U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
|_| 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
incorporation or organization) Identification Number)
2000 Cabot Boulevard West, Suite 110
Langhorne, PA 19047-1811
(address of Principal executive offices)
Issuer's Telephone Number, Including Area Code: 215-750-6606
Not Applicable
(Former name, former address and former
fiscal year, if changed since last report.)
Check 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 ( )
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes ( ) No ( )
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: 9,749,975 shares of common stock, no
par value per share, as of November 10, 2000.
Transitional Small Business Disclosure Format (check one): Yes ( ) No ( X )
<PAGE>
eGames, Inc.
INDEX
Page
----
Part I. Financial Information
Item 1. Financial Statements:
Consolidated Balance Sheet as of September 30, 2000......... 3
Consolidated Statements of Operations for the three months
ended September 30, 2000 and 1999 ...................... 4
Consolidated Statements of Cash Flows for the three months
ended September 30, 2000 and 1999....................... 5
Notes to Consolidated Financial Statements.................. 6-7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations .................... 8-12
Risk Factors ............................................... 13-18
Part II. Other Information
Item 1. Legal Proceedings........................................... 18
Item 6. Exhibits and Reports on Form 8-K............................ 19
Signatures ............................................................ 20
Exhibit Index ............................................................ 21
Exhibits ............................................................ 22-23
<PAGE>
Item 1. Financial Statements
eGames, Inc.
Consolidated Balance Sheet
(Unaudited)
<TABLE>
<CAPTION>
As of
September 30,
ASSETS 2000
------------
<S> <C>
Current assets:
Cash and cash equivalents $ 271,863
Accounts receivable, net of allowances totaling $3,249,847 4,594,646
Inventory 1,764,776
Prepaid expenses 187,675
------------
Total current assets 6,818,960
Furniture and equipment, net 304,967
Intangibles and other assets, net 261,694
-----------
Total assets $ 7,385,621
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable $ 60,980
Accounts payable 1,541,335
Revolving credit facilities 500,000
Accrued expenses 1,339,799
Convertible subordinated debt 150,000
Capital lease obligations 16,095
-----------
Total current liabilities 3,608,209
Capital lease obligations, net of current portion 9,345
Notes payable, net of current portion 108,426
-----------
Total liabilities 3,725,980
Stockholders' equity:
Common stock, no par value (40,000,000 shares authorized;
9,981,875 issued and 9,749,975 outstanding) 9,134,234
Additional paid-in capital 1,148,550
Accumulated deficit (5,991,408)
Treasury stock, at cost - 231,900 shares (501,417)
Accumulated other comprehensive loss (130,318)
-----------
Total stockholders' equity 3,659,641
-----------
Total liabilities and stockholders' equity $ 7,385,621
===========
</TABLE>
See accompanying notes to the consolidated financial statements.
<PAGE>
eGames, Inc.
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
Three months ended
September 30,
-------------------------
2000 1999
---- ----
<S> <C> <C>
Net sales $ 4,307,666 $ 4,117,575
Cost of sales 1,900,747 1,603,308
----------- -----------
Gross profit 2,406,919 2,514,267
Operating expenses:
Product development 181,147 242,847
Selling, general and administrative 2,190,775 1,600,406
----------- -----------
Total operating expenses 2,371,922 1,843,253
----------- -----------
Operating income 34,997 671,014
Interest expense, net 7,995 5,100
----------- -----------
Income before income taxes 27,002 665,914
Provision for income taxes 2,821 89,295
----------- -----------
Net income $ 24,181 $ 576,619
=========== ===========
Net income per common share:
- Basic $ 0.00 $ 0.06
=========== ===========
- Diluted $ 0.00 $ 0.06
=========== ===========
Weighted average common shares outstanding - Basic 9,749,975 9,633,973
Dilutive effect of common stock equivalents 53,869 503,569
----------- -----------
Weighted average common shares outstanding - Diluted 9,803,844 10,137,542
=========== ===========
</TABLE>
See accompanying notes to the consolidated financial statements.
