UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


~~(Mark One)~~

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

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

Commission File Number 000-51869

Midlothian, Virginia 23113

Large accelerated filer o¨

Accelerated filer o¨

Non-accelerated filer o¨

Smaller reporting company þ

			Page

	PART I — FINANCIAL INFORMATION			3
Item 1.	Financial Statements			3
	Condensed Consolidated Financial Statements (unaudited)			3
	Condensed Consolidated Balance Sheets as of December 31, ~~2009~~2010 (unaudited) and June 30, ~~2009 (unaudited)~~	2010		3
	Condensed Consolidated Statements of Operations for the three months and six months ended December 31, 2010 and 2009 ~~and 2008~~ (unaudited)			4
	Condensed Consolidated Statements of Cash Flows for the six months ended December 31, 2010 and 2009 ~~and 2008~~ (unaudited)			5
	Notes to Condensed Consolidated Financial Statements			6
	~~Report of Independent Registered Public Accounting Firm~~			27
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations			2824
Item 3.	Quantitative and Qualitative Disclosures about Market Risk			3734
Item ~~4T.~~4.	Controls and Procedures			3735

	PART II — OTHER INFORMATION			40

Item 1.	Legal Proceedings			4036
Item 1A.	Risk Factors		37
Item 2.	40Unregistered Sales of Equity Securities and Use of Proceeds		38
Item 3.	Defaults Upon Senior Securities		38
Item 5.	Other Information			4038
Item 6.	Exhibits			4139

	SIGNATURES			4240

SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

December 31, 2009 June 30, 2009
(Unaudited)
Assets

Current assets:
Cash and cash equivalents $ 658,609 $ 648,311
Restricted cash 849,600 1,245,582
Accounts receivable, net of allowances of $6,648,613 and $7,214,984 at December 31, 2009 and June 30, 2009, respectively 7,327,750 4,972,417
Inventories 3,710,148 4,459,837
Current portion of advances on royalties 6,867,061 8,435,415
Current portion of intellectual property licenses 383,571 410,995
Related party receivables 60,842 33,207
Prepaid expenses and other current assets 530,449 573,145

Total current assets 20,388,030 20,778,909

Property and equipment, net 2,778,721 2,754,139
Advances on royalties, net of current portion 1,551,869 1,556,820
Intellectual property licenses, net of current portion 1,726,071 1,917,858
Goodwill 8,031,766 7,490,065
Intangible assets, net 23,692 43,810
Other assets 11,600 11,872

Total assets $ 34,511,749 $ 34,553,473

Liabilities and Shareholders’ Equity

Current liabilities:
Line of credit $ 5,310,732 $ 5,349,953
Current maturities of long-term debt 63,649 50,855
Production advance payable in default 3,755,104 -
Accounts payable 12,056,142 19,686,168
Accrued royalties 1,693,805 414,696
Accrued expenses and other current liabilities 5,004,449 2,419,100
Accrued litigation costs 4,308,035 -
Deferred revenues 295,301 2,842,640
Due to shareholders - 232,440
Due to related parties 4,400 125,045
Accrued expenses - related parties 137,288 184,766
Total current liabilities 32,628,905 31,305,663

Long-term debt, net of current maturities 1,574,608 1,538,956
Total liabilities 34,203,513 32,844,619

Commitments and contingencies - -

Shareholders’ equity:

Preferred stock, $0.0001 par value; 5,000,000 shares authorized; no shares issued and outstanding at December 31, 2009 and June 30, 2009 - -
Series A convertible preferred stock, $0.0001 par value; 15,000,000 shares authorized; 5,653,833 and 5,953,833 shares issued and outstanding at December 31, 2009 and June 30, 2009, respectively; aggregate liquidation preference of $5,653,833 at December 31, 2009 565 595
Common stock, $0.0001 par value; 90,000,000 shares authorized; 45,106,600 and 44,530,100 shares issued and outstanding at December 31, 2009 and June 30, 2009, respectively 4,511 4,453
Additional paid-in capital 25,675,318 25,210,926
Accumulated deficit (25,101,085 ) (23,145,800 )
Accumulated other comprehensive loss (271,073 ) (361,320 )

Total shareholders’ equity 308,236 1,708,854
Total liabilities and shareholders’ equity $ 34,511,749 $ 34,553,473

	December 31, 2010			June 30, 2010
	(Unaudited)
Assets

Current assets:
Cash and cash equivalents	$	78,631		$	92,893
Accounts receivable, net of allowances of $928,451 and $5,700,931 at December 31, 2010 and June 30, 2010, respectively		1,150,873			3,703,825
Inventories		1,131,915			1,211,301
Current portion of advances on royalties		11,911,559			12,322,926
Current portion of intellectual property licenses		353,571			383,571
Related party receivables		16,260			34,509
Prepaid expenses and other current assets		457,836			695,955

Total current assets		15,100,645			18,444,980

Property and equipment, net		2,559,579			2,667,992
Advances on royalties, net of current portion		1,920,978			1,511,419
Intellectual property licenses, net of current portion		1,237,500			1,534,286
Goodwill		7,911,800			7,911,800
Deferred debt issuance costs, net		532,681			-
Intangible assets, net		10,358			17,025
Other assets		10,955			11,280

Total assets	$	29,284,496		$	32,098,782

Liabilities and Shareholders’ Equity (Deficit)

Current liabilities:
Line of credit	$	-		$	3,830,055
Due to factor		864,902			-
Secured convertible debt in default, net of discount		3,884,377			950,000
Warrant liability		1,276,102			-
Current portion of long-term debt		67,334			65,450
Production advance payable in default		3,755,104			3,755,104
Accounts payable		9,951,665			12,663,788
Accrued royalties		4,455,312			2,530,253
Accrued expenses and other current liabilities		4,877,623			3,781,711
Deferred revenues		77,312			325,301
Due to related parties		4,425			2,200
Accrued expenses - related parties		341,618			322,281
Total current liabilities		29,555,774			28,226,143

Long-term debt, net of current portion		1,507,310			1,541,081
Total liabilities	$	31,063,084		$	29,767,224

Commitments and contingencies		-			-

Shareholders’ equity (deficit):

Preferred stock, $0.0001 par value; 5,000,000 shares authorized; no shares issued and outstanding at December 31, 2010 and June 30, 2010		-			-
Series A convertible preferred stock, $0.0001 par value; 15,000,000 shares authorized; 5,503,833 shares issued and outstanding at December 31, 2010 and June 30, 2010, respectively; aggregate liquidation preference of $5,503,833 at December 31, 2010		550			550
Common stock, $0.0001 par value; 190,000,000 and 90,000,000 shares authorized at December 31, 2010 and June 30, 2010, respectively; 60,181,870 and 59,774,370 shares issued and outstanding at December 31, 2010 and June 30, 2010, respectively		6,018			5,976
Additional paid-in capital		30,559,705			31,154,835
Accumulated deficit		(32,257,094	)		(28,973,325	)
Accumulated other comprehensive income (loss)		(87,767	)		143,522

Total shareholders’ equity (deficit)		(1,778,588	)		2,331,558
Total liabilities and shareholders’ equity (deficit)	$	29,284,496		$	32,098,782

~~See~~

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

SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	For the three months ended December 31,					For the six months ended December 31,						For the three months ended December 31,						For the six months ended December 31,
	2009			2008		2009			2008			2010			2009			2010			2009

Net revenues	$	10,063,952		$	17,308,874	$	26,773,601		$	25,696,577		$	7,470,053		$	10,063,952		$	8,901,912		$	26,773,601

Cost of goods sold:
Product costs		5,149,597			6,939,774		8,696,283			12,365,327			3,097,437			5,149,597			3,858,719			8,696,283
Royalties		1,618,962			1,492,259		6,619,633			2,301,180
Royalties, net													3,298,538			1,618,962			3,231,430			6,619,633
Intellectual property licenses		99,797			67,517		219,457			111,497			95,893			99,797			191,786			219,457

Total cost of goods sold		6,868,356			8,499,550		15,535,373			14,778,004			6,491,868			6,868,356			7,281,935			15,535,373

Gross profit		3,195,596			8,809,324		11,238,228			10,918,573			978,185			3,195,596			1,619,977			11,238,228

Operating expenses:
Operating expenses (income):
Warehousing and distribution		320,723			268,980		607,234			476,563			282,327			320,723			348,416			607,234
Sales and marketing		2,215,620			3,954,803		5,870,676			5,950,539			974,498			2,215,620			1,871,169			5,870,676
General and administrative		2,973,944			2,747,840		6,088,712			4,128,265			2,091,082			2,973,944			4,023,397			6,088,712
Restructuring costs		-			560,806		-			560,806
Transaction costs		-			10,295		-			28,675
Litigation costs		3,075,206			-		3,075,206			-			-			3,075,206			-			3,075,206
Gain on settlement of trade payables		(3,256,489	)		-		(3,256,489	)		-			-			(3,256,489	)		(585,122	)		(3,256,489	)

Total operating expenses		5,329,004			7,542,724		12,385,339			11,144,848			3,347,907			5,329,004			5,657,860			12,385,339

(Loss) income from operations		(2,133,408	)		1,266,600		(1,147,111	)		(226,275	)
Loss from operations													(2,369,722	)		(2,133,408	)		(4,037,883	)		(1,147,111	)

Interest expense, net		508,858			100,055		808,174			158,934
Other expenses (income):
Change in fair value of warrant liability													(1,531,323	)		-			(3,062,646	)		-
Interest and financing costs, net													1,244,436			508,858			2,308,532			808,174
Net loss												$	(2,082,835	)	$	(2,642,266	)	$	(3,283,769	)	$	(1,955,285	)

Net (loss) income		(2,642,266	)		1,166,545		(1,955,285	)		(385,209	)

Deemed dividend related to beneficial conversion feature on Series A convertible preferred stock		-			-		-			1,142,439

Net (loss) income attributable to common shareholders	$	(2,642,266	)	$	1,166,545	$	(1,955,285	)	$	(1,527,648	)

Basic income (loss) per share:	$	(0.06	)	$	0.03	$	(0.04	)	$	(0.04	)
Diluted income (loss) per share:	$	(0.06	)	$	0.02	$	(0.04	)	$	(0.04	)
Basic loss per share:												$	(0.04	)	$	(0.06	)	$	(0.06	)	$	(0.04	)
Diluted loss per share:												$	(0.04	)	$	(0.06	)	$	(0.06	)	$	(0.04	)

Weighted average number of common shares outstanding - Basic		45,039,292			35,920,100		44,930,125			35,920,100			57,252,122			45,039,292			57,140,971			44,930,125
Weighted average number of common shares outstanding - Diluted		45,039,292			53,188,686		44,930,125			35,920,100			57,252,122			45,039,292			57,140,971			44,930,125

SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the six months ended

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

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

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

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements as of December 31, ~~2009~~2010 and for the three and six month periods ended December 31, ~~2009~~2010 and ~~2008~~2009 have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial reporting. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP. In the opinion of management, all adjustments (all of which are of a normal, recurring nature) considered for a fair presentation have been included. Operating results for the three and six ~~months~~month periods ended December 31, ~~2009~~2010 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, ~~2010.~~2011.

The accounting policies followed by the Company with respect to unaudited interim financial statements are consistent with those stated in the Company’s annual report on Form 10-K. The accompanying June 30, ~~2009~~2010 financial statements were derived from the Company’s audited financial statements. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s annual report on Form 10-K for the year ended June 30, ~~2009~~2010 filed with the ~~SEC.~~SEC on October 13, 2010.

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

~~SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(Unaudited)~~

1. ~~Summary of Significant Accounting Policies, continued~~

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

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

1. Principal Business Activity and Summary of Significant Accounting Policies, Cont.

Going Concern

The accompanying condensed consolidated financial statements have been prepared on a going-concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The ability of the Company to continue as a going concern is predicated upon, among other things, generating positive cash flows from operations, curing the default on the production advance payable (see Note 5), and the resolution of various contingencies (see Note 11).

As of December 31, 2010, the Company had insufficient cash resources to satisfy its liabilities, many of which are past due. Further, the Company has various unresolved contingencies that could require future cash payments in excess of available funds (see Note 11).

On August 17, 2009, the Company entered into a unit production financing agreement with a producer relating to the production of certain games, of which the balance outstanding under this agreement was $3,755,104 at December 31, 2010 (see Note 5). The Company has failed to make the required payments under this agreement. As a result, the production advance payable is currently in default and is accruing additional production fees at $0.009 per unit (based upon 382,000 units) for each day after November 15, 2009 (approximately $1,298,000 through December 31, 2010). Given the manner in which the Company was required to enter into this agreement, the Company is contesting its liability for this obligation.

On December 31, 2010, the Company failed to make a timely payment of interest required pursuant to the secured convertible notes (the “Notes”). Such failure triggered a default provision under the Notes following a seven day cure period. On February 16, 2011, the Company entered into a Waiver and Forbearance Agreement (each, a “Waiver Agreement” and collectively, the “Waiver Agreements”) with the holders of the Notes (see Note 6). Pursuant to the Waiver Agreements, the holders of the Notes waived their right of redemption and remedies regarding the Company’s failure to have paid the required interest and agreed to forbear from exercising all remedies available in connection with such failure until March 15, 2011. Pursuant to the Waiver Agreement, the Company is not required to pay the required interest until March 15, 2011 and the interest rates under the Notes increase to 15% and 29%, as applicable, from December 31, 2010 to March 15, 2011.

A failure to generate additional revenues, raise additional capital or manage discretionary spending could have a material adverse effect on the Company's ability to continue as a going concern and to achieve its intended business objectives. Accordingly, there is substantial doubt about the Company’s ability to continue as a going concern. A going concern uncertainty may limit the Company’s ability to access certain types of financing, or may prevent the Company from obtaining financing on acceptable terms. If the Company is unable to obtain additional financing, it may not be able to continue as a going concern after its funds have been exhausted and the Company could be required to significantly curtail or cease operations, file for bankruptcy, or liquidate and dissolve. The accompanying condensed consolidated financial statements have been prepared on the basis of the Company continuing as a going concern. No adjustments have been made to carrying value of the assets and liabilities that might result from the outcome of this uncertainty.

Management plans to maintain the Company’s viability as a going concern by:

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


	•	reducing costs and expenses in order to reduce the Company’s ongoing working capital needs and monthly cash burn;


	•	seeking to raise additional capital.

	•	applying the anticipated profits from several key game releases towards payment of its outstanding obligations.

1. Principal Business Activity and Summary of Significant Accounting Policies, Cont.

While the Company is committed to pursuing these options and others to address its viability as a going concern, there can be no assurance that these plans will be successfully completed or available on acceptable terms; and therefore, there is uncertainty about the Company’s ability to realize its assets or satisfy its liabilities in the normal course of business. If the Company is unsuccessful in pursuing these plans, it may be required to defer, reduce, or eliminate certain planned expenditures.

Concentrations of ~~Credit Risk,~~ Major Customers and Major Vendors

The financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of cash balances with financial institutions and accounts receivable. The Company maintains cash in bank accounts that, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts and believes it is not exposed to any significant risks on its cash in bank accounts.

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

The Company has four customers, Wal-Mart, GameStop, ~~PDQ Distribution Limited,~~Atari, and ~~Solutions 2 Go,~~Target, which accounted for ~~20%~~19%, ~~15%~~17%, ~~11%~~14%, and 10%, respectively, of consolidated gross revenues for the six months ended December 31, ~~2009.~~2010. GameStop, Solutions2Go, and Atari accounted for 29%, 16%, and 15%, respectively, of consolidated gross accounts receivable at December 31, 2010. For the six months ended December 31, 2009, Wal-Mart, GameStop, PDQ Distribution Limited and Solutions 2 Go accounted for ~~22%~~20%, 15%, 11% and 10%, respectively, of consolidated gross revenues. GameStop, Wal-Mart, and Atari accounted for 29%, 15% and 10%, respectively, of consolidated gross accounts receivable at December 31, 2009. For the six months ended December 31, 2008, GameStop, Wal-Mart, and Atari accounted for 18%, 17%, and 13%, respectively, of consolidated gross revenues. Navarre Corporation, GameStop, and Wal-Mart accounted for 20%, 17% and 15%, respectively, of consolidated gross accounts receivable at June 30, ~~2009.~~ 2010.

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

Amounts incurred related to these three vendors as of December 31, ~~2009~~2010 and June 30, ~~2009~~2010 and for the ~~three–month~~three-month and six-month periods ended December 31, ~~2009~~2010 and ~~2008~~2009 are as follows:

Cost of Goods Sold — Products Accounts Payable

For the
three
months
ended
December
31, 2009

For the
three
months
ended
December
31, 2008

For the
six
months
ended
December
31, 2009

For the six
months
ended
December
31, 2008

As of
December
31, 2009

As of
June 30,
2009

Microsoft $ 214,598 $ 705,785 $ 2,952,440 $ 896,934 $ - $ 142,329
Nintendo $ 3,194,743 $ 2,912,174 $ 4,026,539 $ 3,737,477 $ - $ -
Sony $ 81,265 $ 804,075 $ 108,787 $ 1,194,381 $ 96,185 $ 12,493

~~SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(Unaudited)~~

1. ~~Summary of Significant Accounting Policies, continued~~

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

~~Restricted Cash~~

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

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

December 31,
2009

June 30,
2009

Cash collateral for the line of credit (see Note 5) $ - $ 742,199
Funds held in escrow pending resolution of litigation (see Note 10), of which $36,625 and $265,919 is included as a liability at December 31, 2009 and June 30, 2009, respectively 849,600 503,383
Total $ 849,600 $ 1,245,582

	Cost of Goods Sold — Products								Accounts Payable
	For the three months ended December 31, 2010		For the three months ended December 31, 2009		For the six months ended December 31, 2010		For the six months ended December 31, 2009		As of December 31, 2010		As of June 30, 2010

Microsoft	$	503,087	$	214,598	$	702,423	$	2,952,440	$	424,710	$	158,592
Nintendo	$	1,109,701	$	3,194,743	$	1,276,385	$	4,026,539	$	-	$	-
Sony	$	300,123	$	81,265	$	889,985	$	108,787	$	18,121	$	449,042

Allowances for Returns, Price Protection, and Doubtful Accounts

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

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

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

~~SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(Unaudited)~~

1. ~~Summary of Significant Accounting Policies, continued~~

amounts recorded. Similarly, management must make estimates of the uncollectibility of the Company’s accounts receivable. ~~In estimating the allowance for doubtful accounts, the Company analyzes the age~~

1. Principal Business Activity and Summary of current outstanding account balances, historical bad debts, customer concentrations, customer creditworthiness, current economic trends, and changes in the Company’s customers’ payment terms and their economic condition. Any significant changes in any of these criteria would affect management’s estimates in establishing the allowance for doubtful accounts.Significant Accounting Policies, Cont.

