-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, E5JnngCFPvDupDz2cqYZ1E94Ofnw8Dde3JXz48a0iXv8yaHw1/tZg1ZV9j1rOp/q /u51oV3h0NDIw4Wg//IrpQ== 0000948703-00-000003.txt : 20000215 0000948703-00-000003.hdr.sgml : 20000215 ACCESSION NUMBER: 0000948703-00-000003 CONFORMED SUBMISSION TYPE: 10QSB PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000214 FILER: COMPANY DATA: COMPANY CONFORMED NAME: EGAMES INC CENTRAL INDEX KEY: 0000948703 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 232694937 STATE OF INCORPORATION: PA FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10QSB SEC ACT: SEC FILE NUMBER: 000-27102 FILM NUMBER: 542732 BUSINESS ADDRESS: STREET 1: 2000 CABOT BLVD STREET 2: SUITE 110 CITY: LANGHORNE STATE: PA ZIP: 19047-1833 BUSINESS PHONE: 2157506606 MAIL ADDRESS: STREET 1: 2000 CABOT BLVD SUITE 110 CITY: LANGHORNE STATE: PA ZIP: 19047-1833 10QSB 1 CURRENT REPORT U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB (Mark One) |X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 31,1999 |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 0-27102 eGames, Inc. (Exact name of registrant as specified in its charter) PENNSYLVANIA 23-2694937 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification Number) 2000 Cabot Boulevard West, Suite 110 Langhorne, PA 19047-1811 (address of Principal executive offices) Issuer's Telephone Number, Including Area Code: 215-750-6606 Not Applicable (Former name, former address and former fiscal year, if changed since last report.) Check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ( X ) No ( ) APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ( ) No ( ) APPLICABLE ONLY TO CORPORATE ISSUERS State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: 9,745,775 shares of common stock, no par value per share, as of February 10, 2000. Transitional Small Business Disclosure Format (check one): Yes ( ) No ( X ) eGames, Inc. INDEX Page ---- Part I. Financial Information Item 1. Financial Statements: Consolidated Balance Sheet as of December 31, 1999........ 3 Consolidated Statements of Operations for the three and six months ended December 31, 1999 and 1998 ...... 4 Consolidated Statements of Cash Flows for the six months ended December 31, 1999 and 1998 .............. 5 Notes to Consolidated Financial Statements................ 6-8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations .................. 8-14 Risk Factors ............................................. 15-19 Part II. Other Information Item 1. Legal Proceedings......................................... 19 Item 4. Submission of Matters to a Vote of Security Holders....... 20 Item 6. Exhibits and Reports on Form 8-K.......................... 20 Signatures .......................................................... 21 Exhibit Index .......................................................... 22 Exhibits .......................................................... 23 Item 1. Financial Statements eGames, Inc. Consolidated Balance Sheet (Unaudited)
As of December 31, ASSETS 1999 ------ ---- Current assets: Cash and cash equivalents $ 858,656 Accounts receivable, net of allowances totaling $1,763,373 4,530,277 Inventory 1,438,631 Prepaid expenses 73,748 ----------- Total current assets 6,901,312 Furniture and equipment, net 327,758 Other assets 384,930 ----------- Total assets $ 7,614,000 =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Note payable $ 52,218 Accounts payable 1,351,127 Accrued expenses 1,219,504 Capital lease obligations 21,820 ----------- Total current liabilities 2,644,669 Capital lease obligations 11,465 Note payable 148,386 Convertible subordinated debt 150,000 ----------- Total liabilities 2,954,520 Stockholders' equity: Common stock, no par value (40,000,000 shares authorized; 9,977,675 issued and 9,745,775 outstanding) 9,122,432 Additional paid in capital 1,148,550 Accumulated deficit (5,090,221) Treasury stock, at cost - 231,900 shares (501,417) Accumulated other comprehensive loss (19,864) ----------- Total stockholders' equity 4,659,480 ----------- Total liabilities and stockholders' equity $ 7,614,000 ===========
See accompanying notes to the consolidated financial statements. eGames, Inc. Consolidated Statements of Operations (Unaudited)
Three months ended Six months ended December 31, December 31, ------------------------- ------------------------- 1999 1998 1999 1998 ---- ---- ---- ---- Net sales $ 4,521,390 $ 3,611,126 $ 8,638,965 $ 6,117,326 Cost of sales 1,561,637 1,136,731 3,164,945 2,017,308 ----------- ----------- ----------- ----------- Gross profit 2,959,753 2,474,395 5,474,020 4,100,018 Operating expenses: Product development 220,745 236,965 463,592 442,632 Selling, general and administrative 1,980,596 1,318,861 3,581,002 2,298,503 ----------- ----------- ----------- ----------- Total operating expenses 2,201,341 1,555,826 4,044,594 2,741,135 ----------- ----------- ----------- ----------- Operating income 758,412 918,569 1,429,426 1,358,883 Interest expense, net 4,977 13,632 10,077 24,281 ----------- ----------- ----------- ----------- Income before income taxes 753,435 904,937 1,419,349 1,334,602 Provision for income taxes 152,107 57,967 241,402 84,267 ----------- ----------- ----------- ----------- Net income $ 601,328 $ 846,970 $ 1,177,947 $ 1,250,335 =========== =========== =========== =========== Net income per common share: - basic $ 0.06 $ 0.09 $ 0.12 $ 0.13 =========== =========== =========== =========== - diluted $ 0.06 $ 0.09 $ 0.12 $ 0.13 =========== =========== =========== =========== Weighted average common shares outstanding - basic 9,697,486 9,469,031 9,665,729 9,455,680 Dilutive effect of common stock equivalents 437,493 189,156 439,866 171,234 ----------- ----------- ----------- ----------- Weighted average common shares outstanding - diluted 10,134,979 9,658,187 10,105,595 9,626,914 =========== =========== =========== ===========
See accompanying notes to the consolidated financial statements. eGames, Inc. Consolidated Statements of Cash Flows (Unaudited)
