-----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, Q6/LoeASa49NaEA6NW+j8zkCD3pzJj2/iGeFbSi+FaMkUJBx6CwQ/H/MPGQ6dMj+ PzqBGsrjcgqGPWK7RqS5ig== /in/edgar/work/0000948703-00-000013/0000948703-00-000013.txt : 20001115 0000948703-00-000013.hdr.sgml : 20001115 ACCESSION NUMBER: 0000948703-00-000013 CONFORMED SUBMISSION TYPE: 10QSB PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20000930 FILED AS OF DATE: 20001114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: EGAMES INC CENTRAL INDEX KEY: 0000948703 STANDARD INDUSTRIAL CLASSIFICATION: [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: 768022 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 0001.txt 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 September 30, 2000 |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 0-27102 eGames, Inc. (Exact name of registrant as specified in its charter) PENNSYLVANIA 23-2694937 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification Number) 2000 Cabot Boulevard West, Suite 110 Langhorne, PA 19047-1811 (address of Principal executive offices) Issuer's Telephone Number, Including Area Code: 215-750-6606 Not Applicable (Former name, former address and former fiscal year, if changed since last report.) Check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ( X ) No ( ) APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ( ) No ( ) APPLICABLE ONLY TO CORPORATE ISSUERS State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: 9,749,975 shares of common stock, no par value per share, as of November 10, 2000. Transitional Small Business Disclosure Format (check one): Yes ( ) No ( X ) eGames, Inc. INDEX Page ---- Part I. Financial Information Item 1. Financial Statements: Consolidated Balance Sheet as of September 30, 2000......... 3 Consolidated Statements of Operations for the three months ended September 30, 2000 and 1999 ...................... 4 Consolidated Statements of Cash Flows for the three months ended September 30, 2000 and 1999....................... 5 Notes to Consolidated Financial Statements.................. 6-7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations .................... 8-12 Risk Factors ............................................... 13-18 Part II. Other Information Item 1. Legal Proceedings........................................... 18 Item 6. Exhibits and Reports on Form 8-K............................ 19 Signatures ............................................................ 20 Exhibit Index ............................................................ 21 Exhibits ............................................................ 22-23 Item 1. Financial Statements eGames, Inc. Consolidated Balance Sheet (Unaudited)
As of September 30, ASSETS 2000 ------------ Current assets: Cash and cash equivalents $ 271,863 Accounts receivable, net of allowances totaling $3,249,847 4,594,646 Inventory 1,764,776 Prepaid expenses 187,675 ------------ Total current assets 6,818,960 Furniture and equipment, net 304,967 Intangibles and other assets, net 261,694 ----------- Total assets $ 7,385,621 =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable $ 60,980 Accounts payable 1,541,335 Revolving credit facilities 500,000 Accrued expenses 1,339,799 Convertible subordinated debt 150,000 Capital lease obligations 16,095 ----------- Total current liabilities 3,608,209 Capital lease obligations, net of current portion 9,345 Notes payable, net of current portion 108,426 ----------- Total liabilities 3,725,980 Stockholders' equity: Common stock, no par value (40,000,000 shares authorized; 9,981,875 issued and 9,749,975 outstanding) 9,134,234 Additional paid-in capital 1,148,550 Accumulated deficit (5,991,408) Treasury stock, at cost - 231,900 shares (501,417) Accumulated other comprehensive loss (130,318) ----------- Total stockholders' equity 3,659,641 ----------- Total liabilities and stockholders' equity $ 7,385,621 ===========
See accompanying notes to the consolidated financial statements. eGames, Inc. Consolidated Statements of Operations (Unaudited)
Three months ended September 30, ------------------------- 2000 1999 ---- ---- Net sales $ 4,307,666 $ 4,117,575 Cost of sales 1,900,747 1,603,308 ----------- ----------- Gross profit 2,406,919 2,514,267 Operating expenses: Product development 181,147 242,847 Selling, general and administrative 2,190,775 1,600,406 ----------- ----------- Total operating expenses 2,371,922 1,843,253 ----------- ----------- Operating income 34,997 671,014 Interest expense, net 7,995 5,100 ----------- ----------- Income before income taxes 27,002 665,914 Provision for income taxes 2,821 89,295 ----------- ----------- Net income $ 24,181 $ 576,619 =========== =========== Net income per common share: - Basic $ 0.00 $ 0.06 =========== =========== - Diluted $ 0.00 $ 0.06 =========== =========== Weighted average common shares outstanding - Basic 9,749,975 9,633,973 Dilutive effect of common stock equivalents 53,869 503,569 ----------- ----------- Weighted average common shares outstanding - Diluted 9,803,844 10,137,542 =========== ===========
See accompanying notes to the consolidated financial statements. eGames, Inc. Consolidated Statements of Cash Flows (Unaudited)
Three months ended September 30, 2000 1999 ---- ---- Cash flows from operating activities: Net income $ 24,181 $ 576,619 Adjustment to reconcile net income to net cash (used in) provided by operating activities: Depreciation, amortization and other non-cash items 79,277 103,383 Changes in items affecting operations Restricted cash - 0 - 17,560 Accounts receivable (1,869,673) (2,628,050) Prepaid expenses 73,710 36,843 Inventory 373,925 54,649 Accounts payable (559,797) 651,590 Gain on disposal of furniture and equipment (4,041) - 0 - Accrued expenses 544,828 441,906 ----------- ----------- Net cash used in operating activities (1,337,590) (745,500) ----------- ----------- Cash flows from investing activities: Purchase of furniture and equipment (12,105) (30,212) Proceeds from disposal of furniture and equipment 16,170 - 0 - Purchase of software rights and other assets (1,730) (245) ----------- ----------- Net cash provided by (used in) investing activities 2,335 (30,457) ----------- ----------- Cash flows from financing activities: Proceeds from exercise of warrants and options - 0 - 110,000 Proceeds from borrowings under revolving credit facilities 750,000 - 0 - Repayments of borrowings under revolving credit facilities (250,000) - 0 - Repayments of notes payable (13,951) (94,466) Repayments of capital lease obligations (10,849) (6,614) ----------- ----------- Net cash provided by financing activities 475,200 8,920 ----------- ----------- Effect of exchange rate changes on cash and cash equivalents (7,260) 3,148 ----------- ----------- Net decrease in cash and cash equivalents (867,315) (763,889) Cash and cash equivalents: Beginning of period 1,139,178 1,313,853 ----------- ----------- End of period $ 271,863 $ 549,964 =========== =========== Supplemental cash flow information: Cash paid for interest $ 14,423 $ 11,194 =========== =========== Non cash investing and financing activities: Acquisition of furniture and equipment through capital leases $ 11,550 $ 26,809 =========== ===========
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, 2000 should be read in conjunction with the accompanying statements. These statements include all adjustments the Company believes are necessary for a fair presentation of the statements. The interim operating results are not necessarily indicative of the results for a full year. Description of Business eGames, Inc. (the "Company"), a Pennsylvania corporation incorporated in July 1992, develops, publishes, markets and sells a diversified line of personal computer software primarily for consumer entertainment. The Company targets the growing market of home personal computer ("PC") users who value full-featured, value-priced and easy-to-use entertainment software. The Company's sales are made through various national distributors on a non-exclusive basis in addition to direct relationships with certain national and regional retailers. The Company's products generally sell at retail for under $15, a price point that is intended to generate impulse purchases in mass market shopping environments. Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary. All inter-company balances and transactions have been eliminated. 