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 December 31,1999
|_| 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
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: 9,745,775 shares of common stock, no
par value per share, as of February 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 December 31, 1999........ 3
Consolidated Statements of Operations for the three
and six months ended December 31, 1999 and 1998 ...... 4
Consolidated Statements of Cash Flows for the six
months ended December 31, 1999 and 1998 .............. 5
Notes to Consolidated Financial Statements................ 6-8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations .................. 8-14
Risk Factors ............................................. 15-19
Part II. Other Information
Item 1. Legal Proceedings......................................... 19
Item 4. Submission of Matters to a Vote of Security Holders....... 20
Item 6. Exhibits and Reports on Form 8-K.......................... 20
Signatures .......................................................... 21
Exhibit Index .......................................................... 22
Exhibits .......................................................... 23
<PAGE>
Item 1. Financial Statements
eGames, Inc.
Consolidated Balance Sheet
(Unaudited)
<TABLE>
<CAPTION>
As of
December 31,
ASSETS 1999
------ ----
<S> <C>
Current assets:
Cash and cash equivalents $ 858,656
Accounts receivable, net of allowances totaling $1,763,373 4,530,277
Inventory 1,438,631
Prepaid expenses 73,748
-----------
Total current assets 6,901,312
Furniture and equipment, net 327,758
Other assets 384,930
-----------
Total assets $ 7,614,000
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Note payable $ 52,218
Accounts payable 1,351,127
Accrued expenses 1,219,504
Capital lease obligations 21,820
-----------
Total current liabilities 2,644,669
Capital lease obligations 11,465
Note payable 148,386
Convertible subordinated debt 150,000
-----------
Total liabilities 2,954,520
Stockholders' equity:
Common stock, no par value (40,000,000 shares authorized;
9,977,675 issued and 9,745,775 outstanding) 9,122,432
Additional paid in capital 1,148,550
Accumulated deficit (5,090,221)
Treasury stock, at cost - 231,900 shares (501,417)
Accumulated other comprehensive loss (19,864)
-----------
Total stockholders' equity 4,659,480
-----------
Total liabilities and stockholders' equity $ 7,614,000
===========
</TABLE>
See accompanying notes to the consolidated financial statements.
<PAGE>
eGames, Inc.
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
Three months ended Six months ended
December 31, December 31,
------------------------- -------------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net sales $ 4,521,390 $ 3,611,126 $ 8,638,965 $ 6,117,326
Cost of sales 1,561,637 1,136,731 3,164,945 2,017,308
----------- ----------- ----------- -----------
Gross profit 2,959,753 2,474,395 5,474,020 4,100,018
Operating expenses:
Product development 220,745 236,965 463,592 442,632
Selling, general and administrative 1,980,596 1,318,861 3,581,002 2,298,503
----------- ----------- ----------- -----------
Total operating expenses 2,201,341 1,555,826 4,044,594 2,741,135
----------- ----------- ----------- -----------
Operating income 758,412 918,569 1,429,426 1,358,883
Interest expense, net 4,977 13,632 10,077 24,281
----------- ----------- ----------- -----------
Income before income taxes 753,435 904,937 1,419,349 1,334,602
Provision for income taxes 152,107 57,967 241,402 84,267
----------- ----------- ----------- -----------
Net income $ 601,328 $ 846,970 $ 1,177,947 $ 1,250,335
=========== =========== =========== ===========
Net income per common share:
- basic $ 0.06 $ 0.09 $ 0.12 $ 0.13
=========== =========== =========== ===========
- diluted $ 0.06 $ 0.09 $ 0.12 $ 0.13
=========== =========== =========== ===========
Weighted average common shares
outstanding - basic 9,697,486 9,469,031 9,665,729 9,455,680
Dilutive effect of common stock equivalents 437,493 189,156 439,866 171,234
----------- ----------- ----------- -----------
Weighted average common shares
outstanding - diluted 10,134,979 9,658,187 10,105,595 9,626,914
=========== =========== =========== ===========
</TABLE>
See accompanying notes to the consolidated financial statements.
