10-Q/A

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.   20549

FORM 10-Q/A

Amendment No. 1

(Mark One)

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

For the quarterly period ended September 30, 2009

¨ 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 333-124829

ZOO ENTERTAINMENT, INC.

(Exact name of Registrant as Specified in Its Charter)

Delaware	71-1033391
(State or other jurisdiction of incorporation or organization )	(I.R.S. Employer Identification No.)

3805 Edwards Road, Suite 400, Cincinnati, OH	45209
(Address of Principal Executive Offices)	(Zip Code)

(513) 824-8297

(Registrant’s telephone number, including area code)

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

Yes  xNo  ¨

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨    No  ¨

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

Large Accelerated filer ¨	Accelerated filer ¨
Non-accelerated filer ¨ (do not check if a smaller reporting company)	Smaller reporting company x

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

As of November 17, 2009, there were 65,710 shares of the Registrant’s common stock, par value $0.001 per share, issued and 52,707 shares outstanding.

Explanatory Note

The Company is amending its previously filed Form 10-Q for the period ended September 30, 2009 for the following reasons:

1. The Company incurred a triggering event as of September 30, 2009 based on the equity infusion of approximately $4.0 million for 50% ownership in the Company and the conversion of the existing convertible debt during the fourth quarter of 2009. For the September 30, 2009 financial statements, the Company estimated impairment of goodwill at $14.7 million and impairment of other intangible assets at $7.3 million for a total impairment charge of $22.0 million. In accordance with ASC 820-10-35-24 “Fair Value Measurements and Disclosures”, the Company performed an impairment analysis and concluded that the resulting impairment of goodwill is $14.7 million and there should be no impairment of other intangible assets. Therefore, the Company has restated its September 30, 2009 financial statements to reflect this reduction in impairment of other intangible assets of approximately $7.3 million.

2. The Company erroneously reported $2.0 million proceeds from a loan for a customer advance in other changes in assets and liabilities, net in the operating activities section of the statement of cash flows for the nine months ended September 30, 2009. It should be included in the financing activities section of the statement of cash flows and the statement of cash flows has been restated accordingly.

3. On May 10, 2010, the Company effectuated a one-for-600 reverse stock split of its outstanding common stock, par value $0.001 per share, pursuant to previously obtained stockholder authorization. As a result of the reverse stock split, every 600 shares of the Company’s common stock was combined into one share of common stock. All common stock equity transactions have been adjusted to reflect the reverse stock split for all periods presented.

ZOO ENTERTAINMENT, INC.

Table of Contents

		Page
PART I - FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets as of September 30, 2009 (Restated) (Unaudited) and December 31, 2008	F-1
	Condensed Consolidated Statements of Operations (Unaudited) for the Three and Nine Months Ended September 30, 2009 (Restated) and 2008	F- 2
	Condensed Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30, 2009 (Restated) and 2008	F- 3
	Condensed Consolidated Statement of Stockholders’ Equity and Other Comprehensive Loss (Restated) (Unaudited) for the Nine Months Ended September 30, 2009	F- 4
	Notes to Condensed Consolidated Financial Statements	F- 5 - F- 32
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	1
Item 3.	Quantitative and Qualitative Disclosure About Market Risk	16
Item 4T.	Controls and Procedures	16
PART II - OTHER INFORMATION
Item 1.	Legal Proceedings	17
Item 1A.	Risk Factors	17
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	17
Item 3.	Defaults Upon Senior Securities	18
Item 4.	Submission of Matters to a Vote of Security Holders	18
Item 5.	Other Information	18
Item 6.	Exhibits	18
Signatures		19

Zoo Entertainment, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(In Thousands Except Share and Per Share Amounts)

	September 30,  2009			December 31,  2008
	(restated)
	(unaudited)
ASSETS
Current Assets
Cash	$	533		$	849
Accounts receivable and due from factor, net of allowances for returns and discounts of $713 and $1,160		3,254			1,832
Inventory		2,176			3,120
Prepaid expenses and other current assets		4,374			2,124
Product development costs, net		5,739			5,338
Deferred tax asset		491			688
Total Current Assets		16,567			13,951
Fixed assets, net		232			214
Goodwill		-			14,704
Intangible assets, net		16,210			14,747
Total Assets	$	33,009		$	43,616
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable	$	5,597		$	5,709
Financing arrangements		3,503			849
Customer advances		5,241			1,828
Accrued expenses and other current liabilities		2,980			3,099
Notes payable, net of discount of $0 and $145 - current portion		120			1,803
Convertible notes payable, net of discount of $0 and $1,576, including accrued interest of $656 and $240		11,806			9,814
Total Current Liabilities		29,247			23,102
Notes payable, net of discount of $0 and $885 - non current portion		180			1,772
Deferred tax liability		491			688
Other long-term liabilities		2,920			620
Total Liabilities		32,838			26,182
Commitments and Contingencies
Stockholders' Equity
Preferred Stock, par value $0.001, 5,000,000 shares authorized, none issued and outstanding		-			-
Common Stock, par value $0.001, 250,000,000 shares authorized, 65,710 issued and 52,707 outstanding September 30, 2009 and 63,740 issued and outstanding December 31, 2008		-			-
Additional Paid-in-capital		53,303			52,730
Accumulated deficit		(48,671	)		(31,940	)
Treasury Stock, at cost, 13,003 shares September 30, 2009 and 3,729 shares December 31, 2008		(4,469	)		(3,356	)
Accumulated other comprehensive income		8			-
Total Stockholders' Equity		171			17,434
Total Liabilities and Stockholders' Equity	$	33,009		$	43,616

See accompanying notes to condensed consolidated financial statements

F-1

Zoo Entertainment, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations (Unaudited)

 (In Thousands Except Share and Per Share Amounts)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2009			2008			2009			2008
	(restated)						(restated)
Revenue	$	8,583		$	7,865		$	30,136		$	22,364
Cost of goods sold		6,662			5,093			25,887			18,306
Gross profit		1,921			2,772			4,249			4,058
Operating expenses:
General and administrative expenses		1,750			4,037			5,010			7,436
Selling and marketing expenses		548			1,352			2,073			3,269
Research and development expenses		—			2			370			1,481
Impairment of goodwill		14,704			—			14,704			—
Depreciation and amortization		504			434			1,373			1,325
Total operating expenses		17,506			5,825			23,530			13,511
Loss from operations		(15,585	)		(3,053	)		(19,281	)		(9,453	)
Interest expense, net		(370	)		(1,554	)		(2,403	)		(2,533	)
Gain on legal settlement		—			—			4,328			—
Other income – insurance recovery		860			—			860			—
Loss from continuing operations before income tax benefit		(15,095	)		(4,607	)		(16,496	)		(11,986	)
Income tax benefit		—			2,542			—			3,600
Loss from continuing operations		(15,095	)		(2,065	)		(16,496	)		(8,386	)
Loss from discontinued operations		(235	)		(1,731	)		(235	)		(4,279	)
Net loss	$	(15,330	)	$	(3,796	)	$	(16,731	)	$	(12,665	)
Loss per share – basic and diluted:
Continuing operations	$	(290	)	$	(46	)	$	(290	)	$	(239	)
Discontinued operations		(5	)		(38	)		(4	)		(122	)
Net loss	$	(295	)	$	(84	)	$	(294	)	$	(361	)
Weighted average shares outstanding:
Basic and diluted		52,023			45,086			56,878			35,097

See accompanying notes to condensed consolidated financial statements

F-2

Zoo Entertainment, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flow (Unaudited)

(In Thousands)

	Nine Months Ended September 30,
	2009			2008
	(Restated)
Operating Activities:
Net loss	$	(16,731	)	$	(12,665	)
Loss from discontinued operations		(235	)		(4,279	)
Net loss from continuing operations		(16,496	)		(8,386	)
Adjustments to reconcile net loss from continuing operations to net cash used in operating activities:
Gain on legal settlement		(4,328	)		-
Impairment of goodwill		14,704			-
Depreciation and amortization		1,373			1,325
Amortization of deferred debt discount		1,870			2,126
Deferred income taxes		-			(3,899	)
Stock based compensation		566			1,908
Other changes in assets and liabilities, net		(2,412	)		(10,323	)
Net cash used in continuing operations		(4,723	)		(17,249	)
Net cash used in discontinued operations		-			(2,491	)
Net cash used in operating activities		(4,723	)		(19,740	)
Investing activities:
Purchases of fixed assets		(92	)		(65	)
Purchase of Empire IP		(162	)		-
Cash received from acquisition of Driftwood		-			1,669
Net cash provided by (used in) investing activities		(254	)		1,604
Financing activities:
Proceeds from sale of equity securities		7			6,118
Proceeds from Solutions 2 Go note for customer advance		2,000			-
Proceeds from Driftwood issuance of convertible notes - pre-merger		-			7,823
Proceeds from issuance of convertible notes - post-merger		-			1,000
Net borrowings in connection with financing facilities		2,654			5,422
Net cash provided by financing activities		4,661			20,363
(Decrease) increase in cash		(316	)		2,227
Cash at beginning of period		849			138
Cash at end of period	$	533		$	2,365

See accompanying notes to condensed consolidated financial statements

F-3

Zoo Entertainment, Inc. and Subsidiaries

Condensed Consolidated Statement of Stockholders' Equity and Other Comprehensive Loss (Restated) (Unaudited)

For the Nine Months Ended September 30, 2009

(In Thousands)

	Preferred Stock				Common Stock				Additional					Treasury Stock					Accumulated Other
	Shares		Par value		Shares		Par Value		Paid-in- Capital		Accumulated Deficit			Shares		Cost			Comprehensive Loss		Total
Balance December 31, 2008		-		-		64		-		52,730		(31,940	)		4		(3,356	)		-		17,434
Stock-based compensation						-		-		66												66
Value of shares returned to Treasury from settlement of litigation															9		(1,113	)				(1,113	)
Warrants exercised						1		-		7												7
Shares issued to employee for personal guaranty						1		-		100												100
Value of warrants issued for distribution deal										400												400
Net loss												(16,731	)									(16,731	)
Adjustment for foreign currency translation																				8		8
Other comprehensive loss																						(16,723	)
Balance September 30, 2009		-	$	-		66	$	-	$	53,303	$	(48,671	)		13	$	(4,469	)	$	8	$	171

See accompanying notes to condensed consolidated financial statements

F-4

Zoo Entertainment, Inc. And Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

NOTE 1.   DESCRIPTION OF ORGANIZATION AND REVERSE MERGER

Zoo Entertainment, Inc., (“Zoo” or the “Company”) was incorporated under the laws of the State of Nevada on February 13, 2003 under the name Driftwood Ventures, Inc. On December 20, 2007, the Company reincorporated in Delaware and increased its authorized capital stock from 75,000,000 shares to 80,000,000 shares, consisting of 75,000,000 shares of common stock, par value $0.001, per share, and 5,000,000 shares of preferred stock, par value $0.001, per share.  In August 2009, the Company increased its authorized shares of common stock to 250,000,000, par value $0.001 per share. On November 20, 2009, as a result of the Company consummating an approximately $4.2 million preferred equity raise the Company will issue series A preferred stock (“Series A Preferred Stock”).  Concurrently, as a result of the aforementioned preferred equity raise, the Company will convert approximately $11.8 million of existing debt and related accrued interest into series B preferred stock (“Series B Preferred Stock”). The Series A Preferred Stock and the Series B Preferred Stock will convert into common shares of the Company upon a sufficient increase in authorized common shares of the Company. (See Note 20 for further details in connection with the conversion features).  The Company was engaged in acquiring and exploring mineral properties until September 30, 2007 when this activity was abandoned. The Company had been inactive until July 7, 2008 when the Company entered into an Agreement and Plan of Merger, as subsequently amended on September 12, 2008 with DFTW Merger Sub, Inc., a Delaware corporation and a wholly-owned subsidiary of the Company (“Merger Sub”), Zoo Games, Inc. (“Zoo Games”) (formerly known as Green Screen Interactive Software, Inc.) and a stockholder representative, pursuant to which Merger Sub would merge with and into Zoo Games, with Zoo Games as the surviving corporation through an exchange of common stock of Zoo Games for common stock of the Company (the “Merger”). On December 3, 2008, Driftwood Ventures, Inc. changed its name to Zoo Entertainment, Inc.

On September 12, 2008, upon the completion of the Merger, each outstanding share of Zoo Games common stock, $0.001 par value per share (the “Zoo Games Common Stock”) on a fully-converted basis, converted automatically into and became exchangeable for shares of the Company’s common stock, $0.001 par value per share based on an exchange ratio equal to 7.023274. In addition, by virtue of the Merger, each of the 559 options to purchase shares of Zoo Games Common Stock (the “Zoo Games Options”) outstanding under Zoo Games’ 2008 Long-Term Incentive Plan were assumed by the Company, subject to the same terms and conditions as were applicable under such plan immediately prior to the Merger, and converted into 405 options to purchase shares of the Company’s common stock at an exercise price of $1,548 per share, 703 options to purchase shares of the Company’s common stock at an exercise price of $1,350 per share and 2,814 options to purchase shares of the Company’s common stock at an exercise price of $912 per share. The 411 warrants to purchase shares of Zoo Games Common Stock outstanding at the time of the Merger (the “Zoo Games Warrants”) were assumed by the Company and converted into 2,383 warrants to acquire shares of the Company’s common stock at an exercise price of $1,704 and 531 warrants to acquire shares of the Company’s common stock at an exercise price of $1,278 per share. The merger consideration consisted of (i) 43,498 shares of the Company’s common stock, (ii) the reservation of 3,922 shares of the Company’s common stock that are required for the assumption of the Zoo Games Options and (iii) the reservation of 2,914 shares of the Company’s common stock that are required for the assumption of the Zoo Games Warrants.

Zoo Games was treated as the acquirer for accounting purposes in this reverse merger and the financial statements of the Company for all periods presented represent the historical activity of Zoo Games and include the activity of Zoo beginning on September 12, 2008, the date of the reverse merger. As a result of the reverse merger, the equity transactions for the period from March 23, 2007 to September 12, 2008 have been adjusted to reflect this recapitalization.

F-5

Zoo Games, a Delaware corporation, is a developer, publisher and distributor of interactive entertainment software for use on all major platforms including Nintendo’s Wii and DS, Sony’s PSP and PlayStation 3, Microsoft’s Xbox 360, and personal computers (PCs). Zoo Games sells primarily to major retail chains and video game distributors. Zoo Games began business in March 2007, acquired the assets of Supervillain Studios, Inc. (“SVS”) on June 13, 2007, acquired the stock of Zoo Publishing, Inc. (“Zoo Publishing”) on December 18, 2007 and acquired the stock of Zoo Digital Publishing Limited (“Zoo Digital”) on April 4, 2008. The consolidated financial statements include the results of their operations from their respective acquisition dates. We also acquired an interest in Cyoob, Inc., also known as Repliqa (“Repliqa”), on June 28, 2007. During January 2008, Zoo Games’ board of directors made a determination to discontinue its involvement with the operations of Repliqa. During September 2008, Zoo Games sold SVS back to its original owners. In November 2008, Zoo Games sold Zoo Digital back to its original owners. Repliqa, SVS and Zoo Digital have been reflected as discontinued operations for all periods presented. In May 2009, we entered into a license agreement with New World IP (Licensor”) pursuant to which the Licensor granted to Zoo Publishing all of the Licensor’s rights to substantially all the intellectual property of Empire Interactive Europe, Ltd. for a minimum royalty of $2.6 million. In June 2009, we formed a new company called Zoo Entertainment Europe Ltd., a 100% subsidiary of Zoo Games, Inc. based in the United Kingdom for the purpose of sales and distribution of our product in Europe.

Currently, the Company has determined that it operates in one segment and will focus on developing, publishing and distributing interactive entertainment software under the Zoo brand both in North American and international markets.

On May 16, 2008, Zoo Games converted from a limited liability company to a C-corporation and changed its name to Green Screen Interactive Software, Inc. from Green Screen Interactive Software, LLC. In August 2008, it changed its name to Zoo Games, Inc.

NOTE 2.   GOING CONCERN

These consolidated financial statements have been prepared assuming the Company will continue as a going concern. The Company has incurred losses since inception, resulting in an accumulated deficit of approximately $48.7 million and a working capital deficiency of approximately $12.7 million at September 30, 2009. For the nine months ended September 30, 2009 the Company generated negative cash flows from operations of approximately $4.7 million, and for the year ended December 31, 2008 the Company generated negative cash flows from operations of approximately $12.1 million. Although the Company’s business plan anticipates the generation of positive cash flow, there is no assurance that it will succeed in doing so.  An inability to meet its business goals would raise substantial doubt as to the Company's ability to continue as a going concern. In addition, the Company has various notes maturing in February 2010 with an aggregate face value of approximately $11.2 million, $11.8M including accrued interest. On November 2, 2009, the Company and its Senior Secured Convertible Note Holders amended the Senior Convertible Note whereby the parties agreed that if the Company raises at least $4 million in new capital prior to February 2, 2010, the notes will automatically convert into equity.  On November 20, 2009, the requisite Senior Secured Convertible Note Holders agreed to convert their debt into Preferred Shares of the Company that will ultimately convert into common shares that would represent 36.5% of the equity of the Company on a pro-forma basis.

The Company’s ability to continue as a going concern is dependent on, among other factors, the following major short term actions:  i.) its ability to generate cash flow from operations sufficient to maintain its daily business activities ii.) its ability to raise capital from outside sources through the sale of equity or debt instruments primarily to fund the ongoing development and acquisition of new games and iii.) the restructuring of its maturing note obligations. Management’s active efforts in this regard include trade arrangements for advance payments secured by future sales, an agreement with its note holders as detailed above, as well as operational steps to increase cash flow through an increase in both the quantity and quality of its product releases. There can be no assurance that all or any of these actions will meet with success.

On November 20, 2009, the Company consummated a $4.2 million convertible preferred stock equity raise and converted approximately $11.8 million of debt including related accrued interest into preferred stock, improving its working capital by $16.0 million and putting the Company into a positive net working capital position on a pro-forma basis as of September 30, 2009.

These condensed consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded assets, or the amounts of and classification of liabilities that might be necessary as a result of this uncertainty.

F-6

NOTE 3.   BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation and Interim Financial Information

The accompanying unaudited interim condensed consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America and the interim financial statement rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, these statements include all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the Condensed Consolidated Financial Statements. The financial statements should be read in conjunction with the financial statements of the Company together with the Company’s management discussion and analysis in the Company’s Form 10-K Annual Report for the year ended December 31, 2008 filed with the Securities and Exchange Commission on April 15, 2009. The results for the three months and nine months ended September 30, 2009 might not be indicative of the results for the full year or any future period.

The condensed consolidated financial statements of the Company include the accounts of Zoo Games and its wholly and majority owned subsidiaries, Supervillain Studios LLC, Zoo Publishing, Zoo Entertainment Europe Ltd., Zoo Digital Publishing Limited and Repliqa during the periods that each subsidiary was directly or indirectly owned by Zoo Games. All intercompany accounts and transactions are eliminated in consolidation.