Six months ended December 31, ------------ 1999 1998 ---- ---- Cash flows from operating activities: Net income $ 1,177,947 $ 1,250,335 Adjustment to reconcile net income to net cash provided by operating activities: Depreciation and amortization 218,542 187,138 Changes in items affecting operations net of effect from acquired business: Restricted cash 17,560 508 Accounts receivable (2,585,142) (1,946,243) Prepaid expenses 36,251 35,232 Inventory (281,966) (286,555) Accounts payable 307,199 363,767 Accrued expenses 590,047 283,327 ----------- ----------- Net cash used in operating activities (519,562) (112,491) ----------- ----------- Cash flows from investing activities: Acquisition, net of cash acquired - 0 - (12,428) Purchase of furniture and equipment (65,669) (122,790) Purchase of software rights and other assets (1,225) (54,490) ----------- ----------- Net cash used in investing activities (66,894) (189,708) ----------- ----------- Cash flows from financing activities: Purchase of treasury stock - 0 - (247,534) Proceeds from exercise of warrants and stock options 247,543 - 0 - Borrowings under line of credit agreement 250,000 - 0 - Payments under line of credit agreement (250,000) - 0 - Repayment of notes payable (105,078) (85,581) Repayment of lease obligations (13,004) (36,694) ----------- ----------- Net cash (used in) provided by financing activities 129,461 (369,809) ----------- ----------- Effect of exchange rate changes on cash and cash equivalents 1,798 502 ----------- ----------- Net decrease in cash and cash equivalents (455,197) (671,506) Cash and cash equivalents: Beginning of period 1,313,853 953,648 ----------- ----------- End of period $ 858,656 $ 282,142 =========== =========== Supplemental cash flow information: Cash paid for interest $ 20,722 $ 36,835 =========== =========== Cash paid for income taxes $ 236,000 $ 72,500 =========== =========== Non cash investing and financing activities: Capital lease additions $ - 0 - $ 24,915 =========== =========== 150,000 shares of Common Stock issued in connection with an acquisition $ - 0 - $ 213,000 =========== ===========
See accompanying notes to the consolidated financial statements. eGames, Inc. Notes to Consolidated Financial Statements 1. Summary of Significant Accounting Policies Basis of Presentation The accompanying unaudited interim consolidated financial statements were prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The Notes to Consolidated Financial Statements included in the Company's Form 10-KSB for the fiscal year ended June 30, 1999 should be read in conjunction with the accompanying statements. These statements include all adjustments the Company believes are necessary for a fair presentation of the statements. The interim operating results are not necessarily indicative of the results for a full year. Description of Business eGames, Inc. (the "Company"), a Pennsylvania corporation incorporated in July 1992, develops, publishes, markets and sells a diversified line of personal computer software primarily for consumer entertainment. The Company's product line enables it to serve customers who are seeking a broad range of high-quality, value-priced software. The Company's sales are made through various national distributors on a non-exclusive basis in addition to direct relationships with certain national and regional retailers. Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary. All inter-company balances and transactions have been eliminated. 2. Acquisition On August 14, 1998, the Company acquired all of the outstanding shares of Software Partners Publishing and Distribution Limited ("Software Partners"), in exchange for 150,000 shares of the Company's Common Stock, valued at approximately $213,000, which was the fair value of the Company's Common Stock on the closing date of the acquisition. This acquisition was accounted for as a purchase and the corresponding goodwill in the approximate amount of $308,000 is being amortized over five years. On March 31, 1999, Software Partners changed its name to eGames Europe Limited ("eGames Europe"). For the quarters ended December 31, 1999 and 1998, eGames Europe contributed $612,000 and $719,000, respectively, in net sales as well as $113,000 and $158,000, respectively, in net income exclusive of inter-company charges. For the six months ended December 31, 1999 and 1998, eGames Europe contributed $1,189,000 and $1,020,000, respectively, in net sales as well as $191,000 and $264,000, respectively, in net income exclusive of inter-company charges. The following summary of unaudited pro-forma financial information gives effect to the eGames Europe acquisition as though it had occurred on July 1, 1998, after giving effect to certain adjustments, primarily the elimination of inter-company sales and amortization of goodwill. The pro-forma financial information, which is for informational purposes only, is based upon certain assumptions and estimates and does not necessarily reflect the results that would have occurred had the acquisition taken place at the beginning of the period presented, nor are they necessarily indicative of future consolidated results. Notes to Consolidated Financial Statements (continued) Unaudited Pro-Forma Financial Information Six Months Ended December 31, 1998 ----------------- Net sales $6,175,000 Net income $1,142,000 Net income per diluted share $ 0.12 3. Comprehensive Income On July 1, 1998, the Company adopted SFAS 130, "Reporting Comprehensive Income". This Statement requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. Comprehensive income is computed as follows:
Three Months Ended Six Months Ended December 31, December 31, ------------------------ ----------------------- 1999 1998 1999 1998 ---- ---- ---- ---- Net income $ 601,000 $ 847,000 $1,178,000 $1,250,000 Other comprehensive income: Foreign currency translation adjustment (9,000) (5,000) 10,000 1,000 ---------- ---------- ---------- ---------- Comprehensive income $ 592,000 $ 842,000 $1,188,000 $1,251,000 ========== ========== ========== ==========
4. Common Stock On October 26, 1998, the Company's Board of Directors authorized the Company to purchase up to $1,000,000 of its shares of Common Stock in open-market purchases on the Nasdaq SmallCap Market. During the six months ended December 31, 1999 the Company did not purchase any shares of its Common Stock. As of December 31, 1999, the Company had acquired 231,900 shares of its Common Stock, with an approximate cost of $501,000, pursuant to its stock repurchase program. 5. Operations by Reportable Segments and Geographic Area The Company adopted SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information", as of July 1, 1998. SFAS No. 131 establishes standards for reporting information about an enterprise's operating segments and related disclosures about its products, geographic areas and major customers. The Company publishes interactive entertainment software for PCs. Based on its organizational structure, the Company operates in only one non-geographic, reportable segment, which is publishing. The President and Chief Executive Officer allocates resources to each of the geographical areas in which the Company operates using information on their respective revenues and operating profits before interest and taxes. The President and Chief Executive Officer has been identified as the Chief Operating Decision Maker as defined by SFAS No. 131. The accounting policies of these segments are the same as those described in the Summary of Significant Accounting Policies. Revenue derived from sales between segments is eliminated in consolidation. Notes to Consolidated Financial Statements (continued) Geographic information for the quarters and six months ended December 31, 1999 and 1998 is based on the location of the selling entity. The Company records international sales from both the United States and United Kingdom locations. Information about the Company's operations by segmented geographic locations for the quarters and six months ended December 31, 1999 and 1998 is presented below.