<PAGE>
eGames, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Six months ended
December 31,
------------
1999 1998
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,177,947 $ 1,250,335
Adjustment to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 218,542 187,138
Changes in items affecting operations net of effect
from acquired business:
Restricted cash 17,560 508
Accounts receivable (2,585,142) (1,946,243)
Prepaid expenses 36,251 35,232
Inventory (281,966) (286,555)
Accounts payable 307,199 363,767
Accrued expenses 590,047 283,327
----------- -----------
Net cash used in operating activities (519,562) (112,491)
----------- -----------
Cash flows from investing activities:
Acquisition, net of cash acquired - 0 - (12,428)
Purchase of furniture and equipment (65,669) (122,790)
Purchase of software rights and other assets (1,225) (54,490)
----------- -----------
Net cash used in investing activities (66,894) (189,708)
----------- -----------
Cash flows from financing activities:
Purchase of treasury stock - 0 - (247,534)
Proceeds from exercise of warrants and stock options 247,543 - 0 -
Borrowings under line of credit agreement 250,000 - 0 -
Payments under line of credit agreement (250,000) - 0 -
Repayment of notes payable (105,078) (85,581)
Repayment of lease obligations (13,004) (36,694)
----------- -----------
Net cash (used in) provided by financing activities 129,461 (369,809)
----------- -----------
Effect of exchange rate changes on cash and cash equivalents 1,798 502
----------- -----------
Net decrease in cash and cash equivalents (455,197) (671,506)
Cash and cash equivalents:
Beginning of period 1,313,853 953,648
----------- -----------
End of period $ 858,656 $ 282,142
=========== ===========
Supplemental cash flow information:
Cash paid for interest $ 20,722 $ 36,835
=========== ===========
Cash paid for income taxes $ 236,000 $ 72,500
=========== ===========
Non cash investing and financing activities:
Capital lease additions $ - 0 - $ 24,915
=========== ===========
150,000 shares of Common Stock issued in
connection with an acquisition $ - 0 - $ 213,000
=========== ===========
</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, 1999 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'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 and regional 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.
2. Acquisition
On August 14, 1998, the Company acquired all of the outstanding shares of
Software Partners Publishing and Distribution Limited ("Software Partners"), in
exchange for 150,000 shares of the Company's Common Stock, valued at
approximately $213,000, which was the fair value of the Company's Common Stock
on the closing date of the acquisition. This acquisition was accounted for as a
purchase and the corresponding goodwill in the approximate amount of $308,000 is
being amortized over five years. On March 31, 1999, Software Partners changed
its name to eGames Europe Limited ("eGames Europe"). For the quarters ended
December 31, 1999 and 1998, eGames Europe contributed $612,000 and $719,000,
respectively, in net sales as well as $113,000 and $158,000, respectively, in
net income exclusive of inter-company charges. For the six months ended December
31, 1999 and 1998, eGames Europe contributed $1,189,000 and $1,020,000,
respectively, in net sales as well as $191,000 and $264,000, respectively, in
net income exclusive of inter-company charges.
The following summary of unaudited pro-forma financial information gives effect
to the eGames Europe acquisition as though it had occurred on July 1, 1998,
after giving effect to certain adjustments, primarily the elimination of
inter-company sales and amortization of goodwill. The 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.
<PAGE>
Notes to Consolidated Financial Statements (continued)
Unaudited Pro-Forma Financial Information
Six Months Ended
December 31, 1998
-----------------
Net sales $6,175,000
Net income $1,142,000
Net income per diluted share $ 0.12
3. 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:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
December 31, December 31,
------------------------ -----------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income $ 601,000 $ 847,000 $1,178,000 $1,250,000
Other comprehensive income:
Foreign currency translation adjustment (9,000) (5,000) 10,000 1,000
---------- ---------- ---------- ----------
Comprehensive income $ 592,000 $ 842,000 $1,188,000 $1,251,000
========== ========== ========== ==========
</TABLE>
4. 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 six months ended December 31, 1999 the
Company did not purchase any shares of its Common Stock. As of December 31,
1999, the Company had acquired 231,900 shares of its Common Stock, with an
approximate cost of $501,000, pursuant to its stock repurchase program.
5. 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.
<PAGE>
Notes to Consolidated Financial Statements (continued)
Geographic information for the quarters and six months ended December 31, 1999
and 1998 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 and six months ended December 31, 1999 and 1998 is presented below.