On May 10, 2010, the Company effectuated a one-for-600 reverse stock split of its outstanding common stock, par value $0.001 per share, pursuant to previously obtained stockholder authorization. As a result of the reverse stock split, every 600 shares of the Company’s common stock was combined into one share of common stock. All common stock equity transactions have been adjusted to reflect the reverse stock split for all periods presented.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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 revenue and expenses during the reporting periods. The estimates affecting the consolidated financial statements that are particularly significant include the recoverability of product development costs, lives of intangibles, realization of goodwill and intangibles, allocation of purchase price, valuation of equity instruments, valuation of inventories and the adequacy of allowances for returns, price concessions and doubtful accounts. Actual amounts could differ from these estimates.

Concentration of Credit Risk

We maintain cash balances at what we believe are several high quality financial institutions. While we attempt to limit credit exposure with any single institution, balances often exceed FDIC insurable amounts.

If the financial condition and operations of our customers deteriorate, our risk of collection could increase substantially. A majority of our trade receivables are derived from sales to major retailers and distributors. In October 2008, we entered into an agreement with Atari, Inc. where sales from October 24, 2008 through March 31, 2009 for all customers that Atari deemed acceptable would be through Atari and Atari would prepay us for the cost of goods and they would bear the credit risk from the ultimate customer. This agreement was subsequently amended to include sales to certain customers through March 31, 2010. As of September 30, 2009, Atari had prepaid us approximately $3.2 million which is included in customer advances in current liabilities in the condensed consolidated balance sheet and the receivable due from Atari was $264,000, before allowances, which is included in accounts receivable and due from factor in the condensed consolidated balance sheet. Our five largest ultimate customers accounted for approximately 77% (of which the following customers constituted balances greater than 10%:customer A-27%, customer B-18%, customer C-14%, customer D-11%) and 66% (of which the following customers constituted balances greater than 10%: customer A-27%, customer B-19%) of net revenue for the nine months ended September 30, 2009 and 2008, respectively. These five largest customers accounted for 78% and 3% of our gross accounts receivable and due from factor as of September 30, 2009 and December 30, 2008, respectively.  We believe that the receivable balances from Atari and our ultimate customers do not represent a significant credit risk based on past collection experience. During the nine months ended September 30, 2009, we sold $832,000 of receivables to the factor with recourse.  There were $832,000 of receivables from our factor included in our gross accounts receivable and due from factor as of September 30, 2009 and $0 as of December 31, 2008. We regularly review our outstanding receivables for potential bad debts and have had no history of significant write-offs due to bad debts.

F-7

Inventory

Inventory, primarily consisting of finished goods, is stated at the lower of actual cost or market. We periodically evaluate the carrying value of our inventory and make adjustments as necessary. Estimated product returns are included in the inventory balances and also recorded at the lower of actual cost or market.

Product Development Costs

We utilized both internal development teams and third party product developers to develop the titles we publish.

The Company frequently enters into agreements with third party developers that require it to make payments based on agreed upon milestone deliverable schedules for game design and enhancements. The Company receives the exclusive publishing and distribution rights to the finished game title as well as, in some cases, the underlying intellectual property rights for that game. The Company typically enters into these development agreements after it has completed the design concept for its products. The Company contracts with third party developers that have proven technology and the experience and ability to build the designed video game as conceived by the Company. As a result, technological feasibility is determined to have been achieved at the time in which the Company enters into the agreement, and it therefore capitalizes such payments as prepaid product development costs. On a product by product basis, the Company reduces prepaid product development costs and records amortization using the proportion of current year unit sales and revenues to the total unit sales and revenues expected to be recorded over the life of the title.

At each balance sheet date, or earlier if an indicator of impairment exists, the Company evaluates the recoverability of capitalized prepaid product development costs, development payments and any other unrecognized minimum commitments that have not been paid, using an undiscounted future cash flow analysis, and charge any amounts that are deemed unrecoverable to cost of goods sold if the product has already been released. If the product development process is discontinued prior to completion, any prepaid unrecoverable amounts are charged to research and development expense. The Company uses various measures to estimate future revenues for its product titles, including past performance of similar titles and orders for titles prior to their release. For sequels, the performance of predecessor titles is also taken into consideration.

Prior to establishing technological feasibility, the Company expenses research and development costs as incurred. During the three months ended September 30, 2009 and 2008, we wrote-off $0 and $2,000, respectively and during the nine months ended September 30, 2009 and 2008, we wrote-off $370,000 and approximately $1.5 million, respectively, of expense relating to costs incurred for the development of games that were abandoned during those periods. Those costs are included in our statement of operations under research and development expenses.

In December 2007, the Financial Accounting Standards Board (“FASB”) issued FASB Accounting Standards Update (“ASC”) Topic 808-10-15, “Accounting for Collaborative Arrangements” (“ASC 808-10-15”), which defines collaborative arrangements and requires collaborators to present the result of activities for which they act as the principal on a gross basis and report any payments received from (made to) the other collaborators based on other applicable authoritative accounting literature, and in the absence of other applicable authoritative literature, on a reasonable, rational and consistent accounting policy is to be elected. Effective January 1, 2009, the Company adopted the provisions of ASC 808-10-15. The adoption of this statement did not have an impact on the Company’s consolidated financial position, results of operations or cash flows. Our arrangements with third party developers are not considered collaborative arrangements because the third party developers do not have significant active participation in the design and development of the video games, nor are they exposed to significant risks and rewards as their compensation is fixed and not contingent upon the revenue that the Company will generate from sales of our product. If the Company enters into any future arrangements with product developers that are considered collaborative arrangements, the Company will account for them accordingly.

F-8

Licenses and Royalties

Licenses consist of payments and guarantees made to holders of intellectual property rights for use of their trademarks, copyrights, technology or other intellectual property rights in the development of our products. Agreements with rights holders generally provide for guaranteed minimum royalty payments for use of their intellectual property. When significant performance remains to be completed by the licensor, we record payments when actually paid.

Certain licenses extend over multi-year periods and encompass multiple game titles. In addition to guaranteed minimum payments, these licenses frequently contain provisions that could require us to pay royalties to the license holder, based on pre-agreed unit sales thresholds.

Licensing fees are capitalized on the balance sheet in prepaid expenses and are amortized as royalties in cost of goods sold on a title-by-title basis at a ratio of current period revenues to the total revenues expected to be recorded over the remaining life of the title. Similar to product development costs, we review our sales projections quarterly to determine the likely recoverability of our capitalized licenses as well as any unpaid minimum obligations. When management determines that the value of a license is unlikely to be recovered by product sales, capitalized licenses are charged to cost of goods sold, based on current and expected revenues, in the period in which such determination is made. Criteria used to evaluate expected product performance and to estimate future sales for a title include: historical performance of comparable titles; orders for titles prior to release; and the estimated performance of a sequel title based on the performance of the title on which the sequel is based.

Goodwill and Intangible Assets

Goodwill is the excess of purchase price paid over identified intangible and tangible net assets of acquired companies. Intangible assets consist of trademarks, customer relationships, content and product development. Certain intangible assets acquired in a business combination are recognized as assets apart from goodwill. Identified intangibles other than goodwill are generally amortized using the straight-line method over the period of expected benefit ranging from one to ten years, except for intellectual property, which are usage-based intangible assets that are amortized using the shorter of the useful life or expected revenue stream.

The Company is required to perform a goodwill impairment test on at least an annual basis. The goodwill impairment test is a two-step process, which requires management to make judgments in determining what assumptions to use in the calculation. Application of the goodwill impairment test requires significant judgments including estimation of future cash flows, which is dependent on internal forecasts, estimation of the long-term rate of growth for the business, the useful life over which cash flows will occur and determination of weighted average cost of capital. Changes in these estimates and assumptions could materially affect the determination of fair value and/or conclusions on goodwill impairment. The Company conducts its annual goodwill impairment test during the fourth quarter of each fiscal year, or more frequently if indicators of impairment exist. The Company periodically analyzes whether any such indicators of impairment exist. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include a sustained, significant decline in share price and market capitalization, a decline in expected future cash flows, a significant adverse change in legal factors or in the business climate, unanticipated competition and/or slower expected growth rates, among others. The Company compares the fair value of each reporting unit to the carrying value and if the carrying amount of the goodwill exceeds the implied fair value of the goodwill, an impairment loss is recognized. As of September 30, 2009, the Company determined that goodwill was impaired and as such recorded an impairment charge of $14.7 million against the goodwill (see Note 8).

F-9

Impairment of Long-Lived Assets, Including Definitive Life Intangible Assets

We review all long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, including assets to be disposed of by sale, whether previously held and used or newly acquired. We compare the carrying amount of the asset to the estimated undiscounted future cash flows expected to result from the use of the asset. If the carrying amount of the asset exceeds estimated expected undiscounted future cash flows, we record an impairment charge for the difference between the carrying amount of the asset and its fair value. The estimated fair value is generally measured by discounting expected future cash flows at our incremental borrowing rate or fair value, if available.

Revenue Recognition

The Company earns its revenue from the sale of internally developed interactive software titles and from the sale of titles developed by and/or licensed from third party developers ("Publishing Revenue").

The Company recognizes Publishing Revenue upon the transfer of title and risk of loss to our customers. Accordingly, the Company recognizes revenue for software titles when there is (1) persuasive evidence that an arrangement with the customer exists, which is generally a customer 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 net 30 and 60-day terms. Advances received from customers are reported on the consolidated balance sheet as customer advances and are included in current liabilities until the Company meets its performance obligations, at which point it recognizes the revenue.

Revenue is presented net of estimated reserves for returns, price concessions and other allowances. In circumstances when the Company does not have a reliable basis to estimate returns and price concessions or is unable to determine that collection of a receivable is probable, it 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.

Allowances for Returns, Price Concessions and Other Allowances

We may accept returns and grant price concessions in connection with our publishing arrangements. Following reductions in the price of our products, we grant price concessions that permit customers to take credits for unsold merchandise against amounts they owe us. Our customers must satisfy certain conditions to allow them to return products or receive price concessions, including compliance with applicable payment terms and confirmation of field inventory levels.

Although our distribution arrangements with customers do not give them the right to return titles or to cancel firm orders, we sometimes accept returns from our distribution customers for stock balancing and make accommodations to customers, which include credits and returns, when demand for specific titles fall below expectations.

We make estimates of future product returns and price concessions related to current period product revenue based upon, among other factors, historical experience and performance of the titles in similar genres, historical performance of a hardware platform, 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 products 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.

Consideration Given to Customers and Received from Vendors

We have various marketing arrangements with retailers and distributors of our products that provide for cooperative advertising and market development funds, among others, which are generally based on single exchange transactions. Such amounts are accrued as a reduction to revenue when revenue is recognized, except for cooperative advertising which is included in selling and marketing expense if there is a separate identifiable benefit and the benefit's fair value can be established.

F-10

We receive various incentives from our manufacturers, including up-front cash payments as well as rebates based on a cumulative level of purchases. Such amounts are generally accounted for as a reduction in the price of the manufacturer's product and included as a reduction of inventory or cost of goods sold, based on (1) a ratio of current period revenue to the total revenue expected to be recorded over the remaining life of the product or (2) an agreed upon per unit rebate, based on actual units manufactured during the period.

Equity-Based Compensation

We issued options and warrants to purchase shares of common stock of the Company to certain management and employees during 2009 and 2008.  We record compensation expense over the requisite service period based on their relative fair values.

The fair value of our equity-based compensation is estimated using the Black-Scholes option-pricing model. This model requires the input of assumptions regarding a number of complex and subjective variables that will usually have a significant impact on the fair value estimate. These variables include, but are not limited to, the volatility of our stock price and estimated exercise behavior. As a privately-held company until September 12, 2008, the Company used the stock prices of equity raises to assist us in our calculations for 2008 grants. There was no activity subsequent to such date for the balance of 2008. The Company had limited trading volume in 2009; however, the Company determined the fair value of each of the two equity grants during the first nine months of 2009 by using the current market price, bid-ask spreads and a marketability discount to determine the fair value of the stock at the time of each of the equity grants. In January 2009, the stock price was listed at $180 and the Company used that price in the Black-Scholes option-pricing model to determine the fair value of the stock option grant in that period. In August 2009, the stock price was listed at $450, but an independent third party had offered $120 to acquire a significant amount of our stock. Since the trading volume was minimal and the $120 value was within the bid-ask spread, the Company assigned a marketability discount to the quoted market price to determine that the fair value of the stock price for that equity grant was $120.

The following table summarizes the assumptions and variables used by us to compute the weighted average fair value of stock option grants:

	For the Nine Months
	Ended September 30,
	2009		2008
Risk-free interest rate	3.45	%	3.45	%
Expected stock price volatility	60.0	%	45.0	%
Expected term until exercise (years)	5		5
Dividends	None		None

For the nine months ended September 30, 2009 and 2008, we estimated the implied volatility for publicly traded options on our common shares as the expected volatility assumption required in the Black-Scholes option-pricing model. The selection of the implied volatility approach was based upon the historical volatility of companies with similar businesses and capitalization and our assessment that implied volatility is more representative of future stock price trends than historical volatility.

Loss Per Share

Basic loss per share ("EPS") is computed by dividing the net loss applicable to common stockholders for the period by the weighted average number of shares of common stock outstanding during the same period. Diluted EPS is computed by dividing the net income applicable to common stockholders for the period by the weighted average number of shares of common stock outstanding and common stock equivalents, which includes warrants and options outstanding during the same period. Since the inclusion of the 22,509 warrants and 4,321 options outstanding as of September 30, 2009 and the 12,201 warrants and 3,922 options outstanding as of September 30, 2008 are anti-dilutive because of losses, the dilutive loss per share is the same as the basic loss per share.

F-11

Income Taxes

Zoo Games was a limited liability company from inception until May 16, 2008, when we converted to a corporation. As a limited liability company, we were not required to provide for any corporate tax. The loss from the Company’s operations was passed to the unit holders via Form K-1 and the unit holders are responsible for any resulting taxes. One of our subsidiaries, Zoo Publishing, was not a limited liability company and we therefore were required to record a corporate tax provision upon the acquisition of Zoo Publishing.

As a corporation, we recognize deferred taxes under the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred income taxes are recognized for differences between the financial statement and tax basis of assets and liabilities at currently enacted statutory tax rates for the years in which the differences are expected to reverse. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when we determine that it is more likely than not that such deferred tax assets will not be realized.

F-12

Fair Market Value of Financial Instruments

In accordance with “Fair Value Measurements and Disclosures,” Topic 820 of the FASB, ASC defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). Topic 820 of the FASB ASC establishes a fair value hierarchy, which prioritizes the inputs used in measuring fair value into three broad levels as follows:

o Level 1 – Unadjusted quoted market prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

o Level 2 – Quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assts or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asst or liability (i.e. interest rates, yield curves, etc.) an inputs that are derived principally from or corroborated by observable market data by correlation or other means

o Level 3 – Unobservable inputs that reflect assumptions about what market participants would use in pricing assets or liabilities based on the best information available.

This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value.

As of September 30, 2009, the carrying value of cash, accounts receivable and due from factor, inventory, prepaid expenses, accounts payable, accrued expenses, due to factor, and advances from customers are reasonable estimates of the fair values because of their short-term maturity. Notes payable are recorded net of the discount which is computed as the difference between the market interest rate that the Company would pay for financing at the time the note is issued and the stated interest rate on the note.

Non-recurring Fair Value Estimates

The Company’s non-recurring fair value measurements recorded during the year ended December 31, 2008 were as follows (in thousands):

			Quoted
			Prices in
			Active		Significant
			Markets for		Other		Significant
	Fair Value at		Identical		Observable		Unobservable
	Measurement		Assets		Inputs		Inputs		Gains
	Date		(Level 1)		(Level 2)		(Level 3)		(losses)
Warrants issued in connection with:Zoo Entertainment Notes	$	5,879	$	-	$	-	$	5,879	$	-
	$	5,879	$	-	$	-	$	5,879	$	-

Non-recurring Level 3 Basis for Valuation

The fair value of the warrants under the Zoo Entertainment Notes (See Note 11) was determined based upon Level 3 inputs. The Company used the income and market valuation approaches to derive the Company’s business enterprise value and then used the Black-Scholes option-pricing model, applying discounts for illiquidity and dilution, to calculate the value of the warrants.

F-13

Recently Issued Accounting Pronouncements

Effective January 1, 2009, the Company adopted ASC Topic 815 which clarifies the determination of whether an instrument (or an embedded feature) is indexed to an entity’s own stock. The adoption of ASC Topic 815 did not have a significant impact on our results of operations or financial position.

Effective June 30, 2009, the Company adopted ASC Topic 855 which provides guidance on management's assessment of subsequent events and the requirement to disclose the date through which subsequent events have been evaluated. The Company has evaluated subsequent events through November 23, 2009 for this quarterly report on Form 10-Q for the quarter ended September 30, 2009. The adoption of ASC Topic 855 did not have any impact on the Company's consolidated financial position or results of operations.

In June 2009, the FASB issued ASC Topic 105 which establishes the FASB Accounting Standards Codification as the single source of authoritative GAAP for all non-governmental entities, with the exception of the SEC and its staff. ASC Topic 105 changes the referencing and organization of accounting guidance and is effective for interim and annual periods ending after September 15, 2009. Since it is not intended to change or alter existing GAAP, the Codification did not have any impact on the Company’s financial condition or results of operations.  Going forward, the Board will not issue new standards in the form of Statements, FASB Staff Positions, or Emerging Issues Task Force Abstracts; instead, it will issue Accounting Standards Updates. The FASB will not consider Accounting Standards Updates as authoritative in their own right; these updates will serve only to update the Codification, provide background information about the guidance, and provide the bases for conclusions on the change(s) in the Codification. In the description of Accounting Standards Updates that follows, references in “italics” relate to Codification Topics and Subtopics, and their descriptive titles, as appropriate.

Accounting Standards Updates Not Yet Effective

In June 2009, an update was made to “Consolidation – Consolidation of Variable Interest Entities.” Among other things, the update replaces the calculation for determining which entities, if any, have a controlling financial interest in a variable interest entity (VIE) from a quantitative based risks and rewards calculation, to a qualitative approach that focuses on identifying which entities have the power to direct the activities that most significantly impact the VIE’s economic performance and the obligation to absorb losses of the VIE or the right to receive benefits from the VIE. The update also requires ongoing assessments as to whether an entity is the primary beneficiary of a VIE (previously, reconsideration was only required upon the occurrence of specific events), modifies the presentation of consolidated VIE assets and liabilities, and requires additional disclosures about a company’s involvement in VIEs. This update will be effective for the company beginning January 1, 2010. Management is currently evaluating the effect that adoption of this update will have, if any, on the company’s consolidated financial position and results of operations when it becomes effective in 2010.