2. Comprehensive Income (Loss) On July 1, 1998, the Company adopted SFAS 130, "Reporting Comprehensive Income". This Statement requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. Comprehensive income (loss) is computed as follows: Three Months Ended September 30, ----------------------- 2000 1999 ---- ---- Net income $ 24,000 $ 577,000 Other comprehensive income (loss): Foreign currency translation adjustment (61,000) (12,000) -------- --------- Comprehensive income (loss) ($ 37,000) $ 565,000 ======== ========= 3. Common Stock On October 26, 1998, the Company's Board of Directors authorized the Company to purchase up to $1,000,000 of its shares of Common Stock in open-market purchases on the Nasdaq SmallCap Market. During the quarter ended September 30, 2000 the Company did not purchase any shares of its Common Stock. As of September 30, 2000, the Company had acquired 231,900 shares of its Common Stock, with an approximate cost of $501,000, pursuant to its stock repurchase program. Notes to Consolidated Financial Statements (continued) 4. Operations by Reportable Segments and Geographic Area The Company adopted SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information", as of July 1, 1998. SFAS No. 131 establishes standards for reporting information about an enterprise's operating segments and related disclosures about its products, geographic areas and major customers. The Company publishes interactive entertainment software for PCs. Based on its organizational structure, the Company operates in only one non-geographic, reportable segment, which is publishing. The President and Chief Executive Officer allocates resources to each of the geographical areas in which the Company operates using information on their respective revenues and operating profits before interest and taxes. The President and Chief Executive Officer has been identified as the Chief Operating Decision Maker as defined by SFAS No. 131. The accounting policies of these segments are the same as those described in the Summary of Significant Accounting Policies. Revenue derived from sales between segments is eliminated in consolidation. Geographic information for the quarters ended September 30, 2000 and 1999 is based on the location of the selling entity. The Company records international sales from both the United States and United Kingdom locations. Information about the Company's operations by segmented geographic locations for the quarters ended September 30, 2000 and 1999 is presented below. Quarters ended - --------------
North America United Kingdom Eliminations Consolidated ------------- -------------- ------------ ------------ September 30, 2000: - ------------------- Sales $ 3,925,000 $ 591,000 ($ 208,000) $ 4,308,000 Operating income (loss) 160,000 (125,000) - 0 - 35,000 Assets $ 7,359,000 $ 1,056,000 ($1,029,000) $ 7,386,000 September 30, 1999: - ------------------- Sales $ 3,707,000 $ 576,000 ($ 165,000) $ 4,118,000 Operating income 598,000 73,000 - 0 - 671,000 Assets $ 6,791,000 $ 901,000 ($ 588,000) $ 7,104,000
5. Revolving Credit Facilities On August 9, 2000, the Company entered into a $2,000,000 revolving credit facility ("new credit facility") with a commercial bank, which expires on October 31, 2001. This new credit facility replaced the $1,500,000 revolving credit facility that it previously had with another commercial bank. Amounts outstanding under this new credit facility are charged interest at one-half of one percent above the bank's current prime rate and such interest is due monthly. The new credit facility is collateralized by substantially all of the Company's assets. The new credit facility requires the Company, among other things, to maintain certain financial ratios, such as: a minimum working capital balance of $1,500,000 and a maximum senior debt to effective net worth ratio of 1.50 to 1.00. Additionally, this new credit facility has a minimum effective net worth covenant starting at $3.1 million at June 30, 2000 and increasing by $150,000 quarterly to a $3.7 million requirement at June 30, 2001. As of September 30, 2000, the Company was in compliance with each of those covenants. This new credit facility was established to provide, among other things, additional working capital to support the Company's anticipated growth. As of November 13, 2000, the Company had a $500,000 outstanding balance under this new credit facility. The Company's United Kingdom operation has a $225,000 revolving credit facility with a commercial bank. Amounts outstanding under this credit facility are charged interest at two and one-half percent above the bank's current base rate and such interest is due monthly. As of November 13, 2000, the Company did not have any outstanding balance under this credit facility, which expires on September 30, 2001. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations The accompanying consolidated financial statements as of September 30, 2000 include the accounts of eGames, Inc. (the "Company") and its wholly-owned subsidiary. Forward-Looking Statements This Quarterly Report on Form 10-QSB and in particular Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements about circumstances that have not yet occurred, including, without limitation, statements regarding the Company's Store-In-A-Store program resulting in the longer-term placement of the Company's products in the food and drug retail channel, which is intended to increase sales volume within this channel and decrease the rate of product returns due to longer product exposure on retailers' product shelves; the level of the Company's international net sales remaining at about 17% of the Company's consolidated net sales for the remainder of fiscal 2001; the Company's efforts to increase distribution of its products via the Internet; the ability of the "Store in a Store" concept to attract consumer interest and drive impulse purchases of value-priced, Family-Friendly(TM) software products; the Company's goal of balancing promotional sales programs with longer-term, non-promotional software display sections in the food and drug retail channel with the intended result of reducing the Company's exposure to product returns in this channel; the payment of certain promotional costs resulting in increased sell-through rates for the Company's products during short-term promotional programs; the ability of the Company's Store-in-a-Store program to reduce promotional expenses, as a percentage of sales, due to more product sales being non-promotional in nature; the sufficiency of the Company's cash and working capital balances to fund the Company's operations for the foreseeable future; the expectation that certain new accounting pronouncements will not have a significant impact on the Company's results of operations, financial position or cash flows; as well as other statements including words such as "anticipate", "believe" or "expect" and statements in the future tense. These forward-looking statements are subject to business and economic risks, and actual events or the Company's actual future results could differ materially from those set forth in the forward-looking statements due to such risks and uncertainties. The Company will not necessarily update information if any forward looking statement later turns out to be inaccurate. The following important factors, among others discussed elsewhere in this report, could cause the Company's actual results to differ materially from those indicated by the forward-looking statements contained in this report: the market acceptance of the Company's Store-in-a-Store program in the food and drug retail channel and the sustainability of the program over time; the ability of the Store-in-a-Store program to secure longer-term shelf space for the Company's products; whether the longer-term placement of the Company's products at retail will result in better sell-through rates and therefore fewer returns from the food and drug retail channel; the market acceptance and successful sell-through results for the Company's products at retail stores and the ability of the Company to accurately estimate sell-through volume when an order is shipped; the amount of unsold product that is returned to the Company by retail stores; the Company's ability to accurately predict the amount of product returns that will occur and the adequacy of the reserves established for such returns; the Company's ability to continue to implement its Store within a Store program on commercially acceptable terms; the success of the Company's distribution strategy, including its ability to enter into new distribution and direct sales relationships on commercially acceptable terms; the allocation of adequate shelf space for the Company's products in major retail chain stores; the Company's ability to negotiate lower product promotional costs in its distribution and retail relationships; the Company's ability to collect outstanding accounts receivable and establish adequate reserves for un-collectible receivables; increased selling, general and administrative costs, including increased legal expenses; the continued increase in the number of computers in homes in North America and the world; the ability to deliver products in response to orders within a commercially acceptable time frame; downward pricing pressure; fluctuating costs of developing, producing and marketing the Company's products; the Company's ability to license or develop quality content for its products; the Company's ability to access alternative distribution channels and the success of the Company's efforts to develop its Internet sales; consumers' continued demand for value-priced software; increased competition in the value-priced software category; and various other factors, many of which are beyond the Company's control. Risks and uncertainties that may affect the Company's future results and performance also include, but are not limited to, those discussed under the heading "Risk Factors" below at pages 13 to 18, as well as in the Company's Annual Report on Form 10-KSB for the fiscal year ended June 30, 2000 as filed with the Securities and Exchange Commission and other documents filed with the Commission. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Results of Operations Three Months Ended September 30, 2000 and 1999 Net Sales Net sales for the quarter ended September 30, 2000 were $4,308,000 compared to $4,118,000 for the quarter ended September 30, 1999, representing an increase of $190,000 or 5%. As described in the table below, the $190,000 increase in net sales was primarily attributable to the Company's expansion of its distribution into the North American food and drug channel, which was partially offset by decreases in net sales into the traditional North American software retail and distribution channels. Within the food and drug channel, the Company increased it distribution, among other activities, by establishing its first "Store-in-a-Store" entertainment software display sections in more than approximately 4,000 food and drug retail stores. The establishment of these Store-In-A-Store software display sections within certain national and regional food and drug retail stores is intended to secure longer-term placement of the Company's products in this retail channel, with the goal of increasing sales volume within this channel while decreasing the rate of product returns due to longer product exposure on retailers' product shelves. The table below represents the Company's net sales by distribution channel for the quarters ended September 30, 2000 and 1999, respectively.
Quarter Ended Quarter Ended September 30, September 30, Increase Distribution Channel 2000 1999 (Decrease) - ------------------------------------------------ ------------- -------------- ------------- North American Food and Drug Retailers $2,296,000 $ 899,000 $ 1,397,000 North American Traditional Software Retailers 312,000 530,000 (218,000) North American Traditional Software Distributors 989,000 2,040,000 (1,051,000) International Markets 711,000 649,000 62,000 - ------------------------------------------------ ------------- -------------- ------------- Totals $ 4,308,000 $ 4,118,000 $ 190,000 ============= ============== =============
As noted in the table above, the Company's net sales to traditional North American software retailers decreased by $218,000, while sales to traditional North American software distributors decreased by $1,051,000. These sales decreases were consistent with industry-wide reductions of PC software inventory levels held by North American software retailers and distributors, which has negatively impacted the Company's sales to these customers during the quarter ended September 30, 2000. As discussed in the above table, the Company's international sales for the quarter ended September 30, 2000 increased by $62,000 over sales for the same period during the prior year. This minimal sales increase is primarily the result of increased pricing pressures at retail and increased competition for retail shelf space from the Company's competitors in these foreign markets. As a percentage of net sales, the Company's international net sales represented 17% and 16% of the Company's net sales for the quarters ended September 30, 2000 and 1999, respectively. The Company anticipates that international net sales will remain at about 17% of the Company's consolidated net sales for the remainder of fiscal 2001. Included in net sales to the food and drug retail channel are net sales of third-party software titles totaling $364,000 and $165,000 for the quarters ended September 30, 2000 and 1999, respectively. The Company sells these software titles to food and drug retailers as part of its Store-In-A-Store software sections. The Company offers these third-party software titles in order to provide a one-stop, software category management service for these retailers, so that the Company can continue to establish itself as a leading supplier of entertainment software products, of both its own titles and third-party software titles. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) During fiscal 2000, the Company completed its transition from publishing shareware-based PC game software titles to publishing full-release PC game software titles. There were no net sales of shareware-based software titles during the quarter ended September 30, 2000 compared to $90,000 of net sales of such titles during the quarter ended September 30, 1999. The Company has recently initiated several programs designed to increase the sale of its products over the Internet, including: the roll-out of an improved and expanded website; improvement of its electronic distribution capabilities by further developing and expanding its affiliation with Digital River, a leading distributor of digital software over the Internet; and incorporation of user-friendly on-line functionality into its products. Sales of the Company's products via the Internet for the quarters ended September 30, 2000 and 1999 were $52,000 and $21,000, respectively, or approximately 1% of the Company's net sales during both quarters. During the quarters ended September 30, 2000 and 1999, the Company's provisions for product returns were $1,464,000 and $1,041,000, respectively, or 25% and 20% of the Company's gross sales, respectively. This $423,000 increase in the provision for product returns has been caused primarily by the change in the Company's distribution strategy, which involved expanding the number of distribution partners used to distribute the Company's products and selling directly to retailers. All of these non-exclusive arrangements between the Company and its distributors and retailers allow for product returns or markdowns. Additionally, during the last fiscal year, the Company has experienced a significant increase in net sales into the food and drug retail channel. The majority of these sales were "promotional" in nature, meaning that the products were sold in those retail stores for only six to eight weeks. As a result of this short selling period, the Company has experienced higher product returns in food and drug retail stores compared to product returns from traditional software retail stores where the Company's products typically have a longer period of time to sell through to consumers. During fiscal 2001, the Company's strategy is to continue working towards a more profitable balance between short-term promotional sales programs and longer-term, non-promotional sales programs in the food and drug retail channel. This strategy, among other things, is intended to reduce the Company's exposure to product returns in this channel. This Store-In-A-Store strategy is an important component of the Company's growth strategy for fiscal 2001. Cost of Sales Cost of sales for the quarter ended September 30, 2000 were $1,901,000 compared to $1,603,000 for the quarter ended September 30, 1999, representing an increase of $298,000 or 19%. Of this $298,000 increase in cost of sales, $182,000 was due to the increase in sales of lower margin products and $123,000 was due to the increase in sales of non-eGames software titles that the Company acquired at a higher product cost than the Company's own software titles. Product costs consist mainly of replicated compact discs, printed materials, protective jewel cases and boxes for certain products. Gross Profit Margin The Company's gross profit margin for the quarter ended September 30, 2000 decreased to 55.9% of net sales from 61.1% of net sales for the quarter ended September 30, 1999. This 5.2% decrease in gross profit margin, as a percentage of net sales, was caused primarily by an increase in product costs, as a percentage of net sales, due to the Company's: discounting sales of certain software titles with consumer promotions; sales of newly developed promotional titles with lower margins; and increasing sales of third party software titles on which the Company earns a lower profit margin than it earns from the sale of its own software titles. Operating Expenses Product development expenses for the quarter ended September 30, 2000 were $181,000 compared to $243,000 for the quarter ended September 30, 1999, a decrease of $62,000 or 26%. This decrease was caused primarily by a $45,000 decrease in salary and related costs due to headcount reductions among the Company's technology-related staff and no employee bonus accrual for the quarter ended September 30, 2000. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Selling, general and administrative expenses for the quarter ended September 30, 2000 were $2,191,000 compared to $1,600,000 for the quarter ended September 30, 1999, an increase of $591,000 or 37%. This $591,000 increase was caused primarily by the $584,000 increase in marketing promotional expenses associated mainly with the increase in sales into the food and drug retail channel. These promotional costs are intended to increase the sell-through rate for the Company's products during the short-term promotional programs that these retailers offer periodically to their customers, as well as expand the longer-term placement of the Company's products in the food and drug channel through the Company's Store-in-a-Store program. This program is intended to ultimately reduce promotional expenses, as a percentage of sales, due to more product sales being non-promotional in nature. Additionally, the Company continues to experience higher promotional costs in the traditional software retail channels due to increased competition for shelf space and the related expenses charged by retailers and distributors to promote and support sales of the Company's products. Interest Expense, Net Net interest expense for the quarter ended September 30, 2000 was $8,000 compared to $5,000 for the quarter ended September 30, 1999, an increase of $3,000. The $3,000 increase was primarily due to the utilization of $500,000 under the revolving credit facility for the quarter ended September 30, 2000. Provision for Income Taxes Provision for income taxes for the quarter ended September 30, 2000 was $3,000 compared to $89,000 for the quarter ended September 30, 1999, a decrease of $86,000 or 97%. This $86,000 decrease in the provision for income taxes was primarily due to the $639,000 decrease in the Company's income before income taxes for the quarter ended September 30, 2000. Net Income As a result of the factors discussed above, net income decreased to $24,000 for the quarter ended September 30, 2000 from $577,000 for the quarter ended September 30, 1999, a decrease of $553,000 or 96%. Weighted Average Common Shares The weighted average common shares outstanding on a diluted basis decreased by 333,698 for the quarter ended September 30, 2000 to 9,803,844 from 10,137,542 for the quarter ended September 30, 1999. This 333,698 decrease in weighted average common shares outstanding was caused primarily by a decrease in common stock equivalents resulting primarily from the Company's decreasing quarterly average common share price in the Nasdaq SmallCap market. Liquidity and Capital Resources As of September 30, 2000, the Company's cash and working capital balances were $272,000 and $3,211,000, respectively, and the Company's total stockholders' equity balance at September 30, 2000 was $3,660,000. Net cash used in operating activities was approximately $1,338,000 and $746,000 for the quarters ended September 30, 2000 and 1999, respectively. The $1,338,000 in net cash used in operating activities resulted primarily from a $1,870,000 increase in accounts receivable and a $560,000 decrease in accounts payable, which were partially offset by a $545,000 increase in accrued expenses and a $374,000 decrease in inventory. Additionally, the Company's net income for the quarter ended September 30, 2000 was $24,000, inclusive of depreciation, amortization and other non-cash expenses of $79,000. Net cash provided by investing activities for the quarter ended September 30, 2000 was $2,000 compared to net cash used in investing activities of $30,000 for the quarter ended September 30, 1999. The $2,000 in net cash provided by investing activities resulted from $16,000 in proceeds from the disposal of furniture and equipment, which was offset by purchases of $12,000 in furniture and equipment and $2,000 in other assets. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Net cash provided by financing activities for the quarters ended September 30, 2000 and 1999 were $475,000 and $9,000, respectively. The $475,000 in net cash provided by financing activities reflects net proceeds from the Company's borrowing of $750,000 under the revolving credit facilities, which was offset by repayments of this borrowing under the revolving credit facilities, notes payable and capital lease obligations of $250,000, $14,000 and $11,000, respectively. On August 9, 2000, the Company entered into a $2,000,000 revolving credit facility ("new credit facility") with a commercial bank, which expires on October 31, 2001. This new credit facility replaced the $1,500,000 revolving credit facility that it previously had with another commercial bank. Amounts outstanding under this new credit facility are charged interest at one-half of one percent above the bank's current prime rate and such interest is due monthly. The new credit facility is collateralized by substantially all of the Company's assets. The new credit facility requires the Company, among other things, to maintain certain financial ratios, such as: a minimum working capital balance of $1,500,000 and a maximum senior debt to effective net worth ratio of 1.50 to 1.00. Additionally, this new credit facility has a minimum effective net worth covenant starting at $3.1 million at June 30, 2000 and increasing by $150,000 quarterly to a $3.7 million requirement at June 30, 2001. As of September 30, 2000, the Company was in compliance with each of those covenants. This new credit facility was established to provide, among other things, additional working capital to support the Company's anticipated growth. As of November 13, 2000, the Company had a $500,000 outstanding balance under this new credit facility. The Company's United Kingdom operation has a $225,000 revolving credit facility with a commercial bank. Amounts outstanding under this credit facility are charged interest at two and one-half percent above the bank's current base rate and such interest is due monthly. As of November 13, 2000, the Company did not have any outstanding balance under this credit facility, which expires on September 30, 2001. The Company's ability to achieve and maintain positive cash flow depends upon a variety of factors, including the timeliness and success of the collection of outstanding accounts receivable, the creditworthiness of the primary distributors and retail customers of the Company's products, the continuing retail demand for value-priced PC game software, the development and sell-through of the Company's products, the costs of developing, producing and marketing such products, and various other factors, some of which are beyond the Company's control. In the future, the Company expects its cash and working capital requirements to be affected by each of these factors. The Company believes cash and working capital balances, in addition to the Company's revolving credit facilities mentioned above, will be sufficient to fund the Company's operations for the next twelve months. However, there can be no assurances that the Company will be able to achieve and maintain a positive cash flow or that additional financing will be available if and when required or, if available, will be on terms satisfactory to the Company. On November 10, 2000, the Company received notification from Nasdaq that its common stock had failed to maintain a minimum bid price of $1.00 over a period of 30 consecutive trading days as required for continued listing on the Nasdaq SmallCap Market as set forth in Marketplace Rule 4310 (c) (4) (the "Rule"). In accordance with Marketplace Rule 4310 (c) (8) (B), the Company has 90 calendar days, or until February 8, 2001, to regain compliance with this Rule. The Company may appeal Nasdaq's determination pursuant to the procedures set forth in the Nasdaq Marketplace Rule 4800 Series. A hearing request will stay the de-listing of the Company's securities pending the Panel's decision. As of November 10, 2000, the Company continued to satisfy all other aspects of its listing agreement for the Nasdaq SmallCap Market. New Accounting Pronouncements The Company is currently evaluating the potential impact of Emerging Issues Task Force ("EITF") 00-14, "Accounting for