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 March 31, 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 May 12, 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 March 31, 2000............. 3
Consolidated Statements of Operations for the three and
nine months ended March 31, 2000 and 1999 .................. 4
Consolidated Statements of Cash Flows for the nine months
ended March 31, 2000 and 1999............................... 5
Notes to Consolidated Financial Statements.................. 6-8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations .................... 9-15
Risk Factors ............................................... 15-20
Part II. Other Information
Item 1. Legal Proceedings........................................... 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
March 31,
ASSETS 2000
---------
<S> <C>
Current assets:
Cash and cash equivalents $ 601,291
Accounts receivable, net of allowances totaling $2,923,980 3,179,966
Inventory 2,281,456
Prepaid expenses 128,246
-----------
Total current assets 6,190,959
Furniture and equipment, net 379,599
Other assets 347,250
-----------
Total assets $ 6,917,808
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Note payable $ 53,610
Accounts payable 1,646,650
Revolving line of credit 500,000
Accrued expenses 540,231
Convertible subordinated debt 150,000
Capital lease obligations 21,329
-----------
Total current liabilities 2,911,820
Capital lease obligations 6,616
Note payable 134,220
----------
Total liabilities 3,052,656
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 (5,887,701)
Treasury stock, at cost - 231,900 shares (501,417)
Accumulated other comprehensive loss (28,514)
-----------
Total stockholders' equity 3,865,152
-----------
Total liabilities and stockholders' equity $ 6,917,808
===========
</TABLE>
See accompanying notes to the consolidated financial statements.
<PAGE>
eGames, Inc.
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
March 31, March 31,
-------------------------- ------------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net sales $ 1,923,600 $ 2,521,715 $10,562,565 $ 8,639,041
Cost of sales 832,858 937,492 3,997,803 2,954,800
----------- ----------- ----------- -----------
Gross profit 1,090,742 1,584,223 6,564,762 5,684,241
Operating expenses:
Product development 201,479 260,534 665,071 703,166
Selling, general and administrative 1,848,215 1,165,769 5,429,217 3,464,272
----------- ----------- ----------- -----------
Total operating expenses 2,049,694 1,426,303 6,094,288 4,167,438
----------- ----------- ----------- -----------
Operating income (loss) (958,952) 157,920 470,474 1,516,803
Interest expense, net 1,634 8,146 11,711 32,427
----------- ----------- ----------- -----------
Income (loss) before income taxes (960,586) 149,774 458,763 1,484,376
Provision (benefit) for income taxes (163,106) 74,520 78,296 158,787
----------- ----------- ----------- -----------
Net income (loss) ($ 797,480) $ 75,254 $ 380,467 $ 1,325,589
=========== =========== =========== ===========
Net income (loss) per common share:
- basic ($ 0.08) $ 0.01 $ 0.04 $ 0.14
=========== =========== =========== ===========
- diluted ($ 0.08) $ 0.01 $ 0.04 $ 0.13
=========== =========== =========== ===========
Weighted average common shares
outstanding - basic 9,745,820 9,467,659 9,692,426 9,459,673
Dilutive effect of common stock equivalents - 0 - 762,102 422,848 427,189
----------- ----------- ----------- -----------
Weighted average common shares
outstanding - diluted 9,745,820 10,229,761 10,115,274 9,886,862
=========== =========== =========== ===========
</TABLE>
See accompanying notes to the consolidated financial statements.
