SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark one)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 1999
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 0-27102
eGames, Inc.
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2694937
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
2000 Cabot Boulevard, Suite 110, Langhorne, PA 19047-1833
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code 215-750-6606
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
Common Stock, No Par Value NASDAQ
Indicate by check mark whether the issuer (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes (X) No ( )
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. (X)
State issuer's revenues for its most recent fiscal year: $10,022,000
State the aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the price at which the common equity
was sold, or the average bid and asked price of such common equity, as of a
specified date within the past 60 days: $20,250,000 as of September 14, 1999.
ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS
DURING THE PRECEDING FIVE YEARS:
Check whether the issuer has filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by a court. Yes ( ) No ( )
APPLICABLE ONLY TO CORPORATE REGISTRANTS
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: 9,661,490 shares of Common Stock, no
par value per share, as of August 31, 1999. Transitional Small Business
Disclosure Format (check one): Yes ( ) No ( X ) DOCUMENTS INCORPORATED BY
REFERENCE Portions of Registrant's definitive proxy statement for its 1999
Annual Meeting of Stockholders are incorporated by reference into Part III as
set forth herein. With the exception of those portions, which are expressly
incorporated by reference, said proxy statement is not deemed filed as a part
hereof.
<PAGE>
eGames, Inc.
Form 10-KSB
For the Fiscal Year Ended June 30, 1999
INDEX
Page
----
PART I
Item 1. Business........................................................ 3
Item 2. Properties...................................................... 16
Item 3. Legal Proceedings............................................... 16
Item 4. Submission of Matters to a Vote of Security Holders............. 16
PART II
Item 5. Market for the Registrant's Common Stock and Related
Stockholder Matters............................................. 17
Item 6. Management's Discussion and Analysis of Results of Operations
and Financial Condition......................................... 17
Item 7. Financial Statements ........................................... 23
Item 8. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure........................................ 42
PART III
Item 9. Directors and Executive Officers of the Registrant.............. 43
Item 10. Executive Compensation.......................................... 43
Item 11. Security Ownership of Certain Beneficial Owners and Management.. 43
Item 12. Certain Relationships and Related Transactions.................. 43
PART IV
Item 13. Exhibits, List and Reports on Form 8-K.......................... 44
Index of Exhibits........................................................ 44
Signatures............................................................... 47
<PAGE>
PART I
This annual report on Form 10-KSB contains forward-looking statements regarding
future events or the future financial performance of the Company that involve
certain risks and uncertainties. Actual events or the actual future results of
the Company may differ materially from the results discussed in the
forward-looking statements due to various factors, including, but not limited
to, those discussed in "Factors Affecting Future Performance" below at pages 10
to 16.
Item 1. Business
GENERAL
eGames, Inc., formerly RomTech, Inc., (the "Company"), a Pennsylvania
corporation incorporated in July 1992, publishes, markets and sells a
diversified line of personal computer software primarily for consumer
entertainment. The Company also offers personal productivity products for sale,
but the Company anticipates minimal future investment in that category of the
market and expects sales from these products to be less than 15% of the
Company's net sales in the foreseeable future. In October 1995, the Company
completed its initial public offering coincident with its acquisition of Applied
Optical Media Corporation ("AOMC"), a developer of educational and reference
software titles. In April 1996, the Company acquired Virtual Reality
Laboratories, Inc. ("VRLI"), a software developer of landscape generation, space
exploration, and business forms manipulation programs. In August 1998, the
Company acquired Software Partners Publishing and Distribution Ltd. ("Software
Partners"), a United Kingdom-based distributor of personal computer software for
consumer entertainment and small office/home office applications. On March 31,
1999 Software Partners changed its name to eGames Europe Ltd. ("eGames Europe").
As a result of these acquisitions, together with the Company's own internal
development efforts, the Company offers primarily consumer entertainment
software titles and to a lesser extent certain personal productivity titles. The
Company's product line enables it to serve customers who are seeking high
quality, familiar, easy-to-play value-priced entertainment software.
The Company believes that today's consumers base their software purchase
decisions on the same criteria as other consumer product purchases, relying on
recognized brands for consistent quality, value and ease of use. The Company
promotes its proprietary brand names, including eGames(TM), Game Master
Series(TM), Multi-Pack and Galaxy of Home Office Help(TM) (the "eGames Series")
in order to generate customer loyalty, encourage repeat purchases and
differentiate the eGames Series products to retailers and consumers. The Company
targets the growing market of home personal computer ("PC") users who value
fully-featured, value-priced and easy-to-use entertainment software. All eGames
Series titles are "Family Friendly", which means they are easy-to-use,
non-violent, and appeal to all ages. The Company's software packaging is labeled
with the distinctive Family Friendly(TM) logo to help attract consumers towards
its software. The Company's eGames Series, Game Master Series, and Galaxy of
Home Office Help products generally sell at retail for under $15, a price point
which is intended to generate impulse purchases in mass market shopping
environments. The Company's Game Master Series titles are boxed software
products that generally sell at retail for $14.99, yet feature packaging and
content usually found in software titles selling for more than $20 at retail.
The balance of the eGames software titles, including its Galaxy of Games(R)
collections, are typically sold in jewel case packaging and sell at retail for
$9.99 or are occasionally sold in special value boxes at $12.99. The Company is
in the process of launching its Multi-Pack software titles, which are intended
to be sold in special retail point-of-sale packages at $4.99.
Industry Background
According to a recent Arbitron NewMedia Pathfinder Study, the number of U.S.
households with PCs nearly doubled to 54 percent in 1999 from 29 percent in
1995. The worldwide consumer entertainment software market is estimated to
exceed $6 billion in revenues in 1999 versus $5.5 and $4.1 billion in 1998 and
1997, respectively. This dramatic growth in recent years has been driven by the
increasing number of multimedia PCs in the home and office, the increasing
number of game console devices in the home, the proliferation of software
titles, and the development of new and expanding distribution channels.
Declining prices of microprocessors and CD-ROM drives have made high-end
interactive computer entertainment more affordable, resulting in low-end PCs
targeted to the mass consumer market costing under $500.
<PAGE>
The worldwide consumer entertainment software industry has also recently
undergone a number of profound changes with the introduction of new hardware
platforms and new technologies, such as on-line networks and the Internet. The
proliferation of on-line networks and the Internet has created new opportunities
for the consumer entertainment software industry, including on-line game playing
by users in different locations and direct on-line marketing, sales and
distribution to end users.
Growth in the installed base of multimedia PCs has created a mass market for
consumer entertainment software products. The development of a mass market for
consumer entertainment software products has been characterized by the growing
importance of mass merchant software sales as a distribution channel, increasing
price pressure and competition for retail shelf space. This increased
competition has emphasized the importance of marketing, merchandising and brand
name recognition. Faced with the challenges of marketing and distribution, many
independent software developers and content providers are pursuing relationships
with publishing companies with broader distribution capabilities, including
better access to mass market retailers and greater merchandising, marketing and
promotional support. At the same time, retailers with limited shelf space are
faced with the challenge of managing an increasing number of new titles. A
significant result of these market pressures is a trend in the industry toward
the consolidation of entertainment software companies and the diversification of
products offered by such companies.
BUSINESS STRATEGY
The Company believes that its success in the industry will be achieved by
executing a business plan that focuses on: gaining brand name recognition of its
Family Friendly brand products; developing new top-selling titles within
existing brands; developing new brands; establishing strong distribution and
retail relationships; consistently offering a diversified high-quality,
high-value software portfolio of products that provide significant sell-through
and return-on-investment opportunities for all types of retailers; and
implementing a sound Internet strategy and comprehensive web site. The intended
result of the Company's business strategy is to be a leading publisher of
high-quality, value-priced consumer entertainment software in the consumer
entertainment category of the market. To implement its business strategy, the
Company intends to utilize the following tactics.
Rely On Consumer Research and Marketplace Data. The Company utilizes consumer
research and marketplace sales data to determine which products are achieving
favorable sales results in the consumer entertainment software categories that
the Company serves. The Company then focuses on developing top-selling products
that have a sustainable product life and also appeal to the broadest age group
of consumers regardless of gender. This involves either developing or obtaining
rights to products that the Company expects will meet these criteria while
complementing and supporting the Company's branding strategy.
Deliver Products To Market Quickly To Maximize Sales Opportunities. The Company
believes that one of its significant competitive strengths, primarily as a
result of market research, is its ability to identify products that consumers
are buying and which they will continue to buy. The Company leverages this
competitive strength by quickly developing or procuring product content that the
Company believes will achieve favorable sales results in its category when the
product is combined with the Company's attractive, distinctive and informative
packaging that is designed to encourage impulse purchases in retail stores. The
Company's development efforts focus primarily on product design, consistent and
user friendly interfaces, ease of use, product quality and consistency. The
Company's internal product development activities are supplemented by utilizing
existing technologies and externally developed programming and content. The
Company maintains control over the creative and market-driven aspects of product
development while utilizing outside resources to reduce development costs and
minimize risks.
Develop Products That Are Easy To Use. Based on information from registered
users of the Company's products, most of the Company's customers are new
computer owners. Therefore, the Company's products are designed to be simple and
easy to install and use, requiring little or no technical expertise. The Company
provides technical support for all of its products and revises or upgrades
products in response to consumer feedback gained from customer's registration of
products they have purchased.
<PAGE>
Develop Efficient Distribution Channels and Expand Internet Strategies. The
Company has historically used large and well-established merchandising and
distribution organizations to distribute its products to North American
retailers. The Company is in the process of implementing a new distribution
strategy, which focuses on increasing domestic and international sales to
retailers on both a direct basis as well as through a network of independent
distributors, and increasing sales through the Internet, cable television and
alternative retail markets such as supermarkets, drug stores and convenience
stores. The Company believes the Internet has created new opportunities for the
consumer entertainment software industry to better serve its customers
including: strengthening existing customer relationships; effecting direct
marketing, promotion and distribution activities to broaden its reach to new
customers; adding value to existing products; and developing new products and
markets. The Company has taken steps to capitalize on these opportunities
including: the continuous improvement and expansion of its site on the World
Wide Web; the development of its Internet infrastructure and capabilities,
including electronic distribution capabilities, incorporation of on-line
functionality into existing products, continued development of new
Internet-based partnerships and products; and infusing web-based advertising
opportunities into the Company's entertainment software products. In order to
reduce the resources required for effective distribution, the Company has
incorporated Internet capabilities into its products, which permit customers or
prospective customers to review or demonstrate the Company's products at its
website, (www.egames.com), before purchasing them.
Market Brand Names That Deliver Consistent Quality. The Company focuses its
marketing resources on developing brands that represent consistency, quality and
value to the consumer. The Company believes that to the consumer, brands offer a
safe and secure choice in an otherwise confusing, fast-changing and often
intimidating software marketplace. Consumers view successful brand logos as
friendly marks of quality assurance. Once a consumer becomes highly satisfied
with a brand in any given product category, the Company believes that the
consumer will typically tend to actively seek out that brand versus competing
brands. The Company believes that successful brands can lead to consistently
successful sell-through results, which is one of the Company's long-term goals.
Maintain Profitable Operations. During its first two years as a public company,
the Company did not achieve profitability. During the second half of fiscal 1997
the Company undertook changes in its operations and business strategy to focus
on the value-priced segment of the consumer software market while structuring
the Company to be profitable in fiscal 1998. During fiscal 1999, the Company
further focused its business strategy to concentrate on consumer entertainment
software products (specifically PC games). The value-priced segment of the
consumer entertainment software market continues to be the largest and most
rapidly growing category of the consumer entertainment software market, as
reflected in the monthly reports by the reporting firm PC Data. This trend is
expected to continue for the foreseeable future as consumers demand lower prices
for software. In order to achieve and maintain profitable operations, the
Company has created a business model that focuses on: delivering top selling
branded titles with predictable, controllable development costs and risks;
outsourcing production and warehousing while achieving high quality products and
packaging, low costs, timely and efficient deliveries and predictable overhead
costs during periods of rapidly increasing sales volume; and controlling
operating expenses.
MARKETING
The Company's marketing efforts include: developing its World Wide Web site,
(www.egames.com), promoting specific Company titles; engaging a public relations
firm for announcements and disclosures; advertising in trade journals and other
publications; coordinating in-store and industry promotions including
merchandising and point of purchase displays; participating in cooperative
advertising programs with specific retailers; and utilizing demonstration
software distributed through the Internet or on compact discs. In addition, the
Company's products contain software that enables customers to register their
purchases via electronic mail, while at the same time providing a variety of
additional market research data.
The Company's marketing department is responsible for creating marketing
programs to generate product sell-in (sales to retailers) and sell-through
(sales to end user customers). These programs generally are based on established
consumer product marketing techniques that the Company believes are becoming
more important as software becomes more of a consumer product. The Company uses
consumer product graphic designers and copywriters to create effective package
designs, catalogs, brochures, advertisements and related materials. The
Company's marketing and sales personnel and outside contractors work together to
coordinate retail and publicity programs so that those programs are in place
when products are initially shipped to retailers and consumers. Public relation
campaigns, in-store advertising, catalog mailings and advertisements are
designed in advance of product availability.
<PAGE>
SALES AND DISTRIBUTION
North American Sales and Distribution. The Company has determined that there are
a number of strategic advantages to selling its products on a direct basis to
major computer and software retailing organizations, mass market retailers,
consumer electronic stores, discount warehouses and mail order companies.
Management of the Company believes that direct sales relationships with retail
accounts would result in more effective inventory management, merchandising and
communications than are possible through indirect sales relationships. Direct
sales to retailers also diminish the Company's dependence on third-party
distributors for sales of the Company's products and increases the potential
gross profit margin that can be realized on the sale of its products.
Accordingly, the Company has established direct sales relationships with several
traditional national software retailers such as Electronics Boutique, CompUSA
and Toys-R-Us, as well as non-traditional software retailers such as Rite Aid
Corporation.
The Company has entered into relationships with third party suppliers of
electronic data interchange ("EDI") services to establish linkages with its
direct sales retailers, which in turn facilitates the placement, control and
shipment of orders and the processing of payments and credits. The Company seeks
to continue to increase the number of retail outlets served directly through its
internal sales force. However, to a larger extent, the Company sells its
products through wholesale distributors, such as GT Value Products, Navarre
Corporation, Merisel Americas, Inc., SVG Distribution, Inc. and Beamscope
Canada. GT Value Products accounted for approximately 65% and 81% of the
Company's net sales during fiscal 1999 and 1998, respectively. From May 1997 to
April 1999 GT Value Products was the exclusive distributor of the Company's
products in North America. In April 1999, the Company terminated its exclusive
distribution relationship with GT Value Products and entered into a
non-exclusive distribution relationship with them. (See "Dependence on
Distributors and Retailers", page 10). Internet sales currently account for
approximately 1% of the Company's sales.
International Sales and Distribution. The Company currently distributes its
products in Argentina, Australia, Belgium, Brazil, the Caribbean, Chile,
Colombia, Denmark, Finland, France, Germany, India, Ireland, Israel, Italy,
Mexico, the Middle East, the Netherlands, New Zealand, Panama, the Philippines,
Portugal, Saudi Arabia, Singapore, South Africa, Spain and the United Kingdom.
The Company seeks to maximize its worldwide sales and earnings by releasing high
quality localized foreign language titles, whenever practicable, and by
continuing to expand the number of direct selling and distribution relationships
it maintains with key retailers and distributors in major territories. The
Company currently publishes localized products in French, German, Italian,
Spanish and Portuguese, and the Company offers localized product packaging for
all of these languages as well as in Hebrew and Brazilian Portuguese.