At December 31, ~~2009~~2010 and June 30, ~~2009,~~2010, accounts receivable allowances consisted of the following:

	December 31, 2009		June 30, 2009		December 31, 2010		June 30, 2010
Sales returns	$	1,821,643	$	1,294,082	$	121,338	$	2,634,097
Price protection		3,932,078		4,998,622		297,544		2,257,171
Doubtful accounts		845,743		874,645		505,056		771,442
Defective items		49,149		47,635		4,513		38,221

Total allowances	$	6,648,613	$	7,214,984	$	928,451	$	5,700,931

~~Inventories~~Assessment of Impairment of Assets

Inventories are stated at the lower of average cost or market. Management regularly reviews inventory quantities on hand and in the retail channel and records a provision for excess or obsolete inventory based on the future expected demand for the Company’s games. Significant changes in demand for the Company’s games would impact management’s estimates in establishing the inventory provision. Inventory costs include licensing fees paid to platform proprietors. These licensing fees include the cost to manufacture the game cartridges. These licensing fees included in “cost of goods sold - product costs” amounted to $3,490,606 and $7,087,766 for the three and six months ended December 31, 2009, respectively, and $4,422,034 and $5,828,792 for the three and six months ended December 31, 2008, respectively. Licensing fees included in inventory at December 31, 2009 and June 30, 2009 totaled $2,108,028 and $920,747, respectively.

~~Advances on Royalties~~

The Company utilizes independent software developers to develop its games in exchange for payments to the developers based upon certain contract milestones. The Company enters into contracts with the developers once the game design has been approved by the platform proprietors and is technologically feasible. Accordingly,Current accounting standards require that the Company capitalizes such payments to the developers during development of the games. These payments are considered non-refundable royalty advances and are applied against the royalty obligations owed to the developer from future sales of the game. Any pre-release milestone payments that are not prepayments against future royalties are expensed to “cost of goods sold - royalties” in the period when the game is released. Capitalized royalty costs for those games that are cancelled or abandoned are charged to “cost of goods sold - royalties” in the period of cancellation. Capitalized costs for games that are cancelled or abandoned prior to product release are charged to “cost of goods sold - royalties” in the period of cancellation. There were no costs for games cancelled or abandoned during the three-month and six-month periods ended December 31, 2009 and 2008, respectively.

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

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

~~SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES~~

~~Notes to Condensed Consolidated Financial Statements~~

~~Significant management judgments and estimates are utilized in the assessment of~~assess the recoverability of ~~capitalized royalty costs. In evaluating~~purchased intangible assets subject to amortization and other long-lived assets whenever events or changes in circumstances indicate the recoverability of capitalized royalty costs, the assessment of expected game performance utilizes forecasted sales amounts and estimates of additional costs to be incurred. If revised forecasted or actual game sales are less than, and/or revised forecasted or actual costs are greater than, the original forecasted amounts utilized in the initial recoverability analysis, the net realizableremaining value may be lower than originally estimated in any given quarter, which could result in an impairment charge. Material differences may result in the amount and timing of charges for any period if management makes different judgments or utilizes different estimates in evaluating these qualitative factors.

~~Intellectual Property Licenses~~

Intellectual property license costs consist of fees paid by the Company to license the use of trademarks, copyrights, and software used in the development of games. Depending on the agreement, the Company may use acquired intellectual property in multiple games over multiple years or for a single game. When no significant performance remains with the licensor upon execution of the ~~license agreement,~~assets recorded on its condensed consolidated balance sheets is potentially impaired. In order to determine if a potential impairment has occurred, management must make various assumptions about the ~~Company records an asset and a liability at the contractual amount. The Company believes that the contractual amount represents the~~estimated fair value of the ~~liability. When significant performance remains with~~asset by evaluating future business prospects and estimated cash flows. For some assets, the ~~licensor,~~Company’s estimated fair value is dependent upon predicting which of its products will be successful. This success is dependent upon several factors, which are beyond the ~~Company records~~Company’s control, such as which operating platforms will be successful in the ~~payments as an asset when paid and as a liability when incurred, rather than upon execution~~marketplace, market acceptance of the ~~agreement. The Company classifies these obligations as current liabilities to~~Company’s products and competing products. Also, the ~~extent they~~Company’s revenues and earnings are contractually due within the next twelve months. Capitalized intellectual property license costs for those games that are cancelled or abandoned are charged to “cost of goods sold - intellectual property licenses” in the period of cancellation. There were no costs for games cancelled or abandoned during the three-month and six-month periods ended December 31, 2009 and 2008, respectively.

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

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

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

~~Goodwill and Intangible Assets~~

Goodwill is the excess of purchase price paid over identified intangible and tangible net assets of Gamecock. Intangible assets consist of acquired game sequel titles, distribution and non-compete agreements. Certain intangible assets acquired in a business combination are recognized as assets apart from goodwill. Identified intangibles other than goodwill are generally amortized using the straight-line method over the period of expected benefit ranging from oneconsidered to ~~three years, except for acquired game sequel titles, which is a usage-based intangible asset that is amortized using the shorter of the useful life or expected revenue stream.~~

~~SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES~~

~~Notes to Condensed Consolidated Financial Statements~~

~~The Company evaluates goodwill and intangibles with~~have an indefinite life, and is carried at cost. Goodwill is not amortized, but is subject to an impairment test annually ~~(performed~~and in ~~the fourth quarter) and upon the occurrence of certain triggering~~between annual tests when events or ~~substantive changes in~~ circumstances ~~that~~ indicate that the ~~fair~~carrying value ~~of goodwill or indefinite lived intangible assets~~ may not be ~~impaired.~~recoverable. The Company performs its annual impairment testing at June 30. Impairment of goodwill is tested at the reporting unit level. The Company has one reporting unit, because none of the components of the Company constitute a business for which discrete financial information is available and for which Company management regularly reviews the results of operations.

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

The Company determined that current business conditions, and the resulting decrease in the Company’s projected cash flows, constituted a triggering event which required the Company to perform interim impairment tests related to its long-lived assets and goodwill during the quarter ended December 31, ~~2009.~~2010. The Company’s interim test on its long-lived assets indicated that the carrying value of its long-lived assets was recoverable and that no impairment existed as of the testing date. As of December 31, 2010, there was no impairment to goodwill. The Company will continue to monitor its goodwill and indefinite-lived intangible and long-lived assets for possible future impairment.

~~Assessment of Impairment of Assets~~

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

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

~~SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES~~

~~Notes to Condensed Consolidated Financial Statements~~

1. Principal Business Activity and Summary of Significant Accounting Policies, ~~continued~~Cont.

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

~~Some~~The Company has an arrangement pursuant to which it distributes videogames co-published with another company for a fee based on the gross sales of the ~~Company’s videogames provide limited online features at no additional cost to~~videogames. Under the ~~consumer. Generally,~~arrangement, the Company ~~considers such features to be incidental to~~bears the ~~overall product offering and an inconsequential deliverable. Accordingly, the Company recognizes revenue related to videogames containing these limited online features upon the transfer of title and~~inventory risk of loss to the customer. In instances where online features or additional functionality are considered a substantive deliverable in addition to the videogame, the Company takes this into account when applying its revenue recognition policy. This evaluation is performed for each videogame together with any online transactions, such as electronic downloads or videogame add-ons when it is released. When the Company determines that a videogame contains online functionality that constitutes a more-than-inconsequential separate service deliverable in addition to the videogame, principally because of its importance to game play, the Company considers that its performance obligations for this game extend beyond the delivery of the game. Fair value does not exist for the online functionality, as the Company purchases and takes title to the inventory, warehouses the inventory in advance of orders, ships the inventory, and invoices its customers for videogame shipments. Also under the arrangement, the Company bears the credit risk as the supplier does not ~~separately charge~~guarantee returns for this component of the videogame. As a result, the Company recognizes all of the revenue from the sale of the game upon the delivery of the remaining online functionality. In addition, the Company defers the costs of sales for this game and recognizes the costs upon delivery of the remaining online functionality.

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

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

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

~~Consideration Given to Customers and Received from Vendors~~

non-collection. The Company ~~offers sales incentives and other consideration to its customers. Sales incentives and other consideration that are considered adjustments~~records the gross amount of revenue under the ~~selling price of~~arrangement as it is not acting as an agent for the Company’s games, such as rebates and product placement fees, are reflected as reductions to revenue. Sales incentives and other consideration that represent costs incurred by the Company for assets or services received, such as the appearance of games in a customer’s national circular ad, are reflected as sales and marketing expenses.

~~Cost of Goods Sold~~

~~Cost of goods sold includes: manufacturing costs, royalties, and amortization of intellectual property licenses.~~

~~SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES~~

~~Notes to Condensed Consolidated Financial Statements~~

~~Stock-Based Compensation~~

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

~~Stock-based compensation expense recognized~~Foreign Currency Translation

Foreign exchange transaction gains (losses) included in general and administrative expenses in the accompanying condensed consolidated statements of operations ~~is based on awards ultimately expected~~for the three and six months ended December 31, 2010 amounted to ~~vest~~$(14,884) and ~~has been reduced~~$(64,670), respectively. Foreign exchange transaction gains (losses) for ~~estimated forfeitures. Stock compensation guidance requires forfeitures to be estimated at~~ the ~~time of grant~~three and ~~revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.~~

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

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

~~Fair Value Measurements~~

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

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

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

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

The determination of where assets and liabilities fall within this hierarchy is based upon the lowest level of input that is significant to the fair value measurement. While the Company has previously invested in certain assets that would be classified as “level 1,” as ofsix months ended December 31, 2009 the Company does not hold any “level 1” cash equivalents that are measured at fair value on a recurring basis, nor does the Company have any assets or liabilities that are based on “level 2” or “level 3” inputs.amounted to $10,535 and $(7,497), respectively.

~~SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES~~

~~Notes to Condensed Consolidated Financial Statements~~

Comprehensive (Loss) Income ~~(Loss)~~

For the three-month and six-month periods ended December 31, ~~2009~~2010 and ~~2008,~~2009, the Company’s comprehensive ~~income (loss)~~loss was as follows:

Fair Value Measurements

The following table summarizes the Company’s financial assets and liabilities that are measured at fair value on a recurring basis.

1. Principal Business Activity and Summary of Significant Accounting Policies, Cont.

On July 19, 2010, the Company issued Series A warrants in connection with the sale of $5,500,000 of senior secured convertible notes. The Series A warrants entitle the holders to purchase an aggregate of 12,761,021 shares of common stock. The Series A warrants have an exercise price of $0.375 per share and a term of five years, and became exercisable upon the issue date. The Company has accounted for the Series A warrants as a liability because the exercise price of the warrants will reset if the Company issues stock at a lower price. At inception, the fair value of the Series A warrants of $4,338,748 was separated from the debt liability and recorded as a derivative liability which resulted in a reduction of the initial notional carrying amount of the senior secured convertible notes. The fair value of the warrants was computed using the Black-Scholes option pricing model. The Company assumed a risk-free interest rate of 1.73%, no dividends, expected volatility of 148.24% and the contractual life of the warrants of 5 years.

In addition, the purchasers of the senior secured convertible notes received Series B warrants which will expire, if the warrants become exercisable, on the fifth year anniversary of the date the Company announces its 2011 operating results. The number of Series B warrants each purchaser received is equal to 75% of the Series A warrants they obtained. The Series B warrants can only be exercised if the EBITDA Test under the senior secured convertible notes is not achieved or if the Company fails to announce its 2011 operating results by September 28, 2011. The obligation to deliver the Series B warrants was determined to be an embedded derivative. The Company has approached the valuation of this embedded derivative based on the probability that the EBITDA Test under the senior secured convertible notes will be achieved. Because the probability at inception that the EBITDA Test will not be achieved is considered to be de minimis (less than 5%), the fair value of the derivative instrument is not considered to be material and no value has been assigned to it.

The Company measures the fair value of the warrants at each balance sheet date, and records the change in fair value as a non-cash charge or gain to earnings each period. The warrants were valued at $1,276,102 at December 31, 2010. The Company recorded a non-cash gain of $3,062,646 due to the change in fair value of warrants during the six months ended December 31, 2010. The fair value of the warrants at December 31, 2010 was computed using the Black-Sholes option pricing model. The Company assumed a risk-free interest rate of 2.01%, no dividends, expected volatility of 126.64% and the remaining contractual life of the warrants of 4.6 years.

The following table is a rollforward of the fair value of the warrants, as to which fair value is determined by Level 3 inputs:

Earnings (Loss) Per Common Share

Inventories consist of the following:

The Company had a $8.0 million revolving line of credit facility with SunTrust Banks, Inc. (“SunTrust”) that was scheduled to mature on November 30, 2010. The line of credit bore interest at prime plus 1½%, which was 4.75% at June 30, 2010. At June 30, 2010, the Company ~~reported a net loss for~~was not in compliance with certain financial and non-financial covenants and $3,830,055 was outstanding. For the three and six ~~month periods ended December 31, 2009, basic and diluted earnings per share were the same for this period. Potentially dilutive securities totaling 6,293,273 shares for the three~~ months ended December 31, ~~2009 were excluded from~~2010, interest expense relating to the ~~diluted earnings per share calculation because~~line of ~~their anti-dilutive effect. Potentially dilutive securities totaling 6,058,925~~credit was $-0- and ~~17,616,289 shares for~~$2,021, respectively. For the three and six months ended December 31, 2009, interest expense related to the line of credit was $65,211 and ~~2008,~~$116,970, respectively. There was $33,284 of accrued interest at June 30, 2010.

On July 12, 2010, the Company repaid in full the entire outstanding balance under the credit agreement as a result of entering into a factoring agreement with Rosenthal & Rosenthal, Inc. (see Note 4, Due to Factor for further discussion). As a result of such repayment, (i) the loan agreement has automatically terminated, (ii) SunTrust’s lien or security interest in the Company’s assets has been terminated, and (iii) all obligations of the Company under the loan agreement have been satisfied in full.

On July 7, 2010, the Company entered into a Factoring Agreement with Rosenthal & Rosenthal. Under the Factoring Agreement, the Company agreed to sell certain receivables to Rosenthal & Rosenthal arising from sales of inventory to customers. In connection with the execution of the Factoring Agreement, the Company, certain subsidiaries, and the chairman, Terry Phillips, have executed guarantees in favor of Rosenthal & Rosenthal. In addition, the Company and certain subsidiaries each granted to Rosenthal & Rosenthal a security interest against all their respective assets.

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

4. Due to Factor, Cont.

Due (to) from factor consists of the following:

Accounts receivable totaling $5,200,626 were sold to the factor at December 31, 2010, of which the Company assumed credit risk of $1,578,909. The following table sets forth adjustments to the price protection and other customer allowances included as a reduction of amounts due (to) from factor:

For the three-month and six-month periods ended December 31, 2010, interest and financing costs relating to the factoring agreement were $102,480 and $257,938, respectively.

On August 17, 2009, the Company entered into a euro-denominated unit production financing agreement with a producer relating to the production of certain games, of which the balance outstanding under this agreement was $3,755,104 at December 31, 2010. Production fees relating to this production advance for the three-month and six-month periods ended December 31, 2010 totaled $294,018, and $572,878, respectively. The production fees for the three-month and six-month periods ended December 31, 2010 related to the default status of the production advance, as described in the subsequent paragraph. These amounts are included in interest and financing costs, net on the accompanying condensed consolidated statements of operations. As of December 31, 2010 and June 30, 2010, accrued and unpaid production fees totaled $1,658,914 and $1,000,392, respectively, and are included in accrued expenses and other current liabilities. The Company is obligated to pay approximately $99,000 of production fees for every month the full production advance is outstanding past its due date of November 15, 2009. Pursuant to the agreement, the Company has assigned to the producer a portion of the net revenues related to the sale of certain games in Europe.

On April 29 and 30, 2010, the Company entered into a note purchase agreement pursuant to which the Company could issue up to $5,000,000 of junior secured subordinated promissory notes (the “Junior Notes”) in one or more closings and each of the Company’s subsidiaries guaranteed the Company’s obligations under the Junior Notes. Pursuant to the note purchase agreement, the Company issued Junior Notes in the aggregate principal amount of $950,000 in private placements that closed on April 30, 2010 and May 6, 2010. Of the Junior Notes issued on April 29 and 30, 2010, the Company’s chairman, purchased $500,000.

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

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

On July 16, 2010, the Company repaid the $450,000 Junior Note plus accrued interest thereon with proceeds from the ~~diluted earnings~~senior secured convertible notes. On July 16, 2010, the Company exchanged the $500,000 Junior Note issued to the Company’s chairman for a $500,000 senior secured convertible note (see discussion below). Interest expense for the three-month and six-month periods ended December 31, 2010 related to the Junior Notes was $5,411 and $5,411, respectively. There was $-0- and $15,548 of accrued interest outstanding at December 31, 2010 and June 30, 2010, respectively.

On July 16, 2010, the Company entered into a Securities Purchase Agreement with CNH Diversified Opportunities Master Account, L.P., CNH CA Master Account, L.P., AQR Diversified Arbitrage Fund and Terry Phillips, the Company’s chairman, for the sale of $5,500,000 of senior secured convertible notes (the “Initial Notes”) and warrants. Mr. Phillips’ Initial Note was issued in exchange for a Junior Note originally issued to him on April 30, 2010. The Company received $5,000,000 in cash for $5,000,000 of the Initial Note and exchanged a $500,000 prior Junior Note for $500,000 of the Initial Note. The Initial Notes are due and payable in full on July 19, 2013 and bear interest at the rate of 10.0% per ~~share calculation because~~annum. Interest is payable semi-annually commencing on December 31, 2010. The Company did not make its first interest payment of $252,083 on December 31, 2010 and was in default on the Notes with respect to which default the Company entered into a Waiver Agreement with each holder of the Initial Note (see discussion regarding the waiver and forbearance agreements below). Pursuant to their ~~anti-dilutive effect.~~respective terms, in the event of a default, the interest rate of the Initial Notes increases to 15.0% per annum until the interest is paid. Once the interest is paid, the interest rate will return to the original 10.0% per annum. The Initial Notes are senior to all obligations of the Company with the exception of the indebtedness under the Company’s Factoring Agreement with Rosenthal & Rosenthal (see Note 4). Interest expense for the three-month and six-month periods ended December 31, 2010 was $140,556 and $252,083, respectively, and there was $252,083 of accrued interest outstanding at December 31, 2010.