Other Accounting Standards Updates not effective until after September 30, 2009, are not expected to have a significant effect on the company’s consolidated financial position or results of operations.

NOTE 4.   DISCONTINUED OPERATIONS

The loss from discontinued operations for the three and nine months ended September 30, 2009 of $235,000 relates to a write-off of a receivable from the disposition of Zoo Digital that was determined to be uncollectible in the three months ended September 30, 2009.

The loss from discontinued operations for the three and nine months ended September 30, 2008 is summarized as follows:

	(Amounts in Thousands)
	ThreeMonthsEnded September30,2008			NineMonthsEnded September30,2008
Supervillain	$	1,644		$	3,174
Zoo Digital		527			1,204
Repliqa		-			219
Online concept		25			147
Tax benefit		(465	)		(465	)
Loss from discontinued operations	$	1,731		$	4,279

F-14

The revenues from the discontinued operations for the three and nine months ended September 30, 2008 were $951,000 and approximately $1.9 million, respectively.

NOTE 5.   INVENTORY

Inventory consisted of:

	(Amounts in Thousands)
	September 30,		December 31,
	2009		2008
Finished products	$	1,568	$	2,939
Parts and supplies		608		181
Totals	$	2,176	$	3,120

Estimated product returns included in inventory at September 30, 2009 and December 31, 2008 were $122,000 and $337,000, respectively.

NOTE 6.   PREPAID EXPENSES AND OTHER CURRENT ASSETS

Prepaid expense and other current assets consisted of:

	(Amounts in Thousands)
	September30,2009		December31,2008
Vendor advances for inventory	$	3,174	$	555
Prepaid royalties		689		1,072
Income taxes receivable		-		55
Other prepaid expenses		511		442
Totals	$	4,374	$	2,124

NOTE 7.   PRODUCT DEVELOPMENT COSTS

Details of our capitalized product development costs were as follows:

	(Amounts in thousands)
	September 30,		December 31,
	2009		2008
Product development costs, internally developed, net of amortization	$	25	$	170
Product development costs, externally developed, net of amortization		5,714		5,168
Totals	$	5,739	$	5,338

F-15

NOTE 8.   GOODWILL and INTANGIBLE ASSETS, NET

The Company incurred a triggering event as of September 30, 2009 based on the equity infusion of approximately $4.0 million for a 50% ownership in the Company and the conversion of the existing convertible debt during the fourth quarter of 2009. As such, the Company performed an impairment analysis utilizing an approach employing multiple valuation methodologies, including a market approach (market price multiples of comparable companies) and an income approach (discounted cash flow analysis). This approach is consistent with the requirement to utilize all appropriate valuation techniques as described in ASC 820-10-35-24 “Fair Value Measurements and Disclosures.” The values ascertained using these methods were weighted to obtain a total fair value, which was less the carrying value, therefore the Company recorded an impairment charge of $14.7 million to fully impair the goodwill during the third quarter of 2009.

The following table sets forth the components of the intangible assets subject to amortization:

			(Amounts in Thousands)
			September30,2009				December 31, 2008
			(restated)
	Estimated
	Useful		Gross
	Lives		Carrying		Accumulated		Net Book		Net Book
	(Years)		Amount		Amortization		Value		Value
Content		10	$	14,965	$	2,250	$	12,715	$	10,931
Trademarks		10		1,510		271		1,239		1,353
Customer relationships		10		2,749		493		2,256		2,463
Totals			$	19,224	$	3,014	$	16,210	$	14,747

Amortization expense related to intangible assets was $476 and $411 for the three months ended September 30, 2009 and 2008, respectively and was approximately $1.3 million and $1.2 million for the nine months ended September 30, 2009 and 2008, respectively.

In May 2009, we entered into a license agreement with New World IP, LLC (“Licensor”) pursuant to which the Licensor granted to Zoo Publishing all of the Licensor’s rights to substantially all the intellectual property of Empire Interactive Europe, LLC for a minimum royalty of $2.6 million to be paid within two years.  At any time prior to April 1, 2011, Zoo Publishing has the option to purchase all rights in and to the Games.  At any time after April 1, 2011, Licensor has the right to sell all rights in and to the Games to Zoo Publishing. The $2.6 million of costs related to this agreement have been capitalized and are included in Intangible Assets and will be amortized over ten years, while $2.3 million of the liability is recorded in other long-term liabilities and $300,000 is recorded in accrued expenses in the balance sheet.

The following table presents the estimated amortization of intangible assets, based on our present intangible assets, for the next five years as follows:

YearEndingDecember31,	(Amounts in Thousands)
	(restated)
Balance of 2009	$	477
2010		1,922
2011		1,922
2012		1,922
2013		1,922
Thereafter		8,045
Total	$	16,210

NOTE 9.   CREDIT AND FINANCING ARRANGEMENTS, ATARI AGREEMENT AND OTHER CUSTOMER ADVANCES

In connection with the Zoo Publishing acquisition, the Company entered into the following credit and finance arrangements:

F-16

The Company and Zoo Publishing entered into a purchase order financing agreement with Transcap Trade Finance, LLC (“Transcap”) on December 19, 2007. This agreement made the Company a party to a Master Purchase Order Assignment Agreement dated August 20, 2001 pursuant to which Transcap agreed to provide purchase order financing to or for the benefit of Zoo Publishing. Total advances under the factoring arrangement include letters of credit for purchase order financing and is limited to $10.0 million. The amounts outstanding as of September 30, 2009 and December 31, 2008 were approximately $2.9 million and $855,000, respectively. The interest rate is prime plus 4.0% on outstanding advances. As of September 30, 2009 and December 31, 2008, the effective interest rates were 7.25%.  The charges and interest expense on the advances are included in the cost of goods sold in the accompanying condensed consolidated statement of operations.

On April 6, 2009, we entered into an amended and restated purchase order financing arrangement with Wells Fargo Bank, National Association (“Wells Fargo”) pursuant to an amended and restated master purchase order assignment agreement (the “Assignment Agreement”). The Assignment Agreement amended and restated in its entirety the master purchase order assignment agreement between Transcap and Zoo Publishing, dated as of August 20, 2001, as amended.

Pursuant to the Assignment Agreement, the Company will assign purchase orders received from customers to Wells Fargo, and request that Wells Fargo purchase the required materials to fulfill such purchase orders. Wells Fargo, which may accept or decline the assignment of specific purchase orders, will retain us to manufacture, process and ship ordered goods, and will pay us for our services upon Wells Fargo’s receipt of payment from the customers for such ordered goods. Upon payment in full of the purchase order invoice by the applicable customer to Wells Fargo, Wells Fargo will re-assign the applicable purchase order to us. We will pay to Wells Fargo a fee upon their funding of each purchase order and we commit to pay a total fee for twelve months in the aggregate amount of $337,500. If the fees earned during the twelve month period do not exceed $337,500, we are required to pay the difference between the $337,500 and the amounts already paid on the earlier of the twelve month anniversary of the date of the Assignment Agreement, or the date of termination of the Assignment Agreement. Wells Fargo is not obligated to provide purchase order financing under the Assignment Agreement if the aggregate outstanding funding exceeds $5,000,000. The Assignment Agreement is for an initial term of twelve months, and shall continue thereafter for successive twelve month renewal terms unless either party terminates the Assignment Agreement by written notice to the other no later than 30 days prior to the end of the initial term or any renewal term. If the term of the Assignment Agreement is renewed for one or more twelve month terms, for each such twelve month term, we will pay to Wells Fargo a commitment fee in the sum of $337,500, to be offset against actual fees paid by us upon their payment of each purchase order, to be paid on the earlier of the twelve month anniversary of such renewal date or the date of termination of the Assignment Agreement. The initial and renewal commitment fees are subject to waiver if certain product volume requirements are met.

In connection with the Assignment Agreement, on April 6, 2009 we also entered into an amended and restated security agreement and financing statement (the “Security Agreement”) with Wells Fargo. The Security Agreement amends and restates in its entirety that certain security agreement and financing statement, by and between Transcap and Zoo Publishing, dated as of August 20, 2001. Pursuant to the Security Agreement, we granted to Wells Fargo a first priority security interest in certain of our assets as set forth in the Security Agreement, as well as a subordinate security interest in certain other of our assets (the “Common Collateral”), which security interest is subordinate to the security interests in the Common Collateral held by certain of our senior lenders, as set forth in the Security Agreement.

Also in connection with the Assignment Agreement, on April 6, 2009, Mark Seremet, President, Chief Executive Officer and a director of Zoo Entertainment and Zoo Games, and David Rosenbaum, the President of Operations of Zoo Publishing, entered into a Guaranty with Wells Fargo, pursuant to which Messrs. Seremet and Rosenbaum agreed to guaranty the full and prompt payment and performance of the obligations under the Assignment Agreement and the Security Agreement.

On May 12, 2009, the Company entered into a letter agreement with each of Mark Seremet and David Rosenbaum (the “Fee Letters”), pursuant to which, in consideration for Messrs. Seremet and Rosenbaum entering into the Guaranty with Wells Fargo for the full and prompt payment and performance by the Company and its subsidiaries of the obligations in connection with a purchase order financing (the “Loan”), the Company agreed to compensate Mr. Seremet in the amount of $10,000 per month, and Mr. Rosenbaum in the amount of $7,000 per month, for so long as the executive remains employed while the Guaranty and Loan remain in full force and effect. If the Guaranty is not released by the end of the month following termination of employment of either Messrs. Seremet or Rosenbaum, the monthly fee shall be doubled for each month thereafter until the Guaranty is removed.

F-17

Additionally, pursuant to the Fee Letters, the Company agreed to grant under the Company’s 2007 Employee, Director and Consultant Stock Plan, as amended to each of Messrs. Seremet and Rosenbaum, on such date that is the earlier of the conversion of at least 25% of all currently existing convertible debt of the Company into equity, or November 8, 2009 (the earlier of such date, the “Grant Date”), an option to purchase that number of shares of the Company’s common stock equal to 6% and 3% respectively, of the then issued and outstanding shares of common stock, based on a fully diluted current basis assuming those options and warrants that have an exercise price below $240 per share are exercised on that date but not counting the potential conversion to equity of any outstanding convertible notes that have not yet been converted and, inclusive of any options or other equity securities or securities convertible into equity securities of the Company that each may own on the Grant Date. The options shall be issued at an exercise price equal to the fair market value of the Company’s common stock on the Grant Date and pursuant to the Company’s standard form of nonqualified stock option agreement; provided however that in the event the Guaranty has not been released by Wells Fargo Bank as of the date of the termination of the option due to termination of service, the option termination date shall be extended until the earlier of the date of the release of the Guaranty or the expiration of the ten year term of the option. In addition any options owned by Messrs. Seremet and Rosenbaum as of the Grant Date with an exercise price that is higher than the exercise price of the new options shall be cancelled as of the Grant Date. The Company estimated the value of the arrangements to be approximately $200,000 as of September 30, 2009 and is included as compensation in the nine months ended September 30, 2009, and has been included in accrued expenses. Once the options are issued, we will adjust the expense accordingly.  As part of the November 2009 financing, Messrs. Seremet and Rosenbaum agreed to amend their respective Fee Letters, pursuant to which: in the case of Mr. Seremet, the Company will pay to Mr. Seremet a fee of $10,000 per month for so long as the Guaranty remains in full force and effect, but only for a period ending on November 20, 2010; and, in the case of Mr. Rosenbaum, the Company will pay to Mr. Rosenbaum a fee of $7,000 per month for so long as the Guaranty remains in full force and effect, but only for a period ending on November 20, 2010.  In addition, the amended Fee Letters provides that, in consideration of each of their continued personal guarantees, the Company’s Board of Directors has approved an increase in the issuance of an option to purchase (restricted stock or other incentives intended to comply with Section 409A of the Internal Revenue Code, equal to) a 6.25% ownership interest, to each of Mr. Seremet and Mr. Rosenbaum respectively.

Zoo Publishing uses a factor to approve credit and to collect the proceeds from a portion of its sales. In August 2008, Zoo Publishing entered into a factoring agreement with Working Capital Solutions, Inc., which utilizes existing accounts receivable in order to provide working capital to fund all aspects of our continuing business operations. A new factoring agreement was entered into on September 29, 2009 with Working Capital Solutions, Inc.  Under the terms of our factoring and security agreement, we sell our receivables to the factor, with recourse. The factor, in its sole discretion, determines whether or not it will accept each receivable based upon the credit risk factor of each individual receivable or account. Once a receivable is accepted by the factor, the factor provides funding subject to the terms and conditions of the factoring and security agreement. The amount remitted to us by the factor equals the invoice amount of the receivable adjusted for any discounts or allowances provided to the account, less 25% which is deposited into a reserve account established pursuant to the agreement, less allowances and fees. In the event of default, valid payment dispute, breach of warranty, insolvency or bankruptcy on the part of the receivable account, the factor can require the receivable to be repurchased by us in accordance with the agreement. The amounts to be paid by us to the factor for any accepted receivable include a factoring fee of 0.6% for each ten (10) day period the account is open. Since the factor acquires the receivables with recourse, we record the gross receivables including amounts due from our customers to the factor and we record a liability to the factor for funds advanced to us from the factor. During the nine months ended September 30, 2009, we sold $832,000 of receivables to the factor with recourse.  At September 30, 2009, accounts receivable and due from factor included $832,000 of amounts due from our customers to the factor.  The factor had an advance outstanding to the Company of $624,000 which is included in financing arrangements in the current liability section of the condensed consolidated balance sheet. At December 31, 2008, accounts receivable and due from factor did not include any amounts due from our customers to the factor and the factor did not have any advance outstanding to the Company. In connection with the factoring facility, on September 29, 2009, Mark Seremet, President, Chief Executive Officer and a director of the Company and Zoo Games, and David Rosenbaum, the President of Operations of Zoo Publishing, entered into a Guaranty with Working Capital Solutions, Inc., pursuant to which Messrs. Seremet and Rosenbaum agreed to guaranty the full and prompt payment and performance of the obligations under factoring and security agreement.

F-18

Atari Agreement

As a result of a fire in October 2008 that destroyed our inventory and impacted our cash flow from operations, we entered into an agreement with Atari, Inc. (“Atari”). This agreement became effective on October 24, 2008 and provided for Zoo Publishing to sell its products to Atari without recourse and Atari will resell the products to wholesalers and retailers that are acceptable to Atari in North America. The agreement initially expired on March 31, 2009, but was amended to extend the term for certain customers until March 31, 2010. This agreement provided for Atari to prepay to the Company for the cost of goods and pay the balance due within 15 days of shipping the product. Atari’s fees approximate 10% of our standard selling price and they have been recorded as a reduction in revenue. During the three and nine months ended September 30, 2009, we recorded approximately $2.5 million and $23.5 million, respectively, of net sales to Atari.  Atari takes a reserve from the initial payment for potential customer sales allowances, returns and price protection that is analyzed and reviewed within a sixty day period to be liquidated no later than July 31, 2010.  As of September 30, 2009 and December 31, 2008, Atari had prepaid the Company approximately $3.2 million and approximately $1.8 million, respectively, for goods not yet shipped which is recorded as customer advances in current liabilities. Also, as of September 30, 2009 and December 31, 2008, Atari owed the Company $264,000 and approximately $1.8 million, respectively, before allowances, for goods already shipped which are recorded in accounts receivable and due from factor.

Other Customer Advance – Solutions 2 Go, Inc.

On August 31, 2009, Zoo Publishing entered into an Exclusive Distribution Agreement with Solutions 2 Go Inc., a Canadian corporation (“S2G Inc.”) and an Exclusive Distribution Agreement with Solutions 2 Go, LLC, a California limited liability company (“S2G LLC,” and together with S2G Inc., “S2G”), pursuant to which Zoo Publishing granted to S2G the exclusive rights to market, sell and distribute certain video games, related software and products, with respect to which Zoo Publishing owns rights, in the territories specified therein.  In connection with these distribution agreements, on August 31, 2009, the Company entered into an Advance Agreement (the “Advance Agreement”) with S2G, pursuant to which S2G made a payment to the Company in the amount of $1,999,999, in advance of S2G’s purchases of certain products pursuant to these distribution agreements. From August 31, 2009 until recoupment of the advance in full, interest on the outstanding amount shall accrue at the rate of ten percent (10%) per annum. The amount of any unrecouped advance outstanding shall be repaid in its entirety to S2G no later than September 15, 2010. The advance shall be recouped, in whole or in part, from sales generated by S2G of products purchased by S2G under the distribution agreements. A percentage of the gross margin on the S2G Sales shall be applied to a recoupment of the advance until the earlier of (i) the date on which the amount of the unrecouped advance has been reduced to zero or (ii) September 15, 2010, on which any unrecouped advance shall be repaid. As of September 30, 2009, the balance remaining on the advance is $1,986,000 and this is included in customer advances in the current liabilities section of the balance sheet.

Notwithstanding the foregoing, if, at any time prior to the recoupment of the advance in full, the Company receives proceeds in connection with any sale of securities, or otherwise raises additional capital, exceeding an aggregate of five million dollars ($5,000,000), other than under the anticipated qualified financing, (as defined below), the entire unrecouped advance under the advance agreement shall at once become due and payable in full as of the funding date of the additional capital transaction without written notice of acceleration to the Company.  Additional capital transaction shall include, but not be limited to the sale or issuance of any security by the Company, or any subsidiary of the Company, of any kind or character whatsoever, where “security” is given its broadest meaning including stock, warrants, options, convertible notes, and similar instruments of all types.

In  consideration of S2G entering into the advance agreement, the Company agreed to issue to S2G Inc. a warrant to purchase 12,777 shares of the Company’s common stock (or such other number of shares of Common Stock that on the warrant grant date (as defined below), represents 6% of the Company’s modified fully-diluted shares, computed as if all outstanding convertible stock, warrants and stock options that are, directly or indirectly, convertible into Common Stock at a price of $450 or less, have been so converted), upon the occurrence of an anticipated qualified financing, which means (i) the consummation of the sale of shares of Common Stock by the Company which results in aggregate gross proceeds to the Company of at least $4,000,000 and (ii) the conversion of the Company’s senior secured convertible notes, in the aggregate original principal amount of $11,150,000, into shares of Common Stock.  The warrant will have a term of five years and an exercise price equal to $180.  The warrant to acquire 12,777 shares was issued on August 31, 2009.  The warrant, which was issued in connection with the loan, was accounted for as a financing instrument under ASC Topic 470-20-05, “Debt Instruments with Detachable Warrants” and valued at $400,000 using the Black-Scholes model, and this amount will be amortized over a period not to exceed 12 months from the maturity date of the investment through interest expense. For the period ended September 30, 2009, $33,000 of interest expense is recorded in the statement of operations for this advance.

F-19

The advance is guaranteed by Messrs. Seremet, Rosenbaum and another employee.  Messrs. Seremet and Rosenbaum did not receive any additional compensation for this guarantee.  The employee who guaranteed the advance was granted 834 shares of common stock.  The value of the shares issued was computed at $100,000 and is recorded in the general and administrative expenses in the three months ended September 30, 2009.