<TABLE>
<CAPTION>
Quarters ended
- --------------
United States United Kingdom Eliminations Consolidated
------------- -------------- ------------ ------------
December 31, 1999:
- ------------------
<S> <C> <C> <C> <C>
Sales $ 4,184,000 $ 612,000 ($ 275,000) $ 4,521,000
Operating income 731,000 27,000 - 0 - 758,000
Assets $ 7,845,000 $ 1,176,000 ($1,407,000) $ 7,614,000
December 31, 1998:
- ------------------
Sales $ 3,079,000 $ 719,000 ($ 187,000) $ 3,611,000
Operating income 793,000 126,000 - 0 - 919,000
Assets $ 6,061,000 $ 1,307,000 ($ 579,000) $ 6,789,000
Six months ended
- ----------------
United States United Kingdom Eliminations Consolidated
------------- -------------- ------------ ------------
December 31, 1999:
- ------------------
Sales $ 7,890,000 $ 1,189,000 ($ 440,000) $ 8,639,000
Operating income 1,384,000 45,000 - 0 - 1,429,000
Assets $ 7,845,000 $ 1,176,000 ($1,407,000) $ 7,614,000
December 31, 1998:
- ------------------
Sales $ 5,342,000 $ 1,020,000 ($ 245,000) $ 6,117,000
Operating income 1,148,000 211,000 - 0 - 1,359,000
Assets $ 6,061,000 $ 1,307,000 ($ 579,000) $ 6,789,000
</TABLE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The accompanying consolidated financial statements as of December 31, 1999
include the accounts of eGames, Inc., (the "Company"), and its wholly-owned
subsidiary.
Results of Operations
Three Months Ended December 31, 1999 and 1998
Net Sales
Net sales for the quarter ended December 31, 1999 were $4,521,000 compared to
$3,611,000 for the quarter ended December 31, 1998, representing an increase of
$910,000 or 25%. For the quarter ended December 31, 1999, the Company's net
sales were comprised of full-release game products (87%), shareware-based
products (0%), personal productivity products (5%) and non-eGames products (8%).
For the quarter ended December 31, 1998, the Company's net sales were comprised
of full-release game products (51%), shareware-based products (34%), personal
productivity products (14%) and non-eGames products (1%). These changes in
products sold reflect the Company's transition from publishing and distributing
primarily shareware-based products to full-release, proprietary products, which
transition began during the first quarter of fiscal 1999.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
The Company's international sales for the quarter ended December 31, 1999 were
$766,000 or 17% of net sales, compared to $808,000 or 22% of net sales for the
quarter ended December 31, 1998, representing a decrease of $42,000 or 5% of net
sales. The decrease in international sales from quarter to quarter can be
attributed, primarily to pricing pressures and increased competition in the
United Kingdom.
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 relationships with certain retailers. This
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 may 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 net
sales to GT Value Products accounted for 8% and 77% of the Company's net sales
for the quarters ended December 31, 1999 and 1998, respectively. For the
quarters ended December 31, 1999 and 1998, sales of the Company's products to
other distributors accounted for approximately 33% and 8% of the Company's net
sales, while direct sales to retailers accounted for approximately 59% and 15%
of the Company's net sales during those same periods, respectively.
The Company has continued to take steps to increase distribution of its products
via the Internet, including improving and expanding its web site; establishing
electronic distribution capabilities over the Internet; and incorporating
on-line functionality into existing products. Sales of the Company's products
via the Internet represented less than 1% of the Company's net sales for the
quarters ended December 31, 1999 and 1998, respectively.
During the quarters ended December 31, 1999 and 1998, the Company's provision
for product returns was approximately $805,000 and $97,000, respectively, or 15%
and 3% of the Company's gross sales, respectively. The Company has increased its
provision for product returns primarily as a result of higher returns caused by
the change in the Company's distribution relationship with GT Value Products, as
well as the Company's other recently established distribution and direct retail
relationships, all of which allow for product returns. The Company may also
experience a higher return rate as a result of distribution of more of the
Company's products into non-traditional retail stores, such as drug stores and
supermarkets. The Company expects the return rates from these stores to be
higher than returns experienced historically from retail stores that have
traditionally sold PC software products.
Cost of Sales and Gross Profit Margin
Cost of sales for the quarter ended December 31, 1999 were $1,562,000 compared
to $1,137,000 for the quarter ended December 31, 1998, representing an increase
of $425,000 or 37%. This increase was caused primarily by the 25% increase in
product sales along with increases in freight and royalty costs associated with
the Company's expanded distribution of its full-release software titles into new
and existing retail relationships. While a year ago sales of the Company's
products had been achieved largely by shipping products to a small number of
distributors and retailers, for the quarter ended December 31, 1999, the Company
shipped approximately 59% of its products directly to retailers compared to only
15% of its products being shipped directly to retailers during the quarter ended
December 31, 1998, resulting in higher shipping, handling and freight costs.