<PAGE>
eGames, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Nine months ended
March 31,
2000 1999
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 380,467 $ 1,325,589
Adjustment to reconcile net income to net cash
(used in) provided by operating activities:
Depreciation and amortization 331,641 299,073
Changes in items affecting operations net of effect
from acquired business:
Restricted cash 17,560 (765)
Accounts receivable (1,240,147) (673,972)
Prepaid expenses (18,895) 1,703
Inventory (1,126,524) (154,900)
Accounts payable 604,991 (17,311)
Accrued expenses (88,132) 328,227
----------- -----------
Net cash (used in) provided by operating activities (1,139,039) 1,107,644
----------- -----------
Cash flows from investing activities:
Acquisition, net of cash acquired - 0 - (12,428)
Purchase of furniture and equipment (181,246) (185,457)
Purchase of software rights and other assets (16,225) (98,490)
----------- -----------
Net cash used in investing activities (197,471) (296,375)
----------- -----------
Cash flows from financing activities:
Purchase of treasury stock - 0 - (277,928)
Proceeds from exercise of warrants and options 259,345 407,063
Borrowing under revolving line of credit 750,000 - 0 -
Repayment under revolving line of credit (250,000) - 0 -
Repayment of notes payable (117,118) (74,778)
Repayment of lease obligations (19,178) (57,860)
----------- -----------
Net cash (used in) provided by financing activities 623,049 (3,503)
----------- -----------
Effect of exchange rate changes on cash and cash equivalents 899 - 0 -
Net (decrease) increase in cash and cash equivalents (712,562) 807,766
Cash and cash equivalents:
Beginning of period 1,313,853 953,648
----------- -----------
End of period $ 601,291 $ 1,761,414
=========== ===========
Supplemental cash flow information:
Cash paid for interest $ 20,722 $ 43,272
=========== ===========
Cash paid for income taxes $ 236,000 $ 112,051
=========== ===========
Non cash investing and financing activities:
Capital lease additions $ - 0 - $ 26,809
=========== ===========
150,000 shares of Common Stock issued in connection
with an acquisition $ - 0 - $ 213,000
=========== ===========
See accompanying notes to the consolidated financial statements.
</TABLE>
<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
March 31, 2000 and 1999, eGames Europe contributed $568,000 and $774,000,
respectively, in net sales as well as $83,000 and $183,000, respectively, in net
income exclusive of inter-company charges. For the nine months ended March 31,
2000 and 1999, eGames Europe contributed $1,757,000 and $1,794,000,
respectively, in net sales as well as $274,000 and $447,000, 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
Nine Months Ended
March 31, 1999
--------------
Net sales $ 8,697,000
Net income $ 1,217,000
Net income per diluted share $ 0.12
3. 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:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
March 31, March 31,
-------------------------- ----------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income (loss) $ 797,000) $ 75,000 $ 380,000 $ 1,326,000
Other comprehensive income (loss):
Foreign currency translation adjustment (9,000) (19,000) 2,000 (18,000)
----------- ----------- ----------- -----------
Comprehensive income (loss) ($ 806,000) $ 56,000 $ 382,000 $ 1,308,000
=========== =========== =========== ===========
</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 nine months ended March 31, 2000 the
Company did not purchase any shares of its Common Stock. As of March 31, 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.
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.
Geographic information for the quarters and nine months ended March 31, 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 and nine months ended March 31, 2000 and 1999 is presented below.
<PAGE>
Notes to Consolidated Financial Statements (continued)
Quarters ended
- --------------
<TABLE>
<CAPTION>
United States United Kingdom Eliminations Consolidated
------------- -------------- ------------ ------------
March 31, 2000:
- ---------------
<S> <C> <C> <C> <C>
Sales $ 1,637,000 $ 568,000 ($ 281,000) $ 1,924,000
Operating income (loss) ($ 911,000) ($ 48,000) $ - 0 - ($ 959,000)
Assets $ 7,361,000 $ 1,391,000 ($ 1,834,000) $ 6,918,000
March 31, 1999:
- ---------------
Sales $ 2,014,000 $ 774,000 ($ 266,000) $ 2,522,000
Operating income (loss) ($ 67,000) $ 225,000 $ - 0 - $ 158,000
Assets $ 5,962,000 $ 1,185,000 ($ 389,000) $ 6,758,000
</TABLE>
Nine months ended
- -----------------
<TABLE>
<CAPTION>
United States United Kingdom Eliminations Consolidated
------------- -------------- ------------ ------------
March 31, 2000:
- ---------------
<S> <C> <C> <C> <C>
Sales $ 9,527,000 $ 1,757,000 ($ 721,000) $10,563,000
Operating income (loss) $ 474,000 ($ 4,000) $ - 0 - $ 470,000
Assets $ 7,361,000 $ 1,391,000 ($1,834,000) $ 6,918,000
March 31, 1999:
- ---------------
Sales $ 7,356,000 $ 1,794,000 ($ 511,000) $ 8,639,000
Operating income (loss) $ 985,000 $ 532,000 $ - 0 - $ 1,517,000
Assets $ 5,962,000 $ 1,185,000 ($ 389,000) $ 6,758,000
</TABLE>
6. Revolving Line of Credit
On September 28, 1999, the Company entered into an agreement with a commercial
lender to extend and increase its existing $1.0 million revolving line of credit
to a $1.5 million revolving line of credit expiring October 31, 2000. This
revolving line of credit was established to provide, among other things,
additional working capital to support the Company's anticipated growth. Amounts
outstanding under this revolving line of credit are charged interest at one-half
of one percent above the bank's current prime rate and such interest is due
monthly. The revolving line of credit is collaterallized by substantially all of
the Company's assets. The revolving line of credit requires the Company, among
other things, to achieve certain levels of income ("earnings covenant"),
throughout its fiscal year and 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 March 31, 2000, the Company was in
compliance with or had obtained waivers for all of those covenants. The Company
and its commercial lender have discussed the probability that the Company is
likely to be in technical default of the line of credit's existing earnings
covenant for the year ending June 30, 2000. The Company and its commercial
lender are currently evaluating how to address this potential default prior to
its occurrence. As of May 12, 2000, the Company did not have a balance
outstanding under this revolving line of credit.