NOTE 10.   ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

Accrued expenses and other current liabilities consisted of:

	(Amounts in Thousands)
	September 30,		December 31,
	2009		2008
Due to customers	$	612		710
Obligation arising from Zoo Publishing acquisition		93		254
Obligations relating to Cyoob acquisition		100		100
Obligations to compensate current and former employees		650		720
Royalty		888		252
Operating expenses		637		982
Interest		-		81
Totals	$	2,980	$	3,099

NOTE 11.   NOTES PAYABLE

Outstanding notes payable, net of unamortized discounts, are as follows:

	(Amounts in Thousands)
	September 30,		December 31,
	2009		2008
Zoo Entertainment convertible notes, net of discounts attributable to the warrant value of $0 and $1,576	$	11,150	$	9,574
Interest on convertible notes		656		240
3.9% Zoo Publishing notes, net of discount of $0 and $1,030		-		2,536
2.95% note due June 2012 assumed from Zoo Publishing acquisition		300		370
8.25% Wachovia demand note assumed from Zoo Publishing acquisition		-		45
Note assumed from Zoo Publishing acquisition, 12% interest		-		25
Employee loans, payable on demand		-		331
Zoo Publishing employee loans at 4% interest		-		268
Totals		12,106		13,389
Current portion		11,926		11,617
Non-current portion	$	180	$	1,772

The principal and interest amounts for the Zoo Entertainment convertible notes were converted into equity as part of the November 2009 financing.

F-20

The face amounts of the notes payable as of September 30, 2009 are due as follows:

	(Amounts in Thousands)
Year Ending December	Amount Due
Balance of 2009	$	11,200
2010		120
2011		120
2012		10
Total	$	11,450

Zoo Entertainment Notes

On July 7, 2008, as amended on July 15, 2008 and July 31, 2008, the Company entered into a note purchase agreement under which the purchasers agreed to provide loans to the Company in the aggregate principal amount of $9.0 million, in consideration for the issuance and delivery of senior secured convertible promissory notes. In connection with the issuance of such notes, the Company issued to the note holders warrants to purchase 13,637 shares of common stock of the Company. The notes bear an interest rate of five percent (5%) for the one year term of the note commencing from issuance, unless extended. Upon the occurrence of an investor sale, as defined in the notes, the entire outstanding principal amount of the notes and any accrued interest thereon will be automatically converted into shares of common stock of the Company determined by dividing the note balance by the lesser of (i) an amount equal to the price per share of investor stock paid by the purchasers of such shares in connection with the investor sale, or (ii) $1,200; provided, that in the event that the investor sale is for less than $600 per share, then the notes will only be automatically convertible with the consent of the Company.  In connection with the note purchase agreement, the Company satisfied a management fee obligation by issuing additional senior secured convertible promissory notes in the principal amount of $750,000 and warrants to purchase 1,137 shares of common stock of the Company. All of the warrants have a five year term and an exercise price of $6.00 per share. Pursuant to a security agreement, by and among the Company and the purchasers, dated as of July 7, 2008, as amended on August 12, 2008, the Company granted a security interest in all of its assets to each of the purchasers to secure the Company’s obligations under the notes.

On September 26, 2008, the Company entered into a note purchase agreement pursuant to which the purchasers agreed to provide a loan to the Company in the aggregate principal amount of $1.4 million, in consideration for the issuance and delivery of senior secured convertible promissory notes. In connection with the issuance of such notes, the Company also issued warrants to purchase 2,122 shares of common stock of the Company to the note holders. The notes bear an interest rate of five percent (5%) for the time period beginning on September 26, 2008 and ending on September 26, 2009, unless extended. On October 6, 2009, the maturity date was extended to November 2, 2009 and on November 2, 2009, the maturity date was subsequently extended to February 2, 2010.  Upon the occurrence of an investor sale, as defined in the notes, the entire outstanding principal amount of the notes and any accrued interest thereon will be automatically converted into shares of common stock of the Company determined by dividing the note balance by the lesser of (i) an amount equal to the price per share of investor stock paid by the purchasers of such shares in connection with the investor sale, or (ii) $1,200; provided, that in the event that the investor sale is for less than $600 per share, then the notes will only be automatically convertible with the consent of the Company. The warrants have a five year term and an exercise price of $6.00 per share. Pursuant to a security agreement, by and among the Company and the purchasers, dated September 26, 2008, the Company granted a security interest in all of its assets to each of the purchasers to secure the Company’s obligations under the notes.

The total principal amount of all of the notes described above is approximately $11.15 million, $9.8 million of which was incurred prior to the date of the reverse merger. The warrants issued with all the notes were valued at approximately $5.9 million by the Company. We used the income and market valuation approaches to derive the Company’s business enterprise value and then used the Black-Scholes option-pricing model, applying discounts for illiquidity and dilution, to calculate the value of the warrants. The total deferred debt discount of $5.9 million is amortized over the one year life of the notes. Prior to September 12, 2008, 7,576 warrants were exercised and the interest expense related to the discount of these warrants was accelerated. As of September 12, 2008, the deferred debt discount of the existing notes was approximately $2.4 million and the net value of the notes recorded as of September 12, 2008 was approximately $7.8 million. On September 26, 2008, we issued $1.0 million of the notes and 1,516 of the warrants which were valued at $527,000 using consistent valuation methodologies as those used for all the previously issued notes. As of September 30, 2009, the net deferred debt discount of all the notes is $0 and the net value of the notes recorded as of September 30, 2009 is approximately $11.8 million including $656,000 of accrued interest.

F-21

On June 26, 2009, the Company entered into Amendment No. 2 to Senior Secured Convertible Note (“Amendment No. 2”), with the requisite holders (the “Holders”) of the Company’s senior secured convertible notes issued in the aggregate principal amount of $11.15 million.  Pursuant to Amendment No. 2, the parties agreed to extend the maturity date of the notes that were originally scheduled to mature during July 2009 to August 31, 2009, or, if the Company receives comments from the SEC with respect to the Information Statement Pursuant to Section 14(c) (the “Information Statement”) that the Company filed on July 7, 2009 in connection with an amendment to the Company’s Certificate of Incorporation authorizing a sufficient number of shares of the Company’s common stock to permit the conversion of the notes (“Certificate of Amendment”), September 15, 2009. The Company did not receive comments from the SEC with respect to the Information Statement and, as such, the maturity dates of such notes shall be August 31, 2009. Amendment No. 2 also provides that the notes shall automatically convert into shares of the Company’s common stock effective immediately on the date by which the following two events have occurred, regardless of the order in which they occur: (a) the effectiveness of the filing the Certificate of Amendment, and (b) the consummation of a financing by the Company for which such sale results in aggregate gross proceeds to the Company of at least $4.0 million. Notwithstanding, if the notes do not convert on or prior to the revised maturity date, Amendment No. 2 provides that the provisions of Amendment No. 2 with respect to automatic conversion shall become null and void and shall be of no further effect. In consideration of the Holders’ execution and delivery of Amendment No. 2, the Company entered into a letter agreement, dated as of June 26, 2009, pursuant to which the Company granted to the Holders registration rights which require the Company to file with the SEC a registration statement covering the resale of the shares of common stock issuable upon conversion of the notes, within 30 calendar days after receipt of approval of the Company’s stockholders of the Certificate of Amendment or 60 calendar days following the closing of a financing by the Company for which such sale results in aggregate gross proceeds to the Company of at least $4.0 million, whichever is later.  The Company entered into subsequent amendments with the Holders extending the maturity date to November 2, 2009 and then subsequently to February 2, 2010.

On November 20, 2009, the requisite Senior Secured Convertible Note Holders agreed that if the Company raises a minimum of $4.0 million new capital, they will convert their debt into convertible preferred shares of the Company that will ultimately convert into common shares that represent 36.5% of the equity of the Company. As a result of the Company consummating an approximately $4.2 million preferred equity raise on November 20, 2009, upon which approximately $11.8 million of existing debt including related accrued interest converted into convertible preferred equity, the Company will issue shares of Series B Preferred stock to the Senior Convertible Note Holders in exchange for their Notes.

Zoo Publishing Notes

In connection with the acquisition of Zoo Publishing, the Company issued various promissory notes (“Zoo Publishing Note”) in an aggregate of approximately $6.8 million. Approximately $1.8 million of principal was payable at the earlier of the Company’s completion of another round of financing or by December 2008 with the $5.0 million balance to be paid in two installments pursuant to the “Zoo Publishing Note.” The first installment of $2.5 million of principal together with accrued interest at the rate of 3.9% per annum would be due on the earlier of June 18, 2009 and the date on which the Company consummates a round of equity financing of $40.0 million or more. The balance of the Zoo Publishing Note (including accrued interest) would be payable December 18, 2010. In connection with the aforementioned note, the Company recorded a debt discount of approximately $2.3 million. For the three and nine months ended September 30, 2009, amortization of deferred debt discount and interest expense was $0, $294,000, $0 and $64,000, respectively. For the three and nine months ended September 30, 2008, amortization of deferred debt discount and interest expense was $146,000, $754,000, $32,000 and $164,000, respectively. In July 2008, the $6.8 million of notes were restructured and approximately $3.2 million of this debt was converted to common stock of the Company based on fair value and of the remaining $3.6 million, approximately $1.1 million became due September 18, 2009, $113,000 became due September 18, 2010, $2.0 million became due December 18, 2010 and approximately $316,000 became due July 31, 2011.

F-22

In connection with the Settlement Agreement dated June 18, 2009 (See Notes 14 and 18), all the Zoo Publishing Notes were cancelled and no cash payments were required to be made for either the principal amounts of the notes or the interest accrued. The net amount of the obligation relieved for the Zoo Publishing Notes was approximately $3.0 million and is included in the gain on legal settlement on the statement of operations (see Note 14).

In connection with the acquisition of Zoo Publishing, the Company also assumed a liability of $1.2 million as part of the Zoo Publishing purchase price. Other notes payable assumed from the Zoo Publishing acquisition included:

· $200,000 demand note with 12.0% percent interest per annum, callable in six months, minimum guaranteed interest per renewal is $12,000. The note is guaranteed by the Zoo Publishing President. The note was totally paid off by March 31, 2009.

· Zoo Publishing purchased treasury stock from a former employee in December 2006 for the amount of $650,000. The balance on the note as of September 30, 2009 was $300,000; $120,000 is classified as current and $180,000 is classified as long-term. The payments are due monthly and the amount of the payment is $10,000 per month.

NOTE 12.   INCOME TAXES

Through May 15, 2008, the Company and certain of its consolidated subsidiaries were taxed as a partnership under the provisions of the Internal Revenue Code. Accordingly, the losses incurred by the Company and those subsidiaries through May 15, 2008 were allocated to the respective members and reported on their individual tax returns. Effective May 16, 2008, the Company changed its tax status from a partnership to a corporation and, as a result, began filing consolidated corporate tax returns with its domestic subsidiaries. The provision for income taxes is based on income recognized for financial statement purposes and includes the effects of temporary differences between such income and that recognized for tax return purposes as well as the deferred tax assets and liabilities recognized for existing timing items relating to the Company's change in tax status.

The components of income tax benefit for the nine months ended September 30, 2009 are as follows (in thousands):

Current:
Federal	$	—
State		152
Total Current		152
Deferred:
Federal		—
State		(152	)
Total Deferred		(152	)
Total	$	—

We paid $20,000 to various state jurisdictions for income taxes during the nine months ended September 30, 2009.

The reconciliation of income tax benefit computed at the U.S. statutory tax rates to income tax benefit for the nine months ended September 30, 2009 is:

Tax at U.S. federal income tax rates	(34.0	)%
State taxes, net of federal income tax benefit	(1.7	)%
Valuation allowance	4.1	%
Nondeductible expenses and other	31.6	%
	0.0	%

F-23

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities as of September 30, 2009 are as follows (in thousands):

Deferred tax assets:	Current			LongTerm
Net operating loss carried forward	$	-		$	3,778
Capital loss carried forward		-			515
Allowance for doubtful accounts		371			-
Bonus and other accruals		542			36
Interest on convertible notes		260			-
Non-qualified options		-			520
Gross deferred tax assets		1,173			4,849
Valuation allowance		(682	)		-
Net deferred tax assets		491			4,849
Deferred tax liabilities:
Property and equipment		-			(23	)
Intangibles		-			(5,317	)
Total deferred tax liabilities		-			(5,340	)
Net deferred tax asset (liability)	$	491		$	(491	)

The Company has approximately $1.2 million of available capital loss carried forward which expires in 2013. A valuation allowance of approximately $515,000 has been recognized to offset the deferred tax assets related to these carried forward. The Company currently does not have any capital gains to utilize against this capital loss. If realized, the tax benefit of this item will be applied to reduce future capital gains of the Company.  Additionally, a valuation allowance of $167,000 has been recognized to offset the net remaining deferred tax assets in excess of deferred tax liabilities because we cannot reasonably project if and when we will generate enough taxable income to utilize any of the deferred tax assets.

As of September 30, 2009, the Company has U.S. federal net operating loss (NOL) carried forward of approximately $8.4 million which are available to be used to offset taxable U.S. income during the carried forward period. The federal NOL will begin to expire in 2028. The Company has various state net operating loss carried forward of approximately $9.4 million which will be available to offset taxable state income during the carried forward period. The state NOL will also begin to expire in 2028.  The tax benefit of these items is reflected in the above table of deferred tax assets and liabilities.  Generally, Section 382 of the Internal Revenue Code imposes limits on the utilization of net operating loss carryforwards if the Company experiences a greater than 50% change of ownership in a three year period.  The Company will conduct a study to determine if it has had the requisite change of ownership for section 382 to apply.  If the requisite change of ownership has occurred or occurs in the future, the utilization of the net operating loss carryforwards may be limited.

NOTE 13.  STOCKHOLDERS’ EQUITY (DEFICIENCY) AND STOCK-BASED COMPENSATION ARRANGEMENTS

Common Stock

The Company has authorized 250,000,000 shares of common stock, par value $0.001, and 5,000,000 preferred shares, par value $0.001. As of September 30, 2009, there were 65,710 shares of common stock issued and 52,707 shares of common stock outstanding.

On June 26, 2009, our Board of Directors and stockholders holding approximately 63.6% of our outstanding common stock approved an amendment to our Certificate of Incorporation to increase the number of authorized shares of common stock from 75,000,000 shares to 250,000,000 shares (the “Share Increase”). The consents we have received constitute the only stockholder approval required for the Share Increase under the Delaware General Corporation Law (the “DGCL”) and our existing Certificate of Incorporation and Bylaws. Pursuant to Rule 14c-2 of the Securities Exchange Act of 1934, as amended, stockholder approval of these amendments will become effective on or after such date that is approximately 20 calendar days following the date we first mailed the Information Statement to our stockholders. After such date, the board of directors may implement the Share Increase at any time, at its discretion, by filing a Certificate of Amendment to our Certificate of Incorporation with the Secretary of State of the State of Delaware. The Information Statement was first sent to our stockholders on July 31, 2009. The board of directors effectuated the Share Increase on August 26, 2009.

F-24

In conjunction with the settlement of the litigation with the sellers of Zoo Publishing on June 18, 2009 (see Notes 14 and 17), the sellers returned 9,274 shares of common stock to the Company.  These shares were valued at $120, based on the bid-ask spread of the Company’s stock price and assigning a marketability discount to the quoted market price of the stock, and were recorded as treasury shares.

Options

As of December 31, 2008, the Company’s 2007 Employee, Director and Consultant Stock Plan allowed for an aggregate of 1,667 shares of common stock with respect to which stock rights may be granted and a 417 maximum number of shares of common stock with respect to which stock rights may be granted to any participant in any fiscal year. As of December 31, 2008, an aggregate of 1,625 shares of restricted common stock of the Company are outstanding under the Company’s 2007 Employee, Director and Consultant Stock Plan, and 42 shares of common stock were reserved for future issuance under this plan.

On January 14, 2009, the Company’s Board of Directors approved and adopted an amendment to the 2007 Employee, Director and Consultant Stock Plan, which increased the number of shares of common stock that may be issued under the plan from 1,667 shares to 6,667 shares, and increased the maximum number of shares of common stock with respect to which stock rights may be granted to any participant in any fiscal year from 417 shares to 1,250 shares. All other terms of the plan remain in full force and effect.

On January 14, 2009, the Company granted Mr. Seremet an option to purchase 1,250 shares of the Company’s common stock at an exercise price of $180 per share, pursuant to the Company’s 2007 Plan, as amended. There were no other options issued during the nine months ended September 30, 2009.

On May 12, 2009, the Company entered into a letter agreement with each of Mark Seremet and David Rosenbaum, pursuant to which, in consideration for Messrs. Seremet and Rosenbaum entering into a Guaranty with Wells Fargo for the full and prompt payment and performance by the Company and its subsidiaries of the obligations in connection with a purchase order financing (the “Loan”) (see Note 18), the Company agreed to grant under the Company’s 2007 Employee, Director and Consultant Stock Plan, as amended to each of Messrs. Seremet and Rosenbaum, on such date that is the earlier of the conversion of at least 25% of all currently existing convertible debt of the Company into equity, or November 8, 2009 (the earlier of such date, the “Grant Date”), an option to purchase that number of shares of the Company’s common stock equal to 6% and 3% respectively, of the then issued and outstanding shares of common stock, based on a fully diluted current basis assuming those options and warrants that have an exercise price below $240 per share are exercised on that date but not counting the potential conversion to equity of any outstanding convertible notes that have not yet been converted and, inclusive of any options or other equity securities or securities convertible into equity securities of the Company that each may own on the Grant Date. The options shall be issued at an exercise price equal to the fair market value of the Company’s common stock on the Grant Date and pursuant to the Company’s standard form of nonqualified stock option agreement; provided however that in the event the Guaranty has not been released by Wells Fargo as of the date of the termination of the option due to termination of service, the option termination date shall be extended until the earlier of the date of the release of the Guaranty or the expiration of the ten year term of the option. In addition any options owned by Messrs. Seremet and Rosenbaum as of the Grant Date with an exercise price that is higher than the exercise price of the new options shall be cancelled as of the Grant Date. The Company determined the fair value of the option grant obligation by using the Black-Scholes option-pricing model using the current market price, bid-ask spreads and a marketability discount.  In August 2009, the stock price was listed at $450, but an independent third party had offered $120 to acquire a significant amount of our stock. Since the trading volume was minimal and the $120 value was within the bid-ask spread, the Company assigned a marketability discount to the quoted market price to determine that the fair value of the stock price for that equity grant commitment to be $120. The amount related to this equity grant commitment that was included in general and administrative expense as of September 30, 2009 was approximately $200,000.