<PAGE>
eGames, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Three months ended
September 30,
2000 1999
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 24,181 $ 576,619
Adjustment to reconcile net income to net cash
(used in) provided by operating activities:
Depreciation, amortization and other non-cash items 79,277 103,383
Changes in items affecting operations
Restricted cash - 0 - 17,560
Accounts receivable (1,869,673) (2,628,050)
Prepaid expenses 73,710 36,843
Inventory 373,925 54,649
Accounts payable (559,797) 651,590
Gain on disposal of furniture and equipment (4,041) - 0 -
Accrued expenses 544,828 441,906
----------- -----------
Net cash used in operating activities (1,337,590) (745,500)
----------- -----------
Cash flows from investing activities:
Purchase of furniture and equipment (12,105) (30,212)
Proceeds from disposal of furniture and equipment 16,170 - 0 -
Purchase of software rights and other assets (1,730) (245)
----------- -----------
Net cash provided by (used in) investing activities 2,335 (30,457)
----------- -----------
Cash flows from financing activities:
Proceeds from exercise of warrants and options - 0 - 110,000
Proceeds from borrowings under revolving credit facilities 750,000 - 0 -
Repayments of borrowings under revolving credit facilities (250,000) - 0 -
Repayments of notes payable (13,951) (94,466)
Repayments of capital lease obligations (10,849) (6,614)
----------- -----------
Net cash provided by financing activities 475,200 8,920
----------- -----------
Effect of exchange rate changes on cash and cash equivalents (7,260) 3,148
----------- -----------
Net decrease in cash and cash equivalents (867,315) (763,889)
Cash and cash equivalents:
Beginning of period 1,139,178 1,313,853
----------- -----------
End of period $ 271,863 $ 549,964
=========== ===========
Supplemental cash flow information:
Cash paid for interest $ 14,423 $ 11,194
=========== ===========
Non cash investing and financing activities:
Acquisition of furniture and equipment
through capital leases $ 11,550 $ 26,809
=========== ===========
</TABLE>
See accompanying notes to the consolidated financial statements.
<PAGE>
eGames, Inc.
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited interim consolidated financial statements were
prepared in accordance with generally accepted accounting principles for interim
financial information. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. The Notes to Consolidated Financial Statements included in
the Company's Form 10-KSB for the fiscal year ended June 30, 2000 should be read
in conjunction with the accompanying statements. These statements include all
adjustments the Company believes are necessary for a fair presentation of the
statements. The interim operating results are not necessarily indicative of the
results for a full year.
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 targets the
growing market of home personal computer ("PC") users who value full-featured,
value-priced and easy-to-use entertainment software. The Company's sales are
made through various national distributors on a non-exclusive basis in addition
to direct relationships with certain national and regional retailers. The
Company's products generally sell at retail for under $15, a price point that is
intended to generate impulse purchases in mass market shopping environments.
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.
2. Comprehensive Income (Loss)
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 (loss) is computed as follows:
Three Months Ended
September 30,
-----------------------
2000 1999
---- ----
Net income $ 24,000 $ 577,000
Other comprehensive income (loss):
Foreign currency translation adjustment (61,000) (12,000)
-------- ---------
Comprehensive income (loss) ($ 37,000) $ 565,000
======== =========
3. Common Stock
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 open-market purchases
on the Nasdaq SmallCap Market. During the quarter ended September 30, 2000 the
Company did not purchase any shares of its Common Stock. As of September 30,
2000, the Company had acquired 231,900 shares of its Common Stock, with an
approximate cost of $501,000, pursuant to its stock repurchase program.
<PAGE>
Notes to Consolidated Financial Statements (continued)
4. 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.
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 quarters ended September 30, 2000 and 1999 is
based on the location of the selling entity. The Company records international
sales from both the United States and United Kingdom locations. Information
about the Company's operations by segmented geographic locations for the
quarters ended September 30, 2000 and 1999 is presented below.
Quarters ended
--------------
<TABLE>
<CAPTION>
North America United Kingdom Eliminations Consolidated
------------- -------------- ------------ ------------
<S> <C> <C> <C> <C>
September 30, 2000:
-------------------
Sales $ 3,925,000 $ 591,000 ($ 208,000) $ 4,308,000
Operating income (loss) 160,000 (125,000) - 0 - 35,000
Assets $ 7,359,000 $ 1,056,000 ($1,029,000) $ 7,386,000
September 30, 1999:
-------------------
Sales $ 3,707,000 $ 576,000 ($ 165,000) $ 4,118,000
Operating income 598,000 73,000 - 0 - 671,000
Assets $ 6,791,000 $ 901,000 ($ 588,000) $ 7,104,000
</TABLE>
5. Revolving Credit Facilities
On August 9, 2000, the Company entered into a $2,000,000 revolving credit
facility ("new credit facility") with a commercial bank, which expires on
October 31, 2001. This new credit facility replaced the $1,500,000 revolving
credit facility that it previously had with another commercial bank. Amounts
outstanding under this new 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 new credit facility is collateralized by substantially all of the
Company's assets. The new 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 senior debt to effective net worth ratio of
1.50 to 1.00. Additionally, this new credit facility has a minimum effective net
worth covenant starting at $3.1 million at June 30, 2000 and increasing by
$150,000 quarterly to a $3.7 million requirement at June 30, 2001. As of
September 30, 2000, the Company was in compliance with each of those covenants.