~~Reclassifications~~

6. Secured Convertible Debt, Cont.

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

~~Recent Accounting Pronouncements~~

The ~~Financial Accounting Standards Board (“FASB”) has codified~~principal and interest due under the Notes are convertible at a ~~single source~~price of ~~U.S. GAAP,~~$0.431 per share at the ~~“Accounting Standards Codification.” Unless needed to clarify a point to readers,~~option of the holders. The Company evaluated the conversion feature of the Notes and determined that there was no beneficial conversion feature as the conversion price of $0.431 per share was greater than the fair value of the stock at the time of issuance.

On August 31, 2010, the Company entered into an Amended and Restated Securities Purchase Agreement (the “Amended Purchase Agreement”), pursuant to which it sold an aggregate of $2,000,000 of a new series of senior secured convertible notes (the “Additional Notes”) to AQR Opportunistic Premium Offshore Fund, L.P., Advanced Series Trust, solely on behalf of the AST Academic Strategies Asset Allocation Portfolio, and Terry Phillips, the Company’s chairman. The Company received $2,000,000 in cash for $2,000,000 of the Additional Notes, of which $200,000 was paid by Terry Phillips, the Company’s chairman. The Additional Notes are due and payable in full on March 15, 2011 and bear interest at the rate of 24.0% per annum. Interest is payable on December 31, 2010 and on March 15, 2011, the maturity date. The Company did not make its first interest payment of $161,333 on December 31, 2010 and was in default on the Additional Notes as of December 31, 2010 with respect to which default the Company entered into a waiver and forbearance agreement with each holder of the Initial Note (see discussion regarding the waiver and forbearance agreements below). Pursuant to their respective terms, in the event of a default, the interest rate of the Additional Notes increases to 29.0% per annum until the interest is paid. Once the interest is paid, the interest rate will ~~refrain~~return to the original 24.0% per annum. The Additional Notes are subject to the Pledge and Security Agreement and the Guaranty made by the Company’s subsidiaries. Interest expense for the three-month and six-month periods ended December 31, 2010 was $122,667 and $161,333, respectively, and there was $161,333 of accrued interest outstanding at December 31, 2010.

The principal and interest due under the Additional Notes are convertible at a price of $20.00 per share at the option of the holders. The Company evaluated the conversion feature of the Notes and determined that there was no beneficial conversion feature as the conversion price of $20.00 per share was greater than the fair value of the stock at the time of issuance.

As a part of the issuance of the Notes, the Company issued Series A warrants to the purchasers of the Notes giving them the right to purchase up to an aggregate of 12,761,021 shares of common stock at an exercise price of $0.375 per share. The Series A warrants expire on July 19, 2015, unless sooner exercised.

In addition, the purchasers of the Notes received Series B warrants which will expire, if the warrants become exercisable, on the fifth year anniversary of the date the Company announces its 2011 operating results. The number of Series B warrants each purchaser received is equal to 75% of the Series A warrants they obtained. The Series B warrants can only be exercised if the EBITDA Test, as defined under the Notes, is not achieved or if the Company fails to announce its 2011 operating results by September 28, 2011. The exercise price of the Series B warrants is equivalent to the weighted average price of the Company’s common stock for each of the 30 consecutive trading days following the earlier of the announcement of the Company’s 2011 operating results or September 28, 2011. The exercise price per share is also subject to full ratchet anti-dilution protection and limitations on exercise similar to the provisions for the Series A warrants.

The Company’s Notes and certain warrants have been accounted for in accordance with applicable authoritative guidance for derivative instruments which requires identification of certain embedded features to be bifurcated from ~~citing specific section references when discussing application~~debt instruments and accounted for as derivative assets or liabilities. The derivative assets and liabilities are initially recorded at fair value and then at each reporting date, the change in fair value is recorded in the condensed consolidated statements of ~~accounting principles or addressing new or pending accounting rule changes.~~operations.

The Company has accounted for the Series A warrants as a liability because the exercise price of the warrants will reset if the Company issues stock at a lower price. At inception, the fair value of the Series A warrants of $4,338,748 was separated from the Notes and recorded as a derivative liability which resulted in a reduction of the initial notional carrying amount of the Notes, and as unamortized discount, which is being accreted over the term of the Notes using the straight-line method. The fair value of the warrants was computed using the Black-Scholes option pricing model. The Company assumed a risk-free interest rate of 1.73%, no dividends, expected volatility of 148.24% and the contractual life of the warrants of 5 years.

The obligation to deliver the Series B warrants was determined to be an embedded derivative. The Company has determined the valuation of this embedded derivative based on the probability that the EBITDA Test, as defined under the Notes, will not be achieved. Because the probability at inception that the EBITDA Test will not be achieved is considered to be de minimis (less than 5%), the fair value of the derivative instrument is not considered to be material and no value has been assigned to it.

~~SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES~~

6. Secured Convertible Debt, Cont.

~~Notes to Condensed Consolidated Financial Statements~~

~~(Unaudited)~~

1. ~~Summary~~As of ~~Significant Accounting Policies, continued~~December 31, 2010, the unamortized debt discount amounted to $3,615,623. Total amortization of the debt discount recorded as interest expense was $361,562 and $723,125 for the three-month and six-month periods ended December 31, 2010, respectively.

In ~~October 2009,~~connection with the ~~FASB issued Accounting Standards Update (“ASU”) No. 2009-14, “Software (Topic 985): Certain Revenue Arrangements That Include Software Elements—a consensus~~sale of the ~~FASB Emerging Issues Task Force (“EITF”)” (formerly EITF 09-3). ASU 2009-14 revises FASB ASC 985-605~~Initial Notes and warrants, the Company executed a Registration Rights Agreement under which it agreed to ~~drop~~register the shares of common stock underlying the Initial Notes and warrants. The Registration Rights Agreement has been amended and currently provides that the Company file a registration statement by November 19, 2010 and to have it declared effective by January 31, 2011, if it is not subject to full review by the SEC, and by March 15, 2011, if it is subject to full review. Failure to have the registration statement declared effective within 60 days from ~~its scope~~the prescribed effectiveness deadline constitutes a default under the Initial Notes.

On December 31, 2010, the Company failed to make a timely payment of interest required under the Notes. Such failure triggered a default provision under the Notes following a seven day cure period. On February 16, 2011, the Company entered into Waiver Agreements with each holder of the Notes. Pursuant to the Waiver Agreements, the holders of the Notes waived their right of redemption and remedies regarding the Company’s failure to have paid the required interest and agreed to forbear from exercising all ~~tangible products containing both software~~remedies available in connection with such failure until March 15, 2011. Pursuant to the Waiver Agreement, the Company is not required to pay the required interest until March 15, 2011 and ~~non-software components~~the interest rates under the Notes increase to 15% and 29%, as applicable, from December 31, 2010 to March 15, 2011.

The purchasers of the senior secured convertible notes and warrants were introduced to the Company by an investment bank pursuant to an engagement letter agreement with the Company. Pursuant to the engagement letter, the investment bank received a cash fee that ~~operate together~~was approximately equal to ~~deliver~~5.0% of the ~~products’ functions. It also amends~~aggregate proceeds raised in the ~~determination~~financing. The Company recorded the cash fee and other direct costs incurred for the issuance of ~~how arrangement consideration should be allocated to deliverables~~the senior secured convertible notes in ~~a multi-deliverable revenue arrangement. ASU 2009-14 is effective for fiscal years beginning after June 15, 2010. Early adoption is permitted with required transition disclosures based~~aggregate of $733,959 as deferred debt issuance costs. Debt issuance costs are amortized on the ~~period~~straight-line method over the terms of ~~adoption. The~~the senior secured convertible notes, with the amounts amortized being recognized as interest expense. Amortization of deferred debt issuance costs included in interest expense for the three-month and six-month periods ended December 31, 2010 totaled $135,186 and $201,278, respectively.

7. Inventory Financing Payable

On September 20, 2010, the Company ~~is currently evaluating~~entered into a Master Purchase Order Assignment Agreement with Wells Fargo Bank, National Association (“Wells Fargo”). In connection with the ~~impact that the adoption~~execution of this ~~guidance will have on its consolidated financial statements.~~

~~In October 2009, the FASB issued ASU No. 2009-13, “Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements – a consensus~~Agreement, each of the FASB Emerging Issues Task Force” (formerly EITF 08-1), which amends the revenue recognition guidance for arrangements with multiple deliverables. ASU 2009-13 addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting and how to allocate consideration to each unit of accounting in the arrangement. This ASU replaces all references to fair value as the measurement criteria with the term selling price and establishes a hierarchy for determining the selling price of a deliverable. It also eliminated the use of the residual value method for determining the allocation of arrangement consideration. ASU 2009-13 is effective for fiscal years beginning after June 15, 2010. Early adoption is permitted with required transition disclosures based on the period of adoption. The Company, ~~is currently evaluating the impact that the adoption of this guidance will have on~~ its ~~consolidated financial statements.~~

2.~~Gamecock Acquisition~~

~~On October 10, 2008, the Company acquired Gamecock pursuant to a definitive purchase agreement (the “Gamecock Agreement”) with Vid Agon,~~subsidiaries, Gone Off Deep, LLC ~~(the “Seller”)~~ and Vid Sub, LLC, and the chairman, Terry Phillips (the ~~“Member”~~“Guarantors”)~~. The Member is~~, have executed a ~~wholly-owned subsidiary~~Guaranty in favor of, and, along with the Company, have entered into a Security Agreement and Financing Statement with, Wells Fargo.

Under the terms of the ~~Seller~~agreement, the Company may request that Wells Fargo accept the assignment of customer purchase orders and ~~Gamecock is~~request that Wells Fargo purchase the required materials to fulfill such purchase orders. If accepted, Wells Fargo, in turn, will retain the Company to manufacture, process, and ship the ordered goods. Wells Fargo’s aggregate outstanding funding under the agreement shall not exceed $2,000,000. As of December 31, 2010, no amounts were outstanding under the agreement. Interest expense for the three month and six month periods ended December 31, 2010 was $42,070 and $42,070, respectively.

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

In addition, Wells Fargo is entitled to a commitment fee of $120,000 to be paid on the earlier of (a) September 20, 2011 or (b) the date on which the Agreement is terminated. Wells Fargo is also entitled to additional commitment fees for each renewal of the ~~Member in exchange for aggregate consideration~~Agreement, and such fees will be paid on the earlier of 7%(a) the first anniversary of the ~~future revenues from sales~~beginning of ~~certain Gamecock games, net of certain distribution fees and advances, and a warrant to purchase 700,000 shares of the Company’s common stock.~~

~~The amount of the contingent purchase price payment obligations (the “Gamecock Earn-Out”) will be added to the purchase price (i.e., goodwill) when the contingency is resolved.~~

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

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

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

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

~~SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(Unaudited)~~

2.7. ~~Gamecock Acquisition~~Inventory Financing Payable, ~~continued~~Cont.

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

Preliminary
Purchase Price
Allocation as of
June 30, 2009

Final Purchase
Price Allocation
as of October 10,
2009

Working capital, excluding inventories $ 827,287 $ 827,287
Inventories 156,745 156,745
Other current assets 36,369 36,369
Property and equipment 209,441 209,441

Estimated useful
life

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

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

The following table presents the gross and net balances, and accumulated amortization of the components of the Company’s purchased amortizable intangible assets included in the acquisition as of December 31, 2009:

Accumulated
Gross Amortization Net

Royalty agreements (Advances on royalties) $ 3,424,000 $ 2,699,171 $ 724,829
Intangible assets, net
Game sequel titles $ 1,142,000 $ 1,142,000 $ -
Non-compete agreements 200,000 200,000 -
Distribution agreements 40,000 16,308 23,692

Total intangible assets, net $ 1,382,000 $ 1,358,308 $ 23,692

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

~~SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(Unaudited)~~

2. ~~Gamecock Acquisition, continued~~

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

Year ending June 30,

2010 (six months ended June 30, 2010) $ 6,667
2011 $ 13,333
2012 $ 3,692

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

As of December 31, 2009, a total of $1,473,177, which may be netted contractually against adjustments for excess payables, as defined pursuant to the Gamecock Agreement, of the Gamecock Earn-Out has been achieved and was recorded as goodwill in the consolidated balance sheets.

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

For the three
months ended
December 31, 2008

For the six
months ended
December 31, 2008

Pro forma net revenues $ 17,472,058 $ 26,505,788
Pro forma net loss $ 940,575 $ (34,722,961 )
Pro forma net loss per share—basic $ 0.03 $ (0.97 )
Pro forma net loss per share—diluted $ 0.02 $ (0.97 )

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

3. ~~Inventories~~

~~Inventories consist of the following:~~

December 31,
2009

June 30,
2009

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

~~SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES~~

~~Notes~~Subject to ~~Condensed Consolidated Financial Statements~~

~~(Unaudited)~~

4. ~~Property and Equipment, net~~

~~Property and equipment, net was comprised~~the rights of ~~the following:~~

December 31,
2009

June 30,
2009

Land $ 544,044 $ 544,044
Building and leasehold improvements 1,496,099 1,496,147
Computer equipment and software 765,659 719,621
Office furniture and other equipment 439,990 353,406
3,245,792 3,113,218

Less: accumulated depreciation and amortization 467,071 359,079

Property and equipment, net $ 2,778,721 $ 2,754,139

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

5. ~~Line of Credit~~

The Company has a $7.5 million revolving line of credit facility with SunTrust that matured on December 31, 2009 and has been extended on a month to month basis. From time to time SunTrust in its sole and absolute discretion may increase the Company’s line of credit in the form of an overadvance agreement. As of December 31, 2009 and June 30, 2009, the Company’s borrowing base may not exceed 65% of eligible accounts receivable plus $500,000. The line of credit bears interest at prime plus ½%, which was 3.75% at December 31, 2009 and June 30, 2009. SunTrust processes payments received on such accounts receivable as payments on the revolving line of credit. The line is collateralized by gross accounts receivable of approximately $8,247,000 and $8,673,000 at December 31, 2009 and June 30, 2009, respectively. The line of credit is further collateralized by personal guarantees, and pledge of personal securities and assets by two Company shareholders, one of whom is the Company’s chairman, and certain other affiliates. The agreement contains certain financial and non-financial covenants. At December 31, 2009,senior lenders, the Company ~~was~~and the Guarantors have granted security interests in ~~compliance with these covenants.~~their assets to Wells Fargo under the Security Agreement and Financing Statement to secure the LLC’s obligations under the Agreement and the Guarantors’ guarantees of such obligations.

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

~~SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(Unaudited)~~

6. ~~Long-term Debt~~

~~Long-term debt was comprised of the following:~~

December 31,
2009

June 30,
2009

Mortgages payable
First National Bank $ 1,027,099 $ 1,039,078
Southwest Securities, FSB 486,356 493,437
Vehicle notes payable 124,802 57,296

Total debt 1,638,257 1,589,811
Less current portion 63,649 50,855
Total long-term debt $ 1,574,608 $ 1,538,956

In connection with the purchase of an office building in Grapevine, Texas, the Company entered into a five year mortgage with a financial institution in the amount of $500,000. The interest rate on the mortgage adjusts daily to prime plus 1.0% (5.5% at December 31, 2009). Principal and interest are payable in monthly installments of $3,439 continuing until January 28, 2014 when the entire balance of principal and accrued interest is due and payable. The mortgage is secured by the land and building. The Company’s chairman has personally guaranteed the mortgage note.

In connection with the purchase of an office building and land in Grapevine, Texas, the Company entered into a 20 year mortgage with a financial institution in the amount of $1,068,450. The interest rate on the mortgage adjusts every five years to prime minus ¼% (7.5% at December 31, 2009). The monthly principal and interest payment is $8,611 with interest only payments for the first six months. The mortgage is secured by the purchased land and building. Two shareholders of the Company, one of whom is the Company’s chairman, have personally guaranteed the mortgage note.

~~The scheduled maturities of the long-term debt are as follows:~~

Year ending June 30,
2010 (six months ended June 30, 2010) $ 31,734
2011 65,451
2012 68,993
2013 73,347
2014 489,276
Thereafter 909,456

Total 1,638,257

Less: current maturities 63,649

Long-term debt, net of current portion $ 1,574,608

~~SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(Unaudited)~~

7.8. Related Party Transactions

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

Related Party Receivables

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

~~Due to Shareholders~~

During the year ended June 30 2009, the Company’s chairman advanced the Company $307,440. The advance was unsecured, payable on demand and non-interest bearing. Subsequent to June 30, 2009, the amount was repaid. AtAlso included in related party receivables at December 31 ~~2009~~ and June 30, ~~2009, the amount due was $-0- and $232,440, respectively.~~

~~Due~~2010 is a receivable attributed to ~~Related Parties~~

~~During the year ended June 30, 2009, the~~lease income. The Company ~~collected sales commissions totaling $226,216 on behalf of an affiliate of two~~leases certain office space to a company whose shareholders are also shareholders of the Company, one of whom is the ~~Company’s~~Company's chairman. At December 31, 2010 and June 30, ~~2009, $113,499~~2010, $-0- and $7,815, respectively, was ~~payable~~owed to the ~~affiliate~~Company and is included in ~~due~~related party receivables.

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

The Company incurred fees for broadband usage to an entity partially owned by two shareholders of the Company, one of whom is the Company’s chairman. Broadband usage fees for the three and six months ended December 31, ~~2009~~2010 were ~~$6,600~~$6,625 and ~~$13,200,~~$13,225, respectively. Broadband usage fees for the three and six months ended December 31, ~~2008~~2009 were ~~$20,850~~$6,600 and ~~$41,700,~~$13,200, respectively. These amounts are included in general and administrative expenses in the accompanying condensed consolidated statements of operations. At December 31, ~~2009~~2010 and June 30, ~~2009, $4,400~~2010, $4,425 and ~~$11,546,~~$2,200, respectively, remained as a payable to the affiliate and is included in due to related parties in the accompanying condensed consolidated balance sheets.

Accrued Expenses - Related Parties

Accrued expenses - related parties as of and for the six months ended December 31, ~~2009~~2010 and the year ended June 30, ~~2009~~2010 are as follows:

	Six months ended December 31, 2009			Year ended June 30, 2009			Six months ended December 31, 2010			Year ended June 30, 2010
Balance at beginning of period	$	184,766		$	5,770		$	322,281		$	221,493
Expenses incurred:
Rent		55,000			100,250			55,000			110,000
Commissions		265,297			705,032			56,848			551,932
Cash in advance								210,623			-
Less: amounts paid		(367,775	)		(626,286	)		(303,134	)		(561,144	)
Balance at end of period	$	137,288		$	184,766		$	341,618		$	322,281

The Company incurred sales commissions for the marketing and sale of videogames with ~~two~~four affiliates of the Company’s chairman. Sales commissions for the three and six months ended December 31, 2010 were $16,478 and $56,848, respectively. Sales commissions for the three and six months ended December 31, 2009 were $172,231 and $265,297, respectively. ~~Sales commissions for the three and six months ended December 31, 2008 were $171,331 and $273,227, respectively.~~ These amounts are included in sales and marketing in the accompanying condensed consolidated statements of operations.