Product costs consist mainly of replicated compact discs, printed materials,
protective jewel cases and boxes for certain products. Gross profit margin for
the quarter ended December 31, 1999 decreased to 65.5%, from 68.5% for the
quarter ended December 31, 1998. This decrease in gross profit margin was caused
primarily by increased freight costs associated with the Company's expansion
into new retail opportunities, and increased royalty costs associated with the
Company's transition to publishing and distributing primarily full-release
products. These increased
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
freight and royalty costs were partially offset by a decrease in product costs
resulting from a reduction in per-unit product costs due to volume discounts.
Operating Expenses
Product development expenses for the quarter ended December 31, 1999 were
$221,000 compared to $237,000 for the quarter ended December 31, 1998, a
decrease of $16,000 or 7%. This decrease was caused primarily by a decrease in
outside labor costs, which was partially offset by an increase in salary and
related costs for employees hired to focus on the Company's product development
and quality assurance efforts in conjunction with the Company's transition from
publishing and distributing primarily shareware-based products to full-release,
proprietary products.
Selling, general and administrative expenses for the quarter ended December 31,
1999 were $1,981,000 compared to $1,319,000 for the quarter ended December 31,
1998, an increase of $662,000 or 50%. This increase was caused primarily by an
increase in initial marketing promotional costs incurred to gain additional
retail shelf space at both new and existing retail stores, and to promote the
Company's products in order to achieve the 25% increase in net sales. The
Company believes that these promotional costs will continue to be incurred, but
may decline over time as the Company's newer retail relationships develop and
mature from a promotional product launch phase, into a more established and
recurring order phase. Marketing promotional costs primarily include: slotting
fees, in-store ads, mail-in consumer rebates and display costs. Additionally,
the Company incurred increases in salary and related costs and operating
expenses incurred by the Company's sales and distribution operation in the
United Kingdom.
Interest Expense, net
Net interest expense for the quarter ended December 31, 1999 was $5,000 compared
to $14,000 for the quarter ended December 31, 1998, a decrease of $9,000 or 64%.
The primary reason for this decrease was the reduction in notes payable and
capital lease obligations due to scheduled principal payments.
Provision for Income Taxes
Provision for income taxes for the quarter ended December 31, 1999 was $152,000
compared to $58,000 for the quarter ended December 31, 1998, an increase of
$94,000. The increase in the provision for income taxes was primarily due to the
increase in the quarterly effective income tax rate to 20% for the quarter ended
December 31, 1999 compared to 6% for the quarter ended December 31, 1998. This
change reflects the limitation of certain net operating loss carryforwards not
available to offset federal and state taxable income.
Net Income
Net income for the quarter ended December 31, 1999 was $601,000 compared to
$847,000 for the quarter ended December 31, 1998, a decrease of $246,000 or 29%.
This decrease in profitability resulted primarily from an increase in operating
expenses necessary to support the Company's increased sales and the increase in
the Company's effective income tax rate, which costs were partially reduced by
the increase in gross profit derived from the 25% increase in net sales.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
Results of Operations
Six Months Ended December 31, 1999 and 1998
Net Sales
Net sales for the six months ended December 31, 1999 were $8,639,000 compared to
$6,117,000 for the six months ended December 31, 1998, representing an increase
of $2,522,000 or 41%. For the six months ended December 31, 1999, the Company's
net sales were comprised of full-release game products (79%), shareware-based
products (0%), personal productivity products (10%) and non-eGames products
(11%). For the six months ended December 31, 1998, the Company's net sales were
comprised of full-release game products (46%), shareware-based products (37%),
personal productivity products (14%) and non-eGames products (3%). These changes
in products sold reflect the Company's transition from publishing and
distributing primarily shareware-based products to full-release, proprietary
products, which transition began during the first six months of fiscal 1999.
The Company's international sales for the six months ended December 31, 1999
were $1,415,000 or 16% of net sales, compared to $1,259,000 or 21% of net sales
for the six months ended December 31, 1998, representing an increase of $156,000
or 12%. The increase in international sales can be primarily attributed to an
increase in non-recurring special order sales under an original equipment
manufacture ("OEM") agreement, which was partially reduced by the decrease in
traditional sales in the United Kingdom experienced as a result of pricing
pressures and increased competition.