Quarters ended - -------------- United States United Kingdom Eliminations Consolidated ------------- -------------- ------------ ------------ December 31, 1999: - ------------------ Sales $ 4,184,000 $ 612,000 ($ 275,000) $ 4,521,000 Operating income 731,000 27,000 - 0 - 758,000 Assets $ 7,845,000 $ 1,176,000 ($1,407,000) $ 7,614,000 December 31, 1998: - ------------------ Sales $ 3,079,000 $ 719,000 ($ 187,000) $ 3,611,000 Operating income 793,000 126,000 - 0 - 919,000 Assets $ 6,061,000 $ 1,307,000 ($ 579,000) $ 6,789,000 Six months ended - ---------------- United States United Kingdom Eliminations Consolidated ------------- -------------- ------------ ------------ December 31, 1999: - ------------------ Sales $ 7,890,000 $ 1,189,000 ($ 440,000) $ 8,639,000 Operating income 1,384,000 45,000 - 0 - 1,429,000 Assets $ 7,845,000 $ 1,176,000 ($1,407,000) $ 7,614,000 December 31, 1998: - ------------------ Sales $ 5,342,000 $ 1,020,000 ($ 245,000) $ 6,117,000 Operating income 1,148,000 211,000 - 0 - 1,359,000 Assets $ 6,061,000 $ 1,307,000 ($ 579,000) $ 6,789,000
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The accompanying consolidated financial statements as of December 31, 1999 include the accounts of eGames, Inc., (the "Company"), and its wholly-owned subsidiary. Results of Operations Three Months Ended December 31, 1999 and 1998 Net Sales Net sales for the quarter ended December 31, 1999 were $4,521,000 compared to $3,611,000 for the quarter ended December 31, 1998, representing an increase of $910,000 or 25%. For the quarter ended December 31, 1999, the Company's net sales were comprised of full-release game products (87%), shareware-based products (0%), personal productivity products (5%) and non-eGames products (8%). For the quarter ended December 31, 1998, the Company's net sales were comprised of full-release game products (51%), shareware-based products (34%), personal productivity products (14%) and non-eGames products (1%). These changes in products sold reflect the Company's transition from publishing and distributing primarily shareware-based products to full-release, proprietary products, which transition began during the first quarter of fiscal 1999. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) The Company's international sales for the quarter ended December 31, 1999 were $766,000 or 17% of net sales, compared to $808,000 or 22% of net sales for the quarter ended December 31, 1998, representing a decrease of $42,000 or 5% of net sales. The decrease in international sales from quarter to quarter can be attributed, primarily to pricing pressures and increased competition in the United Kingdom. Until April 1999, the Company primarily distributed its entertainment software products in North America through a large national distributor, GT Value Products, a division of GT Interactive Software Corporation. At that time, the Company terminated its exclusive distribution agreement with GT Value Products and began entering into non-exclusive distribution agreements with various national distributors, including GT Value Products. The Company has also entered into several direct sales relationships with certain retailers. This distribution strategy is intended to diversify the Company's distribution channels to retail, provide for more effective inventory management, merchandising and communications with retailers, diminish the Company's dependence on any one third-party distributor for sales of the Company's products, and increase the potential gross profit margin that may be realized on the sale of its products. The Company continues to distribute its products through GT Value Products to certain mass merchandise retailers that purchase value-priced software exclusively through GT Value Products. The Company's net sales to GT Value Products accounted for 8% and 77% of the Company's net sales for the quarters ended December 31, 1999 and 1998, respectively. For the quarters ended December 31, 1999 and 1998, sales of the Company's products to other distributors accounted for approximately 33% and 8% of the Company's net sales, while direct sales to retailers accounted for approximately 59% and 15% of the Company's net sales during those same periods, respectively. The Company has continued to take steps to increase distribution of its products via the Internet, including improving and expanding its web site; establishing electronic distribution capabilities over the Internet; and incorporating on-line functionality into existing products. Sales of the Company's products via the Internet represented less than 1% of the Company's net sales for the quarters ended December 31, 1999 and 1998, respectively. During the quarters ended December 31, 1999 and 1998, the Company's provision for product returns was approximately $805,000 and $97,000, respectively, or 15% and 3% of the Company's gross sales, respectively. The Company has increased its provision for product returns primarily as a result of higher returns caused by the change in the Company's distribution relationship with GT Value Products, as well as the Company's other recently established distribution and direct retail relationships, all of which allow for product returns. The Company may also experience a higher return rate as a result of distribution of more of the Company's products into non-traditional retail stores, such as drug stores and supermarkets. The Company expects the return rates from these stores to be higher than returns experienced historically from retail stores that have traditionally sold PC software products. Cost of Sales and Gross Profit Margin Cost of sales for the quarter ended December 31, 1999 were $1,562,000 compared to $1,137,000 for the quarter ended December 31, 1998, representing an increase of $425,000 or 37%. This increase was caused primarily by the 25% increase in product sales along with increases in freight and royalty costs associated with the Company's expanded distribution of its full-release software titles into new and existing retail relationships. While a year ago sales of the Company's products had been achieved largely by shipping products to a small number of distributors and retailers, for the quarter ended December 31, 1999, the Company shipped approximately 59% of its products directly to retailers compared to only 15% of its products being shipped directly to retailers during the quarter ended December 31, 1998, resulting in higher shipping, handling and freight costs. Product costs consist mainly of replicated compact discs, printed materials, protective jewel cases and boxes for certain products. Gross profit margin for the quarter ended December 31, 1999 decreased to 65.5%, from 68.5% for the quarter ended December 31, 1998. This decrease in gross profit margin was caused primarily by increased freight costs associated with the Company's expansion into new retail opportunities, and increased royalty costs associated with the Company's transition to publishing and distributing primarily full-release products. These increased Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) freight and royalty costs were partially offset by a decrease in product costs resulting from a reduction in per-unit product costs due to volume discounts. Operating Expenses Product development expenses for the quarter ended December 31, 1999 were $221,000 compared to $237,000 for the quarter ended December 31, 1998, a decrease of $16,000 or 7%. This decrease was caused primarily by a decrease in outside labor costs, which was partially offset by an increase in salary and related costs for employees hired to focus on the Company's product development and quality assurance efforts in conjunction with the Company's transition from publishing and distributing primarily shareware-based products to full-release, proprietary products. Selling, general and administrative expenses for the quarter ended December 31, 1999 were $1,981,000 compared to $1,319,000 for the quarter ended December 31, 1998, an increase of $662,000 or 50%. This increase was caused primarily by an increase in initial marketing promotional costs incurred to gain additional retail shelf space at both new and existing retail stores, and to promote the Company's products in order to achieve the 25% increase in net sales. The Company believes that these promotional costs will continue to be incurred, but may decline over time as the Company's newer retail relationships develop and mature from a promotional product launch phase, into a more established and recurring order phase. Marketing promotional costs primarily include: slotting fees, in-store ads, mail-in consumer rebates and display costs. Additionally, the Company incurred increases in salary and related costs and operating expenses incurred by the Company's sales and distribution operation in the United