2117

~~SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(Unaudited)~~

7.8. Related Party Transactions, ~~continued~~Cont.

Cash in Advance - Related Party

Lease - - Related Parties

The Company leases certain office space from a company whose shareholders are also shareholders of the Company, one of whom is the Company’s chairman. Related party lease expense was $27,500 and $55,000 for the three months and six months ended December 31, ~~2009,~~2010, respectively. Related party lease expense was ~~$22,625~~$27,500 and ~~$45,250~~$55,000 for the three and six months ended December 31, ~~2008,~~2009, respectively. These amounts are included in the general and administrative expense in the accompanying condensed consolidated statements of operations. The lease expires on December 31, ~~2010.~~2013.

The Company leases certain office space to a company whose shareholders are also shareholders of the Company, one of whom is the Company’s chairman. Related lease income was $3,907 and $7,815 for the three months and six months ended December 31, ~~2009,~~2010, respectively. Related lease income was $3,907 and $7,815 for the three and six months ended December 31, ~~2008,~~2009, respectively. These amounts are included in general and administrative expense in the accompanying condensed consolidated statements of operations. The lease expires on ~~December~~January 31, ~~2010.~~2014.

Total future minimum commitments are as follows:

Total future commitments pursuant to vendor settlement agreements are as follows:

~~Developer of Intellectual Property Contracts~~

The Company regularly enters into contractual arrangements with third parties for the development of games as well as the rights to license intellectual property. Under these agreements, the Company commits to provide specified payments to a developer or intellectual property holders, based upon contractual arrangements, and conditioned upon the achievement of specified development milestones. These payments to third-party developers and intellectual property holders typically are deemed to be advances and are recouped against future royalties earned by the developers based on the sale of the related game. On October 26, 2007, the Company executed an agreement with a third party game developer in connection with certain development agreements. Pursuant to the agreement, the Company has committed to spend specified amounts for marketing support of the related game which is to be developed. “Cost of goods sold - royalties” related to this development agreement amounted to $1,618,962 and $6,619,633 for the three and six months ended December 31, 2009, respectively, and $1,492,259 and $2,301,180 for the three and six months ended December 31, 2008, respectively.

~~Lease Commitments~~

In January 2008, the Company entered into a new four year lease for its United Kingdom office, with a yearly rent of approximately $30,000 plus value added tax (VAT). Office rent expense for the three and six months ended December 31, 2009 was $8,906 and $14,767, respectively. Office rent expense for the three and six months ended December 31, 2008 was $16,437 and $33,537, respectively.

The Company entered into a non-cancelable operating lease with an affiliate, on January 1, 2008, for offices located in Midlothian, Virginia. The lease provided for monthly payments of $7,542 for the first 12 months and increased to $9,167 in January 2009 for the remaining 24 months. Office rent expense for the three and six months ended December 31, 2009 was $27,500 and $55,000, respectively. Office rent expense for the three and six months ended December 31, 2008 was $22,625 and $45,250, respectively

~~SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES~~

~~Notes to Condensed Consolidated Financial Statements~~

~~Employment Agreements~~

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

In May 2008, the Company’s board of directors and its shareholders approved the 2008 Equity Incentive Compensation Plan (the “2008 Plan”) for the grant of stock awards, including restricted stock and stock options, to officers, directors, employees and consultants. The 2008 Plan expires in May 2018. Shares available for future grant as of December 31, ~~2009~~2010 and June 30, ~~2009~~2010 were ~~1,379,867~~695,989 and ~~2,924,200,~~919,372, respectively, under the 2008 Plan.

10. Stock-based Compensation, Cont.

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

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

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

	For the six months ended December 31, 2010		For the six months ended December 31, 2009
Risk-free interest rate		1.60 – 3.30%		2.20 – 3.85%
Weighted-average volatility		154 - 157%		160.78 – 166.29%
Expected term		5.5 – 8.7		5.5 - 9.4 years
Expected dividends		0.0%		0.0%

For the six
months ended
December 31, 2009

For the six
months ended
December 31, 2008

Risk-free interest rate 2.20 – 3.85 % 2.87 – 4.01 %
Weighted-average volatility 160.78 – 166.29 % 57.56 %
Expected term 5.5 – 9.44 years 5.5 - 6 years
Expected dividends 0.0 % 0.0 %

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

	For the three months ended December 31, 2010			For the three months ended December 31, 2009		For the six months ended December 31, 2010		For the six months ended December 31, 2009
Sales and marketing	$	(1,196	)	$	12,196	$	9,509	$	39,818
General and administrative		61,877			191,528		204,774		320,102
Total stock-based compensation expense	$	60,681		$	203,724	$	214,283	$	359,920

For the three
months ended
December 31,
2009

For the three
months ended
December 31,
2008

For the six
months ended
December
31, 2009

For the six
months ended
December
31, 2008

Sales and marketing $ 12,196 $ 37,734 $ 39,818 $ 75,468
General and administrative 191,528 132,790 320,102 267,037
Total stock-based compensation expense $ 203,724 $ 170,524 $ 359,920 $ 342,505

As of December 31, ~~2009,~~2010, the Company’s unrecognized stock-based compensation for stock options issued to employees and non-employee directors was approximately ~~$742,719~~$388,206 and will be recognized over a weighted average of 1.8 years. The Company estimated a 5%5.0% forfeiture rate related to the stock-based compensation expense calculated for employees and non-employee directors.

~~SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(Unaudited)~~

9. ~~Stock-based Compensation, continued~~

The following table summarizes the Company’s stock option activity for employees, non-employee directors, and non-employees for the six months ended December 31, ~~2009:~~2010:

	Options		Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Term (in years)		Aggregate Intrinsic Value
Outstanding as of June 30, 2010		2,882,128	$	1.16		-	$	-
Activity for the six months ended December 31, 2010
Granted		696,500		0.30		-		-
Exercised		-		-		-		-
Forfeited, cancelled or expired		666,768		0.69		-		-
Outstanding as of December 31, 2010		2,911,860	$	0.93		8.51	$	-
Exercisable as of December 31, 2010		1,227,013	$	1.40		7.93	$	-
Exercisable and expected to be exercisable		2,764,994	$	0.96		8.47	$	-

10. Stock-based Compensation, Cont.

Options
Weighted-
Average
Exercise
Price

Weighted-
Average
Remaining
Contractual
Term
(in years)

Aggregate
Intrinsic
Value

Outstanding as of June 30, 2009 1,960,300 $ 1.69 - $ -
Activity for the six months ended December 31, 2009
Granted 567,000 0.64 - -
Exercised - - - -
Forfeited, cancelled or expired 87,667 1.75 - -
Outstanding as of December 31, 2009 2,439,633 $ 1.44 9.03 $ -
Exercisable as of December 31, 2009 360,999 $ 2.27 8.52 $ -
Exercisable and expected to be exercisable 2,049,071 $ 1.46 9.02 $ -

The aggregate intrinsic value represents the total pre-tax intrinsic value based on the Company’s closing stock price ($~~0.32~~0.14 per share) as of December 31, ~~2009,~~2010, which would have been received by the option holders had all option holders exercised their options as of that date.

~~The weighted average fair value of stock options granted to employees and non-employee directors during the three months ended December 31, 2009 was $0.50 per share.~~

The following table summarizes the Company’s restricted stock activity for the six months ended December 31, ~~2009:~~2010:

	Shares		Weighted- Average Grant Date Fair Value
Outstanding as of June 30, 2010		1,085,000	$	0.37
Activity for the nine months ended December 31, 2010
Granted		195,651		0.23
Vested		396,333		0.41
Forfeited, cancelled or expired		2,000		1.20
Outstanding as of December 31, 2010		882,318	$	0.32
Vested as of December 31, 2010		509,833	$	0.80

Shares
Weighted-
Average
Grant Date
Fair Value

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

As of December 31, ~~2009,~~2010, the Company’s unrecognized stock-based compensation for restricted stock issued to employees and non-employee directors was approximately ~~$360,420~~$268,545 and will be recognized over a weighted average of ~~2.7~~1.85 years.

~~10.~~11. Contingencies

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

~~SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(Unaudited)~~

~~10.��Contingencies, continued~~

Since the registration statement was not declared effective by the SEC within the prescribed time period, the Company is obligated to make pro rata payments to each holder of Series A convertible preferred stock in an amount equal to .5% of the aggregate amount invested by such holder of Series A convertible preferred stock for each 30 day period (or portion thereof) for which no registration statement is effective. Accordingly, the Company has recognized a liability for liquidating damages and interest totaling $196,511 for the year ended June 30, 2009. The amount of the liability at December 31, 2009 and June 30, 2009 was $196,511.

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

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

As part of the court proceedings between the Company and the videogame distributor, the Company agreed (to avoid further costly hearings) to pay 35% of certain European sales into an escrow account pending the final resolution of the case. As of December 31, 2009, the amount held in escrow was approximately $849,600 and is included in restricted cash. Legal expenses associated with this complaint have been expensed as incurred. As a result of the court’s ruling, the Company recorded accrued litigation costs of $4,308,035 for this matter. ~~This amount represents the full amount of the judgment against Gamecock and its subsidiary. Of this judgment, $555,332 represents the judgment liability of SouthPeak Interactive Corporation.~~

On October 27, 2008, Gamecock was served with a demand for arbitration by a developer alleging various breaches of contract related to a publishing agreement entered into between Gamecock and the developer on December 12, 2007. The developer is seeking an award of $4,910,000, termination of the agreement, exclusive control of the subject videogame, and discretionary interest and costs. Gamecock has responded stating that the developer’s attempts to terminate the publishing agreement constitute wrongful termination of the agreement and breach of the agreement. Gamecock has also filed a counterclaim against the developer seeking the return of approximately $5.9 million in advances on royalties in the event the publishing agreement is terminated. The developer has filed a supplemental demand for arbitration concerning royalty payments due under a separate publishing agreement and is seeking an award of $41,084. An arbitration scheduled for January 2010 has been ~~postponed and a new date has not been set.~~put on hold pending possibility of settlement. As of December 31, ~~2009,~~2010, the Company believes it has accrued sufficient amounts to cover potential losses related to this matter. The Company’s management currently believes that resolution of this matter will not have a material adverse effect on the Company’s consolidated financial position or results of operations. However, legal issues are subject to inherent uncertainties and there exists the possibility that the ultimate resolution of this matter could have a material adverse effect on the Company’s consolidated financial position and the results of operations in the period in which any such effect is recorded.

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

On May 10, 2010, SouthPeak Interactive, L.L.C. and Melanie Mroz were served with a complaint by Spidermonk Entertainment, LLC or Spidermonk, alleging various breach of contract and other claims related to a publishing agreement, or the Publishing Agreement, entered into between Southpeak and Spidermonk in November 2007. Spidermonk is seeking the unpaid milestone payments related to the development of the game “Roogoo” videogame as well as other highly speculative damages related to the poor sales performance of this game. The Company and its subsidiaries intend to vigorously defend all claims.

11. Contingencies, Cont.

In September 2010, the Company instituted summary proceedings in the Lyon France Commercial Court against Nobilis Group in which the Company has alleged the Licensing and Distribution Agreements for the games the Company was to obtain and has obtained from Nobilis, including the My Baby games, were wrongfully terminated. The Company is seeking the reinstatement of the agreements and damages associated with the actions of Nobilis. Following a hearing on October 26, 2010, the court has rendered a temporary summary judgment reinstating the agreement for My Baby First Steps and ordered Nobilis to advise Nintendo to build all products pursuant to the My Baby First Steps contract, which includes the My Baby First Steps game and an additional fourteen games. On December 7, 2010, the Lyon France Commercial Court issued a judgment confirming that Nobilis's termination of the distribution agreement was null and void. The Court has ordered that Nobilis restore SouthPeak's ability to manufacture licensed games under the agreement with immediate effect.

~~Other than~~In November 2010, in connection with the Circuit City Stores, Inc. (“Circuit City”) bankruptcy proceedings, Alfred H. Siegal, Trustee of the Circuit City Liquidating Trust, filed a lawsuit against the Company in United States Bankruptcy Court in the Eastern District of Virginia for the avoidance of payments totaling $1,155,300 as allegedly preferential transfers paid to the Company during the 90 days preceding the filing of the bankruptcy petition of Circuit City on November 10, 2008. The Company believes it has meritorious defenses to these avoidance actions, intends to vigorously defend against them and believes that the likelihood of the avoidance actions prevailing is remote. Accordingly, the Company has not accrued any loss reserve related to this claim.

In October 2010, BVT Games Fund IV Dynamic GmbH & Company (“Fund IV”), an investment fund based in Germany that finances the development of video games, sued the Company in the Regional Court in Munich, Germany to recover funds advanced to the Company to manufacture two titles which a sister fund, BVT Games Fund III Dynamic GmbH & Company (“Fund III”), had financed. A distribution agreement existed for these titles with Phillips Sales, Inc. and not the Company although the Company had guaranteed the obligations of Phillips Sales, Inc. In this litigation, Fund IV is seeking €3,115,341 (approximately USD $4.1 million) plus interest. The Company is actively contesting this litigation and has multiple defenses. The liability associated with the production advance is reflected in the Company’s condensed consolidated financial statements.

In November 2010, the Company first learned that Fund III had obtained a judgment against the Company in the Regional Court in Munich, Germany, seeking payments of approximately €2,300,000 (approximately USD $3.0 million) due under the above-referenced distribution agreement. Prior to gaining such knowledge, Fund III served upon the Company’s then chief financial officer, as required by law, what was supposed to be the English translation of the lawsuit which Fund III had filed. Instead, Fund III served upon the Company a translation of the Fund IV lawsuit that Fund IV intended to serve on the Company. Because the Company knew of the filing of the Fund IV case before being properly served with that case, the Company had already engaged German counsel to represent its interests in the Fund IV case. Since German counsel’s representation had been noted in the Fund IV case, counsel was awaiting notice from the court or opposing counsel that service of the Fund IV case had occurred. Therefore, when the Fund III case was served with a translation of the Fund IV case, the Company took no action since it believed this matter was already in the hands of its attorney. The failure to respond resulted in a default judgment in the Fund III case for which no proper translation has yet been received. Because of this error in translation, the Company is seeking to have the judgment vacated and believes it will be successful in this regard. The Company is of the opinion when, and if, it is required to defend the litigation, that it has strong defenses to assert, including that Phillips Sales is not obligated to Fund III thereby avoiding the Company’s guaranty obligation. The Company cannot predict the potential outcome. No amounts have been recorded in the Company’s condensed consolidated financial statements in connection with the liability underlying the claim.

On January 26, 2011, Codemasters Group Holdings Limited filed suit against the Company in the United States District Court for the Eastern District of Virginia, Richmond Division, seeking to enforce a Settlement Agreement under which Codemasters claims that $1,265,000 plus interest thereon is due. No answer has yet been filed. The Company recognizes its liability to Codemasters which has been recorded on its condensed consolidated financial statements but believes it is entitled to certain credits which Codemasters has not reflected in its lawsuit. It is the Company's intent to try to resolve this matter with Codemasters.

11. Contingencies, Cont.

In addition to the foregoing, the Company is engaged in litigation incidental to the Company’s business to which the Company is a party. While the Company cannot predict the ultimate outcome of these various legal proceedings, it is management’s opinion that, individually, the unfavorable resolution of these matters ~~should not~~could have a material effect on the condensed consolidated financial position or results of operations of the Company. ~~Excluding the $4,308,035 accrued for the ruling against Gamecock Media Europe, Ltd.,~~As of December 31, 2010, the Company has accrued an aggregate amount of ~~$2,314,650~~$2,376,153 related to such matters. The Company expenses legal costs as incurred in connection with a loss contingency.

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

~~SOUTHPEAK INTERACTIVE CORPORATION AND SUBSIDIARIES~~

~~Notes~~On September 3, 2010, the Company, Terry Phillips, the Company’s chairman, and Melanie Mroz, the Company’s CEO, received Wells Notices from the staff of the Securities and Exchange Commission advising that the staff will recommend to ~~Condensed Consolidated Financial Statements~~

~~(Unaudited)~~the Securities and Exchange Commission that cease and desist orders issue for alleged violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934 and Rules 12b-20 and 13a-13 adopted under this act. In addition, the staff has alleged violations by Mr. Phillips and Ms. Mroz of Rule 13b-2 and Rule 13a-14 by Ms. Mroz. These alleged violations result from the facts underlying the need to file an amended Form 10Q/A for the fiscal quarter ended March 31, 2009.

~~11.~~ ~~Production Advance Payable~~

~~On August 13, 2009,~~From time to time, the Company ~~entered into~~is subject to various claims and legal proceedings. If management believes that a ~~unit production financing agreement with~~loss arising from these matters is probable and can reasonably be estimated, the Company would record the amount of the loss, or the minimum estimated liability when the loss is estimated using a ~~producer relating to~~range, and no point within the production of certain games, of which the balance outstanding under this agreement was $3,755,104 at December 31, 2009. Production fees relating to this production advance for the three and six months ended December 31, 2009 totaled $375,658 and $575,604, respectively, and include the production fees of $160,000range is more probable than another. As additional information becomes available, any potential liability related to these matters is assessed and the ~~default status of the production advance, as described in the subsequent paragraph. These amounts~~estimates are included in interest expense on the accompanying statements of operations . As of December 31, 2009, accrued and unpaid production fees totaled approximately $565,000 and are included in accrued expenses and other current liabilities. The Company is obligated to pay approximately $103,000 of production fees for every month the full production advance is outstanding past its due date of November 14, 2009. Pursuant to the agreement, the Company has assigned to the producer a portion of the net revenues related to the sale of certain games in Europe.revised, if necessary.

The Company has failed to make the required payments under this agreement. Accordingly, the production advance payable is currently in default and is accruing production fees at $0.009 per unit (based upon 382,000 units) for each day after November 14, 2009 (approximately $160,000 through December 31, 2009). Pursuant to the terms of the production financing agreement, the producer is free to exercise any rights in connection with the security interests granted.