On September 30, 1999, the Company's United Kingdom operation entered into an
agreement with a commercial bank to extend and increase its existing $80,000
revolving line of credit to a $160,000 line of credit expiring September 30,
2000. Amounts outstanding under this line of credit are charged interest at two
and one-half percent above the bank's current base rate and such interest is due
monthly. As of May 12, 2000, the Company had not utilized this line of credit.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The accompanying consolidated financial statements as of March 31, 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 product return
reserves for sales into the food and drug retail channels and reductions in the
quantities of products that it ships into these retail channels; the Company's
efforts to increase distribution of its products via the Internet; the Company's
intention to work towards increasing advertising revenues by selling a
customized "branded browser" within its products; the Company's efforts to
secure non-promotional product positioning in the food and drug retail channels
through its "Store in a Store" concept; 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 ability of the "Store
in a Store" strategy is to secure better merchandising of displays, more timely
product replenishment, and fewer product returns in the food and drug retail
channels; the potential for marketing promotional costs to decline over time, as
a percent of net sales, as well as the potential for the Company's newer retail
relationships to develop and mature from a promotional product launch phase,
into a more established and recurring order phase; the continued distribution of
the Company's products through GT Value Products; the Company's estimated annual
tax rate and the availability of the Company's net operating loss
carry-forwards; the probability that the Company is likely to be in technical
default of its $1.5 million commercial line of credit's existing earnings
covenant for the year ending June 30, 2000, and the ability of the Company and
its commercial lender to reach a satisfactory resolution to this potential
default prior to its occurrence; the sufficiency of the Company's cash and
working capital balances to fund the Company's operations for the foreseeable
future; the costs the Company expects to incur in defending its position in the
Hasbro litigation described under Part II, Item I "Legal Proceedings" and the
impact of such ongoing expenses on the Company's future liquidity and capital
resources; 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 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 successfully implement
its Store within a Store program on commercially acceptable terms; the Company's
ability to successfully sell its "branded browser" concept on terms that
generate advertising revenues; 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 uncollectible 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
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
include, but are not limited to, those discussed under the heading "Risk
Factors" below at pages 15 to 20, as well as in the Company's Annual Report on
Form 10-KSB for the fiscal year ended June 30, 1999 as filed with the Securities
and Exchange Commission and other documents filed with the Commission.
Results of Operations
Three Months Ended March 31, 2000 and 1999
Net Sales
Net sales for the quarter ended March 31, 2000 were $1,924,000 compared to
$2,522,000 for the quarter ended March 31, 1999, representing a decrease of
$598,000 or 24%. For the quarter ended March 31, 2000, the Company recorded net
sales into the following distribution channels: $1,383,000 to North American
distributors, $745,000 to International markets, $477,000 in direct shipments to
North American traditional software retailers, and $681,000 in net product
returns from North American food and drug retailers. For the quarter ended March
31, 1999, the Company recorded net sales into the following distribution
channels: $1,659,000 to North American distributors, $863,000 to International
markets, with no direct shipments to North American traditional software
retailers or to North American food and drug retailers. The primary reason for
the $598,000 decrease in quarterly sales in the quarter ended March 31, 2000 as
compared to the quarter ended March 31, 1999, was the greater than anticipated
amount of product returns realized during the quarter ended March 31, 2000 in
connection with the completion of various short-term promotional programs in the
North American food and drug retail channels. In response to these greater than
anticipated returns, the Company has increased its product return reserves for
sales into these food and drug retail channels and is reducing the quantities of
products that it ships into these food and drug retail channels on a per store
basis.