Kingdom. Interest Expense, net Net interest expense for the quarter ended December 31, 1999 was $5,000 compared to $14,000 for the quarter ended December 31, 1998, a decrease of $9,000 or 64%. The primary reason for this decrease was the reduction in notes payable and capital lease obligations due to scheduled principal payments. Provision for Income Taxes Provision for income taxes for the quarter ended December 31, 1999 was $152,000 compared to $58,000 for the quarter ended December 31, 1998, an increase of $94,000. The increase in the provision for income taxes was primarily due to the increase in the quarterly effective income tax rate to 20% for the quarter ended December 31, 1999 compared to 6% for the quarter ended December 31, 1998. This change reflects the limitation of certain net operating loss carryforwards not available to offset federal and state taxable income. Net Income Net income for the quarter ended December 31, 1999 was $601,000 compared to $847,000 for the quarter ended December 31, 1998, a decrease of $246,000 or 29%. This decrease in profitability resulted primarily from an increase in operating expenses necessary to support the Company's increased sales and the increase in the Company's effective income tax rate, which costs were partially reduced by the increase in gross profit derived from the 25% increase in net sales. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Results of Operations Six Months Ended December 31, 1999 and 1998 Net Sales Net sales for the six months ended December 31, 1999 were $8,639,000 compared to $6,117,000 for the six months ended December 31, 1998, representing an increase of $2,522,000 or 41%. For the six months ended December 31, 1999, the Company's net sales were comprised of full-release game products (79%), shareware-based products (0%), personal productivity products (10%) and non-eGames products (11%). For the six months ended December 31, 1998, the Company's net sales were comprised of full-release game products (46%), shareware-based products (37%), personal productivity products (14%) and non-eGames products (3%). These changes in products sold reflect the Company's transition from publishing and distributing primarily shareware-based products to full-release, proprietary products, which transition began during the first six months of fiscal 1999. The Company's international sales for the six months ended December 31, 1999 were $1,415,000 or 16% of net sales, compared to $1,259,000 or 21% of net sales for the six months ended December 31, 1998, representing an increase of $156,000 or 12%. The increase in international sales can be primarily attributed to an increase in non-recurring special order sales under an original equipment manufacture ("OEM") agreement, which was partially reduced by the decrease in traditional sales in the United Kingdom experienced as a result of pricing pressures and increased competition. The Company's net sales to GT Value Products accounted for 15% and 74% of the Company's net sales for the six months ended December 31, 1999 and 1998, respectively. For the six months ended December 31, 1999 and 1998, sales of the Company's products to other distributors accounted for approximately 33% and 13% of the Company's net sales, while direct sales to retailers accounted for approximately 52% and 13% of the Company's net sales, respectively. Sales of the Company's products via the Internet represented less than 1% of the Company's net sales for the six months ended December 31, 1999 and 1998, respectively. During the six months ended December 31, 1999 and 1998, the Company's provision for product returns was approximately $1,846,000 and $112,000, respectively, or 18% and 2% of the Company's gross sales, respectively. The Company has increased its provision for product returns primarily as a result of higher returns caused by the change in the Company's distribution relationship with GT Value Products, as well as the Company's other recently established distribution and direct retail relationships, all of which allow for product returns. The Company may also experience a higher return rate as a result of distribution of more of the Company's products into non-traditional retail stores, such as drug stores and supermarkets. The Company expects the return rates from these stores to be higher than returns experienced historically from retail stores that have traditionally sold PC software products. Cost of Sales and Gross Profit Margin Cost of sales for the six months ended December 31, 1999 were $3,165,000 compared to $2,017,000 for the six months ended December 31, 1998, representing an increase of $1,148,000 or 57%. This increase was caused primarily by the 41% increase in product sales along with increases in freight and royalty costs associated with the Company's expanded distribution of its full-release software titles into new and existing retail relationships. While a year ago sales of the Company's products had been achieved largely by shipping products to a small number of distributors and retailers, for the six months ended December 31, 1999, the Company shipped approximately 52% of its products directly to retailers compared to only 13% of its products during the six months ended December 31, 1998, resulting in higher shipping, handling and freight costs. Product costs consist mainly of replicated compact discs, printed materials, protective jewel cases and boxes for certain products. Gross profit margin for the six months ended December 31, 1999 decreased to 63.4%, from 67.0% for the six months ended December 31, 1998. This decrease in gross profit margin was Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) caused primarily by increased freight costs associated with the Company's expansion into new retail opportunities, and increased royalty costs associated with the Company's transition to publishing and distributing primarily full-release products. These cost increases were partially offset by a decrease in product costs resulting from a reduction in per-unit product costs due to volume discounts. Operating Expenses Product development expenses for the six months ended December 31, 1999 were $464,000 compared to $443,000 for the six months ended December 31, 1998, an increase of $21,000 or 5%. This increase was caused primarily by an increase in salary and related costs for employees hired to focus on the Company's product development and quality assurance efforts caused by the Company's significant increase in the development of full-release products during the six months ended December 31, 1999 as compared to the six months ended December 31, 1998, which costs were partially offset by a decrease in outside service expenses related to various external development projects. Selling, general and administrative expenses for the six months ended December 31, 1999 were $3,581,000 compared to $2,299,000 for the six months ended December 31, 1998, an increase of $1,282,000 or 56%. This increase was caused primarily by an increase in initial marketing promotional costs incurred to gain additional retail shelf space at both new and existing retail stores, and to promote the Company's products in order to achieve the 41% increase in net sales. The Company believes that these promotional costs will continue to be incurred, but may decline over time as the Company's newer retail relationships develop and mature from a promotional product launch phase, into a more established and recurring order phase. Marketing promotional costs primarily include: slotting fees, in-store ads, mail in consumer rebates and display costs. Additionally, the Company incurred increases in salary and related costs and operating expenses incurred by the Company's sales and distribution operation in the United Kingdom. Interest Expense, net Net interest expense for the six months ended December 31, 1999 was $10,000 compared to $24,000 for the six months ended December 31, 1998, a decrease of $14,000 or 58%. The primary reason for this decrease was the reduction in notes payable and capital lease obligations due to scheduled principal payments. Provision for Income Taxes Provision for income taxes for the six months ended December 31, 1999 was $241,000 compared to $84,000 for the six months ended December 31, 1998, an increase of $157,000. The increase in the provision for income taxes was primarily due to the increase in the year to date effective income tax rate to 17% for the six months ended December 31, 1999 compared to 6% for the six months ended December 31, 1998. This change reflects the limitation of certain net operating loss carryforwards not available to offset federal and state taxable income. Net Income Net income for the six months ended December 31, 1999 was $1,178,000 compared to $1,250,000 for the six months ended December 31, 1998, a decrease of $72,000 or 6%. This decrease in profitability resulted primarily from an increase in operating expenses necessary to support the Company's increased sales and the increase in the Company's effective income tax rate, which costs were partially reduced by the increase in gross profit derived from the 41% increase in net sales. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Liquidity and Capital Resources As of December 31, 1999, the Company's cash and working capital balances were $859,000 and $4,257,000, respectively, and the Company's total stockholders' equity balance at December 31, 1999 was $4,659,000. The Company's cash balance has decreased by $455,000 since June 30, 1999, primarily as a result of reduced cash collections from the Company's customers and additional cash payments relating to promotional activities incurred to support the 41% growth in net sales for the six months ended December 31, 1999 compared to the same six month period last fiscal year. Additionally, the Company experienced a gradual slowing in receivable collections from one of its existing distributors during the first six months of fiscal 2000. Subsequent to December 31, 1999, the Company has had discussions with this distributor regarding improvements in cash collections from this distributor over the remaining six months of fiscal 2000. At December 31, 1999, this distributor represented approximately 29% of the Company's accounts receivable. Since December 31, 1999, the Company has received payments from this distributor totaling approximately $685,000, which represented 72% of the past due balance as of December 31, 1999 and 38% of the total receivable balance with this distributor as of December 31, 1999. Net cash used in operating activities for the six months ended December 31, 1999 and 1998 were $520,000 and $112,000, respectively. The $520,000 net cash used in operating activities for the six months ended December 31, 1999 resulted primarily from increases in accounts receivable and inventory, which were partially offset by increases in the Company's net income adjusted for non-cash depreciation and amortization expense, accounts payable and accrued expenses. As indicated in the accompanying financial statements, the Company's net income for the six months ended December 31, 1999 was $1,178,000 and the Company's net income for the six months ended December 31, 1998 was $1,250,000. Net cash used in investing activities for the six months ended December 31, 1999 and 1998 were $67,000 and $190,000, respectively. The $67,000 in net cash used in investing activities for the six months ended December 31, 1999 resulted from the purchase of additional furniture and equipment needed to support the increase in personnel necessary to facilitate the continued growth in the Company's sales. Net cash provided by financing activities for the six months ended December 31, 1999 was $130,000 and net cash used in financing activities for the six months ended December 31, 1998 was $370,000. During the six months ended December 31, 1999, the Company received net proceeds from the exercise of Common Stock options totaling $248,000, and made repayments of notes payable and capital lease obligations of $105,000 and $13,000, respectively. Additionally, during the six months ended December 31, 1999, the Company borrowed and repaid $250,000 under its current revolving credit facility. On September 28, 1999, the Company entered into an agreement with a commercial bank to extend and increase its existing $1 million revolving credit facility to a $1.5 million revolving credit facility expiring October 31, 2000. This credit facility was established to provide, among other things, additional working capital to support the Company's anticipated growth. Amounts outstanding under this credit facility are charged interest at one-half of one percent above the bank's current prime rate and such interest is due monthly. The credit facility is collaterallized by substantially all of the Company's assets. The credit facility requires the Company, among other things, to maintain certain financial ratios, such as: a minimum working capital balance of $1,500,000 and a maximum debt to net tangible assets ratio of 1.50 to 1.00. As of December 31, 1999, the Company was in compliance with each of those covenants and did not have an outstanding balance under this revolving credit facility. On October 26, 1998, the Company's Board of Directors authorized the Company to purchase up to $1,000,000 of its shares of Common Stock in the Nasdaq SmallCap Market. During the six months ended December 31, 1999 the Company did not purchase any shares of its Common Stock. As of December 31, 1999, the Company had acquired 231,900 shares of its Common Stock, at an approximate cost of $501,000, pursuant to its stock repurchase program. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) The Company's ability to achieve and maintain positive cash flow depends upon a variety of factors, including the timeliness and success of the collection of outstanding accounts receivable, the creditworthiness of the distributors and retailers that purchase the Company's products, the successful development and sell-through of the Company's products, the costs of developing, producing and marketing such products, and various other factors, some of which are beyond the Company's control. In the future, the Company expects its cash and working capital requirements to be affected by each of these factors. The Company believes cash and working capital balances will be sufficient to fund the Company's operations for the foreseeable future. However, there can be no assurances that the Company will be able to achieve and maintain a positive cash flow or that additional financing will be available if and when required or, if available, will be on terms satisfactory to the Company. Forward-Looking Statements This report contains statements that are forward-looking, as that term is defined by the Private Securities Litigation Reform Act of 1995 and by the Securities and Exchange Commission in rules, regulations and releases. These statements include, but are not limited to, statements regarding: the Company's efforts to diversify the distribution channels used to distribute its products in order to diminish the Company's dependence on any one third-party distributor or retailer and provide for more effective inventory management, merchandising and communications with retailers; the Company's expectations regarding increased product returns caused by the change in the Company's distribution relationships as well as increased distribution of its products into non-traditional retail stores; the Company's belief that product promotional costs will continue to be incurred, but may decline over time; the ability of the Company's localized products to further penetrate foreign markets; the sufficiency of the Company's cash and working capital balances to fund the Company's operations in the future; and the increase in the Company's gross profit margin. All forward-looking statements are based on current expectations regarding significant risk factors, and such statements should not be regarded as a representation by the Company or any other person that the results expressed in this report will be achieved. The following important factors, among others discussed elsewhere in this report, could cause the Company's actual results to differ materially from those indicated by the forward-looking statements contained in this report: the success of the Company's new distribution strategy, including its ability to enter into new distribution and direct sales relationships on commercially acceptable terms; the market acceptance and successful sell-through of the Company's existing and new products in the United States and international markets; the allocation of adequate shelf space for the Company's products in major retail chain stores; the Company's ability to negotiate lower product promotional costs in its distribution and retail relationships; the Company's ability to collect outstanding accounts receivable and establish adequate reserves for uncollectible receivables; the amount of returns of the Company's products from distributors and retailers and the Company's ability to establish adequate reserves for product returns; the continued increase in the number of computers in homes in North America and the world; the ability to deliver products in response to orders within a commercially acceptable time frame; downward pricing pressure; fluctuating costs of developing, producing and marketing the Company's products; the Company's ability to license or develop quality content for its products; the Company's ability to access alternative distribution channels and the success of the Company's efforts to develop its Internet sales; consumers' continued