Distribution Procedures. The Company's product line focuses on branded content
for the value-priced category of the consumer entertainment market. By
maintaining a branded product category focus, the Company believes that its
advertising, promotion, merchandising and packaging expenditures will build
long-term benefits for all the products in each category.
The Company's internal sales staff calls on retail accounts directly and works
with each distributor's sales personnel in order to maximize the sales potential
with retail accounts. The Company's sales staff works closely with the retail
buyers and their distributors to ensure that appropriate Company products are
inventoried for each retail outlet, stocking levels are adequate, promotions and
advertising are coordinated with product availability and in-store merchandising
plans are properly implemented.
The Company's agreements with its distributors and retailers provide for rights
to return the Company's products if the Company's products do not sell through
at satisfactory levels to the retailers. The Company sells to its distributors
and retailers on credit, with varying discounts and credit terms. (See
"Dependence on Distributors and Retailers", page 10). The Company also has some
limited exposure to returns by consumers. Reserves for returns by distributors,
retailers and consumers are established at levels that the Company believes are
adequate based on product sell-through, inventory levels and historic return
rates (See Note 1 to Financial Statements, "Summary of Significant Accounting
Policies, Revenue Recognition"). However, there can be no assurance that the
actual returns will not exceed the established reserves. The Company typically
accepts returns from customers, even when not legally required to do so, in
order to maintain good customer relations to enhance repeat purchasing by
consumers.
<PAGE>
COMPETITION
The consumer entertainment software industry is intensely competitive and is in
the process of substantial consolidation. The market for value-priced consumer
entertainment software in the category in which the Company competes is
especially competitive. The Company believes that the principal competitive
factors generally include content quality, brand name recognition, ease of use,
merchandising, product features, quality, reliability, on-line technology,
distribution channels and price. Based on its current and anticipated future
product offerings, the Company believes that it competes or will compete
effectively in these areas, particularly in price, brand name recognition,
quality, ease of use and product features.
The Company competes primarily with other software publishers, although certain
book publishers, magazine publishers, entertainment companies and media
companies may expand their product offerings to compete with the Company's
products. The Company's competitors vary in size from very small companies with
limited resources to very large corporations with greater financial, marketing,
distribution, technical and other resources than the Company. Although there are
a variety of consumer and business software publishers, based on product lines
and price points, Hasbro Interactive, Mattel Media, Activision, GT Interactive,
Electronic Arts, Humongous (a subsidiary of GT Interactive), Cosmi, Microsoft,
and Interplay are the Company's primary competitors. In addition, it is possible
that certain large software companies, hardware companies and media companies
may increasingly target the value-priced segment of the software market
resulting in additional competition.
The Company believes that increasing competition in the consumer entertainment
software market may result in lower selling prices, which could adversely affect
the Company's business, operating results and financial condition. To the extent
that competitors achieve performance, price or other selling advantages, the
Company could be adversely affected. In addition, commercial acceptance of new
technologies such as the Internet may reduce demand for the Company's existing
products. Intense price competition, reduced demand, or distribution channel
changes may have a material adverse effect on the Company's business, financial
condition, liquidity and operating results.
The market is also extremely competitive with respect to access to third-party
developers and content providers. The Company may not be successful in competing
for the most sought-after content for its products to the extent that
competitors achieve better access to distribution channels, have greater
financial resources to pay for development fees or royalties, or have developed
a widely-recognized reputation. (See "Factors Affecting Future Performance,
Rapid Technological Change; Product Development" beginning on page 12.)
PRODUCT DEVELOPMENT
The Company seeks to develop a broad line of branded products in rapidly growing
and sustainable market categories. The Company utilizes consumer research and
marketplace sales data (including reported industry sales, computer trade show
sales and retail sell-through results) to determine which products are achieving
top ranked sales results in the consumer entertainment software categories that
the Company serves. New product ideas are evaluated based upon market research
in the subject area, the type and demographics of the target consumer, and the
existence and characteristics of competitive products. The Company then either
develops or procures products that the Company expects will meet these criteria
while complementing and supporting the Company's branding strategy. The Company
believes that its development process has certain material advantages over other
software companies, including consistent product quality, reliable delivery
schedules and predictable cost estimates. The Company has also acquired products
through the acquisition of other software companies or the acquisition or
licensing of software products or technologies and will most likely continue to
acquire products this way in the future.
<PAGE>
The Company's Director of Product Development oversees the development of a
product from conception through completion, and controls the scope, design,
content and management of the project. The Company seeks to publish new products
that incorporate all of the important functions and features of the leading
competitive products and to add innovative, helpful concepts and upgrades to
achieve a "better than" positioning relative to directly competitive products.
Once a product is approved for development, a design specification is created
that includes the product's features, estimated development time and cost,
projected delivery date and projected selling price. Whenever possible, the
software is designed to incorporate technology used in the Company's current
products in an effort to shorten the development cycle and improve quality and
consistency. The overall product, including packaging and documentation, is
designed to comply with a manufacturing specification that will meet the
Company's margin requirements at the intended consumer price points.
The Director of Product Development executes the project with a development team
that typically may include programmers, designers, artists and testers. The
development team members are usually employees of the Company but may be
independent contractors depending on the scheduling of and skills required for
each project.
The Company's internal development efforts focus primarily on product design and
features, consistent user interfaces, and product quality and consistency. The
Company supplements its internal product development resources by utilizing
existing technologies and externally developed programming and content when such
utilization results in a more efficient method of creating a higher quality
product. Using this method, the Company maintains internal control over the
creative and market-driven aspects of product development while using external
resources to shorten development time and lower development costs and risks.
Development costs associated with externally licensed technology are generally
paid through a nominal one-time customization fee and royalties based on actual
sales of the product, thereby reducing the Company's investment risk in a
product.
Developed products are tested for quality assurance before being released for
production. Products are typically tested for bugs, compatibility with numerous
popular PC brands and configurations, typical installation issues, functionality
and ease-of-use. Marketing or development employees, under a manager's
supervision, are responsible for reviewing customer feedback, competitive
products, product performance and market positioning in order to introduce
upgrades that keep abreast of consumer tastes and trends while satisfying the
Company's business strategy.
DEPENDENCE ON KEY PERSONNEL
The continued success of the Company depends to a significant extent upon the
continued performance and contribution of its top management and its ability to
continue to attract, motivate and retain highly qualified employees. The loss of
the services of any of the Company's top management could have a material
adverse effect on the Company's business, operating results and financial
condition. Competition for highly skilled employees with technical, management,
marketing, sales, product development and other specialized training is intense.
Specifically, the Company may experience increased costs in order to attract and
retain skilled employees. The Company's failure to attract additional qualified
employees or to retain the services of key personnel could materially and
adversely affect the Company's business, operating results and financial
condition.
BACKLOG
The Company typically ships its products within one to two days after accepting
a customer's order, which is common in the consumer entertainment software
industry. Consequently, the Company does not usually generate a backlog of
orders that would be a significant or important indicator of future revenues or
earnings.
<PAGE>
CUSTOMER AND TECHNICAL SUPPORT
Customer and technical support standards are very high in the consumer
entertainment software market. In order to remain competitive, the Company
provides telephone and Internet technical support to its customers at no
additional charge. However, costs associated with these activities are not
significant. The Company believes that high-quality, user-friendly technical
support provides valuable feedback to the Company's marketing and software
development personnel for use in the product development process.
OPERATIONS
The Company's accounting, purchasing, inventory control, scheduling, order
processing and development activities are conducted at its headquarters location
in Langhorne, Pennsylvania. The Company maintains a sales and distribution
operation in St. Ives, England, which it obtained through its acquisition of its
United Kingdom distributor, Software Partners Distribution Ltd., in August 1998.
Most product shipments to major customers are performed by independent
contractors at their warehousing and production facilities working under the
Company's direction. The Company's information management system handles order
entry, order processing, picking, billing, accounts receivable, accounts
payable, general ledger, inventory control, and mailing list management. Subject
to credit terms and product availability, orders are typically shipped from the
Company's facilities within one to two days after accepting a customer's order.
Third party contractors replicate the software and assemble manuals, catalog
inserts and boxes in which the Company's products are shipped. The Company has
multiple sources for all components of its products, and has not experienced any
material delays in production or assembly.
EMPLOYEES
As of June 30, 1999, the Company had 39 full-time employees, of which 12 were
employed in software development; 17 in sales, marketing and customer support;
and 10 in operations, finance and administration. In addition, the Company
regularly utilizes approximately 20 independent contractors in connection with
its product development activities. No employees are represented by labor
unions, and the Company has never experienced a work stoppage.
INTELLECTUAL PROPERTY RIGHTS
The Company relies primarily on a combination of trademark, copyright, trade
secret and other proprietary rights laws, license agreements, third-party
nondisclosure agreements and other methods to protect its proprietary rights.
United States copyright law, international conventions and international
treaties, however, may not provide meaningful protection against unauthorized
duplication or infringement of the Company's software. The Company generally
sells its published software under licenses from independent developers and, in
such cases, does not acquire the copyrights for the underlying content.
Policing unauthorized use of an easily duplicated and broadly disseminated
product such as computer software is very difficult. Software piracy is expected
to be a persistent problem for the software industry for the foreseeable future.
Software piracy is a much greater problem in certain international markets such
as South America, the Middle East, the Pacific Rim and the Far East. If a
significant amount of unauthorized copying of the Company's products were to
occur, the Company's business, operating results and financial condition could
be adversely affected.
Software developers and publishers are subject to infringement claims, and there
has been substantial litigation in the industry regarding copyright, trademark
and other intellectual property rights. If any such claims or litigation, with
or without merit, were brought against the Company, such claims could be costly
and result in a diversion of management's attention, which could have a material
adverse effect on the Company's business, operating results and financial
condition. Adverse determinations with respect to such claims or litigation
would have a material adverse effect on the Company's business, operating
results and financial condition. As of the date of filing this document, the
Company is not subject to such a claim.
<PAGE>
FACTORS AFFECTING FUTURE PERFORMANCE
This report contains certain forward-looking statements involving risks and
uncertainties that could cause actual results to differ materially from those
anticipated, including, but without limitation: economic and competitive
conditions in the software business affecting the demand for the Company's
products; the Company's need for additional funds; the ability to hire and
retain key management personnel to manage anticipated growth; the development,
market acceptance and timing of new products; access to distribution channels;
and the renewal of licenses for key software products. Those factors, the
factors discussed below, and the factors identified on page 22 of Management's
Discussion and Analysis should be considered by investors in the Company. All
forward-looking statements are necessarily speculative and there are numerous
risks and uncertainties that could cause actual events or results to differ
materially from those referred to in such forward-looking statements. The
discussion below highlights some of the more important risks identified by
management, but should not be assumed to be the only factors that could affect
future performance.
Early Stage Company; Consumer Entertainment Software Business; Maintaining
Profitability. The Company commenced operations in July 1992. The Company
experienced significant losses from inception through the end of fiscal 1997.
Fiscal 1998 was the first year that the Company earned a profit. After earning
$463,000 and $1,253,000 in fiscal 1999 and 1998, respectively, the accumulated
deficit for the Company at June 30, 1999 was approximately $6,268,000. Prior to
fiscal 1998, the Company's operations were funded primarily through proceeds
from the Company's initial public offering of Common Stock in October 1995 and
through the sale in private offerings of preferred stock and Common Stock
warrants in November 1996 and in January and April 1997. Subsequently, the
Company has funded its activities through income from operations. The Company's
operations today are still subject to all of the risks inherent in the
development of a recently profitable business, particularly in a highly
competitive industry, including, but not limited to, development, distribution
and marketing difficulties, competition and unanticipated costs and expenses.
The Company's future success will depend upon its ability to increase revenues
from the development, marketing and distribution of its current and future
software products. The development of multimedia software products, which can
combine text, sound, high quality graphics, images and video, is difficult and
time consuming, requiring the coordinated participation of various technical and
marketing personnel and outside developers. Other factors affecting the
Company's future success include, but are not limited to, the ability of the
Company to overcome problems and delays in product development, market
acceptance of products and successful implementation of its sales, distribution
and marketing strategy. There can be no assurance the Company will be successful
in maintaining and expanding a sustainable consumer entertainment software
business.
Dependence On Distributors And Retailers; Risk Of Customer Business Failure;
Product Returns. Many of the largest mass-market retailers have established
exclusive buying relationships under which such retailers will buy consumer
entertainment software only from certain distributors. In such instances, the
Company will not be able to sell its products to such mass-market retailers if
these distributors are unwilling to distribute the Company's products.
Additionally, even if the distributors are willing to purchase the Company's
products, the distributor is frequently able to dictate the price or other terms
on which the Company sells to such retailers, or the Company may be unable to
sell to such retailers on terms that the Company deems acceptable. The inability
of the Company to negotiate commercially viable distribution relationships with
these and other distributors, or the loss of, or significant reduction in sales
attributable to, any of the Company's principal distributors or retailers could
materially adversely effect the Company's business, operating results and
financial condition.
Distributors and retailers in the computer industry have from time to time
experienced significant fluctuations in their businesses and there have been a
number of business failures among these entities. The insolvency or business
failure of any significant retailer or distributor of the Company's products
could have a material adverse effect on the Company's business, operating
results and financial condition. Sales are typically made on credit, with terms
that vary depending upon the customer and the nature of the product. The Company
does not hold collateral to secure payment.
<PAGE>
The Company maintains allowances for uncollected receivables that it believes to
be adequate, but the actual allowance maintained may not be sufficient in every
circumstance. The failure to pay an outstanding receivable by a significant
customer or distributor could have a material adverse effect on the Company's
business, operating results and financial condition. Although the Company has
established allowances for returns that it believes are adequate, there can be
no assurance that actual returns will not exceed such allowances. The Company
may also accept substantial product returns in order to maintain its
relationships with retailers and its access to distribution channels. As a
result of the Company's termination of its exclusive distribution relationship
with GT Value Products, and its new non-exclusive distribution relationships
with other distributors, including GT Value Products, the Company is now
increasingly exposed to the risk of product returns from these retailers and
distributors. Product returns that exceed the Company's allowances could have a
material adverse effect on the Company's business, operating results and
financial condition.
During the years ended June 30, 1999 and 1998, sales of the Company's products
to GT Value Products accounted for approximately 65% and 81%, respectively, of
the Company's net sales. As of June 30, 1999 and 1998, the Company's accounts
receivable with GT Value Products accounted for 63% and 85 % of gross accounts
receivable, respectively. Since either GT Value Products or the Company can
terminate the distribution relationship between the parties at any time for any
reason, there can be no assurance that GT Value Products will continue to
distribute the Company's products. The loss of GT Value Products as a
distributor or an inability to collect receivables from GT Value Products or any
other adverse change in the Company's relationship with GT Value Products would
have a material adverse effect on the Company's business, operating results,
liquidity and financial condition.