Additionally, for the quarter ended March 31, 2000, compared to the quarter
ended March 31, 1999, the Company experienced a $940,000 increase in net sales
as a result of new distribution relationships, which was offset by a $953,000
decrease in sales to GT Value Products, a division of GT Interactive Software
Corporation. Until April 1999, GT Value Products distributed the Company's
entertainment software in North America through an exclusive distribution
agreement that the Company terminated during April 1999. As a result of this new
distribution strategy, the Company has diversified its distribution channels to
retailers, provided for more effective inventory management, merchandising and
communications with retailers and diminished the Company's dependence on any one
third-party distributor for sales of the Company's products. The Company
continues to distribute its products through GT Value Products on a
non-exclusive basis 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 42% and 70% of the Company's net sales
for the quarters ended March 31, 2000 and 1999, 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 3% and 1% of the Company's net sales for the
quarters ended March 31, 2000 and 1999, respectively. Additionally, all of the
Company's current software titles now include an Internet-based and
advertising-enabled "browser" interface, which contains links to the Company's
website and has the capability to deliver advertising content directly to the
consumer. To date advertising revenues from this browser interface have been
minimal. The Company intends to work towards increasing these revenues by
selling a customized "branded" version of the browser, combined with the
Company's game content, to third parties seeking a branding medium.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
During the quarters ended March 31, 2000 and 1999, the Company's provisions for
product returns were approximately $1,751,000 and $449,000, respectively, or 48%
and 15% of the Company's gross sales, respectively. The Company has increased
its provision for product returns primarily as a result of the higher than
expected product returns that have been experienced in the newly developed food
and drug retail channels. Sales in these channels have been primarily part of
short-term promotional programs. The Company has experienced substantially lower
return rates in traditional retail software channels as a result of securing
longer-term, non-promotional shelf-space for its products at these retail
stores. In an effort to secure similar product positioning in the food and drug
retail channels, the Company is now marketing its "Store in a Store" concept.
This concept groups together an assortment of the Company's software titles
along with a select number of other publishers' software titles within a
designated section of the store, which is intended to attract consumer interest
and drive impulse purchases of value-priced, Family-Friendly(TM) software
products. One of the Company's intended goals of its "Store in a Store" strategy
is to secure longer-term, non-promotional shelf-space for the Company's products
in the food and drug retail channels which would provide for a longer period of
time for products to be purchased by consumers, better merchandising of
displays, and more timely product replenishment, which may in turn result in
fewer product returns.
Cost of Sales and Gross Profit Margin
Cost of sales for the quarter ended March 31, 2000 were $833,000 compared to
$938,000 for the quarter ended March 31, 1999, representing a decrease of
$105,000 or 11%. This decrease was caused primarily by decreased product costs
associated with the 24% decrease in product sales and a reduction in per-unit
product costs achieved through volume discounts, which were partially offset by
increased reclamation and freight costs related to product returns from the food
and drug retail channels during the quarter ended March 31, 2000. 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
March 31, 2000 decreased to 56.7%, from 62.8% for the quarter ended March 31,
1999. This decrease in gross profit margin was caused primarily by increases in
reclamation and freight costs as a percent of sales due to returns from sales
into the food and drug retail channels recognized during the quarter. The
decrease in gross profit margin was partially offset by a decrease in product
costs resulting from a reduction in per-unit product costs due to volume
discounts and higher selling prices of the Company's titles compared to the same
quarter last year.
Operating Expenses
Product development expenses for the quarter ended March 31, 2000, were $202,000
compared to $261,000 for the quarter ended March 31, 1999, a decrease of $59,000
or 23%. This decrease was caused primarily by a decrease in outside labor costs,
which was partially offset by an increase in salary and related costs incurred
to improve the Company's product development and quality assurance efforts.
Selling, general and administrative expenses for the quarter ended March 31,
2000 were $1,848,000 compared to $1,166,000 for the quarter ended March 31,
1999, an increase of $682,000 or 58%. This increase was caused primarily by an
increase in 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 these retail channels. The Company believes that these promotional
costs will continue to be incurred, but may decline over time, as a percent of
net sales, 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: shelf-space fees, in-store
ads, mail-in consumer rebates and display costs.