F-25

As part of the November 2009 financing, Messrs. Seremet and Rosenbaum agreed to amend their respective letter agreements, pursuant to which, in consideration of each of their continued personal guarantees, the Company’s Board of Directors has approved an increase in the issuance of an option to purchase (restricted stock or other incentives intended to comply with Section 409A of the Internal Revenue Code, equal to) a 6.25% ownership interest, to each of Mr. Seremet and Mr. Rosenbaum respectively.

A summary of the status of the Company’s outstanding stock options as of September 30, 2009 and changes during the nine months ended September 30, 2009 is presented below:

				Weighted
				Average
	Number Of			Exercise
	Shares			Price
Outstanding January 1, 2009		3,895		$	1,056
Granted		1,250		$	180
Canceled		(824	)	$	1,176
Exercised		-			-
Outstanding at September 30, 2009		4,321		$	774
Options exercisable at September 30, 2009		2,836		$	1,104

The fair value of options granted during the period was approximately $225,000.

The following table summarizes information about outstanding stock options at September 30, 2009:

	Options Outstanding						Options Exercisable
			Weighted-
			Average		Weighted-				Weighted-
			Remaining		Average				Average
Range of	Number		Contractual		Exercise		Number		Exercise
Exercise Prices	Outstanding		Life (Years)		Price		Exercisable		Price
$1,548		281		3.7	$	1,548		281	$	1,548
$1,350		352		4.0	$	1,350		117		1,350
$912		2,438		3.9	$	912		2,438	$	912
$180		1,250		4.2	$	180		-		-
$180 to $1,548		4,321		4.0	$	774		2,836	$	1,104

The following table summarizes the activity of non-vested outstanding stock options as of September 30, 2009 and during the nine months ended September 30, 2009:

				Weighted- Average		Weighted- Average Remaining
	Number			Fair Value at		Contractual Life
	Outstanding			Grant Date		(Years)
Non-Vested shares at December 31, 2008		703		$	1,350		4.7
Options Granted		1,250		$	180		4.2
Options Vested		(117	)		1,350		-
Options forfeited or expired		(351	)		1,350		-
Non-Vested shares at September 30, 2009		1,485		$	474		4.3

F-26

 As of September 30, 2009, there was approximately $185,000 of unrecognized compensation cost related to non-vested stock option awards, which is expected to be recognized over a remaining weighted-average vesting period of 2.0 - 2.2 years.

The intrinsic value of options outstanding at September 30, 2009 is $0.

Warrants

On August 31, 2009, in consideration of Solutions 2 GO Inc. entering into an advance agreement with the Company, we issued to Solutions 2 GO Inc. a warrant to purchase 12,777 shares of the Company’s common stock, par value $0.001 per share. The warrants have a term of five years and an exercise price equal to $180.

As of September 30, 2009, there were 22,509 warrants outstanding. All are currently exercisable and have a five-year life, expiring in 2012 through 2014.

A summary of the status of the Company’s outstanding warrants as of September 30, 2009 and changes during the nine months then ended is presented below:

	Number Of			Weighted Average Exercise
	Warrants			Price
Outstanding at beginning of period		10,869		$	438
Granted		12,777		$	180
Canceled		-			-
Exercised		(1,137	)	$	6
Outstanding at end of period		22,509		$	312
Warrants exercisable at end of period		22,509		$	312

The following table summarizes information about outstanding warrants at September 30, 2009:

	Warrants Outstanding
			Weighted-
			Average		Weighted-
			Remaining		Average
Range of	Number		Contractual		Exercise
Exercise Prices	Outstanding		Life (Years)		Price
$1,704		2,383		3.3	$	1,704
1,278		531		3.4		1,278
180		12,777		4.9		180
6		6,818		3.9		6
$6 to $1,704		22,509		4.4	$	312

F-27

NOTE 14.  GAIN ON LEGAL SETTLEMENT

On June 18, 2009, we settled a lawsuit brought by the former sellers of Zoo Publishing, resulting in a net gain on legal settlement of approximately $4.3 million. (See Note 17)

The settlement eliminated the following Company’s obligations totaling $3,925,000:

· outstanding notes with a face value of $3,565,900, discounted as of June 18, 2009 for $736,000 and interest accrued of $219,000

· employee loans totaling $574,000

· other obligations for an aggregate amount of $302,000

In conjunction with the settlement of the litigation with the sellers of Zoo Publishing, the sellers returned 9,274 shares of common stock to the Company. These treasury shares were valued at $120 and included as part of the gain on legal settlement for approximately $1.1 million.

The Company’s remaining cash obligations and litigation expense amounted to approximately $710,000, resulting in a total net gain on settlement of approximately $4.3 million.

NOTE 15.   INSURANCE RECOVERY

During the 2009 period, our third party warehouse received $860,000 from their insurance company relating to losses incurred by us from a fire in October 2008.  Those proceeds were applied against other amounts due to the third party warehouse by reducing our payables and are reported as other income in the statement of operations.

NOTE 16.   INTEREST, NET

	(Amounts in Thousands)
	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2009		2008		2009		2008
Interest arising from amortization of debt discount	$	180	$	1,205	$	1,870	$	1,813
Interest on various notes		190		349		533		725
Less interest income		-		-		-		(5	)
Interest expense, net	$	370	$	1,554	$	2,403	$	2,533

NOTE 17.   SUPPLEMENTAL CASH FLOW INFORMATION

Supplemental cash flow information for the nine months ended September 30, 2009 and 2008 is as follows:

	(Amounts in Thousands)
	2009			2008
	(restated)
Changes in other assets and liabilities:
Accounts receivable and due from factor	$	(1,422	)	$	(4,020	)
Inventory		944			(154	)
Prepaid expenses and other current assets		(2,118	)		(3,532	)
Product development costs		(401	)		(3,854	)
Accounts payable		(112	)		989
Customer advances		1,413
Accrued expenses and other current liabilities		(716	)		248
Net changes in other assets and liabilities	$	(2,412	)	$	(10,323	)
Cash paid during the period of interest	$	-		$	92
Cash paid during the period of taxes	$	20		$	6
Non-cash investing and financing activities:
Receipt of 9,274 shares for partial settlement of litigation	$	1,113		$	-
Notes and obligations relieved for partial settlement of litigation	$	3,925		$	-
Acquisition of Intangible for long-term obligation	$	2,600		$	-
Issuance of 2,634 shares for partial payment of Zoo Digital	$	-		$	4,086
Exchange of debt for equity at original face value	$	-		$	6,266

F-28

NOTE 18.   LITIGATION

On February 19, 2009, Susan Kain Jurgensen, Steven Newton, Mercy Gonzalez, Bruce Kain, Wesley Kain, Raymond Pierce and Cristie Walsh filed a complaint against Zoo Publishing, Zoo Games and Zoo in the Supreme Court of the State of New York, New York County, index number 09 / 102381 alleging claims for breach of certain loan agreements and employment agreements, intentional interference and fraudulent transfer. The complaint sought compensatory damages, punitive damages and preliminary and permanent injunctive relief, among other remedies. On June 18, 2009, we reached a settlement whereby we agreed to pay to the plaintiffs an aggregate of $560,000 (the “Settlement Amount”) in full satisfaction of the disputed claims, without any admission of any liability of wrongdoing as follows: (a) $300,000 on June 26, 2009; (b) $60,000 on or before the earlier of (i) the date that is 90 days from June 18, 2009 or (ii) the date the Company obtains new and available financing, including any amounts currently held in escrow that will be released from escrow after June 18, 2009, in any form and from any source, in an amount totaling at least $2,000,000; (c) $100,000 on or before December 18, 2009; and (d) $100,000 on or before June 18, 2010. To date, $300,000 of the Settlement Amount has been paid to the plaintiffs. The Zoo Publishing Notes and all other notes, employment,  agreements, loan agreements, options, warrants and other agreements  relating to the plaintiffs (except with respect to that certain Employment Agreement between Zoo Publishing and Cristie Walsh) were terminated and all outstanding obligations of the Company related to these agreements were cancelled. In addition, the plaintiffs returned to us an aggregate of 9,274 shares of our common stock owned by them prior to such date.

In connection with an action brought by Revolution Partners, LLC against Zoo Games, Inc., the claimant Revolution Partners, LLC was seeking money damages for claimed investment banking or finder’s fee purportedly earned in connection with a reverse merger transaction and related financing that we entered into in the third quarter of 2008. We settled this claim in June 2009 for $140,000, of which $120,000 was paid as of September 30, 2009.  The balance is included in accounts payable as of September 30, 2009 and was paid in October 2009.

We are also involved in various other legal proceedings and claims incident to the normal conduct of our business. Although it is impossible to predict the outcome of any legal proceeding and there can be no assurances, we believe that our legal proceedings and claims, individually and in the aggregate, are not likely to have a material adverse effect on our financial condition, results of operations or cash flows.

NOTE 19.   RELATED PARTY TRANSACTIONS

We leased office space in New York from 575 Broadway Associates, LLC, a company owned principally by one of our principal investors, from April 2007 to October 2008. We paid rent expense of $0 and $209,000 during the nine months ended September 30, 2009 and 2008, respectively, to this related party.

Certain Zoo Publishing employees loaned us an aggregate of up to $765,000 in 2008 on a short-term basis. The Company accrued interest at 4% per annum and all amounts were cancelled as part of the Settlement Agreement (see Note 11).

F-29

On April 6, 2009, we entered into an amended and restated purchase order financing arrangement with Wells Fargo Bank, National Association (“Wells Fargo”) pursuant to an amended and restated master purchase order assignment agreement (the “Assignment Agreement”). In connection with the Assignment Agreement, on April 6, 2009 we also entered into an amended and restated security agreement and financing statement (the “Security Agreement”) with Wells Fargo, pursuant to which we granted to Wells Fargo a first priority security interest in certain of our assets as set forth in the Security Agreement, as well as a subordinate security interest in certain other of our assets (the “Common Collateral”), which security interest is subordinate to the security interests in the Common Collateral held by certain of our senior lenders, as set forth in the Security Agreement. Also in connection with the Assignment Agreement, on April 6, 2009, Mark Seremet, President and Chief Executive Officer of Zoo Games and a director of Zoo Entertainment, and David Rosenbaum, the President of Zoo Publishing, entered into a Guaranty with Wells Fargo, pursuant to which Messrs. Seremet and Rosenbaum agreed to guaranty the full and prompt payment and performance of the obligations under the Assignment Agreement and the Security Agreement. On May 12, 2009, we entered into a letter agreement with each of Mark Seremet and David Rosenbaum (the “Fee Letters”), pursuant to which, in consideration for Messrs. Seremet and Rosenbaum entering into the Guaranty with Wells Fargo for the full and prompt payment and performance by the Company and its subsidiaries of the obligations in connection with a purchase order financing (the “Loan”), we agreed to compensate Mr. Seremet in the amount of $10,000 per month, and Mr. Rosenbaum in the amount of $7,000 per month, for so long as the executive remains employed while the Guaranty and Loan remain in full force and effect. If the Guaranty is not released by the end of the month following termination of employment of either Messrs. Seremet or Rosenbaum, the monthly fee shall be doubled for each month thereafter until the Guaranty is removed.

Additionally, pursuant to the Fee Letters, we agreed to grant under the Company’s 2007 Employee, Director and Consultant Stock Plan, as amended to each of Messrs. Seremet and Rosenbaum, on such date that is the earlier of the conversion of at least 25% of all currently existing convertible debt of the Company into equity, or November 8, 2009 (the earlier of such date, the “Grant Date”), an option to purchase that number of shares of our common stock equal to 6% and 3% respectively, of the then issued and outstanding shares of common stock, based on a fully diluted current basis assuming those options and warrants that have an exercise price below $240 per share are exercised on that date but not counting the potential conversion to equity of any outstanding convertible notes that have not yet been converted and, inclusive of any options or other equity securities or securities convertible into our equity securities that each may own on the Grant Date. The options shall be issued at an exercise price equal to the fair market value of our common stock on the Grant Date and pursuant to our standard form of nonqualified stock option agreement; provided however that in the event the Guaranty has not been released by Wells Fargo Bank as of the date of the termination of the option due to termination of service, the option termination date shall be extended until the earlier of the date of the release of the Guaranty or the expiration of the ten year term of the option. In addition, any options owned by Messrs. Seremet and Rosenbaum as of the Grant Date with an exercise price that is higher than the exercise price of the new options shall be cancelled as of the Grant Date.  As part of the November 2009 financing, Messrs. Seremet and Rosenbaum agreed to amend their respective Fee Letters, pursuant to which: in the case of Mr. Seremet, the Company will pay to Mr. Seremet a fee of $10,000 per month for so long as the Guaranty remains in full force and effect, but only for a period ending on November 20, 2010; and, in the case of Mr. Rosenbaum, the Company will pay to Mr. Rosenbaum a fee of $7,000 per month for so long as the Guaranty remains in full force and effect, but only for a period ending on November 20, 2010.  In addition, the amended Fee Letters provides that, in consideration of each of their continued personal guarantees, the Company’s Board of Directors has approved an increase in the issuance of an option to purchase (restricted stock or other incentives intended to comply with Section 409A of the Internal Revenue Code, equal to) a 6.25% ownership interest, to each of Mr. Seremet and Mr. Rosenbaum respectively.

NOTE 20.   SUBSEQUENT EVENTS

On November 2, 2009, the Company entered into Amendment No. 5 to Senior Secured Convertible Note with the requisite holders of the Company’s outstanding senior secured convertible notes issued in the aggregate principal amount of $11,150,000.  The amendment further extends the maturity date of the notes to February 2, 2010.  Also, the amendment provides that the notes shall automatically convert into shares of common stock upon the consummation of a sale of shares of common stock that results in aggregate gross proceeds to the Company of at least $4,000,000, at a price per share equal to $120.   Notwithstanding, if the notes do not convert on or prior to February 2, 2010, the amendment provides that the provisions of the notes, as amended, with respect to automatic conversion shall become null and void and shall be of no further effect.

F-30

On November 20, 2009, the Company entered into Amendment No. 6 to Senior Secured Convertible Note with the requisite holders of the Company’s outstanding senior secured convertible notes issued in the aggregate principal amount of $11,150,000.  The amendment provides that, among other things, the outstanding principal balance and all accrued and unpaid interest under the notes shall convert into shares of the Company’s Series B Preferred Stock upon the consummation of an investor sale that results in aggregate gross proceeds to the Company of at least $4,000,000, at a rate of one (1) share of Series B Preferred Stock for each $10.00 of value of the note.   Moreover, the amendment provides that the notes shall no longer be deemed to be outstanding and all rights with respect to the notes shall immediately cease and terminate upon automatic conversion, except for the right of each holder to receive the shares to which it is entitled as a result of such conversion.

On November 20, 2009, the Company entered into a securities purchase agreement (the “SPA”) with certain investors, consummating an approximately $4.2 million convertible preferred equity raise, pursuant to which the Company will issue Series A Preferred Stock that will convert into common shares of the Company upon an increase in sufficient authorized common shares, representing 50% of the equity of the Company. The Series A Preferred Stock will have a rate of one (1) share of Series A Preferred Stock for each $2.50 of value of the investment amount. In addition, on November 20, 2009, the lead investor under the SPA, will receive a warrant to purchase shares of the Company’s common stock, par value $0.001 per share.   Moreover, Messrs. Seremet and Rosenbaum agreed to amend their respective fee letters, pursuant to which: in the case of Mr. Seremet, the Company will pay to Mr. Seremet a fee of $10,000 per month for so long as the personal guarantees in connection with certain financing arrangements remain in full force and effect, but only for a period ending on November 20, 2010; and, in the case of Mr. Rosenbaum, the Company will pay to Mr. Rosenbaum a fee of $7,000 per month for so long as the personal guarantees in connection with certain financing arrangement remains in full force and effect, but only for a period ending on November 20, 2010.  In addition, the amended Fee Letters provides that, in consideration of each of their continued personal guarantees, the Company’s Board of Directors has approved an increase in the issuance of an option to purchase (restricted stock or other incentives intended to comply with Section 409A of the Internal Revenue Code, equal to) a 6.25% ownership interest, to each of Mr. Seremet and Mr. Rosenbaum respectively.  In addition, as a result of the Company consummating an approximately $4.2 million preferred equity raise, the Company will convert approximately $11.8 million of existing debt and related accrued interest into Series B Preferred Stock during the fourth quarter of 2009. The immediate effect of this transaction on the Balance Sheet is to eliminate $11.8 million of notes payable, including interest, in the current liability section and to record $11.8 million of Series B Preferred Stock as a component of the stockholders’ equity section.  The Series A Preferred Stock and the Series B Preferred Stock will automatically convert into common shares of the Company upon a sufficient increase in authorized common shares of the Company. On a pro forma basis at September 30, 2009, as a result of both the equity infusion of $4.2 million and the debt conversion of $11.8 million, stockholders’ equity would have increased from $171,000 to approximately $16.2 million and total liabilities would have decreased from approximately $32.8 million to approximately $21.0 million.

NOTE 21.   RESTATEMENT OF SEPTEMBER 30, 2009 FINANCIAL STATEMENTS

The Company incurred a triggering event as of September 30, 2009 based on the equity infusion of approximately $4.0 million for 50% ownership in the Company and the conversion of the existing convertible debt during the fourth quarter of 2009. For the September 30, 2009 financial statements, the Company estimated impairment of goodwill at $14.7 million and impairment of other intangible assets at $7.3 million for a total impairment charge of $22.0 million. In accordance with ASC 820-10-35-24 “Fair Value Measurements and Disclosures”, the Company performed an impairment analysis and concluded that the resulting impairment of goodwill is $14.7 million and there should be no impairment of other intangible assets. Therefore, the Company has restated its September 30, 2009 financial statements to reflect this reduction in impairment of other intangible assets of approximately $7.3 million.

In addition, the Company erroneously reported $2.0 million proceeds from a loan for a customer advance in other changes in assets and liabilities, net in the operating activities section of the statement of cash flows for the nine months ended September 30, 2009. It should be included in the financing activities section of the statement of cash flows and the statement of cash flows has been restated accordingly.