This new credit facility was established to provide, among other things,
additional working capital to support the Company's anticipated growth. As of
November 13, 2000, the Company had a $500,000 outstanding balance under this new
credit facility.
The Company's United Kingdom operation has a $225,000 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 November 13, 2000, the Company did not
have any outstanding balance under this credit facility, which expires on
September 30, 2001.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The accompanying consolidated financial statements as of September 30, 2000
include the accounts of eGames, Inc. (the "Company") and its wholly-owned
subsidiary.
Forward-Looking Statements
This Quarterly Report on Form 10-QSB and in particular Management's Discussion
and Analysis of Financial Condition and Results of Operations contains
forward-looking statements about circumstances that have not yet occurred,
including, without limitation, statements regarding the Company's
Store-In-A-Store program resulting in the longer-term placement of the Company's
products in the food and drug retail channel, which is intended to increase
sales volume within this channel and decrease the rate of product returns due to
longer product exposure on retailers' product shelves; the level of the
Company's international net sales remaining at about 17% of the Company's
consolidated net sales for the remainder of fiscal 2001; the Company's efforts
to increase distribution of its products via the Internet; the ability of the
"Store in a Store" concept to attract consumer interest and drive impulse
purchases of value-priced, Family-Friendly(TM) software products; the Company's
goal of balancing promotional sales programs with longer-term, non-promotional
software display sections in the food and drug retail channel with the intended
result of reducing the Company's exposure to product returns in this channel;
the payment of certain promotional costs resulting in increased sell-through
rates for the Company's products during short-term promotional programs; the
ability of the Company's Store-in-a-Store program to reduce promotional
expenses, as a percentage of sales, due to more product sales being
non-promotional in nature; the sufficiency of the Company's cash and working
capital balances to fund the Company's operations for the foreseeable future;
the expectation that certain new accounting pronouncements will not have a
significant impact on the Company's results of operations, financial position or
cash flows; as well as other statements including words such as "anticipate",
"believe" or "expect" and statements in the future tense. These forward-looking
statements are subject to business and economic risks, and actual events or the
Company's actual future results could differ materially from those set forth in
the forward-looking statements due to such risks and uncertainties. The Company
will not necessarily update information if any forward looking statement later
turns out to be inaccurate.
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 market
acceptance of the Company's Store-in-a-Store program in the food and drug retail
channel and the sustainability of the program over time; the ability of the
Store-in-a-Store program to secure longer-term shelf space for the Company's
products; whether the longer-term placement of the Company's products at retail
will result in better sell-through rates and therefore fewer returns from the
food and drug retail channel; the market acceptance and successful sell-through
results for the Company's products at retail stores and the ability of the
Company to accurately estimate sell-through volume when an order is shipped; the
amount of unsold product that is returned to the Company by retail stores; the
Company's ability to accurately predict the amount of product returns that will
occur and the adequacy of the reserves established for such returns; the
Company's ability to continue to implement its Store within a Store program on
commercially acceptable terms; the success of the Company's distribution
strategy, including its ability to enter into new distribution and direct sales
relationships on commercially acceptable terms; the allocation of adequate shelf
space for the Company's products in major retail chain stores; the Company's
ability to negotiate lower product promotional costs in its distribution and
retail relationships; the Company's ability to collect outstanding accounts
receivable and establish adequate reserves for un-collectible receivables;
increased selling, general and administrative costs, including increased legal
expenses; 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; and various other factors, many of which are
beyond the Company's control. Risks and uncertainties that may affect the
Company's future results and performance also include, but are not limited to,
those discussed under the heading "Risk Factors" below at pages 13 to 18, as
well as in the Company's Annual Report on Form 10-KSB for the fiscal year ended
June 30, 2000 as filed with the Securities and Exchange Commission and other
documents filed with the Commission.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
Results of Operations
Three Months Ended September 30, 2000 and 1999
Net Sales
Net sales for the quarter ended September 30, 2000 were $4,308,000 compared to
$4,118,000 for the quarter ended September 30, 1999, representing an increase of
$190,000 or 5%. As described in the table below, the $190,000 increase in net
sales was primarily attributable to the Company's expansion of its distribution
into the North American food and drug channel, which was partially offset by
decreases in net sales into the traditional North American software retail and
distribution channels. Within the food and drug channel, the Company increased
it distribution, among other activities, by establishing its first
"Store-in-a-Store" entertainment software display sections in more than
approximately 4,000 food and drug retail stores. The establishment of these
Store-In-A-Store software display sections within certain national and regional
food and drug retail stores is intended to secure longer-term placement of the
Company's products in this retail channel, with the goal of increasing sales
volume within this channel while decreasing the rate of product returns due to
longer product exposure on retailers' product shelves.