Interest Expense, net
Net interest expense for the quarter ended March 31, 2000 was $2,000 compared to
$8,000 for the quarter ended March 31, 1999, a decrease of $6,000 or 75%. The
primary reason for this decrease was the reduction in notes payable and capital
lease obligations due to scheduled principal payments.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
Provision (Benefit) for Income Taxes
(Benefit) for income taxes for the quarter ended March 31, 2000 was $163,000
compared to a provision of $75,000 for the quarter ended March 31, 1999, a
decrease in the provision for income taxes of $238,000. This decrease in the
provision for income taxes was primarily attributable to the Company's loss
before income taxes of $961,000 for the quarter ended March 31, 2000, compared
to income before income taxes of $150,000 for the quarter ended March 31, 1999.
Additionally impacting the provision for income taxes was the change in the
estimated annual income tax rate as of March 31, 2000, due to the expected
utilization of net operating loss carry-forwards.
Management calculates the income tax expense for each quarter under APB Opinion
28 and FAS Statement 109 based on its estimate of the effective tax rate
expected to be applicable for the full fiscal year. Adjustments to the estimated
annual tax rate are reflected in the quarter in which the adjustments occur. The
estimated annual tax rate is determined based on expected income tax results for
the fiscal year, after considering the availability of the Company's net
operating loss carry-forwards.
Net Income (Loss)
Net (loss) for the quarter ended March 31, 2000 was ($797,000) compared to net
income of $75,000 for the quarter ended March 31, 1999, a decrease in net income
of $872,000. This decrease in profitability resulted primarily from higher than
anticipated product returns from the food and drug retail channels, combined
with an increase in marketing promotional expenses incurred to support the
Company's product sales as part of its revised distribution strategy.
Results of Operations
Nine Months Ended March 31, 2000 and 1999
Net Sales
Net sales for the nine months ended March 31, 2000 were $10,563,000 compared to
$8,639,000 for the nine months ended March 31, 1999, representing an increase of
$1,924,000 or 22%. For the nine months ended March 31, 2000, the Company
recorded net sales into the following distribution channels: $4,926,000 to North
American distributors, $2,160,000 to International markets, $1,970,000 in direct
shipments to North American traditional software retailers, and $1,507,000 in
direct shipments to North American food and drug retailers. For the nine months
ended March 31, 1999, the Company recorded net sales into the following
distribution channels: $6,517,000 to North American distributors, $2,122,000 to
International markets, with no direct shipments to North American traditional
software retailers or food and drug retailers. Factors contributing to this
$1,924,000 increase in net sales include: increases in net sales into the food
and drug and direct retail channels and International markets totaling
$1,507,000, $1,970,000 and $38,000, respectively, which were partially offset by
a $1,591,000 decrease in sales through North American distributors. These
changes in the Company's distribution channels are a result of the revised
distribution strategy that the Company implemented during the fourth quarter of
fiscal 1999. This distribution strategy has diversified the Company's
distribution channels to retailers, provided for more effective inventory
management, merchandising and communications with retailers and diminished the
Company's dependence on any one third-party distributor, such as GT Value
Products, for sales of the Company's products. The Company continues to
distribute its products through GT Value Products on a non-exclusive basis 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 20% and 74% of the Company's net sales for the nine
months ended March 31, 2000 and 1999, respectively.
For the nine months ended March 31, 2000 and 1999, the Company's provision for
product returns was approximately $3,598,000 and $561,000, respectively, or 25%
and 6% of the Company's gross sales, respectively. The Company has increased its
provision for product returns primarily as a result of the higher than expected
product returns realized in the Company's newly developed North American food
and drug retail channels. In response to these greater than anticipated returns,
the Company has increased its product return reserves for sales into these food
and drug retail channels and is reducing the quantities of products that it
ships into these food and drug retail channels on a per store basis.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
Cost of Sales and Gross Profit Margin
Cost of sales for the nine months ended March 31, 2000 were $3,998,000 compared
to $2,955,000 for the nine months ended March 31, 1999, representing an increase
of $1,043,000 or 35%. This increase was caused primarily by product costs,
freight and royalty costs associated with the 22% increase in product sales,
which were partially offset by a reduction in per-unit product costs achieved
through volume discounts. Product costs consist mainly of replicated compact
discs, printed materials, protective jewel cases and boxes for certain products.