The Company's net sales to GT Value Products accounted for 15% and 74% of the
Company's net sales for the six months ended December 31, 1999 and 1998,
respectively. For the six months ended December 31, 1999 and 1998, sales of the
Company's products to other distributors accounted for approximately 33% and 13%
of the Company's net sales, while direct sales to retailers accounted for
approximately 52% and 13% of the Company's net sales, respectively. Sales of the
Company's products via the Internet represented less than 1% of the Company's
net sales for the six months ended December 31, 1999 and 1998, respectively.
During the six months ended December 31, 1999 and 1998, the Company's provision
for product returns was approximately $1,846,000 and $112,000, respectively, or
18% and 2% of the Company's gross sales, respectively. The Company has increased
its provision for product returns primarily as a result of higher returns caused
by the change in the Company's distribution relationship with GT Value Products,
as well as the Company's other recently established distribution and direct
retail relationships, all of which allow for product returns. The Company may
also experience a higher return rate as a result of distribution of more of the
Company's products into non-traditional retail stores, such as drug stores and
supermarkets. The Company expects the return rates from these stores to be
higher than returns experienced historically from retail stores that have
traditionally sold PC software products.
Cost of Sales and Gross Profit Margin
Cost of sales for the six months ended December 31, 1999 were $3,165,000
compared to $2,017,000 for the six months ended December 31, 1998, representing
an increase of $1,148,000 or 57%. This increase was caused primarily by the 41%
increase in product sales along with increases in freight and royalty costs
associated with the Company's expanded distribution of its full-release software
titles into new and existing retail relationships. While a year ago sales of the
Company's products had been achieved largely by shipping products to a small
number of distributors and retailers, for the six months ended December 31,
1999, the Company shipped approximately 52% of its products directly to
retailers compared to only 13% of its products during the six months ended
December 31, 1998, resulting in higher shipping, handling and freight costs.
Product costs consist mainly of replicated compact discs, printed materials,
protective jewel cases and boxes for certain products. Gross profit margin for
the six months ended December 31, 1999 decreased to 63.4%, from 67.0% for the
six months ended December 31, 1998. This decrease in gross profit margin was
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
caused primarily by increased freight costs associated with the Company's
expansion into new retail opportunities, and increased royalty costs associated
with the Company's transition to publishing and distributing primarily
full-release products. These cost increases were partially offset by a decrease
in product costs resulting from a reduction in per-unit product costs due to
volume discounts.
Operating Expenses
Product development expenses for the six months ended December 31, 1999 were
$464,000 compared to $443,000 for the six months ended December 31, 1998, an
increase of $21,000 or 5%. This increase was caused primarily by an increase in
salary and related costs for employees hired to focus on the Company's product
development and quality assurance efforts caused by the Company's significant
increase in the development of full-release products during the six months ended
December 31, 1999 as compared to the six months ended December 31, 1998, which
costs were partially offset by a decrease in outside service expenses related to
various external development projects.
Selling, general and administrative expenses for the six months ended December
31, 1999 were $3,581,000 compared to $2,299,000 for the six months ended
December 31, 1998, an increase of $1,282,000 or 56%. This increase was caused
primarily by an increase in initial marketing promotional costs incurred to gain
additional retail shelf space at both new and existing retail stores, and to
promote the Company's products in order to achieve the 41% increase in net
sales. The Company believes that these promotional costs will continue to be
incurred, but may decline over time as the Company's newer retail relationships
develop and mature from a promotional product launch phase, into a more
established and recurring order phase. Marketing promotional costs primarily
include: slotting fees, in-store ads, mail in consumer rebates and display
costs. Additionally, the Company incurred increases in salary and related costs
and operating expenses incurred by the Company's sales and distribution
operation in the United Kingdom.
Interest Expense, net
Net interest expense for the six months ended December 31, 1999 was $10,000
compared to $24,000 for the six months ended December 31, 1998, a decrease of
$14,000 or 58%. The primary reason for this decrease was the reduction in notes
payable and capital lease obligations due to scheduled principal payments.
Provision for Income Taxes
Provision for income taxes for the six months ended December 31, 1999 was
$241,000 compared to $84,000 for the six months ended December 31, 1998, an
increase of $157,000. The increase in the provision for income taxes was
primarily due to the increase in the year to date effective income tax rate to
17% for the six months ended December 31, 1999 compared to 6% for the six months
ended December 31, 1998. This change reflects the limitation of certain net
operating loss carryforwards not available to offset federal and state taxable
income.