Certain Sales Incentives", EITF 00-10 "Accounting for Shipping and Handling Fees and Costs" and Staff Accounting Bulletin 101 "Revenue Recognition" and related amendments and interpretations. All of these pronouncements become effective no later than the Company's fourth quarter of fiscal 2001. The Company does not expect the adoption of these or any other recently issued accounting pronouncements to have a significant impact on its results of operations, financial position or cash flows. Risk Factors Factors Affecting Future Performance This report contains certain forward-looking statements involving risks and uncertainties that could cause actual results to differ materially from those anticipated, including, but without limitation: economic and competitive conditions in the software business affecting the demand for the Company's products; the Company's need for additional funds; the ability to hire and retain key management personnel to manage anticipated growth; the development, market acceptance and timing of new products; access to distribution channels; and the renewal of licenses for key software products. Those factors, the factors discussed below, and the factors identified on page 8 of Management's Discussion and Analysis, should be considered by investors in the Company. All forward-looking statements are necessarily speculative and there are numerous risks and uncertainties that could cause actual events or results to differ materially from those referred to in such forward-looking statements. The discussion below highlights some of the more important risks identified by management, but should not be assumed to be the only factors that could affect future performance. The Company's business is subject to many risks and uncertainties, which may affect its future financial performance. Some of the important risks and uncertainties which may cause the Company's operating results to vary or which may materially and adversely affect the Company's operating results are as follows: Maintaining Profitability. The Company commenced operations in July 1992. The Company experienced significant losses from inception through the end of fiscal 1997. Fiscal year 1998 was the first year that the Company earned a profit. The Company has earned $253,000, $463,000 and $1,253,000 in fiscal 2000, 1999 and 1998, respectively, and the accumulated deficit for the Company at June 30, 2000 was approximately $6,016,000. Prior to fiscal 1998, the Company's operations were funded primarily through proceeds from the Company's initial public offering of Common Stock in October 1995 and through the sale in private offerings of preferred stock and Common Stock warrants in November 1996 and in January and April 1997. Subsequently, the Company has funded its activities mainly through income from operations. The Company's operations today are still subject to all of the risks inherent in the development of a recently profitable business, particularly in a highly competitive industry, including, but not limited to, development, distribution and marketing difficulties, competition and unanticipated costs and expenses. The Company's future success will depend upon its ability to increase revenues and profits from the development, marketing and distribution of its current and future software products. Risks Inherent in the Consumer Entertainment Software Business. The development of multimedia software products, which can combine text, sound, high quality graphics, images and video, is difficult and time consuming, requiring the coordinated participation of various technical and marketing personnel and outside developers. Some of the factors that could affect the Company's future success include, but are not limited to, the ability of the Company to overcome problems and delays in product development, market acceptance of products, successful implementation of its sales, distribution and marketing strategy, and the implications of the settlement of litigation discussed under Part II, Item 1, "Legal Proceedings." There can be no assurance the Company will be successful in maintaining and expanding a sustainable consumer entertainment software business. Dependence On Distributors And Retailers. Many of the largest mass-market retailers have established exclusive buying relationships under which such retailers will buy consumer entertainment software only from certain distributors. In such instances, the Company will not be able to sell its products to such mass-market retailers if these distributors are unwilling to distribute the Company's products. Additionally, even if the distributors are willing to purchase the Company's products, the distributor is frequently able to dictate the price, timing and other terms on which the Company sells to such retailers, or the Company may be unable to sell to such retailers on terms that the Company deems acceptable. The inability of the Company to negotiate commercially viable distribution relationships with these and other distributors, or the loss of, or significant reduction in sales attributable to, any of the Company's principal distributors or retailers could adversely affect the Company's business, operating results and financial condition. Risk Factors (continued) Risk of Customer Business Failure. Distributors and retailers in the computer industry and in mass-market retail channels have from time to time experienced significant fluctuations in their businesses and there have been a number of business failures among these entities. The insolvency or business failure of any significant retailer or distributor of the Company's products could have a material adverse effect on the Company's business, operating results and financial condition. Sales are typically made on credit, with terms that vary depending upon the customer and the nature of the product. The Company does not hold collateral to secure payment. The Company maintains allowances for uncollected receivables that it believes to be adequate, but the actual allowance maintained may not be sufficient in every circumstance. The failure to pay an outstanding receivable by a significant customer or distributor could have a material adverse effect on the Company's business, operating results and financial condition. Product Returns. Although the Company has established allowances for product returns that it believes are adequate, there can be no assurance that actual returns will not exceed such allowances. The Company may also accept product returns in order to maintain its relationships with retailers and its access to distribution channels. As a result of the Company's termination of its exclusive distribution relationship with Infogrames, Inc. in April 1999, and its new non-exclusive distribution relationships with other distributors and its direct sales to retailers, the Company is now increasingly exposed to the risk of product returns from these retailers and distributors. Product returns that exceed the Company's allowances could have a material adverse effect on the Company's business, operating results and financial condition. The Consumer Entertainment Software Market is Highly Competitive and Changes Rapidly. The market for consumer entertainment software is highly competitive, particularly at the retail shelf level where a constantly increasing number of software titles are competing for the same amount of shelf space. Retailers have a limited amount of shelf space on which to display consumer entertainment software products. Therefore, there is intense competition among consumer entertainment software publishers for adequate levels of shelf space and promotional support from retailers. As the number of software titles continues to increase, the competition for shelf space continues to intensify, resulting in greater leverage for retailers and distributors in negotiating terms of sale, including price discounts and product return policies. The Company's products represent a relatively small percentage of any retailer's sales volume, and there can be no assurance that retailers will continue to purchase the Company's products or promote the Company's products with adequate levels of shelf space and promotional support. Most of the Company's competitors have substantially greater sales, marketing, development and financial resources. Moreover, the Company's present or future competitors may be able to develop products, which are comparable or superior to those offered by the Company, offer lower priced products or adapt more quickly than the Company to new technologies or evolving customer requirements. The Company's competitors may also have more money to spend on marketing promotions and advertising efforts. Competition is expected to intensify. In order