Highly Competitive Market; Pricing Concerns; Rapidly Changing Marketing
Environment; Competition for Retail Shelf Space. The market for consumer
entertainment software is highly competitive, particularly at the retail shelf
level where a rapidly increasing number of software titles are competing for the
same amount of shelf space. Retailers have a limited amount of shelf space
relative to the number of consumer entertainment software products competing for
that space. Therefore, there is intense competition among consumer entertainment
software publishers for adequate levels of shelf space and promotional support
from retailers. As the number of software titles continues to increase, the
competition for shelf space continues to intensify, resulting in greater
leverage for retailers and distributors in negotiating terms of sale, including
price discounts and product return policies. The Company's products represent a
relatively small percentage of any retailer's sales volume, and there can be no
assurance that retailers will continue to purchase the Company's products or
promote the Company's products with adequate levels of shelf space and
promotional support.
Most of the Company's competitors have substantially greater sales, marketing,
development and financial resources. The Company believes that the competitive
factors affecting the market for its products and services include the
traditional attributes used in determining a product's value such as: vendor and
product reputation; product quality, performance and price; product
functionality and features; product ease-of-use; and the quality of customer
support services and training. The relative importance of each of these factors
depends upon the specific customer involved, and while the Company believes it
competes favorably in each of these areas, there can be no assurance that it
will continue to do so. Moreover, the Company's present or future competitors
may be able to develop products which are comparable or superior to those
offered by the Company, offer lower priced products or adapt more quickly than
the Company to new technologies or evolving customer requirements. The Company's
competitors may also have more money to spend on marketing promotions and
advertising efforts. Competition is expected to intensify. In order to be
successful in the future, the Company must respond to technological change,
customer requirements and competitors' current products and innovations. There
can be no assurance that the Company will be able to continue to compete
effectively in its market or that future competition will not have a material
adverse effect on its business operating results and financial condition.
Need for Additional Funds. The Company's future capital requirements will depend
on many factors, but particularly on cash flow from sales of the Company's
products. If the Company is not able to maintain cash flow from operations at a
level sufficient to support continued growth of its business, the Company may
require additional funds to sustain and expand its product development,
marketing and sales activities. Adequate funds for these purposes may not be
available or may be available only on terms that would result in significant
dilution or otherwise be unfavorable to existing stockholders. If the Company is
unable to secure additional funding, or if the Company is unable to obtain
adequate funds from operations or other external sources when required, the
Company's inability to do so would have a material adverse effect on the
long-term viability of the Company.
<PAGE>
On March 10, 1999, the Company entered into a $1,000,000 revolving credit
facility with a commercial bank. Amounts outstanding under this credit facility
are charged interest at one-half of one percent above the bank's current prime
rate and such interest is due monthly. The credit facility is collateralized by
substantially all of the Company's assets. The credit facility requires the
Company, among other things, to maintain certain financial ratios, such as: a
minimum working capital balance of $1,500,000 and a maximum debt to net tangible
assets ratio of 1.50 to 1.00. As of June 30, 1999, the Company was in compliance
with each of those covenants. This credit facility was established to provide,
among other things, additional working capital to support the Company's
anticipated growth. As of August 31, 1999, the Company had not utilized this
credit facility, which expires on October 31, 1999. On September 20, 1999, the
Company and its commercial bank signed a commitment letter to increase the
Company's credit facility from $1,000,000 to $1,500,000 and to extend its term
to October 31, 2000. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources" in Part
II, Item 6 of this document.
Uncertainty of Market Acceptance; Short Product Life Cycles. The market for
consumer entertainment software has been characterized by shifts in consumer
preferences and short product life cycles. Consumer preferences for
entertainment software products are difficult to predict and few products
achieve sustained market acceptance. There can be no assurance that new products
introduced by the Company will achieve any significant degree of market
acceptance, that such acceptance will be sustained for any significant period,
or that product life cycles will be sufficient to permit the Company to recover
development, marketing and other associated costs. In addition, if market
acceptance is not achieved, the Company could be forced to accept substantial
product returns to maintain its relationships with distributors and retailers
and its access to distribution channels. Failure of new products to achieve or
sustain market acceptance or product returns in excess of the Company's
expectations would have a material adverse effect on the Company's business,
operating results and financial condition.
Rapid Technological Change; Product Development. Frequent new product
introductions and enhancements, rapid technological developments, evolving
industry standards and swift changes in customer requirements characterize the
market for the Company's products. The Company's continued success depends upon
its ability to continue to quickly and efficiently develop and introduce new
products and enhance existing products to incorporate technological advances and
responses to customer requirements. If any of the Company's competitors
introduce products more quickly than the Company, or if they introduce better
products, the Company's business could be adversely affected. There can be no
assurance that the Company will be successful in developing and marketing new
products or enhancements to its existing products on a timely basis or that any
new or enhanced products will adequately address the changing needs of the
marketplace. From time to time, the Company or its competitors may announce new
products, capabilities or technologies that have the potential to replace or
shorten the life cycles of the Company's existing products. There can be no
assurance that announcements of currently planned or other new products by
competitors will not cause customers to delay their purchasing decisions in
anticipation of such products, which could have a material adverse effect on the
Company's business, liquidity and operating results.
Fluctuations in Quarterly Results; Uncertainty of Future Operating Results;
Seasonality. The Company's quarterly operating results have varied significantly
in the past and will likely vary significantly in the future depending on
numerous factors, many of which are not under the Company's control. Future
operating results will depend upon many factors including: the size and rate of
growth of the consumer entertainment software market; the demand for the
Company's products; the level of product and price competition; the length of
the Company's sales cycle; seasonality of individual customer buying patterns;
the timing of new product introductions and product enhancements by the Company
and its competitors; the timing of orders from major customers; delays in
shipment of products; access to distribution channels; product defects and other
quality problems; product life cycles; levels of international sales; changes in
foreign currency exchange rates; the ability of the Company to develop and
market new products and control costs; general domestic and international
economic and political conditions; and personnel changes. Products are usually
shipped as orders are received so the Company operates with little or no
backlog. Therefore, net revenues in any quarter are dependent on orders booked
and shipped during that quarter.
<PAGE>
The consumer entertainment software industry is somewhat seasonal due primarily
to holiday shopping and back-to-school buying patterns. Accordingly, in
descending order, the calendar fourth, first and third quarters are typically
the strongest quarters for sales results with the calendar second quarter
typically the weakest.
Therefore, revenues and operating results for any future quarter are not
predictable with any significant degree of accuracy. Consequently, the Company
believes that period-to-period comparisons of its operating results are not
necessarily meaningful and should not be relied upon as indications of future
performance.
Risk of Defects. Products offered by the Company can contain errors or defects.
The PC hardware environment is characterized by a wide variety of non-standard
peripherals, such as sound and graphics cards, and configurations that make
pre-release testing for programming or compatibility errors difficult and
time-consuming. Despite the extensive testing performed by the Company's quality
assurance personnel, new products or releases may contain errors discovered
after shipments have commenced, resulting in a loss of or delay in market
acceptance, which could have a material adverse effect on the Company's
business, operating results and financial condition.
Possible Inadequacy of Protection of Trade Names; Software Technology; and Other
Proprietary Rights. The Company holds copyrights on the products, manuals,
advertising and other materials owned by it. The Company also either owns
trademark rights or is in the process of applying for such rights in the
Company's name and logo, and the names of the products owned or licensed by the
Company. The Company's success depends in part on its ability to protect its
proprietary rights to the trademarks, trade names and content used in its
principal products. The Company relies on a combination of copyrights,
trademarks, trade secrets, confidentiality procedures and contractual provisions
to protect its proprietary rights. There can be no assurance that the Company's
existing or future copyrights, trademarks, trade secrets or other intellectual
property rights will be of sufficient scope or strength to provide meaningful
protection or commercial advantage to the Company. Also, in selling certain of
its products, the Company relies on "shrink wrap" licenses that are not signed
by licensees and, therefore, may be unenforceable under the laws of certain
jurisdictions. In addition, the laws of some foreign countries do not protect
the Company's proprietary rights as do the laws of the United States. There can
be no assurance that such factors would not have a material adverse effect on
the Company's business or operating results.
The Company may from time to time be notified that it is infringing on certain
patent or intellectual property rights of others. Combinations of technology
acquired through past or future acquisitions and the Company's technology will
create new products and technology that may give rise to claims of infringement.
While no actions are currently pending against the Company for infringement of
patent or other proprietary rights of third parties, there can be no assurance
that third parties will not initiate infringement actions against the Company in
the future. Any such action could result in substantial cost to and diversion of
resources of the Company. If the Company was found to be infringing the rights
of others, no assurance can be given that licenses would be obtainable on
acceptable terms or at all, that significant damages for past infringement would
not be assessed, or that further litigation relative to any such licenses or
usage would not occur. The failure to obtain necessary licenses or other rights,
or the advent of litigation arising out of any such claims, could have a
material adverse effect on the Company's operating results.
Acquisition-Related Risks. Since its initial public offering, the Company has
acquired Applied Optical Media Corporation, Saturn Publishing, Virtual Reality
Laboratories, Inc. and Software Partners Publishing and Distribution Ltd.
Consistent with the Company's strategy of enhancing its sales and distribution
capabilities and product offerings, the Company intends to continue to pursue
acquisitions of companies, intellectual property rights and other assets that
can be purchased or licensed on acceptable terms and which the Company believes
will contribute to profitability. Some of these transactions could be material
in size and scope. While the Company searches for appropriate acquisition
opportunities, the Company may not be successful in identifying suitable
acquisitions. If potential acquisition opportunities are identified, the Company
may not be able to consummate such acquisitions and if such an acquisition does
occur, it may not enhance the Company's business or be accretive to the
Company's earnings. As the consumer entertainment industry continues to
consolidate, the Company faces significant competition in seeking acquisitions
and may in the future face increasing competition for acquisition opportunities.
This competition is likely to inhibit the Company's ability to complete suitable
transactions.
<PAGE>
The Company may, in the future, issue additional shares of Common Stock in
connection an acquisition, which may dilute its existing stockholders.
Future acquisitions could divert substantial management time that would
otherwise be available for the ongoing development of the Company's business,
and could result in short term reductions in earnings or special transaction or
other charges. An acquired business may also be difficult to integrate with
existing operations or assets. If the Company's management is not able to
respond to these challenges effectively, the Company's results of operations
could be adversely affected. Moreover, there can be no assurance that the
anticipated benefits of an acquisition will be realized. The Company believes
that its future growth will depend, in part, on its ability to continue to
identify, acquire and integrate companies that have software development,
publishing and/or distribution capabilities. While the Company reviews
acquisition opportunities in the ordinary course of its business, the Company
presently has no commitments or undertakings with respect to any material
acquisitions. There can be no assurance that the Company will be successful in
identifying and acquiring suitable acquisition candidates or integrating such
acquired businesses into the Company's operations.
Dependence on Key Management and Technical Personnel. The Company's success
depends to a significant degree upon the continued contributions of its key
management, marketing, technical and operational personnel, including members of
senior management. The loss of the services of one or more key employees could
have a material adverse effect on the Company's operating results. The Company
also believes its future success will depend in large part upon its ability to
attract and retain additional highly skilled management, technical, marketing,
product development and operational personnel. Competition for such personnel is
intense, and there can be no assurance that the Company will be successful in
attracting and retaining such personnel.
International Sales. In fiscal 1999, the Company derived approximately 27% of
its total revenues from international sales versus 8% in fiscal 1998. The
Company expects international sales to continue to comprise a significant and
increasing percentage of the Company's sales. The Company's international
business is subject to certain risks including: varying regulatory requirements;
tariffs and trade barriers; political and economic instability; reduced
protection for intellectual property rights in certain countries; difficulties
in supporting foreign customers; difficulties in managing foreign distributors;
potentially adverse tax consequences; the burden of complying with a wide
variety of complex operations; customs, foreign laws, regulations and treaties;
fluctuating currency valuations; and the possibility of difficulties in
collecting accounts receivable.
Year 2000 Issues: the Company's State of Readiness; Cost to Address the Year
2000 Issues; Year 2000 Contingency Plan. The Company has reviewed its critical
information systems for Year 2000 compliance. The compliance review revealed
that all but one of the Company's critical information systems were Year 2000
compliant due to the fact that most of the Company's network hardware and
operating systems are "off-the-shelf" products from third parties with Year 2000
compliant versions. The one critical information system that required an upgrade
to become Year 2000 compliant was upgraded during December 1998. The Company has
determined that there should be no Year 2000 issues for the products it has
already sold since the Company's products predominantly contain no
date-sensitive software. As part of the Company's Year 2000 compliance review,
the Company is in the process of contacting its primary vendors, distributors
and customers to determine the extent to which the Company is vulnerable to such
third parties' failures to address their Year 2000 compliance issues. The
Company will continue to work to obtain sufficient information and assurances
from its significant vendors, distributors and customers as part of its Year
2000 compliance review. However, there can be no guarantee that third parties on
which the Company's business relies will adequately address their Year 2000
compliance issues nor is there any guarantee that the failure by such third
parties to adequately deal with such issues would not have a material adverse
effect on the Company and its operations.
<PAGE>
The Company has completed its Year 2000 compliance review of its critical
information systems, including the upgrading of one if its software systems at
an approximate cost of $15,000. The Company's Year 2000 compliance review of its
third party suppliers, distributors and vendors is an ongoing process, but to
date has not required any material amount of Company resources or funds. The
Company does not expect the cost of its Year 2000 compliance to be material to
the Company's financial position, cash flow or results of operations. The
Company believes that its primary risk associated with Year 2000 compliance is
the failure of third parties upon whom the Company's business relies to timely
address their Year 2000 issues. Failure by third parties to adequately address
their Year 2000 issues in a timely manner could result in disruptions in the
Company's supply of products, packaging and related materials, late or missed
payments, temporary disruptions in order processing and other general problems
related to the Company's daily operations. While the Company believes its Year
2000 compliance review procedures will adequately address the Company's internal
Year 2000 issues, until the Company receives responses from all of its
significant vendors, distributors and customers, the overall risks associated
with the Year 2000 issue currently remain difficult to accurately describe and
quantify, and there can be no guarantee that such uncertainty will not have a
material adverse effect on the Company's business, operating results and
financial position.
The Company has not, to date, implemented a Year 2000 contingency plan. The
Company intends to develop and implement a contingency plan by the end of
October 1999.
Stock Price Volatility. The Company believes that a variety of factors could
cause the price of its Common Stock to fluctuate, perhaps substantially, over a
short period of time including: quarter to quarter variations in operating
results; announcements of developments related to its business; fluctuations in
its order levels; general conditions in the technology sector or the worldwide
economy; announcements of technological innovations, new products or product
enhancements by the Company or its competitors; key management changes; and
developments in the Company's relationships with its customers, distributors and
suppliers. In addition, in recent years the stock market in general, and the
market for shares of software, high technology stocks, micro-cap and small cap
stocks in particular, has experienced extreme price fluctuations which have
often been unrelated to the operating performance of affected companies. Such
fluctuations could adversely affect the market price of the Company's Common
Stock.
Listing of Securities; Risk of Low Priced Stocks. The Company's Common Stock is
listed on the Nasdaq SmallCap Market under the symbol EGAM. A listed company may
be de-listed if it fails to maintain minimum levels of Stockholders' equity,
shares publicly held, number of Stockholders or aggregate market value, or if it
violates other aspects of its listing agreement. At June 30, 1999, the Company
satisfied the minimum level of Stockholders' equity required to be listed
($2,000,000) and all other aspects of its listing agreement.