The table below represents the Company's net sales by distribution channel for
the quarters ended September 30, 2000 and 1999, respectively.
<TABLE>
<CAPTION>
Quarter Ended Quarter Ended
September 30, September 30, Increase
Distribution Channel 2000 1999 (Decrease)
------------------------------------------------ ------------- -------------- -------------
<S> <C> <C> <C>
North American Food and Drug Retailers $2,296,000 $ 899,000 $ 1,397,000
North American Traditional Software Retailers 312,000 530,000 (218,000)
North American Traditional Software Distributors 989,000 2,040,000 (1,051,000)
International Markets 711,000 649,000 62,000
------------------------------------------------ ------------- -------------- -------------
Totals $ 4,308,000 $ 4,118,000 $ 190,000
============= ============== =============
</TABLE>
As noted in the table above, the Company's net sales to traditional North
American software retailers decreased by $218,000, while sales to traditional
North American software distributors decreased by $1,051,000. These sales
decreases were consistent with industry-wide reductions of PC software inventory
levels held by North American software retailers and distributors, which has
negatively impacted the Company's sales to these customers during the quarter
ended September 30, 2000.
As discussed in the above table, the Company's international sales for the
quarter ended September 30, 2000 increased by $62,000 over sales for the same
period during the prior year. This minimal sales increase is primarily the
result of increased pricing pressures at retail and increased competition for
retail shelf space from the Company's competitors in these foreign markets. As a
percentage of net sales, the Company's international net sales represented 17%
and 16% of the Company's net sales for the quarters ended September 30, 2000 and
1999, respectively. The Company anticipates that international net sales will
remain at about 17% of the Company's consolidated net sales for the remainder of
fiscal 2001.
Included in net sales to the food and drug retail channel are net sales of
third-party software titles totaling $364,000 and $165,000 for the quarters
ended September 30, 2000 and 1999, respectively. The Company sells these
software titles to food and drug retailers as part of its Store-In-A-Store
software sections. The Company offers these third-party software titles in order
to provide a one-stop, software category management service for these retailers,
so that the Company can continue to establish itself as a leading supplier of
entertainment software products, of both its own titles and third-party software
titles.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
During fiscal 2000, the Company completed its transition from publishing
shareware-based PC game software titles to publishing full-release PC game
software titles. There were no net sales of shareware-based software titles
during the quarter ended September 30, 2000 compared to $90,000 of net sales of
such titles during the quarter ended September 30, 1999.
The Company has recently initiated several programs designed to increase the
sale of its products over the Internet, including: the roll-out of an improved
and expanded website; improvement of its electronic distribution capabilities by
further developing and expanding its affiliation with Digital River, a leading
distributor of digital software over the Internet; and incorporation of
user-friendly on-line functionality into its products. Sales of the Company's
products via the Internet for the quarters ended September 30, 2000 and 1999
were $52,000 and $21,000, respectively, or approximately 1% of the Company's net
sales during both quarters.
During the quarters ended September 30, 2000 and 1999, the Company's provisions
for product returns were $1,464,000 and $1,041,000, respectively, or 25% and 20%
of the Company's gross sales, respectively. This $423,000 increase in the
provision for product returns has been caused primarily by the change in the
Company's distribution strategy, which involved expanding the number of
distribution partners used to distribute the Company's products and selling
directly to retailers. All of these non-exclusive arrangements between the
Company and its distributors and retailers allow for product returns or
markdowns. Additionally, during the last fiscal year, the Company has
experienced a significant increase in net sales into the food and drug retail
channel. The majority of these sales were "promotional" in nature, meaning that
the products were sold in those retail stores for only six to eight weeks. As a
result of this short selling period, the Company has experienced higher product
returns in food and drug retail stores compared to product returns from
traditional software retail stores where the Company's products typically have a
longer period of time to sell through to consumers. During fiscal 2001, the
Company's strategy is to continue working towards a more profitable balance
between short-term promotional sales programs and longer-term, non-promotional
sales programs in the food and drug retail channel. This strategy, among other
things, is intended to reduce the Company's exposure to product returns in this
channel. This Store-In-A-Store strategy is an important component of the
Company's growth strategy for fiscal 2001.