The effects of our restatement on previously reported unaudited condensed consolidated financial statements as of September 30, 2009 are summarized as follows:

The effects on the Condensed Consolidated Balance Sheet as of September 30, 2009 (in thousands):

F-31

	September 30, 2009
	(as previously reported)			(restated)
Selected Balance Sheet Data:
Intangible assets, net	$	8,914		$	16,210
Total assets		25,713			33,009
Accumulated deficit		(55,967	)		(48,671	)
Total stockholders’ equity (deficiency)		(7,125	)		171

The following table reflects the impact of the restatements on the Condensed Consolidated Statements of Operations (in thousands except per share amounts):

	Three Months Ended September 30, 2009
	(as previously reported)			(restated)
Selected Statement of Operations Data:
Impairment of goodwill and other intangible assets (as restated, goodwill only)	$	22,000		$	14,704
Total operating expenses		24,802			17,506
Loss from operations		(22,881	)		(15,585	)
Loss from continuing operations		(22,391	)		(15,095	)
Net loss		(22,626	)		(15,330	)
Net loss per share – basic and diluted		(435	)		(295	)
Weighted average shares outstanding – basic and diluted		52,023			52,023

	Nine Months Ended September 30, 2009
	(as previously reported)			(restated)
Selected Statement of Operations Data:
Impairment of goodwill and other intangible assets (as restated, goodwill only)	$	22,000		$	14,704
Total operating expenses		30,826			23,530
Loss from operations		(26,577	)		(19,281	)
Loss from continuing operations		(23,792	)		(16,496	)
Net loss		(24,027	)		(16,731	)
Net loss per share – basic and diluted		(422	)		(294	)
Weighted average shares outstanding – basic and diluted		56,878			56,878

The following table reflects the impact of the restatements on the Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2009 (in thousands):

	Nine Months Ended September 30, 2009
	(as previously reported)			(restated)
Selected Cash Flow Data:
Net loss	$	(24,027	)	$	(16,731	)
Loss from continuing operations		(23,792	)		(16,496	)
Impairment of goodwill and other intangible assets (as restated, goodwill only)		22,000			14,704
Other changes in assets and liabilities, net		(412	)		(2,412)
Net cash used in continuing operations		(2,723	)		(4,723)
Proceeds from Solutions 2 Go note for customer advance		-			2,000
Net cash provided by financing activities		2,661			4,661

F-32

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

AND RESULTS OF OPERATIONS

In this section, references to “we,” “us,” “our,” “ours,” and “the Company” refer to Zoo Entertainment, Inc. (formerly known as Driftwood Ventures, Inc.) and its operating and wholly-owned subsidiary, Zoo Games, Inc. (formerly known as Green Screen Interactive Software, Inc.) and its operating and wholly owned subsidiaries, Zoo Publishing, Inc. (formerly known as Destination Software, Inc.) and Zoo Entertainment Europe Ltd.

The following discussion should be read in conjunction with, and is qualified in its entirety by, the financial statements and the notes thereto included in this report. This discussion contains certain forward-looking statements that involve substantial risks and uncertainties. When used in this report, the words "anticipate," "believe," "estimate," "expect” and similar expressions as they relate to our management or us are intended to identify such forward-looking statements. Our actual results, performance or achievements could differ materially from those expressed in, or implied by, these forward-looking statements. Historical operating results are not necessarily indicative of the trends in operating results for any future period.

Recent Events

On November 20, 2009, we consummated a convertible preferred equity raise of approximately $4.2 million and converted approximately $11.8 million of debt, including related accrued interest, to convertible preferred equity.  The convertible preferred equity will convert to common shares as soon as we have the sufficient number of common shares authorized.  This transaction eliminates all of our long term convertible debt and significantly improves our working capital position.

Background and History

We are a developer, publisher and distributor of video game software for use on major platforms including Nintendo’s Wii, DS, GBA, Sony’s PSP and PlayStation 2. In addition, we intend to publish packaged entertainment software titles for use on a variety of other gaming platforms, including Sony’s PlayStation 3 and Microsoft’s Xbox 360. We will also seek to create and sell downloadable games for Microsoft’s Xbox Live Arcade, Sony’s PlayStation 3 Network, Nintendo’s Virtual Console, iPhone and for use on personal computers (PCs). Our current video game titles are targeted at various demographics, primarily at a lower-priced “value” title. In some instances, these titles are based on licenses of well known properties and, in other cases based on original properties. We collaborate and enter into agreements with content providers and video game development studios for the creation of our video games.

Zoo Entertainment, Inc. was originally incorporated in the State of Nevada on February 13, 2003 under the name Driftwood Ventures, Inc. On December 20, 2007, through a merger, the Company reincorporated in the State of Delaware as a public shell company with no operations.

On July 7, 2008, the Company entered into an Agreement and Plan of Merger, as subsequently amended on September 12, 2008 (the “Merger Agreement”) with DFTW Merger Sub, Inc., a Delaware corporation and a wholly-owned subsidiary of the Company (“Merger Sub”), Zoo Games and a stockholder representative, pursuant to which Merger Sub would merge with and into Zoo Games, with Zoo Games as the surviving corporation through an exchange of common stock of Zoo Games for common stock of the Company (the “Merger”).

1

On September 12, 2008, the Company, Merger Sub, Zoo Games and the stockholder representative completed the Merger and each outstanding share of Zoo Games common stock, $0.001 par value per share (the “Zoo Games Common Stock”), on a fully-converted basis, converted automatically into and became exchangeable for shares of the Company’s common stock, $0.001 par value per share, based on an exchange ratio equal to 7.023274. In addition, each of the 559 options to purchase shares of Zoo Games Common Stock (the “Zoo Games Options”) outstanding under Zoo Games’ 2008 Long-Term Incentive Plan were assumed by the Company, subject to the same terms and conditions as were applicable under such plan immediately prior to the Merger, and converted into 405 options to purchase shares of the Company’s common stock at an exercise price of $1,548 per share, 703 options to purchase shares of the Company’s common stock at an exercise price of $1,350 per share and 2,814 options to purchase shares of the Company’s common stock at an exercise price of $912 per share. The 411 warrants to purchase shares of Zoo Games Common Stock outstanding at the time of the Merger (the “Zoo Games Warrants”) were assumed by the Company and converted into 2,383 warrants to acquire shares of the Company’s common stock at an exercise price of $1,704 and 531 warrants to acquire shares of the Company’s common stock at an exercise price of $1,278 per share. The merger consideration consisted (i) 43,498 shares of the Company’s common stock, (ii) the reservation of 3,922 shares of the Company’s common stock that are required for the assumption of the Zoo Games Options and (iii) the reservation of 2,914 shares of the Company’s common stock that are required for the assumption of the Zoo Games Warrants.

Upon the closing of the Merger, as the sole remedy for the Zoo Games stockholders’ indemnity obligations, on behalf of the Zoo Games stockholders pursuant to the Merger Agreement, the Company deposited 4,350 shares of the Company’s common stock, otherwise payable to such stockholders, into escrow to be held by the escrow agent in accordance with the terms and conditions of an escrow agreement.

Effective as of the closing of the Merger, Zoo Games became the Company’s wholly-owned subsidiary. As a result thereof, the historical and current business operations of Zoo Games now comprise the Company’s principal business operations.

Zoo Games is treated as the acquirer for accounting purposes in this reverse merger and the financial statements of the Company represent the historical activity of Zoo Games and consolidate the activity of Zoo beginning on September 12, 2008, the date of the reverse merger.

Zoo Games commenced operations in March 2007 as Green Screen Interactive Software, LLC, a Delaware limited liability company, and in May 2008, converted to a Delaware corporation. On August 14, 2008, it changed its name to Zoo Games, Inc. Since its initial organization and financing, Zoo Games embarked on a strategy of partnering with and/or acquiring companies with compelling intellectual property, distribution capabilities, and/or management with demonstrated records of success.

In June 2007, Zoo Games acquired the assets of Supervillain Studios, Inc. which were held by the wholly-owned subsidiary of Zoo Games, Supervillain Studios, LLC. The acquisition provided Zoo Games with access to proprietary high end casual gaming content, established video game designers, technical experts and producers capable of providing Zoo Games with high quality, original casual games. On July 22, 2008, Zoo Games released Order Up!, its first offering from Supervillain. In our effort to refocus our cash on our core business, the Company sold the assets of Supervillain Studios LLC back to its original owners on September 16, 2008.

In December 2007, Zoo Games acquired the capital stock of Zoo Publishing. The acquisition of Zoo Publishing provided Zoo Games with a profitable core business, North American distribution, and further enhanced its experienced management team. Zoo Publishing distributes software titles throughout North America and generated over $30 million in annual revenue in 2007. Zoo Publishing expects to exploit its development expertise, in combination with its sales, marketing and licensing expertise, to target the rapidly expanding market for casual games, particularly on Nintendo’s platforms, where Zoo Publishing has experienced considerable success. By nurturing and growing this business unit, Zoo Games believes it will be able to rapidly build a much larger distribution network, enabling it to place a significant number of software titles with major retailers.

In April 2008, Zoo Games acquired the capital stock of Zoo Digital Publishing Limited (“Zoo Digital”), a business operated in the United Kingdom. This acquisition provided Zoo Games with a profitable core business in the United Kingdom, European distribution, and further enhanced its experienced management team. Zoo Digital distributes software titles throughout Europe and generated over $6.8 million in annual revenue in 2007. In our effort to refocus our cash on our core business operations, the Company sold Zoo Digital back to its original owners on November 28, 2008.

In June 2009, the Company formed a new company in the United Kingdom that is a 100% owned subsidiary of Zoo Games called Zoo Entertainment Europe Ltd. (“Zoo Europe”) that will focus on the sales and distribution of our products in Europe. Zoo Europe incurred initial start-up costs and began to record revenues during the quarter ended September 30, 2009.  The activity of Zoo Europe is immaterial through the period ended September 30, 2009, and the Company records all operating activities as one segment.

2

The financial statements of Zoo Entertainment include operations of each division from the date that they were acquired. The results for Supervillain, Repliqa and Zoo Digital are included in discontinued operations for the three and nine months ended September 30, 2008.

3

Three Months Ended September 30, 2009 As Compared to the

Three Months Ended September 30, 2008

Results of Operations

The following table sets forth, for the period indicated the amount and percentage of net revenue for significant line items in our statement of operations:

	(Amounts in Thousands Except Per Share Data)
	For the Three Months Ended September 30
	2009					2008
	(restated)
Revenue	$	8,583		100	%	$	7,865		$	100	%
Cost of goods sold		6,662		78	%		5,093			65	%
Gross profit		1,921		22	%		2,772			35	%
Operating expenses:
General and administrative expenses		1,750		20	%		4,037			51	%
Selling and marketing expenses		548		6	%		1,352			17	%
Research and development expenses		—		—	%		2			—	%
Impairment of goodwill		14,704		171	%		—			—	%
Depreciation and amortization		504		6	%		434			6	%
Total operating expenses		17,506		204	%		5,825			74	%
Loss from operations		(15,585	)	(182	)%		(3,053	)		(39	)%
Interest expense, net		(370	)	(4	)%		(1,554	)		(20	)%
Other income – insurance recovery		860		10	%		—
Loss from continuing operations before income tax benefit		(15,095	)	(176	)%		(4,607	)		(59	)%
Income tax benefit		-		—	%		2,542			32	%
Loss from continuing operations		(15,095	)	(176	)%		(2,065	)		(26	)%
Loss from discontinued operations, net of tax benefit		(235	)	(3	)%		(1,731	)		(22	)%
Net loss	$	(15,330	)	(179	)%	$	(3,796	)		(48	)%
Loss per share from continuing operations	$	(290	)			$	(46	)

Net Revenues

Net revenues for the three months ended September 30, 2009 were approximately $8.6 million, an increase of approximately 9% over the sales for the three months ended September 30, 2008 which were approximately $7.9 million, primarily consisting of casual game sales in North America. The sales in the 2009 period are recorded net of the $265,000 fee to Atari for the period; without this fee, the sales increase from 2008 to 2009 would be 12%. The breakdown of gross sales by platform is:

	Three Months Ended September 30,
	2009			2008
Nintendo Wii		72	%		52	%
Nintendo DS		27	%		44	%
Microsoft Xbox		1	%		0	%
Nintendo GBA		0	%		1	%
SONY PS2		0	%		2	%
SONY PSP		0	%		1	%

The biggest sellers during the 2009 period were (i) Deal or No Deal on the Nintendo Wii platform, (ii) Hello Kitty - Big City Dreams on the Nintendo DS platform, and (iii) Build ‘N Race on the Nintendo Wii platform. The biggest sellers during the 2008 period were (i) Order Up, (ii) M&M Kart Racing and (iii) Chicken Shoot, all on the Nintendo Wii platform. The 2009 period consisted of approximately 873,000 units sold at an average gross price of $9.38, while the 2008 period consisted of approximately 663,000 units sold at an average gross price of $10.86increase in unit sales is a result of both new games introduced in 2009 and new customers and distribution channels to sell our product to in 2009.  The average gross price in 2008 was higher than the average gross price in 2009 due to the introduction of the Wii Order Up game at a higher-than-normal price point during the 2008 period and no comparable product sales in the 2009 period.

4

Gross Profit

Gross profit for the three months ended September 30, 2009 was approximately $1.9 million or 22% of net revenue, while the gross profit for the three months ended September 30, 2008 was approximately $2.8 million, or 35% of net revenue. The costs included in the cost of goods sold consist of manufacturing and packaging costs, royalties due to licensors relating to the current period’s revenues and the amortization of product development costs relating to the current period’s revenues. The Atari sales agreement was in place during the entire 2009 period and the Atari’s fees that are recorded as a reduction in revenue during this period were approximately $265,000 as compared to $0 in the corresponding period in 2008. During the 2008 period, 18% of the revenues were derived from the Wii Order Up game which was introduced at a high price point and resulted in an unusually high gross margin that period.  There were no similar items introduced during the comparable period in 2009.

General and Administrative Expenses

General and administrative expenses for the three months ended September 30 2009 were approximately $1.8 million as compared to $4.0 million for the comparable period in 2008.  Additional costs incurred in the 2008 period resulted from the Company’s reverse merger and costs relating to going public, which were approximately $964,000 in accounting and legal fees and approximately $582,000 in other consulting costs. These specific costs did not recur in the 2009 period; however, the 2009 period had approximately $200,000 of other professional and consulting fees.  Equity compensation included in general and administrative expenses are approximately $121,000 in the 2009 period and approximately $1.3 million in the 2008 period. During the 2009 period, we incurred approximately $285,000 in cost for our European sales office. These costs are included in the 2009 general and administrative expenses.

Selling and Marketing Expenses

Selling and marketing expenses for the three months ended September 30, 2009 and 2008 were $548,000 and approximately $1.4 million, respectively. These expenses all relate to the sales of casual games in North America and consist primarily of the salaries, commissions and related costs for Zoo Publishing. The expenses in the 2009 period reflect a reduction in salaries and related costs of approximately $300,000 from the 2008 period due to the transition of that operation from New Jersey to Ohio in 2009 and resulting reduction in headcount and base salaries.The 2008 period included approximately $500,000 of advertising and marketing expenses for various products that did not recur in 2009.

Impairment of Goodwill

The Company incurred a triggering event as of September 30, 2009 based on the equity infusion of approximately $4.0 million for 50% ownership in our equity and the conversion of the existing convertible debt during the fourth quarter of 2009. As such, we performed an impairment analysis, resulting in the full impairment of goodwill of $14.7 million.

Depreciation and Amortization Expenses

Depreciation and amortization costs for the three months ended September 30, 2009 were $504,000 as compared to $434,000 in the prior period. Both periods include $412,000 resulting from the amortization of intangibles acquired from the Zoo Publishing acquisition. The 2009 period includes $65,000 resulting from the amortization of intangibles acquired from the Empire IP acquisition.  The balance relates to depreciation of fixed assets during the period.

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Interest Expense

Interest expense for the 2009 period was $370,000 as compared to approximately $1.6 million for the 2008 period. The 2009 period includes $180,000 of non-cash interest expense relating to the amortization on the Zoo Entertainment Notes, $139,000 of interest relating to the Zoo Entertainment Notes and approximately $51,000 of interest related to the advance for the Canadian distribution rights.  The 2008 period includes $922,000 of non-cash interest expense relating to the accelerated amortization of the debt discount resulting from the early extinguishment of debt and $320,000 of interest on the various promissory notes due to the sellers of Zoo Publishing of which $262,000 is non-cash interest imputed at the then market rate.

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Other Income – Insurance Recovery

During the 2009 period, our third party warehouse received $860,000 from their insurance company relating to losses incurred by us from a fire in October 2008.  Those proceeds were applied against other amounts due to the third party warehouse and are reported as Other Income in 2009.

Income Tax Benefit

We did not record any income tax benefit for the three months ended September 30, 2009 as compared to $2.5 million for the three months ended September 30, 2008. As of December 31, 2008, we had already maximized the allowable amount of deferred taxes, so no additional tax benefits could be recorded for the 2009 period. 

Loss from Discontinued Operations

During the three months ended September 30, 2009, we wrote-off $235,000 relating to the balance due from the sale of Zoo Digital in 2008 because it was determined to be uncollectible during this period.  During the three months ended September 30, 2008, we generated a loss of approximately $1.7 million, net of tax benefit, from three operating divisions which were subsequently discontinued, so the net losses relating to those operations are recorded separately as a loss from discontinued operations. The loss relating to Supervillain was approximately $1.6 million, the loss relating to Zoo Digital was $527,000, the loss relating to Repliqa was $25,000 and the tax benefit related to these losses was $465,000.

Loss per Share from Continuing Operations

The loss per share from continuing operations for the three months ended September 30, 2009 was $290, based on a weighted average shares outstanding for the period of 52,023, versus a loss per share from continuing operations of $46, based on a weighted average shares outstanding of 45,086 for the three months ended September 30, 2008.

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Nine Months Ended September 30, 2009 As Compared to the

Nine Months Ended September 30, 2008

Results of Operations

The following table sets forth, for the period indicated the amount and percentage of net revenue for significant line items in our statement of operations: 

	(Amounts in Thousands Except Per Share Data)
	For the Nine Months Ended September 30,
	2009					2008
	(restated)
Revenue	$	30,136		100	%	$	22,364		100	%
Cost of goods sold		25,887		86	%		18,306		82	%
Gross profit		4,249		14	%		4.058		18	%
Operating expenses:
General and administrative expenses		5,010		17	%		7,436		33	%
Selling and marketing expenses		2,073		7	%		3,269		15	%
Research and development expenses		370		1	%		1,481		7	%
Impairment of goodwill		14,704		49	%		—		—	%
Depreciation and amortization		1,373		5	%		1,325		6	%
Total operating expenses		23,530		78	%		13,511		60	%
Loss from operations		(19,281	)	(64	)%		(9,453	)	(42	)%
Interest expense, net		(2,403	)	(8	)%		(2,533	)	(11	)%
Gain on legal settlement		4,328		14	%		—		-	%
Other income – insurance recovery		860		3	%		—		-	%
Loss from continuing operations before income tax benefit		(16,496	)	(55	)%		(11,986	)	(54	)%
Income tax benefit		-		-	%		3,600		16	%
Loss from continuing operations		(16,496	)	(55	)%		(8,386	)	(37	)%
Loss from discontinued operations net of tax benefit		(235	)	(1	)%		(4,279	)	(19	)%
Net loss	$	(16,731	)	(56	)%	$	(12,665	)	(57	)%
Loss per share from continuing operations	$	(290	)			$	(239	)

Net Revenues

Net revenues for the nine months ended September 30, 2009 were approximately $30.1 million, an increase of approximately 35% over the sales for the nine months ended September 30, 2008 of approximately $22.4 million, primarily all consisting of casual game sales in North America. The sales in the 2009 period are recorded net of the $2.7 million fee to Atari for the period; without this fee, the sales increase from 2008 to 2009 would be 47%.  The breakdown of gross sales by platform is:

	Nine Months Ended September 30,
	2009			2008
Nintendo Wii		65	%		35	%
Nintendo DS		31	%		60	%
Microsoft Xbox		2	%		0	%
SONY PS2		2	%		1	%
Nintendo GBA		0	%		2	%
SONY PSP		0	%		2	%

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The biggest sellers during the 2009 period were (i) Deal or No Deal, (ii) M&M Kart Racing, and (iii) M&M Beach Party, all on the Nintendo Wii platform. The biggest sellers during the 2008 period were (i) the compilation of Battle Ship, Connect 4, Sorry & Trouble on the Nintendo DS platform, (ii) M&M Kart Racing on the Nintendo Wii platform and (iii) the compilation of Clue, Perfection & Aggravation on the Nintendo DS platform. Approximately 3.4 million units were sold in North America at an average gross price of $9.54 in the 2009 periodas compared to approximately 2.1 million units sold for an average gross price of $10.19 in the 2008 period.   The increase in unit sales is a result of both new games introduced in 2009 and new customers and distribution channels to sell our product to in 2009. The average gross price in 2008 was slightly higher than the average gross price in 2009 due to the introduction of the Wii Order Up game at a higher-than-normal price point during the 2008 period and no comparable product sales in the 2009 period.

