SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark one)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended June 30, 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 Identification Number)
incorporation or organization)
2000 Cabot Boulevard, Suite 110, Langhorne, PA 19047-1811
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code 215-750-6606
Securities registered pursuant to Section 12(b)of the Act: None
Securities registered pursuant to Section 12(g)of the Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
Common Stock, No Par Value NASDAQ
Indicate by check mark whether the issuer (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes (X) No ( )
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. (X)
State issuer's revenues for its most recent fiscal year: $13,640,000
State the aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the price at which the common equity
was sold, or the average bid and asked price of such common equity, as of a
specified date within the past 60 days: $12,182,000 as of September 11, 2000.
ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS
DURING THE PRECEDING FIVE YEARS:
Check whether the issuer has filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by a court. Yes ( ) No ( )
APPLICABLE ONLY TO CORPORATE REGISTRANTS
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: 9,749,975 shares of Common Stock, no
par value per share, as of September 20, 2000.
Transitional Small Business Disclosure Format (check one): Yes ( ) No (X)
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Registrant's definitive proxy statement for its 2000 Annual Meeting
of Shareholders are incorporated by reference into Part III as set forth herein.
With the exception of those portions, which are expressly incorporated by
reference, said proxy statement is not deemed filed as a part hereof.
<PAGE>
eGames, Inc.
Form 10-KSB
For the Fiscal Year Ended June 30, 2000
INDEX
Page
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PART I
Item 1. Business....................................................... 3
Item 2. Properties..................................................... 15
Item 3. Legal Proceedings.............................................. 15
PART II
Item 5. Market for the Registrant's Common Stock and Related
Stockholder Matters............................................ 16
Item 6. Management's Discussion and Analysis of Results of Operations
and Financial Condition........................................ 16
Item 7. Financial Statements .......................................... 22
Item 8. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure....................................... 40
PART III
Item 9. Directors and Executive Officers of the Registrant............. 41
Item 10. Executive Compensation......................................... 41
Item 11. Security Ownership of Certain Beneficial Owners and Management. 41
Item 12. Certain Relationships and Related Transactions................. 41
PART IV
Item 13. Exhibits, List and Reports on Form 8-K......................... 42
Index of Exhibits....................................................... 42
Signatures.............................................................. 45
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PART I
This annual report on Form 10-KSB contains forward-looking statements regarding
future events or the future financial performance of the Company that involve
certain risks and uncertainties. Actual events or the actual future results of
the Company may differ materially from the results discussed in the
forward-looking statements due to various factors, including, but not limited
to, those discussed in "Factors Affecting Future Performance" below at pages 10
to 15.
Item 1. Business
GENERAL
eGames, Inc., formerly RomTech, Inc., (the "Company"), a Pennsylvania
corporation incorporated in July 1992, publishes, markets and sells a
diversified line of personal computer software primarily for consumer
entertainment. The Company also offers personal productivity products for sale,
but the Company anticipates minimal future investment in that category of the
market and expects sales from these products to be less than 10% of the
Company's net sales in the foreseeable future. In October 1995, the Company
completed its initial public offering coincident with its acquisition of Applied
Optical Media Corporation ("AOMC"), a developer of educational and reference
software titles. In April 1996, the Company acquired Virtual Reality
Laboratories, Inc. ("VRLI"), a software developer of landscape generation, space
exploration, and business forms manipulation programs. In August 1998, the
Company acquired Software Partners Publishing and Distribution Ltd. ("Software
Partners"), a United Kingdom-based distributor of personal computer software for
consumer entertainment and small office/home office applications. On March 31,
1999 Software Partners changed its name to eGames Europe Ltd. ("eGames Europe").
The Company believes that today's consumers base their software purchase
decisions on the same criteria as other consumer product purchases, relying on
recognized brands for consistent quality, value and ease of use. The Company
promotes its proprietary brand names, including eGames(TM), Galaxy of Games(TM),
Game Master Series(TM), Multi-Pack and Galaxy of Home Office Help(TM) (the
"eGames Series"), in order to generate customer loyalty, encourage repeat
purchases and differentiate the eGames Series products to retailers and
consumers. The Company targets the growing market of home personal computer
("PC") users who value full-featured, value-priced and easy-to-use entertainment
software. All eGames Series titles are "Family Friendly", which means they are
easy-to-use, non-violent, and appeal to all ages. The Company's software
packaging is labeled with the distinctive Family Friendly(TM) logo to help
attract consumers towards its software. The Company's products generally sell at
retail for under $15, a price point that is intended to generate impulse
purchases in mass market shopping environments. The Company's Game Master Series
titles are boxed software products that generally sell at retail for $14.99, yet
feature packaging and content usually found in software titles selling for more
than $20 at retail. The balance of the eGames software titles, including its
Galaxy of Games(R) collections, are typically sold in jewel case packaging and
sell at retail for $9.99. The Company also sells its Multi-Pack software titles
in special retail point-of-sale packages at $4.99.
RECENT DEVELOPMENT
As described in the Legal Proceedings (Item 3), on September 8, 2000, the
Company settled its litigation with Hasbro Interactive, Inc., Atari Interactive,
Inc., Zao Elorg d/b/a Elorg Corporation (collectively, the "Plaintiffs"), which
had alleged that certain of the Company's products infringed copyrights and
trademarks owned by the Plaintiffs, and also alleged that the Company had
engaged in unfair competition.
INDUSTRY BACKGROUND
It is estimated that there are approximately 180 million PC users and 50 million
PC game players in North America. The worldwide consumer entertainment software
market is estimated to exceed $23 billion in revenues by 2003 compared to $6
billion in revenues during 1999. This dramatic growth in recent years has been
driven by the increasing number of multimedia PCs in the home and office, the
increasing number of game console devices in the home, the proliferation of
software titles, and the development of new and expanding distribution channels.
Declining prices of microprocessors and CD-ROM drives have made high-end
interactive computer entertainment more affordable, resulting in low-end PCs
targeted to the mass consumer market costing under $500.
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The worldwide consumer entertainment software industry has undergone a number of
profound changes over the past few years with the introduction of new hardware
platforms and new technologies, such as on-line networks and the Internet. The
proliferation of on-line networks and the Internet has created new opportunities
for the consumer entertainment software industry, including on-line game playing
by users in different locations and direct on-line marketing, sales and
distribution to end users.
Growth in the installed base of multimedia PCs has created a mass market for
consumer entertainment software products. The development of a mass market for
consumer entertainment software products has been characterized by the growing
importance of mass merchant software sales as a distribution channel, increasing
price pressure and competition for retail shelf space. This increased
competition has emphasized the importance of marketing, merchandising and brand
name recognition. Faced with the challenges of marketing and distribution, many
independent software developers and content providers are pursuing relationships
with publishing companies with broader distribution capabilities, including
better access to mass market retailers and greater merchandising, marketing and
promotional support. At the same time, retailers with limited shelf space are
faced with the challenge of managing an increasing number of new titles. A
significant result of these market pressures is a trend in the industry toward
the consolidation of entertainment software companies and the diversification of
products offered by such companies.
BUSINESS STRATEGY
The Company continues to work towards implementing a business plan that focuses
on: gaining brand name recognition of its Family Friendly software products;
developing new top-selling titles within existing brands; developing new brands;
establishing strong distribution and retail relationships; consistently offering
a diversified high-quality, high-value software portfolio of products that
provide significant sell-through and return-on-investment opportunities for all
types of retailers; and implementing a sound Internet strategy and comprehensive
web site. The intended result of the Company's business strategy is to be a
leading publisher of high quality, value-priced interactive consumer
entertainment software in the consumer entertainment category of the market.
The eGames Business Model. An important element of our strategy is bringing
familiar, fun, Family Friendly games to PC users of all ages and levels of
experience at affordable prices. Therefore, our business model is based on the
premise that the under $15 retail segment, the value-priced segment, of the PC
game software market will be the fastest growing segment of the market for the
foreseeable future. Since 1996 that's been the situation in North America
according to PC Data as unit sales in this segment have increased 106% compared
to an increase of 73% for the overall PC game software market. During this same
period of time, dollar sales for the value-priced PC game software market
increased by 111%, compared to 32% for the overall PC game software market. The
business model we have created focuses on this growing segment of the market in
an effort to gain market share and increase sales.
Rely On Consumer Research and Marketplace Data. The Company primarily uses
marketplace sales data to determine which products are achieving favorable sales
results in the interactive consumer entertainment software categories that the
Company serves. The Company then focuses on developing top-selling products that
have a sustainable product life and also appeal to the broadest age group of
consumers regardless of gender. This involves either developing or obtaining
rights to products that the Company expects will meet these criteria while
complementing and supporting the Company's branding strategy.
Deliver Products To Market Quickly To Maximize Sales Opportunities. The Company
believes that the best method of bringing successful products to market is to
identify products that consumers are buying and will continue to buy. The
Company then focuses on quickly developing or procuring product content that the
Company believes will achieve favorable sales results in its category when the
product is combined with the Company's attractive, distinctive and informative
packaging that is designed to encourage impulse purchases in retail stores. The
Company's development efforts focus primarily on product design, consistent,
user-friendly interfaces, ease of use, product quality and consistency. The
Company's internal product development activities are supplemented by utilizing
existing technologies and externally developed programming and content. The
Company maintains control over the creative and market-driven aspects of product
development while utilizing outside resources to reduce development costs and
minimize risks.
<PAGE>
Develop Products That Are Easy To Use. Based on information from registered
users of the Company's products, most of the Company's customers are new
computer owners. Therefore, the Company's products are designed to be simple and
easy to install and use, requiring little or no technical expertise. The Company
provides technical support for all of its products and revises or upgrades
products in response to consumer feedback gained from customer's registration of
products they have purchased.
Gaining Distribution. Gaining widespread retail and Internet distribution is
another important element of the Company's strategy. The Company's flexible
distribution strategy enables retailers to buy eGames products directly from us
or from a distributor that may already be effectively serving the retailer's
software needs. Our challenge is to make every retailer aware of the eGames
business proposition and to make sure they have access to our products in the
manner best suited or matched to their operations. The Company's goal is to make
our products available to more consumers as they find our products in the stores
that they shop most frequently or on the Internet.
Growing The PC Interactive Entertainment Software Category. Another aspect of
the Company's strategy is to grow the size of the market that eGames serves. It
is estimated that there are approximately 180 million PC users and 50 million PC
game players in North America. One of the Company's key objectives is to
introduce PC game-play to more and more of the millions of PC users that do not
currently play PC games on a regular basis. To accomplish this objective the
Company offers "samplers" of familiar, fun, Family Friendly games to these PC
users at price points that are irresistible ($4.99 Multi-Packs) in the stores
where they shop most frequently - drug stores and supermarkets. The goal of
these programs is to increase the number of PC game players in the PC game
player category who will ultimately seek to buy the Company's other great games.
Providing A Managed Solution For Consumer Entertainment Software. Providing
today's national retailers with a managed solution for the value-priced
interactive entertainment software category is another element of the Company's
strategy. Getting retailers to commit to dedicated shelf space or promotional
displays is very challenging. But because of the unique advantages eGames can
offer retailers--including excellent rates of return on inventory investment,
product co-branding opportunities, and Internet enabling features--the Company's
retail partners are responding enthusiastically to the wide variety of permanent
and temporary display programs that we have developed for their stores. These
displays not only make it easier for consumers to find the products they want,
they also continually reinforce the eGames brand.
Establishing the "Store in a Store" Program. Another important element of the
Company's strategy is the concept of a "Store in a Store". The Company's "Store
in a Store" concept is to provide a category-managed solution for retailers that
will give them a one-stop solution to place an attractively displayed, Family
Friendly collection of value priced software products in their stores. The idea
is to give consumers an opportunity to choose from a wide variety of quality,
safe, family-oriented software titles for their PC or console in one easy to
find display section. The Company's goal is to provide the leadership and to
create the partnerships necessary to make the safe, Family Friendly software
entertainment section a reality. Certain major food and drug retailers have
already committed to establishing such Family Friendly software entertainment
sections within their retail stores during fiscal 2001.
Market Brand Names That Deliver Consistent Quality. The Company focuses its
marketing resources on developing brands that represent consistency, quality and
value to the consumer. The Company believes that to the consumer, brands offer a
safe and secure choice in an otherwise confusing, fast changing and often
intimidating software marketplace. Consumers view successful brand logos as
friendly marks of quality assurance. Once a consumer becomes highly satisfied
with a brand in any given product category, the Company believes that the
consumer will typically tend to actively seek out that brand versus competing
brands. The Company believes that successful brands can lead to consistently
successful sell-through results, which is one of the Company's long-term goals.
<PAGE>
INTERNET STRATEGY
The Company's Internet strategy is based upon three underlying principles:
providing exceptional customer service, building customer equity, and creating
mutually beneficial relationships with advertisers and business partners. By
focusing on these three fundamentals, the Company is working towards creating a
powerful Internet presence that not only reinforces the Company's retail
strengths, but also provides innovative and unique methods for building new
business opportunities and generating additional revenue streams.
The Company's web site, www.egames.com, is a comprehensive Family Friendly web
site where visitors can: try out great demos; play fun games for free; join and
participate in game clubs; buy all of the Company's products (both tangible and
downloadable versions); register software purchases; access the Company's SEC
filings and press releases; link to the Company's international partners' web
sites; download software updates; visit the eGames superstore; or access
technical support. The Company seeks to maintain www.egames.com as a leading
edge web site in the services and information that are presented to visitors.
While the Company strives for a visually appealing web site, it is important
that it be intuitive in its functionality. The Company's goal is to maintain
this level of service so that the Company's Internet presentation represents its
commitment to providing fun, easy-to-use products and services.
The cornerstone of the Company's Internet strategy is the "eGames browser." The
eGames browser was developed in 1998 as a standard, user-friendly interface for
presenting the Company's games to consumers on their personal computers (PCs).