12. Gain on Settlement of Trades Payables

The gain on the settlement of trade payables at less than recorded values results from negotiations with various unsecured creditors for the settlement and payment of the trade payable at amounts less than that the recorded liability. For the ~~three months and~~ six months ended December 31, ~~2009,~~2010, the Company’s gain on settlement of trade payables was as follows:

	Trade Payables Settled		Other Assets Acquired/ Liabilities Assumed			Payments in Cash			Payments in Equity			Forgiveness of Debt		Net Trade Payables Settled		Other Assets Acquired/ Liabilities Assumed		Payments in Cash			Payments in Equity		Forgiveness of Debt

Vendor 1~~(1)~~	$	6,418,334	$	(1,422,334	)	$	(2,000,000	)	$	-		$	2,996,000	$	12,000	$	-	$	(10,000	)	$	-	$	2,000
Vendor 2~~(2)~~		250,000		-			(50,000	)		(104,500	)		95,500		1,064,848		-		(481,726	)		-		583,122
Vendor 3		232,347		-			(67,358	)		-			164,989
Total	$	6,900,681	$	(1,422,334	)	$	(2,117,358	)	$	(104,500	)	$	3,256,489
														$	1,076,848	$	-	$	(491,726	)	$	-	$	585,122

For the six months ended December 31, 2009, the Company’s gain on settlement of trade payable was as follows:

	Net Trade Payables Settled		Other Assets Acquired/ Liabilities Assumed			Payments in Cash			Payments in Equity			Forgiveness of Debt

Vendor 1(1)	$	6,418,334	$	(1,422,334	)	$	(2,000,000	)	$	-		$	2,996,000
Vendor 2(2)		250,000		-			(50,000	)		(104,500	)		95,500
Vendor 3		232,347		-			(67,358	)		-			164,989
	$	6,900,681	$	(1,422,334	)	$	(2,117,358	)	$	(104,500	)	$	3,256,489

12. Gain on Settlement of Trades Payables, Cont.

(1)

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

(2)

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

13. ~~Subsequent Events~~Additional Financial Statement Information

~~In February 2010, the Company, SouthPeak Interactive, L.L.C., and Gamecock were served with a complaint by TimeGate Studios, Inc., or TimeGate, alleging various breach of contract~~Accrued expenses and other ~~claims related to a publishing agreement,~~current liabilities consist of the following:

	December 31,		June 30,
	2010		2010

Accrued expenses	$	1,705,947	$	1,700,208
Reserve for marketing development funds (MDF)		446,141		344,210
Commissions		157,461		161,678
Guaranteed royalty payments		-		135,000
Accrued payroll and payroll taxes		153,442		266,740
Customer cash in advance deposits		117,786		31,793
Accrued interest		2,132,966		1,062,200
Other		163,880		79,882

	$	4,877,623	$	3,781,711

No other items accounted for greater than five percent of total current liabilities as of December 31, 2010 or ~~the Publishing Agreement, entered into between Gamecock and TimeGate in~~ June 2007. TimeGate is seeking the return of all past and future revenue generate from the videogame related to the Publishing Agreement, an injunction against the Company and its subsidiaries, damages to be assessed, and discretionary interest and costs. ~~The Company has no estimate at this time of its potential exposure and cannot, at this time, predict the outcome of this matter.~~ ~~The Company and its subsidiaries intend to vigorously defend all claims.~~30, 2010.

2623

~~REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM~~

~~To the Board of Directors and Shareholders of~~

~~SouthPeak Interactive Corporation~~

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

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

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

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

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company’s default on its production advance payable, a material uncertainty in connection with the renewal of its line of credit and significant contingencies raise substantial doubt about its ability to continue as a going concern. Management’s plans concerning these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

~~/s/ Reznick Group, P.C.~~

~~Vienna, Virginia~~

~~February 16, 2010~~

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes that appear elsewhere in this report and in our annual report on Form 10-K for the year ended June 30, ~~2009.~~2010.

This report includes forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements can be identified by the use of words such as “anticipate,” “believe,” “estimate,” “may,” “intend,” “expect,” “will,” “should,” “seeks” or other similar expressions. Forward-looking statements reflect our plans, expectations and beliefs, and involve inherent risks and uncertainties, many of which are beyond our control. You should not place undue reliance on any forward-looking statement, which speaks only as of the date made. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this report, ~~particularly~~and in “Risk Factors” in Item 1A of Part ~~II.~~I of our annual report on Form 10-K for the year ended June 30, 2010.

Going Concern

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

Overview

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

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

handheld platforms such as Nintendo DS, Nintendo DSi, Sony PSP, Sony PSPgo and Apple ~~iPhone;~~iPhone, game applications for the Next Generation NVIDIA® Tegra™ mobile processor used in Droid phones and tablets; and

personal computers.

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

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

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

Sources of Revenue

Revenue is primarily derived from the sale of software ~~titles~~video games developed on our behalf by ~~independent software developers~~third parties and ~~videogame studios.~~other content partnerships. Our unique business model of ~~globally~~ sourcing and developing creative product allows us to better manage our fixed costs relative to ~~our competition. In North America, we sell our videogames both to retailers and distributors, and in Europe, Australia and Asia, we primarily sell our videogames to distributors.~~industry peers.

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

Second Quarter ~~2010~~2011 Releases

We released the following videogames in the three months ended December 31, ~~2009:~~2010:

Title	Platform	Date Released
~~Horrid Henry~~Sled Shred	~~NDS,~~ Wii PC	10/~~30/09~~12/10
~~My Baby First Steps~~	~~NDS, Wii~~	~~11/3/09~~
~~Fast Food Panic~~Noah’s Ark	NDS	~~12/18/09~~11/2/10
~~Schrodinger’s Rat~~Nail’d	~~iPhone~~X360, PS3, PC	11/30/10
SBK X	X360, PS3, PC	12/~~23/09~~7/10
NewU Yoga & Pilates Workout	Wii	12/7/10

Cost of Goods Sold and Operating Expenses

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

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

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

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

General and Administrative Expenses. General and administrative expenses primarily represent personnel-related costs, including corporate executive and support staff, general office expenses, consulting and professional fees, and various other expenses. Personnel-related costs represent the largest component of general and administrative expenses. We expect that our personnel costs will increase as the business continues to grow. ~~Depreciation expense also~~

Gain on Settlement of Trade Payables. Gain on settlement of trade payables is ~~included~~the result of negotiations with various unsecured creditors for the settlement and payment of trade payables at amounts less than the recorded liability.

Change in ~~general~~Fair Value of Warrant Liability. Our senior secured convertible notes and ~~administrative expenses.~~certain warrants have been accounted for in accordance with applicable authoritative guidance for derivative instruments which requires identification of certain embedded features to be bifurcated from debt instruments and accounted for as derivative assets or liabilities. The derivative assets and liabilities are initially recorded at fair value and then at each reporting date, the change in fair value is recorded in the condensed consolidated statements of operations.

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

Critical Accounting Policies and Estimates

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

Our significant accounting policies are described in Note 1 to the accompanying condensed consolidated financial statements and in our annual report on Form 10-K for the year ended June 30, ~~2009.~~2010. The following accounting policies involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our consolidated financial condition and results of operations.

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

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

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

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

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

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

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

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

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

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

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

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

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

~~Some~~We have an arrangement pursuant to which we distribute videogames co-published with another company for a fee based on the gross sales of ~~our videogames provide limited online features at no additional cost~~the videogames. Under the arrangement, we bear the inventory risk as we purchase and take title to the ~~consumer. Generally,~~inventory, warehouse the inventory in advance of orders, ship the inventory and invoices its customers for videogame shipments. Also under the arrangement, we ~~consider such features to be incidental to~~bear the ~~overall product offering and an inconsequential deliverable. Accordingly, we recognize revenue related to videogames containing these limited online features upon~~credit risk as the transfer of title and risk of loss to our customer. In instances where online features or additional functionality are considered a substantive deliverable in addition to the videogame, we take this into account when applying our revenue recognition policy. This evaluation is performed for each videogame together with any online transactions, such as electronic downloads or videogame add-ons when it is released. When we determine that a videogame contains online functionality that constitutes a more-than-inconsequential separate service deliverable in addition to the videogame, principally because of its importance to game play, we consider that our performance obligations for this game extend beyond the delivery of the game. Fair valuesupplier does not ~~exist~~guarantee returns for the online functionality, as we do not separately charge for this component of the videogame. As a result, we recognize all of the revenue from the sale of the game upon the delivery of the remaining online functionality. In addition, we defer the costs of sales for this game and recognize the costs upon delivery of the remaining online functionality.

With respect to online transactions, such as electronic downloads of games or add-ons that do not include a more-than-inconsequential separate service deliverable, revenue is recognized when the fee is paid by the online customer to purchase online contentunsold videogames and we are ~~notified~~not reimbursed by the ~~online retailer that~~supplier in the ~~product has been downloaded. In addition, persuasive evidence~~event of non-collection. We record the gross amount of revenue under the arrangement as we are not acting as an ~~arrangement must exist, collection of~~agent for the ~~related receivable must be probable and~~principal in the ~~fee must be fixed and determinable.~~arrangement.

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

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

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

We account for equity instruments issued to non-employees in accordance with ~~accounting guidance surrounding stock compensation and equity-based payment for non-employees.~~ASC Topic 505, Equity, Subtopic 50, Equity-Based Payments to Non-Employees.

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

~~Business Combinations~~Amortizable Intangible Assets.~~. We~~ Intangible assets subject to amortization are carried at cost less accumulated amortization. Amortizable intangible assets consist of game sequels, non-compete agreements and distribution agreements. Intangible assets subject to amortization are amortized over the estimated useful life in proportion to the pattern in which the economic benefits are consumed, which for some intangibles assets are approximated by using the straight-line method. Long-lived assets including amortizable intangible assets are reviewed for impairment in accordance with ASC Topic 360, Property, Plant, and Equipment, whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset and its eventual disposition. Measurement of any impairment loss for long-lived assets and amortizable intangible assets is based on the amount by which the carrying value exceeds the fair value of ~~assets acquired, and liabilities assumed in a business combination. Our assessment of~~ the estimated fair value of each of these can have a material effect on our reported results as intangible assets are amortized over various lives. Furthermore, a change in the estimated fair value of an asset or liability often has a direct impact on the amount to recognize as goodwill, an asset that is not amortized. Often determining the fair value of these assets and liabilities assumed requires an assessment of expected use of the asset, the expected future cash flows related to the asset, and the expected cost to extinguish the liability. Such estimates are inherently difficult and subjective and can have a material impact on our financial statements.asset.

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

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

~~Potential Loss Contingencies.~~ Change in Fair Value of Warrant Liability~~From~~. We are required to classify the fair value of certain warrants issued as a liability, with subsequent changes in fair value to be recorded as income (loss) on change in fair value of warrant liability. The fair value of the warrants is determined using the Black-Scholes option pricing model and is affected by changes in inputs to that model including our stock price, expected stock price volatility, the contractual term, and the risk-free interest rate. Our estimate of the expected volatility is based on historical volatility. The expected term of the warrants is based on the time to time, the Company is subject to various claims and legal proceedings. If management believes that a loss arising from these matters is probable and can reasonably be estimated, the Company would record the amountexpiration of the ~~loss,~~warrants from the date of measurement. Risk-free interest rates are derived from the yield on U.S. Treasury debt securities. We will continue to classify the fair value of the warrants as a liability until the warrants are exercised, expired or ~~the minimum estimated liability when the loss is estimated using~~are amended in a ~~range, and~~way that would no ~~point within the range is more probable than another. As additional information becomes available, any potential liability related~~longer require these warrants to ~~these matters is assessed and the estimates are revised, if necessary.~~be classified as a liability.

Consolidated Results of Operations

The following table sets forth our results of operations expressed as a percentage of net revenues for the three months and six months ended December 31, ~~2009~~2010 and ~~2008:~~

2009:

	For the three months ended December 31,						For the six months ended December 31,
	2010			2009			2010			2009

Net revenues		100.0	%		100.0	%		100.0	%		100.0	%

Cost of goods sold:
Product costs		41.5	%		51.2	%		43.3	%		32.5	%
Royalties		44.2	%		16.1	%		36.3	%		24.7	%
Intellectual property licenses		1.3	%		0.9	%		2.2	%		0.8	%
Total cost of goods sold		86.9	%		68.2	%		81.8	%		58.0	%

Gross profit		13.1	%		31.8	%		18.2	%		42.0	%

Operating expenses (income):
Warehousing and distribution		3.8	%		3.2	%		3.9	%		2.3	%
Sales and marketing		13.0	%		22.0	%		21.0	%		21.9	%
General and administrative		28.0	%		29.6	%		45.2	%		22.8	%
Litigation costs		-	%		30.6	%		-	%		11.5	%
Gain on settlement of trade payables		-	%		(32.4)	%		(6.6)	%		(12.2)	%
Total operating expenses		44.8	%		53.0	%		63.6	%		46.3	%

Loss from operations		(31.7)	%		(21.2)	%		(45.4)	%		(4.3)	%

Other expenses (income):
Change in fair value of warrant liability		(20.5)	%		-	%		(34.4)	%		-	%
Interest and financing costs, net		16.7	%		5.1	%		25.9	%		3.0	%

Net loss		(27.9)	%		(26.3)	%		(36.9)	%		(7.3)	%

For the
three months ended
December 31,

For the
six months ended
December 31,

2009 2008 2009 2008

Net revenues 100.0 % 100.0 % 100.0 % 100.0 %

Cost of goods sold:
Product costs 51.2 % 40.1 % 32.5 % 48.1 %
Royalties 16.1 % 8.6 % 24.7 % 9.0 %
Intellectual property licenses 0.9 % 0.4 % 0.8 % 0.4 %
Total cost of goods sold 68.2 % 49.1 % 58.0 % 57.5 %

Gross profit 31.8 % 50.9 % 42.0 % 42.5 %

Operating expenses:
Warehousing and distribution 3.2 % 1.6 % 2.3 % 1.9 %
Sales and marketing 22.0 % 22.8 % 21.9 % 23.2 %
General and administrative 29.6 % 15.9 % 22.8 % 16.1 %
Restructuring costs - % 3.2 % - % 2.2 %
Transaction costs - % 0.1 % - % 0.1 %
Litigation costs 30.6 % - % 11.5 % - %
Gain on settlement of trade payables (32.4 )% - % (12.2 )% - %
Total operating expenses 53.0 % 43.6 % 46.3 % 43.4 %

(Loss) income from operations (21.2 )% 7.3 % (4.3 )% (0.9 )%

Interest expense, net 5.1 % 0.6 % 3.0 % 0.6 %

Net (loss) income (26.3 )% 6.7 % (7.3 )% (1.5 )%

Deemed dividend related to beneficial conversion feature on Series A convertible preferred stock - % 0.0 % - % 4.4 %
Net (loss) income attributable to common shareholders (26.3 )% 6.7 % (7.3 )% (5.9 )%

Three Months Ended December 31, ~~2009~~2010 and ~~2008~~2009

Net Revenues. Net revenues for the three months ended December 31, ~~2009~~2010 were ~~$10,063,952,~~$7,470,053, a decrease of ~~$7,244,922,~~$2,593,899, or ~~42%~~26%, from net revenues of ~~$17,308,874~~$10,063,952 for the three months ended December 31, ~~2008.~~2009. The decrease in net revenues was primarily driven by athe decrease in ~~the number of titles released, the product mix sold and a weaker than expected retail environment in~~units shipped during the three months ended December 31, ~~2009~~2010 versus the three months ended December 31, ~~2008.~~2009. For the three months ended December 31, ~~2009,~~2010, the number of videogame units sold decreased to approximately ~~645,000,~~464,000, a decrease of ~~approximately 125,000~~181,000 units from ~~the units~~645,000 sold in the prior period. Average net revenue per videogame unit sold ~~decreased 31%~~increased 3%, from ~~$22.48~~$15.60 to ~~$15.60~~$16.10 for the three months ended December 31, ~~2008~~2009 and ~~2009,~~2010, respectively. This average ~~decrease~~increase in price per unit is due to ~~the Company’s concentration on the My Baby brand and the~~ selling ~~of fewer~~more units for next generation platforms (Xbox 360, PlayStation 3), which have a higher Manufacturer’s Suggested Retail Price (“MSRP”), induring the three months ended December 31, ~~2009~~2010 versus the prior period.

Cost of Goods ~~Sold.~~Sold. Cost of goods sold for the three months ended December 31, ~~2009~~2010 decreased to ~~$6,868,356,~~$6,491,868, down ~~$1,631,194,~~$376,488, or ~~19%~~5%, from ~~$8,499,550~~$6,868,356 for the prior period. Product costs for the three months ended December 31, ~~2009~~2010 decreased ~~$1,790,177,~~$2,052,160, or ~~26%~~40%, from the comparable period in ~~2008.~~2009. This decrease was primarily driven by the ~~concentration on the My Baby brand, which is produced only for the Nintendo DS and Wii platforms and, accordingly, costs less to build. The~~ decrease in ~~product costs was offset by an increase in royalty expense.~~units shipped. The cost of royalty expense for the three months ended December 31, ~~2009~~2010 was ~~$1,618,962,~~$3,298,538, an increase of 8%104%, from royalty expense of ~~$1,492,259~~$1,618,962 for the three months ended December 31, ~~2008.~~2009. This increase is primarily attributable to ~~an increase in developer royalty agreements~~expense associated with the ~~European release~~sale of ~~Section 8~~our co-publishing games, Nail’d, SBK X, and ~~Horrid Henry.~~NewU Yoga & Pilates Workout.

Gross ~~Profit.~~Profit. For the three months ended December 31, ~~2009~~2010 and ~~2008,~~2009, gross profit decreased to $978,185 from $3,195,596, ~~from $8,809,324,~~ or ~~64%~~69%. Gross profit margin decreased to approximately ~~32%~~13% for the three months ended December 31, ~~2009~~2010 from ~~51%~~32% in the same period in ~~2008.~~2009. The decrease in gross profit is attributed to ~~selling fewer units for next generation platforms, which have a higher MSRP, in the three months ended December 31, 2009 versus the prior period.~~

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

~~Sales and Marketing Expenses.~~ For the three months ended December 31, 2009, sales and marketing expenses decreased 44% to $2,215,620 from $3,954,803 for the three months ended December 31, 2008. This decrease is primarily due to lower direct spending as a result of releasing fewerco-publishing titles during the three months ended December 31, ~~2009~~2010 versus the prior period. ~~The majority of marketing associated with the My Baby brand was expensed during~~

Warehousing and Distribution Expenses. For the three months ended ~~September 30,~~December 31, 2010 and 2009, warehousing and distribution expenses were $282,327 and $320,723, respectively, resulting in an decrease of 12%. This decrease is primarily attributed to the decrease in units produced and shipped.

Sales and Marketing Expenses. For the three months ended December 31, 2010, sales and marketing expenses decreased 56% to $974,498 from $2,215,620 for the three months ended December 31, 2009. This decrease is primarily due to our cost reduction strategy. Sales and marketing costs vary on a videogame by videogame basis depending on market conditions and consumer demand, and do not necessarily increase or decrease proportionate to sales volumes. Included in sales and marketing expenses for the three months ended December 31, 2009 and 2008 is a non-cash charge of $12,196 and $37,734, respectively, for stock options granted to vendors and other non-employees.