If the Company fails to maintain the criteria for trading on the Nasdaq SmallCap
Market, its Common Stock may be de-listed. Public trading, if any, would
thereafter be conducted in the over-the-counter market in the so-called "pink
sheets," or on the NASD's "Electronic Bulletin Board." If the Common Stock were
de-listed, it may be more difficult to dispose of, or even to obtain quotations
as to the price of, the Common Stock and the price, if any, offered for the
Common Stock may be substantially reduced.
In addition, if the Common Stock is de-listed from trading on the Nasdaq
SmallCap Market, and the trading price of the Common Stock is less than $5.00
per share, or the Company has less than $2 million in net tangible assets,
trading in the Common Stock would be subject to the requirements of Rule 15g-9
promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). Under this rule, broker/dealers who recommend such securities to persons
other than established customers and accredited investors (generally
institutions with assets in excess of $5 million or individuals with a net worth
in excess of $1 million or an annual income exceeding $200,000 or $300,000
jointly with their spouses) must make a special written suitability
determination for the purchaser and receive the purchaser's written agreement to
a transaction prior to sale. The requirements of Rule 15g-9, if applicable, may
affect the ability of broker/dealers to sell the Company's securities and may
also affect the ability of purchasers to sell their shares in the secondary
market. The Securities Enforcement Remedies and Penny Stock Reform Act of 1990
(the "Penny Stock Rule") also requires additional disclosure in connection with
any trades involving a stock defined as penny stock (any non-Nasdaq equity
security that has a market price or exercise price of less than $5.00 per share
and less than $2 million in net tangible assets, subject to certain exceptions).
Unless exempt, the rules require the delivery, prior to any transaction
involving a penny stock, of a disclosure schedule prepared by the SEC explaining
important concepts involving the penny stock market, the nature of such market,
terms used in such market, the broker/dealer's duties to the customer, a
toll-free telephone number for inquiries about the broker/dealer's disciplinary
history and the customer's rights and remedies in case of fraud or abuse in the
sale. Disclosure must also be made about commissions payable to both the
broker/dealer and the registered representative, and current quotations for the
securities. Finally, monthly statements must be sent disclosing recent price
information for the penny stock held in the account and information on the
limited market in penny stocks.
<PAGE>
Item 2. Properties
The Company leases 11,000 square feet of office, development and warehouse space
in Langhorne, Pennsylvania and 5,000 square feet of office and warehouse space
in St. Ives, England. The Company believes that its current facilities will be
adequate for the Company's anticipated needs through fiscal 2000. The Company
leases its North American and United Kingdom operating facilities under two
operating leases, expiring in September 2002 and in March 2007, respectively.
Rent expense was $204,000 and $157,000 for the years ended June 30, 1999 and
1998, respectively. The Company anticipates that it may require additional space
as its business grows but anticipates no difficulty in obtaining such space in
the vicinity of its current facilities on terms substantially similar to those
of the Company's current lease.
Item 3. Legal Proceedings
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
<PAGE>
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
The Company's Common Stock is traded on the Nasdaq SmallCap Market System
("Nasdaq") under the symbol EGAM. The following are the range of high and low
bid prices for fiscal 1999 and 1998, as reported by Nasdaq:
High Low
---- ---
Fiscal 1998
-----------
First quarter ................... $2.000 $0.969
Second quarter .................. $3.000 $1.500
Third quarter ................... $2.813 $2.375
Fourth quarter .................. $2.719 $1.719
Fiscal 1999
-----------
First quarter ................... $2.125 $0.938
Second quarter .................. $1.935 $0.938
Third quarter ................... $6.156 $1.625
Fourth quarter .................. $4.500 $2.375
On August 31, 1999, the Company had approximately 118 shareholders of record.
The Company has not paid any dividends on its Common Stock. The Company
currently intends to retain earnings, if any, for use in its business and does
not anticipate paying cash dividends in the foreseeable future.
Item 6. Management's Discussion and Analysis of Results of Operations
and Financial Condition
Results of Operations
The following discussion should be read together with the Company's Consolidated
Financial Statements and Notes thereto beginning on page 23.
Year Ended June 30, 1999 Compared to the Year Ended June 30, 1998
Net Sales and Cost of Sales
Net sales for the year ended June 30, 1999 were $10,022,000 compared to
$9,276,000 for the year ended June 30, 1998, representing an increase of
$746,000 or 8%. As it relates to the mix of products sold, this increase
generally resulted from increases in sales of the Company's full-release game
products, while sales of the Company's shareware-based products, personal
productivity and non-eGames products decreased. For the year ended June 30,
1999, the Company's net sales were comprised of full-release game products
(60%), shareware-based products (25%), personal productivity products (10%) and
non-eGames products (5%), respectively. For the year ended June 30, 1998, the
Company's net sales were comprised of full-release game products (3%),
shareware-based products (59%), personal productivity products (24%) and
non-eGames products (14%), respectively. These changes in products sold reflect
the Company's transition from publishing and distributing primarily
shareware-based products to full-release, proprietary products, which occurred
during the 1999 fiscal year. Additionally, due to issues arising from the
Company's year-end transition towards multiple relationships for the
distribution of its products, as described in the following paragraph, the
Company's domestic sales for fiscal 1999 decreased by $1,251,000 from fiscal
1998 results. This decrease in the Company's domestic sales was offset by a
$1,997,000 increase in the Company's international sales achieved during fiscal
1999 as compared to fiscal 1998 results, which increase in international sales
resulted primarily from the Company's acquisition of Software Partners
Publishing and Distribution Ltd., a United Kingdom-based software distributor,
that occurred in August 1998. The Company's international sales represented 27%
and 8% of the Company's net sales for the 1999 and 1998 fiscal years,
respectively.
<PAGE>
Until April 1999, the Company primarily distributed its entertainment software
products in North America through a large national distributor, GT Value
Products, a division of GT Interactive Software Corporation. At that time, the
Company terminated its exclusive distribution agreement with GT Value Products
and began entering into non-exclusive distribution agreements with various
national distributors, including GT Value Products. The Company has also entered
into several direct sales agreements with certain retailers. This new
distribution strategy is intended to diversify the Company's distribution
channels to retail, provide for more effective inventory management,
merchandising and communications with retailers, diminish the Company's
dependence on any one third-party distributor for sales of the Company's
products, and increase the potential gross profit margin that can be realized on
the sale of its products. The Company continues to distribute its products
through GT Value Products to certain mass merchandise retailers that purchase
value-priced software exclusively through GT Value Products. The Company's
product sales to GT Value Products accounted for 65% and 81% of the Company's
net sales for the years ended June 30, 1999 and 1998, respectively. The Company
believes that for the year ending June 30, 2000, sales to GT Value Products
could account for a decreasing, but significant, amount of the Company's net
sales.
As a result of its transition to a new distribution strategy, the Company's
sales for the fourth quarter ended June 30, 1999 were adversely affected. The
Company's sales were $1,383,000 for the quarter ended June 30, 1999 as compared
to $1,931,000 for the quarter ended June 30, 1998.
During April 1999, pursuant to its new distribution strategy, the Company
shipped its first order on a direct basis to over 2,600 individual Rite Aid drug
stores. As competition for shelf space in traditional software retail stores
continues to increase, the Company intends to aggressively target
non-traditional software retailers for opportunities to distribute the Company's
products. These non-traditional software retailers may include grocery stores,
drug stores, convenience stores, music stores and bookstores.
During the 1999 fiscal year, the Company has taken steps to increase
distribution of its products via the Internet, including: devoting resources to
the improvement and expansion of its web site; establishing electronic
distribution capabilities by entering into an agreement with Digital River, a
distributor of digital software over the Internet; and incorporating on-line
functionality into existing products. Sales of the Company's products via the
Internet were less than 1% of the Company's net sales for the years ended June
30, 1999 and 1998, respectively.
Product returns experienced by the Company during the years ended June 30, 1999
and 1998 were $859,000 and $39,000, respectively, or nine percent and less than
one percent of the Company's net sales, respectively. This increase in product
returns was caused primarily from the change in the Company's distribution
relationship with GT Value Products, which occurred during the year ended June
30, 1999, as well as the Company's new distribution relationships which also
allow for product returns.
Cost of sales for the year ended June 30, 1999 were $3,597,000 compared to
$3,442,000 for the year ended June 30, 1998, representing an increase of
$155,000 or 4%. This increase was caused primarily by additional inventory
obsolescence costs of $207,000 and increased royalty costs of $345,000, both
associated with the Company's transition from shareware to full-release software
products, which was initiated during fiscal 1999. The increase in cost of sales
was partially offset by a $569,000 decrease in replication and assembly costs
resulting from negotiated contract manufacturing pricing with third party
replicating and box assembly vendors. Product costs consist mainly of replicated
compact discs, printed materials, protective jewel cases and boxes for certain
products. The increase in gross profit margin to 64.1% from 62.9% was caused
primarily by increased sales of the Company's full-release products, which have
a higher gross profit margin than the Company's discontinued shareware products,
combined with replication and assembly cost savings achieved during the year
ended June 30, 1999.
<PAGE>
Operating Expenses
Product development expenses for the year ended June 30, 1999 were $937,000
compared to $397,000 for the year ended June 30, 1998, an increase of $540,000
or 136.0%. This increase was caused primarily by a $248,000 increase in salary
and related costs for employees hired to focus on the Company's product
development efforts and a $277,000 increase in independent developer costs,
which were both due to the Company's significant increase in the development of
full-release products during the year ended June 30, 1999.
The development of full-release software requires substantially greater
resources than producing shareware-based software, because it involves
identifying potential sources of software content, negotiating licensing
agreements with the developers of such content, and preparing a finished product
based upon the acquired content, which requires additional in-house or
independent contractor development efforts. During the 1999 fiscal year, the
Company has also devoted additional resources to its quality assurance efforts
in order to determine that each of the versions of products that are developed
and marketed - including demonstration, full release and collection versions -
function properly. As competition for quality software content intensifies, the
Company anticipates that it will require additional resources to continue to
develop high-quality products. The Company has also utilized independent
contractors during the 1999 fiscal year to localize its software products into
foreign languages. The Company currently publishes localized products in French,
German, Italian, Spanish and Portuguese. The Company intends to continue to
increase the number of products that are available in foreign languages, which
would require the Company to incur additional product development expenses.
The Company recorded sales from 38 full-release game products for the year ended
June 30, 1999 compared to recorded sales from 3 full-release game products for
the year ended June 30, 1998. The Company is currently working towards
publishing between 35 and 40 new full-release game products during fiscal 2000.
Selling, general and administrative expenses for the year ended June 30, 1999
were $4,814,000 compared to $4,135,000 for the year ended June 30, 1998, an
increase of $679,000 or 16.4%. This increase was caused primarily by operating
expenses incurred by the Company's sales and distribution operation in the
United Kingdom, acquired on August 14, 1998, which were partially offset by
reductions in the Company's marketing promotional costs incurred in the North
American marketplace.
Interest expense, net
Net interest expense for the year ended June 30, 1999 was $32,000 compared to
$46,000 for the year ended June 30, 1998, a decrease of $14,000 or 30.4%. The
reason for this decrease was the reduction of long-term debt and capital lease
obligations due to normal monthly principal payments made during the year ended
June 30, 1999, and the increase in interest income earned from higher cash
balances held by the Company during fiscal 1999.
Provision for income taxes
Provision for income taxes for the year ended June 30, 1999 was $180,000
compared to $3,000 for the year ended June 30, 1998, an increase of $177,000.
The increase in the provision for income taxes was primarily due to foreign
income taxes related to the Company's United Kingdom subsidiary acquired during
fiscal 1999, the expiration of net operating losses available to offset state
taxable income and federal taxable income not offset by net operating losses.
Net income attributable to Common Stock
Net income attributable to Common Stock for the year ended June 30, 1999 was
$463,000 compared to $1,135,000 for the year ended June 30, 1998, a decrease of
$672,000 or 59.2%. This decrease in profitability was primarily a result from
increases in operating expenses and provision for income taxes of $1,219,000 and
$177,000, respectively, which were partially offset by a $591,000 increase in
gross profit and a $118,000 decrease in the accretion of the beneficial
conversion feature on preferred stocks.
<PAGE>
Weighted average common shares
The weighted average common shares outstanding on a diluted basis increased by
184,835 during the year ended June 30, 1999. During the 1999 fiscal year,
150,000 shares of Common Stock were issued in connection with the acquisition of
Software Partners Publishing and Distribution Ltd., now eGames Europe, Ltd.
("eGames Europe") in August 1998, and 312,140 shares of Common Stock were issued
in connection with the exercise of 270,308 Common Stock warrants and 41,832
Common Stock options. In addition, due to the $118,000 accretion of the
beneficial conversion feature of the Class Two and Class Three Convertible
Preferred Stock for the year ended June 30, 1998, the Company's net income per
Common Share was negatively impacted by $0.01 for the year ended June 30, 1998.
During the year ended June 30, 1999, the Company acquired 231,900 shares of its
Common Stock for approximately $501,000 as part of a stock repurchase program
approved by the Board of Directors in October 1998.
Liquidity and Capital Resources
As of June 30, 1999, the Company's cash and working capital balances were
$1,314,000 and $2,708,000, respectively, and the Company's total stockholders'
equity balance at June 30, 1999 was $3,224,000. As of September 21, 1999, the
Company's unaudited cash balance was approximately $300,000, primarily as a
result of lower than expected cash collections from the Company's distributors
since the end of the 1999 fiscal year. On September 20, 1999, the Company and
its commercial bank signed a commitment letter to increase the Company's credit
facility from $1,000,000 to $1,500,000 and to extend its term to October 31,
2000.
As indicated in the accompanying financial statements, the Company's net income
for fiscal 1999 was $463,000 and the Company's net income for fiscal 1998 was
$1,253,000. In addition, cash provided by operating activities was $866,000 and
$707,000 for the years ended June 30, 1999 and 1998, respectively. The $866,000
net cash provided by operating activities for the year ended June 30, 1999
resulted primarily from the Company's net income adjusted for non-cash
depreciation and amortization expense for the period, in addition to a decrease
in accounts receivable, which was partially offset by an increase in inventory.
Net cash used in investing activities for the year ended June 30, 1999 and 1998
were $313,000 and $403,000, respectively. Purchases of software rights and
furniture and equipment totaled $108,000 and $193,000, respectively, for the
year ended June 30, 1999. On August 14, 1998, the Company acquired all of the
outstanding shares of Software Partners Publishing and Distribution Ltd., in
exchange for 150,000 shares of the Company's Common Stock, valued at
approximately $213,000. On March 31, 1999, Software Partners changed its name to
eGames Europe Ltd. Acquisition costs, net of cash received, were approximately
$13,000.
Net cash used in financing activities was $193,000 for the year ended June 30,
1999 and net cash provided by financing activities was $205,000 for the year
ended June 30, 1998. On October 26, 1998, the Company's Board of Directors
authorized the Company to purchase up to $1,000,000 of its shares of Common
Stock in the Nasdaq SmallCap Market. As of June 30, 1999, the Company had
purchased 231,900 shares of its Common Stock at an approximate cost of $501,000,
pursuant to its stock repurchase program. During the year ended June 30, 1999,
the Company received net proceeds from the exercise of Common Stock warrants and
options totaling approximately $485,000. During the year ended June 30, 1999,
the Company made $124,000 in notes payable repayments and $53,000 in capital
lease repayments.