The Company designed a browser interface since marketplace data revealed that
consumers were buying PCs for their homes in order to get connected to the
Internet - a trend or buying behavior that management believes will continue to
drive PC purchases for the foreseeable future. Since consumers are already
familiar with "Internet browsers," the Company's management believes that
providing the same functionality and connectivity in the eGames browser provides
added value and ease of use for consumers. The browser is also an easy way to
access the eGames website to enable consumers to purchase additional games on
the Internet and access the trend towards increased software purchases
online-marketplace data forecasts that consumers will, over time, purchase more
and more of their software on the Internet.
Creating New Revenue Streams. A primary objective in fiscal 2001 is to combine
the features and competitive advantages of the eGames browser and the compelling
nature of the eGames game content to create a product offering that will enable
the Company to create revenue streams from advertising, direct marketing
services, and the sale of special promotional product offerings for the premiums
and promotions industry. The Company also believes that many of today's leading
"bricks and mortar" retailers will become the leading Internet retailers of
tomorrow. Today's leading retailers know what their customers want and possess
the resources to develop and implement the systems and services to provide what
their customers want - whether it's on the Internet or in their local store.
Additionally, these retailers possess the brand equity and the store traffic
that can be converted to traffic on their websites. The Company believes there
are ways that the eGames browser can help retailers create store and website
traffic and demonstrating this to some of our large national retail customers is
another of the Company's primary objectives in fiscal 2001.
MARKETING
The Company's marketing efforts include: participating in retail trade shows;
developing the Company's website, (www.egames.com); working with public
relations and investor relations firms in issuing press releases and
establishing media contact; coordinating in-store and industry promotions
including merchandising and point of purchase displays; participating in
cooperative advertising programs with specific retailers; and utilizing
demonstration software distributed through the Internet or on compact discs. The
Company's marketing department is responsible for creating marketing programs to
generate product sell-in (sales to retailers) and sell-through (sales to
end-user customers). These programs generally are based on established consumer
product marketing techniques that the Company believes are becoming more
important as software becomes more of a consumer product. The Company uses
consumer product graphic designers and copywriters to create effective package
designs, catalogs, brochures, advertisements and related materials. The
Company's marketing and sales personnel and outside contractors work together to
coordinate retail and publicity programs so that those programs are in place
when products are initially shipped to retailers and consumers. Public relation
campaigns, in-store advertising, catalog mailings and advertisements are
designed in advance of product availability.
<PAGE>
SALES AND DISTRIBUTION
North American Sales and Distribution. The Company has determined that there are
a number of strategic advantages to selling its products on a direct basis to
major computer and software retailing organizations, mass market retailers,
consumer electronic stores, discount warehouses and mail order companies.
Management of the Company believes that direct sales relationships with retail
accounts can result in more effective inventory management, merchandising and
communications than are possible through indirect sales relationships. Direct
sales to retailers also diminish the Company's dependence on third-party
distributors for sales of the Company's products and potentially can increase
the Company's gross profit margin that can be realized on the sale of its
products. Accordingly, the Company has established direct sales relationships
with several traditional national software retailers such as: Electronics
Boutique, CompUSA and Toys-R-Us, as well as non-traditional software retailers
such as Rite Aid Corporation, Walgreen Company and Eckerd Corporation.
The Company has invested in its own electronic data interchange ("EDI") hardware
and software systems in order to provide this capability with its direct sales
retailers that prefer to transact business this way. This capability in turn
facilitates the placement, control and shipment of orders and the processing of
payments and credits. The Company seeks to continue to increase the number of
retail outlets served directly through its internal sales force. However, to a
larger extent, the Company sells its products through wholesale distributors,
such as Infogrames, Inc. (formerly GT Value Products), Navarre Corporation,
Merisel Americas, Inc. and Beamscope Canada. Infogrames, Inc. accounted for
approximately 18% and 65% of the Company's net sales during fiscal 2000 and
1999, respectively. From May 1997 to April 1999, Infogrames, Inc. was the
exclusive distributor of the Company's products in North America. In April 1999,
the Company terminated its exclusive distribution relationship with Infogrames,
Inc. and entered into a non-exclusive distribution relationship with them. (See
"Dependence on Distributors and Retailers", page 11). Internet sales currently
account for approximately 1% of the Company's net sales.
International Sales and Distribution. The Company currently distributes its
products in Australia, Austria, Belgium, Brazil, the Caribbean, Central America,
Chile, Colombia, Cyprus, Czech Republic, Denmark, France, Germany, Hungary,
Iceland, India, Ireland, Israel, Italy, Mexico, the Middle East, the
Netherlands, New Zealand, Panama, the Philippines, Portugal, Puerto Rico, Saudi
Arabia, Singapore, South Africa, Spain Sweden, Sweden, Uruguay and the United
Kingdom. The Company seeks to maximize its worldwide sales and earnings by
releasing high quality localized foreign language titles, whenever practicable,
and by continuing to expand the number of direct selling and distribution
relationships it maintains with key retailers and distributors in major
territories. The Company currently publishes localized products in French,
German, Italian, Spanish and Portuguese, and the Company offers localized
product packaging for all of these languages as well as in Hebrew, Dutch and
Brazilian Portuguese.
Distribution Procedures. The Company's product line focuses on branded content
for the value-priced category of the consumer entertainment market. By
maintaining a branded product category focus, the Company believes that its
advertising, promotion, merchandising and packaging expenditures will build
long-term benefits for all the products in each category.
The Company's internal sales staff calls on retail accounts directly and works
with each distributor's sales personnel in order to maximize the sales potential
with retail accounts. The Company's sales staff works closely with the retail
buyers and their distributors to ensure that appropriate Company products are
inventoried for each retail outlet, stocking levels are adequate, promotions and
advertising are coordinated with product availability and in-store merchandising
plans are properly implemented.
<PAGE>
The Company's agreements with its distributors and retailers generally provide
for rights to return the Company's products if the Company's products do not
sell through at satisfactory levels to the retailers. The Company sells to its
distributors and retailers on credit, with varying discounts and credit terms.
(See "Dependence on Distributors and Retailers", page 11). The Company also has
some limited exposure to returns by consumers. Reserves for returns by
distributors, retailers and consumers are established at levels that the Company
believes are adequate based on product sell-through, inventory levels and
historic return rates (See Note 1 to Financial Statements, "Summary of
Significant Accounting Policies, Revenue Recognition" and Item 6 "Management's
Discussion and Analysis of Results of Operations and Financial Condition").
However, there can be no assurance that the actual returns will not exceed the
established reserves. The Company typically accepts returns from customers, even
when not legally required to do so, in order to maintain good customer relations
to enhance repeat purchasing by consumers.
COMPETITION
The consumer entertainment software industry is intensely competitive and is in
the process of substantial change and consolidation. The market for value-priced
consumer entertainment software is especially competitive. The Company believes
that the principal competitive factors include content quality, brand name
recognition, ease-of-use, merchandising, product features, quality, reliability,
on-line technology, distribution channels and price. Based on its current and
anticipated future product offerings, the Company believes that it competes or
will compete effectively in these areas, particularly in price, brand name
recognition, quality, ease of use and product features.
The Company competes primarily with other software publishers. The Company's
competitors vary in size from very small companies with limited resources to
very large corporations with greater financial, marketing, distribution,
technical and other resources than the Company. Although there are a variety of
consumer and business software publishers, based on product lines and price
points, Electronic Arts, Havas, Activision, Infogrames, Inc. (formerly GT
Interactive), Hasbro Interactive, Mattel Media, Cosmi, Microsoft, and Interplay
are the Company's primary competitors. In addition, it is possible that certain
large software companies, hardware companies and media companies may
increasingly target the value-priced segment of the software market,
particularly in on-line Internet gaming and other Internet-based gaming models,
resulting in additional competition.
The Company believes that increasing competition in the consumer entertainment
software market has already caused retail price erosion, which could adversely
affect the Company's business, operating results and financial condition. To the
extent that competitors achieve performance, price or other selling advantages,
the Company could be adversely affected. In addition, commercial acceptance of
new gaming technologies, such as the Internet, cable modem and DSL, may reduce
demand for the Company's existing PC-based products. Intense price competition,
reduced demand, or distribution channel changes may have a material adverse
effect on the Company's business, financial condition, liquidity and operating
results.
The market is also extremely competitive with respect to access to third-party
developers and content providers. The Company may not be successful in competing
for the most sought-after content for its products to the extent that
competitors achieve better access to distribution channels, have greater
financial resources to pay for development fees or royalties, or have developed
a widely-recognized reputation. (See "Factors Affecting Future Performance,
Rapid Technological Change; Product Development" beginning on page 13.)
PRODUCT DEVELOPMENT
The Company seeks to develop a broad line of branded products in rapidly growing
and sustainable market categories. The Company primarily utilizes marketplace
sales data (including reported industry sales, computer trade show sales and
retail sell-through results) to determine which products are achieving top
ranked sales results in the consumer entertainment software categories that the
Company serves. New product ideas are evaluated based upon market research in
the subject area, the type and demographics of the target consumer, and the
existence and characteristics of competitive products. The Company then either
develops or procures products that the Company expects will meet these criteria
while complementing and supporting the Company's branding strategy. The Company
believes that its development process has certain material advantages over other
software companies, including consistent product quality, reliable delivery
schedules and predictable cost estimates. The Company has also acquired products
through the acquisition of other software companies or the acquisition or
licensing of software products or technologies and will most likely continue to
acquire products this way in the future.
<PAGE>
The Company's Vice President of Product Development oversees the development of
a product from conception through completion, and controls the scope, design,
content and management of the project. The Company seeks to publish new products
that incorporate all of the important functions and features of the leading
competitive products and to add innovative, helpful concepts and upgrades to
achieve a "better than" positioning relative to directly competitive products.
Once a product is approved for development, a design specification is created
that includes the product's features, estimated development time and cost,
projected delivery date and projected selling price. Whenever possible, the
software is designed to incorporate technology used in the Company's current
products in an effort to shorten the development cycle and improve quality and
consistency. The overall product, including packaging and documentation, is
designed to comply with a manufacturing specification that will meet the
Company's margin requirements at the intended consumer price points.
The Vice President of Product Development executes the project with a
development team that typically may include programmers, designers, artists and
testers. The development team members are usually employees of the Company but
may be independent contractors depending on the scheduling of and skills
required for each project.
The Company's internal development efforts focus primarily on product design and
features, consistent user interfaces, and product quality and consistency. The
Company supplements its internal product development resources by utilizing
existing technologies and externally developed programming and content when such
utilization results in a more efficient method of creating a higher quality
product. Using this method, the Company maintains internal control over the
creative and market-driven aspects of product development while using external
resources to shorten development time and lower development costs and risks.
Development costs associated with externally licensed technology are generally
paid through a nominal one-time customization fee and royalties based on actual
sales of the product, thereby reducing the Company's investment risk in a
product.
Developed products are tested for quality assurance before being released for
production. Products are typically tested for functionality performance,
compatibility with numerous popular PC brands and configurations, typical
installation issues, functionality and ease-of-use. Marketing or development
employees, under a manager's supervision, are responsible for reviewing customer
feedback, competitive products, product performance and market positioning in
order to introduce upgrades that keep abreast of consumer tastes and trends
while satisfying the Company's business strategy.
BACKLOG
The Company typically ships its products within one to two days after accepting
a customer's order, which is common in the consumer entertainment software
industry. Consequently, the Company does not usually generate a backlog of
orders that would be a significant or important indicator of future revenues or
earnings.
CUSTOMER AND TECHNICAL SUPPORT
Customer and technical support standards are very high in the consumer
entertainment software market. In order to remain competitive, the Company
provides telephone and Internet technical support to its customers at no
additional charge. The Company believes that high-quality, user-friendly
technical support provides valuable feedback to the Company's marketing and
software development personnel for use in the product development process.
OPERATIONS
The Company's accounting, purchasing, inventory control, scheduling, order
processing and development activities are conducted at its headquarters location
in Langhorne, Pennsylvania. The Company maintains a sales and distribution
operation in St. Ives, England, which it obtained through its acquisition of its
United Kingdom distributor, Software Partners Distribution Ltd., in August 1998.
Most product shipments to the Company's customers are performed by independent
contractors at their warehousing and production facilities working under the
Company's direction. The Company's information management system handles order
<PAGE>
entry, order processing, picking, billing, accounts receivable, accounts
payable, general ledger, inventory control, and mailing list management. Subject
to credit terms and product availability, orders are typically shipped from the
Company's facilities within one to two days after accepting a customer's order.
Third party contractors replicate the Company's software and assemble the
Company's jewel case and box products, along with any corrugated or in-line
displays that are required by its customers. The Company has multiple sources
for all components of its products, and has not experienced any material delays
in production or assembly.
EMPLOYEES
As of June 30, 2000, the Company had 45 full-time equivalent employees, of which
11 were employed in software development, 19 in sales, marketing and customer
support, and 15 in operations, finance and administration. In addition, the
Company regularly utilizes approximately 20 independent contractors in
connection with its product development activities. No employees are represented
by labor unions, and the Company has never experienced a work stoppage.
INTELLECTUAL PROPERTY RIGHTS
The Company relies primarily on a combination of trademark, copyright, trade
secret and other proprietary rights laws, license agreements, third-party
nondisclosure agreements and other methods to protect its proprietary rights.
United States copyright law, international conventions and international
treaties, however, may not provide meaningful protection against unauthorized
duplication or infringement of the Company's software. The Company generally
sells its published software under licenses from independent developers and, in
such cases, does not acquire the copyrights for the underlying content.
Policing unauthorized use of an easily duplicated and broadly disseminated
product such as computer software is very difficult. Software piracy is expected
to be a persistent problem for the software industry for the foreseeable future.