demand for value-priced software; increased competition in the value-priced software category; and various other factors, many of which are beyond the Company's control. The Company does not undertake to update any forward-looking statement made in this report or that may be made from time to time by or on behalf of the Company. Risk Factors The discussion below highlights some of the more important risks identified by management, but should not be assumed to be the only factors that could affect future performance. Early Stage Company; Consumer Entertainment Software Business; Maintaining Profitability. The Company commenced operations in July 1992. The Company experienced significant losses from inception through the end of fiscal 1997. Fiscal 1998 was the first year that the Company earned a profit. After earning $463,000 and $1,253,000 in fiscal 1999 and 1998, respectively, the accumulated deficit for the Company at June 30, 1999 was approximately $6,268,000. For the six months ended December 31, 1999, the Company earned $1,178,000 in net income and the accumulated deficit was approximately $5,090,000. Prior to fiscal 1998, the Company's operations were funded primarily through proceeds from the Company's initial public offering of Common Stock in October 1995 and through the sale in private offerings of preferred stock and Common Stock warrants in November 1996 and in January and April 1997. Subsequently, the Company has funded its activities through income from operations. The Company's operations today are still subject to all of the risks inherent in the development of a recently profitable business, particularly in a highly competitive industry, including, but not limited to, development, distribution and marketing difficulties, competition and unanticipated costs and expenses. The Company's future success will depend upon its ability to increase revenues from the development, marketing and distribution of its current and future software products. The development of multimedia software products, which can combine text, sound, high quality graphics, images and video, is difficult and time consuming, requiring the coordinated participation of various technical and marketing personnel and outside developers. Other factors affecting the Company's future success include, but are not limited to, the ability of the Company to overcome problems and delays in product development, market acceptance of products and successful implementation of its sales, distribution and marketing strategy. There can be no assurance the Company will be successful in maintaining and expanding a sustainable consumer entertainment software business. Dependence On Distributors And Retailers; Risk Of Customer Business Failure; Product Returns. Many of the largest mass-market retailers have established exclusive buying relationships under which such retailers will buy consumer entertainment software only from certain distributors. In such instances, the Company will not be able to sell its products to such mass-market retailers if these distributors are unwilling to distribute the Company's products. Additionally, even if the distributors are willing to purchase the Company's products, the distributor is frequently able to dictate the price or other terms on which the Company sells to such retailers, or the Company may be unable to sell to such retailers on terms that the Company deems acceptable. The inability of the Company to negotiate commercially viable distribution relationships with these and other distributors, or the loss of, or significant reduction in sales attributable to, any of the Company's principal distributors or retailers could adversely effect the Company's business, operating results and financial condition. Distributors and retailers in the computer industry have from time to time experienced significant fluctuations in their businesses and there have been a number of business failures among these entities. The insolvency or business failure of any significant retailer or distributor of the Company's products could have a material adverse effect on the Company's business, operating results and financial condition. Sales are typically made on credit, with terms that vary depending upon the customer and the nature of the product. The Company does not hold collateral to secure payment. The Company has a non-exclusive distribution relationship with GT Value Products which is terminable by either party at any time for any reason, and therefore there can be no assurance that GT Value Products will continue to distribute the Company's products. The loss of GT Value Products as a distributor or an inability to collect receivables from GT Value Products or any other adverse change in the Company's relationship with GT Value Products would have a material adverse effect on the Company's business, operating results, liquidity and financial condition. The Company maintains allowances for uncollected receivables that it believes to be adequate, but the actual allowance maintained may not be sufficient in every circumstance. The failure to pay an outstanding receivable by a significant Risk Factors (continued) customer or distributor could have a material adverse effect on the Company's business, operating results and financial condition. Although the Company has established allowances for returns that it believes are adequate, there can be no assurance that actual returns will not exceed such allowances. The Company may also accept substantial product returns in order to maintain its relationships with retailers and its access to distribution channels. As a result of the Company's termination of its exclusive distribution relationship with GT Value Products, and its new non-exclusive distribution relationships with other distributors, including GT Value Products, the Company is now increasingly exposed to the risk of product returns from these retailers and distributors. Product returns that exceed the Company's allowances could have a material adverse effect on the Company's business, operating results and financial condition. Highly Competitive Market; Pricing Concerns; Rapidly Changing Marketing Environment; Competition for Retail Shelf Space. The market for consumer entertainment software is highly competitive, particularly at the retail shelf level where a rapidly increasing number of software titles are competing for the same amount of shelf space. Retailers have a limited amount of shelf space relative to the number of consumer entertainment software products competing for that space. Therefore, there is intense competition among consumer entertainment software publishers for adequate levels of shelf space and promotional support from retailers. As the number of software titles continues to increase, the competition for shelf space continues to intensify, resulting in greater leverage for retailers and distributors in negotiating terms of sale, including price discounts and product return policies. The Company's products represent a relatively small percentage of any retailer's sales volume, and there can be no assurance that retailers will continue to purchase the Company's products or promote the Company's products with adequate levels of shelf space and promotional support. Most of the Company's competitors have substantially greater sales, marketing, development and financial resources. Moreover, the Company's present or future competitors may be able to develop products which are comparable or superior to those offered by the Company, offer lower priced products or adapt more quickly than the Company to new technologies or evolving customer requirements. The Company's competitors may also have more money to spend on marketing promotions and advertising efforts. Competition is expected to intensify. In order to be successful in the future, the Company must respond to technological change, customer requirements and competitors' current products and innovations. There can be no assurance that the Company will be able to continue to compete effectively in its market or that future competition will not have a material adverse effect on its business operating results and financial condition. Need for Additional Funds. The Company's future capital requirements will depend on many factors, but particularly on cash flow from sales of the Company's products. If the Company is not able to maintain cash flow from operations at a level sufficient to support continued growth of its business, the Company may require additional funds to sustain and expand its product development, marketing and sales activities. Adequate funds for these purposes may not be available or may be available only on terms that would result in significant dilution or otherwise be unfavorable to existing stockholders. If the Company is unable to secure additional