Gross Profit

Gross profit for the nine months ended September 30, 2009 was approximately $4.2 million, or 14% of net revenue, while the gross profit for the nine months ended September 30, 2008 was approximately $4.1 million, or 18% of net revenue. The costs included in the cost of goods sold consist of manufacturing and packaging costs, royalties due to licensors relating to the current period’s revenues and the amortization of product development costs relating to the current period’s revenues. The Atari sales agreement was in place during the entire 2009 period and Atari’s fees recorded as a reduction in revenue during this period were approximately $2.7 million as compared to $0 in the corresponding period in 2008.  As part of our business plan to focus on higher margin games and more cost effective product licenses, we opted to discontinue certain lower-margin products in the 2009 period through the accelerated sale of such products at lower than normal prices. This resulted in a significant amount of sales at very low margins, which along with royalty fees and amortization of product development costs resulted in a low overall gross margin for the 2009 period. The 2008 period included a close-out initiative for a license that terminated during that period resulting in similar low overall margins for the 2008 period.

General and Administrative Expenses

General and administrative expenses for the nine months ended September 30 2009 were approximately $5.0 million as compared to $7.4 million for the comparable period in 2008.  Additional costs incurred in the 2008 period resulted from the Company’s reverse merger and costs relating to going public, which were approximately $964,000 in accounting and legal fees and approximately $582,000 in other consulting costs. These costs did not recur in the 2009 period. Equity compensation included in general and administrative expenses are $566,000 in the 2009 period and approximately $1.9 million in the 2008 period. During the 2009 period, we incurred approximately $405,000 in cost for our European sales office. These costs are included in the 2009 general and administrative expenses.

Selling and Marketing Expenses

Selling and marketing expenses for the nine months ended September 30, 2009 and 2008 were approximately $2.1 million and $3.3 million, respectively. These expenses all relate to the sales of casual games in North America and consist primarily of the salaries, commissions and related costs for Zoo Publishing. The expenses in the 2009 period reflect a reduction in salaries and related costs of approximately $300,000 from the 2008 period due to the transition of that operation from New Jersey to Ohio in 2009 and resulting reduction in headcount and base salaries.The 2008 period included approximately $900,000 of advertising and marketing expenses for various products that did not recur in 2009.

Research and Development Expenses

Research and development expenses for the nine months ended September 30, 2009 were approximately $370,000 as compared to approximately $1.5 million for the nine months ended September 30, 2008. These expenses are a direct result of our decision to discontinue the development of certain games during these periods. The Company has modified its business model to focus on casual products which carry significantly lower development risks and costs.

Impairment of Goodwill

Impairment of goodwill was $14.7 million for the nine months ended September 2009.  This was based on the November 2009 equity infusion of approximately $4.0 million for 50% ownership interest in the Company and conversion of the existing convertible debt, resulting in a pro-forma market capitalization of approximately $8.0 million as of September 30, 2009.

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Depreciation and Amortization Expenses

Depreciation and amortization costs for the nine months ended September 30, 2009 were approximately $1.4 million as compared to approximately $1.3 million in the prior period. Both periods include approximately $1.2 million resulting from the amortization of intangibles acquired from the Zoo Publishing acquisition. The 2009 period includes $65,000 resulting from the amortization of intangibles acquired from the Empire IP acquisition.  The balance relates to depreciation of fixed assets during the period.

Interest Expense

Interest expense for the 2009 period was approximately $2.4 million as compared to approximately $2.5 million for the 2008 period. The 2009 period includes approximately $1.6 million of non-cash interest expense relating to the amortization on the Zoo Entertainment Notes, $418,000 of interest relating to the Zoo Entertainment Notes and approximately $358,000 of interest on the various promissory notes due to the sellers of Zoo Publishing of which $293,000 is non-cash interest imputed at the then market rate. The 2008 period includes $922,000 of non-cash interest expense relating to the accelerated amortization of the debt discount resulting from the early extinguishment of debt, approximately $1.1 million of interest on the various promissory notes due to the sellers of Zoo Publishing of which approximately $1.0 million is non-cash interest imputed at the then market rate and $536,000 of interest expense on other notes including the Zoo Entertainment Notes.

Gain on Legal Settlement

During the 2009 period, we settled a lawsuit brought by the former sellers of Zoo Publishing, resulting in a net gain on settlement of approximately $4.3 million. The settlement eliminated the Company’s obligations for certain outstanding notes, employee loans and other obligations for an aggregate amount of approximately $3.9 million. The settlement returned 9,274 shares to treasury valued at approximately $1.1 million. The Company’s remaining cash obligations and litigation expense amounted to approximately $710,000, resulting in a net gain on settlement of approximately $4.3 million.

Other Income – Insurance Recovery

During the 2009 period, our third party warehouse received $860,000 from their insurance company relating to losses incurred by us from a fire in October 2008.  Those proceeds were applied against other amounts due to the third party warehouse and are reported as Other Income in 2009.

Income Tax Benefit

We did not record any income tax benefit for the nine months ended September 30, 2009. As of December 31, 2008, we had already maximized the allowable amount of deferred taxes, so no additional tax benefits could be recorded for the 2009 period. During the nine months ended September 30, 2008, we recorded a tax benefit of approximately $3.6 million.

Loss from Discontinued Operations

During the nine months ended September 30, 2009, we wrote-off $235,000 relating to the balance due from the sale of Zoo Digital in 2008 because it was determined to be uncollectible during this period.   During the nine months ended September 30, 2008, we incurred an aggregate of approximately $4.3 million in losses, net of tax benefit, from four operating divisions which were subsequently discontinued, so the net losses relating to those operations are recorded separately as a loss from discontinued operations. The loss relating to Supervillain was approximately $3.2 million, the loss relating to Zoo Digital was approximately $1.2 million, the loss relating to Repliqa was $219,000 and the loss relating to the on-line concept was $147,000.  The tax benefit related to the discontinued operations was $465,000.

Loss per Share from Continuing Operations

The loss per share from continuing operations for the nine months ended September 30, 2009 was $290, based on a weighted average shares outstanding for the period of 56,878, versus a loss per share from continuing operations of $239 based on a weighted average shares outstanding of 35,097 for nine months ended September 30, 2008.

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Liquidity and Capital Resources

We incurred a loss from continuing operations of approximately $16.5 million, including an impairment charge related to goodwill of $14.7 million, for the nine months ended September 30, 2009 and a net loss of approximately $8.4 million from continuing operations for the nine months ended September 30, 2008. Our principal source of cash during the 2009 period was from the use of our purchase order and receivable financing arrangements, and cash generated from operations throughout the period.

Net cash used in continuing operations for the nine months ended September 30, 2009 was approximately $4.7 million, while net cash used in continuing operations for the nine months ended September 30, 2008 was $17.2 million. The specifics of the Atari sales agreement, which was in effect during the 2009 period for some of our customers, where Atari prepays us for the cost of goods for most of our sales and pays the balance due within 15 days of shipping the product, resulted in significant improvements for our cash provided from operations in the 2009 period, as compared to the 2008 period. The nature of the customer advances from Atari also reduces our receivables, as compared to standard trade sales where we generally would not collect the receivable until up to 60 days after shipment of our goods. As of the end of December 2008, Atari was distributing for all of our customers, while at the end of September 2009, Atari was distributing for only certain customers. The net increase in receivables for the nine months ended September 30, 2009 was approximately $1.4 million. The inventory decreased by $944,000 from December 31, 2008 to September 30, 2009 as we made an effort to minimize our cash outlay for product by building product to order and increasing our inventory turns. Also in the 2008 period, we were spending more cash developing higher-cost video games that had a longer development cycle which put a strain on our working capital for that period. In 2009, we focused mostly on developing lower-cost video games and our cash constraints also limited our spending on development of new video games in 2009.

Net cash used in investing activities for the nine months ended September 30, 2009 was $254,000, while net cash provided by investing activities for the nine months ended September 30, 2008 was approximately $1.6 million. The cash used in the 2009 period consisted of $162,000 invested for intellectual property and $92,000 for the purchase of fixed assets. During the 2008 period, the Company benefited from the receipt of approximately $1.7 million of cash from the reverse merger and used $65,000 cash for the purchase of fixed assets.

Net cash provided by financing activities for the nine months ended September 30, 2009 was approximately $4.7 million, while net cash provided by financing activities for the nine months ended September 30, 2008 was approximately $20.4 million. The 2009 period includes approximately $2.0 million, net borrowings on the purchase order financing facility and net proceeds of $630,000 received from the receivable factoring facility, as well as $7,000 from the exercise of warrants. In addition, we received a $2.0 million customer advance from Solutions 2 Go, Inc. in the 2009 period for exclusive Canadian distribution rights which is being treated as a loan due to the fixed maturity date and interest bearing features of the advance. During 2008 we received approximately $6.1 million from the sale of equity securities, received approximately $8.8 million from the issuance of convertible notes and borrowings of approximately $5.4 million, net for the purchase order financing and factor arrangements.

The $4.2 million sale of our Series A Preferred Stock and common stock purchase warrants that closed on November 20, 2009, and the conversion of approximately $11.9 million underlying our convertible notes into equity, put us into a positive net working capital position on a proforma basis of approximately $3.3 million as of September 30, 2009, leaving us better positioned to meet our cash needs.

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Zoo Entertainment Notes

On July 7, 2008, as amended on July 15, 2008 and July 31, 2008, we entered into a note purchase agreement under which the purchasers agreed to provide loans to us in the aggregate principal amount of $9.0 million, in consideration for the issuance and delivery of senior secured convertible promissory notes. As partial inducement to purchase the notes, we issued to the purchasers warrants to purchase 13,637 shares of our common stock. The notes bear an interest rate of five percent (5%) for the one year term of the note commencing from issuance, unless extended. Upon the occurrence of an investor sale, as defined in the notes, the entire outstanding principal amount of the notes and any accrued interest thereon will be automatically converted into shares of our common stock determined by dividing the note balance by the lesser of (i) an amount equal to the price per share of investor stock paid by the purchasers of such shares in connection with the investor sale, or (ii) $1,200; provided, that in the event that the investor sale is for less than $600 per share, then the notes will only be automatically convertible with our consent. All of the warrants have a five year term and an exercise price of $6.00 per share. Pursuant to a security agreement, by and among the Company and the purchasers, dated as of July 7, 2008, as amended on August 12, 2008, we granted a security interest in all of our assets to each of the purchasers to secure our obligations under the notes.

On September 26, 2008, we entered into a note purchase agreement with four investors, pursuant to which the purchasers agreed to provide a loan to us in the aggregate principal amount of $1.4 million, in consideration for the issuance and delivery of senior secured convertible promissory notes. As partial inducement to purchase the notes, we issued to the purchasers warrants to purchase 2,122 shares of our common stock. The notes bear an interest rate of five percent (5%) for the time period beginning on September 26, 2008 and ending on September 26, 2009, unless extended.  The term of the notes was subsequently amended to mature on November 2, 2009 and then to February 2, 2010.  Upon the occurrence of an investor sale, as defined in the notes, the entire outstanding principal amount of the notes and any accrued interest thereon will be automatically converted into shares of our common stock determined by dividing the note balance by the lesser of (i) an amount equal to the price per share of investor stock paid by the purchasers of such shares in connection with the investor sale, or (ii) $1,200; provided, that in the event that the investor sale is for less than $600 per share, then the notes will only be automatically convertible with our consent. The warrants have a five year term and an exercise price of $6.00 per share. Pursuant to a security agreement, by and among the Company and the purchasers, dated as of September 26, 2008, we granted a security interest in all of our assets to each of the purchasers to secure our obligations under the notes.

On June 26, 2009, the Company entered into Amendment No. 2 to Senior Secured Convertible Note (“Amendment No. 2”), with the requisite holders (the “Holders”) of the Company’s senior secured convertible notes issued in the aggregate principal amount of $11.15 million. Pursuant to Amendment No. 2, the parties agreed to extend the maturity date of the notes that were originally scheduled to mature during July 2009 to August 31, 2009, or, if the Company receives comments from the SEC with respect to the Information Statement Pursuant to Section 14(c) (the “Information Statement”) that the Company filed on July 7, 2009 in connection with an amendment to the Company’s Certificate of Incorporation authorizing a sufficient number of shares of the Company’s common stock to permit the conversion of the notes (“Certificate of Amendment”), September 15, 2009. The Company did not receive comments from the SEC with respect to the Information Statement and, as such, the maturity dates of such notes shall be August 31, 2009. Amendment No. 2 also provides that the notes shall automatically convert into shares of the Company’s common stock effective immediately on the date by which the following two events have occurred, regardless of the order in which they occur: (a) the effectiveness of the filing the Certificate of Amendment, and (b) the consummation of a financing by the Company for which such sale results in aggregate gross proceeds to the Company of at least $4.0 million. Notwithstanding, if the notes do not convert on or prior to the revised maturity date, Amendment No. 2 provides that the provisions of Amendment No. 2 with respect to automatic conversion shall become null and void and shall be of no further effect. In consideration of the Holders’ execution and delivery of Amendment No. 2, the Company entered into a letter agreement, dated as of June 26, 2009, pursuant to which the Company granted to the Holders registration rights which require the Company to file with the SEC a registration statement covering the resale of the shares of common stock issuable upon conversion of the notes, within 30 calendar days after receipt of approval of the Company’s stockholders of the Certificate of Amendment or 60 calendar days following the closing of a financing by the Company for which such sale results in aggregate gross proceeds to the Company of at least $4.0 million, whichever is later. The Company entered into subsequent amendments with the Holders extending the maturity date to November 2, 2009 and then subsequently to February 2, 2010. On November 20, 2009, the requisite Senior Secured Convertible Note Holders agreed that if the Company raises a minimum of $4.0 million new capital, they will convert their debt into convertible preferred shares of the Company that will ultimately convert into common shares that represent 36.5% of the equity of the Company. As a result of the Company consummating an approximately $4.2 million preferred equity raise on November 20, 2009, upon which approximately $11.8 million of existing debt including related accrued interest converted into convertible preferred equity, the Company will issue shares of Series B Preferred stock to the Senior Convertible Note Holders in exchange for their Notes.

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Zoo Publishing Notes

In connection with Zoo Games’ acquisition of Zoo Publishing, there was an outstanding 3.9% promissory note for the benefit of the former shareholders of Zoo Publishing in the aggregate principal amount of $2,957,500. Of that amount, $1,137,500 of the principal plus accrued and unpaid interest was scheduled to be paid on or before September 18, 2009 and the remaining $1,820,000 plus accrued and unpaid interest was scheduled to be paid on or before December 18, 2010. Also in connection with the acquisition of Zoo Publishing, Zoo Games was required to pay an individual an aggregate of $608,400. Of that amount, $292,500 was due on December 18, 2010 and $315,900 was scheduled to be paid on July 31, 2011, in cash or our common stock based on the fair market value of our common stock as of July 31, 2011, at the election of Zoo Games. In connection with the Settlement Agreement dated June 18, 2009, all the Zoo Publishing Notes and the note to the individual were cancelled and no cash payments were required to be made for either the principal amounts of the notes or the interest accrued. The net amount of the obligations relieved for the Zoo Publishing Notes was approximately $3.0 million and is included in the Gain on Settlement on the Statement of Operations.

As part of the acquisition of Zoo Publishing, Zoo Games was required to pay $1,200,000 to an employee of Zoo Publishing. Of that amount, as of September 30, 2009, Zoo Games paid $487,000; $93,000 is past due and $620,000 will be paid on July 31, 2011, in cash or our common stock based on the fair market value of our common stock as of July 31, 2011, at the election of Zoo Games.

Zoo Publishing has additional debt outstanding which debt existed prior to Zoo Games’ acquisition of that subsidiary. As of September 30, 2009, Zoo Publishing owes approximately $300,000 as a result of the repurchase of certain stock from a former stockholder. The terms of this note are repayment in monthly increments of $10,000.

Zoo Publishing also takes advances from our factor, Working Capital Solutions, Inc., which utilizes existing accounts receivable in order to provide working capital to fund all aspects of our continuing business operations. Under the terms of our factoring and security agreement, our receivables are sold to the factor, with recourse. The factor, in its sole discretion, determines whether or not it will accept each receivable based upon the credit risk factor of each individual receivable or account. Once a receivable is accepted by the factor, the factor provides funding, subject to the terms and conditions of the factoring and security agreement. The amount remitted to us by the factor equals the invoice amount of the receivable adjusted for any discounts or allowances provided to the account, less 25% which is deposited into a reserve account established pursuant to the agreement, less allowances and fees. In the event of default, valid payment dispute, breach of warranty, insolvency or bankruptcy on the part of the receivable account, the factor can require the receivable to be repurchased by us in accordance with the agreement. The amounts to be paid by us to the factor for any accepted receivable include a factoring fee of 0.6% for each ten (10) day period the account is open. We began to use the factor again in September 2009 and as of September 30, 2009, we had factored $832,000 of invoices and received $624,000 advance against these receivables.

In addition to the receivable financing agreement with Working Capital Solutions, Inc., Zoo Publishing also utilizes purchase order financing with Transcap Trade Finance, LLC, to fund the manufacturing of video game products. Under the terms of our agreement, we assign purchase orders received to Transcap Trade Finance, LLC, which may accept or decline the assignment of specific purchase orders. The purchase order financing allows us to order manufactured video game product from the manufacturer. Upon receipt of a purchase order, Transcap Trade Finance, LLC opens a letter of credit to the video game product manufacturer. The letter of credit permits us to order the video game product to satisfy the purchase orders and projected purchase orders submitted by our accounts. The interest rate is prime plus 4.0% on outstanding advances.