Software piracy is a much greater problem in certain international markets such
as South America, the Middle East, the Pacific Rim and the Far East. If a
significant amount of unauthorized copying of the Company's products were to
occur, the Company's business, operating results and financial condition could
be adversely affected.
Software developers and publishers are subject to infringement claims, and there
has been substantial litigation in the industry regarding copyright, trademark
and other intellectual property rights. When claims or litigation, with or
without merit, are brought against the Company, such claims can and have been
costly and result in a diversion of management's attention, which could have a
material adverse effect on the Company's business, operating results and
financial condition. The Company can and has incurred substantial expenses in
evaluating and defending against such claims, regardless of the merit of the
claims (see Part I, Item 3, "Legal Proceedings"). In the event that there is a
determination that the Company has infringed on a third party's intellectual
property rights, the Company could incur significant monetary liability and be
prevented from using these rights in the future.
FACTORS AFFECTING FUTURE PERFORMANCE
This report contains certain forward-looking statements involving risks and
uncertainties that could cause actual results to differ materially from those
anticipated, including, but without limitation: economic and competitive
conditions in the software business affecting the demand for the Company's
products; the Company's need for additional funds; the ability to hire and
retain key management personnel to manage anticipated growth; the development,
market acceptance and timing of new products; access to distribution channels;
and the renewal of licenses for key software products. Those factors, the
factors discussed below, and the factors identified on page 20 of Management's
Discussion and Analysis should be considered by investors in the Company. All
forward-looking statements are necessarily speculative and there are numerous
risks and uncertainties that could cause actual events or results to differ
materially from those referred to in such forward-looking statements. The
discussion below highlights some of the more important risks identified by
management, but should not be assumed to be the only factors that could affect
future performance.
<PAGE>
RISK FACTORS
The Company's business is subject to many risks and uncertainties, which may
affect its future financial performance. Some of the important risks and
uncertainties which may cause the Company's operating results to vary or which
may materially and adversely affect the Company's operating results are as
follows:
Maintaining Profitability. The Company commenced operations in July 1992. The
Company experienced significant losses from inception through the end of fiscal
1997. Fiscal 1998 was the first year that the Company earned a profit. The
Company has earned $253,000, $463,000 and $1,253,000 in fiscal 2000, 1999 and
1998, respectively, and the accumulated deficit for the Company at June 30, 2000
was approximately $6,016,000. Prior to fiscal 1998, the Company's operations
were funded primarily through proceeds from the Company's initial public
offering of Common Stock in October 1995 and through the sale in private
offerings of preferred stock and Common Stock warrants in November 1996 and in
January and April 1997. Subsequently, the Company has funded its activities
mainly through income from operations. The Company's operations today are still
subject to all of the risks inherent in the development of a recently profitable
business, particularly in a highly competitive industry, including, but not
limited to, development, distribution and marketing difficulties, competition
and unanticipated costs and expenses. The Company's future success will depend
upon its ability to increase revenues from the development, marketing and
distribution of its current and future software products.
Risks Inherent in the Consumer Entertainment Software Business. The development
of multimedia software products, which can combine text, sound, high quality
graphics, images and video, is difficult and time consuming, requiring the
coordinated participation of various technical and marketing personnel and
outside developers. Some of the factors that could affect the Company's future
success include, but are not limited to, the ability of the Company to overcome
problems and delays in product development, market acceptance of products,
successful implementation of its sales, distribution and marketing strategy, and
the 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.
Dependence On Distributors And Retailers. Many of the largest mass-market
retailers have established exclusive buying relationships under which such
retailers will buy consumer entertainment software only from certain
distributors. In such instances, the Company will not be able to sell its
products to such mass-market retailers if these distributors are unwilling to
distribute the Company's products. Additionally, even if the distributors are
willing to purchase the Company's products, the distributor is frequently able
to dictate the price, timing and other terms on which the Company sells to such
retailers, or the Company may be unable to sell to such retailers on terms that
the Company deems acceptable. The inability of the Company to negotiate
commercially viable distribution relationships with these and other
distributors, or the loss of, or significant reduction in sales attributable to,
any of the Company's principal distributors or retailers could adversely affect
the Company's business, operating results and financial condition.
Risk of Customer Business Failure. Distributors and retailers in the computer
industry and in mass-market retail channels have from time to time experienced
significant fluctuations in their businesses and there have been a number of
business failures among these entities. The insolvency or business failure of
any significant retailer or distributor of the Company's products could have a
material adverse effect on the Company's business, operating results and
financial condition. Sales are typically made on credit, with terms that vary
depending upon the customer and the nature of the product. The Company does not
hold collateral to secure payment.
The Company maintains allowances for uncollected receivables that it believes to
be adequate, but the actual allowance maintained may not be sufficient in every
circumstance. The failure to pay an outstanding receivable by a significant
customer or distributor could have a material adverse effect on the Company's
business, operating results and financial condition.
<PAGE>
Product Returns. Although the Company has established allowances for product
returns that it believes are adequate, there can be no assurance that actual
returns will not exceed such allowances. The Company may also accept product
returns in order to maintain its relationships with retailers and its access to
distribution channels. As a result of the Company's termination of its exclusive
distribution relationship with Infogrames, Inc. in April 1999, and its new
non-exclusive distribution relationships with other distributors and its direct
sales to retailers, the Company is now increasingly exposed to the risk of
product returns from these retailers and distributors. Product returns that
exceed the Company's allowances could have a material adverse effect on the
Company's business, operating results and financial condition.
The Consumer Entertainment Software Market is Highly Competitive and Changes
Rapidly. The market for consumer entertainment software is highly competitive,
particularly at the retail shelf level where a constantly increasing number of
software titles are competing for the same amount of shelf space. Retailers have
a limited amount of shelf space on which to display consumer entertainment
software products. Therefore, there is intense competition among consumer
entertainment software publishers for adequate levels of shelf space and
promotional support from retailers. As the number of software titles continues
to increase, the competition for shelf space continues to intensify, resulting
in greater leverage for retailers and distributors in negotiating terms of sale,
including price discounts and product return policies. The Company's products
represent a relatively small percentage of any retailer's sales volume, and
there can be no assurance that retailers will continue to purchase the Company's
products or promote the Company's products with adequate levels of shelf space
and promotional support. Most of the Company's competitors have substantially
greater sales, marketing, development and financial resources. Moreover, the
Company's present or future competitors may be able to develop products, which
are comparable or superior to those offered by the Company, offer lower priced
products or adapt more quickly than the Company to new technologies or evolving
customer requirements. The Company's competitors may also have more money to
spend on marketing promotions and advertising efforts. Competition is expected
to intensify. In order to be successful in the future, the Company must respond
to technological change, customer requirements and competitors' current products
and innovations. There can be no assurance that the Company will be able to
continue to compete effectively in its market or that future competition will
not have a material adverse effect on its business operating results and
financial condition.
Need for Additional Funds. The Company's future capital requirements will depend
on many factors, but particularly on cash flow from sales of the Company's
products and access to the Company's recently established $2,000,000 revolving
credit facility with a commercial bank that expires on October 31, 2001. If the
Company is not able to maintain cash flow from operations at a level sufficient
to support continued growth of its business, the Company may require additional
funds to sustain and expand its product development, marketing and sales
activities. Adequate funds for these purposes may not be available or may be
available only on terms that would result in significant dilution or otherwise
be unfavorable to existing stockholders. If the Company is unable to secure
additional funding, or if the Company is unable to obtain adequate funds from
operations or other external sources when required, the Company's inability to
do so would have a material adverse effect on the long-term viability of the
Company.
Difficulty in Protecting the Company's Intellectual Property Rights. The Company
either owns or has obtained licenses to the rights to copyrights on the
products, manuals, advertising and other materials owned by it. The Company also
either owns trademark rights or is in the process of applying for such rights in
the Company's name and logo, and the names of the products owned or licensed by
the Company. The Company's success depends in part on its ability to protect its
proprietary rights to the trademarks, trade names and content used in its
principal products. The Company relies on a combination of copyrights,
trademarks, trade secrets, confidentiality procedures and contractual provisions
to protect its proprietary rights. There can be no assurance that the Company's
existing or future copyrights, trademarks, trade secrets or other intellectual
property rights will be of sufficient scope or strength to provide meaningful
protection or commercial advantage to the Company. Also, in selling certain of
its products, the Company relies on "shrink wrap" licenses that are not signed
by licensees and, therefore, may be unenforceable under the laws of certain
jurisdictions. In addition, the laws of some foreign countries do not protect
the Company's proprietary rights, as do the laws of the United States. There can
be no assurance that such factors would not have a material adverse effect on
the Company's business or operating results.
<PAGE>
Substantial Expenses and Resources Can Be Used to Defend Infringement Claims;
Effects of Settlements are Uncertain. The Company may from time to time be
notified that it is infringing on the intellectual property rights of others.
Combinations of content acquired through past or future acquisitions and content
licensed from third party developers will create new products and technology
that may give rise to claims of infringement. In February, 2000, the Company was
sued for trademark and copyright infringement by Hasbro Interactive, Inc. (the
"Hasbro Action") (See Part I, Item 3, "Legal Proceedings"). Although this case
has been settled, the Company incurred significant defense costs and utilized
internal resources to defend this action prior to the settlement. Additionally,
pursuant to the settlement of this case, the Company has agreed to discontinue
selling certain of its software titles after September 30, 2000, which titles
accounted for $2,100,000 and $2,000,000 in the Company's net sales for fiscal
2000 and 1999, respectively, or 15% and 20% of net sales for those same fiscal
years. Although the Company is working with its retail and distribution
customers to replace these titles with acceptable alternatives from the
Company's existing and newly released product offerings, there can be no
assurance that these replacement titles will generate similar sales for the
Company. There can also be no assurance that other third parties will not
initiate infringement actions against the Company in the future. Any future
claims could result in substantial cost to and diversion of resources of the
Company. If the Company is found to be infringing the rights of others, no
assurance can be given that licenses would be obtainable on acceptable terms or
at all, that significant damages for past infringement would not be assessed, or
that further litigation relative to any such licenses or usage would not occur.
The failure to obtain necessary licenses or other rights, or the commencement of
litigation arising out of any such claims, could have a material adverse effect
on the Company's operating results.
Fluctuations in Quarterly Results; Uncertainty of Future Operating Results;
Seasonality. The Company's quarterly operating results have varied significantly
in the past and will likely vary significantly in the future depending on
numerous factors, many of which are not under the Company's control. Future
operating results will depend upon many factors including: the size and rate of
growth of the consumer entertainment software market; the demand for the
Company's products, particularly value-priced, casual PC games; the level of
product and price competition; the level of product returns; the length of the
Company's sales cycle; seasonality of customer buying patterns; the timing of
new product introductions and product enhancements by the Company and its
competitors; the timing of orders from major customers; delays in shipment of
products; access to distribution channels; product defects and other quality
problems; product life cycles; levels of international sales; changes in foreign
currency exchange rates; and the ability of the Company to develop and market
new products and control costs. Products are usually shipped as orders are
received so the Company operates with little or no backlog. Therefore, net
revenues in any quarter are dependent on orders booked and shipped during that
quarter.
The consumer entertainment software industry is somewhat seasonal due primarily
to holiday shopping and back-to-school buying patterns. Accordingly, in
descending order, the calendar fourth, first and third quarters are typically
the strongest quarters for sales results, with the calendar second quarter
typically the weakest. Therefore, net sales and operating results for any future
quarter are not predictable with any significant degree of accuracy.
Consequently, the Company believes that period-to-period comparisons of its
operating results are not necessarily meaningful and should not be relied upon
as indications of future performance.
Uncertainty of Market Acceptance; Short Product Life Cycles. The market for
consumer entertainment software has been characterized by shifts in consumer
preferences and short product life cycles. Consumer preferences for
entertainment software products are difficult to predict and few products
achieve sustained market acceptance. There can be no assurance that new products
introduced by the Company will achieve any significant degree of market
acceptance, that such acceptance will be sustained for any significant period,
or that product life cycles will be sufficient to permit the Company to recover
development, marketing and other associated costs. In addition, if market
acceptance is not achieved, the Company could be forced to accept substantial
product returns to maintain its relationships with distributors and retailers
and its access to distribution channels. Failure of new products to achieve or
sustain market acceptance or product returns in excess of the Company's
expectations would have a material adverse effect on the Company's business,
operating results and financial condition.
Rapid Technological Change; Product Development. Frequent new product
introductions and enhancements, rapid technological developments, evolving
industry standards and swift changes in customer requirements characterize the
market for the Company's products. The Company's continued success depends upon
<PAGE>
its ability to continue to quickly and efficiently develop and introduce new
products and enhance existing products to incorporate technological advances and
responses to customer requirements. If any of the Company's competitors
introduce products more quickly than the Company, or if they introduce better
products, the Company's business could be adversely affected. There is also no
assurance that the Company will be successful in developing and marketing new
products or enhancements to its existing products on a timely basis or that any
new or enhanced products will adequately address the changing needs of the
marketplace. From time to time, the Company or its competitors may announce new
products, capabilities or technologies that have the potential to replace or
shorten the life cycles of the Company's existing products. There can be no
assurance that announcements of currently planned or other new products by
competitors will not cause customers to delay their purchasing decisions in
anticipation of such products, which could have a material adverse effect on the
Company's business, liquidity and operating results.
Risks Related to Added Product Features and Increased Regulation of the Internet
and Advertising. Due to the competitive environment in the consumer
entertainment software industry, the Company has and will continue to seek to
incorporate features into its products, such as an Internet browser interface
and advertising technology, in order to differentiate its products to retailers,
provide value-added features to consumers, and to potentially create new revenue
streams based on advertising and promotional opportunities. There can be no
assurance that such features will enhance the product's value, and in fact such
features may detract from a product's value if they are not accepted in the
marketplace or if new regulations governing the Internet and related
technologies are enacted which impact these features.