The Company's ability to achieve and maintain positive cash flow depends upon a
variety of factors, including the timeliness and success of the collection of
outstanding accounts receivable, the creditworthiness of the primary
distributors of the Company's products, the development and sell-through of the
Company's products, the costs of developing, producing and marketing such
products, and various other factors, some of which are beyond the Company's
control. In the future, the Company expects its cash and working capital
requirements to be affected by each of these factors. The Company believes cash
and working capital balances will be sufficient to fund the Company's operations
for the foreseeable future. However, there can be no assurances that the Company
will be able to achieve and maintain a positive cash flow or that additional
financing will be available if and when required or, if available, will be on
terms satisfactory to the Company.
<PAGE>
On March 10, 1999, the Company entered into a $1,000,000 revolving credit
facility with a commercial bank. Amounts outstanding under this credit facility
are charged interest at one-half of one percent above the bank's current prime
rate and such interest is due monthly. The credit facility is collateralized by
substantially all of the Company's assets. The credit facility requires the
Company, among other things, to maintain certain financial ratios, such as: a
minimum working capital balance of $1,500,000 and a maximum debt to net tangible
assets ratio of 1.50 to 1.00. As of June 30, 1999, the Company was in compliance
with each of those covenants. This credit facility was established to provide,
among other things, additional working capital to support the Company's
anticipated growth. As of August 31, 1999, the Company had not utilized this
credit facility, which expires on October 31, 1999. On September 20, 1999, the
Company and its commercial bank signed a commitment letter to increase the
Company's credit facility from $1,000,000 to $1,500,000 and to extend its term
to October 31, 2000.
At June 30, 1999, the Company continued to satisfy the minimum level of
stockholders' equity required and all other aspects of its listing agreement for
the Nasdaq SmallCap Market. At June 30, 1999, the Company had $2,967,000 in net
tangible assets.
Year 2000
The Company's State of Readiness
- --------------------------------
The Company has reviewed its critical information systems for Year 2000
compliance. The compliance review revealed that all but one of the Company's
critical information systems were Year 2000 compliant due to the fact that most
of the Company's network hardware and operating systems are "off-the-shelf"
products from third parties with Year 2000 compliant versions. The one critical
information system that required an upgrade to become Year 2000 compliant was
upgraded in December 1998.
The Company has determined that there should be no Year 2000 issues for the
products it has already sold since the Company's products predominantly contain
no date-sensitive software.
As part of the Company's Year 2000 compliance review, the Company has contacted
its primary vendors, distributors and customers to determine the extent to which
the Company is vulnerable to such third parties' failures to address their Year
2000 compliance issues. The Company has received responses from several, but not
all, of the Company's primary vendors, including the primary third-party
manufacturers of the Company's products and packaging. Responses have also been
received from several, but not all, of the significant distributors of the
Company's products. The Company will continue to work to obtain sufficient
information and assurances from its significant vendors, distributors and
customers as it completes its Year 2000 compliance review. However, there can be
no guarantee that third parties on which the Company's business relies will
adequately address their Year 2000 compliance issues nor is there any guarantee
that the failure by such third parties to adequately deal with such issues would
not have a material adverse effect on the Company and its operations.
The Cost to Address the Company's Year 2000 Issues
- --------------------------------------------------
The Company has completed its Year 2000 compliance review of its critical
information systems, including the upgrading of one of its software systems at
an approximate cost of $15,000. The Company's Year 2000 compliance review of its
third party suppliers, distributors and vendors is an ongoing process, but to
date has not required any material amount of Company resources or funds. The
Company's costs to review and address any Year 2000 compliance issues are not
expected to be material to the Company's financial position, cash flow or
results of operations.
<PAGE>
The Risks Associated with the Company's Year 2000 Compliance
- ------------------------------------------------------------
The Company believes that its primary risk associated with Year 2000 compliance
is the failure of third parties upon whom the Company's business relies to
timely address their Year 2000 issues. Failure by third parties to adequately
address their Year 2000 issues in a timely manner could result in disruptions in
the Company's supply of products, packaging and related materials, late, missed
or unapplied payments, temporary disruptions in order processing and other
general problems related to the Company's daily operations. While the Company
believes its Year 2000 compliance review procedures will adequately address the
Company's internal Year 2000 issues, until the Company receives responses from
all of its significant vendors, distributors and customers, the overall risks
associated with the Year 2000 issue currently remain difficult to accurately
describe and quantify, and there can be no guarantee that such uncertainty will
not have a material adverse effect on the Company's business, operating results
and financial position.
<PAGE>
The Company's Contingency Plan
The Company has not, to date, implemented a Year 2000 contingency plan. The
Company intends to develop and implement a contingency plan by October 31, 1999.
It is the Company's intention to devote whatever resources are necessary to
assure that all of its Year 2000 compliance issues are resolved.
Forward-Looking Statements
This report contains statements that are forward-looking, as that term is
defined by the Private Securities Litigation Reform Act of 1995 and by the
Securities and Exchange Commission in rules, regulations and releases. These
statements include, but are not limited to, statements regarding: the Company's
efforts to diversify the distribution channels used to distribute its products,
including direct sales to traditional and alternative software retailers, use of
the Internet and expansion into international markets through the Company's
wholly-owned subsidiary, eGames Europe; the projected amount of sales of the
Company's products to GT Value Products Corporation during the 2000 fiscal year;
the costs associated with the development and localization of the Company's
products; the number of new full-release products that the Company will develop
during the 2000 fiscal year; the sufficiency of the Company's cash and working
capital balances to fund the Company's operations in the future; the affect of
adopting new accounting pronouncements on the Company's financial statements and
practices; the Company's expectations and cost estimates regarding its Year 2000
compliance efforts; and the Company's expansion of its product offerings in the
United Kingdom and distribution of its products into the European markets. All
forward-looking statements are based on current expectations regarding
significant risk factors, and such statements should not be regarded as a
representation by the Company or any other person that the results expressed in
this report will be achieved.
The following important factors, among others discussed elsewhere in this
report, could cause the Company's actual results to differ materially from those
indicated by the forward-looking statements contained in this report: the
success of the Company's new distribution strategy, including its ability to
enter into new distribution and direct sales relationships on commercially
acceptable terms; the market acceptance and successful sell-through of the
Company's existing and new products in the United States and international
markets; the allocation of adequate shelf space for the Company's products in
major retail chain stores; the Company's ability to collect outstanding accounts
receivable and establish adequate reserves for uncollectible receivables; the
amount of returns of the Company's products from distributors and retailers and
the Company's ability to establish adequate reserves for product returns; the
continued increase in the number of computers in homes in North America and the
world; the ability to deliver products in response to orders within a
commercially acceptable time frame; downward pricing pressure; fluctuating costs
of developing, producing and marketing the Company's products; the Company's
ability to license or develop quality content for its products; the Company's
ability to access alternative distribution channels and the success of the
Company's efforts to develop its Internet sales; consumers' continued demand for
value-priced software; increased competition in the value-priced software
category; the ability of the Company and its key distributors, vendors and
suppliers to effectively address Year 2000 compliance issues; and various other
factors, many of which are beyond the Company's control. The Company does not
undertake to update any forward-looking statement made in this report or that
may be made from time to time by or on behalf of the Company.
<PAGE>
Item 7. Financial Statements
eGames, Inc.
Index to Consolidated Financial Statements
Page
----
Independent Auditors' Report...................................... 24
Consolidated Balance Sheet June 30, 1999.......................... 25
Consolidated Statements of Operations for the years
ended June 30, 1999 and 1998...................................... 26
Consolidated Statements of Stockholders' Equity for the years
ended June 30, 1999 and 1998...................................... 27
Consolidated Statements of Cash Flows for the years
ended June 30, 1999 and 1998...................................... 28
Notes to Consolidated Financial
Statements........................................................ 30
<PAGE>
Independent Auditors' Report
The Board of Directors and Stockholders
eGames, Inc.:
We have audited the accompanying consolidated balance sheet of eGames, Inc. and
subsidiary as of June 30, 1999, and the related consolidated statements of
operations, stockholders' equity, and cash flows for the years ended June 30,
1999 and 1998. These consolidated financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and the significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of eGames, Inc. and
subsidiary as of June 30, 1999 and the results of their operations and their
cash flows for the years ended June 30, 1999 and 1998, in conformity with
generally accepted accounting principles.
/s/ KPMG LLP
Philadelphia, Pennsylvania
August 19, 1999
<PAGE>
eGames, Inc.
Consolidated Balance Sheet
June 30, 1999
<TABLE>
<CAPTION>
1999
----
ASSETS
<S> <C>
Current assets:
Cash and cash equivalents $ 1,313,853
Restricted cash 17,560
Accounts receivable, net of allowances totaling $417,732 1,934,503
Inventory 1,153,198
Prepaid expenses 108,702
-----------
Total current assets 4,527,816
Furniture and equipment, net 375,717
Intangibles and other assets, net 487,233
-----------
Total assets $ 5,390,766
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,040,438
Accrued expenses 627,264
Notes payable 129,210
Capital lease obligations 22,986
-----------
Total current liabilities 1,819,898
Capital lease obligations, net of current portion 22,459
Notes payable-long term portion 174,471
Convertible subordinated debt 150,000
-----------
Total liabilities 2,166,828
Commitments and contingencies - Notes 6, 7, 8 and 14
Stockholders' equity:
Common Stock, no par value (40,000,000 shares authorized;
9,833,340 issued and 9,601,440 outstanding) 8,874,889
Additional paid in capital 1,148,550
Accumulated deficit (6,268,169)
Treasury Stock at cost - 231,900 shares (501,417)
Accumulated other comprehensive loss (29,915)
-----------
Total stockholders' equity 3,223,938
-----------
Total liabilities and stockholders' equity $ 5,390,766
===========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
eGames, Inc.
Consolidated Statements of Operations
Years ended June 30, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Net sales $10,022,305 $ 9,275,889
Cost of sales 3,596,982 3,441,793
----------- -----------
Gross profit 6,425,323 5,834,096
Operating expenses:
Product development 936,938 397,272
Selling, general and administrative 4,814,345 4,135,266
----------- -----------
Total operating expenses 5,751,283 4,532,538
----------- -----------
Operating income 674,040 1,301,558
Interest expense, net 31,761 45,859
----------- -----------
Income before income taxes 642,279 1,255,699
Provision for income taxes 179,724 3,069
----------- -----------
Net income 462,555 1,252,630
Accretion of beneficial conversion feature on
preferred stocks, including dividend
payable in the form of Common Stock - 0 - (117,991)
----------- -----------
Net income attributable to Common Stock $ 462,555 $ 1,134,639
=========== ===========
Net income per common share - basic $ 0.05 $ 0.13
=========== ===========
Net income per common share - diluted $ 0.05 $ 0.12
=========== ===========
Weighted average common shares outstanding - basic 9,494,988 8,716,756
Dilutive effect of Common Stock equivalents 344,453 937,850
----------- -----------
Weighted average common shares outstanding - diluted 9,839,441 9,654,606
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
eGames, Inc.
Consolidated Statements of Stockholders' Equity
Years ended June 30, 1999 and 1998
<TABLE>
<CAPTION>
Additional
Preferred Stock Common Stock Paid-in Accumulated
Shares Amount Shares Amount Capital Deficit
---------- ---------- --------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance as of June 30, 1997 3,521,340 $3,415,899 6,535,614 $ 4,368,736 $ 1,148,550 ($7,865,363)
Net income 1,252,630
Shares issued in connection with
exercise of warrants and options 137,100 274,200
Shares issued in connection with the
conversion of Class One Preferred (1,000,000) (1,000,000) 303,030 1,000,000
Shares issued in connection with the
conversion of Class Two Preferred (1,271,340) (1,271,340) 907,948 1,271,340
Shares issued in connection with the
conversion of Class Three Preferred (1,250,000) (1,250,000) 1,487,508 1,250,000
Effects from the beneficial conversion
feature of Class Two Preferred 3,716 (3,716)
Effects from the beneficial conversion
feature of Class Three Preferred 101,725 (101,725)
Stock dividend accrued
on Class Three Preferred 12,550 (12,550)
---------- ---------- ----------- ----------- ----------- -----------
Balance as of June 30, 1998 - 0 - $ - 0 - 9,371,200 $ 8,176,826 $ 1,148,550 ($6,730,724)
Net income 462,555
Shares issued in connection with
exercise of warrants and options 312,140 485,063
Purchase of Treasury Stock
Foreign currency translation
adjustment
Shares issued in connection with
acquisition 150,000 213,000
---------- ---------- --------- ----------- ----------- -----------
Balance as of June 30, 1999 - 0 - $ - 0 - 9,833,340 $ 8,874,889 $ 1,148,550 ($6,268,169)
========== ========== ========= =========== =========== ===========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Accumulated
Other
Treasury Stock Comprehensive Stockholders'
Shares Amount Loss Equity
--------- --------- --------- ------------
<S> <C> <C> <C> <C>
Balance as of June 30, 1997 - 0 - $ - 0 - $ - 0 - $1,067,822
Net income 1,252,630
Shares issued in connection with
exercise of warrants and options 274,200
Shares issued in connection with the
conversion of Class One Preferred - 0 -
Shares issued in connection with the
conversion of Class Two Preferred - 0 -
Shares issued in connection with the
conversion of Class Three Preferred - 0 -
Effects from the beneficial conversion
feature of Class Two Preferred - 0 -
Effects from the beneficial conversion
feature of Class Three Preferred - 0 -
Stock dividend accrued
on Class Three Preferred - 0 -
---------- --------- --------- ------------
Balance as of June 30, 1998 - 0 - $ - 0 - $ - 0 - $2,594,652
Net income 462,555
Shares issued in connection with
exercise of warrants and options 485,063
Purchase of Treasury Stock 231,900 (501,417) (501,417)
Foreign currency translation
adjustment (29,915) (29,915)
Shares issued in connection with
acquisition 213,000
---------- --------- --------- ------------
Balance as of June 30, 1999 231,900 ($501,417) ($29,915) $3,223,938
========== ========= ========= ============
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
eGames, Inc.
Consolidated Statements of Cash Flows
Years ended June 30, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 462,555 $ 1,252,630
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 413,605 262,276
Changes in items affecting operations:
Restricted cash (1,029) 8,257
Accounts receivable 173,007 (944,766)
Prepaid expenses 891 146,154
Inventory (206,127) (431,160)
Accounts payable (95,956) 216,312
Accrued expenses 118,749 196,793
----------- -----------
Net cash provided by operating activities 865,695 706,496
Cash flows from investing activities:
Purchase of furniture and equipment (192,685) (187,416)
Acquisition, net of cash acquired (12,929) - 0 -
Purchase of software rights and other assets (107,498) (217,615)
Repayments of loan from related party - 0 - 2,000
----------- -----------
Net cash used in investing activities (313,112) (403,031)
Cash flows from financing activities:
Purchase of Treasury Stock (501,417) - 0 -
Repayments of notes payable (123,851) (39,594)
Proceeds from exercise of warrants and stock options 485,063 274,200
Repayments of capital lease obligations (52,674) (29,897)
----------- -----------
Net cash provided by (used in) financing activities (192,879) 204,709
Effect of exchange rate changes on cash and cash equivalents 501 - 0 -
----------- -----------
Net increase in cash and cash equivalents 360,205 508,174
Cash and cash equivalents:
Beginning of period 953,648 445,474
----------- -----------
End of period $ 1,313,853 $ 953,648
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
eGames, Inc.