to be successful in the future, the Company must respond to technological change, customer requirements and competitors' current products and innovations. There can be no assurance that the Company will be able to continue to compete effectively in its market or that future competition will not have a material adverse effect on its business operating results and financial condition. Need for Additional Funds. The Company's future capital requirements will depend on many factors, but particularly on cash flow from sales of the Company's products and access to the Company's recently established $2,000,000 revolving credit facility with a commercial bank that expires on October 31, 2001. If the Company is not able to maintain cash flow from operations at a level sufficient to support continued growth of its business, the Company may require additional funds to sustain and expand its product development, marketing and sales activities. Adequate funds for these purposes may not be available or may be available only on terms that would result in significant dilution or otherwise be unfavorable to existing stockholders. If the Company is unable to secure additional funding, or if the Company is unable to obtain adequate funds from operations or other external sources when required, the Company's inability to do so would have a material adverse effect on the long-term viability of the Company. Risk Factors (continued) Risks Related to Added Product Features and Increased Regulation of the Internet and Advertising. Due to the competitive environment in the consumer entertainment software industry, the Company has and will continue to seek to incorporate features into its products, such as an Internet browser interface and advertising technology, in order to differentiate its products to retailers, provide value-added features to consumers, and to potentially create new revenue streams based on advertising and promotional opportunities. There can be no assurance that such features will enhance the product's value, and in fact such features may detract from a product's value if they are not accepted in the marketplace or if new regulations governing the Internet and related technologies are enacted which impact these features. Difficulty in Protecting the Company's Intellectual Property Rights. The Company either owns or has obtained licenses to the rights to copyrights on the products, manuals, advertising and other materials owned by it. The Company also either owns trademark rights or is in the process of applying for such rights in the Company's name and logo, and the names of the products owned or licensed by the Company. The Company's success depends in part on its ability to protect its proprietary rights to the trademarks, trade names and content used in its principal products. The Company relies on a combination of copyrights, trademarks, trade secrets, confidentiality procedures and contractual provisions to protect its proprietary rights. There can be no assurance that the Company's existing or future copyrights, trademarks, trade secrets or other intellectual property rights will be of sufficient scope or strength to provide meaningful protection or commercial advantage to the Company. Also, in selling certain of its products, the Company relies on "shrink wrap" licenses that are not signed by licensees and, therefore, may be unenforceable under the laws of certain jurisdictions. In addition, the laws of some foreign countries do not protect the Company's proprietary rights, as do the laws of the United States. There can be no assurance that such factors would not have a material adverse effect on the Company's business or operating results. Substantial Expenses and Resources Can Be Used to Defend Infringement Claims; Effects of Settlements are Uncertain. The Company may from time to time be notified that it is infringing on the intellectual property rights of others. Combinations of content acquired through past or future acquisitions and content licensed from third party developers will create new products and technology that may give rise to claims of infringement. In February 2000, the Company was sued for trademark and copyright infringement by Hasbro Interactive, Inc. (the "Hasbro Action") (See Part II, Item 1, "Legal Proceedings"). Although this case has been settled, the Company incurred significant defense costs and utilized internal resources to defend this action prior to the settlement. Additionally, pursuant to the settlement of this case, the Company has agreed to discontinue selling certain of its software titles after September 30, 2000, which titles accounted for $2,100,000 and $2,000,000 in the Company's net sales for fiscal 2000 and 1999, respectively, or 15% and 20% of net sales for those same fiscal years. Although the Company is working with its retail and distribution customers to replace these titles with acceptable alternatives from the Company's existing and newly released product offerings, there can be no assurance that these replacement titles will generate similar sales for the Company. There can also be no assurance that other third parties will not initiate infringement actions against the Company in the future. Any future claims could result in substantial cost to and diversion of resources of the Company. If the Company is found to be infringing the rights of others, no assurance can be given that licenses would be obtainable on acceptable terms or at all, that significant damages for past infringement would not be assessed, or that further litigation relative to any such licenses or usage would not occur. The failure to obtain necessary licenses or other rights, or the commencement of litigation arising out of any such claims, could have a material adverse effect on the Company's operating results. Risks Associated With the Company's Distribution of Third-Party Software Titles. During the fourth quarter of fiscal 2000 and the first quarter if fiscal 2001, the Company launched its Store-in-a-Store program and other related programs in the food and drug retail channels. These programs have required the Company to purchase software titles from third-party software publishers in order to fulfill the orders placed for these retail programs. In some cases, beginning in the Company's fiscal second quarter, the agreements governing the purchase of these third-party software titles may provide that the third-party publisher will not accept returns of the software, unless such software is defective. Therefore, if the Company is required to accept returns of these software titles from food and drug retailers, the Company will have no recourse against such third-party software publishers. Although the Company believes that it has established adequate reserves for these returns and that the purchase price paid for these titles reflects their non-returnable nature, there can be no assurance that the Company will not experience losses as a result of these transactions in the event that retailers return more product than had been anticipated. Risk Factors (continued) Fluctuations in Quarterly Results; Uncertainty of Future Operating Results; Seasonality. The Company's quarterly operating results have varied significantly in the past and will likely vary significantly in the future depending on numerous factors, many of which are not under the Company's control. Future operating results will depend upon many factors including: the size and rate of growth of the consumer entertainment software market; the demand for the Company's products, particularly value-priced, casual PC games; the level of product and price competition; the level of product returns; the length of the Company's sales cycle; seasonality of customer buying patterns; the timing of new product introductions and product enhancements by the Company and its competitors; the timing of orders from major customers; delays in shipment of products; access to distribution channels; product defects and other quality problems; product life cycles; levels of international sales; changes in foreign currency exchange rates; and the ability of the Company to develop and market new products and control costs. Products are usually shipped as orders are received so the Company operates with little or no backlog. Therefore, net revenues in any quarter are dependent on orders booked and shipped during that quarter. The consumer entertainment software industry is somewhat seasonal due primarily to holiday shopping and back-to-school buying patterns. Accordingly, in descending order, the calendar fourth, first and third quarters are typically the strongest quarters for sales results, with the calendar second quarter typically the weakest. Therefore, net sales and operating results