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 fiscal 2000, international sales represented 21% of net
sales as compared to 27% of net sales for fiscal 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.
<PAGE>
Listing of Securities; Risk of Low Priced Stocks. The Company's Common Stock is
listed on the Nasdaq SmallCap Market under the symbol EGAM. A listed company may
be de-listed if it fails to maintain minimum levels of Stockholders' equity, bid
price, shares publicly held, number of Stockholders or aggregate market value,
or if it violates other aspects of its listing agreement. At June 30, 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.
Potential for Further Trading Restrictions for Low-Priced Stock. If the Common
Stock is de-listed from trading on the Nasdaq SmallCap Market, and the trading
price of the Common Stock is less than $1.00 per share, or the Company has less
than $2 million in net tangible assets, trading in the Common Stock would be
subject to the requirements of Rule 15g-9 promulgated under the Securities
Exchange Act of 1934, as amended (the "Exchange Act"). Under this rule,
broker/dealers who recommend such securities to persons other than established
customers and accredited investors (generally institutions with assets in excess
of $5 million or individuals with a net worth in excess of $1 million or an
annual income exceeding $200,000 or $300,000 jointly with their spouses) must
make a special written suitability determination for the purchaser and receive
the purchaser's written agreement to a transaction prior to sale. The
requirements of Rule 15g-9, if applicable, may affect the ability of
broker/dealers to sell the Company's securities and may also affect the ability
of purchasers to sell their shares in the secondary market. The Securities
Enforcement Remedies and Penny Stock Reform Act of 1990 (the "Penny Stock Rule")
also requires additional disclosure in connection with any trades involving a
stock defined as penny stock (any non-Nasdaq equity security that has a market
price or exercise price of less than $5.00 per share and less than $2 million in
net tangible assets, subject to certain exceptions). Unless exempt, the rules
require the delivery, prior to any transaction involving a penny stock, of a
disclosure schedule prepared by the SEC explaining important concepts involving
the penny stock market, the nature of such market, terms used in such market,
the broker/dealer's duties to the customer, a toll-free telephone number for
inquiries about the broker/dealer's disciplinary history and the customer's
rights and remedies in case of fraud or abuse in the sale. Disclosure must also
be made about commissions payable to both the broker/dealer and the registered
representative, and current quotations for the securities. Finally, monthly
statements must be sent disclosing recent price information for the penny stock
held in the account and information on the limited market in penny stocks.
Item 2. Properties
The Company leases 11,000 square feet of office, development and warehouse space
in Langhorne, Pennsylvania, 150 square feet of office space in Coral Gables,
Florida and 5,000 square feet of office and warehouse space in St. Ives,
England. The Company believes that its current facilities will be adequate for
the Company's anticipated needs through fiscal 2001. The Company leases its
North American and United Kingdom operating facilities under three operating
leases, expiring in September 2002, March 2001 and in March 2007, respectively.
Rent expense for these facilities was $180,000 and $160,000 for the years ended
June 30, 2000 and 1999, respectively. The Company anticipates that it may
require additional space as its business grows but anticipates no difficulty in
obtaining such space in the vicinity of its current facilities on terms
substantially similar to those of the Company's other current leases.
Item 3. 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 alleged that
certain of the Company's products infringed copyrights and trademarks owned by
the Plaintiffs, and also alleged that the Company had engaged in unfair
<PAGE>
competition. The suit had sought to have the Company enjoined from
manufacturing, marketing, distributing and selling the Company's allegedly
infringing games and from using the allegedly infringing trademarks; to have the
Company recall the allegedly infringing products and related materials from the
distributors and retailers currently selling these products; to require the
Company to pay the Plaintiffs the profits derived from the allegedly infringing
products; and to pay Plaintiffs' legal fees and costs. The Company has recently
entered into a settlement agreement with the Plaintiffs in which the Company
incurred a non-recurring expense of $205,000 charged against the Company's
fiscal 2000 fourth quarter, ended June 30, 2000. This $205,000 charge consisted
of a $160,000 cash payment to the plaintiffs, a $15,000 fee to a third party
consultant and $30,000 in an increased provision for inventory obsolescence. In
total, including outside legal costs, during the year ended June 30, 2000, the
Company incurred $390,568 in costs relating to this litigation, including the
$205,000 charge noted above. These costs are reflected in the Statement of
Operations for the year ended June 30, 2000, as follows: $30,000 in cost of
sales and $360,568 in operating expenses, as detailed in note 18 of the
Consolidated Financial Statements. The settlement does not require the recall of
any eGames products and also does not admit to any infringement by the Company
of the titles named in the suit. Also, under the terms of the settlement, eGames
may continue to sell certain games alleged to infringe on Hasbro's copyrights
through September 30, 2000, at which point these products will be discontinued.
The settlement involves the following titles: Intergalactic Exterminator, 3D
Astro Blaster, Missile Launch, Missile Launch 2000, TetriMania, TetriMania
Master, 3D TetriMania, 3D Maze Man, 3D Chomper, 3D Frogman, 3D Ms. Maze and
Tunnel Blaster. The titles that will be discontinued on September 30, 2000
generated net sales of $2,100,000 and $2,000,000 for fiscal 2000 and 1999,
respectively, or 15% and 20% of net sales for those same fiscal years.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters
The Company's Common Stock is traded on the Nasdaq SmallCap Market System
("Nasdaq") under the symbol EGAM. The following are the range of high and low
bid prices for fiscal 2000 and 1999, as reported by Nasdaq:
High Low
---- ---
Fiscal Year Ended June 30, 2000
-------------------------------
First Quarter $ 3.813 $ 1.969
Second Quarter $ 4.125 $ 2.125
Third Quarter $ 3.281 $ 1.875
Fourth Quarter $ 2.125 $ 0.500
Fiscal Year Ended June 30, 1999
-------------------------------
First Quarter $ 2.125 $ 0.938
Second Quarter $ 1.935 $ 0.938
Third Quarter $ 6.156 $ 1.625
Fourth Quarter $ 4.500 $ 2.375
On September 21, 2000, the Company had approximately 111 shareholders of record.
Shares held by all persons in street name are considered to be one shareholder
of record. The Company has not paid any dividends on its Common Stock. The
Company currently intends to retain earnings, if any, for use in its business
and does not anticipate paying cash dividends in the foreseeable future.
Item 6. Management's Discussion and Analysis of Results of Operations and
Financial Condition
Results of Operations
The following discussion should be read together with the Company's Consolidated
Financial Statements and Notes thereto beginning on page 24.
<PAGE>
Year Ended June 30, 2000 Compared to the Year Ended June 30, 1999
Net Sales
Net sales for the year ended June 30, 2000 were $13,640,000 compared to
$10,022,000 for the year ended June 30, 1999, representing an increase of
$3,618,000 or 36%. The $3,618,000 increase in net sales was primarily
attributable to the Company's expansion of its distribution channels, primarily
within the North American retail marketplace. Within this geographical area, the
Company increased it distribution by expanding its direct sales to both
traditional software retailers and non-traditional software retailers such as
food and drug stores. This distribution strategy has allowed the Company to more
widely distribute its software game titles to more retailers, either on a direct
basis or through third party distributors. During fiscal 2000, the Company's net
sales were comprised of sales into the following markets:
o North American Traditional Retailers - $2,455,000;
o North American Food and Drug Retailers - $1,846,000;
o North American Distributors - $6,528,000; and
o International Markets - $2,811,000.
By comparison, during fiscal 1999, a large portion of the Company's net sales
were through third party distributors, as shown below:
o North American Traditional Retailers - $147,000;
o North American Food and Drug Retailers - $339,000;
o North American Distributors - $6,877,000; and
o International Markets - $2,659,000.
The transition in the Company's distribution strategy has resulted in the
following increases in net sales during fiscal 2000 as compared to fiscal 1999:
o North American Traditional Retailers - $2,308,000 or 1,570%;
o North American Food and Drug Retailers - $1,507,000 or 445%; and
o International Markets - $152,000 or 6%.
These increases were partially offset by a $349,000 or 5% decrease in net sales
to North American Distributors, which was largely due to the Company's
establishment of new direct relationships with retailers in the North American
markets and the Company's transition away from its exclusive distribution
relationship with Infogrames, Inc. (formerly GT Interactive), in April 1999. The
Company's net sales to Infogrames, Inc. accounted for 18% and 65% of the
Company's net sales for the years ended June 30, 2000 and 1999, respectively.
The Company will continue to work to maintain a balanced distribution network
that does not rely on any single distributor or retailer to a material extent.
The Company believes that the software titles that will no longer be sold after
September 30, 2000 pursuant to the settlement agreement between the Company and
Hasbro Interactive (as described in Part I, Item 3, "Legal Proceedings") , had
reached maturity within their respective product life cycles and updates or
replacements were anticipated for these products during the next twelve months.
These products represented net sales of $2,100,000 and $2,000,000 for fiscal
2000 and 1999, respectively, or 15% and 20% of net sales for those same fiscal
years. The Company is working with its retail and distribution customers to
replace these titles with acceptable alternatives from the Company's existing
and newly released product offerings.
The Company's international sales represented 21% and 27% of the Company's net
sales for the 2000 and 1999 fiscal years, respectively. The Company anticipates
that international sales will represent approximately the same percentage of net
sales during fiscal 2001 as occurred in fiscal 2000. The Company's international
sales for the year ended June 30, 2000 increased by $152,000 over sales for the
prior year. Some of the reasons that this increase was not larger include:
increased pricing pressures at retail and increased competition for retail shelf
space from the Company's competitors in these foreign markets.
<PAGE>
During fiscal 2000, the Company completed its transition from publishing
shareware-based PC game software titles to publishing high quality full-release
PC game software titles. Sales of shareware-based software titles amounted to
only $106,000 of the Company's net sales for fiscal 2000 compared to $2,421,000
of the Company's net sales for fiscal 1999.
During fiscal 2000, the Company targeted non-traditional software retailers such
as food and drug stores for opportunities to distribute the Company's products.
As illustrated above, these efforts resulted in net sales of $1,846,000 into
this retail channel in fiscal 2000, or an increase of $1,507,000. In fiscal 2001
the Company has targeted other non-traditional software retailers such as
convenience stores, music stores and bookstores for the sale of the Company's
products.
During fiscal 2000, the Company initiated several programs to increase the sale
of its products over the Internet, including: the roll-out of an improved and
expanded website; improvement of its electronic distribution capabilities by
further developing and expanding its affiliation with Digital River, a leading
distributor of digital software over the Internet; and incorporation of
user-friendly on-line functionality into its products. Sales of the Company's
products via the Internet for fiscal 2000 and 1999 were $177,000 and $51,000,
respectively, or approximately 1% of the Company's net sales during both years.
Product returns experienced by the Company during the years ended June 30, 2000
and 1999 were $2,546,000 and $859,000, respectively, or 19% and 9% of the
Company's net sales, respectively. This $1,687,000 increase in product returns
was caused primarily by the change in the Company's distribution strategy, which
involved expanding the number of distribution partners used to distribute the
Company's products. All of these non-exclusive agreements between the Company
and its distributors allow for product returns or markdowns. Additionally, as
discussed above, the Company experienced a significant increase in net sales
into the food and drug retail channel. All of these sales were "promotional" in
nature, meaning that the products were sold in those retail stores for only six
to eight weeks. As a result of this short selling period, the Company
experienced higher than expected product returns when compared to product
returns from traditional software retail stores where the Company's products
typically have a longer period of time to sell through to consumers. During
fiscal 2001, the Company will be working towards placing its products into
longer-term, non-promotional product displays in the food and drug retail
channels in order to reduce the Company's exposure to product returns in this
channel.
Cost of Sales
Cost of sales for the year ended June 30, 2000 were $5,302,000 compared to
$3,597,000 for the year ended June 30, 1999, representing an increase of
$1,705,000 or 47%. This increase was caused primarily by the $1,090,000 increase
in product costs, $535,000 increase in royalty expense and the $234,000 increase
in freight expense, which were partially offset by a $154,000 decrease in the
provision for inventory obsolescence. Product costs consist mainly of replicated
compact discs, printed materials, protective jewel cases and boxes for certain
products.
Gross Profit Margin
The Company's gross profit margin for fiscal 2000 decreased to 61.1% of net
sales from 64.1% of net sales for fiscal 1999. This 3.0% decrease was caused
primarily by increases, as a percentage of net sales, in royalty, freight and
reclamation expenses of 2.6%, 0.8% and 1.0%, respectively, which were partially
offset by a 0.6% decrease in product cost, as a percentage of net sales,
achieved from higher volume discounts associated with the 36% increase in net
sales for Fiscal 2000. The increase in royalty expense was caused by the
Company's transition away from shareware-based software titles to full-release
software titles that earn, on average, a 10% royalty on net sales. The
increase in freight expense was caused primarily by the Company's increased
distribution requirements and greater reclamation expenses caused by the
increase in product returns experienced from the food and drug retail channel.
<PAGE>
Operating Expenses
Product development expenses for the year ended June 30, 2000 were $860,000
compared to $937,000 for the year ended June 30, 1999, a decrease of $77,000 or
8%. This decrease was caused primarily by a $260,000 decrease in third-party
development costs, which was partially offset by a $185,000 increase in salary
and related costs for full-time employees hired to focus on the Company's
product development and quality assurance efforts.
Selling, general and administrative expenses for the year ended June 30, 2000
were $6,772,000 compared to $4,814,000 for the year ended June 30, 1999, an
increase of $1,958,000 or 41%. This increase was caused primarily by a
$1,189,000 increase in marketing promotional expenses associated with the 36%
increase in net sales. These sales have increasingly been made directly to
retailers, who frequently require the Company to pay various slotting fees and
to participate in promotional programs. Additionally, increases in employment
costs due to the establishment of an internal direct sales force and related
support personnel were incurred to support the Company's growth during fiscal
2000.