On April 6, 2009, we entered into an amended and restated purchase order financing arrangement with Wells Fargo Bank, National Association (“Wells Fargo”) pursuant to an amended and restated master purchase order assignment agreement (the “Assignment Agreement”). The Assignment Agreement amended and restated in its entirety the master purchase order assignment agreement between Transcap Trade Finance, LLC and Zoo Publishing, dated as of August 20, 2001, as amended.

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Pursuant to the Assignment Agreement, the Company will assign purchase orders received from customers to Wells Fargo, and request that Wells Fargo purchase the required materials to fulfill such purchase orders. Wells Fargo, which may accept or decline the assignment of specific purchase orders, will retain us to manufacture, process and ship ordered goods, and will pay us for our services upon Wells Fargo’s receipt of payment from the customers for such ordered goods. Upon payment in full of the purchase order invoice by the applicable customer to Wells Fargo, Wells Fargo will re-assign the applicable purchase order to us. We will pay to Wells Fargo a fee upon their funding of each purchase order and we commit to pay a total fee for twelve months in the aggregate amount of $337,500. If the fees earned during the twelve month period do not exceed $337,500, we are required to pay the difference between the $337,500 and the amounts already paid on the earlier of the twelve month anniversary of the date of the Assignment Agreement, or the date of termination of the Assignment Agreement. Wells Fargo is not obligated to provide purchase order financing under the Assignment Agreement if the aggregate outstanding funding exceeds $5,000,000. The Assignment Agreement is for an initial term of twelve months, and shall continue thereafter for successive twelve month renewal terms unless either party terminates the Assignment Agreement by written notice to the other no later than 30 days prior to the end of the initial term or any renewal term. If the term of the Assignment Agreement is renewed for one or more twelve month terms, for each such twelve month term, we will pay to Wells Fargo a commitment fee in the sum of $337,500, to be offset against actual fees paid by us upon their payment of each purchase order, to be paid on the earlier of the twelve month anniversary of such renewal date or the date of termination of the Assignment Agreement. The initial and renewal commitment fees are subject to waiver if certain product volume requirements are met.

In connection with the Assignment Agreement, on April 6, 2009 we also entered into an amended and restated security agreement and financing statement (the “Security Agreement”) with Wells Fargo. The Security Agreement amends and restates in its entirety that certain security agreement and financing statement, by and between Transcap Trade Finance, LLC and Zoo Publishing, dated as of August 20, 2001. Pursuant to the Security Agreement, we granted to Wells Fargo a first priority security interest in certain of our assets as set forth in the Security Agreement, as well as a subordinate security interest in certain other of our assets (the “Common Collateral”), which security interest is subordinate to the security interests in the Common Collateral held by certain of our senior lenders, as set forth in the Security Agreement.

Also in connection with the Assignment Agreement, on April 6, 2009, Mark Seremet, President and Chief Executive Officer of Zoo Games and a director of Zoo Entertainment, and David Rosenbaum, the President of Zoo Publishing, entered into a Guaranty with Wells Fargo, pursuant to which Messrs. Seremet and Rosenbaum agreed to guaranty the full and prompt payment and performance of the obligations under the Assignment Agreement and the Security Agreement.

On May 12, 2009, the Company entered into a letter agreement with each of Mark Seremet and David Rosenbaum (the “Fee Letters”), pursuant to which, in consideration for Messrs. Seremet and Rosenbaum entering into the Guaranty with Wells Fargo for the full and prompt payment and performance by the Company and its subsidiaries of the obligations in connection with a purchase order financing (the “Loan”), the Company agreed to compensate Mr. Seremet in the amount of $10,000 per month, and Mr. Rosenbaum in the amount of $7,000 per month, for so long as the executive remains employed while the Guaranty and Loan remain in full force and effect. If the Guaranty is not released by the end of the month following termination of employment of either Messrs. Seremet or Rosenbaum, the monthly fee shall be doubled for each month thereafter until the Guaranty is removed.

Additionally, pursuant to the Fee Letters, the Company agreed to grant under the Company’s 2007 Employee, Director and Consultant Stock Plan, as amended to each of Messrs. Seremet and Rosenbaum, on such date that is the earlier of the conversion of at least 25% of all currently existing convertible debt of the Company into equity, or November 8, 2009 (the earlier of such date, the “Grant Date”), an option to purchase that number of shares of the Company’s common stock equal to 6% and 3% respectively, of the then issued and outstanding shares of common stock, based on a fully diluted current basis assuming those options and warrants that have an exercise price below $240 per share are exercised on that date but not counting the potential conversion to equity of any outstanding convertible notes that have not yet been converted and, inclusive of any options or other equity securities or securities convertible into equity securities of the Company that each may own on the Grant Date. The options shall be issued at an exercise price equal to the fair market value of the Company’s common stock on the Grant Date and pursuant to the Company’s standard form of nonqualified stock option agreement; provided however that in the event the Guaranty has not been released by Wells Fargo Bank as of the date of the termination of the option due to termination of service, the option termination date shall be extended until the earlier of the date of the release of the Guaranty or the expiration of the ten year term of the option. In addition any options owned by Messrs. Seremet and Rosenbaum as of the Grant Date with an exercise price that is higher than the exercise price of the new options shall be cancelled as of the Grant Date.

14

As a result of a fire in October 2008 that destroyed our inventory and impacted our cash flow from operations, we entered into an agreement with Atari, Inc. (“Atari”). This agreement became effective on October 24, 2008 and provided for Zoo Publishing to sell its products to Atari without recourse and Atari will resell the products to wholesalers and retailers that are acceptable to Atari in North America. This agreement provides for Atari to prepay to the Company for the cost of goods and pay the balance due within 15 days of shipping the product. Atari’s fees approximate 10% of our standard selling price. Atari takes a reserve from the initial payment for potential customer sales allowances, returns and price protection that is analyzed and reviewed within a sixty day period to be liquidated no later than July 31, 2010. The agreement initially expired on March 31, 2009, but was amended to extend the term for certain customers until March 31, 2010.

With the November 2009 $4.2 million equity raise and the conversion of all our convertible notes into equity, we believe the existing cash and cash generated from operations are sufficient to meet our immediate operating requirements, along with our current financial arrangements. We may need to raise additional capital to strengthen our cash position, facilitate expansion, pursue strategic investments or to take advantage of business opportunities as they arise.

The report of our independent auditors on our financial statements for the fiscal year ended December 31, 2008 includes an explanatory paragraph raising doubt about the Company’s ability to continue as a going concern.

Critical Accounting Policies and Estimates

There were no changes to our critical accounting policies and estimates since the year ended December 31, 2008. A complete description of our critical accounting policies and estimates can be found in our Annual Report on Form 10-K for the year ended December 31, 2008, filed with the Securities and Exchange Commission on April 15, 2009 and also in Note 3 to the unaudited condensed consolidated financial statements included in this quarterly report for the period ended September 30, 2009.

Recently Issued Accounting Pronouncements

See Note 3 to the unaudited condensed consolidated financial statements included in this quarterly report for the period ended September 30, 2009.

15

Off-Balance Sheet Arrangements

We do not have any relationships with unconsolidated entities or financial partners, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not have any undisclosed borrowings or debt, and we have not entered into any synthetic leases. We are, therefore, not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

Fluctuations in Operating Results and Seasonality

We experience fluctuations in quarterly and annual operating results as a result of: the timing of the introduction of new titles; variations in sales of titles developed for particular platforms; market acceptance of our titles; development and promotional expenses relating to the introduction of new titles, sequels or enhancements of existing titles; projected and actual changes in platforms; the timing and success of title introductions by our competitors; product returns; changes in pricing policies by us and our competitors; the size and timing of acquisitions; the timing of orders from major customers; order cancellations; and delays in product shipment. Sales of our products are also seasonal, with peak shipments typically occurring in the fourth calendar quarter as a result of increased demand for titles during the holiday season. Quarterly and annual comparisons of operating results are not necessarily indicative of future operating results.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable as we are a smaller reporting company.

ITEM 4T.  CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management is responsible for establishing and maintaining adequate internal controls over financial reporting, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e), as of the end of the period covered by this report. Based on the evaluation of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) were not effective at a reasonable assurance level.

Our management has determined that we have a material weakness in our internal control over financial reporting related to not having a sufficient number of personnel with the appropriate level of experience and technical expertise to appropriately resolve non-routine and complex accounting matters or to evaluate the impact of new and existing accounting pronouncements on our consolidated financial statements while completing the financial statements close process.

Until this deficiency in our internal control over financial reporting is remediated, there is a reasonable possibility that a material misstatement to our annual or interim consolidated financial statements could occur and not be prevented or detected by our internal controls in a timely manner.

We are committed to appropriately addressing this matter in 2009 and we have engaged additional qualified personnel to assist in these areas. We will continue to reassess our accounting and finance staffing levels to ensure that we have the appropriate accounting resources to handle the existing workload.

Changes in Controls and Procedures

There were no changes in our internal controls over financial reporting identified in connection with the evaluation of such internal control that occurred during the during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

16

PART II - OTHER INFORMATION

ITEM  1.  LEGAL PROCEEDINGS

On February 19, 2009, Susan Kain Jurgensen, Steven Newton, Mercy Gonzalez, Bruce Kain, Wesley Kain, Raymond Pierce and Cristie Walsh filed a complaint against Zoo Publishing, Zoo Games and Zoo in the Supreme Court of the State of New York, New York County, index number 09 / 102381 alleging claims for breach of certain loan agreements and employment agreements, intentional interference and fraudulent transfer. The complaint sought compensatory damages, punitive damages and preliminary and permanent injunctive relief, among other remedies. On June 18, 2009, we reached a settlement whereby we agreed to pay to the plaintiffs an aggregate of $560,000 (the “Settlement Amount”) in full satisfaction of the disputed claims, without any admission of any liability of wrongdoing as follows: (a) $300,000 on June 26, 2009; (b) $60,000 on or before the earlier of (i) the date that is 90 days from June 18, 2009 or (ii) the date the Company obtains new and available financing, including any amounts currently held in escrow that will be released from escrow after June 18, 2009, in any form and from any source, in an amount totaling at least $2,000,000; (c) $100,000 on or before December 18, 2009; and (d) $100,000 on or before June 18, 2010. To date, $360,000 of the Settlement Amount has been paid to the plaintiffs. The Zoo Publishing Notes and all other notes, employment, agreements, loan agreements, options, warrants and other agreements relating to the plaintiffs (except with respect to that certain Employment Agreement between Zoo Publishing and Cristie Walsh) were terminated and all outstanding obligations of the Company related to these agreements were cancelled. In addition, the plaintiffs returned to us an aggregate of 9,274 shares of our common stock owned by them prior to such date.

In connection with an action brought by Revolution Partners, LLC against Zoo Games, Inc., the claimant Revolution Partners, LLC was seeking money damages for a claimed investment banking or finder’s fee purportedly earned in connection with a reverse merger transaction and related financing that we entered into in the third quarter of 2008. We settled this claim in June 2009 for $140,000, $120,000 of which was paid as of September 30, 2009 and the balance is included in accounts payable as of September 30, 2009 and was paid in full in October 2009.

We are also involved in various other legal proceedings and claims incident to the normal conduct of our business. Although it is impossible to predict the outcome of any legal proceeding and there can be no assurances, we believe that our legal proceedings and claims, individually and in the aggregate, are not likely to have a material adverse effect on our financial condition, results of operations or cash flows.

ITEM 1A.  RISK FACTORS

There have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2008, filed with the Securities and Exchange Commission on April 15, 2009.

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Issuer Purchases of Equity Securities

Period	(a) Total Number of  Shares (or Units)  Purchased			(b) Average Price Paid  per Share (or Unit)		(c) Total Number of  Shares (or Units)  Purchased as Part of  Publicly Announced  Plans or Programs	(d) Maximum Number  (or Approximate  Dollar Value) of  Shares (or Units)  that May Yet Be  Purchased Under  the Plans or  Programs
July 1, 2009- July 31, 2009
August 1, 2009- August 31, 2009		834	(1)		(1)
September1, 2009- September 30, 2009

17

(1)  On August 31, 2009, in consideration for an employee entering into a guaranty with Solutions 2 Go Inc. and Solutions 2 Go, LLC for the full and prompt payment and performance by the Company and its subsidiaries of the obligations in connection with an advance agreement, the Company entered into a letter agreement with the employee, pursuant to which, among other things, the Company agreed to deliver to the employee 834 shares of common stock.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

On June 26, 2009, the Company received, in lieu of a meeting, written consents from the holders of 32,244 shares of common stock, representing approximately 63.6% of the total issued and outstanding shares of common stock, approving an amendment to the Company’s Certificate of Incorporation to increase the number of authorized shares of common stock from 75,000,000 shares to 250,000,000 shares.

ITEM 5. OTHER INFORMATION

None.

ITEM 6.  EXHIBITS

10.1 Amendment No. 3 to Senior Secured Convertible Note, dated as of August 31, 2009, by and among Zoo Entertainment, Inc. and the holders of Notes set forth therein.

10.2 Note Purchase Agreement Waiver and Consent, dated as of August 31, 2009, by and among Zoo Entertainment, Inc. and the holders of Notes set forth therein.

10.3 Advance Agreement, by and among Zoo Entertainment, Inc., Solutions 2 Go Inc. and Solutions 2 Go LLC, dated as of August 31, 2009.

10.4 Exclusive Distribution Agreement, by and between Zoo Publishing, Inc. and Solutions 2 Go Inc. and Solutions 2 Go LLC, dated as of August 31, 2009.

10.5 Exclusive Distribution Agreement, by and between Zoo Publishing, Inc. and Solutions 2 Go LLC, dated as of August 31, 2009.

10.6 Warrant to Purchase 7,665,731 shares of Common Stock of Zoo Entertainment, Inc.

10.7 Amendment 1 to Fee Letter Agreement, by and between Zoo Entertainment, Inc. and Mark Seremet, dated as of August 31, 2009.

10.8 Amendment 1 to Fee Letter Agreement, by and between Zoo Entertainment, Inc. and David Rosenbaum, dated as of August 31, 2009.

10.9 Continuing Personal Guaranty of Mark Seremet for the benefit of Solutions 2 Go Inc. and Solutions 2 Go LLC, dated as of August 31, 2009.

10.10 Continuing Personal Guaranty of David Rosenbaum for the benefit of Solutions 2 Go Inc. and Solutions 2 Go LLC, dated as of August 31, 2009.

10.12 Continuing Personal Guaranty of Ryan Brant for the benefit of Solutions 2 Go Inc. and Solutions 2 Go LLC, dated as of August 31, 2009.

10.13 Amendment No. 4 to Senior Secured Convertible Note, dated as of October 6, 2009, by and among Zoo Entertainment, Inc. and the holders of Notes set forth therein.

10.14 Amendment No. 5 to Senior Secured Convertible Note, dated as of November 2, 2009, by and among Zoo Entertainment, Inc. and the holders of Notes set forth therein.

31.1 Certification of Chief Executive Officer. †

31.2 Certification of Chief Financial Officer. †

32.1 Certification by Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as added by Section 906 of the Sarbanes-Oxley Act of 2002. †

† Filed herewith

18

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.

Dated: June 4, 2010 

ZOO ENTERTAINMENT, INC

/s/ Mark Seremet

Mark Seremet

President and Chief Executive Officer

(Principal Executive Officer)

/s/ David Fremed

David Fremed

Chief Financial Officer

(Principal Financial Officer)

19

 EXHIBIT INDEX

10.1	Amendment No. 3 to Senior Secured Convertible Note, dated as of August 31, 2009, by and among Zoo Entertainment, Inc. and the holders of Notes set forth therein.
10.2	Note Purchase Agreement Waiver and Consent, dated as of August 31, 2009, by and among Zoo Entertainment, Inc. and the holders of Notes set forth therein.
10.3	Advance Agreement, by and among Zoo Entertainment, Inc., Solutions 2 Go Inc. and Solutions 2 Go LLC, dated as of August 31, 2009.
10.4	Exclusive Distribution Agreement, by and between Zoo Publishing, Inc. and Solutions 2 Go Inc. and Solutions 2 Go LLC, dated as of August 31, 2009.
10.5	Exclusive Distribution Agreement, by and between Zoo Publishing, Inc. and Solutions 2 Go LLC, dated as of August 31, 2009.
10.6	Warrant to Purchase 7,665,731 shares of Common Stock of Zoo Entertainment, Inc.
10.7	Amendment 1 to Fee Letter Agreement, by and between Zoo Entertainment, Inc. and Mark Seremet, dated as of August 31, 2009.
10.8	Amendment 1 to Fee Letter Agreement, by and between Zoo Entertainment, Inc. and David Rosenbaum, dated as of August 31, 2009.
10.9	Continuing Personal Guaranty of Mark Seremet for the benefit of Solutions 2 Go Inc. and Solutions 2 Go LLC, dated as of August 31, 2009.
10.10	Continuing Personal Guaranty of David Rosenbaum for the benefit of Solutions 2 Go Inc. and Solutions 2 Go LLC, dated as of August 31, 2009.
10.11	Amendment No. 4 to Senior Secured Convertible Note, dated as of October 6, 2009, by and among Zoo Entertainment, Inc. and the holders of Notes set forth therein.
10.12	Amendment No. 5 to Senior Secured Convertible Note, dated as of November 2, 2009, by and among Zoo Entertainment, Inc. and the holders of Notes set forth therein.
31.1	Certification of Chief Executive Officer. †
31.2	Certification of Chief Financial Officer. †
32.1	Certification by Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as added by Section 906 of the Sarbanes-Oxley Act of 2002. †

† Filed herewith

20

EX-31.1

Exhibit 31.1

CERTIFICATIONS UNDER SECTION 302

I, Mark Seremet, certify that:

1. I have reviewed this Quarterly Report of Zoo Entertainment, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b. designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c. evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d. disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:  June 4, 2010

/s/ Mark Seremet

Mark Seremet

President and Chief Executive Officer

(Principal Executive Officer)

EX-31.2

Exhibit 31.2

CERTIFICATIONS UNDER SECTION 302

I, David Fremed, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of Zoo Entertainment, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b. designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c. evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d. disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:  June 4, 2010

/s/ David Fremed

David Fremed

Chief Financial Officer

(Principal Financial Officer)

EX-32.1

Exhibit 32.1

CERTIFICATIONS PURSUANT TO 18 U.S.C. SECTION 1350

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

Pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter 63 of title 18, United States Code), each of the undersigned officers of Zoo Entertainment, Inc., a Delaware corporation (the “Company”), does hereby certify, to such officer’s knowledge, that:

The Quarterly Report on Form 10-Q for the period ended September 30, 2009 (the “Form 10-Q”) of the Company fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and the information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date:  June 4, 2010

/s/ Mark Seremet

Mark Seremet

President and Chief Executive Officer

(Principal Executive Officer)

Date:  June 4, 2010

/s/ David Fremed

David Fremed

Chief Financial Officer

(Principal Financial Officer)