Cost of Sales
Cost of sales for the quarter ended September 30, 2000 were $1,901,000 compared
to $1,603,000 for the quarter ended September 30, 1999, representing an increase
of $298,000 or 19%. Of this $298,000 increase in cost of sales, $182,000 was due
to the increase in sales of lower margin products and $123,000 was due to the
increase in sales of non-eGames software titles that the Company acquired at a
higher product cost than the Company's own software titles. Product costs
consist mainly of replicated compact discs, printed materials, protective jewel
cases and boxes for certain products.
Gross Profit Margin
The Company's gross profit margin for the quarter ended September 30, 2000
decreased to 55.9% of net sales from 61.1% of net sales for the quarter ended
September 30, 1999. This 5.2% decrease in gross profit margin, as a percentage
of net sales, was caused primarily by an increase in product costs, as a
percentage of net sales, due to the Company's: discounting sales of certain
software titles with consumer promotions; sales of newly developed promotional
titles with lower margins; and increasing sales of third party software titles
on which the Company earns a lower profit margin than it earns from the sale of
its own software titles.
Operating Expenses
Product development expenses for the quarter ended September 30, 2000 were
$181,000 compared to $243,000 for the quarter ended September 30, 1999, a
decrease of $62,000 or 26%. This decrease was caused primarily by a $45,000
decrease in salary and related costs due to headcount reductions among the
Company's technology-related staff and no employee bonus accrual for the quarter
ended September 30, 2000.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
Selling, general and administrative expenses for the quarter ended September 30,
2000 were $2,191,000 compared to $1,600,000 for the quarter ended September 30,
1999, an increase of $591,000 or 37%. This $591,000 increase was caused
primarily by the $584,000 increase in marketing promotional expenses associated
mainly with the increase in sales into the food and drug retail channel. These
promotional costs are intended to increase the sell-through rate for the
Company's products during the short-term promotional programs that these
retailers offer periodically to their customers, as well as expand the
longer-term placement of the Company's products in the food and drug channel
through the Company's Store-in-a-Store program. This program is intended to
ultimately reduce promotional expenses, as a percentage of sales, due to more
product sales being non-promotional in nature. Additionally, the Company
continues to experience higher promotional costs in the traditional software
retail channels due to increased competition for shelf space and the related
expenses charged by retailers and distributors to promote and support sales of
the Company's products.
Interest Expense, Net
Net interest expense for the quarter ended September 30, 2000 was $8,000
compared to $5,000 for the quarter ended September 30, 1999, an increase of
$3,000. The $3,000 increase was primarily due to the utilization of $500,000
under the revolving credit facility for the quarter ended September 30, 2000.
Provision for Income Taxes
Provision for income taxes for the quarter ended September 30, 2000 was $3,000
compared to $89,000 for the quarter ended September 30, 1999, a decrease of
$86,000 or 97%. This $86,000 decrease in the provision for income taxes was
primarily due to the $639,000 decrease in the Company's income before income
taxes for the quarter ended September 30, 2000.
Net Income
As a result of the factors discussed above, net income decreased to $24,000 for
the quarter ended September 30, 2000 from $577,000 for the quarter ended
September 30, 1999, a decrease of $553,000 or 96%.
Weighted Average Common Shares
The weighted average common shares outstanding on a diluted basis decreased by
333,698 for the quarter ended September 30, 2000 to 9,803,844 from 10,137,542
for the quarter ended September 30, 1999. This 333,698 decrease in weighted
average common shares outstanding was caused primarily by a decrease in common
stock equivalents resulting primarily from the Company's decreasing quarterly
average common share price in the Nasdaq SmallCap market.
Liquidity and Capital Resources
As of September 30, 2000, the Company's cash and working capital balances were
$272,000 and $3,211,000, respectively, and the Company's total stockholders'
equity balance at September 30, 2000 was $3,660,000.
Net cash used in operating activities was approximately $1,338,000 and $746,000
for the quarters ended September 30, 2000 and 1999, respectively. The $1,338,000
in net cash used in operating activities resulted primarily from a $1,870,000
increase in accounts receivable and a $560,000 decrease in accounts payable,
which were partially offset by a $545,000 increase in accrued expenses and a
$374,000 decrease in inventory. Additionally, the Company's net income for the
quarter ended September 30, 2000 was $24,000, inclusive of depreciation,
amortization and other non-cash expenses of $79,000.
Net cash provided by investing activities for the quarter ended September 30,
2000 was $2,000 compared to net cash used in investing activities of $30,000 for
the quarter ended September 30, 1999. The $2,000 in net cash provided by
investing activities resulted from $16,000 in proceeds from the disposal of
furniture and equipment, which was offset by purchases of $12,000 in furniture
and equipment and $2,000 in other assets.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)
Net cash provided by financing activities for the quarters ended September 30,
2000 and 1999 were $475,000 and $9,000, respectively. The $475,000 in net cash
provided by financing activities reflects net proceeds from the Company's
borrowing of $750,000 under the revolving credit facilities, which was offset by
repayments of this borrowing under the revolving credit facilities, notes
payable and capital lease obligations of $250,000, $14,000 and $11,000,
respectively.