Legal settlement costs reflected in the operating expense section of the
Statement of Operation for the year ended June 30, 2000 amounted to
approximately $361,000 during fiscal 2000 in connection with certain trademark
and copyright litigation, as described in Item 3, "Legal Proceedings." These
costs included approximately $186,000 in legal fees incurred during the 2000
fiscal year to defend the litigation and costs associated with the settlement of
the litigation, a cash payment to the plaintiffs of $160,000 and a $15,000 fee
to a third party consultant.
Interest Expense, Net
Net interest expense for the year ended June 30, 2000 was $12,000 compared to
$32,000 for the year ended June 30, 1999, a decrease of $20,000 or 63%. The
decrease was primarily due to the reduction of long-term debt and capital lease
obligations due to normal monthly principal payments made during the year ended
June 30, 2000, and the increase in interest income earned from the Company's
higher cash balances during fiscal 2000.
Provision for Income Taxes
Provision for income taxes for the year ended June 30, 2000 was $81,000 compared
to $180,000 for the year ended June 30, 1999, a decrease of $99,000 or 55%. The
decrease in the provision for income taxes was primarily due to the $309,000
decrease in the Company's income before income taxes for fiscal 2000 along with
the utilization of certain net operating loss carry-forwards that were available
to offset some of the Company's state and federal taxable income.
Net Income
As a result of the factors discussed above, net income decreased to $253,000 for
the year ended June 30, 2000 from $463,000 for the year ended June 30, 1999, a
decrease of $210,000 or 45%.
Weighted Average Common Shares
The weighted average common shares outstanding on a diluted basis increased by
157,572 during the year ended June 30, 2000 to 9,997,013 from 9,839,441 for the
year ended June 30, 1999. During the year ended June 30, 2000, 12,300 shares of
Common Stock were issued in connection with a consulting agreement for services
rendered during the current year. The $30,000 fair value of these shares was
expensed as incurred. Additionally, 136,235 shares of Common Stock were issued
during fiscal 2000 in connection with the exercise of Common Stock options and
warrants.
Liquidity and Capital Resources
As of June 30, 2000, the Company's cash and working capital balances were
$1,139,000 and $3,191,000, respectively, and the Company's total stockholders'
equity balance at June 30, 2000 was $3,697,000.
<PAGE>
Cash used in operating activities was approximately $36,000 for the year ended
June 30, 2000 versus $866,000 in cash provided by operating activities for the
year ended June 30, 1999. This $36,000 in net cash used in operating activities
resulted primarily from increases in inventory, accounts receivable and prepaid
expenses, which were partially offset by increases in accounts payable and
accrued expenses. Additionally, the Company's net income for the year ended June
30, 2000 was $253,000, inclusive of depreciation, amortization and other
non-cash expenses of $484,000.
Net cash used in investing activities for the years ended June 30, 2000 and 1999
were $215,000 and $313,000, respectively. This $215,000 in net cash used in
investing activities reflects purchases of $200,000 in furniture and equipment
and $17,000 in software rights, which were partially offset by $2,000 in net
proceeds from the disposal of certain furniture and equipment.
Net cash provided by financing activities was $79,000 for the year ended June
30, 2000 compared to net cash used in financing activities of $193,000 for the
year ended June 30, 1999. This $79,000 in net cash provided by financing
activities reflects net proceeds from the exercise of Common Stock warrants and
options totaling approximately $229,000, which was partially offset by
repayments of $126,000 in notes payable and $24,000 in capital leases.
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. The Company did not purchase any shares under this stock repurchase
program during the year ended June 30, 2000. As of June 30, 2000, the Company
had purchased 231,900 shares of its Common Stock at an approximate cost of
$501,000, pursuant to its stock repurchase program.
On August 9, 2000, the Company entered into a $2,000,000 revolving credit
facility ("new credit facility") with a commercial bank, which expires on
October 31, 2001. This new credit facility replaced the $1,500,000 revolving
credit facility ("prior credit facility") that it previously had with another
commercial bank. The Company was not in compliance with certain covenants of the
prior credit facility at June 30, 2000. Amounts outstanding under this new
credit facility are charged interest at one-half of one percent above the bank's
current prime rate and such interest is due monthly. The new credit facility is
collateralized by substantially all of the Company's assets and requires the
Company, among other things, to maintain certain financial ratios, such as: a
minimum working capital balance of $1,500,000 and a maximum senior debt to
effective net worth ratio of 1.50 to 1.00. Additionally, this new credit
facility has a minimum effective net worth covenant starting at $3.1 million at
June 30, 2000 and increasing by $150,000 quarterly to a $3.7 million requirement
at June 30, 2001. As of June 30, 2000, the Company was in compliance with each
of those covenants. This new credit facility was established to provide, among
other things, additional working capital to support the Company's anticipated
growth. As of September 26, 2000, the Company had $400,000 outstanding under
this credit facility.
The Company's United Kingdom operation has a $225,000 revolving credit facility
with a commercial bank. Amounts outstanding under this credit facility are
charged interest at two and one-half percent above the bank's current base rate
and such interest is due monthly. As of September 26, 2000, the Company did not
have any outstanding balance under this credit facility, which expires on
September 30, 2001.
The Company's ability to achieve and maintain positive cash flow depends upon a
variety of factors, including the timeliness and success of the collection of
outstanding accounts receivable, the creditworthiness of the primary
distributors and retail customers of the Company's products, the development and
sell-through of the Company's products, the costs of developing, producing and
marketing such products, and various other factors, some of which are beyond the
Company's control. In the future, the Company expects its cash and working
capital requirements to be affected by each of these factors. The Company
believes cash and working capital balances, in addition to the Company's
revolving credit facilities mentioned above, will be sufficient to fund the
Company's operations for the next twelve months. However, there can be no
assurances that the Company will be able to achieve and maintain a positive cash
flow or that additional financing will be available if and when required or, if
available, will be on terms satisfactory to the Company.
<PAGE>
The Company believes that the legal settlement described in Item 3, "Legal
Proceedings", will not have a material impact on the Company's cash flow or
financial condition for the year ending June 30, 2001.
At June 30, 2000, the Company continued to satisfy the minimum level of
stockholders' equity required and all other aspects of its listing agreement for
the Nasdaq SmallCap Market. At June 30, 2000, the Company had $3,402,000 in net
tangible assets.
Year 2000
The Company experienced no significant Year 2000 compliance issues and Year 2000
issues did not have a material effect on the Company's business, operations or
financial condition.
New Accounting Pronouncements
The Company does not expect the adoption of recently issued accounting
pronouncements to have a significant impact on its results of operations,
financial position or cash flows.
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
ability to maintain a balanced distribution network that does not rely on any
single distributor or retailer to a material extent; the Company's ability
during fiscal 2001 to place its products into longer-term, non-promotional
product displays with the non-traditional software retailers and the possibility
of such placement resulting in reduced product returns in these channels; the
placement of the Company's products in food and drug retail stores in
longer-term display units during the back to school and upcoming holiday selling
seasons; the sale of sampler packs of the Company's game titles to increase the
number of PC game players; the Company's ability to create products that will
increase revenues; the growth of the consumer entertainment software market; the
Company's ability during fiscal 2001 to sell its products into other
non-traditional software retailers such convenience stores, music stores and
bookstores for the sale of the Company's products; and the sufficiency of the
Company's cash and working capital balances, in addition to the Company's
revolving credit facilities, to fund the Company's operations for the next
twelve months. 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
Company's ability to sell its products to a number of distributors and retailers
in quantities and on terms that are commercially acceptable; the Company's
ability to continue to enter into additional distribution and direct sales
relationships on commercially acceptable terms; 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-in-a-Store program on commercially acceptable terms; Company's ability to
negotiate lower product promotional costs in its distribution and retail
relationships; increased selling, general and administrative costs, including
increased legal expenses; the Company's ability to penetrate additional
non-traditional retail channels such as convenience stores, music stores and
bookstores for the sale of its products; the allocation of adequate shelf space
for the Company's products in retail stores; the Company's ability to collect
outstanding accounts receivable and establish adequate reserves for
un-collectible 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
<PAGE>
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>
Item 7. Financial Statements
eGames, Inc.
Index to Consolidated Financial Statements
Page
----
Independent Auditors' Report........................................... 23
Consolidated Balance Sheet June 30, 2000............................... 24
Consolidated Statements of Operations for the years
ended June 30, 2000 and 1999........................................... 25
Consolidated Statements of Stockholders' Equity for the years
ended June 30, 2000 and 1999........................................... 26
Consolidated Statements of Cash Flows for the years
ended June 30, 2000 and 1999........................................... 27
Notes to Consolidated Financial Statements............................. 29
<PAGE>
Independent Auditors' Report
The Board of Directors and Stockholders
eGames, Inc.:
We have audited the accompanying consolidated balance sheet of eGames, Inc. and
subsidiary as of June 30, 2000, and the related consolidated statements of
operations, stockholders' equity, and cash flows for the years ended June 30,
2000 and 1999. These consolidated financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
the significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of eGames, Inc. and
subsidiary as of June 30, 2000 and the results of their operations and their
cash flows for the years ended June 30, 2000 and 1999, in conformity with
accounting principles generally accepted in the United States of America.
/s/ KPMG LLP
Philadelphia, Pennsylvania
July 25, 2000, except for notes 8 and 18, which are as of August 9, 2000 and
September 8, 2000, respectively
<PAGE>
eGames, Inc.
Consolidated Balance Sheet
<TABLE>
<CAPTION>
As of
June 30,
ASSETS 2000
------ ----
<S> <C>
Current assets:
Cash and cash equivalents $ 1,139,178
Accounts receivable, net of allowances - $1,329,098 2,742,414
Inventory 2,145,142
Prepaid income taxes and other expenses 263,595
-----------
Total current assets 6,290,329
Furniture and equipment, net 336,135
Intangibles and other assets, net 295,043
-----------
Total assets $ 6,921,507
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Notes payable $ 59,487
Accounts payable 2,073,076
Accrued expenses 798,189
Convertible subordinated debt 150,000
Capital lease obligations 18,971
-----------
Total current liabilities 3,099,723
Capital lease obligations, net of current portion 984
Notes payable, net of current portion 124,220
-----------
Total liabilities 3,224,927
Commitments and contingencies - Notes 6, 7, 8 and 13
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 (6,015,588)
Treasury stock, at cost - 231,900 shares (501,417)
Accumulated other comprehensive loss (69,199)
-----------
Total stockholders' equity 3,696,580
-----------
Total liabilities and stockholders' equity $ 6,921,507
===========
See accompanying notes to consolidated financial statements.
</TABLE>
<PAGE>
eGames, Inc.
Consolidated Statements of Operations
Years ended June 30, 2000 and 1999
<TABLE>
<CAPTION>
2000 1999
---- ----
<S> <C> <C>
Net sales $13,640,160 $10,022,305
Cost of sales 5,301,828 3,596,982
----------- -----------
Gross profit 8,338,332 6,425,323
Operating expenses:
Product development 860,330 936,938
Selling, general and administrative 6,772,136 4,814,345
Legal settlement and related costs 360,568 - 0 -
----------- -----------
Total operating expenses 7,993,034 5,751,283
----------- -----------
Operating income 345,298 674,040
Interest expense, net 11,967 31,761
----------- -----------
Income before income taxes 333,331 642,279
Provision for income taxes 80,750 179,724
----------- -----------
Net income $ 252,581 $ 462,555
=========== ===========
Net income per common share:
- Basic $ 0.03 $ 0.05
=========== ===========
- Diluted $ 0.03 $ 0.05
=========== ===========
Weighted average common shares
outstanding - Basic 9,706,813 9,494,988
Dilutive effect of common stock equivalents 290,200 344,453
----------- -----------
Weighted average common shares
outstanding - Diluted 9,997,013 9,839,441
=========== ===========
See accompanying notes to consolidated financial statements.
</TABLE>
<PAGE>
eGames, Inc.
Consolidated Statements of Stockholders' Equity
Years ended June 30, 2000 and 1999
<TABLE>
<CAPTION>
Common Stock Additional Treasury Stock
------------------------ Paid-in Accumulated ----------------------
Shares Amount Capital Deficit Shares Amount
--------- ------------ ------------ ------------ --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Balance as of June 30, 1998 9,371,200 $ 8,176,826 $ 1,148,550 ($6,730,724) - 0 - $ - 0 -
Net income 462,555
Shares issued in connection with
exercise of warrants and options 312,140 485,063
Purchase of treasury stock 231,900 (501,417)
Foreign currency translation
adjustment
Shares issued in connection with
acquisition 150,000 213,000
--------- ------------ ------------ ------------ --------- ----------
Balance as of June 30, 1999 9,833,340 $ 8,874,889 $ 1,148,550 ($ 6,268,169) 231,900 ($ 501,417)
========= ============ ============ ============ ========= ==========
Net income 252,581
Shares issued in connection with
exercise of warrants and options 136,235 229,345
Shares issued in connection with a
consulting agreement 12,300 30,000
Foreign currency translation
adjustment
--------- ------------ ------------ ------------ --------- ----------
Balance as of June 30, 2000 9,981,875 $ 9,134,234 $ 1,148,550 ( $6,015,588) 231,900 ($ 501,417)
========= ============ ============ ============ ========= ==========
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Accumulated
Other
Comprehensive Stockholders'
Loss Equity
------------- -------------
<S> <C> <C>
Balance as of June 30, 1998 $ - 0 - $ 2,594,652
Net income 462,555
Shares issued in connection with
exercise of warrants and options 485,063
Purchase of treasury stock (501,417)
Foreign currency translation
adjustment (29,915) (29,915)
Shares issued in connection with
acquisition 213,000
------------- -------------
Balance as of June 30, 1999 ($ 29,915) $ 3,223,938
============= =============
Net income 252,581
Shares issued in connection with
exercise of warrants and options 229,345
Shares issued in connection with a
consulting agreement 30,000
Foreign currency translation
adjustment (39,284) (39,284)
------------- -------------
Balance as of June 30, 2000 ($ 69,199) $ 3,696,580
============= =============
See accompanying notes to consolidated financial statements.