Gross profit margin for the nine months ended March 31, 2000 decreased to 62.2%
from 65.8% for the nine months ended March 31, 1999. This decrease in gross
profit margin was caused primarily by increases in royalty and freight costs
associated with the Company selling more of its full-release products into more
retail locations, which was partially offset by a decrease in product costs
resulting from a reduction in per-unit product costs due to volume discounts and
higher selling prices of the Company's titles compared to the same nine months
last year.
Operating Expenses
Product development expenses for the nine months ended March 31, 2000 were
$665,000 compared to $703,000 for the nine months ended March 31, 1999, a
decrease of $38,000 or 5%. This decrease was caused primarily by a decrease in
outside labor costs, which was partially offset by an increase in salary and
related costs incurred to improve the Company's product development and quality
assurance efforts.
Selling, general and administrative expenses for the nine months ended March 31,
2000 were $5,429,000 compared to $3,464,000 for the nine months ended March 31,
1999, an increase of $1,965,000 or 57%. This increase was caused primarily by an
increase in marketing promotional costs incurred to gain additional retail shelf
space at both new and existing retail stores, and to promote the Company's
products. The Company believes that the above-mentioned promotional costs will
continue to be incurred, but may decline, as a percent of net sales, 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. Short-term promotional retail programs typically carry higher marketing
promotional costs than longer-term, non-promotional shelf-space. Marketing
promotional costs primarily include: shelf-space fees, in-store ads, mail-in
consumer rebates and display costs.
Interest Expense, net
Net interest expense for the nine months ended March 31, 2000 was $12,000
compared to $32,000 for the nine months ended March 31, 1999, a decrease of
$20,000 or 63%. 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 nine months ended March 31, 2000 was $78,000
compared to $159,000 for the nine months ended March 31, 1999, a decrease of
$81,000. This decrease was primarily attributable to the Company's income before
income taxes of $459,000 for the nine months ended March 31, 2000 compared to
income before income taxes of $1,484,000 for the nine months ended March 31,
1999. Additionally impacting the provision for income taxes was the change in
the estimated annual income tax rate as of March 31, 2000, due to the expected
utilization of net operating loss carry-forwards.
Management calculates the income tax expense for each period under APB Opinion
28 and FAS Statement 109 based on its estimate of the effective tax rate
expected to be applicable for the full fiscal year. Adjustments to the estimated
annual tax rate are reflected in the period in which the adjustments occur. The
estimated annual tax rate is determined based on expected income tax results for
the fiscal year, after considering the availability of the Company's net
operating loss carry-forwards.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
Net Income
Net income for the nine months ended March 31, 2000 was $380,000 compared to
$1,326,000 for the nine months ended March 31, 1999, a decrease in net income of
$946,000. This decrease in profitability resulted primarily from the higher than
anticipated product returns in the food and drug retail channels, combined with
increases in marketing promotional expenses incurred to support the Company's
product sales as part of its revised distribution strategy.
Liquidity and Capital Resources
As of March 31, 2000, the Company's cash and working capital balances were
$601,000 and $3,279,000, respectively, and the Company's total stockholders'
equity balance at March 31, 2000 was $3,865,000. The Company's cash balance has
decreased by $713,000 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 22% growth in net sales for
the nine months ended March 31, 2000 compared to the same nine-month period last
fiscal year.
Net cash used in operating activities for the nine months ended March 31, 2000
was $1,139,000 and net cash provided by operating activities for the nine months
ended March 31, 1999 was $1,108,000. The primary causes for this $2,247,000
reduction in net cash generated from operating activities for the nine months
ended March 31, 2000 compared to the nine months ended March 31, 1999 include a
decrease in relative year-to-date net income of $946,000, in addition to
relative year-to-date increases in inventory and accounts receivable of $972,000
and $566,000, respectively.
Net cash used in investing activities for the nine months ended March 31, 2000
and 1999 was $197,000 and $296,000, respectively. The $197,000 in net cash used
in investing activities for the nine months ended March 31, 2000 resulted
primarily 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 nine months ended March 31,
2000 was $623,000 and net cash used in financing activities for the nine months
ended March 31, 1999 was $4,000. The main factors causing the $627,000 increase
in net cash generated from investing activities for the nine months ended March
31, 2000 compared to the nine months ended March 31, 1999 include the $500,000
increase in net cash provided by borrowings under the revolving line of credit,
in addition to the $278,000 decrease in the Company's repurchasing of its shares
under its stock repurchase program.