Gain on Settlement of Trade ~~Payables.~~Payables. For the three months ended December 31, 2010 and 2009, the gain on settlement of trade payables was $-0- and $3,256,489, which was the result of negotiations with various unsecured creditors for the settlement and payment of trade payables at amounts less than the recorded liability.

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

~~General and Administrative Expenses.~~ ~~For the three months ended December 31, 2009,~~2010, general and administrative expenses ~~increased $226,104~~decreased $882,862 to ~~$2,973,944~~$2,091,082 from ~~$2,747,840~~$2,973,944 for the prior period. Wages included in general and administrative expenses ~~increased~~decreased from ~~$687,724 for the three months ended December 31, 2008 to~~ $1,019,144 for the three months ended December 31, 2009 ~~an increase of 48%. Professional fees increased 40% from $452,830~~to $643,880 for the three months ended December 31, ~~2008 to~~2010, a decrease of 37%. Professional fees increased 41% from $632,714 for the three months ended December 31, 2009 ~~as a result of legal and accounting fees related~~ to ~~current litigation and costs associated with being a public company. Travel and entertainment expenses were $124,896~~$891,810 for the three months ended December 31, ~~2008,~~2010, as ~~compared to~~a result of legal fees associated with the successful resolution of the Nobilis litigation. Travel and entertainment expenses were $61,828 ~~for the three months ended December 31, 2009. Bad debt expense decreased 100% from $534,312 for the three months ended December 31, 2008 to $2,210~~ for the three months ended December 31, 2009, as ~~a result of bad debt incurred during~~compared to $71,580 for the ~~prior period.~~three months ended December 31, 2010. General and administrative expenses as a percentage of net revenues ~~increased,~~decreased, to approximately ~~30%~~28% for the three months ended December 31, ~~2009~~2010 from ~~16%~~30% for the prior period. In addition, for the three months ended December 31, ~~2009,~~2010, general and administrative expenses includes ~~$191,528~~$61,877 for noncash compensation related to employee stock options and restricted stock granted, ~~an increase~~a decrease of ~~$58,738,~~$129,528, or ~~44%~~68%, from the comparable period in ~~2008.~~2009.

~~Restructuring and Transaction Costs.~~ For the three months ended December 31, 2008, we incurred $560,806 in restructuring costs related to the Gamecock acquisition. These primarily consist of salaries and severance for Gamecock employees who separated from service after the Gamecock acquisition as part of restructuring Gamecock’s operations. For the three months ended December 31, 2008, we incurred $10,295 in costs related to the reverse acquisition. These costs included professional fees to accounting firms, law firms and advisors.

Operating ~~(Loss) Income~~Loss. For the three months ended December 31, ~~2009,~~2010, our operating loss was ~~$2,133,408, a decrease~~$2,369,722, an increase of ~~$3,400,008,~~$236,314, or ~~268%~~11%, over operating ~~income~~loss of ~~$1,266,600~~$2,133,408 for the prior period.

~~Interest~~Change in Fair Value of Warrant Liability. We are required to classify the fair value of certain warrants issued as a liability, with subsequent changes in fair value to be recorded as income (loss) on change in fair value of warrant liability. The fair value of the warrants is determined using the Black-Scholes option pricing model and ~~Financing Costs.~~ ~~For~~is affected by changes in inputs to that model including our stock price, expected stock price volatility, the contractual term, and the risk-free interest rate. This revaluation resulted in a gain of $1,531,323, which we recorded to operations during the three months ended December 31, 2009, interest and financing costs increased to $508,858 from $100,055 for the prior period due to an increase in average borrowings as a result of the increase in our accounts receivable as well as interest expense related to the production advance payable. The production advance payable is currently in default and is accruing production fees at $0.009 per unit (based upon 382,000 units) for each day after November 14, 2009 (approximately $160,000 through December 31, 2009).2010.

~~Net (Loss) Income~~Interest and Financing Costs. For the three months ended December 31, ~~2009,~~2010, interest and financing costs increased to $1,244,436 from $508,858 for the prior period due to due to amortization of debt issuance costs, interest attributed to the secured convertible debt, amortization of the secured convertible debt discount, and interest associated with the production advance payable. Amortization of debt issuance costs amounted to $135,186 for the three months ending December 31, 2010. Interest attributed to the secured convertible debt totaled $263,223 and amortization of the secured convertible debt discount was $361,563 for the three months ending December 31, 2010. Interest associated with the production advance payable totaled $294,018 for the three months ending December 31, 2010.

Net Loss. For the three months ended December 31, 2010, our net loss was ~~$2,642,266,~~$2,082,835, a decrease of ~~$3,808,811,~~$559,431, or ~~327%~~21%, over net ~~income~~loss of ~~$1,166,545~~$2,642,266 for the prior period.

Six Months Ended December 31, ~~2009~~2010 and ~~2008~~2009

Net Revenues. Net revenues for the six months ended December 31, ~~2009~~2010 were ~~$26,773,601, an increase~~$8,901,912, a decrease of ~~$1,077,024,~~$17,871,689, or 4%67%, from net revenues of ~~$25,696,577~~$26,773,601 for the ~~comparable period in 2008.~~six months ended December 31, 2009. The ~~increase~~decrease in net revenues was primarily driven by ~~the increased volume of~~a decrease in units ~~sold, which was partially offset by selling fewer units for next generation platforms, which have a higher MSRP, in~~produced and shipped during the six months ended December 31, ~~2009~~2010 versus the ~~prior period.~~six months ended December 31, 2009. For the six months ended December 31, ~~2009,~~2010, the number of videogame units sold ~~increased~~decreased to approximately 599,000, a decrease of 783,000 units from 1,382,000 ~~units, an 82,000 increase from 1,300,000 units~~ sold ~~for~~in the ~~comparable period in 2008.~~prior period. Average net revenue per videogame unit sold decreased 2%23%, from ~~$19.77~~$19.37 to ~~$19.37~~$14.86 for the six ~~month periods~~months ended December 31, ~~2008~~2009 and ~~2009,~~2010, respectively. This average decrease in price per unit is due to ~~selling fewer units for next generation platforms in~~ the ~~current~~sale of predominantly older titles during the six months ended December 31, 2010, which were marked down considerably, versus the prior period ~~as we focus on~~when the ~~My Baby brand, a Nintendo DS and Wii game. The decrease is also a result~~majority of the sales ~~discounts being higher than expected which is attributed to the difficult retail environment.~~incurred were comprised of new releases.

Cost of Goods ~~Sold.~~Sold. Cost of goods sold for the six months ended December 31, ~~2009 increased~~2010 decreased to ~~$15,535,373, up $757,369,~~$7,281,935, down $8,253,438, or 5%53%, from ~~$14,778,004~~$15,535,373 for the prior period. Product costs for the six months ended December 31, 2010 decreased $4,837,564, or 56%, from the comparable period in ~~2008. This increase is primarily attributed to an increase in royalty expense.~~2009. The cost of royalty expense for the six months ended December 31, ~~2009 increased $4,318,453, or 188%~~2010 was $3,231,430, a decrease of 51%, ~~to $6,619,633, which was driven by the release of Section 8, Horrid Henry, and My Baby First Steps. The increase in~~from royalty expense ~~was offset by a $3,669,044, or 30%, decrease in product costs~~of $6,619,633 for the six months ended December 31, ~~2009 when compared to the same period in 2008. The decrease in product costs was~~2009. These decreases were primarily driven by the ~~concentration on the My Baby brand, which is~~decrease in units produced ~~only for the Nintendo DS~~ and ~~Wii platforms and costs less to build.~~sold.

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

~~Warehousing and Distribution Expenses.~~ For the six months ended December 31, 2010 and 2009, gross profit decreased to $1,619,977 from $11,238,228, or 86%. Gross profit margin decreased to approximately 18% for the six months ended December 31, 2010 from 42% in the same period in 2009. The decrease in gross profit is attributed to high royalty costs attributed to the sale of co-publishing titles as well as lower selling price due to the sale of older titles during the six months ended December 31, 2010 versus the prior period.

Warehousing and ~~2008,~~Distribution Expenses. For the six months ended December 31, 2010 and 2009, warehousing and distribution expenses were ~~$607,234~~$348,416 and ~~$476,563,~~$607,234, respectively, resulting in ~~an increase~~a decrease of ~~27%~~43%. This ~~increase~~decrease is ~~due~~ primarily attributed to ~~increase~~the significant decline in units ~~shipped~~produced and ~~units currently being held at our third party warehouse when compared to 2008.~~shipped.

Sales and Marketing Expenses. For the six months ended December 31, ~~2009,~~2010, sales and marketing expenses decreased 1%68% to ~~$5,870,676~~$1,871,169 from ~~$5,950,539~~$5,870,676 for the ~~comparable period~~six months ended December 31, 2009. This decrease is primarily due to our cost reduction strategy as well as the decrease in ~~2008.~~the number of new titles released during the six months ended December 31, 2010 versus the prior period. Sales and marketing costs vary on a videogame by videogame basis depending on market conditions and consumer demand, and do not necessarily increase or decrease proportionate to sales volumes. Included in sales and marketing expenses for the six months ended December 31, ~~2009~~2010 and ~~2008~~2009 is a non-cash charge of ~~$39,818~~$9,509 and ~~$75,468,~~$39,818, respectively, for stock options granted to vendors and other non-employees.

Gain on Settlement of Trade ~~Payables.~~Payables. For the six months ended December 31, 2010 and 2009, the gain on settlement of trade payables was $585,122 and $3,256,489, which was the result of negotiations with various unsecured creditors for the settlement and payment of trade payables at amounts less than the recorded liability.

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

~~General and Administrative Expenses.~~ ~~For the six months ended December 31, 2009,~~2010, general and administrative expenses ~~increased 48%~~decreased $2,065,315 to ~~$6,088,712~~$4,023,397 from ~~$4,128,265~~$6,088,712 for the ~~comparable period in 2008.~~prior period. Wages included in general and administrative expenses ~~increased~~decreased from ~~$1,276,583 for the six months ended December 31, 2008 to~~ $1,981,694 for the six months ended December 31, 2009 ~~an increase of 55%. Professional fees increased 178% from $688,320~~to $1,360,447 for the six months ended December 31, ~~2008 to~~2010, a decrease of 31%. Professional fees decreased 45% from $1,910,561 for the six months ended December 31, 2009 ~~as a result of legal and accounting fees related~~ to ~~current litigation and costs associated with being a public company. Travel and entertainment expenses were $209,499~~$1,044,865 for the six months ended December 31, ~~2008, decreasing 45% to~~2010, as a result of prior period litigation costs and accounting fees. Travel and entertainment expenses were $115,151 for the six months ended December 31, ~~2009.~~2009, as compared to $150,144 for the six months ended December 31, 2010. General and administrative expenses as a percentage of net revenues increased, to approximately ~~23%~~45% for the six months ended December 31, ~~2009~~2010 from ~~16%~~23% for the ~~same period in fiscal year 2009.~~prior period. In addition, for the six months ended December 31, ~~2009,~~2010, general and administrative expenses includes ~~$320,102~~$204,774 for noncash compensation related to employee stock options and restricted stock granted, ~~an increase~~a decrease of ~~$53,065,~~$115,328, or ~~20%~~36%, from the comparable period in ~~2008.~~2009.

~~Restructuring and Transaction Costs:~~ For the six months ended December 31, 2008, we incurred $560,806 in restructuring costs related to the Gamecock acquisition. These primarily consist of salaries and severance for Gamecock employees who separated from service after the Gamecock acquisition as part of restructuring Gamecock’s operations. For the six months ended December 31, 2008, we incurred $28,675 in costs related to the Acquisition. These costs included professional fees to accounting firms, law firms and advisors.

Operating ~~(Loss) Income~~Loss. For the six months ended December 31, ~~2009,~~2010, our operating loss ~~increased 407% to $1,147,111 from~~was $4,037,883, an increase of $2,890,772, or 252%, over operating loss of ~~$226,275~~$1,147,111 for the prior period.

Change in Fair Value of Warrant Liability. We are required to classify the fair value of certain warrants issued as a liability, with subsequent changes in fair value to be recorded as income (loss) on change in fair value of warrant liability. The fair value of the warrants is determined using the Black-Scholes option pricing model and is affected by changes in inputs to that model including our stock price, expected stock price volatility, the contractual term, and the risk-free interest rate. This revaluation resulted in a gain of $3,062,646, which we recorded to operations during the six months ended December 31, 2010.

Interest and Financing ~~Costs.~~Costs. For the six months ended December 31, ~~2009,~~2010, interest and financing costs increased to ~~$808,174~~$2,308,532 from ~~$158,934~~$808,174 for the prior ~~year~~ period due to ~~an increase in average borrowings as a result~~amortization of debt issuance costs, interest attributed to the secured convertible debt, amortization of the ~~increase in our accounts receivable as well as~~secured convertible debt discount, and interest ~~expense related to~~associated with the production advance payable. ~~The~~Amortization of debt issuance costs amounted to $201,278 for the six months ending December 31, 2010. Interest attributed to the secured convertible debt totaled $413,416 and amortization of the secured convertible debt discount was $723,125 for the six months ending December 31, 2010. Interest associated with the production advance payable ~~is currently in default and is accruing production fees at $0.009 per unit (based upon 382,000 units)~~totaled $572,878 for ~~each day after November 14, 2009 (approximately $160,000 through~~the six months ending December 31, ~~2009).~~2010.

Net Loss. For the six months ended December 31, ~~2009,~~2010, our net loss ~~increased 408% to $1,955,285 from a~~was $3,283,769, an increase of $1,328,484, or 68%, over net loss ~~of $385,209 in~~was $1,955,285 for the prior period.

Quarterly Operating Results Not Meaningful

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

Liquidity and Capital Resources

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

attempting to expeditiously resolve our contingencies for amounts significantly less than currently accrued for in order to reduce aggregate liabilities on our balance sheet on payments terms manageable by us;

seeking the renewal of our line of credit with SunTrust Bank, Inc., or SunTrust, and/or obtaining alternative or additional financing in order to address the month to month nature of our current line of credit; and

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

While the Company is committed to pursuing these options and others to address its viability as a going concern, there can be no assurance that these plans will be successfully completed; and therefore, there is uncertainty about the Company’s ability to realize its assets or satisfy its liabilities in the normal course of business (See Item 1A, “Risk Factors” of Part II of this report).

Our primary cash requirements have been to fund (i) the development, manufacturing and marketing of our videogames, (ii) working capital, and (iii) capital expenditures. Historically, we have met our capital needs, including working capital, capital expenditures and commitments, through our operating activities, our ~~line of~~ credit arrangements, through the sale of our equity securities, and, prior to the reverse acquisition, loans from related parties and our shareholders. At this time, however, execution of management’s plan to maintain our viability as a going concern is necessary for us to continue to fully fund our cash requirements from operations. If we are unable to negotiate a significant reduction to our contingencies or we cannot renew our line of credit or obtain other financing on acceptable terms, cash from our operations will not be sufficient to fund our obligations as they come due. Our cash and cash equivalents were ~~$658,609~~$78,631 at December 31, ~~2009~~2010 and ~~$648,311~~$92,893 at June 30, ~~2009.~~2010.

Factoring Agreement. On July 12, 2010, we entered into a factoring agreement (the “Factoring Agreement”) with Rosenthal & Rosenthal, Inc. (“Rosenthal & Rosenthal”). Under the Factoring Agreement, we agreed to sell receivables arising from sales of inventory to Rosenthal & Rosenthal. Under the terms of the Factoring Agreement, we are selling all of our receivables to Rosenthal & Rosenthal. For the approved receivables, Rosenthal & Rosenthal will assume the risk of collection. We have agreed to pay Rosenthal & Rosenthal a commission of .60% of the amount payable under all of our invoices to most of our customers against a minimum commission of $30,000 multiplied by the number of months in a contract period, with the first period being 12 months and the second 7 months. All payments received by Rosenthal & Rosenthal are payable to us after amounts due to Rosenthal & Rosenthal are satisfied. Under the Factoring Agreement, we have the right to borrow against payments due us at the rate of 65% of credit approved receivables. The borrowing rate against non-credit approved receivables is subject to negotiation. The interest rate on borrowings is equal to the greater of prime plus 1.5% per annum or 6.5% per annum. A $10,000,000 loan cap applies against our borrowings, which is subject to an increase of up to $3,000,000 if shareholders’ equity increases. The initial term of the Factoring Agreement ends on February 28, 2012. At December 31, 2010, $864,902 was due to Rosenthal & Rosenthal under the Factoring Agreement.

~~Line of Credit~~. We have a line of credit with SunTrust that matured on December 31, 2009 and has been extended on a month to month basis. The line of credit bears interest at prime plus ½%, which was 3.75% at December 31, 2009. Availability under the line of credit is restricted to 65% of our eligible accounts receivable plus $500,000. The line of credit is primarily secured by our accounts receivable. The line of credit is further secured by the personal guarantees and pledge of personal securities and assets, of two of our shareholders and certain of their affiliates. At December 31, 2009, we were in compliance with all of the line of credit’s covenants and requirements. We are currently negotiating a renewal of our line of credit, however, there are no assurances that the line of credit will be renewed or renewed at terms that are acceptable to us.

At December 31, 2009 and June 30, 2009, the outstanding line of credit balance was $5,310,732 and $5,349,953, respectively, and the remaining available under the line of credit amounted to $49,796 and $-0-, respectively.

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

At December 31, ~~2009~~2010 and June 30, ~~2009,~~2010, amounts due from our three largest customers comprised approximately ~~43%~~61% and ~~52%~~54% of our gross accounts receivable balance, respectively. We believe that the receivable balances from these largest customers do not represent a significant credit risk based on past collection experience, although we actively monitor each customer’s credit worthiness and economic conditions that may impact our customers’ business and access to capital. We continue to monitor the lagging economy, the global contraction of credit markets and other factors as they relate to our customers in order to manage the risk of uncollectible accounts receivable.

~~Preferred Stock~~Senior Secured Convertible Notes. On July 16, 2010, we entered into a Securities Purchase Agreement with CNH Diversified Opportunities Master Account, L.P., CNH CA Master Account, L.P., AQR Diversified Arbitrage Fund and Terry Phillips, our chairman, for the sale of $5,500,000 of senior secured convertible notes (the “Initial Notes”) and related warrants. Mr. Phillips’ Initial Note was issued in exchange for a junior secured convertible note originally issued to him on April 30, 2010. We received $5,000,000 in cash for $5,000,000 of the senior secured convertible notes and exchanged a $500,000 prior junior secured convertible note for $500,000 of the senior secured convertible notes.