</TABLE>
<PAGE>
eGames, Inc.
Consolidated Statements of Cash Flows
Years ended June 30, 2000 and 1999
<TABLE>
<CAPTION>
2000 1999
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $ 252,581 $ 462,555
Adjustments to reconcile net income to net cash
(used in) provided by operating activities:
Depreciation, amortization and other non-cash items 483,991 413,605
Changes in items affecting operations:
Restricted cash 17,560 (1,029)
Accounts receivable (823,859) 173,007
Prepaid expenses (156,839) 891
Inventory (997,145) (206,127)
Accounts payable 1,037,896 (95,956)
Gain on disposal of furniture and equipment (769) - 0 -
Accrued expenses 151,061 118,749
----------- -----------
Net cash (used in) provided by operating activities (35,523) 865,695
Cash flows from investing activities:
Purchase of furniture and equipment (199,726) (192,685)
Proceeds from disposal of furniture and equipment 2,006 - 0 -
Acquisition, net of cash acquired - 0 - (12,929)
Purchase of software rights and other assets (17,395) (107,498)
------- -----------
Net cash used in investing activities (215,115) (313,112)
Cash flows from financing activities:
Purchase of treasury stock - 0 - (501,417)
Repayments of notes payable (126,460) (123,851)
Proceeds from exercise of warrants and stock options 229,345 485,063
Repayments of capital lease obligations (24,224) (52,674)
----------- -----------
Net cash provided by (used in) financing activities 78,661 (192,879)
Effect of exchange rate changes on cash and cash equivalents (2,698) 501
----------- -----------
Net (decrease) increase in cash and cash equivalents (174,675) 360,205
Cash and cash equivalents:
Beginning of period 1,313,853 953,648
----------- -----------
End of period $ 1,139,178 $ 1,313,853
=========== ===========
See accompanying notes to consolidated financial statements.
</TABLE>
<PAGE>
eGames, Inc.
Consolidated Statements of Cash Flows, continued
Years ended June 30, 2000 and 1999
<TABLE>
<CAPTION>
2000 1999
---- ----
<S> <C> <C>
Supplemental cash flow information:
Cash paid for interest $ 40,516 $ 58,409
======== ========
Cash paid for income taxes $236,000 $128,051
======== ========
Non-cash investing and financing activities:
Capital lease additions $ - 0 - $ 26,147
======== ========
150,000 shares of Common Stock issued in connection with
an acquisition - 0 - $213,000
======== ========
12,300 shares of Common Stock issued in connection with
a consulting arrangement $ 30,000 $ - 0 -
======== ========
See accompanying notes to consolidated financial statements.
</TABLE>
<PAGE>
eGames, Inc.
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Description of Business
eGames, Inc. (the "Company"), a Pennsylvania corporation incorporated in July
1992, develops, publishes, markets and sells a diversified line of personal
computer software primarily for consumer entertainment. The Company's product
line enables it to serve customers who are seeking a broad range of
high-quality, value-priced software, primarily distributed on CD-ROM media. The
Company's sales are made through various national distributors on a
non-exclusive basis in addition to direct relationships with 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.
Fair Value of Financial Instruments
The recorded amounts of cash and cash equivalents, accounts receivable, and
accounts payable at June 30, 2000 approximate fair value due to the relatively
short period of time between origination of the instruments and their expected
realization. The Company's debt is carried at cost, which approximates fair
value, as the debt bears interest at rates approximating current market rates
for similar instruments.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all highly
liquid instruments purchased with an original maturity of three months or less
to be cash equivalents.
Inventory
Inventory, consisting primarily of finished goods, is valued at the lower of
cost or market. Cost is determined by the first-in, first-out method (FIFO).
Furniture and Equipment
Furniture and equipment are stated at cost. Depreciation is calculated on the
straight-line method over the estimated useful lives of the assets ranging from
three to five years.
Leasehold improvements are amortized on the straight-line method over the
shorter of the lease term or estimated useful life of the assets. Maintenance
and repair costs are expensed as incurred.
Foreign Currency Translation
Assets and liabilities of the Company's foreign subsidiary operation are
translated into US dollars at the exchange rate in effect as of the balance
sheet date. Revenues and expenses are translated into US dollars at average
exchange rates in effect during the reporting period. The resultant translation
adjustment is reflected as "Accumulated other comprehensive income (loss)", as a
separate component of stockholders' equity of the Consolidated Balance Sheet.
<PAGE>
Long-Lived Assets
In accordance with Statement of Financial Standards (SFAS) No. 121, "Accounting
for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of", the Company records impairment losses on long-lived assets, including
intangible assets, used in operations when indicators of impairment are present
and the undiscounted cash flows estimated to be generated by those assets are
less than the assets' carrying amount.
Intangible Assets
The Company has intangible assets resulting primarily from $308,000 in goodwill
associated with the eGames Europe, Ltd. acquisition on August 14, 1998 and the
purchase of software rights. Accumulated amortization at June 30, 2000 was
$745,000. The Company amortizes its goodwill using the straight-line method over
five years and other intangible assets using the straight-line method over three
years. The Company recorded amortization expense of $210,000 and $249,000 for
the years ended June 30, 2000 and 1999, respectively.
Revenue Recognition
Product Sales:
--------------
Revenue from the sale of products is recognized when the product has been
shipped. Customers generally have the right of return on products purchased from
the Company. The Company recognizes product sales to its customers, in
accordance with the criteria of FASB No. 48, at the time of the sale based on
the following: the selling price is fixed at the date of sale, the buyer is
obligated to pay the Company, title of the product transfers to the buyer, the
buyer has economic substance apart from the Company, the Company does not have
further obligations to assist the buyer in the resale of the product and the
returns can be reasonably estimated at the time of sale. While the Company has
no other obligations to perform future services subsequent to shipment, the
Company provides telephone customer support as an accommodation to purchasers of
its products and as a means of fostering customer loyalty. Costs associated with
this effort are insignificant and, accordingly, are expensed as incurred.
Allowance For Product Returns:
------------------------------
The Company distributes the majority of its products through several third-party
distributors and directly to national and regional retailers. The distribution
of these products is governed by distribution agreements, direct sale agreements
or purchase orders, all of which allow for product returns. The Company records
an allowance for returns as a reduction of gross sales at the time of product
shipment. This allowance, which is included in accounts receivable, is estimated
based primarily upon historical experience, analysis of distributor and retailer
inventories of the Company's products and analysis of retail sell-through of the
Company's products. Actual product returns experienced by the Company during the
years ended June 30, 2000 and 1999 were $2,546,000 and $859,000, respectively,
or nineteen and nine percent of the Company's net sales, respectively.
Software Development Costs
Software development costs are expensed as incurred until technological
feasibility has been established. After technological feasibility has been
established, any additional costs are capitalized in accordance with SFAS No.
86. To date, amounts qualifying for capitalization, net of valuation allowances,
have not been material.
Marketing Promotional Costs
Marketing promotional costs are charged to expense as incurred and were
approximately $1,659,000 and $534,000 for the years ended June 30, 2000 and
1999, respectively.
Income Taxes
The Company uses the asset and liability method of accounting for income taxes.
Under the asset and liability method, deferred tax assets and liabilities are
recognized for the estimated future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. Deferred tax assets and liabilities
are measured using enacted tax rates in effect for the year in which those
temporary differences are expected to be recovered or settled.
<PAGE>
Computation of Earnings Per Share
Net earnings per common share is computed in accordance with SFAS No. 128,
"Earnings per Share". Basic earnings per share is computed by dividing net
earnings by the weighted average number of common shares outstanding during each
year. Diluted earnings per share is computed by dividing net earnings by the
weighted average number of common and common share equivalents outstanding
during each year. Common share equivalents include stock options and warrants
using the treasury stock method.
Accounting for Stock-based Compensation
Stock-based compensation is recognized using the intrinsic value method in
accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees" (APB 25). For disclosure purposes, pro forma net
income (loss) and income (loss) per share data are provided in accordance with
SFAS 123, "Accounting for Stock-Based Compensation" as if the fair value method
had been applied.
Management's Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
New Accounting Pronouncements
The Company does not expect the adoption of recently issued accounting
pronouncements to have a significant impact on its results of operations,
financial position or cash flows.
2. Inventory
Inventory consists of the following:
Finished goods $ 1,718,122
Raw materials 550,193
-----------
2,268,315
Provision for obsolescence (123,173)
-----------
Inventory, net $ 2,145,142
===========
3. Furniture and Equipment
Furniture and equipment consists of the following:
Equipment $ 561,395
Furniture 413,849
Equipment under capital leases 154,332
-----------
1,129,576
Accumulated depreciation (793,441)
-----------
Furniture and equipment, net $ 336,135
<PAGE>
4. Accrued Expenses
Accrued expenses consist of the following:
Accrued marketing promotions $ 256,342
Accrued settlement costs 175,000
Accrued payroll 128,281
Other accrued expenses 238,566
---------
Accrued expenses $ 798,189
=========
5. Notes Payable
Notes payable consists of the following:
Note payable, bearing interest of 11%. Matures on June 2, 2002,
principal and interest of $418 payable monthly. $ 8,884
Note payable to bank, bearing interest at the prime rate plus
2.75%(11.75% at June 30, 2000). Matures on March 24, 2003,
principal and interest of $6,120 payable monthly. The note
is guaranteed by a former officer of the Company and the Small
Business Administration. 174,823
---------
Notes payable $ 183,707
=========
Less current portion 59,487
---------
Long term portion $ 124,220
=========
6. Lease Obligations
The Company leases its North American and United Kingdom operating facilities
under three operating leases, expiring in September 2002, March 2001 and March
2007, respectively. The Company has financed the purchase of office equipment
and vehicles through various operating and capital lease agreements. Rent
expense incurred under the Company's operating leases was $244,000 and $204,000
for the years ended June 30, 2000 and 1999, respectively. The capital lease
obligations are collaterallized by the leased assets, which had a net book value
of approximately $26,000 and $63,000 at June 30, 2000 and 1999, respectively.
Future payments of leases are as follows:
Operating Capital
Leases Leases Total
--------- -------- ---------
2001 $ 247,860 $ 22,421 $ 270,281
2002 237,919 992 238,911
2003 91,168 - 0 - 91,168
2004 55,521 - 0 - 55,521
2005 52,704 - 0 - 52,704
2006 and thereafter 91,560 - 0 - 91,560
--------- -------- ---------
$ 776,732 $ 23,413 $ 800,145
========= -------- =========
Less interest (3,458)
--------
Present value of future lease payments 19,955
Less current portion (18,971)
--------
Long term portion $ 984
========
<PAGE>
7. Convertible Subordinated Debt
In connection with a merger in April 1996, the Company assumed $150,000 of 10%
convertible subordinated debt, maturing in November 2000. The note is
convertible at any time into 46,685 shares of Common Stock at a price of $3.213
per share (the conversion price established at the time of the merger). Interest
is payable quarterly. The convertible debt is subordinated to the note payable
($174,823 at June 30, 2000) guaranteed by the Small Business Administration.
8. Revolving Credit Facilities
On August 9, 2000, the Company entered into a $2,000,000 revolving credit
facility ("new credit facility") with a commercial bank, which expires on
October 31, 2001. This new credit facility replaced the $1,500,000 revolving
credit facility ("prior credit facility") that it previously had with another
commercial bank. The Company was not in compliance with certain covenants of the
prior credit facility at June 30, 2000. Amounts outstanding under this new
credit facility are charged interest at one-half of one percent above the bank's
current prime rate and such interest is due monthly. The new credit facility is
collateralized by substantially all of the Company's assets. The new credit
facility requires the Company, among other things, to maintain certain financial
ratios, such as: a minimum working capital balance of $1,500,000 and a maximum
senior debt to effective net worth ratio of 1.50 to 1.00. Additionally, this new
credit facility has a minimum effective net worth covenant starting at $3.1
million at June 30, 2000 and increasing by $150,000 quarterly to a $3.7 million
requirement at June 30, 2001. As of June 30, 2000, the Company was in compliance
with each of those covenants. This credit facility was established to provide,
among other things, additional working capital to support the Company's
anticipated growth. As of September 26, 2000, the Company had $400,000
outstanding under this credit facility.
The Company's United Kingdom operation has a $225,000 revolving credit facility
with a commercial bank. Amounts outstanding under this credit facility are
charged interest at two and one-half percent above the bank's current base rate
and such interest is due monthly. As of September 26, 2000, the Company did not
have any outstanding balance under this credit facility, which expires on
September 30, 2001.
9. Acquisition
On August 14, 1998, the Company acquired all of the outstanding shares of
Software Partners Publishing and Distribution Ltd. ("Software Partners") in
exchange for 150,000 shares of the Company's Common Stock, valued at
approximately $213,000, which was the estimated fair value of the Company's
Common Stock on the acquisition date. This acquisition was accounted 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 Ltd. ("eGames Europe").
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 unaudited pro-forma
financial information, which is for informational purposes only, is based upon
certain assumptions and estimates and does not necessarily reflect the results
that would have occurred had the acquisition taken place at the beginning of the
period presented, nor are they necessarily indicative of future consolidated
results.