for any future quarter are not predictable with any significant degree of accuracy. Consequently, the Company believes that period-to-period comparisons of its operating results are not necessarily meaningful and should not be relied upon as indications of future performance. Uncertainty of Market Acceptance; Short Product Life Cycles. The market for consumer entertainment software has been characterized by shifts in consumer preferences and short product life cycles. Consumer preferences for entertainment software products are difficult to predict and few products achieve sustained market acceptance. There can be no assurance that new products introduced by the Company will achieve any significant degree of market acceptance, that such acceptance will be sustained for any significant period, or that product life cycles will be sufficient to permit the Company to recover development, marketing and other associated costs. In addition, if market acceptance is not achieved, the Company could be forced to accept substantial product returns to maintain its relationships with distributors and retailers and its access to distribution channels. Failure of new products to achieve or sustain market acceptance or product returns in excess of the Company's expectations would have a material adverse effect on the Company's business, operating results and financial condition. Rapid Technological Change; Product Development. Frequent new product introductions and enhancements, rapid technological developments, evolving industry standards and swift changes in customer requirements characterize the market for the Company's products. The Company's continued success depends upon its ability to continue to quickly and efficiently develop and introduce new products and enhance existing products to incorporate technological advances and responses to customer requirements. If any of the Company's competitors introduce products more quickly than the Company, or if they introduce better products, the Company's business could be adversely affected. There is also no assurance that the Company will be successful in developing and marketing new products or enhancements to its existing products on a timely basis or that any new or enhanced products will adequately address the changing needs of the marketplace. From time to time, the Company or its competitors may announce new products, capabilities or technologies that have the potential to replace or shorten the life cycles of the Company's existing products. There can be no assurance that announcements of currently planned or other new products by competitors will not cause customers to delay their purchasing decisions in anticipation of such products, which could have a material adverse effect on the Company's business, liquidity and operating results. Risk of Defects. Products offered by the Company can contain errors or defects. The PC hardware environment is characterized by a wide variety of non-standard peripherals, such as sound and graphics cards, and configurations that make pre-release testing for programming or compatibility errors difficult and time-consuming. Despite the extensive testing performed by the Company's quality assurance personnel, new products or releases may contain errors discovered after shipments have commenced, resulting in a loss of or delay in market acceptance, which could have a material adverse effect on the Company's business, operating results and financial condition. Risk Factors (continued) Dependence on Key Management and Technical Personnel. The Company's success depends to a significant degree upon the continued contributions of its key management, marketing, technical and operational personnel, including members of senior management. The loss of the services of one or more key employees could have a material adverse effect on the Company's operating results. The Company also believes its future success will depend in large part upon its ability to attract and retain additional highly skilled management, technical, marketing, product development and operational personnel. Competition for such personnel is intense, and there can be no assurance that the Company will be successful in attracting and retaining such personnel. International Sales. International net sales represented 17% and 16% of the Company's net sales for the quarters ended September 30, 2000 and 1999, respectively. The Company anticipates that international net sales will remain at or about 17% of the Company's net sales for the remainder of fiscal 2001. The Company's international business is subject to certain risks including: varying regulatory requirements; tariffs and trade barriers; political and economic instability; reduced protection for intellectual property rights in certain countries; difficulties in supporting foreign customers; difficulties in managing foreign distributors; potentially adverse tax consequences; the burden of complying with a wide variety of complex operations; customs, foreign laws, regulations and treaties; fluctuating currency valuations; and the possibility of difficulties in collecting accounts receivable. Stock Price Volatility. The Company believes that a variety of factors could cause the price of its common stock to fluctuate, perhaps substantially, over a short period of time including: quarter to quarter variations in operating results; announcements of developments related to its business; fluctuations in its order levels; general conditions in the technology sector or the worldwide economy; announcements of technological innovations, new products or product enhancements by the Company or its competitors; key management changes; and developments in the Company's relationships with its customers, distributors and suppliers. In addition, in recent years the stock market in general, and the market for shares of software, high technology stocks, micro-cap and small cap stocks in particular, has experienced extreme price fluctuations which have often been unrelated to the operating performance of affected companies. Such fluctuations could adversely affect the market price of the Company's common stock. Listing of Securities; Risk of Low Priced Stocks. The Company's common stock is listed on the Nasdaq SmallCap Market under the symbol EGAM. A listed company may be de-listed if it fails to maintain minimum levels of Stockholders' equity, bid price, shares publicly held, number of Stockholders or aggregate market value, or if it violates other aspects of its listing agreement. At September 30, 2000, the Company satisfied the minimum level of Stockholders' equity that is required to be listed ($2,000,000), as well as all other requirements of its listing agreement for inclusion on the Nasdaq SmallCap Market. On November 10, 2000, the Company received notification from Nasdaq that its common stock had failed to maintain a minimum bid price of $1.00 over a period of 30 consecutive trading days as required for continued listing on the Nasdaq SmallCap Market as set forth in Marketplace Rule 4310 (c) (4) (the "Rule"). In accordance with Marketplace Rule 4310 (c) (8) (B), the Company has 90 calendar days, or until February 8, 2001, to regain compliance with this Rule. The Company may appeal Nasdaq's determination pursuant to the procedures set forth in the Nasdaq Marketplace Rule 4800 Series. A hearing request will stay the de-listing of the Company's securities pending the Panel's decision. If the Company fails to regain compliance with this rule or any other criteria for trading on the Nasdaq SmallCap Market, its Common Stock may be de-listed. Public trading, if any, would thereafter be conducted in the over-the-counter market in the so-called "pink sheets," or on the NASD's "Electronic Bulletin Board." If the common stock were de-listed, it may be more difficult to dispose of, or even to obtain quotations as to the price of, the common stock and the price offered for the common stock may be substantially reduced. Risk Factors (continued) Potential for Further Trading Restrictions for Low-Priced Stock. If the Common Stock is de-listed from trading on the Nasdaq SmallCap Market, and the trading price of the Common Stock is less than $1.00 per share, or the Company has less than $2 million in net tangible assets, trading in the Common Stock would be subject to the requirements of Rule 15g-9 promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Under this rule, broker/dealers who recommend such securities to persons other than established customers and accredited investors (generally institutions with assets in excess of $5 million or individuals with a net worth in excess of $1 million or an annual income exceeding $200,000 or $300,000 jointly with their spouses) must make a special