On August 31, 2010, we entered into an Amended and Restated Securities Purchase Agreement, pursuant to which we sold an aggregate of $2,000,000 of a new series of senior secured convertible promissory notes (the “Additional Notes”) to AQR Opportunistic Premium Offshore Fund, L.P., Advanced Series Trust, solely on behalf of the AST Academic Strategies Asset Allocation Portfolio, and Terry Phillips, our chairman. We received $2,000,000 in cash for $2,000,000 of the Additional Notes, of which $200,000 was paid by Mr. Phillips.

On December 31, 2010, we failed to make a timely payment of interest required under its secured convertible notes (the “Notes”). ~~During~~Such failure triggered a default provision under the ~~fourth quarter~~Notes following a seven day cure period. On February 16, 2011, we entered into a Waiver and Forbearance Agreement (each, a “Waiver Agreement” and collectively, the “Waiver Agreement”) with the holders of ~~fiscal year 2008~~the Notes. Pursuant to the Waiver Agreements, the holders of the Notes waived their rights of redemption and remedies regarding our failure to have paid the required interest and agreed to forbear from exercising all remedies available in connection with such failure until March 15, 2011. Pursuant to the Waiver Agreement, we are not required to pay the required interest until March 15, 2011 and the ~~first half of fiscal year 2009, we sold 14,563,833 shares of preferred stock valued at $14,563,833, which provided additional liquidity~~interest rates under the Notes increase to ~~fund our continued growth through investment in videogame development.~~15% and 29%, as applicable, from December 31, 2010 to March 15, 2011.

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

Although there can be no assurance, we believe our current cash and cash equivalents and projected cash flow from operations, along with availability under our factoring line and Wells Fargo agreement, will provide us with sufficient liquidity to satisfy our cash requirements for working capital, capital expenditures and commitments through at least the next 12 months. Our belief is based upon the revenues we anticipate generating from two video games, many of our creditors are providing us with concessions on payment terms and we have, but for one litigation claim, limited exposure within the next 12 months, for the litigation in which we are involved. In addition, if we were unable to fully fund our cash requirements through current cash and cash equivalents and projected cash flow from operations, we would need to obtain additional financing through a combination of equity and debt financings. If any such activities become necessary, there can be no assurance that we would be successful in obtaining additional financing. In their report on our audited financial statements for the year ended June 30, 2010, our independent registered public accounting firm included an explanatory paragraph regarding concerns about our ability to continue as a going concern. See "Note 1. Summary of Significant Accounting Policies- Going Concern" to our condensed consolidated financial statements included elsewhere in this report for additional information.

Cash Flows.We expect that we will make expenditures relating to advances on royalties to third-party developers to which we have made commitments to fund. Cash flows from operations are affected by our ability to release successful titles. Though many of these titles have substantial royalty advances and marketing expenditures, once a title recovers these costs, incremental net revenues typically will directly and positively impact cash flows. However, if sales projections or the release schedule dates do not meet our forecast, this could have a negative impact on our cash flows.

For the six months ended December 31, 2010 we had net cash used in operating activities of $1,724,228, and in 2009 we had net cash provided by operating activities of ~~$6,932, and~~$6,932.

During the six months ended December 31, 2010, investing activities resulted in ~~2008 we had~~ net cash used ~~in operating activities $6,822,255.~~

~~During~~of $16,737 and during the six months ended December 31, 2009, investing activities resulted in net cash provided of ~~$330,438 and during the six months ended December 31, 2008, investing activities resulted in net cash used of $469,122.~~$330,438. The cash provided was a result of the increase in restricted cash during the six months ended December 31, 2009.

During the six months ended December 31, 2010, financing activities resulted in net cash provided of $1,957,992 and during the six months ended December 31, 2009, financing activities resulted in net cash used of ~~$417,319 and during the six months ended December 31, 2008, financing activities resulted in net cash provided of $3,589,922.~~$417,319.

The Gamecock acquisition along with our various contingencies have caused a strain on our cash flows, as we have needed to fund the payment of certain liabilities Gamecock incurred prior to the Gamecock acquisition and pay certain amounts in settlement of our contingencies. This strain on cash flows has limited our ability to fund additional production of videogames. In particular, our Chairman, Terry Phillips, advanced $307,440 to us in order to fund the production of additional cartridges for a particular videogame. The advance was unsecured, payable on demand and non-interest bearing. At June 30, 2009, the amount due was $232,440. Subsequent to June 30, 2009, the amount was repaid.

International ~~Operations.~~ Operations. Net revenue earned outside of North America is principally generated by our operations in Europe, Australia and Asia. For the three months ended December 31, 2010 and 2009, approximately 4% and ~~2008, approximately~~ 27% ~~and 4%~~, respectively, of our net revenue was earned outside of the U.S. We are subject to risks inherent in foreign trade, including increased credit risks, tariffs and duties, fluctuations in foreign currency exchange rates, shipping delays and international political, regulatory and economic developments, all of which can have a significant impact on our operating results.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

For quantitative and qualitative disclosures about market risk, see Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” of our annual report on Form 10-K for the year ended June 30, ~~2009.~~2010. Our exposures to market risk have not changed materially since June 30, ~~2009.~~2010.

Item ~~4T.~~4. Controls and Procedures

Restatement of Previously Issued Financial Statements

On September 11, 2009, we filed an amendment to our quarterly report on Form 10-Q for the quarter ended March 31, 2009 with the Securities Exchange Commission (the “SEC”) to restate our previously issued financial statements included in the report. In connection with ~~the~~that filing, ~~of our Form 10-Q/A with the SEC on September 11, 2009,~~ during the first fiscal quarter of 2010, management reevaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, ~~or the Exchange Act.~~(the “Exchange Act”)). Based on that reevaluation, ~~the Chief Executive Officer,~~our chief executive officer, who iswas then also serving as our interim ~~Chief Financial Officer,~~chief financial officer, and in consultation with our ~~Chairman,~~chairman, concluded that ~~the~~ our disclosure controls and procedures were not effective as of March 31, 2009 as a result of ~~the following~~a number of material ~~weaknesses~~weakness in our internal control over financial ~~reporting.~~reporting, all of which, other than as set forth in the following paragraph, were remediated during the fiscal year ended June 30, 2010 and disclosed in our Form 10-K for such period.

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

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

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

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

Evaluation of Disclosure Controls and Procedures

An evaluation was carried out under the supervision and with the participation of our management, including our ~~Chief Executive Officer, who is also serving as~~chief executive officer and our ~~interim Chief Financial Officer,~~chief financial officer, and in consultation with our ~~Chairman and our interim Chief Accounting Officer,~~chairman, of the effectiveness of the design and operation of our disclosure controls and procedures, to ensure that the information required to be disclosed by us in this quarterly report was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and Form 10-Q and that such information required to be disclosed was accumulated and communicated to management, including our ~~Chief Executive Officer~~chief executive officer and our ~~Chief Financial Officer,~~chief financial officer, to allow timely decisions regarding required disclosure. Based upon this reevaluation, our ~~Chief Executive Officer, who is also serving as~~chief executive officer and our ~~interim Chief Financial Officer,~~chief financial officer, concluded that our disclosure controls and procedures were not effective as of December 31, ~~2009~~2010 as a result of the ~~previously identified~~ material ~~weaknesses~~weakness in our internal control over financial ~~reporting.~~reporting identified in the paragraph above.

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

Changes in Internal Control over Financial Reporting

As discussed above, as of ~~June 30, 2009,~~December 31, 2010, we had a material ~~weaknesses~~weakness in our internal control over financial reporting.

In addition to the remediation measures described below under the heading “Remediation Steps to Address Material Weakness,” we have made the following changes to address the previously reported material weaknesses in internal control over financial reporting and disclosure controls and procedures:

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

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

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

~~Remediation Steps to Address Material Weakness~~

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

we ~~have hired an interim Chief Accounting Officer~~did appoint a chief financial officer with the requisite experience in internal accounting in the videogame industry and made other related personnel ~~changes;~~changes to improve our internal controls;

we ~~have provided training~~engaged external consultants to backfill duties and controls performed by the chief financial officer upon her exit from our ~~management and accounting personnel regarding established controls and procedures for related party transactions;~~company;

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

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

we have ~~had communications with our employees regarding ethics~~made staff changes so that the accounting persons responsible for the preparation of external reporting, including public filings, are qualified accountants who stay abreast of new requirements through subscriptions and training. New pronouncements are summarized and reported to accounting staff, management and the ~~availability of our internal fraud hotline.~~

audit committee as appropriate; and

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

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

we ~~are enhancing~~continue to communicate and enforce all policies and procedures ~~and documentation supporting~~relating to purchasing for our ~~accruals; and~~company.

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

In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law. This legislation includes an exemption for companies with less than $75 million in market capitalization (non-accelerated filers) to Section 404(b) of the Sarbanes-Oxley Act of 2002, which requires an external auditor’s report on the effectiveness of a registrant’s internal control over financial reporting. The SEC has not published a final rule on this new law. We are in the process of determining the effects, if any, of this new law.

Remediation Steps to Address Material Weakness

During the quarter ended December 31, 2010, we continued to remediate the remaining material weakness in our internal controls over financial reporting by putting in effect further additional controls to restrict access to our automated accounting system and restricting access to our automated accounting system to only those employees under the direct supervision of our Chief Executive Officer.

Management anticipates that the actions described above and the resulting improvements in controls will strengthen its internal control over financial reporting relating to the preparation of the condensed consolidated financial ~~statements and will remediate the material weakness identified by the end of our fiscal year 2010.~~statements. As we improve our internal control over financial reporting and implement remediation measures, we may supplement or modify the remediation measures described above. Management is committed to implementing effective control policies and procedures and will continually update our Audit Committee as to the progress and status of our remediation efforts to ensure that they are adequately implemented.

PART II

Item 1. Legal Proceedings

~~On March 12, 2009,~~In September 2010, we ~~along with Gamecock, SouthPeak Interactive, Ltd.~~instituted summary proceedings in the Lyon France Commercial Court against Nobilis Group in which we have alleged the Licensing and ~~Gamecock Media Europe, Ltd.,~~Distribution Agreements for the games we were ~~served with a complaint by CDV alleging various breach of contract~~to obtain and ~~other claims related to a publishing and distribution agreement, or~~have obtained from Nobilis, including the ~~Distribution Agreement, entered into between Gamecock Media Europe, Ltd. and CDV in January 2008. CDV is~~My Baby games, were wrongfully terminated. We are seeking the ~~return~~reinstatement of ~~$4,590,000 in videogame development advances,~~the agreements and damages associated with the actions of Nobilis. Following a hearing on October 26, 2010, the court rendered a temporary summary judgment reinstating the agreement for My Baby First Steps and ordered Nobilis to advise Nintendo to build all products pursuant to the My Baby First Steps contract, which includes the My Baby First Steps game and an ~~injunction~~additional fourteen games. On December 7, 2010, the court confirmed its reinstatement of the agreement and that Nobilis’ termination of the agreement was null and void.

On September 3, 2010, we, Mr. Phillips, our chairman, and Melanie J. Mroz, our CEO, received Wells Notices from the staff of the SEC (the “Staff”) advising that the staff will recommend that the SEC institute a cease and desist proceeding against us and Ms. Mroz with respect to our ~~subsidiaries,~~alleged violations of Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act and certain rules adopted thereunder, and bring a civil injunctive action against Mr. Phillips for abiding and abetting the foregoing violations of our company. In addition, the Staff intends to recommend that, in the civil action, the SEC seek a civil penalty against Mr. Phillips. These alleged violations result from the facts underlying then need to file an amended quarterly report on Form 10-Q for the fiscal quarter ended March 31, 2009.

In October 2010, BVT Games Fund IV Dynamic GmbH & Company (“Fund IV”), an investment fund based in Germany that finances the development of video games, filed suit against us in the Regional Court in Munich, Germany to recover funds advanced to us to manufacture two titles which a sister fund, BVT Games Fund III Dynamic GmbH & Company (“Fund III”), had financed. A distribution agreement existed for these titles with Phillips Sales, Inc. (“Phillips Sales”) and not us although we had guaranteed the obligations of Phillips Sales. In this litigation, Fund IV is seeking €3,115,341 (approximately USD $4.1 million) plus interest. We are actively contesting this litigation and believe that we have multiple defenses. The liability associated with the production advance is reflected in our condensed consolidated financial statements.

In November 2010, we first learned that III had obtained a judgment against us in the Regional Court in Munich, Germany, seeking payments of approximately ~~$650,000 in specified damages, further damages~~€2,300,000 (approximately USD $3.0 million) due under the above-referenced distribution agreement. Prior to gaining such knowledge, Fund III served upon our then chief financial officer, as required by law, what was supposed to be ~~assessed, and discretionary interest and costs. Gamecock Media Europe, Ltd. filed~~the English translation of the lawsuit which Fund III had filed. Instead, Fund III served upon us a ~~counterclaim against CDV for $950,000 and discretionary interest and costs, resulting~~translation of the Fund IV lawsuit that Fund IV intended to serve on us. Because we knew of the filing of the Fund IV case before being properly served with that case, we had already engaged German counsel to represent our interests in the Fund IV case. Since German counsel’s representation had been noted in the Fund IV case, counsel was awaiting notice from videogame sales and the achievement of a milestone under the Distribution Agreement. The hearing for both CDV’s claims and Gamecock Media Europe’s counterclaim concluded on July 22, 2009. On November 20, 2009, the court issued its ruling in which some of CDV’s claims were upheld and some were denied. Additionally, Gamecock Media Europe, Ltd.’s counterclaim was dismissed. The court awarded CDV approximately $3.8 million plus interest and legal expenses. ~~This amount, plus interest and legal expenses, represents the full amount~~or opposing counsel that service of the ~~judgment against Gamecock and its subsidiary. Of this judgment, SouthPeak Interactive Corporation is also liable for legal expenses.~~

~~On October 27, 2008, Gamecock~~Fund IV case had occurred. Therefore, when the Fund III case was served with a demand for arbitration by a developer alleging various breaches of contract related to a publishing agreement entered into between Gamecock and the developer on December 12, 2007. The developer is seeking an award of $4,910,000, terminationtranslation of the ~~agreement, exclusive control~~Fund IV case, we took no action since we believed this matter was already in the hands of our attorney. The failure to respond resulted in a default judgment in the Fund III case for which no proper translation has yet been received. Because of this error in translation, we are seeking to have the judgment vacated and believes we will be successful in this regard. We are of the ~~subject videogame,~~opinion when, and ~~discretionary interest~~if, we are required to defend the litigation, that we have strong defenses to assert, including that Phillips Sales is not obligated to Fund III thereby avoiding our guaranty obligation. We cannot predict the potential outcome. No amounts have been recorded in our condensed consolidated financial statements in connection with the liability underlying the claim.

In November 2010, in connection with the Circuit City Stores, Inc. (“Circuit City”) bankruptcy proceedings, the Trustee of the Circuit City Liquidating Trust filed a lawsuit against us in United States Bankruptcy Court in the Eastern District of Virginia for the avoidance of payments totaling $1,155,300 as allegedly preferential transfers paid to us during the 90 days preceding the filing of the bankruptcy petition of Circuit City on November 10, 2008. We believe that we have meritorious defenses to these avoidance actions, intend to vigorously defend against them and ~~costs. Gamecock has responded stating~~believe that the ~~developer’s attempts to terminate the publishing Agreement constitute wrongful termination~~likelihood of the agreement and breach of the agreement. Gamecock has also filed a counterclaim against the developer seeking the return of approximately $5.9 million in advances on royalties in the event the publishing agreementavoidance actions prevailing is terminated. The developer has filed a supplemental demand for arbitration concerning royalty payments due under a separate publishing agreement and is seeking an award of $41,084. An arbitration scheduled for January 2010 has been postponed and a new date hasremote. Accordingly, we have not ~~been set. As of December 31, 2009, the Company has~~ accrued ~~sufficient amounts to cover anticipated liabilities~~any loss reserve related to this ~~matter.~~ claim.

On January 26, 2011, Codemasters Group Holdings Limited (“Codemasters”) filed suit against us in the United States District Court for the Eastern District of Virginia, Richmond Division, seeking to enforce a settlement agreement under which Codemasters claims that $1,265,000 is due. No answer has yet been filed. We recognize our liability to Codemasters which has been recorded on our books but believe we are entitled to certain credits which Codemasters has not reflected in its lawsuit. It is our intent to try to resolve this matter with Codemasters.

Other than the foregoing, ~~we are not currently subject to~~there have been no material development in any material legal proceedings. From time to time, however, we are named as a defendant in legal actions arising from our normal business activities. Although we cannot accurately predict the amount of our liability, if any, that could arise with respect to legal actions currently pending against us, we do not expect that any such liability will have a material adverse effect on our consolidated financial position, operating results or cash flows. We believe that we have obtained adequate insurance coverage, rights to indemnification, or where appropriate, have established reserves in connection with these legal proceedings.

Item 1A. Risk Factors

“Item 1A. Risk Factors” of our annual report on Form 10-K for the year ended June 30, ~~2009~~2010 includes a discussion of our risk factors. ~~There~~Except as presented below, there have been no material changes to risk factors as previously disclosed in our annual report on Form 10-K filed with the Securities and Exchange Commission on October 13, ~~2009.~~2010.

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

~~Our independent registered public accounting firm noted in their review report accompanying our consolidated balance sheet~~We have a history of ~~December 31, 2009~~operating losses and ~~the related consolidated statements of operations and~~negative cash flows ~~for~~from operating activities and we anticipate such losses and negative cash flows in future reporting periods. Unless we are able to generate operating profits and positive cash flows from operating activities, we may not be able to continue operations in the ~~three-month and six-month periods~~manner we have in the past, or at all.

For the six months ended December 31, 2010 and for the fiscal years 2010 and 2009, our operating losses were $4,037,883, $4,205,300 and ~~2008 that~~$11,807,405, respectively, and negative cash flows from operating activities were $1,724,228, $961,475 and $3,251,878. We expect operating losses and negative cash flows from operating activities to continue in future reporting periods and to possibly increase from current levels if we increase expenditures for sales and marketing, license fees and general business enhancement to support efforts to grow our ~~default~~business. Increase in on-going operating expenses would require us to generate significant revenues to achieve profitability. Consequently, we cannot predict when we would achieve profitability. Even if we do achieve profitability, we may not sustain or increase profitability on a ~~production advance payable,~~quarterly or annual basis in the ~~material uncertainty~~future. If we are unable to achieve or sustain profitability in ~~connection with~~ the ~~renewal of our line of credit and our significant contingencies raise substantial doubt about our ability~~future, we may be unable to continue ~~as a going concern. Management plans~~our operations in the manner we have in the past, or all.