Unaudited Pro-Forma Financial Information
Year Ended
June 30,
1999
------------
Net sales $ 10,080,000
Net income $ 354,000
Net income per diluted share $ 0.04
<PAGE>
10. Income Taxes
The provision for income taxes is comprised of the following components for the
years ended June 30, 2000 and 1999:
2000 1999
---- ----
Current
Federal $ 62,696 $ 60,800
State 7,859 85,151
Foreign 10,195 33,773
-------- ----------
80,750 179,724
Deferred
Federal (273,085) (1,623,400)
State 6,486 (97,299)
-------- ----------
(266,599) (1,720,699)
Valuation allowance 266,599 1,720,699
-------- ----------
Provision for income taxes $ 80,750 $ 179,724
======== ==========
The reconciliation between the statutory federal income tax rate and the
Company's effective rate for income tax expense for the years ended June 30,
2000 and 1999 is as follows:
2000 1999
---- ----
Statutory federal income tax rate 34% 34%
Increase (decrease) in taxes resulting from:
Non-deductible goodwill amortization and other permanent items 8 3
Foreign taxes 2 (7)
Utilization of net operating loss carry-forwards and other (20) (2)
---- ----
Effective rate for income tax expense 24% 28%
==== ====
The tax effect of temporary differences that give rise to significant portions
of the deferred tax assets and deferred tax liabilities at June 30, 2000 and
1999 is as follows:
2000 1999
---- ----
Deferred tax assets:
Accrued expenses and other $ 70,235 $ 112,707
Reserves for accounts receivable and inventory 308,340 204,442
Depreciation 10,714 6,821
Tax credits 9,152 10,003
Net operating losses 1,055,659 1,386,726
---------- ----------
Gross deferred tax assets 1,454,100 1,720,699
Less: Valuation allowance (1,454,100) (1,720,699)
---------- ----------
Net deferred tax assets - 0 - - 0 -
Deferred tax liabilities: - 0 - - 0 -
---------- ----------
Net deferred tax assets (liabilities) $ - 0 - $ - 0 -
========== ==========
<PAGE>
The deferred tax asset is offset by a full valuation allowance as of June 30,
2000, as management currently believes that the deferred tax asset may not be
realized. The valuation allowance for net deferred tax assets decreased by
approximately $267,000 during fiscal 2000. The reduction was a result of net
changes in temporary differences and the reversal of valuation allowance based
on existing taxable income for fiscal 2000.
As of June 30, 2000, the Company had approximately $3,100,000 of net operating
loss carry-forwards ("NOL's") for federal income tax purposes (expiring in years
2011 through 2012), available to offset future federal taxable income. The
Company also has alternative minimum tax credit carry-forwards of approximately
$9,000 to reduce Federal income taxes, which have no expiration date.
Section 382 of the Internal Revenue Code of 1986 subjects the future utilization
of net operating losses to an annual limitation in the event of an ownership
change, as defined. Due to the Company's prior year equity transactions, a
portion of the net operating losses and tax credits of the Company are subject
to an annual limitation of approximately $1,314,000. To the extent that any
single-year limitation is not utilized to the full amount of the limitation,
such unused amounts, which approximated $624,000 at June 30, 2000, are carried
over to subsequent years until the earlier of its utilization or the expiration
of the relevant carry-forward period.
11. Common Stock
On June 30, 1995, the Company amended its articles of incorporation to authorize
the issuance of 40,000,000 shares of Common Stock, without par value, and
10,000,000 shares of preferred stock, without par value.
On June 1, 1999, the Board of Directors adopted a Stockholders Rights Plan (the
"Plan"). The Plan is intended to protect the interests of the Company's existing
stockholders' in the event that the Company is confronted with coercive or
unfair takeover tactics. The Plan contains provisions to safeguard existing
stockholders' in the event of an unsolicited offer to acquire the Company,
whether through a gradual accumulation of shares in the open market, a partial
or two-tiered tender offer that does not treat all stockholders equally, or
other abusive takeover tactics, which the Company's Board of Directors believes
are not in the best interests of the Company's stockholders. These tactics can
unfairly pressure stockholders and deprive them of the full value of their
shares.
The Plan is not intended to prevent a takeover of the Company and will not do so
if the terms are favorable and fair to all stockholders. The declaration of the
rights dividend (the "Rights") should not affect any prospective offer at a fair
price to all stockholders, and will not interfere with a merger or other
business combination transaction approved by the Company's Board of Directors.
The issuance of the Rights will not change the way in which stockholders can
currently trade the Company's shares. The Rights were issued to stockholders of
record on June 21, 1999, and will expire on June 1, 2009. Initially, the Rights
will not be exercisable, certificates will not be sent to any stockholders, and
the Rights will automatically trade with the Common Stock.
The Rights will not be exercisable until ten days after any person or group
becomes the beneficial owner of 15% or more of the Company's Common Stock, or if
any person or group commences a tender or exchange offer which would, if
consummated, result in such person becoming the beneficial owner of 15% or more
of the Company's Common Stock. At that time, separate certificates representing
the Rights will be distributed, and the Rights could then begin to trade
independently from the Company's shares. At no time will the Rights have any
voting power.
The Rights may be redeemed by the Company at $0.01 per Right prior to the time
any person or group has acquired 15% or more of the Company's shares or voting
power. After any person or group has acquired 15% or more of the Company's
shares or voting power, the Rights may be redeemed only with the approval of a
majority of the Continuing Directors. "Continuing Director" means any member of
the Board of Directors who was a member of the Board on June 1, 1999 or any
person who is subsequently elected to the Board if such person is recommended or
approved by a majority of the Continuing Directors.
<PAGE>
If the Rights become exercisable, a holder will be entitled to buy from the
Company one one-hundredth (1/100) of a share of a new Series A Preferred Stock
of the Company at a purchase price of $35. If a person acquires 15% or more of
the Company's Common Stock, each Right not owned by such person would become
exercisable for Common Stock of the Company (or, in certain circumstances, cash,
property or other securities of the Company) having a market value equal to two
times the exercise price of the Right.
12. Stock Options and Warrants
Stock Option Plans:
On August 31, 1994 the Company adopted its 1994 Stock Option Plan (the "1994
Plan") under which options to purchase an aggregate of 132,000 shares of the
Company's Common Stock were granted to officers, directors or employees at an
exercise price of $2.00 and with an expiration date of August 31, 1999. As of
August 31, 1999, 99,000 of the options under the 1994 Plan had been exercised,
at which time the remaining 33,000 options under the 1994 Plan expired. The 1994
Plan has been terminated and no additional options will be granted thereunder.
During 1995, the Company adopted, amended and restated its 1995 Amended and
Restated Stock Option Plan (the "1995 Plan"). At the Company's 1997 Annual
Meeting of Stockholders, the shareholders of the Company approved an amendment
to increase the number of shares available for issuance under the 1995 Plan from
the 950,000 shares of Common Stock approved during the 1996 Annual Meeting of
Stockholders to a total of 1,950,000 shares. The 1995 Plan is administered by
the Board of Directors and provides for the grant of incentive stock options and
non-qualified stock options to employees and eligible independent contractors;
and non-qualified stock options to non-employee directors at prices not less
than the fair market value of a share of Common Stock on the date of grant. The
1995 Plan also provides for automatic grants of options to non-employee
directors of the Company. Each non-employee director will receive options for
10,000 shares of Common Stock upon appointment or election to the board and, in
addition, each director receives options for 5,000 shares of Common Stock on the
first trading day in January of each year that the Company's Common Stock is
available for sale on the Nasdaq SmallCap stock market system. On December 14,
1998, the Company granted options for 25,000 shares of Common Stock to each
non-employee director in lieu of the automatic annual option grants for 5,000
shares to each non-employee director pursuant to the 1995 Plan, which would have
been issued in January 1999.
The expiration of an option and the vesting period will be determined by the
Board of Directors at the time of the grant, but in no event will an option be
exercisable after 10 years from the date of grant, or in the case of
non-employee directors, after 5 years from the date of grant. In most cases,
upon termination of employment, vested options must be exercised by the optionee
within 3 months after the termination of the optionee's employment with the
Company.
Information regarding the stock option plans is as follows:
Number of Weighted Average
Options Exercise Price
--------- --------------
Balances, June 30, 1998 1,226,151 $ 2.08
Granted 549,400 2.00
Canceled (63,819) 1.95
Exercised (41,832) 1.99
--------- ------
Balances, June 30, 1999 1,669,900 $ 2.06
========= ======
Granted 468,000 2.80
Canceled (130,900) 1.97
Exercised (115,000) 1.84
--------- ------
Balances, June 30, 2000 1,892,000 $ 2.27
========= ======
At June 30, 2000, 1,074,382 options outstanding under its various Plans were
vested and 50,168 options were available for issuance under these plans. The
following summarizes information about the Company's stock options outstanding
at June 30, 2000:
<PAGE>
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
---------------------------------------------- -------------------------
Weighted Avg. Weighted Weighted
Number Remaining Avg. Number Avg.
Range of Exercise Outstanding at Contractual Life Exercise Exercisable at Exercise
Prices June 30, 2000 (in years) Price June 30, 2000 Price
--------------- ------------- ---------- ----- ------------- ------
<S> <C> <C> <C> <C> <C>
$1.063 - $2.000 1,067,500 2.34 $1.783 781,432 $1.856
$2.130 - $4.094 824,500 3.89 $2.892 292,950 $2.744
--------------- --------- ---- ------ --------- ------
$1.063 - $4.094 1,892,000 3.01 $2.266 1,074,382 $2.098
========= =========
</TABLE>
The Company applies APB 25 and related interpretations in accounting for its
stock option plans. Had compensation costs for the Company's Plans been
determined under Statement No. 123, the Company's net income (loss) and net
income (loss) per share would have been negatively impacted by the pro forma
amounts indicated below:
<TABLE>
<CAPTION>
Years ended June 30,
2000 1999
---- ----
<S> <C> <C>
Net income (loss) As reported $ 252,581 $ 462,555
Pro forma ($ 576,082) ($ 280,761)
Net income (loss) per share - basic As reported $ 0.03 $ 0.05
Pro forma ($ 0.06) ($ 0.03)
Net income (loss) per share - diluted As reported $ 0.03 $ 0.05
Pro forma ($ 0.06) ($ 0.03)
</TABLE>
The per share weighted-average fair values of stock options granted during the
years ended June 30, 2000 and 1999 were $2.03 and $1.47, respectively, on the
date of grant using the Black-Scholes option-pricing model with the following
assumptions:
Years ended June 30,
2000 1999
---- ----
Dividend Yield 0% 0%
Volatility Factor 119.52% 119.85%
Risk-Free Interest Rate 5.86% - 6.54% 4.41% - 5.35%
Average Expected Option Life 3.00 Years 3.19 Years
On December 14, 1998, the Company granted a total of 75,000 options to its
non-employee Board members. Each non-employee director received 25,000 options
at an exercise price of $1.656, the fair value of the Company's Common Stock on
the date of grant. These options vest over a three-year period and expire after
a period of five years. These options were not issued pursuant to any plan and
were issued in lieu of the automatic annual option grants for 5,000 shares to
each non-employee director pursuant to the 1995 Plan, which would have been
issued in January 1999. During the year ended June 30, 1999, the Company
received approximately $83,000 in net proceeds from the exercise of 41,832 stock
options with exercise prices ranging from $1.83 to $2.00.
During the year ended June 30, 2000, the Company received $211,550 in net
proceeds from the exercise of 115,000 stock options with exercise prices ranging
from $1.50 to $2.00. During the year ended June 30, 2000, the Company granted
468,000 options with exercise prices ranging from $1.06 to $3.56.
Common Stock Warrants:
In April 1995, the Company received $100,000 in connection with the private sale
of a warrant to acquire 220,662 shares of the Company's Common Stock at any time
on or before April 27, 2002 at an exercise price of $0.45 per share. The warrant
holder was also granted certain registration rights for the Common Stock
issuable upon exercise of the warrants, which shares have been registered by the
Company. No value was assigned to these warrants. On October 18, 1995, in
connection with the Company's initial public offering of Common Stock, the
<PAGE>
underwriter was granted 155,000 warrants. These warrants are exercisable at
anytime on or before October 13, 2002 at an exercise price of $3.60 per share.
Registration rights were granted for the Common Stock issuable upon exercise of
the underwriter's warrants, and such Common Stock shares have been registered by
the Company. In addition, 425,000 warrants were issued to the former owners of
Applied Optical Media Corporation. These warrants are exercisable anytime before
October 16, 2002 at an exercise price of $0.50.
Information regarding the warrants is as follows:
Number of Exercise
Warrants Price
-------- -----
Balances, June 30, 1998 838,787 $0.50 - $6.00
Warrants granted - 0 - - 0 -
Warrants canceled - 0 - - 0 -
Warrants exercised (270,308) 0.50 - 2.81
-------- -------------
Balances, June 30, 1999 568,479 $0.50 - $6.00
======== =============
Warrants granted - 0 - - 0 -
Warrants canceled (15,000) 3.60
Warrants exercised (22,185) 0.50 - 2.81
-------- -------------
Balances, June 30, 2000 531,294 $0.50 - $6.00
======== =============
During the year ended June 30, 1999, the Company received net proceeds of
$402,000 from the exercise of 270,308 warrants with exercise prices ranging from
$0.50 to $2.81.
During the year ended June 30, 2000, the Company received net proceeds of
$17,795 from the exercise of 22,185 warrants with exercise prices ranging from
$0.50 to $2.81. Included in the 22,185 of exercised warrants were 6,000 warrants
that were exercised by a warrant holder using the "net issuance" method. That
warrant holder received 5,050 shares of the Company's Common Stock after using
950 shares at $3.158, that day's current market price, in exchange for the
$3,000 in proceeds that would have been due upon the warrants exercise if the
cash method had been used.
13. Commitments and Contingencies
Under various licensing agreements, the Company is required to pay royalties on
the sales of certain products that incorporate licensed content. Royalty expense
under such agreements, which is recorded in cost of sales, was approximately
$1,042,000 and $507,000 for the years ended June 30, 2000 and 1999,
respectively.