written suitability determination for the purchaser and receive the purchaser's written agreement to a transaction prior to sale. The requirements of Rule 15g-9, if applicable, may affect the ability of broker/dealers to sell the Company's securities and may also affect the ability of purchasers to sell their shares in the secondary market. The Securities Enforcement Remedies and Penny Stock Reform Act of 1990 (the "Penny Stock Rule") also requires additional disclosure in connection with any trades involving a stock defined as penny stock (any non-Nasdaq equity security that has a market price or exercise price of less than $5.00 per share and less than $2 million in net tangible assets, subject to certain exceptions). Unless exempt, the rules require the delivery, prior to any transaction involving a penny stock, of a disclosure schedule prepared by the SEC explaining important concepts involving the penny stock market, the nature of such market, terms used in such market, the broker/dealer's duties to the customer, a toll-free telephone number for inquiries about the broker/dealer's disciplinary history and the customer's rights and remedies in case of fraud or abuse in the sale. Disclosure must also be made about commissions payable to both the broker/dealer and the registered representative, and current quotations for the securities. Finally, monthly statements must be sent disclosing recent price information for the penny stock held in the account and information on the limited market in penny stocks. Part II. Other Information Item 1. Legal Proceedings In August, 2000, the Company settled the lawsuit filed by Hasbro Interactive, Inc., Atari Interactive, Inc., and Zao Elorg d/b/a Elorg Corporation (collectively, the "Plaintiffs") against the Company, Xtreme Games LLC, GT Interactive Software Corporation, MVP Software, Inc., Webfoot Technologies, Inc. and Varcon Systems, Inc. on February 9, 2000, in the United States District Court for the District of Massachusetts. The suit had alleged that certain of the Company's products infringed copyrights and trademarks owned by the Plaintiffs, and that the Company had engaged in unfair competition. The suit had sought to have the Company enjoined from manufacturing, marketing, distributing and selling the Company's allegedly infringing games and from using the allegedly infringing trademarks; to have the Company recall the allegedly infringing products and related materials from the distributors and retailers currently selling these products; to require the Company to pay the Plaintiffs the profits derived from the allegedly infringing products; and to pay Plaintiffs' legal fees and costs. The settlement agreement with the Plaintiffs caused the Company to incur a non-recurring expense of $205,000 charged against the Company's fiscal 2000 fourth quarter, ended June 30, 2000. This $205,000 charge consisted of a $160,000 cash payment to the plaintiffs, a $15,000 fee to a third party consultant and $30,000 in an increased provision for inventory obsolescence. In total, including outside legal costs, during the year ended June 30, 2000, the Company incurred $390,568 in costs relating to this litigation, including the $205,000 charge noted above. The settlement did not require the recall of any of the Company's products and also did not admit to any infringement by the Company of the titles named in the suit. Under the terms of the settlement, the Company was permitted to sell certain games alleged to infringe on Hasbro's copyrights through September 30, 2000, at which point these products were discontinued. The settlement involved the following Company titles: Intergalactic Exterminator, 3D Astro Blaster, Missile Launch, Missile Launch 2000, TetriMania, TetriMania Master, 3D TetriMania, 3D Maze Man, 3D Chomper, 3D Frogman, 3D Ms. Maze and Tunnel Blaster. The discontinued titles generated net sales of $2,100,000 and $2,000,000 for fiscal 2000 and 1999, respectively, or 15% and 20% of net sales during those same fiscal years. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits Exhibit No. Description of Exhibit ----------- ---------------------- 10.1 Description of eGames, Inc. 2001 Employee Incentive Compensation Plan 27.1 Financial Data Schedule (b) Reports on Form 8-K On July 27, 2000, the Company filed a report on Form 8-K regarding a press release announcing the Company's unaudited results for the fourth quarter and year ended June 30, 2000. On August 17, 2000, the Company filed a report on Form 8-K announcing that the Company had entered into an agreement with Summit Bank for a $2 million revolving credit facility that replaced an existing $1.5 million revolving credit facility with another commercial bank. On September 13, 2000, the Company filed a report on Form 8-K regarding a press release announcing the settlement of the trademark and copyright infringement suit filed by Hasbro Interactive, Inc., Atari Interactive, Inc. and ZAO Elorg d/b/a Elorg Corporation against the Company in the U.S. District Court in Boston, Massachusetts. On October 27, 2000, the Company filed a report on Form 8-K regarding a press release announcing the Company's unaudited results for the first quarter of fiscal 2001 ended September 30, 2000. SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. eGames, Inc. (Registrant) Date: November 14, 2000 /s/ Gerald W. Klein ----------------- -------------------- Gerald W. Klein, President, Chief Executive Officer and Director Date: November 14, 2000 /s/ Thomas W. Murphy ----------------- -------------------- Thomas W. Murphy, Chief Financial Officer and Chief Accounting Officer Exhibit Index Exhibit No. Description of Exhibit Page Number ----------- ---------------------- ----------- 10.1 Description of eGames, Inc. 2001 Employee Incentive Compensation Plan 22 27.1 Financial Data Schedule 23 EX-10.1 2 0002.txt 2001 INCENTIVE COMPENSATION PLAN Exhibit 10.1 DESCRIPTION OF EGAMES, INC. FISCAL 2001 EMPLOYEE INCENTIVE COMPENSATION PLAN On July 26, 2000, the Board of Directors of eGames, Inc. ("the Company") approved the adoption of a company-wide Employee Incentive Compensation Plan (the "Plan"). The amount of incentive compensation that each Company employee is eligible to earn under the Plan is contingent on the Company achieving certain net income objectives. Under the Plan, each employee is eligible to earn a specified percentage of the employee's total annual salary in incentive compensation. These percentages range from 10% of the annual salaries for administrative employees to 50% of the annual salaries for the Chief Executive Officer and Executive Vice President. No bonuses will be earned until the Company has earned net income of at least $750,000 (the "Minimum Threshold") during the 2001 fiscal year. Upon reaching the Minimum Threshold, plus the amount required to pay the bonuses earned if the Minimum Threshold were achieved, then 50% of the potential bonus to which each employee was eligible would be earned. If net income of $1,500,000 (the 100% Threshold") is earned during the 2001 fiscal year, plus the amount required to pay the bonuses earned when that net income level had been achieved, then 100% of the potential bonus to which each employee was eligible would be earned. If the Company earns net income during the 2001 fiscal year that exceeds the Minimum Threshold, plus the amount required to pay the bonuses earned, then each employee would earn a bonus equal to the percentage of the potential bonus to which they were eligible equal to the percentage of earnings as measured against the 100% Threshold. For example, if an employee earned $50,000 per year and was eligible to earn a bonus equal to 10% of his or her salary if the 100% Threshold were met, then that employee would be paid a $5,000 bonus if the 100% Threshold were met. On the date of adoption of the Plan, based on the number of employees of the Company and their respective bonus percentages, the Company would have been required to achieve pre-bonus earnings of approximately $1,100,000 during the 2001 fiscal year in order to earn the minimum bonus (50%). There is no maximum incentive compensation level. If the Company exceeds the 100% Threshold, then additional incentive compensation will be earned on a linear basis. Any bonuses earned under this Plan will be paid subsequent to the completion of the 2001 fiscal year's financial statement audit. EX-27 3 0003.txt ART. 5 FDS FOR 1ST QUARTER 10-QSB
5 1 3-MOS JUN-30-2001 SEP-30-2000 271,863 0 7,844,493 (3,249,847) 1,764,776 6,818,960 1,103,535 (798,568) 7,385,621 3,608,209 0 0 0 9,134,234 (5,474,593) 7,385,621 4,307,666 4,307,666 1,900,747 1,900,747 2,371,922 0 7,995 27,002 2,821 24,181 0 0 0 24,181 .00 .00
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