Consolidated Statements of Cash Flows
Years ended June 30, 1999 and 1998
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Supplemental cash flow information:
Cash paid for interest $ 58,409 $ 56,229
======== ========
Cash paid for income taxes $128,051 $ - 0 -
======== ========
Non-cash investing and financing activities:
Capital lease additions $ 26,147 $ - 0 -
======== ========
150,000 shares of Common Stock issued in connection with
acquisition $213,000 $ - 0 -
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
eGames, Inc.
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Description of Business
eGames, Inc. (the "Company"), a Pennsylvania corporation incorporated in July
1992, develops, publishes, markets and sells a diversified line of personal
computer software primarily for consumer entertainment. The Company's product
line enables it to serve customers who are seeking a broad range of
high-quality, value-priced software. The Company's sales are made through
various national distributors on a non-exclusive basis in addition to direct
relationships with certain national retailers.
Consolidation
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiary. All inter-company balances and transactions have
been eliminated.
Fair Value of Financial Instruments
The recorded amounts of cash and short term investments, accounts receivable,
and accounts payable at June 30, 1999 approximate fair value due to the
relatively short period of time between origination of the instruments and their
expected realization. The Company's debt is carried at cost, which approximates
fair value, as the debt bears interest at rates approximating current market
rates for similar instruments.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all highly
liquid instruments purchased with an original maturity of three months or less
to be cash equivalents.
Inventory
Inventory is valued at the lower of cost or market. Cost is determined by the
first-in, first-out method (FIFO).
Furniture and Equipment
Furniture and equipment are stated at cost. Depreciation is calculated on the
straight-line method over the estimated useful lives of the assets ranging from
three to five years.
Leasehold improvements are amortized on the straight-line method over the
shorter of the lease term or estimated useful life of the assets. Maintenance
and repair costs are expensed as incurred.
Long-Lived Assets
In accordance with Statement of Financial Standards Board No. 121, "Accounting
for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of", the Company records impairment losses on long-lived assets, including
intangible assets, used in operations when indicators of impairment are present
and the undiscounted cash flows estimated to be generated by those assets are
less than the assets' carrying amount.
<PAGE>
Intangible Assets
The Company has intangible assets resulting primarily from goodwill associated
with the eGames Europe, Ltd. acquisition on August 14, 1998 and the purchase of
software rights and clip art images. Accumulated amortization at June 30, 1999
was $535,000. The Company amortizes its goodwill totaling $308,000 using the
straight-line method over five years and other intangible assets using the
straight-line method over three years. The Company recorded amortization expense
of $249,000 and $141,000 for the years ended June 30, 1999 and 1998,
respectively.
Revenue Recognition
Product sales:
- --------------
Revenue from the sale of products is recognized when the product has been
shipped. The Company offers rights of return to substantially all of its
customers. The Company recognizes product sales to its customers, in accordance
with the criteria of FASB No. 48, at the time of the sale based on the
following: the selling price is fixed at the date of sale, the buyer is
obligated to pay the Company, title of the product transfers to the buyer, the
buyer has economic substance apart from the Company, the Company does not have
further obligations to assist the buyer in the resale of the product and the
returns can be reasonably estimated at the time of sale. While the Company has
no other obligations to perform future services subsequent to shipment, the
Company provides telephone customer support as an accommodation to purchasers of
its products and as a means of fostering customer loyalty. Costs associated with
this effort are insignificant and, accordingly, are expensed as incurred.
Allowance for product returns:
- ------------------------------
The Company distributes the majority of its products through various national
and regional distributors and directly to national retailers. The distribution
of these products is governed by distribution agreements, direct sale agreements
or purchase orders, all of which allow for product returns. The Company records
an allowance for returns as a reduction of gross sales at the time of product
shipment. This allowance, which is included in accounts receivable, is estimated
based primarily upon historical experience, analysis of distributor and retailer
inventories of the Company's products and analysis of retail sell-through of the
Company's products. Actual product returns experienced by the Company during the
years ended June 30, 1999 and 1998 were $859,000 and $39,000, respectively, or
nine percent and less than one percent of the Company's net sales, respectively.
Software Development Costs
Software development costs are expensed as incurred until technological
feasibility has been established. After technological feasibility has been
established, any additional costs are capitalized in accordance with Statement
of Financial Accounting Standards (SFAS) No. 86. To date, amounts qualifying for
capitalization, net of valuation allowances, have not been material.
Marketing Promotions and Advertising Costs
Marketing promotions and advertising costs are charged to expense as incurred
and were approximately $534,000 and $520,000 for the years ended June 30, 1999
and 1998, respectively.
Income Taxes
The Company uses the asset and liability method of accounting for income taxes.
Under the asset and liability method, deferred tax assets and liabilities are
recognized for the estimated future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. Deferred tax assets and liabilities
are measured using enacted tax rates in effect for the year in which those
temporary differences are expected to be recovered or settled.
<PAGE>
Computation of Earnings Per Share
Net earnings per common share is computed in accordance with SFAS No. 128,
"Earnings per Share". Basic earnings per share is computed by dividing net
earnings by the weighted average number of common shares outstanding during each
year. Diluted earnings per share is computed by dividing net earnings by the
weighted average number of common and common share equivalents outstanding
during each year. Common share equivalents include stock options and warrants
using the treasury stock method.
Accounting for Stock-based Compensation
Stock-based compensation is recognized using the intrinsic value method in
accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" (APB 25). For disclosure purposes, pro forma net
income/(loss) and income/(loss) per share data are provided in accordance with
SFAS 123, "Accounting for Stock-Based Compensation" as if the fair value method
had been applied.
Management's Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
New Accounting Pronouncements
In March 1999, the FASB issued an exposure draft, "Accounting for Certain
Transactions involving Stock Compensation". This exposure draft addresses the
application of Accounting Standards Board No. 25 to stock-based compensation
granted to independent contractors and independent members of an entity's Board
of Directors, as well as the accounting for option re-pricing and modification
to the terms of a stock option or award. The Company intends to review this
exposure draft to determine its impact on the Company's financial position and
results of operations.
In April 1998, the AICPA issued Statement of Position 98-5, "Reporting on the
Costs of Start-Up Activities"
(SOP 98-5). SOP 98-5, which is effective for fiscal years beginning after
December 15, 1998, provides guidance on the financial reporting of start-up
costs and organization costs. It requires costs of start up activities and
organization costs to be expensed as incurred. As the Company has historically
expensed these costs, the adoption of this standard will not have an impact on
the Company's results of operations, financial position or cash flows.
2. Inventory
Inventory consists of the following:
Finished goods $ 879,028
Raw materials 274,170
----------
$1,153,198
==========
3. Furniture and Equipment
Furniture and equipment consists of the following:
Equipment $ 436,710
Furniture 266,173
Equipment under capital leases 232,279
---------
935,162
Accumulated depreciation (559,445)
---------
Furniture and equipment, net $ 375,717
=========
4. Accrued Expenses
Accrued expenses consist of the following:
Accrued payroll $203,264
Accrued professional fees 123,321
Accrued taxes 76,643
Accrued marketing promotions 68,504
Other accrued expenses 155,532
--------
$627,264
========
<PAGE>
5. Notes Payable
Notes payable consists of the following:
Note payable, bearing interest of 9%. Scheduled
principal payments of $39,500 each are due on July 1, 1999
and October 1, 1999. $ 79,000
Note payable to bank, bearing interest at the prime rate plus
2.75% (10.50% at June 30, 1999). Matures on March 24, 2003,
principal and interest of $5,953 payable monthly. The note is
guaranteed by a former officer of the Company and the Small
Business Administration. 224,681
--------
303,681
Less current portion 129,210
--------
Long term portion $174,471
========
6. Lease Obligations
The Company leases its North American and United Kingdom operating facilities
under two operating leases, expiring in September 2002 and March 2007,
respectively. Rent expense was $204,000 and $157,000 for the years ended June
30, 1999 and 1998, respectively.
The Company has financed the purchase of office equipment and vehicles through
capital lease agreements. The obligations are collaterallized by the leased
assets, which had a net book value of approximately $63,000 and $36,000 at June
30, 1999 and 1998, respectively and are recorded in Furniture and Equipment.
<PAGE>
Future payments of leases are as follows:
Operating Capital
Leases Leases Total
-------- ------- --------
2000 $156,546 $27,560 $184,106
2001 143,223 22,724 165,947
2002 142,196 3,425 145,621
2003 79,147 - 0 - 79,147
2004 56,709 - 0 - 56,709
2005 and thereafter 135,828 - 0 - 135,828
-------- ------- --------
$713,649 53,709 $767,358
======== ------- ========
Less interest (8,264)
-------
Present value of future lease payments 45,445
Less current portion (22,986)
-------
Long term portion $22,459
=======
7. Convertible Subordinated Debt
In connection with the merger of its subsidiary with Virtual Reality
Laboratories, Inc. ("VRLI") on April 5, 1996 the Company assumed $150,000 of 10%
convertible subordinated debt, maturing in November 2000. The note is
convertible at any time into 46,685 shares of Common Stock at a price of $3.213
per share, (the conversion price established at the time of the merger).
Interest is payable quarterly. The convertible debt is subordinated to the note
payable ($224,681 at June 30, 1999) guaranteed by the Small Business
Administration.
8. Revolving Lines of Credit
On March 10, 1999, the Company entered into a $1,000,000 revolving credit
facility with a commercial bank. Amounts outstanding under this credit facility
are charged interest at one-half of one percent above the bank's current prime
rate and such interest is due monthly. The credit facility is collateralized by
substantially all of the Company's assets. The credit facility requires the
Company, among other things, to maintain certain financial ratios, such as: a
minimum working capital balance of $1,500,000 and a maximum debt to net tangible
assets ratio of 1.50 to 1.00. As of June 30, 1999, the Company was in compliance
with each of those covenants. This credit facility was established to provide,
among other things, additional working capital to support the Company's
anticipated growth. As of August 31, 1999, the Company had not utilized this
credit facility, which expires on October 31, 1999. On September 20, 1999, the
Company and its commercial bank signed a commitment letter to increase the
Company's credit facility from $1,000,000 to $1,500,000 and to extend its term
to October 31, 2000.
The Company's United Kingdom operation has an $80,000 revolving credit facility
with a commercial bank. Amounts outstanding under this credit facility are
charged interest at two and one-half percent above the bank's current base rate
and such interest is due monthly. As of August 31, 1999, the Company had not
utilized this credit facility, which expires on September 30, 1999. The Company
is currently in discussion with the bank to extend the facility's term through
September 30, 2000.
<PAGE>
9. Acquisition
On August 14, 1998, the Company acquired all of the outstanding shares of
Software Partners Publishing and Distribution Ltd. ("Software Partners") in
exchange for 150,000 shares of the Company's Common Stock, valued at
approximately $213,000, which was the estimated fair value of the Company's
Common Stock on the acquisition date. This acquisition was accounted for as a
purchase and the corresponding goodwill in the approximate amount of $308,000
will be amortized over five years. On March 31, 1999, Software Partners changed
its name to eGames Europe Ltd. ("eGames Europe"). For the year ended June 30,
1999, eGames Europe contributed $2,252,000 in net sales and $181,000 in net
income. At June 30, 1998, the Company had a trade accounts receivable of
$122,000 with Software Partners and for the year ended June 30, 1998 the Company
had recorded $457,000 in sales through Software Partners. The Company believes
that this acquisition will allow the Company to expand its product offerings in
the United Kingdom, while providing a base for the Company to distribute its
products into the European markets.
The following summary of unaudited pro-forma financial information gives effect
to the eGames Europe acquisition as though it had occurred on July 1, 1997,
after giving effect to certain adjustments, primarily the elimination of
inter-company sales and amortization of goodwill. The unaudited pro-forma
financial information, which is for informational purposes only, is based upon
certain assumptions and estimates and does not necessarily reflect the results
that would have occurred had the acquisition taken place at the beginning of the
period presented, nor are they necessarily indicative of future consolidated
results.
Unaudited Pro-Forma Financial Information
Years Ended
June 30,
---------------------------
1999 1998
---- ----
Net sales $10,080,000 $10,453,000
Net income attributable to Common Stock $ 354,000 $ 758,000
Net income per diluted share $ 0.04 $ 0.08
10. Income Taxes
The provision (benefit) for income taxes is comprised of the following
components for the year ended June 30, 1999:
Income Tax
Provision
-----------
Current
-------
Federal $ 60,800
State 85,151
Foreign 33,773
-----------
179,724
Deferred
--------
Federal (1,623,400)
State (97,299)
-----------
(1,720,699)
Valuation allowance 1,720,699
-----------
Provision for income taxes $ 179,724
===========
<PAGE>
The reconciliation between the statutory federal income tax rate and the
Company's effective rate for income tax expense for the year ended June 30, 1999
is as follows:
Rate
----
Statutory federal income tax rate 34%
Increase (decrease) in taxes resulting
from:
Non-deductible goodwill amortization and other permanent items 3
Foreign taxes (7)
Utilization of net operating loss carryforwards and other (2)
---
Effective rate for income tax expense 28%
===
The deferred tax asset is offset by a full valuation allowance as of June 30,
1999, as management believes that it is more likely than not, that the deferred
tax asset will not be realized.
The tax effect of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities at June 30, 1999 and
1998 is as follows:
1999 1998
---- ----
Deferred tax assets:
Accrued expenses and other $112,707 $108,900
Reserves 204,442 39,668
Depreciation 6,821 - 0 -
Tax credits 10,003 - 0 -
Net operating losses 1,386,726 1,742,696
---------- ----------
Gross deferred tax assets 1,720,699 1,891,264
Less: Valuation allowance (1,720,699) (1,891,264)
---------- ----------
Net deferred tax assets - 0 - - 0 -
Deferred tax liabilities: - 0 - - 0 -
---------- ----------
Net deferred tax assets/(liabilities) - $ 0 - - $ 0 -
========== ==========
As of June 30, 1999, the Company had approximately $4,000,000 of net operating
loss carry-forwards ("NOL's") for federal income tax purposes (expiring in years
2005 through 2012), which may be available to offset future federal taxable
income. The Company's NOL's may be subject to the provisions of Internal Revenue
Code Section 382 ("Section 382"), as established by the Tax Reform Act of 1986,
related to changes in stock ownership. As of June 30, 1999, the Company was in
the process of having an independent study performed to make a determination on
what effect, if any, the application of Section 382 may have on the utilization
of the NOL's. Should these regulations apply, the amount of the NOL's that can
be utilized to offset taxable income in future periods may be subject to an
annual limitation. As a result of the Company's previous acquisitions, it is
possible that some portion of the NOL's may never be utilized due to this
Section 382 limitation.
11. Preferred Stock
During the year ended June 30, 1998, 1,000,000 shares of the Company's Class One
Convertible Preferred Stock were converted into 303,030 shares of Common Stock;
1,271,340 shares of the Company's Class Two Convertible Preferred Stock were
converted into 907,948 shares of Common Stock; and 1,250,000 shares of the
Company's Class Three Convertible Preferred Stock were converted into 1,487,508
shares of Common Stock. As of June 30, 1999, there were no shares of preferred
stock outstanding.
During the year ended June 30, 1998, the Company amortized to accumulated
deficit $118,000 in the accretion of the beneficial conversion feature of the
Class Two and Class Three Convertible Preferred Stock, including a dividend
payable in the form of Common Stock, which negatively impacted the net income
per share during that period. There was no such accretion during the year ended
June 30, 1999.