On August 9, 2000, the Company entered into a $2,000,000 revolving credit
facility ("new credit facility") with a commercial bank, which expires on
October 31, 2001. This new credit facility replaced the $1,500,000 revolving
credit facility that it previously had with another commercial bank. Amounts
outstanding under this new 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 new credit facility is collateralized by substantially all of the
Company's assets. The new 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 senior debt to effective net worth ratio of
1.50 to 1.00. Additionally, this new credit facility has a minimum effective net
worth covenant starting at $3.1 million at June 30, 2000 and increasing by
$150,000 quarterly to a $3.7 million requirement at June 30, 2001. As of
September 30, 2000, the Company was in compliance with each of those covenants.
This new credit facility was established to provide, among other things,
additional working capital to support the Company's anticipated growth. As of
November 13, 2000, the Company had a $500,000 outstanding balance under this new
credit facility.
The Company's United Kingdom operation has a $225,000 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 November 13, 2000, the Company did not
have any outstanding balance under this credit facility, which expires on
September 30, 2001.
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 and retail customers of the Company's products, the continuing
retail demand for value-priced PC game software, 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, in addition to the Company's
revolving credit facilities mentioned above, will be sufficient to fund the
Company's operations for the next twelve months. 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.
On November 10, 2000, the Company received notification from Nasdaq that its
common stock had failed to maintain a minimum bid price of $1.00 over a period
of 30 consecutive trading days as required for continued listing on the Nasdaq
SmallCap Market as set forth in Marketplace Rule 4310 (c) (4) (the "Rule"). In
accordance with Marketplace Rule 4310 (c) (8) (B), the Company has 90 calendar
days, or until February 8, 2001, to regain compliance with this Rule. The
Company may appeal Nasdaq's determination pursuant to the procedures set forth
in the Nasdaq Marketplace Rule 4800 Series. A hearing request will stay the
de-listing of the Company's securities pending the Panel's decision. As of
November 10, 2000, the Company continued to satisfy all other aspects of its
listing agreement for the Nasdaq SmallCap Market.
New Accounting Pronouncements
The Company is currently evaluating the potential impact of Emerging Issues Task
Force ("EITF") 00-14, "Accounting for Certain Sales Incentives", EITF 00-10
"Accounting for Shipping and Handling Fees and Costs" and Staff Accounting
Bulletin 101 "Revenue Recognition" and related amendments and interpretations.
All of these pronouncements become effective no later than the Company's fourth
quarter of fiscal 2001. The Company does not expect the adoption of these or any
other recently issued accounting pronouncements to have a significant impact on
its results of operations, financial position or cash flows.
<PAGE>
Risk Factors
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 8 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.
The Company's business is subject to many risks and uncertainties, which may
affect its future financial performance. Some of the important risks and
uncertainties which may cause the Company's operating results to vary or which
may materially and adversely affect the Company's operating results are as
follows:
Maintaining Profitability. The Company commenced operations in July 1992. The
Company experienced significant losses from inception through the end of fiscal
1997. Fiscal year 1998 was the first year that the Company earned a profit. The
Company has earned $253,000, $463,000 and $1,253,000 in fiscal 2000, 1999 and
1998, respectively, and the accumulated deficit for the Company at June 30, 2000
was approximately $6,016,000. 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
mainly 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 and profits from the development,
marketing and distribution of its current and future software products.
Risks Inherent in the Consumer Entertainment Software Business. 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. Some of the factors that could affect 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,
successful implementation of its sales, distribution and marketing strategy, and
the implications of the settlement of litigation discussed under Part II, Item
1, "Legal Proceedings." 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. 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, timing and 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 adversely affect
the Company's business, operating results and financial condition.
<PAGE>
Risk Factors (continued)
Risk of Customer Business Failure. Distributors and retailers in the computer
industry and in mass-market retail channels 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.
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.
Product Returns. Although the Company has established allowances for product
returns that it believes are adequate, there can be no assurance that actual
returns will not exceed such allowances. The Company may also accept 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 Infogrames, Inc. in April 1999, and its new
non-exclusive distribution relationships with other distributors and its direct
sales to retailers, 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.