The Company has a retirement plan covering substantially all of its eligible
employees. The retirement plan is qualified in accordance with Section 401(k) of
the Internal Revenue Code. Under the plan, employees may defer up to 15% of
their pre-tax salary, but not more than statutory limits. The Company
contributes 50% of each dollar contributed by a participant. The Company's
matching contributions to the plan were $100,000 and $76,000 during the years
ended June 30, 2000 and 1999, respectively. The Company's matching contributions
vest in fifty percent increments over a two-year period.
14. Related Party Transactions
On June 22, 1998, the Company accepted the resignation of Joseph A. Falsetti,
the Company's Chairman and Chief Executive Officer. As the result of the
separation agreement and general release dated June 22, 1998 between the Company
and Mr. Falsetti, the Company expensed approximately $225,000 in severance costs
in the year ended June 30, 1998, which was paid out over the next twelve months
during the year ended June 30, 1999.
15. Major Customers and Export Sales
During the year ended June 30, 2000, the Company had two major customers, which
accounted for approximately 18% and 10% of net sales, respectively, compared to
the year ended June 30, 1999, when the Company had one major customer, which
<PAGE>
accounted for approximately 65% of net sales. During April 1999, the Company
transitioned its previously exclusive distribution agreement with GT Value
Products Corporation ("GT Value Products"), (a division of Infogrames, Inc.)
covering distribution of the Company's products to retailers in North America,
to a non-exclusive distribution relationship. Infogrames, Inc. (formerly GT
Interactive, Inc.) is currently one of the largest distributors of consumer
entertainment software to mass merchants worldwide. During the years ended June
30, 2000 and 1999, Inforgrames, Inc. accounted for approximately 18% and 65%,
respectively, of the Company's net sales. The amount of export sales included in
net sales was approximately $2,811,000 and $2,659,000 or 21% and 27% of the
Company's net sales for the years ended June 30, 2000 and 1999, respectively.
16. 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 two years ended June 30, 2000 and 1999 is based
on the location of the selling entity. Information about the Company's
operations by segmented geographic locations for the years ended June 30, 2000
and 1999 is presented below.
<TABLE>
<CAPTION>
North America United Kingdom Eliminations Consolidated
------------- -------------- ------------ ------------
2000:
<S> <C> <C> <C> <C>
Sales $ 12,211,417 $ 2,302,587 ($ 873,844) $ 13,640,160
Operating Income 296,774 48,524 - 0 - 345,298
Assets $ 6,782,956 $ 1,245,174 ($1,106,623) $ 6,921,507
1999:
Sales $ 8,490,642 $ 2,251,628 ($ 719,965) $ 10,022,305
Operating Income 444,794 229,246 - 0 - 674,040
Assets $ 5,010,286 $ 862,219 ($ 481,739) $ 5,390,766
</TABLE>
17. Comprehensive Income
On July 1, 1998, the Company adopted SFAS 130, "Reporting Comprehensive Income".
This Statement requires that all items that are required to be recognized under
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. Comprehensive income is computed as follows:
Years Ended
June 30,
--------------------------
2000 1999
---- ----
Net income $ 253,000 $ 463,000
Other comprehensive loss:
Foreign currency translation adjustment (39,000) (30,000)
--------- ---------
Comprehensive income $ 214,000 $ 433,000
========= =========
<PAGE>
18. Subsequent Event
On September 8, 2000, the Company and Hasbro Interactive, Inc., Atari
Interactive, Inc., and Zao Elorg d/b/a Elorg Corporation (collectively, the
"Plaintiffs") entered into a settlement agreement with respect to the suit that
the Plaintiffs filed on February 9, 2000 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 alleged that certain of the Company's products
infringed copyrights and trademarks owned by the Plaintiffs, and also alleged
that the Company had engaged in unfair competition. Under the terms of the
settlement, the Company may continue to sell certain games alleged to infringe
on Hasbro's copyrights through September 30, 2000, at which point these products
will be discontinued. The products that will be discontinued on September 30,
2000 amounted to net sales of $2,100,000 and $2,000,000 for fiscal 2000 and
1999, respectively, or 15% and 20% of net sales for those same fiscal years.
The following represents the total cost to the Company relating to this
litigation that is reflected in the Statement of Operations for the year ended
June 30, 2000.
Year Ended
Description of cost relating to this litigation June 30, 2000
----------------------------------------------- -------------
Operating expense:
------------------
Legal fees $ 185,568
Settlement fee to plaintiffs 160,000
Consulting fees 15,000
---------
Total operating expense 360,568
Cost of sales:
--------------
Provision for obsolescence 30,000
---------
Total cost relating to this litigation $ 390,568
=========
Item 8. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
<PAGE>
PART III
Item 9. Directors and Executive Officers of the Registrant
There is hereby incorporated herein by reference the information appearing under
the caption "Election of Directors", under the caption "Executive Officers of
the Company", and under the caption "Compliance with Securities Laws" of the
Registrant's definitive Proxy Statement for its 2000 Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission.
Item 10. Executive Compensation
There is hereby incorporated herein by reference the information appearing under
the caption "Executive Compensation" and under the caption "Election of
Directors" of the Registrant's definitive Proxy Statement for its 2000 Annual
Meeting of Stockholders to be filed with the Securities and Exchange Commission.
Item 11. Security Ownership of Certain Beneficial Owners and Management
There is hereby incorporated herein by reference the information appearing under
the caption "Voting Securities and Principal Holders Thereof" of the
Registrant's definitive Proxy Statement for its 2000 Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission.
Item 12. Certain Relationships and Related Transactions
There is hereby incorporated by reference herein the information appearing under
the caption "Certain Transactions" of the Registrant's definitive Proxy
Statement for its 2000 Annual Meeting of Stockholders to be filed with the
Securities and Exchange Commission.
<PAGE>
PART IV
Item 13. Exhibits, List and Reports on Form 8-K
The following is a list of exhibits filed as part of this
annual report on Form 10-KSB. Where so indicated, exhibits
which were previously filed are incorporated by reference.
Exhibit No. Description of Exhibit
----------- ----------------------
(1) 2.1 Form of Amended and Restated Agreement and Plan of Merger
between and among Applied Optical Media Corporation and the
Registrant ("AOMC Merger Agreement").
(2) 2.2 Agreement and Plan of Reorganization dated April 4, 1996 by
and among the Registrant, the Registrant's wholly-owned
subsidiary and Virtual Reality Laboratories, Inc.
(2) 2.3 Agreement and Plan of Merger dated April 4, 1996 by and
among the Registrant, the Registrant's wholly-owned subsidiary
and Virtual Reality Laboratories, Inc.
(3) 2.4 Sale and Purchase Agreement between the Registrant and the
stockholders of Software Partners Publishing and Distribution
Ltd. Dated August 14, 1998.
(5) 3.1 Amended and Restated Articles of Incorporation of the Registrant.
(6) 3.2.1 By-Laws of the Registrant.
(7) 4.1 Promissory Note in the amount of $350,000 from Virtual Reality
Laboratories, Inc. to Heller First Capital Corporation dated
March 25, 1996; Commercial Security Agreement dated March 25, 1996
between Virtual Reality Laboratories, Inc. and Heller First
Capital Corporation; and U.S. Small Business Administration
Guaranty dated March 25, 1996.
(4) 4.2 Rights Agreement, dated as of June 1, 1999, between the Registrant
and StockTrans, Inc.
(5) 10.1 Form of Redeemable Warrant for the Purchase of the Registrant's
Common Shares (Exhibit A to AOMC Merger Agreement).
(5) 10.2 Form of Underwriter's Warrant Agreement.
(5) 10.3 1994 Stock Option Plan.
(3) 10.4 Amended and Restated 1995 Stock Option Plan.
(8) 10.5 Form of Purchase Agreement for the Class Two Convertible Preferred
Stock (the "Class Two Preferred") dated as of November 15, 1996.
(8) 10.6 Form of Warrant Agreement for the Warrants (the "Warrants") issued
to the holders of the Class Two Preferred dated as of
November 15, 1996.
(8) 10.7 Form of Registration Rights Agreement for the Common Stock
underlying the Class Two Preferred and the Warrants dated as of
November 15, 1996.
(8) 10.8 Form of Agreement amending certain terms of the Class Two
Preferred Certificate of Designation, Warrants and Registration
Rights Agreement dated as of November 15, 1996.
(9) 10.9 Purchase Agreement dated January 30, 1997 between the Registrant
and Odyssey Capital Group, L.P.
<PAGE>
Exhibit No. Description of Exhibit
----------- ----------------------
(9) 10.10 Agreement dated January 30, 1997 between the Registrant and
Odyssey Capital Group, L.P.
(9) 10.11 Registration Rights Agreement dated January 30, 1997 between the
Registrant and Odyssey Capital Group, L.P.
(10) 10.12 Form of Securities Purchase Agreement for the Class Three
Convertible Preferred Stock (the "Class Three Preferred").
(10) 10.13 Form of Warrant Agreement for the Warrants (the "Class Three
Warrants") issued to the holders of the Class Three Preferred.
(10) 10.14 Form of Registration Rights Agreement for the Common Stock
underlying the Class Three Preferred and the Class Three Warrants.
(11) 10.15 Warrant Agreement dated January 30, 1997 by and between
Registrant and PJM Trading Company, Inc.
(3) 10.16 Separation Agreement and General Release dated June 22, 1998
between the Registrant and Joseph A. Falsetti.
(12) 10.17 Loan Agreement dated August 9, 2000 by and between Summit Bank
and the Registrant.
(12) 10.18 Security Agreement dated August 9, 2000 by and between Summit Bank
and the Registrant.
(12) 10.19 $2,000,000 Secured Line of Credit Note.
10.20 Stipulation and Consent Judgement by and between plaintiffs Hasbro
Interactive, Inc., Atari Interactive, Inc., ZAO Elorg, d/b/a Elorg
Corporation and defendants MVP Software Inc., Webfoot
Technologies, Inc. and the Registrant, dated August 16, 2000.
10.21 Description of Registrant's Fiscal 2000 Employee Incentive
Compensation Plan
21.1 Subsidiaries.
23.1 Consent of KPMG LLP.
(13) 24.1 Power of Attorney.
27.1 Financial Data Schedule.
---------------------------------------
(1) Incorporated by reference herein from Amendment No. 3 of the
Registrant's Form SB-2 as filed with the Securities and Exchange
Commission on October 4, 1995.
(2) Incorporated by reference herein from the Registrant's Form 8-K as
filed with the Securities and Exchange Commission on April 19, 1996.
(3) Incorporated herein by reference from the Registrant's Form 10-KSB
for the year ended June 30, 1998 as filed with the Securities and
Exchange Commission on September 10, 1998.
(4) Incorporated by reference herein from the Registrant's Form 8-K as
filed with the Securities and Exchange Commission on June 10, 1999.
(5) Incorporated by reference herein from the Registrant's Form SB-2 as
filed with the Securities and Exchange Commission on July 28, 1995.
(6) Incorporated by reference herein from the Registrant's Form 10-QSB
for the quarter ended September 30, 1998 as filed with the Securities
and Exchange Commission on November 16, 1998.
<PAGE>
(7) Incorporated by reference herein from the Registrant's Form 10-QSB
for the quarter ended March 31, 1996 as filed with the Securities and
Exchange Commission on May 14, 1996.
(8) Incorporated by reference herein from the Registrant's Form 8-K as
filed with the Securities and Exchange Commission on November 27,
1996.
(9) Incorporated by reference herein from the Registrant's Form 8-K as
filed with the Securities and Exchange Commission on February 4,
1997.
(10) Incorporated by reference herein from the Registrant's Form 8-K as
filed with the Securities and Exchange Commission on April 9, 1997.
(11) Incorporated herein by reference from the Registrant's Form 10-KSB
for the year ended June 30, 1997 as filed with the Securities and
Exchange Commission on September 29, 1997.
(12) Incorporated by reference herein from the Registrant's Form 8-K as
filed with the Securities and Exchange Commission on August 17, 2000.
(13) See signature page.
Reports on Form 8-K
On July 27, 2000, the Company filed a report on Form 8-K regarding a press
release announcing the Company's sales and earnings for the year ended June 30,
2000.
On August17, 2000, the Company filed a report on Form 8-K regarding a press
release announcing that it had entered into an agreement with Summit Bank for a
$2 million revolving credit facility that replaces an existing $1.5 million
revolving credit facility with another commercial bank.
On September 13, 2000, the Company filed a report on Form 8-K regarding a press
release announcing the settlement of the trademark and copyright infringement
suit filed by Hasbro Interactive, Inc., Atari Interactive, Inc. and ZAO Elorg
Corporation against the Company in the U.S. District Court in Boston,
Massachusetts.
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
eGames, Inc.
By: /s/ Gerald W. Klein
--- -------------------
Gerald W. Klein,
President and Chief Executive Officer
Date: September 28, 2000
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant and in the capacities and
on the dates indicated.
Date: September 28, 2000 /s/ Gerald W. Klein
------------------ --------------------
Gerald W. Klein,
President and Chief Executive Officer
Date: September 28, 2000 /s/ Thomas W. Murphy
------------------ --------------------
Thomas W. Murphy,
Chief Financial Officer and
Chief Accounting Officer
Each person in so signing also makes, constitutes and appoints Thomas
D. Parente, Chairman of the Board of Directors, and Gerald W. Klein, President
and Chief Executive Officer, and each of them severally, his true and lawful
attorney-in-fact, in his name, place and stead to execute and cause to be filed
with the Securities and Exchange Commission any or all amendments to this
report.
Date: September 28, 2000 /s/ Thomas D. Parente
------------------ ----------------------
Thomas D. Parente
Chairman of the Board of Directors
Date: September 28, 2000 /s/ Robert M. Aiken, Jr.
------------------ -------------------------
Robert M. Aiken, Jr.
Director
Date: September 28, 2000 /s/ Lambert C. Thom
------------------ --------------------
Lambert C. Thom
Director