<PAGE>
12. Common Stock
On June 30, 1995, the Company amended its articles of incorporation to authorize
the issuance of 40,000,000 shares of Common Stock, without par value, and
10,000,000 shares of preferred stock, without par value.
On June 1, 1999, the Board of Directors adopted a Stockholders Rights Plan (the
"Plan"). The Plan is intended to protect the interests of the Company's existing
stockholders' in the event that the Company is confronted with coercive or
unfair takeover tactics. The Plan contains provisions to safeguard existing
stockholders' in the event of an unsolicited offer to acquire the Company,
whether through a gradual accumulation of shares in the open market, a partial
or two-tiered tender offer that does not treat all stockholders equally, or
other abusive takeover tactics, which the Company's Board of Directors believes
are not in the best interests of the Company's stockholders. These tactics can
unfairly pressure stockholders and deprive them of the full value of their
shares.
The Plan is not intended to prevent a takeover of the Company and will not do so
if the terms are favorable and fair to all stockholders. The declaration of the
rights dividend (the "Rights") should not affect any prospective offer at a fair
price to all stockholders, and will not interfere with a merger or other
business combination transaction approved by the Company's Board of Directors.
The issuance of the Rights will not change the way in which stockholders can
currently trade the Company's shares. The Rights were issued to stockholders of
record on June 21, 1999, and will expire on June 1, 2009. Initially, the Rights
will not be exercisable, certificates will not be sent to any stockholders, and
the Rights will automatically trade with the Common Stock.
The Rights will not be exercisable until ten days after any person or group
becomes the beneficial owner of 15% or more of the Company's Common Stock, or if
any person or group commences a tender or exchange offer which would, if
consummated, result in such person becoming the beneficial owner of 15% or more
of the Company's Common Stock. At that time, separate certificates representing
the Rights will be distributed, and the Rights could then begin to trade
independently from the Company's shares. At no time will the Rights have any
voting power.
The Rights may be redeemed by the Company at $.01 per Right prior to the time
any person or group has acquired 15% or more of the Company's shares or voting
power. After any person or group has acquired 15% or more of the Company's
shares or voting power, the Rights may be redeemed only with the approval of a
majority of the Continuing Directors. "Continuing Director" means any member of
the Board of Directors who was a member of the Board on June 1, 1999 or any
person who is subsequently elected to the Board if such person is recommended or
approved by a majority of the Continuing Directors.
If the Rights become exercisable, a holder will be entitled to buy from the
Company one one-hundredth (1/100) of a share of a new Series A Preferred Stock
of the Company at a purchase price of $35. If a person acquires 15% or more of
the Company's Common Stock, each Right not owned by such person would become
exercisable for Common Stock of the Company (or, in certain circumstances, cash,
property or other securities of the Company) having a market value equal to two
times the exercise price of the Right.
13. Stock Options and Warrants
Stock Option Plans:
On August 31, 1994 the Company adopted its 1994 Stock Option Plan (the "1994
Plan") under which options to purchase an aggregate of 132,000 shares of the
Company's Common Stock were granted to officers, directors or employees at an
exercise price of $2.00 and with an expiration date of August 31, 1999. As of
June 30, 1999, 44,000 of the options under the 1994 Plan had been exercised. As
of August 31, 1999, an additional 55,000 options under the 1994 Plan had been
exercised and the remaining 33,000 options under the 1994 Plan expired. The 1994
Plan has been terminated and no additional options will be granted thereunder.
During 1995, the Company adopted, amended and restated its 1995 Amended and
Restated Stock Option Plan (the "1995 Plan"). At the Company's 1997 Annual
Meeting of Stockholders, the shareholders of the Company approved an amendment
to increase the number of shares available for issuance under the 1995 Plan from
the 950,000 shares of Common Stock approved during the 1996 Annual Meeting of
Stockholders to a total of 1,950,000 shares. The 1995 Plan is administered by
the Board of Directors and provides for the grant of incentive stock options and
non-qualified stock options to employees and eligible independent contractors;
and non-qualified stock options to non-employee directors at prices not less
than the fair market value of a share of Common Stock on the date of grant. The
1995 Plan also provides for automatic grants of options to non-employee
directors of the Company. Each non-employee director will receive options for
10,000 shares of Common Stock upon appointment or election to the board and, in
addition, each director receives options for 5,000 shares of Common Stock on
January 1 of each year in which they are a director. On December 14, 1998, the
Company granted options for 25,000 shares of Common Stock to each non-employee
director in lieu of the automatic annual option grants for 5,000 shares to each
non-employee director pursuant to the 1995 Plan, which would have been issued in
January 1999.
<PAGE>
The expiration of an option and the vesting period will be determined by the
Board of Directors at the time of the grant, but in no event will an option be
exercisable after 10 years from the date of grant, or in the case of
non-employee directors, after 5 years from the date of grant. In most cases,
upon termination of employment, vested options must be exercised by the optionee
within 3 months after the termination of the optionee's employment with the
Company.
Information regarding the stock option plans is as follows:
Number of Weighted Average
Options Exercise Price
---------- --------------
Balances, June 30, 1997 729,972 $ 3.10
Granted 1,045,000 2.06
Canceled (528,821) 3.44
Exercised (20,000) 2.00
---------- ------
Balances, June 30, 1998 1,226,151 $ 2.08
Granted 549,400 2.00
Canceled (63,819) 1.95
Exercised (41,832) 1.99
---------- ------
Balances, June 30, 1999 1,669,900 $ 2.06
========== ======
At June 30, 1999, 835,750 options outstanding under its 1994 and 1995 Plans were
vested and 420,268 options were available for issuance under these plans. The
following summarizes information about the Company's stock options outstanding
at June 30, 1999:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
---------------------------------------------- --------------------------
Weighted Avg. Weighted Weighted
Number Remaining Avg. Number Avg.
Range of Outstanding at Contractual Life Exercise Exercisable at Exercise
Exercises Prices June 30, 1999 (in years) Price June 30, 1999 Price
---------------- ------------- ---------- ----- ------------- -----
<S> <C> <C> <C> <C> <C>
$1.35 - $2.00 1,258,000 3.08 $1.80 682,750 $1.93
$2.03 - $4.09 411,900 3.81 $2.86 153,000 $2.69
--------- ---- ----- ------- -----
$1.35 - $4.09 1,669,900 3.26 $2.06 835,750 $2.07
========= ==== ===== ======= =====
</TABLE>
The Company applies APB 25 and related interpretations in accounting for its
stock option plans. Had compensation costs for the Company's 1994 and 1995 Plans
been determined under Statement No. 123, the Company's net income/(loss) and net
income/(loss) per share would have been negatively impacted by the pro forma
amounts indicated below:
<TABLE>
<CAPTION>
Years ended June 30,
1999 1998
---- ----
<S> <C> <C> <C>
Net income/(loss) attributable to Common Stock As reported $462,555 $1,134,639
Pro forma ($280,761) $563,254
Net income/(loss) per share - basic As reported $0.05 $0.13
Pro forma ($0.03) $0.06
Net income/(loss) per share - diluted As reported $0.05 $0.12
Pro forma ($0.03) $0.06
</TABLE>
<PAGE>
The per share weighted-average fair values of stock options granted during the
years ended June 30, 1999 and 1998 were $1.47 and $1.52, respectively, on the
date of grant using the Black-Scholes option-pricing model with the following
assumptions:
Years ended June 30,
1999 1998
---- ----
Dividend yield 0% 0%
Volatility factor 119.85% 119.43%
Risk-free interest rate 4.41% - 5.35% 5.51% - 6.13%
Average expected option life 3.19 Years 4.74 Years
On May 22, 1997, the Company cancelled the options outstanding under the 1995
Plan that had exercise prices in excess of the market price of the Company's
Common Stock on May 22, 1997, and reissued all such options with an exercise
price of $3.50. On July 1, 1997 the Company cancelled the options outstanding
under the 1995 Plan that had exercise prices in excess of the market price of
the Company's Common Stock on July 1, 1997, and reissued all such options with
an exercise price of $2.00.
On March 24, 1998, 20,000 stock options were exercised and the Company received
net proceeds of $40,000.
On December 14, 1998, the Company granted a total of 75,000 options to its
non-employee Board members. Each non-employee director received 25,000 options
at an exercise price of $1.656, the fair value of the Company's Common Stock on
the date of grant. These options vest over a three-year period and expire after
a period of five years. These options were not issued pursuant to any plan and
were issued in lieu of the automatic annual option grants for 5,000 shares to
each non-employee director pursuant to the 1995 Plan, which would have been
issued in January 1999.
During the year ended June 30, 1999, the Company received approximately $83,000
in net proceeds from the exercise of 41,832 stock options with exercise prices
ranging from $1.83 to $2.00.
Common Stock Warrants:
In April 1995, the Company received $100,000 in connection with the private sale
of a warrant to acquire 220,662 shares of the Company's Common Stock at any time
on or before April 27, 2002 at an exercise price of $.45 per share. The warrant
holder was also granted certain registration rights for the Common Stock
issuable upon exercise of the warrants, which shares have been registered by the
Company. Also in April 1995, the Company issued 15,000 warrants to a group of
private investors. These warrants are exercisable at any time on or before May
1, 2000 at an exercise price equal to the greater of $3.00 per share or 120% of
the offering price of the Company's Common Stock pursuant to the first
registration statement filed by the Company pursuant to the Securities Act of
1933. No value was assigned to these warrants. On October 18, 1995, in
connection with the Company's initial public offering of Common Stock, the
underwriter was granted 155,000 warrants. These warrants are exercisable at
anytime on or before October 13, 2000 at an exercise price of $3.60 per share,
which exercise price was adjusted as described below. Registration rights were
granted for the Common Stock issuable upon exercise of the underwriter's
warrants, and such Common Stock has been registered by the Company. In addition,
425,000 warrants were issued to the former owners of Applied Optical Media
Corporation, of which 1,200 warrants were exercised on March 1, 1996, 45,200
warrants were exercised on January 24, 1997 and 198,687 warrants were exercised
on January 30, 1997. The remaining warrants from this group are exercisable at
any time on or before October 16, 2002 at an exercise price of $.50 per share.
<PAGE>
Information regarding the warrants is as follows:
Number of Warrants Exercise Price
------------------ --------------
Balances, June 30, 1997 955,887 $0.50 - $6.00
Warrants granted - 0 - - 0 -
Warrants canceled - 0 - - 0 -
Warrants exercised (117,100) 2.00
--------- --------------
Balances, June 30, 1998 838,787 $0.50 - $6.00
Warrants granted - 0 - - 0 -
Warrants canceled - 0 - - 0 -
Warrants exercised (270,308) 0.50 - 2.81
--------- --------------
Balances, June 30, 1999 568,479 $0.50 - $6.00
========= ==============
The exercise price of 355,975 warrants was automatically adjusted from $6.25 to
$2.81 per share in June 1997 as a result of an anti-dilution provision in the
warrant agreements.
On October 1, 1997, the Company adjusted the exercise price of 332,988 warrants
to acquire the Company's Common Stock to $2.00 per share, the fair market value
of the Company's Common Stock on October 1, 1997, until December 12, 1997. Of
the 332,988 warrants, 155,000 were originally issued at $3.60 per share and
177,988 were issued at $6.00 per share. During the quarter ended December
31,1997, 117,100 of such warrants were exercised and the Company received net
proceeds of $234,200. The warrants that were not exercised during the exercise
price reduction period were subsequently returned to their original exercise
prices.
During the year ended June 30, 1999, the Company received net proceeds of
$402,000 from the exercise of 270,308 warrants with exercise prices ranging from
$0.50 to $2.81.
14. Commitments and Contingencies
Under various licensing agreements, the Company is required to pay royalties on
the sales of certain products that incorporate licensed content. Royalty expense
under such agreements, which is recorded in cost of sales, was approximately
$507,000 and $162,000 for the years ended June 30, 1999 and 1998, respectively.
The Company has a retirement plan covering substantially all of its eligible
employees. The retirement plan is qualified in accordance with Section 401(k) of
the Internal Revenue Code. Under the plan, employees may defer up to 15% of
their pre-tax salary, but not more than statutory limits. The Company
contributes 50% of each dollar contributed by a participant. The Company's
matching contributions to the plan were $76,000 and $42,000 during the years
ended June 30, 1999 and 1998, respectively. The Company's matching contributions
vest in fifty percent increments over a two-year period.
15. Related Party Transactions
During the years ended June 30, 1999 and 1998, the Company engaged in certain
related party transactions with a company owned and operated by an individual
who also performed the buyer function for the Company as a part- time employee
during the year ended June 30, 1998. As of June 30, 1998, this individual was no
longer an employee and was continuing to perform the function of a distributor
of the Company's line of products. The Company recorded $56,000 in sales and
$16,000 in commission expense with this related party during the year ended June
30, 1999. The Company recorded $773,000 in sales and $220,000 in commission
expense with this related party during the year ended June 30, 1998. At June 30,
1999, the Company had a trade accounts receivable of approximately $22,000 with
this related party.
On June 22, 1998, the Company accepted the resignation of Joseph A. Falsetti,
the Company's Chairman and Chief Executive Officer. As the result of the
separation agreement and general release dated June 22, 1998 between the Company
and Mr. Falsetti, the Company expensed approximately $225,000 in severance costs
in the year ended June 30, 1998, which was paid out over the next twelve months
during the year ended June 30, 1999.
<PAGE>
16. Major Customers and Export Sales
During the years ended June 30, 1999 and June 30, 1998, the Company had two
customers, which accounted for approximately 65% and 5% and 81% and 8% of net
sales, respectively. As of June 30, 1999 these customers represented 63% and 5%,
respectively, of gross accounts receivable. During April 1999, the Company
transitioned its previously exclusive distribution agreement with GT Value
Products Corporation ("GT Value Products"), (a division of GT Interactive
Software Corp. "GTIS") covering distribution of the Company's products to
retailers in North America, to a non-exclusive distribution relationship. GTIS
is currently one of the largest distributors of consumer entertainment software
to mass merchants in the United States. During the years ended June 30, 1999 and
1998, GT Value Products accounted for approximately 65% and 81%, respectively,
of the Company's net sales. The Company is continuing to distribute its products
through GT Value Products as well as through various other distributors on a
non-exclusive basis. The Company believes that for the year ending June 30,
2000, sales to GT Value Products could account for a decreasing, but
significant, amount of the Company's net sales. The amount of export sales
included in net sales was approximately $2,691,000 and $694,000 or 27% and 8% of
the Company's net sales for the years ended June 30, 1999 and 1998,
respectively.
17. Liquidity
As indicated in the accompanying financial statements, the Company's net income
for fiscal 1999 was $463,000 and the Company's net income for fiscal 1998 was
$1,253,000. In addition, cash provided by operating activities was $866,000 and
$707,000 for the years ended June 30, 1999 and 1998, respectively.
On September 20, 1999, the Company and its commercial bank signed a commitment
letter to increase the Company's credit facility from $1,000,000 to $1,500,000
and to extend its term to October 31, 2000.
The Company's ability to achieve positive cash flow depends upon a variety of
factors, including the timeliness and success of developing and selling its
products, the costs of developing, producing and marketing such products and
various other factors, some of which may be beyond the Company's control. In the
future, the Company's capital requirements will be affected by each of these
factors. The Company believes cash and working capital balances will be
sufficient to fund the Company's operations for the foreseeable future. However,
there can be no assurances that the Company will be able to maintain a positive
cash flow or that additional financing will be available if and when required
or, if available, will be on terms satisfactory to the Company.