The Consumer Entertainment Software Market is Highly Competitive and Changes
Rapidly. The market for consumer entertainment software is highly competitive,
particularly at the retail shelf level where a constantly increasing number of
software titles are competing for the same amount of shelf space. Retailers have
a limited amount of shelf space on which to display consumer entertainment
software products. 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. 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 and access to the Company's recently established $2,000,000 revolving
credit facility with a commercial bank that expires on October 31, 2001. 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>
Risk Factors (continued)
Risks Related to Added Product Features and Increased Regulation of the Internet
and Advertising. Due to the competitive environment in the consumer
entertainment software industry, the Company has and will continue to seek to
incorporate features into its products, such as an Internet browser interface
and advertising technology, in order to differentiate its products to retailers,
provide value-added features to consumers, and to potentially create new revenue
streams based on advertising and promotional opportunities. There can be no
assurance that such features will enhance the product's value, and in fact such
features may detract from a product's value if they are not accepted in the
marketplace or if new regulations governing the Internet and related
technologies are enacted which impact these features.
Difficulty in Protecting the Company's Intellectual Property Rights. The Company
either owns or has obtained licenses to the rights to 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.
Substantial Expenses and Resources Can Be Used to Defend Infringement Claims;
Effects of Settlements are Uncertain. The Company may from time to time be
notified that it is infringing on the intellectual property rights of others.
Combinations of content acquired through past or future acquisitions and content
licensed from third party developers will create new products and technology
that may give rise to claims of infringement. In February 2000, the Company was
sued for trademark and copyright infringement by Hasbro Interactive, Inc. (the
"Hasbro Action") (See Part II, Item 1, "Legal Proceedings"). Although this case
has been settled, the Company incurred significant defense costs and utilized
internal resources to defend this action prior to the settlement. Additionally,
pursuant to the settlement of this case, the Company has agreed to discontinue
selling certain of its software titles after September 30, 2000, which titles
accounted for $2,100,000 and $2,000,000 in the Company's net sales for fiscal
2000 and 1999, respectively, or 15% and 20% of net sales for those same fiscal
years. Although the Company is working with its retail and distribution
customers to replace these titles with acceptable alternatives from the
Company's existing and newly released product offerings, there can be no
assurance that these replacement titles will generate similar sales for the
Company. There can also be no assurance that other third parties will not
initiate infringement actions against the Company in the future. Any future
claims could result in substantial cost to and diversion of resources of the
Company. If the Company is 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 commencement of
litigation arising out of any such claims, could have a material adverse effect
on the Company's operating results.
Risks Associated With the Company's Distribution of Third-Party Software Titles.
During the fourth quarter of fiscal 2000 and the first quarter if fiscal 2001,
the Company launched its Store-in-a-Store program and other related programs in
the food and drug retail channels. These programs have required the Company to
purchase software titles from third-party software publishers in order to
fulfill the orders placed for these retail programs. In some cases, beginning in
the Company's fiscal second quarter, the agreements governing the purchase of
these third-party software titles may provide that the third-party publisher
will not accept returns of the software, unless such software is defective.
Therefore, if the Company is required to accept returns of these software titles
from food and drug retailers, the Company will have no recourse against such
third-party software publishers. Although the Company believes that it has
established adequate reserves for these returns and that the purchase price paid
for these titles reflects their non-returnable nature, there can be no assurance
that the Company will not experience losses as a result of these transactions in
the event that retailers return more product than had been anticipated.
<PAGE>
Risk Factors (continued)
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, particularly value-priced, casual PC games; the level of
product and price competition; the level of product returns; the length of the
Company's sales cycle; seasonality of 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; and the ability of the Company to develop and market
new products and control costs. 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.
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, net sales 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.
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 is also 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.
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.
<PAGE>
Risk Factors (continued)
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. International net sales represented 17% and 16% of the
Company's net sales for the quarters ended September 30, 2000 and 1999,
respectively. The Company anticipates that international net sales will remain
at or about 17% of the Company's net sales for the remainder of fiscal 2001. 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.
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, bid
price, shares publicly held, number of Stockholders or aggregate market value,
or if it violates other aspects of its listing agreement. At September 30, 2000,
the Company satisfied the minimum level of Stockholders' equity that is required
to be listed ($2,000,000), as well as all other requirements of its listing
agreement for inclusion on the Nasdaq SmallCap Market. On November 10, 2000, the
Company received notification from Nasdaq that its common stock had failed to
maintain a minimum bid price of $1.00 over a period of 30 consecutive trading
days as required for continued listing on the Nasdaq SmallCap Market as set
forth in Marketplace Rule 4310 (c) (4) (the "Rule"). In accordance with
Marketplace Rule 4310 (c) (8) (B), the Company has 90 calendar days, or until
February 8, 2001, to regain compliance with this Rule. The Company may appeal
Nasdaq's determination pursuant to the procedures set forth in the Nasdaq
Marketplace Rule 4800 Series. A hearing request will stay the de-listing of the
Company's securities pending the Panel's decision. If the Company fails to
regain compliance with this rule or any other 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 offered for the
common stock may be substantially reduced.