funding, or if the Company is unable to obtain adequate funds from operations or other external sources when required, the Company's inability to do so would have a material adverse effect on the long-term viability of the Company. Possible Inadequacy of Protection of Trade Names; Software Technology; and Other Proprietary Rights. The Company either owns or has obtained licenses to the rights to copyrights on the products, manuals, advertising and other materials owned by it. The Company also either owns trademark rights or is in the process of applying for such rights in the Company's name and logo, and the names of the products owned or licensed by the Company. The Company's success depends in part on its ability to protect its proprietary rights to the trademarks, trade names and content used in its principal products. The Company relies on a combination of copyrights, trademarks, trade secrets, confidentiality procedures and contractual provisions to protect its proprietary rights. There can be no assurance that the Company's existing or future copyrights, trademarks, trade secrets or other intellectual property rights will be of sufficient scope or Risk Factors (continued) strength to provide meaningful protection or commercial advantage to the Company. Also, in selling certain of its products, the Company relies on "shrink wrap" licenses that are not signed by licensees and, therefore, may be unenforceable under the laws of certain jurisdictions. In addition, the laws of some foreign countries do not protect the Company's proprietary rights as do the laws of the United States. There can be no assurance that such factors would not have a material adverse effect on the Company's business or operating results. The Company may from time to time be notified that it is infringing on certain patent or intellectual property rights of others. Combinations of content acquired through past or future acquisitions and content licensed from third party developers will create new products and technology that may give rise to claims of infringement. The Company has recently been sued for trademark and copyright infringement by Hasbro Interactive, Inc. (the "Hasbro Action") (See Part II, Item 1, "Legal Proceedings"). The Company intends to defend this action vigorously. There can be no assurance that additional third parties will not initiate infringement actions against the Company in the future. The Hasbro Action, as well as any other future claims, could result in substantial cost to and diversion of resources of the Company. If the Company is found to be infringing the rights of others, no assurance can be given that licenses would be obtainable on acceptable terms or at all, that significant damages for past infringement would not be assessed, or that further litigation relative to any such licenses or usage would not occur. The failure to obtain necessary licenses or other rights, or the advent of litigation arising out of any such claims, could have a material adverse effect on the Company's operating results. Fluctuations in Quarterly Results; Uncertainty of Future Operating Results; Seasonality. The Company's quarterly operating results have varied significantly in the past and will likely vary significantly in the future depending on numerous factors, many of which are not under the Company's control. Future operating results will depend upon many factors including: the size and rate of growth of the consumer entertainment software market; the demand for the Company's products; the level of product and price competition; the length of the Company's sales cycle; seasonality of individual customer buying patterns; the timing of new product introductions and product enhancements by the Company and its competitors; the timing of orders from major customers; delays in shipment of products; access to distribution channels; product defects and other quality problems; product life cycles; levels of international sales; changes in foreign currency exchange rates; the ability of the Company to develop and market new products and control costs; general domestic and international economic and political conditions; and personnel changes. Products are usually shipped as orders are received so the Company operates with little or no backlog. Therefore, net revenues in any quarter are dependent on orders booked and shipped during that quarter. The consumer entertainment software industry is somewhat seasonal due primarily to holiday shopping and back-to-school buying patterns. Accordingly, in descending order, the calendar fourth, first and third quarters are typically the strongest quarters for sales results, with the calendar second quarter typically the weakest. Therefore, net sales and operating results for any future quarter are not predictable with any significant degree of accuracy. Consequently, the Company believes that period-to-period comparisons of its operating results are not necessarily meaningful and should not be relied upon as indications of future performance. Uncertainty of Market Acceptance; Short Product Life Cycles. The market for consumer entertainment software has been characterized by shifts in consumer preferences and short product life cycles. Consumer preferences for entertainment software products are difficult to predict and few products achieve sustained market acceptance. There can be no assurance that new products introduced by the Company will achieve any significant degree of market acceptance, that such acceptance will be sustained for any significant period, or that product life cycles will be sufficient to permit the Company to recover development, marketing and other associated costs. In addition, if market acceptance is not achieved, the Company could be forced to accept substantial product returns to maintain its relationships with distributors and retailers and its access to distribution channels. Failure of new products to achieve or Risk Factors (continued) sustain market acceptance or product returns in excess of the Company's expectations would have a material adverse effect on the Company's business, operating results and financial condition. Rapid Technological Change; Product Development. Frequent new product introductions and enhancements, rapid technological developments, evolving industry standards and swift changes in customer requirements characterize the market for the Company's products. The Company's continued success depends upon its ability to continue to quickly and efficiently develop and introduce new products and enhance existing products to incorporate technological advances and responses to customer requirements. If any of the Company's competitors introduce products more quickly than the Company, or if they introduce better products, the Company's business could be adversely affected. There can be no assurance that the Company will be successful in developing and marketing new products or enhancements to its existing products on a timely basis or that any new or enhanced products will adequately address the changing needs of the marketplace. From time to time, the Company or its competitors may announce new products, capabilities or technologies that have the potential to replace or shorten the life cycles of the Company's existing products. There can be no assurance that announcements of currently planned or other new products by competitors will not cause customers to delay their purchasing decisions in anticipation of such products, which could have a material adverse effect on the Company's business, liquidity and operating results. Risk of Defects. Products offered by the Company can contain errors or defects. The PC hardware environment is characterized by a wide variety of non-standard peripherals, such as sound and graphics cards, and configurations that make pre-release testing for programming or compatibility errors difficult and time-consuming. Despite the extensive testing performed by the Company's quality assurance personnel, new products or releases may contain errors discovered after shipments have commenced, resulting in a loss of or delay in market acceptance, which could have a material adverse effect on the Company's business, operating results and financial condition. Dependence on Key Management and Technical Personnel. The Company's success depends to a significant degree upon the continued contributions of its key management, marketing, technical and operational personnel, including members of senior management. The loss of the services of one or more key employees could have a material adverse effect on the Company's operating results. The Company also believes its future success will depend in large part upon its ability to attract and retain additional highly skilled management, technical, marketing, product development and operational personnel. Competition