Net Income
Net income for the six months ended December 31, 1999 was $1,178,000 compared to
$1,250,000 for the six months ended December 31, 1998, a decrease of $72,000 or
6%. This decrease in profitability resulted primarily from an increase in
operating expenses necessary to support the Company's increased sales and the
increase in the Company's effective income tax rate, which costs were partially
reduced by the increase in gross profit derived from the 41% increase in net
sales.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
Liquidity and Capital Resources
As of December 31, 1999, the Company's cash and working capital balances were
$859,000 and $4,257,000, respectively, and the Company's total stockholders'
equity balance at December 31, 1999 was $4,659,000. The Company's cash balance
has decreased by $455,000 since June 30, 1999, primarily as a result of reduced
cash collections from the Company's customers and additional cash payments
relating to promotional activities incurred to support the 41% growth in net
sales for the six months ended December 31, 1999 compared to the same six month
period last fiscal year. Additionally, the Company experienced a gradual slowing
in receivable collections from one of its existing distributors during the first
six months of fiscal 2000. Subsequent to December 31, 1999, the Company has had
discussions with this distributor regarding improvements in cash collections
from this distributor over the remaining six months of fiscal 2000. At December
31, 1999, this distributor represented approximately 29% of the Company's
accounts receivable. Since December 31, 1999, the Company has received payments
from this distributor totaling approximately $685,000, which represented 72% of
the past due balance as of December 31, 1999 and 38% of the total receivable
balance with this distributor as of December 31, 1999.
Net cash used in operating activities for the six months ended December 31, 1999
and 1998 were $520,000 and $112,000, respectively. The $520,000 net cash used in
operating activities for the six months ended December 31, 1999 resulted
primarily from increases in accounts receivable and inventory, which were
partially offset by increases in the Company's net income adjusted for non-cash
depreciation and amortization expense, accounts payable and accrued expenses. As
indicated in the accompanying financial statements, the Company's net income for
the six months ended December 31, 1999 was $1,178,000 and the Company's net
income for the six months ended December 31, 1998 was $1,250,000.
Net cash used in investing activities for the six months ended December 31, 1999
and 1998 were $67,000 and $190,000, respectively. The $67,000 in net cash used
in investing activities for the six months ended December 31, 1999 resulted from
the purchase of additional furniture and equipment needed to support the
increase in personnel necessary to facilitate the continued growth in the
Company's sales.
Net cash provided by financing activities for the six months ended December 31,
1999 was $130,000 and net cash used in financing activities for the six months
ended December 31, 1998 was $370,000. During the six months ended December 31,
1999, the Company received net proceeds from the exercise of Common Stock
options totaling $248,000, and made repayments of notes payable and capital
lease obligations of $105,000 and $13,000, respectively. Additionally, during
the six months ended December 31, 1999, the Company borrowed and repaid $250,000
under its current revolving credit facility.
On September 28, 1999, the Company entered into an agreement with a commercial
bank to extend and increase its existing $1 million revolving credit facility to
a $1.5 million revolving credit facility expiring October 31, 2000. This credit
facility was established to provide, among other things, additional working
capital to support the Company's anticipated growth. 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 collaterallized 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 December 31, 1999, the
Company was in compliance with each of those covenants and did not have an
outstanding balance under this revolving credit facility.
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. During the six months ended December 31, 1999 the Company did not
purchase any shares of its Common Stock. As of December 31, 1999, the Company
had acquired 231,900 shares of its Common Stock, at an approximate cost of
$501,000, pursuant to its stock repurchase program.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
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 distributors and
retailers that purchase the Company's products, the successful 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.
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
in order to diminish the Company's dependence on any one third-party distributor
or retailer and provide for more effective inventory management, merchandising
and communications with retailers; the Company's expectations regarding
increased product returns caused by the change in the Company's distribution
relationships as well as increased distribution of its products into
non-traditional retail stores; the Company's belief that product promotional
costs will continue to be incurred, but may decline over time; the ability of
the Company's localized products to further penetrate foreign markets; the
sufficiency of the Company's cash and working capital balances to fund the
Company's operations in the future; and the increase in the Company's gross
profit margin. 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 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 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; 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>
Risk Factors
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. For the
six months ended December 31, 1999, the Company earned $1,178,000 in net income
and the accumulated deficit was approximately $5,090,000. 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
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.