On September 28, 1999, the Company entered into an agreement with a commercial
lender to extend and increase its existing $1.0 million revolving line of credit
to a $1.5 million revolving line of credit expiring October 31, 2000. This
revolving line of credit was established to provide, among other things,
additional working capital to support the Company's anticipated growth. Amounts
outstanding under this revolving line of credit are charged interest at one-half
of one percent above the bank's current prime rate and such interest is due
monthly. The revolving line of credit is collaterallized by substantially all of
the Company's assets. The revolving line of credit requires the Company, among
other things, to achieve certain levels of income, ("earnings covenant"),
throughout its fiscal year and 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 March 31, 2000, the Company was in
compliance with or had obtained waivers for all of those covenants. The Company
and its commercial lender have discussed the probability that the Company is
likely to be in technical default of the line of credit's existing earnings
covenant for the year ending June 30, 2000. The Company and its commercial
lender are currently evaluating how to address this potential default prior to
its occurrence. As of May 12, 2000, the Company did not have a balance
outstanding under this revolving line of credit.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations (continued)
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 nine months ended March 31, 2000, the Company did not
purchase any shares of its Common Stock. As of March 31, 2000, the Company had
acquired 231,900 shares of its Common Stock, at an approximate cost of $501,000,
pursuant to its stock repurchase program.
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.
In connection with the Hasbro litigation that is described in Part II, Item 1
under "Legal Proceedings", as of March 31, 2000, the Company had incurred
approximately $60,000 in legal expenses in connection with its defense of the
Company's position in this matter. The Company expects to continue incurring
similar costs for the foreseeable future as the Company continues to actively
defend its position in this matter. Such ongoing expenses could impact the
Company's future liquidity and capital resources.
Risk Factors
The Company's business is subject to many risks and uncertainties, which may
affect its future financial performance. Some of those 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:
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
nine months ended March 31, 2000, the Company earned $380,000 in net income and
the accumulated deficit was approximately $5,888,000. 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 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 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
outcome of the 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.
<PAGE>
Risk Factors (continued)
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 affect 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
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
<PAGE>
Risk Factors (continued)
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
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 level of
product returns; 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;
<PAGE>
Risk Factors (continued)
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 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
<PAGE>
Risk Factors (continued)
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 nine months ended March 31, 2000, international
sales represented 20% of net sales as compared to 25% of net sales for the nine
months ended March 31, 1999. 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
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 March 31, 2000, the Company
satisfied the minimum level of Stockholders' equity that is 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
<PAGE>
Risk Factors (continued)
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 the
award of Plaintiffs' legal fees and costs. The Company intends to defend this
action vigorously.
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 April 27, 2000, the Company filed a report on Form 8-K regarding a press
release announcing the Company's anticipated unaudited results for the third
quarter and nine months ended March 31, 2000.
On May 2, 2000, the Company filed a report on Form 8-K regarding a press release
announcing the Company's unaudited results for the third quarter and nine months
ended March 31, 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: May 15, 2000 /s/ Gerald W. Klein
------------ --------------------
Gerald W. Klein, President, Chief
Executive Officer and Director
Date: May 15, 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
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<ARTICLE> 5
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JUN-30-2000
<PERIOD-END> MAR-31-2000
<CASH> 601,291
<SECURITIES> 0
<RECEIVABLES> 6,103,946
<ALLOWANCES> (2,923,980)
<INVENTORY> 2,281,456
<CURRENT-ASSETS> 6,190,959
<PP&E> 1,110,584
<DEPRECIATION> (730,985)
<TOTAL-ASSETS> 6,917,808
<CURRENT-LIABILITIES> 2,911,820
<BONDS> 0
0
0
<COMMON> 9,134,234
<OTHER-SE> (5,269,082)
<TOTAL-LIABILITY-AND-EQUITY> 6,917,808
<SALES> 10,562,565
<TOTAL-REVENUES> 10,562,565
<CGS> 3,997,803
<TOTAL-COSTS> 3,997,803
<OTHER-EXPENSES> 6,094,288
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 11,711
<INCOME-PRETAX> 458,763
<INCOME-TAX> 78,296
<INCOME-CONTINUING> 380,467
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 380,467
<EPS-BASIC> .04
<EPS-DILUTED> .04
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