At June 30, 1999 the Company continued to satisfy the minimum level of
Stockholders' equity required and all other aspects of its listing agreement for
the Nasdaq SmallCap Market. At June 30, 1999, the Company had $2,967,000 in net
tangible assets.
18. Operations by Reportable Segments and Geographic Area
The Company adopted SFAS No. 131, "Disclosure about Segments of an Enterprise
and Related Information", as of July 1, 1998. SFAS No. 131 establishes standards
for reporting information about an enterprise's operating segments and related
disclosures about its products, geographic areas and major customers.
The Company publishes interactive entertainment software for PCs. Based on its
organizational structure, the Company operates in only one non-geographic,
reportable segment, which is publishing.
The President and Chief Executive Officer allocates resources to each of the
geographical areas in which the Company operates using information on their
respective revenues and operating profits before interest and taxes. The
President and Chief Executive Officer has been identified as the Chief Operating
Decision Maker as defined by SFAS No. 131.
<PAGE>
The accounting policies of these segments are the same as those described in the
Summary of Significant Accounting Policies. Revenue derived from sales between
segments is eliminated in consolidation.
Geographic information for the two years ended June 30, 1999 and 1998 is based
on the location of the selling entity. Information about the Company's
operations by segmented geographic locations for the years ended June 30, 1999
and June 30, 1998 is presented below.
<TABLE>
<CAPTION>
United States United Kingdom Eliminations Consolidated
------------- -------------- ------------ ------------
1999:
<S> <C> <C> <C> <C>
Sales $8,490,642 $2,251,628 ($719,965) $10,022,305
Operating Income 444,794 229,246 - 0 - 674,040
Assets $5,010,286 $ 862,219 ($481,739) $ 5,390,766
1998:
Sales $9,275,889 $ - 0 - $ - 0 - $ 9,275,889
Operating Income 1,301,558 - 0 - - 0 - 1,301,558
Assets $4,403,422 $ - 0 - $ - 0 - $ 4,403,422
</TABLE>
19. Comprehensive Income
On July 1, 1998, the Company adopted SFAS 130, "Reporting Comprehensive Income".
This Statement requires that all items that are required to be recognized under
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. Comprehensive income is computed as follows:
Years Ended
June 30,
---------------------------
1999 1998
---- ----
Net income attributable to Common Stock $462,555 $1,134,639
Other comprehensive income:
Foreign currency translation adjustment (29,915) - 0 -
-------- ----------
Comprehensive income $432,640 $1,134,639
======== ==========
Item 8. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
None.
<PAGE>
PART III
Item 9. Directors and Executive Officers of the Registrant
There is hereby incorporated herein by reference the information appearing under
the caption "Election of Directors", under the caption "Executive Officers of
the Company", and under the caption "Compliance with Securities Laws" of the
Registrant's definitive Proxy Statement for its 1999 Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission.
Item 10. Executive Compensation
There is hereby incorporated herein by reference the information appearing under
the caption "Executive Compensation" and under the caption "Election of
Directors" of the Registrant's definitive Proxy Statement for its 1999 Annual
Meeting of Stockholders to be filed with the Securities and Exchange Commission.
Item 11. Security Ownership of Certain Beneficial Owners and Management
There is hereby incorporated herein by reference the information appearing under
the caption "Voting Securities and Principal Holders Thereof" of the
Registrant's definitive Proxy Statement for its 1999 Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission.
Item 12. Certain Relationships and Related Transactions
There is hereby incorporated by reference herein the information appearing under
the caption "Certain Transactions" of the Registrant's definitive Proxy
Statement for its 1999 Annual Meeting of Stockholders to be filed with the
Securities and Exchange Commission.
<PAGE>
Item 13. Exhibits, List and Reports on Form 8-K
The following is a list of exhibits filed as part of this annual
report on Form 10-KSB. Where so indicated, exhibits which were
previously filed are incorporated by reference.
Exhibit No. Description of Exhibit
----------- ----------------------
(1) 2.1 Form of Amended and Restated Agreement and Plan of Merger
between and among Applied Optical Media Corporation and the
Registrant ("AOMC Merger Agreement").
(2) 2.2 Agreement and Plan of Reorganization dated April 4, 1996 by
and among the Registrant, the Registrant's wholly-owned
subsidiary and Virtual Reality Laboratories, Inc.
(2) 2.3 Agreement and Plan of Merger dated April 4, 1996 by and
among the Registrant, the Registrant's wholly-owned subsidiary
and Virtual Reality Laboratories, Inc.
(3) 2.4 Sale and Purchase Agreement between the Registrant and the
stockholders of Software Partners Publishing and Distribution
Ltd. dated August 14, 1998.
(5) 3.1 Amended and Restated Articles of Incorporation of the Registrant.
(6) 3.2.1 By-Laws of the Registrant.
(7) 4.1 Promissory Note in the amount of $350,000 from Virtual
Reality Laboratories, Inc. to Heller First Capital Corporation
dated March 25, 1996; Commercial Security Agreement dated March
25, 1996 between Virtual Reality Laboratories, Inc. and Heller
First Capital Corporation; and U.S. Small Business Administration
Guaranty dated March 25, 1996.
(4) 4.2 Rights Agreement, dated as of June 1, 1999, between the
Registrant and StockTrans, Inc.
(5) 10.1 Form of Redeemable Warrant for the Purchase of the
Registrant's Common Shares (Exhibit A to AOMC Merger Agreement).
(5) 10.2 Form of Underwriter's Warrant Agreement.
(5) 10.3 1994 Stock Option Plan.
(3) 10.4 Amended and Restated 1995 Stock Option Plan.
(8) 10.5 Form of Purchase Agreement for the Class Two Convertible
Preferred Stock (the "Class Two Preferred") dated as of November
15, 1996.
(8) 10.6 Form of Warrant Agreement for the Warrants (the
"Warrants") issued to the holders of the
Class Two Preferred dated as of November 15, 1996.
(8) 10.7 Form of Registration Rights Agreement for the Common Stock
underlying the Class Two Preferred and the Warrants dated as of
November 15, 1996.
(8) 10.8 Form of Agreement amending certain terms of the Class Two
Preferred Certificate of Designation, Warrants and Registration
Rights Agreement dated as of November 15, 1996.
(9) 10.9 Purchase Agreement dated January 30, 1997 between the
Registrant and Odyssey Capital Group, L.P.
<PAGE>
Exhibit No. Description of Exhibit
----------- ----------------------
(9) 10.10 Agreement dated January 30, 1997 between the Registrant
and Odyssey Capital Group, L.P.
(9) 10.11 Registration Rights Agreement dated January 30, 1997
between the Registrant and Odyssey Capital Group, L.P.
(10) 10.12 Form of Securities Purchase Agreement for the Class
Three Convertible Preferred Stock (the "Class Three Preferred").
(10) 10.13 Form of Warrant Agreement for the Warrants (the "Class
Three Warrants") issued to the holders of the Class Three
Preferred.
(10) 10.14 Form of Registration Rights Agreement for the Common
Stock underlying the Class Three Preferred and the Class Three
Warrants.
(11) 10.15 Warrant Agreement dated January 30, 1997 by and between
Registrant and PJM Trading Company, Inc.
(3) 10.16 Separation Agreement and General Release dated June 22,
1998 between the Registrant and Joseph A. Falsetti.
(12) 10.17 Line of Credit Note dated March 10, 1999 by and between
the Registrant and Sovereign Bank.
(12) 10.18 Line of Credit Loan and Security Agreement dated March 10, 1999
by and between the Registrant and Sovereign Bank.
10.19 Description of Registrant's 1998 Employee Incentive Compensation
Plan
21.1 Subsidiaries.
23.1 Consent of KPMG LLP.
(13) 24.1 Power of Attorney.
27.1 Financial Data Schedule.
- --------------------------------------------------------------------------------
(1) Incorporated by reference herein from Amendment No. 3 of the
Registrant's Form SB-2 as filed with the Securities and Exchange
Commission on October 4, 1995.
(2) Incorporated by reference herein from the Registrant's Form 8-K as
filed with the Securities and Exchange Commission on April 19, 1996.
(3) Incorporated herein by reference from the Registrant's Form 10-KSB
for the year ended June 30, 1998 as filed with the Securities
and Exchange Commission on September 10, 1998.
(4) Incorporated by reference herein from the Registrant's Form 8-K as
filed with the Securities and Exchange Commission on June 10, 1999.
(5) Incorporated by reference herein from the Registrant's Form SB-2 as
filed with the Securities and Exchange Commission on July 28, 1995.
(6) Incorporated by reference herein from the Registrant's Form 10-QSB
for the quarter ended September 30, 1998 as filed with the Securities
and Exchange Commission on November 16, 1998.
(7) Incorporated by reference herein from the Registrant's Form 10-QSB
for the quarter ended March 31, 1996 as filed with the Securities and
Exchange Commission on May 14, 1996.
(8) Incorporated by reference herein from the Registrant's Form 8-K as
filed with the Securities and Exchange Commission on November 27,
1996.
(9) Incorporated by reference herein from the Registrant's Form 8-K as
filed with the Securities and Exchange Commission on February 4,
1997.
<PAGE>
(10) Incorporated by reference herein from the Registrant's Form 8-K as
filed with the Securities and Exchange Commission on April 9, 1997.
(11) Incorporated herein by reference from the Registrant's Form 10-KSB
for the year ended June 30, 1997 as filed with the Securities and
Exchange Commission on September 29, 1997.
(12) Incorporated by reference herein from the Registrant's Form 8-K as
filed with the Securities and Exchange Commission on March 22, 1999.
(13) See signature page.
Reports on Form 8-K
On June 10, the Company filed a report on Form 8-K regarding a press release
announcing that the Company's Board of Directors had adopted a Shareholder
Rights Plan.
On July 23, the Company filed a report on Form 8-K regarding a press release
announcing the Company's sales and earnings for the year ended June 30, 1999.
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
eGames, Inc.
By: /s/ Gerald W. Klein
------------------------------------------------------
Gerald W. Klein, President and Chief Executive Officer
Date: September 28, 1999
------------------
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated.
Date: September 28, 1999 /s/ Gerald W. Klein
------------------ -------------------
Gerald W. Klein, President and Chief
Executive Officer
Date: September 28, 1999 /s/ Thomas W. Murphy
------------------ --------------------
Thomas W. Murphy, Chief Financial Officer
and Chief Accounting Officer
Each person in so signing also makes, constitutes and appoints Thomas
D. Parente, Chairman of the Board of Directors, and Gerald W. Klein, President
and Chief Executive Officer, and each of them severally, his true and lawful
attorney-in-fact, in his name, place and stead to execute and cause to be filed
with the Securities and Exchange Commission any or all amendments to this
report.
Date: September 28, 1999 /s/ Thomas D. Parente
------------------ ---------------------
Thomas D. Parente
Chairman of the Board of Directors
Date: September 28, 1999 /s/ Robert M. Aiken, Jr.
------------------ ------------------------
Robert M. Aiken, Jr.
Director
Date: September 28, 1999 /s/ Lambert C. Thom
------------------ -------------------
Lambert C. Thom
Director
Exhibit 10.19
DESCRIPTION OF
EGAMES, INC. 1999 EMPLOYEE INCENTIVE COMPENSATION PLAN
On November 18, 1998 the Board of Directors of eGames, Inc. ("the
Company") approved the adoption of a company-wide Employee Incentive
Compensation Plan (the "Plan"). The amount of incentive compensation that each
Company employee was eligible to earn under the Plan was contingent on the
Company achieving certain net income objectives. Under the Plan, each employee
was eligible to earn a specified percentage of the employee's total annual
salary in incentive compensation. These percentages ranged from 10% of annual
salary for administrative employees to 50% of the annual salary for the Chief
Executive Officer.
No bonuses were to be earned until the Company had earned net income of
at least $1,135,000 (the "Minimum Threshold") during the 1999 fiscal year, which
amount was equivalent to the net income earned in fiscal 1998. Upon reaching the
Minimum Threshold, plus the amount required to pay the bonuses earned if the
Minimum Threshold were achieved, then 50% of the potential bonus to which each
employee was eligible would be earned. If net income of $2,750,000 (the 100%
Threshold") was earned during the 1999 fiscal year, plus the amount required to
pay the bonuses earned when that net income level had been achieved, then 100%
of the potential bonus to which each employee was eligible would be earned.
If the Company earned net income during the 1999 fiscal year that
exceeded the Minimum Threshold, plus the amount required to pay the bonuses
earned, then each employee would earn a bonus equal to the percentage of the
potential bonus to which they were eligible equal to the percentage of earnings
as measured against the 100% Threshold. For example, if an employee earned
$50,000 per year and was eligible to earn a bonus equal to 10% of his or her
salary if the 100% Threshold were met, then that employee would be paid a $5,000
bonus if the 100% Threshold were met. If the Company achieved earnings of
$2,063,000, plus the amount required to pay the bonuses earned, or an amount
equal to 75% of the 100% Threshold, then the employee would earn a bonus of
$3,750.
On the date of adoption of the Plan, based on the number of employees
of the Company and their respective bonus percentages, the Company would have
been required to achieve pre-bonus earnings of approximately $1,311,000 during
the 1999 fiscal year in order to earn the minimum bonus (50%). There was no
maximum incentive compensation level. If the Company exceeded the 100%
Threshold, then additional incentive compensation would be earned on a linear
basis.
Any bonuses earned were to be paid subsequent to the completion of the
1999 fiscal year's financial statement audit.
EXHIBIT 21.1
SUBSIDIARIES
Name Place of Incorporation
- ------------------------- ----------------------
1. eGames Europe Limited England and Wales
Exhibit 23.1
Consent of Independent Auditors
The Board of Directors
eGames, Inc.:
We consent to incorporation by reference in the registration statements (No.'s
333-23709 and 333-26305) on Form S-3 and in the registration statement (No.
333-42661) on Form S-8 of eGames, Inc. of our report dated August 19, 1999,
relating to the consolidated balance sheet of eGames, Inc. and subsidiary as of
June 30, 1999, and the related consolidated statements of operations,
stockholders' equity, and cash flows for each of the years in the two-year
period ended June 30, 1999, which report appears in the June 30, 1999 Annual
Report on Form 10-KSB of eGames, Inc.
/s/ KPMG LLP
Philadelphia, Pennsylvania
September 27, 1999
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
Exhibit 27.1
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-END> JUN-30-1999
<CASH> 1,313,853
<SECURITIES> 0
<RECEIVABLES> 2,352,235
<ALLOWANCES> (417,732)
<INVENTORY> 1,153,198
<CURRENT-ASSETS> 4,527,816
<PP&E> 935,162
<DEPRECIATION> (559,445)
<TOTAL-ASSETS> 5,390,766
<CURRENT-LIABILITIES> 1,819,898
<BONDS> 0
0
0
<COMMON> 8,874,889
<OTHER-SE> (5,650,951)
<TOTAL-LIABILITY-AND-EQUITY> 5,390,766
<SALES> 10,022,305
<TOTAL-REVENUES> 10,022,305
<CGS> 3,596,982
<TOTAL-COSTS> 3,596,982
<OTHER-EXPENSES> 5,751,283
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 58,409
<INCOME-PRETAX> 642,279
<INCOME-TAX> 179,724
<INCOME-CONTINUING> 462,555
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 462,555
<EPS-BASIC> 0.05
<EPS-DILUTED> 0.05
</TABLE>
