTE 7  STOCK OPTION PLAN (CONTINUED)



During the three months ended September 30, 2008, a total of 871,667 of unvested stock options were forfeited due to termination of employment and 50,000 were forfeited due to a board member leaving.



There were no stock options granted during the three months ended September 30, 2008.



The following table summarizes all fiscal year stock option activity of the Company for the three months ended September 30, 2008:



|                            |  |                         |  |                            |  |             |  |         
|--------------------------- |  | ----------------------- |  | -------------------------- |  | ----------- |  | --------
|                            |  | Incentive Stock Options |  | Nonqualified Stock Options
|                            |  |                         |  | Weighted                   |  |             |  | Weighted
|                            |  | Stock                   |  | Average                    |  | Stock       |  | Average 
|                            |  | Options                 |  | Exercise                   |  | Options     |  | Exercise
|                            |  | Outstanding             |  | Price                      |  | Outstanding |  | Price   
|                            |  |                         |  |                            |  |             |  |         
|Balance, June 30, 2008      |  | 3,321,967               |  | $0.25                      |  | 230,000     |  | $0.41   
|                            |  |                         |  |                            |  |             |  |         
|Forfeited                   |  | (871,667)               |  | $0.54                      |  | (50,000)    |  | $0.10   
|                            |  |                         |  |                            |  |             |  |         
|Balance, September 30, 2008 |  | 2,450,300               |  | $0.15                      |  | 180,000     |  | $0.49   







|         |  |                        |  |                                 |  |               |  |               |  |             |  |              
|-------- |  | ---------------------- |  | ------------------------------- |  | ------------- |  | ------------- |  | ----------- |  | -------------
|         |  | Summary of ISO Options |  | Summary of Nonqualified Options
|         |  | Outstanding            |  | Exercisable                     |  | Outstanding   |  | Exercisable  
|         |  | Number                 |  | Weighted                        |  | Number        |  | Number        |  | Weighted    |  | Number       
|         |  | Outstanding            |  | Average                         |  | Outstanding   |  | Outstanding   |  | Average     |  | Outstanding  
|         |  | at                     |  | Remaining                       |  | at            |  | at            |  | Remaining   |  | at           
|Exercise |  | September 30,          |  | Contractual                     |  | September 30, |  | September 30, |  | Contractual |  | September 30,
|Price    |  | 2008                   |  | Life                            |  | 2008          |  | 2008          |  | Life        |  | 2008         
|         |  |                        |  |                                 |  |               |  |               |  |             |  |              
|$0.10    |  | -                      |  | xx                              |  | -             |  | -             |  | xx          |  | -            
|$0.11    |  | 2,000,000              |  | 9.75 Years                      |  | -             |  | -             |  | xx          |  | -            
|$0.15    |  | -                      |  | xx                              |  | -             |  | -             |  | xx          |  | -            
|$0.35    |  | 135,000                |  | 6.50 Years                      |  | 81,250        |  | 100,000       |  | 6.50 Years  |  | 75,000       
|$0.40    |  | -                      |  | xx                              |  | -             |  | 50,000        |  | 9.67 Years  |  | -            
|$0.80    |  | -                      |  | xx                              |  | -             |  | -             |  | xx          |  | -            
|$0.89    |  | 50,000                 |  | 8.83 Years                      |  | 12,500        |  | -             |  | xx          |  | -            
|$1.00    |  | 260,000                |  | 7.25 Years                      |  | 30,000        |  | -             |  | xx          |  | -            
|$1.04    |  | 5,300                  |  | 8.17 Years                      |  | 891           |  | -             |  | xx          |  | -            
|$1.12    |  | -                      |  | xx                              |  | -             |  | 30,000        |  | 8.50 Years  |  | 7,500        
|         |  |                        |  |                                 |  |               |  |               |  |             |  |              
|         |  | 2,450,300              |  |                                 |  | 124,641       |  | 180,000       |  |             |  | 82,500       







F-20



---

THEATER XTREME ENTERTAINMENT GROUP, INC.

NOTES TO FINANCIAL STATEMENTS

SEPTEMBER 30, 2008 AND 2007







NOTE 8  INCOME TAXES



There is no income tax benefit for the losses for the three months ended September 30, 2008 and 2007, because the Company has determined that the realization of the net deferred tax asset is not assured.  The Company has created a valuation allowance for the entire amount of such benefits.



As of July 1, 2008, the Company had no unrecognized tax benefits, or any tax related interest or penalties.



There was no change in unrecognized tax benefits during the period ended September 30, 2008 and there was no accrual for uncertain tax positions as of September 30, 2008.



The Company files income tax returns in the U.S. federal jurisdiction and various state jurisdictions.  In general, the Companys filed income tax returns are no longer subject to examination by the respective taxing authorities for years ending before June 30, 2004.





NOTE 9  FORGIVENESS OF DEBT



During the three months ended September 30, 2008, the Company settled numerous past debts, lawsuits and actions for less than owed.  The amount of forgiveness of debt for the three months ended September 30, 2008 was $19,789.





NOTE 10  SUBSEQUENT EVENTS



In October 2008, the Company issued 12%, senior unsecured convertible debentures due July 2009 in the amount of $295,000, with warrants to purchase 59,000 shares of the Companys common stock at an exercise price of $0.10 per share, netting $251,550 after fees, pursuant to a private placement memorandum dated July 23, 2008.  In connection with this offering, a Class B Warrant to purchase 5,900 shares of the Companys common stock at an exercise price of $0.10 per share was issued, valued at $276, fair value.  Class A Warrants to purchase 368,750 shares of the Companys common stock at an exercise price of $0.10 per share was also issued in connection with this offering, valued at $25,420, fair value.



The Company closed its Lutherville, Maryland store in November 2008 and has negotiated a verbal agreement from the landlord to be released from all future lease obligations for six months rent totaling $38,988 less the security deposit of $12,500.  The total future lease obligations are $202,027.  This verbal commitment is not binding and there can be no assurances the landlord will abide by his verbal commitment and begin to take action to demanding fulfillment of lease obligations.



F-21