The Company has a non-exclusive distribution relationship with GT Value Products
which is terminable by either party at any time for any reason, and therefore
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.
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
<PAGE>
Risk Factors (continued)
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.
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. 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.
Possible Inadequacy of Protection of Trade Names; Software Technology; and Other
Proprietary 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
<PAGE>
Risk Factors (continued)
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 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. The Company has recently been sued for trademark and
copyright infringement by Hasbro Interactive, Inc. (the "Hasbro Action") (See
Part II, Item 1, "Legal Proceedings"). The Company intends to defend this action
vigorously. There can be no assurance that additional third parties will not
initiate infringement actions against the Company in the future. The Hasbro
Action, as well as any other 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 advent of litigation arising out of any such claims,
could have a material adverse effect on the Company's 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.
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
<PAGE>
Risk Factors (continued)
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.
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.
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. For the six months ended December 31, 1999, international
sales represented 16% of net sales as compared to 21% of net sales for the six
months ended December 31, 1998. The Company expects international sales to
continue to comprise a significant 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.
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
<PAGE>
Risk Factors (continued)
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 December 31, 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 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.
Part II. Other Information
Item 1. Legal Proceedings
On February 9, 2000, Hasbro Interactive, Inc., Atari Interactive, Inc., and Zao
Elorg d/b/a Elorg Corporation (collectively, the "Plaintiffs") filed suit in the
United States District Court for the District of Massachusetts against the
Company and Xtreme Games LLC, GT Interactive Software Corporation, MVP Software,
Inc., Webfoot Technologies, Inc. and Varcon Systems, Inc. The suit alleges that
certain of the Company's products infringe copyrights and trademarks owned by
the Plaintiffs, and also alleges that the Company has engaged in unfair
competition. The suit seeks 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 that
the award of costs and attorneys fees. The Company intends to defend this action
vigorously.
<PAGE>
Item 4. Submission of Matters to a Vote of Securities Holders
The Company held its Annual Meeting of Shareholders on December 7, 1999. At that
the meeting, the following matters were acted upon, together with the number of
votes cast for, against or withheld as to each such matter:
Votes Cast
For Against Abstain
-----------------------------
(i) The election of the following directors:
Robert M. Aiken, Jr. 8,555,992 - 0 - 60,473
Gerald W. Klein 8,411,964 - 0 - 204,501
Thomas D. Parente 8,411,614 - 0 - 204,851
Lambert C. Thom 8,412,164 - 0 - 204,301
(ii) Ratification of the appointment of KPMG LLP as the Company's auditors
for the 2000 fiscal year:
Votes Cast
For Against Abstain
-----------------------------
8,527,255 60,250 28,960
No broker non-votes were recorded for any of the matters acted upon.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit No. Description of Exhibit
----------- ----------------------
27.1 Financial Data Schedule
(b) Reports on Form 8-K
On January 21, 2000, the Company filed a report on Form 8-K regarding a press
release announcing the Company's unaudited results for the second quarter and
six months ended December 31, 1999.
On February 10, 2000, the Company filed a report on Form 8-K regarding a press
release announcing that Hasbro Interactive, Inc. has filed suit against the
Company and several other defendants in the U.S. District Court in Boston,
Massachusetts alleging that the Company, among other parties, infringed Hasbro's
copyrights and trademarks in the production of certain games
<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: February 14, 2000 /s/ Gerald W. Klein
----------------- --------------------
Gerald W. Klein, President, Chief
Executive Officer and Director
Date: February 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
----------- ---------------------- -----------
27.1 Financial Data Schedule 23
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JUN-30-2000
<PERIOD-END> DEC-31-1999
<CASH> 858,656
<SECURITIES> 0
<RECEIVABLES> 6,293,650
<ALLOWANCES> (1,763,373)
<INVENTORY> 1,438,631
<CURRENT-ASSETS> 6,901,312
<PP&E> 995,676
<DEPRECIATION> (667,918)
<TOTAL-ASSETS> 7,614,000
<CURRENT-LIABILITIES> 2,644,669
<BONDS> 0
0
0
<COMMON> 9,122,432
<OTHER-SE> (4,462,952)
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<CGS> 3,164,945
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<EPS-BASIC> .12
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</TABLE>