We are exposed to ~~maintain our viability as a going concern by:~~

~~attempting to expeditiously resolve our contingencies for amounts significantly less than currently accrued for in order to reduce aggregate~~legal proceedings and contingent liabilities that could result in material liabilities ~~on our balance sheet on payment terms manageable by us;~~

~~seeking the renewal of our line of credit with SunTrust and/or obtaining alternative or additional financing in order to address the month to month nature of our current line of credit; and~~

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

~~Although management is confident~~ that we ~~will be able to renew our line~~have not reserved against and the incurrence of ~~credit and implement the other aspects of this plan, we cannot assure you that the plan will be successful. This doubt about our ability to continue as a going concern~~which could adversely affect our ~~ability~~results of operations or significantly harm our business.

We are a party to ~~obtain additional financing~~various legal proceedings described in Part II, Item 1. Legal Proceedings and are subject to certain important contingent liabilities described more fully under the caption “Contingencies” in the notes to our condensed consolidated financial statements included in this report. If one or more of these legal proceedings or contingent liabilities, or others that may later arise, were to be resolved in a manner adverse to us, we could suffer losses that are material to our business, results of operations and financial condition. We have established reserves for these contingent liabilities, and certain of these contingent liabilities, if resolved at ~~favorable terms, if at all, as such an opinion may cause investors~~levels exceeding the reserved amounts, could have a material adverse effect on our business, results of operations and financial condition in addition to the effect of any potential monetary judgment or sanction against us. Furthermore, any legal proceedings, regardless of the outcome, could result in substantial costs and diversion of resources that could have ~~reservations about~~a material adverse effect on our ~~long-term prospects,~~business, results of operations, and ~~may adversely affect our relationships with customers. If we cannot successfully continue as a going concern, our stockholders may lose their entire investment in us.~~

financial condition.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. (Removed and Reserved)

Item 5. Other Information

~~Subsequent Events~~On February 16, 2011, the Company entered into a Waiver and Forbearance Agreement (each, a “Waiver Agreement” and collectively, the “Waiver Agreements”) with the holders of the Notes (see Note 6). Pursuant to the Waiver Agreements, the holders of the Notes waived their right of redemption and remedies regarding the Company’s failure to have paid the required interest and agreed to forbear from exercising all remedies available in connection with such failure until March 15, 2011. Pursuant to the Waiver Agreement, we are not required to pay the required interest until March 15, 2011 and the interest rates under the Notes increase to 15% and 29%, as applicable, from December 31, 2010 to March 15, 2011. The description of the Waiver Agreements and the terms thereof are qualified in their entirety to the full text of the form of Waiver Agreements, which is filed as an exhibit hereto and incorporated herein by reference.

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

4038

Item 6. Exhibits

Exhibit
Number		Exhibit

3.1(1)		Amended and Restated Certificate of Incorporation.
3.2(1)		Amended and Restated Bylaws.
15* 3.2(2)		~~Independent Registered Public Accounting Firm’s Awareness Letter.~~First Certificate of Amendment of Amended and Restated Certificate of Incorporation.
10.1*		Form of Guarantee, dated July 7, 2010, executed by the Registrant, certain of its subsidiaries and its chairman.
10.2*		Form of General Security Agreement, dated July 12, 2010, executed by the Registrant and certain of its subsidiaries.
10.3*		Form of Waiver and Forbearance Agreement, dated February 16, 2011, between the Registrant and each holder of the Notes.
31.1*		Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.
31.2*		Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Act of 1934, as amended.
32.1*		Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

*	Filed herewith

(1)	Incorporated by reference to an exhibit to the Current Report on Form 8-K of the Registrant filed with the Securities and Exchange Commission on May 15, 2008.
(2)	Incorporated by reference to an exhibit to the Quarterly Report on Form 10-Q of the Registrant filed with the Securities and Exchange Commission on November 15, 2010.

4139

SIGNATURES

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

	SOUTHPEAK INTERACTIVE CORPORATION

	By:	/s/ Melanie Mroz
		Melanie Mroz President and Chief Executive Officer ~~and Interim Chief Financial Officer~~

		/s/ James Huyck
		James Huyck Senior Cost Accountant
		(Principal Accounting Officer)
Date: February ~~16, 2010~~17, 2011

4240

INDEX TO EXHIBITS

Exhibit
Number		Exhibit

~~3.1(1)~~10.1*		~~Amended~~Form of Guarantee, dated July 7, 2010, executed by the Registrant, certain of its subsidiaries and ~~Restated Certificate of Incorporation.~~its chairman.
~~3.2(1)~~10.2*		~~Amended~~Form of General Security Agreement, dated July 12, 2010, executed by the Registrant and ~~Restated Bylaws.~~certain of its subsidiaries.
15* 10.3*		~~Independent Registered Public Accounting Firm’s Awareness Letter.~~Form of Waiver and Forbearance Agreement, dated February 16, 2011, between the Registrant and each holder of the Notes.
31.1*		Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.
31.2*		Certification of ~~Chief Financial~~Principal Accounting Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Act of 1934, as amended.
32.1*		Certification of Chief Executive Officer and ~~Chief Financial~~Principal Accounting Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

*	Filed herewith

~~(1)~~

~~Incorporated by reference to an exhibit to the Current Report on Form 8-K of the Registrant filed with the Securities and Exchange Commission on May 15, 2008.~~

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

	For the six months ended December 31,						For the six months ended December 31,
	2009			2008			2010			2009
Cash flows from operating activities:
Net loss	$	(1,955,285	)	$	(385,209	)	$	(3,283,769	)	$	(1,955,285	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation and amortization		129,972			164,909			132,142			129,972
Allowances for price protection, returns, and defective merchandise		(531,050	)		3,542,272			(2,463,231	)		(531,050	)
Bad debt expense, net of recoveries		(35,321	)		538,622			(49,161	)		(35,321	)
Stock-based compensation expense		359,920			342,505			214,283			359,920
Common stock and warrants issued to vendor		104,500			-			-			104,500
Amortization of royalties and intellectual property licenses		5,443,825			1,844,853			960,543			5,443,825
Loss on disposal of fixed assets		4,839			-			-			4,839
Amortization of debt discount and issuance costs								924,403			-
Change in fair value of warrant liability								(3,062,646	)		-
Fair market value adjustment to common stock issued for advances on royalties								(2,112	)		-
Gain on settlement of trade payables		(3,256,489	)		-			(585,122	)		(3,256,489	)

Changes in operating assets and liabilities:
Due to/from factor, net								(1,395,186	)		-
Accounts receivable		(1,788,962	)		(2,079,345	)		7,325,432			(1,788,962	)
Inventories		749,689			1,559,586			79,386			749,689
Advances on royalties		(3,651,309	)		(5,604,552)			(1,575,876	)		(3,651,309	)
Intellectual property licenses		-			(915,000	)
Related party receivables		(27,635	)		24,673			18,249			(27,635	)
Prepaid expenses and other current assets		42,696			(40,518	)		238,119			42,696
Other assets		-			(5,017	)
Production advance payable		3,755,104			-			-			3,755,104
Accounts payable		(4,318,114	)		(5,188,640	)		(2,127,001	)		(4,318,114	)
Accrued royalties		1,279,109			(363,324	)		1,925,059			1,279,109
Accrued expenses and other current liabilities		1,988,225			618,998			1,230,912			1,988,225
Accrued litigation costs		4,308,035			-			-			4,308,035
Deferred revenues		(2,547,339	)		(872,886	)		(247,989	)		(2,547,339	)
Accrued expenses - related parties		(47,478)			(4,182	)		19,337			(47,478)

Total adjustments		1,962,217			(6,437,046	)		1,559,541			1,962,217

Net cash provided by (used in) operating activities		6,932			(6,822,255	)
Net cash (used in) provided by operating activities								(1,724,228	)		6,932

Cash flows from investing activities:
Purchases of property and equipment		(65,544	)		(219,666	)		(16,737	)		(65,544	)
Cash payments to effect acquisition, net of cash acquired		-			(247,542	)
Change in restricted cash		395,982			(1,904	)		-			395,982
Net cash provided by (used in) investing activities		330,438			(469,112	)
Net cash (used in) provided by investing activities								(16,737	)		330,438

Cash flows from financing activities:
Proceeds from line of credit		16,557,571			16,825,346			-			16,557,571
Repayments of line of credit		(16,596,792	)		(14,254,607	)		(3,830,055	)		(16,596,792	)
Proceeds from inventory financing								1,710,281			-
Repayments of inventory financing								(1,710,281	)		-
Repayments of long-term debt		(25,013	)		(12,211	)		(31,887	)		(25,013	)
Net proceeds from (repayments of) amounts due to shareholders		(232,440	)		(228,998	)		-			(232,440	)
Net proceeds from (repayments of) amounts due to related parties		(120,645	)		10,111			2,225			(120,645	)
Proceeds from the issuance of Series A convertible preferred stock, net of cash offering costs		-			1,250,281
Proceeds from the issuance of subordinated convertible promissory notes								7,000,000			-
Payment of debt issuance costs								(733,959	)		-
Repayments of subordinated convertible promissory notes								(450,000	)		-
Proceeds from the exercise of common stock warrants								1,668			-

Net cash (used in) provided by financing activities		(417,319	)		3,589,922
Net cash provided by (used in) financing activities								1,957,992			(417,319	)

Effect of exchange rate changes on cash and cash equivalents		90,247			(180,944	)		(231,289	)		90,247

Net increase (decrease) in cash and cash equivalents		10,298			(3,882,389	)
Net (decrease) increase in cash and cash equivalents								(14,262	)		10,298
Cash and cash equivalents at beginning of the period		648,311			4,095,036			92,893			648,311

Cash and cash equivalents at end of the period	$	658,609		$	212,647		$	78,631		$	658,609

Supplemental cash flow information:
Cash paid during the period for interest	$	243,011		$	157,744		$	514, 642		$	243,011
Cash paid during the period for taxes	$	-		$	-

Supplemental disclosure of non-cash activities:
Intellectual property licenses included in accrued expenses and other current liabilities	$	-		$	135,000
Fair value of common stock warrant liability at issuance date							$	4,338,748		$	-
Fair market value adjustment to common stock issued for advances on royalties							$	811,039		$	-
Conversion of junior secured subordinated convertible promissory note to senior secured convertible note							$	500,000		$	-
Issuance of vested restricted stock							$	40		$	-
Contingent purchase price payment obligation related to Gamecock acquisition	$	597,124		$	421,956		$	-		$	597,124
Decrease in goodwill with respect to finalizing purchase price allocation	$	55,423		$	-		$	-		$	55,423
Purchase of vehicle through the assumption of a note payable	$	73,459		$	-		$	-		$	73,459

	Three months ended						Six months ended						Three months ended						Six months ended
	December 31, 2009			December 31, 2008			December 31, 2009			December 31, 2008			December 31, 2010			December 31, 2009			December 31, 2010			December 31, 2009

Net income (loss)	$	(2,642,266	)	$	1,166,545		$	(1,955,285	)	$	(385,209	)
Net loss													$	(2,082,835	)	$	(2,642,266	)	$	(3,283,769	)	$	(1,955,285	)
Other comprehensive income (loss)
Change in foreign currency translation adjustment		7,747			(85,581	)		90,247			(180,944	)		44,089			7,747			(231,289	)		90,247
Comprehensive income (loss)	$	(2,634,519	)	$	1,080,964		$	(1,865,038	)	$	(566,153	)
Comprehensive loss													$	(2,038,746	)	$	(2,634,519	)	$	(3,515,058	)	$	(1,865,038	)

			Fair Value Measurements at Reporting Date Using
			Quoted Prices in
			Active Markets		Significant
			for Identical		Other		Significant
	As of		Financial		Observable		Unobservable
	December		Instruments		Inputs		Inputs
	31, 2010		(Level 1)		(Level 2)		(Level 3)
Assets:
Advances on royalties	$	389,667	$	389,667	$	-	$	-

Total assets at fair value	$	389,667	$	389,667	$	-	$	-

Liabilities:
Warrant liability	$	1,276,102	$	-	$	-	$	1,276,102

Total liabilities at fair value	$	1,276,102	$	-	$	-	$	1,276,102

	December 31, 2010
Outstanding accounts receivable sold to factor	$	5,200,626
Cash collateral		109,650
Less: allowances		(2,260,088	)
Less: advances from factor		(3,915,090	)
	$	(864,902	)

	December 31, 2009			June 30, 2009
	(Unaudited)
Assets

Current assets:
Cash and cash equivalents	$	658,609		$	648,311
Restricted cash		849,600			1,245,582
Accounts receivable, net of allowances of $6,648,613 and $7,214,984 at December 31, 2009 and June 30, 2009, respectively		7,327,750			4,972,417
Inventories		3,710,148			4,459,837
Current portion of advances on royalties		6,867,061			8,435,415
Current portion of intellectual property licenses		383,571			410,995
Related party receivables		60,842			33,207
Prepaid expenses and other current assets		530,449			573,145

Total current assets		20,388,030			20,778,909

Property and equipment, net		2,778,721			2,754,139
Advances on royalties, net of current portion		1,551,869			1,556,820
Intellectual property licenses, net of current portion		1,726,071			1,917,858
Goodwill		8,031,766			7,490,065
Intangible assets, net		23,692			43,810
Other assets		11,600			11,872

Total assets	$	34,511,749		$	34,553,473

Liabilities and Shareholders’ Equity

Current liabilities:
Line of credit	$	5,310,732		$	5,349,953
Current maturities of long-term debt		63,649			50,855
Production advance payable in default		3,755,104			-
Accounts payable		12,056,142			19,686,168
Accrued royalties		1,693,805			414,696
Accrued expenses and other current liabilities		5,004,449			2,419,100
Accrued litigation costs		4,308,035			-
Deferred revenues		295,301			2,842,640
Due to shareholders		-			232,440
Due to related parties		4,400			125,045
Accrued expenses - related parties		137,288			184,766
Total current liabilities		32,628,905			31,305,663

Long-term debt, net of current maturities		1,574,608			1,538,956
Total liabilities		34,203,513			32,844,619

Commitments and contingencies		-			-

Shareholders’ equity:

Preferred stock, $0.0001 par value; 5,000,000 shares authorized; no shares issued and outstanding at December 31, 2009 and June 30, 2009		-			-
Series A convertible preferred stock, $0.0001 par value; 15,000,000 shares authorized; 5,653,833 and 5,953,833 shares issued and outstanding at December 31, 2009 and June 30, 2009, respectively; aggregate liquidation preference of $5,653,833 at December 31, 2009		565			595
Common stock, $0.0001 par value; 90,000,000 shares authorized; 45,106,600 and 44,530,100 shares issued and outstanding at December 31, 2009 and June 30, 2009, respectively		4,511			4,453
Additional paid-in capital		25,675,318			25,210,926
Accumulated deficit		(25,101,085	)		(23,145,800	)
Accumulated other comprehensive loss		(271,073	)		(361,320	)

Total shareholders’ equity		308,236			1,708,854
Total liabilities and shareholders’ equity	$	34,511,749		$	34,553,473

	December 31, 2009		June 30, 2009
Cash collateral for the line of credit (see Note 5)	$	-	$	742,199
Funds held in escrow pending resolution of litigation (see Note 10), of which $36,625 and $265,919 is included as a liability at December 31, 2009 and June 30, 2009, respectively		849,600		503,383
Total	$	849,600	$	1,245,582

	Six Months
	Ended
	December 31,
Description	2010
Beginning balance	$	-
Purchases, issuances, and settlements		4,338,748
Total gain included in net loss		(3,062,646	)
Ending balance	$	1,276,102

	December 31, 2010		June 30, 2010
Finished goods	$	970,232	$	1,085,433
Purchased parts and components		161,683		125,868
Total	$	1,131,915	$	1,211,301

	Six months ended December 31, 2010
Beginning balance	$	-
Add: provision		(5,441,699	)
Less: amounts charged against allowance		3,181,611
Ending balance	$	(2,260,088	)

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

		Preliminary Purchase Price Allocation as of June 30, 2009			Final Purchase Price Allocation as of October 10, 2009

Working capital, excluding inventories		$	827,287		$	827,287
Inventories			156,745			156,745
Other current assets			36,369			36,369
Property and equipment			209,441			209,441

	Estimated useful life

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

			Accumulated
	Gross		Amortization		Net

Royalty agreements (Advances on royalties)	$	3,424,000	$	2,699,171	$	724,829
Intangible assets, net
Game sequel titles	$	1,142,000	$	1,142,000	$	-
Non-compete agreements		200,000		200,000		-
Distribution agreements		40,000		16,308		23,692

Total intangible assets, net	$	1,382,000	$	1,358,308	$	23,692

Year ending June 30,

2010 (six months ended June 30, 2010)	$	6,667
2011	$	13,333
2012	$	3,692

	December 31, 2009		June 30, 2009
Land	$	544,044	$	544,044
Building and leasehold improvements		1,496,099		1,496,147
Computer equipment and software		765,659		719,621
Office furniture and other equipment		439,990		353,406
		3,245,792		3,113,218

Less: accumulated depreciation and amortization		467,071		359,079

Property and equipment, net	$	2,778,721	$	2,754,139

	December 31, 2009		June 30, 2009
Mortgages payable
First National Bank	$	1,027,099	$	1,039,078
Southwest Securities, FSB		486,356		493,437
Vehicle notes payable		124,802		57,296

Total debt		1,638,257		1,589,811
Less current portion		63,649		50,855
Total long-term debt	$	1,574,608	$	1,538,956

Year ending June 30,
2010 (six months ended June 30, 2010)	$	31,734
2011		65,451
2012		68,993
2013		73,347
2014		489,276
Thereafter		909,456

Total		1,638,257

Less: current maturities		63,649

Long-term debt, net of current portion	$	1,574,608

	Software		Office
	Developers		Lease		Total
For the year ending June 30,

2011 (six months ended June 30, 2011)	$	2,506,000	$	74,122	$	2,580,122
2012		596,318		148,244		744,562
2013		-		125,935		125,935
2014		-		55,000		55,000
2015		-		-		-
Total	$	3,102,318	$	403,301	$	3,505,619

	Software		Office				Vendor
	Developers		Lease		Total		Payments
For the year ending June 30,

2010 (six months ended June 30, 2010)	$	4,536,364	$	74,712	$	4,611,076
2011		637,818		94,424		732,242
2011 (six months ended June 30, 2011)							$	386,738
2012		-		39,424		39,424		-
2013		-		16,427		16,427		-
2014								-
2015								-
Total	$	5,174,182	$	224,987	$	5,399,169	$	386,738

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

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