for such personnel is intense, and there can be no assurance that the Company will be successful in attracting and retaining such personnel. International Sales. For the six months ended December 31, 1999, international sales represented 16% of net sales as compared to 21% of net sales for the six months ended December 31, 1998. The Company expects international sales to continue to comprise a significant percentage of the Company's sales. The Company's international business is subject to certain risks including: varying regulatory requirements; tariffs and trade barriers; political and economic instability; reduced protection for intellectual property rights in certain countries; difficulties in supporting foreign customers; difficulties in managing foreign distributors; potentially adverse tax consequences; the burden of complying with a wide variety of complex operations; customs, foreign laws, regulations and treaties; fluctuating currency valuations; and the possibility of difficulties in collecting accounts receivable. Stock Price Volatility. The Company believes that a variety of factors could cause the price of its Common Stock to fluctuate, perhaps substantially, over a short period of time including: quarter to quarter variations in operating results; announcements of developments related to its business; fluctuations in its order levels; general conditions in the technology sector or the worldwide economy; announcements of technological innovations, new products or product enhancements by the Company or its competitors; key management changes; and developments in the Company's relationships with its customers, distributors and suppliers. In addition, in recent years the stock market in general, and the market for shares of software, high technology stocks, micro-cap and small cap stocks in particular, has experienced extreme price fluctuations which have Risk Factors (continued) often been unrelated to the operating performance of affected companies. Such fluctuations could adversely affect the market price of the Company's Common Stock. Listing of Securities; Risk of Low Priced Stocks. The Company's Common Stock is listed on the Nasdaq SmallCap Market under the symbol EGAM. A listed company may be de-listed if it fails to maintain minimum levels of Stockholders' equity, shares publicly held, number of Stockholders or aggregate market value, or if it violates other aspects of its listing agreement. At December 31, 1999, the Company satisfied the minimum level of Stockholders' equity required to be listed ($2,000,000) and all other aspects of its listing agreement. If the Company fails to maintain the criteria for trading on the Nasdaq SmallCap Market, its Common Stock may be de-listed. Public trading, if any, would thereafter be conducted in the over-the-counter market in the so-called "pink sheets," or on the NASD's "Electronic Bulletin Board." If the Common Stock were de-listed, it may be more difficult to dispose of, or even to obtain quotations as to the price of, the Common Stock and the price offered for the Common Stock may be substantially reduced. In addition, if the Common Stock is de-listed from trading on the Nasdaq SmallCap Market, and the trading price of the Common Stock is less than $5.00 per share, or the Company has less than $2 million in net tangible assets, trading in the Common Stock would be subject to the requirements of Rule 15g-9 promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Under this rule, broker/dealers who recommend such securities to persons other than established customers and accredited investors (generally institutions with assets in excess of $5 million or individuals with a net worth in excess of $1 million or an annual income exceeding $200,000 or $300,000 jointly with their spouses) must make a special written suitability determination for the purchaser and receive the purchaser's written agreement to a transaction prior to sale. The requirements of Rule 15g-9, if applicable, may affect the ability of broker/dealers to sell the Company's securities and may also affect the ability of purchasers to sell their shares in the secondary market. The Securities Enforcement Remedies and Penny Stock Reform Act of 1990 (the "Penny Stock Rule") also requires additional disclosure in connection with any trades involving a stock defined as penny stock (any non-Nasdaq equity security that has a market price or exercise price of less than $5.00 per share and less than $2 million in net tangible assets, subject to certain exceptions). Unless exempt, the rules require the delivery, prior to any transaction involving a penny stock, of a disclosure schedule prepared by the SEC explaining important concepts involving the penny stock market, the nature of such market, terms used in such market, the broker/dealer's duties to the customer, a toll-free telephone number for inquiries about the broker/dealer's disciplinary history and the customer's rights and remedies in case of fraud or abuse in the sale. Disclosure must also be made about commissions payable to both the broker/dealer and the registered representative, and current quotations for the securities. Finally, monthly statements must be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. Part II. Other Information Item 1. Legal Proceedings On February 9, 2000, Hasbro Interactive, Inc., Atari Interactive, Inc., and Zao Elorg d/b/a Elorg Corporation (collectively, the "Plaintiffs") filed suit in the United States District Court for the District of Massachusetts against the Company and Xtreme Games LLC, GT Interactive Software Corporation, MVP Software, Inc., Webfoot Technologies, Inc. and Varcon Systems, Inc. The suit alleges that certain of the Company's products infringe copyrights and trademarks owned by the Plaintiffs, and also alleges that the Company has engaged in unfair competition. The suit seeks to have the Company enjoined from manufacturing, marketing, distributing and selling the Company's allegedly infringing games and from using the allegedly infringing trademarks; to have the Company recall the allegedly infringing products and related materials from the distributors and retailers currently selling these products; to require the Company to pay the Plaintiffs the profits derived from the allegedly infringing products; and that the award of costs and attorneys fees. The Company intends to defend this action vigorously. Item 4. Submission of Matters to a Vote of Securities Holders The Company held its Annual Meeting of Shareholders on December 7, 1999. At that the meeting, the following matters were acted upon, together with the number of votes cast for, against or withheld as to each such matter: Votes Cast For Against Abstain ----------------------------- (i) The election of the following directors: Robert M. Aiken, Jr. 8,555,992 - 0 - 60,473 Gerald W. Klein 8,411,964 - 0 - 204,501 Thomas D. Parente 8,411,614 - 0 - 204,851 Lambert C. Thom 8,412,164 - 0 - 204,301 (ii) Ratification of the appointment of KPMG LLP as the Company's auditors for the 2000 fiscal year: Votes Cast For Against Abstain ----------------------------- 8,527,255 60,250 28,960 No broker non-votes were recorded for any of the matters acted upon. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Exhibit No. Description of Exhibit ----------- ---------------------- 27.1 Financial Data Schedule (b) Reports on Form 8-K On January 21, 2000, the Company filed a report on Form 8-K regarding a press release announcing the Company's unaudited results for the second quarter and six months ended December 31, 1999. On February 10, 2000, the Company filed a report on Form 8-K regarding a press release announcing that Hasbro Interactive, Inc. has filed suit against the Company and several other defendants in the U.S. District Court in Boston, Massachusetts alleging that the Company, among other parties, infringed Hasbro's copyrights and trademarks in the production of certain games SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. eGames, Inc. (Registrant) Date: February 14, 2000 /s/ Gerald W. Klein ----------------- -------------------- Gerald W. Klein, President, Chief Executive Officer and Director Date: February 14, 2000 /s/ Thomas W. Murphy ----------------- -------------------- Thomas W. Murphy, Chief Financial Officer and Chief Accounting Officer Exhibit Index Exhibit No. Description of Exhibit Page Number ----------- ---------------------- ----------- 27.1 Financial Data Schedule 23 EX-27.1 2 ART. 5 FDS FOR 2ND QUARTER 10-QSB
5 1 6-MOS JUN-30-2000 DEC-31-1999 858,656 0 6,293,650 (1,763,373) 1,438,631 6,901,312 995,676 (667,918) 7,614,000 2,644,669 0 0 0 9,122,432 (4,462,952) 7,614,000 8,638,965 8,638,965 3,164,945 3,164,945 4,044,594 0 10,077 1,419,349 241,402 1,177,947 0 0 0 1,177,947 .12 .12
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