<PAGE>
Risk Factors (continued)
Potential for Further Trading Restrictions for Low-Priced Stock. 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 $1.00 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.
Part II. Other Information
Item 1. Legal Proceedings
In August, 2000, the Company settled the lawsuit filed by Hasbro Interactive,
Inc., Atari Interactive, Inc., and Zao Elorg d/b/a Elorg Corporation
(collectively, the "Plaintiffs") against the Company, Xtreme Games LLC, GT
Interactive Software Corporation, MVP Software, Inc., Webfoot Technologies, Inc.
and Varcon Systems, Inc. on February 9, 2000, in the United States District
Court for the District of Massachusetts. The suit had alleged that certain of
the Company's products infringed copyrights and trademarks owned by the
Plaintiffs, and that the Company had engaged in unfair competition. The suit had
sought to have the Company enjoined from manufacturing, marketing, distributing
and selling the Company's allegedly infringing games and from using the
allegedly infringing trademarks; to have the Company recall the allegedly
infringing products and related materials from the distributors and retailers
currently selling these products; to require the Company to pay the Plaintiffs
the profits derived from the allegedly infringing products; and to pay
Plaintiffs' legal fees and costs. The settlement agreement with the Plaintiffs
caused the Company to incur a non-recurring expense of $205,000 charged against
the Company's fiscal 2000 fourth quarter, ended June 30, 2000. This $205,000
charge consisted of a $160,000 cash payment to the plaintiffs, a $15,000 fee to
a third party consultant and $30,000 in an increased provision for inventory
obsolescence. In total, including outside legal costs, during the year ended
June 30, 2000, the Company incurred $390,568 in costs relating to this
litigation, including the $205,000 charge noted above. The settlement did not
require the recall of any of the Company's products and also did not admit to
any infringement by the Company of the titles named in the suit. Under the terms
of the settlement, the Company was permitted to sell certain games alleged to
infringe on Hasbro's copyrights through September 30, 2000, at which point these
products were discontinued. The settlement involved the following Company
titles: Intergalactic Exterminator, 3D Astro Blaster, Missile Launch, Missile
Launch 2000, TetriMania, TetriMania Master, 3D TetriMania, 3D Maze Man, 3D
Chomper, 3D Frogman, 3D Ms. Maze and Tunnel Blaster. The discontinued titles
generated net sales of $2,100,000 and $2,000,000 for fiscal 2000 and 1999,
respectively, or 15% and 20% of net sales during those same fiscal years.
<PAGE>
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit No. Description of Exhibit
----------- ----------------------
10.1 Description of eGames, Inc. 2001 Employee Incentive
Compensation Plan
27.1 Financial Data Schedule
(b) Reports on Form 8-K
On July 27, 2000, the Company filed a report on Form 8-K regarding a press
release announcing the Company's unaudited results for the fourth quarter and
year ended June 30, 2000.
On August 17, 2000, the Company filed a report on Form 8-K announcing that the
Company had entered into an agreement with Summit Bank for a $2 million
revolving credit facility that replaced an existing $1.5 million revolving
credit facility with another commercial bank.
On September 13, 2000, the Company filed a report on Form 8-K regarding a press
release announcing the settlement of the trademark and copyright infringement
suit filed by Hasbro Interactive, Inc., Atari Interactive, Inc. and ZAO Elorg
d/b/a Elorg Corporation against the Company in the U.S. District Court in
Boston, Massachusetts.
On October 27, 2000, the Company filed a report on Form 8-K regarding a press
release announcing the Company's unaudited results for the first quarter of
fiscal 2001 ended September 30, 2000.
<PAGE>
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
eGames, Inc.
(Registrant)
Date: November 14, 2000 /s/ Gerald W. Klein
----------------- --------------------
Gerald W. Klein, President, Chief
Executive Officer and Director
Date: November 14, 2000 /s/ Thomas W. Murphy
----------------- --------------------
Thomas W. Murphy, Chief Financial
Officer and Chief Accounting Officer
<PAGE>
Exhibit Index
Exhibit No. Description of Exhibit Page Number
----------- ---------------------- -----------
10.1 Description of eGames, Inc. 2001 Employee Incentive
Compensation Plan 22
27.1 Financial Data Schedule 23
